MEDIA REVIEWS – January 1-7, 2021

Normally by now I would have reviewed the articles in Financial Planning magazine, Investor Advisor or Financial Advisor.  But, well, none of those January issues are out yet—and here we are almost two weeks into the new year.  We are seeing the rapid decline of the trade magazine marketplace in the advisor space, and it’s frankly not a pretty sight.

But Advisor Perspectives continues apace, with a lot of articles in the first couple of weeks of the year warning us that we may be in the last stages of a bull market.  They make an interesting case; one compares 2020 to 1999, both good years for the investment markets—but we know how 2000 turned out.  Michael Lebowitz, meanwhile, offers evidence that the Fed is deliberately juicing the stock market, while market analyst Neil Ramsay provides a lot of facts that indicate that the dam may break at any moment.

I really enjoyed the article by Joe Tomlinson which appears to show that rebalancing client portfolios when they are in the withdrawal phase doesn’t much affect their long-term sustainability.  The median outcome when there is no rebalancing at all over 35 years is slightly higher than if you rebalance over shorter yearly intervals (which produces higher equity allocations over the course of retirement), although the extreme downside Monte Carlo results are lower than if you rebalance.  Using wide tolerance bands seems to improve the median performance as well, though once again the extreme downside is a bit worse.  The kicker is that when rebalancing is most beneficial—when the markets are down and you’re moving to a higher stock allocation—is exactly when clients are likely to give you the most pushback.

Also, Bob Veres offers his views on the professional marketplace in the coming year, suggesting that advisory firms will best adapt to a rapidly evolving professional marketplace.

The articles:

“Shades of 1999 as “Market Mania” Returns in 2020”
by Lance Roberts
Advisor Perspectives, December 28, 2020
Relevance: high

You may remember that 1999 was a very good year for the investment markets, but what came afterwards was pretty catastrophic.  The article draws some obvious parallels: exceedingly high valuations, a rush by private equity investors to IPO companies as quickly as possible, and the fear of missing out by retail investors.

What is driving the bullish psychology?  The Fed is backstopping the markets, another few trillion dollars in stimulus checks will go out to buoy the U.S. equities markets, and any bear retracement is a good opportunity to “buy the dip.”  There’s also a chart that shows that retail trading growth exploded in 2020, suggesting that a lot of amateur speculators have moved into the market.  Another chart shows that U.S. option call volume is spiking to unprecedented levels.

The article says that the last time we saw asset prices surge 20% in a single month was in 1999.  It tells us that the majority of investors today are simply chasing performance—in other words, speculating.  When will the bear market happen?  The author confesses that he doesn’t have a clue.

“Navigating the Sea of Mediocre ESG Fund Performance”
by Larry Swedroe
Advisor Perspectives, January 4, 2021
Relevance: high

The author says that more than 1,000 research reports have been published about ESG funds, and focuses on one from the February 2020 issue of The Journal of Portfolio Management that examined 15 years of performance for active and passive funds and ETFs with a U.S. ESG investment focus.  The authors removed from their sample all industry-specific funds, and ended up with 98 funds at the beginning and 267 funds by the end of 2018.  51 were index funds, 216 were actively-managed.

The researchers found that once they controlled for style factor exposures, most funds in every category did not produce statistically significant positive or negative (before fees) alpha.  The differences in allocates produced by the screens produced close to zero contribution to performance.  Because ESG portfolios were, by design, less diversified than the market, they tended to be more volatile than the broad market.  ESG funds with higher average expense ratios generally produced lower net alpha (just like all funds). 

Overall, there was such a wide difference in returns that the authors avoided generalizations, and suggested that investors assess the unique attributes of individual funds.  This is all interesting, but one wonders how any of this is different from any category of funds available to investors.

“The 95-Year History of Stock and Bond Returns in Four Pictures”
by Ron Surz
Advisor Perspectives, January 2021
Relevance: high

The first chart shows that the returns on stocks and bonds in 2020 were much higher than the market averages.  An interesting chart shows the dispersion of returns by year, and you can see that the left tail is greater than the right tail, but the center of the curve is shifted to the right (positive returns).  Another chart shows that the 1990s had the highest overall stock returns, followed by the 1950s, followed by the decade that just ended.  On a risk-reward basis, stocks have recently completed their second-best decade since the 1940s, while bonds posted their third-best.

“Parents Shouldn’t Wait to Pass Down Their Wealth”
by Erin Lowry
Advisor Perspectives, January 2021
Relevance: high

This is an argument that helping the next generation get on their financial feet and find their successful track in the economy is not “spoiling” your kids.  Millennials are already predicted to be the first generation to be worse off, financially, than their parents, even though a higher percentage have a bachelor’s degree. 

