|
A Monthly Newsletter Source of Financial Sources • When the Perfect Storm of Financial Challenges Hits Financially Prudent Families: • Put Options: the Hidden Advantage of Convertible Bonds: • The Reality and Frustration of a Lower Return Environment for Investors: • Markets Move in Spurts: • Managed Accounts Trump Target Date Funds’ Performance in 401(k) Plans: ---------------------------------------------------------------------------------------------------------------------------- When the Perfect Storm of Financial Challenges Hits Financially Prudent Families Take the Gallihers. John and Emily both work, are both 50-years-old, have met the match in their 401(k)s at work for many years. As well they have regularly put money into a taxable account for retirement, and done a too modest job (they now say) of saving for college for their four teenagers. Their current financial realities are not theirs alone, but shared by numerous other families. • John used to spend $100 a month in gas. It now costs $500. The trade-in values for gas-inefficient cars has gone down dramatically. Buying a new car is simply not in the budget. for the Gallihers considering how little they could get for a trade-in. These are not unusual worries and many Americans may have one or two of this list to deal with at any one time, but John and his wife, Emily, are dealing with all of them at once. What can they do? • Consider public transportation, or work hard to create a car pool with other employees Pearson Financial Services, Dennis, MA, is the author of "The Million Dollar Gift: Dynasty Trusts. Why Leave Your Assets Any Other Way", written for his clients, his clients' families, and his own family. He offers a fully integrated wealth management process, incorporating investment, retirement, financial and estate planning specialists under one roof, serving clients as their family's office, designing and implementing strategies to protect and distribute their wealth and highly appreciated property. Seth Pearson, CFP, 800-385-7925, seth.pearson@verizon.net. Put Options: the Hidden Advantage of Convertible Bonds: Many investors know that most bonds, except Treasuries, can be “called’ or redeemed by the bond issuer at a predetermined time prior to the bond’s maturity. The main cause of a call is a decline in interest rates. If interest rates have declined since a company first issued the bonds, the issuer will likely want to refinance this debt at a lower rate of interest. The company will call its current bonds and reissue them at a lower rate of interest. Obviously, this is to the detriment of a bond investor. But few investors know that a majority of convertible bonds have a very special feature --- they are putable. A bond that is putable allows the holder to force the issuer to repurchase the security at specified dates before maturity. The repurchase price is set at the time of issuance. This is a great advantage to convertible bondholders because it can protect the price of a long-term bond against possibly rising interest rates or declines in the underlying value of the common stock. Years ago zero coupon bonds were generally the only convertibles offering convertible bondholders the ability to put the bond back to the issuer. The put feature on zeros – and on all convertibles - is the right to sell the bond back to the company (which is obligated to buy it) on specific dates for a specified price. Although puts began as a characteristic of deeply discounted bonds such as zero coupon bonds, today the situation has dramatically changed. Most convertibles that mature in six years or more have put options and are putable at par. There will frequently be a series of put options at specific future dates. The exact dates, conditions and put conversion amounts are spelled out in the prospectus of each individual bond. So, in addition to the annual interest provided and the hope that the underlying common stock will increase and produce capital gains, additional safety and protection of principal is provided by periodic puts. There are two types of convertible bond puts: “hard puts” and “soft puts.” A hard put is when holders receive only cash by the issuing company. Soft puts, on the other hand, can be settled by the issuer in cash, stock or notes, or any combination thereof. The advantage of a hard put is this: if the investor does not plan to hold the underlying stock, the market value of exercising the put is guaranteed and will not vary one iota from the market value of the stock when it is actually received from the issuing company. If a bondholder does plan to hold the stock after exercising the put, a soft put paid in stock may be more advantageous from a tax standpoint. That is because the IRS does not consider conversion of a bond to stock as a taxable event. The period of time from the date of exercising a soft put to actual receipt of common stock is usually a few weeks. Clearly, having put opportunities on an investment brings many advantages. One of those advantages is that existence of a put date and price acts as a de facto maturity date, with a different redemption value, and the yield to put will often be very different than the issue’s yield to maturity. Because of this, there will be situations when the yield to put is greater than the bond’s yield to maturity and exercising the put may be more favorable to the investor than holding the bond to maturity. If the convertible is trading more on its investment value than its conversion value, the yield to put will usually be in line