Financial Bubble Still Here with Yet More to Unravel?

Is there such a thing as a secular financial bubble? Has the financial sector become bloated out of proportion to the economy over the last few decades and is there be a contraction in store, abrupt or prolonged, back to a smaller financial sector? Was the crisis of 2008 merely the start?

I'm not sure of the answer but a couple of data points have stuck in my mind recently:

1) Below is a copy of two charts from the paper Fundamental Indexation by Rob Arnott, Jason Hsu and Philip Moore. Note how the Financial sector, both on a cap-weighted market value basis, the upper chart, termed the Reference Portfolio and on a fundamental accounting basis, the lower chart, has expanded steadily since the 1970s and now has become the dominant sector of the US equity market. By comparison, the Tech bubble was a fleeting aberration, now absent from the trends. In the same charts, updated to June 2007, found in their book The Fundamental Index, there was only a slight pullback in the share of the Financial sector in the Fundamental chart while the market value chart looked the same. Unfortunately, there are no numbers visible so it is hard to compare with today's data and I wish and hope that the folks at Research Affiliates where messrs Arnott et al work will do updates.


2) Financials have bounced back from 11.6% of US total market cap at the end of February 2009 to 16% in 2010, according to the proportions of holdings in Vanguard's Total Stock Market ETF VTI.

3) In Canada, one could almost say that the equity market consists of Financials and a few other bits and pieces - by market cap, Financials occupy 31% of the iShares TSX Composite ETF (XIC), while the Canadian RAFI Fundamental Index ETF of Claymore (CRQ), which contains 65 of the largest companies measured by a combination of sales, cash flow, dividends and book equity, has no less than a 47.4% weight in Financials. The folks who make the RAFI indices describe them as representing the companies' economic footprint. Is that really what the Canadian economy now consists of, and is it normal or healthy such that a change may happen sooner or later? The comparable market cap ETF to CRQ is iShares TSX 60 (XIU). Interestingly, it shows the market under-weighting Financials, especially insurance companies like Manulife and Sunlife, by some 13.4% (i.e. Financials are 34% of XIU) compared to CRQ.

4) The UK's FTSE All Share Index still has about 21% of its market cap weight in Financials as of the end of February 2010, judging by the db x-trackers ETF that tracks this index. Again, it is the single largest sector, though just barely ahead of oil and gas.

Tax Filing and Foreign Income Form T1135 - Save Some Trees and Your Time

Tax filing tip of the day ...
The Canada Revenue Agency is keen to track down potential tax cheats who hide their millions and billions away in foreign tax havens. So they oblige everyone to declare their foreign holdings over $100,000 by filling in form T1135 "Foreign Income Verification Statement" to submit with their tax return. Unfortunately, in the course of testing online tax prep packages I have noticed that the packages are not always clear about a couple of common situations where taxpayers do NOT need to fill in T1135:
1) if those holdings happen to be within a registered account, such as an RRSP, RESP, RRIF, TFSA, LIRA, LRIF, RPP etc; or
2) foreign investments held in Canadian ETFs (e.g. iShares XSP, which holds the S&P 500, but is registered in Canada by iShares Canada and traded on the TSX) or Canadian mutual funds

The instructions and examples on page 2 of the T1135 (available here from the CRA with an FAQ here) make this clear. It makes sense that it would be so as the CRA already is able to collect and control taxes on such accounts.

If you do have over $100k in foreign assets, such as US shares or ETFs in a taxable account, then you must mail in the signed paper copy, even though the rest of the tax info has been NetFile'd online.

QuickTax Winner

Congratulations to Jon, the winner of the QuickTax web tax preparation contest. If you are reading this Jon, please contact me via email to claim the prize. There is a link in the right-hand column of the blog to email me.

Tax Saving Idea for Couples: the Superficial Loss Shuffle

"Superficial loss shuffle" is such an appealing name and the concept itself has the amusingly ironic quality of turning the CRA's superficial loss rules, which normally disallow tax advantages to an investor, on their head and give an advantage instead to the couple with investments in separate taxable accounts, one of which has capital gains and the other losses.

The idea is that the spouse with the losses be able to transfer them to the spouse with the gain and eliminate any tax owing. The idea and the description of how it works is here on the CCH website in Tax Planning in a Downturn in the February 2009 issue of the Financial Planning eMonthly newsletter under the pen of lawyer and accountant David Louis.

