Canadian Financial DIY

Risk-Efficient Indices - Evidence from Live Results

2012-01-27T15:58:00.009Z

One of the biggest problems with any financial research is that patterns and strategies that worked in the past may not work in the future. The folks at the EDHEC Research Institute who created supposedly "new, improved" Risk-Efficient Indices about which I wrote a year ago, have now come out with data in the Live Results article that tests their theory. It uses actual results from the last two years, data that comes from the time after the new index method was worked out and thus could not merely be suited to the method simply because it was part of the data set used to create it.

The "new, improved" indices are put up against the traditional cap-weighted index method which is taken as the benchmark or representation for all major markets like the S&P 500, the TSX 60 or Composite, the FTSE 100 and which underpins all the biggest ETFs around. EDHEC also compares results of other alternative indexing methods (which die-hard cap-weight believers refuse to call indices at all) like Equal-weighting, RAFI Fundamental and Minimum volatility. Here's one of the EDHEC charts for the US market.

1) The good ole cap-weight S&P 500 loses to every other method, not only in terms of raw return but also in various measures to adjust for risk (Sharpe ratio, Sortino ratio, Information ratio, Treynor ratio), just as it did in the model-building time period.
2) The FTSE EDHEC Risk-Efficient Index wins by the most and by a huge amount over the S&P 500.
3) Minimum Volatility is a close second, perhaps even first, given the risk adjustment ratios. Perhaps the new ETFs launched on this basis, which I wrote about in my other blog in Low Volatility ETFs - Promising Safety and Reward, are worthwhile.
4) The Risk-Efficient out-performance is repeated separately in the UK, Eurobloc, Japan and Developed Asia ex Japan. RAFI fares indifferently (oh-oh, for my portfolio!). The other two couldn't be tested.
5) The Risk-Efficient performance is primarily NOT due to exposure to small cap and value factors. It comes from better stock weighting.
6) "... provide some evidence that the performance advantages of efficient indices largely stem from the improved diversification."

So far, I've only been able to find one actual live fund that applies the new Risk Efficient index method, the Parworld Track FTSE EDHEC-Risk Efficient Eurobloc traded in Luxembourg. Expect more to come from the ETF industry.

Is this a real improvement over cap-weighting, or an artifact of data that doesn't go far enough back (only to 1959 for the S&P 500)? Of course, by the time there is enough data to satisfy everyone, we will all be dead.

World Economy Trends from McKinsey: Long Slow Recovery in Progress

2012-01-24T16:35:00.008Z

Consulting firm McKinsey Global Institute's Debt and deleveraging: Uneven progress on the path to growth tells us that the recovery from the global credit crisis, three years later, has only just begun and will still take many years to complete. That's the bad news. The good news is that this is in line with past similar crises.

Canada used to be so much better off than the USA in terms of total debt but now things are fairly equal as Canadians have added debt while Americans have shed it. Amongst major economies, the USA is going fastest in the right direction according to McKinsey. Breaking the debt down by sector, another chart (Exhibit E4) shows that Canadian financial institutions have considerably more debt proportionally than those in the USA.

Exhibit A4, copied below from the long version of the report, shows that counting unfunded US government pension and health benefits for retirees pushes the US debt burden up to 140% of GDP. That still leaves it no worse in total than countries like Spain and France. The two countries by far in the worst overall debt shape, both of which have not even started deleveraging, are Japan and the UK, yet their borrowing costs are not at crisis levels. Huh?

Takeaways for investors: 1) Canadians should not be smug and should not count out the USA (you don't get to be number 1 for no reason); 2) Expect 3-4 years more of uneven weak economic times before things get much better though the "getting worse" phase seems to be finished; 3) Opportunities will arise for companies in infrastructure and public sector projects since governments won't be able to add more debt to build them; 4) Consumer demand won't be strong.

Penalties on Securities Lawbreakers - a Fine Mess

2012-01-23T11:48:00.008Z

Last week the Ontario Securities Commission revealed its poor record of collecting fines it imposed on those it found guilty of violating securities laws since 2005 - collecting only about half of total amounts owed, almost all of which came from negotiated settlements (with mainly major financial companies who always pay up) and virtually none of which came from contested hearings, where the most egregious fraudsters get sanctioned.

Though I suppose we should be a little grateful that the OSC is even revealing its performance - a new departure and a good step - and that improvement seems to be the OSC's goal, a brief analysis of the numbers in the Globe and Mail by law reporter Jeff Gray shows that the effort is a long way from anything that could be considered acceptable performance.

The Globe quotes the OSC director of enforcement on how tough the collection job is. Out in Alberta the ASC gives the same "we're doing all we can" explanation / excuse about its dismal record of not collecting fines.

Well, that's not good enough. They say they want to improve. Perhaps they could start with The Collection Gap's lengthy examination of the collection issue in the USA, where they have the same poor performance problem. The multitude of reasons advanced (including those of OSC and ASC) to explain woeful collection of fines, like individual incentives, institutional incentives, regulatory capture and insufficient resources, are reviewed and evaluated. The authors conclude that the fine collection impediments are mainly within the control of the agencies, not beyond their control (as the OSC seems to claim). Though the report is about the USA, the situation sounds a lot like Canada. (Thanks to Ken Kivenko of CanadianFundWatch.com for the link to this document.)

For more tips on how to collect, they might want to consult Canada's "Collections R Us" aka Canada Revenue Agency. CRA's tax debt (taxes not paid on time) was only about 5.5% of total collections back in 2005 when the Auditor General last looked.

If there were a national securities regulator, whose terms of reference included a stronger mandate, incentives and mechanisms for enforcement and collection than provincial regulators evidently now have, greater cooperation with the CRA might also be possible. The CRA should be very interested. After all, income from investment fraud and illegal gains are subject to income tax too as noted at IncomeTaxCanada by Jim Maroney.

Bloggers for Charity Guest Post: Walking to End Women’s Cancer

2012-01-17T12:54:00.006Z

It's the Bloggers for Charity guest post day! Blog readers will recall, and will certainly notice if they read other Canadian financial blogs, that today is the day for the publication of the guest posts for bidders with the winning donation to a charity of their choice. Kudos again to blogger Mark Goodfield of the Blunt Bean Counter for coming up with the idea and getting it organised. The winning bidder here came up with $200 and here is her post.

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Why do I walk in the Walk to End Women’s Cancer?

By Jamie Woodyatt

The Weekend to End Women’s Cancers (http://to12.endcancer.ca/site/PageServer?pagename=to12_homepage) walk, this year taking place September 8-9, 2012, came to Toronto 10 years ago with a goal to raise funds for research and treatments for women facing Breast Cancer. The funds are distributed locally so that it benefits the women where the “walks” take place. In Toronto the funds go to Princess Margaret Hospital. Participating in the event is a true commitment; each walker must generate a minimum of $2,000 in donations for the privilege of walking 60km over 2 days. The bonds formed during the ‘walk’ between walkers, volunteers, survivors, team mates, crew, is amazing as thousands of people join together for their individual reasons for a common goal TO WIN THE WAR AGAINST WOMEN’S CANCERS – NOW!!!.

Some of my inspiration… My aunt is very socially aware and has many causes that she raises funds for and she has walked in the 60km Princess Margaret 8 times. She also took on the 60 km walk in each Canadian city that holds a 60km walk in 2009 (that would be 7 cities). That means that she has walked over 800 km to raise funds and awareness. She also sponsors and participates in the Make a Wish ( http://www.makeawish.ca/)golf tournament each summer. She throws a Christmas bash each year for her friends, family and work associates where guests bring gifts/donations to Nelly’s (http://www.nellies.org/) a charity that offers shelter to women and children leaving violence. She walks for her Mom who lost her battle with breast cancer before I was born and she walks as a survivor as she battled breast cancer herself. She is definitely an inspiration and a role-model which pushes me to be a better person.

In 2010 both my Grandfather and my Mom were diagnosed with cancer. I felt blind-sided I needed to do something, so I joined my Aunt's team and walked for the first time in September 2010. It was incredible; the people you meet and the families who contribute. The support is unbelievable; I HAD to walk again the following year.

My Aunt no longer does the walk herself so she has “passed the torch” so to speak. So In 2011 I started both days walking alone; I met fantastic people along the way and made new friends on both days. On 'day one' I met a walker who had lost his younger sister to cancer the year before; she was only 7 years old. On ‘day two’ I met a woman my age that hadn’t lost anyone to cancer but believed in the cause. I was inspired by her most of all, her intentions were entirely self-less and it was her 3rd year to make the commitment!! Since I had walked the previous year too I know from experience its no ‘walk in the park’… although we do walk through some of the most beautiful parks in Toronto!

I would like to give a special Thank You to the people that continually support the walkers; Their families, those that make donations, the volunteers, the crews, the bikers that stop traffic and keep us safe, the people that honk and boost morale, the people that hand out beer and champagne (definitely helps!), the older lady that made home-made pizza and treats (delicious, I wish you were my grandma!), the guys that set up the mist tents outside their houses (AMAZING! Nothing is more refreshing during a hot walk than a mist BLAST), All the little girls who hand out pink lemonade (SO CUTE!) And the list goes on…. You guys make the walk fun and add so much to the roller coaster of emotion we feel!

I walk so there WILL be a cure in my lifetime. I can’t imagine a world without my Aunt or my Mom. With my family’s history I am at risk too. I am a single Mother and the love of my life is Nathan my wonderful rough and tumble 3 year old that I would do anything for. I not only walk for my survivors but for the next generation too.

I am proud to say I will be walking another 60K this year. With over 120 million dollars raised, The Princess Margaret Weekend to End Women Cancers is making a difference, and is a cause I am proud to be a part of. Aside from my son’s birth, it is the most exhilarating experience of my life and will continue to walk for years to come!

If you wish to help me this year I have attached my link - http://www.endcancer.ca/site/TR/Events/Toronto2012?px=3408993&pg=personal&fr_id=1463. I hope that everyone that reads this realizes that giving your time and effort to a greater good is a heady experience and I recommend it highly; nothing makes you feel better than helping.

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To which I, your regular blogger here, would add this. This guest post could not be more appropriate for my blog. It's perhaps fate, or maybe just a reflection of the prevalence of breast cancer (talk to anyone you know, it is pretty sure that a close friend or family member has had the disease), that this post concerns the disease that stole away my first wife eleven and a half years ago. Support this cause, support Jamie. The link above to donate works great, as I can say from having used it myself. Good luck, Jamie!!

BlackRock Purchase of Claymore ETFs - Do the Smart Thing Please!

2012-01-11T23:09:00.010Z

Today's announcement that BlackRock will acquire Canadian ETF provider Claymore could be a good thing for BlackRock and for ETF investors, if some smart, and not dumb changes, ensue.

Claymore charges quite high MERs - about 0.5 % too high - for its ETFs in comparison to those of BMO Financial, iShares and Vanguard. The takeover is a great opportunity for BlackRock, which already owns iShares in Canada, to lower the Claymore MERs and bring them in line. This will attract more investors and not cannibalize its iShares ETFS. In the USA, similar fundamental RAFI-based ETFs (e.g. Invesco Powershares US broad market equity fund trading under symbol PRF) have expense ratios about 0.3% lower than Claymore's, though even that is too high.

Why would BlackRock not lose by lowering fees? Claymore's ETFs are considered to be actively managed (though I do not agree with this characterization, that's the dominant public perception), more an alternative to actively managed mutual funds than to traditional passive market-cap weighted index ETFs. Let BlackRock take on the mutual fund industry with a much more compelling price proposition. After all, Claymore's ETFs already have most of the attractive features of mutual funds - auto & free DRIP and Systematic Withdrawal, Pre-authorized chequing purchases.

The dumb strategy would be to leave Claymore as is, with continued stagnation, or to raise fees, a recipe for investor flight. Claymore's ETFs are being left in the dust. For instance, the flagship Canadian equity fund Canadian Fundamental Index ETF (CRQ) has only $218 million in assets despite being started 3 years before BMO's Dow Jones Canada Titans 60 Index ETF (ZCN), which has $604 million in assets.

Book Review: Uncontrolled Risk by Mark T. Williams

2012-01-10T10:12:00.011Z

"Occupy" protesters would benefit from reading this book. Instead of the mindless directionless opposition to everything capitalistic they would know a lot better who and what to blame for the narrowly averted collapse of the world's financial system in 2008. Better, they would know the kinds of reforms and controls that need to be implemented to make the system operate with more stability to avoid a future recurrence.

In fact, every shareholder and voter needs to know this stuff too. After all, when things go wrong with the financial system, we all get a rather severe smack as a result. The scary fact of the matter is that the conditions that allowed the crisis to build up, the way the system works, have not substantially changed.

Williams informs us by telling the story of the rise and fall of investment banker Lehman Brothers. The story method is very effective in showing how the situation built up over decades as the people, the company, the industry, the regulatory bodies, the political scene all evolved to the 2008 climax of Lehman's collapse and the ensuing beginnings of financial Armageddon. Along the way the author introduces and explains in terms the layman can understand what might be called the technical stuff, the financial products and structures like CDO, MBS, CDS that ended up being the bombs that blew things apart.

We learn that it wasn't just the "greedy bankers" at fault. Things are not that simple in the real world. Williams takes a whole 25 page chapter to list the bad guys and institutions and summarize to what degree they did wrong, everyone from Dick Fuld, Lehman CEO and other key Lehman players, Boards of Directors, the US Congress and several Committees, the Federal Reserve, the SEC, the media, academics, accounting firms, credit rating agencies, lobbyists, the FASB, US Treasury Secretary and former Goldman Sachs CEO Hank Paulson and last but not least consumers who binged on debt and housing.

Apparently, the bankers (and others) weren't simply greedy, they were also stupid and did not truly understand the risks being taken. Prior incidents that should have been learning and warning signs, like survival and recovery from the 1998 LTCM fiasco, instead made people over-confident. Risk models used by industry that work well most of the time failed utterly in times of extreme stress when they would be most useful.

Williams sticks to the facts in the book but it would have been fascinating to get more into the psychology of the players to see what was the mix of flaws and vices. The 2008 crisis could provide valuable insight into how the thinking of institutions and societies go wrong.

The last chapter contains Williams' ten point plan for changes to reduce chances of a new financial systemic risk event. Some can easily form the basis of policy lobbying and legislation - things like mandating higher capital levels, imposing leverage constraints, creating a systemic risk regulator. Others can lie with investors - things like requiring greater executive accountability, improving Board oversight, creating smarter compensation schemes. (In the case of this latter set of changes, I am left wondering how this jives with passive index investing where investors are distant, ignorant and often uninterested in the individual companies like Lehman where dominant managers held sway and escaped control with destructive results. It's another reason I like the idea of pension savings being managed by a body like CPPIB with the motivation, resources and power to kick butt in corporate governance.)

The book and its story unfortunately contents itself, except very peripherally, with happenings in the United States. The reader therefore does not get to see how the worldwide systemic contagion occurred, or how events and conditions elsewhere exacerbated the problem.

Favorite Quotes and Notes:

"... the U.S. government has failed to find the perfect balance between excessive regulation - viewed as stifling to bank profitability and economic growth - and lax regulation and oversight - viewed as a recipe for financial and economic instability" - which I find to be a far more balanced and rational worldview than the strident "capitalist system is rotten" view of some people
"Companies that take no risk go out of business just as easily as those that take too much risk."
in 2006, Lehman's Chief Risk Officer Madelyn Antoncic received an industry award for best risk manager of the the year; a year later Fuld/Lehman removed her from the job and demoted her; i.e. the elaborate risk management structure at Lehman was just a facade to fool credit rating agencies into giving Lehman a lower cost of borrowing/capital to increase profits.
Value at Risk (VaR) the commonly used industry measure of risk is described by a Lehman shortseller in a quotation as "an airbag that works all the time, except when you have a car accident"
the boyhood home of Fed Reserve chairman Ben Bernanke, since then sold on to several others, was subject to a sub-prime mortgage loan foreclosure - how symbolic!
"Post-credit crisis, executives from TARP-taking banks continue to express public support for re-regulation of the financial markets while their paid lobbyists attempt to defeat or weaken any new regulations."
Canada is cited by Williams as a model to emulate, praising the consistently strict oversight and regulation here

For the individual investor, the important lesson is first, that the financial system and consequently investment markets, are still very exposed and subject to severe shocks and second, that risk assessment and management are essential never-ending tasks.We need to be ever aware and wary of what is going on. Since some risks are not controllable or often not knowable by the individual, the idea of diversification, spreading investments, gains reinforcement.

A quick 220-page read, it is well foot-noted and indexed. The writing flows smoothly too. Don't be surprised if you come out of reading it a bit angry and less confident in the capabilities of business and political leaders.

My rating: Though missing the greed vs stupidity assessment and the international linkages, it is excellent on what it does present - 4 out of 5 stars. Definitely worth reading.

Thanks to publisher McGraw-Hill for providing a review copy. The book comes in Adobe's eBook format (see McGraw-Hill site)as well as paper.

Bloggers for Charity Results

2011-12-24T02:41:00.003Z

The results are in for the Bloggers for Charity contest organized by The Blunt Bean Counter. Other blogs have received some fantastic bids, especially Canadian Capitalist and WhereDoesAllMyMoneyGo. Here at CanadianFinancialDIY a bidder who wishes to remain anonymous is donating $100 to a favorite charity. The person's guest post, which is to be about the charity, will be appearing the same day as all the bloggers' guest posts, January 17th.

Well done to Bean Counter Mark Goodfield for putting together this very successful initiative.

What to do about Losing mental acuity or outright incapacity

2011-12-12T17:23:00.006Z

A reality of getting older is declining mental ability. As with the body, so with the brain. It may be more obvious with the body but small gradual or sudden drastic falling away in our ability to make financial decisions will occur. It may be due to disease or natural ageing but it happens. We need to anticipate that and plan for it.

Among the kinds of decline: short-term memory recall, a long slow progression that starts from around age 40 (see graph here in Flickr); language facility; mathematical and analytic capabilities. The result is that good financial decision-making falls off with age, even amongst those who have known and applied good financial principles for a long time.

Whether the onset is gradual or sudden, mental decline gets to be a bigger and bigger issue as one gets older. The rising prevalence of dementia and increasing life expectancy ensure that it will become ever more common for retirees to reach a point of being incapable, both legally and practically, of managing their own financial affairs.

The problem is that when such incapacity strikes, chances are we won't even be aware of it. Worse, even if we are aware, at the point when we have been medically certified as mentally incapable, we lose the legal power to do all sorts of critical things.

What a mentally incapable person legally cannot do:

• make a new will, add a codicil to an existing will or revoke an existing will
• prepare a power of attorney
• put a bank account into joint names with children
• change the beneficiary of his/her RRSP/RRIF or an insurance policy
• carry out estate planning, such as reducing probate costs
• give investment instructions to his/her financial advisor.

What to do about mental decline and incapacity:

Mental exercise ... “use it or lose it” – The Seattle study (http://www.memory-key.com/problems/aging/seattle-study) followed a large group of people throughout their lives and discovered that amongst other factors a complex and intellectually stimulating environment and efforts to maintain a high level of perceptual processing speed seem to help reduce cognitive decline. The study suggested that cognitive decline observed in community-dwelling older people was mostly the result of disuse and could be reduced through training. Along with such activities as reading books, guessing at the answers of TV game shows, taking courses and doing a part-time job (paid or not), consider that continuing to manage your investment portfolio can be good mental stimulation, a challenging game that never ends.
Physical exercise - “a sound mind in a healthy body” - Though the original Latin expression was more a prayer than a prescription, keeping fit can help stave off mental deterioration.
Simplified portfolio and financial affairs – The simpler and more automatic are your affairs, the easier and less error prone they will be to manage, whether it is you yourself doing the job or someone else.
Power of Attorney – It is a dangerous misconception that a spouse or an adult child can automatically step in when incapacity happens. A sensible step is therefore to put in place, in advance of anything happening, a Power of Attorney (POA) that authorizes another person to take financial action on one's behalf. The POA authority may be narrow or complete, with the exception that the delegate, known as the Attorney, can never make a will on the person's behalf. The authority can include banking, signing cheques, paying bills, borrowing money, hiring contractors, selling or buying real estate, stocks, bonds, consumer goods etc.

Qualities of the Attorney - There are some obvious qualities the person(s) selected to exercise the POA power should have:

the time and willingness to fulfill the responsibilities (BMO says the average time a person fulfills a CPOA role is four years - if you are well advanced in age, it probably isn't the best idea to name someone the same age as you, like your spouse)
someone in whom you have complete trust (the CPOA has wide ranging power and possible abuse of the power is a major consideration; sadly, even one's own children can sometimes be less than reliable)
enough financial knowledge, along with diligence and organization, to handle your affairs, or the astuteness to recognize the need for professional help (tax, accounting, legal etc)

POA Permutations - Many variations are possible in a POA to suit individual circumstances, including: when the POA starts (immediately, or upon incapacity) or stops (it ends automatically upon death but make sure it doesn't stop unexpectedly since special language needs to be in the POA to keep an immediate active when you do become incapacitated, since that event normally voids it), limits to the authority being granted, whether it is one or several people as Attorney, and whether they must act jointly or may do so separately, aka severally; and whether the Attorney must account to some third party regularly. Be careful about whether it is a continuing / enduring POA since one without that feature activated before incapacity would cease to be valid upon incapacity.

Consider using a lawyer or notary to prepare the POA – Consider how complex your finances and family situation are. The more complex, the more it makes sense to use a professional to set up the POA and avoid the nasty surprise that a home-made POA is not valid. Without a valid POA, someone will have to face the cost, time and trouble later on to go to court to apply for a POA. If there is no one around to step forward, the provincial government's Office of the Public Guardian and Trustee steps in as a last resort to manage the affairs of the incapacitated. Would it matter that a government official probably won't understand what you want done? If so, picking your own Attorney and creating a POA is the route to follow.

Watch out for – 1) Banks are apparently wont to ask people to sign their own POA forms, which might conflict with or invalidate a general POA. Try to insist on them accepting your own general POA or get words inserted that it does not alter other POAs. 2) Each province has its own variations and those slight differences might be critical. Get one for the province where you live, changing it when you move. If you spend time in the US and have US assets, a Canadian POA may not be accepted. You would need to consult a lawyer in the US state concerned.

Doing the Attorney job is work - Some may imagine that being appointed under a POA is an easy job but it is serious business, more onerous even than managing one's own affairs. There is a fiduciary duty, which obliges the Attorney to act in the person's best interest. The Attorney must avoid conflicts of interest, must keep records, must consult with the person when possible, must keep the other's assets separate from their own. As a result, an Attorney often gets paid. In Ontario, the permitted amount is 3% of monies received and paid out and 0.6% of average annual value of assets administered, though it is possible to state in the POA that the Attorney will not get paid (keeping in mind the Attorney is not obliged to accept the job either and is allowed to resign later on). It is also a good idea to name one or more substitute individuals as backup in case the first Attorney is unavailable for whatever reason.

