Unlocking Real Value Blog

It’s time for my annual review of my predictions for the year. In a few weeks, I’ll try again to predict what will happen next year. Overall I did okay for the year – the big miss being my negative outlook for the stock market. Who knew? More reason to be thankful that I don’t make my living looking into a crystal ball!

(See bolded comments after each prediction)

As 2012 comes to a close, it’s time to make predictions for next year. With no election, I at first thought it might be difficult to come up with predictions, but as I began to write down some ideas, I found that there is indeed a lot going on worthy of discussion. Unfortunately, I am anticipating a difficult 2013, in large part driven by political uncertainty here and abroad. Here goes:

10 – Regardless of how the current fiscal cliff negotiations end (I am thinking there will be a small deal to get us through either just before or just after Dec. 31), no grand bargain will take place next year – on either tax reform or entitlement reform. Obama’s continued campaigning to rally public support for his ideas has ensured that Republicans will do almost anything to block him next year. Not saying that this behavior is right – it’s just inevitable. I turned out to be right on this one – there was no grand deal, but we got through the fiscal cliff alive with less negative impact on the economy than predicted, and virtually no impact on the stock market.

9 – The one area where we will see major legislation is immigration reform. The Republicans desperately need an image boost here, and so this is the one exception where the two parties will work together to pass something. (Given the events in Newtown next week, there will be some movement on gun control, perhaps a ban on assault weapons, but more far-reaching gun control will be hard to attain.) Half right here – nothing on either front as we had a Congress that did almost nothing (but fight!). We have passed on major reforms once again. Immigration could hurt the Republicans next year – more on this in my 2014 upcoming predictions blog.

8 – The Euro crisis will deepen once again after a relatively quiet 2012. Italian elections could become a farce, and Greece, Spain and Portugal remain trouble spots. I don’t see any exits from the Euro in 2013, but I do expect more dissent from the populaces of the Northern European countries. Kinda right in that no countries exited from the Euro, but overall the crisis did not deepen. I will say, however, it did not get much better! Southern Europe remains a problem, and well Italian politics, what can you say? Greece’s credit ratings were recently raised, providing some hope for the future.

7 – By the end of 2013 Hillary Clinton will strongly signal (if not outright declare) her intention to run for President in 2016. Not sure what to say here – she kinda did and kinda didn’t – but her husbands recent criticism of Obamacare does signal a break from the current Administration – which does signal a run …..

6 – Merkel will win re-election in Germany, but her victory will be very small and her party will be weakened as German voters show their displeasure over the continued drain the Euro crisis is having on the country. She won – and rather convincingly on the public vote – but she had trouble putting a coalition government together, and just did so after months of negotiation; her new government will certainly be weaker than her current one. But she is regarded as the strongest European leader (by far).

5 – The stock market will be down for the year, perhaps by 10%. I think January is going to be a very tough month as realty sets in that the country’s finances are in real trouble. Even if the fiscal cliff is partially solved, it will hit home that tax rates are going to go up (in part because of some of the provisions of Obamacare going into effect) and people will realize that the recovery is not as strong as believed. Encouraging employment numbers will reverse, and the reality will set in that the numbers have been skewed by more people leaving the work force – which is not a positive sign. I was dead wrong here! Despite a still struggling economy, the markets have had a great year. I still am somewhat surprised by this – but luckily I only bucked the trend for part of the year – admitted my mistake and moved on!

4 – The US economy will not go into a major  recession, though it may come close and may even technically experience a minor recession. As stated above, I see growth slowing. I also see declines in consumer sentiment and business confidence, but I don’t think the slowdown will be enough to push us into a major downdraft. We did not go into recession, but overall growth has remained weak – we are stuck in a slow growth economy that still needs Fed intervention to keep it moving. That is and of itself is not a good sign.

Specifically for financial services:

3 – I do see a major deal being announced among the major wirehouses – Bank of America Merrill Lynch, UBS, Morgan Stanley and Wells Fargo. I’m not sure what it’s going to look like – perhaps a bank selling off its wealth management division – but something major is going to take place. This did not happen either. There were no major deals among the wirehouses, although there was quite a bit of movement in the RIA space. Overall, wirehouses have been experienced somewhat of a renaissance, as a lot of the negative press about them has abated. Banks are now the real bad guys!

2 – I see continued consolidation in the asset management arena, with a number of major deals being announced. Firms will continue to find it hard to go it alone, and will benefit from the operational synergies of combining forces. Perhaps it was the good stock market that encouraged many firms to stay independent – nothing like growth in AUM to increase optimism!

