Michael Kitces’ weekend reading for financial advisers

This week’s installment of “weekend reading for financial planners” kicks off with the announcement that Jeff and Kim Camarda have decided to appeal the unfavorable ruling they received in their case against the CFP Board, alleging that there are serious issues with the CFP Board’s disciplinary process that still haven’t come to light and that they believe they can ultimately prevail in court, even as the CFP Board insists that Judge Leon’s ruling was appropriate and will be upheld.

From there, we have several technical articles this week, including: a Morningstar discussion of the recent Wells notice the SEC served to Pimco for alleged mispricing issues with certain non-agency mortgage-backed securities held within their BOND ETF; why affluent clients may wish to implement a GRAT sooner rather than later (if they’re thinking about doing one at all); ongoing trends to watch in the long-term care insurance industry; how, despite their early hype, adoption of QLACs in retirement accounts continues to be slow; and a discussion by Wade Pfau of how portfolios that combine stocks and immediate annuities (i.e., partial annuitization) may be superior for retirement income and wealth accumulation over just buying traditional stock-and-bond balanced portfolios.

We also have a few practice management articles, from a look at the latest industry trends research on the continued rapid growth of RIAs (which drove hiring of 31,000 non-clerical financial services jobs last year, and added a whopping 2 million clients in the aggregate), to a discussion of how despite recent growth of firms there are concerns that profitability is slipping (which does not bode well for when the next real bear market occurs), and a look at how the ongoing evolution of the financial services industry (especially thanks to technology) will increasingly put pressure on advisers to add (more) value or be put out of business.

We wrap up with three interesting articles: the first looks at several new studies coming out suggesting that the “midlife crisis” phenomenon may not just be a “first-world problem” but that instead the “U-shaped curve” of happiness throughout life is something found across the globe, and even in other species; the second is a fascinating futurist look at whether small/solo law firms will survive in our increasingly technology-driven world, and the implications it raises for financial advisers who are following a similar path to the legal profession; and the last is a good reminder that for advisory-firm owners in particular, the ego that may have given you the courage (or stubborness!?) to go out and start your own firm and succeed in the first place may well be the same ego that is now limited your ability to continue to grow and succeed from here.

And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in adviser tech news at the end, including a look at LPL Financial’s recently revealed intent to offer a “robo” solution for its advisers, the announcement from Wealthbox CRM that it will be the first adviser CRM to integrate with popular business communication platform Slack, and a new service from Smarsh that will archive web-based Office 365 email and documents!

Enjoy the reading!

Camardas Appeal CFP Board Case To Right ‘Grave Wrongs’ (Melanie Waddell, ThinkAdvisor) – On Thursday, Jeff and Kim Camarda announced that “after very deep consideration” they will appeal the recent ruling by U.S. Distrct Judge Richard Leon in their case against the CFP Board, in order to right what they allege are “grave wrongs” that they believe will come to light once their case sees a public trial. The Camardas emphasized that the CFP Board’s subsequent actions since their original disciplinary action have further shown the “unfairness” of the process, particularly after the organization granted blanket amnesty to advisers at several broker-dealers who should have indicated they were commission-and-fee based on CFP Board rules but were claiming to be “fee-only” on the CFP Board’s website (a compensation disclosure conflict first pointed out on Nerd’s Eye View shortly following the Goldfarb decision). The Camardas also allege that the CFP Board has made public statements about them and the case that “contain material and demonstrable falsehoods” they wish to prove in court. In response, the CFP Board stated that it still believes Judge Leon’s original decision to dismiss the case will stand, and that the Appeals Court will affirm the judge’s decision that the organization followed its own rules throughout the disciplinary proceedings without any bad faith or ill will, though critics also raise the question of whether CFP certificants should be even more concerned if the CFP Board does prevail, given the tremendous latitude the courts are now affording the CFP Board to enforce against certificants based on its broad Terms and Conditions of Certification that they all must sign.

