Month: May 2019

Potential Winners of the SECURE Act (other than the American People)

Posted on by Sage Advisory

by Andy Poreda

Last week, the House passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. It was a clear win for the American People, many of whom are in desperate need of ways to enhance their dreary retirement savings prospects. The act will provide desperately needed changes to retirement legislation, an area that has been largely ignored since the Pension Protection Act of 2006 was signed into law. And although the American people stand to benefit immensely once the SECURE Act is signed into law by the President, so too do quite a few players within the $27 trillion retirement industry. Let us take a look at some of the groups that stand to gain the most from this act.

401(k) Providers

401(k) service providers just hit the jackpot with the SECURE Act. One of the key provisions of the act further facilitates the formation of open multi-employer retirement plans, allowing groups of small employers to band together to offer a common 401(k) plan. This pooling of unrelated employers (previous rules allowed for some related employer groups to band together) will ideally lead to lower fees and less fiduciary burden for small businesses. Consequently, employee access will also improve, and participants may receive a more robust set of investment options. Since somewhere between a third and a half of employers do not currently sponsor any type of retirement plan, 401(k) service providers will have tens of millions of potential new clients that may be more willing than ever to finally establish a plan.

With current all-in fees (includes administration, record-keeping, and financial advising) running upwards of 3% on some plans, the actual benefit of setting up a 401(k) is severely eroded. So expect providers to quickly respond with a push to capture the wide-open small business market with comprehensive plan management options offering low fees and basic financial advising as part of multi-employer group deals. Small businesses that are already sponsoring retirement plans but that are unhappy with their current fee structure will also be targets to change providers, as lower fees or better services may become available. Ultimately, a seismic shift is about to occur in the 401(k)-provider landscape over the next few years.

Insurance Companies

Some retirees view annuities with disdain, while others are fearful of the details, worrying about whether they made the right financial decision with their limited retirement savings.  Regardless of one’s perspective on annuities, it is undeniable that for many retirees a properly selected annuity could provide added utility to their portfolio, especially for those fearful they might outlive their savings. Since the Safe Harbor provisions of the SECURE Act shift most of the burden of annuity choices from the employers to the insurance companies, it is likely that many more employers will soon start offering more annuity options to their employees. The insurance companies will clearly look to capitalize on the enhanced access to millions more retirees in search of investment options.

A specific product to look out for is the Qualified Longevity Annuity Contract (QLAC), a deferred income annuity where payments can be delayed up to the age of 85. One big benefit of the QLAC is that a portion of one’s 401(k) (up to 25% or $130,000) can be used to purchase one, and it is exempt from required minimum distribution calculations, a factor to consider for some retirees. The other huge benefit is the significant increase in the monthly payout values that are a result of delaying payments until a much later date. As many retirees may have to deal with the distinct possibility that they live well into their late 90s, while also facing significant medical care costs, a QLAC could provide these individuals the peace of mind that they are not going to outlive their savings. When coupled with a traditional retirement account, one could drawdown from funds remaining in a traditional IRA, and once depleted the QLAC would kick in, in essence acting as an insurance policy against longer life expectancy. Currently many employers are reluctant to offer QLACs and annuities in general, but we predict that will soon change.

Insurance companies might also stand to gain from the elimination of the “IRA stretch” strategy. The “IRA stretch” was an effective estate planning tool that allowed for heirs of IRA plans to make minimal withdrawals, thereby allowing the account to continue to accrue tax-deferred benefits for years. The SECURE Act now forces withdrawals to be made fully within 10 years of an individual’s death, and it is possible that the timeline will be further compressed, as the Senate’s retirement act lowers the timeline to five years. Either way, the benefit of passing down IRAs to heirs will be diminished as a transfer-of-wealth option. Could this open up a shift to other investment choices, such as life insurance policies? Death benefits are not income-taxable, so purchasing a life insurance policy structured with a large death benefit may become a viable option for some investors seeking to transfer wealth. Obviously, it will take some time to fully analyze the ramifications of some of these provisions, but it is interesting to think about the impact on future estate planning.

Although the retirement industry aims to profit from the sweeping reform taking place in Washington, as we mentioned before, American workers are the true winners. Here at Sage, we are excited to see the new focus that politicians are placing on retirement issues. In a time where most issues have become heavily divisive, it is pleasant to see an area where there is so much agreement. Hopefully retirement reform will enjoy continued momentum, and more complex issues such as Social Security and automatic IRA enrollment will be addressed in the future. Any help the American People get on retirement is a plus. Sage and its team of professionals build dynamic liability and cash-flow-oriented investment strategies for pension and cash balance plans, in addition to providing asset allocation strategies for 401(k) plans. For more information, visit: https://www.sageadvisory.com/retirement-plans/

 

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Landmark Retirement Reform Legislation May Finally Become a Reality

Posted on by Sage Advisory

by Andy Poreda

On Thursday morning, the House of Representatives took a big step toward sweeping retirement reform. A bipartisan legislation package was near-unanimously approved by the House 417-3 (no thanks to dissenting GOP Reps. Justin Amash (R-MI), Thomas Massie (R-KY), and Chip Roy (R-TX)). Although there was some last-minute frustration by Republicans over the removal of a provision that would have allowed 529 plan funds to be used for K-12 private education and homeschooling, we believe the primary focus of the legislation was a no-brainer for the country.

