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Category: Bob Veres’ Blog
Does it make sense to allow Wall Street to write the rules of the game for their own benefit?
How can we predict the future, and what is the most likely outcome of the problems we see now?
The world is our best teacher, if we have the wit to understand her lessons. And 2012 provided, for me, one of the best, clearest and most useful lessons of my brief career in this profession. I think we can all say with confidence that 2012 was not one of those happy time periods where the world seemed to be shining with opportunity and optimism. There was the Libor scandal, the continuing saga of the Eurozone credit mess, miserable jobs reports and painfully slow recovery from the Great Recession that is now 4 years behind us and still casting its shadow over our economic growth and psyches. Morgan Stanley and Jon Corzine found creative ways to make billions of dollars evaporate. After all the negative advertising in the runup to the highly-partisan Presidential election, I sometimes felt as if the end of the world was upon us. And then came the fiscal cliff debate. I find myself wondering: How can such an awful year have turned out so great for investors? When people of the future look back at their investment history, they'll probably think of 2012 as one of those bright, happy years for U.S. stocks. The Wilshire U.S. Large Cap Index provided us with a 15.75% return last year, and all the various other indices, domestic and foreign, were up at least 13%. Eurozone stocks rose an aggregate 17.45% for the year. No doubt, those people of the future will think of 2012 as a time when we were confident about our economic future and the direction of the markets. Haven't you heard it said that it's easy to invest in those years when the markets are generating double-digit returns? The lesson I take from this is that it really is never easy to stay invested, and only in retrospect can we say that any random 12-month period was a good time to hold stocks. Most of the friends and neighbors I talked to about the markets were asking me how to hedge against the possibility of a dramatic drop, or a recession, or some unnamed catastrophe that would occur if we elected one or the other candidate for President. At professional conferences, it was much the same. The conversations were often directed toward taking money off the table and skepticism about the future. We can learn from 2012 what we could have learned in any random year, but perhaps the lesson was clearer in the past 12 months: that it is very hard work to keep your clients invested even in the years which, in retrospect, turn out to have been generous. There will always be things to worry about, and manifold indications that the future is not bright. The next time I look back at those years when the markets delivered above-average returns, I'll know that the people who actually received those returns were pretty brave, and had a lot of doubt, uncertainty and headlines to ignore, even if we don't remember them today. I have no idea what 2013 will bring, but the odds in the investing casino are pretty good: seven out of ten years deliver positive returns. I have learned all over again, perhaps more clearly now, that trying to predict what's going to happen in the swirl of global headlines is not a game I want to engage in. Many of us were fearful and perhaps a little depressed this past year, and yet we got a pretty darned good return on our stock investments. This coming year, I'll take the odds. And I'll predict, here and now, that in the coming 12 months, there will be myriad great reasons not to own stocks, and many great arguments that the end is just around the corner. I'm willing to bet all comers that 2013 will be another tough year to stay invested–and that if we have another year of double-digit gains, most of us will soon, again, forget how tough it was.
My first instinct, when I saw that Elisse Walter had been nominated to replace outgoing SEC chairperson Mary Schapiro, was to go into a long and angry rant. I think it was obvious to everybody but the current Administration that Schapiro's primary focus at the SEC was to advance the causes that she had pursued when she was CEO of FINRA: protect the brokerage regulatory model, make sure nobody went to jail after visible accounting fraud in the brokerage world in 2008, and transfer regulatory oversight of RIAs from the SEC to FINRA–because, well, that's what the brokerage industry was asking for. Walter, of course, was Schapiro's chief assistant at FINRA before following her over to the SEC to sit on the Board of Governors. It would be hard to find any policy differences between them, which means that once again the fiduciary RIA community has an enemy sitting in the SEC's top chair. I think history will record that Schapiro was, of all SEC commissioners, the least interested in meaningful consumer protection, but it is possible that Walter will become, in time, her chief rival. If, that is, she is nominated to take over the SEC chair for a full term. It is still possible that the Obama Administration–which seems clueless about fiduciary issues and strangely beholden to a Wall Street community that offered little support for his candidacy–will nominate somebody else. Bloomberg Press wants Sallie Krawcheck, currently employed at Merrill Lynch, to take over that role–which sounds like Wall Street offering the president a choice of cronies who are cozy with the brokerage industry. What I find myself wondering, though, is why we keep hiring people from the nonfiduciary world to run the regulator of fiduciary advisors? If we ask that question, posed in that way, it becomes obvious that Wall Street is controlling the selection process–the same Wall Street that fears being held to a consumer-focused strict fiduciary standard because, well, how can you make an obscene profit by putting the clients' best interests first? This is, of course, the same Wall Street that Congressional leaders declared would be reined in after they precipitated the 2008 meltdown. I think the RIA world should get behind another candidate, and I think I see a plausible one: David Tittsworth, who currently serves as executive director and executive vice president of the Investment Adviser Association. I finally met Tittsworth in person recently, and of course have followed his work for years. He's thoughtful, smart, he knows the RIA industry better than anybody Wall Street is likely to recommend, and my impression from dozens of communications and the personal contact is that he is a genuinely good person–something I cannot imagine myself saying about Schapiro and Walter. They are great organizational infighters, terrific politicians, sly, shrewd and very smart. But "good" is not the first word that comes to mind about either of them. Tittsworth may not want the job, but it seems to me that if we can pull top executives from the brokerage industry's primary organization to run the SEC, it makes a hell of a lot more sense to do the same thing from the RIA world's. Do you agree?
