Nationwide Mutual Life Insurance expects to launch a variable annuity with that will shift funds into some fixed income account when equity markets decline. The Investment News article does not provide many details, but those cited are illuminating.
The provision is expected to be included in contracts carrying a living benefit provision. The article notes that Nationwide provides a growing living benefit and that the company had increased the growth rate from 5% to 5.25% in 2010. Nationwide attributes its 32% growth in 2010 to the increase.
Now Nationwide will take discretion to move assets from an equity fund into a fixed account. This is being advanced as a benefit claiming that "dynamic allocation stabilizes your account balance (in times of volatility). A steep drop in account balances is unnerving to the client."
Well now! Isn't that the reason to invest in a variable annuity? The fees charged by VA contracts have been justified by the "death benefit" and the guaranteed income provisions. This discretionary power now limits Nationwide exposure, but it will also lock in client losses and may prevent the client from realizing any gains from subsequent market increases.
Unless the fee structure of the contract is reduced, the value of the contract is impaired. Advisors should be very careful in evaluating whether clients are still receiving value for their money in this variable annuity.
Monday, February 28, 2011
Friday, February 18, 2011
Defending Buy-and-Hold?
It is the age old debate: buy-and-hold versus market timing. Of course, these are actually the two ends of the continuum of actively managing the allocation among asset classes. We all find ourselves somewhere along the spectrum, so it is unfair to demonize the extreme.
This discussion is prompted by an IN profile of Jeff Benjamin of the WBI Absolute Return Balanced Fund (WBADX). The fund appears to be managed as a tactical asset allocation fund, varying asset class weights according to anticipated effects of economic conditions. Not a particularly novel idea, and not exactly uniformly successful in execution.
We have all herd the pitches for buy-and-hold (BAH): market timing must show 70% success is necessary to break even versus BAH; all value is lost if the four best days in the market are missed; must be right twice. these arguments are precisely accurate, but it doesn't ring totally true. n That is because these are answers to a questions that was not asked.
As I've mentioned before, Charles Ellis advocates for measuring performance against client-specific goals, rather than market indexes. There are a lot of reasons, but the most important one is that it is the one that is of highest priority to the client. Investment policy is then set to achieve the goal with the lowest risk portfolio. Risk is determined by the portfolio's long-term asset allocation and is defined as the probability of missing the goal. Over time, conditions will change, the portfolio will grow, valuations in the market will change, goals will shift. The risk profile of the portfolio, and thus the asset allocation, changes only as a function of the return necessary to allow the current portfolio to meat the client goals. The portfolio is not being managed to maximize performance. Therefore, tactical moves to take advantage of short-term trading opportunities are not contemplated by the policy. To move away from the established policy is implicitly adding risk to the portfolio, because the portfolio is moving away from the lowest risk allocation that is expected to meet its objectives.
And this is where the middle of the spectrum comes in. When and how does the asset allocation get changed? From a practical standpoint, all policies should include a rebalancing scheme. Thus variance around the target allocation can be tolerated to a certain point. Technically, it is calculated as the point at which shortfall risk exceeds trading costs. As so many trading costs are difficult to measure, a rule of thumb is usually adopted, typically 5% variance.
On the other hand, more strategic changes demand a great deal of work, Exactly the same work that established the policy in the first place. And as this process is costly, in terms of time and effort on the part of the client as well as the advisor, the exercise does not take place often. That is not to say that it couldn't, just that more frequent analyses are not cost-effective.
So that is how I come to defend Buy-and-Hold; not as a performance maximizing strategy, but as a low cost implementation approach to the lowest risk portfolio that will meet a client's goals. There are other roads to reach the same destination and they each have their benefits. This just seems to be one that is simple, cheap and effective.
This discussion is prompted by an IN profile of Jeff Benjamin of the WBI Absolute Return Balanced Fund (WBADX). The fund appears to be managed as a tactical asset allocation fund, varying asset class weights according to anticipated effects of economic conditions. Not a particularly novel idea, and not exactly uniformly successful in execution.
We have all herd the pitches for buy-and-hold (BAH): market timing must show 70% success is necessary to break even versus BAH; all value is lost if the four best days in the market are missed; must be right twice. these arguments are precisely accurate, but it doesn't ring totally true. n That is because these are answers to a questions that was not asked.
