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Why bonds fit awkwardly in the separate account space

Posted on April 8, 2021 by -

Despite its importance as an asset class in the separate account space, fixed income represents less than 5% of model-delivered accounts, according to the latest Cerulli Edge—U.S. Managed Accounts Edition. Given how bonds are traded, asset managers struggle to deliver a bond portfolio to a broker/dealer (B/D) in a model format.

“Low-grade corporate, emerging market, and municipal issues trade infrequently, whereas the average daily trading volume of many stocks numbers in the tens of millions of dollars,” says Tom O’Shea, a Cerulli director.

When asset managers send sets of equity tickers to an overlay portfolio manager (OPM) at a large B/D, the B/D can usually send the trade straight to the market because there’s enough liquidity in equity trading, O’Shea said.

But if the asset manager were to send CUSIPs for a municipal bond to the B/D, the OPM would have to enter the bond market and post bid or ask prices for the bond and wait for a buyer or seller to emerge.

Additionally, fixed-income trading still depends on human networks. Stocks are usually traded through electronic networks that execute trades in seconds. Bonds are traded through buyers and sellers with long-established relationships that facilitate negotiation.

“Fixed-income asset managers typically have deep sell-side relationships, developed over years, that allow them to buy and sell bonds at institutional-level pricing that is unavailable to an investor buying through a retail overlay portfolio manager,” he added. 

The few asset managers that offer model-delivered bond portfolios do so through only the largest B/Ds, whose trading desks typically have the same deep relationships with counterparties that large fixed-income asset managers do. These model portfolios are also limited to high-grade, highly liquid fixed-income securities.

Fixed-income models will remain difficult to deliver in a model format, Cerulli believes. “The bond market is structured around the trading habits of large institutions,” said O’Shea. “With rare exceptions, fixed-income separately managed accounts are likely to continue to be manager-traded.”

© 2021 RIJ Publishing LLC. All rights reserved.

Raising Revenue–and Consciousness

Posted on April 8, 2021 by -

The Biden administration unveiled its plan for generating more revenue from US corporations yesterday. The plan would raise the statutory tax rate on corporate profits to 28% from 21%. That’s about halfway back to 35%, its level before the Tax Cut and Jobs Act (TJCA) in 2017.

Treasury Secretary Janet Yellen released a 19-page summary, “The Made in America Tax Plan” on Wednesday. The tax reforms described in the plan are intended to help offset his eight-year, $2 trillion project to renew the nation’s infrastructure and tilt from fossil fuels to green energy.

President Biden

The tax measures described in the white paper would do more than simply raise money to replace rusty bridges and subsidy solar panels. The administration would explicitly use the tax code to correct what it characterizes as long-standing ethical injustices, such as wealth inequality.

The paper reflects the stark change in Oval Office philosophy that occurred last January 20—an about-face as abrupt as any since 1932. President Biden might be counting on broad public support for his initiatives—evidenced by polls—to overcome his skinny majorities in Congress. He must know, however, that tax increases are the “third rail” of Republican politics: Raise them and you die. 

Since the measures in this latest segment of Biden’s tax plans apply mainly to multinational enterprises, rather than to taxes that directly hit citizens’ wallets, they might be difficult for anyone outside of the tax department of a multinational corporation tax department to tell what their exact impact might be. But here they are.

‘GILTI’ or not guilty

Much of the summary focuses on the alleged practice by US multinational corporations of minimizing taxes by reporting profits in tax havens overseas instead of at hone. In a reversal from the previous administration, the Biden plan accuses Corporate America of underpaying its taxes, not paying punitively high taxes. It distinguishes between tax rates and what corporations actually pay. In a sense, it charges companies with doing too good a job of reducing their US tax burdens.   

“The effective tax rate on US profits of US multinationals—the share of profits that they actually pay in federal income taxes—was just 7.8%,” the report said. “And although U.S companies are the most profitable in the world, the US collects less in corporate tax revenues as a share of GDP (gross domestic product) than almost any advanced economy in the Organization for Economic Co-operation and Development (OECD).”

The Biden plan would eliminate incentives in the TCJA that it claims encourage the “offshoring of assets.” The TCJA “created new offshoring incentives through two provisions, the Global Intangible Low-Tax Income (GILTI) provision and the foreign-derived intangible income (FDII) deduction.” The administration would work with other nations to set a uniform minimum corporate tax rate that would discourage regulatory arbitrage. 

Labor and Corporate Share of Federal Tax Revenue (1950-2019)

The Made in America Tax Plan would end the tax exemption for the first 10% return on foreign assets, would calculate the GILTI minimum tax on a per-country basis (raising an estimated $500 billion over a decade, and increase the GILTI minimum tax to 21% (three-quarters of the proposed 28% corporate tax rate, instead of the current one-half ratio).

“In addition to these reforms to GILTI, the plan would disallow deductions for the offshoring of production and put in place strong guardrails against corporate inversions. Overall, the stronger minimum tax regime would substantially reduce the current tax law’s preferences for foreign relative to domestic profits, creating a more level playing field between domestic and foreign activity,” the report said.

Paying at the pump, or not

The Biden plan also proposes deep changes in the taxation of energy, with an eye toward removing implicit and explicit subsidies for fossil fuel producers and creating incentives for developing sources of renewable energy. These changes are intended to slow the catastrophic warming of the earth under a shroud of heat-trapping gasses—a phenomenon that many Republicans still claim to disbelieve, despite well-documented evidence.

“Eliminating the subsidies for fossil fuel companies would increase government tax receipts by over $35 billion in the coming decade,” the report said, citing figures from the Treasury’s Office of Tax Analysis. The main impact would be on oil and gas company profits, not gas or energy prices, the report predicted.

For instance, the production tax credit and investment tax credit for clean energy generation and storage would be extended for ten years. There would be a new tax incentive for long-distance transmission lines and expansion of incentives for electricity storage projects.

The proposal would remove so-called allowances that shield corporations from federal taxes, such as the use of separate “book” and “tax” reporting. “Corporations are simultaneously able to signal large profits to shareholders and reward executives with these returns, while claiming to the IRS that income is at such a low level that they should be freed from any federal tax obligation,” the report said.

Instead, there would be a minimum tax of 15% on book income (the profit firms generally report to the investors). Firms would pay the IRS for the excess, up to 15%, on their book income over their regular tax liability. A firm with zero federal income tax liability computed based on its taxable income would still face a minimum tax of 15% on book income.

Easing labor’s pains

The Biden administration has previously announced its desire to reduce disproportionate wealth and income inequality in the US. His tax proposal would address that problem. “The labor share of national income has been declining for years, representing a worrying trend for workers and a contribution to rising income inequality,” the report said.

Inequality is “is exacerbated by a worldwide trend of governments shifting relative tax burdens away from corporations and capital and onto workers by reducing tax rates on capital gains, dividends, and corporate income while increasing tax burdens on sales and wages.” Consequently, the share of federal revenue raised by the corporate tax has fallen to under 10%, while the share of revenue raised by taxing labor has grown to over 80%.“In 2019, the top 5% of the income distribution earned just 26% of labor income, but 71% of capital income,” the report said.

© 2021 RIJ Publishing LLC. All rights reserved.

What’s Cooking at ‘Income Lab’?

Posted on April 8, 2021 by -

True story: Around midnight, a sleepless retiree speed-dials her adviser. Their last meeting had ended on what the adviser thought was a positive note: a Monte Carlo simulation showed that the client’s portfolio had a 94% likelihood of success through age 90.

But now the client was bedeviled by bankruptcy goblins. “Was 94% safe enough?’ she wanted to know. ‘Shouldn’t they reach for 96% or 97%?” 

Anxiety attacks like those are what Johnny Poulsen and Justin Fitzpatrick, two former Jackson National Life executives turned entrepreneurs, see their software curing. Their product, beta-launched a year ago and now available to advisers, is called Income Lab. The name sounds scientific—like the AgeLab at MIT.

Denver-based Income Lab is designed to help quell the fearful client question: Will I run out of money? and emphasize the more common question, How much can I spend in retirement? The goal is to maximize annual income during retirement rather than maximize gains or final wealth. 

“Most people begin retirement with a lot of upside, relatively speaking,” said Fitzpatrick, who earned a Ph.D. in linguistics at MIT. “There’s more upside to their situations than downside. But other software doesn’t capture that at all. There’s no way to tell the hopeful story. We have a system that shows people the upside, and encourages them to ‘live a little.’”

With a financial planning software market that’s both crowded and concentrated in just a couple of firms, one has to wonder if there’s room for one more. Poulsen and Fitzpatrick believe that none of the existing tools do a very good job with income planning. “We worked with 20 different finance professors when we were developing this, and nobody disagreed that there’s a need for a massive upgrade,” Poulsen told RIJ.

Grabby screenshot

The grabbiest screenshot in Income Lab, of what I saw, is a chart that resembles a scenery artist’s grey and blue silhouette of a distant urban skyline. This is Income Lab’s “Economic Context” tool. (For a video, click here.) Each of the tightly packed vertical bars on the chart represents a month in market performance history, and the height of each bar indicates the maximum amount a particular client could have safely spent from his or her portfolio in such a month.

Three colored lines run horizontally across the width of the chart. A purple line represents the retiree’s minimum spending need; a higher green line represents the retiree’s desired spending, and an even higher blue line represents the advisers proposed spending level. The blue line shows a spending level that’s in-the-money—affordable, that is—for almost every month in history, going back to the 19th century. (See below.)

Exactly how Income Lab generates those numbers, I don’t know. But I suspected that a client would find this chart soothing to look at before and during retirement. In practice, an adviser would get an automatic ping from Income Lab’s software every year, recommending that clients should tweak their incomes up or down a notch.

“We call it ‘guardrail-based retirement income planning,’” Fitzpatrick told RIJ. “Any time you have dynamic income planning, you need triggers. That’s the framework that a lot of advisers would like to use but, given the software that they’re using, it’s a square peg in a round hole.”

Under-applied research

Poulsen emigrated to the US from Denmark in the late 1990s. He joined Jackson National at its Denver office, eventually becoming senior vice president for distribution. Fitzpatrick had been a linguistics professor before arriving at Jackson. When he met Poulsen, Fitzpatrick was leading a team of  CFPs and CPAs who were studying research on advanced financial planning.

“That got me thinking about the state of the art of financial planning,” Fitzpatrick told RIJ recently. “Retirement planning is such a difficult problem. It’s attracted the heavy hitters in the financial world, like Robert Merton and Bill Sharpe. So there’s been a lot of great research.” But advisers and clients weren’t applying much of it, he thought.

Fitzpatrick (l) and Poulsen of Income Lab

By 2018, a time when Jackson National was starting to change course—it vacated its Denver office for Nashville and began separating from its long-time owner, Asia-focused Prudential plc, in 2020—the two men and a distribution colleague, Gregg Mahalich, decided to put what they’d learned (and their own savings) to work by starting Income Lab.

“Johnny and I were part of a team looking at technology,” said Mahalich, who is chief revenue officer at Income Lab. “Justin was researching retirement planning. We found a lot of high quality research that we thought could greatly improve the process of retirement planning.”

They had three implicit goals: To make the software dynamic, so that a retiree’s income would adapt to market conditions; to help retirees avoid unnecessary worry (an affliction common even among the well-off); and to help retirees avoid under-spending.

“I have a 59-year-old neighbor who invests with a national broker-dealer. He got a plan from his adviser with a 90% success probability,” Fitzpatrick said. “His wife is 49. She’ll probably outlive him by at least 10 years. He assumed she’ll face a 10% risk of portfolio failure. We showed him that their worst-case scenario would involve an 8% decrease in spending. Would that be inconvenient for them? Maybe. Would it mean ‘failure’? No.”