Before I get too deeply into my commentary, please take a look at the chart to the right, which shows the monthly mutual fund flows, in billions of dollars, into/out of bond funds (green bars) and stock funds (blue bars) since the end of July, 2008–measured in billions of dollars as per the scale on the left. Take your time; I'll be here when you get back. Welcome back. I think it's pretty clear that, after everybody sold all their investments like lemmings during the 2008 disaster, an enormous amount of money has poured into the bond side of the stock/bond allocation over the past four years, and a corresponding tidal wave of consumer investment dollars has continued to flow out of stocks. Seeing the actual dollar flows in graphical form–taken from the Investment Company Institute website–makes one wonder how we managed to sustain a mini-bull market in stocks since March of 2009. It also suggests that an awful lot of people have parked their money in what they believe are the safe haven of fixed-income investments, and are safely divested out of those risky stocks. There may once have been some logic to this–at least short-term. The Fed, with its QE3 program and ongoing Operation Twist, has been driving interest rates lower in two of the major components of the Barclay's Capital Aggregate Bond Index using the simple expedient of buying everything in sight with newly-created money. As David Schawel points out on the Advisor Perspectives forum (http://advisorperspectives.com/newsletters12/Will_Bonds_Be_Burnt_to_a_Crisp.php#) roughly 18% of the index is represented by Treasury bonds, which, as a result of the greater demand manufactured by the Fed, have generated a total return of 3.77% so far this year as 10-year rates have fallen to (at this writing) about 1.625%. Rates on corporates have fallen in synch, and prices have accordingly appreciated. But how long will that continue? If we look at the risk/reward profile for this massive bond component of consumer portfolios going forward, it becomes clear that above-yield returns are not the most likely scenario. If the rate on 10-year Treasuries were to fall dramatically, down to 1.25%, investors would reap an annual gain of about 3.5%. If yields were to rise to 2.5%, investors would lose 8% on the year. You can draw a similar picture for mortgage-backed securities and corporate issues. In fact, the most likely scenario for the future is that someday soon, the U.S. economy will start growing at levels the Fed finds acceptable, at which point all the twisting and QE activity will cease, pulling the rug out from under the bond market and sending rates back up to where market conditions probably would have led them on their own. Investors will be spooked by the losses, and you'll see that graph suddenly turn around, driving rates up further as demand suddenly becomes oversupply. If there is a predictable rush to the exits, I wouldn't be surprised if rates rise much faster than any economist today is predicting. To me, this is reminiscent of 1987, when there was a long accelerating increase in money flowing into bond funds, followed by a catastrophic rise in interest rates in the early spring. Money poured back out of bond funds into stocks, locking in losses and creating the next bubble which burst spectacularly on Black Monday. I think everybody who communicates with the investing public–including, of course, advisors–has an obligation to sound a warning: specifically, to tell anybody who will listen that the prices of fixed income investments have been distorted by the Fed at the same time that record amounts of investor dollars have tipped the supply-demand see-saw dangerously over to one side. This is a classic bubble, and when it bursts, you're going to see people blindsided with losses which might eventually be comparable to what they experienced in 2008–only this time in the (ever-expanding) part of their investment nest egg that they believed were safe and conservative. It's going to be a shock. I hope you're preparing now.
