Hot Off the Web- January 13, 2014

Contents: Advisers don’t understand ‘alternative funds’, travel health insurance claim denied? rising equity glide-path in retirement, Canada real estate industry: “no landing, no slowdown, no correction”? pension funds eliminate underfunding but Nortel pensioners still 40% underwater, old 60:40 allocation still good- just remember to rebalance, not just index funds but portfolios built on them better, cross-generational inequity due to chance not policy, Medicaid for millionaires? European deflation? emerging markets are definitely heading down or up or staying flat, Wolves of Wall Street: tigers can’t change their stripes but may peddle new products.


Personal Finance and Investments

The New York Post reports in “Financial advisers admit: We need ‘alternative’ advisers” that “75 percent of advisers surveyed by Natixis Global Asset Management admit they themselves need more education when it comes to understanding and explaining alternative investments such as hedge funds and long/short equity funds”. (But fund companies in search of new revenue sources, with ETFs stealing a growing market share from actively managed funds, ‘alternative funds’ might be the answer to fund management industry’s rent-seeking ways: more complexity, less transparency and higher fees in investors’ search of the new holy grail of diversification and higher returns.) An example of fund families expanding into ‘alternatives’, Jason Kephart reports in IndexUniverse’   “Invesco makes big push into alternatives” on the launch of “all-cap market-neutral fund, a global-market-neutral fund, a U.S. long/short equity fund, a global-macro long/short equity fund, an international-macro long/short equity fund, and a global macro fund”.  In InvestmentNews’ “Finra keeping pressure on complex products in 2014” Schoeff and Braswell write that even Finra, the financial industry self-regulator, is concerned; “Finra remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles, including their sensitivity to interest rate changes, underlying product or index volatility, fee structures or complexity may be challenging for investors to understand…” (So perhaps we need neither ‘alternative’ advisers, nor ‘alternatives’, just qualified/competent advisers who have the investor best interest as fiduciaries.)

In the Financial Post’s “Five reasons your insurance travel claims will be denied” Mark Halpern’s list of reasons includes: missing information, failure to secure preapproval before treatment, and buying cheaper coverage with longer list of exclusions.

Pfau and Kitces in The Journal of Financial Planning’s “Reducing retirement risk with rising equity glide-paths” explore the “appropriate default glide path during retirement…(and) the results show that rising equity glide paths from conservative starting points can achieve superior results, even with lower average lifetime equity exposure”, contrary to the traditional constant or decreasing with age allocation to equities. (Of course portfolio risk, with equity allocation as one of the key risk drivers, should be governed by the retiree’s personal risk tolerance which is likely to change a few times during retirement. (e.g. see my old Are “target-date” funds or age-independent “fixed-asset allocation” right for you? blog post where I discuss the challenges of target-date funds, and the difficulties of working with long-term default glide-paths in a world of changing market context and personal circumstances.) This article confirms that decreasing equity allocation with age is not the panacea that some have suggested. But rather than thinking about this as increasing equity glide-path in retirement vs. constant (or reducing) equity allocation, it also confirms that it makes sense to reduce the equity allocation (as one approaches retirement and) early in retirement to minimize the most damaging impact of much discussed and dreaded “sequence of return risk”. As to the model, I always struggle with default glide paths and/or inflation adjusted income streams (which this research assumes), because few real people “set it and forget it” for 30 or 40 years; individual circumstances change, and humans adapt to the changing circumstances.)

Real Estate

What housing bubble- not in Canada! The Financial Post’s “What soft landing? Bullish realtors see no slowdown at all for ‘strong’ housing market” reports that Royal LePage predicts that, after fourth quarter home price increases of between 1.2% and 3.8%, 2014 home “prices are expected to maintain a “healthy momentum“ this year and rise a projected 3.7% over 2013”. One industry insider is quoted as saying that “in the absence of “some calamitous event or material increase in mortgage financing costs,“ he expects positive momentum to characterize 2014… We expect no landing, no slowdown, and no correction in the near-term. Conditions are ripe for as strong a market as we saw in the post-recessionary rebound of the last decade.” (To some this might sound like a sure thing and others a Wall Street wolves style “pump-and-dump” or pumping up transactions to generate come commissions by Canada’s real estate industry- but I am not rushing out to buy any investment property.)

Pensions and Retirement Income

In the Financial Times’  “Pension funds beat actuarial targets” Steve Johnson explains how UK and US (and Canadian as well “Canadian pension plans post dramatic rebound” ) private sector pension plans have substantially recovered over the past 5 years. “The improvement was driven by a combination of strong equity returns and a rise in corporate bond yields, which allows schemes to discount their liabilities at a faster rate.”

