Archive for the ‘Investment Management’ Category
At the Financial Advisor Webinar Series on December 11, Ben Norquist of Convergent Retirement Plan Solutions delivered a presentation that was highly rated by attendees about how advisors can seize the 2010 Roth IRA conversion opportunity.
Norquist showed a simple web-based application he developed that makes it easy for advisors to calculate complex conversion scenarios to show the net benefit of conversion.
The tool's strength is that it allows you to dynamically on-the-fly change variables affecting a client's conversion options. The variables include future tax rates, the amount of cash available to pay income taxes incurred on the withdrawal of assets being converted from traditional IRAs or qualified plans, the monthly withdrawals of the IRA owner for living expenses, what you'll earn on a traditional IRA that's not converted, required minimum distributions on the traditional IRA, and the amount left for beneficiaries.
While the software is a one-trick pony and is only good for Roth IRA conversion calculations, the opportunity to advise on Roth IRA conversions justifies the software’s $600 perpetual license fee. I don't believe any of the financial planning applications can make these dynamic calculations and illustrations on the fly, making it a great app to work with live in front of clients.
To receive CFP CE credit for this session and dozens of other webinars, please join Advisors4Advisors.
You can also see a replay of the session (without getting CE credit) at the Financial Advisor Webinar Series page on Advisor Products’ website.
At Norquist's session, we had more questions from attendees than we could answer. So Norquist sent me answers to some of the questions we did not have time for. Below are four of the 15 questions he sent me answers for. To see the rest of the Q&A, please join Advisors4Advisors.
Q: Does the five-year rule apply to distributions made from Roth Conversions after age 59½?
A: No. The five-year rule that applies specifically to Roth IRA conversion assets is only pertinent in situations where an individual under age 59½ takes a distribution of conversion assets within five years of the conversion transaction.
Q: Can an individual with a 401(k) plan convert even if he is still employed? Must the plan allow for in-service distributions? If allowed, can this be converted directly into a Roth IRA or must it first go into a traditional IRA?
A: A 401(k) participant can potentially take a distribution of 401(k) assets for Roth conversion purposes provided the plan he is covered under contains some type of in-service withdrawal provision. If an individual is able to request an "eligible rollover distribution" from his 401(k) plan, he can elect to roll over (i.e., "convert") the distribution directly to a Roth IRA without first going through a traditional IRA. (If the 401(k) distribution occurred during 2009, the individual would be subject to the $100,000 income restriction on Roth IRA conversions.)
Q: Can you address re-characterization options if the market should go down after the point of conversion?
A: The re-characterization option basically allows you to "rewind" a Roth IRA conversion and treat the transaction as if it never happened. In situations where the market value of your IRA assets declines following a Roth IRA conversion, the re-characterization option can provide you with the opportunity to undo your original conversion, thereby avoiding an income tax liability on the value of the assets at the time of original conversion. It should be noted that you cannot re-convert the same assets until the latter of a) January 1 following the year of original conversion, or b) 30 days following the date of re-characterization.
Q: What about the impact of estate taxes on Roth IRAs as Income in Respect of a Decedent?
A: Both traditional IRA assets and Roth IRA assets are included in a decedent's overall estate when assessing potential estate tax liability. Part of the beauty of Roth IRA conversion is that, by paying taxes up front, an individual is able to reduce the overall value of his or her estate, thereby potentially decreasing the amount of estate tax liability. While it is true that the beneficiaries of deceased traditional IRA holders are potentially eligible to take subsequent tax deductions due to Income in Respect of a Decedent (IRD), some financial planning professionals believe it is often more beneficial to reduce the aggregate estate tax liability rather than depending on recouping taxes over a period of years through the IRD deduction.
Last Friday, at the Financial Advisor Webinar Series, economist-turned-money-manager Rob Stein, predicted a "W-shaped" recession.
Forecasts of a W-shaped recession are drawing attention. See the Carlos Lozada commentary in The Washington Post on April 19, FT Columnist John Authers’ on May 17, or economist Nouriel Roubini on July 16.
Stein, who heads Astor Financial LLC, predicted that technology will be among the sectors that gain disproportionately from the coming economic rebound. Stein’s also bullish on China.
