Fund Manager Success: Repeatable or Not?

For those of you who read my blog posts or receive our emails, you'll know that Standard and Poor's compiles some very interesting information on mutual fund manager performance versus their benchmarks.  The SPIVA Scorecard is a piece that I reference often.

Today, I ran across a new paper from S&P, The Persistence Scorecard.  This report looks at performance persistence in mutual funds.  For example, let's say a broker tries to sell you a fund whose manager has been on fire this year, beating the market by 10%.  Should you take this as an assurance that you will enjoy these lofty returns into the future?

Without retyping the entire article, I'll relay one of their findings that essentially summarizes the findings.  Over the three year period ending March of 2013, out of the top 25% of all performing US Equity funds at the start, only 4.69% of those funds remained in the top 25% of performers at the end of the 3 year period.

So, if you are entertaining purchasing a fund just because of its manager's stellar record, you may want to reconsider that decision, and find other, better criteria for fund selection.

Fidelity's at it Again

Well folks, remember when I did the blog post about Fidelity encouraging advisors to sell their stock mutual funds a few months ago--- after much of the market has recovered?  Well, they are at it again with a new slick marketing piece.  This is just the inside.  It's more than a postcard this time.

I'd just like to make a few comments on this.  First, they do point out that the market (S&P 500) is up 160% since the low in 2009.  How many of these marketing pieces did Fidelity make like this at the bottom?  Zero.  Stock funds will sell now because stocks are up.

Second, notice the first sentence "Fidelity experts forecast".  Whenever you see the word forecast from your investment professional, you should run, not walk, away.  Forecasting is part and parcel to market timing and stock picking, two activites that are speculating, not investing.

Their comment of "why are your clients avoiding stocks" should more accurately be put "why are you avoiding stocks".  During the market decline we never sold our clients out to cash, gold, or any annuity product.

But, who can blame them.  Fidelity needs to sell funds.  With their gold fund down 46.65% year to date, why not go with what's doing well.

Are You a High Net Worth Investor?

Almost daily we recieve solicitations from companies wanting us to sell their products, and advising us on how to "target" high net worth individuals.

Are you a high net worth individual? Are you tired of being "targeted" by commissioned based agents/advisors? Many firms specialize in targeting individuals with $250,000 or more to invest.  (Trust us, we can buy lists of these exact prospects).  These individuals are vulnerable to salespitches that are not necessarily designed for their best interest.  Held capitive by commission based compensation, the typical advisor has strong incentive to close the sale and make sure their bills get paid.

 Maybe you don't think of yourself as a "High Net Worth" individual.. but you are if you have $250,000 or more in your 401K or other investable assets. If you want a prudent no-nonsense approach to managing your "nest egg" maybe you should learn about the Veritas approach.

What is the Real Rate of Return?

One of the intriguing paradoxes in investing is the difference between a fund’s reported return, and the personal rates of return for the people that own that fund.  For example, fund x may have earned 10% in the last 3 years on average, but, what did the “average” investor in that fund earn over the same time period?  The difference may be surprising to you.

Let’s look at a stalwart fund of the broker sold community: The Growth Fund of America.  If you look up the fund on any internet based reporting service, you notice that its five year return is 3.73% per year.  Not bad considering that time period held some of the 2008 downturn.  But what does that number mean?  That is not the return of the average investor, it is simply the return of the fund.  For an investor to have earned that, they would have had to buy the fund on day one, held it entirely, and still have been holding it at the end of the five year period.  As advisors and investors, what concerns us is INVESTOR return, not fund return.  The average investor return over that same period was only 1.18%!   That means that if we look at all of the investors that held that fund during that five year period their average return was only 1.18% per year. 

How could that be?  Well, here again we see that investor behavior trumps the many other factors that contribute to successful investing.  Over that five year period, investors in that fund continued to engage in many of the bad behaviors that investors fall prey to, among them likely market timing and track record investing.  But this is not something that we only see at American Funds.  Fidelity Growth company has a five year return of 7.04%, while its five year “investor” return is only 3.86%.  Here again, investor’s fail to get their full rate of return because of a lack of discipline; discipline which can only be acquired through a commitment on the part of the advisor and client to lifelong investor coaching. Without it, investors do and will continue to leave money on the table.

