Hot Off the Web- July 15, 2013

Contents: Fiduciary standard to drive advisers from mutual to segregated funds? no incremental cost with fiduciary duty and revenues higher, the 3-ETF portfolio, OBSI changes reduce effectiveness, new target maturity bond EFTs, US foreclosures down but Florida still 3x national average, DB pensions in danger zone, a tale of two boomers, no pension crisis for MPs, IOSCO principles to improve ETF disclosure, investors should relax about ETF ‘discounts’.


Personal Finance and Investments

Under the heading of either “is this a joke?” or “how sick is this?”, Rudy Luukko in Investment Executive’s  “Why some advisors might abandon mutual funds” reports that Canada’s Federation of Mutual Fund Dealers suggest that if compensation models and/or fiduciary (client best interest) standards are introduced to mutual funds, this “would have the unintended consequence of having advisors move assets from mutual funds to segregated funds”. Segregated funds are much higher cost mutual fund-like investment products which typically come with some insurance component, are manufactured by insurance companies, are sold through insurance salespeople and are more loosely regulated. A few weeks ago the mutual fund industry threatened reduced availability of ‘advice’ to people with lower incomes/assets if the trailer commission system was done away with. According to this article investor advocates indicate that this new threat of regulatory arbitrage just reinforces the urgent need for reform to protect investors.  (Thanks to Ken Kivenko for bringing this article to my attention. If this isn’t a joke, then the Canadian mutual fund industry’s repeated threats to act against the best interest of their investor clients should be the final nail in the coffin of the industry. Anyone proffering to provide financial advice, such as brokers, mutual fund salespeople, and insurance salespeople should all be required to observe a fiduciary level of care or stand down as ‘advisers’. But why are people still buying/holding mutual funds? Why do people accept a 50% reduction in their retirement income/assets voluntarily? And, when are regulators going to act to protect those who still don’t understand the dire consequences of holding such toxic products, when much cheaper ones are readily available?)

And by the way, in Investment News’ “Fiduciary duty boosts revenue not compliance cost: FPC”  Mark Shoeff Jr. Reports thatFinancial advisers who operate under a fiduciary duty achieve stronger asset and revenue growth without taking on additional compliance costs, according to a group of adviser advocates.” The so called ‘advice’ industry in the U.S. (and Canada) argued that fiduciary standard would increase the cost of doing business and therefore the cost of advice, and they demanded that a cost benefit analysis be provided before the SEC rules on the matter. The Financial Planning Coalition, a group of advisers already operating under the fiduciary standard, indicated that “research shows that brokers moving from commission-based accounts to fiduciary accounts do not experience an increase in compliance expenditures”, but those currently not operating under the “best interest of the client” standard predict that costs will increase if fiduciary requirement is introduced. (I suppose that those who switched to the fiduciary model would have more objective data on its costs, but in any case why are ‘advisers’ objecting to work in the “best interest of the client?” and should this not be a “red flag” to the clients that something is not right?)

In the WSJ’s “A portfolio that’s as simple as One, Two, Three” Anna Prior quotes some experts who argue that it is not only possible but desirable “to construct a well-diversified portfolio using just three low-cost mutual funds”. One approach mentioned based on Vanguard funds is using: VTI (Total US stock market), VXUS (Total international stock) and BND (Total US bond market); the example in the article allocates 40, 20% and 40% to the three funds, respectively. For those who want to include international bonds BNDX (Total international bond) can be added. Of course the exact asset allocation is a function of the investor’s risk tolerance. The article also notes the importance of rebalancing periodically, even if it is “extraordinarily hard to” buy more equities after they have just dropped; but do it at least annually. (Canadians’ portfolios would be different (due to: asset allocation, withholding tax, currency hedging, etc consideration) but still implementable with a handful of ETFs.)

Investor advocate Ken Kivenko brought to my attention the “Consultation on Proposed Changes to OBSI’s Terms of Reference” whereby OBSI is requesting public feedback before August 12, 2013 on proposed changes. OBSI is a Canadian financial industry funded free independent conflict resolution service available in case you can’t get satisfaction from your bank or investment firm. Ken writes in an email that the proposed changes “are regressive and not in the best interests of investors in our view. One change for example would require investors to split their complaint if they own segregated funds. Another eliminates their mandate to investigate systemic issues that harm investors. To the extent OBSI is weakened, it is to that extent investor protection is weakened. The alternative to OBSI is costly, time consuming, frustrating civil litigation.” He urges everyone to send comment letters expressing their concerns. (By the way RBC’s and TD’s recent announcements to withdraw from OBSI already undermined its effectiveness and the current proposals will further weaken it. Coincidentally, the Globe and Mail’s “Banking watchdog to track dementia-related cases” discusses a new OBSI thrust intended to “create a national registry that will flag complaints in which dementia may be a factor”. The article also discusses OBSI in general.)

