Hot Off the Web- June 3, 2013

Contents: Professionalism in finance a requirement for rebuilding trust, watch out for impact of rising rates on “can do no wrong” dividend/yield favoring strategies, options trading even more damaging than stock trading, U.S. home prices advance broadly, U.S. estate tax changes lighten burden on snowbirds, PBGC protects itself/pensioners against financial manipulation, pensions: “that which can’t work, won’t”, active “index” strategies? tax-managed “indexing”, private ‘digital cash” to be quashed.


Personal Finance and Investments

In CFA Institute Magazine’s “Rebuilding trust with professionalism” Nitin Mehta argues that financial reforms will be ineffective without addressing the “need to improve the values and conduct of practitioners”. Mehta suggests that what’s required is application of existing professional templates (doctors, accountants, etc) which “regulated their members’ behavior for the ultimate benefit of society”. He mentions as an example that the CFA Institute provides the framework and implementation of such a global professional template which is: self-regulating, has specified entry/certification requirements, defined continuing educational infrastructure, defined code of ethics and standards of practice,  and disciplinary procedures. What’s missing is universal application of stringent and consistent global standards of behavior by those who put themselves out there as financial professionals. Mehta notes that in the past couple of decades there has been a value shift that came with “too much emphasis on profits and not enough on professionalism”. Rebuilding trust requires not just regulations (including professional business practice models conducive to professional behavior), but regulator driven professionalism in the financial industry.

In the WSJ’s “Tokyo sends a warning” Jason Zweig warns investors that “REITs, utility stocks, high dividend companies and “low volatility” stocks” have outperformed until recently, however they became quite expensive and  should interest rates start (or be feared to start) to rise these will be hit hard. In fact, he writes, that during May they already didn’t keep up with the S&P500. (Same comments apply for Canada.) By the way in the WSJ’s “Swoon in bonds puts eye on Fed” Wessel and McGrane report that 10-year US Treasury note interest rates have increased almost half a percent to 2.1% since start of May and 30-year mortgage rates are also up half percent to almost 4%.

In the NYT’s “Growth in options trading helps brokers but not small investors” Nathaniel Popper reports that many brokers are making a big push to encourage customers to trade options, with some brokers now having derivative trades representing 40% of all trades in 2012 compared to <20% five years ago. According to the article, investors don’t understand how radically their portfolio risk profile can change when they engage in derivative trading and “academic research suggests that on the whole, options traders do worse than stock traders, who, in turn, have been shown in many studies to underperform buy-and-hold investors. The most comprehensive study looked at 68,000 Dutch retail investors. It found that from 2000 to 2006, retail options traders lost an average of 4.5 percent each month, while people who just traded stocks lost 1.6 percent. ”


Real Estate

According to the just released March 2013 S&P Case-Shiller index “Home prices in all 20 cities posted annual gains for the third month in a row. Twelve of the 20 saw prices rise at double-digit annual growth… Other housing market data reported in recent weeks confirm these strong trends: housing starts and permits, sales of new home and existing homes continue to trend higher. At the same time, the larger than usual share of multi-family housing, a large number of homes still in some stage of foreclosure and buying-to-rent by investors suggest that the housing recovery is not complete.” But in the WSJ’s “Home prices jump 10.9%, largest annual gain in 7 years” Nick Timiraos reports “But some economists and real-estate agents have warned that the current pace of gains isn’t sustainable and that some buyers could be priced out of the market, especially once interest rates rise.” Particularly instructive is a graph from the S&P Case-Shiller announcement which superimposes in the same chart the index level and the percent change in index level, showing how deceptive graphs can be and how important it is to pay attention to what one is looking at; according to this graph the price levels are still only back to 2003 levels. By the way Florida (Miami and Tampa) prices are up about the same levels as the national averages over the past year, but Las Vegas and Phoenix increased over 20% or about double the national average.


Another measure of the stabilization/bottom appears to have been hit in Florida real estate values is in the Palm Beach Post’s “Tax base grows in Palm Beach County, 34 of its 38 cities” in which Jennifer Sorentrue reports that PBC property appraiser Garry Nikolits indicates a preliminary view of  3.7% increase in the County’s tax base, higher than the 3% previously predicted; a further 0.5% upward adjustment is possible before numbers are cast in concrete. The data is based on January 1, 2013 values and it’s the second year in row when the tax base grew.


In the very short Globe and Mail video “What snowbirds need to know about U.S. estate taxes” Rob Carrick interviews Terry Ritchie on what the latest U.S.  estate tax changes mean to Canadian snowbirds who own property in the U.S. Ritchie indicates that although those who own property with value in excess of $60,000 must file an estate tax return but, with individual exemptions now set at $5.25M, no taxes are payable for couples with worldwide assets under $10.5M.


