In Defense of Investment Advisers

After collecting their one percent annual fee, most investment advisers are doomed to underperform the market. More likely than not, an amateur investor could do better – just invest in index funds, sit back, be patient and get richer.

Investment advisers, not to mention brokers, appear redundant. – useless or worse. William Berstein sees them as a threat to financial health and happiness:

As an investor, you must recognize the monsters that populate the financial industry. *** … most “finance professionals” don’t even realize that they’re moral cripples, since in order to function they’ve had to tell themselves a story about how they’re really helping their customers.

Some critics are less polite.

Polite or not, the critics ignore a key reality: Most people cannot invest sensibly on their own. At best, perhaps a third are willing and able to put their money into a few diversified, low-cost funds and stay the course.

Others need somebody to hold their hands and discourage them from buying high, selling low. Some are reluctant investors. In begone times they would have been contented savers, putting their money into 3.5-percent savings accounts and 6-percent CDs. Nowadays they must seek investment help or grow poorer.

In short, most people with money to invest still need advisers. What’s different is the adviser’s mission. Instead of tilting with windmills and seeking to beat the market, the adviser’s aim should be to produce better results for the investor than the investor would achieve on his or her own.

And that goal should be often achievable;. The bar is set surprisingly low. From 1994 through 2013, the S&P 500 produced an annualized return of 9 percent. The average stock fund investor earned 5 percent.

Some estimates suggest the gap in returns is even greater after accounting for all fees and other expenses.

Does a 20 percent increase in investment performance sound worthwhile? By controlling expenses with ETFs and limiting fruitless trading, an adviser could achieve that impressive improvement merely by increasing the investor’s annualized return from 5 percent to 6 percent.  A low-cost, exceptionally patient adviser might achieve 7 percent – a 40 percent improvement!

Helping clients beat the average investor rather than beat the market doesn’t sound glamorous. It won’t earn advisers enough to acquire a beach house in Malibu. But it is doable.

Like politics, investing is the art of the possible.

Indexing 2.0: Smart Beta

On average, monkeys throwing darts at the stock listings could outperform most investment managers. Actually, Barron's notes, they can do even better. They can beat the S&P 500.

Reason: the monkeys are assumed to invest an equal number of dollars in each stock they hit upon, regardless of market capitalization. Equal weighting seems to produce better returns. 

[T]he S&P 500 Equal Weight index has returned 9.1% a year over the past 15 years, beating the S&P 500 cap-weighted index by a whopping 4.6 percentage points a year.

Inspired by the monkeys, so-called smart beta investing has produced an expanding list of quasi-index funds not weighted by market capitalization. The more sophisticated models sound a lot like automated stock picking.

Does smart beta investing have legs? Whether passing fad or significant trend, Paul Sullivan's renaming seems appropriate:

[A] better, if less marketable way to think about smart beta might be to call it “lazy alpha”….

The 3% Solution – a Tough Sell

In his weekly Wealth Matters column, Paul Sullivan looks at Evercore Wealth Management. Founded by escapees from US Trust after Bank of America swallowed the nation's oldest trust company, Evercore asks the wealthy to focus on net investment results. That is, net returns after fees, taxes and inflation.

Admirable idea, but a tough sell. Even Sullivan has his doubts:

[W]hat I would have liked to see was a pre-fee return along with the returns before taxes and inflation.

Evercore's web site is cleaner than most. Also worth emulating, their uncluttered, plain-spoken newsletter.

Dogs of the Dow: Woof, Woof!

Dow Dogs Vastly Outperform The Broader Dow And S&P 500 In 2011.

Double dips

Just one day before the Dow closed under 10,000, perhaps as a result of another rotten jobs report, Daniel Gross at Slate stated that there is very little  chance of a double dip recession.  Talk about a double dip springs, he argued, from the excessive of optimism of 2007.  Having been stung by that error, now there is an excess of pessimism. 

Liberals saying there's nothing to worry about in the economy?  I'd call that a sell signal.

Is “Socialism” Bullish?

From today's Wall Street Journal (subscription):

Will the [health care reform] bill really "turn America into a socialist country"? It's easy to laugh at this notion, of course, but let's look at it from another point of view. Even if that were correct, should you really sell everything and flee?

Socialism, or social democracy, or whatever else you want to call it, doesn't seem to have hurt stockholders overseas too badly. Over the past 10 years, according to MSCI Barra, stock markets across socialized Europe have produced total returns of about 2% a year in U.S. dollar terms, according to MSCI Barra. The figure for France is just over 2% and for left-wing Britain and Holland nearer to 3%. Pinko Denmark has boomed by 10% a year.

Meanwhile, here in the land of the free, investors have made zero.

Should Investors Watch the Calendar?

According to 60 years of data analyzed by Robert Henkel of Weyland Capital Management, last month's decline in the stock averages bodes ill for the rest of the year.

With 60 years of price data from the S&P 500 averages — from January 1950 through December 2009 — we found that the January market movement was a good indicator. When January returns were positive, the average return for the rest of the year was plus 12.3 percent. That covers both up and down years. On top of that, if stocks moved up in January, there was an 89 percent chance of the market going up for the rest of the year (from February through December).

