Contents: Best online broker, value of CFP to brokerage, embedded mutual fund commissions-NOT, good guys-bad guys, hedge funds not worth it, 100% stock? Vanguard international bond ETFs, 3^rd party custodians? pullback on buy-to-rent houses? No retirement crisis in Canada? Canadian pension sponsors worry about fiduciary accountability, “actuarial lunacy” liability discount rates, men/women invest differently, higher interest rate threat to bonds, low-volatility overrated? household debt, virtual currencies under attack, repeated crises for trading based financial system inevitable? inequality exacerbated by QE.

Personal Finance and Investments

In the Globe and Mail’s “For the DIY investor, which online broker is the best” Gail Bebee concludes that BMO Investorline is the best choice. Among the reasons she mentions to consider are: portfolio performance metrics, ability to hold USD in RRSP account, access to all types of securities, research, support, competitive fees, ease of use. One of the BMO criticisms she offers is lack of transparent bond pricing. (While I haven’t evaluated the other available online offerings at this time, I can attest that I am a satisfied BMO Investorline for more than a decade and I do agree that bond pricing transparency is inadequate.)

In Reuters’ “Brokerage firms debate value of Certified Financial Planner title” Jed Horowitz discusses disagreement among Wall Street brokerages on the value of a CFP designation on the broker’s business card to the brokerage business. This also means that some of these brokers might start offering financial plans for an extra fee (price range mentioned is $4,500-50,000), and they have to resolve the potential conflict between the CFP promise to “put client interest ahead of their own” (fiduciary) and brokers’ lower “suitability” requirement which may allow them to sell a more expensive/profitable product. Firms are mentioned which started requiring that their brokers/agents/salesperson give up their CFP designation since the firm is only selling proprietary products. (This struggle will continue to grow as customers and regulators are increasingly going to demand fiduciary standard of care.)

As usual in Canada the financial protection discussions are about topics usually settled years before in the U.S. and/or U.K. In the Financial Post’s “Ban commissions on mutual funds, decreases access” Greg Pollock President of Advocis, the Financial Advisors Association of Canada is trying to defend the embedded compensation system of mutual funds in Canada by arguing that eliminating it would leave many Canadians without financial advice. (Some might say that these are just self-serving concerns.) On the positive side he also writes that that “If consumer protection is the real issue for regulators, why not start with increasing advisor professionalism? Consumers would benefit tremendously from a requirement that their advisor meet ongoing proficiency standards, satisfy continuing education requirements, and adhere to a code of professional and ethical conduct that ensures the client’s interest is always put first.” ( I might add that I suspect if this latter recommendation of the Advocis President was implemented with a real fiduciary standard of care, which in turn would naturally lead to the demise of most of the Canadian mutual funds, it would also lead to the provision of real financial advice (i.e. a financial plan, for a fee), and by the way it would also lead to the demise of the mutual fund industry as we know it in Canada. (Thanks to Ken Kivenko for recommending.)

In the Globe and Mail’s “Investor advocate Daniel Solin names the good guys and bad guys” Rob Carrick discusses Daniel Solin’s list of Canadian bad guys (banks, mutual funds,…) and friends (index portfolios, discount brokers, Vanguard….).

In The WSJ’s “The verdict is in: Hedge funds aren’t worth the money” Mark Hulbert looks at the increasing availability of hedge funds, previously restricted to high net worth investors, in the form of mutual funds (e.g. absolute return funds). Hulbert (as other before him) indicates that while the “allure” to “do well in all kinds of markets” sounds great, the reality of 2-and-20 fees, and even higher in case of funds-of-funds, turns out to be less appealing; though hedge funds did provide some downside protection in the 2008 market crash (but then one could have obtained the same with a balanced portfolio). So conclusion is to invest in low cost index funds and allocate the appropriate portion of your portfolio to less risky fixed income securities.

In the WSJ article “The 100% stock solution” coincidentally Liam Pleven discusses having a portfolio dedicated to 100%, that while it may work for some younger accumulating investors a long way from retirement, it is not appropriate for most especially as they approach retirement. A “2010 survey showed that just 6% of families have all their investments in stocks”.  This article offers some (risk tolerance) questions one must explore before committing 100% to stocks, such as: other bond-like assets to be able to deal with the volatility (e.g. secure government job), horizon (when do you need the money), emotional impact (will you panic into selling if market drops) and real impact of worst case scenario (markets crash and won’t recover by when you need the money or even ever, could you adjust to the new reality)?

