Contents: testamentary trusts to go, rebalancing, trailer fees must go, alternative mutual funds, Madoff: index funds the best, financial abuse, reverse-mortgage abuse, third party custodians, Canada housing up a little- but has it peaked? U.S. housing strength sustainable? Florida: state with highest foreclosures, still no pension reform in Canada, $1M illusion, higher UK rates reduce liabilities, longevity pension/insurance, America lost its way? disappearing financial repression? implications of end of western affluence, fast walkers are survivors.
Personal Finance and Investments
In the Financial Post’s “Graduated tax system for testamentary trusts likely on the way out” Jamie Golombek explains the Canadian government’s proposed elimination of the current tax advantages testamentary trusts by 2016. Testamentary trusts can be specified as part of one’s will whereby executor/beneficiary could choose to activate a trust for the ongoing management of the inherited assets. Currently the trust is considered as a separate entity/person so it gets the advantages of the lower graduated tax rate on the investment returns flowing to beneficiaries.
In WSJ’s “Keeping your investments in balance” Carolyn Geer writes that rebalancing is usually promoted as a risk reduction mechanism, but for the past 10 years it also delivered enhanced returns. Rebalancing to a target (strategic) asset allocation is the act of selling asset classes which have appreciated and buying instead those which have done relatively less well. Risk tolerance determines asset allocation and if stocks had a good run, the stock allocation might have increased, resulting in higher risk level than may be appropriate to the individual, or vice versa. So the selling of the stocks to buy fixed income assets not only reduces risk, but also forces investor to sell appreciated assets and buy assets which have relatively underperformed. During volatile markets of the last decade, rebalancing delivered superior returns (though that’s not necessarily true in all market conditions and/or over all time intervals). One rebalancing strategy mentioned is doing an assessment every 6-12 months and rebalance if asset allocation drifted more than 5% away from target.
In the Globe and Mail’s “Mutual fund trailer fee ban should come soon, expert says” Jacqueline Nelson writes that the chairman of Ontario securities Commission argues that it is time to do away with trailer-fees for Canadian mutual funds, but the industry is resisting with (self serving) arguments. (This foot-dragging is getting a little long in the tooth. Investors should just walk away from Canadian mutual funds and shift to ETFs with or without the help of ‘advisers’, depending on how they perceive their needs. Do-it-yourself-ers should just dump mutual funds (I don’t own any), in favor of ETFs, in a manner consistent with reaping unrealized capital gains still embedded in their holdings in acceptable ways. Certainly, any new funds invested should be done based on a sound financial plan, using low cost vehicles like ETFs. Those needing advice should consider fee-only advisers who commit to fiduciary level of care.)
Also on embedded commission, is CanadianFundWatch.com’s “Eliminate embedded commissions…and professionalize advice”, which Ken Kivenko calls “one of the worst inventions ever created for the “benefit” of Canadian investors”. In his scathing, and must read article for every investor who still owns Canadian mutual funds, he explains how embedded commissions exploit unsuspecting investors and how “trailer commissions have helped the mutual fund industry grow and prosper while exploiting the information asymmetry on an unprecedented scale”. He concludes that “a Caveat Emptor environment cannot and should not remain as the status quo. Let’s bury the trailer commission”. (While echoing his call to bury trailer commission, I might add that we might as well bury the mutual funds industry with it. Canadian investors would be better served if they went for real advice to a qualified fee-only financial planner who is prepared to offer advice on a fee for service basis at a fiduciary level of care. By the way, as I indicated last week, real advice with a fiduciary level of care would probably lead to the demise of most Canadian mutual funds and the industry. Real advice is usually not about security selection, but about the plan and ongoing support in its execution. Real advisors with the skills, training, integrity and dedication to help investors achieve their financial objectives would transition and thrive under such a professional business model.)
And those who still doubt that actively managed mutual funds are not the way to go, listen to Bernie Madoff’s advice. In Bloomberg’s “Solid financial advice. From Bernie Madoff.” Eric Balchunas writes that when “…Madoff was asked where the safest place is to invest money with the least amount of risk for fraud. His answer: “The best chance for the average investor is to put money in an index fund. There are lower commission rates and more professional management with these types of firms. It’s the safest and least likely place to get scammed.”
