Wall Street’s Stupid Inventions

Some years ago, Wall Street decided that Brazil, Russia, India and China would be ‘hot’ markets, with all that growth and development happening. These countries in aggregate were called the BRIC, an acronym coined by Goldman Sachs’ Jim O’Neill. Every conference we attended, we heard BRIC BRIC BRIC. Inevitably, BRIC mutual funds and ETFs proliferated. We checked several well known versions recently – Templeton’s TABRX, iShares CBQ, iShares BKF, and Guggenheim’s EEB. None of these funds have produced returns even close to 1% per year over the last five years. In order to harvest a decent return out of these funds, you would have had to be as nimble as a cat on a hot tin roof, skipping in and out year by year. No one can do that effectively.

Next was hedge funds. Technically we can’t really call these a Wall Street invention. Some hedge funds are run by people who want nothing to do with Wall Street. Still, Wall Street has been more than happy to jump on the bandwagon, spurring the proliferation of these funds beyond all reason. Outrageous fees have aided the trend towards more offerings. Why work for 1% of assets when you can get 2% and then 20% of profits (shorthand: two and twenty). The hedge fund trend has sucked managers from mutual fund companies where they felt they were underpaid, so they can trade in the same securities but pocket more at the expense of the investor. CALPERS, the big California pension fund, came to its senses first, and is excising hedge funds from its investment program. More pension funds will follow. The funds have struggled to beat a plain old 60/40 stock/bond mix. This may be due to the sheer number of funds now picking over every opportunity, and thus arbitraging away all excess return.

What’s next? “Liquid Alts.” This refers to a fund containing investments in normally illiquid, exotic instruments like merger arbitrage, private credit issues, derivatives, and packaged hedge funds. Of course, these cost an arm and a leg, too. The trend to liquid alts was supported by the ‘failure’ of diversification in the ’08/’09 credit crisis. (We’re not going to take up the notion that diversification ‘failed’ here, except to say it didn’t. Most investors, after a long bull market, were simply positioned with too much risk.) Billions of dollars have flowed to these strategies, alarming the SEC, which is conducting examinations of big liquid alt providers to figure out if they will actually be liquid in a very bad market. We bet they won’t. We were completely shocked to read an article in one of the worst publications put out by our industry which very nearly declared that any advisor not using liquid alts was as good as committing malpractice, and that – according to a Goldman rep, who conveniently sells liquid alts – at least 19% of client assets should be in liquid alts.

Don’t fall for this crap. View it like it is: Wall Street’s effort to make you part with more of your money to line their pockets. And possibly, more dangerously, a sore spot that will turn to gangrene when the next bear market visits.