Contents: Need 25% drop in stocks? “folklore of finance”, “will” plus a “letter of instruction”, small value stocks superior to private equity, disallowed tax shelter donations, house sale: another way to scam seniors, taxing issues for Canadians with US real estate, lawyers’ feasting on Nortel carcass continues on the backs of pensioners/creditors, PBGC’s multiemployer pension protection fund near bankruptcy, active managers’ lunch about to be eaten by smart-beta funds, active managers continue to underperform, symmetric approach to fees, Alzheimer detectable a decade before onset.

Personal Finance and Investments

In the WSJ’s “We need stock prices to fall 25%” Jonathan Clements writes that investors feel good when they look at the value of their portfolios but the higher valuations will also mean lower future returns, and “unless you never again plan to add to your stock portfolio, you should have mixed feelings about the market’s heady gains”. After looking at the “three components of the market’s return: the dividend yield, corporate earnings growth and the value put on those earnings, as reflected  in the market’s price/earnings ratio”, he concludes that the best we can expect is a 7% total return on the market (including a 2% inflation). As one who is still make new investments in the market, he hopes for a 25% market drop to improve his entry point for future stock purchases. (This is somewhat of a bizarre argument for a market decline, given how a large proportion of investors react in such situations (see next article below). I try not to worry too much about market ups/downs, instead try to focus on maintaining portfolio at the target asset allocation by means of rebalancing when thing go out of whack.)

And speaking of investors continuously making the wrong decisions “The folklore of finance: Believes that contribute to investors’ failure” Paul Sullivan discusses a new study indicating that “the way individual and professional investors made investment decisions was so skewed that achieving both high returns and long-term objectives was nearly impossible”. What the study found is that due to “’the folklore of finance’…people were overconfident in their investing ability, unable to focus on their stated long-term goals when distracted by short-term noise in the markets, and had come to distrust their advisers and lose interest in receiving professional investing help.”  The study also found that the prognosis is poor for changes to investor current behavior exemplified by: “futile quest for alpha”, short-term orientation instead of focus on “setting a financial goal and meeting it”. If your advisor is not calling you regularly to discuss how you are doing against your long term goals, perhaps you should be looking for a new advisor.

In WSJ’s “When a will is not enough” Lindsay Gellman writes that “in estate planning, detailed bequests can avert lots of grief…and sometimes an ugly family feud”. The article recommends a “letter of instruction” in addition to the will; the letter would cover at least funeral arrangements (including who should be notified: people, organizations, attorney/accountant/banker, Social Security, wishes on organ donation, burial arrangements, designated charities for donations, etc), financial and personal affairs (current info for executor: contact info for lawyer/accountant/insurance broker/ investment manager, location of documents, accounts, beneficiaries),  and distribution of personal effects. (Some even suggest sitting down with family to explain what goes to whom.). (The article is well worth reading as a source for ideas of what goes into this non-legally binding addendum to the will to make life easier for executor and beneficiaries.)

In ETF.com’s “A close look at private equity” Larry Swedroe looks at private equity opportunities and concludes that “The evidence clearly demonstrates that investors seeking higher returns than those provided by the S&P 500 Index, and considering investing in private equity, would, on average, be better served by looking to small value stocks (both domestically and internationally) in the public markets.”

In the Financial Post’s “Beware of these tax shelters: You will be audited and your claim will probably be rejected” Jamie Golombek warns that you should not fall for tax shelters “often based on questionable donation schemes in which you made a cash payment and acquired some property in return. These were then gifted to a charity with the result that you received a donation receipt that was much higher than the amount of cash you actually “donated.”” The CRA “has reassessed all participants and denied the donation tax credits claimed.”

Real Estate

In the Financial Post’s “One way to lose money even when you made 5000% on your home” Garry Marr describes how Toronto seniors are being taken advantage of when selling their bungalow purchased 60 years ago for $14,000. They get cold called by builders and flippers who “want to scoop it out from under him for below market value, hoping to fleece an elderly homeowner who has no idea of today’s housing prices”, and they get solicited to make a private deal “to save the real estate fees”. Getting an offer to buy for 50x the original purchase price might seem like a great deal, but unfamiliarity with the local market prices might lead to getting taken. One recommendation mentioned is to get at least three appraisals of their property. But keep in mind MarketWatch’s “10 things real estate appraisers won’t tell you” where Daniel Goldstein looks at all the problems that come with real estate appraisers: low credibility due to past sins, not knowing the neighborhood, typically (really) working for the bank rather than homeowner, etc.

