Are You Ready to Bear the Full Brunt of Volatility from Equity Markets? Consider Fixed Income Ahead of the Market’s Next Downturn

What is the role of fixed income in your portfolio? There are two key considerations for fixed income that all investors should understand.

First, fixed income’s role is not diminished by what may be greater hurdles in the future (ie. rising interest rates). When the next downturn comes, we fully expect fixed income to outperform equity assets.

Second, price returns of bonds are not the whole story. Remember, what you glean from a month-end investment statement is only part of the narrative.

How did we arrive at these findings? Let’s take a look at what brought us here.

What Do Tariffs and Trade Wars Mean for Investors?

What You Can Expect and Resources from Fi3

Talks of tariffs and trade wars dominate the news. But what does this mean for investors? Market returns have been far more mixed and volatile in 2018. There are several factors involved, the most recent being rising tensions over trade between the U.S. and China. A series of recently announced tariffs has increased concerns for a broader trade war, which has impacted the markets.

The Impact of Recent FERC Announcement on MLPs

The Ruling May Revitalize the Discussion Surrounding MLPs Changing Corporate Structure

The Federal Energy Regulatory Commission (FERC) recently announced changes to the way certain Master Limited Partnerships (MLPs) set rates, or prices, for their services. Partnerships that transport crude oil or natural gas, and also operate on a cost of service basis, specifically are impacted by this ruling. Cost of service contracts allow an MLP to set rates and provide a constant return to equity and debt holders.

Historically, a component of this return comprised a tax allowance that all midstream companies could take. The ruling by FERC reversed this allowance, stating that parent companies can only use the allowance if they are actually paying those taxes. The market responded unfavorably to this news. While the announcement and ruling surprised the market, we suspect the hasty market reaction resulted in many investors selling first and asking questions later. Below are our key points and takeaways from the announcement.

• Who is Impacted? The FERC ruling only impacts FERC regulated interstate oil and gas pipelines which operate cost of service contracts. MLPs that do not operate these types of contracts or those that do not transport across state lines are not impacted. Additionally, the rules are unlikely to affect pipelines transporting liquids until 2020. It’s important to note, this will not affect negotiated rate pipelines, market-based pipelines, pipelines held in C-corps, and gathering and processing assets. Harvest Fund Advisors estimates suggest the EBITDA at risk for the Alerian MLP Index is merely 3.1%[1].

• What is the Impact? The tax allowance makes up approximately 5-10% of the whole tariff for regulated pipelines. While this will materially impact a limited number of names in the space, other assets will remain unaffected by the announcement. Given the unexpected nature of the announcement, information is still being collected. However, many major MLP companies have provided press releases around the materiality, or lack thereof, for their business.

Does this Change the Nature of MLP Contracts? No. There will be no material follow-on effects of how contracts are set between pipelines and their counterparties. Pipelines operating a cost of service model are generally at least 10 years old. Given the market has already shifted away from this type of pricing, the ruling will not create a fundamental disruption to companies’ business models.

• What is Our Outlook? Our assessment of value in the asset class remains unchanged. While the group has been out of favor, it remains an area that provides diversification from traditional stocks and bonds, protection from inflation and higher forward-looking return expectations.

We will continue to monitor developments as more details emerge and additional commentary is provided on potential impact at a company-specific level. This ruling is likely to revitalize the discussion surrounding the MLPs changing corporate structure to a C-corp. While the C-corp midstream companies are untouched in this ruling, it remains a single point of consideration for a long-term decision by company management. As details and clarity emerge, we will continue to assess the overall long-term impacts.

Please feel free to contact any of our professional advisors at Fi3 for more information. 

[1]Harvest Fund Advisors, March 2018

Federal Reserve Raises Rates

Investors Should be Patient and Stay the Course with Portfolio

As expected, Federal Reserve officials raised the federal funds rate 0.25% to a range of 1.50% to 1.75% last week at their March meeting and reiterated their forecast for a total of three rate hikes this year. The committee upgraded their forecasts for GDP and unemployment for 2018, citing stronger economic activity and tighter labor market trends. Fed policymakers revised their GDP forecast higher by 0.2% to 2.7% and expect the unemployment rate to decline to 3.8% by year end. The committee previously forecasted unemployment would be 3.9%. In step with the improved growth outlook, Fed officials raised their forecast from two to three rate hikes in 2019.

