Hot Off the Web- December 15, 2014

Contents: Bonds and volatility, Vanguard: largest robo-adviser, estate planning for singles, retirement: not just about money, don’t bother with forecasts/forecasters, Canadian homes: up to 30% overvalued, measuring your 401(k), UK pension reform risks collateral damage? Ontario tables mandatory pension plan, fix in place for multiemployer PBGC pension insurance? OECD warns of need for pension changes, build medical expenses into retirement plan, asset classes not a strategy, CAPM evolving into multi-factor models, closet-trackers exposed, how Wall Street transforms/repackages the ‘scary’ into ‘warm-and-fuzzy’.

Personal Finance and Investments

In WSJ’s “Not all bonds protect you from volatility” Jonathan Clements warns that “When stocks tumble, bonds are supposed to salvage your portfolio’s performance. But it turns out that many bond funds behave suspiciously like stocks.” He reminds readers that in 2008 when stocked fell 37%, bonds funds were also hit: emerging market -17%, bank loan funds -29% and all the way to even short-term corporate funds at -4%. Check how your bond funds performed in 2008 and then ascertainwhether you can handle a similar drop in the future. Some advisers suggest a “clean division between a portfolio’s risky and safe assets”. The only ‘safe’ parts are short/intermediate government bonds, certificates of deposits (GICs); high quality corporate bond funds can be used but should be considered to be part of the risky assets of your portfolio.

In the Financial Times’ “Vanguard turns firepower on shake-up of financial advice market” Stephen Foley reports that Vanguard has been developing mechanism to give “simple and effective portfolio advice to US savers” at 0.3% fee well below what a financial adviser would typically charge. This is done with a combination of online tools and webcam chats with advisers. Their challenge is to do this without being accused of poaching customers from and/or conflict of interest with independent financial advisers who have been using Vanguard funds at a growing rate and might choose to switch to using other low cost funds. (Vanguard could also just decide to allow outside advisers to use  the online tools so they can leverage an enhanced offering to their clients built on the Vanguard platform, after all Vanguard is not in business to make a profit, it is structured as a mutual entity.)  By the way, in InvestmentNews’ “Vanguard quintuples assets in robo-adviser, leapfrogging competitors” Trevor Hunnicutt reports that Vanguard already became the largest robo-adviser having accumulated $4.2B of robo-advised assets.

In WSJ’s “Estate planning essentials for single people” Carolyn Geer discusses special considerations for single people in estate planning: default rules should you die without a will exposes your estate to end up in the hands unintended heirs governed by defaults set by your state, if you are incapacitated even a stranger might end up making financial and medical decisions for you, the need to keep beneficiary designations on  retirement accounts and life insurance policies up to date or else your unintended ex-spouse  might end up receiving the proceeds. Some estate tax considerations are also discussed.

In the Globe and Mail’s “Retirement: It’s not all about the money” Josh O’Kane discusses the  challenges associated with the retirement timing decision of one individual not wanting to essentially die in the harness like her father. The trade-offs that come with an early retirement are things like: reduced pension (for those lucky to have one) or just less accumulated assets (due to having worked fewer years), the need to finance more years in retirement (not just due to retiring younger but also living longer), trying not to overspend early (though that’s when one is most able to be more active and travel), having a clear understanding of one’s spending (and where the money goes), willing to be flexible and make the necessary adjustments/priorities to insure that you won’t run out of money before you die or if/when life throws you a curve-ball due to health or family needs (parents and children) suddenly surprise. Finding the balance if always a challenge. (This reminds me of a quote attributed to William A. Ward: “The pessimist complains about the wind. The optimist expects it to change. The realist adjusts the sails.” Ultimately, the only realistic way to handle the surprises that life presents you is flexibility/adaptability. The future is unknown, in the meantime, enjoy the present.)

