Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with several big news announcements, including President Obama's public endorsement of the Department of Labor's looming fiduciary proposal, Envestnet's acquisition of robo-advisor-for-advisors platform Upside Advisor barely more than a year into its existence, and the decision of Fidelity to merge its broker-dealer and RIA custodian clearing units into one while also creating a new Fidelity Wealth Technologies division to push forward the company's increasing focus on next generation technology.
From there, we have several investment-related articles this week, from the emerging "existential" crisis for indexing (and whether non-cap-weighting indices like fundamental indexing represent true "indexing" at all), to whether rebalancing really does increase returns or not, to the opportunities of "local investing". There are also discussion of the surging popularity of cash balance pension plans for high-income professionals and small business owners, a nice "lessons learned" article about the world of investment management, and an interesting look at whether owning long-term Treasury bonds might still make sense even at today's low rates (think: defending against deflation risk that could take rates even lower from here).
We wrap up with three interesting articles: the first is a look at the life of 109-year-old Irving Kahn, an investment adviser who started in the business in 1928, profited by shorting stocks in the crash of 1929, and ultimately went on to become a deep value investor after working as a research assistant directly under investing legend Benjamin Graham; the second article is a discussion of how parents should properly set allowances for children, suggesting that most parents do not give children nearly enough responsibility with money early on when it can be best used to teach important lessons about values; and the last is a look at how the "Uberization" of work could lead to an entirely new era of how we find employment and earn money, that may allow for more flexible work than ever, but also lead to a significant decline in the stability and security of employment, with profound ramifications for how we give career, earnings, and saving advice to young people today.
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including the Envestnet acquisition of Upside Advisor, the "Superfish" vulnerability on Lenovo laptops, and a new integration from mobile dictation service Mobile Assistant!
Weekend reading for February 28th/March 1st:
Obama Endorses DOL Fiduciary Redraft, Girds for Fight (Melanie Waddell, ThinkAdvisor) - The big industry news this week was the a speech on Monday by President Obama, endorsing the Department of Labor's fiduciary rule redraft that is anticipated to be released soon. To support the push, the White House released a new report on "The Effects of Conflicted Investment Advice on Retirement Savings" noting that brokers extract $17B from middle-class retirement savers every year (while also highlighting "good" advisors and calling our Garrett Planning Network founder Sheryl Garrett by name), and the President also noted that while industry lobbying groups have threatened that the middle class may lose access to advice the outcome of even more stringent anti-commission laws in other countries around the world has not led to this doomsday result. The immediate aftermath of the White House announcement to support the rule immediately drew a wide range of responses, with anti-fiduciary critics blasting the White House's statements, House Republican Ann Wagner proposing legislation to block the DOL, fiduciary supporters lauding the effort, and some raising good questions of whether the current fiduciary effort is focusing too much on a complex set of rules that may just make it harder for good advisors to do business while bad advisors hide within the complexity. Notably, though, at this point the DOL proposal itself still has not been presented to the Office of Management and Budget (OMB), which in turn will review the rule (in a process that could take 3+ months) before the DOL publishes it for public comment... which means there's still a ways to go before anything is actually implemented.
Upside Acquired By Chicago Wealth Management Tech Company [Envestnet] (Brian Feldt, St. Louis Business Journal) - The "robo-advisor-for-advisors" platform Upside Advisor has been acquired by Envestnet. Having been seeded with just $100,000 by St Louis-based FinTech accelerator SixThirty as a direct-to-consumer platform, Upside then raised another $1.1M in funding in early 2014 as it pivoted to target advisors instead, and after doing development most of the year the new platform only became visible in the advisory world just a few months ago when it landed popular advisor-bloggers Barry Ritholtz and Josh Brown who used the platform to develop their "Liftoff" offering for smaller client accounts. Envestnet indicated that it plans to leverage Upside's tools and technology as a part of its own technology tools for advisors.
