Inside the Vault

HSW Advisors' Jordan Waxman is in his 20th year as a private wealth advisor. He is an attorney, an MBA, Accredited Investment Fiduciary® Designee, Certified Financial PlannerTM, Certified Investment Strategist® and Certified Investment Management Analyst®.


He has advised substantial families, company founders, CEO's, endowments, foundations and pension plans on all manner of offshore and onshore planning, securities and investment matters. He co-teaches Investments at McGill University and is a Member of the Board of Directors of HighTower, the largest advisor-owned independent private wealth management firm in the US.


Inside the Vault is a blog that will clarify and illuminate all aspects of private wealth management and investments. Jordan will describe the inner-workings of the investment world, highlighting inherent risks, opportunities and potential conflicts of interest.


Please contact Jordan Waxman at 212-286-1173 or jwaxman@hightoweradvisors.com. Twitter: @hswadvisors

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  • Reading the Signs

    Thursday, July 24, 2014

    Image: Randy Glasbergen

    Image: Randy Glasbergen

     

    The first non-textbook on investing I ever read was One Up on Wall Street by Peter Lynch.  In it, the former Fidelity fund manager detailed his homespun rules of investing.  One I remember, and follow to this day, is that when people line up to enter a store and the merchandise is at full price, versus on sale, it usually augers well for the retailer.  As a father of three, I more than seldom find myself in shopping malls, and as a habit, walk in and out of retailers to put the discipline to the test.  Even with the growth of online sales, the boots-on-the-ground research is often spot on.

    In 2008 and 2009, business activity was reeling from the recession.  Restaurants were half full at lunch and dinner, and airports were sparse.  Now that many of the large airlines have had their debts forgiven and merged with other carriers, ticket prices are higher than ever and service at its low-point.  Since that time, global equities have returned about 20% per year, twice the long-term average.

    A few weeks ago I took my teenage daughter, Lily, on a trip to Italy.  45 minutes outside of Florence is a designer outlet mall, in which the highest fashion brands have elegant stores with this season’s new wares.  The mall was full of tourists, mostly from Asia and Russia, who arrived in cars and buses to shop for Milan-designed pocketbooks, clothes, shoes and accessories.  Some of the stores queued the shoppers to control store traffic.

    On my last trip to Slovakia, I noticed that Business Class was full, as were the airport lounges in Austria and Germany, the restaurants and bars.  In Paris, velvet ropes made the stores in the Galleries Lafayette seem like nightclubs and in London, businessmen packed the Wolseley until 10:30 a.m.

    These observations are all to say that in the developed world, business is booming, and people from the entire world, including the emerging markets are spending capital on luxury goods, whether real estate in Manhattan or London, or Prada bags in Florence.

    Given how low global interest rates and inflation are, the fact that there are more consumers who are spending on goods, services and travel is a bullish sign for the equity markets.  In addition to the fact that companies can grow their profits with inexpensive cost of capital, investors are living longer (needing more growth in their portfolios), companies are buying back their shares (boosting stock prices and earnings per share) or finding companies with which to merge (thus sucking the supply of stock from the market).

    So, the question on many people’s minds is “When does the bull market end?”  Usually bull markets end when the market goes up on bad economic and corporate news.  That is a signal that the majority of investors are bullish, believing the market cannot go down.  That is not the case today.  The market is split between bulls and bears, according to most surveys.

    Bear markets also tend to start when valuations are excessive.  The price to earnings ratio of the broad market is often cited, and today it is elevated but not excessive.

    In addition, companies discount their future earnings stream by their cost of capital, which in turn is influenced by interest rates generally, credit spreads and inflation.  These latter elements are quite low today, and firms have more financial flexibility (cash) than ever before, cautious about embarking on a hiring spree for fear of the next downturn.  This means corporations can withstand shocks and engineer profit growth amid the economic recovery.

    Despite my observations on global commerce, the recovery itself is muted but consistently positive.  Economists postulated that the reason the US GDP showed contraction in the First Quarter of 2014 was due to the Polar Vortex – an unseasonably cold winter across parts of the globe.  If ice and snow can keep folks from getting higher wages and buying homes (labor and housing are the driving forces in the US economy), then we are probably far from having inflation and high interest rates spoil the stock market rally.

