Hot Off the Web- Sep 22, 2014

Contents: Disability insurance? Cleaning the portfolio clutter, how to burn $100 bills, a universal fiduciary requirement would eliminate RIA’s competitive advantage? robo-advisers in Canada, look around before renewing mortgage, best portfolio protection? equity indexed annuities (EIAs)? inheritance secret, Canada house prices up: 0.6% in month and 5% in year, Toronto/Vancouver house prices insane or not? private sector pensioners in Canada screwed again, living abroad cheaply??? Calpers exits hedge-funds, active managers still don’t make the grade.

Personal Finance and Investments

In the NYT’s “Looking out for yourself with disability insurance” Ron Lieber discusses the need for “long-term disability insurance” or more appropriately perhaps called “income replacement insurance” in particular, but more generally the growing trend of shifting responsibility (cost and selection) for complex financial decisions (investment and insurance) to individuals who are unqualified to make the decisions. He notes that it started with the move from “pensions to retirement accounts”, then health insurance, and next is long-term disability. The article mentions a new start-up PolicyGenius aiming to provide insurance advice (and sales) which offers an overall five-minute insurance checkup online (I haven’t tried it as it requests too much personal info) and they “attempt to sell long-term disability insurance online that is especially groundbreaking”. Lieber notes that “…we live in a world with an increasing and frustrating tendency to push people into making big financial decisions on their own, often before the experts themselves know what the right ones are. In that regard, the education that PolicyGenius is providing is a true public service, regardless of whether it ultimately succeeds as a business.”

In the WSJ’s “Clean up that cluttered portfolio” Tom Lauricella suggests that over time your portfolio needs a major cleanup just like your garage. Specifically “trimming back on brokerage accounts and consolidating old retirement plans. Niche investments can be pruned, as can investments inherited from relatives that have an emotional tie but make no financial sense.” But iris important to execute the process in a way that doesn’t generate “unwanted tax bills”.

In the WSJ’s “How to throw away a fortune” Jonathan Clements looks at strategies which are guaranteed to waste a fortune over your lifetime (just like burning $100 bills); among these are: delay start of saving for retirement, not taking advantage of the employer match, buying active rather than passive mutual funds, paying (20%) interest on credit card balances, buying a new car every 3 years.

In InvestmentNews’ “Looking for middle ground in a fiduciary solution” Liz Skinner reports that some investment advisors (RIA’s in the US) are worried that a uniform fiduciary standard for advisers and brokers is not only difficult to define but also would result in RIAs essential differentiating advantage (i.e. that they are fiduciaries who act in clients’ best interest) compared to brokers (who are not fiduciaries and are not held to a clients’ best interest standard). (That is true, however clients (at least the retail ones, though I suspect they are not the only ones) appear unable to differentiate between advisors who are and are not fiduciaries since they all call themselves advisers/advisors. I am not worried that RIAs couldn’t compete, after the real value is added in the least automatable piece of the advice puzzle which is the Investment Policy Statement; few brokers do it, even fewer like to do it and even fewer know how to do it.)

In the Globe and Mail’s “Robo-advisers have arrived (and may be just what your portfolio needs)” Rob Carrick looks at robo-advisers in Canada and writes that robo-advisers have “been stuck with an unfortunate nickname that may do it more harm than good”. He mentions: Nest Wealth, Wealthsimple, WealthBar and ShareOwner and notes that “you should expect to pay something in the area of 0.6 to 1 per cent of the value of your account on an all-in, annualized basis”. Carrick argues that, while these offerings typically (though not always) are missing the financial planning component, they are a better option that going with a mutual fund salesman, or a “haphazard portfolio of mutual funds sold at a bank branch” or incompetent DIY investing. Still he notes that for many “It’s a big leap to give your money to an online firm you’ve never heard of and trust the people there to invest it intelligently for you.” (I think over time, “robo-adviser” name will turn into an advantage as people start to realize that low-cost automated rebalancing and tax-harvesting is far superior than the false hope of active management peddled by many brokers. Where advice can add value is in the customized Investment Policy Statement (financial plan), which few clients actually receive.)

