Trendspotting

Differentiating Factors 

Report says behavioral-driven factors can help advisers stand out 

In spite of stock market rebounds and emerging signs of recovery in various economic indicators, wealthy investors apparently have decided to exercise caution.

According to the 14th annual World Wealth Report by Merrill Lynch Global Wealth Management and Capgemini, while 59% of high-net-worth individuals (HNWIs)—defined as those having investable assets of $1 million or more, excluding primary residence, collectibles, consumables, and consumer durables—indicated they had regained trust in their adviser over the past year and nearly as many (56%) had regained trust in their wealth management firm, nearly three-quarters (71%) of HNWI investors have yet to regain trust in the regulatory bodies that are supposed to monitor the markets and protect investors.

The report notes that those HNWI clients are “demanding fundamental changes in how they are served, and are rewarding firms that can clearly demonstrate a sharper understanding of their emotional and intellectual needs and objectives.”

“Behavioral-driven investing can serve as a differentiator among firms and advisers,” said Sallie Krawcheck, President, Global Wealth and Investment Management, Bank of America. “Many firms already are beginning to embrace behavioral factors as part of HNWI investing strategies and the holistic advice they provide their clients. Long term, however, firms and advisers understand that adapting a sustainable or profitable behavioral finance strategy means consistently capturing information that can drive deeper, goal-oriented conversations­ with clients consistently and ­efficiently.”

According to the report, while the level of industry adoption probably will vary, there are significant opportunities for leaders to reposition their firms and drive further innovation, including the way in which: advice is delivered; existing products are positioned; new products are developed and delivered; the service delivery model is tailored to reach more focused customer segments and behavior styles; and the desktop tools for advisers, investment specialists, and clients take client behavior into account.

The report authors say that adapting to these new market realities­ and changing client behaviors will require different degrees of transformation and change that potentially can “affect all aspects of the operating model, including products, processes and platforms, and service models. The specific adaptations each firm ultimately makes will depend on the firm, its size, focus, specialization, and its vision for its future, as well as its desire and ability to adapt and lead.” As a result, the report says it will be “essential to deliver the right level of high-touch advice and market-relevant product and service innovations to meet the needs of all clients in a scalable way.”

The report says that HNWIs are especially keen as they work more actively with their advisers to “properly understand the nature and potential performance of specific investments, manage their downside risk, and receive advice that is aligned with realistic­ and appropriate goal-setting, based on their actual risk profile.”

—Nevin E. Adams

Staying Put 

Morgan Stanley adviser suits’ dismissal upheld 

A federal judge was right when he threw out lawsuits against two Morgan Stanley advisers alleging they improperly told groups of Xerox and Kodak employees they had enough of a nest egg on which they could retire early and live on their investment earnings, an appellate court ruled.

The 2nd U.S. Circuit Court of Appeals said Senior U.S. District

Judge David G. Larimer of the U.S. District Court for the Western District of New York properly ruled the allegations leveled at the advisers under New York state law were preempted by the federal Securities Litigation Uniform Standards Act (SLUSA). The appellate court ruling came in a consolidated case involving both Morgan Stanley suits.

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Writing for the appellate court, Circuit Judge Barrington D. Parker rebuffed arguments by lawyers for the retirees that applying SLUSA was inappropriate because the suits do not allege the advisers’ fraud or misrepresentation in connection with the purchase or sale of nationally traded securities. The retirees also insisted that the time lag between meetings with the advisers and their eventual investments with Morgan Stanley made the SLUSA preemption argument not applicable.

“So, at the end of the day, this is a case where defendants’ alleged misrepresentations induced appellants to retire early, receive lump sum benefits, and invest their retirement savings with defendants (Morgan Stanley), where the savings were used to purchase covered securities,” Parker wrote. “When the securities plummeted in value, appellants sued to be made whole. Because both the misconduct complained of, and the harm incurred, rests on and arises from securities transactions, SLUSA applies.”

According to Parker’s opinion, the Morgan Stanley cases involved:

* Allegations by William D. Lawton and Gerald G. Miller, Jr., long-time Xerox employees, that David Isabella, a Senior Vice-President of Morgan Stanley, a “retirement specialist,” and a former Xerox employee, told them that if they could live on annual withdrawals of approximately 10% of their retirement savings, they could retire early without exhausting their savings’ principal. Lawton and Miller further allege that they elected early retirement in reliance on Isabella’s advice, leaving behind job security and substantial benefits. Both men opted for a lump-sum retirement benefit, which they invested, about 18 months after they first met with Isabella, in various securities through Morgan Stanley. The value of their portfolios later dropped precipitously, resulting in substantially reduced monthly withdrawals and significant financial hardship.

