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Oct 14, 2018

Roger IbbotsonIn the inaugural episode of the JTalks Podcast, host Jack Martin, strategic marketing consultant and founder of Elite Advisor Group, talks with Dr. Roger Ibbotson about his latest research and why financial advisors should consider Fixed Index Annuities as a bond alternative.

Dr. Ibbotson is an economist and creator of the iconic "Stock, Bonds, Bills, and Inflation" chart. He is Professor Emeritus of Finance at the Yale School of Management. He is a Member and the Chairman of Zebra Capital Management, LLC. We are also joined by John Holmgren who is the President of Zebra Capital Management.




Suzanne Lynn:    00:01     Welcome to our JTalks Podcast, where leading advisors find the fuel to drive their Business Alpha. InsurMark is an advisor development organization. This is the next step in our 35 year history of aligning the independent financial advisor with best of breed resources and services, from a dedicated professional team, product partners, technology vendors, practice management leaders, and business development systems.

00:31     Today, Jack Martin, our Strategic Management Consultant and Founder of Elite Advisor Group will be talking with Dr. Roger Ibbotson about his latest research, and why financial advisors should consider the fixed index annuity, a bond alternative. Dr. Ibbotson is an economist, and a creator of the iconic Stock, Bonds, Bills, and Inflation chart. He is Professor Emeritus of Finance at the Yale School of Management. He is a member and the Chairman of Zebra Capital Management, LLC.

01:05     We are also joined by John Holmgren, who is the President of Zebra Capital Management. And now, let's join Jack and Dr. Ibbotson.

Jack Martin:        01:14     Hello, Dr. Ibbotson. Hey, thanks for joining us on the Jay Talks Podcast today. It looks like Yale might win the Ivy League in football again.

Roger Ibbotson: 01:23     Well, I'm certainly hoping so, but I'm not gonna be an expert on that although I have attended a game already, so.

Jack Martin:        01:30     Yeah, so today what we wanna talk about is your white paper. We wanna talk about Fixed Annuities and Bond Alternatives. You started your career as a Bond Manager at the University of Chicago, right?

Roger Ibbotson: 01:45     Yes, I actually managed the bond portfolio at the University of Chicago, and it was a very interesting time. It was a time when bond deals were still rising, but they were about ready to hit their peaks in the early 1980s. And they got into the double digits, so it was an interesting time but not exactly like today, because today's yields are much lower of course. Although we may have the rising yields.

Jack Martin:        02:10     Right. So what's your thinking about where interest rates and the bond market are today?

Roger Ibbotson: 02:16     Well, you know I think they are really low actually, because bonds have actually, yielding around three percent today. And this is after a long drop in yields from the early '80s when they were double digits, falling all the way to three percent, so it's been a time when people historically have really yielded great returns on bonds. Because during that period of drop, they actually had a high yield, plus they actually got a capital gain from the drop in yields, but the way a bond works is, you get the yield and then when the yield drops, you're practically, you're holding the higher yielding bonds and your bonds go up in price. So, people for decades have really realized not only that yield, but substantial capital gains in bonds.

Jack Martin:        03:09     In the title of your white paper, you use the term bond alternatives. So, help our audience understand what that means and why we need to be thinking about those today.

Roger Ibbotson: 03:17     Well, you can see why we might need the bond alternative when you think of today's yields now, because now they are at that three percent, where are they gonna go from here? They're much more likely to go up than down. And if they go up, you end up with a yield plus a capital loss. And so you financially have negative returns on your bonds. So, we need an alternative actually, and that's why we looked at this whole situation because we need to look at some other way of actually taking less risk, at the same time getting a decent return. So we need another way to do this, which we don't wanna have capital losses in our bonds, which we might very well have. We need an alternative.

Jack Martin:        04:02     Do you think investment advisors and investors generally maybe have a little bit of a blind spot about those bond risks?

Roger Ibbotson: 04:09     Well, they do because they've been so used to actually getting positive big returns on their bonds. So, they've viewed bonds as a really a substantial source of returns. But that's not what's gonna happen going forward. Even the three percent is probably a high estimate of what you'll get going forward, because as bond yields rise, you're gonna have capital losses. So, yes they do have a blind spot, and for good reason. They're looking at history, and certainly bonds have served everybody very well, historically. It's just that today, times are a little bit different, and that today at that low yield, you're not gonna get those high returns anymore, and you may even have capital losses.

Jack Martin:        04:53     So, is there something in the way that we're wired or is there something behavioral, you know behind why people are still so in love with bonds, based on what you just said?

