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A Monthly Newsletter Source of Financial Sources • Convertibles are ripe for this market:
• Portfolio Managers Please Take Note, At the Moment, the Play is in Private Real Estate Equity: • Stress Testing a Boomer’s Retirement Plan: • It is Crucial to Know the True Cost of Your Brokerage Account: • Strategies for Handling Losses in a 401(k) Account: • It’s all About Avoiding Transfer Taxes •
401kToolbox Managed Account QDIA Product
Grows to over $150 million AUM ---------------------------------------------------------------------------------------------------------------------------- Convertibles are ripe for this market: Investors are using converts to limit risk and seek absolute returns for their portfolios. Sometimes considered hard to understand and invest in, convertibles have a lot to offer investors in volatile and bear markets and over the long term. When purchased and managed properly, convertible bonds can offer the safety and yields of traditional bonds while offering much of the upside potential of stocks. For the first time since the credit scare of 2002, most taxable bonds offer a compelling alternative to stocks, according to Barron’s. “The new convertible preferred shares generally yield 6% to 7%, and offer a more secure dividend than common shares, and, quite important, give investors plenty of time to benefit from stock appreciation thanks to five years of call protection,” they recently reported. Put convertible bonds under the microscope and their seemingly tedious and esoteric characteristics have many benefits for the investor. In volatile markets, they can offer stability. They may not always achieve the same growth of a bull market stock, but they benefit from a rise in a stock issued by the same company. In a down market, the converts have put options embedded in the instrument itself. These options can provide investors with a “safety net” or floor -- allowing the bond to be redeemed at a certain price (often part) on a certain date. The put option may be exercised, and unless there is a credit failure on the part of the company, investors are thus provided with a guaranteed minimum. The very existence of the put “guaranty” will tend to support the bond’s price, making it easier for an investor to hold the bond in volatile times. Surprisingly, over full market cycles – bull and bear markets together – carefully managed convertibles can result in market-beating returns. Consider the following: For the ten years ended December 31, 2007:
It is true that good convertible managers are specialists, and that trading and managing a convertible bond portfolio is a niche within the world of money management. “Experience really does pay when it comes to handling convertibles,” says Darlene Murphy, CPA, CFP ®, President of Wellesley Investment Advisors, Inc. , “You need to know the nuances of the convertible instruments such as the conversion ratios, the delta, the bond analysis, and the particulars of the put and call options. But at the end of the day, the two most important factors to us are whether and to what extent the principal is protected, and what are the growth prospects of the underlying stock. We look at financials and perform a fundamental analysis to determine whether the company has decent prospects for growth, while limiting exposure to principal.” The best prospects for convertible bonds or bond funds are investors who seek absolute returns, wish to minimize volatility, and like the idea of limiting risk to principal. For investors who are looking for something “different” in their portfolios that can also offer performance and stability, convertibles are definitely worth the effort. Ask questions, get educated. Contrary to boring, investments that limit risk and seek to provide positive absolute return can be exciting. 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 capacity for other investment managers around the country. Darlene Murphy 781-416-4000 x123, dmurphy@wia.cc. Portfolio Managers Please Take Note, At the Moment, the Play is in Private Real Estate Equity: Some Assumptions Have Changed in Private Equity Deals The sub-prime crisis has changed the landscape for companies who use leverage (specifically debt) to reach for returns in the teens or higher. Without debt, private real estate equity doesn’t work. Old relationships of trust are changing. Even companies with an excellent reputation for paying loans have seen long term relationships with lenders severed because the owners of the divisions that are doing the lending are changing dramatically. The following scenario actually occurred: A prospective hotel borrower processing a loan through Citibank’s hospitality division last year decided to seek better terms from GE Credit. Shortly, he read in the Wall Street Journal one morning that GE Credit was pulling out of hotel financing in secondary markets. He returned, hat in hand, to Citi Hospitality. “We’d have been glad to consider it,” he was told, “but this morning we were bought by GE Credit and we aren’t making loans until this all settles out.” As borrowers seek new