How your money is managed: the Mutual Fund industry up close (transcript)

This transcript is of a conversation I had with Theresa Hamacher (listen to the podcast), author of the new book,  The Fund Industry: How your Money is Managed. You can always subscribe to Tradestreaming Radio on iTunes.

Today’s episode is all about mutual funds, the product and the industry. As a guest on the program we have Theresa Hamacher, a co-author of the new book, The Fund Industry: How Your Money is Managed. She co-wrote the book along with Robert Pozen. Hamacher is currently the president at NICSA, a position that she’s held since March of 2008. For those of you who don’t know, NICSA is the National Investment Community Service Association, which bills itself as the leading provider of independent education and networking forums to professionals in the global investment management community.

Mutual Funds: How your $$ is managed by tradestreaming

Theresa had her background in investment management before that. She was the chief investment officer, CIO, for Pioneer, where she oversaw $15 billion in global equity in fixed income assets. Before that she was the CIO of Prudential Mutual Funds, where she supervised over $60 billion dollars in assets. Earlier in her career she was an equity fund manager. She began her career as a securities analyst.

Clearly the book is written from Hamacher’s extensive experience and perspective within the mutual fund industry. I do broaden the conversation to try to incorporate how the mutual fund industry is coping with new product innovation in the ETF, the exchange traded fund community.

I think talking about mutual funds is an interesting topic right now. They are a well designed product for a variety of situations. There seems to be an overriding mantra that sort of was born out of do it yourself investing that somehow mutual funds are inherently bad. I don’t see things that way. They have their time and their place. They’re particularly good products for scenarios where it doesn’t necessarily make sense to have an index product.

Exchange traded funds are obviously the fastest growing security, in terms of gaining new assets within the industry. It’s also interesting to me that mutual funds view exchange traded funds as competitors, and not necessarily as just new products, or innovative products in the industry.

I ask Hamacher a lot of these questions, but one thing that’s important to me is that when I speak to investors they say first thing, “Mutual funds are bad.” They have a connotation obviously, particularly ones that are sold with the sales load of being expensive, and that’s true. Continue reading “How your money is managed: the Mutual Fund industry up close (transcript)”

How your money is managed: the Mutual Fund industry up close (podcast)

Mutual funds have introduced millions of Americans to investing in the stock market.  While their popularity and usage may have changed throughout the last 30 years,mutual funds still play a critical role in many portfolios.  Yet, many investors — smart, educated people — still don’t quite understand how they work.

Summary

In this episode of Tradestreaming Radio (if you don’t see it below, click here), we talk to Theresa Hamacher, a true mutual fund industry veteran.  Along with Bob Pozen, Hamacher is the co-author of the new book, The Fund Industry: How Your Money is Managed (Wiley Finance).  It’s a good read and an important book to have in your investment library because it’s scope is so broad.  The book discusses the history of mutual funds, their legal structure, career paths in the industry, how different funds are managed (stocks vs. bonds), and how fund analysts decide which securities to invest in.

Our discussion meanders through different facets of the industry, investing, and Hamacher’s book.

We discuss:

  • how to use mutual funds
  • the asset management industry
  • the financial crisis and how funds were involved/affected
  • how mutual funds shape up against exchange traded funds (ETFs).
  • why the mutual fund industry views the upstart ETF industry as competitive.

Listen below

 

 

Resources:

When the anti-Wall Street rant morphs into just another sales pitch

I know there’s a movement spearheaded by indexers, Bogleheads, Efficient Market Hypothesists, Random Walkers and just plain haters of vampire squid to hate everything Wall Street.  This is not a post defending the barbarians at the gate or even the monkeys in charge of the business.  Rather, I’m riffing on a more recent phenomenon I’m experiencing — that of the mainstream contrarian.

Just another sales pitch

Listen, with so much money at stake, Wall Street has brought opprobrium on itself with outsized returns, lavish lifestyles and bigger than life personalities.  Cramming poor investment schemes and products down clients who should and shouldn’t know better has been a staple of the business for decades.

So, of course, it comes as no surprise that a lot of people have been looking for alternatives.  Better ways of investing, saving and planning for their financial futures.  And it comes as no surprise that a whole industry of products and services arose to supply these investors.  From slick investment newsletters, communities of pundits punters like Seeking Alpha, talking heads on CNBC and even the ETF industry — all have merely taken the old Wall Street model and merely updated it.

Enter the mainstream contrarian.

So, instead of crappy structured products being sold hard by brokers, investors are left with hundreds of arcane ETFs without any real idea what to do with them.  Buy and hold ’em?  Well, that doesn’t really work for investors on the cusp — or in — retirement who need to actively generate income.  Asset allocation?  Well, who really knows what the right mix of risk and return is for anyone?  401(k)s?  Well, those are being manipulated and forcibly rebalanced in a way that’s good for the mutual fund companies, bad for investors.

