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Cypen & Cypen
December 6, 2018

Stephen H. Cypen, Esq., Editor

A decade after the last major recession of the U.S. economy, many have been convinced that the current environment is the new normal. Soaring equities and low interest rates have been predominant features of investments; rising Pension Benefit Guaranty Corporation premiums, artificially smoothed discount rates and increasing settlement activity have also been present. While some of these features might become part of a new normal, some might be cyclical. To understand the future, we need to examine the past. In this paper, we will look at 10 investment actions and discuss what they mean for future planning.

1. Avoid surprises.
During the global financial crisis (GFC), the average plan saw its funded ratio fall by 25%. Businesses were stressed, and those with large pension obligations got an extra kick in the shin as they were forced to source extra cash for their plan. The good news is there are still tools that can be used to simulate different economic environments to help clients better understand the potential impacts of financial risks and develop strategies to manage them.

2. Reduce uncompensated risks.
Not all asset classes, managers and strategies struggled during the GFC. Some investment strategies — like reinsurance, merger arbitrage and momentum — came out of the period ahead. Going forward, it’s unlikely that everything will implode at the same time, so diversity is key. Potentially reducing reliance on the high-flying equity portfolio should be explored.

3. Make every dollar work harder.
In the 1990s, before liability-driven investing became the dominant paradigm, most sponsors thought like endowments. They intended to keep plans open forever, and targeting an 8% expected return seemed perfectly reasonable. With the shift toward closed, frozen and terminated plans with the potential transfer of risk to insurers, many portfolios have loaded up on long credit bonds, reducing their return potential. There is a delicate balance between building a powerful return generator and managing your liabilities, but it need not be one or the other. Through capital efficiency and diversification, we believe the appropriate balance can be achieved. 

4. Concentrate your equity bets.
Before the 1970s, active management dominated equity strategies. Then, in 1975, Vanguard introduced passive management and later, in 1992, Fama & French introduced smart beta. Today, there is a well-documented flow of assets from active to passive strategies. But according to academic research from Brands, Brown and Gallagher, and Jiang, Verbeek and Wang, plan sponsors may be missing an opportunity to add value. To implement this research, we’ve partnered with a number of equity managers to build high-concentration mandates without all the extra fluff. And we have to say: We’re very pleased with the results.

5. Be a bond market trendsetter.
At the end of 1989, the global bond universe represented $12 trillion; 61% of debt was issued in the U.S. Today, the bond market represents nearly $110 trillion with 36% issued in the U.S., 41% in developed markets and 21% in emerging markets. If your governance structure allows, (see item 9), we believe there are large opportunity sets in securitized credit, banks loans and private debt. Even for the less adventurous investor, it’s worth exploring ways you can use the expanded bond universe to overcome the dwindling long credit supply or to build an attractive growth complement to equities. Remember: If you’re going to dabble in more esoteric investments, diversification is crucial.

6. Revisit financial management strategies.
Sponsors may be seeing their highest plan funded status since the GFC. This could be due to accelerated contributions to capture higher deductions prior to tax reform, strong equity returns or higher interest rates. If you saw your funded status nosedive a decade ago, you have a second chance at locking in your improved position. Revisit your company’s funding and accounting policies, the plan’s strategic asset allocation, and progress along your de-risking glidepath and long-term forecasts of plan financials to confirm the path you’re on is the right one for you.

7. Stay informed about the changing annuity marketplace.
Prior to 2012, the annuity purchase marketplace averaged $1.5 billion in transactions per year. In 2017, this figure was $23 billion.Increasing funding levels have further shifted the focus to the de-risking journey. The majority of the obligations that have been settled to date have been focused on retiree-only transactions. Insurance markets are continually evolving to meet plan sponsor demand, with more flexibility in how sponsors transact. When your investment consultant and actuary partner together, we believe you can better define the appropriate transaction size, manage the required liquidity and identify potential asset-in-kind transfer opportunities.

