Thursday, September 24, 2020

Going Public via a "Direct Listing" - Vested Interests (... Wall Street Compensation) at Risk

An interesting development: the Council of Institutional Investors has acted to pause the effectiveness of an SEC staff-approved NYSE rule change permitting capital-raising "direct listings." A capital-raising direct listing lets a company go public by listing its shares on an exchange -- and raising capital -- without engaging (and compensating) IPO underwriters. "Direct listings" like these have some pros and cons; a major "pro" is avoiding underwriting fees (... investment costs matter ...).

Apparently the Council of Institutional Investors isn't conceptually opposed to capital-raising direct listings. Instead, the Council wants the SEC to first complete the overhaul of the country's proxy voting system (aka the SEC's "proxy plumbing project"). The Council wants the overhaul completed in order to clarify and preserve investor rights that have been called into question in a capital-raising direct listing occurring in the current proxy voting system.

Sunday, June 17, 2018

The Now-Defunct DOL Fiduciary Rule: Darn Good While It Lasted ... and Still Good

Although the DOL's fiduciary rule is no more, per the United States Court of Appeals for the Fifth Circuit and the DOL's decision to not seek a rehearing, the rule leaves a legacy:  the rule fueled the trend of lower retail investment costs by forcing "many brokerages to make changes to product lineups and compensation structures that are likely to remain in place long after the DOL rule is gone."

And a result of those changes?  "A Morningstar Inc. report released in April showed that average mutual fund and exchange-traded fund fees declined by 8% in 2017, saving investors approximately $4 billion in fund expenses.  It was the largest year-over-year decline that the research firm had ever recorded."

See DOL Rule Will Continue to Loom Large

In closing, below is a link to a post on this blog from about three years ago.  My prophecy then about the DOL's fiduciary rule is stated in the last two paragraphs.  (Was I close?)

The U.S. Department of Labor's Proposed Fiduciary Standard Rule

Saturday, March 3, 2018

Index-Based vs. Active Investment Management: Getting Less Impersonal?

You can tell this conceptual battle is heightening because the aspersions are more frequent.  


Index-based investing:  "mindless investing."

Active investment management:  "fortune-telling investing."

Tuesday, January 30, 2018

In the Future, Folks in Finance won't be as Flush From Fees

A short worthwhile article:  Vanguard CEO: Lower Fees Coming to Advisers

Let me prophesize:  the fee compression experienced now by asset managers will continue for another decade.  And I'll venture that investment banks - from the bulge bracket to the boutiques - are just beginning to experience the same intense client pressure for lower fees.

Tuesday, October 11, 2016

Friday, January 29, 2016

There's the Time Value of Money - and There's the Value of Your Time

An underappreciated benefit of low cost, index-based investing is the modest time involved.  That is, in comparison to the time commitment associated with individual stock-picking or some other variant of active investment management.  The low cost, index-based approach gives an investor more time to enjoy other pursuits.  Such as time with family and friends, a good book, music, charitable and civic activities, hobbies (what's a hobby?) ... and on occasion a nice glass of wine.
Active investment management in contrast goes hand-in-hand with consistent if not constant dedication to general economic news, industry-specific business news, and company-specific news.  Attention to all the topics, risks, and developments described in detail in Securities and Exchange Commission filings or other disclosure documents that few investors read in time-consuming detail.  Attention that's paid by oneself or by compensating another to pay that attention.  (It's commonly forgotten that the word "pay" in the phrase "pay attention" is literal.  One pays with one's time, a precious, perishable, and irretrievable item.  A costly item.)     
"Found time" via indexing has value of course.  Value that may be hard to quantify, but quantification matters little.  Please remember this:  the average human life span is less than one million hours.
Concern yourself not with Chinese export trends and currency manipulation, Midwest factory capacity utilization, Janet Yellen's disposition, Vladmir Putin's territorial ambitions of the month, Apple's iphone sales during the most recently concluded quarter, the price of oil, or the like.  Or whether that company of which you hold many shares of stock will successfully bid that contract, win that lawsuit, or get that drug approved.
Instead, relax.  Yes, index-based investing consumes time - just not much.  For example, a little time is involved in prudent rebalancing.  That's time well-spent.  As is time taking advantage of opportunities to reduce one's investment costs, as cost pressures on investment managers of all stripes continue to lower costs.  And with "robo-advisors" and their increasingly sophisticated auto-pilot portfolios sprouting like weeds these days, the time commitment to be a responsible low-cost, index-based investor decreases even more.  
Unless an investor consumes the greater part of daily economic news for enjoyment or as a hobby - and seems that's a tall order with today's information proliferation - what's not to like about time saved?  Especially when coupled with low-cost, index-based investing that can be expected, as empirical studies time and again show, to yield higher risk-adjusted net returns?

Monday, November 23, 2015

A Wealth of Common Sense - a Book by Ben Carlson (2015; John Wiley & Sons, Inc.)

Every year numerous books are published about investing.  Most soon fade into obscurity, sometimes because of their focus on current investment conditions.  (Like investors, authors often succumb to short-termism.) 

However, occasionally an investment book stands out.  "A Wealth of Common Sense" by Ben Carlson is such a book.  (That's Ben Carlson, not Ben Carson.)

The book's central premise is that simplicity in one's investments - including the lower costs of intermediation, etc. associated with simplicity - have underappreciated benefits.  Simplicity swims against the tide of much financial advice.  And against the tide of financial services firm's advertisements.  But the book's central premise, if implemented, and related suggestions give an investor good tools to build an investment portfolio that, odds are, will growth satisfactorily.  Or even better.

The book covers a range of investment topics, goes into depth but not too much depth, is well-researched, and is well-written.  The writing's clarity is reminiscent of a Warren Buffett letter to shareholders. 


Monday, August 24, 2015

An Increasingly Common Story

Here's a link to a worthwhile recent short article about cost conscious, index-based investing:

Pension Advisers Learn the Folly of Trying to Beat the Market (Ron Lieber - NYT)

Excerpt:  "While pension fund managers pay much less than the 1 percent or so of assets that an individual might pay for an actively managed mutual fund, every basis point ... matters."

Sunday, August 23, 2015

Beating the Market

I've been an investor for forty years.  (I'm either older than pictures indicate, started investing before high school, or both.  Please take your pick.)  And I've been a securities/capital markets attorney for most of those years.

