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Quote of the Week

Posted on November 17, 2010 by Editor Test -

American Funds Is the Top Brand in Large Cap Funds

Posted on November 17, 2010 by Editor Test -

American Funds is considered the “go-to” provider of large-cap growth and large-cap value funds among registered investment advisors, according to a new report from Cogent Research.

Virtually all advisors who use mutual funds include large-cap growth or value funds in their lineup; 39% use large-cap American Funds product for the growth portion and 31% for the value.

BlackRock, American Funds’ nearest competitor in these two asset classes, is named as the “go-to” fund provider by 7% and 6% of advisors, respectively.

No single fund company dominates among advisors seeking mid-cap, small-cap, or international product offerings, according to Cogent’s Advisor Trends in Asset Class Mix 2010TM, a report based on a nationally representative survey of over 1,400 registered advisors.

American Funds dominate all channels except for the registered investment advisor (RIA) channel, where Vanguard Group, Fidelity Investments, and, to a lesser extent, DFA (Dimensional Fund Advisors) pose a challenge.

In all six style boxes comprised of mid-cap and small-cap asset classes, Fidelity Investments and Franklin Templeton are just a few points behind American Funds for advisors who name them as “go-to” providers in these categories.

Franklin Templeton is strong among Regional and Bank channel advisors. “There’s a lot more competition… outside of the large-cap arena,” said Tony Ferreira, Managing Director of Cogent’s Wealth Management practice. “At least a half dozen fund companies are in the hunt within the mid- and small-cap fund space.”

“Take The Hartford and Lord Abbett, for example,” he added. “Among Regional [broker-dealers], these two players match or surpass what a number of larger competitors, including American Funds, are doing in all three mid-cap categories.”

For international equity funds, American Funds and Franklin Templeton were named by 25% and 17% of advisors respectively as their “go-to” provider. Beyond those two providers there are at least 30 contenders each with their own small piece of the pie.

UK’s National DC Plan Considers Investment Options

Posted on November 17, 2010 by Editor Test -

The National Employment Savings Trust (NEST), the U.K.’s state-sponsored defined contribution plan, has ruled out any direct investments in infrastructure, commodities and high yield assets in its first few years of existence, IPE.com reported.

“We won’t be investing in a single infrastructure fund, though, or a single commodities fund, or a single high-yield fund until we get bigger,” said Mark Fawcett, CEO of the program. The fund could get some exposure to those asset classes through its diversified beta fund, however.

The fund isn’t required to invest in UK equities, Fawcett said, but its overall global equity mandate will allow for 10% to be invested in local equities.

While it is still undecided whether NEST will link its pensions to the consumer price index (CPI) or the retail price index, Fawcett acknowledged the government had recently deemed CPI the appropriate measure for pensioners.

Fawcett hoped that, in time, the program would clear internally, lowering the cost and minimizing selling and buying, as the constant influx of new members would create ongoing demand for funds sold by members who are retiring.

He said that with the help of target-dated funds, NEST would be able to minimise confusion and allow people to simply set a retirement date, allowing the default investment strategy to then adjust as the pension age approached.

However, the notion of high risk and return, as well as low risk and return, socially responsible investment funds and religiously compliant funds are still being considered, and final details will be announced in the new year when trustees unveil the scheme’s Statement of Investment Principles.

As for the ultimate size of the scheme after launch, Fawcett said it was impossible to predict, as the soft launch will still require the employees of select companies to opt into the scheme.

Fawcett said that “hedge funds might have a place, certainly, at some point” in the program, but their huge performance fees conflict with the program’s low-fee philosophy. “A lot of pension funds are going into hedge funds at the moment, but it’s perhaps not the first place we’re likely to go,” he added.

75-Year Financing Plan Would Stabilize Social Security: NASI

Posted on November 17, 2010 by Editor Test -

A research brief released by the National Academy of Social Insurance (NASI) describes what it calls a program of affordable Social Security reforms that most or many Americans would support.

The new policy paper, Strengthening Social Security for the Long Run, by NASI president Janice M. Gregory, Thomas N. Bethell, Virginia P. Reno, and Benjamin W. Veghte.

While Congress addressed the immediate funding crisis the program faced in 1983, it did nothing to resolve the program’s long-term deficit except to call for phasing in an increase in the retirement age from 65 to 67. That benefit reduction is still being phased in today, the report explains. Congress did not add any new revenue, even though providing future revenue had been an accepted practice in the past.

The Social Security program today does not face the same kind of crisis it did in 1983, when a short-term financing problem occurred. Nor is its cost ballooning out of control: Even though the percent of the population receiving Social Security benefits will increase from about 17% today to 25% in 75 years, the cost of the program as a percent of the economy will increase only from about 5% to about 6%.

But NASI sees three reasons to doubt the future adequacy of Social Security benefits. First, average benefits are only about $14,000 today; second, benefits are projected to decline as a percent of prior earnings; third, other sources of retirement income are becoming less secure and less adequate.

Covering the projected long-term shortfall facing Social Security would require revenue increases equal to slightly more than 2% of taxable payroll over the next 75 years, according to the authors. That revenue could be raised by lifting the FICA contributions cap to again cover 90% of earnings “as Congress intended and scheduling potential FICA rate increases for points in the distant future when additional funds would strengthen the program,” NASI said in a release.

An Alternative Deficit Reduction Plan

Posted on November 17, 2010 by Editor Test -

Former Federal Reserve vice chair Alice Rivlin, a member of President Obama’s deficit-reduction commission and co-chair of a separate 19-member group sponsored by the Bipartisan Policy Center in Washington, today proposed a 6.5 percent national sales tax to reduce the U.S. budget deficit.

Rivlin’s recommendations come as week after the commission’s co-chairmen, Erskine Bowles and Alan Simpson released a draft proposal and two weeks before the commission’s recommendations are to be delivered to Congress.

As reported by Bloomberg News, Rivlin, a Democrat, and former New Mexico Republican Senator Pete Domenici, are offering a more aggressive approach to tax increases and cuts to Medicare than the Bowles-Simpson plan did.

Similar to the Bowles-Simpson proposals, the Rivlin plan would lower income tax rates while eliminating most deductions and credits. It would replace the home mortgage and charitable contribution deductions with 15% refundable credits.

The plan also makes $756 billion in cuts to health care costs through 2020, including raising Medicare premiums from 25% to 35% over five years, and starts a premium support program to limit growth in federal spending on the health-care program for the elderly. It also attempts to spark economic growth with a one-year Social Security payroll tax holiday designed to create 2.5 million jobs.

“It is a fundamental difference” with the Bowles-Simpson plan, said Steve Bell, a scholar at the Bipartisan Policy Center. “They assume that this deficit reduction plan in and of itself is sufficient. We don’t.”

On Social Security, instead of raising the retirement age, as in the Bowles-Simpson plan, the Rivlin group proposes a gradual increase in the amount of wages subject to payroll taxes, currently $106,800, over the next 38 years to cover 90% of all wages. It would also trim the annual cost-of- living adjustments and reduce the growth in benefits for the top 25% of beneficiaries.

The Rivlin-Domenici plan seeks to illustrate why a combination of spending cuts and tax increases is the only way to stabilize the debt by 2020. According to their report, targeting domestic discretionary spending cuts alone would require eliminating almost everything from law enforcement and border security to education and food and drug inspection.

The nation also cannot grow fast enough to grow its way out of the deficit, the report says. To stabilize the debt at 60% of GDP, the economy would have to grow at a sustained rate of more than 6% a year for at least the next 10 years—more than 1.5 points faster than in any decade since World War II.

Finally, raising taxes on wealthy Americans won’t by itself solve the problem, the report says. Reducing deficits to manageable levels by the end of the decade would require raising rates on the top two income brackets to 86% and 91%, the report says.

Millionaires Haven’t Abandoned the Equities Market

Posted on November 17, 2010 by Editor Test -

A new survey of millionaire investors commissioned by U.S. Bank and conducted online by Harris Interactive offers a fresh look at how this group managed their assets through the recession and how they are investing today.

