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Vanguard continues to dominate mutual fund flows: Morningstar

Posted on August 18, 2016 by Editorial Staff -

With $32.9 billion exiting in July, outflows from actively-managed U.S. equity funds surpassed the estimated $21.7 billion in outflows in June, according to Morningstar’s monthly asset flow report on U.S. mutual funds and exchange-traded funds (ETFs) for July 2016. All passive category groups saw net inflows during the month, led by $33.8 billion in inflows to passive U.S. equity funds.

The ongoing flight to index funds continues to benefit The Vanguard Group, which pioneered the use of retail index funds 40 years ago and offers a long list of index mutual funds and ETFs. Vanguard passive funds gathered $21.1 billion in July, or about 62% of the total net flow into index funds, even though its European Stock Index Fund lost $1.5 billion, one of the highest outflows. Vanguard and State Street were the only top-10 U.S. fund families to see positive flows into active strategies for the second consecutive month.

In 2015 (about $220 billion) and so far in 2016 (about $160 billion), Vanguard’s flows are positive while the rest of the fund industry, collectively, has net outflows of about $60 billion. Actively managed funds, though battered in recent years, still dominate the broker-dealer channels and account for almost twice as much in total assets under management as passive funds, by $9.75 trillion to $5.09 trillion.

The Vanguard index funds cost as little as 10 basis points (0.1%), but low cost is not the firm’s only advantage, according to Morningstar. “Cost definitely plays an important part [in Vanguard’s success], but it’s not the only reason,” Morningstar’s Alina Lamy told RIJ. “A lot of it has to do with quality and transparency, as well—building a reputation and living up to it.

“Many investors saw their savings wiped out almost overnight during the crisis and lost trust in money managers who had promised stellar returns. Vanguard didn’t over-promise and didn’t disappoint. All they promise is market returns at low cost, and this is something transparent and reasonable that resonates with investors.

“Also, in their own words from their website: “Vanguard is client-owned. As a client owner, you own the funds that own Vanguard.” This keeps them free from potential conflicts of interest that might arise for a fund company that’s affiliated with other institutions, such as big banks, etc.

Invesco Diversified Dividend Fund, which has a Morningstar Analyst Rating of Silver, led flows into active funds in July, garnering nearly $1.3 billion. The highest inflow to a passive fund went to SPDR S&P 500 ETF, which took in more than $11 billion in July, representing the fund’s highest monthly inflow since December 2014.

The data in the flows report only includes open-end and exchange-traded funds, Morningstar said. Target date funds or funds of funds are excluded in order to avoid double counting. The data doesn’t include defined contribution investment options, retirement accounts or variable annuity subaccounts.

Taxable bonds offer high returns

When bond yields fall, bond prices rise. That’s good for current bond fund owners and it attracts new money. In the first half of 2016, international bonds returned 17.3% and emerging market bonds returned 10.9%. Long-term government and corporate bonds returned 11.9% and 11.7%, respectively. Overall, active and passive funds in the taxable bond category group garnered $34.0 billion in July.

The intermediate-term bond fund category garnered the most flows for the fifth month in a row, taking in nearly $15.0 billion in July. The diversified emerging markets and emerging-markets bond categories joined the top five categories in July, in terms of inflows, collecting $6.5 billion and $4.6 billion, respectively.

Investors continued to withdraw assets from funds in the large growth, Europe stock, and world allocation categories. Fidelity and Franklin Templeton led active outflows in July, experiencing $8.9 billion and $3.8 billion in outflows, respectively. Total outflows in the allocation category group were $3.5 billion.

Morningstar estimates net flow for mutual funds by computing the change in assets not explained by the performance of the fund and net flow for ETFs by computing the change in shares outstanding.

RIJ Takes a Two-Week Vacation

Posted on August 18, 2016 by Editorial Staff -

Advisors in limbo regarding DOL rule

Posted on August 18, 2016 by Editorial Staff -

Most advisors are considering changes to their business model as they wait to learn their firm’s new compliance procedures under the Department of Labor fiduciary rule, according to a new survey sponsored by the Nationwide Retirement Institute.

Nationwide’s “Countdown to Implementation” advisor survey is intended to provide a quarterly snapshot of the progress the industry is making to implement the new rule standards.

“Firms are taking this seriously, but still have a lot to work through. As we move through the next 18 months, we anticipate shifts in product mix and levels of understanding and concern,” said Kevin McGarry, director of the Nationwide Retirement Institute, in a release.

Almost nine in ten (87%) of advisors are considering changes to how they do business, according to the survey of 622 financial advisors commissioned in May by Nationwide.

More than four in ten advisors (43%) said they may plan to expand services offered to more holistic planning and 26% may plan to focus on non-qualified accounts. “Advisors are considering a shift from a transaction-based business model to more of a service-oriented model,” McGarry said.

Among the survey findings:

Only 42% of advisors say they are aware of their firm’s timeline for implementation or what training or support the firm will provide.
Only 33% are aware of their firm’s new compliance procedures.
Only 23% of advisors are aware of their firms’ plans with respect to adoption of the BICE to sell variable compensation products.
78% identified the BICE as one of the greatest areas of impact to their business.

The advisors Nationwide surveyed consider themselves at least somewhat knowledgeable about:

Fiduciary requirements (82%)
Products subject to fiduciary standards (76%)
Fee/compensation disclosure requirements (76%)
BICE (73%)
The difference between advice vs. education (69%)
Grandfathering provisions/conditions (64%)
Levelized compensation requirements (64%)

The Nationwide Retirement Institute’s new DOL website provides resources for firms and advisors wrestling with the complexities of the new fiduciary rule. In addition to the website, Nationwide is holding webcasts and local market events to provide resources and tools on practice management, best-in-class fiduciary practices and how advisors can build and grow their business.