In Reuters’s “FINRA warns investors on alternative mutual funds” Trevor Hunnicutt reports that over recent years investors in a search of simultaneous extra return and downside protection have put $176B in alternative mutual funds which “choose more exotic strategies and asset mixes than their traditional counterparts”. However FINRA warns about the complexities, the specific risk factors associated with the strategies (e.g. hedge funds) and assets (e.g. private equity and REITs) used, and the corresponding liquidity issues which might be associated with the investments. (Mutual funds are also under assault in the U.S. even though the costs associated with them are much lower; the advantages of broad index based investing implemented with ETFs are overwhelming and thus siphoning off assets from traditional mutual funds. Alternative mutual funds are one way the mutual fund industry is trying to put a finger in the cracks of the dyke, but the power of an idea (ETFs) whose time has come is unstoppable.)
In CareGiver.com’s “Financial Abuse: Could you spot it?” Eileen Beal looks at: who are typical targets for financial abuse (at highest risk are: women 80-89, men who just lost spouse, and those living alone), who are the most likely financial abusers (“telemarketing scammers”, “paid caregivers”, “sweethearts” or even family- like son/son-in-law), signs to watch for (adequate funds, sudden changes in will, new “best friends”, unexplained disappearance/transfer of money/valuables, etc) and preventive actions (staying connected with otherwise isolated individual, vigilance about person’s physical/mental health, keep person aware of mechanisms of financial exploitation). And speaking of scams, in the USAToday’s “Reverse mortgages backfire on some seniors” Diana Olick reports on a reverse mortgage scam where a couple were looking for funds from a reverse mortgage to pay off their actual mortgage so they no longer have to carry the load of monthly payments. In this case the wife was 10 years older than the husband, and they were sold a reverse mortgage which only the wife was named, with the promise that the husband could be added later (this was a lie). It so happened that she died shortly after the reverse mortgage was activated. The husband is now facing foreclosure, because “he would have to pay back the $300,000, but the house is now worth about half that, so he could never get a loan to cover it “. The article also notes that almost 10% of the reverse mortgages are delinquent”. (Thanks to Ken Kivenko for recommending these financial abuse articles; well worth reading and heeding their warnings!)
In my last week’s Hot Off the Web- June 10, 2013 I discussed the Financial Post’s “Go for safety of third-party custodian” in which Martin Pelletier warns about the importance and safety of independent third-party custodial services for your brokerage account. Marc Ryan of IndependentInvestor.info sent me a note reinforcing the point and taking it to another level, which if I understand it correctly, is that ‘independent’ is not enough. In his note he indicates that the old advice of relying on your assets being ‘segregated’ (as customer’s assets separate from dealer’s which occurs when: you paid in full when buying, and you owe no other amounts to dealer) then your assets are safe in case of dealer bankruptcy; he notes that this was so only until 1997 when the law was changed in both the U.S. and Canada. Now this protection only applies to the case of custodian firms which do not buy/sell securities themselves (i.e. going to another bank’s custodian subsidiary would not provide the necessary protection). So he recommends going with a reputable custodian who is not also a securities dealer. (Any other readers that would like to weigh with additional information would be appreciated. In the meantime, for those with <$10M J but > $1M in assets, splitting/keeping assets at <$1M with any one investment dealer/broker might be worth considering.)
Canada’s May 2013 Teranet-National-Bank House Price Index shows a nationwide 2% increase in the index over 12-months ago, compared to 10.9% increase in the Case-Shiller US index. 7 of 11 Canadian markets beat the average: “Quebec City (6.5%), Calgary (5.8%), Hamilton (5.8%), Winnipeg (4.6%), Edmonton (4.0%), Toronto (3.9%) and Halifax (2.3%)”. Montreal and Ottawa came in at/near the 2% national average, while “Victoria (−4.1%) and Vancouver (−3.2%)” were in negative territory. “The May monthly gain was 1% or more in seven of the 11 markets surveyed: Calgary (2.3%), Edmonton (1.9%), Hamilton (1.4%), Montreal and Winnipeg (1.2%), Ottawa-Gatineau (1.1%) and Toronto (1.0%). Lesser monthly increases were recorded in Quebec City (0.8%) and Vancouver (0.7%). Prices were flat in Halifax and down from the month before in Victoria (−0.8%).
