MEDIA REVIEWS – February 16-28, 2018

There’s not much to this issue of Financial Advisor magazine, but fortunately I was able to include a gem of an article from the Advisor Perspectives service, which examines in some detail how to spot funds that have a higher-than-average chance of outperforming (basically, high active share and low R-squared), and the environments when they are most likely to outperform.  The interesting thing about the research is that in almost half of all market environments, they will NOT outperform, and we have just experienced a nightmarish eight years for active fund managers.

In Financial Advisor, there’s a guest column from Ken Rogoff, the economist who has detailed the problems from a debt crisis, here telling us that the underlying conditions for the bull market may not be as favorable as they seem.  Does that mean we’re moving into a chaotic market like the one that favors the best active managers?

Articles that received a “high” relevance rating:

“How to Know When Active Management Performs Best”
by C. Thomas Howard
Advisor Perspectives, February 12, 2018
https://www.advisorperspectives.com/articles/2018/02/12/how-to-know-when-active-management-performs-best
Relevance: high

You know that funds with high active share and low R-squared with respect to their benchmarks tend to be the best candidates for market outperformance.  But even these funds have lagged during the still-ongoing bull market.  So does that mean that active management skill works in some markets and not in others?

Typically you hear that the better active managers outperform in bear markets, but that seems to be a relatively imprecise measure of when to move from passive to active.

The author, professor emeritus at the University of Denver’s school of finance, gives a more precise environmental cue; he introduces something called the active equity opportunity (AEO)—which is really a measure of market volatility, and how much dispersion and skewness the markets are exhibiting.  The higher the AEO—that is, the more chaotic the markets happen to be, the better opportunities there are for skilled stock selection processes.  There’s a graph which shows periods when there is high AEO, and we learn that 2017 was a very low AEO, the lowest in a half century.  But AEO has been relatively low for the past eight years.

Another graph shows that active managers with high conviction tend to underperform in low AEO periods, more than the underperformance of active manages with high tracking error (low R-squared) and with less assets in their portfolios.  But all three characteristics show up well in above-average AEO environments, with up to 2-5 percentage points annual alpha added when the AEO is at the upper range of the measuring tool. 

There’s another graph which shows that the best ideas of the best-performing funds (measured after the fact) tend to be the worst ideas of the worst funds by a higher margin in higher AEO environments.  The author suggests that some fund managers are actually selecting stocks they know will likely generate negative alpha because the fund company (and its marketing arm) demands low tracking error, low volatility and therefore smaller drawdowns.

What to do?  The conclusion is that closet index funds will outperform the high active share/low R-squared managers in low AEO environments, but will still generate negative alpha.  Better to stock with index funds as AEO declines, and consider moving to more active management as it starts to pick up.  Nothing here tell us exactly how we would monitor or predict THAT, however.

“Disruptive Custodian”
by Jeff Schlegel
Financial Advisor, February 2018
https://www.fa-mag.com/news/-disruptive–custodian-36901.html?issue=297
Relevance: high

Dallas, TX-based Apex Clearing does the automated clearing and custody services for Wealthfront, Betterment and other leading robo-online platforms.  The company opens 450,000 accounts a month and few know the firm even exists.  The firm created a seamless online investment experience for its financial services customers, and allowed them to market robo services to the retail community.

Apex now wants to enter the custodial space for mainstream advisors, competing against clearing and custodial platform infrastructures that are decades old.  This is why it takes multiple days to open accounts or transfer money from a bank to a custodial account.  The firm has created a series of application program interfaces that enable the integration of different software programs in a plug-and-play sequence, automating client onboarding, account aggregation and portfolio rebalancing.  Accounts open in seconds instead of days.  No paperwork, no web signatures, no DocuSign, no waiting.  Apex could enable traditional advisory firms to offer a much better investing experience than they currently provide.   (p. 15)

“Averting Disaster When Hiring Family”
by Philip Palaveev
Financial Advisor, February 2018
https://www.fa-mag.com/news/averting-disaster-when-hiring-family-36886.html?issue=297
Relevance: high

Do you want your son or daughter to follow in your footsteps and join your firm?  Palaveev says he has seen key employees leave when the heir apparent arrives at the firm, and vibrant cultures become awkward and lose energy.  Then the son or daughter leaves the firm anyway.

The advice: Don’t be your son/daughter’s first employer.  Have them work at least five years somewhere else before they come to the firm—so they gain some experience, establish their careers and develop confidence in themselves.  It helps if they’ve achieved something on their own before coming to work for Mom or Dad.

