Thursday, May 25, 2017


According to the World Federation of Exchanges database, there were about 15,000 publicly traded companies worldwide, in 1975.  This count grew to just over 43,000 by 2015.  What’s interesting is the change across these 40 years. 
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In 1975, according to WFE data, Australia, Canada, and Japan each had about 1400 publicly traded companies, with Germany, France and Spain coming in at between 500 and 1000 companies.  Over the next 40 years, the Australia count grew by 44%, while Japan and Canada more than doubled.  Germany grew by just 13%, while the France public company count dropped.  The winner in headcount growth though, is Spain, which went from 940 to 3480 publicly traded companies, a multiple of almost four over these years.

We haven’t audited the WFE data, as posted at, and we question some of the information.  However, the trends can be instructive.  According to this dataset, South Korea, Malaysia, Poland, Singapore, and Thailand had no or few public companies in 1975.  In 2015, they each had from 650 to more than 2000 companies whose stock was available for purchase on exchanges.

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The story in the U.S. is also instructive.  In 1975, there were about 4500 publicly traded companies.  This number grew to almost 9000 by 1997, and stands today at about 4500.  With a generally healthy (though slow growing) economy, why has the number of publicly traded companies stalled?

Most observers, of which we are one, offer three compelling reasons.  First, the cost of going public is substantial, with underwriting and regulatory costs absorbing as much as 14% of funds raised.  So on a $500 million offering, investment banks and attorneys could absorb as much as $70 million.  And, there is significant ongoing regulatory and administrative expense with a public company.

Second is market volatility.  The underlying or intrinsic value of a company is just one of the components that can drive stock price.  The others include, but certainly aren’t limited to, interest rates and investor sentiment.  If I as company founder don’t need the liquidity, why go through the pain of the price volatility, when the price on so many days may poorly represent underlying value.

Third is ease of access of funds.  With private equity available to fund growth or owner exits, options other than a public offering are attractive. 

It would seem that to foster a healthy public market for stocks, the regulatory and underwriting costs need to make sense, the ongoing reporting requirements need to work from a cost standpoint, and the overall costs of maintaining the stock in a public environment need to compete well with other options available to ownership.  In too many cases, in the U.S., this isn’t the case.

Looking at the economy across the world, the Eurozone is hoping for economic growth of 1% annually, while the U.S. is growing at 2%, and many of us think we can move toward 3% annual growth.  Stateside, unemployment is less than 5%, which means employers are scraping the bottom of the barrel looking for those who are employable.  Meanwhile, the Eurozone features unemployment at or near 12%.
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As a result, foreigners are investing heavily in the U.S.  This week, the Treasury reported net long-
term inflows, of international funds, of $59.8 billion in March, and this on top of $53.1 billion in inflows in February.  Just $1 billion went to equities, with the large majority of these funds going to Treasury and corporate bonds.

Canada and Mexico were the largest sellers of Treasury bonds, Russia the largest buyer.

Always Dreaming won the Run for the Roses this year, paying $11.40 on a $2 bet, and landing his owners a $1,635,800 purse.  Always Dreaming got the glory and the roses, though it wasn’t a one horse show.  Also involved were owners Tony Bonomo and Vince Viola, trainer Todd Pletcher, and jockey John Velazquez.  And of course, the generous U.S. tax code.

Code Section 183, which contains the “hobby loss” rules, says you can deduct business losses against your other income but…you can’t deduct losses from your hobby against other income.  The basic rule that distinguishes business activity from hobby activity is that you have to enter the activity with an intent to make a profit.  A helpful rule of thumb is that for most activities, if you make a profit in three out of five years, you are presumed to be engaging with the intent to make a profit.

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But, one kind of business gets a special pass.  That business is the one “which consists in major part of the breeding, training, showing, and racing of horses”.  For these businesses, the rule of thumb for profitability is two years out of seven.  In addition to this relaxed standard, racehorses are depreciated over three years, compared to a seven year depreciation for other horses, such as service animals.

Keep in mind that horse racing is generally a very expensive hobby for those with very large wallets, so we wouldn’t suggest adding racehorses to your list of alternative investments.  

However, a good race can be fun to watch, and for the owners, those losses can offset what for many is significant income.

