Good new, bad news: Living even longer than previously expected

Back in February a Canadian Institute of Actuaries press release told us that as a result of compiling data specifically on Canadians (previously, they had always apparently relied on US data), they discovered that we can all expect to live a couple of years longer. If a man gets to 65, he can expect to live another 22.1 years, vs the older US-based estimate of 19.8 years. Women go up from 22.1 to 24.4 years. Good news - we get to live longer. Bad news - we have to find the money to pay for it, as do our pension plans, which apparently take anywhere from a 1% to to 7% under-funding hit. It also means we'll be getting lower monthly income henceforth when purchasing annuities. Fortunately, it seems from the detailed report on the CIA website that the revised estimates are in accord with the assumptions used in the C/QPP so their long term funding sustainability is not being put in question.

How long in advance to buy air tickets: USA data

Interesting post on CheapAir.com on the best time to buy a US domestic air ticket - but warns answer is different for international flights. Need this stuff for Canada! Their advice - check early and often.

Why my core Canadian equity ETFs deviate from the norm

Some years back I switched my core Canadian equity holdings from the norm - the ETF with the largest net assets by far, the iShares S&P / TSX 60 Index ETF (XIU), which is built on the traditional cap-weight principle - to a combination of two non-cap weight ETFs in equal amounts:

• Invesco PowerShares FTSE RAFI Canadian Fund (PXC)
• BMO Low Volatility Canadian Equity ETF (ZLB)

Here's why such a move was the right thing for me (I'm now semi-retired in my early 60s).

1) Better long term returns - Both the RAFI fundamental indexing strategy and the low volatility have been shown by plenty of research to reliably outperform, by 1 to 2% per year, cap-weight over long periods, like 10 years minimum but more surely over 15 years. Given that my selected ETFs have higher MERs by about 0.3 to 0.4% vs XIU and probably extra trading costs, I'm expecting to outperform anywhere from about 0.5 to 1.5% net per year over the long haul. Over 15 years, an extra 1%, such as 4% vs 3% annual compound growth, means an extra 15% more in end value. I'll take that thanks.

But achieving that expectation depends on several other factors and circumstances.

2) Sticking to the strategy - One big danger is getting nervous or impatient in deviating from the norm, being different from everyone else. That's a danger especially when the inevitable lag in performance of PXC and ZLB vs XIU happens and it is tempting to sell out and switch back to XIU. We dumb money retail investors are notorious for switching funds at the wrong time and earning less than the funds we invest in. Though one never knows for sure, I believe the odds of avoiding the premature abandonment of ZLB and PXC are on my side for these reasons:

a) Real after-inflation, after-tax positive return, not the TSX Composite, is my benchmark. My measure of success is going to be on absolute gain or loss terms, not one of keeping up with the XIU Joneses. I am my own investment boss, unlike professional portfolio managers, who get judged compared to the equity market index and so have a marked tendency to need to perform accordingly. It is quite serious stuff for institutional asset managers, as one can detect reading the extreme efforts to build investment strategies that do not deviate too far from the index but still outperform, such as those being developed at EDHEC Risk Institute in papers like Smart Beta 2.0.

b) Expectations, knowledge and experience. I have now been actively investing on my own since 1997, and doing plenty of reading and writing, like this blog and my other blog http://howtoinvestonline.blogspot.com/. I've lived through both the tech bubble cum crash and the credit crisis and its aftermath. I've experienced the sickening sinking feeling. I think I know what can happen. I know it can take 15 years for my strategy to pay off.

Despite being semi-retired, my time horizon is not zero, or even a few years. Though I am consuming my capital saved over my life to date, I expect, and plan, to live many more years. My time horizon is a continuum. Some of my money will only get used in twenty five years if I'm only of average life expectancy. And if I'm wrong and die sooner, then it doesn't matter.  Shrouds have no pockets as the old expression goes. Dying cannot hurt you financially.

c) Properly diversified portfolio. I think I've built a portfolio structure with various types of assets that will be resilient to inevitable future shocks, unless the world descends into nuclear war or a global pandemic wipes out half the global population, in which case it won't matter anyway. I also own lots of resiliency enhancing non-equity assets like ordinary bonds and real return bonds. In addition, the Canadian equity ETFs above have some other features that are beneficial.