The Setting Every Community up for Retirement (SECURE) Act of 2019 is a multi-faceted set of provisions aimed to enhance the ability for Americans to save for retirement, providing the first major set of updates to retirement plans since 2006. The estimated $16 billion landmark bill would ease the multi-employer plan rules (MEPs) to allow two or more unrelated employers to join a pooled employer plan (PEP) through a designated pooled plan provider.

Other key provisions of the legislation include:

  • Increasing the auto enrollment safe harbor cap for existing plans
  • Simplifying safe harbor 401(k) rules
  • Increasing the tax credit for small employer plan start-up costs
  • Providing portability of lifetime income options
  • Allowing long-term part-time workers to participate in 401(k) plans
  • Allowing plans adopting by the filing due date to be treated as in effect as of close of year
  • Providing a fiduciary safe harbor for selection of lifetime income provider
  • Modifying the treatment of custodial accounts on termination of section 403(b) plans
  • Requiring disclosures regarding lifetime income
  • Modifying the nondiscrimination rules to protect longer service participants

Source: American Society of Pension Professionals & Actuaries

According to a recently released Federal Reserve report, a quarter of American adults have no money saved for retirement. A likely culprit is the fact that over half of American workers do not have access to an employer-based retirement plan, according to a 2018 Stanford study; exacerbating the situation, life expectancy is on the rise and future Social Security benefits remain tenuous at best. Meaningful legislation that provides opportunities for Americans to start saving for the future while also lessening the blow of an impending retirement epidemic must be hailed as a monumental success.

Our hope is that the SECURE Act is the start of a bigger reform movement, as future bills are already being pushed. The similarly focused Retirement Enhancement and Savings (RESA) Act still needs to pass through the Senate and is currently stuck at the committee level. A few key differences need to be sorted out, as the Senate version has included no provisions for part-time employees or increasing the required minimum distribution age; however, all signs point to Senate and House Leadership working them out. The bipartisan team of Senator Portman (R-OH) and Senator Cardin (D-MD) are encouraging a bill that would enhance the saver’s credit for low-income individuals and increase catch-up contribution, among other improvements to current rules.

Only time will tell, but these current changes are all a step in the right direction. Here at Sage, our team of professionals build dynamic liability and cash-flow oriented investment strategies for pension and cash balance plans, in addition to providing asset allocation strategies for 401(k) plans. For more information, visit: https://www.sageadvisory.com/retirement-plans/.

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

The U.S. Economy – Signs of A Sneaky Slowdown

Posted on by Sage Advisory

By Komson Silapachai

We are in the longest U.S. economic expansion in modern history.

Barring a black swan of epic proportions this month, the U.S. economy will break the record in June for the longest expansion since 1854. The current leader, which is soon to be surpassed, is the 1990’s economic expansion, which lasted for 10 years. Is this a cause for a celebration, or is the economy due for a downturn?

Economic expansions don’t die of old age. Just because the expansion has lasted this long doesn’t mean it should end. In fact, there are many positive indicators of why this expansion should continue. Private-sector balance sheets remain strong, as financial assets and home prices are near all-time highs. The labor market is solid – the U.S. unemployment rate stands at 3.6%, just 0.2% from its all-time low. Inflation remains subdued and serves as a tailwind to the economy, as the Federal Reserve has not moved to tighten conditions.

An additional positive indicator, the Chicago Fed’s National Financial Conditions Index, which indicates conditions in debt, equity, and “shadow” banking systems, illustrates that financial conditions are at their easiest levels post-crisis.

 

However, we’re starting to see initial signs that the economy could be softening. While we don’t believe these indicators point to an imminent recession, the economy is experiencing a material slowdown that warrants observation for the remainder of the year.

 

1. Business Loan Activity

The Federal Reserve’s Senior Loan Officer Survey’s measure of business loan activities points to moderation in business investment. The percentage of loan officers reporting stronger demand are the lowest in the post-crisis period, while loan standards have moved tighter since the second half of 2018.

 

2. Transport Volume

Key transportation indicators have turned negative. The Association of American Railroads has reported a slowing in U.S. rail traffic volumes, with total volumes falling in the first 17 out of 19 weeks in 2019.

