Today is the four-year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Has it made our financial system fundamentally safer? Unclear. But one thing about the law is certain: It's forced the financial industry to get much more interested in individual investors.
Even today, a full four years after the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, it remains unclear whether this massive set of financial regulations has made our banking system fundamentally more stable. But one thing about the law is certain: It’s gotten the financial industry much more interested in individual investors.
How important have mom and pop become to the titans of capital? On Thursday Morgan Stanley reported second-quarter operating profits jumped by nearly half to $1.3 billion. The biggest contributor wasn’t the bank’s investment bankers or traders, but its army of 16,000 financial advisers working with Main Street clients. That didn’t happen by chance, either: Chief executive James Gorman, a former management consultant who took over the storied bank in the wake of the financial crisis, has made a point of made a point emphasizing relatively steady activities like wealth management.
That flies in the face of Wall Street tradition. Historically, so-called Masters of the Universe have earned their status advising on giant mergers or trading bonds, which were far sexier (and more profitable) than telling well-to-do lawyers and dentists which stocks to buy. Then the financial crisis hit. Hot-shot bond traders, who once seemed able to conjure millions from thin air, no longer looked so bright. Meanwhile, blockbuster corporate deals that investment bankers specialize in dried up. The economy has finally bounced back. But relatively calm financial markets combined with new regulations like higher capital requirements and the so-called Volcker rule have made it harder for Wall Street trading machines to regain their glory.
That’s given Main Street financial advisers new prestige. It’s not just Morgan Stanley. Big banking firms like UBS and Bank of America, which acquired Merrill Lynch in 2009, have been racing to poach – and keep – top advisers, offering signing bonuses and other perks, even as they’ve sometimes thinned ranks among bankers.
Of course, for you and me, the $10,000 question is not who’s top of the pecking order but whether advisers’ new stature will mean better treatment for small investors who, to put it mildly, haven’t always been the Street’s top priority.
In some ways, being a chief profit engine could be a curse more than a blessing. The more banks rely on small investors for profits, the harder they’re going to push to wring every last cent out of their customers. There’s some evidence of this already: While big banks used to be satisfied with handling clients’ investments, they’re now leaning on advisers to pitch fee-laden products like loans and credit cards.
The attention that banks give to individual clients hasn’t been evenly distributed, either. Wealthy clients tend to be more profitable. And banks have pushed advisers to focus on these, sometimes at the expense of middle-class investors.
But there’s hope too. On Wall Street profitability eventually becomes clout. Wealth management divisions traditionally haven’t had much. One of the most painful examples: During the financial crisis many small investors got burned after buying instruments known as auction-rate securities, which were supposed to offer the safety of cash but turned out to be illiquid during the crisis. One of the industry’s biggest stars – Smith Barney’s Sallie Krawcheck, then among the highest ranking women on Wall Street – pushed Citigroup to provide restitution to her division’s clients. Instead, she was shown the door. Maybe in the future that sort of thing won’t happen.
A bar in Kalamazoo, Michigan, takes the fun of happy hour to a whole new level.
The Beer Exchange has been going viral on Reddit and Imgur in the last day because its beer list resembles a stock ticker — or a Bloomberg Terminal that dispenses alcohol. It displays the current prices for various kinds of beer, and as demand for the different types ebbs and flows, the prices rise and fall. Once in a while, there’s even a market crash that brings the beverages to their all-time low.
It’s a happy hour all the time—as long as you’re interested in the right beer. But unlike stock trading, there’s no reward for buying low and selling high. Besides getting buzzed, that is.
When finance calls the shots, we all lose
It’s widely known that more than half of all corporate mergers and acquisitions end in failure. Like many marriages, they are often fraught with irreconcilable cultural and financial differences. Yet M&A activity was up sharply in 2013 and reached pre-recession levels this year. So why do companies keep at it? Because it’s an easy way to make a quick buck and please Wall Street. Increasingly, business is serving markets rather than markets serving business, as they were originally meant to do in our capitalist system.
