1ST QUARTER 2016
- MARKET COMMENTARY
- CAPITAL MARKETS OVERVIEW
- FIDUCIARY CORNER
- PLANNING CONCEPTS
- PROTECTING CLIENT ASSETS
- INSIDE THE MARKETS
- OPA NEWS
The Worm Turns?…
Not a question posed as evidence of one’s years as a misspent youth, but instead the investor question as the first quarter of the new year, after the worst ever 6-week start for US equities, recovered to close with a very different leadership group than had been seen over the recent past. With the growth side of the equation, and in particular the new technology of the FANG’s, leading the pack (and sometimes actually dragging the pack forward) the last two years, Q1 2016 saw the resurgence of the dividend-paying value contingent, after another bout of volatility akin to last summer’s Sino-centric swoon.
As we wrote last quarter, Facebook, Amazon, Netflix and Google (aka FANG) accounted for nearly all of the positive returns generated by the S&P 500 in 2015, while the “value” camp languished in negative territory for the year. This year’s first quarter saw a reversal in those fortunes, with the FANG’s down an average of 3.9%, while the S&P Dividend Aristocrat, after dropping 3.2% in 2015, surged up 8.6% to open the new year. Not merely an idle analogy, the “worm will turn” is far more than just a comment about a mescal inspired adult beverage, but actually traces its roots back to Shakespeare’s Henry VI, where reference is made that the meek will retaliate after being trodden on. After several years of “growth” beating “value”, it appears that, at least for now, the early 2016 stock market volatility is perhaps starting a “mean reversion” in their relative performance going forward. The media’s justification for this volatility focused on so-called empirical data ranging from dropping oil prices, to the health of the Chinese economy and the perceived impact of future increases in Fed induced domestic interest rates. We however, also believe that there are two other, perhaps less quantifiable, contributing factors to the capital markets’ gyrations over the last year or so.
One is the seventh anniversary, marked this quarter, of the market lows hit in March of 2009 when we were in the initial throes of the Great Recession. Fear is a remarkable “reminder” mechanism, and the market swings of last summer and early 2016 triggered an almost subconscious fear-induced flight response as many individual retail investors sought the solace of cash rather than enduring the “what if” angst of another potential black swan.
Our view of this “repeat” fear is that there are a number of basic differences between where we are now and where we were then. First on the list, and directly correlated with the housing bubble that was beginning to collapse in 2008, has been the decline in household debt from 130% of annual household income at the end of 2007, down to 103% late last year, according to the Fed. Additionally, banks ended 2014 with $1.1 trillion in common equity capital, up from only $459 billion at the start of 2009, while their common equity capital ratio (a measure of the banks’ buffer reserves) has grown from 5.5% to 12.5% during the same period. Granted, there are still, and will always be, challenges to address within our economy – but it’s instructive to recognize that there are white swans as well.
Another contributing factor has been what we could politely (but probably not accurately) describe as our once-every-four-year experience with Presidential political discourse…and which we should probably refer to more correctly as the rumble in the kindergarten sandbox. Our “body politic” has had to endure candidates-behaving-badly for more than a year, and each one of them describes our country, its economy and future prospects in dire terms in order to create a rationale for his or her candidacy. Be it TV, the internet, robo-callers, Twitter or Facebook, the message from both parties’ primaries has not been “Everything is great – vote for me and I’ll just maintain the status quo.” But instead we’ve endured a cacophony of dread and multiple impending societal and economic Armageddon’s, so it’s no wonder that the voters are described as “angry” and that investors have come down with a chronic case of manic pessimism.
