Dodging the DOL Chainsaw: Small Business Owner Protection

The DOL is Coming!   The DOL is Coming!

As if you weren’t already up to your elbows in rules, regulations, and expenses, the Department of Labor has empowered itself to fine at least half of the Employer/Plan Sponsors it audits… for multiple investment related reasons.

These include, among other things, the cost of the products in your investment menu and the market value performance of those products. As a plan fiduciary (right, you are a plan fiduciary), it’s your job to keep costs below average and performance above average…. and, yes, you are deemed responsible for your employees private investment decisions… no matter how foolish.

Hardly seems fair, does it. You give them money to invest, and you’re too blame when they mess up.

But, true to form within the 401k “space”, no one (other than the plan participants) seems to care about the retirement income benefit that 401k plans should provide to employers and employees alike… not even the DOL, ERISA champions of the interests of employees.

Since roughly half the plans will always be below average, it’s fair to expect that large numbers of plans will be fined….

In fact, 70% of plans audited in 2013 were penalized or forced to make reimbursements. Neither ETF providers nor Mutual Fund promoters share this responsibility with you, and all of this stress is on top of the “top heavy” problems you deal with year, after year, after year…

You may be able to protect yourself from the fines and the “top heavy” audits in one fell swoop by switching your plan to a professionally-managed-by-a-fiduciary, self-directed 401k they call a “Safe Harbor” Plan. In this type of plan, there is no menu of one size fits all products, none of which focus on income purpose investments that support the ultimate benefit of the program.

You see, the goal of the providers is to keep your money in their funds forever, hoping for upward only markets and their ability to convince you that you just can’t do better than 2% income anywhere. That’s the 401k space “end game”, but you can do much better, and considerably safer in a… “Safe Harbor”, managed growth and income program…

In the self directed, private portfolio “space”, you can require the safest equity selections, and growing retirement income, in a flexible asset allocation geared to the age and risk profile of each participating employee. Employees don’t have to participate, but you have to provide an immediately vested matching contribution if they do…. BUT, the top heavy problems disappear, and your contribution levels have no backdated limitations.

Not so long ago, I brought a QDI (Quality, Diversification, and Income) portfolio series to the 401k space. None of the product pushers were even slightly interested in any facet of the program… not even the superior retirement income generation capabilities… the “good ‘ole boys club” just couldn’t be bothered.

With the stock market at the peak of a six year sustained rally, what protections do you have from a correction? In the managed programs I’m describing, equity profits have already been taken, and the income keeps growing… monthly, in most cases. The Target Date Funds 401k providers are in love with are low quality equity, seriously low income time bombs, ready to go… KABOOM!

The Vanguard 2015 Fund, for example, was 50% invested in no less than 5,000 stocks at the end of January 2015; the total portfolio income was just barely 2%. What do you think the 2020 or 2025 portfolio looks like?

Here’s a look at the workings of a professionally managed retirement income program: a high quality, individual security, 30% Equity portfolio, generating three times the Vanguard 2015 TDF income, with a whole lot less risk:

https://www.dropbox.com/s/28ty6z5dkgn5ulu/Retirement%20Income%20Webinar.wmv?dl=0

Hmmmm, Small Business Owners, seems to me that would resolve your fiduciary issues.

Pitfalls of Target Date Funds… and some proposed replacements

The LinkedIn Group Communities are abuzz with the idea that, even as popular as they have become, Target Date Funds (TDFs) are just not wonderful after all…

Several fixes have been proposed. I’ve done so myself. as you know. This one is from plansponsor.com “A Better Option than Target Date Funds” and needs some cautionary commentary.
——————————
What to say when you agree that Target Date Funds are a sham, and do little to prepare 401k plan participants for retirement?

But what to shout out loud, when the fix for a low income, inappropriate asset allocation, is a “half-gainer” into a river of high risk speculations being promoted as “alternative investment” asset classes!

