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How much money does it take to rise above "retail" status? A lot. Is $1 million enough? No way. Most big banks and wealth management shops turn away all money management accounts that fall below that level. Some customers with accounts between $500,000 and $1 million may permitted to stay, but are given 1-800 telephone numbers for account inquiries and deal with new hires at a service center. Accounts with more than $1 million, traditionally the amount required to be considered a "high net worth" client, are given a personal investment advisor, but these days the portfolio manager follows a strict investment model and his job performance is measured mostly on new sales. Shockingly, at the big banks, management may care more about how many checking account referrals a portfolio manager has made than about the performance of his clients’ stock portfolios. For them, it’s all about cross-sales and what they call “share of (your) wallet.” They focus not on investment performance, but on selling customers as many products as possible because this makes it more and more inconvenient for customers to change banks.
Thus, to even be considered a wealthy individual requires a net worth of much more than $1 million! In fact, it probably takes about ten times that much money to begin to play in the institutional arena. Moreover, a $10 million investor can probably expect to pay at least $100,000 per year in money manager fees. Below that amount, you’re considered part of the hoi polloi, along with Homer Simpson and the Beverly Hillbillies.
The mutual fund supermarket invention is important because it allows retail investors to buy institutional money management expertise directly. It puts a professional advisor on the customer’s side of the table instead of leaving investors dependent on sell-side brokers for advice.
- What is the problem with the old way?
Trust departments are even worse. Some affluent folks, when they die, create trusts to avoid estate taxes by creating long-term accounts for the benefit of someone else, often next generation family members. A trustee, often a large bank or brokerage firm, is named to be in charge of the money. Trustees are fiduciaries, meaning they are supposed to act as a proxy for the benefactor in the best interest of the beneficiaries. Trustees, however, view that money as their own. A real beneficiary who might want to spend the money that has been left for them is quickly labeled a spendthrift. The problem with spendthrifts is that they spend down the assets in the account, which reduces fees to the trustee. Trustees have every incentive to turn down even legitimate requests. It’s also very difficult to change trustees. It requires agreement on the part of all beneficiaries, who are generally kept in the dark about investment performance. I know of one small business owned in a trust which was sold after the death of the business owner to the trust officer managing the estate, at a hefty discount, after which the trust officer promptly retired and moved to Florida.
In the meantime, the notion that Wall Street or the big banks are looking out for investors’ interests is patently absurd. Take Goldman Sachs, widely considered one of the best firms on the Street. During the technology bubble, Goldman’s global and domestic underwriting effort was second to none. In 1999, Goldman was the lead underwriter in 47 initial public offerings, second only to Merrill Lynch. More than four-fifths of the 1999 IPO’s were technology and internet companies. A year later, they claimed over 20% market share in bringing what were eventually proven to be pseudo-companies to the market, enriching themselves and dot-com founders at the expense of their clients. Nowadays, when you ask firm strategist Abby Joseph Cohen about that era, she claims that Goldman was timely in turning negative on tech stocks. However, you’d never know it by what was sold to customers.
More recently, the bubble has been in real estate, especially the overpriced kind sold to people who can’t afford it. Goldman has been an active underwriter of this debt, especially to its hedge fund clients. Interestingly, when the sub-prime bubble popped and prices of the garbage securities sank like a stone, Goldman Sachs reported an extremely strong finish to its 2007 year. It had sold the securities short, so it stood to make billions of dollars when prices came tumbling down. Give Goldman credit for being smart. They knew this merchandise better than anyone else because they had underwritten it. And they knew to sell it short, because it was toxic. They will continue to earn great bonuses ($623,000 per employee in 2006) because of how they treat customers…but not because of how well they treat customers. Goldman is easy to pick on only because they are so good at what Wall Street does. This is simply the way Wall Street works, and the big banks worship at the same altar. The banks really want to be like Merrill Lynch. They would function in exactly the same fashion, if only they weren’t so incompetent.
