Contents: Target-date funds, ‘good news’ in lower markets, risky: “cash-flow” assets, riskier: “exempt markets”, states: life settlements OK, mutual fund trailer fees good for you-NOT, reverse mortgages- last resort only, Canada: housing collapse cancelled or delayed, US: buying 41% cheaper than renting, Florida: threat of rising sea level, state pensions=”ruinous promises”, Detroit to pensioners: take 10¢/$ of shortfall or worse, Sun Life assumes CWB pension risk, Chile’s annuity puzzle/risk: 65% annuitize 100% of retirement assets, un-indexed annuities transform investment to inflation risk, rating agencies: AAA for $$$s, Ferguson rips into U.S.: intergenerational transfers/regulations/lawyers/education, China’s credit bubble irreversible? Swedroe on skewness: insurance against market losses not worth it, Japan: global crisis trigger? Bogle: gratified and terrified by Vanguard growth, U of Michigan/Thomson-Reuters sell early access to consumer confidence data to elite traders, QE exit: impact greater and timing later than expected?
Personal Finance and Investments
In the WSJ’s “Missing the target” Pleven and Light discuss the advantages and disadvantages of target date funds which have now amassed $550B in 401(k) plans. The funds, which reduce stock allocation as one approaches retirement, have become defaults in many retirement plans but it does come with complications. Target-date funds are all different in cost and asset allocation, and typically have been designed to hold all of an investor’s retirement assets. Then there are the different individual risk tolerances, risk management difficulties given that individual has other assets as well, one size doesn’t fit all (factors include: level of assets, need for income, annuity, having debt, employer stock). The article also notes that even if the target date fund is ideal for the investor, investor must still make sure to save adequately to meet retirement needs.
Jason Zweig in WSJ MoneyBeat’s “Why the markets’ latest stumbles are good news” writes that unless you’re “on the verge of retirement, your fondest wish should be for another whiff of fear that will tip even more assets into the bargain bin… Investors should welcome the falling prices that make assets cheaper”.
In the WJ’s “’Cash-flow’ assets lure investors” Julie Steinberg discusses “cash flow” assets which the article notes: are not for everyone, tie up funds for years, charge 1 -2%/yr plus 15-20% of profits and “target returns in the midteens” by purchasing “profits from actors’, writers’ and directors’ shares in films and television shows, rent from residential and commercial properties, or natural gas and oil wells.” Income stream is generally more volatile and less liquid. These are considered risky investments.
And speaking of risky, in the Financial Post’s “Welcome to Canada’s exempt market: Exclusive, anything goes investments, but play at your own risk” Barbara Shecter discusses “Canada’s loosely regulated exempt market” where “anything goes”. “The exempt market does not require extensive and expensive offering documents and often documentation does not have to pass muster with regulators at all because the firms are supposedly dealing with sophisticated investors who meet minimum investment, income or asset thresholds.” Recent examples given where investors lost most of their investments, were cases where the funds were invested in “factoring” receivables of businesses, real estate limited partnerships, and outright fraudulent activities. Even worse, an audit of those who invested in exempt securities, indicated 20% of the dealers were selling these securities to people who did not qualify as “accredited” (i.e. >$200k/yr income and >$1M assets excluding principal residence.)
In WSJ’s “States ease use of life policies for elder care” Kelly Greene reports that some states (e.g. Texas) gave “Medicaid officials the authority to tell people applying for help they can sell long-held life-insurance policies to a third party to pay for custodial health care of their choice. Those who do so would remain eligible for Medicaid when those funds run out… The states hope to stop people from dropping their life-insurance policies in order to qualify for Medicaid.” Many people were previously just abandoning life insurance policies to qualify for Medicaid and this way they can at least get some money for their policy, and it also allows people to choose their preferred healthcare providers.
In the Financial Post’s “In praise of mutual fund trailer fees” Brendan Caldwell, the CEO of Caldwell Mutual Funds, opines that “trailer fees are one of the greatest inventions ever created for the benefit of Canadian investors” , The reasons given: small incremental investment, access to “greatest money managers in the world”, better diversification and encourage long holding period. (How silly is this! There is not even a mention of fees/costs…if you believe this, I have a bridge to sell you!)
In the Globe and Mail’s “Are reverse mortgages a good idea for retirees?” Shelley White explores reverse mortgages. (The short answer to the question in the title of this article is NO! The long answer is to use only as a last resort. Much of this article reads like an advert for reverse mortgages. In most instances there are better options available for retirees who need cash from their homes. Several years ago I wrote a blog on Reverse Mortgages and much of the arguments against have not changed substantially.)