The by-product of all of this has resulted in a change of fate within the domestic capital markets, somewhat like the post-internet bubble:
“The past decade hasn’t been kind to devotees of legendary value investor Benjamin Graham. Value stocks, underpriced relative to corporate fundamentals, have trailed the broad market as investors embraced growth stocks… In recent months, however, the market’s leadership has begun to change, as growth stocks have become too rich for investors’ liking, and value stocks too cheap to ignore.” A. Bary – Barron’s 3/12/16
With our long-standing focus on dividend cash flow, combined with low relative valuation ratios, we look forward to the continuing opportunities that this potential, and perhaps overdue, change may offer, both domestically and overseas.
More Than Meets The Eye…
U.S. stocks were little changed in the first three months of the year as the S&P 500 finished the quarter at 2060, only a touch above where it started, potentially leading one to think not much had changed. However, what transpired between January and March was anything but mundane. Early on, the expectation of further interest rate hikes from the Federal Reserve created some investor angst. On top of that, oil prices coming off a dismal year in 2015, continued south and quickly cracked below $30/barrel in January reaching lows not seen since 2003. Correlation between the price of oil and US stocks spiked as the two asset classes moved nearly in tandem with one another. Despite relative economic strength, it was becoming less clear whether the U.S. would remain insulated from China’s economic woes as its markets entered into bear market territory. More and more the word recession began to creep into the media. Investor sentiment turned swiftly from optimistic to fearful as was reflected in the reversal of the equity markets. By the third week in January, the S&P 500 had corrected over -11% from the start of the year touching levels not seen since 2014. Volatility was back.
Fixed income markets responded favorably as economic fears mounted. Investors flocking to the safe-haven investment grade bond space drove prices higher. Treasuries, municipal bonds, and high quality corporate bonds were the main beneficiaries, a welcome contrast to the direction of riskier assets. On the other end of the spectrum, high yield bonds, particularly those in or related to the energy sector were under duress as oil dipped below $30/barrel. In some cases, bonds issued by some of the weaker players in the energy patch were priced for default.
Before the quarter came to an end, settling commodity markets and further actions from central banks helped risk assets reverse course. Oil began recovering from the lows, and stocks again correlated with the commodity. The Fed calmed markets with dovish policy language. Janet Yellen emphasized the Fed’s approach to lifting rates would be “gradual” and also acknowledged that conditions overseas would factor into their decision making. The Bank of Japan and the European Central Bank reinforced commitments to their Negative Interest Rate Policies, a controversial tactic, but one that we believe eventually provided a further tailwind for asset prices.
By the time the books were closed on Q1, investor sentiment boomeranged back to optimism. The S&P and High Yield Bond indices both experienced V-shaped recoveries making up all losses and both ending in the black. Investment grade fixed income maintained their gains experienced earlier in the quarter, but at the expense of lower yields. The Ten-year treasury ended the quarter yielding 1.78%, down from 2.27% on December 31st 2015. Although many benchmarks finished with positive returns for the quarter, some fell short on recouping losses suffered earlier in the quarter. Both the Russell 2000 (small cap stocks) and the MSCI EAFE (international developed stocks) ended the quarter with losses of -1.5% and -2.5% respectively.
|Equities||Percentage Change for the 1st Quarter||Percentage Change for the Year||Annualized 10-Year Returns|
|DJ UBS Commodity Index||0.42%||0.42%||-6.16%|
|NAREIT Equity REIT Index||6.00%||6.00%||6.56%|
|Barclays U.S. Treasuries||3.20%||3.20%||4.64%|
The DOL’s Final Fiduciary Regulation, Part 1
On April 6, 2016 the Department of Labor (DOL) released the Final Fiduciary Regulation Package. This was the culmination of a year’s worth of intense industry lobbying regarding the re-proposed April 2015 regulation, which had its genesis in the original proposal from October 2010 which was withdrawn (because of intense industry lobbying).
The new rule is a win for the individual investor and mostly targets stock brokers and wire houses, although no one is immune to the required changes (you may recall that Registered Investment Advisors or RIA’s are already required to act in a fiduciary capacity by doing what is in their client’s best interest at all times). In particular, the final rule re-defines who is a fiduciary when providing investment advice to a qualified retirement plan or an Individual Retirement Account (IRA).