Stein, who began his career at the Federal Reserve in 1983, believes The Great Recession of 2008-2009 has combined two recessions in one: a traditional V-shaped recession and a credit-bubble recession. While the US economy is now slowly coming out of the traditional recession and economic growth starting up, a second downturn is likely to follow in the next couple of years because of continuing losses from the credit crisis.
Investment advisors who have reflexively blasted SEC Chairman Mary Schapiro for saying the government should further regulate RIAs ought to look upon the civil fraud complaint filed against former NAPFA President James Putman as a cautionary tale.
I’m no big fan of FINRA. The Self-Regulatory Organization’s rules often get in the way of communicating with clients and running an honest advisory business. But the SEC’s allegations against Putman are so terribly damning.
Inarguably, additional rules are needed to better protect investors from unscrupulous RIAs. Far less clear, however, is whether being regulated by FINRA would have prevented the fraud Putman is accused of carrying out.
While the case against Putman is but one of a string of SEC enforcement actions targeting RIAs in recent weeks, it’s notable because Putman was a prominent member of the fee-only advisor community and at the moment this once-priestly segment of the advisor world benefits by confronting some ugly realities about the erosion of fidelity within its ranks. With RIAs vociferously protesting SEC Commissioner Schapiro’s stated intention to “harmonize” rules faced by RIAs with those faced by securities salespeople, reps of RIA may be more mindful that something must be done to protect the public’s trust in investment professionals if they understand the facts of the case against Putman.
In reading my summary of the facts stated in the 30-page, nine count SEC civil complaint filed against Putman, his RIA, and his former president and chief investment officer, please think about whether FINRA regulation would have better protected his clients. Leave a comment with your thoughts.
Putman, 57, started Wealth Management LLC, an Appleton, Wis. RIA, in 1985. He served as president of NAPFA in 1996 and 1997. Putman reportedly has not been active in NAPFA in recent years. However, as recently as September 2006, he participated as a panelist at a “NAPFA Cutting Edge Conference,” speaking at a session entitled, “The Search for the (NEW) Investment Paradigm.”
Putman is charged by the SEC with a litany of securities law violations, along with Simone Fevola, 49, who was president and CIO of Wealth Management (WM) from September 2002 to October 2008. The wrongdoing allegedly surrounds six unregistered private limited partnerships created in 2003 by Putman, which significantly changed his firm’s business model. In one of several similarities withthe Madoff fraud, WM took custody of client assets in the pools.
The pooled investments were structured like hedge funds and, as private vehicles, were unburdened by the need to register publicly. Each of the six funds had a specific objective, according to Part II of Wealth Management’s (WM’s) Form ADV ranging on the risk spectrum from capital appreciation to income producing. None was described as speculative. They were to invest in other private funds, funds of funds, debt, real estate partnerships and trusts, and asset-based loans.
As is often the case, the funds wese given an assortment of cryptic names, such as Gryphon, Quetzal, Pantera, and Watch Stone. Putman, who had discretion to invest on behalf of his clients, invested about 47% of his firm’s clients in Watch Stone and 40% of them in Gryphon.
According to the SEC complaint, offering documents for Watch Stone and Gryphon, the two largest of Putman’s pools, say their investment objective would be “to achieve a high level of income consistent with the preservation of capital” and the pools would primarily invest in “investment grade debt securities.” However, Putman and Fevola invested in “risky illiquid alternative investments,” the SEC says. It gets much worse.
An April 14, 2009 Form ADV filing by the federally regulated RIA claimed investments in the six pools were worth $102 million and that WM had another $29 million in separately managed accounts. The SEC says nearly 90% of the $102 million in client funds was invested in two of the partnerships, Watch Stone and Gryphon, which respectively had $50 million and $38 million. The SEC says now that the six WM funds “appear to have limited remaining assets.”
The SEC says Putman loaded up Watch Stone and Gryphons with investments in a life-insurance premium financing partnership that was managed by Joseph Aaron. Aaron in 1996 had been the subject of an SEC enforcement action alleging that Aron had committed fraud in selling promissory notes to investors. Moreover, the SEC says, Putman and Fevola knew about Aaron’s disciplinary history by 2004 but they still failed to verify that valuations Aaron placed on his funds were accurate.
Not only did Putman and Fevola fail to disclose Aaron’s shady past to WM’s clients, but the SEC says they also each accepted “undisclosed kickbacks” from him of $1.24 million in 2006.
