Lack of Performance Reporting (Part 9)

Working through Robyn Post’s 2014 article in Money magazine, I left off with the argument that pre-existing client-specific securities or portfolios render performance reporting of representative accounts meaningless.

Sean Gilligan writes [e-mail correspondence] that GIPS offers two options to handle such cases. The portfolio can be labeled “non-discretionary” and left out of the composite records altogether if client-specific securities amount to a significant percentage. Alternatively, these securities may be labeled “unsupervised” and removed from the performance calculation.

Part of establishing and maintaining compliance involves definition of discretion in the “GIPS policy and procedures.” This specifies how much customization is allowed before the portfolio gets excluded from the composite. Gilligan agrees that SMAs will generally have more customization than investors within a pooled fund, which relates to my initial mention here.

With options available to handle client customization, I wonder if the “performance reporting just doesn’t make sense” claim is less serious belief and more an excuse to avoid the GIPS compliance expense. It could also be GIPS ignorance.

Continuing on with the article:

     > Other factors that can also sway performance returns include
     > the wide range of investment goals and risk tolerances among…
     > advisers’ clients, said [financial adviser] Dave O’Brien.

I disagree with this. Although I do not currently have experience trading for a wide range of clients, I think suitability and risk tolerance levels can be broken down into granular GIPS composite categories.

GIPS composite categories are not the same as representative accounts because the latter leaves the door open to cherry picking better results. Time-weighted return (TWR) is performance without the impact of deposits or withdrawals. Comparing managers based on representative accounts from their strategies can be meaningful provided that TWRs are used along with consistently-implemented strategies. GIPS require compositing rather than representative accounts to aggregate TWRs across all portfolios with the same objectives and constraints. Composites cover the firm’s cumulative performance.

     > …O’Brien [says] advertising historical track records is more
     > suited to hawking a product, such as a mutual fund, instead of
     > comprehensive advice… “We’re providing a service… that’s
     > unique to each client… To the layman they may seem the
     > same, but they’re not.”

If not by comparing performance then I wonder how O’Brien suggests we evaluate investment advice. I am hoping to get a return phone call to explain this.

Lack of Performance Reporting (Part 8)

Today I want to discuss a Money magazine article published by Robyn Post on September 23, 2014 entitled “Why Won’t Advisers Disclose Their Investment Performance.”

     > Clients of Jim Winkelmann, an adviser in St. Louis… can request
     > a free performance report… But a warning in bold, red letters…
     > [says] little to nothing can be learned from past performance.
     > “Do not base decisions on this information.”

Even if investing is more luck than skill, I would rather take my chances with someone who outperformed in the past given that we do not know what is in store for the future.

I [completely agree and] am more familiar with the “past performance is no guarantee of future results” disclaimer.

     > Winkelmann… is among a minority of advisers who share their
     > investment track records. Yet some financial services professionals

Emphasis is mine. Robyn Post now joins Kenneth Winans, Jason Zweig, Tim Medley, David Spaulding, Mark Perry [and readers], and Eric Tyson in opining about a lack of performance reporting in the financial industry.

     > believe the practice should be more common because it can help
     > prospective clients determine if an adviser will do a good job.
     >
     > Some advisers… are skittish because of a maze of rules… from
     > the… [SEC] and state regulators that make advertising tricky…

Jonathan Pond is an adviser who said he wouldn’t report performance for this reason (see Part 5).

     > [FINRA], Wall Street’s industry-funded watchdog, also warns…
     > against advisers boasting “above-average account performance.”
     >
     > Regulators typically prefer, but do not require, that advisers
     > who advertise returns follow… [GIPS], the king of performance
     > guidelines, say securities industry experts…

The “king” was discussed here.

     > The group that developed the GIPS standards also recommends that
     > advisers hire a reputable, independent firm to verify those figures…

“You get what you pay for.”

     > Michael Kitces, an adviser in Washington and industry blogger…
     > [says] the steep price tag… is keeping some advisers away…

This is a barrier to entry.

     > Instead some advisers use their own calculations. But those can
     > mislead investors or land advisers in hot water with regulators.
     > Some advisers… showcase only the years of their best results.

This echoes Eric Tyson’s article (Part 7).

     > Many advisers… do not believe the [performance] figures are
     > an accurate reflection of their client portfolios. That is
     > especially true of advisers who… must often work with some
     > assets clients already have… [such as] retirement plans that
     > offer poor fund choices or mediocre employer stock the client
     > wants to keep… Those investments can skew returns…
     > [rendering them meaningless] to potential [future] clients…

This is an interesting point with which I will eventually disagree.

