Book Review: The New Investment Frontier III by Howard Atkinson

This is the 3rd edition of Howard Atkinson's book on Exchange Traded Funds. The fact that a 3rd edition was published in 2005, following so quickly on the first edition of 2001 and the second in 2003, reflects the enormous growth and success of ETFs as a new investment vehicle. There's a good reason for that success and Atkinson, with writing assistance from financial journalist Donna Green, explains the what, who, why and how of ETFs with much practical detail, balance and thoroughness. This book is a detailed compendium of ETFs, tailored for Canadians through the inclusion of a great deal of pertinent and useful Canadian tax information, probably everything an individual investor could need or want to know.

The thorough treatment is accorded not just to the tax implications. The same completeness characterizes the rest of the book. The book begins with a brief explanation of what ETFs are and why index investing makes sense, why passive index ETFs offer better returns than actively managed mutual funds and even index mutual funds. It does a lot of comparison to mutual funds, especially useful since that is the alternative for most investors, and shows how ETFs are more tax efficient and lower cost than mutual funds. He demonstrates the tremendous negative effects that higher costs have on an investor's net return returns over the long run. The balance I mentioned above is evident in this section since Atkinson lists such advantages as mutual funds do have over ETFs - namely ability to invest small amounts on a regular basis, automatic dividend reinvestment, no trading commissions on purchases or sales (the term commissions excludes the onerous and pernicious deferred sales charges on many mutual funds) and the availability to obtain certificates to be able to use the fund holding as collateral. There is lots of explanation and discussion of the merits of different indexes that many ETFs track, very handy for making informed decisions about one's asset allocation choices.

Atkinson throughout the book names products, ticker symbols and companies, giving references and copious weblinks; it's a very practical book. Probably, it would be possible to amass through the Internet all the same information that's in this book. However, it would take a huge amount of time and effort. Some of the more arcane detail in the book - things like the effect of trading by institutional investors - comes from Atkinson's position as an industry insider. He works for, or did at the time of publication at least, Barclays Global Investors Canada, which offers many of the leading ETF products. However, it is worth saying that the book does not read like an infomercial for Barclays - all the competing ETFs and companies with their various flavours are reviewed in a factual manner.

One area in which I find Atkinson goes a bit over the top is the discussion of how ETFs are perfect for doing tilts, style weightings, sector rotations in a portfolio termed the Core and Satellite (pages 93 to 122) and then how ETFs can support those who like to do technical analysis (page 123). I think Atkinson knows better since he includes a note of caution that says those tactics really amount to market timing and he has put forth the evidence right at the beginning of the book of the book that market timing doesn't work. Just because ETFs can be (mis)used that way doesn't mean he should tell everyone how to misuse them. He even quotes John Bogle, founder of Vanguard Group, saying that ETFs are like giving investors a loaded shotgun. Yes, indeed! This part of the book is the explanation of how the shotgun can be used, instead of for hunting geese, ducks, or partridge, as it was designed to do, for blowing off your own financial foot. Effectiveness isn't always the test of whether you should be doing something. Atkinson isn't completely wrong - there are two tilts, justified by proper peer-reviewed financial research, that produce greater risk-adjusted returns. These are small capitalization and value (as defined by price/book value only) companies/equities, known as the Fama and French Three Factor Model (see this Wikipedia entry for a brief explanation and link to the scholarly research article). There may other tilts and it is possible that they are beneficial but they remain to be proven so the average investor is best to stay away.

The chapter on using ETFs with a financial advisor provides an excellent introduction to the alternative types of fee arrangements that are possible. It shows how ETFs enable a convergence of interests of the advisor who charges fees (instead of collecting commissions and trailer fees from fund companies) and of the investor. The fee-based relationship with ETF investments can save the investor money compared to mutual funds and provide more comprehensive advice to boot. This happy result is illustrated and explained with real examples of advisers citing hard numbers. Atkinson, however, says forthrightly that for total holdings of under $100,000 the investor is better off with a DIY approach or simply the famous Couch Potato Portfolio.

Quotes

• ''... some active managers do beat the market, sometimes even after costs, but the trick is to find them before they do it.'' before, not after, is indeed the key; manager out-performance does not typically last so you cannot reliably use the past good performance to pick the future winners
• ''The more you pay in management fees and expenses, the less you get in returns. Period. Always scrutinize MERs.''
• ''The capital gains distribution and consolidation confuses many investors and advisors.'' investors, ok, but advisers too? ... a good example arguing for mandatory formal training for advisers, n'est-ce pas?
  

