Beware of the Industry
Craig Slayen, Principal
Winship Wealth Partners
The Financial Media, The
Brokerage Firms And The
Mutual Fund Companies Are
Not Your Friends.
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Introduction
Between the financial services companies and the media, there is no
shortage of investment information or guidance for investors. But
before you go wading in those waters to look for objective advice or
relevant information, you should know that these institutions, once
thought to be bastions of trust and integrity, may not have your best
interests at heart.
With tens of trillions of dollars in client assets and hundreds of billions
in profits at stake, the companies that comprise the financial services
industry can only serve one master, their shareholders. In their quest
for short-term profits to appease shareholders and to justify multimillion dollar bonuses for senior management, the brokerage firms and
banks are constantly focused on ways to increase profit margins for the
next earnings report. The only way to do that is by raising sales quotas,
increasing product fees or reducing client services.
Mutual funds, which now number in the thousands and hold as much
as 60 percent of investor assets, have become the tail that wags the
dog in the financial services industry. Although an increasing number
of their product sales come directly from investors, they rely heavily on
the brokerage firms to sell their funds. Because a significant portion of
their revenue comes from “soft dollars” paid to them by the mutual
funds to put their products on the front shelf, the brokerage firms need
them equally as much. That pretty well puts investors in the middle,
with expenses and fees hitting them from all sides.
Finally, there is the financial media – the 24-hour cable news, the print
media and the unleashed blogosphere – that take in tens of billions in
advertising dollars from the brokerage firms and mutual funds. As the
primary source of information and reporting on investment issues, they
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are entrusted with the sacred duty to provide unbiased and comprehensive coverage of an
industry that controls trillions of dollars of the public’s assets. Yet, to do so honestly and
objectively could very well bite the hand that feeds them.
It’s understandable that expounding the virtues of mundane long-term, buy-and-hold asset
allocation strategies may not hold the attention of an investing public clamoring for hot stock
picks or the clairvoyant musings of market forecasters. In fact, it can be downright
detrimental to an industry that generates much of its revenues from investors who continue to
believe they can time or beat the market by trading stocks and picking mutual fund winners.
Either way, the financial media, like the financial services industry, must put profits first, and
that almost always comes at the expense of investors’ best interests.
The Brokerage
Industry Conflict:
Serve Clients or
Shareholders
An unbridgeable conflict exists in corporate governance between shareholders and clients.
Over the brief history of publicly owned companies, it had been made clear, by business
scholars and senior-level management alike, that it is the obligation of the company to serve
the interests of its shareholders, and to pursue policies and strategies that serve to increase
shareholder value. When management compensation is tied to share performance, the
strategic emphasis is focused on short-term earnings. And when management’s
compensation is based on the annual bonus, you can be assured they aren’t thinking much
beyond next year in terms of where their profits are coming from. By implication then, the
customer’s interests are secondary at best.
With an eye toward quarterly earnings reports, management decisions are focused on revenue
generation and profit maximization for the next three months. Decisions are more tactical in
nature, and are often centered on ways to boost sales or lower costs. Compensation is
tweaked, new products are introduced, and incentives are dangled. Clients receive unexpected
calls from brokers who have the stock idea de jour, and brokers receive accolades from their
managers for meeting their production quota. Sales revenues then inch their way up to the
top, peeling off bits for managers’ overrides, office overhead, product managers, regional
managers, division management, provider revenue shares, and senior management, plus 15
percent going to profits. Next quarter it’s simply “rinse and repeat” – sales, production and
profits.
There was a time when stock brokerage firms were more customer-centric. Up until the
1960s, most firms were owned as partnerships, and their only focus was in trading stocks on
behalf of their customers. Then the investment banks started buying these firms and taking
them public in order to raise capital. Investment banks are essentially product manufacturers.
They create investment products and they underwrite investment offerings on behalf of their
corporate clients. So the stock brokerage firms became their distribution centers, their retail
arm to deliver their products to market. Under this arrangement, the big stock brokerage/
investment banks were able to make money on the “buy side”, by manufacturing or
wholesaling products, and through big price markups on the “sell side”, they generated even
bigger profits.