Evoluton, not revolution

We’ve taken the honorable pursuit of looking for better alternatives to Wall Street yet have merely replaced Wall Street with another manifestation of slick sales people taking advantage of unsuspecting investors.  Investors eat up the anti-Wall Street pitch.  That there is a better way.

And there is.  But it can’t be sold; It has to be bought.  It requires being intellectually honest and not just compliantly honest.  It requires creating technologies, services, and platforms that say:

hey, the old way typically didn’t work.  We have just one possible solution.  But to be honest — we’re dealing with uncertainty. Nobody really knows the right way to do this.  We believe ours is a good product/service but ultimately, we’re all in this together, trying to plan for a future which is ultimately unknowable.

I guess these aren’t really solutions as much as they are gamemplans.  This way, this evolution (not, revolution) in financial services truly departs the old way.  Otherwise, it’s just the Wall Street wolf dressed up in anti-wolf clothing.

Retail Brokerage Manifesto

I’ve been in the investment business for 10 years now wearing a variety of hats.  I’ve been a hedge fund analyst (small cap/tech/retail/food), ran business development for Seeking Alpha, and hold both a brokerage rep license (Series 7) and an investment advisory license (Series 65).

For the nuanced, a broker makes a living transacting stuff and an advisor is prohibited from doing this.  Even though the vast majority of my business is done as a fee on assets (not based on commissions), it’s sometimes strange wearing both hats.  I approach the business as an investment advisor would but typically manage accounts under my brokerage license — this allows me to develop unique portfolios for individual clients.  It’s inherently less scalable than an one-size-fits-all portfolio but it’s also good service and good business.

As I reflect on the past and plan for the future, I’d like to share the tenets of how I personally approach the business of investments.  It’s the creed I live by and it’s what helped me continue to grow.  Some of this is required by law, regulatory statute or is just plain my opinion.

Tradestreaming Broker’s Manifesto

  1. I don’t believe it’s inherently wrong being paid to manage client assets, even if I get paid a commission
  2. That’s because I always have the client’s best interest in mind
  3. Even if it conflicts with my own personal financial incentives
  4. Even if I *lose money* on the trade (independent reps have transaction costs on trades that they need to cover)
  5. I always told myself that in spite of the power a broker has over client decision making, I would never hard sell anything
  6. Always look for ways for clients to save money
  7. That may mean comparing Mutual Fund A vs. Mutual Fund B but it also means comparing Mutual Fund A vs. ETF A (one pays a trailer, the other is a transaction)
  8. Nobody says anyone needs to be in the market or needs to have a 60/40 portfolio
  9. The extension of this is that the best client performance sometimes comes from designing a portfolio from the ground-up, not top down and not by cramming a client into a pre-ordained portfolio or allocation
  10. I don’t believe in the Efficient Market Hypothesis (EMH) and do believe that clients can do better than the markets without having to assume more risk
  11. That said, while the potential to beat the market exists, it may be elusive and in specific cases, may not be worth trying
  12. Sometimes an honest broker makes his money by keeping clients out of trouble and that’s worth something, too, even if clients don’t necessarily recognize this
  13. There are a lot of brokers making their clients a lot of money and really doing good by them.  I want to be part of this group.
  14. Everyone in financial services has conflicts of interests and how you get paid is just one of them.  Regardless of licensing structure, good financial advice requires being honest and open with yourself and clients.
  15. Clients don’t begrudge their advisors making money and some feel good giving the business even if they could transact using an online broker
  16. But they won’t forgive if it’s done at their expense
  17. That said, very few clients could rightfully decipher if this was the case so the whole thing rests upon the broker/advisor being honest and open with him/herself.
  18. There aren’t many of us who behave as we do and that’s OK.

Do you have anything to add? Let me know in the comments.

photo courtesy of battlecreekCVB

Blowing up the fine print in financial product marketing

As a user of various financial products over the years, I sometimes wonder what it is I actually own (most of the time this occurs sometime after hitting some single malt before bed and sometime before day break).  I dunno — I read the labels on food that I ingest.  Just thought it might be interesting to know what’s in the mutual fund into which I invested all my life’s savings.  Just for kicks, you know?

