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Corporate pension funded status improved by $12.4 billion in 2011: Milliman

Milliman, Inc., has released the results of its annual Pension Funding Study, which consists of 100 of the nation’s largest defined benefit pension plans. In 2011, these plans experienced asset returns of 12.8% (a $115 billion improvement) that were offset by a liability increase of 7.7% (a $103 billion increase) based on a decrease in the discount rate.

The decline in discount rates fueled record levels of pension expense for these plan sponsors. Collectively, these pensions went into the year expecting a $30 billion charge to earnings, with the final number almost doubling that estimate, at $59.4 billion.

“This was a record year for pension contributions, though the number could have exceeded $60 billion if a few things had gone differently,” said John Ehrhardt, co-author of the Milliman Pension Funding Study.

“Pension funding relief enacted last summer helped reduce the funding burden, along with positive investment performance.  If interest rates remain at current levels (or decline), contributions will be even higher in 2011.”

While the funded status for the year changed only modestly, the year was marked by several significant events. In August, falling interest rates drove up the projected benefit obligation and resulted in a record deficit for the 11 year history of this study.

Over the course of the year, several companies adopted new accounting approaches, which involved full or substantive recognition of accumulated losses and a larger charge to 2010 balance sheets.

Had similar accounting changes been instituted across all of the companies in this study, the resultant charge would have totaled $342 billion.

Despite the eventful (and sometimes volatile) year, pension investment strategies remained relatively consistent.

“For the year, the asset allocation of these 100 pension plans did not change significantly, as investment in equities only decreased from 45% to 44%,” said Paul Morgan, co-author of the Milliman Pension Funding Study. “Fixed income allocations were unchanged at 36%, but allocations to other (alternative) investments increased from 19% to 20%. On average, there were not many changes, though we did see eight of the 100 companies decrease their equity allocations by more than 10%.”

Morningstar gives just six fund families an “A” for stewardship

Morningstar, Inc. released the findings from its 2011 Mutual Fund Stewardship Grade research study, which evaluated more than 1,000 funds from more than 40 fund families on how well each fund treats its fund shareholders’ capital.

The study calculated an average Stewardship Grade for all of the funds it grades within 44 different fund families. Six fund families currently earn an average overall Stewardship Grade of “A”: American Funds, Clipper, Davis, Diamond Hill, Dodge & Cox, and PRIMECAP.

Average overall Stewardship Grades of “B” are assigned to another 16 fund families, and 17 fund families receive “C” grades. Five fund families receive “D” grades in the report. No fund family currently receives an average overall Stewardship Grade of “F.”

Grades assigned to fund families                                by Morningstar, Inc.

 “A”

“B”

“C”

“D”

American Funds

Bridgeway

Allianz

Alliance Bernstein

Clipper

FPA

Artisan

ING

Davis

Franklin

Aston

John Hancock

Diamond Hill

Harbor

BlackRock

Principal

Dodge & Cox

Invesco

Columbia

Putnam

PRIMECAP

Janus

DWS

 

 

JPMorgan

Federated

 

 

Longleaf

Fidelity

 

 

MFS

Legg Mason

 

 

Osterweis

Neuberger Berman

 

 

Perkins

Oppenheimer

 

 

Royce

PIMCO

 

 

T. Rowe Price

RiverSource

 

 

Thornburg

Sentinel

 

 

Vanguard

TCW

 

 

Weitz

TIIA-CREF

 

 

 

 

 

Source: Morningstar Inc.’s 2011 Mutual Fund Stewardship Grade Research Paper

The study looked at how funds have performed since Morningstar first issued its Stewardship Grades in 2004 and again after the company revised its Stewardship methodology in 2007.

It concluded that funds with high Stewardship Grades (those receiving grades of “A” or “B”) are very likely to survive in the long-term, and more likely to provide competitive risk-adjusted returns in the ensuing period.

For purposes of the study, funds are considered successful if they have a Morningstar Rating of three stars or higher, a metric that broadly measures whether a fund’s shareholders have fared well relative to peer funds on a risk-adjusted basis. Funds were deemed unsuccessful if they received a Morningstar Rating of two stars or lower or if the funds did not survive.  

Morningstar uses five major criteria to arrive at a Stewardship Grade: the corporate culture of a fund’s parent organization; the quality of the board of directors overseeing the fund; the fund managers’ financial incentives; the fund’s fees; and the fund firm’s regulatory history.

Morningstar analysts assign each component an individual grade, and combine the scores to provide an overall Stewardship Grade. Funds that are determined to be the best stewards of capital receive an “A” grade, while the worst receive an “F.”  Morningstar currently assigns Stewardship Grades to more than 1,000 of the approximately 1,750 funds that its analysts actively follow.

The study found that of the funds Morningstar graded in 2004 and 2007:

  • About 99% of funds that received “A” Stewardship Grades survived.
  • More than 80% of the funds earning grades of “A” or “B” in 2007 had competitive risk-adjusted returns relative to their peers.
  • Approximately one-third of funds receiving an “F” grade in 2004 didn’t survive to today.
  • About one-quarter of funds receiving a “D” grade were liquidated or merged away.

Other positive correlations include:

  • Approximately 87 percent of funds that earned “A” grades for corporate culture in 2007 were successful in the ensuing period;
  • Managers who have their own financial incentives aligned with fund shareholders had good results—more than 75 percent of the equity funds earning “A” grades in 2007 in the manager-incentive category were successful in the ensuing period;
  • Funds with low fees had the best risk-adjusted returns, primarily over long-term periods.

Among all current fund evaluations, the most common Stewardship Grade is a “C,” which Morningstar assigns to 455 funds. On the high end of the scale, 90 funds currently earn an “A” overall grade and 359 funds receive a “B.” On the lower end, 145 funds currently receive a “D,” and just two funds receive an overall Stewardship Grade of “F.”

Morningstar assigns Stewardship Grades only to funds that Morningstar analysts actively follow, meaning an analyst reviews and writes an analysis on the fund at least once per year. Every one to two years, the analysts review and update the Stewardship Grades for the families’ funds that are listed below.

The overall grades are based on the sum of the points associated with each of the five methodology areas: corporate culture, board quality, manager incentives, fees and regulatory history. The maximum Stewardship Grade score is 10 points, with corporate culture contributing up to 4 points; board quality, manager incentives, and fees each contributing up to 2 points; and regulatory history contributing up to 0 points but as low as negative 2 points for funds with poor regulatory histories.

 

 

The Bucket

Janus hires Malinsky as regional retirement director for the Financial Institutions team

Janus Capital Group Inc. has appointed Mike Malinsky to be regional retirement director of Financial Institutions. He reports to Chris Furman, vice president and managing director of Financial Institutions.

Malinsky will partner with divisional managers and wholesalers in the insurance industry to promote Janus’ strong product options. He will also be responsible for facilitating sales, servicing and strategy implementation within the Financial Institutions team.

Malinsky had been vice president and funds manager at Genworth Financial. He has more than 17 years of experience in the financial services industry, including 11 years with Genworth. He managed all mutual fund relationships within Genworth’s variable annuity and group annuity policies, which represented approximately $12 billion of assets under management. 

Malinsky earned a bachelor of science degree in finance and a master of business administration from Virginia Commonwealth University.

ING hires Cruz to lead individual retirement investor channel

ING has named Orlando R. Cruz as president of its Individual Retirement Investor Channel.  Reporting to ING Individual Retirement CEO Lynne Ford, he will lead a team responsible for providing phone-based guidance and support to both new and existing ING customers looking for help with their retirement savings and income needs.  

Cruz had been at Wells Fargo, where he most recently served as senior vice president and head of internal retirement consultant program for its Retail Retirement Group. In this capacity he led a team whose members were the “advisors’ advisors” for retirement and guaranteed income planning.

In more than 20 years at Wells Fargo and its predecessor companies, Cruz served as senior vice president and director of the internal retirement consultant program, as national sales manager of offshore products, as Southern Divisional sales manager of the field-based retirement consultant program, and as director of global and intermediary distribution.  He has extensive experience with retirement and insurance product distribution in the U.S., Latin America and Europe as well as experience with institutional products, including 401(K) retirement plans.

Cruz earned a bachelor’s degree in finance from the University of Miami, and a certificate from SIFMA’s Securities Industry Institute at The Wharton School.  He is a general securities principal and investment advisory representative holding FINRA Series 7, 9, 24 and 63 licenses.  Cruz also serves on the membership committee of the Insured Retirement Institute (IRI).

AXA Equitable offers turn-key service for small, mid-sized plans

AXA Equitable Life has launched Retirement Gateway, a group variable annuity, to fund retirement plans for the small- to mid-size market. Nick Lane, president of the Retirement Savings division of AXA Equitable, described it as a full service retirement benefit for plan sponsors.   

Retirement Gateway includes a broad range of investment options; fiduciary support; administration support and service; and ongoing, interactive and customizable employee education and service. In addition to the traditional 401(k) plan, Gateway supports other retirement benefit plan types including profit-sharing, age-weighted/new comparability plans, money purchase plans, Safe Harbor plan provisions and a Roth 401(k) feature.

Gateway gives plan sponsors more than 100 investment options from well-known fund families and all major investment categories.

