Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the news that the SEC has adopted a new ETF Rule 6c-11, adding new formal disclosure requirements about daily holdings, bid/ask spreads, and trading premiums or discounts... but also eliminating the requirement for all new ETFs to obtain costly and time-consuming exemptive relief to be launched, which is anticipated to even further accelerate the pace of new ETF launches in the coming years (though inverse and leveraged ETFs, and non-transparent 'active' ETFs, will still remain with the slower high-scrutiny exemptive relief process).
Also in the news this week is a new joint initiative from the Foundation for Financial Planning along with the CFP Board, FPA, and NAPFA, to promote pro bono financial planning services, and notable internal compliance review underway at Merrill Lynch on advisors who are using Merrill's home-office-created model portfolios, which happen to be the same as the portfolios offered directly to consumers in their Guided Investing and broker-facilitated Merrill Edge programs, and create an interesting microcosm of the challenge for advisors to justify exactly what value they're providing over and above what a direct-to-consumer offering provides (especially when it's your firm providing the side-by-side offering).
From there, we have a few more investment-related articles, including a look at the recent turmoil in interbank lending and the overnight repo market that may be signaling the end of banking excess reserves fueling economic growth, a discussion of the new "FedNow" system being developed to facilitate truly "instant" bank-to-bank payments (which may entirely eliminate overdraft fees, payday lending, and check-cashing services in the coming decade), and an early warning for mutual fund holders that a 10-year bull market coupled with rising outflows from mutual funds (as investors increasingly shift towards ETFs) could trigger very sizable mutual fund capital gains distributions in 2019 (far beyond what the funds themselves have appreciated this year).
We also have a number of articles on health insurance, including one that finds Affordable Care Act (ACA) marketplace plans may finally be "stabilizing" with premium increases slowing and some insurers increasing their options and competing in more state markets, a study that finds overall health insurance costs continue to march higher in the employer marketplace (with family coverage up 5% in 2019, leading the total cost of coverage for family plans for employers to top $20,000 in 2019), and a look at some of the behavioral finance research about why people have such difficulty choosing the right health insurance plan even when one is 'clearly' dominant (a combination of complex math, overwhelming choices, and a strong aversion to deductibles even when they may be cost effective).
We wrap up with three interesting articles, all around the theme of what motivates advisors themselves: the first looks at a recent Financial Planning Review study finding that women who have entered the profession find more career satisfaction going independent than working in large corporate environments; the second explores a new Morningstar study around practice management and the conflict between advisors who started firms because they want to serve their clients but have trouble finding and attracting them; and the last exploring the importance of avoiding peer pressure, including as a financial advisor, and creating the firm that is most fulfilling to you personally (and not just what the "industry says" you should be building towards).
Enjoy the 'light' reading!
SEC Passes Landmark 'ETF Rule' (Lara Crigger, ETF.com) - This week, the SEC announced it will adopt a new Rule 6c-11, providing a broad update to the regulatory framework for both how ETFs are established upfront and then how they operate on an ongoing basis. The biggest shift is the elimination of what has been a multi-decade requirement that ETF issues file with the SEC to get special permission ("exemptive relief") to avoid certain provisions of the Investment Company Act of 1940 for standard-issue ETFs, which in practice costs tens or even hundreds of thousands of dollars, a delay of 3-6 months, and created confusion because the SEC hadn't even been consistent over time in what was permitted (or not). On the other hand, the new ETF Rule will increase the obligation on ETFs for a number of disclosure requirements, including that providers publish their daily portfolio holdings on their websites, along with historical information regarding premiums and discounts and bid/ask spreads for their ETFs. ETF providers will also now be permitted to use "custom baskets", which are creation/redemption baskets that do not reflect a proportional representation of their portfolio (as long as the issuers publish written policies and procedures showing how the custom baskets are in investors' best interests), and which in practice are typically used to adjust portfolio holdings more efficiently (e.g., spreading out the impact of big changes, and/or minimizing capital gains from forced turnover). The new ETF rule will initially go into effect 60 days after it is published in the Federal Register, but will provide a one-year transition period for issuers to bring up their policies, procedures, and disclosures to full compliance. Notably, though, the new ETF Rule will permit fund-of-fund ETFs but not master-feeder ETFs that were commonly used by hedge funds to accrue investor capital (although some existing master-feeder ETFs will be grandfathered in, even though in practice they weren't very popular). In addition, the new ETF rule will not apply to leveraged or inverse ETFs, nor ETFs structured as a share class of a multi-class fund (i.e., the Vanguard model), nor the new nontransparent active ETF structures now coming to market, which will still have to pursue individualized exemptive relief with the SEC to be established going forward.