Note that the CRA prescribed rate of 3% mentioned in the article is now down to the can-never-go-lower rate (since it must be a positive whole number) of 1%.

QuickTax Online Tax Return Giveaway

Tax preparation season is in full swing with just over a month to go till the April 30th filing deadline. To help us get through with a minimum of fuss and bother and maybe to promote their product, tax software heavyweight QuickTax has provided me with an access code to give away to readers for use of any of its online versions (cannot be used for the download version to install on your own PC). That's a value of up to $39.99.

Enter by leaving a comment on this post by midnight eastern time Friday March 26th. Use a unique name (not as anonymous) so I can do a random draw from the entries. I will post the winner's name for him/her to contact me via email so I can send the code. The winner's email will not be used for any other purpose.

Disclosure: QuickTax has given me another access code for my own use. I am busily using it to test all the NetFile certified online tax prep software out there to find out which is the best as I did last year for the 2008 tax year. Look for the results soon.

Understanding Wall Street Book Draw Winner - AC!

Congratulations to blog reader AC, winner of the draw for the book Understanding Wall Street, which I reviewed last week.

AC, please contact me via the email link in the right margin column with your postal address so I can send you the book.

Inflation at 4% to be the New Normal?

Cynics might say it is a conspiracy to prepare the ground for higher inflation to be accepted by central banks. Realists will observe and weigh the probability that it will happen and think how to protect themselves or profit from the eventuality. Whatever one's attitude it is worth noting recent comments and facts on the subject.

Chief economist at the International Monetary Fund Olivier Blanchard published a paper in February advocating a higher inflation target of 4%, which idea influential US economist Paul Krugman praised in the NY Times, citing other economists who have proposed the same. A UK news article in the Independent then discusses the idea, saying the old targets of 2% may have been fine in the past but not for the future.

Meanwhile, the most recent actual UK inflation rate was 3.5% and the National Posts reports that the World Bank forecasts that inflation worldwide will be 3.7% this year and that a rate of 4-5% in emerging markets is not a problem. Canada's inflation rate was only 1.9% in the latest January figures. That's nice and right in the middle of the official target range of 1 to 3%. However, it might be good to keep in mind one of Wayne Gretzky's secrets of success, the advice from his dad Walter to "skate where the puck's going, not where it's been".

Of course, not everyone agrees that 4% would be a good thing, but who listens to blogger Mike Moffatt when a Nobel Laureate like Krugman speaks? The fact that higher inflation would reduce the real value of the huge amounts of public debt taken on to recapitalize banks and to stimulate the economy conveniently enhances the acceptability of the idea to governments.

So, what are some of the investments to counter or profit from higher inflation?

• Real return bonds - the best and surest: best, because it offers an automatically-adjusted positive return over and above CPI and; surest, because it has the guarantee of the government (which admittedly is not an absolute but it is better than anyone else's). Note that in Canada, if RRBs are held in a taxable account, the government taxes all of the return, including the nominal increase to adjust for inflation. The higher the inflation and the higher the tax bracket, the more taxes to pay. That can result in a net after-tax loss relative to inflation (e.g. 4% inflation + 1.5% real return less 40% tax = 3.3% net after-tax). RRBs are most effective in a registered, tax-protected account.
  
• Equities - when inflation is higher but steady - businesses can and do adjust their prices; not so good to deal with unexpected inflation and big erratic jumps, like the 1970s. This scenario seems to be more the case now with the talk of new inflation-targeting of 4%.
  
• Gold - probably best for unexpected hyperinflation or crisis scenarios and not for steady, expected high(er) inflation like a 4% target that is maintained and adhered to

Update April 1: the Globe and Mail reports that a Bank of Canada deputy governor doesn't like the IMF idea. Good on him! If most people were to be asked, if there was any change made to the inflation target it should be downwards to 0%, in other words price stability.

Comparing Fundamental and Equal Weight Index ETFs - and the Winner is ...

Last week I posted about the very enticing results of academic research that found significant and sustained out-performance by both fundamental and equal weight indices compared to the cap-weighted index method that has been the basis of choice for passive index investors for decades.