Options include:

  • A choice of Target Date and Risk-Based Asset Allocation Portfolios for investors who want a one-step approach.
  • Individualized investment options that include active, passive (index) and multi-manager styles for those who want to take a more active role in managing their portfolios.
  • A Guaranteed Investment Option (GIO) with a guaranteed fixed rate of return.
  • A Stable Value Fund that offers potential for principal protection with investment diversification.
  • Automatic Asset Rebalancing, a feature that periodically rebalances an employee’s account so the ratio of stocks to bonds resets to the account’s target asset allocation.

Gateway’s investment options can satisfy Safe Harbor provisions under ERISA Section 404(c) provisions, including Qualified Default Investment Alternatives (QDIAs) – the default investment options when employees do not indicate how they wish to invest.

Plan sponsors can choose from co-fiduciary or full fiduciary services for investment selection and monitoring offered by an independent third-party investment advisory firm. Sponsors receive quarterly plan reports including investment updates, a model investment policy statement, a performance summary, a review of investment alternatives, a summary of changes and additions, and an investment watch list.

The plan also offers a choice of bundled and unbundled recordkeeping services. With the bundled service option, an AXA Equitable retirement account manager and plan design specialist work together to create a retirement plan based on the company’s objectives and employee base. With the unbundled services, sponsors choose their own Third-Party Administrator (TPA); AXA Equitable works with the TPA to prepare compliance forms, plan testing and reports.

Gateway provides a secure web-based automated recordkeeping platform to help minimize recordkeeping tasks, increase accuracy and reduce data entry time. The platform provides extensive online reporting capabilities and enables sponsors to submit enrollment data for new plan participants; update plan information; perform numerous transactions; and access plan reports and forms.

AXA Equitable has created a proprietary education program to support the Gateway plan. An innovative, needs-based system, it is designed to aid participant’s decisions. The centerpiece is a multi-media online interactive tool that can be customized to the plan and individual participants.

Morningstar to provide mutual fund platform to eRollover

eRollover, a free online consumer destination focused on retirement planning, today announced it will provide the U.S. open-end mutual fund platform from Morningstar to eRollover members to research trailing performance, as well as the Morningstar Rating for Funds, via proprietary analytical tools.

 “This agreement with Morningstar will allow our members access to the Morningstar platform via various investment tools and screeners. Specifically, our members will be able to research mutual fund performance as well as current Morningstar Ratings for funds,” said Tim Harrington, CEO of eRollover.

eRollover was formed to fill a void in the availability of retirement planning information to the public at a time when people were frustrated over diminishing value in their IRAs and 401(k)s, and not knowing what to do, he added. “The mission of eRollover is to enable people to take control of their retirement and achieve financial independence by providing unique, independent content, so they can make informed decisions about their future.”

At eRollover, a Rollover Center enables people to  complete a 401(k) or IRA rollover.  An Education Center provides unbiased content previously not available to the general public for retirement planning. A Financial Advisor Center will provide access to professional financial advisors via an easy to use database. eRollover is headquartered in Atlanta.

Curian Capital to offer ‘income-oriented’ investment strategy

Curian Capital, LLC, a registered investment advisor that provides a fee-based wealth management platform to financial professionals, today announced the launch of the Curian Income Dynamic Risk Advantage (IDRA) Strategy.

 Designed for investors who want to generate a steady stream of income while protecting against market volatility, IDRA is available as a standalone strategy or within Curian’s new Research Select portfolios.

IDRA builds on Curian’s existing Dynamic Risk Advantage Strategy by incorporating securities that can generate income in the form of dividend payments. The strategy uses a tactical asset allocation process to shift between a group of higher-risk income-oriented investments and a lower-risk portfolio of high-quality, short-term Treasury investments. Through this process, the investor’s exposure to risk is reduced when equity markets are in decline, and increased when markets appreciate.

Curian’s Income Dynamic Risk Advantage Strategy is part of the company’s new Research Select offering, which includes two distinct sets of portfolios that focus on either asset accumulation or income distribution, and can help advisors meet a range of client objectives in a single account. The IDRA strategy is managed by Curian, with Mellon Capital Management Corporation acting as a non-discretionary sub-advisor.

Economy ‘hopelessly addicted’ to federal support: Trimtabs

The U.S. economy added 293,000 jobs in March, the sixth consecutive monthly increase, according to TrimTabs Investment Research.

“Economic growth is stronger than many forecasters and market participants realize,” said Madeline Schnapp, Director of Macroeconomic Research at TrimTabs. “Trillions of dollars in fiscal and monetary stimulus are finally producing the desired increases in growth and employment.”

She added, however, that “while the improvement is welcome, we believe the economy is hopelessly addicted to fiscal and monetary support. Growth slowed last summer after QE1 ended, and we think it could do so again after QE2 is scheduled to end in June.”

TrimTabs’ employment estimates are based on analysis of daily income tax deposits to the U.S. Treasury from all salaried U.S. employees.  They are historically more accurate than initial estimates from the Bureau of Labor Statistics.

In a research note, TrimTabs points out that various indicators suggest the economy is strengthening:

  • Wages and salaries increased an adjusted 7.8% year-over-year in March, up from 3.3% y-o-y in January and 4.7% y-o-y in February.  Moderate economic growth is characterized by year-over-year increases between 5.0% and 5.5%. 
  • The TrimTabs Online Job Postings Index was flat in March, probably because the disaster in Japan disrupted supply chains and made hiring managers more uncertain.  Nevertheless, the index is up 11.0% this year.
  • The four-week average of new claims for unemployment insurance declined to 385,250 in the latest reporting week, the lowest level since July 2008.

Vanguard announces active, multi-manager emerging markets equity fund

Vanguard has filed a registration statement with the U.S. Securities and Exchange Commission for a new actively managed emerging markets equity fund that will complement the firm’s existing emerging markets index fund.

The Vanguard Emerging Markets Select Stock Fund is expected to have an expense ratio of 0.95%, or about 40% less than the 1.68% expense ratio of the average actively managed emerging markets fund (Source: Lipper, December 31, 2010).

The fund will require a $3,000 minimum initial investment and is available only to individual investors who invest directly with Vanguard. As with many of its other international stock funds, Vanguard will assess a 2% redemption fee on shares held less than 60 days in an effort to deter short-term trading. The fee, which is not a load, is paid directly back to the fund to offset transaction costs.

The fund’s four advisors will each oversee 25% of the assets initially. They are:

  • M&G Investment Management Limited, which advises the $5 billion Vanguard Precious Metals and Mining Fund and a portion of the $18.3 billion Vanguard International Growth Fund. Portfolio managers Matthew Vaight and Michael Godfrey will use a valuation-based, return on capital-focused approach to create a portfolio with no country or sector constraints.
  • Oaktree Capital Management, L.P., which advises the $2 billion Vanguard Convertible Securities Fund. The portfolio managers, Tim Jensen and Frank Carroll, will employ a bottom-up research process to invest in a diversified portfolio, limiting exposures by country and industry to avoid concentrated bets.
  • Pzena Investment Management, LLC, which advises the $47 million Vanguard U.S. Fundamental Value Fund. (This fund is domiciled in Dublin, Ireland, and is available only to non-U.S. investors.) The firm will follow a deep value strategy to invest in stocks based on the research of the three portfolio managers, John Goetz, Caroline Cai, and Allison Fisch, supported by a team of analysts.
  • Wellington Management Company, LLP, which advises 19 Vanguard funds representing $195 billion in assets.  Portfolio manager Cheryl Duckworth, along with the deep experience of Wellington’s team of global industry analysts, will seek to add value through in-depth fundamental research.

In a recent article posted on Vanguard.com, “Practice portion control with emerging markets” (www.vanguard.com/portioncontrol), the company encouraged investors not to load up on emerging market equities.   

“Emerging markets can be an important part of an overall investment portfolio, but we suggest that investors use market capitalization as a yardstick for the appropriate amount of an investment,” said Joseph H. Davis, Ph.D., Vanguard’s chief economist.

“Today, emerging markets make up 25% of the international stock market, so we recommend that emerging markets represent no more than 25% of an investor’s international equity holdings.”

Past strong economic growth of emerging markets may not necessarily lead to strong stock returns in the future, he said. A Vanguard research paper (Investing in emerging markets: Evaluating the allure of rapid economic growth, www.vanguard.com/emresearch) published in April 2010 showed virtually no correlation between the average cross-country correlation between long-run GDP growth and long-run stock returns.

State pension reform may undermine Britain’s DB plans

Last week’s announcement by the UK Chancellor of the Exchequer that the UK will simplify its two-tier state pension to a one-tier, £140-per-week ($227) plan has roiled the providers of employer-sponsored defined benefit plans in Britain, IPE.com reported.

The new reforms will disrupt the practice of “contracting out,” whereby employees could contribute to a workplace DB plan instead of making full contributions to the second-tier of the state pension, consultants warn.

Pension experts at Aon Hewitt and PwC expect that the end of contracting-out will increased the costs of DB plans by about 3.4% of employees’ salaries and lead to the closure of the few remaining DB schemes. 

Marc Hommel, pensions partner at PwC, said: “The end of this incentive will make up the minds of those few remaining employers to accelerate defined benefit closures.”

Paul McGlone, principal consultant at Aon Hewitt agreed, saying those employers that had not yet closed their DB schemes had not done so because of the complexity of such a step.

“The danger with the proposal to abolish contracting-out is that, if companies are going to have to go through a painful consultation process anyway, then they may take the opportunity to simply close the scheme at the same time and use other arrangements to fulfill their forthcoming auto-enrolment obligations,” he said.