* Allegations by John D. Romano, Stanley J. Morrill, and Richard V. Patrick, former longtime Kodak employees who consulted with Michael J. Kazacos, a Senior Vice President, financial consultant, and retirement specialist at Morgan Stanley. The Kodak retirees allege that, during seminars­ as well as during individual appointments, Kazacos advised them that they had sufficient assets to retire and encouraged them to retire early and take lump-sum retirement benefits. The three men each elected to retire early and take a lump-sum retirement benefit, which they placed with Morgan Stanley for investment, which suffered ‘disastrous’ declines in value, allegedly because Kazacos’ retirement advice was inappropriate and “had a significant probability of failure,” the suit alleged.

In arguing for the applicability of SLUSA, the opinion said that Morgan Stanley pointed out that the retirees in both cases had deposited their retirement savings into Morgan Stanley IRA accounts, where covered securities were purchased on their behalf: mutual funds in the case of the Kodak suit and mutual funds and listed securities or securities authorized for listing in the case of the Xerox allegations. Both cases were being pursued as class actions, reportedly on behalf of hundreds of other Xerox or Kodak retirees. —Fred Schneyer

Misconceptions 

Participants not as knowledgeable as employers think 

A survey reveals that 401(k) participants do not know as much about plan fees and investing as employers think they do.

The 11th Annual Transamerica Retirement Survey found many of the legislative and regulatory proposals regarding fee disclosure designed to offer summarized information and electronic delivery should be well-received by workers. A majority of workers surveyed prefer some type of summary in regard to fee information (55%), and respondents have a strong preference for electronic delivery of fee information—74% would like it to be available on the plan provider’s Web site and/or electronic statements.

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However, the survey also found a significant impediment to any new legislation’s or regulation’s potential effectiveness in informing workers is that 401(k) plan sponsors do not seem to be concerned with the issue. Approximately two-thirds of plan sponsors surveyed indicate they are not interested in receiving more information about fees.

In addition, approximately seven in 10 plan sponsors say they think their employees are aware of fees, while only a little more than a quarter of workers say they are aware.

Although the majority of employers and workers agree that workers are receiving the right information to make decisions about the plan, most workers (68%) say they do not know as much as they should about retirement investing, and very few workers know “a great deal” about asset allocation (6%). More than half (51%) of workers guessed at their retirement savings needs.

A large percentage of workers rely on financial Web sites, family and friends, financial planners/brokers, retirement plan provider Web sites, and print newspapers and magazines for education. Workers also state that larger tax breaks and educational material that is easier to understand would motivate them to learn more about saving and investing for retirement. —Rebecca Moore

Reaching Out 

Advisers use social media to drive growth, connect with clients 

A study from BNY Mellon’s Pershing Advisor Solutions finds nearly half of registered investment advisers (RIAs) work for a firm that has a written policy governing the use of social media tools and, among those firms, 81% prohibit or limit the use of social media.

Still, among RIAs already using social media, 42% said it has helped them reach new prospects, 31% credit it with helping them to generate awareness of their business, and 27% with helping them differentiate themselves from their competition, according to “Creating Growth: The Increased Use of Social Media by Independent Advisors.”

Although RIAs who use social media on average manage fewer assets and advise fewer clients than those who do not, the survey found that they have experienced higher growth in terms of revenue, assets, and clients advised. One in five advisers attributed increased revenue or fees from existing clients to their social media-related efforts.

Users are not limited to younger RIAs, either. While more than half of advisers under 30 do use social media for professional purposes, so do 48% of those in their 30s and 42% of those in their 40s. The most common social media tool advisers reported favoring is LinkedIn (53%), followed by Facebook (39%), and Twitter (27%). Twenty percent even reported having a professionally oriented blog. —PA

End of an Era? 

SEC proposes rules on 12b-1 fees 

The Securities and Exchange Commission (SEC) has proposed measures that would replace existing provisions, including Rule 12b-1, that allow mutual funds to use their assets to compensate securities professionals who sell shares of the fund.