In the Financial Post’s “Renewing your mortgage? Here’s why you should pick up the phone” Ted Rechtshaffen warns that Canadians should never accept their bank’s mortgage renewal offer without shopping around for the best rate at your and other institutions. In his personal case his bank’s offered renewal was 4.79%, compared to 2.79% at a competitor and his own bank’s 2.99% best rate when you called for a 5 year renewal term.

In the Financial Post’s “How to put protection on your investment portfolio” Martin Pelletier considers three ways to protect current portfolio gains: ”reduce positions and lock in the profit”, implement stop losses” or “buying a put option, which is similar to an insurance policy”. He opines that the put option is the best right now since puts are cheap and you can protect (some or all of) your downside, yet allow you to participate in the upside. (The other approach that you can consider is to just rebalance your portfolio periodically to your strategic asset allocation, as this will not only keep your portfolio risk consistent with your risk tolerance, but will force you to sell more expensive appreciated assets and replace them with currently cheaper assets; trying to time the market is a loser’s game.)

And speaking of protecting the downside with insurance in’s “Looking under the annuity hood” Larry Swedroe looks at equity indexed annuities and compares them with an alternative strategy for portfolio risk reduction by using a combination of: a lower stock market allocation, within the stock component increasing allocation to small and value stocks in US and developed world, while in the bond component only using “highest quality fixed income investments”. He then shows how 30%, 40% and 50% equity allocations outperformed the equity indexed annuities in 8 of 9 5-year periods looked at. His conclusion is “EIAs will continue to be popular because commissioned-driven advisors and insurance salespeople love them… Historically, however, such a strategy (like the proposed alternative to EIAs) has greatly reduced a portfolio’s risk while allowing investors to maintain the portfolio’s expected returns and retain a significant portion of the upside.”

In the Globe and Mail’s “Living in retirement: The last best-kept secret is the inheritance” Joyce Wayne explores the reluctance of sharing information about the (size and distribution of) inheritance with the beneficiaries. (This could be an interesting discussion in itself, whether to share or not such information.) But then Wayne points to her situation where her mother who knew nothing about investments and died of dementia10 years after her father, upon the death of Wayne’s father, handed “her portfolio over – lock, stock and barrel –– to a trust company, which charged dearly to manage her money… In my mother’s final will, the one the trust company encouraged her to compose, the managers became the trustees of the estate and it was not until I turned 50 that I could inherit her money without multiple strings attached. If I had inherited it immediately upon my mother’s death, I could have paid off my mortgage 15 years sooner. Other members of my extended family faced similar quagmires, and in the process, watched their inheritance shrink through fees and questionable investments.” (This is another unpleasant example of some in the financial industry exploiting the elderly. Still the example illustrates that when financially feasible/safe (i.e. there are sufficient assets relative to retirement needs), it really does make sense to consider distributing some of the planned inheritances when impact on beneficiaries’ financial health is the greatest.)


Real Estate

The August 2014 Teranet-National Bank House Price Index  indicates that Canadian home prices increased +0.6% during the month of August and 5% in the past 12-months. Calgary (+7.9%), Toronto (+6.7%) and Vancouver (+6.1%) increased more that the index, while Montreal (+1.1%), Ottawa (+1.2%) and Quebec (-0.1%) underperformed it.

In the Financial Post’s “Toronto and Vancouver’s red-hot housing markets aren’t as ‘insane’ as they look, says CIBC’s top economist” Jonathan Ratner reports that predictions of “house prices to fall significantly…surface every year, but when the results don’t materialize, people are quick to say “wait until next year.”” A CIBC report suggests that “The vast majority of gains have come at the upper end of the price spectrum. Yes, this applies to the most expensive cities to live in Canada – Vancouver and Toronto – but more notably in their urban cores, as opposed to lower-priced alternatives in the suburbs.” Much like in Manhattan “there is no room to expand the single family housing stock anywhere near these cities, which translates into long commute times for homeowners… But land scarcity, and poor transport from distant suburbs, helps make the insanity of Canada’s house price climb look just a bit less insane”