But indices are only a theoretical construct, the proof in the pudding for the investor is whether the practical challenges of operating a fund to track the index - trading costs from reconstitution (buying and selling as companies enter or leave the index) and rebalancing, management expenses, bid-ask spreads, tax costs (e.g. if too much capital gains get distributed causing taxes to be payable) - eat up the return differential and leave the investor no better off. A second major question is whether the out-performance persists in the time after the research data ended (so-called out of sample performance) and whether it does on a risk-adjusted basis.

Comparison Table
I've compared the original cap-weighted leader, the SPDR S&P 500 ETF (symbol SPY), against these US-traded ETFs which mimic the promising index candidates I named in my first post:

• Powershares FTSE RAFI U.S. 1000 Portfolio (PRF) - Fundamental RAFI
  
• Rydex S&P Equal Weight ETF (RSP) - Equal Weight
• Powershares Dynamic Market Portfolio (PWC) - Intellidex
• WisdomTree Equity Income Fund (DHS) - WisdomTree Equity Income Index
  

Key criteria where an ETF has the best number are highlighted in green.



My Conclusions

• Winners - PRF and RSP - both these funds have outperformed SPY by a significant margin in the last three years - by 1.3 to 1.8%; that is exactly what we hoped to see in the out-of-sample period after 2006. Both have also outperformed on a risk-adjusted basis as the higher Sharpe ratio (it's less negative) shows. Both have total extra expenses (Expense Ratio of about 0.3% extra plus Tracking Error vs its own index of 0.4% to 0.7%) that add up to less than the extra return. Recall that the academic study found longer term index annual out-performance of almost 2% so if the extra cost for these two ETFs stays below 1% per year, the investor will be better off net by about 1% a year. That's pretty darn good. Other measures like bid-ask spread, potential capital gains exposure and tax cost do not alter this conclusion, and perhaps favour PRF and RSP even more. Of course, it all could still be a flash in the pan and RSP and PRF could under-perform forever from now on, or next month or next year. More likely is that another bubble will come along when the over-valued stocks will leap ahead for a number of years, as happened during the 1990s, and then RSP and PRF will under-perform for years.
  
• Jury is Still Out on PWC and DHS - 3-year returns and Sharpe ratios are both quite a bit worse than SPY's. Maybe this is just a temporary period and the two funds will shoot ahead but no one knows. The funds' costs are in line so it is the actual portfolio that has caused the performance difference. The high proportion of assets (30% and 45% respectively) in the top ten holdings of each makes clear that the ETFs' results depend heavily on a few companies only. It's something that makes me as a passive index investor nervous.

Implications for a Portfolio

• Replace SPY and "Value" ETFs with either or both PRF and RSP - as the academic studies showed and the RAFI index creators say themselves, RSP and PRF have an inherent value tilt. Though strictly speaking all the funds are considered Large Cap, they could replace Total Market ETFs for someone who doesn't want to own lots of funds. Invesco Powershares does offer a small-mid-cap fund (PRFZ) and it might be a good combination, though I haven't looked at it detail.
  
• The Fundamental Index (as in RAFI, which is trademarked by the creators at Research Affiliates) claims that it works by systematically putting less weight on over-valued stocks and more weight on under-valued stocks. It that is so then it will produce superior risk-adjusted returns in other countries and markets like Canada, Europe, Japan etc. The RAFI folks say they have looked at data for other places and the principle pans out. If that's true, then goodbye any and all Value funds.

I have not compared the ETFs (from Claymore Canada) and mutual funds (from Pro-Financial and Invesco Trimark) available in Canada that are also SPY replacement candidates using RAFI fundamental index tracking. That comparison will be fodder for another post. No funds like RSP exist in Canada, so far as I know, to track the S&P 500 equal weight index.

Book Review and Giveaway: Understanding Wall Street (5th ed) by Jeffrey Little and Lucien Rhodes

That this book is now in its 5th edition 30 years after its initial publication attests to its on-going value. It is an excellent primer and reference source for all investors, a good place to start, whether it is to read it from end to end as an introduction to investing or to brush up on a new topic. Though its intended audience and subject matter is American, it will be of great value to Canadian investors, because many of us do invest there directly and because things work pretty much the same on Bay Street as on Wall Street.

