Highmount Newsletter: Third Quarter 2013 Volume 12: Third Quarter 2013 Quarterly Newsletter 1 Risk and Return Revisted 3 Horns of Dilemma 4 Investment Update 5 Your Last Letter GLOBAL WEALTH MANAGEMENT (continue on page 2) Kevin Bannon Managing Director [email protected](646) 217-3304 Investments Risk and Return Revisted The bond market has been spoiling investors for many years. The broadest benchmark of taxable fixed income securities, the Barclay’s Aggregate, has not posted a negative total return (that is, income +/- any change in price) since 1999, and then the loss was only 0.8%. Going back to 1981, when the yield on the 10-year Treasury peaked at 15.8%, the Barclay’s Aggregate has logged only two negative calendar year total returns, with 1994 being the other. Over this 32 year period, however, the price change component of this index has shown losses in 14 years, the worst being a 9.5% drop in 1994. Coupon yields were more than high enough to offset price declines in all but the two above cited years. Going forward, with coupon yields currently still hovering close to 30-year lows, the ability to offset any price decline is considerably more limited. Through September 30 of this year, the Barclay’s Aggregate was down 1.9%. Unless interest rates decline during the fourth quarter, 2013 will be the third down year for bonds in the past 33. Are bonds risky? They are certainly riskier than they have been for a long time just based on where interest rates are today. With the benchmark 10-year Treasury yielding about 2.6%, there is clearly more room for rates to rise than to fall. Are bonds risky in absolute terms? The answer to this question depends on the direction and magnitude of the next shift in interest rates. If economic growth accelerates from its recent lethargic pace -- as we believe is likely -- increased demand for money will tend to push interest rates (the “price” of money) higher and send bond prices lower. On the other hand, if economic growth remains disappointing, Page 1
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Highmount Newsletter: Third Quarter 2013
Volume 12: Third Quarter 2013Quarterly Newsletter
1 Risk and Return Revisted3 Horns of Dilemma4 Investment Update5 Your Last Letter
The bond market has been spoiling investors for many years. The broadest benchmark of taxable fixed income securities, the Barclay’s Aggregate, has not posted a negative total return (that is, income +/- any change in price) since 1999, and then the loss was only 0.8%. Going back to 1981, when the yield on the 10-year Treasury peaked at 15.8%, the Barclay’s Aggregate has logged only two negative calendar year total returns, with 1994 being the other. Over this 32 year period, however, the price change component of this index has shown losses in 14 years, the worst being a 9.5% drop in 1994. Coupon yields were more than high enough to offset price declines in all but the two above cited years. Going forward, with coupon yields currently still hovering close to 30-year lows, the ability to offset any price decline is considerably more limited. Through September 30 of this year,
the Barclay’s Aggregate was down 1.9%. Unless interest rates decline during the fourth quarter, 2013 will be the third down year for bonds in the past 33. Are bonds risky? They are certainly riskier than they have been for a long time just based on where interest rates are today. With the benchmark 10-year Treasury yielding about 2.6%, there is clearly more room for rates to rise than to fall. Are bonds risky in absolute terms? The answer to this question depends on the direction and magnitude of the next shift in interest rates. If economic growth accelerates from its recent lethargic pace -- as we believe is likely -- increased demand for money will tend to push interest rates (the “price” of money) higher and send bond prices lower. On the other hand, if economic growth remains disappointing,
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Highmount Newsletter: Third Quarter 2013
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ents interest rates could move even lower. Another
part of this answer depends on the outlook for inflation, which will determine the real -- that is, after inflation -- return investors earn. Inflation has been very subdued in recent years and is currently running only slightly
above 1.0%, making it almost a non-factor in investors’ calculations. From this level, however, like interest rates, there would certainly seem to be much greater room for inflation to increase than decrease. Boosting inflation to a higher 2.0-2.5% rate is, in fact, one of the goals of the Federal Reserve’s quantitative easing strategy.