In 1975, the DOL issued a fiduciary definition that included a five-part test to determine if the investment recommendations being given were fiduciary in nature. Pre-Final Regulation, the five qualifications that needed to be met for advice to be considered “fiduciary” were:
- making recommendations to invest in securities;
- advice was provided on a regular basis
- the advice included a mutual agreement
- the advice given was the primary basis for any decision made
- the advice was individualized to the needs of the plan
Going forward, the new regulation defines fiduciary recommendations as “communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action”. There is no longer a five part test.
In order for a non-fiduciary (brokers, certain fund platforms, etc.) to continue working with qualified retirement plans and IRA’s, they will need to meet one of several exemptions that have been created by the DOL. The primary regulation and certain aspects of the exemption are to be implemented by April 2017. The partial implementation allows firms to adjust to the new regulations, with them being fully enforceable eight months later in January 2018.
Old Port Advisors has always held itself as a fiduciary with regard to retirement plans, and will be minimally impacted by this regulation. Next quarter, in Part 2, I will review the various exemptions available to advisors, in particular the Best Interest Contract and how different brokers and service providers will be impacted.
Naming Guardians for Minor Children
Guardianship is one topic always discussed with our clients who have minor children. While most parents have a plan in place, I find that detailed discussions with the guardians doesn’t happen. Providing for the needs of your minor children involves two specific concerns: the physical custody of the children and the management of financial resources for their benefit. These responsibilities are sometimes held by the same person but many times the duties are separated. Who should be a trustee for the money is a whole other topic.
As your kids grow the guardianship plan you have may need to change also. Some changes may facilitate having to select a different guardian or the need to update your estate plan.
There are a number of things to consider when choosing a guardian. Asking information-seeking and personal questions isn’t always comfortable or easy. It is not as simple as some may think. By asking the hard questions, the parents and potential guardians are finding a common understanding for the care of the children. Saying “Yes” should always come after a lengthy discussion between the parents and the guardians – there is too much a stake to go into this agreement without full knowledge of responsibilities or without the uncomfortable acceptance something might happen. Here are some high level questions but ones that need to be addressed:
- Does the potential guardian have the time and energy to take care of your children? Are there age concerns, health issues, geographic restrictions, or job responsibilities in play? While a grandparent would seem to be a loving guardian, will he/she be able to keep up with the children.
- Does the potential guardian have children of his/her own? You would never want resentment. Your 45-year old married sister with no kids who travels extensively with her husband may not really want to be a soccer mom or taxi service.
- Does the guardian love (or at least care about) your children? How much have they interacted with your children? And do your children like them?
- If the guardian isn’t part of the family, will they make it possible for your children to visit family members? It should be the responsibility of the guardian to make sure a positive family connection is available to your children.
- Do you want to have your children stay where they are currently being raised? Is the guardian willing to move in order for the children to stay in their own school system? The age of the children might be a factor in your wishes. Your plan might need to be reevaluated if your kids are in High School and friendships are established. Moving a 6-year old to a new environment might not be as disruptive as an older child’s moving. Consider speaking with your children about this possibility as well.
- Does the guardian have room for your children if a move is the best thing plan?
- Do they have similar values surrounding religion or lifestyle?
For those of us with children we know how precious (and expensive) they can be. Financial consideration is a topic that most parents don’t think about in detail when choosing the guardian. While it may be expressed that you don’t want your children to be a financial burden, it will be important for all involved to have an understanding of what that would entail. This would include the legal document’s language to be spelled out specifically. Things to consider discussing with your estate planning attorney and the guardian would be:
- Are you going to pay your guardian?
- Will you pay for home upgrades to facilitate children?
- Will you pay for a move?
- Pay for part of mortgage, utilities taxes?
- Pay for different vehicles for guardians?
- Will they maintain your children’s lifestyle (sports/music etc.…).