“The vast majority of millionaire investors have persevered and remained in the market,” said Mark Jordahl, president of U.S. Bank Wealth Management Group. “They haven’t overreacted. They’ve maintained a balanced approach to risk and its potential rewards, and they are confident about achieving their long-term investment goals over the next six to ten years.”

The Private Client Reserve of U.S. Bank Millionaire Investor Insights Annual Survey, which looks at investment attitudes, behaviors, risk profile and strategies of millionaire investors, was conducted between September 27 and October 15 among 1,609 U.S. households with investable assets of $1 million or more.

Some of the findings challenge conventional assumptions about investor behavior since the economic and market downturn began. The highlights:

92% of millionaires have not abandoned the stock market, with 43% currently engaged in moderate to heavy buying or selling and 49% waiting for the right opportunity to buy or sell.
20% of millionaires who lost value in their investments since 2008 have already seen their investments return to pre-2008 levels, and 90% indicated that their investments performed better or about the same as other investors since the beginning of 2008.
47% say their investment risk tolerance has not changed during the last three years and only one in 10 say they are not willing to take any investment losses in the current investment market.
In the past three years, 47% percent of millionaires made no change in their allocation to equities, 42% made no change in their allocation to fixed income, and 47% made no change in their allocation to cash.
72% said the U.S. stock market performance has a major or moderate impact on their investment strategies.
Many (43%) are currently engaged in moderate to heavy buying or selling to take advantage of market opportunities, and 49% are looking for the right opportunity to buy or sell.

20% percent have already seen the value of their investments return to pre-2008 levels, and 54% feel it will take up to five years for their investments to get to where they were prior to 2008.
90%say their investments performed better or about the same as other investors.

Many millionaires (45%t) say they have become more conservative with regard to their investment risk tolerance during the past three years, but 47% say their investment risk tolerance has not changed.
A vast majority (93%) says worries about their investment performance have not caused them to lose sleep at night.
Only 10% of millionaires said their primary motivation for investing is to protect their wealth by limiting losses.
A majority (61%) are investing to maintain their wealth by seeking a rate of return that outpaces inflation, fees and taxes or to increase their wealth by seeking portfolio growth (29%).
80% are personally involved in making decisions about their investment portfolios, with 20% delegating most or all of their investment decisions to their financial advisor.
A majority of millionaires (70%) trust their financial advisor to help them grow their investments and 71% say they get advice from others about how to invest, but go with their own instincts.

The Private Client Reserve of U.S. Bank inaugural Millionaire Investor Insights Annual Survey monitors the investment attitudes, behaviors, risk profile and strategies of millionaire investors in the United States. The national survey was conducted online for U.S. Bank by Harris Interactive between September 27 and October 15, 2010 among 1,609 respondents over age 18 with $1 million or more in household investable assets (excluding primary and secondary residence and assets held in employer-sponsored retirement plans).

Fees vs. Commissions in SPIA Sales

Posted on November 17, 2010 by Curtis Cloke -

After reading RIJ’s article last week on the proceedings of the recent NAPFA conference in Boston (“Singing from the Fee-Only Song Book,” RIJ, November 11), financial planner Curtis Cloke of Burlington, Iowa, sent these comments:

There are many myths and misunderstandings about income annuities. The reality is not always obvious. Take the issue of advisor compensation, for instance. When a client incorporates an immediate annuity into a custom financial plan, we shouldn’t ask what revenue method is best for the advisor; we should ask what method is best for the client.

When the issuer pays the advisor a 3% commission, the commission comes from the spread that’s priced into the contract and the issuer recoups it over the life of the contract. A fee-only advisor, on the other hand, charges a fee in addition to the cost of the annuity and the client pays him or her with purely after-tax dollars.

Let’s assume, for example, that you have a non-qualified deferred annuity contract that has been in effect for a period of time and has grown from an initial $75,000 to a current value of $100,000. Let’s further assume that the client wants to 1035-exchange the contract to an immediate or deferred income annuity.

If the manufacturer pays the advisor—perhaps an insurance agent—a 3% commission, the manufacturer would amortize $3000 over the life of the contract, and deduct it internally with no tax implications for the client at the time of purchase.

But a fee-only advisor, recommending the same product, would discount the cost of the annuity by $3,000 and charge a one percent fee over three years. In that case, the client will have to pay that fee with after-tax earnings. Counting the tax, the client might end up effectively paying more like $3,550 than $3,000. Is that better for the client?

If the income annuity was purchased with qualified money from an IRA or a 401(k), the manufacturer who pays an upfront commission is re-paid from the client’s pre-tax assets. The transaction creates zero tax impact to the client. The client who pays a fee-only advisor doesn’t get the same benefit.

In addition to manufacturers that will price a “net of commission” single premium income annuity (SPIA), there are also platforms that offer institutionally priced SPIAs. The platform typically charges a 2% to 2.5% fee, on top of which the fee-only advisor charges one percent. The platform fee and the fee charged for the advice must now be paid for with after-tax income. In this scenario, the client may pay significantly more for the annuity than when a commission is internally financed by the manufacturer.

If you do the calculations, you’ll find that charging a fee instead of a commission may in fact be less beneficial for the client. In any case, it’s certainly no better for the client to pay three percent in fees than to pay a three percent commission.

Your story also touched on the cost of an inflation rider on an income annuity. Today you can purchase an inflation rider that increases the payout by a fixed annual percentage or by the change in the Consumer Price Index. I advise my clients to elect the fixed percentage and not the CPI-driven rider.

As the RIJ article accurately explains, when the insurance company prices an open-ended benefit like a CPI-driven adjustment, it will always use worst-case assumptions. If you elect a KNOWN percent inflation feature, there is no guesswork or risk to the manufacturer. A fixed inflation adjustment purchased as a rider on a period-certain income annuity will actually provide higher internal rates of return than an income annuity with no inflation rider. In our clients’ retirement plans, we often build ladders of SPIAs and deferred income annuities with fixed-percentage inflation adjustments.

Curtis Cloke is the creator the THRIVE Income Distribution System.

How to Expect the Unexpected (in a Retirement Income Plan)

Posted on November 17, 2010 by Editor Test -

The traditional “4% rule” regarding sustainable lifelong withdrawals from retirement savings works only if you neglect to anticipate the cost of emergencies, says a noted financial consultant.

If you incorporated the risk of emergencies, the sustainable withdrawal rate would sink to 3%, writes Gordon B. Pye, Ph.D., in the current issue of the Journal of Financial Planning. To put it another way, you’d have to arrive at retirement with 33% more savings than you thought you needed.

Emergencies can be worse than bear markets because they don’t correct themselves, Pye says; they don’t obey the principle of reversion-to-the-mean. Like bear markets, however, they pose timing risks. Their effect is worse if they occur near the beginning of retirement instead of near the end.

The retirement planning software that exists today is flawed to the extent that it doesn’t help advisors incorporate the risk of emergencies into their spend-down rates, either before or after an expensive emergency, he says.

There’s a one in 20 chance of an emergency occurring every year during retirement and, on average, one expensive emergency will occur during a 20-year retirement, Pye says. He projects a 38% chance of one emergency during retirement, a 36% chance of no emergencies, a 19% chance of two, a 6% chance of three and a one percent chance of more than three.

In the past, Pye has written about the Retrenchment Rule, a discounting technique that adjusts withdrawal rates downward during retirement. This rule accommodates the tendency for retirees to spend more money early in retirement (during the Go-go years) than later (during the Slow-go and No-go years). He uses an annual Retrenchment Discount Rate of 8% to deflate future projected withdrawals during retirement.

“A more active and expensive standard of living gradually becomes less desirable as lifestyles necessarily slow with age even for those who remain in relatively good health,” he mordantly observes.

If a large unexpected emergency expense takes a chunk out of savings, he recommends sticking to the prescribed withdrawal rate, even if doing so entails a reduction in standard of living. To protect against insufficient income later in life, Pye has in the past recommended either buying a life annuity or allocating a “sizable portion of the portfolio each year to fixed-income issues.”

