Fund Architects Announces Envestnet Launch

Wed, 30 Nov 2011 07:00:00 GMT

New Relationship To Include Six Dynamic Investment Models

Fund Architects LLC, a provider of dynamic asset allocation portfolios designed for a broad range of investors, today announced the firm will be launching six of its dynamic investment models on the Envestnet platform.

Envestnet, Inc. (NYSE: ENV) is a leading provider of integrated wealth management solutions for financial advisors. The new relationship with Fund Architects further expands Envestnet’s product offerings.

The Fund Architects models will offer institutional quality money management with a wide range of portfolios designed to meet the goals of nearly every investor. Each portfolio will be constructed from a broad universe of ETF’s and mutual fund managers, using fundamental fund selection and asset allocation tools.

“Our goal is to make independent, quality money management easily accessible to the marketplace,” said Keith Reed, co-founder and Executive Vice President of Fund Architects, “and our inclusion on the Envestnet platform goes a long way toward that end. We’re very pleased with this new relationship.”

Todd Porter, CFA, a co-founder of the firm and its Chief Investment Officer, will oversee each of the models on the Envestnet platform. Mr. Porter, who served as Chief Investment Strategist at Morningstar Associates before helping launch Fund Architects, has been developing actively managed fund-of-fund asset allocation products for the last decade. With more than 20 years of investment experience and extensive macroeconomics training from the University of California, Berkeley, and Harvard University, Mr. Porter helped pioneer the process of building dynamic asset allocation portfolios.

Fund Architects, an SEC-registered investment advisory firm, was launched in 2007. The firm’s strategies include strategic global diversification, dynamic allocations, high-quality active fund managers, and alternative or non-correlated strategies. Fund Architects has relationships with major custodians and clearing firms and is able to work with self-clearing and trust accounting operations. For more information on the firm, or to access Mr. Porter’s quarterly commentary, visit www.fundarchitects.com.

About Fund Architects

Fund Architects is a discretionary, fee-based money management firm providing professional asset allocation models and management to financial advisory firms. Headquartered in Texas, the firm has arrangements with Broker/Dealers, Insurance Companies, Qualified Plan Providers, and Registered Investment Advisors around the country. Fund Architects’ proprietary asset allocation models are constructed from a broad universe of managers using a fundamental analysis approach to fund selection and asset allocation tools. Offerings include Separate Accounts, Retirement Management Services, and Private Money Management. For more information, visit www.fundarchitects.com.

Fund Architects ENVESTNET press release can be found on the Wall Street Journal web site at: http://online.wsj.com/article/PR-CO-20111116-908984.html

FAENVPR-1111

Easier Riders

Thu, 02 Jun 2011 06:00:00 GMT

When It Comes To Variable Annuities, Smart Planning Demands Smarter Questions

It’s really no surprise that variable annuities attracted a little more than $140 billion in 2010 according to LIMRA. After all, once you’ve maxed out your qualified retirement accounts, how many ways are there to invest an unlimited amount of money on a tax-deferred basis? Answer: Not many. Add to that a promise of a guaranteed future income stream regardless of how well the investment choices fare and folks pay attention. Many financial advisers feel that no long-term financial plan should be complete without considering a variable annuity and its available riders.

Riders are a kind of add-on benefit to the insurance policy that allows investors to protect against risks for an additional fee. The most common VA options are Living Benefit riders for those thinking about protecting their income after retirement and Death Benefit riders for those thinking of protecting their bequest after they’re gone. It is our contention that these riders will have a dramatic effect on the risk and return the investor realizes from the VA, and yet these effects are not systematically incorporated into the asset allocation decision. Investors, as a result, are not getting the full benefits of the riders they are buying.

Value and Volatility

The benefits of the riders are obvious to those that bought them in recent years. You don’t have to look far to find a satisfied variable annuity owner who has slept better than most during the two major stock market downturns of the last ten years, or a surviving spouse who has received far more than the VA account value at the owner’s death.

That’s not to say a VA is a simple investment for everybody. It really isn’t, and the process demands the guidance of a skilled investment professional, especially when it comes to complex decisions related to the investment choices and the riders. And even when done correctly, we’re afraid that all too often these decisions end up being made separately rather than jointly. For example, an advisor explains the benefits and the costs of a risk reduc- tion rider and a decision to add the rider is made. Then, somewhere down the road, the investor and advisor work through a risk questionnaire that guides them to a particular asset allocation model—the rider conversation now out of sight and effectively out of mind.

The fact is, there should always be a clear correlation between the rider and portfolio decisions. Why? Because the more volatile the investment portfolio selected, the more valuable the rider is to the investor. Or, said the other way, the more valuable the rider the more volatile the investment portfolio can be. Which, by the way, translates to more expense for the insurance company. That’s why a fair number of providers limit living benefit riders to their products’ more conservative asset allocation models. Actuaries fully understand that the volatility of the invest- ment choices is directly related to the expense of providing the rider.

But while insurance companies may fully understand the relationship between the rider and the portfolio deci- sion, it’s not so clear that investors see, or get to see, the connection. Nowhere is that more apparent than the risk questionnaire that guides the advisor and the investor to the right asset allocation model. In our experience, the questionnaire never considers whether or not the investor selected a rider as a factor in recommending a model.

