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Obama nominates Mary Jo White to chair SEC

Posted on January 24, 2013 by Editor Test -

On January 24, President Obama is expected to nominate Mary Jo White, a former U.S. Attorney, director of the NASDAQ Stock Exchange, and current white-collar defense lawyer, to be the next chairwoman of the Securities and Exchange Commission.

The White House was also expected to re-nominate Richard Cordray, another former prosecutor, to run the Consumer Financial Protection Bureau, which he has done for the past year under a recess appointment.

White, a partner at Debevoise and Plimpton, spent almost 10 years as the U.S. Attorney in New York, the first woman appointed to that job. She oversaw the prosecution of John Gotti, the mafia boss, as well as the individuals responsible for the 1993 World Trade Center bombing.

In private practice, however, she has defended some of Wall Street’s biggest names, including Ken Lewis, the former head of Bank of America. Debevoise and Plimpton’s list of clients has included AIG, AXA, Deutsche Bank, Goldman Sachs, JP Morgan, MetLife and Prudential Financial, among many others.

White’s husband, John W. White, was head of the S.E.C.’s division of corporation finance, which oversees public companies’ disclosures and reporting, from 2006 through 2008.

As the attorney general of Ohio, Mr. Cordray sued Wall Street companies, including Bank of America and American International Group, in the wake of the financial crisis.

White will replace Elisse Walter, a longtime S.E.C. official, who served as chairwoman since Mary L. Schapiro stepped down as the agency’s leader in December. Mr. Cordray joined the consumer bureau in 2011 as its enforcement director.

The Senate already declined to confirm Mr. Cordray, with Republicans vowing to block any candidate for the consumer bureau, a new agency created to rein in the financial industry’s excesses.

Other people said to have been considered for the SEC chairman’s job included Sallie L. Krawcheck, a longtime Wall Street executive, and Richard G. Ketchum, chairman and chief executive of the Financial Industry Regulatory Authority.

After 30 years, Ben Nelson returns to NAIC

Posted on January 24, 2013 by Editor Test -

Former Nebraska Sen. Ben Nelson has been named CEO of the National Association of Insurance (NAIC), the organization announced. News outlets reported that Nelson has already met with Federal Insurance Office Director Michael McRaith and insurance lobbyists.

Nelson, who has extensive experience in insurance, will lead the NAIC at a time when security products play an increasing role in the offerings of insurance companies and when some have called for federal as well as state oversight of insurance products.

He has served as an insurance commissioner and has a foundation as an insurance executive. Before retiring from the Senate in 2012 after two terms, he served as governor of Nebraska from 1990 to 1998. He also served as executive vice president and chief of staff for the NAIC (1982-1985); Director of the Nebraska Department of Insurance (1975-1975); and executive vice president and then president/CEO of the Central National Insurance Group (1977-1981). Nelson earned a Juris Doctorate, as well as undergraduate and graduate degrees in philosophy, from the University of Nebraska.

A Democrat from a “red” state, Nelson irritated many conservative constituents by voting for the Patient Protection and Affordable Care Act. As NAIC CEO, he is expected to face difficult issues, including challenges to the tradition of state-by-state regulation of the insurance industry.

The NAIC announced in August that then-NAIC CEO Dr. Therese M. (Terri) Vaughan intended to retire. Vaughan left the association earlier than expected, on Nov. 30 rather than the first quarter of 2013, and Andrew Beal became acting CEO for the second time.

Vaughan had been the longest-serving insurance commissioner in Iowa history (1994-2004) as well as a past NAIC president and as a professor of insurance and actuarial science at Drake University. She served on the board of The Principal Financial Group and was a member of the Executive Committee of the International Association of Insurance Supervisors (IAIS).

The NAIC CEO position, which used to have a disclosed salary, no longer does, as the NAIC is exempt from filing a public form 990 with the IRS. In January 2008, the NAIC released pay information for top executives that stated the CEO’s salary at $370,000.

Can We Survive Four More Years?

Posted on January 24, 2013 by Martin Hutchinson -

President Obama’s intransigence on economic matters is increasingly clear, so compromise seems unlikely and a succession of tax increases and wasteful spending programs seems inevitable. Meanwhile Ben Bernanke’s Fed enables this dangerous course by massive “quantitative easing.”

Assuming Bernanke is succeeded by a like-minded colleague (more on that below), we will thus suffer this economically poisonous combination of policies until January 2017. The U.S. economy is unlikely to make it that far in anything like its present shape.

Neither Obama’s nor Bernanke’s damaging policies would be possible without the cooperation of the other. If the Fed were maintaining short-term rates at above the rate of inflation, without buying large quantities of Treasuries, the Treasury would have great difficulty financing endless $1 trillion deficits without pushing up long-term interest rates to intolerable levels and loading future years with huge debt interest payments.

Without Obama and his deficits Bernanke would have great difficulty purchasing $1 trillion of long-term Treasuries and Agency securities annually, since new Treasury bonds would only be issued to replace retiring bonds. The distortions he created by doing so would disrupt the bond market, feeding rapidly into a level of consumer price inflation that he would have a statutory duty to address.

Both Obama and Bernanke appear determined to continue pursuing their ruinous policies. Obama has announced he will not permit spending cuts in connection with a debt ceiling hike, while Bernanke on January 14 said the “worst thing the Fed could do” would be to raise rates “prematurely.”

Had we gone over the “fiscal cliff” as this column advocated, more than three quarters of the federal deficit would have been eliminated, and further deficits could have been prevented by the Republican House of Representatives. However the GOP House leadership wimped out, and as a result we are left in a position where taxes on the rich have already been raised substantially, but the deficit has been left almost unaffected – indeed it has been increased in the first year by the disgraceful $60 billion of tax breaks granted to politically favored corporations and scam artists.

Obama is with us until January 2017, but Bernanke has indicated he may retire next January when his term of office is up. In general Bernanke’s is the scalp lovers of sound policy should seek. Obama’s damage has already been done, and while he may prevent any near-term attempt to address the deficit, Republican control of the House means he cannot increase spending more than marginally. Every extra month of Bernankeism, on the other hand, distorts the economy further.

It was not difficult to determine before his appointment that Bernanke would be a disaster as Fed chairman; this column said so in a piece published a week before he was appointed, remarking that “Bernanke’s approach to monetary policy, in which all economic problems can be solved by creating money, is that of the 1919-23 Weimar Republic, which achieved in September and October 1923 inflation rates of 2,500% per month.”

This column can claim only partial credit for prescience; in the event we got the policy, but did not suffer the predicted inflation, being rewarded by an exceptionally deep and prolonged recession instead. Such are the vagaries of economic prognostication!

Next time around, there are few candidates who might move to a tighter policy, although former Fed vice chairman Roger Ferguson, currently CEO of the pension fund TIAA-CREF, is eminently qualified and as a registered Democrat is at least a plausible appointment for President Obama. More likely however is the current Fed vice chairman Janet Yellen, whose published views suggest that she would favor even more easing. However as a known liberal Democrat without Bernanke’s long service she might find it more difficult to attract a majority on the Federal Open Market Committee than has Bernanke. A Yellen Fed would thus probably be a modest improvement over the current one.

One disquieting suggestion I have seen recently is that New York Mayor Mike Bloomberg might want the job; his combination of primitive Keynesianism and proven tendency to meddle obtrusively in everybody’s lives would be truly frightening in a job with such power.

Thus it is highly unlikely that Bernanke’s successor will be much of an improvement. Hence we are for the next four years likely to be subject to ultra-loose monetary policy and trillion-dollar budget deficits.

One area where my crystal ball is now unclear is whether this will cause an outburst of inflation. By monetarist theory it should; M2 money supply has risen at an annual rate of 9.9% in the last 6 months while the St Louis Fed’s MZM, the nearest proxy we have to M3, has risen at 10.6% in the same period. With output rising at only 2%, that should produce inflation of around 8%.