The $1.1 Trillion Tax Hike

Posted on November 17, 2010 by Kerry Pechter -

The most provocative idea in the PowerPoint slides released last week by the co-chairs of the National Commission on Fiscal Responsibility and Reform was “Option 1: The Zero Plan.” It was buried so deeply in the document, however, and was couched in such bureaucratic language, that not everyone noticed it.

Option 1, on page 23, says that the government should “eliminate all $1.1 trillion of tax expenditures” and apply the new revenue to reduce the deficit and tax rates. It would add back any particularly desirable tax expenditures and increase the tax rate to pay for them.

This modest proposal—assuming that it’s more than a bluff or a bargaining chip—obviously isn’t so modest.

First, it suggests that Americans already give themselves a generous $1.1 trillion in tax breaks every year. Second, it implies that every exemption, deduction, exclusion, credit and deferral in the IRS code—from the mortgage interest deduction to corn syrup price supports—is a form of government spending.

Third, and most importantly for anyone in the retirement income industry, it knocks the legs out from under the employer-sponsored retirement savings industry and the insurance industry, which are predicated on tax deferral and exemptions.

Some observers recognized right away what the Zero Option meant. One of the first to attack it last week was Brian Graff, CEO of the American Society of Pension Professionals and Actuaries (ASPPA), which represents thousands of third-party retirement plan administrators and others.

“The proposed ‘Zero Option Plan’ would decimate the savings rate by eliminating tax incentives for contributing to employer-sponsored retirement plans, such as 401(k) plans, likely triggering mass terminations of company retirement plans—directly impacting a worker’s ability to save for retirement,” Graff said in a press release.

“The 401(k) acts as the primary savings vehicle for most Americans and eliminating these tax incentives would strip them of critically important benefits and protections provided by the Employee Retirement Income Security Act of 1975 (ERISA). Simply put, the retirement security of American workers will greatly suffer if the Deficit Reduction Commission’s recommendations are enacted.”

Another first-responder was blogger Michael Cannon at the Cato Institute website. For Cannon, the use of scornful expressions like “tax expenditure” and “backdoor spending in the tax code” in the Proposal when referring to tax breaks was a sure sign that someone’s hand was about to reach into his pocket.

“To call them ‘tax expenditures’ or ‘tax subsidies’ or ‘backdoor spending in the tax code’ is to claim that when the government fails to take a dollar from you, it is spending that dollar,” Cannon fumed. “It implies that your dollar actually belongs to the government, which is graciously letting you keep it. And it implies that eliminating a tax loophole is not a tax increase, because that dollar already belonged to the government anyway. The government has simply decided to spend its money somewhere else. When you hear a politician use the terms tax expenditure, tax subsidy, or backdoor spending in the tax code, beware. He’s about to raise your taxes.”

The Zero Option was so audacious that some people gave it little chance of being taken seriously. (After reading the Deficit Commission’s PowerPoint last week, I e-mailed a prominent figure in the 401(k) industry. “I think it’s a trial balloon or a negotiation ploy, rather than a serious threat,” I wrote. “They’re just saying ‘Everything is on the table.’” “Agreed,” he wrote back.)

Others felt the same way. In an e-mail to a LinkedIn discussion group, Boston-based consultant Leslie Prescott wrote, “The implications would be enormous. Aside from any company matches, there would be little incentive for employees to participate. Their proposal is completely at odds with the efforts of other areas of the government to increase retirement savings, and the industry’s lobbyists will be furiously trying to squash it. I believe this measure has 0% chance of being implemented.”

That may be why more people focused on the Social Security section of the draft proposal. It suggested a wide range of partial fixes for the old age insurance program, including raising the retirement age, adopting a more conservative COLA index, and gradually increasing the wage base for payroll taxes to about $175,000 from $106,000 over the next 40 years.

Steven Sass of the Center for Retirement Research at Boston College, who has written a history of the private pension system in the U.S. and recently helped produce a Social Security Claiming Guide, was generally positive about the Bowles-Simpson recommendations.

“Raising the retirement age is sensible. The change in the CPI makes sense. It makes Social Security work the way it ought to work, with two caveats. The chained CPI is based on notion that people change their shopping habits when prices go up. But older people don’t necessarily change habits as easily as younger people, so chain linking isn’t a good measure for them,” Sass said.

“The basic issue for social security—it’s largely a matter of what the young want,” he continued. “People approaching retirement won’t be affected by the increase in the retirement age, so a lot of reform is based on [changing Social Security for] young people. Ultimately, they will have to decide whether they want to pay less tax or get more benefits. It would be great to hear from them. The current proposal is weighted more toward benefit cuts than tax increases, and I don’t know if that would be their choice. It’s hard for them to appreciate the difference. I’d love to have someone set up a national vote on it.

“For Social Security, the shift in the dependency ratio is the underlying problem. If we move the retirement age out five years, we can get back to a three-to-one ratio of workers to retirees. But the more you raise the retirement age, the more people you get on disability. That’s a mess,” Sass said.

“My real fear is that we’ll quickly slip into a means-tested system. Pretty soon you have half the population on means testing. Means-testing makes people hide their means or it discourages work. There’s pain coming, and we’ve got to take our medicine. We’ve known for over 20 years that Social Security had a long-term financing problem, but liberals don’t want to cut benefits and conservatives want individual accounts and we haven’t been able to deal with that.

“But the solution is not look for scapegoats or nostrums. We have to find a better way than, ‘We don’t want to take our medicine.’ People tend to overestimate the utility of money and underestimate the utility of not being surprised by financial problems or not having to worry about money.”

Draft of Deficit Reduction Proposals Released

Posted on November 11, 2010 by Editor Test -

On Wednesday, the chairmen of the Obama administration’s bi-partisan National Commission on Fiscal Responsibility and Reform released a PowerPoint draft of their recommendations for reducing the annual federal budget deficit, now over $1 trillion as a result of spending to mitigate the effects of the financial crisis.

The draft proposes a wide range of cuts throughout the federal budget, but makes a point of strengthening Social Security without privatizing it and suggests simplifying the IRS code to three tax brackets with a maximum marginal income tax rate of 35% and a corporate tax rate of 26%.

But the commission’s modest proposal to question all $1.1 trillion worth of annual “tax expenditures,” including tax deferral in retirement plans, has some worried.

“We are deeply concerned that recommendations from the draft report issued today from the chairs of the Deficit Reduction Commission would eliminate tax incentives for retirement savings and negatively impact the ability of working Americans to effectively prepare for retirement,” wrote Brian Graff, CEO of the American Society of Pension Professionals and Actuaries, in a release.

“As drafted, one of the options listed in the proposal would eliminate the tax incentive for employers to offer retirement plans to their employees—which ultimately hits low and moderate income workers the hardest. Data prepared by the Employee Benefit Research Institute (EBRI) suggests that only 5% of workers save for retirement on their own, without the benefit of an employer sponsored plan. By contrast, 70% of moderate to low income workers earning between $30,000 and $50,000 participate in employer sponsored retirement plans when they are offered,” the release continued.

“The proposed “Zero Option Plan” would decimate the savings rate by eliminating tax incentives for contributing to employer-sponsored retirement plans, such as 401(k) plans, likely triggering mass terminations of company retirement plans—directly impacting a worker’s ability to save for retirement,” Graff said.

The plan reduces the budget deficit to “sustainable levels” by 2015 but doesn’t predict a balanced federal budget until 2037—when the youngest boomers will have just begun taking required minimum distributions.

Social Security reform is covered on pages 42 through 50 of the draft proposal. The recommendations include preventing the 22% across-the-board benefit cuts anticipated in 2037, making the benefit formula more progressive so that high-income recipients receive relatively less, taxing 90% of covered earnings by 2050, indexing the retirement age to longevity gains, dampening COLAs and many other specific optional measures.

The draft proposal also includes recommendations to:

Cut defense spending by $100 billion in 2015, with savings to come from overhead reduction, overseas base closings, and reductions in defense contracting.
Freeze federal non-defense pay for three years.
Reduce the federal workforce by 10% and eliminate 250,000 non-defense contracting jobs.
Eliminate all $1.1 trillion in “tax expenditures,” i.e. subsidies, and reinstate them on a case-by-case basis.
Limit mortgage deduction to primary residences, cap at $500,000 mortgages and eliminate tax deduction for home equity loans.
Cap the federal share of Medicaid payments for long-term care.

