Hi Guys,
To quote President Bill Clinton. “I feel your pain.”
I was moved to write this post by Igno’ s palpable distress over the unseemly misbehavior of financial agents of various stripes. For the most part, he sees this huge cohort populated by unscrupulous highwaymen and undisciplined charlatans. Here is his posting on the matter:
http://www.mutualfundobserver.com/discussions-3/#/discussion/3376/exactly.
Igno draws some approximately accurate pictures, but he paints with too broad a brush. He condemns an entire industry because of some popular misunderstandings within that community, because of a few miscreants, and because of common everyday advertising puffery.
Bad stuff happens. Even as victims of these unhealthy practices, we should try to forgive bad advice if it is honestly offered. Admittedly, it is sometimes difficult to ferret-out the innocent advisor from the guilty or the incompetent one. But we do have resources to do so.
The flood of information accessible on the Internet to both professional and amateur investors alike makes this task doable. Our connectivity to these sources is unparalleled. However, since many of them are unverified, the reliability of each candidate source must be challenged by skeptical scrutiny. Aiding our task is the daily (for the day trader, the minute-by-minute) pricing of the global marketplace. It has never been simpler to keep score by comparing the hired-hand’s performance against a good benchmark.
Many members of the MFO family can help in this task and freely volunteer to do so.
Let me now address the specific issues that troubled Igno. He was angered by the tortured statement "Studies have shown that over the long-term it is not your individual investments that determine your investment results, but your investment allocation." In this instance, that quote was lifted from the SeekingAlpha website. The quote purportedly comes from the 1986 research paper “Determinants of Portfolio Performance” by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower. That paper is almost universally misunderstood and misquoted. The SeekingAlpha article just continued that legendary misrepresentation.
The Brinson paper focused on the monthly variability of institutional portfolio returns, not on their absolute returns. The paper reported that 93.6 % of the VARIABILITY in the returns could be coupled (correlated) to asset allocation. Other studies have made similar conclusions, although the specific percentage is not quite as high as the original Brinson finding. Some academics and industry researchers have contested the methodology in the original study.
William Jahnke is an often referenced critic. Here is a Link to his “The Asset Allocation Hoax” article:
http://www.norcal-ai.org/dwnld/2008-AssetAllocationHoax-Jahnke.pdfThe debate continues in detail, but the accumulated evidence is overwhelming. Asset allocation does directly influence absolute expected returns, and when properly deployed can control return variability. The Brinson research definitely did not conclude that it is highly likely that Warren Buffett and Jim Cramer would generate similar outcomes if they managed your portfolio. They would not.
Profits are a requisite target when assembling any venture. One of the guiding principles of any economic model is that there are no free lunches. In some way, you must always pay to play.
In a lottery, the charge is usually about 50 % pot retention for the lottery organizers. On a racetrack, the track operators withhold about 15 % of each race kiddy, about half for the State and about half for themselves. As John Bogle often says: the croupier must be paid.
The good news is that the marketplace is not a zero-sum game. Unlike the lottery, or the racetrack, or Las Vegas, all of which extract their fees so that the gamble payoff matrix reverts to a less than zero-sum game, the financial marketplaces have historically delivered positive outcomes even after fees have been extorted.
For any investment, it is very important to have a general sense of the potential payout matrix. Realistic expectations are mandatory when making asset allocation decisions. The key is to get some premium over annual inflation rates.
The historical database suggests that Money Market funds will generate about 0.5 % annually above inflation. Short term government bonds generate about a 0.75 % premium. Moving up the scale, longer term government bonds offer about a 3 % advantage, whereas high quality corporate bonds typically sweeten the payout by 4 % over inflation to accommodate increased risk. Large cap equities typically provide a 5 to 6 % premium, and small cap equities advance the expectations to perhaps 9 %. Historically, gold has merely traced inflation rates. Recognize that these are approximate values meant to illustrate an escalading returns scale as a function of risk.
Given the Gold recent ascendancy, this last historical statement demonstrates just how distorted annual returns can become, dependent on political, economic, and public sector sentiment factors. These distortions can persist for an extended period, but eventually there is a regression to the mean. Patience is a critical component when implementing any investment strategy. Overall, market return base rates must be recognized and acknowledged during portfolio construction.
All businesses are designed to be money machines. Las Vegas casinos are not in business to give away money. All aspects of their various branch operations are distinct profit centers. The same is true in the financial world. Financial consultants are no exception.
It is the clients duty to measure the contributions of their hired consultants against their costs. Cost/benefit analysis is an economic way of life. If a hired consultant disappoints relative to his promises, and/or misrepresents his performance record, fire the bastard. You are always free to choose.
I certainly agree that it is sometimes difficult to separate the wheat from the chaff. However, that too is your duty as the ultimate decision maker.
You must be particularly alert when doing the separation. I’m not certain, but it is likely that Oscar Wilde once remarked that some of us have a compulsion to complete the separation process fairly, and then inexplicably toss away the wheat.
I’m not sure of that last attribution, but this one definitely came from Oscar Wilde: “The salesman knows nothing of what he is selling save that he is charging a great deal too much for it.”
All literature and talking points originating from the vested-interest party must be interpreted skeptically. That’s a universal given. The source and the source’s motivates must always be assessed. I am currently rereading Edward Bernay’s frightening book, “Propaganda”.
Bernay is associated with being an early proponent for influencing public opinion using statistical analysis and psychological tools. He is credited with changing America’s breakfast habits to a ham and eggs society. His 1928 book is considered a classic, and supposedly served as a template for Joseph Goebbels Nazi propaganda agenda. The opening paragraph in the book is appalling in its scope and frankness. Here it is:
“THE conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country.”
Complete honesty and transparency is a rare commodity in the financial services community. Each entity is a slave to its own incentives. But if that entity understands the art of long term strategy, those incentives must reflect customer considerations. An informed customer knows how to keep score, and the servicing agency knows that he knows. To remain a viable business in the long haul, that agency must incorporate a client’s wealth wellbeing in their business model; otherwise it is doomed. So, there are some excellent money managers and financial organizations.
I suspect, with a few outstanding exceptions (like Bernie Madoff), most mutual fund operations do faithfully attempt to properly align the client’s portfolio with their goals. Unfortunately, given political, economic, and market uncertainties coupled to the vicissitudes of unreliable public sentiment that is all too prone to be stampeded by Bernays-like propaganda, these firms frequently fail to satisfy those goals.
Indeed, at times, I too share Igno’s pain and hurt. But that experience is an inherent part of investing. Skill matters, but luck happens.
Your comments are welcomed.
Best Regards.