Thus, even if you believe that Putman and Fevola were victims duped by Aaron, the SEC allegations paint a picture of Putman and Fevola falling in deeper with Aaron instead of blowing the whistle on him and admitting their mistakes to WM’s clients.
Meanwhile, in addition to the disastrous investments in Aaron’s life insurance investment scheme, other investments made by Stone Watch and Gryphon also went bad. Three of Stone Watch and Gryphon’s largest investments beyond Aaron’s partnerships are now in bankruptcy. Two are real estate funds, managed by California-based MKA Advisors, that went bankrupt in April 2009 and another investment is in fund called Sagecrest, a Connecticut partnership investing in asset backed loans that went bankrupt in the summer of 2008. While Putman in December 2008 wrote off 50% of the value of Sagecrest, the SEC says Putman has continued to value MKA’s investments at pre-bankruptcy levels in reports to clients.
The SEC alleges Putman had never fully disclosed the risks of the underlying funds invested in by Stone Watch and Gryphon, saying the funds were investing in investment grade securities when the offering documents for the underlying funds said investments were be risky and speculative, such as oil drilling deals. The SEC complaint cites a 70-year-old retiree with Alzheimer’s disease who had signed an investment policy statement targeting a fund with a 95% allocation to fixed income securities.
The Case Now
In the last 10 months, a majority of WM’s staff resigned or was terminated, the SEC says. To a reporter who has read many such SEC complaints over the last 25 years, it seems likely that WM staff, possibly Fevola, is actively cooperating with the SEC investigation and that the SEC is now targeting Putman.
As of December 30, 2008, the SEC says Putman valued Watch Stone at $47 million and Gryphon at $22 million. But according to notes taken by a staffer of the RIA during a recent client meeting, the SEC says, Putman admitted to the client that its investment in one of Aaron’s deals could be worthless.
One investor, whose statement cites an investment worth $1 million, was recently told by Putman that his investment could be worthless. Another investor, with a reported value of $670,000 on his 2008 year-end statement, told SEC investigators that he was recently informed by Putman that his investment could also be worth nothing. The SEC says Putman has continued to collect his 1.25% management fee on the funds based on the allegedly overstated valuations of the assets.
The government says that in February 2008 Putman wrote to clients saying that he was was limiting redemptions to 2% per quarter of the value of each client’s holdings for liquidity reasons. However, the SEC says he has arbitrarily honored full redemption of some investors.
“Absent immediate relief, it is likely WM and Putman will distribute the remaining assets of the WM Funds to a few investors who submitted redemption requests prior to September 3, 2008 and leave remaining investors with little or no recovery.”
What's It Mean?
The SEC complaint against Putman should serve as a cautionary tale to advisors. Those who knew Jim Putman say he was a straight shooter and cannot imagine what could have led him down such a tragic path. It's unlikely that Putman intended to defraud his clients when he started the partnerships in 2003.
Anyone who understands human nature should know that we are all tempted by greed, hubris, and corruption. Years of good bullish stock and bond markets and over-the-top returns on alternative investments could easily have caused some advisors to believe they could do no harm and to underestimate risks posed by some deals. From there, it’s a slippery slope and easier to fall in with scoundrels and become corrupt in desperation.
That's why I think advisors should start talking about the shape of coming regulation. Instead of knee-jerk reactions that dismiss calls for new regulation, groups respresenting advisors should be constructively helping to propose solutions.
For example, officals from the Financial Planning Asssociation, Investment Advisers Association, and NAPFA are quoted in an Investment News story pusblshed this afteroon saying that they strongly oppose an SEC proposal to conduct surprise audits by outside firms and have the cost of the exams come out of advisory fees.
How can FPA say that such a program would not affect investor protection? Why is NAPFA saying it's "overkill?" What are these people thinking?
I cannot remember a time when NAPFA and the Consumer Federation of America have been at odds. What's happened with NAPFA's penchant for being on the right side of consumer issues?
The Putman case shows that advisors need to be better policed, and the industry's leadership should embrace that idea by coming up with realistic good-faith proposals–not rhetoric aimed at protecting the interests of advisors but solutions that protect both investors and advisors and, thus, in the long run make for a better business environment for advisory firms.
