The Float

Some Good 401(k) News

Yesterday's debut of BrightScope isn't the only ray of sunshine in the 401(k) world. There's also this:

Despite the financial crisis and plummeting markets, employees are still contributing to their 401(k) plans, an analysis from Boston-based Fidelity Investments released today showed.

Fidelity analyzed its 17,095 corporate 401(k) plans, which represent more than 11 million participants.

The firm found that 2008 participants contributed an average of $5,600 in pre-tax earnings to their 401(k) accounts--slightly higher from the 2007 average of $5,500.

We spill a lot of pixels complaining about the state of disrepair in which our retirement savings system finds itself. It's nice to see a little bit of good news, especially insofar as participants' contributions can take advantage of depressed asset prices.

Source

Lisa Shidler, "Workers upped 401(k) contributions in '08," InvestmentNews, January 28, 2009

Putnam's "Absolute Return" Funds

This isn't exactly breaking news anymore, but we thought we'd offer a few thoughts on Putnam's introduction of four "absolute return" funds, which the firm claims will "pursue positive returns with less volatility over time than more traditional funds." Sounds great. But...

The lineup is four funds deep, with target returns of 1, 3, 5, and 7% above Treasury bills "in good markets and bad." Let's start at the low end and work our way up. We're not sure how much of a market there is for an entirely new type of fund that seeks to beat T-bills by 1 or 3%. As far as we can tell, those vehicles exist now. They're called "online savings accounts" and "municipal bonds" and "Treasury ETFs."

As for the +5 and +7% targets, Putnam's massive ad campaign includes this telling passage on risks:

Asset allocation decisions may not always be correct and may adversely affect fund performance. Use of leverage through derivatives to increase exposure to asset classes could increase this risk by magnifying the impact of underperforming asset classes.

Indeed!

All of this strikes us as a bit strange. It's as if the mistake money managers and investors made all along was not targeting absolute returns precisely enough. If they'd only pursued "positive returns with less volatility," maybe things would have turned out better. If only it were that simple.

In the January 13th Wall Street Journal, Matthew Cowley published a "Fund Track" piece that struck us as a kind of revved-up stenography for Putnam. "With household wealth pummeled by the financial and housing-markets crisis," Cowley wrote, "investors want access to mutual funds with more predictable rates of return." Again: No doubt! Here's more press-release pass-through, conspicuously missing quotation marks:

Putnam launched four mutual funds on Jan. 1 that aim to provide returns of one, three, five and seven percentage points more than Treasury bills, as measured by a Merrill Lynch index. The returns are measured over a three-year period, so a downturn in one year should be offset by higher returns in another year.

So if things go poorly in those first couple years, don't sweat it. The downturn should be offset by higher returns in the third year. And if the third year doesn't turn out quite as planned, we'd expect various allusions to market conditions being unusually difficult, which leads us to this:

The fees charged by Putnam, which are similar to those charged for its existing relative return funds, increase if returns come in above target, and decline if the returns fall below.

That's actually sort of interesting, and the reduction of fees in the case of under-performance could be a nice feature.*

But what about fees going up in the case of out-performance? It's safe to assume that such out-performance would generally be driven substantially by broader trends in the financial markets--trends that are, by definition, more market-driven than manager-driven. So the better the broad market does relative to T-bills, the less of that margin rank-and-file investors get to keep. Pretty impressive business model!

Over the last decade, of course, this model might have redounded to investors' benefit, as T-bills have outperformed equities over various periods (depending, of course, on when you start counting). In that case, Putnam's managers would have had to do some serious alpha-generation to deliver absolute returns of +5 or +7%. Now, however, with equity prices depressed, and expected future (medium- to long-term) returns higher than they've been in years, Putnam probably has the edge.

But then that's the nature of the Wall Street Selling Machine, isn't it? Figure out where investors are emotionally fragile, assemble products to meet their psychological (if not always financial) needs, and cash some very big checks.

