Hot Off the Web- December 8, 2014

Contents: Inheritance fight, tax-loss selling, middle-class cost squeeze, TFSA scrutiny? Florida: 9-years hurricane free, ALM risk management in retirement, ‘advisers’ fight DOL fiduciary rule, multi-employer PBGC near broke, state/city pension plans risk challenged, perceptions about aging all wrong, active managers’ performance sucks, “closet indexers” worst than active managers, does more risk mean more returns- not if risk=volatility, lower oil schadenfreude, end-of-life-care wishes.

Personal Finance and Investments

In the NYT’s “A Respectful Deference to Elders Curdles Into a Fight Over Assets” Ron Lieber discusses a new film “Black heirlooms” showing how a family can be broken up over a small inheritance and disagreement about how to deal with end-of-life-care of parent/grandparent when there has been insufficient discussion about the subject with that parent/grandparent while that would have been possible. The shortened version of the film by one of the grandchildren is available in an 18 minute version which you might find of interest. (It’s a complicated story, but it does get the message across that it is irresponsible to die without an up-to-date will and without a clear expression of instructions/wishes for end-of-life-care.)

In the Globe and Mail’s “Tax-loss selling: If you are dumping your dogs, read this first” John Heinzl lists some consideration for those preparing to do some tax-loss selling (i.e. selling shares which dropped in value relative to cost, to reduce taxes paid on appreciated shares sold on which capital gains taxes would otherwise be due). Some of the considerations mentioned are: only losses on assets in non-registered accounts are usable, settlement date must be in 2014 so last trading date is December 24, watch for “superficial loss” trap if you buy same share within 30 days (similar is likely OK), transferring share to a registered account is a “deemed sale” so while capital gain is taxable but credit for capital loss is not permitted (considered to have been bought within 30 days?). (And just remember that if you are near OAS clawback territory, your cap-losses cannot be used to reduce your gains toward income calculation for OAS clawback purposes.)

Some interesting/disturbing statistics in the WSJ article “Basic costs squeeze families” by Knutson and Francis indicate the financial squeeze suffered by 2013 middle income (mid-60% of population with incomes between $18K-95K) American households since they are ”losing ground”  with overall spending up 2.3% but inflation increased by 12%  compared 2007. This is due to stagnating incomes accompanied by massive cost increases in: health care spending (+24%) including health insurance (+42% for Affordable Care Act), mobile phone service (+49%), home internet (+81%), rent (+26%, though owned homes decrease-11%), education (+22%) and food at home (+12%). Discretionary spending has been squeezed as a result, showing reductions in spending on: clothing, major appliances, entertainment restaurants, furniture.

In the Financial Post’s “Canadians with too many wins in TFSA are being targeted by CRA” Garry Marr reports that the CRA is auditing individuals with high value and frequent trading of stocks inside their TFSA (e.g. one case where TFSA was run up to $180K as compared to $31K depositable since 2009.). While the stated objection appears related to running a business in the TFSA, it is unclear whether the real issue is the use of closely held undervalued stocks. (Perhaps TFSA rule changes are forthcoming, but neither of these scenarios should apply to most TFSA users.)

 

Real Estate

In the WSJ’s “Florida’s hurricane dry spell lasts” Spencer Jakab reports that 9-years of hurricane calm in Florida is the good news as it “has allowed the state to keep insurance costs artificially low for many homeowners and still build up coffers to pay claims. Yet a devastating storm or series of smaller ones risk wiping out the cushion built up by Citizens Property Insurance Corp., the state-owned “insurer of last resort,” and two other state-controlled entities—putting all insured residents on the hook for potentially billions and even tens of billions of dollars.” No hurricanes making landfall (dumb luck) and low interest rates have helped keep costs down, however the article suggests that we may be just one hurricane away from massive increases in costs. (The article didn’t discuss that many of the highest risk properties have make considerable investments in wind mitigation such as hurricane windows and improved roofs in preparation for the next storm; but effect of these improvements fortunately remain untested as yet.)

 

Retirement Income and Pensions

In the WSJ’s “How to think about risk in retirement” William Bernstein discusses methods of determining one’s appropriate stock allocation but he prefers to come at the problem from the perspective of building an ALM (asset liability managed) portfolio where it “throws off enough principal and income to cover investor’s expenses” . For those who can afford it, he suggests some combination of inflation adjusted annuities and/or a TIPS ladder and/or short-term corporate debt to match spending. He notes that this is not just expensive due to current low interest rate environment, but insurance company or its (state) guarantor might not be willing/able to honor their commitment in a financial crisis; also a 30 year TIPS ladder may be insufficient given longevity tails. So he suggests an ALM approach to cover expenses to age 98 with 75% of his assets and then allocates 25% to stocks (in his example) to be held in reserve for expenses beyond age 98. He notes that this approach would likely (but not certainly) result in an increasing stock allocation during retirement, but this is no different than “a variant of the long-established “two-bucket” approach that separates, with mental accounting, a safe portfolio dedicated to essential living expenses from a risky one aimed at one’s heirs, charities and the odd business-class seat.”