    Investing is both art and science.  We consider qualitative and quantitative factors of each solution in sync with the investor’s needs for liquidity, income, safety and growth.  However, the degree to which we emphasize any particular asset class or investment is heavily influenced by our future outlook.  We look for direction from current economic readings, but often, like in the case of the contraction in First Quarter 2014 GDP, contrasted with over 200,000 new non-farm jobs created in each of the first five months of 2014, the data is contradictory.  It is then that boots-on-the-ground scent-smelling helps us better read the signs.

  • Too Slick to Jail?

    Thursday, May 29, 2014

    Image: Caglecartoon.com

    Image: caglecartoon.com

     

    I tell my teenage children, who are starting to plan for the future, “If you are lucky enough to do what you love and love what you do, and you work very hard, you will be happy and successful.”  It took me a long while to find my calling (I tell people I was on the 10 year university plan), but Private Wealth Management has been my first and only career, one that has been changing, exciting and challenging.

    I was interested in finance and economics from an early stage, and during Law School, my buddy Phil and I waited each day to buy the only two copies of the New York Times at the kiosk and flip right to the Business Section.  As we studied in Montreal, there was no Wall Street Journal and it was 1987 – before the internet took hold.

    Two seminal events stuck with me from that era and shaped our respective paths, at least for a while:  the Leveraged Buyout of RJR Nabisco (subject of the must-read book, Barbarians at the Gate) and the successful prosecution of gangster, Manuel Noriega.  Phil was intrigued by the LBO and he has gone on to succeed as an M&A attorney, investment banker and now partner in a prominent asset management firm.  Having studied the Lost Generation and the history of American gangters in college, and bank secrecy, criminal procedure and securities regulation in law school, I could not get enough of the capture and trial of “Pineapple Face” Noriega.

    My dream was to become a white-collar criminal prosecutor, pursuing bank, securities and wire fraudsters.  To this day, having dinner in Miami with Miles Malman, the District Attorney who won Noriega’s conviction on tax evasion—a modern day Al Capone story—was one of my most cherished memories.  Having him sign a copy of his final summation was like having Derek Jeter sign his rookie card.  I was a giddy law geek and did not care!

    Here we are, 22 years after graduating, and the US Attorney General, Eric Holder, is talking tough about a new breed of modern day rogues–large banks.  Holder said recently that he is personally overseeing major financial institutions and that his department is on the verge of laying criminal prosecutions.

    While that may sound like a shark with big teeth, lurking beneath the surface, to date, there has been little bite –virtually no arrests, let alone incarcerations.  According to prosecutors, the goals in bringing criminal charges are threefold:  forcing structural changes, punishing bad behavior and pursuing individuals. In fact, deferred prosecution agreements prevail, where companies promise to reform and pay large fines in lieu of a guilty plea.

    First, let us look at the crimes.  I say “crimes” and not “alleged crimes”, as the banks have admitted liability.  Acknowledged acts include abetting tax evasion, money laundering, price fixing and bribery, to name a few.  The same firms bend the rules as well, inflating the price of commodities and colluding on interest rates.

    The punishment for individuals engaged in such activities would likely be imprisonment.  Most insiders who are caught trading on insider information go to jail.  These other crimes similarly create illegal profits, and should be prosecuted and sentenced the same way.

    In reality, these firms have “gotten away with” paying fines to various government departments without anyone serving jail time.  And who pays the fines? Not the execs, but the shareholders.  Considering that the role of these institutions is to safeguard deposits and investor capital, provide credit, advice and smooth capital markets, you would think execs would be prosecuted, fired and ostracized.

    Ironically, a large firm recently admitted having miscalculated the way securities are valued on its balance sheet, wiping out $4 Billion from its reserves, squelching it ability to raise its dividend and buy back stock, and causing the stock to decline 8% over the next few trading days.  My first thought was, “Isn’t the very definition of a financial services firm one that is made up of people who know finance?” Since the CEO’s pay was increased substantially in 2013 based on the firm’s alleged vigor and “growing” reserves, my second thought was, “The CEO should take a pay cut for sure or the CFO should be fired.”  I was wrong on all counts:  at the shareholder meeting a week after the admission, shareholders gave the CEO and CFO a pass and raised CEO pay by 17% to $14 million.

