Is 70 the New 65?

The Canadian Business Journal reports, Raise retirement to 67, think tank says:

A policy think tank believes increasing retirement eligibility by two years may fix an impending demographic crunch.

The Mowat Centre for Policy Innovation, a think tank affiliated with the University of Toronto, published a report today calling for a raise in eligibility ages for the Canadian Pension Plan and Quebec Pension Plan from 65 to 67, and the earliest ages from 60 to 62.

“By 2050, an age increase would reduce CPP expenditures by about $15 billion per year and increase contribution revenues by about $5 billion per year,” the report said. “Increasing the eligibility ages is a fair solution for financing the costs of population aging, because doing so divides these costs across younger and older generations.”

The report, Is 70 the New 65? Raising the Eligibility Age in the Canada Pension Plan, was written by Martin Hering and Thomas R. Klassen, compared Canada's situation to similar legislation enacted in Australia, the United States and throughout Europe.

You can download the full report by clicking here. Table 1 above shows that even though the retirement age increase would be implemented gradually over a relatively long period of time, its impact on the CPP’s finances would be significant after 2025:

Specifically, policy makers could reduce the CPP’s minimum contribution rate (the rate required to sustain the CPP), from the current 9.82 to 9.06 per cent, without affecting benefit levels and while maintaining the required size of assets.8 Alternatively, benefits could be increased over time while maintaining current premium levels.

A reduction of the minimum contribution rate from 9.82 to 9.06 per cent would create a significant buffer between the minimum and the legislated contribution rate. This would make it more likely that plausible demographic and economic developments— such as a higher than expected increase in life expectancy, a slower than expected growth of wages, or lower than expected investment returns—would have a much smaller impact on the sustainability of pension finances and would reduce the need for significant policy shifts, including increased premiums or reduced benefits.

The table also shows that a gradual increase in retirement ages increases contributions and decreases expenditures each year, so that by 2050 the CPP has $982 billion more in assets than otherwise would be the case. An important measure of the CPP’s financial health is the assets in years of expenditure: by 2050, the CPP would have assets of 11 years of expenditure, and thus twice the legal minimum of 5.5 years. Put differently, the plan’s funding would grow from about 25 per cent to about 50 per cent of liabilities.

The consequence is that an increase in eligibility age creates a cushion for the CPP, allowing the existing contribution rate of 9.9 per cent to remain unchanged if demographic and economic conditions were more unfavourable than expected. In our projections, we assumed that employees would delay their retirement by 2 years and used the same assumptions regarding retirement rates that the Chief Actuary used in the 2006 actuarial report on the CPP (see Appendix B). Specifically, we expected that about 40 per cent of workers retire at the earliest retirement age, about 30 per cent at the normal retirement age, about 20 per cent between the earliest and normal retirement ages, and less than 5 per cent after the normal retirement age.

The assumption that a very high proportion of workers— about 40 per cent—chooses to receive an actuarially reduced CPP benefit at the earliest possible age primarily reflects the role of private retirementincome sources, especially occupational pensions, in the retirement decisions of individuals (Wannell 2007b, 2007a). The assumption that Canadians would change their behaviour significantly and delay their retirement by 2 years allows us to estimate the potential size of the effect of a retirement age increase. If individuals did not delay their retirement by as much as we assumed, the impact of an age increase on the minimum contribution rate and on the level of funding would be smaller than that shown in our estimates.

Even though an increase of eligibility ages would certainly lead to savings because individuals would have to postpone their receipt of CPP benefits at least until age 62 and would receive reduced benefits if they retired before age 67, it would not force them to wait until age 67. For example, workers who plan to retire at age 65 could still do so if they accept a permanent actuarial reduction of their pension by 14.4 per cent. In this case, the retirement age increase from 65 to 67 would reduce expenditures but would not increase contribution revenues.

The study is interesting but increasing the retirement age to 67 will not be easy. Also, I worry that if we do increase it to 67, then in a few years, who is to say policymakers won't try to increase it again to 70? Nevertheless, with people living longer and healthier lives, increasing the retirement age may be an option worth exploring.

***Feedback***

Bernard Dussault, former Chief Actuary of Canada had this to share with me on this topic:

Current CPP contributors pay too much (9.9% rather than 5.5%) to the CPP because their predecessors:

• did not pay enough into it (3.6% for 20 year, increased to 6% by 1996, etc.) and

• got full accrual of benefit rights after 10 rather than 47 years.

Why would/should we consider penalizing further the current contributors by increasing the pensionable age? The 9.9% remains somewhat sufficient to afford the payment of pensions commencing at age 65.

...

There is no new issue with the CPP. It had big ones that were addressed through the 1998 reform. Its partly funded status is due to the insufficient contributions made from 1966 to 1996 and to granting full accrued benefits after only 10 years of contributions to the original (1866) cohorts of contributors, which gave rise to a huge deficit, too huge to ever be amortized. Therefore , our children, grand children, grand-grand children and so on will have to pay 9.9% (half paid by employer) rather than 5.5%. Pure case on intergenerational inequity.

The CPP is not a target benefit plan and not meant to be one. The decreased in future benefits in 1998 (the then current pensioners were not affected) was one good mean to correct errors (re: insufficient contributions) of the past. Real target plans do not allow known insufficient contributions. In 1966, it was clearly reported that the CPP 3.6% contribution rate was insufficient. It was a political decision to go ahead with the 3.6% and leave the problems to future generations.

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Eurozone's Big Boys Hold the Aces?

