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In TPA merger, Retirement LLC–Series Two acquires Capella

Posted on January 9, 2014 by Kerry Pechter -

Capella Inc., a third-party qualified plan administrator (TPA) based in Sioux Falls, SD, has agreed to merge with Retirement LLC–Series Two, an independent TPA based in Oklahoma City, OK. The transaction closed on January 2.

Established in 1999, Capella is the largest retirement plan consulting organization in South Dakota. It works with financial professionals, bank trust departments, CPAs and attorneys nationwide. Dana Hagen, who acquired the firm in 2011, will join the merged company’s executive team.

“This is our third merger in the last 12 months and we have no plans to slow down in 2014,” said Robert Krypel, CEO of Retirement LLC–Series Two.

“The TPA retirement business is very fragmented and it’s challenging for smaller firms to both grow their client base and provide high service levels,” said Hagen in a release.

Retirement LLC–Series Two is a TPA and record-keeper for more than 1,600 tax-qualified retirement plans ranging in size from one to 2,500 participants. Its corporate headquarters is in Northbrook, IL. Plans include defined benefit and cash balance, defined contribution, profit sharing, 401(k), ESOP, and 403(b) plans.

Terms of the transaction were not disclosed. Wallingford Partners, LLC advised Retirement, LLC–Series Two.

Broadridge unit signs DCIO service deal with The Standard

Posted on January 9, 2014 by Kerry Pechter -

The Standard has selected Access Data, a Broadridge company, to provide DCIO reporting services to fund partners offering products on The Standard’s retirement recordkeeping platform, Broadridge Financial Solutions announced this week.

Starting in the first quarter, defined contribution investment only (DCIO) reports will be available to The Standard’s fund partners through a new technology portal designed to provide access to asset, trading and sales information at a plan level.

The new portal allows firms offering funds on The Standard recordkeeping platform to monitor sales across retirement plans and to understand the advisor selling those plans. This increased transparency “will provide mutual funds with deeper insight into the advisor-driven retirement market comprised of The Standard and other independent recordkeeping platforms” that serve small and medium DC plans, a Broadridge release said.

Defined contribution assets are forecast to grow to $6.7 trillion over the next five years, the release said. The small to medium-sized plan segment supported by independent recordkeeping platforms is the fastest growing segment for DC assets, the company said.

Access Data provides data management and reporting services for fund firms. Its DCIOConnect aggregates and “cleans” data across 18 leading recordkeeping platforms and the advisor-driven plan market.

Private pension funding level rises 18 points in 2013

Posted on January 9, 2014 by Kerry Pechter -

Higher equity values and rising interest rates pushed the overall funded status of U.S. corporate pension plans to 95.2% in December 2013, a month-over-month improvement of 1.3 percentage points and the highest level since September 2008, said BNY Mellon’s Investment Strategy & Solutions Group (ISSG).

Public defined plans, endowments and foundations benefited in December from the equity rally as well as their holdings in private equity, ISSG said.

For U.S. corporate plans, assets of U.S. corporate plans increased 0.8% and liabilities fell 0.6%, ISSG said. An eight-basis-point increase in the Aa corporate discount rate to 4.93% caused the decline in liabilities.

“The funded status of the typical U.S. corporate plan increased more than 18 percentage points in 2013,” said Jeffrey B. Saef, managing director, BNY Mellon, and head of ISSG, in a release. “It was the best of all worlds.”

On the public side, the typical defined benefit plan in December achieved excess return of 0.4% over its annualized 7.5% return target, ISSG said. Public plan assets must earn at least 0.6% each month to keep pace with the 7.5% annual target.

For endowments and foundations, the net return over spending and inflation was 0.7% as plan assets increased 1.1%. Endowments and foundations continue to be aided by the low-inflation environment, ISSG said.

Equity funds gain record $352bn; bond funds lose record $86bn

Posted on January 9, 2014 by Kerry Pechter -

Equity mutual funds and exchange-traded funds (ETFs) listed in the U.S. enjoyed a record net flow of $352 billion in 2013, nominally breaking the previous record inflow of $324 billion in 2000, according to TrimTabs Investment Research.

Of the record flow, U.S. equity mutual funds and exchange-traded funds received a net $156 billion in 2013, while global equity mutual funds and exchange-traded funds received $195 billion. For U.S. funds, it was the first net inflow since 2007 and the biggest since the record of $274 billion in 2000; for global equity funds and ETFs, the flow exceeded the previous record inflow of $183 billion in 2006, TrimTabs reported.

“Retail investors are particularly enthusiastic about non-U.S. stocks, which should make contrarians wary,” said David Santschi, CEO of TrimTabs.

“Global equity mutual funds took in $137 billion last year, which was more than seven times the inflow of $18 billion into U.S. equity mutual funds. These highly disproportionate inflows occurred even though non-U.S. stocks as a whole badly lagged U.S. stocks.”

Meanwhile, U.S.-listed bond mutual funds and ETFs redeemed a record $86 billion, nominally topping the previous record outflow of $62 billion in 1994.

“The Fed finally succeeded last year in its long-running campaign to coax fund investors to speculate. The ‘great rotation’ that some market strategists long anticipated is under way,” Santschi said in a release.

“Bond funds have suffered seven consecutive months of redemptions for the first time since late 1999 and early 2000,” noted Santschi. “Nevertheless, the outflow of $196 billion in the past seven months reverses just a fraction of the inflow of $1.20 trillion from 2009 through 2012.”

Hedge fund thrive

Hedge funds took in $17.5 billion (0.9% of assets) in November, the highest inflow in six months and the second highest in the past two years, according to BarclayHedge and TrimTabs Investment Research.

“The hedge fund industry has taken in a net $66.9 billion in 2013, a healthy turnaround from an outflow of $8.2 billion in the same period in 2012,” said Sol Waksman, president and founder of BarclayHedge. Hedge funds had net inflows in nine of the first 11 months of 2013.

Industry assets climbed to a five-year high of $2.1 trillion. “Assets are up 17% in 2013 but are still 14% below the all-time peak of $2.4 trillion in June 2008,” Waksman said.

The monthly TrimTabs/BarclayHedge Hedge Fund Flow Report said:

The hedge fund industry gained 0.8% in November, underperforming the S&P 500, which gained 3.1%.
Equity Long Only hedge funds gained 2.3%, adding to October’s 1.9% gain.
Equity Long Bias funds gained 1.6%, down from a 2.3% gain in October.
Funds of hedge funds took in $1.9 billion (0.4% of assets) in November, reversing course after redeeming $1.1 billion October.
Funds of funds added assets in just three of the past 24 months.
The hedge fund industry posted inflows in 15 of the past 24 months.

The monthly TrimTabs/BarclayHedge Survey of Hedge Fund Managers finds a plurality of managers bullish on the S&P 500’s prospects for January. Bearish sentiment is at a three-month high, while bullish sentiment is at a three-month low. Nearly two-thirds of respondents expect equities to outperform bonds and precious metals over the next six months, and a similar proportion expects developed markets to outpace emerging and frontier markets in the same period.

The latest 401(k) stats from EBRI

Posted on January 9, 2014 by Kerry Pechter -

If all 401(k) participants were a single investor, he or she would be a moderate-risk investor with an asset allocation very close to the classic middle-of-the-road portfolio of 60% equities, 30% bonds and 10% cash, according to the December 2013 Issue Brief from the Employee Benefits Research Institute (EBRI).