Top-heavy field

Fitzpatrick, Poulsen and company are now taking their product to market. They have added a tax module to the original software, so that advisers can help clients spend tax-efficiently from their various taxable, tax-deferred and Roth IRA accounts. So far they’ve been working with a few firms in the XY Planning Network, the group of independent planners created in part by advisory guru Michael Kitces.

Gregg Mahalich

“We launched a beta version in April 2020, and we stayed under the radar for a while to get product feedback. We started in earnest in the fourth quarter of last year, and launched the tax module this year. We see ourselves at the intersection of academics, technology, and practice,” Fitzpatrick said.

Pricing is volume based. A single adviser would pay $159 a month to use the software, with a 10% discount for annual payment. Teams up to nine people would pay $149 per month and teams of ten or more would pay $139 per month. Again, the 10% discount for annual payment is available.

They’re trying to penetrate a market dominated by a handful of big players. According to Bob Veres and Joel Bruckenstein’s 2020 survey of advisers on their choices of financial planning software, two providers accounted for 50% of the market. MoneyGuidePro, which Envestnet owns, had a 28% share. Fidelity’s eMoney Advisor had a 21.5% share. Right Capital was a distant third at 5.5%. MoneyTree and Advicent/Naviplan filled out the top five. 

Of course, it seems as if all planning software makers claim to provide dynamic modeling, retirement income projections, side-by-side plan comparisons, risk assessment, a holistic, all-encompassing approach and the ability to integrate annuities into the plan.

But they arguably tend to emphasize investment management and optimal accumulation. That may reflect the fact that most advisers have those priorities. It may also signify that many affluent people over age 65 don’t think of themselves as retirees but as full-time investors. 

Fitzpatrick sees it differently. “People ask us, ‘Why has no else one done this before?’” he said. “Because it’s really hard. It’s much easier to run a static plan. The plans that people create on Income Lab are fully dynamic. Many other planning platforms will tell you that they’re dynamic. But while they may be able to update account balances through integration, their plans are static. We recognize that things change. People adjust their spending as their circumstances change.”

© 2021 RIJ Publishing LLC. All rights reserved.

Security Benefit Life’s Secret Sauce

Posted on April 1, 2021 by -

There’s a belt-and-suspenders aspect to pegging the performance of a fixed indexed annuity (FIA)—a product that can’t lose money unless “surrendered” prematurely—to the movement of an index designed to move less than the market. 

From a marketing perspective, however, it makes perfect sense to use a managed-volatility index inside an FIA. It allows the issuers to offer attractively high participation rates or caps on returns—or even “uncapped” returns. You don’t need to cap the returns if the cap is baked into the index.

This week, Security Benefit Life, the eighth largest seller of FIAs in the US in 2020 ($2.88 billion), according to LIMRA, added two new managed-vol index options to its Strategic Growth Series FIAs.

The two new options are the S&P500 Factor Rotator RC2 7% Index and the S&P Multi-Asset Risk Control (MARC) 5% Index. Both rebalance daily among several asset classes as they pursue 7% and 5% volatility levels, respectively. Both indexes were launched in March 2017, but they’ve been hypothetically back-tested to 2011. 

A dozen years ago, people thought FIAs were “complex,” with their bewildering variety of crediting methods. Today, FIAs are even more complex. They use bespoke indexes designed by rocket scientists. Recommending the “right” index to a client (especially if you’re subject to a “best interest” advisory standard) won’t be easy. 

Security Benefit Life is a highly rated (A-) life insurer with assets of about $40 billion, as of the end of 2019. Like Athene, Global Atlantic and F&GL, it is one of FIA issuers acquired by big investment firms or holding companies since the Great Financial Crisis, and which now collectively dominate the FIA market.

Factor Rotator

The Factor Rotator index includes a mechanism that shifts money between the five factors: Quality, Value, Momentum, Low Volatility, and High Dividend. “The index varies allocations between the equity factor components, the Treasury Note Futures Index, and cash, depending on market performance on a daily basis,” according to an S&P fact sheet.

Here are the steps that the Factor Rotator Index follows:

1. Calculate historic risk-adjusted momentum based on short, medium, and long-term return horizons for the five eligible factor indices.

2. Select the two factors with the highest composite risk-adjusted momentum scores.

3. Weight 75% of the account value to the highest-ranking index, 25% to the index with the next-highest rank.

In addition, there’s a Risk Control 2.0 (RC2) overlay that tries to maintain portfolio volatility at 7% by adjusting the portfolio allocation between the underlying index and the S&P 20Year US Treasury Note Futures Index liquid bond index.

In effect, a kind of CPPI (Constant Proportion Portfolio Insurance) mechanism is built into the index. CPPI ensures that a dynamically rebalanced portfolio will always contain at least enough safe assets to cover the guarantee. It was CPPI that protected Prudential’s Highest Daily variable annuity liabilities from getting underwater during the Great Financial Crisis. 

MARC

The S&P 500 Multi-Asset Risk Control 5% Index reaches for yield by using leverage (up to 150%) and keeps volatility down to 5% by rebalancing every day between three underlying indexes: the S&P 500 Excess Returns Index, the S&P GSCI Gold Index, and the S&P 10-Year US Treasury Note Futures Excess Returns Index. Its methodology:

The underlying commodities and fixed income indices are calculated and published by S&P Dow Jones Indices on a daily basis as excess return indices. [In this case, the equity component is an “excess return,” i.e., levered, version of the S&P 500, derived from the S&P 500 Total Return Index.] The indices are calculated using a risk-weighted approach that utilizes a maximum leverage of 150% and a 5% volatility target.

As the index brochure says, “In low-volatility environments, the S&P MARC 5% Index risk control mechanism increases market exposure to riskier assets by increasing the allocation to the Index (up to a leveraged position of 150%).”

Powered by former Guggenheim president

Joe Wittrock

In an interview with RIJ, Security Benefit chief investment officer Joseph Wittrock said, “With the Rotator, we researched the factors that produce outperformance. Everybody knows that there are certain factors driving long-term returns. But some do better in some environments than others. We asked, ‘How do we create an evergreen strategy that gives the benefits of factor outperformance all the time?’”

Guggenheim Partners bought Security Benefit in 2010 and spun off the life insurer to one of its senior executives, Todd Boehly, when he left Guggenheim in 2015. Wittrock noted that the investment skills that Guggenheim brought to Security Benefit had paid off. “When you look at track record, it speaks to consistent returns. We have the highest earn rates in industry, and that enables us to offer higher [FIA crediting] rates.”

For example, Security Benefit has, like several of its peers in the FIA business, been able to lift its general account returns by investing in CLOs, or Collateralized Loan Obligations. These are securitized bundles of the type of “leveraged loans” often made to equipment leasing, cellphone tower, or music-royalty companies with strong cash flow but weak credit. Life insurers can buy the senior or investment-grade “tranches” of these bundles, which offer higher yields than similarly rated corporate bonds.

Security Benefit’s FIA-issuing peers include Athene, Global Atlantic, F&GL, Great American, American Equity, EquiTrust, and Delaware Life. Many of these companies are owned by or affiliated with powerful asset managers or holding companies like Eldridge, Apollo, KKR, Blackstone, Guggenheim, Group1001 and others. (Great American was acquired last year by MassMutual.) Together, they accounted for 42% of all FIA sales in 2020, according to LIMRA. Their close competitors in the FIA market—AIG, Sammons, Allianz Life, and Nationwide— have quite different business models. 

Daily allocations of the MARC Index (pre-March 2017 backtesting data is hypothetical.)

Wittrock said that Security Benefit allocates about 40% of its general account to CLOs, and that most of that 40% is in tranches rated BBB. “If you look at our asset allocation, and look at the other companies, you’ll notice that we look very different. That’s intentional. If we look like everybody else, you’ll get the same outcome,” he told RIJ.

Some of his firm’s competitors enhance their earnings by moving part of their liabilities to captive reinsurers in offshore regulatory havens like Bermuda, Wittrock said, but only about one percent of his company’s assets are reinsured, and those are reinsured in Vermont. [Vermont, along with South Carolina and Delaware, is a domestic insurance regulatory haven.]

What’s striking about Security Benefit and at least some of the other life insurers named above, is the integrated business model they’ve created, which Fed economists described in a research paper a year ago. In this model, a life insurer accumulates (by purchase or new issue) blocks of long-dated liabilities, such as FIAs.

An affiliated asset manager (or strategic partner providing investment expertise) originates loans to companies with good cash flow but poor credit, bundles those loans into CLO securities, and then carves out made-to-order tranches suitable for purchase by the FIA issuer for its general account.  In such cases, the FIAs are sold to provide stable assets for the purchasing and holding the tranches of the CLOs. 

Within a single holding company, there might be an investment firm specializing in loan origination, an affiliated reinsurance company, an annuity issuer, and perhaps a Registered Investment Advisor or insurance marketing organization, that are vertically integrated. Security Benefit is a property of the Eldridge Industries, which is led by former Guggenheim president billionaire Todd Boehly. 

Along with the investment skills and properties (including Security Benefit) that Boehly brought with him from Guggenheim in 2015, Eldridge owns or controls Maranon Capital, a private equity firm, CBAM Partners, an alternative investment management firm, SE2, a life insurance and annuity web platform, as well as a variety of media properties that earn the types of streams of royalties that can finance CLOs.

As a Bloomberg reporter wrote in 2019, Eldridge “incorporates some elements of both Warren Buffett’s Berkshire Hathaway and Athene Holding. Like Berkshire, Eldridge is a holding company that uses premium revenue from a captive insurer — the so-called float — to fund investments. Like Athene, the insurer whose assets are managed by Apollo Global Management, it issues annuities to create that float.”

© 2021 RIJ Publishing LLC. All rights reserved.

Updates from Allianz Life, Athene and Investors Heritage

Posted on April 1, 2021 by -

New caps on AllianzIM Buffered Outcome ETFs

Allianz Investment Management LLC announced new upside caps for the April series of its Buffered Outcome ETFs suite: the AllianzIM US Large Cap Buffer10 Apr ETF and the AllianzIM US Large Cap Buffer20 Apr ETF.

Introduced in June 2020, the AllianzIM Buffered Outcome ETFs offer exposure to the S&P 500 Price Return Index up to a stated cap, while aiming to buffer investors from losses on the downside. AllianzIM currently offers two strategies on the S&P 500 Index: a 10% buffer and 20% buffer, each with quarterly offerings and 12-month outcome periods.

“The funds are the lowest cost defined outcome ETFs on the market today and consistently trade with some of the tightest spreads among peers in the category,” an Allianz Life release said.. AllianzIM manages its ETF line-up on a proprietary in-house hedging platform with over $150 billion in hedged assets.

Investors Heritage Life offers climate-friendly index on new FIA

Investors Heritage Life Insurance Company has launched Heritage Income Advantage, a single-premium fixed indexed annuity. The product offers a Guaranteed Lifetime Withdrawal Benefit (GLWB) Rider, which guarantees income for life, and an Enhanced Income Benefit Rider, which can double income for up to 60 months when certain unexpected health situations occur.

“The Enhanced Income Benefit can be used for five years non-consecutively. A client and spouse can use it for hospital or home-healthcare costs,” said John F. Frye, president of Investors Heritage. HIA allows policyholders to realize upside potential based on three index options: the S&P 500, the S&P MARC 5% (Multi-Asset Risk Control) Index, and SG Entelligent Agile 6% VT Index

Société Générale partnered with Entelligent to launch the SG Entelligent Agile 6% VT Index. The index uses Entelligent’s Smart Climate model to score companies in the S&P 500 based on the potential impact from new environmental-focused regulation and technology as well as forecasted energy costs. The index provides exposure to the 250 companies in the S&P 500 with the highest scores. 