Nils Pratley of the Guardian reports, Eurozone's big boys hold the aces:

Markets tremble in the face of Irish resistance. It was a reasonable reaction since even the European Union's top officials seem unable to agree on the size of the threat. Herman van Rompuy, European president, said the eurozone was in a "survival crisis" while economic affairs commissioner Olli Rehn insisted that "it's not a matter of the survival of the euro." Find the consistent message in those statements if you can.

It looks as if the EU officials are trying to hit two impossible targets at once – crank up the pressure on Ireland to accept a bailout while simultaneously reassuring the wider world that the debt crisis will not spread to Portugal, or at least not to Spain.

Investors will tolerate such confusion only for so long. They understand that verbal gymnastics are part of the process of forcing a resolution but, in the end, markets want to see a deal. Germany, France and European Central Bank appear to have agreed that Ireland needs a bail-out to prevent a loss of confidence in the eurozone. If they cannot then impose their will on a junior member of their club, the crisis enters new territory.

Sympathy for Ireland is entirely justified, however. The country is fully funded until next summer, as its government keeps reminding us. Its politicians are entitled to seek the best possible terms and brinkmanship is entirely understandable. The focus will be Ireland's freedom to set taxes. The ultra-low corporation tax rate of 12.5% is the symbol of Ireland's economic freedom and a cause of resentment in Germany and elsewhere. Hard bargaining might secure a marginally more freedom.

Ultimately, though, the big boys of the eurozone hold the aces. The wholesale markets are virtually closed to Irish banks, who can fund themselves on a day-to-day basis only because the ECB provides liquidity. That is why it seems inevitable that Ireland will bow to the pressure to accept a bail-out package.

It may be dressed up as a recapitalisation of the broken banking system but that's merely a detail since Ireland continues to stand behind its promise to support its banks. That die is now cast.

A succession of eurozone finance ministers have sought clarity from the Irish government on its plans to resolve the banking crisis. Meanwhile, the Bangkok Post reports that Europe and the International Monetary Fund announced the launch of an urgent mission to Dublin to finalize emergency support for Ireland's devastated banking sector:

EU economic affairs commissioner Olli Rehn said plans in gestation for days would have "an accent on restructuring Ireland's banking sector".

Dublin had "committed" to explore shelter, he said, after tension on the bond market that reflected the mounting market uncertainty over the country's financial prospects.

"We will act in a determined and coordinated way if necessary to ensure the stability of the eurozone," said Luxembourg Prime Minister Jean-Claude Juncker, who chairs the group of euro finance ministers who must validate an application for support from partner states.

The Irish government would have to decide on financial aid, with inevitable strings attached, within "days," said Juncker.

Cowen had insisted to lawmakers in Dublin's Dail that the unfolding discussions were about seeing how "irrational" markets could be "taken out of the equation".

Ireland should not become "enslaved" to ruthless traders, he argued.

In Washington, the IMF said a "short and focused consultation" would have as its goal "to determine the best way to provide any necessary support to address market risks."

US Treasury Secretary Timothy Geithner has said Europe would be well advised to act "very, very quickly."

Not too quickly, after all, big US banks and their big hedge fund clients are absolutely loving this volatility. They get to profit from all the 'market mayhem'. I've seen this movie so many times, I can write books on it. While European "big boys" continue to vacillate, looking like a bunch of incompetent fools, traders and hedge funds are just setting themselves up for the next leg up.

Continue buying the dips. Just like last November's Dubai scare was way overblown, so is all this nonsense of a 'eurozone crisis' because of Ireland's banking woes. There will be plenty of fear mongering, but behind all these rumors, some big funds are setting up for the next leg up. And you can mark this post -- that's how confident I am that this is just more nonsense to feed the real big boys running the big banks and top hedge funds.

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On the Road to Pension Poverty?

Myra Butterworth of the Telegraph reports, Pensions 'decimated' by low interest rates, warns Saga:

Speaking at the Bank of England today, Ros Altmann, director-general of the Saga Group, warned that historically low interest rates could lead to another financial crash that would leave pension pots “decimated”.

She explained poor returns were prompting savers to take greater risks with their pensions as they approached retirement.

Savers have seen their rate of returns hit rock bottom as the Bank of England has maintained interest rates at just 0.5 per cent since March 2009.

Dr Altmann said: “Very low interest rates are having a damaging effect on pensions and pensioners.”

She warned of the dangers of rising inflation if interest rates stay too low for too long.

“Pension investors and people buying annuities are being hit by low long-term rates and pensioners suffer from low short-term rates as well, as their savings income having fallen and they cannot make that up.

“In addition, they have been hit by high inflation, so they can no longer protect the value of their capital.

“We already see signs of rising inflation and this has damaged pensioners significantly already. Their savings income has not kept up with inflation, most annuities are being purchased without any inflation protection and a continued increase in inflation will plunge more pensioners into poverty in future.”

An ageing population, with less money to spend, could depress consumption and economic growth, she added.

She called on the Government to take action, suggesting it issues special pensioner bonds that help provide additional income to pensioners caught by the loss of their savings income.

She said the Government could also consider inflation-protection products for pensioners, such as reviving the National Savings products that were recently withdrawn.

Two of the most popular state-backed investment products were withdrawn from the market earlier this year amid the Government’s austerity drive.

National Savings & Investment pulled its inflation beating and fixed interest savings certificates and cut rates on other products.

The group feared demand from consumers could place too high a burden on the taxpayer, at a time when the public finances are under unprecedented strain.

Andrew Hagger, a savings expert at personal finance website at Moneynet, said: “There seems to be no light of the tunnel, with many people having already used up a large proportion of their savings. They are going to get to a stage where there is no where else to turn.”

