The Advisor- March 2017

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The Advisor
See below for the March 2017 edition of our E-newsletter, The Advisor 

Assessing the International Equity Markets

The end of 2016 saw another subpar year in the international equity markets when compared to U.S. equity markets. The MSCI EAFE1 (NR USD Index2), a proxy for international stocks, finished slightly higher during 2016, up 1.00 percent3. Compare that to the S&P 5004 (TR5), a proxy for U.S. stocks, which was up 11.96 percent3 over the same time period. The margin of outperformance for U.S. stocks is even greater when you look out over the past five calendar years. The five-year annualized performance for the S&P 500 was 14.66 percent, which was sizably better than the MSCI EAFE, at 6.53 percent, over the same time period.3

In addition to the aforementioned weaker relative performance, there are other issues and risks inherent with non-U.S. investing. Currency risk6 is one in particular to consider. Our research shows that the current environment has the U.S. dollar in a position of strength and appreciating in relative value versus most other currencies. A stronger U.S. dollar leads to dilutive returns in the international markets (unless a manager is hedging a fund’s currency exposure) as investments are translated back into U.S. dollars. In our experience we find that geopolitical risks7 continue to surprise investors. In addition to Brexit (Britain’s exiting from the European Union) there could be more departures in 2017. With all of these issues, as a plan sponsor, you may be questioning whether or not it’s worth the risk of having any direct international managers in your plan’s lineup.

Valuations Exhibit

Index  Forward P/E  Price/Book  Dividend Yield
S&P 500 (Large Stocks) 17.08 2.89 2.08%
Russell 2000 (Small Stocks) 23.89 2.13 1.51%
MSCI EAFE (International Stocks) 14.79 1.60 3.27%
MSCI Emerging Markets 11.61 1.45 2.60%

Source: JPMorgan Asset Management Weekly Market Recap, December 26, 2016

Despite the challenges in the international equity markets, risks appear to be priced in from a valuation perspective. As shown in the chart above, U.S. large cap and small cap stocks have much higher forward price-to-earnings (P/E)8 ratios and price-to-book (P/B) valuations9 than international stocks. International stocks sport a higher dividend yield by more than 1 percent when compared to U.S. large stocks. In addition to international stocks, emerging markets appear to be even more attractively priced, at least from a forward P/E and P/B perspective. While we generally do not advocate emerging markets as a stand-alone option in a fund lineup, most active international managers have a dedicated allocation to this asset class. We believe that international and emerging markets appear priced for bad news, and any surprise to the upside, could lead to multiple expansion and an improvement in international equity returns.

Growth and Value Correlations10

Note: This chart shows the 1-Year Rolling Correlations of Growth and Value indices. The Growth indices are the correlations between the Russell 1000 Growth and MSCI EAFE Growth. The Value indices are the correlations between Russell 1000 Value11 and MSCI EAFE Value.

There was also a strong political trend toward anti-globalization in 2016 (i.e., Brexit, Trump’s win and the Italian referendum, etc.) As a result, international stocks may benefit from this trend. Over the last few decades, there have been rising correlations among equity asset classes, a result that some might argue is due to globalization and the overall positive trading environment. If that trend is no longer true, correlations could reverse the trend and start falling, thus offering greater diversification benefits to investors. The chart above shows the one-year rolling correlations between U.S. and international stocks, from the perspective of value and growth indices12. While it is still early in the anti-globalization movement, it does appear that correlations are starting to roll over for both growth and value stocks and the trend is lower.

Reversion to the mean is the tendency for prices and returns to eventually move back toward their long-term averages. While the scope of this article is beyond a detailed review of research supporting this hypothesis, an example showing long-term returns might be helpful. The 40-year average annual return for the MSCI EAFE is 9.07 percent3, well above that for the last five years (6.53 percent3). The 40-year average annual return for the S&P 500 is 11.07 percent3, well below that for the last five years (14.66 percent3). If you buy into the “reversion to the mean” hypothesis and also take into account better valuations, the expectations for the MSCI EAFE returns should be better in the future.

While there are risks involved with international investing, and to be fair, some of those risks are not associated with U.S. investing, there are also good reasons to continue to support having a dedicated International asset class in your lineup. Valuations look better overseas than here in the U.S., correlations between U.S. and International stocks could fall further, and if you believe in reversion to the mean, international markets could outperform U.S. stocks over the next few years.