Vox Populi on the ‘Volcker Rule’

Posted on November 11, 2010 by Editor Test -

The deadline for public comments on the so-called Volcker Rule—Section 619 of the Dodd-Frank financial regulatory bill—has just passed. The Rule would discourage banks and non-bank financial firms from “proprietary” trading and limit their involvement in risky hedge funds or private equity funds.

More than 1,400 Americans sent comments to the Treasury Department, many of them quite emotional in their support of the Rule. Hundreds of members of the activist group, Public Citizen, praised the Rule, often submitting the same boilerplate text in the fashion of grass-roots (or “Astroturf, ” if you prefer) campaigns.

A much smaller but far more influential group—including Spencer Bachus, the likely chair of the House Committee on Financial Services come January—wrote to criticize the rule. Former Fed chairman Paul Volcker, the inspiration for the eponymous rule, also weighed in.

Representatives of the insurance industry, of course, sent in comments that reflected what they’ve asserted publicly: that variable annuity and variable life insurance separate accounts should “not fall under the purview of the Volcker Rule.” If separate accounts were classified as hedge funds or private equity funds under the Rule, they said, insurers might be hindered or prevented from using them. That would be a game-changer, and not a good one.

‘Mass exodus’ feared

Bachus, a Republican congressman from Alabama, argued that the Volcker Rule would weaken the competitiveness of the U.S. financial sector. It “will spark a mass exodus of clients from U.S. banks to banks based abroad” that are not barred from proprietary trading, he wrote.

More specifically, the Rule would deprive U.S. private equity funds of an important source of financing by preventing banks and investment banks from investing in them, Bachus wrote. Flows to U.S. private equity funds dropped by 90% from fourth quarter 2007 to fourth quarter 2009, to $10 billion, he claimed. Bottom line, he said: proprietary trading didn’t cause the financial crisis.

Others charged the opposite. Simon Johnson, an MIT professor and blogger at baselinescenario.com, wrote, “Mismanagement of risks that involved effectively betting the banks’ own capital was central to the financial crisis of 2008… the separation between banks and the funds they sponsor, in any fashion, needs to be complete.”

Johnson worries that the failure of a risky hedge fund or private equity fund can bring down the bank that sponsored it and, if the bank is big enough, jeopardize the whole financial system. Not so, say BNY Mellon, Northern Trust, and State Street Global Advisors.

Lawyers representing those institutions argued that certain kinds of “sponsorship” by banks of speculative funds are benign. Banning all sponsorship through the Volcker Rule, they say, would kill healthy and even essential activities along with excessively risky activities.

“Preventing banks from offering normal banking services in connection with directed trustee services to funds would be highly disruptive, particularly for pension plan sponsors and beneficiaries, and could undermine the competiveness of U.S. custody banks,” wrote attorneys from those three giant banks.

The voice of the people

In contrast to the bank’s legalese, the individual Americans who wrote to the Treasury’s Financial Stability Oversight Committee were bluntly, emotionally, succinctly and almost categorically in favor of establishing the Volcker Rule and even perhaps reinstating the Glass-Steagel Act of 1999, which de-regulated banking activities. Here are a few representative samples of the hundreds of spontaneous comments:

“Stop the fraud. Regulate financial transactions by banks. No more bailouts with citizens’ money”—Abigail Winston, sole proprietor.

“Banks should be freed from the incentives of the derivatives market so they can fully appreciate the incentives of investing in real markets. People here in Texas aren’t only up in arms about it, they’re practicing their aims. Be careful how far y’all let things slide before someone decides to add that critical spark to the well fueled fire-pit”—Sam Houston State University

“We must control the Banksters and Wall Street, if we are to have a government of, for & by the People”—Lewis Patrie, Physicians for Social Responsibility

“Stop gambling and play by the rules the rest of us follow”—Don Cramer, retiree.

“I think you must look VERY carefully at any deregulation of Wall Street. They have committed a HUGE amount of destruction and are busily going Who? Me? now. You must think of the good of the country and apply standards as rigorous as you would apply to the safety of airplanes, hospitals etc. Not doing so would be saying that, well, blah, let’s just fail here”—Bill Jaynes, Swan River Software

Volcker’s own view

Paul Volcker himself wrote to Treasury Secretary Tim Geithner to comment on the Volcker Rule. He spoke, not surprisingly, in favor of the rule. Though not in so many words, he seemed to describe the spirit of the rule as this:

That banks should no more invest in hedge funds and private equity funds on their own account than a lawyer should sue corporations for negligence and compensatory damages without first having an injured client. “Hedge and private equity funds should be aligned with and support established customer-focused asset management business,” he wrote.

Volcker took note that proprietary traders at the banks might, like attorneys who advertise for injured clients after they decide to file a class-action lawsuit, seek cover in legitimate market-making activities for customers:

“The press has carried reports that proprietary traders of banking organizations are being reassigned where their professional skills may be utilized for market-making within existing customer trading and investment management operations,” he wrote.

“I am conscious that some of those reports suggest implicit (or even explicit!) expectations that proprietary trading may continue in that guise. The ability of supervisors should be clear to undertake close scrutiny of trading books if there is reason to suspect significant proprietary activity may exist and be tolerated by management.”

The Bucket

Posted on November 11, 2010 by Editorial Staff -

Financial Engines Reports 3Q 2010 Results

Financial Engines, the provider of investment management and advice to employees in retirement plans, today reported financial results for its third quarter ended September 30, 2010.

“Financial Engines increased its assets under management by 45% and our revenue by 31% year over year,” said Jeff Maggioncalda, president and CEO of the Palo Alto-based, NASDAQ-listed company. “When we started the business fourteen years ago, we bet on the long-term trends of demographics and the growing importance of the 401(k), and these trends continue to fuel our growth.”

Financial results for the third quarter of 2010 compared to the third quarter of 2009:

Revenue increased 31% to $28.8 million for the third quarter of 2010 from $22.0 million for the third quarter of 2009
Professional Management revenue increased 46% to $19.9 million for the third quarter of 2010 from $13.6 million for the third quarter of 2009
Net income was $53.4 million, or $1.15 per diluted share, for the third quarter of 2010, due in part to an income tax benefit of $49.9 million, compared to net income of $2.1 million, or $0.06 per diluted share, for the third quarter of 2009

Non-GAAP Adjusted Net Incomeincreased 57% to $4.7 million for the third quarter of 2010 from $3.0 million for the third quarter of 2009
Non-GAAP Adjusted Earnings Per Share were $0.10 for the third quarter of 2010 compared to $0.07 for the third quarter of 2009
Non-GAAP Adjusted EBITDAincreased 27% to $7.1 million for the third quarter of 2010 from $5.6 million for the third quarter of 2009

Key operating metrics as of September 30, 2010:

Assets under contract (“AUC”) were $344 billion
Assets under management (“AUM”) were $34 billion
Members in Professional Management were 463,000
Asset enrollment rates for companies where services have been available for 26 months or more averaged 11.9%

Jackson National Sets VA Sales Record

Jackson National Life recorded more variable annuity sales during the first nine months of 2010 than during any previous full-year reporting period, generating $10.5 billion in premium or 57% more than in the same period in 2009. Total sales and deposits were $14.3 billion during the first nine months of 2010, up 37% over the same period last year.

Jackson, an indirect wholly owned subsidiary of Britain’s Prudential plc, increased its share of the VA market to 10.5% during the first half of 2010 (according to the latest industry data available), up from 6.2% during the same period of the prior year.

In the second quarter of 2010, Jackson’s Perspective II was the top-selling individual retail VA contract for the third consecutive quarter, with sales of $1.88 billion—the highest quarterly retail sales ever recorded for a single contract. Jackson’s VA asset growth of 45.2% was the highest increase in the industry from June 30, 2009 to June 30, 2010.