lenders, realistic ongoing forecasts will help establish credibility, particularly in forecasting capitalization rates -- but something strange is happening. REIT prices, for 40 years, tended to be 30 to 40% less volatile than the S&P. Recently they have bounced down, dramatically. The FTSE NAREIT All REIT Index, up 35% in 2006 was down almost 18% in 2007, and has bounced back to 7% positive in 2008. REITs are generally selling at 20% + discounts to their estimated net asset value, and some think the stock market is forecasting a collapse in real estate pricing. At the same time the “cap rates”, the prices paid for property in the real world is almost stable, maybe down 3 to 5%. Long term investors in the private real estate market, while concerned more about risk, clearly do not share the REIT market’s near panic. If they are right, the underlying market for commercial real estate rental developments will not plunge into chaos. If these investors are right they can “see across the valley” to a market where supply and demand are in pretty good balance after Wall Street and the banks sort out their liquidity problems. If they are right, in the words of the Torto Wheaton consulting firm “Commercial real estate… has the opportunity to demonstrate its relative value and resilience in the face of volatility in the capital markets. If the space markets remain healthy and commercial real estate performs well on a risk-adjusted basis relative to other asset classes as capital markets turmoil begins to subside, commercial real estate’s integral role within institutional and retail investors’ asset allocation mix will be strongly reinforced.” But at the moment the play is in the private real estate arena, an important thing for portfolio managers to note. Millennium Credit Markets, LLC, headquartered in Rockefeller Center, New York is an affiliate of United Group of Companies. Contact: Michael Dowd, Senior Vice President, 781 264 2678 mdowdmcm@aol.comwww.ugoc.com. Stress Testing a Boomer’s Retirement Plan Your advisor should balance “best case” assumptions with “worst case” to give you solid information about what to expect as you enter retirement. Stress testing is a way to analyze and project someone’s retirement circumstance under extreme conditions. Traditionally retirement projections have been made using assumptions that may have been “best case” assumptions. For example; that investment return will be fairly steady over many years, or that you do not retire at the beginning of a severe bear market. Unfortunately the real world is not always so nice and predictable. Ask your advisor to run projections showing you how bad the “worst case” can actually be. Why is it so important now? Stress testing is more important as life expectancy increases and people retire at younger ages – the exact scenario for the baby-boomer generation. They may spend as many years in retirement as they did earning and working. The longer the time spent in retirement, the greater the demands on their assets intended to provide most of their income in retirement. Stress testing is less important for those who have large pensions -- something most baby-boomers will not have. The longer people spend in retirement, the greater the odds that they will experience many different economic conditions including periods of high inflation and low investment return. The issue of retirement planning under more realistic assumptions has been addressed to some extent over the last decade by the adoption of a technique from the fields of science and engineering called Monte Carlo analysis. Most practitioners are now familiar with this approach and better ones routinely use it. Monte Carlo has helped the field move away from the erroneous assumption that investment return and inflation are the same year in and year out. Unfortunately while useful Monte Carlo analysis has some problems:
Event Analysis or Scenario Creation Including event analysis in your portfolio modeling is something you may want to ask if your advisor offers. To properly model someone’s retirement years you need to consider the worst case scenarios that Monte Carlo cannot model. As one example, consider that studies consistently show the worse thing for a retiree might have been to retire in January 2000 just before the awful bear market. Even a well-diversified portfolio may have decreased 15-20% over the next three years. That combined with what is considered a safe rate of withdrawal from the portfolio of 4% annually means that in three years the retiree’s portfolio may have decreased by 35%. Studies show that even after several years of decent returns the retirees’ portfolio may never recover, greatly impacting their lifestyle for the remainder of their retirement. There may not be any way to adequately and completely protect against a “worst case” investment occurrence. The possibility, though, should be modeled and discussed so you can be prepared. You may need to generate a game plan if it happens -- a plan that includes part-time work for a few years or a lower expectation of your monthly spending. Put your advisors to work modeling “worst case” scenarios in your portfolio. Your goal is to enter retirement with realistic expectations and not be faced with a nasty surprise. 