Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the announcement of the CFP Board’s new Chair-Elect Blaine Aikin, a long-standing CFP certificant who has spent the past decade not working as a practitioner but in a leadership position with fiduciary training program Fi360, and raising the question of whether it’s a problem for the CFP Board to have a “non-practitioner” Chair, or a positive for it to have a fiduciary leader at a time of potentially significant fiduciary regulatory change (with the Department of Labor fiduciary rule anticipated in early 2016). Also in the news this week was the decision of high-yield bond fund Third Avenue Focused Credit to not only shut down, but suspend redemptions to ‘ensure it can liquidate in an orderly manner’, raising both concerns about how severe the stress in the high-yield bond market really is, and questions of whether more bond funds may soon limit their redemptions given the illiquidity of their underlying bond holdings as well.
From there, we have a few technical financial planning articles this week, from a discussion of whether advisors need to give a fresh look at the uses of reverse mortgages, to year-end planning strategies to optimize FAFSA reporting for those looking to qualify for financial aid, and a review of the rules and requirements for clients to hold investments of gold within an IRA and avoid disqualifying the account (given that IRAs normally cannot invest in “collectibles”, which includes some forms of gold).
We also have a couple of practice management articles this week, including: the value of adding a virtual meeting with clients between the data-gathering process and the plan presentation meeting, to review and reaffirm the data and make sure it’s accurate before crafting recommendations; how defining a niche for an advisor is about more than just targeting a certain level of wealth; how the real challenge for succession planning is not actually selling the business, but transitioning the founder’s role from advisor to business leader; and some tips for young advisors looking to be a successor about how best to prepare themselves for the transition from their end.
We wrap up with three interesting articles: the first is a Reuters investigative report about whether the explosion of share buyback activity is no longer just enhancing returns for investors but may be overdone to the point of threatening American innovation and even exacerbating income inequality; the second is a discussion of upcoming regulatory trends in 2016, including not only a looming DoL fiduciary rule, but also new anti-money laundering rules for RIAs, an expansion to Form ADV, and a new regulatory fight about whether the SEC should use third-party reviewers to increase the pace of RIA exams; and the last is commentary for RIABiz founder Brooke Southall about whether the vendors serving advisors (particular the RIA community) today are still operating too much like the ‘traditional’ Wall Street firms that advisors are increasingly running away from.
Enjoy the reading!
Weekend reading for December 12th/13th:
A Worrisome Precedent? CFP Board Taps Non-Full-Time Planner As Chairman (Ann Marsh, Financial Planning) – Earlier this month, the CFP Board announced its newest slate of members elected to the Board of Directors, along with the election of Blaine Aikin as the organization’s new Chair-Elect for 2016. What’s notable about Aikin is that while he has been a CFP certificant for nearly 30 years, he has not been a practitioner for many years now, serving instead as a consultant to advisors and the head of Fi360, the organization that helps to train advisors on fiduciary issues and offers the AIF and AIFA fiduciary designations. And after a long-standing string of current-planner-practitioner chairs, some have raised the question of whether it’s problematic to have a non-current-practitioner in the role, and whether it is setting the stage for a future chair who might have never been a practitioner. The concern is that given the CFP Board’s role in overseeing the CFP marks, having Board leadership too disconnected with the actual practice of financial planning could lead it to make less-than-ideal decisions. On the other hand, Aikin’s long-standing contributions to the financial planning profession, including his in-depth experience on fiduciary issues at the exact time that the DoL may implement a fiduciary rule (which the CFP Board has actively lobbied for via the Financial Planning Coalition), suggests that he may be uniquely qualified to lead the organization given the current regulatory environment. Nonetheless, he does enter the CFP Board amidst a high volume of recent leadership transitions, given the untimely exit of two prior CFP Board chairs – Alan Goldfarb and also Joe Votava – in just the past few years.