Quote of the week:

“Some people regard private enterprise as a predatory tiger to be shot.  Others look on it as a cow they can milk.  Not enough people see it as a healthy horse, pulling a sturdy wagon.”   
                                                                               Winston Churchill

“I’ve often said there’s nothing better for the inside of a man than the outside of a horse.”
                                                                               Ronald Reagan


Wednesday, May 17, 2017


Last week, we spoke briefly of the American Health Care Act, which has been passed by the House.  Following are additional details about the AHCA, as passed by the House.  The legislation would:

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     1.   Do away with both the individual and employer mandate, and their associated taxes,
     2.   Do away with the Medicine Cabinet Tax, which places a tax on medical devices, drug companies, and health insurers,
    3. Do away with the 40% tax on high-cost employer-sponsored group plans, known as the Cadillac tax,
     4. Shift Medicaid funding to a fixed amount per year per Medicaid enrollee,
    5. Give states the option of receiving Medicaid funding in block grants, rather than per capita, for certain populations,
     6.  Waive the Essential Health Benefits requirement, thereby giving states much more latitude, and control over, what each state considers “required” coverage and benefits,
      7.   Waive the “community rating” and “mandatory age rating” rules, giving states and insurers much        more flexibility regarding pricing,
     8.  Eliminate income based subsidies, and replace them with age-based tax credits, ranging from $2000    to $4000 per individual, 
      9.     Eliminate the tax on FSAs, HSA withdrawals, and the 3.8% surtax on investment income, and the        0.9% tax for certain high income households.

Overall, this restructuring is a major step in the right direction, in terms of returning control of health care financing decisions to the individual, household, and state level where, in our opinion, they rightfully belong.  And, it returns dollars to the pockets of taxpayers, again, where those dollars rightfully belong.

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For most households, there is a 100% correlation between earned income and cash flow.  Cash flow though, can come from several sources, including earned income, business income, pension income, and portfolio income.  Business income is a fairly broad category, and can include rents, royalties, and distribution of profits, among other things. 

Cash flow can also come from reimbursed expenses, or funded by corporate expense accounts, in specific situations, or from debt or equity financing.  Note that financing, whether debt or equity, comes with its own set of costs and other considerations.

The business marketplace has an interesting array of participants.  Traditional business or company owners tend to focus on developing several types of tax efficient cash flow.  The focus is on cash flow diversification and revenue quality.  These provide some level of safety and security.  And done well, there should be sufficient cash flow, after taxes and lifestyle expenses, to redeploy into building additional cash flow.  Cash flow from operations, and return on equity, or net dollars invested, are two key metrics we like to keep an eye on.

Tax efficiency matters.  Tax efficiency though, is not just income taxes.  It also includes personal and real property taxes, and can includes sales and use taxes.

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Another group of participants in the business marketplace are what we can call shareholders.  We
typically find these in startup companies, or in disruptive sectors.  Over the last 20 to 30 years, the large majority of these shareholders have been in the technology arena. 

The goal with shareholders is not to maximize sources and efficiency of cash flow.  The goal of shareholders is to ramp revenue into eight or nine figures within a short time frame, such as three to seven years.  The purpose of the quick ramp up in revenue is to achieve a liquidity event, as an exit strategy for shareholders, and especially founding shareholders. 

This sale could be to a larger company, or through the public markets with an IPO.  Whether one or the other is one of several considerations in preparing for the liquidity event.

Shareholders who experience a liquidity event can be surprised by the tax implications of the event.  And many times, founding shareholders will take some of the proceeds and repeat the process, building another company.  Like all of us though, at some point they will be looking for cash flow.

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Quote of the week:

“From birth to age 18, a girl needs good parents.  From 18 to 35 a girl needs good looks.  From 35 to 55 a girl needs a good personality.  From 55 on, a girl needs good cash.”
                                                                                                                                                                Sophie Tucker