For a particularly stark example, consider American pharmaceutical giant Pfizer’s recent bid to buy British drugmaker AstraZeneca. The deal made little strategic sense and would probably have destroyed thousands of jobs as well as slowed research at both companies. (Public outcry to that effect eventually helped scuttle the plan.) But it would have allowed Pfizer to shift its domicile to Britain, where companies pay less tax. That, in turn, would have boosted share prices in the short term, enriching the executives paid in stock and the bankers, lawyers and other financial intermediaries who stood to gain about half a billion dollars or so in fees from the deal.
Pfizer isn’t alone. Plenty of firms engage in such tax wizardry. This kind of short-term thinking is starting to dominate executive suites. Besides tax avoidance, Wall Street’s marching orders to corporate America include dividend payments and share buybacks, which sap long-term growth plans. It also demands ever more globalized supply chains, which make balance sheets look better by cutting costs but add complexity and risk. All of this hurts longer-term, more sustainable job and value creation. As a recent article on the topic by academic Gautam Mukunda in the Harvard Business Review noted, “The financial sector’s influence on management has become so powerful that a recent survey of chief financial officers showed that 78% would give up economic value and 55% would cancel a project with a positive net present value–that is, willingly harm their companies–to meet Wall Street’s targets and fulfill its desire for ‘smooth’ earnings.”
Some of this can be blamed on the sheer size of the financial sector. Many thought that the economic crisis and Great Recession would weaken the power of markets. In fact, it only strengthened finance’s grip on the economy. The largest banks are bigger than they were before the recession, while finance as a percentage of the economy is about the same size. Overall, the industry earns 30% of all corporate profit while creating just 6% of the country’s jobs. And financial institutions are still doing plenty of tricky things with our money. Legendary investor Warren Buffett recently told me he’s steering well clear of exposure to commercial securities like the complex derivatives being sliced and diced by major banks. He expects these “weapons of mass destruction” to cause problems for our economy again at some point.
There’s a less obvious but equally important way in which Wall Street distorts the economy: by defining “shareholder value” as short-term returns. If a CEO misses quarterly earnings by even a few cents per share, activist investors will push for that CEO to be fired. Yet the kinds of challenges companies face today–how to shift to entirely new digital business models, where to put operations when political risk is on the rise, how to anticipate the future costs of health, pensions and energy–are not quarterly problems. They are issues that will take years, if not decades, to resolve. Unfortunately, in a world in which the average holding period for a stock is about seven months, down from seven years four decades ago, CEOs grasp for the lowest-hanging fruit. They label tax-avoidance schemes as “strategic” and cut research and development in favor of sending those funds to investors in the form of share buybacks.
All of this will put American firms at a distinct disadvantage against global competitors with long-term mind-sets. McKinsey Global Institute data shows that between now and 2025, 7 out of 10 of the largest global firms are likely to come from emerging markets, and most will be family-owned businesses not beholden to the markets. Of course, there’s plenty we could do policy-wise to force companies and markets to think longer term–from corporate tax reform to bans on high-speed trading to shifts in corporate compensation. But just as Wall Street has captured corporate America, so has it captured Washington. Few mainstream politicians on either side of the aisle have much interest in fixing things, since they get so much of their financial backing from the Street. Unfortunately for them, the fringes of their parties–and voters–do care.
The Crumbs cupcake shop in my neighborhood just shut down. It’s a sad day for the entire sugar industry: Crumbs, a once-growing collection of shops with visions of becoming a national bakery chain, abruptly folded its 65-store operation in 12 states, putting hundreds of people out of work. The company had been delisted from NASDAQ last week, its stock trading for pennies from a high near $14. Sales were falling, Crumbs was losing money and unlikely to become profitable anytime soon. As of its last quarterly filing, the company had just $300,000 in cash on hand, and its liabilities included $244,000 in gift cards outstanding. Hope you didn’t own any of them. Crumbs lost $5 million in its last quarter.