Your estate planning attorney will have clauses in the legal document for much of these decisions but it still warrants a conversation with the guardian. You need to step back and look at your life thinking what would change if you were not there any longer. Yes, you would not be in the stands for your children’s sporting events but how would you be assured your kids would still have that support without you? Obviously there is a lot parents do for their children financially and emotionally. It is worth a hard conversation with the guardian to ensure he/she is willing to maintain the children’s lifestyle if you are unable to. If you don’t have a legal document and a guardianship in place then please consider what this article has talked about and make it a priority to safeguard your children’s future.
The majority of high net worth families engage a team of professionals to assist with the management, direction and preservation of assets. These teams often consist of an investment manager, an accountant and an estate planning attorney. All families and investment plans are unique requiring customized advice. Some families have additional advisors on their teams such as an insurance professional, a banker or even a realtor, in cases where a substantial amount of the family’s net worth is invested in real estate.
Because the required training and general knowledge base of the financial advisor (or investment manager) tends to be broader and more comprehensive than the other professionals on the team, the investment manager will typically serve as team captain. Each specialist on your team will have expertise with advising on certain pieces of your financial puzzle, and like a picture puzzle everything is interconnected.
Your investment manager may recommend that there be an annual meeting of the team, if possible – either all together in one room, or via teleconference from different locations – so that all parties receive the same information and understand the family’s long and short-term financial goals. We at Old Port Advisors, recommend that this meeting also include one or more of the family’s adult children OR the appointed, Durable Power-of-Attorney, Executor or Trustee who will take over at the death or incapacity of one or both of the primary investors. Often times, those delegates are one and the same, but having someone at the meeting who will be assuming the responsibility for the assets is important to ensure a smooth transition when the time comes.
Your OPA financial advisor is well-versed in taxes, insurance, estate planning, retirement income planning, education savings, charitable giving and other related topics in addition to the primary role of managing investments. Assembling a qualified team and hosting an annual meeting allows for the organizing of your entire financial picture which will create the framework for mapping out a customized future plan. It’s important that all participants know the current situation and future wishes of the account holders. Waiting until there is a serious illness or a death to look back at old notes or legal documents and then trying to piece together a plan for moving forward isn’t advisable.
OPA also recommends that clients avoid the temptation of One Stop Shopping no matter how convenient it may seem or how well-marketed it is. Some tax firms and law firms are now also providing investment management to their clients in addition to their primary specialties. From a client perspective, transparency on fees being charged for various services is crucial, as is avoiding any conflicts of interest that may exist with multiple professional services coming from one provider. Separating your services across independent providers allows you to clearly see the value added by each and creates an automatic check and balances system. Additionally, certain fees charged for professional services related specifically to investment management may be tax deductible, so having those separated and clearly spelled out makes the IRS happy.
Your OPA investment advisor would be happy to set-up and facilitate your team meeting with the professionals and family members you choose to include. These meetings give your OPA advisor a chance to meet the other members of your team and at the same time provide all of your professional resources an opportunity to solidify your family’s current goals and future plans. If you do not currently have a tax or legal professional you’re comfortable working with or need a referral to any other related specialists, we at OPA can provide referrals for most all services both in and out of Portland and are happy to assist you in locating someone you trust to fill any empty positions on your team.
“Laws and institutions must go hand in hand with the progress of the human mind. As that becomes more developed, more enlightened, as new discoveries are made, new truths disclosed, and manners and opinions change with the change of circumstances, institutions must advance also, and keep pace with the times." ~ Thomas Jefferson
As Steve discussed in his column (see above), the Department of Labor has finally issued a rule that will hold investment product salespeople (aka brokers) to the fiduciary standard that a Registered Investment Advisor (RIA) must follow as a matter of course. Despite what you may read from the financial industry or their allies in Congress, this is not the end of investing as we know it. Not even close. It is an attempt for regulations to keep pace with current investment products. In the words of Thomas Jefferson, institutions must advance, even kicking and dragging.
