Hedge Fund Performance - nothing to write home about

Morningstar reports that the average hedge fund was up 6.12 % for the year through November 30. Most performance numbers for Hedge Funds are difficult to interpret even for market professionals and the headline numbers in isolation are basically meaningless as there is no clearly defined yardstick against which to measure it. 6 pct compared to what? how was it achieved? what risks have been taken? Investors are strongly advised not to fall for simplistic sales patter.

Many portfolios poorly structured

The portfolios of many investors are poorly structured. Their holdings are often concentrated in assets that are located in their home country or offer too much exposure to fashionable sectors or assets. To blame your investment adviser for such deficiencies means that criticism is addressed to the wrong target. Any financial services firm should control the asset allocation and investment strategy that is executed in individual client portfolios and should not leave these all-important decisions to the whim of individual customer service employees.

Do not blindly rely on regulators!

Investors are advised not to blindly rely on the fact that a financial services firm is regulated by some official institution such as the SEC in the USA or the FSA in the United Kingdom.While these two organisations may have somewhat sharper teeth than their mostly tame equivalents in other jurisdictions it does not mean that being regulated by them is an official seal of approval. The same can be said for any diploma, membership in a professional organisation or academic or other qualification the financial adviser may exhibit. One could even say that the more these are put into the foreground the more suspicious any potential customer should become as it may be a promotional tactic that is intended to impress and put wool over the eyes of the prospective client. Large organisations such as the 'universal' banks may appear to be safe at first glance but in their case they may trade too much on the belief that they are too large to fail. While they may indeed be safer in a moment of crisis that should not divert anyone from closely analysing their performance record.

Are Financial Advisers listening to their customers?

As study by EDHEC as reported by the Financial News "revealed that when portfolios are designed for clients, private bankers take market factors into account more frequently than client requirements". In our opinion this distracts attention from the real problem that exists in the relationship between investors and their financial advisers. We mean the insufficient ability to measure the performance that is produced by the investment firm. Of course it is important to attend to the customer's wishes but this should not become a convenient smokescreen to excuse poor investment performance. For example, who can blame the portfolio manager for doing a bad job when the customer asked him to be 'careful'? Clearly stated performance benchmarks that are easy to monitor should be the essential building bloc for any investment mandate and all other aspects of the advisory relationship should be arranged around this cornerstone.

Ireland, Hungary expropriate pension funds

The idea of putting one's savings into officially-sanctioned pension funds receives another serious setback when EU member states (or better their ineffective politicians) think that the only way they can save themselves from further fiscal and economic disasters of their making is the expropriation of pension funds that to all intents and purposes have been created to provide their beneficiaries with benefits during their years of retirement. Where are the regulators that are so busy sticking their noses into every aspect of our daily lives? Where is justice and democracy?

Did you agree to 'The Protocol'?

Nearly 500 US financial service firms have agreed to follow the rules stipulated by the 'Protocol for Broker Recruiting'. This specifies what practices are permitted when a financial adviser changes employment and what proprietary information they are allowed to take from an old employer to a new one. It must be noted that no one has considered the role of the investor in such a situation and information can therefore be passed on without the investor having a say in it. We advise to be extremely careful when the adviser changes employment and not to let emotions get the better of your best interest. In particular, as we promote the idea that investment performance should be on a transparent basis to allow comparisons between financial service providers, we doubt that any individual adviser will really be able to make a meaningful contribution to the performance of any investment portfolio. If his performance is substantially different from the model portfolio of his employer the adviser should set up shop under his own name.

And you think you can rely on your pension?

Pension cuts ruled out after backlash

for now your pension may be safe, but for how much longer?

Are Structured Products Suitable for Retail Investors?

Those who understand advanced financial market concepts may read the whole paper but for the rest of our readers we provide the conclusion:

Equity-linked notes are complex, opaque and expensive - and the more complex and opaque they are, the more expensive they are. Even with the best disclosure materials and the most thoroughly trained and supervised registered representatives, it is unlikely that retail investors can understand the risk-return tradeoff and the costs being incurred in some of the complex equity-linked notes and structured products currently being marketed. (Are Structured Products Suitable for Retail Investors? by Craig McCann and Dengpan Luo, Securities Litigation and Consulting Group, 2006)

Do you really need a 'comprehensive package of services'?

