Contents: Are you a risk-taker? wealth and market reaction, robo-advisers: coming shakeout and driving “margin compression” for advisers? Real advisers like “financial physicians”, updating RRIF rules, understanding bond ETF yields, Canadian housing correction: don’t worry -be happy, South Florida housing market improving? Preventing early 401(k) withdrawals? actuaries finally recognize higher life- expectancies, return distributions are not risky but uncertain, best returning investment styles? shareholder value revolution destroyed bank clients’ interests, ETFs and bond market liquidity, have we dug out of the Great Recession hole yet? dangers of deflation?

Personal Finance and Investments

In the WSJ’s “So you think you’re a risk-taker?” Jason Zweig writes that “Nothing is more important for investors than learning how much they can stand to lose. But nothing is harder to learn—before it’s too late.” Risk tolerance measurement is one of the most difficult tasks, and financial advisors attempt to asses this via assorted questionnaires. But there is no good way to insure that one gets a good handle on one’s risk tolerance because one expert suggests that “the most damaging risk is…deviating from your long-term plan in pursuit of short-term emotional comfort in a time of unease”. Zweig recommends honest answers to these four questions will help assess your risk tolerance: (1) “what did I do in 208 and 2009?” (did you sell then?), (2) “how flexible are my goals?” (do you have spending flexibility?), (3) “what risks have I protected against?” (did you replace too much of your investment bond allocation with junk and emerging market bonds?), and (4) “have I turned rules into habits?” (stop looking at your portfolio value every time the market has a hiccup). And by the way the WSJ’s “Bad stock-market timing fueled wealth disparity” reports that “Millions of Americans inadvertently made a classic investment mistake that contributed to today’s widening economic inequality: They bought high and sold low…New research from the Federal Reserve and the University of Michigan shows the role that panic about the market played in widening wealth inequality…among the bottom 90% of households by wealth, families bailed out of the stock market between 2007 and 2010”.

In the Globe and Mail’s “How the pros deal with market selloffs” John Heinzl writes “Corrections are normal. They have happened before and will happen again. It’s never too early to start preparing for the next one by reviewing your asset allocation, reminding yourself to think long term and keeping some cash on hand to spend when great companies go on sale.”

In the Financial Times’ “Disruption arrives for investment managers” Pauline Skypala discusses the emergence of robo-managers in the investment world but she comments that even with all-in-costs (i.e. including underlying ETF management fees) of about 0.5% for robo and 1.5-2.0% for human investment managers, if algorithms can do the job of advisors, the investment industry is in for an even larger “margin compression” than the publishing industry. However she is betting against that, because of a track record of demonstrated “ability of the financial services industry to overcharge and under deliver, with much miss-selling along the way. Competition does not work to lower costs for investors”, though she admits that Vanguard had changed the competitive landscape in the US. In the Financial Post’s “Five reasons robo-advisors will give financial advisors a run for their money” Peter Hodson gives 5 reasons why robo-advisers will be successful: (1) while ETFs appear all the same robo-advisers will be able to differentiate their brands, (2) the value is in asset allocation and to calm nerves in crisis, which is exactly what they are promising, (3) lower cost, (4) some personal touch and (5) smaller accounts accepted. (My sense is that just as with indexing, many people are underestimating the power of an idea (and a capability) whose time has come. The good news is that the potential to cause damage by a robo-adviser is much lower than a human-adviser. On the upside the human adviser who takes a holistic view of the client, crafting a portfolio based on customized goals/objectives, risk tolerance, constraints, horizon, etc (as a good IPS based approach can deliver) executed at a fiduciary level of responsibility including risk mitigation beyond the investment portfolio (i.e. insurance needs) has an opportunity to more fully meet the clients’ needs, of course at a higher asset-base and/or price-point; these custom/personalized services would be in addition to asset allocation, portfolio implementation, automatic rebalancing and tax-minimization that robo-advisers are claiming to deliver with a TBD level of quality. By the way, as we are beginning to see, advisers can build their incremental deliverables on top of robo-tools.)

And the robo-advisor pressure is building further as described in InvestmentNews’ “Charles Schwab to launch free robo-adviser next quarter” where Mason Braswell reports that Charles Schwab is launching Schwab Intelligent Portfolio tool to be made “available free of charge to investors with $5,000 (!) or more to invest, will include 24/7 support from a licensed representative and will be white labeled to investment advisers who custody assets with Schwab later next year”. The article notes that this could disruptive to both the field of emerging robo-adviser companies and hasten a shake-out in the list of providers, as well as put pricing pressure on RIAs fees even if they are offering superior personalized service. In a related article in Financial Advisor’s  “Advisors at risk of losing lots of assets” that financial advisors “are ineffective in communicating their value proposition.” Unless advisors can articulate the value proposition, they risk the assets leaving when the assets pass to the next generation (or even having their lunch eaten by robo-advisors.)