Third Avenue Blocks Redemptions From Credit Fund Amid Losses (Charles Stein, Bloomberg) – This week, the Third Avenue Focused Credit Investor Fund (TFCVX) announced that it will block clients from pulling money out of the fund, so it can be liquidated in an orderly fashion. Rather than honor normal daily redemption requests as required under the Investment Company Act of 1940, investors in the fund will receive an in-kind exchange of shares in a liquidation trust around December 16th, and the trust in turn will systematically liquidate the bond holdings of the fund over time. The Third Avenue fund has experienced severe outflows in the past 18 months as high-yield “junk” bonds have been in decline; the fund was as high as $3.5B of AUM last July, fell to nearly $2B of AUM by the end of last year, and has suffered almost $1B in outflows through the end of November (and now sits at “just” $788M of assets). Of course, mutual fund redemptions aren’t necessarily unique, and the normal daily liquidation process of funds is supposed to handle redemptions; the concern in this case is that because the fund is concentrated in high-yield bonds that are generally not as liquid (and have become even less liquid as credit markets have tightened and yield spreads have widened), that a high volume of forced liquidations in a short period of time may have just been exacerbating losses further. In fact, the fund is already down 27% this year, having lost 13% in just the past month alone between bond price declines and forced liquidations. Though ultimately, the real concern of the Third Avenue liquidation is not merely for the investors of the fund itself, but whether this is a harbinger of bond market problems, and accentuates the ongoing recent concerns about the ability of bond funds and ETFs to meet investor liquidity demands and redemption requests when the funds still hold illiquid bonds themselves.
Advisors Need A Fresh Look At Reverse Mortgages (Wade Pfau, Advisor Perspectives) – Advisors generally have a poor perception of reverse mortgages, Pfau notes that a growing base of academic research is suggesting that reverse mortgages deserve greater consideration as a part of the overall retirement plan. The fundamental issue is that in situations where a retiree may ultimately need to use the equity in the home (or more generally, the asset value of the home) as one of their long-term retirement assets, what is the best way to tap the value of that assets – to sell it (and find other housing arrangements), or to borrow against it, and if borrowing to do so with a reverse or a traditional “forward” mortgage. The typical approach is to spend from liquid investment assets first, preserve the equity in the home until later, and then only use a reverse mortgage to tap home equity as a “last resort”. Yet more recent research suggests that it may be better to tap home equity sooner rather than later, in part because borrowing against home equity can be done at a relatively appealing interest rate, allowing the portfolio to remain invested longer to earn its potentially-higher rate of return. In addition, tagging home equity earlier also reduces the potential exposure to sequence-of-return risk, as the reverse mortgage can be used to fund retirement spending while a portfolio is down and waiting to recover. Of course, using the reverse mortgage does entail accruing interest that can further undermine the equity in the home, but since a reverse mortgage is a non-recourse loan, ultimately “the worst” that can happen is simply that the retiree uses all the equity in the home (with any excess loan losses borne by the lender, not the retiree’s other assets). Overall, Pfau highlights four different types of reverse mortgage strategies that may be relevant for retirees: debt consolidation (e.g., pay off existing mortgage and relieve cash flow); portfolio coordination (e.g., use home equity first to allow portfolio to remain invested longer without sequence of return risk); improving retirement efficiencies (e.g., reverse mortgage as a spending bridge while delaying Social Security, or to cover the cash flow obligations of paying taxes on a Roth conversion); and as a reserve for contingencies (e.g., a standby line of credit to tap in a long-term care emergency, after the portfolio is depleted, during a bear market, etc.).
Financial Aid Year-End Plan (Fred Amrein, EFC Plus) – Because the process of financial aid for college students is so dependent on the details of the family tax return (as reported on the FAFSA), the year-end “tax planning” process takes on special importance for those who have children going off to college soon. Thus strategies which can reduce or defer income for tax purposes take on a special value when it overlaps with the years that those income amounts will be reported for FAFSA purposes as well. Notably, though, the Department of Education recently changed the FAFSA rules as well, requiring each school year to use the “prior prior year” tax data, which means students matriculating in 2017 (today’s sophomores!) will actually use this year’s 2015 data for financial aid (although if a significant change in circumstances occurs, it’s possible to get an appeal by requesting what’s called a “professional judgment” of the situation). End of year planning is also an opportunity to change where/how assets are held (e.g., spending down a child’s UTMA/UGMA account, or moving it into a 529 plan), particularly if this is the last year before the data will be considered (e.g., today’s high school freshman, whose assets/income will be considered next year but not this year). On the other hand, it’s also notable that for families whose income and assets are already too high (e.g., based on existing parental income/assets), there may actually be little value to trying to manipulate assets and income (of the parents or the student) as it may already be a moot point.