Roger Ibbotson: 05:05     Well, people tend to extrapolate of course. Whatever happened to them last year or last decade, they expect that to happen again. But what actually, you know bonds have a structure to them. You know that's not gonna happen again. We actually know what the yield is today. So when you actually know what that yield is, you know that the only way you're gonna get a capital gain is if the yields fall further. There's not too much further they could actually fall. But they could rise definitely. So behaviorally, people tend to look back at the past and think that's the future. But obviously that's not the case in the bond market.

Jack Martin:        05:42     When you were at Ibbotson back in 2007, you wrote a monograph titled, Lifetime Financial Advice, and in that you discussed investing over one's life cycle. So, should investors be concerned about longevity risks with that in mind?

Roger Ibbotson: 05:59     Well, they certainly should, and actually you know when you think of the whole life cycle that somebody invests in, actually the insurance can kind of play a role in every piece of it. In the early years, people have steady wage income typically, and they could take on a lot of equity risk. But the other thing they often need is life insurance. So, life insurance pays a role.

Roger Ibbotson: 06:21     Now, as you start approaching retirement, you actually have to take less risk and here again, insurance can play a role, and here now we're looking at accumulation annuities, such as FIAs can play a role in accumulating your capital in a less risky way. And then when you get into retirement, annuities can also play a role, because here the retirement people need continual income streams. They can have payouts. They don't know how long they're gonna live though, because that's part of the ... that's what longevity risk is all about. Of course, we want to live for a long time, but if we do there's some chance we would run out of money, and actually the pay out annuities actually help to solve that problem because they pull everybody together, so that each one of us can actually get an income stream for the rest of our lives.

Jack Martin:        07:14     So, just to follow up on that, conventional wisdom says that as we approach retirement, we wanna invest a little bit more conservatively. So, what makes those years right before retirement so critical?

Roger Ibbotson: 07:26     Well, those years are, we've been saving up for retirement and actually, those are the years to actually have your sort of your maximum financial wealth because as you start into retirement, you start withdrawing from that, and paying for your retirement. Now, if you have a loss when you have the biggest amount of money at stake, that loss actually can ruin your retirement really. So, they're really important years. And that's why we're recommending in general, and I've always recommended, that as you start approaching retirement, you need to de-risk. You need to take less risk in that portfolio, and of course the conventional way that's been done is with bonds. But I guess now, now we have other instruments like Fixed Index annuities.

Jack Martin:        08:14     And so, there's been a lot of conversation about those first few years after retirement, and the risks associated with that sequence of returns and those kinds of things. So, are the risks different? Should we have a different perspective on those first few years after retirement? Should we invest a little differently?

Roger Ibbotson: 08:33     Well they are especially critical because we no longer have the wage income, and we are actually typically making these withdrawals. So, the combination of having that relatively large financial stake and withdrawals taking place, and then superimposing it on a return, if you have a bad return here, it's actually gonna take a large chunk out of your financial wealth. If you have a bad return much later, it doesn't matter as much because you won't have as much financial capital anyway at that point.

Jack Martin:        09:08     We've been throwing around this term, fixed indexed annuities. What is a fixed indexed annuity?

Roger Ibbotson: 09:15     Well, first of all it's based on an index and actually, it's based on ... and it's an insurance contract that is participating in an index. So, in our case, we'll talk about that later, but in our case it's actually an equity based index. So, if you participate in an index, like in a fixed index annuity, you're getting the upside of that index. Now, because this is an insurance product, it's actually principal protected. So, as you get the principal protection on the one side that's insured by the insurance company, and you get the participation in the index which could be an equity index, and so you get the positive returns, or part of the positive returns of the equity market, at the same time you have no real downside risk.

Jack Martin:        10:07     So, is that what you were talking about in your white paper when you said, "A major advantage of the FIA is the ability of the insurance provider to transform equity returns into a more tailored risk return profile?"

Roger Ibbotson: 10:22     Yes. That's exactly it because actually if you think about what people really want here, they want to participate in the equity market certainly, but they're afraid to, and they're naturally afraid to. In particularly they're afraid to as they start approaching retirement. So how do they get that participation while the reason why they're afraid is because they know that stocks can drop, and here is where the insurance company plays such a big role with these fixed indexed annuities, which if you actually had some principal protection, you're not gonna have the losses. At the same time, you're gonna get equity exposure on the upside. So, this is actually a product, fixed indexed annuities that are designed specifically to meet the needs of the investor. And that's why actually we're calling it a tailored product, because it's actually tailored to meet the specific needs of the investor.

Jack Martin:        11:23     So there are a lot of investment advisors we've heard, who have a little bit of a bias against annuities. I guess they think FIAs are maybe too complicated, maybe too expensive. Are they right? What are they missing?

Roger Ibbotson: 11:41     Well they can be complicated, of course. And the reason why they're complicated is, because they're tailored. I mean, if you buy suits off the rack, you know they're not gonna be as complicated as a tailored suit that is actually designed to fit you real neat. And here, by tailoring it in this case, is principal protection and equity participation, that combination is by its very nature, somewhat complicated, and so any contract that actually gets you that is somewhat complicated.

