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Questions for the DOL’s Tim Hauser

Posted on October 1, 2015 by Kerry Pechter -

Hubert A. Ross, a tall, 53-year-old CFP from Destin, Florida who clears his trades through LPL, was almost pleading for a simple answer to what he considered a simple question: Couldn’t the combatants in the battle over Department of Labor’s fiduciary proposal lock themselves in a room for a day or two, negotiate a settlement, and end the five-year standoff over the DOL’s attempt to start regulating rollover IRAs like mini ERISA plans?

“You’re all intelligent people,” Ross said, to anyone nearby, which included panelists David Blass of the Investment Company Institute, Steve Hall of Better Markets, Bonnie Treichel of the Retirement Law Group, and David Certner of AARP, who had just finished debating the proposal at the National Press Club in Washington, DC. “Shouldn’t you all be able to solve this?”

Ross was right: the DOL proposal is simple. It would bar the dodgy “suitability” standard of conduct for sellers of mutual funds and annuities to IRA owners, which allows them to make self-serving recommendations. But, like Nancy Reagan’s “Just Say No” anti-drug campaign, it’s not just simple—it’s simplistic.

Like Ross, I was at the symposium on the proposal hosted by the Investment Management Consultants Association on Tuesday. The luncheon speaker and main drawing card was deputy assistant Labor Secretary Tim Hauser (right), who in mid-August chaired four days of public hearings on the proposal.

IMCA has a stake in all this. Its members could be affected by the final proposal when it is published in early 2016. If they are “fee-based,” like Hubert Ross, and earn both asset-based fees and commissions on the sales of securities, they may no longer be able to sell commission-based products to IRA owners without signing a pledge to act solely in the client’s “best interest.”

This requirement, known as the Best Interest Contract (BIC) Exemption, rankles broker-dealers. It entails both a legally binding pledge of good faith and a fresh layer of red tape. Broker-dealer trade groups have warned that they will cease selling commissioned products —such as variable annuities and load mutual funds—to IRA owners just to avoid the BIC. Broker-dealers say the BIC will force them to abandon those consumers, since commissions on packaged products are the compensation-model-of-choice for middle-market clients. (Some believe the industry is bluffing.)

I attended the meeting mainly because Hauser was speaking and welcoming questions from members of the audience, which numbered about 150. Handed a wireless microphone, I was able to ask him: “After what you heard at the hearings, do you now think that the DOL was in fact naive to think that broker-dealers could ever accept the terms of the BIC?”

This question was not as unfairly loaded as it sounds, because during the August hearings Hauser twice asked industry attorneys in just those words: Are we naïve to think that this compromise can work? (One lawyer murmured No and one said frankly Yes.)

Watching the webcast of the hearings at home, I nodded Yes, yes, yes. For one thing, the DOL had not adequately defined “best,” as a legal definition. Also, the agency seemed to offer a paradox: Advisers can accept conflicted compensation if they pledge to provide unconflicted advice.

To me, conflicts of interest are not mere temptations, which an intermediary can choose to ignore if he or she is sufficiently self-disciplined. They are dark masses whose gravity curves the ethical space around them. They reduce transparency and limit the available range of options. Even when disclosed, they can work to the disadvantage of consumers. So when I first read the DOL proposal, I thought: This can’t work.

Of course, it would have been naïve to believe that Hauser might confess that the DOL had woken up to the impracticability of the BIC exemption, and he didn’t. “I didn’t ask that question several times,” he demurred, and went on to explain that most of the witnesses at the hearing had assured him that the DOL wasn’t naïve and that the BIC was in fact workable. He politely, and at length, turned my loaded question aside.

After his address, Hauser paused in the adjoining hallway to field a few more questions. Hundreds of portraits of newsmakers, from Eliot Spitzer to Sharon Stone, cover the length of one wall. Hauser, who worked as a Legal Aid attorney in rural Missouri for six years after graduating from Harvard Law School in 1985, is tall and lanky with tousled light brown hair. He wore wire-rimmed glasses, a grey suit and soft black walking shoes—not the glossy cap-toe Oxfords or tasseled loafers popular on Wall Street or K Street.

I asked Hauser if the DOL was targeting variable annuities with its proposal. The proposal would require VA sellers to meet the BIC exemption and pledge to act solely in the IRA client’s interest. Under the status quo, advisors can sell VAs for a commission as long as they meet the requirements of so-called PTE 84-24, which does not require such a promise.

Hauser said, “The proposal isn’t intended to favor one product over another.” He noted that variable annuities are complicated, but that they also offer some beneficial guarantees. No, he said, the DOL is not targeting VAs.

That wasn’t a satisfying answer. VAs, about a third of which are sold through independent broker-dealers, have been under attack in the mass media. Journalists often use VAs as an example of sales predation. Jill Schlesinger, the well-known CBS financial reporter, made VAs the butt of a joke at a recent robo-advice conference in New York. Ironically, sales of VAs have already leveled off or dropped. Some broker-dealers now hesitate to sell investment-only VAs to IRA owners because they duplicate the tax deferral that IRA owners already have.

Finally, I asked Hauser if the DOL distinguishes between different types of commissions. After all, not all commissions are equal. Annuity commissions can be especially opaque. The average purchaser of a B-share VA probably doesn’t know how the contingent deferred sales charge regime works. The commissions that purchasers pay on fixed annuities are built into the prices of the contracts. FIAs are sometimes even advertised as “no-fee” products. But he said, “No we treat all commissions the same.”

That gave me pause. The agency either doesn’t fully understand the many different business models in the financial services industry, or it doesn’t care. Hauser and his boss, EBSA chief Phyllis Borzi, may believe that, by establishing a blanket “Best Interest” principle, they can protect the consumer without picking winners and losers in the marketplace. But they can’t avoid picking winners and losers. A one-size solution never fits all.

Hauser assured the audience on Tuesday that the DOL staff will read all 2500-plus public comments and tweak the final draft of the proposal accordingly. We’ll know more in a few months.

Will DOL proposal trigger “ratings events”? Too soon to say: A.M. Best

Posted on October 1, 2015 by Editorial Staff -

The Department of Labor’s fiduciary proposal isn’t considered damaging enough to trigger “rating events” for life insurance companies—at least not until “there is more clarity on the fiduciary guidelines,” the ratings agency A.M. Best said in a release this week.

“According to the public comments by insurance executives, the DOL has been receptive to insurers’ concerns and the next proposal could have significant changes,” A.M. Best analysts wrote. A final draft of the proposal is expected in late 2015 or early 2016.

After reviewing comments posted by insurance groups on the website of the DOL’s Employee Benefit Security Administration, A.M. Best summarized industry sentiment as follows:

The insurance industry believes the DOL proposal needs significant changes to make it workable.
The insurance industry is concerned the regulation, as originally drafted, could limit advice available to small investors, further confuse potential investors and adversely impact the advisor-client relationship.
Costs associated with making changes to products, pricing and compliance practices including greater systems capabilities and additional staffing, would impact future revenues and further increase compliance costs.
The proposed definition of a fiduciary is seen as too broad.
The DOL should narrow the proposed definition of fiduciary investment advice to exclude routine sales activity, including IRA rollovers.
Insurance companies are recommending a time frame of twenty-four to thirty-six months to comply with the DOL proposal instead of the eight months suggested by the DOL. Compliance will require new disclosures, new marketing materials, new support infrastructure and new advisor training programs.

The Best Interest Contract Exemption part of the proposal has drawn strong objections. The BIC allows brokers to continue to receive commissions on sales to IRA owners, but only if brokers pledge to act solely in the best interest of the client. Today, brokers’ recommendations to IRA owners can be self-serving and need only be “suitable” for a client.