All That Glitters: What Happens When IRA Clients Want To Hold Gold? (Ed Slott, Financial Planning) – With rising market turmoil, and gold often viewed as a “safe haven” investment, many clients are asking about investing in gold, and some inevitably want to do it within an IRA (if that’s where the investment dollars are available). Yet the problem is that IRAs are generally prohibited from investing in S corporation stock, life insurance, and collectibles, which includes not only classic cars and comic books but also ‘collectible’ coins and metals including gold. Fortunately, though, an exception in the tax code allows gold to be purchased within an IRA anyway, as long as it is either in the form of Treasury-Department-minted U.S. gold coins (in one-tenth, one-quarter, one-half, or full one ounce units), or in the form of high-quality (fineness of at least 995 parts per 1,000) gold bullion (i.e., pure gold bars). It’s important to get the “type” of gold investing right, though, as buying gold that is not IRA-worthy causes any dollars invested into the improper version to be treated as a taxable distribution (and for an IRA owner under age 59 ½, early withdrawal penalties apply too!). If the mistake is caught quickly, it can be “fixed” by liquidating the improper collectible and rolling over the proceeds back into an IRA within 60 days (assuming the once-per-year IRA rollover rule hasn’t limited doing so). Also, it’s important to recognize that gold owned within the IRA must actually be owned by the IRA, so the gold must be held by a qualified IRA trustee or custodian (which may have additional storage and security costs), not in the client’s possession (e.g., in their home, a safety deposit box, etc.). Alternatively, clients can also own gold in their IRA by simply investing into an ETF that holds gold (which in several PLRs has been affirmed as not violating the collectibles rule even though the underlying ETF owns the gold directly).
3 Steps That Made Our Business Work Better (Katherine Vessenes, Research Magazine) – Most financial planners have a process of gathering data to do a financial plan in an initial meeting, and then presenting the plan with recommendations in a subsequent meeting. As Vessenes notes, though, often the plan presentation meeting ends out hitting a ‘speed bump’ because a data input error appears – either because of a mistake make in putting in the data, or because the client didn’t quite give the right numbers/details in the first place, and now realizes the problem as the plan results are displayed. Except once the plan has been “done” and created, it’s too late to correct the data (or at least correcting it will now require another/subsequent meeting). To address the issue, Vessenes adopted a “1.5 meeting”, where the paraplanner/support staff (but not the senior advisor, who doesn’t really need to be there) engages in a videoconference meeting with the client directly, simply to review the data as entered into the plan and verify it’s correct (or make adjustments as necessary), ensuring that the plan presentation meeting is maximally productive. In fact, the approach worked so well, that Vessenes also adopted a “2.5 meeting” as well, conducted as a video conference between the plan presentation meeting (#2) and the implementation meeting (#3), typically to review the client’s spending and cash flow (as if clients have no idea what their available cash flow really is, they’ll have no idea if/whether/how they can implement the plan recommendations). Another strategy Vessenes recommends for internal efficiency is, for any of the more complex products/situations that may arise, develop a checklist of the points/issues to consider, so it’s faster and easier to evaluate the situation the next time it comes up.
Wealth Is Not A Niche (Mark Tibergien, Investment Advisor) – As more and more clients transition into retirement and begin withdrawals, advisors are growing increasingly focused on how to accelerate growth to more-than-offset client spending. Yet as Tibergien notes, most advisory firms are limiting their own growth in various ways. For some, the biggest issue is capacity, where it’s becoming impossible to service clients consistently (not to mention take on any new ones), which means the advisor needs to narrow the focus and concentrate more effectively on ideal clients, improve operational efficiencies and workflows so it’s easier to service those clients, or outright hire more staff to support the clients. For other firms, the problem is not the capacity to serve clients, but the lack of business development talent in the firm to get them, especially if/when/as the founding advisor slows down his/her own business development efforts; the problem in many firms is compounded by the fact that the talent they’ve hired excel at servicing clients but not finding and bringing in new ones. Accordingly, Tibergien suggests that the solution to this – and many firms’ overall marketing and growth woes – is to more clearly position the firm with a clear position and marketing message that can be repeated by anyone/everyone in the firm, as well as clients who might refer the firm. This means going beyond just stating the firm’s ideal client based on wealth or an asset minimum – as the needs of a wealthy divorcee are different than a wealth business owner who had a liquidity event which in turn are different than a lottery winner – and instead really focus into a clear niche or specialization.