And now, for a truly amazing thing.  Do you know that an investor in a fund can actually earn MORE than the fund itself?  Take for example a fund that many of our clients own internally in their own portfolio, DFA US Small Cap.  Its five year fund return is 9.44%, while the INVESTOR return over that period was 10.22%.  Can you figure out how this can possibly be?  We’ll have the answer in our next newsletter.

What We Do

I received a phone call this morning from a non-traded REIT wholesaler (salesman), requesting to set up an appointment with me.  For some background, a REIT is a real estate investment trust.  In a REIT, investors pool their funds, and a manager purchases properties with these funds.  The investors earn a return from these properties when the tenants of these properties pay rent, or properties are sold off.  Non-traded means that you typically cannot easily "sell" out of these arrangements.  Once you are in, you are in. 

What struck me in a subtle way, was how the wholesaler kept feeding me facts about how these would be easy to sell to my clients.  He mentioned the 6% dividend, and how much "success" they have had in raising funds.  Nothing was said about the dangers for REITs, how they were not appropriate for most investors- and how many of them fail.  It was all about how I could get my clients money into their product...all about me.

That got me to thinking, what is another way I can describe what I do?  Why do I do what I do?  This relates to other conversations that I have had along the lines of "can't I just go direct to ______ (Vanguard, E Trade, etc) ?  Why should I pay you?" The direction of this industry, like many other things, is going online.

Here is the bottom line.  You can go direct to an online brokerage, or work with a broker that will just give you want you want: gold, hot stocks, annuities, oil and gas partnerships....  what do all of these have in common?  They are not in business for you.  They are in business to earn profits from your activity, and believe me there will be no end to the neat "activities" they will show you.  They have no responsibility to keep you disciplined, or to keep you from getting in over your head.  In fact, the more you transact, the better they do.  They only have to recommend things that are "suitable".  Not the best options, just ones that are not completely inappropriate.  They are the dealers at the black jack table of investing.  We, on the other hand work for you.  We won't let you do anything under the sun.  We stick to an academic and disciplined plan.  We want you not necessarily to have the most "fun" in your portoflio, we want you to get the best results possible.  Sometimes that is bitter medicine.  That is why coaching is important.  You could go to a gym and have a trainer write you a 365 day plan for total fitness.  If you followed it exactly, you would get the results you wanted on 12/31.  However, how many people, with a written plan only, will be successful at the end of the year?  I am guessing close to 0.  Why?  No discipline and no accountability.  What if we added to that written plan, an in person trainer who you met with regularly?  Do you think your weight loss results would increase?  We think the same concept applies with money management. 

Mind Over Money

Last week the advisors of Veritas Financial were in Colorado Springs for a Matson Money Conference.  It was an excellent conference, and I thought I would summarize a few of the takeaways that I had after the conference, and how this applies to investors.

We always thought the "enemy" was active management-- or retail mutual fund companies, and the brokers who unknowingly preach that failed way of investment thinking.  However, there is a new, much more powerful force waging war on the American investor.  This is the true "Evil Empire" as they were coined.  Collectively, these four companies hold a vast amount of investor wealth, and are accumulating more each day:  Fidelity, E Trade, TD Ameritrade, and Charles Schwab.

Just how big are these firms?  E Trade: $201 Billion.  Schwab $1.9 Trillion.  TD $481 Billion, and adding $160 M each day. Fidelity $1.7 Trillion.  Many investors are by and large ditching their brokers and going to do it themselves.  Why?  Well, these four firms are doing an all out assault on advisors, spending hundreds of millions on advertising.  Secondly, the average investor, with their own experiences, have lost faith in the brokerage industry (which, of course, we would say you could predict with their behavior as it is).  And the traditional broker dealers see the writing on the wall.  Did you know that LPL now has it's only "direct" channel to investors?  No longer do you need your friendly LPL agent, go directly to LPL itself!

These firms tell you to ditch your advisor, and save boat loads of cash in expenses.  The problem is, that these firms a) do not have the investor's best interest in mind, and b) are not all that cheap after all.  E Trade has it's own advisory fees.  You want Fidelty's low cost trades?  Better be ready to trade 110 times a month.  You also may be pushed to trade in complicated securities, like options.  Many of the same costs you think you are avoiding, will crop up again.  Instead of disciplining investors, these firms amplify bad investor behavior by encouraging constant trading in pursuit of the best investments.

