Contents: Unlink adviser compensation from product sold, unclaimed funds for a fee, some securities unfit for TFSAs, home prices: U.S. up 12.1% YoY and 2.5% MoM, Florida up 13% YoY but concerns continue on foreclosure rates and abandoned homes, the solution to the retirement no-crisis crisis, Nortel: bankruptcy trial set for January 2014; score: ‘lawyers’=;$1B retirees=NIL, pension funds go passive for low cost and market returns, family credit union, 12M world millionaires, gold nearing $1,200- so what? equities are investments while cottages are a lifestyle, retirement abroad, ETF markets broke?

Personal Finance and Investments

In WSJ’s “Going Dutch- Could fee hurdles come down everywhere?” Jason Zweig writes that “investing advice remains confusing, costly and opaque- and that needs to change”. The solution already implemented or on the way to being so in Australia, UK and the Netherlands, is to change advisor compensation so “what the adviser gets paid is no longer linked to which product the adviser sells to the client”. This would certainly eliminate the existing temptation for the advisor to sell funds which compensates them the best. The industry will be disrupted during the transition, and an estimated 25% of the “advisors” cum salespeople might drop out along the way. As usual, some in the industry say that this would reduce access to advice for “middle- and lower-income market”, but others argue that new advice models will be developed and investors will ultimately benefit. (The article doesn’t even mention Canada’s trailer-fees; as usual these are among the highest; Canada is years behind even in talking about how to make the industry more investor friendly. For a more detailed insight on the Canadian picture see the FAIR summarized proceedings of the OSC’s Mutual Fund Fees Roundtable which took place this month at Disingenuous Arguments from Mutual Fund Lobbyists  )

In the NYT’s “For a fee, seeking owners of unclaimed money” Paul Sullivan discusses some unsavory practices of services offering to locate unclaimed moneys (accounts, checks, dividends, life insurance benefits, etc)  for a fee, often as high as 36% of value of account. Firms holding the dormant/unclaimed account are required by law to track down the rightful owners; after a specified number of years the moneys must be handed over to the state. “Yet there is a gray area of time between when a company realizes an account is dormant and when it has to turn the money over to the state, typically three to five years. This is where locator companies operate with little regulation on the fees they can charge.” New York limits the charge to 15%, Ohio to 10%. Sullivan’s recommendation is to keep good records, so you don’t need these services.

In the Financial Post’s “Are you sure you can put that in your TFSA?” Jamie Golombek discusses restrictions on the type of securities that can be held in TFSAs; specifically “in order for a stock to be a qualified investment for a TFSA, it generally must be listed on a designated stock exchange”. Non-qualified investments attract 50% penalty in purchase year and “TFSA must pay tax, at top marginal tax rate on any income or capital gain earned… (and) the capital gain is taxed in full”!

Real Estate

The just released April 2013 S&P Case- Shiller Home Price Indices indicate that the 20-city index is up 12.1% YoY and 2.5% MoM. ““The 10- and 20-City Composites posted their highest monthly gains in the history of“ the index. “Thirteen cities posted monthly increases of over two percentage points, with San Francisco leading at 4.9%.  The recovery is definitely broad based. The two Composites showed the largest year-over-year gains in seven years. Atlanta, Las Vegas, Phoenix and San Francisco posted year-over-year gains of over 20% in April. San Francisco was the highest at 23.9%…average home prices across the United States are back to their early 2004 levels…” The indexes are still 26% below their 2006 peak but are 13.6% higher than their 2012 low.

The Florida homes story is mixed; prices are up but so are the number of foreclosures and abandoned homes. In the Palm Beach Post’s “South Florida home prices soar 13%, six straight months of gain” Kim Miller reports that in month of April the county saw a 2.4% increase in home prices, while the south Florida saw a 13% increase over April 2012. The WSJ’s “Foreclosures are still a concern” reports that “the foreclosure problem is not solved; it was simply delayed. While foreclosure filling rate in the U.S. overall was1 in 885, the states with the highest rates were Florida 1 in 302 (up 12% over previous year), Nevada 1 in 305 and Ohio 1 in 584. As home prices firm, banks feel more comfortable repossessing properties which they feel that they can then sell. In Palm Beach Post’s “Abandoned foreclosures mar Florida real estate” Kimberly Miller reports that “About 55,500 Florida homes with defaulted mortgages are deserted, that’s 33 percent of the national total…(these homes) are sitting empty while waiting for the bank to take possession”.

