Recovery to Exceed Expectations: Barclays

NEW YORK-Following one the worst global financial meltdowns, the economic recovery has exceeded almost anyone's expectations and will get another jolt when employment numbers begin to improve in the next couple of months, according to Barclays Capital.

The key risk to the markets will be the withdrawal of policy stimulus in America and especially in China, which "faces an overheating economy growing at breakneck speed and needs slow growth reasonably quickly," according to Barclay's global research report.

Although the Fed's expected tightening will generate some volatility in the asset markets, it is seen as less of a threat because there is no imminent inflation threat, nor any desire to slow growth. Larry Kantor, director of research for Barclays, said at the firm's headquarters here that the global economy has grown at a 4% clip since the middle of last year to return to its pace prior to the economic crisis. Furthermore, he said the recovery is not in the "late innings," but rather just beginning. "The global economy is not only growing but it's growing at a pretty rapid clip," Kantor said. "You wouldn't know that from reading the newspaper and talking to people. Part of that is because the recovery is being led by the emerging markets, and the developed countries have lagged."

In addition, Kantor said that the labor market is also still weakened, which makes people leery of the recovery's strength. Yet, he predicts improving employment numbers in the next couple of months, which "will convince people we're in a self-sustaining recovery."

Kantor also called into question the emphasis many people have placed on budget deficits and the threat of double-dips, which he calls "backward-looking views" at the economy. Although the deficit will have to be addressed, he argued that recessions breed rising deficits, mainly because the way to fight back at a recession is through fiscal stimulus. As the most recent recession grew deeper, "[the government] threw the kitchen sink" at it. Thus, the budget deficit "is not the start of something new. This is a vestige of what we've been through," he said, adding that as that normal GDP growth returns, the deficit will subside.

Going forward, Barclays is recommending investors have significant exposure to equity and credit markets, hedged with a short position in U.S. Treasuries and a long position in volatility. Investors should be rewarded for taking risk over the next few months.

Financial Engines IPO Underscores Bright Future For Advice in 401(k) Plans

The hugely successful initial public offering earlier this month by Financial Engines, a retirement plan advisor co-founded by a Nobel Prize winner, affirmed investor belief in a business model offering low-cost sophisticated retirement advice to individual investors.

In its debut, Financial Engines' shares were originally offered at $9 to $11 each, but priced at $12. At deadline, they were trading at $17.71. "The market is looking for quality," said Bill Buhr, an IPO strategist at Morningstar.

Similar to Morningstar, Financial Engines offers retirement planning and investment advice to investors enrolled in company-sponsored 401(k)s and other defined contribution retirement plans. Launched in 1996, it uses an automated, web-based platform to collect information from investors and assess their retirement-income needs. It then uses mathematical algorithms to make recommendations.

"There is a growing market for financial advice, specifically for defined contribution plans," Buhr said.

In its registration statement filed with the Securities and Exchange Commission in December, Financial Engines said shifting retirement-industry trends would allow it to provide independent and customized portfolio management, investment advice and retirement advice to investors who are not affluent and would not be able to afford personalized services.

Much is said in the financial planning professions these days about how Americans are not preparing for retirement adequately. Evidently, a 14-year-old company that offers respected web-based advice has finally convinced the capital markets that its business model offers a viable way to address that issue.

Financial Engines provides easy-to-understand retirement advice, said Katharine Wolf, a senior analyst at Cerulli Associates in Boston. "What sets them apart is their ability to provide something that is not so much investment-focused as it is outlook-focused," Wolf said, adding she has heard from broker/dealers who have implemented some of the Financial Engines solutions for their employer-sponsored retirement plan advisory services.

Financial Engines generates revenue by signing contracts with employers and plan providers like Vanguard, which has been using Financial Engines' computer-based advice program since 2001. "We thought highly of their methodology, as a low-cost provider," said Linda Wolohan, a Vanguard spokeswoman. 'It made more sense to use a third-party provider for their computer-based model."

Financial Engines is appealing mostly to investors who want to be actively involved in their retirement planning and are comfortable using web-based financial services, she said.

The company offers two levels of service: Online Advice allows investors to take Financial Engines' recommendations, and its Professional Management service is the managed account function that allows Financial Engines to carry out its recommendations. The managed account service charges a fee of about $60 a year, Wolohan said.

But there are caveats to Financial Engines' success. It has had net income losses every year since 2006, which Buhr attributes to its cost structure, which has not allowed the firm to generate enough scale to be profitable. In addition, its revenue structure depends on three- to five-year contracts, which can be canceled at any time for fiduciary reasons or breach of contract.

At Sept. 30, Financial Engines had signed contracts with 107 Fortune 500 companies, and had $23.5 billion of assets under management from 383,000 plan participants. It plans to increase enrollment in managed accounts by converting plans from active enrollment, which requires the employee to opt in, to passive enrollment, which signs them up automatically.

Pension Funds Seek More Reliable Alternatives

More than $2 trillion in public pension fund assets could potentially change management as these funds question the advantage of alternative investment classes and seek more reliable, less correlated choices in the wake of 2008 losses.

Alternative investments like private equity and real estate are supposed to buffer investors from losses in stocks and bonds, but pension fund managers found that in many cases, alternatives fell along with everything else during the market crash. Thus, they are now reevaluating the anticipated outcomes of alternative investments, rather than their objectives.

"We wanted to make sure we grouped assets so we understood why we owned them, and what we expected them to do in various scenarios," said Michael Burns, chief executive of Alaska's $35 billion Permanent Fund Corp.

Burns and his staff started rethinking their asset classifications in 2008, when their fixed-income portfolio stopped correlating with relevant interest rates. This change caused them to question other traditional ideas about diversification.

The fund created new asset classes, including a cash portfolio, an asset class for periods of economic growth, an inflation hedge, high-quality bonds for deflationary periods and a special opportunities class to take advantage of unique market situations.

Money Market Funds Could Claw Back Fees

Money market mutual funds could continue to pay low yields, even after a future rise in interest rates turns their income around.

Once that happens, legal advisers warn investors that money market funds that absorbed fees to keep their net asset values from falling below $1.00 could look to recoup those fees, thanks to a claw-back or "recapture" clause in most fund prospectuses.

A recapture clause in most fund prospectuses, often located in the fine print, allows funds to recapture these waived fees once yields turn around.

Money fund yields have been extremely low-often just two basis points-since 2008, and likely would have been negative had fund companies not waived their fees. The Federal Reserve has said it plans to keep rates near zero for the near future, but once interest rates start to rise again, money funds will no longer have to prop up their NAVs.

12b-1s Still on SEC's Radar

The Securities and Exchange Commission is promising to take another look at revising or eliminating 12b-1 fees this year, now that the financial crisis seems to be abating. "I hope that 12b-1 fees stop being one of these perennial issues," said Andrew "Buddy" Donohue, associate director of the division of investment management at the SEC. "We're going to be addressing them again soon." The industry collected $9.5 billion in 12b-1 fees in 2009, according to the Investment Company Institute.

(c) Copyright 2010 Money Management Executive and SourceMedia, Inc. All rights reserved.

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