Investors are their own worst enemenies, and it is very difficult for them to resist this urge to break away.  Many believe they are "sophisticated", and don't need an advisor.  Here is one concept that is very hard to swallow for investors: THERE ARE NO SOPHISTICATED INVESTORS.  Just take a look at the victims of Bernie Madoff.  There were professional money mangers among that list, people who worked in the industry for years, yet fell victim to the most simple of all schemes: the ponzi scheme.  Secondly, we think that investing is so easy... how can we possibly mess it up?  We just have to follow three basic rules: diversify, rebalance, and own stocks.

Lets look at something also very "simple".  We all are taught at an early age to brush our teeth and floss regularly to keep our teeth and gums healthy.  But in 2002, we spent over $70 Billion dollars in dental expenses (much of it was surely preventable).  A very simple thing, but we fail to do it.  We also have an obesity epidemic in a country where almost everyone knows what they need to do to stay fit; with fitness centers in every city and easy access to athletic trainers.  But investing has an added element:  If you skip brushing your teeth for one day, or you splurge on the dessert for a weekend we can fairly easily repair the damage.  But with investing, one lapse in judgement can destroy thousands in wealth.  Just one.

So what is the bottom line?  It is this.  Investing isn't all about the portfolio.  True, a good portfolio is important.  But why investors fail is not that we have people with portfolio problems, we have portfolios with people problems.  If investors are to be saved, it will take not just academically sound portfolios, but actual disciplined guidance.  As financial coaches we work hard to educate our clients.  It's good that you trust us, but unless you are educated and disciplined, eventually your emotions will betray you.  We won't be there at 2am when you are up at night, worrying about the market, or when that annuity salesman knocks on your door.  Only a good investor education can keep an investor grounded for the long term.

A Money Smart Week Review

This week was the annual "Money Smart Week" event, sponsored by the Federal Reserve.  For us, that means a long week of daily presentations on financial topics.  And for the public it is a great opportunity to get some financial education without the pressure of a sales pitch (as that is not allowed by the rules of the event).  We had great attendance in Sheboygan County, and last Saturday's Money Conference in Oshkosh was a great success.

However, I still can't help but wonder what happens after all of the events are done.  As a presenter I get a lot of interesting questions, and I tend to hand out a fair many business cards over the course of the week.  However, these are not great client acquisition events for us, and the time spent on paper and presentation design are quite high compared to the return on investment.  But we do it anyways because of our commitment to investor education.

I often wonder what people decide to do.  Do they go just get busy and put these great intentions of change on hold?  Do they go back to their old broker and get talked out of things--or further confused?  Do they simply try to take what they learned and apply it on their own.  In any event, some day it sure would be interesting to know. What I fear that happens in many cases is that they will take all of the wonderful knowledge they learn attempt to implement it on their own, and will yet again be unhappy with their results. I mentioned this in my one classes this week.  You can do everything right on the costs aspect, you can remove all active management from your portfolio and make it extremely cheap, but there are other overriding factors that determine investor success. 

DALBAR does a study every year on the do it yourself crowd; their QAIB study.  Each year it looks back at the past 20 years and compares average investor performance to the S&P 500 Index.  Year in and year out the index outperforms the average investor by about 2 to 1.  If we are honest with ourselves, we know that we cannot all be above average investors, and only the very luck or very very highly trained are getting a return any where close to the market average.  This is human nature however to deny our "averageness".  A famous way to show this bias is to ask all of the people in the room who feel they are above average drivers to stand up.  Usually about 75% of the crowd will stand up.  We of course know that that cannot be true- half of the people in the room are below, and half of the people are above, the average skill level driver.

Even if somone realizes they do need help, I think people struggle with what to look for in an advisor.  That will be a topic for my next blog post.

A Question of Ethics

Recently I came across a situation that I thought would make a good topic of discussion, as it deals with understanding how people in our industry get paid, and also ethics.

For this story to make sense, you have to first understand how people in financial services get paid. 

The first method is under the old commission based system.  The true name for these individuals is "investment representative", although they will use many different titles.  In the old days they were just called brokers, but that name has taken on a negative connotation.  In this system, individuals are paid a comission by the company who's product they sell to you.  This product could be a mutual fund, insurance policy, or annuity.  These payment rates will all vary by product, and as you can imagine one way these companies try to attract agents is to pay a good commission rate.  You, the customer, are not paying the agent directly.  Many people critique this system, pointing out the obvious conflict of interest between client and financial products company.  The agent may be inclined to sell the products with a higher payout, while another product may be better for the client.  Interestingly enough, brokers only have to sell a product that is "suitable".  A suitable product may or may not be the best for the client- but it's ok.

