Contents: Buffett: buy and index fund, retirement investment tools, universal life still problematic, is CIPF over-rated? retirees advised to leverage? fund investor returns trail fund returns, U.S. housing up 12.8% YoY but Las Vegas/Miami still >40% below peak, Canada’s no-bubble housing bubble, house auctions don’t need agent, investors compete with families for housing, provincial finance ministers agree on conditions for CPP expansion, Teachers’ Leach advocates for saving BD plans, Buttonwood on pensions: “save yourself; save more”, DB plans good for economy, dealing with financial impact of increasing longevity, banks/insurers/pension funds struggle with low interest rates, Dimensional: “If risk was always rewarded then you wouldn’t call it risk”, demographics and excess capacity to continue to drive low interest rates and low returns, passive vs. active? from hedge funds to indexing, low inflation and low growth leaves Eurozone with default as only solution to debt? broker-dealers appropriate $50B of investor assets each year!

Personal Finance and Investments

In the Financial Post’s “Warren Buffett’s advice to amateur investors: Don’t make this common mistake”  he recommends that investors: shouldn’t try to time the market or try to flip stocks (a la high frequency traders) “the best thing the average investor can do is buy an index fund over time”.

In WSJ’s “New tools for nest eggs” Robert Powell provides some useful links to access (U.S. based) services such as annuityreview, wealthfront  and betterment to ease retirement investing.

Leslie Scism in WSJ’s “Universal life policies hurt by low-rate era” discusses an example of potential problems with universal life policies. In her example a couple purchased a $2,000,000 policy and recently they were given the choice to “put up tens of thousands of dollars to keep the policy alive at its existing face value or reduce the death benefit sharply”; in this case to reduce benefits to $658,000 rather than the original $2M. These policies typically promised a tax-deferred investment component coupled with life insurance. Interest is paid on deposited amount into the policy account (often even included a minimum interest) and insurance company withdraws annually the typically increasing cost of the life insurance component from the account. With the ultra low interest rate environment, many of these policies risk depleting the account value rapidly and policyholder needs to make unexpected premiums to keep original insurance in force and/or they must reduce the amount of insurance. (Some years ago I looked at some Canadian universal life policies in an old blog post at  Universal life and the picture wasn’t very encouraging in that context.)

In The Financial Post’s “Costly advice: Canadian Investor Protection Fund difficult to tap” Barbara Shecter discusses the history and challenges of actually getting the protection implied by the name of the Canadian Investor Protection Fund (CIPF) which is backed by the IIROC and intended to compensate individual investors up to $1M for losses resulting from insolvent investment firms. But “Since 1971, CIPF has returned just shy of $36-million to investors, with more than 40% of that paid out following the demise of a single firm, Osler Inc., in 1987.”

Barbara Shecter also discusses in the Financial Post’s “Costly advice: Leveraging was new to me” how an inexperienced retired couple was persuaded by their financial ‘adviser’ to “borrow $200,000 and try to invest their way to a more comfortable life in their golden years… Instead, they have found themselves no richer from their investments and more than $30,000 in debt after borrowing money on a line of credit to get out of the much larger loan they realized they could not repay.”  The article discusses: leverage, concentrated/risky investing, questionable adviser designations, adviser conflict of interest, commissions/fees, the debate about fiduciary responsibility, the difficulty of getting redress via the financial industry’s self-regulatory bodies. (It’s not news, but worth retelling over and over again, until it is fixed. In the meantime caveat emptor!)

In WSJ MoneyBeat’s “How investors leave billions on the table” Jason Zweig writes that “investors underperformed their U.S. stock funds by 1.6 percentage points annually between 1991 and 2004… So find a financial adviser who favors a handful of highly diversified funds rather than a jumble of narrowly focused, volatile funds. Make sure he tends to hold on for at least three years at a time.”