Fidelity Merges Clearing and Custody Arms And Launches Tech Unit (Jamie Green, ThinkAdvisor) - As the business models of the industry continue to converge, Fidelity has announced that it will be merging together its RIA custodian and broker-dealer clearing units into one, along with creating a new Fidelity Wealth Technologies division that will include the recently acquired eMoney Advisor. The changes will not mean any impact to the service teams that advisors currently use under National Financial or Fidelity Institutional Wealth Services, but are ultimately intended to help leverage resources across both divisions, including Fidelity's investments into a "next generation technology platform" that can service both advisors and consumers directly. In fact, statements from Fidelity executives clearly emphasize the central role that eMoney Advisor may play in Fidelity's technology build going forward. Notably, the fact that all broker-dealers and RIAs being serviced by Fidelity on one central platform may make it easier for Fidelity to retain advisors as they "break away" from broker-dealer to RIA and make the transition smoother for clients, and/or even give resources to independent broker-dealers using their platform to help the broker-dealer better retain its advisors in the first place.
Indexing’s Existential Controversy (Jeff Schlegel & Evan Simonoff, Financial Advisor) - Back in 2000, Rob Arnott (of Research Affiliates) was working with George Keane (CEO of the Common Fund Group), who lamented that cap-weighted indexes meant that funds being allocated to an index would be putting a whopping 4% allocation into the single stock of Cisco, Wall Street's tech darling of the time that contrarian Keane feared was overvalued. Within 18 months, Cisco had in fact lost more than half its value, and as a result Keane and Arnott began to work on a new/different way to build an index that would not rely on cap-weightings and the Cisco-style problems they create; the end result five years later was the launch of "Fundamental Indexing" and the idea that weighting an index based on "fundamentals" like revenues, sales, book value, dividends, and cash flow, could lead to better index results than cap weighting (by avoiding the fact that cap weighting systematically overweights stocks that are overvalued and underweights the undervalued) while still retaining most of indexing's underlying benefits. A decade later, this framework - now broadly labeled "smart beta" - is increasingly popular, though with its rising popularity are also a growing chorus of skeptics who raise the question of whether it's realistic that a portfolio could be created that has such a 'structural' alpha available (and the inefficiency that would imply about the markets). Nonetheless, studies (at least based on back-tested numbers) are finding an average outperformance of a whopping 2%/year on average, although even Arnott notes there are still long stints when traditional cap-weighting may outperform, and smart beta strategies are becoming so popular - with so many different flavors and varieties - that it's not always clear which may be more or less valid, or even whether they all belong in the category or are really just more active management strategies in disguise. In fact, one of the biggest debates that have emerged around the movement now is simply whether it's fair and appropriate to call such strategies "indexing" at all, though Arnott maintains that at its core the movement isn't about active management but simply breaking the link of weighting stocks based on their price.
Does Rebalancing Add Value (Corey Hoffstein, Newfound Financial Innovations) - The commonly accepted view is that rebalancing (e.g., on an annual basis) is a value-add activity by systematically "buying low and selling high". Yet to test this, Hoffstein looked at the rolling 25-year returns of a 50/50 portfolio of the S&P 500 and a constant maturity 10-year Treasury Bond index, and finds that the results are not so consistent at all. In fact, rebalancing portfolios that ran from the 1970s into the 2000s generally underperformed (to the tune of 50-100bps of annualized underperformance!) portfolios that were simply invested up front and allowed to drift to higher equity exposure as equities grew faster than bonds, and rebalancing generally only added for portfolios that started in the 1980s and ran through the present 2010s (where rebalancing averaged about 25-50bps of additional positive performance). In retrospect, this makes sense; if you rebalance during a time period dominated by a single directional trend (e.g., the equities bull market through the 1980s and 1990s) rebalancing trims back a top performing asset class, while in flat/volatile periods rebalancing can help (e.g., the 2000-2010 era). On the other hand, Hoffstein does find that when viewed from a "risk" perspective (based on volatility), rebalancing does consistently result in less volatile portfolios (by limiting the upward drift of equity exposure). Notably, Hoffstein found that September was especially "anomalous" and was the one month of the year that rebalancing was most likely added value (and/or added the greatest value, especially because it successfully 'timed' the crash of 1987).