A.M. Best analysts wrote, “Some companies have stated that the BIC Exemption creates uncertainty while adding unnecessary cost complexity for financial institutions. Primerica classified the BIC Exemption as ‘unworkable,’ finding the exception ‘being so complex and burdensome that it is not administratively or operationally feasible.’ There is also concern that the BIC Exemption could expose brokerage firms and investment firms to increased exposure to significant litigation risk.”

Voya adds volatility-controlled index to its FIAs

Posted on October 1, 2015 by Editorial Staff -

A new index crediting strategy, called the Point-to-Point Volatility Control Strategy, is now available on the Voya Secure Index series and Retirement Index Select series of fixed index annuities (FIAs), Voya Financial announced this week.

The Point-to-Point Volatility Control Strategy tracks Deutsche Bank’s proprietary CROCI (Cash Return on Capital Invested) US 5% Volatility Control Index, Voya said. CROCI is designed to reduce volatility to 5% by moving money between select U.S. equities and cash in response to changes in market volatility.

The CROCI valuation methodology selects 40 of the most undervalued stocks from among approximately the 250 largest companies (by market capitalization) of the S&P 500 Index and groups them together in a propriety index.

Only a small fraction of FIA premiums is used to buy options on the performance of (typically) equity indexes, so FIAs can deliver only a fraction of index gains. They may credit investors with equity returns below a designated “cap” percentage or the gains above a “spread.” Or, especially recently, they can offer nominally unlimited (“uncapped”) credits that are internally limited by volatility control strategies. (FIA owners do not receive dividends, because they do not invest directly in equities.

These uncapped strategies have been successful in boosting FIA sales, and have created new business for the investment banks that design the custom indices for the issuers. According to a Voya release, the Point-to-Point Volatility Control Strategy uses both volatility controls and a spread to arrive at the percentage gain that it pays investors. “Point-to-point” means that the gains are locked in on each contract anniversary date.

Voya Secure Index series and the Retirement Index Select fixed index annuity are issued by Voya Insurance and Annuity Company and ReliaStar Life Insurance Company, respectively.

Kehrer Bielan releases bank annuity sales study for 2014

Posted on October 1, 2015 by Editorial Staff -

The 25 largest bank broker-dealers produced almost $22 billion in fixed and variable annuity premium in 2014, accounting for 57% of the total sold by all banks and credit unions, according to new research from Kehrer Bielan.

The ten largest third-party broker dealers, which support annuity and investment sales in 2,559 banks and credit unions, accounted for 38% of the total annuity premium sold through financial institutions. (See chart below, provided by Kehrer Bielan.)

The remaining 3% was sold in the smaller bank broker-dealers or the community banks and credit unions that work with the smaller third party broker dealers.

The large bank BDs produced $11.7 billion in fixed annuity premium (58.0% of the financial institutions channel total) compared to $10.2 billion in variable annuities (56.5%).

BD Annuity Sales Kehrer Bielan

“Many large bank broker-dealers supplement their financial advisors with licensed platform bankers, whose sales are skewed toward fixed annuities,” said Tim Kehrer, senior research analyst at Kehrer Bielan. “The banks and credit unions affiliated with the third-party BDs are much less likely to license customer-facing bank and credit union staff to sell annuities.”

The ten largest TPMs (third-party broker-dealers) accounted for 36% of all fixed annuity premium sold in financial institutions, but 41.2% of variable annuity premium. “Even as firms take steps towards more financial planning and advisory activities, a significant amount of fixed and variable annuities are distributed to their client base,” said Peter Bielan, a principal of the firm. “We find that variable annuities are more popular in banks and credit unions that still do mostly transaction business.”

Life insurers will take ‘manageable’ GAAP charges in 3Q2015: Fitch

Posted on October 1, 2015 by Editorial Staff -

Fitch Ratings issued the following alert this week:

US life insurers will be under increased pressure to rationalize long-term rate assumptions used to establish reserves given the market’s revised expectations for low rates, says Fitch Ratings. We see a heightening risk that life insurers could take charges in third-quarter 2015 due to rate expectations.

With last week’s Fed decision reinforcing expectations for a very prolonged return to higher interest rates, the probability dimmed for near-term low rate relief. Low interest rates mean lower average investment yields for fixed-income investments, which pressures life insurers’ earnings and reserve-adequacy projections.

In the third quarter, life insurers typically conduct a comprehensive review of assumptions underlying GAAP policy reserves. We believe that the Fed’s position increases the likelihood that life insurers will take GAAP charges in third-quarter 2015 tied to a revision in long-term rate assumptions.

While the probably of GAAP charges have increased, Fitch expects that potential charges tied to any assumption updates are expected to be very manageable in the context of life insurers’ earnings and capital. As a result, we believe that the impact of low interest rates on ratings assigned to life insurers to be limited over the near term.

The life insurance industry’s exposure to “interest-sensitive” liabilities that provide investment guarantees, deposit flexibility and liquidity options has increased over time and exacerbated the low-yield issue.

As industry sales have shifted away from traditional protection products involving mortality and/or morbidity (e.g. term-life policies are not considered “interest-sensitive”), products such as annuities and universal life insurance incorporating no-lapse guarantees, have increased. Insurers fund these interest-sensitive liabilities through general account assets.

Over the past several years the spread between investment returns on assets in the general accounts and the minimum rate guarantees (on products such as fixed annuities) has compressed, putting reserve margins at risk.

Envestment managed accounts to be offered in MassMutual 401(k)s

Posted on October 1, 2015 by Editorial Staff -

In what sounds like the introduction of in-plan robo-advice, MassMutual and the registered investment advisor Envestnet Retirement Solutions, LLC are partnering to offer custom managed accounts to participants in MassMutual’s 401(k)s and similar qualified plans.

The service is called “RetireSmart Ready Managed Path.” The asset allocations use investment options already offered by the plan. The service is available to MassMutual plans with at least $5 million in assets.

MassMutual also uses BlackRock managed accounts and CustomChoice Strategies, an asset allocation methodology created by Morningstar, a spokesman for the insurer told RIJ. “But those products are customized at the plan level whereas RetireSmart Ready is customized at the participant level,” he said.

Employers who sponsor MassMutual-administered plans can offer RetireSmart Ready Managed Path either as an actively chosen option for participants or as a Qualified Deferred Investment Alternative (a default option) for automatically enrolled participants. The option is currently available and the QDIA will be available this fall, a MassMutual release said. The RetireSmart QDIA won’t be a target date fund, MassMutual said.

MassMutual’s recordkeeping data shows that the percentage of assets within asset allocation strategies increased by 26.2% in the last five years. Participants can enroll in RetireSmart Ready Managed Path online through the MassMutual RetireSMART Ready Tool after establishing a separate advisory account with ERS.

MassMutual’s PlanALYTICs tool, launched in 2013, will be used to measure each participant’s progress toward the goal of replacing 75% of pre-retirement income, including full Social Security benefits. The tool uses each participant’s “current age, target retirement age, risk tolerance, existing savings and future retirement needs, including whether or not he or she has a defined benefit plan,” according to a release.

Will the ‘BIC’ Affect QLAC Sales?

Posted on September 24, 2015 by Kerry Pechter -

Is an element of the DOL fiduciary proposal at odds with the Treasury Department’s QLAC provision? During the House Finance Committee hearing on the DOL proposal earlier this month and in written testimony, a financial services industry executive suggested that it is.

Caleb Callahan, chief operating officer (below right) at ValMark Securities in Akron, Ohio, argued that the DOL’s proposed amendment to “PTE [Prohibited Transaction Exemption] 84-24” contains language that would discourage his firm and other firms from selling Qualifying Longevity Annuity Contracts to IRA owners because it raises questions of fiduciary liability. He says that the amendment leaves open the possible interpretation that sellers of QLACs might have to meet the new “BIC” (Best Interest Contract) exemption, which involves pledging to act purely in a client’s best interest.