AccuMax is launched by Athene

Athene Annuity and Life Company, a unit of Athene USA, has launched AccuMax, a fixed indexed annuity (FIA) that the company describes as designed for “patient money set aside for retirement or other long-term savings goals.” 

AccuMax makes available multi-year indexed interest crediting strategies, multi-asset indexes, and crediting rates that are guaranteed for the annuity’s withdrawal (surrender) charge period. All fixed and indexed strategy crediting rates are guaranteed for the duration of the Withdrawal Charge period. Additional product features include:

  • Multi-year and annual crediting terms provide growth potential and liquidity.
  • Features new AI Powered Multi-Asset Index (AiMAX1) and Shiller Barclays CAPE Allocator 6 Index (BXIISC6E1).
  • Innovative Annual Interval Sum crediting strategy tied to the S&P 500® combines the benefit of higher rates through a multi-year strategy with the ability to measure index performance in annual steps.
Prudential adds Invesco and BlackRock ETFs to its FlexGuard RILA

Prudential Financial, Inc., has added the Invesco QQQ ETF, which tracks the Nasdaq-100 Index, and the BlackRock iShares Russell 2000 ETF as options within the crediting strategies of Prudential’s FlexGuard indexed variable annuity.

FlexGuard has achieved close to $2 billion in sales within less than a year of launching, according to annuity sales data from the Secure Retirement Institute. Indexed variable annuities are also RILAs (registered index-linked annuities). Sales of RILAs, introduced in 2011 by AXA Equitable, grew more than 30% in calendar 2020.

“FlexGuard’s index strategies allow customers to select strategies providing the potential to accelerate gains above and beyond the index return when certain targets are met. Importantly, FlexGuard is designed to adapt with consumers’ needs, allowing periodic changes to investment length, protection level and growth strategies, as the markets shift, and individual financial goals evolve,” a Prudential release said.

  • © 2021 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on March 31, 2021 by -

Edward Jones to pay $34 million, agrees to improve treatment of minority advisors

Edward Jones, the broker-dealer and 16,000-adviser financial products distribution network, has agreed to pay $34 million to settle a racial discrimination lawsuit filed in 2018 on behalf of current and former African American financial advisers, according to news reports this week. Edward Jones also agreed to change its hiring, training, promotional practices and policies to better support financial advisers of color.

“The settlement includes measures Edward Jones is taking to report diversity progress to its leadership team, create a financial advisor council with diverse representation and reduce training cost obligations,” the brokerage said in a release.

Wayne Bland, a Black financial adviser who worked at Edward Jones from 2014 to 2016 filed the class action suit in 2018. The Chicago law firm of Stowell & Friedman, which negotiated class-action settlements on similar claims against Merrill Lynch and Wells Fargo, represented the class.

Bland’s suit alleged that management at Edward Jones repeated passed over Bland and other Black advisers in favor of equally or less-qualified white advisers when granting or assigning the most desirable assignments, clients, training programs, mentorships, and promotions, all of which reduced the ability of the Black advisors to get ahead at the firm. to young advisers.

The class includes Black financial advisers employed by Edward Jones at any time between May 24, 2014, and Dec. 31, 2020, according to settlement documents filed with the federal court in Chicago.

According to the 2018 complaint, African American hires at Edward Jones were “disproportionately” from the “Legacy” and “Goodknight” training programs, where new advisers received office space, administrative support, and mentoring from an established FA. The suit claims that these programs disproportionately went to white advisers. The best territory assignments and the opportunity to inherit clients from retiring advisers also went mainly to white advisers, the suit said.

“The Firm disproportionately relegates African American FAs to territories and offices in less lucrative locations with less investable income and that are less productive for the FA. The Firm also reserves territories with greater investment opportunities for non-African American FAs in order to race-match its FAs to the neighborhood demographics,” according to the complaint.

Bland and co-plaintiffs said that, in 2015, only 6% of Edward Jones advisers were Asian, African American or Latino, compared with 21% of financial advisers nationally.

J.P. Morgan to diversify advisor hiring by 2025

J.P. Morgan Wealth Management unveiled plans this week to serve more Black and Latinx clients and increase diverse advisor hiring by 2025. The firm said it had made a “$30 billion commitment to advance racial equality.”

The plans will include partnerships with Historically Black Colleges and Universities (HBCUs), initiatives to promote internal mobility, resources to allow diverse employees to grow their career over time and a goal of hiring 300 additional Black and Latinx advisors by 2025.

Over the next five years, J.P. Morgan Wealth Management will partner with various HBCUs to offer students resources and information about careers in wealth management, and to provide scholarships, training and licenses. The initiative will create 185 full time positions specifically for this program by 2025.

The Advisor Development Program is a 24-36 month training that is providing about 270 candidates with the investments knowledge, mentorship and coaching needed to become a successful financial advisor. Nearly 80% of the participants are women or minorities.

HUB launches bundled retirement plan for small to mid-sized employers

The introduction of HUB Retirement Select, a bundled retirement plan solution for small to mid-sized businesses “looking for amenities traditionally afforded to large organizations,” was announced this week by HUB Retirement and Private Wealth, a unit of Hub international Ltd.

HUB Retirement Select is designed for owner-only organizations to those with hundreds of employees, providing “advanced technology and analytics, leading retirement benefits specialists and compliance support at an affordable cost,” according to a news release.  HUB Retirement Select’s managed account service offer investment guidance to participants.

HUB Retirement Select is being positioned as “a highly competitive alternative option to state-mandated and voluntary retirement plans for employers.” California, Illinois, Oregon,  Washington, New York, Vermont, Connecticut, New Jersey, Massachusetts, Maryland, and Seattle have enacted mandated and voluntary retirement programs.

HUB RPW provides investment advisory services on more than $93 billion in assets through its SEC-registered RIAs. It offers institutional and retirement services to for-profit and not-for-profit organizations and customized private wealth management services to individuals and families. Joe DeNoyior is National President of HUB RPW.

Insurance services are offered through HUB International, an affiliate. Global Retirement Partners, LLC, Silverstone Asset Management, LLC, Hub International Investment Advisory Services, Inc., and Sheridan Road Advisors, LLC are SEC-registered investment advisors and wholly owned subsidiaries of HUB International. 
Headquartered in Chicago, Illinois, HUB International Ltd is a full-service global insurance broker with more than 13,000 employees. It provides risk management, insurance, employee benefits, retirement and wealth management products and services.

Allstate Corp. concludes exit from life/annuity business

Wilton Re will pay $220 million to acquire Allstate Life Insurance Company of New York (ALNY) from the Allstate Corporation, according to a release this week. The transaction is expected to close in the second half of 2021, subject to regulatory approval and other closing conditions.

With this transaction, and its announced agreement to sell Allstate Life Insurance Company (ALIC) and certain affiliates to entities managed by Blackstone, Allstate has exited the life and annuity businesses. Allstate agents and advisers will offer life insurance and retirement products of third-party providers. The agreement includes termination of an ALIC stop-loss reinsurance treaty.

Allstate has agreed to contribute $660 million of capital into ALNY, then receive a payment of $220 million from Wilton Re. The transaction will reduce GAAP reserves and invested assets by $5 billion and $6 billion respectively.  The combined divestitures will result in an estimated GAAP net loss of approximately $4 billion, which will be recorded in the first quarter of 2021, and generate approximately $1.7 billion of deployable capital.

J.P. Morgan Securities LLC and Ardea Partners LP acted as financial advisers, and Willkie Farr & Gallagher LLP was the legal adviser to Allstate.

Prudential adds Invesco and BlackRock ETFs as options on its FlexGuard RILA

Prudential Financial, Inc., has added the Invesco QQQ ETF, which tracks the Nasdaq-100 Index, and the BlackRock iShares Russell 2000 ETF as options within the crediting strategies of Prudential’s FlexGuard indexed variable annuity.

FlexGuard has achieved close to $2 billion in sales within less than a year of launching, according to annuity sales data from the Secure Retirement Institute. Indexed variable annuities are also RILAs (registered index-linked annuities). Sales of RILAs, introduced in 2011 by AXA Equitable, grew more than 30% in calendar 2020.

“FlexGuard’s index strategies allow customers to select strategies providing the potential to accelerate gains above and beyond the index return when certain targets are met. Importantly, FlexGuard is designed to adapt with consumers’ needs, allowing periodic changes to investment length, protection level and growth strategies, as the markets shift, and individual financial goals evolve,” a Prudential release said.

© 2021 RIJ Publishing LLC. All rights reserved.

VAs suffer record outflows, but enjoy record assets

Posted on March 31, 2021 by -

The registered index-linked annuity, or RILA, has perhaps the least self-descriptive name in the entire annuity industry, and that’s saying something. A few distributors flat-out hate the acronym for this hybrid product—which combines features of a variable annuity, a fixed indexed annuity, and a structured note.  

But no one can argues with the sales numbers that RILAs are putting up. As Morningstar’s VA quarterly sales analysis for 4Q2020 shows, sales of these cap-and-buffer contracts were up 70% in the fourth quarter of 2020, versus 4Q2019, and LIMRA had them growing almost 40% in 2020, to $24 billion.

The RILA market is still much smaller than either the traditional VA market ($74.9 billion sales in 2020), where Jackson National dominates ($16.6 billion), or fixed indexed annuities ($55.7 billion) in 2020, where the private equity firms have muscled in. But both of those categories saw overall falling sales in 2020.

That makes sense. RILAs don’t seem to carry the annuity stigma, and they give nervous investors a Goldilocks alternative to high-priced stocks or bonds. Not that the average investor would understand how RILAs work. To structure them, insurers buy upside calls and sell downside puts on domestic or international equity indexes. The call options buy gains up to a cap, and the puts buy buffers against the first five to 35 percentage points of loss over a given term. The S&P 500, Russell 2000 and MSCI are among the indexes commonly used.

With their fixed income assets yielding so little in today’s low interest rate environment, life insurers have for a decade had to tap into the robust equity market, either by wrapping guarantees around mutual funds (in a traditional VA) or buying options on an equity index. Equitable (then owned by AXA) brought the first RILA to market in 2011; others have followed.

Five of the 10 best-selling VA contracts in 4Q2020 were RILAs: Prudential Flexguard B (2), Equitable’s Structured Capital Strategies (3), Lincoln’s Level Advantage (4), Allianz Life Index Advantage Income (6) and Allianz Life Index Advantage (10). The top seller, with a whopping 14.3% market share, was Jackson’s Perspective II.

Flexguard was the top-selling rider in the fourth quarter of last year, but, as a newcomer to the market, was only fifth in sales for the year. Lincoln’s Level Advantage B-share was the top seller for 2020, with $4.18 billion in sales. Allianz’s Index Advantage Income moved into the list of top 10 best-selling VAs jumping 14 places compared to Q4 2019. RILAs accounted for almost 24% of all VA sales in the fourth quarter, up from 14% a year ago.

VA assets top $2 trillion

Sales of traditional variable annuities, with and without lifetime income guarantees, have taken a huge hit from the low interest rate environment of the past decade. While a rising stock market would be expected to favor VAs—which consist of tax-deferred mutual funds—low interest rates makes it expensive to hedge them. Costs have gone up and benefits have gotten less generous.

Sales of VAs have stabilized at between $87 billion to $91 billion a year for the last three or four years, after peaking at $125 billion in 2011. But the real damage shows up in the net flow statistics. The category has suffered increasingly large negative net flows. In 2020, for the first time, net outflows of money from VAs (-$94.9 billion) surpassed new sales ($87.1 billion). 