Was Crumbs a victim of Americans turning toward eating healthier, especially among children, as the First Lady has encouraged? Fat chance. We are as plump and pleased as ever, and our appetite for donuts, cronuts, deep-fried Oreos and Baconators will not be reposing anytime soon. Long live junk food, if maybe not us.
But you could see this one crumbing long before it happened. Crumbs made good cupcakes—one of those sweet bombs could keep an 8-year old wired for about three days—but its failure isn’t so much about the product so much as the way Wall Street works to bake new companies. The recipe almost guarantees trouble in the future for many firms. Crumbs joins the long list of once hot food franchises that couldn’t resist the smell of growth and ultimately had difficulty managing it: David’s Cookies, Krispy Kreme, Einstein Bagels, World Coffee, just to name a few. They can survive, but generally after massive restructuring. Crumbs ran out of time and money.
The pattern is similar: a good product or idea becomes increasingly popular, and investors get moon-eyed about the prospects. At the same time, other operators and investors will swear to you that there’s plenty of room for more than one brand—or that if there isn’t much room, their concept is superior.
In the mid-90s, it was the humble bagel’s turn for the national spotlight. The players included Bruegger’s Bagel Bakery, Einstein Bros. Bagels, Chesapeake Bagel Bakery, Manhattan Bagel, Noah’s New York Bagels, Big Apple Bagels and the Great American Bagel among others. Several of them went public, which funded overexpansion. They dreamed big. “What happened to the pizza in the ’40s and ’50s is happening to the bagel today,” said the ceo of Manhattan Bagel at the time. “Soon there will be bagel shops on every street corner.” Except in Manhattan, where there are no Manhattan Bagel shops. Einstein, Noah, Chesapeake and Manhattan would eventually become part of one company, as the craze subsided and the industry consolidated. Then it was doughnuts. Krispy Kreme also got creamed by massive overexpansion funded by its very popular IPO. Even in the U.S., we can only eat so many doughnuts.
Cupcakes are now repeating the pattern, with predictable results. In the cupcake game, Crumbs competitors include Magnolia Bakery, Sprinkles, and any number of hipster-preneurs in major cities not to mention the likes of Duncan Donuts and Starbucks, which flanked the cupcake shops with offerings of their own. If cupcakes were that hard to make, your mom wouldn’t have churned them out on demand.
Why isn’t there more caution? Because that’s not Wall Street’s real concern. The investment industry’s mission is to throw money at enough startups—from cupcakes to social media—and hope to land on a winner. Failure is built in, the only question being who is going to take the losses. A lot of time it’s overeager shareholders who pile in these stocks because all they see is unlimited growth. In food, the best case scenario is Starbucks, whose original store still operates on Pike Street in Seattle along with thousands of others around the world. An IPO allowed Starbucks to enjoy rapid growth and made a lot of investors rich. But part of Starbucks strategy was to be capitalized enough to blow other rivals out of the water by grabbing the best locations. That left everyone else to scramble to remain competitive—and why there’s really no No. 2 in premium coffee.
Fortunately, the U.S. is not going to run out of cupcakes anytime soon. This is basically a mom and pop business that is still best run by mom and pop. Cupcakes may have had their run for now, but investors are always going to be hungry to find the next new food style to fund. And grilled cheese is waiting in the (chicken) wings.
Jamie Dimon told employees the disease is “curable”+ READ ARTICLE
Investment banking firm JP Morgan’s CEO Jamie Dimon told staff Tuesday that he has throat cancer.
“The good news is that the prognosis from my doctors is excellent, the cancer was caught quickly, and my condition is curable,” Dimon, CEO of the bank since 2005, said in a note to staff.
Dimon said the disease will require about eight weeks of radiation and chemotherapy treatment, CNBC reports.
“I feel very good now and will let all of you know if my health situation changes,” he said.