For about thirty years I was an "active" investor.  Active in the sense in believing in my ability to pick individual securities and sectors better than the average investor.  (And better even than the average market professional.  Who, after all, is the average person one is competing against primarily when choosing securities.)

A clarification:  I was not "active" in the sense of trading frequently.  I traded (and continue to trade) maybe four to six times a year.

Some early successes -- a stock that appreciated ten-fold; another twenty-fold -- reinforced my belief I could pick stocks successfully.  That is, beat the market.

About ten years ago, after several years of focused study of emerging academic research, I became a convert to so-called index-based investing.  The research (especially the research that I'd suggest is objective), is increasingly incontrovertible, more so each passing quarter as additional studies are published, that index-based investing leads to better long-term risk-adjusted net investment returns.

Paradoxically, the early successes probably cost me money.  Because without them and the overconfidence they fostered I likely would have converted earlier.  But time proved those early successes were not replicable.

In the past, active investing had a decent shot at success, defined as above-average risk-adjusted returns.  But for the past several years active investing has not had that shot.  In 2015, active management is "betting against the house."  Sure, sometimes one beats the house.  But the odds are against it.  How this came to be recently is explained -- better than I can explain -- in the recently published book "The Incredible Shrinking Alpha." 

A main premise of index-based investing is that markets are inherently unpredictable.  This is a difficult concept for most people to accept.  Fundamentally because it has elements of randomness that are at odds with our predisposition to trained, analytical, linear thinking.  As humans it is part of our make-up to believe that we can with some degree of accuracy ascertain the future.  We can do so in other areas of life - results bear that out.  And that leads us to believe we can do so in securities markets.  But study after study after study shows we can't.  (Most of those very, very few "market beaters" lauded by the general interest financial press can be chalked up to - yep - probability.  Aka chance.  Not skill.)

Index-based investing is also difficult for people to accept because it often runs counter to a personal narrative.  As a personal example, in providing for my family - handling my family's investments, including my children's accounts - it is discordant to think that I wasn't doing things as I should have been.  And doing so for many years.  Years I cannot get back.  As another example, consider an investment professional whose livelihood is based on active management.  Can that person easily accept that there is and has been a "better model"?  From the view here, rarely.  To even raise the questions of "has active investment management been the right route?; is it still, now?" can be unsettling.

Let me suggest that the years-ongoing debate about active versus index-based investing is in some ways like the climate change debate:  huge amounts of data do not end the debate.  Psychology, climate politics, and vested interests, etc. complicate what would in another context likely be settled.  Much like the climate change debate, my one prediction (ironically) for this blog post is that the active versus index-based debate will continue for at least another decade.  Perhaps one more generation.

The strategy of index-based investing is pretty basic:  diversify, rebalance with discipline, and keep one's costs low.  As to the latter, little doubt we'll all seen the numerous popular finance press articles sprinkled here and there throughout the years that costs (one of the few factors controllable in investing) are the most accurate predictor -- top o' the list of factors (and a higher predictive factor than the identity of one's investment manager) -- of good-to-very-good risk-adjusted returns.  And that inattention to costs can eat up approximately one-quarter to one-third of one's account balance over the long term.

Friday, July 10, 2015

The U.S. Department of Labor's Proposed Fiduciary Standard Rule

Years ago I worked with a prominent attorney, a brilliant “older statesman” now deceased.  Late in his career he was lauded at a banquet held in his honor.  One of the banquet speakers noted the attorney’s unusual method of simplifying his law practice.  The method was a major factor in his law practice’s remarkable success, it was said.

His simplification method?

Three stacks of paper.  On his credenza.

One stack was for legal matters needing immediate attention.  One stack was for legal matters that would likely benefit from extended time for thinking, analysis, and reflection.  And, somewhat of a surprise, one stack was for legal matters that were likely to resolve themselves, typically by non-legal means.  That stack received little attention – purposely. 

The attorney’s brilliance included an uncanny ability to determine which legal matter belonged in which stack of paper.  And an even better ability to determine if and when a legal matter needed to be moved from one stack to another.

The U.S. Department of Labor is considering a rule under the Employee Retirement Income Security Act of 1974 (ERISA) that would, in a nutshell, assign “fiduciary status” to those who provide financial advice about employee retirement – for example advice about your 401(k) account.  As a fiduciary, the advice provider would be duty-bound to place the advice recipient’s interests first, ahead of the provider’s own interest.  Presently, a provider of retirement financial advice generally need only meet a suitability standard:  i.e., is the suggested investment suitable?

The proposed ERISA rule has triggered substantial debate and politicking.  Opposition to the proposed rule is fierce including because the stakes are high:  U.S. financial services firms receive billions of dollars of revenue annually in connection with retirement financial products that, although suitable, may not always place the advice recipient’s interest first.  A House of Representatives committee and a Senate subcommittee have voted to not fund implementation of the rule.  An influential trade association for financial services firms has proposed an alternative that doesn’t include a true fiduciary concept.  And there’s little doubt that if the rule as currently proposed becomes effective, then the rule’s validity and enforceability will be challenged in federal lawsuits.

Some financial services firms’ principal opposition to the proposed rule is their view that it would have the opposite of its intended effect.  Instead of helping retirement financial planning, goes the argument, the rule’s burdens (and associated administrative and compliance costs, etc.) paradoxically would limit the amount and quality of retirement financial advice available to the U.S. workforce and retirees.  Some commentators believe that paradoxical forecast is accurate.  Others believe that forecast is pretext, the real reason being financial services firms’ desire to preserve substantial recurring revenues.

Let me suggest that the debate over the proposed ERISA rule is a matter which belongs in that last stack of paper:  a matter that likely will resolve itself over time, by non-legal means.  That is, in the long term it likely won’t much matter whether the proposed rule becomes effective or is watered down, tabled, or withdrawn.

Why?  The reason is technological advances in investment software systems, which are becoming increasingly sophisticated, efficient (for both advice providers and advice recipients), customizable, and popular.  These technological advances will continue to lower the costs of providing quality, tailored investment advice and investment choices, thereby addressing directly the principal opposition to the proposed ERISA rule.  The same advances will make higher quality advice and planning more available, in most cases at lower costs, addressing directly the principal aim of the proposed rule.  And so improved, innovative technologies will both defuse the principal argument advanced by the proposed rule’s opponents and achieve the objectives intended by the proposed rule’s proponents.

