The Regulations Are Reasonable…The Thoughts That Go Along With Them Aren’t

Saw this in today’s Wall Street Journal and just had to mention it:

Policy Makers Take Aim at Credit-Card Practices

Credit-card companies are going to have to start adhering to the followin rules, which take effect in July 2010:

• Banks can’t treat payments as late unless consumers have a “reasonable amount of time” to make the payment; at least three weeks before the due date.

• Banks must allocate minimum payments to balances with the highest rate first, or pro-rata among all balances.

• Banks cannot raise interest rates from the opening amount unless it’s a variable rate or an introductory rate with an increase disclosed in advance; or a year after the account opens, a 45-day advance notice has been made; or if a minimum payment is received more than 30 days after the due date.

• A ban on double-cycle billing, which allows banks to calculate interest based on a prior month’s balance in addition to the current month, even if the prior month had been paid off.

The comments from “advocates” and politicians are what bug me (emphasis mine):

Consumer groups have been pushing lawmakers to act, saying cardholders need relief now. The current rules “give very little help to families that are struggling with their debt,” said Lauren Saunders, managing attorney at the National Consumer Law Center.

“I don’t think the issuers should wait for these rules to come out to start dealing fairly with consumers,” she said. “The issue that’s hurting consumers the most right now are these big retroactive rate increases. They could just stop doing those tomorrow.”

Okay, here’s the deal:

If you are a debtor, you are a slave! You don’t get to pick your payment and you aren’t entitled to help when something bad happens and you can’t pay your bills. That’s the RISK of credit card debt (or any debt for that matter). You made that choice when you opened the account and started using the card—for whatever reason that was.

As much as I disliked the consumer advocate’s comments, these comments from Lawrence Summers really get on my nerves:

Over the weekend, White House economic adviser Lawrence Summers said President Obama would focus on “credit-card abuses” and “the way people have been deceived into paying extraordinarily high rates that they wouldn’t have paid if they knew what they were getting themselves into.”

Mr. Summers, speaking on NBC’s Meet the Press, added: “We need to do things to stop the marketing of credit in ways that addicts people to it and so that our households are again saving, and families are again preparing to send their kids to college, for their retirement and so forth.”

I’m not sure that people were really deceived into paying high interest rates. I’m pretty sure all the terms were spelled out in the fine print. If they weren’t then people should have the right to take legal action.

I also think Mr. Summers is smoking somthing if he thinks the big bad credit card companies are the reason why people aren’t putting money back for their kid’s college educations. If people are so stupid that they are “deceived into paying extraordinarily high rates” do you really think they are going to be smart enough to figure out how much they should be saving for their kid’s college education?

The victimization of America…

Where does it end?

Reader Comment on My Asset Management Post

AFM reader, Chris, left this comment on my post from last week:

What is the profit margin on a bag of cheetos, 50%?? The margin on the gel for my hair is over 100%. Why do we quibble over 1%? Do we expect money managers to work for free? I know it sounds like a lot of money (and it is), but 1% is less than grocery store margins.

The definition of Profit margin (“margin of profit”) according to the Barron’s Finance & Investment Handbook:

The relationship of gross profits to net sales. Returns and allowances are subtracted from gorss sales to arrive at net sales. Cost of good sold (sometimes including depreciation) is subtracted from net sales to arrive at gross profit. Gross profit is divided by net sales to get the profit margin, which is sometimes called gross margin. The result is a ratio, and the term is also written as margin of profit ratio.

In other words, the 1% management expense ratio should not be confused with gross margin. It is simply the fee charged to manage money and is not a margin.

For instance, let’s say I manage a $200 million portfolio for a 1% fee. Not including any other fees, my income for managing this $200 million portfolio would be $2 million per year (not counting any growth in the value of the portfolio). For simplicity’s sake, we’ll assume that the $2 million per year is my net sales. Now lets say my cost of goods sold is $1.5 million per year (seems a bit high to me but I like round numbers), making my gross profit $500,000 per year. Dividing $500,000 by $2 million, makes my profit margin 25%. Not a bad margin, if you ask me.