Investment Management vs. Financial Planning (Part 2)

I wanted to discuss one other financial planning function that relates to investment management: acting as a “circuit breaker.”

I recently spoke with a financial adviser about how I might enter the investment management business. He invited me in for a free consultation. After explaining that I was a self-directed investor, he suggested I could still benefit from a financial adviser as someone to monitor my performance and act as a “circuit breaker.” I wasn’t completely clear what he meant.

This comment in response to Dr. Mark Perry’s July 2014 blog post explains:

     > I am not a financial advisor but I do investment research for
     > a company that services financial advisors.
     >
     > …full service advisors offer one value that Vanguard does
     > not. They provide a voice of reason to keep their client from
     > making foolish investment decisions… individual investors
     > that manage their own blended portfolio tend to do much
     > worse than any static blend of equities and bonds. The reason
     > for this disparity is because individual investors make emotion-
     > based investment decisions that destroys performance.
     >
     > During recessions, Vanguard will not contact clients to
     > alleviate their fears to stop panic selling, which prevents
     > investors from participating in the market recovery. Vanguard
     > won’t actively advise clients to stay away from the hot tech
     > mutual fund that rose 1000% from 1997 to 2000.

This review suggests that Vanguard advisers can serve this function (especially for clients with $500,000 or more). I would certainly think it to be in Vanguard’s best interest to keep clients invested since that is how they get paid.

     > During market extremes, the full service advisor can be the
     > voice of reason that keeps their investors invested in a
     > static mix of equities and bonds. Will this strategy beat the
     > S&P 500 or a blended index similar to the static mix? Most
     > likely not because of fees.
     >
     > However, as long as advisors keep their investors invested
     > in a strategic equity and bond mix, the advisors will likely
     > generate performance above what individual investors can do
     > on their own. It’s not hard especially since the hurdle is low.

I’m guessing many of the self-directed fall into the “buy-and-hold” category. These comments are quite apropos for them.

Ideally though, I think that even long-term, self-directed investors should have a trading plan. They should know when they will get into positions and when they will get out. “Prepare for war in a time of peace” is the saying that comes to mind.

For shorter-term investors who are trading for a living, I don’t think the “circuit breaker” function makes as much sense. I’d be skeptical about whether a financial adviser (planner) could help me unless s/he knew the details of my system and/or had studied it in detail. Also, anyone approaching trading as a business should understand how detrimental rash decisions based on fear and greed can be to performance. I think a stoic outlook is essential for survival.

     > I don’t believe advisors can truly help clients beat the market.
     > However, advisors can help investors beat themselves. From
     > that perspective, the fees are worth it.

Advisers are acting as coaches in the “circuit breaker” role. If they can’t help clients beat the market, though, then the clients’ best interests might be served by leaving investing out of the financial planning domain altogether.

Investment Management vs. Financial Planning (Part 1)

One other comment on Dr. Mark Perry’s July 2014 blog post addressed financial planning and investment management:

     > At the higher asset levels in particular, clients of the major
     > full service firms are likely to be serviced by teams, some of
     > whom may have CFAs, law degrees or other advanced degrees
     > and designations.

These are the investment managers and this is the first description I have seen of “people/entities like myself.” In lieu of my expensive pharmacy degree, I find “law degrees” to be interesting. I think both place heavy emphasis on critical thinking.

Contrast the above description with this excerpt from study.com on typical education for a financial advisor:

     > While there may be no official [education] requirements…
     > most employers prefer those who have a college education.
     > Some colleges and universities offer undergraduate and
     > graduate degree programs in financial advising. Degrees
     > in business, accounting or finance is also recommended…
     >
     > Coursework in financial advising programs often includes
     > investing tactics, retirement planning and insurance…

I would like to see a syllabus for the average investing course(s).

     > Certificate programs in financial advising are available for
     > those who already hold a degree. These programs are offered
     > online, on-campus or through professional workshops. Options
     > for financial advising certificate programs can include
     > risk management, tax planning and employee benefits.