Robert Bullivant, chief executive of pensions broker Annuity Direct, said: “The only saving grace is the performance of the stock market and so anyone who has stayed in equities will see a larger fund than they did a year ago. But if they have switched to cash, they have not seen much growth. People now need to switch to cash to lock in the stock market gains. If you lose those gains and suffer with low interest rates, it’s a double whammy for pensioners.”

Here in Canada, Ray Turchansky reports, Financial crisis is putting pressure on an aging workforce:

While the financial crisis has forced Canadians to come to grips with the idea that a pension may not be a promise, employee benefits are similarly in peril.

"I find it almost incomprehensible that Nortel LTD (long-term disability) claimants could lose their benefits, but this is possible; let alone losing their health care and a portion of their pensions," said Kevin Dougherty, president of Sun Life Financial Canada, speaking at the Canadian Pension and Benefits Institute conference.

"We saw how benefits and pensions can literally disappear in an instant."

Now people nearing retirement face a new twist.

"Millions of people asked the questions, what if I have to leave the workforce five or 10 years early, or what if I have to stay in the workforce five or 10 years more."

The leading edge of baby boomers will hit age 65 next year, when each day a thousand people in Canada will retire.

"Today with boomers age 50 to 65, with kids grown and many through school, the question they're asking isn't 'what if I die,' it's 'what if I live?' That saps my income and retirement savings. What if I have to live through another financial crisis?"

Dougherty joins federal Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney in worrying about the growing debt Canadians are piling up.

"How can we be the only place in the developed world where real estate prices continued to increase for the last two-and-a-half years? What does that mean? - more and more debt for Canadians."

While Canadians who can't resist a bargain stock up on moulding empty homes in the United States, there is fear that the Home Equity Line Of Credit or HELOC could do in Canada what subprime mortgages did in the U.S.

Of course, retirement won't affect all people the same.

"Women who are widowed early in retirement actually live three years longer (than those who aren't), and men widowed early in retirement live three years less."

While more and more companies with underfunded pension plans have been reducing benefits and commuted value payouts, the malaise has spread to employment benefits. Many firms offer minimal health-care coverage in retirement or have eliminated it, while more and more current employees find themselves on the hook to find vision and dental insurance.

Meanwhile, the average number of days lost annually to sickness per worker has risen from eight in 1989 to 13 in 2009.

Dougherty's conclusion is that neither government nor lawyers will take care of an aging workforce, "and the next generation of children is not going to want to take care of us."

He said there is more onus on people in the pension and benefits and human resources areas to devise products and provide advice.

"Our industry needs to be much more than just helping to attract and retain employees. The financial security of millions of Canadians depends on the work we do."

One such move is encouraging government to establish a new personal health- savings account.

"We've been advocating something called the registered health savings plan, where people can save money on a pre-tax basis to be used for their health-care costs in retirement. There are other examples like critical illness insurance. But we've got to step up to this. I think this is going to be one of the big areas of the future."

Even with defined contribution pension plans, where investment risk lies with the individual, the employers can provide advice through plan sponsors.

"Narrowing the field from 4,000 fund managers to 12 is providing advice. Overseeing and switching out of managers is providing advice. Setting a level of contribution and matching is providing advice. Providing tools that ask questions and lead people to recommendations is providing advice."

But there is need to help educate people about financial literacy, abetting the federal government's task force on the issue that has been touring Canadians for submissions and will issue a report in December.

"The most striking finding is the degree of the challenge that we have, the surprising lack of financial literacy in the general population is really, really striking," Dougherty said.

"There's a challenge in literacy - reading and writing in English, because we have such large immigration; a challenge in numeracy, lots of people don't like working with numbers; and you layer on top of that the knowledge and skills of financial consequences."

All this is set against a backdrop in which the financial crisis produced severe stock market downturns that scared individuals from investing personally, while corporations were similarly spooked and didn't invest in technology to improve productivity and grow their workforces.

"There was a two-year period in which we didn't invest, and that's going to hurt us for two to five years," said Glen Hodgson, chief economist of the Conference Board of Canada. "Health care will soon emerge as a top concern for Canadians. Aging is going to suck the life out of our economy slowly."

But just as baby boomers were told 40 years ago that the investment of the future would be "plastics," Hodgson has his own tip: "India will be the next China, it will keep growing at eight per cent for a number of years."

You can bet your hip replacement on it.

Finally, my favorite deflationist, Gary Shilling was interviewed on Yahoo's Tech Ticker on Monday warning us that the age of deleveraging is upon us:

The key to understanding the difference between today's economic weakness and normal economic weakness, Gary says, is to look at the past 30 years.

Beginning in 1982, Americans spent their way to apparent prosperity. Savings rates plummeted, as consumers spent almost everything they earned. Home equity withdrawals soared, as consumers realized they could use their rapidly appreciating houses as personal ATM machines. And, across the economy, total debt surged to a previously unheard-of 375% of GDP.

But now all those forces have reversed. Savings rates are climbing again, as consumers realize they have almost nothing left to retire on. Home equity withdrawals have ceased, because house prices have stopped appreciating and started falling (Gary thinks they'll fall another 20%). And consumers are looking at ways to reduce their debts, not borrow more money.

These trends will continue for at least another decade, Gary Shilling thinks. He lays out this theory in his new book, "The Age Of Deleveraging."

The economy will grow in the next decade, Gary says, but it will grow much more slowly than it has grown in the past. Unemployment will remain high. Consumers will continue to be forced to embrace a new frugality. And no matter how cheap the Fed makes money, overall borrowing will continue to decrease.

In the process of this, stocks will do poorly. House prices will fall another 20%. Only Treasury bonds will do well.