News that a major player in the international private banking world will offer clients of its new family office hub in Singapore a 'comprehensive package of services' causes us to remind readers that Private Banking Advisory argues for a long time that investors should focus more on transparent and clear performance records rather than on 'soft' aspects like the name of the tennis player who fronts the publicity campaign of the investment adviser or additional 'services' that would much better be provided at arm's length by professionals such as accountants, lawyers and tax experts.

Who benefits from this bonus program?

When the head of a large wealth management organisation openly states that adjustments to the bonus program for financial advisers mean that they get more pay if they reduce discounts offered to their customers it demonstrates that the interests of clients and advisers in many financial service firms are far from being aligned. In the same interview the manager also admits that advisers are being asked to sell more products to their customers. This also is in many cases contrary to the best interests of investment clients. Both aspects underline the need for impartial and disinterested independent advice when dealing with brokers and financial service providers that are working on a commission basis.

Madoff Fraud - the absurd gets even absurder

Not enough that regulators have ignored warnings about the Madoff Ponzi scheme for many years and that many advisers were negligent - if not fraudulent - when they advised 'clients' to put their money into Madoff-related investment vehicles, now even many of those investors among their customers who had made positive returns from their investments before Madoff crashed are being pursued by those same advisers for the return of their profits in order to allow the intermediaries to be able in turn to satisfy the claw-back demands of the bankrupty administrator (who in the meantime is running up an amazing amount of fees for himself). The lesson for the investor is: do not rely on anyone with a financial interest in your investments uncontrolled authority over your affairs without taking unbiased advice from a truly independent and trusted adviser - and do not wait for the regulators to help you either when things go wrong.

Another Government grabs private pension savings

The Hungarian government takes a leaf out of Argentina's books and has announced that it intends to confiscate part of the private pension savings of its citizens. We have cautioned for a long time to consider all options carefully before relinquishing control over one's savings. The laws in most jurisdictions make it very difficult - often impossible - to withdraw funds from pension plans before a certain age. Even after retirement access is carefully prescribed. If the increasingly desperate governments in most countries can no longer be trusted any commitment of funds to pension plans should be carefully evaluated.

Kafka alive and well in US Government

The absurd consequences of the obsession with fighting symptoms rather than causes and increasing the reach of government and civil servants at all costs is demonstrated by news (Wall Street Journal, 20 Nov 2010) that major US banks are intimidated enough to refuse to conduct business with a large number of foreign embassies in the USA. In countries such as the UK opening a bank account is a major burden for consumers and achieves no demonstrable benefit in terms of fighting crime or terrorism. The costs of complying with regulations that become more complicated by the day is immense, not only in direct costs related to the governmental enforcement agencies but also in terms of additional staffing in financial service firms.

Lunatics running the asylum?

This expression comes to mind when reading the judgement concerning the repackaging of a repackaging of notes that represented an interest in an investment fund. Anyone who thinks that the activities described in the judgement represent more than a pass-the-parcel round trip designed to harvest fees at every stop at the expense of (which?) real investors may well be the right candidate to be sold in-transparent investment products in the future. Anyone who scratches his head and asks: 'What does all this have to do with sound long-term investment?' is well advised to be wary of overcomplicated investment vehicles and scrutinise the costs and risks associated with his investments very carefully.

Are you a client or a customer?

The question at first may appear to be irrelevant but think again. If your financial adviser treats you as a clients he should have your interests at heart, if he treats you as a customer he probably will have more interest in his commission than in the performance of your investments. What lesson can you learn from this distinction? First of all, make sure that the financial incentives for your advisers are aligned with your own interests. Then beware of all 'products' that advisers try to sell to you. It is always better to measure the value of advice on a 'holistic' basis and be wary of piecemeal advice that comes in dibs and drabs and were the advisers are not responsible for the overall performance of your portfolio.

