Bob Carlson

2011 was a bad year for hedge funds, at least most hedge funds. Investors flocked to hedge funds after the tech stock bubble burst in 2000. The funds promised less risk and positive returns in almost any market environment. But they haven’t delivered for a while, and they especially didn’t deliver in 2011.

The result was a humbling year for the $1.7 trillion hedge fund industry, with the average fund dropping 4.8 percent and some stock-focused funds suffering an average 19 percent decline, according to research compiled by Hedge Fund Research and Bank of America Merrill Lynch analysts.

Investors who sidestepped hedge funds and instead chose mutual funds fared much better. For example, the Vanguard 500 Index fund gained 2 percent, and PIMCO’s StocksPLUS Long Duration Fund, 2011′s best performing mutual fund, enjoyed a 21.2 percent return.

But those are only averages. Not all hedge funds or hedge fund strategies did poorly. Our Retirement Watch “hedge fund” portfolio of mutual funds that use hedge fund strategies had another good year. Its consistently delivered returns higher than the S&P 500 with less volatility and risk. We recently made some changes in the portfolio, so I anticipate it will deliver better returns with less risk going forward. Plus, we don’t pay the high fees of traditional hedge funds.

There’s a of research on how to have a happy and successful retirement. Most of it these days reaches similar conclusions. You need to be active physically, mentally, and socially. You need relationships with people, some structure to your life, and things to keep you busy. A new study from the Sloan Center on Aging & Work at Boston College takes the research a step further. The study found that the older people with the highest well-being are those who are highly engaged in their activities. It doesn’t matter what the activities are. They could be work, caregiving, volunteering, education, or anything else. What matters is that it is something you care about and are enthusiastic about.

Furthermore, the study found that overall well-being among older adults appears to be considerably higher among those who are engaged in these activities. Older adults who reported being involved in one of these four activities, but not engaged, had well-being scores no higher than those who were uninvolved. Nevertheless, those reporting high or moderate levels of engagement also showed high levels of well-being. This difference was widest in the 65-and-older age group, suggesting that the quality of one’s experience with paid work, caregiving, education and volunteering may be particularly consequential for the well-being of people in later life.

It’s easy to find guides to the best places to retire. There are numerous books and articles. But it’s not so easy to find a list of places you shouldn’t retire to. Of course, you could pick up the latest Census report and see which areas are losing population. But the web site TopRetirements.com put together a list of the 10 worst states to retire. There aren’t any real surprises in the list. The worst five states, starting from the bottom, are Connecticut, Illinois, Rhode Island, Vermont, and Massachusetts.

A few words of caution always are in order when considering such surveys. This survey considers only five factors: fiscal health, property taxes, income taxes, cost of living, and climate. The survey doesn’t consider sales taxes, saying that in most states they’re only a nuisance. It’s really a survey to determine the most expensive states to retire in. Fiscal climate is considered, with an emphasis on government employee pensions, because poor fiscal conditions and underfunded pension plans likely would lead to higher taxes. California was on the list of worst states last year. But this year the survey added two new criteria. The state fell off the list because despite its high income tax rates the prototype retired couple used in the survey would pay almost no income taxes, plus California has a great climate.

These surveys should be only a starting point, because the criteria used might not be the most important ones to you, or you might be in a different tax situation than the prototype taxpayer used. They’re interesting, worth reading, but aren’t the final word.

There’s been a lot of big news from global central banks over the last month or so, but the events have one consistent effect: Traditional savers and investors are in a lot of trouble. To support global economies and offset the deleveraging in the developed world, the central banks have decided to drop any restrictions on their money creation. Since 2008, the Federal Reserve and the European Central Bank have had stop-and-go money creation policies. They’ve decided that isn’t going to be enough in the face of the growing sovereign debt crisis in Europe. The ECB made clear it no longer would have restrictions on money creation with its willingness to make three-year low interest loans to European banks backed by virtually any collateral. The Fed already announced it would facilitate loans to European banks through the ECB. On Wednesday the Fed went a step farther. It plans to keep short-term interest rates low at least through mid-2014. It’s also going to try to keep long-term rates low to make mortgages affordable and help the housing market.

The Fed’s made no secret that it plans to support the U.S. stock market. It believes increasing household wealth through higher asset prices will increase confidence and generate more economic activity. I’ll have more to save about this in future issues of Retirement Watch, especially its implications for investors. I’ll also discuss it in the free webinar coming Feb. 1 at 3:30 p.m. eastern time. Spaces are limited. To reserve your place in this free webinar, contacting TJT Capital at info@tjtcapital.com or 877-282-4609. You can review past webinars at www.tjtcapital.com.

