Category Archives: Advisors

The Bad News

The demise of Active Management has resulted in a brighter future for all investors (the good news), but the bad news is the continued business practice of paying commission to sales people creating an obvious conflict of interest. The incentives are structured to maximize revenue for Wall Street and those masquerading as advisors. I realize I am not telling you something you don’t already know.

I have written about this problem in the past. The system drove me out of the brokerage business after a very brief stay. That was almost 30 years ago, but last May I wrote and shared with you well documented evidence that nothing has changed. It’s part of the culture and too profitable for every one but the investor.

You should go back and review those two posts. I pointed out the banning of this practice in the U.K. and Australia while recognizing the difficulty of reforming the system here in the U.S. Wall Street simply has too much, well paid for, influence over our legislators.

What brought my attention back to this issue now are the current attempts to pass legislation that would create a fiduciary responsibility for Wall Street’s sales people to put their clients interest ahead of their own. (It would be simpler and more effective to simply ban commissions, but I’ll take what we can get for investors.)

Paul Ryan is the lead defender of commissioned based investment advice telling us that the government has no business telling brokers how to charge for their services. He claims 7 million middle class Americans will be unable to get appropriate investment advice. Sorry Paul, but thanks to the Internet, everyone has access to investment advice. This blog alone has more appropriate investment advice than you could ever get from a sales representative striving to maximize their own income. There are numerous articles regarding this subject you can access with Google. Brokers are claiming that most of them already put their clients interest ahead of their own. According to the research I referred to above, that is far from the truth.

So this is the bad news. It’s one more example of the control Wall Street has over our lawmakers. Paul Ryan receives a major portion of his campaign funds from Wall Street so he is simply acting in his own self-interest. I wish however, he could sit in (anonymously) on a couple of sales meetings at a local brokerage office in his own state of Wisconsin. He would then understand what Wall Street is doing to those he represents. He is supposed to be on their side and not a Wall Street lapdog.

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Good News-Bad News

Time for all you advisors and your clients to break out the champagne and celebrate. It has taken almost 30 years but it appears that many of the proponents of active management are “throwing in the towel” and searching for new sources of revenue. Thirty years ago, virtually every dollar invested in mutual funds, was managed by Wall Street firms claiming they could “beat the market”.  Management fees were high and in most cases you had to pay an 8% commission just to get started.

What follows, are direct quotes from Bloomberg Business Week dated June 27, 2016.

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“Top executives at some of the largest fund companies, including Larry Fink at BlackRock and Gregory Johnson at Franklin Resources, are warning that a reckoning is coming. The pain is focused on companies that emphasize active management, picking stocks and bonds in an effort to beat the market.”

“Over the past five years passive funds, attracted a net $1.7 trillion dollars in the U.S., while active funds saw a slight outflow. The active managers haven’t been able to show they deliver a performance edge for their higher fees. In the five years ended in December, only 39% of actively managed equity mutual funds beat their benchmark indexes, according to Morningstar.

“Fink, who runs the world’s largest money manager, said at a conference on May 31 that the shift into indexing will not only continue but will be massive.”

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I just wanted to share this with you advisors who have played no small role in bringing this about. You can truly say you’ve made a difference. It was not easy, especially in the beginning, but with the truth on our side, I knew we would win. We have, and I love it.

So what is the Bad News? The “bad news” is the persistence of commissioned driven investment advice and the obvious “conflict of interest”.  The “market” showed the failure of active management. A battle Wall Street knew it would eventually lose.

But hiring “salespeople” to provide investment advice is still a very profitable business strategy. It’s just too profitable to let “ethics” get in the way. It’s both sad and shameful. More next week……………..!

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The Spinning “Talking Heads”

Watching the “market” squeeze the “false credibility” out of the “experts” these past few days has been entertaining if nothing else.  After Monday’s drop the message was that “everyone should have seen the correction coming.”  For example, the lead story in the New York Times read “Signs, Long Unheeded, Now Point to Risks in U.S. Economy.”  OOPS!

I never have liked the term “correction” to explain a move in the market indices.  By definition it implies that the market “got it wrong,” being under or over valued.  So looking at the market as I write this, I guess the past few days the market “over corrected” and has now “corrected” the “correction.”  You can see how this starts to become a bit silly, but it also shows how little credibility should be given to the “talking heads” and journalist posing as “experts.”

