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Fidelity the target of new lawsuits over float income in 401(k) plans

Posted on March 14, 2013 by Editor Test -

A putative Class Action Complaint was filed in the United States District Court for the District of Massachusetts last week, accusing Fidelity Management and Trust Company and others of fiduciary breaches over its handling of float income, according to press reports.

The suit was filed by participants in 401(k) plans from Bank of America, EMC Corp. and Safety Insurance Co., and it contains similar allegations to another suit, filed in the Boston federal court February 5, by current or former participants of plans from Hewlett-Packard Co., Delta Air Lines Inc. and Avanade Inc., a subsidiary of Accenture.

The February 5 suit was filed for Timothy Kelley (an ex-participant in the Avanade and Hewlett-Packard 401(k) plans) and Jamie Fine (a participant in the Delta 401(k) plan), but class action status is being sought on behalf of all Fidelity 401(k) participants, not just participants in the Avanade, Delta and HP plans.

According to the February 5 complaint:

Fidelity caused certain of the Plans’ assets to be deposited on an interim basis in interest-bearing accounts before it invested or disbursed monies as directed by the Plans’ participants. Income earned on or derived from the Plans’ assets while invested in such accounts is “float income.” The float income was an asset of the Plans under ERISA. Fidelity exercised discretion and control over the investment of the Plans’ assets in such accounts and over the collection and allocation of float income. Accordingly, Fidelity was a fiduciary for the Plans with respect to the float income. As a fiduciary, Fidelity was prohibited from dealing with the float income for itself or for the benefit of another and was required to deal with that float income with prudence and unflagging loyalty. Fidelity did not. Instead, it engaged in prohibited transactions and breached its fiduciary duty in two distinct ways.

First, Fidelity used float income to pay itself trust and record-keeping fees above and beyond the fees authorized in the trust agreements between the Plans and Fidelity. Thus, Fidelity engaged in repeated self-dealing transactions and breaches of duty in violation of § 406 and § 404 of ERISA whenever it paid itself float income.

Second, Fidelity remitted float income into the mutual fund options selected by the Plans’ participants without crediting the amount of that float income to the contributions made by Plans or the Plans’ participants. This had the effect of disseminating the value of the float income generated by the Plans’ assets to all of the investors in the mutual fund, and substantially diluting the value of the float income received by the Plans and the Plans’ participants. Thus, Fidelity engaged in repeated transactions for the benefit of others and breaches of duty in violation of § 406 and § 404 of ERISA whenever it invested float income into its mutual funds.

Both float-income suits refer to a March 2012 opinion of a judge in U.S. District Court in Kansas City, Mo., in a lawsuit by plan participants against ABB Inc., Cary, N.C., and Fidelity. The judge ruled that Fidelity had “breached its fiduciary duties” in the use of float income, and ordered Fidelity to pay the plan $1.7 million. Fidelity is appealing the decision.

“Our practices are in compliance with ERISA and DOL guidelines,” Jennifer Engle, a Fidelity spokeswoman, told Pensions & Investments magazine. “We believe that the practices described in the lawsuit are consistent with the law and fair to all parties and that we provide valuable services to 401(k) clients for whom Fidelity serves as a record keeper and trustee.”

When the Empire Didn’t Strike Back

Posted on March 14, 2013 by Martin Hutchinson -

Benn Steil’s excellent new study The Battle of Bretton Woods (Princeton, 2013) focuses on the 1944 global monetary conference as a struggle between its two principal protagonists, the U.S. Treasury’s Harry Dexter White, and Britain’s celebrity economist, Maynard Lord Keynes.

Even Steil, an American who has considerable sympathy with Keynes, is quite clear that he lost, playing a bad hand poorly. To this British-born columnist with less sympathy for Keynes’ bizarre economic beliefs, his Bretton Woods performance was not merely a defeat, it was a historic disaster.

Britain went into the Bretton Woods negotiations with an unfounded belief in the goodwill of Franklin Roosevelt’s administration. Churchill had, a few years earlier, described the U.S. Lend-Lease arrangements as “the most unsordid act in the whole of recorded history.”

In reality the Lend-Lease arrangements of 1940-41 were designed to leave Britain as close to insolvency as possible while she wore out her economy and people in a life-and-death struggle that had little relevance to particular British interests.

Keynes himself had been notably uninvolved in the British economic successes of the 1930s, but had been brought back into influence only at the outbreak of war, when Chamberlain’s pacific free-market approach to Britain’s needs seemed discredited.

He was philosophically opposed to the centerpiece of British 1930s policy, the Imperial Preference agreements of 1932, which had finally ended the unilateral trade disarmament of 1846-1932 and imposed a modest 10% tariff on imports to the Empire and Dominions to combat the tariffs of 50% and more imposed by Britain’s trading partners, notably the United States under the 1930 Smoot-Hawley tariff.

Keynes was also philosophically opposed to private-sector bankers, refusing to negotiate a possible post-war loan with Wall Street, which would have greatly increased his bargaining power at Bretton Woods. He apparently failed to perceive that Britain’s interests coincided in many respects with Wall Street’s, since both groups wanted to avoid a post-war financial system dominated by the public sector bureaucrats of Washington.

Finally, Keynes was opposed to the pre-World War I Gold Standard, and also to a floating exchange rate system, typically wanting a system in which exchange rates would be determined by a superior group of public sector mandarins. He also favored a new currency, “bancor,” which the mandarins could create through the IMF, which would prevent a repeat of the deflation of the 1930s.

On the American side, White (who we now know was an active Soviet agent) and his boss Treasury Secretary Henry Morgenthau were convinced that much of the U.S. misery in the 1930s had been due to British and French “competitive devaluation,” so they were determined to establish a system of fixed exchange rates.

White (who was unpleasant and intellectually misguided, but not corrupt) also believed that the Soviet economic system was the wave of the future, to which we were all converging – perhaps not as lunatic a belief in the middle of World War II as it seems today – and so was determined to help that convergence along as far as he could.

He therefore wanted Imperial Preference dismantled, a fixed gold/dollar exchange rate system that gave the U.S. dollar primacy as the only reserve currency, and a World Bank/IMF that could lend money but not create it. He opposed Keynes’ “bancor,” since that would weaken the position of the dollar and effectively act as a hidden subsidy from the U.S. (the only fully solvent economy) to everyone else.

A negotiator with Britain’s true economic interests at heart would not have allowed chimerical new schemes of international finance to dominate the conference, but would have focused on Britain’s three crucial interests:

The preservation of Imperial Preference
The largest possible post-war loan
Permission for an immediate sterling devaluation similar to the 30% fall which became inevitable in 1949

Imperial Preference had proved its value in the 1930s, in allowing a modest reciprocal arrangement against the still gigantic American tariffs, so that British manufacturers had a chance in Empire, Dominion and later Commonwealth markets of competing against U.S. products that had built huge efficiencies of scale behind their high tariff wall.

Britain would have had its own free-trade area that was well designed to balance its raw-material-poor manufacturing and service economy. Joining the European Economic Community would have been superfluous and indeed obviously economically counterproductive.

When Keynes came to focus on Britain’s postwar loan, in 1945, he concentrated fanatically on the interest rate, demanding an interest-free loan instead of the 50 years at 2% that was on offer. In consequence he obtained a loan of only $3.5 billion instead of the $5 billion Britain needed—with conditionality of restoring full convertibility of sterling in July 1947, an impossibly early date.

A better negotiator would have opened negotiations with Wall Street, securing a $5 billion commitment, which appeared to be available, and then negotiated with the U.S. Treasury only for a top-up, sufficient to carry Britain through to 1950 or so, when private markets would be functioning properly again.

Finally, since both sides were determined to abandon a true gold standard (because of its automaticity and deflationary nature), Keynes should have pressed for floating exchange rates (which Britain almost introduced in 1952 by the “Robot” scheme, but alas wimped out of). At a minimum a good negotiator would have insisted on a 1949-style devaluation immediately.

As for the World Bank and IMF, a good negotiator would have avoided setting up these useless bodies altogether. Without (until 1968 with Special Drawing Rights) the ability to create Keynes’ bancor, they did nothing useful to solve Britain’s dollar shortage problem in the post-war years.

Moreover, once they got going they provided and have continued to provide subsidized competition to London merchant banks, which in the pre-1914 Gold Standard world had made a very good business out of providing advice and arranging loans for the world’s emerging markets.

With sterling freely convertible at a floating exchange rate after, say, 1950 there was no reason why the merchant banks could not have resumed this business, driving out their domestically-oriented and undercapitalized U.S. cousins who had gained a position in the business in the 1920s.

