Reuters Money

Investors prepare for more volatility in 2012

Whether or not Europe resolves its banking crisis, the United States its deficit or China its cooling economy, U.S. investors should be prepared for more volatility in 2012.

This year’s roller coaster sent billions of dollars to the sidelines but also rewarded many investors who stuck with bonds and dividend-producing funds. These are some of the key issues fund managers, such as Dan Fuss of Loomis Sayles and David Giroux of T. Rowe Price (TROW.O), will examine during the 2012 Reuters’ Global Investment Summit Outlook taking place next week in New York, London and Hong Kong.

THE BIG PICTURE

The U.S. fund business saw net outflows of $62.9 billion through November 30, according to Lipper, a Thomson Reuters unit that tracks mutual fund data. While equity funds were down by almost $21 billion, taxable fixed-income funds took in almost $167 billion, says Tom Roseen, a senior analyst at Lipper.

“There was a tale of two cities in the equity universe,” Roseen says. “Open-end funds witnessed outflows of $51.35 billion, while their ETF counterparts saw net inflows of almost $30.5 billion.” Why? ETFs appeal to investors — especially institutional investors — because unlike mutual funds, they can be traded all day. “They could be in and out in a matter of moments,” he says.

Cost and availability also make ETFs appealing, especially to institutional and large investors, says Fran Kinniry, a principal in Vanguard’s Investment Strategy Group.

EQUITY WINNERS

from Felix Salmon:

How volatility hits pension plans

Nanea Kalani of Honolulu Civil Beat has obtained non-public performance numbers for the Hawaii Employees' Retirement System, and they're not pretty at all: in the three months to September 30, the fund managed to lose $1.4 billion, or 11.2% of its value.

What we're seeing here is the brutal effect of volatility on portfolio performance. Let's say you start with $1,000. If your portfolio falls by 5% and then rises by 5% -- or, for that matter, if it rises by 5% and then falls by 5% -- you end up with $997.50 -- just a quarter of a percentage point away from where you started. But if it falls and rises (or rises and falls) by 20%, then you end up with just $960, down 4% on your initial investment.

There's two different lessons to be drawn from the way that Hawaii is investing its money. Firstly, going for active rather than passive investment doesn't work very well. The policy benchmark -- what the fund would have returned if it was passively invested rather than actively managed -- has consistently outperformed actual performance. And

Secondly, Hawaii hasn't chosen its managers very well: it's also consistently underperforming the median public pension fund. If you're relatively small (about $10 billion, in this case), it's hard to outperform. As the Pension Consulting Alliance note puts it, "Relative underperformance can largely be attributed to the Plan's equity (domestic and international) managers' combined performance trailing their respective benchmarks".

But there's a deeper problem here, I think -- and that's related to the fact that the fund is being asked to return an "assumed actuarial rate" of return of 8% per year -- in an environment of high volatility and extremely low interest rates. The right thing to do is to say "sorry, I can't do that" -- but that's a great way to get fired. So instead, fund managers move further and further out the risk curve, in an attempt to hit their target returns. With predictable consequences.

Sometimes, the strategy works. In fact, the strategy is always going to work some of the time. The note proudly says that "the Plan outperformed the policy benchmark and the Median Plan in three of the last five 12-month periods". But this is the problem with volatility: if you overshoot on the way up and you overshoot on the way down, you end up underperforming overall.

One man’s retirement crusade to help Detroit and baby boomers

Randal Charlton has had a long, colorful career with plenty of ups and downs. In his 71 years, he’s done everything from tending dairy cows for a Saudi sheik to starting a jazz club in Florida. And as a lifelong entrepreneur, he has bought and sold 14 different companies.

Charlton’s last venture was a Detroit-based biotech company called Asterand, which he co-founded and then merged in 2006 with a U.K.-based competitor. He was 67 years old after the deal closed – a time when many would hang up their spikes and take it easy.

Instead, Charlton took on a daunting new challenge: fighting Motor City’s economic blight by building a successful business incubator for entrepreneurs called TechTown. Charlton raised $24 million from foundations and government, gathered together an impressive array of resources for training and start-up funding and recruited a small army of start-ups that have created a total of more than 1,800 local jobs.

TechTown is located in an old five-floor automotive plant with 130,000 square feet. When Charlton took over, just one floor was built out, and the center was running on loans guaranteed by nearby Wayne State University. Since then, the incubator has been home to 250 companies, and more than 2,200 entrepreneurs have graduated from its training programs. Last year, 14 TechTown companies received capital infusions totaling more than $1.35 million. The incubator has invested $700,000 directly in early-stage businesses and helped clients raise $14 million in follow-on funding.