The approach is very descriptive, practical and intuitive, an everyman's way of thinking rather than academic or analytical. For example, the chapter on bonds explains very well how yield to maturity works in common language and then shows a bond table with prices for various maturities and yields with a note that the calculation is done with a calculator or computer. A more analytical text would have given the actual formula. As a practical matter, as long as one understands the concept of YTM, it doesn't matter too much since when one actually gets to buying a bond through a broker, the broker will tell you the yield.

Many simple examples illustrate and help explain the topics. In keeping with its updating to current times, many websites are given for access to data (though blogs are not mentioned at all!).

The book's small inaccuracies do not introduce any fatal flaws - such things as the index getting a bit out of sync in spots as a result of new material being inserted into this edition (basis points page ref in the index says p.183 but is actually 193), or the fact that the first successful ETF was launched in Canada (TIPS) NOT in the USA (SPY), or the implication that Canada's stock market is primarily mining and industrials (it's financials and energy). One change that would make the book more useful as a reference is to expand the index.

One topic (do the "Click to Look Inside" to see table of contents on Amazon) the authors do not cover is taxes. Though perhaps the omission of taxes is deliberate and understandable given the complexity of the topic, a broad coverage of investing must include a discussion of portfolio construction and diversification, which the book does not do. That would be far more useful than the concluding chapter on Wall Street personalities, which has no practical investing knowledge value and is not very entertaining either.

My rating: 4 out of 5 stars. Not a perfect book but very useful and practical.

Thanks to the publisher McGraw-Hill for providing a review copy and another copy for a ...

DRAW and GIVEAWAY!

I am giving away one copy of Understanding Wall Street to a blog reader. To be eligible for the random draw to be done amongst entries received by next Thursday March 18th midnight Eastern time, leave a comment on this post (perhaps suggest another book you would like me to review?) with some unique name (i.e. not anonymous). I will then announce the winner who should contact me with postal details to receive the book. That information will be used for no other purpose, nor passed along to anyone else.

It's Time for Passive Index Investors to Dump Cap-Weighted Indices Like the S&P500

Passive equity index investors just want to get a broadly diversified stake in equities to benefit from the higher returns that accrue to equities and to do so in the most efficient manner, i.e one that produces the greatest bang (return) for for the buck (risk).

Academic researchers armed with ever more complete data sets, computing capability and more sophisticated statistical and mathematical techniques have been pushing forward the boundaries of what is the best. The original US equity index, the Dow Jones Industrial Average, has long been discarded as inadequate. Now the S&P 500's limitations as an index are too apparent. It simply doesn't do a good job compared to alternatives.

A couple of papers from the EDHEC - Risk Institute (an arm of the largest French business school by the same name) test the cap-weighted S&P 500 against a number of alternatives and find large, statistically significant differences in favour of the alternatives. The papers:

1. A Comparison of Fundamentally Weighted Indices: Overview and Performance Analysis by Noël Amenc, Felix Goltz and Véronique Le Sourd (March 2008)
2. Efficient Indexation: An Alternative to Cap-Weighted Indices by Noël Amenc, Felix Goltz, Lionel Martellini and Patrice Retkowsky (January 2010)

Paper 1 compares these indices for the US market against the standard S&P 500 Cap-Weighted and on some measures, a US Total Cap-Weighted Market Index they built themselves based on all NYSE stocks:

• Equal Weight S&P 500
  
• Various Indices using Fundamental Financial data to select and weight stocks for each index -
• FTSE GWA US index
• Dow Jones US Select Dividend
• AMEX Dynamic Market Intellidex
• WisdomTree Domestic Earnings- or Dividend-Weighted Indices - 4 permutations of each kind
• FTSE / Research Affiliates RAFI 1000 Index
• Mergent/AMEX Broad Dividend Achievers Index
• VTL Associates / Standard & Poors Revenue-Weighted Large Cap Index

The RAFI and the WisdomTree indices have data going back to the mid 1960s while the rest all start around 1990, which limits the ability to conclude that some out-performance is statistically significant.