The merchant banks would have had a much larger fee income, and would thereby have been saved from the depredations of the 1986 “Big Bang” while emerging markets would have received advice that helped rather than hindered their development—and far fewer opportunities for the local elites to siphon off loan monies.

The drawbacks of Keynes’ approach were recognized by clear thinkers at the time. Leo Amery, Secretary of State for India, wrote in a Cabinet memo: “We must be free to take whatever measures we think necessary to the safeguard of our own production, to develop Imperial Preference, to use our bargaining power with foreign countries, and to strengthen that wonderful monetary instrument the sterling system. We must enter into no international commitments which in any way limit that freedom.”

White and Morgenthau became notorious in 1944-45 by their “Morgenthau Plan” which would have stripped Germany of industry, thereby leaving Soviet tanks a clear run to the Channel ports. They didn’t get to implement that one—but by the Bretton Woods Agreement, with the aid of the vain and foolish Keynes, they did just about as much damage to the British economy, damage that lasted until exchange controls were lifted in the early days of Margaret Thatcher.

Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005). This article appeared unabridged at prudentbear.com.

Distribution of Wealth in the U.S.

Posted on March 13, 2013 by Editor Test -

Where the Wealth Is

Posted on March 13, 2013 by Kerry Pechter -

Despite the fines they’ve paid, their high fees and their resistance to a fiduciary standard, the so-called wirehouses—Merrill Lynch, Morgan Stanley, Wells Fargo, UBS, etc.—still control the lion’s share of professionally managed wealth in the U.S.

While employing only about 16.3% of all advisers and brokers, the wirehouses direct the investment of about 41.1% of the $27.3 trillion that’s “addressable” by advisors in the U.S. according to the latest report from Boston-based Cerulli Associates.

Asset managers—including mutual fund manufacturers—must therefore include wirehouses in their distribution strategies, even though, as Cerulli notes, they “have raised the cost of doing business through higher platform placement fees and more expensive revenue sharing agreements.”

That situation is changing, but only at the margins, said the proprietary report, titled, “The State of U.S. Retail and Institutional Asset Management 2012.” Wirehouse assets shrank by 0.3% from 2011 to 2012, as many advisors fled or got laid off in the wake of the financial crisis, taking some of their clients along.

Components of U.S. Asset Market

(Investment vehicles with the most assets, with highest dollar amount at the top)

Institutional separate accounts

Open-end mutual funds

Money markets

Hedge funds

Collective trust funds

ETFs

Subadvisory: Mutual funds

Fixed annuities

Variable insurance trusts

Subadvisory: Retail separate accounts

Closed-end mutual funds

Open program retail separate accounts

Non-traded REITs

Model retail separate accounts

ETNs

Source: Cerulli Quantitative Update: The State of U.S. Retail and Institutional Asset Management 2012.

Where are they going? The advisor-distribution channels that grew the most in 2012 were the RIA (Registered Investment Advisor) channel (assets up 14.7%) and the overlapping “dually registered” channel (up 19.1%), whose advisors are both FINRA-registered brokers and SEC-registered investment advisors. But those two channels combined handle only about 20.1% of total AUM and 14.9% of advisors, according to Cerulli, and they’re highly fragmented.

State the financial union

The main point of the Cerulli report is to show the size and strength of the various advisor-led distribution channels. “The report is meant to be a ‘state of the union’ of domestic markets,” its author, Cerulli associate director Tyler Cloherty told RIJ this week.

“Asset managers are asking, ‘What are our distribution options? How large are they? Are they growing or shrinking?’ We’ve seen that the RIA and the dually-registered advisor channel are growing faster than any other part of the market,” he said. “So asset managers might want to tailor their products to the needs of those two segments of the distribution marketplace,” he added.

But the proprietary report—RIJ saw only excerpts—offers a detailed snapshot of the institutions and the products where most of America’s investments are held. (Cerulli estimates that U.S. invested assets may be worth as much as $36 trillion, with only about three-quarters of that “addressable” by asset managers and advisors.)

According to the Flow of Funds Accounts of the U.S., March 7, 2013, personal financial assets in the U.S. at the end of 2012 was $50.13 trillion, and “household net worth—the difference between the value of households’ assets and liabilities—was about $66.0 trillion at the end of the fourth quarter of 2012, $1.1 trillion more than at the end of the third quarter.”

That wealth isn’t evenly distributed. According to “An Analysis of the Distribution of Wealth Across Households,” a July 17, 2012 report by the Congressional Research Service, 34% is in the hands of the richest one percent of Americans and the richest 10% hold almost three-quarters of it.

“The share of wealth held by the top 10% of wealth owners grew from 67.2% in 1989 to 74.5% in 2010. Declines occurred in the remaining 90% of households. The share of total net worth owned by households in the 50th to 90th percentile of the wealth distribution fell from 29.9% in 1989 to 24.3% in 2010, and the share of households in the bottom half fell from 3.0% to 1.1%,” the report said.

The Cerulli report also looked at how U.S. financial wealth is divided among different investment products. Institutional separate accounts and open-end mutual funds are the by far two biggest categories, with about $13.8 trillion between them. Both saw minor asset shrinkage in 2012 after three years of double-digit growth.

The two fastest-growing categories in 2012 were “model retail separate accounts” and “open program separate accounts, but both started from a very low base compared with open-end mutual funds and institutional separate accounts.

One of the main takeaways from the Cerulli report: Asset managers need to fine-tune their sales approach if they want to shift some of their resources from the wirehouse advisors to the RIAs and dually-registered advisors.

“These advisors operate their own independent practices,” Cloherty told RIJ. “They don’t have as much institutional support as an advisor at a wirehouse like UBS or Merrill Lynch. To get that kind of technology or research support they have to buy it themselves. Consequently, they may need more support from their asset manager partners in terms of macroeconomic research or marketing support.”

A change in pitch

The shift from wirehouse to RIAs and dually-registered advisors also involves a shift from the suitability standard to the fiduciary standard, and that has an impact on how asset managers and their wholesalers make their pitches.

“The asset managers are all moving toward the consultant approach, where they frame the macroeconomic environment and show try to show their customers where their product fits into their strategic outlook. It’s distinct from the commission-based formula where you say, ‘Here’s the product, buy our product,’” Cloherty said.

“In the fee-based arena, the salesperson or wholesaler needs more quantitative ability. He or she needs to move away from the mindset of, ‘I need to create sale activity.’ Now that intermediary is an advisor and a fiduciary.”

Despite their bad publicity and high fees, the wirehouses still have a grip on investors because of their strong brands and long-term relationships with clients, Cloherty pointed out. The wirehouses also benefit from the fact that most clients don’t understand how advisors get paid or what ethical standards they observe.

“Clients tend to separate their relationships with their advisors from their opinions about the firm. A client might say, ‘I’ve read about XYZ wirehouse acting in ethically dubious ways. But I know my advisor down at the local office would never do anything that wasn’t in my interest,’” he told RIJ.

“People don’t understand the difference between a fiduciary or a suitability standard. Clients have no idea how their advisors are compensated. They don’t understand how the firm’s proprietary products might harm them, and they don’t understand the pressure on wirehouse advisors to push the products that the wirehouse underwrites.

The link between underwriting and the suitability standard is strong. “That’s why you see so much lobbying against the fiduciary standard. It would blow up the way [the wirehouses] do business,” Cloherty said.

“The wirehouses still have brand recognition, but they are under pressure. Some of the clients are drifting away because they see the firms’ names in the paper every day. A bigger factor is that advisors are leaving the wirehouses because they don’t like forcing products down people’s throats.”

But the confusion about ethical standards apparently doesn’t end there, Cloherty added. “As advisors leave the wirehouses and move to the independent channel, they tell their client, I’m a fiduciary now. The client says, ‘I thought you were always a fiduciary.’”

More chatter about ‘defined ambition’ plans in the UK

Posted on March 7, 2013 by Editor Test -

The UK’s pension minister, who has proposed a “defined ambition” approach to retirement funding that would spread longevity and investment risk among plan providers and plan participants, says the private sector might need public help in underwriting the guarantees that such plans would entail.

Speaking at a joint OECD/Pension Institute conference on defined contribution, Steve Webb said that a government-backed DC protection fund could be the best way to allow for cheap guarantees due to the “challenges” posed by the solvency requirements for private sector approaches.

“If we are going to have financial guarantees, they have got to be backed,” Webb told a joint OECD/Pensions Institute conference on DC, guarantees and risk sharing yesterday. “Backing through solvency is very, very expensive.”

