Sense and insight from Ontario Health sector pension fund CEO

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

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

There are also some thoughts useful to individual investors:

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

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

Good news for investors - BlackRock Canada slashes fees on key index ETFs

iShares Canada ETF providers BlackRock have just announced immediate significant cuts to nine mainstream index ETFs, covering Canadian, US, developed country market and emerging market equities, as well as several bond funds. Morningstar compares the old and new expense ratios here while the BlackRock info is here.The reason this is great news for investors was well said by BlackRock itself - every dollar less in expense flows right into the pocket of the investor.

The longer the investment period the greater the impact through the effects of compounding. The cut of 0.20% in the MER of the Canadian Capped Composite equity index fund XIC means, for instance, that a $10,000 investment held thirty years that earned 5.2% net returns instead of only 5.0% would end up being worth $45,758 versus only $43,219, a $2,539 or 5.88% difference. Extend the holding period to thirty-five years and the difference grow to 6.9%.

Though not as powerful an effect of such lower MERs, at current low rates of return on all types of assets, the same compounding math provides a greater relative boost to net returns e.g. change the return pair to 4.2% vs 4.0% and the above calculation makes for $34,358 vs $32,434, a $1,924 or 5.93% difference.

Kudos to BlackRock. Let's hope this competitive move spurs the other ETF providers to sharpen their pencils too.

Investing History Lessons on Emerging Markets, Dividends from Credit Suisse 2014 Yearbook

The annual release of the Credit Suisse Global Investment Returns Yearbook is a delight. As before the free download 2014 Yearbook, written and compiled primarily by London Business School professors Elroy Dimson, Paul Marsh and Mike Staunton, provides unique data - equity and fixed income returns for 114 years across 25 countries - and topical insights - this year on Emerging Markets.

The report is well worth the time for everyone to read, but here is what I found especially noteworthy:

• Emerging Markets equity return volatility has dropped drastically since the 1980s from about 2x developed markets to only 1.1x today. In classic risk terms of volatility, emerging markets are not much riskier than developed markets.
• Correlation of returns has been rising strongly due to globalisation but " emerging markets still offer useful diversification benefits". In other words we should keep an allocation to them in our portfolio. ... but ....
• Canada's equity market is less correlated with developed markets than emerging markets (see chart page 10). In other words, for Canadian investors, it is more important for diversification to have a developed market holding than one for emerging markets.
• Countries with the weakest currencies give the strongest future returns. 
• Stock markets predict economic growth, not the other way round
• Canada's real foreign exchange movement against the US dollar from 1964 to 2013 was 0.0% (see Fig.3 on page 41). Does a long term investor really need currency-hedged funds and their considerable drag that will exact a far greater and far more certain cost on returns?
• Canadian investors seem to be the smartest in the world! In every other country, the buy and hold returns of an index exceeded the dollar / asset weighted returns of investors per the chart below based on this study published on SSRN. The lesson for the investor to avoid under-performing is to maintain a consistent asset exposure. 
• 
• China has given equity investors over the period  1993-2013 negative real returns (see page 42).
• Dividends constitute by far the major part of equity returns over the long run. Per table 1 on page 27, of the total real return on equities averaged over 21 developed countries from 1900 to 2013, dividends provided 4.35% return while the total return was 4.54%! In Canada, the numbers were 4.35% and 5.75%. Message to corporations everywhere - show me the dividend. 

UFile Tax Software Giveaway Winners!

Don't you wish the lottery ran like this? There were five codes to give away for the UFile web version and exactly five comments. So, you smart folks who noticed the giveaway, come and claim your prize:

• canoetoo aka Harold R
• erloo
• skip
• unknown aka Niels R
• Crescent

Would these lucky winners please contact me by the email link in the right hand column of this blog page so that I can send you the access code. Congratulations!

UFile Tax Software Giveaway!

It's tax season and those receipts should be flowing into your inbox or mailbox. Here's an opportunity for blog readers to ease some of the hassle of doing taxes by taking advantage of a giveaway from one of the leading tax software providers. The software will let you prepare and file online electronically on Canada Revenue Agency's NETFILE tax submission service. 

