The Goals of ASCET
In designing ASCET, Glenn set out the following goals for the technique, based on our twin objectives of increase portfolio survivability while increasing the standard of living of our clients:
§ The client should achieve the overall long-term market appreciation of the Equity portion of the portfolio in line with a properly diversified portfolio invested in index mutual funds or ETFs. The technique should only enhance these returns.
§ The client should be able to achieve a spending level, adjusted for inflation, of well in excess of 4% per year without jeopardizing the long-term survival of the portfolio
§ In years where the value of a diversified portfolio invested only in ETFs or mutual funds falls, the technique should generate a significant level of income that offsets much of the decline. In years where the value of the diversified portfolio rises, income in excess of 4% should still be produced.
§ GABA should only be rewarded for generating results that permit the client to spend in excess of 4% per year, as it is this “excess” amount that provides for an increase to the client’s standard of living, or ability to meet financial goals.
Asset Allocation
The overall portfolio allocation is divided into two Pools:
§ Pool 1: Fixed Income – 16% of overall portfolio.
o Minimum of 4% (1 year of withdrawals) in money market account
o Minimum of 4% in a short-term, high quality bond fund or individual bonds
o Remainder in a mixture of bond funds
§ Note that with a traditional 4% withdrawal rate, the fixed income portion of the portfolio equals 4 years worth of required withdrawals.
§ Pool 2: Equities – 84% of portfolio
o Invested in a selection of ETFs as chosen by GABA in order to provide a diversified equity portfolio. Two key criteria of the ETF selection process are:
§ ETFs with a wide selection of call positions available
§ ETFs covering various asset classes, such as large-company, small company and international stocks
o A portion of Pool 2 will remain in cash in order to facilitate the management of the ASCET process. This will start as 5% - 10% of Pool 2 and may grow throughout the year as income is realized.
o A primary feature of the technique is that ETF holdings are rarely sold, and are never to be sold at a loss.
o The use of ETFs should keep the average fund expenses for the Equity portion of the portfolio to less than 25 basis points (0.25%,) and ensure that the bulk of the Equity Portfolio matches the long-term growth of the appropriate indexes, before the additional income generated from the application of covered call techniques.
o Each ETF held within Pool 2 is diversified as defined by the relative benchmark whose performance it has been designed to track. We also prefer to further diversify the Equity portfolio across various asset classes, such as large-company stocks, small-company stocks and international stocks, given the following ETF Selection Allocation Constraints:
§ Availability of ETFs with sufficiently narrow bid and ask spreads on the associated calls, which simply makes it easier to realize income during the natural up/down cycles of the ETF share price.
§ Sufficient size of Equity portfolio to allow a minimum purchase of 100 shares of the ETF
Income Generation
Income will be generated on the ETFs in Pool 2 by the selling and buying of covered calls, including LEAPS, which are simply calls with longer expiration dates. GABA will utilize a rules-based process, as well as specific tools, developed by Compound Stock Earnings of Ft. Worth to identify which calls to sell and when to sell and buy the calls.
§ While income is initially generated upon the sale of the call, it is not officially recognized as realized until the call has been re-purchased, closing out the transaction.
Targeted Returns of the Technique
The ASCET technique targets two components of return from Pool 2:
§ Yearly income generation of 10% - 20% per year on the beginning value of the total value of the Equity portfolio. Note that this income is purely excess income over the traditional, three pool approach previously recommended by GABA.
§ Long-term growth of the ETF portfolio in line with overall stock returns, generating unrealized capital gains.
Pool 1 – The Safety Factor
In order to avoid having to immediately depend on the income generation of ASCET for living expenses, and to introduce a margin of safety into the technique, Pool 1 holds four year’s worth of living expenses (based on the “safe” 4% withdrawal rate.)
Client Withdrawal Process
§ Year 1 of ASCET Process
o The client withdrawal is capped at 4% of the overall portfolio value as of the beginning of the year, unless an interim payout based on realized income generation is jointly agreed upon by the client and GABA.
o This withdrawal is from the Money Market funds of Pool 1.
§ Future Years
o Future year withdrawal rates will be based on income generation in Pool 2 from the ASCET process in the prior year (assuming no interim withdrawals in Year 1.) For example, if income generation in Year 1 is 10%, spending in year 2 can be increased to 10% rather than 4%, with no change in the odds of portfolio survivability. This can amount to a significant increase in the retiree’s standard of living.
Measuring GABA Performance - GABA Compensation
§ The compensation structure has been designed to complement the goals of ASCET, with the objectives of the compensation program stated as follows:
o GABA should earn a small, fixed compensation for annual performance reviews and portfolio administration, generally based on the hours necessary to perform these tasks.
o GABA should only earn additional compensation for income generated on the equity portion of Pool 2 excess of the normal 4% “safe” withdrawal rate.
o No compensation should be earned as a result of the growth over time in the asset value of the ETFs in Pool 2. Conversely, GABA should not be penalized during years when the ETFs fall in value.
o No compensation should be earned as a result of income generated by the Fixed Income portion of the portfolio in Pool 1.
§ GABA Compensation will be calculated as follows:
o The minimum annual retainer fee shall be $1,000, covering the following:
§ Annual Plan Update
§ Annual Portfolio Review, including performance reports
§ Goal Setting Performance plan for the upcoming year
o Performance-Based Compensation (PBC,) earned in addition to the annual retainer fee will be calculated as follows:
§ If the percentage income realized from the Equity portion of the portfolio is 4% or less, no PBC is earned by GABA
§ For amounts of income realized from the Equity portion of the portfolio between 4% and 12%, the PBC will be 15% of the incremental income above the 4% threshold.
§ For amounts of income realized from the Equity portion of the portfolio in excess of 12%, GABA will receive 30% of the incremental income above the 12% threshold.
o Performance-Based Compensation will be calculated and payable to GABA on a semi-annual basis, based upon the start of the annual ASCET cycle.
Performance Monitoring
General ASCET performance updates will be supplied to you at least semi-annually. An annual detailed performance report will be compiled and supplied at the conclusion of each year. This annual performance report will be the basis for the performance based portion of GABA’s compensation, and will be used to set the withdrawal levels and performance goals for the coming year.
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