MEDIA REVIEWS – August 8-15, 2018

For the past few years, I’ve been sending out three Media Reviews messages a month, but that’s changing here.  Advisor Perspectives—the online service—has become a strong competitor to the other trade publications, and it’s time I reviewed some of its best content in a separate message.

In the past month, Larry Swedroe has been particularly prolific, with an article that looks at the potential problems with simply choosing ETFs and index funds based on their expense ratios, and two other articles that I think merit your attention, one on the historical performance of private real estate investments vs. publicly traded REITs, and on the (rather uneven, but otherwise consistent) historical performance of factor investing—and which factors to pay attention to.

I have no conflict of interest at all in pointing you to my excellent article reviewing four excellent books about different aspects of building a financial planning business, and Joe Tomlinson—one of my favorite thinkers in the financial planning space—offers an article that breaks with conventional wisdom, and suggests that the evidence that Americans are approaching a retirement savings crisis may not be as compelling as what you’re reading.

Altogether, there’s a lot of value here, and I’m happy to help you sort through it and get the key points and nuggets.

Have a great week.

“The Problem with Focusing on Expense Ratios”
by Larry Swedroe
Advisor Perspectives, August 9, 2018
Relevance: high

There’s a clear link between long-term performance and the cost of an investment, but when it comes to ETFs, the cost factors only tell part of the story.  Swedroe says you should consider other factors, such as trading costs, bid-offer spreads and market impact costs—where funds have to trade when stocks enter or leave the index, and active managers can front-run that trading.

Thus one passively-managed fund might suffer market impact costs, while structured portfolios from AQR, Bridgeway and Dimensional Fund Advisors accept random tracking error when they pursue patient trading strategies to minimize trading costs.  Swedroe also looks at how three different U.S. small value funds provide very different kinds of exposure—so you should probably look at that factor as well.  The Vanguard Small Value Admiral Shares invests in funds with an average market cap of $3.6 billion, while the Bridgeway Omni Small Value fund’s holdings have an average market cap of $800 million.   Bridgeway’s average price-to-book is 1.3, compared with Vanguard’s 1.8.

Another example is interval funds.  Swedroe compares Stone Ridge Alternative Lending Risk Premium Fund with RiverNorth Marketplace Lending.  Both invest in consumer, small business and student loans.  Stone Ridge’s fund has an expense ratio of 1.94%, but that is applied only to the investor assets, not to the roughly 28% leverage the fund uses.  The RiverNorth fund’s 1.50 expense ratio is imposed on the investor assets plus the leverage, so it is actually more expensive.  Also, the Stone Ridge fund is much larger, and therefore can negotiate better terms when it buys loans.

The point is not that you should avoid inexpensive funds, but once you get into the universe of inexpensive funds, you might want to drill down into the specifics.

“Four Books That Will Change Your Professional Life”
by Bob Veres
Advisor Perspectives, August 6, 2018
Relevance: unrated

The columnist offers brief reviews of four books he considers to be excellent, which provide value to a financial planner’s career.  Caleb Brown’s Successful Hiring for Financial Planners is your best resource for winning the ongoing recruiting contest for talent at your firm.  You see the interview process from the recruit’s perspective, and there’s a step-by-step guide to making your firm a more attractive location for the prospective new hire, and things to look for that will help you evaluate prospects.  Brown provides a detailed overview of typical compensation packages in different parts of the country, and a section where young planners, newly-hired, share candid assessments of their workplaces.

The most valuable part of the book may be the appendices, where you get a sample job description, template candidate rejection letter, sample interview agenda, an offer letter, a first-day training schedule and a template welcome letter.

Philip Palaveev’s G2: Building the Next Generation takes up where Successful Hiring leaves off: it provides a detailed process for getting that new hire up-to-speed and up the career ladder at an accelerated rate, adding value to your firm at every rung.  There are admonitions: avoid promoting and advancing purely by seniority, because your star employees will expect to be moving up faster than those who are slower to master skills or are less motivated.  If you don’t give them preferential treatment, they’ll have no trouble finding employment elsewhere.

