and stocks

A couple of days ago my California son sent me a picture of a Stockpile kiosk in an office supply store.  I’d known about the company, a subsidiary of stock market clearing house Apex, for a while but hadn’t looked into it before this.

The idea is that you can buy or gift small fixed dollar amounts of high profile stocks, like Amazon, Nexflix or Tesla, or index ETFs for that matter, either using a gift card you buy in office supply stores, supermarkets etc. or find online (gift card or e-card) at  The recipient can either redeem the card for cash or use it to purchase fractional shares of the stock whose name is on the card.

My son’s first reaction is that this is a symptom of the kind of craziness that marks the top of a stock market cycle, like when strangers on the subway start to trade stock tips or when a cab driver does the same thing, explaining he’s a day trader who now drives as a hobby.  (I was a cab driver in Manhattan once and I can’t imagine anyone doing this who doesn’t have to.)

My hunch is that this isn’t a sign of the market topping, however (I’d be more worried if the kiosk offered bonds).  Of course, I think I’m pretty good at recognizing bottoms, but I know I’m bad at seeing tops.

Rather, I think this is another step in the evolution of stock investing away from the traditional brokerage model.  That model has three main defects:  the prices are outrageously high; the brokerage salesperson (around 90% are men) has no legal responsibility to do what’s best for the client; and in my experience the service and advice are poor., in contrast, is bare bones.  No advice.  All trades are done at the day’s closing price.  Commissions are $.99 a trade.  And, of course, you can buy and sell fractional shares.

Target customers appear to be either impulse buyers, desperate gift givers or younger investors without much money to spare.  It’s hard to know how long the service will stay this way or how it will evolve.

I remember speaking with traditional brokers when marketing my mutual funds who believed (correctly, I think) that many clients kept most of their investment assets with Fidelity or Charles Schwab.  That way they would get advice from their brokers but only do, say a third of their trading at several hundred dollars  pop and the rest for $7 or $8 with a discount broker.

Maybe Millennials will end up keeping a third of their money with Fidelity or Schwab to get access to the statistical information they have available but do most of their trading for $.99 with Stockpile.  Maybe retiring Boomers, now more money-conscious, will do the same thing.

My overall reaction:  another evolutionary step, another nail in the coffin of traditional brokers.





the Supreme Court and 401k plans

On Monday, the Supreme Court made a narrow ruling on a technical point that may have far-reaching implications.

Participants in the 401k plan offered by Edison International, a California utility, sued the company claiming that it stocked the plan with “retail” versions of investment products that charge higher management fees than the lower-cost  “institutional” versions that it could have chosen instead.

The company defended itself by successfully arguing in a lower court that the statute of limitations for bringing such a lawsuit had expired.  The Supreme Court said the lower courts were mistaken.  An employer has a continuing duty to supervise its 401k offerings.  So even though years had passed since the 401k offerings were placed in the plan, the statute of limitations had not expired.

So the case goes back to the lower court, where presumably the question of whether Edison was right to offer a higher cost product than it might otherwise have.

Was this a mistake?

Why wouldn’t any company have the lowest cost share possible in the 401k plan?

The short answer is that the company receives a portion of the management fee in return for allowing the higher charges.

Typically the company argues that the fee-splitting helps cover the costs of administering the 401k plan.  In practical terms,thought, the move doesn’t eliminate the costs.  It shifts them from the company to the plan participants.

If the Wall Street Journal is correct, this is the case with Edison, which is reported as pointing out that the fee-splitting is disclosed in plan documents.

I have two thoughts:

–the sales pitch from the investment company providing the 401k services probably sounded good at the time.  The 401k would be inexpensive (free?) to Edison.  High fees would shift the cost onto employees instead–which makes sense, the seller might argue, since employees are the beneficiaries of the plan.

On the other hand, to anyone without a tin ear, this sounds bad.  The amounts of money are likely relatively small.  Edison is probably spending more on legal bills than it “saved” by choosing the plan structure it did.  And if it turns out that Edison is profiting from the arrangement rather than just covering costs, the reputational damage could be very great.

