Archive → March, 2010
The top separately managed accounts
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Spotlight on VAs
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The humble variable annuity is gaining in popularity
Investment in young people can pay off
Investment in young people can pay off
Not all planners will work with them, but they can turn into blue-chip clients in time.
By Lisa Shidler
March 7, 2010 6:01 am ET
Twenty years ago, investment adviser Greg Merlino woudn’t take on clients unless they had at least $250,000 of investible assets. For one young man, however, he made an exception, and it turned out to be one of the best decisions he ever made.
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Mr. Merlino, whose firm manages $75 million, put the 30-year-old client on a systematic savings program. Today, the client holds the biggest chunk of the assets the adviser manages — $25 million.
“If I told him he didn’t meet my ideal situation, he never would have grown into this great client,” Mr. Merlino said. “I thought this guy would be successful, but I didn’t think he’d turn into the type of client he is now.”
Many advisers don’t market their services to younger people, because working with them is not as profitable as handling money for middle-age and older individuals. Those advisers who do relax guidelines on minimum assets often put young clients through a rigorous screening process and establish different fee structures and protocols to make sure they can still make money while satisfying their clients’ expectations. The hope is that these customers will thrive financially and eventually can be treated like other clients.
To determine whether a young client has the potential to increase his or her net worth substantially, pre-screening is a must, said Brian Peardon, a wealth adviser at Harrison Financial Group, which manages $200 million in assets. His firm turns away younger clients who don’t want to be coached and who don’t meet savings requirements.
SUPER SAVERS
Evan Shear, a certified financial planner and branch manager for The CrossleyShear Group, which manages $300 million, sets aside his firm’s $200,000 minimum requirement for younger clients if they are willing to save about 20% of their earnings a year.
“My view is [that] someone who is 30 and has the ability to put that money away will be one of my best clients by the time they’re 50,” he said.
Advisers who do take a chance say their young clients are open to being coached.
“Ultimately, they follow our advice to the T more so than clients of other age groups,” said David Hefty, chief executive of Cornerstone Wealth Management, which manages $125 million in assets. “They’re more engaged in terms of wanting to build the financial plan and follow the plan.”
Still, Mr. Hefty concedes that taking on these younger clients often means spending extra time with them, dealing with such matters as student loans, tax-planning, mortgage-financing and estate-planning issues.
Accepting the fact that these clients may take more of an adviser’s time also means accepting the fact that advisers may not earn much profit from these clients in the near term, said Chris Michalak, a principal at Moneta Group, which manages $7.2 billion in assets.
‘ONE RELATIONSHIP’
Mr. Michalak said his firm takes on young clients, regardless of the size of their investible assets, if they are the children of older clients. “If they’re the children of current clients, there’s not a lot we can do,” he said. “We tend to look at the family as one relationship.”
“Some years, it’ll be extremely profitable, and some years, you’ll lose money with these relationships,” he said.
Mr. Peardon said the only way his firm can devote attention to these younger clients is to develop a less costly way to serve them. While his firm offers its younger clients the same services it does the older ones, it has discovered that most of the former prefer e-mail and demand fewer office visits, which reduces the firm’s costs.
“We’ve been able to reduce the time and money so that everything is operating more efficiently and we can get a profit from this age range,” he said.
Mr. Merlino offers clients who don’t meet the firm’s minimum-assets guideline a pared-down version of a financial plan, which ordinarily costs up to $8,000, and charges commissions rather than asset management fees.
Having a cost-effective system of working with younger clients is essential, agrees Don DeWaay, founder and chief executive of DeWaay Capital Management, a registered investment advisory firm, and DeWaay Financial Network, a broker-dealer. The two firms manage $900 million in assets.
His firm’s younger advisers build their practices by working with younger clients.
“The problem with younger clients is [that] seasoned advisers don’t have the time or interest to work with these people,” he said. “These young investors aren’t getting compromised by working with younger advisers, because they have backup from more seasoned advisers.”
NOT THEIR DAD
Younger advisers also often have more in common with younger clients, said Justin Smith, 29, an adviser with Jonathan Smith & Co., which manages $23 million in assets. The firm belongs to his father, but he oversees the younger clients.
“I can sit down and have this conversation with them, and they don’t feel like it’s their dad telling them what to do,” he said. “I tend to enjoy it. I know if we can get these clients thinking like they should about markets and investments, they’re going to be our easiest clients in 10 to 15 years.”
One adviser who targets younger customers said he has reaped unexpected dividends from his relationship with them.
“When I decided to go into this market segment, I was reading in books that it’s hard to make a living in this segment,” said Lyman Jackson, president of Jackson Financial Management, which oversees $12 million. “And certainly there’s a lot of truth to that.”
“But many of these young families have referred us to their parents,” he said. “Just in the first two months of the year, we got two sets of parents referred by younger clients. You start serving other family members if you’re doing a good job for people.”