As I've mentioned before, Charles Ellis advocates for measuring performance against client-specific goals, rather than market indexes. There are a lot of reasons, but the most important one is that it is the one that is of highest priority to the client. Investment policy is then set to achieve the goal with the lowest risk portfolio. Risk is determined by the portfolio's long-term asset allocation and is defined as the probability of missing the goal. Over time, conditions will change, the portfolio will grow, valuations in the market will change, goals will shift. The risk profile of the portfolio, and thus the asset allocation, changes only as a function of the return necessary to allow the current portfolio to meat the client goals. The portfolio is not being managed to maximize performance. Therefore, tactical moves to take advantage of short-term trading opportunities are not contemplated by the policy. To move away from the established policy is implicitly adding risk to the portfolio, because the portfolio is moving away from the lowest risk allocation that is expected to meet its objectives.
And this is where the middle of the spectrum comes in. When and how does the asset allocation get changed? From a practical standpoint, all policies should include a rebalancing scheme. Thus variance around the target allocation can be tolerated to a certain point. Technically, it is calculated as the point at which shortfall risk exceeds trading costs. As so many trading costs are difficult to measure, a rule of thumb is usually adopted, typically 5% variance.
On the other hand, more strategic changes demand a great deal of work, Exactly the same work that established the policy in the first place. And as this process is costly, in terms of time and effort on the part of the client as well as the advisor, the exercise does not take place often. That is not to say that it couldn't, just that more frequent analyses are not cost-effective.
So that is how I come to defend Buy-and-Hold; not as a performance maximizing strategy, but as a low cost implementation approach to the lowest risk portfolio that will meet a client's goals. There are other roads to reach the same destination and they each have their benefits. This just seems to be one that is simple, cheap and effective.
Thursday, February 17, 2011
Impact Investing
Financial Advisor magazine has a sister publication called FA Green. According to the masthead on its home page, it is dedicated to "strategies for sustainable, responsible investing and giving." This brings to mind two investment themes: Socially responsible investing (SRI) which has enjoyed some economic success, and "targeted" investing intended to attract capital to achieve some societal good. Examples of the latter include historic preservation, non-traditional energy, and low income housing, Targeted investing typically carries some form of subsidy because it is not projected to be economically successful on its own.
Now I find a blog on the FA Green site called "Tom Kostigen's Impact Investor blog" It is defining Impact Investing (II) in a way that is attractive to someone who likes the idea of getting away from measuring performance only as the sum of income and growth and comparing it to some benchmark. While the hype of naming II a new asset class is probably premature and exaggerated, there may be some actual investment merit in some of the ventures.
One example of II that has attracted a lot of attention is microfinance. Extending small amounts of capital in order to allow entrepreneurs to fund very small businesses is an appealing idea. The capital allows individuals to boo0tsrtrap themselves out of the depths of poverty. The returns are high enough to cover the very high fixed costs of servicing the small loans. At least that is the idea, and I've seen articles in the Wall street Journal and Forbes documenting the success of some of its early practitioners.
Another example are the free trade businesses that are springing up. Starbucks gets some advantage from this strategy, and it works because creates value far beyond the commodity that it is buying. Apparel companies (Nike especially comes to mind) can be seen as participating in this trend, as they pay far above the prevailing wage for assembly workers.
On the other hand, a lot of the other "investments" touted on the websites that Mr. Kostigen links to sound eerily similar to the windmill farms and redevelopment projects that I have seen so many times in the past. These projects sound good, but they can not compete in the marketplace and provide a competitive return on capital.
It is interesting enough that I will be keeping an eye on the space. However, there is enough of an echo of pie-in-the-sky opportunities from years ago that I am not getting my hopes up.
Now I find a blog on the FA Green site called "Tom Kostigen's Impact Investor blog" It is defining Impact Investing (II) in a way that is attractive to someone who likes the idea of getting away from measuring performance only as the sum of income and growth and comparing it to some benchmark. While the hype of naming II a new asset class is probably premature and exaggerated, there may be some actual investment merit in some of the ventures.
One example of II that has attracted a lot of attention is microfinance. Extending small amounts of capital in order to allow entrepreneurs to fund very small businesses is an appealing idea. The capital allows individuals to boo0tsrtrap themselves out of the depths of poverty. The returns are high enough to cover the very high fixed costs of servicing the small loans. At least that is the idea, and I've seen articles in the Wall street Journal and Forbes documenting the success of some of its early practitioners.