The reader also listed other financial planning* activities. I like this better than my brief list:

1. Proactively calling when it’s a good time to refinance your mortgage(s), handling all the tax return information, paperwork, and seeing it through to closing
2. Specific-expense & cash flow financial planning
3. Assiduous year-round tax loss harvesting
4. Proactively coordinating 1099 delivery to your CPA at tax time
5. Complimentary review of trusts and estate structures by an on-staff attorney
6. Quarterly in-person performance review vs. global balanced benchmarks
7. Private equity capital-call liquidity planning
8. Review of life insurance products and applicability
9. Social security optimization
10. Retirement planning
11. Educating adult children about capital markets, investing, and capital preservation

I would want a colleague with related expertise to handle all but #6, perhaps. I think the investment manager is in a better position to discuss performance.

With regard to fees, Investopedia interviewed Arden Rodgers, financial advisor with Arbus Capital Management:

     > You may want to hire a financial advisor to manage investments…
     > [they] usually charge a percentage of your… AUM each year.
     > This… fee can vary based on a number of factors including the
     > expertise of the manager… the size of the firm… investment
     > strategy… amount of money you are investing [but] the typical
     > range of AUM fees for investment managers is 0.5% to 3.0%.

Once again, my 2% seems reasonable.

In summary, between investment managers, financial advisors, financial planners, and investment advisors (not to mention “advisers” or “advisors”—both of which are acceptable), the industry is somewhat of a mess. My brain wants to create some boundaries where none may really exist.

* As one further layer of complexity, “Financial advisor” is not necessarily the same thing as “financial planner” particularly
   when a professional has the Certified Financial Planner credential.

Comments on Performance and Fee Structure (Part 2)

Today I continue with discussion of some insightful comments to Dr. Mark Perry’s July 2014 blog post.

With regard to Tim’s Medley’s “baffling” comment, another reader writes:

     > That statement is an outright lie or he’s extremely obtuse. I
     > suspect the former. If anyone has worked in the financial
     > advisory business, the possible reasons should be fairly obvious.
     >
     > The most obvious reason is that clients accounts are often highly
     > customized to meet financial goals and specific needs. This means

I addressed the issue of SMAs here and here.

     > each client will have different levels of risk assets, defensive
     > assets, alternative investment exposures, socially responsible
     > investments, single stock holdings and etc. You should not create
     > a performance track record from a group of portfolios that all
     > unique. The numbers wouldn’t be a fair representation of the
     > performance of the financial advisor.

GIPS compliance is the way to track performance of SMAs. I think there must be some standardization but there’s plenty of wiggle room available and GIPS will track performance of all composites.

     > That being said, financial advisors are mostly salespeople,
     > who are better at schmoozing than investment analysis.

I’m clearly not the only one who has picked up on this.*

     > I would suspect that most performance would be terrible.
     > If you add up all the fees, which include advisory,
     > custodial, mutual fund, trading, and others fees, it
     > can be in the 2-3% range…

This makes me more confident that my fee would not be excessive if I can outperform. While I believe in the fairness of performance fees (see footnote and its referent here), as a pure management fee I would begin consideration with 2%.

     > Unless an advisor is a phenom (if [so then]… he/she
     > wouldn’t be an advisor), a client probably will probably
     > underperform the benchmark.

As mentioned in the Part 7 footnote, professionals capable of generating solid performance seem to be investment/portfolio managers rather than financial advisers. Legally speaking, though, they both fall under the IA(R) definition.

Another reader comments:

     > “The numbers wouldn’t be a fair representation of the
     > performance of the financial advisor”
     >
     > I agree. That would be like shopping for doctors by how
     > many patients did not die. I don’t know how much I would

I believe that while the composition of patients may differ, mortality is a meaningful statistic given a large sample size.

     > trust performance measurements that were not verified
     > by a third party such as Morningstar anyhow.

Reputable verification services are not cheap but should be regarded as well worth the cost for credibility.

I will continue next time.

* Also see here, here, here, and here.

Comments on Performance and Fee Structure (Part 1)

Today I continue discussing comments on Dr. Mark Perry’s July 2014 blog addressing the Jason Zweig post.

     > this gets badly exacerbated by the fact that commissions have
     > dropped like a rock. trading commissions are down maybe 90%
     > since the late 90’s…
     >
     > this has… driven… better advisers into other businesses (like
     > hedge funds… to get profit share, not trading commissions),
     > which has taken the cream (and then some) off this group…

Thereby “dumbing down” performance as a result of going cheap with investment expense?

     > if you get 3 times the fee for recommending an active fund and
     > 10 times for selling life insurance or annuities, the adviser
     > now has his incentives set up in opposition to his or her client.
     >
     > they sell you what’s profitable for them, not for you.

