Category Archives: Getting financial advice

Wall Street firms are running out of retail brokers

June 27, 2014 By in Getting financial advice, How your broker gets paid, Investment firms, mutual fund holders and financial advisors, Where are the customers' yachts? Tags: , , , , , , , Leave a comment

In the post-recession world, traditional brokerage/investment banking firms have become much more interested in the steady income that can come from providing financial advice to individuals.  This is partly due to the demise of proprietary trading, partly a new respect for recurring income.   But Wall Street is finding it hard to maintain its retail sales forces.

One would think that with the Baby Boom beginning to retire, and having 401ks and IRAs rather than traditional pensions to support them in their “golden” years, there would be a lot of demand from this quarter for professional investment advice.  Yet, brokerage firms are finding it hard to recruit salesmen.  The demographics of the big (or “full service,” as they’re called) brokerage forces themselves are also telling:  lots of over-fifties, few under-thirties.  Why is this?

In general:

1.  The internet has replaced financial services as the destination of choice for ambitious college graduates.

2.  Brokerage firms have traditionally been hostile toward women, thereby eliminating half the possible job candidates.

3.  Being a financial adviser is–something I kind of get, but kind of don’t–a relatively low status position, down there with used car salesman.

Specifically:

4.  People under the age of, say, fifty (maybe it’s sixty, though) would prefer to deal with a discount broker over the internet than face-to-face with a traditional brokerage salesman.  I have no short answer as to why, but they do–even when introduced to an honest, competent broker by their parents.  Of course, maybe that in itself is the kiss of death.

5.  Traditional brokerage firms have decimated their research departments as cost-cutting measures during the recession.  This eliminates the only reason I personally would consider a traditional broker.

6.  A broker typically gets a little less than half of the commission revenue he generates (see my post on how your broker gets paid for more detail).  The rest goes to the firm, which uses part of that to pay for offices, recordkeeping, and marketing…   For many years, however, firms like Fidelity, Charles Schwab or other, more low-profile companies have been willing to provide established brokers with back-office support for a small fraction of that amount.  I’m not current on today’s arrangements, but while I was working a broker could easily increase his “net” commission from 45% to 80% by switching to one of these firms.  Yes, he might have to provide his own office, but the headline is that he could increase his income by 78% with the move.

 

What’s new about this situation isn’t that it’s happening–this has been going on for well over a decade–but that traditional brokers are finally concerned.   Their retail business model is broken, however, and I don’t see it getting fixed any time soon.  My question is how Baby Boomers are going to get the financial advice they need to manager their money during retirement.

 

 

 

 

 

 

 

US 401ks may be facing negative cash flows in two years

June 18, 2014 By in Getting financial advice, Investment firms, securities markets, stock market, Strategy Tags: , , , , , , , Leave a comment

That’s the conclusion of a study by consultant Cerulli Associates reported earlier this month in the Financial Times.    

In 2016, Cerulli estimates inflows from plan participants will be $364 billion; withdrawals by retiring workers will amount to $366 billion.  And the negative cash flow gap widens from there.  This doesn’t mean that aggregate 401k assets will decline precipitously, or even decline at all for a while.  Presumably appreciation of assets in the system, now at about $3.5 trillion, will more than offset net withdrawals for a long while. Still, this marks another milestone in the waning of the wealth and influence of the Baby Boom.

Most often, 401k withdrawals find themselves rolled over into IRAs, which now amount in total to about $5.4 trillion, according tothe FT.  Despite the inflow of refugee 401k money, however, the IRA market isn’t a picture of health, either.  It’s possible that the overall defined contribution market (401ks + IRAs) will turn cash flow negative by the end of this decade.

Although some retirees may be permitted to remain in the company 401k plan, most opt for the greater flexibility, arguably more favorable tax treatment and wider universe of choice afforded by IRAs.  When they do so, they apparently go from reasonable asset allocations of 45% -60% stocks, with the rest in fixed income, into a conservative shell, with 65% – 80% in bonds. It’s not clear whether this has always been the case, or whether current behavior is a PTS reaction to the financial collapse of 2008-09.  It may also be that IRA holders need that large an allocation to bonds just to generate a reasonable amount of income.

