Contents: A stockpicker’s conversion, inadequate savings, estate planning docs, can’t beat the system, U.S. home sales slow, “private webcast” for Nortel bankruptcy trial? federal and provincial pension reform talk again, advice on annuity or lump sum? Canadian middle class richer than Americans, even minor index composition changes degrade index fund performance, beware of ‘hedgefundification’ of active investing, hedge funds don’t protect against systemic risks- but cause them!

Personal Finance and Investments

In the NYT’s“The Re-education of a Brash Young Stock Picker” Ron Lieber tells story of Randy Kurtz’s journey from money management at Wall Street firms to private money manager who charged nothing unless he beat the S&P500 and one-third by which he exceeded it. While he made money for his clients and himself with this arrangement, he wasn’t able to “promise them that the outperformance would continue”, i.e. there always is a question whether outperformance was a result of luck or skill.  He has since had a “conversion “ (“capitulation”) from a stock picker to someone who mostly buys index and exchange traded funds for his clients”. He now plans to put most of his clients’ money in index (Dimensional Funds) and exchange traded funds, though he currently favors active management for international bond funds and he does sometimes shift his portfolios to favor certain asset classes.” (Thanks to EF for recommending.)

In WSJ’s “If you are not saving, you’re losing out” Jonathan Clements reports that the 2008 financial crisis driven increase in savings rate to 8.1% was just a blip. Savings averages 11.1% for 35 years ending in 1984, but then fell to as low as 2.6% in 2005. The 2008 blip was followed by 6.1% in 2009 and dropped to 4.5% last year. Clements writes that while this is good for the economy, “how will they pay for retirement”? Unless you are out of work or paying off debt, there are no valid excuses for inadequate savings, which he defines as anything less than 12-15%.

Tom Lauricella in WSJ’s “Four estate planning documents everyone should have” lists the four estate-planning docs required for everyone: a will, a durable power of attorney (an agent to act on legal/financial matters when you are incapacitated), medical power of attorney (designating individual to make medical decision for you when you can’t) and a living will (end-of-life care wishes).

In the NYT’s “Investors trying to beat the system invariably are disappointed” Carl Richards reminds readers that risk and return are inseparable; trying to time the market or investing in “clever” financial products which are CD-like but higher return are a waste of time; “ Investors make a similar mistake every time they try to make stocks feel safe like bonds or try to get bonds to generate big returns like stocks… a lot of our investing behaviour comes from these unrealistic expectations”

Real Estate

In Reuters’“U.S. home resales hit 1-1/2 year low, but may be stabilizing” Lucia Mutikani reports that  according to the National Association of Realtors, U.S. median home prices are up 7.9% YoY, but sales are off -7.5% compared to March 2013 and were down 0.2% during March of this year. The March 2014 sales annualized to 4.59M level was the lowest since July 2012. The realtors suggested lower affordability due to higher prices, unusually cold weather, and higher mortgage rates. The WSJ’s “U.S. new-home sales plunge 14.5% in March” reports a 14.5% drop in new home sales during March and a 13.3% drop from March 2013, which is attributed to median prices of $290K or +11.2% higher prices than in February, and lower inventory due to the harsh winter slowing down new construction. The WSJ also reports that “Demand for home loans plunges” to a 14-year low due to “interest rate spike”.

In Palm Beach Post’s“Home prices rise in March, but not as swiftly”Kimberly Miller reports that according to realtor association data Palm Beach County MoM median home prices dropped -3%, but YoY increased +6%; this was the first single digit YoY increase in over a year. “…sales volume continued to grow with 1,369 closed deals countywide representing a 34 percent increase from February and an 8 percent jump from March 2013”. “Statewide, March’s median sales price was $173,000 on a single-family home, a 7 percent increase from the previous year and 5 percent higher than February.”

Pensions and Retirement Income

Peg Brickley’s WSJ blog entitled “Nortel prepares private broadcast of $7.3B cash trial” she reports that Nortel is proposing to spend over $1M on a “private broadcast” the creditors’ court fight, starting on May 12 and scheduled to run about 6 weeks, but this will only be accessible to “authorized users”. “Nortel’s “authorized users” are the legal and professional firms that have tapped the bankrupt and defunct company’s coffers for more than $1 billion in fees (how unconscionably sick and stupid is that!?!), and who will be able to log in from the comfort of their homes and offices to view the courtroom action…Meanwhile, members of the public, including thousands of Nortel retirees and disabled workers who lost benefits and pay in the company’s collapse, will be barred from the webcast. If they want to know what’s going on, they must travel to Toronto or Wilmington, Del., at their own expense… will likely be relegated to a “gallery” courtroom where they can gaze at the courtroom action on monitors.” Those interested to “watch” may go to the Court House at 393 University Avenue in Toronto. (Thanks to Bert Hill for bringing to article to my attention.)