Another example are the free trade businesses that are springing up. Starbucks gets some advantage from this strategy, and it works because creates value far beyond the commodity that it is buying. Apparel companies (Nike especially comes to mind) can be seen as participating in this trend, as they pay far above the prevailing wage for assembly workers.
On the other hand, a lot of the other "investments" touted on the websites that Mr. Kostigen links to sound eerily similar to the windmill farms and redevelopment projects that I have seen so many times in the past. These projects sound good, but they can not compete in the marketplace and provide a competitive return on capital.
It is interesting enough that I will be keeping an eye on the space. However, there is enough of an echo of pie-in-the-sky opportunities from years ago that I am not getting my hopes up.
Wednesday, February 16, 2011
CB Richard Ellis Makes an Acquisition
Bloomberg and the Wall Street Journal have reported that CB Richard Ellis has acquired the Real Estate Management operations of ING. This transaction furthers CBRE's stated objective of increasing the company's fee based business. It will bring assets under management to just under $100 billion and add a significant portfolio of core type properties to the value-added portfolios the company already has under contract. Thew acquisition also brings a highly European client base to complement CBRE's US investors. Finally, the acquisition includes an operation called Clarion Real Estate Securities (Clarion), which appears to be in the bossiness of creating product for retail and institutional investors.
CBRE is currently raising funds in a non-traded REIT, CB Richard Ellis Realty Trust (CBRERT), in a partnership with CNL. The REIT has raised approximately $1.5 billion of equity in two public offering over just under four years.
Investors in CBRERT will get the benefits of the additional management competencies and business scale. There may also be some specific opportunities to participate min transactions that have not been fully funded by the ING organization. However, longer-term, it would appear that this may be CBRE's last advisor distributed fund. I certainly would not expect them to partner with CNL again. A non-traded REIT is an expensive vehicle in which to raise capital, and four years is a very long time in whi8ch to increase AUM by just over 1.5%. AS CBRE now has in-house experience in creating product and raising capital (through Clarion), I would look for CBRERT to close soon, and their capital raising efforts to be focused elsewhere.
CBRE is currently raising funds in a non-traded REIT, CB Richard Ellis Realty Trust (CBRERT), in a partnership with CNL. The REIT has raised approximately $1.5 billion of equity in two public offering over just under four years.
Investors in CBRERT will get the benefits of the additional management competencies and business scale. There may also be some specific opportunities to participate min transactions that have not been fully funded by the ING organization. However, longer-term, it would appear that this may be CBRE's last advisor distributed fund. I certainly would not expect them to partner with CNL again. A non-traded REIT is an expensive vehicle in which to raise capital, and four years is a very long time in whi8ch to increase AUM by just over 1.5%. AS CBRE now has in-house experience in creating product and raising capital (through Clarion), I would look for CBRERT to close soon, and their capital raising efforts to be focused elsewhere.
Wednesday, February 9, 2011
CalPERS Real Estate Portfolio
Wall Street Journal articles yesterday and today (subscription required) talk about how CalPERS has been counseled by its consultants to restructure its real estate portfolio. In summary, the real estate portfolio is being transitioned from a return enhancement vehicle to a risk reduction vehicle. The new strategic focus comes with new implementation scheme. Among the recommendations is a recommendation to eliminate the use of publicly traded REITs from the real estate portfolio. Publicly traded REITs will continue to allowable in the traditional equities portion of the portfolio. A memo and PowerPoint presentation from Pension Consulting Alliance are available on the CalPERS website.
I bring this up to discuss some misconceptions about real estate risk and returns which are poorly addressed in the CalPERS reports. Real estate is a portfolio diversifier in that its return streams are affected by economic risk factors differently than other asset classes. That is, real estate has a relatively low correlation with stocks, bonds, and cash.
This is not to say that real estate is less risky or that it is less volatile than publicly traded securities. Illiquidity and valuation mechanism combine to create that illusion. As one erstwhile boss was fond of saying, "If people knew how the value of their houses fluctuated on a daily basis, no one would ever own their own home." Likewise, the appraisal and desktop valuation methodology used in establishing quarterly values for institutional real estate holdings relies heavily on historical transactions and thus tend to lag market conditions. The consultant acknowledges this risk by assigning a 14% standard deviation expectation in line with what one might expect from a publicly traded equities portfolio, to the real estate pool.