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. Steve Craffen, stevec@stonegatewealth.com, office, 201-791-0085 It is Crucial to Know the True Cost of Your Brokerage Account: A more reasonable approach is working with a fee-only, independent financial advisor using institutional asset classes of investments with low costs For most investors working with a brokerage firm, the true and complete cost of expenses in your brokerage account takes a special effort to find and understand. Smart investors understand that mutual funds come with internal costs. Beyond that, other expenses are difficult to unearth. Mutual fund investors can request a statement of additional information (SAI) that outlines turnover of individual stocks in a mutual fund. The turnover often adds an additional 1% or more to the already built-in operating expenses which, for the average U.S. stock mutual fund, is in excess of 1.4% annually. It is no wonder why most mutual fund managers do not keep up with the indexes in their market sector. To keep up with or to beat an index, the mutual fund manager must take more risk -- he must gamble just as you would in a casino -- that he can pick a stock that will have great returns, catapulting the fund over the index. The overall under performance of mutual funds against the market averages shows that most portfolio managers are poor gamblers. A more reasonable approach is to invest in a properly diversified account that allows access to an institutional asset class with lower than retail prices. Cutting the costs of your investment is crucial in a time of a volatile and down trending market. The DFA US Value Fund, managed by Dimensional Fund Advisors and available through financial advisors for instance, has an internal turnover of assets of only about 9%. An actively managed mutual fund with a manager trying to beat the indexes can have a turnover of as much as 90-115%. Every time an asset is sold and replaced there are trading costs, and if the assets are not in a qualified plan, there are also tax consequences of each sale that accrue to the portfolio. 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. Strategies for Handling Losses in a 401(k) Account: Participants should examine their Allocation to see if it is in keeping with their risk tolerance. Should a 401k account suffer a big loss during a period of market turbulence, the participant should examine the allocation to see if it matches the desired risk tolerance. If the asset mix creates too much volatility for comfort, the participant should make the allocation more conservative rather than simply going to cash. Also, a person’s time horizon gets shorter each year. If retirement is approaching, perhaps a more conservative approach is appropriate. At a minimum, participants should review their balances and allocation to see if any changes need to be made. Unfortunately, many people take this step only during times of market stress when it is often too late. Participants should always be making allocation decisions looking forward and not overreacting to what just happened.their 401k investments. Most investors urgently want to avoid a repeat of 2000 to 2002 when their retirement savings took a beating. They want to know if they should sell out because the market has dropped or become more aggressive if the market is at a discount. Either tactic would be correct if one could know the best time to sell out or buy in. 401k accounts are intended to be long-term investments growing to help pay expenses in retirement. Typically, these accounts are NOT (probably you mean to add a NOT here) designed for active trading, and 401k participants shouldn’t look at these accounts for rapid transactions. For an investor to successfully move from fully invested to cash and back again would require luck rather than intelligence. The idea is that through regular payments, also known as dollar cost averaging, a participant allocates retirement savings to an array of securities. Pay attention to basics in your 401(k) account and consider asking your financial planner to help you manage your choices within your plan. Donald L. McCoy, J.D., CMFC--Planners Financial Services, Inc., 952-835-9000. Minneapolis, Minnesota. Registered investment adviser and subsidiary company Montgomery Investment Management, specialize in the management of no-load mutual fund portfolios for individuals and retirement plans designed to protect capital by reducing risk. 952-835-9000 - pfshim@usinternet.com. It’s all About Avoiding Transfer Taxes Emily and Abner Brown have spent many years running their popular and financially successful seaside resort valued at $5 million. They want their grown children to take it over. But the Brown’s have already used up all their gift tax exemptions. The resort is appreciating in value and the Browns want to get it out of their taxable estate with the fewest tax consequences possible. If they give the business to their children outright, the kids will owe the IRS over 40% of