    Recently I served jury duty in New Jersey.  During the selection process for a personal injury case, prospective jurors were asked, “Do you know what tort reform is?”  I was a bit surprised that almost none of my peers knew what it was and I wondered if they did would they be in favor or opposed.  You can imagine that by not knowing, they were much more attractive jury candidates for the case! I was not.  I told the attorneys and judge that in addition to being an attorney, I know full well what tort reform is.  The judge asked me if I was for or against.  When I resoundingly answered in favor, I was nicely excused from the case.

    I bring this up because while there is pressure on the DOJ to bring criminal prosecutions on financial services firms, it seems the public and shareholders are complacent.  Laws are written to create social order, protect the rights and freedoms of citizens, promote justice and deter crime.  It stands to reason then that breaking laws harms society as a whole.  Trillions of dollars, millions of jobs, lives and families were lost and destroyed by greed and crime leading up to, during and after the credit crisis.  Stylizing deviant acts in Scorsese’s The Wolf of Wall Street does not begin to cure the loathsome behavior of the perpetrators, so either the government is toothless, or perhaps unmotivated.

    In the end, deferred prosecutions are the Malibu rehab of Wall Street: a well-intentioned but naïve form of tough love.  In order to cure the addiction to greed, nothing promotes cold turkey like the unpromising clink of prison bars.

  • If You Can’t Do the Time, Just Pay the Fine

    Thursday, February 20, 2014

    Inside the Vault Jordan Waxman Blog

    Image: Randy Glasbergen

     

    Imagine you park your car every day in front of a “No Parking” sign, amassing tens of thousands of fines, payable to the local municipality.  Imagine after paying these enormous penalties for your admitted wrongdoing that you ask your accountant to deduct them from your taxable income, thereby lowering the amount of tax you owe the government.  Sound ludicrous?  Of course.

    Now imagine you are a large financial institution that avoided its risk management, anti-money laundering, regulatory and administrative duties and paid individuals, the government and its agencies over $20 billion in 2013.  So egregious were these violations that the government still may levy criminal sanctions.  Should the bank be able to write off the fines against taxable income, as a “cost of doing business?”  Ironically, it can, and it is making some Congressmen and plenty in the financial services industry burning mad.

    In late October 2013, reps Gutierrez (D-IL) and Welch (D-VT) re-introduced H.R. 3445, aka the Stop Deducting Damages Act of 2013 and sent it to the House Ways and Means Committee for consideration.  The bill’s purpose is “To amend the Internal Revenue Code of 1986 to disallow deductions for the payment of compensatory and punitive damages to a government, and for other purposes.”

    This was the second try for Mr. Welch, having amended an earlier version of the bill.  These irked Congressmen were livid that a certain “too big to fail” institution, which helped Bernie Madoff move $150 Billion through its coffers over decades, would be able to lower its corporate taxes.  This double standard is effectively double whacking the taxpayers by first helping to create the worst economic depression in history and then getting a tax break for ‘fessing up’ to it.

    The bank CEO’s pay package was raised a mere 74% in 2013, approved by the Chairman, who some time ago negotiated his own $400 million retirement package from a Fortune 100 company.  The government no longer controls most financial institutions’ executive compensation, so that issue remains up to shareholders to address.  However, as long as the economy gradually improves, interest rates and stock prices tick higher and the fines are viewed as a cost of doing business, what can shareholders expect to accomplish?

    Regulation has increased and yet the malfeasance continues.  What H.R. 3445 needs is a little bipartisan support and much more power behind the message.  For now, on Wall Street, if you can’t do the time, just pay the fine.

  • If it Quacks like a Duck

    Monday, January 13, 2014

    Jordan Waxman Blog

    Image: Leo Cullum

     

    The other day I asked my partner, Rich – a former Research Analyst — the following hypothetical:  if I found a company that was the darling of many storied investors, and that company made, say, pain relievers, bandages and candy…and it was discovered that the management failed to notice, or was complicit in the act of ignoring the FDA’s rules around the safety of the pain reliever, made bandages with cheap dissolving glue and candy with toxic ingredients…and paid tens of billions of dollars in fines and penalties for that bad behavior…would you say this was good management or bad management?  Would you ever work for that company or invest in it?

    These were rhetorical questions, of course, but Rich gave me an incredulous look and said emphatically, “Not a chance!”

    For the past five years, since the fall of Lehman Brothers, the SEC, FINRA and the Department of Justice, in addition to State regulators and Attorneys General, have been suing for and recovering hefty sums from financial services firms.  It seems the practices that led to an overextension of easy credit and a bubble in housing markets, followed by the implosion of credit and stock markets were promulgated and accelerated by these firms.  They hyperactively leveraged, lent and securitized assets to grow profits, disregarding proper standards and procedures.  Simply put, they wronged investors, clients, taxpayers and society.