Highlights of the brief included:

The bulk of 401(k) assets continued to be invested in stocks. On average, at year-end 2012, 61% of 401(k) participants’ assets were invested in equity securities through equity funds, the equity portion of balanced funds, and company stock. A third was in fixed-income securities such as stable-value investments and bond and money funds.
72% of 401(k) plans included target-date funds in their investment lineup at year-end 2012. At year-end 2012, 15% of the assets in the EBRI/ICI 401(k) database were invested in target-date funds and 41% of 401(k) participants in the database held target-date funds.
More new or recent hires invested their 401(k) assets in balanced funds, including target-date funds. For example, at year-end 2012, nearly 54% of the account balances of recently hired participants ages 20-29 were in balanced funds, compared with 51% in 2011, and about 7% in 1998. A significant subset of that balanced fund category is in target-date funds. At year-end 2012, 43% of the account balances of recently hired participants ages 20-29 were invested in target-date funds, compared with 40% at year-end 2011.
401(k) participants continued to seek diversification of their investments. The share of 401(k) accounts invested in company stock edged down to 7% at year-end 2012. This share has fallen by more than half since 1999. Recently hired 401(k) participants contributed to this trend: they tended to be less likely to hold employer stock.
Participants’ 401(k) loan activity remained steady, although loan balances increased slightly in 2012. At year-end 2012, 21% of all 401(k) participants who were eligible for loans had loans outstanding against their 401(k) accounts, unchanged from year-end 2011, 2010, and 2009, but up from 18% at year-end 2008. Loans outstanding amounted to 13% of the remaining account balance, on average, at year-end 2012, down one percentage point from year-end 2011. Nevertheless, loan amounts outstanding increased slightly from the previous year.
The year-end 2012 average 401(k) account balance in the database was 8.4% higher than the year before. That figure may not accurately reflect the experience of typical 401(k) participants in 2012, however. To understand changes in 401(k) participants’ average account balances, it is important to analyze a sample of consistent participants. As with previous EBRI/ICI updates, analysis of a sample of consistent 401(k) participants (those that have been in the same plan since 2007) is expected to be published in 2014.

RetiremEntrepreneur: Borden Ayers

Posted on January 9, 2014 by Kerry Pechter -

What do you do? I’m a principal with The Diversified Services Group Inc., a consulting and research firm focused on the financial services industry that was established in 1989. I am involved in the retirement market segment. When I joined the practice in 1996, we wanted to find a niche that was not yet a focal point for the industry. We concluded that the retirement income market was overlooked, and I focused on that. In 1997, we launched a syndicated research initiative on attitudes and perceptions about retirement income. We’ve also concluded a number of proprietary research and consulting engagements for clients on the retirement income opportunity. In 2003, we started the Retirement Management Executive Forum, or RMEF.

Who are your clients? DSG’s clients are banks, insurance companies, broker-dealers, and asset management firms. The RMEF provides a platform where representatives of our 33 member firms can meet and discuss retirement income issues. The forum meets twice a year, with about 45 people at each meeting. They tend to be executives charged with developing, implementing, and managing their firms’ retirement distribution and income market strategies. The representative may manage the business overall, or a product line specific to retirement income. Although we sometimes look at the institutional side of the retirement business, we pay more attention to the retail consumer market.

Why do they hire you? When it comes to retirement savings, the market for research and business strategy planning services is mature and the field is crowded. In retirement income, however, we were early entrants. With the RMEF, we simply want to provide a forum for structured and informative discussion about the retirement income market. We aren’t a lobbying organization, an educator or a vendor. We simply provide a forum where our clients can learn about the retirement income market and discuss the real challenges they face.

Where did you come from? Back in 1978, I started my career with a major insurance company. Initially responsible for the marketing and sale of qualified retirement plans in the Midwest, I moved to Philadelphia and eventually headed the firm’s pension, annuity, and mutual find sales. In 1994 I became the president of a regional trust company, managing the personal trust services business and the sale of financial products. After 18 years in the corporate world, I wanted to do a venture of my own and joined DSG. The firm has a bank services practice and retirement management market practice. I have four partners, all of whom come from management roles in the financial services industry, along with support staff and several strategic alliances.

What motivated you to go independent? There’s a point in corporate management life where form takes precedence over substance and one has less control over events. I decided I could have a greater impact if I was unencumbered by corporate constraints. Ownership in my own business was also a factor. I am one of five owners.

How do you get paid? The RMEF charges a nominal annual membership fee. For consulting and research, we get paid for our experience and the range of business planning and research services we provide. Client co-sponsorship fees cover our syndicated research projects. Rather than advertise the RMEF, we rely mostly on word-of-mouth and testimonials.

How do you feel about annuities? An annuity is simply a way for people to acquire their own individual pension. Unfortunately, they’re perceived negatively and they’re misunderstood. They’re tagged with labels like “use it or lose it,” “high costs,” and “annuicide,” most of which don’t apply to current versions of the product. Personally, I have owned and own annuities, principally for non-qualified tax deferred savings and to provide retirement income.

The Equities Outlook for 2014

Posted on January 8, 2014 by Ron Surz -

Part I: The Present

After feasting on the U.S. stock market’s 54% run-up from 2009 to 2010, we starved in 2011, suffering a 1% loss. Those who said the markets were due for a healthy lull turned out to be right. Stock markets both here and abroad had a good 2012 followed by a spectacular 2013, generating another 54% return in the U.S over two years.

The past five years have been among the best on record, almost erasing the memory of the five years ending 2012, as shown in the graph on the right. These past five years produced the third highest return, albeit following two of the lowest performing 5-year periods.

Although concerns about another market bubble have emerged, the graph below suggests otherwise. Even though stock prices have surged, both dividends and earnings have kept pace. Prices appear to be reasonable.

It’s useful and insightful to examine the sources of these returns. The following formula works quite well:

Return = Dividend Yield + (1 + Earnings Growth) X (1 + P/E expansion/contraction) – 1

This formula is simple yet elegant, stating that total return equals dividend yield plus sources of price change, namely the compounding of earnings growth with investor-driven changes in the price/earnings (P/E) ratio. I’ll use this formula again when we discuss the future.

The components of returns for the past two five-year periods are shown in the graph on the right. As you can see, P/E expansion and contraction has been the driving force. This component is primarily driven by investor behavior, and may well be the cause of future economic results rather than being a leading indicator of the economy.

In his 1998 book, Beast on Wall Street, Robert Haugen contends that the market crash of 1929 caused the Great Depression, as opposed to predicting it. In other words, the market drives the economy rather than anticipating it. If so, recent P/E expansion bodes well for the economy, if this expansion continues.

The big question remains: what will be the ultimate effects of quantitative easing? There’s no doubt the bond market is being manipulated and that this has a material effect on stock markets. Stock buy-backs are proliferating because money is cheap. Corporations can borrow at very low interest rates to buy their own stock, which drives up share prices. Will buy-backs continue when the brakes come off of interest rates? What forces will drive future P/E expansion/contraction? We don’t know.

America the Beautiful

The U.S. stock market has performed best, particularly in 2013, as shown in the graph below. Consequently there is a wide dispersion of performance among multi-asset managers, especially target date funds. The primary benefits of target date funds are diversification and risk control, both of which suffered on a relative basis in 2013.

