King Kong meets Godzilla. The January 10th issue of the Wall Street Journal discussed the comparison between Merrill Lynch (now B of A) versus Morgan Stanley as the two firms duke it out to gain supremacy and profitability in the asset management business.
Some interesting statistics in the article left anyone thinking about that old anecdote, “Where are the CUSTOMER’S yachts?” In very general terms, these firms together averaging around 15,000 brokers each bring in similar annual revenue of about $11.5 billion. That’s a little less than about $800,000 per broker per year. Reuters, in July of 2014, pointed out that one of the firms reduced the payout to brokers from 60 percent to 55 percent of the gross commissions and estimated that they were saving $880 million at a time when that firm’s numbers were obviously higher.
It’s a lot of money sloshing around. An experience I had recently offers a clue as to who is paying for it. I was asked to review the results of a retirement plan dinosaur which was a profit-sharing sharing plan with no 401(k) voluntary option. The employer contributed all the money equal to 15 percent of employees’ annual pay and the money all went into one pool managed by one of the above-mentioned firms. It was a pure expression of how the firm performed, because the fund had a starting balance at the beginning of each year, and an ending balance on December 31st audited by a CPA firm. Subtracting any net changes of inbound and outbound money so that we could isolate the changes in plan assets attributable solely to performance, we were able to calculate the year’s percentage return.
Those returns were as follows: 2012 / 11 percent; 2013 / 14 percent; 2014 / (-1) percent. (No 2015 audit yet.) By comparison, a popular mutual fund with a long-term Morningstar five-star rating holding a 60/40 mix of stocks and bonds had generated the following results AFTER ITS FEES: 2012 / 13 percent; 2013 / 20 percent; 2014 / 10 percent. The S&P 500 index was actually closer in investment composition to the mostly-stock brokerage account. Its returns were as follows: 2012 / 16 percent; 2013 / 33 percent; 2014 / 10 percent.
The problem for many individuals who have these managed accounts is that the money is spread out over hundreds of companies and mutual funds with small amounts as low as $10,000 in each. It would have been fruitless to analyze each investment to determine which ones to keep and which to jettison.
Obfuscation may be the whole point. Beyond this particular plan, I see individual accounts run by these major wealth management firms and the pattern seems to be comparable --- and incomprehensible. Apart from what is negotiated as a management fee, there are other fees that the firms extract that have to be hidden --- like the “order flow” fees from high frequency traders received by the brokerage industry that cost us all money in ways impossible to determine. But they generate hundreds of millions for the firms as described in the book “Flash Boys” by Michael Lewis. An acquaintance who worked with a major firm for two years, said that he was expected to earn at least two percent per year for the firm on managed assets (of which he would receive 60 percent or less.) and right there is part of our explanation. Mutual funds, by comparison are totally transparent with both their fees and performance history.
Anyone working with one of these major firms can do the same math and compare it with any equivalent mutual fund that mirrors approximately the same proportions of stocks and bonds reflected in their managed portfolio. Compare the beginning and ending balance for the year but subtract out any fresh deposits which would make the earnings look better --- and, don’t count any distributions which would make the earnings look worse. What’s left is the investment return. A missing 4 percent per year compounded can cost half or more of what could have been your nest egg in twenty years. Or worse yet, it is almost all of what you might have looked forward to as a safe 5 percent annual income distribution from a portfolio when retirement itself rolls around. Don’t let the rising market from 2009 to 2014 that made everyone look good lull you into a sense of complacency.