Real Estate

The August 2013 S&P Case-Shiller Home Prices Indices show a 12.8% YoY price increase and “Composites showed their highest annual increases since February 2006. All 20 cities reported positive year-over-year returns. Thirteen cities posted double-digit annual gains. Las Vegas and California continue to impress with year-over-year increases of over 20%…Denver and Dallas again set new highs. All the other cities remain below their peaks. Boston and Charlotte are the two MSAs closest to their peaks with only 8-9% left to go. Las Vegas is still down 47.1% from its peak level… average home prices across the United States are back to their mid-2004 levels”. To get a sense of the Florida numbers, Miami is up 14% for the year, up 23% from November 2011 through, but still 41% lower than the 2006 peak.

In the Financial Post’s “Canada won’t interfere in housing market- for now: Flaherty”  Louise Egan reports that  “The Canadian government has no plans for now to clamp down on the housing market even though prices are rising again…” With the central bank signaling that interest rates will stay low due to low inflation and slow economy, house prices are expected to “reaccelerate”. In fact some people might be considering variable rate mortgages. And as to the ‘no-bubble’ housing bubble in the Globe and Mail’s  “Welcome to the bubble: Central banks drive global real estate higher” Brian Milner looks at the housing bubbles around the world driven by central bank created financial repression and argues that they should know better than expect any but a housing bubble. He argues that that the inevitable will follow and house prices will fall even in supply-constrained markets. Also in the Globe and Mail David Parkinson writes in “Poloz boxed in as embers of overheated housing market flare up” that with Canada’s central bank continuing to hold rates very low, the upward trajectory of home prices is unlikely to change. And by the way the latest report in the Financial Post’s “Housing market firing up again as Toronto sales leap 19%” Garry Marr reports that “Sales in the Greater Toronto Area jumped more than 19% in October from a year ago…Prices also continue to be strong. The average sale price in the GTA was $539,058 in October, up 7.4% from a year ago.” Will finance minister Flaherty intervene?

The WSJ’s “Auctions: Do you need an agent?” discusses auctions for homes and whether an agent is required. Typically an agent is not required, though you must find out in advance and comply with the auctioneer’s process: financing must be in place before the auction, as well as whatever inspection you might wish to do must also be done before. Property sales are either reserve (subject to seller approval) or absolute (highest bidder takes property independent of price.) Closing is essentially immediate “So if you change your mind, you will lose your deposit—and, depending on the auction house’s rules, may even have to bear the cost of reselling it.”

In Bloomberg’s “Families blocked by investors from buying U.S. homes” Kathleen Howley reports that 14% of home sales were to institutional buyers, while 49% of sales were all cash. “Both investors and traditional buyers are trying to snap up cheap homes before prices go higher, but the investors have the advantage of paying cash and not having to go through a convoluted mortgage process…People are being bid out of some markets because of investor demand.”

Pensions and Retirement Income

Clearly (at least) talk pension reform is back on the table.

In the Globe and Mail’s “Provinces reach agreement on CPP reform conditions”  Adrian Morrow reports that provincial finance minister reached agreement on the four conditions that an expanded CPP must meet: “Enhancements would have to be fully funded, have a limited effect on businesses that would have to pay higher rates, improve retirement payouts for the middle class, and protect low-income earners.” However the ministers did not agree on a specific implementation, though they did agree to study the matter. Some worry about the timing of the expansion so that it shouldn’t affect the economy; others worry about the impact on companies but Canada’s Federation of independent Business wants none of it. BenefitCanada’s “Finance ministers agree on CPP reform conditions” indicates that it is understood that “any CPP enhancement should be responsible and fully funded and focus on today’s workers; moderate the short-term effects on businesses, families and the economy; improve the future retirement incomes of middle-income earners; and protect lower-income workers.” (With all the feverish talk about pension reform a la “expanded CPP” there is little or no indication at this time that any value will flow to those near or already in retirement. Hopefully this will change or government better start planning for higher OAS/GIS payments- see Jim Leech comment below. I plan to do an expanded CPP problems and solutions blog post in next couple of days.)