Pimco Put On Notice (Michael Herbst, Morningstar) – This week, Pimco announced that it had received a Wells notice from the SEC regarding its Pimco Total Return Active ETF (BOND), the ETF-based counterpart to its flagship Pimco Total Return (PTTRX) mutual fund. A Wells notice indicates the SEC is considering charges against an advisory firm, and in this case Pimco’s notice is regarding a preliminary SEC investigation into how the firm priced some odd-lot purchases of non-agency mortgage-backed securities between February 29th and June 30th of 2012, not long after the BOND ETF launched. The SEC’s concern is that if the value of these odd lots were overstated, even if they only comprised no more than 10%-15% of BOND’s assets, it may have artificially elevated the price of the BOND ETF itself, resulting in overstated performance early on (and harmful adverse performance to those who bought in later and had to absorb the subsequent price decline as the bonds were priced back to ‘reality’). And Morningstar does note that in those early months (when the alleged pricing discrepancies happened), the BOND ETF really did materially outperform its PTTRX mutual fund counterpart, while in the years since the performance between the ETF and fund have converged closer and closer together (though some discrepancies are to be expected, as they are different funds with different flows, even if they run with the same underlying strategy). Ultimately, it remains to be seen whether the Wells notice will lead to full charges and any disciplinary action against Pimco (which could include a settlement that provides restitution to BOND shareholders, or fines, or both), and either way the issue appears to pertain only to holdings and pricings several years in the past, and nothing current. And Morningstar notes that effective bond pricing is always a challenge, not unique to Pimco nor to ETFs in particular, which has only been accentuated in recent years by increased illiquidity as traditional fixed income market makers have been scaling back inventories since the 2008 crisis (especially in non-agency mortgage-backed securities at question here) – and ironically, the illiquidity means that a large firm like Pimco may really have gotten the bonds in question at a genuine market discount, and then simply marked them up to a reasonable price. Still, for the time being it remains to be seen whether the case will proceed from here, and either way Pimco’s Stewardship Grade remains a C from Morningstar at this point.

Grab a GRAT Before It’s Too Late (Robert Gordon, On Wall Street) – The Grantor Retained Annuity Trust (GRAT) estate transfer strategy is one where an individual (e.g., the patriarch of the family) transfers assets into a trust, and agrees to receive back the principal plus a “reasonable” rate of return over time, with the remainder paid out to subsequent beneficiaries (e.g., future heirs) free of any gift or estate taxes. The strategy has been especially popular in recent years, driven by the fact that in today’s low interest rate environment, the IRS-specified “reasonable” rate of return (known as the Section 7520 rate) that must be used is also very low (today the 7520 rate is 2%, compared to 6% in 2007 and 8% in 2000!), providing an easy hurdle rate to clear (and at worst if the returns are not better, there’s no tax downside, and the only adverse impact would be the legal and administrative costs expended to set up the GRAT in the first place). The caveat to the GRAT strategy is that the grantor must outlive the time period required to receive payments of all the principal back from the trust, but many attorneys suggest that a GRAT as short as two years will be permissible, and clients can simply set up new rolling GRATs every two years to keep repeating the strategy with additional assets to transfer. Notably, because it is so effective – especially in today’s environment – the IRS has been trying to limit the strategy, yet because it is entirely legal under the Internal Revenue Code, the only “fix” is for Congress to act and change the law, and recent White House budget proposals have been asking Congress to make the change for several years now. While it remains to be seen when/whether Congress will act, to say the least Gordon suggests that clients who are interested in the strategy may want to get started sooner rather than later, just in case.

7 Long-Term Care Insurance Trends To Watch (Brian and Murray Gordon, Journal of Financial Planning) – Relative to life insurance, which has been around in “modern” form since the early 1700s, the long-term care insurance (LTCI) industry is “just” 41 years old, with the first policies appearing in 1974. And as a result, the industry is still changing and learning, in terms of both how to effectively design products, and what consumers want to buy (and when). Accordingly, the Gordons note several key trends for long-term care insurance in the current environment, including: policies are being bought earlier (15 years ago LTCI was bought by people in their 70s, now it’s typically purchased mid-50s); consumers are increasingly self-insurance (buying LTCI to cover 25%-50% of their potential liability, rather than 100% of it); costs and claims continue to rise as care gets more expensive, but utilization is rising and changing as well (in particular, LTCI was originally focused towards nursing homes, but now 70% of claims start out as home care or assisted living); premiums are rising, but now that actuarial assumptions have improved, the rate of long-term care premium increases (for new policies) has slowed and should be more manageable in the future; underwriting for LTCI continues to be more “refined” (which means those with health conditions will find it increasingly difficult to qualify for coverage), and carriers are going deeper (some now require full paramedical exams and underwrite based on family history as well) and have also added in gender-based pricing for long-term care insurance; carriers are looking to adapt the elimination periods, potentially shifting from a time-based elimination period (e.g., 90 days) to a dollar-based one (e.g., $250,000) that would allow policies with significantly longer elimination periods and potentially much lower premiums; and so-called “asset-based” (or “hybrid”) long-term care insurance policies that combine LTCI with life insurance or annuity coverage continue to become more popular (though as some critics including yours truly have pointed out, such hybrid LTCI policies could be disappointing if/when/as interest rates rise).

