Asset Management Fees and the Growth of Finance

From 1980 to 2006, the financial services sector of the United States economy grew from 4.9 percent to 8.3 percent of GDP. A substantial share of that increase was comprised of increases in the fees paid for asset management. This paper examines the signifificant increase in asset management fees charged to both individual and institutional investors. Despite the economies of scale that should be realizable in the asset management business, the asset weighted expense ratios charged to both individual and institutional investors have actually risen over time. If we exclude index funds (an innovation that has made market returns avail- able even to small investors at close to zero expense), fees have risen substantially as a percentage of assets managed.

One could argue that the increase in fees charged by actively managed funds could prove to be socially useful, if it reflflected increasing returns for investors from active management or if it was necessary to improve the effificiency of the market for investors who availed themselves of low-cost passive (index) funds. But neither of these arguments can be supported by the data. Actively managed funds of publicly traded securities have consistently underperformed index funds, and the amount of the underperformance is well approximated by the difference in the fees charged by the two types of funds. Moreover, it appears that there was no change in the effificiency of the market from 1980 to 2011. Arbitrage opportunities to obtain excess risk-adjusted returns do not appear to have been available at any time during the early part of the period. Passive portfolios that bought and held all the stocks in a broad-based market index substantially outperformed the average active manager throughout the entire period. Thus, the increase in fees is likely to represent a deadweight loss for investors. Indeed, perhaps the greatest ineffificiency in the stock market is in “the market” for investment advice.

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Taxes versus the Necessities of Life: The Canadian Consumer Tax Index

Income taxes form only a portion of the total tax bill imposed on us by all levels of government (federal, provincial, and local). According to our calculations, a Canadian family with average income of $74,113 paid $9,195 (a 12.4% rate) in income taxes in 2012. While personal income taxes are the single largest type of tax paid by families, they represent less than one-third of the total.

Main Conclusions:

  • The Canadian Consumer Tax Index tracks the total tax bill of the average Canadian family from 1961 to 2012. The total tax bill of the average Canadian family, including all types of taxes, has increased by 1,787% since 1961.
  • Taxes have grown much more rapidly than any other single expenditure for the average Canadian family. In contrast to the increase in taxes, expenditures on shelter increased by 1,290%, clothing by 607%, and food by 578% from 1961 to 2012.
  • The 1,787% increase in the tax bill has also greatly outpaced the increase in the Consumer Price Index (675%), which measures the average price that consumers pay for the goods and services they buy of their own choice including food, shelter, clothing, transportation, health and personal care, education, and many others.
  • The average Canadian family now spends more of its income on taxes than it does on basic necessities such as food, shelter, and clothing. In 2012, 42.7% of the average family’s income went to pay taxes while it spent 36.9% of its income on food, shelter, and clothing. In comparison, in 1961, the average family spent 56.5% of its income on basic necessities, while only 33.5% of the family’s income went to taxes.
  • In 1961, the average family had an income of $5,000 and paid a total tax bill of $1,675 (33.5%). In 2012, the average Canadian family earned an income of $74,113 and paid total taxes equalling $31,615 (42.7%).
  • Unfortunately, the federal and most provincial governments are running budget deficits, meaning that current taxes do not cover current spending. Of course, these deficits must one day be paid for by taxes. Including deferred taxes (deficits) means the tax bill of the average Canadian family has increased by 1,932% since 1961.

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Reducing Bonds? Proceed with caution

Historically low yields from bonds and recent cautions in the media about a potential “bond bubble” have led many investors to reconsider the role, if any, that high-quality bond funds should have in their portfolios. Investors’ concern is not unreasonable, given that the best predictor of bonds’ future returns—that is, their current yield to maturity—projects returns of 1%–2% over the next ten years. With return expectations low and interest rates close to 0%, investors are justifiably worried about the return potential for bonds. It’s not surprising, therefore, that investors are increasingly looking for alternative ways to improve the expected returns of their portfolios. Our analysis concludes, however, that bond substitutes are unlikely to offer the same diversification potential as broad, high-quality bonds, particularly when the diversification is needed most—that is, when equities are performing poorly. Although bonds’ ability to mitigate equity market risk in down markets is likely to persist, it’s also important to understand what low bond yields mean for balanced portfolio returns. This paper reiterates Vanguard’s belief that bonds remain by far the best diversifier for equity risk, but that current low yields will not provide the same portfolio amplification (i.e., high-return potential) as they have in the past. Low yields from bonds and unchanged equity market volatility will require investors to accept lower total returns and greater downside risk in their portfolios.