In Business Insider’s “The mother of all asset bubbles will burst in 2016” Akin Oyedelle reports that according to Nouriel Roubini we are at the mid-point of the buildup for the next bigger bubble which will end in an even bigger crash than in 2008. Next year he sees more gains to be followed by a 2016 collapse. (The reality is, that the future is unknown/unknowable and as the old saying goes “forecasting is difficult, especially about the future”).  So here are some good articles in the past week that suggest that you disregard all market forecasts/forecasters. In’s  “Ignore forecasters at all costs” Larry Swedroe takes aim at Jeremy Grantham’s market direction miscalls driven by different views about P/E ratios. He notes that it is possible-if not very likely- that , like a broken clock…gurus who scared investors away from the markets based on fears surrounding high valuations and high profit margins will eventually be correct in their forecasts. Many of the forecasters have highly persuasive arguments but “no matter how hard maintaining discipline can be, it is still much easier than trying to predict which active managers will randomly beat the approach of building a globally diversified portfolio of passively managed funds and staying the course, rebalancing as required. That’s why author Charles Ellis called active investing the loser’s game—the surest way to win is not to play.” Another article on forecasting is Bloomberg’s “Burt Malkiel: Walk away from 2015 know-it-alls” where Ben Steverman interviews Burton Malkiel who argues that: you can’t time the market nor can anyone else do it consistently, while emerging markets are riskier the valuations are cheaper so longer term returns may be better (I think that was a forecast?), but the only certainty in investments is that the lower the fees/costs are the more you’ll have left from whatever returns are delivered by each asset class and the constituted portfolio. Also’s “Legends of indexing: John Bogle” includes Bogle’s views on assorted investment related subjects including the futility of market forecasting. Other topics covered by Bogle were: his views on ETF’s (they won’t cause much damage if you don’t try to rebalance too frequently), US vs. international stocks (stick with US stock, but if you must include foreign, don’t allocate more than 20%), stock bond allocation (he suggests a stock allocation of (100-age) though he himself at age 80+ is 60% in stocks), Fama-French factors (worked great for 90 years, but never take for granted in investing that past is prologue), biggest concerns now (geo-political events).

Real Estate

In the Globe and Mail’s “Canada’s housing market overvalued by as much as 30%: BoC” McKenna and Younglai report thatThe Bank (of Canada) is still expecting a soft landing in housing, and that may already be happening in Eastern Canada. But it said prices are still rising in cities, such as Toronto, Calgary and Vancouver…Among the worsening “vulnerabilities,” the bank’s Financial System Review pointed to a growing subprime mortgage market…About 35 per cent of new, uninsured mortgages by smaller federally regulated banks since the end of 2012 could be considered non-prime, according to the report.”  In another related Globe piece David Parkinson reminds his readers to “Consider that when last decade’s massive U.S. bubble burst, the ultimate damage was a 35-per-cent decline before it found solid footing again.”


Retirement Income and Pensions

In WSJ’s “The new way to measure your 401(k)” Liz Moyer reports on a new (?) approach intended to give a more meaningful view of the state of one’s 401(k) savings, by presenting it not as an indicator against a savings goal, but as an indicator of against future income goal. Specifically this is based on a set of indexes designed for 55 to 65 year olds to estimate the required assets at each age necessary to deliver $1 of inflation adjusted income starting at age 65. A 65 year old needs $20.54 as of November 13 to generate $1 income per year, whereas only $14.54 is needed if one will be 65 in 2024. “BlackRock uses three variables for measuring projected income: the portfolio value, current annuity rates and years remaining until age 65. BlackRock factors in the effects of inflation, interest rates and risk, too. The withdrawal rate is floating rather than the rule-of-thumb 4% fixed amount because it adjusts daily to current annuity prices.” The index called CORI is based on a proprietary process, but you can buy the resulting funds from Blackrock; they also offer a calculator so you can explore your savings requirements against your desired income objectives. As a cautionary note, in “Jack Bogle: I wouldn’t risk investing outside the U.S.” Bogle warns thatNew products aren’t typically about the business of investing. They are about getting people to buy and sell things. There are very few companies that focus on the long-term business of investing.” (I agree with Bogle, though to be fair I have to admit to not having found the necessary documentation which explains this BlackRock proprietary approach to their index development and implementation, as yet.)