As to Nortel pension plan beneficiaries, who have tended to draw the short straw in most bankruptcy court rulings so far, true to form also failed to benefit from pension plan recoveries delivered by the markets over the last 5-years. My understanding (if in fact correct) is that unfortunately the Ontario regulator required the immunization of the Nortel portfolio (i.e. essentially converting all assets to bonds to match assets and liabilities durations in order to protect portfolio against interest rate changes). This action would have had the effect of locking-in the 40% plan underfunding (at the worst possible time given the timing of the (January 2009) bankruptcy and the (March 2009) market bottom. If this actually did happen in this way, it was like closing the barn door after all the horses were gone, and it could have had the effect of selling all the equities at the market bottom; not a particularly brilliant strategy (certainly in retrospect). The only reasons that I can readily think of which might have driven this action would be: (1) to protect pensioners against further deterioration in funded status (if markets and interest rates continued their descent) and/or (2) perhaps  having to explain that additional losses occurred under one’s watch, (3) the expectation that the windup would occur in 4 months rather still not completed after 5 years, or (4) the expectation in early 2009 that the financial world as we know it was coming to an end. In any case the Nortel pensioners’ horror story seems to continue unabated.)


Things to Ponder

In IndexUniverse’s “Buckley: Rebalancing an investor’s blind spot” Drew Voros interviews Vanguard’s CIO Tim Buckley on questions like: does 60:40 stock:bond allocation still make sense? (Yes), do investors understand diversification? (No), and the importance of rebalancing which creates the discipline of “selling into euphoria and buying on the fear” as opposed to “just let it ride” by completely failing to rebalance or rebalancing too infrequently.

In IndexUniverse’s “A case for index fund portfolios” Ferri and Benke write that while “The success of index investing in individual asset class categories has been widely documented…(but) surprisingly little research is available that compares the performance of diversified portfolios of index funds with portfolios of actively managed funds.”  The article reports on work aimed to rectify this lack of research in the area and not surprisingly “The outcome of this study favors an all-index-fund strategy.”

In the Financial Times’ “Bad luck, not policy, is the scourge of the young” Janan Ganesh discusses what he calls the developing “generational faultline” in Britain due to the inequity between the old and young: the “old are seen to have done well from the economy and the state during their lives; the young are perceived victims” which he suggests to be more due to fortuitous “benign circumstances” than policy. He concludes that there are no guarantees of increasing prosperity of successive generations, and it is the politicians’ responsibility to tell it the way it is (rather than incite cross-generational strife.)

In WSJ’s “Millionaires on Medicaid” Mark Warshawsky explains how misleading Americans’ perception is that Medicaid only serves the poor. However, two-thirds of US long-term-care costs are paid by state and federal governments and “Significant long-term care benefits flow to individuals in the top 20% of retirement earnings, enabled by Medicaid’s generous asset-exclusion limits.” In some states $800K homes, assorted life insurance policies, unlimited retirement account assets, Social Security and DB pension plan income are not obstacles to receiving Medicaid support. “Despite these generous rules, some individuals even game the system further by arranging complex asset transfers or insurance transactions that sidestep congressional efforts to curb fraud.” He notes that “The current Medicaid long-term care program is neither equitable nor fiscally sustainable.” and includes four recommendations to remedy the situation.

In the WSJ’s “Where deflation risks stir concerns” Steven Fidler discusses the risk of European deflation, and the associated fear that it would be an obstacle to growth. In a deflationary environment borrowers’ real debt servicing costs increase, and nominal debt stays unchanged while incomes decrease. The problem in Europe is that Greece/Spain/Portugal/Italy are not just the biggest debtors but also the “slowest-growing, deflation-prone countries”. If they won’t be able to bear load more they’ll just have to default and cause collateral damage to the creditor countries as well, so Fidler sees much to worry about.

Of course it is well known that “forecasting is difficult, especially about the future”, but various Wall Street sources have been quoted in the past week predicting continuing lower emerging market stock and bond prices. Today Bloomberg’s “Skagen says ignore Wall Street, bet on emerging markets” argues the opposite thesis. (A few comments/questions here: first note the word ‘bet’ is appropriate since stocks are part of the risky portion of your portfolio, did ‘Wall Street’ provide the sell emerging market recommendation first to favoured/own customers to act upon before releasing to press? Is Wall Street preparing to buy at a lower entry point once gullible public accepts/acts-on their recommendations? Or perhaps it is just spreading FUD (fear-uncertainty-doubt), just another effort to persuade investors that index investing cannot succeed in emerging markets and you must instead buy their actively managed emerging market funds to benefit from their stock pickers’ wisdom? There may be several of these at play, but my most likely guess would be the latter. Other than rebalancing to my strategic asset allocation as needed, I tend not to react to every Wall Street analyst’s hot-air emission.)

And finally, in InvestmentNews’ “How many more wolves are left on wall Street” Bruce Kelly writes that “advisers and their clients may want to know… Could a Stratton Oakmont rise again? Is the American investing public better protected now than it was almost two decades ago?” Experts quoted opine that “Investors and securities regulators, to varying degrees, are more wise to pump-and-dump stock scams…and regulators are less tolerant.” But people continue to fall for various Ponzi schemes (e.g. Madoff) which is a reminder that “plenty of dangers remain in the marketplace, particularly involving the sale of single products” (perhaps rent-seeking ‘alternatives’?) and continued vigilance is required, even if less so against “pump-and-dump” today. The nature of the product pushed might be different but it is likely pushed by ‘wolves’ of similar character. (As to the movie, while it deals with some of the character of the perpetrators of financial scams, I can’t recommend it to those in search of better understanding of financial fraud or its impact on its victims. A sensible solution at least in general terms might be Bloomberg’s “Cut out the wolves of Wall Street with ETFs”.)


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