E-mail Lisa Shidler at lshidler@investmentnews.com.
Hilary Johnson contributed to this story.
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Young don’t see value in rolling the dice
Young don’t see value in rolling the dice
Coming off one of the worst decades for stocks, they take a more conservative outlook on investing
March 7, 2010 6:01 am ET
Advisers who work with clients in their 30s are witnessing something they’ve never seen before from younger investors: high levels of risk aversion.
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“I’m talking with a lot more younger clients today who are worried about avoiding losses, and wanting to take the kinds of conservative approaches that have historically been appealing to older folks,” said Clinton Struthers, who advises on $110 million as the owner of Struthers Financial Services.
“It used to be all about “the sky’s the limit’ when it came to advising younger people,” he added. “But now, I see their whole outlook is more conservative as a result of so much uncertainty about the future.”
That caution, as the financial planning community is realizing, is grounded in the general economic turmoil and investing experiences of the past few years.
Any multiple-decade snapshot of the stock market can usually be made to look optimistic, but for most people in their 30s, a personal investing history doesn’t go back much farther than 10 years.
In that time, the financial markets have experienced two very harsh cycles — leaving most investors about where they were a decade ago.
With that in mind, it’s understandable that today’s thirty-somethings might be among the most gun-shy of generations.
Understandable, but not acceptable — at least not if there’s any hope of staying ahead of taxes and inflation.
“The biggest hurdle right now is to get those people in their 30s to step off the sideline and embrace some risk,” said Tim Knepp, chief investment officer at Genworth Financial Asset Management, a firm with $7 billion under management.
Mr. Knepp underscored the recurring theme that is being presented to risk-averse young people across the land: Time is on your side.
“The market pays you to take risks, and 30-year-olds should keep that in mind,” he said. “When you’ve got to make up losses, your greatest risk is not portfolio volatility, it is loss of purchasing power.”
Encouraging younger investors to save as much as they can — and then invest as aggressively as they can stomach — seems to be a standard message throughout much of the financial planning industry these days.
But there are still a variety of ways to execute a plan once the investor is on board.
“For younger people, their biggest asset is their potential income stream, and their capacity to bear risk is very high,” said Neal Ringquist, president of Advisor Software Inc.
“If you’re in your 30s, you could easily be 100% in stocks and afford to lose 40%, and still make it up over your lifetime,” he added.
Advisor Software is a financial technology firm and a registered investment adviser that manages more than $200 million for other financial advisory firms.
Because people in their 30s, in general, are wealthier in income than assets, Mr. Ringquist views salaries as an asset under the resource category of a household balance sheet.
Other examples of resources are real estate and investments.
The other side of the household balance sheet is claims, which are all legal financial liabilities, such as debt.
“We’re looking at the household through a balance sheet to determine a capacity to bear risk, not just risk tolerance,” Mr. Ringquist said.
With that in mind, he is a strong proponent of life insurance and disability insurance, which are rarely considered high priorities among younger investors, especially if they’re single or childless.
“Looking at the household balance sheet leads to certain implications that people might not always realize,” he said. “Because the income stream is the biggest asset, you need to protect anything that might cut into it.”
Not all financial advisers factor in the personal residence as part of an overall financial plan, but managing the cost of a home should be a priority for younger clients, according to Bert Whitehead, president of Cambridge Connection Inc.
“There were a lot of young people who made mistakes in real estate during the run-up,” said Mr. Whitehead, who charges clients he advises a flat or retainer fee.
“People paid too much for the houses they were buying, and then put the rest of their money in stocks or whatever,” he said.
While Mr. Whitehead believes in appropriate use of aggressive, long-term investing strategies for younger investors, he also favors maintaining cash reserves that could be tapped to cover mortgage payments in the event of a job loss or illness.
Taxes are another issue that should be considered early, according to Laurence Greenberg, president of Jefferson National Life Insurance Co.
He recommends low-cost variable annuities once the allocations to traditional qualified retirement plans such as 401(k)s and IRAs have been maxed out.
“The recent dislocation in the markets has made everyone question whether they’ll have enough money when they’re ready to retire,” Mr. Greenberg said. “The best way to make sure you have enough money is to save it, and when saving, there’s nothing more valuable than tax deferral.”
As with any strategy, the key is finding one that works and sticking with it.
That’s something a lot of investors — as well as a lot of financial advisers — have struggled with in the wake of the market’s upheaval.
“One of the benefits of being in your 30s is, virtually any investment strategy can work pretty well because you have so much time,” said Michael Ball, president of Weatherstone Capital Management, which manages $425 million.
“The problem is, people in their 30s are impatient,” he added. “They’ll try something once and if it doesn’t work right away, they just write it off.”
Long-term outlooks and historical performance charts notwithstanding, it ultimately boils down to suitability, and that might be where advisers face their greatest challenge.