Square Peg QLACs Can’t Seem to Fit in 401k Fiduciary Round Hole (Christopher Carosa, Fiduciary News) – While the insurance industry was abuzz last year when the Treasury Department issued new regulations permitted a so-called “qualified” longevity annuity contract (QLAC) to be purchased inside a retirement account without running afoul of the RMD rules, critics suggested at the time that QLACs may be a solution in search of a problem and that there was little consumer demand. And now after a year, the views on QLACs are still mixed at best. Some have simply suggested that QLAC pricing is still too expensive, and that while the payout rates may seem appealing – one adviser found a $100,000 QLAC purchased at age 60 would pay $5,000/month ($60,000/year) of lifetime income at age 85, but when compared to simply purchasing a balanced portfolio that won’t be touched for the same 25-year waiting period, those QLAC payout rates are actually still inferior in almost all Monte Carlo scenarios. In addition, some plan sponsors appear concerned about the lack of portability for a QLAC as well – once retirement account dollars are allocated into a QLAC, the plan participant is stuck with that QLAC forever, and even plan sponsors will have trouble changing providers in the future as “old” dollars would have to remain behind in an “old” QLAC that was previously purchased. And of course, there’s still the mental barrier that few consumers even seem to want to buy a traditional single premium immediate annuity for fear that they may not live long enough to recover the value, a fear that is only exacerbated by a QLAC where payments don’t even begin for decades (even if they’re far larger when they do begin, and the retiree doesn’t need to allocate as much to the annuity contract in the first place to provide for a target level of retirement income in later years). On the other hand, the possibility remains that QLAC pricing will improve in the future, which may change their outlook and adoption down the road.

Why Bond Funds Don’t Belong in Retirement Portfolios (Wade Pfau, Advisor Perspectives) – Income annuities (e.g., a single premium immediate annuity) function as a fixed income vehicle that provide lifetime cash flows precisely matched to a client’s longevity, which raises the question of whether or what role traditional bonds should play at all in a traditional retiree’s portfolio. After all, the challenge of designing a traditional bond portfolio for retirement is that, not knowing how long the retiree will live, the time horizon or length of the required bond ladder is uncertain; by contrast, because annuities pool a group of individuals together, which allows the law of large numbers to accurately predict the time horizon, a lifetime annuity doesn’t struggle with uncertain time horizon. And in fact, the known mortality allows income annuities to pay more than a bond portfolio could, even over a similar aggregate time horizon, because knowing that some participants will not live the entire time horizon makes it feasible to pay out more in the first place (a phenomenon known as mortality credits). Notably, the point here is not that income annuities would be used for an entire portfolio – which may unduly sacrifice the retiree’s liquidity or legacy goals – but that income annuities might just replace the fixed income portion of the portfolio, such that the retiree ends out invested in a combination of stocks and income annuities (i.e., partial annuitization). And in fact, when Pfau analyzes combinations of stocks and partial annuitization versus “traditional” stock-and-bond portfolios to find an “efficient frontier” of retirement income products, that’s exactly what he finds – that combinations of stocks and annuities can actually be more effective at satisfying spending goals and preserving financial assets in the long run (i.e., the remaining value for legacy goals can actually be larger with partial annuitization!), driven primarily by the fact that income annuities function like “actuarially-enhanced” bonds that provide a better return in the long run than traditional bonds while also helping to buffer early withdrawals from equities that can grow over time.

Retiring Boomers Lead To Increase In Number Of RIA Firms, Clients And AUM (Alessandra Malito, InvestmentNews) – The 15th annual “Evolution Revolution” study by the Investment Adviser Association and National Regulatory Services finds that the RIA segment of the industry continues to grow, in terms of both firms, clients, and AUM. In fact, total employment across all SEC-registered investment advisers was up 4.3% (by 31,000 “non-clerical jobs”) in just the past year, with such firms now employing a total of 750,000 people, and the total number of RIA firms actually rose at an even faster pace of 5.4% to 11,473. In terms of client growth, RIAs in the aggregate are now serving a whopping 2 million more clients than they were in 2014, a 6.8% year-over-year growth rate. And based on total regulatory AUM, all RIAs in the aggregate now oversee $66.7 trillion, up 8.1% year over year, though notably the distribution of AUM is very skewed – just 128 firms managing over $100B each control more than 54% of AUM (including many mutual fund managers operating as RIAs), while the other 11,300+ firms control the remaining 46%. Industry commentators suggest that the growth is being driven primarily by the wave of baby boomers approaching and entering retirement, who are seeking out RIAs for advice and guidance on the retirement transition.