Dimon steered JP Morgan through the financial crisis but met with controversy after the bank was involved in a scandal in 2012, leading to billions of dollars in losses and calls for Dimon’s ouster. The notoriously blunt bank chairman was criticized for calling the fiasco a “tempest in a teapot.”
According to a new study, nearly 25 percent of all public company deals involve some insider trading.
Argentina, the Obama Administration and a host of international financial and humanitarian organizations got a load of bad news Monday from the U.S. Supreme Court. But hedge funds and other investors that specialize in risky international bonds could not be more pleased.
After a 13-year international legal battle that seemed, at times, to borrow its narrative from daytime soap operas, the Court made two decisions Monday morning that will change the way countries borrow and service their national debts. The Supreme Court first declined to hear two cases, choosing instead to leave intact lower court decisions requiring Argentina to pay back all of its bondholders—even those that refused the country’s offers to restructure their debt. The lower court decisions said Argentina was obliged to treat all of its investors equally, even if doing so would force the South American nation to default or sell off military equipment or other vital assets.
The Court then handed down a decision on a new case, Republic of Argentina vs. NML Capital, Ltd, in which a hedge fund and other investors who were owed $2.5 billion in damages demanded that certain banks disclose information about Argentina’s global assets. The Court backed the hedge funds, saying it was perfectly legal for them to subpoena financial institutions, including Bank of America, for information about Argentina’s assets in an effort to help investors get repaid. Assets belonging to foreign countries that fall outside of U.S. borders are still fair game, the Court said.
While all three cases are mired in reams of wonky international finance law, the bottom line is a huge win for hedge funds and other financial firms. The Court decided that when investors buy up foreign countries’ risky (or “distressed”) bonds, they can demand repayment at the same rate as all other bondholders, and seek repayment through all national assets, no matter where those assets are located.
The Obama Administration and many international finance groups think this is a very bad idea. They argue it upsets the delicate balance of foreign countries’ borrowing, threatens international credit markets, and creates incentives for investors to resist the debt-restructuring process, which is vital for many developing countries struggling to provide basic services for their citizens. They say investors no longer have a good reason to agree to less favorable terms in a debt-restructuring deal since doing so does not increase the probability that they will be paid back.
Humanitarian and religious organizations like Jubilee USA said the decision will have the effect of forcing impoverished countries to pay hedge funds rather than use their scarce resources to rebuild domestic social programs or otherwise serve their citizens.
In the lower court cases, which the Supreme Court declined to hear, Argentina’s lawyers described the hedge funds as “vultures” seeking repayment on debt they originally bought at heavy discounts during one of the country’s many economic collapses. They warned the Court that requiring the country to repay all of its bondholders equally “could trigger a renewed economic catastrophe with severe consequences for millions of ordinary Argentine citizens.” They also argued that Argentina would have to sell some of its military equipment to finance the debt, so the court’s decision could have the effect of weakening its military defense.
Both cases attempted to define the scope and limits of Argentina’s obligation to its bondholders, which hinged on two guarantees: that all Argentinian bonds would get “equal treatment,” and that investors’ rights apply equally to everyone. Argentina argued that the “equal treatment” guarantee didn’t apply to everyone to whom it owned money, but to everyone within the same bracket, so to speak. In other words, everyone who had agreed to restructure their investments in 2005 and 2010 would be repaid at the same rate, while those who had refused to refinance would be paid back at the same rate. (In 2001, Argentina announced they would not paid back at all.)
A New York federal court, and later the U.S. Court of Appeals in the Second Circuit, didn’t buy it. Both courts decided Argentina had violated the “equal treatment” guarantee by paying back some of its debtors but not all of them. By deciding not to hear those cases, the Supreme Court allowed those lower court decisions to stand.
In Argentina v. NML Capital, Justice Antonin Scalia wrote for the majority in a 7-1 decision that the Foreign Sovereign Immunities Act (FSIA), which governs such transactions, does not protect foreign countries’ non-U.S. assets from seizure by U.S. firms, where a court has granted their right to repayment. In previous cases, Argentina argued that FSIA only applied to assets in the U.S. Justice Ruth Bader Ginsburg dissented and Justice Sotomayor recused herself.