Only Treasury bonds will do well? I'm not as sure as Mr. Shilling about bonds, but you can listen to the interview below and make up your own mind.

One thing I'm sure of is we're well on our way towards widespread pension poverty. These markets are brutal even for the best money managers. And we expect individuals to take care of their investments and save enough to enjoy a decent retirement? Good luck, this mess is going to end up costing taxpayers billions in healthcare and social costs. Unfortunately, policymakers have yet to grasp the long-term implications of pension poverty. When they do wake up, it's going to be too late.

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Is the Rally Losing Steam?

Ben Levihsohn and Jane J. Kim of the WSJ wrote an interesting weekend piece, How to Play a Market Rally:

Forget "buy and hold." It is time to time the stock market.

For 10 long years, market rallies have ended badly for investors. Now, with stocks up 15.6% in four months, strategists are beginning to suggest that ordinary investors start dialing back on risk.

That doesn't mean dumping shares willy-nilly. With the Federal Reserve committed to flooding markets with liquidity, it still makes sense to be in equities. But "if you've ridden the market up, you might want to do some trimming," says Steven Shueh, managing partner at Roundview Capital.

Some investors may already be starting. The Dow Jones Industrial Average has given up 2.2% from its Nov. 5 high.

The first step is to disabuse yourself of the notion that it's impossible to time the market. It turns out that sometimes you can. When markets are stuck in a trading range for an extended period, selling into strength and buying into weakness can outperform buy-and-hold investing.

If that sounds like sacrilege, it may be because mutual-fund firms have spent decades persuading you to keep your money in their stock funds through thick and thin so they could collect bigger profits.

Consider an investor with a $1 million portfolio on Dec. 24, 1998, the first time the Standard & Poor's 500-stock index was at its current level. But if the investor had merely held on, he would have seen essentially zero appreciation through Nov. 11 of this year. If that same investor instead had sold one-tenth of his portfolio every time the stock market gained 20% and allocated one-fifth of his cash to the market when stocks fell more than 10%, he would have gained about $140,000, according to a Wall Street Journal analysis.

An approach using broad valuation measures performed even better. One metric, the ratio of stock-market capitalization to gross domestic product, tracks the market's value versus that of the underlying economy. An investor with $1 million on Dec. 24, 1998, who sold 10% at the end of each month when the ratio was above 115% and bought stocks with 20% of his cash when the ratio was below 75%, produced a gain of around $365,000. (The average has been about 91% over the past 20 years.)

Of course, investing success depends greatly on when you start. If you had tried the strategy at the market low of October 2002, for example, you would have come out about the same as if you had bought and held.

Throughout this year the market has traded in a band of about 20%—far away from both its 2007 high and its 2009 low. Stocks gained 15% from Feb. 8 to April 23 on hopes that a robust economic recovery in the U.S. would sustain global growth. By July 2, it had dropped 16% to 1022.58, as disappointing economic data fueled fears of a double-dip recession.

Now stocks are up again—but for how long?

Says Tobias Levkovich, head of U.S. equity strategy at Citigroup Inc.: "Investors should be more willing to hedge."

The smartest way to do that now, strategists say, is to switch from riskier holdings to steadier stocks and dividend payers; to embrace "tactical" mutual funds that can jump in and out of asset classes; and to consider bond funds designed to benefit from rising interest rates.

Dividends

Investors looking for safer stock plays should consider companies that are initiating or boosting dividends, say strategists. Such companies tend to be less volatile than the overall stock market. According to Ned Davis Research, their "beta," a measure of volatility, is just 0.78 versus the broad market, compared with 1.08 for non-dividend payers. (A beta of 1.0 means a stock is as risky as the market.)

Dividend payers may be especially attractive at this stage of the bull market. Whereas non-dividend stocks typically trounce dividend payers during the first leg of a bull run, dividend stocks since 1974 have outperformed by three percentage points during the second leg and seven percentage points during the third, according to Ned Davis Research.

"The biggest headwind for dividend stocks occurs in the very early stages of the bull market, and we're past that in all likelihood," says Ed Clissold, global equity strategist at Ned Davis.

Some dividend boosters in the S&P 500 include Dr Pepper Snapple Group Inc., Time Warner Cable Inc., Starbucks Corp., International Paper Co. and UnitedHealth Group Inc.

Big Tech

The four-month rally has been led by the technology sector: the Nasdaq's 20.4% rise has outpaced the Standard & Poor's 500-stock index's 17.3% jump. Yet the tech sector has a price-earnings ratio of 13.7, only slightly higher than the 13.3 P/E for the market as a whole, according to Thomson Reuters data. Tech also has the fourth-lowest P/E of the 10 major market sectors.

Investors concerned that the rally is overstretched might want to shift away from highfliers and toward the 10 largest tech stocks, which Bank of America Merrill Lynch dubs the "tech titans"—Microsoft Corp., International Business Machines Corp., Apple Inc., Intel Corp., Hewlett-Packard Co., Cisco Systems Inc., Oracle Corp., Google Inc., Qualcomm Inc. and Corning Inc.

Cisco, in particular, may be a better deal now after Thursday's 16% fall.

"When bad news drives these stocks down, it makes them more compelling," says David Bianco, head of U.S. equity strategy at Bank of America Merrill Lynch. He notes that as a group, big tech has gained just 4.0% this year, versus 6.6% for the entire sector, and carries a P/E of about 12.8, versus about 16.7 for the others.

The key advantage big tech outfits hold, says Mr. Bianco, is their strong balance sheets, which should help them boost earnings even if growth slows. "They will issue bonds, buy back shares and acquire other companies," he says. "Large tech will benefit from that."