Joint ownership and and Living Trusts as alternatives – It is possible to transfer property to joint ownership or to a trust, but those solutions have their own issues. Amongst the issues: deemed disposition rules can occasion capital gains taxes; risks of abuse by the joint owner, or dispute among siblings if only one is named joint owner (was it a gift, an advance on inheritance or merely a means to allow administration on your behalf? etc); exposure of the joint assets to the joint owner's creditors, spouse or estate; when the asset is real estate, joint ownership requires consent of the joint owner for sale, which will be problematic if you have become incapacitated, plus the provincial Public Guardian may decide to get involved; costs of tust administration if professionals are hired. Professional expert advice may help a lot to unravel the best option.

Resources:

BMO Retirement Institute – videos and paper Financial Decision-making: Who Will Manage Your Money When You Can't? on mental incapacity from medical and legal viewpoints, points to consider in creating a Power of Attorney.

Sandra E. Foster, You Can't Take It With You – Common Sense Estate Planning for Canadians, 5^th edition, John Wiley & Sons, 2007

Douglas Gray and John Budd, The Canadian Guide to Will and Estate Plannning, 3rd edition, McGraw-Hill Ryerson, 2002

Ontario Power of Attorney kit – pdf link from the Ministry of Attorney General

British Columbia Enduring Power of Attorney Form pdf link; Nidus Personal Planning Resource Center and Registry – centralized registry for POAs in BC with many FAQs

Alberta, Manitoba, New Brunswick, Nova Scotia, Yukon, Newfoundland and Labrador – info links but standard forms not available

Saskatchewan Enduring Power of Attorney and Common Questions at Ministry of Justice and Attorney General

Quebec – pdf link My Mandate in Case of Incapacity instruction booklet and forms at Curateur Public du Québec; prior to incapacity - Power of Attorney sample text with rules explained at Ministry of Justice

Nunavut (formerly North West Territories) – pdf backgrounder and forms

Humongous Provincial Tax Credits for Student Graduates

2011-12-10T15:11:00.003Z

Know any recent graduates who can use special income tax breaks worth up to $25,000?

Publisher CCH's tax newsletter for December describes these significant tax incentives for student graduates in Tax incentives for Post-secondary graduates. The article gives more detail, and links to each province's program, but here are some key points:

applies to any college or university graduate
takes form of tax credit or rebate of provincial income tax, so you must live in the province
are Not tied to graduates who are originally from that province or who attended school there (not necessarily even in Canada), i.e. they are designed to entice recent graduates to live and work in a province ... call it the "brain scoop by tax" strategy
pay out over several years
for year 2000 graduates onwards, varying by province
Only in Saskatchewan (up to $20,000), Manitoba ($25k max), New Brunswick ($20k max), Nova Scotia ($15k max), Quebec ($8k max)
claim is not necessarily made (e.g. not in N.B.) through the normal income tax return; it varies by province, so graduates need to check, and perhaps apply separately, to be sure to get it. It's a good check item to add to my review list, for provinces like N.S., where the claim is made on the tax return, when I do my annual online tax software ratings.

Thanks to CCH for the lovely pre-Christmas gift of valuable information.

Book Review: No Hype, second edition by Gail Bebee

2011-11-30T10:56:00.010Z

Almost four years ago, I reviewed the first edition of Bebee's No Hype book and gave it a high (by my standards) rating. The just-released second edition contains essential updates and excellent refinement of specific portfolio suggestions, which is probably what readers want most. The most notable addition is a new section on TFSAs, though there are also many revisions to organization names, website links, addresses etc that make the book practically useful for investors today.

There has also been reordering of material, such as moving the discussion of annuities into the retirement chapter alongside RRSP sections, addition of many more links and references to online resources, such as a list of useful blogs, (including my own I gratefully acknowledge!). Most of the links are available on her website www.gailbebee.com under Resources.

The Asset Allocation and Portfolio Building material has the most interesting updates.

real return bonds added as a component of the fixed income asset class; they now get included as part of all suggested portfolios
revisions (mostly downward) to guidance on what rate of return to expect, based on historical averages, as well as addition of figures for several very useful asset classes - Canadian vs US bonds, Canadian vs US vs Emerging Market stocks, real estate; all this allows better estimation of what various portfolios will yield and will be very useful as more and more investors are taking to the idea of diversifying beyond Canada
completely ETF sample portfolios specified right down to percentage sub-divisions within asset classes e.g. 35% equities in the Large Income Focused portfolio broken down to 20% iShares S&P TSX 60 Index (XIU) and 15% Claymore Global Monthly Adv Dividend (CYH)
all-in-one single mutual funds or ETFs that suffice as a good-enough ultra-simple portfolio solution
one non-update is that the individual stocks suggested for the equities allocation in larger portfolios have pretty well remained the same; Bebee's picks from four years ago still seem to be holding strong!

Caveats: There are a few niggling typos and minor errors such as: the Balanced Portfolio in Fig. 25.2 that only adds up to 95% (it looks like the 5% Foreign Bonds that was in the 2008 edition got deleted; Fig. 10.1 confirms this supposition); some of the ETF tickers do not match the fund name e.g. in the Income Focused Portfolio the iShares S&P TSX 60 Index ETF has the XIC ticker when it should be XIU. I could not find, as the preface promises, expanded material, though there are updates in chapter 8, on how to resolve problems with financial service providers - was I looking in the wrong place?

To make this book even more convenient for the investor, maybe the next edition could combine the advice on what goes in RRSP vs TFSA along with sample portfolios e.g. take one of the more elaborate portfolios, like the ETF Growth Portfolio, which has 11 separate holdings, and lay out what should go where. For example, I just did this post - ETF Asset Allocation Across RRSP, TFSA and Taxable Accounts - about this topic on my other blog.

This book has established itself as a fine beginner's guide to investing that successfully bridges the challenge of a "good-enough" compromise between the practical simplicity that people will actually read and use and the ideal complete perfection of a thousand page brick that almost nobody would read or be able to apply.

Gail Bebee's website takes orders for the book directly, though it's also available from Chapters.ca.

My rating creeps up from its first edition four to 4.5 out of 5.

Disclosure: Gail Bebee provided me with a draft of the second edition (and a copy of the published version too - thanks Gail!) and I submitted comments and suggestions to her, some of which have been incorporated into it.

"Something Will Work Out" Retirement Planning

2011-11-28T10:38:00.007Z

Benefits Canada reports in Retirement income adequacy still a problem for pension plan members some scary results of a survey of pension plan members by pension consultants Towers Watson. That people "just aren't getting it" and not even using such retirement tools as employers make available and just hoping and trusting that "something will work out" for retirement doesn't augur well for the future. The article also notes the continuing shift from Defined Benefit pension plans to Defined Contribution retirement savings plans, which places more onus on the individual to both save enough and to invest wisely. Towers Watson goes on from these to talk of other warning signs. Is all this likely to work out well?

Meanwhile, the progress (recently tabled federal legislation) on the federal government retirement solution for the private sector, the DC-type Pooled Retirement Pension Plan, is revealing some interesting features of the PRPPs. The banks and insurance companies are apparently objecting to established pension plans like OMERS trying to get in on the action claiming that OMERS has unfair advantages on costs and regulation. Hmm, so now we see an admission that PRPPs run by banks cannot and will not do as good a job (costs, planning assistance etc) as traditional DB pension plans run by purpose-built organizations for public servants. Is there something wrong here?

Bloggers for Charity

2011-11-22T19:27:00.005Z

Blunt Bean Counter has set off an interesting challenge to raise money for charity. He has challenged bloggers to auction off the opportunity for a winning bidder to write a guest post on their blog. Here goes, count me in.

Here are the rules:

1. I am auctioning off the opportunity to write a guest post here on CanadianFinancialDIY.

2. Bid in confidence to my email account - click on the "Email me" link in the right-hand column.

3. The auction will close on December 16, 2011. I will notify the winning bidder by email ( I will use your email for nothing else than this contest).

4. The winning bidder will be required to send me a copy of a donation receipt, dated between December 17th and December 31st (personal information can be blacked-out) to confirm the donation has been made e.g. using a scanned copy by email will do. Pick any registered charity (no, Greece or Italy are not yet charities) you want. It's easy to donate online, as I wrote about here. This donation will be tax deductible to the winning bidder when the donation is made to a registered charity.

5. For unanimity amongst bloggers, January 17, 2012 be the date all the Blogger for a Day posts are posted.

6. The winner can write a post on any topic (subject to censorship for stuff that is illegal, violent, profane, defamatory, links to naughty or nasty websites etc ... no, smartalec, that doesn't mean you cannot write about the financial industry), although in the spirit of the contest, it would be great if the winning bidder wrote about a charity or charitable experience, e.g. the best and the worst donation you ever made, but that is not a requirement. The guest post cannot be a marketing piece. However, at the bottom of their post, the guest blogger can provide their name, name of their company and a brief description of their company and its products. Alternatively, the guest blogger can remain anonymous.

7. This is an extra rule so that there are seven in all, a much luckier number than six.

Pooled Retirement Pension Plan Draft Legislation Revealed - Will PRPP Help?

2011-11-21T12:58:00.013Z

Last Thursday November 17th, the Federal government announced and tabled draft legislation (Bill C-25) for creating Pooled Registered Pension Plans.

Will this help the target group - people who have no company pension and are not voluntarily saving through RRSPs or TFSAs? The answer is a mild "yes" in absolute terms and a resounding "no" in relative terms.

Yes, it does help somewhat.

Anything is better than nothing - The most critical problem is that those people right now are not saving for retirement, so any program that gets them to save will help. Despite the provisions of the PRPP legislation that do not require companies to opt in and that allow individuals to opt out, the default auto-enrollment rule (par.39(1)), the default investment option rule (par. 23(3)) and a default contribution rate (par.45(1)) will be quite effective in getting more people to save. "Nudge" works.
Cost and fees have a fair chance to be less than for mutual fund RRSPs - Why might there be a grain of truth to the confident assertion by Minister Menzies who told the Globe and Mail, subsequent to receiving financial industry assurances, that management fees will be "substantially less" than they are for RRSPs? 1) Money will be locked into the PRPP unlike the RRSP. You may be able to switch between funds but the fact that the investment management company knows the money will not be withdrawn means less need for cash balances and less urgency for short-term return-chasing by funds that undermine returns. 2) Marketing costs, which are embedded into management fees could well be less since the target market for the financial industry is not the individual consumer but small and medium-size companies. That should mean no glitzy TV ads. There will be no trailer fees to salespeople (aka financial advisors); in fact, the draft bill specifically bans kickbacks by fund companies to employer sponsors (par.33). 3) The regulatory structure should help to control the most egregious overcharging. Good 'ole politics might even have a bearing since the Governor in Council, i.e. the government, gives itself the power to decide what "low cost" fees means (par.76 (1) (j)).

No, the PRPP will NOT help, it may even do harm.

NoHype Investing author Gail Bebee emailed me her comments, which I think are spot on, so I'll simply reproduce them with my highlighting):
"1. Employers are not required to offer this, or any other, employer-sponsored pension plan.

2. Employees will be able to opt out at will.

3. The financial industry, the same folks who charge Canadians some of the highest mutual fund fees in the world, will be managing the pension funds and will have a major say on the fees charged to do so.

4. More government bureaucracy will be set up to regulate this new program.

5. RRSPs already offer a similar retirement savings option. The issue is that not enough Canadians participate."
Wealthy Boomer Jonathan Chevreau's comments in the Financial Post gave some nuance to Gail's points.
The PRPP will complicate and confuse - The retirement landscape is already tough enough to understand, what with RRSPs, Defined Contribution and Defined Benefit Pension plans and TFSAs. Another layer of complexity is added. How will people make intelligent informed decisions about which to choose under what circumstances? There is no advice-giving component included in the PRPP structure. Blogger Preet Banerjee was right on the mark pointing this out in a CBC article on the announcement. With each province being required to implement its own complimentary legislation, it's a sure thing Canada will add another patchwork of permutations and combinations in rules, all of it totally unnecessary. What will happen when people move to different jobs in different provinces or with different companies? The minister says the plans are portable and transferable but sure as to betsy a lot of folks will end up with several plans. I already have two different LIRAs that cannot be combined (one is federal, the other provincial) on top of an RRSP and a TFSA. Another possibility to add?! Gimme a break!
Low pay workers will likely get scr***d - Tax-wise, the logic of the PRPP will work the same as an RRSP. In a couple of posts here and here on the HowToInvestOnline blog comparing the TFSA and the RRSP for retirement savings, it is quite clear that anyone earning less than $37,000 is better off using a TFSA. If such workers get auto-enrolled into the PRPP and they don't opt out (who is to tell them to opt out except for lowly bloggers that they never read anyway?), they will be appreciably worse off in retirement. Thanks for your help, government!
PRPPs pale in comparison to the CPP - The much debated alternative solution, that of expanding the CPP, as we have previously argued here and here, meets the criteria of what is needed much better. Over at Moneyville, author and pension expert Moshe Milevsky points out that the Pooled Retirement Pension Plan doesn't even live up to its name. It doesn't provide a pension - a lifetime of secure guaranteed income - at all, it is only a savings and investment plan that will go up and down with stock and bond markets.

Later addition: Commenter Leo's new blog PRPP Canada devoted to PRPP (the blog's mere existence is a sign of the additional complexity Canadians are soon to face) contains a link to lawyers McCarthy Tétrault's review of some of the ins and outs of C-25. From what McCarthy says, the law won't require that there be a default option if the PRPP offers a menu of investment (aka fund) choices that a "reasonable and prudent" person could use to assemble a retirement savings portfolio. That's one less small but critical nudge.

WaterFurnace Renewable Energy Inc 3Q2011 Results

2011-11-16T11:07:00.011Z

In September 2010, I reviewed WaterFurnace Renewable Energy Inc (TSX: WFI), a manufacturer of geothermal heat pumps, and decided to buy shares. Four quarters on, how do things look?

Industry Prospects - The business environment remains weak.

Residential slump continues - US Housing starts, a prime driver of demand for WFI's residential products, continue at an extremely low rate of about 500,000 - 600,000 starts per year vs historical norms well above 1 million. That situation doesn't look set to improve soon. In the latest conference call and in the published report on Q3 results, company management says it expects 2012 to see an overall industry decline of 10-15% for residential geothermal heat pump sales in the USA. Residential products, according to WFI management, have a higher profit margin than the commercial products that the company has emphasized to fill the sales gap. New housing, in which the substantial initial capital cost of geothermal is embedded and financed by a mortgage for amortization over a long period, overcomes the sticker shock impediment to geothermal's market success.

Financials - The overall picture is that the company is maintaining its financial strength, or even improving it slightly, in the continuing difficult environment.

Gross Profit Margin - GPM seems to be staying about the same. This is not so bad considering the shift in product mix from residential to lower margin commercial. But GPM is not improving as management says on page 3 of the Quarterly report - if one adds back the $727k difference for Q1-3 of 2011 that resulted from the change in method of calculating Warranty costs (page 31), then GM is not 37.7% as stated but only 32%, which is at the lower end of those in the last five years according to ADVFN.
Net Profit Margin - The same ADVFN page shows that the NPM has stayed quite stable at around 10% through the last five quarters.
Cash Flow - Whether it is by simple cash flow from operations or including capital expenditures (or depreciation instead of capex since the relatively new factory doesn't seem to be needing much investment for now), 2011 results are stronger than 2010 which were an improvement over 2009. WFI is thus adding to its cash reserves, probably more than it has an opportunity to spend effectively at the moment. No doubt this has enabled and justified the announced increase this quarter in the dividend from USD$0.22 to $0.24 per share.
Dividend - The strong and improving cash flow, along with complete absence of debt on the balance sheet, indicates that the dividend is quite sustainable. The dividend salves the pain of the stock price drop since last year.
Warranty Reserves - The rapidly rising warranty reserves, a non-cash liability but one which eventually happens in cash if the estimate is correct, could become an issue down the road. About half the increased liability, according to note 12 on page 31, in the first nine months of 2011 came from increased claim rates, not merely extra sales of units. It does not yet come to a level that is at all a problem but might be something to monitor.

Market Share - In the Q3 report, management states that it is gaining market share but the story is not so clear to me. It may be a question of how one defines the market.

WFI's sales increased 2.3% in the first nine months of 2011 while competitor LSB Industries saw a 19% rise (cf its Q3 report).
Though the numbers are out of date and have not yet even been released for 2010, WFI's shipments fell from 2008 to 2009 (as indicated by the figures Indiana) while those of LSB rose (cf the numbers for its home base of Oklahoma) according to the US Energy Information Administration website.

Insider Trading - Company insiders are keeping the faith.

The only activity in the past six months (see CanadianInsider.com here) consists of stock purchases or dispositions by gift.

Strategy - The theme at WFI seems to be "steady-as-she-goes".

The HyperEngineering acquisition earlier this year has not been mentioned in the last two conference calls and is a minor revenue generator ($2.9 million in total with regular WFI international product sales) with a profit margin of around 8% (cf page 26 of the Q3 report), slightly less than the overall company margin.
Cash is being given back to shareholders through dividends instead, for instance, being kept in the company to make acquisitions
There are no initiatives to address a key issue of the large capital outlay required by a residential homeowner doing a retrofit conversion to geothermal of an existing home. The development of options to allow customers to finance installation costs as well as other strategic challenges and opportunities is laid out in the business school case study on WFI prepared by Charles Shanabruch in 2009.
Not much has changed since that date under CEO Tom Huntington who took over from the dynamic former CEO Bruce Ritchey. Perhaps the only glimmer of a new direction is international sales expansion beyond the USA and Canada, where the tiny sales volume tripled despite receiving no focus by management.

Valuation - Somewhere above the low end valuation of $29 per share that I estimated last year seems reasonable.

WFI has grown EPS 4.5%, and Free Cash Flow from negative to positive, over 2010; both are positives
US housing starts remain flat, a constraining negative that tends to the lower valuation. The guess/assumption last year that it might take two years to get back to normal levels should probably be re-stated as two more years from today in order to be conservative.
The stock price of WFI has slumped considerably from the $25-26 range of last year to around $19 nowadays. That makes WFI an even better value. Last year I said that WFI is a good buy, but for the long term. That is still my view.

Disclosure: I still own the shares I bought last year. I even bought more at around $21.

Disclaimer: This post is my opinion only as to how and why I came to my own investment decision. Whether you agree or not, it should not be taken as investment advice.

Book Review: Financial Statement Analysis by Martin Fridson & Fernando Alvarez

2011-10-31T15:54:00.009Z

Any book that reaches its 4th edition (updated to 2011) should be good. That's true in spades for Financial Statement Analysis. Fridson and Alvarez have written a classic. It should be required reading and a constant reference source on the bookshelf of any investor intending to buy individual company stocks or bonds. It is a book for those who intend to follow Warren Buffett and increase the security of their investments not by diversification but by depth of knowledge and confidence in the companies whose securities they hold.

The book is not primarily an accounting text in the sense of indicating the mechanics or the theory of accounting. It assumes basic familiarity with balance sheets, income statements and cash flow statements. What the book does thoroughly and brilliantly is to explain how to analyze and interpret the numbers to enable an investor to figure out what is really going on in a company.

The authors take account of and put heavy emphasis on the motivations of company management for their own personal ends - everything from presenting results in the best light at the legal end to outright fraud at the illegal end. Through many simple examples they show where and how to look for signs of manipulation of accounts. They admit the limitations of even the most expert analysis. They note, explain and give examples of the necessity to be wary of auditors, regulators and boards of directors. Frank and severe commentary abounds but the book is not a diatribe and the reader is not left with a sour or negative view. It is entirely practical and realistic. The book moves the investor from the textbook into the real world.

Though not to the same depth, the book also explains how industry conditions need to be taken into account in interpreting financial ratios. It explains how factors like seasonality, cyclicality, capital intensiveness, size of company, maturity of the company or the industry all can impinge on the safety/danger of debt or equity and the relative over-/under-valuation of securities. Want to know the hows and whys of leveraged buyouts, mergers, serial acquirers, stock buybacks, reserves and write-offs? This book will tell you.

The viewpoint is that of an investor arming him or herself with defensive detective tools. Its motto could be the modification of the adage "trust but check" to "check, and keep checking".

One of the surprising, given the subject matter, and delightful features of this book is that it is highly readable and accessible. The writing style is engaging with enjoyable turns of phrase, the sentences are understandable and never confusing, the examples are simple enough but not too simple, the organization of topics within chapters flows naturally. The authors have mastered the art of providing just enough detail - sometimes only a little, sometimes a lot - to make their point.

My Highlights:

The walk through the dividend discount model is the most intuitive and insightful version I've come across.
The five pages on Nortel weave together the methods (mostly abuse of accruals) and motivations (management bonuses) of the company's death spiral into a succinct morality tale.
My strongest takeaway is a sense that the integrity of management is a critical element to judge since there are so many ways for manipulation to be done and it can be very difficult if not impossible to detect till it is too late.

Caveats:

Page 232 reflects a small lapse in updating the new edition as the dates in a table do not match the text and the table on page 234 does match the text, though one can still understand what is going on. Perfection is hard to achieve!
The reader can only gain understanding through this book. Being able to apply the knowledge would require a person to work through examples to fully absorb it as a practitioner. Presto! The authors have written a companion Workbook.

Rating: A gem, 5 out of 5 stars.

Individual Investors Need a Strong Ombudsman

2011-10-11T09:08:00.004Z

OBSI. It looks like another boring acronym ... until your investment advisor screws up costing you money, refusing to reimburse or compensate you when you complain. Then the OBSI (Ombudsman for Banking Services and Investments) becomes a top of mind way to get redress.

It seems to have been doing too good a job, at least for investors, since the financial industry is now ganging up to undercut, criticise and opt out of OBSI being the one and only dispute resolution body (see various articles in the Financial Post over the last few months).

In fact, far from being watered down the OBSI needs to be protected and strengthened as a recent review commissioned by the OBSI Board suggests in the package of balanced recommendations that meets both consumer and justifiable industry interests. But the industry thinks the report is "delusional" according to a quoted reaction in a Financial Post article by Theresa Tedesco.

The financial industry needs to realize is that in-reality fair, and perceived-by-consumers to be fair, dispute resolution is good for it. One of the lasting psychological effects of the credit crunch is that bankers and investment dealers are a bunch of devious, avaricious crooks (witness the "Occupy" protests), lining their pockets and then letting taxpayers or investors take the fall. The industry's current campaign against OBSI reinforces the negative perception by showing unwillingness to fix errors or misdeeds . As both a shareholder in Canadian financial firms (directly and through ETFs) and an investor / consumer I want to see a fair, balanced system, not one that stacks all the advantages on one side (the FP Tedesco article cited above makes reference to the statistic that industry already wins 70% of cases adjudicated by OBSI - is it only 100% that is acceptable?).