In her dissent, Justice Ginsburg lambasted the idea that a U.S. court would allow a group of U.S. investors “unconstrained access to Argentina’s assets.”
A new group of funds that claim to outperform the broad market while taking less risk are worth exploring—if you're willing to look under the hood.
Ever since the dot-com crash more than a decade ago, Wall Street and the mutual fund industry have been on a relentless push to plug what they are now calling “smart” beta strategies. These funds promise reasonable returns with lower risk through a variety of techniques.
But pursuing a smart-beta strategy isn’t as simple as just buying a fund with that name and thinking it will outperform conventional index funds. There’s always a trade-off in costs, risk and return, so you need to dig much deeper to get beyond simplistic marketing pitches.
For example, let’s say you were seeking an alternative strategy to traditional S&P 500 index funds that weight the holdings in their portfolios by market valuation.
In such traditional “cap-weighted” S&P 500 funds, the top holdings would be Apple at about 3% of the portfolio, followed by ExxonMobil at 2.6% and Microsoft MICROSOFT CORP. MSFT -0.1933% at just under 2%. Every other stock in the portfolio would represent a slightly lower percentage of the total holdings.
The idea behind cap-weighting is that the biggest U.S. stocks by popularity ought to represent the largest portions of a broad-market portfolio. This is what economist John Maynard Keynes called a “beauty contest,” with investors bidding up the prices of the most glamorous stocks. The downside is that these companies may be overpriced and may not have as much room to grow as other, bargain-priced stocks.
One alternative in the smart beta fund category is a so-called equal-weighted stock index fund such as the Guggenheim S&P 500 Equal-weight ETF RYDEX ETF TR GUGGENHEM S&P500 EQUAL WEIG RSP -0.4691% , which holds the same stocks as the S&P Index, only in equal proportions. This design somewhat side-steps the overpricing issue because it’s less exposed to beauty contestants, especially when they falter a bit.
To date, both the long- and short-term performance of the equal-weighted strategy has been better than cap-weighted index funds. The Guggenheim fund has beaten the S&P 500 index over the past three, five and 10 years. With an annualized return of 9.7% over the past decade through June 6, it’s topped the S&P index by more than two percentage points over that period. But it costs 0.40% in annual expenses, compared with 0.09% for the SPDR S&P 500 Index ETF.
Once you start to ignore the beauty pageant for stocks, is there an even “smarter beta” strategy?
What if you picked the best stocks based on a combination of value, sales, cash flow and dividends? You might find even more bargains in this pool of companies. They’d have strong fundamentals and might be more consistently profitable over time.
One leading “fundamentally weighted” portfolio, which also resides under the smart beta umbrella, is the PowerShares FTSE RAFI US 1000 ETF POWERSHARES EXCHAN FTSE RAFI US 1000 PORTFOLIO PRF -0.3929% , which also has outperformed the S&P 500 by about two percentage points over the past five years with an annualized return of 20 percent through June 6. It costs 0.39% annually for management expenses.
The PowerShares fund owns some of the most-popular S&P Index stocks like Exxon Mobil, Chevron CHEVRON CORP. CVX -0.6154% and AT&T AT&T INC. T 2.6367% , only in much different proportions relative to the cap-weighted indexes. The RAFI approach focuses more on cash, dividends and finding undervalued companies, so it’s not necessarily looking for the most-popular stocks.
Although looking at the rear-view mirror for index-beating returns seems to make equal- and fundamental-weighted strategies appear promising long term, you also have to look at internal expenses to see which strategy might have the edge.
Turnover, or the percentage of the portfolio that’s bought and sold in a year, is worth gauging in both funds. Generally, the higher the turnover, the more costly the fund is to run. That eats into your total return. The PowerShares fund has the advantage here with an annual turnover of 13%, compared to 37% for the Guggenheim fund.