“All you can do, as financial advisers, is encourage your clients to be aggressive enough,” said John Diehl, senior vice president of business development at the Hartford Financial Services Group Inc.
“The investment time frame will help determine the asset allocation mix,” he added. “I’d say for people in their 30s, a minimum 80% in equities makes sense, but not if somebody is going to lose sleep.”
E-mail Jeff Benjamin at jbenjamin@investmentnews.com.
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Keeping up with the Joneses
Keeping up with the Joneses
March 7, 2010 6:01 am ET
If there is one stage of life in which competing demands for income are most intense, it is when couples first start out. It is a time when they typically make the biggest purchase of their lives — a home — as well as when they begin the most expensive long-term project of all: raising a family. And let’s not forget getting an early start on retirement planning. Precisely because of these many demands, planners advise young couples to get into the saving and investing habit. To demonstrate the challenges facing such couples — and possible courses of action — InvestmentNews created a hypothetical young family and asked two seasoned financial planners, Janet Stanzak and Thomas J. Henske, to review their finances and come up with some solutions.
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The Jones family: John, 35, and Jenny, 34, have two children — Jenna, 9, and James, 6.
Income: John, assistant director of human resources at a computer software company, earns $135,000.
Jenny, an accountant at a midsize regional firm, earns $70,000.
Major assets: Residence: single-family house purchased in 2005 for $425,000; now worth $375,000
Retirement funds: John’s 401(k) account, $40,000
Jenny’s 401(k) account, $3,000
College savings: $25,000
Emergency savings: $10,000
Major liabilities: Mortgage balance:
$380,000 (30-year fixed), at 6.5%; monthly payment (plus taxes and insurance), $2,951
Credit cards: Payments of $300 a month on total debt of $15,000
Insurance: John has a term life policy through work with a death benefit of $675,000, for which he contributes $1,200 a year; Jenny has a term life policy (also through work) with a death benefit of $350,000, for which she pays $600 a year.
Concerns:
College and retirement saving. Now that Jenny has returned to work after a five-year hiatus, the Joneses would like to ramp up saving for college and retirement. But the couple is not sure where to invest after the 2008 market crash erased $20,000 from John’s 401(k) account. The market rebound last year has restored about $10,000 of that.
Credit card debt. To landscape and furnish their new home, the Joneses ran up $15,000 in credit card debt. They don’t know whether they are making a sufficient monthly payment on the balance.
Inheritance. Jenny expects to receive a $50,000 inheritance following the death of her grandmother. They don’t know what to do with that money.
Mortgage debt. The couple is also concerned about owing more on their mortgage than their home is worth. They don’t want to move, but have heard about people walking away from “underwater” mortgages.
Ms. Stanzak’s solutions
COLLEGE SAVING
Using a college savings calculator, I ran one scenario for James, assuming that half, or $12,500, of the current college funding dollars are designated for him. To fund 100% of a four-year college — $220,065 — would require monthly contributions of $653 (assuming college costs rising at 6% per year and a 7% return on investment). That’s just for James, and does not include the calculation for Jenna. Funding 100% may not be realistic. As for specific investments, consider Section 529 plans. After-tax contributions to a 529 plan grow tax-deferred, and distributions to pay for the beneficiary’s college costs come out federal-tax- free. Some states offer tax incentives to investors as well.
RETIREMENT SAVING
A good goal would be to maximize their 401(k) contributions — the maximum deferral is $16,500 in 2010 — or to make annual contributions of 10% to 15% of income. The Joneses should consider completing a retirement analysis to determine the appropriate amount to save and invest each year. Also, a complete risk tolerance assessment is needed to determine an asset allocation with which they can be comfortable and which also helps them meet their goals. Their current portfolio provides no diversification. Typically, a diversified portfolio includes cash, fixed income (bonds, CDs), large-cap stocks, small- and mid-cap stocks, international stocks, and often real estate and commodities as a hedge. The couple’s uncertainty after the losses in John’s 401(k) plan suggests that more than 25% should be allocated to cash and fixed income to give the portfolio a more conservative allocation, thus potentially reducing volatility.
CREDIT CARD DEBT
It appears that the $300 a month is the minimum payment. At 12% interest, it would take 368 months — over 30 years — to pay off the cards, and it would cost $14,545 in interest. If they double the payment to $600 a month, it would take 29 months — about 2 years — to pay off the debt, and it would cost $2,347 in interest. But a better option is to use part of Jenny’s $50,000 inheritance to wipe out all credit card debt. In the future, they should use credit cards only for purchases they know they can pay off each month.
INSURANCE
The Joneses should complete a capital-needs analysis to see exactly how the premature death of either spouse would affect the family’s ability to meet expenses. In addition, the analysis would take into account paying off debts such as their mortgage, credit cards and auto loans, as well as college and retirement funding. This needs analysis would determine how much insurance they actually require. At their age, lower-cost term insurance makes sense, but in addition to the group coverage provided to John, he should consider a policy of his own. The group coverage will end if he changes jobs and a personally owned policy can be maintained, regardless of insurability in the future.