The most diversified funds underperformed their U.S.-centric competitors, as did funds with rigorous risk controls. This leads to the potential for error on the part of plan sponsors, and to the hiring and firing investment managers for the wrong reasons.

Using the return components formula above, the U.S. stock market’s 2013 return breaks down as follows:

33% Return = 2% Dividend + (6.5% Earnings Growth compounded with 23% P/E Expansion)

Some styles and sectors have thrived while others have struggled. Outside the U.S. country-by-country performance varied widely. The following section examines these results.

Recent winners and losers

U.S. stocks

Growth stocks led the way in 2013, with small-cap growth stocks earning 44%. Large-cap-core companies earned “only” 23%, and large-value earned 28%. Style returns clustered around 30%, which was a pretty good place to be. This has been one of those unusual periods where the “stuff in the middle” (core) has not performed in line with the “stuff on the ends.” (I use Surz Style Pure^® classifications throughout this commentary.) Core might well outperform value and growth going forward, in a regression toward the mean.

Stocks by sector

On the sector front, consumer discretionary and health care fared best, earning more than 43%. By contrast, materials eked out a meager seven percent return, and telephones-and-utilities also lagged at 16%. Consumers led the year, in contrast to previous periods when infrastructure spending and the “Chindia” effect led the way.

Over the past five years, smaller companies of all styles have led, as have consumer-oriented stocks. The big change in 2013 was in the leadership of technology stocks, which had performed relatively well prior to 2013. Interestingly, the previous five years (2004-2008) were led by value stocks in the energy and materials sectors. The leadership of the U.S stock market has shifted dramatically.

But the interesting details lie in the cross-sections of styles with sectors, especially for those who want to exploit momentum effects, as discussed in “Part 2: The Future” below.

Stocks by region

Foreign markets earned 16.5%, lagging the U.S. stock market’s 33% return and EAFE’s 23% return. Japan and Europe earned 30% on a dollar basis. In yen, the Japan return was an even more impressive 44%. The Japanese stock market soared this year as the yen was purposely weakened against the dollar. Countries outside Europe and Japan earned less than 11%. Latin America lost 4% (all in $US).

On the style front, core surprised, as it did in the U.S. It led rather than lagged, though not by much.

Leadership in 2013 shifted to Japan and Europe from Latin America and Australia/New Zealand. Style leadership shifted from value to core. EAFE and ADRs have both underperformed. This is because smaller companies have performed best. They’ve earned 20% per year while large companies have lagged with annualized returns of 16% per year.

My 2012 Commentary indicated that Japan would become a bargain in 2013—a deep value play—and that was a pretty good call. As concerns about a weakening U.S. dollar have been allayed, at least temporarily, interest has diminished in Latin America and Australia/New Zealand.

Part II: The Future

To forecast future returns, you can use the components formula shown above. Simply plug in your earnings growth estimates and ending P/E. If 2014 turns out to be an “average” year (See yellow cell in table below), we should see a 16% loss. But returns may not be average. The purple cells highlight a band around the average and indicate a performance range from +13% to -18%. Losses are not in most forecasts for 2014. Only contrarians would predict a 16% loss.

This framework can also be used for foreign markets. Because they are currently near historical averages, their expected returns in 2014 are near norm, at plus-9%.

Despite recent market gains, or perhaps in response to them, investors have flocked to hedge funds as defensive moves. Demand for these products should increase substantially in the years ahead as the harsh realities set in. Separating the alpha wheat from beta’s chaff will always be crucial in selecting hedge funds.

The market will continue to put a premium on human intellect. We won’t pay much for exotic hedge fund betas (risk profiles). We’ll know the difference because we’ll abandon simple-minded performance benchmarks like peer groups and indexes, and replace them with the science (as envisioned in my short film, the Future of Hedge Fund Evaluation and Fees).

Forecast for 2014

In Searching for Alpha in Heat Maps, published in early April 2013, I showed how to use heat maps to profit from momentum effects. I have published my forecasts each quarter, and promised to report on their success at year-end. Here’s that report.

Momentum investing worked in 2013 for investors who went long my forecasted winners and short my forecasted losers. If you simply went long my forecasted winners, you won in the U.S. but not in foreign stocks, relative to their respective markets. If you simply went short my forecasted losers, you won in foreign stocks. The momentum of lagging segments persisted longer than the momentum of winners.

Now I’ll offer forecasts for the first quarter of 2014 using heat maps. Shades of green indiciate good performance relative to the total market. Shades of red indicate underperformance. Yellow is neutral.

A U.S. equities heat map for the year ending December 31, 2013 can be seen below. The best performing market segment comprises $45 billion (not shown) of small-cap growth companies in the industrial sector, which earned 62.9%. Small-cap growth companies in the materials sector performed worst, losing 16.7%.

Many quantitative managers employ momentum in their models, buying “green” and selling “red.” Fundamental managers use heat maps as clues to segments of the market that are worth exploring, for both momentum and reversal potential.

Using this heat map, I forecast the following domestic winners and losers for the first quarter of 2014. I’ll continue to track the results on a cumulative and quarterly basis. Let the games continue.

Similarly, the following table is a heat map for foreign stocks in calendar 2013. Health care stocks in Canada have thrived with a 61% return, while materials in Canada have suffered 33% losses.

Accordingly, my forecasts for foreign market returns in the upcoming quarter are:

Probing the Minds of Advisers

Posted on January 8, 2014 by Kerry Pechter -

If anyone knows what financial advisers are thinking about, it’s Howard Schneider, of the Practical Perspectives research firm. For years, he and collaborator Dennis Gallant of GDC Research have regularly surveyed the attitudes and practices of financial advisers.

For their newest publication, “Retirement Income Insights 2014—Using Products and Providers,” they take another deep dive into the space between advisers’ ears. The 155-page report is a result of surveys of a representative sample of 600 advisers across all individual distribution channels.

One quick takeaway: The percentage of advisers who combine annuities and systematic withdrawals (SWP) from risky assets has remained steady over years at about one-third. Most advisors still create retirement income the old-fashioned total-return way, with dividends and/or systematic withdrawal plans (SWP) from a diversified portfolio.

“Academically, there’s this agreement some people need insured or guaranteed income—an income floor—and that they can manage the rest of the portfolio as they like. But that philosophy isn’t taking hold in the field,” Schneider (right) told RIJ this week.

“If you go back five or six years, there’s been no change,” he added. “About 35% of advisors use the floor-and-upside method, about 40% use systematic withdrawals from a diversified portfolio, and about a quarter use a pool or bucket approach.”

More fundamentally, Schneider said, product manufacturers and their wholesalers continue to face the challenge of trying to mass-produce solutions for advisers and investors who resist one-size-fits-all solutions. That seems to be the beauty and the bane of the retirement income challenge, at least for manufacturers.

“Many firms trying to build an attractive advisor offering have been daunted by the highly individualized and nuanced approach to income support that most advisors employ and the wide variety of distinctions that exist among practitioners,” the study said.

“Although narrowly defined prescriptive approaches are inherently appealing to providers and distributors, these initiatives do not resonate with advisors. The reality is that the market for support remains highly fragmented, whether in the methods used for creating income, the products advisors rely on, and the providers and sources they associate with retirement income,” the Schneider-Gallant research showed.