And by the way, if you are interested in the attributes of an advisor should you need one the read in ETF.com’s “Your advisor should be like a top doctor” where Larry Swedroe based on a  Meir Statman (author of highly recommended book “What investors really want”) presentation  explains why the best financial advisors should think of themselves as “financial physicians”. Swedroe concludes that “if you decide to hire a financial advisor, be sure that: (1) they are educators, (2) the only thing they are selling is advice, not a product, (3) they provide fiduciary standard of care, (4) their advice is based on science, and (5) their investment plan has been integrated into an overall financial plan that includes estate and tax strategies.” (Very good advice on advice…if you are not getting these you should be asking your advisor what are getting for your advice dollars.)

In the Globe and Mail’s “Why Canada needs to update its RRIF withdrawal rules” Rob Carrick discusses some of the pros and cons of minimum annual RRIF withdrawal requirements. He quotes one expert’s presentation to the Common Finance Committee that “A RRIF withdrawal schedule suited to today’s world would allow seniors to withdraw less per year and max out at 15 per cent… lower RRIF minimums would affect the government’s cash flow in the near and medium term, but he believes the long-term impact would be neutral at worst.” “Our argument isn’t that the RRIF minimum is evil…It’s that the minimum hasn’t kept up with changes in life expectancy and interest rates.”  By the way, the government’s significantly downsized income splitting promises were announced allowing an up $50,000 split for those with children under 18 but with a $2,000 tax benefit cap as described in the Globe’s “Tories set to announce income-splitting tax break “ .

In the Globe and Mail’s “You might want to double check the yield on your bond ETF” Rob Carrick reminds readers about the difference between distribution yield and yield-to-maturity (YTM), only the latter is the one that reflects the total return, the former excludes bond price changes (decreases) due to current interest rates being lower than the coupon rate.

Real Estate

For a much less pessimistic perspective on the Canadian housing market, here is Baskin Wealth Management perspective in “Is the Canadian housing market due for a correction?”  where David Baskin looks at three arguments for each of: (1) why house prices too high (price-to-income, price-to-rent, house prices doubled in 10 years), (2) why house prices not too high (low carrying cost, high demand from immigrants and foreign buyers, price/SF not high compared to world cities) and (3) why not to worry too much about house prices (lenders conservative, no short-term upward mortgage rate pressure, law discourages high mortgages and default). Baskin argues that while he doesn’t know direction of housing market he is “convinced that there is no real possibility of the kind of credit crisis that engulfed the US housing industry from 2007 to 2009….Canada will most likely muddle through”. (He has an illustration of how monthly costs would vary as interest rates increased from 3% to 6% to 12% for $400K, $300K and $200K mortgages would result in monthly costs of $1,893, $1,919 and $2,063. It might have been a fairer comparison to use $400K, $340K and $305K which are the residual mortgage values upon renewal at the higher rate at end of 5 and 10 years, which would have resulted in monthly payments of $1,893, $2,175 and $3,147. But point made that significant interest rate increase would be required to dramatically affect monthly payments, doubling won’t do it. Of course should the economy go south significantly and unemployment would increase by several percent, a job-loss would significantly affect ability to pay mortgages in Canada where ‘non-recourse’ mortgages don’t exist like in the US; non-recourse mortgages are now spreading to Europe according to the Gillian Tett Financial Times article entitled “The jingle that sounds the road to economic recovery”.)

On the other hand is the Globe and Mail article entitled “Canadians spend more income on housing than almost anyone in the world” where Roma Luciw reports that “The global investor pulse survey, released Thursday morning by money manager BlackRock Inc., found that “many Canadians feel that they are in a financial squeeze – hard pressed to save amid what they perceive as a high cost of living, including devoting much of their income to paying for their homes.”… Only the Netherlands and Sweden had higher housing costs, at 51 per cent and 45 per cent, respectively”. But then, on the other other hand is the Globe and Mail’s “Toronto condo market sees one of its best years” which indicates not only is this one of the best condo market years, but 84% of condos in development have been presold with “Average selling prices rose by 3 per cent from a year earlier, to $555 a square foot, while those for unsold units increased by 2 per cent to an average $571.”

In Sun-Sentinel.com’s “Housing market improving in South Florida, Freddie Mac says” Paul Owers reports that Freddie Mac’s MIMI (Multi-Indicator Market Index) for August suggests that “housing market in South Florida still has plenty of room to recover, but it is one of the most-improved metro areas in the nation”. MIMI is used “to measure four key factors in local housing markets: home purchase applications, affordability, mortgage delinquencies and employment. A score below 80 shows weakness, Freddie says. A perfect score is 100.” Florida is at 69.2.

Pensions and Retirement Income

In the NYT’s “Combating a flood of early 401(k) withdrawals” Ron Lieber writes that “Over a quarter of households that use one of these plans take out money for purposes other than retirement expenses at some point. In 2010, 9.3% of households who save in this way paid a penalty to take…” $60B out compared to the almost $300B added. While some do take money out because they have lost jobs or want to take a big vacation, experts believe that most take the money out because they have significant bills to pay and people don’t fully understand the consequences of doing so. One solution that seems to work to some extent is calling people when they try to withdraw assets; apparently about a third of those who take the call decide not to complete the planned withdrawal.