Conflicts of interest at bank-owned funds

A new study highlights possible conflicts of interest at bank-owned funds. While the study co-authored by Jose Marin and Benjamin Golez focuses at Spanish institutions another 2008 study by Massimo Massa and Zahid Rehman found similar conflicts at a wider range of investment management firms affiliated with banks. These findings highlight the importance of independent financial advice.

Governments wage war on savers?

Not only are taxes on investment income excessive in many countries but governments who support 'Quantitative Easing' (Cleartext: Money Printing) also threaten the very survival of thrifty pensioners and savers who rely on fixed incomes from their investments.

How much fees should you pay for a hedge fund investment?

In order to attract investors still smarting from losses incurred during the credit crunch and stung by what some see as unfair treatment by funds, some hedge funds have resorted to offer more flexible fee structures than the traditional 2 plus 20 formula that was the norm until recently. But are they a big enough move or should investors demand more than just a few percentage points off the performance fees (while at the same time being asked to commit their money for ever-longer periods)? If anything, required returns on investment should be higher in the case of illiquid investments and having to wait up to five years before being able to access one's money is not to every one's taste.

Are you ready for FATCA?

A major US investment bank was famously described as 'a great vampire squid wrapped around the face of humanity' but we would say that this description much better fits the US government. The recently enacted 'Foreign Account Tax Compliance Act' is another step back into the time when a citizen was treated more like the property of the ruler and could be taxed at will. Other countries would be well advised to prohibit their institutions from passing on any information to authorities in a foreign country. The whole idea of sovereignty of states is at stake when one country is allowed to apply its laws in other jurisdictions. If the US wants to make sure that it's citizens are complying to all tax laws the authorities are well within their rights to close the borders for capital leaving the country. From a practical point of view, FATCA means that investors have to take even greater care when selecting a financial advisor. Non-US investors are also in danger of being compromised by information flowing too easily from a compliant bank or money manager to the US authorities.

Fund of Hedge Funds - A critical view

A study of the performance of Swiss Funds of Hedge Funds throws light on the performance of a product that is increasingly recommended by Fund Managers and used in the construction of private client portfolios.

Ski Jumping, Soccer and Private Banking Advice

Do you know what the connection between these three items is? If your first reaction is: not much! then you are on the way to understand that you have to treat all kind of advertising by the financial advice industry with caution. The fees that are spent on 'image advertising' may be a welcome windfall for the 'personalities' involved in the publicity campaigns but - apart from indirectly being a charge on your investment performance - they will do little to make sure that the return on your investments is as good as it should be.

Don't mess with 'J.R.' - Larry Hagman wins arbitration case

News that actor Larry Hagman has won an arbitration award against the employer of his former financial adviser illustrates the importance of supervising the activities of any adviser. In this case Hagman and his wife were sold an expensive (and possibly unnecessary) investment 'product' and their portfolio was subjected to substantial turnover which implied a high level of fees and commissions. The case also illustrates that is is not enough to rely on the image/reputation of the employing bank or fund manager - sponsorship of sports or cultural events is no substitute for performance. Careful vetting of any new adviser should also be conducted and include the use of references and all other available information.

Formula 1 Driver as Private Banker?

Pedro de la Rosa has been appointed as figure-head for the new brand 'Santander Select' that is intended to cater for private banking clients with substantial assets. The battle for the opportunity to manage the money of the well-off threatens to become farcical when reputable and large banks such as Santander turn to sportspeople in order to increase their appeal to potential customers. Investors are well advised to remain sceptical about such (expensive) methods to attract their attention and instead focus on performance, costs and risk when analysing their existing or prospective investment advisers.

Fraud even the Specialists may find a challenge

The full complaint by the SEC against a hedge fund manager demonstrates in all its 46 pages how difficult it is even for specialised lawyers and auditors to detect fraud that may be perpetrated by intelligent and determined individuals. Every protection against abuse is only as strong as the weakest link and investors are well advised to get all the protection they can get.

Can an ETF collapse?