Key Findings:

1. Every Fundamental index had higher returns than the standard S&P 500 and the Total Market index; the best outperformed by a statistically significant margin: the RAFI, the Intellidex and the WisdomTree HighYield Equity Index (now called the Equity Income Index)
2. None of the Fundamental indices does better than the Equal Weight index (most do worse), in fact a couple of WisdomTree indices underperform the S&P 500 by a statistically significant margin.
3. Fundamental indices had long periods - almost 16 years for the worst index - when their performance lagged the S&P 500, and the lag was quite large - over 50% in the worst case. Among the indices with a long history, the RAFI was the best with only 88 months underwater and 22% maximum performance lag. The killer period for relative performance of all the fundamental indices was the 1990s, the time of the tech bubble!
4. Some of the indices provide true alpha (excess return) compared to the S&P 500 - the RAFI, Intellidex, WisdomTree Dividend and HighYield Equity.
5. When taking account of exposure to small cap size, value (based on stock book value) and price momentum, it turns out that most of the out-performance is due to a value tilt by all these indices. There is still a bit of statistically significant alpha in the RAFI, the FTSE GWA and the Intellidex. The WisdomTree HighYield comes close but doesn't quite make it.
6. Analysis of sector weightings show that almost all of the variability of fundamental indices is due to sharp divergences in weightings with what the S&P 500 contains - much less Tech, Telecom and Health Care and much more Utilities, Consumer Discretionary and Finance. As the authors say, the fundamental indices underweight typical growth sectors and overweight value sectors. Despite taking this into account, a few indices still show positive alpha - RAFI, Intellidex, WisdomTree HighYield and Dividend 100.
7. Net selectivity measures the success in adding value after adjusting for total risk in addition to the alpha, which took account of systematic risk. Almost all of the indices had positive net selectivity over the S&P 500 even after after deducting the alpha.
   
8. By constructing a theoretical optimal portfolio (in terms of the highest Sharpe ratio aka greatest bang for the buck, or return divided by standard deviation) , they conclude that none of the tested indices is optimal.
   

Authors' Conclusions
They call the indices "nothing but value-tilted active indices". That is not a condemnation or a dismissal of their value. Indeed, they say, "... the main value added of these indices may be to provide investors with a liquid, systematic, and relatively cheap alternative to other value-tilted strategies."

The opportunity for an investor to incorporate in a portfolio the proven value of a value tilt with one fund instead of buying another to provide it is intriguing. In fact, one index, the Intellidex also includes a small cap tilt and a momentum tilt and both these tilts have been found by researchers to be beneficial.

Practical Implications
The indices are tangible and based on real data but that is not the end of the process to decide to jump into the ETFs or mutual funds that implement the indices as their guide for investment.

"In practice, of course, management fees, transaction costs and out-of-sample performance may reduce the value of characteristics-based indices." The alpha must be at least greater than the expenses difference to compensate. Other features of funds that affect real investor returns like index tracking error, transaction costs from rebalancing and reconstitution, bid-ask spreads and divergences between NAV and market price of a fund must also be taken into account to figure out if there is a net advantage for an investor at the moment.

'Out-of-sample' means the future may not be like the past. The data used in the study went up to December 2006 so we are now in the test period that will answer whether the past out-performance results will continue. Are we in period when the fundamental approach will lag, another time of irrational exuberance and a bubble? It is impossible to know for sure.

Bottom Line Takeaway
I'm impressed and convinced that some of the fundamental indices offer a better solution than the S&P 500. The indices that seem to be worth pursuing, based on the paper's results and comparisons, from most to least promising, are:

1. RAFI - long back data, probably more reliable results, consistently shows positive statistically significant alpha across many measures, though its alpha at 1.9% is less than the others; fell in the low end below the S&P 500 during its period of under-performance from 1993 to 2001; very highly correlated to the S&P 500, which means it will play the same asset allocation role in a portfolio
   
2. WisdomTree HighYield Equity (now called Equity Income) - another with data going back to the 1960s, seems to have lowest downside risk though a longer period of under-performance; achieved higher alpha than RAFI
   
3. Intellidex - amazingly higher return difference over the S&P 500 with positive statistically significant alpha of 0.48% per month (c.5.8% per year) but has much shorter history with data only going back to 1992 (will it continue to work in other market environments?); lowest lag and shortest period of under-performance relative to S&P 500; has exposure to all excess return risk factors - momentum, value and small cap, unlike the other fundamental indices, which only include the value factor
4. Equal Weight - since none of the fundamental indices performed any better
   

Paper 2 describes how to construct the optimal efficient index. The Fundamental indices assessed in Paper 1 certainly fall short of that goal but until some fund company puts one together and offers it on the market, they are appreciably better than the venerable cap-weighted indices like the S&P 500.

