CFDD - January, 2009

As noted in the CFDD’s 2008 Advisor Conference keynote session, No More Business As Usual, the retirement plans industry will have to adjust to more scrutiny, new regulations, litigation, limited growth, less revenue, reduced margins and more consolidation.

DC plan assets have declined by over $1 trillion, but Stable Value Fund assets are approaching record levels. They are also positioned to capture significant cash flow due to growing risk aversion, low yields, money market fund closings and threats to the $1.00 per share NAV gold standard. On the other hand, the lack of wrap capacity and concerns over losses in the underlying portfolios have some sponsors concerned.

While the aforementioned are all key issues, nothing will be more important than surviving the current financial crisis and helping clients earn a reasonable return on their investments. Alternative approaches to asset allocation and asset classes, particularly commodities, seem destined to play a larger role in the investment arena. To help advisors bridge the educational gap, the CFDD will commit intellectual capital to this area.

The Federal Reserve has written a new chapter in the aggressive expansion of fiscal and monetary policies. The Fed is using all available tools on an “all in” basis to stabilize a credit crisis that morphed into a solvency crisis. With economic concerns mounting, more quantitative easing (asset purchases) will no doubt follow.

The Fed deserves an “A” for effort in their attempts to thaw the credit markets, but the financial markets have not really responded and the results are unknown at this time. Like a game of poker, the stakes are high because modern economies run on liquidity, credit, trust and confidence. If things are not managed properly, unlike a poker game, all players at the table could be losers.

Assuming there are no new shocks, including a major terrorist event, the Fed policies could work, but they won’t work quickly and they could have unintended consequences. Stabilizing the financial crisis will take years and additional deleveraging will be accompanied by low or no growth, high unemployment, huge deficits and total federal debt far in excess of our GDP. In short, we are paying the price for a lack of responsible leadership and fiscal mismanagement during the growth years.

The healing process mentioned above will, however, be dependent on foreign willingness to finance our debt. If the dollar collapses, something we don’t expect, long term rates could rise and ignite another wave of problems. A successful adjustment process will also require stimulus expenditures that enhance productivity rather than postpone the inevitable.

Deleveraging is not yet complete and bank balance sheets, particularly foreign banks, remain unknown. The lack of credit availability is our primary problem and lending standards have never been higher. However, assuming new surprises are minimal; we could weather the storm through an extended recovery period that would include major adjustments.

After trillions in worldwide losses and an eleven year low, equities are attempting to bottom. We are in uncharted waters and there are no guarantees, but the retested lows could hold. Even if equity prices stabilize, the lack of growth drivers and a reduced appetite for investment risk will make sustained rallies unlikely.

When growth does return, the decrease in leverage is unlikely to produce the high earnings experienced in recent years. Higher corporate taxes are also inevitable. As a result, the traditional approach to valuations, asset allocation, diversification, rebalancing and broad equity indexing could be disappointing in the years ahead.

ASSET ALLOCATION & THE NEW ERA

The era of leveraged growth, particularly at the consumer level, and the golden age of equity investing is over. Change is difficult to accept and most of the financial services industry is stuck in the past and basing decisions on blind faith.

The industry has not adjusted to the new era, but the relentless selling of all major asset classes has generated non-traditional opportunities of major proportions. To capitalize on these opportunities, the industry will have to adjust and step outside their comfort zone. Most will not make the adjustment and those that fail to adapt will risk marginalization or worse.

Deleveraging resulted in unprecedented correlation. With the exception of gold and Treasury securities, all asset classes have been clobbered. Diversification is a basic principle of investing and it may work over time, but it doesn’t ensure against losses, particularly during a crisis period. Ironically, a simple balanced portfolio would have fared better over the last year than one constructed with sophisticated diversification strategies, particularly high cost diversification.

Commodities have not provided hedge protection during the credit induced deflationary bust. The demand destruction is, however, nearing completion and supply shocks are ahead. The supply shocks will be exacerbated by capital expenditure curtailments in many commodity-based industries. Unlike equities, commodities, not commodity stocks, are undervalued and positioned for recovery. Indeed, non-industrial commodities may have bottomed already. Equally weighted commodity indexes are also diverging from energy heavy commodity indexes.

While commodities may offer major opportunities for growth, it’s worth noting that other favorable risk/reward opportunities seem limited. Like commodities, TIPs are “real return” assets and they seem compelling at current levels. Equities and bonds are “financial assets” and while emerging markets might offer value at current levels, Treasuries are another story. High quality corporate bond yields are attractive, but they come with bankruptcy risk. Real estate is also a “real return” asset, but commercial real estate could be the next disaster.

Gold, not precious metals or precious metals funds, remains a safe haven in a dangerous world without safe havens. The CFDD has recommended gold as an alternative asset class for almost a decade, but the industry has not acknowledged the yellow metal’s unique status. Dwarfing the return of the Specialty-Precious Metals Fund Category, the SPDR Gold Shares (GLD) has become the top performing ETF over the last three years and the third largest ETF.

Advisors have an opportunity to add value, grow and prosper, but it will require a break with tradition. To position for the next cycle, advisors should identify severely undervalued assets with the potential for recovery. On strength, assets that are not expected to recover should be liquidated.