Did Income Inequality Cause the Crisis?

The disparity between the incomes of the wealthiest Americans and the incomes of the rest—especially the 180 million folks in the lowest three wealth “quintiles”—has widened over the past three decades. Lots of evidence shows this.

That widening has coincided with: a) bull markets in equities and bonds; b) ballooning public and personal indebtedness; c) a halving of the marginal tax rates on the highest earners (69.125% in 1981 to 35% in 2003).

Hmm. Are there causal links among those phenomena, or just associations? Lately, as the country has struggled to find solutions (or scapegoats) for its massive debt and deficits, that question seems worth asking. 

A recent paper, “Inequality, Leverage and Crises,” by Michael Kumhof and Romain Ranciére of the International Monetary Fund, provides some answers. The authors describe a mechanism whereby, just as the cycle of freezing and thawing splits pavement, a cycle of lending and borrowing worsens income disparity. 

Here’s how Kumhof and Ranciére explain our recent economic history:

“The key mechanism is that investors use part of their increased income to purchase additional financial assets backed by loans to workers. By doing so, they allow workers to limit their drop in consumption following their loss of income, but the large and highly persistent rise of workers’ debt-to-income ratios generates financial fragility which eventually can lead to a financial crisis,” they write.

“Prior to the crisis, increased saving at the top and increased borrowing at the bottom results in consumption inequality increasing significantly less than income inequality. Saving and borrowing patterns of both groups create an increased need for financial services and intermediation.

“As a consequence the size of the financial sector, as measured by the ratio of banks’ liabilities to GDP, increases. The crisis is characterized by large-scale household debt defaults and an abrupt output contraction as in the 2007 U.S. financial crisis.”

Sounds familiar, doesn’t it?  The downward spiral was also driven by our economy’s dependence on personal consumption and the country’s failure to put borrowed money to more productive uses:

“With 71% of the economy’s final demand coming from workers’ consumption, this output cannot be sold unless a significant share of the additional income accruing to investors is recycled back to workers by way of loans. With workers’ bargaining power, and therefore their ability to service and repay loans, only recovering very gradually, the increase in loans is extremely persistent.

“If a large share of the funds is invested productively, higher debt is more sustainable because it is supported by higher income. If instead the majority of the funds goes into investors’ consumption, or into loan growth, in other words an increasing “financialization” of the economy, the system becomes increasingly unstable and prone to crises.”

The least effective solution to the crisis, the authors claim, would be the bailouts that we’ve seen, because they perpetuate the conditions that caused the crisis. A better long-term solution, they say, would be to reduce the debt load and increase the purchasing power of rank-and-file citizens. Inequality of income hurts the rich, the poor, the economy and the country.  

© 2011 RIJ Publishing LLC. All rights reserved.

When Herds Get Overconfident, Run for Cover

There are about as many explanations for the financial crisis as for the Kennedy assassinations. Fear and greed undoubtedly played their usual parts, along with faulty economic models, moral hazard, and bad monetary policy.

That’s just for starters. Misplaced incentives, ineffective corporate governance, lax regulation, and, if you’re conspiratorially minded, fraud and political corruption may also have acted in supporting roles.

What about plain old human psychology? A new whitepaper by Steve Utkus of the Vanguard Retirement Research Center proposes a model that describes the life cycle of a typical financial bubble. He also uses a term that seems to be coming into wider usage:  “representativeness heuristic.”

Utkus’ paper, “Market bubbles and investor psychology,” divides a financial bubble’s life into four stages.

  1. Initial errors in statistical inference caused by the representativeness heuristic.
  2. The emergence of skewed forecasts because of overconfidence and excessive extrapolation.
  3. The amplification of these views through a “risky shift” or group polarization process across the financial system.
  4. The resetting of forecasts to an excessively cautious view.

1. Initial errors in statistical inference caused by the representativeness heuristic.

In the final seconds of a tie basketball game, whom should the coach choose for the last shot: the player with a hot hand tonight or the player with the highest shooting percentage for the season?

Tough call, right? If you choose the hot hand, you might be blinded by the representativeness heuristic. To illustrate this phenomenon, Utkus uses the analogy of a carnival game:

In the game, people are asked to estimate the proportion of black and red balls in a container based on two sample withdrawals. Person A draws out 20 balls, 12 of which are black. Person B draws out five balls, four of which are black.

Experiments show that people put greater weight on the smaller sample with the stronger pattern.  “Player B is the person we most believe in because of the strength of his apparently nonrandom outcome,” Utkus writes. “He has what we call a ‘hot streak’ in sports or a ‘hot hand’ in cards—winning four of five games, as it were.”

This type of illusion encourages return chasing, where investors follow the hottest mutual fund managers. It also tends to make  people over-optimistic at the beginning of a bubble. 

“Applying the representativeness heuristic to the mortgage problem is straightforward,” Utkus writes. Consider “a mortgage analyst estimating default rates on mortgage securities. By analogy, the container is the housing market and mortgage finance system. Player A is the long-term track record of prime mortgages. Player B is the recent short-term track record of subprime or exotic (such as interest-only or negative amortizing) mortgages.

“The mortgage analyst tends to assign to the subprime and exotic mortgages some of the general characteristics of prime mortgages, which dominate the container. In addition, the analyst overlooks the fact that the sample size of subprime and exotic mortgages is consistently smaller and so may not have the statistical validity of a larger, longer-term series.”

2. The emergence of skewed forecasts because of overconfidence and excessive extrapolation.

Over-confidence is endemic, inside and outside the financial system, especially among males, Utkus says. Just as a strong majority of Frenchmen regard themselves as above average lovers, most CEOs regard themselves as above-average among their peers. This leads to overconfidence and straight-line forecasting based on a recent positive returns.

“Our mortgage analyst may start with a forecast default rate on mortgages modeled by a normal distribution with an expected value of 5%. Based on recent mortgage data showing below-average default rates, the forecast begins to shift to the right, with now 5% the maximum expected default rate.

With additional short-term positive information, the forecast becomes centered on

a 0% default rate, with only a low probability of any modest level of defaults. It is through such a dynamic that forecasts of future asset values—whether mortgages or Internet stocks or other financial instruments—become increasingly skewed to the positive.”

3. The amplification of these views through a “risky shift” or group polarization process across the financial system.

The phenomenon of herding, where market participates go lemming-like over a cliff together, is typical of bubbles, Utkus writes. Herding is related to “group think,” which leads to a still-sketchy phenomenon he calls “group polarization.” It’s characterized by a  “collective shift to riskier behavior in the system as a whole.” Mobs, in other words, are capable of acts that no individual or small group would commit. 

4. The resetting of forecasts to an excessively cautious view.

While pessimism turns to optimism very slowly after a bear market, over-optimism during a bubble can turn into over-pessimism with all the speed and force of a sailboat’s boom during an unanticipated jibe. 

“The recalibration phase is the reassertion of more rationally grounded expectations for the future. Market participants come to recognize that their forecasts of the future were unduly positive and revise their expectations accordingly. Depending on how overly optimistic the assumptions had become, the size of this change could be substantial,” Utkus writes.

What can be done to prevent bubbles, or at least to avoid being sucked into believing in one? Experience, expert advice, disinterested perspectives, and especially a focus on long-term investment performance rather than short-term volatility, are ways to avoid a roller coaster ride in the markets, he suggests.

While analyzing bubbles through a psychological prism, Utkus acknowledges that lots of factors can help inflate them. His list of suspects for the recent crisis: “excessive profit-seeking by mortgage originators, bankers, and rating agencies; a lack of institutional investor or homeowner foresight in evaluating the risks of mortgage instruments; differences in sophistication or experience between mortgage originators and homeowners, or between underwriters and investors; misaligned incentives for government-sponsored mortgage agencies; and alleged fraud and deception by various parties in the mortgage process.”

© 2011 RIJ Publishing LLC. All rights reserved.

Profits, Politics and the Ruin of Fannie & Freddie

The following excerpt from “Guaranteed to Fail” is reprinted with permission from Princeton University Press and from the authors, Viral Acharya, Matthew Richardson, Stijn van Nieuwerburgh and Lawrence J. White. 

Selection 1: The Race to the Bottom

While there is little doubt that the housing goals played an important role in shifting Fannie Mae and Freddie Mac’s profile to riskier mortgage loans, it remains an interesting question whether Fannie Mae and Freddie Mac deliberately chose to increase the riskiness of the loans that they bought 2004 onward or whether they were forced to do so by the U.S. Congress, which wanted to promote home ownership.

While the public/private nature of the GSEs leads to a moral hazard problem even in normal times, the question is whether moral hazard was exacerbated by the astronomical growth of the subprime market segment.

As pointed out earlier, the GSEs saw consecutive increases in their low- and moderate-income, special affordability, and underserved areas goals in each of 1996, 1997, 2001, 2005, 2006, 2007, and 2008. However, the largest increases took place in 1996 and in 2001, outside of the rapid growth of the 2003 period and onward.

Moreover, the target increases in 2005, 2006, and 2007 were more modest, yet that is when most of the increase in riskiness took place. Finally, Fannie and Freddie missed one or more of their mission targets on several occasions, without severe sanctions by the regulator, suggesting that adherence was largely voluntary.