    One would think that after frenetically gearing up, lending and securitizing assets to grow profits, disregarding proper standards and procedures, the financial services firms at the heart of the recent credit crisis would shape up.  After all, they harmed investors, clients, taxpayers and society and have paid massive fines for their wrongdoings.  However, even after receiving government bailouts and favorable resolution of liabilities, the shenanigans continue.  For example, one of the largest “Too Big to Fail” institutions claim it was hedging its own risk while its traders racked up enormous risk, resulting in a $6 billion loss.  See my blog:  “Institutional Trading—The Whale and the Sharks.”

    This same firm recently agreed to pay the government a penalty of $920 million and another of $13 billion and admitted they broke laws.  The smaller probe into the bank accused it of “unsafe banking practices, misstating financial results and lacking sufficient controls.”  This is like probing a toy company for using lead paint and asbestos in their action figures! The CEO—who received $18.7 million in compensation last year– in unison with his Board, claimed the firm was now, “Smarter, Stronger, and Better.”  Thoughts of Lee Majors in the Six Million Dollar Man ran through my mind… “We have the technology.  We can rebuild him!”

    So, was this the work of rogue employees? Were the traders misguided or simply greedy? The answer is all of the above, but the bald-faced truth is that they were arrogant, and their firms support a culture of arrogance.

    The firms and their leaders have been in the headlines month after month, either for calling their clients “Muppets”, for robo-signing mortgage forms, shuffling tons of aluminum among dozens of warehouses to jack up storage fees, spending millions to revamp executive offices, or issuing hubris-laced statements like having now created a “bionic bank” while client service is but a vestige of what it used to be.  See my blog “Not Just Bank Tellers in Dubuque.”  These companies have ingrained in them a belief system which encourages management and employees to act in a way superior to their clients and to answer to no one, rather than a culture in which one serves humbly at the pleasure of their clients.

    This is not just shameful and deplorable behavior, it is endemic.  CEOs of financial services firms have lost touch with this simple principle: do what is in the best interest of your clients, and your own success will follow. That is the culture of a fiduciary relationship between advisor and client.

    Finding a sucker to buy snake oil is as easy and as old as the Bearded Lady at Barnum and Baileys herself.  Building a culture of accountability for doing what is right takes unanimous adoption of values around serving the interests of clients with an undivided loyalty.

    My partners and I worked at some of the firms to which I alluded in this blog.  In the early days we felt their leaders were honorable and noble and treated clients with deference, humility and professionalism.  Today, it appears the flock have lost their way.  Conversely and refreshingly, HighTower is committed to accountability for doing the right things and to the fiduciary standard.  The executives and partners know the right way to run a financial service business.

    Investors and private clients have a choice.  If they want to work with or make investments in companies that are socially responsible, well managed and put their clients’ interests first, there are plenty of birds of that feather.  However, if it does quack like a duck, it is probably a big canard.

  • The IPS – A Business Plan For Your Wealth

    Thursday, October 10, 2013

    Business Plan - Jordan Waxman

    Image: Ted Goff

     

    Successful CEOs run companies with business plans.  Good business plans are both comprehensive and flexible.  They spell out the purpose of the entity and its divisions, assigns roles for the execution and oversight of projects as well as the management and care of employees.  Traditional plans outline strengths, weaknesses, opportunities and threats confronting the business and it core competitive advantages in the marketplace.

    CEOs manage and grow according to these plans, and involve management and employees in business direction and the regular review and modification of the plan.  However, when it comes to their own family wealth and the decisions around investment, wealth transfer, retirement, tax and insurance planning, few CEOs have a well-articulated plan.

    The Investment Policy Statement (“IPS”) is the document most fiduciaries, investment consultants and Certified Financial Planners produce as the comprehensive “business plan” for substantial wealth.  Most institutions, whether regulated (for example, Taft-Hartley) or not, are required to have an IPS in place and to review it regularly.  Boards of Directors of endowments, foundations and pension plans may have a legal duty to follow these directives, and many also fall short of this requirement.

