June 1, 2000

Fiscal Electrification

In case you haven't noticed, banks are going elect

Illustrations by Barry Blitt

An editorial published last year in Electronic Banking Digest (www.technicorp.net/ebd/ebd.htm) talked of the global decline of bricks-and-mortar banks, charging the institutions with maintaining a conservative approach to change - "exhibiting an almost Luddite attitude to threshold technology" - noting that functions such as branch clearing and interbank settlement have changed little in recent years. During those same years the noise generated by the rumbling of bank customers over rising fees and charges has grown louder. When bank deregulation sprang forth last November in the form of a long-awaited repeal of the Glass-Steagall Act, the angry mob responded with understated enthusiasm, a sign that should by no means diminish the import of what has occurred. Free of restraints, we can expect banks to do almost anything.

Charles Schwab Corp's late April investment of $40 million into Dublin, California-based E-Loan Inc. (www.e-loan.com) is an endorsement that strengthens not only E-Loan's future, as Schwab's exclusive provider of online mortgage services, but that of electronic banking in general. E-Loan, launched in 1996, provides mortgages, auto loans, credit cards, and small business loans online. The company already partners with Yahoo!, E-Trade, Telebank, and CarsDirect; and it has relationships with over 70 lenders. Schwab's alliance with E-Loan will provide some 3.3 million Schwab online brokerage customers with "a convenient way to shop for and compare low-cost home loan products right from our Web site," says chairman Charles Schwab.

Another company only a click away is BankDirect (www.bankdirect.com), which went online in May 1999. The benefits BankDirect touts are generic to e-banking: better rates (BankDirect presently offers 3.25% checking interest; 5.25% money market), fewer fees, and greater consumer convenience than its brick and mortar counterparts. Other online virtual banks include Netbank, Telebank, and SFNB.

Why should you care? Traffic on the Internet reportedly is doubling every 100 days, and the number of households in the U.S. with at least one personal computer is expected to exceed 50% by 2001. Gomez Advisors says the banking market will triple by 2002, with 24 million Internet users banking online, up from 6.9 million at the end of 1998. According to Gomez, of those who bank online, 62% manage their investments online; 33% use online insurance information and services; 24% use online mortgage information and services; 16% applied for a credit card online; and 6% applied for a loan online. - Cort Smith


Mutual Fund Report

Dreyfus Corporation has settled a case concerning one of its mutual funds for which it advertised 80% returns. Penalties totaling $2 million have been assessed for the company, which agreed to the settlement without admitting any wrongdoing. Fund manager Michael Schonberg had been placed on administrative leave but has since left the company. The Aggressive Growth Fund's 80% return record was advertised without disclosure of the facts that much of the first-year profit was a result of one-time investments in IPOs and that most of the fund consisted of shares of microcap companies with high risk.. . . .Janus has closed three more of its top funds because of an embarrassment of wealth: so much money has come into the funds that the managers are unable to invest it properly. Janus Worldwide, Olympus, and Global Life Sciences Funds all closed effective May 10. . . .Fidelity Investments announced that Beth Terrana, who managed Fidelity Fund and two others, will no longer be an active manager. James Lowell, editor of Fidelity Investor, suggests that Fidelity may be grooming Terrana for a senior management position, though she has said her long-term plans may lie outside the fund industry altogether. Nick Thakore, who managed Fidelity Trend, will take over at Fidelity Fund. - Marlene Y. Satter


Bushwhacked Taxes

W. would do to taxes what he once did to baseballs: whack 'em over the fence

George W. Bush never dreamed of being president when growing up. He wanted to be Willie Mays. While Bush never made The Show, he did serve for five years as one of the Texas Rangers' managing general partners, until he was elected Governor of Texas in 1994.

The ball-loving Bush hasn't moved into the Oval Office yet, but he has picked up another nickname. No, not "W". He's being called the New Democrat, having, as critics claim, left behind his ardent conservatism and become in some ways more like Al Gore than Al Gore. Mainline camp followers hope the new Bush is an aberration, that he's a chip off the old Bush, both his father and former self.

Spin-doctored personas aside, what's this 54-year-old baseball nut, Yale grad, Harvard MBA, Texas Air National Guard pilot, oil and gas businessman-turned-politico have in mind for the nation, financially speaking? The Texas governor's "New Prosperity Initiative" shoves taxes - which have reached a peacetime high, absorbing at all levels of government some 36% of net national product - through the shredder, leaving a tax code that is "simpler, flatter, and fairer." The resulting federal surplus should be used by Americans "to save and invest," Bush says, not spend as would Gore. And he plans to do it all without touching Social Security.

