With stock prices in the stratosphere, a Tampa insurance company is offering some money managers crash protection for their clients' portfolios.
The unusual insurance policy, underwritten by Cumberland Casualty & Surety Co., is the financial services industry's latest attempt to sell peace of mind to nervous investors. In this case, Cumberland is insuring market timers, enabling those professional money managers to promise clients they will get at least their principal back after five years.
Don't expect mutual fund companies and stockbrokers to be marketing similar guaranties any time soon, though. Portfolio insurance is expensive and the drawbacks often outweigh the benefits (see related story, Page XX). Cumberland's policy is available only to a small group of money managers, who use it in conjunction with aggressive trading strategies. However, it does represent a new twist in portfolio insurance.
Bernard "Bud" Koyen, who runs IGIC Management Co. in Sarasota, came up with the idea and began researching it nine years ago. He brought his proposal to Cumberland, which began offering it as a form of liability insurance last year. So far, 13 money managers have signed on, paying hefty annual premiums of 1 percent of insured assets.
"After 30 years as an investment adviser, I wondered why more people didn't invest in mutual funds as opposed to certificates of deposit and fixed investments," Koyen said. "I came to realize that it was because the others were insured against loss."
In addition to an initial five-year guarantee, each year the market goes up, the new value is guaranteed and a new five-year clock starts running.
Managers eligible for the insurance all buy and sell mutual funds based on computer-generated signals, which are supposed to get them out of the market at times of high risk without missing out on high returns. In fact, the systems must go to cash after a significant downward move. A 3 percent to 4 percent decline is a typical trigger point, Koyen said.
Each manager's system is a little different, but they all are based on crunching numbers such as price and volume trends, interest rates and money supply. The systems are back-tested to prove they would have made money in the past, on the theory that they'll be able to do it again in the future. The systems don't always work, but insured managers are not allowed to override their computers' signals.
"We insure only computerized programs that involve no human interpretation," Koyen said. And just to make sure insured advisers are following their programs, he monitors their accounts daily.
While investors like the idea of shifting some of their risk to somebody else, the reason Cumberland can offer the policy is that a loss over five years is unlikely. The Dow Jones Industrial Average has finished with a gain in 46 of the last 65 years. The last time a five-year guarantee would have paid off for an investor who simply bought and held the stocks in the Dow was 1981, after the average had fallen from 1,004.65 to 875.00.
"One of the things I raised with the insurance company was how they could truly justify charging people for this program when the market has been up for 15 years," said Steven Duval, president of Duval Investment Management in Newport Beach, Calif. "I thought it was kind of a hoax or a joke." However, he became a convert when he saw how investors reacted.
"What we have found is a lot of people who otherwise would be in money market funds, CDs or banks, who haven't participated in the stock market in the past, are jumping on the bandwagon because of this," he said. "It's something that helps people sleep."
Duval was already charging clients an annual management fee of 3 percent of assets, so he cut into his profits to pay the insurance premium and chalked it up as a marketing expense. Some other managers raise their fees to cover the cost.
MTA Capital Management of Largo, the only Florida money manager in the program, raised fees from 2.5 percent to 3 percent of assets, recouping half the cost of the insurance.
"I find it awfully exciting," MTA president Hal Marlow said. "People can participate in the market upside in an aggressive fashion and still have no risk of loss of principal."
Of course the reason to use a money manager is to make money, which some managers are better at than others. "Hulbert Financial Digest," an investment newsletter that monitors the performance of many market timers, has found that most fail to beat a buy-and-hold strategy. Another drawback is that the frequent trading that is part of most timing strategies increases income taxes in taxable accounts.
"I've never seen proof that over a long period of time market timing adds enough value for the cost involved," said Laura Waller, a financial planner with Laura Waller Advisors in Tampa. "It's better to allocate assets in a prudent fashion according to what your comfort level is with risk and when you will need the money."
"There are a lot of market timers who really aren't good at it," Koyen acknowledged. "But good market timing does work."
Marlow said he produced a 19 percent return the first quarter using his timing with a group of more than 900 funds, while the same strategy using Fidelity Select funds gained 9 percent. By comparison, the Standard & Poor's 500 Index was up 14 percent. Marlow follows a momentum strategy _ "buy high and sell higher" _ that involves staying in the market most of the time, switching from one type of fund to another.
Marlow said he could not say what returns were for last year because he just adopted his current strategy in October. Seven years ago his firm admitted inflating returns reported to rating organizations, although clients were not affected. However, Koyen expressed confidence in Marlow and his current methodology.
"What he's doing now is totally different than what he was doing then," Koyen said.
The insurance program is not likely to grow very large because of the strict criteria for participation and the daily monitoring, Cumberland underwriter Edward Rood said.
"This is a pioneering effort to bring professional liability coverage to a class of professionals that was never able to write it before," he said.
As a side benefit, investors get a third party checking up on their money manager.
"Without our program, when you hire a timer, you have no way to determine if he's following his signal or not," Rood said.