"Where Are the Customers' Yachts? Or a Good Hard Look at Wall Street" is a great book by Fred Schwed Jr.
The title comes from the famous line asked of some stockbroker in the 1920s referring to all the yachts that were owned by wealthy customers of Wall Street investment bankers. I thought of that line last week after reading the Bloomberg News account of the epic battle between Merrill Lynch and Morgan Stanley. The two brokerage firms are neck and neck at about $1.5 trillion under management.
According to Bloomberg, each of these firms is on track to gross about $12.5 billion in annual revenues. Merrill Lynch has 15,000 sales people who each generates about $836,000 per year in revenue. Morgan Stanley has 18,000 sales people generating $682,000 on average. To collect $12.5 billion in fees on $1.5 trillion in assets amounts to an annual cost to clients just short of 1 percent.
Does earning 10 times what a money market fund pays seem a little steep? Large investors wouldn't be caught dead paying that much, so small investors must be picking up the slack by paying 2 percent to 3 percent per year -- the current charge on these firm's popular "wrap accounts."
If the average broker gives up perhaps a third of that roughly $800,000 to pay for office overhead and assistants, it still leaves him or her with enough to provide for a pretty eccentric personal lifestyle -- one offering some insulation from the major recession we've just endured.
This then begs the question, "What are these investment professionals accomplishing for their clients?" Overcoming a 1 percent fee hurdle (much less a 3 percent annual charge) is something that a few people may have done over a 10-year period, but it is next to impossible to know, prospectively, who might do it in the future.
Back in the 1980s, there was a statistic indicating that the average small investor lost money over any 5-year period when working with a major national brokerage firm -- and this was after one of the greatest sustained rises in market history. It would be interesting to know what that statistic is today.
Meanwhile, the average stock is held just six months, today where the same average holding period in the 1950s and 1960s was seven years. This churning of assets creates a feeding trough for the brokerage industry.
Which brings us to what the financial industry is really selling, and that's confidence. Whether false or real, we tend to put a premium on confidence. Nothing wrong with that when we're picking a defense attorney or a heart surgeon. We want someone who has a great track record that justifies the confidence they exude.
When it comes to money managers, we want to think we're dealing with experts, but in this profession, we can be fooled by a veneer of respectability when there's nothing tangible to back it up.
Sophisticated brain imaging experiments show that we actually stop thinking when we're in the process of receiving advice from someone we perceive as being an "expert." Other experiments indicate that we (at least some of us) will demonstrate blind obedience to authority.
Confidence combined with authority best describes what the investment institutions are selling. It's like when someone buys a drill, fundamentally they're buying the holes that they plan make. On the same fundamental level, large financial institutions are selling the ability to sleep at night along with the fantasy of a bountiful future retirement.
Wait a minute. Aren't these the same institutions that jumped at the chance, in 2004, to suddenly leverage themselves 30 to 1? Didn't they go broke and get driven into the arms of government-guaranteed institutions? How much do we think has actually changed?
A YouTube clip of that fateful SEC meeting allowing this leverage to happen ends with an SEC board member who actually says, "We think their self interest will cause them to control themselves "... so I guess we cross our fingers and hope this works." I can't understand why the American public still trusts these two companies with $3 trillion in assets when there are alternatives with better track records that behaved responsibly prior to, and through, the crisis.