A chapter lists the characteristics of a lead advisor and how to get there, and also recommends that advisors give their young advisors client-facing responsibilities sooner rather than later.  Palaveev even addresses the complaint that younger advisors don’t bring in business; he says that if the firm is generating leads and referrals, the actual closing process is simply exploring, in a face-to-face meeting with the prospect, where your firm can add value.  Once you find that, the prospect will inevitably become a client.

Speaking of marketing, in G2, Palaveev references the marketing research and advice of Steve Wershing, author of Stop Asking for Referrals.  The book provides insights into the actual referral dynamic; when friends ask your client for the name of a great restaurant, he or she doesn’t give out the name of one where the proprietor asked for referrals.  The referral is given based on perceived merit, and the client expects the friend or neighbor to have a great experience.  So instead of asking clients for referrals (or, worse, saying you get paid two ways…), provide a great experience, and then help the client articulate who you prefer to work with and what you do for those people.

The book includes a chapter devoted to helping you select your target niche, and how to get feedback from clients that helps you see what makes you unique.  At the end, you are speaking at local and national meetings where your target niche gathers, and written the definitive planning book for your niche.  Powerful stuff.

Finally, The Enduring Advisory Firm by Mark Tibergien and Kim Dellarocca debunks a bunch of common business myths in the profession (margins are getting squeezed; younger employees lack a work ethic, etc.), and then recommends that you define your “why”—the purpose of the firm and its mission to improve a certain type of client’s life.  Later chapters focus on how best to attract and serve women, mature clients, baby bookers, Gen X clients and Millennials.

Most importantly, The Enduring Advisory Firm provides guidance on how to transform a practice into a business, with a constant re-examination of workflow and process.  There’s a chapter on leadership, which is fundamentally about the behavior you exhibit if you do (or do not) live your personal values openly in the office, and personify the values of the firm.

The books are all compact and full of insights, and were written by masters in the profession.  They all come highly recommended.

“The Danger in Private Real Estate Investments”
by Larry Swedroe
Advisor Perspectives, August 2, 2018
Relevance: high

Should clients invest in private deals as an alternative to publicly-traded REITs?  Swedroe examines the evidence, in the form of a private investment database compiled by Cambridge Associates.  It contains historical performance of more than 2,000 fund managers, more than 7,300 funds, and the gross performance of more than 79,000 investments underlying venture capital, growth equity, buyout, subordinated capital and private equity energy funds. 

The database shows that for the 25-year period ending in 2017, private funds returned 7.6% a year, on average, while comparable REITs returned 10.9%.  The private investments were also taking on much more risk, in the form of leverage above 50% of the value of the underlying properties.  One research report summarized more than a dozen academic studies across various time periods, and all of them reached the same conclusion: REITs outperformed private deals.

“The Long-Term Track Record for Factor Investing”
by Larry Swedroe
Advisor Perspectives, August 2, 2018
Relevance: high

A study in a special 2017 issue of the Journal of Portfolio Management looked back over 100 years of market data across 23 countries, to determine which factors provided outperformance.   It found that, small cap stocks greatly outperformed large caps since 1926, and micro-cap stocks did best of all.  Returns for large caps were 9.7% a year, vs. 12.1% for small caps, and 12.7% for micro caps.  From 2000 through 2016, the size premium was positive in every country except Norway, and averaged 5.6% a year.  But it performed poorly over the previous 16 years; the world size premium lost an average of 2.7% a year from 1984 through 1999.

The value premium, meanwhile, was positive in 20 countries since 1926, negative in three, and averaged 2.1% a year.  But value stocks performed poorly during the booming 1990s. The value premium appears to be larger among small companies than among larger ones.

What about dividend yield?  In all 21 countries examined in the study, the average return premium for high dividend paying companies was 3.9% a year.  These higher-yield strategies were also less volatile than zero-yield portfolios, and earned a Sharpe ratio almost twice that of the low-yielding strategy.

Momentum?  Interestingly, the premium from momentum strategies tended to be persistent, pervasive, robust and it survived transaction costs.  It averaged 8.5% a year over the 22 countries included in the study.

Finally, volatility: low-beta securities vs. more volatile stocks.  The study showed that the highest-beta stocks underperformed dramatically, and the results hold up over a wide range of markets.