Wednesday, June 17, 2015

Calpers Takes a Next Step Towards Improved Returns. How? By Reducing Wall Street's Cut

When Calpers' decision to jettison some alternative investment firms leads to a New York Times editorial -- available here and please note: it's not just an article, column, or op-ed -- you know a trend is emerging.  In this trend the tie to New York is that "[a] recent analysis by New York City's comptroller, Scott Stringer, found that the high fees and low returns of its investment managers had cost the City's pension system $2.5 billion in lost value over the last 10 years."

Calpers moves somewhat slowly.  But deliberately.   Expect Calpers to, over time, further reduce its remuneration of alternative investment firms.   And later to end its relationships with many managers of actively managed publicly-traded securities portfolios.  Many other investors - large and small, institutional and otherwise - will sooner or later follow suit.

Thursday, April 16, 2015

The Department of Labor's Proposed Fiduciary Standard Rule for Retirement Investment Accounts: Putting Clients' Interest First

Much has been written about the Department of Labor's recently proposed fiduciary standard rule for retirement investment accounts.  So much so that we need not use much more ink here.  (And here's a fact sheet summarizing the 120 page proposal.)  Ink-to-date is largely about the politics of the proposal, financial service firms' expected challenges to the proposal, the fierce opposition from those firms to the DOL's similar proposal in 2010, and the chances the proposed rule becomes effective.
According to a recent article in Investment Advisor magazine, financial services firms are the largest source of campaign contributions to federal political candidates and political parties.  And the second largest source of lobbying money.  You can expect opposition to the proposed rule to be well-organized, well-funded, smart, and – as in 2010 - fierce.  And expect the Financial Services Roundtable, the Financial Services Institute, the Securities Industry and Financial Markets Association, and the U.S. Chamber of Commerce to not sit this one out.  In the least.     
The proposed rule, if it becomes effective without watering down, will likely be among the most significant means of lowering retail, net investment costs in perhaps a generation.  The DOL's proposing release states that for IRAs "[t]he underperformance associated with conflicts of interest – in the mutual funds segment alone – could cost IRA investors more than $210 billion over the next 10 years and nearly $500 billion over the next 20 years."
Please stay tuned.

Friday, March 6, 2015

Free Online Service Helps Reduce Costs, Fees

I was recently contacted by FeeX, a relatively new online service that helps people find and reduce the hidden costs in their 401(k) accounts, IRAs, and other investment accounts.  For now, the service is free.  I hope to write more about the service after spending more time reviewing the FeeX website.

Thursday, February 12, 2015

Costs Reductions Galore

These days it's difficult to pick up an investment trade publication and not see headlines like this:

State Street ... Lowers Fees ... on ETFs

An Investment News article about State Street's announcement notes that "State Street's move accelerates competition on fees among top players in the investment management business."  The acceleration matches the investing public's increasing awareness of the predictive value of lowered costs in improved investment performance.

Friday, January 2, 2015

So Exactly What is Insider Trading? When is it Unlawful? Lawful or Unlawful, What Does it Cost You as an Investor?

Costs associated with investing in publicly-traded securities aren’t always apparent.  Examples of non-apparent investment costs include (1) the expenses of your trades being “front-run” via flash orders, (2) collusive bid-ask spreads, (3) excessive executive compensation, and of course (4) seemingly small intermediary fees that in fact are unreasonably large.  These costs add up.  And they reduce investment returns, sometimes significantly.

Another investment cost is the amount by which, through an imbalance in available investment-related information between parties to a securities trade, an investor pays more than he or she should to buy securities.  Or receives less than he or she should to sell securities.

The key word in the foregoing sentence is “should.”  “Should” in this context encompasses a notion of fairness.  What information should an investor expect to be available relative to the information available to the person or institution on the other side of the trade?  What is fair?

Recently the influential United States Court of Appeals for the Second Circuit, in the case of United States v. Newman and Chiasson, overturned insider trading convictions of two Wall Streeters who received tips of material non-public information, third- and fourth-hand.  The Wall Streeters then traded on that information and profited.  Substantially.  The Second Circuit overturned the convictions because the government did not demonstrate two elements that the Second Circuit stated must exist to convict a person for unlawful insider trading:  one, that the original source of the material non-public information received a personal benefit in exchange for providing illicit tips and, two, that the individuals who traded profitably knew of that personal benefit.  The Second Circuit cited the United States Supreme Court case of Dirks v. SEC, 463 U.S. 646 (1983) as precedent for the required demonstration of these two elements.

Despite the Second Circuit’s view that its decision only follows existing law, an upshot of the decision is that trading in American public securities markets on the basis of material non-public information will increase.  There are too many gray areas in securities trading fact patterns for an increase to not result.  So, if you and I as investors trade without access to that information then with correspondingly increasing probability the person or institution on the other side of our trade will be “informationally-advantaged.”

That advantage is another investment cost to you and me.

How should an investor in publicly-traded securities respond to United States v. Newman and ChiassonAs a practical matter not much can be done.  (All increases in non-apparent investment costs, quantifiable or unquantifiable, further erode confidence in our public securities markets.  Eroded confidence decreases the liquidity and vitality of those markets.  That’s a subject for another day however.)  From an optimist’s perspective here’s a suggestion, which isn’t new and just reinforces existing good investment practices:  minimize the informational disadvantage - and resulting costs - by trading as infrequently as practical.  Trade only to rebalance or put excess cash to work for the long-term.  When trading in funds such as ETFs, trade very infrequently – again, only to rebalance or put new cash to work - and try to identify funds with low internal turnover.

Monday, November 24, 2014

$600 Billion - for What, Exactly?

A new report from the Center for Applied Research, a think tank associated with State Street Corporation, estimates that investment management industry annual fee revenue from active management is $600 billion.  The estimate is derived from a Boston Consulting Group report and based on estimates of world-wide assets under active management.

In a 2008 post on this blog I noted a John Bogle-authored book's reference to $300 billion as the amount investors pay annually in investment fees and costs.  The differences, I suppose, are due to the smaller amount being a domestic-only amount and perhaps ensuing years of growth and inflation.

