Wednesday 26 October 2016

Work for your passion or for money?

Recommended reading: "Don't do what you love for a career - do what makes you money" by Catherine Baab-Muguira.

It's a timely rebuttal to the rose-coloured glasses view that you should follow your passion and only work at something that you love. Baab-Muguira is right with respect to 99% of the population. No job is perfect and no job is without considerable hassles. Very often one discovers that the "passion" fades. Circumstances can and do change. Let's face it, humans are built to be adaptable. Almost all of us are not so gifted at anything that our legacy to the world and our happiness is uniquely tied to one job, occupation or career.

My wife is a perfect example of what can happen when you start a job for money. While in secondary school she wanted to study languages and possibly be a translator. The family situation did not permit this and she was obliged to go into something practical, which would help support the family (this being the bygone era when kids were expected to contribute financially as soon as they could work). That undesired, unsought occupation was teaching. Guess what, by determination and hard work (e.g. taking extra courses necessary for advancement while having two children) she got really good at her job. So much so that she rose to become principal of a primary school. She also learned to love the job. So much so that she worked on for a year and half beyond the age at which she could retire with full pension. And the languages since she retired? Nope, she has not gone and done it. She's more interested in our grand-children.

Retirement is no uninterrupted orgy of selfish passionate pursuits either. The phase of not being able to do whatever the heck you like never arrives, not even in retirement. You can do more of what you want to do and less of what others want you to do with financial independence, but as long as there are other people around, starting with family, and extending to whatever groups you belong to, the mix of good and bad, success and disappointments, is always there to contend with.

Saturday 21 May 2016

Fraser Institute Trying to Damn the CPP with Faint Praise

The Canada Pension Plan will generate only a 2.1% real rate of return for Canadian workers starting out today, concludes Rates of Return for the Canada Pension Plan (May 2016) by Jason Clemens and Joel Emes of the Fraser Institute. Therefore, we Canadians seem to be invited to further conclude (given the Fraser Institute's past attacks on the idea of expanding the CPP), that's a very poor investment and therefore a good reason for Canadians not to support expansion of the CPP.

Telling half the story truthfully is a sly way to debate an issue. Clemens and Emes appear to have crunched the numbers properly. Here's what they forgot or neglected to say.

2.1% compared to what? - For CPP to be judged as poor, it needs to be compared against a realistic alternative that covers both the savings phase and the retirement phase of life, such as an RRSP and a life annuity. I calculated and posted such a review in 2015 and found that the relative attractiveness of the CPP varied enormously according to whether the person is a man or woman, single or married, and self-employed or an employee. Married women employees benefit most from the CPP, enjoying the equivalent of a prospective lifetime guaranteed real return of 5.1%, while single self-employed men would get only about 1.1% return. The biggest difference arises from the fact that employers pay half the contribution on behalf of employees while self-employed pay the full shot.

Managing investments yourself vs Total auto-pilot of CPP - It's easy to say you can beat 1.1%  or even 2.1% real return investing money in an RRSP yourself without breaking a sweat but consider:
  • Will you with absolute regularity for 39 years without fail save out of your income to accumulate investment funds like the CPP imposes automatically, or will you like most people find a more pressing use for your pay, especially early on in life, and only start to save seriously when the reality of retirement stares you in the face? Starting to invest late means needing to achieve much higher returns since you miss out on the power of long term compounding.
  • Will you then invest wisely, maintaining a sensible strategy of diversified low cost funds, or instead like most individual investors, buy return-sapping high-cost funds that are offered by salespeople disguised as advisors, or chase returns and hot ideas that only occasionally pay off? Will you properly compare the riskiness of your portfolio, probably containing a lot of riskier equities, to the lowest risk triple A guarantee of the Government of Canada? To be comparable risk, you would need to invest in Government of Canada bonds, which currently yield a nominal max of 2% (on long term bonds), or about 0.3% after the latest 1.7% inflation. And how much is your time and effort worth to do all this in comparison the fully automatic zero effort required by you for the CPP?
CPP extras that are difficult to price but very valuable - As my above-linked post mentioned, CPP also has bundled into it disability benefits, survivor children's benefits, survivor spouse benefits, a death benefit.