Don’t cry for VA issuers, however. They are still huge fee generators for the companies that issue them. The market value of assets held in VAs surpassed $2 trillion for the first time in 2020. Since VAs generate both insurance and investment fees (as high as 4%, in contracts with income benefits), those assets could easily produce more than $50 billion in fees for annuity issuers and asset managers. Of that $2 trillion, more than 25% is at TIAA, where it is held mainly in group annuities at the firm’s network of 403(b) plans. The top 10 VA issuers account for about 80% of VA assets.

VAs with GLWBs

The sale of non-RILA VAs offering guaranteed lifetime withdrawal benefits (GLWBs) fell 12% y/y but grew 12% over the previous quarter—signaling a slow recovery for the segment. Jackson’s Perspective II, AIG’s Polaris Platinum III B, and Ameriprise’s RVS RAVA5 Advantage all showed significant sales movement, according to Morningstar.

The Perspective II retained its top position and saw sales jump by 7% to $3.4 billion in the fourth quarter. Its living benefit offers an average fixed percentage increase (FPI) of 6% and its withdrawal rates lie near the 75th percentile of the industry. AIG’s Polaris Platinum grew 8% y/y in sales; its GLWBs offer better-than-average benefit fees and withdrawal rates.

Sales of Ameriprise’s RVS RAVA5 Advantage dropped 34% y/y and the contract fell out of the top 10 sellers. While its living benefits offer a relatively high FPI of 6%, the withdrawal rates of its GLWBs dropped by 20 to 50 basis points year-on-year. Benefit fees increased by 15 to 55 basis points in the same period.

Though Perspective II and RVS RAVA5 have comparable FPIs, withdrawal rates and benefit fees, The discrepancy in quarterly sales between Perspective II and RVS RAVA5 may reflect the role of distribution channels and surrender schedules. The Perspective II is distributed primarily through independent agents; that channel rebounded after restrictions on businesses were lifted in the third quarter.

RVS RAVA5 is distributed through captive agencies, which continue to record negative quarter-on-quarter sales growth. Moreover, interest rates increased in the fourth quarter, which may have led investors to favor more liquid products. RVS RAVA5 has a 10-year surrender schedule, whereas Perspective II has a relatively short 7-year schedule. 

Four new VA contracts were introduced and five closed down in 4Q2020, as new product activity remained sluggish. Seven new living benefits appeared while twelve closed, perhaps because high market volatility drove up the cost of hedging.

© 2021 RIJ Publishing LLC. All rights reserved.

Hardwired COLA vs. Performance-Based COLA: What’s Best?

Posted on March 30, 2021 by -

Retirees understandably would like their income during retirement to increase each year. They can accomplish that in either of two ways: by hardwiring the cost of living adjustment (COLA) into the annual withdrawal schedule or by letting the annual growth of the portfolio (if any) determine the COLA.

A hardwired increase in the annual withdrawal from a retirement portfolio (for example, a 3% annual COLA) sets in motion a schedule of withdrawals that

  • Is known in advance
  • Increases each year 
  • Is blind to the annual performance of the portfolio (thus adding to the portfolio loss after a down year)

Alternately, an annual withdrawal based on a percentage of the portfolio’s year-end value (the Required Minimum Distribution method) will fluctuate from year to year and can decrease in some years. 

The withdrawal will decrease because it is based on the portfolio’s ending account value; if the account value declines, the withdrawal will decline proportionately. This built-in protection mechanism minimizes the damage to a retirement portfolio, especially after a year like 2008. Retirees won’t be guaranteed a larger withdrawal every year, but this approach will be kinder to their portfolios.

Let’s back-test these two methods of withdrawal over the past 95 years (from 1926-2020). We’ll look at 71 rolling periods of 25 years each, where each period represents a retiree who might withdraw money from ages 70 to 94, for example. This multi-period analysis allows us to account for a wide array of possible sequences-of-returns—a vitally important issue to retirees.

We allocated our hypothetical retirement portfolio to 40% large-cap US equity, 20% small-cap US equity, 30% US aggregate bond market, and 10% cash (using common index returns throughout.) We rebalanced annually and for simplicity, excluded taxes and inflation. The portfolio’s starting balance was $1 million and the initial first-year withdrawal was 4%, or $40,000. 

When we used a hard-wired 3% COLA in years 2-25, the withdrawal each year was known in advance and escalated each year by 3% (See Table 1). In year two, the withdrawal was $41,200 (or 3% more than in year one). In year three, the withdrawal was $42,436, and so on. Per the Rule of 72, the withdrawal was $81,312 in year 25, or roughly double the withdrawal in year one. 

Performance-based COLA

We now turn to the performance-based COLA. As Table 1 below shows, a 4% withdrawal rate produced a larger average annual withdrawal in years 2-25 than a fixed 3% COLA. But the different sequences of returns over the 71 rolling periods produced considerable variation in the size of the annual withdrawals.

Table I. Annual Withdrawals. Results drawn from 71 rolling periods of 25-year retirement withdrawal periods from 1926-2020. Assumes $1m starting balance and allocation of 40% large US stock, 20% small US stock, 30% bonds, and 10% cash.

 

For example, in year 14 (highlighted in yellow), the hardwired COLA of 3% produced a withdrawal of $58,741 in year 14, while the 4% method produced an average withdrawal of $88,813. The highest withdrawal in year 14 (recall that there were 71 year 14’s) ranged from a high of $155,046 (based upon a lucky sequence of returns) to a low of $27,029. The variation in the annual withdrawal in year 14 (and in each year after year 1) was wide—and grew wider over time.

The tradeoff between a hardwired COLA and a performance-based COLA is shown in Table 2. Assuming a 4% initial withdrawal, a performance-based COLA produced an average annual withdrawal of over $90,000 whereas the average annual withdrawal for a hardwired 3% COLA was $58,335. However, your withdrawal using the performance-based COLA would be smaller than in the previous year about 35% of the time.

Is the dollar decline in the annual withdrawal significant? As shown below in Table 2, withdrawing 4% of the portfolio balance each year resulted in year-over-year declines in the annual withdrawal 35% of the time, but the average decline was only $5,807 (with an average annual withdrawal of $90,701 over the 71 rolling periods). Thus, a performance-based COLA exposed the retiree to a 6.4% decline in annual income roughly 35% of the time. The upside of the performance-based COLA was an average annual withdrawal over a 25-year withdrawal period that was 55% higher than a hardwired COLA of 3%.

Table II. Fixed % COLA vs. Performance-based COLA. Results drawn from 71 rolling periods of 25-year retirement withdrawal periods from 1926-2020. Assumes $1m starting balance and allocation of 40% large US stock, 20% small US stock, 30% bonds, and 10% cash.

Portfolio failure rate

Notice in Table 2 that we also analyze withdrawal rates of 5% and 6%. Assuming a 4% initial withdrawal rate, both the hardwired 3% COLA and the performance-based COLA produced no portfolio failures over any of the 71 rolling 25-year periods. When we raised the initial withdrawal rate to 5%, the hardwired COLA of 3% led to a failure rate of 4.2%. That is, 4.2% of the portfolios ran out of money before 25 years. When we raised the initial withdrawal rate to 6% a hardwired COLA led to portfolio failure 8.5% of the time.

Conversely, withdrawing 5% of the portfolio balance at the end of each year led to no failures. Neither did a 6% withdrawal rate. In fact, a 10% withdrawal rate does not lead to any portfolio failures because of the self-protecting nature of a “%-of-portfolio-withdrawal” approach. Of course, at higher and higher withdrawal rates the retirement portfolio will have a lower ending balance after 25 years.

For retirees who don’t mind slight to moderate reductions in their annual retirement income roughly one-third of the time, we believe that withdrawing a fixed percentage of their portfolio’s ending account value each year will be a superior approach.

© 2021 RIJ Publishing LLC. All rights reserved.

Research Roundup

Posted on March 25, 2021 by -

As the Biden administration begins its hunt for revenue to offset the trillions of dollars it hopes to spend on infrastructure renewal and green energy projects, we bring you recent research about taxes. One article describes how the very wealthiest Americans minimize or evade their taxes. The other article, by the Congressional Budget Office (CBO), describes how a big spending program might affect taxpayers and the economy.

You’ll also find an article by MIT’s Adam Solomon and James Poterba (the current president of the National Bureau of Economic Research) on estimating the “money’s worth” of an income annuity. This article is must-reading for retirement plan sponsors who are now required by the Labor Department to tell plan participants how much income their current savings might buy. The answer: It depends.

Finally, financial advisors should benefit from a paper about the ways that millionaires decide how much of their portfolios to allocate to equities. The findings are based on a survey by UBS, GuideWell (a health insurance holding company) and two economists. Millionaires apparently disregard academic dogma. Links to the four articles can be found below.

The Rich Cheat on Their Taxes

Americans with the biggest incomes naturally have the biggest tax bills, and new research finds that they go to great lengths to hide part of their income from the IRS, either in offshore accounts or by underreporting income from private businesses they own, according to new research.

“We estimate that 36% of federal income taxes unpaid are owed by the top 1% and that collecting all unpaid federal income tax from this group would increase federal revenues by about $175 billion annually,” write economic researchers from the Research, Applied Analytics and Statistics office of the Internal Revenue Service and from three universities.

Their paper, “Tax Evasion at the Top of the Income Distribution: Theory and Evidence,” reports on efforts by what they describe as an underfunded IRS to go beyond conventional random audits, which they say fail to detect the sophisticated tax evasion techniques of Americans at the apex of the income spectrum.

“Random audits do not capture most tax evasion through offshore accounts and pass-through businesses, both of which are quantitatively important at the top,” the paper said. “We provide a theoretical explanation for this phenomenon, and we construct new estimates of the size and distribution of tax noncompliance in the United States.”

According to the paper, forms of evasion include “the abuse of syndicated conservation easements, micro-captive insurance schemes, private inurement in tax-exempt organizations, and the use of offshore trusts to evade tax. Many of these strategies involve pass-through businesses or other entities controlled by the taxpayer.” 

Wealthy Americans have more than $1 trillion outside the US, leading the researchers to estimate that “$15 billion in taxes was evaded from offshore accounts, with $10.5 billion of this total attributed to the top 0.1%, and $6.4 billion attributed to the top 0.01%.”

How Millionaires Set their Equity Allocations

A survey of 2,484 US individuals with at least $1 million of investable assets shows that the most important factors determining the share of equities in their portfolios are “professional advice, time until retirement, personal experiences, rare disaster risk, and health risk.”

How well do their financial beliefs and decisions follow “leading academic theories”? Not a whole lot, according to a new paper, “Millionaires Speak: What Drives Their Personal Investment Decisions?” by a team from the Yale School of Management, GuideWell, the health insurance holding company, UBS and the University of Toronto law school.

Only 15% of the survey respondents said that the fundamental consideration affecting equity allocation in most modern asset pricing theories—return covariance with the marginal utility of money—was very or extremely important to them. Only 9% of respondents said that “return covariance with the marginal utility of consumption” was very or extremely important. 

“On average, respondents hold 53% of their portfolio in equities,” the paper said. Only 6% hold no stocks (vs. 48% of the total 2016 Survey of Consumer Finance US study population). Of the stocks they own, 83% are domestic US. Only 10%  of the millionaires invest in hedge funds, venture capital, or private equity. Those who do allocate 13% of their portfolio to these vehicles.

“Rich investors collectively believe that high-profitability stocks offer high risk-adjusted returns. Indeed, it is not that such stocks have risk that is elevated, but not sufficiently elevated to offset their higher expected returns: our respondents tend to believe that these stocks have lower risk while offering higher expected returns,” the paper said.

“Conversely, they believe that high-momentum and high-investment-expenditure stocks offer low risk-adjusted returns, featuring lower expected returns and higher risk. Value stocks are thought to have both low expected returns and lower risk.

