The Growth of Shadow-Banking Risk

The International Monetary Fund (IMF) is renewing its call for greater oversight of the aptly named shadow-banking industry. As a result of the financial crisis, regulators around the world tightened oversight of the traditional banking sector which resulted in the migration of lending and risks to the shadow-banking industry. The sector which includes mutual funds, ETFs, hedge funds and other institutional investors has skyrocketed to now over $75 trillion in assets. The IMF has identified several key risks including the concern that a large number of assets are being managed by a small number of institutional investors which could send shock waves throughout the financial markets if there is any change in the consensus on any number of market-moving events.1 Keep an eye out to see if regulators heed the IMF’s warning and start to take measures to reduce the risks inherent in the shadow-banking industry.

 

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How Sweet It Is To Be Paid Like You

In the five years after the financial crisis, CEOs at large U.S. companies collectively realized at least $6B more in compensation than initially estimated in annual disclosures according to a recent Reuters analysis. The reason for the windfall: the soaring value of their stock awards. The S&P 500’s total return (including dividends) of 166% – from the end of 2008 through Monday March 23 – has some investors re-evaluating how they judge compensation plans. In some cases, they say CEOs may be benefiting from the bull market even when their performance might be weak.1 Keep an eye out for increased shareholder activism over the coming months as more investors evaluate the merits of current CEO compensation plans.

Voices: Lyle Wolberg, on Extending the Fiduciary Standard

President Obama backs DOJ plan to impose stricter standards on brokers who advise on retirement investments

 

Voices is an occasional column that allows wealth managers to address issues of interest to the advisory community. Lyle Wolberg is partner and senior adviser at Telemus Capital in Southfield, Mich.

Changes are afoot in the retirement account investment arena. President Obama has asked the Department of Labor to develop stricter standards for brokers and others who advise clients on retirement investments.

To Read the Full article click here.

 

Posted by Wall Street Journal, see the original article here.

EUR/USD – Is Parity a Real Possibility?

The euro fell to a fresh 12-year low this morning which has extended a broad decline just day after the ECB launched its €1T bond-buying program. On the other hand, the dollar index soared to its highest in more than 11 years at 99.41, buoyed by expectations that the Fed could soon lift U.S. interest rates. Nearly all financial experts now believe the FOMC will remove the word “patient” from its policy statement after its March 17-18 meeting which will open the door for a rate increase in June. Today, the EUR/USD is currently at $1.0585,1 so keep an eye out over the coming months as a potential rate increase by the FOMC coupled with continuing ECB QE could make EUR/USD parity a real possibility.

Negative Interest Rates

There are now a total of $2 trillion of negative yielding notes and bonds in Euroland, a staggering number considering negative interest rates have never before really been contemplated, even in the halls of academia. To be clear, what this means is that investors are paying for the opportunity to lend money to Germany and several other countries in Euroland. Bill Gross keenly cutely described the dynamic as follows: “Modern day Oliver Twist investors have to pay to come to the dinner table and then sit there staring at an empty plate.”

The important thing to understand in this new world of negative interest rates is that it is a brand new financial circumstance without precedence and without any historical context of the interrelationship with other financial assets. We are playing a new game, on a new playing field, with new rules, many of which we are making up as we go along. The result of such a circumstance is uncertainty and heightens volatility, both of which scream caution to investor of all shapes and sizes. Be careful out there!

Europe’s Quantitative Easing Program

The European Central Bank (ECB) will begin its long awaited Quantitative Easing (QE) program this coming Monday. The ECB has pledged to buy 60 billion euros of EU member government bonds per month until September of 2016 in an effort to stimulate economic growth in the growth-stagnant Eurozone. Similar QE programs have been implemented in the US, the UK, and Japan, which have successfully purchased various types of government bonds. Whether these programs successfully stimulate economic growth is highly suspect, but they have been successful in terms of pushing interest rates down, forcing investors toward risk assets, and inflating equity markets.

The US, the UK, and Japan operate single-country financial systems, which facilitate much easier QE implementation than will be the case in the 19-member EU with 19 different financial systems. While the ECB has laid out a purchase plan that may theoretically navigate the complexities of buying in the different markets, practically speaking there may not be enough bonds available to purchase! There are a number of reasons for this dynamic, including the fact that German government bonds are in short supply and pensions and insurers may be unable or unwilling to sell such high quality bonds. Suffice it to say, the ECB’s QE program will be difficult to implement and its success is not ensured.

European Debt Markets – How low can you go?