Note that “alternative investment” is a euphemism for those high risk mechanisms described in Investments 101 textbooks as “speculations”.

No matter how they are sliced, diced, sauteed, or seasoned, no recipe for speculations will ever produce the taste of a fundamentally sound investment.

Similarly, when considering ETF derivatives, the risk increases exponentially with each level, so a fund of funds is likely to be riskier than the funds it contains.

The article mistakenly merges all “Life Cycle” programs and products into the TDF category. There are at least three that are retirement income focused, and asset allocated to accommodate several different risk tolerances at retirement.

They are constructed with Investment Grade Value Stocks and Income ETFs. Not sexy at all, but they should provide lower drawdowns and higher income… and they can be converted security-for-security into a rollover retirement portfolio at any time.

Target date funds do not prepare us for retirement, though they may shield us a bit from maximum correction drawdowns.

My concern with them is that the inappropriate DOL/SEC focus on fund expenses and market value is (all good intentions aside) producing a low income retirement scenario that will only generate enough income if the market never, ever, goes down.

The popular Vanguard Target 2015, for example, is more than 50% in the stock market (with no signs of reducing exposure) and generating much less than 2% in spending money.

The fund holds positions in more than 5,000 different stocks (there are less than 500 Investment Grade Value Stocks)… clearly not a retirement fund in any sense of the word. The ideal “retirement fund” never invades principal, thus allowing for growth in the annual income provided.

But the portfolio alternative being proposed in the PlanSponsor.com article is absurd, or should be to any plan sponsor or fiduciary.

Commodities, private real estate, private equity speculations, and hedge funds may well be alternative asset classes BUT they are absolutely not investments. These are textbook speculations, nothing more, and certainly nothing that should ever be considered  suitable for a retirement program.

The Retirement Income Gap

A BlackRock and EBRI analysis (from Think Advisor, July 9th) suggests that older retirees are further from being retirement ready than their younger counterparts… go figure.

Ironically, since most benefit plan investors (really speculators) at all ages are market value focused instead of income focused, this observation will likely be the same ten years from now.

… and this is so easy to fix, if plan participants are forced to start thinking “income” from the get-go. Retirement readiness is a planning issue that “target date funds” and most other 401k product shopping menus are just not equipped to deal with.

Plan advisors, fiduciaries, and plan sponsors need to make sure they have “serious income production options” in the benefit plans they are advising.

What if you could liquidate your “all time high market value with nearly zero programmed income” benefit plan balances and trade them in for a 5% or so compound income machine that is convertible, security for security, at retirement? You can. And, at retirement, you’ll actually be able to increase the income production significantly with a few simple tweaks….

Here’s where the 401k industry and DOL focus on expense ratios make no sense at all. Income Closed End Funds pay in excess of 6%, and have for years. Nearly all of them (the hundreds that I’m familiar with) continued their payments without a hiccup throughout the financial crisis and continue to do so now…

The 6% is AFTER EXPENSES. The best from Vanguard Target Funds is maybe 1.5%; Stable Value Funds are in the 2% area, again, maybe….

Isn’t it our fiduciary responsibility to focus on the income purpose of benefit programs? Isn’t it our responsibility to educate plan sponsors and participants enough so that they understand that it is the income that pays the bills… not the market value, and not the three year total return.

Isn’t our responsibility to school the DOL…. that performance of a retirement income program should be measured in terms of income production… and that market value and expense ratios are not the predominate considerations? Well maybe not that one.

There is only one product I know of that has the proper income focus — and with a reasonable expense ratio. For more information, contact a qualified 3(38) fiduciary at either QBOX Fiduciary Solutions or Expand Financial.

Investment Industry needs independent players!

The most recent print issue of Money noted that the big Canadian banks managed to earn $31.7 billion in 2012, just a few years after there was grave concern that they’d even remain solvent.