“Nearly half of our respondents have invested in an active investment strategy through a fund or professional manager, and the most common reasons for doing so are professional advice and the expectation that they will earn higher average returns from active investing. Past fund manager performance is seen as a strong evidence of stock-picking skill.”

The Present Value of an Annuity is a Moving Target

Because the Department of Labor (DOL) now requires defined contribution plan sponsors to provide participants with annual estimates of the annuity income stream that their plan balance could purchase, two MIT economists have looked into the “money’s worth” of US individual retail annuities during 2020.

The money’s worth of an annuity is its expected present discounted value of future payments (EDPV) divided by the annuity’s purchase price. The economists used discount rates drawn from the corporate BBB yield curve. They used future mortality rates that combine a Society of Actuaries individual annuitant mortality table with projections of future mortality improvements from the Social Security Administration.

Their paper,  “Discount Rates, Mortality Projections, and Money’s Worth Calculations for US Individual Annuities,” James Poterba and Adam Solomon demonstrates that the costs and potential benefits of the kind of retail annuities available to retiring plan participants are (and will always be) moving targets, affected by factors such as interest rates, the health of the annuity purchaser, and the design of the individual annuity contract (i.e., period certain, joint-and-survivor).   

The papers shows that coming up with those estimates may be difficult for plan sponsors, considering the numerous variables involved. The low interest rate environment has also been driving down the payout rates of income annuities for years. “Our central estimates… suggest money’s worth values for annuities offered to 65-year-old men and women of about 92 cents per premium dollars.” the authors write. 

The government’s push to promote annuities unfortunately happens to coincide with a trough in the payouts of retail annuities, which results from an ongoing decline in bond yields. As the paper shows:

The average annual payout on a $100,000 SPIA [single premium immediate annuity] for a 65-year-old man was $5,748 in June 2020, [and between June 2020 and January 2021 dropped 3.3%, from $5,748 to $5,556. There was a similar drop, from $5,424 to $5,244, for 65-year-old women].

Payouts were $6,456 in June 2015, $7,344 in June 2010, and $7,740 in June 2005. The yield on a 10-year Treasury bond, which averaged 0.73% in June 2020, was 2.36% in June 2015, 3.20% in June 2010, and 4.00% in June 2005.

Deferred annuities (and their tax-deferred equivalents, called Qualified Longevity Annuity Contracts), which characteristically produce income starting at age 80 or 85, offer less value than immediate annuities, the paper showed, partly because of adverse selection.

“The lower EPDV for the deferred annuities may reflect insurers’ reluctance to offer long- duration policies with substantial risk of medical progress or other unexpected developments before payouts begin. It is also consistent with more pronounced selection in the market for deferred annuities, with only the healthiest individuals at age 65 choosing to purchase deferred annuities,” the authors explained. That’s unfortunate, because deferred annuities have long been envisioned by academics as the thriftiest way for retirees to mitigate the financial consequences of living to extreme old age.

The authors also note that employers who follow DOL instructions and use the 10-year Treasury rate to calculate annuity payouts would understate the payouts.

“The regulations outline a procedure for calculating the potential annuity payout assuming that future benefits are discounted at the 10-year Treasury yield,” they wrote. “Our findings suggest that the use of the Treasury yield in this calculation may understate the income stream that will be available to future retirees.”

The Effects of Biden’s Spending Plan on Future Taxes: CBO

In their timely article, “The Economic Effects of Financing a Large and Permanent Increase in Government Spending,” analysts at the CBO examine the fiscal challenge the US government will face if it tries to finance—without raising the federal deficit—an increase in annual federal spending by 5% or 10% of Gross Domestic Product (GDP) for 10 years. 

The analysts, Jaeger Nelson and Kerk Phillips, rule out the possibilities of financing the increase with budget cuts or deficit spending. Instead, they focus on the tax implications and consider the impact of three types of taxes:

  • A uniform tax on labor income only. That tax is like the Medicare hospital insurance payroll tax, which has no maximum taxable income. 
  • A flat (single rate) tax on all sources of income, including both labor and capital income.
  • A progressive tax on labor income, similar to the current income tax, and a flat tax on capital income. 

They conclude that:

To maintain deficit neutrality, tax rates for all three tax policies must rise over time to offset behavioral responses that result in smaller tax bases. After 10 years, the level of GDP by 2030 is between 3% and 10% lower than it would be without the increase in expenditures and revenues.

Younger households would experience greater loss in lifetime consumption and hours worked than older households, they write. A progressive income tax causes the largest fall in lifetime consumption and hours worked for higher-income households and smallest for lower-income ones. It also generates the largest decline in total output and the smallest decline in consumption among the bottom two-thirds of the income distribution.

But this isn’t the whole story, the authors concede. “The analysis does not consider any effects of the expanded government spending…  Well-targeted government spending on physical capital, education and training, and research and development increase the productivity of private businesses. Productivity increases brought on by well-targeted government spending boosts GDP, private investment, and, ultimately, the amount households can consume,” they write.

The paper makes assumptions that are not universally held, such as:

“Taxes on labor income reduce after-tax wages, so they reduce the return on each additional hour worked. That reduced incentive to work is then partially offset because people have lower expected future income, which creates an incentive to work more to make up for their lost after-tax income. On average, the former effect is greater than the latter in CBO’s assessment; therefore, higher labor taxes tend to reduce hours worked in the economy. Higher taxes on capital income, such as dividends and capital gains, lower the average after-tax rate of return on private wealth holdings (or the return on investment), which reduces the incentive to save and invest and leads to reductions in saving, investment, and the capital stock.”

Those assumptions are based on the following belief, which behavioral economists, among others have questioned as dated and unfaithful to the real world:

“Households in the model used in this paper have perfect information about the path of future policy and the distribution of their potential earnings over their lifetime; moreover, households’ behavior is perfectly rational and consistent with their preferences about private consumption and hours worked.”

© 2021 RIJ Publishing LLC. All rights reserved.

 

Honorable Mention

Posted on March 25, 2021 by -

Canadian firm buys Ohio National for $1 billion

Constellation Insurance Holdings Inc., an insurance holding company financed by Canadian public pension plans, is buying the mutual holding company that owns Ohio National Financial Services for $1 billion, the companies announced today.

Ohio National Mutual Holdings Inc. is the parent of Ohio National Financial Services. The firm’s flagship subsidiary, The Ohio National Life Insurance Company, has operated in Cincinnati since 1909.

Constellation plans to help Ohio National shift away from the mutual holding company structure, through a process called a “sponsored demutualization,” the companies said. Constellation will provide $500 million that Ohio National could use to pay the policyholder owners to extinguish their mutual holding company ownership interests, the companies said.

Also, Constellation will add $500 million in capital to the company over four years, to strengthen its capital position and its ability to meet its obligations, the companies said in a release.

Barbara Turner, Ohio National’s CEO, said in a statement that the company agreed to the deal “in the midst of a challenging economic environment, historically low interest rates, increased regulatory costs and pressure for the entire industry.” The Constellation deal will fortify Ohio National with more capital and create a more flexible capital structure, she said.

Anurag Chandra, the founder, chairman and CEO of Constellation, said his firm wants to give Ohio National and other insurers more access to capital, “while preserving the independence, brand, existing operations and culture for which they are recognized.”

Net income of life/annuity industry fell almost 50% in 2020

The US life/annuity (L/A) insurance industry saw its net income cut nearly in half in 2020, to $24 billion from $45 billion. These preliminary results are detailed in a new Best’s Special Report, titled, “First Look: 12 Month 2020 Life/Annuity Financial Results.”

The data is derived from companies’ annual statutory statements received as of March 17, 2020, representing an estimated 98% of total industry premiums and annuity considerations.

According to the report, premiums and annuity considerations for the L/A industry declined 8.3%, as Jackson National Life entered into a coinsurance agreement with Athene Life Re and ceded $24 billion of individual annuities to Bermuda. Increases in the amortization of interest maintenance reserve and other income offset the decline, and resulted in a 4.7% drop in total income, compared with prior year.

Due to the drop in income exceeding a 2.6% reduction in expenses, pretax net operating gain fell by 35.0% to $39.9 billion from the prior year. Income tax expense was also down in 2020, by $4.1 billion, but net realized capital losses increased by $3.9 billion, resulting in the drop of total industry net income to $24 billion.

New index annuity income rider from AIG

AIG added a new “protected lifetime income benefit,” to the contracts in its Power Series of index annuities, according to a release this week from AIG Life & Retirement, a division of American International Group, Inc. The contracts are available only through agents of independent marketing organizations (IMOs).

The Lifetime Income Choice benefit rider is automatically included at contract issue in the Power 7 Protector Plus Income and Power 10 Protector Plus Income Index Annuities for an annual fee of 1.10% of the so-called Income Base.

The Income Base is initially equal to the first eligible purchase premium. It increases when new premiums are paid, and it is adjusted for withdrawals. On each contract anniversary, the owner’s Income Base is marked up to which ever is greater: the contract value on the anniversary value or the Income Base plus any available income credits. 

The rider includes two options, Max Income and Level Income. The Max Income option weights income toward the early, so-called go-go years of retirement. Level Income provides a consistent income for life. Both options guarantee income growth every year prior to activating the lifetime income benefit.

Lifetime Income Choice locks in the greater of cumulative interest earned or an annual income credit of 5.50% as a deferral bonus for every year that lifetime withdrawals are delayed, “ensuring that future income will increase, even if index performance is flat or down,” the release said.

When contract owners start taking income, Max Income offers initial annual withdrawal rates ranging from 3.65% at ages 50 to 59 to 7.25% at age 72 and older for a single person. Rates are lower for couples. If the annuity’s account balance is depleted before the contract owner(s) die, the contract owner(s) will receive annual income of up to 4.00% for life.

The Level Income option offers a level payout for life, even if the annuity’s account balance is depleted. The annual withdrawal rate for one person ranges from 3.4% at ages 50 to 59 to 5.85% at age 72 and older. The Max Income option may not provide more cumulative income than the Level Income option.

SIMON adds First Trust Target Outcome ETFs

First Trust’s Target Outcome ETFs are now available at SIMON, a structured products sales, education and management platform serving some 85,000 asset managers with more than $3 trillion under management. SIMON offers “on-demand education, an intuitive marketplace, real-time analytics, and lifecycle management,” a release said.

First Trust Advisors L.P., the second largest provider of actively managed funds in the US, said in the release that its recently issued Target Outcome ETFs have grown to over $1.6 billion, as of the end of last year.

First Trust is initially offering buffered ETFs tied to the SPY, QQQ, and EFA indexes in SIMON’s ETF Marketplace, with additional offerings in the pipeline. The ETFs offer index gains up to a cap and down to a “buffer,” which protects investors up to but not beyond a downside buffer limit.

SIMON’s digital platform enables financial professionals to learn about, analyze, and invest in defined outcome ETFs.

KKR, owner of Global Atlantic, reports earnings

Between January 1 and March 22 of this year, KKR, the investment company that recently acquired Global Atlantic Holdings, earned gross realized carried interest and total realized investment income of approximately $600 million, according to a “monetization activity update” by the firm.

The earnings were driven primarily by strategic and secondary sale transactions that have closed quarter to-date, as well as dividend and interest income from KKR’s balance sheet portfolio, according to the update.

“The estimate disclosed above is not intended to predict or represent the total revenues for the full quarter ending March 31, 2021, because it does not include the results or impact of any other sources of income, including fee income, losses or expenses. This estimate is also not necessarily indicative of the results that may be expected for any other period, including the entire year ending December 31, 2021,” the release said.

KKR offers alternative asset management and capital markets and insurance solutions. The company sponsors investment funds that invest in private equity, credit and real assets and has strategic partners that manage hedge funds. Its insurance subsidiaries offer retirement, life and reinsurance products under the management of The Global Atlantic Financial Group. 