1MSCI EAFE® (Europe, Australia and Far East) Index – is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the US & Canada. As of December 2003 the MSCI EAFE Index consisted of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom. EAFE is a registered service mark of Morgan Stanley Dean Witter, Discover & Co.
2Net returns U.S. Dollar
3Data from Morningstar
4S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index.
5Total returns
6Commonly referred to as exchange-rate risk, arises from the change in price of one currency in relation to another
7Risks of one country’s foreign policy influencing or upsetting domestic political and social policy in another country or region
8A measure of the P/E ratio using forecasted earnings for the P/E calculation. It is used to calculate a relative value based on a company’s level of earnings and stock price
9A ratio used to compare a stock’s market value to its book value. A stock’s market value is forward-looking and reflects a company’s future cash flows. A company’s book value is based on its historical cost
10Data from MPI
11Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.
12The Value indices are the correlations between Russell 1000 Value and MSCI EAFE Value. The Growth indices are the correlations between the Russell 1000 Growth and MSCI EAFE Growth.

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2017 Tax Saver’s Credit

Participants may be eligible for a valuable incentive, which could reduce their federal income tax liability, for contributing to your company’s retirement plan. If they qualify, they may receive a Tax Saver’s Credit of up to $2,000 ($4,000 for married couples filing jointly) if they made eligible contributions to an employer sponsored retirement savings plan. The deduction is claimed in the form of a non-refundable tax credit, ranging from 10 percent to 50 percent of their annual contribution.

When participants contribute a portion of each paycheck into the plan on a pre-tax basis, they are reducing the amount of their income subject to federal taxation. And, those assets grow tax-deferred until they receive a distribution. If they qualify for the Tax Saver’s Credit, they may even further reduce their taxes.

Participants’ eligibility depends on their adjusted gross income (AGI), tax filing status and retirement contributions. To qualify for the credit, a participant must be age 18 or older and cannot be a full-time student or claimed as a dependent on someone else’s tax return.

The chart below can be used to calculate the credit for the tax year 2017. First, participants must determine their AGI –total income minus all qualified deductions. Then they can refer to the chart below to see how much they can claim as a tax credit if they qualify.

Filing Status/Adjusted Gross Income for 2017

Amount of Credit  Joint  Head of Household  Single/Others
50% of amount deferred $0 to $37,000 $0 to $27,750 $0 to $18,500
20% of amount deferred $37,001 to $40,000 $27,751 to $30,000 $18,501 to $20,000
10% of amount deferred $40,001 to $62,000 $30,001 to $46,500 $20,001 to $31,000

Source: IRS Form 8880

For example:

• A single employee whose AGI is $17,000 defers $2,000 to their retirement plan will qualify for a tax credit equal to 50 percent of their total contribution. That’s a tax savings of $1,000.

• A married couple, filing jointly, with a combined AGI of $38,000 each contributes $1,000 to their respective company plans, for a total contribution of $2,000. They will receive a 20 percent credit reducing their tax bill by $400.

With the Tax Saver’s Credit, participants may owe less in federal taxes the next time they file by contributing to their retirement plan. Accompanying this newsletter is a memo you can distribute to your employees regarding the 2017 Tax Saver’s Credit.

This illustration is hypothetical and there is no guarantee that similar results can be achieved. If fees had been reflected, the return would have been less.

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Test Your CIT Knowledge

More retirement plan sponsors are considering collective investment trusts (CITs), along with mutual funds and other investment vehicles, as part of their investment menus. As knowledge is growing about CITs (pooled investment funds designed exclusively for qualified retirement plans), there are still many questions about how CITs work.

To help you gauge your knowledge about CITs (also known as collective trust funds, or CTFs), take this short quiz. There are no prizes — other than the CIT knowledge you need when developing your lineup of investment options for your plan participants. Answers are at the end.

1. CITs are issued by banks or trust companies and regulated by:
a. The Office of the Comptroller of the Currency (OCC)
b. A state banking examiner
c. The Securities and Exchange Commission (SEC)
d. Either a or b

2. Participants of which types of plans are eligible to invest in CITs?
a. 401(k)s
b. Defined benefit/pension plans
c. Certain 457 government plans
d. All of the above

3. CITs have reporting similar to that of mutual funds.
a. True
b. False

4. Which document governs a CIT?
a. A prospectus
b. A fact sheet
c. A Declaration of Trust (DOT)

5. Features of a CIT can include:
a. The ability to customize fees
b. Availability on recordkeeping platforms
c. Access to different asset classes
d. All of the above

