The Markets January 7, 2015

Bob Doll Peers into the Tea Leaves for 2015

Investor skepticism gives way to optimism, the equities market will continue delivering (but brace for a rocky ride) and retirement plans will want to take a hard look at their fixed-income choices.
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For more than a quarter of  a century, Bob Doll, senior portfolio manager and chief equity strategist for Nuveen Asset Management, has been forecasting the economy with a careful consideration of the key factors—economic, global, political—that will have an impact on the financial markets. And every year, he scrupulously keeps track of his own performance in making these predictions.

Last year, Doll predicted active managers would outperform index funds—and a handful did—but the majority failed to outperform their benchmarks, the worst performance since 2003. One reason, Doll said, is that generally active managers outperform when interest rates rise, which he predicted would happen. The continuing low interest rate environment definitely functioned as a drag on active managers’ performance, Doll said.

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Doll predicts again this year that interest rates will rise (No. 3: The Federal Reserve raises interest rates, as short-term rates rise more than long-term rates.) The likely scenario is a meeting and guidance issued in March, ahead of an actual rate raise in June, Doll said.

Doll’s prediction hinges on several factors, including the U.S. economy growing above trend; nominal growth approaching 5%; a strengthening job market with unemployment below 6%; and a likelihood of higher wage rate increases.

However, retirement plan sponsors and advisers will want to keep an eye on interest rates and manage the fixed-income in their portfolios if rates rise, Doll said.

If interest rates rise, obviously you’ll want less fixed income, Doll told PLANADVISER. “You want to be careful of your duration and your maturity; you want to be in fixed-income products that have lower Interest rate risk than a Treasury, so it takes you out various credit curves in other places,” he said. “Some investors will look to high-yielding equities,  where you can get a good total return on stocks if rates go up and last, equity market neutral funds tend to have bond-like returns, bond-like volatility but are absent interest rate risk.”

Improving Economy

The U.S. economy continues strong, Doll said, and his forecast calls for 3% growth in GDP for the first time since 2005. The first quarter of 2014 was in stark contrast from the rest of the year, and if 2015 resembles the last three quarters, this is an easy one to get right, Doll said. “The U.S. economy looks increasingly able to stand on its own two feet and no longer requires first aid from the Fed,” he said.

Except for exports, the key parts of the U.S. economy are improving. Jobs growth and an uptick in business and consumer sentiment have been especially impressive, Doll feels. Falling oil prices may have some negative economic consequences, but the upside to consumers and other users of oil will likely be a net benefit.

Core inflation will remain in check, but wage growth begins to increase. Aside from falling oil prices, Doll said he believes core inflation has been moving from around 1% to closer to 2%. He expects wage growth to begin rising in 2015 since unemployment has dropped to under 6%.

Doll’s other predictions are:

  • The European Central Bank institutes a large-scale quantitative easing program.
  • The U.S. contributes more to global GDP growth than China for the first time since 2006.
  • U.S. equities enjoy another good yet volatile year, as corporate earnings and the U.S. dollar rise.
  • The technology, health care and telecom sectors outperform utilities, energy and materials.
  • Oil prices fall further before ending the year higher than where they began.
  • U.S. equity mutual funds show their first significant inflows since 2004.
  • The Republican and Democratic presidential nominations remain wide open.

Doll’s predictions for 2015 can be downloaded here, including a full version that includes a scorecard of his predictions for 2014. (He scored 6.5 out 10, slightly below his average of 7 to 7.5 for the past 26 years that he has been forecasting the economy.) Financial advisers can subscribe to Doll’s weekly commentary and special market reports through this link.

In Practice January 7, 2015

Standing Out in 2015 Won’t Be Easy for Advisers

Consulting firm Mercer predicts advisers across retirement and wealth management channels will face some common challenges in 2015 as a lower-return environment takes hold.
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A lower-return environment is forcing advisory firms to reassess client risk exposures and search for strategies to contain costs, Mercer notes in a 2015 practice management outlook analysis. The firm says it has identified a list of priorities that advisers should consider to best serve their clients in the year ahead, and to help them stand out in an increasingly competitive advice marketplace.