Lull in “fintech” funding observed

Posted on August 18, 2016 by Editorial Staff -

Investment in venture capital-backed financial technology or “fintech” companies fell 24% in the U.S and nearly 50% globally during the second quarter of 2016, according to the Pulse of Fintech, a quarterly global report published jointly by KPMG International and CB Insights.

The report attributed the drop to “a tougher climate for marketplace lenders and a drop in mega-round activity,” according to a release this week.

U.S. fintech companies saw funding of $1.3 billion in the second quarter, down from $1.7 billion in the first quarter and from $2.4 billion in the year-ago quarter. Deal activity to venture-backed fintech companies in the U.S. also experienced a five-quarter low with just 90 deals.

Corporate venture funds played a larger role in deals to North American VC-backed fintech companies in the second quarter, participating in 30% of all fintech deals, up from 23% last quarter.

Over the last five quarters, Goldman Sachs, Citigroup and Banco Santander or their venture arms (excluding independent VC firms associated with these banks) have invested in 25 VC-backed fintech companies. Other banks making investments globally across the fintech landscape include HSBC, JPMorgan Chase, and Mitsubishi UFJ Financial Group.

“We see more partnering with fintechs by traditional financial services companies to help develop new business models, while also enabling fintechs to expand their customer base and get the support they need to become sustainable,” said Brian Hughes, partner, KPMG LLP’s Venture Capital Practice.

The 30 largest fintech funding rounds during the first half of 2016 totaled over $4.6 billion in aggregate funding. North America accounted for 19 of these rounds. Fintech early stage deal share in the U.S. fell to a five quarter low in Q2. Seed deal share fell to 21% after taking almost one-third of all U.S. VC-backed fintech deals in the first quarter of this year.

InsurTech is coming into its own as an area of fintech for venture capital investment, hitting $1 billion across 47 deals in the first half of 2016, KPMG said. Health insurance-related companies claimed the three largest deals of 2016 to date, but companies in life insurance are also seeing an increasing amount of investment, the release said.

TIAA creates fund to invest in ‘super-regional’ malls

Posted on August 18, 2016 by Editorial Staff -

TIAA Global Asset Management has raised $1.25bn (€1.11bn) for a real estate fund specializing in US regional shopping malls. The T-C Super Regional Mall Fund will be backed by domestic and foreign institutions as well as TIAA’s general account, IPE.com reported this week.

The TIAA fund has invested around $685 million so far. With leverage, the commitments give the fund $2.5bn to invest in the sector. APG, the Netherlands’ largest pension fund investor, has invested in super regional malls with TIAA for several years, but it was not clear if APG is an investor in this fund.

Super regional’ malls are those with over 800,000 sq. ft. of gross leasable area, three or more anchor tenants and a primary trade radius of five to 25 miles, according to the International Council of Shopping Centers in the US.

They are “a distinctly strong and stable performer throughout multiple cycles,” said Suzan Amato, managing director of TIAA Global Asset Management. “They have demonstrated high net-operating-income growth, low volatility compared to other property sectors, and a history of outperforming the NCREIF Property Index.”

“Given the current lack of mall construction and the shift towards consumers seeking entertainment experiences outside the home,” US super-regional malls present a sound long-term investment, said Scott Kempton, managing director and portfolio manager for the fund.

“These assets are unique, hands-on environments, often offering extensive food hall and fine dining options, as well as movie theatres and other attractions that can ultimately help drive traffic and sales,” he added.

T. Rowe Price reports on trends in its retirement plans

Posted on August 18, 2016 by Editorial Staff -

T. Rowe Price Retirement Plan Services, which serves nearly 1.9 million retirement plan participants across more than 3,500 plans, has released the latest version of Reference Point, an annual benchmarking report based on T. Rowe Price’s full service recordkeeping client data.

The report provides plan sponsors the ability to review retirement plan trends and plan participant behavior patterns to help them make more informed plan decisions. Here’s a summary of the report’s findings:

Auto-services trends

Among T. Rowe Price clients, the use of auto-enrollment has increased every year since the enactment of the Pension Protection Act in 2006. T. Rowe Price found that as of year-end 2015:

About half (51%) of the plans it administers have adopted an auto-enrollment feature, up 28% since 2011.
30% of plans have auto-enrolled participants at 6% or more, compared with just 17% in 2011.
Participation rates continue to be strongly tied to the adoption of auto-enrollment. Plans with an auto-enrollment feature have a participation rate of 88%, while those that do not have this feature have a participation rate of just 48%.
Target-date investments continue to be the default of choice for 96% of plan sponsors.

Contribution trends

By the end of 2015, the option to make Roth contributions was available to particpants in half of the 401(k) plans record-kept by T. Rowe Price, an increase of nearly 49% since 2011. Roth contributions among participants increased for the eighth consecutive year. In terms of matching contributions, 40% of plan sponsors are now matching at a threshold of 6%.

The average deferral rate among T. Rowe Price plan participants was 7%, far below the recommended level of 15% (which includes the employer match). About one-third of participants are not deferring any money to their retirement account.

Generational findings

Generational differences often exist when it comes to saving behaviors and attitudes that plan sponsors should consider. Of the T. Rowe Price plan participant base:

Of all age groups, participants between ages 20 and 29 have the widest difference in participation rates when auto-enrolled (84%) versus not auto-enrolled (30%).
Younger participants invested in target date funds at higher rates (70%) than other age groups (36%).
Younger participants save 5% of pay, considerably lower than the rate of older participants (between 7-10%).
The 40-59 and 50-59 age groups continue to maintain the highest outstanding loan balances, which have increased each of the past two years.