Instead of withholding the inheritance until your death, the author recommends that you gift early to encourage your children to start building their own financial freedom.  You will be able to see and enjoy the impact of your legacy, and you can reduce economic struggle.  Some examples: you can pay off medical debts, or subsidize the cost of college education.

“The VIX Dog That Didn’t Bark”
by Rick Roche
Advisor Perspectives, January 4, 2021
Relevance: high

Skipping a lot of explanation about what the VIX index measures (expected volatility), the author notes that the index offered no warning of the October 19, 1987 market crash, not even the previous Friday.  Nor was there a VIX warning before the onset of the global financial crisis; the VIX index closed close to its historical average one week before the Lehman Brothers bankruptcy filing.  It only spiked after the news spread of the Lehman filing. 

And, of course, there was no spike in the VIX before the February/March 2020 market downturn. 

The author says that the VIX is a lagging indicator; it reacts quickly to the onset of market regime changes.  In other words, it tells you that the market has turned after the market has turned.

“Concerns About Annuity Issuer Failures are Misguided”
by Ben Mattlin and David Lau
Advisor Perspectives, January 4, 2021
Relevance: high

Apparently, advisors are worried that if they recommend these new no-load annuities, that the annuity company will go broke and not meet their obligations.  (Do you feel that way?)  So the authors note several things, first that the biggest headline-grabbing defaults are found in long-term care or property and casualty companies, which are exposed to unexpected calamities.  Annuity providers are immune to floods, fires and illnesses.

During the financial crisis, they tell us, no annuity providers went under.  Even the AIIG debacle of 2008 involved only the parent company, not the annuities operations, which are now being spun off into a separate company.  There WAS an outstanding default: in 2002, London Pacific Life & Annuity Co. in Raleigh, NC defaulted on nearly $2 billion in annuity obligations.  But the state regulators liquidated its assets and brought in Hartford Life Insurance as a buyer.  All annuity holders were made whole.

The state regulatory system requires a capital cushion to make sure the obligations will be met, and an analysis by the American Council of Life Insurers shows that 94% of annuity providers have at least twice the minimum required.  And there are restrictions on how annuity dollars can be invested on behalf of annuitants.  (Anybody remember Executive Life?)

The authors concede that annuities can be complex, expensive and illiquid, but they also guarantee lifetime income and cannot lose money as they are structured.  Every state has its own guaranty association that covers $250,000 in annuity benefits (except New York, New Jersey and Connecticut, where the minimum is $500,000). 

“Bond Ratings tell Only Part of the Story”
by Larry Swedroe
Advisor Perspectives, January 6, 2021
Relevance: high

A 2020 study of the bond markets, looking at fixed-rate U.S. corporate bond data from 1999 through 2018 (sample of 1,270 issuers and 11,298 unique issues) found that investors were taking very different risks even if they bought bonds with identical ratings.  They found that a sizable portion of the bonds exhibited much higher credit spreads than same-rated peers—that is, they had yields closer to those of lower-rated bonds.  Those with higher credit spreads were reliably liable to have a future downgrade in the next three to 12 months.  The above-midpoint group had an average downgrade frequency of 12.1%, 20.1% and 32.4% in the next three, six and 12 months, respectively.  There were 2.7%, 5.6% and 11.4% chances of a downgrade in the below-midpoint group.

Focusing on BBB-rated bonds, the annualized standard deviation of the higher-yielding bonds was 10.81%, double the standard deviation of the below-midpoint group, and the worst rolling one-year return was -30.27% for the above-midpoint BBB-rated group,  vs. -11.55% for the below-midpoint BBB rated group.  The point is that these differential yields are not examples of mispricing, but real-time data from active investors looking at the underlying fundamentals.

“Estate Planning Tips for 2021”
by Michael Winn
Advisor Perspectives, January 2021
Relevance: high

The author notes that the pandemic has led to an increase in the federal deficit (did the tax cut play a part as well?) and the new Democratic administration has talked about addressing the lifetime estate and gift tax exemptions.  The 2020 exemption was $11.58 million per person.  What if that amount were lowered back to the $5 million range?

The author says this is a good time to talk about an irrevocable trust or an intentionally defective grantor trust to shelter assets that can be passed on to future generations.  The parents would create the trust, it would exist outside of their estate with a professional advisor or trusted friend as the trustee.  When the grantor’s heirs come of age, the trusteeship can be transferred to them, and the trust can be split into sub-trusts for their heirs. 