Milton Friedman said “Inflation is always and everywhere a monetary phenomenon,” so where the hell is it? Leads and lags are all very well, but even taking into account a flat stretch between mid-2009 and mid-2010 M2 has been growing at an annual rate of 7.2% since the end of 2007, far in excess of the feeble 2.3% growth in nominal GDP. Monetary “velocity,” that elusive concept, has dropped like a rock (mathematically it had to, given the data), but its ability to do so without any reasonable explanation in itself makes monetary theory look increasingly chimerical.

More likely than a sudden resurgence of Weimar-like inflation is a market crash. Global sub-zero real interest rates have boosted corporate profits to record levels (in terms of US GDP) as well as the value of bonds, commodities and other assets. The Dow Jones index remains about 6,000 points higher, in terms of U.S. GDP, than when Greenspan began easing monetary policy in February 1995. Gold is at double its 1980 high. U.S. house prices have bottomed out and are rapidly reflating. Global foreign exchange reserves have been increasing at 16% annually since the Asian crash of late 1997.

For the current market to be sustainable for another four years the value of capital assets would have to have moved to a permanently higher level in terms of the value of everything else. Capital assets have become the destination for the world’s excess money supply, but it doesn’t seem likely that even Ben Bernanke and his colleagues can sustain this disequilibrium forever. Most likely, like tech stock prices in 1997-2000 and house prices in 2004-06, the overvaluation will persist long enough for a substantial body of dozy opinion to decide it’s permanent and put all their money on it continuing, doubtless leveraging up to the eyeballs to do so.

Once the silly money has piled in, as with housing in 2007 and tech stocks in 2000, valuations will start to slip. Most likely this will be seen first in the Treasury bond market, where even Bernanke’s trillions will prove insufficient to keep the 10-year yield below 2% forever. That will cause a price collapse similar to that of 2007, where previously unassailable financial institutions will be found to have eroded their capital base by overinvestment in T-bonds. Since the Treasury bond market is so huge this in turn will cause a sell-off in the world’s equity markets, with corporate earnings being eroded by the rise in interest rates.

Another example of such a slow-motion collapse is Japan after 1990, where eventually a high percentage of Japan’s most admired corporations were found to have speculated excessively in short-term “tokkin” funds. In that case, the major banks propped up the loser corporations, wrecking the banking system, filling the country with zombie corporations and causing a 20-year period of economic sluggishness.

In the early years of that period, Japan’s policy responses remained fairly orthodox, but since Ben Bernanke’s visit to the country in 1998, dispensing truly awful advice, it has been plagued by misguided Keynesian “stimulus” and money-printing by the central bank, prolonging the downturn more or less ad infinitum. On the Japan analogy, if U.S. policy remains as bad as Japan’s has been, we are due a downturn lasting until 2035 or so.

If the Obama/Bernanke policies do not cause inflation, but instead produce a collapse of markets and a major recession, we will finally have an answer to the century-old battle between monetarists, Keynesians and the Austrian school of economists.

Keynesian economists will be discredited by the failure of $1 trillion annually of deficit “stimulus” to stimulate anything beyond an asset bubble, with unemployment remaining stubbornly high.

Monetarists will be discredited by the failure of Bernanke’s gigantic monetary stimulus to produce economic recovery, and by the corresponding absence of a serious burst of inflation. The winner in the intellectual battle will be the Austrian school, in its pure Ludwig von Mises form, which will have seen monetary and fiscal expansion produce only a mountain of “malinvestment,” the collapse of which will take several years and a major depression to work out.

Of course, that economic victory will be of little consolation to those of us forced to live through the depression, although we can hope that the next such episode in 2070 or so will be solved more effectively, with Keynes and Friedman relegated to the sidelines.

As for the timing, I have said before that I don’t think 2013 will be the year in which the bubble bursts – there is as yet insufficient speculative frenzy, although the market temperature is certainly rising. Moreover, it would be a pity to have such a record-breaking blow-off without a serious speculative bubble in gold similar to that of 1978-80 – which if the $1500-1900 gold price of the past 15 months is regarded as a base, suggests a gold price peaking certainly above $3,000, very possibly above $5,000.

Equally, it would seem impossible for the present bubble to outlast President Obama, and fairly unlikely for it to last into the election year of 2016. The 18-month period between July 2014 and December 2015 would thus be my best guess for the onset of collapse, with a prolonged rolling crisis lasting for the greater part of that period being the most likely outcome. 2016 and 2017 would then be years of grinding depression, benefiting the 2016 electoral prospects of both Republicans and extremist fruitcakes on both ends of the spectrum.

In the very long term, U.S. reserves of cheap energy, the intellectual capital in its research facilities and the political distaste of its people for infinite Washington expansion are pretty good guarantees that we will again see prosperity. But it’s not going to happen within the next four years.

Martin Hutchinson’s work can usually be found at prudentbear.com.

A Primer on Safety-First Retirement Planning

Posted on January 24, 2013 by Editor Test -

One book I picked up on a whim for my new Kindle is Erin Botsford’s The Big Retirement Risk: Running Out of Money Before You Run Out of Time. I didn’t know what to expect. And I almost stopped reading in the first chapter when she laid claim to creating something she calls Lifestyle Driven Investing.

This is the basic goals-based approach to investing, which is already called Liability Driven Investing when used by pension funds. Changing the word liability to lifestyle is a good idea, because while pension funds think of their future payment promises as corporate liabilities, individuals also have liabilities that are less natural for them to identify as such. These liabilities are their future spending needs to support their lifestyle.

Investing, especially in retirement, shouldn’t be driven by maximizing risk-adjusted returns over a single time period, but by what can best help you to secure your future spending needs.
That being said, I’m glad I finished the book. She did cite other resources, and she does seem to be well-intentioned and not just another snake oil salesperson claiming credit for others’ work.

What she describes in the book is a good example of the safety-first approach to retirement planning. As she is a practicing financial planner, it is nice to be able to add another name to the list of planners using the safety-first approach.
Usually, the safety-first approach is criticized as being too academic and too unrealistic for the real world. The book doesn’t really contain anything new, but it is a nice overview and introduction to safety-first ideas.

Erin does a good job explaining the safety-first approach to readers who may be unfamiliar with the concept, and whose knowledge about retirement planning may be based mostly on concepts like the 4% rule from the diametrically opposed school of thought of retirement income: the probability-based approach.

First she explains four Wall Street myths: The stock market always goes up in the long-term; the modern portfolio theory concepts of diversification and asset allocation are the keys to retirement success; financial service firms provide a broader range of investment options than are otherwise available to household investors; it is net worth which determines one’s lifestyle in retirement.

The book then takes an excursion about the relationship between investment returns and demographic trends and also the relationship between demography in the social welfare system. It’s a nice overview, but perhaps not all that relevant to the overall purpose of the book.

Next, she returns to safety-first principles by describing how one’s lifestyle spending can be separated into different categories. She identifies four categories in her house of security: Needs, wants, likes, and wishes. Here she is talking directly about the spending, rather than the assets that will cover each of those spending categories, but the overall concept is the same. This is because different assets are used to meet the different spending categories.

For spending needs, she recommends using what she calls lifestyle investments. These are investments that produce income, and that must be considered either safe or predictable or guaranteed. She also suggests that these assets be in a legal entity that will provide protection in the event of a lawsuit.

This is the basic concept of goals-based investing in which you first build a floor to meet basic needs. Investment categories can include bonds and annuities. She describes a variety of different types of annuities, and I think she did a good job in explaining advantages and disadvantages of different approaches.

For wants and likes, she suggests hybrid investments. These are investments that would generally provide an income that is not safe or guaranteed. Examples include preferred stock, publicly traded REITs, covered calls, master limited partnerships, dividend stocks, etc. Once needs, likes, and wants are met, more volatile, [growth-oriented] investments can be used to achieve one’s wishes.

