Contents: Active management a pseudoscience, signals that adviser behaving badly, paying too much in fees, SEC backing away from broker fiduciary level of care? target-date fund problems, Canada house prices up, condo hell, own vs. rent in Toronto, talk of longevity insurance in Canada? UK financial industry in upheaval due to non-mandatory annuitization, Mom’s winning retirement plan? advisers outsourcing tasks, bond ladders? Dividends vs. total return in decumulation, pension funds get private-equity pay-off, momentum investing, dumb investors? bias curse, commoditization of investment industry.
Personal Finance and Investments
In the Financial Times’“We do not need 80% active management”Michael Johnson reports on the latest UK sourced “independent and damning evidence emerged that skewers any justification that active fund management”. The report calls active management “a web of meaningless terminology, pseudoscience and sales patter… (in which) ludicrously expensive talent is deployed in the pointless pursuit of continually trying to outperform one another…a negative-sum game”.
In the Globe and Mail’s“How to know when your adviser is behaving badly” John Heinzl notes that while there is value to working with an adviser, there are unethical ones out there and you must educate yourself sufficiently to protect yourself. Things to watch out for: being pushed to take loans to enhance returns, inadequate disclosure of returns and fees, forecasting future returns, in addition to the other usual junk products (e.g. principal protected notes) and excessive trading.
In the WSJ’s “You’re paying too much in fees” Moyer and Light look at fees and their impact. Some high impact items mentioned were mutual funds (US average annual cost 1.25%) vs. some ETF covering similar asset space (fee of 0.04%) leads to $200K investment returning 8% over 30 years resulting in $1.4M vs. $2M, cost of financial advice 1% of assets vs. fee-only planner charging by the hour or even using a robo-adviser (e.g. LearnVest, Wealthfront or Betterment). Other examples covered include savings opportunities when buying a home.
Is the SEC backing away from pursuing a common fiduciary standard for brokers and registered investment advisers (RIAs who already have a fiduciary responsibility)? In “SEC’s Gallagher: Fiduciary debate biased against brokers” Melanie Waddell reports that SEC Commissioner Gallagher calls the debate whether SEC should write a “rule for to put brokers under fiduciary mandate is “not fair right now” because of mismatch in exam data between brokers and advisers”. (This makes absolutely no sense. Congress gave the SEC the necessary authority to insure that brokers are required to act as fiduciaries, just as RIAs are already required to do. Anyone wanting to call themselves an “adviser” rather than “salespersons”, the fiduciary requirement should not even be open for debate; “advisers” must be fiduciaries, salesmen, as we all know, are not.)
In Bloomberg’s “The retirement fund that people set, forget and regret” Ben Steverman writes that people don’t understand that target-date funds, currently an acceptable default in 401(k) plans, are intended to be an “all-in-one solution”. “But it won’t work unless all of your money in the plan is in the fund. Mix and match with other plan funds and odds are you’ll end up with just the wrong amount of risk.”Right now that’s not what is happening. (This ‘simple’ solution is also complicated by the fact that not all target-date funds have the same stock allocation glide-path, whether they are intended to be ‘to’ or ‘through’ retirement funds; it is more complicated than it seems, so more guidance is required.)
Canada’s April 2014 Teranet-National Bank House Price Index was up 0.5% during the month of April and 4.9% over the year for the 11-City composite which reached an all time high. Calgary recorded the highest in-month increase of +1.5% as well as the highest YoY increase of +10%. MoM/YoY changes in Toronto were +0.5%/+5.8%, Vancouver +0.5%/+9.0%, Montreal +0.8%/-0.4% and Ottawa +0.7%/-0.4%.
In Macleans.ca’s“Condo hell”Tamsin McMahon does a pretty good job describing problems with Canadian condo living indicating that “neighbour disputes, crazy restrictions and incompetent boards, condo dwellers are increasingly finding themselves boxed in”. (Florida condo living is no different, except Canadian snowbirds pay a disproportionately higher property taxes for identical units as their neighbours.)
Garth Turner in his recent “Market update” blog looks at a couples’ sell-and-rent vs. continue sitting in a $1.2M home in Toronto’s bubble priced market; he says it’s a no-brainer given the lower cost of renting a similar or better property and opportunity to add over $1M into their liquid assets.
Pensions and Retirement Income
In BenefitCanada’s “Who is concerned about de-accumulation anyway?” Alyssa Hodder reports on (Canadian) decumulation options for DC plan members discussed at a breakfast meeting with marketing and product development primes from a couple of Canadian Life Insurance companies. Products mentioned included cashable guaranteed minimum withdrawal benefits (GMWBs…the only one that I’ve seen worth buying is the one offered by Vanguard in the US only) and non-cashable deferred annuities (I haven’t seen specific examples of these deferred annuities). The article notes the availability in the US of target-date funds, managed-payout funds and in-plan auto-annuitization (yes-if unavailable in Canada they should be made available despite of challenges that come with them). The article also notes the lack of availability of longevity insurance type deferred annuities starting at age 85 (this is what I’ve been advocating for the past decade, it’s available in the US for about 5–years or so but nothing in Canada.) The article suggests that there are challenges for these longevity insurance products such as “setting a realistic withdrawal rate, as well as tax issues” …(didn’t say why other than) “you can’t actually build such a solution in Canada today because members are required to make withdrawals before age 85”. (I don’t understand the specifics of the problem.)