Over the long term, “fundamentally weighted smart beta strategies are likely to outperform the equal weighted approach,” note Engin Kose and Max Moroz with Research Affiliates, a financial research company based in Newport Beach, California, which largely developed the concept of fundamental weighting and is behind RAFI-named indexes.
But just considering costs doesn’t end the debate on equal- and fundamentally weighted funds. While they may be higher-performing than most U.S. stock index funds over time, they are not immune from downturns. Both lost more than the S&P 500 in 2008 and 2011.
While it may be difficult to predict how these funds will perform in a flat economy or a sell-off, they are worth considering to replace your core stock holdings, and may be the wisest choices among the smarter strategies.
Mutual funds that mimic hedge funds are Wall Street's hot new thing. Too bad they hedge away your best shot at returns.
So-called liquid alternative funds are the latest product Wall Street is pushing on retail investors. In 2013, about $40 billion of new investments flowed into the funds, up from $13 billion the previous year. The funds employ the kinds of strategies used by hedge funds, the less-regulated portfolios reserved for institutions and high-net worth investors. For example, in addition to owning investments outright, they’ll go “short”—that is, bet on stocks or market indexes to go down.
Hedge funds have benefited from the mystique of exclusivity, and for a while boasted pretty great returns. Lately, though, their returns aren’t all that impressive compared with what you can make just owning an S&P 500 index fund.
And mutual funds that mimic these strategies haven’t exactly shot the lights out either. For instance, the average market neutral fund, which seeks to deliver gains in both good and lousy markets, has returned only around 2% a year over the past five years, according to Morningstar. That’s about a tenth of the gains of the broad market during that time.
Financial sophisticates will call that an unfair comparison. Fine. But there’s a reason besides performance to give clever-sounding hedge-like strategies a pass.
Consider this deal: I’ll sell you this very nice antique vase. And I’ll let you in on a secret, too. A magic fairy lives inside the vase, and will grant the owner a wish.
You do not really believe in magic fairies. But you might still buy the vase at the right price, because, hey, it’s a nice vase. And if there’s a chance about the fairy…
When you buy a regular stock fund, you’re buying the vase. Most of what you get is the market’s return. When the market goes up, most funds make money. And when the market goes down, most funds go down. Managers try to add a bit of performance on top, by making smarter picks than the competition. But for the most part, if you know how the S&P 500 did this year, you can make a pretty good guess about how your fund did. Even if your manager isn’t all that skilled, you can still do okay so long as the market rises.
Buying a hedge fund, on the other hand, is like paying for the magic fairy without getting the vase.
The classic hedge strategy tries to eliminate or reduce the market factor. There are lots of ways to do this, including chasing illiquid assets or hopping among wildly different asset classes. In a long-short or market-neutral strategy, a manager might look at Apple and Microsoft and decide that Apple is a relatively better investment than Microsoft. By buying Apple and “shorting” Microsoft, the manager can in theory make money in both rising and falling markets, as long as Apple falls less than Microsoft in a down market, and rises more than Microsoft in an up market. (Many hedge strategies are head-spinningly more complex than this, but this captures the rough idea.) Investing in a hedge fund might reduce your market risk, but in return it bets more heavily on the manager’s investment-picking skill.
Skilled managers aren’t as elusive as magical fairies, but for practical purposes they may as well be. After fees, the vast majority of regular mutual funds don’t beat their benchmark indexes. The reason is simple: Almost by definition, the average money manager must deliver the market’s average, minus fees. Though some managers do outperform over time, it’s hard to tell which ones were lucky and which ones have a skill that will persist over time.
It might be that managers of real hedge funds, who have some control over when money comes into and out of their funds, can use the extra flexibility they have to find an edge. But it is doubtful that in the world of mutual funds, which must be able to hand investors their cash back on any given day, that there is a special secret pool of skilled managers who only work for funds where shorting and leverage and other exotic tactics are allowed.