8. Focus on value-for-fees rather than the fees themselves.
In the year 2000, the average mutual fund or exchange-traded fund cost 100 bps for active and 25 bps for passive; today, those numbers are 72 bps and 15 bps. Sponsors are increasingly focused on reducing investment fees, and rightly so. However, at Willis Towers Watson we emphasize the value for fees, not the fees themselves. Many of the strategies we describe earlier might result in higher headline fees, but if they lead to significantly lower contributions for you, the value-add might just be worth the higher fee. All this said, managing headline costs and negotiating with high-conviction managers can get you the right product at the right price.

9. Consider your governance structure.
Sponsors have constantly faced too many decisions with insufficient time to vet them. That’s why, in 1998, Willis Towers Watson ran its first “implementation consulting” mandate. Twenty years later, delegation — or outsourced chief investment officer — is everywhere; we manage over $116 billion in assets for our clients. Across all providers, there are almost $2 trillion in global delegated assets, and there’s good reason why. Sponsors are continuing to find that delegation can potentially lead to better financial outcomes, better execution and better value and also help to provide an additional layer to fiduciary documentation and oversight that is critical to supporting fiduciary decisions.

10. Maintain your defined benefit (DB) plan if it’s the right fit for your company.
While corporate pension plans were established as early as 1875, the modern pension plan took its form following the Great Depression, alongside Social Security. The main objectives were to help older employees to retire and to prevent poverty for the aged. Today, as more and more sponsors close or freeze their DB plans and switch to defined contribution (DC) only arrangements, their ability to accomplish these goals may be challenged. Despite the trend from DB to DC, many of our clients maintain commitments to open DB plans, working with us to construct risk managed and sustainable plan designs and portfolio solutions. Willis Towers Watson, November 27, 2018.

When Warren Buffett speaks, investors tend to listen. Buffett’s Berkshire Hathaway (BRK.A) buys undervalued companies to hold for the long term, and between 1965 and 2016, the company returned an annualized 20.8 percent to its investors, in contrast with the S&P’s 9.7 percent return. The Nebraska billionaire’s long history of success has earned him the moniker “The Oracle of Omaha,” and many investors hang on his every word for insights on succeeding in the market. One of Buffett’s most famous quotes is “Be fearful when others are greedy, and greedy when others are fearful.” This particular piece of investing wisdom is a contrarian recommendation — advising, essentially, to go against the investing grain. But implementing this strategy is more difficult than it appears.
Understanding How Markets Behave
Investment markets are cyclical. Stock prices rise, peak, fall, and then rebound. Investor sentiment changes along with the stock price trends: As prices rise, many investors see these market gains, get excited, and jump on the bandwagon by pouring money into the market. Buffett characterizes these return-chasing investors as “greedy,” seeking to profit from an increasing stock market. Those greedy investors chasing a rising stock market tend to overlook a most important factor purchasing stocks: Price. Regardless of broad market trends, if you pay too high a price for a stock or fund, you’re likely to lose money when the market corrects and the price comes back to earth. That’s the nexus of why Buffett cautions against greed when investing.
Stock Market Valuation Matters
In a rising stock market, asset values tend to get inflated. For example, during the past 30 years, investors have paid a range of prices for one dollar of earnings, as measured by the Price Earnings (PE) ratio. From a low PE ratio of 11.69 in Dec 1988 to a peak of 122.39 in May 2009, this stock market price tag is a precursor to future stock market prices. Higher current PE ratios predict lower future stock prices. Greedy, return-chasing investors buying into highly priced stocks are certain to experience lower returns going forward. Then when the stock price uptrend turns around and goes south, and investors panic and get scared. These same investors who bought at market peaks turn around and sell during the subsequent market trough. These scared investors are doing exactly what Buffett warns against: Selling on fear. As market prices fall, the PE values fall, and stocks get cheaper. Those savvy investors who buy when others are fearful, typically purchase undervalued, lower PE ratio stocks and enjoy higher returns in the future. Buffett’s wisdom plays out in reality, as lower valued stocks outperform higher PE assets going forward and vice versa. So, to implement the Buffett advice, don’t get swayed by the crowd. When assets are richly valued, be cautious and don’t jump into the markets with all your investment dollars. As stock market values fall, be brave and pick up on-sale shares. That all makes sense at first blush. But this advice seems to clash with another classic bit of investing wisdom.