EMERGENCY FUND
They Joneses should build up their cash reserves to equal six to 12 months of income. This can be saved in a money market or in short-term CDs.
MORTGAGE DEBT
They would have trouble refinancing, because they owe more than the home’s value. They could pay down some of the loan balance with the inheritance and try refinancing at that time. They’d have to pay $42,500, plus closing costs, to obtain a $337,500 mortgage with 10% in equity in the house. This would use most of the inheritance and is unrealistic in their current situation.
Mr. Henske’s solutions
COLLEGE SAVING
They are behind in their college savings. To be on track, Jenna’s account should have at least $90,000, and James should have $60,000. They’ve got some work to do in adding regularly to these accounts. From an asset allocation perspective, I always like the age-based models, as they take the guesswork out of this important part of the planning process and help prevent taking an emotional approach to the investing process.
RETIREMENT SAVING
Both John and Jenny should max out their 401(k) contributions. If either of their employers has a Roth 401(k) option, they should take advantage of it. Wherever possible, they should convert any traditional IRAs or former employer 401(k) balances to Roth IRAs. Because the couple sustained losses in the ‘08 crash and seem to be uncertain about equities, I would recommend a less aggressive portfolio to ease them back; they can always readjust the portfolio as their risk tolerance matures. Here’s my recommendation: 55% equities (half in emerging markets and half in developed markets), consisting of large-cap core (5%), large-cap growth (11%), large-cap value (11%), mid-cap (8%), small-cap (3%) and international (17%); 27% taxable fixed income, divided among Treasury inflation-protected securities (5%), high yield (4%), investment-grade corporate (14%) and international/ foreign fixed income (4%); and 18% alternatives, consisting of global real estate (2%), private equity (2%), commodities (4%) and absolute return (10%).
CREDIT CARD DEBT
It would seem logical for them to use their inheritance to pay off the debt. Clearly, from a rate-of-return standpoint, it makes sense. Another option would be to pay off a portion of the debt from the inheritance and then pay down the balance down at the rate of $500 a month. This would get them in the habit of putting money aside. When the debt is eventually paid off, they can switch these payments into a long-term dollar-cost-averaging investment strategy and make those payments into a balanced mutual fund portfolio.
INSURANCE
John is significantly underinsured. The rule of thumb is to protect 10 to 20 times your income. Based on an annual income of $135,000, there should be a minimum of $1.35 million of life insurance on John. The good news is that assuming he’s healthy, he could probably get a policy for the same cost — with double the amount of coverage — by going outside of his employer’s plan. This would also protect him, should he leave his current employer or if his company were to eliminate its life insurance benefits. Jenny’s coverage should also be doubled, at least. The same strategy of looking outside her company for a policy would let her do so for about the amount she’s paying for her present policy.
EMERGENCY FUND
They need to build adequate reserves of at least 12 months’ living expenses — about $72,000. They can use the $50,000 inheritance and existing $10,000 in emergency savings to get started.
MORTGAGE DEBT
The Jones’ current mortgage rate, 6.5%, is significantly higher than what’s available in the marketplace today. Unfortunately, the home value is currently less than the mortgage outstanding, which will make it highly unlikely that the lender will allow this borrower to refinance. They cannot just walk away from the house without significant consequences, such as having to declare personal bankruptcy, which would affect their ability to get any type of credit for years to come.
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Thirtysomethings ask: ‘What do we do now?’
Thirtysomethings ask: ‘What do we do now?’
Rocked by the recession, they are focused on debt rather than savings
March 7, 2010 6:01 am ET
Over the past year, at least six young couples have come to investment adviser Susan Spraker in desperate need of financial help. All of them have children, and the wives, for the most part, have been laid off or are stay-at-home moms. The husbands, many of whom were in real estate or financial services, have lost their jobs and are now in positions that pay far less. All of them are dealing with high amounts of mortgage debt after taking out jumbo loans for homes they couldn’t really afford.
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“They all had these lifestyles of high expenses,” said Ms. Spraker, whose firm, Spraker Wealth Management Inc., has $60 million under management. “Now they are dealing with the shock of: “What do we do now?’”
The financial crisis and recession have had a major impact across all segments of the population, and the young-emerging-affluent class has not been immune. This group has cut back its spending, is heavily in debt and is more focused on improving cash flow than saving for retirement — at least for the short term. While they are not as conservative when it comes to investing as affluent people in general, they are less tolerant of risk than they used to be. They also consider it important to have a written financial plan, even though they acknowledge that they don’t take enough time to manage their finances.
