Investing January 25, 2016

Affluent Investors, Institutions Eye Active Funds

Institutional investors and more affluent individuals aren’t pulling out of markets amid increased volatility—opting instead to reassess risk and seek out more strategic approaches.

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“Volatility Doesn’t Shake Investor Optimism for 2016,” a survey published by AMG Funds of investors with over $250,000 in household investable assets, shows most active-mutual fund owners (90%) plan to maintain or increase their allocations to active funds this year.  

According to AMG Funds Chief Marketing Officer Bill Finnegan, this segment of affluent investors also widely anticipates an ongoing rise in interest rates and “moderate to high volatility,” amid modestly increasing inflation. Importantly, Finnegan notes, the survey sample represents a different segment of investors than a general survey with no wealth limit or investing style filter. Given their larger pools of resources and stated interest in active funds, it’s fair to say these are more engaged investors than the norm in many workplace retirement plans.

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Even so, Finnegan says it is encouraging to see this group’s willingness to stay invested and even increase investment amid significant market volatility—understanding there are real opportunities and pockets of fundamental strength amid the global turbulence. In this way, individual affluent investors are looking more like their large-scale institutional counterparts, for example pension plans or endowments. Even with major market swings occurring nearly weekly since Q3 2015, these highly sophisticated investors are not widely turning off risk.

In fact, according to new data published by BlackRock compiling the investment outlooks of 170 of the firm’s largest clients ($6.6 trillion in combined assets), large institutional investors “expect to embrace active management in 2016 to combat macro-economic trends, anticipated market volatility and divergent monetary policy.” The data further shows institutions increasingly embracing illiquid assets, including private credit and real assets, as a way to meet their long-dated liabilities.

Mark McCombe, senior managing director and global head of BlackRock’s institutional client business, explains investors are “attempting to look past the current market environment and find alpha generating opportunities that match their liabilities.” Individuals may only have limited access to investment strategies in private credit and real assets—depending on their own wealth level and pathways of investing—but the ripple effect from recent price swings is causing all sorts of investors to “more actively manage risk and seek alternative sources of returns,” BlackRock finds.

NEXT: How allocations are changing

Amid the recent volatility, the sector that has seen the largest increase in investor interest has been long-dated illiquid strategies, led by private credit strategies, with more than half of institutional investors indicating an increased allocation, “closely followed by real assets (53% increase / 4% decrease / +49% net), real estate (47% increase / 9% decrease / +38% net), and private equity (39% increase / 9% decrease / +30% net).”

Taken all together, clients are “clearly expressing demand for the return premium offered by illiquid assets,” BlackRock finds. Specific to U.S. and Canadian institutions, the shift toward illiquid assets is occurring as institutions slightly reduce their allocations in equities. 

Despite the muted returns in 2015, allocations to hedge funds remain fairly steady globally, BlackRock finds. When asked how they plan to manage their modestly scaled-back equity exposures, BlackRock’s data shows 25% of respondents plan on increasing their allocations to active managers, compared to 16% looking to increase index-based allocations. Within fixed income, institutions are anticipating modest reductions, “with the majority of that ... coming from their core allocations.”

Plugging for AMG Fund’s own active investment products, Finnegan predicts 2016 will provide a complex environment for both institutions and individuals, in which the more strategic/contrarian nature of high quality active mutual strategies “has more room for advantage over indexers.” Specifically, active strategies that focus on limiting the potential of large losses on the downside should be popular among both individuals and institutions—even at the expense of a few percentage points of potential return when markets are up.

NEXT: Who volatility really hurts

“There is a lot of evidence showing long-term investors will do better in this type of product over time, one that limits shocks to the downside, even though they may miss out on the top of the upside,” Finnegan explains. “Dalbar, for example, has data that shows this over a 30 year period—it is freakishly consistent that the investment always does better than the investor. This is because people, over this long of a time period, cannot help but to get really scared by volatility and pull out of their investments at least once at the wrong time, for the wrong reason, and with no rational plan to get back in.”

Finnegan likes to summarize the point this way: “Volatility generally does not hurt the investment, but it can hurt the investor.” The AMG survey data supports this, he notes, as a solid majority (58%) of affluent investors say large swings in the stock market “make them very uncomfortable.” The problem is not necessarily the discomfort, Finnegan notes. It’s when discomfort translates to ill-timed trading actions.

“Pulling out of funds prematurely is even more detrimental for investors that have already taken the step of going active to limit volatility,” Finnegan warns. “When an investor reacts to volatility and actively trades in and out of active products, this is essentially attempting to actively manage an active manager.” It’s not a winning proposition from the fee and portfolio efficiency perspective, not to mention the problems with attempting to time the markets.

Reading further into the data, Finnegan says the firm “always finds that wealth preservation is a top goal for clients across age cohorts and wealth segments. My message here is that, if you want to preserve wealth, there are definitely strategies out there that can reduce the amount of volatility you’re exposed to.” Investors have to find the strategies that fit, and they have to stick with them.

“It doesn’t help that a lot of investors, according to our surveys, still have faulty beliefs about their portfolios,” Finnegan concludes. “For example, in our last survey it is apparent that nearly half of investors think simply owning a lot of different stocks will guarantee you have a diversified portfolio. Sophisticated investors know you can limit the downside a whole lot just by investing in a truly diversified portfolio that takes asset classes and correlations into consideration.”