In the Financial Post’s “Canada’s impending housing collapse not in sight” Gordon Isfeld suggests that Canada’ housing collapse is not imminent and “any correction down the road could likely be a mild one”. According to CREA sales of existing homes increased 3.6% in May (but off 2.6 YoY), following an April increase. Prices increased 3.7% in May over previous year. (It’s a strange way to report the numbers as MoM increases in sales vs. YoY increase on prices; but I guess one reports whatever shows positive results? J)
In Bloomberg’s “Running the numbers: 41%” Nikhil Hutheesing reports that according to Trulia it is 41% cheaper nationally in the U.S. to buy than rent a home. “The calculation assumes you get a 3.9 percent, 30-year fixed mortgage and make a 20 percent down payment, stay in your home for 7 years and deduct mortgage interest and property tax payments at the 25 percent tax bracket.“ Interest rates would have to rise to over 10% to reach the breakeven point which varies by location; interest breakeven in Detroit is 36%, San Jose is 5.2%, New York 6-7%.
The Economist’s “You’re going to get wet” discusses the impact of rising oceans on those living near coastal water. Between 1880-2011 oceans rose 1.8 mm/yr, while between 1993-2011 they rose by 3mm/yr; prior to 1880 “sea levels remained relatively constant”. In 2007 the IPCC forecasted 23in or almost 60cm rise in seas by 2100. “Hurricanes and storms are nothing new for Florida. But as the oceans warm, hurricanes are growing more intense. To make matters worse, this is happening against a backdrop of sharply rising sea levels, turning what has been a seasonal annoyance into an existential threat.” Seawalls, breakwaters and other storm barriers (like gates protecting London and Rotterdam) more intelligent shoreline management techniques will be introduced if predictions come true, otherwise oceans will turn shorelines into “beaches, dunes or wetlands”.
Pensions and Retirement Income
The Economist’s “State pensions in America- States cannot pretend to be in good financial health unless they tackle pensions” calls them “ruinous promises” given the $4T funding gap of state pensions, equivalent to 25% of U.S. GDP. The information presented is not new but bears repeating often. A combination of ludicrously high expected returns on plan assets and ludicrously high discount rates for plan liabilities were the basis of ultra generous benefits granted in the knowledge that “…if you offer public-sector workers bigger retirement benefits, they vote for you today and the bill does not arrive for years”, and in the short term you can also reduce pension contributions! But the article notes that Moody’s is switching to bond yield based discount rates to assess states’ creditworthiness. The recommendation is to: tell taxpayers of the real size of pension deficits, stop offering “final-salary pensions” to new employees, and for current employees protect already accrued pensions but renegotiate future benefits, e.g. pensionable ages and extra time worked final pre-retirement year to boost pension. (Thanks to DA for recommending.)
And speaking of public pension troubles, in WSJ’s “Pennies or bankruptcy, Detroit tells creditors” Nolan, Dolan and Glazer report that of most at risk of the city’s $20B debt “is the $11 billion in unsecured debt. That includes almost $6 billion primarily in health benefits for retired city workers; more than $3 billion for retirees’ pensions; and about $530 million in general-obligation bonds. Retirees are set to get less than 10% of what is owed them under the plan.” According to Bloomberg’s “Detroit’s recovery plan dips into pensions to keep city afloat” the pressure is on the unions to try to prevent a formal bankruptcy filing because then federal rather than Michigan law may apply which would lead to a battle about whether bondholders have higher priority than pension plan shortfall. Vallejo, Stockton and San Bernardino have squeezed significant concessions from their unions to keep the cities running. The Economist’s Buttonwood in “Do employees pay for their retirement” uses the Detroit threat to pensions as opportunity to look at employee and employer shares of the pension costs and concludes that “either employers or employees are not recognising the full cost/benefit of a final salary pension. And if employers aren’t recognizing it properly, that also means taxpayers may be unaware of the public sector promises they have agreed to fund.”