In a December survey of a group it calls the “accumulating affluent,” Merrill Lynch Wealth Management found that 56% had made some adjustments to their lifestyle in the last year. Half had cut back on personal luxuries such as spa visits, and gym and country club memberships, compared with 43% in the affluent population in general.
The survey also found that 57% of the younger group expressed concern about the effect of the economy on their ability to meet their financial goals.
HIGH DEBT LEVELS
One defining characteristic of the young-emerging-affluent class is debt. Whether because of cheap credit or profligate spending, these people are now carrying much more debt than affluent people overall.
Phoenix Marketing International, which at the request of InvestmentNews looked at Americans 30 to 39 with $150,000 or more of annual household income, or investible assets of at least $100,000, found that they have a debt-to-liquidity ratio of 58%, compared with just 18% for the affluent in general.
“Clearly, [the] younger-emerging-affluent [class] has been impacted most keenly by the deleveraging of consumer credit,” a recent Phoenix report says. “With enormous amounts of debt, these investors will be unable to take advantage of many wealth accumulation offers over the short term, and many will likely have to put retirement planning on the back burner.”
Indeed, when Phoenix asked younger affluent people what their single most important financial goal is, only 23% said it is to “assure a comfortable standard of living for retirement” compared with 47% of affluent people overall. The top financial goal for young people (24%) was “improving household cash flow,” a top goal for only 14% the affluent people in general.
While young, debt-strapped investors may not be candidates for retirement planning right now, Phoenix says they offer opportunities for services targeted at credit management and cash flow planning.
Sheryl Garrett, founder of the Garrett Planning Network Inc., which comprises 300 fee-only financial advisers and planners, tells clients who have significant credit card debt to attend a consumer credit-counseling session. Once they’re on the road to recovery, it helps if financial advisers check in with couples monthly to see how they are doing with managing their expenses, she said.
In the Phoenix survey, 59% of respondents said they were willing to take on “calculated risks” to make money, compared with 51% of the affluent market overall. When asked to describe their investment approach, 82% of the younger respondents chose the words “moderate risk” or “risky,” compared with 72% of the total market.
David Thompson, managing director of affluent-market research for Phoenix, said the gap between the young affluent and the total market has significantly narrowed from five to 10 years ago. “The risk profile has become much more conservative,” he said.
Nearly 48% of the young affluent believe it is important to have a written financial plan, compared with 38% of the total market. But 41% say they don’t take enough time to manage their finances, compared with 33% of the total market.
Salesforce.com senior account executive Don Readhimer, 35, who travels frequently for his job, said before hiring Rick Salmeron as his financial adviser two years ago, he rarely looked at his portfolio. Mr. Salmeron is president of Salmeron Financial Network Inc., which has $30 million under management.
“There’s just very little time,” Mr. Readhimer said. “The only time I looked at my investments was during tax time or when we needed the money to do something like buy a car or take a trip.”
Mr. Readhimer and his wife, Anne, also 35 and a food technology director at Yum Brands Inc., have no kids as yet, earn about $400,000 a year, have $260,000 in their 401(k) plans, other investments totaling $340,000 and another $100,000 in their bank accounts, Mr. Readhimer said. They also have mortgages totaling $326,000 on their home, which was purchased six years ago for $380,000.
Mr. Salmeron has found that clients like the Readhimers appreciate the financial planning services he can offer. “My younger clients value time — a lot,” he said. “It’s a huge value to them, because it’s so scarce.”
Lyman Jackson, president of Jackson Financial Advisors Inc. in Newton, Mass., knows that only too well. When he decided to target an emerging-affluent clientele, many of them young parents with children, he realized he would have to make some concessions in light of time constraints.
To accommodate his clients’ busy schedules, he spends a lot of time driving to their homes, staying late at his office for after-work meetings, or arranging meetings in the early morning. And, of course, he often has to call clients back, if kids are screaming and yelling in the background.
NEED FOR FLEXIBILITY
“It’s not a 9 to 5 job, let’s put it that way,” said Mr. Jackson, who oversees $12 million. “Sometimes I go to their homes, and I meet with them around their dining room tables. You have to have a tolerance for kids, but it’s interesting, because it gives you a window into how they live.”
Just a few weeks ago, in fact, Mr. Jackson went to the home of one of his clients who lives outside Boston, to deliver an updated life insurance policy — worth $1.5 million — that does a better job covering a $340,000 mortgage, plus the future education expenses for their two young boys, ages five and eight.
For the client, who together with his wife makes about $400,000 a year, has a net worth in excess of $750,000, and carries no debt outside of the mortgage, the flexibility and the family-friendliness that Mr. Jackson offers have been key during their two-year relationship.
E-mail Jessica Toonkel Marquez at jmarquez@investmentnews.com and Hilary Johnson at hjohnson@investmentnews.com.