For starters, if elected, Bush would kill the "death" tax (phased in over eight years), which means wealth would be taxed once, when it is earned, not again when entrepreneurs and senior citizens pass the fruits of their labors to the next generation; end the Social Security earnings test (President Clinton beat him to it, signing a law to that effect April 7); and veto any increase in personal or corporate income taxes.

"W" joins Gore in his desire to reduce the marriage penalty, this time by restoring the Reagan 10% deduction (eliminated in 1986) for two-income married couples, allowing them to deduct up to an additional $3,000. In addition to a raft of other tax cuts, he would significantly increase the annual contribution limit on Educational Savings Ac-counts, and allow the nation's approximately 80 million non-itemizers to deduct charitable donations. - Cort Smith


Foreign Relations

U.S.-style financial planning is finding a reception abroad

The globalization of financial planning continued in May with the presentation of awards to academics in Capetown, South Africa, at the second annual meeting of the International Academic Advisory Panel, held in conjunction with the International CFP Council's semiannual meeting.

Harold Evensky chairs the Council, which counts 11 nations as members: Australia, Canada, France, Germany, Japan, New Zealand, Singapore, South Africa, Switzerland, the UK, and the U.S.

The Council says the rest of world is catching up with the United States: the responsibility for financial well-being is being pushed from employer to employee following the move from defined benefit plans to defined contribution plans. With that comes a need for planners to help people make financial decisions. A major part of the Council's work, it argues, is to educate consumers worldwide about the benefits of financial planning. - Marlene Y. Satter


Capital Capers

Overshadowing the April 7 unveiling of the Social Security Administration's online retirement planning service is the ongoing controversy over Social Security privatization. It centers on George W. Bush's proposal to let individuals invest up to 2% of their current Social Security payroll taxes into privately controlled equity accounts. The general idea has been under discussion for years, based on the premise that taking advantage of the stock market's higher returns would relieve some of the pressure on the Social Security Trust Fund. Workers retiring today will receive from the fund an average rate of return on their lifetime payroll taxes of only 1.6%, while persons born today can expect to receive returns on their payroll taxes scarcely exceeding 0.9%. According to The Cato Institute, a think tank in Washington, D.C., voters will likely support privatization by a large margin (68% to 30%). Meanwhile, in May two Democratic senators, Daniel Moynihan of New York and Bob Kerrey of Nebraska, joined forces with Republican Senator John McCain of Arizona to propose a bipartisan Congressional commission to explore ways to overhaul the system. . .The SEC delivered a warning in May to its 8,000-plus RIAs over some advisors' hyperbolic claims about their experience, performance, and assets. Lori Richards, the SEC's director of compliance inspections and examinations, said the SEC will take measures to curb infractions. The issue was addressed at a SEC-sponsored Investment Roundtable held on May 23 in Washington, at which statutory exceptions from the definition of "investment advisor" were revisited. Discussions also centered on the blurring lines between investment advisors and broker/dealers, conflicts faced by advisors, and the implications of the Internet and other new technology. - Cort Smith


Wireheads on Campus

Those big, bad firms are filling the seats at CFP training courses around the country

Employees of banks, insurance companies, and wirehouses have begun enrolling in CFP educational programs around the country in much greater numbers than ever before. The move reflects the financial services giants' embrace of financial planning and is likely to reshape the profession over the next few years.

According to interviews with financial planning educators and administrators at major colleges and universities accredited by the CFP Board of Standards, corporate contracts to educate employees at large companies rose dramatically in the last year.

Louis Cino, associate dean of the School of Continuing Education at the C.W. Post campus of Long Island University in Brookville, New York, says that 50% of the students in the school's financial planning program are studying on-site at corporations these days, compared to only 20% a year ago. His experience is not uncommon.

"We're seeing a lot more interest from big companies like Fidelity, Met Life, and some Merrill Lynch brokers," says Bob Glovsky, director of Boston University's financial planning program.

Tom Warschauer, a professor of finance at San Diego State University who has run the school's master's and undergraduate programs for nearly 20 years, says that only 5% of the students in the school's master's program were from large financial services firms a few years ago, but that this group now accounts for 50% of the students in the program. He says that, for the first time, a wirehouse has asked his school to run the CFP educational curriculum at its office. "We've taken our program downtown," says Warschauer. A class of 30 Merrill Lynch employees is now taking the coursework needed to qualify for the two-day comprehensive CFP exam. Next year, he says, the school will begin offering additional classes downtown for employees from other companies in banking and insurance as well as the wirehouses.

Charles "Chic" Finn, director of the financial planning program faculty at Oglethorpe University in Atlanta, says that the program five years ago had a total annual enrollment of 90 students. Today, the financial planning program has 180 students. In the past, Finn says that close to half of the students in the courses were "career changers" looking to move into the planning profession from another job. Now, he estimates that there are so many more students from the banking, insurance, and brokerage sectors that each class only has a handful of career changers.