True inflation protection - Only the CPP offers true inflation protection, i.e. CPI-linked increases. The best fudge available in the annuity market are annuities that ratchet up by a pre-set amount you choose, like 1.0, 1.5 or 2.0%. You have to guess at what future inflation will be. Guess too high and you over-pay un-necessarily, or guess too low and you still lose to inflation. Either way the uncertainty about inflation is not removed and your retirement annuity income does not keep in step with inflation, drifting further and further apart as years roll on and the differences compound.

Hilarious irrelevant comparisons - The Clemens/Emes report also details some laughable calculations about how people who started receiving CPP back in the 60s and 70s have been getting phenomenally high returns, mainly because they did not contribute long but get full benefits. As if that should make present-day contributors jealous and angry to not want to pay any more - i.e. not support an expanded CPP because they would be handing even more money to retired rich so and so's. Well, we should first note that anyone retiring at 65 in 1969 on CPP launch would now be 112. They're all dead. The ranks are pretty thin at the older higher return end. There's only one living 111 year old Canadian and one of 110. Besides, what happened is done, We must look forward. And, individuals can do much worse or better than the average - die soon after after retirement and get a tiny of your money back, live long beyond the average life expectancy and your rate of return rises to very high amounts. If the report authors are inferring inter-generational inequity needs to be fixed, then the payouts to past retirees needs to be reduced. It is not by stopping CPP expansion.

Most proposals for CPP expansion are that higher benefits come only when they have been earned through higher contributions. That would be fair. You get back for what you put in and you are not paying extra for someone else already a recipient to receive more.

When the full context is given and the whole story told, the CPP sure looks a lot more reasonable than a single low return number seems to imply.

Saturday 30 April 2016

Canadian Securities Administrators Ignore Rule #1 about Rules

What's rule #1? A rule is not a rule unless it's enforced. Any two year old knows that if the parents say to do or not do something, unless there is a sanction that is actually applied, you can behave as you want. And that's what kids do. The rule doesn't actually exist in any practical sense.

The CSA is exactly in that situation as the "parent", supposedly regulating financial firms and their employees dealing with the public, getting them to behave honestly and responsibly towards the public. The Small Investor Protection Association recently released a shocking and dispiriting report Unpaid Fines: a National Disgrace, which details the almost non-existent collection of fines imposed on financial miscreants in recent years. As the report says, this abysmal performance undermines the whole system of regulation. Investors will lose confidence. The financial industry will not feel deterred against misdeeds.

Such utter neglect of the CSA's mandate is especially annoying in the light of its recent excellent proposal to institute a best interest standard (as opposed to the weak suitability standard now in force) for financial advice on the investment industry. That proposal, even if implemented, won't have much real beneficial effect unless enforcement takes place. It's high time for the CSA to start doing its job properly. Just ask any parent.

Thursday 7 April 2016

Visitors to Canada Beware - You might need a "not-a-visa" eTA

Formerly, Brits, like my wife, travelling to Canada for a visit needed only their passport and no visa. That has changed, as from March 15, 2016 (with an interim grace period till the fall of this year) she and other foreign nationals, except US citizens, will need an Electronic Travel Authorization to enter Canada by air. The eTA is not formally a visa but it sure feels like one to my wife, since after the grace period, without it you don't get to board the plane.

Some key things facts I discovered digging through the website and phoning a Canadian consulate:
  • you can apply in advance, even before you make a booking or plan a trip
  • the eTA is good for five years, but ...
  • if you need to renew your passport before then, you need to buy ($7 now) a new eTA because the eTA is linked to your passport number
  • the eTA is stored in the Canadian government's vast databases so that you do not need any piece of paper to prove you bought one (of course, it's gonna be your problem if you say you bought one and may even have the printout but for some reason the database says no, you don't)
  • it supposedly takes "minutes" to apply online and receive an email confirmation i.e. make sure you know where your airport internet access is or your phone has access just in case
Welcome to the new world of travel to Canada!