The active investment management industry as a whole is a zero-sum game, gross of fees.  Mathematically, that must be.  And so it is difficult to disagree with a statement that the net contribution to society resulting from these fees, however estimated, is approximately zero.  (Well, unless one includes the benefits of "price discovery," which is the setting of market prices based on trading by active investment managers.)

To put $600 billion in perspective, according to the National Priorities Project the fiscal 2015 budget for the U.S. Department of Defense is $555 billion.

Sunday, November 16, 2014

The Rise and Fall of Performance Investing (aka Game Soon to be Over)

I encourage a person even mildly interested in this blog's topics to read Charles D. Ellis' article The Rise and Fall of Performance Investing, published in the July/August issue of the Financial Analysis Journal.  In addition to Mr. Ellis' well-stated views about the merits of low cost, broad-based, index-based investing, he provides informative, persuasive, historical context for how those merits came to be.

Tuesday, September 16, 2014

CALPERS Exits Hedge Funds, Citing Investment Costs

After the market closed last evening CALPERS announced that it is pulling its $4 billion in hedge funds.  “One of our fundamental investment principles is that cost matters,” CALPERS' interim Chief Investment Officer said, “[A hedge fund] is an expensive investment vehicle, especially at our scale.”

Wednesday, September 10, 2014

The SEC's Anti-"Pay to Play" Rule is Challenged in Court

"Pay to play" occurs when an investment adviser contributes to the political campaign of a political candidate who, if elected or re-elected, can influence the selection of an investment adviser for public funds* - with the contributor and the candidate having improper motives.  Some "pay to play" practices are outright quid pro quo corruption:  a lucrative investment advisory assignment is exchanged for a campaign contribution.  Most "pay to play" practices are subtle, allowing plausible deniability for those involved.  Sometimes the subtlety involves intermediaries who make campaign contributions and receive compensation from an investment adviser ostensibly for other services provided to the adviser, with murky causality between the campaign contribution outflow and the compensation inflow.

Investment advisers have sometimes made campaign contributions not with a mindset that a contribution will result in a significant probability of receiving investment advisory business, but with the mindset that not contributing will eliminate the non-contributing investment adviser from a list of advisers to be considered for future business.  

In response to several headline-making "pay to play" scandals, in 2010 the SEC adopted a rule to prevent "pay to play."**  The rule is complicated - several pages long - so here's the nutshell version:  in general, the rule prohibits a campaign contributor, for two years after the contribution, from managing public funds for which the recipient politician has influence in the selection of an investment adviser for those funds.  The rule's blanket two year prohibition avoids the difficulty of discerning motivations:  which contribution motivations are well-intended and which are improper.  

The stated purpose of the anti-"pay to play" rule is to provide integrity in the selection of investment advisers for public funds.  In this writer's view the rule also has the significantly beneficial effect of reducing the investment costs associated with public funds investment management.


Because considering politics in adviser selection distorts decision-making.  Distortions increase costs.  More objective decision-making in adviser selection tends to reduce costs including because low investment costs are the best indicator of desirable long-term risk-adjusted investment returns. 

Last month, in a little noticed lawsuit, two state political organizations sued the SEC seeking to invalidate the SEC's anti-"pay to play" rule.  New York Republican State Committee and Tennessee Republican Party v. SEC (United States District Court for the District of Columbia; Case No. 1:14-cv-01345-BAH).  The plaintiffs allege that the rule violates First Amendment rights and exceeds the SEC's rulemaking authority.     

If the federal courts declare the SEC rule invalid then, nationwide, investment costs borne by public funds will increase.  The increased costs will be borne by taxpayers and pensioners.  (There is no free lunch; incrementally increased investment costs must be borne by someone, soon or later.)  Taxpayers will bear most of the burden through taxes that pay for incrementally larger ongoing contributions to public pension funds, to keep those funds from becoming underfunded or, all too frequently, more underfunded.  Retired government employee pensioners will bear some of the cost increase, too, in those infrequent occasions when government pension benefits can be reduced through the government unit's bankruptcy.    

*Another "pay to play" situation involves the selection of underwriters of municipal and other government debt.  A anti-"pay to play" rule of the Municipal Securities Rulemaking Board is analogous to the SEC's anti-"pay to play" rule.  Municipal Securities Rulemaking Board Rule G-37, upheld by the D.C. Circuit Court of Appeals in Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995).

**Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended.  17 C.F.R. Section 275.206(4)-5.

Sunday, June 8, 2014

The SEC's Two Recent Investor Bulletins: How Costs Affect You

Earlier this year the SEC's Office of Investor Education and Advocacy published an investor bulletin about how investment costs affect a portfolio.  And recently the same SEC office published a similar, but narrower investor bulletin on the investment costs associated with mutual funds.  The first bulletin received a fair amount of press; the second bulletin not so much.

Whether a particular development external to the SEC, such as a new academic study, triggered these bulletins' publication is unknown to this writer.  Maybe the bulletins reflect only the SEC office's view that more public awareness is needed about the effect that costs have on long-term net investment performance, especially given the increasing prevalence and importance of defined contribution retirement plans.

Regardless of the reason or reasons for these two bulletins, here's the skinny:  they are helpful to their intended broad audience and they are well-written, in plain English.  Here's hoping the SEC's Office of Investor Education and Advocacy keeps the topic of investment fees and expenses top of mind -- internally at the SEC and externally with the investing public -- including by supplementing the bulletins from time to time as developments warrant.

P.S. - Please click here for a Scott Burns column in today's Dallas Morning News generally on the same topic as the bulletins.  Burns playfully uses the modus operandi of television ads that pitch the viewer on relief from maladies; he does so by giving the malady of excess investment costs a catch-phrase name:  "intermediary drain."  (Maybe you suffer from it or know someone who does?)

Wednesday, May 28, 2014

Indifference to the Costs of 401(k) Plans has Consequences

A recent federal appeals court opinion, in the case of Tussey v. ABB, Inc., available here, could spur companies that sponsor 401(k) plans to pay more attention to the costs directly and indirectly borne by plan participants.  The opinion is instructive, refreshingly short for a federal appeals court opinion of some complexity, and an easy read.