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There is another way to think about the question, “Are bonds risky?” The answer is a function of first answering this more fundamental question: What exactly is risk? In the investment management business, risk is very frequently defined in terms of volatility, that is, how bumpy is the process of getting from Point A to Point B likely to be? On the way to earning a 10% compound annual return over a five-year investment horizon, for instance, never slipping more than 5% below this 10% target growth path during this five-year holding period would make for fewer sleepless nights than dropping 20% or more below the projected trend line, even for a short while. There is nothing like adverse price performance to call investors’ conviction levels in their positions into quick question. We all know from painful experience that markets can be volatile and, yes, sometimes even irrational. When negative
price momentum appears to be overpowering investment fundamentals, the temptation to avoid further pain can be very difficult to resist. This is the real risk posed by high volatility.
Our experience has been that, for most investors, risk is much more a matter of avoiding real losses and permanent impairment of their capital. For these investors, the primary goal is to get from Point A to Point B with as high a degree of certainty as possible. A smoother ride will always be preferable, but it is reaching the ultimate destination successfully
that counts most in the end. If the coupon return of a bond purchased today will meet an investor’s income requirements over the period to the issue’s maturity and there are no concerns regarding the issuer’s ability to make timely payments of interest and principal, should the bond’s price during the interim really be a cause for concern? This is not to say that a significant change in market conditions shouldn’t prompt a careful reevaluation of the original investment rationale. Our point is that what is most important is understanding the part each security is designed to play in a portfolio and evaluating performance in this context.
Horns of DilemmaTransparency Versus Opacity in Trust Disclosure
In recent years, the increased gift tax and generation-skipping transfer tax exemptions and the threat of reduction in those exemptions by Congress, (viz., “the house divided against itself”) have prompted wealthy individuals to make substantial gifts to children and grandchildren, often in trust. Many times, those gifts in trust engender concern in the donor that knowledge of the trust may serve as a disincentive to the beneficiary to forge a productive and rewarding life. The donor may be torn between the desire to make a tax-efficient gift and the fear of producing a discontent, aimless “trust fund baby.”
But what if a donor could provide for a beneficiary in a tax-efficient manner without fear that knowledge of the trust will squelch the beneficiary’s motivation? Prior to the turn of this century, it would have been difficult to suppress the information flow from a trustee to an adult (over age 18) beneficiary. One of the time honored fiduciary duties of a trustee is the duty to account to an adult trust beneficiary. How else would a beneficiary protect himself from the possibility of fraud or mismanagement by the trustee? In the past, even if it were legally permissible to waive the duty to account, it would have been difficult to convince a professional trustee to agree to such non-disclosure. Over the years, however, the duty to account (now often referred to as a duty to “inform and report”) has been eroded – a trend driven by donors intent on fostering independence and self-reliance in the recipients of their bounty.
The Sounds of Silence
During this and the last decade, several U.S. jurisdictions have enacted legislation or other measures easing, to varying degrees, a trustee’s duty to inform and report. One of the factors prompting this easing has been the promulgation of the Uniform Trust Code (UTC) in 2000. Controversial statutes within the UTC mandate provision of information and accountings for beneficiaries over
age 25. Several States that enacted versions of the UTC have modified these mandates.1 For example, Massachusetts adopted the UTC provision “Duty to Inform and Report,” but it did not adopt another provision of the UTC that would have made that duty mandatory. This means that, the duty to inform and report can be changed and customized in a Massachusetts trust. In states that adopted the UTC2 provisions without revision, the mandates cannot be waived in the trust instrument. In contrast, Florida’s version of the UTC is even stricter than the uniform law – for instance, the trustee’s duty to furnish a copy of the entire trust instrument can be modified in under the UTC, but Florida makes that provision mandatory. New Hampshire’s version of the UTC is among the most flexible: it provides that none of information and account provisions are mandatory, and, further, trust advisors and protectors must provide information to the Trustee. There are other variants of the duty: States that have not adopted the UTC nevertheless may have strict rules regarding information dissemination and accountings. For example, under California law, any waiver in the trust instrument of the duty to inform and report is deemed void and against public policy. The myriad ways that States address the disclosure and accountings needs to be understood by a donor seeking to limit one or both of those duties.
