The Float

The Warning

Frontline's latest--"The Warning," about Brooksley Born, Alan Greenspan, and the anti-regulatory ideology that helped put us where we are--is required, morally imperative viewing.

One revealing/disturbing highlight: "Greenspan didn't believe that fraud was something that needed to be enforced." No. We aren't making that up.

We recommend that you watch it at your earliest opportunity.

UPDATE: The bit about Greenspan's bizarro reluctance to discourage/discover/punish fraud is a real jaw-dropper. But the most affecting segment of "The Warning" is former SEC Chair Arthur Levitt's acknowledgment that Brooksley Born was good and right. Here are Levitt's words, roughly 48 minutes into the show: 

"I've come to know her as one of the most capable, dedicated, intelligent, and committed public servants I've ever come to know. I wish I knew her better in Washington. I could have done much better. I could have made a difference." 

Those words mean a lot, but the genuine emotion--the pain--underlying Levitt's statement can only be sensed by watching him. It's as if he becomes, in those few seconds, the personification of so much national regret. Amazing stuff.

More on Time's Recent 401(k) Takedown

Yesterday we offered a few thoughts on Stephen Gandel's furious assault on defined-contribution retirement plans. Today we'll pick up where we left off...

Gandel's core argument is that workers would be better off in traditional defined-benefit pensions than in defined-contribution plans.* In the abstract, we can't argue with that, assuming all such pensions were (and were to remain) fiscally sound. But we know that many, in the private and public sectors alike, aren't fiscally sound. So it strikes us as a little too simple to hold up traditional pensions as the rock-solid, safe-and-sound alternative to the 401(k). That doesn't diminish the problems in the 401(k) world. Not at all. But it does complicate the question of alternatives a little.

Gandel notes the virtue of portability, a clear advantage of DC over DB. (Alas, the accompanying quality of "raidability," the opportunity to pillage one's retirement account during one's working years, has impaired many participants' balances in a big way.) In an economy where people change jobs and careers more frequently than ever, portability will be an indispensable part of any retirement plan regime policymakers might come up with.

Gandel returns repeatedly to the perils of retiring in a down market. "If you retired last year," he writes, "you're toast." Um...no. Not necessarily.

As we've noted in the space time and again, the "retirement moment" isn't the true finish line; instead, it's one's life expectancy. Now, it's absolutely true that taking initial withdrawals from a depressed portfolio does real damage to that's portfolio's likelihood of surviving as long as its owner. But again, the solution for those at or nearing retirement is absolutely obvious and utterly simple: Hold a few years' living expenses in safe, liquid positions. Doing so eliminates the need to tap (or, worse yet, fully annuitize) a beaten-down portfolio of securities.

If an investor (in a 401(k) plan or not) experiences a substantial decline in portfolio value at the retirement moment, he or she shouldn't annuitize that portfolio, and should minimize (or, better yet, fully avoid) tapping any holdings whose prices have fallen precipitously.

The system has the technology to facilitate this approach, one that mitigates (but doesn't eliminate) the single biggest disadvantage of DC plans relative to their DB counterparts: the concentration of longevity and investment risks at the individual level.

Gandel finishes his piece with a discussion of "retirement insurance" proposals. Though we're pretty darn skeptical about a lot of products that mix investments and insurance, we're not remotely "anti-insurance." If our systems of social insurance are inadequate or unreliable, we'll have to supplement them with private/individualized resources.** Getting those systems right is one of the most important problems  policy makers, plan sponsors, service providers, and individual participants will tackle as our population ages.

We aren't thrilled by the status quo in the 401(k) marketplace, but we don't think the system is beyond repair. Indeed, recent legislative and regulatory changes have helped, and more such improvements are on the way. Unless and until the system is overhauled in some fundamental way, the moral and practical imperative is to make defined-contribution plans work as well as they can.

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* "Some said they were happy with their 401(k)," Gandel writes. "But all the people who shared their financials with us would have been better off in a pension." 

** Our view is that they're more inadequate than unreliable. We think Social Security will be around when today's young workers retire, but it'll never be enough, and can't be enough.

Source

Stephen Gandel, "Why It's Time to Retire the 401(k)," Time, October 9^th, 2009

A Toles Performance Bonus

The guy's just too good...

Time Takes a Mighty Swipe at the 401(k)

In a recent issue of Time, Stephen Gandel puts the defined-contribution retirement plan on trial...and convicts it of some pretty serious offenses. Check out Gandel's opening salvo: 

[T]he 401(k) was never meant to replace the employer-guaranteed pension fund, supplemented by Social Security, as the cornerstone of our nation's retirement system. But propelled by a combination of companies looking to cut costs and consumers who wanted control of their retirement destiny, that's exactly what happened.

The ugly truth, though, is that the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves.

Gandel guides readers through a familiar set of concerns: inadequate savings during participants' working years, ineffective management of individual accounts, and the risk of severe market downturns coinciding with retirement.