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Medicare tax may apply to investment income
The health care proposal that the White House released last Monday would extend the existing 2.9% Medicare tax to unearned income — including interest, dividends, annuities, royalties and rent — for taxpayers with income exceeding $200,000 for singles and $250,000 forcouples.
Currently, the Medicare tax is assessed only on wages or earned income.
The president also wants to hit these higher earners with an additional 0.9% Medicare tax on their earned income. The additional Medicare taxes are similar to those proposed in the Senate’s health care bill.
The new taxes wouldn’t affect income from active participation in S corporations, according to the administration.
Not surprisingly, the life insurance industry opposes the proposed changes. Industry groups claim that Americans already have problems securing their retirement income and that the tax would dissuade many from buying annuities.
“Policymakers should consider tax policy that encourages additional retirement savings and that encourages individuals to take their savings in an income stream that cannot be outlived,” American Council of Life Insurers president and chief executive Frank Keating wrote in a letter to Treasury Secretary Timothy Geithner.
“The administration’s proposal to tax annuity income would counter both of these goals and negatively impact an important tool used to accumulate retirement savings and to secure lifetime retirement income,” Mr. Keating added.
The White House said that the additional revenue from the tax on unearned income would be credited to Medicare’s Federal Supplementary Medical Insurance Trust Fund, which pays for non-hospital care.The additional revenue from the tax on earned income would be credited to the HI trust fund, which is used for inpatient care in hospitals.
In December, Congress’ Joint Committee on Taxation estimated that expanding Medicare taxes — as the president is proposing — would raise $111 billion in revenue over 10 years.
The administration’s revised health care insurance plan would reportedly cost about $950 billion over 10 years.
Securities Industry and Financial Markets Association spokesman Andrew DeSouza declined to comment.
The Investment Company Institute didn’t return e-mails seeking comment.
Darla Mercado contributed to this story.
E-mail Dan Jamieson at djamieson@investmentnews.com.
Expected about-face on placement agents invites criticism
After facing a storm of industry protest, the SEC is now looking at a regulatory solution to take the place of the ban that it originally proposed.
But “the issue isn’t one of regulating them properly — it’s an issue of [placement agents] selling their influence,” said Mercer Bullard, a former SEC lawyer and founder and president of Fund Democracy Inc., an investor advocacy group.
Even if agents work under the guise of a broker-dealer, the influence-peddling will continue, he said.
The SEC proposed the controversial ban last fall along with limits on how much advisers could give to political candidates and a prohibition on raising money for political parties. Placement agents typically help hedge funds and private-equity managers get business from institutional investors.
The proposal was prompted by a number of scandals involving public pension funds and placement agents, some of whom were politically connected former state officials.
Observers say that many agents aren’t registered as brokers or advisers.
Many large investment firms run their own placement-agent units.
About 400 smaller broker-dealers also work as placement agents, according to Lisa Roth, chief executive of Keystone Capital Corp., and a ban would be a severe hardship for them.
She and other industry observers say that requiring registration would level the playing field — a suggestion that the SEC is considering.
“If broker-dealers were prohibited by [the Financial Industry Regulatory Authority Inc.] from engaging in pay-to-play practices on behalf of investment advisers, then perhaps they could continue … to serve as placement agents,” John Nester, an SEC spokesman, said in a statement.
SEC staff members haven’t yet made a final recommendation to the commission regarding the proposal, he said.
In December, Andrew “Buddy” Donohue, director of the SEC’s Division of Investment Management, asked Finra to consider implementing pay-to-play rules for broker-dealers who work with advisers.
Finra spokesman Herb Perone said that the request is “under discussion.”
Many of the several hundred industry members who submitted comments to the SEC on the proposal suggested that placement agents should be registered and regulated rather than banned.
They argued that placement agents provide valuable services to pension plans and give smaller managers a chance to gain business from large pools of money.
“The ones hurt [by a ban would be] small, emerging managers, minorities and women-owned firms that don’t know how to present themselves to the marketplace,” Ms. Roth said.
Critics of placement agents, though, say that large investment funds shouldn’t have a problem finding smaller, competent managers on their own.
State officials and pension funds also opposed a ban on agents.
In a comment letter, Connecticut Treasurer Denise Nappier said that banning placement agents would deprive “institutional investors of … valuable services” and that “the blanket ban on contributions to political-party committees is fraught with enforcement challenges and unfairly affects party committees in states like Connecticut with … robust campaign-finance laws.”
‘LEGITIMATE PRACTICE’
Sen. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, jumped into the fray last month with a comment letter to the SEC reiterating Ms. Nappier’s point that using placement agents is a “legitimate and beneficial business practice.”
“It’s remarkable that someone from Connecticut of all places wouldn’t understand the issue with placement agents,” Mr. Bullard said. “It’s the site of one of the most abusive pay-to-play regimes we’ve seen.”
