Your financial advisor is probably ripping you off…

Maybe not actually, but at the very least you are probably paying more than you should for financial advice. A Bloomberg piece recently covered a study looking at the median fees paid by individuals for advisory services. The study, conducted by Inside Information, looked at both fund and advisor fees individually and the combined total individuals are paying for financial advice. The results, shown below, speak to a financial industry where the good of  the client is secondary to profit motive.

The difference between paying 1.85% and 1.2% adds up to be huge over time, not even to mention the difference if your all in fees are nearer .6%. Assuming you invested $100,000 for 40 years with a 5% annual return, the difference between paying 1.85% and 1.2% ends up being  $100,790. That’s a huge hit. It gets worse if you lower the fees to .6%. If you paid .6% annually, in the simple model, you’d end up with  $553,384, a difference of $219,817 from the highest fee bracket quoted in the study.

This is not to suggest that investment advisors aren’t worth the money, at the right fee level they most certainly are, but rather that fees make an enormous in the long term prospects of an individuals portfolio and wealth. A quality advisor helps clients in myriad ways, and serve as a psychological buffer when the markets get tough.

There is good news though. On both fronts, advisor fees and funds fees, prices are coming down and should continue to do so. The shift toward indexing has reduced the fund fee burden for most investors significantly, and much like hedge-fund fees, advisor fees have also felt pressure from new and different models of providing financial advice. Individuals need to be prepared to grill a potential advisor about the underlying securities they suggest, since those fees often fly under the radar and can do as much damage as the advisors fee.

Greyfox Investors is committed to providing top tier service and advice at a reasonable cost. We endeavor to form lasting partnerships with our clients, not transactional relationships. If you are interested in learning more email

What happens when index funds eat the market?

I’ll preface this by saying, I employ primarily index ETFs for my clients as they offer diversified exposure to asset classes at a minimal cost. That said, it is interesting to consider the larger market effects of the ever larger move towards indexed investments.


Though indexed strategies have been around since the late seventies, their popularity has boomed since 2008, and they currently make up 29% of US markets, and that share is only expected to grow over the next decade. As you can see from the chart above, index funds have been gaining hundreds of billions of dollars each year. This growth begs the question of what effects large scaled indexing has on individual stocks and the markets in general.

The majority of the money held by index funds tracks ‘dumb’ indexes, or indexes that include stocks purely by market cap or some other rudimentary metric. This means most large US companies are held by the lions share of index funds. In an environment where assets are moving into index funds, these companies experience ongoing buying from the index funds regardless of fundamentals, financial performance etc. As Seth Klarman notes this process could create inflated valuations for companies of less than stellar quality, and when that happens the stock market’s ability to determine the intrinsic value of a company is diminished. Or said another way index fund growth is reducing the informational efficiency of the markets.

Why does that matter? you might ask. It reduces the value of owning quality companies, both when asset flows are pouring into index funds, and when they are pouring out (a more concerning problem). When assets flow into index funds en masse, the index funds work like a rising tide, lifting all stocks (all stocks commonly held by index funds). When the asset flows reverse, however, the exodus from index funds acts as a drag on all commonly owned stocks regardless of their quality. In short, it makes owning individual stocks yet more uncertain and subject to the whims of broader asset flows. For index investors it means less, but it could mean that valuations are getting stretched by the non-evidence based buying index funds engage in.

In the end, I don’t think this information is going to change the decision making of most investors, but advisors should be cognizant the potential risks for index funds are still not fully understood.



More evidence on the power of simple investment strategies

Simplicity and clarity of investment strategies are key parts of my investment philosophy and more and more data is starting to back up a low cost, broadly diversified investment plan. For instance, the New York Times just ran a story about Houghton College, a small college in western New York, and how their endowment outperformed Harvard, and the rest of the ivy league for that matter, during their last fiscal year. Houghton ditched their allocations to hedge funds, and instead invested in a broadly diversified set of low cost index and mutual funds. Their allocation was 76% equities (38% US, 38% International) and 24% bonds; A fairly aggressive positioning seeing as they had no hedging. During the fiscal year ending June 30, 2016 they were able to put together a return of 11.85%, as apposed to a negative ~2% at Harvard.