In the WSJ’s “Housing’s up, but is foundation strong?” Nick Timiraos looks at the debate between U.S. housing bulls and bears. The bulls argue that the “Great Recession” has led to big “slump in new-construction and household formation” and now there is significant pent up demand to drive growth in prices and new-construction. Furthermore supply is limited not just by lower levels of new construction, but people unable/unwilling to sell when they are underwater on their mortgages, as well as banks holding “shadow inventory” off the market to drive up prices. The bears argue that recent house price increases were primarily investor driven, and credit availability constraints will continue to limit further increases. Bears also focus on declining home ownership rates, but others argue that is not relevant; what counts is “declining vacancies” thus tightening of supply. Then the bear side adds that for decades prior to the 2006 housing peak there was a “democratization of credit”, which has since ended resulting with more limited access to credit. But the real concern of bears is that investor driven price increases are only sustainable so long before owner occupied buyers must weigh in, and that’s when we’ll find out which way prices will be heading.
In IndexUniverse’s “Shiller: Housing rebound could be flaky” Olly Ludwig interviews Robert Shiller who wonders whether waning public enthusiasm about home ownership (as indicated by his recent survey) and given that much of the home price increases were driven by the low interest rates associated with the financial repression, will result in flat or even decreasing home prices going forward. He argues that home price increases are at least partly driven by fewer foreclosures (usually at prices about 20% lower than sales between consenting adults), so fewer foreclosure sales mean higher average/median prices. Investor buying action also has been driving up prices, but Shiller warns that they can exit as quickly as they entered. Also, credit availability is not what it was pre-2006. He notes however that concerns about prices if mortgage rates increase, are not warranted based on historical data (this could be tested very soon, if/when interest rates rise); the most important price drivers historically were price momentum and employment. Also interest in rentals is increasing especially among the young mobile generation, as is in “walkable cities”. His conclusion is that price increases might continue for another year or so,” but beyond that, all bets are off”.
In the Palm Beach Post’s “Florida ranks top in foreclosures as more homes go to auction” Kimberly Miller reports that Florida is once again at the “top spot nationally for foreclosure activity in May”, but this was not driven by a “surge in new foreclosure cases…(rather it is) a signal the state is working through its housing glut..(via) scheduled auctions.”
In the Financial Post’s “Upbeat new housing numbers could be ‘last hurrah’” Garry Marr reports that while the latest news from CMHC on Canadian new housing start sounds good, many experts question the interpretation of the numbers. One suggests that “While these numbers paint a good picture, most of the construction going on today is of previously sold units rather than a sign of fresh interest in the housing market…” Another expert indicates “Even if they presale to 80%, they don’t sell to just end users, there are investors…The demand is not there from end users. It’s simple economics, it can’t continue”. However even the gloomy experts are not universally in agreement that a crash is coming in Toronto, as long as the investor-buyers (flippers) don’t panic into selling; however they at least agree on a slowdown. And in the Globe and Mail’s “Canada’s lucky to come late to the housing-crash party” Larry Macdonald argues that a housing crash in Canada is not a foregone conclusion because Canadian government had a opportunity to learn from the experience of other countries and “will be doing their utmost to avert such an outcome”.
Pensions and Retirement Income
In the Globe and Mail’s “Any day now, we’ll get to pensions” Konrad Yakabuski (like I did in my last week’s blog) disagrees with Fred Vettese’s view, supported by his plan, that there is no pension crisis in Canada. (Rob Carrick calls the Vettese plan “The new retirement plan: Keep working”.) Yakabuski’s article is also a good summary of the federal government’s inaction and refusal to enact real pension reform by (some form of an) expanded-CPP or other means (except the deeply flawed PRPP). The article also mentions a recent Quebec announcement (which I missed in the papers a few weeks ago) that they are considering a “longevity pension” starting at age 75, which is mentioned again last week in the Montreal Gazette’s “Conference looks at the future of Quebec pensions”; this article indicates that the cost of this would be 1.65% of earnings, for each of the employer and employee, up to $51,000 of income. (This is a good idea; I proposed a similar “longevity insurance” associated (or independent of) CPP/QPP in my “Pure longevity insurance payout option in CPP would reduce retirees’ longevity risk” and other blogs/presentations, though starting at a later age and thus significantly cheaper.)