BenefitCanada’s “Canadian Wheat Board transfers pension risk to Sun Life” reports that the Canadian Wheat Board has transferred its DB plan to a Sun Life annuity. The article notes that “The agreement is unique in the Canadian market because it involves pension income that grows with inflation as well as the annuity buy-in solution. An annuity buy-in is an investment that a pension plan makes to transfer investment and longevity risk to an insurance company, without any impact on plan members’ pensions.” InvestmentExecutive’s “Sun Life, Canadian Wheat Board sign annuity deal” explains “annuity buy-in” as “a policy that is similar to a traditional annuity, however instead of issuing individual certificates to the covered retirees and paying pensions to them individually, it involves a single annuity contract that is issued to the pension fund. The pensions are then paid to retirees by the plan fund; not by the insurer.” See also the Financial Post’s “Sun Life signs ‘game-changing’ deal to take Wheat Board’s pension risk” (It would be interesting to better understand the cost and terms of the indexing that has been purchased.)
In AdvisorOne’s “Solving Chile’s annuity puzzle” Moshe Milevsky discusses how 65% of Chileans (compared to 5% in the US) end up voluntarily annuitizing all of their accumulated assets upon retirement after saving a mandatory minimum 10% of earnings through the payroll system and investing it into a low-cost limited investment option private sector run 401(k)-like DC plan. Each person’s accumulated assets will typically be different depending on the amount saved, the timing of contribution, funds and asset allocations chosen. Chilean regulators are concerned that as a result of the very high annuitization rate, 85% of Chilean insurance companies’ “reserves are linked to life annuity liabilities” compared to only 15% to life insurance liabilities. This leaves insurance companies exposed to a significant longevity risk. So, regulators are looking for ways to reduce annuitization rate by making systematic withdrawal plans (SWiPs) more attractive. Milevsky suggests some reasons for the high annuitization rate: compulsory advisor’s commission is the same independent of what retiree chooses (though more of those advised by mutual fundco associated advisors choose funds rather than annuities), mandated illustrations show “volatile and possibly declining income stream with SWIP”, all annuities are inflation indexed, there are no other pensions in Chile, perceived safety of a government guarantee of annuities. He agrees that these do not explain the Chilean annuity puzzle and his personal preference would be to some mix of annuities and SWIP, and he would annuitize in stages. (Thanks to EF for recommending the article.)
In the Financial Times’ letter “Sharing pensions investment risk is a dead end” Stuart Fowler agrees that it is true that in pensions “better outcomes (will result) for members stemming from the lower costs of very large, and not-for-profit, collective structures”, but investment risk sharing is not one of the benefits. Longevity risk sharing is also a benefit of large scale pooling, but savings are insufficient “individually or collectively to live off inflation protected annuity incomes…annuities without inflation protection simply transform the risk from equities to inflation”. His recommendations are: phasing annuities over adjusting drawdown rates as an alternative to buying annuities. (These are very sensible suggestions. Some might rephrase this as: try to make it work with a sensible systematic withdrawal plan, if adverse market conditions at some point make that unworkable then activate phased annuitization if necessary.)
Things to Ponder
In Rolling Stone’s “The last mystery of the financial crisis” Matt Taibbi writes about what we now know from the documents which recently became public from lawsuits against rating agencies is “that the nation’s two top ratings companies, Moody’s and S&P, have for many years been shameless tools for the banks, willing to give just about anything a high rating in exchange for cash”, and they have done this with full knowledge as visible from internal emails included in the documents. These documents “also lay out in detail the evolution of the industry-wide fraud that led to implosion of the world economy – how banks, hedge funds, mortgage lenders and ratings agencies, working at an extraordinary level of cooperation, teamed up to disguise and then sell near-worthless loans as AAA securities.” And Taibbi concludes that “Given a choice between money and integrity, they took the money. Which wouldn’t be quite so bad if they weren’t in the integrity business.” (Worth a read.)
In Bloomberg’s “Harvard’s grumpy Ferguson says the world is going to hell” Joe Mysak writes that Ferguson’s diagnosis is “We spend too much, especially on intergenerational transfer programs like Medicare, Medicaid and Social Security. We seek redemption in elaborate regulation, which is guaranteed to throttle the economy. We are in danger of replacing the rule of law with the rule of lawyers. Our system of education perpetuates the existence of a mandarin class. Finally, we have abdicated our responsibility as citizens in favor of the state.” Mysak challenges some of Ferguson’s data and its interpretation, but he still calls himself a Ferguson fan. In the WSJ’s “The regulated states of America” Niall Ferguson discusses Alexis de Tocqueville’s 1833 “Democracy in America” in which he “saw a nation of individuals who were defiant of authority” who “unlike Frenchmen…who looked to the state to provide economic and social order, Americans relied on their own efforts. “In the United States, they associate for the goals of public security, of commerce and industry, of morality and religion. There is nothing the human will despairs of attaining by the free action of the collective power of individuals.” But Americans increasingly became dependent on government. Cost of regulation in the U.S. is estimated to be $1.8T. (He even includes a swipe at the in development “new fiduciary rule, which will increase the cost of retirement planning to middle class workers”.)