Former FHFA director James Lockhart testified that both Fannie and Freddie “had serious deficiencies in systems, risk management, and internal controls.” Furthermore, “there was no mission related reason why the Enterprises needed portfolios that totaled $1.5 trillion.” He chalked it up to “the Enterprises’ drive for market share and short-term profitability.” In fact, in testimony to the Financial Crisis Inquiry Commission on April 9, 2010, former Fannie Mae CEO Daniel Mudd admitted as much:

“In 2003, Fannie Mae’s estimated market share of new single-family mortgage-related securities was 45%. By 2006, it had fallen to 23.7%. It became clear that the movement towards nontraditional products was not a fad, but a growing and permanent change in the mortgage marketplace, which the GSEs (as companies specialized in and limited to, the mortgage market) could not ignore.”

Similar language can be found in Fannie Mae’s own strategic plan document, “Fannie Mae Strategic Plan, 2007-2011, Deepen Segments – Develop Breadth,” in which the company outlined its 2007 onwards strategy:

“Our business model – investing in and guaranteeing home mortgages – is a good one, so good that others want to ‘take us out’… Under our new strategy, we will take and manage more credit risk, moving deeper into the credit pool to serve a large and growing part of the mortgage market.”

The data tell the story. From 1992 to 2002, Fannie Mae and Freddie Mac were clearly major participants in high risk mortgage lending. Nevertheless, the period 2003-2007 represented a significant shift.  

For comparison purposes, we restrict ourselves to the size of mortgages at or below the conforming limit level. For example, from 2001 to 2003, for mortgage loans with LTVs greater than 80% and/or FICO scores less than 660, Fannie Mae and Freddie Mac represented respectively 86%, 80% and 74% of this high risk activity.

From 2004-2005, this changed as both the dollar volume and share of high risk lending of conforming size loans moved towards the private sector, with  $168 billion (and a 26% share) in 2003 to $283 billion (and a 52% share) in 2004 and $330 billion (and 58% share) in 2005.

Consistent with the race to the bottom, Fannie and Freddie responded by increasing their high-risk mortgage participation by recovering a majority share of 51% in 2006 and an almost complete share of the market in 2007 at 87%. Equally important, as a percentage of its own business, Fannie and Freddie’s risky mortgage share increased from 25% in 2003 to 36% in 2007.

Even more telling, if the above analysis is restricted to the very highest risk mortgage loans, i.e., those with LTVs [loan to value ratios] >90% and FICO<620, [the data] shows an almost identical “race-to-the-bottom” pattern in Fannie and Freddie’s share during the 2003- 2007 period, culminating in a doubling of these particularly risky mortgages from $10.4 billion in 2006 to $20.3 billion in 2007.

The SEC 10-K credit-risk filings of Fannie Mae are also revealing of the deterioration in mortgage loans that were purchased by the GSEs during the 2004-2007 period, either for their own portfolios or to be sold off to others. For example, 17% of the 2006 and 25% of the 2007 mortgages that Fannie bought had a loan-to-value ratio in excess of 80%.

The fraction of loans with CLTVs greater than 95% went from 5% in 2004 to 15% in 2007. The borrowers also had lower credit scores: 17.4% of 2006 loans and 18% of 2007 loans had FICO scores below 660. A relatively large share was ARMs (16.6% in 2006 and 9% in 2007) or interest-only loans (15.2% in both years). The Alt-A fraction of purchases was 21.8% in 2006 and 16.7% in 2007, up from 12% in 2004.

Finally, non-full documentation loans went from 18% in 2004 to 31% in 2007. If anything, Freddie Mac’s credit-risk profile was worse than Fannie’s. In 2004, 11% of the loans that Freddie bought had CLTVs above 100%, which increased to 37% by 2007.

Interest-only loans grew from 2% to 20%, and low-FICO-score loans from 4% to 7%. As a final indication of its all-in approach to mortgage lending in 2007, note that mortgage loans with both FICO<620 and LTV>90% reached $20.3 billion, essentially double that of any other year.

Clearly, the quality of GSE loans deteriorated substantially from 2003 to 2007. It seems that the GSEs were able to stretch the concept of a prime, conforming loan much beyond what its regulator had intended.

© 2011 Princeton University Press.

RIIA Marks a Few Milestones

At the depth of the financial crisis two years ago, Francois Gadenne, the co-founder of the Retirement Income Industry Association, had to dig deep for the industry support that would keep his then three-year-old organization alive. 

Two years later, RIIA has not only survived, but was able to mark several important milestones at its fifth annual Spring Conference, held this week at Morningstar Ibbotson headquarters in Chicago. Those accomplishments include:

  • The publication of the third edition of its “Body of Knowledge,” by Francois Gadenne and Michael Zwecher (with editorial support from Kerry Pechter, editor and publisher of Retirement Income Journal). The book articulates RIIA’s philosophy and acts as the text for candidates who want to apply for RIIA’s professional designation, the Retirement Management Analyst.
  • The publication of the first issue of the Retirement Management Journal. Edited by Robert J. Powell III, the retirement columnist at marketwatch.com. The first issue contains feature articles by Shlomo Benartzi, Ph.D., the behavioral economist, researchers Dennis Gallant and Howard Schneider, Sharon Carson of Bank of America Merrill Lynch, as well as the Journal’s first prize-winning essay, “Capturing the Income-Distribution Opportunity: A Historical Analysis of Distribution Philosophies and a Solution for Today,” by Zachary S. Parker, CFP, and Paul R. Lofties, CFP, ChFC, of Securities America.
  • The conferral of the Retirement Management Analyst designation to 50 people, and the “hope of doubling that in 2011,” according to Gadenne. 
  • The consolidation of a base of corporate sponsors that reflects the diversity of its membership. Sponsors of this week’s Spring Conference included Ibbotson Morningstar, Allianz Global Investors, Dimensional SmartNest, Guided Choice, Putnam Investments, Barclays Capital, Boston University’s Center for Professional Education, and DST Systems.

© 2011 RIJ Publishing LLC. All rights reserved.

IRIC offers guidance on selecting in-plan GMWB

In a white paper published by the Institutional Retirement Income Council, a trade group, ERISA attorneys Fred Reish and Bruce Ashton offer guidance for plan sponsors and their advisors who are thinking about adding an in-plan annuity option—specifically a variable annuity with a guaranteed minimum withdrawal benefit (such as Prudential’s IncomeFlex program or Great-West’s SecureFoundation)—to their plan’s investment options.

“The decision to offer an investment with a GMWB feature in a 401(k) plan is a fiduciary one. Not all GMWBs are the same. For this reason, before offering GMWBs, fiduciaries should engage in a prudent process to assess whether to offer such a feature and if so, which one to offer,” the attorneys write. “This paper discusses the legal standards governing a fiduciary’s decision to offer a GMWB, particularly in choosing the insurance carrier that offers the feature. It provides fiduciaries with a starting point for that process.”

Concluding that the choice of an in-plan annuity requires “a prudent decision-making process” on the part of a fiduciary, the attorneys describe the following considerations as the most relevant:

  • The current financial strength of the insurance company offering the feature; that is, at the time the decision to offer the GMWB is made, is there a reasonable basis to believe that the insurance company will be financially able to make all future guaranteed payments if it is required to do so?
  • The premium cost of the GMWB and the fees and expenses of the underlying investment option to which the feature is attached.
  • The portability of the feature – that is, portability by a participant to a different 401(k) plan if he changes jobs, the ability to continue the feature if the participant’s benefit is rolled over to an IRA, and the continued availability of the feature if the plan sponsor changes providers
  • The education provided by the insurance company so that participants can understand and decide whether it is appropriate for them – particularly with respect to the impact of withdrawals that exceed the guaranteed minimum.

CIO who timed real estate market for MetLife becomes its CEO

The board of MetLife Inc. has named Steven Kandarian –who in 2006 sold the Peter Cooper Village/Stuyvesant Town apartments in Manhattan to Tishman Speyer and BlackRock Realty for $5.4 billion – to succeed C. Robert Henrikson as president and chief executive officer. The real estate is now worth $1.8 billion.

Henrikson, who has been chairman, president and CEO of MetLife, New York (NYSE:MET), since 2006, will turn 65, the company’s mandatory executive management retirement age, in May 2012.

The MetLife board says Kandarian, who is now the company’s chief investment officer, will take over as president and CEO May 1. In April, the board will nominate him to for a seat on the board.

Henrikson will stay on as chairman until the end of the year, the board says.

Kandarian has been MetLife’s CIO since April 2005. He led efforts to diversify the company’s investment portfolio, in part by making the decision to sell the Peter Cooper Village/Stuyvesant Town development for $5.4 billion in 2006, at the market peak.

A report January 25, 2010 in Bnet.com told the story well:

“Insurers are generally known as plodders who are paid to be careful with their clients’ premiums. For them a long-term Treasury is considered a risky investment.

“So the decline and fall of prominent New York realtor Tishman Speyer and private equity firm Blackrock Inc.’s investment in two of New York City’s biggest apartment complexes deserves a closer look – especially when the winner in this game of Monopoly is MetLife the nation’s largest, and arguably one of the most conservative, life insurers.

“In the mid-1940’s MetLife developed and then owned two sprawling housing developments, Peter Cooper Village and Stuyvesant Town. But when Steve Kandarian became MetLife’s chief investment officer in 2005, recognized two things early on. First, the commercial mortgage-backed securities market had turned into a bubble, with banks underwriting bad investments and then passing them along to other investors. And second, the Peter Cooper/Stuyvesant Town holdings had become too big a part of MetLife’s overall real estate portfolio.

