Retirement Income With Limited Risk
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. The Retirement Income Dilemma
2. Convertible Bonds as an Income Option
3. Revisiting the Advantages of Convertible Bonds
4. The Wellesley Advantage – A New Webinar
5. Another Chance to Hear Greg Miller, CPA
As long-time readers know, my company has almost a thousand investment clients spread throughout almost all of the 50 states. Every other year or so, we send a detailed survey questionnaire to our clients just to get a feel for their thinking on a variety of topics. We do this, for one reason – since most of our clients come to us by way of referral, we have never met many of them in person. I shared the results of this year’s Client Survey with you in my August 17 E-Letter.
In all of our client surveys over the years, we’ve asked for suggestions on how we can improve our various services, and if there are other products they would like us to offer. Since many of our clients are older, the subject of retirement income always comes up in the surveys. Recently, there has been more interest in this topic than ever before. Almost 70% of respondents told me that they need help as they move from the accumulation stage (ie - working career) of their lives to the distribution phase (ie - retirement).
Given this high level of interest in income-generation among my readers, this week I will revisit one of our favorite investment programs which is ideal for those who need income – whether you are in retirement or not. The Wellesley Convertible Bond Program actively manages portfolios of individual convertible bonds, a special class of bonds that has both equity and bond characteristics, and this program can be used to generate income.
The Wellesley Convertible Bond Program delivered a stellar 34.6% return in 2009, net of all fees and expenses. So far in 2010 through September, Wellesley has a gain of 7.62%, also net of all fees and expenses. Over its 15 year actual track record, this program has delivered average annualized returns of over 10%, with only one losing year. (As always, past performance is no guarantee of future results.)
Obviously, when considering any investment program for income-generation, you want to see a solid long-term performance record, which Wellesley certainly has (15+ years), and you want to see a serious commitment to capital preservation, which Wellesley also has demonstrated. While capital preservation is important before retirement, it’s imperative afterwards.
In an effort to respond to my readers’ interest in a solid income-generating investment program, I will use the rest of this E-Letter to revisit the Wellesley Convertible Bond Program and how it has delivered these impressive returns over many years. As you read on, I think you will understand why I have my largest personal allocation in this program, among all of the programs we recommend.
The Retirement Income Dilemma
A successful income-generating strategy can be attractive to many investors, but especially for those at or near retirement. Obviously, today is a very uncertain time to be making decisions about how to withdraw funds for retirement. Plus, those who are at or near retirement age are more wary than ever of programs that offer guarantees but tie up their money for years (ie – annuities), or those that expose them to potentially significant market losses.
As you may know, there are many income strategies out there. As always, there are some successful programs, but many are not. In light of having experienced two bear markets over the past decade, many investors are attempting a balancing act between having enough money to live comfortably in retirement and making sure they don’t run out of money before they die.
The insurance industry is quick to offer up “immediate annuities” as a solution to this dilemma, but many investors do not want to tie up their money for years in exchange for guaranteed income. Plus, the guarantees offered by these companies are only as strong as the companies themselves. Having lived through the credit crisis, most investors are no longer convinced that a company’s size translates to safety.
In the investment management world, investors are often counseled to adjust their asset allocations during retirement to favor bonds over stocks. However, many classes of bonds could be hurt badly as interest rates inevitably rise in the future. Plus, many bond issues are paying rates of interest that are far below an amount needed to keep up with long-term inflation, much less provide meaningful income.
Fortunately, there is a particular bond strategy that is, in my opinion, a godsend to retirees needing to access money from their investments in retirement. Back in April of this year, I introduced you to the Wellesley Convertible Bond Program. Convertible bonds, by their very nature, are hybrid investments, having characteristics of both stocks and bonds. Plus, many convertible bonds offered today have a unique “put” option that provides interim liquidity (exit opportunities) and the ability to manage risk. I will discuss the details of how these put options work below.
The bottom line is, the Wellesley Convertible Bond Program is my hands-down favorite of all the convertible bond strategies I have seen. It has almost zero correlation to stocks or bonds. And best of all, it can be used for income-generation, as I will illustrate below.
Before we get to the income illustrations, I want you to focus on Wellesley’s long-term performance record. As noted above, The Wellesley Convertible Bond Program delivered a stellar 34.6% return in 2009, net of all fees and expenses. So far in 2010 through September, Wellesley has a gain of 7.62%, also net of all fees and expenses.
Over its 15 year actual track record, this program has delivered average annual returns of over 10%, with only one losing year. These are real returns, not some hypothetical or “model” track record. For more detailed information on Wellesley’s actual performance record, click here to review our detailed Advisor Profile.