Thanks to UFile, I am giving away five codes for the online web version of their personal tax preparation software for Canadians. That's a value of $15.95.

Here are the details of the giveaway:

• To enter, submit a comment on this post below - Though you don't have to, I'd be interested in your comments on tax prep software since I am again working on my annual review of all the CRA NETFILE certified packages; use a unique name (Anonymous won't suffice!) so I can distinguish people
• One entry per person please
• Entries close Tuesday, March 4th midnight EST
• I'll do a random draw of five (5) names from amongst the entries after the deadline
• Winners will be announced on the blog and asked to contact me via email with their own email address so I can reply with the code to enter in the UFile tax software (your email will not be used for any purpose other than to contact you as a winner)

Good luck! 

Tax Havens - the pot calling the kettle black

When it comes to preventing tax avoidance or evasion, it seems that many countries apply the principle that while making sure collection of their own taxes is high priority, enabling other countries to collect their own doesn't matter so much. The degree of secrecy taken together with the scale of activity in each country make for some surprises in the Financial Secrecy Index ranking of world countries by the Tax Justice Network.

Achetype tax havens like the Cayman Islands are high (#4) on the list for sure but it is refined, reserved Switzerland in top spot. Nipping at the Cayman's heels, ahead of Bermuda, Panama and Jersey, is the good ole USA in #6 spot! Why? Because while it is fanatical about collecting its own taxes, it doesn't bother nearly as much in helping other countries collect theirs. #17 Canada sins that way too, if one reads the linked country report, backed up by very detailed database info.

Let he who is without sin etc.

CP Rail vs CN Rail - Pricing in perfection?

Ever since the big shareholder battle and the installation of Hunter Harrison as CEO of CP Rail (TSX: CP), CP stock has been on tear, with returns far outstripping those of rival CN (CNR). Is this justified, should I be riding the rails with CP instead of my well-established holding in CN?

The short answer is, I don't think so. It sure looks like CP shareholders are fully paying in advance for business improvements that meet or exceed present performance of CN, which is termed the best-run railway in North America. No doubt tremendous improvements are taking hold at CP, as evidenced by CP's most recent quarterly results.

But the numbers below, which include the latest results despite some sources that have not yet updated their databases weeks after the results were released (I ignored those), say to me that CP still has a lot of catching up to do. CN is green / better almost everywhere, except for profit improvement.

Management is getting richly rewarded for the job they are supposed to carry out in future. The cart is before the horse. Named Executive Officer (which includes CEO Harrison and the other top execs) pay is up enormously since the doldrum years of 2007 and is now a much bigger slice of the pie than at CN. It's not just Harrison receiving platinum compensation, it's all the execs. CP's execs are about 85% over-paid. It's like paying one of your kids more to clean her room when another kid doesn't get anything because her room is already clean.

Business performance measures still lag CN's by a lot. Whether you look at ROE, ROA, Operating or Net Margins, Operating Ratio, Revenue per employee (and different data sources give frustratingly different numbers for the supposed same metric), CN is still far ahead of CP. CP is also more levered / riskier with its higher debt load.

Valuation of CN is much less rich than CP. The ratio of market Price to present Earnings, Book Value, Sales, Cash Flow or EV to EBITDA, all point to a cheaper CN. There is evidently an expectation of significant improvements to come at CP. How much improvement is expected? It looks like pretty much complete catch up to CP, as suggested by the highlighted cells. Expectations of sales growth are not be the source of CP's potential advance, it is all in profitability gains, as analyst Sales and Earnings estimates testify. But CN isn't standing still, it has been increasing dividends steadily and is still much ahead of CP's and it is forecast to grow Sales and Earnings.

The overall combination of various sources on analyst recommendations seems to indicate CP more over-valued than CN. Blogger Sylvia Brunner's more thorough run-through of CN's numbers concludes that CN itself is on the pricey side.

But like her I will continue to hold it. Good luck to CP shareholders. Here's hoping all goes perfectly according to plan as you seem to expect. Meantime, for CEO Harrison congrats on picking a nice bet - heads, you win and tails, you win too!