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* Forgive us. We haven't taken the time to investigate the particulars of such fee adjustments. Over what periods will performance be measured? How big are the potential fee adjustments? How often would those adjustments be made? If you have that information, send it in and we'll pass it along.

Source

Matthew Cowley, "Putnam Targets Absolute Returns," Wall Street Journal, January 13, 2009

Our Kind of Forecast

Earlier today, we posted an item on the difficulties (and that's putting it mildly) of short-term forecasting. In a Wall Street Journal story on declining revenues at T. Rowe Price, we ran across our kind of forecast (emphasis added in bold):

Looking ahead, President and Chief Executive James A.C. Kennedy expects a rough first half of 2009 with some relief towards the end of the year. He said, "While the more-than-year-old recession could linger -- and stocks could suffer more downturns -- a market recovery could begin later this year."

No doubt! Which illustrates our point perfectly: It's pretty darn hard to make a short-term forecast simultaneously honest and useful. Kennedy's? It's very honest.

Source

Kathy Shwiff and Katherine Wegert, "Redemptions Hit T. Rowe Price's Net," Wall Street Journal, January 29, 2009

David Swensen Tells It Like It Is

For those who work in financial services, knowing the difference between fiduciary and non-fiduciary practices is one thing. Being willing to stand up and describe that difference out loud is another. To his everlasting credit, David Swensen is willing to describe it out loud.

As Yale's Chief Investment Officer, Swensen has built an immensely impressive record (see the adjacent image). As an author, Swensen has also helped institutional and individual investors understand their respective challenges and opportunities.

In the Janaury 13th Wall Street Journal, Craig Karmin provided excerpts from a recent conversation with Swensen. Here's a classic example of Swensen pulling the curtain back on a corner of the financial services industry that had it way too good and way too easy for way too long:

WSJ: What about fund of funds and consultants? Can they be a solution?

Mr. Swensen: Fund of funds are a cancer on the institutional-investor world. They facilitate the flow of ignorant capital. If an investor can't make an intelligent decision about picking managers, how can he make an intelligent decision about picking a fund-of-funds manager who will be selecting hedge funds? There's also more fees on top of existing fees. And the best managers don't want fund-of-fund money because it is unreliable. You need to be in the top 10% of hedge funds to succeed. In a fund of funds, you will likely be excluded from the best managers. [Mr.] Madoff also relied enormously on these intermediaries. He wouldn't have had nearly as much resources were it not for fund of funds.

Consultants make money by giving advice to as many people as possible. But you outperform by finding inefficiencies most of the market has not yet uncovered. So consultants ultimately end up doing a disservice to investors.

The point about Madoff is exactly right. We've always preferred to put fewer intermediaries between our clients and the actual management of their assets. The alternative introduces all sorts of potential problems, including the worst-case scenario of a Madoff-style catastrophe.

Source

Craig Karmin, "Yale's Investor Keeps Playbook," Wall Street Journal, January 13, 2009

On "Missing the Mark"

In last weekend's Wall Street Journal, Jason Zweig's "Intelligent Investor" column focused on the difficulties inherent in forecasting relatively short-term market outcomes. The most obvious example is the obligatory, tiresome prediction of what stocks will do in a given calendar year.

We think the answer to the question implicit in the column's title ("Why Market Forecasts Keep Missing the Mark") is pretty straightforward: Because they're impossible. Or, to put it another way, forecasts that are "right" are simply lucky. In short slices of time (and if your forecast is annual, your n=1), draws from the distribution of possible returns are so substantially driven by random variation that whatever "skill" the forecaster brings to bear on his or her forecast is pretty much swamped by randomness. This is a simple point, and it's beyond dispute.

But there are magazines to sell, and blogs to fill, and clients to impress, so forecasters churn these things out on a regular basis. It's a strange game, but we understand why people want to play it. The alternative, a kind of agnostic resignation to markets' unpredictability, deprives us of things we're programmed to want: A feeling of control, expectations that can guide our decision-making, and, perhaps most importantly, the chance to be--and cash in on being--right.