That doesn’t mean they can’t be won over. “Every adviser is different,” Schneider told RIJ. “They all arrive at an approach by trial and error. They don’t want to change what works. And they are all confident that their clients will achieve their goals. But, while they are confident, they are looking over their shoulders and wondering if they’re doing the right thing.”

Insurance companies that issue annuities tend to be more “top of mind” than asset managers among advisers with regard to retirement income expertise, said Schneider, who is based in North Andover, Mass. But that’s to be expected, he said, because annuities are identified specifically with retirement income while mutual funds and ETFs are also used during the accumulation period.

Regarding income products, advisers continue to say that the latest products tend to be too complicated. “Advisers want their clients to be able to understand what they’re buying, but sometimes even they can’t explain the products to their clients,” Schneider said. That point is another source of frustration for manufacturers, who know that many advisers love the latest “bells and whistles.”

Instead of needing or wanting help in managing money or generating income in retirement, Schneider said, advisers want help with their blind spots, like Social Security, Medicare and long-term care insurance. That could mean that a Social Security calculator on an insurance company’s adviser web portal might attract more fee-based advisers than a pitch for annuities.

Other findings in the report, which includes 128 charts, tables and graphs, were:

Over 70% of advisors increased the number of retirement income clients they serve in the past 12 months.
Wariness over rising interest rates in the coming year is driving changes in how advisors expect to manage retirement income portfolios in 2014.
Fewer than 20% advisors are highly satisfied with retirement income support available to them from asset managers or insurance companies.
Only 10% of advisors using variable annuities for more than 50% of their retirement income clients.
About two-thirds of advisors believe yield/income, liquidity, total return, and safety or stability are the most important factors in selecting the investment products for generating sustainable income for clients.
Almost two-thirds advisors cite simplicity as a major challenge in using new products and solutions for retirement income.

The Principal to deregister as an S&L

Posted on January 3, 2014 by Kerry Pechter -

The Principal Financial Group has received the required approvals from the Federal Reserve Board to deregister as a savings and loan holding company, the company said in a release.

During the deregistration process, Principal Bank narrowed its activities to those of a limited purpose trust savings bank. Principal Bank will continue offering individual retirement accounts (IRAs) with FDIC-insured deposits.

“As a limited purpose trust savings bank, we will continue to provide our customers with the income and savings options they desire to help them prepare for retirement,” said Larry Zimpleman, chairman, president and CEO of The Principal.

Prudential in Malaysian joint-venture

Posted on January 3, 2014 by Kerry Pechter -

A newly-formed joint venture of Prudential Financial, Inc. (PFI), doing business as Pramerica, and Bank Simpanan Nasional (BSN), has bought all of the shares and paid-up ordinary share capital of Uni.Asia Life Assurance Berhad (UAL) from Uni.Asia Capital Sdn Bhd (UAC), it was announced this week.

PFI and BSN paid Malaysian Ringgit (RM) 518 million ($160 million) in cash for the UAL shares. PFI’s ownership is through a subsidiary, The Prudential Insurance Company of America (PICA), which holds 70% of the UAL shares, while BSN, a part of the Malaysia Ministry of Finance, holds the rest.

With the closing of the agreement, UAL will develop “customized solutions for BSN’s customers and develop a more integrated bancassurance platform that fully leverages BSN’s distribution network and customer base,” the firms said in a release.

UAL will also continue to sell its products through Pos Malaysia Berhad, a unit of BSN and Malaysia’s only mail services provider, and through its 1,000 retail outlets across the country.

UAL’s former parent, UAC, is owned by Gadek (Malaysia) Bhd, which engages in cultivation and marketing of rubber, oil palm and coffee and operates as an investment holding company. Through its subsidiaries, the company also engages in construction work and project management. The company was incorporated in 1978 and is based in Shah Alam, Malaysia.

Bowl games feature new Northwestern Mutual “Columns” ad

Posted on January 3, 2014 by Kerry Pechter -

Northwestern Mutual debuted new, financial planning themed advertising during the January 1 broadcast of the Rose Bowl Game on ABC. The commercial that was aired during the Rose Bowl can be viewed here.

The ads, created by Olson in Minneapolis, Minn., are the latest iteration in Northwestern Mutual’s “Columns” campaign, which began in 2010. They were directed by James Gartner (live action) and Capacity (animation), with music composed by Nylon.

The new spots “will leverage and amplify Northwestern Mutual’s multiyear partnership with the NCAA by including footage of actors portraying student-athletes as the first live-action images to appear during the animated campaign,” the mutual life insurer said in a release.

The series includes six 30-second spots that will air during the Rose Bowl, Fiesta Bowl, Orange Bowl and BCS Championship game. Other spots will feature actors portraying collegiate student-athletes playing men’s and women’s basketball, baseball, and softball.

Basketball themed ads will launch during regular college basketball season on networks such as ESPN and CBS, and continue into the NCAA Women’s Final Four on ESPN and NCAA Men’s Division I Championship airing across TBS, CBS, TNT and truTV, with this year’s 2014 Men’s Final Four airing on TBS and National Championship airing on CBS.

The ads will be supported by local sponsorships, events in key markets, and a short video series exclusively on ESPN and ESPN.com featuring current NCAA basketball coaches sharing how they help their teams plan for success.

For those 65+, work and wealth are linked

Posted on January 3, 2014 by Kerry Pechter -

Not retiring is the most reliable retirement income strategy, judging by AARP’s December 2013 Fact Sheet. The report was based on data from the U.S. Census Bureau’s March 2013 Current Population Survey Annual Social and Economic Supplement.

About one-fifth (21.6%) of the 43.3 million Americans who are age 65 or older still work full-time or part-time. They had the highest personal incomes ($44,470 average; $25,000 median) in 2012. No other sub-group came close.

More older people are working. Americans who are 65+ now get 30.3% of their income from earned income, up from 15.3% in 1990, a generation ago. This reflects their growing labor force participation. In 2000, only about one in eight (13.5%) of people age 65+ worked; In 2012, about one in five did (19%).

Those with the most income—from any source—were the most likely to be working. More than half (54.8%) of the members of the highest income quintile (with at least $43,259 in income, and a median of $65,567) had earned income. While that group also had the highest median Social Security benefits ($18,384) and highest income from pensions and savings ($30,000), their earnings (median, $50,000) was what set them apart, income-wise.

These numbers, based on quintiles and averages, paint a rough picture, of course. They fail to reveal much about the finances of the very wealthiest older Americans. But they also don’t reinforce the stereotype of idle rich with big incomes from pensions and investments. While investment income may distinguish the top 1% or 5%, employment income is still the biggest source of income for top 20%.

Though members of the top income quintile were least likely to receive public welfare assistance (less than one percent do), they were the most likely (8.2%) to receive other government transfers, such as veterans’ benefits, at a median rate of $13,200.

The older people in the lowest income quintile receive a median Social Security income of just $7,559, and only two-thirds receive it at all. Their next highest source of income for that group was public welfare, at a median of $6,000 for those who receive it. Interestingly, only 8.5% of the poorest older Americans reported receiving public welfare. Almost 10% received other types of government transfers, but their median income from that source was just $1,050 per year.

If Social Security vanished overnight, the top quintile of older Americans (income over more than about $43,000) might not miss it. It accounts for only about one-sixth of their income, according to the AARP data. But for all other older Americans, Social Security benefits represent between 45% and 86% of their incomes, on average.

