Enjoy the current installment of "weekend reading for financial planners" – this week’s issue starts off with three big articles on industry trends: the first is a review of the comment letter submitted by the Financial Planning Coalition to the SEC, with a growing cadre of high-profile organizations supporting a fiduciary duty; the second is an interesting look at how CFP certification continues to grow in the large firm environment, even though some firms aren’t entirely convinced the certification results in higher professional success; and the third looks at some of the trends with RIAs, including how margins are getting squeezed as the advisor environment gets more competitive. In a similar vein, there’s also an article discussing some of Bob Veres’ latest perspective about whether many advisors may actually be misjudging their competitive environment and undercharging clients.
From there, we have several technical articles this week, including a roundtable discussion about implementing a tactical asset allocation investment approach in your firm, a look from Moshe Milevsky at how in Chile the biggest annuity problem is that so many people choose to annuitize, a summary of some of the big changes coming to the healthcare system in 2014 as the major provisions of the Affordable Care Act kick in, and good overview of the health insurance exchanges in particular will work as they open up on October 1st, and an interesting warning from The Slott Report about clients who may be using their retirement plans to fund a business venture but are not reporting it properly on Form 5500 to the IRS.
We wrap up with two final articles: the first is a summary of a recent "Barron’s top advisors" panel sharing what the keys to success were for them (most common theme: specialize); and the second is a good read from Jason Zweig of the Wall Street Journal about our shaken trust in the integrity of the financial system, and how important it is – due to our behavioral biases – that we continue to see ourselves living in a just world, which means it’s still important for regulators to get more aggressive against wrongdoing, for Wall Street to show some contrition for its actions, or ideally both. Enjoy the reading!
(Editor’s Note: Want to see what I’m reading through the week that didn’t make the cut? Due to popular request, I’ve started a Tumblr page to highlight a longer list of articles that I scan each week that might be of interest. You can follow the Tumblr page here.)
Weekend reading for June 8th/9th:
Historic Moment As Planner Groups Voice Clear Support For Fiduciary Standard – On his Advisor One blog, Bob Clark provides a good recap of the recently submitted comment letter from the Financial Planning Coalition on the SEC’s Request For Information on the costs and benefits of a uniform fiduciary standard. As Clark notes, the letter voices unequivocal support for the fiduciary standard, and is signed not only by the Coalition members themselves – including the CFP Board, the FPA, and NAPFA) – but also a litany of major consumer protection groups, including the AICPA, the Investment Adviser Association, the Consumer Federation of America, NASAA, Mercer Bullard’s Fund Democracy, and AARP, and with that kind of support, the SEC will have to take the comments of the letter seriously. The general tone of the letter is fairly negative, and emphasizes that even the assumptions in the SEC’s request for information were flawed and didn’t sufficiently address the fundamental "act in the best interest of the consumer" purpose of a fiduciary standard. Comments from the supporting organizations were similarly strong; Barbara Roper from the Consumer Federation specifically noted that broker-dealers are calling their sales representatives financial advisors, are marketing themselves based on advice, and encourage investors to rely on them as trusted advisers, so they should be regulated as such. On the other hand, it’s important to note that the FPA’s comments (voiced by FPA president Michael Branham) still support a compensation neutral version of the fiduciary standard, stated "Requiring a fiduciary standard of broker-dealers doesn’t mean they need to stop earning commissions or providing services to middle-class clients. Rather, it means that they need to put their clients’ interests first by, among other things, fully disclosing and appropriately managing conflicts of interest. Financial planners, who have voluntarily embraced the fiduciary standard, have demonstrated that it can be applied successfully across business models for the benefit of both clients and advisors."
Brokerage Firms Debate Value Of Certified Financial Planner Title – This Reuters article takes an interesting look at how some of the large wirehouse firms are debating whether CFP certification for their brokers is really adding to the bottom line, even while they continue to vigorously continue to encourage their brokers to get the designation; at this point, about half of all CFPs work under one of the 50 largest financial services firms (i.e., broker-dealers), and Merrill Lynch along is now requiring almost 4,000 new brokers in its training program to complete the CFP curriculum within 3 years (there are about 68,000 CFP certificants in total), on top of the 3,500 CFP certificants who already work at the firm. The push towards CFP certification at larger firms seems to have picked up since the financial crisis in particular, as the poor investment results shook consumer faith in their brokers, who are now shifting to position themselves more as trusted advisers on a wide range of goals rather than being purely investment centric. At the same time, whether providing more comprehensive advice really "helps" is still being debated at the firms; Merrill Lynch management insists that having a CFP certification allows its advisors to grow faster, and Wells Fargo finds there is at least an incremental increase, but the head of wealth management transformation at UBS cannot find any connection between CFP certification and better business results amongst its 7,000 advisor base. On the other hand, a wider industry survey by Aite Group last year showed that brokerage teams with a CFP holde were generating 30% more revenue than teams without, and solo practitioners with CFP certification were producing 40% to 100% more than brokers with no certificates (and the payoff is biggest for those in the earlier stages of their careers); an Aite Group analyst suggests that the lack of payoff for the credential in some traditional broker firms may be more a problem of their own structural, supervisory, and legal hurdles in handling the growth of credentialized financial planners.
