Wednesday, 27 April 2011

CPP "Diseconomies of Scale" Study by Fraser Institute - Spreading FUD

FUD, for those unfamiliar with the acronym, stand for Fear, Uncertainty and Doubt. It is a familiar marketing technique to make people doubt and prevent them doing something. In this case, the Fraser Institute is applying FUD against the idea of expanding the Canada Pension Plan.

The FUD is found in Should the Canada Pension Plan be Enhanced? by Neil Mohindra, published and downloadable on the Fraser website here. The Fraser summary blurb says:
"The study concludes that diseconomies of scale present a risk to the CPPIB’s investment performance. The actions that the CPPIB is taking to offset diseconomies of scale in investment returns will likely become less effective as its assets continue to grow."

The first sentence is true, the Mohindra study does arrive at that conclusion. The problem is that neither the research it presents, nor other facts, support the statement in anything more than the sophistical (as in sophistry = plausible but fallacious argumentation) sense - yes, if diseconomies of scale do arise, then there is a risk, although not a certainty, that the CPPIB's investment performance will suffer. Mohindra delves into a series of research papers that address aspects of diseconomies of scale/size associated with investment funds and pension funds. Here is why I think we can dismiss the alarmist rhetoric of the Fraser report:
  1. If diseconomies of scale were inevitable, the CPPIB would have hit the wall long ago. As Mohindra belatedly notes, "A limitation in applying existing literature on economies and diseconomies of scale to the CPPIB is the sheer size of the CPPIB in comparison to the size of funds covered in the literature." The CPPIB years ago had assets that dwarfed any funds in the literature. Why did CPPIB not exhibit diseconomies of scale long ago? The rise in costs that Mohindra documents about the CPP/CPPIB has become apparent only in the last two years (look at his table A1 on page 34).That rise has less to do with scale than other reasons.
  2. The higher admin/expense numbers of the CPPIB can just as plausibly be interpreted as temporary, a result of the financial crisis and markets' recovery process combined with the investment mix of the CPPIB. It all hinges on the considerable amount of private equity, real estate and infrastructure investments that the CPPIB has deliberately made since 2006. While stocks on public markets such as the TSX rebounded sharply in 2009, the other stuff has lagged and the higher overheads that go with those other types of investments has driven up those costs as a percentage of assets. It's possible the CPPIB may be fundamentally wrong about investing in such other assets (along with many other pension plans out there, like the Alberta Teachers' Retirement Fund Board whose 2010 annual report announces that it has switched its investment policy to go in that direction). However, the explicit aim of the CPPIB is that such assets present the opportunity to gain higher returns that more than offset the higher fees. It is ironic that Mohindra quotes a speech by CPPIB CEO David Denison where Denison sets out a vision for using scale as a competitive advantage. If scale is a reality, I think I prefer the "glass half full" view (opportunity) from the CPPIB over the "glass half empty" picture (diseconomies) of the Fraser Institute.
  3. The pursuit of private equity, real estate and infrastructure by the CPPIB, rather than being a symptom of incipient diseconomies as Mohindra claims, is in fact the appropriate response and strategy to keep costs low and maintain superior risk-reward results. One of the studies cited by Mohindra, that of Dyck and Pomorski confirms that the CPPIB is following the successful path of other large funds: "In their private equity and real estate investments large plans have both lower costs and higher gross returns, yielding up to 6% per year improvement in net returns." Furthermore, most of the increase in operating expenses of the CPPIB during 2009 and 2010 came from the ramping up of internal management capability to replace external managers, another factor that Dyck and Pomorski say is a significant source of cost savings for bigger plans. It looks more like like CPPIB is on the road to exploiting increasing economies of scale, not butting up against diseconomies.
  4. Governance matters a lot more than scale. Small organizations can be poorly run as easily as big ones. A much more convincing explanation of what determines the success of a pension/investment fund comes from Keith Ambachtsheer of the Rotman International Centre for Pension Management. Pension organizations properly aligned with the interests of the pension benficiaries, proper definition of roles between a board and professional management, appointment of financially knowledgeable and independent individuals to boards, effective risk management processes - those are what get good results.
  5. The CPP's overheads, if they were to stay at current total all-in levels of about 1% (total operating expenses in 2010 of $498 million Government of Canada plus $236 million CPPIB plus $466 million in external investment management fees on average CPP total assets of $120,721 million per Volume 1 of the Public Accounts of Canada with CPP data starting page 171 of the pdf), or even rise further, are still small compared to the all-in costs of alternatives, like TFSAs and RRSPs. Start adding up the costs of mutual funds where most people place their retirement investments, or even of the best case lowest fee ETFs around, then add fees like deregistration/withdrawal fees from RRIFs, or the implicit charges when buying an annuity to turn the savings into retirement income (read Peter Benedek's series on annuities on this page of his RetirementAction website to see how poor a deal they are). The average person will be losing more in various costs than 1%. This ignores the "costs" from investing mistakes that so many people make along the way when left to do it themselves in TFSAs and RRSPs.
Instead of concluding that "the size of the assets the CPPIB will be managing even without expansion shows that diseconomies of scale is a reason not to expand CPP", Mohindra would be more accurate in saying that "the opportunity to exploit economies of scale is a reason to expand CPP".

