Bond King’s Messy Exit

Financial advisors and the investment community were shocked this past Friday when Bill Gross, sometimes referred to as “the bond king” resigned from Pimco, a firm he founded in 1971 that rose to become one of the largest mutual fund management firms in the world.  Gross also served as fund manager for the $221.6 billion Pimco Total Return fund, and made frequent television appearances.

Although the move was surprising, it was not hard to find reasons for the departure.  The Total Return Fund had seen investor redemptions totaling $68 billion in the past 16 months, and more recently, Gross has been under investigation by the Securities and Exchange Commission on a charge that an exchange-traded fund he was managing had illegally inflated its performance numbers.  Prior to that, Gross publicly feuded with the man regarded as his successor, Mohammed El Erian, who had become a public face of Pimco with his book outlining a “New Normal” in the investment landscape.

Gross has taken a new position at Janus Capital Group, where he will manage a new fund called Janus Global Unconstrained Bond Fund in a new Janus office to be opened near his home in Newport Beach, CA.  Some have speculated that investors will pull more money out of the Total Return Fund and follow Gross over to the new fund, where Gross will have the total control that he sought, and was denied, in his later years at Pimco. 

Meanwhile, Pimco seems to be in good hands, with Gross succeeded by Daniel J. Ivascyn, formerly deputy chief investment officer.  The Total Return Fund will be managed by longtime Gross associates Mark Kiesel, Scott Mather and Mihir Worah.

What are we to make of all this?  Today’s mutual funds are typically managed under a team approach.  Gross was a throwback to an era when one manager would call all the shots and be rewarded (or not) according to whether his performance exceeded the market.  Over time, it became obvious that he was impatient with consensus decision-making, which simply means he was out of step with modern fund management styles.  It will be interesting to see if he is able to reproduce his (generally excellent) long-term track record in a more competitive market, particularly during this time period when the bond market has been dependent on Federal Reserve stimulus, which is winding down going into next year.  Many advisors benefited from Gross’s investment talents, but some are also undoubtedly happy to see Pimco Total Return managed in a more collaborative atmosphere.

Alibaba The Newest Largest IPO in History

Last fall it was Twitter.  Before that, it was Facebook.  Now it’s Alibaba, the huge Chinese e-commerce company that just became the largest tech IPO in history, after raising $21.8 billion in its initial public offering on September 18.

As it turns out, Facebook and Twitter turned out to be decent investments at their IPO price.  Post-IPO buyers purchased Twitter shares at roughly $45 a share, and over the nearly 12 months since, the stock has climbed to around $50--an 11% return that is below what the market as a whole has delivered, but above the negative returns most investors experience in the first year after a public offering.  Facebook has done better, starting life at $38 a share in May of 2012, following a very bumpy path that saw investors deeply under water for months, and then recovering so that shares are now trading around $75. 

Will Alibaba continue the streak?  Amid all the hype, one voice to listen to is veteran emerging markets analyst/manager Mark Mobius, of Franklin Templeton Investments.  Mobius acknowledges that Alibaba has some interesting fundamentals--including a return on equity of 24%, operating margins of 26% and revenue of $1.02 billion, making it by far the biggest e-commerce engine in China.

But he also notes that the company has an unusual corporate structure that could lead to problems for investors down the road.  He warns that the company’s ownership team controls the board of directors, which means that if shareholders are concerned about the direction of the company, or if the owners decide to loot the assets and put the money in their own pockets, well, there isn’t much shareholders could do about it. 

What, exactly, did investors buy in this IPO?  In most cases, IPO investors are purchasing direct ownership shares of the company.  But Alibaba is listed as a variable interest entity, which creates a somewhat more complicated ownership structure.  The bottom line is that shareholders, in this public offering, are actually buying a stake in a company registered in the Cayman Islands, which has a contract to share in Alibaba’s profits.  If shareholders ever became concerned about Alibaba’s management decisions, they would have to go to a Chinese court to get redress.  It is hard to imagine a positive outcome for American investors.

Along this line, it is interesting to note that the original plan was for Alibaba to go public on the Hong Kong stock exchange, but the Hong Kong regulators declined to allow it, citing concerns about (you guessed it!) the ownership structure and fairness to Hong Kong investors.  The New York Stock Exchange may have been more focused on a big payday than on consumer protection when it allowed the company to list in the U.S.

How many new financial plans and clients can a financial planner take care of in a year?

I’ve always had a rather altruistic view concerning the role and purpose of financial planning. In my opinion, a financial plan is a tool to determine the most prudent course of action. Just as a physician orders various tests to assist in the diagnosis, I consider the plan as the instrument which directs my recommendations. Therefore, I rarely render advice before I review the results of the plan.

I would hope that the majority of financial planners share this paradigm. I would also contend that there are several who do not and use the “financial plan” as a tool to increase product sales. The difference depends on the focus of the individual advisor. Either they are sales driven or advice driven. You cannot act in one fashion and profess another, although many do.