The Skinny On RIAs – From Investment News, this article provides an interesting look at the current landscape for RIAs. Overall, Cerulli projects that the RIA channel will continue to increase market share (up to 14.4% by the end of 2014, up from 12.9% last year), but rising margin pressures may begin to increasingly favor the larger RIAs over the mass of smaller ones. This projection isn’t unique – Mark Hurley has made a similar case for years, reiterated in his latest report on the wealth management space. The dominant trends: costs are rising 5%-7% per year (squeezed from the cost of talent, software/technology, and more), aging clients are taking more and more withdrawals (and certainly not contributing like they were 10-20 years ago), the market isn’t providing much of an AUM tailwind, and it’s getting harder to find new clients. Rob Francais from Aspiriant re-emphasizes the latter point, noting that while once being independent, objective, and fee-based was a strong differentiator, but that’s no longer the case; instead, many large firms seeking more growth and scale are beginning to acquire other smaller firms to help fuel growth. On the other hand, the reality is that a trend towards consolidation is natural for most maturing industries; the same thing has happened in accounting and law as well. Notably, the long-term projection is not that the mass of smaller advisory firms will vanish, but simply that they’ll be making less money than they used to, and have to work harder in the business; developing a niche with specialized expertise and systems will become increasingly important for both efficiency, and marketing differentiation to grow.
Six Reasons You’re Charging The Wrong Fees – This article by Bob Veres in Advisor Perspectives recaps a recent survey he did of his Inside Information newsletter readers, regarding what they charge for the services they provide. In Veres conclusion was that many advisors are charging less than what the market will bear, and identified six major "oddities" in how advisors are structuring their pricing. The first issue is that there is remarkably little relationship between advisory fees charged and the amount or quality of work provided to a client; there are advisors charging 50bps for investment management plus comprehensive planning, and advisors charging 150bps for just managing assets with little planning work; similarly, while the average fee in the industry is still around 1% on AUM, there is wide variability and little consistency from one firm to the next, beyond the fact that almost all firms have some kind of graduated fee schedule with breakpoints. A related issue is that there is no consensus in the profession about whether planning fees should be separate from asset management fees or not (a topic previously discussed on this blog as well), and as a result there’s a great deal of variability in fee structures. The separation is even more problematic because of the third issue, which is that there’s no consensus on what pure asset management services are worth in the first place. Similarly, there’s also remarkable inconsistency in the amount of upfront fees versus ongoing fees that are charged (or indeed whether there is any separate upfront fee at all). Finally, Veres noted that while about 20% of his readers are now charging retainer fees, there is no more consistency in how retainer fees are structured, either, with prices ranging from numbers plucked out of this air, retainers that are intended to be similar to AUM fees, retainers that are calculated based on income or net worth, or other more complex formulas. Ultimately, Veres is unsure what to make of all this – are asset-only managers sliding in to competition against full-service advisors and consumers just don’t realize it, or are consumers just not sophisticated enough, or are advisors just not good business managers when it comes to pricing? But the bottom line is that a lot of firms could probably benefit from a more careful analysis of their fee structures and what they are charging… and whether they are undercharging.
Tactical Asset Allocation: Advice And Guidance From Experts – This article from the Journal of Financial Planning is a roundtable discussion about the ongoing industry trend towards tactical asset allocation with Mebane Faber, Jerry Miccolis, and Ken Solow (moderated by yours truly). The discussion begins with just trying to define tactical asset allocation, which still seems to mean different things to different people; Solow labels it as changing the asset allocation of a portfolio to take advantage of value opportunities, while Faber classifies virtually anything as a form of being tactical (since even passive portfolios have active tactical rules for things like rebalancing), and Miccolis suggests that the difference between strategic and tactical may soon vanish as we increasingly acknowledge that because markets and the economy are dynamic, even "strategic" passive allocations should arguably shift over time. In fact, most of the roundtable participants ultimately suggest that tactical is entirely consistent with a passive portfolio constructed using modern portfolio theory, and is simply the result of inputs that change over time and using more forward-looking assumptions rather than just relying on historical market performance to be a predictor of the future. So how do you be more tactical if you want to? Basic adjustments you can make on your own, but getting some third party independent research to support your process, so you’re not just relying on guesswork, is a good idea (and some firms outright hire one or more full-time investment analysts); other firms have decided that a tactical process is good for their clients, but they don’t have the time to do it themselves, so they are outsourcing the entire investment process. For those that do it themselves, it’s crucial to be model-based in your implementation, or it can quickly become unmanageable. The article also provides some guidance on how to get started, how to evaluate the success of being tactical, communicating with clients, and the end provides some recommended resources for further reading and insight.
Chile’s Annuity Puzzle – In Research Magazine, retirement "quant" Moshe Milevsky looks at the so-called "annuity puzzle" – the fact that so few people ever annuitize – and how it plays out in the retirement system of Chile, where the "annuity puzzle" is actually the fact that so many of them do choose to annuitize, voluntarily walking into their neighborhood insurance company with their accumulated nest egg and asking to exchange it in return for income for life. In Chile, retirement savings are primarily in the form of a pre-tax defined contribution plan funded with 10%-of-salary contributions through the Chilean payroll system, invested into a limited set of low-cost mutual funds managed by the private sector; think of it like having one giant national 401(k) plan where every worker is required to save and uses their own money for retirement. At retirement, they can continue to invest their account and take systematic withdrawals, or annuitize, and approximately 65% of Chileans choose the latter with 100% of their retirement funds (whereas in the the US, the rate is about 5% at best). Ironically, annuitization is so rampant in Chile, their regulators are concerned that the domestic insurance companies are overexposed to life annuitization risks (approximately 85% of insurance industry reserves in Chile are linked to life annuities, with only about 15% linked to life insurance); as a result, there is fear that unexpected longevity could produce problems for the insurance private sector there, and regulators wonder whether Chileans are overannuitizing and if more citizens should be using systematic withdrawal plans instead! While the ultimate determination of the Chilean annuity puzzle is a mystery, Milevsky hypothesizes a few reasons why it may be so popular there, contrasted with the US, including: Chilean retirement advisors (which are mandated at retirement!) have the same compensation regardless of whether an annuity or strategic withdrawal solution is selected (unlike in the US where business models complicate the question); retirees are shown (again mandated and regulated) illustrations of the risks of market volatility on their retirement income; all retirement annuities are inflation-adjusted in Chile, not nominal as is so common in the US; there is no other floor for Chilean retirees, as Chile has no Social Security or (other) pension programs; and the Chilean government explicitly guarantees insurance company payments (up to a limit) in the event of insolvency. This still doesn’t fully explain why Chileans not only choose annuitization so frequently, but commonly do it with all of their money as well; nonetheless, it raises some interesting questions about whether there is some unacknowledged bias in the US that tilts so many retirees away from immediate annuitization at retirement?
15 PPACA Provisions That Will Take Effect In 2014 – Although many parts of the Patient Protection and Affordable Care Act (also known as "Obamacare") have been phasing in for several years, the bulk of the new rules kick into gear in 2014. This article provides a nice summary of all the new rules that are will be implemented next year, including: state health insurance exchanges, the new large employer "pay or play" coverage requirements, the individual mandate tax penalty (individuals must buy coverage or pay a penalty), tax credit subsidies for those who cannot afford coverage from the exchange to avoid being exposed to the mandate penalty, automatic enrollment in health insurance for large (200+ employee) firms, the elimination of rules discriminating against pre-existing conditions, more uniform restrictions on maximum lifetime costs to an insured, and more.
Everything You Ever Wanted to Know About Obamacare’s State-Run Health Exchanges – This article from Motley Fool provides a good synopsis of the coming health insurance exchanges that will take effect in 2014, their purpose, how they may impact clients, and what might go wrong. The basic purpose of the health insurnace exchanges were to ensure that people have access to health insurance, and to fill the gap for those individuals who fall between employer coverage and Medicare (or Medicaid), while also having a mechanism to better control prices by making health insurance offerings more standardized with pricing that is more transparent; on the other hand, because the minimum coverage for health insurance exchanges is higher than in the past, some individuals buying low-cost catastrophic-only policies may have a bit of sticker shock as they see the cost of new, more comprehensive, coverage options. For those already receiving coverage through an employer or Medicare, there won’t be much impact from exchanges in the near term, as it is targeted primarily at individuals. Ultimately the hope is that states will run their own exchanges, however at this point it looks like only 17 states will run their own, and the Federal government will run the rest on behalf of the states. The biggest concern is that insurers may simply choose not to participate on the exchanges and offer policies at all; on the other hand, some insurers may be eyeing the growth opportunities of having an opportunity to expand their pool of business (though poor communication about health insurance exchanges to the public may limit the uptake, at least in the first year). In any event, the exchanges will open on October 1st, so stay tuned!
ROBS Plans And IRS Form 5500 – From The Slott Report blog, this article highlights some of the concerns with using retirement accounts to finance business ventures, which the IRS has been scrutinizing under its so-called "RollOvers as Business Start-ups (ROBS)" project (and the IRS’ chosen acronym says a lot about its opinion on the matter!). The most common strategy is to roll over retirement accounts to an IRA, create a business, establish a new 401(k) plan for the business, roll all the IRA assets into the new 401(k) plan, and then use the plan to purchase all the stock of the newly established business. The end result – the business shares are in the 401(k), and the cash from the 401(k) is in the business’ checking account, and voila the money has been morphed from retirement funds into startup funds with no current tax liability. At this point, the IRS is not directly attacking the plans – as in theory, these steps are all permissible under the tax code (though watch out for prohibited transaction rules!); however, the IRS notes that plan administrators under this setup have been failing in their Form 5500 reporting obligations. Form 5500 is required to be filed for all retirement plans unless the plan assets are less than $250,000 and the plan has funds for only the business owner and/or their spouse who wholly own the business; however, since under the ROBS structure the plan owns the business, not the individual and his/her spouse, a 5500 needs to be filed. If you haven’t filed a Form 5500 yet for 2012, the due date is the end of July. (In the long run, we’ll see whether the IRS uses the data gathered on these ROBS-based Form 5500s to enact further crackdowns on the strategy.)
Three Top Advisors Tell What Knocked Them On Course – This article provides a review of a recent panel of three "Barron’s top advisors" at IMCA; while there has been some controversy about whether the Barron’s list are really "top advisors" the results of the discussion were nonetheless quite interesting, as the panelists shared the epiphanies they had that made them successful. The first theme of the discussion was that all of the advisors had ultimately chosen some form of specialization; one advisor said his seminal moment was when a coached asked him "who are you stealing from?" to realize that he needed to clearer niche. In most cases, though, the specializations only came about ‘accidentally’ or serendipitously in the midst of their existing practice, and the advisors shifted to focus there entirely over the span of several years that followed. Notably, all the advisors emphasized the time they spend servicing clients, with no more than 20% of their time spent on investments. Working in a higher net worth space, all of the advisors emphasized the importance of family meetings, both for estate planning for the client, and because advisors are only retained 46% of the time when assets transfer to a spouse (e.g., at death), and only 2% of the time when the money goes to the younger generations. The easiest first step to going down this road – one advisor suggested that you go home today and fire whatever one client gives you the biggest stomach ache, making your team happier, and giving you an opportunity to take on another client who will be more grateful for your services instead.
Trust: Easy to Break, Hard to Repair – This article by Jason Zweig at the Wall Street Journal takes a hard look at the trust – or lack thereof – that the public has for Wall Street and the integrity of financial markets these days. Zweig cites renowned short-seller Jim Chanos regarding three key points undermining the trust: 1) financial fraud in recent years has not been detected by the ‘normal guardians of the marketplace’ like accountants, regulators, and law-enforcement authorities, but instead by whistleblowers, short-sellers, and journalists; 2) prosecution of financial crimes is essential in the minds of investors, but has been discretionary at best in the eyes of government officials; 3) as long as these issues are not addressed, the trust problems will persist. And unfortunately, while the financial crisis arguably should have been a perfect chance to transform (or at least reform) Wall Street, Zweig believes the opportunity has been squandered, and instead the perception from the financial crisis has been something closer to "good things happened to bad people, and bad things happened to good people." This kind of environment threatens us to the core, as Zweig notes that essential human function (and certainly capitalism) thrives on what are called "positive illusions" including our overconfidence, illusion of control, and unrealistic optimism – while those are behavioral and cognitive errors, they are also necessary for us to be effective, as if we honestly accepted how little we know, how little we can control, and how little advantage we have over others, most of us probably wouldn’t get out of bed in the morning! But perhaps the most crucial cognitive "error" we make is that we have a "belief in a just world" – and although it’s often not true, Zweig suggests more needs to be done to preserve that perception, or the whole system risks breaking down, as recent research showed that when we don’t believe the world is just, we become significantly less willing to wait for a financial gain and cease to invest in our futures. So what’s the solution? Zweig suggests three ways trust can be restored: a ritual humbling of Wall Street by aggressively pursuing wrongdoing; Wall Street apologizing and taking responsibility for its own role in the crisis; and forgetfulness. While the last option is not the most appealing in a just world, it unfortunately may be the most likely outcome at this point.
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!