My question is: What regulatory framework is best able to restore investor trust when it has been so badly abused under the current compliance regime? Would FINRA oversight of Putman have made a difference? What do you think?
It was only a matter of time before NAPFA’s reputation would be tainted in the national media.
Ron Lieber, the personal finance columnist at The New York Times, wrote a story in today’s paper entitled, “How a Personal Finance Columnist Got Caught Up in Fraud.”
Lieber last week received a letter from his advisory firm's custodian, Charles Schwab & Company, saying it “had discovered unauthorized money transfers out of accounts associated with the financial planning firm I use.”
Ironically, Lieber hired advisor Matthew Weitzman of AFW Wealth Advisors after writing a “secret shopper” article about how to pick a financial advisor, which was published by in May 2003 by his former employer, The Wall Street Journal.
“Matthew Weitzman , one of our partners, has been placed on leave from AFW,” Furst said in the letter emailed to Lieber. “As part of this leave, Mr. Weitzman will have no further contact with any client accounts. We do not anticipate that Mr. Weitzman will be returning to AFW in any capacity.
“We believe that the affected accounts have already been identified and that the total amount of the discrepancy is less than 5% of the total assets under management at the firm,” Furst added. “However, it is possible that additional accounts may be identified during the investigation and that the current estimation may change as a result of the investigation.”
The letter from Furst left little doubt that he blames Weitzman for the wrongdoing. Furst said be notified the Securities And Exchange Commission and that the agency is investgating the matter.
“AFW views these potentially unauthorized transactions as the isolated acts of Mr. Weitzman,” AFW told Lieber in a prepared statement when he asked for the firm to comment. “AFW, its many clients and I are saddened, angered and betrayed by the apparent actions of Mr. Weitzman, Mr. Furst reportedly added. “AFW is sorry for any harm this has caused to its clients.”
And then Lieber brands NAPFA with the black mark that very publicly stains its once unblemished record with the consumer press.
“Mr. Weitzman and Mr. Furst belong to the National Association of Personal Financial Advisors, an organization of financial planners who have sworn off commissions and make money only through fees they charge their clients,” Lieber writes. “Members have made a lot of noise in recent years about ethics and the importance of acting as a fiduciary, in a client’s best interests.”
“I’ve always believed that advisers in the association were plenty smart and morally upright, but it’s hard to recommend them now without at least including an asterisk.”
The consumer press has been infatuated with NAPFA for far too long and it was only a matter of time before one of the group’s members strayed from the lofty principles embraced by the association.
NAPFA members are generally better-trained than the average advisor, and the group has a history of backing ethical practices. But the fee-only compensation model that once differentiated NAPFA members from other advisors has been co-opted by planners who do not practice excellence or are outright unethical. Mode of compensation stopped being an accurate litmus test for professional competence over a decade ago. The consumer press just didn’t know it!
Ron Lieber shouldn’t feel betrayed by NAPFA. He and the rest of the consumer press should have been telling consumers years ago about ways to ensure an advisor is honest. Instead the financial press lazily used the NAPFA membership directory to find the same sources in article after article year after year.
Lieber is now telling readers to read their statements carefully, as if consumers are actually going to do that. He’s a personal finance reporter and didn't detect a problem!
Smart consumers and the consumer press finally have figured out that joining a membership association and networking with ethical financial advisors is no guarantee of integrity and competence.
NAPFA remains a powerful and positive force in the financial advice business. But it needs to reinvent itself and rethink. The same old ideas that used to work are no longer good enough to keep NAPFA in the warm embrace of the press and consumers.
The best way for advisory firms to fight the rising tide of consumer mistrust is by embracing transparency systematically. Transparency must be integrated in an advisory firm’s technology platform and system for client communications.
“If you go to a doctor because your elbow hurts, the doctor isn’t going to treat you heart or hand,” says Craig Israelsen. “He’ll treat your elbow. That’s what advisors need to do with clients now.”
Israelsen, an associate professor at Brigham Young University and frequent contributor to Financial Planning Magazine, likens the market crash of 2008 to a client’s elbow that's taken a very unfunny blow to the funny-bone.
Israelsen will speak about how the market cataclysm affects rebalancing at this Friday’s 4 p.m. EDT session of the Financial Crisis Webinar Series.