Manufacturers lead in adoption of auto-increase

Significant industry-specific findings include:

Only 35% of plans in the retail industry have adopted an auto-enrollment feature, compared with 51% of plans across all industries.
Only 14% of participants in the finance and insurance industries have an outstanding loan, compared with 24% of participants across all industries.
77% of the manufacturing industry plans have adopted an auto-increase feature, compared with 69% of plans across all industries.
In the utilities industry, plans with auto-enrollment have a 92% participation rate, compared with 78% for non-auto-enrollment plans. The all-industry average is a 88% participation rate with auto-enrollment and a 46% participation rate without.

Methodology

Data are based on the large-market, full-service universe—TRP Total—of T. Rowe Price Retirement Plan Services, Inc., retirement plans (401(k) and 457 plans), consisting of 662 plans and over 1.6 million participants.

For plan-level analysis (e.g., averages by industry), a plan-weighted average is shown. This process takes the average from each plan and averages them together. A plan-weighted average assigns plans with a smaller number of participants the same weight as plans with a larger number of participants.

For participant-level analysis (e.g., averages by age and tenure), a participant-weighted average is shown. This process adds up all participants for all plans and takes one overall average. A participant weighted average assigns plans with a smaller number of participants less weight than plans with a larger number of participants.

Data and analysis cover the time periods spanning calendar years ended December 31, 2007, through December 31, 2015.

Yale, MIT and NYU Sued over Retirement Plan Fees

Posted on August 11, 2016 by Kerry Pechter -

To the countless American workers without access to a retirement plan at work, and to the millions with plans whose employers don’t contribute to their accounts, participants in the retirement plans at Yale, MIT and New York University would surely be objects of envy.

After all, the faculty, staff, administrators who participate in these multi-billion-dollar plans receive pre-tax contributions from their universities of between 5% and 12.5% of salary if they themselves contribute at least five percent.

Brightscope, the compiler of retirement plan data and rater of plans, currently ranks the NYU plan in the top 15% of its peer group, with a rating of 80. MIT’s plan also has a Brightscope rating of 80. Brightscope gives the Yale plan a rating of 87, the highest score in its peer group.

Yet all three prestigious universities were named as defendants in federal class action suits filed in New York, Connecticut and Massachusetts this week by the St. Louis law firm of Schlichter, Bogard and Denton, which has filed more than dozen lawsuits of this type against deep-pocketed plan sponsors and providers over the past decade.

Generally, the suits charge that the schools, as sponsors of so-called jumbo retirement plans, failed to use their plan size to bargain for lower fund expenses and administrative fees for the participants, thus breaching their fiduciary duties under the Employee Retirement Income Security Act of 1974.

Even though the expense ratios of the TIAA and Vanguard funds in the NYU and Yale plans were relatively low—mostly below 50 basis points a year—the suits assert that the plans could have negotiated much lower fees from the fund companies.

The suit against the MIT plan, unlike the other two, targets close ties between MIT and Fidelity, including the presence of Abigail Johnson, the CEO of Fidelity, on MIT’s board of trustees, as a reason why the MIT plan included scores of high-cost actively managed Fidelity funds until July 2015, when MIT cut its fund lineup to 37 from 340 and eliminated all but one of its Fidelity funds in favor of a lineup heavy on Vanguard index funds.

The suits, the first that Schlichter has filed against universities, may also reflect a generalized discontent within higher education today. One of the NYU plaintiffs is Mark Crispin Miller, a professor of Media, Culture and Communication and prominent author whose books explore the border between media and politics.

“As faculty members we find ourselves ripped off in a breathtaking range of ways,” Miller told RIJ yesterday. “We’ve had our benefits slashed, we’ve had rent raised on university housing, and our pay raises have been below the cost of living. So we are not surprised by the law firm’s demonstration of breach of fiduciary duty by the retirement plan.”

Regarding the lawsuit, Miller said that a lawyer from Schlichter’s firm had approached NYU’s plan participants, not the other way around. “We were persuaded that the management of the plan was inadequate, that we were paying higher fees than we ought to be paying, and that the investments were not optimal,” Miller said regarding the participants’ decision to work with the law firm.

None of the complaints name TIAA, Vanguard, or Fidelity, as defendants. Since 2006, the Schlichter law firm has filed over a dozen such lawsuits against plan sponsors and plan providers, winning one suit in court, settling several others and in some cases winning awards as large as $30 million.

The MIT 401(k) plan has over 23,300 active participants and over $3.9 billion in plan assets, according to Brightscope. Until recently it offered 342 different investment options, according to Brightscope, which gives it a rating of 80 and places it in the top 15% of plans in its peer group.

The Yale University Retirement Account Plan, which has over 16,400 participants and $3.6 in assets, has a Brightscope rating of 87, the highest in its peer group. It offers 114 investment options. A quarter of plan assets are in the TIAA Traditional Annuity, whose 2.5% surrender fee and 10-year minimum drawdown period—features that allow it to achieve higher yields—are criticized in Schlichter’s suit as unfiduciary.

The NYU Retirement Plan for faculty, research staff and administrators has a Brightscope rating of 80, 16,400 active participants and $2.4 billion in assets. It offers 103 investments, and 27% of assets are in the TIAA-CREF Traditional Annuity and 21% in the TIAA-CREF Stock fund. The NYU School of Medicine’s plan has over 7,700 active participants, over $1.6 billion in assets and a Brightscope rating of 76.