Insurance Gets Expensive

Each rider that’s added to a variable annuity adds to the annual cost of the contract annuity, which ultimately comes out of the investor’s return. That incremental expense could be as low as 5 basis points for a basic death benefit rider (a protection against investment loss if a client dies in a down market) or as high as 100 basis points for a living benefit rider. These increasingly-used living benefit riders have steadily risen in cost over the years. They serve to guarantee that a certain level of withdrawals can be made over the lifetime of the owner, even if the account has long since been reduced to zero. In practice, it’s not at all unusual for a VA owner to have both a living and a death benefit rider. One way or the other, the additional expense eats into a policy’s returns.

All of that expense can wind up taking an exponentially large bite out of long-term accumulation results. How big a bite? More than you might think. The attached chart shows the effects of a 100-basis point living benefit rider on a typical $100,000 VA policy. Assuming a gross 8% annually compounded return, a policy with no riders would accrue to $215,892 in 10 years and $466,095 in 20 years. Bolt a 100-basis point living benefit rider to the policy, and the numbers drop to $196,715 and $386,968 respectively.

In simple arithmetic, and without consideration to its benefit, the rider costs more than $19,000 across 10 years and a whopping nearly $80,000 over 20 years.

At the same time, some insurance companies, depending on the rider, typically maintain discretion to move a VA’s sub-accounts to cash or money market if the company is concerned about market risk. If the account balance sinks too low, the insurance company will shift assets into cash to protect itself. This, almost by definition, ends up being a ‘sell-at-the-bottom’ investment strategy that seldom works out well for the investor. The actuarial formulas for how and when these changes are effected are seldom, if ever, disclosed, but they most certainly alter the short- and long-term returns. In addition, the VA owner still has to pay 100% of the rider cost even though his or her market exposure may have been greatly reduced.

Insurance Reduces Risk

While the cost of living benefit and death benefit riders can have a significant effect on the growth in the value of a VA policy, that sacrifice may be worthwhile, in terms of risk reduction.Consider the market meltdown in 2008. Retirees looking to take distributions in the face of this so-called “Black Swan” event (by definition an outsized occurrence that’s extremely difficult to predict) were left to either spend down their retirement savings or stop taking withdrawals altogether. Meanwhile, policy owners of VAs with guaranteed withdrawal riders lived through that trauma without the burden of making any financial decisions at all. Many have said that feeling is priceless.

“Moral hazard” refers to the idea that a person protected in some way from risk will act differently than if he or she didn’t have that protection. And it’s usually considered in a negative light: people build homes in flood plains because they have flood insurance; banks make sloppy loans if they think they’ll get bailed out; folks are more likely to trash a rental car if they have rental car insurance. But in the context of VA riders, moral hazard is not negative in the least. The risk-reducing effect of VA riders simply allows investors to bear more stock market risk.

Asking the Right Questions

Generally speaking, Death Benefit riders reduce the risk of losing some of an investment for the VA owner’s heirs, while Living Benefit riders protect future distributions to the VA’s annuitant, regardless of investment performance. For those who buy such riders, the relevant question is: whether the additional risk protection that is being purchased should be considered among other factors as an opportunity for a portfolio to be managed with more risk, and therefore more potential growth.

For example, a sophisticated investor and his trusted adviser select an excellent variable annuity for all the right reasons...great company, great sub-accounts, great riders, and so on. With good fortune and good advice, this sophisticated investor can—through the addition of certain living benefit riders—lock in a targeted amount of income in retirement from this variable annuity. A sophisticated investor can, in other words, eliminate his most significantly perceived threat—the income risk—with the purchase of a rider or riders. Why then, wouldn’t both investor and advisor view the other half of his personal planning equation—the investment risk—in a whole new light?

We think they should. So instead of just relying on the traditional risk questionnaire and managing money purely to the time horizon and risk tolerance of a client, Fund Architects incorporates two additional questions in the process. Specifically, we want to determine if any consideration should be given to the reasons any riders were added to the contract and, if so, what impact this decision should have on the outcome of the risk tolerance questionnaire. One way or the other, it's an important discussion for an advisor to have with a client. The questions are fairly straightforward, but the results can be significant.

Risk questionnaires, we call ours an Account Qualification Questionnaires, are typically designed around a point system that rolls up to define the respondent's risk profile. Our two additional questions essentially add points to the final score. If the potential VA buyer is already on the lower end of the scoring system, the extra points from our questions may not be enough to actually change their recommended risk model. In many cases, however, answers in the affirmative to the additional questions could easily bump the investor up one risk model -- a 'Conservative' becomes a 'Moderate', for example.

Typically, the effect of moving up a notch on the risk profile curve means somewhere around 20% more exposure to equities in the portfolio. In our work, that increased allocation should mean another 60 basis points or so of expected return. Coincidentally, that‟s more than half the cost of most living benefit riders.

One way or the other, a change in an investor risk profile driven entirely by the recognition of policy riders will ultimately change the investment portfolio we construct for that VA client.

A Better Plan

If nothing else, our two additional questions on the AQQ give the financial advisors an opportunity to have a meaningful, in-depth discussion with their clients on just how Death Benefit and Living Benefit riders work, and how they can influence an overall investment plan.

In the end, it’s important to know that the cost of riders and extra insurance is never zero. It’s just as important to know a customized investment plan could very well be priceless.

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Fund Architects EASIER RIDERS paper was also published on Morningstar’s web site at: www.morningstar.com

http://news.morningstar.com/articlenet/SubmissionsArticle.aspx?submissionid=118898.xml

Morningstar Submissions | Fund Architects | 06/02/2011

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