The AARP data was for individuals, not couples or households. So, for some households, these income numbers could presumably be doubled.

The average and median benefit for the 36.4 million Americans ages 65+ who received Social Security in 2012 was only about $14,000 in 2012, according to AARP. The richest Americans ages 65 or older had a median income of $65,567. The income threshold for entrance to the top 20% was only $43,259. More than half (54.8%) of those in the highest income had earned income.

The AARP data doesn’t take into account the uneven dispersion of income throughout the U., or the possibility that the cost of living in low-income areas is much lower than in high-income areas. As everybody knows, it can cost a lot more to live in New York City than in rural Arkansas. In addition, many older people undoubtedly confine their needs and appetites to fit their income.

Below is a chart of income by county in the United States, provided by ArcGIS.com. The areas of darkest green have median household incomes of $82,000 or more, and a more likely to be urban. The areas of lightest brown have median incomes of $24,000 or less, and are more likely to be rural. To people who stay close to home and don’t visit a lot of different or distant zipcodes, the U.S. might appear more financially homogeneous than it actually is.

FINRA Talks a Good Game, Part II

Posted on January 3, 2014 by Kerry Pechter -

FINRA, the self-regulatory body for broker-dealers, has put its members on alert about not giving conflicted advice to people who are between jobs and aren’t sure whether to keep their money in an employer-sponsored plan or roll it over to an IRA.

The purpose of Regulatory Notice 13-45, FINRA said, “is to remind firms of their responsibilities when (1) recommending a rollover or transfer of assets in an employer-sponsored retirement plan to an Individual Retirement Account or (2) marketing IRAs and associated services.”

The notice, issued in late December, added that “The recommendation and marketing of IRA rollover will be an examination priority for FINRA in 2014.”

The regulators are evidently worried about 401(k) advisors encouraging people to move tax-deferred retirement savings out of the highly regulated institutional world of 401(k) plans to the less-restrictive retail world of IRAs.

The notice comes only two months after the release of FINRA’s Report on Conflicts of Interest, which surprised broker-dealers with its sudden focus on the ever-present potential conflict between their imperative to gather assets and their pledge not to recommend actions unsuitable for clients.

The notice also comes at a time when the broker-dealer world awaits the next version of the Department of Labor’s proposal to raise the standard of conduct to “fiduciary” from “suitability” for advisors who work with ERISA-regulated retirement plans.

Part of the problem is that some advisers and broker-dealer reps sell 401(k) plans and/or offer advice to participants as well as to retail investors. Indeed, some advisors rely on their work with 401(k) participants as a way to meet future retail clients. At retirement or when they change jobs and opt for a rollover, participants can become retail clients.

At the same time, the Department of Labor is clearly worried that 401(k) plans, like college football and basketball programs, can become tantamount to farm systems where accounts gain weight and experience before transferring to the pros, i.e., brokerage IRAs. Broker-dealers and their clients may see such a transition as a liberation of the money from ERISA restrictions, but the DoL sees it as a corruption of public policy because it could expose tax-deferred savings to higher volatility and expenses.

FINRA may feel caught between the government and the broker-dealers. In October, and again at the end of the December, it has put broker-dealers on notice not to allow advisors to violate the suitability standard when exploiting the IRA loophole, through which money moves from the employer-sponsored space to the retail space.

These notices might be FINRA’s way of telling the DoL that FINRA can make the suitability standard work, and that broker-dealers don’t need a DoL fiduciary standard to keep them from abusing the rollover process.

A Liquidity Option for DIAs?

Posted on January 2, 2014 by Kerry Pechter -

Deferred income annuities (DIAs) have been one of the surprise success stories of the post-crisis, low-interest era. The potential market might be larger, some life insurers say, if contract owners had more flexibility to cancel the policy and withdraw a lump sum.

But a number of regulatory hurdles, as well as some potential hurdles in product pricing and design, apparently stand in the way of such a change. Some of those legal hurdles were the topic of a presentation by New York Life attorney Judy Bartlett at the annual American Law Institute’s Continuing Legal Education Conference on Life Insurance Products, held last November at a hotel in Washington, D.C.’s Foggy Bottom section.

The conference attracted enough insurance industry attorneys from all over the U.S. to fill a large Marriott ballroom. Attorneys from Allstate, Ameriprise Financial, Midland National, Pacific Life, Prudential, TIAA-CREF and Transamerica, in addition to New York Life, served as panelists or presenters.

In addition, lawyers from the big Washington law firms that specialize in securities and insurance law, as well as regulators from FINRA, the Securities and Exchange Commission, the Department of Labor, walked, took the Metro or drove over from their nearby offices. State insurance commissioners from Pennsylvania and Missouri flew in.

For a day and a half, a series of discussions touched on two dozen or so major and minor legal controversies that currently vex the retirement industry, either directly or indirectly. Lawyers from two prominent Washington firms, Steve Roth of Sutherland Asbill & Brennan and Richard Choi of Jorden Burt, chaired the meeting.

The meeting gave visiting lawyers a chance to earn educational credits by learning more about issues both familiar and new. Familiar issues included, for instance, the summary prospectus for variable annuities, federal regulation of insurance products and preservation of tax-preferences for retirement and insurance products.

New issues included potential conflicts of interest in the design of managed-volatility funds, the transparency of fees for mutual fund sub-advisors, principles-based reserve requirements, and the recent flurry of decisions in “excessive fee” class action lawsuits. In short, the meeting was a cram course in the state of securities and insurance regulation. (The study materials were published by the ALI in a 1,000-page, phone book sized document.)

DIAs and the law

Of the topics covered at the conference, the regulatory status of deferred income annuities was of particular interest, given the sudden popularity of these products in the past two years. Eight or nine life insurers now offer DIAs, whose sales were expected to reach about $2 billion in 2013. The product’s lack of liquidity can be a deal-breaker for many potential buyers, however.

The latest DIA designs do offer some liquidity. There are death benefits during the deferral period, optional cash refunds or installment refunds of remaining principal if the annuitant dies, and the option to take several months’ payments as a lump sum. Some contracts allow owners to move their chosen income start date forward (i.e., shorten the pre-selected deferral period), if they decide they need income sooner than they thought they would.

But DIA owners can’t as a rule cancel their contracts and commute their future payments into a lump sum. Such a possibility wasn’t even considered by state regulators when they looked at DIAs in 2010. At the time, DIAs were understood to be marketed as “longevity insurance”—a heavily discounted, long-dated, no-cash-value, life-only product that would provide lifetime income only if and when a person reached age 85 or so.

Only about a year after those standards were developed, however, that product (which had so far been a non-starter, sales-wise) changed dramatically. Starting in mid-2011, New York Life tweaked the product and repositioned it as a personal pension, to be purchased at age 55 to 60 for retirement income starting as early as age 65 or 70.

To the surprise of many, sales quickly leapt to $100 million a month. They could be higher if there were a cancellation option for a period certain DIA, as there may be for a single-premium immediate annuity with a period certain. But this would require new proposals to the states or the state consortium, the IIPRC, which currently doesn’t allow the payment of a commuted value for a period certain DIA. It’s not clear whether proposals to change that have been made, will be made, or even considered.

(Adding a cancellation option in a life-contingent annuity doesn’t work, because the insurer would be vulnerable to the very real risk that sick people might disproportionately cash out, thus corrupting the mortality assumptions on which the prices and payout rates were based.)