One hopes the opinion's core holding is being studied by 401(k) plan sponsors.  That holding is that 401(k) plan assets shouldn't subsidize a plan sponsor's receipt of other services from an investment firm.  Through that subsidization the plan sponsor and investment firm benefit to the detriment of plan participants, in this case through revenue sharing payments to the investment firm.  A plan sponsor may be liable even if the subsidization results through inattention or indifference rather than intention.  Arrangements between companies and investment firms in which subsidization potentially exists can be subject to fact-based legal challenges:

"The district court found, as a matter of fact, that the [company's] fiduciaries failed to (1) calculate the amount the Plan was paying [the investment firm] for recordkeeping through revenue sharing, (2) determine whether [the investment firm's] pricing was competitive, (3) adequately leverage the Plan's size to reduce fees, and (4) 'make a good faith effort to prevent the subsidization of administration costs of [company] corporate services' with Plan assets, even after [the company's] own outside consultant notified [the company] the Plan was overpaying for recordkeeping and might be subsidizing [the company's] other corporate services."  [Emphasis added.]

The appeals court panel remanded the case for the district court's consideration of holdings apart from the core holding.  The plan participants-plaintiffs and the company have filed petitions with the appeals court requesting a rehearing.

Monday, April 28, 2014

Investment Management 3.0

The remarkable growth in assets managed by "new model" low cost online investment management firms, such as Wealthfront and FutureAdvisor, is a well-publicized major trend.  Please see these recent articles:  The Rise of the Robo AdvisorsFinancial Advice ..., and ... New Funding. 

An investment manager who doubted the staying power of the "new model" firms is likely to have his or her doubts reduced or removed upon hearing this news:  Vanguard expands online advice.

Wealthfront in particular looks worth closer looks.  The emphasis on low costs ("extremely low costs," per Wealthfront's website), tempered with an eye to ETF tracking error and liquidity, is on the money.

And Wealthfront's tax-loss harvesting is innovative by being available to smaller accounts that typically have not been able to benefit from similar services.  This writer's prediction is that the innovation will soon be available more broadly due to competitive pressures.  (Another prediction:  broad availability of online tax-lost harvesting for most account sizes, large or small, will eventually lead to a change in the tax code to stem the government's tax revenue decline.)

Another "plus factor" to Wealthfront:  the firm's FAQs.  Acknowledged that a company's FAQs often wouldn't seem to matter much.  However, in this writer's view Wealthfront's FAQs are in the nature of small things that can really matter, and a harbinger of good things.  The FAQs are remarkably informative and well-organized.  They provide good insight into Wealthfront management's approach to investing and reflect reassuring attention to detail.   


Sunday, March 16, 2014

Labor Department Proposes that 401(k) Plan Service Providers provide a Roadmap to Fee Disclosures

The U.S. Department of Labor has determined that disclosures about 401(k) plan fees required by a 2012 rule frequently occur in lengthy contract documents and are hard to find.  And also that fee disclosures often are dispersed in multiple documents, hindering transparency.  As a result the department is proposing a rule requiring that 401(k) plan service providers provide a guide, or "roadmap," to those disclosures.

The DOL's news release about the proposed rule is here.  As proposed, the rule would provide that "[t]he guide must specifically identify the document, page or other specific locator, such as section, that enables the employer to quickly and easily find fee information."

In a Washington Post column this week about the DOL's proposed rule ("On 401(k)s, plan fees really do matter ...") columnist Michelle Singletary highlighted a DOL example in which a difference in fees of one percent -- 0.5 percent versus 1.5 percent -- reduces the total of an individual's account at retirement by 28 percent.


Private Equity: Persistence in Fund-Raising ... but Performance?

An above-the-fold article on the front page of a NYT business section last fall states that in the U.S. nearly 2,000 PE firms "are making pitches to state retirement systems, corporate pension funds and wealthy investors in the hope of raising nearly three-quarters of a trillion dollars for their next, new funds ... ."

A key inquiry in a decision to invest in PE is the likelihood that a PE firm's past acceptable performance persists in the firm's new fund.  Independent research, although not conclusive, indicates a low likelihood of performance persistence, not much different than what would occur randomly.

If one subscribes to PE performance persistence then deploy your or your pensioners' capital with past top performers.  And good luck.  If one doesn't subscribe to PE performance persistence then a next key inquiry is whether average net-of-fees and net-of-profit-sharing PE performance justifies the capital deployed. (Justifying here means having an expected return exceeding the cost of that capital.)

At today's prevailing fee and profit-sharing levels, independent research - again not conclusive - indicates investments in PE are not, on average, justified.  This indication is despite many super-lucrative home runs.

A point of view:  PE as an industry benefits from tailwinds of (1) a tendency of underpriced lending, (2) the tax deductibility of interest expense, (3) capital gains taxation of carried interests, and (4) PE firm compensation levels that despite having become customary do not on average adequately compensate PE investors for risks and illiquidity.  Yes, PE firms can and often do add value to their portfolio companies through better management and improved business operations.  However, the average PE firm has not been able to do so in a way that translates into adequate net returns for investors.

Thursday, March 6, 2014

Warren Buffett's Recent Letter to Shareholders Touts Low Investment Costs

An earlier post, linked here, states that Warren Buffett inadvertently harms investors by being the near-universal top-of-mind example of the merits of active investment management. In his recent letter to Berkshire Hathaway shareholders Mr. Buffett seems to go out of his way to remedy the inadvertent harm.

How so?

By mention and repetition of the benefits of low cost, indexed investments. Or conversely of the reduced performance, on average, associated with high-fee managers or other substantial costs.

An excerpt from the letter: "[t]he 'know-nothing' investor who both diversifies and keeps his cost minimal is virtually certain to get satisfactory results."

The reference to a "know-nothing investor" brings to mind John Bogle's famous tenet about investing: "Nobody knows nothing." With these three words Mr. Bogle makes the point that trying to outsmart the market is difficult to the point of futility.

Here's another excerpt from the letter, in which Mr. Buffett speaks about a trust that will receive a cash bequest under his will:

"My advice to the trustee could not be more simple: [p]ut 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals - who employ high-fee managers."

Sunday, August 25, 2013

New Academic Study of Reduced Returns Associated with Costs of 401(k) Plans

A new study by two law professors shines an unflattering light on the high costs of typical 401(k) plans.  These costs, of course, reduce investment returns.  Insidiously.

