Fred Schwed Jr. was a professional trader who saw his investments crash in 1929. He shifted his focus to writing, creating his classic satirical book Where Are the Customers’ Yachts? The story follows a visitor to New York that admires the yachts owned by wealthy individuals working on Wall Street, who made their fortunes giving financial advice, while wondering why their customers didn’t own yachts too. The tale suggests there’s a lot more money to be made by giving financial advice than by following it.
Wall Street has a long history of hiding, complicating and obscuring fees. A study for the Securities and Exchange Commission revealed that when investors were given a document fully outlining their investment fees, nearly one-third couldn’t remember ever seeing it. Astonishingly, many investors think that higher fees lead to higher returns, even though plenty of evidence debunks it.
Monitor fees
Vigorous monitoring of fees should be a key component of our investment process. It’s easy to get caught up in chasing returns without noticing the costs involved. Investment fees may appear small, but given time they have a significant impact on what we retain. A $100,000 portfolio earning a very modest 4% annually for 20 years with a 0.25% fee would reach near $210,000. But make that fee 0.50% and it’s $10,000 less. And with a fee of “just 1%” it’s $29,000 less. We should always ask the salesperson, “How much will we be paying?”
“Opening up access” to alternative assets is the latest trend; private equity, private credit and such. The flow of investment monies into these channels has been remarkable, and now Wall Street is reaching for retirement accounts. The sales pitch often taps into FOMO, promising opportunities that were once reserved “only for the ultra-wealthy.”
What’s left unsaid is that fees are typically very high, there’s usually little transparency about the actual assets and how they’re valued, and these investments are often highly illiquid. That liquidity point becomes especially critical when there’s a rush to cash out. (The latest example began unfolding in February.) The importance of liquidity isn’t realized until needed and then it’s too late.
Public vs. private disclosure requirements
Publicly traded companies have to share detailed information about their performance, making it helpful to check their balance sheets, revenue, income, cash flows, daily price movements and more. Conversely, private companies face far fewer disclosure requirements. Plus, understanding performance and value data for private market assets can be perplexing for most people. In short, leap of faith investments should serve as a cautionary alert.
Pairing limited disclosures with complex structures can also influence the fees tied to private asset investing. For instance, an “interval fund” might hold private equity (or credit) directly, or it could own these assets through other instruments like a special-purpose vehicle or a private fund, each carrying its own fees too. Taking a close look at what we’re really paying for the “access privilege” makes good sense.
We recently came across another example of the relentless pursuit of fees; seen in leveraged investments and performance multipliers. The catch is the harsh impact of what’s called “volatility decay,” where price swings can eat into long-term returns, even if the underlying asset rises. Imagine a security and a 2x daily leveraged investment both starting the week at $1000. If the investment drops 30% on Monday, it ends at $700, but the 2x leveraged one plunges 60% to $400. Say on Tuesday, the security bounces back with a 50% gain to $1050, now ahead for the week. The leveraged investment doubles that day’s gain too, jumping 100% to $800, but still lags behind the original asset. In the end, we take the loss, while those selling the structure still collect their fees.
In January 2015, there were 1,345 alternative mutual funds, using strategies like hedging, shorting or trend-following, with names such as “multi-alternative,” “market-neutral,” and “absolute return.” Today, about 340 remain. The other 1,000 or so have been liquidated or merged away, a staggering 75% mortality rate. That didn’t happen from success. And yet, the fees still got paid.
About a decade ago, Wall Street was buzzing about liquid alternative assets and their supposed ability to act as shock absorbers missing from traditional portfolios. Traditional assets were deemed outdated, with alternatives promising new ways for investors to build sturdier portfolios. The hype turned out to be just that, hype.
There’s a familiar ring to the current push of unlocking access to private markets. There’s a saying that goes, He who pays the piper calls the tune. But not if Wall Street can help it. They call the tune while we still pay the piper. And, the more extravagant the sales pitch, the more it begs the question: Where are our yachts?
Patrick J. Kelly has spent more than four decades at the most senior levels in the financial services industry. He has held executive leadership positions in banking and securities firms, served numerous profit and nonprofit boards, possesses advanced education in economics, accounting and finance, and has been a featured guest in numerous financial media forums. At present, he endeavors to impart his experience and knowledge to younger generations whenever possible while also offering consultation on securities and banking industry practices for litigation-related expert witness testimony.
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