“Treasury Bonds are the Only Bonds You Need”
by Eric Hickman
Advisor Perspectives, July 30, 2018
Relevance: high

Well this is certainly different.  The author compares the long-term performance of the Bloomberg Barclays Aggregate Bond Index (composed of a mix of Treasury bonds, investment-grade corporates, mortgage-backed bonds and other asset-backed bonds) with the subset of Treasuries, measured by the Bloomberg Barclays U.S. Treasury Index.  Since 1976, as you would expect, the yield of the Treasury index has averaged 0.78% less than the whole index, due to the lack of default risk.

But here’s the interesting part: the long-term performance of the two indices is virtually the same: 7.14% a year, on average, for Treasuries, vs. 7.29% for the broader index.  There’s a graph that shows that the two track each other pretty closely over time.  The author says that this isn’t really surprising: corporates and other bonds offer a yield premium because they can default, and because their credit quality can degrade.  In an efficient market—and the close performance suggests that the markets are fairly efficient—the various defaults and degradations in credit quality would equal (and cancel out) the yield premium.

There’s one more interesting part: if you buy bonds so that they’ll do well when stocks perform the worst, Treasuries are actually better at this than the other bonds.  Again, this is not really surprising: when the economy is doing poorly, the credit spread will tend to widen, putting pressure on credit-bond performance precisely when stocks are performing poorly.  Another chart shows that during the ten biggest market downturns since the beginning of 1978, Treasuries outperformed the larger index.

The point of the article: why buy anything but Treasuries for portfolio ballast. Why get fancy when plain vanilla does the job better?

“The Liquidity Risk in Bond ETFs”
by Vitaliy Katsenelson
Advisor Perspectives, July 23, 2018
Relevance: high

If the previous article didn’t convince you, this one might: Katsenelson says his firm recently replaced all short-term bond ETFs with U.S. Treasury Bills, because of the risk that there will be a panic sell-off in the bond market at some point in the future, and there will be a mismatch in liquidity between bond ETFs and their underlying securities.

Yes, short-term corporate bonds are fairly liquid.  But theoretically, ETFs are absolutely so.  During a market scare, if investors were to sell ETFs at several times the average daily volume, the ETFs would be forced to sell the bonds they hold.  Supply might temporarily exceed demand, and the prices of bonds would drop—creating unexpected additional losses for remaining ETF holders.  Add to that the fact that Treasuries are now yielding 2%, giving higher yields than the bonds that Katsenelson’s firm sold.

“Do We Face a Retirement Crisis?”
by Joe Tomlinson
Advisor Perspectives, July 23, 2018
Relevance: high

Americans have not saved enough, and are going to be impoverished in retirement—you know that, right?  Only 50% of works participate in employer-sponsored retirement plans, and the median balance in tax-advantaged investment accounts is just $135,000.  Social Security estimates that 21% of married couples and 43% of single seniors rely on Social Security for 90% or more of their income.  The Center for Retirement Research at Boston College estimates that 50% of nonretired households are at risk of not being able to maintain their living standards in retirement—and when health care costs are taken into account, the outlook worsens.   A crisis, right? 

But the author is reading reports from a few experienced researchers which say that retirees are actually not doing as badly as reported.  Andrew Biggs of the American Enterprise Institute found that retires have not been depleting their wealth in retirement, and in fact have actually been increasing their wealth over the course of retirement.  Using data from the Survey of Consumer Finances, he looked at retirees that were 65-67 in 1989 and followed this cohort over time.  In the beginning, their median net worth was just $122,318 in 2013 dollars.  By 2007, it had risen to $247, 532.  After the financial crisis, their average net worth was still $202,400.

The point is that retirees seem to find a way to live off of the income they earn, often consisting mostly of Social Security benefits.  They are reluctant to spend down savings to meet lifestyle needs; they hold onto those funds throughout retirement.  The often-cited 70% retirement-income replacement ratio should probably be lowered to 50% for households with no mortgage and children out of the home.  But… at the end, Tomlinson cites studies showing that the percentage of retired families carrying mortgage and other forms of debt is increasing, and the average amounts of debt are increasing even faster.

The author, after sifting through all the data, has come to the view that we do not yet face a retirement crisis.  However, certain population cohorts—such as single women—may be in much worse shape than others.  Retirees seem to be more capable of downsizing their lifestyle than researchers have assumed in the past, but increasing debt loads are a future concern.