What do you put into the trusts?  Whatever has a high probability for growth or can generate a significant income stream.  Undeveloped real estate might have a relatively low value when granted to the trust, but once developed, it gains value outside the parents’ estate.

Or clients can make intra-family loans at today’s low interest rates.  The children can use the money to buy real estate or stock in a closely-held business.    

“The State of the Profession—and What to Look for in the Coming Year”
by Bob Veres
Advisor Perspectives, January 2021
Relevance: high

Who predicted the pandemic at the beginning of last year?  Or how the stock market would ignore it and keep rising?  Or that wild dip in February and especially March, when it seemed like the markets would actually respond to the biggest recession in history?  Or the biggest recession in history, for that matter?  Or that clients would get accustomed to Zoom meetings, and advisory firms would quickly adjust to everybody working remotely?

The article notes that many advisors believe they’ve trained their clients to ignore bear markets, because, well, they didn’t call in March.  But what happens if we have a longer, more prolonged downturn?  The real lesson of the pandemic is that clients want deeper conversations with their advisors, and the ability to talk about and plan for more than just their portfolios.  Advisors who learn this lesson will bear-proof their client relationships when the markets do finally turn down. 

The other big issue is how the Zoom interactions are changing the dynamics of the professional marketplace.  Now, suddenly, you can work with anybody, anywhere, and just set up Zoom meetings with them. That means that every other advisor can work with clients in your neighborhood as well.  This will force advisory firms to specialize in particular professions or psychographic profiles, and offer the very best service there is to be had for those people—so they seek you out no matter where you’re located.

And… has anybody yet figured out how to maintain a corporate culture when your staff is working remotely?  When the pandemic ends, many members of your team will want to continue working from home, eliminating a lot of face-to-face interaction and ad hoc water cooler conversations.  This is creating a big practice management challenge that is yet to be solved.

And now let’s talk about the new tax regime that advisors are going to have to master and give advice on. The article says that instead complaining about it, you might regard a new tax reform initiative as a blessing.  May of your clients are not fond of paying federal taxes, and you can educate them, provide advice, and attract other do-it-yourselfers who may finally realize they need a professional in their lives.

The article also points to the author’s recent fee survey, showing that 33% of advisory firms are experimenting with different fee structures—most often, flat fee arrangements to work with people who have not accumulated a sizable retirement portfolio, and subscription models for younger clients.  The profession will migrate from AUM to these revenue models as it begins to work with more and more younger, less-wealthy clients, and greatly expand the market for their services.

“Ask Brad: Do RIAs Have to Pay for Their Own Compliance?”
by Brad Wales
Advisor Perspectives, January 6, 2021
Relevance: high

A consultant who helps brokerage reps move to a fee-only model says that, yes, RIAs do have to pay for their own compliance, partly by doing it themselves, partly by hiring consultants.  But he says that employees or independent contractors working in the broker-dealer model are likely paying more for compliance than what they need.  It’s included in your payout—or, rather, the amount that the brokerage or BD keeps from your payout to pay its own expenses.  And a lot of the compliance work doesn’t really apply to you.  Do you take foreign clients who might be laundering money?  Are you prevented from creating blog because the firm is scared of opening up the spigot to others who might be less honest than you would be about not soliciting through it?

The RIA firm knows exactly what it is paying in compliance costs, and has control over them.  And it doesn’t have to pay for the mistakes and oversight of others.

“What I’d Like to See More and Less of in 2021”
by Dan Solin
Advisor Perspectives, January 6, 2021
Relevance: high

The list is short, simple and accurate.  Solin hopes that more brokers will leave the wirehouse world and become RIAs—because that means they would embrace the fiduciary standard when they serve clients.  Quote: “It’s always been a mystery to me why any investor would entrust their life savings and financial security to someone who doesn’t have the highest fiduciary obligation to them.”  More brokers = more ethical, professional service.

Second: less private equity.  The gist here is that private equity firms that acquire advisors are greedy, looking to flip their investment in five to seven years to a new buyer at two to three times what they initially paid.  That puts a lot of pressure on the acquired firms to cut corners when it comes to service, in the service of profitability.  Quote: “It’s ironic that advisory firms that would never recommend hedge funds to their clients or advise them to buy stocks on margin have shareholders that are hedge funds and fund their acquisitions with borrowed capital.”