1 – RIAs will continue to make news by taking advisors from the wirehouses, but I think the wirehouses will hold their own and have a pretty decent year. The negative news about the brokerage arms of these institutions will continue to abate. This did happen – as mentioned above. 

Those are my top ten – but as I am doing them – I realize that I have to add two more:

11 – While I don’t see major changes to Dodd/Frank, I do think the banks are going to be beat-up on by Elizabeth Warren in her new role on the Senate Banking Committee. Bashing banks seems to be in vogue, and perhaps if my other predictions of other major legislation getting bogged down come true, the Democrats might use the banks as their way to show how tough they are. This definitely happened – and how scary it is to the financial services industry to think of her rise in the party – some even thinking she could challenge Hillary. More on this to come in 2014 and beyond.

12 – Alabama will win the BCS Championship and the 49ers the Super Bowl. You can’t have predictions without sports, now can you? One for two on this one – although the niners almost pulled it off.

Hardly a day goes by that you don’t see another fund company jumping further onto the retail alternative investments bandwagon. While this news is not all negative, as some firms are upgrading their educational capabilities along with their product offerings, I still fear that we are seeing the newest bubble in the financial services industry.

When everyone climbs on board to avoid presumadly being left behind, my worry antenna rises. I have nothing against alternative investments; they have been a very successful diversifier for many institutions and institutional investors for years. But I have also seen my share of very sophisticated investors who don’t understand them.

The latest onslaught of retail alternative investments news included:

1) AllienceBernstein has begun its largest ever alternative investments marketing campaign – which includes a road show targeted at major broker/dealers and investment advisor firms. On the positive side, their new website does include a quiz to test financial advisors on their knowledge of liquid alternatives.

2) In the past year, according to Cerulli Associates, fund companies added more sales positions related to alternative investments than any other area. More than 40 firms were interviewed for the study. The general belief is that more salespeople are needed to sell alternatives because it is a more difficult sale than more traditional investments.

But these trends back the idea that supply is leading demand. Despite all of the efforts of fund companies to grow this marketplace, with large numbers of new funds continuing to be introduced, growth remains slow. Again according to Cerulli Associates, alternatives represent just 2% of mutual fund assets.

Lack of track records and high fees, explain part of this phenomenon, along with the previously mentioned lack of advisor and investor knowledge in this area. But it worries me that fund companies continue to push and push, and invest and invest, and the question remains what the demand really is.

I don’t doubt the efficacy of the asset class, particularly for institutions. I do, however, question whether this retail push is indeed positive for individual investors. There are enough alternative investment funds out there for those investors who understand them and desire them. There is no lack of supply. Shouldn’t the lack of demand be telling us something? Are we going to listen to what the market tells us? Or are we going to strive to increase profitability at the expense of doing the right thing (again)?

I fear that the answer is not the one that is best for investors.

I was asked to write an opinion piece for Ignites Asia (A Financial Times Service) on whether Nomura’s exit from the open-ended mutual fund is the start of a trend in the Asian asset management business or an isolated incident. I believe that it’s an isolated incident and that growth opportunities still exist. To quote from the article:

“Nomura Asset Management (Nomura AM) had a number of things going against it when it entered the U.S. in 2008, as it:

• Entered just before the fall of Lehman Brothers and the onset of the financial crisis
• Overestimated the awareness and marketability of its name
• Failed to make the necessary investment in distribution and
• Chose to concentrate its offerings in the open-end mutual fund business rather than in alternatives such as exchange-traded funds. (It is continuing to operate two closed-end funds.)

I would find it hard to see any firm succeeding when faced with all those impediments. Some of the impediments were out of the firm’s control, such as the financial crisis, while others were certainly avoidable. And therein lies the lesson. I am not saying that it is easy to enter or succeed in the highly competitive U.S. mutual fund market or even Europe’s retail fund market. But there are still opportunities if firms enter the market with their eyes wide open, have a long-term time frame and have a sound distribution strategy.

Below are some of the key factors that will have the biggest influence on whether or not a firm succeeds outside the Asia-Pacific region.

Distribution – A key decision to be made upfront concerns whether asset managers are going to go it alone in distribution or partner with a more established firm in the given territory. There are, for example, opportunities to subadvise funds with proven distribution power as an alternative to putting the asset manager’s own network together in a foreign region.

Product choice – There will always be opportunities; managers just have to give the market what it wants. Nomura AM’s decision to primarily offer open-end mutual funds, particularly when any market observer could see the growth trend was in ETFs [exchange-traded funds], was in retrospect a mistake.