He said individual banks had discussed with his department how best to achieve guarantees and that the Department for Work & Pensions (DWP) had been examining both the possibility of private and quasi-government solutions – the latter of which, he said, were potentially more able to provide security “cheaply.”

Speaking at the same event, the chairman of the National Employment Savings Trust (NEST) Lawrence Churchill praised the proposed DC Pension Protection Fund (PPF), which Webb has described as a “smoothing fund” for participant outcomes.

He appeared to view greater risk sharing as a possible route, telling attendees: “We do need a better solution than merely transferring all of that risk onto those who don’t understand it.”

But Tim Jones, chief executive of NEST, noted that NEST had considered introducing a level of guarantee, but decided against it. He appeared to favor higher contributions by members rather than guarantees. He said it was important for “people to put more money in and to put that extra money to harder work.”

Cerulli surveys global DC trends

Posted on March 7, 2013 by Editor Test -

Global defined contribution (DC) assets should reach US$13.7 trillion by 2016, according to the latest report from Cerulli Associates. By then, Australia will be the third-largest market after the United States and the United Kingdom.

In other Cerulli findings:

The United Kingdom is the only market with assets in excess of US$1 trillion that is expected to have double-digit growth. Asia ex-Japan shows immense potential with Korea and Taiwan registering the strongest growth rates across the region. China, Hong Kong, and Thailand are expected to grow more than 10%.

Europe has the greatest immediate potential for growth. The region is forecast to have more than US$6.8 billion in assets under management in 2013. The United Kingdom and the Netherlands have the greatest potential, but Poland also offers huge opportunities. Managers can tap growth in disparate markets, but local knowledge, language skills, and after-sales service are needed to access the addressable assets. While it is possible to identify common themes, much also depends on a country’s regulatory environment and investment heritage.

“Performance is considered an important attribute by most European trustees and consultants, but low fees act as a trump card in competitive tenders in Italy,” says Barbara Wall, director at Cerulli Associates. “In Germany it is steadiness of returns and a coherent investment strategy that win. In the Netherlands and the Nordic region expertise in proven alpha niches is a competitive advantage, whereas in France it is an association with an insurance company that holds sway.”

In other findings:

In the United States, United Kingdom, and Latin America, consultants are the most important gatekeepers. In contrast, their role is less significant in Asia and continental Europe, where banks and insurance companies are the primary gatekeepers. Auto-enrollment in the United Kingdom opens the door to platforms, which will be particularly appealing to employers keen to outsource complex and time-consuming processes.
In the United States, as income from defined benefit schemes dwindles, consultants’ interests in DC plans clashes with retirement specialist advisors. Advisors are moving up-market from small plans and have developed fee-for-service models. Cerulli research indicates that there are more than 3,000 specialist advisors in the United States, of which about 600 teams demonstrate consultant-like characteristics. Opportunities for consultants in Brazil, meanwhile, are likely to mushroom as rules on international investing are liberalized.
Pressure on fees is one trend that is close to being universal. Most of the investors polled in the Nordic region, the United Kingdom, and the Netherlands told Cerulli the crisis has prompted them to negotiate fees more vigorously. These same interviewees also said they were prepared to share extra returns with managers who could deliver stable performance. Continuity in returns was the common requirement and a key to new business.

US at rear of peloton in retirement security: Natixis

Posted on March 7, 2013 by Editor Test -

The United States ranks 19th worldwide in the retirement security of its citizens, according to a new annual index compiled by Natixis Global Asset Management (NGAM), the world’s 13^th largest investment management firm.

The Natixis Global Retirement Index gauges how well retired citizens live in 150 nations, based on measures of health, material wellbeing, finances and other factors. The study was released today by the NGAM Durable Portfolio Research Center, which conducts research on risk management, asset allocation and other investment issues.

Though the U.S. is the world’s biggest pension market, it lags behind less-affluent nations on measures of income and health, according to the index. While the U.S. leads the world in per-capita health spending, individuals are still responsible for a portion of this expense.

Western European nations with universal health care and retiree social programs dominate the top of the rankings, taking the first 10 spots. Norway is first overall, followed by Switzerland, Luxembourg, Sweden and Austria. Australia is the highest-ranked non-European country, followed by Israel and Canada. The U.S. finished ahead of the United Kingdom, but trailed the Czech Republic and Slovakia.

Demographic challenges
Like many other nations, the U.S. is grappling with significant demographic change, including a rapidly aging population, rising life expectancy rates and declining birth rates. Globally, the number of people aged 65 or older is on track to triple by 2050, when the ratio of the working-age population to those over 65 in the U.S. is expected to drop from 5-to-1 to 2.8-to-1.

According to a recent Senate report, the U.S. faces a retirement savings deficit of $6.6 trillion, or nearly $57,000 per household. As a result, 53% of American workers 30 and older may be unprepared for retirement, up significantly from 38% in 2011.

Only half of all workers have access to employer-sponsored plans, and those who do participate often make the common mistakes of saving too little or investing too much in lower-returning products.

The Natixis Global Retirement Index is a composite index that combines 20 indicators grouped into four major categories: health; material well-being; quality of life in retirement; and finances.

CoreData Research, a London-based financial research firm, captured data from a variety of sources, calculated a mean score in each category and combined the category scores for a final overall ranking of 150 nations.

The categories, and the subjects they comprise, are:

Health: Per-capita health spending, life expectancy, the availability of physicians and hospital beds per 1,000 citizens, and the level of noninsured health spending. (Sources: World Bank’s Development Indicators, 2012; World Health Organization)
Material well-being: Per-capita income, income inequality and unemployment. (Source: World Bank)
Finances: Old-age dependency (the ratio of retirees to workers), inflation, interest rates, taxation level and bank nonperforming loans. (Sources: World Bank, United Nations)
Quality of life: The level of happiness and satisfaction of citizens, as well as the quality of the climate and environment. (Sources: Gallup World Poll 2012; Environmental Performance Index 2012)

New FIA from ING U.S. offers living benefit and deferral bonuses

Posted on March 7, 2013 by Editor Test -

ING U.S. has launched the ING Lifetime Income single premium deferred fixed annuity, issued by ING USA Annuity and Life Insurance Company (ING USA).

ING U.S. currently offers an in-plan guaranteed income investment option for 401(k) participants as well as a series of retirement income planning and education resources for ING Financial Partners’ financial advisors.

“ING USA’s new deferred fixed product rewards those who have the ability to postpone their income withdrawals, by stepping up their future available income withdrawal amount. If their needs shift, the individual can access a portion of the funds along the way although this will result in reduced future income withdrawal amounts,” said Chad Tope, president of ING U.S. Annuity and Asset Sales.

The ING Lifetime Income annuity offers two deferral bonus opportunities. If income payments are deferred for five years, the available income withdrawal amount is boosted by 150%. With a ten-year deferral, the available income withdrawal amount gets a guaranteed boost of 225%.

Another potential growth feature is linked to changes in the S&P 500® Index. If the S&P 500 Index is higher at the end of a contract year than at the beginning, the available income amount increases by this percentage subject to an annual cap on the amount of this increase. The index cap is currently 6% and is fixed for the life of the contract. ING may declare a different index cap in the future for new contracts.

While there is upside potential, the income amount will not be decreased as a result of a decline in the S&P 500 over the course of the year. The step up benefit and index-linked growth increase the benefit value, which is used to determine the income withdrawal amount only and do not increase the contract’s account value.

The income amount has the potential to grow until lifetime income withdrawals start, at which point the amount is locked in and the income withdrawals will continue for an individual’s lifetime, or the lives of two spouses if there are joint owners. An optional death benefit grows in a similar way, providing protection for beneficiaries and helping with legacy planning.

Forethought Launches ‘ForeRetirement’ VA

Posted on March 7, 2013 by Editor Test -

The life insurance unit of Houston-based Forethought Financial has launched the ForeRetirement variable annuity with “daily benefit options.” The contract, which marks the company’s first entry into the VA market since acquiring The Hartford’s annuity business, is available in B, C and L shares.

ForeRetirement will be distributed in partnership with national, regional and independent broker/dealers, as well as banks. It has been approved in 49 states and the District of Columbia, covering all jurisdictions where Forethought Life Insurance Company issues variable annuity business.

The contract’s “Daily Lock Income Benefit” guarantees lifetime withdrawals for retirees as a percentage of the benefit base, which can grow through favorable investment performance. The benefit captures new contract value highs on a daily basis, known as “step-ups,” to age 90, with a minimum deferral bonus of 6% simple interest credited until the 10^th contract anniversary or the first withdrawal if sooner.