Go-Anywhere Funds

Investors who wish to take some profits on stocks and redeploy it elsewhere should consider "tactical allocation" mutual funds that allow managers to jump into and out of asset classes at will.

When the stock market trades in a band, as it has for the past decade, these sorts of funds can perform well. According to data from investment-research firm Morningstar Inc. through October, "world allocation" funds have returned 5.08% annually over the past five years and 5.78% annually over 10 years, compared with the S&P 500's 1.73% annualized gain over five years and an annualized loss of 0.02% over 10 years.

Some tactical funds handily beat traditional equity funds during the financial panic. "There were many investors in 2008 and 2009 who were disappointed by how little their fund managers could do to react to or react ahead of what was developing," says Loren Fox, senior analyst at research firm Strategic Insight.

So far this year, financial-services firms have launched 28 world allocation funds, according to Morningstar.

Steven Roge, a portfolio manager in Andover, Mass., has been moving more of his clients' money from traditional equity funds to flexible funds—such as IVA Worldwide Fund, Pimco Global Multi-Asset Fund and FPA Crescent Fund, among others—because of the managers' ability to make swift asset-allocation decisions and their use of derivatives to reduce risks.

"Asset allocation plays such a big part in the return of the portfolio that we could probably add 2% to 3% more in returns with less downside just from the timeliness of the shifts in asset allocation," says Mr. Roge, who estimates that about 40% of his clients' portfolios are in flexible funds, up from about 12% a few years ago.

The Goldman Sachs Dynamic Allocation Fund, launched in January, aims to shift between asset classes based on volatility. If, for example, the volatility of the S&P 500 increases, the fund would pare stock holdings.

"By taking some risk off the table as asset-class risk increases, that potentially sidesteps some of the downward movement in the market," says Theodore Enders, portfolio strategist at Goldman Sachs Asset Management.

Tactical funds can be unpredictable. The $25 billion Ivy Asset Strategy Fund, for example, held an 80% net equity position at the beginning of 2010, then pared it back to 18% at the end of February, only to ramp it up again a few months later. "If you have a fund that's changing its asset allocation frequently, it can be difficult to know how to position the other funds in your portfolio," says Kevin McDevitt, a Morningstar analyst.

Note, also, that fees for these funds can be high. The Direxion Spectrum Global Perspective Fund, for example, has annual expenses of 2.55%.

Rising-Rate Funds

A typical move after a powerful stock rally is to sell shares and buy bonds. But with the Treasury markets surging to record highs recently, putting more money there could be even riskier than leaving it in stocks.

The Fed is buying Treasurys now, but not all maturities. When it said last week it would avoid 30-year bonds, their prices promptly tanked. That could be a hint of what's to come once the Fed stops buying other maturities. Its ultimate goal, after all, is to juice the inflation rate. Rising inflation is usually bad for bonds.

Instead of Treasurys, investors should consider "floating rate" funds, which buy variable-rate corporate loans—and therefore collect more money when rates rise. In 2003, for example, when the Fed started raising rates, floating-rate funds gained 10.4% while short-term bond funds gained 2.5%, according to Morningstar.

There are at least 31 open-end funds and 10 closed-end funds to choose from. Morningstar's picks in this category include the Eaton Vance Floating-Rate Fund and the Fidelity Floating Rate High Income Fund, which boast experienced management teams and solid track records.

Warren Ward, a financial adviser in Columbus, Ind., says he is considering the Fidelity Advisor Floating Rate High Income Fund for his clients because of manager Christine McConnell's experience through up and down markets. Another plus: The fund holds a considerable amount of cash, which should allow it to meet any redemptions without having to sell securities, he says.

"If rates rise, floating-rate funds offer investors some protections," says Mr. Ward. "I would like to say go into bonds to get yourself out of stocks, but I think they're more risky right now."

Bonds are a hell of a lot more risky right now, but as Randall Forsyth of Barron's notes, Bonds Are Not Dead Yet:

Bond yields continued to climb last week even as the Federal Reserve began its bond-buying operation known as QE2. As the U.S. central bank began the second phase of its quantitative easing, heavy new-issue supplies in all sectors encountered buyer resistance.

The result was a rise in yields, especially for longer maturities, of about 45 basis points (0.45 percentage points) from their lows of early October, with about half of the increase coming in the past week alone. That translated into price losses upward of 2%, roughly equal to the give-back in the stock market.

In the Treasury market, the 10-year- note's yield rose to 2.776% from 2.538% a week earlier and a low of 2.332% on Oct. 8, the low-water mark since January 2009, Dow Jones Newswires notes. Meantime, the 30-year bond yield rose to 4.274% Friday from 4.122%, in part because of weak demand at Wednesday's auction of the issue.

That sounds relatively trivial but it resulted in the price of iShares Barclays 20+ Year Treasury Bond exchange-traded fund (ticker: TLT), a popular way to participate in the long end of the market, falling 2.2% on the week. Even the less volatile iShares Barclays 7-10 Year Treasury ETF (IEF) lost 1.4% for the week.

The corporate market also buckled under the weight of $21 billion of new issues in the first three days of the week, prior to the Veterans' Day holiday, and is bracing for $25 billion of offerings this week. The iShares iBoxx $ Investment Grade Corporate ETF shed 2% in sympathy.

The municipal market was hit as well with yields of triple-A 20-year bonds up over 20 basis points to around 3.70%. As a result the iShares S&P National AMT-Free ETF (MUB) was down 2.3% on the week. Some closed-end muni funds were pummeled by upward 7%-10%, according to Jerry Paul, who heads Essential Investment Partners in Denver, which specializes in closed-end-fund special situations. Closed-end funds' use of leverage makes them inherently more volatile. Moreover, many had been bid up to large premiums. Still, growing disquiet over municipal finances cast a pall over the sector.

