Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the interesting announcement that LPL (the country's largest independent broker-dealer and 5th largest RIA custodian) is going to partner with BlackRock to offer its FutureAdvisor "robo" platform to advisors (but, notably, using LPL's model portfolios!). Also in the 'recent news' this week is a good recap of where the DoL fiduciary rule stands, now that it's been issued, and the experts are starting to digest and interpret its finer points.
From there, we have a number of technical financial planning articles this week, including a discussion of the looming "final countdown" for the Social Security file-and-suspend strategy, a research study suggesting that "low vol" equities can improve safe withdrawal rates, an analysis of whether it's better to use fixed or inflation-adjusting annuities for guaranteed retirement income, a look at how the IRA prohibited transaction rules work and what to avoid, an examination of how even "buy-and-hold" investors can take advantage of basic momentum strategies, and a discussion of why the popular "stock buybacks are propping up the stock market" view isn't an accurate reflection of how markets set stock prices.
We wrap up with three interesting articles: the first looks at how you need to handle team meetings a bit differently if you're working with your team "virtually" and not in-person; the second takes a dive into the growing recognition that differences in income are associated with significant differences in life expectancy, but why income inequality itself may not be the direct cause; and the last is a good reminder that being able to generate alpha in a portfolio is about more than "just" being able to predict future trends (as difficult as that already is), but also being able to know what expectations are about those trends (which is even harder), and also predicting what the attitudes about those future trends will be in the future (which is nearly impossible)!
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, which this week includes coverage of the LPL deal with BlackRock's FutureAdvisor platform, a new integration between risk tolerance software Riskalyze and financial planning software Advizr, and the Facebook announcement of "messenger bots" and how they may ultimately impact the world of financial advisors.
Enjoy the "light" reading!
Weekend reading for April 16th/17th:
LPL Unveils BlackRock’s FutureAdvisor As Its Robo Partner, With LPL Model Portfolios (Lisa Shidler, RIABiz) – This week, LPL announced a partnership with FutureAdvisor, the “robo-advisor” platform acquired by BlackRock last year to be made available as a solution for advisors. The deal marks the first large RIA custodian arrangement (while LPL is known primarily as an independent broker-dealer, it’s also the 5th largest RIA custodian as well), though notably with BlackRock’s acquisition, and the fact that FutureAdvisor was built to be more flexible to privately white label (not built on the Apex Clearing platform like most other robo-advisors), more deals are expected soon (and recent partnerships with broker-dealer RBC and bank BBVA Compass have also been recently announced). The FutureAdvisor offering itself will be accessible through a (presumably standalone) web portal, and also will be integrated to LPL’s custodial platform, though it remains to be seen whether LPL advisors can actually drive investors to their websites to use the robo-platform in the first place. Also notable is the fact that LPL mentioned in its announcement that the FutureAdvisor software will use LPL’s model portfolios – not the existing FutureAdvisor portfolios – though it’s not yet clear what funds or ETFs will be included in these model portfolios, and whether BlackRock products will be featured or not. (Michael’s note: To the extent that BlackRock clearly acquired FutureAdvisor as a distribution channel for iShares ETFs, it would be very surprising to not see iShares in the final LPL models; in fact, it’s possible and I suspect even likely that BlackRock is offering FutureAdvisor “for free” to institutions that are willing to use iShares in the model portfolios that the FutureAdvisor technology manages.)
Tweaks To Final DoL Fiduciary Rule Help Ease Implementation Without Sacrificing Core Principles (Blaine Aikin, Investment News) – While there have been many “DoL fiduciary explainer” articles recently (including a lengthy one here on Nerd’s Eye View earlier this week), this article does the best job of concisely explaining each and all the key points for advisors, including what changed from the original ‘proposal’ to the final rule itself. Aikin notes that the biggest change is the DoL’s change to what constitutes a “fiduciary” in the first place, eliminating a 40+ year old 5-part fiduciary test that was rife with loopholes that had allowed most to avoid being subject to a fiduciary duty. Under the new rules, virtually everyone who provides investment advice for compensation in the retirement space will be fiduciaries, where advice includes both recommendations about what to buy/hold/sell in retirement accounts, whether to roll over a retirement account, how to invest after a rollover event, or the selection of portfolio composition or investment managers. Other key items include: the DoL did clarify a range of “non-fiduciary communications” which include counterparty transactions, platform provider services, swap transactions, recommendations by employees of plan sponsors, and investment education; the three-way Best Interests Contract (BIC) between advisor, client, and firm, was simplified to a two-way contract between the client and firm, and doesn’t have to be signed until the implementation phase (though prior recommendations leading up to implementation are still subject to fiduciary scrutiny); proprietary products remain permitted, along with commission-based products, albeit still subject to a fiduciary best-interests standard on the recommendation (and may ultimately at least somewhat limit the use of both); and there’s a new category of “level fee fiduciaries” who will be exempt from many of the most arduous provisions and requirements of the new rules, though still required to act in their clients’ best interests.