    The Investment Policy Statement is a custom-tailored document for the proper oversight, management and stewardship of substantial pools of assets.  The IPS enumerates the specific biographical information and influences of the individuals, their cash-flow, liquidity and other needs, investment biases, restrictions and objectives, and assigns roles and responsibilities to the parties under the plan, including communication guidelines and timetables and performance benchmarks and metrics.

    Whether or not an obligation exists to use an IPS, having a well-crafted plan is simply a best practice of those who view their wealth with a holistic or long-term view or who think deeply about the values they espouse and how to transmit those in a legacy to family members.

    Those who believe they can stay on top of the complexities of overseeing their own wealth should consider the following:

    CEOs have myriad professional responsibilities which limit the amount of self-directed investing and planning they may employ;

    1. They may lack the specific and current knowledge of tax, retirement, wealth-transfer, estate, trust and insurance planning, portfolio construction, manager search and selection and performance reporting which form parts of the IPS;
    2. With interest rates at historic lows and tax laws ever-changing, the costs of unpreparedness or inertia are high;
    3. Finally, unlike the days not long ago of stock and bond-brokers calling CEOs to execute commission-based trades, qualified holistic private wealth managers on whom to rely for a comprehensive suite of critical capabilities now exist.  These holistic managers are not simply asset gatherers, but rather are skilled in listening, drafting the IPS and providing advice and guidance on all the elements of the plan, as well as in constructing and executing “best-of-breed” investment solutions and delivering reliable consolidated reporting.

    Smart and successful CEOs take their businesses seriously enough to develop and adhere to business plans for their companies.  This ultimately leads to better decision-making and performance, nimble and flexible management in the face of changing regulations and industry trends, resource allocation and succession planning.  The same holds true when a properly drafted and executed IPS is employed for their family wealth.  The long-term financial success, ease of mind, and the fulfillment of one’s legacy are all by-products of proactive up-front IPS planning by qualified professionals.

  • The Perfect Flavor Is A Blend Of Spices

    Tuesday, July 9, 2013

    Inside the Vault Jordan Waxman Blog

    Image: Liza Donnelly

     

    This morning I had breakfast with a talented and creative client who has become a dear friend.  We talked about the trend for advisors to create “simpler” portfolios of mutual funds and Exchange Traded Funds (“ETF’s”) instead of using separately managed accounts (“SMA’s”). But what exactly are the differences between these investment vehicles and which one may be best for the individual investor?

    ETF’s are a burgeoning group of financial products that are designed to give the investor access to an underlying index or strategy through the purchase of a single stock.  For some investments, like commodities, it is normally difficult to buy and sell, because the futures market is generally limited to institutional investors.  So, buying an ETF to own for instance an interest in gold, agricultural commodities or palladium is easier and less costly.  Other ETF’s provide access to broad stock and bond indexes, and there are well-discovered areas of the markets in which passive indexes may be superior to active managers and should be considered.  Finally, there is a class of ETF’s that are 2x and 3x leveraged to the return of the underlying investment.  We do not use these, as they increase volatility risk and do not always work as advertised.

    The disadvantages of ETF’s are: 1. The investor cannot take delivery of the underlying investment, whether a portfolio of stocks or a bar of gold; 2. They are not very tax-sensitive.  In fact the advisor must actively sell and buy ETF’s to harvest gains and losses.  3. They often lack liquidity so the low cost of ownership is offset by higher trading spreads.

    Mutual Funds are pooled investments in funds over which the Registered Investment Advisor (“RIA”) has authority.  The investor owns shares of the fund, and inherits the unrealized gains or losses of the fund when buying in.  Mutual funds come in many flavors and one can even invest in strategies once in the purview exclusively of hedge funds, but now in mutual fund format, as well as in international strategies in local shares—something not normally achievable by the average investor.  Shares come in several classes, each with different management fees and placement or sales cost.  We typically own institutional classes that carry the lowest internal management fees, as we are also charging an advisory fee to search for, select and monitor the investments.

    The disadvantages of mutual funds are: 1. Not all investment managers issue mutual funds for their strategies.  Many boutique money managers only have SMA’s, so by focusing on ETF’s and mutual funds, the advisor avoids many managers with superior track records.  As a fiduciary, it is more important to deliver investment returns that satisfy client needs than reducing the number of accounts to administer.  2. The all-in cost of mutual funds is often higher than that of SMA’s, and 3. The mutual fund investor gets capital gains (and income) distributed on a n annual basis, whether or not he or she actually has a gain in net asset value of the fund from the time of purchase.