The professors recognize two types of costs:  those associated with plan fiduciaries, costs which the authors refer to as "fiduciary losses," and the costs of investors' allocation "mistakes."  In the law professors' view the total of the two types of costs "consume about a quarter of the optimal potential risk premium."

There are plenty of takeaways from the study, which as best I can tell analyzed data from over 12,000 401(k) plans.  This takeaway, however, resonates:

"Our results suggest that investors incur unnecessary losses due to fiduciaries’ decisions to include a preponderance of costly funds in plan menus.  Plans that feature index funds show lower fiduciary losses. A portfolio consisting of only retail share classes of Vanguard index funds incurs lower fiduciary losses than 90% of plans in our sample."

One of the law professors stirred the 401(k) plan community pot by writing companies sponsoring plans he believes burden plan participants with higher-than-average costs, notifying those companies of his analysis.

One prominent law firm responded in an "open letter" that alleges the professor's analysis is "outdated and based on incomplete information."  The law firm concluded that plan sponsors should not rely on his letters and study, basing the firm's conclusions on its work for unnamed plan sponsors.  The law firm cites several reasons in support of its conclusion.  However, in this writer's view the supportability of the law firm's response largely hinges on a single statement -- which will become legally suspect in the not too distant future, this writer predicts -- that "... it is commonly accepted that the use of actively managed funds is prudent."

* * *     
Postscript:  I've been planning to post about the new study since reading James Kwak's August 9, 2013 blog post about it.  Procrastination sometimes pays in investing.  But procrastination didn't pay in this instance since columnist Scott Burns has now beaten me to it:  see The Conspiracy for Failure in 401(k) Plans.  Kwak's post is here.  Kwak in his post notes that a study co-author is his former professor.


Monday, July 1, 2013

Investors' Cost Consciousness on the Rise

A recent Vanguard analysis of Morningstar data reveals that funds with lower expense ratios increasingly are receiving a greater share of investor dollars.  Vanguard's "whitepaper" about its analysis is here:  Costs matter: Are fund investors voting with their feet?

401(k) plan sponsors and plan participants are gravitating to low cost funds, too:  Mutual fund costs for 401(k) plans still dropping.  A new Department of Labor fees disclosure rule and pending lawsuits may also be contributing to the positive trends affecting 401(k) plans:  see Limiting the 401(k) Finder's Fee.

Tuesday, April 23, 2013

Pension Funds' Embrace of Hedge Funds Will End Disappointingly

“Pensions are embracing hedge funds because they’re desperate to improve results” writes business columnist Mitchell Schnurman in today’s Dallas Morning News.  Today’s column also notes that a large public pension fund is “trying to ‘turbocharge’ results.”

Both developments are reminiscent of 1980s S&Ls in the final years leading up to the S&L crisis.  Many S&Ls, although then liquid, were insolvent.  And non-transparently so.  Many insolvent S&Ls tried to make up lost ground by attracting additional deposits using offers of above-market interest rates -- that is, pricey interest rates.  With the additional deposits, which included troubling brokered deposits, insolvent S&Ls hoped to invest aggressively and reduce or eliminate “the size of the insolvency hole.”

Depositors didn’t worry about getting their money back because of FSLIC deposit insurance.

This set of facts was a heck of a deal for a broke S&L owner, who was in essence using taxpayer money to attract additional deposits.  If aggressive investment of the additional deposits worked out, well then the S&L owner was no longer broke.  And if it didn’t work out then the S&L owner was no worse off than before, with FSLIC bearing the additional losses.

Trying to make up lost ground rarely worked.  A typical insolvent S&L lost more ground. But depositors did fine, courtesy of FSLIC.

Substitute a significantly underfunded pension plan for a non-transparently insolvent S&L.  Then fast forward 25 years:  the same result of additional lost ground can be expected eventually.

Public pension funds’ investments in pricey, fee-laden hedge funds are slow motion gradual transfers of pension assets to those hedge funds’ managers.  The slow motion, long time-lag, and occasional appearances of intermediaries mask the transfers.  But Follow the Money.

The S&L crisis ended badly.  Significantly increased investment allocations to expensive alternative investments will on average end badly, too, over the long term.

And not only for pensioners but sometimes for taxpayers.  And many will regret when pension funds embraced expensive alternative investments

Wednesday, February 27, 2013

Nothing Passive About It

Starting now let’s call low cost index-based investing just that:  index-based investing.  And for the reasons below let’s no longer use the term passive investing.
There’s plenty of precedent for relabeling financial terms:  the speculative pools of the 1920s are today’s hedge funds.  And the leveraged buyout shops of the 1980s are today’s private equity firms.

Why just one name?
Let’s call index-based investing only just that because the term is much more accurate.  There’s nothing passive about low cost index-based investing.  “Passive” is a common English usage opposite of “active" and there’s considerable activity in index-based investing.  Asset allocation is key to index-based investing and requires timely decision-making.  Also key of course is being a costs-sensitive investor, analyzing investment costs and minimizing the “investment returns friction” of those costs.  To those two activities let's add the activity of periodic rebalancing. 

(Granted that index-based investing involves less time and costs than "active investing."  But since when did time-efficiency and cost-efficiency become associated with “passivity”?)
And there are the milquetoast connotations of “passive”:  docile, accommodating, and – in an investing context – average.  None of the connotations comport with desired self-image.  (Who aspires for average?)  Or with The American Way.  But in truth what fits with those connotations is not cost-minimized index-based investing but instead not being financially astute enough to know that so-called “active management,” delegated to well-compensated helpers, is swimming against strong currents in the seas of investments.  (… Hey let’s make some money together, the helpers say to prospective clients.)

Consider two investors.

