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In the world of investments, the phrase “crowded trade” is used to describe a security or an investment theme that has attracted an unusually large number of participants.
As an investment idea becomes more and more popular, it attracts greater inflows of capital, but the fun never lasts forever. As contrarian investors, we want to avoid being the last person to arrive at the party.
Over the past ten years, we have witnessed extraordinary turmoil in financial markets, caused by a tech bubble, a real estate bubble, two stock market crashes and a full-blown financial crisis. U.S. equity markets endured a decade of flat returns for the first time since the 1930s.
All of this has driven investors into asset classes that salesmen promote as “safe.” Gold has surged. Bond mutual funds have delivered robust returns as interest rates have plummeted to the lowest levels on record. Alternative assets have become all the rage. And variable annuities, insurance-based investments that promise competitive returns with negligible risk, are experiencing vigorous sales. We believe that this phenomenon – the idolization of so-called safe investments – is today’s most crowded trade.
The most adamant fear mongers are focusing their marketing efforts around concepts like asset preservation, retirement income strategies and tax reduction. These buzzwords tend to be harbingers of a “can’t-lose” sales pitch that promises absolute safety on the downside while still registering respectable returns on the upside. A detailed analysis of these alleged cure-all products can illustrate that they are contrary to the best interest of clients.
A prime example of advisors peddling such products comes in the story of a market prognosticator named Harry S. Dent, Jr., the producer of a newsletter geared primarily toward financial advisors who are part of his HS Dent Advisors Network.
Dent says his predictions, which have swung 180 degrees from intense optimism to extreme pessimism over the past decade, are primarily based on demographic trends. His present prophecy centers around the aging of the baby boomer population, which he theorizes will lead to a collapse in consumer spending, the largest component of the American economy. Yet just over a decade ago he used the same baby boom demographic arguments to predict a savings-induced economic windfall, which proved stunningly inaccurate.
Mr. Dent’s track record indicates that he is an opportunist. Thirteen years ago, in 1998, Dent penned the book, The Roaring 2000s: Building the Wealth and Lifestyle You Desire in the Greatest Boom in History. Publishing a book about an imminent stock market boom during the sixth year of the biggest bull market in history undoubtedly helped Dent sell plenty of books. At the time, Dent’s bullish outlook confirmed the underlying optimism that existed in America. It probably also helped his followers sell aggressive investment vehicles to clients eager to cash in on the dot-com phenomenon at precisely the wrong time.
Dent’s most recent literary effort, published in September, is entitledThe Great Crash Ahead: Strategies for a World Turned Upside Down. In our experience, financial professionals adhering to Dent today are often pushing variable annuities as they foretell doom and gloom. (Variable annuities come with a variety of claims, but in reality they are frequently low returning, highly complex and extraordinarily expensive.)
Another, albeit less egregious, example of industry salesmanship lies in “absolute return” mutual funds. Although Morningstar does not have a specific category for these vehicles, it has identified roughly three dozen funds that adopted the term, according toInvestmentNews. Of these funds, only ten existed just three years ago.
The name “absolute return” is clearly designed to imply positive returns regardless of the market environment. But as any successful businessperson will attest, you can only garner meaningful gains when undertaking a degree of risk. Economic history has demonstrated again and again that there is no free lunch.
In the real world, where periodic losses are inevitable,InvestmentNews reports that just four of the 24 absolute return funds that were around on January 1, 2011 have produced positive performance through September. Once again, the industry has mass-produced ineffective products to play on the current hysteria among consumers.
Another crowded “trade” is the financial planning profession itself. Today, a sea of advisors with countless credentials, affiliations and specialties seek clients with one ambitious marketing effort after another.
The market for investment advice is among the most confusing in existence for consumers. Our advice is simple – insist on two things – modest fees and a fiduciary standard.
The fiduciary standard, which does apply to registered investment advisors (RIAs) like our firm, requires that we only recommend investments that we believe are in the client’s best interest. Furthermore, the fiduciary standard demands that we act with prudence, disclose all material facts (such as disciplinary records), disclose all fees and compensation, control investment expenses and avoid all material conflicts of interest. In the case that a conflict is unavoidable, it must be fully revealed.
Brokers and registered representatives, on the other hand, are subject only to a suitability standard. In other words, as long as a product or transaction is not considered unsuitable, they are generally permitted to put personal and firm interests ahead of the client’s.
For example, a broker who recommends a variable annuity for a client is under no obligation to select the lowest-cost, most understandable product in the marketplace. In fact, the broker may choose the most complex product paying the highest commission as long as the variable annuity is considered suitable given the client’s circumstances.
According to a survey of 502 RIAs conducted by TD Ameritrade in August, 90% said that they either added new clients or held steady in the past year. More importantly, 29% of these RIAs named the fiduciary standard as the primary reason why they earned the new clients’ business, outweighing any other rationale.
In a congested profession with a less-than-stellar reputation, it appears that the fiduciary standard is catching on as a means of ensuring that clients come first.