Wealth Management Industry Outlook 2012

Wealth Managers Reflect a Surprising Optimism

On October 9, Ingram’s Magazine hosted its Wealth Management Industry Outlook for the eighth consecutive year. As always, we gathered a savvy group of wealth managers, financial planners, analysts and attorneys who were happy to share their insights with readers.

In a politically volatile year, in an economically volatile era, participants were almost uniformly more optimistic than one might have anticipated. That optimism rests largely in their faith in America’s long-term success.

“We feel very strongly about the human spirit,” said Mark Henke, a wealth manager for Creative Planning. “We take the long view. For most of our clients, we’re looking at 20- and 30-year horizons, not just the next 90 days, and feel very strongly about the future.”

About short-term prospects, those gathered were a little more cautious. “I’m telling my clients more that there’s a threat coming,” said Lynn Mayabb, office director for the Kansas City and St. Louis practices of BKD Wealth Advisors. She alluded to the storied “fiscal cliff,” the phrase used to describe the potential mayhem the economy could face at the end of 2012 when the terms of the Budget Control Act of 2011 go into effect. This combination of tax increases and budget cuts, if not modified, could mean “less money in the economy to help spur a long recovery,” said Mayabb.

Good Numbers

“The market has been very, very strong this year,” said Bob Rippy, certified financial planner and senior vice-president for Baird Financial Planners. “Somehow the market is predicting right now that we’re going to get through this thing.” Rippy was asked why this was happening in what Bill Greiner, chief investment officer for Mariner Wealth Advisors, described as a bear market in its 12th or 13th year of duration. “There’s nowhere else to go,” said Rippy. With Treasury rates as low as they have been, dividend-paying stocks appear all the more attractive.

Greiner cited a poll in which 63 percent of investors listed themselves as “bullish.” As he explained, easy monetary policies, not only here in the United States, but also in Europe and Japan, had flooded the equity and fixed-income markets with cash. “I think the real driver over the last nine months,” Greiner added, “has been the anticipation in the actual movement of the Federal Reserve policy and of the central bank policies.”

“I think the markets move to frustrate the masses,” said David Neihart, managing director of investments for Wells Fargo Advisors, quoting a time-tested axiom. Neihart, however, had not been seeing the bullishness in stocks that Greiner’s survey suggests. “I see people vote with their money,” he said. “We see lots of accounts that are way over-weighted in fixed-income out of fear.”

Debt

The question was raised as to whet-her the $16 trillion or so that the U.S. gov-ernment owes might have a depressing effect on public confidence. Steve Soden, CEO of Great Plains Trust, did not think so. “Maybe we’re numbed out,” said Soden. As he noted, the debt has been hanging over the public’s head since he start-ed his career, “even when the debt was by modern standards really miniscule.” He added, “It seems like the rubber band stretches but never truly breaks.”

“I agree with you,” said Dana Abra-ham, president of investment and wealth management for UMB Financial Corp. She argued that the industry had chosen to focus on those elements that it can control and to strengthen individual relationships with clients. Bob Rippy noted that “fear of all the total debt” is one of the most frequently heard concerns among his clients.

Jon McGraw, president of the Buttonwood Financial Group, took a different tack. He believes that “the big issue” is the way our government and governments around the world manage their debt loads. As he noted, there are also the issues of corporate debt and personal debt to consider.

David Neihart expressed more concern than his colleagues. Although he dislikes the word “unprecedented,” he found himself using it nonetheless to talk about the debt. “We’ve all seen how interest rates could rise and overwhelm the federal budget,” he worried. “If rates go to 5–6 percent, that wipes out discretionary spending and whole huge blocks of the federal government.”

“To me,” said Scott Boswell, president of the Commerce Trust Co., “the question is really the will of the people.” As Boswell noted, although everyone seems to agree that spending needs to be cut, interest groups resist cuts in their own sectors.

Bill Greiner cited the numbers coming from Macro Advisors, an economic think tank, whose experts believe the proper formula for resolving the nation’s debt issues entails 70 percent spending cuts and 30 percent tax increases. “The best minds that I’ve seen thinking about this issue suggest that something along the lines of Simpson-Bowles needs to be enacted,” said Greiner. “There’s no ox spared on that issue. All of them got gored.”

Managing Expectations

The challenge for wealth managers in any market, but especially a volatile one, is to manage client expectations. On this point there was consensus.

“If you’re not managing their expectations,” said Lynn Mayabb, “that’s when you’re going to get negative calls” from unsatisfied clients. Mayabb stressed the importance of advising clients in advance on what to expect in a volatile marketplace.

As Steve Soden noted, clients can get agitated when their income levels do not reach their expectations. “You see them bump up against the need to either start invading principal or take risks that you know they shouldn’t take,” said Soden. “It comes back on all of us as advisers to do the right thing for the client.”

Bob Rippy sees the need to steer clients away from what may seem to them the most natural place to invest their money. He was referring to long bond funds, which he considers “the biggest risk right now to a lot of individual investors.” Many are unaware that rising interest rates could play havoc with these funds, as has happened in the past.