“So Kandarian and MetLife took steps to cut back on the insurer’s investments in risky mortgages, and put the two big real estate investments on the market.

“Tishman Speyer was quick on the draw, perhaps because the realtor and its backers believed they could rid themselves of the subsidized units and make a huge profit, according to New York magazine. They paid $5.4 billion for the two complexes at the height of the market.

“They were wrong. Tenants at the two projects took the realtor and its backers to court and fought them to a standstill. Meanwhile, New York apartment prices were hammered, as were highly leveraged deals by private companies like Blackrock that got closed out of the capital markets during the recession, according to the Wall Street Journal.   

“The two developments are now worth about $1.8 billion, according to some sources, about a third of what MetLife sold it for. And Tishman Speyer and Blackrock just defaulted on the $4.4 billion debt used to finance the project, leaving it in the hands of equity investors like the Church of England, CalPERS and The Hartford.

“In an audit of U.S. financial corporations MetLife was found to be one of the healthiest. And, at a time when other insurers held their hands out for TARP money, MetLife refused it. The $5.4 billion it got from the sale of Peter Cooper Village and Stuyvesant Town undoubtedly helped.”

In 2009, Kandarian assumed responsibility for MetLife’s global brand and marketing services department.

In July 2009, MetLife put its institutional operations, its individual operations and its auto and home unit in a single U.S. business as a result of a strategic review started by Kandarian.

In October 2009, Kandarian testified at a House Financial Services Committee hearing on efforts to develop what became components of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Kandarian was executive director of the Pension Benefit Guaranty Corp.

The Bucket

Mutual of Omaha  Adds 401(k) Wholesalers

Mutual of Omaha subsidiary, Retirement Marketing Solutions, Inc.  (RMS), has appointed two new retirement plan  wholesalers, Charles Lutzow and John McCabe, in the Chicago and Houston areas, respectively. The move increases Mutual of  Omaha’s reach in two of the largest cities in the country, Chicago and  Houston.         

The move “addresses an increasing  demand for retirement services from small and midsize plan sponsors in  Texas and Illinois,” said Chuck Lombardo, president and CEO of Retirement  Marketing Solutions.Lutzow recently served as the founder and  owner of CAL Financial Group, Inc. specializing in mergers and acquisitions  and CAL Financial, Inc. an insurance and investment firm in the State of  Illinois. 

He holds the Series 6 Investment Company/Variable Contracts Products  Limited Representative, 7 General Securities Representative, 24 General  Securities Principal, 63 Uniform Securities Agent, and 65 Uniform  Investment Adviser licenses.

Lutzow also has Life and Health licenses in  the State of Illinois. He received a bachelor’s degree from Loyola University in  Chicago. He also holds professional designations of Chartered Financial  Consultant and Certified Funds Specialist. McCabe most  recently served as a senior 401(k) wholesaler for AXA-Equitable in Houston.  Prior to that, he was the East Coast director of pensions for  Oppenheimer & Co. Inc. Retirement Services, where he specialized in  selling/closing cash balance plans with 401(k) plans to law practices and  physician groups.

McCabe began his career in 1984 with AXA-Equitable and  held numerous upper management positions with the company before moving to  Oppenheimer in 2004.  He earned his bachelor’s degree from Wake Forest University. He  has a General Securities Series 7 license and holds professional  designations of Chartered Life Underwriter, Chartered Financial Consultant  and Master of Science in Financial Services.   

 

Jackson launches Portfolio Construction tool

Jackson National Life has launched a new Portfolio Construction Tool, an interactive online solution that helps advisers build customized investment portfolios. Jackson provides a wide range of investments within its variable annuity offering, with no asset allocation restrictions. The Portfolio Construction Tool helps advisers select the mix of subaccount options that best meet their clients’ retirement income needs.

The tool, which is available for appointed producers who register on www.jackson.com, aggregates historical performance information, subaccount analytics and educational materials. A variety of interactive filters allow advisers to screen investment options by asset class, portfolio manager, investment style, expenses and performance. Advisers can to marketing and educational materials, including fact sheets, brochures and videos.

Advisers can also save and edit individual proposals, create templates for future use, and   generate summary reports to review with clients.

“Jackson’s product development philosophy has always been focused on investment freedom, choice and flexibility,” said Daniel Starishevsky, senior vice president of marketing for Jackson.  

The Portfolio Construction Tool is the latest in a series of products and services for advisers. In October 2010, Jackson introduced LifeGuard Freedom Flex, the first customizable guaranteed minimum withdrawal benefit (GMWB). In 2007, Jackson introduced the Living Benefits Selection Center, which helps advisers identify the right living benefit for clients.

 

EBRI’s 2011 Retirement Confidence Survey: Working for Pay in Retirement

How many workers expect to work for pay after they retire?

The 2011 EBRI Retirement Confidence Survey (RCS) has consistently found that Workers are far more likely to expect to work for pay in retirement than retirees are to have actually worked, according to the 2011 EBRI Retirement Confidence Survey. The age of workers planning to work for pay in retirement now stands at 74%, up from 70% in 2010.

The survey found:   

• Retirees are far less likely to report having worked for pay in retirement than workers are to say they will work. Only 23% of retirees in the 2011 RCS say they worked for pay since they retired. Moreover, very few of those who have not worked for pay in retirement think it is likely that they will return to paid employment sometime in the future (2% very likely, 8% somewhat likely).

• Large majorities of retirees who worked in retirement in the 2010 RCS say reasons for doing that include wanting to stay active and involved (92%) and enjoying working (86%). However, almost all retirees who worked in retirement name at least one financial reason for doing so (90%), such as wanting money to buy extras (72%), a decrease in the value of their savings or investments (62%), needing money to make ends meet (59%), and keeping health insurance or other benefits (40%).

• Many workers are also planning to rely on income from employment to support them in retirement. Three-quarters of workers say that employment will provide them (and their spouse) with a major (24%) or minor (53%) source of income in retirement (77%)  total, up from 68% in 2001, but statistically equivalent to 79% in 2009 and 77% in 2010).

Full details of the 2011 Retirement Confidence Survey are in the March 2011 EBRI Issue Brief and online at www.ebri.org/surveys/rcs/2011/   The RCS is conducted by the nonpartisan Employee Benefit Research Institute (EBRI) and Mathew Greenwald & Associates. The RCS, now in its 21st year, is the longest-running annual retirement survey of its kind in the nation.

 

Nationwide finds value in business coaches 

At Nationwide Financial Services, there’s apparently no contradiction between “business class” and “coach class.”

Nationwide’s top sales people can now receive training in coaching and mentoring from the Worldwide Association of Business Coaches (WABC). The insurer believes that coached helped increase variable annuity sales by 32% and first-year fixed life insurance sales by 70% in 2010.

The firm’s sales people can become Certified Business Coaches by participating in an 18-month program that involves 120 hours of in-class training, 500 hours of hands-on coaching practice, and 120 “oversight” hours in which they receive feedback from coaches who have already earned their certification.

Twenty-one sales leaders in the field and internal sales and service organizations have become Certified Business Coaches through the WABC program so far. The program was recently expanded to Nationwide’s public-sector retirement plans sales leadership.

The WABC is the first international professional association dedicated exclusively to business coaching and the only association of its kind to require advanced qualifications for membership.  

 

Nonqualified deferred compensation plans help retain key workers: Principal 

As the economy improves and key employees ponder outside offers, nonqualified deferred compensation plans can help retain them, according to a new white paper from the Principal Financial Group, How to Recruit, Retain & Retire Key Employees.  

The findings are based on a study of nonqualified deferred compensation plan sponsors and plan participants conducted with Boston Research Group. Key findings include:

  • Nearly one in five employers report nonqualified benefits have become more valuable to recruitment and retention efforts in the past year.
  • Almost all employers (97%) with nonqualified plans in place say they will continue offering these benefits next year.
  • Employees participating in nonqualified plans also say they value the plans to help reach their retirement goals. Nine out of 10 participants (91%) expect to maintain or increase deferrals in the coming year.

 “Now is the time for employers to review their employee benefits, which offer a powerful bargaining chip when convincing employees to stay put,” said Gary Dorton, vice president of nonqualified benefits for the Principal Financial Group.  

The study noted an increase in the number of mid-level managers participating in these plans (36% , up from 17%), suggesting nonqualified plans may be becoming a more mainstream benefit and no longer just for executives.

To view additional research and insight from The Principal, visit our Principal Research Center

Many advisors overlook rollovers: Cogent

Nearly half of all advisors fail to take advantage of the opportunity to manage their clients’ rollover assets, according to a new survey by Cogent Research.

But about a third of advisors, apparently more resourceful or aggressive, said they gained $5 million or more of rollover assets in the previous year. On average, these high performing advisors have an average of $128 million in assets under management.

The Investment Company Institute estimated in May 2010 (Research Fundamentals, Vol. 19, No. 3) that Americans held about $4.2 trillion in traditional or rollover IRAs, exceeding the $4.1 trillion in defined contribution plans. Together, IRAs and DC plans accounted for more than half of the $16.0 trillion in retirement assets at year-end 2009.

 “There is a group of highly focused advisors who not only build the biggest books of business, but also put their mind to winning rollover assets. They are firing on all cylinders,” said David Feltman, Cogent’s managing director for Syndicated Research.  