with the yield of a non-convertible bond with a maturity equivalent to the put date and same investment grade. The existence of put options can reduce the issue’s sensitivity to interest rate risk. If the yield curve is not inverted, this will tend to provide a higher theoretical floor below which the issue should not trade, in turn reducing the volatility of a putable convertible bond. Another advantage of the put options is this: if the bond is purchased properly (that is to say, employing an absolute return strategy), holders can frequently be confident of a positive return. This, of course, is provided the issuing company is financially sound, and does not default. The yield to put is often called the “yield to worst” for a convertible. The yield to worst is the minimum return an investor should realize by holding the convertible bond to date of the next put, assuming there is no default. For zero coupon holders, the put feature can provide a limited check on the financial strength of the company. Coupon bondholders gain some control in the case of a company that defaults on interest payments. Although, a zero coupon bond makes no interest payments, many debenture agreements include a similar provision if the issuing company does not honor its puts. Convertible puts are an extremely attractive and little known feature of convertibles, most effective when deployed in an absolute return strategy. They can provide a greater investment value than bonds based on yield to maturity and can provide a minimum return as long as the issuing company remains financially viable. If the underlying stock tumbles or interest rates rise, the time value to the next put can provide a floor to the value of the bond, making them extremely attractive in protecting principal. Darlene Murphy, CPA,, and Greg Miller, CPA, co-partners of Wellesley Investment Advisors, Inc., Wellesley, Mass, offer convertible bond strategies to investors through separately managed accounts, and through the Miller Convertible Fund (ticker: MCFAX). Founded in 1991, the firm manages convertible assets for retail clients in New England, and in a subadvisory Millennium Credit Markets, LLC, headquartered in Rockefeller Center, New York is an affiliate of United Group of Companies. The Reality and Frustration of a Lower Return Environment for Investors Financial industry economists and academicians are wrestling with data indicating that the first decade of this millennium will yield sub par returns and that this trend will continue into the foreseeable future. Many advisors cap recommended withdrawals from an investment portfolio at 4%; greater rates of withdrawal are considered risky. How many investors retiring at this time have enough assets so that 4% is a livable income? The buy American crowd will need to get over it. The economy is global – the design of a portfolio, whether ultra conservative or very aggressive must consider incorporating a significant allocation to global investments. Data indicates that the American economy and American businesses will not generate enough return to support performance expectations. Never has it been more important to focus on fees that an investor must pay. In an environment of 10 to 12% returns, 1.2% or 2% fees are often not questioned. However, in an environment of 7% returns, the combination of inflation, taxes and fees can take a significant toll on performance. The answer is not hedge funds. As they continue to implode, the investing public has backed away from utilizing considerable leverage to enhance performance. Rebalancing of portfolios has never been more important. Maintaining your portfolio's diversification is one key to good performance returns. Allowing a portfolio to become stagnant may lead to serious losses if singular or highly concentrated market trends supporting near term performance end abruptly. Investors can handle their frustration in several ways: • Make certain you are receiving advice from advisors with a good long term investment records. Such advisors rarely reached for huge growth in portfolios, but have strategies for preserving capital. Understand that we are all in this together. There is no easy answer when the U.S. economy is in recession mode. It is the time for prudence, caution, and paying attention to best practices in building a long-term portfolio. Ask a professional for help. You are going to need it. Stonegate Wealth Management’s,highly experienced professionals, including partners Thomas J. Geraghty, Jr., CPA, CFP, Steve Craffen, MBA, CFA, and Craig Marson, JD, CPA, solve complex financial challenges and provide counsel for the pressing financial issues confronting their high net worth clients. They have deep knowledge and experience in taxes, estate planning, investment management and divorce settlement counseling. The firm manages $175 million in assets under management. Craigm@stonegatewealth.com, office, 201-791-0085 Markets Move in Spurts Consumer confidence is at a 26-year low, so it’s no wonder that investors are expressing negative emotions about investing and the economic picture as they see it. For many, the greatest temptation is to pull out of the market and put all of their assets in a mattress. Add to the economic discomfort the fact that most investors have heard or read, often, that over an extended period of time, 1926 to the present, the U.S. Stock Market has averaged an annual return a little over 10% a year. The same investors do not realize that during most of that time the market never returned 10%, but