“There is no question that Canadian banks play a vital role; locally, provincially, nationally and inter-nationally. Without the banks, our economy could simply not function efficiently or effectively. But are the banks getting too big and going too far to gain market share and profits at the expense of their own customers?” (Quote from Spring 2013 issue of Money Magazine.)

In November of last year I published a piece entitled Banks own the investment industry! A good thing? In many respects allowing the banks to provide everything from our mortgage to investment services is incredibly convenient. But at what price? It has become near impossible for many smaller investment dealers to stay in business. Fraser Mackenzie is a recent victim of an industry that requires scale in order to compete:

At their shareholder meeting on April 29th, 2013 it was decided: “Our assessment of the current business climate has led the owners to conclude that deploying our capital in the continuance of our regulated investment dealer businesses can no longer generate an acceptable rate of return. Institutional interest in early stage mining and oil & gas companies, sectors to which we have been heavily committed, has dried up: as has the associated trading in the equities of early stage resource companies. Furthermore, the regulatory cost burden is increasing at a time that industry-wide revenues are declining. On balance, it makes sense for our shareholders to re-deploy their capital.”

Indeed, well over half of the total value of trading done on the TSX in a typical month is conducted by the banks.

My guess is their actual market share of all trading is far above half if we were to also include trading platforms not part of the Toronto Stock Exchange. The banks keep growing, and the regulatory burden also grows more onerous. In my estimation, the larger financial companies relish regulation as an additional barrier to entry. Regulatory oversight is a minor inconvenience to the big banks, whereas for less diversified specialty businesses (mutual fund companies, standalone investment dealers, investment managers) the added expense can be devastating.

Obviously there are huge benefits to scale – but do consumers really benefit or are these economies of scale all kept as bank profits? MER’s for their proprietary mutual funds might appear very reasonable, but it’s impossible to determine whether or not the plethora of fees I pay for other services are subsidizing these seemingly lower expense ratios. Transparency is near impossible. Although many banks did collapse as a result of the the financial crisis, the massive rebound in the profitability of those surviving banks (even though they lost ridiculous amounts of capital doing stupid things with asset backed securities, derivatives trading etc.) suggests that those everyday fees paid by consumers and businesses must exceed the marginal cost of providing these services by quantum leaps and bounds.

Another concern I have – besides the demise of competition in the financial services industry – has to do with motivation. It’s true that every business is designed to make money, but in days of yore a mutual fund company, investment manager or stock broker had to have happy customers in order to succeed. If they didn’t help the client make money, the client would go somewhere else. I believe that as each independent firm disappears, so does choice. Making a great deal of money from you no longer requires you to be served well. What are you going do? Go to another bank?

The prime directive (to borrow an expression from Star Trek) of the financial services behemoths is profits. The financial advisor’s role is to enhance corporate profitability. Financial advisors today are increasingly handcuffed not just by regulatory compliance, but also ‘corporate’ compliance. Wouldn’t an investment specialist whose only mandate is to do well for his client be more properly motivated (and less conflicted professionally)? Would your investment objectives be better served by an independent advisor who is rewarded only because you the client are earning profits (and not because you are earning his employer more revenues)?

It isn’t necessarily true that an independent advisor is any better than one employed at a bank. I personally know of hundreds of outstanding advisors working at banks and insurance companies. But it must also be true that a satisfied, properly motivated, objective and focussed financial professional will do a better job whether he/she is at an independent or a bank.

We can’t begrudge the banks their success but left to their own devices, they’d all have merged into one by now. In December of 1998 then Canadian Finance Minister Paul Martin rejected the proposed mergers of the Royal Bank with the Bank of Montreal and CIBC with the Toronto-Dominion Bank. We know from our U.S. history that government and regulatory authorities are frequently frustrated by the political muscle (lobbyists, lawyers) of the large financial firms. Ultimately having one gigantic Canadian bank – providing all our financial services, investment needs, insurance requirements – might (or might not) be a worthy corporate ambition, but it’s hard to imagine such a monopoly being good for the likes of us. After all, just consider the progress that has been made in telecommunications since Bell Canada (or AT&T) was forced to reckon with serious competition.

