August 20, 2009
Since I began complaining about manipulation of the stock markets back on December 18, I’ve been comforted by the fact that a number of bloggers have voiced similar concerns. At such websites as Naked Capitalism, Zero Hedge, The Market Ticker and others too numerous to mention — a common theme keeps popping up: some portion of the extraordinary amounts of money disseminated by the Treasury and the Federal Reserve is obviously being used to manipulate the equities markets. One paper, released by Precision Capital Management, analyzed the correlation between those days when the Federal Reserve bought back Treasury securities from investment banks and “tape painting” during the final minutes of those trading days on the stock markets.
Eliot “Socks” Spitzer recently wrote a piece for Slate, warning the “small investor” about a “rigged” system, as well as the additional hazards encountered due to routine breaches of the fiduciary duties owed by investment firms to their clients:
Recent rebounds notwithstanding, most people now are asking whether the system is fundamentally rigged. It’s not just that they have an understandable aversion to losing their life savings when the market crashes; it’s that each of the scandals and crises has a common pattern: The small investor was taken advantage of by the piranhas that hide in the rapidly moving currents. And underlying this pattern is a simple theme: conflicts of interest that violated the duty the market players had to their supposed clients.
The natural reaction of the retail investor to these hazards and scandals often involves seeking refuge in professionally-managed mutual funds. Nevertheless, as Spitzer pointed out, the mutual fund alternative has dangers of its own:
Mutual funds charge exorbitant fees that investors have to absorb — fees that dramatically reduce any possibility of outperforming the market and that are set by captive boards of captive management companies, not one of which has been replaced for inadequate performance, violating their duty to guard the interests of the fund investors for whom they supposedly work.
Worse yet, is the fact that mutual funds are now increasing their fees and, in effect, punishing their customers for the poor performance of those funds during the past year. Financial planner Allan Roth, had this to say at CBS MoneyWatch.com:
After one of the most awful years in the history of the mutual fund industry, when the average U.S. stock fund and international fund fell by 39 percent and 46 percent respectively, you might expect fund companies would give investors a break and lower their fees. But just the opposite is true.
An exclusive analysis for MoneyWatch.com by investment research firm Morningstar shows that over the past year, fund fees have risen in nearly every category. For stock funds, the fees shot up by roughly 5 percent.
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Every penny you pay in fees, of course, lowers your return. In fact, my research indicates that each additional 0.25 percent in annual fees pushes back your financial independence goal by a year.
What’s more, the only factor that is predictive of a fund’s relative performance against similar funds is fees. A low-cost domestic stock fund is likely to outperform an equivalent high-cost fund, just as a low-cost bond fund is likely to outperform an equivalent high-cost fund. . . . As fund fees increase, performance decreases. In fact, fees explained nearly 60 percent of the U.S. stock fund family performance ratings given by Morningstar. Numerous studies done to predict mutual fund performance indicate that neither the Morningstar rating nor the track record of the fund manager were indicative of future performance.
Another questionable practice in the mutual fund industry — the hiring of “rookies” to manage the funds — was recently placed under the spotlight by Ken Kam for the MSN TopStocks blog:
In this market, it’s going to take skill to make back last year’s losses. After a 40% loss, it takes a 67% gain just to get back to even. You would think that mutual funds would put their most experienced managers and analysts to work right now. But according to Morningstar, the managers of 28 out of 48 unique healthcare funds, almost 60%, (see data) have less than five years with their fund. I think you need to see at least a five-year track record before you can even begin to judge a manager’s worth.
I’m willing to pay for good management that will do something to protect me if the market crashes again. But I want to see some evidence that I am getting a good manager before I trust them with my money. I want to see at least a five-year track record. If I paid for good management and I got a rookie manager with no track record instead, I would be more than a little upset.
Beyond that, John Authers of Morningstar recently wrote an article for the Financial Times, explaining that investors will obtain better results investing in a stock index fund, rather than an “actively managed” equity mutual fund, whether or not that manager is a rookie:
For decades, retail savers have invested in stocks via mutual funds that are actively managed to try to beat an index. The funds hold about 100 stocks, and can raise or lower their cash holdings, but cannot bet on stocks to go down by selling them short.