The other payment arrangement a person like us who can work under is a fee arrangement, or fee based planning.  Here, advisors may charge hourly rates, a fee for a specific plan, or a fee on assets they oversee.   Here there are fewer conflicts of interest because whether the client buys fund a or fund b, the advisor is paid the same.  Here the client pays the advisor directly.

And here is where our story begins.  Let's say a financial advisor (fee based), charges a client for a financial plan (and not a small fee, like over $1000).  This advisor is free to recommend any product in the financial universe- and they still get their fee because the client is paying them for "the plan", and not selling them the fund.  But what if the advisor is also a broker? 

Do you think it is unethical for a financial advisor to charge a client for a financial plan and then have them purchase a fund that they will in turn earn a commission on by being broker?  Personally I think it is.     

Callan Periodic Table

 Today I thought I would comment on an investor phenomenon routinely encountered by advisors called "selective diversification". 

Recently, I had more than one individual tell me that they wanted to hold off investing because they thought the US stock market was too high, while a colleague had an investor wanting to get of overseas markets because of recent events.  Callan, a investment consulting firm, releases their "periodic table of investements" every year.  It's purpose is to rank different investment categories each year by performance.  As you can see, in 2012 Emerging Markets (orange) took the prize, with Bonds taking last place in performance (green).  I really like this chart because it illlustrates the random and unpredictable nature of the markets, and that not all markets move together. For example,  winners may or may not repeat, and losers may, or may not become winners the following year.  For example, look at Emerging Markets in 1999.  They had been the worst performing class in the two prior years.  Now in 1999 they were first.  Was 2000 the year to jump on the bandwagon?  Nope, they were back to the bottom of the pack in 2000.  What about S&P500 growth stocks in 2004 (red)?  They had been a loser for the three prior years.  Time to get in?  Nope, they were in second last place in 2004-2006!  Emerging Markets in 2005-looks like time to head for the hills right?  History proved it was not.  They continued to perform well for two more years.

The lesson in this story is that "high" and "low" are very subjective.  What is happening today in any market doesn't give us a clue on what we should do tomorrow.

Fidelity's Ironic Announcement and True Independence

Today's post is a two for one. 

The first is a comment about a recent sales flier I got from Fidelity just a few days ago.  It stated that now may be the time for US Equities (stocks).  Inside the brochure it details the various reasons, such as a rebounding housing market and a resurgence in manufacturing that may take place.  I find it ironic that Fidelity makes this announcement now, as the DOW is sitting at a new all time high.  Where was this announcement in March of 2009?  This is an all too familiar theme in the investment industrial complex.  As a retail investor you are "sold" what feels right at the time and seems to make sense.  If Fidelity was really on your side, they would have been saying this forever, and especially in 2009. But, from a sales perspective what is easier, telling people to buy stocks in 2009, or trying to sell them something safe like bonds or some alternative investment like commodities?  There is a difference between giving investors what they want and what will sell, and telling what they need.  Sometimes doing what is necessary does not feel good at the time.

Also, today I had to laugh on the way home.  On a local channel I heard a wealth management firm advertise how it was "independent" and not beholden to any large national financial firms.  It wasn't influenced "by the manufacturers of financial products".  Sounds nice, doesn't it?  But, then comes the fine print.  Any investment office out there is either a) a brokerage office, or b) a fee based planner.  If they have a broker dealer, they ARE affiliated with a larger firm and DO sell financial products. This firm that claimed to be independent, is, in fact not.  They are an Linsco Private Ledger (LPL) office.  Thus, they have to do things that LPL says it must do.  Secondly, they DO then also sell manufactured financial products.  If they really wanted to act in the best interest of the client, they would not need a broker dealer.  The only reason you need a broker dealer is to collect commissions on the sale of commissionable products (financial products).  So, in short, this ad was a sham in my humble opinion.  The firm is not truly independent, and it also does sell the very products it pretends to eschew. Now, no one outside of the industry is going to be able to tell you about this distinction, but that is our mission at Veritas- Investor Education.  Catch our next class on March 28th.