Zweig's column is generally solid, but it concludes in a strange way. After discussing the "sophisticated method" of predicting future results built by a couple professors in Portugal--which, Zweig tells us, forecasts a return of 4.2% in 2009--he finishes with this (emphasis added in bold):

Along the way, the Dow might slump to 6000, or drop 10% or more in a day. But just as huge losses often come out of a clear blue sky, gains can arrive when the world seems darkest. If you forecast the market with your gut feelings alone, you may never hit the target.

Er...um...yes, that's true. But what's strange about this closing passage is that it suggests, contrary to the rest of the column's solid observations about short-run uncertainty, that the professors' quantitative model--and, implicitly, others like it--can (and will) do better than "your gut feelings alone." Though the professors' model* should do a solid job of forecasting long-term outcomes (almost by definition), it's subject to more or less the same short-term errors as any other non-insane method would be.

Why does Zweig finish his column with that strange line? We have to admit: We're uncertain.

Notwithstanding all that, we want to give props to Heath Hinegardner for the incredibly cool image that accompanied Zweig's column. Here it is...

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* For what it's worth, the model appears to invoke the utterly obvious factors of dividend yields, earnings growth, and market multiples. We're sure the published version is more sophisticated, involving lots of superscripts and matrix algebra. Dress it up however you want...the key variables are as straightforward as they come. And they're all uncertain! Dividend yields? They're relatively high, but many dividends have been slashed or eliminated. Earnings growth? Estimates have been too optimistic all the way down. Market multiples? Is anything more uncertain than the animal spirits that drive market multiples?

Source

Jason Zweig, "Why Market Forecasts Keep Missing the Mark," Wall Street Journal, January 24-25, 2009

Happy Birthday, BrightScope

Back on the 14th, we posted an item about BrightScope, a remarkable new tool that will help 401(k) sponsors and participants understand the strengths and weaknesses of their plans in ways that simply weren't possible until...today. 

We're pleased to announce that BrightScope.com is now up and running. We encourage you to take a look.

More on Participant Education

Yesterday, we argued that ERISA 404(c) and its attendant model of "participant education" are ill-conceived and ill-fated, impairing and even imperiling the retirement security of millions of American workers. Here's a little more on that theme.

In an InvestmentNews report on participants' use of target-date funds in 401(k) plans, Sue Asci noted a few interesting findings from a recent Vanguard study.*

• Of the roughly 27% of participants who were invested in a target-date product, only half used a single such fund as their sole investment.
• Those who had a target-date fund and least one other option in their portfolios allocated an average of only 30% of their assets to the target-date product.
• Among those who didn't use a target-date fund, roughly 30% invested only in stocks, with 16% avoiding equities entirely.
• Almost 80% of those who invested in a target-date fund were in plans featuring such funds as their default investment.

What to make of all that? First, it's important to note that some of those "extreme allocations," the all-stock or no-stock participants, might actually make sense. One can certainly imagine a young participant who, sensing a great buying opportunity, goes "all-in" on stocks. With a sufficiently long time horizon and sufficient emotional wherewithal to see the strategy through, that isn't necessarily a bad idea.

In addition, as we've noted repeatedly in this space (here, for example), many target-date funds (yes, even Vanguard's!) suffer from some conspicuous limitations. So one can also imagine a savvy investor unpacking her target-date selection, detecting a few shortcomings, and compensating for those flaws by adding other funds around her target-date selection.

But let's not get carried away with this rosy view of things. In fact, it's almost certainly the case that, yet again, the participant education model simply doesn't--and, in some irreducible way, can't--work very well. Here's Jeff Keil of Keil Fiduciary Strategies:

"I think of all the financial professionals who for years have pounded the notion of diversification....Either people weren't listening or they believe equities are the only place to be, or not to be. I think it shows there is a lot of education that needs to be done."

Where 404(c) prevails, good, solid education is a moral, practical, and legal imperative. And we applaud Mr. Keil for wanting to fight the good fight. But as we argued yesterday, there's a certain doomed-to-fail quality to this debate that few observers seem willing to acknowledge. It's long past time for serious fiduciaries to come to grips with the grim realities of our current system.