Pensions and Retirement Income

In the Globe and Mail’s “What retirement crisis? Share the risk, bridge the gap” Morneau and Vettese, while questioning whether we really do have a retirement “crisis”, still offer some “solutions” to the no-crisis “crisis”. They indicate that “The gap between private- and public-sector coverage is giving rise to an untenable political tension, exerting continued pressure for dramatic cuts to public-sector pension benefits.” The other problem they mention is that we are currently paying 9.9% of insured earnings for 6% of benefits (what a deal!…but not news). They also table three recommendations to solve the no-crisis ”crisis”: expanded-CPP (by increasing covered earnings to $75K from $50K, and benefits from 25% to 35%), PRPPs and move from DB to target-benefit plans. (If I recall correctly from his other recent articles, Mr. Vettese progressed from no -crisis in one article, to “I’ve got the solution to the crisis” in another article: work longer, people must sell their houses and people can make do on a lot less in retirement…all the way to the solution is: expanded-CPP, PRPP and target-benefit plans in this article…and somewhere along the way he declared annuitization as the best solution for everybody, even at age 65. Who knows what’s next; something will work and fix the no-crisis crisis. The PRPP may be the solution to the financial industry, but for those wanting to save for retirement it has been discredited by most unbiased experts. Thanks to CARP’s Susan Eng for bringing article to my attention.)

In the Globe and Mail’s “Nortel case to go ahead with Canada-U.S. trial, Ontario court rules” Linda Nguyen reports that the cross-border trial will proceed in January 2014 despite the objections of some UK creditors who wanted more attempts at mediation (which just further drain the remaining assets in the Nortel estate). By the way, in the Financial Post’s “No end in sight to Nortel fees frenzy” Theresa Tedesco writes almost one billion dollars have been spent so far on “professional” services (mostly legal) from the Nortel estate (What a travesty of justice, this rape and pillage of retirees and the disabled by “professionals”, while the government just sits on its hands and can’t find the time or interest to make the necessary changes to the BIA/CCAA…how pathetic is that?)

In the WSJ’s “Pension fund takes neighborly advice” Corkery and Grind describe the “frustration many pension officials feel toward expensive Wall Street investment managers”. The Montgomery County, Pa pension officials, on the advice on one of their neighbors, John Bogle, are moving 90% of their $470M pension assets into index funds run by Vanguard. The cost will drop from about 0.43% to 0.13%, and at least they’ll be getting the “market” return. (Mutual fund investors, who pay about 1-1.5% in the US and 2-2.5% in Canada, have even more to gain by switching to low cost index funds. Why are people continuing to hold/buy mutual funds?)

Things to Ponder

In CBS 60 Minutes’ “A credit union that’s all in the family” and if interested see the actual 5 min video, you find a very interesting construct of a family credit union with membership restricted to descendants, of a couple by the name of Williams, end their spouses. The story elaborates more broadly on credit unions as being “not-for-profit organizations”, which “doesn’t mean that credit unions don’t make a profit…it just means that their profits are returned to their members”. The article discusses the advantages of such family constructs and credit unions in general. (I suspect the not-for-profit or mutual business structure for financial industry would lead to superior outcomes for customers. Vanguard is an example of a “not-for-profit” investment management firm; the only one in existence I believe. There are some mutual insurance companies which also operate in the not-for-profit mode, but majority of the insurance industry in the US and Canada has converted from the mutual (policyholder owned) to public (shareholder) owned model during the 90s stock market mania.)

In the interesting (but perhaps not very useful) category, the Economist’s  “The rich” reports that there was a 1M increase to 12M in the number of ($) millionaires in the world. The U.S. had 3.4M of them, followed by Japan, Germany, China, Britain, France and then Canada with about 300K.

Numerous articles discuss the precipitous drop in gold price, prompting some to exit their position. For those holding gold now at around $1,200, off significantly from the $1,900 peak, it may feel very painful. But then some may have bought it at $400 a decade or so ago or even $1200 in 2010, and if it was bought as small (3-5%) long-term portfolio allocation as insurance against monetary calamity, perhaps not much has changed. (I rebalanced when my allocation moved above 5% by selling some of my GLD at about $1,750. The question now that allocation has fallen and is nearing 3%, does it make sense to buy some?) Is gold price reflective of deflationary fears returning? In the Economist’s “The other risk” Buttonwood tables the deflationary thesis again.

In the Globe and Mail’s “Why you should keep your eye on the (very) long term” John Heinzl compares the outsized returns of equities (e.g. Royal Bank almost 13%)  vs. cottage (3% after renovations, maintenance and taxes) from 1975 till 2012. His message is that “over long periods, dividends, dividend growth and compounding can produce investment returns that most people wouldn’t think possible”. (I.e. stocks are an investment while the cottage is a lifestyle.)

In the NYT’s “Making a move abroad, and working there, too” Kerry Hannon and in Reuters’ “How to see the world and ‘arbitrage’ your retirement” Chris Taylor discuss advantages of retiring abroad as well as working there; some issues that must be navigated are also mentioned. Coincidentally, the Globe and Mail’s “Retirees are living longer, better lives- outside Canada” Chris Atchison discusses Canadians’ retirement opportunities (and issues) abroad.

In the Financial Times’ “When the interest rate cycle turns vicious” Michael Mackenzie writes that as the “normalization of interest rates” turns inflows into bonds into outflows, there will be a need for a more “liquid secondary market that can help offset the mass sale of bonds and contain investor panic is badly needed”. He discusses proposals by Blackrock to standardize bond issuance timing and specs. Standardization would allow traders to more easily harvest total return on bonds, make it easier for electronic trading and lead to a more liquid secondary market for fixed income ETFs. (Perhaps a the ‘bad’ bond crisis will usher in the ‘good’, not just to a more liquid secondary market but also more transparency in bond pricing, and of course narrower bid-ask spreads; at least the ‘good’ is long overdue.) By the way the WSJ’s “Falling debt prices roil market” discusses the stresses and strains in the fixed income market due to lack of liquidity.