Saturday 26 March 2016

Yikes! Federal Budget Revives Support for Toxic Labour-Sponsored Funds

It was a shock to see the recent Canadian Federal Budget measure to restore the 15% tax credit to encourage retail investors to buy into a proven loser investment vehicle, Labour-Sponsored Venture Capital Corporation funds. I, like almost every other investor in these toxic funds, lost a lot of money in their first incarnation during the tech boom years. The pleasure of a one-time tax credit is sooner or later replaced by the grinding regret of declining asset value and often extreme difficulty in redeeming the investment to limit losses.

I said it four years ago when I slammed labour unions in Labour-Sponsored Rip-off for aiding and abetting such LSVCCs, and I'll say it again: stay away, don't consider for a second investing your money in them.

Look at the track record of one such surviving company, Covington, whose latest annual report tells a sorry numbers tale:
(click on image to enlarge)
Note how the benchmark average, the Retail Venture Capital Index that measures all Ontario-based LSVCCs, has a negative compound 10-year return (which understates the poor performance since it no doubt excludes all the worst loser funds that have disappeared along the way).

Even people in the investment industry mince no words about LSVCCs, viz the Investment Executive article linked-to at the top, where Ian Russell, president and CEO of the Investment Industry Association of Canada is quoted: "All our research shows these funds are ineffective in raising capital for successful small businesses, so that's a disappointment," Russell says. "The labour-sponsored venture capital funds were a disaster in the past." They did no good for investors or small business. What is the government thinking, anyhow?

Tuesday 26 January 2016

BMO's SmartFolio Robo Investing Service Offers Convenience but Needs Improvement

BMO's SmartFolio was officially launched Monday January 18th. Thus, one of Canada's major banks has finally entered the automated ETF portfolio investing space but its offering, while slick and convenient, needs improvements on costs, portfolio construction, client assessment and account types offered. SmartFolio appears to be a "good-enough" offering trading on the solidity and trustworthiness of BMO's name, instead of being the leading edge product, in order to prevent customer leakage to competitors like Wealthsimple, National Bank, Canadian ShareOwner and others..

Higher Account Fees - The account management fees are a bit higher than competitors like Wealthsimple and WealthBar as the wire story on the new service says. The 0.1% or so extra may not seem like much but it adds up over the years. For instance, a $100,000 lump sum invested at 5.0% vs 5.1% results in a difference of about $8,000 more ($346k vs $338k) for the higher return after 25 years. But the key question for BMO (and all the robo services), is what do you get for fees of 0.7% on the first $100k invested, scaling down to 0.4% on the assets over $500k (see BMO's disclosure document here)? Is it really worth the money given the inexorable reduction in net investor return from fees?

Not using Lowest MER ETFs - Another bit of extra drag on net investor returns will come from the embedded fees of the ETFs within the portfolios. First, instead of using the broad array of ETFs available in Canada, BMO has stuck to its own ETFs, which in some cases charge higher MERs than equivalent alternatives.

Portfolio Construction
Forgetting the KISS (Keep It Simple Stupid) principle - Second, the portfolios include multiple (up to five) different bond ETFs that put together more or less amount to the broad bond market. Why bother with several when there is likely, in total, to be little or no difference with a single broad market bond ETF? Is this just a marketing ploy to make investors think some sophisticated strategy is going on? The Income portfolio (30% equity, 70% fixed income) has on the fixed income side Canadian Mid Provincial Bonds (MER 0.25%), Short Corporate Bonds (0.12%), Mid Corporate Bonds (0.30%), Long Federal Bonds (0.2%) and USA Mid Corporate Bonds hedged to CAD (0.25%). The weighted MER will exceed 0.2%. This is more than BMO's own broad bond ETF (symbol ZAG) with its 0.2% MER. Worse, SmartFolio could have opted for Vanguard Canada's broad bond ETF (symbol: VAB) with a 0.14% MER or the even cheaper iShares offering named in the conclusion below. There goes another constant 0.1% drag on returns for the investor.