Why anyone thinks their broker is on their side is beyond me. That is just not how it works on the island of Manhattan. Brokers sell products. They represent the product manufacturer, whether the product is a stock (like webvan.com), a bond (issued by a mortgage factory like now bankrupt Delta Financial), or a mutual fund. Twenty-five years ago it was oil & gas limited partnerships, which ultimately proved to be extremely illiquid and valuable only because of the tax write-off they provided when they became practically worthless when the oil boom went bust. Today it’s expensive “manager of manager” platforms, hedge funds, closed-end funds and unit investment trusts. Twenty-five years from now it will be something else, unless investors wake up and change how they get their financial advice.
Brokers are only required to offer suitable products, whereas a fiduciary is actually required to look after the client’s best interest. It matters not that the company in question is nothing more than a bad idea on a napkin with a well connected board which will be given stock at a price far below what the investing public will pay. What matters is the demand side. During the tech bubble, there was huge demand for anything of a dot-com origin, and manufacturers like Goldman Sachs and the venture capital community made a bundle giving investors a fix. Investors wanted excitement, and the brokers delivered. As long as it was suitable, it was saleable. And suitable is a very broad term.
Investors have an amazingly short memory. Merrill Lynch has one of the most widely recognized brands in business, but how many investors remember its connection to the Orange County bankruptcy in 1994 when the county treasurer lost $1.7 billion by borrowing $2 for every $1 in county funds to buy $3 worth of mortgage-backed securities from Merrill Lynch and others. The securities in question were suitable. The investment advice that the county received? Not so much. Merrill Lynch paid $437 million to settle litigation with Orange County, and another $30 million to dispense with a criminal inquiry. But investors remain bullish on Merrill Lynch, nonetheless.
By the time of the tech craze, the overall quality of Wall Street research sank to the point where during the bubble analysts chased bonus pool money controlled by the investment underwriting side of the firm. Highly paid shills like Henry Blodget (and there were many others) wrote glowing reports on companies which they privately viewed as essentially worthless.
Advisors at full-service firms, who hadn’t been told that their research units had sold out, used to let the firm keep as much as two-thirds of their commissions to pay for firm wide resources…like research. A broker generating $300,000 in fees might only take home $100,000 in salary, with the rest going to support the shenanigans in the New York office. Not surprisingly, as the bubble in technology exploded and the general shoddiness of the research effort became more pronounced, individual advisors began to re-think the advantage of letting the house keep so much of the take, given that the support being provided to the retail brokers had all but dried up. By changing broker/dealers from a major Wall Street firm to an independent broker/dealer, a financial advisor might keep all but $30,000.
Investors need to realize, however, that they are no longer tied to the old order. Just as Johannes Gutenberg by inventing the movable type press eventually enabled the distribution of the bible to the masses and was a key factor leading to the Renaissance, the development of the discount brokerage mutual fund supermarket has wide ranging consequences for how investors organize their investment program.
Martin Luther split the Catholic Church by publishing translations of the Bible in German. The Vatican lost its exclusive control over access to, and interpretation of, God's word. Martin Luther's followers studied scripture on their own and were able to challenge the Pope's interpretation of the words they were reading. Where once information had been centralized to the benefit of a few, suddenly it was available to the many. Individuals re-evaluated the Church's role in society, instigating a broad cultural reformation that eventually resulted in the concept of individual empowerment taking root.
Individual empowerment is why now investors can break away from Wall Street to find mutual fund firms willing and able to invest on their behalf without the self-interest and self-dealing that permeates so much of Wall Street. The research to find these good funds is available. Just as Gutenberg made the Word of God accessible to the masses without requiring a life solely devoted to intense scholarship, so these new web-based brokerage accounts open the world of institutional money management to anyone with an internet connection.
Next post: Looking Ahead
To start at the beginning of the Investment Heresies eMag, click here
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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