Contract owners who elect the income benefit can also elect the “Legacy Lock” death benefit option. It allows contract owners to provide beneficiaries with death benefit proceeds at least equal to the amount of premium invested. The death benefit will not reduce for withdrawals, unlike traditional annuity death benefits, as long as the benefit’s requirements and guidelines are met.

Two Dollar Fallacies

Posted on March 7, 2013 by Martin Feldstein -

The United States’ current fiscal and monetary policies are unsustainable. The US government’s net debt as a share of GDP has doubled in the past five years, and the ratio is projected to be higher a decade from now, even if the economy has fully recovered and interest rates are in a normal range.

An aging US population will cause social benefits to rise rapidly, pushing the debt to more than 100% of GDP and accelerating its rate of increase. Although the Federal Reserve and foreign creditors like China are now financing the increase, their willingness to do so is not unlimited.

Likewise, the Fed’s policy of large-scale asset purchases has increased commercial banks’ excess reserves to unprecedented levels (approaching $2 trillion), and has driven the real interest rate on ten-year Treasury bonds to an unprecedented negative level. As the Fed acknowledges, this will have to stop and be reversed.

While the future evolution of these imbalances remains unclear, the result could eventually be a sharp rise in long-term interest rates and a substantial fall in the dollar’s value, driven mainly by foreign investors’ reluctance to continue expanding their holdings of US debt. American investors, fearing an unwinding of the fiscal and monetary positions, might contribute to these changes by seeking to shift their portfolios to assets of other countries.

While I share these concerns, others frequently rely on two key arguments to dismiss the fear of a run on the dollar: the dollar is a reserve currency, and it carries fewer risks than other currencies. Neither argument is persuasive.

Consider first the claim that the dollar’s status as a reserve currency protects it, because governments around the world need to hold dollars as foreign exchange reserves. The problem is that foreign holdings of dollar securities are no longer primarily “foreign exchange reserves” in the traditional sense.

In earlier decades, countries held dollars because they needed to have a highly liquid and widely accepted currency to bridge the financing gap if their imports exceeded their exports. The obvious candidate for this reserve fund was US Treasury bills.

But, since the late 1990’s, countries like South Korea, Taiwan, and Singapore have accumulated very large volumes of foreign reserves, reflecting both export-driven growth strategies and a desire to avoid a repeat of the speculative currency attacks that triggered the 1997-1998 Asian financial crisis. With each of these countries holding more than $200 billion in foreign-exchange holdings – and China holding more than $3 trillion – these are no longer funds intended to bridge trade-balance shortfalls. They are major national assets that must be invested with attention to yield and risk.

So, although dollar bonds and, increasingly, dollar equities are a large part of these countries’ sovereign wealth accounts, most of the dollar securities that they hold are not needed to finance trade imbalances. Even if these countries want to continue to hold a minimum core of their portfolios in a form that can be used in the traditional foreign-exchange role, most of their portfolios will respond to their perception of different currencies’ risks.

In short, the US no longer has what Valéry Giscard d’Estaing, as France’s finance minister in the 1960’s, accurately called the “exorbitant privilege” that stemmed from having a reserve currency as its legal tender.

But some argue that, even if the dollar is not protected by being a reserve currency, it is still safer than other currencies. If investors don’t want to hold euros, pounds, or yen, where else can they go?

That argument is also false. Large portfolio investors don’t put all of their funds in a single currency. They diversify their funds among different currencies and different types of financial assets. If they perceive that the dollar and dollar bonds have become riskier, they will want to change the distribution of assets in their portfolios. So, even if the dollar is still regarded as the safest of assets, the demand for dollars will decline if its relative safety is seen to have declined.

When that happens, exchange rates and interest rates can change without assets being sold and new assets bought. If foreign holders of dollar bonds become concerned that the unsustainability of America’s situation will lead to higher interest rates and a weaker dollar, they will want to sell dollar bonds. If that feeling is widespread, the value of the dollar and the price of dollar bonds can both decline without any net change in the holding of these assets.

The dollar’s real trade-weighted value already is more than 25% lower than it was a decade ago, notwithstanding the problems in Europe and in other countries. And, despite a more competitive exchange rate, the US continues to run a large current-account deficit. If progress is not made in reducing the projected fiscal imbalances and limiting the growth of bank reserves, reduced demand for dollar assets could cause the dollar to fall more rapidly and the interest rate on dollar securities to rise

Martin Feldstein is professor of economics at Harvard University and president emeritus of the National Bureau of Economic Research.

They Just Don’t Get It

Posted on March 7, 2013 by Editor Test -

At the ASPPA/NAPA 401(k) Summit in Las Vegas this week, you could hear a lot of defensive anger at the government and at academics for their efforts to shrink the tax expenditure for retirement savings or kill it entirely.

A cynic might accuse the retirement industry of biting the hand that feeds when it attacks Uncle Sam, since tax deferral is the mother’s milk of the business. But occupants of the House-that-ERISA-Built are not unjustified when they say that bureaucrats and Ivory Tower experts—my epithets, not theirs—don’t get it.

Here’s the disconnect. To certain policy kibitizers, Ivy League professors and reportedly the White House, some of the $50 billion to $70 billion that the government “spends” each year to incentivize Americans to save for retirement is wasted on upper-income DC plan participants who would have saved for retirement anyway.

These mainly liberal policymakers and academics would prefer to cap the tax break for well-to-do participants at 28% (compared with the maximum of 39.6%) and use some of the tax expenditure to help undersavers save more and/or to extend the availability of workplace retirement plans to the currently underserved half of the working population.

ASPPA (American Society of Pension Professionals and Actuaries), which lobbies on behalf of plan advisors and service providers, is particularly upset about last years’ “Danish” study, published by the National Bureau of Economic Research. In it, academics with excellent credentials produced evidence that tax incentives have little positive impact on the mass of participants.

What don’t the policymakers and academics understand? They don’t get that the 401(k) industry, like the beer industry or the fast food industry or the arts or the “gaming” industry, relies on its largest customers and contributors for a disproportionate amount of its revenues.

The biggest contributors to 401(k) plans cover a disproportion of the plan expenses (unless perhaps the plan has a flat administrative fee). And small business owners, the wealthiest of whom who can save almost $20,000 in taxes each year by contributing the maximum to their plans, are the ones who often decide whether to sponsor a plan for employees or not.

These are the people whom the retirement industry wants to incentivize—not to save more per se, but to support the 401(k) business. The industry wants to reward these crucial customers more. It understandably drives the industry nuts to hear New England professors and Beltway theorists proposing to reduce the incentives for high rollers. They’ll just take their chips someplace else.

But if the policymakers live in a utopian fantasy to some extent, so does the 401(k) industry. Its fantasy is that auto-enrollment and auto-escalation and behavioral tricks will propel the mass of participants to retirement with accounts fat enough to replace (along with Social Security) as much as 85% of their peak salaries every year from age 65 to age 90.

Of course they want people to save more—for the same reason that Starbuck’s wants you to drink more lattes. AUM drives their business. But only a slim minority of plan participants will ever save enough to finance a long retirement, let alone finance a rising share of their health care costs and legacies for their kids. Most people are going to need insurance products, as a component of overall savings, to help themselves and society deal with the cost of rising longevity.

Besides the rivalry between these utopian visions, another rivalry manifested itself at the ASPPA/NAPA Summit. That’s the rivalry between those who see the reform activities of the Department of Labor and the actions of plaintiff’s attorneys (the legal equivalents of short-sellers) as an opportunity and those who see them as threats.

It’s the rivalry between entrenched retirement interests, which desperately want to hold onto the increasingly-hard-to-justify extra 50 bps they’ve been surreptitiously charging participants for years, and the smaller service providers who hope to use the new climate of transparency and fee competition to steal business from the profiteers. It will be interesting to watch the game play out.

Cutting Longevity Tail Risk Down to Size

Posted on March 7, 2013 by Kerry Pechter -

Longevity tail risk is expensive, regardless of who has to finance the beast. Save for it, hedge against it, or pool it, it can be a heavy burden for individual retirees, for pension plans and even for national governments to bear.

Uncertainty about life spans is an age-old problem for which a bunch of new solutions have been suggested lately. One of the most recent proposals comes from a team of actuaries at Milliman, the global consulting firm.

In Longevity Plan, a white paper published last month, Milliman actuaries describe a design for a mini defined benefit plan that a plan sponsor could tuck inside a defined contribution plan like a donut tire in the trunk of a car.

