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November-24-15

Buy This Annuity So I Can Take a Cruise

The current controversy over the proposal by the U.S. Department of Labor to impose a fiduciary standard on those who advise retirement plans has little to do with the rule's merit. Rather, I believe it's at issue because stockbrokers are the beneficiaries of a cozy system that permits them to have conflicts of interest which are not disclosed to their clients. They can (and often do) resolve those conflicts in a way that benefits their bottom line, as long as their recommendation meets the murky definition of being "suitable."

Conflicted advice harms investors

The cost of this conflicted advice has been estimated by the White House Council of Economic Advisers to be $17 billion annually. Investors relying on conflicted advice earn lower returns from their investments, about 1 percentage point less each year.

I have never met an investor who would knowingly do business with a financial advisor who could provide them conflicted advice with impunity. The problem is many investors have no idea this is happening.

My litmus test

I recently made a recommendation that will help you determine whether your advisor has conflicts. Simply ask for confirmation, in writing, that your advisor "will always put your interests first." Every Registered Investment Advisor will do so. I know of no stockbrokers, who sometimes also like to be called "wealth advisors" to conflate the difference in the legal standard between themselves and Registered Investment Advisors, who will make this representation.

Kickbacks

It's difficult to get investors to pay attention to this issue in a vacuum. Thanks to a shocking (and depressing) report from the Office of U.S. Sen. Elizabeth Warren, the tawdry details of how this system works against the interests of investors is now a matter of public record.

The report details how kickbacks are paid to agents for recommending high-cost financial products. While a system involving the receipt of kickbacks is troublesome enough, it's worse that investors are not told about them. As a consequence, many investors believe they are getting objective advice when in reality the opposite is true.

Sen. Warren asked 15 leading annuity providers whether they offered "non-cash incentives" like lavish cruises, luxury car leases and other "perks" to agents in exchange for promoting their annuity products. Thirteen of the 15 companies who responded admitted to offering these kickbacks directly, indirectly or both. One company described these payments as "common in the industry."

Typical incentives were "all-expense-paid trips to expensive vacation destinations" like Aruba, the Bahamas and other resorts, golf outings, dinners, tickets to sporting events and theatre tickets.

The report found current disclosure rules were inadequate to ensure that investors were informed about these kickbacks.

Kickbacks work

These incentives clearly are having an impact. The report found that $235 billion of annuities were sold to customers in the United States in 2014. While annuities may be suitable for some investors in some circumstances, the report detailed abuses that included sales to seniors for whom the products were not appropriate, sales to those with terminal illnesses and even sales to some investors suffering from Alzheimer's or dementia.

An easy choice for your stockbroker

Think about it this way. Your stockbroker has many options when considering what investments to recommend. He could suggest a globally diversified portfolio of low management fee index funds, passively managed funds or exchange traded funds in a suitable asset allocation. This type of portfolio is "evidence-based," meaning it's supported by dozens of peer-reviewed, academic articles indicating that your expected returns will be higher if costs are kept low.

Alternatively, your stockbroker could recommend a high-commission annuity, without telling you he will receive an all-expense-paid trip to Aruba next winter if you buy it. Which option do you believe he will select?

The report concludes with this understated observation:

"New regulations are needed to protect consumers and end this financial conflict of interest."

You think?

 

Buy This Annuity So I Can Take a Cruise blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
November-20-15

A Game You Shouldn't Play

It seems like almost every week a new study appears to debunk the myth of active management. This week was no exception.

Robin Powell, a U.K.-based journalist and financial blogger, discussed a recent study that covered 561 U.K.-based stock funds between 1998 and 2008.

The study's findings were consistent with similar research done on funds based in the United States and elsewhere. It found underperformance by the average stock mutual fund manager, after fees and allowing for common risk factors.

The conclusion reached by the study's authors was sobering: "The results provide powerful evidence that the vast majority of fund managers in our dataset were not simply unlucky, they were genuinely unskilled."

This study is a dry, academic treatise and unlikely to be read or understood by the general public.

That's exactly the way the securities industry likes it.

