Contents: Passive beats active-again, bonds: what now? fee transparency needed, unit investment trusts-Not, no sustainable value in market timing, money mistakes, young adults’ insurance needs? clients beware: your adviser might retire before you, US/Florida home sales down in June but prices up, Shiller: home ownership not a virtue, living on the “edge”, Detroit: pensioners-taxpayer-bondholders fight, Poland: “potential quasi-nationalization” of pensions, Canada’s premiers back to expanded-CPP? fund managers add little value but paid extravagantly, Arnott: emerging markets attractive.

Personal Finance and Investments

Mutual fund holders should pay attention! In IndexUniverse’s “The amazing power of passive portfolios” Olly Ludwig reports that a new study again concludes that “It’s already fairly clear to those who follow the passive-versus-active debate that the typical passively managed fund does better than a comparable actively managed fund. The point in this new study is that the results are more striking when the analysis comprises full portfolios, not just individual funds.”  (So (actively managed) mutual fund holders should note that the definition of insanity is “doing the same thing over and over again, and expecting different outcomes”; passive investing leads to superior outcomes for the vast majority of instances, as compared to active approach.)

In the Vanguard paper “Reducing bonds? Proceed with caution” Kinniry and Scott writes that “…Vanguard’s belief (is) that bonds remain by far the best diversifier for equity risk, but that current low yields will not provide the same portfolio amplification (i.e., high-return potential) as they have in the past…. U.S. investment-grade bonds and international bonds have been a reliable cushion to equity market volatility when investors value a cushion most—that is, during sharp stock declines…. Investors should recognize that lower expected bond returns have not altered the fundamental relationship between risk and return or the role that a strategic bond allocation has in reducing equity market volatility.”

In the Globe and Mail’s “How to navigate a stormy bond market” Rob Carrick does an interview a bond expert on how to approach bonds in the current volatile bond market. He discusses: the importance of duration as the critical measure of bond value sensitivity to interest rates, the recommendation not to buy long bonds (i.e. with duration risk) but for those seeking more risk (return) consider credit risk instead, the mix he leans toward is 20% government and 80% corporate at this time, he considers bond ETFs as having “great pricing” for those investing <$100,000 in bonds but the trade-off is that there is no fixed maturity date (though now increasing there are target-maturity bond ETFs available), he also notes that high-yield or junk bonds are really a stock/bond hybrid so be careful not to over-allocate, he is concerned about emerging market bond liquidity, and on bond ladders he currently leans toward 3-10 year ladders. And, by the way, he doesn’t see interest rates escalating rapidly in the near term. (Read the interview for more details.)

In the Globe and Mail’s “Financial industry needs more transparency on fees” Preet Banerjee discusses the drastically different treatment of two investors paying the same fees on the same mutual fund, largely due to lack of transparency and bundling of investment management fees and advice; one will get “incredible service and comprehensive financial planning” while the other will get little more than confirmation slips for security transactions. He argues persuasively for unbundling. (I agree, transparency is a necessary condition, and then we need to add the requirement for fiduciary level of care, and we might see a new works for the average investor. But why are people still buying mutual funds? I can’t figure it out.)

In the WSJ MoneyBeat’s “The forgotten funds that are suddenly drawing crowds” Jason Zweig writes about the comeback of “unit investment trusts” in the US, which he calls “a peculiar cross between mutual funds and exchange-traded funds”. He writes that they may be cheaper than mutual funds if you wanted to delegate all your thinking to your advisor, but “You should be able to meet your income needs more cheaply elsewhere—mainly through index funds or ETFs that hold comparable assets at much lower cost. You could even supplement your investment income by holding an ETF like Vanguard Total Stock Market (VTI) …and selling a smidgen of your position in regular increments”. (Always great analysis/advice from Jason Zweig.)

Mark Hulbert in the WSJ’s “Can market timers beat the index?” writes that “Even those who do beat a buy-and-hold strategy in one market cycle have no greater odds of success in the next cycle… A surer strategy is to keep a steady allocation through thick and thin.” You should reduce your stock allocation to the level that you don’t lose sleep over it and then just stick to it.