Pension reform talk is again heating up, primarily driven by Ontario’s renewed push to go alone, if necessary, to start to deal with Canada’s private sector pension crisis. I just came across the Ontario Government advert“Ontario pensions and retirement savings”whichexplains why pensions are important, how private sector employees are particularly exposed and why Ontarians need to save more now to reduce the burden on future generation of taxpayers and government budgets. A great pitch for the immediate need for pension reform action. Responding to the pressure from the Ontario initiative, in Globe and Mail’s “Ottawa opens door to new shared-risk pension plans” Bill curry reports that the “Conservative government is throwing a new (?) idea into the heated debate over pensions…plans that share the investment risk between employers and employees.” This target benefit plan proposal is aimed at Crown corporations and to all federally regulated private sector (e.g. transportation, banking and telecom) companies. This proposal would reduce cost to employers and water down existing DB plan benefits, but may improve benefits to those without DB plans; target benefit plans are a half way house between DB and DC. The article notes that “other provinces, including Ontario, have already passed legislation to allow such plans in companies they regulate”. Also in the Globe and Mail is Janet McFarland’s article “Expanded CPP essential to boost Canadians’ inadequate savings” reporting on a new study prepared for the Ontario government by Dodge and Dion which calls for “an expansion to the Canada Pension Plan to boost retirement savings, but says many Canadians also need access to new voluntary savings options like the proposed Pooled Registered Pension Plan program”. The report notes that an expanded CPP would have a small near-term economic impact “relative to the longer run benefits of a more adequate retirement income and higher potential output and consumption”.

In Reuters’ “Helping clients choose annuities or lump sums” Ed McCarthy explores the challenge of making the annuity vs. lump sum decision. A 2012 Towers Watson survey indicates that “among retirees of similar wealth and health, those with annuitized incomes were happier than those without annuities”. McCarthy notes that the happiness would be short lived given that even in low inflation environment the purchasing power of the pension will be eroded; “Fixed incomes are like aging knees: what works at age 65 won’t get you nearly as far at 80.” But financial advisers also have to deal with their built-in conflict of interest whereby lump sum would generate fees while an annuity would not. One advisers starts with age and life expectancy from IRS tables (though insurance companies indicate that the self-selected annuitant population has higher than average life expectancy) and calculate the internal rate of return, which he then compares with the return that he might be able to generate investing the funds. Another indicates that based on calculations, “for those with normal health and normal longevity expectations, it doesn’t make sense to annuitize in most cases”. Other considerations driving to lump sum include: lack of flexibility, it is all taxable, upon death heirs get nothing, and upon bankruptcy of employer pension may be reduced (even for the U.S. private sector pensioners protected by PBGC but protection capped thus affecting larger pensions). But advisers must also consider clients’ risk tolerance which might override lump sum advantages; ultimately client’s preference of inflation risk vs. market risk is determinant of lump sum vs. annuity.

Things to ponder

In the NYT’s“The American middle class no longer the world’s richest” Leonhardt and Quealy report that “While the wealthiest Americans are outpacing many of their global peers, a New York Times analysis shows that across the lower- and middle-income tiers, citizens of other advanced countries have received considerably larger raises over the last three decades. After-tax middle-class incomes in Canada — substantially behind in 2000 — now appear to be higher than in the United States. The poor in much of Europe earn more than poor Americans.”

In the Globe and Mail’s “Index funds, passive? They trade too much” Norman Rothery reports that even S&P500 index fund returns are affected by trading when they are required to adjust for changes in the index composition due to corporate events like mergers, companies with better prospects and other changes in order to maintain the index as representative of the overall market. Even though only 3% of the stocks are swapped in such changes, various experiments (Siegel and Schwatrz’s Long-Term Returns on the Original S&P 500 Firms) show that minimizing historical S&P500 changes resulted in about 0.5% (11.4%  vs. 10.85%) higher returns and about 1% (15.72/16%  vs. 17.02%) lower standard deviation, i.e. “the less active portfolios achieved both higher returns and provided smoother rides than the index itself”.

In the Financial Times’“Investors should be wary of creeping hedgefundification” Stephen Foley explores whether index and exchange traded funds will crush the traditional active fund manager, or new investment theory and coming end of easy money will result in the emergence of a more aggressive form of active management which he calls “hedgefundification”; he also wonders whether this will be good for “end investors”. Examples mentioned are emergence of “unconstrained” bond funds which can go anywhere domestic or emerging markets, junk and derivatives, long and short. Such changes require investors to do as much due diligence as when investing in hedge funds. Investment theory now leans toward a “barbell approach” of cheap index funds for the core with trimmings of “more aggressive alpha generators”. However as more and more money uses the hedge fund-like approach this is a zero sum game and returns will be much lower as there is less money managed “traditionally” that they can try to game. Also increased market volatility is predicted and the asset management industry will try to expand its margins due to this “hedgefundification”.

And finally, in the WSJ’s “The systemic risk of hedge funds” Al Lewis discusses a “new study showing how hedge funds threaten the financial system”. The new Fed study by Reint Gropp indicates that “More important than commercial banks or investment banks, hedge funds may be the most important transmitters of shocks during crises…(and they) may amplify systemic risk more than previously thought.” The initial tremors of the 2008 crisis were visible when two Bear Stearns hedge funds collapsed in 2007. These “glorified mutual funds for the rich…charge exorbitant fees…The great ones outperform the market for a time, but are destined to hit patches of underperformance. The mediocre ones often shut down quietly in the night.” Investment strategies range from illegal insider trading to Ponzi to legitimate schemes, but they have underperformed the S&P500 (at least) since 2009 low. The $3T hedge fund industry is unregulated, new funds often pull in billions of dollars in a short time and then amplify their effect with massive borrowing; then when they run into trouble their need to sell billions to cover margin calls which “can set off a damaging chain reaction”. Hedge funds are so named partly because they’re supposed to “hedge” against systemic financial calamity. Instead, as the Fed letter warns, they cause them.”