Running parallel to a DC plan, this new type of plan would resemble a DB plan. But it would be cheaper and less risky than a traditional DB plan because accrual wouldn’t start until age 45 or so and payouts wouldn’t start until age 80 or 85.

This “unit-accrual design” is still just a concept, not a product. But the authors of the white paper think the only thing that prevents it from widespread adoption is an outdated ERISA regulation against delaying pension payouts past age 65.

“Everyone’s talking about this and lots of new products has been proposed,” said Bill Most, a Milliman principal who worked on the paper with principals Zorast Wadia and Daniel Theodore and consulting actuary Danny Quant.

“But we don’t need new products, we need changes from government. And the results will hopefully give us something that employers might embrace. We’re not kidding ourselves. We don’t deny that there’s a lot of bad faith toward defined benefit plans. But from a cost perspective, this makes sense.”

How it works

Milliman offers the following example for how such a plan would work. The plan sponsor would start contributing to a fund on behalf of an employee when the employee reaches age 45, and stop contributing at age 65. The pension would pay out about two-thirds of the participant’s final salary at age 80.

If the employee died after retiring but before age 80, a lump sum death benefit of three times the pension would be paid. If a married employee died after starting payments, the spouse would receive a 75% continuation.

The plan would be much cheaper than a traditional DB plan, and not merely because of the long deferral period. Because of the career plateau effect, salary paths after age 45 become much less variable. Also, the distribution of life expectancies after age 80 is narrower than at age 65. Less variability means lower risk and therefore lower cost for the underlying fund.

How much lower? According to Milliman, it would cost an employer about 10% of pay for a lifetime pension paying out two-thirds of final salary starting at age 65, with a 75% spousal continuation. The same pension based on career-average earnings would cost about 6.5% of pay.

But under Milliman’s longevity plan, the cost for the final-salary pension, including death benefit and spousal continuation would drop to 2.9% of pay. Without the death benefit, the plan would cost 2.4% of pay; without the death benefit or spousal continuation, the cost would drop to 2.1% of pay.

Between retirement age and age 80, the employee would presumably rely on Social Security and either systematic withdrawals from the defined contribution plan account or rollover IRA, or perhaps on a 15-year period certain annuity purchased with tax-deferred assets or personal savings.

Outside perspective

The Milliman actuaries don’t pretend that these concepts originated with them, as outside observers pointed out to RIJ. “All of the actuarial consulting firms have got some of their so-called ‘thought leaders’ imagining the ideal pension plan that combines the best of all worlds and universes,” said Moshe Milevsky, professor at York University in Toronto.

Milevsky wonders who will underwrite such plans. “Most of these ideas have been thrashed in the academic pension and economics literature, which few practitioners ever read. In general, I think everyone agrees that retiring with a ‘random variable,’ which is the amount of money in your DC plan, isn’t the way to finance a random lifetime. We all need more certainty. But who is going to provide that certainty? Who will back it?”

Wade Pfau, Ph.D., who is about to begin teaching advisors about retirement income planning at the American College in Bryn Mawr, Pa., likes the Milliman proposal. “I generally think that deferred income annuities (DIAs) have a lot of potential for helping to reduce longevity risk at a reasonable cost. That is what this proposal is about,” he told RIJ.

“[Milliman] takes the discussion in an interesting direction by talking about how to get something more sustainable for employers. One issue about DIAs, though, is that there are not currently any inflation-adjusted versions. Even a small difference between actual and assumed inflation can make the real value of future spending quite different than planned after 20 years of compounding.”

Currently, plan sponsors could not put the Milliman concept into practice even if they wanted to. Pension regulations, written decades ago to protect plan participants, don’t allow the deferral of defined benefit payouts past age 65.

“They’ve relaxed certain rules related to required minimum distributions starting at age 70½, but they have not made changes in the terms of defined benefit plans,” said Zorast Wadia. “If you’re no longer working, you must begin payments from a defined benefit plan no later than age 65. If you’re still working past age 65, they won’t force you to take benefits. But ERISA won’t let the company purposely delay payments beyond 65 if you’re retired.”

Milliman believes, as many retirement income experts now do, that self-insuring for retirement is too expensive, and that it’s going to take a revival of some form of defined benefit pension with mortality pooling to finance longevity tail risk.

“It’s not even disputable [that people will be able to save enough for a retirement of us to 30 years],” said Most. “It’s not going to happen, though 401(k) pp will tell you differently. Even if you save a substantial amount, you still don’t know when you’re going to die.”

The Research Points to Annuities

Posted on March 5, 2013 by Editor Test -

The four scholarly papers that are summarized below aren’t exactly suitable for summer beach reading, I’ll admit. But for any advisor who wants to explore the rationale for including a guaranteed income product in their clients’ retirement plans, they could be described as page-turners. In case you overlooked them last week when they were included among our selection of the Best Retirement Research of 2012, here they are again.

A Utility-Based Approach to Evaluating Investment Strategies

Joseph A. Tomlinson, Journal of Financial Planning, February 2012.

In exploring the often-overlooked “utility” or insurance value of annuities, this actuary and financial planner ventures where few others care to tread. He rejects the popular notion that an annuity represents a gamble with death. “Immediate annuities are often viewed as producing losses for those who die early and gains for those who live a long time, whereas I am portraying no gain or loss regardless of the length of life,” he writes. “This is an issue of framing or context. If one thinks of an annuity as providing income to meet basic living expenses, both the income and the expenses will end at death.” He also asked 36 people how much upside potential they would require—i.e., how much surplus wealth at death—to justify a retirement investment strategy that carried a 50/50 risk of depleting their savings two years before they died.

Spending Flexibility and Safe Withdrawal Rates

Michael Finke, Texas Tech University; Wade D. Pfau, American College; and Duncan Williams, Texas Tech. Journal of Financial Planning, March 2012.

The “4% rule” is a needlessly expensive way to self-insure against longevity risk, this paper suggests. “By emphasizing a portfolio’s ability to withstand a 30- or 40-year retirement, we ignore the fact that at age 65 the probability of either spouse being alive by age 95 is only 18%. If we strive for a 90% confidence level that the portfolio will provide a constant real income stream for at least 30 years, we are planning for an eventuality that is only likely to occur 1.8% of the time,” they write. They also show that a mixture of guaranteed income sources and equities burns hotter and more efficiently than a portfolio of stocks and bonds: “The optimal retirement portfolio allocation to stock increases by between 10 and 30 percentage points and the optimal withdrawal rate increases by between 1 and 2 percentage points for clients with a guaranteed income of $60,000 instead of $20,000.”

A Framework for Finding an Appropriate Retirement Income Strategy

Manish Malhotra, Income Discovery. Journal of Financial Planning, August 2012.

No two retirees have exactly the same needs, and advisors need a process for finding the best income strategy for each client. The author has created a framework that advisors can use to tackle this challenge. His framework includes two “reward metrics” (income and legacy) and three “risk metrics” (probability of success, the potential magnitude of failure, and the percentage of retirement income safe from investment risk). “Using this framework, advisers can incorporate a variety of income-producing strategies and products, and decisions about Social Security benefits, into their withdrawal analyses—lacking in much of the past research focused purely on withdrawals from a total return portfolio,” Malhotra writes.

An Efficient Frontier for Retirement Income

Wade Pfau, Ph.D. September 2012 (Published as “A Broader Framework for Determining an Efficient Frontier for Retirement Income.” Journal of Financial Planning, February 2013.

Just as there’s an efficient frontier for allocation to risky assets during the accumulation stage, so there’s an efficient frontier for allocation to combinations of risky assets and guaranteed income products in retirement, this author proposes. He describes “various combinations of asset classes and financial products, which maximize the reserve of financial assets for a given percentage of spending goals reached, or which maximizes the percentage of spending goals reached for a given reserve of financial assets” and asserts that “clients can select one of the points on the frontier reflecting their personal preferences about the tradeoff between meeting spending goals and maintaining sufficient financial reserves.”

A Few Words of Advice for You Advisors

Posted on March 5, 2013 by Editor Test -

Lightyears ago, when the Great Boom was a toddler and I knew bupkis about financial services, a Merrill Lynch broker called and invited me to invest my savings with her. I felt flattered, which tells you how many lightyears ago that was.

We chatted. She happened to own a Fiat Spider. I had owned a Fiat Sport Coupe! The next thing you know, I owned a few hundred shares in a Health Sciences mutual fund and a few hundred more in an Information Sciences fund. The rest of my money went into a new concept called a Money Market fund.