That means U.S. investors starved for yield will have to continue their search for income by extending maturities or durations of their fixed-income holdings, or putting money in riskier, higher-yielding securities, said Dean Junkans, chief investment officer of Wells Fargo Advisors and Wells Fargo (WFC) Private Bank, which are units of Wells Fargo & Co.

“There’s not an easy answer for retirees,” said Junkans, who’s based in Minneapolis. “Don’t be lulled into the belief that buying intermediate Treasury-type products or strategies at these low, low interest levels are risk free.”

I’ve always wondered how Google makes all that money. Like many small business owners I’ve tried advertising through Google Search and similar methods. It didn’t work. I’ve talked to other business owners who reported the same thing. They paid Google money for clicks and generated few sales. From that it’s easy to see how Google could earn initial revenue from everyone trying various Google ads. But there wouldn’t be any repeat business, and word of mouth would slow the traffic of new business. So how does Google make money?

One avenue is revealed in The Wall Street Journal in a long article detailing a government sting. For those who don’t have access to the article, here’s a summary. Last summer Google agreed to settle criminal charges by paying $500 million in a forfeiture, one of the largest ever in the U.S. In the sting, the federal government recruited someone who recently was convicted of selling illegal drugs and other things online and was awaiting sentences. In hopes of earning a reduced sentence, he posed as a broker for various web sites that wanted to sell steroids, human growth hormone, and other prescription or illegal drugs without prescriptions. He bypassed the automated features of Google’s advertising network to talk with Google employees. They were fully informed of the details of the sites and knew they were illegal. Yet, they accepted ads for them on Google, and the sites generated a lot of traffic and orders. After accumulating enough evidence, the feds presented it to Google and closed the operation.

This could be just a sample of how Google makes money. There are continuing allegations that it knowingly accepts ads from web sites that are selling pirated entertainment (music, movies, etc.) and fraudulent mortgage brokers or restructuring firms.  It’s a strange story for a firm that boasts the motto: “Don’t Be Evil.”

“We banned the advertising of prescription drugs in the U.S. by Canadian pharmacies some time ago,” the company said in its sole comment on the matter. “However, it’s obvious with hindsight that we shouldn’t have allowed these ads on Google in the first place.”

The half-billion dollar forfeiture, although historically large, was small change for Google, which holds $45 billion in cash. But the company’s acceptance of responsibility opened the door to potential liability for taking ads from other people involved in unlawful acts online, such as distributing pirate movies or perpetrating online fraud.

Google has long argued it wasn’t responsible for the actions of its more than one million advertisers. But the forfeiture paid by Google represented not just the money it made from the ads, but also the revenue collected by illegal pharmacies through Google-related sales.

In an important shift, the settlement “signals that, where evidence can be developed that a search engine knowingly and actively assisted advertisers to promote improper conduct, the search engine can be held accountable as an accomplice,” according to Peter Neronha, the lead prosecutor.

Unknown is whether the company will toss aside advertisers as a result. “If Google were to adopt a much more restrictive definition of problematic advertisements, everyone would immediately notice a drop in their revenue,” said Eric Goldman, director of the High Tech Law Institute at Santa Clara University.

I always warn people against using rules of thumb and other easy tools to make decisions. A good example is interest rates, bonds, and deficits. At the beginning of 2011, most analysts were convinced interest rates in the U.S. would rise. They had to rise, people reasoned, because the U.S. deficit was so high that it would push interest rates and inflation higher. But the opposite happened. That’s because the economy and markets are complex. There are many factors at work, so you can’t rely on a simple A+B=C formula.

John Makin of the American Enterprise Institute explains why interest rates remained low in 2011. He identifies three factors: inflation remained under control; economic growth was less than expected; and investors put a premium on safety. In fact, while the theory that high budget deficits cause higher inflation and interest rates seems sound, there hasn’t been a strong correlation between those factors in the U.S. What’s likely to happen to interest rates in 2012? Here’s a tease:

Looking ahead, 2012 may see fewer risk events shocking investors than occurred in 2011. The recent rise in stock prices suggests that some investors are hoping for such an outcome. But the persistence of low interest rates on high-grade government bonds suggests residual caution among many investors who apparently are more worried about weaker growth and volatile credit risks among low-rated government bonds than they are about higher inflation.

