Paul Winkler: Welcome. This is “The Investor Coaching Show.” I’m Paul Winkler talking about money and investing. One of the things I do on this show is educate you as an investor through talking about the news of the week and investment research.
Blind Trust and Expectations
The reason I do this is because I believe blindly trusting the investment industry is not a good idea. It has never been a good idea. The industry has not necessarily been a great advocate for the investor as is evidenced by certain research.
We see it anecdotally when we look at investor portfolios. We see that they are poorly diversified, missing many different asset categories. Typically, funds are bought based on past performance—which, as I always emphasize, is not a good indicator of future performance.
Here’s the problem with investing based on past performance: Investors end up buying after it’s already done well, and they weren’t there when it did well.
They did the research by looking at when money flowed in and when money flowed out in an attempt to estimate what returns actually were for investors in equity mutual funds and asset allocation funds and things like that. What they found is that investors would, after something did well, think that since it did they ought to buy it.
Then after they get involved with it, there isn’t the performance they were expecting.
Expectations are everything.
If you expect a certain level of return and those returns are below what you expected, you’ll likely get frustrated and start to look for something else that has done better.
You can make the same mistake over and over again. Insanity is not an unusual thing. Then, after it does poorly and investors get out, it ends up going up and then the opportunity is missed. It just goes back and forth. That’s what happens with people.
You don’t want to be a rearview mirror investor, but there are certain things in the rearview mirror that you can learn from. You can learn where returns really come from by looking at what has happened historically.
So if we look at various market segments, what is the expected return? It is not driven by a fund manager’s ability to get in, get out, and buy the right companies. Asset categories tend to have a cost of capital, like a company that is more risky has to pay more to use your money.
Understanding Reasoning and Motives Behind Behavior
So in effect, what you are doing when you look for companies that have had great past performance or are performing well, they don’t have to pay much to use your money. I don’t care how popular they are and how much they’re likely to be successful, their success is already baked into their pricing of their stocks and therefore the expected return in the future may be actually lower than many other areas of the market because they don’t have to pay much to use your money.
Now that leads us to what’s happening with a lot of companies. You wonder what on earth they are thinking. It’s political posturing. You have to recognize that whoever’s in power in Washington, they can make your life a little bit difficult as a CEO of a company.
So you kind of understand it from the CEO’s perspective. We all do things, right? And sometimes we wonder why a person is doing what they’re doing.
Well, actually it makes perfect sense to them and you’d probably do the same exact thing if you were in their position. That’s just it.
People have to do things that are going to be best for their company.
They may talk a good game and you don’t know if these people believe in what they’re saying because they have to play the political game.
A lot of times companies will do things and jump on bandwagons so that they get lauded by the media. Because when the media is talking well of you, that’s free advertising, and when you’re a CEO of a company, you want all the positive press you can get.
You can have a few naysayers and people saying that what you’re doing is awful and all of that, but it doesn’t typically offset all the positive press that you’re getting someplace else. So you can see why they would engage in this type of thing.
But here’s the thing as the investor. I’ve never been a big fan of this type of investing, the environmental, social, and governance investing, or ESG investing, simply because I look at it as you’re looking at companies.
Maybe they’re well-run, great companies, but remember, if you own nothing but the greatest companies of the time, you have to pay a lot for them and then your expected return is lower. Historically that’s been proven.
Fiduciary Means What Exactly…?
Now there are companies that, let’s just go into a totally different direction, are putting out products that aren’t that great. Back in history, we call them value companies.
When they turned around the rates of return were incredible, and as you’ve heard me say before if you listen to the show, 96% of value companies in a 20 year period have outperformed growth companies.
What you’re doing with ESG is you’re investing all in growth companies, and the bigger they are and the higher the prices, the further they have to fall. So it can be very, very risky.
Just because someone claims the word fiduciary doesn’t mean they are guaranteed to keep your best interests in mind as an investor.
I am not a big fan of that rule. Not because I don’t think that the investment advisor ought to keep people’s best interest first, but the problem is they can’t.
What do I mean by that? If you look at the level of education it takes to become an investment advisor, the bar is not that high. Let me just put it that way.