performed above or below this “average.” There were even times, such as 1966 to 1982 when the markets underperformed treasury bills. It is a significant challenge for individual investors during times of market lulls, where for months and years on end, the market goes nowhere and they get discouraged. Month-after-month or quarter-after-quarter, statements show investments that are flat or down. Often, investors will question themselves, looking back, and say they would have been better in a bank CD, rather than the stock market for the last few years. Most investors are not taught that the market moves in spurts. Most of those gains in long-term averages happen in short spurts. Missing a short 20 to 30% short spurt, because of impatience and temptation to pull out, guarantees that they will never receive those long-term averages. It is the short spurts that add to the growth expressed by the long term averages. Even though investors worry over an extended period of time, sticking with a diversified portfolio and forcibly developing patience is the answer to achieving long-term performance. When invested properly, watching your investments should be more like watching paint dry or grass grow. When the rain comes, it supports great growth. If you are not fully invested, you will miss the longer-term averages. Tim Decker, President, ISI Financial Group, Lancaster, PA, is a fee-only financial advisor providing comprehensive financial advice and retirement planning. He is the author of the soon to be released book “The Sleep At Night Investor”. He can be reached at 800-342-5474. His radio show “Financial Freedom” can be heard every Saturday at 2:00 pm on WHP 580 AM providing financial guidance and answering questions from callers. Which New Hotel Trends Make Interesting Investing? The hotel industry has been a VERY hot performing sector over most of the last 5 years. If you had put $100 into the S& P in June 0f 2004 by last August you'd have had about $158. But for every $100 you had put into the Dow Jones Lodging Index at the same that time, by today you would have had a pretty staggering 168% increase pushing the balance in your account up to $268. Since the third quarter of last year, increasing doubts about the economy and fears of rising gas prices have taken back about half those gains. As of Mid-June the value of your S&P investment would be back down to about $140. Your $100 bet on the DJ lodging Index would still have left you with $175 in your portfolio. Not bad for 5 years.* Looking forward, the economics of the sector are not nearly as good as they were. New hotel construction is getting dramatically harder to finance so there will be little increase in supply over the next few years. Most analysts forecast a decrease in occupancy nationally this year, and beyond that will depend on many unknowns. As many US hotels are operating well into the 70% occupancy range, increasing room rates is still a realistic possibility, so the industry RevPAR (Revenue Per Available Room) will probably increase a bit in 2008. On the other hand if people and companies start getting really scared about gas and the economy, RevPAR could fall. Meanwhile hotel operating costs are growing faster than in the past. Energy costs are up as it costs more to heat and air condition buildings, but increased energy expense is hitting food, liquor, and anything the hotel requires that needs to be transported there. There will be a profit squeeze on hotels and the hotel industry. In the meantime, many of our existing chain hotels were built ten to twenty years ago. Many of the once leading-edge, full service suburban Marriotts and Hiltons are looking a bit tired. Increasingly, business travelers are willing to forsake the full service hotel's restaurant and bar for the advantages of extended stay properties with larger rooms, high-tech computer connections, and free buffet breakfasts. The leading up-market extended stay hotel brand is Marriott's Residence Inn. Even a dozen years ago Marriott was expanding the brand into market after market, but it is becoming increasingly difficult to find a good place to locate a Residence Inn that doesn't already have one nearby with a clause in its franchise agreement forbidding any new ones in the neighborhood. While there are hotel REITs that own many good, limited service properties (Hospitality Properties Trust for example) REITs under law can't manage their own hotels, and many analysts do not like that inherent conflict of interest. Also many of the public company-owned properties are approaching the 20-year mark where keeping them fresh enough to lead the market and get the best rates becomes much harder. Other new brands are riding different trends, Sheraton's "W" brand mimics the trendy minimalist decor of the properties Ian Schrager made famous while recycling aged hotels into trendy oases for Madonna and her friends. A new brand, "Indigo" is attempting to do the same thing with older suburban and downtown properties but whether Madonna wanna-bes will flock to former Holiday Inns in places like Waltham Massachusetts remains to be seen. For investors who are intrigued by the new trends and hotels, it's difficult to find targeted investment vehicles. You can buy Starwood stock (Starwood owns Sheraton which in turn owns Homewood Suites and some other good limited service or extended stay brands, but they are not a large portion of Starwood, a huge company which primarily owns very mature franchises.) There are an increasing number of private placements focused