6. Paperwork for a plan to invest in a CIT is onerous.
a. True
b. False

7. Stable value strategies are available in all investment vehicles.
a. True
b. False

8. In 2015, CITs held how much in retirement plan assets?
a. $2.5 trillion
b. $1.6 trillion
c. $0.5 trillion


1. D. CITs are exempt from registration with the SEC. However, they are governed by several federal and state laws and regulations. The primary regulator will either be the OCC or a state banking examiner, depending on the charter of the CIT provider. Additional regulators that have oversight of CITs include the Department of Labor, the Internal Revenue Service and the SEC.
2. D. Participants in qualified retirement plans can invest in CITs. Plans must be exempt from federal income tax under the IRS Code Section 501.
3. True. CITs are not required to prepare prospectuses, but they offer participant fact sheets, holdings information and performance data. They also provide 404(a)5, 408(b)2 and 5500 Schedule C information.
4. C. The DOT spells out the CIT’s terms and conditions, including investor eligibility, valuations, subscriptions and redemptions.
5. D. Many CITs offer flexibility in terms of fees and strategy selection, as well as accessibility through recordkeeping platforms.
6. False. While a Participation Agreement is required, it is typically fairly standard language across CIT providers.
7. False. A retirement plan may offer a stable value strategy through a CIT or a separate account; it is not available in a mutual fund vehicle.
8. A. In 2015, retirement plan investors held $2.5 trillion in CITs, up from about $1.6 trillion in 2010, according to Cerulli Associates. (The Cerulli Report: The State of U.S. Retail and Institutional Asset Management 2016)

This quiz was contributed by Invesco.

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IRS/DOL Plan Error Self-Correction Programs

In the event that a plan discovers a practice breach based on IRS or DOL regulations, they may be well advised to attempt to apply for one of the self-correction programs identified below. It is typically advantageous to self-correct prior to the error being discovered by the IRS or DOL, as penalties and consequences may be significantly more severe.

IRS Self-Correction Programs
Plan errors can be corrected though the IRS Employee Plans Compliance Resolution System (EPCRS) to avoid the consequences of plan disqualification. There are three ways to correct mistakes under EPCRS:

1. Self-Correction Program (SCP) – permits a plan sponsor to correct certain plan mistakes without contacting the IRS or paying any fee.

2. Voluntary Correction Program (VCP) – permits a plan sponsor to, any time before audit, pay a fee and receive IRS approval for correction of plan failures.

3. Audit Closing Agreement Program (Audit CAP) permits a plan sponsor to pay a sanction and correct a plan failure while the plan is under audit

Department of Labor Self-Correction Programs
DOL programs for correcting reporting and fiduciary issues;

The Delinquent Filer Voluntary Compliance Program (DFVCP) assists late or missed Form 5500 filers in coming up to date with corrected filings.

The Voluntary Fiduciary Correction Program (VFCP) affords plan sponsors the chance to identify and fully correct certain transactions such as prohibited purchases, sales and exchanges, improper loans, delinquent participant contributions and improper plan expenses.

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Communication Corner: Tax Saver’s Credit Reminder

This month’s employee memo reminds participants that they may be eligible for a valuable incentive, which could reduce their federal income tax liability by contributing to the company’s retirement plan.

Memo: Tax Saver’s Credit Reminder

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Past performance does not guarantee future results. The above information is supplemented by the Index Disclosure located at the end of this presentation. The data should be reviewed in conjunction with the disclosure to understand the limitations of the performance data. Investors cannot invest directly in an index. Actual performance for client accounts will differ.

Collective Investment Trusts are available only to qualified plans and governmental 457(b) plans. They are not mutual funds and are not registered with the Securities and Exchange Commission.

The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or to participate in any trading strategy. Any decision to invest according to investment advice provided by NFP should be made after conducting such investigations as the investor deems necessary and consulting the investor’s own investment, legal, accounting and tax advisors in order to make an independent determination of the suitability and consequences of an investment.

The “Retirement Times” is published monthly by Retirement Plan Advisory Group’s marketing team. This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney, tax adviser, investment professional or insurance agent. (c) 2017. Retirement Plan Advisory Group.

Securities are offered through Mid Atlantic Capital Corporation (MACC), a registered Broker Dealer, Member FINRA/SIPC. Financial Advice is offered through Everhart Advisors a Registered Investment Adviser. Everhart Advisors is not a subsidiary or control affiliate of MACC.
ACR#232966 03/17