It's not just perception either. When effective penalties are known to occur, firms will tend to improve their internal processes and controls so that problems don't arise in the first place. Industry calls this zero defects or six sigma. Consumers call this peace of mind.

What really needs to happen is for the federal minister of Finance Jim Flaherty to put the OBSI function on a stronger footing through permanent legislative authority on a national level, instead of its present voluntary, industry-funded status and to include insurance in its mandate.

One Limit to Financial DIY - Mental Incapacity

2011-10-06T07:24:00.005Z

There are limits to everything, including being a DIY investor. One such limit is when mental incapacity strikes. It gets to be a bigger and bigger issue as one gets older. The rising prevalence of dementia and increasing life expectancy ensure that it will become ever more common for retirees to become incapable of managing their own financial affairs.

The problem is that when such incapacity strikes, chances are we won't even be aware of it. Worse, even if we are aware, at the point when we have been medically certified as mentally incapable, we lose the legal power to do all sorts of critical things, as the report Financial Decision-making: Who Will Manage Your Money When You Can't? from the BMO Retirement Institute points out, including:

"• prepare a power of attorney
• make a new will, add a codicil to an existing will or revoke an existing will
• put a bank account into joint names with children
• change the beneficiary of your RRSP/RRIF or an insurance policy that you own
• carry out estate planning, such as reducing probate costs
• give investment instructions to your financial advisor."

As the report recommends, a sensible solution is to put in place, long in advance of anything happening, a Continuing Power of Attorney (CPOA), that kicks in automatically if and when incapacity happens. The report also mentions some obvious qualities the person(s) selected to exercise the CPOA power should have:

the time and willingness to fulfill the responsibilities (BMO says the average time a person fulfills a CPOA role is four years - if you are well advanced in age, it probably isn't the best idea to name someone the same age as you, like your spouse)
someone in whom you have complete trust (the CPOA has wide ranging power and possible abuse of the power is a major consideration; sadly, even one's own children can sometimes be less than reliable)
financially-knowledgeable enough to handle your affairs, or astute enough to recognize the need for professional help (tax, accounting, legal etc)

An interesting issue is what BMO calls "family dynamics", aka family politics, where other children are jealous because only one child is named as the CPOA attorney. In a sense, being picked as a CPOA person is a badge of honour but there is also work involved and like it or not, children do not always have the same capabilities and talents, not to mention availability. Being a Parent is a lifetime job (!) and making sure peace and fairness are maintained while doing what needs to be done may be a key part of setting up a CPOA successfully.

The BMO website hosts five other short worthwhile videos by lawyer Elena Hoffstein and Dr. Michael Baker talking about topics such as: how to recognize mental incapacity; its effects on ability to marry (you can still do it! I can imagine the smart alec comments that one must already be mentally incapable to get married at all... ) or to make a will and the unintended consequences of the two facts together (you may end up with no will at all); pitfalls of joint ownership (of house, investments, bank accounts etc) as a method to address incapacity.

Investor Fraud: the IFFL Brost Sorenson Case and How to Caveat Investor

2011-10-05T09:18:00.002Z

The indefatigable Ken Kivenko of CanadianFundWatch.com (I don't know how he manages to keep positive given the seeming endless flood of info he collects and analyzes about the weaknesses of investor protection in Canada) sent along a CTV W5 video link to Who is protecting your investments? on the latest yet-to-be-proven-in-court fraud perpetrated on investors - that of the Institute for Financial Learning (IFFL) operated by Milowe Brost and Gary Sorenson. It's a sad and shocking tale, especially in view of the fact that the RCMP and the Alberta Securities Commission have been completely ineffectual in preventing the fraud. If the past is any guide, little or none of the many millions that have disappeared will be recovered and the perpetrators will not suffer any punishment, except for having to spend years going through the legal system while drinking their pina coladas in Panama or wherever.

It is one thing for us to indulge in gawking at the financial catastrophe of others or to stoke our anger at the various "SOBs" who fail in their duty to protect us. More important is to remind ourselves how to do due diligence or exercise caution before we invest - a penny of investigative prevention is worth a million dollars in lawyer cure.

1) Official Sources like the various provincial securities commissions, the RCMP, e.g. through links in my previous post on this subject Scam and Investor Fraud Alert Sources - Fraudsters often do it again and again so they may well show up in previous judgments (maybe it's the light penalties and sanctions that encourage them? just asking). Do a search for Brost in the ASC website and lo and behold we see him caught doing naughty things way back in 2005.

2) Google search - Ain't the Internet handy, typing in Milo Brost brings up a whole host of links that would or should raise a dubious attitude. One that is wryly amusing is this 2004 Institute for Financial Learning discussion thread on www.scam.com where a certain Winer says the promised 40% return is entirely reasonable and is not a warning flag! The Internet savvy will always have their idiot and BS detectors in operation I hope. Bottom line: Trust, but verify. The more the stakes, the more you need to verify. The hard-hit couple featured in the CTV story did the former but obviously not the latter. It might even be worthwhile to get a second opinion from someone else with your interests at heart and without an interest in the potential investment.

The obvious answer to the CTV W5 title question right now is "you yourself, my friend, you are the only one protecting your investments". Caveat investor.

PS In one of my Google searches for this post, I came across the Behind MLM blog, an amusing anti-scam site. It also displays Google ads, one of which advertized a "200% Return on Investment Exclusive Diamonds from £5k". With the Google good comes also the bad ...

Book Review: The Rules of Risk by Ron Dembo & Andrew Freeman

2011-10-03T13:49:00.007Z

The book isn't just about investing risk though the book's subtitle is "A Guide for Investors". This must have been added by the influence of the publisher since the more accurate description of the content is on the back cover: "A Dynamic Framework for Forward-Looking Risk Management". Likely the latter would have been judged too technical and jargonish to appeal to a broad book audience.

The book is a broad conceptual guide, and a useful one, to figuring out what to do about various financial risks one faces in life, like house buying, insurance or investing. There is some jargon (do you want to figure out your lambda?) but it presents mostly common sense argumentation and nothing beyond arithmetic in the numerical examples.

Despite some attempt to flesh out their methods, the book falls short of being a practical guide. I find it difficult to see exactly how I could systematically apply, in order to develop an overall financial and investing plan, all of their ideas in their multi-step process, which consists of:
1) Know the value of your holdings today - I'm ok with this one, I think, though an important caveat is the definition of "my holdings", which they do not explore. They seem to think of such holdings as consisting only of a portfolio of financial securities, which I believe is far too limiting. The single most valuable financial asset we own is ourselves, our own money-earning capacity, often called human capital. Unlike almost every other financial risk, which they explicitly define as those subject to changes in the [external] environment (i.e. that we can do nothing about directly), we can enhance, or neglect, our earning capacity through education, diet, health protection etc. I suppose the authors might respond that their book does not intend to go into that detail. And I suppose that doesn't matter as long as this book is only considered a conceptual, not a practical, guide. This book does not hand you solutions on a plate. You would have to do quite a bit of work to apply them to your own circumstances.
2) Pick an appropriate future time horizon - Though Dembo and Freeman acknowledge that most people are likely to have multiple future financial goals (car, House, retirement etc) with different time horizons, they do not flesh out how to deal with the resulting complexity when this fact is added into downstream steps below. Nor do they address at all what to do about the very real fact that life contains surprises and your best laid plans / time horizons may not be the ones that actually happen e.g. a good number of people retire sooner than they thought due to job changes or health. That really complicates the next step.
3) Choose a range of scenarios of the future, making sure to include bad extremes and assign a probability to each scenario - This is the range of future end results for "the portfolio under consideration". Of course there could or would likely be multiple portfolio possibilities an investor might want to consider. This is the point where I'd guess almost anyone trying to follow their method would give up. Huh? How do I make up scenarios and figure the odds? They touch on but do not resolve the issue on page 81: " ... there are many occasions when it is impossible to attach useful probabilities to an unknowable future, then we have to find ways to model the uncertainties we face."
4) Pick a benchmark - The benchmark seems to be a kind of base case to compare the scenario & portfolio combinations (& presumably the multiple time horizons). They say that one can choose whatever benchmark one desires.
5) Value your portfolio and benchmark for time horizons under all scenarios - a lot of mechancial work
6) Compute the appropriate risk measure based on values coming out of step 5 - Here enters one of the intriguing contributions of the book, the idea that something they call Regret is the best measure of risk to use instead of popular commonly used measures like standard deviation (aka volatility) or Value-at-Risk (VAR, used by institutional investors).

Regret, with a capital R, is what I found to be the most useful, as well as the most accessible and natural, concept in the book. It is a way of taking account of potential harmful outcomes to make better decisions. Regret deliberately embodies the emotional impact of negative possible outcomes. A wrong decision, as judged later, can gnaw away at a person forever after. Second, the Regret evaluation process of Dembo and Freeman tells us to assess the cost of preventing the big negative, which in many cases is just insurance. Then we decide whether the cost is worth it considering more the consequences of decisions rather than the probabilities of particular outcomes.

As the authors say, "It is a sensible rule of thumb that an operation should not take on positions that expose it to the worst possible outcome - that a catastrophic loss might occur, resulting in ruin." This way of thinking would be very helpful in considering, for instance, whether to buy long term care or critical illness insurance. The same loss may matter a lot more to some people than others e.g. Warren Buffett will never be interested in buying long term care insurance since he can easily afford the fanciest care imaginable.

The obverse of Regret is what they call Upside, a positive consequence that can result from a choice. The thinking process is the same - how much could the positive result amount to and is the cost of the "bet to enter the game" worth it?

The book also has several interesting or amusing bits:

there are a number of praiseful references (this book was written in 1998) to the revised and improved risk management techniques of major investment banks following big losses in the 1980s and 1990s, rather ironic given the 2008 debacle; the notion presented by the book that these financial institutions were really trying to manage risk and avoid disastrous financial consequences instead of going willy nilly for the gigantic gains strikes me as rather naively quaint. Dembo and Freeman's own framework provides a handy simple tool to figure out the big banker's personal risk perspective - lots and lots of personal $$$ Upside with the worst personal Regret being fired and having to look for another job.
Dembo and Freeman show in Chapter 3 that Kahneman and Tversky are wrong to say that people are irrational or making behavioural mistakes when they make choices that violate expected value (EV = probability x outcome) rationality. They also make buying lottery tickets an entirely reasonable and rational decision (spending a few dollars a week won't cause even poor people financial ruin but it could, despite the bad odds, make them rich, so there's lots of Upside and really no potential Regret).

Bottom line: Though the framework will get too complicated to apply to a total personal financial planning effort, it can apply to one-off decisions. The Rules of Risk is worth buying for its thought-provoking content and useful concepts.

Rating: 4 out of 5 stars

Mutual Funds Institute Ham-Handed Research Hurts Own Cause

2011-09-27T09:53:00.009Z

Mutual funds in Canada have been under fire for their high fees and under-performance (hat tip to Canadian Capitalist). The industry body, the Investment Funds Institute of Canada has been attempting to shoot back at mutual funds' main competitor, ETFs. But its latest sloppy and slapdash salvo in the form of the July 2011 report Active and Passive Investing does more to discredit the IFIC and its cause than to help it. How so?

1) Consider the publication of the report itself. Is it secret or not?

Not Secret - Though I received a copy from Ken Kivenko of CanadianFundWatch.com (thanks, Ken) who forwarded the email attaching it sent out under the signature of IFIC CEO Joanne De Laurentiis.
Secret - The IFIC original email has the warning at the bottom "This e-mail (including attachments) is confidential and is intended solely for the addressee..." Oh really?
Not Secret - Why then does the text from De Laurentiis' say "It is the objective of the Report to clarify and counter misperceptions associated with active and passive investing so that research organizations and public policy makers can be better informed...". That sure looks as though it is intended to be publicly disseminated.
Secret - The IFIC website itself, however, seems not to show the report in any public area, only in a reserved members area (through this search link).
Not Secret - This secret public report meant to be used per De Laurentiis "... as a reference authority in materials developed by you (e.g., articles, reports, etc.)" can actually be accessed through (marvels of the Google and the Internet!) a link at the bottom of this post on Arbetov.ca.

On the whole the image one is left with is that IFIC is trying to feed ammunition to its membership of fund distributors and sellers to have numbers to quote to clients but that it does not want to release the report to wider public scrutiny, including skeptical bloggers!

2) The suspicion of devious intent gets stronger once one looks at the flawed report itself. Its basic approach is to show that passive investing can be expensive, done by trying to show that ETF costs are higher than many people think. However,

ETF does not equal passive investing (and the flipside is that Mutual fund does not equal active investing). The report throughout treats all ETFs as if they are the same as passive index investments. That might have been a fair generalization ten years ago but today ETFs have become very diverse. Many high cost, poor-quality, narrowly focussed ETFs have come on the scene, some even with explicit active strategies.
Mixing all ETFs together and calculating average costs raises the apparent cost of a passive index (i.e. a broadly based market-cap) strategy. Transaction costs, bid/ask spread and tracking error, which the report says add up to 1.2% ETF under-performance relative to index, is at most 0.1% for a fund like Vanguard's Total (US) Stock Market ETF (VTI) or the grand-daddy biggest-of-them-all SPDR S&P 500 (SPY). The true lesson is not that passive indexing is expensive, it is that today investors need to be just as careful picking ETFs as mutual funds. ETFs that are too small, too narrow and only sample stocks instead of replicating an index are prone to index under-performance from large tracking error.
The 1% that IFIC says goes to providing advice to mutual fund investors, which ETF investors do not get, and therefore causes ETF under-performance by that amount, rests on the dubious conclusion that investors get 1% worth of advice. The previous IFIC report The Value of Advice (which also seems to be hidden away in IFIC's website) it cites as evidence received a thrashing on its release in 2010 - e.g. see Canadian Capitalist's Readers Rip IFIC Report to Shreds.
Risk, as expressed in volatility, is not or should not be an end in itself, so for IFIC to state that actively managed funds offer investors the risk exposure they wish is beside the point. As books like Richard Ferri's The Power of Passive Investing, David Swensen's Unconventional Success and many others have repeatedly documented in great detail, actively managed mutual funds have performed poorly on a risk vs return adjusted basis. It doesn't help to take on risk if you lose in doing so.
As I said in my review of Ferri's book, the issue is not active investing vs passive investing in principle or in general, it is with the funds actually available to small individual investors and how they perform in reality. That's why I am currently testing the RAFI fundamental strategy, which I think is better in principle and has been shown to be so using (non-investable) index data, against cap-weight using actual ETFs available to investors. A key question is whether the higher fees on the RAFI funds overcome their theoretical advantage and give off lower net returns.

There is nothing wrong with mutual funds per se. I don't think that as a technical legal structure they are any better or worse than ETFs. The problem is simply that the current mass of available mutual funds suffer from too high fees that negate their value. They don't add enough value to earn their fees. This lackadaisical offering from IFIC doesn't inspire much respect or do much to help their cause.

New Innovative ETFs that Investors Really Really Need

2011-09-26T17:10:00.001Z

Sure, there are lots of ETFs and more weird and wonderful concoctions seem to come out every day. Think the financial industry is running out of ideas for ETFs to appeal to every possible interest? Just in case, here are my suggestions for innovative ETFs that could hit the sweet spot for investors.

Darwin's Centenarians - "Survival of the Fittest" is the theme of this ETF. Darwin told us that merely surviving is the definition of being fitter. If a company has survived 100 years or more, it has to be fit, right? Twelve Ultimate Buy and Hold Canadian Stocks lists the Canadian stocks to include. Wikipedia's List of oldest companies tells us that no less than 21,666 companies worldwide are centenarians or better exist. That choice is good because diversification through holding a basket of many companies is still required. Age does not guarantee survival - witness the demise in 2006 of Kongo Gumi the oldest continually operating independent company that had been operating for 1400 years. It was a victim of, you guessed it, too much debt.
Random Dartboard - We've all read that randomly throwing darts at a dartboard to select stocks works just as well as the average active mutual fund manager. So let's have that fund, please. In order to remove any human bias, and to give the fund a marketing handle, the fund management will consist of chimp Sammy Stockpicker (photo below) along with a human handler. Another advantage - the MER will be peanuts. . This will also help restore a bit of balance in markets, as apparently mathematicians like the one below are taking over trading in markets according to BBC's Quant Trading: How mathematicians rule the markets.
High-Yield Sovereign Debt ETF - Nicknamed the "Merkel Put Fund" in honour of the German leader who will be backed into "bailing out" Greece (i.e. having German taxpayers paying for Greek non-taxpayers), this fund will hold the debt of various countries with dubious ability to repay. There are already high yield corporate bond funds like Claymore's CHB so this new fund would only extend the concept. It might be a challenge to define what countries to include since the bond rating agencies' ratings of countries doesn't correspond systematically with countries that pay high yields e.g. Ireland pays quite hefty yields upwards of 8% despite its BBB+ Investment grade rating (see Wikipedia explanation) from Standard & Poors in this list of Credit Ratings by country in Wikipedia. I would propose the "if it looks like a duck and walks like a duck, then it is a duck" method of determining what is high-yield.
High Dividend Yield Country ETF - Nicknamed "the future will be like the past" fund, this one will invest in the market basket for the highest dividend yield countries. After all, if famous researchers Elroy Dimson, Mike Staunton and Paul Marsh tell us on page 21 in the Credit Suisse Global Investment Returns Yearbook 2011 (my review here) that an evenly balanced portfolio of the equity index for the highest dividend yield countries handily outperformed for 1900 to 2010 and multiple sub-periods within it, what could go wrong?
The Liquid ETF - The ETF Stock Encyclopedia lists a whole range of sector ETFs like retail, telecommunications, oil and gas, mining, utilities, pharmaceuticals, biotechnology, the list goes on and on. Why not set a new direction for themes with a fund that invests in the industries that produce liquids, i.e. a combination of water infrastructure, oil and gas, beer and wine producers. There must be excellent diversification potential as companies are likely to have little correlation with one another.
The Global Mega ETF - Finance theory tells us that an investor should hold the market portfolio, which consist of a holding in every available asset i.e. stocks and bonds in every country. Has anyone offered such a fund yet? The answer is No. Vanguard has something called the Total World Stock ETF (VT) but even that only includes 49 countries and no bonds at all. There isn't even a bond fund in its arsenal that tracks a total world bond index.
The Celebrity Dream ETF - We cannot all look like Angela Jolie (from Top Beautiful Women blog) or Brad Pitt (from Celebrific.com) but maybe we could invest like them. After all, celebs are wont to give us their opinion on politics, social justice, climate change, etc and with such beautiful faces and acting skills, everyone is convinced they are right. And so they will be regarding investments. Markets will follow them! Their stock picks and predictions will be self-fulfilling prophecies. Besides things always turn out fine in Hollywood. We should remember that though markets in the long term are weighing machines, in the short term they are popularity machines, as all technical traders know. Why bother with charts, statistics, patterns, moving averages and the like when we can go to the next step and actually lead the markets where we want to go? The only possible drawback is that celebs don't come cheap and fees may be high, though surely nowhere near as high as what the typical Canadian mutual fund now collects. So the ETF should still be competitive.

How about it, all you ETF providers out there, innovation has to keep moving ahead, n'est-ce pas?

Passive Indexing Trend Leading to Increased Investment Risk

2011-09-09T15:40:00.008Z

Too much of a good thing for individuals can be bad for everyone collectively when it comes to passive index investing. James Xiong and Rodney Sullivan explain how this has come about in How Passive Investing Increases Market Vulnerability, available for download here at Top100Funds.com and here at SSRN.

Through a series of statistical tests on US equity data back to 1979, they show how the take-off of passive index investing since 1997 is strongly associated with their disquieting stock effects:

"... the rise in passive investing meaningfully corresponds to a decrease in the ability of investors to diversify risk in recent decades" and
"... the diversification benefits of equity investing have decreased for all styles of stock portfolios (small, large, growth, or value). The decline in diversification benefits can couple with increased market volatility and firm-specific volatility."

Passive index investments in mutual funds and ETFs by late 2010 reached about a 1/3 share, or $1.2 trillion, of the total in such funds of $3.5 trillion - active investment funds makes up only 2/3 of the total. (The paper also tells us that institutional investors now hold 70% of US equity stock vs 44% in 2000 and only 24% in 1980.)

The chart below from the paper shows the vertiginous rise in correlations between pairs of stocks. Note how the more passively indexed segment, the SP500 large caps, has higher correlations than smaller caps, the non SP500 stocks in the chart.

They checked that the effects were not only manifest during the recent periods of extreme market crisis - the dot com crash in 2001/02 and the credit crisis crash in 2008/09 - when all asset class correlations rose significantly. The same pattern of rising correlations continued through the other more normal years of the study period.

There may still be value for individual investors to buy those passive index funds but the free lunch of passive diversification now appears to be merely selling at a discount. One thing for sure, as I tried to suggest in the thought experiment post What Would Happen if Everyone Did Passive Indexing? the success of passive indexing, when it becomes big enough, does have an effect on markets. In another post last year, Index Investing Becoming a Victim of Its Own Success, I noted research by Jeffrey Wurgler on the S&P 500 that reaches similar conclusions. No wonder the avant-garde of risk-aware, efficiency-aware institutional investors is moving away from cap-weight passive index investing, some to private equity direct investing, such as the big pension funds and others to alternative-weighting indices.

Cool Tool: Stock and ETF Market Visual Heat Maps

2011-09-08T17:51:00.006Z

Like to get a quick impression of how various stocks, sectors and ETFs are doing today or in the past year? Check out these heat maps, which show through colours - red down, green up - how markets have been doing. On most, you can drill down by clicking on individual trading symbols to get a lot more detail.

FinViz.com - S&P500 grouped by sector, Foreign Stocks (including Canadian) Traded on US exchanges, US-traded ETFs. Data includes performance today to 1-year, P/E, P/B, P/S. Dividend Yield, Earnings

StockMapper.com - NYSE Euronext stocks (which includes 66 largest Canadian stocks), S&P 500, World Regions. Data includes today's percent change, latest news

SmartMoney.com - US stocks "over 500". Data includes daily percent price change organized by sector.

What Would Happen If Everyone Did Passive Indexing?

2011-09-02T12:32:00.000Z

There is much advice out there telling us investors to buy passive market-cap weighted index funds (e.g. iShares' TSX Composite XIC for Canada and Vanguard's Total Market VTI for the USA) instead of actively-managed funds which try to beat the market, and instead of trying to pick winning stocks ourselves. Suppose everyone woke up one morning and "went 100% passive" so that no one held anything other than one of these ETFs or something equivalent? What would happen?

From then on, there would be no change in price of any stock as everyone, through the fund, simply accepted the last going price. There would not even be any reason to have different bid-ask prices. There would be no change in price in a day, a year, or ten years ... no matter what happened to any of the companies whose stock was in the portfolio. Now that would be interesting, we/ the fund could happily be paying big bucks for the stock of shrunken companies, or tiny amounts relatively speaking for vastly expanded others. The investor would receive no capital gains, only dividends, increasing from some successful companies and declining or disappearing from the unsuccessful ones. Things would get very out of whack.

