Category Archives: Getting financial advice

what will a soft dollar-less world look like

February 12, 2015 By in economics, Industry Analysis, Investment firms, Portfolio management, securities markets, Securities regulation, sell-side analysts, soft dollars, stock market, Trading Tags: , , , , , , , 3 Comments

Yesterday I wrote about an EU regulatory movement to eliminate the use of soft dollars by investment managers–that is, paying for research-related goods and services through higher-than-normal brokerage commissions/fees.

Today, the effects of a ban…

hedge funds?

I think the most crucial issue is whether new rules will include hedge funds as well.  The WSJ says “Yes.”  Since hedge fund commissions are generally thought to make up at least half of the revenues (and a larger proportion of the profits) of brokerage trading desks, this would be devastating to the latter’s profitability.

Looking at traditional money managers,

 $10 billion under management

in yesterday’s example, I concluded that a medium-sized money manager might collect $50 million in management fees and use $2.5 million in soft dollars on research goods and services.  This is the equivalent of about $1.6 million in “hard,” or real dollars.

My guess is that such a firm would have market information and trading infrastructure and services that cost $500,000 – $750,000 a year in hard dollars to rent–all of which would now be being paid for through soft dollars.  The remaining $1 million or so would be spent on security analysis, provided either by the brokers themselves or by third-party boutiques (filled with ex brokerage house analysts laid off since the financial crisis).

That $1 million arguably substitutes for having to hire two or three in-house security analysts–and would end up being distributed as higher bonuses to the existing professional staff.

How will a firm pay the $1.6 million in expenses once soft dollars are gone?

–I think its first move will be to pare back that figure.  The infrastructure and hardware are probably must-haves.  So all the chopping will be in purchased research.  The first to go will be “just in case” or “nice to have” services.  I think the overwhelming majority of such fare is now provided by small boutiques, some of which will doubtless go out of business.

–Professional compensation will decline.  Lots of internal arguing between marketing and research as to where the cuts will be most severe.

smaller managers

There’s a considerable amount of overhead in a money management operation.  Bare bones, you must have offices, a compliance function, a trader, a manager and maybe an analyst.  At some point, the $100,000-$200,000 in yearly expenses a small firm now pays for with soft dollars represents the difference between survival and going out of business.

Maybe managers will be more likely to stick with big firms.

brokers

If history is any guide, the loss of lucrative soft dollar trades will be mostly seen more through layoffs of researchers than of traders.

publicly traded companies

Currently, most companies still embrace the now dated concept of communicating with actual and potential shareholders through brokerage and third-party boutique analysts.   As regular readers will know, I consider this system crazy, since it forces you and me to pay for information about our stocks that our company gives to (non-owner) brokers for free.

I think smart companies will come up with better strategies–and be rewarded with premium PEs.  Or it may turn out that backward-looking firms will begin to trade at discounts.

you and me

It seems to me that fewer sell-side analysts and smaller money manager investment staffs will make the stock market less efficient.  That should make it easier for you and me to find bargains.

 

 

 

hedge funds and investment research

January 29, 2015 By in Getting financial advice, hedge funds Tags: , , , , , , Leave a comment

On Monday, the Wall Street Journal ran an interesting article, “Hedge Funds Learn Secrets Not So Safe.”  It’s about brokerage house research reports on individual companies.

Brokers provide research to customers either by giving them access to a research website, which contains all a broker’s research reports, and/or by responding to requests for specific research items, including meetings with analysts.  The problem with this is that brokers collect and analyze all their points of contact for the information they contain.  Conclusions will certainly wind up on the firm’s sales desk and can easily end up on the firm’s proprietary trading desk, too.

The same written  information is also available to authorized customers through third-party information services like Bloomberg.  I can use my Bloomberg account not only to call up a chart of a company’s stock price, see summary financial statistics and find out who a company’s major suppliers and customers are.  I can also read brokerage research from the brokers I do business with.  Not having read the service agreements they’ve signed, hedge funds have apparently assumed that if they read brokerage house report on a given target investment using a third-party information service, the broker never finds out.  By doing so, they’ve outwitted the broker and avoided information leakage.

Not so.

The third-party information providers supply such usage data to brokers, sometimes being as specific as what person at a given firm has accessed a report.  In fact, the article cites an instance of an unnamed analyst finding out his research wasn’t as stealthy as he’d thought when the broker whose report he’d been reading called him up and offered to arrange a meeting with the target company.