Again, these are all basic tenets of the safety-first school of thought, which provides a stark contrast to probability-based notions like failure rates and “safe” withdrawal rates. Anyone seeking a basic introduction to this school of thought could be well served by reading this book.

This book review was adapted from a post at wpfau.blogspot.com.

Quote of the Week

Posted on January 21, 2013 by Editor Test -

“When there is a stock-market boom, and everyone is scrambling for common stocks, take all your common stocks and sell them. Take the proceeds and buy conservative bonds. No doubt the stocks you sold will go higher. Pay no attention to this—just wait for the depression which will come sooner or later. When this depression—or panic—becomes a national catastrophe, sell out the bonds (perhaps at a loss) and buy back all the stocks. No doubt the stocks will go still lower. Again, pay no attention. Wait for the next boom. Continue to repeat this operation as long as you live, and you’ll have the pleasure of dying rich.”

— Where are the Customers’ Yachts? or A Good Hard Look at Wall Street, by Fred Schwed Jr.

As an Investment, Will Gold Pan Out?

Posted on January 21, 2013 by Editor Test -

Gold, the value of gold, and the wisdom of owning large amounts of gold today is the topic of a new research paper written by Campbell R. Harvey of Duke University and Claude Erb and published by the National Bureau of Economic Research.

In their conclusion, the authors write, “Investors are faced with a golden dilemma. Will history repeat itself and the real price of gold revert to its long-term mean – consistent with a ‘golden constant’?

“Alternatively, have we entered a new era, where it is dangerous to extrapolate from history? Those are the uncertain outcomes that gold investors have to grapple with and the passage of time will do little to clarify which path investors should follow.”

The paper lists six traditional arguments for owning gold: As an inflation hedge; a currency hedge; an alternative to assets with low real returns; as a safe haven; because the world will return to a gold standard; and because it is “under-owned.”

Then the authors assess each of these rationales. Goldbugs may not agree with their findings. They write:

We find little evidence that gold has been an effective hedge against unexpected inflation whether measured in the short term or the long term. The gold-as-a-currency-hedge argument does not seem to be supported by the data.

The fluctuations in the real price of gold are much greater than FX changes. We suggest that the argument that gold is attractive when real returns on other assets are low is problematic.

Low real yields, say on TIPS, do not mechanically cause the real price of gold to be high. While there is possibly some rational or behavioral economic force, perhaps a fear of inflation, influencing variation in both TIPS yields and the real price of gold, the impact may be more statistically apparent than real. We also parse the safe haven argument and come up empty-handed.

History buffs may enjoy the article, which offers such nuggets of knowledge as this:

In the era of Emperor Augustus (reigned from 27 B.C. to 14 A.D.), a Roman legionary was paid about 2.31 oz. of gold a year (225 denarii) and a centurion was paid about 38.58 oz. of gold a year (3,750 denarii). Converted to U.S. dollars, the pay of a Roman legionary was about 20% that of a modern day private in the U.S. Army and the pay of a centurion was about 30% greater than the pay of a captain in the U.S. Army.

And those who relish science or even science fiction may enjoy the following:

The near‐Earth asteroid 433 Eros might contain up to 125,000 metric tons of gold… There are currently 15 near‐Earth asteroids with expected profit greater than $1 trillion. Closer to home, perhaps someday in the future someone will figure out how to implement Nobel prize winner Fritz Haber’s plan to electrochemically recover some of the estimated 8 million tons of gold in the world’s oceans.

My personal fascination with gold and the gold standard stems from a long-ago experience in Europe. In mid-August 1971, while pedaling my pannier-laden Peugeot UO-8 from Fontainebleau to Paris, I stopped at a local bank branch in Melun to change a traveler’s check into francs.

The teller was flustered because she didn’t know how many francs to trade me for my green $20 American Express check. President Nixon had just for practical purposes ended the Bretton Woods Agreement and taken the dollar “off gold.” That eventually left the exchange rate to float… or, as Nixon’s aides might have put it, “to twist slowly in the wind.” For some reason, the teller chose to give me the (higher) previous day’s rate. I continued on my way, and the rest is history.

Correction: Nixon didn’t take the dollar “off gold” in 1971 as suggested above. According to Erb and Harvey, the U.S. did not officially embrace a monetary system of pure fiat money until October 1976. According to “A Brief History of the Gold Standard in the United States, by the Congressional Research Service (June 23, 2011):
“The United States began to halt its redemptions of dollars into gold for international transactions in 1967 and 1968. The actions of 1971 and 1973 were not the adoption of floating exchange rates and fiat money, but the loss of the ability to redeem dollars at a fixed price. Floating occurred by default.”

DoubleLine repeats as fastest-growing active fund manager

Posted on January 21, 2013 by Editor Test -

Emerging market bond and stock funds, non-traditional investment strategies, innovative income approaches, and bond fund leadership typified the investment themes of the mutual fund managers (of those managing at least $2 billion) with the highest rate of net inflows in 2012, according to Strategic Insight.

The list of the fastest growing managers in 2012 includes many small and mid-size mutual fund managers. Each of the listed managers enjoying over $10 billion of net inflows during 2012 has increased their flows from 2011, some more than doubling. (See table of fastest-growing active managers below.)

DoubleLine Capital, a $37 billion Los Angeles firm, was the fastest-growing actively-managed mutual fund firm in the study for the second consecutive year. Of its assets, almost all is in DoubleLine funds and about $35 billion is invested in mortgage-backed securities. (See chart at bottom.)

“During 2012 fund managers across a wide range of strategies and size benefitted from rapid expansion of their assets and clients’ relationships,” said Avi Nachmany, Strategic Insight’s Director of Research, in a release. “In 2013 we expect the range of participating managers to expand further as demand for equity funds increases.”

Managers of index mutual funds and index-based Exchange Traded Products have benefited from dramatic expansion during 2012, as assets managed by such funds eclipsed $2.5 trillion and net inflows exceeded $250 billion.

About half of these annual flows were captured by Vanguard’s managed funds or ETFs, with significant gains also by BlackRock’s iShare unit and by State Street Global Advisors (SSgA).

“Economy of scale allows the largest providers of index strategies to pass costs savings to investors. But a number of smaller managers of index funds and ETFs also grew meaningfully last year,” added Nachmany.

A number of managers of target date strategies beyond the traditional major players experienced substantial growth over the year. “Fastest growing target date managers in 2012 included JPMorgan, MFS and John Hancock,” said Bridget Bearden, head of Strategic Insight’s Defined Contribution and Target Date funds practice.

(Source: Strategic Insight.)

(Source: DoubleLine.com)

Immediate annuities unattractive today: Journal of Financial Planning

Posted on January 21, 2013 by Editor Test -

Given today’s low payout rates from immediate fixed annuities (IFA), many retirees would likely be better off waiting until interest rates improve or delaying the IFA purchase decision to an older age.

So concludes an article published in the current issue of the Journal of Financial Planning by David M. Blanchett, CFP, of Morningstar, who also asserted that IFAs appear more attractive for individuals than couples.

“IFAs remain an attractive longevity hedge for retirees age 80 or older, as well as for retirees who have a strong preference for guaranteed income and want to simplify the income-generation process, versus attempting to self-fund from a traditional retirement portfolio,” Blanchett writes.

The article is filled with charts and tables demonstrating the value of an immediate annuity at different ages, different withdrawal rates, and different prevailing interest rates.

New Cerulli report focuses on the top 1% of U.S. households

Posted on January 21, 2013 by Editor Test -

High-net-worth investors maintain an average of 3.7 investment provider relationships, up from 3.3 in 2008, according to the latest research from Boston-based global analytics firm, Cerulli Associates.

“High-net-worth investors have more provider relationships and are more likely to change providers than other investors,” said Cerulli director Bing Waldert in a release.