OT: One of the ONLY Videos I Have Ever Put Together

My how the time flies. It’s hard to believe that I shot this video nearly FIVE years ago. The music is called “First Youth” from Philip Aaberg’s CD, “Cinema.” I thought the title was appropriate. The music brings tears to my eyes nearly every time I hear it. I’m a sentimental dude.

I’d like to do more videos but the JVC software refuses to work on my computer. I don’t know what the deal is. I need to figure out something because I enjoyed putting this video together.

Investment Management is Big Business

Check this out. I found this on page 161 of Christopher Jones’ book, The Intelligent Portfolio*, regarding mutual fund fees. I never really looked at fees in this way.

The aggregate numbers on the magnitude of investment fees are sustantial. For example, look at the fees charged by mutual fund companies. According to the Investment Company Institute (an industry trade group for the mutual fund industry), mutual fund assets totaled $10.4 trillion at the end of 2006 (yes, that is trillion with a “t”)**. Equity mutual funds alone held $6.6 trillion in assets. The average fee for these equity funds was 1.07 percent per year on an asset-weighted basis. This implies that investors paid over $70.6 billion in management expenses and load fees alone in 2006. In addition, there was over $1.5 tillion invested in bond mutual funds, generating an estimated $12.4 billion per year in fees. Money market fund accounted for another $2.4 trillion in assets and generated an estimated $9.6 billion in fees for hte fund industry. Adding it all up you get to a grand total of $92 billion in annual mutual fund fees—a lot of money by anyone’s standards. Putting these fees into perspective, $92 billion is equivalent to an average payment of about $300 per year for every man, woman, and child in the United States. And this estimate does not even include the many trillions of dollars managed by institutional investment managers outside of the mutual fund industry, nor the costs associated with brokerage commissions, transactions fees, custody fees, account fees, and other advisory fees. needless to say, the investment management industry is a very big and lucrative business.

That paragraph was written using 2006 data. I did a little research and found that according to the latest report, the average equity mutual fund has a fee of .99 percent. I also noticed that the 2006 numbers were adjusted downward by one basis point to 1.06 percent. According to that same report, it’s not likely that fees will continue to drop:

Recent press reports have suggested that fund expense ratios could begin to rise owing to the market downturn that began in the fall of 2007 and the attendant decline in the assets of stock mutual funds. No such increase in fund expense ratios is evident in this paper, but experience from past market cycles indicates that a rising trend is possible. During the market downturn that lasted from early 2000 to early 2003, for example, average expense ratio of stock funds rose several basis points.

Why might declining assets lead to rising expense ratios? There are a number of reasons; two stand out:

• Some fund expenses are relatively fixed. Among other things, these include transfer agency fees (which tend to be charged as a fixed number of dollars per account), the cost of mailing fund literature, accounting and audit fees, and director fees. When fund assets fall, these fixed costs will rise as a percentage of assets, tending to boost a fund’s expense ratio.

• Some fund complexes offer “breakpoints” in the management fee that they charge their funds. Such a fee structure reduces the fee rate as the fund’s assets grow, sharing with investors the benefits of economies of scale. As asset levels fall, the fund may lose some of the benefi t of those reduced rates, resulting in a higher expense ratio.

It stinks that when account values are dropping, fund expenses tend to increase. But, I suppose the opposite is true when account values are increasing. The skeptic in me wonders if fees fall as quickly as they rise? Regardless, investment management is big business.

*Affiliate Link
**Source: Research Fundamentals: Fees and Expenses of Mutual Funds, 2006 (PDF)

Lately, Reading the Wall Street Journal is as Good as a Fiction Thriller

Over the last few months, the Wall Street Journal has covered some fascinating stories. This is stuff that would normally be found in a John Grisham thriller but sadly is real:

• The Bernard Maddoff Fraud

• The Stanford Fraud

• Danny Pang

The Danny Pang fraud broke yesterday. If the Wall Street Journal is to be believed, this guy is a real character. From yesterday’s article:

Mr. Pang’s résumé depicts a glittering success story: a Taiwanese immigrant who earned an M.B.A., worked on Wall Street and now heads a $4 billion investment fund. He also became a partner in another fund firm with business luminaries such as Frank Carlucci, the former defense secretary and ex-Carlyle Group chairman, and former Lockheed Martin Chief Executive Norman Augustine.