In Index Universe’s “Vanguard international bond ETFs go live Tuesday” Olly Ludwig reports that Vanguard’s new hedged Total International (ex-US) Bond ETF (BNDX) and hedged Emerging Markets Government Bond Index ETF (VWOB), costing 0.20% and 0.35% respectively, became available this week. You can read more about them at Vanguard website.

In the Financial Post’s  “Go for safety of third-party custodian” Martin Pelletier discusses the importance and safety of independent third-party custodial services for your brokerage account. But he also notes that “the brokerage firms associated with the various Canadian banks provide their own ‘self-custody’ that is completely separate from their bank’s ‘third-party custody service’ division…Therefore, we recommend wealthy investors ask to use the bank’s specialized third-party custodian services rather than accepting the implied self-custody route.” (or perhaps even independent 3^rd party service?) Pelletier suggests that the additional 10-25 bp cost of independent 3^rd party custodian is cost-effective way of buying the additional protection against well publicized “mishaps” like those at MF Global, Lehman Bros. And Madoff, that could have been prevented with 3^rd party custodians (The article doesn’t discuss that some protection is available from the industry provided CIPF perhaps because a quick read of the restrictions and the discretion that the board may use in determining who is eligible and to how much, how accounts are combined and how there is an overall $1M max cover; therefore many might readily resonate with Pelletier’s recommendation that 3^rd party custodians are advisable for wealthier investors, and certainly explore whether at least might make sense to limit exposure at any broker to no more than $1M total.)

Real Estate

In Bloomberg’s “Carrington stops buying U.S. rentals as Blackstone adding” John Gittelsohn reports that some investors are starting to pull back from buying and some early investors are even selling U.S. single family houses intended for rental, because “with house prices climbing at the fastest pace in seven years and investors swamping the rental market…it no longer makes sense to be a buyer.” With dropping home ownership rate the demand for rentals is increasing but “yields are declining”.

Pensions and Retirement Income

In one of the articles in the Rotman ICPM  (which I referred to last week) Fred Vettese explains “Why Canada has no retirement crisis”, if I read it correctly all we have to do are some ‘minor’ changes/assumptions such as: we should plan on spending all our assets (i.e. down to zero including homes), set acceptability standard by consumption (not income) replacement ratio of 75% being adequate, we anyways spend less as we age (cause or effect?) and therefore we can work with fixed un-indexed immediate annuities, and we should work 3-5 years longer than currently before retiring. Not everyone might agree that these are acceptable assumptions (e.g. it would take some work to convince me). For example, if you worry about at the working longer assumption you might want to read the Bloomberg’s “Retirement roadblock: The dangers of magical thinking” in which Carla Fried calls average retirement age of 68 “magical thinking”. She tables some statistics which show what small percentage of people actually work past 65 she argues that “Given the low percentage of retirees who managed to pull off what you’re probably banking on, making working longer the centerpiece of a retirement plan seems a dicey proposition. That’s especially true if your plan to work longer means saving less today.”

In BenefitCanada’s “Smart idea: Creating a funding policy” Brooke Smith discusses the advisability for private sector employer/sponsor of DB plans to create formal funding policy statements  because “The legislation in Ontario is not clear if funding is actually a fiduciary duty, said Kathryn Bush, a partner with Blake, Cassels & Graydon LLP, speaking at the firm’s breakfast seminar earlier this week in Toronto. “Under Ontario pension legislation, it may well be a plan sponsor choice, but there isn’t a court case that says that yet.”… (because she is) starting to see allegations made based on breach of fiduciary duty only”. (Great opportunity for lawyers, but this just reinforces systemic problems with Canada’s private sector pensions, if that requires reinforcement after the pension fiasco associated with the Nortel bankruptcy.)

In the Economist’s “Another discount rate illusion” Buttonwood discusses how “US public plans discount their liabilities by the expected return on their assets. They then invest in risky assets, assume a higher return, and thus reduce the expected value of their liabilities… pension plans seek to exploit a risk premium (on equities, for example) and then assume the premium is guaranteed. If it was guaranteed, it wouldn’t be risky. (This is a very interesting article on discounting pension liabilities by the expected return of pension investments which, in my earlier blogs I referred to as “actuarial lunacy” leading to underfunded pension plans and, upon employer bankruptcy, to (Canadian) pensioners being stuck with massive pension reductions. This is probably (J) related to the previous story about (potentially optional?) fiduciary responsibility of private sector pension plan sponsor.)