The highly successful “rollover advisors” convert more retirement accounts and the size of those accounts is 2.4 times larger, at $344,000, than the advisors who fall into the second tier in terms of rollover success.

The Cogent Study revealed a significant opportunity for both asset managers and advisory firms to win both IRA and ESRP (employer sponsored retirement plans) conversions.

“These assets are available to be won and those who work hardest succeed at winning them,” said Feltman. “Given the propensity of retirees to move their employer-sponsored account at retirement, these funds are a ripe opportunity.”

A year ago, Cogent reported that for the first time that it had been tracking investor allocations, wealthy Americans held more assets in IRAs than in workplace-based retirement accounts like 401(k)s and 403(b)s.  The findings were included in the report, 2010 Investor Assets in Motion: IRA & Retirement Marketplace Opportunities.

The report, based on a nationally representative sample of 4,000 affluent and high net-worth Americans, found that while ownership of both types of retirement accounts is down since 2006, ownership of workplace-based retirement accounts have decreased much more dramatically.  Since 2006 IRA ownership has slid by just 5%, meanwhile ownership of workplace-based retirement accounts has decreased by almost one quarter (23%).

It appears that the majority of dollars that investors formerly allocated to ESRPs have been funneled into IRA accounts and, to a lesser extent, bank accounts.  This shift has resulted in the proportion of assets affluent Americans hold in IRAs (31%) to surpass the proportion of assets they hold in 401(k) and other employer-based retirement plans (25%).

Domestic non-financial debt level now $36.3 trillion

Debt of the domestic nonfinancial sectors expanded at a seasonally adjusted annual rate of about 5% in the fourth quarter of 2010, after an increase of 4.25% in the previous quarter, according to the Federal Reserve’s Flow of Funds Accounts of the U.S., Fourth Quarter 2010.

Private debt edged up 1.25% at an annual rate in the fourth quarter, while government debt increased 12.75% percent.

Household debt, which declined 0.5% in the fourth quarter, has contracted each quarter since the first quarter of 2008. Home mortgage debt fell at an annual rate of 1.25% in the fourth quarter, compared to an average decline of more than 2.5% percent during the previous four quarters. Consumer credit rose at an annual rate of 2%, retracing the previous quarter’s decline.

Nonfinancial business debt rose 3.5% in the fourth quarter, on the heels of a 2.25% increase in the third quarter. Corporate bonds outstanding posted strong increases in both the third and fourth quarters, more than offsetting declines in commercial mortgages and commercial paper outstanding.

State and local government debt rose about 8% at an annual rate in the fourth quarter, after a 5.5% increase in the third quarter. Federal government debt increased at an annual rate of 14.5% percent in the fourth quarter. For 2010 as a whole, federal government debt grew a bit more than 20%.

At the end of the fourth quarter of 2010, the level of domestic nonfinancial debt outstanding was $36.3 trillion; household debt was $13.4 trillion, nonfinancial business debt was $11.1 trillion, and total government debt was $11.9 trillion.

Household net worth was an estimated $56.8 trillion at the end of the fourth quarter, up about $2.1 trillion from the end of the previous quarter.

RIIA ‘Gets’ Open Architecture

Open architecture is arguably the key to growth in the retirement income business. Choice and transparency, which now drive the markets for cars, books and shoes, etc., are starting to drive the markets for investments, advice and annuities.

Few financial services trade organizations seem to understand this better than the Retirement Income Industry Association. You can read it in RIIA’s slogan, “The view across the silos,” and hear it in the noisy diversity of viewpoints at its conferences.

The latest of those conferences—RIIA’s fifth annual Spring Conference—was held this week at Morningstar-Ibbotson headquarters in Chicago. Attended by just 150 (but sold-out), it was an occasion for networking, new product presentations, and for marking RIIA’s achievement of a couple of important milestones.   

What follows are jottings-down of conference factoids and observations. Certain topics—breaking news from Putnam Investments CEO Robert Reynolds and publication of the third edition of RIIA’s “Body of Knowledge—are handled in the accompanying feature articles.

 

Updates on products and services

Leo Clark, director, Barclays Capital, talked about Barclays Notes for the second time at a RIIA conference. The notes promise to provide 10 or 20 years of flat or inflation-adjusted income for retirees. They compete with fixed-period income annuities and with the fixed-period TIPS-based payout funds currently marketed by PIMCO.

So far Barclays Notes haven’t gotten much traction in the marketplace well and have been met with some skepticism by attendees at both RIIA conferences. One attendee suggested that Notes are a mass-affluent product that is mismatched with Barclays’ traditional high-net worth market.

Others find Barclays Bank, which guarantees the Notes, to be a less credible guarantor than an insurance company. Still others characterized the product as simply “lending money to Barclays” as opposed to using Barclays as a traditional financial intermediary.

Larry Kiefer, systems officer at DST Systems, which designs software and builds systems for 401(k) recordkeepers and other clients, talked about his company’s plans to solve some of the technical problems that discourage plan sponsors and recordkeepers from offering annuity options to participants. 

In the third quarter of 2011, his company plans to launch a platform or hub that would connect multiple insurance product providers to 401(k) recordkeepers, participant websites, and call centers.

The hub, which Kiefer called a “field of dreams” project because DST plans to build it in hopes that customers will come, would allow recordkeepers to offer more than one insurance product without having to build a separate system to interface with each insurer, and would allow recordkeepers to switch providers more easily and less expensively.

Jerry Bramlett, vice president and head of U.S. institutional sales and marketing of Dimensional SmartNest, described the Dimensional Fund Advisors’ entry  into the increasingly competitive market for managing the accounts of plan participants as they transition from accumulation to distribution.   

SmartNest will be officially launched later this year. It was created a few years ago by a team led by Nobel Laureate Robert C. Merton, and has been used by companies in Europe. It will be a topic of future RIJ stories.

Bramlett’s discussion was juxtaposed with presentations by Sherrie Grabot of GuidedChoice, the 401(k) advice provider that recently launched GuidedSpending, an income program for 401(k) participants without managed accounts, and by David Ramirez, portfolio manager at Financial Engines, which recently launched Income+, a managed account income planning program with which SmartNest will apparently compete.  

 

A health care cost monster of our own creation

A panel of health experts and one speaker, Charles Baker, former Harvard Pilgrim Health Care CEO, had scary things to say about the impact of rising health care costs on retirees and on the nation at large.

Baker expected growth in health care costs to continue to outpace inflation and GDP growth in coming years. The larger the health sector grows, he said, the more entrenched and influential the health care industry lobby will be, making it increasingly harder to make the disruptive changes that are necessary to slow the growth in health care spending, now at about 16% of GDP. 

Asked what he would do if he were “health czar,” Baker, who ran unsuccessfully for the governorship of Massachusetts in 2010 as a Republican, said he would shift Medicare’s emphasis on reimbursement for high-tech procedures to an emphasis on “cognitive care.”

“What Medicare pays for is where the industry goes. It’s the chassis on which the whole health care system sits,” he said. He would also shift the emphasis of medical education to a team-orientation from an individual orientation.

Physician Bryan Negrini, warned that Alzheimer’s disease will become increasingly prevalent as the U.S. population ages, at much greater cost. The cost of long-term care for someone with Alzheimer’s will come on top of the estimated $250,000 or more that couples should expect to have to pay out-of-pocket for health care during retirement.

 

The 80:20 rule, as applied to household incomes

Doug Short, a retired IT professional whose steady, constantly updated production of stock market historical charts attracts some 2.7 million visitors to his website, dshort.com, gave a presentation called “The Retirement Puzzle in an Age of Uncertainty.”

His slides showed the somewhat startling widening of income growth disparity between the highest-earning 20% of U.S. households, and especially the highest-earning 5%, and the other 80%.

Starting in 1985, and roughly following the contours of the subsequent bull market in equities and bonds, the real incomes of the top 5% roughly doubled, to $300,000. The average incomes of the top 20% rose about 70%, to $170,000. Income growth at lower quintiles was increasingly flat.

Given that by 2001, the top 2.7% of households owned 58% of publicly-traded stock, that may be no mystery—although the relationship between equity ownership and income growth isn’t transparent. It could have something to do with the huge growth of compensation through stock options. The divergence of income also coincided with the rise of U.S. government debt, the 401(k) system, and tax reduction, Short noted.

© 2011 RIJ Publishing LLC. All rights reserved.

Putnam’s Man with a Plan

Since moving from Fidelity in 2008 to run Putnam Investments—the two firms are only a short stroll apart along Water St. in Boston—Robert Reynolds has been vocal and visible in raising Putnam’s profile in the retirement income space. 

On Tuesday, the frequently flying Reynolds stumped for Putnam in Chicago, where he spoke at length from a prepared text at the Retirement Income Industry Association’s annual conference, held at Morningstar-Ibbotson headquarters.

Reynolds had plenty to say. His speech coincided with his firm’s announcement of a “suite of income-oriented funds that aim to help advisors work with retirees in developing strategies for monthly income flows, at varying levels of risk tolerance, to flexibly address their changing lifestyle financial needs throughout retirement.”

He said a prospectus for the funds was filed with the SEC earlier this week and the funds, along with a planning tool for participants and advisors, will be available in the middle of this year.

He also slightly surprised the RIIA audience—about 150 executives and professionals from many silos of the retirement industry—by calling for a new regulatory body called the “Lifetime Income Security Agency,” or LISA. As an acronym, “it beats PBGC,” Reynolds said.