Progress is slow

The message regarding the failure of active management is starting to resonate with investors, but it still has a long way to go. While the percentage of assets invested in passively managed funds has increased dramatically, according to Morningstar, as of January 2014, it accounted for only 27 percent of total invested assets.

If everyone understood the data, I suspect that percentage would be significantly higher.

A different way to convey the message

In a recent column, Barry Ritholtz quoted legendary investor Charles Ellis on the perils of competing for returns against investment professionals. Ellis reportedly said: "Watch a pro football game, and it's obvious the guys on the field are far faster, stronger and more willing to bear and inflict pain than you are. Surely you would say, 'I don't want to play against those guys!'

"Well, 90 percent of stock market volume is done by institutions, and half of that is done by the world's 50 largest investment firms, deeply committed, vastly well prepared -- the smartest sons of bitches in the world working their tails off all day long. You know what? I don't want to play against those guys either."

That's a message that's easy to understand.

There's a better way

Instead of competing against the pros -- and often losing -- there's another option that is disarmingly simple: Don't play the game.

Opt out of relying on your stockbroker, the one who tells you he can "beat the markets" through stock picking, market timing and fund manager selection even though there is likely to be a professional on the other side of your trades.

The performance of the average investor who succumbs to this "advice" is shockingly poor. According to one study, for the 20-year period ending Dec. 31, 2013, the returns of the average investor barely kept up with inflation. During the same period, investing in a simple S&P 500 index fund would have yielded more than twice those returns.

Here's a different approach. It eliminates the perils of competing against "the smartest sons of bitches in the world." Instead, it involves capturing the returns of the global marketplace, less very low fees, through the use of index funds. I discuss how in this article.

If you continue to ignore this advice, you will be engaged in an effort described by my colleague, Larry Swedroe, and his co-author, Andrew Berkin, in their excellent book, The Incredible Shrinking Alpha, as follows:

"Active management is the triumph of hype, hope and marketing over wisdom and experience. Choosing passively managed funds to implement your investment plan is the winning strategy, and the one most likely to allow you to achieve your goals."

It's not that it is impossible to win at the game of active management. It's just that the odds are so stacked against you that it makes no sense to try.

This is a game you shouldn't play.

 

A Game You Shouldn't Play blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
November-03-15

Misleading "Debates" on Active vs. Passive Harm Investors

While it's a low bar, Bloomberg TV always seemed to me to be the best of the financial media. Its anchors are professional and knowledgeable. Its coverage is broad and responsible. It avoids the hype and sensationalism typical of many of its competitors.

Bloomberg recently launched a new morning program, Bloomberg Go. It features some high-powered on-air talent, including David Westin, who previously had final behind-the-scenes say at Good Morning America and is the former president of ABC News. Westin is an on-camera fixture of the new program. He works with Stephanie Ruhle, a respected Bloomberg anchor.

According to Westin, the target audience of Bloomberg Go is "busy people who want to get something they can use something they aren't going to get somewhere else." He continues: "If we don't give them that, they are going to go on to somewhere else."

The "debate"

On Oct. 12, Bloomberg Go featured a brief "debate" on the merits of active versus passive funds. On the "passive" side was my colleague, Larry Swedroe, director of research at The BAM Alliance. Taking up the active cudgel was David Barse, chief executive officer at Third Avenue Management. You can watch the clip of this "debate" here.

Swedroe explained that "while it is certainly possible to beat the market through active management...you have about a 1 in 50 chance of outperforming." He doesn't "like the odds." He added that, as set forth in his recent book, The Incredible Shrinking Alpha, the odds of an active fund outperforming its appropriate risk-adjusted benchmark have been persistently declining. Twenty years ago, about 20 percent of active funds were generating statistically significant alpha. That number is down to about 2 percent today.

Barse responded that Third Avenue, since its inception, has been able to beat the benchmark it uses. He noted that the "active share" of their funds is in the "high 90s," so the index is not a "relevant measurement" of what the firm is actually doing, which is "generating good, long-term returns."

When confronted with data on the general underperformance of active managers against standard benchmarks (in this case the S&P 500 index) Barse acknowledged that generating alpha was "hard," but also stated that attempting to do so was a "thrill" and an "intellectual challenge." He said Third Avenue works "hard to do it" and it's what the firm strives to do "every day."