Part of my "portfolio" is the fact that my income stream to live off is not wholly dependent on withdrawals from my investments accounts. Sources like CPP and part-time income allow me to fund a good chunk of my essential spending and I can reduce withdrawals somewhat without major lifestyle constriction. Having observed that equity dividend income is in fact quite stable at an aggregate level, even through the worst of times like the recent credit crunch crash, I figure that withdrawing the 2 to 2.5% distribution yield (ZLB's is currently 2.1%, PXC's is 2.6%) will allow me to avoid selling shares at market bottoms and thus largely counter sequence of returns risk. Plus I have a near-term cash cushion for my year-ahead spending that lets me avoid any withdrawals during frequent market corrections aka short-term volatility.

Features of PXC and ZLB

1) PXC essence is a Value tilt while ZLB is a Small Cap and Low Vol tilt. PXC's fundamental strategy relies a lot on a heavier emphasis on out of favour "Value" stocks, while ZLB is accidentally focussed on Smaller Cap stocks (amongst albeit the larger cap end of the TSX) and explicitly selected and weighted by low beta (which more or less corresponds to low volatility and has been found in research to behave the same way). The different essence means that ZLB and PXC will be less correlated with each other (according to InvestSpy.com's calculator over the past year, the correlation between the two is only 0.43) and provide a diversification benefit. Both ETFs have so far been more correlated with XIU than each other. Looking inside the ETFs, that is not such a surprise. No less than 58 of XIU's 60 holdings are held within PXC, accounting for almost 85% of its assets. In contrast, the overlap in holdings between ZLB and PXC makes up only 20% of PXC's total weight in assets.

Of course when a big crisis hits again, their correlations will rise (see this table from William Coaker for an instructive look at how correlations changed in the USA under the various market environments since 1970), so it is other asset classes / holdings, like real return bonds and cash that will provide the un-correlation, but in the meantime of relative market calm, it is worthwhile benefit.

There's a bit of a psychological bonus to ZLB and PXC being so different. At times one will follow along XIU better while the other lags, or vice versa. So far, PXC seems to have tracked XIU better than ZLB, which has powered ahead of both, as the chart below shows. To the extent even I cannot resist comparing with the TSX, I can comfort myself that I am not as much different as all that.

2) ZLB is considerably less volatile. It is no surprise that an ETF whose holdings are selected for low volatility should be less volatile overall. The InvestSpy tool shows that ZLB's past year volatility (standard deviation) of daily prices is only 8.0% vs XIU's 10.2% and PXC's 10.1%. Anything that reduces volatility is especially beneficial for me in the early stages of semi-retirement, where withdrawals at the time of severe downside (historical worst-case figures on this post) can permanently damage a portfolio, the so-called sequence of returns risk. ZLB's maximum downside drawdown should be less than XIU's (as Cass Business School found in table 2 of this paper for this type of fund strategy) though PXC might do worse (table 1 of this paper).

3) PXC and ZLB inherently and automatically incorporate the Value and Small Cap factor tilts. Most investors beyond the beginning stage recognize the accepted reality of outperformance from Volatility, Value and Small cap factor tilts. It's finance mainstream accepted truth. But there's a practical problem for individual investors wanting to take advantage. Using cap-weight ETFs to tilt and capture such benefits requires buying a multiple funds and figuring how much of each to buy. There's no finance theory about how much of each to hold. I have not seen anything more than arbitrary suggested funds and percentages. Do I buy a separate small cap fund only, or a small cap value fund and large cap value fund and should the allocation be 5% or 10% etc? Multiply that by many countries and geographies (Canada, USA, developed market, emerging market) and pretty soon you have a dog's breakfast of funds that is an increasingly costly nightmare to rebalance. Add in multiple account types (TFSA, RRIF, LRIF, LIRA and taxable) and the brain starts to hurt. I like the practical the convenience of two funds only that cover the field. The fewer ETFs I have to own across my multiple accounts, the better.