Roger Ibbotson: 12:14     But that's a necessary component of a FIA and it's there for a reason. Now, the other aspect of this is the potential costs, and people have said that annuities can have costs like FIAs. Well let me say that these are really for a long term contract, and the costs are high if you get in and then you get out, and you have surrender charges and so forth. But these contracts are designed for people who can hold them for the whole term, like eight, nine, twelve years, whatever they select. But the whole term. Once they're held for the whole term, the accrued costs each year are not that high. So, the key is that these are for the long term investor, and I think the key is matching them up. In fact, by having trusted advisors here match up the right kind of investor with the FIA. Because once you have the right kind of investor that has that long term perspective, it's actually meeting their needs and the costs are not that high.

Jack Martin:        13:23     In your white paper, you talk about an uncapped fixed indexed annuity strategy. What does that mean, and what's the benefit of that approach?

Roger Ibbotson: 13:36     Well, we get equity exposure in those fixed indexed annuities and some of them can be capped, and some of them are uncapped. Actually I think the uncapped has the advantage though of participating in equity markets, getting equity exposure during some very big years, and so there are years where you could have very high returns in a fixed indexed annuity, and if you chop that off, of course it's much harder to get a high return by owning a fixed indexed annuity. A lot of the benefit comes in some of these great years, and we don't wanna cap it I guess, because if we cap it, we're not gonna get that benefit.

Jack Martin:        14:17     So, in your white paper, you did a lot of modeling of what different investments would look like, what their performance would look like under different scenarios. And I think it's in charts 11A through 11D where you talk about, you know what happens to a 60/40 portfolio, a 60/20/20 kind of portfolio, and if interest rates are rising, if there's market volatility. So, can you talk a little bit about that modeling that you did there, and how it impacts the way we look at assets and portfolios?

Roger Ibbotson: 14:53     Yes, we wanted to consider a lot of different scenarios. Of course the stock market can go up or the stock market can go down. And of course, interest rates are looked at, particularly they could be flat and unchanged but they could also rise. So we tried to look at all the combinations of these, and see what would happen to different types of portfolios. And the kind of portfolios we looked at were, well first of all, how would a stock portfolio do and how would a bond portfolio do under these scenarios, but also how we would actually, most of us would wanna put together some diversification in their portfolios. And so we would wanna see how a 60/40 stock bond portfolio would do and how a 60/20/20 where we put fixed indexed annuities in with the stocks and bonds, or just entirely putting in, taking out the bonds entirely and putting in only the annuities in a 60/40 portfolio.

Roger Ibbotson: 15:53     Well, we're looking at all these scenarios with the changing interest rates, and the changing stock market. It turns out that adding fixed indexed annuities is generally very favorable. It's mitigating the risk, and for the most part the returns are very good under these scenarios. Except if the stock market drops and you have fixed indexed annuities in the portfolio, that would have that equity exposure, but it will not actually participate fully in the drop of the market because the fixed indexed annuity itself will be principally protected over the two of three years.

Jack Martin:        16:33     So, over your career, you've done a lot of work on asset allocation, obviously. How do you think FIAs fit into that traditional asset allocation mix? How do they fit on an efficient frontier?

Roger Ibbotson: 16:48     Well, fixed indexed annuities are essentially lowering the risk of the portfolio. And but they're doing it in a way that you're actually getting some equity participation at the same time. So they actually do very well in a portfolio. So the portfolio itself is gonna have less risk as you add fixed indexed annuities to it, and for the most part, as you substitute the bonds out and put in the fixed indexed annuities, we would mostly predict that the fixed indexed annuities would outperform the bonds. So then actually, maybe the kind of the appropriate good storm here, where you end up with potentially less risk but more upside.

Jack Martin:        17:30     So it sounds like that's a positive effect on a traditional efficient frontier then right?

Roger Ibbotson: 17:36     Well, it's definitely a positive effect, of course an efficient frontier means higher ... you wanna get the highest return at the least risk, and here we're lowering the risk and raising the return, and so that's exactly what you would like as an investor.

Jack Martin:        17:51     So, one of your areas of interest over the years has been investor behavior. So with the markets again hitting record highs this year, is greed one of those emotions that can adversely impact pre-retirees?

Roger Ibbotson: 18:07     Yeah, I would say it's not only greed. It's actually I would say both fear and greed are the sort of the key ingredients of an investor, because when things are up they wanna be all in, and then as soon as things drop a bit, they get very careful. They would tend to have their own to swing perhaps, with the markets. What we're trying to really do is actually satisfy the behavioral characteristics of people, which I guess we could sum up as fear and greed. So, on the fear side, with the principal protection, once you alleviate that fear, people are actually willing to have some equity exposure. Of course, they wanted that equity exposure when markets are up, and if they didn't get it they get greedy, and they figure, "Well, I should have done that, I should have been in the equity market." But of course when the equity market goes down, they said, "Well, I shouldn't have been in the equity market."