One question of importance to international investors and not addressed in these papers, is whether Fundamental indices would work equally well for markets outside the USA. The answer is almost surely yes, since their inherent nature is building in exposure to value stocks and the value premium has been found across other markets.

In the next post, I'll compare the funds, mostly ETFs, that implement the above best indices.

Was Madoff Predictable? Academics Say Yes

Finding Bernie Madoff: Detecting Fraud by Investment Managers by Stephen G. Dimmock and William C. Gerken, a December 2009 paper available in the GARP Digital Library say that yes, Bernie Madoff could have been stopped using the publicly available information of mandatory SEC filings. " ... we find the firm’s fraud risk is on the 95th percentile of all firms in our sample, and the firm’s felony fraud risk is on the 98th percentile. The firm’s economic interests in clients’ transactions, affiliation with a broker/dealer, and its history of regulatory violations all contribute to the high score." That with filings done 11 months before he was charged.

Dimmock and and Gerken found that such public information could have been used to predict over 70% of frauds at 13,592 investment managers serving 20 million investors between 2000 and 2006. The list of things that can predict future fraud:

• past legal and regulatory violations; history of crime, including non-investment crime such as drunk driving, is strong indicator of fraud risk!
  
• conflicts of interest - 1) advisors that have economic interests in securities traded on behalf of clients, 2) accepting soft dollars (when investment advisors direct client trades to a brokerage with relatively high commissions, and in return the broker supplies the advisor with research or other benefits), or, 3) affiliation with brokers/dealers.
• firms with smaller investors - The presence of large institutional clients is negatively related to fraud disclosures (i.e. somebody with clout and capability is actually watching the advisor to keep them in line). They found that the converse is also true - " ... firms with smaller investors have significantly more frauds."
  
• when advisors hide or non-transparently disclose information, as allowed by SEC rules
  

Smaller firms with fewer investment advisors were not associated with higher rates of fraud risk. Another factor that is not associated with future fraud is a history of investor lawsuits.

They also discover that investing money with managers high on their fraud risk scale did not have any payoff in higher returns - there's no payoff for taking the risk of ripoff.

Their methods result in very few predictions of fraud when in fact none occurred. Applying their tests would not unfairly exclude many good investment advisors.

Especially troubling is that it is common practice for firms to remove previously disclosed crimes from subsequent filings (as allowed by the SEC) when such information has high marginal value in predicting fraud.

They offer some suggestions for simple and cheap (as in zero marginal cost to advisors) improvements to disclosure. I wonder if the SEC is listening? That would help, given the less than 100% prediction ability of their methods.

Meantime, US investors can use the Securities and Exchange Commission webpage where there is a link to Check Out Brokers and Advisors. It is Form ADV that provided the basis for Dimmock and Gerken's research.

In Canada, information similar to that used by the study in the USA seems not to be available to investors, judging by the Ontario Securities Commission website for Investors. The only data online seems to be whether the advisor has any actions outstanding against him/her, by which time it is of course too late if fraud is the issue. We must trust the regulator to protect us behind the scenes and attempt to do our own due diligence without assistance.

Scam Psychology: Invoking the "Just-in-Case-It's-True" Worry

Received the text below by email from a friend. I found myself laughing at it since the first part with the story of Sir Alexander Fleming is patently untrue as Wikipedia points out in the section of the entry under personal life; so too does Snopes.com. (A few weeks ago my wife and I were out walking and went right by the Lochiel farmstead where Fleming was born. It's very pretty countryside but there's no evidence of Churchills ever being in the area. And what does Irish luck have to do with Scotland, anyway?) It's innocent enough but illustrates how susceptible we can be since I also found myself feeling compelled to carry out the instruction to send on the email! In fact, this post is just that - all of you my readers and friends have now received it and I should be receiving my wish any moment now. The psychology is the same employed by those infamous Nigerian fraudsters who say they need someone to unlock some money by giving over bank details or paying some fees - we know it's not true but just suppose it isn't, we'd be missing out.

Irish Luck - Remember to send it back!

I want this back. It DOES work.

His name was Fleming, and he was a poor Scottish farmer. One day, while trying to make a living for his family, he heard a cry for help coming from a nearby bog. He dropped his tools

and ran to the bog.

There, mired to his waist in black muck, was a terrified boy, screaming and struggling to free himself. Farmer Fleming saved the lad from what could have been a slow and terrifying death.