The UK investors and financial industry are about to go through a major upheaval with the UK government’s decision to eliminate the requirement to annuitize accumulated assets upon retirement. The race is on to identify new investment products aimed at decumulation phase of the investment lifecycle and to figure out what’s the most cost-efficient way to provide advice/guidance which is in the best interest of the retiree/investor, and even to figure out the difference between guidance and advice; the regulators are concerned that investors may not fully understand the differences between guidance, simplified advice, non-advised, fully advised. Here are two articles discussing this subject “Pension ‘mess’ looms, warns Royal London” and “Watchdog eyes ‘guidance’ websites” in the Financial Times.
In Reuters’ “Why moms-and all women-need a winning retirement plan” Mark Miller reminds readers on Mother’s Day that women tend to “have lower income on less time in the workforce…as a result, they have less in savings, lower Social Security benefits, and they live longer than men. Those things don’t go well together.” Miller recommends for a Mother’s Day gift a “chat about retirement planning”. (Canadian women have it even worse as CPP/OAS benefits are significantly less generous than Social Security, even though we have been told that Canada’s retirement system has one of the lowest levels of poverty in the developed world. But, is being above the government’s poverty line, the standard against which we want to measure our mothers’ retirement success?)
Things to ponder
In Reuters’“When investment advisers outsource” Robyn post reports that a new trend is emerging among CFPs whereby they outsource administrative and investment management tasks allowing the adviser to spend more time with clients. Risk tolerance is assessed by the adviser who then matches it with one of the portfolios offered by the outsourcee. “Hiring a third-party provider to handle anything from portfolio construction and management to rebalancing, compliance, research and back-office support has been a fast-growing trend among advisers over the past decade” (and most importantly independent custodianship of the assets). The cost of the services mentioned was of the order of 0.45%, so there is still room to the adviser to charge for his value added services. (Interesting trend, which suggests that these advisers don’t feel they can add much value on the investment management side, which makes sense but then the follow-on question is why not just go whole-hog passive approach to implement the asset allocation driven from the clients’ risk tolerance?)
In InvestmentNews’ “Bond ladders for fans of portfolio safety” Jeff Benjamin reports according to some portfolio managers “When it comes to fixed income, we believe that safety always trumps yield, and going for more yield always compromises safety…(and) proponents of bond ladders say the tried-and-true strategy works in all cycles if safety is your guide”. They specifically suggest now a “zero-coupon US Treasury bond” ladder “maturing at regular intervals over a 10-15-year period”.
In ETF.com’s“Rethinking dividend strategies” Larry Swedroe discusses dividend strategies in decumulation vs. a total return approach where you will need to sell stock to meet your retirement income needs. He also refers to a Vanguard paper on this subject entitled “Spending from a portfolio: Implications of a total-return approach versus an income approach for taxable investors”. The recommendation “is to use a total-return approach, with the investor first deciding on an asset allocation that is based on his or her unique goals and objectives, and their ability, willingness and need to take risk. “This decision should be the investor’s highest priority.” Investors should then stick to their plan, rebalancing along the way as needed.”
In the WSJ’s“Pension funds wrestle with what to do with cash from private equity”Michael Wursthorn reports that massive amount of capital is flowing back to US pension funds from earlier private equity investments whose managers were able to sell the private companies in the strong public equity markets. Most pension funds were doubling down in private equity and were reinvesting much of their winnings but some are concerned that the gravy tray won’t last and actually decreased their allocation and perhaps it’s a good time to “take some money off the table”. The article also notes that “private equity firms are sitting on a mountain of cash to invest.”
In the Financial Times’“The hard facts about momentum investing” John Authers discusses momentum strategies triggered by a new Clifford S just published Asness paper entitled “Fact, fiction and momentum investing”. Momentum investing “refers to the propensity for relative winning stocks to keep winning, and losing stocks to keep losing”. The data shows that momentum works. However investors are uncomfortable with momentum investing as it “has nothing to do with fundamentals of a company, and much more to do with human propensity to extrapolate the flimsiest trends into the future.” Momentum keep moving stock prices in one direction, until of course it reverses but momentum investors have demonstrated that they can set up automated strategies they keep making money. (I haven’t read the paper but sounds like worth doing so.)
In the WSJ’s “Just how dumb are investors” Jason Zweig reports that the latest Dalbar study indicates that the “average investor in all US stock funds earned 3.7% annually over the past 30 years, while the S&P 500 stock index returned 11.1% annually”. The dominant reason for the difference in returns is due to investors’ behavior- they pile in after a big price run-up and then pull out after the big drop. Interestingly, other studies also show that investors underperform the funds they invest in but the difference is only a couple of percentage points; the difference is methodologically based. While one can argue about the size and the source of the difference, investor behaviour is the driver of the level of the underperformance; in fact Zweig notes that investor could even outperform their “fund if you add money when the markets fall and stand pat (or trim a little) when markets are on the rise.”
And much of investors’ underperformance is explainable by behavioural flaws that humans have. In the Economist’s “The bias curse” Buttonwood does a great summary of investors’ behavioral biases discussed in Bob Swarup’s “Money mania: Booms, panics, and busts from ancient Rome to the great meltdown”. (This quick read is a great reminder of our potential failings.)
And finally, The Economist’s“Will invest for food”discusses the massive changes undergoing the investment industry with its growing commoditization. Three factors are driving the commoditization: low cost passive ETFs now with $2.5T invested globally, smart-beta indexing with $330B (“though some dismiss it as a fad” for example an AdvisorPerspectives blog“Smart-beta makes me sick” quotes William Sharpe saying at last week’s CFA conference that “smart beta strategies must eventually do no better than the market”) and the shift to DC pension plans where a growing proportion of the assets flow in index funds.