Here are several key points investors need to keep in mind: 

• Federal Reserve policymakers remain on track to raise the federal funds rate three times in 2018. This is consistent with median expectations for 2018 released last December and is in line with market-based estimates observed in federal funds futures contracts. The full impact of fiscal policies, such as the recently passed tax bill, changes to foreign trade, the Fed’s balance sheet reduction program and increases in the federal funds rate, will take time to flow through economic channels. In addition, the interplay of these changes could make the path of monetary policy normalization less discernible going forward. However, absent material impacts from these policies, improving labor market and inflation trends are supportive of three total rate increases this year. Market implied estimates are still forecasting two rate hikes in 2019.

• U.S. equities were mostly unchanged on the day of the Fed announcement because the move was widely expected. The committee's upgraded forecast indicates they are raising rates for the right reasons – namely tightening labor market conditions and accelerated economic growth. Furthermore, global monetary policy remains largely accommodative. While we consider potential impacts of future Fed policy decisions on equity markets, we believe the dominant theme driving equities in 2018 is the continued synchronized global growth trend that gained momentum in the second half of 2017.

• The Treasury curve steepened modestly with the 2-year/10-year spread rising 0.05% to 0.59% as higher long-term rates outpaced increases in short-term maturities. The yield curve continues to be relatively flat at levels traditionally associated with tight monetary policy. However, real rates remain low by historical comparison and are still stimulatory. Looking ahead, policymakers will assess potential impacts from expected treasury supply issuance and wind down the Federal Reserve’s balance sheet, an event which has no precedent. Investors will focus on how these two policies influence credit spreads and longer-term interest rates. Fed policymakers are likely to take a “wait and see” approach should either experience a sustained increase. Importantly, these forces are not new but do present more variables for data-dependent Fed policymakers.  

We believe investors should be patient and adhere to a well-constructed, diversified investment portfolio anchored to your goals and time horizon. Despite elevated uncertainty, we do not find compelling reasons at this time that would justify overriding our asset allocation methodology. 
Please contact any of our professional advisors for more information and assistance.



Fi3 Financial Advisors Partner Samuel Muse Receives the Indiana CPA Society’s Emerging Leaders Award

Samuel Muse, CPA, CFP®, is one of five Indiana CPAs being presented with a 2018 INCPAS Emerging Leaders Award.

“We are incredibly proud of Sam for being named an Emerging Leader by INCPAS,” said Ivan Hoffman, Managing Partner of Fi3 Financial Advisors. “Sam works diligently to uncover and analyze new opportunities for our clients. He serves as a Family CFO, which means that he must integrate wealth planning, investment consulting and family leadership for a comprehensive and seamless client experience. This is a challenging but rewarding role, and we are glad to see Sam recognized for his capabilities.”

 Sam Muse, CPA, CFP receives the 2018 Indiana CPA Society's Emerging Leaders Award.

The annual Indiana CPA Society Awards recognize CPAs with active licenses in good standing who have demonstrated excellence in serving the profession, company, community and public interest.

The Emerging Leaders Award was established in 2001 to recognize up-and-coming leaders in the profession. Each recipient must demonstrate leadership and initiative; have made significant contributions to their employer’s success; and be age 34 years or younger.

“CPAs are often the ones working behind-the-scenes to make their companies and clients more successful,” said INCPAS President & CEO Jennifer Briggs, CAE. “We appreciate the colleagues who noticed and nominated these members who have made truly exceptional contributions to the profession. The Society looks forward to spotlighting them at this year’s CPA Celebration!”

Winners for all award categories will be honored at the CPA Celebration at the Indiana Roof Ballroom on May 11, 2018. Categories include Advocacy, Building Bridges to the Profession, Community Service, CPA Center of Excellence®, Distinguished Service, Emerging Leaders and Innovation. Event details at


Stocks Will Rise … and Fall

Thoughtful Investors Should Respond to Fluctuations With a Clinical Approach

Unlike two years ago, when in January 2016, we saw the largest start-of-year decline in the history of the S&P 500, this year, stocks soared out of the gate. It appeared good times would roll on. That changed abruptly a few weeks ago, and investors are left wondering, “What should we do now?” 

Before providing a specific recommendation for how we believe every thoughtful investor should respond, allow us to address two important points.

Unnerving Correction

The downdraft we saw at the beginning of February was especially challenging for many because of its speed (one of the quickest declines of 10% we’ve ever seen) and the fact that it followed one of the calmest years in the history of stocks (no declines of greater than 2% in the S&P 500 last year).

Healthy Correction?

While only time will tell if this decline is constructive or instead leads to a bona-fide bear market and real pain, we feel it’s more likely this was a healthy sell-off. We base this on the fact that this correction wasn’t triggered by fears of a recession, but interestingly just the opposite. This swift move lower was the result of accelerating growth, leading to higher interest rates, which is potential competition for stocks. We’re also encouraged that we didn’t see indiscriminate selling of risk assets; but rather, the more overvalued areas of the market were punished most. 