 

 

3. Industrial Output

Capacity Utilization, which measures the percentage of realized potential industrial output and economic slack, has been declining since its peak in October 2018 and is at a 14-month low.

 

4. Manufacturing Demand

The widely followed ISM Manufacturing Purchasing Manager’s Index (PMI), which surveys purchasing managers at over 300 manufacturing firms, has moved sharply lower in recent months. A PMI index above 50 indicates an expanding economy, and a move below 50 indicates a contraction. While the indicator stands in expansionary territory at 52.5, it has declined from its peak in August 2018 of 60.8. A sustained move below 50 would signal a serious slowdown, if not a recession; however, we are not there yet.

 

5. Economic Activity

The Chicago Fed’s National Activity Index, which is a composite of 85 indicators of national economic activity, has turned lower and points to below-trend growth in recent months.

 

As the U.S. economy moves into its longest expansion in modern history, we are seeing signs of a slowdown bubbling under the sanguine labor market and easy financial conditions. Whether the dip is transitory, as it was in 2016, or a herald of a larger slowdown remains to be seen. It all depends on the outlook for monetary and fiscal policy, as well as a potential fallout from slowing global trade.

 

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

China’s Conundrum: Why a Trade Deal Remains Out of Reach

Posted on by Sage Advisory

by Komson Silapachai

It was the winter of despair, it was the spring of hope, we had everything before us, we had nothing before us. Charles Dickens’ timeless words in the opening of A Tale of Two Cities serves as a poignant reminder of the fear and greed that dictate the movement of financial markets. The trade war was all but resolved; now the deal is effectively off the table.

We think the bar is high for the U.S. and China to strike a deal on structural issues, such as changing China’s laws on forced technology transfer and the protection of U.S. intellectual property. China’s economic development objectives are fundamentally at odds with U.S. interests. Our base case is a prolonged negotiation period with any agreed-upon deals centered around correcting the U.S./China trade imbalance rather than the structural issues around each country’s economic system. In this scenario, we see a prolonged period of uncertainty in which risks of shocks to global growth (especially in Asia), investor sentiment, and asset prices remain squarely on the downside.

To process the current U.S./China trade battle requires a broader look at the larger structural issues that have created the underlying causes of tension.

China’s Economic Development is the Antithesis to U.S. Interests

China’s rapid ascent to the world’s largest economy is attributed to its role as the preeminent low-cost manufacturer. However, China is currently facing the problem of a “middle income trap,” a stage in economic development in which a country loses its competitive edge as purely an exporter, and concurrently, is unable to keep pace with developed countries in the production of value-added goods, such as high technology. Avoiding this outcome is nothing short of an existential issue for such a large, highly-indebted, populous nation.

To transition to a developed economy, China is undertaking a historic transformation: from a low-wage manufacturer dependent on external demand to a high productivity, high technology, value-added producer with increased dependence on its domestic economy. “Made in China 2025,” a state-led industrial policy introduced in 2015, addresses the methods by which China aims to make this transition. According to James McBride and Andrew Chatzky at the Council on Foreign Relations, China’s methods include setting explicit targets, providing direct subsidies, acquiring foreign tech companies, mobilizing state-backed companies, and forced technology transfer.

Therein lies the “structural issues” inherent in a trade agreement – China’s objectives are at the United States’ expense. The U.S. stands to lose its competitive edge as the epicenter of technology and value-added goods; while on the other hand, China cannot afford to deviate from its transition to a developed economy due to the looming middle-income trap.

On May 3, Reuters reported that China sent a diplomatic cable in which it “had deleted its commitments to change laws to resolve core complaints . . . theft of U.S. intellectual property and trade secrets; forced technology transfers; competition policy; access to financial services; and currency manipulation.” At the eleventh hour, China couldn’t commit to abandoning its best hope for an economic transformation.

The U.S. subsequently raised tariffs on $200 billion of Chinese goods to 25% at 12:01am on Friday, May 10. The tariffs are expected to have a material adverse effect on the Chinese economy – Citigroup economists expect the effect of incremental tariffs to result in a -0.5% reduction in Chinese GDP and removal of 2.1 million jobs in China over the medium-term.

Market Implications

Here is our outlook regarding trade for the coming months. Our base case is a prolonged negotiation period stretching into 2020, which should result in a period of higher uncertainty in markets balanced with continued policy support from global central banks. Less probable cases include a near-term trade agreement that could take place in two forms: a correction of the U.S./China trade imbalance with less focus on structural issues (more probable), or a trade deal in which China agrees to change its laws around competition and intellectual property (less probable). The risk of a no-deal is not zero, but we believe it is less likely as it is mutually destructive, and both countries could continue to “kick the can” of negotiations further and further into the future. The table outlining our outlook is below.