In the WSJ’s “Three big money mistakes you could be making right now” Veronica Dagher lists the three biggest money mistakes a: in addition “overspending” as the obvious one, there is  “enabling” (“parents who want to help their adult children who are in chronic financial trouble”), and “denying” (not facing up to the real financial situation and continuing to spend beyond what is realistically sustainably possible under current reality, hoping that we’ll get bailed out by some market miracle.)

In the Financial Post’s “Why young adults need (or don’t need) insurance” Melissa Leong mentions that while most young people who have no dependents (children, parents, spouse) who will be affected financially by their demise don’t need life insurance, there may still be an argument if there will be future dependents then buying insurance early reduced the risk that insurability might be a problem in the future. (This might be an interesting perspective, except for the effect of inflation on the buying power of the policy some decades in the future.)

In the Globe and Mail’s “How to find index yields- and other investing tricks” John Heinzl explains how to determine index yields (trailing yield plus MER) and what’s the difference between ‘portfolio yield’ (“the yield of the individual securities in the fund before expenses… based on the most recent dividend for each of the fund’s holdings”), ‘annualized yield’ (“…based on the most recent distribution of the fund itself”) and ‘distribution yield’ (assumes that the rest of the year will be the same as the “…most recent quarterly distribution”), “12-month trailing yield” ( based on past 12 months of distributions). (You get the idea; you must make sure that you are comparing apples to apples)

The WSJ MarketWatch asks “Will your adviser retire before you do?” and since the average worker age is about 40 while that of adviser 50, and you’d want and need your (already) trusted adviser to be around when you are making your retirement decisions, perhaps “That’s as good rationale as any to justify having a frank talk with your adviser about his or her retirement before you spend much more time discussing your own.”

In IndexUnverse’s  “An ETN credit risk reality check” Larry Swedroe explains the difference between ETNs (which are unsecured securities and you take on the credit risk implicit in the issuer of the ETN) and ETFs where there is no credit risk (except perhaps counterparty risk on securities lending in the ETF) “as they hold the underlying assets of the index they are designed to track”. He notes that given the credit risk exposure, you’d expect to have these ETNs to be priced at discount reflecting that credit risk, but it’s not the case. (Consider yourself warned.)

Real Estate

The Forbes’ “Existing home sales decline in June: Here is what’s behind that drop” reports that according to the NAR, US existing home sales are down 1.2% in the month of June but are still 15% higher than in June 2012. Reasons given for the drop include higher mortgage rates of 4.69% mid-July vs. 3.59% in May, lower inventory levels of 5.2 months nationwide, and a drop in distressed sales.

In the Miami Herald’s “South Florida housing prices are up by double digits in June” Martha Branningan reports that Miami-Dade single family homes and condo prices are up 21.1% and 15.9%, respectively. Also, just as nationally, sales in June were up 25.1% YoY but downs 2.8% MoM. Higher mortgage rates and lower inventories are the reasons given for lower June sales compared to May. Palm Beach County numbers were not available due “kinks in data”. (Reminds me of the old saying…if you torture the data long enough, eventually it will confess to anything you want”.)

In the New York Time’s “Owning a home isn’t always a virtue” Robert Shiller questions “our national commitment to home ownership” and whether “is it wise for the government to subsidize home ownership?” In his answer he references Switzerland where home ownership is at 36.8% rather than the 66.5% in the U.S.  Shiller points to differences in personal taxation incentives (US) and disincentives (Switzerland) to home ownership. He concludes that in the US homeownership was looked as a form of savings, while the Swiss managed to save without it; he would like to remove the US’s “enormous subsidy to homeownership” (not just the deductibility of mortgage interest but also the endless supply of cheap money via Fannie Mae and Freddie Mac).

In the Financial Times’ “America likes living on the edge” Gillian Tett contrasts the British and American coastlines, the former with very little housing whereas the latter very densely built up. The differences she attributes to various factors, but she suggests that the availability of federally subsidized National Flood Insurance Program in the U.S. is a significant contributor to the massive amount ($10T) of built-up coastal property in the U.S., with $3T in each of New York and Florida alone.