I'm sure by now you've heard the news: Marv Tuttle has unexpectedly announced his retirement as CEO of the Financial Planning Association, effective in October. Several people contacted me, including a member of the press, to remind me of what I have no trouble remembering: that I had recommended that the FPA look for new leadership. Was I pleased by the news? Pleased? No. Whatever our differences, it has always been clear that Marv Tuttle is a good man, a good citizen of the financial planning community, a champion of what's right and a stalwart opponent of what's wrong. More than that, he is one of the few people in this business who has a clear idea about what the planning community needs to do in order to become a true profession. I became increasingly critical because the results at the FPA are not good. Membership is falling, services are less robust than they had been, and more than that, I saw instances where Marv would identify a service initiative for the FPA to implement, and then, somehow, the staff would veto the idea and the organization would go back to business as usual. In our last meeting, I urged Marv to take firmer control of the organization, but I have a feeling that he was never quite able to overrule the internal decisions or impose his vision on the staff's work activities. In the end, I think the truest thing I can say about Marv as a leader and manager is that he was too nice a guy. So, first of all, I'm sorry to see one of the profession's best friends and allies retire to the sideline. Second of all, I'm wondering why the FPA decided, suddenly, to cancel the idea of doing a full-scale job search. There's nothing wrong with deciding to promote from inside, but why not explore your options first? The way it is now, the very people who felt empowered to overrule Marv's ideas and initiatives are now running the organization. How did the resignation come about, more than 18 months in advance of the date when Marv had expected to retire? I have no inside information here and haven't asked for any, but the timing is certainly interesting, coming right as the FPA Board was meeting. What matters going forward is whether the FPA staff can resurrect the vitality that the organization carried with it when the ICFP and IAFP–both strong, viable organizations–gave it birth. How? I think new FPA CEO Lauren Schadle was on the right track when she suggested that the FPA will become more CFP-centric. She ran into immediate flak from the American College, whose agenda is to make sure insurance agents have a seat at the table, but I think this actually highlighted the problem. Currently, a lot of salespeople are able to quietly tout their FPA membership, while the credentialed professionals have been leaving the fold. You can see this in the simple chart I've created here, which divides the total number of FPA members by the total number of CFP designees each year since the FPA's formation through the end of last year. This probably understates the case, because I strongly suspect that the percentage of FPA members with the CFP designation has been declining. If we were talking purely about CFP advisors, the graph would actually look steeper than what you see here. The American College rifted from its own alumni organization when NAIFA decided to become less insurance sales-oriented. Now the American College is clearly alarmed that the FPA might follow the same course. I hope Schadle decides to face this criticism head-on, and make the FPA stand for professionalism, and find ways to serve professionals with a richer, expanded, more sophisticated member benefits package. The FPA has long been concerned that this might cost it members–and, of course, it will. But the chart shows us that there is a lot of growth opportunity right there in the CFP world, among advisors who–like the ICFP members–want to belong to an organization that stands for the same things they do. Meanwhile, I hope that Marv Tuttle remains involved in the planning community, to help steer us toward increased professionalism.
Should you take your clients' financial circumstances into account when you set your fees?
If you've been living on the moon these past couple of years, you may have missed the profession's wholesale rush to get on The Cloud–that is, having your software and data hosted and stored remotely, so you can access it from any web-connected computer. You no longer have to update software, you can say goodbye to the expensive servers, and the security risks posed by your office's cleaning personnel has been transferred to large server farms protected by barbed wire and armed guards. It's the future! Right? Recently, I've been trading emails with an advisor who has suddenly been confronted by the dark gray lining of The Cloud. She has been a cloud-based user of a prominent financial planning program (which one doesn't matter for now), and one day she discovered that she no longer had online access to the program OR her data. She was working on a case for her largest client. Alarmed, she contacted the company, which told her that she hadn't paid renewal fees. She later discovered that she had ignored what she believes were cryptic renewal notices. The short version of the story is that the company demanded that she pay a significant price hike and sign a five-year contract before it would renew her site license. The interesting part of the story, to me, is that unless the contract was renewed on the terms of the vendor, all the client information stored on The Cloud was held hostage. No longer could her clients go to their web portals and check out the latest version of their financial plans–or, for that matter, ANY version. Meanwhile, if the advisor decided to pack up and go to another vendor, days of casework for her largest client would be flushed down the drain. In theory, the advisor owns that client data. But without the program that interprets the data, and stores it in the right fields, the raw numbers and letters are meaningless. And since all this data is somewhere out there on remote servers, what if the advisor wants to switch to some other planning program? How could she extract years of accumulated client data and move it over? Hearing this story, it looks to me like all the advantages of The Cloud come with one very big disadvantage: the software company has total control over access to the information you need to run your practice. Because of that, it might be able to raise its rates or dictate its terms without worrying about losing your business. As nearly as I can tell, you're trapped, a prisoner in the murky gray part of The Cloud. The lesson? I would discuss this exact scenario with any Cloud-based vendor you plan to work with–and, of course, any you happen to be working with now. More broadly, I think the profession and the software companies who service it need to have a dialogue about how to resolve this issue. In the past, you were free to migrate from one program to another, which is what people do in a free market. Is it possible to recover that freedom in a Cloud-based software environment? Is it possible that as the profession rapidly moves into the much-hyped Cloud-based future, it is also, without realizing it, becoming trapped in The Cloud?