The net result of all of this is that pension saving is gradually turning from being a mild net positive for stocks into a mild net negative.

My take from this is that it’s one more reason for turning one’s attention away from the Baby Boom and toward Millennials in trying to figure out retail investors’ influence on the stock market.

when quantitative investment strategies “add up to fraud”

April 17, 2014 By in Academic Theories, Constructing a Portfolio, Portfolio management, Where are the customers' yachts? Tags: , , , , , 1 Comment

Yesterday’s online Financial Times contains an article titled “When use of pseudo-maths adds up to fraud.”  It references an academic paper (which I haven’t read yet–and may never) which concludes that while quantitative management strategies may look impressive to neophytes, many are mathematically bogus.  This could be why they often fail deliver the superior investment performance they appear to promise.  Anyone with mathematical training needed to construct such a statistical stock-picking system should know this.

Quelle surprise!, as they say.

There’s a powerful cognitive urge to simplify and systematize data.  But that’ not why investment management companies typically create the mathematical apparatus they tout to clients.

The reality is that investment management has a large right-brain component to it.  It depends on individual judgment and intuition honed by experience.  This fact makes clients uncomfortable.

Typically the company treasurer, or other person in the finance department who is in charge of supervising the company pension plan, has little or no investment training or experience.  He may know corporate finance, but that’s a lot different from portfolio investing.  Suppose the manager I just hired begins to lose something off his fastball, he thinks.  He tells me he reads 10-Ks, but suppose he just goes into his office, takes an hallucinogen and picks stocks based on the visions he experiences.  How can I explain this to my boss if the pension plan returns go south?

That’s why his first step is to hire a third-party pension consultant.  It’s not necessarily that the consultant knows any more than the treasurer–in my experience, the consultant probably doesn’t.  Hiring an “expert” is a form of insurance.

Selecting a manager with a quantitative stock-picking system is another.  The supposed objectivity of the system itself–safe from emotions or other human foibles–is a second form of defense.

Up until now, the apparent safety net created by hiring the consultant and selecting a recommended manager who relies on “science” instead of intuition has been enough to clinch the deal for many quantitative managers.   Of course, while this decision may make the treasurer feel better–and may be an effective defense as/when the quantitative system in question blows up–it doesn’t eliminate the risk in manager selection.  It simply shifts the risk fulcrum away from the human portfolio manager to the statistician who has constructed the stock selection model.  The paper the FT references, “Pseudo-Mathematics and Financial Charlatanism,” argues that, empirically, this is a terrible idea.

I wonder if anything will come of it.

what’s going on at Pimco

March 11, 2014 By in bond market, Current Market Thoughts, Getting financial advice, Portfolio management Tags: , , , , , , Leave a comment

1.  It’s important to understand that although investment management companies can have immense revenues and profits, and may employ hundreds or thousands of people, many have management structures more like an old-fashioned corner candy store than an industrial conglomerate.

There’s a Chief Investment Officer who has a history of superior investment performance, and who is sort of like the star player on a basketball team.  He/she manages the portfolios and may (or may not) supervise other, lesser, investment professionals.  And there’s a CEO/Chief Marketing Officer, who handles the acquisition/retention of clients, administration–and everything else.

In the PIMCO case, the CIO is the bond market’s equivalent of Michael Jordan, Bill Gross.  Bonds are its main product.

2.  Mr. Gross is fast approaching 70.  Although he may still be sharp as a tack and healthy as a horse, this is ten years past the age when clients–who, after all, may be staking their own careers on Mr. Gross’s prowess–begin to worry about the management company’s succession plan.  Deutsche Bank, PIMCO’s parent, may have a concern or two as well.

3.  Until recently, interest rates in the US had been on a steady downward course for thirty years, meaning (in hindsight) a bond manager would have been most successful by setting up an aggressive portfolio and holding to it through thick and thin.  That is much harder to do in practice than the last sentence might suggest (think:  the collapse of Long Term Capital Management).  Bill Gross has done the best job over this period.