The only change within index funds would come as a result of Standard & Poors or other index providers adding or dropping stocks from indices. It would be rather difficult for the index providers to decide which to include or exclude since the basic method relies on the market capitalization of stocks, a number which would never (or almost never, excepting new stock issuance) change in a totally passive world.

That situation wouldn't be at all stable given the reality that a) stock prices should reflect the value of the profits being generated by the components of the index, b) cagey investors would notice the too-high or too-low craziness of prices and start taking advantage by buying up strong companies with extremely high dividends. Prices would change. Active investors are thus the very mechanism that keeps prices more or less fair. Without the active investors constantly making judgements and moving prices up or down, the passive index investor wouldn't be buying a good product. Nobel Laureate Professor William Sharpe notes this ironic relationship between active and passive investing at the end of his easy-to-read article recommending Index Investing.

Why Stewardship is Proving Elusive for Institutional Investors from the Harvard Law School Forum on Corporate Governance and Financial Regulation notes a further likely effect:

passive index funds exhibit poor ownership behaviour, effectively letting company management and boards run amok, as the focus on fund cost minimization leaves little money for company oversight and active involvement as a shareholder; in fact, many funds do not even have the shares to be able to vote as they lend them out to generate extra revenue and thus do not have them in hand to vote.
passive index funds, which own the whole market of perhaps thousands of stocks, cannot practically exercise any corporate owner stewardship even if they attempt it.

In these circumstances, it is a sure thing that abuse, rip-offs and exploitation by insiders at companies at the expense of passive shareholders, would increase considerably.

Scott Vincent in the April 2011 paper published on SSRN called Is Portfolio Theory Harming Your Portfolio? argues that the rising trend to passive index investing is increasing the opportunities for informed investors to take advantage of market inefficiencies. First, he notes that such informed skilled active investors are not new: " ... In reality, there is an abundance of evidence that markets are less than perfectly efficient, yet most practitioners and academics find that exploiting these inefficiencies is, at minimum, very difficult. It is not easy to consistently outperform the market, but talented managers can and empirical data supports this fact... " He also maintains that most studies of actively managed funds get their measurements wrong because a majority of these supposedly active funds are essentially passive. Instead of holding a few stocks, they are quite diversified in fact and therefore mostly track the index, whether consciously or unconsciously.

Furthermore, he says, "Multiple studies indicate that funds which are more actively managed, or more concentrated, outperform indexes and do so with persistence (Kacperczyk, Sialm and Zheng (2005), Cohen, Polk, Silli (2010), Bakks, Busse, and Greene (2006), Wermers (2003), and Brands, Brown, Gallagher (2003), Cremers and Petajisto (2007))".

According to Vincent, the end result of the contemporary trend to passivity is that: "... as more money flows from truly active managers to investment vehicles that deploy money “blindly,” inefficiencies become more prevalent creating opportunities for those whose eyes are open to them."

Vincent's recommendation is that individual investors can take advantage by a) searching out mis-priced securities themselves, or by b) searching out and investing their money with those truly active and truly successful fund managers - " ... look for concentrated, fundamentally-driven, relatively small funds with talented managers. Since persistence has been demonstrated in this subset, it turns out that a good manager may be identified from past performance".

Weekend Reading: ETF Danger, Visa a Scam?, Ireland's Woes Explained, Dividends = Low Risk/High Return, Debt Song

2011-08-28T23:06:00.005Z

Articles of interest, to me at least, and perhaps to you:

"... if you are considering an investment in a mutual fund or ETF, you should understand that you will have little recourse if information provided in the prospectus turns out to be misleading or incomplete, even outright fraudulent" from A license to lie, backdated in Interfluidity.com commenting on the implications of a recent US Supreme Court Case. i.e. we should be very wary of new ETFs; the more complex they are, the more likely something dangerous is being done to investors; with the court case it will be more tempting too for the unethical operators.
Michael Lewis' non-technical article in Vanity Fair explaining how things went pear-shaped in economic revival poster-child Ireland When Irish Eyes are Crying
The Onion's satiric piece Visa Exposed as Massive Credit Card Scam ... isn't the best satire that with a good dose of truth? Found this link on The Browser, which has multiple links to a variety of good stuff
Traditionalist (value investing, Graham philosophy) practically-oriented investment advisor firm Tweedy Browne Company LLC reviews research that reveals "... the importance of dividends, and the association of high dividend yields with attractive investment returns over long measurement periods"
Who knew the debt crisis could be turned into song?! Have a listen to Split-Rated at Versus by Marcy Shaffer

Finally, nothing to do with investing, but if you have Scottish blood or know anyone with a Scottish heritage, you might be amused by this YouTube video Voice Operated Lift.

Investment Benchmarking & Reporting - It's Time to Get Total Return

2011-08-26T14:21:00.006Z

Pull up a chart of the S&P/TSX Composite Index from Google, from MSN, from Yahoo, from the Financial Post, from the Globe and Mail, even from the TSX's own website TMX Money, nor even from the S&P itself, which owns and maintains the index, and what do you get? The price index only, that's what. You do not get the Total Return Index, which includes not just the price, it also includes the dividend income from stocks. The same goes for any other stock index.

Why does it matter? The dividend part of the return - currently running at 2.7% on the TSX according to TMX Money - makes a huge difference over time with compounding. When doing portfolio assessment and benchmarking, whether it's your own, or a financial advisor's, a mutual fund or ETF company's, or a discount broker's, it is deception not to use Total Return for whatever index or asset class is in question.

How are the ETFs? - Amongst ETF providers, iShares and Claymore to their credit explicitly use Total Return indices while with BMO it isn't clearly stated (e.g. neither in the download index spreadsheet nor in the index description for its Dow Jones Canada Titans 60 Index ETF), which in itself is bad.

How about Financial advisors? an example - I don't know how widespread this is amongst financial advisors, and I am only picking on this guy because he happened to be a guest on BNN the other day so I looked up his website, but I was horrified to find that David Baskin Financial's performance against the index in the download blurb clearly uses the price only version of the TSX. How do I know? One of the few places we can access free annual Total Return index data is another financial advisor's website, Norbert Schlenker's Libra Investment Management, in this download spreadsheet. Line up the Baskin and the Libra numbers year by year and see the consistent higher performance of the Libra Total Return numbers e.g. 2010 Baskin TSX 14.4% vs Libra TSX TR 17.6%. Do the compounding of the TR numbers using Stingy Investor's Asset Mixer, who has taken Libra's data and turned it into a handy tool, and the 10-year TSX TR performance up to 2010 is 6.6%. Now the Baskin Financial 6.4% 10-year result doesn't look so good as it did against the blurb's TSX number of 4.2%. (It's also interesting that Baskin's "our team" web info mentions no financial designations but emphasizes TV and public appearances while Schlenker is a CFA, CFP, CIM, FMA and emphasizes his adherence to a code of ethics.)

There's another source of daily updated Total Return data buried within GlobeInvestor. Under Investing > Markets, enter stock symbol TSXT-I for the TSX Total Return Index. It allows one to benchmark year-to-date and one-year TR performance for the TSX on any day. The Libra data is annual year-end only.

Why the limited availability of Total Return data? Perhaps it is just the historical momentum that has seen the price index always being the quoted number, a result of the difficulty in computation in the days before computers and databases (which to my mind explains that widely-cited anachronism, the Dow Jones Industrial Index). Perhaps it is the fact that the TSX sells the data and the Total Return data is the meaningful valuable part while the price index is the loss leader.

Update September 15th - Broker BMOIL confirmed to me (at last, it took about two weeks to get the answer) that their benchmarks which compare against the investor's portfolio do actually use Total returns, not just Price Returns. Good, now I wish they would put a note to that effect on the relevant webpages.

Whatever the reason, ordinary investors need this data. It is time for the financial industry, and the media, to start quoting the right numbers.

Education Savings Options: RESP, TFSA or RRSP?

2011-08-20T18:15:00.010Z

Back in 2007 I compared the RESP and the RRSP as investment savings options for funding higher education, excluding the TFSA since it did not yet exist. The conclusion at the time was that the first $2500 of savings should go into an RESP to take advantage of the free money (courtesy of other taxpayers) available from the federal government in the form of the Canada Education Savings Grant. The $500 annual CESG (20% of contributions up to $500 per year and $7200 maximum lifetime - more details here from TaxTips.ca) made all the difference.

It's time to revisit the question. First, the TFSA now exists. Second, an anonymous comment this past July on the original post suggested the RRSP might be better if one takes into account the possibility that the student can transfer up to $5000 in annual tuition deduction during the time of eventual study, which gives the parent a 15% tax credit (i.e. $750) on the tuition transferred. Excellent question! With interesting results too.

I've built a downloadable spreadsheet (look for the download link on the right hand side of the web page once the spreadsheet opens up as a Google doc in your browser) for readers to play with beyond what I have already done.

Conditions Applied to My Analysis:

Parent Must Have Enough RRSP Contribution Room - The whole analysis presumes you can put in $2500 per year new money plus up to $2100 reinvesting the tax refund each contribution generates, plus the reinvested refund on the reinvested refund, plus the reinvested refund on the reinvested refund on the reinvested refund etc ... (remember that child's song, there's a hole in the bottom of the sea? this is the tax refund version of it); that's why the RRSP part of the spreadsheet extends way out to the right. At the top Ontario marginal tax rate of 46.41% (see TaxTips.ca's tables for personal tax rates in each Province, which readers can use to check what happens in their own bailiwick) that means needing another $2100 or so of extra annual contribution room. Doing this gives the RRSP option its most favourable conditions.
Only $2500 in Annual Contributions - This condition is to give the RESP its most favourable conditions, namely that it gets the most free CESG money, so that each contribution buck is getting the most bang.
Child Must Not Have Enough Income to be Liable for Taxes during Higher Education Years - As I noted in the original post, the RESP's advantage disappears if the student has to pay taxes, even at the lowest tax bracket (see the Student_Taxable tab in the spreadsheet).

Results: (the summary numbers for the discussion below are in the Results tab and the calculation table with inputs you can use to plug in your own numbers is in the RESP_RRSP_TFSA tab; other tabs contain the calculation tables from the original post)

1) RESP is (Almost) Always Best ... if the Child Takes Post-Secondary Higher Education - No matter what the parent's tax rate, the RESP comes out ahead after tax, as shown by the green numbers. The only circumstance when it does not is when, as shown by the red numbers in the Results tab, the parent's tax rate at time of withdrawal is at least three tax brackets lower than at time of contribution - e.g. taxable income goes down from $100k to $70k as in retirement - and the investments earn a low (2%) to medium (5%) annual return. In this latter case, the RRSP wins, but not by much.

2) TFSA Wins if the Child Does Not Attend Higher Education and Parent's Tax Rate Stays the Same - The green numbers under TFSA show that no matter what tax rate the parent is in and regardless of investment returns, the TFSA does better, but not by a lot, than both the RESP and the RRSP.

3) RRSP Wins if Child Does Not Attend Higher Education and Parent's Tax Rate Drops at Withdrawal - The green numbers in the RRSP column show that the RRSP does better and better the more the parent's tax bracket drops between the date of contribution and withdrawal. The higher the investment return, the bigger the effect. When it is three brackets lower and there are high (8%) returns, the net difference is $25,000 more than the RESP and $15,000 more than the TFSA.

Bottom Line:

if you are confident that your child will go to college/university before you retire, put that first $2500 into the RESP; if you have several kids, the chances should be higher that at least one of them will go on.
if you really are not sure your child will go on to higher education , then the RRSP is the better hedging option. The TFSA's advantage when the child does go on isn't big enough to offset the TFSA's lower results compared the RRSP when the child does not go on. Also in the RRPS's favour is that the RRSP's disadvantage compared even to the RESP when the child goes on is much less when investment returns are low and you are in the lower tax brackets.
if you believe that your income will drop two or more tax brackets by the time the higher education decision will need to be taken, the RRSP looks better even than the RESP. When there is no higher education the RRSP is always superior to the RESP and even when there is higher education, at two brackets lower you are ahead except at high investment returns. If your investments within the education account are cautious and low risk, low to medium returns are what you will get.

Ontario Government EATs the Dead

2011-08-17T17:00:00.007Z

It's gruesome. As of January 2013 the Government of Ontario will voraciously EAT dead people, or more precisely, their estates. That's EAT as in Estate Administration Tax, the official name for probate fees in the province. The Government of Ontario has passed into law big changes in the Estate Administration Tax (EAT) and though the tax rate will remain the same, the new provisions for collection will make it a nightmare.

The innocuously titled Ontario to Change the Way it Collects Estate Administration Tax (Probate Fees) by Clare Sullivan, Aird & Berlis LLP in CCH's August 2011 newsletter describes the additional bureaucracy:

"... the new provisions require the estate representative to keep records and books of account ... the value of the assets of the estate for probate or administration purposes will have to be supportable ... valuations will be necessary for all property passing under a probated will" >>> i.e. extra effort, time and cost to get formal assessments on everything
"... The MNR will be able to assess or reassess for a period of four years after the day the tax is payable... The new procedures may also unduly delay the application for a certificate of appointment [my note - this is the document an executor needs to show everyone that he/she is legally entitled to be executor] ... there could be significant delays in obtaining the certificate of appointment and thus delays in administering the estate ... an estate representative may not wish to settle an estate until four years after the application for probate in order to limit his or her personal liability for any unpaid tax" >>> i.e. potential lengthy delays for someone to even getting started as executor. The Catch-22 lunacy of this is that without the certificate of appointment many/most financial institutions will likely refuse to provide any information, which of course can make it impossible to pay the tax and get the certificate. And then there will lengthier delays - goodness knows it takes long enough now - to wrapping up and distributing estates. And even after that, there might be messy reassessments and more to pay later.

Another lawyer, Barry Corbin, goes into more detail about increased liability exposure and complications of distributing estates as a result of the audit and compliance provisions of the new law - see Estate Administration Tax - The Nightmare Begins.

One thing is certain - the Ontario Ministry of Revenue will make sure to collect a lot more tax than now (why else would they have done the amendments?), merely from its rigorous and likely painfully painstaking application of the law. Moreover, with the structure in place, down the road one can expect increases in the already highest in Canada rates (see Canadian Tax Resource blog's table). Just wait till the government needs more money and finds that dead people are easier targets than live voters.

It's a done deal. The new law received Royal Assent May 12th. Of course, the government could forget to Proclaim the law, and it would never go into force. Maybe an election would see a new government that would see fit not to take that final step.

Ontario Securities Commission Ignores Retail Investor Viewpoint

2011-08-16T16:22:00.004Z

Tireless (judging by the quantity and depth of commentary he produces) investor advocate Ken Kivenko of CanadianFundWatch recently sent me the following news on recent machinations of our regulator the Ontario Securities Commission.

"OSC has selected for its new Investment Fund Products Advisory Committee: The IFPAC will advise OSC staff on emerging product developments and " innovations " occurring in the investment fund arena and will discuss the impact of these developments [ on investors?], as well as emerging issues. We put forward a candidate, albeit after the deadline We were not aware of the opportunity. Ref. http://www.osc.gov.on.ca/en/NewsEvents_nr_20110602_osc-members-ifpac.htm All members announced are industry participants – not a single investor or investor advocate. Another missed opportunity by the OSC Investment Funds Branch. However Manulife and RBC are in; they're part of the “gang of five” that are working to clip OBSI's wings or dismember it. It really doesn't matter since we've warned of leveraged ETF's ,SPAC's and CFD's in the past and all were unleashed on retail investors despite our stated concerns. News Release at http://www.newswire.ca/en/releases/archive/August2011/11/c3174.html"

There are many highly knowledgeable non-industry investors around to sit on such committees and provide the retail investor viewpoint but OSC seems to do little bring them into the process. As that famous song phrase goes, when will they ever learn?

Fundamental vs Cap-Weight Portfolio: Surprise Performance Reversal after Year One

2011-08-08T03:46:00.006Z

The first year has now passed in the head to head contest between the fundamentally-weighted portfolio and a parallel portfolio with the same asset allocation based on traditional cap-weighting. Both portfolios started out with $100k last June - see original post announcing the contest.

Both Portfolios Have Gained - up about 10% to $110,000 or so as of August 5th, though it was higher at the 1-year anniversary since the past few weeks have not been kind to market values. Every single asset class is higher than the value at inception. I note that our hypothetical investor is not panicking and is not / has not sold anything, unlike those mythical investors (why doesn't the press just call them speculators, anyway?) who have been obeying the chicken-little sky-is-falling market forecasting gurus.

Cap-weight Ahead Slightly! - Surprise, surprise, after being behind pretty well the whole year, sometimes by more than $1000, or 1%, the cap-weight portfolio spurted ahead in the last month or so and now leads by about 0.6%. I think the quick shift was the European banks getting hammered in the PXF vs VEU category but need to look further into this. Whatever the reason, this contest doesn't look very conclusive so far.

Rebalancing - After accumulating cash from most of the ETFs for the past year our policy called for review and reinvestment of the cash at each year anniversary. Note: Claymore CRQ ETF has automatic DRIP with distributions so I've tracked the reinvestment for CRQ. BMO also does auto DRIP but when BMO switched to monthly distributions with ZRR and ZRE it has not been worth my bother to do all the tracking of reinvestment for single share purchases, so I've simply tallied up the cash. Not one of the ETFs / asset classes had come near to the forced rebalancing point of 25% deviation from its target allocation in the portfolio. None are off even 10% from allocation target.

Nevertheless, to put the cash to work but not pay too much in commissions to rebalance small amounts, and to keep the asset class by asset class contest going, I've split the reinvestment cash to put another $1000 each into CRQ and it cap-weight rival HXT. The remainder has gone into XBB for each portfolio. These were the two asset classes with largest dollar amount divergence so it works out neatly as a quite realistic action.

More shares of XBB have been purchased (all purchases done at closing market prices of August 5th) because the cap-weight ETFs have paid out more than their fundamental weight counter-parts. That's interesting because the fundamental weight ETF holdings are supposed to be selected and weighted in part according to dividends. However, the higher MER's of the fundamental weight ETFs (about 0.5%) have to be paid. That's a cost performance drag of the real world for the fundamental ETFs that their superior index returns do not reflect. Our contest tests whether the stock performance is strong enough to overcome this impediment.

Fundamental DRW Replaces Cap-Weight RWX in the Fundamental Portfolio - Long ago reader Jordan suggested Wisdom Tree's Global ex-US Real Estate Index ETF (symbol DRW) as a fundamentally-weighted alternative to RWX. Now the switch is done it's done and there can be a contest in that asset class too.

As ever, the two portfolios can be seen side by side at the bottom of this blog page.

Government Moving Ahead on PRPPs - Financial Industry is "Salivating"

2011-07-18T03:38:00.005Z

The Financial Post's Jonathan Chevreau article on the plans of the federal government to proceed with Pooled Registered Pension Plans (PRPP) contains the all-too-telling mention that "Naturally, Bay Street is salivating at the prospect. This is a giant potential opportunity for the nation’s banks, mutual fund companies, insurance firms and a growing number of manufacturers of exchange-traded funds." One is "naturally" led to wonder who will benefit most from PRPPs, ordinary Canadians trying to build a pension, or the financial industry. I cannot tell for sure but I own shares in the financial industry.

Also no doubt salivating are the financial planners and advisors Mr Chevreau also mentions, since the added complexity of another retirement savings layer with the PRPP will require more figuring out.

Book Review: Investing and the Irrational Mind by Robert Koppel

2011-06-29T19:51:00.002Z

In this book Robert Koppel relates how he has discovered that the precepts and practises that he knew from practical experience lead to market trading success are underpinned, explained and validated by the findings of behavioural finance research.

Not so much a ground-breaker providing new insight or knowledge, it is readable summary and description of many behavioural finance concepts and how they have been applied successfully by traders. But it falls short in explaining exactly how to change one's own behaviour. There is a difference between saying that intuition is a quality of successful traders, which he does, and setting out an action program to get there, which is not done. One wonders if he thinks that may be impossible using only a book since as he also notes, "... none of what success requires is easy. There are no shortcuts, simple answers, or turnkey solutions."

It has been known for a long time what kinds of behaviours and psychological qualities lead to success. Koppel cites an 1880 list - self-reliance, judgment, courage, prudence and pliability. Koppel also relates how certain highly successful traders through extreme determination and unstinting enormous effort managed to change themselves and imbue themselves with the required qualities. That's learning the hard way, self-taught through much trial and error. Is that really the only way? Surely not, in this age of deliberate formal education that turns out vast numbers of people who are better at many things than would have been the case if left to their own devices. There is a little bit of such content in the section on psychological resilience but the book misses the opportunity to take the next step by providing the training-type advice to operationalize improved investor behaviour. For instance, Koppel cites research which concluded that optimism can be learned, an encouraging bit of news. Ok, tell me how to do that. My family and close friends would really like me to know! It is not just a case of "just do it".

Koppel is not particularly to blame in this. So far, no book I have come across goes beyond describing the problems uncovered by behavioural finance to putting in writing a comprehensive practical training program. As a model for what I think can and should be assembled, there is the classic on how to be a good consultant, Flawless Consulting by Peter Block. It is very specific and tells you exactly what to do step by step.

The book reads easily. It contains some amusing quotes e.g. "I have stuff, therefore I am", a fitting epitaph for the consumer society. Another, said to be Wall Street lore, vividly describes the investing risk-return trade-off "You can't eat like a bird and shit like an elephant". It also contains a good reading list and copious references.

Most likely, the greatest appeal of this book will be to the active investor, especially the short-term trader and market timer. Passive index investors will find the admonitions about finding a trading system that gives a person an investing edge somewhat beside the point. One could say that one of the great benefits of passive investing is that it helps bypass much of the harmful stimulation that leads to bad decisions and portfolio loss. Someone who owns a broad market index fund can simply do a Rip Van Winkle - file, forget and ignore for a decade or two, perhaps awakening every few years to rebalance amongst asset classes.

In short, this is a good though not great book. My rating 3.5 out of 5 stars.

Thanks to the publisher McGraw-Hill for providing me with a gratis review copy.

Protecting the Investor Protector - Threat to Ombudsman for Banking Services and Investments

2011-06-17T07:52:00.004Z

Yesterday I added my voice to the chorus (Ken Kivenko of Kenmar, Fair Canada, Rob Carrick of the Globe and Mail, Ellen Roseman of the Toronto Star) objecting to the attempt by a number of financial industry players RBC, TD, Manulife, Investors Group and Macquarie Group to bypass the OBSI as arbitrator in resolving these firms' disputes with individual investors.