The suit against NYU and the NYU Medical School charges, among other things, that:

The plan offered too many mutual fund options, thereby causing “decision paralysis.”
Because there were so many funds, participants’ contributions were fragmented so that so that they didn’t enjoy the economies of scale they might have gained from putting larger amounts in fewer funds.
The plan relied on two recordkeepers, TIAA and Vanguard, when using one would have been more efficient. “A reasonable recordkeeping fee for the Plans would be approximately $840,000 in the aggregate for both Plans combined (or a flat fee based on $35 per participant)… the Faculty Plan paid between $3.1 and $3.8 million (or approximately $230 to $270 per participant) per year from 2010 to 2014, over 670% higher than a reasonable fee for these services,” the suit said.

The suit against Yale makes similar claims, while acknowledging that the school acted over a year ago to change its plan:

Only in April 2015 did Defendants consolidate the Plan’s recordkeeping and administrative services with a single recordkeeper, TIAA-CREF. Also for many years, the Plan had higher-cost share classes of mutual funds despite the Plan’s tremendous size and bargaining power to demand low-cost investments.
In April 2015, Defendants moved some of the Plan’s investments to lower-cost share classes of the same investments. These lower-cost share classes, identical in every respect except for lower fees, had been available since 2010. Plan participants could have and should have been paying far less for the same investment since that time.

The suit against MIT also acknowledge changes in the plan:

“Effective July 20, 2015, Defendants eliminated hundreds of investment options provided in the Plan, including over 180 Fidelity funds. Only the Fidelity Growth Fund remained. The new investment lineup includes 37 investment options, of which 19 were previously offered. The consolidated investment options include Vanguard collective trust target date funds, two custom funds (Bond Oriented Balanced Fund and Diversified Stock Fund), twelve Vanguard funds, and nine actively managed funds offered by non-Vanguard investment managers. The assets of the funds removed from the Plan were transferred or ‘mapped’ to low-cost Vanguard funds, and for some investments, to the Wellington High Yield Bond Fund.”

Great American Offers No-Commission Indexed Annuity

Posted on August 11, 2016 by Kerry Pechter -

Fee-based advisors say they’ve been waiting for annuities that offer customer value instead of performance-draining commissions. Insurers have been listening—and are now acting.

Great American Life, the third-ranked seller of fixed indexed annuities after Allianz Life and American Equity, has introduced a zero-commission FIA with a living benefit rider that’s intended for distributor to retirement clients of fee-based broker-dealer advisors and registered investment advisors.

Called the Index Protector 7, the product offers higher caps on its point-to-point index crediting method—up to six percent compared with the 3% to 4% cap on similar products. The fee for the “stacked” guaranteed lifetime withdrawal benefit is 50 basis points.

“The real appeal is the strong rates,” Malott Nyhart, senior vice president of the annuity group at Cincinnati-based Great American, told RIJ today. “We think that’s pretty strong for a seven-year product. There are 14 to 16 year products that might have a 5% cap, but broker dealers don’t want to sell those long-duration products.”

According to a press report in July, other FIA manufacturers—Allianz Life, Voya, Symetra and Lincoln—have no-commission FIAs in the works.

The Great American call center was swamped today with calls from broker-dealers and RIAs, Nyhart said. “Their only question they have is how much advisors will charge for this. I think it will be in the 20 to 40 basis point range”—between the amount they charge for managing fixed income money and the amount they charge for managing equities,” he told RIJ.

Regarding the lifetime income benefit, “It’s a 2% stacked rider which pays 2% on top of any or all growth of the FIA annuity value,” he said. It has 5% payout for single contracts beginning at age 65 (4% for joint contracts). The contract has a seven-year duration with a 7% surrender charge for each of the first three years.

The introduction of the new product, which the closely-held Great American discussed with its major distribution partners at a retreat in South Carolina last April, was spurred in part by the DOL’s fiduciary rule, which is expected to discourage the sale of FIAs and variable annuities that pay third-party commissions.

“The DOL gave it some impetus, but the real issue is that the markets are pretty much topping out,” he said. FIAs offer investors a combination of zero risk of downside losses with limited exposure, through options on equity indices, to equity market gains.

Nyhart said that Great American has been building its ties to broker-dealers, the channel where more of its FIA sales come from. “We saw a 30% increase of sales from b/ds in 2015,” he told RIJ, “and 50% of our sales came out of b/ds in first half of this year. We assume that, because of the rider, a lot of the sales will be to qualified accounts.”

Great American’s ability to bring out a fee-based FIA ahead of its competitors may have something to do with its ownership structure. The company is publicly-traded but closely-held by billionaire brothers S. Craig Lindner and Carl Lindner III. There’s a lean management structure that reviews new ideas and makes decisions relatively quickly.

“Our process is faster-to-market. We changed the whole make-up of product development,” Nyhart said in an interview. “We have a system where I look at new ideas and then every two weeks we score them. Then we look at what is the simplest version and drive it from simplest to most complicated. We don’t have to go through committees. We can talk about it over lunch and make a decision.”

Great American intends to review all of its products to determine whether to roll out a no-commission version of others. “This is the first of many,” Nyhart said.

Variable annuity fee income boosts Jackson’s performance

Posted on August 11, 2016 by Editorial Staff -

Benefiting from fee income on a record $138.9 billion in variable annuity separate account assets, Jackson National Life Insurance Co. generated IFRS pretax operating income of $1.3 billion in first half 2016, slightly over the same period a year ago.

Sales and deposits of $11.2 billion in the first half of the year were down 14% from the same period in 2015, however, as reduced VA sales more than offset higher sales of fixed and fixed index annuities, as well as institutional products.