In the Financial Times’ “US financial advisers resist pension rule” Guthrie and Foley report that financial ‘advisors’/brokers/salesmen in the U.S. are putting up a stiff fight in preparation for the expected  DOL requirement for a fiduciary level of care when  providing advice pertaining to retirement accounts. These ‘advisers’ object as they ‘fear’ that this will leave 7M of 46M US households might end up without advisors, as many will chose to exit the business just as 25% have done in the UK when the new fiduciary and fee-only requirement, including outlawing commissions, was recently introduced. Insurance salesmen selling annuities seem to be even more concerned. (Frankly the sooner fiduciary standard is introduced, especially for annuity sales, the better off the consumer will be. For people with smaller accounts, who are most likely to lose their advisor if there are fewer remaining ones, I suspect the new robo-advisors will deliver equal or superior results, after costs.)

In the WSJ’s “A Federal guarantee is sure to go broke” Alex Pollock opines that it is inevitable that the PBGC will go broke, since the Pension Benefit Guarantee Corporation was created by Congress is a fundamentally flawed construct with “conflicting double mission…to run a financially sound insurance company…(and also) to encourage the continuation and maintenance of private sector defined benefit plans”. The PBGC has $90B assets and $152B liabilities, broken down as follows: the single-employer part has $88B assets and $107B liabilities and a multi-employer part has $1.8B assets and $44B liabilities.  The multi-employer “program is likely to run out of money “in as little as five years….Experience has demonstrated that these (pension insurance) plans are extremely risky financial commitments. But when you exist to encourage them, the tendency is to undercharge for the risk, supposing that you know even what the risk is. Such risk includes future increases in the longevity of pensioners, or of low interest rates, or both (in addition to company bankruptcy). This undercharging is inevitable since the insurance premiums are set by Congress and reflect political rather than economic imperatives.” (Good luck with that! Having to recognize and pay for a problem that you or your predecessors have created, that may not necessarily precipitate a financial/political crisis if left hidden until after your political term, might be great economics but lousy politics. Few politicians will actually deal with this until it blows up and they have no choice. On the other hand some might see this as an opportunity to buy some votes?)

And speaking of a house-of-cards, in the WSJ’s “Public pensions need gamblers anonymous”  Andrew Biggs reports that (US) “state and local pension plans invest roughly twice as much in risky assets as would a prudent individual saving for retirement”. Calpers is 75% in risky assets, Illinois also 75%, Texas teacher’s plan 81% Pennsylvania and New Mexico are also over 80%. Plan managers argue that pension plans have longer horizons than individuals so they can afford to take more risk; but the real reason for taking more risk (likely applying flawed arguments like assuming discount rates for liabilities to be the portfolio expected returns) that the higher risk/return is to justify lower minimum current pension contributions. (How are these public sector pension plan shortfalls going to be resolved? Even small and gradual steps taken immediately, using the assumption the earned commitments are sacrosanct but all else is negotiable, would be a good place to start and go a long way to resolve the problem.)

 

Things to Ponder

In WSJ’s “Why everything you think about aging may be wrong” Anne Tergesen does a great job dispelling myths that everyone ‘knows’, i.e. that life becomes less enjoyable as we age due to the inevitable accompanying decline of our minds and bodies. But she says that everyone is wrong!  A “growing body of research shows that, in many ways, life gets better as we get older.” Research shows that: “our moods and overall sense of well-being improve with age”, “friendships tend to grow more intimate”, and “knowledge and certain types of intelligence continue to develop in ways that can even offset age-related declines in the brain’s ability to process new information and reason abstractly. Expertise deepens, which can enhance productivity and creativity. Some go so far as to say that wisdom—defined, in part, as the ability to resolve conflicts by seeing problems from multiple perspectives—flourishes.” An NIH researcher notes that “those who fall into the “stereotype of being depressed, cranky, irritable and obsessed with their alimentary canal” constitute “no more than 10% of the older population”. Tergesen then lists “six prevalent myths about aging- along with recent research that dispels common misconceptions”. (All those over 65 should read this great article, and then enjoy the ride by “get(ting) out of your comfort zone”.)

In ETF.com’s “Questioning the value of endowments” Larry Swedroe reviews recent research on endowments, both average and elite ones, on whether they show any alpha relative to benchmarks and even if they do at times, “is there evidence of performance persistence in endowment returns”. As you can imagine the conclusion Swedroe reaches from the reports is that “active management is the triumph of hype, hope and marketing over wisdom and experience”.

