Financial Symmetry News & Views

Archive for March, 2010

What if you never again had to prepare your tax return? Or pay someone to do it for you?  The catch is that the IRS would be the ones who prepare it.  Sound a little scary?  The Bipartisan Tax Fairness and Simplification Act of 2010 introduced in the Senate has a provision for just that scenario.

http://www.theatlantic.com/business/archive/2010/02/will-the-new- tax- reform-bill-kill-h-r-block/36605/

In this issue of “Under the Hood” we reference an article written by Bob Veres and give some insight into our decision-making process when it comes to evaluating different mutual funds.  We also include an excerpt from an interview with one of our mutual fund managers.

HOW TO LOSE MONEY IN THE TOP-PERFORMING FUND

by Bob Veres

An article in the December 31st issue of the Wall Street Journal makes a point that many of us in the financial planning world have long suspected. It says that the CGM Focus fund was the top performing mutual fund, by far, over the past ten years, generating an annualized return of more than 18% a year since January 1, 2000.

Now here’s the punchline: the average investor in this top-performing fund lost an average of 11% a year over the same ten-year period.

How is it possible for investors to lose their shirts in a fund that posted outsized returns?

Most planning professionals know the fund’s manager, Ken Heebner, as a swing-for-the-fences investor, somebody prone to huge runups and equally scary drops.

A Chicago-based investment research firm called Morningstar – whose data is used by most financial advisors — calculated what is called the “dollar-weighted” return of the CGM Focus fund, which gives a picture of what investors in the fund actually experienced.

If you had bought and held Ken Heebner’s portfolio throughout the 2000s, you would indeed have received returns of 18% a year. But the fund was so up and down that investors were alternately panicked and selling out or optimistic and crowding back in.

The article says the most dramatic example came after the fund was up 80% in 2007. Investors flocked in, putting $2.6 billion into the CGM portfolio — just in time to catch its equally-dramatic 48% drop through the end of 2008.

There have been credible studies showing that the average investor underperforms the market, and this illustrates exactly how it happens. Right after an investment generates strong returns, people tend to jump on the bandwagon — and then they experience the subsequent return to reality.

When an investment is struggling, people tend to abandon it, and miss out on its recovery. Missing the upside and catching the downside, consistently, is human nature, perfectly understandable behavior.

But it inevitably leads to dismal investment results — as it did for the battered, unhappy, money-losing investors in the best-performing mutual fund of the 2000s

WHY WE PASSED ON CGM IN 2007

Bob Veres’ commentary illustrates why we were not recommending CGM in 2007 when it was generating so much excitement. That same sentiment is why we are currently emphasizing funds like Allianz NFJ Dividend Value Fund, which may not be popular at the moment, but have proven to outperform after periods of lackluster results.

ALLIANZ NFJ DIVIDEND VALUE, PNEAX

The following is an excerpt from an interview with Ben Fischer, portfolio manager of NFJ Investment Group, on the recent performance of Allianz NFJ Dividend Value Fund:

(The Full interview can be found at www.AllianzInvestors.com)

Q: Why haven’t the financials in the portfolio fully participated in the rally?

A: You need to remember that NFJ seeks to invest in low-priced stocks with attractive fundamentals. NFJ believes that many of the benchmark constituents that have driven recent index performance have not done so because of their fundamentals. In fact, many of the stocks that improved the most were those that declined most precipitously in 2008.

Further, among financials, it is the very lowest quality stocks that have delivered the best performance since the market bottom on March 9.

While we are not limited to investing in only high-quality names, our process does prevent us from owning the lowest quality names. This positioning has served our shareholders well in the past, and will do so over the long term.

Q: Your Morningstar rankings have been affected. Explain a bit about that.

A: Morningstar rankings can be useful, but must be understood in context. Growth has significantly outpaced value year to date. In that environment, a deep value manager like us will likely underperform relative to its Morningstar peer group.

Further, deep value funds like NFJ Dividend Value will lag traditional and relative value peers. In addition, given the way the rankings are weighted, one-year performance has a greater effect on longer-term rankings, so any performance lag over, say, four months, will have an unusually significant impact on three- and five-year rankings.

Q: Has the portfolio ever lagged its benchmark and Morningstar peers in the past?

A: Yes, in the late ’90s, when growth outpaced value, the portfolio lagged both its benchmark and peer group. Again in 2003, when lower quality names outperformed, the fund lagged the benchmark and its peers.

However, both of these periods were followed by periods of outperformance.

Q: What are you doing to protect your shareholders in this environment?

A: We are focusing intently on absolute yield. We are also focusing on the cushioning effect of dividends.

To the latter point, though dividend cuts by many companies have been well publicized, among the Fund’s holdings, raises have actually outnumbered cuts three to one. Only eight of 45 holdings have reduced payouts over the past year, and the median holding still pays more than it did one year ago.

We have also emphasized companies with no looming debt maturities or pension plan concerns. We have highlighted companies that have recently hiked their payouts, even in the midst of the current economic malaise, as NFJ views these companies as less likely to turn around and slash their dividends.

Further, in the future, dividends may become rarer, and company managements will probably think twice before instituting standard payout hikes unless they are certain that they can be maintained.

