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Today's Commentary: 06.23.06
Going Private: A Possible Solution to Soft Money
The Investment Company Institute, the lobbying arm of the mutual fund industry suggested recently that the prospectuses issued by these investments be either eliminated or put online. The thinking goes like this: Investors receive these documents and even with advancements in layout and ease of use, they still do not use them as they were intended.
They point out that this obvious under-use would be money saved if the information was already available online. There, not only would the document be accessible and hyperlinked, but the information contained in it could be updated more regularly and be kept current.
Not so fast. While many investors seem lazy and the mutual fund industry has lulled them into this complacency with their follow-the-leader investment style, eliminating the one document that can be referred to much like a snapshot in time is just as lazy on the industry's part.
Those who support mutual funds as the way to invest passively may have been partly responsible for this lack of interest in the document. I am among them. Mutual funds, for all of their faults, one of which I will discuss a little further on, have given many households the opportunity to invest in the markets under the heavy-handed regulations in place by the Congress via the S.E.C. This has given investors a sense, and not a false one either, of security that at least their decision to send money to a fund will be invested and done so with the same eye towards value as they might use when shopping for the best deals.
How well those investments do many investors know is based on a variety of elements at play but that doesn't change the simple fact that fund managers should be trying to their job as inexpensively as possible with the best results for their shareholders.
To their credit, mutual funds have explored every facet of the investor psyche looking to tailor make something suitable for every investor taste. That. although has come with a cost. Many mutual fund companies are publicly held entities beholden to shareholders of another kind.
I was struck by an interview in the Wall Street Journal with the founder of Craigslist and the companys CEO Jim Buckmaster. Brian M. Carney, a member of the Journalıs editorial board seemed increasingly incredulous as the interview progressed. How could anyone responsible for running such an obviously successful enterprise do so without all eyes focused on taking advantage of every opportunity to create unbelievable wealth? How could any company succeed as well as Craigslist had led by a corporate chief with such an un-business-like skill.
To date, Craigslist has been profitable in every year of its existence. Mr. Carney wondered why it was not more so even going so far as to estimate the untapped revenue available with the simple addition of ads on the site. Carney suggested the unrealized profits could exceed $500 million a huge jump from annual revenues of only $25 million.
Mr. Buckmaster's reply was that customers don't want it. When asked how newspapers could compete with his free site, one that essentially offers what are the newspaper industry's bread and butter for free, he suggested they go private, divorcing themselves from shareholders and Wall Street and become more consumer-centric. Buckmaster believed that the end user would keep the paper profitable. You could almost hear the dismay in Carney's writing and Buckmaster went somewhat Zen on the subject.
But Mr. Buckmaster does have a point. When a business is solely in existence for the good of its users, the users are the shareholders of note, not the faceless investors recruited when the company went public. Those masters demand profits and can be ruthless in their desire that you share the same goals at all costs. Removing them from the equation does not deter capitalism one iota and may just be the solution mutual fund investors need whether they realize it or not.
Such thinking would change the face of the mutual fund industry. Publicly traded companies who are mutual fund families are supposed to make money, first for the investors in the funds run by the company and then for the shareholders on Wall Street. That unfortunately is not the way it happens. All too often, it is the reverse that prevails.
Consider the issue of soft money. Christopher Cox, the Security and Exchange Commissioner believes the practice of soft money, a section written into the Exchange Act some 30 years ago, be tightened if not eliminated because it no longer works in todayıs world. His concern should prompt Congress to act.
Soft money referred to by Mr. Cox as an anachronism allows trade commissions to pay for research. The idea was that mutual fund managers would shop for the best price from a broker who in theory, had the best execution. Brokers began adding on services such as research and analysis to make their business seem more attractive to institutional investors like fund managers.
This means that not only are we the shareholders paying for the execution of trades on our behalf, we are also paying for research as well. Once we are paying the bill, everything changes.
The fund manager, who is supposed to be our advocate no longer needs to shop for the best deals for our money but instead shops for the best deal for the company that owns the fund. By allowing clients to pay for services beyond what we think we are paying for, the company becomes more profitable while investors in the fund lose potential gains.
While it is difficult to determine exactly how much we would stand to gain if soft money was eliminated altogether, numbers have run as high as 1% of the total return for the fund. If soft money were eliminated, the costs of such research would appear in the fundıs management fees (and detailed in the prospectus) and not deducted from our gains. Managementıs fees, something investors have been very diligent about to their credit, would be forced lower in a competitive open market place.
This would have the net effect of creating a mutual fund manager who is also a very smart shopper. Not only will trade execution be important but also any bundled services would need to be competitively priced to attract new investors.
Or funds could take Mr. Buckmaster's suggestion and go private. Once the monkey of Wall Street is off their backs, fund families could operate in a more paternal fashion with the understanding that when investors in their products profit, so would they.
Today's Commentary: 06.18.06
Learning to Swim - While Drowning
A recent remark made at the opening of the convention of the United Auto Workers portrays the current state of the union as "in need of structural changes". And although the union is faced with accepting concessions from here on, the influence that can be welded by its membership is much wider than it gives itself credit. (Many of them voted for the current business friendly administration without regard to how those policies would affect them.)
Unions have often consoled themselves with a pendulum hypothesis for their ebbs and flows in membership and strength. Long chided and secretly envied by a non-union workforce, those who do not have the protection afforded these organized groups of workers often see the union workforce as the enemy rather than the barometer of workplace health.
