Journal of Financial Planning: January 2015
Harold Evensky, CFP®, AIF ®, is chairman of Evensky & Katz in Coral Gables, Florida. He is the author of Wealth Management and co-editor of The Investment Think Tank: Theory, Strategy, and Practice for Advisers and Retirement Income Redesigned. He is also professor of practice at Texas Tech University.
Welcome once again to a brief review of some of the more interesting and important recent research-related articles and papers. This collection is pretty eclectic, and I hope you find at least a few of these papers of value in your practice.
“The Physician Orders for Life-Sustaining Treatment (POLST) Coming Soon to a Health Care Community Near You” by Robert B. Wolf, Marilyn J. Maag, and Keith Bradoc Gallant (Real Property, Trust and Estate Law Journal, Spring 2014).
If you’re like me, you probably spend most of your time focused on investment issues followed closely by saving on taxes. I’ll admit that I find these by far the most interesting subjects; however, as planners, we need to remain holistic in our outlook, and what I refer to as “living estate planning” should be at the top of our list. It is certainly nice to develop an estate plan that saves many hundreds of thousands of dollars, but that will seem of little importance to a client who faces a life-threatening illness without the power to direct the nature of their treatment. This paper is a very comprehensive treatment of POLST, a documentation compliment to the advanced health care directive for patients with serious illness allowing them to convey their wishes in light of existing conditions.
“Our Benchmark Is Better than Your Benchmark: The Municipal Bond Market” by Haiwei Chen, Jim Estes, and Daniel Jubinski (Journal of Financial Planning, July 2014).
OK, now I’ll move on back to my favorite subject—investment issues. This paper will be of interest to any adviser who uses municipal bonds in his or her clients’ allocations. Noting that there are two well-established market indexes in the municipal bond sector—the Barclays Capital Market Bond Index (BC Index) and the Bank of America Merrill Lynch Municipal Securities Master Index (ML Index), this paper explores the difference in the two and how they are used in practice.
It concludes that the returns of the BC Index are consistently lower than the returns of the ML Index. In fact, 60 percent of the funds beat the BC Index, but less than 48 percent beat the ML Index despite individual funds being equally correlated with both. The authors find long-term national municipal bond funds overwhelmingly pick the BC Index. What a surprise. The obvious moral is practitioners should not simply default to accepting a fund’s selection of the BC Index.
“Investing in Emotional Assets” by Elroy Dimson and Christophe Spaenjers (Financial Analyst Journal, March/April 2014).
This one is also off the beaten path for many of us; in fact, I’d never even heard the term “emotional assets.” It turns out this is the authors’ term for collectibles, or as they note, “investments of passion.” Much to my surprise, their research finds that collectables have outperformed government bonds, T-Bills, and gold over the long run (from 1900). Their conclusion is that although these investments can be rational purchases, they obviously come with their own unique risks and are most appropriate for individuals who already hold well-diversified portfolios of financial assets, who have a long time horizon, and who can sit out long periods of high illiquidity and low demand.
“Dividend Indexes and Value Indexes” by Konrad Sippel (Journal of Indexes, March/April 2014).
This paper was of particular interest to me as I have a value bias in my investment philosophy but have generally rejected the “dividend” argument as a value alternative. The conclusion of Sippel’s research is: looking at the returns over a longer period of time suggests that both concepts provide more conservative approaches to portfolio selection than a market-cap weighted index. Investors looking for a pure value exposure fare better with a value-based selection method; however, if the focus is on lower volatility exposure, dividend-based selection methods may provide a strong alternative.
“The Importance of Benchmark Choice in Commodities” by John Hyland (Journal of Indexes, March/April 2014).
This paper doesn’t offer final answers, but it does raise an important consideration for advisers who are looking to add commodities to their investment basket. The main point Hyland makes is that while the dispersion of returns for major fixed income and equity indexes is relatively small, it is much larger for commodity indexes.
Looking at the period 2004–2013, Hyland found the average returns for bonds was 3.3 percent and for U.S. stocks it was 1.6 percent. However, for the commodity indexes he considered (S&P GSCI, Dow Jones-UBS Commodity Index, SummerHaven Dynamic Commodity Index, Rogers Commodity Index, and Deutsch Bank Optimal Yield Index) the dispersion of returns averaged 21.2 percent! His conclusion is that although it may be appropriate to spend 20 percent of our time looking under the hood of stock and bond indexes and 80 percent on the cost and risk of implementation, for commodities we should be spending 80 percent of our time deciding on the right index, and 20 percent on how to implement.
Food for Thought
Although I’ve not been a big fan of the hot new topic of “smart beta,” it’s been hard to ignore if you follow any investment publication, so I thought the series of articles by Ben Johnson, Alex Bryan, and Paul Kaplan in the April/May 2014 issue of Morningstar Magazine provided a useful background on the subject. Referring to the concept as strategic beta (a bit less marketing hype), Morningstar defines the category as funds that seek to either improve the return profile or alter the risk profile relative to traditional indexes. Demonstrating the reality of its popularity, the papers noted that although the universe of “strategic beta” represents only 18 percent of the global exchange-traded product universe, it grew 59 percent in 2013 (25 percent from appreciation and 34 percent from new cash inflows). The authors’ conclusion is that, “This layering of complexity adds to the due-diligence burden for investors.” Despite this rather obvious conclusion, the papers are an excellent overview of this relatively new universe of investments.
I’ve saved these for last because I believe their importance transcends the relatively short-term horizon for my paper selections. If you do not read any others, at least check these out.
“The True Impact of Single-Premium Immediate Annuities on Retirement Sustainability: A Total Wealth Perspective” by Michael Kitces and Wade Pfau (Retirement Management Journal, Spring 2014).
How could I miss a column without including Michael and Wade? Obviously I couldn’t. Challenging the conclusions of most prior research, the authors conclude “… the results suggest that most prior studies which indicated a benefit of partially annuitizing a retiree’s portfolio were actually showing the benefits of a bucketed liquidation strategy that spends down fixed assets first and allows the household equity allocation to rise… .” And, if that conclusion isn’t challenging enough, the ultimate conclusion is “… for most retirees, though, the more effective way to improve outcomes is simply to implement a rising equity glide path.” This paper is definitely sending me back to revisit my belief that SPIAs are the investment of the next decade.
“Asset Valuations and Safe Portfolio Withdrawal Rates” by David Blanchett, Michael Finke, and Wade Pfau (Retirement Management Journal, Spring 2014).
This paper allows me to include the two additional authors who need to be included in my “how could I not include list,” David Blanchett and Michael Finke. These four practitioner/academics continue to expand our understanding of the issues related to retirement planning, and in the process, often turn our long-held beliefs on their head. This paper is another classic example concluding, “Given the current market environment with bond yields at approximately 2 percent and the CAPE ratio of 22, a 4 percent initial withdrawal rate has less than a 50 percent probability of success over a 30-year period with a 40 percent equity portfolio.”
As always, I hope you found these research tidbits useful.