Successful Transitions: Getting It Right (Matt Lynch, Journal of Financial Planning) – While succession planning and figuring out how to successfully sell an advisory firm is an increasingly hot topic, Lynch points out that in reality the hardest transition for most advisors is not selling the practice, but the transition from being the advisor/owner to being the non-advisor leader of the business (usually a necessary pre-requisite to selling as the founding advisor hires staff and transitions clients). In fact, the successful development of internal staff as the leader of the business can actually groom the best successors to buy the firm anyway (as an internal succession plan)! Yet staff development is difficult, because most advisors coming into firms today will not follow the path of the advisory firm’s founder – instead of being salespeople who became advisory firm owners and entrepreneurs later, today’s young advisors typically begin as advisors, and may or may not have any inclination towards sales or entrepreneurship. Those skills can potentially be trained over time, but few founding advisors are good managers and trainers, and instead Lynch finds that many act too much as the “egoist” (making themselves too central as the lifeblood of the business, even though many of their duties could be transitioned) or the “martyr” (wearing/keeping too many hats at once and refusing to delegate even when necessary/appropriate to do so). By contrast, Lynch suggests that the ideal advisor-owner who wants to maximize the value of the business must operate like a strategist, taking a forward-looking view of the business and what must happen/evolve to get it to where it needs to be.
From One Millennial To Another: Advice On Being The Succession Plan (Kelly Kennedy, Journal of Financial Planning) – While there is a growing focus on the importance of executing a successful succession plan from the perspective of the founding advisor/owner, there is remarkably little written for the younger/newer advisor who will be the successor. As a prospective successor to her father’s own advisory firm, Kennedy provides several tips to fellow Millennial advisors who might one day be a successor, including: absorb as much as you can early on (Kennedy sits in on client meetings with her father to meet clients, take notes, but also just to witness and absorb the experience as a learning opportunity); initiate opportunities to change and improve the process of serving clients, based on your perspective as an observer in working with clients; seek outside knowledge as well (Kennedy worked in another firm’s planning department for a period of time, and also joined her broker-dealer’s networking group for other young advisors); recognize that you still have to be yourself, and that while you might learn from a mentor (or founding advisor/owner), you will ultimately adapt what you learn in a way that’s relevant for you (not just become a carbon copy of the other advisor); and do your due diligence to recognize that not every advisory firm succession opportunity is going to be the right fit, so it’s ok to look at several options before picking the one you plan to stick with as the successor.
The Cannibalized Company (Karen Bretell & David Gaffen & David Rohde, Reuters) – As the pace of corporate buybacks reaches record levels, this Reuters investigative report raises the question of whether the trend is going too far, and if the “cult of maximizing shareholder value” is now doing more harm than good to corporate America (and America itself). For instance, from 1999 to 2005 Carly Fiorina spent $14B doing buybacks of HP stock, even though the company only had $12B of profits in that time, and her successor Mark Hurd spent another $43B on buy-backs in the next 5 years with only $36B of cumulative profits (and his successor Leo Apotheker did another $10B of buybacks in his 11-month tenure ending in 2011). This pace of buybacks may have supported the stock price and put money in the hands of shareholders, but HP also hasn’t had a blockbuster product in years, and is increasingly struggling with profitability, as new services have grown slowly and core businesses face contracting revenue and margins – a remarkably change for a company that historically the poster child for a large innovative enterprise that retained profits to reinvest productively. And the phenomenon isn’t unique to HQ – almost 60% of the 3,297 publicly traded non-financial U.S. companies Reuters examined have bought back shares since 2010, and in fiscal 2014 spending on buybacks and dividends surpassed the companies’ combined total net income (for the first time ever outside a recessionary period), a remarkable shift in just over 30 years (as share buybacks generally were prohibited up until President Reagan’s financial deregulation reforms in 1982). In essence, the issue is that just as globalization has made the world more competitive, American companies seem obsessed with maximizing (short-term) shareholder value with buy-backs, possibly even exacerbated by activist shareholders demanding that companies spread the wealth, even at the risk of cannibalizing innovation and future growth (not to mention potentially worsening income inequality). The issue is now even becoming political, as some Senators have called on the SEC to investigate share buybacks as a potential form of market manipulation, and Hillary Clinton is making the shifting of companies’ short-term focus to be more long term a key plank of her election campaign.