In the Financial Post’s “Thinking of heading south to escape the winter cold? U.S. vacation properties can be a taxing affair” Jamie Golombek list a number of taxing reasons to consider: when renting out your property you will be liable for both US and Canadian tax though you may claim foreign tax credit on Canadian return, when selling both Canadian and US capital gains taxes may be applicable and foreign tax credit may be claimed for US cap gain tax paid, careful with gifting to the next generation for both US (gift tax) and Canadian (cap gains) tax reasons, upon death deemed disposition may result in cap gains while in the US there are estate taxes if you have global assets in excess of about $5M. (Golombek failed to mention the discriminatory property taxes that Canadians are charged in Florida.)

Pensions and Retirement Income

In WSJ’s “Nortel spends big money in bankruptcy” Peg Brickley reports that Nortel’s “US unit spent $169 million on its bankruptcy case in the first nine months of this year, and there’s no end in sight to the spending on lawyers and advisers for a company that, for all practical purposes, has not existed for years.” The article notes that while the creditors are waiting to get paid, not so the lawyers and other professionals who have collected so far $1.3B. “Court papers show that Nortel Canada had approximately $143.6 million available cash as of Sept. 13, down from $226 million as of Jan. 18. Nortel U.S. had cash of $827 million at the close of 2013. But by the end of September, Nortel U.S.’s cash fell to $658 million despite there no being no business to run.” Presumably there still is an additional $7.3B in the JPMorgan lockbox which are the proceeds of the sale of businesses and patents (and the bond holders are determined to get every last penny of it.).

In the WSJ’s “Federal private-sector pension safety net running $62 billion deficit” John McKinnon reports that the PBGC’s multiemployer pension safety-net covering about 10 million workers has a $42B deficit, and should it become bankrupt it will impact over one million pensioners. “…several large multiemployer plans are now officially projected to become insolvent within the next decade… two have previously been identified as a United Mine Workers plan and a Teamsters Central States plan”. The unions are looking to Congress for a bailout to avoid sharp benefit cuts. The (larger) single employer PBGC insurance plan covering 31 million workers is in better condition with only a $20B deficit.

Things to Ponder

In the Financial Times’ “Smart beta is eating active managers’ lunch” Sophia Grene discusses the expectations of some that “smart beta” or “cheap, rule-based strategies…may offer a free-lunch”. While many are enthusiastic, she notes that Burton Malkiel calls these “more a testament to smart marketing rather than smart investing…(since) any outperformance of these products is purely the result of taking on more risk”. Still smart beta may eat “active managers’ lunch, as it offers to outperform at a price closer to that of index funds”. While others agree with Mr. Malkiel, they believe there might be opportunities to outperform “by chasing specific factor premia”.

In the Financial Times’ “Torrid time for active fund managers” David Oakley notes that according to a Merrill Lynch report, over the past 20 years <20% of the active managers are beating the market. William Sharpe notes that this should not be a surprise since “investing is a zero-sum game, so active managers who beat the market do so only at the expense of those who do not. The market return is the average of its participants’ returns, so the average active manager achieves the same return as the passive, before costs. Net of costs, the average result is poorer.” According to Morningstar 83% of the global and 75% of US assets are in active funds. Others dangle the carrot that top investment funds don’t use average managers; much like top sports teams don’t use average players. (Good luck with that; even if one could identify winners in advance then everyone would be investing only with them. Suddenly they would be overflowing with assets and promptly underperform compared to when they had fewer assets.)

In the Financial Times’ “End ‘heads we win, tails you lose’ fees” Chris Flood writes that a Cass Business School report recommends doing away with the current asymmetric fees charged by funds (e.g. 1% flat fee or 1.5% fixed plus 15% performance fees) and replacing them with a “symmetric fee where manager retained 50% of any outperformance and repaid 50% of any underperformance”. The researchers indicated that symmetric fees delivered better returns to investors. (I can just see, investment management companies lining up to offer this deal; don’t hold your breath, if it isn’t coming your way. If you want better performance than active management, just go passive.)

In Bloomberg’s “Alzheimer’s test detects disease decade ahead of onset” Megan Scudellari reports that “A new blood test for Alzheimer’s appears to detect the disease as many as 10 years before clinical diagnosis is possible… the test (only evaluated on 174 individuals) distinguishes between patients and healthy elderly with 100 percent accuracy.”