But alas, they are not the problem.  As Pogo once said, “we have found the enemy and it is us!”  Investors, both large and small, demand an explanation regarding what has happened in the past, but more importantly, a forecast of what to expect in the future.  The first demand, an explanation of what has already happened, that’s not worth much.

The second demand, a forecast of what the market will do in the future, that would be invaluable, if only it was accurate.  Anyone who could make accurate forecasts consistently, would have unlimited wealth and not be spending their time on CNBC or Fox Business News sharing their forecast with us.

For you advisors, about a year ago, four years into a bull market, I suggested you hold a “fire drill” for your clients.  If you did, great, if not perhaps this would be a good time.  For you investors, not speculators, you are in it for the long run, so don’t waste your valuable time stressing about the market.  Enjoy your life knowing with certainty, that you will have a successful investment experience.

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It’s About Time II

I have shared with many of you, stories of my brief experience as a stockbroker for a major wire house back in the mid 80’s.  My experience was brief because it was apparent, from day one, that the lack of ethics and the exploitation of investors were ingrained in the firm’s culture.  My favorite “take away” from the many “sales meetings” was:  “if you can’t sell it with a clear conscience, we will find someone who can.”  (By the way, these sales meetings were always held in the basement far from the ears of customers.)  There were other cultural rules to be followed but the message was always clear, I was there to make money for the firm.  I was not there to provide investment advice, even if that was the advertised role of the broker.  It was apparent investors needed an alternative.

Fortunately investors do have a better alternative today, the “fee-only advisor.”  Being a part of the development of this new profession I came to know a great number of this new breed and many of them were “converts” from the “dark side” as I love to call it.  This conversion was easy because they had a conscience and wanted to work with a “clear conscience.”  As the years went by, I would hear stories about their experiences on the “dark side,” and they would always tell me that their experiences were similar to mine even if it was 10, 15, 20 years later.  In other words, nothing has really changed.

Thanks to research conducted by some folks at the University of Notre Dame you don’t have to take my anecdotal evidence that the Wall Street culture has not changed.  I came across this from a New York Times article yesterday summarizing the research.  Over 1400 Wall Street employees participated in the confidential survey.

You can and should read the survey but here are a couple of highlights:

1.    Of those earning more than $500,000 annually, 34% have witnessed, or had first hand knowledge of, wrongdoing in the workplace.

2.    51% of these folks believe their competitors are engaged in unethical or illegal activities to gain an edge in the market.

3.    32% of employees with less than 10 years experience would likely use non-public information to make a guaranteed $10 million if there was no chance of getting arrested for insider trading.  So much for a new breed of stockbroker.

4.    Nearly one third of respondents believe the compensation structure could incentivize employees to compromise ethics or violate the law.

There is more but you get the idea.  But here’s the kicker, the reporter writing the article was trying to make the point that Wall Street has not learned its lesson, even after the last recession.  I disagree; Wall Street learned its lesson decades ago.  Keep politicians, who make the laws, beholden to you while they are in office, and reward them, after they leave office.  Wall Street has no incentive to change the culture.  There is too much money to be made.  No one ever goes to jail and the billions in fines are insignificant relative to their bottom line.

Note:  nytimesdealbookmay182015

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It’s About Time

The death of “conflicted investment advice” may be at hand.  When commissions were banned in both the U.K. and Australia, I applauded their Regulators, who took a stand for investors against the Financial Industries in their respective countries.  It was a long time coming but it is now a reality.

Having witnessed these developments I began to speculate whether or not such a ban could ever be implemented in the U.S.  Being aware of the strong financial ties between Wall Street and politicians of both parties, I have been skeptical that such reforms could ever become law in the U.S.

However the debate has begun.  The arguments against banning commissions are twofold:

1.    “The small investor will be left out of the advice market.”  Excuse me?  That should be one of the main objectives of any legislation.  Small investors are exploited more than others because they are sold the products with the highest commissions.  Otherwise it is not worth the sales person’s time.  Once people realize they are being ripped off, they will be motivated to invest some time learning how to invest their savings.  I used to say, if people would spend as much time making investment decisions as they do when making decisions about which car to buy, they would have a much better investment experience.