“The DOL proposed rule would make it difficult, if not impossible, for our business to offer these critical retirement savings products to our clients, contradicting this Treasury Department initiative and sending a conflicting message to Americans,” Callahan wrote in testimony submitted to the DOL. He testified as chairman of the Association of Advanced Life Underwriters’ Retirement Planning Committee.

Reish: QLACs fall under 84-24

QLACs are deferred income annuity contracts (DIAs), sold to IRA owners, whose income payments don’t begin until after the owner reaches age 70½. Before action by the Treasury Department in July 2014, sales of DIAs were problematic because their terms conflicted with rules requiring that distributions from tax-favored accounts begin at age 70½.

The Treasury Department capped QLAC premiums at the lesser of $125,000 or 25% of tax-favored savings, and required that income from a QLAC start by age 85.

But prominent pension law attorney Fred Reish told RIJ that the amendment won’t affect advisors who want to recommend QLACs to their clients. “As I look at it from a purely legal perspective, I don’t think it will be that big a change for QLACs. That’s because QLACs, as far as I know, are fixed annuities (from the general accounts of insurance companies) and therefore fall under 84-24,” Reish told RIJ in an email.

The language of the proposed amendment seems clear on this point. It says that the DOL wants to deprive only sellers of variable annuities and certain sellers of mutual funds of the existing exemption from fiduciary liability when earning a commission on such sales to IRA owners. According to the DOL/Employee Benefits Security Administration website:

“The amendment would revoke relief for insurance agents, insurance brokers and pension consultants to receive a commission in connection with the purchase by IRAs of variable annuity contracts and other annuity contracts that are securities under federal securities laws and for mutual fund principal underwriters to receive a commission in connection with the purchase by IRAs of mutual fund shares.”

Instead, sellers of variable annuities to IRA owners and mutual fund underwriters would need to sign a contract pledging that their sales were in the client’s “best interest.” “A new exemption for the receipt of compensation by fiduciaries that provide investment advice to IRA owners is proposed elsewhere in this issue of the Federal Register in the ‘Best Interest Contract Exemption,’” the proposal reads.

A cloud remains over QLACs

Whichever prohibited transaction exemption DOL offers to commission-earning sellers of QLACs, Callahan says, the DOL still considers a QLAC sale to be prohibited transaction by fiduciary, and therefore puts it under a legal cloud. And, regardless of what the DOL intends, if its amendment makes broker-dealers hesitant to sell QLACs for fear violating the regulations, it will effectively frustrate Treasury’s QLAC initiative.

“Each business will need to make a decision on its own basis,” Callahan told RIJ in an email. “But it is pretty clear these are prohibited and you would need to choose an exemption to avoid the prohibition. (That’s why you need an exemption…because it’s prohibited). I’m suggesting for many businesses, including ours—we would choose not to take this risk.”

Callahan added that, even if selling QLACs is safe, recommending the sale of IRA assets to fund a QLAC might not be. “In addition, while the actual sale of the QLAC… could be exempted under 84-24—although it is unclear—the act of advising on how much and when to take [money] out of other plan funds and put [it] into the QLAC is not able to be exempted. In practice, most firms will just pass on this uncertainty and risk when you look at the typical account size and risk/reward. The fact is, it is unclear. And all that matters is what businesses actually do.”

Impact on VA sales

If any annuity appears to be in the DOL’s cross-hairs, it would be variable annuities, not QLACs. Advisors sells tens of billions of dollars worth of VAs each year, and the market for QLACs is undeveloped. The DOL proposal to amend 84-24 is clearly aimed at making sure that the sale of a variable annuity is in the IRA owner’s best interest.

“[PTE] 84-24 was first issued in 1979 and then updated in 1984 (hence the 84 in the name),” Reish wrote in an email. “A number of broker-dealers and insurance companies have successfully used that exemption for many years. … It has some proposed changes–mainly the fiduciary standard (the “best interest” requirement) and the prohibition on misleading statements. But I think that, for quality agents and advisors, that will be manageable.

“For other types of annuities—meaning variable annuities—sold to IRA owners, the changes will be much more material,” he added. “That’s because those sales, or recommendations, will be under BICE, which will be better than largely anticipated, but more burdensome than 84-24.”

A Conservative Retirement Portfolio in 3 Buckets

Posted on September 24, 2015 by Christine Benz -

Many retired investors are comfortable embracing a healthy equity stake in their portfolios. That’s a sensible tack for retirees with longer time horizons or those who know that they want to leave money behind for their children, other loved ones or charity.

This conservative bucket portfolio has a more modest goal: preserving purchasing power and delivering living expenses for the retiree who has an approximately 15-year time horizon (that is, life expectancy).

This portfolio does stake more than 30% in equities, but it also holds about 55% of its assets in bonds and another 12% in cash. The remainder of the portfolio is in commodities and other securities, such as convertibles and preferred stock.

Let time horizon lead the way
The main idea behind the bucket approach is to segment the portfolio by the spending time horizon: Assets that will be tapped sooner are parked in short-term holdings, and longer-term monies are stashed in higher-returning, higher-volatility asset types, mainly stocks.

To construct a bucket portfolio, the retiree starts with anticipated income needs for a given year, then subtracts certain sources of income such as Social Security and a pension. What’s left over is the amount of cash flow that the portfolio will need to supply each year.

In the case of the conservative portfolio, one to two years’ worth of living expenses (those not covered by Social Security, and so on) are housed in cash instruments (Bucket One), and another 10 years’ worth of living expenses are housed in bonds (Bucket Two). The remainder of the portfolio is invested in stocks and other more volatile assets, such as commodities and a high-risk bond fund. Income and rebalancing proceeds from Buckets Two and Three are used to replenish Bucket One as it becomes depleted.

As noted earlier, the conservative portfolio’s focus is on capital/purchasing power preservation and income production, so it stakes roughly 70% in bonds and cash. That will likely strike many retirees and pre-retirees as overly bond-heavy.

After all, starting yields are minuscule, and the next few decades are unlikely to be as kind to bonds as the previous three were. Yields will go up, but they’ll hurt bond prices in the process. In recognition of that fact, I’ve generally aimed to steer the portfolio away from the most interest-rate-sensitive bonds.

Moreover, as with the Moderate and Aggressive portfolios, the specific parameters of the Conservative portfolio can be altered to suit a retiree’s own goals and preferences. For example, a more risk-tolerant, growth-oriented retiree may choose to hold just one year’s worth of cash in bucket one while also shrinking the number of years’ worth of assets in bonds, thereby enlarging the equity stake as a percentage of assets.

And though I’ve supplied specific fund recommendations in my model portfolios, a retiree needn’t reinvent the wheel to put the bucket approach to work: Many of the key ingredients likely already appear in well-diversified retiree and pre-retiree portfolios.

A total stock market index fund or a portfolio of individual dividend-paying equities could stand in for Vanguard Dividend Growth (VDIGX), for example. Meanwhile, a retiree in search of simplification could use an all-in-one-type investment such as T. Rowe Price Spectrum Income (RPSIX) to supplant the individual holdings that make up Bucket Two.

The portfolio includes three buckets, one each for short-, intermediate-, and longer-term spending needs.

Bucket One: Years 1-2

12%: Cash (certificates of deposit, money market accounts, and so on)

This portion of the portfolio is geared toward meeting near-term spending needs. Because of this role, it sticks with true cash instruments, as noncash alternatives like ultrashort bond funds have lower yields and more risk than CDs right now.