In the Financial Post’s “China’s credit bubble unlike anything in modern history: Fitch” you can read about China’s credit bubble “is so massive that it can no longer grow out of its excesses”. Credit increased from $9T in 2008 to $23T, and credit reached 200% of GDP a 75 percentage point increase. The article includes charts showing that credit is growing faster than GDP, questionable wealth management products are growing exponentially, and other disconcerting signs.
In IndexUniverse’ “The skinny on skewness” Larry Swedroe explains “skewness” being negative/positive “…when the values to the left/right of the mean are fewer—but farther from the mean—than are values to the right/left of the mean”. A lottery ticket is an example of positive skewness whereas stock investments exhibit negative skewness. Investors sometimes buy “insurance” to protect against steep market losses; but because high demand for such insurance products leads to “overpricing and low returns to the buyers of such products and high returns to the sellers”. Swedroe writes that “to cut the risk of the left-tail, the historical evidence suggests that the most efficient way to accomplish that objective is to take a “bar-bell” approach—have a low exposure to stocks and a high exposure to safe bonds…(but the) stock allocation would have a high, or even exclusive, allocation to U.S. small value stocks, international small value stocks, and emerging market small and value stocks—the stocks with the highest historical returns, and also the highest volatility”.
In the Financial Post’s “Japan will cause the next big global crisis within the next 18 months” Steven Perlberg reports that according to Felix Zulauf with the Yen rising again and the Nikkei heading down Abenomics appears to have failed. Given Japan government debt well in excess of 200% of GDP and that 50% of tax revenues are required to service it at current interest rates, rising rates will leave Japan bankrupt. (Perhaps, but vast majority of Japan’s debt is in Yen and to domestic borrowers; they might be able to muddle along their technical bankruptcy by printing Yen for a while longer than 18 months.)
In InvestmentNews’ “Why John Bogle is both gratified and terrified by Vanguard’s success” Jason Kephart looks at the Vanguard difference and Bogle role: “not only structured the company so it’s owned by the fund shareholders” but also where marketing was/is not “finding what people want and giving it to them” and excluded the word “product” from their vocabulary. This led to assets of $2T ETFs vs. $1T in 2008, a fund market share increase from 13% to 17.3% and now “it’s taking in something like 70% of the industry’s cash flow”, the latter of which John Bogle finds both gratifying and terrifying.
In CNBC’s “Thompson Reuters gives elite traders early advantage” Eamon Javers discusses “A contract signed by Thomson Reuters, the news agency and data provider, and the University of Michigan, which produces the widely cited (consumer confidence) economic statistic, stipulates that the data will be posted on the web for the general public at 10 a.m. on the days it is released. Five minutes before that, at 9:55 a.m., the data is distributed on a conference call for Thomson Reuters’ paying clients, who are given certain headline numbers. But the contract carves out an even more elite group of clients… (who) receive the information in a specialized format tailor-made for computer-driven algorithmic trading at 9:54:58.000…” The article discusses whether this is fair and whether there is adequate disclosure of this or not. Thompson Reuters pays University of Michigan $1M for the extra 2 seconds but is not prepared to divulge what it charges for access to its clients. It appears according to the WSJ’s “Data group ends peaks after leaks” that the practice, which came under scrutiny after the news leaked about selling early access to the data, will be ended.
In the Financial Times’ “QE addiction may be hard to kick” Satyajit Das fears that not only “zero interest rates and QE do not address the real issues and may not be capable of restoring economic health: but “It may also be impossible to exit current policies without major economic disruption…” In the Financial Posts “Jim O’Neill: We could see a bond crash” Steven Perlberg reports that according to O’Neill 5% 10 year Treasuries are not out of the realm of possibilities (over an unspecified time frame) in a “return to normalcy” one the Fed starts to cut back on its QE.
And finally, in the Economist’s “The long goodbye” Buttonwood columnist assesses the market reaction (most everything but the dollar fell) to Mr. Bernanke’s announcement, and he argues that we may be entering a “period in which good news on the economy (falling unemployment) is bad news for the markets (faster QE tapering)”. But he adds that “The old saying is that the best way to make God laugh is to tell him your plans. We might get to tapering but your blogger doubts whether the end of QE is coming as soon as the markets fear.” (So why are investors panicking and heading for the exits?)