Contents: Sharpe/Ameriks/Cunnif on retirement finance, insured annuities-still questionable, calendar based investing is astrology, fee-only vs. fee-based and ‘broker-dealers’ vs. fiduciaries, long-term care insurance owners in for another premium increase? Canada’s house price increase slowing- or is it teetering? Canada’s house stats not all credible? Florida house sellers reducing asking prices, rising seas affect beachfront property prices? expanded CPP good but not now? expanded CPP better than putting off pension reform but must bring value to all Canadians, collective defined contribution pensions (CDCs), Ontario ready to move alone on pension reform, “Is your pension safe?”- don’t bet on it, consider emerging markets a separate asset class even though more correlated with developed ones, little left for hedge fund investors after intermediation costs, “Investors don’t need more protection”- really?
Personal Finance and Investments
I mentioned a few weeks ago the Stanford professor Joshua Rauh’s free “Finance of retirement & pensions” course which was brought to my attention by a very knowledgeable reader of this blog who is participating in the course. Over the weekend he send me a link to a panel discussion chaired by Rauh with (Nobel laureate) William Sharpe, Vanguard’s John Ameriks and TIAA-CREF’s John Cunnif; it would not be an exaggeration to call this a panel of retirement finance all-stars! You can access this under 48 minute Sharpe/Ameriks/Cunnif video in which they discuss: saving as the cornerstone of retirement finance (if you start young 15-20% of income is sufficient), make sure to participate in 401(k) like plans to get full benefit of the free-money (employer match), company stock in 401(k) not recommended, life-cycle funds (be careful since these are designed for average individual, costs are higher, different glide-paths, question advisability for continuing risk reduction beyond retirement), the ongoing debate around appropriate “spending-down” strategies (percentage, asset allocation, endowment models, desire to leave a bequest or spend everything), risks: market/inflation/longevity, annuities (people are not necessarily acting irrationally when they actively choose not to annuitize), 1% is too high a price for financial advice, stocks are risky even in the long-term (e.g. 50% loss in 2008), bonds are necessary (offset market risk), inflation risk mitigated with stock allocation and inflation linked bonds, longevity risk mitigated with annuities. (Well worth watching this retirement finance educational opportunity. Thanks to VP for recommending.)
Is it must “insured annuity month” or just a “slow insurance month” as the Globe had a similar article a couple of weeks ago. You might want to read the Financial Post’s “Preserving income through insured annuities” together with my recent blog post “Insured annuities? Not so fast”. To its credit, the article indicates that due to ‘variables’ to consider you should consider “qualified advice”. (I would suggest that independent qualified advice would be even more important.)
In IndexUniverse’s “Calendar based investing Folly” Larry Swedroe counts calendar-based investing tactics (e.g. “September is stock’s cruelest month” or “Sell in May and go away”) as part of the ‘Astrology’ flavored “investment pornography” class of articles.
In the WSJ’s “Much ado about adviser compensation” Daisy Maxey discusses differences between ‘fee-only’ (“flat fee or percentage of assets under management annually, an hourly fee or fee per task”) vs. ‘fee-based’ (which more like “fee and commission”), and the confusion in how advisers are regulated Registered Investment Advisers RIAs (fiduciaries “who must divulge everything about compensation”, SEC or state regulated) vs. ‘broker-dealers’ (not fiduciaries, self-regulated under industry’s FINRA). Broker-dealers often get dual registration as broker-dealers and RIAs further adding to the confusion.
In InvestmentNews’ “Largest long-term-care insurance sellers go after premium increases” Darla Mercado reports that John Hancock (ManuLife) indicated that “it will be filing requests with state insurance regulators to raise premiums on half of its in-force business by an average of 25%…(just) three years after the insurer had asked regulators in the U.S. for rate hikes averaging out to 40%”. Similarly Genworth “started filing for rate increases of 6% to 13% on the in-force business that was purchased between 2003 and 2012”. And industry watchers warn that more increases are on the way (and remember these increases are on existing policies that were bought years ago). Companies indicate that it is not just interest rates on bonds but there is much lower lapse rate on policies than anticipated (i.e. insurance companies were expecting a much higher proportion of policy holders to drop policies before they actually need benefits. But when premiums rise, policyholders have to either pay up (if they can still afford to do so) or reduce their coverage/inflation protection or just drop the policy and end up with nothing. This is a great insurance product, at least for the insurance companies; or judging by the repeated request for premium hikes it might not even be good for them. You might be interested in reading my Long- term Care Insurance (LTCI- I) and Long-Term Care Insurance (LTCI) II- Musings on the Affordability, Need and Value: A (More) Quantitative View blog posts on the subject.)
Real Estate
The October 2013 Teranet-National Bank Composite House Price Index indicates a +0.1% increase in prices from September and a +3.1% increase compared to previous year. YoY price increases were shown in 9 of 11 metropolitan areas with Toronto +4.1%, Calgary +6.7%, Montreal +0.9% and Ottawa +0.9%. On a MoM basis only 3 of 11 markets were in positive territory; Calgary at +0.9%, Vancouver at +1.1% while on the downside Toronto at -0.2%, Montreal -0.1% and Ottawa at -0.5%.