The SEC’s proposal would: limit fund sales charges; improve transparency of fees; encourage retail price competition; and revise fund director oversight duties, according to the regulator.

The proposal would limit the amount of asset-based sales charges that individual investors pay. A fact sheet said, in particular, the proposal would restrict “ongoing sales charges” to the highest fee charged by the fund for shares that have no ongoing sales charge. For example, if one class of the fund charges a 4% front-end sales charge, another class could not charge more than 4% in total to investors over time. The fund would keep track of how long investors have been paying ongoing sales charges.

Separately, funds could continue to pay 0.25% per year out of their assets for distribution as “marketing and service” fees for expenses such as advertising, sales compensation, and services.

The proposal would require the fund to identify and more clearly disclose distribution fees. In particular, the fund would have to disclose any “ongoing sales charges” and any “marketing and service fees” in the fund’s prospectus, shareholder reports, and investor transaction confirmations. Transaction­ confirmations also would have to describe the total sales charge rate that an investor will have to pay.

The proposal would enable funds to sell shares through broker/dealers who determine their own sales compensation. As a result, broker/dealers could establish their own sales charges; tailor them to different levels of shareholder service; and charge shareholders directly, similar to how commissions are charged on securities such as common stock.

The proposal would prevent funds that rely on this exemption from deducting other sales charges from fund assets for that class of shares to prevent double-charging.

The proposed amendments, which would set automatic limits on fund fees and charges, would eliminate the need for fund directors to explicitly approve and reapprove fund distri­bution financing plans.

There was a 90-day public comment period after publication of the proposal in the Federal Register. —Rebecca Moore

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 What Advisers Do Online 

Financial advisers spend more than 23 hours per week online at industry, social, and asset manager sites, according to a recent study by kasina.  

Eighty-five percent of advisers admitted to visiting asset manager sites at least occasionally, and 71% even reported that the quality of asset manager sites they visit affects their product designs. The report found that wholesaler discussion of firm Web sites affects adviser usage of those sites, and more high-AUM advisers seek news and commentary on adviser sites.

The most commonly accessed sites are advisers’ intranets, which are visited by 94% of advisers, and social media sites such as LinkedIn, Facebook, and Twitter are on the rise as well. Most advisers admitted to using mobile devices to access work content and, while most feel that they get too much e-mail from asset managers, more than two-thirds reported sharing content with clients. —PA

A Crack in the Nest Egg 

Rich Americans also could deplete retirement savings 

Some 64% of Americans in the two lowest pre-retirement income levels will be running short of money after 10 years in retirement, a new study found.

A release from the Employee Benefit Research Institute (EBRI) about its 2010 EBRI Retirement Readiness Rating also indicated that, after 20 years of retirement, 29% of those in the next-to-highest income level will run short of money, as will more than 13% of those in the highest-income level.

The highest-income Americans are at the lowest risk of running short of money in retirement, but many in the highest-income category still face significant risks of not being able to pay basic expenses and uninsured medical expenses for the remainder of their lives, EBRI said.

According to EBRI, nearly half of early Baby Boomers—56 to 62—are at risk of not having sufficient income to pay for basic retirement expenditures and uninsured medical expenses, and nearly the same fraction of Gener­ation Xers are in a similar position.

“As the private-sector retirement plan system evolves from a largely paternalistic one to a system in which workers must make their own decisions, policymakers need to understand what percentage of the population is likely to fail to achieve retirement security under current conditions,” said Jack VanDerhei, EBRI Research Director and principal author of the study. “Even more important is to identify which of those households still have time to modify their behavior to achieve retirement security, and how they need to proceed.”

When the results of the analysis are classified by future eligibility in a defined contribution plan, the differences in the “at-risk” percentages are quite large, EBRI said. For example, Gen Xers with no future years of eligibility have an “at-risk” level of 60%, compared with only 20% for those with 20 or more years of future eligibility.

The analysis also models how much additional savings would need to be contributed from 2010 until age 65 to achieve adequate retirement income 50%, 70%, and 90% of the time for each household.

The EBRI Retirement Readiness Rating is based on EBRI’s Retirement Security Projection Model.

—Fred Schneyer

Falling Short  

Advisers say clients not reaching goals 

Advisers responding to a recent survey say clients are at risk of falling short of their financial goals if corrective action is not taken.   