Things to Ponder

The Economist’s “Men: They just don’t listen” is a very interesting discussion of the differences between men and women’s investing habits. In it Buttonwood also explains why insider buying may be a sign of confidence, but insider selling is not necessarily an indicator of lack of confidence.

In InvestmentNews’ “Bond investors get a glimpse of what’s coming- and it ain’t pretty” Jason Kephart is discussing the challenges associated with the threat of rising interest rates, given that “there’s is a lot more room for rates to go up than down”. The article discusses ways in which investors are trying to protect the bond portion of their portfolio: reduced duration, more geographic diversification, bond funds which are also permitted a slice of other assets (e.g. dividend stocks and/or bank loans, etc). However many of these continue to be sensitive to rising rates. The bottom line is that paper losses “will be inevitable” but “holding on to them for the long term, it won’t result in an actual loss”. (Not mentioned are target-date bond funds which in effect are designed to mature on specified date. E.g. “iShares adds 4 target-maturity ETFs to plans” which the article notes will be priced at 0.1% which is significantly lower than the 0.24% charged by Guggenheim for similar funds. )

For those who heard about the opportunities that might be available in “low-volatility” stocks, here is a warning to consider. In IndexUniverse’s “When low volatility bites back” Elizabeth Kashner writes that recently “low-volatility funds have fallen out of bed with a thud” at least partly due to over-weighting in certain sectors/styles. Some other reasons mentioned why ‘low-volatility’ strategy may not be advisable strategy for all seasons, are: low statistical significance of the phenomenon, underperformance in bull markets, any supposed advantages wiped out by its popularity. However the real reward of low-volatility approach might be when volatility is high, which it is not right now.

For the data junkies, in the Economist’s “Household debt” you can find some interesting “households’ gross debt as % of disposable income” pre-2000, pre-crisis level 2007 and in 2012 stats. Canada’s 150% is #2 but pales compared to the 280% for Netherlands in 2012; he US is near 110%. (I can’t think offhand of list of policies/reasons and potential impacts for the huge variability between these OECD countries.)

In the WSJ’s “’Virtual’ currencies draw state scrutiny” Sidel and Johnson discuss the growing scrutiny/crackdown on Bitcoin-like virtual currencies, e.g. Costa Rica based Liberty Reserve’s,  in an effort to prevent large-scale money laundering to hide profits from illegal business activities. The Financial Times’ “Cyber crime: Without a trace” has very interesting specific details pertaining to the Liberty Reserve case including an IRS investigator being quoted as saying that given the anonymity and untraceability of financial activities in the virtual currency world “If Al Capone were alive today, this is how he would be hiding his money…”

In the Financial Times’ “Financial system ‘waiting for next crisis’” David Oakley discusses John Kay’s warning that “…the world is heading for another financial crisis because the economic system is geared around trading profits that create market bubbles that inevitably burst.” He argues that the financial “system is geared around (often momentum based) trading profits” which are essentially borrowed money to be repaid in the future at which point a crisis ensues.

The Financial Times’ “A small footnote on challenging orthodoxy” also discusses the brouhaha surrounding the error found in the work of Rogoff and Reinhart which some suggest invalidates their conclusion that when government debt reaches 90% of GDP growth rate of economic activity drops. In this article the author suggests that the conclusion that very high debt levels result in lower economic growth is valid, irrespective if the trigger is 90% or not. The article then continues with a discussion of the competition between investors and fund managers for as large a share as possible of the available cash flows from the funds (and by the way, this occurs even if there are no real cash flows from the funds). This conflict was aggravated when in 1958 managers were allowed “to sell (and capitalize) their mandate to manage the funds in their care. One fund manager mentioned, created a structure preventing him from selling his majority interest as a means of addressing this issue (but I suspect this would only be a partial answer, and a mutual construct (like Vanguard) is ultimately more effective.)

And finally, in the Economist’s “The rich and QE” Buttonwood’s notebook discusses the “irony that monetary policy may be having the unintended consequence of exacerbating growing inequality”. One measure of this is that the richest 10% of households’ share of stocks and mutual funds has increased from 84.5% (2001) to 91.4% today; “the richest 1% own almost half…”