Dow 30 adds Nike Goldman and Visa, and drops HP BofA and Alcoa

Dow Jones is adding Nike, Goldman and Visa to the Industrial Average, and dropping Hewlett-Packard, Bank of America and Alcoa. They are adding youth and dropping the old guard. Young people wear Nikes and use Visa to purchase them. Goldman may be wily but smart and cool. HP makes money on ink; the B of A can't get over its past mistakes; and Alcoa? Well, aluminum stopped being cool when people started drinking bottled water - about 20 years ago? The inclusion in the Dow should not have any effect on the index, but the included stock will make their way into some passive portfolios tied to the Dow index.

Verizon Sells $49 Billion Bonds at T10+225

Verizon is selling $49 billion 10-year bonds priced at 225bp over the 10-year Treasury. The issue is twice oversubscribed. Investment-grade corporate bonds continue to be popular with investors as safe alternative to super low yielding Treasuries. The bond issue will help finance Verizon's buyout of Vodafone's 45% stake in Verizon Wireless. It sounds crazy, but why wouldn't you want to earn 5.2% annually on a super safe investment. Cell phone service revenues have only one way to go - up.

A Solution for U.S. Social Security

The Economist describes the three main models of government pensions, the two extremes "pay-as-you-go" (today's workers pay for today's pensioners, explicitly in Europe and implicitly in the U.S.) and defined contribution (as in 401-K-type corporate plans or in the fully funded Chilean scheme), and the brilliant in-between system of notional defined-contribution (NDC). The latter was first adopted by Sweden in the 1990s and more recently by Latvia, Poland and Italy. The plans define the contribution rate from the current workers (16% in Sweden). The money pays for today's pensions, but also counts toward an individual notional account. The notional capital in the accounts grows with the total wages in the economy. At retirement, the balance is annuitized. The beauty is the automatic adjustment of benefits. If the worker pool shrinks over time, or the longevity of the retirees increases, the per-year annuitized amount declines. If people work longer and retire later, the amount increases. The individual is sheltered from investment risk. The design is a simple use of college finance math: set the present value of future benefits equal to the accumulated value of the acounts. That is, the level of pensions is tied to how much we can afford. If only our politicians could add and subtract. Alas, they don't teach that in law schools...

Clever Europeans Propose a 0.1% Tax on Financial Transactions

If you are a government in need of money and you don't want to tax your own citizens, what do you do? You tax other countries' citizens. Eleven European countries have proposed just that. Since most financial transactions are intermediated by U.S. and British firms, the continental Europeans - the French and the Germans - decided not to tax beer and cheese, but finance. Should the U.S. tax subtitled movies and long compound words? The tax is popular with the public as many people have lost money in 2008 and are looking for scapegoats. The tax, while it appears small, is huge. A 100 share trade for $100 each would net $10 from both the buyer and the seller. Currently commissions are $6-10, so effectively this would double or triple them and undo 20 years of financial markets liberalization. The tax is so cleverly designed that it would also apply to Citi trading a German bond with JP Morgan in New York. I just hope it does not apply to me trading my junky VW car to CarMax and me buying some Yoplait at the grocery store.
http://online.wsj.com/article/SB10001424127887324432004578302242512322674.html?KEYWORDS=US+slams+EU%27s+tax

Rising Rates Will Help Banks

The management of a bank boils down to a tradeoff between the higher interest rates earned on the assets (assets are longer term) and lower interest rates paid on liabilities (on-demand deposits like checking and savings accounts). The difference is called the net interest margin, and is currently very low. As interest rates rise,while the value of the currently held loans will go down, new loans will be issued at higher rates, slowly improving the net interest margin equation.See the WSJ: http://online.wsj.com/article/SB10001424127887324906004578292201463497178.html?KEYWORDS=rising+rates+banks
This is similar to a landlord being able to lock in higher rents as rents go up even though old rents look low. It helps future margins.

John Bogle on ETF trading

John Bogle, the founder of the first index fund and theVanguard Group, on what not to do with ETFs:
http://finance.yahoo.com/blogs/breakout/etf-trading-no-way-invest-says-bogle-140924616.html

20 Years of ETFs

The January 26th issue of the Economist goes through the 20 years of ETFs. The Spider, SPY, the first ETF was introduced 20 years ago. Today, there are 4,731 funds, and the industry controls $2 trillion, with no sign of slowing. Index tracking offers obvious economies of scale. Running a small fund or a large fund requires the same number of people if all we are doing is tracking an index. So the Spider today charges only 0.09% a year. Great for small investors if used for creating diversified portoflios. Some of the synthetic ETFs make no sense. Investing in Treasuries and going long or short futures (often in a leveraged way) arguably serves no purpose: 3x Treasuries, 2x short currencies, etc. The cost of rolling the futures combined with the basis risk destroy whatever purpose these synthetic ETFs are supposed to have. How about 4x the temperature in Boston (we have weather futures after all) and 6x one minus Libor (we have Eurodollar futures)? C'mon, somebody think those up. I can see the hedging purpose of the futures. Why anyone needs these in an investable form is beyond me.

Investors are learning the duration risk of zero coupons

According to the WSJ, investors are turning away from muni bonds that pay no coupons. In an upward yield curve, these typically carry much higher yields than their coupon cousins. Their accruing interest is also tax-exempt like the actual coupon interest on a bullet bond. However, now that the prospect of higher interest rates is on the horizon, investors are recalling their college investment courses in which they (should have?) learned that the duration of a zero is equal to the maturity while the duration of a coupon is much much lower.

Commodities Less Popular with Pension Funds

The WSJ reports that the largest U.S. pension funds have lost their love for commodity indexes. Just a few years ago, commodity indexes were touted as must-have in any large portfolio as  diversification and inflation protection tools. Now that some of that wisdom has been debunked, investors are not so eager. Commodity ETFs have proven to be volatile, often delivering huge tracking errors, and not at all diversifying. Commodity returns have also been quite disappointing relative to equities and high yield. Perhaps that is the real reason behind the retreat.

Impact of Low Rates on Pension Plans

The WSJ describes how the low interest rates impact the level of unfunded pension liabilities. The main channel is not the current low returns on pension assets, but the lower discount rates applied to present value future pension liabilities. Intuitively, comparing to a long term bond, the issue is not the reinvestment rate, but the long duration (=interest rate sensitivity) of the liabilities.