In Investment News’ “Target maturity ETF market maturing as BlackRock launches four new funds” Jeff Benjamin reports that BlackRock added four target maturity funds to its existing stable of target maturity funds (municipals and ex-financials). These are intended to address people’s concerns about potential rise in interest rates and its impact on bond fund values. Target maturity funds can be used to build a bond-ladder (or GIC/CD ladder) like exposure to fixed income. These bond funds, unlike their previous ones, include financials, and management fees are 0.1%. (Note that YTM (Yield-to-Maturity) for the 2016, 2020, and 2023 are 1.29%, 3.37%, and 3.93%. As target maturity funds are aimed at those intending to hold until maturity, you need to watch out for durations which are 2.17%, 5.16% and 7.66%., respectively; duration indicate the percent drop in bond value for each 1% drop in interest rates. You’ll also want to consider the credit risk at BBB+. (These target-maturity funds have the potential to be a win-win for the industry and investors; it offers an exit strategy for existing bond funds in case of large sell-off (and create fees in the process) and they have better understood risk characteristics for investors. It might turn out that target maturity bond funds are a better mousetrap than bond index funds; only time will tell.)


Real Estate

Reuters reports “U.S. home foreclosure fillings at 6-1/2-year low in June” with MoM decrease in foreclosures of 14% and YoY decrease of 35% nationally in the U.S. Realty Trac commented that “We are getting tantalizingly close to being back to normal, healthy foreclosure levels, at least on a nation-wide basis…(but) hard-hit Florida had the highest foreclosure rate in the first half of the year, with a foreclosure filing on 1.7 percent of homes, or one in every 58. That’s nearly three times the national average of one in every 164 homes.”


Pensions and Retirement Income

In Benefits Canada’s  “Pension plan deficits in the danger zone” Craig Sebastiano reports that the DBRS study entitled “Pension Plans: The 401 Slowdown” indicates the poor shape of DB pension plans around the world, including Canada and the U.S. “…the aggregate funding status of 461 plans reviewed fell to a low point of 78.3% in 2012” which the report calls in “danger zone” (i.e. below 80%). “The funded status of Canadian plans is 84.4%—six percentage points higher than the average. There were 12 plans below 70%, and all were above the funding level of 55%…there are plans that require significant improvements. Magna had the worst funded status on a percentage basis at 55.4%, followed by Catalyst Paper (60.3%), Canadian Oil Sands Trust (62.1%), Barrick (63.1%) and Agrium (64.6%).”  The article also notes that “Assuming that plan assets, contributions and benefits remain the same, the rate increase would help bring the funded status above the 80% threshold today.” (…which it has relative to this year end 2012 view.)

According to AdvisorOne’s “Boomers are two generations: IRI” boomers should not all be painted with a single brush; there are significant differences between early and late boomers, with the latter group facing “additional challenges”. Differences include early boomers more likely to have DB pensions, whereas late boomers are more likely to have DC plans, lower retirement savings, mortgages, and are supporting adult children. Of course surveys also indicates that higher proportion of late boomers expect their situation to improve (as they are still working) than early boomers.


Things to Ponder

In IndexUniverse’s “IOSCO calls for clearer ETF classifications and disclosures” Rebecca Hampson reports that IOSCO issued principles which are intended to improve disclosure relating to: differences between ETFs and ETPs, “fees and expenses”, “impact of securities lending and the complete, accurate and understandable disclosure addressing the types of risks investors may be exposed to particularly when ETFs use complex strategies that may involve the use of leverage (or reverse leverage)”, and “management of potential inherent conflicts of interest and of counterparty risks arising from both physical and synthetic replication methods”.

And finally, articles continue to discuss (though in a much more rational way) the perceived strange behaviour of ETFs a couple of weeks ago. In Bloomberg’s  “Crowded ETF exit proving costly as bonds trail: Credit markets” Abramowicz and Childs look at the liquidity driven apparent discount that ETFs were trading at relative to “NAV” and comment that “The gap reflects the extra charge investors paid for a speedier exit in a declining market by using ETFs that trade like stocks rather than buying and selling the less-liquid debt”. In Morningstar’s (thanks to VP for recommending)  “Don’t fret over phantom ETF discounts” (which I also discussed in the last item of  Hot Off the Web- July 1, 2013 ) John Gabriel pretty well sums up the story by addressing the liquidity and inaccuracy of NAV issues for bond ETFs and stale NAV pricing when securities listed on overseas/closed exchanges are traded in ETF packages in the U.S. throughout the day. In IndexUniverse’s “Pros & cons of bond ETFs and mutual funds” Matt Hougan extends the discussion by looking differences in behavior of bond ETFs vs. mutual funds at time of market stress. He opines that “…ETFs are the “true” market for bonds and the live prices generated by the ETF are closer to the true clearing price of the bonds than the matrix-calculated NAV…During periods of market stress, spreads will widen on the underlying bonds, pricing will become uncertain and you will get less (or more when demand is high) than NAV when you trade.” Mutual funds, on the other hand, guarantee that you can sell at NAV at end of the (market stress plagued) day, but of course continuing bond mutual fund holders are short changed because to pay for the redemptions of the day when the fund might have to sell “$105” worth of bonds to cover $100 redemption. So his conclusion is that in case of bond funds, traders might be better off with mutual funds while long-term investors are better off with ETFs. (Bet you expected that traders would want ETFs and long-term investors mutual funds; well things are turned on upside down.)


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