Contrary to what is intimated by a syndicator in a recent Registered Rep article, illiquidity is a benefit only in that it quiets a lot of the noise inherent in publicly traded securities. Illiquidity is actually a risk factor which demands an incremental return expectation.
Meanwhile, NAREIT says that the CalPERS recommendation is "inappropriate and ill-advised.” The claim is based on a study that indicates that adding publicly traded REITs to a non-traded real estate portfolio would reduce the overall volatility. As a matter of fact, this is the principle on which the recommendation is based. The reduced volatility comes from combining two asset classes that have return streams that are affected differently by economic risk factors. In the CalPERS portfolio, real estate is being utilized as a diversifier to its traditional liquid equities portfolio. Publicly traded REITs are included in the liquid equities portion of the portfolio.
In summary, real estate is a diversifier because its returns stream behaves differently under various economic conditions than stocks, bonds, or cash. Illiquidity is not a diversifier nor is it a benefit. Illiquidity is a risk factor. Providing liquidity to a real estate holding transforms its return streams sufficiently that a liquid real estate vehicle (REIT) becomes a diversifier for non-liquid real estate holdings.
Special thanks to the Rational Realist
I bring this up to discuss some misconceptions about real estate risk and returns which are poorly addressed in the CalPERS reports. Real estate is a portfolio diversifier in that its return streams are affected by economic risk factors differently than other asset classes. That is, real estate has a relatively low correlation with stocks, bonds, and cash.
This is not to say that real estate is less risky or that it is less volatile than publicly traded securities. Illiquidity and valuation mechanism combine to create that illusion. As one erstwhile boss was fond of saying, "If people knew how the value of their houses fluctuated on a daily basis, no one would ever own their own home." Likewise, the appraisal and desktop valuation methodology used in establishing quarterly values for institutional real estate holdings relies heavily on historical transactions and thus tend to lag market conditions. The consultant acknowledges this risk by assigning a 14% standard deviation expectation in line with what one might expect from a publicly traded equities portfolio, to the real estate pool.
Contrary to what is intimated by a syndicator in a recent Registered Rep article, illiquidity is a benefit only in that it quiets a lot of the noise inherent in publicly traded securities. Illiquidity is actually a risk factor which demands an incremental return expectation.
Meanwhile, NAREIT says that the CalPERS recommendation is "inappropriate and ill-advised.” The claim is based on a study that indicates that adding publicly traded REITs to a non-traded real estate portfolio would reduce the overall volatility. As a matter of fact, this is the principle on which the recommendation is based. The reduced volatility comes from combining two asset classes that have return streams that are affected differently by economic risk factors. In the CalPERS portfolio, real estate is being utilized as a diversifier to its traditional liquid equities portfolio. Publicly traded REITs are included in the liquid equities portion of the portfolio.
In summary, real estate is a diversifier because its returns stream behaves differently under various economic conditions than stocks, bonds, or cash. Illiquidity is not a diversifier nor is it a benefit. Illiquidity is a risk factor. Providing liquidity to a real estate holding transforms its return streams sufficiently that a liquid real estate vehicle (REIT) becomes a diversifier for non-liquid real estate holdings.
Special thanks to the Rational Realist
Tuesday, February 8, 2011
Goal-based Performance Presentation
I just read an article that will be included in the proceedings of the GIPS Standards Annual Conference that was held in San Francisco this past September. The proceedings are scheduled to be published in March. The article is available on the CFA Institute website. I highly recommend the article to anyone who advises clients whose investment objectives include a spending policy.
Stephen Campisi, CFA, Director of Institutional Investments at Bank of America Merrill Lynch, gave a presentation that advocates presenting performance focused on the spending goals of the client. The cornerstone of the presentation is a notional portfolio that reflects the spending and portfolio growth objectives (e.g spending policy of 5% of portfolio value + portfolio growth equal to inflation) from the portfolio. This notional portfolio is then compared with the performance of a benchmark portfolio (reflecting investment allocation policy) and the actual portfolio experience. The difference between the notional portfolio and the benchmark portfolio is attributable to market conditions, over which the client, advisor, and money managers have no control. The difference between the benchmark portfolio and the actual portfolio can be credited to the decisions of the investment team. The article presents several tables and charts that can be used to present the data in simple client friendly manner.
