Institutions like mutual funds and pension funds are beginning to cut out primary Wall Street dealers and buy Treasuries directly at auction. It turns out they are simply following suit from China. A recent Reuters report says China is the only major US debt purchasing country that has been given a computer link between the People's Bank of China and the US Treasury auction system.
Primary dealers have traditionally handled the trades. In doing so, they require certain information that foreign countries may prefer not to disclose.
The China exception may seem to be a privileged arrangement. But, in fact, anyone or any entity can buy directly from the Treasury if all the guidelines have been followed and appropriate arrangements have been made.
China holds $1.7 trillion in US Treasury debt. Its ability to buy that debt directly symbolizes the close links between the two countries' economies. Especially with the size of China’s US debt purchases, buying directly makes managing its US holdings easier than having to go through an intermediary.
Whether China has received favorable treatment relative to other large purchasers of US debt, the two countries need each other. The US needs China's demand for US imports to manage its high level of debt. China feels uncomfortable with the perception that it is financing a spendthrift country with the labor of its citizens. Buying directly helps China with its internal political perception and provide the US with the funding it needs.
As each week has passed, it has became more and more expensive to have Greece as part of the Eurozone. Since there is no provision for a member country exiting the common currency, the euro, no one really knows what effect a member departure might have. Worries have mounted that Europe’s woes could spill over into the November US elections.
But the last few days has seen the Greek public rally around the austerity programs laid out by the European Central Bank (ECB).
A May 26 survey showed that Greece’s New Democracy party, which supports the terms for austerity mandated by the most recent ECB bailout, gained across the board. High premiums for corporate bond insurance in Europe have retreated. Global stock futures are up. For the first time in over three weeks the MSCI All-Country World Index has turned positive. The Euro also strengthened against the dollar for the first time since mid-2010.
Until this point, confusion and uncertainty had driven investors to seek safe havens like US Treasury bonds. The fear was that, in the case of a Greek default, the contagion might then spread to the rest of Europe and then to the US.
A Greek failure would have indicated that much-needed funding to boost debt-laden countries out of their malaise might no longer be available. This would have fed directly into the US fiscal cliff at the end of 2012 when Congress will either have to act to extend current tax laws or do nothing and let them expire as scheduled.
Doing nothing to address the problem still could throw the US economy back into recession or cause significant contraction. With the laws due to expire, no action does not mean no decision. If Greece gets behind the austerity program and fears are allayed, attention may turn to the US fiscal cliff situation.
Clients who put off taking their Social Security benefits not only get a larger check when they do start tapping the fund, they also end up buying an annuity that pays much better in today’s low interest rate environment than commercial annuities. The annuity benefit comes in the form of a benefit check that could be as much as 76% higher if retirees wait until age 70 to start drawing funds. This makes sense and the time to start planning is before clients retire.
Planning in advance has tons of advantages and this is yet another. By planning to delay the receipt of Social Security benefits, you can help your clients build their other retirement savings to take up the slack until age 70.
Commercial annuities have marketing, asset management, and other costs to pay from the sales loads they receive. The increase investors get from waiting to draw benefits costs them nothing extra. Retirees can draw benefits from the fund anytime between ages 62 and 70. Some may choose to continue working until age 70. Others may tap 401(k) plans and IRA savings to cover their income needs until they start drawing Social Security benefits.
Another great reason to wait as long as possible before taking Social Security payments is to provide a larger benefit for spouses in case the primary beneficiary dies. With the low interest rate environment providing little in the way of income for retirees, utilizing retirement savings and waiting until age 70—if possible—to draw Social Security benefits may make a good deal of sense.
Vanguard, perhaps the most cost-conscious, investor-friendly mutual fund complex in the world, this week eliminated the fees on some of its funds that were once prone to gaining and losing assets rapidly.
Vanguard, which manages $1.8 trillion in mutual fund assets, is eliminating what are called contingent redemption fees – the fees charged to investors who sell funds that were bought within a certain time period – on 19 equity index funds and 14 actively managed funds, effective immediately, according to a release.
“After careful analysis of investor transaction activity and net cash flow, Vanguard determined that these fees, one of several measures in place to discourage frequent trading, are no longer needed,” the company said in its release. “The other measures include prohibiting an investor’s purchases or exchanges into a fund account for 60 calendar days after the investor has redeemed or exchanged out of that fund account. Vanguard funds also retain the right to reject any purchase request (including exchanges from other Vanguard funds) if such a purchase may negatively affect a fund’s operation or performance.”
