Advisors who are planning for the rest of 2005 face changes that could derail even the best-made investor plans. Calm waters in both equity and fixed-income markets could face hurricane gales in the face of terrorist attacks, a continued low-return environment and implosions in overvalued sectors. As future projections call for more of the same, advisors stay wary.
Equities and bonds have done reasonably well this year, and few expect that to change. The economy should stay stable, equity markets end up about the same as last year, and we'll live with the flat yield curve for the near future.
"We're optimistic about the equity and fixed-income markets," said Carl Kunhardt, CFP, of Quest Capital Management, in Dallas. "There's nothing on the horizon that will change that."
Equities and bonds both have reasons for optimism. Businesses will need to allocate their cash hoards to either dividends or capital reinvestment, providing a cushion for equity prices. And Federal Reserve Chairman Alan Greenspan's impending retirement telegraphs a stable interest rate environment. "The chairman likely wants to leave a legacy of an economy in recovery, not one who put the brakes on growth," said Kunhardt.
But possible storm clouds keep advisors from feeling complacent about the remaining months of this year. Recent terrorist attacks unnerved clients, and advisors responded to help increase their comfort levels. At Quest Capital, planners are paying close attention to exit strategies. They've gone client by client and reassessed risk tolerance, sometimes down to the level of individual equity holdings. If the exit strategy changes and pulls clients out earlier than expected, Quest planners then show what impact that would have on the client's overall plan. "We've got no control over future terrorist attacks, and clients want to discuss it," said Kunhardt.
At high-profile financial planner Evensky & Katz, advisors have been defensive for a while. They've laddered bond portfolios and shortened durations to hedge against possible rising interest rates. Planners moved significant allocations to foreign bonds to hedge potential volatility in the domestic interest rate environment.
"A series of major terrorist attacks, especially those with economic implications, would upset markets," said Harold R. Evensky, CFP and principal of the Coral Gables, Fla.-based firm. "A dirty bomb in an oil-producing region could have far worse implications for investors."
Evensky also listed his concerns about China's move to unpeg the yuan from the dollar, and repeg it to a basket of currencies. "If China's currency policy affects their holdings of U.S. bonds, then interest rates could move up rapidly."
Even in a moderating market, some asset classes seem vulnerable. Advisors caution investors about direct real estate investing, for fear the bubble will burst. Real estate investment trusts could be vulnerable for another reason. "Reports of so many managers allocating money to REITs mean there could be too much money chasing too few goods," said Cliff Oberlin, CPA/PFS, CFP, of Oberlin Financial Corp., in Bryan, Ohio. "Lots of investors are practicing rear-view-mirror investing there as well, because the returns have been good."
Oberlin's firm is also concerned about the potential for market-cratering events caused by hedge funds. "So many hedge funds have been created," he said, "and no one knows what sort of risks they might be taking."
The increased universe of hedge funds also means that more money is chasing the same strategies. That puts pressure on spreads, potentially lowering returns and prompting some funds to take even greater risks. "There's the perception that hedge funds are now taking ever greater risks to deliver high returns," said Evensky. "There's a very small probability of a very big disruption in those markets as a result."
Changes in the regulatory and legal environment affect planners as well. Congress is currently debating refinements to the estate tax that would affect the structure of every estate plan. Evensky predicts a $3-million-to-$5-million-per-person lifetime exemption. "Clients would need to take a look at all irrevocable life insurance trusts or other trusts for estate tax purposes, to see if they still make sense," he said.
Higher exemptions might lead lawmakers to do away with the provision of stepped-up basis at death.
If that happens, some clients' plans would need to change. "One 80-year-old client is hanging on to securities purchased over a half-century ago," said Kunhardt. "There's no way of even finding the cost basis of those. There will be lots of estate planning changes if the stepped-up basis goes away."
Expectations for the new chair at the Securities and Exchange Commission lead Washington watchers to conclude that the flood of advisor regulations may be slowing. But firm owners must still work through the steps necessary to comply with existing laws. Advisors are still working through how to maintain e-mails and what constitutes an effective compliance structure. Oberlin's firm recently went through a mock audit to make sure that they had addressed the new requirements. "No matter how much we know, each year there's more and more," he said.
Advisors point to possible changes in the use of insurance. Oberlin highlighted the need to watch allocations in variable annuities or whole life.
The low-return environment might also support increased use of immediate annuities. Retirees with lump sum distributions might allocate some to an immediate annuity out of the fear of not having enough to live on. "This changes how we plan, plus also lowers fees for advisors as those assets are no longer under management," Evensky said.
The new disclosure requirements for brokers known as the "Merrill Rule" could impact the marketing strategies of fee- based advisors. Starting on July 22, brokers must announce in bold letters that "brokerage accounts are not advisory accounts" and that "the firm's interests may not always be aligned with the client's."
"A large percent of wirehouse producers might move over to the registered investment advisor," said Evensky.
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