The File And Suspend Countdown (Mary Beth Franklin, Investment News) – At the end of the month, on April 30th, new Social Security rules kick in for those who are interested in the popular File-And-Suspend claiming strategy, which will render the strategy effectively dead. Those who are at least full retirement age of 66 by April 29th can still get in under the old rules, though, and as a result advisors should review with any eligible clients whether they do wish to file-and-suspend by the deadline. Scenarios that may be relevant include where a spouse or dependent child would currently be eligible for spousal or family benefits (but otherwise aren’t entitled until/unless the primary worker does that file-and-suspend), or for those single individuals who want to file and suspend just to have the option to reinstate them by age 70 if there’s a change in health and they no longer wish to have delayed after all. After the deadline, though, anyone who files and suspends will lose access to the reinstatement option, and spouses and dependents won’t be entitled to benefits based on the earnings record of someone who suspended. Notably, though, voluntary suspension may still remain relevant in some scenarios where people started benefits and just want to stop – but it will no longer be a valid technique specifically to “turn on” spousal and dependent benefits anymore. And of course, bear in mind that the deadline is a moot point for those who have already begun to claim their benefits, anyway!
Improving Withdrawal Rates In A Low-Yield World (Andrew Miller, Journal of Financial Planning) – While prior research has shown a 4% initial withdrawal rate from a 50/50 stock/bond portfolio is “safe” (a 0%-5% failure rate in historical simulations, depending on the bond index used), some recent research has suggested that in today’s low-real-return environment, the safe withdrawal rate may have to be even lower going forward. Given that these reduced outcomes are driven heavily by the current low-bond-yield environment, but that reduced bond (and increasing stock) exposure introduces other risks, Miller suggests an alternative of constructing a portfolio with a higher allocation to “low volatility” stocks. By doing so, the investor can reduce exposure to low-yield bonds and boost equities to roughly 70%, without increasing the overall standard deviation of the portfolio. Using this type of portfolio in a forward-looking Monte Carlo analysis, Miller then found that a 70%-equity low-vol stock allocation did in fact provide superior safe withdrawal rates and lower failure rates than a 50% “normal” stock allocation, in an otherwise low-return environment. In other words, to the extent that the failure of retirement portfolios is driven heavily by sequence of return risk where a volatile portfolio has a poorly timed “bad decade” of returns, adding in low-volatility stocks introduces a means to gain access to the equity risk premium (and higher safe withdrawal rates) without exacerbating sequence risk itself (thanks to the lower volatility).
Using Fixed SPIAs And Investments To Create An Inflation-Adjusted Income Stream (Luke Delorme, Advisor Perspectives) – While much research has shown virtues to creating some form of ‘guaranteed income’ floor, relatively little has dug in depth to whether it’s better to create that income floor with an inflation-adjusting single premium immediate annuity (SPIA), versus using a fixed SPIA and then tapping the portfolio to cover inflation adjustments along the way. The issue is especially challenging given some concerns raised by other researchers, including most notably Wade Pfau, that inflation-adjusted SPIAs may not be priced as competitively as they should be (i.e., their actual payouts from available products aren’t as good as what research models suggest the products could support). Delorme analyzes the situation by looking at actual annuity quotes from available products – SPIAs of both the inflation-adjusted and fixed variety – and comparing how well the price difference between a fixed and inflation-adjusted SPIA could be invested to hedge against the inflation adjustments that the fixed SPIA lacks. Ultimately, the study found that for most retirements, it is feasible to ‘invest the difference’ to handle inflation adjustments, but that in long-lived (or especially high inflation) scenarios, the inflation-adjusting SPIA is still superior, implying that investors should view using an inflation-adjusting SPIA as a risk/return trade-off and that risk-averse investors would be better to skip the fixed SPIA.