The surge in interest from the financial giants is a sensible strategic decision. With the Internet driving stock trading commissions down to about $10 a trade and Ameritrade offering free trading to some clients, full service firms know that customers will soon be unwilling to pay $75 for a trade through their brokers. The brokers will have to become professional financial advisors and be able to offer financial advice to justify charging clients fees.

A year ago, when the CFP Board proposed creating an Associate CFP designation that would allow brokers, insurance agents, and bank sales representatives to receive a junior-level financial planning designation, the CFP Board cited these trends as justification in a white paper about the future of the profession. It appears the CFP Board's prediction about the migration of financial services companies into what has been a cottage industry was correct. However, the CFP Board's assertion that corporations would not send employees through a program requiring 18 months to two years of classroom work and passage of a two-day comprehensive exam appears to have been off-base.

"The large companies are doing exactly the opposite of what the CFP Board had predicted," says Cino. "They said the Associate CFP designation was needed because the big financial services firms would otherwise create their own designation, but it does not appear that's happening."

No one can predict how the planning profession will be affected by a flood of CFPs working at financial services giants. "The big question is whether the large insurers and wirehouses truly believe in training people to be financial planners and compensating them in ways consistent with financial planning," says Glovsky.

Finn believes the giants will end the dominance of small, independent planning firms. He says the complexity of planning and technology makes it likely the large firms will succeed.

Warschauer has the most provocative prediction: the giants will never be the same, he says, because their CFP employees will adopt the CFP-prescribed financial planning process and change their corporate culture. "It's like a Trojan horse," he says. "The CFPs at these giant firms will cause enormous change in the philosophy of those firms. These firms are encouraging employees to get the CFP designation because they think it will help them improve their assets under management, but the interesting thing is what will happen when their people buy into the financial planning philosophy."

Warschauer doesn't see a threat to independent planners from these giants because the independents will continue to provide personal service and solutions that the big firms cannot provide, augmented by using the growing legion of business-to-business online services created for planners.

There are only 35,394 CFPs while tens of thousands of financial services sales people claim to practice financial planning. According to the CFP Board, 4,433 individuals sat for the CFP exam in 1999, compared to 3,303 in 1996 and 2,123 in 1995. A CFP Board spokesman says it does not track how many candidates come from large financial services firms.


Margin of Error

The markets really are more volatile. Watch your step

While five straight years of total returns in excess of 20% in the Standard & Poor's 500 has numbed many clients to warnings about the risk of the stock market, research from Frank Russell Company shows just how much the market has fundamentally changed in recent years and how the potential for profits and losses has become magnified.

"We've been at high valuations for so long that there's a high degree of acceptance of these valuations as normal when in fact they are extreme by any historical standard," says Paul Greenwood, a senior analyst at Russell.

It's no secret that despite the recent correction in Nasdaq stocks, the market still trades at high valuations. But the size of the aberration is mind-boggling.

Clearly, Greenwood says, valuation levels have risen far more in recent years than underlying fundamentals. For instance, in December 1978, when Russell first began collecting data for its indexes, the price-earnings multiple on the Russell 1000 Growth Index of large-company stocks was 10.4. It's now 44.8. While this valuation measure has risen more than 400% over those years, the five-year earnings growth per share on the Russell 1000 has gone from 17.8% to 22.5%, a rise of 26%. So the market multiple has expanded far more than the underlying earnings numbers.

The changes run deeper than the valuation and earnings numbers, and are obvious in the style and sector composition of the Russell indexes. When you examine the growing influence of large-cap growth stocks over the last 20 years and of certain industry sectors, the higher concentration in riskier stocks is glaring.

As an indication of just how much influence large caps have gained versus small caps, Greenwood says the top three stocks in the Russell 3000 as of the end of April--GE, Cisco, and Intel--had a higher combined market capitalization than the entire Russell 2000.

The sector weightings in the Russell indexes over the last two decades show a similar skewing toward one industry - technology - at the expense of other key sectors such as autos, transportation, and energy. The technology sector comprised 11.4% of the total market capitalization of the Russell 1000 in December 1978. Today, it accounts for 30.2% of the market capitalization in the Russell 1000.

Greenwood says the higher weighting of tech stocks in the total stock market means the market's behavior is less predictable. And that means correlation coefficients underlying asset allocation models are less reliable. "So many of the technology companies are so new and unseasoned it is difficult to predict what sort of diversifying impact they will have on a portfolio," he says.