Still, it seems to me (even though I’m an equity manager) that the bond market has changed.  Mr. Gross himself has on several occasions declared the long bond bull run to be over.  Yet, as far as I can see, he has still committed himself to put up the big numbers he achieved when the rules of the game were more supportive.  The result has been big bets, greater volatility and so-so returns.

4.  All these issue have come to a head with the recent resignation of Mohamed El-Erian, the presumed successor to Mr. Gross.  Mr. El-Erian, the marketing face of PIMCO, was always a curious choice to take the reins from Mr. Gross, in my view.  The fact that he spent so much time marketing implied to me that he was not well-integrated into the portfolio management process.  And the only independent portfolio management experience Mr. El-Erian has had, that I’m aware of, was a short stint at Harvard that ended badly.  I would have pegged him as CEO/Chief Marketing Officer, not CIO.  Yet clients didn’t seem to mind.

Where to from here?

Let’s ignore the gossipy press commentary about conflict between Mr. Gross and Mr. El-Erian, or the former’s reported references to the latter’s lack of investment experience (makes you wonder how he was chosen to succeed Mr. Gross).

–PIMCO appears to have addressed the succession issue with the promotion of a number of successful in-house forty-something portfolio managers.

–That leaves the performance issue.  The prudent course of action would be to try to stabilize performance by reducing risk (read:  get close to the index) and aiming to be slightly north of middle of the pack.  Not very ego-satisfying for Mr. Gross, but the right thing to do.   But that might be like telling MJ not to shoot the basketball.   Let’s see if that can happen.

 

 

 

third-party endorsements: why experts appear on financial tv/radio

March 10, 2014 By in Constructing a Portfolio, Current Market Thoughts, Getting financial advice, Stock ideas Tags: , , , , , Leave a comment

the 95/5 rule

I was driving through a rural part of southern New Jersey last week and listening to Bloomberg Radio on XM.  The program I was listening to got me thinking about my first job as a full-fledged portfolio manager. On my first day (in 1984), my boss pointed to a three-foot high stack of research reports that she had received in the mail that morning.  This was an everyday occurrence, she said.  95% was trash; part of her job–and now mine–was to read through a pile like that each day looking for the 5% that wasn’t.

Something like that is why I was listening to Bloomberg.

Once in a while, though, a genuine financial expert will appear on one of the Bloomberg shows.  The interviewer will ask intelligent questions–or at least allow the expert to speak, rather than filling the air with the host’s views.  The guest will give interesting and useful answers.  This isn’t the norm.  But it happens.  Hence my thoughts about my old boss’s 95/5 rule.

But why do really knowledgeable guests appear on financial tv/radio?  Why do they fawn on their hosts in the clear attempt to be invited back?

third-party endorsements

The answer is that an analyst or portfolio manager’s appearance on TV or radio legitimizes him to his clients in a uniquely powerful way.

This doesn’t make an enormous amount of sense.  But it’s true, nonetheless.

The client may understand that the media personalities don’t have a particularly deep knowledge of finance.   Some have had past brushes with the law.  A few have clearly adopted a entertainment-first attitude, and make no pretense of preparation or expertise.

The client may also realize that the guest may only have been invited to appear on a show because his firm is a big advertiser.

Still, the appearance on tv or radio can carry as much weight with that client as the manager’s track record.  For retail investors, it carries more weight than the numbers.  Even better if the manager is a frequent guest or if the interviewer says nice things about him.

The bottom line:  despite evidence to the contrary, people believe the financial press is objective and knowledgeable.  At the same time, people generally distrust marketers who work for, i.e., are paid by, an investment manager.

Therefore, a press endorsement–a favorable mention in a newspaper or magazine article, an interview on tv or radio–is a huge help in selling the interviewee’s investment services.  So experts–and non-experts, as well–have a strong financial interest in courting the media, flattering the interviewers and generally twisting themselves into pretzels, if need be, to appear in print or on shows.