To preserve capital, Jackson continues to manage fixed index and fixed annuities, although low interest rates have dampened demand for those products. Jackson sold $1.3 billion in fixed index annuities (FIAs) during the first nine months of 2010, compared to $1.6 billion during the same period in 2009. Sales of traditional deferred fixed annuities totaled $1.0 billion, versus $1.3 billion during the first nine months of 2009.

Despite these results, Jackson increased its FIA market share from 5.5% during the first half of 2009 to 6% during the first half of 2010, and its traditional deferred fixed annuity market share from 2.3% during the first half of 2009 to 3.1% during the first half of 2010.

Curian Capital, Jackson’s separately managed accounts subsidiary, collected record deposits of nearly $1.5 billion during the first nine months of 2010, up 91% over the same period of the prior year. As of September 30, 2010, Curian’s assets under management (AUM) were $4.8 billion, up from nearly $3.6 billion at the end of 2009.

In 2010, Jackson added two new optional lifetime guaranteed minimum withdrawal benefits (GMWBs) to its VA products. LifeGuard Freedom 6 Net GMWB, introduced in May, allows investors to offset their tax liability by increasing their available withdrawal amounts. The LifeGuard Freedom Flex GMWB, introduced in October, allows investors to customize their benefit. Jackson added American Funds and BlackRock funds to its VA investment options in 2010.

As of September 30, Jackson National was rated A+ (superior) by A.M. Best, AA (very strong) by Standard & Poor’s, AA (very strong) by Fitch and A1 (good) by Moody’s.

Strong 3Q Annuity Sales at Allianz Life

Allianz Life Insurance Company of North America reported premium of $2.9 billion for the third quarter of 2010, a 63% year-over-year increase, and growth of 11% over last quarter’s strong sales.

For the quarter, fixed index annuity sales were $1.9 billion of premium, up 36% from the third quarter of last year. Variable annuity sales exceeded expectations, the company said, with premium of $800 million, up 275% above the third quarter of 2009.

The company posted operating profit of $57 million for its third quarter 2010, down from the second quarter due to the poor market environment and low interest rates. Total assets under management grew to $85 billion, up from $75 billion a year ago.

“Annuity sales are on the rise, and innovations such as inflation protection and increasing income options are making them extremely attractive, which, combined with a strong distribution network, is driving our top line results,” CEO Gary C. Bhojwani said.

Pershing Platform Adds Janus and PacLife Funds

Pershing LLC, a unit of BNY Mellon, has added Janus Funds and Pacific Life Funds to FundVest, its no-transaction-fee mutual fund platform. Those funds are now available to clients of Pershing’s introducing broker-dealer customers and to clients of independent registered investment advisors who use Pershing Advisor Solutions LLC. FundVest offers over 3,700 load and no-load mutual funds from more than 230 fund companies without regular transaction fees.

Penn Mutual Launches Inflation-Sensitive VA

Penn Mutual Life Insurance Company, based in Horsham, Pa., has launched the Inflation Protector variable annuity, whose living benefit rider provides contract owners with an income base that increases with the Consumer Price Index (CPI-U) or market performance (whichever is greater) annually in both the deferral and withdrawal phases.

The product features two withdrawal options, life or 20 years certain. Single and joint coverage is available. Withdrawal percentages can be as high as 6% depending on the age of the annuitant and how long the contract has been in force at the time of the first living benefit withdrawal.

Nationwide Enriches Online Participant Education

Nationwide Retirement Plans now offers an “On Your Side” Interactive Retirement Planner to help participants and plan advisors establish savings goals, track progress, and project “what if” scenarios.

The tool has ambitious goals. According to a release from Nationwide, it allows participants to take an “in-depth look at their retirement situation” and helps improve their “unique retirement outlook—all in about 10 minutes.”

In addition to the new retirement planner, Nationwide Retirement Plans has enhanced its home page, where participants can assess investment options, learn about investing and link to the new Interactive Retirement Planner. Nationwide also introduced a new Rollover Center, where participants can learn about IRAs and rollover options, compare traditional and Roth IRAs and talk with a financial professional.

American Equity Earns $27.6 Million in 3Q 2010

American Equity Investment Life Holding Company, a leading underwriter of index and fixed rate annuities, reported 2010 third quarter operating income of $27.6 million, or $0.45 per diluted common share, a 2% decrease compared to 2009 third quarter operating income of $28.2 million, or $0.47 per common diluted share.

Highlights for the third quarter of 2010 and the first nine months of 2010 include:

“A-“ (Excellent) rating from A.M. Best
Risked based capital ratio (RBC) of approximately 363%.
Net income for the third quarter of 2010 was $20.5 million, compared to a net loss of $3.0 million for the same period in 2009.

12% annuity sales increase, to $3.1 billion, for the first nine months of 2010 compared to $2.8 billion for the same period in 2009.
15% increase in invested assets at September 30, 2010, to $18.5 billion, compared to $16.1 billion a year earlier.
Investment spread on annuity liabilities was 3.09% for the third quarter of 2010 compared to 3.13% for the same period in 2009.
Book value per share including accumulated other comprehensive income of increased to $18.03 compared to $13.08 at December 31, 2009.

“Sales of new annuities reached record levels during the third quarter of 2010 with average monthly sales volumes exceeding $400 million per month. The increase in the pace of sales reflects continued high demand for safe money products as a result of market volatility as well as the relatively lower rates available on competing products such as bank certificates of deposit. In addition, rate reductions by competitors helped drive a higher volume of sales to American Equity,” the company said in a release.

“Finally, the demise of Securities and Exchange Commission Rule 151A has lifted an impediment to sales caused by the uncertainty surrounding the impact of that Rule on the index annuity market.”

Genworth Announces $250 Million Repayment

Genworth Financial, Inc., announced that it has repaid $250 million of outstanding borrowings under its five-year revolving credit facilities, paying $125 million of outstanding borrowings under each of the two facilities. Following such repayments, the company has approximately $240 million of borrowings outstanding under each of these facilities, totaling $480 million. These facilities expire in May and August of 2012.

ING Plans IPOs to Pay Back Dutch Bailout

ING, the Dutch financial services company, is planning separate initial public offerings of its U.S. and European insurance businesses to satisfy regulators’ demands for divestitures, Ifa.com reported. The IPOs are “most likely” in 2012, said ING CEO Jan H.M. Hommen, but could happen late next year.

Hommen said the company was making “good progress” toward creating stand-alone insurance and banking companies, and that while a single IPO remained a possibility, the company was preparing for a “base case” of two for the insurance units.

One would be a “Europe-led I.P.O. with solid cash flow combined with strong growth positions in developing markets.” The other would be a “separate U.S.-focused I.P.O. with a leading franchise in retirement services.”

Under pressure from the European competition authorities, ING agreed last October to separate its insurance and banking businesses in exchange for its 2008 bailout by the Dutch government, which gave ING €10 billion, or $14 billion, and took on most of the risk on its U.S. real estate portfolio. The regulators had worried that the government aid gave ING an unfair advantage over rivals.

A banking analyst at SNS Securities in Amsterdam estimated the book value of ING’s insurance portfolio at about €21 billion. The proceeds of the sale of the insurance business would help pay the company’s remaining €7.5 billion debt to the Dutch government. Shares of ING rose 2.9 percent in Amsterdam afternoon trading.

ING, based in Amsterdam, reported that third-quarter profit declined 26% percent from a year earlier, to €371 million, or $511 million, as it wrote down the goodwill on the U.S. insurance business by €513 million. Without the writedown, it said, underlying profit rose 43% to €1 billion. Goodwill represents the excess of an asset’s purchase price over its fair market value.

Financial Reform Not Dead in 112th Congress: Wolters Kluwer

The Republican triumphs in the mid-term elections will shift the agenda for financial regulation in the 112th Congress, but reform isn’t dead-on-arrival, according to Wolters Kluwer, a provider of CCH and Aspen information and software solutions.

“”Financial reform will most certainly shift priorities in the 112th Congress, but it will continue. “There is a growing bipartisan consensus for certain areas of reform, including issues related to reform of government-sponsored enterprises such as Fannie Mae and Freddie Mac… and reform of the Public Company Accounting Oversight Board,” said Wolters Kluwer Law & Business Principal Securities Law Analyst James Hamilton, a lead analyst for Wolters Kluwer Law & Business’ Dodd-Frank Wall Street Reform and Consumer Protection Act: Law, Explanation and Analysis.

