Contents: Advisor vs. adviser and advice, self-delusions, negative rates: lower returns and deflation? withdrawal strategies, Canada home prices higher but slowing? minimizing tax when transferring assets, 401(k) automation, pension plan funding levels, actuarial insanity, longevity insurance, smart-beta? un-real assets? ETF ratings: G/PG/PG13/R/NC, “decline of moral capital”, technology driven discontinuities- not necessarily for the good.

Personal Finance and Investments

Jin Won Choi in his “Is your financial advisor deceiving you?” blog writes that “According to the laws in Canada, anyone licensed as a financial adviser (note the ‘e’) owes a fiduciary duty to their clients. However, most financial advisors in Canada go by the designation advisor, which doesn’t bind them to the fiduciary duty…This fact allows a financial advisor to say, with a straight face, that financial advisers are obligated by law to have their clients’ best interest at heart, and at the same time sell products that line their own pockets at the expense of the client.” (Thanks to Larry Elford for referring. I have never actually seen this ‘adviser’ (‘fiduciary’) vs. advisor’ (‘suitability’ rather than investor’s best interest standard) stated this explicitly, in the Canadian context (in the U.S. the RIA vs. broker-dealer is very explicit). There are such ‘adviser’ categories in various Canadian regulatory regimes which apply to discretionary portfolio managers, which might be another way of skinning the fiduciary cat, but you’ll may or may not have to go somewhere else to get your financial plan, and you might not get a lower cost passive portfolio implementation. See PMAC portfolio managers who develop a client IPS and operate on a fiduciary basis for institutional and private clients with investable assets >$500K.) As an aside  those interested in the subject of getting financial advice, you might consider looking at a couple of recent articles on the subject in the MoneySense.ca’s  “Find the perfect financial planner” in which he discusses 3 legs of the financial advice stool (planning, investment advice and execution/implementation) and Globe and Mail’s  ‘The flaws in Canada’s financial adviser system” which discusses investment industry: conflicts of interest, clients assuming fiduciary level of care, how brokers/salesperson get paid, investor difficulty to evaluate the quality of the advice and what they’re actually paying for. (By the way, neither of these two discussed or made a distinction between adviser and advisor, unless I missed it.)

In the WSJ’s “Two costly self-delusions” Jonathan Clements warns that “Expecting Money to Buy Happiness, and Trying to Beat the Market, Can Hurt You”. He presents data showing the untruth of these and argues that these behaviors are bad for our finances. Neither the “hedonic treadmill” (the pursuit of the next promotion and more money) will lead to happiness, nor “looking for patterns, working hard, minimizing the chances of loss and mimicking the behavior of others” will help us sustainably beat the market.

In the Financial Post’s “Important lessons for Canadian borrowers and investors in Europe’s historic plunge into negative interest rates” Jason Heath warns that Canadians near or in retirement should consider themselves warned that thinking that Canada’s low interest rates “have nowhere to go but up” may not be so, and that “double-digit portfolio returns can’t be counted on when doing your retirement planning. Stocks have performed reasonably well in recent years, but low interest rates, low inflation and low growth are becoming increasingly prevalent within the developed world”. In the context of the potentially ongoing low interest and lower than historical returns “those who are close to or into retirement need to evaluate what a sustainable withdrawal rate is from their investment portfolio to ensure they don’t outlive their savings.” Martin Wolf in the Financial Times’ “Draghi has pulled another rabbit out of his hat”discusses Europe move into negative interest rate territory and opines that “Further falls in inflation are likely and Japanese style deflation is conceivable”. However the WSJ reports today that the two US inflation measures CPI and the PCE deflator are up to 1.6% and 2.0 respectively!