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Equity Research
Clients Can
Count On
Security analysts, ostensibly, exist to serve the firm’s clients, both the institutional client and
the investor client, by providing research on securities. They are part of the investment
banking team when they conduct extensive analyses on prospective security offerings, and
they support the retail distribution channel by providing the data and context for stock
recommendations. They also serve the interests of corporate finance clients when they put out
positive research reports that include a “buy” or “hold” recommendation.
While they also publish negative reports with “sell” recommendations on companies, it isn’t
very likely that those companies would be found on the client list of the firm. In the past,
security analysts came under fire when it was discovered that they were using positive
analyses as a quid pro quo for securing corporate finance business, and alternatively,
threatening reluctant prospects with negative analyses.
If the inherent conflict-of-interest of the incestuous inner-relationships between the security
analysts and the investment bank wasn’t apparent, a closer examination of the way they are
compensated would probably erase any doubt. When security analysts perform for the supplyside, they are incentivized to create a compelling story for the investment bank’s corporate
finance client. A successful stock offering will generate huge fees for the firm, a percentage of
which the security analysts can receive as compensation. They also can earn a percentage of
commissions from the ongoing sale of the offering through the distribution channel. Like the
investment bank, the security analysts always make money, whether or not the clients lose
theirs.
Much has changed from the days of the partnership firms that acted as true stewards over
their client’s money. The industry veered off course and lost its way, moving away from
stewardship to salesmanship. The driving force became gathering assets and increasing profits
at any cost, even at the expense of their clients. Short-term speculation and aggressive
product marketing became default strategies for pleasing the shareholders. If conflicts of
interest were created along the way, they could be papered over with clever name changes and
new products to build a façade of client-centricity.
Brokers Are Paid
To Sell, Not Give
Advice
Today, brokers are presented to the public as “financial consultants”, or “Vice President of
Investments”, or whatever the title de jour is that’s printed on their business cards, but
internally, stockbrokers are colloquially referred to as “producers.” Producers are compensated
by the firm through commissions and bonuses paid on products sold. The more products a
stockbroker sells, the more compensation is generated for both the broker and the firm,
regardless of whether their clients make or lose money on their investments. Sales managers
and branch managers are compensated on the basis of product sales. They earn big bonuses
when production quotas are exceeded and when the firm’s profit margins and earnings
increase it generates huge bonuses for senior management.
Nowhere in their compensation plan does it reward them for the quality of their advice or
client service, because it simply isn’t measured. Brokers are paid to sell investment products.
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Beware Of The
Media Trap
Most people would argue that living in a digital world, with instant access to an endless
stream of information has made us smarter and more self-empowered than past generations.
Investors believe that it has “leveled the playing field”, enabling them to make investment
decisions based on the same information once only available to the investment pros. The
incessant quest for information has reached such a fever pitch that the media outlets,
including the cable channels, print media, and now the blogosphere, are churning out content
24/7, and it still isn’t enough to satiate peoples’ ravenous appetite for information. So, it’s all
good? WRONG.
There is a much stronger argument that can be made that, for people in general and investors
especially, information overload not only makes it more difficult to make rational decisions, it
often leads to behavior that can be harmful, if not devastating to your financial health. While
there has obviously been a marked increase in the quantity of information, the quality of the
information will always be in question. Where you have quantity without quality, all you really
have is “noise.” And for people who really should be listening for legitimate financial advice
and relevant information, it can be deafening.
With 85 percent of the population wired to the Internet and mobile devices, information has
become so ubiquitous that it has become an entitlement for people who take its availability
for granted. The media is taking full advantage of that entitlement attitude to layer on as
much content as it thinks the public can consume. In order to attract the attention of a preoccupied public, and therefore the advertising dollars its viewership generates, the
information has to be entertaining, pithy, and compelling. To that end, the media has no fear
or shame in hyping a story beyond a reasoned reality, in order to make its information more
essential.