 

What I find odd is that there’s an obvious way to prevent information leakage–do the research yourself.  There’s a ton of relevent information available from the SEC’s Edgar site, as well as from government agencies and industry trade associations.  There are also suppliers and customers to talk to.  There’s gossip on the internet, too.

In my experience, except for a narrow set of highly technical areas (where you can always hire a consultant), the picture you create yourself will be more accurate, relevant and in-depth than anything a brokerage report can provide.  Yes, the brokerage analyst may be willing to say things on the phone or in person that he wouldn’t care to commit to paper, but that’s another issue.

Two issues:  compiling a thorough analysis of a company may take a week or two, as opposed to taking an hour to read someone else’s work.  Also, the analyst has to have the skill and experience to do independent work.

I can’t imagine that taking an extra week is the crucial variable.  That leaves the possibility that the firms the WSJ is writing about are so weak they don’t know how to do research themselves.  Hard to fathom.  I guess they’re just great marketers.

 

 

 

 

why more equity managers don’t outperform

January 14, 2015 By in Getting financial advice, index funds, Industry Analysis, Investment firms, Where are the customers' yachts? Tags: , , , , 1 Comment

1.  Most US equity managers, prompted by personal inclination and the wishes of their employers and their institutional clients, adopt either a value (buying undervalued assets) or a growth(buying accelerating profit growth) investment style.  In a typical business cycle, the first two years favor value stocks, the latter two growth issues.  Over that cycle, a manager is likely to have two good years, one so-so year and one bad year.  A skilled manager, however, will outperform over the cycle sc s whole, no matter what his style is.

This is another way of saying that the criterion of outperforming every year is unreasonable.

2.  a truism:  the pain of underperformance lasts long after the glow of outperformance has faded.  A manager who builds a riskier portfolio expecting fame and fortune from significant outperformance risks exploding on liftoff and outperforming badly–thereby losing both his clients and his job. He also gives his firm a significant black eye. No one, however, gets fired for underperforming slightly and being in the middle of the pack of competitors.

As a result, many long-lived investment organizations are constructed on the idea of strong marketing and so-so performance.  I’ve always regarded Merrill as the poster child of this approach in the mutual fund arena.

In other words, outperformance isn’t the most important attribute of a successful investment product.

3.  Most investment organizations find that a running a research department of their own is difficult and expensive.  Many, especially (in my view) the majority which are run by professional marketers, have long since eliminated proprietary research and have been depending heavily on brokerage houses to supply this service.   Doing so has the additional advantage that in-house analysts are no longer a drain on management fees received (brokerage house research is paid for with clients’ commissions).  That “solved” a problem and enhanced profits at the same time.

However, brokerage houses gutted their research departments during the market downturn in 2008-09.  The sharp decline has also accelerated an ongoing trend away from traditional investment managers and toward a diy approach using index funds.

So there’s no longer a plethora of high-quality brokerage reports and no “extra” management fee money to reconstitute proprietary research departments. Where are the good new ideas going to come from?  I think this new client preference for investment performance over salesmanship will create severe difficulties for traditional investment organizations.

 

the Mainstay Marketfield fund

December 29, 2014 By in Current Market Thoughts, Getting financial advice, hedge funds, index funds, liquid alternatives Tags: , , , , , , , 3 Comments

I was reading in the Financial Times over the weekend about the Mainstay Marketfield mutual fund.  It gathered the most money of any mutual fund in the US during 2013, $13 billion, but it is now apparently suffering sharp redemptions after very badly underperforming in 2014.

Mainstay Marketfield

Mainstay Marketfield is the leader among “liquid alternative” funds, which purport to provide the hedge fund experience to ordinary investors like you and me through a mutual fund.  Why exactly that’s a good thing is another issue, since hedge funds as a class appear to underperform an S&P index fund on a regular basis (on top of this, the information the public has about them comes from their voluntary self-reporting, whose accuracy academic research has shown to be suspect).

Anyway, on the idea that one can learn a lot by examining things that go wrong, I thought I’d take a look at Marketfield.

Here’s what I found by spending a couple of hours looking at the fund’s SEC filings, the managers’ backgrounds, the Mainstay fund family site and charts of the fund’s performance.  The picture may not be complete, but it’s what I think a careful observer would come away with:

–the lead manager has worked in finance, mostly as a strategist, for 34 years.  His colleague has 21 years in the business.  As far as I can see, neither had any training/experience/supervision in portfolio management before they opened the Marketfield fund in 2007.