In the Globe and Mail’s “Canadian workplace pensions are under threat. Can we save them?” Rob Carrick interview Ontario Teachers’ Pension Plan head Jim Leach  about his new book with Jacqui McNish  entitled “Confronting Our Pension Failures” in which “The book is… totally persuasive in its argument that workers, unions, politicians and business need to collaborate on ways to help people better prepare financially for retirement. Most importantly, it offers pragmatic solutions that have worked to solve pension challenges in places such as New Brunswick and Rhode Island.” The book discusses the most exposed group which $30K-100K wage earner largely unprepared for retirement and unless solutions are found the government will have to increase OAS and GIS which are taxpayer funded. Also discussed is the disappearance of private sector DB plans, even though they are cheaper than DC plans because of professional management, lower costs and pooling of longevity. To preserve the essential advantages of DB plans some flexibility is required to allow benefit changes, i.e. some employee/employer risk sharing. Leaches book supports an enhanced CPP as a way to compensate for inadequate savings for retirement.

In the Economist’s “Save yourself” Buttonwood writes that with more and more companies abandoning final salary DB for DC plans where all risk is shifted to employees, but the latter don’t seem to have increased their contributions to compensate for the change. “This either means that a) they have no spare income to contribute, b) they are indifferent to a sharp fall in disposable income in old age or c) they are unaware of the problem and will get a nasty shock. One suspects the answer is a combination of a) and c)… people find the whole issue too complicated and just give up. But just as today’s twentysomethings may regret those tattoos as their skin wrinkles in their 60s, they may regret not thinking more about their pensions. Save yourself; save more.”

Leo Kovilakis in “New study on the benefits of DB pensions” does a great summary of a new report which suggests that “DB pensions provide significant benefits to Canadian economy”. In the BCG study commissioned by OMERS, Teachers, HOOPP it estimated that only “10 to 15% of DB beneficiaries collect the GIS, compared with 45-50% of other Canadian retirees” and DB “recipients contribute $14 – $16 billion annually to government coffers across Canada through income, sales and property taxes”. The reports discusses other benefits including  “The two most significant advantages DB plans offer members are pooling longevity risk and pooling asset risk. “ (Given the disintegration of Canada’s private sector pension system, public sector plan managers/beneficiaries roll out full court press to protect public sector plans? Where were all these studies over the past 20-30 years as private sector DB was disappearing?)

In the Financial Post’s “You are going to live longer, but just how long is anybody’s guess” Fred Vettese recommends that since life expectancy is increasing, in addition to taking better care of ourselves, one should consider: working longer (for one’s financial and mental health), consider annuities in particular if interest rates increase, take some risk with investments (GICs just guarantee losses at current 2% rate), postpone CPP and OAS to age 70 to get a boost of 42% and 36% relative to age 65. (Advice well worth considering so long as one realizes that: (1) annuities are just a trade-off between longevity and inflation risk, especially prior to age 75, (2) while GICs might lock in the 2% interest rate for 1-5 years, an annuity lock the current low rate in for life, and (3) if you are in the fortunate position of being near OAS claw-back range the increased OAS/CPP resulting from taking them later may turn out to be an illusion due to having shifted the lower OAS/CPP income stream from a lower to a much higher effective tax rate regime. Tough choices everywhere for retirees living in an era of financial repression, and who knows, this may last longer than we expect or that sanity justifies as it’s just too convenient for debtors/governments to receive a wealth transfer from creditors.)

In BenefitCanada’s “Public sector pension reform includes retirees” Jana Steele writes that “When considering changes to pension benefits as a part of a strategy to address an underfunded pension plan, plan sponsors have tended to focus on changes that would only impact active plan members—with retiree entitlements often considered “off limits.” However, with underfunded pension plans, inter-generational equity issues and taxpayers’ wrath becoming of increasing concern to Canadian governments, there appears to be a greater willingness to explore alternative solutions that broaden the impact of pension reform to include all plan beneficiaries.”