If cashing-out were allowed during the deferral period of a DIA, it’s been suggested, taking income might become a secondary rather than primary characteristic of the product, and it wouldn’t be much different from an ordinary deferred annuity.

Another complication might arise, related to the regulatory status of a DIA. If the calculation of the commuted cash value was affected by interest rates, then the annuity owner might in effect be exposed to investment risk, which might prevent a DIA from being exempt from registration with the SEC.

As it stands, Bartlett pointed out in her presentation, DIAs aren’t as clearly exempt from SEC regulation as fixed indexed annuities (FIAs) are. Both SEC Rule 151 Safe Harbor and the Harkin Amendment to the Dodd-Frank law in 2010 specifically protected FIAs from SEC regulation but said nothing about the current designs of DIAs. FIAs with guaranteed lifetime income benefits compete with DIAs.

In sum, there are a variety of reasons why DIAs probably won’t be allowed to offer cash-out cancellation options and why life insurers won’t even try to change the regulations to make cash-outs easier. That might mean a smaller potential market for DIAs; it might also mean that the product will retain its integrity.

A Guide that Perplexes

Posted on January 2, 2014 by Kerry Pechter -

The National Association of Insurance Commissioners has just e-mailed me a copy of its new “Buyer’s Guide for Deferred Annuities: Fixed and Variable.” I read it through. Like many explanations of annuities, it was fairly awful.

If consumer-friendliness was one of NAIC’s objectives in publishing this guide, it fell short. It is a study in defense, not hospitality. I understand that years of attacks have put annuities on the defensive, but that’s all the more reason to try and change the tone of the conversation.

There were at least three points at which the average reader would surely have bailed out, if he or she even got that far. The first was right up front.

“An annuity is a contract with an insurance company.” Sadly, many texts about annuities begin exactly this way. You might as well describe marriage to teenagers as “a legal contract between two people of the same or opposite genders.”

How would I define annuities? As financial tools that people use to protect themselves and their savings against certain risks, including interest rate risk, stock market risk, the risk of retiring during a market slump, and/or the risk of outliving their savings, also known as longevity risk.

Next, I would have stopped reading when the author urged me to read the prospectus carefully. Everyone knows that prospectuses are written by lawyers for lawyers. The most complex annuities, fixed indexed annuities, don’t even come with prospectuses.

Finally, if still reading, I’d have stopped near the end of the document, where it says, “Don’t buy an annuity you don’t understand or that doesn’t seem right for you.” Who besides an actuary really understands annuities?

The “Questions You Should Ask” section reminded me of the suitability questionnaires that I used to be assigned to edit, but usually ended up rewriting completely out of sheer pity for the reader. On some level the reader looks at these questions and realizes he’s being asked to waive his rights to something.

But the main reason for my admittedly peevish reaction to this probably well-intended document is the way it is organized. It’s a recipe for confusion. It makes a mistake that people frequently make when writing about annuities.

As I learned when writing the outline for Annuities for Dummies, you only create a massive fog around annuities by trying to define a single product called “Annuities” and then compare and contrast the different “types.”

Annuities can be so unalike in their designs and purposes that putting them in a single box isn’t helpful. The differences are so numerous that they overwhelm the number of similarities. Pretty soon MEGO sets in.

It’s better, when trying to help people understand these odd-duck products, to handle each type separately—within the same document, but separately. Start with the readers’ own potential financial problems, and then show how each annuity can or can’t help solve that problem.

The explanations must begin and end with the consumer’s concerns, not with the compliance department’s. Otherwise you mystify more than you de-mystify. You leave people confused and mistrustful. As an industry, we’ve been describing annuities in the same cautious, legalistic, industry-centric way for years. To keep doing so doesn’t make much sense.

Stocks poised to keep rising in 2014: Fidelity

Posted on December 26, 2013 by Kerry Pechter -

A new report from Fidelity Investments, U.S. Corporate Earnings: A Key Driver of Equity Market Returns in 2014, asserts that the 2012-2013 bull market is sustainable for the following reasons:

Reasonable corporate profitability. The aggregate corporate return on equity (earnings relative to shareholders’ equity) for S&P 500 companies was 14.1% in the third quarter of 2013, slightly above the index’s 13.6% long-term average. From 1990 to 2013, the maximum trailing annual return on equity for the S&P 500 Index was 18.8%, while the minimum was 4.1%. Based on this measure, profitability for the U.S. equity market looks reasonable relative to history, and there is potential for further upside.

Overseas revenue is an increasing contributor to U.S. earnings. During the past decade, foreign sales have represented more than 40% of total revenues for S&P 500 companies, and the proportion has grown over this period. The growing global diversification of the revenue stream for U.S. companies could continue to provide a positive influence on earnings going forward, for two reasons. First, sales growth in some emerging market sectors continues to be higher than the growth in developed economies, in part due to the burgeoning middle class populations in such countries as China and India. In addition, if the recent economic stabilization in Europe and China continues, it would provide a backdrop supportive of higher future profit growth.

Prudent capital allocation policies. U.S. companies have been disciplined with their use of capital in recent years, and a continuation of this trend could support future earnings growth. In particular, merger and acquisition activity has been subdued, and overall capital expenditures as a percentage of sales have remained at a moderate level. Despite increased share buyback activity and dividend payouts, corporate cash balances are at elevated levels, providing managements with a cushion with which to further increase capital returns to shareholders.

Reasonable valuation. During the post-2008 period, the 106% upward move in stocks (through Sep. 30, 2013) has coincided with a 111% increase in corporate earnings. At the same time, U.S. economic conditions have been stable, if unremarkable; the nation’s nominal GDP growth has been 16% since the end of 2008. In December 1999, the equity market’s price-to-earnings (P/E) ratio using trailing earnings was 28.4, implying unsustainably high earnings growth. Comparatively, at the end of 2008, the S&P 500 Index’s aggregate trailing P/E ratio was only 18.2, below the historical average of 19.5. Today, the equity market’s valuation is still quite reasonable and somewhat below its long-term average, despite the market’s significant move during the past four-plus years — implying that investors generally expect a moderate level of earnings growth.

Allocations to TDFs continue to climb: EBRI and ICI

Posted on December 26, 2013 by Kerry Pechter -

At year-end 2012, 41% of 401(k) participants held target-date funds (TDFs), according to a report from the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI). That’s an increase from 39% in 2011 and 19% in 2006.

Assets in TDFs, which are qualified default investment alternatives (QDIAs) and suitable for automatically-enrolled participants, represented 15% of the total assets in the EBRI/ICI 401(k) database at the end of 2012, up from 13% in 2011 and 5% in 2006.

The findings are available in the report, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2012,” from EBRI and ICI. Other findings in the report were:

61% of 401(k) plan participants’ accounts were invested in equities at year-end 2012, either through equity funds, the equity portion of TDFs, the equity portion of non-TDF balanced funds, and company stock. Younger 401(k) plan participants had more than half their account assets in equities while participants in their 60s had less than half of theirs in equities.
Younger participants are more likely to hold TDFs and TDFs represent a much larger share of their 401(k) assets. At year-end 2012, 52% of 401(k) plan participants in their 20s were invested in TDFs, and those funds made up 34% of their 401(k) assets.
Nearly 54% of the account balances of recently hired participants in their 20s was invested in balanced funds, including TDFs, compared with about 7% in 1998.
21% of all 401(k) participants who were eligible for loans had loans outstanding against their 401(k) accounts at the end of 2012, unchanged from the prior three years (2009−2011), although slightly higher than before the 2008 financial crisis.
The average 401(k) participant account balance was $63,929 and the median account balance was $17,630 at the end of 2012. The variation reflected differences in age, tenure, salary, contribution rate, rollovers from other plans, asset allocation, withdrawals, loan activity, and employer match.
The average account balance among 401(k) plan participants in their 60s with more than 30 years of tenure was $224,287.