The banks need independent players. Not only should banks discourage the obliteration (by bullying or by absorption) of non-bank competition, they should use their political muscle to keep the regulators from picking on Independent players. Government agencies cannot help themselves – if they are impotent against the strong they naturally attack the weak – even though when all the weak are dead the regulators would have no jobs. You don’t need a police force when there’s nobody you can effectively police.

Independent players create minimum standards of service and ethics, and fuel industry innovation. In every instance, the independent is a bank customer too. Mutual fund and investment managers pay fees to banks, buy investment banking offerings, custodial services and commercial paper and also trade through bank facilities. Independent dealers provide services and financing to corporations deemed too small to matter by larger financial companies; that is, until these businesses grow into large profitable banking customers. Put another way, why not adopt the Costco model where smaller independents can shop for stuff to sell to their own customers, and higher end specialty shops and department stores can all remain standing, rather than the take-no-prisoners approach of Walmart?

Let’s hope that the few surviving independent firms can be allowed to thrive, and if we’re lucky perhaps new players will arise to provide unique services to Canadian clients and homes for advisors who are inclined to specialize in managing and not just gathering assets.

Mal Spooner

 

 

 

 

 

Conflicting “fiduciary duty” – who is first, the client or the company selling the product or service?

Assuming this comes to pass, how do the institutions sort out the conflicts? Over the past year or so, I have been looking at a number of codes of conduct for employees and advisors within the financial services industry and they do make interesting reading.

The all have some type of statement along the lines of: “I hereby agree to conduct the affairs of XYZ Financial Institution in a manner consistent with standard operating practices and procedures and acknowledge that I have at all times, a fiduciary duty and responsibility to XYZ Financial Institution.” This is wonderful, but interestingly enough, in all of my reviews, I have NEVER once seen a statement that says that the employee also has a fiduciary duty or responsibility to the clients. This same scenario applies to advisors who have to sign codes of conduct or similar statements acknowledging that they will treat the companies they represent fairly, etc.

The conundrum therefore is – which fiduciary duty has supremacy? The duty to the financial institution or the duty to the client? Consider the following two examples.

So far, none of the work from the Canadian Securities Administrators has examined these issues and nor, does it appear, that the rest of the financial services industry has considered them either. IMHO, this needs to be very carefully examined by all constituents. I believe, speaking personally of course, that the priority must be with the interests of the client. Any comments??

Finding an investment adviser is no easy task!

 

When RRSP season rolls around, it’s not unusual for dissatisfied clients to consider firing their investment adviser and finding a new one.  Even though most of the time it’s the client who’s the problem and not the adviser (more about this later), once the decision is made the question is how to select a new adviser?

Out of the several thousand investment advisers and financial planners I’ve met over the years, at least a few ‘hundred’ have what I consider to be the savvy to do an excellent job for their clients.  If only 10% of potential advisers are exceptional, finding one will require some work.  Ideally some of what follows will make the job a bit easier for some.

The most important thing to remember is that a capable stockbroker or financial planner doesn’t have to meet the stereotype.  For example, I was looking to hire a new sales rep for my fund company and received a resume from a fellow who was actually an investment adviser looking for a change.   I arranged to meet with him, and just happened to be standing on the street in front of our building when this black BMW pulls up, and a jittery youngster (young compared to me anyway) gets out.  He has his hair gelled straight back like Gordon Gekko, the fictional bigwig from the movie Wall Street, wearing the well-tailored pinstripe suit complete with suspenders that weren’t really necessary.  I didn’t hire him.