 

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

 

Five Questions to Ask your Municipal Bond Manager

Posted on by Sage Advisory

by Jeffrey Timlin

  1. At current valuations, should I wait to invest cash in the municipal market?

All things being equal, history has shown that bonds outperform cash over most time periods. Although municipal valuations are not super attractive right now, every asset class is rich and trading at or near their all-time highs. The benefit of municipal bonds is not only tax-free income, but as an asset class, it is negatively correlated to the broad market during market downturns. If equities enter a corrective phase, municipal bonds typically hold up well and may even experience modest price appreciation.

 

  1. When will the strong technical environment normalize?

To be sure, the record municipal cash inflows experienced year-to-date cannot last forever. The caveat to that remains the ongoing reduction in new issue supply, as well as the elevated levels of maturity and coupon payments coming due. Historically, periods of significant outflows have coincided with negative returns as investors and funds alike were forced to liquidate positions to raise cash. Unlike those periods, the current environment shows mutual funds sitting on higher levels of cash and they are cushioned by higher levels of maturity and coupon roll-off. Lastly, as a result of the decade-long recovery, a record number of millionaires now reside in the U.S. – more than 11 million people. These millionaires benefit fully from the tax-exempt income offered by municipal bonds, especially the ones who live in high-tax states.

 

  1. Are there any credit issues that I should be concerned with?

Overall, there are no serious credit concerns within the municipal market. Several well-known credits, such as the State of Illinois, City of Chicago, and Puerto Rico remain challenged and should be reviewed on a quarterly basis. Although mid-to-long-term issues do exist regarding pension and health care funding levels, there is not cause for immediate concern. Due to the monopolistic characteristics and taxation powers inherent in most municipal issuers, the municipal market remains one of the safest areas within the fixed income markets.

 

  1. I am worried about losing money in fixed income. What can I do to protect myself?

Many investors overestimate the downside risk of municipal bonds. Over the past 15 years, a core municipal strategy that has an effective duration of approximately six years and invests in maturities out to 30 years only had two negative-return years: 2008 (-2.49%) and 2013 (-2.55%). Even on a quarterly basis, the worst return during that time was -4.17% in the fourth quarter of 2010, after Meredith Whitney’s bogus municipal default prediction. To put that into perspective, the worst quarterly return for municipal bonds has occurred to daily returns in the equity markets on a fairly consistent basis. For investors looking to minimize downside risk, municipal strategies with a duration of four years or less tend to offer an attractive yield, while limiting principal loss on a yearly basis.

 

  1. Why does it take a few weeks to get my portfolio fully invested?

Municipal portfolio cash could be invested in a day or two, provided the investor is not concerned with valuations or optimizing their sector and credit profile. Unlike equities, which are constantly available, municipal bond supply ebbs and flows daily. A bond that trades today may never trade again if held by buy-and-hold investors. In addition, Sage is a value-based investor that screens the market for attractive offerings. A combination of new issue, secondary offerings, and bid wanted are utilized to source bonds at attractive levels. Each of these avenues opens and closes daily and takes time to access. Sage believes that having the patience to wait a few weeks to purchase the most attractive offering will pay dividends in the long run.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Auto Loan Losses: Navigating Through the Noise

Posted on by Sage Advisory

by Seth Henry

Over the last few quarters, there have been numerous news headlines noting the rise in auto loan delinquencies. The headlines tell only part of the story, however, as many of the losses can be attributed to subprime auto loans, which comprise roughly 40% of the auto loan market.

Over the past decade, losses on automobile asset-backed securities (ABS) had actually trended downward and reached historic lows. This is due in part to the strong financial position of the American consumer. A decade of historically low rates combined with very low unemployment helped to keep the consumer in a stable environment and auto loan defaults relatively low. While it is true that delinquencies and losses have increased, this is due primarily to losses in the subprime portion of the auto loan market, which is $55 billion of the $140 billion market. Specifically, delinquencies and losses have increased for subprime issuers who have a poor track record for underwriting and managing risk.

While current losses on prime auto loans are higher than their historical lows (0.56% vs 0.30%), they are still very low and well within expectations.

 

Over the last five years, smaller-scale (non-benchmark) subprime issuers have seen losses increase from 7.60% to 9.90%, a much larger increase that weighs on the sector as a whole.

 

 

Despite subprime auto weakness, Sage believes that prime auto borrowers are in a healthy position and do not pose a systemic risk. Given the strong job market, consumer ABS is still a healthy sector with a compelling risk-reward value. The sector is largely AAA-rated, and a great alternative to other high-quality, lower-yielding assets.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.