The month of December has many of us looking towards the New Year with eager anticipation. With 2013 showing positive signs of turn around and the economy picking up steam, why not dream about even brighter days ahead in 2014? While we always encourage our clients to have an eye toward the future, it is also crucial to make sure that their portfolio is performing at its absolute best before filing year-end regulatory reports. Here are a few things to consider with regard to portfolio downgrades:
If the bond positions in your portfolio fall below investment grade quality, they could severely affect the quality of your surplus. Once a bond drops from a “BBB” rating to a “BB” rating (or lower) it is considered to be “junk” status, taking it out of the rankings of solid investments available in your portfolio.
Mutual fund investments by town mutuals are required to be rated 4 star by Morningstar in order to be considered a qualified investment. When a mutual fund is downgraded by Morningstar to a point below the required 4 star rating, you are likely to receive negative commentary from the OCI if that fund is still held by you at the time of your year-end report and you are not on top of the situation. You should have a procedure in place to regularly monitor the Morningstar ratings for each of your mutual fund holdings to ensure their continued compliance with OCI regulations.
Some investors have been tempted to move into preferred stock investments in this era of very low interest rates. However, such stock also carries S&P or Moody’s ratings. A downgrade in the rating of your preferred stock can have the same effect as a downgrade in the rating of one of your bond investments.
The failure to recognize downgrades within your portfolio before filing your regulatory reports could result in serious OCI non-compliance issue. Bonds and preferred stocks downgraded to “junk” status are no longer Type 1 but are now Type 2 investments. Do you have an adequate surplus in the amount of your Type 1 investments to be able to accept a reduction in Type 1 investments and still remain in compliance with the OCI requirements?
This leads to the obvious question “how can we be sure that we have solid investment offerings in our portfolio before our reports are filed?” The best way is to develop the necessary procedures yourself to monitor these types of things or hire a trusted financial advisor (we always recommend a fee-only advisor) to perform this important ongoing due diligence work for you. Your advisor is intimately aware of the latest ratings for all of your investment instruments and can give you solid advice in restructuring your offerings if downgrades develop. And (of course) if your advisor is truly fee-only, you can rest assured their recommendations concerning needed changes to your portfolio arise from legitimate concerns about quality or compliance issues with some of your investments and not simply because the broker needs to make another sale.