The trouble with most money managers, advisors and investment products is that they are structured to collect the highest fees when assets are allocated to the riskiest assets. Equity and corporate debt allocations routinely exact higher fees than those held in cash and the lowest risk fixed income holdings. After all, how can you convince people to pay you out-sized management fees each year if you don’t tell them you will make them ‘rich’ with big gains no matter what the market cycle or valuations look like? This is the inherent and rarely mentioned bias of the industry. The fact that this glaring conflict of interest is not brought to the attention of investors, is a failure of fiduciary duty that litigation lawyers, suing to recover client losses, should not overlook.
For all the marketing hype about ‘smart money’, the truth is that captive money–that’s paid most to remain in risky assets even at irrational prices–is not smart at all, it’s indiscriminate and dumb. And thanks to years of QE-goosing, liquidity swamped markets have continued to float dumb and reckless participants a few years longer than usual this cycle. Nevertheless, it is likely a grave error to think mean reversion or bear markets have been abolished, or that confident, long-always gurus actually are the geniuses they pretend.
This article from David Rosenberg in the Financial Post yesterday summarizes the remarkable chaos presently dominating the high-risk-highest-fee asset management world. See: If you think this market is confusing, wait until you see what the ‘smart money’ is doing?
Of course, Rosenberg works for Gluskin Sheff who also collects a higher fee percentage on the client capital it advises to riskier asset classes. After founders floated a $133 million initial public offering of their shares in May 2006, prices plunged 79% to $3.61 in December 2008 before rebounding on QE with overall markets to top at $29.57 in April 2014. Today at $17.63 Gluskin shares are below their IPO a decade ago, and have fallen 40% from the most recent 2014 peak as the founders sue the company for post-retirement entitlements of $185 million.
You need a lot of client fees to sustain this kind of compensation for executives and board members (remember media personality and Senator Pamela Wallin was pulling down 450k as an annual stipend just for sitting in as one of the members on quarterly Gluskin board meetings until she resigned in 2013). Wallin wasn’t there to offer her non-existent financial expertise on how to best manage risk and keep fees low for the company’s clients. She was there for profile to help impress and attract new believers to the company’s investment products.
As in 2008 with all risk-selling financial gurus, the next bear market is likely to try client faith further still. Warren Buffett has famously said, you only know who is swimming naked when the tide goes out. If you really want to know how adept a financial guru is at managing risk for their clients, you have to look– not at how they do in rising markets– but at how their accounts performed during negative years like 2007-09. For Buffett, ironicially, the answer for his Berkshire shares was a stark naked -50%–nearly lock step with declines on the S&P 500. What management genius?
The majority of investment capital today is held captive in risk exposed funds and products. The managers are not ‘smart’ so much as self-interested in growing their management fees above all else. Investors need to be aware of this before they buy in.