Cerulli’s report, High-Net-Worth and Ultra-High-Net-Worth Markets 2012: Understanding Bank Trust Departments, Family Offices, Private Client Groups, and Other HNW Providers, analyzes the U.S. high-net-worth (investable assets > $5 million) and ultra-high-net-worth (investable assets > $20 million) marketplaces. It covers vehicle usage, fees, and services provided at bank trust departments, family offices, and private client groups.

Despite the high-net-worth market’s competitiveness, it remains appealing to providers and asset managers, said the Cerulli report, now in its fifth iteration. Providers are drawn to the large balances of high-net-worth investors and to their complex situations.

High-net-worth investors will begin to consolidate their providers and urges providers to consider how to position themselves as the advisor of choice when the time comes, the release said.

Cerulli gathered data from proprietary surveys of bank trust asset managers, bank trust groups, HNW providers, and HNW asset managers. Investor data is drawn from Cerulli’s relationship with Phoenix Marketing International, while advisor data is provided by Cerulli’s annual advisor survey.

According to the Spectrem Group, 1,078,000 U.S. households are worth $5 million or more and about 107,000 people are worth $25 million or more. The $5 million-plus crowd is dominated by senior corporate executives (17%) and entrepreneurs/owners (12%).

Interested in a D.C. pied-a-terre?

Posted on January 21, 2013 by Editor Test -

The opulent, historic and highly-secure Washington, D.C., residence of Barack and Michelle Obama has been valued by Zillow, publisher of the Zillow Home Value Index, at $294.9 million, or about 7% more than its appraised value when the Obamas moved in four years ago. Average home values in the city of Washington rose 13.6% during the past four years.

If the White House were for sale, the official residence of the U.S. president would be the third most highly-appraised home in the world, ahead of the penthouse of One Hyde Park in London and behind the Villa Leopolda on the French Riviera. The most expensive home in the world is the 27-floor “Antilia” in South Mumbai, valued at at least $1 billion.

Zillow calculates the value of the White House as if it were a home that could be bought and sold, using the proprietary Zestimate algorithm, which determines a home’s estimated worth based in part on public data and recent sales.

To determine the White House Zestimate, Zillow looked at the home’s physical characteristics, including 55,000 square feet of indoor space, 132 rooms, 35 bathrooms, 16 bedrooms, three kitchens and 18 acres of premium, downtown Washington, D.C., land.

They then considered the most expensive home sales in Washington, D.C., as well as other historic homes in the D.C. area recently for sale, and calculated the amount historic homes typically fetch over similar homes with no historical significance.

Zillow’s statisticians deemed the White House the most historic home in America and applied a maximum historical premium to their models to determine its Zestimate value.

A standard 30-year fixed rate mortgage on the White House today (assuming 20% down and a 3.276% interest rate) would require a monthly payment (including taxes, insurance, principal and interest) of $1,130,832, according to Zillow. As a rental, the White House would bring more than $1.75 million per month, according to Zillow’s Rent Zestimate.

Five Questions to Ask about DIAs

Posted on January 19, 2013 by Kerry Pechter -

In their quest for low-risk yield, investors and advisors have looked into every financial nook and cranny that they can dream of. That search has helped to turn a former step-child of the annuity world into a Cinderella.

We’re talking now about deferred income annuities (DIA), aka Advanced Life Deferred Annuities (ALDAs), aka longevity insurance. If your client has a good chance of living to age 90 or 95, he or she might consider buying this.

Until mid-2011, few people other than annuity wonks like Moshe Milevsky of York University or Jason Scott of Financial Engines championed DIAs, which allow a person to fund an income that starts up to 40 years after purchase. Advisors and the public largely ignored it.

Things began to change in 2011, after New York Life introduced a DIA called the Guaranteed Future Income Annuity. Sales rapidly crossed the $1 billion mark, which is lemonade-stand money on Wall Street but a large sum in the income annuity world. Soon MetLife, Symetra, MassMutual, American General (AIG) and Guardian were dusting off existing DIAs or christening new ones. Just last week, Fidelity announced that it had added MassMutual’s RetireEase Choice DIA to its Fidelity Insurance Network platform, along with the New York Life Guaranteed Future Income Annuity II.

Why the surge? Part of the explanation has to be that, in a low-yield era, people can get an attractive discount on future income by buying it a decade or more in advance. A life insurer who issues the contract can offer a discount for two reasons: because the premium generates interest during the deferral period and because (in the case of a life-contingent DIA) the annuitant may not live to collect.

If you’re determined to think of DIAs and other income annuities purely as investments, and you hear an internal voice asking what their IRRs are, they’re probably not for you. But if you think of them as insurance that relieves your client of the need to hoard cash against the possibility that he or she might live to age 90 or 95, then DIAs can make a lot of sense… at least in principle.

Consider the Guardian Life SecureFuture DIA. Today, if a man plops down $100,000 at age 45 for a Guardian DIA, he can get $22,386 a year for life at age 75, with income guaranteed for at least 10 years. The contract pays a cash refund if he dies during the deferral period. Time is money, of course: If your client has just turned 60 and wants to buy that DIA, he will get only about $13,100 a year at age 75, thanks to the shorter deferral period.

To get the maximum value out of a DIA, you should do what few people choose to do in practice: take a life-only DIA contract that doesn’t pay out until after age 85, when a 65-year-old’s chance of still being alive is about 50/50. For instance, for $100,000 at age 60, MetLife will provide a man with a single life-only contract that pays $42,400 (for a woman, it’s $41,000) starting at age 85.

You can buy a DIA with either after-tax or qualified money, but the required minimum distribution requirements add a wrinkle (though not necessarily a serious obstacle) to the use of qualified money. If you’re looking for a deep-dive analysis of the DIA, and a comparison between DIAs and GLWBs, I recommend papers that Joe Tomlinson, CFP, wrote for Advisor Perspectives in March and April of 2012.

One nice feature of most of the current products is that they allow flexible premiums. A person can open a DIA for as little as $5,000 or $10,000 at age 40, say, and add to it over time. Contract owners don’t have to commit all of the money during today’s low-rate environment.

Given the long-dated nature of the guarantee, you naturally need to buy from a life insurer with stellar financial strength ratings. Independent advisors who make their living from a percentage of AUM may still be able to earn a fee, albeit a smaller one, from the money that goes into the DIA. But that’s a topic for another day.

Questions you might ask your or your client when considering a DIA:

1. Does your client have $500,000 to $1 million in investable assets? If so, he probably has enough liquidity to apply 10% to 20% toward eliminating his risk of living a very long time, and not so much wealth that he can easily self-insure against longevity risk.

2. Is your client, or your client’s spouse, a healthy, non-smoking woman? If so, there’s a good chance she will be alive for five to 10 years after age 85, and able to collect the benefit. Like diamonds, a DIA can be a girl’s best friend.

3. If you decide to buy, how should you design the contract? DIAs come with most of the same options that you’ll find in single-premium immediate annuities, including cash refunds, joint-and-survivor payouts, periods certain, and inflation adjustments. The product costs the least (and, conversely, has the highest risk of forfeiture) when there’s no cash value and income starts after age 85. Most clients will choose to give up some income in favor of some protection against forfeiture.

4. Does your client have a strong bequest wish? This is a trick question. Under the typical scenario, someone who wants to maximize his bequest to heirs is a terrible candidate for a life-contingent annuity. On the other hand, someone who knows he has an income starting at age 85 may, as mentioned above, feel less pressure to hoard wealth right up until the time he dies. He can be more generous during his lifetime.

5. Do you think a longevity annuity would allow you to invest the client’s remaining money with more freedom? The biggest benefit of a DIA, or any income annuity, may be the added risk it allows a client to take with the rest of his money. A 60-year-old client with $1 million and no DIA has to be careful with his money. A 60-year-old with $900,000 and an annuity that pays $40,000 a year in 25 years can arguably take on more investment risk and worry less about the future during the interim. The potential gains from greater risk-taking could offset the price of the annuity. On the other hand, if your client intends to be cautious with his $1 million anyway, and has a strong “bequest motive,” there may be little opportunity lost by foregoing the annuity.