Convertible Bonds as an Income Option
Anyone who says that a convertible bond program can’t produce a reasonable return with limited risk obviously hasn’t seen Wellesley’s actual track record. While much has been written about the stock market’s “lost decade,” Wellesley’s performance seems to defy gravity.
The goal to produce consistent absolute investment returns makes the Wellesley Convertible Bond Program a natural for investors wanting the potential for reasonable growth, dependable income and principal protection.
The table below illustrates the effects had one invested $500,000 and taken a 5% annual distribution at the end of each year, using Wellesley’s actual performance record:
* Because no client actually took a 5% annual distribution in every year shown above, the results are hypothetical. Please see inherent limitations of using hypothetical results under Important Notes below.
We used the investment amount of $500,000 because this makes it easy to estimate what the numbers could have been using other investment amounts. For example, had an investor originally committed $1 million to this income program, the annual withdrawals would have been double those shown above. Likewise, if an investor had contributed $250,000, the annual withdrawals would have been half of those illustrated in the table.
As you review the numbers above, there are a of couple points that deserve your attention. First, total income withdrawn over the past 15 years would have been over $553,000, meaning that an investor would have been able to withdraw more than the original investment as income over that time. Not only that, but the original $500,000 would have grown to over $823,000 even after paying out over $553,000 in annual income. This is possible due to Wellesley’s focus on consistent absolute returns.
In the illustration above, annual withdrawals were made at the rate of 5% of the accumulated balance. As you can see, this results in annual income of varying amounts, making it somewhat hard to budget for expenses. We usually counsel our clients to work out a budget to determine their income needs, and then withdraw that flat amount from their investment on a periodic basis.
To illustrate this option, the table below shows a $500,000 investment at the inception of the Convertible Bond Program and withdrawals beginning at a flat $30,000 the first year, and then increasing by a 3% cost of living adjustment (C.O.L.A.) over time:
* Because no client actually took the exact annual distribution in every year shown above, the results are hypothetical. Please see inherent limitations of using hypothetical results under Important Notes below.
As you can see, the income produced using a flat-dollar withdrawal is much more predictable and stable for budgeting purposes. Even using a flat amount increasing by 3% each year, the Wellesley Convertible Bond Program still grew the original investment to over $800,000 while producing almost $558,000 of accumulated annual withdrawals.
We could go on and on with illustrations, showing monthly withdrawals, different withdrawal amounts, etc., but I think you get the picture. Wellesley’s historical ability to produce consistent positive returns while also preserving principal would have made an excellent retirement income investment in the past. Of course, we can’t guarantee you the same level of performance or income for the future, but we do know that Greg Miller and his staff at Wellesley will be using the same types of fundamental analysis techniques to manage money in the future as they have in the past.
Wellesley requires a minimum investment of $200,000 in its managed accounts in order to provide sufficient diversification among various convertible bond issues. At this level, Wellesley can also tailor the account to meet the specific needs of the individual investor, including being structured for income. Client accounts are held at TD Ameritrade, and detailed account statements are provided monthly.
How to Get Started
If you have read this far, I trust you agree that the performance results illustrated above are very impressive! I think you would also agree that the Wellesley Convertible Bond Program may be an excellent choice for investors needing retirement income from their investments.
If you would like more information about the Wellesley Convertible Bond Program, give one of our Halbert Wealth Investment Consultants a call at 800-348-3601 or click on the following link to complete one of our online request forms.
Remember, it doesn’t matter where you live; we have clients in almost all 50 states. Plus, it’s unlikely that you’d ever hear about Wellesley from your local broker or Investment Advisor.
Don’t Miss the Next Wellesley Webinar
On Thursday, October 14, at 1:00 p.m. EST, we will sponsor a second live webinar featuring Greg Miller, CPA, Wellesley’s founder, president and CEO. Greg will again describe the Wellesley approach to managing convertible bonds and the emphasis on fundamental analysis. Greg will also discuss how convertible bonds can be used for income generation at retirement, so it’s an event you don’t want to miss. To learn more and register for the free, no obligation Wellesley webinar, click on the following link:
* If you cannot attend the live webinar, a recorded version will be available a few days later on our website: www.halbertwealth.com.
Now that I have shown you the actual performance numbers and the income-generating potential of the Wellesley Convertible Bond Program, you are probably wondering how Greg’s strategy works. To help with that, I have included more detailed information below.
Why Convertible Bonds?
The stock markets are inherently volatile – we all know that, especially with two bear markets in the last decade alone. Over 15 years ago, Wellesley’s founder, Greg Miller, CPA sought a way to participate in the stock market’s upside, but also have a measure of downside protection along the way. He found just such a vehicle in the form of convertible bonds. These bonds have the potential to participate in the upside movement of the stock market, yet have downside protection in the form of the issuer’s guarantee of the return of principal at maturity.