Israelsen says that advisors who did not have retiree or pre-retirees holding age-appropriate cash positions before the global economic crisis decimated stock prices are vulnerable but have no one but themselves to blame. He has always argued that it was misguided to think of cash as being a drag on portfolios. “No one thinks cash is a drag now!”
Prudent advisors did have retirees and clients over age 55 in a portfolio with a reasonable amount of cash. For retirees, this is the time to draw down on cash. And it is also a time to focus on the performance of their cash position, that is, to focus on what worked in 2008.
“They should be pulling their retirement income from their cash positions,” says Israelsen, who offers advisors a subscription to his research for $350 a year. “That’s what the cash is there for. It’s a pantry.”
“Leave the equity positions alone for now,” he says. “They will come back.”
In client communications right now, advisors should be focusing on the part of their portfolios that have been bullet-proof, says Israelsen, a 50-year old tri-athlete and father of seven. By focusing on what has been working, you make it easier for clients to sit tight and wait for stocks and stock mutual funds to rebound.
“The entire portfolio you manage for a client may show a negative return,” says Israelsen. “But you don’t need to liquidate the entire portfolio. You only need to be sure the client has money for living expenses now, and that is what the cash is for.” Cash is there for a rainy day, and it has been pouring.
Israelsen’s research has long focused on broad diversification. His 7Twelve portfolios use seven asset classes and invest in 12 underlying mutual funds or ETFs. The portfolio is designed to be used as a core position within virtually any portfolio.
While many advisors think of the Standard & Poor’s 500, or perhaps an ETF or fund investing in the total stock market, as their core portfolio position, Israelsen says the core position of a portfolio should be a widely diversified bundle of asset classes.
The core of Israelsen’s 7Twelve portfolio is comprised of equal-weighted positions including real estate, natural resources, commodities and bonds as well as of large-, small, and mid-cap stocks and several other asset classes, including cash.
Using the 7Twelve portfolio as the core holding in a balanced 60/40 portfolio makes sense. For example, a 60% position in the 7Twelve portfolio combined with a 40% position in the Vanguard Total Bond Index lost 12.8% in 2008, but had a 6.6% 10-year annualized return between 1999 and 2008. Alternatively, a 60% position in the Vanguard Total Stock Index combined with a 40% position in the Vanguard Total Bond Index lost 20.2% in 2008 and had a 2.4% 10-year annualized return as of 12/31/08.
An article in today's issue of Investment News, entitled "Performance Reporting Isn't Cutting It For Clients," contains some good points but also contains some confusing information.
The story is about how important it’s been for advisors to be able to post performance reports online daily. Since the market crisis erupted in early October, the need has become acute.
That makes sense. A small portion of clients are probably looking for daily updates. But the story quotes Celent Communications LLC analyst Robert Ellis saying, "Reporting is the biggest reason for wealth management client attrition." That's ridiculous.
Most advisor relationships fall apart because of a lack of communication. I've never heard of an advisor getting fired because his performance reports were issued too infrequently–never mind because the reports were formatted poorly, difficult to understand, or not available online.
I have no quarrel with the basic premise of the story. More clients want to view performance reports online than a year ago. But only a fraction of clients will check them daily, even in turbulent times.
The story also rightly says that web-based systems make it easier for advisors to provide online reports. But what’s missing from the article is any mention of the fact that the desktop applications are accommodating advisors who want to post reports daily. Which brings me to my next point.
Contrary to the thrust of the article, just because an advisory firm is using a desktop application does not mean it cannot provide online reporting daily. For instance, Advisor Products has developed an interface for uploading PortfolioCenter reports that allows advisors to batch upload client reports. An advisory firm can create an XML extract of its client reports in PortfolioCenter every morning and upload it to our AdvisorVault 2.0 in minutes. The reports are parsed by an application that runs on our server and they are automatically dropped into each client's secure, encrypted vault folder. While the manual upload process surely is an extra step that is avoided if your firm uses an online portfolio reporting system, it is—contrary to the impression you'd get from the article—very doable daily.
Another place where the story goes wrong is in confusing the information contained in the reports with the ability to post reports online daily. Specifically, the story quotes Celent analyst Ellis saying that wealthy clients might get "subpar" performance reports "because their portfolios tend to contain esoteric asset classes and sophisticated securities. In addition, their portfolios are held with several custodians, and assets are denominated in many currencies, a situation that creates a huge reconciliation and reporting nightmare."