–fee-splitting arrangements on Wall Street are far more common than I think most people realize.  This case could have wide ramifications for the investment management industry if the courts ultimately decide that Edison acted improperly.



should brokers be fiduciaries?

…my answer is Yes.

In his recent spate of initiatives, President Obama is proposing that retail brokers be legally declared to be fiduciaries, the way investment advisers already are.   I’ve written about this before, when the SEC carried out a study of the topic, ordered in the Dodd Frank Act, which it published in early 2011.  Nothing happened back then.  Probably the same result this time.

The issue?

As I see it the change would mean that, for example:

–unlike today, your broker would have to point out, when he gives you a computer-generated analysis of your financial needs and a resulting asset allocation, that the names suggested consist solely of funds that pay fees to be on the list–and that potentially better-performing, lower cost funds that don’t pay have been excluded.

–that his (about 90% of traditional brokers are men) favorite fund families, whose offerings he always touts to you, also treat big producers like him (and a companion, usually) to periodic educational seminars at a sunny resorts in return.

More than that, depending on how any new regulations are written, he might also have to tell you that the trade his firm is charging $300 for could be executed just as well at a discount broker for less than $10.

brokers say No!

Brokerage houses are strongly opposed to Mr. Obama.  They’ve apparently already raised enough of a lobbying fuss in a very short time to cause the President to weaken his proposal.

How so?  From a business perspective, wouldn’t it make sense for traditional brokers to hold themselves to a higher standard of conduct?   They might thereby improve their very low standing  in the public mind and possibly stem the continual loss of market share they’re suffered over the past decades.

Two practical problems:

loss of skills

–over the past twenty years, brokers have homogenized their sales forces, moving them away from having their own thoughts and opinions about stock and bond markets to being marketers of pre-packaged products and ideas developed at central headquarters.

The ascendancy of pure marketing over investment savvy may have had sound reasoning behind it (although I regard it as one more triumph for the former in the battle of jocks (traders) vs. nerds (researchers) that I’ve witnessed through my Wall Street career).  However, most of the experienced researchers who had the skills to shape an investment policy and retrain the sales force have been fired either before or during the recent recession.

It’s easier in the short run to lobby against change than to revamp operations–or rehire the newly laid-off nerds needed to accomplish the task.

red ink = loss of bonuses

–in almost any phase of economic (or any other kind of) life, the status quo is extremely powerful.

Traditional retail brokerage is extremely high cost.  Remember, the retail broker himself nets only about half the fees he generates.  The rest goes to support very elaborate–and now seriously outmoded–bricks-and-mortar infrastructure and central overhead.  Lowering fees to get closer to discount broker levels, spending to raise the quality of proprietary products sold or consolidating real estate would all diminish–or even temporarily erase–operating income.  In a culture that values short-term trading profits over all else, it’s hard to develop support for a move like this.


massive redemptions at PIMCO? …I don’t think so

Late last week, bond guru Bill Gross, founder and public face of PIMCO, resigned from that firm to go to work for a much smaller rival, Janus.  This has led to speculation that the departure of Gross, who crafted the superior long-term record of the PIMCO flagship Total Return bond fund, would cause the loss of as much as 30% of the $1.8 trillion PIMCO has under management.

I don’t think the outflows will be anywhere near this bad, for a number of reasons:

1.  PIMCO deals in load funds, meaning that retail investors must pay a fee to buy them.  Two consequences:

–owners find the fact of the fee, not necessarily the size of it, a psychological barrier to sale.

–the load-fund client typically places a sell order through his broker.  The fact he can’t just go online in the middle of the night and redeem is another barrier to sale.  When called, the financial adviser can make reasoned arguments that persuade the client to hold on.  The broker may also convince the client to move to another bond fund in the PIMCO family, so that money leaves the Total Return fund but stays in the group.