“Despite the headwinds we faced in the first half of 2016, Jackson experienced positive variable annuity net flows of $3.6 billion,” said Barry Stowe, chairman and chief executive officer of the North American Business Unit of Prudential plc, which owns Jackson.

“However, consistent with the rest of the industry, variable annuity sales have slowed due to market volatility and activity surrounding the U.S. Department of Labor fiduciary rule.”

Jackson’s first half performance allowed the company to remit a $450 million dividend to its parent company while continuing to hold capital in excess of regulatory requirements, according to a release.

TIAA buys Everbank

Posted on August 11, 2016 by Editorial Staff -

TIAA (formerly TIAA-CREF) has agreed to buy EverBank, a nationwide consumer and commercial bank with $27.4 billion in assets. The acquisition, expected to close in the first half of 2017, expands TIAA’s banking and lending products and complements its retirement, investment and advisory services.

EverBank stockholders will receive $19.50 per share in cash, or an approximate total of $2.5 billion. “The combination of TIAA’s existing banking operations and EverBank will significantly bolster TIAA’s banking capabilities and form a full-service banking company uniquely positioned to help both companies’ customers succeed,” said a TIAA release.

TIAA currently offers a variety of savings and lending products to its customers. EverBank’s established banking operations will enable TIAA to provide a wider range of services to those customers. The acquisition gives TIAA an employee base and significant business operations in Jacksonville, Florida, and other key markets.

EverBank’s board of directors has approved the transaction, as have the insiders who control 22% of Everbank’s outstanding common stock. The deal is subject to approval from the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and EverBank’s common stockholders.

The holders of the EverBank’s Series A 6.75% Non-Cumulative Perpetual Preferred Stock will have the right to receive the liquidation preference of $25,000 plus accrued and unpaid dividends on a share in cash at closing.

Lazard acted as lead financial advisor and Davis Polk & Wardwell LLP served as legal counsel to TIAA. J.P. Morgan Securities LLC also acted as financial advisor to TIAA. UBS Investment Bank advised EverBank and Sullivan & Cromwell LLP served as its legal counsel.

Lincoln Financial Distributors enhances annuity sales demonstrator

Posted on August 11, 2016 by Editorial Staff -

The Lincoln Investor Advantage Visualizer—which illustrates the potential benefits of incorporating the i4Life variable annuity income rider into a client’s retirement plan, now includes a Tax Deferral Illustrator created by Morningstar, according to Lincoln Financial Distributors.

The enhancement “helps advisors address the impact taxes have on retirement planning and the need for income in retirement,” said John Kennedy, head of Retirement Solutions Distribution, Lincoln Financial Distributors.

“We believe our proprietary Wealth Forecasting Engine (WFE) is a sophisticated way to illustrate the power of tax deferral,” stated John McCarthy, senior product manager at Morningstar.

i4LIFE Advantage is a patented income distribution method, offered only with Lincoln variable annuities. Available for an additional charge, i4LIFE provides tax-efficient income when investing with nonqualified money.

Scalable Capital, a German robo, enters UK market

Posted on August 11, 2016 by Editorial Staff -

Already established in Germany and Austria, digital investment manager Scalable Capital has become the latest robo-advisor to enter the UK market, opening its portfolio management business with portfolios built of exchange-traded funds, ETFstrategy.co.uk reported.

Scalable Capital currently manages more than 1,200 client portfolios, according to Adam French, its managing director and co-founder.

After a risk tolerance assessment, the firm’s algorithm builds a custom globally diversified portfolio of ETFs to offer exposure to equities, government and corporate bonds, covered bonds, commodities, real estate and cash. Average ETF fee is 25 basis points per year.

The average total expense ratio of ETFs used by the firm is 0.25% per annum), while also maintaining high liquidity and transparency.

The firm said it ensures risk preferences of its investors at all times, “including during abnormal ‘stressed’ market conditions.” Accounting for “all previous market conditions,” its “value-at-risk analysis” tells investors each year what amount or percentage of their portfolio for a given probability (usually 5%) over the following year.

In addition to the average ETF fee of 25 basis points, Scalable Capital charges an all-in annual fee of 75 basis points, for an approximate annual expense ratio of 100 basis points (one percent).

After a Series-A funding round of £5.6m in March 2016, taking the firm’s total funding to £8.8m, Scalable Capital has announced plans to build out Scalable Capital’s UK client base, as well as to fund expansion into selected new markets.

Manweb Group and Abbey Life complete £1bn pension risk transfer

Posted on August 11, 2016 by Editorial Staff -

In a pension risk transfer deal, Manweb Group, an electric power company in the UK and a participant in the £32bn Electricity Supply Pension Scheme (ESPS), has agreed to pay Abbey Life, a subsidiary of Deutsche Bank, £1bn, to assume the longevity risk of 4,000 of its members.

The deal is structured as a tri-partite insurance policy between Electricity Pension Trustee Limited, Manweb (a unit of Scottish Power, which is a unit of Iberdrola) and Abbey Life, according to IPE.com. Mercer acted as the lead advisor on the transaction.

The deal was announced days after Legal & General transferred some of the longevity risk associated with its bulk annuity business to Prudential Retirement Insurance and Annuity Company, citing uncertainties created by the Brexit vote.

Prudential said its ability to transfer risk was “unaffected” by the vote to stay out of the European Union.

Bank of England’s rate cut draws criticism

Posted on August 11, 2016 by Editorial Staff -

UK pension experts have protested the Bank of England’s announcement that it will cut interest rates, saying that it will hurt the funding status of already-ailing pensions.