Al’s stockbroker (whose business card bears the title financial advisor) at a Brand Name investment firm handles all investments for Al and his family.  Maybe Al met the broker at Al’s country club.  Or maybe the stockbroker was referred to Al by his cousin or brother-in-law.  (His cousin or brother-in-law really likes the broker for his engaging social manner and because at least one stock over some favorably selected time period beat a market average, also favorably selected.)  Al has no involvement with his investments except to occasionally review his monthly statement and to from time to time phone his broker about some stock his club buddies are “getting into.”  (The broker fancies himself a stock picker and mostly listens when Al calls to kick around those hot stock pick ideas.)  Al has little understanding about the true investment costs of his Brand Name account.  His reasoning is that those costs can’t be other than as they should be (or be material) or else Brand Name wouldn’t have as many clients as it does.
Bruce studies investing doggedly and handles his family’s investments, minimizing investment costs and taxes.  Although in Bruce’s heart of hearts he knows individual stock picking is folly, occasionally he strays into the realm of the stock picker.  But mostly Bruce has the discipline to stick to a well-diversified portfolio of low cost index funds, changing asset allocations as appropriate and rebalancing periodically.

So tell me:  if one of Al and Bruce could be labeled an active investor and the other a passive investor, who is which?

Wednesday, January 23, 2013

Columnist Scott Burns Explains How to Get the Cost of Your Investments Down to 0.10%

Scott Burns is spot-on again:  click here.  As mentioned before on this blog -- borrowing a line from Jack Bogle -- in investing, you get what you don't pay for.

Thursday, January 17, 2013

Dallas Fed's Richard Fisher Sees So Clearly: TBTF is TB

The transcript of Dallas Fed President Richard Fisher's remarks last night about American banking -- linked here -- is off-topic for this blog.  But the remarks are too important to not spread via this posting.  Please, please read.  And then act.

Wednesday, January 2, 2013

Looking Back: An Overlooked Cause of the Financial Crisis (Off Topic)

At least a dozen factors contributed to the financial crisis.  Let's add one more -- a counterintuitive, overlooked factor -- and you heard it here first:  SEC compensation disclosure rules.

Among the most fervent readers of a public company's proxy statement compensation disclosures are executives at peer companies.   And few people have gone broke betting against the suppression of ego.

The SEC's 1992 overhaul of compensation disclosure rules, intended to curb executive compensation through comprehensive, meticulously detailed disclosures, instead had an opposite effect, creating favorable conditions for a compensation "arms race" that began in ensuing years.   (The law of unintended consequences strikes again.  And the Sarbanes-Oxley Act of 2002 did little to curb the then-developing compensation "arms race," as that act mostly concerned other, related topics.)   The SEC's 2006 revision of the rules, continuing its 1992 policy aims, intensified the race. The race was most intense and competitive at publicly-traded financial services firms and the largest public companies.

Seeking greater compensation to not fall behind actual peers and, too frequently, ostensible peers, senior executives at financial services firms -- few of which executives by their own estimation are average or below average performers -- increasingly caused or allowed their firms to take greater risks.  (Taking on greater risk is, on average, quicker, easier and more easily justified at financial services firms than at companies in other sectors.)  Also, over time, increasingly larger shares of the rewards of those risks benefited senior executive management at those firms, incentivizing even greater risk-taking.

Monday, December 31, 2012

High Costs Warning Signs for 2013

Here are four warning signs of situations likely to involve high investment costs and otherwise be unsuitable:

1---A financial advisor or potential advisor would like to visit with you about or send you information about what he or his firm's research department "sees in the market" for 2013.  Or about his or that department's stock pick recommendations for 2013.  (Especially to be avoided: an advisor or potential advisor who would like to visit with you about how you should position your portfolio based on his or the firm's views on future geopolitical events.)

2---A recitation of historical performance, now including full year 2012 performance, unaccompanied by a measure of historical risk assumed.

3---Worse, an investment referred to as risk-free.

4---A free investment seminar.  With very limited exceptions, free investment seminars are purely trolling-for-clients exercises.  According to a recent New York Times article, a 2009 survey "found that nearly one in 10 people over 55, or about 5.9 million Americans, had attended a free financial seminar in the last three years."  As Helaine Olen explains in her new book Pound Foolish: Exposing the Dark Side of the Personal Finance Industry, “a panicked baby boomer is [the industry's] best customer.”

Happy New Year!

Wednesday, September 5, 2012

The Bursting Bubble of Investment Management Riches

Investment management in the U.S. has always been a well-heeled endeavor.  As an industry, even in troubled times investment management usually has been prosperous.  But beginning in the 1970s investment management became an even more lucrative business, in many cases leading to fabulous wealth.

Several factors contributed to the formation of what has become an investment management bubble:  mass-media marketing caused a broader slice of the U.S. population to view the industry’s services as helpful if not necessary.  More clients meant more assets under management.  And more fees.  The mutual fund industry experienced explosive growth.  Institutional endowments also saw tremendous growth including from favorable demographic changes.  And inflation and periods of increasing stock market values helped mask the investment manager’s “take.”

These factors and business norms – the perceived unseemliness of negotiating fees below “customary” levels – significantly alleviated pricing pressure on investment managers’ fees.

But no more.  Recent events indicate the accelerating deflation of a forty year bubble in the profitability of investment management.  A golden era is beginning to experience a “perfect storm” of four converging factors.

The first factor is academic research revealing that the cost of active investment management is unjustified by performance.  Today the revelation is nearly incontrovertible.   In the 1990s and early 2000s that wasn’t so:  then, it wasn’t difficult for full-price investment managers to dismiss as a fluke ten or even more years of investment history indicating that broad-based, low cost index funds performed better on average, after costs and taxes, than investment approaches and vehicles more lucrative for managers.  The stock market breaks of 1987, 2000, and 2008-2009 facilitated dismissal including by making comparisons not straightforward.

But accumulated data since the 1976 launch of the first index fund causes a similar dismissal – today -- to sound hollow.  (“It is difficult to get a man to understand something when his salary depends upon his not understanding it.”  – Upton Sinclair.)  Managers and consultants continue to be creative in their explanations of why the better performance of a low cost, index strategy is still a fluke after all these years.  Here’s a very recent explanation: "[w]eve been in a period of non-selectivity in the markets.  An index in that environment should do better."  See Are State Pension Funds Paying Wall Street Too Much?, August 15, 2012.