Connecticut enacted a tough pay-to-play law in 2005 after then-Gov. John Rowland resigned in the midst of a corruption investigation. He later served 10 months in prison.
The state bans lobbyists and prospective state contractors from making campaign contributions to candidates for statewide offices, and requires placement agents to be registered.
A spokeswoman for Ms. Nappier declined to comment.
Public officials and the plans they oversee “have a vested interest” in seeing political contributions continue, said Edward Siedle, founder of Benchmark Financial Services Inc., a consultant to pension plans.
That is why critics say an outright ban is needed.Placement agents are “basically political insiders, devoid of investment credentials, who are being compensated to sell … unregistered products to funds within a politicized investment process,” Mr. Siedle said.
“The use of placement fees has grown exponentially,” he said, adding that public pension plans have “tripled and quadrupled” the number of money managers they use, and “every one is [paying] a placement fee.”
Although institutional clients generally have a formal bidding and selection process, “you’re much more likely to win a contract if you’ve hired the right people and made political contributions,” Mr. Bullard said.
Getting around consultants and staff designated to review all applicants “is precisely the conduct which is objectionable,” said a comment letter submitted by Common Cause, a good-government group that supports the ban. A call to Common Cause wasn’t returned.
Although Mr. Siedle questions the need for placement agents, he said that a registration requirement would help. “A lot of placement agents would find it very uncomfortable to operate under the level of scrutiny that a broker does,” he said.
Many placement agents are former elected officials, lawyers or lobbyists, and “oftentimes, they’re successful because they don’t appear to have a stake in the outcome” of a successful sale, Mr. Siedle said.
Disclosure requirements and other rules would make it clear to investors that agents are operating on behalf of the money manager, he added.
E-mail Dan Jamieson at djamieson@investmentnews.com.
Secondary market for annuities comes under pressure
Last Monday, the Interstate Insurance Product Regulation Commission, composed of the insurance regulators from 35 states and Puerto Rico, voted in favor of a uniform provision that would allow insurance carriers to terminate at their discretion guaranteed living and death benefits in the event of a change in ownership or assignment.
Indiana was the sole dissenter among the represented jurisdictions.
The vote could make it harder for clients to sell annuities to others, which could limit the attractiveness of the market.
The commission will officially announce the provision this week, and it will likely become effective by the end of May, according to executive director Karen Schutter.
The commission applies uniform structural standards to life insurance policies and annuities sold in the member jurisdictions.
The reasoning behind the commission’s decision, members have said, was concern over the price of the products and the potential for controversial stranger-originated transactions.
The approval of the provision has already struck a nerve with the National Conference of Insurance Legislators. That group’s president, Robert R. Damron, a member of the Kentucky House of Representatives, has since proposed legislation in the state’s General Assembly to exclude the Bluegrass State from having to comply with the commission’s decision.
Although life settlements, which are a secondary market for insurance, and the secondary market for annuities aren’t the same, they share some commonalities. The Life Insurance Settlement Association was in communication with the commission on the proposed provisions, opposing their passage.
Experts in the life settlements field have a hard time determining the exact size of the secondary market for annuities but estimate that it is much smaller than the life settlements market. Last year, life insurance policies with some $8 billion in death benefits were settled, according to estimates from Aite Group LLC.
“We want to preserve consumers’ ability to [sell their products in the secondary market] if their products don’t perform,” said Brian Staples, president of Right LLC, a regulatory-compliance consulting firm that specializes in life settlements.
“We know that there are annuity products that aren’t performing as they were sold,” he said. “We know that there are consumers whose circumstances have changed because of the crisis.”
Some of the better-known players in the small annuity-purchasing business are J.G. Wentworth Inc.and Peach-tree Financial Solutions.
Other companies think that there is a potential for growth when it comes to buying underwater variable annuities from clients who don’t want them.
“Consumers own valuable variable annuity contracts now, and their death benefits are very high,” said an executive at a firm that has been aggregating variable annuities. The executive asked that neither he nor his firm be identified because the company is approaching broker-dealers in the hope of giving firms an option when clients want to sell an annuity.
ADDITIONAL OPTIONS
Advisers and consumer advocates assert that annuity holders could benefit from the existence and growth of such a market.
“I’ve had clients who could have benefited from the legitimate sale of their variable annuity in the secondary market,” said Joy Slabaugh, partner at EST Financial Group. She declined to disclose the amount of assets the firm has under management.
In one situation, a client wanted to surrender his variable annuity because he had a large purchase in mind — a helicopter. Despite Ms. Slabaugh’s attempt to dissuade the client from cashing in the annuity, the client surrendered the product and got his cash.
“There are times like this when a person’s objective changes and the investment that was suitable a few years ago is no longer suitable,” she said.
“The way I see it, there were some riders on this annuity that could’ve been attractive to an institutional investor. Having a secondary market provides more liquidity options,” Ms. Slabaugh said.