The full analysis is published in the December 2013 EBRI Issue Brief and ICI Research Perspective, online at www.ebri.org and www.ici.org/research/perspective. The 2012 EBRI/ICI database includes statistical information on 24 million 401(k) plan participants in 64,619 plans holding $1.536 trillion in assets, covering nearly half of the universe of 401(k) participants.

Nobelist Sharpe makes retirement income planning software available

Posted on December 26, 2013 by Kerry Pechter -

William Sharpe, the Nobel Prize winner and co-founder of Financial Engines, has been publishing a blog called RetirementIncomeScenarios. So far, the blog has provided followers with instructions on how to use software that Sharpe has created for income planning.

The blog started last August with Sharpe’s simple announcement: “This is a new blog on which I plan to post material on creating and analyzing ranges of scenarios for retirement income using different strategies for investing, spending and annuitizing retirement savings.”

In September, Sharpe explained that he’s using the Scratch programming language, created at MIT for non-professionals such as schoolchildren, to develop his suite of software tools. Apparently anyone, for free, can go to the Scratch website (scratch.mit.edu), create an account, and try to put Sharpe’s software to work.

“Here is my plan,” he wrote on September 17: “I will start with an overall structure that allows me to add features as items on a menu. The first release will have only one such feature (a “longevity graph”). Subsequent releases will add other features, all related in some manner to the forecasting and analysis of retirement income scenarios. I invite you to try the programs. Together we will see how far this undertaking can go.”

We’ll keep you posted on the progress of Sharpe’s endeavor. Thanks to Wade Pfau for alerting us to the new blog, and to Dr. Sharpe for creating it.

Inflation-Proof Retirement Income

Posted on December 25, 2013 by Kerry Pechter -

Building bond ladders for retirement income is an important but understudied topic. Especially as we are at a point in time when many are worried about future interest rate increases, bond mutual funds will lose value as rates rise, while a bond ladder will still provide the desired income at the bond maturity dates no matter what happens with interest rates. This potentially suggests, to the extent that one is worried about future rate increases, that today’s retirees could be better off by building a bond ladder for their desired bond allocation rather than holding bond mutual funds.

I’m now working on a column for Advisor Perspectives in which I review existing knowledge (preview: the best work I’ve seen comes from the Asset Dedication team of Stephen Huxley and J. Brent Burns) and also investigate how long one might want their bond ladder to be. For that, I will be using Treasury Strips. In that column I will not be getting too much into the details of how to actually construct a bond ladder for retirement income. The purpose of this post is to explain how to build a ladder of TIPS to provide retirement income.

The difference between bond ladders as they are usually discussed and a bond ladder for retirement income, is that with retirement income the idea is to spend the income thrown off by the ladder each year. This means that you set up the bond ladder to generate the amount of planned income you desire. With a traditional bond ladder, you wouldn’t spend the income, but reinvest it to lengthen the bond ladder. With bond ladders for retirement income, you would generally lengthen the bond ladder using other resources, such as stock investments, rather than using the income provided by the bond ladder.

For anyone actually seeking to build a bond ladder with TIPS, I highly recommend Harry Sit’s book, Explore TIPS. He provides all the details needed to actually go out and buy TIPS. My discussion here is more technical in the sense that I’m explaining what you would need to buy, but I’m not getting into the mechanics of how you would actually go about making those purchases (opening a brokerage account, etc.).

I’m getting the raw data for this explanation from the Wall Street Journal‘s Market Data Center. They provide a daily report of wholesale prices from the secondary markets for all of the outstanding TIPS issues. [Note: one of the issues that Harry’s book explores is how household investors will need to pay a mark-up above these prices, so building the bond ladder could cost a couple percentage points more than the prices I’m reporting]. This is the data available for December 18, 2013:

There are a lot of details to note from this data. First, though the Treasury is again issuing 30-year TIPS such that we can find maturities out until 2043, they had stopped that for a period, and there are no TIPS maturing in 2024, 2030-31, and 2033-2039. This actually complicates things a bit. If we try to build a 30-year bond ladder, we need to make assumptions for what to do about the missing years. The common assumption I’ve observed is that one buys more of the TIPS for the later available maturity date and assumes they can be sold off at their accrued value at the earlier date assuming that there are no changes in interest rates until that time. For example, to cover 2024, one buys more of the 2025 issue and then sells it in 2024 to get the income desired for 2024.

This does leave someone exposed to interest rate risk: if rates rise, the income they will receive from selling their TIPS early will be less than otherwise. But it’s the best we can do within the constraint that we are only using TIPS. Strips do provide a work-around for this issue, since one can get stripped coupon payments for years when no bonds mature, but they do not provide inflation protection. The general benefit of building a bond ladder for retirement income is that when you hold the bonds to their maturity dates, you know exactly how much you are going to get.

Next, we need to know what all of these columns are:

Maturity is the maturity date when principal and the final coupon payment is provided.

Coupon is the coupon rate paid by the TIPS. This is one of the most confusing aspects of bonds for people to understand. When the bond is issued, it pays a set coupon rate. For a regular Treasury bond, if the coupon rate is 2% and then face value is $1000, then the bond pays coupons of $20 per year. Usually these are paid semi-annually. Two coupon payments of $10 in this case. Note: the coupon rate NEVER changes. Interest rates can change. But that will affect the yield, not the coupon rate. If interest rates rise, then the price that the bond can be sold at will decrease, raising the underlying yield to maturity to match t he increasing interest rate. But if I buy a $1000 face value bond on the secondary market for only $700 and it has a 2% coupon, it is important to understand that my coupon income will be based on 2% of $1000, not 2% of $700. Though this may seem basic and simple as I explain it, I assure you that this can be a huge source of confusion.

Next are the bid and asked columns. Bid is the price TIPS can be sold for, and Asked is the price they can be purchased for… in the wholesale market. The difference in prices is the spread made by the party helping to conduct the exchanges between buyers and sellers. Again, household investors will experience lower bids and higher asked than reported here as they are not participating directly on the wholesale market. For these prices, they are referenced in terms of face values of $100, though bonds usually have face values of $1000.

The Chg column is just how much change there was in the asked price since the previous day.

Next, the yield is the yield to maturity based on the asked price. This is the return that the investor would get for buying the bond today and holding it to maturity. If the Asked price is 100, then the yield would be the same as the coupon. If the asked price is above 100, then the yield will be less than the coupon, and if the asked price is below 100, then the yield will be higher than the coupon.

Why? This gets back to the point I was stressing before about how the coupon never changes. The bond provides a promise for a fixed set of payments. It pays all of the fixed coupon amounts and it repays the face value at the maturity date. These payments NEVER change. But bonds can be sold and resold on secondary markets prior to the maturity date. If I pay $900 for a bond providing a fixed set of promised payments, then I’m going to get a higher return on my $900 investment than if I paid $1,100 for the same set of promised payments. So lower asking prices imply higher yields, and vice versa. Note that these yields are expressed in real terms for TIPS.