Bucket Two: Years 3-10

12%: Fidelity Short-Term Bond (FSHBX)
5%: Fidelity Floating Rate High Income (FFRHX)
20%: Harbor Bond (HABDX)
6%: Vanguard Short-Term Inflation-Protected Securities (VTIPX)
5%: Vanguard Wellesley Income (VWINX)

Bucket Two is designed, in aggregate, to preserve purchasing power and deliver income with a dash of capital appreciation. Fidelity Short-Term Bond serves as the portfolio’s next-line reserves in case Bucket One were depleted and bond and dividend income and/or rebalancing proceeds were insufficient to refill it.

Fidelity Floating Rate High Income, one of the most conservative bank-loan vehicles, provides both a cushion against rising bond yields (bank-loan yields adjust upward along with lending rates) and a measure of inflation protection (yields are often heading up at the same time inflation is).

Harbor Bond is the portfolio’s core fixed-income holding; the PIMCO-managed bond fund has a good deal of flexibility to adjust duration (a measure of interest-rate sensitivity), invest in foreign bonds, and range across bond-market sectors.

I also used Vanguard Short-Term Inflation-Protected Securities to provide a measure of inflation protection; it owns bonds whose principal values adjust upward to keep pace with the Consumer Price Index, but it’s less sensitive to interest-rate-related volatility than intermediate- and long-term Treasury Inflation-Protected Securities vehicles.

Finally, bucket two includes the conservatively allocated Vanguard Wellesley Income, which is anchored in fixed-income investments but also holds roughly 40% in stocks, both U.S. and foreign.

Bucket 3: Years 11 and Beyond

23%: Vanguard Dividend Growth (VDIGX)
7%: Harbor International (HIINX)
5%: Harbor Commodity Real Return (HCMRX)
5%: Loomis Sayles Bond (LSBRX)

As the long-term portion of the portfolio, Bucket Three holds primarily stocks. Its anchor holding, as in the Aggressive and Moderate portfolios, is Vanguard Dividend Growth, an ultra-cheap equity fund that skews toward high-quality mega-cap stocks. I’ve also included a healthy stake in Harbor International. The equity portion of the portfolio includes limited exposure to small- and mid-cap stocks; investors who would like more exposure to that area might consider a fund such as Vanguard Small Cap Index (NAESX) or Royce Special Equity (RYSEX).

In addition to two equity holdings, the portfolio also includes a small stake in a commodities investment as well as a position in Loomis Sayles Bond. The former is in place to provide an additional layer of inflation protection, whereas the latter supplies exposure to more aggressive bond types (and even stocks) that are not well represented in Bucket Two.

The DOL’s Missed Opportunity

Posted on September 24, 2015 by Kerry Pechter -

The Department of Labor missed an opportunity by not recommending in its fiduciary proposal that advisors to IRA owners should have training in retirement income or perhaps even a retirement designation, such as the RICP, RMA, CRC or CRCP.

As many people have pointed out, the “best interest” standard is idealist but unworkable. It’s impossible to define and it doesn’t address the most important issue. Retirement income planning is fundamentally different from “accumulation” planning. If the DOL wants people to turn their 401(k)/IRA savings into lifetime income, it should point them to professionals who are trained to do that.

Retirement income advice requires skills that most investment advisors don’t have. Income planning demands an understanding of the risks of retirement (longevity risk, health care risk, inflation risk, etc.) and how to mitigate them. It calls for a familiarity with products (like income annuities), processes (like flooring or bucketing) and benefits (like Social Security and Medicare) that don’t matter before retirement.

The right training has been getting easier to find. The American College has trained thousands of Retirement Income Certified Professionals. The Retirement Income Industry Association runs bootcamps for its Retirement Management Analyst designation. For years, InFRE has offered the Certified Retirement Counselor degree to bank advisors and others. The College for Financial Planning offers the Chartered Retirement Planning Counselor program.

Requiring advisors to hold one of these designations before advising an IRA owner might address the DOL’s primary concern—that too many elderly Boomers will run out of money and end up on public assistance—more directly than merely requiring advisors to act in their clients’ “best interest,” whatever that may be.

Yes, it would be time-consuming and expensive to retrain enough advisors to meet the demand for retirement counseling. But probably no more expensive than complying with a best interest standard. And it would move the advice industry in a useful direction. New layers of disclosure and reporting won’t.

Instead of taking that approach, the DOL focused on the conflicts-of-interest that third-party commissions can create for advisor/distributors. The DOL is right in believing that these conflicts distort the advice that IRA owners receive. Many of the distortions are common knowledge in the financial industry. But eradicating them through a “pledge” is quixotic. A positive approach might have worked better.

By proposing a solution that would disrupt the distribution of financial products and deny broker-dealers a major source of revenue, the DOL guaranteed a wall of resistance. Instead, it might have encouraged or required IRA advisors to demonstrate retirement planning expertise. A number of financial firms, who already recognize that retirement expertise can be a competitive advantage, might even have embraced it.

Assets of Money Market Institute firms rise to $4.2 trillion

Posted on September 24, 2015 by Editorial Staff -

The Money Management Institute, whose investment advisory and wealth management firm members manage some $4.2 trillion, has released a statistical overview of data and trends in its industry for the second quarter of 2015. Highlights of the overview, MMI Central 3Q 2015, included:

¶ Investment advisory solutions assets rose 2% to $4.2 trillion. The increase occurred despite volatility in the global equity and fixed-income markets, and continued a six-year upward trend. The S&P 500 Index gained 0.3% during the quarter.

¶ Unified Managed Accounts (UMAs) rose 6% (recording the largest increase in assets for the fourth consecutive quarter), Rep as Portfolio Manager again followed with a 3% gain, followed by Separately Managed Accounts (SMAs) at 2%, and Rep as Advisor (a non-discretionary, fee-based advisory option) and Mutual Fund Advisory programs, both at 1%.

¶ One-year IAS asset growth of 11% through June 2015 bettered the 7% gain in the S&P 500 Index. Here too UMA (46%) and Rep as Portfolio Manager (17%) were the leading segments while SMA Advisory, Rep as Advisor and Mutual Fund Advisory lagged both the overall IAS industry and equity markets with gains for the trailing year of 6%, 5% and 5%, respectively.

¶ The longer-term UMA growth trend is an indication that some of the steam is being taken out of SMA and Mutual Fund Advisory programs, as advisors increasingly see the benefits of consolidating various sleeves in one custodial account.

¶ Total IAS net flows continued strong at $63 billion for the second quarter, up $3 billion over the preceding quarter. Rep as Portfolio Manager net flows of $28 billion led all segments and was followed by UMA Advisory with a healthy $18 billion in flows. SMA Advisory programs were also relatively strong for the quarter with net flows of $11 billion. Mutual Fund Advisory posted net flows of $5.5 billion while Rep as Advisor was barely in positive territory with net flows of less than $1 billion.

¶ The aggregate trailing four-quarter net flows for the second quarter of 2015 were $267 billion, just $1 billion ahead of the trailing one-year flows for the second quarter of 2014.

Rep as Portfolio Manager, with $959 billion in assets, continues to steadily edge closer to the $1 trillion mark, which only Mutual Fund Advisory has surpassed. While UMA Advisory outpaces Rep as Portfolio Manager on a percentage basis in quarter-over-quarter asset growth, it does so off an asset base just less than half the size of Rep as Portfolio Manager. The real growth story is to be found in the trailing flow data over the past three years, which Rep as Portfolio Manager dominates.

Among major industry segments, the 2% growth in IAS assets in the second quarter compares to an approximate 5% increase for exchange-traded funds, a 2% gain for long-term mutual Funds, and a 1% decline for money market munds.