In fact, 44% of advisers considered up to a quarter of their client base to be at “significant risk,” and an additional 36% considered a quarter to half of their client base to be at “significant risk,” according to the most recent Financial Professional Outlook (FPO) quarterly survey of financial advisers by Russell Investments.

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Asked about the reasons why clients were at risk, approximately a quarter of the advisers said clients are not willing to save enough (24%), or that they simply do not have enough money (22%). Other respondents cited “overall market risk” (20%) or “clients holding portfolios that are too conservative” (17%) for their retirement.

The three most common reasons advisers fear they may not reach revenue goals in 2010 are a lack of qualified leads and referrals (23%); the fact that clients remain on the sidelines (in cash) due to market concerns (22%); and increased regulatory oversight and compliance requirements (19%).

On the practice management front, most advisers indicated that they will respond to regulatory changes by “seeking advice from compliance officers/hierarchy” (62%), “reassessing their clients’ situations, risk tolerances, and goals” (48%), and “explaining changes to clients” (40%).

Investment Selection  

Advisers responding to the survey appear to have a greater level of certainty about the equity markets over the next 12 months.  

Regarding each of 13 asset classes, noticeably fewer advisers marked “not sure” about their plans to shift allocations compared to three months ago. For each asset class, 21% to 40% fewer advisers are unsure, compared to the first quarter survey results in which, on average across the asset classes, 31% of advisers planned to increase allocations (now up to 33%) and 23% planned to decrease allocations (now up to 27%).

Advisers’ planned allocations to value-oriented U.S. equity asset classes and real estate increased (up 7 percentage points and 8 points, respectively). On the flip side, 39% and 43% of advisers plan to decrease their allocation to corporate and high-yield bonds respectively, an increase of 9 points since March 2010 in both instances. —PA

“Must-Have” Technologies 

The results of a recent survey of financial advisers reveal the “must-have” technologies for running a more efficient and profitable advisory business. According to the ByAllAccounts survey, the top five technology solutions deployed in-house or through an application service provider are: portfolio management/performance reporting (83.6%); CRM tools/client reporting (71.2%); trading (57.4%); financial/estate planning (56.8%); and  rebalancing/asset allocation (51.4%).

The results suggest that account aggregation technologies are becoming an increasingly important part of the overall technology mix for many registered investment advisers (RIAs). Many advisers rely on new technologies to help their firms run smoothly, streamlining operations as they advise existing clients and pursue prospects. Some firms are even integrating technology solutions to open entirely new revenue streams, going beyond simply viewing client’s held-away assets to advise on those and bill for that service. —Sara Kelly

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Blackout Notice Suit Allowed To Move Forward 

A federal judge in Ohio ruled that a 401(k) profit-sharing plan and two participants can press forward with their lawsuit alleging that Principal Life Insurance Co. breached its duty to make a timely notice of a plan blackout period.   

U.S. District Judge Sara Lioi of the U.S. District Court for the Northern District of Ohio ruled that Principal and various Principal entities named as defendants violated the 30-day blackout advance notice requirement in the Employee Retirement Income Security Act (ERISA).   

Lioi rejected defense arguments that Principal was not plan administrator of the Roholt Vision Institute Inc. 401(K) Profit Sharing Plan. Lioi asserted that there was a “strong inference” that the defendants had been delegated the plan administrator role since they had control over a separate plan asset account. Lioi also pointed to the fact that the Principal announced the blackout only hours before it started.   

According to the opinion, Principal announced the blackout on September 25, 2008, that was to start the following morning and end three years after that.   

The participants claimed their account values dropped because of the inability to transfer assets during that time. The case is Roholt Vision Institute Inc. 401(k) Profit Sharing Plan v. Principal Life Insurance Co. —Fred Schneyer

Crystal Ball 

BlackRock’s Doll says no boom but better investing conditions in next decade 

The investing environment for the next 10 years will not match the boom conditions of the 1980s and 1990s, but will be much better than that of the decade just ended, according to “10 Predictions for the Next 10 Years” developed by Robert C. Doll, Vice Chairman and Chief Equity Strategist for Fundamental Equities at ­BlackRock, Inc.   

“We’re not likely to see double-digit stock returns in the coming 10 years due to ongoing deleveraging and significant structural problems, but two disastrous market decades in a row is extremely unlikely as well.” Doll said.   

