Many financial advisors have long believed they bring a unique and tangible value to their clients. Now Morningstar Inc. has come up with an actual financial-planning factor that outlines the kinds of financial advice that can increase a client’s retirement income every year.

Traditionally, the value added from active management and the selection of individual securities (alpha) and investment decisions based on asset allocation (beta) have formed the basis of financial planning. Now David Blanchett, CFA, CFP and head of retirement research for Morningstar Investment Management in Chicago and Paul Kaplan, PhD, CFA and director of research at Morningstar Canada, have co-authored a report outlining their new gamma factor.

“Clients seek your services to achieve an outcome,” Blanchett told advisors attending the Morningstar conference in Toronto in early June. “They want to work with you because you can better help them accomplish their dreams.”

While there are literally dozens of financial planning strategies retirees can take, Blanchett and Kaplan concentrated on five specific plans to provide “intelligent” decision-making that Blanchett said can bring an additional return of 1.82 per cent a year to a retiree’s portfolio.

The five strategies include:
• determining asset allocation based on total wealth, including human capital (the ability to make a living) and an investor’s ability to assume risk – as opposed to risk preference
• finding a dynamic and safe withdrawal strategy that may vary year over year depending on factors such as market conditions rather than using the theory of a set annual withdrawal rate throughout retirement
• adding guaranteed income products into retirement such as annuities, being aware of the benefit, risk and cost of an annuity to help determine whether a particular annuity is right for the investor

  • increasing tax efficiency, such as withdrawing money from taxable accounts before removing funds from more tax-efficient accounts, and
  • utilizing “liability-relative optimization,” which looks at building portfolios that can better hedge against risks faced by retirees, including inflation.
According to the paper the two wrote called Alpha, Beta and now…gamma, the 1.82 per cent was achieved when compared to a scenario of a four per cent withdrawal rate and a 20 per cent equity allocation portfolio. The 1.82 per cent annual increase “represents a significant improvement in portfolio efficiency for a retiree. Unlike traditional alpha, which can be hard to predict, we find that gamma … can be achieved by anyone following an efficient financial planning strategy.”

At the conference, Blanchett also noted that each client is different in terms of how these gamma strategies work. But by using this gamma factor, he said, advisors will bring more value through sound financial planning decisions.
“What I am talking about in this presentation are things you can do to help someone better accomplish their goals,” said Blanchett. “And we all recognize that clients better accomplish a goal through good financial planning.”

Lower growth

Meanwhile, Canadian and U.S. economists weighed in at a different presentation at the conference, giving their views on the coming year as one of lower growth, what Nelli Oster, investment strategist for BlackRock Inc. who holds a PhD from Stanford, characterized as “the great idle.”

“The global economy is running faster than last year, but not by much,” Oster said. She said she believes there is still some upside for equity market returns this year, but they’re unlikely to repeat the speed of the increases from the first quarter of this year.

At the same time, dire predictions of the recent past failed to materialize: take the fears that the U.S. would go off the fiscal cliff, that the Chinese economy would be in the dumps and the Euro disaster would spread around the world.
Instead there were aggressive moves by some central banks to control their economies amid this period of “non-negative news,” said Douglas Porter, CFA and chief economist and managing director at BMO Capital Markets.

Porter is bullish on the United States in particular, expecting growth there to be pushed forward thanks to massive budget cuts stemming from fiscal tightening and sequestration cuts. “To me it’s astonishing that the U.S. economy has continued growing in the face of the deficit.”

He said he is watching and waiting to see what will happen in Japan, where aggressive actions have been taken recently to stimulate growth.

“I see it as a kind of mild success,” said Porter. “I think the market has got a little bit ahead of itself in Japan over the last six months and perhaps that is why it’s been pulling back over the past few weeks. This is very aggressive action by the bank of Japan. But I suspect that at the end of the day it will be a partial success. There may be a little bit of inflation. But monetary policy is not a panacea for all the problems that face Japan.”

Porter said he doesn’t see the Japanese economy miraculously turning a corner because of the aggressive actions by the Bank of Japan.

Oster is neutral on Japan. She characterized the Japanese economy as having three legs, including aggressive fiscal and monetary policies, but disappointing structural reforms, including liberalizing some markets such as agriculture. She said this last leg will have the biggest importance on the Japanese market.

On the opposite side of that fence was Wilfred Hahn, chairman of HAHN Investment Stewards & Co. Inc.
He said tighter monetary policies would not solve Japan’s problems, noting the country could go into a “death spiral.”

What Japan has done “sets up a dangerous precedent when you devalue your currency as they have – at one point almost 40 per cent against the Euro,” said Hahn, adding Japan needs to have some policy alternatives.

As for Canada, even though Ottawa has tightened mortgage measures four times in four years, Porter said he believes prices are still up in most of the country. While Canadian housing prices are not out of line, he said the performance over the past 10 years cannot be repeated.

And while Hahn agreed with Porter that there will not be a housing bubble for a number of years, Oster said she remains bearish on Canada as a whole because of the huge debt loads individual Canadians continue to shoulder.

Hahn said his biggest concern is the need for retirees to have more core money for a reasonable lifestyle. While the consumer price index is low, he said it takes more in savings and capital today to afford the same retirement lifestyle as it did 10 years ago when interest rates were higher.

“How are we going to get real returns over the next 10 years? Will they be good enough to increase the principal needed to fund a reasonable retirement lifestyle?”

As far as Oster was concerned, it was disappointing growth globally that gave her the most pause.

Porter added that he is worried that governments around the world have done all they can to keep rates down and business moving.

“My biggest concern is that we have basically got the monetary engine with a foot to the absolute floor and there’s no further room for monetary policy or fiscal policy to really help the global economy.”