Ben Strubel, Strubel Investment Management
Charles Schwab recently released a survey of 201 brokers conducted late last year. While the survey was mainly centered around questions about brokers’ attitudes towards becoming an RIA or turning independent, I thought the survey highlighted a lot of good reasons why I believe the Spoke Fund® model I use truly is a superior way for clients to invest.
The most telling chart, I thought, was the one below. (Click to enlarge.)
More than 52% of brokers thought that corporate goals were taking priority over client goals and 38% thought that there was too much focus on selling special proprietary products.
The other interesting survey finding was that 79% of brokers found themselves having to explain more things in conversations with clients because of their connection to Wall Street firms. It’s no surprise that something like this is happening as Wall Street’s behavior has become increasingly egregious and the regulatory agencies are doing little to stop it. The never-ending stream of settlements over abuses tied to subprime mortgage products that were usually marketed to institutional investors are bad enough. But much of the bad behavior affects advisors’ clients as well. This recent settlement involving Morgan Stanley Smith Barney shows how the firm marked up corporate and municipal bond prices 3% to 8% over the market price when it sold them to clients (or marked down by 3% to 8% when it was buying them from clients).
Of course you may think your broker is watching out for you, but the survey shows that is not the case. While most brokers present themselves to clients as experts on managing investments, only one-third (or 34%) actually manage their client’s money. Most of the investment management work is simply outsourced to a third party (adding yet another layer of return-killing fees) or handled by the corporation for which they work.
It is surveys like these that show why I’m proud to be a Spoke Fund® manager and not a broker at a large Wall Street firm. My interests and my clients’ interests are aligned, and I can do what is best to manage their investments. More than that, unlike many advisors who work in the industry, Spoke Fund® managers are actually managing their clients’ money. Clients know who is ultimately responsible for investment decisions and that there are no hidden fees or hidden agendas.
“I suppose if I was to reflect on it…I would hope that out of all this would come a major change in the way the financial investment business in the U.S. operates – to go away from speculating and toward investment, which serves everybody but Wall Street. Wall Street is too big a part of the equation, and we need to get them out…[we need] funds you buy and hold that don’t get tempted by the machinations of the market. And so the big thing would be a slow, probably quiet revolution to return to the basics of what investing is all about.”
In the spirit of scarfing down that turkey you’re about to deep fry, here’s more indirect support for Spoke Funds® and the idea of eating your own cooking as a portfolio manager.
This comes from the 2006 working paper from the European Corporate Governance Institute titled Portfolio Manager Ownership and Fund Performance.
Highlight # 1:
For every basis point of managerial ownership, excess performance of the fund improves by about three to five basis points.
Highlight # 2:
Our evidence indicates that fund managers either have superior information about their future performance and/or that increased ownership in the fund improves a manager’s incentives to generate superior performance. We are unable to distinguish between these two interpretations, but both sets of arguments are equivalent from the perspective of the fund’s investors, in that they allow them to better predict future performance.
And check out these rationalizations for why mutual funds should not disclose how much their managers invest in their own funds…
Regulators in other countries and members of the U.S. fund industry have argued that the increased disclosure of fund manager ownership is not necessarily helpful. David Cliffe at the Financial Services Authority (an independent non-government agency in the U.K. that provides services to firms it regulates) stated in a Financial Times interview: “From a cost-benefit analysis, we just don’t see meaningful value for investors in requiring funds to disclose such information.”…
…Objections also came from large fund families such as Vanguard and Fidelity. Both publicly expressed their doubts regarding the impact of disclosing a fund manager’s personal stake in his own fund. For example, Fidelity spokeswoman Anne Crowley argued that “knowing a manager’s stake in a fund may tell potential investors whether the fund makes sense for the manager’s personal portfolio, but does not tell investors whether the fund fits into their own portfolio.”
Ah, yes. The ole “Why, investors can’t be trusted to handle that information, you fool!” defense.
It’s usually quickly followed by the “Investors should just trust us!” smile, and then the “Brokers who sell our funds could actually be making that determination about fit with their investors, but won’t” shoulder shrug.
I see your spin, Ms. Crowley, and raise you some sarcasm.
In any case, here’s the rest of the paper. And Happy Thanksgiving!
I wrote a post on my blog last week mentioning the highlights of the study below. I thought the entire study and data might be more useful for Spoke Fund® guys to see.
The study backs up the informal point I’ve made in prior posts here: that, all things being equal, ownership in your fund means better long-term performance. Here’s part of the conclusion (emphasis mine):
Regression analyses reveal that higher managerial ownership is positively associated with mutual fund returns and negatively related to fund turnover. Both findings are consistent with the reduction of the agency costs set forth in the Dow and Gorton (1997) model, where managers make value-reducing trades in lieu of making no trades when they cannot identify any suitable investments.