My relationship with Merrill Lynch was brief and unremarkable. The Dow was then hovering at an all-time high of 3,500 or so. I was nervous. Even my broker thought that the bull market was too good to last. So I liquidated those assets and put the money down on a little brick row-home.

Flip forward a few years. My wife and I had accumulated enough savings to start investing again. We consulted our friends and, just to play it safe, turned our assets over to my wife’s former roommate, a recently licensed broker at a brokerage whose brand no longer exists.

Ignorance was bliss—until our first statement arrived. I noticed that our account had taken a 5% haircut—though at the time I had not yet heard the word “haircut” in any but a tonsorial context—and phoned the ex-roommate. Surely, I said, there’d been a mistake. Fees or expenses hadn’t been mentioned during our sole interview with her.

No mistake, she said cheerfully. That’s how it works; didn’t I understand how it works? No, I didn’t. Welcome to the big city, she said, adding just a tiny schmear of irony to her good cheer. I protested. That seemed to sadden her, though not in the way I’d hoped it would.

Memories of these experiences came rushing back to mind recently while I was reading an excerpt of a new report about advisors and clients from Boston-based Cerulli Associates and Phoenix Marketing. (Not to be confused with The Phoenix Companies.)

The report, titled Retail Investor Advice Relationships 2012: Meeting Investor Needs Post-Crisis, described a state of affairs in the advice industry today that echoes my encounter with the Merrill Lynch agent so many years ago. For instance:

“In many cases, especially for younger households, these sessions [between clients and advisors] would have little focus on long-term accumulation portfolios as these investors are more interested in saving for short to intermediate goals such as home ownership or funding a wedding.”

That captures my former self perfectly. And the Merrill Lynch agent, for her part, handled me with the kind of light touch that Cerulli and Phoenix recommend.

“An important part of understanding the advice process is realizing that many investors consider it a temporary need,” the report said. “Rather than engaging in an ongoing comprehensive financial planning engagement, many investors would prefer the opportunity to have periodic check-ins with advice providers regarding their overall financial position.”

The Merrill Lynch broker treated me exactly that way. If she hadn’t dropped out of finance, I might have remained her client. Her behavior toward me was in line with Cerulli’s description of an advisor who takes the long view regarding client acquisition:

“Providers interested in establishing trust relationships with younger investors should consider being able to provide basic, but personalized, financial planning guidance for these clients. Simply having a representative qualified to speak for few minutes on the choices a client faces with financial topics such as life insurance or mortgages could go a long way toward strengthening client relationships.”

Another section of the Cerulli-Phoenix report was also spot-on in describing at least one of the elements of my run-in with my wife’s former roommate. I may have been clueless about the terms of our relationship, but apparently many people are. As we implicitly did, most people assume that a broker puts their interests ahead of his or her own.

“Nearly two-thirds of investors who identify having a commission-only relationship with their provider also indicate that the provider is obligated to operate under a fiduciary standard,” the Cerulli-Phoenix report said. “Households in commission relationships largely believe that their advisor must put their best interests first.”

Back then, I don’t think we even understood how commissions work. My wife’s ex-roommate, of course, was simply doing her job—which she turned out to be very good at—and following the suitability standard. One irony of the situation was that while we assumed that no harm (or haircuts) could come to us if we invested with her, she must have assumed that friends and family would help jump-start her business.

At the time, the situation was awkward. We weren’t sure how to handle it. So our money, some of it in trust accounts for our children, remained with her for 15 years. But she eventually lost us as a client. Now part of our money is in a rollover IRA at a do-it-yourself no-load fund company and part is in a 403(b) account with TIAA-CREF.

Our disenchantment with our treatment under the suitability standard happens to be something else that the Cerulli report warns advisors about:

“In Cerulli’s opinion, trying to cling to business models that allow for ongoing conflicts of interest holds the industry back from making true advances that would ultimately rebuild investor trust and advance the industry overall,” the report said.

“Firms that continue to operate solely on a suitability standard basis must be ready to answer client questions as to how they ensure clients are being served, and potentially lose clients if the public comprehension spreads about how the various standards impact client relationships.”

Emphasis added.

Vanguard closes Wellington Fund and a bond fund to some customers

Posted on March 5, 2013 by Editor Test -

Vanguard’s oldest fund—Wellington Fund—and its Intermediate-Term Tax-Exempt Fund have stopped accepting new accounts from financial advisor or institutional clients, but will remain open to additional purchases from those clients, the direct no-load fund company announced this week.

Retail clients may continue to establish new accounts and make additional purchases without limitation, however, a Vanguard release said, adding that the funds may open if the situation changes.

The action was taken to “ensure that [the funds’] investment advisors can continue to effectively manage the portfolios,” said Vanguard CEO Bill McNabb. “Our commitment is to protect the interests of the funds’ current shareholders.”

Over the years, Vanguard has often restricted cash inflows to maintain fund assets at levels that don’t compel fund managers to buy suboptimal investments. Currently, seven Vanguard funds are closed to most new accounts:

Admiral Treasury Money Market Fund
Federal Money Market Fund
High Yield Corporate Fund
Convertible Securities Fund
Capital Opportunity Fund
PRIMECAP Core Fund
PRIMECAP Fund

Wellington Fund, Vanguard’s oldest mutual fund and the fund industry’s largest balanced fund, with $68 billion in assets, invests approximately 65% of its assets in stocks and the remaining 35% in investment-grade corporate bonds, with some holdings in U.S. Treasury, government agency, and mortgage-backed securities.

As substitutes, Vanguard offers its Balanced Index Fund and Vanguard STAR Fund. Both invest about 60% of their assets in equities. STAR Fund is a fund of 11 actively managed Vanguard stock and bond funds.

The $39 billion Vanguard Intermediate-Term Tax-Exempt Fund is Vanguard’s largest municipal bond fund and the largest tax-exempt fund in its category, according to Lipper Inc. The fund invests in high-quality muni-bonds and has an average duration of five years.

As substitutes, the company suggested its Limited-Term Tax-Exempt Fund, which has an average duration of 2.4 years, or its Long-Term Tax-Exempt Fund, which has an average duration of 6.1 years.

Vanguard also said it will add to its low-cost bond offerings with a Vanguard Emerging Markets Government Bond Index Fund and ETF Shares by the end of the second quarter of 2013.

The expense ratios for the ETF, Investor, Admiral, and Institutional Shares will range from 0.30% to 0.50% (as shown in the table below). The average emerging markets bond fund features an expense ratio of 1.21% (source: Lipper, as of December 31, 2012).

The fund will assess a purchase fee of 0.75% on all non-ETF Shares to help offset the higher transaction costs associated with buying emerging markets bonds.

Four Share Classes of Vanguard Emerging Markets Government Bond Index Fund
	Minimum Initial Investment	Estimated Expense Ratios	Purchase Fee
Investor Shares	$3,000	0.50%	0.75%
Admiral Shares	$10,000	0.35%
Institutional Shares	$5,000,000	0.30%
ETF Shares	—	0.35%	—

“Emerging markets bonds have presented low correlations with domestic and developed market bonds, and have the potential to add value for certain risk-tolerant investors holding an otherwise broadly diversified portfolio,” said Vanguard CEO Bill McNabb in a release.

Vanguard Emerging Markets Government Bond Index Fund offers “low-cost exposure to a sizable and growing portion of the international fixed income universe” while incurring higher risk than to the average international bond fund.

In early February, Vanguard announced plans for a Total International Bond Index Fund, which along with the new fund, represent the company’s first international fixed income offerings for U.S. investors.

The fund will use a new target benchmark—the Barclays USD Emerging Markets Government RIC Capped Index. It features approximately 540 government, agency and local authority bonds from 155 issuers. As of January 31, 2013, the top three country holdings were Russia (13.8%), Brazil (10.6%), and Mexico (8.5%). The fund will invest solely in U.S. dollar denominated emerging market bonds.

AnnuityRateWatch.com launches GLIB calculator

Posted on March 5, 2013 by Editor Test -

Annuityratewatch.com, Inc. has expanded its suite of fixed annuity analysis software to calculate the highest Guaranteed Lifetime Income Benefit for prospective annuitants.

With an input of the annuitant’s age, premium, state of residence and the year in which they would like retirement income to begin, the GLIB Calculator solves for the highest income payment.

The software calculates all the possible combinations of over 250 annuity products combined with more than 100 riders to find the product and rider that provides the highest income payout for that individual.

The calculations include increasing, inflation adjusted, joint, and enhanced payout values. The GLIB Calculator’s detailed reports include a “Payout by Age” report, which shows the impact of deferral before commencing income payments. The “Detailed Ledger” report shows a complete income scenario including how contract values are affected by the associated cost of Lifetime Income Riders.