Pensions and Retirement Income

In WSJ’s “Detroit bankruptcy likely to spark pension brawl” Corkery and Dolan write that states can’t file for bankruptcy, cities can. Most cities have been cutting pensions and other retiree benefits for new hires, but several small cities have successfully shed retiree costs via bankruptcy. Detroit is the big city test case. Bankruptcy experts argue that Detroit will demonstrate why it’s better public-sector unions to accept cut before bankruptcy. The article notes that $10B of $18B long-term liabilities of Detroit are related to pensions and other retiree benefits. While the Federal government indicated no help was forthcoming, in the 70s it did help NYC dig out of its financial mess.  By the way Margaret Wente has an interesting article on source of Detroit’s problems in the Globe and Mail entitled “Who killed Detroit? Not who you think” where she points the finger at corrupt politicians. Meredith Whitney in the Financial Times’ “Detroit aftershocks will be staggering” writes that the outcome in the huge battle between taxpayers, bondholders and unions representing municipal employees/pensioners will have serious and widespread repercussions. So far profligate politicians just made increasingly rich promises to their supporters (employees) and haven’t worried about the future cost of those promises. When the financial crunch hit, taxpayers just received reduced services year after year despite often increasing taxes, but pensions and bondholders were protected. The outcome in Detroit will affect dozens of other municipalities which also are on the precipice of bankruptcy.

In the Financial Times’ “Private Polish pensions face the chop” Steve Johnson reports that Poland’s “second-pillar” (CPP-like?) private pension system is under the threat of “potential quasi-nationalization” of assets accumulated under a compulsory 7.3% of wages contributory plan since 1999 (and 2.3% since of 2011); the plan is guaranteed by the government and run by Aviva, Axa and ING; fees were as high as 3.5% in some cases. The article seems to suggest that the proposed changes might be driven by these high fees or Poland’s debt approaching 55% of GDP which would constitutionally require that the government to “run a balanced budget”. The article indicates that the nationalization of the pension fund would reduce the deficit to 37% of GDP. (Argentina, if I recall correctly, similarly nationalized pension assets a few years ago; the article reminds me why robbers hold up banks-because that’s where the money is. So some might consider the QE-driven interest rates as another form of commandeering the assets of people in general (retirees in particular, though a less extreme case perhaps.).

In the Globe and Mail’s “Premiers’ summit to press Canada Pension Plan overhaul” Curry and Morrow write that “Premiers are planning to put Canada Pension Plan reform back on the national agenda when they meet this week at Niagara-on-the-Lake.” They also remind their readers that last December that “…Canada’s finance ministers agreed that officials should draft a plan in which higher CPP premiums to pay for more generous benefits would begin once the economy is stronger.” (Just to set your expectations correctly, no CPP change based on ‘fully funded requirement’ can have substantive impact for those already or soon to retire, without unfair cross-generational transfers (i.e. having your children pay for your retirement); the only exception is  some form of ‘longevity insurance’, i.e. either taking a cut in CPP benefits say between 65-85 in order to significantly boost benefits starting at age 85 so as to protect retirees against running out of money, or alternately allow the purchase of CPP based longevity insurance with a single premium paid at say age 65 and benefits starting at age 85.)

Things to Ponder

In the Financial Times’ “The temptation of the fund managers” Jonathan Davis asks why fund managers get paid so well when all the available data suggests that they add, at best temporary but more likely,  little or no value. He observes that given this pay anomaly we would no doubt be surprised if this career didn’t attract “new and less scrupulous breed of employee, more intent on personal wealth accumulation than fulfilling a mandate to manage money in their clients’ best interest”. The article discusses the challenge of working in the best interest of the client rather than oneself “in the face of powerful financial incentives”, and the challenge for the client to “measure or to judge” whether his interest came first. (The article appears to have been triggered by last week’s Bloomberg article on the oxymoronic “Wall Street ethics” mentioned in the Hot Off the Web- July 22, 2013 which felt the Wall Street may have been besmirched by an improperly run survey of industry insiders. ) But Davis notes that we don’t have to feel sorry for professionals, like bankers and lawyers who have often been paid “extravagantly” for jobs not as “worthy or deserving as they are made out to be”.

And finally, in IndexUniverse’s “Emerging markets look attractive” Rob Arnott (after making the usual pitch for fundamental indexing) concludes with his views on emerging markets arguing that with current Shiller P/E of 13 they are vastly cheaper than the US market as a Shiller P/E of 24. And yes there are risks but also opportunities.