Prohibited Transactions Are Death Knell For Individual Retirement Accounts (Michael Jones, Wealth Management) – One of the biggest caveats of investing dollars in an IRA is the so-called “prohibited transaction” rules, which if violated can cause the entire IRA to be disqualified (losing its tax-deferral status). The prohibited transaction rules have become a focal point for those who try to put an operating business into an IRA, especially one in which the IRA owner wishes to take an active role. The recent Tax Court case of Thiessen provides an illustrative example – where a retiree took a rollover from his 401(k) plan, used the proceeds to buy a local business (a metal fabrication business), which was accomplished with a combination of a direct purchase of the business assets and a loan used to finance the transaction (for which the Thiessens provided a personal guarantee). However, since lending money between the IRA and a “disqualified person” (which includes the IRA owner) is a prohibited transaction, the personal guarantee of the IRA’s loan was deemed an indirect extension of credit from them to their IRA and caused the IRA to be disqualified. And furthermore, since the Thiessens had never reported the transaction as a loan in the first place, the Court viewed that the statute of limitations hadn’t run, and that the Thiessens were still liable. And notably, even if the transaction itself had survived, subsequent compensation from the business to the Thiessens would have likely caused yet another prohibited transaction later, anyway!
Momentum For Buy-And-Hold Investors (Gary Antonacci, Dual Momentum) – For many advisors, the thought of trying to "time the market" by going in/out of stocks is unrealistic (or downright dangerous), but Antonacci suggests that even for advisors (and their clients) who will remain fully invested into equities, there are still opportunities to rotate amongst equities to take advantage of the fact that certain equity asset classes tend to exhibit momentum (persistent trends to outperform for multi-year periods of time). For instance, a relatively simple strategy of just shifting equities between US and foreign stocks (either the S&P 500, or the MSCI All-Country World Index ex-US) by reallocating every month based on whichever one has had the better trailing 12-month performance produces a significantly higher return (approximately 300bps higher) over the past 35 years. Notably, such momentum following does entail slightly more volatility as well, though it's primarily upside volatility, and the portfolio's Sharpe ratio actually improves with the momentum strategy. In addition, the reality is that because US-vs-foreign momentum trends tend to persist for very long periods of time, the strategy actually has rather few trades - foreign outperformed from 1975 to 1990, then US stocks won for a full decade, then foreign did better for 3 years, then foreign for another 6 years, etc. Notably, some may question whether the strategy will be as effective in the future, given that large firms are increasingly global in their corporate profits, but Antonacci notes that in reality the biggest driver of US vs foreign outperformance is not US-vs-foreign profitability anyway, but instead is driven by shifts in the U.S. dollar, as U.S. stocks tend to outperform when the dollar is strong and languish when the dollar is weak. Which means in reality, this kind of momentum trade is simply a way to invest in the positive or negative momentum of the dollar in a very inexpensive manner. Notably, this strategy can be further boosted by introducing a value tilt as well, and the widespread availability of ETFs to implement this with broad-based indexes (rather than with individual stocks) drastically reduces any transaction costs (especially bid/ask spreads) along the way.
Myth Busting: Stock Buybacks Aren’t Propping Up The Stock Market (Cullen Roche, Pragmatic Capitalism) – There’s a popular discussion in today’s marketplace that “stock buybacks are helping to prop up the bull market”, because of the record flows from corporations that are being allocated back into stock buybacks. However, Roche notes that the “flows” of money are not actually the driver of financial asset prices, they’re simply a marker of what dollars are flowing through. For instance, the fact that real estate in your neighborhood is changing hands frequently, or not, isn’t actually the determinant of whether home prices are going up or down; instead, the driver is the eagerness of the investors to pay more (or not), rather than the mere volume of flows. In fact, Roche points out that pace of buybacks is more of an outcome itself than a driver; corporations are buying back shares because their profits are at near record levels, which gives them high cash flows to deploy, and stock prices are high because those record profit levels are driving high expectations of future profits, too. Which means that strong stock markets are associated with strong buyback activity (and that a weak stock market would be associated with declining buyback activity), but not because the buybacks (or lack thereof) are driving stock prices, but because both are correlated to the overall economic health of the business. And in fact, when stock buybacks are viewed as a percentage of the corporate profits being reinvested, the flow of dollars isn’t even that high, and is still sitting at barely half the level of stock buyback activity that was occurring back at the prior peak in 2007! But the bottom line is simply to recognize that stock buybacks are “procyclical” (they rise and fall in line with the rise and fall of the stock market), but that today’s buyback activity has not been causative of stock prices rising, it’s merely an indicator that for companies already experiencing good profits in today’s environment, they’re choosing to return that capital to investors through buybacks, rather than via dividends or reinvesting into other endeavors, instead. So if you want to know what’s “propping up” the stock market, the answer is that it’s record corporate profits themselves, not the corporate buybacks those profits are funding.