That final point brings us to the final column: Accrued Principal. This is a unique term for TIPS. The accrued principal is the inflation-adjusted principal since the TIPS was issued. The special points about TIPS are that the coupon rate is actually paid on the accrued principal, not the nominal initial $1000 principal. As well, at the maturity date, the investor receives the accrued principal back, not the nominal $1000. This is how the inflation adjustments are incorporated: a real coupon rate is paid on an inflation-adjusted amount and and inflation-adjusted amount is returned at the maturity date.

Another point about this data. If I was constructing it, I would have made one difference. The ask price is in terms of 100, but when you purchase the TIPS, you have to pay in terms of the accrued principal, not in terms of 100. The way I would have presented the asked price in that table is:

“Actual” Asked Price = [Asked] x [Accrued Principal] / 1000

And one final point about this data. Coupon payments are made every 6 months. When you buy the TIPS, you also have to pay any interest that the previous owner would have earned since the last coupon payment up until the data they sold it to you. I believe this is what really throws off the pricing for the TIPS maturing on January 15, 2014. The Yield is artificially high by quite a bit because the purchaser is going to also have to pay about 5/6 of the coupon payment to the previous owner (which, for review, would be 0.5 x 2% x $1265 = $12.65). There is just a month left until maturity.

When I construct my bond ladder below, I will ignore this “accrued interest” problem because it is a rather minor issue, but it does affect that 2014 TIPS a lot. My bond ladder will use the first available TIPS maturing in each year except for 2014. In this case, I use the TIPS maturing in July 2014. Based on what I just wrote, this is the yield curve I have available for constructing the TIPS ladder for retirement income.

Now we are ready to actually construct the bond ladder and determine its cost. To do this, we work backwards. One more simplification I am now going to make to reduce the complexity of the explanations is to assume that coupons are paid only once per year rather than twice per year. I’m also going to assume we can buy fractions of bonds, when in reality we can only get as close as possible to our income goal in increments of $1,000, since fractions of bonds cannot be bought and sold.

Let’s construct a ladder to provide $10,000 of inflation-adjusted income for 30 years between 2014 and 2043. Starting at 2043, we need to buy enough shares of TIPS to give us $10,000 of inflation-adjusted income that year. This involves buying the TIPS maturing in 2043, which has a coupon of 0.625%, an asking price of 77.14, a yield of 1.596%, and accrued principal of $1016. The accrued asking price is this $783.74 out of $1000. In real terms based on today’s accrued principal, and with my simplification that only one coupon payment is made per year instead of 2, on Feb. 15, 2043, this bond will pay 1016 x (1 + 0.00625) = 1,022.35 in interest and principal. We want an income of $10,000. So we need to buy 10000/1022.35 = 9.78 shares.

Given the wholesale accrued asking price, these shares cost us 9.78 x 783.74 = $7,664.98. Actually, these numbers have been rounded. In my computer, the precise cost without rounding is $7,666.09. In other words, paying $7,666.09 today entitles you to $10,000 of REAL income on Feb. 15, 2043. The amount you actually receive on that date in nominal terms will actually be larger to the extent that we experience inflation over the next 30 years.

Now we move to 2042. We want $10,000 of real income for that year too. The trick is that we have to account for the fact that the 2043 maturing TIPS we just purchased is going to give us coupon payments of 9.78 shares x 0.625% coupons x 1,020 accrued value = $62.11 of income in every year for years 1-29 as well. So we can subtract that from what we need to purchase. We need to buy enough 2042 bonds to provide real income of $9937.89 in 2042.

And so this process goes, working backward to 2014. Actually, for 2014, we will have $4280.32 of real income coming from all of the coupons for bonds we purchased which are maturing between 2015-2043. So we only need to purchase enough 2014-maturing bonds to get $5719.68.

That is the logic behind the following table, which shows our menus of purchases to obtain a 30-year TIPS ladder.

Now for some final comments on this table. Note that the cost of building a 30-year TIPS ladder providing $10,000 of annual real income is $247,588.14. This is scalable. If you want $50,000 of real income, the cost is 5 times greater ($1.24 million), etc. Also, this is an approximation due to some simplifying assumptions I’ve listed throughout the post. Note that this cost with regard to the $10,000 income represents a 4.04% withdrawal rate.

With the bond ladder, nothing will be left at the end of the 30th year though. Actually, interest rates have been rising in recent months, and 4.04% is currently the payout rate on an inflation-adjusted SPIA for a 65-year old couple with joint and 100% survival benefits. Also, for what it’s worth, the implied return on the $247k to get these cash payments is 1.29% in real terms. That’s the current “riskless” rate of return for 30 years of retirement income. There is still longevity risk though.

Seven Wishes for the Year Ahead

Posted on December 25, 2013 by Kerry Pechter -

The earth has circled the sun again and, without stopping for breath, has begun yet another lonely lap around the solar stadium. The solstice is past; a pale new year awaits. What will happen in the retirement industry in 2014? Beats me. But I hope that:

Someone will engineer a plan to stabilize Social Security. We need to solve the Social Security question soon, and not by shrinking the program. Young people need their confidence in it restored. Older people need to appreciate that it protects them against sequence of returns risk, which is to say that, unlike the markets, it prevents the division of neighbors into retirement winners and losers.

Interest rates will rise without toppling equity prices. A decade ago, Alan Greenspan played a game of Jenga with the short-term rate, raising it in quarter-point increments. The strategy worked for a while, but eventually the stock market tumbled like a tower of Jenga blocks. Maybe we’ve learned a lesson or two since then. Good luck, Chairman Yellen!

The Department of Labor issues a sagacious re-proposal of the fiduciary rule. Granted, mandating a fiduciary standard for all financial intermediaries seems a bit quixotic. But it does seem reasonable to me that more of the ERISA restrictions and protections that apply to 401(k) money should follow that money when it rolls over to an IRA, and/or for as long as it continues to grow tax-deferred.

Employers start contributing more money to their employees’ retirement accounts. I once worked for a company that contributed 10% of pay to employees’ 401(k) plans and matched a chunk of the employee contributions. If plan sponsors are concerned about their employees’ retirement security, they need to try this—even if means carving some or all of the contribution out of take-home pay. Nudges and calculators aren’t enough.

Deferred income annuities find their way into 401(k) plans. Participants need the option of allocating at least part of their contributions to an account that will produce guaranteed income 10, 15 or 20 years hence. It’s unrealistic to expect many people to buy annuities at retirement; the loss of liquidity is too drastic and interest rate risk is too high.

The public-pension funding crisis gets resolved in a non-divisive way. The current crisis is a symptom of the 2008 crash, low interest rates and the erosion of the tax bases of America’s towns and cities. It’s a shame to see retired firefighters, bus drivers and policemen ridiculed for expecting to receive the pensions they legally bargained for.

Americans elect smarter politicians in the 2014 elections. We need fewer hacks and ideologues, and more men and women with the brains, courage, and large-mindedness necessary to collaborate on wise, far-sighted solutions to our problems, including our retirement problems. Too many elected officials seem to know almost nothing about the way our financial system works (and even less about how insurance works).

Recent winners and losers

Part II: The Future

Data Connection

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