In late July, the House Financial Services Committee reported out the U.S. Covered Bond Act, HR 5823. It has bipartisan support, having been cosponsored by Rep. Spencer Bachus (R-AL) and Rep. Paul Kanjorski (D-PA).

Bachus, who is slated to become the chairman of the House Financial Services Committee, recently outlined the principles for draft legislation to reform the secondary mortgage market, with a covered bond market as an integral part of the effort. Among the provisions included in this legislation are:

Sunset over a four-year period the current government-sponsored enterprises (GSE) conservatorship and wind down the federal subsidies granted through their charters;
Introduce full transparency and accountability to the secondary market;
Reduce leverage by phasing in, over four years, capital requirements that are consistent with global standards for large, complex financial institutions; and
Create a regulatory safe-harbor for mortgages that meet underwriting standards consistent with the Federal Reserve Board’s final Home Owner’s Equity Protection Act (HOEPA) rule.

“The safe-harbor provision is designed to encourage the return of private capital to the mortgage finance market by giving investors transparency and confidence that the loans they purchase meet appropriate underwriting standards, including the ability to repay and the integrity of the documentation,” said Hamilton. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which establishes only a limited safe harbor from legal liability.

A centerpiece of the Bachus reform legislation is the establishment of a regulatory framework for a U.S. covered bond market, Hamilton said. A covered bond is a form of debt issued by a financial institution where a specific set of high quality assets, typically loans, are set aside into a pool for the benefit of the bondholders. The issuers of covered bonds are responsible to their bondholders for the risk posed by the underlying loan pool.

“Covered bonds are a source of private mortgage market financing which have worked well in many European countries, and they are used as a private market solution to the need for market participants to have skin in the game,” said Hamilton.

Another piece of legislation that appears to be bipartisan involves the reform of Public Company Accounting Oversight Board (PCAOB) procedures. PCAOB Acting Chair Dan Goelzer has asked for legislation amending Sarbanes-Oxley so that Board disciplinary hearings against individual auditors and accounting firms will be public.

No ‘Lost Decade’ for Diligent Savers: Fidelity

Pre-retiree participants who steadily contributed to a 401(k) plan with Fidelity for the past 10 years more than doubled their account balances in that time, Fidelity Investments reported.

The average account balance for these pre-retirees, aged 55 years or older, rose to $211,300 by the end of the third quarter of this year from $96,000 ten years ago. Pre-retirees with a contribution rate at or above 8% this year showed average balances increasing more than 130 percent over the past 10 years to $291,700, from $125,600.

“The past decade was certainly not a lost decade for participants who remained committed to saving even through all of the market’s ups and downs,” said James M. MacDonald, president, Workplace Investing, Fidelity Investments.

The same group of pre-retirees had a 10-year, average cumulative time-weighted personal rate of return (PRR) of 18.3%, while the S&P 500 returned a negative 4.2%.

Chapman Named Chief Risk Officer at Securian

Leslie Chapman, vice president and chief actuary, Securian Financial Group, was appointed chief risk officer by the board of directors in October.

Chapman oversaw the five-year, multifaceted development of Securian’s enterprise risk management (ERM) program, which all Securian business units and financial management departments use.

A graduate of Moorhead State University, Moorhead, Minn., Chapman joined Securian in 1976 as an actuarial trainee. She has held increasingly responsible positions in several areas of the company, including taxation, rating agency relations, and risk management.

New York Life Reports Strong Third Quarter

New York Life Insurance Company, the largest mutual life insurer in the U.S., today announced strong gains in sales of life insurance, income annuities, long-term care insurance and mutual funds through the first nine months of 2010.

The market share leader in fixed immediate annuities, New York Life reported record sales of $1.3 billion in the first nine months of 2010. This represents an increase of 4% over the same period last year led by strong sales through New York Life agents and third party distribution channels.

“We’re on pace to achieve a seventh consecutive year of record sales of lifetime income annuities,” said Chris Blunt, executive vice president in charge of Retirement Income Security.

Sales of New York Life’s mutual funds (MainStay Funds) are up 43%, totaling more than $7 billion in the first nine months of the year, with strong performances from third party channels accounting for approximately $6 billion of the total.

Individual life insurance sales increased 47% through September, compared to the previous all-time record for sales in the first nine months of 2009. This growth is being driven by agents, with life insurance sales through the company’s 11,500-member national field force up 34% over the same 2009 period.

The company’s sales of long-term care insurance are up 10% over last year. New York Life reported earlier this year that for the sixth consecutive year, it will pay a dividend to its LTCSelect Premier long-term care insurance policyholders.

Global Fund Flows on Pace for $850B in 2010

Posted on November 11, 2010 by Editor Test -

Led by demand for bond funds, the global mutual fund industry is on pace for $850 billion in net inflows to stock and bond mutual funds (including ETFs and variable annuity subaccounts) in calendar 2010, according to Strategic Insight.

More than half of those flows, which are on track to fall short of the $890 net inflows in 2009, are expected to go into U.S.-domiciled funds. Flows in 2009 and 2010 mark a resumption of fund investing after the net outflows of 2008.

Strategic Insight’s projections for the full year are based on SI’s Simfund databases and projections for November and December (and for October for some international markets).

In the U.S., Strategic Insight expects 2010 full-year flows to stock and bond funds to hit $400 billion, including ETFs and funds underlying VAs. That would be just the second time in history that long-term fund flows topped $400 billion; a record $500 billion flowed into long-term funds in the U.S. in 2009.

Flows into bond funds and bond ETFs are on pace to top $300 billion for 2010, crossing the $300 billion mark for just the second time. In October, U.S. investors put $30 billion into bond and stock funds, including just over $22 billion into bond funds and roughly $7.5 billion into stock funds (including $10 billion into international and global equity funds, and $2.5 billion out of domestic equity funds).

Globally, more than 60% of long-term fund flows are going into bond funds, including short- and intermediate-duration bond funds that appeal to investors seeking higher yields than those available in bank deposits or money-market funds.

Some fund buyers are also seeking out bond funds as a way to participate in financial markets without taking on equity risk, as investors continue to be weighed down by concerns about economic growth, especially in the U.S., and about debt problems, especially in Europe.

“Many of the forces driving investors’ choices this year remain in place for 2011 and maybe beyond,” said Avi Nachmany, SI’s Director of Research. “Financial insecurity, zero cash yields (being extended by the Federal Reserve’s recently announced quantitative easing), the depreciating U.S. Dollar, and the expansion of bond fund mandates (to search globally and in the U.S. for higher-yielding securities) all support the continuation of strong bond fund demand.”

Dinosaur Cloning Will Precede Social Security Fix: Survey

Posted on November 11, 2010 by Editor Test -

More than half of respondents (51%) to a recent survey think it’s likelier that scientists will clone dinosaurs in their lifetime than that Congress will save Social Security, and 77% of those with children at home say their child is more likely to catch a foul ball in the seats at a baseball game than cash a Social Security check.

The survey was sponsored by the ING Retirement Research Institute and conducted by Mathew Greenwald & Associates.

A majority of the 1,000 workers surveyed (87%) said they could be saving more in their employer-sponsored retirement plan. Nearly two-thirds (64%) said their employer-sponsored retirement plan accounts for all or most of their retirement portfolio.

Many participants apparently rely on “guesswork” when setting contribution levels, and don’t fully understand the importance and long-term impact of small increases in contribution rates. Nearly two-thirds (65%) determined their contribution rate themselves, and 21% said they “go by gut feeling.”

Of those participants who are not contributing the maximum to their retirement plan, 87% said they could afford to increase their annual contribution by 1% of their annual salary; 59% said they could up their contribution by 3% of salary; and 32% said they could afford a 5% increase.

Nearly half of the plan participants polled (44%) said that “if they didn’t have a retirement plan at work, they probably wouldn’t be saving for retirement at all.” Most respondents (58%) said their employer-sponsored retirement account was their first investment and 52% said their plan was the main place they learned about investing.