Here is what I wrote:
" Flaherty.J@parl.gc.ca,
publicaffairs@obsi.ca,
csa-acvm-secretariat@acvm-csa.ca,
publicaffairs@iiroc.ca,
mfda@mfda.ca,
hwetston@osc.gov.on.ca

Dear Mr Flaherty et al,
This is to state my voice of support in the strongest terms for the continued mandatory involvement of the OBSI as a means of redress for ordinary investors.

Do not allow the banks and investment dealers to opt out of OBSI. The odds are already heavily stacked in favour of the industry in permitting abuses to take place and then to avoid responsibility and compensation for wrongs. Both as an investor with financial scars and as a personal finance / investment blogger looking closely at the many complexities of financial products, it is critical that ordinary individuals be able to count on fair treatment by the financial industry. The OBSI is an important mechanism to keep the industry in line. Recent efforts by various industry players to opt out of OBSI confirm that its decisions sometimes hurt them and that it is doing a worthwhile job.

Regards,
Jean Lespérance
CanadianFinancialDIY"

As a completely self-directed investor I hope never to be obliged to use the OBSI but I want it to be there, even in a stronger form than it is now. I directly or indirectly (and so does everyone else who buys ETFs like iShares' S&P TSX 60 Index) own shares in RBC's parent and in all the public financial industry players who make more profit, at least in the short term, from avoiding their moral obligations to compensate accidental or deliberate screw-ups of client portfolios. But friends and family who use brokerage advisors need the protection of OBSI. I also think it's good business in the long term for the firms themselves to have a strong counterbalance keeping them in check.

PS Why doesn't the Ontario Securities Commission post any email addresses to receive comments - see the Contact Us page? I had to guess at Chairman Howard Wetston's. Looks a lot like hiding behind a wall. If Minister Flaherty can do it, surely the OSC can too. The next step is to actually respond. I hate to think this is a case of "Speak to the hand".

SRI and ESG Issues for Corporations: What the Press Talks About

2011-06-16T14:06:00.002Z

Presuming, a) that public opinion obliges corporations to respond and, b) that newspapers reflect and shape that opinion, the Trends in Sustainability website's online analysis tool tells us what is important these days. It does that by counting buzzwords and phrases in such newspapers as the Globe and Mail, the National Post, the Vancouver Sun, the Toronto Star and the Toronto Sun (but not any elsewhere in the country) day by day going back to 1990. It also contains the results for 110 other newspapers around the world. Take a look at the graph below I pulled up from the tool.

Human rights and Climate change are the hot topics, much dominating such issues as child labour, air pollution, poverty and biodiversity. Another take on this is through their other metric, which they call concepts, in which Sustainability is the tops in newsprint in Canada and around the world (including the USA), ahead of business ethics, governance and citizenship. It is also interesting to note that Canada leads the world average in such concern, or at least in writing about it! (though I must also note that Australia is even more interested in Climate Change and Sustainability than Canada) In any case, this more or less sets the corporate agenda in what to address, whether it is with mere words or with action.

WaterFurnace Renewable Energy Inc 1Q2011 Conference Call

2011-06-16T07:25:00.004Z

My investment pick (original analysis post here) of the environmental litter, WaterFurnace (WFI) finally issued (delayed by conversion to the IFRS accounting standard) its first quarter report covering the three months up to March 31, 2011 and held the conference call on the results.

Things, in a word, look rosy. President Huntington and Treasurer Andriano provided reasonable explanations and assurances that some quarterly report negatives are one-offs (like the extra taxes that really reduced profits), erring on the cautious side (the rise in warranty reserves despite better reliability of newer products) or taking advantage of an opportunity (the rise in inventories to get 2% price savings on input materials vs only 1.5% return on cash). The company also successfully (sales dollars are up) implemented a price increase to restore margins in the face of rising input costs.

More important for the long term is that despite the continued hapless state of the US residential market, WFI is making sales gains and solid profits. There was lots of talk of expansion in China through a joint venture, sales opportunity in new market segments from the Hyper Engineering acquisition, where they are hiring, and a renewal of sales increases in Canada after the promise of the Conservative government to renew the EcoEnergy retrofit subsidy program.

After the call, WFI's price went up in the broadly declining market yesterday, up to $21.50 (which is still way down from the $26 or so of last September when I bought some stock). Maybe speculators (or investors?) have taken a cue from the closing seconds of the call when Huntington said he was looking forward to a solid second quarter. Looking forward? The end of the second quarter is in two weeks!

I still have confidence in the long term worth of this company and still have my shares.

Investing Morally: ESG and SRI Ain't Easy or Simple

2011-06-14T09:00:00.006Z

"The BP disaster fits very well here. The company was ranked best-in-class by many socially responsible funds and indices such as FTSE4Good and the Dow Jones Sustainability Index. The disaster really highlights some of what the ESG industry is actually rewarding right now, which is the transparency and reporting found in glossy reports." Thomas George, Co-manager of the TD Sustainability Fund, quoted in Benefits and Pension Monitor, September 2010

"... bcIMC tried for a decade, if not more, to make changes at a macro level. We recently reduced our investment exposure to the Japanese market because we found there just did not seem to be an appetite or a willingness to bring fair and reasonable practices into its public equity market. ... That decision about Japan was very much a difficult one to make, but it was largely based on governance concerns." Susan Enefer, Manager of Shareholder Engagement, BC Investment Management Corporation in the same magazine issue

Not even the pros who specialize in SRI (Socially Responsible Investing) and ESG (Environmental, Social and Governance) find it easy it seems. The bottom line from the magazine roundtable's article is that making PRI and ESG a core part of the investment process is: a) in its infancy, but the way of the future, b) a worthwhile risk-reduction effort, c) successful only by digging below the surface stats.

As it happens, my SRI stock pick, Waterfurnace International (WFI), gets a middling rating on governance from the Clarkson Center for Business Ethics and Board Effectiveness of the U of Toronto Rotman School. WFI got only a 77 score out of a 100 in the small and medium company 2010 report. Its main deficiencies have to do with lack of a regular and formal process to assess the Board and its members, as well as too little Board member independence. There are always compromises. ...

Postal "Service" Canada - UK: Canada 1, UK 0

2011-06-11T09:42:00.002Z

It is always a frustrating and anxious time when sending international letters or parcels since even when a premium is paid for accelerated or tracked delivery, the system doesn't work on an end to end basis and it typically fails to meet the poor consumer's expectations or even indicated times on postal service websites. The attitude of each country's post office is that it did what it promised and the other one is at fault.

Today, I received a letter from Canada here in the UK. A registered letter, which is meant to be tracked and signed for on delivery. The standard is 4 to 7 business days. Oops, neither happened this time. Mailed on May 31st, it arrived June 11, which is at least 8 business days, or 9 if one considers that in the UK mail gets delivered Saturdays too. Worst, the registered letter was simply put through our front door mail slot. Though we were home at the time, we heard the letter being put through and the doorbell was not rung. Canada Posts tracking system says the item left Canada June 1st and arrived in the UK June 3 (did they fly via South America, or what?). After that, it disappeared for 8 days in the UK postal system till it arrived here. All that for a big premium on postage. I've had the same experience going the other direction, from the UK to Canada, with similar results of significantly slower delivery than promised. The item leaves the originating country quickly and then goes into some sort of slow delivery mode.

The Canadian postal strike just reinforces a negative impression.

CPP Opponent William Robson Spreads Bafflegab and FUD

2011-06-10T22:48:00.008Z

Today's commentary in the Financial Post by William Robson of the CD Howe Institute, CPP is a gamble, not a guarantee, attacks the CPP with bizarre arguments that indicate nothing about the CPP's riskiness, nor the merits of expanding the CPP.

Robson asserts that CPP proponents are going around claiming that the CPP is fully funded in the sense that all future obligations can be met with assets on hand, or alternatively that its promised benefit payments can be met at the current 9.9% contribution rate. Huh? One would have to be very ignorant of CPP not to know that the payments and contribution rates fundamentally and forever rely on a substantial continuing inflow of funds from current workers. The CPP will never be fully funded in the ultra-narrow, unrealistic sense that Robson defines as being invested only in real return bonds. It was not designed that way, it doesn't work that way and it would be stupid to do it that anyhow.

Whether one quibbles, as Robson does, about the use of the word guarantee, promised, targeted or anything else to refer to the likelihood future CPP payments will be met doesn't matter. What does matter is whether the whole CPP set-up as it is now structured, will be able to make those payments. Robson surely knows full well that the CPP gets regular health checks by the Chief Actuary of Canada. Go to the CPPIB website and read FAQ number one: "Canadians’ CPP pensions are not at risk and Canadians should not be concerned about their CPP pensions. In November 2010, the Chief Actuary of Canada reaffirmed through his triennial review that the CPP remains sustainable at the current contribution rate of 9.9% throughout the 75-year period of his report." Or, read for yourself the latest actuarial report here.

Robson says the CPP is a gamble because it relies significantly on investments across a whole range of asset types other than real return bonds to attain its required 4% real return. No private or public pension could or would ever follow an investment policy of exclusively RRBs, which Robson sets up as his acid test of riskless. Conversely, just about every pension plan invests with a mix of assets like the CPP. Besides, RRBs are only as good as the government backing them. It was not long ago that Canada's credit rating was in jeopardy. Now it's the turn of that other riskless asset, the US Treasury Bill to begin looking somewhat dodgy. So, strictly speaking, RRBs would be a gamble too. In an absolute sense, the CPP is a gamble, not a sure thing. But I'd say it's not a 50-50 gamble, more like 95+% chance of success. Robson must know that too and his use of the word gamble sure looks deliberately designed to overstate the risks of the CPP, i.e. intended to stop support of CPP expansion by spreading Fear, Uncertainty and Doubt (FUD) among FP readers.

One can infer some good news from this piece, however. If this is the best criticism CPP opponents can come up with, then CPP must be pretty good. Also, for it to be worthwhile to write and publish such an attempt to reduce CPP's public support, it must mean that CPP expansion is still being considered in the corridors of power.

Managing Financial Effects of Health in Retirement: 2) Narrowing Your Own Chances of Problems

2011-05-26T09:56:00.001Z

The figures in the previous post on health problems that could happen and their likelihood are averages for the population. Everybody's individual chances will be different partly based on genetics – ask yourself how many in your family have had the various ailments – and partly based on your lifestyle actions. You can tilt the odds in your own favour. The same kinds of factors that the life expectancy calculators use to estimate your lifespan will greatly influence your health while alive.

Diet – Eat fruits and vegetables. Eat foods with Omega-3 Fatty Acids (helps avoid Alzheimer's apparently). Eat fish and shellfish. Limit salt, caffeine (over 3 cups of coffee per day starts to do damage), high cholesterol and fatty foods. Drink some alcohol – 1 to 2 drinks per day – but taking more is to your detriment. Warning sign - being overweight, or even worse, obese with a Body Mass Index over 30. Oh, and remember to floss as it might keep a heart attack away, according to the Livingto100.com lifespan calculator.
Smoking – It's bad, there is no dividing line or upside. Smoking raises chances of cancer and stroke.
Friends and Family – Having regular social contacts, loving and being loved, obviously will improve emotional satisfaction with life but there is a spillover into physical health too. Keeping a pet dog or cat falls into this category as well.
Exercise – Nature-walking, mall-walking, golf, curling, tennis, treadmill, skiing, ballroom dancing, weights and, why not, sex. Take your pick, anything that requires muscle use, gets you moving, breathing a bit hard and the heart rate up helps bring about healthy life.
Brain Activity – Your brain is like your muscles. It needs regular workouts to stay in shape. Keeping your mind active can delay or avoid the onset of dementia. Reading books, blogs, magazines and better, trying to figure something out or learn something about whatever is of interest to you, will benefit your brain. Doing some sort of work, paid or volunteer, where there is responsibility and a sense of achievement, however small in the grand scheme of things, does wonders for the mind. It can also be a good social activity. On-going brain exercise may be a reason people with higher levels of education have lower incidence of dementia.

You can reduce health risks but the fact remains that you cannot eliminate them.

The next post in this series will look at the range of financial consequences of the various types of health problems, i.e. if you get cancer, have a stroke, or get Alzheimer's, what will it cost?

Managing Financial Effects of Health in Retirement: 1) What can happen and what are the odds?

2011-05-18T07:40:00.010Z

"Odds are you don't know what the odds are."

Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes

Health is a big concern to most people as they get older. The image of a decrepit, half-deaf, frail, confused person immobile in a wheel chair haunts us all. Such a prospect is scary, not only for the feeling that life will be joyless and empty but also for the financial implications. Will costs of care bankrupt us? Will we become a resented burden on family? Are financial products that can provide protection like critical illness insurance and long term care (LTC) insurance necessary or worth the cost? How should we go about deciding whether to buy them and what are the alternatives?

Most Seniors Will be Healthy During Old Age and Never Need Long Term Care
This is the encouraging news. People do not get to 65 or whatever retirement age and suddenly become wheelchair cases unable to take care of themselves. In fact, the 2011 OECD report Help Wanted? Providing and Paying for Long-Term Care contains a chart showing that only 2% of the Canadian population as of 2007 was receiving LTC. Most of them are women over 80.

In another study (in the Eight Conference on Health Survey Research Methods), Michael Wolfson and Geoff Rowe of Statistics Canada projected levels of disability in Canada for the year 2021. In the chart below, presented by Wolfson using that data in Projecting the Adequacy of Canadians' Retirement Incomes, the predominant light grey area in the centre is the population with no disability at all and the next area outwards from the middle are those with mild disability, moving through ever darker bands of moderate to severe disability to institutionalized. Note that at every age group moving upwards the vast majority of men and women will be generally healthy and able to enjoy life, even for people in their 80s and 90s. Even in the 90+ age group, only 43% are likely, according to this projection, find themselves moderately or worse disabled.

There is a very gradual increase in the amount of disability with age, but no sudden abyss of decrepitude. There is an increase nevertheless.

The Big 4 Old Age Health Problems
The things that will hurt most, both physically and financially, are:

Cancer – the biggie at 65, around double the rate of any other problem, hits 8.5% of women, 14.2% of men age 65
Heart attack and Bypass surgery – affects men more than twice as much as women
Stroke – tends to have long term consequences since 75% survive a first stroke and 60% are left with a disability according to Critical-Illness-Insurance.com citing the Heart and Stroke Foundation
Dementia (including Alzheimer's) – much more a woman's disease, it is already significant at 65, rises with age and really spikes upwards in older age, affecting 35% of those over 85. With people living longer and medical advances controlling chronic diseases better, dementia will become an ever greater issue for the Baby Boom generation. The 2010 report commissioned by the Alzheimer Society, Rising Tide: The Impact of Dementia in Canada, projects that the number of people living with dementia will rise from 1.5% of the population in 2008 to 2.8% in 2038. Of course, almost all of that increase will be amongst older people. The following graph from the report shows the huge spike upwards from age 80 that is expected to occur.

The next post will mention a few of the actions we can all take to reduce those odds to live healthier longer. After that, it's on to the the financial consequences of ill health during retirement and then the options for dealing with the financial risk, like various forms of insurance and whether they are worth it. Meantime, where the heck is the darn dental floss?

Working after Retirement Not a Government Conspiracy

2011-05-17T08:40:00.003Z

Those who observe the recent changes to the Canada Pension Plan rules which punish early retirement and reward later retirement, can be misled into thinking that the idea of working in retirement is somehow a bad thing, that it is a negation of the luxury of complete leisure that we have worked for throughout our lives.

Well, it ain't so. From a purely selfish point of view, working as long as you can is a good thing, even ignoring the money it can provide. We humans are happier and physically and mentally healthier when working.

Within Michael Wolfson's Projecting the Adequacy of Canadians' Retirement Incomes is the following table. Isn't it interesting that when people who are actually over 65 were asked the question what gave them the most satisfaction, work came out on top! That's right - ahead of all those activities people supposedly look forward to doing, like volunteering, dining out, clubs. Now some activities are curiously missing from the questions, such as travel and ahem, intimate activities, but it still confirms what I said before here and here about the merits of working in retirement.

Reading across the table, we can see that over 65s even enjoy work more than any other age group. Perhaps that has a lot to do with the fact that many people in retirement get the freedom and flexibility to do work they like and the hours they like.

It is certainly not all just working for the fun of it though. As Jonathan Chevreau's recent Financial Post article Full retirement a thing of the past noted, a good portion of working retirees need the money too.

Whatever way you slice it, working in retirement is good.

Bank Research Views on Inflation, Future Rates of Return and TSX Profits

2011-05-11T07:52:00.008Z

Grist for the planning / expectations mill:

Inflation - BMO Capital Markets Economic Research in the May 6 Focus on pages 5-6 weighs up likely changes to the Bank of Canada inflation targeting mechanism and 2% target and concludes that for now it will all remain the same, though in few years the BOC might move to a lower target since "CPI provides an upward biased measure of the true cost of living (because people tend to substitute lower- for higher-priced items and many new tech-type goods exhibit significant price decay)".
Future rates of return - TD Financial Group Economics in the March 17th An Economics Perspective On Long-Term Financial Returns estimates that a long term investor with a diversified portfolio could expect 5 to 7% returns (before inflation, which they estimate at around 2%) on average, with big swings above and below that year by year as the usual result of business and market cycles. The breakdown: T-bills 3.4%, Universe (whole of market) Bonds 4.0%, Canadian/US/International Developed Equities 7.5%. Emerging markets equities get a one-line comment - "the MSCI Emerging Market Index could deliver an annual return of 11% to 12%"
TSX profit margins - CIBC World Markets in the April 29th TSX Earnings: At the Margin figures that profit margins of companies on the TSX look strong overall in relation to the S&P 500 and their rising trend has some potential to advance yet more. Sectors differ considerably however, with a range of hot 20+% margins in metals and mining at the top of the table to woeful 2% margins in airlines and in machinery.

Canadian Pension Fund Asset Mix Evolution - Ideas for the Individual?

2011-05-10T13:35:00.010Z

The Pension Investment Association of Canada has a fascinating pull-down on its Publications page here that brings up the composite asset mix of its Canadian pension fund members for any year from 1990 to 2010. I've used it to compare the evolution from 1990 to 2000 to 2010. It tells an interesting story.

The Table
An asset class that wasn't there at all in the previous ten-years-ago period, or which has gone up, is shown in green while those going down are in yellow.

Fixed Income & Cash Down

from over 60% of the total mix, these two asset classes together now occupy less than a third of the portfolio; in fact, with a negative cash balance, it looks like pension funds are actually using borrowed funds aka leverage
is this because the pressure is on to gain higher returns now that the 20-year stock market boom of the 1980s and 1990s is long gone?
mortgages are passé, real return bonds and foreign bonds have replaced them

Equities Up, then Down with the Ascendancy of Non-Traditional Assets

hedge funds, private equity, infrastructure investments and other esoteric stuff are the new direction (fad?)

Real Estate Love-in Keeps Growing

the pension funds are now almost 10% in real estate; we can be comforted when we go shopping knowing that we are helping fund someone's pension, quite likely our own (even when in Scotland as I am a lot, where the CPPIB has half ownership of Silverburn near Glasgow ... note to fellow Canadians, it seems to busy all the time!)

Inflation-Protection Assets (Real Estate, Infrastructure, Real Return Bonds) Growing Too

we've had 15 years of 2% inflation so why would pension keep moving in that direction? ... I would guess because increasing longevity makes the long-term cumulative ravages of "low" 2% inflation a big factor for funds that aim to maintain their member retirees' standard of living

Foreign Equities Almost Double Canadian

probably that's due to the small overall size of the Canadian investing pond and the vast amounts of capital the pension funds need to deploy, along with the goal of diversification and the possible attractive returns in new markets, plus perhaps the fact that it is easier and easier to be a global investor

Ways to Apply this to an Individual Portfolio

Doug Cronk of the Institutional Investing for Individual Investors blog, who works for a pension fund and on whose site I found the link to the PIAC site, recommends an example portfolio, show here. It's missing real return bonds, available in ETFs such as ZRR and XRR or directly as individual bonds, also doesn't have any extra infrastructure per se (it is already within equities to some extent) and is much heavier on equities, but it is a good start.
Another view, from my other blog HowToInvestOnline, is How to Invest for Retirement Like a Pension Fund by Using ETFs, which suggests an ETF line-up modeled on the three biggest pension funds in Canada - the CPPIB, Ontario Teachers' Pension Plan and Ontario Municipal Employees Pension System.

Who Controls Financial Markets in Canada? Individual vs Institutional Investors

2011-05-05T13:03:00.008Z

Have you ever been annoyed at those breathless news reports on market moves? You know what they are - "investors today have been spooked/cheered by the quarterly inflation figures / credit crisis in Greece / nuclear incident / trade figures / royal wedding / hurricane / terrorist killing" etc (in fact, often it seems that the person writing the text merely attaches the market result, whatever it is, to the current headline news item of the day, good or bad. For those who believe that markets are random, the random association of events to ups and downs makes a certain sense I suppose.)

Anyhow, on reading these news reports, I find myself muttering that it wasn't me, I didn't do it! I have a portfolio apportioned amongst fixed percentages of various passive ETFs and I only trade when rebalancing, taking money out, or buying more. Even when I do trade, my amounts are so puny and I almost always place orders at market price, it cannot make a jot of difference to move markets up or down.

So who does have enough heft in the market to influence things, individual or institutional investors? Are there a few super-rich individual investors with enough money to manipulate things, or is it the mass of ordinary Canadians? Are the mainstream mutual funds the heavyweights or is it the pension funds? It seems to be really difficult to find out through simple Googling but here is what I found out, with admitted uncertainty through some of the guesstimation I've had to do. This is all 2009 data, which seems to be the most common recent data available. The grand total of financial assets in 2009 was $1713.3 billion. Here is the breakdown of who more or less controls or decides how to invest the money (as opposed to who it may belong to or for whose benefit it is being invested).

1) Pension Funds - $898.1 billion 52% share
This is only the top 102 funds - the 100 biggest from the Benefits Canada 2010 report plus the two biggest funds of all in Canada, the Caisse de dépôt et placement du Québec ($131.6 billion in net assets) and the Canada Pension Plan Investment Board ($105.5 billion). Interesting fact - these two plus the top 10 of the Benefits Canada list are all government or public servant plans and together they control about 1/3 of total financial assets in Canada. Reminds one of an old joke ... "what is the difference between capitalism and communism? ... capitalism is the exploitation of man by man while communism is the reverse".

2) Mutual Funds - $595.2 billion, 35% share
(source IFIC reports)

3) The Mega-Rich $140 billion and the Quite Rich guesstimate. $40 billion, combined 11% share
The Mega-Rich cutoff in 2009 was $1 billion for the 55 richest Canadians (see Wikipedia List of Canadians by net worth). For the Quite Rich I had to guess that the next 100, down to about $200 million in assets, might hold around $40 billion in total at an average $400 million each.