Voya, Morningstar in managed accounts partnership

Voya Financial, Inc., and Morningstar Investment Management LLC are collaborating on a new adviser managed accounts advisory program for Voya’s suite of financial wellness offerings, to be used by Registered Investment Advisors (RIAs) who advise retirement plan participants.

A new Voya survey shows that 76%)of working Americans currently enrolled in a workplace retirement plan want access to a financial adviser. New research from Morningstar Investment Management suggests that remote-working arrangements are likely to increase demand for managed accounts.

Remote workers are less likely to use default investments (such as target-date funds) than  personalized advice options (such as managed accounts), Morningstar’s research showed.. 

The same study also notes that participants who use managed accounts tend to save more for retirement — both when the service is offered as an opt-in and opt-out method.3

When Voya serves as plan recordkeeper, Morningstar Investment Management provides the technology support for adviser managed accounts and serves as the fiduciary for portfolio assignment and recommendations on savings rates and retirement age. Participants use a “single sign-on” to enroll in the plan and the managed account. 

Voya has already launched the adviser managed accounts program with advisory firms CBIZ Investment Advisory Services LLC, and Resources Investment Advisors – A OneDigital Company. As the program advances, Voya expects to work with additional RIAs. 

A ‘longevity’ biotech SPAC  

Shareholders of Longevity Acquisition Corporation (LOAC) have approved its merger with 4d pharma plc, a British biotech firm focused on Live Biotherapeutics (LBPs). In October 2020, 4d pharma announced its intention to merge with LOAC and seek a NASDAQ listing.

The merger and the NASDAQ listing of 4d pharma American Depositary Shares (ADSs) under the ticker symbol ‘LBPS’ are expected to become effective in early 2021, subject to approval of 4d shareholders and Longevity shareholders, and the SEC review process.

LOAC, a “blank check” or Special Purpose Acquisition Company (SPAC), is sponsored by Whale Management Corporation, a Bermuda-based LLC. 4d pharma develops LBPs, a class of drugs that contain a live organism, such as a bacterium, that is applicable to the prevention, treatment or cure of a disease. 

4D has developed a proprietary platform, MicroRx, that “rationally identifies LBPs based on a deep understanding of function and mechanism,” according to a release. 4d pharma’s LBPs are orally delivered single strains of bacteria that are naturally found in the healthy human gut. 

The company has six clinical treatment programs underway, for cancer, Irritable Bowel Syndrome, COVID-19, Parkinson’s disease and other maladies. It has a research collaboration with MSD, a trade name of Merck & Co., Inc., Kenilworth, NJ, to discover and develop LBPs for vaccines.

© 2021 RIJ Publishing LLC. All rights reserved.

 

At the Supreme Court, a stress test of ‘best interest’ promises

Posted on March 25, 2021 by -

If a company promises shareholders that it will always act in their best interest and then compromises its reputation and hurts its stock price by behaving badly, is the company guilty of fraud and are those investors entitled to compensation for their investment losses?

Or can an investment company call itself a “best interest” actor and then not be liable for the conflicted actions of one of its many departments? And are we talking about “best interest” as established by the Trump SEC or the Obama DOL?

Those hefty questions will be taken up by the US Supreme Court next Monday when it hears oral arguments in the case of Arkansas Teacher Retirement System versus Goldman Sachs Group.

The case took a decade to reach the high court. A complaint was first filed in 2010, after Goldman shareholders learned that the firm created and sold complex but flawed collateralized debt obligations (CDOs) and then knowingly betting against them with its own money. In a case related to that incident, Goldman paid the Securities and Exchange Commission a record $550 million fine.

Investors who bought Goldman stock in the early days of the financial crisis said they paid an inflated price for the stock based on Goldman’s “false statements about its high standard of conduct and strong protections against conflicts of interest,” according to a release this week by the Consumer Federation of America, a Washington watchdog group.

“To protect its sterling image, and its share price, Goldman made false statements that it always acted in its clients’ best interest and carefully managed its conflicts, even as it was selling mortgage-backed securities to its clients without warning them that the investments were destined to fail,” said Barbara Roper, director of investor protection, Consumer Federation of America.

“Goldman is asking the Supreme Court to conclude that its disclosures, which led directly to investor losses, were too generic to permit those investors to recover their losses in court,” Roper said. “But such a maneuver, if allowed to go unchallenged by the Court, would let companies off the leash, ushering in a wide range of misleading behavior that could materially harm U.S. investors.”

Goldman had made public assurances that it had “extensive procedures and controls that are designed to identify and address conflicts of interest” and that “[o]ur clients’ interests always come first,” the CFA release said. The release did not include a response from Goldman Sachs group.

On March 3rd, former SEC Chairs William H. Donaldson and Arthur Levitt, Jr., were among six former SEC officials cautioning the Supreme Court about the peril of allowing Goldman Sachs to avoid facing an investor lawsuit related to false and misleading claims that the investment firm admits that it made. Amicus briefs in opposition to Goldman Sachs also were filed by state securities regulators, investor advocates, pension funds, and others.

Andrew Park, senior policy analyst, Americans for Financial Reform Education Fund, said in the release: “There remains overwhelming evidence, courtesy of the 2011 Senate Permanent Subcommittee on Investigations report, showing how Goldman’s employees were not only aware of the poor quality of mortgage-backed securities and collateralized debt obligations they were selling, but also that they knowingly failed to disclose to their clients key details on how the bank or hedge funds were on the other side betting against them.

“If shareholders faced with losses have no recourse against companies who concealed their behavior and knowingly skirted a number of laws, a terrible precedent will be set for investor protection going forward.”

© 2021 RIJ Publishing LLC. All rights reserved.

China’s Bond Market: Too Big To Ignore

Posted on March 25, 2021 by -

Over the last two decades, China has grown into the world’s second largest economy, generating around 20% of the world’s GDP. It is now the world’s most populous country, its leading manufacturer and purchaser of automobiles, and its largest exporter.

China also hosts the world’s second largest bond market. In the past, restrictions and complications have kept that market off American investors’ radar screens. But with low yields in the US, Europe, and Japan, China’s bonds—government or corporate, denominated either in dollars or yuan—warrant more attention. 

Dollar-denominated bonds

China’s US dollar bonds should be seen as credit investments, not unlike US corporate bonds. The key risk is in repayment: Will coupons and principal be paid back on time. China sovereign debt carries credit ratings of A+ from Standard & Poor’s, similar to Moody’s equivalent rating, and better than many countries in Europe. But not all issuers in China carry such a high rating. China is one of the rare emerging markets (EM) with both an active investment grade market for US bonds and a high-yield market with more than 160 hard currency issuers. Backed by an economy nearly as large as all other EM countries combined, China’s US dollar-denominated corporate issues now comprise 27% of the J.P. Morgan EM corporate debt benchmark.

Large state-linked players dominate China’s high-grade market. That includes global banks, energy companies, and tech players. The 106 Chinese investment grade issuers in the J.P. Morgan Corporate EM Broad Investment Grade Index yield 2.60%, with an average spread of 1.42% over comparable US Treasuries.

The risks of these bonds tend be similar to those of US bonds, and are largely interest rate driven. If rates go up, longer-dated bonds tend to get marked down more than shorter term bonds. Default risk in high-grade bonds is low. Bonds with deteriorating credit typically are downgraded to junk levels but rarely if ever default as an investment grade rated instrument. In the US dollar high-yield sector, China has more than 60 issuers with an average yield of 7.30%. This segment has had the highest year-to-date net issuance of any country in the EM corporate high yield index.

Yuan-denominated bonds

The Chinese have slowly opened their local bond markets to foreigners. Access to these bonds are still highly regulated and not 100% fully accessible, but large mutual fund and exchange traded funds (ETF) companies have been paving the way for retail and institutional investors to gain exposure in recent years. And for good reason: at approximately $16 trillion in value, the Chinese market has become too big to ignore as it grows in bond indices and offers higher yields than in the other large economies.

China’s yuan has slowly grown into a reserve currency, as the country has become the world’s largest trading partner. Local bond investments prices are affected by local interest rate and foreign exchange rates. The Chinese currency has ranged between 6.27 and 7.18 against the U.S. dollar for the last five years according to Bloomberg, and now hovers around 6.50.

Almost 200 foreign funds held Chinese bonds in late 2020 via the expanding China Interbank Bond Market (CIBM). That was 42% above year-ago levels, according to Reuters. As of mid-March 2021, two-year local government bonds yielded 2.83% vs. only 15 bps in US Treasuries, and comparable 10-year debt paid 3.26% vs. 1.62%. By comparison, Japanese and Germany 10-year yields were at .10bps and -33bps, respectively, as of the same date. Two-year yields both were negative yielding: -14bps. and -68 bps, respectively. Credit issued by Chinese government entities, banks, and corporations pay additional credit spreads above these yields.

The chart below shows how five-year local rates have fluctuated since February 2015.

China is also one of the world’s largest issuers of “green bonds,” floating $37.6 billion worth in 2020, according to S&P. That’s considerably less than the record $55.58 billion in 2019 but still significant given the global pandemic slowdown. President Xi Jinping’s announced in September that China plans to reduce greenhouse gas emissions and become carbon neutral by 2060; that may drive more issuance of green bonds.    

Caveat emptor

Investors should exercise more-than-usual care when venturing into Chinese bonds. Local defaults have risen, especially since 2018, according to J.P. Morgan. That said, the default rate was only about 1.10% overall in 2020, but investors need to pay close attention to specific segments. During the 2020 pandemic, the consumer-sector default rate jumped to 4.8%.

China’s disclosure rules differ from those in the US. Some information is lacking by American standards. US sanctions against several Chinese companies in recent years add an element of political risk that American investors seldom encounter. Individual – and even institutional – investors might prefer an exchange traded fund (ETF) or mutual fund, with professionals managing the credit and political risks. Funds also help diversify and minimize issuer-concentration risk.

US investors took decades to globalize their equity portfolios, and they’ve taken even longer with bonds. It’s time to look at China. The country contained COVID-19 quickly, and its economy actually expanded by 2% in 2020. The growth rate may top 6% in 2021, and the economy is on track to surpass America’s in a decade or two. Once small and protected, the country’s local bonds markets—like its stock market and overall economy—can’t be ignored. 

Peter Marber, PhD, is a 30-year Wall Street veteran, heads emerging markets at Aperture Investors, LLC and lectures at Harvard and Johns Hopkins. He would like to thank Yardley Peresman of Aperture Investors, LLC for her contributions to the article.

The views expressed are those of Peter Marber but may not be the views of Aperture Investors, LLC.

DISCLOSURES

This whitepaper was prepared by Peter Marber. The examples cited herein are based on public information and we make no representations regarding their accuracy or usefulness as precedent. The author’s views are subject to change at any time based on market and other conditions. The information in this report represents the opinions of the author as of the date hereof and is not intended to be a forecast of future events, a guarantee of future results, or investments advice. The views expressed may differ from other investment professionals or from the firm as a whole.

This whitepaper is not an offer to sell any security nor is it a solicitation of an offer to buy any security. For more information, visit our website:  www.apertureinvestors.com

Of Politics and the Pension-Saving ‘Butch Lewis Act’

Posted on March 25, 2021 by -

An $86 billion provision in the new $1.9 trillion American Rescue Act should soon bring some relief to the walking-wounded of the retirement income world: retirees from or participants in financially distressed multiemployer pension plans (MEPs), who have faced or could face deep cuts in their promised pension benefits.

The provision, known as the Butch Lewis Emergency Pension Relief Act of 2021, would give enough money to the Pension Benefit Guaranty Corporation, which backstops MEPs, to help fund the pensions of more than a million members of hundreds of troubled MEPs. Some MEPs, like the United Mine Workers pension and the Central States Teamsters pension, are huge.