In the Financial Times’ “Canada’s housing market teeters precariously” Anjli Raval reports that some housing economist believe that “Canada’s housing market exhibits many of the symptoms that preceded disruptive housing downturns in other developed economies, namely overbuilding, overvaluation and excessive household debt”. With household debt at 163% of disposable income, spending housing near record 30% of income, and price-to-rent ratio 60% higher than average; the prediction is for a 25% drop over the next few years. (We’ve been on the precipice for the last few years already, if interest rates start rising aggressively a correction is more likely; otherwise I wouldn’t bet too heavily on it- but then my forecasting record is dismal, given that I thought that Toronto prices peaked about 3 years ago.)
In the Globe and Mail’s “Canada’s housing numbers don’t measure up” David Parkinson questions housing statistics coming from various sources (e.g. housing starts numbers from CMHC the government mortgage insurer and home sales/prices from CREA the Canadian Real Estate Association). He question the consistency of the numbers and potential distortions (from conflicted sources like CREA’s sales numbers), and lack of data (e.g. foreign and investor purchases). He also notes that “One of the more amazing phenomena is the amount of “investment porn” that passes as financial journalism. Even worse is that so many people allow this nonsense to impact their decision-making.” (There are also tons of articles based on financial industry product promotional material masquerading as financial journalism, some of it referred to earlier in this week’s blog post.)
In Sun-Sentinel’s “Redfin: S. Fla. housing market slows, sellers cut asking prices” Paul Owers writes that according to a new report 18% of Palm Beach County and 25% of Broward County homes for sale had price cuts in October.
In the Sun-Sentinel’s “Rising seas haven’t hurt property values-yet” David Fleshler reports that “The Atlantic Ocean is rising, but the South Florida real estate market doesn’t care.” But a panel of real estate, finance and insurance professionals…(suggested that) this could change…if insurance premiums start to reflect the true risks of owning coastal real estate.” (Perhaps it is time for Florida to take the necessary steps to protect the coastline against the encroachment of the ocean before a Hurricane Sandy like loss. Government regulators are among the most significant obstacles preventing action in the past decade. Sandy resulted in over 140 lives lost and over $50B property damage, see Hurricane Sandy One Year Later)
Pensions and Retirement Income
In the Globe and Mail’s “Canadian pension plans face further restructuring, survey says” Janet McFarland reports that “Canadian pension plans have taken major steps to restructure because of ongoing funding problems – and a new survey suggests more change is coming.” Private sector pension plans closed to new employees are increasingly the norm. Even public sector plans are reviewing inflation protection and are increasing employee contributions. Employers are struggling with funding deficits and more sponsors “are “curious” about target benefit plans”. The provinces appear to have reached consensus on the desirability of some form of expanded CPP but as the Globe and Mail’s “Expanded CPP is a good idea- but not right now, Flaherty says” indicates the federal government still doesn’t think that it is the right time for pension reform. (The federal government is right, now is not the right time, a decade ago would have been better! Even those that don’t think that an expanded CPP is the best solution, like myself, would have to agree that it is far better than doing nothing; and given the existence of the CPP it can also be used as an administrative infrastructure for pension reform.)
There is not much discussion on one aspect of the expanded CPP, but if this will unfold as expected, given the pre-funded requirement and no cross-generational subsidization (as it should be) it will take decades of employee and employer contributions to fully fund the promised steady state benefits. I have seen no indications that special steps will be taken to deliver some benefit enhancement to those near or in retirement and those who are homemakers/caregivers. In my new Expanded CPP: Should address the needs of ALL Canadians blog post, based on my understanding/assumptions of the expanded CPP proposals, retirees/boomers/caregivers/homemakers are at risk of being very disappointed given the expectations that might have been created in their minds by the buildup given to an expanded CPP. Provisions must be made to at least allow lump-sum purchase of CPP benefits, but pure longevity insurance payout option and access to effective systematic withdrawal mechanisms without requiring annuitization at retirement would be even more valuable. To address Mr. Flaherty’s concerns about its potential economic impact, if necessary, an expanded CPP can start immediately with employee only contributions, with employer match to commence when pre-specified economic conditions are met.
In Ontario’s just released “2013 Ontario Economic Outlook and fiscal review- Chapter V: Retirement Income Security” Retirement income security (which used to be called pension reform) is high on the provinces agenda. Ontario is taking a leadership role in working with the federal and other provincial governments toward “an enhancement to the Canada Pension Plan (CPP) to protect the middle class in retirement. If agreement cannot be reached, the government will move forward with a “made in Ontario” solution” (Thanks to Ken Kivenko for recommending.)