But both Mr. Pang’s past and his business may not be quite as they appear. The university from which he says he has an M.B.A. and another degree says it has no record of either. Morgan Stanley, where Mr. Pang’s bio says he was a senior vice president and senior high-tech merger adviser, says it can find no record it ever employed him.

Further down in the article:

Danny Pang was born Dec. 15, 1966, in Taiwan, where, according to people who know him, his mother’s family was the wealthy owner of a furniture-making business. He came to the U.S. as a youth. Later, at the University of California, Irvine, he became a student leader, chairman of the Asian Pacific Student & Staff Association in 1988-89.

University records, however, show a “Danny Pang” with his Social Security number and birth date enrolled only for a single summer term, in 1986, and don’t show that anyone with his name or Social Security number ever received the degrees he lists. Asked how someone unenrolled could be a student leader, a university spokeswoman said, “He could just walk on campus, be Mr. Personality and get elected chairman. How would they know if he was a student?”

The article then goes on to say that Pang claims he got his degrees under a Chinese name that we won’t disclose and that he has proof of his degrees but hasn’t provided them.

Not only that, the article directly below this article is about the murder of his wife! According to that article, his wife answered the door one day and some nicely-dressed guy pulled a gun out, she ran away and hid in a closet. The murderer shot her to death as she cowered in a closet. Oh, and all of this happened while Mr. Pang was out of town. He was never found guilty. You can read the article here.

My question is: does fiction mirror life or does life mirror fiction? Hmmm…

Scott Burns Responds to the Paul Farrell Article

I sent an email out today to several people I like and respect in the investment field, asking for their opinions on the Paul Farrell piece I wrote about yesterday. Here is the response I got back came from Scott Burns:

I certainly appreciate Paul Farrell’s anger and contempt for Wall Street. It is richly deserved. And Gary Shilling isn’t alone in having spotted a major opportunity in long bonds back in 1981. Van Hoisington also spotted it and has built a winning fixed income fund on the secular decline in interest rates. Your readers would do well to read economist Lacy Hunt, who works at Hoisington Management. Here’s a link to their most recent report.

Similarly, Steve Leuthold wrote a stunning analysis, back then, comparing prospective returns on zero coupon Treasurys (and conventional long Treasurys) against common stocks under different future interest rate assumptions. He continues to do that analysis for institutional clients today. Back then he showed that it was virtually impossible to lose investing in a 12 percent zero.

Finally, there is a growing camp in academia that advocates TIPS as the best and safest investment for most people. The best known economist in this group is Zvi Bodie at Boston University. Analyst Rob Arnott has also put in good words for TIPS over equities.

The basic argument is simple: You can get a 2 percent real return in TIPS and that’s a lot more certain than, say, a 3 percent yield on equities with an uncertain upside from growth. Factor in the destructive power of volatility (think variance sink) and a fixed income investment looks pretty good compared to equities after the last 8 years.

Shilling, however, may just be one of the first voices to echo the famed Business Week “death of equities” story in 1981 or 1982. While he’s looking forward to more of the same in equities and thinking that bonds look good, I can make a good case that this is NOT the time to invest in bonds. Shilling may be a “buy” signal.

Why? Because the same force of inflation that made bonds a terrible investment in the 60s and 70s (negative after-inflation returns) may return in the near future because governments tend to inflate their way out of problems. Not to mention the horrendous unfunded liabilities of Social Security and Medicare. Today, bond returns are barely keeping up with very low inflation. Stocks, on the other hand, are providing a higher yield and may be building book value at a rate that will keep up with (or surpass) inflation.

Other research of prospective equity returns as a function of starting P/E ratio indicates that we may be approaching a level where future equity returns are higher than average. Here’s a link to a recent column on the subject. If your readers will scroll to the bottom of the column they can download Kitces analysis in the context of portfolio survival.

Finally, it is never a good idea to hang your future on a single call— stocks or bonds. We diversify because we don’t know the future.

Scott Burns
Chief Investment Strategist
AssetBuilder, Inc.
Plano, TX

Thanks, Scott! I’m sure AFM readers will appreciate your input.

I think the key is the same key that it’s always been: DIVERSIFICATION!