The ETF concept is spreading fast so it is useful to pause for a moment and consider possible risks that are not mentioned by the marketing men selling these products. When a headline such as this one catches our eye we therefore pay attention. It demonstrates that all investments carry some risk and investors are well advised to do their own due diligence rather than rely on marketing patter or recommendations by 'friends'

Still no end to conflicts of interest

One of the areas where PBA helps clients to navigate the investment scene is the prevention of possible conflicts of interest among the client's money managers. Recent trends in the regulation of financial service firms also tend to strengthen this aim. So it is with curiosity and surprise that we learn that a major player in the private banking industry has just taken a stake in a large hedge fund business (Credit Suisse pays $425 million for a 30 per cent stake in York Capital Management). The deal may well work out for CS - it certainly will for York's management. But Private Banking Advisory has reservations about a bank's investment advisers recommending in-house funds. While CS only owns a stake in the profits this creates a possible conflict of interest. And does a bank like Credit Suisse really need to buy access to a fund? If performance at York weakens what will the bank then do? Will the advisers still give preference to York's funds? and if there is no preference - as it should be - to begin with, why buy a stake?

SEC to examine Investment Advisors for conflicts of interest

Fund allocators in Private Banking and so-called Hedge Fund of Funds have traditionally been a major source of investment money that found its way into the Hedge Fund sector. Both sources are widely spread internationally and have been subject to little or no supervision and regulation until now. There is also scant disclosure of the terms they exact from the funds they allocate money too and many investors - especially private individuals - did not know to ask the right questions and were also kept in the dark. So we welcome the decision by the SEC to examine whether firms that collect fees for funneling investors into hedge funds are properly overseeing client money and dealing with potential conflicts of interest (Wall Street Journal, 10 Sept 2010).

Fraud: Keneth Starr stole $50 million

Not a day passes without a headline about another investment scam.

Fraud: another Mini-Madoff gets unmasked

Not even law enforcement personnel is safe from the attentions of investment fraudsters.  Wayne Macleod's ponzi harvested US$ 43 million from duped investors.

Dangers of Performance Pay

News that a highly risky mortgage bond has found ready buyers illustrates the danger of paying financial advisers or money managers a performance bonus. This type of compensation encourages fund managers to take undue risks. As it is not their own money that is at stake they find it that much easier to take risky investment decisions. Should things turn out well they are in line to earn a performance bonus. On the other hand, should the investment under perform or even turn sour they have still been paid their regular salary for the duration. With a bit of luck and the gift of the gab they may well find an excuse for the poor result by pointing to difficult markets. At worst they are losing the mandate or their job.

Los Angeles Jewish-Iranian Community hit by suspected $500 Million fraud

The roll-call of investment scams and frauds gets longer by the day. This story illustrates that it is not enough to follow recommendations by friends and acquaintances or to be overly impressed by appearances.

Private Bankers lured with huge guarantees

The somewhat stronger financial markets that we have seen after the markets bottomed out in March 2009 have led to a scramble to hire experienced private bankers away from their present employers. Large guaranteed pay packages are offered as incentive to move. Naturally, their new employers expect them to move many - if not all - their existing customer portfolios. These pay packages put enormous pressure on the candidates to convince their customers of the benefits of moving their accounts. Clients are advised to be on the defensive when they get told of the purported advantages of moving their money to the new firm as the banker has every incentive to paint things in a rosy light. Guaranteed compensation also tends to push employees to produce revenue (commissions, fee income on investment funds and other products) at any cost - often to the detriment of performance in the client portfolios.

More on the subject: Your adviser is changing firms. Should you follow? (Wall Street Journal)

Callable Snowball Floater - another confusing investment

The structured investment product world is full of technical terms that make even the heads of many a seasoned investment pro spin. But how many individual investors - sophisticated or not - really understand all the terms of the structure when they sign on the dotted line before parting with their hard-earned money? And if the investment is made on their behalf by investment managers - do these professionals understand them? We would bet that 99 percent of those putting money into structured investment products did not read the full prospectus - and even if they did they probably would not be much the wiser as it needs a mathematical PhD to look behind the scene and understand the risk-reward ratio and underlying fees. What is even more dangerous is when these products are given a tempting and innocuous sounding name such 'Guaranteed Investment'. As we have recently seen, nothing is guaranteed in the investment world, even the obligations of governments are subject to modification as demonstrated in countries such as Argentina. And who would put all his money into Greek government bonds now?