    SMA’s are separate accounts over which the Registered Investment Advisor (“RIA”) has discretion.  The client signs one or two contracts, depending on the advisory platform, and the RIA has unique authority to buy and sell securities in a discreet account, for a negotiated fee.  The client owns all the underlying securities, unlike owning shares of an ETF or mutual fund.  As the investor owns the underlying securities in an SMA, it is the most tax-sensitive–easier to harvest gains and losses to reduce a client’s capital gains exposure.

    The downside to owning SMA’s is that it creates another account to track.  However, if an advisor provides robust consolidated reporting and takes the time to educate the client on how to understand and internalize the report, it may be harder on the advisor to administer, but beneficial to the client.

    ETF, Mutual Fund, SMA Graph 2

    This last point is the real crux of the conflict of interest.  An Investment Steward carefully screens for and selects the best potential investment, regardless of the structure, but takes into consideration the cost of managing the assets when comparing performance of various alternatives.  Many advisors pitch their clients on the simplicity of having two or three accounts per taxpayer, when in fact that allows the advisor to be offer less customization, and be an asset gatherer rather than an investment steward.

    Endowments, foundations, pension and other retirement plans are mandated to hire fiduciary investment stewards who focus solely on what is in the best interest of the client, not the advisor.  They have customized, broadly diversified plans which are agnostic to whether they own ETF’s, mutual funds or SMA’s.  It is the fiduciary’s focus on the time horizon, cash flow, preservation and growth requirements of the client that drive the decision on how to allocate capital.  It is not what allows a broker to streamline his business.

    Image: Liza Donnelly

  • The Butcher vs. The Nutritionist

    Wednesday, May 1, 2013

    About a year ago, HighTower released the whiteboard video about butchers versus nutritionists:

     

     

    The video makes a simple point:  butchers will sell you any cut of meat they have on the shelves and racks of their shop.  A nutritionist measures, analyzes and recommends the best diet for each individual.  He or she prescribes more veggies and vitamins for one, more iron and protein for another.  They are not paid to distribute food like the butcher.  The butcher is the broker, while the nutritionist is the fiduciary.

    This is one of my favorite allegories, and one that I share with the Investments class I co-teach at McGill University. While the video might be enough for most folks to “get it” about fiduciaries versus brokers, global fiduciary practices are actually more structured and complex.  Among other issues, financial fiduciaries must draft Investment Policy Statements (the architecture or business plan for the assets), define roles and responsibilities clearly, avoid self-dealing and other conflicts, identify risk levels, model investment returns, follow due diligence processes and disclose and document all fees.

    For brokers, some of who have hundreds of clients or who place clients’ assets in the same “core” portfolios of their choosing, these standards are too cumbersome.  That is just like the butcher selling red meat to every customer.  Yet many investors “trust” their broker and are “confident” in them, even if they lack the patience, skill or resources to serve in the best interests of their clients.

    Most of my dialogue with clients today is around issues that are central to clients but are ancillary to investments:  “What are best practices for insuring one’s legacy? How do I transfer wealth appropriately to next generations?  What should I do to mitigate estate taxes?  I need a family office structure and a plan of action…how can your team help me?”

    I think about the kind of relationships I have in both my personal and professional lives that are the most enduring.  They always come down to both of us being open, transparent, honest and giving.

    Fiduciary practice means the investment process is defined, focused, documented and specific to each client’s needs.  At a minimum, proper disclosure and transparency are essential.   While regulators duke it out to protect investors, the investors themselves should be raising the bar, probing their advisors and insisting on the highest standard of care and excellence.  We have taken the approach of the nutritionist, benefitting from the health, wellness and satisfaction of clients, not of the butcher who benefits from shoppers who buy products.

  • A Matter of Standards

    Monday, April 22, 2013

    Photo: bemanaged.com

    Photo: bemanaged.com

    I started in the private client business in 1994 when it seemed like sales proficiency was not only the key to succeeding in the business, but was what most investment relationships were built upon:  determining suitability and building portfolios by selling research-driven ideas.  Years later came fee-based brokerage business, followed by discretionary management using the firm’s own research, then asset allocation among third-party solutions, and finally to what I believe is the optimal relationship, one of independence and fiduciary care which is agnostic to where the ideas are sourced or custodied or how the investment is structured.

