Contents: Long-term care insurance fix? recency bias, renting in retirement, real and worsening retirement crisis, pension plan sponsors make poor decisions, Canada’s pension regime needs overhaul…duh, deflationary threat? smart-beta promise? factor investing- flavour of the month!

Personal Finance and Investments

In the WSJ’s “A way to fix long-term care insurance?”  Glenn Ruffenach discusses a Michael Kitces’s proposal to solve the affordability of LTCI by dramatically lengthening the elimination period, perhaps to 2-3 years, followed by a 5-10 benefit period, instead of the current more common practice of 90 day elimination period, though 1-year is also available. (Yes, this would make LTCI cheaper, but perhaps the question we should be asking is whether LTC is a risk which is appropriate for insurance mitigation? Insurance is applicable for risks that have low probability of occurrence but very high adverse (financial) impact, and for people who need that insurance. Is LTC which, according to sources selling LTCI, which has high (40-50%) probability of occurrence, an appropriate risk for insurance? Probably not…Long (2-3 year) elimination period is an attempt to transform a high probability event into a much lower one, but the answer is still probably NO, especially when you add in load factors of the order of 50%, and insurance company demonstrated ability to increase future premiums (unknown cost) for existing policies. Self insurance is a more appropriate solution for most, as discussed in some old blogs I wrote on this subject at Long- term Care Insurance (LTCI- I) and Long-Term Care Insurance (LTCI) II- Musings on the Affordability, Need and Value: A (More) Quantitative View )

In ETF.com’s “Recency bias damages returns” Larry Swedroe explains what ‘recency bias’ is (“the bias toward overweighting recent events or trends, and ignoring long-term evidence”) and why it is “one of the more common and costly investing mistakes”. Swedroe argues that this drives investors to ‘buy high’ and ‘sell low’, rather than what than doing the right thing, i.e. ‘rebalancing’. He also notes that while asset allocation is the primary determinant of risk and return, your “ability to stay the course, adhere to your plan and rebalance as required is more important than the asset allocation itself …Unfortunately, behavioral mistakes lead to a failure to maintain discipline, which causes investors to end up with portfolio returns that are typically below the returns of the investments themselves.”

Real Estate

In the Financial Post’s  “Renting during retirement? 10 cases when t might be  right for you” Ted Rechtshaffen writes that despite of home ownership being the Canadian dream, there are many situations  when you might conclude that renting is better, such as: affordability, debt elimination, diversification of assets, spend some of the assets locked up in house, snowbirding, planning to relocate and no maintenance responsibility.

Retirement Income and Pensions

In InvestmentNews’ “Retirement crisis is real and getting worse: Study” Hazel Bradford reports that according to a new Center for American Progress study, “more than half of U.S. households don’t have enough saved for retirement” and “even the most optimistic studies predict that nearly one-quarter of retirees will fall” short. The main reasons are: no access to any/good private-sector retirement plan, stagnant wages and shift of retirement income responsibility to individual. “While the growing crisis could force households to significantly reduce their standards of living in retirement, it will also place greater stress on the government and other social sources such as charities…” The situation is deteriorating with time.

In ETF.com’s “Plan sponsors’ weak returns” Larry Swedroe discusses how pension plan sponsors, as a result of their poor quality of decisions, “persistently destroy value. He refers to “Absence of Value: An Analysis of Investment Allocation Decisions by Institutional Plan Sponsors” and “How Do Employers’ 401(k) Mutual Fund Selections Affect Performance?” to argue that their lack of success despite their increased level of sophistication compared to individual investors demands that “the plan sponsors need to justify their existence”. “Paul Samuelson, put it this way: “[A] respect for evidence compels me to incline toward the hypothesis that most portfolio decision makers should go out of business—take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed. Few people will commit suicide without a push.””

In BenefitCanada’s  “Why Canada’s pension fund regime needs and overhaul” Ian Edelist writes that “Canada’s pension legislators need to fix the pension solvency funding system to reflect current realities”. Interest rates are suggested as the root cause of the solvency problems and the article notes the number of times the government had to step in to provide relief to sponsors (employers) from this burden (but nothing was done to protect pensioners). He notes that the solvency regimes for DB pensions introduced in 1987 were intended to protect the solvency of pension plans even if sponsor went bankrupt. However, not only didn’t protect pensioners but also ended up dramatically reducing the number of private sector employees who had DB plans. (Duh…Canada’s governments (federal and provincial) have done nothing beyond band-aids to fix the systemic failure that has destroyed the retirements of thousands of private sector Canadians. And while, interest rates might have been the trigger for higher costs to maintain solvency, and inadequate legislation may have been a contributor, but lax regulatory implementation, inadequate diligence /competence and failure to deliver on fiduciary responsibilities and/or professional standards/codes of conduct among sponsor board/executives, pension professionals and regulators have all conspired by specific acts or failure to act, which led to the disastrous outcomes such as the 1000s of Nortel pensioners who took a 40% haircut on their pension and are now in the 6^th year of bankruptcy litigation which so far cost about $1.5B+ of the remaining Nortel carcass. Nothing of substance has been done to remedy the situation retroactively for pensioners, or proactively to prevent a recurrence. Pensioners were just thrown under the bus and nobody took responsibility for what happened, least of all the government.)

Things to Ponder

In the Financial Times’ “History is the antidote to fear of falling prices” John Kay argues that history should help put investors’ minds at ease about deflation. Instead of just focusing on our (UK) own past 100 years of inflationary experience, in the century ending in 1913 prices were essentially unchanged. He also notes that of the 140 fold price increase since 1750, “all the increase up to 1938 is accounted for by inflation during the Napoleonic and first world wars”. Inflation is not necessarily good and deflation not necessarily bad, without understanding the root cause of the fall. If prices decrease due productivity increases or massive drop in oil prices rather than as a result of “depression and social strife”, that is good deflation. And deflation is the effect not the cause of “economic transformations and recessions”.

In ETF.com’s “The promise of smart beta” Jason Hsu (of Research Affiliates which is a prominent purveyor of “smart beta” products) makes a less than persuasive case for smart-beta as the future of indexing, but is more convincing when arguing that smart-beta may shake up active investment management business models by using “systematic and rules-based portfolio construction and thus promotes transparency, we can lower governance cost and reduce investment management expenses”. (While smart beta may succeed in drawing assets from active managers, the article is less convincing in its pitch that this is the new indexing, since it lacks many of the capitalization weighted index’s promise to investors for “a transparent, low-cost, low-governance, high-capacity strategy for accessing the equity risk premium through cap-weighted exposure to market beta”. It remains to be seen whether smart beta strategies are scalable and whether some of its currently perceived benefits are sustained should asset volume increase significantly. Time will tell, though one might be skeptical given that the ‘disclaimer’ accompanying the article is almost as long as the article itself.)

And finally, on John Authers in the Financial Times’  “Why factor investing is flavour of the month” discusses ‘factors’ (the ingredients which are used to create so-called ‘smart-beta’) such as value, size, momentum, low-volatility, quality, dividends, low-liquidity, etc and observes that the data over the past 20 years suggests that it isn’t just marketing and perhaps there is some opportunity here to be explored. But while factor investing is showing strong growth its industry asset-share is very small, and “the risk is that factor investing becomes a victim of its own success…in the short term there is the risk of overcrowding…longer term, once people understand that there is an anomaly, and act accordingly, it will go away”. (This article drives home the comments in the previous paragraph on smart-beta.)