The GLIB Calculator can be found at annuityratewatch.com and is available for license to broker-dealers, banks, insurance distributors, investment advisors and brokers.

Odd new online game lets you “play” the market

Posted on March 5, 2013 by Editor Test -

You’ve heard the one about the two hunters trapped by an angry bear. When Hunter One calmly switches from boots to running shoes, Hunter Two says, “What good is that? You can’t outrun the bear.” The first replies: “I don’t have to. I just have to outrun you.”

A new online game allows people to practice that principle in the world of investing. Called Invoost and produced by a social gaming startup of the same name, the game gives players a chance to profit from the market regardless of if it goes up or down. Invoost players compete against one another in stock trading tournaments that can last from one hour to two weeks.

Players are able to interact with one another through the social gaming functions. Invoost provides real-time market data on four of the world’s largest markets: Eurostoxx 50, FTSE 100, Ibex and NASDAQ 100. Every open market hour more than 30 hourly, daily and weekly tournaments are being played, Invoost said in a release.

Players pay an entry fee to enter the tournament and receive $10,000 virtual dollars to trade with real stock market data. At the end of the tournament the player with the best portfolio return will win a cash prize ranging from $10 to $10,000.

As one early-adopter put it, “Playing Invoost has given me a new perspective on the stock market. I can win money by being the best in a tournament, not by whether the market goes up or down. Those are odds I like!”

Flood into foreign equities bodes ill: TrimTabs

Posted on March 5, 2013 by Editor Test -

An estimated $55.1 billion poured into global equity mutual funds and exchange-traded funds in January and February, the biggest two-month inflow on record, according to TrimTabs Investment Research.

“Bulls should be concerned” that in-flows into foreign stock funds have been so heavy this year, said David Santschi, TrimTabs CEO. “Big inflows from fund investors often occur near market tops.”

Global equity mutual funds and exchange-traded funds received an all-time record $34.4 billion in January, according to TrimTabs note to clients. While inflows subsided to $20.1 billion in February, last month’s inflow was still the second-highestsince October 2007.

“It’s remarkable that U.S. investors are convinced the grass is greener offshore even though global equities have been underperforming,” said Santschi. “The average U.S. equity fund is up 6.2% so far this year, more than double the average global equity fund’s 2.4% gain.”

TrimTabs reported that U.S. equity mutual funds and exchange-traded funds issued $5.9 billion in February, down from $32.0 billion in January. Bond mutual funds and exchange-traded funds issued $17.2 billion in February, down from $33.5 billion in January.

“Inflows into U.S. stocks slumped dramatically last month,” said Santschi. “But global equity funds raked in more than $1 billion daily in fresh cash, and inflows didn’t slow much as the month progressed.”

The previous two-month record for inflows into global equity mutual funds and ETFs was $49.1 billion in January and February of 2006 amid growing enthusiasm over investments in emerging markets and China, in particular, TrimTabs said.

Stable Value Funds: Performance to Date – Part I

Posted on March 3, 2013 by David Babbel and Miguel Herce -

Stable Value Investment Funds (SVIF) are offered in almost half of all defined contribution (DC) plans in the USA, with more than $800 billion dollars worth of assets under management. Historically, they have been one of the two most popular asset classes for people enrolled in such plans.

Unlike stocks, bonds, and many other asset classes, they are generally not susceptible to large fluctuations in value, but accrue attractive interest over time while providing necessary liquidity at book value. Therefore, they may be especially suitable as people approach retirement and are also useful after retirement.

Their stable value allows a person to transition into retirement without any late-inning unwelcome market surprises that can devastate a retirement plan. After retirement, for those plans that allow participants to retain a portion of their assets in SVIF, the availability of funds at book value is important when extraordinary expenses are incurred.

In three related studies[1] conducted over the past seven years, we have examined SVIF performance relative to six other major asset classes, including U.S. large stocks, small stocks, long-term government bonds, corporate bonds, intermediate-term government and corporate bonds, and money market funds.

Our evidence suggests that going back to their inception in 1973, SVIF have dominated two (and nearly three) major asset classes based on a historical analysis and that they often occupy a significant position in optimal portfolios across a broad range of risk aversion levels.

We discuss the factors that contributed to stable value’s remarkable performance and whether it can continue to maintain it into the future. Our various studies used three methods to examine historical performance:

Mean-variance analysis
Stochastic dominance analysis
An enhanced multi-period utility analysis

In Part I of this report, we will briefly discuss the mean-variance results. Part II will summarize the performance results using the other methods.

What are Stable Value funds?

SVIF offer principal protection and liquidity to individual investors, and steady returns that are competitive with intermediate-term bond yields. However, over ensuing one-to-three-month intervals, the guaranteed rate of return moves much more slowly than intermediate-term bond yields.

This is achieved by having a process that allows the provider to smooth market volatility through amortizing gains and losses over the duration of the portfolio. This smoothing is effected through the rate re-set mechanism and insulates against day-to-day volatility. Consequently, SVIF provide investors with positive returns of very low volatility. This combination of bond-yield-like returns and low volatility generates contract or book value accounting of the investment.

The underlying investment portfolios of SVIF are comprised of high quality, short maturity corporate and government bonds, mortgage-backed securities, and asset-backed securities. In all but a few pre-specified circumstances, investors in SVIF are able to transact (make deposits, withdrawals, transfers) at book or contract value, which is deposits plus accrued interest, less any past withdrawals.

While SVIF do not require a set holding period but provide full access to the participant’s principal and accumulated interest, they are subject to the general restrictions within the overall plan. For example, many plans restrict participants from the direct transfer to a competing short-duration bond or money market fund by requiring that money transferred out of SV be first invested in a non-competing (e.g., stock or long-term bond) fund for a short period such as 30-90 days to eliminate arbitrage.

This rule, together with the fact that plan participants do not act in concert regarding the allocation of their funds, allows the investment contract protections to be provided for a fraction of what it would cost if interest arbitrageurs dominated the pool and were revising their allocations aggressively.

Mean-variance analysis

From an investor’s viewpoint, SV funds operate like a passbook savings account. They accrue interest at a pre-specified crediting rate that is generally updated every one to three months to slowly incorporate changing market conditions. Below are compared the relative yields of stable value and money market funds in the stressful post-crash period.

SVIF also fared well over a longer time period. The SVIF returns shown are net of all fees. Note that over the twenty-one-year period shown below, there were only two brief intervals lasting a month or two each when the money market fund average yield exceeded the stable value average.

Despite shortcomings, the mean-variance approach is a popular analytical tool and provides useful insights into the ability of SV investments to dominate other asset classes.

The historical record provides evidence that, even as stand-alone investment, SV funds have been superior in the mean-variance sense to money market and intermediate-term government/credit bond funds.

Based solely on historical returns, when included in optimal mean-variance portfolios, SV funds contribute significantly to the portfolio, to the exclusion of money market, intermediate-term government/credit bonds, long-term corporate bonds and even large stocks.

In other words, optimal mean-variance portfolios based on past data contain only SV funds, long-term government bonds and small stocks in proportions that naturally vary with the expected return (or, alternatively, the expected volatility) of the optimal portfolio.

(Looking forward, we would expect long-term government bonds to be excluded from the set of efficient portfolios because their historical returns benefitted from a significant drop in yields, producing huge capital gains. We cannot expect such a significant drop in yields going forward, so their future returns relative to other investment classes cannot benefit from the capital gains.)

For example, over the past 23 years, from January 1989 through January 2012, SV returns exhibited both a higher mean and lower volatility than either money market or intermediate-term government/credit bond returns. This feature can be seen in the figure below, where we plot two efficient frontiers, one including all seven asset classes in our study and one that excludes the value-weighted SV (VW-SV) funds. The plot extending back to 1973 looks about the same.

While not shown here due to space constraints, we observed that no optimal mean-variance portfolio along the efficient frontier included money market instruments, intermediate-term bonds or long-term corporate bonds. Not even large US stocks were included. We also observed that SV funds predominated in the lower portion of the expected return range, where one would conventionally anticipate seeing money market and intermediate-term bond investments.

The Sharpe ratio, commonly used in performance measurement, measures excess return per unit of risk. It measures how well an investor is compensated per unit of risk taken. Higher ratios denote greater return for the same level of risk.

The Sortino ratio focuses more on the downside risk. It is based on the Sharpe ratio, but penalizes for only those returns that fall below the target return, which in our case is the average riskless rate of return over the period of analysis. It gives the actual rate of return in excess of the risk-free rate per unit of downside risk.

