Little did I know when making this post complaining about BMO's policies regarding foreign exchange rates when buying and/or selling US securities in a registered account that much has already happened.
First, there was the $100 million dollar class action lawsuit launched back in August 2006 against BMO claiming that BMO has illegally forced customers to change foreign currency from Canadian dollars into US dollars or vice versa in registered accounts since June 2001 when the tax laws changed and began allowing foreign currency to be held in such accounts. You can register with the lawyers Paliare Rolland to be kept informed of the case's progress. Or you can sit back and keep an eye out for news, or just wait - I'm betting years - for a letter from BMO or the lawyer, saying the case has been settled for x amount and here is what you get.
The second development is the internal memo issued by BMO and reported by the Toronto Star in April this year to allow clients who trade in and out of US dollars on the same to take a single exchange rate for both the buy and the sell and thus avoid the buy-sell spread and/or any fees for the conversion. There is also a lower fee structure - down to 75 basis points (0.75%) or 70 basis points for all you folks who have trades over $30million. There isn't any notice or warning on the website about this situation, so BMO clients be aware - you must phone and ask for the single rate out of and into US dollars.
Maybe someday the big bank brokerages will manage to convince their software supplier to make the necessary changes to the program they all use in common to manage registered accounts. Apparently the bottleneck is the software and the supplier just won't change it (no it isn't Microsoft). Those of you at all familiar with the world of IT will not laugh and scorn but will quote the old saying, "God could not have created the world in seven days if he had had an installed base." Some who have had similar experience with the bugs that follow on new versions of software might just wisely note, "be careful of what you wish for, you just might get it."
Thursday, 28 June 2007
Monday, 25 June 2007
The Slippery Meaning of "Value" in ETFs and Indexes
Investing in Value stocks through an ETF brings diversification and higher returns to an equity portfolio. That has been proven in finance research published by Fama and French in their famous three factor model of stock returns, available in all its mathematical glory at the Social Science Research Network. The implications for investing are explained in english language at the Index Fund Advisors.
As the old saying goes, there's many a slip between the cup and the lip. When the research-proven notion of Value, which is simply that the price of a stock is cheap based on the ration of the stock's market price to the company's book value (p/b)(book value is simply assets minus liabilities in the financial statements), the meaning of Value gets transformed and expanded by index providers. Index-based ETFs need to have a reference index and they take them from such providers as Morningstar, Russell, MSCI, Standard & Poors and Dow Jones/Wilshire.
The best explanation of the way Value, and other indexes such as large vs small cap are constructed, is here at the Moneychimp.
So what do we find that the index providers have added to the original p/b measure? First, there are additional historical price measures like price/earnings, price/sales and dividend payout ratio. That might not be so bad as the basic principle that the stock is somehow low-priced compared to a fundamental historical measure is still respected. But where the definition of value really starts to take on hocus-pocus falsity is those indexes that include forecasted of such numbers as earnings! What lunacy! That replaces the best guess, as expressed in the price, of the market, whose guess is better, as shown time and again by research, with the guesses of analysts who are more wrong than right,
How do the index providers stack up?
The Bad
As the old saying goes, there's many a slip between the cup and the lip. When the research-proven notion of Value, which is simply that the price of a stock is cheap based on the ration of the stock's market price to the company's book value (p/b)(book value is simply assets minus liabilities in the financial statements), the meaning of Value gets transformed and expanded by index providers. Index-based ETFs need to have a reference index and they take them from such providers as Morningstar, Russell, MSCI, Standard & Poors and Dow Jones/Wilshire.
The best explanation of the way Value, and other indexes such as large vs small cap are constructed, is here at the Moneychimp.
So what do we find that the index providers have added to the original p/b measure? First, there are additional historical price measures like price/earnings, price/sales and dividend payout ratio. That might not be so bad as the basic principle that the stock is somehow low-priced compared to a fundamental historical measure is still respected. But where the definition of value really starts to take on hocus-pocus falsity is those indexes that include forecasted of such numbers as earnings! What lunacy! That replaces the best guess, as expressed in the price, of the market, whose guess is better, as shown time and again by research, with the guesses of analysts who are more wrong than right,
How do the index providers stack up?