This focus on the client's objectives is consistent with the theme of Charles Ellis' Investment Policy: How to Win the Loser's Game. While the performance figures are nice, and actually have a lot of information, ultimately performance is only a means to the goal of spending, be it college expenses for a child, pension payments to retirees, or support payments for a charitable organization. Meeting those specific objectives over a reasonable time horizon can, and should, be the greatest measure of success. Excess return is cocktail party fodder.
Stephen Campisi, CFA, Director of Institutional Investments at Bank of America Merrill Lynch, gave a presentation that advocates presenting performance focused on the spending goals of the client. The cornerstone of the presentation is a notional portfolio that reflects the spending and portfolio growth objectives (e.g spending policy of 5% of portfolio value + portfolio growth equal to inflation) from the portfolio. This notional portfolio is then compared with the performance of a benchmark portfolio (reflecting investment allocation policy) and the actual portfolio experience. The difference between the notional portfolio and the benchmark portfolio is attributable to market conditions, over which the client, advisor, and money managers have no control. The difference between the benchmark portfolio and the actual portfolio can be credited to the decisions of the investment team. The article presents several tables and charts that can be used to present the data in simple client friendly manner.
This focus on the client's objectives is consistent with the theme of Charles Ellis' Investment Policy: How to Win the Loser's Game. While the performance figures are nice, and actually have a lot of information, ultimately performance is only a means to the goal of spending, be it college expenses for a child, pension payments to retirees, or support payments for a charitable organization. Meeting those specific objectives over a reasonable time horizon can, and should, be the greatest measure of success. Excess return is cocktail party fodder.
Monday, February 7, 2011
The New Indexing
Index investing has been around for a long time. The Vanguard 500 fund was formed in 1976, and institutional indexing is older still. The attractions are abundant: inexpensive implementation, broad diversification, complete exposure to a market, straightforward monitoring.
Traditionally, indexes have been constructed on a cap-weighted basis. This was done so that the performance of the index would reflect the return available to an investment in the entire market, the investable universe. Thus, a security that represents more invested capital, or a higher market capitalization, is included in the index with a greater weight than a security with a lower market cap.
This size-weighting is counter-intuitive, given the studies suggesting that superior returns can be earned by investing in small companies, companies with low P/E ratios, and companies that pay dividends. For a long time, these anomalies were exploitable only through active management, along with the higher implementation costs. Consulting firm Russell Investments was one of the first to formalize a set of indexes to measure size and style cohorts that were fully inclusive and accounted for the entire capitalization of the market. Investable products followed. But the indexes were still cap weighted.
The Wall Street Journal has an article (subscription required) about the new index products that use these factors to create alternative weighting schemes. The article highlights the funds, both traditional open-end and ETF, that are employing alternative weighting schemes, from equal weighted, to single-factor weighting to Research Associates' Fundamental Indexing. All of these new weighting schemes tend to outperform cap weighted indexes, though typically with greater volatility.
Clarity Finance has adopted a paired indexing strategy using both cap weighted and Fundamental Indexing schemes. Cap weighting ensures close tracking to the return offered by the investable universe and typically lower cost implementation than alternative schemes. Fundamental Indexing's use of multiple characteristics on which to weight holdings gives a better exposure to economic and (theoretically) return factors. The experience of the model portfolios has been performance net of fees comparable to the benchmark with similar volatility.
Traditionally, indexes have been constructed on a cap-weighted basis. This was done so that the performance of the index would reflect the return available to an investment in the entire market, the investable universe. Thus, a security that represents more invested capital, or a higher market capitalization, is included in the index with a greater weight than a security with a lower market cap.
This size-weighting is counter-intuitive, given the studies suggesting that superior returns can be earned by investing in small companies, companies with low P/E ratios, and companies that pay dividends. For a long time, these anomalies were exploitable only through active management, along with the higher implementation costs. Consulting firm Russell Investments was one of the first to formalize a set of indexes to measure size and style cohorts that were fully inclusive and accounted for the entire capitalization of the market. Investable products followed. But the indexes were still cap weighted.
The Wall Street Journal has an article (subscription required) about the new index products that use these factors to create alternative weighting schemes. The article highlights the funds, both traditional open-end and ETF, that are employing alternative weighting schemes, from equal weighted, to single-factor weighting to Research Associates' Fundamental Indexing. All of these new weighting schemes tend to outperform cap weighted indexes, though typically with greater volatility.