The biggest negative of this book results from the passage of time and the inevitable hazard that information has become dated. The explosion of ETFs and similar new products such as Exchange Traded Notes (ETNs) has continued unabated. Of particular note to Canadian investors are:

• the exit of TD Asset Management from ETFs in March 2006 and replacement by the e-Series index mutual funds (which make a reasonable alternative to ETFs for investors with smaller portfolios)
• the entry of Claymore Investments Inc in September 2006 with a variety of rules-based such as fundamental weighted indices

My thanks to Mike at the publisher Insomniac Press for providing a free copy of the book to review.

I look forward to version four of this very useful book. Four and a half out of five stars.

You can buy it at Chapters.ca.

As Fear Grips the Market, Bargains Appear or Are They Bargains?

This morning, shares of Northern Rock (Ticker LSE: NRK), one of the biggest home mortgage lenders in the UK (18.9% of the market according to the BBC) are down 24%. That's on the day only. The 12 month decline is 41%, all of it since March this year. The company is caught in the crosswinds of the mortgage lending squeeze, though it has itself no direct connection with any of the sub-prime mortgages in the USA. Is this one of those bargains we dream about, a solid company whose shares are dragged down by external events and which will recover when the storm passes? Check out BBC reporter Robert Peston's blog posts on NRK and why central banks are bailing out commercial banks and the comments, many of which suggest NRK has its own UK sub-prime mortgage over-lending.

Is the UK government likely to allow a company with that proportion of the market to fail, especially a company that deals primarily with consumers i.e. voters? (reminds me of the old saying, if you owe the government a million dollars and can't pay, then you're in trouble, but if you owe the government a billion dollars and can't pay, then the government's in trouble). The Aug. 20 post provides a good explanation of how the US sub-prime mess has spilled into Europe.

Capital Losses and Superficial Loss Rule Using an RRSP

Investoid posted a comment that is worthy of a new separate post. In it he says he was not aware of the tactic to sell a holding in an open taxable investment account to lock in a capital loss then to immediately re-acquire the same holding inside an RRSP.

Oops, should have noticed that in the document before posting. There's a rule of investing - if it looks too good to be true, it probably isn't. It applies here. Or does it? Let us say we have conflicting opinions, including from the CRA itself!

This extract from Chapter 5 of the CRA's T-4037 Capital Gains Guide seems to say no, you cannot do that, the superficial loss rule applies. It states:
''you, or a person affiliated with you, buys, or has a right to buy, the same or identical property (called "substituted property") during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale ....
Some examples of affiliated persons are:

• you and your spouse or common-law partner;
• you and a corporation that is controlled by you or your spouse or common-law partner;
• a partnership and a majority-interest partner of the partnership; and
• after March 22, 2004, a trust and its majority interest beneficiary (generally, a beneficiary who enjoys a majority of the trust income or capital) or one who is affiliated with such a beneficiary.''

In other words, the RRSP is a trust and you are the beneficiary so the CRA says no it isn't allowed. Probably, people started taking advantage too much and the CRA changed the rules in 2004 to stop it.

That's not the end of the CRA story, however. It doesn't actually say trust = RRSP and you = beneficiary. In my zeal to get a definitive confirmation I called the CRA helpline. After a good long wait to get to a rep and then again while he went off to consult with someone, the answer was, the CRA says yes it is allowed, and quoted me from an internal document #2001-008077, written in 2001. When I expressed my doubts and asked him to re-confirm, since I was about to post this on the Internet and I am not out to embarrass the CRA (really!), he said he would get back to me by next Tuesday at the latest. (For those who think badly of the CRA for this, ask yourself whether a service rep at a typical corporate helpline, say Bell Canada's, would even consider looking further into such a matter.) Wouldn't it be nice if the CRA added a specific mention of RRSPs (and RRIFs since they would presumably be similarly affected) to their Capital Gains guide regarding this matter?

Web sources don't seem to agree either, perhaps no surprise. Here's a brief sample of results from a bit of Googling:

No, It is Not
AIM Trimark's Capital Loss Planning
Posting in Canadian Business forum in April 2006
Another posting in Canadian Business from Jan. 2006 that mentions an Altimira Funds publication saying No as well.
CIBC Wood Gundy article on Tax Loss Selling with no date and the added footnote, hilarious in light of the absent date, ''The information contained herein is considered accurate at the time of posting.''

Yes, It is OK
Milestone per the previous post (April 2002)
TaxTips.ca. And it's one of my favorites!
Advisor.ca column by Jamie Golombek (a VP at AIM at the time of writing in Nov. 2002)
Canadian Shareowner article from NovDec 2000
Bylo posting of Jonathan Chevreau article in the National Post from Nov.21, 2000
Sterling Mutuals article Avoid Superficial Losses in Nov.2001
Institute of Chartered Accountants of BC Tax Traps and Tips article Nov. 2003

My bet is on the ''not allowed'' side. Any opinions? I suspect all this is to re-discover the sad truth of stale content on the web and the fact that one cannot necessarily believe everything that is written, even from reputable organizations.