Tuesday, May 9, 2017


Let's talk about something other than taxation of retirement plan distributions, and what constitutes a fiduciary, since those topics have been the focus of the last few weeks of commentaries.
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The public markets have had a fine year, through Friday's close, whether you are investing stateside or elsewhere.  The S&P 500 is up 7.2% from the first of the year through Friday May 5th, not including dividends, while the NASDAQ Composite is up 13.3%.  The international markets, whether developed or emerging markets, have also done well, up between 12% and 14%.
Even bonds have held their own, with long bonds (BLV) up 1.6% and short bonds (BSV) up 0.35%, not including interest paid.
As we have discussed at other times, it is time for international markets to have a good year, and for this we are grateful.  Domestic equity markets appear to be driven by lack of other opportunity, corporate earnings, and anticipation of good things to come, in the way of tax and health care reform.
Overall, earnings reports have been good during this quarterly reporting season, though there have been a few challenges.  Just ask IBM.
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IBM created Watson, one of the early AI developments.  Unfortunately for Big Blue, they have yet to fully capitalize on this achievement, with revenue continuing to decline, as they fight for AI and cloud dominance against one-time (and now fully established) upstarts such as Alphabet and Amazon, among others.
IBM continues its attempts to turn the ship and rebuild revenue, which has dropped from $105 billion in 2011, when Watson won Jeopardy, to $89 billion in 2016.  In the meantime, Moody's downgraded IBM's debt on Wednesday, to A1 from Aa3.  And, at the Omaha business lovefest, known as the Berkshire Hathaway annual meeting, Buffet said he'd made a bad call on IBM and announced he'd sold 30 million shares since the first of the year, roughly one third of his position.
Speaking of health care reform, an amended version of the American Health Care Act has passed the House of Representatives.  Given the need to get this legislation through the Senate, we won't spend much time on it here.  The short version is that the legislation, which made it through the House, would eliminate the current mix of "essential health benefits", handing back to the states the responsibility of determining "mandated" benefits.  This would apply to both group and individual coverage.
The current version would also do away with "community" premium rates, once again permitting individual underwriting.  It would also allow a multiple of 5 instead of 3, in the premium price spread between the younger and older insureds.  The proposed legislation would also do away with the 3.8% surcharge on net investment income, and the 0.9% surcharge on earned income, for certain high income tax payers. 
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On the economic front, the Bureau of Labor Statistics has announced 211,000 new additions to non-farm payroll for April, with the official unemployment rate holding steady at 4.4%.  The employment gains were in leisure and hospitality, health care and social services, financial activities, and mining.  You can read the full release at
It's easy to find bad news.  Turn on any "news" channel, or logon to any "news" site, and you can get your fill of what's wrong with anything.
Some good news?  Check out the charts at  Max Roser has done a yeoman's job compiling some fascinating information, for our edification.  Some highlights include:  In 1820, 84% of the world population lived in extreme poverty.  Today, that number is less than 10%.  In 1800, only about 10% of the world population could read.  Today, more than 84% can read.  Today, more than half the world population lives in a democratic society, where the individual gets a vote, up from nearly zero 200 years ago.  Currently, virtually no one lives in colonies, and closed autocracies are becoming scarce.
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So that concept articulated as natural law, the freedom of the individual to control his/her own person, and thinking?  And that those who govern do so only with the express consent of the governed? It has worked, and spread.  Not perfectly, but for vast majorities of the world population, this world is a much better place than it was for their parents, grandparents, and the generations before them.  Hats off to those who have fought and died for these ideals.
"Those who can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety."
                                      Benjamin Franklin

Wednesday, May 3, 2017


You have probably heard by now that the new DoL fiduciary rule, slated to go into effect on Monday April 10th, has had implementation pushed back to June 9th.  The short version of this rule is that it requires any advisor who oversees IRA money on behalf of clients to function in a fiduciary role.  The rule has been especially disturbing to the brokerage and annuity industry.

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To the financial profession however, this ruling is long overdue.  The rule brings to bear on the retail side, guidelines similar to those which have been in place for many years for those who interact with employer sponsored retirement plans.  And of course the most common employer sponsored retirement plan is the 401(k) plan.

The Employee Retirement Income Security Act of 1974 (ERISA), as amended with TRA ’86, and other legislation, is the primary governing legislation when it comes to how retirement plans function.  The Department of Labor (DoL), through its Employee Benefit Security Administration, is responsible for generating regulations which interpret the legislation.  