What’s to stop a broker from using the Gross departure to call all his clients and tell them to take their money from PIMCO and place it with a different family of load funds–thereby generating another commission for him/her?  Generally speaking, such churning is illegal.  The transactions might even be stopped by the broker’s own firm.  Worse yet for the broker, this kind of call is pretty transparent as a fee grab.  It might also invite questions about where the broker was when the Gross performance began to deteriorate.

2.  My experience in the equity area is that while no-load funds can lose a third of their assets to redemptions in a market downturn.  Under 5% losses have been the norm with the load funds I’ve run.  Even smaller for 401k or other retirement assets.

3.  Money has already been leaving PIMCO for some time.

–Bill Gross’s performance has been bad for an extended period.

–He’s been acting like a loose cannon.

–Mohamed El-Erian’s leaving PIMCO was particularly damaging.  I think most people recognize that Mr. El-Erian is a professional marketer, not an investor.  But he was being paid a fortune to replace Gross as the public face of PIMCO.  Why leave a sweet job like that  ..unless the inside view was frighteningly bad?

At some point, however, PIMCO will have lost all the customers who are prone to quick flight.

PIMCO will try hard to get clients to stay.  It will presumably concede that it waited much too long to rein Mr. Gross.    But, it will argue, a seasoned portfolio manager at PIMCO, Dan Ivascyn, has now taken over the Total Return fund.  Supported by the firm’s broad deep research and investment staff of more than 700 professionals, Ivascyn will stabilize performance.  So the worst is now over.  In fact, Gross’s departure may have been a blessing in disguise.

4.  Arithmetic.  About $500 million of PIMCO’s assets come from its parent, Allianz.  Presumably, none of that will leave.  Third-party assets total about $1.3 trillion.  A loss of 30% of total assets would mean a loss of over 40% of third-party assets.  That would be beyond anything I’ve ever seen in the load world/

5.  Although individuals are prone to panic, institutions act at a more measured pace.  It would certainly be difficult to persuade institutional clients to add more money now, but it should be easier to persuade them to allow the assets they now have at PIMCO to remain, while keeping the firm on a short leash.

In sum, I can see that in the wake of the Gross departure, PIMCO could easily lose 10% of the third-party assets it has today.  I think, however, that the high-end figures are being put out for shock value and without much thought.

making it clearer who pays for investment research

paying for research information

Who pays for the investment research that professionals use in managing our money?

We do, of course.

But this happens in two ways, one of them not transparent at all.

management fees

–We pay management fees, out of which the management company pays for its portfolio managers and securities analysts.  That’s straightforward enough.

research commissions aka soft dollars

–We also permit, whether we know it or not, our managers to pay higher commissions, or to allow higher bid-asked spreads, on trades they do with our money.  They are so-called “research commissions” or “soft dollars.”  These are not so transparent.  It’s our money, and it does to pay for  the manager’s newspaper subscriptions, Bloomberg machines, brokerage research reports…

In 2007, there was a movement afoot in the US, spearheaded by Fidelity, to eliminate soft dollars and have management companies pay for all its research out of the management fee income paid by customers.  This effort fell victim to the recession.

EU financial authorities have now revived the idea.  They’re proposing to ban research commissions completely–that is, they will demand that investment managers obtain the lowest price and best execution on all trades–that is, they won’t permit a certain portion to be paid for at, say, double the going rate in return for access to the work of the brokerage house security analysts.


According to the Financial Times, smaller investment management firms could have their operating income cut in half if they had to pay for all the research they get out of their own pockets.

But that won’t happen.  Every investment manager, big or small, will go over the list of research providers with a fine tooth comb and eliminate sources whose value is unclear but who are being paid anyway because it’s “just” a soft dollar payment.

I think there will be three main consequences of European action:

1.  Pressure for the US to follow suit will be enormous.  Balking by US managers will open the door for UK-based specialists on the US market to gain business from domestic managers.

2.  Analysts who produce original research will be much more highly prized;  those who do more prosaic “maintenance” research will be replaced by robots (not a joke, more a question of how quickly).

3.  The overall size of sell-side research will continue to shrink, not just boutique firms but at the big brokers as well.