The Bad
- Russell - "...the Price-to-book ratio and the I/B/E/S forecast long-term growth mean"; affects IWM, IWW
- MSCI - p/b, dividend yield and 12-months forward earnings /price; affects VBR, VTV
- Morningstar - 50% weighting on forecasted estimates; affects JKL
- Dow Jones/Wilshire - uses p/b and p/ projected earnings (see the Moneychimp link above); affects XCV
- Standard & Poors - uses p/b, p/cash flow, p/sales and dividend yield; affects IJS, IJR, RZV
Friday, 22 June 2007
ETFs, ETNs and Commodities Reading Material
Inside the Research Magazine Guide to ETF Investing 2007, there are a couple of articles I found to be quite useful for a deeper understanding of my portfolio holding in DJP the iPath DJ-AIG Commodity ETN. One article on page 10 compares ETFs to Exchange Traded Notes (ETN) and the other on page 12 describes and compares the various commodity funds one can buy. Good stuff for those who want to include commodities within their portfolio. Barclays Bank iPath website also describes ETNs and its own products.
Don't Tell Your Wife!
Came across this amusing slide in a downloadable presentation by Moshe Milvesky, given recently at the MFC Global Expo 2007 in Hong Kong. Guys, better make sure you keep your wife very happy!
The rest of the slides are, as usual for material from Mr. Milevsky (see my reviews of his books), full of interesting and thought-provoking material on financial issues of retirement.
Thursday, 21 June 2007
Mortality Swaps aka Back-to-Back Annuity and Life Insurance
In a comment on my latest book review Insurance Logic, Mike asked what a Mortality Swap is. The insurance industry apparently uses another term for this investment strategy - Back-to-Back Annuity and Insurance.
The concept is relatively straightforward. Here is an excerpt from the research paper titled Mortality Swaps and Tax Arbitrage in the Canadian Insurance and Annuity Markets by Narat Charupat and Moshe Milevsky:
"We show that by engaging in seemingly counter-intuitive transactions involving two insurance products, one can create a risk-free portfolio whose after-tax return is greater than that of available risk-free securities. The two insurance products in questions are (i) a standard term-to-100 life insurance policy; and (ii) a single-premium fixed immediate life annuity with no guarantee period.
Consider an individual who invests $100,000 in a fixed immediate life annuity, and then uses part of the periodic income from the annuity to pay the premium on a life insurance policy whose death benefit is also $100,000. This 'back-to-back' transaction, which we shall henceforth refer to as a "mortality swap", will create a constant periodic flow of income and will return the original $100,000 upon the death of the policy owner. This payoff pattern is similar to that of a risk-free investment such as a bank deposit whose principal is redeemed (by the individual's estate) at the time of death."
Another description is here.
The Insurance Logic book provides an an example for a 65 year old female based on actual quotes from insurance companies at the time. The risk-free rate of return pre-tax for the assumed 50% marginal tax bracket was 8% and was described as "much higher than comparable bond yields". The rate of return for this strategy was higher the older the age of the woman, using a joint and last survivor policy with the spouse and using leverage (i.e. borrowing to buy the annuity. The basis for the profitability of the whole thing is apparently that only a "relatively small portion" of a prescribed annuity is taxable.
This strategy came up for discussion in the Financial Webring - see the post by jiHymas on Dec.29, 2005 for an opinion on some cons. I had an amusing time phoning the CCRA today trying to get information to confirm whether this is still a kosher strategy but no one over there seems to have heard of it. They suggested asking an insurance company. Guess that would be the logical next step since they are the ones selling this, though an insurance broker who could arrange the two sides (insurance and annuity) from the required two separate companies would also likely be a good source.
Overall it seems that this could form part of the low-risk part of a retirement cash flow, replacing T-bills or money market funds.
The concept is relatively straightforward. Here is an excerpt from the research paper titled Mortality Swaps and Tax Arbitrage in the Canadian Insurance and Annuity Markets by Narat Charupat and Moshe Milevsky:
"We show that by engaging in seemingly counter-intuitive transactions involving two insurance products, one can create a risk-free portfolio whose after-tax return is greater than that of available risk-free securities. The two insurance products in questions are (i) a standard term-to-100 life insurance policy; and (ii) a single-premium fixed immediate life annuity with no guarantee period.
Consider an individual who invests $100,000 in a fixed immediate life annuity, and then uses part of the periodic income from the annuity to pay the premium on a life insurance policy whose death benefit is also $100,000. This 'back-to-back' transaction, which we shall henceforth refer to as a "mortality swap", will create a constant periodic flow of income and will return the original $100,000 upon the death of the policy owner. This payoff pattern is similar to that of a risk-free investment such as a bank deposit whose principal is redeemed (by the individual's estate) at the time of death."