Most viewers would come away with the impression that there was merit to both sides of the argument. They might even consider investing with Third Avenue, since the import of Barse's argument in favor of active management was that Third Avenue has a track record of successfully overcoming the odds against "beating the market."

Not quite so fast.

The data paints a different picture

In a subsequent article, Swedroe examined the returns of three of Third Avenue's funds. His findings were at odds with Barse's assertions during the debate.

The Third Avenue Small Cap Value Fund (TASCX) is categorized by Morningstar as a small-value fund. Fund managers often confuse investors by using the wrong benchmark as a basis of comparison for fund performance. Swedroe clearly used the correct benchmark in his comparison, relying on Morningstar.

TASCX returned 5.20 percent per year and 8.34 percent per year for the 10- and 15-year periods ending Oct. 13. According to Morningstar, this fund underperformed all but about 10 percent of the small-value funds that survived during these periods.

Investors would have been far better off in a comparable index fund from Vanguard. The Vanguard Small Cap Value Index Fund (VSIIX) outperformed Third Avenue's fund by a staggering 3.17 percentage points per year over the 10-year period and 1.58 percentage points over the 15-year period.

An analysis of Third Avenue's global and international funds also demonstrated underperformance. Swedroe again used Morningstar data to ascertain the correct benchmark. He found the Third Avenue Value Fund (TAVFX) underperformed the 10- and 15-year returns of comparable passively managed funds from Dimensional Fund Advisors, no matter which mix of Dimensional's large- and small-value funds were used, or which mix of domestic and international funds were selected.

Finally, Swedroe looked at the Third Avenue International Value Fund (TAVIX), which is categorized by Morningstar as a small-mid value fund. For the 10-year period ending Oct. 13 (the fund didn't have 15 years of returns), TAVIX returned 1.75 percent per year. The comparable Dimensional fund, the DFA International Small Cap Value Fund (DISVX), outperformed TAVIX by a whopping 4.56 percentage points a year.

Swedroe concludes his article as follows: "Not only did Third Avenue's funds fail to outperform in each of the cases I analyzed, but they underperformed by wide margins. Maybe, just maybe, alpha is a lot harder to deliver than many, including David Barse, think. The Third Avenue funds I looked at certainly weren't generating alpha or beating appropriate benchmarks."

Swedroe excluded from his analysis Third Avenue's largest and most popular fund, the Third Avenue Real Estate Value Fund (TAREX). He later explained this omission by noting that Vanguard doesn't have an international real estate fund and Dimensional's comparable fund does not have a long enough track record, so he had no basis for comparison. When he looked at a 5-year time period, and took an average of the returns for Dimensional's domestic and international REIT fund, TAREX marginally outperformed (10.48 percent to 10.2 percent).

Nevertheless, even when including this fund, Third Avenue outperformed in only one of four funds, which, as Swedroe says, isn't "very good odds." What's more, the single fund that did manage to outperform just barely accomplished this feat, while the three funds that underperformed did so by greater amounts. This is consistent with the evidence showing that the margins of active management outperformance tend to be much slimmer than the margins of active management underperformance.

I asked Third Avenue for its comments on Swedroe's analysis. It declined.

The responsibility of the media

While the interviewers on Bloomberg GO challenged Barse with general data about the underperformance of actively managed funds, they were unprepared to confront his contention that Third Avenue Management is the exception to the rule.

The data in Swedroe's article is readily available. Think about how helpful it would have been if the moderators of this "debate" had been aware of it and asked Barse some pointed questions, like: "For the past 10 and 15 years, isn't it a fact that investors would have earned higher returns in comparable index and passively managed funds than in your Third Avenue Small Cap Value Fund, your Third Avenue Value Fund and your Third Avenue International Value Fund?" and "How can you justify your assertion that Third Avenue Management adds 'alpha' for investors in these funds?"

Now that would be a real debate.

It would also be responsible journalism.