4) The Hoi Polloi (that's you and me the retail investor) - $40 billion, 2% share
I'm being optimistic here I think, assigning an average $1200 in directly held investments of stocks, bonds and ETFs (i.e. not owned within pensions or mutual funds) or so to each of the remaining 33 million Canadians. For comparison, consider that the total market value of Canadian ETFs in 2009 was $33.7 billion according to TMX Money.

Let's put a personal face on it. Today when the TSX go down or up we can point the finger at Michael Sabia (Caisse CEO), David Denison (CPPIB) or maybe Jim Leech (OTPP). One thing for sure, it wasn't me.

PS came across figures for the USA ... John Bogle said in the Wall Street Journal in Jan. 2010 that insititutional investors control 70% of US shares, with mutual funds 26%, private pension plans 11% and government pension plans 9%.

Conservative Election Majority: Three Implications for Personal Finance & Investing

2011-05-03T15:08:00.009Z

Yesterday's election results gave the Conservatives a majority. My take on three things that will (not) happen as a result:

CPP expansion is dead in the water. Pension "reform" will take the form of the PRPPs. The parliamentary majority that takes the pressure off, combined with the justification provided by opposition of some Provinces, and by "there is no problem" deniers allows the Government to say to the official opposition NDP that more urgent matters concern Canadians. Besides, the problem is not a pressing volatile crisis and will only manifest itself gradually.
Banks, insurance companies and financial companies are back on the profits bandwagon. They who benefit from the pension savings flows can rest easy and go back to making steady money. Some of these outfits, where the managers do not take all the money for themselves, will be good investments for individual investors. Corporate tax cuts will help too. (Disclosure: I own some shares directly & ETFs with those shares ... who doesn't in one way or another?)
TFSA doubling promises and other deficit-dependent promises won't happen (see several mentioned by Michael James). With a majority, the Conservatives are likely to relax and the economy / financial conditions are not likely to force its hand on deficit-elimination like it did during the (in)famous 1990s when Chretien and Martin did the job that has made Canada's fiscal life good since then. The bureaucrats are more likely to convince the Conservatives those measures would be too expensive anyhow.

CPP "Diseconomies of Scale" Study by Fraser Institute - Spreading FUD

2011-04-27T15:06:00.015Z

FUD, for those unfamiliar with the acronym, stand for Fear, Uncertainty and Doubt. It is a familiar marketing technique to make people doubt and prevent them doing something. In this case, the Fraser Institute is applying FUD against the idea of expanding the Canada Pension Plan.

The FUD is found in Should the Canada Pension Plan be Enhanced? by Neil Mohindra, published and downloadable on the Fraser website here. The Fraser summary blurb says:
"The study concludes that diseconomies of scale present a risk to the CPPIB’s investment performance. The actions that the CPPIB is taking to offset diseconomies of scale in investment returns will likely become less effective as its assets continue to grow."

The first sentence is true, the Mohindra study does arrive at that conclusion. The problem is that neither the research it presents, nor other facts, support the statement in anything more than the sophistical (as in sophistry = plausible but fallacious argumentation) sense - yes, if diseconomies of scale do arise, then there is a risk, although not a certainty, that the CPPIB's investment performance will suffer. Mohindra delves into a series of research papers that address aspects of diseconomies of scale/size associated with investment funds and pension funds. Here is why I think we can dismiss the alarmist rhetoric of the Fraser report:

If diseconomies of scale were inevitable, the CPPIB would have hit the wall long ago. As Mohindra belatedly notes, "A limitation in applying existing literature on economies and diseconomies of scale to the CPPIB is the sheer size of the CPPIB in comparison to the size of funds covered in the literature." The CPPIB years ago had assets that dwarfed any funds in the literature. Why did CPPIB not exhibit diseconomies of scale long ago? The rise in costs that Mohindra documents about the CPP/CPPIB has become apparent only in the last two years (look at his table A1 on page 34).That rise has less to do with scale than other reasons.
The higher admin/expense numbers of the CPPIB can just as plausibly be interpreted as temporary, a result of the financial crisis and markets' recovery process combined with the investment mix of the CPPIB. It all hinges on the considerable amount of private equity, real estate and infrastructure investments that the CPPIB has deliberately made since 2006. While stocks on public markets such as the TSX rebounded sharply in 2009, the other stuff has lagged and the higher overheads that go with those other types of investments has driven up those costs as a percentage of assets. It's possible the CPPIB may be fundamentally wrong about investing in such other assets (along with many other pension plans out there, like the Alberta Teachers' Retirement Fund Board whose 2010 annual report announces that it has switched its investment policy to go in that direction). However, the explicit aim of the CPPIB is that such assets present the opportunity to gain higher returns that more than offset the higher fees. It is ironic that Mohindra quotes a speech by CPPIB CEO David Denison where Denison sets out a vision for using scale as a competitive advantage. If scale is a reality, I think I prefer the "glass half full" view (opportunity) from the CPPIB over the "glass half empty" picture (diseconomies) of the Fraser Institute.
The pursuit of private equity, real estate and infrastructure by the CPPIB, rather than being a symptom of incipient diseconomies as Mohindra claims, is in fact the appropriate response and strategy to keep costs low and maintain superior risk-reward results. One of the studies cited by Mohindra, that of Dyck and Pomorski confirms that the CPPIB is following the successful path of other large funds: "In their private equity and real estate investments large plans have both lower costs and higher gross returns, yielding up to 6% per year improvement in net returns." Furthermore, most of the increase in operating expenses of the CPPIB during 2009 and 2010 came from the ramping up of internal management capability to replace external managers, another factor that Dyck and Pomorski say is a significant source of cost savings for bigger plans. It looks more like like CPPIB is on the road to exploiting increasing economies of scale, not butting up against diseconomies.
Governance matters a lot more than scale. Small organizations can be poorly run as easily as big ones. A much more convincing explanation of what determines the success of a pension/investment fund comes from Keith Ambachtsheer of the Rotman International Centre for Pension Management. Pension organizations properly aligned with the interests of the pension benficiaries, proper definition of roles between a board and professional management, appointment of financially knowledgeable and independent individuals to boards, effective risk management processes - those are what get good results.
The CPP's overheads, if they were to stay at current total all-in levels of about 1% (total operating expenses in 2010 of $498 million Government of Canada plus $236 million CPPIB plus $466 million in external investment management fees on average CPP total assets of $120,721 million per Volume 1 of the Public Accounts of Canada with CPP data starting page 171 of the pdf), or even rise further, are still small compared to the all-in costs of alternatives, like TFSAs and RRSPs. Start adding up the costs of mutual funds where most people place their retirement investments, or even of the best case lowest fee ETFs around, then add fees like deregistration/withdrawal fees from RRIFs, or the implicit charges when buying an annuity to turn the savings into retirement income (read Peter Benedek's series on annuities on this page of his RetirementAction website to see how poor a deal they are). The average person will be losing more in various costs than 1%. This ignores the "costs" from investing mistakes that so many people make along the way when left to do it themselves in TFSAs and RRSPs.

Instead of concluding that "the size of the assets the CPPIB will be managing even without expansion shows that diseconomies of scale is a reason not to expand CPP", Mohindra would be more accurate in saying that "the opportunity to exploit economies of scale is a reason to expand CPP".

The large size of the CPPIB portfolio is NOT a problem. As long as CPPIB governance and management continues to be good, the move into private equity, real estate and infrastructure provides opportunity, not rising risk. In the 2006 speech quoted by Mohindra, CPPIB CEO David Denison also mentioned that the size of private market opportunities is vastly larger than those in public stock markets. It is a good thing for CPPIB and for Canadians who have their money being invested there by the CPPIB.

Review and Ratings of Canadian Online Tax Software: 2010 Taxes Edition

2011-04-08T14:33:00.024Z

It's here again! For the 5th year running, these are my ratings and assessments of the best and the worst of the online tax preparation programs available to Canadian taxpayers for 2010 tax returns. As before, I've gone through all the packages certified by the Canada Revenue Agency for electronic submission of a return through NETFILE. The same ratings method has been used but the results are a bit different. Some packages are better, some just the same as last year and there's one new entrant.

Ratings Method: total score out of 45 max points on 5 factors

Privacy and security (10 points) - How well does the online tax prep company protect your data and your privacy? What do they promise and what evidence is there of their capability to deliver? Unfortunately, this is the weakest area of the ratings - my numbers could be fairly wide of the mark - since it is hard to get much tangible proof of the reality vs the promises made, even compared to the minimal promises as are publicly made on the websites. Only one company (Acetax) actually claims to have been audited by an external party. CRA does not do anything, as they woefully admit in the disclaimer on the webpage with the list of packages, to check up on the companies and how they handle our data, which I think is shocking and unacceptable, given that a lot of people likely believe that NetFile certification somehow gives assurance of security protection.
Flow, readability and layout (10 points) - How does the appearance and the flow of the program guide the taxpayer through all the steps, ensuring that everything is entered correctly in the right places? Is it easy to go back and forth, to review results and check one's work or make changes? The programs vary enormously on this factor, from simple on-screen versions of the paper forms, which merely do the arithmetic correctly and transfer amounts (or are supposed to!) between forms, to sophisticated interview processes akin to interaction with an accountant, asking questions to uncover all income and deductions and credits.
Help (10 points) - How much access to explanations about tax rules is provided and how well placed is it? One of my on-going pet peeve test items is the infamous T1135 Foreign Income Verification Statement which a taxpayer with foreign property over $100,000 in cost must fill in, sign and send in to CRA. Does the program tell you, ideally at the point when you have to tick that box, that it is not required for foreign holdings within registered accounts like RRSPs? Some do not say so and others do not say that the T1135, if required, cannot be done online and that it must be submitted by mail on paper.
Responsiveness (5 points) - How fast is the online application at saving data and refreshing the screen? slow = frustration! A couple of programs either went haywire on me or were unavailable for login - not good if you are in the final throes of meeting the April 30th deadline.
Accuracy (10 points) - How good a job does the program do at calculating your taxes and helping you legally pay the least amount? For those who think that NetFile certification means the programs will all come up with the same answer (as I believed myself before starting to look at all these packages a few years ago), it is time to recognize the reality. As I commented two years ago, CRA's certification only means the program is correctly including all the revenues. the programs differ enormously in their ability to automatically detect and claim all deductions and credits to which you are entitled. As a result, in my own case with all the packages my total income on line 150 was identical but balance owing on line 485 showed different amounts, anywhere from a few dollars to a few thousand dollars apart. In the cases where I had thousands less to pay this was the result of incorrect eligibility for deductions that the programs did not prevent. It is only because I used them all that I got to learn what should be the correct result. Some are much better than others at preventing incorrect input but it is always worth the time to use a couple of the programs to enter your data and compare the results. They all allow you to see the bottom line in much detail, if not actually to print or submit the completed return. The very best package (TaxChopper) at using deductions and credits for an individual and/or shared amongst family members is almost like having a skilled accountant doing your taxes - it is essentially an expert system for income tax. Three examples tested the packages' ability to optimize using age amounts and pension splitting, tuition and education transfers, foreign tax credits with inter-provincial residence thrown in for the trickiest rule. In no case did any other package beat TaxChopper - it always found deductions, transfers and credits to use and end up with the lowest taxes to pay. The difference on a potential $4700 tax bill was over $300. Optimization can be very worthwhile.

Rankings:

Highly Recommended
#1 TaxChopper - 39 points -
"A tax expert system – Delivers on the biggest refund / lowest tax to pay promise. Best value for money."
Alone in first place this year by dint of considerably beefed up help and continued clean-up of appearance and language.

#2 UFile - 38 points
"Polished, easy to use and handles all but the more sophisticated tax reduction optimizations"

Recommended
#3 H&R Block - 34 points
"Technically, it's Ufile but it has a few less desirable privacy features"

#4 TurboTax (formerly QuickTax) - 33 points
"Guidance every step of the way with plenty of questions, reminders and some useful suggestions for future tax planning"

#5 AceTax - 29 points
"Just fine for those who need minimal help and are familiar with tax forms"

#6 eTaxCanada - 26 points
"Takes some getting used to but if you know what you are doing and which forms to use, works very well"

#7 Taxnic - 25 points
"OK package if you know what forms to fill and credits to claim. What CRA would give us if they created a NetFile package – no error checking or optimization, just the forms and correct transfer of amounts from box to box and form to form."

#8 WebTax4U - 24 points
"For those who know where things go and are familiar with tax forms"

Merely OK
#9 MBOTax - 20 points
"It's like working with the paper forms except amounts get transferred automatically and arithmetic is done correctly."

#10 EachTax - 18 points
"Looks like the forms. Not much more than a spreadsheet with colours."

Not Recommended
#11 (tie) - FileTaxOnline - 13 points
"Not recommended – too many weaknesses, some fatal"

#11 (tie) - EasyCTax - 13 points
"Chinese language version is unique on the market but not a lot else going for it. New entrant, looks like beta version."

#13 5DollarTax - 2 points
"Crude, half-finished effort, not worth using."

One Investor's Wish List for the Canadian Election

2011-04-01T15:36:00.004Z

Rob Carrick of the Globe and Mail published his wish list to politicians in the current Canadian election, so here is mine.

Expand the CPP by increasing pensionable earnings limits and raising contribution rates to target a 40% income replacement rate. If I could only get one wish, this is it. It is the best solution by far for what retirees need and in comparison to present alternatives or to the proposed PRPPs.
Triple the annual TFSA contribution limit ... ok, I'll compromise with doubling it. It is a simple, understandable, effective multi-purpose account but the $5000 is too little.
Start selling Real Return 1-5 year maturity Canada Savings Bonds as I wrote about here. Retirees without inflation-indexed DB pensions need them. That might reverse what the Globe recently described as their "long slow death".

Tax Shocker? Rich Pay More than Their Fair Share in Canada

2011-03-23T18:11:00.004Z

It will no doubt come as an interesting discussion point for those both on the right and the left of the political scene to learn that Canada is right up there near the top of countries in terms of taxing the highest income earners! Canada is far above the OECD average, trailing only four countries in the OECD. Now the ideological left can shorten the slogan for the upcoming federal election - "make the rich pay their fair share" can become simply "make the rich pay".

The USA, surprise, surprise, is the country that taxes its rich the most, repeat the MOST. And the country that has been given the image of socialist paradise, Sweden, only taxes the rich their fair share. Poland and Switzerland are refuges for big earners - they tax the least.

This comes from the Tax Foundation website's No Country Leans on Upper-Income Households as Much as the U.S. The place I found this, William M. Briggs, has a neat graph, where Canada hides under the Czech Republic.

Budget Restoration of EcoENERGY Program - Good and Bad

2011-03-23T08:43:00.006Z

Yesterday's federal budget restored the popular EcoENERGY home retrofit program, though the government's heart really isn't in it (apparently this is a sop to bribe, oops, accommodate a demand of, the NDP) since the funding of $400 million is only for the 2011-12 fiscal year.

The temporary short extension of the program is bad but at least the program itself is good for homeowners. Home energy efficiency investment is a one-time cash outflow that replaces future constant regular cash outflow on energy bills. It provides permanent inflation protection against energy price rises (see my original post on my friend's actual geothermal home installation for the financials of his situation). For the retiree especially, a cash flow saving that automatically exactly matches inflation on an essential living expense is a great boon. Consider the difficulty of trying to find an investment that even gets close to doing that.

This budget item is also a good thing for investors (of which I am one) in WaterFurnace Renewable Energy (TSX: WFI), a manufacturer of EcoENERGY-eligible ground source home heating and cooling systems whose Canadian sales dropped 14.3% in 2010 per the annual report after the EcoENERGY program was allowed to lapse last year. For a year at least, WFI's Canadian sales should get a boost, though they are at such a low proportion (12.7% in 2010) of WFI's total sales, that won't make a huge difference.

Map of Inflation around the World

2011-03-18T09:12:00.001Z

The Globe and Mail recently published a neat map of inflation in major world economies. Though Canada and the USA still have relatively benign inflation, it is not so elsewhere. When our currency stops appreciating (see RatesFX 1-year chart for CAD), can we be far behind?

Waterfurnace Renewable Energy YE2010 - Trudging Along

2011-03-17T05:33:00.002Z

The 2010 annual report and conference call (on Newswire.ca) for WaterFurnace Renewable Energy (TSX: WFI) are now available. What do they tell us (I do own some) shareholders?

The financial results bring no great surprises. Earnings in the last quarter followed the trend of 2010, being down from 2009, which itself was down from 2008. Sales went up a bit, at much lower profitability, as the company only in late 2010 implemented a price increase to try to recoup some of the input price rises, notably copper.

The company has continued its fairly dramatic shift away from the moribund new US residential housing market to the residential replacement and commercial sectors.

Strangely, given the big drop announced today in US housing starts (to 480k in February from 620k the month before and the analyst forecast of 580k) the tone from management on the conference call (yesterday) was quite positive. They said they expect an upside of 15 to 20% in 2011 from residential new construction.

Apart from the upside uncertainty of housing starts, the major downside risk is that US government cost-cutting may remove the 30% tax credit for geothermal home installation that is supposedly in place till 2016. Management said they feel the tax credit is relatively secure based on their lobbying contact with lawmakers.

Another upside uncertainty that would increase the financial attractiveness of geothermal is how much, if at all, natural gas prices will go up.

The acquisition of Hyper Engineering sounds like a reasonable move. Its technology for limiting the inrush current on startup of electric motors can both be integrated into its own products and continue to be sold, even expanded, as a separate business. WFI managers even said that Hyper is a profitable business right now.

Due to the removal of the federal retrofit rebate program, Canadian sales kept falling through 2010 (now under 15% of total sales) and according to WFI management, have now hit a solid bottom. Some provinces continue to support geothermal for residential.

WFI continues to fly under the radar - only two analysts, one for CIBC and another whose affiliation wasn't stated - took part in the conference call.

One of the Board directors, Thomas Dawson, even bought 100 shares in February at $25.25. There have been no sales by insiders for over 12 months so that is positive.

All in all, maybe things will get better in 2011 as WFI management expects, but at worst it is still a waiting game, perhaps another year or two before growth resumes. Other investors in the last two days seem to like the results - the stock is back up over $26. I am comfortable holding onto my WFI shares.

LSE-TSX Merger - FAIR Makes a Sensible Suggestion to Help Investors

2011-03-16T11:35:00.002Z

Amongst all the confused and confusing commentary, it is a relief to read a sensible suggestion by FAIR Canada that the merger of the LSE and the TSX be taken as an opportunity to change the regulatory side of the TSX market's operation, a move that would help protect investors a bit better.

FAIR Canada says the TSX's responsibility to set and to police the listings requirements should be moved to an arms-length body (like IIROC) away from where it is now, within the TSX itself in the same group that goes out soliciting listings by companies. That would avoid the obvious conflict of interest and danger that the pursuit of listings and the associated revenue for the TSX might be done at the cost of too-loose control of listing conditions.

The second aspect of listing rules is that the merged LSE-TSX would have to decide how to deal with listing rules - e.g. whether to keep them separate or come up with a single aligned set. Making a single set of stronger/better rules would be a welcome development. The Globe and Mail's In a TMX/LSE merger, whose rules apply? by Dave Milstead explains some examples of differing LSE vs TSX rules.

Looking on the positive side, instead of the prevalent negative blather that seems to predominate these days, the merger is a good opportunity to fix existing TSX deficiencies in a way that helps investors in Canada.

TSX Market Darlings & Dogs in March 2011

2011-03-15T15:37:00.005Z

It is always worthwhile to compare the iShares TSX S&P 60 Index ETF (XIU) with Claymore Canada's Fundamental Index (CRQ). CRQ selects and weights its constituents according to historical accounting data while XIU does so based on the market value of companies. As such, the comparison tells us which sectors are popular and where the market expects future excess profitability and growth will come from - i.e. when XIU has more weight in a company or sector than CRQ.

Here's what my comparison table below tells me:

Dogs (in Red on the table): Financials are still unpopular (less weight in XIU than CRQ) as a sector and across the board company by company with one exception, the Royal Bank, whose weight in XIU is slightly more than in CRQ. CRQ's 13.5% greater weighting than XIU in Financials and its overall weighting of 45% in that sector makes it extremely dependent on it. Incredibly, CRQ's Financial weighting has even increased since my last comparison. Inklings of popularity amongst banks and insurance companies are beginning to glimmer as most of them have gone up slightly in their weight within XIU from last August to today. Even Manulife and Sunlife, though still way less weighted in XIU than CRQ, have become less doggy i.e. have gained a little ground within XIU.
Darlings (in Green, naturally): Energy (as in petroleum) has not only maintained its popularity, it is continuing to rise in XIU, both relative to CRQ, where it was already a heftier component, and to past August within XIU. The biggies are Suncor, Canadian Natural Resources and Cenovus and they have all gotten bigger. They must be making more money than other sectors since they have gone up within CRQ too.
Waning Darlings: The Materials sector is still a grossly over-weight in XIU compared to CRQ but some slimming has occurred. Gold companies Barrick Gold and Goldcorp both lost ground as did Potash Corp of Saskatechewan. By the end of the day, uranium producer Cameco (CCO) (not shown on the table as it is too low down the list) might be considerably less as a proportion of XIU (it is down c. 6% as of 11:30am). CRQ has less to lose that way as Cameco is only have the size within CRQ as it is within XIU.
CRQ's sector weightings have evolved much more slowly than in XIU. None of CRQ's sectors has changed as much as the 1.5% increase in Energy's weight, or Materials' 1.2% drop, in XIU. Accounting profits, sales and the like do not change as rapidly as market expectations, or should I say, today, market panic.

Inflation Control Debate Underway in Canada: Why We Need to Pay Attention

2011-03-09T12:04:00.010Z

Inflation is one of those things where most often the best a citizen or investor can do is not lose ground. Whether it is a salary that does not keep up with rising expenses (just today, Canadian Capitalist was justifiably moaning about huge increases in home insurance premiums) or GIC rates that do not compensate for inflation even before taxes, we always seem to be one step behind or losing ground. The problem is especially acute for retired people where normal annuities are not indexed and a pot of money must suffice for ever longer life expectancy.

That there should be inflation is government policy. The target, characterized as "low inflation", is currently at 2% and allowed to vary within a 1 to 3% range according to the organization mandated to make sure that happens, the Bank of Canada.

Right now, the debate about how much inflation is to be created or allowed is wide open. The reason is that the five-year agreement between the federal Minister of Finance and the Bank of Canada on the target and the system to measure or control inflation expires at the end of 2011.