Thanks, Investoid for the topic!

Update Oct.10 - Finally got a call back from Revenue Canada and the answer is now NO, you are not allowed to do it, or more precisely, your capital loss will be declared superficial and denied on your tax return. The relevant subsection is 251.1 (g) of the Income Tax as modified in 2005.

Tax Minimizing Strategies from a Financial Planner

Came across this interesting summary list of tax strategies for Canadians on the website of Milestone Investment Counsel. Good stuff!

Mutual Funds and Total Expense Ratio (TER) vs Management Expense Ratio (MER)

Management Expense Ratio (MER) is the overhead cost of running a mutual fund. It is required to be published by mutual fund companies in Canada, which is good since high cost mutual funds return less to the investor. In fact, the simplest way to shop for a mutual fund is just to find the one with the lowest fee since that is apparently an effective way to find the ones which will give an investor the best return.

But the MER doesn't include all costs as the Investment Funds Institute of Canada (IFIC, the mutual fund industry trade body in Canada) explains in this FAQ on fees. Some of those costs can substantial, further reducing returns to an investor.

Notable excluded costs are:

• brokerage commissions for trading; with turnover in funds up to 80% in a year, that can add up and reduce the performance of the fund (See The True Cost of Funds on Fundscope)
• sales charges, either front-load or deferred/back-end; actual performance for the investor is reduced to the extent that these charges apply - the front-load negative impact is obvious but it has been found that the deferred charges usually come into play since typical mutual fund investors apparently have short holding periods, averaging perhaps 3 years, while charges apply typically for six years.
• miscellaneous other charges, that may or may not be levied, such as RRSP admin fees, account opening fees, transfer out fees, short-term trading fees.
• trading impact costs aka the buy-sell spread, an opportunity cost, explained in The Hidden Costs of Mutual Funds by Milestone Investment Counsel
  

Note that yours truly discovered that the above IFIC FAQ said the direct opposite - that trading fees ARE included - but a phone call to the IFIC reached a certain Dennis, who said they are NOT included in the MER. He promised to correct the FAQ within the day. Hmmm, the document was dated 2005! Either no one reads the IFIC website or many people have been misled - not good. ... Update Friday, September 14th: The IFIC FAQ document still has not been updated to correct this error. Later on Friday, Dennis says the updated document will be posted next week. Update Oct.10 - the link to the IFIC FAQ doesn't work any longer. There has been a wholesale change to the IFIC website and the FAQ seems to have disappeared altogether. Better no information than wrong information, I suppose, but it isn't very helpful either way.

Nor are brokerage fees included in US published MERs, which are often called simply Expense Ratios. However, Total Expense Ratio does include include it - See this description of Total Expense Ratio in the Investopedia. In the UK TER also includes brokerage commissions and the information is usually published. Out with MER, bring on TER.

Consultants Advise on Ways to Pluck Us Financial Chickens

Came across this fascinating study by the hot-shot consulting company McKinsey as publicized in a pr piece on the CTV website. The study discusses retirement anxieties of consumers in the United States, at least some of which one might presume would also hold true in Canada, and suggests ways for the financial industry for ways to either better serve us consumers, or if you have a suspicious outlook, to pluck more of our money. It's interesting to see how the industry looks at us consumers.

The report contains this too-true observation about the financial industry, which is almost certainly also the case in Canada and probably the UK:

'' ... our research uncovered a widespread belief among consumers that
financial advisors are primarily interested in "pushing products," as opposed
to providing unbiased retirement advice, and are placing their own
compensation objectives above the interests of their customers.''

It says that comprehensive (holistic and integrative covering all the financial elements not just one at a time), high quality (knowledge of products and alternatives) and neutral/unbiased advice is lacking, with the exception of independent financial advisers. The attached chart from the McKinsey report is spot on as far as I'm concerned. Let's hope that financial companies take the analysis to heart and improve those dimensions of their current offerings. The thought struck me that the report doesn't say anything about the Internet and bloggers - perhaps the growing popularity of such information channels partly reflects the inadequacies of the financial industry.

The recommendations include simplifying offerings but then gives an example of a structured product that sounds much like index linked GICs, something that is generally not a good deal for the investor. Simplification is a laudable aim but it should not be a cover for products that raise costs for the consumer and extract more hidden fees and commissions. One major recommendation is to push reverse mortgages as a way for retirees to stay in their homes while using some of the equity to fund retirement. If that is to be the aim, the high costs of reverse mortgages would have to come down.