This model has, it appears, been savaged by a flock of sheep.
Index investing, which cuts costs by replicating an index rather than trying to beat it, has been gaining in popularity.
Active managers argued that they could raise cash, or move to defensive stocks, in a downturn. Passive funds would track their index over the edge of the cliff.
But active managers, in aggregate, failed to do better than their indices in 2008.
So … if you have become too frustrated to continue investing in stocks, be mindful of the fact that equity-based mutual funds have problems of their own.
As for other alternatives: Ian Wyatt recently wrote a favorable piece about the advantages of exchange-traded funds (ETFs) for SmallCapInvestor.com. Nevertheless, if the stocks comprising those ETFs (and the ETFs themselves) are being traded in a “rigged” market, you’re back to square one. Happy investing!
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Invoking Thomas Paine
August 24, 2009
In January of 1776, Thomas Paine wrote a 48-page pamphlet, entitled: Common Sense, in which he argued the case that the American colonies should be independent from Britain. He published the pamphlet anonymously, providing only a hint of authorship with the statement: “Written by an Englishman”. This aspect of Paine’s pamphlet brings to mind the debate over the issue of anonymity in the blogosphere, which became quite heated-up this past weekend. As it turned out, a writer for one of Rupert Murdoch’s newspapers, who uses the surname “Whitehouse”, targeted the Zero Hedge website, accusing its publisher (who uses the pseudonym: Tyler Durden — i.e. Brad Pitt’s character from the movie Fight Club) of being a fellow who was “banned from the securities industry” for making $780 on an “insider” trade. For whatever reason, Naked Capitalism’s Yves Smith (whose real name is Susan Webber) saw fit to write a posting (now removed from the site) critical of the “messianic zeal and strident tone” of the material at Zero Hedge, despite the fact that Tyler Durden has written many guest posts for her own Naked Capitalism site. She also criticized the use of pseudonyms by bloggers, particularly at financial sites — because the practice “raises questions about credibility”. She differentiated her own situation with the explanation that her true identity could be ascertained with only “a modicum of digging”. Making a point more supportive of Zero Hedge, she shared her suspicion about the motive behind the attempt to identify Tyler Durden as a disgraced trader:
Ms. Smith (or Webber) believes that “Tyler Durden” is actually a pseudonym used by a number of writers at Zero Hedge.
As a result of that posting, Naked Capitalism lost one of its best contributors: Leo Kolivakis of Pension Pulse, whose final contribution to Naked Capitalism can be found here. Mr. Kolivakis then immediately joined the team at Zero Hedge, providing this explanation. When reading his posting, be sure to read the comments, which are always entertaining at Zero Hedge.
I enjoy both Naked Capitalism and Zero Hedge and I will continue to keep them both on my blogroll, despite this dust-up. In response to the intrigue concerning the identity of Tyler Durden, his cohort, Marla Singer submitted this proposed op-ed piece to The New York Times, reminding readers of the anonymous writings by Thomas Paine.
This past weekend brought us another invocation of Thomas Paine, with the publication of a piece entitled: “Common Sense 2009”, which appeared in The Huffington Post. The author did not conceal his identity, since he has made a point of generating controversy about himself throughout his life. He was none other than Larry Flynt. Flynt began with the explanation that last fall’s financial crisis was caused by the fact that “the financial elite had bribed our legislators to roll back the protections enacted after the Stock Market Crash of 1929”. He rightfully criticized President Obama for attempting to lay part of the blame for this disaster on “Main Street”. Beyond that, he noted how Obama continues to facilitate the same bad behavior that started this mess:
Larry Flynt then offered a bold solution to break the hold of the plutocracy that has been controlling our country for too long:
This initiative is a much more effective and constructive use of populist rage than what saw at recent “town hall” meetings and “teabagging” events. Besides: If anyone knows what can and cannot be accomplished by “teabagging” – it’s Larry Flint.