So, I decided to do a little sleuth work and *pull back the covers* on the disclaimer language on some of the most widely held financial products.  What I found written in Arial font size 6 might be a little surprising to owners of mutual funds and ETFs:

Of course, past results are not at all, in any way, form, or fashion indicative of future performance.  No way and it doesn’t even matter that we have to say that.  We probably would anyway just to cover our own asses.  Anyway, in terms of performance, it’s really just a crapshoot.  Who wrote that Random Walk thingie again?  We’re not big fans of him (he’s probably an academic).  We don’t love Bogle either — he’s the one who tried to force us into buy and hold strategies.  Cramer’s more our speed, if you care.  We sell/market financial products that trade in a secondary market so we don’t really care all that much anyway how they perform.  As long as we grow our assets under management and provide liquidity to the products.  In fact, we’re not quite sure what to make of all the blogger research that shows that our ETFs don’t come close to tracking the indices they’re supposed to follow.  And those leveraged ones — the 2x, 3x, 4x, XXXs — who really understands how all those things work?  I mean, can you really use daily future rebalancing as part of a core strategy anyway??  Thankfully for us, it’s products like these that enable us to raise our management fees in an environment that continuously pushes fees down.  We had it good with mutual funds — whose stupid idea was to transition to lower-fee ETFs? By the way, if you really want performance, why not try just giving your money to one of those fancy hedge fund vehicles?  They seem to know what they’re doing, right?  Man, I’d like to be in their shoes.  Me?  I’d be David Tepper or maybe  Bill Ackman.  Yeah, Ackman.  With his build and that gray heirhair, he’s totally a baller investor. Also, you should know, that we don’t really believe all that new-fangled behavioral research that shows that for investors, our products are sort of like drugs in the hands of addicts.  In essence, there’s no way these people are going to make money in the market anyway.  So, why not provide a vehicle that purports to do as much.  Is that so bad?  Is it?

Wow, who knew what was written in all that small print?

photo courtesy of somegeekintn

New tactical ETF products coming to market

new tactical etfs launchingBit late to this, but Kudos to Mebane Faber and Cambria Investments for beginning the launch phase of new tactical ETFs with AdvisorShares.

From the press release:

AdvisorShares Investments, LLC, a developer of and investment adviser to actively managed Exchange Traded Funds, announced today a partnership with Cambria Investment Management, Inc., a Los Angeles based investment manager, to create a GTAA strategy in an actively managed ETF. The proposed ETF would join AdvisorShares‘ growing stable of innovative actively managed ETFs

Meb Faber is author of the Ivy Portfolio and the portfolio manager of Cambria Investment Management.  His paper, A Quantitative Approach to Tactical Asset Allocation, has been dowloaded over 50,000 times and is one of the top 5 most downloaded papers on the SSRN.  These ETFs seem to productize many of the concepts Faber has built in his research.

Source: AdvisorShares Announces Partnership with Cambria Investment Management to Develop a Global Tactical Asset Allocation (GTAA) – Marketwire

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Photo credit: Drab Makyo

Read the fine print, investors: Some mutual fund fees higher than thought

We’ve written for a while that for certain purposes, Exchange Traded Funds (ETFs) are a better mousetrap.

As Mutual Funds 2.0, ETFs have introduced:mousetrap

  • new ways to implement investing ideas (eg. country exposure to Poland, Chile, etc.)
  • made existing ideas easier to trade (leveraged long and short funds, buy-write strategies)
  • provided continuous pricing (unlike Mutual Funds that price once at the end of the day)
  • more competitive management fee structure (ETFs are typically passive investment tied to an index)
  • eased the tax burden (some ETFs are able to pass on very little capital gains to the investor either through legal loopholes or just low turnover of the portfolio)

Mirroring as a new investment model

What’s true of ETFs is also true for new investment models, called mirroring.  Trade mirroring allows investors to synch their online brokers with a portfolio manager’s every move.  Unlike a traditional mutual fund manager who pools assets together, newer structures have portfolio managers managing a theoretical model (3% in X, 5.5% in Y, etc.).  This model is executed in client accounts (which are typically held elsewhere).  When a portfolio manager makes a change in the portfolio, it is then mirrored in the client account.  See this example of a mirrored account that tracks Warren Buffett’s moves.

Pricing is typically competitive to similar mutual fund strategies and investors pay a management fee + some fee whenever a trade is executed in their accounts.  Because assets are held in the investor’s own account and not comingled (like in mutual funds), the investor never has to share in gains or losses of the fund as a whole — in fact, the investor has some leeway to practice tax loss selling as well to pair losses vs. gains.  In this sense, mirrored accounts are much more tax efficient when compared to mutual funds.

Brokers have sold these types of accounts for years, called Separately Managed Accounts (SMAs), where investors could get access to some of the world’s best asset managers with just a fraction of the assets typically required to access these managers.  Now, we’re seeing the same models rolled out to do-it-yourself (DIY) investors.

It’s these last 2 benefits of newer investment vehicles – lower management fees and softer tax burden — that’s become an interesting bone of contention in the ongoing tug-of-war between the mutual fund industry and new emerging types of asset managers (including, but not only, ETFs).

Disagreement over *real* pricing

kaChing, an expert investing community which allows investors to invest alongside rising-star portfolio managers, recently introduced its own analysis (along with help from Lipper), that shows the average fees charged by mutual funds are much higher than investors typically realize — averaging over 3%.