Book Review: The Canadian Retirement Guide by O'Donnell, McWaters and Page

The Canadian Retirement Guide, published in 2004, aims to be a comprehensive handbook on aging, retirement, care-giving and health by setting up ''... a process by which we can plan for retirement as a family, taking into consideration the retiree, the spouse and those who depend on them''. The book is like a 298 page checklist of questions to answer, of issues to consider and of situations that may arise as one gets older. The net effect is to raise awareness rather than to offer enough information to develop a solution. Particularly in the legal and financial sections, there is the constant refrain, ''go consult a specialist'', and indeed, there are thirty pages of appendices with checklists of information to prepare to meet with a financial advisor or lawyer and questions to ask of them. There is almost no reference information to specific books or websites that provide further detail on the topics covered. This book is somewhat like the old joke about statistics: statistics are like a bikini - what they reveal is interesting, but what they conceal is vital.

Here is a typical example of the level of depth and manner of treatment of subjects. Regarding sex, ''While sexual activity does tend to decline with age, there are tremendous individual differences. Chronological age isn't the critical factor in sexual activity or physical intimacy. Neither age, nor illness, nor dementia necessarily diminishes or extinguishes sexual desire. It's a normal and healthy part of of being human, at all stages of life.'' That's it - no further references, no further mentions throughout the book. Would that be helpful to you?

The book is written by a team of authors, each evidently handling specific chapters in their area of expertise: Jill O'Donnell, a gerontologist and registered nurse; Graham McWaters, from a major financial institution (un-named); John Page, a financial planning advisor and holder of the Certified Financial Planner certification which I mentioned in my recent post on financial planners in Canada; with contributions from Rev. Dr. George McClintock, a United Church minister who specializes in the pastoral care of elders (I don't know why but that word elder grates on me), Barbro E. Stalbecker-Pountney, a lawyer with special interest in elder issues and estate practice, Philip Crawford, an undertaker, and finally, Rick Page, another financial planner (but minus the CFP).

Subject Matter Covered

• growing older and life planning, personal mission statement (yup, they use that corporate jargon)
  
• health of body and mind, stress (unfortunately, neither pets, nor sex are prescribed as stress-relievers!)
• housing situations - house, apartment, retirement homes, living with family
• relationships with family, second marriages
• legal - wills, power of attorney, trustees, executors, family law
• death - funeral, burial, cremation
• care giving and dementia
• financial planning (about half the book) - financial plan, investments, diversification, risk, life & disability insurance, taxes, pensions, estate, annuities, reverse mortgages, financial advisers
  

Quotes

• ''... the longer you live, the sooner you are going to die.''
• ''If a family member's irritating habit is not destructive, try not to worry about it.'' (p.80) (of course, this stress-saving tip only applies to older folks ... ;-)
• ''A will speaks for you from the grave; powers of attorney speak for you from your hospital bed.''

Surprises

• most old, retired people, oops sorry ''elders'', live independently; less than 10% are in care or homes (p.66)
  
• a person who is paid to care for someone may not legally have power of attorney for that person (p.86)
• a guardian outranks someone with power of attorney (p.87)
  
• under family law, if you have supported someone, the obligation to continue the support will survive your death ... in other words, your cannot put whatever you please in your will and expect that it will happen, the courts may over-rule what you say (p.93)
  
• along the same vein, your executor is not legally bound to dispose of your household and personal assets as per your will (p.91)

My Take Away Action Points

• pre-pay up to $15k in funeral expenses, known as an eligible funeral arrangement (EFA) in tax-code speak, to a funeral home for funeral expenses; interest on the $15k, which is invested in GIC, is tax-free (p.105)
  
• continue writing this blog for mental stimulus, since it is not known if Alzheimer's is caused by genetics or whether deliberate mental activity can stave it off (p.142)
  

There are certain inaccuracies or mis-wordings in the financial sections that diminish the usefulness of the information, for it does provide a reasonable introductory over-view. For instance, this statement, ''If your portfolio were 100% fixed-income and interest rates dropped, your whole portfolio would suffer. '' Huh? If interest rates drop, then the market value of existing fixed income holdings would RISE and the value of your portfolio would increase, which is the opposite of suffering. Probably, the author means that over time as the fixed income investments matured and needed to be reinvested, the income stream from interest payments would drop and that would cause suffering for a retired person who lives off that income. That's exactly what happened through the 1990s. Unfortunately there are a number of other instances of sloppy language. Was there peer-review prior to publication that might have helped clear these up?

Many thanks to Mike at the publisher Insomniac Press for supplying a copy of the book for review.

My rating: 3 out of 5 stars.

You can buy it at Chapters.