Charlton’s work has just been recognized with a 2011 Purpose Prize, announced today. The award, given annually by the Encore Careers campaign, recognizes older career trailblazers who have demonstrated creative and effective work tackling social problems. Now in its sixth year, the prize was created to promote and encourage civic engagement among baby boomers. It’s a program of Civic Ventures, a nonprofit that works to engage boomers in encore careers combining personal meaning, income and social impact.

Each prize winner receives $100,000. The other winners this year include a San Francisco-area screenwriter who adopted two daughters from China in her fifties, then found a way to partner with the Chinese government in efforts to transform the care of 800,000 orphans there; an Oregon woman who produces and distributes low-cost, safe, fuel-efficient cookstoves in Latin America; and a Santa Fe, New Mexico architect working to improve energy efficiency and reduce emissions in buildings.

A native of England, Charlton started his career after college as an agriculture journalist, and then worked for an agricultural export company. His work has taken him to 40 countries and many adventures, including living for weeks in a Saudi Arabian desert nursing a sheik’s herd of cows back to health. Later he acted as a consultant for cattle breeding associations and for the European Development Fund, and as an executive for several global biotechnology companies.

from Felix Salmon:

Why the big banks aren’t sweating Bank Transfer Day

It's Bank Transfer Day on Saturday, and some unknown number of people are going to transfer their money from their too-big-to-fail bank to a friendly local community bank or credit union. Good for them! Unfortunately, Bank Transfer Day is happening the week that MF Global declared bankruptcy, with the possible loss of some $700 million in client funds. And the net effect of the two is almost certainly going to be money flowing in to TBTF banks, rather than out of them.

Matt Levine has a fantastic post today explaining why it doesn't make sense to be the customer of a small-enough-to-fail institution. This doesn't apply to small depositors at retail banks, of course, who are federally insured. But for institutional clients, whose funds are uninsured, the moral-hazard trade here is clear:

If you were trading commodity futures in the last few years, a lot of things could have gone wrong. Like, your commodities could have moved against you. One thing that you were probably less focused on was that your CME member, CFTC regulated, SIPC insured futures broker would not only file for bankruptcy but also maybe forget where it put your money. In the future, you’ll be focused on it...

The main fallout will probably be that if you have the choice to work with a too-big-to-fail bank or a just-small-enough to fail bank, on a whole variety of things, you’re going to go too-big-to-fail. Sure, there are lots of small brokers who are well capitalized and take the time to get the little things right, like segregating customer accounts. But how can you know unless you do a lot of diligence? Easier to just trust that a megabank squarely in the regulators’ sights will get it right – or, if they get it wrong, won’t be allowed to blow up in a way that blows up customers.

This is one reason why the big banks are blithely unconcerned about people withdrawing their funds on Saturday. (Which in reality won't actually happen overnight: first you open up a new account at a credit union, then you move some of your funds over, while leaving the old bank account open, then you start changing your direct-deposit and direct-debit instructions, and eventually, after a month or two, you feel safe closing down the old account.)

And the big banks don't particularly want all those retail-deposit funds -- they're getting precious little interest on them, and they come with all manner of expensive obligations to mail out statements and provide smiling service at teller windows and generally do the whole customer-service thing, which as we all know big banks are very bad at. Historically, they've done what they have to do on that front because they've been able to extract all manner of overdraft fees and interchange fees and the like, but that fee income is shrinking now, thanks to Dodd-Frank, and the fact is that millions of small bank accounts are actually unprofitable now for the big banks, and those banks won't shed many tears if those customers go off to a credit union instead.

Meanwhile, the big-fish customers -- large corporations, and municipal governments, and the like -- are moving their millions to the TBTF banks, using a kind of "no one ever got fired for buying IBM" logic.

So while I think it's great that people are moving to smaller banks and credit unions, I'm not kidding myself that doing so is going to harm the big banks at all. In fact, it might even help them, at the margin.

Zap zombie funds within your portfolio

Do you have zombie index funds within your portfolio?

Instead of eating up your brains, they devour your nest egg with high expenses and walking dead performance. They may be lurking within your 401(k)-type plan or individual retirement account.

I like index funds because they generally can track nearly any kind of asset class. As such, they are the white bread of investing and should cost about the same from fund to fund. The cheaper the better. Why pay Nieman-Marcus prices for the same thing you can get at Costco or Sam’s Club for less?

You can vanquish these funds without overtly violent acts, but first you have to identify them. Unfortunately, mandated fee disclosure is still pending, so you have to take the initiative.

So how do you identify a zombie fund? First you need a reliable benchmark for comparison purposes. The easiest way is to look at the index that the fund is supposed to be tracking. A good proxy for the U.S. bond market, for example, is the Barclays Capital Aggregate Bond Index. It’s a basket of listed bonds. If a fund tracks the index return within 0.20 percentage points or less, then that’s pretty good and not expensive.

A low-cost bond index fund would look like the Fidelity Spartan Intermediate Term Bond Index investor class fund, with a 0.20 percent expense ratio. You’d need at least $10,000 to get into this fund, though.