“You can’t create yield where yield doesn’t exist,” said Scott Boswell. “People have these income needs that aren’t necessarily being met by their portfolio.” He observed that over the past 20 years, whether a client invested in bonds, equities, gold, or just about any asset class, he ended up with an average 7 percent return. The paths there could be wildly divergent, but the end result was not.

Given the many investment options, and the flood of available data, said Dana Abraham, clients are “hungry for someone who can provide them with the information that they need to make decisions for themselves and their families.”

The Election’s Impact

“We’re calling the election a pivot point,” said Bill Greiner, assessing the November elections. He expects the results to produce more tactical decisions among investors than long-term strategic ones. They will adapt to either outcome. “It’s this period of time where the uncertainty is so high is where people are very, very anxious,” he noted.

Jon McGraw agreed. “There’s more noise now than ever,” he said of the many Internet and cable channels that have helped aggravate tension about the outcome of the election. “Once some of those areas can hush a little bit, then there’s a lot of money that has the potential to move from the sidelines.”

Many of John Woolway’s clients would prefer to refrain from making key investment decisions until after the election, but, as he tells them, the cost of just waiting and sitting on cash is enormous. “We always have uncertainty,” said Woolway, chief investment officer and president of Vantage Investment Partners. “If you wait and wait and wait, you’re going to be always sitting on the sidelines and then, the time you want to get in, the bus has already left the station.”

Ken Eaton, a principal with Stepp & Rothwell, explained that an adviser has to act as a sounding board for his or her clients. If they are fearful about the outcome of the election, there are always ways to mitigate that fear—for instance, buying put options on the S&P 500 for the next two months. There are, however, costs associated with any such move. “When they know what that cost is and they compare it to the possible benefit they have,” said Eaton, “then they can really decide whether they’re as fearful as they thought they were in the first place.”

To allay fears, Bob Rippy advises his Republican clients to recall the Clinton presidency and the tremendous run the stock market had during that period. He advises his Democrat clients to rem-ember how good it was under Reagan. “The reality is,” he said, “that the two greatest runs in the markets in most of our clients’ memory came under one Republican, one Democrat.”

Tommy Taylor, a Polsinelli Shughart estate planner, expressed skepticism that the election outcome would be meaningful without a veto-override-proof Congress, which seems unlikely. Bill Greiner disagreed. “I think this election, in my opinion, is very meaningful,” he said. “I’m concerned that the world’s capital markets aren’t going have patience for another four years of trillion-dollar deficits in the U.S.”

Bob Rippy compared the president to a drum major. He may not set the route of the parade, but he can determine its pace. One other thing that a new president can do, suggested Ken Eaton, is change the monetary policy by deciding who will succeed Ben Bernanke at the Fed.

For those of Lynn Mayabb’s clients in the medical profession, the response to the election may be quick and decisive. “If certain things happen in the election,” said Mayabb referring discreetly to the enactment of Obamacare, “they will stop practicing next year.” She was referring specifically to doctors, high-end specialists among them. “It is not, ‘I will think about it,’ ” said Mayabb. “It’s like, ‘I will be done.’”

Regulation

“My personal thought is that a Romney victory would be more bullish, given our client base,” said Steve Soden, “but corporate America is not hiring because of the intense regulation.” Soden expressed particular concern about the added regulation of the banking industry.

Scott Boswell singled out the Consumer Financial Protection Bureau as the most potentially problematic of new regulatory regimes. “They can take funding whenever they want,” said Boswell. “They have no control from Congress or an elective body. I think that is incredibly scary.”

Dana Abraham recommended a complete reversal of Dodd-Frank. Scott Boswell agreed: “The legislation is flawed, and that is the scariest part, because it’s completely uncontrolled right now. They can basically claw whatever they want from the Fed to pay for themselves. The banks will fund that.”

Boswell worried that this massive regulatory oversight had not been defined yet, but he was certain it would add cost to the system. Abraham noted that the added cost would inevitably result in the elimination of services to the customer.

Taxes

In the second part of the session, participants were asked to pose a relevant question to their colleagues. Steve Soden observed that the expiration of the Bush tax cuts would be tantamount to a tax increase. He argued that their expiration, combined with other elements of the “fiscal cliff,” would have a negative impact and wondered whether others saw as much of a problem as he did if taxes were allowed to increase.

“My concern,” said Lynn Mayabb referring to the potential increases in Social Security and payroll taxes, “is more for the normal person, how it’s going to impact their ability. They are already living paycheck to paycheck, and now they’re going to lose an additional 5 percent of their income.”

Bob Rippy expressed confidence that  members of Congress would be able to work out some sort of resolution: “We do remember that congressmen and senators want to be re-elected.” Said Tommy Taylor, “We need something permanent. Whatever they’re going to do, do something and make it permanent.”

Inflation

With inflation on the horizon, Jon McGraw wondered how fixed-income investors with money flowing on the bond side would be able to protect those dollars.