The most visible part of the debate, though no doubt there is lots going on behind closed doors at the Bank of Canada and the Ministry of Finance, and invisible to us ordinary schmucks, seems to be emanating from the CD Howe Institute in a series of reports. The main issues and/or suggestions include whether to:

lower the target rate for CPI increases from 2% to 1.5%, 1.4% or even 1%, about which I ask, why not a zero percent inflation target?
replace inflation targeting, which we have now, with price level targeting; "The key distinguishing feature of price- level targeting is that shocks pushing the price level off its intended growth path must be recouped, meaning that a temporary rise in inflation above 2 percent must at some point be offset by future inflation of less than 2 percent. In contrast, with inflation targeting, the same positive inflation shock is subsequently reversed, but not recouped: for the price level, bygones are bygones." (from Precision Targeting: The Economics – and Politics – of Improving Canada’s Inflation-Targeting Framework by Christopher Ragan at CD Howe). In other words, with price level targeting, we don't have a permanent loss of purchasing power that we somehow have to try to recoup on our own under inflation targeting. Why not let the Bank of Canada do the job for everyone through price level targeting?
mandate the Bank of Canada to include control of asset price bubbles as one of its objectives in setting monetary policy. That goal does not form part of its mandate right now. Why not have the BOC prevent asset bubbles? In the last ten years we've had the painful High-Tech stock bubble and the USA/European housing bubble. Though the housing bubble that caused the 2008 crash wasn't in Canada and thus would not have spurred BOC action, would not such a policy be worth it for all central banks? Would it not have been less painful to avoid the big crashes? No doubt there would be costs and possible downsides but maybe they are less than the damage of recurring asset crashes. Authors like Robert Barbera in The Cost of Capitalism (my review here) make a reasonable case for central bank control of bubbles.

Do a Google search of the phrase "too important to be left to the experts" and you will find it popping up in any number of contexts - health care, finance, biotechnology, war, science and in general. If we don't say something, inflation will surely be done to us for "our own good" though we may not like the result.

Book Review: The Power of Passive Investing by Richard Ferri

2011-03-07T12:03:00.011Z

If ever there was any question or hope that a person could succeed in beating market returns (or their fund equivalent, market-cap weighted low-fee index funds) through investing in actively managed mutual funds, this book utterly destroys the notion. In The Power of Passive Investing author Richard Ferri presents piles of research results that slice and dice the data backwards and forwards, inside and out, upside and down. Whether it is high- or low-fee funds, past-winners, before- or after-tax, bond or equity funds, foreign or domestic investments, large funds or small, portfolios of funds, manager qualifications, Morningstar ratings, risk-adjustment that is used to select a mutual fund, none of it works better than cap-weighted index funds.

Worse, Ferri gives us the disquieting evidence that individual mutual fund investors get significantly poorer returns than even the average under-performing mutual fund because of bad trade timing.

It is thus difficult to dispute the practicality of his advice that individuals should buy passive index funds and focus their efforts instead on an asset allocation, matched with long term goals and personal circumstances (emotional strength aka risk aversion, age, wealth, job, health etc), that should change infrequently - only when the goals and circumstances do.

Ferri says it is not just individual investors who will be better off following that strategy. He makes an argument that charities, personal trusts, pension funds (especially small ones) and financial advisors should do the same to best carry out their responsibilities.

The referencing, presentation, writing style, grammar, diction and organization of the book is thankfully up to snuff (much better than another of his books that I reviewed).

That's the good stuff. Here is what I didn't like.

1) The big one:
Dismissal of active management and fundamental indexing - Showing that actively-managed mutual funds are, on average, losers, does not mean that active management, the seeking of "alpha", cannot ever work. Ferri indirectly and inadvertently (I think) recognizes such when he quotes (p.149) famed Yale University endowment manager David Swensen: "Low cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high quality active management decisions". Or, on page 112, "Most of the great managers aren't for hire by the general public. The truly talented managers like to fly under the radar ... ". Or, again, on page 128 where he discusses where the dumb-money investors' money goes: "Much of it went to brokers, brokerage firms, and their trading desks. Another portion went to a handful of talented money managers who skillfully separate investors from their money". (my bolding)

He might admit that such managers really do exist (eg. Warren Buffett isn't just on a long lucky streak) but in effect says that we small-fry investors cannot tell them apart. Perhaps with active mutual funds that is so, but is it true with fundamental indexing, which he summarily dismisses on pages 75-76 with a stream of invective instead of looking at evidence? The historical performance evidence, along with the theoretical dissection of why fundamental indexing makes sense, presented most notably by Robert Arnott (whose book The Fundamental Index I reviewed here) deserves more attention than that from a smart guy like Ferri. The fact that some high-powered and neutral researchers like the EDHEC Risk Institute have effectively been trashing the value of market cap-weighted indexes for practical and theoretical reasons, suggests strongly that we, including Ferri, need to pay attention to this particular innovation, especially when it comes offered in reasonably low cost funds. The big question is whether the higher fees or tracking error of such funds (e.g. the US equity ETF from PowerShares PXF's 0.39% MER vs the classic S&P 500 ETF SPY's 0.0945%) offsets any alpha they might generate. That question is why I have the little practical side-by-side experiment going at the bottom of this blog (so far, fundamental is winning).

2) Minor annoyances:

the mysterious 1:2 winner to loser ratio - all through the dismemberment of mutual fund performance, Ferri keeps emphasizing that the ratio of winners to losing funds in various studies settles around 1:2 (except even more mysteriously, that the bond fund ratio is even worse at 1:4), but he never explains why. There must be a Dan Brown novel in this!
the big-5 lifetime financial liabilities in chapter 10 misses health costs - especially in the USA, and less so in Canada, health care costs, most likely in retirement, need to be a prime financial factor to be dealt with somehow
the suggestion that it is too difficult to implement passive investing on one's own (page 191 chapter summary) - "The mechanics for prudent asset allocation and investment selection are more involved than how they are presented in this book. More reading is required to a portfolio is much easier said than done. Do-it-yourself investors often do not complete the process or maintain it well." Ok, here goes: US investor - 50% VTI (or PXF), 50% AGG; Canadian investor - 50% XIC (or CRQ), 50% XBB. Rebalance annually, or never, if you are really lazy. Add money by topping up the one below 50%. Withdraw money by selling off the one over 50%. Is that simple enough? It's only a good enough, not nearly optimal solution, but it should be possible for anyone to follow.

In short, this is a very good book with one significant flaw that is more of a missed opportunity than a damaging omission, as individual investors would not go wrong following the author's advice.

My rating: 4 out of 5 stars.

Disclosure: Thanks to the author's firm Portfolio Solutions for providing a free review copy.

Perils of Procrastination - Missed Stock Opportunity

2011-03-02T10:40:00.003Z

Looks like I missed the boat from delaying looking at two companies suggested by a commenter on a post about Waterfurnace Renewable Energy's (TSX: WFI). "Anonymous", also a WFI shareholder, had asked whether I had looked at Computer Modelling Group (TSX: CMG) and 5N Plus (TSX: VNP). Prices of both companies are up considerably since that post. 5N has just announced an acquisition per this GlobeInvestor article, boosting its price 17% in a couple of days, which brings it to c. plus 50% since my post! CMG is up over 40% since October! Got any more stock analysis suggestions, Anon?

WFI has its conference call March 15 and full year results release March 14, which I will be reviewing. The company has already authorized and paid the quarterly dividend at the same rate as the previous one. I'm not expecting much sales or profit rises given the continuing bad state of the US housing market. The rise in energy prices is making the value proposition of its product - geothermal heating - increasingly attractive, however.

Global Investment Returns Yearbook 2011 from Credit Suisse

2011-03-01T10:05:00.015Z

The 2011 edition of the Credit Suisse Global Investment Returns Yearbook is out ( free download here). It is again full of fascinating material that gives a long term (111 years of data from 1900 to 2010) perspective on investment returns of stocks and bonds across 19 countries, including Canada, which again looks rather good compared to just about anywhere else. It also has three excellent topical articles, two by principal authors / data compilers Elroy Dimson, Paul Marsh and Mike Staunton, and one by Credit Suisse analysts David Holland and Bryant Matthews. These are my highlights:

Stock-Bond Drawdown Extremes, Correlations and Inflation Impact

Equities outperform bonds over the long run ... "Yet that superiority [of equities] has been dented by the striking performance of bonds over intervals that exceed the investment horizon of most individuals and institutions." e.g. 1980 to 2010 (31 years)
"Historically, bond market drawdowns have been larger and/or longer than for equities. ... UK government bonds were underwater, in real terms, for 47 years until December 1993. While bonds appeared less risky in nominal terms, it is clear that their real value can be destroyed by inflation" [Drawdown = the difference between the portfolio’s value on a particular date and its high-water mark] Look at figure 2 (USA) or 3 (UK) for visual proof of how unsafe bonds can be.
The drawdown of a portfolio 50% stock 50% bond portfolio has been much less pronounced and much briefer - see figure 4 - i.e. a balanced portfolio really reduces risk.
Correlations between stocks and bonds have been negative for the last few years. That has been great for diversification in regularly rebalanced portfolios but the correlation is likely to rise so the risk reduction effect won't be as strong.
The past decade has been brutal for equities. Here is what they write about the US, which is more or less the case for every country: "After the tech-bubble burst in March 2000, equity prices also collapsed and, by October 2002, the real equity index was down in nominal terms by 48%, and in real terms by 52%. While the nominal recovery took only 47 months, in real terms the market remains underwater to this day."
"It is sheer fantasy to expect bond performance to match the period since 1982. Yet expecting bond returns to be lower than in the golden era is not the same as asserting they will enter a protracted period of negative performance." Bond returns might simply remain low but positive.
High inflation is to be feared. All sorts of bad things happen - bond prices have their worst drawdowns. Stocks experience big losses too. And the correlation between stocks and bonds increases, lessening the risk reduction achievable from diversification.
Real returns on bonds are higher [not lower, as one might think] in high inflation countries but they find that only reflects greater risk in the form of volatility and uncertainty

Dividends and Dividend Yield Investing

"... long-term returns are heavily influenced by reinvested dividends ... the total return from US equities, including reinvested dividends, grows cumulatively ever larger than the capital appreciation ... the longer the investment horizon, the more important is dividend income. For the seriously long-term investor, the value of a portfolio corresponds closely to the present value of dividends"
"... historically, investment strategies tilted towards higher-yielding stocks have generally proved profitable ..."
Stocks with high dividend yields provide higher returns, even after adjustment for risk: "... an equity investment strategy tilted towards higher-yielding markets would have paid off handsomely"
"... our research indicates that portfolios of higher-yielding stocks (and countries) have actually proved less risky than an equivalent investment in lower-yielding growth stocks". They lay out the long term evidence for 21 countries in the chart below which plots the risk-adjusted return metric known as the Sharpe ratio compared to high- vs low-yielding stocks. It sure looks like investing in high dividend stocks pays off. It also looks like investing in no-dividend stocks will greatly under-perform.
Similarly, investing in countries with high dividend yields e.g. through a market index, has paid off handsomely. "... the high-yielding countries outperformed the low-yielding countries by an appreciable margin. The results are not therefore period-specific. Nor are they attributable to risk."
However! "... there can be extended periods when the yield premium goes into reverse and low-yielders outperform ... there have been extended periods when even the rolling five-year premium has remained negative. These include the early 1980s, much of the 1990s, and the present time"

Expected Future Equity Returns
Holland and Matthews use a model to assess what current market expectations are for future equity returns of industrial firms based on analyst forecasts of future cash flows.

As of mid-January 2011, the required rate of return on industrials in the USA was at 5.1%, which is less than the historical median of 5.8%, implying a market where investors are willing to take on risk. The current figure is just at the dividing line they label overheated. But the premium of equity to Treasuries, the equity risk premium (ERP), is still attractive, so stocks looks good in that sense. "We would caution bullish investors that the risk premium will only stay high so long as Treasury yields remain low. A robust global recovery would stoke inflation and long-term Treasury yields."
"We estimate the ERP for key regions in Figure 6, and see that the ERP for developed markets is far more attractive than the ERP for developing markets. This prompts the question of whether equity investors will be compensated for the extra risk they are taking in developing markets."

Canada

Canada has been one of the best countries in the world to invest in over the past 111 years. "Canadian equities have performed well over the long run,
with a real return of 5.9% per year. The real return on bonds has been 2.1% per year." On equities returns, that ranks it behind only Australia (7.4%), South Africa (7.3%), Sweden (6.3%) and the USA (6.3%) amongst the 19 countries listed. Resource-rich countries have done well.
It seems to continue to be a good place to invest - falling in the middle of the over/under heated charts (see Figure 5 on page 29)
Canada's stock market was the world's 4th largest as of the end of 2010. I wonder if Bloomberg will ever notice and start displaying the TSX on its TV channel streamers.

Portfolio Cap-Weight vs Fundamental Test and Monthly ETF Distributions

2011-02-26T00:31:00.007Z

The portfolio contest between traditional Cap-Weight and Fundamental Weight Index ETFs has become a little more tedious to track manually with the switch by both BMO and iShares to more frequent monthly instead of former quarterly distributions on more ETFs.

It also undermines one of BMO's advantages compared to iShares, namely the automatic, free DRIP program since now much smaller amounts are being distributed monthly, which in many cases won't be enough to buy whole shares. Even with a $100k portfolio, the January and February amounts for ZRE are not enough to buy even one share. Since for ZRR both portfolios have the same holding it won't any difference between them. Therefore, I will simply accumulate the cash for both portfolios until rebalancing at the annual anniversary date in mid July presents an opportunity to re-invest it. The spreadsheet at the bottom of the blog now includes the cash for both January and February distributions (which is anticipating a bit since BMO only distributes the cash March 7th but again it doesn't make any comparative difference).

Cash or no cash, it is quite interesting to see that the Fundamental portfolio has now opened up a significant lead of $1602 since the beginning of the year. It's easy to spot that it is because of the huge leap of the Developed Markets Fundamental fund PXF over its Cap-Weight rival VEU. Both portfolios have positive returns in every asset class! It's just that "some are more equal than others" with bigger gains. That includes Canadian Bonds where the price level of XBB is flat but the cash interest distribution would push its return into plus territory. Nothing is really close to the 1/4 share out-of-whack rebalancing trigger point though XBB is starting to get down there with 21.5% versus its target 25%. If interest rates start to rise then XBB is likely to start falling though equities might too.

The 4% Retirement Withdrawal Rule: International Data Casts Doubt

2011-02-23T09:37:00.012Z

There is a rule of thumb that says a person can withdraw 4% of the value (as of the date of retirement) of an investment portfolio and adjust the amount every year for inflation without fear of running out of money. A prime proponent of this idea is William Bengen (review of his book here) who based his conclusions only on US data.

Not all countries are created equal, so a key question is how people elsewhere might have fared using the 4% rule. Along has come Wade Pfau and his provocatively titled paper An International Perspective on Safe Withdrawal Rates: The Demise of the 4% Rule in the February 2011 issue of the Journal of Financial Planning. (Author Pfau has his own blog here)

The results are not very encouraging: "... from an international perspective, the 4 percent real withdrawal rule has simply not been safe." Using data over a longer period from a different source than Bengen (but which validates Bengen's results about the US), Pfau calculated what would have happened in 17 developed countries using quite generous assumptions and found that in only three other countries - Canada, Sweden and Denmark - the 4% rule would have worked out.

The paper's main aim is really only to get a feel across different countries. It deliberately excludes several extremely important factors that could dramatically alter the specific maximum Sustainable Withdrawal Rate in realistic conditions:

mainly downwards - no adjustment for rebalancing trading and fund management costs to the index data, no taxation on returns, using the stock vs bond allocation that gave the best result, as if the retiree could perfectly forecast the best combo for the next 30 years;
or upwards - possible other asset classes like REITs, foreign stocks, small cap stocks, value stocks; longer rebalancing intervals than yearly

The study confirms another Bengen US finding, though exact figures vary country by country: stocks always comprise a substantial part - at least 50%, some up to 100% - of the portfolio that had the best SWR; for Canadians that was about 50%.

A scary bit to the paper is table 4 (which appears in the blog article version but not in the FPA version). Table 4 shows that for an arbitrary commonly cited 50% equity/50% bond portfolio (as opposed to the stock bond split that gave the best result), in no country would a retiree never have run out of money using the 4% withdrawal rate.

The key question highlighted in the conclusion applies to every country. The past is all well and good but for any particular country, which past will most resemble the future? Will the US or Canada continue to outperform compartheed to everywhere else
or will they revert to some lower international mean? One can simply blindly lower the SWR e.g. to 3.5% or 3%, or try to adjust expected future stock and bond returns using current relative valuation.

The even larger issue for the retiree is whether an investment portfolio with systematic withdrawals is the most appropriate way to fund retirement expenses. I don't believe so. I've already noted objections to the 4% SWR approach by Scott, Sharpe and Watson. The critical correction needs to be that assets should be matched with liabilities in terms of income risk (variability, default) and timing of income.

Defining Mutual Fund Return: a Black Comedy

2011-02-21T11:36:00.015Z

Black comedy, as in dark, little or no light visible. That's how things are regarding the meaning of the word Return when used for mutual fund performance.

Reader Marypat in a comment on my last post says she is a new investor and asks a simple question: "I was wondering if the returns they report for mutual funds would already include the payment of the MER. For example, one fund shows a 1 year return of 3.8% but it also has a MER of 2.55%. Does this mean that my return is actually 3.8%, or is it 3.8% less the MER?" The simple answer is that the reported Return is net of / after deduction of the MER, i.e. in the example, 3.8% net. The MER gets automatically deducted from the fund by the managers and reduces the fund's asset value. When the net asset value is used to calculate the Return, the MER money is already gone.

MER is not the only Returns-reducing cost, though. There are other costs that get deducted and reduce reported Returns, notably trading expenses and GST. The fund Return also should include the assumption that all distributions are reinvested instead of being received in cash. Finally, there are other possible or variable costs that will reduce Returns but which are NOT shown in reported performance - fund switching fees, one-time front-end sales fees or back-end early redemption fees and income tax (see a previous post on MER vs TER).

I say "should include" because the exact description of how mutual fund Return is calculated seems impossible to find on any official website!

Try to find an FAQ, a footnote in fine print, a pop-up definition in GlobeInvestor or in Morningstar.ca that explains the performance numbers displayed for a fund. Good luck. For a random fund picked from a recent Globe article on Lipper's Top Mutual Funds Over Three Years - the Brandes Emerging Markets Equity Class A - here is the GlobeInvestor Brandes fund info and the Morningstar info. See any explanation of Returns on either website? Another mutual fund database and comparison site, FundLibrary.com, had no detailed definition of Return that I could find under Novice Investor or Q&A. The Glossary entry for Return had this definitional piece of fluff - "The amount of money earned by an investment".

Go to the Investment Funds Institute of Canada "The Voice of Canada's Investment Funds Industry" to look in their Investor Centre for an FAQ. Sorry, nothing. Does the Mutual Fund Association of Canada page For Investors have anything? Nope. Does the Canadian Securities Administrators Investing Tools section, including the hopeful looking Understanding Mutual Funds document contain the answer? Keep looking.

Does the regulatory body Ontario Securities Commission new Point of Sale Disclosure for Mutual Funds document Fund Facts contain the explanation? It's better! - "Returns are after expenses have been deducted" and then itemizes various expenses and fees (except for the GST, which isn't there at all). But there should be a more explicit explanation of which expenses to the investor are included or excluded in Returns data. Are those expenses with a capital E - i.e. only those in item 2) Fund expenses of the How much does it cost section, or possibly the 1) Sales charges and 3) Other fees too? It is a bit artificial to describe the fund's Returns only in strict terms as those after costs directly deducted from the fund on an on-going basis, instead of the investor's Returns which come after deduction of all the other charges, taxes and fees. Illustrations using typical examples e.g. median or average holding period for mutual funds would be very revealing. Apart from paper disclosure, it would be useful for mutual fund companies to be obliged to provide historical Returns calculators on their website that can incorporate holding periods and tax rates for funds.

The Investor Education Fund content, created especially for consumers by an organization funded by the OSC and copied on the Globe and Mail website, is positively befuddling in its What will it cost to invest in mutual funds? First it says "When your account statement shows you your return, what you see is what the fund made after costs." Then it lists the top three costs for mutual funds and includes the front- and back-loads that are NOT part of Returns figures cited by one and all. Thanks for the help. Please don't help us any more.

The mutual fund company Brandes Investment Partners includes a note at the bottom of its Fund Performance document - "The indicated rates of return are the historical annual compounded returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns." But what the heck does the statement preceding it mean - "Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments"? We are left wondering how the MER and other expenses were treated in calculating those Returns. To figure it out, you have to already know that the MER causes a "change in unit value".

I've taken some liberty with regards to the meaning of Black Comedy, but let's try to avoid the approach of Humpty Dumpty in Alice In Wonderland:
`When I use a word,' Humpty Dumpty said in rather a scornful tone, `it means just what I choose it to mean -- neither more nor less.'

`The question is,' said Alice, `whether you can make words mean so many different things.'

`The question is,' said Humpty Dumpty, `which is to be master - - that's all.'

Groucho Marx Helps Explain Mutual Fund Under-Performance

2011-02-14T16:20:00.013Z

Bet you never thought that Groucho Marx ever said anything bearing on mutual funds. Never did I till I pondered this quote (on Wikipedia): "Please accept my resignation. I don’t care to belong to any club that will have me as a member."

Why do mutual funds want us as members? The answer sadly for most mutual funds, is to collect management fees and not to provide the supposed membership benefit of a fair investment return. Consider the simple arithmetic. Funds charge a fee based on assets, such as 2% per year. Thus, for example, if a fund has $100 million in assets, the managers collect a $2 million fee annually. Boosting assets raises fee pay for the managers. There are two ways to boost assets - 1) investment return, 2) sales of fund units to the public. The question then is, which is easier?

For option 1 generating investment return, as long as the fund invests in something it will gain a certain return somewhere around the market, but beating the market is very difficult, some say impossible on average. Going from 6% market return, approximated by simply investing in a broad range of holdings within the particular asset class, to 7% (outperformance by 1%), requires a lot of effort and/or skill, or luck (if you believe in efficient markets). In fact, actively managed mutual funds have been shown in many many studies not to be able to outperform by much (e..g read Richard Ferri's new book The Power of Passive Investing which slices and dices US actively-managed mutual fund performance against passive index investing every possible way, citing those numerous studies) even before fees. The one-third of funds that were actually successful in outdoing a US S&P 500 index fund from 1985 to 2009 (graph p.38 of the book) only averaged about 1% per year extra return and the very best only attained under 5% per year extra return. Two-thirds of the active funds lagged the index fund - by an average 1.69%. That's before sales commissions and income taxes, which would knock a bunch more down into the lagging side. The net effect on fees of 1% outperformance / $1 million excess return (which raises assets by 0.01 x $100M) is 2% of that extra $1 million or only $200k.

Option 2 is to raise assets by marketing and sales. Through advertising tailored to highlight its winning funds, companies can stimulate fund inflow. Winning funds are defined advatageously - they are compared only to other funds, not market indices, which means half can be above average as opposed to only the third when compared to indices. When a fund's performance almost inevitably falls behind it gets terminated or merged into another more successful fund to incite investors to stick with it and not withdraw their money. New funds are constantly being created or incubated to find some that outperform so they can be featured to attract new money.