Isn’t the fiduciary standard supposed to prevent this? To be discussed at a later time…

     > so, the guys that are really good investors leave the business,
     > and the guys who are good salesmen stay but have incentives set
     > up opposite yours.

Here again is the idea that advisers* are salespeople rather than knowledgeable/experienced investors (mentioned here, here, and here).

     > this is a space one needs to be VERY careful with.
     >
     > most of the folks in it are not adding any value and would not be
     > paid to do so even if they could.

This is an interesting reference that echoes my previous discussion of how difficult it is to generate solid performance.

Another reader replied:

     > …Guiding clients into one of three or four risk categories and then
     > publishing the results of each category solves the tailoring problem.

I certainly agree that all clients do not need to be different. I will address this in another post.

     > Clients should not be self-directing. Company stock, large amounts of

I’m not sure why he would discourage self-directed investment activity. I encourage this for anyone looking to improve financial literacy while performing better than most of the “professionals” because with knowledge and experience I certainly believe they can.

     > cash for real estate, and other unique holdings can be segregated
     > into a holding account that is not included in the performance report.
     > Even brokers can charge flat fees now, so commission incentives should
     > be a thing of the past.

I agree. I also think the incentive to outperform run-of-the-mill robo-investors or passive index strategy approaches must be provided as something more than a bare-bones management fee to make these advanced efforts worthwhile.

* “Financial” or “investment,” which I think are used interchangeably even though the latter has a legal definition (and more
   appropriately refers to representatives rather than IAs themselves

Lack of Performance Reporting (Part 6)

In July 2014, Dr. Mark Perry wrote about the Jason Zweig blog entry I have been discussing. Dr. Perry is scholar at the American Enterprise Institute in Washington, D.C. Today I will discuss some reader comments in response to Perry’s post.

     > If routinely tracking and disclosing… [performance info]
     > was good for financial advisors it would already be happening.
     >
     > I agree with everything in this post except the idea that
     > this failure to disclose is baffling. Nothing baffling about
     > people acting in their own self-interest

That caught my eye, too.

Another reader claims to have experience with hedge funds:

     > …as a hedge fund you are not allowed to share your numbers
     > until you have a relationship with someone and believe them
     > to be… accredited… or… qualified… for me to post my
     > [performance] numbers on a public website or to send out a
     > mailer is illegal.
     >
     > of course, once i do have a relationship… we ALWAYS show
     > them our numbers. hell, we’re dying to.
     >
     > anyone who does not should be regarded with great suspicion.

I have written about how vendors/advisers exaggerate returns when marketing and advertising trading systems and strategies. Critical thinking is great for debunking such frauds.

On the other hand, though, if you genuinely had solid performance then why wouldn’t you advertise it?

     > this gets a lot more difficult for an RIA… as his or her
     > results are anything but uniform.
     >
     > such advisors tend to create bespoke products and portfolios
     > for their clients based on different goals.
     >
     > if you seek low risk capital protection or dividend income,
     > comparing you to someone who seeks… growth is… irrelevant.
     >
     > even among 2 investors with the same stated goals, the way
     > they go about it may be very different. one might want emerging
     > market and currency exposure, one might not.
     >
     > clients have idiosyncratic issues like big holdings in an employer…
     >
     > this creates a real problem in terms of demonstrating returns.
     > just which account is supposed to be the benchmark?

This is why I erroneously believed separately managed accounts could be exempt from performance reporting.

     > the flip side of that, of course, is cherry picking, something
     > that RIA’s and brokers are justifiably notorious for. they have

In a subsequent comment, another reader mentions GIPS compliance as a way to avoid this fallacy.

     > 200 accounts, they pick the best 3 and market based on them.
     > the results are not typical and may have even been driven by
     > something the RIA did not do.
     >
     > so, there is a real issue here around reporting even with the
     > best of intentions, and intentions in the advisory space are
     > often far from pure.

When he puts it that way, it sounds more like chicanery than a simple “fallacy.”

I will continue next time.

Lack of Performance Reporting (Part 5)

Today I continue discussion of a July 2014 blog post by Jason Zweig.

Zweig addresses how financial planning activities like tax reduction, estate and retirement, [life and long-term-care] insurance, debt management, and asset protection provide value. I alluded to this here and I wonder if a failure to separate these fees enables advisers to “go cheap” with the investment expense (as mentioned in a previous footnote).

