Fiduciaries, Expenses, ETFs and Timespans

Introduction

Apparently the favorite interview press query at the Academy Awards is “what are you wearing?” The answer, according to script is the designer’s name. However, this is an incomplete description of the garment. The question and answer works in a sound bite commercial world for some but does not tell us anything as to the talent of the actress (or actor), the role portrayed, and most importantly how the performance worked. This is an example as to how we use labels to convey a familiarity of topic knowledge and “being in the know” exclusivity. The media, government agencies, and some investors also use labels in the same way and these could be traps in terms of making sound long-term investment decisions.

Fiduciary

This week the US Department of Labor produced a 208 page document which I actually read. The full title is “Fiduciary”; Conflict of Interest Rule - Retirement Investment Advice. In brief summary the document mostly discusses the appropriate disclosure of compensation arrangements by various investment intermediaries. As both a registered investment advisor and an employer of other fiduciaries, I read this as a cynical document. One of the definitions of a cynic is that he or she knows the price of everything and the value of nothing.

The investment process at the professional level is long and often difficult in terms of coming to present conclusions from past performance and the surrounding analysis. (It is worthwhile that the Securities and Exchange Commission requires a cautionary statement to be appended to investment performance claims that past performance does not guaranty future performance.) I am sympathetic to the government’s desire to help investors, in particular ones investing for retirement. They believe that disclosing various ways that the investment system has found to receive compensation is useful. This is like the true statement that at some future point we all will meet our maker.

The real problem is that the professional community has been unable to fully identify the system-wide cost of investing, from securing a relationship, lifetime training and servicing, all of the administrative expenses including legal and tax professionals, as well some recognition of the standby costs to have these services available for when they are needed. In aggregate, I don’t know  what the real costs are. 

For many individuals the biggest single investment in their lifetime is the purchase of a home. Before the pressure of competitive pricing, the “going in” costs are quoted at 6% + closing costs. (I have often said “protect me from a ready to move-in house.” Within the first couple years of ownership perhaps another 10% or more may be spent converting the home to what we really want.) Thus realistically I view the true cost of a new home as the transaction price plus 10-20% a few years out. I suggest that the true cost of the time and efforts of all professionals dealing with your retirement capital is probably in the same order of magnitude on a much larger amount.

With the exception of performance fees, no one attempts to recapture these kinds of costs on the surface when investing retirement money. This does not mean that these service provider costs are not there or that they are a great deal lower than residential real estate transaction costs. Traditionally the investment community has recognized that there was a customer barrier to charging up front the lifetime expenses of a transaction. Thus, the favored way to earn compensation is first to receive annual payments which if the accounts stay with them long enough; e.g., 10-20 years, payments may reach equivalent to residential real estate expenses. The second way is to have many more transactions than the average real estate broker, which in turn probably means a significant increase in marketing costs.

The hope of the financial community is that investing for an individual’s retirement is a long-term effort and can receive periodic payments to make the effort worthwhile. Getting back to the cynic (who similar to the Department of Labor, is focusing on price disclosure) like many in the investment community wants to be paid on the basis of value received. Financial professionals have not been very good at demonstrating the value received beyond relatively few performance fee contracts which often are counterproductive by emphasizing shorter term performance. Without this ability, all too often the investment community charges relatively nominal amounts on the surface and has found methods to get additional compensation other ways. The DoL wants these to be fully disclosed. Good luck. The hope is that analyzing fully identified expenses will become the model of retirement investing behavior.

As a continuing student of investing and the investment communities, I think there is a substantial chance that when one restricts the price of a service the value provided in that service declines. What may happen is that instead of the title of fiduciary being something of an honorific, it will identify those that can’t make enough money by being good investors. If there is any chance that I am correct, those with small amounts, albeit growing, of retirement capital will find it difficult to get a high level of service. (Under these conditions some employer-sponsored savings plans; e.g., 401(k), 403b, and 457 plans may be modified to accept additional investments from existing and retired employees who will be able to keep their retirement capital relatively safe within their plans for their lifetimes. We would be interested in working with them on that prospect.) 

Exchange Traded Funds (ETFs)

Many people throw around this term, but don’t understand the differences between these vehicles. Most of the money in ETFs is in beta-matching products attempting to replicate various published indices. These indices were never designed to be prudent portfolios or to  meet specific investment needs. A smaller group (in terms of assets) but much larger in terms of numbers of funds are indexed to various sectors or in some cases to various investment factors. These presuppose that the creators of these profits selected correctly those stocks (or in some cases bonds) that will now and in the future capture the essence of the sector or factor. I question whether anyone can predict the future well enough to lock into future investments. Finally there are ETFs and ETNs (Exchange Traded Notes) that are “super-securities” used as a way to capture the general movement of items that don’t trade frequently or have enough liquidity; for example bonds of various qualities and duration, very small companies, emerging market securities, and commodities. As one can easily see, each different type of ETF or ETN is sufficiently different that labeling the same thing can be misleading. At some future date I will discuss the practice of managing accounts exclusively with these products.

TIMESPAN L Portfolios

          Regular readers of this blog are aware of my TIMESPAN L Portfolios^®.  A unique benefit of this construct is its ability to enable the management of capital through single-purpose beneficiary portfolios that allocate investments over specific timeframes and risk tolerances.  TIMESPAN L Portfolios can be a suitable strategy for defined contribution retirement plans, non-profit organizations and family wealth. 

          A visual example and description of TIMESPAN L Portfolios is available in hard-copy.  Qualified institutional investors: Please send me your mailing address and a brief description of your interest to aml@lipperadvising.com .

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