What Everyone Should Know About Running Virtual Meetings (Paul Axtell, Harvard Business Review) – For decades, the work environment has been shifting to a more flexible one where the focus is not necessarily on time/hours in the office, but on whether the work itself is getting done. Yet this transition has created new pressures on how to create the necessary infrastructure for companies with a growing volume of sometimes-or-always-remote workers to stay connected and be productive. Accordingly, Axtell provides several recommendations of how to make the essential virtual team meeting more effective, including: allow time for relationship-building to happen, including opening up meeting lines 10 minutes early so people can chit-chat about their relationships and personal lives (and include a few minutes on the agenda for it as well), to replicate the kinds of relationship-building that ‘naturally’ happen when workers are in a physical office space together; be prepared with an agenda, which should be published in advance, and should include the topic, what needs to be discussed/accomplished, and how much time is allocated to it (with an allowance for 20% ‘extra’ time for everyone to weigh in!); be certain that everyone who needs to bring information to and contribute to the meeting knows what they need to come to the table with; be cognizant that you need to rotate the conversation around to all the participants, and call on them (by name), because the ‘normal’ non-verbal cues that facilitate in-person conversation don’t necessarily work in a virtual meeting; also, recognize that without the visual cues, it’s harder for people to process what’s being said, so key conversation points may need to be repeated (or add a step on the agenda specifically to confirm clarity about the decision being made); and don’t forget that when virtual team members are actually in town, it’s a good opportunity to (re-)connect in person, too!
The Rich Live Longer Everywhere, But For The Poor, Geography Matters (Neil Irwin & Quoctrung Bui, New York Times) – One of the emerging conversations of income inequality is the increasing volume of research showing that differences in income are associated with very material differences in life expectancy as well. A study in the Journal of the American Medical Association recently found that the gap in life expectancy between rich and poor widened from 2001 to 2014, and at this point men in the top 1% of income live an average of 15 years longer than those in the poorest 1% (for women, the gap is 10 years). And notably, another major new research study on the subject finds that these differences are accentuated by geography, particularly with respect to those at the lower end of the income scale; while the top 1% of earners have consistently long life expectancy regardless of where they live, for the poor there was significant differences in geography, where the bottom 5% of earners live an average of almost 5 years longer in the New York area versus Detroit. What this implies is that a material portion of the life expectancy gap across income levels may actually be a function of local public health policy, and not entirely a result of the income inequality itself. And notably, there’s little relationship between a region’s Medicare spending rate or health insurance coverage on life expectancy gaps, either; it appears the differences are specifically by behavioral factors that are more common in some areas than others. Thus, areas that have been more aggressive in providing everything from accessibility to vaccinations, to banning smoking in restaurants and workplaces, are seeing more material improvements in life expectancy for the poor and a small life expectancy gap across income levels, suggesting such public health policies may actually be far more effective than previously realized.
Performance Vs Outcomes (Morgan Housel, The Motley Fool) – One of the most interesting phenomena in the world of investing is that successfully picking what will do well requires not only predicting what may happen in the future, but also outpredicting what everyone else’s expectation of what the future will be as well. In other words, to be successful with investing, it’s not only necessary to predict what may happen in the future, but also to evaluate whether the rest of the market is already pricing in that same expectation, or not. For instance, we’ve long known that soda consumption is on the decline (for 12 years now), but Coca-Cola stock is at an all-time high, even as optimism about the growth potential of WalMart has proven true with net income tripling since 2000… but its stock is down 1.5% since then; similarly, Apple fans for years have been “right” about the company as its earned almost a quarter of a trillion dollars in profit since 2012… but its stock has barely budged, even as Amazon’s profits have rounded down to zero since 2012 but its stock has tripled as the markets just see more and more opportunity for the company going forward (even if it’s not profiting yet). What this reveals is that the further complication for investment outcomes is that in the future, stocks are then priced based on what future expectations are at that time – the future-future expectations! – which means it’s not only necessary to evaluate the future (which may be feasible for some who analyze the trends), and expectations about the future (which is harder but perhaps possible with today’s sentiment indicators), but what expectations about the future-future will be in the future… which has proven almost impossible (as noted in the examples above of Apple vs Amazon and Coca-Cola vs Walmart), and similarly who could possibly know what the mood of 7 billion investors will be in April of 2021, even though that may overwhelmingly determine where market levels will be by then. Ultimately, then, the reality is that when we try to go from just predicting trends of the future, to making investment decisions on that basis, we increasingly must recognize that we’re not just trying to predict the future, but are trying to predict future-future emotions and expectations, which is the real determinant of the outcome.
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!
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!
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