A convertible bond is simply a corporate bond that can be exchanged for a specific number of the issuing company’s shares of common stock. The conversion feature is typically included as an incentive for the holder to accept a rate of interest lower than prevailing rates. Buyers of these types of bonds hope that an increase in the value of the underlying stock will raise the value of the convertible bond.
Thus, the conversion privilege allows bondholders to participate in the upside potential of the underlying stock, yet have some underlying principal protection at the bond’s maturity or at certain “put” option dates prior to maturity. Of course, any principal protection ultimately relies on the issuer’s financial ability to retire the debt.
Convertible bonds are typically sold at a price representing a premium over the current conversion value, meaning that the stock must appreciate in order for the bond to become more valuable. While there is a yield (interest rate) component to most convertible bonds, Wellesley manages its bond portfolio primarily for capital gains, with any interest earnings being icing on the cake.
Perhaps the most valuable feature of convertible bonds is the “put” option available in many of the offerings. This option allows the bondholder to redeem it for cash or stock at pre-determined prices at various points in time. Thus, while the price of a convertible bond will likely fluctuate over the life of the bond, the availability of the “put” option can help to stabilize the bond price, assuming the financial condition of the issuer remains stable.
The Wellesley Advantage
It takes only a few minutes with Greg Miller to recognize both his expertise and his enthusiasm for investing in this special kind of corporate bond. He actually developed this strategy to manage his own money after selling a successful business. Greg recognized early-on that the standard buy-and-hold approaches he was receiving from brokers could lead to major losses in bear markets. So, he took on the challenge of finding a way to invest that would produce reasonable returns with limited risk. The result of his hard work over the years is Wellesley’s Convertible Bond Program.
The way Wellesley limits investment risk is by managing for “absolute returns,” which is a strategy with the goal of producing positive returns in both up and down markets (no guarantees, of course). Based on Greg’s extensive research, he believes one way investment risk can best be managed is by investing in a diversified portfolio of individual convertible bonds that include the “put” options for additional liquidity, as opposed to holding the bonds to maturity.
Wellesley’s investment strategy is a four-step process that employs fundamental analysis as a means to evaluate convertible bond issues. First, Wellesley screens the convertible bond universe to find issues that meet their strict standards. They typically look for convertible bond issues that are “investment grade,” that have attractive “put” and “call” provisions and an appropriate equity premium.
Next, Greg and his team put their financial analysis skills to work in researching the companies issuing the bonds. Greg primarily seeks companies with growing profits and at least 10 years of positive growth. He also seeks 10 years of continued strengthening of the corporate balance sheets and strong management performance. The stock of the company should also be at a satisfactory “valuation multiple” in relation to its peers and the market as a whole.
It is also important to note that Greg and his team do not put much faith in the major credit rating agencies when doing their financial analysis on prospective issuers. Greg did not trust these agencies even before the credit crisis revealed how unreliable their ratings can be.
Third, economic factors are then considered that might affect the bond issue being reviewed. Greg and his research team consider the overall economic outlook, interest rate projections, prospects for the sector and industry, and reach a preliminary investment decision. Wellesley’s goal is to select convertible bonds with the potential to produce an average absolute return of 10% or more annually over five to10 year periods, without annual losses.
The final step of the process is to determine whether to buy a particular issue or pass it by. Additional screens and requirements are considered, with the overall goal of not losing money. This same analysis is also performed regularly on the existing bonds held in client accounts.
Wellesley constantly monitors each position in relation to the strength of the issuer, conversion value of the bond and any upcoming “put” and “call” dates. Wellesley calls this ongoing review their “buy, hold, sell, put or convert decision.” While you may find a conventional broker who will sell you a convertible bond, few are likely to understand the importance of the put options and how to execute them to your advantage, much less provide this level of hands-on active involvement.
The importance of effective fundamental analysis cannot be overemphasized. Convertible bonds have all of the normal characteristics of most other bonds (maturity date, interest rate risk, default risk, etc.), so it is important to determine the financial health of the company issuing the bond. However, a major factor in the potential growth of a bond’s value is based on the underlying stock. Thus, Wellesley’s analysis goes far beyond the company’s ability to retire the debt, and seriously considers its long-term prospects in relation to its stock price.
Most investors know relatively little or nothing about convertible bonds, especially those that include “put” options, offer entry and exit strategies and opportunities to limit risk. This investment niche is largely the domain of very sophisticated institutional investors, hedge funds and the like.
For all the reasons outlined above, I feel that the Wellesley Convertible Bond Program could be an excellent choice during the current uncertain market environment. While much of this E-Letter has concentrated on Wellesley as a retirement income option, it’s important to know that this strategy is also an excellent bond allocation for investors in the accumulation phase of their financial lives.