LISA, he said, would vet retirement income products, establish a “risk-based national insurance pool” to be funded like the Federal Deposit Insurance Corporation and discourage products that make “unsustainable promises that lower the public’s trust.”

Reynolds also railed at deficit hawks in Washington who regard the tax incentives for savers as “tax expenditures” that are costing the Treasury money. He warned of an imminent attack on the deductions for contributions to IRAs and 401(k) plans. “The torpedo is already in the water,” he said.

Putnam’s retirement income solution appears to revolve around a systematic withdrawal calculation tool that advisors can use when helping their clients draw a non-insured, non-guaranteed income stream from a portfolio of Putnam’s  RetirementReady target date funds with its existing Absolute Return funds. (The latter aren’t to be confused with true absolute return funds that use long-short positions, derivatives and leverage to achieve their returns.)    

Reynolds said the new offerings were filed with the Securities and Exchange Commission on March 22. The suite consists of three Putnam Retirement Income Funds, called Lifestyle 1, Lifestyle 2, and Lifestyle 3.

According to Putnam’s press release:

  • Lifestyle 1, the suite’s retirement income conservative option, will be the new name of Putnam RetirementReady Maturity Fund, which includes a combination of Putnam Absolute Return 100, 300 and 500 Funds, Putnam Asset Allocation: Conservative Portfolio and Putnam Money Market Fund.    
  • Putnam Retirement Income Fund Lifestyle 2, a moderate retirement income portfolio, will be a new fund and strategy based on a combination of Putnam Absolute Return 100, 300, 500 and 700 Funds, domestic and international equity securities, convertible securities and fixed income securities.   
  • Putnam Retirement Income Fund Lifestyle 3, the most aggressive option in the suite, will be the new name of Putnam Income Strategies Fund, which will be modified to include a combination of Putnam Absolute Return 700 Fund, domestic and international equity securities, convertibles and fixed income securities.

“The suite, which is designed for investors who are already in retirement, who plan to retire in the near future or who expect to begin withdrawing their invested funds soon,” Putnam’s release said.

Jeff Carney, Putnam’s head of global products and marketing, told RIJ yesterday, “By integrating the Absolute Return funds with the relative return funds, you’re providing risk reduction. When you’re drawing down your assets, it’s volatility that kills you. This strategy gives you a better shot at a more controlled sequence of returns. Let’s say the targets of the Absolute Return funds are one, three and five percent. You could blend two of the funds to try and get 2.5%.” 

Carney went on, “If [a pre-retiree] says, ‘I need a return of three percent of $100,000, the tool would tell you how much you have to save to generate enough income at that rate, and what your expected risk will be. It tells them the trade-offs. A great application for this is stay-in-the-plan assets. If I’m in our RetirementReady Maturity Fund”—the last and most conservative of Putnam’s target date fund series—“I can now change it to a mix of [target-date, absolute return and relative return] funds. The numbers of dollars in the Maturity Fund are quite small today, but over the next ten years, they’ll be huge. [Rollover] IRAs are another huge marketplace.”

Putnam’s program is not a decumulation plan or a form of non-guaranteed annuitization, Carney made clear, if one defines decumulation or annuitization as a mixed drawdown of both principal and returns over the course of retirement. It’s for individuals and advisors who want to preserve principal while getting a fairly stable income from a specific portfolio of both equities, fixed income investments and cash. 

Income annuities and guaranteed lifetime income benefits are not a part of Putnam’s solution, which is aimed at the large group of investors and advisors who still shy away from insured products. “We’ve done a lot of work on annuities. We’ve made the fees on our product to be extremely competitive with them. The challenge on the annuity side is the complexity, the fees, and the mandates,” Carney told RIJ.

Industry observers have been somewhat skeptical of Putnam’s Absolute Return Funds, saying that their stated return goals are promissory and that they don’t truly meet the traditional definition of absolute return funds, sophisticated vehicles that combine long-short strategies, derivatives and leverage. Carney dismissed the skepticism.  

“We can short up to 30% of the [Absolute Return] funds, though we’re not short much right now. ” he said. “We’ve been using these types of funds on the institutional side for years, and we decided that what was good for the institutional market is good for the individual market. People say that the names of the funds are a misnomoer or promissory, but that’s missing the point. When equities zag, these funds zig. They don’t behave like relative return funds. They stress the target return rather than the relative return over a rolling three-year period. We’ve got 10,000 advisors using these things and over $3 billion in assets. There’s a reason why they work.”

A Putnam release added, “The products can be used as a stand-alone solution or to work in tandem with other retirement income vehicles, and will offer funds with differing levels of return potential and risk.”

“The funds will be accompanied by a new, prescriptive planning tool to help guide advisors and clients in creating a range of personalized income strategies drawing from their retirement savings. These Putnam Funds, combined with the planning tool, allow risk levels and withdrawal rates to be customized and regularly updated to meet individuals’ needs and evolving circumstances.”

“Subject to regulatory review, the funds are expected to be available in their entirety by midyear. The tool will be available at or near the funds’ launch.”

© 2011 RIJ Publishing LLC. All rights reserved.

China outlines Social Security Fund expansion

The assets under management of China’s National Council for Social Security Funds (SSF) are expected to reach 1 trillion yuan ($148.70 billion) by the end of 2011, Investment & Pensions Asia reported.

The fund, which was established in 2000 and receives a statutory 10% of the proceeds of all IPOs by Chinese state-owned enterprises (SOEs), is the largest pension fund investor in China.

Its current allocation is made up of 45% fixed-income assets, 30% stocks and 25% private equity. IPOs by SOEs are expected to swell the fund’s coffers by RMB 20 to 30 billion per year until 2015.

The chairman of the fund, Dai Xianglong, said it is looking “to increase its allocation to social housing projects as well as taking an active role in driving development of China’s nascent private equity markets. It is also seeking to improve returns from fixed-income products against an expected backdrop of rate hikes this year.”

China’s government announced this week it will build 10 million social housing units at a cost of RMB 1.3 trillion ($198 billion) in the coming year, and the SSF looks set to play an important role in the welfare spending hikes outlined in the government’s latest five-year economic plan, which runs to 2015.

The fund has an upper limit for overseas assets of 20%, although currently this has remained stable at 7% since last July. The fund has a long-stated aim of fulfilling this quota, but Dai refused to put a time-scale on this expansion.

In December, the fund added seven asset management companies and one securities company to its list of external asset managers. Notably, whereas previously these have almost all been foreign companies, the most recent additions are nearly all Chinese-run: China Universal, Dacheng, Fullgoal, Guangfa, Haitong Fortis, ICBC Credit Suisse, Yinhua and Citic Securities.
Dai said there were unlikely to be more such appointments in 2011.

U.S. Insurance M&A Rebounds in 2010

Insurance mergers and acquisitions in the U.S. picked up momentum in 2010. Sharp increases were seen for insurance service providers and distribution targets, a potential leading indicator of market shift. A prominent theme underlying insurance company transactions was selectively targeted bolt-on acquisitions of specialized units, according to a new study by Conning Research & Consulting.
“Mergers and acquisitions in the U.S. insurance market increased significantly in 2010, with a 35% increase in transactions and a 224% increase in deal values. This represents a reversal of a five-year decline in merger activity in the market,” said Jerry Theodorou, analyst at Conning Research & Consulting. “The increased activity was the result of buyers responding to soft market insurance conditions as well as generally improving conditions for M&A, including a more vibrant economy, more buoyant equity markets, and stronger capital positions at insurers.”
The Conning Research study, “Global Insurance Mergers & Acquisitions in 2010: Moving from Defense to Offense” tracks and analyzes both U.S. and non-U.S. insurance industry M&A activity across property-casualty, life, health and distribution and services sectors.
“Despite the pickup in M&A in 2010, insurers were generally cautious in their plays. Target properties were largely midsized companies offering accretive bolt-on opportunities, in contrast to the large consolidations seen in earlier periods of strong insurance M&A activity,” said Stephan Christiansen, director of research at Conning. “Specialty underwriting units were a strong focus for activity, as were specialty distribution groups. Insurers in 2010 also actively pursued alternatives to outright M&A of risk bearing entities in order to minimize reserve risk and the complexities of integration following a merger. Marquee underwriters or underwriting teams were sought out and hired, and managing general agents were acquisition targets as well.”

Don’t Subsidize ‘Middle-Age Retirement’

The idea of changing the retirement age, or the age of eligibility for Social Security benefits, has long been part of a narrow debate about how to ensure the long-term fiscal sustainability of that program. But we should really confront the retirement age as part of the much broader debate about societal progressivity: Who in our society has the ability to give more, who needs more support, and when do they need it?

The income tax, for example, is progressive in that households with higher incomes are expected to contribute a higher share of it, while lower-income households pay little or no tax. In the case of the retirement age, we should be asking whether we really intended to create what Social Security has become—increasingly a retirement system for people in middle age, most of whom report good or excellent health.

For over half of beneficiaries retiring in their early 60s today, the result is that one member of a couple with average life expectancy spends well more than a quarter century retired. We need to ask whether such a system leaves Americans adequately prepared for old age and, more broadly, allows society to take advantage of older citizens’ tremendous potential. That is, does the typical 62-year-old have more ability to give and less need for support than the typical 90-year-old?