Given that the laws of New Hampshire, as well as Alaska and Delaware, provide flexibility with respect to the duty to inform and report, one or another of them is often the State of choice for creating “quiet” or “silent” trusts – that is, trusts that delay the provision of trust information regarding the trust to the beneficiary. In order to avail oneself of the trust laws of a State other than the donor’s State of residency, however, usually one must appoint a
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1 Only about half of the States have enacted a version of the UTC.2 Most of the UTC statutes operate as default provisions; that is, “filling in the blanks” in the event that the trust does not have specific provisions. Very few UTC laws are mandatory; the most important mandate being the duty to inform and report
Highmount Newsletter: Third Quarter 2013
FINANCIAL MARKETS OUTLOOK: THE START OF THE LONG AWAITED “GREAT ROTATION”?Investors finally appear to be warming up to stocks again.
3rd Quarter 2013 Year to Date
Global Equities
MSCI All World 8.1% 15.0%
International Equities
MSCI EAFE Index 11.7% 16.8%
• United Kingdom 11.9% 12.9%
• Germany 12.3% 15.5%
• Japan 7.5% 23.8%
• Netherlands 13.7% 15.1%
• Switzerland 9.3% 21.4%
Emerging Markets Equities
MSCI E.M. Index 5.9% -4.2%
• Brazil 10.1% -21.2%
• Russia 12.1% -3.4%
• India -4.5% -11.5%
• China 11.4% 0.6%
3rd Quarter2013 Year to Date
U.S. Fixed Income
Treasury Bills 0.0% 0.1%
Municipal Bond Index -0.2% -2.9%
Barclays Aggregate Index 0.6% -1.9%
• Treasuries 0.1% -2.0%
• Corporates 0.8% -2.6%
• Asset Backed 0.2% -0.6%
High Yield Index 2.3% 3.7%
U.S. Equities
Dow Jones 2.1% 17.6%
S&P 500 5.2% 19.8%
Russell 2000 10.2% 27.7%
Currencies
U.S. Dollar (trade-weighted) -3.5% 0.6%
Dollar vs. Euro -4.0% -2.5%
Commodities
Oil (WTI) 6.0% 11.4%
Gold 7.6% -20.7%
Investment Returns through September 30, 2013 (in U.S. $)
MARKET MONITOR: Signs of imporiving global growth spurred a catch-up rally in non-U.S. equities.
Imagine your father has just died and you’ve gathered with your mother and siblings to formulate the next steps. There are dozens of details to attend to – the funeral, financial issues, taxes and bills – all in a milieu of deep, immediate grief. Amid all the tasks that must be performed so quickly and efficiently, how do you honor your father, and all he’s meant to you and your family?
So you and your family pull the relevant files from your father’s desk. Out come the wills, the trusts, the insurance policies and other papers. If you are as fortunate as the writer of this article, you also come across a letter written in your father’s handwriting. Written years ago, it provides some of your father’s personal reflections, his wishes for how he would like to be remembered, and even some guidance for the funeral service. Although the letter is serious, you smile as you read his handwriting, rendered in the blue ink he typically used – you can almost hear his voice. The letter injects an element of calm into the initial chaos. You are thankful not only for this precious memento but also for this final kindness of a loving father.
In preparation for this day, perhaps your father had his lawyers, wealth advisors and accountants assist him in putting his affairs in order. In their minds, his estate plan was up to date. His trusts reflected his intentions and were integrated with the other components of his financial, tax, and estate plans. His philanthropic wishes were in place. Yet as essential as all these plans and instruments are to an orderly passing, they do not articulate his memories, values, and hopes, or provide guidance in preparing an appropriate and lasting tribute.
Writings such as the handwritten letter discussed above pick up where legal documents leave off. They provide personal, heartfelt information and guidance written in a loved one’s own words, not legal jargon. Sometimes called “life legacies,” these
instruments are not legally enforceable, nor are they intended to be. The goal usually is to convey non-monetary legacies to loved ones. This instrument can be a personal statement of your memories and value system. It also can provide guidance on how you would like to see the recipients continue to implement your goals and values, and how you would like to be remembered. An ethical will may set forth an anecdote you would like to have read at the funeral or memorial service. A statement of and background for philanthropic wishes may be expressed as well. Like a legal will, an ethical will is a work in progress that should be updated and revised as life experiences accumulate.
A variation on the ethical will is a “letter of wishes.” These provide non-binding guidance – including values based guidance – for trustees of discretionary trusts. The letter of wishes has been a standard instrument in foreign trusts for years. But in recent years these documents have been incorporated into U.S. trust planning as well. A letter of wishes often gives the trustee advice about the circumstances under which a beneficiary should benefit from the trust (e.g., the beneficiary should be employed full-time or have a meaningful career).