Another description is here.
The Insurance Logic book provides an an example for a 65 year old female based on actual quotes from insurance companies at the time. The risk-free rate of return pre-tax for the assumed 50% marginal tax bracket was 8% and was described as "much higher than comparable bond yields". The rate of return for this strategy was higher the older the age of the woman, using a joint and last survivor policy with the spouse and using leverage (i.e. borrowing to buy the annuity. The basis for the profitability of the whole thing is apparently that only a "relatively small portion" of a prescribed annuity is taxable.
This strategy came up for discussion in the Financial Webring - see the post by jiHymas on Dec.29, 2005 for an opinion on some cons. I had an amusing time phoning the CCRA today trying to get information to confirm whether this is still a kosher strategy but no one over there seems to have heard of it. They suggested asking an insurance company. Guess that would be the logical next step since they are the ones selling this, though an insurance broker who could arrange the two sides (insurance and annuity) from the required two separate companies would also likely be a good source.
Overall it seems that this could form part of the low-risk part of a retirement cash flow, replacing T-bills or money market funds.
Canada vs UK Tax Comparison Updated for 2007 and 2008
Back in March I posted a comparison of various personal tax rates for Ontario Canada and the UK using 2006 rates. Here's an update based on the 2007 rates.
This chart shows the rates for 2008-09. Not much change , the UK is still lower for every level of employment income except for a narrow sliver at around $75,000 taxable income where the top UK rate of 40% is a tiny bit higher than the Canadian 39.41% rate. Woohoo!
This time I've coloured cells green where one country or the other has better / lower rates. I've made a correction on the dividend tax for the UK - there is actually no exemption, the 10% rate applies as soon as tax kicks in up to the start of the highest band where it becomes 32.5%. This correction changes the advantage such that Canada generally comes out ahead with respect to dividends for almost every income level. With virtually everything else, the UK is better and usually by quite a bit, a seen by the content of the green cells. With respect to capital gains, though the rate is lower in Canada in low to middle income brackets, the availability of an annual exemption of almost Cdn$20,000 probably means the effective tax rate for a large proportion of UK investors is zero. For example, if a £100,000 portfolio has net 10% of £10,000 gains in a year, the £9200 exemption would mean almost no tax to pay. Adding the availability of tax-exempt ISA accounts in which up to £7000 can be placed annually, it is likely that all but the rich won't pay any capital gains tax in the UK.
A lot of UK interest income would likely be effectively tax-exempt within ISAs too, though not dividends because the tax is deducted before payment is made to the investor and it is not recoverable / claimable. The comparative Canadian RRSP account temporarily shelters interest, dividends and capital gains from tax of course. However, when I came to the point in my career/life where I could start saving larger amounts for retirement, my RRSP was maxed out so I had to put most of the annual savings into a non-registered taxable account. I really have been paying tax on those investments. Were I a UK taxpayer, my savings could have been absorbed by an ISA.
The conclusion I reached in March still holds - the UK is the clearly superior country when it comes to personal taxes.
Source for UK tax information: UK DirectGov website.
Source for Canadian tax rate: TaxTips website.
Wednesday, 20 June 2007
Travel Costs for Visitors to the UK / Scotland
CTV's new story Canadian cities cheap in cost-of-living was a reminder and a confirmation of what I experience every day here in Scotland - it's expensive to live here. In the rankings, the most expensive Canadian city is Toronto, 82nd on the list with an index of 78.8 points while Glasgow, near where I live, or "stay" as they say here, is 36th with an index of 88.1. The company that compiled the data is Mercer and more details are here. It's hard to tell how to interpret the index but if it is meant to be linear - i.e. an index number twice as high means twice the cost of living - then I don't think the survey quite captures the reality. My experience is that things in Scotland and the UK cost about twice as much as in Canada, not the 10-15% the Mercer numbers suggest. My rule of thumb is £1 here buys more or less what $1CDN buys in Canada. Clothing, hotels, food at grocery stores or in restaurants, gas (petrol), golf - just about everything is costlier (The only thing about the same price is booze - it is an essential of life here - most Scots can outdrink Canadians by a mile!). The pain has been lessening somewhat in the past few months as the exchange rate has fallen from around $2.30/£1 to about $2.10 but travellers and vacationers be forewarned in your budgeting.
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