Patience – Especially if asset managers decide to go it alone on the distribution side, they must be patient in the best of times, let alone in the midst of a crisis and recovery.

Performance – I haven’t mentioned performance yet, but obviously you have to have good performance with a solid track record. I don’t believe performance is what caused Nomura AM to fail in this case. I hate to put it this way, but there are plenty of poor-performing funds out there that have amassed significant assets.

All in all, for all of the reasons cited above, I don’t see Nomura AM pulling out of the U.S. open-end mutual fund market as a signal of a change in the Asian asset management business. Instead, it should be looked at as a failed strategy on Nomura AM’s part coupled with bad timing and perhaps a tinge of impatience. Others should not take this move as an indication that the U.S. markets, or other foreign developed marketers, are over-saturated or too mature to explore. One can find promise in comments made by Nikko Asset Management’s CEO, Tokyo-based Charles Beazley, after news emerged about Nomura’s departure. Beazley told Ignites Asia that his firm is “extremely happy” today with its place in the North American market.

Nomura AM’s experience should be a wake-up call to other Asian firms wanting to enter the U.S. markets and should offer some guidance on what to do – and not to do – to be successful.”

Only time will tell.

Recent studies by two research firms confirm that the growth trend in retail investment alternatives is poised to continue:

• Cerulli Associates predicts that alternative mutual funds will represent 14% of the industry’s assets in the next 10 years, up from the current 2%; and
• Strategic Insights expects liquid alternatives to reach $490 billion by 2018, up from $237 billion at the end of August.

Those surveyed include managers, investors, advisors and industry executives. Cerulli also found that 25% of advisors they spoke to plan to increase their allocation to alternatives. What the implications of this growth?

The Good – investors will have more of a variety of funds from which to choose. Presumably, as the growth in retail alternative investments continues, so will the education process, of both advisors and investors, as will transparency. But I have commented before that I am worried about the growth of alternative investments in the retail space, because many investors have no idea what they are actually investing in. Advisors are also at risk if they don’t take the time to truly explain how hedges fit into a portfolio.

The Bad – while assets are forecast to increase significantly over time, up until now the proliferation of new funds has outpaced this growth. In 2012, for example, 101 alternative mutual funds were launched. While this number has abated this far, to around 30, I fear that this could be an example of the industry creating the demand – rather than the demand leading to product development. Some industry executives already see an alternatives fatigue setting in.

The Ugly – this trend proves to be the next bubble and further deteriorates investor confidence in advisors and the industry as a whole. The ugly word “derivatives” comes to mind – is the product development world getting ahead of itself again in creating innovate products that investors (and advisors) don’t really understand and may not truly need? Will investors balk when their hedged portfolios underperform in years such as 2013 and they fire their advisors, without ever giving their portfolios the opportunity to outperform in down markets?

My hope is that the many mistakes of the past will not be repeated, and that I am being overcautious. My fear is that I am right.

What do you think?

Advisors constantly struggle with the question of how to price their services. Rarely do you go to an attorney or physician who offers to discount their fees; so why should advisors? The answer is quite simple – they shouldn’t. But underlying this answer is the assumption that the advisor has clearly articulated his/her value added from the beginning of the relationship and follows through as the relationship develops.

This concept is often referred to as pricing your value. For example, should fee-based business be priced differently than commission business (for “hybrid” clients) that utilize both services? The answer depends on what services you are providing. If commission clients are getting many of the same services – such as asset allocation advice and quarterly reporting – on that portion of their business, the answer is yes; if they are not, the answer is no.

PriceMetrix, a leading industry pricing service and think tank know for the quality and depth of their research, recently released a study on whether or not advisors price the fee-based and commission portions of their hybrids differently – is one discounted as a loss leader for the other? The results showed that the answer is basically no – most advisors show consistency in pricing – either higher or lower than average; only 21% of advisors seemed to price the two kinds of services differently.

(The study included data from hybrid households with investment assets between $500,000 and $1 million and come from the PriceMetrix database that includes nearly 500 million transactions and over $3.5 trillion in assets.)

These results are encouraging in that they hopefully reflect that advisors are consciously deciding that they are worth their fee, regardless of the type of transaction. In the event that these results are just a coincidence, it’s worth mentioning a few golden rules of pricing:

• Advisors should clearly articulate to new clients their value added proposition and casually remind them of their commitment and follow through on an on-going basis;
• Fees and how they are earned and charged should be discussed upfront – if clients have to bring up fees before you do, you are probably going to be on the defensive for the duration of the relationship; and
• The type of investment – fee-based v. commission – should be irrelevant in pricing because you want to be seen as a solution provider rather than simply an order taker.