In the Financial Times’ “CDC: A road map to better pension provision” Kevin Wesbroom reviews the UK government report “Reshaping workplace pensions for future generations” and Collective Defined Contribution (CDC) pensions in particular. The UK pensions minister (in the UK they actually think that pensions are important enough to have a minister dedicated to the task) appropriately calls private DB plans in “terminal decline”. They concluded that “CDC plans could make material improvement to retirement outcomes” through: cross-cohort risk sharing “allowing more risk to be taken more efficiently”, independent trustees selecting investment professionals, economies of scale, etc. CDC plans also do not force annuitization at retirement (particularly important for those retiring in a period of historically low interest rates). They estimate that CDC pensions might be one third higher than DC based ones. The challenge is to communicate clearly the benefits of such a plan which does not come with guarantees. (Certainly sounds like massive opportunity to consider for those tasked with pension reform agenda, especially in Canada.)
In Yahoo Finance’s “Is your pension safe” David Aston argues that for Canadian private sector employees “even if your pension plan has a large shortfall, that doesn’t necessarily mean you should start to worry about getting shortchanged. With most private sector pensions, employers are solely responsible for making up the difference…The main cause for concern over the safety of your pension comes when both the plan and your employer are in poor financial shape… (however) the enormous cost of these plans means unearned future pension entitlements are less secure.” (Personally, as I have indicated in the past, I believe that earned pension benefits should be sacrosanct. You don’t pull the rug from under retirees who can no longer take any evasive/corrective action. I have personal experience with this, and while Aston’s intentions are no doubt honorable in trying to reduce anxiety of seniors about their pensions, I believe Canada’s private sector pensions are in systemic failure as discussed for example in my Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now? blog post written shortly after Nortel declared bankruptcy. Perhaps when companies/sponsors of DB pension plans can’t and/or won’t fund the employees’ already earned pension obligations, it is an indication of financial and/or moral decay for the company/management, and not just employees but investors should pay attention too. Of course all the professionals and regulators must also bear their fair share of the situation.)
Things to Ponder
In IndexUniverse’s “Questioning emerging markets” Larry Swedroe looks at a report on emerging markets which indicates that: correlations with develop markets are up to 0.9 vs 0.4 in early 90s, they represent 30% of world GDP but only 13% of equity capitalization, past 25 years their excess returns were double that of world index, but their volatility was 23.8% vs 15% for world markets and had “more downside risk”, and others. Swedroe adds that they are also cheaper at P/E of 11.7 compared to 15.4 for the S&P 500. He concludes that they still are a separate asset class, they remain attractive and are “generally underrepresented in individual investor portfolios”.
In the Financial Times’ “Investors need to starve the hedge fund beast” Jonathan Ford notes that Alfred Winslow Jones, the originator of the concept of hedge funds, would be shocked to learn that hedge fund assets today are $2.5T. In fact he thought in the 70s that hedge funds had limited future primarily due to what he saw as their limited asset capacity since their “investment styles were too easily copied, and the inefficiencies on which they thrived too swiftly eroded”. By one estimate over the past 20 years hedge fund fees have consumed “98% of the returns they made”, because they are very expensive to run (info gathering, computing infrastructure and hedge fund manager compensation and other costs.) The largest investors into hedge funds are pension funds, which are also” exposed to the whole market” so any gains the hedge funds might deliver at the expense of the overall market, these gains are delivered after costs and benefits incurred by intermediaries; i.e. a zero-sum game before intermediary costs. In fact one estimate suggests that all in costs of hedge funds to be about the same as the 7% long term return of equities. (Ouch…and yes more and more private and public pension funds are increasingly adding alternative assets including hedge funds, in the hope of increasing returns.)
And finally, in the you must be kidding” category is the Financial Post’s “Investors don’t need more protection, industry report says” where Barbara Shecter reports that prestigious Toronto law firm Torys LLP says that “there is no gap in Canada that need to be filled by imposing further statutory obligations on investment advisors and dealers”; (you’ll no doubt be surprised to hear that) the “report was commissioned by Investment Industry Association of Canada and the Investment Funds Industry of Canada”. The financial industry must be terrified that the regulators’ umbrella group, Canadian Securities Administrators, currently studying the matter will actually impose a requirement that somebody calling themselves an “adviser” might be required to act in the client’s best interest. That might be a set-back for the industry, but absolutely necessary from the perspective of any objective observer who considers the current overwhelming disadvantage of the average investor vs. the industry. (Thanks to Ken Kivenko for recommending.) (You can find my comments to the CSA on the subject of fiduciary requirement in the Fiduciary – Response to “CSA Consultation Paper 33-403 – The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients” blog post.) On the same general topic, in the NYT’s “Seeking to toughen the rules for brokers” Tara Siegel Bernard writes that despite most individuals hope (actually surveys indicate that most people don’t just hope but actually believe) that when they approach professional for financial advice “the advice giver is acting in your best interest — not profiting at your expense”. There are parallel efforts in the U.S. to introduce requirement to act in the client’s bets interest: the Department of Labor addressing requirements for IRAs and the SEC looking at harmonizing requirements for broker-dealers and registered investment advisers (who already have a fiduciary requirement). The article discusses the relentless financial industry’s onslaught against fiduciary requirement. (I am still in a state of disbelief how anyone aspiring to call themselves advisers could be fighting against acting/advising in the clients’ best interests!?! What’s even more amazing is that there are so many people seeking advice from such sources.)