on new or recently built Residence Inns, Homewood Suites and the like, but investors should take care. It is critical to look for experienced operators, transactions where there is some real identity of interest between the sponsor/owner and the manager, and where the properties are themselves not over-leveraged. As always, with private placements, beware of the lack of liquidity. They should not be the bulk of a passive investors' portfolio. *http://bigcharts.marketwatch.com Contact: Michael Dowd, Senior Vice President, 781 264 2678, mdowdmcm@aol.com, www.ugoc.com Lisbeth Wiley Chapman, beth_chapman@inkair.com, 508-479-1033 Challenge Any Hedge Fund to Pit Itself Against This Cost-Benefit Equation: Consider an investment with a remarkable track record: 23% annualized returns over the past ten years, capped by an all-time high of 80% in 2007. Consider your good fortune to have invested $200,000 at the beginning of this investment’s ten-year run and watched from the sidelines as your $200,000 became $1.6 million (before taxes). Consider the alchemy of hedge funds. Or NOT! This remarkable investment opportunity does not come with the following characteristics. Genius, thy name is CGM Focus Fund (ticker: CGMFX). No, this is not a shill for the CGM fund family and its brilliant portfolio strategist, Kenneth Heebner. Rather it is the opinion of a devoted investor – most certainly. You can challenge any hedge fund to pit itself against this cost-benefit equation! Paula Chauncey, CFA, Etre, LLC, an investment management firm. Paula Chauncey, CFA, Managing Partner, être llc, 617-716-0257 works with individuals, and their closely held businesses, to develop and execute wealth-building strategies. pchauncey@etrellc.com. Managed Accounts Trump Target Date Funds’ Performance in 401(k) Plans Professionally managed accounts for 401(k) plan participants are far superior to target date funds because they avoid the built-in performance difficulties of target date funds. This has become a center front issue given last quarter’s poor performance record for 2010 target date funds where the assets are needed by would-be retirees in two years. The past quarter has worried plan sponsors and plan participants alike as they watch the down trending market erode their 401(k) savings. There are a number of reasons for the problems in target date funds. All target date funds do not have the same equity exposure that could lead to fiduciary problems for the plan sponsor. For instance, T. Rowe Price Retirement 2020 is 74% equity, Principal Lifetime 2020 is 70% equity and Fidelity Freedom 2020 is 65% equity. The plan sponsor may have a target date fund in a multiple fund lineup that is simply a bad performer. For instance, recent 3-year returns for 2010 showed a wide variance in performance with the best performer at 7.03% and the worst performer at 2.32%. The 3-year returns for 2020 funds show the same discrepancies. The best 2020 performer is 7.31% and the worst performer is 3.42%. Interestingly, both the best and worst performing 2020 funds had 57-74% equity. • It is unlikely that plan participants will use the target date funds correctly: - A Fidelity study showed that 51% of participants holding a lifecycle/lifestyle target date fund owned other funds also, despite education that showed participants that such funds were a complete portfolio investment. - Industry reports show repeatedly that participants will allocate 10% of their deferrals across all of the target date funds, effectively negating their function. - Additionally, it is unlikely that plan participants who will retire close to 2010 can tolerate losses as they near retirement. Their fear of having all their eggs in one basket may cause them to bail out of the target date fund (the only fund listed) and they will be forced to make a decision of what to do with their assets, a decision they are ill prepared to make. • The benefits of managed accounts are numerous: - A managed account can be actively managed by professionals diligently working to protect assets on the downside and grow assets when the market is rising. - A managed account provider is usually independent from the 401(k) plan vendor or fund companies who are providing the investments in the plan. - Managed account providers offer an additional layer of fiduciary protection for the plan sponsor. As an example, look at 401k Toolbox’s Capital Preservation 70+ - a managed account strategy, comparing it to Fidelity Freedom 2010 target date fund, and T Rowe Price 2010 fund.
Plan sponsors must investigate offering managed accounts to their 401(k) plan participants, particularly in Qualified Default Investment Alternatives (QDIAs), to avoid the predictable problems stemming from the increasing numbers of target date funds inside 401(k) plans and their built-in performance issues.
PMFM offers separate account management services, proprietary mutual funds, and is the advisor to 401k Toolbox, one of the leading 401(k) managed account and investment advisory services in the nation. As of 12/31/07, PMFM manages more than $1 billion. The firm has increased its assets under management by nearly 25 percent in the last year. The management team at PMFM includes experienced investment advisors with offices in Watkinsville, Georgia. PMFM offers 401k Toolbox, it’s investment advice and managed account service, via vendor partnerships with 401k providers and direct to large plan sponsors. You can reach Senior Vice President, Tim McCabe, at 800-222-7636 or tim.mccabe@401ktoolbox.com. |
||||||||||||