Leading Financial Planning Organizations Agree To Promote Pro Bono Work (Geoffrey Brown, Jon Dauphiné, Kevin Keller and Lauren Schadle, Investment News) - Earlier this year, the Foundation for Financial Planning (the leading charitable organization specifically devoted to providing pro bono financial planning services to people in need) convened its first "Nonprofit CEO Summit on Pro Bono Financial Planning", including the leadership of the CFP Board, the FPA, and NAPFA, in an attempt to drive forward the delivery of pro bono financial planning. Recognizing that one of the key hallmarks of a true profession is the willingness of practitioners to donate their skills to the underserved who otherwise can't access them, a joint resolution of the organizations stipulates a number of key pledges going forward, including: developing a shared definition of what "pro bono" really is (which the Foundation defines as "free, no-strings-attached financial advice and planning for underserved people, including low-income individuals and families, military personnel and veterans, domestic violence survivors, and people affected by natural disasters, serious medical crises and bankruptcy, that's provided by or in conjunction with a volunteer CFP professional), which may be delivered one-on-one or through interactive group sessions; gathering and sharing relevant data about the prevalence of pro bono work (as the CFP Board and FPA now ask CFP professionals to voluntarily track their pro bono hours as they renew their certification or membership); encouraging CFP professionals to volunteer their time and talents, supported by the new "pro bono volunteer training" initiative jointly launched last year by the Foundation and the FPA, FPA providing members free pro bono errors & omissions insurance, and NAPFA's introduction of "pro bono services" as an option for its CE program beginning in 2020; developing more opportunities for volunteer CFP professionals to serve others (building on the success of its Pro Bono for Cancer Initiative, the Foundation is now working on an online volunteer-matching function to connect volunteers with pro bono programs); expanding the reach of pro bono engagement to both "CFP Board Emeritus" members (retired CFP professionals) and next generation CFP professionals; recognizing pro bono work as being important to the profession, which will include a new joint FPA and Foundation "Power of Financial Planning Award" to recognize outstanding pro bono contributions of an FPA chapter, and NAPFA's ongoing recognition of extraordinary member pro bono achievements; and fostering ongoing dialogue to spur pro bono growth amongst CFP professionals going forward.
Merrill Scrutinizes Managed Portfolio Account Fees (Mason Braswell, Advisor Hub) - An internal compliance review at Merrill Lynch Wealth Management has kicked off concerns that their advisors may have certain client advisory accounts terminated or moved to other parts of the organization. The core issue is that certain Merrill advisors have been opting to use models that are centrally created and managed by Merrill's Chief Investment Office (particularly focused on ESG themes), but the models are also available through Merrill's "Guided Investing" robo-advisor platform, or via a Merrill Edge broker. However, that means the client effectively gets the same portfolio for either 0.45% through Guided Investing, or for 0.85% with a Merrill Edge broker... raising concerns about what exactly the Merrill Lynch Wealth Management advisors are doing to justify their own advisory fee schedule that often starts at 1.25% or more. Notably, the issue is not necessarily that a full-service human advisor cannot charge more for their services, but that when a large financial services firm like Merrill specifically offers a model in both a self-directed robo (Guided Investing) and broker-facilitated (Merrill Edge) option, it's imperative that the advisor be able to show exactly what ongoing advice they're providing to clients to justify the higher fee. Nonetheless, that means the pressure is now on any Merrill advisors using the home office portfolios to explicitly justify what ongoing services (e.g., financial planning, portfolio customization, etc.) they're providing over and above what Merrill is offering to consumers directly without their Private Wealth advisory services. Which arguably is a reality of the marketplace regardless - that human advisors must justify what they're doing to justify their fees over and above what a robo or broker-facilitated solution offers - but is drawn into sharp relief when Merrill creates such unified home office portfolios across their Guided Investing, Merrill Edge, and Wealth Management solutions that it becomes an internal compliance issue to ensure their advisors really are delivering above and beyond what Merrill's own direct-to-consumer solutions provide.