The investment environment is fraught with danger. Now more than ever, liquidity, selectivity (including one's approach to indexing), risk control and being rewarded for risk are essential. It is also important not to confuse asset classes with investment vehicles. Indeed, the most efficient investment vehicles are often simple, low cost, liquid, accessible, passive, targeted and transparent.

The passive sector exposure, including commodities, offered by ETFs is currently unmatched. ETF cash flow & trading volume continue to increase and major new players are expected to enter the market. ETFs are positioned to grow sharply in the years ahead, but advisors need to understand as well as communicate the strategy and methodology employed by the ETFs they recommend.

In addition to increased hedging, weighting, trading and individual ETF use, we also believe that new technology will facilitate the increased use of ETFs within the retirement plans market.

As noted, the seven year commodity bull market was subject to the same indiscriminate liquidation that plagued all asset classes. Commodities entail risk, volatility and periods of underperformance. However, when the traditional approach to asset allocation is augmented, commodities can lower risk and improve returns.

Being grounded in reality, we would not consider a managed futures approach. Additionally, we would not consider commodities unless they were severely undervalued, low priced and their forward looking conditions were overwhelmingly positive. We believe those conditions exist today.

In short, commodities can provide the following, but only under the right circumstances:

•	High Returns
•	Risk Diversification
•	Low Correlations
	-Traditional Asset Classes -Other Commodities -Business Cycles
•	Event/Risk Protection

To assist advisors with the education process, we have scheduled a suite of breakout sessions around commodities at the CFDD’s October 5-7, 2009 Advisor Conference, Adapt, Survive & Prosper.

Tom Idzorek (CIO & Director of Product Research for Ibbotson Associates) will discuss Real Return Assets. Bob Greer (EVP & Manager of Real Return Products for PIMCO) will discuss Why Commodities. The agenda will also include a session on Commodity-Based Investment Vehicles (BGI, PIMCO &others), Tactical Asset Allocation and Customized Benchmarks (Fiduciary Risk Assessment, MPI, fi360 & UpTick Data).

Greg Porteous (National Sales Manager, iShares 401(k), Barclays Global Investors) will discuss ETFs & Retirement Plans and Glenn Dial (VP Investment Only DC for JPMorgan Asset Management) will discuss Tools For Categorizing & Analyzing Target Date Funds.

The fifty plus different sessions on the CFDD’s 2009 Advisor Conference agenda will be featured in a separate release. However, it’s worth noting that one of the conference sessions will have a MAJOR impact on the retirement plans industry, including a redirection of market share.

Consistent with the CFDD’s “all business” approach, our keynote sessions will feature Steve Saxon (Principal, Groom Law Group), David Wray (President, Profit Sharing/401(k) Council) and Blaine Akin (President & CEO, fi360).

Advisors are not currently supported in the commodity related area. To accelerate the educational effort, we are attaching the first of a four-part release on commodities. The CFDD is also building a commodity resource website area for advisors which will include hard to find commodity index benchmarking data, including sub-sector information, and other pertinent information.

Part I of the attached commodity release focuses on Evaluating Commodity Indexes. The subsequent releases will include Commodity Based Investment Vehicles and the Outlook for Commodity Prices.

CFDD 2009 ADVISOR CONFERENCE

The CFDD’s October 5-7, 2009 Advisor Conference, Adapt, Prosper & Survive, is developing early. If you would like to participate in the agenda or suggest a topic, it is strongly suggested that you contact us as soon as possible.

In addition to rich content, the 2009 Advisor Conference will feature an Old/Wild West theme, entertainment and unique social activities for networking purposes. All registrants are eligible for the CFDD’s Western Attire Awards and our Grand Prize Dude Ranch Vacation, a dream getaway for two at one of the nation’s top luxury resorts.

Exhibition space is limited and almost half of the available booths have already been selected. If you plan to exhibit, you may wish to choose your premium booth location early. In addition to rich content and unmatched advisor attendance, the CFDD’s Advisor Conference offers unequalled value. More than any other conference, the CFDD provides an industrial strength conduit to the most accomplished retirement plan advisors and their HNW teams.

© Copyright 2008. All rights reserved. Center for Due Diligence. This release is published exclusively for the trade as general information and should not be viewed as a recommendation to buy or sell securities, other investments or to adopt any investment strategy. This material should also not be viewed as a forecast as CFDD opinions are influenced by marketplace dynamics and subject to change. The CFDD is not a law, advisory or investment firm. We do not give legal, tax, investment or any other type of advice. The CFDD does not warrant and is not responsible for the accuracy of content, errors or omissions. All investments involve risk. Reliance upon information in this material is at the sole discretion of the reader. The CFDD is an information & strategic resources firm serving retirement plan advisors. The CFDD also hosts the industry’s largest conference for retirement plan advisors. The CFDD’s October 5-7, 2009 Advisor Conference, Adapt, Survive & Prosper will be held at the Fairmont Scottsdale Resort in Scottsdale, Arizona. For more information about our publications, conferences and advertising opportunities, contact: CFDD, PO Box 8, Western Springs, IL 60558. We can be reached by phone at (630) 662-0284, by fax at (630) 662-0286 and by email at CFDD@TheCFDD.com. You may also visit our website for more information at: http://www.thecfdd.com.

ASSET ALLOCATION IN A CHANGING WORLD, COMFORT ZONES & GROWTH OPPORTUNITIES