June 13, 2016
What We’re Reading this Week
Jonathan Mathew was accused of manipulating Libor rates along with his colleagues Stylianos Contogoulas, Jay Merchant, Alex Pabon, and Ryan Reich between 2005 and 2007. Matthews was 24 at the time, a junior banker at Barclays, and still living with his parents. His partners in crime were derivatives traders and more senior staff. Early on in the case, his defense focused on his junior status at the bank and the fact that he did what he was told to do. His boss said change Libor, so he did. The attorney said, “No one ever told him what he was doing was wrong, no one ever criticized him.” Incompetence is an interesting defense, but I don’t think it really exonerates him. It must not be working because his attorney has taken a more aggressive tactic over the past few months. Instead of asserting malignant ineptitude they have decided to convince the court that Matthews wasn’t just doing what he was told, but was actually too stupid to have committed a crime. His lawyer stated that Matthews has only “average intelligence” and “Truth be told, Jonathan Mathew is no mathematical genius, he’s not a brilliant man, nor was he cherry picked by Barclays.” Ouch. I suppose it beats being convicted of conspiracy to commit fraud but can you imagine trying to get a job after that? When asked if he was the guy that manipulated Libor, what will he say? “No, I wasn’t convicted of that, the court ruled that I just did what I was told.” So you never learned basic principles of your job?” “Well, I only have average intelligence.”
Wall Street Cred
Earlier this month Harvard Business School Dean Nitin Nohria wrote an op-ed for the Wall Street Journal called “Imagine an Economy Without Wall Street”. The article defends the value position of Wall Street against John Bogle’s (Vanguard Group founder) new book “Makers and Takers: The Rise of Finance and the Fall of American Business.” Bogle fired back with an article of his own. Full disclosure, I haven’t read the book but by reading both pieces it’s pretty easy to guess the premise. Mostly because Bogle spells it out, “as finance has nearly quadrupled in size as a percentage of the U.S. economy over the last several decades, business has suffered and economic growth has slowed.” There is a lot of back and forth about what Wall Street does and when it wins and when it loses, but Bogle’s final point is a good one. “What we need isn’t a financial system that’s bigger. What we need is a financial system whose primary function is to support real Main Street business.” It’s very easy for retail investors to understand that financial intermediaries charge fees and that hurts them, but it is an extremely shortsighted view. With such a strong focus on short term profits and stock market performance, many companies in the US have turned to sacrificing long term goals for shareholder approval. When they can’t do that they utilize creative accounting methods to manipulate company performance. Not that Bogle doesn’t address the bigger issue, it’s just refreshing to see people talking about it in a meaningful way.
Everything Old Is New Again
It seems like just yesterday “robo-advisors” were disrupting the financial services industry by replacing human beings with computers that would trade based on modern portfolio theory. Now “ETrade Financial Corp. is launching a robo-adviser, with a twist: human beings.” Ummm, ok. Many firms have created their own version of a robo-advisor investment platform for clients. From established firms like Schwab to new comers like Betterment, everyone is jumping on the passive, low-cost investment train leaving many humans in the industry to wonder, how will I fit in to this? One strategy is to actually use real active management, like we have done at Gainplan. Another strategy is to bury your head in the sand. ETrade has decided to play nice with the robots. Typically, robo-advisor platforms use low cost index funds, chosen and reallocated by an algorithm to mirror a client’s risk level with (hopefully) less fluctuation in performance. At ETrade “deep in the gears of (their) robo-adviser, people are fully in charge, defying contemporary investing trends.” No. There are still plenty of firms where people make trades. The robo-advisor trend has only just begun. ETrade hasn’t defied anything yet. I understand that one day, when the robots have taken over, human portfolio managers will start a new campaign to prove investing with a person at the helm is better. However, we should really wait until robo-advisors have more market share. The real lesson here is the fee compression. ETrade will use 2 core portfolios, one with higher-cost mutual funds and one with low-cost ETFs. The human element will cost .30% and the ETF model has internal expenses of .2%-.45%. So all-in the investor would pay .75% on the high end. This is more than half of what is typically seen in the industry, where an advisor will charge 1%-2% to put a client in a basket of mutual funds chosen by someone in their home office, with average internal expenses of .70%. The trend today is too many layers of management for what a computer can do for much less in fees. I will continue monitoring the ETrade offering but it so far it seems like more of the same.
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