MEDIA REVIEWS – MARCH 24-31, 2019

Boy, there are a lot of good articles for you to review here, starting with Michael Kitces’ analysis of the Financial Planning Association’s botched attempt to quell rumors that it is being less-than-transparent with its financial condition—by producing numbers that conflict with audited financials from past years!  The new OneFPA Network initiative may be on its way to an ignominious retreat—unless the FPA simply concludes that it has the power to take away chapter autonomy by fiat, and that it is willing to risk the membership attrition that would surely follow.

Meanwhile, Chris Sidoni of Gibson Capital Management discusses ways to deal with clients who want to live off the income in their portfolios during retirement—and therefore demand that you create an income-generating rather than total return portfolio for them.  Ron Rhoades provides an eye-opening expose of how the brokerage industry’s trade organizations are conspiring with the SEC to destroy the financial planning profession—and he provides a dialogue that sounds eerily realistic based on recent hearings and the new Reg BI proposal.

Jeffrey Gundlach of DoubleLine Capital is worried about U.S. debt levels and recommends that investors go long emerging markets and short the dollar.  And MMT theorist Stephanie Kelton reviews Ray Dalio’s 3-volume analysis of 48 major debt crises around the world over the last 100 years, and finds some interesting conclusions.

You might want to read some of these articles in their entirety; they all made me smarter.

“How Can FPA National Account for its Chapters When it Can’t Account for Itself?”
by Michael Kitces
Nerd’s Eye View, March 2019
https://www.kitces.com/blog/fpa-national-audited-financials-mismatch-overview-national-finances-membership-transparency/
Relevance: high

You may be familiar with the Financial Planning Association’s OneFPA Network initiative, which would basically strip away each chapter’s autonomy and put their assets into a single account controlled by FPA’s headquarters staff.  Opposition has suggested that the FPA is leaking members and revenues, and needs those chapter assets to remain solvent.

The obvious solution?  The FPA could do what it has not done since 2015: provide detailed financial reporting in its annual report.  The skeptics were not quieted when the FPA released a 2018 annual report with no financial numbers whatsoever.  Are they hiding something?  Kitces has previously reported having cobbled together numbers which show that FPA’s revenue is down nearly $6 million over the past 10 years, including $1.5 million from lost dues due to declining membership and a $4.5 million decrease from sponsorships, advertising and conferences.

To quell the rumors surrounding this decrease in transparency and manifest decline in assets, the FPA scheduled a webinar and some private meetings with chapter leaders, and came clean on its balance sheet.  But did they?  The most recent financial report disagrees with the FPA’s own audited financials, going back to 2009.  There are graphs which show the discrepancy, but they lead to a question you’ve probably heard in legal circles: “Are they lying now, or were they lying then?”  Neither conclusion is favorable.

Kitces lets them off the hook, attributing the discrepancy not to lying, but merely to incompetence.  They don’t really know what their revenues are, year-to-year, and sometimes they just make stuff up.  But that raises a bigger question: should the chapters trust their finances to a staff that can’t seem to account for its own revenues?  Or (the conclusion this article leads to) should they resist the OneFPA Network initiative as a potentially dire threat to their operational efficiency?

“How to Counsel Clients Who Prefer Income to Total Return Portfolios”
by Chris Sidoni
Advisor Perspectives, March 18, 2019
https://www.advisorperspectives.com/articles/2019/03/18/how-to-counsel-clients-who-prefer-income-to-total-return-portfolios
Relevance: high

The Chief Investment Officer at Gibson Capital addresses a common issue among advisors: many clients want to live off the income generated by their portfolios, and they expect you to invest for income rather than total return.  What do you say?

The article delves into the psychology research on client perspectives.  Hersh Shefrin and Meir Statman theorize that some investors control their spending by imposing on themselves a “spend only the income” constraint.   They also believe that some clients are averse to selling stock positions to generate cash distributions (living expenses) because they want to avoid selling at a loss.  A third explanation by Shefrin and Statman involves regret aversion—the idea that investors want to avoid selling an asset that later appreciates in price.  Receiving a dividend, in contrast, occurs independently from any action on the part of the investor.

Other research suggests that some clients have trouble spending.  Shefrin and Richard Thaler have posited that some individuals create mental buckets composed of current income, current assets and future wealth.  Individuals have a greater propensity to consume from dividends and interest than from current assets, and Malcolm Baker, Stefan Nagel and Jeffrey Wurgler believe the propensity to consume from dividends is higher than from capital gains.  Spending income from the portfolio can ease the pain of spending.