    In 2008, the RAND Institute for Civil Justice conducted a study on behalf of the SEC entitled, “Investor and Industry Perspectives on Investment Advisers and Broker-Dealers.”  The study distinguished among a broker (defined as someone who conducts transactions in securities on behalf of others); a dealer (someone who buys and sells securities for his or her own accounts); and an investment adviser (one who provides advice to others regarding securities), but concluded that as a result of the changes I described, and the bundling of Wall Street products, that clients by and large did not know how they were legally or practically different.

    Making matters more opaque, in July of 2012 FINRA, the overseer of brokerages, implemented upgraded suitability standards for brokers that sound eerily similar to those of the SEC, the RIA supervisor.  This may be a power play to overtake the SEC as advisor watchdog, but the SEC itself is moving toward a universal fiduciary standard in its quest to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The thud of weighty regulation is clearly a response to Wall Street’s egregious behavior leading up to the Credit Crisis, and rogue hedge funds that seem to sprout like suckers on a blackberry bush.

    For most clients and advisors, there exists the kind of relationship that a fiduciary agreement merely contractualizes.  I hear radio and TV announcers talk in fiduciary terms like “trust” and “confidence,” but they never quite say that brokerage firm advisors are legally bound to act in the best interests of clients.

    “Why is that?” the attorney in me wondered.

    According to thefreedictionary.com, a fiduciary is “An individual in whom another has placed the utmost trust and confidence to manage and protect property or money.  The relationship wherein one person has an obligation to act for another’s benefit.”

    When a financial firm has investment advisors who place the firm’s own investment offerings with clients, it is clearly a conflict of interest.  It can be mitigated with disclosure and a suitability review, but clearly requires an extra standard of care in determining whether that solution is in the best interests of the clients.  In the NBA, the best professional teams are made of athletes who are recruited from different colleges, high schools and pro teams.  Similarly, how can the best investment teams or ideas come from one place?

    When firms place third party asset managers with clients, but the managers are paying the bank part of their fees and profits to the firm for “shelf space,” is the client getting the best selection, or just the ones who pay to play? Again, there must be a higher standard to determine if the investment is in the best interest of the client, or simply the firm.  At the very least, shouldn’t the client be aware of what fees are paid to whom?  At HighTower, we call that giving the client an Unobstructed View.

  • Chasing the Stars

    Tuesday, April 9, 2013

    Stars

    The other day, my partner Ken and I were reviewing an action plan with a new prospective client.  We were speaking about diversification and mitigating risk, trying to get a sense for his biases and experience, when the subject of TV messaging came up.  In his mind, most of the financial news, interviews and advertising today revolve around trading ideas, software and execution.  He could not believe the promises behind these ads or that the customers of commercial trading programs could really accumulate wealth by trading.

    That evening I tuned into one of the major channels and counted the number of ads for technical charting, low cost trading and fast execution.  The pundits on the following panel talked about “high frequency trading,” and option strategy for the next week or two of the stock market.

    Personal and professional experience have taught me that a long-tem strategic investment plan, using proper asset allocation that fits the investor’s time horizon, analytical manager search and selection and proactive tactical overlays allow one to build wealth slowly, tax-efficiently and without getting burned chasing stars.  Can a self-directed individual investor buy and sell stocks repeatedly and beat this disciplined approach?

    One advertisement I saw showed a chap in a polo shirt executing trades with a steaming cup of coffee beside him in the morning light, then whipping his jacket over his shoulder, ostensibly to go and enjoy the rest of his day.  The premise is that individual traders can be part-timers, who enter a series of automatic prompts to execute strategies and control risk.  In other words, making money is as easy as selling books on eBay.  I have known and advised professional traders for almost 20 years, and I am not buying it.

    Sometimes I picture my dad in these commercials.  He has been a leading criminal lawyer for 45 years.  As a kid, he would tell me about his cases, the accused, the judges and Crown prosecutors, and I saw him draft briefs for trials and appeals, the legal-sized papers stacked on our dining room table.  Now we still talk law, but more and more he brings up the investment newsletters to which he subscribes, trading seminars he attends and “can’t miss” strategies he buys.  When you add up the cost of subscription, travel, software, data, taxes and commissions, I cannot see how he or other individual investors, especially on a part-time basis, can actually build wealth.

    There is an old riddle on Wall Street about currency trading: Q. “How do you make a small fortune in currency trading?” A. “Start with a large fortune.” The same is true of individuals trying to make millions with a small amount of capital and some trading software.  Against professional asset managers, with better access to information, trading flows and capital, the little guy cannot compete.