“Don’t Fight the Tape”
“Don’t fight the tape” is another snippet of old investing advice, essentially warning investors not to trade against a trend. That wisdom suggests that rising stocks will continue to go up, and falling stocks will continue to decline. Thus, as stocks go up, if you practice the “don’t fight the tape” advice, you’ll continue to buy, regardless of the stock market PE ratio. This saying describes the momentum investing strategy. On the surface, Buffett’s advice seems to clash with the momentum strategy. Yet, there is some overlap. Buffett’s wisdom guides investors to invest in under- or fairly-valued assets with good future investment prospects. The “don’t fight the tape” camp recommends investing as long as stock prices are rising. As stock prices rise, in the early stages of a bull market, stock prices may be undervalued. At this point in an economic cycle, both Buffett and momentum strategies are in accord. Later, as stock market prices continue to soar, and surpass their intrinsic value, investors tend to get greedy and momentum investors continue to buy in. This is where the two investing camps diverge: Momentum investors pay less attention to a stock’s valuation and more attention to the price trend.
Reconciling the Strategies
The secret to smart investing strategy is to understand the value of your investments. If asset prices are substantially above their historical norms, and investors are giddy with enthusiasm, be cautious — and vice-versa Following trends is great if you know exactly when the trend will reverse course. If you don’t, then it’s best to understand market valuation and avoid paying too much for your financial assets.

Retire like Warren Buffett.

Barbara A. Friedberg, The Balance, November 20, 2018.
The Institute for Pension Fund Integrity (IPFI) would like to congratulate the Canada Pension Plan Investment Board (CPPIB) for refusing to divest its assets from private prison companies. The move comes after political organizers recently put pressure on the board to remove its investments as a form of protest against the immigration policies of the United States Government. IPFI is strongly against politically motivated divestment. Investment decisions should be made solely on the basis of financial performance and risk, and should never be made for political reasons. Politically motivated acts of divestment are a violation of fiduciary duty and have led to the loss of billions of dollars of income in the past. For example, when the California Public Employees’ Retirement System divested from tobacco stocks in 2003, it was estimated to have cost the fund over $3.5 billion during the ensuing decade. “Unfortunately, some pension fund trustees believe that their political agenda is more important than their fiduciary responsibility, ” said IPFI Chairman, Christopher Burnham and former Connecticut State Treasurer. “Pension beneficiaries, of which I am one, deserve better. CPPIB made a courageous and correct decision.” Within the United States, acts of divestment have been occurring within several prominent pension plans. Both the New York City Employees’ Retirement System and the California Teachers’ Retirement System have voted to divest their funds from private prison holdings. These divestment actions follow long political battles and weaken the already underfunded pension funds. For more on this, see the research available on IPFI would like to congratulate CPPIB for choosing to fulfill its fiduciary responsibility instead of giving into political pressure. Moving forward, the decision by CPPIB should be used a model of behavior for other public pension funds. The Institute for Pension Fund Integrity says that it seeks to ensure that local, state and federal leaders are held responsible for their choices in investment, led not by political ideation and opinion but instead by fiduciary responsibility. IPFI is a non-partisan, non-profit organization based out of Arlington, Virginia, and spearheaded by former Connecticut State Treasurer Christopher B. Burnham. Institute for Pension Fund Integrity, November 28, 2018.
The Internal Revenue Service issued proposed regulations for a provision of the Tax Cuts and Jobs Act, which limits the business interest expense deduction for certain taxpayers. Certain small businesses whose gross receipts are $25 million or less and certain trades or businesses are not subject to the limits under this provision. For tax years beginning after Dec. 31, 2017, the deduction for business interest expense is generally limited to the sum of a taxpayer’s business interest income, 30 percent of adjusted taxable income and floor plan financing interest. Taxpayers will use new Form 8990, Limitation on Business Interest Expense Under Section 163(j), to calculate and report their deduction and the amount of disallowed business interest expense to carry forward to the next tax year. This limit does not apply to taxpayers whose average annual gross receipts are $25 million or less for the three prior tax years. This amount will be adjusted annually for inflation starting in 2019. Other exclusions from the limit are certain trades or businesses, including performing services as an employee, electing real property trades or businesses, electing farming businesses and certain regulated public utilities. Taxpayers must elect to exempt a real property trade or business or a farming business from this limit. Taxpayers may rely on the rules in these proposed regulations until final regulations are published in the Federal Register. Written or electronic comments and requests for a public hearing on these proposed regulations must be received within 60 days of publication in the Federal Register. IR-2018-233, November 26, 2018.