Clarity Finance has adopted a paired indexing strategy using both cap weighted and Fundamental Indexing schemes. Cap weighting ensures close tracking to the return offered by the investable universe and typically lower cost implementation than alternative schemes. Fundamental Indexing's use of multiple characteristics on which to weight holdings gives a better exposure to economic and (theoretically) return factors. The experience of the model portfolios has been performance net of fees comparable to the benchmark with similar volatility.
Friday, February 4, 2011
Walton Elm Creek Ranch Investor Communications
I received an email from Walton Elm Creel describing a transaction that is taking place. Basically, a Real Estate Investment Trust is being formed as a subsidiary of Walton Elm Creek Ranch Development LP, the units of the Elm creek Ranch project offering that were designed for qualified fund investors. The REIT is being formed in order to shield the qualified investors from Unrelated Business Taxable Income (UBTI). All of this was a part of the original business plan, and outlined in the PPM. Most importantly, investors do not need to take any action.
Qualifying as a REIT requires a minimum number (100) of shareholders. The partnership is to be the sole common shareholder, so the REIT is distributing one preferred share to each of the largest investors in the development partnership. The preferred share has a par value of $500 and carries a cumulative, non-compounded preferred dividend of 6%. The investors that are receiving the preferred shares will have their capital accounts in the partnership reduced by $500. The remainder of theses investors' capital, as well as the capital of those investors that are not receiving preferred shares, will continue to accrue their 10.5% preferred return. Thus, while the investors receiving preferred shares will acquire an advantage in terms of preference in return of capital, that capital is but a small portion of the total capital invested (<1%), and the preferred return is 450 basis points less than the preferred return on the remaining capital.
Walton has prepared a letter to investors which was attached to the email. While pretty readable, it still has some thick language plus it includes a copy of the partnership agreement. Advisors can count on those clients who are invested in the development fund to call for support. As I see it the two biggest points to make are 1) This is all a part of the business plan, and is taking place to safeguard the tax advantages of qualified plan investing, and 2) no action by investors is necessary.
Qualifying as a REIT requires a minimum number (100) of shareholders. The partnership is to be the sole common shareholder, so the REIT is distributing one preferred share to each of the largest investors in the development partnership. The preferred share has a par value of $500 and carries a cumulative, non-compounded preferred dividend of 6%. The investors that are receiving the preferred shares will have their capital accounts in the partnership reduced by $500. The remainder of theses investors' capital, as well as the capital of those investors that are not receiving preferred shares, will continue to accrue their 10.5% preferred return. Thus, while the investors receiving preferred shares will acquire an advantage in terms of preference in return of capital, that capital is but a small portion of the total capital invested (<1%), and the preferred return is 450 basis points less than the preferred return on the remaining capital.
Walton has prepared a letter to investors which was attached to the email. While pretty readable, it still has some thick language plus it includes a copy of the partnership agreement. Advisors can count on those clients who are invested in the development fund to call for support. As I see it the two biggest points to make are 1) This is all a part of the business plan, and is taking place to safeguard the tax advantages of qualified plan investing, and 2) no action by investors is necessary.
Thursday, February 3, 2011
Hedge Fund Strategy in a Mutual Fund
HedgeCo.Net carried an announcement of the opening of the Frost Diversified Strategies Fund (FDSFX), which is supposed to provide "investors access to alternative investment management strategies previously available to hedge fund and private equity fund investors." The objective is to appreciate in up markets and outperform in down markets. The fund will have 60% of its assets invested in traditional assets and 30% of asset will be invested in a "hedge replication module" which will be supported by "publicly available products." Apparently, the hedge replication module will be invested primarily in products that replicate the performance of hedge fund, commodity, and currency indexes. The fund carries a 0.80% management fee and expense ration of 2.00%.
Mutual funds trying to utilize or replicate hedge fund strategies are not new. PIMCO Total Return has used futures, options, and swaps strategies to add value in a very competitive bond market. A few years ago saw a wave of "130-30" funds attempting to implement the original hedge concept. And about three years ago, Absolute Investment Advisors launched the Absolute Strategies Fund (ASFIX), a fund that employs eleven sub-advisors, each of which manages a portion of the fund using a strategy typically reserved for hedge funds. There are also those publicly available products to provide exposure to alternative strategies.
The point is that there are many options available to the individual investor to participate in alternative assets and strategies, most with a lower cost structure and almost all with a track record that can be evaluated. FDSFX may emerge as a viable option, but I would recommend patience in assessing its usefulness.