In reaction to the news, Daniel P. Wiener, the editor of The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of developments at Vanguard, issued this statement: “You may think the big news this week has been the fallout from the Facebook IPO debacle, or the gamesmanship around the Greek bailout, or lack thereof. But in my book the big news is that Vanguard has stripped the back-end loads off of virtually all of its funds.”
According to Weiner, Vanguard has removed the onerous back-end trading fees on most of its foreign equity funds, removed the one-year, 2% loads on the sector funds, and also gotten rid of the 1% back-end loads on closed funds like the PRIMECAP-run funds, and others like High-Yield Corporate and Selected Value. Only World ex-U.S. SmallCap and Global ex-U.S. Real Estate retain back-end loads or fees.
Why is Vanguard doing this? Well, Weiner’s take on it is this: “Vanguard says it’s (eliminating the back-end because the frequent trading it was trying to control just isn’t an issue any longer (if it ever was.) I would also bet that computer systems that block investors who trade into, or out of funds with rapidity or regularity have become good enough that the extra fees just aren’t needed.”
In addition, Weiner wrote that “back-end fees reflect poorly on a company that wants to be seen as consumer friendly, and it wouldn’t surprise me if some portfolio managers told Vanguard that with zero-transaction fee ETFs as competition, asset flows were simply not keeping up with expectations. Remember that Vanguard gets away with paying its outside managers very low fees in part because they can claim that their vast size will bring more assets the managers’ way. It’s the volume model. But maybe that’s not working so well for the outside managers. Vanguard certainly won’t say, but it’s a possibility.”
Weiner also examined “the actively-run (Vanguard) funds that are having the fees taken off and all of them but one, the brand-new Emerging Markets Select Stock, have seen net asset outflows (redemptions) over the last six months and last year. The move is obviously a positive for shareholders and, hopefully, keeps the active managers happy if it means there’s incrementally more interest in their funds now that the restrictions have come off.”
At least one advisor praised Vanguard’s decision to remove the contingent fees. “It is always encouraging to hear about a large investment provider, such as Vanguard, giving investors greater flexibility in buying and selling investments without restrictions,” said Aaron Skloff, AIF, CFA, MBA, the chief executive officer of Skloff Financial Group.
Skloff said his firm, through its institutional relationship with Fidelity Investments, is able to purchase mutual funds on a load-waived basis, or purchase load funds that normally have a load at Net Asset Value (NAV) without a load. Some of those funds have a 60-day holding period to avoid a small fee, for example $30 or one-half of 1%.
“Fortunately, we are able to utilize mutual funds with and without the holding period since we generally do not purchase and sell within 60 days,” said Skloff, who noted that an example of a load-waived mutual fund with a 60-day holding period that his firm owns is the Thornburg International Value A.
Another advisor, Erika Safran, CFP®, the founder of Safran Wealth Advisors, questioned whether Vanguard’s decision was in reaction to what’s happening in the world and in the Eurozone in particular. Allowing investors to sell their funds without having to pay a fee, especially in sectors that could fall in value rapidly such as Eurozone-specific funds, will prove to be investor friendly.
As for whether advisors ought to use mutual funds with contingent redemption fees, Safran offered these thoughts: Advisors need not avoid buying such funds if they make sense for a client nor avoid selling such funds within the period in which a contingent redemption fee would be charged if necessary. Such fees, Safran said, are “irrelevant for a thinking investor but not someone who is caught up in fees.”
For the record, there are 1,485 distinct U.S. mutual funds (3,466 if you include the various share classes) with a contingent redemption fee, according to Morningstar. Slightly more than 2,000 of the 3,466 funds have a 2% redemption fee, about 100 funds have a 1.5% redemption fee, and the rest have a 1% or less redemption fee.
As much as you might think you would never get involved in any type of fraud, a rehabilitated former advisor warns that it can become all too easy. With financial success a constant driving factor that rewards instant gratification, the tendency toward hubris (inflated ego) can gradually overtake sound judgment. This is what happened to Patrick Kuhse who was arrested and spent an entire month in horrible conditions at a Costa Rican jail before being extradited to the US to face legal proceedings here.
Obviously, Kuhse is no longer a financial planner or an employee of a major financial services firm. He’s built a new career as a speaker, bringing advisors back to reality who may not realize how easy it is to fall victim to the same tendencies that ended his career.
Markets in strong rally mode can make us feel that we are invincible, offering our clients exceptional returns and causing us to get stuck thinking that there can never be too much of a good thing. This kind of thinking can cause us to rationalize a decision that compromises our integrity. Kuhse is spending his new career warning advisors that no temporary reward is worth such a compromise.