Do Morningstar’s ratings work or not? (revisited)

Last week in the WSJ, Joe Light shined some light on a study that took issue with Morningstar’s ability to forecast winning mutual funds.

The paper looks at Morningstar’s overweighting of “corporate culture” as the major input into what the research firm calls, “corporate stewardship”.

Corporate culture is one of the mushier components, answering questions like “do talented investors spend their careers at this fund firm?”

To see what value the culture rating adds, Pace University professors Aron Gottesman and Matthew Morey took Morningstar’s corporate culture ratings and compared them to fund performance between 2005 and 2010, finding that the two don’t necessarily go hand-in-hand. (Can Corporate Culture Predict Mutual Fund Performance)

Morningstar responds

Well, the mutual fund rating firm wasn’t going to let this slide without a fight. The WSJ published Morningstar’s retort:

Continue reading “Do Morningstar’s ratings work or not? (revisited)”

The art of investing in today’s economy — with Jonathan Clements (podcast)

On Tradestreaming Radio, we’re interviewing lots of innovative entrepreneurs, investors, and researchers all trying to make investors better at what they do.  Check out our archives.  Subscribe on iTunes.

Investors have been through a tsunami of challenges the past couple of years.  What I hear right now more than anything is a cacophony of voices, all with differing advice for investors on how to survive in today’s environment.

Jonathan Clements is a beacon of sound, rational investing guidance in a sea of short-termism.  Author of The Little Book of Main Street Money: 21 Simple Truths that Help Real People Make Real Money (Little Books. Big Profits), Clements was the award-winning personal finance columnist for the Wall Street Journal.  He’s now the head of investor education at Citi.

I love Clements’ approach because he’s a pragmatist, synthesizing the best Wall St. has to offer with the do-it-yourself attitude characterizing many of today’s investors.

Clements joins us this week for Tradestreaming Radio.

We discuss:

  • how to navigate today’s investing climate, post financial crisis
  • how experience and time help create investor expertise
  • the struggle investors and advisors have in describing risk
  • why we continue to make decisions antithetical to what we know we should do

Listen below

The Art of Investing in Today’s Economy by tradestreaming

Audio Transcript

Get the audio transcript for The Art of Investing in Today’s Economy (transcript purchased from SpeechPad)

More resources

New insider trading case could alter buy-side research

Tradestreaming and Screening 2.0

Unless you’ve been living in a cave last week (i hear it’s nice there this time of year), you’ve probably seen/heard/felt the aftereffects of the WSJ article U.S. in Vast Insider Trading Probe.

What’s going on

The short of it is:

  • the U.S. suspects the existence of multiple insider trading rings
  • the size of the impact of this net would vast eclipse previous insider trading networks
  • ensnared are consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts
  • holy mackerel, batman

Interesting for readers of Tradestreaming and my book is the focus on expert networks. As per the WSJ

One focus of the criminal investigation is examining whether nonpublic information was passed along by independent analysts and consultants who work for companies that provide “expert network” services to hedge funds and mutual funds. These companies set up meetings and calls with current and former managers from hundreds of companies for traders seeking an investing edge.

These expert networks are de facto for most large investment funds.  As I wrote, expert networks like Gerson Lehrman provide unique research experiences, connecting fund analyst with industry experts for one-off interviews.

Not all bad

Unlike traditional sell-side research that is distributed to many investors and loses its value with greater distribution, expert networks provide extremely valuable interactions.  My book includes an interview with a senior GLG executive.  Much of our time spent together was spent dissecting the compliance engine the leading network had put together and I believe this was as much for PR purposes as much as it was for legal purposes.

It is clear that expert networks have been cited numerous times in the past few years as potentially being involved in facilitating investors’ access to material nonpublic information.  However, we are convinced that the financial markets are better off using “best of breed” expert networks than without them — Integrity Research

Other insider trading rings busted recently (like Galleon) were their own creations.  I have to agree with Integrity Research‘s opinion — this wasn’t by chance.  If Galleon’s vast web of insider information had existed on GLG’s platform, there would have been a clear audit trail of who was involved and to what level.  That didn’t occur — instead, by using individual contacts, Galleon was able to obfuscate its activities for years.

