Sent: 14-06-2011 12:02:25
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ETFs and Pensions
a. Last week in The Spectator (www.spectator.co.uk) was an interesting article by Martin Vander Weyer about Exchange Traded Funds.
He pointed out that they have become a very popular product of late for many reasons. (The Australian newspaper contains a good article about their popularity - http://www.theaustralian.com.au/business/opinion/etfs-set-for-explosive-growth/story-e6frg9if-1226069764439).
Vander Weyer said that many ETFs own the assets who value they aim to reflect but many others are synthetic ("meaning they own derivatives which may behave erratically or involve unreliable counterparties") and others are leveraged ("meaning they deploy borrowed money in the hope of amplifying returns").
"...wise folk are beginning to feel uneasy about them [ETFs]. The Bank of England is said to be worried. The Financial Stability Board in Basel, set up by the G7 ministers to watch for smoke on the financial horizon, has just issued a warning. Gillian Tett, the FT [Financial Times] columnist who predicted the credit-derivatives crash two years before it happened, says, 'It's hard to not feel a sense of déjà vu.' And the loquacious City play Terry Smith agrees: 'The pace of the development in the ETF area has been described as breakneck,' he blogged recently. 'I just wonder whose neck will get broken.' You have been warned."
Well we have been warned indeed.
b. Pension Income and Changes to the Design of Pensions
The following first appeared in one of my recent DIY Super columns in The Australian:
Some recent media reports have suggested that current pension products do not deliver enough certainty in terms of the income that will be paid because of market volatility. In some of these reports it's been suggested that equities have too much volatility to deliver a stable income for retirees and that super funds, life insurance companies and others should be attempting to design products which are similar to the aged pension.
It is true that Account Based Pensions have an inadequate design. Most of the blame however lies with the financial services industry. Not only are their fees too high but they predominantly insist on using unitized investments funds which provide a combined income and capital return and are constantly revalued based on prevailing market prices.
In previous articles I've looked at this problem by considering the following example - an investor puts $100,000 into a managed fund that has a $1.00 unit price which means they 'own' 100,000 units. Suppose that after several years the unit price has increased to $2. Their 100,000 units were worth $200,000.
If the investor wanted to pay themselves $10,000 income from this fund they would need to sell 5,000 units whilst the unit price was $2.
Now suppose that the price of the units has crashed to 75 cents but they still wish to pay themselves $10,000 income. They now need to sell 13,333.33 units.
Under this scenario units are literally walking out the door as income.
Why does the industry design pension products like this and, more importantly, why do investors accept such an outcome?
Finally please consider purchasing a copy of this book "A How To Book Of Self Managed Super Funds". You can look at the contents page at the following link: http://www.atcbiz.com.au/r.php?r=0mjd6ne
The 5th edition has just been released.
For details of the changes made from version 4 to version 5 visit: http://www.atcbiz.com.au/r.php?r=1nhgpm2
As you'll see from the list there have been many changes.
Two purchase options are available - once only subscription - $55 inc GST - or an annual subscription will gives you access to all the updates made throughout the year ($120 inc GST). The book can be purchased at the following link: http://www.atcbiz.com.au/r.php?r=5a4agqb
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