Doll predicts U.S. equity returns will lead the developing world, outpacing those of other developed markets due to more attractive valuation measures, stronger secular growth, more shareholder-friendly management practices, and more serious structural problems in non-U.S. economies. Though stocks likely will record a positive decade, investors will need to cope with a larger number of recessions than they have over the past 20 years, as the frequency of recessions returns to a more “normal” level, Doll believes.   

He also believes that, in a global environment where emerging econ­omies will lead world growth, China will continue to grow strongly as an economic and political force.   

Here are Doll’s “10 Predictions for the Next 10 Years”:   

1. U.S. equities experience high single-digit percentage total returns after the worst decade since the 1930s.   

2. Recessions occur more frequently during this decade than only once a decade as occurred in the last 20 years.   

3. Health care, information technology, and energy alternatives are leading growth areas for the U.S.   

4. The U.S. dollar continues to be less dominant as the decade progresses.   

5. Interest rates move irregularly higher in the developing world.   

6. Country self-interest leads to more trade and political conflicts.   

7. An aging and declining population gives Europe some of Japan’s problems.   

8. World growth is led by emerging-market consumers.   

9. Emerging markets’ weighting in global indexes rises significantly.   

10. China’s economic and political ascent continues.

Doll suggested several areas of long-term opportunity for investors­ and their advisers, including overweighting stocks and other risk assets versus Treasurys and cash; overweighting U.S. stocks versus other developed market equities; focusing on opportunities in emerging markets; and allocating to better-positioned sectors. —Sara Kelly

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Managerial Change 

DoL announces prohibited transaction exemption amendment 

Financial institutions now are allowed to act as qualified professional asset managers (QPAMs) for their plans, as a result of a recently announced change to a 2005 rule.

The U.S. Department of Labor (DoL) said it has amended prohibited transaction exemption PTE 84-14 to allow certain parties-in-interest to engage in limited transactions with plan assets, as well as giving additional relief. The amendment allows transactions such as leasing office space or other ordinary business deals between contributing employers or QPAMs and plan assets.

The DoL change also allows a QPAM to own an investment fund containing the assets of his or her own plan or an affiliate’s plan. A QPAM can be a bank, savings and loan association, insurance company, or investment adviser acting as an independent fiduciary, according to the amendment.

The class exemption will apply only if the qualified professional asset manager:

• has discretionary control of the plan assets involved in the exempted transactions,

• adopts written policies and procedures that will ensure compliance with the terms of the exemption, and

• obtains a qualified independent auditor to conduct an exemption audit.

The changed rule exempts employers and QPAMs from penalties under Section 406 of the Employee Retirement Income Security Act and from certain taxes under Sections 4975(a) and (b). —Fred Schneyer

Gorillas in Our Midst? 

Many are not skilled at expecting the unexpected 

As it turns out, expecting the unexpected doesn’t necessarily turn out as one might expect.  To test the theory, researchers at the University of Illinois put together a study in which volunteers watched a video of two groups of people—some dressed in black, others in white—passing basketballs back and forth.  Study participants were told to count the passes between those dressed in white, but to ignore those dressed in black.

At one point in the video, a person in a gorilla suit walked into the game, faced the camera, pounded his chest, and then walked out of view.

Now, some of the study participants knew that the gorilla would appear while others weren’t expecting it.  As it turns out, all of those who had prior knowledge of the event spotted the gorilla—while only about half of those who weren’t looking for it spotted the unexpected event.

However, just 17% of those who were expecting the “unexpected” gorilla spotted one or more other “unexpected” events in the video (such as the background curtain changing color, and one player left the scene)—only about half the number (29%) of the study participants who didn’t have foreknowledge of the gorilla—but who, apparently, were more cognizant of other unexpected events.

Interestingly, this finding actually was consistent with a phenomenon called “satisfaction of search,” where people have been found to be less likely to search for additional targets once they have found their original target.

“The main finding is that knowing that unexpected events might occur doesn’t prevent you from missing unexpected events,” researcher Daniel Simons, a psychology professor at the University of Illinois at Urbana-Champaign, said in a university news release.

In other words, when people know to look for an unexpected event, they tend to notice that event, but are less likely to notice the truly unexpected events.  So, apparently foreknowledge of unexpected events might simply blind you to others. —Nevin E. Adams