When asked to estimate the lifetime value of a 2% increase in their contribution rate, 40% underestimated by 50% or more and 32% over-estimated by 50% or more.

ING has posted a calculator to its website to demonstrate the potential long-term financial impact of contribution rate changes. The calculator is available to the public at http://ing.us/.

Many Plan Sponsors Puzzled by TDFs

Posted on November 11, 2010 by Editor Test -

Defined contribution (DC) plan sponsors are unaware or unsure about many key aspects of target date funds, despite the fact more plans than ever are offering such options, according to a recent survey of 6,300 DC plan sponsors by Janus Capital Group and Asset International Inc.

“A broad gap [exists] between plans’ utilization and understanding of target date funds,” the survey showed. The poll, which Janus has conducted annually for four years, focuses on DC plan sponsors’ qualified default investment alternative (QDIA) fund selection, construction, monitoring and satisfaction.

The survey showed that:

Compared to 2009 findings, more plans don’t know what the end date of the glide path is in their target date funds (50% compared to 32% last year).

More than one-third of all plans are not familiar with the “to” or “through” glide path dilemma.

35% of plans (compared to 29% last year) are not sure what the best QDIA option is for their employee population.

“The findings reveal a disconnect,” said Russ Shipman, senior v.p. and managing director of Janus’ Retirement Strategy Group. “Respondents believe they’re less than well informed about their chosen target date offerings, but remain confident their employees understand the products and use them correctly.”

Plan sponsor perceptions of target date funds, as compared to other QDIA options, are shifting, the survey showed. An increasing number of sponsors indicated they believe balanced funds and target risk funds are the best QDIAs for their employee populations. Just 34% of respondents indicated they believe target date funds are the best QDIA for their plan, down from 57% last year.

When asked to compare QDIA options based on fees, transparency, overall performance, risk management and correct usage by participants, balanced funds saw gains in each category compared to last year, while target date funds saw declines.

“With these fairly pronounced changes in plan sponsor perceptions about QDIA options, it seems possible, if not probable, that many early target date adopters are rethinking their selections,” said Shipman. “Target date funds are surely a good choice for many, but we continue to believe that balanced funds and other target risk solutions will hold their own—due largely to their simplicity and proven performance histories.”

Uncertainty Hurts More Than QE2 Helps, Finance Pros Say

Posted on November 11, 2010 by Editor Test -

The results of the recent mid-term elections is more likely to boost the U.S. economy more than the Fed’s decision to buy $600 billion in Treasury bonds will, according to a survey of members of the Association for Financial Professionals (AFP).

At the AFP’s annual conference, 54% of those surveyed, including bankers as well as CFOs and treasurers at companies with median revenues of $1.5 billion, said the elections would have a beneficial impact on general business conditions and 51% said the elections would help their own organizations.

Regarding the Fed’s “quantitative easing” efforts, known as QE2, only 42% thought it would enhance their own company’s prospects in the next 12 months. A minority (22% percent) said that anti-business sentiment in Washington, perceived or real, was “holding companies back.”

One in five cited uncertainty about future tax policy and one in three cited uncertainty about the extent of other regulations as contributing to recent business paralysis. Two in ten financial professionals said their organizations have delayed investment decisions because of the current risk-averse climate.

Other factors cited as hurting investment were weak consumer demand (40%), a weak job market (24%), commodity price volatility (12%), and foreign exchange volatility (9%).

Among respondents, 42% said that their organizations’ access to debt markets or bank lending has improved over the last six months, and 40% percent expect it to continue to improve over the next 12 months.

Quote of the Week

Posted on November 11, 2010 by Editor Test -

Singing from the Fee-Only Song Book

Posted on November 10, 2010 by Kerry Pechter -

If you’ve never heard a chorus of two hundred fee-only financial planners shouting out Johann Sebastian Bach’s Ode to Joy in fractured, phonetic German, perhaps you haven’t really lived.

You may have lived, but obviously you weren’t there for the rousing start of NAPFA’s 2010 Connections conference in Boston last week, where the attendees were coaxed into song by Boston Philharmonic conductor and motivational speaker Benjamin Zander (at left).

Registered investment advisors are a key market for purveyors of mutual funds and annuities. They’re often the gatekeepers to wealthy individuals and families. They don’t work from approved product lists, so they’re free to entertain new pitches and new approaches from wholesalers.

Their independence makes them elusive, however, and the fee-only advisors who belong to NAPFA (National Association of Personal Financial Advisors) may be the most elusive. Clients pay them directly and they’re typically not licensed to sell securities or insurance. So, by definition, they’re indifferent to most of the usual incentives.

But fee-only planners are, by all accounts, very interested in designing retirement income strategies for their clients. Judging by the conference agenda and exhibitors, they’re open to bond ladders, fixed income funds, dividend-paying stocks, long-term care insurance and even immediate annuities.

Commission-free SPIA

In a session called, “Income Now or Income Later: Comparing Immediate to Variable Annuities with a Living Benefits Rider,” Western & Southern Life executive Barry Meyers made some interesting comments about inflation-protected immediate annuities and about a way that fee-only planners can get compensated for selling SPIAs.

Generally, it’s better not to buy a straight inflation-protected SPIA, Meyers said. In some cases, the manufacturers play it safe and assume a high inflation rate, such as 4%, making the products expensive. “You have to pay the insurers to buy the hedge,” he said.

To create your own inflation protection, “you’re better off hedging yourself” by putting a little less money in the SPIA and investing the difference in equities or by “laddering in a series of immediate annuities,” he said. Another strategy: buy a SPIA with a specific annual adjustment, such as two percent, rather than open-ended inflation protection.

As for compensation, fee-only planners can buy a no-commission SPIA from Integrity Life (a Western & Southern unit) and then charge their usual fee on the SPIA premium for a limited period of five years, in lieu of the 3.5% or 3% upfront commission (sometimes with a 25-basis point trail) that insurance agents are paid. (Nationwide and New York Life also reportedly offer SPIAs with a no-commission option.)

Dividend strategy

For the many advisors who still favor non-insurance solutions to the retirement income dilemma, there was a break-out session called “Gambler’s Ruin: Using Dividends to Manage Volatility,” presented by Greg Thomas of ThomasPartners Inc., an RIA specializing in dividend-driven portfolio strategies with $1.2 billion under management.

Through a proprietary process, he said, his company has identified about 40 value stocks whose high dividend payouts largely eliminate the need for bonds in a retirement income portfolio, either for diversification or as a source of income. Thus ThomasPartners is able to flip conventional wisdom on its head.

“There’s no demonstration of a tradeoff between risk and return,” Thomas told the fee-only advisors. “Dividends mitigate the effects of volatility. They minimize the amount of principal you have to take out” to supplement other income sources. “Value is an anomaly that doesn’t get diversified or arbitraged away. All you have to do is fish in that pond.”

His company focuses on the 350 stocks in the S&P 500 that pay dividends, and tries to narrow it down to value stocks of companies that have added or increased their dividend [“Dividend Growers”] rather than curtailed or cut their dividend. To narrow it down further, they segment dividend-growing value stocks into five yield quintiles and focus on the fourth highest quintile rather than the fifth, on the theory that the highest quintile includes many stocks whose high dividend yields merely reflect sunken stock prices.

Short cut to LTC coverage

Quite a few people listened attentively to an overview of the new long-term care insurance hybrids, which permit investors to apply the assets of non-qualified fixed deferred annuities or the cash value of life insurance policies to the purchase of long-term care insurance, tax-free.

Although the hybrids have not been in the market for long (only since January 1, 2010, in the case of annuity/LTC hybrids), they haven’t gotten much notice. But, as Jerry Skapyak of Low Load Insurance Services, Inc., explained, they offer people with existing fixed annuities or life policies a new opportunity to buy long-term care insurance at a significant discount.

“The money does double duty,” he said. For example, a person with $100,000 in a fixed deferred annuity could transfer it to one of the hybrid LTC insurance/fixed annuities. Part of the interest earned on the annuity would go, tax-exempt, to the purchase of a LTC policy.