When they come onboard, hire for an actual position that exists at the firm, rather than a position without a job description or a set of responsibilities.  Palaveev says he has seen firms create fictitious positions, like “director of strategy,” “chief of staff” or “partner in training.” Have your son/daughter compete with external candidates for a position that is openly advertised.  Ideally, the hiring manager and other partners will decide the son/daughter is the best candidate available.

If/when your son or daughter joins the firm, acknowledge to the staff that it will create difficult issues, and propose how you intend to safeguard the situation.

Ask yourself: is your son/daughter qualified for the job he/she was hired to do?  Will he/she advance up the career ladder regardless of achievement?  Will those opportunities detract from others who are key to the firm’s success?  Will the child employee be a spoiled brat who throws his/her weight around?  Put them on the normal career track in the firm, following the same rules of advancement as everyone else.  This will help them avoid being crushed by expectations that they will be as knowledgeable as Mom or Dad from day one.

Listen to team members and their concerns.  They may raise issues that have no resolution.  (p. 36)

“Giddy Markets and Grim Politics”
by Kenneth Rogoff
Financial Advisor, February 2018
https://www.fa-mag.com/news/a-giddy-market-and-grim-politics-36900.html?issue=297
Relevance: high

The manifest political instability in the U.S. seems not to be affecting the soaring stock market.  The author says that the world economy is finally leaving behind the long shadow of the 2008 financial crisis.  We are experiencing payback for years of weak demand.  In addition, central banks have been free to operate independently of political influence.

Rogoff sees an erosion of public trust in core institutions in the advanced economies.  The recent wave of populism is a threat to the culture and institutions that underly democratic nations.  He worries about high Italian and Japanese government debt and high corporate dollar debt in emerging markets.  A plausible pickup in business investment in the U.s. and northern Europe, combined with a sudden slowdown in Asian economies with surplus savings, could produce a rapid rise in global interest rates, jeopardizing today’s frothy stock markets.  The seeming disconnect between market performance and politics might end messily.  (p. 72)

The rest of the articles:

“Philanthropy in the Post-Tax Overhaul World”
by Karen DeMasters
Financial Advisor, February 2018
https://www.fa-mag.com/news/philanthropy-in-the-post-tax-overhaul-world-36902.html?issue=297
Relevance: low

The new tax law will offer less incentive for charitable giving in the years to come, particularly the doubling of the standard deduction.  People may be more thoughtful in planning their giving; they may give more every other year and itemize in those years, for instance, and anyway, we are told, most philanthropy is not tax-driven anyway.  (p. 18)

“Fintech Helps Fight Against Elder Financial Abuse”
by Karen DeMasters
Financial Advisor, February 2018
https://www.fa-mag.com/news/fintech-helps-fight-against-elder-financial-abuse-36903.html?issue=297
Relevance: low

A company called EverSafe, founded by former Manhattan prosecutor Liz Loewy, specializes in detecting financial abuse and exploitation.  But we’er never told exactly what technology does or how EverSafe works.   (p. 20)

“Countries Matter in International Investing”
by Kurt Lieberman
Financial Advisor, February 2018
https://www.fa-mag.com/news/countries-matter-in-international-investing-36888.html?issue=297
Relevance: low

Hmmmm.  Be ready for your intelligence to be insulted.  We are told that “every country is governed by different laws, and companies tend to follow the laws of a country.”  That means you can’t compare one, say, telecom firm in one country with another.  We are told that the financial statements for Chinese companies are not always reliable or accurate.  When evaluating a country, remember that (this is an actual quote) “good governance equals honesty and transparency.”  Canada and Australia have good governance; so too does Northern Europe.  The author then touts his firm’s own global governance report.  (p. 27)

“Pricing Power: The New Reality for Fees”
by Gail Graham
Financial Advisor, February 2018
https://www.fa-mag.com/news/pricing-power–the-new-reality-for-fees-36889.html?issue=297
Relevance: moderate

The latest Fidelity Investments Benchmarking Study shows that 64% of RIAs are discounting their fee schedules to win new business.  The article doesn’t mention that this is a sample size of 408 firms, and goes on to speculate that financial planners have lost pricing power. It then says that Vanguard, Fidelity, Schwab and TD Ameritrade are all either in or going to get into the low-cost planning model, further driving fee compression.  Then it says “it’s easy to see how investment management can be commoditized.”