The Sharpe and Sortino ratios for quarterly net return data from 1989-2011 are reported in the table below.

	Large Stocks	Small Stocks	Long-Term Corporate Bonds	Long-Term Government Bonds	Intermediate-Term Gov’t/Credit	Stable Value	Money Market
Mean	2.21%	3.27%	1.99%	2.15%	1.38%	1.41%	0.87%
Std. Deviatn	8.19%	11.68%	4.78%	5.46%	1.84%	0.38%	0.59%
Sharpe Ratio	0.16	0.20	0.23	0.24	0.29	1.69	N/A
Sortino Ratio	0.24	0.33	0.44	0.46	0.52	25.77	N/A

Note that the Sharpe ratio values for five of the asset classes are mostly clustered together, but that for SV it is about six times greater than the highest of the other asset classes. This pattern is even more pronounced for the Sortino ratio. The extremely high ratio for SV funds results from the fact that throughout the period under consideration, the risk-free rate exceeded the SV credited rate only for only a few months and by small amounts. Hence, there were only a few, small observations that factored into the denominator.

The Value Proposition, Challenges and Future Prospects

The positive evidence shown above also holds true over the entire 40-year period of existence for traditional and synthetic forms of SVIF. It raises two questions: What has been the value proposition that allowed these returns to be achieved? Should we expect this kind of performance over the future?

The value proposition has two facets. On the asset side, some of the return above money market yields comes from investing at durations sufficient to capture the term premium that has been traditionally available. The funds also are able to take on a very small amount of credit and convexity risk and thereby gain additional spread. They also invest in some less liquid securities and Guaranteed Investment Certificates (GIC), which provide higher spreads than the most liquid assets.

The first two of these factors help explain why SV returns have generally outpaced money market yields, but do not explain why they also have outpaced intermediate-term government/credit returns. For that we must turn to the liability side of fund management.

On the liability side, the contribution to performance derives from behavioral finance factors. SVIF have contingent liquidity that FASB and GASB define as “benefit responsive.” From the point of view of participants, SV has liquidity similar to money market funds. Banks, insurers or other financial institutions that issue the investment contracts take on the transfer/liquidity risk as well as the investment/market risk that everyone will not withdraw at the same time, since the underlying portfolio has to be less than contract value to cause the investment contract to make up the difference.

SV providers mitigate their risk largely by being astute at predicting and underwriting participant behavior. Providers know that SV investors tend to use less liquidity than they think they need. They know that the vast majority of participants, because of tax penalties, equity wash requirements that inhibit interest rate arbitrage, and simple investor inertia, tend to leave their money in stable value options for a fairly long time. Providers are willing, therefore, to guarantee a fixed rate for a traditional GIC or a minimum zero percent crediting rate each quarter for a synthetic GIC. This allows “wrap” providers to offer their guaranties at lower prices than otherwise would be the case.

Going forward, SVIF will need to be able to continue earning term premia, liquidity premia, and credit spreads while investors will need to continue to behave as they have over the past 40 years for it to continue to be a widely sought investment vehicle for accumulation and decumulation.

David F. Babbel, professor emeritus, The Wharton School, Univ. of Pennsylvania, is a Senior Advisor to CRA (Charles River Associates) and leader of its Insurance Economics practice. Miguel A. Herce, Ph.D., is a Principal at Charles River Associates.

[1] Our previous studies were published in the Working Papers Series of the Wharton Financial Institutions Center website (Babbel and Herce, 2007-#21, 2009-#25, 2011-#1). http://fic.wharton.upenn.edu/fic/papers.html These studies provide references to the literature that explain the details.

Ten Questions about Quantitative Easing

Posted on February 28, 2013 by Nouriel Roubini -

Most observers regard unconventional monetary policies such as quantitative easing (QE) as necessary to jump-start growth in today’s anemic economies. But questions about the effectiveness and risks of QE have begun to multiply as well. In particular, ten potential costs associated with such policies merit attention.

First, while a purely “Austrian” response (that is, austerity) to bursting asset and credit bubbles may lead to a depression, QE policies that postpone the necessary private- and public-sector deleveraging for too long may create an army of zombies: zombie financial institutions, zombie households and firms, and, in the end, zombie governments. So, somewhere between the Austrian and Keynesian extremes, QE needs to be phased out over time.

Second, repeated QE may become ineffective over time as the channels of transmission to real economic activity become clogged. The bond channel doesn’t work when bond yields are already low; and the credit channel doesn’t work when banks hoard liquidity and velocity collapses. Indeed, those who can borrow (high-grade firms and prime households) don’t want or need to, while those who need to – highly leveraged firms and non-prime households – can’t, owing to the credit crunch.

Moreover, the stock-market channel leading to asset reflation following QE works only in the short run if growth fails to recover. And the reduction in real interest rates via a rise in expected inflation when open-ended QE is implemented risks eventually stoking inflation expectations.

Third, the foreign-exchange channel of QE transmission – the currency weakening implied by monetary easing – is ineffective if several major central banks pursue QE at the same time. When that happens, QE becomes a zero-sum game, because not all currencies can fall, and not all trade balances can improve, simultaneously. The outcome, then, is “QE wars” as proxies for “currency wars.”

Fourth, QE in advanced economies leads to excessive capital flows to emerging markets, which face a difficult policy challenge. Sterilized foreign-exchange intervention keeps domestic interest rates high and feeds the inflows. But unsterilized intervention and/or reducing domestic interest rates creates excessive liquidity that can feed domestic inflation and/or asset and credit bubbles.

At the same time, forgoing intervention and allowing the currency to appreciate erodes external competitiveness, leading to dangerous external deficits. Yet imposing capital controls on inflows is difficult and sometimes leaky. Macroprudential controls on credit growth are useful, but sometimes ineffective in stopping asset bubbles when low interest rates continue to underpin generous liquidity conditions.

Fifth, persistent QE can lead to asset bubbles both where it is implemented and in countries where it spills over. Such bubbles can occur in equity markets, housing markets (Hong Kong, Singapore), commodity markets, bond markets (with talk of a bubble increasing in the United States, Germany, the United Kingdom, and Japan), and credit markets (where spreads in some emerging markets, and on high-yield and high-grade corporate debt, are narrowing excessively).

Although QE may be justified by weak economic and growth fundamentals, keeping rates too low for too long can eventually feed such bubbles. That is what happened in 2000-2006, when the US Federal Reserve aggressively cut the federal funds rate to 1% during the 2001 recession and subsequent weak recovery and then kept rates down, thus fueling credit/housing/subprime bubbles.

Sixth, QE can create moral-hazard problems by weakening governments’ incentive to pursue needed economic reforms. It may also delay needed fiscal austerity if large deficits are monetized, and, by keeping rates too low, prevent the market from imposing discipline.

Seventh, exiting QE is tricky. If exit occurs too slowly and too late, inflation and/or asset/credit bubbles could result. Also, if exit occurs by selling the long-term assets purchased during QE, a sharp increase in interest rates might choke off recovery, resulting in large financial losses for holders of long-term bonds. And, if the exit occurs via a rise in the interest rate on excess reserves (to sterilize the effect of a base-money overhang on credit growth), the ensuing losses for central banks’ balance sheets could be significant.

Eighth, an extended period of negative real interest rates implies a redistribution of income and wealth from creditors and savers toward debtors and borrowers. Of all the forms of adjustment that can lead to deleveraging (growth, savings, orderly debt restructuring, or taxation of wealth), debt monetization (and eventually higher inflation) is the least democratic, and it seriously damages savers and creditors, including pensioners and pension funds.

Ninth, QE and other unconventional monetary policies can have serious unintended consequences. Eventually, excessive inflation may erupt, or credit growth may slow, rather than accelerate, if banks – faced with very low net interest-rate margins – decide that risk relative to reward is insufficient.

Finally, there is a risk of losing sight of any road back to conventional monetary policies. Indeed, some countries are ditching their inflation-targeting regime and moving into uncharted territory, where there may be no anchor for price expectations. The US has moved from QE1 to QE2 and now to QE3, which is potentially unlimited and linked to an unemployment target. Officials are now actively discussing the merit of negative policy rates. And policymakers have moved to a risky credit-easing policy as QE’s effectiveness has waned.

In short, policies are becoming more unconventional, not less, with little clarity about short-term effects, unintended consequences, and long-term impacts. To be sure, QE and other unconventional monetary policies do have important short-term benefits. But if such policies remain in place for too long, their side effects could be severe – and the longer-term costs very high.

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