Hot Off the Web- April 8, 2013

Contents: Investing rules, active managers underperform benchmarks again, no IPSs from ‘advisers’, sound investment first then tax efficiency, testamentary trusts scrutinized, age not only determinant of asset allocation, funds massaging numbers, accept low interest rates until reversion to mean, US home prices up, Canadian home sales drop, International Driving Permits in Florida-NOT, save more with auto-enrolment and auto-escalation, is E & Y pulling all the strings in Nortel bankruptcy? DC plans not that risk and a lot better than CPP!?! ecstasy and agony of Canadian pensions, could Cyprus confiscation happen in UK and Canada? capital controls in eurozone? Bogle and Rogers: major market declines coming, bear market in gold? China’s filial piety laws, groupthink the biggest threat in finance.

Personal Finance and Investments

In Market Watch’s “3 investing rules to rescue your retirement” Jonathan Burton reports on a telephone interview with Malkiel and Ellis (about their new book The Elements of Investing) who indicate that “to maximize yield, safety and capital gains during what they expect will be a lengthy period of below-average total returns from stocks” you must remember: that cost matter, to rebalance regularly and that indexing beats the “loser’s game”.

In Index Universe’s “SPIVA: Active bond managers shine in 2012” Cinthia Murphy reports that in 2012 over 50% of active managers in all categories underperformed the indices except the short and intermediate active government bond fund managers over one year. But ability to beat index deteriorated in all fund categories as observation period increased. The short government bond fund category remains the only one where over 50% of active managers beat indices over 3 years, and over the 5 years there is no fund category where >50% active managers outperform the index.

In Investment News’ “Advisers making statement by shunning formal investment statements” Jeff Benjamin writes that “With the industry shift toward advisory-based relationships, it is surprising that so many advisers remain uncommitted to the best practice of utilizing investment policy statements (IPS) with all clients… 61% of those surveyed are not doing it for all clients and many are not doing it for any of their clients…” (Not clear what type of ‘advisers’ were surveyed what percent were RIAs who are fee-only compensated and are required to  meet a fiduciary level of care in the US, but one can assume that the vast majority (if not all) of those surveyed were not RIAs. One might even be encouraged by the numbers which suggest that about 40% actually provide an “investment statement”, if it only were a real IPS. But then of course an IPS is not free and few customers are willing to pay for it explicitly and equally few ‘advisers’ are willing to provide it “free” except to those with significant assets.)

In the Financial Post’s  “Make tax efficiency part of your investment strategy” David Kaufman writes that “While all investors should think in terms of risk-adjusted returns, tax-paying investors should also think of their after-tax risk-adjusted returns.” He also discusses two mechanisms that some investors used to convert income into capital gains: a tax wrapper which uses total return swaps and corporate-class structures which allow deferral of taxes indefinitely. He points out the recent changes announced in the Canadian budget essentially end the former, whereas the latter is of questionable value given the corrosive effect of the cost of funds used in the corporate-class structures. In conclusion he warns that “Sound investments strategies come first; tax efficiency comes second.”

In the Financial Post’s “Testamentary trusts under scrutiny over tax benefits” Jamie Golombek writes that “The budget also indicated that the government was concerned with the growth in what it called the “tax-motivated use of testamentary trusts and the associated impact on the tax base.” As a result, the government is planning to issue a consultation paper to the public on whether the tax benefits that arise from taxing income inside testamentary trusts at graduated rates should be eliminated.”

In the Financial Post’s “Asset allocation rules for any age- even 82” Jason Heath discusses how asset allocation might change with age. The old asset allocation rule(s) of thumb that percent of stock allocation should be (100-age) might with increased longevity even change to (110-age) or (120-age). But it might even change further in case when there is a high probability that you’ll be passing much of the assets on to the next generation, in which case you might be using their age in the rule of thumb, which would lead to a much higher allocation to stocks. He concludes with “Investment strategies, financial planning and rules of thumb are fluid and personalized. Take everything I or anyone else says with a grain salt. After all, it’s your money.” (Of course, he is right that ultimately asset allocation is derived from your individual risk tolerance, in which age is just one of the many factors to consider.)

In WSJ’s “How funds massage the numbers, legally” Carolyn Geer discusses ways in which funds massage their returns with “tricks of the calendar” by appropriately selecting over what interval performance numbers are to be reported or omitted, or by crafting forward going portfolios based on only including previously outperforming sub-managers, or by using back-tested returns to demonstrate “the returns they would have earned in years past if they had been investing the way they do today” which are “made-up” returns not “actually earned in real time”.