Understanding The Great Repo Fiasco (Michael Lebowitz, Advisor Perspectives) - Last Monday, a highly unusual situation occurred in the overnight repurchase agreement (repo) funding market... banks were unwilling (or unable?) to lend on a collateralized basis to other banks overnight, even with the promise of large 'risk-free' profits. The situation is the equivalent of approaching a friend you think is wealthy, and asking to borrow $10,000 for one night, offering collateral to your 2019 Lexus in the driveway along with an interest rate that is 5% above what the friend is already earning, and your friend says "no"... which immediately raises the concern about whether the friend is really as wealthy (and liquid) as you once believed. In point of fact, such overnight repurchase transactions amongst banks are so common - part of the "lubrication" that facilitates the smooth operation of the banking system - that they're rarely even noted in the marketplace. Yet on Monday September 16th, the overnight "General Collateral" (GC) repo market traded as high as 8% (or almost 6% above the Federal funds rate, when the spread is normally just 0.025%, the equivalent of a 42 standard deviation event!), raising concerns of both why some banks were so desperate to get overnight cash that they were willing to pay a nearly 5.5% premium on the normal overnight rate, and also why no other banks were willing to take them up on the lucrative offer. The apparent culprit may lie in the dynamics of the Fed slowly trying to unwind its Quantitative Easing (QE), which originally led the Federal Reserve to start paying banks to hold 'excess reserves' (above what is normally required) during the financial crisis, and then led the Fed to pay an additional "Interest On Excess Reserves" (IOER) to ensure that banks didn't deploy their excess reserves too quickly (which could stoke inflationary pressures) after the financial crisis settled. Yet as "Quantitative Tightening" (QT) has begun, and excess reserves are now (slowly) beginning to decline... and as it turns out, the amount of truly excess reserves may actually be approaching zero, such that suddenly the overnight repo market was far less liquid than anticipated. Notably, the Federal Reserve still has the option to lend its own Fed funds into the overnight market - which it has begun to do since September 17th after the initial disruption - and consequently, the elimination of excess reserves may simply revert overnight cash markets back to how they worked prior to the financial crisis. On the other hand, it also signals that whatever stimulus may have been provided for the past decade by excess reserves in the banking system is now finally gone... which in turn raises questions about whether the economy may begin to tighten from here (at least unless the Fed resumes QE activity again)?
The Fed Is Going To Revamp How Americans Pay For Things (Mike Orcutt, MIT Technology Review) - Last month, the Federal Reserve announced that it is going to create a new payment system called "FedNow", that will allow real-time bank-to-bank payments, all day every day (as contrasted with the current system that closes on weekends and can take several days to settle payments). The Fed's announcement was concerning to the existing commercial bank system, which has been working on its own updated Clearing House system that would have to face direct government competition from the Fed, but the Fed indicated that because Clearing House has been slow to reach smaller banks, the FedNow system became necessary to ensure accessibility to all banks regardless of size (which the Fed is uniquely positioned to do because of the connections it already maintains directly with banks across the country). Ultimately, the significance of a new clearing system - whether the commercial Clearing House, or the Fed's FedNow offering - is that it creates the immediate access to cash transfers, which in turn could also reduce or eliminate most overdraft fees, payday lending, and check-cashing services. And in point of fact, such instant-payment systems are already up and running in a number of other countries around the world (e.g., Alibaba and Tencent in China), and Facebook's Libra digital currency project is itself another form of trying to facilitate instant payments. Though ultimately, given the complexity involved, the Fed has indicated that its own system still isn't likely to launch until 2023 or 2024.
An Early Warning On Capital Gains Tax Distributions (Russel Kinnel, Morningstar) - As assets continue to bleed out of many actively managed mutual funds, which themselves are 10+ years into an ongoing bull market, there is an increasingly looming potential that a wide range of mutual funds will end out with very sizable capital gains distributions at the end of 2019 (far in excess of just the growth in 2019 markets). Notably, the phenomenon has already been emerging for the past several years; for instance, in 2017, Hennessy Focus fund paid out half a penny in capital gains (on a NAV of $87.76), but in 2018 it paid out $14.47 per year (on an NAV of just $67.71), despite the fact that the fund was up almost 20% in 2016 and down over 10% in 2018... because the fund experienced a substantial $792M of outflows from a base that started the year at 'just' $2.8B (triggering capital gains as nearly 25% of the fund was forced to be liquidated by redemptions throughout the year). In other words, in practice, the key trigger for large capital gains distributions isn't 'just' that a fund has sizable gains (which many do after the extended bull market), but the forced liquidation of those gains when the fund experiences net outflows (as many have). Accordingly, Kinnel raises the concern for a number of mutual funds in particular, that have a combination of significant year-to-date outflows, and large embedded potential capital gains exposure, including Davis New York Venture (NYVTX), Victory Munder Mid-Cap Core (MGOTX), and USAA International (USIFX). Of course, for long-term investors facing sizable capital gains, the reality is that selling the fund now just further accelerates the capital gains and doesn't necessarily help to avoid the situation. But it means it's important to be especially cautious with any end-of-year purchases of mutual funds, that could promptly deliver sizable capital gains attributable to prior investors just weeks after a new client buys in.