We think Gandel is a little too dismissive of the benefits of saving more during one's working years, and it's plenty clear to us--from our own experience and systemic data--that many participants don't manage their accounts prudently or effectively.* It's important for sponsors and fiduciary service providers to implement rules and processes that make these problems less likely and less consequential.

But what about the risk of retiring in the middle of an ugly market? This is indeed a big problem, but we don't think it's quite as insurmountable as Gandel suggests. Here's the core of his argument (emphasis added in bold):

In what must seem like a cruel joke to many, the accounts proved the most dangerous for those closest to retirement. During the market downturn, the 401(k)s of 55-to-65-year-olds lost a quarter more than those of their 35-to-45-year-old colleagues. That's because in your early years, your 401(k)'s growth is driven mostly by contributions. You control your own destiny. But the longer you hold a 401(k), the more market-exposed it becomes. It's a twist that breaks the most basic rule of financial planning.

By definition, Gandel's point about contributions playing a larger role in smaller accounts is exactly right. But there's absolutely nothing about the 401(k) system that requires larger accounts (or accounts of any size held by older participants) to be "more market-exposed." As we see it, there's a very simple solution for (rationally) risk-averse participants for whom volatility in their accumulated assets dwarf the impact of their ongoing contributions: Reduce the risk (i.e., expected volatility) of their accumulated assets while directing their contributions into asset mixes with higher expected long-term returns. 

Such a strategy would impose a capital preservation strategy on a participant's accumulated capital while taking full advantage of dollar-cost-averaging with his or her ongoing contributions.

Practical concerns? Any halfway-decent recordkeeping system should make this type of strategy very simple to implement. We can even envision a world in which a plan's automatic provisions "make inertia work for employees, not against them," as Gandel writes, by defaulting participants into this kind of approach.

We'll offer a few more thoughts on this important story tomorrow.

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* The leading causes of poor account management are (1) risk-taking that's wildly off the mark (which is to say, much too much in some cases and much too little in others) and (2) performance-chasing behavior, piling into what's (temporarily) hot and bailing out of what's (temporarily) not.

Source

Stephen Gandel, "Why It's Time to Retire the 401(k)," Time, October 9^th, 2009

Boise Fiduciary Symposium

Two weeks ago, I was participating in the first morning session of the Boise Fiduciary Symposium, a two-day event sponsored and organized by Matthew D. Hutcheson LLC, with Matt himself as the master of ceremonies and featured speaker.

With 40+ attendees, the event was a clear success. This was a group of professionals coming together to learn from Matt, and from each other, about leading-edge principles and practices in the fiduciary world. Topics included technological developments in recordkeeping, participant advice, and portfolio design; legal developments in and around ERISA; and ways to help plan sponsors and participants understand the differences between the fiduciary approach on the one hand and the product-driven approach on the other. 

I found it very satisfying to see serious, ambitious people tethering their careers to the fiduciary side of the business. There was a palpable sense that we were seeing and shaping the future of defined-contribution retirement plans. Exciting stuff.

Matt is planning to hold more events like this in other parts of the country. Anyone who is interested in what it means to serve as a 3(21) ["full-scope"] or 3(38) ["investment"] fiduciary would be wise to attend. Given the information content and networking opportunities, I think you'd find it time well spent. 

We'll post information on future events as soon as we have it.

Toles on the Economy

The guy never fails.

October 5th...

October 6th...

Number of Jobs Back to 2000 Levels

The media-driven focus on the (inevitably revised) monthly non-farm payroll numbers has always seemed a bit misplaced to us. The employment picture matters enormously, of course, but more in terms of its medium- and long-term trends than its short-term vicissitudes. 

Which makes the following charts all the more disconcerting. Note that the total/absolute NFP number has now fallen back to levels first reached nine years ago. In the second chart, you'll see that at no time in the last 50 years has the absolute NFP number fallen so far below its long-term trend. 

Given persistent population growth, the economy has to create lots of new jobs just to keep the employment rate steady. The job losses of the last two years have made it all the more difficult to return to the long-term trendline. 

A new normal? Unfortunately, for a while at least, it looks like the answer is yes.

Chart of the Day

Source

Bob Willis, "September Job Losses Exceed Forecast," Bloomberg, October 2^nd, 2009

A Tale of Two Paragraphs

(From this morning's Bloomberg report on consumer spending and incomes...)

It was the best of times:

Spending by U.S. consumers climbed in August by the most since 2001, indicating the biggest part of the economy is starting to rebound from its worst slump in almost three decades.

It was the worst of times:

Automakers including General Motors Co. benefited from the Obama administration's $3 billion "cash-for-clunkers" incentives. A projected drop in auto purchases last month is a reminder that such gains will be hard to sustain as the stimulus programs expire and households grapple with rising joblessness and stagnant incomes.

And the Bloomberg 'graph that falls between those two explains the disconnect (emphasis added in bold):

The 1.3 percent increase in purchases was larger than forecast and followed a 0.3 percent gain in the prior month that was bigger than previously estimated, Commerce Department figures showed today in Washington. Incomes climbed 0.2 percent for a second month and inflation decelerated.