You want to pay a manager more to get less return on bonds? The ING US Bond Index portfolio charges a hefty 0.95 percent annually, meaning it will lag the index by nearly a full percentage point every year.

Jobless rate for older workers is lower, not better

Rick Lopatin has been looking for work for three years. The 56-year-old is the former chief financial officer of a middle-market pharmaceutical company in the Chicago area; ever since a merger and his subsequent job loss in 2008, he’s been job-hunting and networking intensively, and he’s landed  several interim CFO engagements – including one at a medical devices company on Long Island.

That company offered to make the job permanent, but Lopatin turned it down. He figured the position might have lasted just a few years, and it would have required relocating from the Chicago suburbs, where Lopatin’s wife has a secure managerial position at one of Chicago’s largest hospital systems — a job she’s held for 15 years. “We just couldn’t afford to put that income at risk,” Lopatin explains.

Lopatin’s experience helps illustrate the sharp contrasts in national unemployment data between older and younger workers. The unemployment rate for workers over age 55 is much lower than for the workforce as a whole – it stood at 6.7 percent in September, compared with the 9.1 percent national rate. But at the same time, workers over age 55 who do lose their jobs tend to be jobless far longer – 54.8 weeks, compared with 38.6 weeks for younger workers as of last week.

Reduced mobility helps explain the longer job search time, says Sara E. Rix, an expert on workforce and employment issues at the AARP Public Policy Institute. “Older workers may be ready and willing to move, but they’re not able to do it due to a spouse with a well-established career,” she says. Age discrimination plays a role, too – and Rix thinks some older workers  struggle to acclimate to job hunting when they’ve out of the market for a long time. “At least initially after a job loss, there’s evidence that workers who do get offers tend to hold out for something better. As the jobless period gets longer, they’re willing to accept less than at the beginning.”

What’s more, the lower 55+ jobless rate doesn’t really mean older workers are having an easier time finding new jobs, Rix says. Rather, she thinks it reflects a trend among employers to hang on longer to more experienced workers. The lower jobless rate also reflects a greater tendency of older workers to become discouraged about finding new jobs, and drop out of the labor force entirely. The Bureau of Labor Statistics doesn’t count workers who have stopped looking for jobs in its unemployment calculations, and that brings down the overall 55+ jobless rate.

But don’t mistake discouragement for lack of interest in a job. Rix notes that there’s been a steady rise in labor force participation by older workers – in fact, the number of employed workers over age 55 is up 11 percent since December 2007.

Medicare Part B premium hike will be smaller than expected

Seniors caught a break Thursday when the Obama Administration announced that Medicare Part B premiums won’t rise as much as expected in 2012.

The premium for Part B – which funds doctor and other outpatient services – will be $99.90 in 2012, up just 3 percent compared with this year. And the Medicare Part B deductible will be $140, a decrease of $22 from 2011.

The official government 2012 Part B premium forecast had been $106.60 – an increase that would have taken a significant bite out of Social Security’s cost-of-living adjustment (COLA). Although Social Security beneficiaries will receive a 3.6 percent raise next year, the average beneficiary’s increase would have been shaved to 2.95 percent if the larger Part B increase had been implemented. Part B premiums are deducted from most seniors’ Social Security benefits.

Today’s news means that seniors receiving the average monthly Social Security benefit ($1,177) will see a net 3.3 percent gain in payments – just under $39 per month.

In 2010, the Part B premium jumped to $110.50 from $96.40, and it rose to $115.40 in 2011. The rate is determined partly by healthcare inflation — but also the number of seniors who actually are subject to higher premiums. By law, the premium cannot rise in any given year by a greater amount than the Social Security COLA – a “hold harmless” provision aimed at preventing Social Security payments from ever falling. About 75 percent of beneficiaries were exempted in this way from Part B premium increases in 2010 and 2011 – years in which no Social Security COLA was made.

Medicare enrollees cover 25 percent of projected Part B program costs; in 2010 and 2011, that projected cost was borne by a much more narrow base of beneficiaries. This year’s Social Security COLA means that beneficiaries’ portion of Part B cost will be spread across a much broader pool of seniors, resulting in the more modest premium hike.

The new premium will mean a decrease for seniors who enrolled in Medicare for the first time this year, and have been paying the $115.40 rate. It should also lead to decreases for high-income seniors, who were subject to the higher base premium, along with additional income-related surcharges.

Tax deductions are popular, but penalties may work better

When making tax policy, there’s a choice between carrots or sticks: Does the government give taxpayers credits or deductions for doing the right thing (buying their homes, giving money to charity, not emitting greenhouse cases) or penalize them for doing the wrong thing?