In the Financial Times’ “OECD issues warning on UK pension reform” Josephine Cumbo reports that the UK pension reforms stopping requirement for mandatory annuitization upon retirement “could mean pensioners run out of money” according to an OECD report”. This is because the individuals’ increased “control of their money…could be detrimental to both retirement income adequacy and incentives to work… (due to) myopic behaviour and insufficient financial literacy”. The OECD recommends that retirees should be encouraged to buy “deferred life” annuities” (i.e. a longevity insurance would be a preferred form of annuity resulting in a more balanced overall approach, by allowing one to control a substantial portion of one’s assets while still acting as a backstop to secure a lifetime income stream should one live significantly beyond life expectancy.)

The CBCNews brings a Canadian Press report indicating that “Liberals introduce bill to create pension plan” to create a mandatory Ontario pension plan starting in 2017 which is similar but not the same as the CPP. “The bill would require employers and employees to each contribute 1.9 per cent of a worker’s salary to the ORPP, up to $1,643 a year, which the Ontario Chamber of Commerce warned will result in fewer jobs.” (But arguments are not persuasive that a 1.9% increased labor costs starting in 2 years (actually 3 years after it was first announced) cannot be managed.) If the Federal government decides to expand CPP, as it has indicated a few years ago before it changed its mind in favor of the PRPP pushed by the financial industry, Ontario is prepared to fold the ORPP into the CPP. Another bill was introduced to also create PRPPs in Ontario. (I salute Ontario for taking pension reform initiatives even though a CPP-like solution may not necessarily be the best in my opinion at least; while this will help those who are perhaps 15 or more years from retirement, most of the baby boomers will get little or no benefit from this unless they get the option to buy-in to the plan with a lump sum. As to the PRPP bill, it remains to be demonstrated whether this is of any value to anyone beyond the financial industry. In fact, I seriously doubt it.)

Last week we read about the travails of the multiemployer side of the PBGC  which protects US private-sector pensions should companies be unable to pay, e.g. due to bankruptcy. (There is nothing comparable in Canada except for the minimal protection offered by Ontario.) The WSJ’s “U.S. House reaches bipartisan agreement on pension legislation”  reports that bipartisan agreement was reached for a solution to address the multi-employer PBGC’s massive underfunded status which the politicians say will work for both the unions and employers. (The pension crisis is unfolding as expected. All the false assumptions to minimize pension contributions are coming home to roost. In the U.S. at least, politicians understand their role as legislators, i.e. to protect those who put them there. In Canada little if anything is being done by legislators to protect those who have lost some or all of their pensions due to systemic flaws in Canada’s pension system, which is regulated and supervised by the federal/provincial governments; pity.) Bloomberg’s   “Is Congress about to cut your pension?” elaborates that retirement benefits for millions of workers could be cut by up to 50% (but at least they don’t dry up within about 5 years as predicted in last’s week’s article) and PBGC premiums (set by Congress and paid by employers) are being doubled to help beef reduce the insurance fund deficit.

BenefitCanada’s“Stagnation compounds demographic pressure on pensions” reports that the OECD sees the “low growth, low interest rates and low returns on investment…compounding the problems of population aging for both public and private pension systems”. They recommend “raising taxes on pension income and pension contributions, reducing or deferring the indexation of pension benefits, and increasing statutory retirement age.” They also argue that regulators should make sure that providers use regularly updated mortality tables…” The Economist’s Buttonwood column comments on the same OECD report in “Live poor, die young” and argues that the recommended increase in retirement age will just “exacerbate inequality. The poorer sections of the population tend not to go to university so have longer working lives than the better-off. And they have lower life expectancy as well, so they will also enjoy shorter periods of retirement.” He attributes the longevity differences between the highest and lowest income groups to access to healthcare (in the US, in particular), to variance in diet, and to different stresses caused by different jobs…” Buttonwood thinks that these inequalities should be corrected for, just as many private sector plans already adjust for smokers or those with life-threatening diseases.