So incomes rose 0.2%. And spending rose 1.3%, thanks largely to government spending. Is such a pattern sustainable when deleveraging is the financial imperative of the day? Here's John Hussman to explain:

My discomfort about strenuously overbought and moderately overvalued conditions overlaps with skepticism about the U.S. economic "recovery," which appears to be nothing but an artifact of government spending, while intrinsic economic activity remains weak. Stimulus induced "strength" is unlikely to propagate because, as I've noted before, economic recoveries are invariably led by expansion in debt-financed forms of spending such as gross domestic investment and durable goods. These classes of spending tend to lead other forms of economic activity by nearly a year, and it is difficult to expect this in an environment of heavy continued deleveraging pressure. Rather than abating, foreclosures and mortgage delinquencies are setting further records (pressured even more by continued net job losses), and we have now hit the point where Alt-A and Option-ARM resets are beginning (after a lull in the reset schedule since March).

Indeed. Save more, spend less. That's what's rational at the household level. But short-term Uncle Sam isn't crazy about deleveraging, so periodically we get these induced departures from the larger (and ultimately more durable and powerful) trend. But that trend persists, like it or not.

Sources

Shobhana Chandra, "U.S. Consumer Spending Jumps by the Most Since 2001," Bloomberg, October 1^st, 2009

John Hussman, "Strenuously Overbought," Weekly Market Comment, September 21^st, 2009

A New Slug of Active ETFs

This morning's Wall Street Journal features an Eleanor Laise article on a few new entrants in the category of actively-managed ETFs. We aren't crazy about the concept, largely because we think ETFs work best as part of a strategic asset allocation program with rock-bottom expenses. Here's a telling passage on that front:

Many investors are attracted to ETFs because of low costs. But the new Grail funds will each charge annual expenses of 0.89% of assets, making them pricier than three-fourths of the ETFs tracked by investment-research firm Morningstar. Grail American Beacon Large Cap Value charges 0.79%, only marginally cheaper than the 0.83% charge by investor shares of the nearly identical American Beacon Large Cap Value mutual fund. And the Dent Tactical ETF charges 1.56%. That is more than the average diversified U.S. stock mutual fund.

Roughly one quarter of ETFs have explicit annual expenses of more than 0.89%? Yikes. Then there's this:

Investors haven't flocked to actively managed ETFs. The Grail American Beacon Large Cap Value ETF has roughly $3 million in assets, and the five active PowerShares products have just over $24 million combined.

Brutal. If those numbers don't change soon, these little experiments won't last much longer. What about early returns from these things?

Performance that has lagged behind hasn't helped. PowerShares Active Alpha Multi-Cap Fund is down 21% in the year ending Monday, trailing the Standard & Poor's 500-stock index by 11 percentage points. PowerShares Active AlphaQ Fund is down 3.6% over that period, while its primary benchmark, the Nasdaq 100, gained nearly 4%.

Not a pretty picture. But some sponsors appear undaunted.

Despite the challenges, active ETF providers are aiming high. Grail aims to launch 24 to 30 new active ETFs over the next year or so, said Bill Thomas, the firm's chief executive. And over the past year, the firm has been talking to conventional actively managed mutual funds about converting to an ETF structure.

That's an interesting concept. Many of Vanguard's ETFs are simply different "share classes" of the firm's traditional mutual funds. We'll stay tuned to see if other open-end managers try to break in with ETF versions of their actively-managed funds.

UPDATE: ETFs are growing quickly, but they still occupy a small corner of the investment world. Here are a couple 2008 posts comparing ETFs and index-based vehicles to actively-managed, open-end funds:

• "ETF and Mutual Fund Data: A Reality Check"
• "ETFs and Index Funds: Still Modest in Most Categories"

Source

Eleanor Laise, "Grail's ETFs Take 'Active' Approach," Wall Street Journal, September 30^th, 2009

Independent Advice

Playing catch-up here with a September 14^th InvestmentNews story on the fate of a Bush-era proposal concerning the delivery of advice to retirement plan participants. Here's Sara Hansard's opening riff:

The Department of Labor is killing a regulatory change issued in the last days of the Bush administration that would have allowed brokers affiliated with mutual funds, brokerage firms and other companies that sell investments to provide investment advice to 401(k) participants.

With legislation pending in the House, and the possibility of similar provisions emerging from the Senate, it's likely that the current Congress will act on the question of independent advice. The immensity of the health care reform effort has pushed other things aside for a while, but even if it happens in 2010, and whether it's a product of Congress or the DOL or both, the rules on advice are going to change.

Meaningful legislation on independent advice would help our firm, but our support for these ideas doesn't follow from our firm's position in the marketplace. Instead it's the other way around: Our support for these ideas explains our firm's position, as we wouldn't be in this business if we couldn't do it with absolute independence. 

This is a story worth following.

Source

Sara Hansard, "Labor Department nixes Bush OK to let brokers advice 401(k) plans," InvestmentNews, September 14^th, 2009