Administration January 25, 2016

ACA Deadline Extensions Prompt Regrouping

How should health plan sponsors adjust their strategies with new ACA reporting and Cadillac tax deadline extensions?
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The due date for the 2015 Employer-Provided Health Insurance Offer and Coverage reporting under the Patient Protection and Affordable Care Act (ACA) to employees and the Internal Revenue Service (IRS) has been extended.

In addition, year-end legislation provided for a two-year delay of the implementation of the 40% excise tax on high-cost health plans (also called the Cadillac tax), making it effective in 2020 rather than 2018. The measure would also make the tax deductible for employers, further reducing their cost burden.

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Joe Kra, leader of the health care consulting practice of Mercer in New York City, says the extension of ACA reporting was welcomed by many employers, “but I’ve actually been surprised by how many of our clients already have a process in place to meet the prior deadline. There are a fair number, anecdotally, that are not going to use the extension.”

Kra says there are two fundamental parts to ACA reporting: getting data in order and actually producing reporting for employees and the IRS. If employers aren’t well on their way, it should be a top priority.

According to Kra, Mercer has seen that with the complexity involved, employers feel it is easier to have a third party do it. “Many of [third-party providers] are tapped out, but some may still take on new business,” he says.

NEXT: Taking time to review

For the ACA reporting, plan sponsors need to track monthly data in 2015, determining who is a full-time employee, what coverage was provided to full-time employees, was it affordable and did it meet minimum value standards, Kra notes. If an employer offers a self-insured plan, it needs to identify who was actually enrolled, but for fully insured plans, the insurance provider does that.

Scott Austin, an employee benefits attorney and head of the health care reform initiative at Hunton & Williams in the Atlanta and Dallas offices, and Mike Trabold, director of compliance at Paychex in Rochester, New York, see plan sponsors using this deadline extension to make sure data is accurate, complete and comprehensive.

Austin says, among his clients, he can’t think of one employer trying to do ACA reporting in house; they have hired third-party vendors to manage, oversee and produce reports for individuals and the IRS. “My sense is they were pushing right up to the edge, but felt like they were going to get it done. Now they can step back, review all processes and make sure forms will be accurate and new timing requirements will be met,” he says. Additionally, he notes that this gives some companies time to do a broader education to employees about what they will see.

Asked about employers holding up employees from filing their taxes by delaying the reporting of health plan coverage, Trabold says this is an excellent point and Paychex has had a lot of conversations with employers about it, but the IRS has come out with specific guidance about that. “The IRS says taxpayers should file taxes as early as possible to avoid fraud, but this is a little difficult if they receive health care reporting later,” Trabold notes. “Most employees won’t need this form to do their filing—only in situations where an employee is potentially getting a subsidy to buy insurance. The IRS very specifically told individuals that it is not necessarily to wait; they can rely on other sources about coverage and just maintain the employer’s form with other tax filing information.”

Trabold also says employers were having a challenge in getting test files to the IRS, so with the additional time they may be able to work out the technical issues with filing.

NEXT: Will the Cadillac tax ever happen?

Employers, providers and consultants say the delay of implementation of the Cadillac tax is calling into question whether it will ever happen. “Did we just see a two-year delay or the beginning of a full repeal? Employers are wondering if this is just the first step and there may be future steps, so do they need to plan for it,” Kra says.

Austin says as a practical matter, when employers saw the Cadillac tax relief, they are so busy right now, it pushed this priority down the list. They are thinking about what could happen after the 2016 election; could the tax be repealed altogether? “I’m seeing a switch from a hot-burner issue to a wait-and-see issue,” he states. Trabold agrees that employers are thinking they may not ever have to worry about the Cadillac tax because there seems to be some bipartisan effort to repeal it.

However, employers should not forget about it altogether. According to Austin, it makes sense for employers to still plan for the tax because it could have a significant financial impact on them. But, since the issue has now been pushed out to 2020, he’s not seeing employers spending a lot of time on it.

Kra says employers need to plan—so they won’t be caught off guard—but that’s different from making changes for employees. The question is whether they want to continue to make changes to benefit offerings gradually so there will not be a draconian change overnight, or whether they want to hold off and recalibrate their strategies.

NEXT: Strategies to avoid the tax revisited

Kra believes the measure to make the excise tax deductible for employers is almost irrelevant because most do not want to pay the tax and will do anything not to.

Every strategy to avoid the Cadillac tax is still on the table, he says. The biggest trend has been a switch to high-deductible health plans (HDHPs). HDHP prevalence has escalated—employer offerings as well as employee participation, according to Kra. Another strategy is to use next-generation wellness programs that are data-driven and lead to a measurable impact on cost savings. Kra says employers should think about that now to reap advantages in 2020.

A newer trend is carrier/provider integration, Kra notes. Employees are encouraged to use health care providers that have agreed to use certain cost-saving approaches in return for incentives from health insurance carriers. “Health care cost trends are a challenge regardless of the excise tax, so these are still strategies to consider,” he says.

According to Trabold, in order to avoid the Cadillac tax, Paychex was seeing flexible spending accounts (FSAs), health savings accounts (HSAs) and health reimbursement accounts (HRAs) fall out of favor because pre-tax contributions to those accounts will be included in the calculation to determine if a plan is subject to the tax. Employers also pulled back on benefits offerings.

But, with the extension and the thought that the excise tax may never happen, employers may reconsider offering these savings accounts because they are popular with employees. And, they may go back to a more comprehensive health care offering.

“We are telling people, though, to continue to watch what is happening with the Cadillac tax; there’s no assurance the law won’t still exist in future,” Trabold says.

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