Guaranteed Retirement Income Without The Variable Annuity

Recently, fa-mag.com published a story about a new product which is an alternative to annuities for guaranteed income.  Named RetireOne, it is from Aria Retirement Solutions (ARS), and it uses insurance contracts to provide a guaranteed income wrapper around a client's investment portfolio.  It will cost between 100 and 175 basis points, and provide an income of 4% to 8% of the capital wrapped by the contracts.  There are some limitations on the composition of the portfolio, but beyond that, the portfolio remains under the control of the RIA and his client.  Aegon is currently the only insurance company involved, but ARS is recruiting others.

This is potentially the biggest development in the retirement income area over the past 25 years.  Given the exit of some of the bigger players in the VA business, this can't come at a better time.  I am anxious to see more.

Capitalizing Lobbying Expenses

I saw this item in The Economist and it occurred to me that flimsier ideas have formed the basis for stock portfolio strategies.  The notion that greater lobbying expense is correlated with higher returns is intuitively attractive.  Companies don't make such expenditures without an expectation of return.  The companies that "invest" the most in influencing the regulatory environment are the ones that have reap the greatest from the expenditures.

Still, thirteen years is not an extensive test and it would seem that it would be an increment that woulds be arbitraged very easily. That has never been enough to deter product development in the past.  And this may actually have some staying paower.

BDCs versus Mutual Funds and ETFs

I have been looking at the Business Development Companies (BDCs) being offered by Franklin Square and CNL.  Both of these funds are investing in loans made to private companies, primarily floating rate tied to LIBOR.  Each has an affiliation with the lending desk of a major private equity firm.  Each expects to employ leverage.  Each will invest selectively in fixed rate debt.

The structure of each is about the same as well:  10% load and a 2% management fee plus 20% profit participation in excess of some benchmark.

Everything is sounding fine.  Except that there are already funds that invest in these floating rate loans available to investors.  I wrote about bank loan funds back in January.  Except for the leverage and fixed rate debt, the fund portfolios will be invested the same as the BDC portfolios.  The major difference is the structure: No-load with an expense ratio typically around 1%.

Now PowerShares has a floating rate loan ETF, the Senior Loan Portfolio (NYSE:BKLN).  It is designed to track the S&P/LSTA U.S. Leveraged Loan 100 Index.  Since its March 31, 2011 inception, it has tended to trade at a premium of 50 to 100 basis points.  BKLN has an expense ratio of 0.93% which is is currently being subsidized by ten basis points.

There is the choice:  invest in a traditional mutual fund or and ETF at virtually no load and with a 1% expense ratio.  Or invest with a 10% load and a 2/20 management fee.  PLUS direct expenses.

The promoters of the BDCs point to the leverage and illiquidity as investor benefits.  By borrowing at rates lower than is being earned on the portfolio, leverage is expected to enhance the returns.  The illiquidity of the investment will force an investor to hold during times of uncertainty, relieving selling pressure in a weak market.

In fact, leverage and illiquidity are risk factors, not investor benefits.  Indeed, an investment which exhibits these characteristics should be expected to provide incremental returns relative to similar investment which does not have the characteristics.  It seems rather dubious to rely on these additional risk factors to just overcome the BDCs' structural weaknesses and achieve performance parity with traditional funds and ETFs.

A New Product Has Been Discovered

Investment News has an article about the factoring of annuities purchased in settlement of civil disputes.  It goes something like this: Plaintiff sues for compensation for an injury, defendant settles by agreeing to pay a stream of payments, an annuity is purchased to provide those payments, plaintiff decides he wants cash now, and so decides to sell the annuity.  There have long been a couple of companies that have purchased these contracts in a word-of-mouth market.  Apparently, now the business is ready to "mainstream."

If the structured settlements business follows the same arc as the life settlements business, this is what we will see:

1. Local agents providing a service in their community looking for investors to share in the great yields afforded.
2. Financial advisors solicited for client introductions, under the assurance that "this isn't a security."
3. States bust promoters for selling unregistered securities.
4. Syndicator creates a pool and sells securities through broker dealers to capitalize the fund.
5. Annuities will be written for the express purpose of selling them to structured settlement factors.

All along the way, there will be debates over the ethics of the transactions, and the appropriate regulatory response.

The product development will take several years; the life settlements business started as viaticals in the late 1980s.  The players involved will improve in station and reputation as the investment becomes more mainstream.  The ultimate validation is a mutual; fund and/or ETF dedicated to the trade.  Look for it sometime after 2020.