Wall Street Potholes (1St Edition)
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WALL STREET POTHOLES WALL STREET POTHOLES INSIGHTS FROM TOP MONEY MANAGERS ON AVOIDING DANGEROUS PRODUCTS SIMON LACK Copyright © 2016 by Simon Lack. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. 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Wall Street potholes : insights from top money managers on avoiding dangerous products / Simon Lack. pages cm Includes bibliographical references and index. ISBN 978-1-119-09327-5 (cloth) – ISBN 978-1-119-09329-9 (ePDF) – ISBN 978-1-119-09325-1 (epub) 1. Investments. 2. Portfolio management. 3. Finance, Personal. I. Title. HG4521.L25 2016 332.6 – dc23 2015029534 Cover Design: Wiley Cover Image: © iStock.com/Mlenny Printed in the United States of America 10987654321 This book is dedicated to the anonymous retail investor trying to navigate a complex financial world. CONTENTS Preface xi Acknowledgments xiii CHAPTER 1 Non-traded REITs: A Security That Shouldn’t Exist 1 Poor Advice 1 Why Not Get a Listing? 5 Disingenuous Advice 9 Whose Side Is Your Financial Advisor On? 12 Where Are the Regulators? 15 Overall Returns Are Poor 17 The Importance of Benchmarking 19 Puts and Calls 20 Financial Advisors Need to Do Better 21 CHAPTER 2 Why Investors Pay Too Much for Yield 25 The Mysteries of Closed-End Funds 25 Investors Can Overpay to Simplify Their Taxes 29 The HFT Tax 32 When Managers Run a Company for Themselves 34 The Ham Sandwich Test 37 If the Prospectus Says You’ll Be Ripped Off, It Must Be Legal 38 Timing Is Everything 41 vii viii CONTENTS CHAPTER 3 Why Structured Notes Are Rarely the Best Choice 47 Kevin Brolley Caveat Emptor! 47 Structured Note Basics 49 Why Buy Structured Notes? 52 The Heart of the Matter: The Arguments Against 55 CHAPTER 4 Update to The Hedge Fund Mirage 69 Hedge Funds Remain a Great Business 69 Industry Reaction to the Dismal Truth 72 Why Hedge Funds Are Still Growing 74 Some Accounting Rules Are Dumb 77 Politics Drives Asset Flows 80 Too Much Capital 82 For Once, the Retail Investor Wasn’t Duped 86 CHAPTER 5 Why Is Wall Street So Inefficient? 91 Why Is Finance So Expensive? 91 Trading Doesn’t Build a Secure Retirement 94 Invest Time before Money 97 Sex and Investing 98 Complexity Sells 103 The Hidden Costs of Municipal Bonds 106 Some Bankers Just Don’t Think 109 CHAPTER 6 The Un-Portfolio and Better Portfolio Management Techniques 115 Bob Centrella, CFA Background 118 Un-Portfolios and Diversification 120 Fees and the Black-Box Models 123 Other Examples of Un-Portfolios 125 Exchange-Traded Funds 127 Mutual Funds and Fees 128 Contents ix Load Funds 130 Fiduciary Duty 131 Portfolio Management Basics 133 Summary and Conclusion 137 Bonus Section 138 CHAPTER 7 Annuities 145 Dave Pasi Introduction 145 What Is an Annuity? 147 What Are the Different Types of Annuities? 148 Variable Annuities 151 Associated Risks 152 Other Risks Are Lack of Flexibility 153 Variable Annuity Riders 154 Illiquidity, or the Lack of Being Able to Get to Your Money 157 Evaluation of Returns: Investment Options inside of Variable Annuities 158 Fee and Charges 159 Options If You Already Own an Annuity 162 When Should You Consider Using an Annuity? 163 Recent Developments with Annuities 164 Savings Bonds: Little-Known Good Deal 166 CHAPTER 8 Is the Most Important Professional in Your Life Even a Professional? 171 John Burke My Start as a Broker 172 Pressure to Generate Business 174 Why You Don’t Invest with Borrowed Money 176 Has the Industry Made Any Progress? 178 Is Financial Advisory a Profession? 181 Why You Want a Fiduciary 183 x CONTENTS More Things to Consider When You Choose Your Advisor 189 A Better Way to Measure Results 191 CHAPTER 9 Putting Investors First 197 The Future of Finance 197 Understand Who Your Advisor Works For 200 Really Understand the Fees 204 Try Asking These Questions 207 What Else Can Be Done? 210 The Role of CFA Institute 212 Bigger Isn’t Always Better 215 About the Contributors 219 About the Author 223 Bibliography 225 Index 229 PREFACE Financiers were never especially well liked prior to the financial crisis of 2008. The bank bailouts compounded a general belief that bankers always make money regardless of the outcomes for their clients. This popular view had never sat easily with me as one who had made his career first in London and then on Wall Street. Although there were inevitably bad actors, I clung to the idea that part of the reputational challenge was the result of poor understanding by the general public. Then I met Penelope, as described in Chapter 1, and was prompted to learn about non-traded REITs (real estate investment trusts), a murky corner of the securities markets that can only damage the reputation of anybody involved in the sale of these instruments to the general public. The fees, conflicts of interest, disingenuous marketing, and more fees were breathtaking. That it was all legal, because of its disclosure via a thick, densely written prospectus, was astonishing. Discussions with industry colleagues found like-minded practi- tioners with their own examples of shoddy, self-interested advice pro- vided to trusting clients. It soon became clear that a collection of advice from people on the inside would fill a needed gap in the edu- cation available to people simply trying to save for retirement. xi xii PREFACE The CFA Institute’s efforts to shape the “Future of Finance,” and especially the Putting Investors First initiative, provided further impe- tus to promote better outcomes by warning against the wrong types of advice and products. Too often, the financial salesperson’s interests are placed well ahead of the client’s. It is with this goal in mind, of Putting Investors First and thereby aiding better outcomes, that the five authors of this book have come together. The few we may offend are far less important than the many we hope to help. ACKNOWLEDGMENTS Inspiration for this book came from my contributing authors Kevin Brolley, John Burke, Bob Centrella, and David Pasi. We all share a common vision that investing should be simpler, cheaper, and devoid of fee-laden traps. Further encouragement was provided by many other finance professionals, including Rich Covington and Tony Loviscek. In my career I have had the good fortune to work repeatedly for people in banking for whom integrity was priceless, notably Don Layton, Don Wilson III, David Puth, and Jeffery Larsen. They rep- resent the best of finance and what I still believe is the vast major- ity of financiers, notwithstanding the visible transgressions of some. Their values became mine. The CFA Institute with its “Future of Finance” initiative, includ- ing Putting Investors First, promotes financial ethics as a cornerstone of investment competence, providing an institutional confirmation of the importance of doing the right thing. The wonderful editing staff at John Wiley once again both shared our vision on an important topic and immeasurably improved the final result. xiii CHAPTER 1 NON-TRADED REITs: A SECURITY THAT SHOULDN’T EXIST POOR ADVICE “I’m afraid you’ve been poorly advised,” I told the new client as she sat in my office. That was certainly an understatement—in fact, she’d been ripped off by the advisor at the brokerage firm that invested her money. We had just finished reviewing the investments in her portfolio, which she had brought to me out of dissatisfaction with her existing advisor.