The 2015-2016 MMI Industry Guide to Investment Advisory Solutions, which will be released in late October, includes an annual industry forecast derived from a survey of senior executives at sponsor firms. This year’s survey posed questions about sponsor firms’ commitment to and progress on the transition to goals-based wealth management (GBWM). Among the survey highlights:

¶ GBWM continues to gain traction, and it is clear that it has become a priority among sponsor firms. An overwhelming proportion of respondents (89%) indicated that GBWM is now an important initiative at their firms.

¶ When asked to project the proportion of their firms’ accounts that will transition to GBWM over the next five years, the responses were highly optimistic with a roughly fourfold increase – from the current 10% to 38% – predicted at the end of five years. 88% of executives surveyed indicated that their firms were investing a moderate to significant amount in GBWM, but 89% of those same executives thought that their firms’ spending on GBWM wasn’t adequate and should be increased.

¶ GBWM-related investments are being put to work in a number of ways. Sponsor firms are beginning to put in place the infrastructure – including planning tools, platform software and other technologies – needed to deliver GBWM.

¶ Most of the current initiatives focus on the front end of the advice delivery process because front-end planning is the first step in implementing a goals-based process, planning modules and interface improvements are likely to drive near-term revenue growth, and converting the front end to GBWM reorients both the client and the financial advisor.

Retirement conferences this fall

Posted on September 24, 2015 by Editorial Staff -

FPA (Financial Planning Association) Annual Conference, September 25-27, Boston Convention and Exhibition Center, Boston, MA.

IMCA (Investment Management Consultants Association), Focus on Fiduciary, September 29, National Press Club, Washington, DC.

NAIFA (National Association of Insurance and Financial Advisors) Annual Conference, October 3-5, New Orleans, LA.

ASPPA (American Society of Pension Professionals and Actuaries), October 18-21, Gaylord National, National Harbor, MD.

NAPFA (National Association of Personal Financial Advisors), October 20-23, JW Marriott, Indianapolis, IN.

MMI (Money Market Institute) Fall Solutions Conference, October 21-22, Grand Hyatt, New York, NY.

LIMRA Annual Conference, October 25-27, Sheraton Boston Hotel, Boston, MA.

CFA Institute Research Foundation 50^th Anniversary Forum, October 26, NYSSA Conference Center, New York, NY.

2015 SPARK Forum, November 8-10, The Breakers, Palm Beach, FL.

Society of Actuaries, Application of Predictive Modeling in VA/FIA Management, November 15, Chicago IL.

Society of Actuaries, Equity-Based Insurance Guarantees Conference, November 16-17, Chicago, IL.

T3 (Technology Tools for Today) Advisor Conference, February 10-12, 2016, Marriott Harbor Beach Resort, Fort Lauderdale, FL.

Mega-deals missing from first-half life/annuity M&A: A.M. Best

Posted on September 24, 2015 by Editorial Staff -

Global merger and acquisition activity for the life/annuity segment for the first six months of 2015 “remained elevated but lacked the large mega-deals of the property/casualty and healthcare segments,” according to a new Best Special Report.

The report, “Life/Annuity First Half 2015 Global Merger and Acquisition Trends and Analysis,” describes 37 deals, up 37% from the 27 deals in same period in 2014. The total value of those deals was $6.9 billion, down 47% from $12.6 billion in 2014.

The average deal size fell to $538 million from $787 million. The lack of publicly available deal values makes historical comparisons difficult. A.M. Best believes the following key trends drove the recent M&A activity for the first half of 2015 in the L/A segment:

Selling off of non-core segments and run-off businesses to companies specializing in them;
Regulatory uncertainty regarding Solvency II and SIFI guidelines makes big deals from the largest life insurers unlikely;
International cross-border activity is up as companies seek growth in new markets;
Lack of large deals as companies appear to be more capital cautious and seek to consolidate and specialize in a low interest rate environment rather than vertically and horizontally integrate as A.M. Best sees in the property/casualty and health segments; and
Private equity/investment firms’ activity picks up.

Several deals involved the disposal of non-core businesses. North America had 35% of the market for deals by target investments, followed by Asia, with 26%. Europe made up 24% of deals, down from about 33% in earlier periods. The smaller than average deal count in Europe is partially due to uncertainty regarding Solvency II, A.M. Best believes. Latin America and the Caribbean made up 11% of deals, while Middle East/Africa made up 3%.

Over 40% of all deals were cross-border M&As, as companies go international in search of growth. A.M. Best believes private capital, whether buying or selling, will continue to play an active role in the L/A segment. A.M. Best expects private capital to pursue blocks of business rather than full-on acquisitions.

While A.M. Best believes foreign insurers lack experience in some of the product lines and markets of their newly acquired U.S. insurance carriers, it notes that the U.S. executive management teams in most cases have been incentivized to remain with their companies.

Vanguard and T. Rowe Price launch international funds

Posted on September 24, 2015 by Editorial Staff -

Vanguard has registered its first dividend-oriented international index funds with the Securities and Exchange Commission. They are Vanguard International High Dividend Yield Index Fund and Vanguard International Dividend Appreciation Index Fund.

The funds, expected to be available in December, will offer three share classes: Investor ($3,000 minimum), Admiral ($10,000 minimum) and ETF.

The Investor shares of the International High Dividend Yield Index Fund will have an expected expense ratio of 0.40% per year, while the Admiral shares and ETFs will cost 0.30%. The Investor shares of the International Dividend Appreciation Index Fund will have an expected expense ratio of 0.35% per year, while the Admiral shares and ETFs will cost 0.25%.

Vanguard International High Dividend Yield Index Fund will track the FTSE All-World ex US High Dividend Yield Index, a new benchmark of more than 800 of the highest yielding large- and mid-cap developed and emerging markets securities.

Vanguard International Dividend Appreciation Index Fund will track the new Nasdaq International Dividend Achievers Select Index, which comprises more than 200 all-cap developed and emerging market stocks with a record of increasing annual dividend payments.

The two new funds will complement Vanguard’s existing domestic dividend-oriented funds, the $15 billion Vanguard High Dividend Yield Index Fund and the $23 billion Vanguard Dividend Appreciation Index Fund. Vanguard now offers almost 20 international index fund and ETFs, the company said in a release.

T. Rowe looks for bargains in emerging markets

T. Rowe Price has launched the Emerging Markets Value Stock Fund, which invests in emerging markets companies that are “out-of-favor and undervalued but possess identified catalysts that could drive their stock prices higher,” the Baltimore-based fund company said in a release.

Ernest Yeung, the portfolio manager for T. Rowe Price’s International Small-Cap Equity Strategy, will manage the fund, which will hold 50-80 undervalued stocks from emerging-market and frontier-market companies in Europe, Latin America, Africa, the Middle East, and Asia, minus Japan. Current weightings favor financial, telecommunications services and consumer discretionary stocks in Romania, Russia, Brazil, South Africa, China, South Korea, and Taiwan.

Investor Class shares (Ticker: PRIJX) and Advisor Class shares (Ticker: PAIJX), will have net expense ratios estimated to be capped at 1.50% and 1.65%, respectively, through February 28, 2018. The minimum initial investment is $2,500, or $1,000 for retirement accounts or gifts or transfers to minors (UGMA/UTMA) accounts.

The Bucket

Posted on September 24, 2015 by Editorial Staff -

Allianz Life discovers new client demographic: ‘Post-crash Skeptics’

About 20% of Boomers and “Gen X” generation members are “post-crash skeptics” who have suffered at least six major effects of the 2008 financial crisis and whose financial outlook was permanently altered by it, a new survey by Allianz Life shows.

“This group appears to suffer from a significant psychological impact on their financial attitudes and behaviors, including lost confidence in financial institutions and a switch to more conservative investments,” said the survey, entitled “Generations Apart.”