The author says that among his clients, there is often an aversion to selling anything out of the portfolio—that clients want to avoid losing assets in their portfolios.  He has found that teaching clients with a strong income preference about the merits of the total return approach often fails.  Instead, present the client with tradeoffs.  To increase income, what is the impact on portfolio diversification and risk?  What is the tax impact?  What are the disadvantages to generating additional portfolio income?  You want to build client conviction in the optimal strategy, which may mean making modest accommodations of an income preference from time to time.

“How SIFMA, FSI, FINRA and the SEC Conspired to Doom the Advisory Profession”
by Ron Rhoades
Advisor Perspectives, March 18, 2019
https://www.advisorperspectives.com/articles/2019/03/18/how-sifma-fsi-finra-and-the-sec-conspired-to-doom-the-advisory-profession
Relevance: high

Rhoades is our leading thinker regarding the fiduciary standard and professional regulatory issues surrounding suitability vs. fiduciary, but surely this headline is exaggerating.  Isn’t it?

Maybe not.  The brokerage industry and independent BD trade organizations have found a way to undermine the primary distinction between professional financial planners and sales agents of large organizations: they destroy the existent meaning of the fiduciary standard by changing the obligation from a firm requirement to put the best interests of customers ahead of the firm and brokers, to a disclosure requirement that allows business as usual so long as the client is informed somewhere in the fine print.

That’s step one.  If you can get the SEC to define “fiduciary” as “suitability with disclosure,” then suddenly, in the SEC’s eyes, fee-only advisors and broker-dealer sales agents are essentially providing the same service.

Step two is scary: if the two are providing the same service under the same standards, suddenly that eliminates all the arguments for having FINRA govern both fee-only fiduciaries and brokerage sales agents—under a “harmonized” regulatory structure.  FINRA can then proceed to strangle the fee-only competitors to its brokerage members with a lot of unnecessary regulatory nonsense, in the guise of “protecting consumers.”

That, the author argues, would doom the advisory profession—the key word being “profession.”  Only sales agents would thrive under the new regulatory structure.  The point here is that this is what makes the battle over the SEC’s Reg BI proposal—created at the behest of wirehouse attorneys—so critical to the advisory profession.

The article includes a really interesting, sometimes funny, sometimes scary dialogue between broker-dealer executives as they plot out this assassination of their fiduciary competitors that is worth reading in its entirety.

“Gundlach: We Are on the Road to a Large Debt Problem”
by Bob Huebscher
Advisor Perspectives, March 13, 2019
https://www.advisorperspectives.com/articles/2019/03/13/gundlach-we-are-on-the-road-to-a-large-debt-problem
Relevance: high

Over the last two years, the U.S. government has increased its total debt load by $2 trillion, leading the CIO of DoubleLine Capital to warn of a “highway to hell” debt problem.  The article talks about a global slowdown driven by the falloff in global trade, and a sharp fall from the Conference Board’s leading economic indicators.  They don’t, yet, forecast a recession this year, but Gundlach says it could happen in 2020.  Six-month retail sales were down 1.6% in December, the worst one-month decline since the global financial crisis.

What about the debt crisis?  The national debt includes deficits that are financed by bond issuance as well as the intergovernmental loans used to finance Social Security.  The total debt is $22.13 trillion and growing at about $1.5 trillion a year.  Gundlach calculated that we would need 10% of GDP to pay back the national debt over the next 60 years.  Meanwhile, taxation as a percent of GDP is at its lowest since 1950.

Meanwhile, corporate debt has experienced an incredible increase.  Corporate, governmental and mortgage debt now comprise 210% of GDP.  Gundlach predicts that long-term rates will go up in the next recession unless the Fed monetizes U.S. debt by using its own funds to purchase bonds on the open market.  He pointed out that individuals need a 43% debt-to-income ratio to get a government-guaranteed mortgage; the corresponding ratio for the U.S. balance sheet is 537%.  Look for a lower dollar and emerging market equities to outperform other assets.  Avoid corporate debt, understanding that 55% of BBB-rated bonds would be rated junk based on the leverage ratio of the underlying corporations.  Downgrades are coming.

“Should Advisors Time Factor Exposure?”
by Larry Swedroe
Advisor Perspectives, March 12, 2019
https://www.advisorperspectives.com/articles/2019/03/12/should-advisors-time-factor-exposure
Relevance: high

Research has show that mutual funds demonstrate stock-picking skills on a gross-of-fee basis, but they fail to outperform an appropriate risk-adjusted benchmark net of fees.  It also shows that they don’t outperform by successfully timing the market.  Most importantly, past success in stock picking and market timing does not ensure future success.

So Swedroe asks: can active manages perhaps outperform by successfully timing their exposures to factors that have been found to provide premiums over the long term?  Researchers Arnav Sheth and Tee Lim examined the behavior of six factors—market beta, size, value, momentum, investment and profitability—across business cycles, splitting them into four stages: recession, early-stage recovery, late-stage recovery and very-late-stage recovery.  The factor premiums were very different across the different stages.