Although she has never conducted such a transaction, she noted that her broker-dealer, H. Beck Inc., would call for extensive scrutiny on the sale and questions on the suitability. The firm would most likely have to supervise the business, per the Financial Industry Regulatory Authority Inc.’s rules on how broker-dealers are supposed to approach life settlements with variable insurance products.
The option of turning to the secondary market gives the consumer a chance to bail out if the product was sold inappropriately in the first place, said Birny Birnbaum, executive director of the Center for Economic Justice. He criticized the commission’s decision to push forward with the provision to allow insurers to terminate guaranteed living and death benefits.
“We don’t have effective suitability requirements, so when customers are sold inappropriate annuities, insurers have a monopoly on what you can do,” Mr. Birnbaum said. “This is the life insurance industry getting the government to shield them from competition, so the customer suffers as a result.”
In light of recent news reports on the controversial third-party sales of annuities on sick people so that investors can reap the death benefit and make aggressive investment plays, insurers have raised concerns that a secondary market could encourage stranger-originated-annuity sales.
“Without the ability to terminate riders, there’s a market for [stranger-originated life insurance] with guarantees, which would be detrimental to the genuine consumer’s interest,” Michael Lovendusky, vice president and associate general counsel of the American Council of Life Insurers, said during the conference call.
Mr. Staples argued that it is inaccurate to equate improperly written insurance products with the nature of the overall secondary market.
“The secondary market has been supportive of enforcing insurable interest; we don’t want improper annuities, because they taint the marketplace,” he said.
“Of course there’s concern about stranger-originated annuities, but the response to those types of abuses isn’t to eliminate the market,” Mr. Birnbaum said.
“That’s like saying that there are problems in the secondary-mortgage market, so we should eliminate the market altogether,” he added. “That’s insane.”
E-mail Darla Mercado at dmercado@investmentnews.com.
Financial advisers bullish on 529 plans
Out of 216 advisers surveyed by InvestmentNews for the College Savings Foundation, 88% said that they recommend 529 plans to clients, and when they do, they tend to consider both in-state plans and out-of-state plans.
The results of the survey were presented at the foundation’s annual conference last week in Miami Beach, Fla.
Among those who don’t recommend the plans, 90% said that it is mainly because they prefer other investment options. Almost 60% of the advisers who don’t recommend the plans said that it is because they don’t like the available investment options.
Most advisers surveyed (79%), however, said that they are well-informed about 529 plans. Those who said that they weren’t as well-informed would like more information about the differences among the state plans and how 529 plans fit into an overall financial plan.
They want to know more about using 529s as an estate-planning tool, how 529s affect financial aid, and the relationship of 529 plans to HOPE Scholarships and lifetime learning credits.
One conference attendee said that advisers have to take the initiative to learn about 529 plans in order to do the best job possible for clients. Antoinette Chandler, a senior vice president at Morgan Stanley Smith Barney and a member of the ScholarShare Investment Board, recommended that advisers research available 529 plans, come up with a list of favorites and provide clients with a choice of three possibilities.“Financial advisers have a lot of power,” she said during the conference.
“It is absolutely our job to educate and deliver a very clear and concise message to clients. Clients don’t want to do the work, but that’s why they’re coming to you,” Ms. Chandler said.
Those in the 529 plan industry are pinning their hopes on advisers to help boost sales.
According to the results of another survey, this one by the CSF of 49 of the industry participants who attended the conference, the best way to market 529 plans is through advisers.
So far, advisers have been an important driver for 529 plans, which now hold more than $115.4 billion across the United States, according to Morningstar Inc.
Looking forward, industry experts said that they think that given a higher tax environment, 529 plans will become even more popular and, hopefully, even more highly recommended by advisers.
“529 plans will become more important for any family, in any tax bracket, looking to save for college,” said Peter Mazareas, chairman of the College Savings Foundation and consultant to AllianceBernstein Investments Inc.
Virtually all of those surveyed by the foundation said they are either “very optimistic” or “somewhat optimistic” about the long-term prospects for 529 plans.
And even in the short term, 59% of conference attendants surveyed said that they are “somewhat optimistic” about the growth of 529 assets and accounts, while 20% are “very optimistic.”
Those who are less sanguine are still licking their wounds after the financial crisis, which hit 529 plans hard.
Early last year, the Financial Industry Regulatory Authority Inc. also issued an alert to reps and broker-dealer executives asking them to think twice before selling 529 plans, claiming it was “concerned that investors may be shortchanging themselves by investing in 529 college savings plans with high fees, plans that currently do not offer them state tax benefits, or both.”
However, the economic environment is less of a concern this year than it was last year, the CSF survey suggests. Other important concerns for industry participants include poor consumer awareness of 529 plans, their small size overall, relative to some other investment choices, and the plans’ operational complexity.
E-mail Hilary Johnson at hjohnson@investmentnews.com.