And speaking of sustainable withdrawal rates, in the WSJ’s “How to manage your retirement withdrawals”Walter Updegrave discusses not just the pressure on the “traditional (inflation adjusted)” 4% rule to become the 3% rule to have assets last 30 years, but also research suggesting that “retirees’ outlays may actually decline by as much as 20% after inflation as they age” (in real terms drop about 1% per year). Additional challenges are the unknowns like: market returns, health-care costs, how long you will live. The challenge is to stay flexible and find the balance between spending too much and running out of money at one extreme and spending too little and regretting not having done some things but ending up with a large pile of assets, at the other. The starting point for any sensible plan is “creating a retirement budget, which you can do online with a tool likeFidelity’s Retirement Income Planner or Vanguard’s Retirement Expenses Worksheet”, then factoring in sources of lifetime income, and for some if necessary considering an annuitywww.immediateannuities.com.

Real Estate

The May 2014 Canada’sTeranet-National bank House Price Index “rose to an all-time high, but only three of the 11 metropolitan markets surveyed did the same. In May the index is up +0.8% MoM and +4.6% YoY. Highest YoY increases were Toronto (+6%), Vancouver (+8.2%) and Calgary (+8.7%), while in negative territory were Ottawa (-1.4%), Montreal (-1.2%), Halifax (-0.4%) and Quebec (-1.6%)

In the Globe and Mail’s “How to transfer cottage ownership and reduce taxes”Tim Cestnick looks at ways to reduce taxes when transferring recreational property ownership such as: “keep track of major improvements” to maximize adjusted cost base, leave to spouse on death (tax is deferred), transfer while alive and have future gain accumulate to children, life insurance to cover taxes, and other mechanisms.

Pensions and Retirement Income

In Bloomberg’s“They just reinvested your 401(1) for your own damn good” Ben Steverman notes that “the hottest trend in 401(k) plans is making investing easier for employees”. “On the assumption that many workers invest all wrong, some employers are overriding their workers’ existing selections. Unless employees object, companies are re-enrolling them in new funds, usually in target-date funds with risk profiles suited to their age.”

In the Globe and Mail’s “Employee pension plans see rapid rebound, assets surge”Janet McFarland reports a67% increase in assets since the 2009 bottom (Interesting but not very useful piece of information). In a later article  “Largest pension plans in corporate Canada enjoy healthy funding”McFarland reports that median funded level for Canada’s 25 largest public company pension plans has increased to 97%, with aggregate shortfall declined from $21B to $5B. Significant elements contributing to the funded status of pension plans are: asset price changes, interest rates (used to discount liabilities), employer/employee contributions, plus changes in actuarial “assumptions”. (Bankrupt Nortel’s Canadian pension plans are still underfunded by about 40% as the plan assets apparently were immunized against interest rate changes sometime after bankruptcy and thus market losses were likely locked-in near their lows.)

In the Economist’s “The big bill” the Buttonwood column looks at pensions and illustrates the criticality of the actuarial “assumptions” referred to above. According to Mercer, the U.S. corporate sector pension plans are 84% funded while according to the PPF UK plans are 91% funded. For U.S. state and local plans funded level is only 72% (compared to 103% in 2001). The catch is that liabilities are calculated by discounting future pension promises at the assumed rate of return, currently 7.7%”. (Neither the 7.7% return, and certainly not the use of return rates to discount liabilities makes any sense at all; this approach means that increasing the risk on your assets results in a reduction of your liabilities.  I called this before “actuarial insanity”; they probably call it getting paid). The article continues discussing deficits and changes required on a going forward basis.