The large size of the CPPIB portfolio is NOT a problem. As long as CPPIB governance and management continues to be good, the move into private equity, real estate and infrastructure provides opportunity, not rising risk. In the 2006 speech quoted by Mohindra, CPPIB CEO David Denison also mentioned that the size of private market opportunities is vastly larger than those in public stock markets. It is a good thing for CPPIB and for Canadians who have their money being invested there by the CPPIB.

Friday, 8 April 2011

Review and Ratings of Canadian Online Tax Software: 2010 Taxes Edition

It's here again! For the 5th year running, these are my ratings and assessments of the best and the worst of the online tax preparation programs available to Canadian taxpayers for 2010 tax returns. As before, I've gone through all the packages certified by the Canada Revenue Agency for electronic submission of a return through NETFILE. The same ratings method has been used but the results are a bit different. Some packages are better, some just the same as last year and there's one new entrant.

Ratings Method: total score out of 45 max points on 5 factors
  1. Privacy and security (10 points) - How well does the online tax prep company protect your data and your privacy? What do they promise and what evidence is there of their capability to deliver? Unfortunately, this is the weakest area of the ratings - my numbers could be fairly wide of the mark - since it is hard to get much tangible proof of the reality vs the promises made, even compared to the minimal promises as are publicly made on the websites. Only one company (Acetax) actually claims to have been audited by an external party. CRA does not do anything, as they woefully admit in the disclaimer on the webpage with the list of packages, to check up on the companies and how they handle our data, which I think is shocking and unacceptable, given that a lot of people likely believe that NetFile certification somehow gives assurance of security protection.
  2. Flow, readability and layout (10 points) - How does the appearance and the flow of the program guide the taxpayer through all the steps, ensuring that everything is entered correctly in the right places? Is it easy to go back and forth, to review results and check one's work or make changes? The programs vary enormously on this factor, from simple on-screen versions of the paper forms, which merely do the arithmetic correctly and transfer amounts (or are supposed to!) between forms, to sophisticated interview processes akin to interaction with an accountant, asking questions to uncover all income and deductions and credits.
  3. Help (10 points) - How much access to explanations about tax rules is provided and how well placed is it? One of my on-going pet peeve test items is the infamous T1135 Foreign Income Verification Statement which a taxpayer with foreign property over $100,000 in cost must fill in, sign and send in to CRA. Does the program tell you, ideally at the point when you have to tick that box, that it is not required for foreign holdings within registered accounts like RRSPs? Some do not say so and others do not say that the T1135, if required, cannot be done online and that it must be submitted by mail on paper.
  4. Responsiveness (5 points) - How fast is the online application at saving data and refreshing the screen? slow = frustration! A couple of programs either went haywire on me or were unavailable for login - not good if you are in the final throes of meeting the April 30th deadline.
  5. Accuracy (10 points) - How good a job does the program do at calculating your taxes and helping you legally pay the least amount? For those who think that NetFile certification means the programs will all come up with the same answer (as I believed myself before starting to look at all these packages a few years ago), it is time to recognize the reality. As I commented two years ago, CRA's certification only means the program is correctly including all the revenues. the programs differ enormously in their ability to automatically detect and claim all deductions and credits to which you are entitled. As a result, in my own case with all the packages my total income on line 150 was identical but balance owing on line 485 showed different amounts, anywhere from a few dollars to a few thousand dollars apart. In the cases where I had thousands less to pay this was the result of incorrect eligibility for deductions that the programs did not prevent. It is only because I used them all that I got to learn what should be the correct result. Some are much better than others at preventing incorrect input but it is always worth the time to use a couple of the programs to enter your data and compare the results. They all allow you to see the bottom line in much detail, if not actually to print or submit the completed return. The very best package (TaxChopper) at using deductions and credits for an individual and/or shared amongst family members is almost like having a skilled accountant doing your taxes - it is essentially an expert system for income tax. Three examples tested the packages' ability to optimize using age amounts and pension splitting, tuition and education transfers, foreign tax credits with inter-provincial residence thrown in for the trickiest rule. In no case did any other package beat TaxChopper - it always found deductions, transfers and credits to use and end up with the lowest taxes to pay. The difference on a potential $4700 tax bill was over $300. Optimization can be very worthwhile.


