Hot Off the Web- April 14, 2014

Contents: Bond returns should interest rates rise? mortgaging home to invest? Canada housing starts off, private sector DB plans’ solvency ratios >95%, UK: free and impartial advice instead of mandatory annuitization, US: greater adviser roles needed in retirement transition, Ottawa’s hidden $120B pension deficit, investors’ bad choices, real interest rates to stay low, embracing longevity, smart beta is all marketing, advice industry changing.

Personal Finance and Investments

In WSJ’s “When bonds trump gold” Mark Hulbert writes that bonds performed “surprisingly well” in “past rising rate periods”. Between 1966-81, when 5-year Treasury rates tripled, a portfolio of 5-year U.S. government bonds returned 5.8%/year primarily due to higher reinvestment rates earned during the rising interest rate environment which “offsets the declining bond prices those rates cause”. And yes, bonds are better than gold in a rising interest rate environment.

In the Financial Post’s“Borrowing to invest? There are times when it makes sense, like now” Ted Rechtshaffen argues that since he can lock in five year 2.99% mortgages, giving him after tax borrowing cost of 1.6%/year at the highest marginal tax rate. He figures, based on historical five year periods, that the odds are acceptable with 79% of the time beating costs of borrowing and worst 5-year period being –6.64%. He concludes that “Borrowing at 1.6% after tax and investing in a diversified portfolio for five years, is a smart thing to do, and one that growth investors (who understand the risks) should be considering today.” In the opposing corner Martin Pelletier in the Financial Post’s “Don’t be fooled into mortgaging your home to buy stocks”warns that your home is part of your 1st bucket, i.e. lifestyle assets, which requires that you should pay off all debts against it; and in any case paying off a 3.5% mortgage is equivalent to a risk-free 5.8% before tax interest rate which you should compare against current 5-year GICs. He calls this a no-brainer.

Real Estate

In the Globe and Mail’s “Canadian housing starts, permits drop as market cools” Andrea Hopkins reports that housing starts dropped in both March to annualized rate of 156,823 or -17.7% below forecast of 191,000, and February was also revised downward to 190,639. “Value of building permits tumbled by 11.6% in February” MoM. Much of the drop was attributed to weather related factors. Also “Starts of multiple-unit dwellings, typically condos, plunged 26 per cent in March… Permits for multi-family dwellings plummeted 31.5 per cent”


Pensions and Retirement Income

In Financial Post’s “Good times continue for endangered defined benefit pensions: AON Hewitt:” Barbara Shecter reports that North American equity markets drove “remarkable recovery in the solvency of defined benefit pension plans last year” with plan solvency ratios at 95.4% “up 21 percentage points since first quarter of 2013”. (Nortel pensioners are out of luck again, being stuck probably near the 40% underfunded level at bankruptcy due to a decision by plan administrators and FSCO to asset liability match by converted all assets to bonds after bankruptcy to “protect” (under)funded status and therefore lock in the market losses at the 2009 market bottom.)

In the Financial Times’ “Doubt cast on Osborne’s pledge to revamp pension system” Alistair Gray reports that UK insurance companies, which are expected to be seriously affected by the government’s plans to stop mandatory annuitization of retirement funds, expressed doubts about the promise of “free, impartial, face-to-face advice”. (Get ready for the usual Fear-Uncertainty-Doubt” (FUD) to start emanating from affected financial industry players.)

In Financial Planning’s “No retirement crisis, but advisors’ help urgently needed’ Kenneth Corbin reports that, at a recent conference, retirement experts indicated that “an aging population and worries over Americans’ financial literacy argue for a greater role for advisors in helping workers plan for and transition into retirement”. The complexity of dealing with savings rates to achieve retirement objectives, ongoing asset management, sustainable withdrawal rates, longevity risk, etc are issues that most people are “terrified” to have to consider. This is further aggravated by presumed decline in financial literacy in retirement. The issues are complicated and are best addressed in a person-specific context.

Benefit Canada’s “Ottawa has hidden pension deficit of 120 billion, report says” reports that according to a C.D. Howe study “Using an economically meaningful fair market value estimate, Ottawa’s unfunded liability at the end of the 2013 fiscal year was some $120 billion higher than reported…Few taxpayers are aware of this burden or the risks they bear in backstopping these plans.” The article notes that the culprit is an underestimation of the value of liabilities which are discounted based on inflated expected returns rather than federal bond yields. (That’s about $4,000 for every Canadian.)


Things to Ponder

In Bloomberg’s “Why do investors make bad choices” Cass Sunstein (co-author of behavioural finance book “Nudge” with Richard Thaler) admits to falling prey to behavioural finance mistakes of: “availability bias” (recent events have greater weight on individual decisions even if the probability is low), “loss aversion” (people hate losses from current state of affairs “far more than they like equivalent gains”) and “probability neglect” (focus on worst-case scenario rather than its probability of occurrence). “…the best advice, for most people, is boring and simple, so here’s a nudge: Have a diversified portfolio, consisting in large part of low-cost index funds, weighted toward equities; add money as you get it, and diversify it as well; keep the cash you need; and otherwise hold steady.”

In the Financial Times’ blog “The future of real interest rates” Gavyn Davies shares some new IMF data showing dramatically growing public debt/GDP ratio for advanced economies now close to 120% yet global real long term interest rates dropped from around 6% in1983 to close to 0% today. Looking at these side by side he calls them a “stark contrast and a “conundrum for policymakers and investors”. The article discusses the questions of why the debt explosion has not led to a rise in real borrowing cost for governments and what about the future of real risk-free rates? His conclusion is the long-term real rates by 2018 will still be 1.25% and with a 2% inflationary expectation nominal rates will only be 3.25%, real short-term rates will also be well below 2% and worries about servicing the cost of outsized government debt (e.g. Japan, UK) was perhaps exaggerated.

In the Financial Times’ “Longevity is here to stay- embrace it” Emma Jacobs discusses some challenges to the “perceptions of the ageing population” such as: just as longevity improvements are health improvement driven then “70 is the new 50” with “active ageing” as the “vision of later life’, accompanied by rise in pensionable age, and working longer to” prevent social isolation”. She concludes with “we do older people a disservice if we expect so little of them and fail to engage them in society”.

In’s “Destroying smart Beta: Part 1” Elizabeth Kashner argues that lines are quite blurry between smart vs. dumb beta and the labeling is marketing driven. The author plans a series of articles built around “the smart beta wrecking ball” aimed at “radical suggestion that we ditch marketing labels and talk about what funds actually do”.

And finally, in InvestmentNews’ Special Report on “Advice industry at crossroads” has a collection of interesting articles covering:“Facing down the inevitable fiduciary standard” which argues that “Despite the regulatory inertia, the advice industry is inexorably moving toward what is effectively a fiduciary standard, as clients seek a relationship with their financial advisers that goes beyond securities transactions — and demands trust.” (Not sure that the problem is “regulatory inertia” or financial industry obfuscation of issues),“Goals-based planning takes flight” discusses advisers’ gradual role shift from investment management attempting to maximize returns to “goal-based planning…(to) reach specific goals, such as retirement”, “The wealth management industry at a turning point” looks at adviser roles, objective advice, technology to change client experience, changes driven by age of advisers and need for more women advisers, advising the entire human being not just her financial side, the need for fiduciary standard of care which is also discussed in an under 2 minute video “Why it’s up to the industry to solve the fiduciary standard issue” .


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