In the NYT’s “Buying a guaranteed retirement income, for some peace of mind’ Tara Siegel Bernard looks at the growing interest in “pure longevity insurance” (e.g. single premium at 65, and lifetime income stream starting at 85. By the way, this type of product still not available in Canada yet would be a great business opportunity for insurance companies with a ready market worth perhaps $1B in the next 12 months just from Nortel pensioners who’ll shortly have the option to choose annuity or lump-sum.) Prices quoted from New York Life in the article for a 68 year old individuals and couples to purchase a $12K/year annuity (without any guarantees) is $170K/$181K/$207K for male/female/joint immediate annuity, but only $39K/$48K/$61K if purchased at age 58 to start lifetime income at 78 (and even less starting at 85). In addition to New York Life, Mass Mutual and Northwestern mutual are also mentioned as U.S. sources for such products. (Good article which should be read by insurance companies with product in Canada, but then the three companies mentioned (perhaps not coincidentally) are all “mutuals” where policyholders as the owners, so they are naturally looking for the best products for their customers (you know that ‘fiduciary’ thing that mutuals do like Vanguard); publicly owned insurance companies prefer to sell what’s best for their shareholders, by definition! What a difference.)

Things to Ponder

In the Financial Times’“Is ‘smart beta’ smart enough to last?”John Authers discusses some of the arguments about traditional dumb index funds (‘beta’) which “accept prevailing valuations unthinkingly” and ‘smart-beta’ algorithmically driven funds “exploiting anomalies in stock valuations to try to beat the index”.  Bill Sharpe argues that they are nothing but factor bets or explicit active investing, and they are unlikely to work if everyone does it. Furthermore Sharpe “who believes active management is futile, has some solace. “I used to worry: what if there’s too much indexing? But human nature means people keep on backing active managers.””

In ETF.com’s “Swedroe: Go international to be diversified” Larry Swedroe discusses the importance of diversifying internationally, even though in the past five year U.S. markets have outperformed. Diversifying economic and political risk can be achieved by allocating 30-50% of equity holdings internationally (currently 10% is typical). He recommends that to maximize benefits the international stock holdings should be unhedged. But he warns that the international allocation will be of limited value unless there is a regular rebalancing to target allocation.

In the Financial Times’ “A reality check on the charms of real assets” John Plender reports that despite tremendous demand for inflation linked bonds even at negative real interest rates, yet he calls this “odd” given that falling nominal rates would suggest “lower growth or even deflation” and falling real assets like commodities and gold. Yet real-estate and timber have still been going up. His conclusion is that “the real asset category has little meaning”.

In Investment News’ “This ETF is rated R” a movie-like rating system is proposed for ETFs (after Blackrock’s Larry Fink lashed out at leveraged ETFs as being capable of blowing up the industry; as you can imagine, leveraged ETF providers disagree but they are probably wrong “BlackRock criticism riles leveraged ETF providers” ). The ratings might look as follows: G= capitalization weighted developed market stock and bond indexes, PG=non-cap weighted/”smart-beta”/active ETFs hoping to outperform and physical asset backed ones, PG-13= ETFs tracking more exotic assets like emerging markets/junk bonds, alternative strategies, etc, R= “not suitable for retail investors” e.g. derivative based, leveraged, volatility products, and NC_17= leveraged ETNs the double whammy of leverage and credit risk! (great list!)

In the Financial Times’“The secular decline of moral capital” John Plender writes that “As long as incentives are at odds with ethics, common decency will be a minority pursuit”. (This reminds me of the Upton Sinclair quote: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”) He then drives the point home with examples of: “facilitating tax evasion”, market rigging (Libor, foreign exchange, gold) and underpaying insurance compensation. The result has been “immense personal enrichment and a paucity of prosecutions of people at the top” with the financial system becoming an “ethics-free zone”. He places the blame on: the replacement of “paternalistic corporate capitalism” with the “pressure cooker…which…required to deliver progressive rises in short-term earnings” and the move to performance-related pay and incentives tied to equity values”. Wrong incentives lead to wrong results.

And finally in Bloomberg’s “10 Surprising ways your daily life is feeding the big data beast” Robertson and Milian lists “10 examples of how technology is trawling your life, combing your digital refuse for something valuable” and the Telegraph’s“The coming digital anarchy”in which Matthew Sparkes describes howBitcoin  “technology threatens to eradicate social networks, stock markets, even national governments. We are heading towards an anarchic future where centralized power of any kind will dissolve”.