U.S. companies are raising a record amount of cash through the first two months of 2015; however, where they are raising that cash might initially surprise you – Europe. Lower rates as a result of the ECB’s Quantitative Easing announcement on January 22 coupled with a weakening Euro relative to the U.S. Dollar has led U.S. corporations to issue roughly 150% more Euro-denominated debt through February 2015 than each of the past five years over the same two month time period. Currently, the average yield for investment-grade corporate bonds issued in dollars is roughly 3.03% relative to 0.74% for those denominated in euros. Companies such as Coca-Cola, Mondelez International, and Kellogg Company have crossed the Atlantic in order to take advantage of these record-low interest rates. As we move forward, be on the lookout for other U.S. companies, such as Berkshire Hathaway, to be raising even more capital overseas as opposed to our own backyard.

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Reference Source: Bloomberg – US Rate (BUSC Index) and European Rate (BEUIGSC Index) as of 3.3.2015

We Sold Our Business. Now What Do We Do?

Tens of thousands of privately owned small businesses are expected to change hands in the next decades as Baby Boom business owners retire. They’re left with a wealth management challenge: how to invest the proceeds and plan for the new money in their estates. Crain’s Wealth asked David Post, partner and investment committee chair at Detroit-based Telemus Capital, LLC, to run through a typical scenario for readers.

The story A 60-year-old couple with three grown children and four grandchildren sells its California-based auto supply business to a regional company for $8 million. The sale is structured as an installment sale with $5 million paid up front and $3 million deferred and paid in three equal installments over the next three years.

The taxes: After paying capital gains tax of $1.65 million on the initial $5 million payment, the Smiths have net proceeds of $3.35 from the first leg of the installment sale.

Their existing estate: The Smiths were diligent over the years and the modest home they bought 20 years ago is now worth $1 million. They have contributed to a retirement plan, accumulated a nice nest egg, and paid for their kid’s college educations. With the net proceeds from the initial installment sale the Smiths now have just over $5 million to invest. Their only meaningful expenses are the payments on their $200,000 mortgage, a couple of vacations a year, and spoiling their young grandchildren.

The Smiths shared with their financial advisor very clear objectives:

• They want to retire and not worry that they would ever need to work again.
• They want to help provide educational expenses for their grandchildren.
• They are willing to take enough risk to allow the portfolio to grow over the next few decades.

The financial plan: Let us pretend for a moment that the Smiths situation is happening in real time and that we were selected as their advisor. That being the case, we would first suggest that they establish a 529 College Savings Plan for each grandchild and fund each with $28,000, the maximum annual contribution.

Subsequent contributions to the grandchildrens’ 529 plans would be determined by the individual circumstances of each grandchild and their educational needs. Additional 529 contributions should be funded out of the after-tax proceeds from the next three installment sale payments.

The portfolio: Given the Smiths’ straightforward goals and objectives for their initial $5 million is it $5 million? yes of investible assets, we would suggest the following allocation:

• 30% equities
• 30% alternative assets
• 35% fixed income
• 5% cash

Given the Smiths’ moderate living expenses, as well as the forthcoming $3 million of installment payments, our suggested allocation would provide current income in the range of $175,000 per year, as well as an opportunity for the portfolio to grow in the years ahead. This portfolio allocation, along with expected installment sale proceeds would provide more than sufficient liquidity for the Smiths in case of an emergency. What kind of income are they generating?

The equity allocation: Within the equity sleeve of the portfolio, we would recommend a 55% allocation to international equities and 45% to domestic equities. Given the current stage of the bull market, we would suggest tilting the allocation toward equities with value characteristics, including a very healthy allocation to dividend paying stocks. We would also favor an over- allocation to international equities, with a tilt toward Europe and the Emerging Markets. In the case of Europe, the economy has not yet turned the corner and valuations are attractive. Equity allocations would be spread among large, medium, and small capitalization companies.

As for Emerging Markets, the prospects for long-term economic growth are greater than almost any other market. On the domestic front, we would recommend a tilt toward dividend paying companies with strong balance sheets and energy-related MLPs.

Alternative investment allocation: Our recommendation for the alternative investment sleeve of the portfolio would be to allocate among multi-strategy hedge funds, income producing real estate strategies, and insurance-related assets. Insurance related assets, such as participations in reinsurance, catastrophe bonds, and life settlement contracts are non-correlated to the financial markets. A combination of these alternative investment strategies will provide meaningful portfolio diversification and dampened portfolio volatility (reduce risk).

Our recommendation for the bond portion of the portfolio would be a mix of open and closed-end municipal bond funds combined with credit sensitive taxable bond funds, such as distressed debt and other non-traditional strategies that are more dependent on improving prospects for the economy and the underlying companies rather than changes in interest rates.

Future: The portfolio needs to be regularly rebalanced and, at least on an annual basis, the couple’s risk tolerance should be reassessed. Cognitive bias can be a tricky thing. The couple’s assessment of their risk profile may change substantially in the case of a stock market downturn or life event.