Benefits Canada’s “Society of Actuaries releases new mortality tables” reports that the  SOA’s just released updated mortality tables indicated  that US life expectancy improved for 65 year old males from 84.6 (2000) to 86.6 (2014) while for women from 86.4 (2000) to 88.8 (2014); “SOA estimates there could be a 4% to 8% increase in private pension plan liability” (Finally the increases in longevity will have to be officially recognized by pensions plans and will start to drive somewhat higher employer contributions, but they were kept low long enough to allow many companies to end their DB pension plans over the last 15 years before having to recognize this. Higher life expectancy numbers (by about 2.5-3 years) are typically used for annuity pricing justified by “adverse selection” for the annuitant population. Lots of work is still needed to strengthen pension funding rules and improve transparency of annuity pricing, both in Canada and the US.)

Things to Ponder

In ETF.com’s “Expected returns & Black Swans” Larry Swedroe does a great job explaining expected returns and the full range and probability of possible returns, as well as the unknown shape of the assumed distribution. When somebody suggests based on a Monte Carlo simulation the “odds of success of this portfolio are 85% under this withdrawal assumption”, the reality is that we don’t actually know that and should have been further qualified by indicating “based on current assumptions”. He also discusses Black Swans (e.g. see my blog post reviewing The Black Swan by Nassim Taleb (The Impact of the Highly Improbable))  and the fact that we don’t actually know what the distribution of returns really is. He also covers the difference between uncertainty (where we can only estimate distributions but we don’t know them) and risk (where we know the distributions such as in the case of odds for roulette wheel are fully understood, even mortality tables are relatively well understood). (For those of you interested in the subject of risk, you might wish to read my Risk perspectives: What is risk? Its measurement, dimensions, modeling (asset classes, risk factors and regimes) )

In still another article by Larry Swedroe in ETF.com’s “The best returning styles” he reviews an Ibbotson and Kim paper “Risk and Return Within the Stock Market: What Works Best?” on the “return-predictive characteristics of some well-known investment styles: beta, volatility, size, value, liquidity and momentum”.  He concludes with “Contrary to the popular wisdom that greater reward comes with greater risk, low-beta and low-volatility portfolios outperform high-beta and high-volatility portfolios. In addition, as measured by turnover, less-liquid stocks both outperform and are less risky. And high-momentum portfolios outperform while also being less risky. The authors concluded: “Overall the best-returning characteristics are high earnings/price, high book-to-market, and low turnover. On risk adjusted basis, the best performances were low beta, low volatility, and low turnover.””

In the Financial Times’ “Trustees of the non-financial revolution” John Plender opines that in banking  “shareholder value revolution heightened the conflict between the interests of clients and those of shareholders to an intolerable degree… the fiduciary duty of loyalty holds no meaning for many financial folk.” Most if the rest of the article is focused on fiduciary level of care for pension funds and non-financial firms.

In ETF.com’s “ETFs can’t fix low bond market liquidity” Paul Britt discusses potential corporate bond ETF liquidity/pricing issues due to the lack of liquidity in the underlying corporate bonds. “The worry is that liquidity for bond ETFs will greatly deteriorate in a major downturn given that the underlying markets aren’t strong… For now, we know that healthy bond ETFs trade well in good times and reasonably well in moderately bad times. The true test of how trading holds up in a major meltdown remains to be seen.” The related Economist article “ETFs: Emerging trouble in the future?” also discusses some concerns about potential instability in ETF market including the bond market, and whether they pose a systemic risk like banks or hedge funds might do. The article concludes with “ETFs comprise only a tiny part of demand for the underlying assets. Unlike banks or hedge funds, most ETFs do not use borrowed money, or leverage. There will doubtless be individual ETFs that get into trouble in the future; there will probably be scandals. Some will suffer spectacular falls in value, just as technology funds plunged in the early 2000s. But that does not make them a systemic threat.”

In Bloomberg’s “The Great Recession put us in a hole: Are we out yet?” Ben Steverman does a quick review of how US recovery is coming along since the onset of the Great Recession about 6 years ago. He argues that “most Americans have put their finances in order…but many aren’t rewarded…Americans are making a lot less money and own fewer assets…even as stocks reach new highs”. House prices are still 13% below 2007 levels, but due to affordability (and tighter credit requirements) fewer can afford to buy, “sending rents up 16%”. Also 7 million Americans are working only part time which is 57% more than in 2007. Retirement accounts are up due to lower fees and market strengthening but “thanks to employer cutbacks, fewer workers have access to pensions or retirement plans on the job”. (Interesting data that you may wish to peruse.)

And finally, in the Economist’s “The pendulum swings to the pit” discusses the dangers of deflation and argues that “Politicians and central bankers are not providing the world with the inflation it needs; some economies face damaging deflation instead”. (Perhaps ending the financial repression, the resulting higher interest rates would lead to higher income for retirees, which in turn might drive higher demand for products/services and help further economic improvement?)