Thus, going forward, increasing dividends may work even better as an indicator of quality and management confidence.

We in the financial planning community believe that something called a “fiduciary standard” is the very best framework for professionals to work with our clients.  That’s why we’re so angry over something that happened in the Senate over the weekend: Senator Tim Johnson of South Dakota inserted an amendment into the new regulatory reform bill–and, with the casual stroke of a pen, eliminated an important and powerful consumer protection.

This amendment cuts out a part of the original bill that would have required everybody who gives investment advice to the public to act as a fiduciary.  Senator Johnson wants the Senate to “study” the issue instead.

Why should you care?

The fiduciary standard is a legal concept, but its core idea is not complicated.  To act as a fiduciary means we professionals have to put aside our own financial interests, and also put aside the business/financial interests of any company we work for, and give recommendations that are solely and completely in the best interests of people like you, our customers or clients.

In other words, our recommendations have to be made with only one concern: is this the best thing I (the professional) can do for you, given what I know about who you are and what you want and need?

So what does it mean NOT to be a fiduciary?  Imagine that there were two kinds of health practitioners in the world.  One group functions much like doctors do today: they work out of independent offices, meet with you, diagnose your ailments, prescribe a medical solution that they believe is the very best course of treatment, and you pay them directly for this service.

The other group of health care providers operates somewhat differently.  They’re employed in the branch office of a large multinational health conglomerate which requires its employees to recommend certain treatments which are most profitable to the company, so long as these treatments are considered to be “suitable.”

These might not be the best treatments, but under a set of very complicated regulations, these less-than-ideal prescriptions are deemed to be legally-defensible ways to address certain medical problems.  These other health care providers are paid by the company according to how many of these treatments they can sell.

Now imagine that these larger companies, because of the very high profits they’re making on these treatments, are able to gain a lot of influence over the process that decides which treatments are “suitable.”  In fact, their executives sit on the governing board of the organization that makes these determinations.

Finally, imagine that something went horribly wrong.  Several of the most popular treatments that these non-fiduciary medical professionals were eagerly peddling to their “patients” were not at all as their companies had portrayed them.  The result: catastrophic consequences, pain and suffering throughout the world.  An enormous mess.

To bring the analogy back to the financial world, these terrible treatments (investments) actually DID bring the global economy to the brink of financial collapse, a mess that required our taxpayer money to fix.  These companies had become so entwined in the system that the government had no choice but to help them recoup the staggering losses they brought upon themselves.

Not surprisingly, an outraged public demanded that this must never happen again.  To the real fiduciary practitioners, the solution is obvious: require everybody to act in the best interests of their customers/clients by imposing a fiduciary standard.  No more shady “suitable” treatments.

We were encouraged when Congress drafted legislation which, among other things, would bring every provider of financial advice under a fiduciary standard.

So here’s why professional financial services providers are angry.  Now that the catastrophic global meltdown, TARP, massive losses in the stock market and the longest recession since the 1930s is beginning to fade from memory, those companies that provide “suitable” non-fiduciary advice have gone back to business as usual–and very quietly, a Senator from South Dakota has now inserted a provision into the reform bill saying that instead of imposing this fiduciary requirement, that instead Congress will “study” the issue.

The Senate has decided to leave fiduciary out of the final bill.  Even the Wall Street Journal is outraged–here’s a link to a strongly-worded column that clearly explains what happened: http://online.wsj.com/article/SB10001424052748703940704575089413832399630.html

And here’s a link to another article which talks about how the legislative process favors the organizations that take the most money out of the pockets of their customers: http://www.financial-planning.com/fp_issues/2010_1/angels-and-demons-2665124-1.html

It would be nice if everybody called their Senator and Congressperson and said that they were just as angry as we are in the professional community.  A groundswell of public opinion might make our elected representatives understand that we haven’t forgotten TARP and all the rest of it.  Right now, the only people lobbying on your behalf are the professionals themselves, and there apparently aren’t enough of us to get the attention of the Congressional representatives who may be looking out for their own interests more than ours.

• This article is written by Bob Veres, publisher of Inside Information.  Inside Information is a journal that keeps financial advisors on the cutting edge of industry news. We found this piece particularly relevant to the heated debate surrounding the fiduciary vs. suitability discussion.

If you invest in your employer sponsored retirement plan you have probably heard of Target-Date funds.  These funds are characterized as investments that change the allocation of stocks, bonds, and cash according to your specified retirement date.  In theory, these funds should progressively reduce risk exposure as the target date approaches.  However, there are no universal allocation standards, so the returns have varied widely from plan to plan.  This was highlighted by the market downturn in 2008 when funds with a target date of 2010 lost an average of 25%, with some posting losses of over 40%.

While the concept of these funds is great; taking the guesswork out of retirement planning for the average investor; further research, transparency, and likely regulation is required.  To that aim the Senate Special Committee on Aging will be introducing legislation that would require fiduciary responsibility for target-date fund managers. This is a step in the right direction, but there are still many other concerns that warrant attention.  In October 2009 Morningstar’s vice president of research Jon Rekenthaler testified before the Senate Special Committee on Aging.  You can read his testimony here:

“Five Concerns About Target Date Funds”

http://advisor.morningstar.com/articles/article.asp?docId=17632