Guardian Life launches deferred income annuity

Posted on January 17, 2013 by Editor Test -

Following through on plans announced late last year, The Guardian Insurance & Annuity Co., Inc., part of Guardian Life, has introduced a deferred income annuity (DIA) that can be created with as little as $5,000 and provide income that starts up to 40 years after the purchase date.

The DIA product is called Guardian SecureFuture Income Annuity. Along with SPIAs (single premium immediate annuities) and the Guardian Investor II variable annuity with several guaranteed lifetime withdrawal benefit options, the New York-based mutual company now offers clients multiple ways to avoid outliving their savings.

“There are various ways to structure income in retirement, and different people view the need for income in different ways,” said Douglas Dubitsky, vice president of Product Management & Development for Retirement Solutions at The Guardian Life Insurance Company of America. (See chart at right, taken from a SecureFuture brochure, for hypothetical payout amounts.)

“So we’re creating multiple products. Income products used to be one-size-fits-all. It either fit your needs or it didn’t. It wasn’t a solution; it was a product. Now we have multiple solutions, and an advisor can see what works best for each client,” he added.

Guardian distributes through a captive sales force and Dubitsky envisions agents working with clients to create solutions that provide income at different times during retirement, and where different products offer different strengths—such as mortality credits from income annuities and upside exposure from deferred variable annuities.

“You can ladder a SPIA with a DIA or variable annuity and a DIA. People might say, I want a pay raise at a certain age. There’s such a great need for income-producing products, that there’s no threat of cannibalizing sales” between the Guardian VA and DIA, Dubitsky said.

“You can move the start date forward or back one time during the course of the contract. The low minimum additional premium gives clients the opportunity to make multiple payments. We see scenarios where people add assets to the DIA from different accounts at different times. This is a market we firmly believe in.”

According to the SecureFuture fact sheet, the product can be purchased with non-qualified money at any time up to age 80, and with qualified money between ages 18 and 68. Income must start by age 85 for non-qualified money and by age 70½ for qualified money. The minimum additional purchase premium is only $100.

Guardian has AA+ ratings from Fitch and Standard & Poor’s, A++ from A.M. Best, and Aa2 from Moody’s.

Contract owners can accelerate payments, receiving up to six months at a time once during the life of the contract. Both single and joint contracts are available, and clients can choose life with period certain or cash refund of the unpaid premium. There’s a return-of-premium death benefit if a single annuitant dies during the deferral period. Payments can be increased each year by 1% to 5%.

The Bucket

Posted on January 17, 2013 by Editorial Staff -

Nationwide enhances spousal payouts of lifetime income rider

Recognizing a growing need among Boomers for joint-and-survivor annuity contracts, Nationwide Financial has increased the joint payout rates for the lifetime income rider (Nationwide L.inc) on its Destination Series 2.0 variable annuities, which offers a 7% simple roll-up during the accumulation period.

Lifetime payout rates for Nationwide L.inc with joint option will increase by 0.25% for most age bands, the company said in a release. For example, payouts for someone starting income at age 65 will be 4.75% instead of 4.5%. On a contract with a $500,000 benefit base, that would translate into $1,250 a year or about $104 a month, before taxes.

In addition to Nationwide L.inc with the joint option, Nationwide’s spousal protection feature delivers a guaranteed death benefit covering either spouse, regardless of who passes away first, even on IRAs where there’s a single owner.

Neuberger Berman introduces ‘Dynamic Real Return Fund’

Neuberger Berman Group LLC has launched the Neuberger Berman Dynamic Real Return Fund (tickers: NDRAX, NDRCX, NDRIX), a mutual fund that invests in multiple asset classes in an attempt to “deliver attractive risk-adjusted returns in various inflationary environments,” according to a release.

The actively managed fund will invest in inflation-sensitive asset classes such as commodities, global TIPS, high-yield bonds, leveraged loans, U.S. and emerging markets equities, master limited partnerships (MLPs), and real estate. The fund managers also employ a dynamic overlay designed to capitalize on short-term changes in inflation expectations.

The Fund’s lead portfolio managers are Andy Johnson, chief investment officer for investment grade fixed income, and Thanos Bardas, global head of sovereigns and interest rates.

Symetra proposes SPIA instead of early Social Security claiming

Symetra Life Insurance Company now offers financial advisors a web-based retirement planning toolkit as part of an education campaign that tackles the question: “Does it pay to delay Social Security?”

The education campaign features collateral pieces and a public-facing website, www.symetra.com/itpaystodelay, which will be refreshed monthly through March. It provides links to a variety of resources, presentations and strategy-supporting material from respected industry experts and organizations.

January’s theme is “Does It Pay to Delay Social Security?” The site features a marketing flyer and presentation illustrating specific examples of how delaying Social Security benefits can create more income in the long term. February’s theme — “Have Your Retirement … and Income, Too” — will outline a strategy that gives clients the ability to replicate their Social Security income from ages 62–70 through a period-certain single premium immediate annuity (SPIA).

Phoenix Marketing offers study of social networking by advisors

Almost 60% of financial advisors use social networking platforms to interact with clients, colleagues and firms, according to a new study by Phoenix Marketing International, which has added a “social networking module” to its syndicated study programs for the financial services industry.

Phoenix also found that more than 80% of those who have adopted social networking consider their proficiency to be “above average,” and 30% of non-users plan to start in the next six months. Advisors tend to be less concerned about inability to use social networking than about regulatory issues.

Conducted among financial advisors in the US this month, the new Phoenix social media study also answers:

To what extent have financial advisors (FAs) adopted social networking?
Does adoption vary by FAs’ role, $AUM, annual production, tenure, age, or gender?
Which devices and social networking platforms do FAs use?
What are FAs’ concerns about integrating social networking as a business practice?
Are they governed by a social networking policy or guidelines?
Why do FAs use social networking?
What are specific firms doing in terms of social networking “best-practices”?

A full report on how advisors utilize social networking is available for purchase from Phoenix, which provides competitive information on the attitudes and behaviors of individual investors and financial advisors and how they assess specific brokerage firms and their ROI from multi-media brand advertising.

Firms queried in this study include American Funds, Ameriprise, BlackRock, Charles Schwab, Columbia Management, Franklin Templeton, iShares, Jackson National, John Hancock, Lincoln Financial, MetLife, Nationwide, Oppenheimer, PIMCO, PowerShares, Prudential, Scottrade, State Street, Transamerica and Vanguard.

Our events calendar is now up to date

Posted on January 17, 2013 by Editor Test -

To reach our Events page, click here.

Simplifying the British national pension is complicated

Posted on January 17, 2013 by Editor Test -

As Britain prepares to shift from a two-tier national pension system (basic and earnings-related) to a one-tier system in 2017, the government is trying to make the transition as smooth and transparent as possible—and without undermining the remaining private defined benefit plans, according to a report in IPE.com.

The switch to a one-tier system would end “contracting out,” by which Britons were encouraged to stop all or part of their contributions to the earnings-related second-tier national pension and directed them into an employer-sponsored plan (DB or DC) or personal retirement plan instead.

In a new Department for Work & Pensions (DWP) white paper on national pension reform, the government acknowledged the financial and administrative impacts of ending “contracting out” and pledged not to undermine DB plans.

Pensions minister Steve Webb told the House of Commons that the current multi-tier system was “extraordinarily complex” and did not allow workers to predict their income in retirement, adding that “the overall cost of the new system will be the same as that of the one it replaces.”

After 2017, the earnings-related tier will be gone and the basic national pension will be higher. “This is not a pensions giveaway for the next generation,” said Webb. “A higher flat pension is affordable only because, in the long term, people will not become entitled to very large earnings-related pensions through the state system.”

