Category Archives: Getting financial advice

the record of active fund managers in Europe

October 30, 2015 By in Getting financial advice, indexing, Investment firms, Portfolio management, stock market Tags: , , , , Leave a comment

I’ve been reading the Indexology blog again.  A few days ago, the topic was the performance of actively managed equity funds managed by European fund managers over the past ten years.

The numbers are almost incomprehensibly bad.

In the “best” category, large-cap European stocks in developed markets there, 55% of the funds underperformed over the past year.  That result deteriorates pretty steadily as time progresses, with the result that on a ten-year view 87% underperform.   .and that’s the best!

The race for last place is almost a dead heat among Global, Emerging Markets and US.  Over the past year, 82% -83% of managers in these categories underperformed.  This result also deteriorates over time.  Over the past ten years, 97% – 98% underperformed.

This is the same pattern as for US active managers   …only worse.

The performance figures are after all fees–management, administrative, marketing…–except for the sales charges levied by traditional brokers.

More importantly, the figures for each period include all funds active during that time, not just the ones that made it through the entire period.  That’s key because over the past ten years about half of the funds active for part of the time were either shut down or (more likely) merged with other funds.  It’s possible that one or two of the defunct funds were great performers but  for some reason couldn’t be sold.  However, in my experience, the overwhelming majority would have been folded because the performance was bad.

Similar figures for the survivors confirms my belief.  The 10-year record for this smaller, hardier, group shows around half the funds outperforming their indices–except for the emerging markets category where over two-thirds of the surviving managers still underperform.

Why do clients put up with this?

One answer is that the absolute returns have been between 5% and 10% yearly in euros.  On the low side that means up by almost 65% over the past decade.  That’s not all that investors could reasonable have expected, but it’s not a loss.  So alarm bells don’t go off when holders get their statements.

Another is that they aren’t.  These sad figures for active managers are the biggest explanation for the popularity of passive products.

 

The Signal and the Noise

July 23, 2015 By in Academic Theories, Books, Getting financial advice, Portfolio management Tags: , , , , 1 Comment

I’ve been reading statistician Nate Silver’s 2012 book The Signal and the Noise.  He makes three points that I think are useful for us as investors:

1.  Some ostensible information sources aren’t really that.

TV and radio weathermen, for example, deliberately forecast more rainy days, and amp up the amount of rain that will fall, than they actually think will occur.  Why?  People apparently like to hear about bad weather.  Also, we only get mad if the weather is worse than predicted.  If it’s better ,we regard it as a pleasant surprise.  So there’s every reason for TV and radio to have a consistent “wet” bias–and they do.

Same thing for shows on politics.  Pundits on the McLaughlin Group, for example, have a startlingly bad record at making political predictions.  The show’s many fans don’t seem to care.  Broad, sweeping views, confidently and articulately presented, are all that matters.

It seems to me the same applies to TV financial shows.

 

2.  The group with the absolute worst forecasting record is professional economists.  In fact, predictions about the course of the overall national and world economies are not only highly inaccurate, they’ve gotten worse over time, not better.

In other words, don’t bet the farm on a macroeconomic forecast.

 

3.  Foxes are better thinkers than hedgehogs.

Silver separates forecasters into successful = foxes (he’s one), and really bad = hedgehogs.

The differences:

hedgehogs

highly specialized

“experts” on one or two narrow issues that define their careers; contemptuous of “generalists”

often in the academic world

all-encompassing theories

theory over facts

believe in a neat universe, defined by a few simple relationships

highly confident, meaning resistant to change

foxes

interdisciplinary

flexible

self-aware and self-critical

facts over theory

think the world is inherently messy

careful, probabilistic predictions.

In other words, be careful of highly confident people with overarching theories and elaborate forecasting systems.

 

 

 

the Supreme Court and 401k plans

May 20, 2015 By in bond market, How your broker gets paid, Industry Analysis, Investment firms, mutual fund holders and financial advisors, securities markets, stock market, Where are the customers' yachts? Tags: , , , , , , Leave a comment

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.

 

 

paradox of thrift; paradox of indexing?

March 4, 2015 By in Current Market Thoughts, hedge funds, Investment firms, Portfolio management, securities markets, sell-side analysts, stock market Tags: , , , , , , Leave a comment

The paradox of thrift is the idea that the common sensical approach individuals take in bad economic times–that is, to save a lot more–actually reduces overall consumption and ends up making a bad situation worse.

 

People are beginning to talk about the same sort of situation happening with investing and index funds.

The idea of indexing was initially popularized by Charles Ellis, who argued that large numbers of well-trained, well-educated, highly motivated, highly compensated portfolio managers were battling it out with one another every day in the active management world.  Therefore, he argued, none would be able to maintain a clear competitive advantage over any of the others.  And they would all be running up costs in their (futile) attempts to do so.  Therefore, the wisest course for anyone would be to take the lowest-cost route–simply buying the index.

Of course, it took Vanguard to provide the means and many years for the idea to be accepted.

Today, in contrast, it’s accepted that the lowest risk course of action, and likely the highest return one as well, is to buy an index ETF or mutual fund.

Over recent years, there has been a steady flow of assets away from traditional active managers in the US and into index products–meaning less money from management fees to fund active manager research.  In addition, the recent recession has triggered the mass layoff of seasoned brokerage house equity analysts.  (This is due to the contraction in assets under active management, regulatory constraints on the use of “soft dollar” commissions and the dominance of trading over research in brokerage firm office politics.)

Are we at the point where indexing has culled the herd of active managers enough that the fierce competition which has made the US stock market super efficient over the past generation is no longer functioning?

No, not yet.  2014 was the worst year in a long time for active managers, as far as outperformance is concerned.  And we know that hedge funds have rarely been able to keep up with the S&P.

However, today’s Wall Street seems to me to be much more reactive than proactive when it comes to company news.  That is to say, the market seems to react more strongly to company announcements of good or bad news, rather to have anticipated them from leading indicators.  Take, for example, the shock Wall Street showed when firms had weak 4Q14 results because of euro weakness–even though the size of the firms’ EU business was well-known and the change in value of the euro is shown in currency trading every day.

So something has changed.  It may simply be that brokerage research departments were much more important to the smooth functioning of the equity market than has been commonly perceived.

My question:  will individual investors take the place of active managers in keeping markets efficient?

 

should brokers be fiduciaries?

February 24, 2015 By in Getting financial advice, How your broker gets paid, Industry Analysis, Investment firms, Where are the customers' yachts? Tags: , , , , , Leave a comment

…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.