Similarly, Ben Carlson has compared complex college endowments to a simple three fund portfolio and found out-performance by the simple, cheap portfolio allocation. There are many reasons why institutional investors and high net worth investors often over-complicate their investment plans, and none seems more likely than the fact that simple advice isn’t sexy.

This belief that complexity correlates to quality is misguided at best and harmful to returns at worst. As it says on the front of the Greyfox website “Excess complexity is often a way to give the appearance of sophistication and frequently increases fees without increasing returns”.

There will certainly be times where complex strategies produce superior returns but I believe, and the data supports, that simple strategies will tend to outperform over the long term.





Great Piece on Financial Journalism

It is always important to remember that the financial media are exactly what they sound like, media. They are not fiduciaries, advisors or necessarily experts in finance; they are, however, entertainers who make their wages by getting page views…

Rethinking Active Management

Rethinking Active Management

Active equity management has been much maligned over the past few years as index funds continue to lower their fees and the track record of active managers has been less than impressive. There are many factors for the underperformance of active managers, fees, high equity correlations, markets not driven by fundamentals etc. But let’s make it simpler, beating your benchmark on a consistent basis is hard, really hard. That’s just the nature of investing. With fees on index funds approaching zero, perhaps it is time to rethink what compensation for active management should look like.


Starting with Morningstar’s Large Cap Value mutual fund universe of 1390 funds, I filtered for those funds with 10 years of returns to analyze and I cut out all but the lowest fee share class, leaving me with 163 Large Cap Value mutual funds. Now these are mainly institutional shares that most regular investors are not able to access.  I compared this set of managers to the Russell 1000 Value from 2005 to 2014. Overall, only 43.5% of managers were able to outperform the Russell 1000 Value during that 10 year period. What’s more Dimensional Fund Advisors the broad universe of equity mutual funds and found that outperformance over long time periods was even lower than 43.5%. Their data ends at the end of 2014 and shows over a 15 year time span, if take survivorship into account, 19% of mutual funds outperform their benchmark.

*Source: Dimensional Fund Advisors


These findings are coupled with a paper out of Oxford[1] examining the performance of investment consultants. These consultants help the largest pensions in the United States choose which managers to hire and fire. The authors found that, when selecting US equity managers, the consultants not only do not add any value, they actually detracted value with their selections.  To put it briefly, the highest paid consultants in the US cannot add value by picking managers, why should we expect different from advisors.


With results like these, it is no wonder investors have been jettisoning active managers in favor of cheaper and often more successful index funds. As you can see below the trend towards passive management has been growing for over a decade.

*Source Morningstar


The question to consider is whether we should abandon the idea of active management or if there is a way forward where active management works for investors?


I would argue the latter. I believe reframing the way we think about active management fees can make active funds more attractive to clients and improve performance. With index fund fees reaching for zero, I believe active managers should only be compensated for performance in excess of the benchmark.  In the days of yore managers could justify charging an annual fee for active management because you could not go out and buy the index ETF. I propose a fee structure where the manager is paid a percentage of their annual alpha (outperformance compared to benchmark), and that fees are paid over three years to smooth out manager income.


Using the group of 163 Large Cap Value managers I mentioned above, I compared the performance and fees collected from 2005 to 2014 using the standard fees of each fund and using a 0% base fee and 25% performance fee paid over three years. Overall, if the 163 funds used the proposed fee structure, 95% of funds would charge less, and 95% of funds would have earned their investors more over the 10 year period. The chart below shows how asset growth and fees using the performance fee only methodology compare to the current model.g1

This chart breaks out the 163 funds into four groups, with the first quarter having the best performance during the 10 year period. Fee savings are shown on the left axis and the difference in asset growth is shown on the right axis. For the top quarter of managers, using a performance fee only fee structure would have, on average, lowered investor fees by 38% and increased total asset growth by 3.5%. As you can see the results become magnified as we move down to managers with lessor performance. Switching to a performance fee only model would increase the percentage of managers who would outperform their benchmark from 43% to 53%. This is a significant increase, but still leaves something to be desired.