Advisor Creates Guide To Local Investing (Jeff Schlegel, Financial Advisor) - Financial advisor James Frazier is such a big fan of investing in local businesses, he created a website to support it, entitled the Local Investing Resource Center, which offers advice and education about how to do so for advisors who want to guide their clients through the process. Notably, Frazier points out that advisors and clients who get involved with local investing don't just find investment opportunities (which "typically" run in the low-to-high-single-digit range, with most returning about 5%-6%), but the investors end out working together to build a more prosperous community and engage with local entrepreneurs. The issue from the advisor context is that there are additional regulatory and compliance issues that arise with recommending investments for which there may be very limited due diligence information available, and that given the illiquidity such investments would likely only be a small part of a portfolio anyway (especially since some of the often-five-to-seven-year loans can go under altogether).
Cash-Balance Plans Surge (Miriam Rozen, Financial Planning) - Cash-balance pension plans are becoming increasingly popular, especially for small business owners and highly-paid professionals, due to the fact that as defined benefit plans they are not subject to the same annual contribution limits as 401(k) plans, instead allowing some older high-income participants to contribute as much as $250,000/year as contributions are based on age and earnings. The adoption of cash balance plans has accelerated further with a recent favorable IRS ruling that granted more flexibility to the Interest Crediting Rate (ICR) assumptions used for the plans (allowing higher return assumptions that lead to greater discounting factors and larger current contributions). And although proper expertise is required for appropriate structuring, a cash balance pension plan for a small business can be put in place for an administrative cost similar to or lower than a 401(k) plan. Notably, though, because the plan must cover all (eligible) employees, the details and demographics of the employees must be "right" for a good fit, which generally means older highly-compensated business owners and younger lower-compensated workers. Bear in mind, though, that as a defined benefit plan, the obligations for funding remain on the business owner, and the risk of poor market returns can translate directly into a greater contribution burden for employees to make up any shortfalls (which are only accentuated in situations where higher ICRs are used and the potential for market underperformance is greater).
Observations From a Decade in the Investment Business (Ben Carlson, Wealth Of Common Sense) - As he crosses the 10-year mark of his career, investment manager Ben Carlson shares some poignant thoughts and lessons learned about the investment world, including: everything continues to get faster, and investor time frames just get shorter and shorter; where you went to college doesn't matter beyond getting your first job through connections, and the opportunities to network virtually thanks to technology are making even that less and less relevant; career risk and the role it plays for professional investors is far greater than most realize; everyone is conflicted in some way, so the real trick is to understand how incentives drive people's actions and look for those who are upfront and honest about the potential conflicts; you get to know people better over dinner or drinks than the standard interview process; communication is a highly underrated skill; there's always going to be someone smarter than you, although the best people in the industry are often overlooked; information is everywhere but people still choose to ignore the evidence; and self-awareness is essential for long-term success. Also, always have a spare suit coat in your office for those last-minute (or forgotten) meetings that pop up.
Why You Should Own Bonds (Robert Huebscher, Advisor Perspectives) - Gary Shilling is known for being an advocate of owning long-dated bonds, dating all the way back to 1981 when he predicted we were in for "the bond rally of a lifetime", and since then a strategy of rolling 30-year zero-coupon bonds would in fact have outperformed the S&P 500 by a whopping 6.3 times. Of course, back then interest rates were drastically higher than today, but Shilling makes the case that there is still a role for bonds, owing to the same underlying factor that he has noted all along: declining inflation ultimately leading to deflation. In fact, Shilling notes that going back several hundred years, inflation tends to spike during wartime periods (driven in part by aggressive government spending), but that during peacetime periods productivity growth often leads to low or nonexistent inflation, as is being witnessed today. As a result, with military spending approaching its post-war low, and deleveraging after the financial crisis continues, Shilling suggests that deflation may now be imminent (and would have occurred already if not for recent massive monetary and fiscal stimuli). Similarly, Shilling notes that the CRB commodity index has been declining since early 2011, having finally worked off a decade-long surge after China joined the WTO in 2002, although awareness of the commodities decline has been accentuated in recent months as crude oil prices 'went off a cliff'. And given these dynamics of looming deflation, Shilling emphasizes that long-dated U.S. Treasury bonds may still be one of the best performing asset classes from here, not just because U.S. Treasury bonds are a safe haven, but also because their spread is actually high relative to other sovereign bonds!