When a Growing Firm Is Actually a Bad Sign (Angie Herbers, Investment Advisor) – Earlier this year, Herber’s firm Kaleido launched its “Kaleido Scope” service, a (free) business assessment tool that advisory firms can use to assess themselves in the six key areas of the business: management, human capital, finance, client service, operations, and sales and marketing. The tool is used not only for Herbers’ consulting engagements with clients, but as more and more firms take the assessment (now over 300 of them) it provides a real-time perspective on trends in the industry. And in the midst of today’s growth environment, when most advisory firms’ revenues are up, Herbers has observed a troubling trend: advisory firm profitability seems to be declining (despite the ongoing bull market). The issue seems to be driven by problems in a few key areas for most advisory firms: firms are scoring very high in client retention (less than 5% attrition per year), but scoring poorly in attracting new clients, suggesting that firms are pricing their services too low and may even be over-servicing clients to the point that they don’t want to refer (or alternatively, the industry’s pool of new client referrals may be drying up and that relying on referrals may not be a best practice in the future); notwithstanding all the buzz about succession planning and industry mergers and acquisitions, 80% of owner-advisers still don’t have a clear continuity plan in place (despite the fact that continuing planning is becoming a requirement for state-registered investment advisers!); advisory firms are having trouble finding good young talent, and larger firms appear to be looking to acquire smaller firms to get it. More broadly, Herbers cautions that advisory firms just don’t have a clear vision for where the business is going from here, exacerbated by industry media-hype about online digital advisory platforms, that may be leading some advisers to panic and throw money at everything from new technology to marketing to recruiting to M&A, and sacrificing the bottom line in the process. Which may be especially concerning for the longevity of those advisory firms if they aren’t operating at sufficient profit margins to serve as a buffer for when the next bear market comes.

Add Value Or Get Out Of The Way (Matt Lynch, Wealth Management) – The financial services industry is increasingly advice-oriented, yet as Lynch points out, were it not for today’s regulatory structures in place (e.g., the SEC and FINRA, and the way advisers are licensed under them), it’s hard to imagine that anyone would choose the current model, where the advice-value is often given away “for free” in order to get paid by distributing the financial services products and solutions to be implemented. Yet from the consumer perspective, the value-chain is already beginning to change, as the internet makes it increasingly possible for consumers to get those financial services products directly from the providers. After all, financial products don’t exactly require physical shelf space in a store to be sold, making them especially conducive to digital distribution). Yet this raises the question of exactly what value the advisor-as-middleman still plays. Of course, as the industry’s ongoing shift towards providing financial planning advice shows, the advisor value is the advice. Yet Lynch suggests that often advisers aren’t really delivering much advice at all, and are simply “marking up someone else’s work instead” (e.g., adding their own AUM fee onto an asset management firm’s fee just to get paid to distribute their investment management services), and that in the long run too many middlemen can’t stay involved in the process forever (especially if unbundling of fees increasingly highlights the no-value-added middleman layer). Which means in the end, the advisers who really are adding value with advice will retain a unique and valuable role in the supply chain, but everyone else risks being a middleman who isn’t adding value and will eventually just be cut out of the process altogether.

The Real Roots Of Midlife Crisis (Jonathan Rauch, The Atlantic) – The phenomenon of even highly successful people waking up sometime in their 40s or early 50s and feeling dissatisfied and eager for a change in lifestyle it’s been given a name: the “midlife crisis”. Whether driven by the health challenges of aging, the fact that parents may be declining in health or passing away, or a flattening out of job and career growth, it can be a dark time, from which people often don’t emerge until their mid-50s and beyond. But a growing base of research is finding that the midlife crisis is not just a matter of “first world problems“, but instead a documented biological event that happiness and well-being are related to age. The effect that has been dubbed “the U-curve” by researcher Richard Easterlin, after their research found that happiness is higher when we’re younger, declines through our 30s and into our 40s where it troughs, and then lifts up again in our later years (thus forming a shape like the letter “U”). The effect has been found not just in wealthy countries, but in third-world nations emerging from poverty, and one global study found the trend visibly evident in 55 out of 80 countries, even after controlling for income, marital status, employment, and so on. In fact, one recent set of studies even found U-shaped curves in the state of mind of chimpanzees and orangutans at their species-equivalent of our age 45-50 or so! Ultimately, the key point of the phenomenon is to recognize on the one hand that the “midlife crisis” phenomenon may have some biological roots, along with perhaps the “typical stage of life” issues that arise at the time as our expectations adjust to the realities of life; though it’s also crucial to note that in the end, the researchers find that happiness and well-being on the right side of the U (from our mid-50s to the end of life) rises even higher than it was in the early years, suggesting that after the lull, our best days of happiness really are ahead of us, which one researcher suggests is simply driven by the fact that as we age we become more attuned to what is most important and focus on those activities and relationships… making ourselves happier and happier in the process.