A common question we are asked by prospective investors looking at Wellesley is: How should it perform in a rising interest rate environment? Greg’s research has shown that, historically, convertible bonds have often fared very well during periods of rising interest rates. With interest rates likely to move higher at some point in the future, Wellesley’s Convertible Bond Program could be an important asset class to have in your portfolio. If suitable, it could even be a substitution for your bond allocation when interest rates begin to rise.
I think you owe it to yourself to at least check out this program to see if it can complement your other allocations.
Finally, you should know I have my own money in every investment program that we offer at my company. That includes more than a dozen managed account programs and funds that we recommend. For the record, my largest allocation is with Wellesley.
If you would like more information about the Wellesley Convertible Bond Program managed account, give one of our Halbert Wealth Investment Consultants a call at 800-348-3601 or click on the following link to complete one of our online request forms.
Finally, don’t forget to register for out latest webinar with Greg Miller this Thursday, October 14 at 1:00 EST. It promises to be very interesting and you will have an opportunity to ask Greg any questions you may have. To sign up, click on the Wellesley Webinar Registration Link. If you cannot attend the live webinar, a recorded version will be available a few days later on our website: www.halbertwealth.com.
Hoping you like driving a “convertible,”
Gary D. Halbert
IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM) and Wellesley Investment Advisors ("WIA") are Investment Advisors registered with the SEC and/or their respective states. This article does not constitute a solicitation to residents of any jurisdiction where the program mentioned may not be available. Information in this report is taken from sources believed to be reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal advice. HWM receives compensation from WIA in exchange for introducing client accounts. For more information on HWM or WIA, please consult the respective Form ADV II for the Advisor, available at no charge upon request. Officers, employees and affiliates of HWM may have investments managed by Advisors discussed herein and others.
This presentation reflects only the convertible bond portion of WIA's client accounts. Returns are based on all convertible bond positions held in accounts of all WIA clients during the periods reflected. Actual client accounts include positions other than convertible bond positions. Such other positions are not included in this performance presentation. Accordingly, the actual return of WIA client accounts is different, in some cases substantially, from the performance information presented in convertible bonds. During the periods reflected, WIA did not manage any other accounts that included only convertible bonds in their portfolios. Returns are net of a 1.75% annual management fee, which is the highest management fee charged by WIA during the period (minimum fee is $4,000/year, so smaller accounts may pay a higher fee). Actual management fee rates vary based on each client's assets under WIA's management. These performance numbers have not been verified by HWM, and therefore HWM is not responsible for their accuracy.
WIA's convertible returns have been calculated using the following methodology. The bond’s market value on the last day of the month is determined as is the weight of each bond holding in the portfolio. Each bond's return for the month is calculated. It was assumed that the bond entered the portfolio on the first day of the month in which it was first purchased. When a bond is completely sold out of a portfolio, the prior month-end value is adjusted to reflect the final sales price. Each bond's return for the month was weighted by the bond's weight in the portfolio. The bond’s weighted returns for the month were summed to get the portfolio's return for the month. These numbers were compounded to calculate the annual returns.
The illustrations, “$500,000 Investment at Inception with 5% Annual Withdrawals” and “$500,000 Investment at Inception with Flat-Dollar Annual Withdrawals and 3% C.O.L.A.” are hypothetical. They are based on WIA Convertible Bond Returns (see previous footnotes), and in the first, a hypothetical $500,000 investment in WIA, and end of year withdrawals equal to 5% of the investment balance, and in the second, a hypothetical $500,000 investment in WIA with end of year flat dollar annual withdrawals with a 3% C.O.L.A. No actual WIA client received these exact returns or withdrew these exact amounts. There are inherent limitations in using hypothetical results, particularly the fact that such results do not represent actual trading, and that they may not reflect the impact that material economic and market factors might have had on the adviser's decision-making process if the adviser were actually managing client money.
When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Wellesley Limited Risk trading program.
In addition, you should be aware that (i) the Wellesley Limited Risk trading program involves risk; (ii) the Wellesley Limited Risk trading program’s performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Wellesley will have trading authority over an investor’s account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Wellesley Limited Risk trading program’s fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.
Past performance is not indicative of future results. An investment in convertible bonds involves a risk of loss. The value of an investment in convertible bonds may decrease as well as increase. Performance does not reflect the effects of taxation, which results in lower returns to taxable investors. “Annualized” returns take into account compounding of earnings over the course of an investment’s track record. Statistics for "Worst Drawdown" are calculated at month end. Drawdowns within the month may have been greater. The returns reflect the reinvestment of interest income and dividend income. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic or market conditions.
Copyright © 2010 Halbert Wealth Management, Inc. All Rights Reserved.
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.