His department’s accompanying White Paper, ‘The single-tier pension: a simple foundation for saving’, further outlined how the state second pension would be abolished after 2017 and confirmed a review of the state pension age every five years, starting the same year contracting out would end.

The British Chambers of Commerce said the reforms would simply matters for savers. It would also create a “much-needed incentive” for workers to save privately, said Adam Marshall, the Chamber’s director of policy and external affairs.

Marshall said a proposal to allow defined benefit plan sponsors to amend fund accrual in a “limited” fashion to compensate for the loss of the rebates—the money the plans currently get from employees who have contracted out of the second-tier public pension—was “sensible and necessary.”

But Zoe Lynch, a partner at the law firm Sackers, disagreed, saying that, “With the abolition of DB contracting out, the intention is to retain the contracted-out rights within the plan,” she said. “Plans will therefore be required to retain records and remember the restrictions attached to DB contracted-out benefits.”

The industry raised concerns about the end of contracting out ahead of the publication of the White Paper yesterday. Union Unite expressed concern about the override praised by Marshall, noting the “danger” of employers watering down pension provision to “claw back” the increased national insurance cost.

The DWP white paper also described proposals to review the state pension age every five years, with a 10-year notice period before any increase in the eligibility age.

“More frequent reviews would allow the government to respond quickly to changes in life expectancy projections, but would mean clarity for individuals would be reduced,” the policy paper said. “In contrast, less frequent reviews could result in the need for large adjustments to State Pension age.”

The reform will also introduce a minimum 10-year contribution period to draw the partial state pension and raise the threshold to receive the full state pension, under the reforms a flat-rate sum of £144 ($230) per week in current terms, to 35 years of contributions from the previous 30 years.

DTCC protests swaps data reporting rules

Posted on January 17, 2013 by Editor Test -

DTCC, the Depository Trust & Clearing Corporation, has complained to the U.S. Commodity Futures Trading Commission (CFTC) about a perceived “lack of clarity, arbitrariness, and inconsistent rulemaking” by the agency on the regulatory reporting structure for over-the-counter (OTC) derivatives transactions.

In a comment letter filed with the CFTC this week, the DTCC urged the Commission to “address inconsistencies regarding the conclusion of its recent swaps data reporting public comment period, as well as to publicly address how it plans to consider third party comments and questions raised about the impact of The Chicago Mercantile Exchange Inc. (CME) proposed Rule 1001.”

According to DTCC, proposed Rule 1001 would allow inappropriate commercial bundling of swap data repository (SDR) and clearing services by CME (and other derivates clearing organizations), and eliminate the ability of market participants to choose their preferred SDR.

The proposed CME rule would require, as a condition for using CME clearing services, that all CME customers have their cleared trades directed to CME’s own captive SDR. This would undermine the intent of Dodd-Frank’s provisions on fair and open access, market protection, trading transparency, risk mitigation and anti-competitive practices.

DTCC asked the Commission to extend the review period by 45 days to appropriately analyze the “novel and complex issues” associated with Rule 1001. DTCC also submitted a report by the economic consulting firm, NERA, which outlines the potential anti-competitive and cost-benefit ramifications of CME proposed Rule 1001.

Several trade associations and market participants have all expressed concern with the proposed change, DTCC said in a release. This group includes the Association of Institutional INVESTORS (AII), GFMA FX Division, International Swaps and Derivatives Association (ISDA), Securities Industry and Financial Markets Association (SIFMA), Wholesale Markets Brokers’ Association, Americas (WMBA), Moore Capital Management, LP., Citigroup Inc., Deutsche Bank and JPMorgan Chase & Co.

DTCC has raised a series of objections to CFTC action regarding the swaps data rulemaking process and the impact of proposed Rule 1001, including a January 8, 2013 comment letter in which DTCC showed how Rule 1001 could undermine the intent of Dodd-Frank, decrease transparency for investors and regulators, and increase risk to global financial markets.

Pew report on public pensions draws ire of public pension trade groups

Posted on January 17, 2013 by Editor Test -

A newly-released report on state pension plans by the Pew Charitable Trusts has provoked protests from The National Conference on Public Employee Retirement Systems (NCPERS) and from the National Public Pension Coalition, two trade groups.

The groups, which advocate for public pensions, charged that Pew had shown the status of public pensions in the least flattering light by using data from 2009, a nadir of prosperity for the plans, and that Pew had prescribed remedies that would weaken rather than strengthen the finances of public pensions.

Executive director and counsel of NCPERS Hank Kim said, “The analysis presented in the Pew Charitable Trust’s new report, A Widening Gap in Cities, presents a distorted and outdated picture of the health of municipal pension plans – primarily because the data Pew worked with is four years old.”

The data from 2009, a period that included the financial crisis and its immediate aftermath, “cannot yield a realistic representation of the status of municipal pension plans today,” Kim said.

NPPC executive director Jordan Marks said in a separate release: “Rather than focus on retirement security and the important role that public pensions play in local economies, Pew suggest various reforms that would slash benefits and put retirement benefits at risk.”

NCPERS represents more than 550 public sector pension funds in the U.S. and Canada. NCCP represents millions of public sector employees, including teachers, nurses, police, firefighters and other public sector employees.

28% of plan sponsors offer in-plan retirement income solutions: Aon Hewitt

Posted on January 17, 2013 by Editor Test -

American workers will need 11 times their final pay to meet their financial needs in retirement, but the average U.S. worker falls short of that by about 2.2 times pay, according to a new survey from Aon Hewitt, the global human resources business of Aon plc. The firm surveyed over 425 U.S. employers with 11 million employees.

The survey shows that:

80% of employers are making financial wellness a top priority in 2013.
61% are looking beyond current participation and savings rates and are helping workers evaluate their retirement readiness, up from 50% a year ago.
86% of companies plan to focus communications initiatives on helping workers evaluate and understand how much they need to save for retirement.
76% currently offer target-date funds as a way to provide workers with a simple and straightforward approach to investing.
Of employers who do not offer target-date funds, 35% will likely add this option in 2013.
Managed accounts and online third-party investment advisory services continue to gain popularity (64%), up from 40% a year ago.
28% of companies offer in-plan retirement income solutions—including professionally managed accounts with a drawdown feature, managed payout funds, or insurance or annuity products that are part of the fund line-up, up from 16% a year ago.
Of those employers that do not currently have these options, 30% said they are likely to add them in 2013.

52% of companies will use podcasts and 42% will use text messages to communicate and educate their workers on their retirement benefits in 2013.
The percentage of plan sponsors that plan to use social media channels to communicate with workers has tripled from 6% last year to 18% in 2013.
37% of employers have recently reviewed the total DC plan costs (fund, recordkeeping, and trustee fees). Among those who have not, 95% are likely to do so in 2013.
35% of employers completed a review of DC fund operations, including fund expenses and revenue sharing; 87% plan to do so this year.
31% of employers recently changed their DC plan fund lineup to reduce costs. More than half (52%) of the remaining companies may do so in 2013.

From Prudential, Prudent Forecasts for 2013

Posted on January 17, 2013 by Editor Test -

Dangerous though it is to make predictions, football pundits, Farmer’s Almanac publishers and financial professionals continue to make them, especially at this time of year. They can’t seem to help it. It goes with the territory.

So, at the Millennium Hotel in chilly midtown Manhattan last week, a panel of five Prudential executives delivered their economic forecasts for 2013 to the assembled media representatives—though not in terms that could be construed as promissory or exceeding the legal safe harbor for forward-looking statements.

Sometimes it’s good to be overweight

Prudential has a “bullish tilt” for 2013, said Edward F. Keon, managing director and portfolio manager, Quantitative Management Associates (seated at far right, with Quincy Crosby and John Praveen), a research unit of Prudential Financial. “We’re overweight stocks across the world. We’re also overweight high-yield bonds even though the rally there has been going on a long time.”