Beware of those advisers that are into role-playing.   It is okay I suppose to have a nice car, but a ‘look-at-me’ aura is a warning sign.  When someone deliberately adorns the trappings of success, I believe there’s insecurity in their personality.  Certainly your adviser should exude confidence but shouldn’t need or want to stand out from the crowd by adorning themselves with accoutrements.

You must be realistic.  Your adviser does work for a financial services firm, so expect to be using products and services offered by his company.  However any evidence that he/she is willing to deviate from the company’s party line for your benefit is a very good sign.

Ask him/her what he/she thinks about the market or a mutual fund, or even an individual stock or two.  If he/she simply regurgitates the newspaper headlines or is in love with a top performing mutual fund (you can’t ‘eat’ past performance is one of my favorite expressions), or his/her favourite stocks are everyone else’s favourite stocks too, you might want to avoid this adviser.  On the other hand, if you sense a real independent thinker willing to disagree with conventional wisdom, the adviser is a keeper.

Larger firms are especially good at marketing their wares, and I would recommend that it is infinitely better that you look for the right adviser rather than to just agree to hire the one that lands on your doorstep.  Keep in mind that good investment managers are not always good with people.  A good first impression is not necessarily an indication that the adviser does good work. Ask questions.  For example, ask exactly how they handled themselves in the financial crisis?

Even though it is extremely difficult (likely impossible) to predict market declines, anyone can certainly “do something” about their circumstances once the proverbial poop hits the fan.  Investment professionals often respond differently depending upon depth of experience or temperament:

  • Some are no more experienced (or no smarter) than their clients – they panic and sell at the bottom of markets.
  • Some proclaim a new respect for caution, and hold more cash and bonds….after it’s too late.
  • Some boldly acknowledge they didn’t see the Bear Market coming, apologize and admit that they are buying cheap assets aggressively ‘near’ the bottom (a good sign indeed).

Asking tough questions will enable you to determine whether you’re talking to a pro.  Don’t be afraid to sound stupid – it’s your money we’re talking about here and not your ego.

You may want to stay with the big firm you’re banking with for convenience, or choose to find a smaller firm that is more specialized in managing money for individuals.  It is much easier to learn about what motivates the professionals in a smaller wealth management boutique, learn about their investment philosophy and get personal attention.

Heads up!  When a firm’s performance presented to you seems too good to be true; it probably is.  A prime example was the case of Bernie Madoff.

In March 2009, Madoff pleaded guilty to 11 federal crimes and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors out of billions of dollars. Madoff said he began the Ponzi scheme in the early 1990s. However, federal investigators believe the fraud began as early as the 1980s, and the investment operation may never have been legitimate.

Even small wealth management companies ordinarily have their performance numbers calculated and audited by third party services.  Make sure any performance data you see has been vetted by an independent third party.  Although instances of fraud get volumes of press coverage, they are one in millions.

Most boutique investment firms aren’t gifted marketers, and they rely heavily upon word-of-mouth to get new clients.  Ask friends, your accountant or lawyer for referrals.  There’s no harm calling and arranging to visit a few firms.

Tips:

  1. Never hire a Wealth Management firm based only on past performance.
  2. Don’t complain about investment results.  Ask for an explanation.
  3. Never second guess your adviser.
  4. Pay the fees – sure hey hurt when performance is poor, but you won’t care at all when performance is good.
  5. Be patient. Good things don’t happen overnight or every day.

Don’t pretend to be smarter than your adviser, you’re not!  Tips number 2 and 3 are very important.  I mentioned earlier that oftentimes the client is the problem, not the adviser.  In times of stress, we have a tendency to let our emotions get the better of us.  It’s kind of like swimming – if you panic then you’re more likely to drown.  Your investment adviser cannot walk on water, but is trained to swim.  There is an infinite number of things that can and do damage investment portfolios. The most damaging crises cannot generally be controlled, but wealth can be salvaged and even restored if level heads prevail.  Click on the picture to watch a funny video I made – are you at all like this client?

 

Mal Spooner