An oddball Fixed Income holding - Finally, why include the USA Mid Corp Bond ETF (symbol ZMU) at all? It is the largest chunk of all the fixed income side in the portfolios. The inefficiency of the CAD hedging operation introduces a significant return drag on top of the higher MER that appears to total about 0.5% per year based on the gap between the index return and fund's NAV return. The reasoning for its inclusion no doubt is higher yield than equivalent credit risk Canadian bonds.

However, the credit quality is much poorer; despite being 100% investment grade, is nowhere near the quality of VAB. ZMU has about half its bonds in the lowest investment grade of BBB and only 2% in the highest AAA group while VAB is the opposite - 48% in AAA and only 8% in BBB. In my view the role of bonds in a portfolio is safety and stability. The active management by BMO in picking ZMU is not appropriate, especially when one of the SmartFolio portfolios is named "Capital Preservation".

No real return bond holding - I would suspect, or hope, that it's because the portfolios are meant to be good-enough for any type of account (non-reg, TFSA, RRSP etc) that one of the best diversifiers - real return bonds - is not included in any portfolio, not even the capital preservation account where such bonds' inflation matching properties would be extremely valuable. The problem is with taxable accounts since the inflation ratcheting of the principal is subject to annual taxation, despite not being received till many years later at maturity.

No tailoring of ETFs to account type - The real return bond issue is a symptom of the good-enough approach. There's no tailoring to factors related to account taxation. As I documented in detail on HowToInvestOnline in ETF Asset Allocation across RRSP, TFSA and Taxable Accounts, foreign witholding taxes significantly reduce returns for certain ETFs depending on which account holds them. The ideal robo-advisor should tailor overall portfolios across account types and advise clients with this tax maximization knowledge embedded in it.

No Real Estate at all - None of the portfolios includes any real estate REIT ETF. That's a standard part of any but the most basic portfolio.

Low Volatility Equity a plus - On the plus side, BMO has chosen to depart from using only cap-weighted equity index funds by using its Low Volatility ETFs for part of the Canadian (symbol ZLB) and the US holdings (symbol ZLU). As I have related on HowToInvestOnline, the research says the low volatility strategy works.

Why use specialized ETFs? - But why put in the equity portfolios a couple of specialized ETFs - the USA High Quality Index (symbol ZUQ) and the Developed market Global Infrastructure fund (symbol ZGI)? Basic good-for-anyone portfolios should use broad asset class ETFs, not specialized ones. The specialized ETFs also have higher MERs.

No Emerging Market equity in most of the portfolios - Only the two most equity-laden portfolios (70% equity and 90% equity) include any Emerging Market at all.

Low volatility equity funds make up a substantial proportion of of the equity holdings - Hooray! The inclusion of BMO's low volatility Canadian (symbol ZLB) and US (Symbol ZLU) as mainstream holdings is a positive differentiator compared to other rob-advisors who use only cap-weighted funds

Account Types Offered
Insufficient range of account types - SmartFolio doesn't (yet?) offer the full range of account types. Notably and critically absent are RESPs and all the post-retirement types like LIFs, RRIFs, LRIFs. This factor makes SmartFolio an impossibility for me. SmartFolio is for younger non-retired people only whose goals do not include education investing for kids.

Client Assessment
Too little account choice advice - The start-up questionnaire provides no input to suggesting what type of account the investor should choose. It's only use is risk assessment to select one of the five model portfolios. The next step is to choose which type of account to create - TFSA, RRSP, Spousal RRSP or Taxable. The screen capture image below is the only guidance provided. The online chat person accessed through a click button can only give general advice and can provide no guidance on tax choices.
(click on image to enlarge)

Skimpy know your client "risk assessment" questionnaire - BMO is very much like every other Canadian robo-advisor in asking new investors to answer a cursory - in BMO's case, 10-question - risk questionnaire, the results of which slot the investor into one of five model portfolios. Why does BMO, with all the resources at its disposal, not find the wherewithal to apply industry best practices for tailoring a portfolio to an investor, as exemplified in questionnaires such as IFA's here (25 questions) or FinaMetrica's here (25 questions), or even a blended combination that takes account of all three of the investor risk dimensions - risk tolerance, risk capacity and risk need? At the end of such questionnaires, the range of recommended portfolios is much wider than BMO's minimalist five. (It's ironically hilarious to contrast this there-are-only-five-types-of-investor outcome with the Ontario Securities Commission's new video earnestly informing us that they have just discovered that Every. Person. Matters.)