The ability to handle multi-currency reporting and arcane securities, however, has nothing at all to do with the reporting application's ability to get reports online daily. Moreover, the weakness of the desktop PMS applications is not in their inability to handle multi-currency portfolios and exotic securities. Few advisors need multi-currency reporting. Even the most sophisticated advisors I know aren't running non-dollar denominated accounts. Plus, many exotic investments are not even priced daily–like oil partnerships and real estate deals. And to the extent an advisor is using an esoteric security, the desktop apps are probably more likely than web based applications to be able to account for them simply because they have had so much more experience with handling Original Issue Discount bonds, Zeroes, and other offbeat securities.
The story confuses the information in performance reports with the ability to post reports online. If the data in the reports are not giving clients what they need, however, the advisor needs to simply change the reports. That's a separate issue from whether it is possible to get the reports online.
To be sure, portfolio reporting is headed to the web. Advisory firms using desktop reporting applications will be in the minority in five years. But advisory firms have not been ready for online PMS applications and only recently started to warm to them.
Incidentally, I don't like taking a cheap shot at another advisor-technology writer. The author of the article in question is a careful reporter and has been doing a great job. I've read his articles for months and have enjoyed his work. This just wasn't his best story.
During last Friday’s webinar with guest speakers Bill Bengen and Greg Brousseau, we conducted a series of polls. The results are surprising.
Based on answers to our polls, advisors are sticking with the traditional buy-and-hold asset allocation doctrine that has dominated the profession for two decades. Advisors say they have not reduced equity allocations. But they are looking for a less dogmatic approach. Here are the results of the poll from the webinar attended by about 120 advisors.
With 74% of those polled saying they have not significantly reduced equity allocations,
Yet many advisors are questioning the most fundamental precepts of traditional portfolio management. More than a third of advisors say Modern Portfolio Theory and The Efficient Market Hypothesis are not a valid basis for managing portfolios.
While conventional wisdom has been that a buy-and-hold strategy is the best course of action for long-term investing, two-thirds of the advisors polled say it is wise to make judgments about the future direction of the market. I believe we are witnessing the beginning of the end of the traditional buy-and-hold appraoch to asset allocation. My column in next month's issue of Financial Advisor magazine provides a new approach being put forward by one of the best thinkers among institutional money managers. Please see the magazine's website after December 1 to read about a new approach that could be influential as advisors move into the era of "Post-Modern Portfolio Theory." (I've never seen this term used before. Have you?)
Just how pessimistic are advisors? The good news is that a majority (59%) of the advisors we polled believe the economy will remain in poor condition for one or two years, while only 4% believe the American economy will remain in poor shape for more than five years. However, a significant number of advisors polled (40%) said they believe poor economic conditions will plague the nation for a three- to five-year period.
73% of the advisors polled believe now is a good time to buy stocks. Market sentiment polls like this are actually reverse indicators. The optimstic sentiment could mean that too few advisors have capitulated, and that the market must drop further before hitting bottom. Finally, in what may be the most significant finding, last Friday’s poll revealed significant dissatisfaction with the industry’s membership organizations. At the suggestion of one of our guest speakers, Bill Bengen, CFP®, who is best known for his groundbreaking research into “safe” withdrawal rates for retirees, I asked advisors attending the webinar whether they have been well served during the financial crisis by the industry’s educational apparatus. The answer: 48% of the 110 advisors participating in the webinar disagreed. This means that almost half of the advisors at the session believe they’ve not been well served by the industry’s professional educational system.
I don’t understand why the membership organizations have not produced weekly programs to help financial advisors deal with one of the worst financial events in the nation's history and certainly the worst financial crisis since the advent of personal financial planning. These groups have far greater resources than I do, can reach a much larger audience, and are paid by their members to provide this kind of support. Moreover, even though I’ve been conducting these webinars for over a month now, no one from the educational arms of the major membership organizations has called me to ask how they can help, whether they can provide some expert speakers, offer continuing education credits to attendees, or just to say thank you.
I'm grateful for the many kind words of support from advisors who have attended the webinars. Your encouragement is motivating.
Thank you for placing me in a position to be able to help during this difficult time.
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