No protection for Hedge Fund Investors

At least that seems to be the prevailing opinion in Austrian courts where investors who lost their money in Madoff funds marketed by a major local bank are told that they had accepted that hedge fund managers are allowed to make any investment. By signing a customer agreement that points out that investments in hedge funds can lead to total loss they lost their right to compensation.

Use and Abuse of offshore fund domicile

An expert opinion just published in Austria comes to the conclusion that an offshore fund domiciled in the Cayman Islands but managed in Austria can still be seen as legally domiciled in Austria. This is relevant in case investors in the fund want to sue the fund managers for negligence. The legal protection offered in offshore domiciles is often much weaker than the protection offered in the investor's home country. Even if the legal situation is less favorable it is very expensive for any investor to sue in the tax haven. Investment managers that want to do the right thing by their investors would be well advised to dispense with such legal (and tax) trickery.

Beware of trial balloons in IPO valuations

All-too-often promoters of IPO's use a gullible financial press to spread valuations for their planned initial public offerings that have little bearing to reality. High levels are used to soften up the institutions and retail investors and 'anchor' their price expectations. Once these levels are widely disseminated in the media they become a self-fulfilling reality from which 'concessions' can be offered during the proper offering period. The media usually do little but report the headline number - without questioning how it is derived and whether it can be justified in the first place. While the ultimate investors behind the institutional shareholders have little influence over the actions of their 'fiduciaries', individual investors are well advised to monitor the participation of their fund managers very closely.

The problem with hedge funds

A new book that enthusiastically supports the idea of hedge fund investing may suggest to the non-specialist investor that these funds offer a road to riches. But while we do not want to stop anyone from reading a good tale in an entertaining book we want to point out a major problem for hedge fund investors. This is the regrettable fact that most of them do not really understand the risks that are involved in selecting funds. The marketing of Hedge Funds is often performed out of sight for the real end investor as intermediaries (in private banks and pension funds) are acting on a discretionary basis while bearing little of the ultimate risk themselves. Given the substantial cost of investing in Hedge Funds investors should employ independent advice before committing their funds and not rely on the judgement of those that have a financial interest in the transaction.

PS The title of Sebastian Mallaby's book is 'More Money than God'. This comes shortly after the confession by Lloyd Blankfein - CEO of Goldman Sachs - that he was 'doing God's Work'. Is there any connection between these two references to God?

How often do you have to check your portfolio?

An advertisement for a mobile phone application giving you instant updates on your portfolio is testimony to the increasing short-term orientation of today's financial markets. This is not the result for a real need expressed by investors but the outcome of a sales-driven culture that dominates the financial sector and seduces investors into excessive trading which creates a serious drag on the performance produced by investments.
Prices fluctuate from second-to-second and looking at these gyrations will only confuse investors. A sound investment strategy should instead focus on long-term targets and reduce costs and risks. Real-time quotes may have entertainment value but contribute nothing to the achievement of satisfactory investment results.

How 'independent' are financial advisors?

A new study by SEI discusses the concept of independence in the context of the money management business - with a special emphasis on retail investors and high-networth individuals. The study demonstrates that the customer of a money management firm has to understand the incentives of the advisor(s) in order to make sure that his portfolio is handled in the best possible way. When the chief executive of one of the leading investment banks and wealth managers states publicly that there is no moral obligation to take account of the customer's interests the importance of real independent advice becomes more relevant than ever.

Hedge Funds treat customers in discriminatory fashion

When even Antonio Borges, chairman of the Hedge Fund Standards Board (no, this name is no joke, though it is a misnomer if there ever was one), voices concerns about preferential deals offered to some investors and states that he "may" ask his member firms to bolster disclosure to other clients of the risks the practice poses, the lack of regulation in the hedge fund industry is laid bare for all to see. The "worrisome" practice used by more and more hedge funds of giving some clients so-called "side letters" and charging them a preferential scale of fees clearly demonstrates that the compensation and fee structure of hedge funds needs to be watched carefully by investors. These separately-negotiated agreements, which have attracted the attention of the UK's Financial Services Authority (FSA) in recent years, offer different investment terms to certain clients, some of which could disadvantage other investors.  We wonder why the FSA has not yet acted to protect investor's interests.