If, after getting to know the Smiths better, we determine that their risk profile is less tolerant than they had assumed, we would use the after-tax proceeds from subsequent installment sale payments to shift the portfolio allocation appropriately.

Posted by Crain’s Detroit Business, see the original article here.

We Sold Our Business. Now What Do We Do?

Thinking Ahead

Tens of thousands of privately owned small businesses are expected to change hands in the next decades as Baby Boom business owners retire. They’re left with a wealth management challenge: how to invest the proceeds and plan for the new money in their estates. Crain’s Wealth asked David Post, partner and investment committee chair at Detroit-based Telemus Capital, LLC, to run through a typical scenario for readers.

The story A 60-year-old couple with three grown children and four grandchildren sells its California-based auto supply business to a regional company for $8 million. The sale is structured as an installment sale with $5 million paid up front and $3 million deferred and paid in three equal installments over the next three years.

The taxes: After paying capital gains tax of $1.65 million on the initial $5 million payment, the Smiths have net proceeds of $3.35 from the first leg of the installment sale.

Their existing estate: The Smiths were diligent over the years and the modest home they bought 20 years ago is now worth $1 million. They have contributed to a retirement plan, accumulated a nice nest egg, and paid for their kid’s college educations. With the net proceeds from the initial installment sale the Smiths now have just over $5 million to invest. Their only meaningful expenses are the payments on their $200,000 mortgage, a couple of vacations a year, and spoiling their young grandchildren.

The Smiths shared with their financial advisor very clear objectives:

• They want to retire and not worry that they would ever need to work again.
• They want to help provide educational expenses for their grandchildren.
• They are willing to take enough risk to allow the portfolio to grow over the next few decades.

The financial plan: Let us pretend for a moment that the Smiths situation is happening in real time and that we were selected as their advisor. That being the case, we would first suggest that they establish a 529 College Savings Plan for each grandchild and fund each with $28,000, the maximum annual contribution.

Subsequent contributions to the grandchildrens’ 529 plans would be determined by the individual circumstances of each grandchild and their educational needs. Additional 529 contributions should be funded out of the after-tax proceeds from the next three installment sale payments.

The portfolio: Given the Smiths’ straightforward goals and objectives for their initial $5 million is it $5 million? yes of investible assets, we would suggest the following allocation:

• 30% equities
• 30% alternative assets
• 35% fixed income
• 5% cash

Given the Smiths’ moderate living expenses, as well as the forthcoming $3 million of installment payments, our suggested allocation would provide current income in the range of $175,000 per year, as well as an opportunity for the portfolio to grow in the years ahead. This portfolio allocation, along with expected installment sale proceeds would provide more than sufficient liquidity for the Smiths in case of an emergency. What kind of income are they generating?

The equity allocation: Within the equity sleeve of the portfolio, we would recommend a 55% allocation to international equities and 45% to domestic equities. Given the current stage of the bull market, we would suggest tilting the allocation toward equities with value characteristics, including a very healthy allocation to dividend paying stocks. We would also favor an over- allocation to international equities, with a tilt toward Europe and the Emerging Markets. In the case of Europe, the economy has not yet turned the corner and valuations are attractive. Equity allocations would be spread among large, medium, and small capitalization companies.

As for Emerging Markets, the prospects for long-term economic growth are greater than almost any other market. On the domestic front, we would recommend a tilt toward dividend paying companies with strong balance sheets and energy-related MLPs.

Alternative investment allocation: Our recommendation for the alternative investment sleeve of the portfolio would be to allocate among multi-strategy hedge funds, income producing real estate strategies, and insurance-related assets. Insurance related assets, such as participations in reinsurance, catastrophe bonds, and life settlement contracts are non-correlated to the financial markets. A combination of these alternative investment strategies will provide meaningful portfolio diversification and dampened portfolio volatility (reduce risk).

Our recommendation for the bond portion of the portfolio would be a mix of open and closed-end municipal bond funds combined with credit sensitive taxable bond funds, such as distressed debt and other non-traditional strategies that are more dependent on improving prospects for the economy and the underlying companies rather than changes in interest rates.

Future: The portfolio needs to be regularly rebalanced and, at least on an annual basis, the couple’s risk tolerance should be reassessed. Cognitive bias can be a tricky thing. The couple’s assessment of their risk profile may change substantially in the case of a stock market downturn or life event.

If, after getting to know the Smiths better, we determine that their risk profile is less tolerant than they had assumed, we would use the after-tax proceeds from subsequent installment sale payments to shift the portfolio allocation appropriately.

Posted by Crain’s Detroit Business, see the original article here.