I have communicated with perhaps thousands of financial advisors over my career. The most common theme underlying my exchanges with them is their desire for help in seeing through the sales pitches lobbed at them on a regular basis. I have found that simplicity is the key to picking apart a product or sales pitch effectively.
For instance, when I began receiving questions on Portus Alternative Asset Management Inc.’s products in 2004, I started with the basic steps of checking the firm’s registration and reading the documentation. The registration was fine, but one read through of the offering memorandum and other documents triggered suspicions.
The assets and number of investor totals for the product I reviewed implied an average investment of about $30,000. The OM, however, specified a minimum investment of $250,000. Perhaps more significant was the wording of the OM, which described the structure as a trust that will buy bank notes that “may be structured in such a way that the principal amount is fully protected at maturity.” I review products with a “guilty until proven innocent” attitude. Accordingly, I reread that sentence in the OM, replacing the word “may” with “may not.”
Cue the big, red flag. Those two items were enough to warn my advisor-clients to steer clear of Portus.
Similarly simple reasoning can be applied to one of today’s most popular products — guaranteed minimum withdrawal benefit products. When I first examined GMWB products, I tried to absorb every detail in an effort to grasp each possible scenario. I soon became overwhelmed — although my understanding was sharpening. I shelved my GMWB analysis for a while, later returning to it by zeroing in on two factors.
GMWB products often pay clients an annual 5%-7% of the original deposit if withdrawals are deferred, and a similar percentage (of the accumulated amount) subsequently for life. The approximate total return that must be exceeded for clients to get more than the guaranteed amount can be estimated by adding annual fees (e.g., 3%) to the annual payment rates (e.g., 5%-7%). Thus, the GMWB portfolio generally needs a return north of 8% annually (or higher) to give clients anything above the guarantee. This admittedly crude analysis is still a good estimate that puts the upside potential into context. And with most GMWBs’ asset-allocation constraints, the return hurdles will prove challenging.
The other analysis factor: GMWBs look much less competitive when their cash payouts are compared with those of traditional life annuities.
GMWBs may do the trick for some clients, but these simple tests help sharpen suitability assessments.
So, the next time that you’re pitched a new product to sell to your clients, start by looking at it in the simplest of terms. The simplest analysis just might yield the greatest insight. IE
Dan Hallett, CFA, CFP, is director, asset management, for Oakville-based HighView Financial Group, which designs portfolio solutions for advisors, affluent families and institutions.