Our system of retirement (in)security is a lot like the Six-Million Dollar Man: We have the techology; we can rebuild it. But it's going to take a lot of work.

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* These data were gathered at the end of 2007, when equity prices had fallen from their October highs but remained substantially higher than the lows of late 2008 and early 2009. Note also that the data were gathered from plans for which Vanguard provided recordkeeping services.

Source

Sue Asci, "Plan participants' use of target funds varies, study shows," InvestmentNews, January 18, 2009

Still Blowing Sunshine...But Not Quite as Much

When the real estate bubble began to burst, one man stood above all others in the harsh light of public ridicule: David Lereah, chief economist at the National Association of Realtors. For many months, Lereah denied what anyone willing to see did see, that after a few years of utterly ridiculous appreciation--and absurd assumptions about future appreciation, assumptions that define bubble psychology--residential real estate had rolled over.*

In the January 12^th Wall Street Journal, Nancy Keates described Lereah's efforts to rehabilitate himself and his reputation. We think Lereah and his organization were a big part of the problem, but we also have some sympathy for him as an individual who got caught up in a larger systemic problem. If it hadn't been Lereah blowing the realtors' self-serving sunshine, it would have been someone else.

Alas, at the end of her story, Keates quotes Lereah's successor at the NAR, Lawrence Yun. Here's the passage:

His successor at NAR, Lawrence Yun, however, says things might be looking up. In his latest news release, Mr. Yun says that although the pending home-sales index based on contracts signed in November fell 5.3 from a year earlier, with a "proper real-estate focused stimulus measure," home sales could rise more than expected, by more than 10%, to 5.5 million, in 2009.

And here's the problem: What the market needs isn't more sales as such, it's stable prices. As sales have risen primarily due to falling prices, we can safely conclude that the market is still very much in a clearing process, with grossly elevated inventories and ongoing depreciation in property values.

As it happens, today's Journal features some relevant news (emphasis added in bold):

Existing-home sales rose in December as buyers took advantage of discounted prices in distressed housing markets.

Home resales rose to a 4.74 million annual rate, a 6.5% increase from November's revised 4.45 million annual pace, the National Association of Realtors said Monday. November originally was seen down by 8.6% to 4.49 million.

NAR economist Lawrence Yun said sales in distressed markets were very high amid foreclosures; of all sales in December, about 45% were distress sales at discounted prices.

The median home price was $175,400 in December, down 15.3% from $207,000 in December 2007. The median price in November this year was $180,300. The 15.3% drop was the largest on record, the NAR said.

"It appears some buyers are taking advantage of much lower home prices," Mr. Yun said, adding the market is far from balanced as buyers hold an edge over sellers.

We'll give credit to Mr. Yun for that last point. It's fair to call this a buyer's market. But in a deflationary environment, more than anything else, it's a patient buyer's market, as tomorrow's prices are likely to be even better than today's. And that's the problem. It's inventories and prices that matter, not sales numbers per se.

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* For old times' sake, here's a short collection of Lereah's serial claims that the bottom was in.

Sources

Nancy Keates, "Realtors' Former Top Economist Says Don't Blame the Messenger," Wall Street Journal, January 12, 2009

Jeff Bater, "Home Resales Rise as Prices Tumble," Wall Street Journal, January 26, 2009

404(c) and Participant Education

More frequently that we'd like to admit, we see evidence that the dominant model for defined-contribution retirement plans--delivering "participant education" in the context of ERISA's section 404(c)*--is badly, maybe irretrievably broken.

This evidence often appears in unexpected places, as it did in Saturday's Seattle Times story on the ongoing difficulties at Starbucks. After discussing various sources of employee discontent, reporter Melissa Allison gives us this:

The malaise is not universal. Another East Coast worker said he understands why Starbucks has decided not to guarantee a 401(k) match for employees this year.

Given the stock-market crash, he figures, "if they match, they're just taking money and throwing it into a fire."

