Wall Street is quite the enormous marketing machine, and unfortunately once you become aware of it, you can’t un-see it, it’s everywhere.
Mutual funds with ‘alpha’ in their name usually don’t have it
This article discusses the findings of Morningstar research that looked at funds with ‘Alpha’ and ‘Plus’ in their names, and unsurprisingly found that their performance was subpar. Alpha and Plus are just one of many adjectives that are thrown in to make a fund or strategy sound extra effective. Of course, the data tells us it really does nothing else.
Each time I see a lengthy, complicated sounding product, I can’t help but picture a roomful of people playing a game of Investment Buzzword Boggle, jumbling letters and words together until they get something new and ridiculous. The headline popped in my head this week because I spent 10 minutes listening to a pitch from a portfolio manager with some shiny new products to sell (and man, did they sound cool).
I was approached two weeks ago by a writer for Forbes Magazine, asking if I would comment on a few new financial products. Being asked for a quote isn’t really rare, writers finishing their stories are always looking for a practitioner to give them a usable quote. This particular setup sounded a bit fishy to me – I was going to be contacted by the writer, who was then going to conference me into the portfolio manager of the product. After our chat, I was then supposed to circle back to the writer with my feedback.
I think it was just a not-very-tricky way to have me hear a sales pitch, but I bit anyway, and I did so with this blog in mind. Each time I hear some good Wall St marketing it gives me more fuel to talk about it here (and hey, a quote in Forbes is never a bad thing). The call did not disappoint.
The conversation with the portfolio manager began typically enough, he discussed his background, excellent education, his impeccable successes running various hedge funds, yada, yada. If you’ve been in one of these meetings you’ve been in them all, you’re always dealing with the Smartest Guys in the Room who surprisingly are still working for a living despite making so much money in the markets.
Next came the products; I won’t bore you with names and details, that’s not particularly relevant here, though I’ll say they both sounded all too familiar in their marketing flair. What was very interesting to me, and the reason I felt it was worth mentioning here, is both were ETFs that had been ‘converted’ from a hedge fund format.
ETF is short for Exchange-Traded Funds. The easiest way to understand an ETF is that it is a basket of investments that can be bought and sold under one ticker symbol, just like you would buy a stock. Like a mutual fund takes your dollar and splits it into many underlying investments, so does an ETF. Though there are many differences in structures, the main notable difference between the two is ETFs are traded all day long on an exchange and mutual funds are not.
ETFs have exploded in popularity, you can basically buy an ETF to invest in anything. There’s the Elements Global Warming ETF, the Disability ETF, the Business Cycle ETF…pick a theme, Wall St will sell it to you.
I don’t really have data to support this, but I can tell you anecdotally I’ve noticed clients have become aware of ETFs, but potentially for the wrong reasons. They are not just thought of as the ‘new’ way to invest, but also the ‘cheap’ way to invest, since mutual funds have become the whipping boy of a public seeking cheaper solutions. At some point there may have been a bit of truth to this, ETFs were initially just another way to index. But if you’ve read anything here before, you know what happens when Wall Street can sell a fancy new toy; It makes many, many more toys.
What’s more concerning is not the absurdity of some of these investments, it’s that the perception is out there that ETFs are somehow the ‘better’ investment, or the cheaper investment. They’re not, they can have the same high fees and terrible performance as anything else, and my phone call confirmed it. I was talking to a career hedge fund manager, using a hedge fund strategy, but slapping an ETF wrapper on it and hoping that will catch some assets.
Did I mention the fees? The first one almost made me laugh out loud, coming in at a nosebleed high 2.8% per year. The second, a lower, but still crazy 1.95%. The poor guy – if you’re coming from the hedge fund world you feel like you’re putting things on sale at that price.
We have an entire industry of old guard portfolio managers, that grew up running mutual funds charging 2.5%/year or hedge funds charging the classic ‘2 and 20,’ now suddenly losing assets, losing jobs, and looking for work. What’s the low hanging fruit? Conversion! To mutual funds, or better yet, ETFs, which the consumer thinks are cheap and safe.
Here’s a chart put together by Jeffrey Ptak at Morningstar, it shows mutual funds that were recently converted from hedge funds. You can usually tell by their over-the-top names (picturing the Boggle game again).
Once they file as mutual funds their performance is easily tracked. But as Jeffrey noted, as hedge funds they don’t have to report their performance. Coincidentally, their track record as a hedge fund was stellar, while since converting to mutual funds, it’s been…less than stellar.
To translate that graph, the left side is showing the performance against the benchmark when they were hedge funds, the right side as a mutual fund. Pretty clear which time period they did ‘better,’ suspiciously the same time period they weren’t publicly reporting.
My point is that every minute someone is out there pitching a very sophisticated-sounding product. Someone highly educated, with an excellent resume, and a product name that looks like someone vomited investment words. Not only is that enticing, but now they may be former hedge fund strategies showing off a track record of a time with no transparency.
Remember to always know what you own, why you own it, and what you’re paying for it, don’t fall for a buzzword-filled product without a clear understanding of how it’s going to help you. Often the rules of life intertwine with the rules of investing, and no place is the ‘KISS’ method more important than when you’re shopping the Wall Street product aisle.