The survey canvassed 1,000 baby boomers (ages 49-67) and 1,000 Gen Xers (ages 35-48). They were asked 13 questions regarding the 2008 market crash, including whether their home or 401(k) fell in value, whether they or a family member lost a job, and whether their savings and/or retirement planning were affected.

About 83% of post-crash skeptics (versus 58% of the entire survey group) said they were more cautious now. They were about twice as likely to say they lost confidence in financial institutions (77% versus 38%), that they had changed their view of the market to risky (67% versus 32%), and that they had switched to more conservative investments or financial products (43% versus 22%).

Half of post-crash skeptics reported taking on more debt after the crash (compared to 23% of the total respondents) and 41% (versus 15%) reported that they or a partner had lost a job. Four in 10 post-crash skeptics said they’d stopped saving for retirement since the crash—more than three times the rate of Gen Xers and boomers overall. More than half (52%) of post-crash skeptics are “more pessimistic” about their chances for a successful retirement, versus only 39% of the total group.

How some actively-managed funds can reduce sequence risk: Capital Group

A low expense ratio, high manager ownership and a low downside capture ratio, which measures how a fund has fared relative to the market during downturns, are the three most critical factors to consider when selecting retirement investments, according to a new study by the American Funds, a unit of Capital Group.

Over the last 20 years, “actively managed equity funds sharing these three factors significantly outpaced indexes and active peers in a withdrawal scenario,” the study showed.

The proprietary study examined actively managed U.S. and foreign large-cap equity funds, Moderate Allocation funds (mix of U.S. stocks and bonds) and World Allocation funds (mix of global stocks and bonds), as categorized by Morningstar.

The research showed that, after accounting for regular withdrawals, funds sharing the three critical factors collectively outpaced indexes over the last 20 years, a period that includes the dot-com and financial crisis downturns. The same was true when looking at rolling 10-year periods within that same time frame.

Market downturns can be particularly harmful to retirees because they are drawing regular income from their portfolios and, without a salary to make up for losses, they could suffer serious setbacks.

The study, titled Key Steps to Retirement Success: How to Seek Greater Wealth and Downside Resilience, looked at a hypothetical 65-year-old retiring with $500,000 in savings in 1995, with a plan to withdraw 4% initially each year (increasing by 3% annually to account for inflation).

A portfolio split between Moderate Allocation funds and World Allocation funds sharing the three factors would have generated 85% more wealth than a blended index after 20 years. This investor would have been able to withdraw a total of about $537,000 over this period, with $1.7 million left over.

“This portfolio beat the index while experiencing less volatility (as measured by standard deviation) and greater risk-adjusted returns (as measured by Sharpe ratio),” said the American Funds release. “A similar portfolio of funds managed by American Funds would have generated 105% more ending wealth than the index leaving the investor with $1.9 million at the end of the period.”

Pershing’s Retirement Plan Network adds four new investment models

Four investment model providers—3D Asset Management, Efficient Market Advisors, Morningstar Investment Services, Inc. and Wilshire Associates Inc.—have joined Pershing LLC’s Retirement Plan Network, the BNY Mellon unit announced this week.

Plan advisors who wish to manage their own investment options can use Pershing’s Retirement Model Manager, which allows them to create and manage models across multiple recordkeepers and plans without having to log into separate systems, said a Pershing release.

Other solutions available on the platform include an integrated network of independent recordkeepers, investment products, retirement plan tools and practice management solutions, Pershing said.

RetirePreneur: Sheryl Garrett

Posted on September 17, 2015 by Jenna Gottlieb -

What I do: I have been in the financial services industry 28 years and my current initiative is Garrett Planning Network, an organization with about 300 financial planners around the country.

Where I came from: I was a Money magazine addict by the time I was 19. I would calculate how I could become a millionaire by 22. By 24, I was in the industry. I got a job as a Gal Friday with a fee-only financial planner. I also earned my CFP designation. I then moved to a fee-and-commission planning firm. But my initial experience in selling financial services from 9 a.m. to 9 p.m. was a big turn-off. Eventually I needed to make a change. I met a businesswoman through my involvement with the Financial Planning Association in Kansas City. I joined her firm and we became 50/50 partners in 1995. I stayed until 1998. Sheryl Garrett copy block

We had five employees including ourselves and worked for about 100 families. We offered one service: comprehensive financial planning and portfolio management. A lot of people who wanted to access our advice couldn’t afford to delegate the management of their financial affairs to a professional. I hated turning away people whom I knew I could help, but who didn’t fit our firm’s niche. So I decided to start my own firm.

How Garrett Planning Network works: We’re the professional home for about 300 like-minded advisors. Financial planners who believe in making competent, objective financial advice accessible to everyone may apply for membership. We share our time, talents and resources to leverage our businesses and services to clients. We also help advisors get new clients.

During our three-day live New Member training class, our monthly webinars, our recordings library, and a whole host of marketing templates and examples, we instruct advisors regarding what works in marketing. My primary function is to raise public awareness of this option for financial advice.

Our Director of Financial Planning and Communications and I help to leverage every member’s media coverage and blogs via our network’s website, Facebook page, and other social media. Our members report that one of the top two sources for their new business is due to their membership in the Garrett Planning Network. We also have rules in place for how they must operate. Fee-only and a simple majority of all engagements must be made accessible without regard to any arbitrary minimums.

On working with clients: For the first eight years of my career, I was actually afraid of clients. I was not a good salesperson. I didn’t have a lot of backbone when presenting a fee quote or pitching a service offering. But once I discovered the niche that fit me best, I fell in love with financial planning.

What the retirement income industry can do better: Stop focusing on solutions first. Until we fully understand the needs, circumstances, options, opportunities and challenges that face people as they save for, transition into, and live in retirement, we’re missing opportunities to help people in ways that can be far more impactful on their quality of life than recommending a good investment portfolio. Social Security, Medicare, healthcare and living arrangements in retirement, and end-of-life issues, just to name a few, are critical and often overlooked.

On testifying before Congress: I’ve testified on financial literacy, Social Security reform, and conflict-of-interest issues in the industry. I could relate to Vanguard’s John Bogle when he said, ‘Making laws is like making sausage. You don’t want to watch the process.’

My view on the DOL fiduciary proposal: Advisors need to put their clients’ best interests first. Nearly every financial professional I’ve spoken with has witnessed the minor to devastating harm done by unscrupulous advisors. If you give financial advice, you must be held to the fiduciary standard.

My claim to fame: President Obama mentioned me during his speech at the AARP office in February. I got a call a week or so before from a speechwriter for the White House. She wanted comments for a speech. She said, ‘Tell me your story.’ So I shared some stories of victims of financial abuse, without thinking that the president would actually hear them. A week later, the White House called and asked if I could come for the president’s speech at AARP. I went to AARP, entering through a side door. After the president spoke, he said, ‘Sheryl are you here?’ We made eye contact. The audience turned and looked towards me. He told me to stand up! I did and waved to the audience. He mentioned my name eight times when speaking about advisory issues. It still feels like it didn’t really happen.

What I see ahead for retirement income: I’m delighted to see the industry’s focus on Social Security distribution planning, on healthcare in retirement, on reverse mortgages, on longevity risks and strategies to transfer that risk. As we focus on the holistic needs of our clients, we must also be compensated appropriately. Practitioners are electing to go independent and to charge for services that traditionally they could not be compensated for.

On the evolution of the financial planning business: A lot of advisors poo-poo a focus on middle-income clients. But people are more engaged today. There’s a massive amount of news and books on personal finance. There are CNBC shows, shows with Suzie Orman, Dave Ramsay, and others. Middle-income clients will be a ‘sweet spot’ for many advisors.