  • Institutional Trading — the Whale and the Sharks

    Tuesday, April 2, 2013

    Regualtions

    This past week, I raced the inaugural Ironman Los Cabos.  It was my 7th Ironman and a good race for me, but the treat was having my family there for a vacation together after the finish.  We have done that a few times, and I find there is nothing better than unwinding in a pool or a hot tub, nursing my wounds and horsing around with my wife and children, sharing laughs and good food.

    One day, my younger son and I drove up the coast to the East Cape and Cabo Pulmo, a beautiful spot know for its scuba, snorkeling and wreck diving.  From the shore, we watched humpback whales breach and roll in the Sea of Cortez. We swam together around the reefs, only a half-mile from bull and white-tipped sharks, and I pondered about the order of sea life, and specifically about whales and sharks.

    One of our clients is an old friend and former trader from Goldman Sachs.  As a young private client advisor, I would talk with him, usually after hours or perhaps at lunchtime, and I remember the energy and pace of activity.  I walked the vast floor, visiting with those equity, bond and derivative traders who helped my clients hedge, monetize and diversify their risks and assets.  The trading business was one of the engines there…but it was complicated.

    Here is a brief history of institutional trading, and some of the conflicts that have arisen:  Wall Street firms (also known as the “Sell side”) have trading desks that manage institutional customer flows of stocks, bonds, derivatives and other products, and take some positioning risks of their own.  If the firm has leading research and relationships with investment advisory firms and pension funds (the “Buy side”), the institutional sales people communicate the research and traders take positions to facilitate trading, thus earning firm commissions.

    Underwriting (fed by the Investment Banking and Corporate Finance departments) creates more opportunities for trading, and has led to some “upstanding” firms engaging in less-than-upstanding practices. The central conflict is this:  if allocated hot underwritings, Buy side firms trade more with the underwriting firms, allocating commission dollars.  On its surface this does not seem terrible, but the issue is whether these banks deliberately set the offering prices too low relative to demand, to create a “pop” on the IPO and thus begin the spiral of IOU’s.  This remains front-page Business Section news.

    Since the advent of decimalization (moving from bid-offer spreads of fractions to pennies or fractions of pennies) and the proliferation of electronic crossing networks (“ECN’s”—essentially computers which match buys and sells from many sources), Wall Street trading desks have been making less in commissions and have downsized quite a bit.  After the credit crisis of 2008, regulations tightened around what firms may do with their own capital, thus reducing the need for proprietary trading desks (solely risking firm capital, rather than providing customer flow) as well.  Many of these “Prop Trading” desks are now stand-alone hedge funds; some with start-up capital from the firms whence they came.

    Recently, a major firm lost over 6 billion dollars on a single trading position that the firm claimed afterward was designed to hedge its risk.  This is not the first massive trading loss at a bulge bracket firm, but it is usually a rogue trader with a disguised position that makes the headline.  Here the trader took on a whale of a position, feeling it was a mispriced opportunity and an easy way to help the bank make profits.  The bank was not duped.  They were aware of it! Unfortunately, like great white sharks, other traders smelled out the whale, bet against and devoured him, and went on hunting for prey.

    The Senate Permanent Subcommittee on Investigations, whose examinations into large Wall Street firms produced some of the most insightful work on how banks really operated during the housing boom and bust, held a hearing on this trade.  The Chairman and CEO of the firm retained both titles but had his pay cut (to a mere $11 million).  So, as tight as the regulations are becoming around proprietary trading practices of “too big to fail” institutions, something tells me more rules are coming…which means lower profits for banks, more layoffs, declining service for clients and so on.

    The whale represents the Sell side, and lucky for him, his firm has a massive pool of other marine mammals.  The sharks are the Buy side.  They do not always have full bellies of whale meat, but the better ones survive and thrive.  What we know about whales is that they are big and beautiful, but slow-moving krill and plankton eaters.  Sharks, on the other hand, are angular carnivorous hunters that dine on plodding whales and such.  When there is blood in the water, bet on the sharks.




Jordan Waxman is registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. Jordan Waxman and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.


This document was created for informational purposes only; the opinions expressed are solely those of Jordan Waxman, and do not represent those of HighTower Advisors, LLC, or any of its affiliates.