Keon called 2012 “relatively calm” in terms of volatility and pointed to the S&P 500’s 16% return as evidence. “It’s been a pretty good year despite all the uncertainty,” he said. “A lot of the bad stuff that we feared didn’t happen.”

In contrast to the 20% drop in equities that followed the battle over the debt ceiling in 2011, the market took the tumultuous Presidential contest and the fiscal cliff in stride, he said. The market had apparently decided to “ignore the rhetoric” and assume that politicians can generally be relied on to “do what they think is right” for the country.

Keon expects U.S. GDP to grow by (2% GDP growth?) and corporate earnings to grow by 10% in 2013. The drag from a higher payroll tax and higher taxes on the wealthy could be “offset by a drop in gasoline prices.”

Asked why equities prices rose in 2012 despite huge outflows from equity funds, Keon said that some of the money has simply moved into equity ETFs but that the biggest factor has been corporate buybacks of their own shares. “There’s no evidence of that slowing down,” he said.

A ‘dichotomy’ explained

Reflecting on 2012, John Praveen, managing director and chief investment strategist, Prudential International Investment Advisors, observed a “dichotomy” between weak economies and strong financial markets around the world. Expansive monetary policies rescued the financial sector and eased pressures that might have split the Eurozone.

“Central bank liquidity explains this dichotomy,” Praveen said, attributing actions by Ben Bernanke at the Fed and to Mario Draghi at the European Central Bank with calming the markets and keeping Greece from abandoning the euro.

The ECB, the Bank of England and the Bank of India have all cut interest rates, he said, and the Bank of Japan announced that it would do more in terms of providing liquidity. Praveen noted that a second quarter correction hurt the markets but a fourth quarter uptick in China’s growth rate gave it a second wind.

Moving at ‘muddle speed’

Quincy Crosby, chief market strategist, Prudential Annuities, extended the discussion of the macro-economy. “The markets have been driven by policy announcements,” she said. “Draghi is responsible for the European rally. Credit has eased, there’s less volatility and risky assets have been moving higher.”

Crosby continued, “There have been 326 separate easing actions by central banks around the world, and the stimulus has underpinned markets. The lower rates are helping companies with their debt loads and giving households more disposable income, enabling the economy to move at ‘muddle speed.’

“The truth is, markets don’t need much growth to do well,” she added, predicting industrial stocks and the industrial metals business will pick up in the U.S. in 2013. “Money will be moving to U.S. companies that have strong overseas markets.”

In terms of bonds, she said, “the barbell strategy of 2012 should still be in play”—meaning that investors will put money in short- and long-term bonds but not in intermediate bonds.

“There will a scavenger hunt for yield by consumers,” she added. “Pensions will be taking more risk. The worry is that you could see a buildup of tremors around the world. Inflationary pressures may be rising in emerging markets and the question is, will emerging market central banks ‘tighten’ in response. That’s how the cycle works.”

When emerging markets tighten, she explained, overseas sales of U.S. companies fall.

Crosby expanded on her comment about “tremors.” “I’m a devotee of Hyman Minsky,” she said. “Complacency leads to trouble. Ben Bernanke is forcing people into riskier assets. Risk begets risk until, when fear hits, it gets out of control.” She interprets the flow of money into high-yield bonds and rising levels of margin debt as signs of complacency about risk.

The Fed, she said, may be setting up the markets for a fall. “Bernanke made it clear that he’ll work out an exit strategy when we get to 6.5% unemployment. So now everybody is focused on the labor reports. But there will be dislocations associated with that. What if they all try to sell at the same time?” She would like to see a bit of inflation. “We hope we’re on the cusp of seeing some inflation and rise in yields. That would confirm that growth is picking up in the U.S.”

‘We like high-yield’

“Rates will stay low in 2013,” said Michael K. Lillard, managing director and chief investment officer, Prudential Fixed Income—a prediction that echoes the Fed’s own statements. In Washington, D.C., “budget battles will continue,” he added. Congressional action will be characterized by “small deals, little fixes and lots of brinkmanship.”

Otherwise, he thinks most of the economic indicators are reading positive for the year ahead. Lillard expects 2% growth in the U.S. this year, 5% growth in emerging markets and 3% average growth worldwide.

“The Fed is in a data dependent mode. Depending on the unemployment rate, the Fed will keep buying securities. There’s value in fixed income overall, but not in U.S. Treasury issues or U.S. agency debt. Government debt might be downgraded again. Two thousand twelve was a good environment for credit products,” Lillard said.

“We like high-yield. Companies are holding steady, with cash on hand,” he added. “The high-yield sector doesn’t show any precursors of defaults. We see a 2% default rate.” He likes “double B” bonds paying a 5% coupon and “single B” bonds paying 6% a year. “We like U.S. money center banks. Banks are more liquid and they’ve got fewer bad assets on their books” than had been the case, Lillard said. “Tighter regulations will keep the banks from taking too much risk.”

Lillard also likes AAA-rated floating rate CLOs (collateralized loan obligations) with subordination levels of 35%, which he said currently offer 140 basis points over LIBOR. “We’re also positive about emerging market foreign exchange, which is biased to outperform the dollar,” he said.

Social Security ‘not going away’

George Castineiras, senior vice president, Prudential’s Total Retirement Solutions, said, “The outlook is very positive for retirement income,” pointing to the fundamentals represented by $18.5 trillion in retirement-oriented savings, the inevitable retirement of the Baby Boom generation over the next 20 years and their need for retirement income.

Regarding Social Security, he said, “The average person thinks that it will go away. It won’t go away. Americans depend on Social Security for between 30% and 70% of their income in retirement. You can’t vaporize that.” He called the status of Social Security “grossly misunderstood” and feared that this misunderstanding might motivate too many retirees to start their benefit at age 62 and lock in a minimum payout for life.

Prudential Retirement is of course a big player in the defined contribution plan business, serving some 3.6 million participants and annuitants in more than 4,200 plans with accounts worth about $240 billion.

The big trend in DC plan is automation, he said, referring to automatic enrollment, automatic investment selection, automatic escalation of contributions and automatic income planning (default into a lifetime withdrawal benefit wrapper around target-date fund assets).

To succeed in the DC business, he said, a service provider has to be good at administration, risk management and employee engagement. “Right now, engagement models are bad,” Castineiras said—a reference to the still-evolving regulations intended to govern communication between 401(k) service providers and participants and ensure that participants get unbiased advice about their savings.

How TOPS Avoids Bottoms

Posted on January 16, 2013 by Kerry Pechter -

A funny thing happened in the U.S. equity markets late last May. Jitters about a possible Greek exit from the Eurozone spooked investors. Stocks plunged. S&P volatility spiked. And on the dashboards of certain “managed volatility” funds, red lights flashed.

Among those risk-managed funds were the three TOPS Protected ETF Portfolios that Ohio National, Nationwide and Minnesota Life use to buffer the market risk inherent in the relatively generous lifetime income guarantees of their variable annuities. Without the risk-controls in those funds, in fact, those benefits probably wouldn’t be sustainable in today’s stingy rate environment.

Managed by Valmark Advisors and sub-advised by Milliman, the TOPS Protected ETF Portfolios employ a dynamic short-futures strategy designed to deliver 60% to 70% of the market’s upside during peaceful bull markets while making “drawdowns” shallower.

But the strategy is vulnerable to the kind of head-fake that the equity market put on it last spring, one that can be seen in the red and black chart below (courtesy of Doug Short of Advisor Perspectives). The chart overlays the history of the S&P500 and the VIX volatility index during the past two years, and illustrates the conditions that the portfolios had to weather.

The third-quarter 2011 market correction can be see at left, where the red VIX lines rise above the black S&P500 lines. Farther to the right, in May and June 2012, there were similar hints of an impending correction, but it was a false alarm. Volatility lapsed and the S&P500 recovered. Stiill, the signs temporarily fooled the TOPS Protected strategy, slowing the portfolios’ performance last year.