How much extra effort is required to gain more than $1 million in new assets - and thus be ahead in garnering fees - by advertising and marketing and what is the comparative chance of success? For one thing, the public is constantly being motivated to contribute, being told to save for retirement, especially at this TFSA/RRSP time of year, when the investment decision becomes only a question of which investment to buy. Those dollars are probably easier for the fund company to grab. Furthermore, the process is much more under the control of the fund company than fickle markets are, so it's likely a lot easier to generate more fees with option 2. In sum it appears that mutual fund companies are much more marketing organizations than asset management / portfolio management companies.

Maybe the search for successful active management amongst mutual funds is looking in the wrong place. Ferri himself remarks that "Most of the great managers aren't for hire by the general public. The truly talented managers like to fly under the radar as long as possible to keep their assets manageable." He also quotes famed Yale University endowment manager David Swensen, who said "Low-cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high quality active management decisions." A book I reviewed recently, Pension Revolution by Keith Ambachtsheer, followed the same thinking when discussing pension funds. He found that good governance, which includes properly motivated fiduciary-bound managers, made a big difference to performance. Well-governed pension funds achieved 1% per annum excess risk-adjusted return (he thinks 3% is possible for the best governed), though even the average pension fund achieved 0.2% excess return after fees and expenses. The problem with mutual funds, as Ambachtsheer puts it, is the managers' conflict between producing good returns for clients and profits for themselves. If individual investors are the "dumb money" patsies of the investment world that the "smart money" active investor eats for lunch, then mutual funds are the "conflicted money" that they eat for dinner.

Maybe Groucho had the right idea with respect to actively-managed mutual funds.

TSX - London Stock Exchange Merger Effect on Investors

2011-02-09T10:30:00.007Z

TMX group (TSX: X), operators of the Toronto Stock Exchange, have agreed to merge with the London Stock Exchange (LSX: LDNFX.PK), subject to the Canadian federal government, along with Ontario and Quebec being willing (... funny how there seems to no UK government worry about it according to the UK press e.g. BBC, UK Reuters).

So how might this interest or affect individual investors?

1) TMX as an investment - We can buy shares in the TMX, which has been doing rather well (latest Q4 results here). Will the combination do better? The merger press release talks of synergies and cost savings, as they always do, but many corporate mergers do not succeed (Deloitte says it's about half). Key issues: Will the business cultures fit? Will the technologies fit (what is the essence of a securities market if not a computer and communication/network system)? The old IT joke applies - "God could not have created the world in seven days if He had had an installed base." Blogger Larry Macdonald took a look at TMX Group last November. Wonder if he bought in and made money. The Google stock chart for TMX looks enviously enticing.

2) Inter-listings - If the combination results in there being more companies listed in Canada on the TSX as the press release suggests then that will be good for investors in Canada. Securities sold in Canada can be held in all those registered plans the federal government has created. There is no cost-effective way at the moment for Canadians to buy foreign securities to be held in registered accounts (you have to do this through an agent on the phone and pay commissions that can easily amount to hundreds of dollars), apart from US-traded securities which we can buy cheaply online. The markets in the UK and Canada will of course continue to operate separately, not as one giant market, due to the fact that the companies must comply with the local regulatory requirements, which for the TSX is Ontario/Ontario Securities Commission. Whether a company will choose to go through all the initial and on-going extra cost of registering and complying with the different local regulatory requirements is debatable.

3) Market liquidity - More investors create more trading volume and decrease bid-ask spreads aka investor costs as well as making it easier to buy/sell shares. But will more investors, presumably from outside Canada, show up in the TSX after the merger? That's not obvious.

4) Trading fee effects - If the combined LSE-TSX lower their costs and in turn lower the charges they make on trading for brokers or on listing for companies, that may increase the trading volumes and liquidity, as well as number of companies listing, both to the benefit of us individual investors. The TSX, LSE and all public exchanges are increasingly are increasingly in competition with one another and with alternative exchanges and private deal making networks (e.g. project Alpha described in Canadian Business Online by Jeff Sanford). More competition equals better outcomes for investors.

5) Investor protection - It cannot get worse than it is now for Canadian investors due to the weak laws and enforcement in Canada. To the extent that existing TSX companies decide to Inter-list and become subject to the UK's FSA regulation that will be a benefit.

From the viewpoint of the Canadian citizen, as expressed through our governments, I cannot see why exactly it would matter that, as the Globe and Mail's Boyd Erdman article (linked at the top) puts it "some key levers of control would shift outside Canada". As he also notes, many other national stock markets have already merged or been bought out, including Italy's Borsa Italiana by the LSE. If anything, a stronger, better capital market would be a more likely result for Canadian companies and investment in Canada. The government should probably encourage the merger instead of blocking it.

In short, it's hard to see any downsides for the individual investor, unless I've missed something, and there are some possible upsides. Thumbs up.

Update 15 Feb: best article I've seen on the Canadian regulatory issues being raised - here on Westlaw. Not a single word that any concerns exist in the UK. It's all about Canada. Those xenophobes who fear foreigners, especially Arab foreigners, taking over, may find comfort, or extra fear, from this December Telegraph article on the mistrust and machinations amongst LSE shareholders in Abu Dhabi, Dubai and Qatar. Another excellent Telegraph article puts the proposed merger in a global context.

Book Review: Swindlers by Al Rosen & Mark Rosen

2011-02-08T12:41:00.009Z

An important subject but an opportunity missed. I was very much looking forward to this book, especially as the authors probably know at least as much as anyone about accounting and investment fraud. The sub-title promised much value to the individual investor - "Cons & Cheats and How to Protect Your Investments from Them".

Alas, the book left me disappointed. There is far too much ranting - however justified and true - against corporate crooks, lackadaisical regulators and accountants and the new IFRS accounting standard and too little of the detailed nuts and bolts dissection of how scams can be detected in advance for the investor to be able to avoid being taken in. We are left feeling vulnerable and frightened but not nearly enough better armed to defend ourselves.

That's a shame because the Rosens, especially the elder more experienced Al, could walk us through some case studies (there is one - National Business Systems - too briefly dissected in an appendix) they've encountered e.g. with excerpts from financial statements showing the telltale signs of danger. That would be really useful, for instance, when yesterday I blogged about Matrix Asset Management and the fact that it has reported transactions with related parties, an area that the Rosens state is often dangerous. In the absence of more specific guidance from the book on how to assess whether the transaction is bad or acceptable, should the investor stop right there and reject Matrix as an investment possibility? With this and other cautions regarding the latitude many if not all businesses have to manipulate their financial statements, we'd likely end up rejecting any investment except GICs as too risky. The Rosens don't say that is actually the best approach these days, though they do say this (page 200): "In the 1950s and 1960s, individual Canadians regarded the financial marketplace with grave mistrust. It took a major effort to encourage the public to invest in equities. Are we heading back to those days?"

The dust cover has the most intriguing inside dust cover photo (see scan of it below) I've seen in a long time.

I hope they are on site in an office of one of the cons and cheats and not in their own office! (To complete the image of the hard-bitten experienced detective, they could have rolled up the sleeves and loosened the tie. ... Wonder if they've thought of a TV series?)

Surprisingly, the book makes no attempt to quantify the fraud problem, except to list a number of known cases. Maybe statistics would be difficult to find given that so much goes undetected but that would bolster a case which might be dismissed by authorities as merely the complaints of someone whose recommendation to reject IFRS as a replacement for GAAP was not followed (there is an awful lot of ranting about IFRS in the book).

Surprising also in its absence, and something I would have wanted in a book purporting to provide practical protection advice, is a chapter or an appendix with links to investor protection groups, discussion forums, complaints bodies, ombudsmen and references to pertinent articles or books.

The book does have practical investor value - there is a fair amount of pointing to specific balance sheet, income statement and cash flow lines with indication of how they can be dishonestly manipulated. It's just not extensive and detailed enough, i.e. a bit more "textbook" is needed. Cutting the polemic content word count down to about a quarter would leave a lot more space for the practical.

Bottom Line: I have to applaud its important message and the truth it speaks but as a book it could be a lot better.

My Rating: 3 out of 5 stars.

Mutual Fund MERs - Can You Get Even?

2011-02-07T14:29:00.017Z

We all know the old saying "don't get mad, get even". There has been a lot of justified complaining about high mutual fund expenses in Canada. It so happens that a number of the companies that charge those high fees - all the big banks and insurance companies amongst them - are public companies whose shares we can buy. Presumably those high fees go into the coffers of those companies. So should we investors simply invest in those mutual fund sellers to get our own back and make decent returns?

The answer appears to be yes for some and no for others.

Yes - Royal Bank of Canada (RY) vs RBC Canadian Dividend (RBF266), a flagship mega fund with $10.4 billion in assets
The TMX.com chart shows that over the past ten years the price of RY has risen a lot more than RBF266 (even excluding dividends, which are sure to have been higher for RY than RBF266). It is also interesting, and perhaps significant since RBF266's MER at 1.7% is appreciably less than the typical 2+% equity mutual fund MER, that RBF266 outpaced the TSX Composite by a good margin. The Morningstar.ca entry for RBF266, which includes all dividends/distributions in Total Return figures, confirms that fact - 10-year performance was 8.16% annualized vs only 1.64% for the TSX. An RBC Investor Deck shows total returns for RY to Dec.1st, 2010 at 13.0%.

IGM Financial (IGM) vs Investors Group Dividend A or C (IGI008), another mega fund with $13.5 billion in assets. Here's another chart from TMX.com. Over the past ten years IGM seems to have easily outstripped INI008, which has not even done as well as the TSX Composite (the blue line). Perhaps the 2.78% MER of INI008 has something to do with that?

No, or perhaps more precisely, it's hard to tell which will lose you more money - Matrix Asset Management (MTA) vs GrowthWorks Canadian (WVN612)
It seems to be a choice between the long, slow, steady slide into oblivion of WVN612 (see this Morningstar.ca chart - even the highly volatile TSX Small Cap Index has eventually recovered and is up) vs the yet-to-be revealed hazards of MTA.

The chart above doesn't tell the whole story of WVN612's sorry life. Prior to 2005, it was the Capital Alliance Venture fund, which led an equally horrible life (Returns for CAVI to November 29, 2005 were: 1 yr: -7.7%; 3 yr: -9.8%; 5 yr: -13.8%; since inception: -1.3% per bottom of page 4). It's funny that CAVI founder and longtime president Denzil Doyle was inducted into the Order of Canada in the same year - 2005 - that the failing fund was sold to GrowthWorks. Disclosure: I invested money in CAVI way back in the 1990s and am a disgruntled loser!

Now MTA manages WVN612 along with a whole collection of similar Labour Sponsored Investment Funds (see Globe and Mail's How Risky is an (sic) LSIF?). Though the funds lose money, the management company doesn't need to, since it draws juicy fees e.g. WVN612's MER is currently 4.96% per annum. That should mean juicy profits for MTA, right? Um, no, MTA has eeked out losses or small profits since its reincarnation on the TSX in January last year after spending years as Seamark. (see the Google Finance chart below of how successful Seamark was for investors)

MTA's stock price is down 9.3% from its initial price, though hey, it is ahead of WVN612 which has lost 14.7% in that time.

What is going on at MTA then? It is hard to tell without spending a lot of time in the financial statements. However, I would be worried that the individuals who manage MTA, the executives, having milked the LSIFs (which is why those failures have been kept alive), will garner most of the benefit from the public company, all perfectly legally no doubt. Various worrying signs are visible - transactions with related parties, extra non-GAAP figures like recurring income before taxes in the income statement to more favourably portray company results. Pass me my ten-foot pole please!

The world is never simple.

Investor Protection in Canada: The Sisyphus Myth Backwards

2011-02-05T09:26:00.004Z

In ancient Greek mythology, Sisyphus was an evil man condemned by the gods for his crimes to roll a boulder up a hill, only to have it roll back down on nearing the top and then have to start all over, repeating this forever.

Unfortunately, today in Canada, Sisyphus has been reversed - it is the investor protection advocates, those representing the victims of financial crime, who seem to be condemned to forever rolling the boulder of reform up the steep hill of governmental and bureaucratic indifference.

Having long been aware of such investor advocate stalwarts as Ken Kivenko at CanadianFundwatch.com. Peter Benedek of RetirementAction.com and Marc Ryan of IndependentInvestor.info, I've just come across Pamela Reeve (website here) and her current efforts to get the Investor Advisory Panel of the regulatory body the Ontario Securities Commission on an effective track. To no avail it seems ... after reading her thoughtful and detailed open letter to John Stevenson of the OSC about the IAP, I sent her an email asking about response and progress. A speedy reply the very day came from her (unlike, I might note, responses from the OSC at various times I have emailed them, which took from a few days to never). The essence of the result - a new IAP with no resources and no independence from the OSC (see the OSC page for the IAP here). She also copied me with a letter to the Ontario Minister responsible Dwight Duncan and his dismissive response months later.

Having worked for many years in corporate and government bureaucracies, at times even drafting responses such as the one she received from Minister Duncan, it is sadly evident to me that as yet, there is no will at the top government level to improve things for investors. Meantime, the OSC and other organizations who can and should do something, follow the "keep-them-talking-forever" strategy, paying lip-service only to investor protection. The new OSC IAP amounts to an exercise in co-opting some investor advocates. It's funny that the IAP should get a princely $50k when industry body IIROC is willing to put $3.75 million into FAIR http://faircanada.ca/about-us/background/. The new Canadian Securities regulator doesn't look like it will do any better either, as this article by Independent Investor's Marc Ryan says - http://independentinvestor.info/content/view/955/1/.

I have to admit that I have not devoted much blog space in the four years I have been writing this blog (yup, the 4th anniversary just passed) or personal time to the investor protection system (though I have been burned by the great con of LSIFs and a company called, ironically, Intelligent Detection Systems). I just assume that investor protection essentially does not exist right now in Canada and instead look for financial products and services that are likely legitimate. There are a few I believe and my aim as a blogger is to find and write about them!

Thanks to Pamela, Ken, Marc, Peter and others labouring mightily on our behalf. Hopefully, one day a tipping point will be reached and that rock will reach the top to roll down the other side of the hill and knock down a slew of bad guys hiding over there.

Book Review: Pension Revolution by Keith Ambachtsheer

2011-01-31T13:33:00.019Z

Why should an individual investor read a book about how to fix the pension system that is addressed to pension fund managers and legislators who make the pension rules?

1) To become an informed, opinionated citizen on a topic that is sure to affect you in a significant way, e.g. most recently in Canada, taking a position on the short-lived proposal to expand the CPP and the substitute federal proposal to start something called Pooled Registered Pension Plans (my take here ... written before I read this book, though reading it has only reinforced my opinion)

2) To get ideas to manage your own retirement income, such as probable investment returns, the risk premium for equities over bonds and most uniquely, the importance of matching the time horizon and riskiness of liabilities with assets / investment portfolio. Ambachtsheer doesn't intend to address the needs of individuals and he never explicitly says that the same principles should apply to individuals and to pension funds but they seem highly pertinent to me. As a foundation principle for people like me who must manage a personal pension fund of RRSPs/RRIFs/LIRAs/taxable accounts for themselves, the "match assets with liabilities" phrase makes much more sense than "match bond allocation age".

In other book reviews I have several times objected that the book title or sub-title doesn't deliver what it promises. Not this time. "Revolution" is not too strong a word. Ambachtsheer advocates drastic across the board change. He says corporate defined benefit plans were a disaster waiting to happen from their origins (what better supremely ironic example could there be than the fact that the very company that set the pattern for corporate DB plans after World War II - General Motors - in large measure was scuppered by the liabilities of its DB plan?). Corporate DB plans are good for neither companies nor employees, being riven with inherent unresolvable conflicts. Defined contribution plans are fatally flawed as well, for different reasons but the end result is still bad, an incapacity to deliver a good pension in retirement.

The Optimal Pension System - Revolutionary wearing-suit-and-tie Ambachtsheer (he is the director of the University of Toronto's Rotman International Center for Pension Management) proposes a solution, called TOPS (The Optimal Pension System) with the features below. The book dissects the issues that bedevil our existing DB/DC pension system and tells why and how his TOPS can be viable replacement system. TOPS includes:

auto enrollment and set minimum contribution rate
auto-pilot savings-investment process - no un-necessary choices (e.g. pick one of 20 mutual funds) for individuals to make
auto-pilot conversion of financial capital into deferred life annuities all along during a working career (instead of suddenly needing to decide what to do with a RRSP at retirement)
single -purpose pension plan co-ops (unlike DB plans where corporate goals and constraints interfere and DC plans where financial industry profit motives interfere)
good governance and organization design (like appointing a board based on ability to help achieve the pension mission, not to represent a union or an employer), which he figures can add 3% per annum to returns!!
economies of scale (yup, size matters and he's got the data to prove it - less than $2 to 3 billion - as of four/five years ago when he wrote the book - is too small)

Though much of this looks a lot like the CPP to me (yes, I am still on that hobby horse), Ambachtsheer cites a few other examples that comes close to his ideal - the Dutch national pension system e.g. one provider is APG and the USA's TIAA-CREF.

Investment Environment - Ambachtsheer devotes about 70 pages to investment topics that should interest every individual investor - the stocks for the long run question and the equity risk premium (ERP), which he says predictably varies up and down (metrics like P/E and dividend yield giving reliable indicators of future returns). His rule of thumb formula for the expected ERP gives sobering results these days: (market dividend yield + 80% of future real GDP growth - yield on real return bonds = 2.4% + 0.8*2%(?) - 1.2% = 2.8%. Ambachtsheer does not believe in the Efficient Markets Hypothesis. He thinks instead that skilled investment professionals can add considerable excess returns, especially over the long haul. He poo-poos people like Burton Malkiel (strange that Malkiel still writes a glowing blurb for the book at the front!) who apply simple mechanical investment rules and find no out-performance and then conclude that EMH works just fine - "Highly effective pension and endowment fund management teams know that there is considerably more to to generating excess return over time than applying simple decision rules to buying and selling stocks and bonds."

What's Good for Pensions Would be Good for the Economy - The book puts forward the intriguing idea that pension funds can exert positive influence on companies and on the economy through their long term investment perspective as knowledgable, activist shareholders with considerable clout. Ambachtsheer argues that better-managed pension funds will recognize that what he calls long horizon risky investing brings the biggest returns and in turn that depends on investee companies focusing on long run sustainable growth instead of short-term next quarter results.

How Much We Really Need to Save - It is a shock to read that the riskless creation (i.e. buying only real return bonds) of a riskless lifetime inflation-adjusted pension would require a 25% or more pay deduction rate sustained for 35 years. Failing that strategy, we can buy into equities for probable higher returns but we have to accept investment risk and that could mean taking a lower pension. We also learn that the most expensive pension feature by far - and thus the one that pension providers (whether governments or corporations) are most likely to cut back in cases of under-funding - is inflation protection. Boomers should not be surprised if and when inflation-indexing gets cut, since there has been no change in our pension system since the 2007 publication of the book. Everything in the book is as relevant and topical today as then.

Unless inflation goes up in a huge spike upwards as in the 1970s, the current 2% or so rate will eat away slowly and surreptitiously at living standards of retirees. Unfortunately, most often it takes a sudden crisis to provoke fundamental change. Ambachtsheer does not attempt to forecast the likelihood of change in pensions. He only plays the role of the technician who tells us what is wrong and how to fix it.

The biggest downside of the book is a lot of repetition. The same ideas are presented over and over with a bit of new material in each of the very short (5-6 pages each) 45 chapters. The book also lacks an index, so it is hard to find subjects again, even when one takes extensive notes during reading, as I do. A consolidated reading and reference list would help too, though key papers and books, such those on the investing ideas, are referenced within the text.

The publisher Wiley Finance listing for the book includes the table of contents.

My rating: 4.5 out of 5

The Next Step in Index ETFs: Risk Efficient Index ETFs

2011-01-26T08:53:00.005Z

"The Moving Finger writes; and, having writ, Moves on"
The Rubaiyat of Omar Khayyam

Finance research fingers have written a lot on the various methods of indexing, poking holes in cap-weighting as being neither theoretically nor practically optimal for indexing, whether to use as a benchmark or an investment strategy. It's time to move on, apparently not to fundamental weighting or equal weighting, but to something called a Risk Efficient Index, which maximizes the reward/return to risk (Sharpe) ratio. The EDHEC Risk Institute came up with the new indexing method and provides a good FAQ here that explains the difference with the other indexing methods (and includes links to various papers with detailed comparison of the alternative indexing methods). The second-last question in the FAQ says the method could be used for an ETF. The new Index is where the institutional investors are or will be heading, so why not an ETF for individual investors?

Could we please have Canada Real Return Savings Bonds

2011-01-25T12:15:00.004Z

Now that inflation is just starting again to rear its ugly head (2.4% in December, up from 2.0% in November), perhaps our federal government in its solicitous regard for the ordinary citizen could consider adding to the annual Canada Savings Bond line-up by offering a Canada Real Return Savings Bond.

The idea is very simple. As the name implies, it would be very similar to the existing Savings Bonds, sold in the annual campaign from October to December. In fact, the similar name would have the object of reassuring everyone of the same solidity and safety, as indeed it would have, being an obligation of the Government of Canada.

Why do this? There is a big gap in the product marketplace. While there are plenty of GICs and CSBs around with strong security of principal, the only true inflation-protection product of similar security is the series of real return bonds issued by the federal government. Unfortunately, the RRBs have several important limitations for the average person: one cannot buy small amounts ($5k is the RRB minimum); one has to buy through dealers (with their markup and loss of yield); long maturities only are available (the earliest one now is 2021 - see Finiki).

For people who only really want to preserve their capital and not garner big returns, CRRSBs would be a boon - small purchases, range of near to intermediate term maturities, and above all, no worry about inflation. At the risk of provoking a not-invented-here negative reaction, we in Canada have a convenient model to follow - the UK's Inflation Linked Savings Certificates. There's one feature they have that I especially like - no tax on the interest! (see item 5 in Terms and Conditions) That's only fair. In the UK the Certificates' return is next to nothing but at least the "inflation return interest" is not taxed as it is with our present product the real return bond (which only makes them worthwhile to hold in a registered account). A minuscule real return is still better than the net negative return currently on offer - e.g. 1.7% Bank of Montreal 1yr GIC minus 2.4% CPI to December (if that continues and is it likely to go down or up?) = 0.7% loss of purchasing power.

I can even suggest a silly slogan that would make it a big marketing success "Get Real Canadas"

Update March 9, 2011: It seems I am not the only person who believes shorter term RRBs would be useful. In The Missing Links: Better Measures of Inflation and Inflation Expectations in Canada published in 2009 by the CD Howe Institute, Gregor W. Smith advocates the creation of RRBs with maturities of 1, 2 and 5 years, for the dual purposes of providing savers better options and to enable better measurement of inflation expectations to guide government policy.