Health Insurers Set To Expand Offerings Under The ACA (Anna Wilde Mathews, The Wall Street Journal) - While the overall individual insurance market has shrunk (from 18.8M in Q1 of 2015 to just 13.7M in Q1 of 2019), the marketplace for individual insurance plans under the Affordable Care Act (ACA) has finally turned profitable for insurers, which is leading to an expansion in health insurance offerings in the coming year as more competitors (re-)enter or expand their markets. For instance, Cigna, Bright Health, Molina, and Centene (the biggest seller of ACA plans) are planning larger footprints in the individual health insurance market next year, as is newer health insurance technology upstart Oscar Insurance. Similarly, premium increases in 2020 thus far appear to be moderate in many markets, after rates were relatively flat or even down this year, signaling an overall 'stabilization' of the health insurance marketplace. And notably, the new insurance offerings appear to be especially targeted in areas that have had little competition - and thus, literally, are 'ripe' for price competition from new entrants - though the elimination of the individual plan enrollment penalty may still be contributing to a decrease in overall participation (along with a greater push for individuals to gain access through employers just to avoid the ACA marketplace plans in some states, and just the sheer cost of individual health insurance which is unaffordable for many). Ultimately, though, it may take actual (and sustained) growth in the ACA marketplace to draw in more large national insurers (as UnitedHealth, Aetna, and Humana all stated they have no plans to introduce or expand their ACA plans in 2020), many of which reportedly have decided to stay focused on the employer group segment instead, where they anticipate more growth opportunities.
Cost Of Employer-Provided Health Coverage Passes $20,000 Per Year (Anna Wilde Mathews, The Wall Street Journal) - According to a new survey from the Kaiser Family Foundation, the average cost for an employer-provided family health insurance plan in 2019 has surpassed $20,000/year, clocking in at $20,576 (a 5% increase from 2018), with employers bearing, on average, 71% of the cost. The milestone threshold is significant, with some equating it to the equivalent of 'buying an economy car' over and over again every year. And while employees don't typically bear all of the cost, the relative percentage that employers pay has continued to drop, such that while overall costs were up 5% last year, the employee-paid portion grew an average of 8% (to $6,015). And of course, the growth in health insurance coverage costs overall continue to outstrip the overall average increase in inflation (and the average increase in employee wages), effectively squeezing workers (despite a low unemployment rate that might otherwise encourage companies to sweeten benefits to compete for talent). In fact, the pressure of health insurance costs is now making health care affordability a top voter issue, especially since consumers struggle with not only the cost of premiums themselves, but also the impact of high deductibles, copays, and the cost of prescription drugs. Though the best path forward from here still remains an open debate, with some advocating for a "Medicare For All" approach, and others advocating for maintaining the private market with perhaps an option to let people choose to buy into the public Medicare program instead. The real concern and question, though, is why costs continue to rise, especially since a recent Health Care Cost Institute found that health care utilization declined by 0.2% from 2013 to 2017... even as average prices increased by 17.1%.
Why So Many People Choose The Wrong Health Plans (Richard Thaler, The New York Times) - If only because the effort it takes to evaluate the alternatives can be time-consuming, many people simply stick with their existing health insurance coverage every year when the annual enrollment process occurs. But as Thaler notes, a surprising number of people make inefficient decisions about their health plans - not simply by failing to evaluate some of the trade-offs based on personal preferences for doctors, premiums, and deductibles, but by outright failing to select the 'dominant' plan that may actually be better across the board. The especially problematic scenario is for those who are healthy and have low ongoing medical costs, but who choose high-premium low-deductible health insurance plans even though they wouldn't have incurred higher out-of-pocket costs with a higher deductible plan (because they didn't incur enough expenses to even reach the lower deductible anyway)... which means they simply outright give up on the opportunity for lower premiums. And sometimes there's even a 'premium' on low-deductible plans, such that choosing a higher deductible plan would be cheaper even if the individual hit the higher deductible. Yet one recent study found that even when a more dominant plan is available (i.e., one that is better at every level of spending and outcome), only 11% of people switched to the superior plan. Why? The problem appears to be that the breadth of choices available has become especially overwhelming, which when coupled with the complexity of the math (with so many moving parts), and a general aversion of deductibles, leads inertia to set in and most people just don't switch once settled into a plan, even if it's inferior to subsequent new offerings. For which Thaler suggests employers can themselves couple higher deductible health insurance to contributions to an employee's HSA, which may save on overall costs, while effectively eliminating the employee's aversion to deductibles by funding the deductible from the employer directly to the HSA in the first place.