In the NYT’s “For retirees, a million dollar illusion” Jeff Sommer discusses how being a millionaire is not what it used to be in 1953. Today it would take $8.7M to have same level of wealth, yet only 1 in 10 American families have $1M of assets. The article goes on to mention that it is not just inflation that is responsible for the erosion of the $1M retirement plan, but in addition the current “safe” fixed income returns are so low that a 65 year old couple investing in municipal bonds has a 72% and 33%% chance of running out of money before the last one dies if they plan to use the 4% and 3% withdrawal rule with inflation adjustment; so much for the “safe” fixed income retirement portfolio. Different assumptions lead to somewhat different specific numbers but some stock market exposure is likely necessary for most retirees given current capital market expectations. Further enhancements suggested in addition to perhaps working a little longer than planned, are: make sure you’ve paid off your mortgage, delay Social Security benefits and save like a devil if you’re in your 50-60s as this will not only increase you retirement nest egg but also get you used to spending less in retirement. The article also notes that even an immediate fixed annuity for a 65 year old couple will only bring in about 3.7% inflation adjusted annually and nothing left for the next generation. The bottom line of the article is that even higher income couples, those who have accumulated at least $1M being most likely the top 10% earning families with median income of $150,000, would be dependent on Social Security which tops out at $31,000 at age 66, so now the experts are beginning to explore whether an increased level of Social Security would be appropriate as a safety net? (By the way the maximum (Social Security equivalent) government pension for highest earners in Canada is about $18,000, by comparison, and the federal government is fighting tooth and nail the proposed expanded-CPP. Thanks to MB for recommending)
In perhaps a sign of things to come for DB plans, the Norma Cohen reports in the Financial Times’ “Record improvement in UK pension fund fortunes” that according to the UK Pension Protection Fund the pension funds’ deficit decreased £71B in the month of May due to the rapid rise in UK government bond interest rates with the corresponding lowering of pension liabilities; the value of bonds held also decreased but that was “offset by the rising value of equities”. The article notes that just a0.3% increase in yields reduces value of the bonds by 1.4% but decreases liabilities by 5.9%. (Hopefully if/when interest rates rise significantly in North America, we’ll start seeing DB plan funded status improve as well.)
Things to Ponder
In the WSJ’s “How America lost its way” Niall Ferguson lists some of the signs indicating that the U.S. lost its (economic leadership) way: it is one of only 20 countries where the IMF indicates the total number of days to start a business has actually increased since 2006, it has excessively complex regulations and legislation, the rule of law has changed to the rule of lawyers, there is an exceptionally expensive tort system (e.g. “the plague of class action lawsuits”), and there is a deteriorating measure of World Governance indicators.
In the Economist’s “Too tight or back to normal” Buttonwood reports new data on real yields in Europe, Japan and the U.S. are showing that financial repression might be disappearing and these government may have “stopped inflating their debt away”.
In Bloomberg’s “When market incentives undermine morality” Friedman and McNeill write that while market mechanisms “have greatly improved our moral behavior, they can also degrade it”. The article looks at how the US drug industry through a series of: misrepresentations like: overselling the effectiveness of certain drugs, the under-reporting the serious side-effects of these drugs, lobbying for the need for higher dosages (greater sales), and by incentivizing doctors to increase the usage of the drugs. In 2009 French President Sarkozy said: “Purely financial capitalism has perverted the logic of capitalism.” It is a system in which “the logic of the market excuses everything.”
In the Financial Times’ “A pessimist’s guide to the Great Recession” Ferdinando Giugliano reviews Stephen King’s “When the money runs out: The end of western affluence” in which he discusses the consequences of the coming slow growth in developed countries and he argues that “Western societies may become fractured by three “schisms”: between the rich and the poor; the young and the elderly; and creditors and debtors. Economic dystopia will lead to a political crisis. “When the money runs out, there is only disappointment. And from disappointment comes hardship, tragedy and anger”. (Sounds like a very interesting and thought provoking book which I have added to my reading list.)
And finally, in WTOP’s “Study: Fast walkers stay ahead of the game” indicates that a JAMA research report found that “Looking at the lives of slow and fast walkers who were 75 years old, only 19 percent of the slowest men and 35 percent of the slowest women lived another 10 years. However, 87 and 91 percent, respectively, of the fastest walkers were still going.” (Interesting, hopefully the research considers the difference between correlation and causality.)