A Clinical Approach

So back to how investors can thoughtfully respond to this changed environment. Given that no one can predict with certainty how stocks (or bonds for that matter) will perform, we strongly advocate adopting a clinical approach.

1. Re-assess your risk/return profile. Simply put, do you truly need to take on the added risk that accompanies higher expected returns from your current allocation? Consider it a luxury to ponder this question with markets at these levels.

2. Adjust any of your Three Levers as necessary. Remember that all Three Levers – Inflows, Outflows and Expected Return – might deliver your solution. If you can’t bear the thought of your portfolio dropping, say, 20 percent, consider modifying inflows (e.g., Can you save more?) or delaying/reducing/eliminating outflows (e.g., distributions from your portfolio). 

3. Thoughtfully diversify. Even with recent declines, very few asset classes appear to have cheap valuations. As a result, broad diversification remains a necessity. But that doesn’t mean sitting on bundles of cash. Remember, there’s no guarantee stocks will falter, and trying to time the market is often a loser’s game. 

4. Thoughtfully rebalance. Adopting a disciplined approach to selling winners and reinvesting according to a long-term plan makes perfect sense and becomes particularly important in volatile markets. 

5. Be disciplined when things get rough. The return of volatility can be unsettling, so it won’t shock us if investors react poorly. But by following a clinical approach, you will have affirmed your objectives and why your portfolio is positioned as it is. Knowledge truly can be power – and you’ll have it. It’s also helpful to appreciate that the typical bear market lasts less than 18 months.

History of Bear & Bull Markets Since 1926.JPG

It does not matter much that stocks will rise and fall. It’s normal and a part of investing. What truly matters is whether you will take a clinical approach to overseeing your investments. Absent some essential information, we can’t tell you if you should increase your allocation to stocks or reduce your exposure. However, we can say that now seems like a superb time to assess your allocation and to, as one wise CFO once told us, minimize your maximum regret. 

As always, please feel free to contact any of the professionals at Fi3 Advisors for assistance.


Charitable Giving: Not a One-Trick Pony

Insight on Gifting Appreciated Securities

The beginning of a new year presents an opportunity for investors to recalibrate and review their goals. Often among these is a renewed endeavor to give back in a charitable fashion. While it may seem counterintuitive, the appropriate planning techniques make it possible to maximize return, enhance tax efficiency and satisfy philanthropic ambitions. In lieu of traditional donations, these techniques focus on gifting appreciated securities, one of the more tax efficient methods to give to charitable organizations.

Gifting Appreciated Securities
The mechanism of gifting shares is relatively straightforward. When a long-term asset that has appreciated in value is gifted to the qualified charity, the fair market value of the asset is deemed to be tax deductible for the donor. This includes, but is not limited to, the gift of stocks, bonds and mutual funds. The greater the unrealized gain of the donated asset and the higher the individual’s tax bracket, the more impactful the gift becomes to the donor’s tax deduction relative to simply writing a check or giving cash. No capital gain is created so the donor incurs no tax liability.

An individual should consider two critical factors when donating an appreciated asset. First, the deduction for gifting appreciated assets is limited to 30% of an individual’s adjusted gross income (AGI), which differs from a 60% limit on cash donations and property. However, excess contributions may be carried forward for up to five years. Second, the financial benefit of charitable contributions only applies to those who itemize their tax deductions. With the recent increase in the standard deduction, many taxpayers will not find it advantageous to itemize. For this reason, charitable givers will look to a practice known as “bunching.” Bunching allows an individual to delay and group deductions every other year such that it is financially beneficial to alternate between itemizing one year and taking the standard deduction the next. Creating a strategy that follows this pattern could be advantageous for charitable givers.  

Donor-Advised Fund
Aside from donating an asset directly to a charity, a Donor-Advised Fund (DAF) allows a donor to make a charitable contribution, receive an immediate tax benefit and then control when the gifts are made. The bequest could be immediate or over a series of years. A DAF is particularly useful in the event of a financial windfall, volatile income, deferred compensation and/or stock options. In years when an individual may be pushed into a higher tax bracket, a targeted gift can significantly reduce the tax burden and front-load a charitable fund. Added benefits of establishing a DAF include privacy and simplicity. Gifts can be made anonymously and the recent uptick in popularity has led most major brokerages such as Fidelity, TD Ameritrade and Schwab to allow investors to establish DAF accounts quickly and efficiently.