Mutual funds trying to utilize or replicate hedge fund strategies are not new. PIMCO Total Return has used futures, options, and swaps strategies to add value in a very competitive bond market. A few years ago saw a wave of "130-30" funds attempting to implement the original hedge concept. And about three years ago, Absolute Investment Advisors launched the Absolute Strategies Fund (ASFIX), a fund that employs eleven sub-advisors, each of which manages a portion of the fund using a strategy typically reserved for hedge funds. There are also those publicly available products to provide exposure to alternative strategies.
The point is that there are many options available to the individual investor to participate in alternative assets and strategies, most with a lower cost structure and almost all with a track record that can be evaluated. FDSFX may emerge as a viable option, but I would recommend patience in assessing its usefulness.
Wednesday, February 2, 2011
Reverse Mortgages
I saw an article in Investment News about using reverse mortgages as a first source of capital for retirement income. The article uses Generation Mortgage Co., a reverse mortgage originator, as a source. My recollection was that reverse mortgages are better suited as an income source of last resort, and my skepticism was piqued by the use of an industry vendor as an expert. The article did not go into great detail on how the conclusion was reached, so I constructed a little analysis.
The hypothetical retiree is a 62 year old male. He has a home worth $250,000 and $500,000 of investable assets. He has no mortgage debt on the home. Returns on the investment portfolio are assumed to be 4.5% annually, and home appreciation is expected to be 3% per year. Origination fees are estimated at $7,500 and mortgage insurance is a one-time 2% fee, all of which is payable on the outstanding balance at the death of the borrower. there is also an ongoing mortgage insurance premium of 1.25% of the outstanding balance. allyA website associated with AARP, gave me an estimate of $731 per month in payments to the borrower under the program. All Reverse Mortgage Company has interest rates posted on its site. I used the higher of the two variable rates - 2.5%. A Nationwide Income Promise(R) annuity that will pay $731 per month will require a deposit of $127,279.
The results: For the first twenty years of retirement, using the reverse mortgage as the source of the $731 per month income stream results in a higher terminal net worth than buying an annuity with investable assets. The advantage shrinks from 18% at the end of the first year to 5% at the end of year 20, but the advantage is still significant. A reverse mortgage may be an appropriate income resource for a retiree.
Two big caveats must be mentioned. The program that provides for a payment stream is only available with a variable interest rate. An increase in the interest rate will have an adverse affect on the final net worth under the reverse mortgage scenario. Second, no taxes affects were considered in the analysis as there are too many permutations to consider efficiently. That there is generally no tax on payments received from the proceeds of a reverse mortgage suggest that its advantage would widen.
A surprising result, so it was especially worth the effort. It reminds me that I need to regularly check my assumptions about market conditions and the operation of financial products.
Special thank to David Gaynes and Dayna Adams.
The hypothetical retiree is a 62 year old male. He has a home worth $250,000 and $500,000 of investable assets. He has no mortgage debt on the home. Returns on the investment portfolio are assumed to be 4.5% annually, and home appreciation is expected to be 3% per year. Origination fees are estimated at $7,500 and mortgage insurance is a one-time 2% fee, all of which is payable on the outstanding balance at the death of the borrower. there is also an ongoing mortgage insurance premium of 1.25% of the outstanding balance. allyA website associated with AARP, gave me an estimate of $731 per month in payments to the borrower under the program. All Reverse Mortgage Company has interest rates posted on its site. I used the higher of the two variable rates - 2.5%. A Nationwide Income Promise(R) annuity that will pay $731 per month will require a deposit of $127,279.
The results: For the first twenty years of retirement, using the reverse mortgage as the source of the $731 per month income stream results in a higher terminal net worth than buying an annuity with investable assets. The advantage shrinks from 18% at the end of the first year to 5% at the end of year 20, but the advantage is still significant. A reverse mortgage may be an appropriate income resource for a retiree.
Two big caveats must be mentioned. The program that provides for a payment stream is only available with a variable interest rate. An increase in the interest rate will have an adverse affect on the final net worth under the reverse mortgage scenario. Second, no taxes affects were considered in the analysis as there are too many permutations to consider efficiently. That there is generally no tax on payments received from the proceeds of a reverse mortgage suggest that its advantage would widen.
A surprising result, so it was especially worth the effort. It reminds me that I need to regularly check my assumptions about market conditions and the operation of financial products.
Special thank to David Gaynes and Dayna Adams.
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