In an article last week on the Wall Street Journal entitled “Mutual Fund Fee Debate Heats Up” (sub required), Ian Salisbury compares kaChing’s findings to those of the mouthpiece of the mutual fund industry, the Investment Company Institute (ICI).  As the WSJ reports that the ICI’s tally of the average fees charged on mutual funds hovered just over 1%.

So which is it — >3% or >1?  Clearly the answer is very important for investors.  Why? Because investing is a simple formula:

Net investment returns = Gross investment returns – taxes – fees

Given that higher taxes eat away at any return we get, lowering taxes is extremely important.  If kaChing’s numbers are correct, there’s no way the average mutual fund can even come close to beating the markets.

Couple of caveats to think about here:

  • We’re dealing with averages here:  If the average mutual fund (with 60% turnover per year, as per the ICI’s 2008 Factbook) passes through such a high tax burden to its investors loses versus index funds, that’s not to say that certain funds do charge less and return more.  Let’s not throw the entire mutual fund baby out with the fee bathwater.
  • kaChing’s execution costs for high turnover portfolios: kaChing will be producing a side-by-side analysis of their typical costs vs. those of the average mutual fund in the upcoming moths.  While kaChing (and competitor, Covestor) may indeed have lower management fees and be a lot more tax sensitive for investors, their execution costs (typically $.02/share) will eat up gains.  High volume turnover will still eat into profits.  Investors will continue to pay for professional portfolio management.
  • Transparency typically benefits the investor: It’s hard to tell exactly what mutual funds charge their investors.  Consequently, firms like kaChing are competing head-on with mutual funds and appealing to average investors by attacking the industry’s Achilles Heel: transparency.  They are banking that, as social media’s Facebook and Twitter phenomena have created new levels of visibility, so too investors will demand it in the financial industry.
  • Fees are important but not the only factor: Too many times investors will forgo professional management because they feel the fees are too high.  While that may be relatively true, there are other factors on which an appropriate investment must be sized up (risk-weighted returns is a huge one for individual investors to better understand).  Everyone on all sides of the aisle is trying to sell you something — caveat emptor.  There are no free lunches.

Anyway, check out the kaChing analysis, read what the WSJ had to say, and I’d be interested to hear your feedback.

ETFs, overindexing and the power of financial brands

Just doing some thinking about the growth and future of the ETF industry:

In my eyes, ETFs began as a second-generation of mutual funds with the following characteristics:

  • Passively managed: ETFs were passively managed (though that’s changing), building upon Jack Bogle’s success at Vanguard.  Most research at the time clung to the Efficient Market Hypothesis and academics declared that trying to beat the markets was a fool’s game.  ETFs were this vehicle.
  • Cheap: They were cheap.  If theory shows that you can’t pick stocks and win the game that way, better to index and reduce fees for better long term success.  ETFs’ passive structure enabled fund sponsors to get big and compete on price, driving prices further downward.
  • New access: Beyond their philosophical underpinnings and reduction in asset management fees, ETFs also opened doors to new asset classes (commodities), markets (Peru), and strategies (leveraged short funds) that weren’t easily accessible or understandable for retail investors previously.

Things are a’changin

Things are changing.  With Blackrock’s purchase of Barclays Global Investors iShares (BGI), ETFs are no longer seen as a pure threat to the much larger mutual fund industry.  Diversified asset managers like Blackrock and PIMCO, mutual fund firms like Vanguard and Fidelity, and online brokers like Schwab are building and buying ETFs as part of a larger smorgasboard of choices for their clients.  ETFs fit in like precious metal and international funds into a firm’s offerings.

In a sense, ETFs have now become purely productized, competing against similar strategies in different structures.  Contributing to this trend is the fact that numerous ETF offerings targeting the same strategy/geography have all hit the market. With multiple offerings for almost every market and strategy in ETF land, overindexing has blurred any and all distinctions in investors’ minds about which securities to select.  Instead of doing the work to pick the most appropriate security, brand will ultimately trump other things.

While there may be 3 general, broad ETFs for investors to get Chinese market exposure, most retail investors have no idea that they’ve been structured differently, that the compositions of the indices these ETFs track are wildly different and have led and may very well lead to different performance outcomes.

Brands, brands, brands

What this means, then, is (like most things in life), competition in the ETF space gets muddled.  ETFs compete against mutual funds every bit as much as they do against each other and with this backdrop, the emergence of the firm’s brand will trump performance and index structure.  Index composition or the race to build a better mousetrap becomes less important.  Branding will sway investor decisions and assets away from the smaller, more innovative players, towards the larger, stronger brands.

Like everything commercial, brands wield power.  So true in the financial sector as well.