As you can see below, across each performance quartile transitioning to a performance only model would have increased 10 year returns by a meaningful margin. The lines labeled T represent the average performance of the quartile using the current fund fees. The lines labeled GF represent the average performance of each quartile using the performance fee only formula proposed above.g2

There are caveats for manager and client. For the client there are financial constraints as it would currently only be open to qualified investors per SEC rules. For the manager; they would have to assess the reward of providing a product more in line with investor goals and more honestly priced, with the risk of lower revenue and potentially less consistent revenue.


I for one believe in a performance only model as it better aligns the interest of the investor with the interest of the manager and makes compensation commensurate with actually adding value for the client.


Nathan Wallace


New Evidence on Performance of ESG Strategies

The jury has been out for some time on whether using socially and environmentally responsible investing adds to or reduces investor returns. Papers over the past decade have shown evidence in both directions. Many investors would like to use ESG and SRI strategies, but if there is a chance of reduced returns it makes it a hard pill to swallow. New research from the Journal of Applied Corporate Finance Tim Verheyden, Robert G. Eccles, and Andreas Feiner argues rather persuasively that avoiding companies that have very poor ESG scores does indeed add value. The column in the middle shows the performance of a global portfolio that avoids the bottom 10% of stocks based on ESG scores. As you can see returns are slightly higher and the volatility is ever so slightly lower. esg1

What the data makes clear is that from a purely theoretical perspective, yes, ESG screening and investing can add to returns over time. What the authors fail to address is how the average investor can effectively act on this information, since most of us can’t go out and buy a global portfolio of 1,644 stocks (the size of Global All (10%) above) without going bankrupt on transaction costs alone.

The ESG fund universe suffers from an affordability problem. Due to the greater cost to assemble ESG portfolios, driven by data costs and maybe a bit of good old fashion profiteering, ESG funds are much more expensive than their non-ESG peers. Below is a list showing the costs of ETFs deemed to be socially conscious according to the Charles Schwab fund screener.


With an average fee of .54% annually, these funds are markedly more expensive than other index or pseudo-index funds offered by providers today. Most traditional index ETFs can be bought for under .1% annually, and given the gap in performance seen above (ESG outperforming by .3% annually), it doesn’t appear that investors can have their cake (ESG investing) and eat it too (Maximize performance).

Now, I expect this to change over time as demand for ESG strategies increases. A recent Factset survey of 1,000 high net worth investors found that access to ESG strategies was one of their main concerns. As interest in ESG grows there will be downward pressure on investment fees, just as index fund costs have declined as demand has increased, also forcing down the average fee of actively managed funds. But, much like active funds, there is going to be a floor on how low fees for ESG funds can go. Conducting the research on the environmental, social and governance merits of thousands of companies costs money, no way around it; and conducting quality research is vital to ensure the integrity of any ESG ratings system.

My question is whether we will see enough downward price pressure over the next few years to make the fee adjusted performance of ESG funds comparable to the traditional index peers, or if we will see a shift in investment priorities such that investors will accept the potential of slightly lower returns in exchange for investing in more responsible companies?


Diversification and Hindsight

Corey Hoffstein at the Newfound Research Blog recently posted a great article on diversified investing.

Diversification Will Always Disappoint

The key takeaway from my perspective is the acknowledgement that investing in a diversified portfolio can be hard emotionally. When you look at the past performance of a properly diversified allocation the performance you see will always pale in comparison to other investments you could have made (you could have just bought apple on the IPO and enjoyed your 16,000% return…). The challenge, then, for advisors is to articulate to clients why being diversified, even if it makes you feel disappointed when you look at past returns, is most often the prudent course of action.

Of late this has been quite a challenge as US stocks have so thoroughly outperformed other countries that selling a globally diversified strategy has been tougher than usual.


Despite this we know that the out-performance of one asset class does not persist in perpetuity, and even if it is painful investing in a diversified portfolio is our best hope of long term returns.