“As of 2017, more than 300 plans were classified as critical and more than 100 of those were classified as critical and declining,” the Congressional Budget Office reported last month, noting that 18 “critical and declining plans” have suspended benefits to avert insolvency under the Multiemployer Pension Reform Act of 2014.

Divisive issue

As political wedge-issues go, union pensions with public backing (from the underfunded PBGC, in this case) are among the most toxic. They are also emotional, with retirees and widows testifying to the hardships caused by the loss of benefits. Republicans and Democrats have failed for years to resolve the MEP shortfall in bipartisan fashion.

Butch Lewis

The Biden administration decided to put MEP funding into the American Rescue Act, which the president signed March 11. The bill had passed the Senate with no Republicans voting in favor. Democrats, unions, the Pension Rights Center, and pension experts like Alicia Munnell of Boston College and Joshua Gotbaum (director of the of the PBGC from 2010 to 2014) have praised the Butch Lewis Act in recent web posts.

Conservatives have called it as a taxpayer bailout of poorly managed pension funds, a counter-productive invitation to further employer withdrawals from MEP sponsorship, and a prelude to federal bailouts of underfunded public-sector pensions in the US (which the federal government, however, doesn’t insure). Some objected to the inclusion of the provision in the American Rescue Act because it was unrelated to COVID-19.

Changes in the Senate

To complicate matters, the Butch Lewis Act (named for the late Ohio trucker, Teamster union official, Vietnam veteran, and one-time Pittsburgh Pirate baseball prospect) ran into an eleventh-hour political snag. According to Littler, a Philadelphia labor law firm,

“The original version of the bill the House first passed provided that for 15 years after the fund received the grant, the calculation of an employer’s withdrawal liability would not take into account that subsidy. Thus, for 15 years, if an employer withdrew, it would still owe the same amount as it would have owed had the fund never received the financial assistance.

“The bill changed in the Senate, however. The Senate Parliamentarian determined that the change to the withdrawal liability calculation was not about revenue, and thus could not be included in the bill under the Byrd rule. The law President Biden signed is therefore silent as to what this funding does to an employer’s calculation of withdrawal liability.”

This led to a guest blogpost at the website of Wharton School’s Pension Research Council, in which Aharon Friedman, a former senior tax counsel to the House Ways and Means Committee, characterized the bill as an invitation to moral hazard. The bill would use “byzantine mechanics to preserve plans that may backfire unpredictably, leaving plans to resemble Weekend at Bernie’s, astronomically higher costs, and years of litigation,” he wrote.

If the bailout makes plans healthier, he argued, it would reduce the penalties that employers would face if they withdrew from a plan. Ergo, more employers would abandon plans.

“Under the Senate changes, plans receiving bailouts will be dramatically better funded for purposes of calculating withdrawal liability, allowing employers to wash their hands of the union pension mess for good at low or no cost and terminate the plans,” Friedman wrote, adding that the full cost of the bailout could run to trillions not billions of dollars.

Good but not perfect

For Gotbaum. this puts too cynical a spin on the Butch Lewis Act, which he believes will make retirement more secure for millions of workers.

“The real factor that keeps most employers in plans was and is that the union must agree to withdrawal,” Gotbaum told RIJ. “Prior to passage of the law, participating employers faced the prospect of steadily increasing underfunding and could make a case for being allowed to withdraw.

“A major employer could demand and get agreement from a union to withdraw, generally by making commitments outside the plan or improving the labor agreement in other respects. Butch Lewis completely changes this calculus. While it is true that financial assistance will reduce the calculated withdrawal penalty, it also eliminates the near-term risk of plan insolvency, so both the employer’s need for withdrawal and the union’s willingness to allow withdrawal will be dramatically reduced.”

While Gotbaum praised the new law, he conceded that it was less than he and others had hoped for. “The bill did none of the reforms that most of us would like,” Gotbaum told RIJ. Munnell wrote recently that the legislation didn’t define the appropriate interest rate for calculating liabilities or replace the traditional defined benefit structure with some shared-risk arrangement. Perhaps its flaws will be addressed when the PBGC and the Treasury Department begin writing regulations around it. 

Editor’s note: MEPs covered by the Butch Lewis Act should not be confused with the multiple employer 401(k) plans (also known as MEPs), where employees in unrelated companies can participate in a single Pooled Employer Plan.

© 2021 RIJ Publishing LLC. All rights reserved.

Millennials lead in ETF adoption: Schwab

Posted on March 18, 2021 by -

ETF investors expect the share of ETFs in their portfolios to grow to 38% over the next five years, up from 29% today. Nearly all ETF investors (94%) say they are likely to purchase ETFs in the next two years. Notably, almost half of the non-ETF investors surveyed (45%) say they are likely to purchase ETFs in the next two years. These findings come from the 10th edition of the ETF Investor Study by Charles Schwab & Co., Inc.

“Over the decade we have conducted this study, ETF investors’ appetite and affinity for ETFs has grown dramatically. They feel much more knowledgeable and confident in their abilities to use these products to help achieve their financial goals,” said David Botset, SVP of Product Strategy for Charles Schwab Investment Management, Inc., in a release this week.

Chart furnished by Schwab.

As in years past, Millennials continue to outpace Gen X and Baby Boomers in ETF adoption, though Gen X is not far behind. Over the next year, 29% of Millennial ETF investors plan to significantly increase investments in ETFs, compared to 23% of Gen X investors and 9% of Boomer investors. Millennials estimate that in five years, 43% of their portfolios will be in ETFs, compared to 39% for Gen X and 29% for Boomers.

ETF investors point to actively managed ETFs, market cap index ETFs and fixed income ETFs as the top categories that they feel will add value in helping them reach their investment goals. Active semi-transparent ETFs are beginning to attract investors’ interest, with 16% saying they plan to invest in these specialty ETFs over the next year.

ETF Investor Evolution

The proportion of ETFs in investors’ portfolios increased by about 50% over the last decade, growing from average allocations of 19% to 29%. In 2015, ETF investors predicted that 25% of their portfolios would be in ETFs in five years – a prediction that turned out to be short. They ended up with 29% of their portfolios in ETFs in 2020, and they now expect that to grow to 38% by 2025.

Investors feel much more confident when it comes to making decisions about ETFs. In the latest study, 41% of investors say they are extremely confident in their ability to choose ETFs that can help achieve their investment objectives compared to just 18% in 2015. Similarly, 77% of ETF investors consider themselves experienced or intermediate when it comes to their understanding of ETFs, compared to 57% in 2015.

“Education is a key ingredient to success in all aspects of investing, so it is very exciting to see the evolution that has taken place with ETF investors’ familiarity and comfort with ETFs,” said Botset. “Certainly the myriad strengths of ETFs – from tax efficiency, to low fees, to transparency—have paved the way for investors to adopt them as foundational building block components of an investment portfolio.”

Charles Schwab & Co., Inc. (Schwab) commissioned Logica Research to conduct an online survey of 2,000 individual investors between the ages of 25 and 75 with at least $25,000 in investable assets who are aware of ETFs. Conducted from November 9 – November 29, 2020, the study has a 3% margin of error at the 95% confidence level. Survey respondents were not asked to indicate whether they had accounts with Schwab. All data is self-reported by study participants and is not verified or validated.

© 2021 RIJ Publishing LLC. All rights reserved.

Where investors put their money in February: Morningstar

Posted on March 18, 2021 by -

Rising interest rates and a swing in equity market leadership during February seemed to invigorate investors rather than scare them off. Long-term mutual funds and exchange-traded funds took in a record $144 billion in February, surpassing the previous mark of $132 billion set in January 2018, according to Morningstar’s latest monthly fund flow report.

ETFs collected roughly $92 billion, driven by a move into passive equity funds, while open-end funds took in $53 billion, led by flows into actively managed fixed-income strategies.

Money flowed into Morningstar Categories that might weather an inflationary environment better than most, such as commodities broad basket and inflation-protected bonds. Prospects of a new federal stimulus package along with lower coronavirus case counts likely spurred optimism about future economic activity while sparking concerns about higher inflation.

Equities

US equity funds gathered a record $38 billion after investors redeemed nearly that same amount in January. Despite the wave of interest, all the inflows accrued to passive strategies; in contrast, actively managed US equity funds shed nearly $3 billion. February’s inflows for the category group are still a blip relative to the $228 billion of outflows over the trailing 12 months, but they may be a sign that investors aren’t shying away from equities despite markets nearing all-time highs.

Sector equity funds raked in a record $25 billion, powered by strong inflows into technology funds. For instance, ARK ETF Trust’s tech offerings (ETFs specializing in fintech, internet, robotics and 3D printing) collectively pulled in $4.5 billion, by far the most of any other fund family in the technology category. (See more details on ARK below.)

International-equity funds took in about $13 billion in February, their fourth consecutive month of inflows. The group’s second-largest category by total assets, diversified emerging markets, gathered the largest inflows at about $6.5 billion.

Fixed income

Taxable bond funds continued their run of inflows, gathering $57 billion for the month, bringing their total over the trailing 12 months to $493 billion, the most by far for any group. While rising interest rates led to negative performance for major bond-market benchmarks such as the Bloomberg Barclays US Aggregate Bond Index through the first two months of the year, investors didn’t shy away from the asset class and may still be using it to rebalance away from a red-hot equity market.

They appear to be tailoring their allocations, however. Lower-duration categories (that is, funds with fixed-income investments that are less sensitive to rising interest rates) attracted the most assets. Intermediate core bond funds took in the largest total within the category group, collecting $18 billion, followed by short-term bond funds’ $11.6 billion intake.

Value equity

Following a rough stretch in terms of performance and outflows, value-oriented equity funds may finally be seeing some reversion. US value stocks have outperformed growth stocks through the first two months of the year, and investors seem to be embracing the shift. Large-cap value funds took in $5 billion in February, the most since 2013. While mid-cap value funds took in just $200 million, that broke a streak of 43 straight months of outflows dating back to June 2017.

Leaders

With strong flows into passively managed equity strategies, it comes as no surprise that index-fund titans Vanguard and iShares took in the most and third-most among the largest asset managers. Vanguard pulled in roughly $37 billion, of which $34 billion went to passive strategies, while iShares’ funds raked in $16 billion.

While it’s not one of the largest fund families in terms of AUM, ARK ETF Trust is reaping flows at a remarkable pace. The advisor of a suite of mostly actively managed ETFs has seen its asset base grow from a humble $3.2 billion on Dec. 31, 2019 to $51 billion at the end of February 2021.

While strong gains across its aggressive, high-growth equity offerings account for a meaningful portion of this growth, it also took in more than $36 billion of new assets over the prior 12 months, for an astounding 1,024% organic growth rate. It pulled in $8 billion in February alone, the fifth highest total of any fund family. 

Note: The figures in this report were compiled on March 10, 2021, and reflect only the funds that had reported net assets by that date. Artisan had not reported. Morningstar Direct clients can download the full report here.

© 2021 Morningstar, Inc.

Honorable Mention

Posted on March 18, 2021 by -

Retirement assets total $34.9 trillion in 4Q2020: ICI

Total US retirement assets were $34.9 trillion as of December 31, 2020, up 7.5 percent from September and up 9.3 percent for the year. Retirement assets accounted for 33 percent of all household financial assets in the United States at the end of December 2020, according to the Investment Company Institute’s latest quarterly report.

Assets in individual retirement accounts (IRAs) totaled $12.2 trillion at the end of the fourth quarter of 2020, an increase of 9.1 percent from the end of the third quarter of 2020. Defined contribution (DC) plan assets were $9.6 trillion at the end of the fourth quarter, up 6.8 percent from September 30, 2020. Government defined benefit (DB) plans— including federal, state, and local government plans—held $7.1 trillion in assets as of the end of December 2020, a 7.6 percent increase from the end of September 2020. Private-sector DB plans held $3.4 trillion in assets at the end of the fourth quarter of 2020, and annuity reserves outside of retirement accounts accounted for another $2.5 trillion.