 

Misleading "Debates" on Active vs. Passive Harm Investors blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
November-03-15

Non-Disclosure Is Harming Your Returns

The current debate over a proposal by the U.S. Department of Labor, which would require advisors to act as fiduciaries to the retirement plans they serve, obscures an important issue. It's bad enough that stockbrokers are resisting any regulation obliging them to put the interests of their clients above their own; it's even worse that they fail to disclose this important fact, making it appear as if they are being held to a higher standard.

The real issue is the failure to disclose. It permeates the securities industry, enriching stockbrokers and the big brokerage firms that employ them while reducing the returns of their clients and harming their ability to meet their retirement goals.

Here are some key examples:

Disclosure of a lower duty to clients

As discussed in an article I wrote last month, stockbrokers are not fiduciaries to their clients. They are permitted to have undisclosed conflicts of interest and to resolve those conflicts in their favor, as long as the investments they recommend are "suitable."

Registered Investment Advisors must disclose all conflicts, resolve them in favor of their clients and act solely in their clients' best interest.

According to a report issued by the Office of the Comptroller of the City of New York, an "extensive study of investor financial literacy conducted by the SEC found that the average investor is unequipped to make an informed choice regarding investment advice and is largely unable to distinguish between the very different roles and legal protections offered by broker-dealers and investment advisers."

To remedy this confusion, the New York City Comptroller's report recommended this straightforward disclosure, which would have to be made by all non-fiduciaries:

"I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks, and expected returns for you."

The city's comptroller is not imposing a fiduciary standard on non-fiduciaries. He is simply requiring a disclosure of non-fiduciary status, and its consequences, so investors can make an informed decision.

Underperformance disclosure for actively managed funds

The daily grist of many stockbrokers includes the recommendation of actively managed mutual funds. The managers of these funds attempt to beat the returns of a designated benchmark, like the S&P 500 index.

My colleague, Larry Swedroe, has done a fascinating series of articles in which he analyzed the returns of many prominent mutual fund families in an effort to determine how they performed. You can find a summary of his conclusions at the end of this article.

He examined funds managed by TIAA-CREF, Goldman Sachs, JPMorgan Chase, American Funds, Gabelli Funds, Waddell & Reed, John Hancock, Morgan Stanley, Wells Fargo and Russell. Here's what he found:

  • Only three fund families outperformed comparable Vanguard index fund portfolios. The average for all 10 fund families was an underperformance of 0.2 percent.
  • Only one fund family (American Funds) outperformed comparable portfolios of passively managed funds from Dimensional Fund Advisors, and that outperformance was only 0.1 percent. The average for all 10 fund families was an underperformance of 0.7 percent.

Based on this analysis, and many other studies, I believe stockbrokers should be required to make the following disclosure when recommending the purchase of actively managed funds:

"In any one year and especially over time, most actively managed funds underperform comparable index or passively managed funds. The odds of picking an outperforming actively managed mutual fund prospectively are exceedingly small and diminish over time. Therefore, you should consider whether you would be better advised to purchase lower-cost index or passively managed fund."

A disclosure of this kind would simply inform investors of critical facts that might affect their decision. Stockbrokers, of course, would still be free to advocate for the purchase of actively managed funds.

Underperformance disclosure for hedge funds

The performance record of hedge funds is dismal. According to a recent article in the Financial Times, in "the seventeen years before 2013 investors would have been better off investing in U.S. Treasuries with essentially no risk rather than aggregate hedge funds." The same article notes significant underperformance since 2013.

I believe those recommending hedge funds for inclusion in the portfolios of individual investors or retirement plans should be required to make the following disclosure:

"On average, hedge funds historically have underperformed almost all major asset classes. Investors might be better advised to consider investing in low-cost index funds, exchange-traded funds or passively managed funds."

Investors who still want to invest in hedge funds would be free to do so, but at least they would be well-informed.

Disclosure of Jim Cramer's track record

I believe any financial media outlet on which Mad Money host Jim Cramer appears should be required to make the following disclosure concerning his track record:

"Mr. Cramer's ability to select outperforming stocks is no better than what you might expect from random chance."

These proposals are modest. This information is critical to investors. The securities industry is the beneficiary of ignorance. It profits from it, while its clients suffer.

It's time to level the playing field.

 

Non-Disclosure Is Harming Your Returns blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

 

By: Dan Solin | 0 comments