The second factor is competition from new entrant investment managers challenging name brand incumbents.  Many of these incumbents are tarnished by their but-for-the-bailout failure during the 2008-2009 financial crisis, furthering the new entrants’ competitive advantages.  Firms such as AssetBuilder, Portfolio Solutions, and Wealthcare Capital represent the future via their low costs and academic underpinnings.  Technological innovators such as MarketRiders, Personal Capital, and Betterment are examples of a second wave of low cost new entrants.  These new entrants likely will multiply and grow and, as the winners sort themselves out, take meaningful market share from incumbents.   (For an in-depth view of the newly competitive environment for investment management please see Private pursuits (The Economist, May 19, 2012).)

The third factor is today’s ultra-low fixed income yields.  Today’s yields leave investment managers little room to maneuver to minimize the long-term effects of their fees.

The fourth factor is that the investment management costs of public pensions are starting to become a political issue.  Electorates don’t grasp easily that public pension underfunding, to which high investment management costs contribute significantly, eventually is borne at least in part by taxpayers.   That fact is not yet a front-and-center issue for two main reasons:  the lag times involved -- for example between fees to managers paid currently and underfunding that manifests itself in fiscal distress years later -- and the many factors besides cost that bear on net investment returns.  But it’s only a matter of time before high investment management costs become a signature issue for political candidates.

The campaign of Ron Elmer, who earlier this year ran unsuccessfully for Treasurer of North Carolina, is an example.  Here’s Mr. Elmer’s response to a candidate questionnaire:
            What do you see as the most important issues facing the Treasurer's office? If elected, what are your top three priorities in addressing those issues?

            The biggest issue facing the Treasurer's office is the $3 billion hole in the state pension fund [the state retirement system] caused by poor investment management.  For the first time since 1998 our state pension is underfunded.

            The single biggest impact the State Treasurer can have on North Carolina is by increasing the investment returns within the $75 billion pension fund.  We can reduce the burden placed on state taxpayers and still secure the rightful benefits earned by our faithful public servants.
            First, I will stop and reverse the current flow of funds into the very high cost alternative investments such as hedge funds and private equity.

            Second, I will massively reduce the exploding annual cost of investment manager fees of $300 million that is paid to external managers that essentially funds 3,000 high-paying jobs outside our state.  I will "in-source" these investments at a fraction of the cost of the current policy of out-sourcing the investment management.  We can save hundreds of millions of dollars each year and create a few investment jobs right here in North Carolina.

            Third, I will increase the use of low-cost passive indexing as an investment strategy.  At $75 billion, our pension fund is the 10th largest in the U.S.  The fund is so large that once we add up the portfolios managed by the 200 external managers, the pension fund looks a lot like a very expensive index fund.

            In summary, by eliminating or reducing Wall Street's $300 million drain on our pension fund, the state Treasurer could easily reduce the burden to the state by more than $1 billion over the course of a four-year term.  There is not another public official that has the ability to increase state coffers by $1 billion without raising a single tax or cutting anyone's budget except the state Treasurer.  But, it will take an experienced investment manager to do that.  I am the only candidate in the race with any true investment management training and experience.

Mr. Elmer also noted that his election opponent held a successful fund-raiser on Wall Street.

* * *

Due to these four factors the sun is setting on a golden era of U.S. investment management.  As an investor, you’re well advised to buy low cost, broad-based index funds.  But if you’re addicted to individual stock-picking then at least steer clear of publicly-traded U.S. investment managers.

* * * * *
The Seeking Alpha version of the above post is available here should you want to read comments.

Monday, June 25, 2012

Attempts to Eradicate "Pay to Play" in Pension Investment Management Appear Half-Hearted

In April the U.S. Department of Labor announced a settlement with investment firm Morgan Keegan.  The settlement requires the firm to pay over $600,000 to ten of the firm’s pension plan clients.  The settlement follows a DOL investigation that found Morgan Keegan “violated federal law” in recommending certain hedge funds of funds as investments to the clients.  According to the DOL, “these recommendations resulted in the hedge funds of funds paying Morgan Keegan revenue-sharing and other fees.”

News articles call the payments to Morgan Keegan kickbacks.  A link to the DOL press release announcing the settlement appears here.  The press release states that the behavior investigated occurred during a seven year period that ended November 2008.

Hopefully Morgan Keegan is chastened by the settlement with the DOL, the required payments to clients - some of which one supposes may now be former clients - and the resulting embarrassment from unflattering headlines.  Those consequences should reduce chances the firm is a repeat offender when it comes to accepting monies it shouldn’t.

But what incentives exist to cause a hedge fund of funds to not offer or make payments it shouldn’t to a firm that can steer pension-assets-to-be-managed to the fund?  Apparently not many.  According to the person identified in the press release as a DOL contact person, the DOL is not making public the names of the hedge fund of funds that made the payments.

Hard to stamp out “pay to play” in pension investment management if one works only one end of the problem.  (Granted, some payments that appear questionable may be made with innocent intent.  And of course even if a payment was made with other than innocent intent proving “pay to play” often is difficult.)

And several additional unanswered questions remain.  How many hedge funds of funds made payments to Morgan Keegan?  Did any individuals at the funds or at Morgan Keegan incur any regulatory or legal consequences in the matter?  What was the value of the pension assets invested with the funds as a result of Morgan Keegan’s recommendations?  Did the funds disgorge any management fees or other revenues resulting from the Morgan Keegan recommendations?  Does the $600,000+ bear a relation primarily to, or is it derived primarily from, the total untoward payments Morgan Keegan received?  If a pension plan invested in several hedge fund of funds pursuant to Morgan Keegan’s recommendation then surely in connection with the DOL settlement the plan was told which fund or funds made questionable payments to Morgan Keegan, right?  Are the disclosure obligations Morgan Keegan agreed to in the DOL settlement prospective only?  (The DOL press release isn’t clear about that.)  Was the financial crisis a factor in the November 2008 end of the matters investigated?  And if so then how?  How did the tainted hedge fund of funds investments perform?  (Of course, good performance doesn’t make “pay to play” acceptable.  But also, of course, poor investment performance compounds the foul.)  According to the DOL’s contact person, the DOL isn’t releasing the names of the plans affected.  Why?  And have the plans’ participants been notified – or will they?  And so on.

In investment management, until payors of questionable payments receive the same investigative scrutiny as payees, “pay to play” will slither along.  And payees’ clients and the clients’ beneficiaries – pensioners, in this Morgan Keegan situation - will continue to bear the considerable investment costs of the distortions in investment decision-making caused by “pay to play.”