Investors should consider many variables when they choose to invest in mutual fund shares. The optimal fund choice for each individual depends on his goals, investment horizon, and risk profile. However, the results of this study suggest that investors of any tax status may need to add managerial ownership to the list of variables to consider when choosing a mutual fund investment.
Here’s the study itself:
More from Bruce Berkowitz on the same philosophy behind Spoke Funds® in this article (emphasis mine):
The advice I give to most investors is that…investing is not your profession. That at the end of the day, you’re going to have to trust someone. So there are four, five simple rules that we use, that Fairholme uses when evaluating companies’ managements I think investors should use.
You have to study the paper trail. So if you were looking at a mutual fund, you want to study the paper trail of the fund, especially during stressful periods. Don’t read what the fund is talking about now. Go back to before 1990, go back to 2006, ‘07, read what the fund had to say before a difficult period. See how the fund behaved during a very stressful period.
Now, talk is cheap. But when times get very tough, you see the true person. You see. It all comes out in tough times.
And also you want to make sure that whoever is managing your money has most of their family net worth in the same investments because if it’s going to be good enough for you, it better be good enough for them.
Read the entire interview here.
That’s a great quote from this article in BusinessWeek titled:
Fund Managers: Betting Their Own Money.
A Morningstar study shows that funds with manager investment may do better than their peers. But they remain a minority.
There are more than a few gems in the article, like this one:
More than half of the 4,383 U.S.-based funds in the 2009 study had no manager investment; 413 had investments of over $1 million. “It can be hard for younger managers who’ve just been promoted to invest more than $1 million in their funds,” says Laura Lutton, Morningstar’s editorial director of fund research. “But I have a hard time understanding why so many managers would not invest anything at all.”
Hmmmm….because they know their funds are crap, maybe?
And I suspect the absolute dollar amount a manager has in his fund is probably much less relevant to its future performance than the percentage of his liquid net worth that is in the fund. But I’m guessing that’s not data that will ever see the light of day.
Value investors appear to be over-represented in the study, which also mentions Davis Advisors as a shop that eats its own cooking, as well as closet spokester Bruce Berkowitz again.
Here are some other well-known names that are in it together with their investors:
Four years ago, Royce & Associates, a New York-based fund firm with $28 billion in assets, created a policy requiring lead portfolio managers to invest at least $1 million in their funds. Co-portfolio managers must invest $500,000 and assistant managers $250,000. “If you’re young and don’t have enough money, we will defer your quarterly bonus into the fund,” says Jack Fockler, Royce’s managing director. As a result, the firm’s 100 employees have $100 million invested in its funds.
Then there’s Southeastern Asset Management, parent of the three Longleaf Partners Funds. “If you work for Southeastern or your spouse works for Southeastern, you cannot own individual stocks or other non-Longleaf mutual funds,” says Lee Harper, a Southeastern spokesperson. Spouses of Southeastern employees who don’t have Longleaf funds in their companies’ 401(k) plans must get approval from an “exception committee” before participating. The firm’s 55 employees and its charitable foundation are the funds’ largest shareholders, collectively owning $1 billion in fund shares. The Longleaf Partners Fund has beaten 96% of its peers over the past 10 years.
Fund companies with heavy manager investment tend to be boutique firms. Yet at some big fund companies, including Janus, T. Rowe Price and Dodge & Cox, manager ownership is also part of the corporate culture. Janus in particular has long had a culture of ownership. Its 54 analysts and money managers have $113 million invested in its funds. Since 2005 the firm has paid half of fund manager/analyst bonuses in fund shares, and shares vest over four years. “The day I became manager of Janus Fund, I (JANSX) invested in excess of $1 million in it,” says Jonathan Coleman, Janus’ co-chief investment officer and co-manager of the firm’s $9 billion flagship Janus Fund. “We have a saying: ‘You don’t wash a rental car.’ We don’t treat portfolios as rental cars. We treat them as owners.”
This has nothing to do with Spoke Funds®, but everything to do with being an underdog. I’m an absolute sucker for these kinda clips. And this one is better than a shot of Cuban coffee when it comes to motivation on the longer days.
My favorite bit:
“The theory of evolution claims only the strong shall survive. Maybe so. Maybe so. But the theory of competition says just because they’re the strong doesn’t mean they can’t get their asses kicked.”
Now that’s what I’m talking about.
A few weeks back Joel Greenblatt was making the promo rounds for a new version of The Little Book that Beats the Market.
In this clip on CNBC, Andrew Sorkin of the NYT asks him what percentage of his own assets is invested in a Magic Formula fashion.
80% of his liquid assets are in quantitative strategies similar to the magic formula.
Buffett. Munger. Berkowitz. Greenblatt. All have the majority of their net worth at stake, right alongside their investors. Hmmmm. And who else am I missing?