The next day, a fancy carriage pulled up to the Scotsman's sparse surroundings. An elegantly dressed nobleman stepped out and introduced himself as the father of the boy Farmer Fleming had saved.

'I want to repay you,' said the nobleman. 'You saved my son's life.'

'No, I can't accept payment for what I did,' the Scottish farmer replied waving off the offer. At that moment, the farmer's own son came to the door of the family hovel.

'Is that your son?' the nobleman asked.

'Yes,' the farmer replied proudly.

'I'll make you a deal. Let me provide him with the level of education my own son will enjoy If the lad is anything like his father, he'll no doubt grow to be a man we both will be proud of.' And that he did.

Farmer Fleming's son attended the very best schools and in time, graduated from St. Mary's Hospital Medical School in London, and went on to become known throughout the world as the noted Sir Alexander Fleming, the discoverer of Penicillin.

Years afterward, the same nobleman's son who was saved from the bog was stricken with pneumonia.

What saved his life this time? Penicillin.

The name of the nobleman? Lord Randolph Churchill .. His son's name?

Sir Winston Churchill.

Someone once said: What goes around comes around.

Work like you don't need the money.

Love like you've never been hurt.

Dance like nobody's watching.

Sing like nobody's listening.

Live like it's Heaven on Earth.

It's National Friendship Week. Send this to everyone you consider A FRIEND.

Pass this on, and brighten some one's day.

AN IRISH FRIENDSHIP WISH: You had better send this back!! Good Luck!

I hope it works...

May there always be work for your hands to do;

May your purse always hold a coin or two;

May the sun always shine on your windowpane;

May a rainbow be certain to follow each rain;

May the hand of a friend always be near you;

May God fill your heart with gladness to cheer you.

and may you be in heaven a half hour before the devil knows you're dead.

OK, this is what you have to do.... Send this to all of your friends.

But - you HAVE to send this within 1 hour from when you open it!

Now.....Make A wish!! I hope you made your wish!

Now then, if you send to:

1 person --- your wish will be granted in 1 year

3 people --- 6 months

5 people --- 3 months

6 people --- 1 month

7 people --- 2 weeks

8 people --- 1 week

9 people --- 5 days

10 people --- 3 days

12 people --- 2 days

15 people --- 1 day

20 people --- 3 hours

If you delete this after you read it, you will have 1 year of bad luck!

But, if you send it to 2 of your friends, you will automatically have 3 years good luck!!!

What did I wish for, you ask? A modest, by modern standards, billion dollars CAD. Will let you know how it turns out.

Wordle - Fun with words

The most interesting discovery reading the National Post's news article on the Throne Speech was the image of the speech content as a word picture, as created using Wordle. Contrary to the popular saying, in the case of the Throne Speech, one picture is worth 6000 words.

Wordle is fun, as you can enter any website address - a good way to see what a blogger is currently talking about - or any piece of text, or the sum total of the links one has tagged in del.icio.us. One can play around with fonts, colours, orientation and create some striking and beautiful word images.

One format that I quite like is the following screen capture of my blog. The colour scheme (yramirP) produces a neat three-dimensional effect when I stare at it on the screen for a few seconds. Of course, that may also be due to the fact that I've been looking at the computer screen all day.

Montreal Economic Institute Attacks Québec Public Sector Pensions

The Montreal Economic Institute, which describes itself as "an independent, non-partisan, not-for-profit research and education organization", has just published a brief 4-pager Are public sector plans too generous? Its answer is yes, they are. They are not the first ones to point out the fact that they are generous (e.g. Sherry Cooper shows the same in her book, The New Retirement, reviewed here), though the MEI's overtly political aim of influencing negotiations with public sector unions to reduce their generosity is perhaps not shared by everyone, especially public servants.

The interesting bit in this paper is the assertion that the main advantage for the public sector pension stems from the greater job stability and security in the public service combined with the defined benefit rule that the pension amount is based upon the salary of the five best years of service. They calculate that a hypothetical private sector worker who changes companies and pension plans three times in a career will, at the point of retirement, have fully 41% less value in his/her retirement plan. This is even assuming the presence of am identical private sector defined benefit plan (which most private sector workers no longer have of course) with the same final five best year rule and the same salary throughout a career!! As they explain:

"The job security that many public sector employees enjoy makes all the difference. The five best years providing the basis for the pension are those late in their careers, when their salaries are at their peak. In contrast, the salaries for the five best years in the three different jobs held by the private sector worker are necessarily lower. This reality means that public sector employees are able to get the full benefit of their defined benefit pension plan, which is not the case for private sector workers employees, even with an identical plan."