This is a battle that goes back to at least 1999 when the SEC issued the “Merrill Lynch” rule. The rule was named for what a firm that was once the largest stock broker on Wall Street. The firm is now a division of Bank of America, which rescued it from bankruptcy after it collapsed in 2008. The rule was an attempt to avoid having to register brokers as investment advisors if they sold mainly fee based products.
This rule came about as the role of a broker changed. Historically, the broker's job focused on processing transactions so they were regulated as financial sales people. Brokers could sell someone a mutual fund, some bonds or maybe a few IBM shares and the broker would receive a commission. These commissions were both huge and regulated – so getting a discount was not easy. If the client passed on the opportunity, the broker got nothing. Brokers were paid to create transactions - in direct conflict with clients’ interest in growing their investments. This was how business was done until May 1, 1975, when commissions were deregulated. Without Schwab or E*Trade, commissions on retail trades would still average around 2% rather than today's rates, usually less than $10.00
Faced with the sudden loss of commission revenue, the major brokerage firms turned their focus in a different direction. Rather than sticking with transaction pricing, the firms began urging their sales forces to embrace fee-based pricing. With this arrangement, a broker could charge clients a flat fee or a fee calculated on the amount of assets in their brokerage accounts. While the new focus was on fees, brokers could still use commissioned products when they wanted. This was claimed to be a way to more closely align the interests of clients and brokers. No longer would brokers simply call up with hot stock tips or help you sell your muni bonds. They'd provide advice, for instance, on how to structure an entire portfolio. Seemingly overnight, brokers vanished. In advertising, on business cards and in conversations with clients, brokers started calling themselves investment consultants, relationship managers, financial advisers, wealth managers or some other title. The term broker became poison.
Brokerages are still fighting this battle of definitions. The public assumes that brokers are financial advisers when, in fact, they are not allowed to offer financial advice. Brokers may suggest investment opportunities, but any advice must be “solely incidental” to their business. None of this has to be disclosed to the client. As an example, take a client that has significant amount of money she wants to invest for income in fixed income. Her broker could recommend any suitable strategy using individual bonds, mutual funds, annuities or ETFs. A salesperson is held to a ‘suitability’ standard.
On the other hand, the fiduciary standard is very easy to understand – the interest of the client is always paramount. Most of us do some research before a larger purchase like a house, a college for our kids, a new furnace or a car. We want the best we can find for our dollars: balancing quality and affordability with other personal factors. When the same client consults a fiduciary, such as an RIA, an extra consideration is added to the conversation: the best interest of the client. A fiduciary is held to that same benchmark. That eliminates choosing products based on their commissions like high cost/illiquid annuities or proprietary mutual funds that are not at the top of their category.
The rule has been significantly watered down from the original proposal and only applies to retirement and pension assets. The financial industry has spent millions on lobbying and political donations trying to keep this rule from being instituted and will continue to attempt to block it. They have their messengers in Congress wringing their hands and running around like Chicken Little predicting end times. The rule is not “just more governmental red tape” or whatever current talking point the industry is test marketing. It will not disenfranchise 7 million IRAs. It just asks the industry to take a pay cut.
Fred Williams – Was recently interviewed by MarketWatch, a member of the Dow Jones Network, about Portland – its evolving workforce and the impact those changes have had on the overall community. The article can be found on the OPA website [www.oldportadvisors.com] or via the following link: http://www.marketwatch.com/story/why-maines-portland-like-its-oregon-namesake-is-seeing-an-influx-2016-03-15
We are pleased to announce the following additions to the team of professionals at OPA:
Richard “Chip” Harlow – Has joined us as a Vice President and Portfolio Manager. Chip began his investment career as a financial advisor at Merrill Lynch in 1997, then became an Associate Vice President at Ameriprise in 2009 before joining Old Port Advisors in February of 2016. Chip is a Chartered Retirement Planning Counselor (CRPC), is a member of the firm’s Investment Policy Committee and is currently serving on Portland Community Squash’s (www.pcsquash.com) capital campaign, whose mission is to use squash as a tool to assist our city’s youth in advancing their education. He currently resides in Lebanon, Maine with his wife Debbie as empty-nesters with their adult children Jon and Brittany having flown the coop. Chip spends some of his free time training their dog Izzy in French Ring sport.