My retirement philosophy: I’m a fan of Mitch Anthony’s book, The New Retirementality. It’s not natural for people to quit contributing when they have the freedom to stop working for a paycheck. We can ‘re-tread’ versus ‘retire’. What are we retiring to? That’s a very important question. How about taking a sabbatical or ‘practicing’ retirement? Retirement is not an end-game, it’s the beginning of a new chapter in life. I’m also a strong proponent of guaranteed income, or a paycheck for life, that covers basic living expenses. Going into retirement debt-free is also part of my retirement philosophy. It may not make the most sense mathematically or financially, but it provides an amazing feeling of security.

New investment-focused variable annuity from Nationwide

Posted on September 17, 2015 by Editorial Staff -

Nationwide, the ninth largest seller of variable annuities in the first half of 2015, has introduced a new investment-focused flexible-premium variable annuity with a choice of 130 funds, the financial services firm announced this week.

The product is called Destination Freedom+. This type of VA is generally aimed at long-term investors who have much more appetite for tax-deferred investing than their defined contribution accounts can accommodate, and who also want the benefit of being able to trade risky assets without the friction of capital gains taxes.

(VA account gains are taxed at ordinary income rates when withdrawn, typically after age 59½ when the penalty period for early withdrawals has ended.)

Thirty-two fund families and 132 subaccount options are offered to contract owners, with none of the investment restrictions that accompany guaranteed income riders. There are also four Nationwide Guided Portfolio Solution model portfolios, including a Growth and Income model, an Enhanced Growth and Income model, a Capital Preservation model, and a Capital Appreciation model.

The fund fees range from 0.32% for the least expensive fund to 8.48% a year for the most expensive fund. The higher fund fee doesn’t reflect the actual cost that investors will pay after contractual reimbursements and waivers.

Nationwide posted $2.76 billion in variable annuity sales in the first six months of this year, for a 4% market share. The Columbus, OH-based firm ranked eleventh in total annuities sold (fixed and variable) as of June 30, 2015, with $3.54 billion.

Freedom+ offers a one percent base cost, which includes an 85-basis point mortality and expense risk (M&E) charge and an administration charge of 15 basis points. Investors can choose either a five-year surrender penalty period starting at 7% or a C-class option with no surrender penalty period for an additional charge of 35 basis points. The minimum initial premium is $10,000 and the minimal additional premium is $500 ($50 for automated electronic transfers).

The only insurance features are the death benefit options: a standard return-of-contract value death benefit, a return of premium enhanced death benefit (20 basis points) and a highest anniversary enhanced death benefit (30 basis points).

According to the product announcement, the product includes a spousal protection feature at no additional cost when an enhanced death benefit is elected. It provides a death benefit for both spouses, regardless of who passes away first. The surviving spouse can receive the death benefit or continue the contract at the higher of the death benefit or contract value.

Nationwide considers that an important differentiator for this product. “Our contracts are annuitant-driven, unlike most carriers’ that are owner-driven,” a Nationwide spokesman told RIJ. “For non-qualified contracts, the benefit isn’t as apparent as it is for qualified contracts like IRAs, because those have to be set up with only one owner. So, for owner-driven contracts, there is only one life that is tied to a death benefit. However, our product is annuitant-driven, so we can have a single owner, but also co-annuitants. Which means we can have two lives tied to a death benefit.”

The contract also offers an optional an enhanced surrender value for terminal illness (ESVTI). Terminally ill owner-annuitants can access to their full death benefit value before they die. Nationwide claims to be the only insurer offering that type of feature on a variable annuity.

Since 1967, income has shifted upward: U.S. Census Bureau

Posted on September 17, 2015 by Editorial Staff -

A new report from the U.S. Census Bureau, “Income and Poverty in the United States: 2014,” portrays an America where since 1967 the middle class has shrunk significantly, the lower class has shrunk a bit, and the upper classes have thrived.

In 1967, the Census Data show, 42.7% of the 61,000 households in the U.S. earned between $35,000 and $75,000. They might be considered the middle class. Households earning less represented 38.7% and households earning more represented the smallest share, at 18.6%.

Over the next four decades, a clear shift has occurred. In 2014, only 30.1% were in the middle group. The lowest group had shrunk to 33.7% and the segment with the highest incomes grew to 36.2%, the largest of the three groups.

Snapshot of US householders age 65 and older

While this suggests a country that is growing generally richer, other statistics in the report show that the gains have largely accrued to certain group of people. Households where a married couple is present, for instance, have the highest median income, at more than $80,000. Non-family households led by a female have the lowest median income, at less than $27,000.

Aside from marriage, factors that seemed to favor higher median household incomes, those identifying as Asian or white, males, those ages 35 to 54, those who attained at least a bachelor’s degree, those living in metropolitan areas but not the largest cities, and those living in the West.

The study does not indicate that older Americans in general are at-risk for poverty. Americans over age 65 represent about 14.8% of the population but account for 12.1% of those with household incomes 50% to 99% of the poverty level and 6.1% of those living on less half the poverty level. Corresponding figures for children under 18, who make up 23.3% of the general population, are about 34% and 33%.

Evidence of the concentration of wealth shows up in data that indicates the percent of national income earned by each of five income quintiles. The richest 20% of American households had 51% of the national income in 2014. (The richest 5% had 22%.) The next 20%—those in the 60^th to 80^th percentile—shared 23% of the income. The poorest 60% of American households share just 25.6% of the national income.

Back in 1967, when the oldest Boomers were graduating from college, the top quintile had 43.6% (17.2% to the top 5%). The fourth quintile had 24.2% and the lowest 60% of households shared 32.1% of the national income.

The Census Bureau defined “income” as virtually all cash receipts but excludes capital gains, which have been a significant source of income for upper-income groups during the dramatic rise in stock market indexes after 1982. In adjusting annual income levels for inflation since 1967, the Census Bureau used changes in the Consumer Price Index, which shows inflation since 1977 at an accumulated 347%.

Robo-advisors should shift to B2B model: Cerulli

Posted on September 17, 2015 by Editorial Staff -

Electronic registered investment advisors (eRIAs) in the United States will need to grow aggressively to compensate their venture capital investors after six years, according to the latest research from global analytics firm Cerulli Associates.

“eRIAs have gathered significant assets during the past several years,” said Frederick Pickering, research analyst at Cerulli, in a release. “Although the technology of the eRIA space has allowed them to scale at a much faster rate than existing traditional financial advisors, they will still need to reach end clients.

“Cerulli has constructed several scenarios that approximate the annual growth rate necessary for eRIAs to realize the multiples required for their venture capital and remain standalone direct-to-consumer businesses.”

Through their research, Cerulli believes that eRIAs’ ability to remain a standalone enterprise will be threatened due to commoditization of the eRIA model from traditional firms entering the space and massive fee compression.

“Cerulli projects eRIAs will need to grow approximately 50%-60% per year for the next six years and gather approximately $35 billion in AUM to remain a standalone direct channel for consumer business,” Pickering explains. “Given the threat of commoditization within the software-only eRIA business-to-consumers marketplace and the lack of an economic moat to charge a price premium, eRIAs should consider pivoting to a business-to-business model.”

“The eRIA channel has created a business model that undercuts traditional advisory firms, but may lack the financial resources to compete if the business model becomes commoditized,” Pickering continues. “New entrants from traditional advisory firms and start-ups threaten to commoditize the space, drive down fees, and eliminate any remaining premium in eRIA fee structures.”

These findings and more are from the September 2015 issue of The Cerulli Edge – U.S. Edition, which explores innovation, analyzing the role of private equity, the viability of the eRIA model, and how product developers are focusing on international and global strategies.