–the fund opened to the public in March 2008.  It had a period of strong outperformance vs. the S&P 500 during the stock market decline of late 2008-early 2009, when its losses were only about half those of the market.  From the bottom in March through mid-2013 it matched very closely the performance of the S&P 500.

–in 2012, Marketfield sold itself to the Mainstay fund family of New York Life.  NYL retained the Marketfield managers as subadvisors–meaning the two continued to run the fund.  Sales of fund shares skyrocketed once Marketfield hitched itself to the NYL salesforce.

–in late summer 2013, the fund began to underperform the S&P fairly steadily.  From the beginning of September 2013 though last Friday, the A shares were down by 8.9% vs. a gain by the S&P of 25.6%.  Factor in a 5.5% sales charge holders paid to obtain shares and the results are that much worse.

What happened?

The managers appear to me to be envisioning a world of runaway inflation of the type that beset the US in the late 1970s.  In such an environment, it would be important to own shares of companies that could raise prices at an inflation-beating rate and to avoid those that could not.  In the Seventies, the “bad” sectors were Healthcare, Utilities, Staples and Consumer Discretionary.  The “good”: ones were those that held  hard physical assets, like industrial plant and equipment, real estate or mineral resources.

In the 1970s, financials were losers;  they issued mostly fixed-rate loans, and they were constrained by government regulations that capped the interest rate they could pay for deposits.  In today’s world, those restrictions are gone; loans are typically floating-rate; and the banks can be involved in brokerage/investment banking.  So, arguably, financials would be winners if inflation were to accelerate strongly.

Whether this was their thinking or not, this description fits the portfolio they created.

my look at the portfolio

on the long side

The Marketfield portfolio held/holds Financials, Industrials and Materials.

It has no Healthcare, little IT, no Staples, no Utilities (all of which have been the stars of 2014).  It also has little Consumer Discretionary and almost no Energy, both of which have been good things.

on the short side

The fund shorted Utilities, Staples, and Retail.  It also appears to have winning bets against the euro and the yen, the latter offset by significant holdings in Japanese stocks.

What I find striking is that while the market has been going against Marketfield for over a year, the portfolio strategy I see is basically unchanged.

more going on

There’s also more going on than I’ve been able to see.  Everything I’ve said until now would lead me to believe that the fund’s year-to-date return should be around zero  …not -12+%.  The long US stocks should be up 5% -10% (the only sector in negative territory is Energy).  I’m figuring that shorting industries that are, say, +20%, wipes out those gains, but does little more damage because the shorts are a lot smaller than the longs.

So something else is happening.  I don’t know what.  Broadly speaking, the reasons may be staring me in the face in the quarterly SEC filings I’ve seen (the stock selection looks uninspired, and maybe a little weird–of the holdings, I own only INTC and SPLK–but it’s almost impossible to lose 12 percentage points through bad stockpicking, particularly with the large number os stocks the fund holds).  Or there could be transactions that are opened and closed within the quarter and therefore don’t appear in the quarter-end statements.

my take

Th Mainstay site contains a Barron’s reprint from October in which the author touts Mainstay Marketfield as having double the returns of similar long-short funds since the market bottom in 2009.  Hard to believe that other long-short funds have lagged so far behind the S&P.

I find the $5 billion in redemptions (about 30% of peak assets) the FT says Marketfield has had ito be a stunningly large amount for a load fund.  My experience is that even in deep bear markets load funds have redemptions of maybe 10%.  This implies to me that neither the financial advisers who recommended the fund nor the clients who purchased it really understood what they were buying.

What I find most odd is that NY Life, which presumably has an older and more risk-averse clientele, should have chosen Marketfield to offer to its customers.  What’s odder still is that the move was spectacularly successful as a marketing move–until the wheels came off the performance.

It will be interesting to see if Marketfield can stage a comeback.  If the FT is right about the extent of redemptions (I presume it is; I just don’t know), the first indication will be whether the managers use the selling they have to do to reshape the portfolio.  Standard procedure would be to take some of the edge off the losing bets.  To my mind, “staying the course” would be the worst thing to do (personally, I think the runaway inflation idea is just wrong).  We’ll see when the next SEC filings come out next month.

 

 

 

 

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

September 30, 2014 By in bond market, Getting financial advice, How your broker gets paid, mutual fund holders and financial advisors, securities markets Tags: , , , , , Leave a comment

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.