Position portfolios for growth in a low-growth environment

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Mercer notes that interest rates remain near historic lows, despite the fact that the U.S. is more than five years into an equity bull market. As uncertainty about if and when interest rates will rise persists, Mercer says advisers ought to look beyond traditional investing strategies to consider less constrained funds that can target areas of opportunity, and those with longer perspectives.

Part of this effort will involve determining whether alternative investment strategies are appropriate for a broader group of clients, Mercer says.

“Alternative investments are being democratized and are no longer exclusively available to the wealthiest investors or most sophisticated institutions,” the Mercer analysis explains, urging advisers to evaluate how alternatives can be integrated into clients’ investment strategies to reduce risk or otherwise improve the likelihood of realizing investment objectives. In some cases, there may be a liquid alternative strategy that will help meet client investment objectives, Mercer notes, and in other cases clients may benefit from the illiquidity premium expected of other alternative strategies.

Mercer says 2015 may also be a good year for advisers to consider the impact of socially aware investing as part of portfolio design. Firms have an opportunity to distinguish their offerings by integrating environmental, social and governance factors into their investment process and products, Mercer says. This approach can be difficult in the retirement space, however, due to fiduciary rules prescribed in the Employee Retirement Income Security Act (ERISA).

Adopt a modern client service and communication strategy

Mercer warns that disruptive technology and new business models continue to transform the financial advisory industry. There has been especially rapid development in the areas of cloud computing, client service applications, social media and mobile transaction capabilities.

“Communication and direct access to portfolio information is frequently cited by clients as their main frustration [with their current adviser],” Mercer notes. “Wealth providers can significantly enhance client satisfaction and better manage fixed costs with the adoption of smart technology, but this will require investment to stay ahead of the competition.”

Mercer’s analysis finds rapidly changing markets, technology, regulations and competitive pressures “have shattered the economics of the traditional wealth management business.” Advisers need to review the core skills that provide them with a competitive advantage, and evaluate which resources are best sourced internally versus through an external partner, consultant or other vendor.

Conduct both investment and operational risk assessments

While it’s not exactly a new theme for 2015, Mercer warns that a full understanding of the products that clients are investing in is essential. Mercer says product and portfolio provider risk, from both an investment and operational perspective, is increasingly important and should be fully integrated into the investment decisionmaking process. 

Furthermore, risk assessments at the firm level can help to mitigate unanticipated losses for both clients and the firm. Despite this, Mercer says few advisory firms invest the same care in operational due diligence as they do in investment due diligence. Something else to consider is that many industry models that assess product risk are too backward looking in nature and overly reliant on measures of historic volatility, Mercer says.

“Advisers and clients need to place much greater emphasis on forward-looking and qualitative indicators of risk to fully appreciate potential outcomes,” the analysis says. “These factors will also become increasingly critical in client risk profiling. “

As Mercer explains, many advisory firms have lackluster internal monitoring due to limited resources, decisionmaking that is not responsive to the changing investment environment, or “calcified” operating models. Because of this, advisers must proactively evaluate their firm’s governance environment, consider its effectiveness at meeting the needs of the firm and its clients, and contract or develop the resources, data, and processes that are necessary for a robust and fluid governance process.

Ensure clients are getting what they pay for

Fees should be a factor in investment decisionmaking, Mercer says, but the lowest fees don’t necessarily signal the best product choices.

“Some clients prefer the certainty of lower investment expenses coupled with greater use of index-oriented products; others are more comfortable with active fees and the potential for alpha from active management,” Mercer explains. “It is important to help clients to distinguish between alpha and beta and to reserve higher fees for strategies with the potential for higher alpha.”

Mercer concludes by urging advisers to view the New Year as an opportunity to evaluate new business models, services and enhancements that could help reduce costs and improve performance for clients and the advisory firm.

Additional research and insights from Mercer are available at www.mercer.com.

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