Technology stocks are more volatile because new technology created in someone's garage can sometimes make obsolete solutions owned by large companies. Also, bricks-and-mortar companies do not scale up as quickly as tech stocks. So tech stocks rise and fall more rapidly. These characteristics, along with their lofty valuations, now have a much more profound effect on the total stock market and have intensified the market's risk and return potential, argues Greenwood.

So investors who want to keep up with the market today are going to have 30% of their holdings in tech stocks, and advisors who attempt to outperform the market may feel pressure to place 40% or 50% of holdings in tech stocks. Now, more than ever, investors who want to get market-like returns need to be prepared for high volatility and have a commitment to ride out corrections.


See All, Do All

A new Web-based system can serve as your back office, with separate accounts thrown in

If you're running an independent advisory firm, then back office administration is probably a major headache and expense. Here's some good news: Web-based systems allowing you to outsource your back-office are about to become more prevalent and more dynamic.

ADVISORport.com, a new Web-based back-office system launched in May, will be a serious contender for managing your practice via the Web. Many such systems are likely to be launched in the next few months, but ADVISORport's breadth and sophistication are impressive.

About 18 months ago, we reviewed the first such back-office system, Advent Browser Reporting for Enterprise Users. It lets you use your Web browser to access portfolio reports being run at a remote location.

Next came service bureaus, such as those at SAI, Commonwealth Financial Network, and Pacific Financial, which take your customer account downloads from your custodian or brokerage firm, reconcile your client account data and upload it to the Web. Your client reports sit on their server and you can go to a secure site at any time to access all your client reports. Reports look the same as if you were running Advent's Axys portfolio management system in your office. The cost? SAI says it's four basis points, or as much as six or eight bps for customized reports or manual intervention in your data.

In addition to Advent, Portfolio 2000 is getting into the service bureau business. Its AdvisorMart.com service bureau will charge $50 to $100. For $100, you get Web access to reports and AdvisorMart mails paper reports quarterly to your clients. AdvisorMart not only provides access to many of the different reports produced by Portfolio 2000, your clients also have Web access to reports. This Web back office helped attract Morningstar's significant investment in P2000.

Recently, Centerpiece said it would create a Web-enabled portfolio management system. While Centerpiece plans to also offer a service bureau, it is months away and no details are available about it yet.

The latest entrant, ADVISORport.com, appears to be the most comprehensive back office yet. It offers much more than just portfolio management. It contains client contact management functionality, for instance, and allows you to conduct research via the Web using data from Thomson Financial, IBES, and others. Perhaps ADVISORport's most interesting feature is that it offers a separate account manager program rivaling services offered by Lockwood Financial, SEI, PMC, and others, giving you the ability to easily create proposals for clients. ADVISORport already has about 25 managers in the separate account program.

"ADVISORport.com gives advisors the power to outsource, automate, and customize key advisor functions - like portfolio construction, investment and manager selection, back office accounting requirements, client reporting, and more," according to the firm's Web site.

Gregory Horn, CEO of ADVISORport, gave me and four advisors a one-hour tour of the service. Horn, a founder of Persimmon Capital Management, says the first generation of the ADVISORport platform is geared to separate account management but a new release this summer will integrate mutual funds into the system.

The advisors who saw ADVISORport's online tour were wowed by the technology and the depth of the back office tools. "It's pretty impressive," says Jack Bowman of Private Investment Group, Inc. in Centerville, Ohio. Bowman, who has done some separate account work through Lockwood, says variable annuity data would need to be incorporated into ADVISORport and that turning your back office over to someone is "scary" to him. But the service intrigues him.

Larry Howes of Sharkey, Howes & Javer, of Denver, says that ADVISORport probably would not work for his firm, which manages well over $100 million in assets, but could work well for smaller firms. "These are neat guys and they have the right stuff," says Howes. Howes says the fees charged by ADVISORport.com, which start at 25 basis points and scales down to 10 bps for larger advisors, are likely to make the service too expensive for larger advisory firms.

Glen Buco, of West Financial in Annandale, Virginia, which manages $350 million, had a similar reaction. Buco says that at 10 bps, it would cost his firm $350,000 for ADVISORport.com, and that buys a lot of back office that he could custom tailor to his needs. Still, Buco says, "ADVISORport's the first thing of this nature tying together so many pieces."

Horn says that when you add in the separate account manager administration fees at Schwab and other firms, the back office cost is covered. "When you consider that for between 10 and 25 basis points you get a separate account research administration system as well as back office," Horn says, "the economics should work fine. If you're using one of the other separate account systems, and you're paying 40 bps to them or more and you get only limited Web access and limited proposal generation capabilities, then being able to get all of that and more at half the cost will be attractive. We're shifting the paradigm in the separate account business."

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