Ethical wills and letters of wishes also may provide investment and financial guidance beyond the traditional language of estate planning instruments. With the mere passage of time, the financial markets and personal circumstances will change, but estate planning instruments may not be amendable. By providing non-binding wishes over time regarding the investment, disposal, and disbursement of trust assets, one is able to add a degree of flexibility to otherwise irrevocable instruments. Financial guidance may be specific as to how, when, and whether to invest or dispose of investments. In this way, the family may benefit from the writer’s objectives, as well as his or her years of experience.
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Highmount Newsletter: Third Quarter 2013
We at Highmount believe that ethical wills and letters of wishes can provide invaluable information for a family and may constitute the most meaningful
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DisclosureInformation provided in this newsletter should not be construed as investment, tax or legal advice. Information presented is not an offer to buy or sell, or a solicitation of any offer to buy, sell or invest in any Highmount Fund or in any security or commodity mentioned herein. Some investments discussed herein may be suitable only for sophisticated investors. Although information in this newsletter has been obtained from sources believed to be reliable, we do not guarantee its accuracy or completeness. Highmount disclaims any responsibility to update any information provided herein. Past performance of a security or Fund does not necessarily indicate or predict future performance and investments mentioned herein may lose value. There is no assurance that any security discussed in this newsletter will continue to be held in the applicable portfolio or that securities that have previously been sold will not be repurchased. It should not be assumed that recommendations made in the future will be profitable. There are no assurances that an investor’s portfolio will match or outperform any particular benchmark. If you have any questions, please call (646) 274-7470, or e-mail [email protected], or write Highmount Capital LLC, Attention: Chief Compliance Officer, 12 East 49th Street, 36th Floor, New York, NY 10017.To ensure compliance with Internal Revenue Service requirements, Highmount informs you that any tax information herein is not intended or written to be used, and cannot be used, to (i) avoid penalties under the Internal Revenue Code, or (ii) promote, market or recommend to another party any transaction or matter discussed in this newsletter. Nothing contained in this newsletter constitutes tax advice.
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aspect of an estate plan. The writer of this article knows this to be true from recent personal experience. We will be happy at any time to discuss this process with you in greater detail.
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trustee in that favorable State. The trustee in the target State may be given only limited powers and be a co-trustee with a friend and family member.
If a donor wishes to create a trust that controls or limits the information provided to beneficiaries, the donor will need to first establish what she is looking to limit: for example, does she wish to: (i.) avoid all disclosure of the trust for a defined period of time? and/or (ii.) allow disclosure of the trust but limit accountings – or perhaps require that a trust protector receive accountings on behalf of the beneficiary? Depending on the extent to which a donor wishes the trustee to withhold information from the beneficiary, it may be possible
- and simplest - to establish the trust in the donor’s State of residency.
Quiet trusts may be the answer to many donor’s wishes to make tax-efficient gifts to a beneficiary who or may not have found himself or herself. But there is always the chance that a quiet trust could backfire and cause anger and resentment, so a donor should consider the pros and cons of a quiet trust. Even if a donor is not interested in a quiet trust, it is important to understand the applicable information and reporting rules in order to fine-tune the trust. Our Highmount advisors would be happy to discuss the options with you in detail, so don’t hesitate to ask.
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*Reprinted by popular demand from our Q1 2007 Newsletter.
Highmount Welcomes New EmployeesChristopher Holcombe - Chris joins Highmount as an Associate Director. Prior to joining Highmount, Chris spent six years in private wealth management at BNY Mellon. He received his B.A. from Colby College and is a CERTIFIED FINANCIAL PLANNER®.
Christopher Moran - Chris joins Highmount as a Client Service Associate. Prior to Highmount, he had worked as a Client Service Representative for MFS Investment Management where he provided service for financial representatives and individual shareholders. Chris received his B.S. in Business Management from Salve Regina University.
Third-party rankings and recognition from publications or rating services is no guarantee of future investment success. Working with a highly-rated adviser does not ensure that a client or prospective client will experience a higher level of results. A more thorough disclosure of the criteria used in making these rankings is available upon request. Any views or opinions presented herein are solely those of the author and do not necessarily represent those of Highmount Capital LLC.