It is true that many people in late middle age need help, for reasons of health or the economy. But let’s be honest: Most of the benefits from expanding years of retirement support have gone to relatively healthy middle-income and affluent people, who still have much to contribute. It’s not just that we and everyone else get these extra years of benefits but that those of us with above-average income get higher levels of benefits, often twice as much or more than those with lower lifetime incomes.

Think of it this way: Social Security has expanded years of support universally, resulting in both lower revenues and a lost opportunity to target resources progressively to the disabled, those with low- and moderate-lifetime incomes, and older individuals with greater health needs and fewer capabilities to care for themselves. Such a program, whether chosen or arising by accident, is akin to an across-the-board cut in tax rates that seems fair on the surface but happens to give thousands of dollars in cuts to higher-income taxpayers as a way of giving much less to middle- and low-income taxpayers.

Long-term unemployment and disability are real issues, but they don’t really depend on whether one is 62 or 65. Many workers in their 50s and younger also find themselves unable to handle the physical demands of their jobs or adjust to the fact that the job in which they’ve invested no longer exists anywhere, and no other position currently matches their skills. Nor, despite claims to the contrary, do more years in retirement disproportionately benefit low-income minorities. Yes, some have lower life expectancies, but many of those people die before age 62 or receive disability payments that don’t change with the retirement age. If we really wanted to help disadvantaged minorities and other workers with lower lifetime earnings, we could use the money more progressively by targeting benefits directly to them, through devices like minimum benefits and removal of the discrimination against parents — minority women particularly — who were not married and therefore get nothing out of the current spousal and survivor benefits, although they pay for them.

Unfortunately, in negotiations with the several commissions and task forces on the budget deficit in 2010, many liberals focused so intently on protecting the current benefit system that they overlooked real opportunities to improve the equity and progressivity of our retirement system. The consequence is to endanger a once-in-a-generation chance to improve benefits and security for those in old age, including reductions in poverty and near poverty among the elderly.

The question we should be asking is a simple one: For how many years should people who are not disabled receive benefits to support their retirement?

A single person retiring at the earliest retirement age (65) in 1940 was likely to receive close to 14 years of benefits. By 1975, this person could retire at 62 and would likely receive benefits for 19 years, and today that number has risen to almost 22 years. When it comes to couples retiring at the earliest retirement age, by 2030, at least one partner is expected to receive benefits for nearly 30 years.

Is the decision to provide benefits for an ever-increasing number of years one that we, as a society, have made thoughtfully? Is it one that we would have made independent of other societal needs, such as children’s programs?

Put another way, if you define old age by, say, the last 15, 18, or even 20 years of life, then Social Security has become, almost by definition, a middle-age retirement system.

Arguments about the retirement age often center on a chronological age like 65, the normal (and early) retirement age when Social Security was first created in 1935. However, the number of years spent in this undifferentiated period known as retirement is all the more dramatic when we look to both actual retirement ages and life expectancy. Americans on average retired at age 68 in both 1940 and 1950. If they were to retire for the same number of years on average today as they did in 1940, they would be retiring at age 75. In 2070, they’d quit working at about age 80. Instead, they retire on average at about age 64.

At the same time that people are retiring earlier and living longer, Americans have been having fewer children. Unlike increases in life expectancy, which doesn’t really increase the proportion of the population in the last years of life, fewer births do create fewer younger people (say, in the first three-quarters of their lives) per older person (say, in the last quarter of her life).

These demographic effects — longer lives, more years of support, and lower birth rates — can be combined. Rather than four workers per Social Security beneficiary in 1965, or the current ratio of 3-to-1, we are projected to move to 2.1 workers for every Social Security recipient by 2035. Social Security costs, as a share of gross domestic product, in 2030 will be about twice as high as they were in 1970, mainly because of these demographic effects.

These demographic pressures stretch well beyond Social Security. But so would the benefits of encouraging people to spend fewer years in retirement and more time in the labor force. To the extent we can improve employment rates, we can also increase national income and personal income and in turn, raise income-tax revenues and therefore the level of benefits that government can provide to the truly needy.

Within the Social Security system, reducing the incentives for early retirement would boost payroll-tax revenues. This could allow the system either to provide a higher level of benefits for all or to concentrate benefits progressively on those who are older and who, in our current middle-age retirement system, receive increasingly smaller shares of total benefits over time. Less than 35 percent of benefits to men go to those expected to live 10 or fewer years; in 1968 these older recipients received more than half of all benefits.

Here’s one way this shift toward a more progressive system could work: Suppose reform gradually increases the earliest retirement age, which today is 62. For an average couple retiring at that age, at least one of the two (more often the woman) is likely to make it to about age 90, and that life expectancy is rising.

Under current practices, Social Security balances would change little because that loss of any one year of benefits for some workers is offset by higher benefits they receive later. If people would work one year longer, however, personal incomes would rise by about 8 percent for every year of life thereafter. And as people earn more and delay drawing benefits, they receive higher annual Social Security benefits, draw down their private retirement balances for fewer years, and save longer. The individual or family is likely to be far better off and so, too, is the government — but mostly through higher income-tax revenues. In fact, at any tax rate, the additional revenues to Social Security would support higher average lifetime Social Security benefits as well.

The phenomenon of continually expanded years of retirement, however, is not just a question for Social Security or government policy more generally. It is a question about how we decide to live our lives and best use our nation’s pool of human capital in the 21st century. In the next few decades, older workers will be seen as women were in the last half of the 20th century: the largest pool of underutilized talent in the economy. If we modernize the signals and symbols around the idea of when old age begins — not just in Social Security but in the private sector as well — labor demand is likely to shift toward this pool of talent.

This argument is supported by evidence from history. Over the last half of the 20th century, the entry of women and baby boomers into the workforce made it easy to meet labor demand and allow other workers to retire for ever more years. The employment rate of adults, measured as a percentage of all adults, has increased in almost every non-recession year. That suggests that it’s a mistake to project the future work of those aged 62 to 68 by their recent employment rates, just as it was wrong to project the labor supply of women in 2000 by what they were doing in 1950. And increasing employment for older Americans need not come at the expense of younger workers, because the income older workers earn translates to more demand and more jobs for all. Put another way, by inefficiently pushing people into retirement, we’re reducing their output and personal income in ways that reverberate throughout the economy in the same way as an increase in unemployment does.

We are at a time when we need to look at all the elements of our nation’s social contract — those we created deliberately and those that arose by accident — and question whether they are achieving the goals of social justice and progressivity as well as making the best use of our most valuable resource — our people. The unintended transformation of Social Security into a middle-age retirement system has proved to be a poor way of promoting progressivity and dealing with larger macroeconomic questions, and a gradual shift in the other direction would have countless benefits for older Americans, those with greater needs among old and young alike, and the economy as a whole.

Eugene Steuerle holds the Richard B. Fisher Chair at the Urban Institute in Washington, D.C. and writes the on-line column “The Government We Deserve.”

Stocks Due for an Upturn, says CRR

In contrast to more bearish observers who still regard the U.S. stock market as over-priced, researchers at the Center for Retirement Research are bullish. But they don’t appear to be using the cyclically-adjusted P/E that some observers use.

“Stocks currently are priced near 15 times earnings, offering stockholders a potential real return of 6.5 percent,” write CRR’s Richard W. Kopcke and Zhenya Karamcheva in a new article. “Over the coming decade, if earnings continue to recover as they have during past business cycles, stocks are likely to pay returns that compare favorably to their historical averages.”

“After falling sharply during the last recession, margins for nonfinancial corporations have recovered substantially, reaching 8.5 percent of output despite the weak expansion of business activity,” they added. “… If margins remain near 8%, thereby splitting the difference between the high margins of the 1950s and 1960s and the low margins of the 1970s and 1980s, stock prices would likely remain at or above 15 times earnings as they have done in past economic expansions.”

Even if the overall economy doesn’t improve, stocks can still gain value, the article said. “Even if the growth of GDP remains relatively low for much of the coming decade, corporations can use stock purchases as they have over the last 25 years to boost the growth of their stock prices to match past rates of appreciation,” the authors write.

“The additional appreciation resulting from these purchases generally will not affect the rate of growth of the total value of outstanding stock. Therefore, the additional growth in stock prices will be matched by the rate at which the number of shares shrinks,” they add.

Not all market watchers are as optimistic. In mid-February, John Hussman of Hussman Funds, who relies on the Shiller P/E (this “cyclically-adjusted P/E” or CAPE represents the ratio of the S&P 500 to 10-year average earnings, adjusted for inflation), wrote that the market is still overvalued.

“Last week, the S&P 500 Index ascended to a Shiller P/E in excess of 24. Prior to the mid-1990’s market bubble, a multiple in excess of 24 for the CAPE was briefly seen only once, between August and early-October 1929,” he wrote. “Based on our standard methodology (elaborated in numerous prior weekly comments), we presently estimate that the S&P 500 is priced to achieve an average total return over the coming decade of just 3.15% annually.”

In a March 1, column, Doug Short of dshort.com,  wrote that the S&P 500 has recovered enough from its March 2009 bottom so that the Shiller P/E ratio is now in its second-highest quintile. In other words, stocks went from being undervalued back to being slightly overvalued.

His conclusion: “The Financial Crisis of 2008 triggered an accelerated decline toward value territory, with the ratio dropping to the upper second quintile in March 2009. The price rebound since the 2009 low pushed the ratio back into the top quintile. By this historic measure, the market is expensive.”

© 2011 RIJ Publishing LLC. All rights reserved.