In the Globe and Mail’s “Pensions, insurers brace for pain in wake of new tack on rates” Kiladze, McFarland and Nelson bemoan the impact of continued low interest rates signalled by the Bank of Canada and its negative impact on pension funds, insurance companies and banks, not to speak of pensioners and those who are trying to accumulate retirement savings (and of course the housing bubble driven by the low rates).

Things to Ponder

In the Financial Times’ “With a little help from his Nobel friend” Ellen Kelleher looks at Dimensional Advisers (and its CEO Booth) which the recent Nobel winner Eugene Fama uses as a quasi-laboratory. Fama got his Nobel in part for arguing how difficult it is to “predict direction of markets”; his colleague Ken French showed that certain “factors other than beta, namely a company’s size as measured by market capitalisation and its book to market ratio, a measurement of its price, influence the ups and downs of share prices.” The article discusses how at Dimensional they don’t shut down funds which underperform because they understand that “they won’t outperform in every period”.  “When our results are disappointing, we say it is because risk was not rewarded over that particular time period…If risk were always rewarded, you wouldn’t call it risk.”

In the Globe and Mail’s “Krugman, Gross spat highlights end of financial era” Scott Barlow discusses the reduced need for investment due to developed countries being able to “produce more than is demanded” which is further aggravated by the demographics of a smaller proportion of the peak spending 40-49 year old age group. “We are facing a prolonged period of weaker consumption and slower growth that suggests both low interest rates and low returns on investment. The finance industry’s role as an aggregator of savings for large scale investors will also decline.”

In the Financial Times’ “Pay-offs and perils of passive investing” John Plender argues that even though active managers have a tough time beating the market after costs, passive may not be all roses. Even though passive is “cheap and transparent” but it is “just another form of momentum investing”. So if, as Robert Shiller suggests, as “behavioural blind spots affect market prices, the capitalisation of both the market and of individual companies may part company with underlying value”. Also, passive investing is anything but contrarian in nature, an important factor in successful investing, and the author argues that index approaches are unnecessarily over-diversified. Plender argues that index based bond investing makes the least sense, as issuers in most financial difficulty will be selling the most bonds; definitely not a contrarian approach; he adds that so called “smart beta” approaches try to overcome the above mentioned problems with passive indexing, but they just end up introducing other biases.

On the same topic in IndexUniverse’s “Ex-Hedgiefinance.yahoo now on index crusade” Paul Amery discusses a book by Lars Kroijer entitled “Investing demystified” with the objective of explaining why index investing is the rational approach for almost all of us… combining investment theory with practical advice on how to construct a rational portfolio. His book also covers financial planning, pensions and insurance and how and when to ask for specialist help.” He believes in traditional market cap-weighted indexing. He also notes that indexing works best in “active, liquid markets” with active managers setting the correct price, but he is not worried that with the increasing popularity of indexing fewer active managers remain to set ‘correct’ market prices, because only “15% of global equities are owned by indexes”.

In the Economist’s “The disinflation phenomenon” Buttonwood, referring to very low 0.7-0.8% inflation numbers in Europe and America, writes that “It seems likely that central banks will maintain their very loose monetary policy; they can justifiably claim that, with inflation under control, they can focus on unemployment. For investors, this may mean more support for equities. But it is worth noting that falling inflation rates are now making real bond yields positive again; food for the many bond bears to ponder.” He concludes with “…if you can’t grow your way out of a debt crisis, you must inflate the debt away or default. Well, the euro zone is not growing very fast and it is not inflating; that leaves default as the most likely option.”

And finally, in InvestmentNews’ “The $50B heist” Rudy Adolph reports that according to a Cerulli Associates study “Wirehouses destroy close to $50 billion in portfolio value each year. That’s some 100 basis points in lost value that could be in their clients’ portfolios, and isn’t. It is $50 billion these clients are paying away in the form of unnecessary fees (which they may not even know are there), or depressed performance based on poor product choices, combined with high expense levels. Or both.”