Larger businesses have been doing well since the economy’s bottom in 2009 and have been hiring at a reasonable clip. But employment overall still is weak, and small businesses seem to be the reason. They aren’t hiring, and surveys by the NFIB indicate they don’t plan to hire anytime soon. It’s been assumed that this is partly an effect of the financial crisis and partly because small businesses are more dependent on housing.

But what if there’s another reason? What if small businesses aren’t hiring because their money is paying for higher employee medical care expenses for employees? That’s the argument here. Scott Shane of Case Western Reserve University says he’s looked at the data and that hiring by new businesses has been declining since 1999. He pins the cause on the cost of providing medical coverage to employees.

The slide in job creation appears linked to the rising cost of employee benefits. As the cost of providing for employees’ health care and retirement increases, hiring people becomes more expensive. The cost of employee benefits has been rising faster than businesses’ revenues since at least 2000. The BLS reports that from 2001 to 2010 the cost of employee benefits at private businesses rose faster than inflation, going up 13.6 percent in inflation-adjusted terms. The increase in benefit costs over the past decade suggests that benefit costs are eating into companies’ profits.

EQUIPMENT OVER LABOR

It is only natural that entrepreneurs try to reduce those costs. One way to do that is to hire fewer people. Equipment doesn’t need health insurance or retirement plans. So if a business can produce the same results by substituting investment in equipment for investment in labor, it can solve the rising benefit cost problem, albeit at the expense of employment. Therefore it’s not surprising that a smaller fraction of entrepreneurs hires employees, and those who do hire fewer people than they once did. The profit motive demands it.

He says the solution is to contain medical expenses. But the health care overhaul enacted in 2010 doesn’t do that, and some studies say it increases costs.

I couldn’t resist this piece from Reuters about Americans who are preparing for a collapse of civilization, or at least the economy. It interviews some “preppers” as they call themselves and refers to a web site or two. An important point is that these people are not forecasting a collapse or giving a time frame when it will happen. They believe such an event has a high enough probability that it is prudent to be prepared for a calamity.

Tegeler, 57, has turned her home in rural Virginia into a “survival center,” complete with a large generator, portable heaters, water tanks, and a two-year supply of freeze-dried food that her sister recently gave her as a birthday present. She says that in case of emergency, she could survive indefinitely in her home. And she thinks that emergency could come soon.

“I think this economy is about to fall apart,” she said.

Exchange-Traded Funds are probably the most successful new product launch in the investment industry as measured by the rate of new money flows into it. But things haven’t been all roses for ETFs. A number of ETFs quietly folded or merged into other ETFs because they couldn’t attract enough assets. Many others still are available but have so few shareholders that it’s hard to believe they are profitable for their sponsors. ETFs also attracted some bad publicity, because some that are intended to track certain indexes from time to time haven’t done such a good job. There also are instances of brief, wild fluctuations in the prices of a few ETFs. Some observers blame ETFs for market volatility, arguing that they make rapid trading easier and increase trading volume.

Yet, ETFs keep growing and new ETFs regularly hit the market. Here’s an analysis that thinks these trends finally are nearing an end. It argues that the new ETFs haven’t attracted much money and explores whether PIMCO’s ETF for the Total Return Bond fund will be a success.

Rowland maintains an ETF “death watch” list, which includes all funds that are at high risk of shutting down because they lack sizable assets or negligible trading volume. Since October, the number of ETFs on that list has been growing each month, and currently stands at 268, representing nearly 20% of the entire ETF market.

China’s massive stimulus program in 2008 was earlier and larger than those of the developed economies and did much to propel the global economy out of the depths of the financial crisis. Multinational companies based in the U.S. and Europe earned their profits from rising sales into China and other emerging economies. Over the last year China’s been trying to curtail its growth to curb inflation and deflate some bubbles. The debate now is whether China can engineer a soft landing by reducing economy growth modestly without triggering a recession or whether the decline will be significant. It’s an important point for all of us, because a steep fall in China is likely to adversely effect most of the global economy.

An interesting piece in Fortune argues that a very hard landing in China is inevitable. It relies extensively on a retired University of Chicago economics professor who was early in seeing the debt bubble problems in the U.S. and Europe.

So how far do China’s prices need to fall so that the cost of owning is reasonably close to the level of rents? Aliber reckons that the rental yield on apartments will eventually go from less than 2% to 5%, or even a bit higher.

The rental yield is simply the annual rent divided by the market price, just as the yield on a bond is the fixed interest payment divided by the price of the bond that day. In the U.S., the rental yield averages around 6%, meaning the multiple of prices to rents is around 17. The adjustment to a 5% rental yield in China would push prices down by 60%.