If the average American worker was given the choice between financial stability with the accompanying right to a fair and safe workplace and the alternative: upward mobility, the free market availability to migrate between workplaces, and the constant positioning of oneself to gain the best economic advantage over your fellow workers, I'm inclined to believe that many would choose the former rather than the later.
Even among college educated workers, the ability to increase oneıs economic opportunities at a steady pace, hand in hand with the profits generated by the company they are employed by has its supporters.
But this isn't about the waning union membership or the fact the U.A.W. (and other unions forced to negotiate contracts for their membership) has significant problems facing it in the near future. It is about wages in general and the fact that so much Fed-speak of late is peppered with concerns about controlling those wages.
Two myths need to be discussed at the onset before we talk about the three main players. First of which is the strength of this economic expansion measured by GDP and the other is productivity. There is good reason to celebrate the expansion as measured by Gross Domestic Product. Business has become much better at controlling costs, reining in inventories and developing markets overseas. Trouble is the largely intellectual nature of those products.
While we lead the world our innovation, the actual completion of our production is increasingly done overseas. We design the idea here and export it to be made. Doing this allows many corporations to pat themselves on the backs with increased pay packages and options, dated correctly or not. GDP is mostly an illusory measure of health. (Were you aware that Hollywood is our largest exported product?)
Flush with profits and repatriated tax breaks, companies have been buying shares of their own companies back in record numbers. While this is being hailed in many circles, draining liquidity does not show any investor the true picture of a company's actual worth.
Productivity, a concern of not only the former Fed chief Alan Greenspan but his successor is over-rated as data as well. If companies actually paid attention to such Fed measures, they would see that in order to sustain productivity you need three things in place: inflation of prices at a rate commiserate with raw materials, customers willing to pay for each increase, and a workforce willing to produce at an ever-increasing rate without the award of wages.
Companies will produce their goods or services and will do so at any costs or fail to exist. Which is why the U.A.W. is so concerned. Automakers are strapped and the union is being blamed. Is that condemnation justified? Hardly. In the current state of manufacturing, controlling wages is not the path to increased success. Better products are.
The three main players threatening the economy are wage pressure, inflation, and prices. For the first time in modern history, these three things are not related.
Wage pressures, or as Ben Bernanke likes to call it, the wage price spiral are an effect that was once the primary menace in the inflation battle. Here's how it works: Prices rise and workers would then begin to demand pay increases to stay even with the inflationary pressures they felt. Employees in past years would have been interested in "keeping pace with inflation" as the criterion for their wage negotiations. This would raise the company's expenses and would force them to raise their prices to compensate.
That is not even on the table these days. Wage increases at best are running about 2% if that. Many industries have offset any pay increases by suggesting that the money be used to pay for health (whose own inflationary pressures have risen year over year as little as 5% to as much as 10%, depending on whom you speak) benefits. While unemployment remains low by most measures, the pay for those employed workers has stagnated and is largely void of any real benefits.
Inflation has become a very real nuisance to the average American. Ask most people and they will point out higher prices for fuel naturally leads to higher prices for goods dependent on fuel for production. This creates a situation that forces many consumers to make economic choices and is keeping Mr. Bernanke awake at nights.
In truth, inflation is not so much about prices but the ability of the consumer to borrow to purchase goods and services. Each price increase lowers the willingness of the consumer to go into debt to make any purchases at all. This strips them of the wealth effect embraced by the low interest environment. And the economy slows.
Yet prices continue to increase. And when they do, Mr. Bernanke should fear the embedding of those prices as the new norm, not the result of any shift in the cost of raw materials.
How does this affect the investor? Does the knee jerk reaction by the markets to all of this inflation talk both here at home and abroad show any sort of efficiency?
I was taken to task last week by a reader who called my revisiting of dollar cost averaging as nothing more than an ³old cobbler². He was thankful that I was not investing his money.
"No mention of GOLD" he wrote as the eve of the sell-off in that commodity, a normal hedge for inflation worriers. The long-term bond continues to look as if it believes that inflation is worth worrying about but only in small way. So as stocks sold on the price weighted Dow Jones Industrial Average, folks worried that the Fed had gone too far.
Tools such as indexing and dollar cost averaging are old cobblers. But they offer some comfort when the markets decide that they may have gone too far too fast, are overpriced or are a little of both. Corrections happen and this one is far from over. Inflation however will not be the reason and relying on old cobblers will keep you from panicking.
The Fed chief and his banking cronies believe that they have the power to keep inflation in check. They believe that they can accommodate for the increased prices for commodities used on a global scale by what seems to be an ever-increasing pool of countries in need of raw materials. "Anchoring the publics long-term expectations", Bernanke said recently would make the Fed the champions of price stability.
While teaching someone to swim while they are drowning seems like an exercise in futility, the Fed thinks it is possible. And it would be if they had not already gone too far and far too slowly. Consumers don't buy into the notion that the Fed has the ability to control inflation. Recent University of Michigan surveys have pointed to a perception of an inflation rate closer to 4% or more among the 500 households surveyed than the current core CPI of 2.4% (excluding food and energy).
If that perception continues, the pullback by consumers, so mightily predicted at the beginning of the year will begin in earnest. They will be forced to. Wages will not support any more expansions.
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