“Volatility did spike in the early summer of last year,” Doug Short told RIJ. “So I’m not surprised that some funds got whipsawed in 2012 in their read of the VIX and similar volatility indicators. They were expecting a selloff similar to the year before.”

By the end of 2012, all three TOPS Protected ETF Portfoliios (Balanced, Moderate Growth and Growth) had topped their benchmarks (the S&P Daily Risk Controlled 8%, 10% and 12% Indices, respectively) with returns of 8.39%, 8.66% and 8.24%, but not before the industry began to buzz with gossip that these relatively new-to-annuities TOPS portfolios had been a disappointment in a year when the S&P 500 returned 16%.

“We heard the buzz last year, and we fought it as much as we could,” said Michael McClary of Valmark, an Akron, Ohio-based securities firm that is better known in the ETF world than the mutual fund world. “But it took on a life of its own.”

Gauging the performance and appeal of managed volatility funds is both important and difficult. It’s important because VA issuers can ill afford to offer GLWB riders with generous roll-ups to retiring Boomers unless the contract owners bear some of the market risk—by agreeing to put all or part of their premia in low-volatility investment options.

Yet it’s difficult to compare the various competing managed volatility funds, because they come in so many different flavors. They hold different types of assets, use different risk-management methods, have different objectives and cost structures, and track different benchmarks. And they are so new to the variable annuity space that it may be too soon to evaluate them meaningfully. Morningstar, for instance, doesn’t have a managed volatility fund category yet.

Short futures strategy

The TOPS Protected ETF Portfolios themselves are only about 18 months old. They benefit from a strategy created by Milliman over a decade ago for institutional portfolios. The strategy involves using part of the fund’s own assets to enter short equity-ETF futures contracts. The futures appreciate in value when equity prices fall, and their value offsets the paper losses of the fund’s equity holdings.

“We can still be at an 85/15 allocation, but the short futures could give us an effective allocation of 65/35,” McClary told RIJ. The manager doesn’t have to sell equities and, because losses haven’t been locked in, the technique makes the fund less likely to miss out on the next market rebound.

“The mandate of these portfolios is to manage to a risk level directly by dynamically shifting the hedge position for changes in volatility and increased downside exposure,” said Adam Schenck of Milliman. “We expect the portfolios to capture a significant portion of the upside of protracted bull markets, which play out over many years. What we saw over 2012 was an unusual bull market scenario.”

“We will trail during high volatility bull markets. May 2012 was a down month, but we were still well ahead of the benchmarks heading into June 2012,” McClary said. As volatility spiked, “we de-allocated during that period. Then the market shot right up. It was a short-term high volatility bull market. There’s nothing we can do in that situation.

“That type of situation doesn’t carry on for a long time, and [the slightly lower returns] is not something that will change your standard of living. But that’s not the risk we’re protecting against. We protect against high-volatility bear markets and long-term bear markets. We finished with an 8.2% gain and a beta of 0.24 on our balanced model.”

At the end of 2012, TOPS Protected Moderate Growth held about 30% fixed income, 60% equities and 10% cash. The Growth portfolio had a 76.5% equity allocation at the end of 2012. The Balanced portfolio had a 40% equity allocation. The portfolios also enter into short futures contracts tied to the “Mini” versions of the MSCI EAFE Index, the S&P500 Index, the Russell 2000 Index, the S&P Midcap 400 Index and the MSCI Emerging Markets Index.

In the bond portion, TOPS’ biggest exposures were to TIPS, high quality corporate bonds and high-yield bonds through iShares ETFs. In the equity portion, the holdings were a smorgasbord of largely Vanguard, iShares and SPDR ETFs in a wide range of regions, sectors, and styles.

Apples and oranges

Certain other “managed volatility” funds outperformed the TOPS Protected Portfolios last year, but they had different holdings. For instance, the BlackRock Managed Volatility Fund, classified by Morningstar as a Moderate Allocation Fund, held about 50% equities, 38% bonds and 12% cash as of October 31, 2012. It returned 12.27% in 2012, according to vanguard.com, or about 2% behind the Morningstar Moderate Allocation.

It had a turnover rate of 324% over the past three years and a beta of .80 (vs the Morningstar Moderately Aggressive Target Risk), compared to the TOPS Protected Moderate Growth’s beta of 0.28 and turnover of 7%, according to Morningstar. SEI’s Managed Volatility Fund, classified as a Mid-Cap Blend fund, also returned just over 12%. But that’s an equity fund. PIMCO’s Global Multi-Asset Managed Volatility Portfolio, launched last September, is too new to evaluate.

Two charts from Morningstar.com show the behavior of the TOPS Protected Funds over the past 18 months. In the chart directly below, which shows the change in the value of a hypothetical $10,000 in the TOPS Protected Growth portfolio from June 9, 2011 to December 25, 2012, it’s evident that the TOPS portfolio fell much less than the Morningstar Aggressive Allocation benchmark in the 3Q 2011 downturn. It’s also evident that the TOPS portfolio performance nearly matched that benchmark in mid-2012, but lagged that benchmark in the following rebound.

A second chart (below), compares the progress of a hypothetical $10,000 in TOPS Protected Moderate Growth with that of the BlackRock Managed Volatility Fund (Institutional). Their performance diverges in mid-2012, with the TOPS portfolio falling behind during the second half of the year before closing the gap at the end of 2012.

One satisfied insurer

Annuity executives at Ohio National, the Cincinnati-based mutual company that was the first to offer TOPS Protected portfolios as a variable annuity investment option, said they are satisfied with the results that the funds produced in 2012. The company’s VA sales in 2012 totaled $2.8 billion. Overall, the insurer manages $30.6 billion.

Not knowing if customers and advisors would embrace the trade-offs of the relatively untested managed-volatility investment requirement, Ohio National originally offered two GLWB options last January; the richer option one required putting at least half of the premium in managed volatility investments.

“We got acceptance faster than we expected. The wholesalers got some feedback at first. People were a little nervous. They were asking, ‘Is it working as advertised?’ But now the story is accepted,” said Jeff Mackey, FSA, assistant vice president, Annuity Product Management at Ohio National. The story has been accepted well enough that Ohio National was able to eliminate the less-rich living benefit rider entirely.

Steve Murphy, FSA, Ohio National’s senior vice president, Capital Management, told RIJ, “We thought we would need the other rider for 2012 and 2013, but we’ve closed that one, which indicates that the marketplace likes the story. People buy the product for protection.

“And even though they know their benefit base is protected [by the GLWB], they still feel bad if their account value goes down. This strategy [which buffers falls in account value] provides both belt and suspenders. This story has definitely sold well in the marketplace. We had trouble keeping a lid on sales. We de-risked five times last year and still had no problem with sales,” he added.

Mackey told RIJ, “We think these are a good fit for account holders, for advisors who want a stable trail income, and for us on our balance sheet. They give us more stable earnings. It really has performed as expected and we’re pleased.

“You have to be careful about looking at narrow performance windows,” he added. “These are long-term investments. The time horizons are 30-plus years out, so to look at their performance over a week or a month is a bit shortsighted.

“Also, you have to remember that these portfolios are designed to mitigate severe downturns. There’s no free lunch here. There will be periods where it could underperform. But if you want the extra protection, you might have to give up something on the upside.”

High stakes

The stakes here are measured in billions of dollars, as fund companies compete to offer managed volatility investments to life insurers, as life insurers compete to offer appealing retirement income products to Boomers (despite market, interest rate, and longevity risk constraints), and as retiring Boomers struggle to squeeze more income—and peace-of-mind—out of their savings.

One indication of the level of competition among asset managers: Last November, a person who did not fully identify himself e-mailed RIJ a highly critical two-page review, dated October 1, 2012, of Milliman’s TOPS Protection method apparently written by a firm called “Retirement Products Research.” RIJ was unable to trace the origin of the document, and the original sender did not respond to requests for attribution.

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