The National Association of Insurance and Financial Advisors for New York State has filed a lawsuit in New York Supreme Court claiming the best interest regulation by the New York Department of Financial Services (DFS) contradicts New York law and is unconstitutional. The new best interest standard applies to all investment professionals licensed to sell life insurance and annuity products to state residents. It was specifically adopted by the State Department of Financial Services, which says it has issued the new rules intentionally in the wake of the failure of the Department of Labor’s own attempt to strengthen conflict of interest standards at the federal level. A statement summarizing the regulation says New York will henceforth require insurers to “establish standards and procedures to supervise recommendations by agents and brokers to consumers with respect to life insurance policies and annuity contracts issued in New York State so that any transaction with respect to those policies is in the best interest of the consumer and appropriately addresses the insurance needs and financial objectives of the consumer at the time of the transaction.” According to the complaint, New York State’s Constitution vests the power to make policy in the democratically elected Legislature. An administrative agency may promulgate regulations only if the Constitution allows it or the Legislature enacts a statute that does so. The lawsuit alleges that the DFS exceeded its permissible executive-branch authority by promulgating Regulation 187 without constitutional or statutory authority. The Association says the court should invalidate Regulation 187 for any one of three reasons:

  • DFS did not have constitutional or regulatory authority to promulgate the regulation;
  • Even if the court were to interpret the statutes that DFS cites as authorizing Regulation 187, DFS has breached the New York State Constitution because the regulation violates the separation-of-powers doctrine, contains impermissibly vague and confusing terms, and violates due process because the statutes on which DFS relies for Regulation 187 contain no safeguards; and
  • Even if Regulation 187 were properly promulgated, the court should strike it as arbitrary and capricious because it will not further its stated purpose of protecting New Yorkers from conflicted advice, but would harm consumers by causing the market for and advice about life insurance policies and annuities to shrink. 

The Association says Regulation 187 is arbitrary or capricious because the record does not contain a sufficient—or any—factual predicate for it; there is no rational basis for exempting direct-marketing transactions while imposing a fiduciary standard on all others; and there is no factual basis supporting the decision to conflate agents and brokers into a single group called “producers.” “Ultimately, consumers will be hardest hit by reduced access and choice, forcing many independent insurance agents to exit the New York market. Consumers may also face higher prices because of reduced supply in the marketplace,” the Association states in its complaint. The Association also contends the distinction between agents and brokers, “which has been a cornerstone of statutory and regulatory treatment of agents and brokers for decades,” is settled in the case law. Insurance agents act as agent of an insurance carrier and brokers appear as representative of the insured. Yet, the complaint says, Regulation 187 ignores this basic aspect of New York Insurance Law and places obligations on agents that are inconsistent with their statutory—as well as contractual—duties to insurers. “To be clear, if an agent must act solely ‘in the best interest of the consumer,’ then it cannot carry out its statutory duty ‘to act as agent of [an] authorized insurer,’” the complaint states. Rebecca Moore, Planadviser, November 28, 2018.

Free trial offers can grab your attention. They’re easy to sign up for. And they’re, well, free – right? Not exactly. Some free trials can be expensive. Scammers often use “free” trial offers, with undisclosed or buried terms, to enroll you – without your knowledge – in costly membership programs. At the Federal Trade Commission, we’re actively fighting to take down these scammers. We announced a case against a group of them. But the best first line of defense is you. Please watch the video below, know the signs of a free trial scam and share them with your friends and family.
Consumer Alert: Free Trials Can Cost You
If you’ve been wrongly charged for a free trial offer, report it to the FTC. Federal Trade Commission.
“Lost Time is never found again.”
Why do "overlook" and "oversee" mean opposite things?
The most common way people give up their power is by thinking they don’t have any. – Alice Walker
On this day in 1865, 13th Amendment of the United States Constitution is ratified, abolishing slavery.


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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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