That's painful. Quite to the contrary, if the company matched, they'd help this guy acquire long-term asset at fire-sale prices! That's a very different perspective. Assuming this guy isn't knocking on retirement's door, in which case he should have reduced his short-term risk substantially, he should be celebrating this as a rare, precious opportunity to buy when the buying's good. And he should be bitterly disappointed that Starbucks has reduced his buying power.

We understand the psycho-emotional wellsprings of these ideas, but that's exactly the problem. The 404(c) status quo implicitly assumes that the behavioral demons that plague investors can somehow be vanquished...if only we could deliver more and better "participant education." 

Look, more and better education might help on the margins. We're willing to believe that it would. In our own practice, we try to deliver high quality advice and education wherever we're engaged with participants. But the hard reality here is that we humans aren't programmed to respond well to fianncial markets. Instead, we're programmed to buy high (when things feel "safe," but are in fact most perilous) and sell low (when things feel horrific, but are in fact most advantageous).

Ultimately, we can no more "educate" our way out of 404(c)'s shortcomings than we can eliminate fear and greed from the menu of human emotions. If sponsors, service providers, regulators, and participants themselves are serious about improving the way we save and invest for retirement in this country, we all need to acknowledge 404(c) for what it is: a failed experiment.

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* Here's a checklist for 404(c) compliance from Reish Luftman Reicher & Cohen. Unfortunately, full compliance is a near-impossibility for most plan sponsors. Why? Take a look at that checklist, then see this extensive collection of opinion and analysis on 404(c) from 401khelpcenter.com.

Sources

Melissa Allison, "More layoffs expected at Starbucks," Seattle Times, January 24, 2009

Less of That? Please!

Over at SmartMoney, we ran across an item designed to help Merrill Lynch clients understand how they might be affected by the firm's recent troubles, troubles highlighted by John Thain's ignominious departure.

Drawing on our own experience at Charlie Merrill's old firm, a few passages in Dan Burrow's short column struck as as noteworthy. Here they are, with commentary immediately following each:

"Merrill...is reportedly offering massive retention bonuses to keep its brokers."

Yep. And those massive retention bonuses are effectively financed by U.S. taxpayers.

"Good brokers are good earners."

That depends on what the meaning of "good" is. And who's paying for all that earning. And how.

"Cost-cutting sends analysts packing -- the same folks your broker depends on for investing ideas and market intelligence. The best broker in the world still feeds on timely information. If you see a deterioration in the volume or quality of intelligence, be wary."

We've been reviewing Nassim Taleb's Fooled by Randomness, and, drawing on Taleb's work, this passage strikes us as an absolutely classic misunderstanding of where brokers can add value. The reality of the "in-house research" Burrows mentions is that most of it simply isn't helpful or useful at all to the end-user, the investor-client. It might help brokers pick up the phone, call their clients, and act as if they're delivering something of value. But in terms of giving clients the best possible chance of long-term success, most "analysts" simply can't help.

Most are plenty smart. Some are even diligent. A few have meaningful experience in a given industry and bring that experience to bear on their work in sensible ways. Every now and then a Meredith Whitney will say something out loud that needs very badly to be said. But in general, given the history of analysts, and not just the infamous outliers like Henry Blodget, Merrill clients should be pleased if their brokers will be hearing less noise from the firm's analysts.*

From Taleb, two relevant passages:

A famous television show was told that 'this guy Taleb believes that stock analysts are just random forecasters' so they seemed eager to have me present my ideas on the program. However, their condition was that I make three stock recommendations to prove my "expertise." I didn't attend and missed the opportunity for a great hoax by discussing three stocks selected randomly and fitting a well-sounding explanation to my selection.

...

Regrettably, some people play the game too seriously; they get paid to read too much into things.

Exactly.

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* One notable exception who, though not an analyst per se, is reliably excellent and simply must be named: Chief North American Economist David Rosenberg. Dude's blindingly smart. He always struck us as someone who favored signals over noise...and knew the difference.

Source

Dan Burrow, "Merrill After Thain: What Customers Should Know," SmartMoney.com, January 22, 2009