In Index Universe’s interview “Bernstein: Make peace with T-Bills” Bill Bernstein says “Get over the low expected returns of fixed-income instruments, because you don’t have a choice.” Don’t stretch for yield with emerging market credits, long maturity bonds, high dividend stocks unless you are prepared to take significant capital losses at some unknown future time. Stay short with fixed income assets and wait for the inevitable reversion to the mean. Use the equity portion of your portfolio to get your appropriate risk exposure.

Real Estate

The January 2013 S&P Case-Shiller Home Price Indices indicate that US “average home prices increased 7.3% for the 10-City Composite and 8.1% for the 20-City Composite in the 12 months ending in January 2013…” while the prices increased during the month of January by 0.2% and 0.1%. The report includes city by city MoM and YoY price changes for the metropolitan areas in the indices. The report comments that “Economic data continues to support the housing recovery. Single-family home building permits and housing starts posted double-digit year-over-year increases in February 2013. Despite a slight uptick in foreclosure filings, numbers are still down 25% year-over-year. Steady employment and low borrowing rates pushed inventories down to their lowest post-recession levels.”

However in Canada the Financial Post reports that “Toronto, Vancouver home sales fall sharply in March” with March sales being off in Toronto and Vancouver 17% and 18%, respectively over same month in 2012. “The sales last month were the second lowest March total in Greater Vancouver since 2001 and 30.2% below the 10-year sales average for the month…”

Situation resolved: Canadians driving in/to Florida will be happy to hear that according to a report from the Canadian Snowbird Association “Florida’s legislation requiring foreign drivers to possess an International Driving Permit to legally operate a motor vehicle has been officially repealed… The repeal is retroactive to January 1, 2013.” (This will come as a great relief to those who for a few weeks since mid-February, when the existence of this new Florida requirement became widely known, were significantly apprehensive whether they might be charged for driving without a license or perhaps their Canadian insurance might be invalid.)

Pensions and Retirement Income

In the WSJ’s “How to save more for retirement without really trying” Jason Zweig discusses mechanisms increasing retirement savings by means of harnessing “the most powerful force in the financial universe: inertia. The only thing people hate more than making decisions is changing them….So when people want to save but can’t bring themselves to do it, their retirement funds need to do the saving for them—automatically” with defaults of auto-enrolment, auto-escalation coincident with salary increases. Auto-escalation is the necessary additional step to drive retirement savings up from the very low levels set using auto-enrolment (often as low as 3%).

In the Financial Post’s “Ernst & Young’s multiple Nortel roles shrouded in mystery” Barry Critchley describes the multiple roles that E&Y plays in the Nortel bankruptcy. Not only it is the “monitor” for the Canadian bankruptcy court in this case but it is also the administrator for Nortel UK, the ”Indirect Tax Service Advisor in the U.S. the Unsecured Creditor Committee and the Ad Hoc Bondholder Group control in the U.S. estate…. And those multiple roles mean that its decisions and actions can affect one class of creditor at the expense of another, given that there are more creditor demands than available cash to pay them all.” (If I recall correctly, E & Y was also Nortel’s advisor in preparation to the declaration of bankruptcy protection. So why are Nortel’s Canadian pensioners surprised that they are getting nothing but scraps in every court decision and that bondholders are dug in to milk the Nortel estate even for post-bankruptcy interest?)

In Benefit Canada’s “Are DC plans too risky?” Fred Vittese makes the case with historical data showing that DC pension plans are not nearly as risky to employees as commonly believed. His example is based on 8% contribution rate over 30 years with a target of 30% of final average pay starting with data from 1938; on retirement assets are annuitized in an indexed annuity with 10 year guarantee. The outcomes of the simulation ranged between 15% and 55%, but if employee chose execute some evasive action when outcomes were poor (like work extra two years and take only a 50% indexed annuity), the range narrowed to 24%-55% and “the pension was 30% or more in 43 out of the 46 30-year periods and never fell below 24%.” Then he goes in for the kill that “a pension of 30% of final average pay seems to be a reasonable target relative to an 8% contribution rate…(especially when compared to) the Canada Pension Plan (which) has a target pension of 25% with a 9.9% contribution rate and the death benefit is less generous”! (That expanded-CPP sounds much less attractive in this context. Eh???)