But even if the bull market in bonds is dead, as declared the Bond King, otherwise known as Bill Gross, the founder and co-chief investment officer of Pimco, the manager of the world's biggest bond fund, there's an upside: higher yields.

The end of the bull market does not necessarily mean a bear market has started, counters James Kochan, a bond-market veteran whose career predates the beginning of the bond bull market and is now chief fixed-income strategist of Wells Fargo Advantage Funds. With inflation and short-term interest rates likely to remain low, bonds outside of Treasuries still provide value, Kochan says. "This is the income phase of an income-investment cycle, not the bear phase—yet," he adds.

That means looking to sectors of the bond market where income returns more than offset the risk of rising yields and falling prices. In the corporate sector, that means the high end of high-yield market with credit ratings of single-B or double-B, which provide respective yield spreads of 475 and 375 basis points. More speculative credits, with ratings of triple-C, don't offer commensurate value.

Municipal bonds also offer good value and income, Kochan adds. He prefers longer maturities because of the steep muni yield curve (that is, long bonds yield a lot more than those with shorter maturities). For instance, 30-year triple-A munis yield 4.20%, markedly more than 2.56% for 10-year bonds or 1.18% for five-year bonds.

Instead of triple-A credits, he prefers the yield pickup in the single-A to triple-B muni credits. For 10-year maturities, extra yield equals 100 basis points for single-A bonds and 150 basis points for triple-Bs. For 30-year maturities, the spreads are 250 basis points for single-A credits and 400 for triple-Bs. Quality spreads, already wide this year, have increased in the past couple of weeks, Kochan notes.

I'm not so sure about the municipal bond market where systemic credit risk is very high, causing a great deal of anxiety among bond investors. But at the end of the day, the Fed will do whatever it takes -- even buy municipal bonds -- to head off any systemic crisis.

As far as the stock market, I just see this as another opportunity to load up on shares. My personal favorites remain Chinese solar stocks which sold off strongly after most reported stellar earnings. One of my top picks in this group is LDK Solar, which smashed its estimates and then sold off (warning: these stocks are not for the faint of heart).

Tim Hayes, chief investment strategist at Ned Davis Research, spoke with Carol Massar and Matt Miller on Bloomberg Television's "Street Smart" saying he expects a 3-5% correction in stocks in the next few weeks (click here to watch the interview). Tim is one of the best strategists in the business and a super nice guy. I think he's probably right. It's only normal for portfolio managers to lock in profits going into year-end, but I warn you, if you think this the beginning of some sort of systemic collapse, you're in for a big surprise.

This market is heading higher -- much, much higher. And all of you trying to time these markets will get your heads handed to you. Buy and hold maybe dead for the overall market, but it certainly isn't dead for some sectors and stocks. If you pick your spots well, you'll make decent profits as this rally still has steam. The only thing is you need to accept a lot more volatility. There is is nothing you can do about that.

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Are We Underestimating Funding Shortfalls?

The Toronto Sun reports, Feds have $65B pension funding shortfall:

The federal government has underestimated its employee pension obligations, exposing taxpayers to a $65 billion shortfall, according to a new report released Thursday by the C.D. Howe Institute.

Using fair-value accounting, the measure used in the private sector and based on solvency, the think tank calculated Ottawa’s net pension obligation stands at nearly $208 billion. That’s $65 billion more than reported in the public accounts.

The government lists its unfunded liabilities in the country’s national debt at $143 billion.

Taxpayers could be on the hook to back-fill the funding gap, the report by Alexandre Laurin and William Robson said.

On top of that, large exposure to public sector pensions could fuel fears of sovereign default driving up the cost of borrowing.

"The larger-than-reported gap between federal pension promises in these plans and the assets that back them is a problem, both for federal employees and for taxpayers,” the pair said.

But Canada is not alone. European and U.S. governments share the problem. The United Kingdom for instance is facing a $1.8 trillion shortfall and the U.S. has $3 trillion.

The difference, according to the report, is that heavily indebted countries such as the U.K. have made reducing these obligations a top priority.

Most federal employees in this country have what’s known as defined-benefit pensions, the most stable of all benefit plans since contributions are fixed. And higher-income public servants often qualify for special retirement compensation arrangements.

Backing promises to public service workers, the RCMP and Canadian Forces would require contribution rates of 35%, 41% and 42% of pay respectively, the report says citing the chief actuary.

Actual contributions to these plans today are 19%, 22% and 21% respectively. On average, two-thirds of costs are borne by the government.

Leave it to the C.D. Howe Institute -- a conservative think tank that vigorously defends private sector interests -- to grossly exaggerate the true state of public pension shortfalls. I went over their study, and it's based entirely on fair-value reporting of Ottawa's pension obligations:

More importantly, the federal government arrives at the $201.4 billion liability figure by discounting its accrued benefit obligations using notional interest rates. One of these – a legacy from before April 2000, when federal pensions were completely unfunded, and Ottawa needed a benchmark to track its accumulating obligations – is the interest rate on 20-year federal bonds for obligations arising from service before then. The other is the expected return, currently about 4.2 percent in real terms, on fund assets for benefits earned since April 2000. Neither rate reflects current reality.

Deferred compensation is akin to a loan from employees to the government – in this case, a loan indexed to inflation and backed by taxpayers. For that reason, the best interest rate for discounting the obligation is the yield on federal real return bonds (RRBs). At the RRB rate on March 31, 2010 – 1.56 percent – liabilities for 2009/10 would have totalled about $255 billion, as shown in the second column of Table 1.