2.    “Thousands of jobs will be lost in the Financial Services Industry.”  This brings back memories of when I would write about “conflicted advice” in Investment Advisor Magazine.  I would get emails (maybe it was “hate mail”) accusing me of destroying the sender’s career.  My response would be, “if your career is based on ripping people off, perhaps a new career may be needed.”

Both of these arguments are what I would expect.  They put the Financial Services Industry’s interest ahead of the investors’ interest.  Wall Street is not going to roll over without a fight.  There is too much money at stake.  Rather than simply ban commissions, they will likely settle for a slight tightening of the rules regarding their fiduciary responsibility that requires them to put the investors interest first and no doubt the training syllabus for new brokers will include a course on “how to comply with the law while still maximizing commission income.”  If that is all the reform does, enforcing such a rule will be cumbersome and expensive.

Simply banning commission would be a much more effective way to protect investors and be a lot less expensive to all parties involved.

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Hedge Funds

One of the supposed benefits of investing in a Hedge Fund, is the opportunity to make money in both up and down markets.  This goal is appealing to two types of investors.  First, those who do not have the discipline to stick with a “buy and hold” strategy and secondly, it’s alluring to those who believe in “magic.”

With Hedge Funds, transparency is limited, but this lack of transparency is widely accepted by Hedge Fund investors.  Perhaps it’s because it’s hard to believe in “magic” if the data shows that there is no “magic.”  There is however, enough data to show that the collective performance of hedge funds over the past 10 years, falls short of market rates of return that are easily earned with index funds and other passive strategies.

The standard pricing structure of a Hedge Fund, that is 2% per annum, plus 20% of any gain, seems to be acceptable to those using Hedge Funds.  Do the math:  An investment of $1 billion in a Fund that earned 10% would yield a fee of $40 million.  It’s absolutely ludicrous.  But in spite of this fee structure, the Hedge Fund industry continues to grow, as does the wealth of the Hedge Fund managers.  It is not unusual for a successful Hedge Fund manager to take home over a billion dollars in one year.

So are these Hedge Fund billionaires bad guys?  Not really, there are just very good at moving other people’s money into their own pocket.  And who are these “other people?”  Hedge Fund investors fall into three groups:  Wealthy individuals, Pension Plan sponsors, and those managing University Endowments.

It may be foolish to invest in Hedge Funds but wealthy investors can do whatever they like.  After all, it is their money.  But the last two, Pension Plan sponsors and Endowment committees, are managing “other peoples money.”  The money in Pension Plans belongs to current and former employees, not those making investment decisions, and if Endowment Funds underperform, students and others will be asked to make up the difference.

My former colleague, Rex Sinquefield, once said that Hedge Funds are “Mutual Funds for stupid people.”  That’s a bit harsh, but perhaps Pension Plan sponsors and members of the Investment Committee of Endowment Funds are not stupid, they just fail to understand and/or they refuse to accept the Fiduciary responsibility they have when investing other people’s money.  It may not be their money but it must be quite an ego trip to have control over how the money is invested.

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Looking For Feedback

When working at DFA I always surrounded myself with individuals who shared my passion for moving investors away from active management and for creating an advisor/investor relationship sans the conflict of interest.  You advisors know most of these individuals, including Sam Adams, who led the “charge,” so to speak, in both Europe and Australia.

Sam, along with many advisors and their clients, is passionate about “sustainability.”  He left DFA recently with a goal of creating a family of “sustainable funds” that advisors could use to deliver the capital market rates of return across different asset classes.  Sam has done a lot of work on how to accomplish this but it is more than I can spell out with this post.

Currently, the market is dominated by expensive, actively managed funds, with multiple “social goals” making proper diversification a challenge for advisors and their clients.  And I agree with Sam that the “environmentalist movement” has the investment message all wrong.  The doom and gloom story is not the way to go.  Market forces and technology will create the solutions.

So here is what I am asking.  Let Sam and/or me know what you think.  We believe it’s a win/win for investors and the environment and we are trying to determine whether or not the demand is strong enough to make the funds themselves “sustainable.”

You can email Sam at: sam@vertasset.com

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