Bill Greiner argued that the Fed was willing to trade off some degree of inflationary pressure right now to benefit job growth and economic growth. “If we do see inflation moving to the upside,” said Greiner, “it is probably going to be accompanied by a move on the down side in the value of the dollar.” With that in mind, Greiner recommended maintaining some kind of position in the foreign fixed-income markets.

Ken Eaton recommended that those clients willing to take a little bit of risk might look at those funds that invest specifically in bonds with floating rates. “They won’t be whipsawed by interest rates if they have that kind of a bond,” said Eaton. “It’s not the only solution, but it’s one solution.”

Older Clients

To Darla Goodrich, director of net-work supervision for Northwestern Mutual Financial Network, it seems like a lot of the people in their 70s and older “are fairly terrified of what’s going on.” They are not making any money, she said, and they don’t have much in the way of interest coming in. And they are not comfortable taking risks in a volatile market. She questioned how her colleagues responded to clients in that position.

Jon McGraw recommended a well-balanced portfolio with some equity exposure, insurance options, variable bond annuities, fixed annuities, and the like. “That’s the approach we’ve taken,” said McGraw. “Let’s look at this as a distribution rate from all the assets, how are all the assets working together.”

Tommy Taylor referred to this class affectionately as “Depression-era babies.” “They don’t spend money,” he said. “It’s like Murphy’s 10th law—there’s no such thing as enough money.” They worry because money is not coming in as fast as it used to.

As Bob Rippy noted, this is a phenomenon that will become more pronounced. If a married couple is 65, odds are 50 percent that one of the two will live to age 92. “As the Baby Boomers get older, and health care becomes better and better, this is going to continue to be a larger problem.”

The Next Generation

John Woolway raised the question of transitioning wealth from Baby Boomers, the youngest of whom are nearly 50, to the generation that follows. One strategy that Stepp & Rothwell uses is to employ its own younger advisers when their clients want to impart financial advice to their kids. We have those younger advisers in the room,” said Ken Eaton, “and they do most of the speaking.” Added Eaton, “That makes them feel more comfortable and that brings them into the fold.”

Vantage Investment Partners also works to identify young business people in various markets with the potential to become to, high-income earners. “We want to be working with them early on,” said Woolway. “If you gain their trust and become their trusted adviser, everything else kind of falls into place.”

“One thing I’ve found,” said Bob Rippy, “is that the next generation is refreshingly candid about what they think awaits them. They don’t believe there will be any Social Security for them, or at a very, very reduced rate, and they’re planning for that not to be there.”

In a related vein, Mark Henke asked strategies to cover college tuition, and the return on that investment.

One option that is becoming less attractive, said Rippy, is the state college. These institutions have been shifting more of the cost to the families for a generation. “For the first time,” Rippy said, “college debt is greater than credit-card debt.”

Bill Greiner wondered whether “education costs are really in line with value created.” Today, young graduates must work much longer to repay the cost of their education than did the previous generation. As Lynn Mayabb observed, “Loans are still so easy to get that children don’t realize what they’re really paying.” According to Mayabb, the question of who pays and how much is one of the more contentious ones that arise in a family’s financial planning.

China

Ken Eaton called China “the elephant in the room” and wondered which direction it and other emerging markets seemed to be taking.

Bill Greiner described China’s evolution from a collectivist to more of a capitalist-controlled society. Compared to the United States, the driver in the Chinese economy’s growth has not been consumption, but investment spending and export growth rates. So when you look at China, said Greiner, you have to ask whether the high growth rate is sustainable. “Most economies can’t sustain that kind of growth rate in investment spending forever,” he noted.

A problem that China faces, Greiner continued, is that its biggest export market is Europe, and that market “is shrinking pretty hard right now.” He expects Europe’s overall GDP to contract almost 200 basis points next year. “So I’m concerned about China,” said Greiner. In a world starving for growth, “China is not going to show the growth in generally that we’ve seen for the last 5–10 years.”

Estate Taxes

Given the uncertainty in the gift tax exemption and the estate exemption, Scott Boswell asked his colleagues whether their clients were frozen in place or whether they were actively gifting.

“Pretty static,” said Tommy Taylor. “I don’t see a lot of activity at this point.” He believes that there will be more activity once the election cycle is complete, and people can weigh their options more knowledgeably. “You don’t want to do something that you’re going to regret,” said Taylor.

“We’ve done more charitable gifting of those with appreciated assets,” said Jon McGraw. “We’ve had the discussion with every single client that has that situation. They won’t deal with it. It is something that’s getting kicked down the road.”

“There’s a lot of conversations going on,” Darla Goodrich affirmed. “Clients aren’t actually pulling the trigger quite yet.”

Goodrich anticipates a busy post-election season. Everyone does. After four or five volatile years, politically and economically, investors are hoping for stability, for calm, for a respite. “The removal of uncertainty will be a positive, no matter what,” said Steve Soden.