The final entry in the first column of Table 1, “unamortized estimation adjustments,” is the portion of changes in asset values and liability estimates, using the government’s accounting, not yet reflected in the Public Accounts. The fair value column contains no such entry, because fair-value accounting recognizes all such changes immediately.

The government’s net pension obligation under the fair-value approach thus stands at almost $208 billion – some $65 billion larger than reported in the Public Accounts.

This raises the net public debt by an equivalent amount. And, because the gap between reported and fair-value pension obligations has grown over time (Figure 1), these adjustments also change the annual budget balances. Since 2001/02, the Public Accounts show the cumulative budget balances to be almost exactly zero, with surpluses and deficits offsetting each other. The fair-value approach to pensions, by contrast, shows a cumulative deficit over that period of $72 billion. In 2009/10 alone, the annual deficit would have been not the $55 billion reported, but $63 billion.

I have a problem using the yield on RRBs to project future liabilities. Moreover, fair-value reporting is sketchy, especially when you consider where we are in the cycle and that private investments (private equity, real estate and infrastructure) are not going to be valued fairly using this method. The other thing to bear in mind is that most pension funds do not have to sell their private investments any time soon, which is another reason why relying solely on fair-value reporting grossly distorts the true funding state of public pensions.

***Feedback***

Bernard Dussault, the former Chief Actuary of Canada, shared these comments with me:

The investment yield assumptions used for the projections of pension liabilities in this report do not appear relevant to me, as it is deemed that all categories (including equities) of assets will on the long run yield the same low rate as bonds. This artificially and unduly increases the value of pension liabilities.

The real rate of return of 4.3% assumed for equity investments by the Chief Actuary in his triennial actuarial evaluations of the cost of federal pensions might well be considered somewhat optimistic (e.g. I think it should not exceed 4%) but it would not be reasonable to assume for equities a real rate of return of only 2.75%.

And Patty Ducharme, National Executive Vice-President of the Public Service Alliance of Canada, put out this letter:

The C.D. Howe Institute report described in this article is another attempt to rob hundreds of thousands of hard working Canadians of their retirement security.

By re-releasing their own skewed figures, the C.D. Howe Institute is attempting to strike fear into the minds of Canadians by basing the whole premise of their projections on a doomsday scenario whereby Canada’s federal government ceases to exist.

The Institute's estimate of the “fair-value” costs of the federal public pension liabilities assumes that the federal government will one day cease operations in the same way as a private corporation going bankrupt.

But the latest actuarial report tabled in Parliament in November 2009, in fact, shows that the federal public service plan is adequately funded and is running a surplus – a far cry from the $65-billion liability that C.D. Howe is ringing false alarms over. This surplus is due in part to the large contribution by employees. Contribution rates of public service employees to the federal public service pension plan have been increasing substantially since 2006.

The viability of the pension plan is not in question. On the contrary, recent reports from the Public Sector Pension Investment Board indicate that the market investments of federal public service pension funds are generating significant returns to more than cover future pension plan liabilities.

The authors of the C.D. Howe report should go back and review their research.

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CPPIB Overtakes the Caisse?

Karen Mazurkewich of the National Post reports, CPPIB sees big jump in assets-under-management in Q2:

It wasn’t just the stock markets that added $8.9-billion to the coffers of the Canada Pension Plan Investment Board for the quarter that ended in September.

“Every asset class around the world had positive results,” said David Denison, chairman of CPPIB. The pension plan ended its fiscal second quarter with $138.6-billion in assets-under-management, up from $123.8-billion this time last year thanks to gains across all asset classes including a 14% hike in emerging markets.

The jump meant a 6.6% return-on-investment, and $500-million in new contributions by Canadians.

The pension plan — now the largest in Canada — will continue to focus on private investment opportunities such as the co-investment play it made with Onex Corp. to purchase the U.K. bathroom and auto parts company Tomkins. But Mr. Denison said infrastructure assets and real estate buys “are very much in.” The pension plan is hoping to soon close its deal with Australian-based Intoll Group (formerly Macquarie Infrastructure Group), which owns a 30% stake in the 407 Express Toll Highway in Ontario, as well and additional 10% stake in the highway it is acquiring from the Spanish company Cintra. Such buys — not to mention the bevy of real estate deals the pension fund has signed over the last year — have had a significant impact on our asset mix, added Mr. Denison. “We have to focus on large transactions because we have a large fund,” he added.

The fund went on a real estate shopping spree of the last year, most recently buying up two historic properties in Washington D.C., and minority stakes in two Manhattan office towers, including the 50-story building in the Rockefeller Center complex. CPPIB has also been active in the Australian real estate market, making a $375 million investment in Colonial First State Global Asset Management, and co-investing in a new fund with the Australian-based Goodman Group. The funds buys have tallied over $1.5-billion in 2010.

CPPIB is also flexing its muscle in the private debt asset class. “We are seeing lots of need in public companies to secure debt financing. We have $2-billion invested in the last 18 months, and we will continue to be active.

Next up: expanding the fund’s presence in developing markets, he added.

The CPPIB manages the national pension plan for Canadian beneficiaries. Following the economic crisis, the federal Finance Minister Jim Flaherty, and his provincial counterparts, have been exploring a pension reform option that would see an expansion of the defined benefits under the CPP in order to increase savings adequacy in the future. Pension reform will be one of the key topics to be addressed during the federal and provincial finance ministers meeting scheduled for December 19-20. “We hope there is a set of priorities that come of their deliberations,” said Mr. Denison.