If the covered individual (or couple) goes into a nursing home, the annuity assets (or some combination of client assets and insurance) are applied tax-free to the nursing home expenses. If the annuity owner never needs long-term care services, the assets can be passed to heirs. “It answers the number one objection to buying LTC insurance: ‘What happens if I never use it?’” Skapyak said.

After the session, a few advisors expressed mild skepticism about the expense of the product. The advisors seemed to think they could hammer together their own blend of non-qualified assets and high-deductible LTC insurance more cheaply than Skapyak’s firm, which advertises itself as “The Fee-Only Advisor’s Insurance Advisor,” could sell a packaged version. It was as if a presentation on ready-made furniture had been given to a group of master carpenters.

Marketing to fee-only advisors

Judging by the exhibitors at the conference—78 were listed in the program—NAPFA members are a strong market for sellers of no-load mutual funds. Both major fund managers and boutique fund firms were well represented. But there were also a number of exhibitors whose companies offer retirement-related products.

Aside from Western & Southern Financial Group and Low Load Insurance Services, these included Aegon Advisor Resources, Jefferson National Life, Allianz Global Investors and SBLI, and reverse mortgage lenders from Wells Fargo and MetLife.

Anyone marketing to fee-only advisors might want to be sensitive to some of their differences from other intermediaries. Judging just by NAPFA conference attendees, they include a higher percentage of women than other retail channels. They’re much more focused on the planning process than the sales event and they take their fiduciary responsibility very seriously.

Their skepticism about product-driven solutions and their disinterest in commissions might act as barriers to sellers of retirement income products. But, given their focus on planning rather than sales, they seem well-suited to the labor-intensive process of creating customized retirement income solutions for their clients.

Don’t Let Your Politics Shoot You in the Financial Foot

Posted on November 10, 2010 by Russell Wild -

Joan, a friend of mine, called me on the phone and told me that, thanks to the government and its “inane economic policies,” the dollar was due to get walloped. She asked me how to invest in foreign currencies. I cautioned against it, explaining that financial markets are unpredictable, but she insisted. The dollar rose, and her “investment” (I’d call it a gamble) tanked.

Ken, another friend, certain that Washington’s policies were driving this country to ruin, had kept his money in a savings account for six years. What started off as $70,000, thanks to six years of low-but-steady inflation and taxes on his interest, was now worth something less. That same $70,000, invested in a well-diversified, modestly aggressive portfolio, rebalanced yearly, would have been worth $100,000 or more.

These experiences taught me that politics and investing shouldn’t mix. Whether you are liberal or conservative, please don’t let your politics or your clients’ politics shoot anyone in the investment foot.

In our hyper-intense political environment, I’ve seen more and more of this knee-jerk reaction in which people want to move their investments to reflect their political leanings. The ease of transfer of assets has exacerbated this tendency, too, as I’ve noted in my book, Exchange-Traded Funds for Dummies. ETFs are in many ways the perfect vehicle for these politico-investors. Hate what’s happening in Washington? Invest your money in South Africa, Malaysia, or South Korea. Hate the oil industry? You can plunk your money in an alternative-energy ETF. It’s easy now to target specific market sectors for your political support or opposition.

Ken (the same guy mentioned above), for example, is certain that the exportation of jobs and the resulting squeeze on wages will slaughter the Middle Class. No one will be left to frequent the malls. Stores will be boarded up. The stock market will collapse. He is shocked that it hasn’t happened yet. “How can Wall Street be so blind?!” he asks me. Ken can easily short the market with the ProShares Short S&P 500 ETF. But I wouldn’t advise him to do so.

Wall Street, where many smart and educated people hang out, is not so blind, Ken. They know that even if you are right, even if history proves the administration to be as terrible as you think it is, even if polarized politics is driving this country down, it doesn’t necessarily mean that stocks will suffer.

Experienced financial advisors know that market movements in the short term, and possibly well beyond, are largely random. You’ve read the studies that show the huge disconnect between market returns and practically anything and else going on in the economy. But how do you convey this to clients?

I suggest that in addition to appeals to data or economic theory, you share with your clients anecdotes that will stick in their minds. Consider these tidbits:

Researchers at the London School of Business found that a comparison of stock market returns around the world shows a generally inverse relationship between total market returns and a nation’s economic growth rate.
And speaking of the British: England started off the past century as the undisputed #1 World Power. It ended the century with a lost empire, sky-high unemployment, and crumbling inner cities. During that time, of course, the United States came to dominate the known universe. The return of British large stocks over past 50 years? 11.0%. The return of U.S. large stocks over the past 50 years: 9.1%. Looking to small stocks, the Brits beat us by a mile.
Consider the history of disaster. (Always fun to do!) 1918, the year of the flu pandemic, the worst disease outbreak in modern world history, was a good year for stocks. In 1942 Japan attacked Pearl Harbor and Hitler marched across Europe, but it too was a great year for stocks. The year of the Cuban Missile Crisis—and the near destruction of the entire world—wasn’t so bad for stocks. In contrast, in 1929, when the market began its Mother of all Nosedives, nothing terrible was going on. Ditto for April 2000, the start of the three-year bear market that shredded so many Americans’ 401(k)s.
Compare China to India. China’s growth in gross domestic product has been blowing the doors off India’s, and most other nations’ GDP for the past several years. Headlines of China’s domination of the world economy fill the media.Year-to-date return of The China Fund: 18.53%. Year-to-date return of The India Fund: 24.71%.

I can’t explain all of these apparent contradictions. No one can, really. They are what they are. Stock market returns in the United States have averaged about 10% a year over the past 75 years. That’s way higher than just about any other investment. Will it continue? I don’t know.

But the stock market has been pretty darn resilient so far.

If you intend to be rational about investing, separate politics from portfolio. I hope that each one of you voted your conscience on Nov. 2. But I also hope that each of you—and your clients—invest without your political biases coming into play.

Russell Wild is a fee-only advisor in Allentown, Pa. He has written numerous investment and business publications, including Exchange-Traded Funds for Dummies.

End the Bush Tax Cuts

Posted on November 3, 2010 by Editor Test -

Now that the Republicans have recaptured the House of Representatives—the returns showed a whopping 246-189 advantage for the GOP as of 11 p.m. Eastern time yesterday—we can look forward to gridlock or worse in Washington over the next two years. Forget compromise or progress. Any conservative legislation (or investigation) that the House leadership cooks up will either die in the Senate or perish under the President’s veto pen.

During the lame duck session, however, the Democrats will have to face the dilemma posed by the Bush tax cut extensions. I hope they eliminate the tax cut entirely. Not just for individuals earning over $200,000 a year and couples earning over $250,000. For everyone. If we’re serious about reducing the federal budget deficit, this should be a no-brainer.

For anyone who wants to avoid burying our children in debt, any other course of action would be tantamount to financial infanticide. Extending the cuts indefinitely for everyone would add $3 trillion to the national debt over the next 10 years, according to the recent Pew Fiscal Analysis Initiative. Extending the cuts to those earning under a quarter or a fifth of a million dollars a year would still add $2.3 trillion to the debt.

Killing the tax cuts will be spun as a tax hike. Conservatives will prefer to sustain it with cuts in spending. But where will the cuts come from? A 10% across the board reduction in Social Security benefits over the next 10 years would offset only 36% of the cost of keeping the cuts for another 10 years, the Pew research shows. Eliminating foreign aid would offset another 12%. It would take an across-the-board 6.8% cut in all government spending (except debt service) over the 10 years to cover the entire cost of extending all the tax cuts during that time. That’s what it would cost just to break even on the cuts.

If we’re serious about reducing the deficit, perhaps we should eliminate the Bush tax cuts and cut federal spending by 6.8%. Better yet, we should focus on shrinking two of the largest and least productive burdens on the public purse: the bloated medical industry and the Cold War military machine. We should spend less on heroic life-saving measures for 90-year-olds, and we should stop wasting money (and the lives of 19-year-olds) on foreign wars. The ill-conceived, badly executed adventures in Iraq and Afghanistan have cost over $1 trillion, and we have nothing to show for it but grief.

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