5 Not-So-Bold Regulatory Predictions For 2016 (Chris Stanley, ThinkAdvisor) – With regulatory reform of all sorts on the rise, 2016 is shaping up to be a significant year from the regulatory perspective. The most high-profile issue is the Department of Labor’s fiduciary rule, with its new “Best Interest Contract Exemption” requirement that would require brokers handling IRA rollovers to have a fiduciary duty in their advice to clients (and the possibility that the SEC will get involved as well, as it also has been authorized to promulgate a fiduciary rule under Section 913 of the Dodd-Frank Act, and is indicating the issue will be taken up on the SEC’s 2016 agenda). Other notable regulatory issues on the 2016 horizon include: a potential requirement that RIAs will need to adopt formal written anti-money-laundering programs (and be required to file suspicious activity reports with the Financial Crimes Enforcement Network [FinCEN]); a looming overhaul of Form ADV Part 1A (the check-the-boxes section of the form), that will expand questions into areas from the use of derivatives to available social media pages (which Stanley suggests may be more about the SEC’s thirst for more data to vet and analyze, than any direct consumer benefit of expanding Form ADV disclosures); the discussion of whether or how regulation of robo-advisors needs to expand, especially given a recent controversial paper by Melaine Fein suggesting that at least some robo-advisors may actually be operating with significant conflicts of interest; and in what may become the new ‘hot’ issue after the DoL’s fiduciary rule, Stanley predicts that 2016 will see a big increase in the discussion of whether the SEC should adopt third-party examiners to increase the frequency of RIA exams (which has already received some significant opposition from former SEC Investment Management Division Director Norm Champ).
How Vendors Fail RIAs, And Themselves In The Bargain, By Insulting RIA Intelligence (Brooke Southall, RIABiz) – The rapid growth of the RIA community and its fiduciary client-centric and financial-planning-centric services suggests the RIA model may be the future of financial advice, but Southall notes that many of the vendors serving RIAs are still operating in the same Wall Street fashion… and risk getting themselves rejected entirely by the RIA community. For instance, even as RIAs embody the lack of commissions and a structure of transparency, they are regularly contacted by vendors that still treat RIAs as though they’re salespeople and call the advisory firm’s clients “sales prospects”, with products that can’t address the real-world issues that planners face with their clients (e.g., planning software that still only projects in a linear fashion, or performance reports that don’t holistically report the client’s entire household wealth). Southall notes that some of the RIA custodian platforms are perhaps even worse, generating fees from their RIAs in age-old classic Wall Street strategies like scraping interest margin from client investments or taking revenue kickbacks from fund providers (in a rather opaque fashion) – not to mention touting “open architecture” technology platforms that in practice are far more closed than they claim to be. By contrast, Southall notes that the companies that are truly operating in an RIA-centric fashion, and respecting the advisors they work with, are enjoying the outsized success already – from DFA and Vanguard to TD Ameritrade Institutional, Orion Advisor Services, Jemstep, Tamarac, MarketCounsel, and Dynasty Financial Partners. The bottom line – RIAs have a strong bent towards independence and a client-centric entrepreneurial attitude, and vendors who want to serve them successfully need to recognize and respect it, and message accordingly, or RIAs really will take their business elsewhere.
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you’re interested in more news and information regarding advisor technology I’d highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisors as well.