Sharon Perkins Bunker - Has joined our firm as a Client Service Associate, with her initial focus in the administrative and operational aspects of OPA. Sharon began her financial services career at Ameriprise in 2001, was with Norton Financial working with corporate retirement plans until 2010, and then Nvest Financial until joining our team in March of 2016. She lives in Gorham with her husband Dewey and their two teenage children Alison and Brian.
Save The Dates:
We’re entering the time of year when a variety of non-profit organizations begin their annual fundraising efforts so they can continue to enhance the fabric of our community. Although by no means complete, the events below are but a sampling of the organizations that our firm, employees, colleagues and clients are involved with, should you want to consider supporting their missions.
Wayfinder Schools - Join Wayfinder Schools on Thursday, April 28th for the premiere reading of Richard Russo’s new book, Everybody’s Fool. The new book is the much anticipated sequel to Russo’s 1998 bestseller, Nobody’s Fool, later made into a hit movie starring Paul Newman, Jessica Tandy, Bruce Willis, Melanie Griffith and Philip Seymour Hoffman. The event will be held from 6-9 pm at Waynflete’s Franklin Theater on Spring Street in Portland. Additional information can be found at www.wayfinderschools.org.
Walk MS – The annual spring walk to benefit the MS society will take place on April 23rd at The Portland Expo starting at 9:00 AM. Participation provides help for today and hope for tomorrow through education, support, advocacy, and research funded by the National Multiple Sclerosis Society through its Greater New England Chapter. Details can be found at www.walkmam.nationalmssociety.org.
Bids for Kids - Benefitting Big Brothers Big Sisters of Southern Maine, will be held on Friday, April 29th at the Holiday Inn by the Bay with light dinner fare, and complimentary Shipyard beer. This year will feature more than 200 silent auction items and 15 live items including: 10 days at a comfortable, renovated medieval house nestled in the foothills of Mont. Ste. Victoire France, a private flight up the coast to a romantic dinner for two, and a week in St. Thomas! In addition, the positive effects of mentoring will be celebrated by recognizing the 2016 Matches of The Year. Details can be found at www.SoMeBigs.org.
23rd Annual Child’s Play Golf Benefit – The Dream Factory of Maine is celebrating its 29th anniversary of granting dreams to the children of Maine and is holding its Child’s Play tournament Friday June 17th at Sable Oaks and starting at noon. The Dream Factory grants dreams for critically and chronically ill children nationwide, is based in Louisville, and has 2 chapters in Maine. Additional information can be found at www.dreamfactoryincmep.org.
Fore The Kids Golf Classic – Big Brothers Big Sisters of Southern Maine’s annual fundraiser will be held June 20th at The Woodlands Club. Additional information on this popular two-ball/best-ball event can be found at www.SoMeBigs.org.
Also, please feel free to visit our new website (www.oldportadvisors.com) as we continue our rebranding efforts and build out more of our online capabilities.
Old Port Advisors was founded more than 20 years ago as Investment Management & Consulting Group (IMCG), with a vision to create a boutique independent investment management firm centered on the best interests of our clients. Our principles were simple and still ground us today: a values-driven, personalized, collaborative, and strategic approach to investing, wealth management, and fiduciary consulting. We changed our name to embark on the next 20 years, but our leadership and our calling remain. We’re excited to build on our past experience and success to deliver on our promise of building a secure future for our clients.