Irving Kahn, Investor Who Profited in ’29 Crash, Dies at 109 (Larry Arnold, Bloomberg) - This week marked the death of Irving Kahn, co-founder and chairman of Kahn Brothers Group, an investment adviser with about $1B under management, who up until last year - at age 108 - was still working three days per week in his advisory practice. What's notable about Kahn is not merely his astounding longevity, but that he started working on Wall Street in 1928, made money successfully shorting stocks during the crash of 1929, and ultimately went on to become a part-time teaching and resaerch assistant for the famous Benjamin Graham, including working with Graham and Dodd on their seminal book "Security Analysis" and later with Graham on his legendary "The Intelligent Investor" book as well. He went on to become a founding member of the New York Society of Security Analysts, and was one of the 284 candidates who took the first CFA exam in 1963. Not surprisingly given this background, Kahn was a "contrarian" investor, and emphasizes that he believes Graham's value-investing principles are as relevant as ever today, but are increasingly being drowned out by noise. As Kahn himself stated in an interview two years ago: “I’ve seen a lot of recoveries. I saw crash, recovery, World War II, a lot of economic decline and recovery. What’s different about this time is the huge amount of quote-unquote information. So many people watch financial TV at bars, in the barber shop. This superfluity of information, all this static in the air.”
You're Doing Allowance Wrong (Ron Lieber, Slate) - This article excerpts part of Lieber's new book "The Opposite of Spoiled", and makes the case of how most parents today get it wrong when it comes to properly structuring an allowance for children. The key is to recognize that while many parents feel awkward about money issues and try to avoid them, or otherwise just aim to shelter children from money issues as long as possible, doing so leaves those children ill-prepared for the six-figure decisions they have to make as teenager about college and student loans, not to mention the adulthood financial decisions that follow. Lieber suggests that ultimately, allowances for children should begin as soon as they start asking questions about money, which can begin as early as the preschool years; failing that, introducing allowance when the tooth fairy comes is a good idea, as once kids find money under their pillow, they will begin to sense its power and want more and need to start learning about it anyway. In terms of amount, Lieber suggests a good rule of thumb is to give a dollar a week per year of age, but that it's not about just giving the money to children; parents should also be involved in guiding how they spend it, by creating three containers for "save", "spend" and "give". The key is not just the containers themselves, but the opportunity to use them to teach about values - spending is about modesty, thrift, and prudence, while saving instills patience, and giving is about generosity as well as gratitude. Over time, allowance should rise - and Lieber suggests by a lot, as kids eventually crave responsibility, and heaping it up them (starting around age 10 or so) and allowing them to make mistakes are valuable learning opportunities (in fact, Lieber suggests giving them an annual budget for clothing in a lump sum and getting out of the way, specifically to allow them to fail and learn from the experience, which is far better than doing the same at age 24 with wrecked credit scores). Lieber also suggests that while money can be good for teaching values, it's a bad idea to uses allowance to control and incentivize chores (otherwise you run the risk that the children save, have enough money, don't need to do the chores, and then you're stuck as a parent!); instead, trade privileges for chores (e.g., screen time, car keys, etc.), and in fact Lieber suggests that most kids are capable of far more chores and support work around the house than they're given credit for anyway!
Uber’s Business Model Could Change Your Work (Farhad Manjoo, NY Times) - While not everyone is going to become an Uber driver, Manjoo makes the case that the "Uber-ization" of work could soon be coming to many professions and be highly disruptive in the process. The basic concept is that technology is making it possible to chop up traditional jobs into smaller discrete tasks that can be assigned to people just as needed, with cost/wages set purely by dynamic supply and demand shifts, and every worker's performance constantly tracked. In essence, Uber represents a kind of technology that functions to efficiently allocate human beings (and their possessions) in an increasingly competitive economy. A number of companies are already trying to emulate the Uber business model in other industries, from "Uber for daily chores" or grocery shopping to even on-demand legal services and virtual doctors available at the tap of a smartphone. From the worker's perspective, these Uber-style jobs are creating a new category of employment, that isn't like being a full-time employee but isn't entirely running your own business either. The good news is that the Uberization of work could make work life more flexible, allowing you to fit your work times around your (personal) schedule, rather than vice versa, and create potential new streams of income for people otherwise stuck in a job with stagnant wages (and in fact the majority of Uber drivers work only 1 to 15 hours/week, often as a supplement on top of an existing job). The bad news, though, is that income and work availability could be even more cyclical and less stable and secure.
I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!
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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!