Flows to bond ETFs increased in September: TrimTabs

Posted on September 17, 2015 by Editorial Staff -

Bond exchange-traded fund inflows surged to $9.8 billion (2.8% of assets) in the two weeks ended Friday, September 11, according to TrimTabs Investment Research.

This inflow is the biggest two-week haul since February, and it signals diminishing concern that the Federal Reserve will raise rates soon. “The renewed interest in bonds signals that investors are becoming more risk averse,” said David Santschi, chief executive officer of TrimTabs, in a release. “Concerns about an imminent rate increase are being thrown out the window.”

Inflows into bond ETFs accelerated to $19.9 billion—equal to $400 million daily—since the start of the third quarter, TrimTabs reported. Treasury bond ETFs have been particularly popular, pulling in $7.4 billion (11.2% of assets) since mid-August. Corporate bond ETFs drew heavy buying in the past two weeks, issuing $5.0 billion (2.1% of assets).

“Fund flows are consistent with a range of credit indicators, including the fed funds futures market, that fixed-income investors don’t expect the Fed to raise rates Thursday,” said Santschi.

The rush into bonds has not occurred in response to strong absolute performance, TrimTabs said. Treasury bond ETFs are down 0.4% since the start of August, while corporate bond ETFs are down 0.7%.

How to Personalize Withdrawal Rates

Posted on September 15, 2015 by Kerry Pechter -

Whole forests have been pulped and supertanker-loads of ink spilled to produce articles about the various spending strategies that financial advisors can recommend. Some strategies emphasize safety, others emphasize “optimization.” Some roll Monte Carlo simulations to make the future seem less unknowable. Others rely on historical back-testing.

But experienced financial advisors know that there is no single, sure-fire spending formula. Or rather, the right strategy is the one that satisfies their clients’ fluctuating needs, keeps them solvent until they die, and achieves their legacy goals, if any. “What arrow flies forever?” asked Vladimir Nabokov. “The one that hits its mark.”

So how does the wise advisor, armed with six or seven different peer-reviewed spending formulas, match the right spending formula with the right client at the right time? How does he or she customize the research to each client’s reality?

Luke Delorme, a researcher at the American Institute for Economic Research in Great Barrington, MA, has come up with a “blueprint” that advisors can use to tackle this almost universal problem—a problem complicated by the fact that many people don’t know or can’t describe what they want.

In his article, “A Blueprint for Retirement Spending,” in the September issue of the Journal of Financial Planning, Delorme takes several of the withdrawal rates recommended by retirement specialists like David Blanchett, Michael Finke, Jonathan Guyton, Michael Kitces, and Wade Pfau, and shows how each can be fine-tuned depending on the preferences of each client.

“There are some big withdrawal rules out there,” Delorme told RIJ recently. “I’m trying to break the problem down into something more prescriptive—based on household preferences—and to come up with a structure that you can use to prepare for retirement. It’s a starting point.”

Four spending preferences

The first step toward determining a client-specific withdrawal strategy, Delorme writes, is to locate the client’s position on two continuums. Listening to a client’s comments during an interview, the adviser should be able to estimate how afraid they are (or aren’t) of running out of money and how tolerant they are (or aren’t) of a fluctuating cash flow. Overlaying the locations of two continuums, he arrives at four difference preferences:

Safe and constant income. “I absolutely must not run out of money under any circumstances. I need to know what I can spend every year.”
Safe and flexible income. “I’m moderately concerned about running out of money, but I have a safety net if anything happens.”
Optimal and constant income. “I’m as concerned about not spending enough as I am about spending too much.”
Optimal and flexible income. “I want to maximize lifetime spending. I have a preference for spending while I can. I am willing to adjust spending based on market fluctuations.

Then he assigns a baseline withdrawal rate to each of these preferences, using the work of previous research about withdrawal rates as a guide. Thus he puts the safe and constant spending rate at 3.8%, the optimal and constant rate at 5.4%, the safe but flexible rate as the RMD (required minimum withdrawal rate, according to IRS rules), and the optimal and flexible strategy as the RMD plus the inflation rate.

Period of adjustments

Having established the baseline rate, Delorme fine-tunes it according to the combination of factors that is unique to each case. These factors, and their impact on withdrawal rates) include:

Age of retirement. Later retirement means higher spending rate.
Marital status. Surviving spouses tend to live longer than single people.
Health status. Healthy people tend to live longer.
Guaranteed income (Social Security, pension, private annuity). More guaranteed income means higher spending rate from savings.
Bequest motive. Higher bequest motive means lower spending rate.
Exposure to equities. Exposure between 30% and 60% has little effect on spending rate.
Fee load. The spending rate is directly reduced by the amount of the expense ratio.
Desire to optimize “utility”. Utility maximizers are those who place a lot of importance on traveling or being active as much as possible while they are physically able.

Delorme gives examples of the spending rate changes associated with these variables. For instance, “For optimal and constant spenders, married couples could increase spending by 0.1 percentage points for each year that the couple delays retirement beyond age 65 (based on the younger spouse’s age).” Another example: “As ratio of pension to savings increases, optimal strategies will spend a higher percentage of savings.”

Two hypothetical clients

Along with tables, charts, equations and a respectful rehash of the academic literature, Delorme provides a couple of hypothetical cases that make his thesis easy to understand and apply in the real world. They represent the extremes of withdrawal rates; most clients would probably fall somewhere in between.

The first hypothetical clients are a very healthy couple who want to retire at age 62, are very conservative about money and have no guaranteed income besides Social Security. Their baseline withdrawal rate is an inflation-adjusted 3.8% a year. It drops 0.3% because of early retirement, 1.0% for risk aversion, 0.5% for fees and 0.5% for “relatively strong” bequest motive. Recommended initial spending rate: 1.5% to 3% constant dollars.

The second hypothetical couple, in average health, intended to delay retirement to age 75. They “love travel” and “want to live it up” in retirement. Their baseline withdrawal rate is an inflation-adjusted 5.6%. It goes up 2% because of late retirement, 0.4% because they have a defined benefit pension in addition to Social Security, and 0.2% because of their 60% equity allocation. It drops 0.8% because of fees. Recommended initial spending rate: RMD+2% or 3%, or between 6.4% and 7.4%.

Equities don’t matter much

Except at the extremes, spending rates aren’t sensitive to changes in equity allocations, Delorme believes. “As long as you’re in that range [30% to 60%] there’s not a huge difference in spending rate,” he told RIJ. “I’ve found that how much you’re spending each year is much more critical than your equity allocation. If your big concern is whether the portfolio will run out of money or not, lower spending is more important than a rising equity strategy.

“At the end of the day, it comes down to finding an asset allocation that you think people can stomach. I could tell recommend a 70% equity allocation, but if that makes them want to sell off in a downturn, it’s not right for them. Reality doesn’t always align with the model. For people in their 60s or 70s, I think 30% is reasonable.”

Delorme’s blueprint doesn’t necessarily preclude the use of annuities during all or part of retirement as supplemental “flooring” to Social Security. In his calculations, there’s a slot for pension income; that spot could be just as easily filled by a private annuity as by a pension. His rule of thumb: the higher the ratio of pension income to savings, the higher the safe spending rate from savings.

The AIER

The American Institute for Economic Research was founded in 1933 by Colonel Edward C. Harwood (1900-1980), an American engineer, businessman and economist who is said to have predicted the Great Depression. The non-profit AEIR, which also has a for-profit investment division, is best known for its research on the business cycles.

“Between the 1930s and 1950s, it was one of the few sources of that type of research,” Delorme, who previously worked at the Center for Retirement Research at Boston College, told RIJ. “I’ve come in to start a new retirement planning, investing and personal finance division. The mission is to provide economic and financial research for average Americans.”

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