Things to Ponder

In InvestmentNews’ “Baby boomer clients need input on medical expenses in retirement” Craig Brimhall reports that according to an Ameriprise Financial survey 63% of (US) baby boomers expect their financial advisor to be discussing with them the “impact of health and healthcare cost on their retirement savings”. However on 19% have done something about it. (There is no question US boomers must factor this into their retirement plans. However many Canadians will be surprised to hear that they also need to factor in potential significant healthcare costs in retirement. My accountant surprised me 10-15 years ago when he suggested a $15,000 per year healthcare planning number to be included in a retirement plan. Hopefully he’ll be wrong, but I wouldn’t count on it; when one includes dental costs, travel insurance expenses, potential introduction of income tested government health care benefits and/or paying for explicitly not-covered procedures/services and/or for procedures with long waiting times that you might want to accelerate; before you know it $15,000/year might not be so unbelievable even in Canada.)

In’s “Asset classes vs. investment strategy” Rick Ferri explains why asset classes are not an investment strategy. Quantifiable parts of asset classes are the building blocks for investment strategies. “Indexes are not asset classes, although many total market indices do represent them fairly well. Depending on the asset class, an asset allocation model can be affected by an index provider’s strategy. Knowing the strategy behind an index and being comfortable with it goes a long way to ensuring your portfolio tracks as closely as feasible the risks you’re seeking.”

In’s “Examining a rich post-CAPM world” Larry Swedroe discusses the CAPM which he calls a 1-factor model (beta or risk), and then calls the next phase the “Fama-French and beyond”  factor models, which can be 1-2-3 or 4-factors such as size, value, momentum, etc. The latest phase is the q-factor model which includes: beta, “the difference between the return on a portfolio of small cap stocks and a portfolio of large cap stocks”, “the difference in return on a portfolio of low-investment stocks and high investment stocks”, and difference between the return on a portfolio of high ROE and portfolio of low ROE stocks. Fama-and French looked at a 5-factor model last year: beta, size, value profitability and investment. So no doubt there will be new product coming up which try to take advantage of these factors. And by the way, Swedroe in another article this week entitled “Endowment returns are worsening” argues that the endowments “would be better of focusing their efforts on deciding which factors and return sources they want to gain exposure, and in what amounts. (But as John Bogle cautioned, in one of the group of articles above discussing (the futility of) forecasting, that in investing the “past is not necessarily prologue”, so tread carefully.)

In the Financial Times’ “The future is bleak for closet trackers” Madison Marriage reports that a class action suit was launched against Sweden’s second largest fund house…over allegations that it had mis-sold investors closet trackers- funds that charge high fees for active management, but which in fact do little more than hug an index.” Win or lose the plaintiffs believe “that the legal pressure and growing scrutiny” will force changes.

And finally, speaking of mis-selling, in the Financial Times’ “Wall Street regains its old ways with words” Gary Silverman writes that “the wheelers and dealers of the financial world twist and turn English to their advantage”. After 2008 they were left “stuttering and stammering” but they are regaining their confidence. Silverman’s example is a new IPO of Lending Club a peer-to-peer lender which might suggest to some that participants are members of an exclusive club where “peers” lend to each other, rather than the reality of “stranger-to-stranger” lending without knowing much about each other. And by the way, this is just a continuation of transformation of scary ”junk bonds” into “high yield securities” and  “leveraged buyout firms” to “private equity houses” (and not mentioned, but you will no doubt resonate with, the  transformation of financial industry “salesmen” (whom you might naturally treat with caution)  into “advisors” (who like your physician, is there to help you with advice in your best interest.)


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