Pensions and Retirement Income

In the Globe and Mail’s “U.S. Steel Canada files for creditor protection” Greg Keenan reports that the company was granted CCAA protection. This was the ex-Stelco operation purchased by US Steel in 2007, after “Stelco went through a protracted and bitter restructuring under the CCAA that began in 2004, at the time citing a looming pension deficit.” In US Steel’s CCAA filing they show $837M solvency deficiency on the pension fund, and other employee benefit liabilities of $788M. In another Globe and Mail article Greg Keenan writes that “The Ontario government faces a potential bill of $400-million to bailout U.S. Steel Canada Inc. pensioners if the steel maker’s pension plans are not restructured …”  The Financial Post’s article on the same subject “U.S. Steel Corp’s Canadian unit files for creditor protection” Andrew Mayeda notes that “U.S. Steel acquired its Canadian operations in 2007 when it purchased Hamilton, Ontario-based Stelco Inc. for $1.1 billion. The Canadian government sued U.S. Steel after it said the company hadn’t complied with pledges it made on spending and output. The two sides settled in 2011.”  (If I recall correctly the Canadian government suit was launched because incentives the government has provided came with some strings attached which were not met by the company. How many more Canadian companies have to go bankrupt leaving pensioners with significant pension reductions, before the Canadian government will step up to the plate and fix the worst pension protection system among developed nations in the world?!? Watch this space to see how this will unfold, but expect nothing and won’t be disappointed. Fortunately for Stelco workers/pensioners they are Ontario based and Ontario is the only province in Canada which has even a minimal protection (for the first $12,000 of pension).)

Things to Ponder

In the Globe and Mail’s “The live cheaply abroad retirement plan: A reality check” Ian McGugan writes that Canadians asks whether living in “a low cost, tropical paradise where $30,000 a year can put a couple into upper middle class” meets the reality test, when you factor in that costs might actually be comparable for the same absolute living standard (i.e. Canadian middle class standard), and local environmental factors, even though you can  live cheaper like a local. And certainly, don’t sell everything and move somewhere, without having been there repeatedly for extended stays before, just to make sure that you can adjust to the culture shock (“new holidays and new expectations of polite conduct”) and differences in “medical and legal systems”.

In WSJ’s “Calpers shows masters of Hedge-Fund universe have no clothes” Justin Lahart reports that the $298B Calpers fund is dumping its entire $4B hedge-fund position. The reasons are many: consistent underperformance compared to a benchmark 60% stock and 40% bond portfolio (and this applies to the hedge-fund tracker HFR composite index as well), during the 2008-2009 crisis it only bettered the benchmark with a 19% vs. 22% loss, like other active management schemes some managers outperform but it’s very hard (impossible (?)) and very expensive to (try to) identify them a priori, and increasingly difficult to sustainably outperform with 2/20 fee structure, and with $2.8T of assets chasing such strategies it has become a crowded trade. Even if one could figure out a way of a priori identifying those who might outperform, one would have to invest a significant portion of a portfolio’s assets to make an overall difference in return (resulting in more risk, lower liquidity, etc).  In the Financial Times’ “UK pension fund criticises hedge fund fees” Miles Johnson discusses the growing disaffection with hedge funds among UK pension plans.

And finally, in the Economist’s Revenge of the active manager Buttonwood, in the interest of fairness, presents both sides of the argument and gives airtime to an active manager’s defense of active managers’ performance, arguing that in the 5 year period ending in 2013 “only 40% of active managers underperformed the UK index”; but Buttonwood adds that it was “probably because small and medium sized companies (those not in the big indices) did well. His bottom line is consistent with what others have argued based on the facts: outperformance by some managers is possible but it is not persistent, the outperformers can only be identified in retrospect, and while indexes will not always be the best “but it will be more often than not”. This was likely triggered by the latest SPIVA report, discussed in “Active managers still failing”, which shows that “2,804 equity mutual funds chasing U.S. stocks, 60 percent of them failed to beat a simple benchmark. Over the three-year period, 85 percent failed to beat a simple benchmark. Remember, this is raw performance, not even adjusted for risk… (and) in general, most active managers take more risk than a neutral benchmark” (Do you still own and/or are you still buying mutual funds or rely on your or your broker’s stock-picking ‘skill’? You recall the definition of insanity…doing the same thing over and over again and expecting a different outcome.)


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