Is There a Future for Solos and Small Firms? (Sam Glover, Lawyerist) – The financial advisory industry is not the only one being threatened by technology and automation, and the forces of consolidation; Richard Susskind, author of “Tomorrow’s Lawyers“, suggests that similar forces are acting upon the legal industry, and his predictions of how the situation may play out for lawyers provides interesting insights about what may lay in store for advisers as well. So what does Susskind see in store for lawyers? In the near term, everyone from corporations to individuals are trying to bring down their legal costs, and this cost driver is leading clients to demand that lawyers stop doing work that doesn’t actually require a law degree – leading to significant growth in ‘lawyer support’ jobs in everything from document review and legal research to project management, not to mention the rise of services like LegalZoom. The number of roles for actual lawyers providing legal strategy, tactics, and advocacy, and facilitating transactions for bespoke drafting and legal advice, will decline. Consolidation – long a limited force for lawyers because of limitations of non-lawyer ownership for US law firms – will lead larger law firms that run far more efficiently as businesses, with bona fide corporate management and organization, right down to large court cases being managed not by lawyers but actual project managers who oversee the lawyers. Technology will play a role as well, not just for the potential that in the distant future artificial intelligence could do the legal work, but in the nearer term teleconferencing and video meetings could revolutionize the efficiency of the legal system, from virtual court cases to online dispute resolution. So in this context, what is the future of the small-firm lawyer? At a minimum, solo lawyers will find it difficult, as large law firms will eventually scale to the point that they offer cheaper legal advice, and an inefficient law firm will simply be priced out altogether; however, some niches that still require specialized niche experts, such as criminal defense lawyers, will remain, and in fact many solo practitioner niche experts may wind up simply doing flexible contract work for the clients of the larger firms. Ultimately, as noted earlier, the focus of Susskind’s work is on the future of lawyers, but arguably the parallels to industry predictions for financial advisers are striking, from the potential competitive threat of larger firms with economies of scale, to the need for small firms to find a niche to survive.

Does Your Ego Limit Your Success (Ric Edelman, Financial Advisor) – Ric Edelman has a big ego – as he readily admits – and it’s what led him to launch his own advisory firm nearly 30 years ago, as he was confident that he could do better on his own than working for someone else (nor did he like being told what to do). Accordingly, when his firm did launch, Ric did everything in the business, from taking client calls and meetings, to preparing paperwork, processing checks, and doing trades and reconciliations. Until he hit a wall, where he couldn’t take on any more clients or grow the business, because there was simply no more time left in the day… which he didn’t want to let go us, because he still felt he had to do everything himself. In other words, the ego that helped him launch his business was now preventing him from growing the business further. For Ric, the epiphany came when he hired his wife Jean into the practice, who promptly took over a massive amount of the paperwork, trading, mail, reconciliations, and more, so freeing up Ric’s time to meet with more clients that his practice quickly doubled, and leading to Ric’s current philosophy for building a successful practice: hire great people, make sure they understand the firm’s mission, give them the tools they need to succeed, and then get out of their way. You can tell that you may be suffering from your own “big ego” limitation if any of these constraints sound familiar: you believe you can perform most necessary tasks in the office better than any of your staff; you find it more efficient to handle things yourself than explain to someone else how to do it; you don’t take the time to help staff members learn from their mistakes; you are overworked, but your staff is not; and few or none of your staff members have been with you for more than five years. Or more simply, the key point is this: if you’re struggling in your practice and feel like you’re “too busy”, is it because you’re really too busy, or just that your ego is getting in the way of hiring and delegating the way you need to if you want to keep growing? And in the end, you may find that not only can you grow more by learning to delegate effectively, but you may even find that your staff does a lot of the work better than you, anyway!

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd’s Eye View – including Weekend Reading – directly to your email!

In the meantime, if you’re interested in more news and information regarding adviser technology I’d highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisers. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read “FPPad Bits And Bytes” on his blog!