The issue becomes capacity. How many new comprehensive financial plans can one advisor generate in a year while still taking care of his existing clients? Remember, the more comprehensive the plan is, the lower the number will be. The general consensus at JP Morgan seems to be somewhere between 20 and 24 per year, according to an article in Investment Advisor magazine, written by Mike Patton. I would personally be hard pressed to do over 3 completely comprehensive financial plans per year and still be able to take proper care of my current clients.

Another relevant question is this. How often will you update a client’s plan? It took me several years to settle this issue, but a few years ago I decided that updating each part of a client’s financial plan every 2 to 3 years, during periodic reviews, works best.  However, this can often get preempted during periods of time like the 2008 market meltdown, when a client’s needs are much different than during good times. I inform clients of this at the beginning of our relationship so they will know what to expect.

Here’s the challenge. As the number of planning clients increase, so do the number of plan updates, after a few years it can become problematic. For example, let’s assume I have 64 clients and gain 3 new planning clients each year over the next three years. In year two you have 70 updates and 3 new plans to prepare. In year three, you have 73 plans to update and 3 new plans to prepare. Each year the task becomes increasingly difficult. I am beginning to sense this so I have been trying to streamline our processes, but at what point does the ability to take new clients or keep smaller less productive clients collide?

An Investment That Is A "Guaranteed" Loser

Why would any investment "opportunity" guarantee a negative return to its investors, who happen to be some of the shrewdest minds in the banking industry? 

This situation actually exists today--and the story is interesting.  The European Central Bank has recently dropped its bank deposit rate to -0.1%.  That means that if European-based lending institutions invest their assets in the Central Bank's money fund, they are guaranteed to receive less money when they take it back out again.  The fund is a guaranteed loser.

The comparable number in the U.S.--the return offered by the U.S. Federal Reserve to banks that want to park their excess capital in an interest-bearing account--is 0.25%.  That isn't very much, but many banks find it preferable to, for example, giving you a 30-year mortgage at around 4% (current rates, in other words) when the Fed's own economists expect the Fed Funds rate to reach 4% sometime in the next year or two.  This explains why $4.34 trillion in bank reserves are sitting on the sidelines at a time when our economy sorely needs an investment boost.  (You can see a graph of total reserve assets here: http://research.stlouisfed.org/fred2/series/WALCL).  And it also explains why people with excellent credit scores are having trouble finding a bank willing to finance their home purchase.

So why has the ECB dropped its own rate below zero?  By making it actually painful to park banking reserves, it wants to shake that sleeping money out of its accounts and back where it belongs: into the European economy.  The strategy appears to be working; the graph shows that reserves have dropped--very suddenly, since the announcement--to their lowest point since 2011.  This may be the only example in history where billions of dollars were invested in an investment "opportunity" that was absolutely, positively guaranteed to lose money.

GDP Good News or Bad News?

July joined January as the only two down months for the U.S. investment markets, and the month’s last week (down 3%) provided yet another exciting lurch of the roller coaster.  But if you put it all in perspective, July’s overall 1.5% decline is relatively small. 

One reason investors seem to be optimistic despite the market downturn is the report by the Bureau of Economic Analysis showing that the U.S. gross domestic product grew by a robust 4% rate in the second quarter this year.  This would represent a pretty large reversal from the 2.1% decline in the first quarter.

Any time the economy grows at a 4% rate, it’s an indication that we’re living in a terrific business climate.  But there is reason to wonder about that number and whether it reflects what many people seem to think it does.  For one thing, the final GDP figure will be revised at least twice between now and September.  These revisions can be significant.  The first quarter estimates initially came in at 0.1% growth, then were revised to a 1% drop, then a much larger 2.9% drop before the BEA revised it back to -2.1%. 

For another, the second quarter may have picked up some of the growth that was suppressed in the first quarter by the well-publicized weather anomalies.  Indeed, a big part of the final GDP number came in the form of replenishing inventories and stockpiles, not real spending, which grew by just 2.3% for the quarter.  (Of course, that, too, is subject to heavy revision.)

Job growth has been rising but the housing recovery, so robust last year, has stalled.  People are saving more and spending less.  Gas prices remain about where they were before the ISIS advance through Syria and Iraq.  Add it all up, and we are likely looking at another year of below-historical-average growth, rather than the long-anticipated economic takeoff which was originally projected for 2015 or, perhaps, later.  If the stock markets were buoyed by the comforting feeling that good times are here again, they may experience disappointment when the final numbers come in.

But, ironically, that may actually be good news for the markets in the longer term.  Fed Chairperson Janet Yellen is watching the economy closely for signs of overheating--for, in other words, signs of 4% or greater economic growth.  If the second quarter number is revised downward, and the rest of the year shows steady moderate growth, the Fed is likely to keep interest rates low, stimulating both the economy and the stock market, for the foreseeable future.