Zweig continues:

     > [While financial planning] benefits often can’t be quantified… that
     > shouldn’t exempt advisers from reporting results that can be… like
     > investment returns.
     >
     > Even so, most financial advisers remain reluctant to calculate their
     > results. Jonathan Pond, president of Jonathan D. Pond LLC, a financial-
     > advisory firm… that manages approximately $230 million, says he
     > worries that the SEC would second-guess any such numbers, raising the
     > potential for regulatory reprimand [emphasis mine].
     >
     > “As a result, we absolutely do nothing as far as putting out performance
     > data,” he says. “It will be a cold day in Hades before we put that sort
     > of thing in a brochure.”

I find this shocking and very similar to a 2016 financial adviser discussion about not including inferential statistics in articles.

     > If a prospective client is curious about track record… Pond [says]
     > he will find two existing clients whose situations are comparable.
     > Then his staff prints out portfolio holdings for each, removes
     > the personal identifying information and sends the documents to the
     > prospective client—who is then free… to look up the past
     > performance of each holding separately online.

This sounds like a cheaper alternative to GIPS compliance.

     > Most investors probably won’t even go that far, says David Spaulding,
     > head of a firm… that measures investment performance. “In a relationship
     > business, many clients just say, ‘Why would I ask about numbers? This
     > guy clearly knows what he’s doing.’ So nobody brings it up.”

Salesmanship trumps performance. Put another way, rapport acts as a smokescreen.

With regard to SMAs, which I have mentioned in Parts 1 and 4, Zweig quotes David Fried of Fried Asset Management:

     > “If an adviser says that every client is different, then how can he
     > realistically be an expert on investing in all those different ways?”
     > Mr. Fried asks. “And if they aren’t all different, then the adviser
     > must have a few core strategies, and then the return for each of those
     > can be reported.”

This sounds like a powerful argument to me.

Zweig recommends anyone in the market for a financial adviser ask for a written performance record:

     > That shouldn’t be just the results of a single client, a cherry-picked
     > handful of lucky stock picks or market calls, or a short-term snapshot
     > that starts… at the beginning of an epic bull market.
     >
     > It should instead present a composite of how large numbers of clients’
     > portfolios fared over multiple time periods—say, the past one, three,
     > five and 10 years, after all fees…
     >
     > If enough clients start asking, advisers will have to apply the same
     > scrutiny to their own performance that they claim to apply to funds
     > and other investments.

Powerful argument indeed!

Barrier to Entry (Part 3)

Based mainly on performance and cost requirements, I perceive a high barrier to entry into the asset management (AM) arena whereas James Osborne of Bason Asset Management largely disagrees citing the ease of passing a licensing exam.

Osborne mentioned “holding oneself out as an IAR” whereas I discussed barrier to entry as an IA. He is talking about working as an employee of an IA firm and I am talking about establishing the IA firm.

Trump cards are available to melt away any barrier. For example, becoming an IAR may be even easier in the case of someone who has befriended an IA principal. Friendship can shortcut résumé and interview requirements. With regard to the IA, AUM and/or a strong ability to sell can shortcut the cost/performance barrier by minimizing expenses (as a %).

After all my exploration into hedge funds, IAs, and TPAMs, I have often been amazed that getting into AM could be as easy as spending the money to set up an entity. To me, this is a gamble I will not take because I fail to see the road to assets. Access to enough HNW individuals is all I really need to launch this business.

Requiring a more advanced credential like an MBA or CFA might be the only way to satisfy Osborne. I would argue that even these credentials do not focus on investing performance, which would be necessary to satisfy me. The MBA curriculum at some of the best business schools has one trading course and a second available as an elective.

Another explanation for our differing perceptions of barrier to entry could be the discussion of separate sub-industries. I think raising assets and the business of [minding] investing [performance] (e.g. first paragraph here) can (should?) be mutually exclusive as advisers in the former sub-industry often outsource to the latter.

I get the impression that most professional investing incorporates a plain-vanilla,* plug-and-play approach offered by many robo-advisers and large firms. These firms have marketing muscle and/or economies of scale capable of choking out new startups like me considering a higher fee structure to make efforts worthwhile. Once again, enough sales/marketing panache and/or the right connections would enable me to trump the barrier.

* I perceive the unfortunate consequence to this “dumbing down” of available options for non-accredited investors to be a
   lack of meaningful outperformance.