Finally, more demonstrations of trust from financial planners.  Instead of asking for clients to take a leap of faith, advisors can say: Would you be willing to retain us for a three (or six) month period on a trial basis?  If, at the end of the trial period, you are happy with the relationship, you would pay us our standard fee.  If not, we can part company and there will be no charge for our services.  Interesting…

“Does Rebalancing Help Investors in the Withdrawal Phase?”
by Joe Tomlinson
Advisor Perspectives, January 11, 2021
Relevance: high

I always read Tomlinson’s articles with interest, because he’s very insightful, and also really good (and rigorous) in his numerical analyses.  Here, he looks at rebalancing, running Monte Carlo simulations based on historical 35-year historical stock and bond returns, bootstrapping sequences by randomly selecting yearly returns out of the U.S. market history since 1926.  He starts with a $1 million portfolio, and looks at the average sustainable withdrawals that would be available rebalancing at intervals of 1, 3, 6, and 12 years—and rebalancing never over the 35 year period.  This produces a spectrum of results; the shorter the rebalance period, the tighter the spectrum, but the average sustainable withdrawals (the center of the distribution) drifts up slightly the longer you wait to rebalance, and is highest at the “never” decision.  The extreme downside is higher if you never rebalance, which is down in the 5% chance range, and may not be relevant to clients.

Tomlinson then looks at rebalancing at tolerance bands; when the portfolio is 5%, 10% and 20% out of tolerance, and, once again, never rebalancing.  The results are almost exactly the same from low to high tolerance to never; the averages are pretty much the same, but the 5th percentage downside is slightly higher as you widen the tolerances.  Tomlinson says that the best outcome is probably a 10% tolerance band, which means rebalancing an average of every 7.7 years, given the historical data.  (That, in itself, is an interesting data point.  If you rebalance at a 20% tolerance band, you’re balancing an average of every 31.3 years.)

The gist of the article is that it may not actually matter whether you rebalance client portfolios in the withdrawal phase or not, based on the pure mathematics.  And the interesting thing about the addendum is that clients will probably resist if you act to rebalance when it is most beneficial: moving back into stocks when the markets have gone down.  If you don’t rebalance at all, you end up with the Kitces/Finke recommendation that portfolios become more sustainable if you let the equity allocation drift higher over the course of retirement.

“The Fed is Juicing Stocks”
by Michael Lebowitz
Advisor Perspectives, January 11, 2021
Relevance: high

Lebowitz says that the Fed lowers bond rates by buying Treasury debt, reducing the supply of investible debt.  And it is holding the Fed funds rate at zero percent, boosting prices and lowering yields. 

The lower yields force investors to move from Treasury bills to corporate bonds or mortgages, which lowers yields there as well, crowding out more adventurous investors, who move to equities.  This is one way of juicing stocks.

The Fed has also made borrowing conditions easier, adding to leverage across the economy.  That allows speculators and traders to amass larger holdings than would otherwise be possible.  The Fed has been especially active in the repo markets, providing liquidity at low borrowing rates.  This is another way of juicing stock prices.

Of course, whenever the market goes down, the Fed has provided economic stimulus, which is a direct way to encourage investors to buy stocks and imagine that they will never be allowed to fall in value.

Finally, and somewhat more complicated, the recent Fed actions have encouraged momentum investing as opposed to active management.  Active managers tend to have more cash on the sidelines, looking for opportunities, while passive momentum investors tend to be fully-invested.  The article offers a very interesting chart showing that cash levels in mutual funds is at record lows, down around 2% of all assets invested.  There is more demand to buy assets. 

“Should You Trust the Stock Market Bulls?”
by Neil Ramsey
Advisor Perspectives, January 2021
Relevance: high

Part 1 of this analysis of the current state of the investment markets points out that the forecasters have achieved the biggest consensus in history about equity returns in 2021: stable growth, high earnings potential, herd immunity and bullish returns.  That, in itself, makes him nervous; seldom do so few dispute the central narrative.

What makes him more nervous is the assumption that inflation will continue to stay low as it has since 2009 despite round after round of money creation.  He notes that anybody in construction trying to bid for jobs or pin down subcontractors knows that inflation is already rising.  Beyond that, the put-to-call ratio for U.S. stocks just hit its lowest level since 2000, options volume has surged to its highest on record, and median short interest for the S&P 500 has plunged to 17-year lows.  Market sentiment is the highest it has been since 2018, and for the first time in 15 years, 60% of SentimenTraders indicators are showing an excessive amount of optimism.

Adding evidence: We are finishing 2020 with estimated earnings of $140 for the S&P 500 for 2020 and $170 for 2021—almost 18% below expectations for the year, and the market is up close to 20%. 

The point here is that there are many uncertainties in the future (many are listed, including emerging market debt defaults or massive labor shortages) and the risk level in the markets may be as high as it has ever been.