CNBC put out a story today with some data on advisor use of ETFs. Here’s the lede:
Fee-based financial advisors have been among the more enthusiastic users of low-cost exchange-traded funds for years, but their interest has dramatically increased since the financial crisis.
The latest survey of advisors conducted by the Financial Planning Association found that 88 percent of those surveyed now use ETFs, compared to 40 percent in 2006.
This might be the most controversial thing I’ve written in a while, but I’m going to keep it real. It’s what I honestly think. No disrespect intended toward anyone doing things differently. If you’re able to manage what I’m about to describe in a way that’s satisfying to clients, consistent and rigorous, then god bless you – you’re a better advisor than I am.
Okay, here’s my rap:
Single stock positions don’t work in wealth management.
Managing individual names for separate accounts, in a scalable and equanimous way, is impossible the more I think about it. I have honestly come to believe that it can’t be done. We stopped trying in 2012.
Thank god. What a mishegas.
In 2010, as a newly-minted investment advisor representative (I had dropped my Series 7 brokerage license that year) I was buying some individual stocks for my clients.
The problem wasn’t that it failed. The problem was that it worked. A little too well.
They were all working out huge. Not because of me, because the market was recovering from a 57% decline and the economy was lurching out of recession. I bought Visa, which seemed to be going up every single day. I bought Berkshire Hathaway B shares, another home run. I bought JPMorgan, I bought Apple. These were meant to be a side dish, sitting alongside the main course – asset allocation using ETFs and ’40 Act funds.
All of a sudden, you’ve got a stock like Visa that was supposed to be 1% of a client’s asset allocation metastasizing – it becomes 2%, then does a stock split and continues to run. Now what?
“Tell the clients we’re taking some profits on Visa.”
But we still love Visa. How much do we sell? What if some clients don’t want to sell any? There’s a huge tax liability. It’s still going up.
“Let’s sell after the next earnings report. Not here.”
Wait – we have an edge on what Visa’s fiscal 3rd quarter is going to be relative to market expectations? I had no idea! Dope!
“One of our clients is asking if he should buy more Visa into the earnings. He thinks we’re leaving money on the table by not owning enough, now that we’ve told him why we’re so bullish on it. How should I respond?”
Well, I guess we can honor his request and own more. We’ll just have to open a separate brokerage account for that holding, so it doesn’t skew his portfolio performance versus the composite…it’s like a side pocket.”
“Okay, is that scalable though? What if every client wants a side pocket? Are we brokers now? Are we f***ing E Trade?”
And then we open some new accounts. “Welcome aboard! We’ll get you allocated this week.”
Now what? We bought one batch of clients Berkshire Hathaway at 70. It’s 105 and we’re trimming the position for them. So, the new batch of clients…you want to buy it for them at the same time as you sell it for the others?
“Yes. We need to right-size everyone’s holdings in each name.”
What happens if it keeps going up? We keep buying it for newly allocated accounts? If it’s 150 are we still buyers a year from now? 170? Is Berkshire permanent? What if the Old Man kicks it next year?
“I don’t know, maybe we say there are A accounts and B accounts and the B accounts don’t get Berkshire because it’s up too much. I don’t f***ing know…”
Half the accounts are taxable, the other half are tax-deferred…how do we factor that in?
voicemail: Hey, it’s Richard Morse. I need to pull about $20,000 from my joint account for a few months, we’re doing a new kitchen. Let’s take it out of Exxon, that stock ain’t done s*** for the last six months…
Listen, we have two brothers as clients. We bought Pfizer for the younger one but the older one needed less equity exposure so he didn’t get any. He’s asking why he couldn’t have had a little Pfizer too…
“Did you explain to him that he’s invested based on his risk tolerance and the funding of his future liabilities?
He wants Pfizer. None of that is getting through.
Do we actually know anything more about JPMorgan shares than the 50 sell-side analysts who cover it and the other 10,000 buyside shops who hold it?
“No, but we like the stock. Good dividend.”
Enough to make it a 1% or greater allocation for clients? What would make us change our mind? A price target reached?
“What’s this London Whale s***? It’s gapping down, do we sell out until the dust clears? Do we buy more? No one knows what’s going to happen, the company included. Is it responsible behavior for us to tell investors that we know how bad this will get considering that the CEO probably couldn’t even answer that question?”
“Hey, glad you’re back. We had a handful of clients who are asking about Apple. They want to know what we think of the new iPhone 4.”
email: I told my neighbor how much you made me in Mastercard stock. He wants to buy it through you too. He’s probably not looking for advice beyond that.
There’s some overlap in our core growth portfolio…Apple is 5% of the US equity exposure in the asset allocation model and then we made it a 2% holding on the side. Why do we want to be 20% overweight Apple relative to our benchmark?
“Because it keeps going up?”
And then what, when that stops?
“Good long-term position? I don’t know. Maybe we get out.”
Hey, Mr. Reynolds is on the phone. He’s not happy that we sold some of his Exxon and it went up.
“Mr. Reynolds is up 20% over the last 12 months…his plan only requires 4% inflation adjusted on an average annual basis to reach his goals…that’s 5x his needs!”
He knows. He’s thrilled with our performance, but he’s fixating on the Exxon trade.
“It’s .0005% of his overall net worth. Are you kidding me? What are we doing here?”
ETFs don’t completely fix all these issues – issues that, if left unchecked, will torpedo a relationship and cause the worst sort of behavior in a portfolio: Chasing, second-guessing, missing the forest for the trees, anchoring biases, focusing on the least important thing, falling victim to the endowment effect, buyer’s remorse, seller’s regret, etc. But they preempt a lot of them, from day one.
Sure, the popularity of ETFs can be attributed to costs, transparency, tax efficiency, tradability, advisors keeping more of the overall expense of portfolio management for themselves, optics, social pressure, etc. Tons of reasons.
But ending the madness of tracking, reporting on and obsessing over single stock positions is a big part of the story. The majority of advisors have no business implementing or managing these holdings. Unless it’s for cocktail party chatter or recreation. In that case, we advise clients to keep a small play account for themselves and stay the hell off margin. Have fun! Knock yourself out!
Jack Bogle: “The stock market is a giant distraction from the business of investing.”