Pensions and Retirement Income

In Pensions&Investments’ “PBGC bares fangs in deals that could end in DB plan terminations” Hazel Bradford reports how  the U.S. government run pension Benefit Guaranty Corporation which insures private sector DB plans (in effect protecting plan beneficiaries’ pensions up to close to $60,000 in case of bankruptcy), has an another benefit. In the process of protecting itself from investment grade companies selling themselves or subsidiaries with significantly underfunded pension plans to sub-investment grade entities like private equity groups or leveraged buyouts, and end up becoming transactions which often result in bankruptcies. “Using powers granted by ERISA, the early warning program allows agency officials to zero in on sizable business transactions that could pose problems to the pension plans — and eventually to the PBGC —based on either the company’s financial troubles or its underfunded pension plans.” (In Canada not only pensioners get no pension protection (except a minimal one in Ontario), but when there is a lack of an effective pension insurer and/or regulator can give a free pass to financial manipulation intended to rid a company of its underfunded pension plan.)

In the latest issues of the Rotman ICPM Keith Ambachtsheer’s introduction to the Defining “Defined Ambition” Pension Plans writes that “Defending traditional DB plans at all cost is increasingly seen as fighting a rearguard action in a lost cause. New “defined ambition” narratives are emerging around a dual question: What do sustainable 21st Century pension arrangements look like… and how do we get from here to there?” (It’s difficult to argue with changes being required since as the old saying goes: “that which can’t work, won’t”. I haven’t had a chance to read the issue as yet, but it looks like it contains a number of interesting topics related to the current pension crisis and potential going forward approaches.)


Things to Ponder

As pressure mounts on mutual funds by the shift into cheaper ETFs, there will be growing number of actively managed ETFs sold under some “smart indexing label”. For example in IndexUniverse’s “A heat seeking emerging markets ETF that laps its rivals” discusses an emerging market ETF (PIE) which advanced almost 15% in 2013 while the dominant capitalization weighted EM tracking indices (VWO, EEM) were flat/down. This outperformance was achieved by an “index” strategy which selects each quarter the 100 best performing stocks relative to the approximately 2000 constituents of the capitalization weighted emerging market index. The article observes that this strategy  ended up currently significantly overweighting Indonesia, Thailand, Mexico and Turkey at the expense of much larger BRIC countries, and that the strategy “isn’t beholden to any country or region or sector—it simply follows the heat”. (Most would call this just another active (momentum-like) trading strategy which works until it doesn’t because something changes in the environment; as the small print in investment products notes, the past is not necessarily predictive of the future. Of course all that trading also comes with higher management fees, transaction costs and taxes, but for now PIE is on fire.)

In InvestmentNews’ “Tax managed indexing can offer boost”  Rey Santodomingo discusses some increased pressure on U.S. investors given some recent tax increases. In this context he argues that advisers must look for ways at reducing the “tax drag” of 1-3% on asset growth. He specifically looks at “tax managed indexing” in addition to the usual tax reduction/deferral approaches: tax-deferred and non-taxable retirement accounts, muni bonds, tax-loss harvesting, index strategies which minimize turnover and ETF based index strategies which reduce taxes by allowing in-kind redemptions. Tax-managed indexing mimics an index in separately managed accounts which “can pass capital losses through to the individual investor to offset capital gains elsewhere in the investor’s portfolio. The goals of the approach is that while tracking an index, produce “excess realized losses” and thus produce a net additional tax benefit; this is done by explicitly realizing loss opportunities and buying other securities in the same sector to maintain index tracking. (You can read about tax-loss selling for example at Bogleheads’  “Tax-loss harvesting” which shows the advantages of the approach particularly in the U.S. where you get the additional benefits of using losses of up to $3,000 against income and any unrealized capital gains held at death can be passed on to heirs. But of course the future is very unpredictable and tax laws/rates can change as well. As to “tax managed indexing” approaches is just one of the many very complex strategies that may or may not work after factoring in all costs including advice.)

And finally, (remember Bitcoin mentioned in this blog the past few weeks?) in the WSJ’s “U.S. alleges $6Billion laundering operation” Albergotti and Sparshott report that the U.S. has “filed criminal charges against seven men who allegedly set up an Internet-based currency and used it to launder $6 billion in criminal proceeds, a sign of growing concern among law enforcement about digital cash (not Bitcoin).” The article also notes that, these criminal charges were filed just a couple of weeks after U.S. has frozen the account of a major Bitcoin exchange. (So the war by central banks against digital cash is under way. Such digital currencies as mentioned last week, are a threat once they are more widely accepted because: they undermine governments’ claim as exclusive issuers of legal tender and, since users are anonymous, such digital cash could be useful for money laundering and tax evasion preventing authorities from “following the money”. Looks like private digital cash will be quashed sooner, rather than later.)


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