Speaking at an AARP event in late February, President Obama proposed tougher standards for brokers and other financial “advisors” who oversee retirement accounts such as IRAs and 401ks. Specifically, the White House wants brokers–whose investment recommendations are currently subject to a suitability standard–to instead be held to a more rigorous fiduciary standard. The president’s choice of audience was deliberate: Americans currently have an estimated $7 trillion in IRA accounts, and that number is expected to grow rapidly in the coming years as new retirees “roll over” assets from their company-sponsored retirement plans.
We’ve alluded to the suitability/fiduciary distinction in past commentaries, but the concept is still a bit fuzzy to most investors, and warrants repeating. In a nutshell, the suitability standard requires only that a recommended investment be “suitable” for a client’s specific circumstances, based on age, risk tolerance, etc. This is a fairly broad standard which allows for potential for conflicts of interest. For example, a broker might recommend a mutual fund which is technically consistent with the client’s investment objectives (i.e. “suitable”), but unbeknownst to the client, also carries a much higher commission than similar funds (often because a portion of the commission is rebated to the broker by the fund company, as a sales incentive). . Hence, the broker’s ability to provide the best investment advice may be compromised by his own pecuniary interest in the client purchasing fund A rather than fund B.
Another area ripe for abuse is variable annuities, a type of investment product underwritten by insurance companies. Insurers typically pay a handsome commission to the selling broker, which is subsidized by multiple layers of expenses and fees (even early withdrawal penalties) on the annuity itself. Since these commissions are not disclosed, there is no way for the client to know whether or to what extent the broker’s recommendation is swayed by self-interest.
In contrast, the fiduciary standard requires that an advisor place the client’s interest ahead of his own. Quite literally, the term “fiduciary” implies a relationship of trust. It is a more stringent level of accountability, designed to head off situations where advisors benefit at the expense of their clients. As a Registered Investment Advisor (RIA), Bristlecone is regulated under the Advisors Act of 1940, which requires adherence to the fiduciary standard. Bristlecone is a fee-only advisor, and we receive no sales commissions or other hidden compensation from trading or recommending a particular investment. Moreover, we are proponents of “eating our own cooking,” which is to say that the vast majority of our personal and family assets are invested in the same securities which we recommend for our clients. Finally, Bristlecone employees are subject to a strict pre-approval process for personal trades, ensuring that we do not take positions contrary to our clients, or attempt to trade ahead of them in any way.
The ECB Goes Q.E.
While the Federal Reserve remains cagey about when it expects to raise interest rates in 2015, the currency markets have already placed their bets, bidding up the U.S. dollar vs. other major currencies. The Euro in particular has weakened, as sluggish economic growth and mandated austerity measures have threatened to tip the Euro zone into deflation, prompting the European Central Bank (ECB) to institute aggressive monetary easing of the sort which the U.S. Fed utilized for several years, coming out of the Great Recession. The mechanism for this is that the ECB creates euros and uses them to buys bonds of Euro zone member nations. The combination of increased demand for these bonds, along with reduced supply (less issuance due to fiscal austerity measures) creates a supply-demand imbalance. The end result is that in a handful of European countries, government bonds (and even a few high quality corporate issues) have been bid up in price to a point where their expected yield to maturity is negative.
Who benefits from the ECB’s quantitative easing? Corporate borrowers, for one; since corporate bonds typically trade at a spread to government debt, lower sovereign rates have dragged down corporate borrowing costs in Europe, particularly for large multinational firms. Even U.S. corporations have gotten in on the act. Last November, Apple issued euro-denominated debt for the first time in the company’s history, raising 2.8 billion euros. Just two weeks ago, Berkshire Hathaway followed suit, issuing 3 billion euros of debt at maturities between 8 and 20 years, with interest rates ranging from 0.80% to 1.65%. Cheap debt also fuels merger & acquisition activity, as U.S. companies can exploit a strong home currency to acquire European rivals. Finally, the ~22% decline in the euro against the dollar over the past year is also great news for American tourists. With the current exchange rate at a 14 year low, now is a great time to consider that European vacation!
From a competitive standpoint, European exporters benefit from a weaker euro, as their products become relatively cheaper for American consumers. On the other hand, a strong dollar creates a difficult headwind for U.S. manufacturers and other net exporters, as their goods and services become less competitive overseas. Additionally, for U.S. multinationals that derive a significant percentage of their revenues from outside the U.S., translated earnings from foreign subsidiaries are worth less, when reported in U.S. dollar terms. As we’ve mentioned before, currency fluctuations tend to be self-correcting when they hit extremes. We don’t expect a strong dollar to substantially impact our investment process, but in the near term it will certainly be a disadvantage to some of our holdings, while benefiting others.