Bottom Line: I'm not trying to pick on BMO, because all the Canadian robo advisors appear to have similar offerings, but considering the extra robo fees / costs and the feeble amount of personal situation tailoring carried out, the robo solution is just not worth it. Investors would be better off in a self-directed account in the two-fund Lifelong Portfolio, which puts half the invested money in each of a broad market equity ETF, like the iShares S&P/TSX Capped Composite Index ETF (TSX symbol XIC, MER 0.06%) and a broad bond fund like the iShares Core High Quality Canadian Bond Index ETF (symbol: XQB, MER 0.13%). 

Saturday 2 January 2016

Risk and Complexity of Securities and Funds - a Promising Proposal

How does one know how risky an investment is, whether it's a stock or bond, a mutual fund or an ETF? How complicated and hard is it to understand or predict what the investment's return might depend on? For the retail investor, the basic answer is that you're on your own, having to wade through the security's Prospectus, which for Canadian securities can be found in SEDAR. Trying to compare several alternative possibilities that way is such a nightmarishly time-consuming task that most people likely don't even bother. It's one reason that as my investing years have accumulated, I am more and more oriented to the simplest possible investment structure.

The provincial regulatory authorities under the umbrella of the Canadian Securities Administrators have tried - ineffectually - to help by mandating fund risk rating, the latest revision and supposed improvement exercise of which is currently underway (see Ontario Securities Commission website here). But it relies only on one risk dimension - price volatility - which isn't nearly broad enough to capture real investment risk as I wrote in my last post referring to Howard Marks' fantastic discussion of risk.

Along comes six researchers from Singapore Management University with a promising proposal in A Risk and Complexity Rating Framework for Investment Products, an earlier free version being available here and a $15USD December 2015 version on the CFA website here. Their scheme has been built to work across more or less the whole swath of investing products and asset classes and it looks reasonably workable. In effect, it seems to condense the Prospectus into a rating.

Most important, it seems to capture a much broader characterization of risk and product complexity. Risk, for instance, includes ratings for six items - price volatility, liquidity, credit, duration / cash flow, leverage and diversification. That's a pretty good start, though I would be interested to see them add foreign currency risk and what might be called manager risk, which would assign a higher rating for actively managed funds over index funds, to reflect the fact that most active managers under-perform. As well, some way of including unexpected inflation risk would be very useful, though I cannot think of an easy way to put it in terms of their scheme method.

The rating of complexity is an intriguing proposal and something I like. If a financial product is too complex for me to understand, how can I know how it should fit into my portfolio? It is also likely to disappoint in some way, either by jumping up and biting at the worst possible time, or simply by excessive fee leakage. As the authors point out, "More complex structured products, generally with higher margins ...". Anything more complex than perhaps 3 on their 5 point complexity scale probably should not be available to the average retail investor. It is worth noting the authors' remark that institutional investors, who would likely have the expertise to understand complex products, generally avoid them and stick to basic products. Probably it's because they do understand the products that they avoid them.

The final reality the researchers recognize and try to incorporate is that the behaviour of securities in a crisis such as 2008 can change, notably that correlations of asset types can converge, that liquidity and leverage can have exaggerated effects.

The results of their calibration testing using 100 different funds ended up classifying some of the money market and bond funds with a higher risk rating - at 4 - than a few of the equity funds - at 3 out of 5.  That's an intriguing and useful result, a counter to the too simplistic notion that bonds are "safer" than equities. It sure would be interesting to see our Canadian regulators test the paper's method on Canadian funds and securities. I could foresee a regulatory website where any security's official risk and complexity rating could be found and compared to other user-selected securities.

Thanks to the indefatigible Ken Kivenko, a member of the OSC Investor Advisory Panel, for bringing this fascinating paper to my attention. Go for this one, Ken! According to the paper, no other country has such an investment product rating scheme yet. Maybe Canada could be first in an investor protection move for once?

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