I’ve got one guy that works here and he came to me one day and said, “Hey, I’m thinking about going and taking the test,” the one that would allow him to actually advise clients and be an advisor. He hadn’t worked here that long and I told him to go ahead.
Three weeks later he passed the test. In the investment industry, that’s the bar. But I don’t think that’s a high enough bar.
Investment companies pay for the potential advisor to go through it. That’s a problem.
Now, say you have a big investment firm sending one of their new employees to sell their stuff to the public. They send them to a school that tells the new employee that a lot of stuff that their employer is doing is really bad.
Then the employee comes back to the employer and now realizes the stuff they’re doing is bad. Do you think the employer would be really happy with the educational institution that just ruined their new employee from their perspective? No, I don’t think so.
Your Best Interests
They’re diplomatic so often with the information. They’ll teach some of the right stuff, but a lot of the stuff that they teach will be in alignment with what the employer actually wants the employee to learn.
So therefore what happens is the employee comes back with a little bit of confusion. They don’t know what the right answer is and because they don’t know what the right answer is, they’re not a harm to the company in terms of moving product.
It has been found that advisors make mistakes that harm even themselves when they have no incentive to do so.
We can look at that and see that the advisor didn’t know what they needed to know.
Therefore to keep somebody’s best interest first would be impossible for them to achieve. How do you hold somebody to a standard when they don’t have the high enough level of education to actually do what’s even in their own best interest?
It’s kind of like telling a GP or a brain surgeon to be the best heart surgeon that there is. The problem is that the heart surgeon, the person performing the heart surgery, is a GP and doesn’t do heart surgery. They may be very well educated and qualified but not qualified to do what you need them to do.
So with the fiduciary rule, what it does and the problem that I have with it is that it basically says: You’ve got to do what’s in the client’s best interest. Well, I see people come in and they’re working with fiduciaries, they’re working with companies that market themselves as having to keep the client’s best interest first.
They don’t have conflicts of interest or commissions or anything like that, yet they’re investing in ESG investing, they’re investing in gold, they have commodities in the portfolio, and they have zero expected return after inflation. They don’t really understand investing principles.
They’re actively stock picking and market timing. They’ve chosen mutual funds based on past performance and criteria that actually are not helpful in choosing investment vehicles. They’re not abiding by some of the research on how to put things together, investments that have lower correlations so that you keep the level of volatility down and you’re maximizing expected return for given levels of volatility.
Choose Your Investing Philosophy
Keeping best interests in mind is not really the intent of the rule. You can have people doing things that are not necessarily in the best interest of the client from a return perspective, but maybe you’re not front running.
Maybe you’re not buying something ahead of your client and then telling your client to go do it, or maybe you’re actually trying to choose a lower cost version of the investment vehicle or disclosing conflicts of interest. You could be doing things that would be in line with the spirit of the rule but are still not great for the investor.
Do I believe that stock picking and market timing are a good idea? No. If I believe that stock picking and market timing are a bad idea and I look at the academic research and see that it doesn’t tend to give good results, there’s a good reason behind that belief.
But if you are the client and want to be involved in ESG investing and cryptocurrencies, and that’s what you want your investment advisor to do, then you’ve chosen your investment philosophy.
Who’s to say that you wouldn’t be happy if somebody wasn’t doing that. Now even though statistically the research shows historically lower returns when you do that, it doesn’t matter.
You can choose your own investment philosophy.
You want that and that’s what you want somebody to do. As long as they do it in a low-cost fashion and meet all those criteria, they can manage your portfolio in what I personally would call an imprudent manner and still be abiding by it.
This is why it is so critical that you don’t turn a blind eye, and that’s exactly the problem I have with this rule is that investors think that being a fiduciary means they will keep their best interests first.
It causes, in my humble opinion, the investor to stop paying attention because they don’t think they have to pay attention because the advisor is being held to some standard. That’s a problem.
It is an issue that I think going forward is going to become more and more of a problem. More about that because like I said, there’s some eye-opening stuff out there right now regarding this type of investing and this is why I think it’s going to become worse before it gets better.
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