Corporate (Large Company) Sustainability Leaders in Canada

Those interested in finding companies that are highly rated for Corporate Sustainability with an emphasis on aspects that are financially material may want to look at research company RobecoSAM's list of 2014 leaders from around the world, including 17 from Canada. A similar list is Corporate Knights' 2014 Global 100, which has 13 companies from Canada. Both these lists contain only very large companies.

Then there's a list focussed only on Canada - MacLean's Top 50 Socially Responsible Corporations 2013.

Companies that show up in all three:

• Bank of Montreal
• TD Bank
• Bombardier
• Cenovus Energy Inc
• Teck Resources Ltd

All five are also amongst the 60 companies in the iShares Jantzi Social Index ETF (XEN), which is limited to Canadian companies, and the 443 companies of the UK-listed iShares Dow Jones Global Sustainability Screened UCITS ETF (unfortunately not available to Canadian investors, not even through a US-listed version, an odd situation given the vast array of US-listed ETFs), which contains 28 Canadian companies.

Sense and insight from Ontario Health sector pension fund CEO

This Financial Post interview with HOOPP CEO Jim Keohane just nails it in so many ways on pensions in Canada, it is worth printing and glueing to the wall. What does he say about pensions that makes such good sense?

• Governance under fiduciary duty, by un-conflicted boards and managers for the single purpose of providing a pension, succeeds best
• Risk sharing by companies and employees, who have different objectives, causes trouble; quote - "Shareholders have put on a lot of pressure to get out of that business because if I want to invest in a car company, I want to see the results of the car company, not its pension plan"
• Pooling and portability across many employers and sectors is what is needed for today's work world of multiple job changes in a career
• People want, and should be provided, a PENSION, a target steady stream of income during retirement, (i.e. not a savings plan with a big accumulated lump sum after 40 years that must somehow be turned into income). What he doesn't say, but which is an integral part of HOOPP, is that the assurance of a lifetime pension comes from pooling individual risk so that how long you live is no longer a big issue - they know on average how long people will live and plan on that basis. An individual with a DC plan can only deal with their own unknown life expectancy that through buying an annuity, which entails a higher cost structure than what HOOPP can do internally (HOOPP has none of the annuity-selling insurance company's profit margin to pay for). Peter Benedek at Retirement Action has looked at annuity pricing and found it not very close to fair value. In contrast to a HOOPP-like DB plan, the proposal recently made by Keith Ambachtsheer for a supplementary retirement plan, though it has desirable features of low cost and aligned governance, still appears to (it's not explicit in his paper but the cited example of the UK's new National Employment Savings Trust (NEST) plan does it that way) maintain individual account ownership and thus no automatic, integral promised pension payout i.e. there's no longevity risk pooling. 
• Failure to enact pension improvement today will create social problems down the road as Canadians will not want "grandmothers eating dogfood". This to me is the problem with the argument that people should be free and responsible to save or not - are we really going to let them drown in old age poverty when they fail, as they will since they do not save enough unless coerced or "nudged" into it?
• Costs matter a lot, and DC plans with typical mutual fund fees will inevitably leave people an order of magnitude worse off than a good DB plan like HOOPP (or, not as he says, but as I have said, than the CPP)

There are also some thoughts useful to individual investors:

• Matching the investment portfolio's structure to control the risks - so-called liability hedging - is a key principle. Unexpected inflation is one of their three big risks - something which applies especially to individual retirees as well. HOOPP responds by holding real estate and real return bonds. 

In short, revived Defined Benefit plans along the lines Keohane is advocating, could work as an effective alternative to enhanced CPP.