The author, who has taken a single dubious data point about as far as she can run with it, recommends that advisors adopt a specific fee for investments and another one for advice.  Be ready to articulate what clients get for their annual fee.  The AUM benchmark is now 30 basis points.  Adopt the digital advice platforms.  The advice is good, but the reasoning behind it may be unsteady.  (p. 29)

“Right Makes Might”
by Mitch Anthony
Financial Advisor, February 2018
https://www.fa-mag.com/news/right-makes-might-36890.html?issue=297
Relevance: moderate

Last month, Anthony wrote about how he had been conned by an investment scam out of more than $1 million.  He received an outpouring of support from his readers, and provides their comments here—from advisors who have been through similar swindles and financial scams.  (p. 31)

“Broker-Dealers Seek Reps in Play”
by Dan Jamieson
Financial Advisor, February 2018
https://www.fa-mag.com/news/broker-dealers-seek-reps-in-play-36891.html?issue=297
Relevance: moderate

BD recruiting efforts set records in 2017, as National Planning Holdings BD reps moved to safer ground after the purchase by LPL Financial.  Cambridge, Securities America and Triad Advisors all picked up disenchanted reps, but LPL managed to keep enough to raise its total rep count to 14,253, up 68 over the last 12 months.  But the next sentence tells us that NPH firms (there were four of them) had 3,200 reps.  The Advisor Group and Commonwealth Financial Network both reported record recruiting years.  Raymond James reported recruiting in 2017 was ahead of the previous year, but few were NPH reps because most of those were heavy into variable annuities, which didn’t fit the company’s culture.

The article says the a growing number of wirehouse advisors are moving to the independent broker-dealer model, and the fear that some firms will join Morgan Stanley and UBS’s exodus from the Broker Protocol might induce more of them to leave.  (p. 33)

“From Whistle Blower to Elder Champion”
by Karen DeMasters
Financial Advisor, February 2018
https://www.fa-mag.com/news/from-whistle-blower-to-elder-champion-36887.html?issue=297
Relevance: moderate

Philip Marshall, the grandson of wealthy socialite Brooke Astor, is spearheading an effort to protect vulnerable elderly people.  He saw (successful) efforts to rob his grandmother of her pieces of art as she descended into the darkness of Alzheimer’s—and he eventually testified against his father, sending him to prison for financial elder abuse.  He says that financial planners are in an ideal position to recognize elder fraud in its early stages.  (p. 42)

“Stepping Up Scrutiny”
by Jerilyn Klein Bier
Financial Advisor, February 2018
https://www.fa-mag.com/news/stepping-up-scrutiny-36892.html?issue=297
Relevance: low

This is one of those articles where everybody (advertisers or potential advertisers) gives an opinion about bonds, but they don’t agree and you’re still left wondering what to do.  Nuveen Investments says that clients shouldn’t be moving out of fixed income, but the current market requires more research than in the bull market years.  The firm is focusing on investment-grade, high-yield and emerging market debt.  Advisors, meanwhile, worry that rates will go up unexpectedly.  Pimco is looking for developed market rate upticks.  (p. 49)

“Evaluating Private Investments”
by Nick Veronis and Caroline Rasmussen
Financial Advisor, February 2018
https://www.fa-mag.com/news/evaluating-private-investments-36894.html?issue=297
Relevance: low

A rather dubious poll concludes that 49% of advisors help their clients make direct investments in real estate, startups or mid-round financing.  Most of these “opportunities” are touted by family members.  This article says that you should do due diligence on these opportunities before recommending them yourself, which sounds reasonable.  Look at the management team first, and evaluate its track record and experience.  What is the business itself like, and what are the prospects?  What is the market opportunity, and barriers to entry.  Is the business plan sound?  Will the investors be overpaying or stepping into a financially precarious situation?   

Then conduct site visits and identify other investors.  And then, at the end, consider diversifying this investment with others, because the odds of success will go up as you spread the investment over a wider array of deals.  Make sure you do the due diligence on those as well.  (p. 55)

“A Time for Caution”
by Marla Brill
Financial Advisor, February 2018
https://www.fa-mag.com/news/a-time-for-caution-36897.html?issue=297
Relevance: low

A profile of Stephen Yachtman, manager of the AMG Yachtman Fund.  (p. 58)

“Make Taxes Great Now!”
by Eric Reiner
Financial Advisor, February 2018
https://www.fa-mag.com/news/make-taxes-great-now-36898.html?issue=297
Relevance: moderate

Itemizing may be out of reach for many clients, with the doubling of the standard deduction plus some deductions curtailed or eliminated altogether.  So consider bunching charitable contributions into a single year, or make larger donations every other year.  Some clients may want to move to low-tax states where they won’t be affected by the limit on the deduction of state income tax payments.  Only the interest on $750,000 of new home acquisition debt is deductible through 2025, so some clients will need to talk about financing the purchase of a home.  The maximum Section 179 deduction for business property purchases rises to $1 million and doesn’t begin phasing out until more than $2.5 million of equipment has been bought.  C corporations will pay at a maximum rate of 21% starting this year.  (p. 60)