You can read CPPIB's latest press release by clicking here. The results are impressive but not surprising given how strongly global markets, especially the US market, performed during their second quarter (ending September 30th):

For the six month fiscal year-to-date period, the CPP Fund has increased by $11 billion from $127.6 billion at March 31, 2010. This increase in assets after operating expenses is comprised of $6.7 billion in investment income representing a 5.2% rate of return combined with contributions of $4.3 billion.

“All major equity market indices realized gains this quarter, in particular U.S. markets, which posted their best September results in 70 years,” said David Denison, President and CEO, CPP Investment Board.

For the five-year period ended September 30, 2010, the CPP Fund generated an annualized investment rate of return of 3.4% or $18.3 billion of investment income. For the 10-year period ended September 30, 2010, the Fund generated $44 billion of investment income reflecting an annualized rate of return of 5.5%.

September was indeed an excellent month for global equities, with the S&P 500 posting a gain of 8.8% and with 27 of 45 global markets posting double-digit returns. In other words, the global beta boost benefited all pensions that are long stocks.

CPPIB's impressive returns also had some asking, CPP v. Caisse: Who's the biggest?:

For years the Caisse de dépôt et placement du Québec has been Canada's biggest investor, managing the assets of an assortment of public and private pension funds in Quebec. When it last reported its financial results as of June 30 this year, it had assets under management totalling $135.8-billion.

But the Canada Pension Plan is taking a run at the title. The fund, whose assets are managed by the Canada Pension Plan Investment Board, reported its financial results Wednesday, disclosing its assets grew by $8.9-billion to $138.6-billion in the fiscal second quarter ended Sept. 30. Advantage CPPIB.

But before anyone puts the gold medal around CEO David Denison's neck, we have to wait to see what the Caisse reports for its 2010 returns. Unlike the CPPIB, which reports its results quarterly, the Caisse only opens its books twice a year. That means investors will know early next year where the Caisse's assets stand as of Dec. 31.

Although the CPPIB has the advantage of having new contributions pour in while it does not have to use its assets to fund pensions until 2021, smart money might bet on the Caisse to stay biggest for a while longer. If the Caisse earned the same 6.6 per cent return as the CPPIB in the quarter ended Sept. 30, its asset level would have topped $144-billion by that date.

The year is far from over, and pension funds often earn significantly different returns in the same periods, depending on where they have more and less of their assets invested. So things could change. And the CPPIB can still brag about being Canada's largest single-purpose investment fund, which means it is a single fund and not an agglomeration of various pension plans like the Caisse.

With the S&P/TSX composite index up 14 per cent since June 30 -- and U.S. markets posting their best September returns in 70 years -- it hardly matters which fund stands biggest by Dec. 31. The biggest winners will be the plan members.

And with QE2 now entering its first phase, I think pensions will keep delivering impressive returns. In fact, yesterday Bloomberg reported that assets at the New York State pension fund, the third largest in the U.S., expanded to $132.8 billion at Sept. 30 as the value of investments grew 8% on rising prices for equities, Comptroller Thomas P. DiNapoli said.

As far as "who's the biggest?", my only thought is WHO CARES??? In fact, at one point I believe size becomes an issue at these behemoth funds and they should be cut in half to keep them lean, mean and focused. I have seen many big funds lose their edge, especially when the beta tide goes into reverse. Hope this isn't going to happen to either CPPIB or the Caisse, but in this new normal, bigger isn't always better.

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QE2 Bad For Pensions?

Drew Carter of Pensions & Investments reports, More quantitative easing may cause more funding damage — Mercer:

The recently approved second round of quantitative easing could further deteriorate the funded status of U.S. corporate defined benefit pension plans if long-term interest rates are lowered, putting continued funding pressure on companies, according to Mercer.

In the near term, lower rates on Treasury debt will bring down yields on high-quality corporate bonds used to discount pension liabilities.

However, if the second round of easing, known as QE2 and approved by the Fed last week, jolts life into the U.S. economy, the move could benefit pension funds in the long term.

“Higher interest rates, resulting primarily from a moderately higher inflation rate, would decrease pension liabilities,” Jonathan Barry, partner in Mercer’s retirement, risk and finance group, said in a news release. “At the same time, in a positive scenario, the value of plan assets could increase if the equities market improves as a result of improved business conditions and profitability.”

I've already written on how quantitative easing is bringing pensions to the brink. And don't forget what Leo de Bever of AIMCo recently told me about the Fed's policy:

"Banks do not mark their commercial real estate to market. Quantitative easing (QE) is all about giving banks enough of a cushion to absorb these losses. For Bernanke, keeping the system afloat takes precedence over everything else. Not sure he's wrong but he's solving one crisis by sowing the seeds of another."

While QE2 stirs up passions, the truth is nobody really knows how this is going to end. It might turn out to be a disaster, or it might turn out to be a stroke of genius. For me it's simple, there is no choice but to keep reflating risk assets and introduce mild inflation in the economic system. There are risks to this policy but the reality is they're going to do whatever it takes to avoid a protracted debt deflation cycle.

Pensions need to see asset values and interest rates rise so that deficits start shrinking significantly. And even then, it won't be enough. That's why policymakers are raising the retirement age, lowering investment return assumptions, cutting benefits and increasing contribution rates to shore up pension plans.

I believe QE2 will ultimately help pension plans. The Fed is feeling the state's pension pain and is moving to quickly defuse the neutron bomb using any means necessary. That's why I keep telling people to buy the dips, risk assets will keep rising. No matter what you think, if you fight the Fed, you will lose.

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