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Investment Consultants and Institutional Corruption

Analyses of the financial crisis of 2007-2009 and the continuing effects of a difficult investing environment have largely focused on factors such as the roles of failed and complex financial products, inadequate credit rating agencies, and ineffective government regulators. Nearly unexamined, however, is a key group of actors in the financial landscape, investment consultants. Investment consultants stand as gatekeepers between large investors, such as private and public retirement funds, and those from “Wall Street” who design and sell financial products. Investment consultants hired by these asset owners practically control many investment decisions. Yet, as a whole the profession failed to protect asset owners in the recent financial crisis and has yet to engage in serious self- examination. Much of the reason for the failure can be traced to institutional corruption, which takes the form of conflicts of interest, dependencies, and pay-to- play activity. In addition, a claimed ability to accurately predict the financial future, an ambiguous legal landscape, and a tainted financial environment provide a fertile soil for institutional corruption. This institutional corruption erodes the confidence and effectiveness of the retirement and investment systems today. While not proposing a comprehensive system of reform, this article illuminates a way forward for those in the industry who have the desire to address and implement necessary corrective activity.

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The Weekly Bottom Line - May 17, 2013

Canada

  • National home sales activity rose in April by 0.6%, month-over-month. Home prices increased by 1.3% versus a year ago. In light of recent trends, the housing market is experiencing the hallmarks of a soft landing.
  • Manufacturing sales declined by 0.3% in March, following a 2.6% increase in February. Manufacturing output is expected to perform better towards the second half of this year, in tandem with global and U.S. economic growth picking up.
  • Earlier this morning, Canadian inflation data was released for April. In headline terms, prices decreased by 0.2%, on a month-over-month basis. The same statistic for the Bank of Canada’s core inflation measure was 0.1%. Both numbers reinforce the notion that Canada is in a benign inflationary environment.

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Retirement Security Across Generations

The recession caught early and late boomers at a critical point in their lives—approaching or having just entered retirement—and both were negatively affected, losing 28% and 25% of their wealth, respectively.

But it’s the youngest cohort, Gen-Xers, who experienced the largest declines in median net worth. From 2007 to 2010, this group lost nearly half (45%) of their wealth—a loss at the median of about $33,000, decreasing already low accumulations.

Wealth Losses During The Great Recession

Birth Groups Median Net WorthMedian Losses% Change
 2004200720102007-20102007-2010
Depression Babies (1926 - 1935)$197,508$207,965$207,500$4650%
War Babies (1936 - 1945)$265,797$265,797$212,300$53,497-20%
Early Boomers (1946 - 1955)$192,215$241,333$173,480$67,853-28%
Late Boomers (1956 - 1965)$119,207$147,671$110,870$36,801-25%
Gen-Xers (1966 - 1975)$43,299$75,077$41.600$33,477-45%

The Great Recession caused substantive losses in median net worth, with Gen-Xers taking the hardest hit.

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Canadian inflation likely hit a cyclical low in April

Inflationary pressures moderated further in April, as the all-items consumer price index rose by only 0.4% on a year-over-year basis, down from 1.0% in March. Core inflation also ebbed relative to the prior month, with core prices only 1.1% higher than they were a year ago.

  • Lower gasoline prices in April were a key factor bringing down the inflation rate. Prices at the pump were 6% lower than they were last April. Lower prices for passenger vehicles were also a factor containing the headline rate, after having a dramatic jump up back in February. The overall transportation component was down 2.1% year-on-year in April, the main downward contributor to the benign CPI reading.
  • The only component to see an acceleration in inflation in April was shelter (+1.3% Y/Y versus 1.1% Y/Y in March), driven by higher electricity prices and rents. However, within the key shelter component (26% of the CPI basket), low interest rates have kept mortgage interest costs falling (-4.3% Y/Y) for the past year.
  • Canada’s benign inflation environment is very broad based. Inflation rates for all major categories are below 2%: food (+1.5% Y/Y), household operations and furniture (+1.5% Y/Y), and recreation & education (-0.2% Y/Y).
  • Provincially, price pressures were weakest in BC (-0.8% Y/Y) and New Brunswick (-0.2% Y/Y). B.C. was affected by returning to the GST + PST, while PEI saw the HST implemented in April, taking its inflation rate to 1.8%, the highest reading in Canada tied with Manitoba.

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God Demand Trends - First Quarter 2013

Global first quarter gold demand of 963.0 tonnes was valued at US$50.5bn. Tonnage was 13% lower year-on-year as strong growth in consumer demand – for gold jewellery, bars and coin – was exceeded by substantial net outflows from gold ETFs.

Table 1: Q1 2013 Gold Demand Overview (tonnes)

 1st Quarter 20121st Quarter 20135-Year AverageYear on Year % Change
Jewellery490.8551.0500.08
Technology105.8102.0109.8-7
Investment395.8200.8370.5-51
   Total Bar & Coin342.5377.7281.36
   ETFs53.2-176.989.2-
Central Bank115.2109.240.1-5
Gold Demand1,107.5963.01,020.8-13

Q1 saw a strong resurgence in demand for gold jewellery, bars and coin; however, overall demand was down 13%. Outflows from ETFs accounted for the bulk of this decline; excluding these outflows overall demand grew year-on-year. India and China propelled growth in both jewellery and bar and coin demand once again, with both markets growing by at least 20%. Central bank demand exceeded 100 tonnes (t) for the seventh consecutive quarter, slightly below the exceptional pace of purchases throughout 2012. Technology demand contracted on further losses in bonding wire and continued erosion of dental demand.