Roger Ibbotson: 19:05     Well, you've got that combination of fear and greed which kind of paralyzes people here, and this is what FIAs are really designed to take care of here, because we protect against that fear with the principal protection, and we actually satisfy their greed to some extent by participating with equity exposure in these products. And so, now if the markets are up and they have good returns, they're not upset anymore. Because they can be upset by just not being in the market. And the other hand when the market's down, and they are principally protected then they're upset. So, I said this was tailoring. These products are really tailored to meet the behavioral needs really of investors because they have on their own, they would have very much difficulty in actually taking on equity risk.

Suzanne Lynn:    19:59     How prepared are you? Dr. Ibbotson is doing a great job of teaching us about the power of the fixed indexed annuity, and we'll get right back to the podcast in just a second. But, how prepared are you to integrate his research into building a more sustainable business? At InsurMark, we have a proprietary value engineering process that helps growth minded advisors get more out of their life's work. Advisors engaged with us in this process are realizing more client time, more family time, and more value from their business. That's what we call Driving Business Alpha. So check out our Value Engineering video at to learn more. Now, let's get back to Dr. Roger Ibbotson.

Jack Martin:        20:47     So, we spent most of this podcast talking to Dr. Ibbotson. I'd like to turn to Dr. John Holmgren, who's President of Zebra Capital Management. John, I understand your firm has developed a new index for us in FIAs. Can you talk a little bit about how that works, and why investment advisors should be considering it?

John Holmgren: 21:09     You know, it's right Jack, we have. If you look at the white paper, Fixed Annuities Consider the Alternative, we did that in such a way to make a more academic study, where we looked at a generic index, which would be similar to an S&P500, a large cap generic index on an uncapped basis. And really what we did, is we created the NYSE Zebra Edge Index, which is then utilized in the nationwide new heights platform, to create an FIA that's really harnessing these aspects that Roger was talking about. Particularly the idea of popularity, and we wanna have the less popular stocks that are also lower volatility, which then increases the exposure of the index that can actually be utilized in a risk controlled environment.

John Holmgren: 21:58     So, we're using a behavioral financed drive investment philosophy that's designed to avoid and also the exploit the behavioral biases that Roger just talked about. And this is implemented in a systematic way that is designed to dynamically allocate between the equity index as well as the risk control, to maintain that five percent volatility. And in doing that, you know we really created a product which is really designed again as Roger had referenced, for long term investors who are looking to de-risk their portfolios yet participate in the upside of the equity market, while having a capital protection. And that's really kind of what we've done and how this whole process has evolved.

Jack Martin:        22:44     So, should investment advisors look at that index a little bit differently than what we were talking about earlier with respect to FIAs? How should they be applying it?

John Holmgren: 22:55     Well, it's really in the FIA context, as approaching retirement or in the accumulation phase, the latter stages of accumulation of assets. You know, looking at a way of de-risking. So, again back to the idea of a bond substitute as doing that, where the investor can get again, someone who's willing to invest long term. And I wanna be very clear that these strategies are not for everybody, but they're for longer term investors who are looking at an allocation for a certain time period, and looking also post retirement as well, because as you asked earlier about people in earlier stages of retirement or mid-stages of retirement, we really wanna have a flow of income who cannot withstand a sharp draw down, that's really what this is for. So it really fits into that context. I don't really wanna say that it's a new asset class, but it is an asset class that fits in. You know, somewhat of a hybrid between equity and bonds, giving you the volatility of, similar volatility to bonds but with higher upside potential.

Jack Martin:        24:03     Well, this has been really enlightening, and I wanna thank you John, and I wanna thank you Dr. Ibbotson for taking the time to educate us about FIAs as a bond alternative. We also wanna thank Annexus for making the Zebra Capital Team, the new Zebra strategy, and particularly Dr. Ibbotson's work accessible to all financial advisors. And we wanna thank all of you who are listening, and we'll see you soon on the next JTalks Podcast.

Suzanne Lynn:    24:31     Well, that was a powerful conversation. We have a simple way for you to get your copy of his white paper, along with info about the nationwide, and the NYSE Zebra Index that John Holmgren talked about. Go to and click on the Ibbotson podcast button. It's that simple. Thanks to Annexus for making Dr. Ibbotson and his research available today.

24:55     If you've got questions about FIAs, insurance, or Driving Business Alpha, please call one of our advisor development consultants at 800-752-0207. Stay connected with future episodes by subscribing today and keep posted on all our offerings by following InsurMark on LinkedIn.