Brian Galle, who is on leave as an assistant professor at Boston College Law School and currently a fellow at the Urban Institute in Washington, DC, has been analyzing those choices, and come to a surprising conclusion: Expenditures may be politically expedient, but penalties would often be preferable for fiscal policy.

In his forthcoming paper in the Stanford Law Review, called “The Tragedy of the Carrots,” Galle argues that carrots are overproduced and often misguided, costing the Treasury funds that would be better spent elsewhere in an effort to nudge people towards the behavior it hopes to reward.

“The problem with tax expenditures is not that they are in the tax code, but that they are expenditures,” Galle explains in a recent telephone interview.

As Washington debates tax policy and budget cuts, Galle’s ideas are particularly relevant. Tax expenditures — those credits and deductions that favor some taxpayers over others — have grown dramatically over the years, and their cost to the Treasury is over $1 trillion dollars.

Last year, when the national deficit commission, co-chaired by Alan Simpson and Erskine Bowles, released its bold tax proposals, one of them called for eliminating all the expenditures and lowering marginal tax rates to 8 percent, 14 percent and 23 percent. The commission’s ideas went nowhere, and today the congressional supercommittee is hashing out its plan for budget cuts and tax reform.

Galle’s theory goes one step further in thinking about rewards versus penalties. Economists consider carrots and sticks pretty much indistinguishable. There’s not much difference, as Galle points out, between taxing someone a dollar for each cigarette smoked, versus giving someone a dollar for each cigarette thrown in the trash. Either way, smoking is penalized, and the cost to you (whether explicitly in the tax or implicitly in the foregone reward) is one buck.

from David Cay Johnston:

Underpaid women and their men

New data on U.S. incomes, poverty, pensions and philanthropy all show a common economic reality -- women are still getting shortchanged. Do men care?

Men's median total income in 2010 was $1.54 for each dollar women received, my analysis of new U.S. Census data shows. The median -- half make more, half less -- was $32,137 a year for men, $20,831 for women.

Ignoring investment and other income, at the median men were paid $1.29 to the dollar earned by women in 2010. Men made $47,715 a year, women $36,931, a difference of $207 per week.

Among nonprofit executives and managers, men make much more than women in the same occupations.

Women run a majority of organizations with budgets under $1 million, but as budgets grow the ranks of women shrink. At nonprofits with budgets of $50 million or more, only one in six is run by a woman and as a group those women are paid 25 percentage points less than men, according to the 11th annual nonprofit pay study by Guidestar, a project I long ago urged on its founder.

All of which raises a question: Why do men, especially married men, put up with this? Why aren't men in the vanguard of demanding equal pay for women?

It is unfair to the women they love. Viewed in purely selfish terms, pay discrimination limits a family's resources. And what about fringe benefits? Many couples lose the value of a second health or other benefit plan because plans designed in a one-income era are often incompatible with one another.

With few female angel investors, signs of change

In the traditionally male world of angel investing, Ed Reitler is used to having his voice heard. A partner in Reitler Kailas & Rosenblatt LLC of New York City, he’s also the founder of the ARC Angel Fund, a New York-based investing launched in 2010. So when he says that it’s “incredibly important” to develop female angel investors because “they are crucial to ensuring the funding of a more diverse group of companies,” you’d hope his male counterparts would take notice.

After all, Reitler’s got a point. A 2006 report by the Ewing Marion Kauffman Foundation on women and angel investing concluded that “women entrepreneurs gravitate to women angels,” and that those benefactors “look at more women’s start-up businesses than some of the more traditional [male] groups do.”

That also explains why Reiter serves as a male mentor to the Pipeline Fellowship, a group that trains women to become angel investors through education, mentoring and practice. Its young founder and CEO, Natalia Oberti Noguera, is a lady on a mission: to change the lopsided ratio of male-to-female angel investors, and get female angels involved in finding and supporting female entrepreneurs.

In a new report from the Center for Venture Research at the University of New Hampshire, author Jeffrey Sohl outlines how women represent just 12 percent of all angel investors, and women-owned ventures account for 12 percent of entrepreneurs seeking angel capital. Of these ventures, about one in four received angel investment during the first two quarters on 2011.

Low as those numbers look, they were actually higher in 2010, when 13 percent of angels were female, and women-owned ventures accounted for 21 percent of entrepreneurs seeking angel capital.

Less than two weeks after the Center for Venture Research released its findings, Oberti Noguera hosted an event in New York City on Oct. 20 to announce that Pipeline’s 2011 fellows would invest $50,000 in PhilanTech. Based in Washington, D.C., the company produces an online grants management system for foundations, nonprofits and corporations.

Combined with another $55,000 from the Pipeline Angels alumni network, that means $105,000 in fresh capital for a company that had struggled to gain investment traction — even though PhilanTech’s founder, Dahna Goldstein, was lauded by Bloomberg Businessweek as one of 2009’s most promising social entrepreneurs.