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Spring Selloff Steep, But Canada's Commodity Basket More Resilient

Highlights:

  • Commodity prices have been making headlines lately, thanks to the sharp selloff seen in mid-April. However, while fairly widespread, the pullback was largely concentrated in precious metals and industrials, while others, including natural gas, agricultural and forestry commodities have held up quite well.
  • As a result, the TD commodity price index has held fairly steady, suggesting that the impact of the decline in commodity prices on Canada is likely to be softer than headlines would suggest.
  • Commodity prices overall have exhibited a relatively flat trend since the second half of 2011 – a trend that we expect to continue going forward, as strength in natural gas and lumber prices will be offset by weakness in industrial commodity prices.

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The New Sick Man of Europe: the European Union

The European Union is the new sick man of Europe. The effort over the past half century to create a more united Europe is now the principal casualty of the euro crisis. The European project now stands in disrepute across much of Europe.

Support for European economic integration – the 1957 raison d’etre for creating the European Economic Community, the European Union’s predecessor – is down over last year in five of the eight European Union countries surveyed by the Pew Research Center in 2013. Positive views of the European Union are at or near their low point in most EU nations, even among the young, the hope for the EU’s future. The favorability of the EU has fallen from a median of 60% in 2012 to 45% in 2013. And only in Germany does at least half the public back giving more power to Brussels to deal with the current economic crisis.

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Are DC Pension Plans Too Risky?

Defined Contribution (DC) pensions are often dismissed as being too volatile to meet the needs of individuals or the organizations that employ them. Five years ago, we tried to quantify that volatility. Much has happened since then, including the ongoing financial crisis and some new thinking on income replacement ratios, all of which has prompted us to refine our model and re-examine our conclusions. While DC pensions will never be predictable, the variability in payouts is likely to remain at least tolerable. As Target Benefit Plans and other hybrids are about to be launched it is important to have a clear understanding of what DC plans can deliver.

Even though Defined Contribution pension plans have surged in popularity over the past 20 years, they continue to trouble industry observers. DC plans are almost universally perceived as imposing too much risk on employees, although a clear demonstration of this statement is rarely presented. While there is no shortage of anecdotal evidence, it is neither scientific nor conclusive. Stochastic methods could be used to simulate future performance under DC plans and map out a distribution of possible outcomes but the result is only as good as the input. Yet another approach, and the one we will employ, is to consider what would have happened historically had DC plans always been around. This approach is the most easily understood and has the advantage of relying on actual rather than simulated data.

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Market Indices, Asset & Risk Management Numbers: April 2013

Great summary of investment performance - monthly, quarter, Year to date and 1-year stats. Updated performance data: stocks, bonds, mixed portfolios, etc.

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Annual Retirement Survey

Retirement is changing. It is too easy, however, to focus on the uncertainty about where we are today in the new world of retirement and ignore how far we have come in overcoming the challenges.
That's one of the reasons BlackRock extended this year's Retirement Survey to include recent retirees for the first time. We asked retirees about what helped them prepare for retirement and what might have helped them even more. Our four findings are presented here.

The combined perspectives of retirees, participants and plan sponsors created an often surprising picture of today's retirement, including how participants have enormous power in creating secure retirements if they are fully engaged in their DC plan. The Survey also revealed how motivated plan sponsors are to "do the right thing" for their participants and how much participants welcome their advice and active role. Finally, the Survey explored the role that retirement income plays in creating the financial and psychological foundation of a secure retirement.

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The Weekly Bottom Line - May 3, 2013

Canada

  • Yesterday afternoon, Stephen Poloz was selected to be the new Governor of the Bank of Canada. He will inherit the job from outgoing Governor Mark Carney. In overnight trading, market reaction was mixed and questions arose about the future course of monetary policy in Canada, although uncertainty has since eased this morning. • The challenges presented to Poloz on his first day in the office will be the same ones outgoing Governor Carney has been grappling with for some time: modest global and Canadian economic growth, benign inflation, and domestic risks surrounding household indebtedness and home price overvaluation.
  • There are no obvious policy implications from the upcoming changing of the guards. The central bank is not a one person operation. Instead, several senior officials influence the direction of interest rates. Many factors go into making interest rate decisions, including economic indicators and the risks present. In turn, our interest rate forecast remains the same – the next move in interest rates should be up, with hikes set to resume at the end of 2014.

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