the value of the property or $2 million. Instead, their advisor suggested they set up an intentionally defective trust. This strategy allows them to save gift taxes and allows the value of their business to grow tax-free in the future. The Brown’s chose to sell their business to their children at fair market value inside the trust drawing up a legal mortgage note. The children will use the revenue from the growing business that they now own inside the trust to make the monthly mortgage payments of principal and interest to their parents. By purposely making the trust defective, all the taxes incurred by the business are taxable to the parents, not the children, and will be paid using the parents’ other taxable assets helping them draw down their taxable assets over time, further reducing transfer taxes. The greatest benefit to the parents is, of course, that the $5 million dollar business is no longer in their estate. The mortgage note gets smaller every year and the parents pay all the taxes, which in effect, are additional gifts to the children without gift taxes. Another benefit accrues to the children if the business earns 10% a year going forward and all that revenue goes to trust. The children can pay 5% or $250,000 in mortgage payments and still have an additional 5% or $250,000 revenue to share without any gift tax. If they leave the $250,000 a year in revenue from the business in the trust, growing at 6 or 7 percent annually, the business could be worth $10 million in ten years. The Browns have the potential of saving more than $3.75 million in estate taxes by getting the resort to the next generation with no gift or estate tax using an entirely aboveboard strategy. Pearson Financial Services, Dennis, MA, is the author of "The Two 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. 401kToolbox Managed Account QDIA Product Grows to over $150 million AUM The PMFM/401k Toolbox Qualified Default Investment Alternative (QDIA) managed account service is changing the way employees invest their retirement savings. In a world where volatile financial markets concern many plan participants, this new QDIA option offers professional account management for 401(k) plan participants. Qualified retirement plans that utilize The Guardian Advantage® group variable annuity (issued by The Guardian Insurance & Annuity Company, Inc. (GIAC)) as their funding vehicle and offer the "Manage It For Me" account services of PMFM/401k Toolbox as a QDIA now have over $150 million in these managed accounts. Having a QDIA in place allows a plan sponsor of a qualified retirement plan to default employees into an appropriate investment product such as a managed account. A managed account is one of the three approved investment vehicles for use as a QDIA in qualified plans according to the Pension Protection Act of 2006 (PPA). Under the PPA regulations, a participant will be deemed to have exercised control over assets in his or her account, even if the participant does not undertake any investment direction, so long as the plan invests the assets in a QDIA and meets the notice and other requirements of the regulations. The experience of plan sponsors who utilize The Guardian Advantage® and offer the PMFM/401k Toolbox QDIA is revealing: plan participants seem very willing to use a managed account service to manage their retirement savings. In the case of plans that use The Guardian Advantage® as their funding vehicle, at the end of six months, 83% of plan participants still remain in the QDIA, even though defaulted participants were free to choose any other investment available during that time. Those participants currently represent over 70% of the plans' assets. For further information, or to obtain a proposal, email Sales@DistributionPartnersLLC.com, www.distributionpartnersllc.com, or call (877) 791-8900. About GIAC The Guardian Advantage® is a group variable annuity contract issued by The Guardian Insurance & Annuity Company, Inc. (GIAC), a Delaware corporation whose principal place of business is 7 Hanover Square, New York, NY 10004. GIAC is a wholly owned subsidiary of The Guardian Life Insurance Company of America, (Guardian) New York, NY. The variable investment options offered through GIAC's variable annuities are sold by prospectus only. www.guardianretirement.com. About PMFM/401kToolbox Since the early 1990's, PMFM has managed assets for a wide range of clients, including individual investors, trust accounts, and qualified retirement plans. PMFM is a registered investment advisory firm located in Watkinsville, GA. PMFM offers separate account management services, proprietary mutual funds, and is the advisor to 401k Toolbox. PMFM manages approximately $1 billion in assets. PMFM, Inc. is not an affiliate or subsidiary of The Guardian Life Insurance Company of America or The Guardian Insurance & Annuity Company, Inc. or any of its affiliates. www.401ktoolbox.com.The 401k Toolbox QDIA Warranty is offered solely by 401k Toolbox and 401k Toolbox is solely responsible for the representations, covenants and warranties contained therein.
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