In the investment arena, stories can’t be compelling, or entertaining, for that matter, unless
they are consequential in the short term. In other words, the Facebook IPO, even though it
was of little actual consequence to most investors, is a much more compelling story than an
essay on the superior, long-term performance of index investing, even though it could benefit
the vast majority of investors. The problem is that the information we, as investors, receive is
filtered through an “excitability” gauge. Can you imagine an analyst or stock guru spending
20 minutes on CNBC talking about the 5-year growth prospects of the stock market and how
a diversified portfolio is your best opportunity to outperform the market? Three-quarters of
the audience would switch over to the food channel where they could find much more
“consequential” information.
That’s why we get “investortainers” like Jim Cramer, beeping horns and sounding sirens while
pushing his latest short-term stock picks. It’s entertaining, pithy and compelling; yet, it is, by
and large, useless information for anyone other than misguided, amateur stock pickers.
Investors who try to manage their portfolios based on these stock recommendations will
drastically underperform the stock market over the long term.
In the same way the media likes to hype the stock gurus, it also over-glamorizes professional
investors, such as mutual fund managers. The hottest fund managers of the year are
plastered over the airwaves and magazine covers with the same fervency as sports heroes.
Never mind that fewer than 25 percent of fund managers are able to repeat their marketbeating performance two years in a row. Never mind that index funds - fund portfolios that
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require little or no fund management - consistently outperform the entire universe of mutual
fund managers. Yet, you won’t see an index fund featured on the cover of U.S News. They’re
too mundane, or perhaps they’re just too obvious, and the obvious is always boring.
Conclusion:
Unfortunately, access to more information and technology has not improved investor
performance over the last couple of decades. You do need to remind yourself that these
sources of information don’t necessarily share your agenda. Gathering information and
educating yourself are essential parts of the process, but it should be done in the context of
your clearly-defined objectives and a well-conceived financial plan.
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About the
Author
From an early age, when his friends were thinking only about sports and music, Craig Slayen
became enamored with the stock market, idolizing the heroes of Wall Street, such as Warren
Buffet, Benjamin Graham, Peter Lynch and David Dodd. After graduating from the University
of California at Berkley, it was no surprise to anyone that Craig would start his career with an
investment management firm in the Bay Area in equity research, analyzing companies for the
firm’s investment portfolio.
After mastering fundamental financial analysis on the equity side, Craig was placed in charge
of fixed-income trading where he analyzed and traded municipal, corporate and government
bonds for client accounts. For the first half of Craig’s career, he excelled in a world where
research is coveted as the fuel for finding stocks and bonds to outperform the market.
It wasn’t until he began to manage client relationships that Craig experienced an epiphany
which would forever change his view of investing and ultimately transform his career. Having
the opportunity to work closely with many of the firm’s clients, largely affluent families with
substantial assets and complex planning issues, Craig quickly discovered that the best
research and stock selection that money could buy could not consistently outperform the
markets. This led Craig to ask the question “Is it even possible for a portfolio manager to
consistently outperform the market?”
After several years of compiling the data from client accounts, Craig discovered that the
inconsistencies in portfolio performance were not based on portfolio management skills or
the accuracy of research, rather it was because of the sheer randomness of the market, and all
of the academic research he studied confirmed it. That experience inspired him to start his
own investment advisory practice which he founded with his wife, Melissa in 2006. Since then,
his firm, Winship Wealth Partners, has catered to families and individuals with an emphasis on
comprehensive financial planning, asset allocation and investor behavior management based
on sound academic research.
About Winship
Wealth Partners
Winship Wealth is an independent wealth management firm providing investment consulting
and advanced planning services to individuals and families. Their aim is to deliver sound
investment strategies and disciplined management to help their clients achieve their goals
and have a positive investment experience.
Winship believes in an integrated approach to planning and investment management and is
dedicated to providing objective council to help their clients make good decisions with their
financial resources. While they provide comprehensive planning services which include wealth
accumulation strategies, tax planning, and risk management, they specialize in helping clients
plan for retirement and navigating the myriad of issues and opportunities associated with this
big life transition.