The UK central bank said it would reduce interest rates to 0.25% from 0.50%, expand its quantitative easing (QE) program by £70bn (€81.9bn) via £10bn in corporate bonds and £60bn in UK “gilt” bonds and launch a “term funding scheme” to ensure banks pass the rate cut to borrowers.

Pension consultant Hymans Robertson estimated deficits of UK final salary-type schemes post-Brexit had grown to £935bn.

“A further fall in interest rates as a result of (yesterday’s) Bank of England announcement will see this figure increase further towards the £1trn mark,” said former pensions minister Ros Altmann. “Employers struggling to support these schemes face pressure to put in more money.”

Amlan Roy, of the London School of Economics (LSE) and London Business School (LBS), said fiscal policy measures, as well as structural reforms, were necessary to tackle economic weakness. All three “arrows”—fiscal stimulus, monetary easing and structural reforms—are needed all over the world, he said.

“Trustees of pension schemes, whose deficits keep rising, are facing almost impossible investment dilemmas,” she said. “If the employer has already put huge sums in or cannot afford to do more at the moment, then trustees ideally need to find other ways to reduce the deficit.”

Nigel Green, chief executive of financial consultancy deVere, said the Bank of England’s package of measures designed to cushion the UK from recession won’t solve the country’s economic troubles.

Slashing the key interest rate to historic lows and extending the QE program to £435bn in total was going to unleash more “catastrophic damage on pensions, pension funds and, potentially, the UK’s long-term sustainable economic growth,” he said. “A different solution – a more direct way of boosting growth – rather than forcing Gilt yields lower, has to be found by the Bank of England.”

Advisors: Give this ‘Tilt’ a Whirl

Posted on August 3, 2016 by Kerry Pechter -

A combination of annuities, modulated withdrawals from an investment portfolio and monthly Social Security benefits is emerging as a way—especially for clients who can’t afford to self-insure against longevity risk—to generate safe, sustainable income in retirement.

Flexibility is one of the benefits of this method. By adjusting a) the type, timing and size of annuity purchases, b) the level of spending each year, and c) the Social Security benefit start date, advisors can re-size the legs of this three-legged strategy to suit the needs of virtually any retiree or retired couple.

New research confirms the value of this technique. In the third in a series of articles at AdvisorPerspectives.com, University of Texas at El Paso engineer John Walton (at right), simulates the outcomes of income-generating strategies that employ what he calls a “constant rate” or “mortgage” systematic withdrawal strategy, his “tilt” method of increasing or reducing annual spending in response to market performance, and the purchase of a single premium income annuity at retirement.

“None of the recommended methods ever go broke, and the remaining capital never cascades irreversibly toward zero,” Walton writes. “There is no sequence-of-returns risk and very little longevity risk. The tradeoff is income stability. Income varies each year, and if returns are poor, income will suffer unless stabilized with annuities.”

Constant rate vs. mortgage method

To provide a bit of background from Walton’s earlier articles on this topic: His constant rate strategies are based on the classic 4% rule. Annual spending is fine-tuned by applying a tilt each year with the tilt ranging from -1 (i.e., liquidating 4% of the original account balance each year irrespective of market returns), through +0 (i.e., liquidating 4% of the current account balance), up to +1 (i.e., liquidating less than 4% of current account balance when the market underperforms and greater than 4% when the market over performs).

Alternately, Walton recommends a “mortgage” strategy. It takes advantage of declining longevity to increase the withdrawal rate as the retiree ages. At retirement, the withdrawal rate is pegged to the payout from a hypothetical (unpurchased) period-certain annuity. The premium is equal to the account value and the contract expires at an estimated age of death (e.g., age 85 or 90). Each year, as the period shrinks and the hypothetical annuity payout grows, the retiree can spend an incrementally higher percentage of the remaining portfolio.

In his most recent article, Walton combines these methods with the actual purchase of a single premium inflation-adjusted income annuity (SPIA) that pays out 4.5% starting at age 65, purchased at retirement.

His hypothetical case involves a 65-year-old woman with a starting portfolio of $1 million who expects to receive an inflation-adjusted $25,000 from Social Security each year for life and buys a SPIA with $750,000, $500,000, $250,000 or none of her savings.

The best combination of income and safety resulted when the retiree used 25% to 50% of her initial capital to buy the inflation-adjusted SPIA at age 65, Walton found. The more money dedicated to the annuity, the higher the client’s income floor and the lower the amount left to heirs. Strategies with annuities work best in low-return environments, and can be superfluous in high-return environments.

For the investment portfolio, Walton noted that the income annuities provide a margin of safety that allows clients to allocate 80% of their non-annuitized saving to equities. In the event of market volatility, the advisor conserves the portfolio by adjusting annual liquidation according to the tilt—i.e., spending less in downturns and more in upturns.

“When combined with guaranteed income, the positive tilts provide a very robust combination of high stable income and capital security over a broad range of market conditions,” Walton wrote. “They combine the statistical advantages of annuities—safe return of capital and mortality credits—with the statistical advantages of positive tilts—providing income that adaptively matches market returns while preserving capital.”

Inside the Flight from Active Management

Posted on August 3, 2016 by Kerry Pechter -

What started as a trickle has turned into a flash-flood.

Indexing (aka passive management), which took decades to become established as a legitimate investment practice (and not just a timid way to “settle” for average market returns), has emerged as the dominant form of diversified investing in the 21st century.