Study Shows Women Financial Advisors Are Much Happier At Solo Practices Rather Than Large Firms? (Equita Financial Network) - In a recent study in Financial Planning Review aptly titled "Success and satisfaction of women in financial planning", researchers found that women who had entered financial planning were equivalent or better than men with respect to education, experience, and CFP certification... but had materially higher professional career satisfaction when working for a solo practice over a large firm. The researchers hypothesize that the reason may be limitations on women getting higher salary or promotions (extrinsic components of career success) at large firms, and consequently are opting for the personal happiness and growth (intrinsic motivators of success) at smaller firms, in addition to the ability to control their fees and what they charge (effectively ensuring that they are able to charge what they believe they are worth). Notably, the researchers also found that women in the sample became financial planners in the first place largely out of a motivation to help people, enjoyment from being in the profession, a desire to grow professionally, and a desire to work independently... with a particular emphasis on how women (more so than men) appear to be drawn to financial planning for the opportunity of independence (relative to the dissatisfaction of a corporate environment). Ultimately, the research has implications on how the profession might improve the gender ratio of CFP professionals, which has remained stubbornly at 23% for more than a decade... but at a minimum, it provides an interesting reflection on the paths that women are taking as financial planners having already entered the profession.
What Advisors Want To Achieve (Erik Johnson, Morningstar) - Earlier this year, Morningstar launched a new Advisor Insights Survey on practice management, with a goal of going beyond just basic business metrics, to delve more directly into the challenges advisory firms face (from client acquisition to relationship management to succession planning). Overall, the study found that advisors tend to focus on a very direct link between having an impact on their clients' lives, and building a successful business for themselves, with "the impact I have on clients' lives" as the most common motivator (followed by "I enjoy working directly with clients" in the relationship aspects of the business), and the most common business priorities as growing the business with more clients and retaining clients (while, notably, selling the business or succession planning were amongst the lowest priorities). In terms of what's limiting firms from achieving their goals, though, the study found that the biggest inhibitor was not adding advisors to the practice, but simply acquiring new clients in the first place (and the competition from other firms in an environment where it's increasingly hard to differentiate), when more and more clients already work with another advisor, or simply decide to manage money themselves. Of course, the reality is that many investors ultimately struggle to invest effectively for themselves in the end, but often don't realize the problem until after the fact, for which Morningstar suggests stronger training on effective communication with clients about how to help them understand upfront the behavioral challenges they may face in the future (with the caveat that so few investors believe they're 'below average' in the first place, it's often hard to convince them).
Do Advisors Cave To Peer Pressure? (Carolyn McClanahan, Financial Planning) - When it comes to providing financial planning recommendations to clients that will actually be implemented, one of the biggest sticking points can be the clients' existing 'money scripts' that create certain (not always healthy) habits around money that are hard to break. However, in some cases the issue is one of peer pressure, and the difficulty of resisting the social pressure from our friends and family to make certain money decisions, from co-workers (who make similar income) chiding about not living in a nicer house or driving a fancier car, to the person who wants to retire early not because they don't enjoy their work but because they burn out by trying too hard to work more and earn more to keep up with peers (even if they didn't actually need the money to achieve their original goals in the first place). And as McClanahan notes, the phenomenon isn't unique to clients of financial planners; it impacts us as advisors, too. For instance, there is a dominant narrative that "you must grow your practice to survive", or "you must hire a junior advisor for a succession plan" when in reality, huge swaths of advisors appear to be doing just fine as solo lifestyle firms. Similarly, it's often peer pressure that dictates to advisors you must be 'large' to be considered a good firm (even though technology is actually flattening competitive differences in capabilities). Which means in the end, just as clients themselves are advised, making the decision about the 'right' kind of practice is not about what other advisors with different goals and motivations say is important, but instead is all about your own personal motivations and goals for your firm.
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.
Why is the cost of employer provided health insurance rising? The question answers itself — employers have no business choosing health insurance benefits for their employees. If we change the tax incentives that promote employer sponsored coverage over individual/family coverage, we could open the door to gradual changes that will steadily remove employers from the economics of healthcare.
EconTalk: Ed Dolan on Employer-Sponsored Health Insurance