Reinforcing that view is WSJ’s “As indexes soar, active stock pickers can’t get off the ground” where Jason Zweig writes about what portfolio managers and industry analysts say are the reasons (i.e. excuses) for the underperformance of active approach, including: outperformance of US large stocks (S&P 500) compared international and small cap stock usually included in actively managed funds, unprecedented sector rotation, lower than historical dispersion (lower outperformance of winning over losing stocks) and low interest driven low market volatility. However while active managers need excuses to explain their unusually steep underperformance, even John Bogle notes that: “I’m concerned that people will say that indexing will always win or always win this big…This level of outperformance just doesn’t happen for long.”

In the Economist’s “Come out of the closet” Buttonwood notes that much of the investment management industry battle is framed in terms of active vs. passive, but he notes that the worst of the lot are a third group- managers who charge active fees but are “closet indexers”, sticking closely to the benchmark. This group is impossible to justify; almost doomed to underperform, such managers are guided by a business rationale. If they track the index, they will never be bottom of the performance tables and lose all their business.” The article also discusses “active share score (which) measures how different a fund is from its index benchmark…zero means…same stocks in same proportions…(and) 100 means…none of the same stocks.” Active share score of 61 corresponds to indexers, 60-80 are active funds, >80 are highly active funds and 15-60 are closet indexers. And as you might suspect, you should be looking for outperformers among the highly active (and active), but the data presented does not say anything about persistency of results of those who actually outperform.

In BloomberBusinessweek’s  “One of the most famous rules of investing might be totally wrong” Allison Schrager reports that according to a recent GMO study of US stock returns between 1970 and 2011 indicates that the riskiest (most volatile as measured by standard deviation) 25% of stocks returned 7%/yr while the 25% least risky stocks returned 10.6%, forcing one to ask whether one can still expect a bigger reward for taking more risk? Possible explanations suggested include the growing army of index-hugging active managers or “closet indexers” referred to in the previously mentioned article. However another study from Duke which included “tail risk” (the chance of a 50% price drop) in its definition of risk, concluded that higher risk stocks “do, in fact, have higher returns”. (Volatility is a measure of the historical deviation (both on the upside and downside, though few complaints might be expected due to upside deviations) from the average, but risk is not volatility; it is something else, e.g. the Morningstar article I mentioned last week, suggested that a better definition might be the chance of not meeting your objectives, or as in this article suggests it is related to “tail-risk”.)

If you are interested in the impact of lower oil prices, beyond the fact that a family spending $2500/yr on gas might expect to save something of the order of $700-$800/yr, Bloomberg’s “Oil at $40 possible as market redraws politics from Caracas to Teheran”  discusses the impact on Russia, Venezuela, Iran and others; e.g. see Barron’s “Venezuela, drained of oil revenue goes to China, Iran & Russia for funds” (….couldn’t happen to nicer guys and you will be excused if you have a moment of schadenfreude), while “Good, Bad and Ugly of lower oil prices” examines the good -“positive for global economy”, the bad- “cuts in energy companies’ investment budgets…longer term energy potential undermined”  and “accentuate general deflationary tendency in Europe”, and the ugly- “The possible reaction of certain oil-producing countries that are particularly hard hit by the price declines.“ (e.g. Russia).

And finally, in the WSJ’s “How to make your wishes for end-of-life care clear” Laura Landro discusses that “new concerns arise about how well patients and doctors understand advance directives”. Lack of clarity and misunderstandings can lead to both under-treatment and over-treatment when entering a hospital. “A growing number of states are starting programs known as Physician Orders for Life Sustaining Treatment, or Polst, a form offered to patients who might die within a year so they can document their wishes in a medical record, signed by the doctor.” (e.g. see California’s ) For those interested in the subject there is a great book by Atul Gawande entitled “Being Mortal” it discusses not just that patients don’t know what is the right thing to do, but neither do doctors. The publisher’s description of this book is as follows: “Medicine has triumphed in modern times, transforming birth, injury, and infectious disease from harrowing to manageable. But in the inevitable condition of aging and death, the goals of medicine seem too frequently to run counter to the interest of the human spirit. Nursing homes, preoccupied with safety, pin patients into railed beds and wheelchairs. Hospitals isolate the dying, checking for vital signs long after the goals of cure have become moot. Doctors, committed to extending life, continue to carry out devastating procedures that in the end extend suffering.” Still, many have been raised by parents who lived through times in recent history that nobody thought that humans might be able to survive, yet some did and they thought their children that “where there is life, there is hope”; the WSJ article “Cancer’s super-survivors” Ron Winslow reports on “how the promise of immunotherapy (i.e. enlisting the body’s natural defenses, the immune system against cancer) is transforming oncology” and the encouraging early steps taking place in fighting metastasized melanoma, one of the deadliest of cancers.”

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: