Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the big industry news that the CFP Board is modifying its Terms and Conditions, and beginning in May will require all CFP certificants that have a dispute with the CFP Board to go through mandatory arbitration, forever ending the possibility that the CFP Board will have to defend another case like Camarda in court. Also in the news this week is the continued escalation of life insurance companies changing internal costs to make up for losses due to low interest rates, which has now triggered a class action lawsuit being filed against Transamerica (though it’s certainly not the only company engaging in the practice!).
From there, we have a couple of technical articles this week, from a discussion of the importance of Active Share (the more unique the portfolio, the greater its upside and also downside potential), to a look at how to read through a Financial Aid Award letter (as many have just started going out to college students matriculating in the fall), as well as a look at the practical challenges of using an HSA as a supplemental retiree medical savings account, and the growing concern from the “father of Smart Beta” Rob Arnott that parts of the Smart Beta universe may be in a self-induced bubble that could lead to a Smart Beta crash (even if the underlying concept remains structurally valid when done properly).
We also have a couple of financial technology articles this week, including the launch of a new portfolio design and risk analytics tool called Totum Wealth, some helpful reminders about how to stay on guard against potential cyberattacks, and a discussion of the big #FinTech news that Intuit is going to be shutting down its APIs, potentially leaving a number of account aggregation and client portal services in search of a new partner (and while there are alternatives to choose from, including Intuit’s suggested replacement Finicity, advisors using software relying on Mint APIs may still find their clients soon have to reconnect all their accounts just to get up-and-running again!).
We wrap up with three interesting articles: the first looks at how “99%” of networking events are a waste of time, and the real ways to leverage networking value and opportunities (first hint: when it’s time for sessions, take a nap, so you can be awake and refreshed for the actual social time for relationship-building!); the second is an interesting hypothetical letter from a Millennial to her parents’ advisor, providing a great reminder of the ways that advisors could (and often fail to) engage the children of their clients; and the last is a discussion of the challenge in figuring out, when you’re raising children, how to define what is “Enough”, particularly for a family that is affluent enough to afford whatever their kids want, and have to introduce an “arbitrary” line to tell them no, create some financial discpline, and hopefully instill values of fiscal responsibility.
Enjoy the “light” reading!
CFP Board To Mandate Arbitration From Certificants (Mark Schoeff, Investment News) – The CFP Board announced in a Notice To Certificants this week that beginning May 2nd, all CFP certificants will be subject to new Terms and Conditions of Certification, which includes a requirement that any future disputes between CFP certificants and the CFP Board must be resolved in a mandatory arbtiration process that runs no longer than 9 months. The arbitration process itself will be run by the American Arbitration Association, with a panel of 3 arbitrators who are all former state or Federal judges. Notably, the shift comes as the CFP Board continues its ongoing lawsuit with Jeff and Kim Camarda, which was ruled upon last fall in favor of the CFP Board but remains in Appeal; under the new Terms and Conditions, the Camardas would have been compelled to take the case to mandatory arbitration instead, which the CFP Board suggests would have been more cost effective and expeditious for all involved. On the other hand, for CFP certificants who might have wanted “their day in court”, the new rules would make that impossible, as CFP certificants will be required to waive their right to sue the CFP Board when the new Terms and Conditions go into effect in a few weeks. Of course, CFP certificants always have the right to not sign the Terms and Conditions and instead walk away from the CFP marks, though notably the growth and the success of the CFP Board – and its ongoing public awareness campaign suggesting that “Certified = Qualified” when it comes to financial advisors – puts those who disagree with the Terms and walk away in the awkward position of having the CFP Board’s public awareness campaign question their subsequent competency.
TransAmerica Sued For Cost Increases On Universal Life Insurance Contracts (Greg Iacurci, Investment News) – With persistent low interest rates, insurers are struggling to align their premiums with expected insurance claims, especially for existing policies from years ago that were never designed in contemplation of having rates be so low for so long. And because many insurance policies has interest rate guarantees in the policies, the insurance companies have limited tools to address the issue. Some, including AXA Equitable, Voya, and TransAmerica have tried to fill the gap by raising other “optional” cost provisions in their policies, particularly for universal life policies that are flexible enough to allow it. Now, however, consumers are raising class action lawsuits against the insurers, alleging that the cost shifts have been so significant and are driving required premiums so high that they constitute a breach of the insurer’s obligations. The latest is a new class action lawsuit filed by a Consumer Watchdog group, Feller et al v Transamerica Life, which suggests that the policy’s provisions did allow the company to raise its cost-of-insurance charges, but that doing so to make up for low interest rates is a breach of contract, and that COI rates should only be increased if mortality is unexpectedly high. In the meantime, though, universal life policyholders may find that their cash value is now deteriorating more quickly than expected, given the higher cost burden the policies are now bearing.
The More Unique Your Portfolio, The Greater Its Potential (Patrick O’Shaughnessy, Investor’s Field Guide) – The measure of “Active Share” is meant to determine how different a portfolio is from its underlying benchmark. After all, if a portfolio isn’t materially different than its benchmark, there’s no possible way for it to outperform; or viewed another way, Active Share is a signal for at least the potential excess return of a portfolio manager. Of course, the potential to deviate materially from a benchmark also introduces the possibility of material underperformance as well. And ironically, O’Shaughnessy notes that the biggest potential for underperformance with high active share comes in big up years for the markets, and how much upside can be left on the sidelines by picking losers in an otherwise-winning year. Nonetheless, the fundamental point remains that if you’re going to pay for active management, you want to be certain there’s a high enough active share for it to even be possible for the active manager to outperform. And here, the industry trends have been notable – in the early 1980s, over half of mutual funds had an active share above 80% (indicating no more than 20% overlap to their underlying benchmarks), but as of 2009, only 20% of funds were this active. O’Shaughnessy suggests this may be heavily driven by the fact that in 1950 only about 8% of the market was managed by large institutions, and by 2010 it was up to 67%. Regardless of the cause, though, the concern remains that investment managers are becoming “increasingly homogenous, coalescing around indexes and titled variations of those indexes,” and that it’s more and more important to actually check if an active manager really is being active enough (or not) to be worthy of the active manager fee being paid.
Financial Aid Award Letter Analysis (Fred Amrein, EFC Plus) – As we transition into the Spring season, for parents this is the time of college acceptance letters, and the all-important Financial Aid Award letter that may accompany it. For those unfamiliar, Amrein provides a dissection of the key terms and issues to be aware of in the Financial Aid Award letter, including: the top-level Cost Of Attendance (COA) estimate for attending the school in the first place (though notably this is usually based on averages, and the “real” COA for a particular student may not be clear until the college issues the final bill during the summer), and the various Award types, including Scholarships (“free” money that is a direct reduction of the cost billed by the college, and further broken into merit scholarships based on achievement/talent that tend to be stable from year to year, or need-based scholarships or grants based on the family’s financial strength which may change from year to year) and Self-Help Aid (which includes a wide range of potential student loan types that may or may not defer interest or loan payments, along with the opportunity for Federal work-study programs based on need). Notably, though, the calculations of cash flow and benefits – particularly relating to any form of needs-based aid – can change significantly from year to year, particularly if there are multiple children and the number who overlap in school may change from year to year (not to mention varying costs if students make different choices, e.g., regarding housing options). Consequently, the Financial Aid Award letter may still understate or overstate the expected cash flow obligations over multiple future years, as it’s ultimately calculated only for the current year. And of course, if/when/as students accumulate multiple loans of varying types over time, it’s important to be aware of and coordinate amongst potential favorable repayment or outright forgiveness programs, as well as the potential ramifications on the parents’ credit if they take out student loans for their children.
The Trouble With Saving In HSAs (Brent Hunsberger, The Oregonian) – All else being equal, the Health Saving Account (HSA) is the best tax shelter around, with tax-deductible contributions going in, tax-deferred growth for funds inside the account, and tax-free distributions (for qualifying medical expenses). In addition, contributions to an HSA via an employer cafeteria plan can avoid 7.65% FICA taxes as well (whereas 401(k) contributions are only made after FICA taxes are applied). As a result, some recent research has suggested that savers might even consider contributing to an HSA before other tax-preferenced savings accounts like a 401(k) plan, particularly since the HSA can effectively be used as a supplemental account for retiree health expenses (e.g., Medicare out of pocket costs). However, Hunsberger notes there are some important caveats. The first is simply that your choice of health plan – including whether or not to take a high-deductible health plan to become HSA-eligible in the first place – should be dictated by your actual health needs, not a tax savings strategy. Especially since if you actually do have health and medical expenses, it will be hard to keep much of a balance invested and growing in the HSA, because most will need the money to cover the health care expenditures! In fact, one recent study found that despite being around for a decade, the average HSA balance is only $7,223, and for every $1 contributed to an HSA only $0.26 are typically left in the account to be carried forward into the subsequent year. In addition, there’s still the challenge that in practice, HSAs often have higher fees than a 401(k) plan (and those fees can be especially pernicious on small account balances), and few HSA providers offer investment options beyond a simple money market or savings deposit option (which will probably yield no more than 1%).
How Can “Smart Beta” Go Horribly Wrong? (Rob Arnott & Noah Beck & Vitali Kalesnik & John West, Research Affiliates) – As investors eschew ‘traditional’ active managers, significant dollars have been flowing into various types of “Smart Beta” strategies, that adjust the target weightings for portfolio securities based on various underlying factors besides just market capitalization. However, Arnott points out that many Smart Beta strategies have become so popular so fast, that the rapid inflow of dollars is bidding up the prices of those underlying securities – causing them to rise, and further improving the results of the Smart Beta strategy… but also creating the potential for a subsequent “Smart Beta crash” as the factors eventually return to normal. In other words, a portion of the returns being attributed to the recent success of Smart Beta may simply be a result of the dollar inflows distorting the underlying valuations. And this phenomenon is not new – for instance, in the late 1990s, investors viewed the equity risk premium as being a whopping 7.5%, because that’s what it had been for the preceding 50 years, without recognizing that a significant driver of the outcome was that P/E ratios would barely 10x in 1950 and over 40x by 1999. And when Arnott digs deeper on popular Smart Beta factors, he finds a similar effect; the relative performance associated with factors like value, small cap, illiquidity, and profitability are heavily associated with their relative valuation, which in turn is impacted by inflows and outflows (the effect is less for the momentum and low beta factors). And the same result occurs with entire Smart Beta strategies, such as equal weighting, Fundamental Indexing, quality, low volatility, etc. Ultimately, the point is not that factor weighting or Smart Beta strategies are bad, per se, but simply that investors may be misjudging which strategies are best by looking too much at recent performance, which is impacting flows that drive up the prices and just exacerbate the problem further. Ultimately, for an effective evaluating of Smart Beta strategies or factor tilts, it’s necessary to take a longer perspective that strips out the impact of changing valuations to look at the underlying structural benefits of the strategy; on this basis, many factors still look good, but only a few Smart Beta strategies still stand up (including equal weighting, Fundamental Indexing, and risk-efficient strategies).
New Tool Promises Fresh Approach To Risk Analysis (Joel Bruckenstein, Financial Planning) – A new player in the world of financial advisor risk tolerance tools is Totum Wealth, which aims to take a more holistic look at a client’s “multidimensional” risks than the available alternatives. Created by Pacific Life’s former director of investment risk management (Min Zhang) and Causeway Capital Management’s co-founder (Mark Cone), the software looks not only at a client’s investment portfolio, but also considers his/her health, the rest of the balance sheet, and even the industry in which he/she is employed. In other words, the software actually implements some of the recent research around adjusting a client’s portfolio based on their human capital, including the risks of their employment situation and their job industry. The software can not only evaluate the client’s current risks relative to their portfolio, but can also take in details of the advisor’s model portfolios, to show clients a comparison proposal. Bruckenstein also notes that the software has a very “welcoming and user friendly” design, although the underlying calculations are essentially a black box with little transparency about how they’re determined (perhaps not surprising, as those analytics are Totum’s proprietary process?). In addition, Totum lacks integrations at this point, so advisors who want to use the tool with existing clients would have to re-key all the data, and the output can only be displayed on screen or in a PDF (but not exported via widgets into other client portals or software). Totum is available with a 90-day free trial, and then has a cost of $128/month for its risk analysis tool or its portfolio proposal solution ($248/month for both).
Stay On Guard Against Cyberattacks (Dan Skiles, ThinkAdvisor) – As the adoption of technology has grown, so too have the threats against it, and as a result cybersecurity is becoming a hot topic for financial advisors (in large part because the regulators are making it a hot topic with increased scrutiny!). Skiles suggests that in today’s environment, this means advisory firms need to take real responsibility for cybersecurity risks. The starting point is just to know who exactly has access to log into your network in the first place (your staff? your remote staff? your IT support? have you disabled access for former members of those groups?). In addition, consider what access those people have, and whether it should be limited; by default, have you given all employees administrator-level access to your network, or is it more restricted to ensure that if their system is compromised, the problem doesn’t spread? Similarly, your network firewall should be producing audit reports that detail when, who and how often users are logging into your network, so that you can spot suspicious activity. Notably, though, one of the biggest cybersecurity risks is not technology hackers that penetrate the network directly, but the slew of fake emails that hackers send out to persuade people to click on fake links that may turn over key information or access – so be certain you have up-to-date anti-virus software, and that your employees are trained to verify wire transfer requests, know not to click on suspicious attachments or links, etc. And finally, remember that when your password is protecting vital and private business and client personal information, it needs to be a quality – i.e., complex – password, including upper and lowercase letters, numbers, and special characters, to minimize the risk of a brute force attack successfully “guessing” your password and gaining access to your digital kingdom!
How Intuit’s Account Aggregation Shutdown May Impact The Fintech Solutions You Use (Bill Winterberg, FP Pad) – Last week, Intuit made the major announcement that they will be discontinuing their Financial Data APIs, with an 8-month wind down process to allow time for existing developers to migrate to other sources. The APIs, which gave third-party developers the opportunity to draw on the same data that powers Intuit tools like QuickBooks, Quicken, and Mint.com, powered both a slew of third party account aggregation tools (through Intuit’s Transactions API) and also helped facilitate the establishment of new ACH connections (through their Identification API). Since it rolled out in 2012, a slew of major B2C startups, including LearnVest, SaveUp, Hello Digit, BillGuard, and more, have been using the Intuit APIs, along with a number of financial advisor technology companies like Blueleaf, Wealth Access, Quovo, Plaid, and Right Capital. Fortunately with Intuit’s departure, there are at least a few other options to power account aggregation, including Yodlee, CashEdge, ByAllAccounts, and eMoney Advisor, and many companies (e.g., Quovo, Wealth Access, and Blueleaf) may fill the void by drawing in data from multiple other sources to provide a single consolidated feed (without the advisor needing to worry about which API source in particular it’s coming from). In addition, Intuit itself announced a new alternative provider of aggregation services, called Finicity, to serve as a facade API replacement (which means the API interface of Finicity is made to match the existing Intuity API, so developers won’t need to rewrite their code base), although Winterberg questions whether Finicity is large enough and stable enough to be relied upon. However, Finicity notably is also the company that powers some other popular account-aggregation-driven programs, including the popular budgeting application Mvelopes and a little-discussed (but high-complaint-volume) financial advisor coaching service called Money4Life Coaching. Ultimately, it remains to be seen whether developers will really be willing to make the transition to Finicity, or switch to other API providers instead… but either way, expect to find that clients in the coming months need to reconnect and reauthorize any/all accounts if the Intuit API was being used to power their account aggregation in the past.
99% Of Networking Is A Waste Of Time (Greg McKeown, Harvard Business Review) – In most businesses, relationships are everything (and the world of financial advice is certainly no exception), and the traditional view is that “networking” is the way to build those relationships. To delve deeper, McKeown interviews venture capitalist and entrepreneur Rich Stromback, who is known as “Mr. Davos” because he’s become the unofficial expert on the party scene of the Davos World Economic Forum – and has become so well connected that Stromback has been asked to facilitate introductions between a Middle East Prince and some Fortune 500 CEOs, and the Vatican has called upon him to help negotiate “a peace treaty of sorts”. So what does this “king of networking” have to say about networking? Stromback’s tips include: don’t care about your first impression, and instead just focus on being yourself and let people discover you over time (and in fact, some research suggests we form a stronger bond with people who initially don’t like but come to appreciate later); 99% of any networking event is a waste of time, and in particular if you really want to maximize your networking time, skip the sessions at a networking event and focus on just meeting people; if you’re going to skip the sessions anyway, consider taking a nap from 4PM to 8PM, just to be certain you’re awake and refreshed for the evening, when the social interactions (and relationships and forming of personal bonds) really happen; don’t try to network (i.e., finding the most influential people in particular), and instead just try to put yourself into networking-rich areas/events/groups, and let the conversations flow; and while it’s important to focus on the relationship building when you’re at events, recognize that you don’t have to do it year-round, and it’s ok to take breaks and refresh.
The Letter Advisors Will Never Get From Their Clients’ Kids (Missy Pohlig, SEI Practically Speaking) – Written as a hypothetical letter from a Millennial child to her parents’ advisor (after they passed away), Pohlig highlights the areas that financial advisors often overlook when it comes to the children of their clients, including: it would be nice if you at least introduced yourself once (an email with a photo, a connection on LinkedIn, or even just a one-time meet-and-greet), particularly since it’s not hard to figure out where the kids will be as long as they’re still living at home with Mom and Dad(!); it would have been great to include the kids in the estate planning process, at least to just help them understand what the relevant documents are, what responsibilities would be on their plate, and at least at a high level what the plan will be (because it is a worry for the kids, acknowledged or not!); help the kids understand how their financial decisions impact their parents (i.e., do the kids really understand that choosing College B over College A could delay their parents’ retirement by several years? Is anyone having that conversation with the kids?); if there’s a family business, help to introduce the kids to the business, a transition that parents often struggle with, but if no one facilitates the introduction, an opportunity for a multi-generational family business is lost; and take the opportunity to demonstrate you’re a trustworthy resource, if only because Millennials have seen so much bad information about the financial services industry, they may assume you’re amongst the bad ones, unless you’ve taken the opportunity to connect and show that you’re not. Because ultimately, for advisors who can’t navigate this gap, they may be part of the statistics that 90% – 95% of kids fire their parents’ advisor after receiving their inheritance (though notably, whether it’s a good idea for retiree-centric advisors to pursue the children of their clients is still a debate unto itself!).
How Much Money Is Enough? (Ron Lieber, New York Times) – Raising financially responsible children entails finding the delicate balance between trying to give them “the best of everything” but not too much of anything that it spoils them. For families of limited means, the simple constraint of financial reality is their guide. But for those with above-average income and wealth, a different challenge emerges – how to craft an important yet entirely artificial line of “what is enough”, in a world where “we can’t afford it” isn’t a valid reason, but saying “yes” to everything the family can afford isn’t good, either. At the root of this question is figuring out “How Much Is Enough”, whether it’s getting kids a hoverboard instead of a bicycle, or how many (surprisingly expensive) sport/athletic opportunities to enroll them in. In a recent book entitled “Simple Money“, author Tim Maurer makes the case that the real issue is the tendency of some to not be satisfied by Enough – whatever it is – and to keep wanting More instead, perhaps because we’ve unwittingly surrounded ourselves with others who have More, creating a desire to pursue as well. With kids, though, the desires are at least often more specific and concrete, and accordingly Lieber suggests the family could sit down and actually go through the categories of spending and set their own line on what is enough – whether it’s basic rubber rain boots from Target or fancier ones, and whether you’d allow them to use their allowance to pay the difference for the higher-end version if they wanted. Second, consider going through the exercise of forcing children to wait, even if it’s something you’ll ultimately approve, both because it helps them to better distinguish between what’s really a need versus just a want, and because it teaches a good habit of delaying gratification and avoiding impulse buying. In fact, ultimately the real goal may not even be setting the limits, per se, but having conversations with the children about those limits, as that’s ultimately what creates the opportunity to use decisions about money to teach the real values we want to instill in our children.
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.