Wow! Who'd have thunk, huh? Merely switching jobs in an upward career path at different organizations could royally mess up your retirement.

In a strict sense the public sector DB plan isn't necessarily special or unique. Any such DB plan and career path, private or public, would give the same result. Portable years of service credits and the continuation of the five year rule are the key. Of course, there is a crucial practical difference in that almost all public sector jobs are covered by DB plans so portability agreements which preserve accumulated work year credits ensure that the huge payoff of the "five-best-years" rule is preserved. Transferring accumulated pension savings from a DB plan into a DC plan cuts off the magic of a pension that is calculated on the basis that you earned your highest salary during your whole working career.

The five-best-years rule both catches up for past inflation and captures real salary increases. My guess based on personal observation is that it is also pretty rare for public employees' salaries ever to actually go down - when someone achieves their Peter Principle level, they get shunted aside where they can do less harm and stay at the same "red-circled" salary level.

With the disappearance of DB plans in the private sector, the practical result is that very many private sector workers, even those earning more than public sector employees, and / or who save just as much, will never be able to achieve the same pension.

The effect of the five-best-years rule is akin to the oft-repeated example of the long term benefits of compounding that putting aside a small amount left to grow easily beats saving much larger amounts later.

It is clear that public sector workers' pensions are far ahead of those in the private sector. The debate about whether to redress the fact of the inequality of private vs public sector pensions by reducing the pensions of public servants, or increasing the pensions of private sector workers and the equity or fairness of any solution, will be hotly contested and is not properly addressed in this short paper. However, at least it reveals one of the key practical differences.

The Mighty CAD, Computer Comparison Shopping II: Canada vs UK vs USA and the Olympics

Yes, those things in the blog title post are linked. Let me explain.

A few years ago I compared the price of the same Dell computer and found that a Canadian consumer would need to pay 20-30% more than someone in the UK or the USA.

Goodness, how things have changed. A similar comparison today of a Dell Vostro 220 Mini Tower with the same components delivered within the country tells us that this item in Canada costs 10% more than in the UK and 16% less than in the USA! As noted in the original post, the identical computer should cost the same effective amount in different countries according to the theory of purchasing power parity. The divergence since 2007 has narrowed since 2007 but it is nowhere near purchasing power parity. From being a lot more expensive than in the USA, the Canadian-bought computer is now significantly cheaper. Here are the costs and exchange rates (using mid-market quotes from Google Finance) for this no-monitor system.

• Canada: $598
• UK: £349 at CAD to GBP 1.5475 = approx. CAD $540
• USA: $685 at CAD to USD 1.0357 = approx. CAD $709

Is this only for computers I wonder? Will US shoppers now start reversing the cross-border flow of bargain seekers?

On a shorter time scale of the past year, since the abatement of the flight-to-safety panic of the 2008 crisis, the Canadian dollar has been on a tear against virtually all world currencies, as this chart from RatesFX shows. The blue areas show CAD appreciation and the size of the boxes for each currency on the chart indicate the importance of the currency. Note how the chart is mostly blue. In Olympic terms, the CAD is currently the Gold medal currency ... well maybe silver, since the South Korean won chart is 100% blue (yes, it is tough to own the currency podium ... or does the USD count for more than the won like hockey or curling count for more than short track speed skating? [I've often thought they should count one medal for each player on a team where it is impossible to win more than one medal - like hockey and curling - to compensate for the sports where an athlete can win a half dozen medals]).


That's good for Canadians wanting to travel on the cheap, or Canadian expats who bring Canadian funds into the USA, Mexico, Europe etc to live on. It isn't quite so good from an investment point of view since foreign stock returns have been reduced by the CAD appreciation. Still, as this Google chart showing CAD vs USD and EUR, as well as returns from foreign stock ETFs for the USA (Vanguard's VTI) and the rest of the world excl-USA (Vanguard's VEU) demonstrates, the stock market rebound has far outstripped the CAD currency jump, so a Canadian is still well ahead of the game on a net total basis.