And finally, in Business Insider’s “The ETF market kind of broke yesterday” Linette Lopez writes that on June 20 some ETF prices (appear to have) got seriously disconnected from the NAV, the net asset value based on underlying securities. (Thanks to VP for recommending article.) The most affected were emerging market and municipal bond ETFs resulting in Citi suspending its market making role. But it was not the case of the market maker (Citi) declining to accept additional “market orders”, however they refused to accept “redemption orders” due to internal capital restrictions, as explained in Bloomberg’s more in-depth article  “ETF tracking errors in rout shows access comes with risks” by Condon and Kaske. They explain further how emerging market ETFs (appear to have) sold at “discounts — during U.S. trading hours while exchanges hosting many emerging-market stocks were closed — reflected expectations among market makers for continued price declines” (or as you’ll see later the ‘discount’ was relative to an invalid reference NAV.) The Bloomberg article mentions that “market turmoil” can cause “stress on the creation-redemption process” especially in “ETFs that have questionable liquidity to start with”. Also muni bond ETFs sold at ‘discounts’, but article indicates that they have sold at a discount at various times since 2010. Furthermore, while ETF sponsors often offer the option of cash redemption for a fee, State Street stopped offering it when trading costs started exceeding the fee that they can charge for this service, but redemptions in-kind did not stop. The Financial Times’ Lex column entitled  “ETFs: road to redemption” also discusses “authorized participant” Citi’s “temporary suspension” of “redemption orders” but not “trading orders”. Lex explains further that ”To redeem ETF shares that reference markets such as equities outside the US, or even bonds, the AP must post collateral with the ETF manager equivalent to 100 to 110 per cent of the value of the ETF shares.” This was the cause of Citi exceeding its internal collateral limit and thus refused additional “redemption orders”. For those of you interested in more gory details, IndexUniverse’s “iNAVs for ETFs should be banned” article discusses a closely related issue associated with iNAV which “is intended to approximate the fair value of the securities held in the portfolio by the ETF and should closely represent the value of the fund during the trading day”; iNAV was designed for ETFs whose underlying securities were U.S.-based stocks (not other asset classes now covered by ETFs). IndexUniverse then tears a strip off reputable financial papers for reporting significant discounts on emerging market ETFs, when in fact the foreign markets were closed so iNAV could not be representative of instantaneous fair market value. In fact they opine that “For international ETFs—and, indeed, for most fixed-income and commodity ETFs—iNAVs are beyond useless. They are misleading.” In a follow-up article in IndexUniverse’s “Keep iNAV; Encourage ETF transparency” Egbumike writes that ETFs are neither stocks, not mutual funds nor closed-end funds, even though they have things in common with each of them, but “an ETF’s liquidity is governed by many factors, including the liquidity of the fund’s underlying portfolio, the hedgeability of that portfolio, the creation/redemption policies of the issuers, who the lead market maker is, etc…”  And in the Financial Times’ “ETFs under scrutiny in market turbulence” Alloway and Massoudi discuss the risk associated with the magical transformation of illiquid underlying assets (e.g. bonds in the current world) into apparently very liquid ETFs. The result of the recent turbulence may make it less profitable to be an “authorized participant” (AP) and/or a “market makers” (MM) for ETFs representing illiquid assets, so there will be fewer APs and MMs and there will be wider spreads when liquidity decreases or investors try to dump ETFs in illiquid asset classes. (The problem seems to be people screaming fire in the theater and everybody rushing to the exits at the same time, even though so far we just have a malfunctioning smoke detector.  About three years ago when we had the May(?) 2010 flash crash, there were questions/concerns whether there is something fundamentally wrong with ETFs and I did a blog discussing this topic in There are risks, but I’ll stay with ETFs for my money: ETF concerns- Has anything changed?; I suspect not much has changed; they are not perfect but there are no systemic flaws visible. As time goes on and circumstances change, we occasionally find ‘odd’ ETF behaviors which might be unsettling to some investors especially when fuelled by scare-mongering in the papers and capitalized upon to generate FUD (fear, uncertainty and doubt) by forces whose interests are threatened by ETFs (e.g. mutual fund industry). If the underlying securities are volatile, ETFs built on them can be expected to also be volatile, especially when liquidity is a problem, but long-term investors (unlike traders) are in no different position than holding the underlying securities in their portfolio. Furthermore, when you consider the trillions of dollars that are invested in ETFs mostly over the past few years and the market turbulence that these ETFs have endured essentially unscathed, their robustness, so far, should be reassuring. Bottom line: Nothing that I’ve heard during the past week move ETFs up on my concern list, and I am not losing much sleep over any new ETF specific “problems”, especially compared to concerns about overall economic growth, volatility of markets and the QE-driven financial repression and its impact on returns on “safe assets”  that are essential components of most retirees’ portfolios.)