Americans held $9.6 trillion in all employer-based DC retirement plans on December 31, 2020, of which $6.7 trillion was held in 401(k) plans. In addition to 401(k) plans, at the end of the fourth quarter, $600 billion was held in other private-sector DC plans, $1.2 trillion in 403(b) plans, $384 billion in 457 plans, and $739 billion in the Federal Employees Retirement System’s Thrift Savings Plan (TSP).

Mutual funds managed $4.4 trillion, or 66 percent, of assets held in 401(k) plans at the end of December 2020. With $2.6 trillion, equity funds were the most common type of funds held in 401(k) plans, followed by $1.2 trillion in hybrid funds, which include target date funds.

IRAs held $12.2 trillion in assets at the end of the fourth quarter of 2020. Forty-five percent of IRA assets, or $5.5 trillion, was invested in mutual funds. With $3.1 trillion, equity funds were the most common type of funds held in IRAs, followed by $1.1 trillion in hybrid funds.

Retirement entitlements include both retirement assets and the unfunded liabilities of DB plans. Under a DB plan, employees accrue benefits to which they are legally entitled and which represent assets to US households and liabilities to plans. To the extent that pension plan assets are insufficient to cover accrued benefit entitlements, a DB pension plan has a claim on the plan sponsor.

As of December 31, 2020, total US retirement entitlements were $40.6 trillion, including $34.9 trillion of retirement assets and another $5.8 trillion of unfunded liabilities. Including both retirement assets and unfunded liabilities, retirement entitlements accounted for 39 percent of the financial assets of all US households at the end of December.

Unfunded liabilities are a larger issue for government DB plans than for private-sector DB plans. As of the end of the fourth quarter of 2020, unfunded liabilities were 44 percent of benefit entitlements for both state and local government and federal government DB plans, compared with only 4 percent of benefit entitlements for private-sector DB plans.

Jasmine Jirele succeeds Walter White as CEO of Allianz Life

Jasmine Jirele has been named president and CEO of Allianz Life, effective September 1, 2021, subject to independent auditor and regulatory filings, the company announced this week. She will succeed Walter White, who will step down on that date and retire December 31, 2021.

Jirele has been Allianz Life’s chief growth officer since 2018, with responsibilities for expanding into new markets, where she has been responsible for product innovation, marketing, communications, and Allianz Ventures.

Prior to re-joining Allianz Life in 2018, Jirele was an executive vice president within Wells Fargo’s Consumer Bank division, and was previously a senior vice president in Wells Fargo’s Wealth and Investment Management division.

She also held various leadership roles in marketing, product innovation and operations at Allianz Life. Jirele holds a B.A. in business and journalism from the University of St. Thomas and an MBA from Hamline University. 

White will be nominated to serve as an independent director on the Allianz Life Insurance Company of North America Board of Directors. 

NY Life 2020 numbers include more than $13.7bn in annuity sales

New York Life, the largest US mutual life insurance company, released 2020 results this week, reporting a record $27 billion in surplus, $702 billion in assets under management, $1.1 trillion in individual life insurance in force in the US and $12.5 billion in total dividends and benefits paid to policy owners and their beneficiaries.

In 2020, New York Life declared $1.8 billion in dividends to eligible participating policy owners in 2021, its second largest payout in company history, according to a release. It also reported life insurance sales of $1.2 billion, annuity sales of over $13.7 billion, and $2.3 billion in operating earnings.

New York Life also completed its largest acquisition ever, acquiring Cigna’s group life and disability insurance business. It is now rebranded New York Life Group Benefit Solutions. The $6.3 billion acquisition added about 3,000 employees and over nine million customers to New York Life, placing it among the top five insurers in the group life and disability insurance businesses.

The four major financial rating agencies renewed New York Life financial strength ratings, giving it the highest ratings currently awarded to any US life insurer and making the company one of only two in the industry to achieve this standard out of the 800 life insurers operating in the US today, the release said.

C-level management changes at Voya

Voya Financial is updating its operating model, which focuses on retirement plans, employee benefits, and investment management, and its leadership team, according to an announcement this week by chairman and CEO Rodney O. Martin, Jr.   

New vice chair roles

Michael Smith will serve as vice chairman in addition to his role as chief financial officer and leader of Voya’s Finance and Risk areas. Smith has expanded responsibilities for technology, data science, transformation, continuous improvement, procurement, sourcing and supplier management, and real estate.

Michael Katz, Voya’s chief strategy, planning and investor relations officer, and Santhosh Keshavan, Voya’s chief information officer, will join Voya’s executive committee.

Charles Nelson will serve as vice chairman and chief growth officer, with responsibility for growing Voya’s current base of more than 13 million individual and institutional customers and approximately 55,000 employers. He will oversee sales and distribution, relationship management, health and wealth marketing and customer solutions.

William Harmon will assume a new role as Voya’s chief client officer, leading the health and wealth sales, distribution and relationship management teams.

New CEOs of Health and Wealth Solutions

Heather Lavallee, currently president of Retirement Tax-Exempt Markets, will become CEO of Wealth Solutions.

Robert Grubka, who currently serves as president of Employee Benefits, will become CEO, Health Solutions.

Grubka and Lavallee will join Voya’s executive committee. They will collaborate with Christine Hurtsellers, CEO of Investment Management, on enterprise business growth.

Voya Financial, Inc. (NYSE: VOYA), a Fortune 500 company, serves about 14.8 million individual customers, workplace participants and institutions in the United States. In 2020, it had $7.6 billion in revenue. The company had $700 billion in total assets under management and administration as of Dec. 31, 2020. 

© 2021 RIJ Publishing LLC. All rights reserved.

Social Security Repair Bills, Compared by Actuaries

Posted on March 18, 2021 by -

At the American Academy of Actuaries’ (AAA) website, you can tackle the Social Security funding problem by playing a video game. I solved the problem by reducing the cost-of-living-adjustment by 0.7%, raising the level of income subject to the payroll tax, and hiking the combined employer/employee contribution to 14.8%.

Crisis averted.

As we all know, fixing Social Security is a task that either the Biden administration or its successors must face if the OASI (Old Age and Survivors Insurance) program is to avoid a big problem in the early 2030s. That’s when the program’s reserves or “trust fund” is expected to zero out and expected payroll tax revenue will fall short of earned benefits by about 25%.

In a webinar this week, a panel of Academy actuaries presented their analysis of three legislative proposals now floating inside the Beltway: The Bipartisan Policy Center proposal of 2016, the 2016 Johnson Proposal (after Rep. Sam Johnson, then-head of the House Social Security Subcommittee), and the 2019 Larson-Blumenthal-Van Hollen proposal. They also reviewed the 2020 Biden campaign proposal for Social Security.

The panelists, Amy Kemp, Janet Barr and Ron Gebhardtsbauer (led by moderator Linda K. Stone) tested the proposals, in effect, for their impact on two opposing principles that Social Security since its founding has tried to balance: the “individual equity” of the program and its “social adequacy.”

From ‘The Social Security Game’

Those two expressions are social science terms for, respectively, the degree to which the program is financially fair (giving all taxpayers a reasonable benefit bang for their payroll tax buck) and to which it pays enough even at the low end to keep elderly Americans out of poverty—assuming at the same time that it pays for itself with the employer/employee FICA tax, currently 12.4%.

The AAA chose to consider only reform proposals that closed Social Security’s projected long-term funding shortfall and that kept the program in the form of a PAYGO (pay-as-you-go) defined benefit pension. They didn’t entertain proposals that would convert Social Security to a defined contribution plan with individual accounts, as was suggested by a presidential commission during the early 2000s. 

The Bipartisan Policy Center (BPC) proposal: Mild tax hike, higher retirement age 
  • The minimum benefit would be $726 for an unmarried beneficiary, reduced by 70 cents for each dollar of earned benefit.
  • The normal retirement age would increase by one month every two years starting in 2022 until reaching 69 for those reaching age 62 in 2070.
  • Annual benefit increases would be pegged to the “chained CPI,” rather than the Consumer Price Index.
  • The spousal benefit, now at least one-half the primary worker’s benefit, would change to one-half the benefit of a worker with career earnings at the 75th percentile.
  • A worker’s widow or widower would no longer receive at least 100% of the deceased worker’s benefit but instead receive 75% of that benefit plus his or her own earned benefit.
  • The taxable wage base would gradually increase to $203,700 in 2021, with annual increases according to the national average wage index plus half a percentage point thereafter.
  • The BPC proposal would increase the 12.4% payroll tax gradually until it reaches 13.4% in 2026.
  • Eliminate the 15% exclusion starting in 2022 for single taxpayers with incomes over $250,000 and married taxpayers with incomes over $500,000, so that 100% of benefits would be taxable.
The Johnson proposal: No payroll tax increase
  • Provide a significant benefit increase for the lowest-paid workers, but a significant benefit reduction for those at the high end of the earnings spectrum.
  • Increase the NRA (normal retirement age) by three months every year starting in 2023, until it reaches age 69 in 2030
  • Eliminate the cost-of-living adjustment (COLA) for high-income beneficiaries and adopt the chained CPI for other beneficiaries.
  • Limit the spousal benefit to the amount based on one-half the PIA (“primary insurance amount” or benefit) of a hypothetical worker of the same age, whose earnings equaled the national average wage in all years. The benefits of widows and widowers wouldn’t change.
  • The minimum benefit would be a percentage of the national average wage two years before the person became eligible for benefits. The percentage would be based on a worker’s years of work.
  • Between 2045 and 2053, the thresholds [of earned income] for taxation of benefits would be increased by $7,500 per year for singles and $15,000 per year for couples. In 2054 the tax would be eliminated.
  • Provide a benefit increase to low-income beneficiaries after 20 years of retirement.   
The Larson proposal: Higher tax rates on the wealthy
  • Raise all benefits by making the calculation formula slightly richer.
  • Use the Consumer Price Index for the Elderly (CPI-E) for annual inflation adjustments.
  • Set the minimum monthly benefit for workers with at least 30 years (120 quarters) of covered employment at one-twelfth of 125% of the annual poverty guideline for single persons.
  • Raise these income thresholds for paying taxes on Social Security benefits to $50,000 for singles and $100,000 for couples, so that fewer beneficiaries would pay income tax on their Social Security benefits.
  • Apply the payroll tax rate to earnings in excess of $400,000.
  • Increase the combined employer/employee payroll tax rate by 0.1 percentage point each year until it reaches 14.8% in 2043.
The Biden campaign proposal 

During his 2020 presidential campaign, Joe Biden floated a plan for reforming Social Security. The plan maintained the PAYGO structure but did not raise enough revenue to close the program’s funding gap. Like the Larson proposal, it applied the payroll tax to incomes in over $400,000, but not to taxable incomes between the FICA limit and $400,000—creating a “doughnut hole.”

Biden proposed a minimum benefit at the low end and a five percent increase in benefits after 20 years of retirement. It did not raise benefits for those making more than $400,000 a year, even though it would make them liable for increased taxes. As the panelists pointed out, the Biden campaign plan hasn’t resurfaced as an actual legislative proposal, and probably won’t.

The report leaves the strong impression that Social Security isn’t in crisis, and isn’t in danger of “failing.” (If taxpayers really believed that, they would probably rebel against the withholding of payroll taxes.) All it needs is a few tweaks. Politically, it’s still a high-voltage “third rail” of American politics. For Republicans, the third rail is raising taxes. For Democrats, the third rail is cutting benefits. Finding a third way through the middle may prove difficult.

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