Be wary of forecasts and experts!

During a recent clean-out of the library I came across the following gem: In a review and comparison of the US and UK housing market published in 2005 the 'experts' came to the conclusion that 'there is no significant macroeconomic threat to home prices if our forecasts for interest rates and income growth pan out'. We can only say 'if the word if would not exist all forecasting would be much easier.

Former taxi-driver convicted for £37 million investment fraud

Investors were promised five-fold return on their investment.

Operational Risk often neglected

Most investors are focused exclusively on the quest for securing the best financial return on their investments. But recent developments have highlighted the need to ensure the safe return of the investment. Several prominent banks have been found wanting in protecting the confidentiality of client accounts held by their Swiss Branches. While no money was reported to have been lost as a consequence the fact that client records could have been transferred to a CD and the information offered to governments in surrounding states should set alarm bells ringing among investors. If it seems to be easy enough to steal customer data it may not be beyond some criminal mind to transfer money from client accounts. Clients are advised to conduct thorough due diligence on the operations of any bank or money manager they entrust their investments to. Slick advertising, tips from advisers or friends should not be the sole basis of picking a firm.

Confused by experts?

At any time you can find prominent experts predicting that a market will go up and the similar number of experts predicting that the market will go down. Now we all know that this is what makes markets and as a consequence one should never pay too much attention to any one opinion. But when George Soros states that gold is in a speculative bubble and at the same time his funds increase their long position in gold substantially one has to wonder why one should consider expert's opinions as more than background music.

Are Regulators asleep again?

There is still more talk than action in banking reform. We do not seem to be alone when making this observation. Volcker rule, Basel III, contingent capital - all these buzzwords are worthless if nothing gets implemented at some stage. News of generous bonus pools give the impression that all is back to normal in the banking world but when we had a look at the capital ratios of some large banks we were genuinely surprised - if not shocked - about the abysmal capital ratios that some of them reveal. Balance sheet totals seem to expand and the simple ratio of pure equity is in the low single-digits, and falling! So investors have to be more vigilant than ever when deciding how to allocate their investments. More than ever it is not the return on the investment that counts but the return of the investment.

Are there still any 'safe' Investments?

This question is often asked these day. And with good reason. A large part of investable assets are the debt obligation of states, regional governments, companies, private individuals and banks. While most bank deposits are guaranteed by governments that just pushes the ultimate responsibility for the repayment of bank deposits further up the chain. Only property, company shares and gold are assets that are not the liability of someone else. This explains the resilience of these assets in face of a shaky financial outlook.

Financial Adviser taken hostage

A group of German senior citizens took a financial advisor hostage that they blamed for causing them a loss of Euro 2.5 million. Now while we do not condone this behavior we do at least have some understanding for their frustration with the legal and regulatory system that all-too-often is slow moving and seems to favor those perpetrating investment frauds. It also seems only fair to use extra-judicial methods to get your money back when the governments of several countries seem to be willing to buy supposed bank details that were obtained illegally. (We stress the word supposed as they data may well have been created out of thin air in order to cash in on gullible tax authorities or to get even with people one dislikes).

Who stands behind failing Hedge Funds?

News that a number of - sometimes quite large - hedge funds are moving their operations to Switzerland or other locations (or are in the planning stage) in order to help their promoters or employees avoid taxes they deem to be excessive raises the question of the new host country's ability (or willingness) to stand behind the funds if they get into trouble. As the example of Iceland has shown, the size of the host country should stand in a reasonable relation to the size of the financial institutions that the regulators of the country have to supervise. In case of fraud or other malfeasance investors are well-advised to study the small print in the legislation regarding the regulatory structure of the host countries: Does regulation involve more than box-ticking and are investors able to claim compensation from a well-financed scheme in case of fraud or default?