Although active strategies still account for most existing invested assets, index-linked and multi-asset class (MACS) investment strategies attracted more than 90% of net new money worldwide last year, according to the 2016 Performance Intelligence Asset Management Benchmarking Survey, conducted by Casey Quirk by Deloitte, a strategy specialist for asset managers, and McLagan, a compensation consultant. The survey found:

The global professionally managed active investment management industry, which historically has relied on traditional active funds for most of its revenue and profits, got less than 10% of new money in 2015. Of the asset managers firms surveyed with more than $10 billion in AUM, only 56% reported positive net flows in 2015, compared with 60% one year earlier and 63% in 2013. By contrast, 44% reported net outflows last year, against 40% in 2014 and 37% in 2013. Vanguard, founded by, Jack Bogle, the champion of indexing, has been perhaps the biggest instigator and biggest beneficiary of this trend (see chart below).

One exception to the rule has been American Funds, a $1.22 trillion unit of the Capital Group. Until June, when the active fund family suffered outflows of $707 million, American Funds had experienced positive flows, with a net $6.84 billion for the first six months of 2016. according to Morningstar. Its American Balanced Fund was the most popular active fund in June, with an estimated net inflow of $1.17 billion.

Steve Deschenes, director of product management and analytics at American Funds, said that his firm has become the second largest fund family primarily by pricing its funds 20 to 30 basis points lower than comparable active funds and by hiring managers with good track records who put their own money in their funds. “We are the low cost active manager,” he told RIJ this week. “And all of our funds have a high degree of manager ownership. It’s amazing the differential that you can achieve with that.”

Chart for Flight from Active 8-4-2016

Is low cost the driver?

But American Funds and perhaps MFS are the exceptions. “We see massive change happening,” Jeffrey Levi, Casey Quirk by Deloitte, principal, Deloitte Consulting LLP, told RIJ this week. “Today the average investor pays many layers of fees to get advice. I would expect some of those layers to disappear over time, as players integrate more.

“Some asset managers will be using technology for efficiency, for automating routine functions, to reduce headcount, and to raise accuracy and lower costs. Others will use technology as a differentiator, with automated platforms and mobile asset allocation capability. Some firms will be slow to adopt direct-to-consumer technology because of channel conflict and the high cost of acquiring online customers.

“But you’ll see more to direct-to-consumer efforts among asset managers as they try to build a more scalable business. Most of the robos have aimed for the underserved mass affluent, but direct doesn’t have to be robo. Money managers own the direct-to-consumer high-net-worth private wealth management business. So more asset managers will go direct, but not necessarily pure robo.”

Individual investors, who are projected to generate 90% of all new money invested through 2020, are “increasingly skeptical of active management, fee-sensitive and outcome-oriented,” he added.

A prominent member of the Money Management Institute (MMI), an association of wealth management firms, told RIJ privately, “Low cost is the driver. I don’t think it’s a lot more complicated than that.”

“The asset management industry is now in an era of disruption and consolidation, similar to what Wall Street firms underwent in the late 1970s and 80s,” said Fred R. Bleakley, director of the U.S. Institute, in a release. “Surviving firms will be leaders in specialty active management, Smart Beta passive, and multi-asset class solutions.”

“Many traditional active managers must adapt,” said Levi (right). “Their business models are outdated in a world in which individual investors and their need for advice are the revenue generators. Fees are under increasing scrutiny, and regulatory pressures are on the rise. Jeff Levi This shifting marketplace will in turn drive greater convergence in the industry across wealth management, asset management, insurance and financial technology.”

Buyer archetypes

Four buyer archetypes are emerging—outcome-oriented, cost-conscious, those influenced by gatekeepers, or those interested in investment quality. Each has a distinct set of preferences and behaviors, according to the Casey Quirk by Deloitte report. The largest group, which includes those who favor traditional investment quality, account for roughly half of industry assets under management, but are projected to shrink in the future. The other three groups will see the majority of growth.

Despite the shift in flows, active asset managers still have a lot of money. Global assets under management rose slightly, to an estimated $69 trillion in 2015, from $68 trillion in 2014. Industry revenue fell less than one percent to an estimated $344 billion from $346 billion in 2014.

Aggregate average fees declined to 50.1 basis points, or 0.501%, from 51.4 basis points, or 0.514%, in 2014. Operating margins also fell to an estimated 32% from 34% in 2014. Negative returns from capital markets contributed to low growth overall, according to the survey, now in its 15th edition.

Inequality effect

Financial inequality could help put a floor under the active asset managers’ losses of market share, however. About half of American households owns stocks, but the richest one percent of U.S. households owned more than 40% of all non-home financial wealth in the U.S. in 2010. The richest 20% owned over 95% of financial wealth.

If the richest 20% decide that they prefer to have premium financial services, including active management, there might be a natural limit to the level of growth of the low-cost, automated, indexing sector of the financial services industry.

The Casey Quirk by Deloitte study included more than 100 investment management firms headquartered in North America, Europe, and Asia Pacific, investing more than $20 trillion for institutions and individuals.

The firms surveyed included privately held, publicly traded, and wholly or partly owned enterprises with assets under management ranging from below $5 billion to more than $1 trillion. Survey participants included the executive teams of leading asset management firms as well as senior leaders at investment management firms who belong to the U.S. Institute and European Institute.

The Great Woodstock Festival in the Sky

Posted on August 3, 2016 by Kerry Pechter -

The health care industry in the U.S. is likely to benefit from a big uptick in federal spending in coming decades, as Baby Boomers become eligible for Medicare benefits, according to a July 16 report from the Congressional Budget Office.

Such spending, combined with Social Security outlays, is often framed as an unsustainable burden on the U.S. economy and on future generations. But it can also be perceived as a boost to consumer spending and a boon to all the businesses that sell consumer goods or medical care to the elderly.