So…. Manuel Ammann, Sebastian Fischer and Florian Weigert studied whether actively managed funds were successful at timing factor premiums net of fees, by measuring factor exposure at different stages of the business cycle from late 2000 through 2016.  They found that there was indeed persistent factor timing, but that risk factor timing was associated with future fund underperformance. 

Because the factors tend to outperform at different stages, the author recommends that instead of selecting funds that try to time the factors, diversify client portfolios across factor exposures.

“Debt Cycles are Normal, and Normally Manageable”
by Stephanie Kelton
Advisor Perspectives, March 4, 2019
https://www.advisorperspectives.com/articles/2019/03/04/debt-cycles-are-normal-and-normally-manageable
Relevance: high

The leading spokesperson for Modern Monetary Theory (MMT) reviews Rad Dalio’s 3-volume “Big Debt Crises”—an overview of 48 big debt cycles that have occurred, globally, in the last 100 years.  The takeaway is that debt crises are normal and normally manageable.  But where a significant amount of debt is denominated in a foreign currency (think: Greece), managing the crisis is trickier, and things can get really ugly before they get better.

Dalio regards debt as a critical ingredient for innovation and growth, but at some point the claims on debt begin to grow more rapidly than the cash flows available to service the debt.  This sets off a six-stage pattern, whose ending comes when real GDP contracts and policymakers try to counter the event by driving interest rates toward zero.

Interestingly, the research covers all debt—public and private—and highlights the risks of borrowing in a foreign currency.  The analysis shows that private—not public—debt tends to drive the cycle, and managing the cycle is not complicated provided (once again) that a significant amount of debt is not denominated in foreign currency.  Think emerging markets like Argentina, Brazil or Turkey, where borrowers are taking on foreign-denominated debt but earn cash flows in local currency.  When the Fed tightens interest rates, it triggers a debt squeeze that can become a crisis.  The country can’t print the currency that borrowers most need.

One of the messages Kelton takes from the book is that skimping on debt can make you poorer.  Investing in education, infrastructure, etc. can drive healthy growth and bring prosperity even when you add to the debt to do it.

“How Advisors Rate the Technology They Use”
by Bob Veres
Advisor Perspectives, March 4, 2019
https://www.advisorperspectives.com/articles/2019/03/04/how-advisors-rate-the-technology-they-use
Relevance: high

This is a review of the T3/Inside Information Software Survey (You DO have your copy, don’t you?  It’s free.), which addresses three issues for software buyers in the advisor space:

1) Which vendors are operating in the advisory market and what programs and services are they offering?

2) What’s the respective market share of the different software and service providers in each categories?  (Which programs are most popular?)

3) How satisfied are users with these software and service providers, on a scale of 1-10?

The survey attracted 5,508 advisor participants.  More than 500 different tools were listed.

One interesting takeaway: only 24.26% of the advisors filling out the survey are using document management/document processing tools like Redtail Classic Imaging, DocuPace, Laserfiche, NetDocuments, Worlddox, Citrix Sharefole and box.com.  The advent of the “paperless office” is clearly not here yet.

Also: only 63.57% of the respondents say they use financial planning software for their clients.  How his this possible?  The survey attracted a high number of dually-registered advisors, many of whom appear to be basing their value proposition on gaining above-average investment returns, rather than on financial planning analysis.  The next downturn may not be kind to them.

The article looks at individual market share rankings and user ratings.  Redtail (56.90%; 8.07 rating) dominated the CRM software category, although Concenter/XLR8 (1.51% market share but a high 8.51 user rating) actually had more satisfied users.

Portfolio management tools was an interesting category; market share was divided among Albridge (20.41%; 7.20 rating), Morningstar Office (16.92%; 7.42), Envestnet/Tamarac (13.85%; 7.31), Orion Advisor Services (9.40%; 7.62), Schwab PortfolioCenter, now owned by Envestnet (9.39%; 6.62) and Advent/Black Diamond (5.36%; 7.49).  All have excellent user satisfaction ratings and are jockeying for market share position in the most crowded sector of the marketplace.

Morningstar dominated the Investment Data/Analytics Tools category (38.82%; 7.73), while the financial planning software category was a two-horse race between  MoneyGuidePro (now an Envestnet company; 25.69%; 7.97 rating) and eMoney (22.93%; 8.05).  The survey asked which software category was most key to running your business, and CRM won with 52.29% of the respondents selecting it as their most important software, followed by 22.90% selecting financial planning software, and 12.83% selecting portfolio management software.  The survey also included a “miscellaneous” category that lumped in all the software products that didn’t fit neatly into one of the other 19 categories, and in some ways, this produced the most interesting list.

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