Highly Recommended
#1 TaxChopper - 39 points -
"A tax expert system – Delivers on the biggest refund / lowest tax to pay promise. Best value for money."
Alone in first place this year by dint of considerably beefed up help and continued clean-up of appearance and language.

#2 UFile - 38 points
"Polished, easy to use and handles all but the more sophisticated tax reduction optimizations"

#3 H&R Block - 34 points
"Technically, it's Ufile but it has a few less desirable privacy features"

#4 TurboTax (formerly QuickTax) - 33 points
"Guidance every step of the way with plenty of questions, reminders and some useful suggestions for future tax planning"

#5 AceTax - 29 points
"Just fine for those who need minimal help and are familiar with tax forms"

#6 eTaxCanada - 26 points
"Takes some getting used to but if you know what you are doing and which forms to use, works very well"

#7 Taxnic - 25 points
"OK package if you know what forms to fill and credits to claim. What CRA would give us if they created a NetFile package – no error checking or optimization, just the forms and correct transfer of amounts from box to box and form to form."

#8 WebTax4U - 24 points
"For those who know where things go and are familiar with tax forms"

Merely OK
#9 MBOTax - 20 points
"It's like working with the paper forms except amounts get transferred automatically and arithmetic is done correctly."

#10 EachTax - 18 points
"Looks like the forms. Not much more than a spreadsheet with colours."

Not Recommended
#11 (tie) - FileTaxOnline - 13 points
"Not recommended – too many weaknesses, some fatal"

#11 (tie) - EasyCTax - 13 points
"Chinese language version is unique on the market but not a lot else going for it. New entrant, looks like beta version."

#13 5DollarTax - 2 points
"Crude, half-finished effort, not worth using."

Friday, 1 April 2011

One Investor's Wish List for the Canadian Election

Rob Carrick of the Globe and Mail published his wish list to politicians in the current Canadian election, so here is mine.

  1. Expand the CPP by increasing pensionable earnings limits and raising contribution rates to target a 40% income replacement rate. If I could only get one wish, this is it. It is the best solution by far for what retirees need and in comparison to present alternatives or to the proposed PRPPs.
  2. Triple the annual TFSA contribution limit ... ok, I'll compromise with doubling it. It is a simple, understandable, effective multi-purpose account but the $5000 is too little.
  3. Start selling Real Return 1-5 year maturity Canada Savings Bonds as I wrote about here. Retirees without inflation-indexed DB pensions need them. That might reverse what the Globe recently described as their "long slow death".

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