In’s “The ecstasy and the agony of Canadian pensions” David Agnew has a great article summarizing the good, bad and ugly of Canada’s private sector pension system. He concludes with the question of when will Canada correct the injustice in its private sector pension system? He offers a series of solutions: stopping windup of pension plans into annuities, establish a proper pension insurance program in Canada, make multiemployer pension plans the norm, raise priority of pension plans in case of employer bankruptcy and provide some form of expanded-CPP. Furthermore he points out that most of these solutions are already implemented in most of developed countries in the world and have been recommended by various federal and provincial government initiated pension reform commissions.

Things to Ponder

In the Financial Times’ “Cyprus confiscation could happen in the UK” Neil Collins opines that it could since the UK’s debt level has passed that what can be managed by conventional means “as the deadweight cost of servicing it stifles the growth needed to pay it down”. In that case what’s left is “inflation, taxation or confiscation”. He argues that the first seem harder to achieve than previously thought, taxation is already close to the limit of what is possible. This leaves confiscation as the only credible choice. (Governments could use printing presses when available to them to deal with local currency debts. The UK has this option, which ultimately leads to currency depreciation and/or inflation.) And John Greenwood in the Financial Post’s “Ottawa’s bank ‘bail-in’ talk could be bad for debt holders” writes that last week’s Canadian budget also mentions “plan to establish a roadmap for what happens when a bank gets into trouble, proposing a “bail-in” approach… “This regime will be designed to ensure that in the unlikely event a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital,” the budget said. ”And bank deposits are liabilities and some fear that this might imply a Cyprus like approach to confiscate some percentage of deposits. Finance Minister Jim Flaherty’s office issued a statement that “the bail-in scenario described in the budget has nothing to do with depositors’ accounts and they will in no way be used here.”

And by the way, in the Financial Times’  “Cyprus capital controls threaten eurozone” John Plender discusses some of the implications accompanying the “solution” to the Cyprus crisis including capital controls that “would last only a matter of weeks”. He argues that by this will likely last longer than a few weeks (similarly to Iceland’s controls still in place today having been established in 2008) and with this measure the euro in Cyprus has been effectively devalued. This will leave questions whether similar “solutions” will be applied elsewhere in troubled eurozone countries. He discusses how exchange controls are usually a precursor of totalitarian regimes which not only restrict the movement of money but people as well.

In both “Jack Bogle warns ‘Prepare for two massive market declines in the next decade’” and  “Jim Rogers: Major crash ahead for US investors” Bogle and Rogers are predicting significant market declines in the next few years as a consequence of the escalating debt. The Rogers article suggests that debt expansion and money supply approaches are analogous to pyramid schemes. The Bogle article is less apocalyptic but still sees a couple of significant market swoons, but he suggests that “The market goes up, and the market goes down. It’s never failed to recover from one of those 50 percent declines.”

One might think that given all the talk of currency controls, out of control debt and monetary policy and governments will almost always choose inflation if the available options are is to inflate, stagnate or default, that gold would be considered a safe-haven of sorts that would continue to appreciate in value. However Bloomberg News “Gold ‘bubble’ will turn into bear market- SocGen” quotes one analyst that “Gold is in a “bubble” after the best annual run in at least nine decades and will head into a so-called bear market as a stronger U.S. economy helps increase interest rates and cut bullion demand… Investors are unlikely to raise gold holdings because inflation has remained low…” (The old saying still holds that “forecasting is difficult especially about the future” so I won’t even attempt it.)

In MarketWatch’s “In China, honor thy parents or get sued” Matthew Heimer reports that the over 60 population in China is expected to triple over 40 years and become about 30% of the population. The government has introduced new “filial-piety” laws which “prohibit “’discrimination, insult, ill-treatment and abandonment’ of the aged.” They also require employers to approve leave for children to visit their parents, and even allow parents to sue kids who don’t visit often enough.”

And finally, in the Financial Times’ “How bankers believed their own hype” Gillian Tett discusses new research based on bankers who were deeply involved in subprime lending that they “not only lived by the mortgage sword, but suffered under it too” and that “…it is groupthink and wishful thinking – not deliberate malevolence – that poses the biggest risk in finance…” (i.e. with the market continuing to improve and more people jumping in for the ride, don’t lose sight of your strategic asset allocation which is determined by your risk tolerance, especially if you are about to retire or already a retiree.)


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