Call me a cockeyed optometrist, but that’s how I choose to see it.

In 2015, Social Security spending alone added about $886 billion to the economy, not counting so-called multiplier effects, according to the latest Social Security Trustees’ report. Some economists argue that payroll taxes also reduce the spending power of the nation’s workers by that amount, producing no net benefit. I’m not an economist, but I don’t feel compelled to view Social Security as a zero-sum game. Workers who pay FICA taxes aren’t fleeced; they acquire an asset—future OASI benefits—that they will tap in their own old age.

I’ve asked economists how they account for Social Security’s undeniable contribution to local economies and none of them has ever had an answer, other than to repeat the mantra that Social Security spending comes at the expense of spending by wage earners.

When framed as a pure expense, entitlement spending can certainly appear threatening. Here’s a scary factoid: By 2046, spending for Social Security and the major health care programs (primarily Medicare) for people 65 or older is projected to account for about half of all federal noninterest spending.

Social Security is also on track to increase as a share of the U.S. economy—from 4.9% of gross domestic product (GDP) in 2016 to 6.3% in 2046. Assuming that current laws aren’t changed, gross spending on Social Security and the major health care programs is projected to reach 16.3% of GDP in 2046.

But if you accept that all Social Security and federal health care spending goes directly back into the U.S. economy, and helps every community where the elderly buy groceries and visit doctors, and relieves grown children of the financial burden their frail parents might otherwise impose, then it’s difficult to believe the doomsayers who act as though Social Security spending is an expense that goes to Jupiter in a rocket ship and never comes back.

Sure, there will be stresses to federal and state budgets as the Boomers—with their titanium hips, Van Morrison CDs and organic green tea supplements—push the envelope of human longevity. But that’s just demographics. And it’s temporary.

Eventually the Boomer age-wave will pass. Sometime in the 2060s, the last Boomers will ascend to that great Woodstock Festival in the Sky. Those lacking tickets will duck under or jump over Max Yasgur’s fence, as they did during that heady summer of 1969 when men landed on the moon and Hair opened on Broadway. They will be stardust. They will be golden. They will get themselves back to the Garden.

In July, U.S. equity ETFs received biggest inflow of 2016

Posted on August 3, 2016 by Editorial Staff -

Bond, commodity, and equity exchange-traded funds (ETFs) received $43.0 billion in July, their biggest monthly inflow since December 2014, when these funds hauled in $50.7 billion, according to TrimTabs Investment Research.

It’s a sign that “market participants are as confident as ever that central bank intervention will keep inflating asset prices,” said David Santschi, CEO at TrimTabs. “The only major asset class with significant outflows last month was European equities.”

July’s inflow into ETFs was equal to almost half of the year-to-date inflow of $103.2 billion, TrimTabs reported. U.S. equity ETFs alone took in $27.9 billion, equal to 2.0% of their assets, the biggest monthly inflow since December 2014.

Going against the trend, Europe-focused equity ETFs shed a record $4.5 billion, equal to 10.5% of their assets.

“Several of the riskiest areas of the market, including emerging markets stocks and foreign bonds, had massive inflows,” said Santschi, in the TrimTabs release. “Such enthusiasm is a cautionary sign from a contrarian perspective.”

DC plans still slow to embrace lifetime income: Willis Towers Watson

Posted on August 3, 2016 by Editorial Staff -

Sponsors of defined contribution (DC) retirement plans are slowly embracing lifetime income solutions to help employees improve their financial security in retirement, according to a new survey by Willis Towers Watson, the global advisory company.

The consulting firm described lifetime income solutions generally as the “education and tools necessary to help plan participants determine how to spend down accumulated savings in retirement as well as in-plan and out-of-plan options that create streams of income from employer-sponsored retirement plans.”

According to a release from the firm, most employers currently prefer lifetime income education and planning tools, and partial or systematic withdrawals during retirement to insurance-backed products, annuities or other managed payout options, which Willis Towers Watson described as “more effective solutions.”

The survey also found that almost one-quarter of employers (23%) have adopted one or more of these lifetime income solutions, while another 18% will implement a solution this year or consider solutions for next year and beyond.

The most prevalent lifetime income solutions are systematic withdrawals during retirement (73%), followed by income planning tools (64%) and education (60%). The more effective solutions designed to help plan participants develop a steady flow of income in retirement are much less common, even though 71% of respondents cited the primary reason for adopting a lifetime income solution was to help participants convert DC plan balances into lifetime income.

The survey found less than one-fifth (19%) offer out-of-plan annuities at the time of retirement, although 21% are considering these options for 2017. One-third provides in-plan managed account services with a non-guaranteed payout, and 22% offer an in-plan asset allocation option with a guaranteed minimum withdrawal or annuity component. Less than one in 10 offer an in-plan deferred annuity investment option.

Just over half (53%) of respondents that haven’t adopted a solution say they may do so in the future. When asked why they had not adopted a solution, 81% cited fiduciary risk as a very or extremely important barrier, while two-thirds cited cost. Six in 10 respondents said the market offerings and products were not satisfactory or were too new.

The survey also found low participant usage of available lifetime income solutions. Sixty-one percent of sponsors reported that a quarter or less of their participants used in-plan managed account services with a non-guaranteed payout service, while just over half reported a similar usage of lifetime income education.

Less than a quarter of employees capitalized on lifetime income planning tools, or used partial or systematic withdrawals during retirement at roughly half of the companies.

The Willis Towers Watson Lifetime Income Solutions Survey is based on responses from 196 large and midsize U.S. employers that sponsor a retirement plan. The survey was conducted online in March and April 2016.

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