A down January Effect also told a story. When the January S&P 500 index turned down, the average return for the rest of the year was minus 0.8 percent. And the probability of the market being up for the whole year was only 52 percent.

As this chart reveals, stock returns do show remarkable differences when sorted by month. Before air conditioning, perhaps the stock market's summer slump made sense. Other factors must contribute to the seasonal and monthly variations.

Investors shouldn't worry too much about what month it is, writes Henkel. The more useful question: "What day of the month is it?"

Bipartisan Investment Advice

Objective investment advice can't always beat the benchmarks, but it can help investors avoid losses stemming from their emotional instinct to make the wrong moves.

Buying high and selling low has been shown to shave a point or more off the returns realized by mutual fund investors. In The New York Times, Mark Hulbert observes that political leanings also seem to be a factor. According to a recent academic study, Democrat investors tend to hold more domestic stocks and assume more risk when their party is in power. So do Republican investors, when their party takes over.

What's more, both Democrat and Republican investors tend to trade more frequently when their party is out of power.

What investors need, it seems, is advice that's not only objective but nonpartisan.

A 3% Real Return? "It Doesn't Sell"

From In Search of Competent (and Honest) Advisers in the NYT:

Investors focus on relative and real returns. But Thornburg Investment Management has published a report saying they should also look at a different number — the return after fees, inflation and taxes. A more realistic number going forward is around 3 percent. To achieve it, a balanced portfolio needs a nominal return in the high single digits.

George Strickland, managing director at Thornburg, said most advisers will not tell their clients this because no one wants to hear it. “The vast majority say, ‘That may be true, but that doesn’t help me promote my business. I just can’t sell 3 percent. I can sell 10 percent. I can sell 15 percent,’ ” he said.

Elk, Wall Street Bankers and the Average Investor

Economists may learn more from Charles Darwin than Adam Smith from now on, writes Cornell's Robert H. Frank.

Frank points to the elk. Mutations have resulted in male elk with antlers spreading five feet or more. These weapons of broad destruction help in fights with other males for mates – but they place the elk in deadly peril the first time predators chase him into the woods. (Could that help explain why the Eastern Elk, portrayed here by Audubon, is now extinct?)

Frank doesn't quite single out Wall Street bankers and their financial engineers as similarly maladapted, but one gets the picture: The ability of many to make lots of money individually did not assure their collective survival.

Even average folks may be ill-adapted to the investment world, as demonstrated by Mark Hulbert. We've evolved enough to see the theoretical advantages of timing the market, but not enough to realize we can't actually do it.

Hulbert cites a Morningstar study of the giant Growth Fund of America. In the bear-ridden 12 months through May, an investor holding the fund would have lost 31.4 percent. But "the actual return for the average investor in the fund was worse: down 32.7 percent.… The reason for this bigger loss was that the average investor had more dollars invested in the fund when it was declining than when it was rising."

The gap of 1.3 percentage points echoes the findings of an earlier, broader study. From 1991 through 2004, the tendency of mutual-fund investors to buy high and sell low reduced their average returns by 1.6 percentage points a year.

As for the presumably sophisticated investors who put money in hedge funds, Hulbert points to a study showing that market timing costs them a bundle: "The dollar-weighted return of the average hedge fund is 4 percentage points a year below its time-weighted return."

Why Apple is golden

Last spring the first post on the Trust and Wealth Management Marketing blog concerned Apple computer. So it's none too soon to go slightly off-topic again.

For Christmas your Senior Assistant Blogger received an iPod. Not a video one, not even a Nano. Just a big, old, monochrome-screen iPod. I was expecting something clunky. Instead, there in my hand was a white-and-silver art object of surpassing beauty, demanding to be caressed and cherished. Wow!

Now I see why Apple's market value has soared past Dell's. And why Jonathan Ive, the London-born designer of the iPod, was just honored by his Queen.

The lesson of the iPod, I guess, is that sometimes form is function, and I'm not sure how that applies to marketing financial services. But I do detect a useful reminder in Steve Jobs’ successful marketing of Macintosh computers.

The new "Intel inside" iMacs Steve announced last week run twice as fast as the previous G5 model. The new MacBook laptop is said to run four or five times as fast as the G4 Powerbook it replaces. Yet it wasn't that long ago that Steve was tweaking test statistics to demonstrate that the old models were just as fast as Intel PCs for practical purposes. And the old models were so cool, so convenient and relatively reliable to use, that folks were willing to believe the hyperbole. Macs survived and began to prosper.

Reminds me of our old friend Knute Alphanot, at Lake Woebegone B&T. His trust department's investment performance is never more than mediocre (though rarely less than). But Knute has a winning way of adjusting his returns for volatility, currency fluctuations, and maybe even windage. By the time he's through, he can show his clients he's always above average. Top Quartile, usually.

OK, maybe most of the clients don't believe him. But as many a consultant has pointed out, you can get away with merely decent investment performance if you do the very best you can for your clients in all other respects. Knute's department runs like a Rolex, and client communications — from thoughtful notes and phone calls to newsletters and seminars — are never neglected.

Moral: You don't need great investment returns as long as you offer your clients insanely great service. Make them feel as cherished as . . . an iPod!

P.S. I hope your investment people bought Apple, not Dell!