ERISA defines several types of fiduciaries, and DoL and the EBSA continue to interpret these definitions.  DoL and the EBSA continue to encourage plan sponsors, and those who make decisions on behalf of plan sponsors, to assure that the plan is managed exclusively for the benefit of participants and their beneficiaries, and that the plan is managed with a prudent, documented, process.

ERISA identifies three broad categories of fiduciaries who may interact with retirement plans.  They are defined in Sections 3(16), 3(21), and 3(38).  

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A 3(16) fiduciary acts as the plan administrator.  These administrative functions are varied and many, though they fall into the broad categories of maintaining and interpreting the plan document, providing all required disclosures to participants, providing benefit statements to participants, complying with all government reporting, ensuring timely deposits of participant contributions, and overseeing the plan investment menu. 

Some specialty firms within the 401(k) service universe would purport that they could or can provide all these services, therefore relieving the employer of some or all fiduciary liability.  Whether the employer/plan sponsor chooses to outsource some of these administrative services or not, it is our professional opinion that no service provider, regardless of what they propose, can shift all fiduciary liability away from the plan sponsor, and the executives that act on behalf of the plan sponsor.

We seldom suggest that a plan sponsor pay a separate fee for 3(16) fiduciary services, as we remain unconvinced that this offers any real handoff of fiduciary responsibility.  

Section 3(21) has a broad definition and a narrow definition.  The broad definition of Sec 3(21) says that anyone who offers guidance or input to the 401(k) plan, or has decision making authority relative to the plan, is considered a fiduciary.  This would and could include owners and officers of the plan sponsor, members of the investment committee, financial advisors and consultants, institutions who oversee compliance and some administrative functions, and legal counsel, among others.

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The financial institutions/asset managers in the marketplace who offer 3(21) services do not and almost always will not use this broad definition, nor do they mean to imply this broad definition, in their service offerings, or the language which defines these service offerings.

The narrow definition of 3(21), which almost all financial institutions and asset managers use, applies to investment selection.  The narrow definition of 3(21) says that the financial institution will make recommendations about which funds are appropriate, though plan trustees, or the investment committee charged with this responsibility, have the final decision.  This is often referred to as non-discretionary authority, as the 3(21) fiduciary makes recommendations, but does not make the final fund or investment selection.

It is common for the insurance based providers to offer the narrow definition of 3(21) services, and less common for the asset managers or mutual fund shops to offer the narrow definition 3(21) services. 

Then, we come to what’s called a 3(38) fiduciary.  A 3(38) fiduciary makes decisions on which funds to use.  The 3(38) fiduciary doesn't go to the plan sponsor investment committee for approval.  They make the decision on which funds to use, and replace them as they see fit.  This is often referred to as discretionary authority. 

However, a 3(21) or a 3(38) fiduciary can offer services to different entities.  These fiduciary services can be offered at the platform, the plan, the portfolio, or the participant level.  This is a part of the fiduciary offering which can be confusing to plan sponsor decision makers, as ascertaining what is actually being offered isn’t easy. 

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We have noticed that some vendors offer 3(38) services.  When reading the detail, we find that what they are offering is to approve and select that large group of funds which are available on their platform.  This is the large body of funds which are approved for all plans offered by the financial institution, and which are appropriate for any plans served by this institution.  This is the most common level of 3(38) fiduciary services, and the one which comes with the least risk to the organization offering the service.  It is often provided at no additional cost, over what is already being paid for the existing service suite.

A second level of 3(38) services is deciding, for the plan sponsor, which funds will be used for their specific plan.  This is a less common form of 3(38) service.  When it is offered or available, it is typically available for an additional charge or cost.

A third level of 3(38) services is at the portfolio level.  Many plans offer either age-based or risk based portfolios, as the majority of participants find this the simplest way to participate in the plan.  It is our belief that any financial institution which offers age or risk-based portfolios, and also chooses which funds and allocations are appropriate for those portfolios, serves as a 3(38) fiduciary at the portfolio level.

A fourth level of 3(38) services is at the participant level.  There are firms which specialize in custom built portfolios for participants.  These generally require a separate acknowledgement or agreement by the participant, of the services being offered.  And participants pay separately for these services, typically some percentage of their plan assets, if they choose to use this service.

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Quote of the week:

“When money realizes that it is in good hands, it wants to stay and multiply in those hands.”
                                                                                                                   Idowu Koyenikan