Nathan Wallace


Great piece by John Oliver on the retirement industry

This piece by John Oliver is amazing and sums up, in a much more entertaining way, my views on the current state of the retirement industry. John echoes many of my core values of investing for clients; reasonable advisory fees, low fee funds, honest and transparent process, and most importantly avoiding all the b.s. that is endemic to our industry.

Warning: video contains strong language.



Nathan Wallace

Momentum Strategies Work… Until They Don’t

In their paper “Momentum Crashes”, Kent Daniel and Tobias J. Moskowitz set out to build a better momentum strategy. After reviewing the research on momentum strategies for equities of the years they dive in and create a strategy that aims to avoid the periods when momentum strategies dramatically under-perform the markets:

We show that the low ex-ante expected returns in panic states are consistent with a conditionally high premium attached to the option-like payoffs of past losers. An implementable dynamic momentum strategy based on forecasts of momentum’s mean and variance approximately doubles the alpha and Sharpe Ratio of a static momentum strategy, and is not explained by other factors.

Their primary finding is that stocks that have done very poorly in a market downturn, often outperform when the markets turn around. They go on to explain this in a very mathematical fashion and suggest that:

in bear market states, and in particular when market volatility is high, the down-market betas of the past-losers are low, but the up-market betas are very large. This optionality does not appear to generally be reflected in the prices of the past losers. Consequently, the expected returns of the past losers are very high, and the momentum effect is reversed during these times.

To put in plainly, without the math, stocks that have been punished during a downturn often go on to out perform the market when the recovery starts. The junk rally in 2009 is a great example, the stocks most beat up in 2008 were some of the highest gainers in 2009.

In the end it is a pretty common sense finding, since much of what causes stocks to crater has more to do with psychological panic than real market fundamentals. It stands to reason that irrationally punished stocks will outperform when the market regains a modicum of rationality. We see this phenomenon all the time, particularly when high ranking individuals leave companies or their is a extra salacious headline out about a firm. These events make big news and move stock prices, but often don’t have the slightest effect on the true underlying value of a company.

What does it mean for investors? Not a whole lot unless you are looking to build a complex momentum model, but it does serve as a nice reminder that even in the midst of market chaos there are good opportunities to be had.


Full paper here


Mutual fund return persistence, Part 1: Large Cap Value

There has been tons of research as to the existence of true skill among mutual fund managers. Often researchers will look at advanced statistics and in depth breakdowns of holdings. While this research is interesting, I think it is simpler than that…. Do mutual fund managers actually make me or you more money than owning an index ETF? To me, if a manager can add value over 5 or 10 years then they are skilled in my mind. This proves quite difficult for most managers.

To start, let us look at Large Cap Value. Using Morningstar’s categories, deleting out all funds with fewer than 10 years of performance, and removing all share classes except for the lowest fee class (in an attempt to give mutual funds the best shot at looking at least decent), I come to a database of 163 Large Cap Value funds. Their benchmark should be the Russell 1000 Value. I use IWD, an ETF that tracks the Russell 1000 Value, because let’s be honest, you other option aside from the mutual fund is not owning the index, it is owning the index ETF.

Below is a chart showing the percentage of funds outperforming the benchmark during 1, 3 and 5 year periods.


As you can see from the chart, consistently beating the benchmark is hard… really hard. As of the end of May, fewer than 40% of Large Cap Value funds are beating their index over the last 3 and 5 years, and keep in mind I am using the lowest fee class (investment minimums in these are often $1,000,000 plus).


Whats more, it is not only the act of out-performance that is rare, being able to do so consistently is even rarer. When we look at 3 year periods of performance, we find that funds doing well for one 3 year period will tend to do poorly over the next 3 years. Below is a chart looking at the best 20% of performers over the previous 3 years at each date listed on the right. The line represents the rolling 3 year active return over time. As you can see below, Alpha (return generated over benchmark) tends to bleed lower, going negative in almost all cases meaning that funds producing positive return over the benchmark in one period will tend to drift towards negative return in a future period.lcv2

What is the take away of this really brief look? Doing a good job in active management is really tough. Next post I will take out fees to show the deleterious effect fees have on the performance of these funds.