An ETN to replace the Variable Annuity?
A new exchange traded note (ETN) has come to market offering a well-known approach to investing found in active investment strategies, but new to the exchange traded products. The US RBS Trend Pilot ETN (ticker TRND) tracks the total return of the S&P 500 (actual return plus dividends), but provides safety in that if the S&P 500 drops below its 200 day moving average, then TRND will “sell” the S&P 500 and “purchase” short duration US treasury bonds. Looking back to 2008, TRND would have been in treasuries during the financial crisis, missing the worst decline in the S&P 500 in decades and benefiting from treasuries climbing to record prices.
TRND is an ETN, so the investor is not actually purchasing the S&P 500 or treasuries. An ETN is essentially a promissory note. The investor is taking on the credit risk of the Royal Bank of Scotland, which received a large bailout from Scotland during the financial crisis. TRND is paying a return based on the S&P 500 200 moving day strategy. Should RBS default, the ETN holder will be left with nothing, as there are no assets tied to ETNs.
TRND is the first exchange traded product to have a two tier cost structure. If the S&P 500 is above its 200 day moving average, then the cost is 1% to investors. If the S&P 500 is below its 200 day moving average, thus tracking the short US treasury index, the fee is .50%. Many ETF commentators have balked at this price, but is it really that expensive compared to the alternatives? Can TRND replace other products?
Many variable annuity sales come from investors wanting S&P like returns with no risk. They can’t find this on their own, so they walk into the bank to purchase a CD. The teller then refers them to the bank “financial advisor,” better known as a commission salesperson. This salesperson tells the investor that there is something called a variable annuity available, but that there is a cost involved. Unfortunately, what most investors don’t find out until it’s too late is that the majority of variable annuities are like bags of potato chips, full of air with little substance.
With these annuities, the investor is purchasing an insurance product that allows him or her to invest their cash value into mutual fund-like accounts. The investor can take on the investment risk being guaranteed that their account will grow by 3% or some other predefined amount. This is great in concept, but there’s a catch, of course. The investor has to pay for a death benefit, a fee for the guaranteed account and a fee for each separate managed account within the annuity. These fees are not cheap and add up quickly, deteriorating the real rate of return.
The variable annuity concept is to reduce the overall risk of investing, but is flawed for several reasons. The stock market has never had a twenty year losing record, so over the long term what is the investor insuring against? This makes using a variable annuity as a means for saving for retirement absurd. The fees on insurance based variable annuities are high and oftentimes hidden. Pending legislation may fix this problem, but for millions of investors the damage has been done. Annuities are also a big payday for the commission salesperson. This is why insurance-based annuities charge a high fee to cash them in for seven years or sometimes up to fourteen years. The point here is that the investor is looking for gain with principal protection, specifically protection from financial crises.
This is where TRND can be viewed as a real deal: in its potential as a replacement for the variable annuity. The variable annuity can cost up to 4% a year in fees, which makes TRND’s 1% fee seems bargain basement. The ETN will also provide protection, triggered when the S&P 500 goes below its 200 day moving average.
Variable annuities are also pushed by salespeople for their tax deferral feature, meaning that the money that is invested in the product grows tax deferred. TRND, because of its tax efficiency, provides the same benefit. Until you sell TRND, there are no negative tax consequences. This is possible because TRND’s price is adjusting to compensate the investor for the performance of the S&P 500 200 day moving average strategy and not actually trading this concept. This provides another advantage, as the investor does not have the trading cost of this strategy or the slippage in the reaction time to get the trades placed when the S&P 500 drops below the 200 day moving average.
When an annuity is passed through death to its beneficiaries, the entire gain will be taxed. The ETN, under the current estate tax laws, will receive a step up in basis, making it more tax efficient than the annuity.
Currently, the annuity will offer a complete portfolio under its umbrella. TRND is just an S&P 500 allocation, but an advisor with creative thinking could complement TRND with other ETFs and ETNs to build the same concept.
TRND seems to be a great replacement for index annuities as well. The term ‘index annuity’ is a play off the positive connotation of index funds. The devil is in the detail here, and I assure you the math does not add up. Most index annuities are based on the price changes in the S&P 500, not the total return including dividends like TRND. TRND can be liquidated instantly with no penalty whereas many index annuities have a hefty ‘get out’ fee up to fourteen years. The guarantee of an index annuity is the protection, and that would be accomplished with TRND as it will move to treasuries for safety. In the long run, TRND would have greater returns and even at the 1% fee, it is still considerably cheaper.
Will TRND replace variable and index annuity sales? Financial advisors who sell annuities are compensated by commission. They only have to prove that the investor is suitable for the annuity, not that the annuity is the best product for the client. TRND does not pay a commission to anyone, thus it will probably only show up in advisory firms that fall under fiduciary responsibility and are compensated hourly, by assets under management or a flat fee. Will these advisors embrace TRND? Time will tell, but at first glance, these advisors will think the 1% fee is outrageous because expensive products generally do not show up at fiduciary firms.
Casey T. Smith
Wiser Wealth Management, Inc
This article also appears at http://www.etfmarketpro.com/an-etn-to-replace-a-variable-annuity.html
This article also appears at http://seekingalpha.com/article/244648-rbs-trend-pilot-etn-to-replace-the-variable-annuity?source=dashboard_etfs