Charitable Giving image 2.20.JPG

Portfolio Rebalancing
Gifting can also serve as an effective rebalancing tool for individuals who are charitably inclined. As a result of one of the longest bull markets in recorded history, many are in the process of rebalancing their portfolios. While it is a fairly simple task with respect to tax-deferred assets such as a 401(k) or IRA, rebalancing a taxable portfolio with large unrealized gains can lead to a hefty tax bill. Consequently, the prudent act of rebalancing can appear disadvantageous at times. Gifting appreciated securities provides the opportunity to reduce risk in an individual’s portfolio, avoid capital gains and receive a tax deduction, all while supporting a valued charitable organization. 

When employing a rebalancing strategy, highly appreciated securities representing a significant position in the portfolio, concentrated holdings from company stock vesting or a meaningfully overweight position in the portfolio all make for good candidates. To qualify, the security must be a “long-term” holding (i.e. purchased and held for over a year). 

Note that banks and brokerages typically require a letter of instruction in order to gift the shares, which can take several weeks. Most charitable organizations will already have an investment account established to receive securities that can be monetized with no tax implications. This process should be initiated well ahead of the December 31st deadline for the year in which a giver desires to take the deduction and make a gift.

IRA Charitable Rollover
For those seeking an alternative to taking the Required Minimum Distribution from their IRA, yet another charitable giving strategy exists. In 2015, Congress passed a permanent law allowing individuals over age 70.5 to give up to $100,000 from their IRA directly to charity without paying income tax. The strategy of gifting directly to charity alleviates the tax burden that would have been associated with the IRA distribution flowing through the tax return as income.

The above strategies reflect general guidelines and principles. Always remember to consult with a professional tax advisor to quantify the implications and determine suitability for your personal situation. 

For further assistance with exploring these strategies and optimizing your charitable endeavors, please contact any of the professionals at Fi3

A Reminder of What Volatility Feels Like

Insights and Impact Analysis

What Happened?

On Monday, February 5th, the S&P 500 Index and Dow Jones Industrial Average (DJIA) both fell more than 4%, marking the worst one-day percentage decline since August 2011. When combined with declines from last Friday, the two trading sessions resulted in these indices falling more than 6%, bringing the indices back to levels as of mid-December 2017.

Remarkably, the recent sell-off ends a streak of more than 400 trading sessions since the last time the S&P 500 Index had experienced a 5% pullback (dating back to the Brexit vote of June 2016).

Tuesday, February 6th was another violent trading day. The DJIA had an intraday move of 1,134 points, heading down at the open, but finishing the day strong at +2.33%. 

Equity Markets Pull back Table 1 revised.JPG

What Caused the Pullback?
There was not a notable development or headline that led to the recent market pullback; in fact, corporate earnings and global economic data have generally remained quite strong. Some have pointed to concerns over a pick-up in inflation, rising bond yields and waning central bank stimulus as potential factors behind the volatility. Other possible factors include stop-loss orders (which would have automatically triggered sales during the sharp intraday decline) and algorithmic trading (computer models which recognize the pace of the decline and in turn produce additional selling – a situation of “selling begets more selling”).

Is the Recent Drop in the Markets Unprecedented?
It is important to note that while the recent pullback has been sharp over a short period of time, the move is well within historical norms. Many headlines focused on the Dow Jones Industrial Average (DJIA) recording its biggest single day point decline (-1,175), though the percentage decline (-4.6%) was only its 100th worst single trading day, according to S&P Dow Jones Indices.

The fact that 2017 was such a unique and extended period of low volatility makes the recent market pullback feel extreme. Last year, the S&P 500 Index had a maximum peak-to-trough drawdown of only -3%; since 1928, the index’s average intra-year decline is nearly -14%. The S&P 500 Index did not decline by more than 2% on a single trading day last year, though it did so on 5 days in 2016, 6 days in 2015 and 4 days in 2014 (the index had 21 such days in 2011).

Equity Markets Pull back Table 2.JPG

What Should Investors Do?
While it is understandable for investors to feel frustrated or anxious in the midst of such market volatility, we continue to emphasize the importance of maintaining a longer-term view. While the markets have recently shifted lower, nearly all investors have the same time horizon today as they did a week ago. During periods of heightened volatility, investors often feel the need to “do something,” though short-term, reactive moves are often ill-timed and can significantly impair the effectiveness of a well-designed investment plan. So long as circumstances and long-term objectives have not changed, investors should adhere to their long-term investment plan and should thoughtfully rebalance over time.

For more information, contact a member of the Fi3 team.