That wouldn’t have happened using a professional expert network and markets are better off by having these.  That said, it’s clear why GLG isn’t able to go public and we’re probably looking at increased regulation of these platforms (which would push more investors to skirt their use).

Heavier hand add more carrying costs

What might happen, regardless of the outcome of this particular probe, is

  • increased scrutiny into the investment research space
  • some type of oversight/regulation of expert networks
  • more distrust of Wall Street by people on Main Street
  • employers continuing to crack down on employee participation in expert networks
  • formation of ad hoc expert networks (LinkedIn + phone)
  • prices going up on expert networks because of increased oversight

Murdoch, Good Content, and Pricing

Rupert Murdoch on Fox News post D8 presentation. He’s pushing the Wall Street Journal as a mainstream paper/product and is pretty blunt about turning off non-payers of premium content.

He also claims that he expects similar subscription numbers that the WSJ.com enjoys on the iPad (1MM+).

Check out the video below.

The Atlantic on WSJ iPad app: It’s working

Interesting analysis on The Atlantic today regarding the WSJ’s paid content experiment on the iPad.

Let’s remember (from the article):

  • Apple sold about 500,000 iPad units in its first week
  • 3200 WSJ iPad apps sold so far at $17.29/mo (or bundled together with other editions)
  • 30,000 current WSJ subs trialing a free version of the app — so room for paid conversion

Rupert Murdoch has been a loud proponent of paid, subscription content as a revenue model.  It will be interesting to see how this all pans out.  Ultimately, it may be Apple, though,  that wins in the whole movement towards new forms of paid financial content.

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.

Dow Jones reorganizes, feeling Bloomberg’s man heat

I believe the Dow Jones mouthpiece when they say that the executive changes announced yesterday weren’t motivated by cost cutting.  Dow Jones chief, Les Hinton was quoted as saying:

This structure will provide the focus to make us faster and better than our rivals at identifying and meeting customer needs.  This isn’t about personalities, and it’s not about costs.

heavy_liftingEssentially, consumer ops (which includes the Wall Street Journal, Barron’s and MarketWatch), including marketing, advertising, and production, were consolidated under Todd Larsen, a certainly capable manager who has a good grip on Dow Jones’ capabilities and innerworkings.

Paid Content describes this as DJ’s major business “operating as one.”  PC also has an internal memo sent to News Corp employees announcing the changes.  It’s worth a read.

What this means, as well, is that Dow Jones is gearing up for an epic battle with Bloomberg, an emergent full-blown media firm that already has DJ in its sights with a recent purchase of BusinessWeek.

I’d say that the market for financial content and distribution is heating up but is certainly not a zero sum game; both firms can be winners here.  Bloomberg has an unbelievable distribution network for its terminal business and a long runway to build a consumer brand.

Dow Jones has some of the best consumer brands in the market and a nice entreprise business and it’s going to need to differentiate the WSJ and MarketWatch (anyone interested in this site anymore?) offerings to stay relevant to the business/financial communities.

I’m placing my bets on Bloomberg, though.   Corporate structure, distribution, and a totally unknown website — the makings of a global financial content giant.  I feel like, in spite of their gaffes, Bloomberg gets investing 2.0 better than Dow Jones does.

How do you think this plays out?

Additional Resources:

  • Dow Jones Reorganizes (NYT)
  • Dow Jones undergoes corporate, exec shake-up (Reuters)
  • Dow Jones memo (PaidContent)
  • Bloomberg takes aim at Dow Jones (this site)

Murdoch on Sky News on the WSJ.com

Interesting interview with Rupert Murdoch himself on the WSJ.com, Google, and premium content.

Here’s TechCrunch’s take on what Murdoch has to say:

Murdoch told his own Sky News that he might start blocking Google and other search engines from giving searchers full access to articles on the Wall Street Journal’s website, WSJ.com. Asked whether he realized that Google was sending his news site a ton of traffic, Murdoch responded, “We’d rather have fewer people coming to our Websites, but paying.”