Psychology has brought many ideas to financial analysis, but two that stand out are confirmation bias and myopic loss aversion. Confirmation bias is the tendency to find or accept only research that mainly supports an existing thesis.[1] “The more often one looks at a financial account, the more likely one is to see a loss and, since losses bother us more than gains, they spur turnover.” This is called myopic loss aversion.[2] Combatting these two tendencies is important for investors and their advisors to do, especially in volatile times.
Putting the fruits of investment research into practice means, for Woodstock, putting good companies into client portfolios. Owning a limited number of individual securities can help “reassure clients because they can easily keep track of what they own” and they and their adviser can be “steady in difficult markets.”[3] An additional benefit from owning a group of individual stocks is the ability to use tax-loss selling to enhance return. The latest estimate of this performance advantage over owning exchange-traded funds (ETFs) is 0.80 percentage points per year over a 20-year period,[4] a rather substantial advantage. Mutual funds aren’t structured to allow tax-loss selling by individual owners.
Higher interest rates on investment products may be here to stay. The 80-year chart of federal interest rates from the end of World War II to the present shows a jagged mountain. Interest rates rose from 2-3% in the late 1940s to 18% in the 1980s, and then fell to near zero in the 2020s. If the US economy shows that it can grow even with higher interest rates, then Federal Reserve decision-makers and the market may be in sync in letting them stay high[5] and adapting to the change. Better than trying to hold back the tide with economically disruptive future regulatory actions.
The latest FDIC figures show “$17 trillion sitting at money center banks” earning little to no interest.[6] Individuals don’t tend to keep their cash with advisers or brokers. They are following very good advice to “avoid behavior that could result in any uncomfortable cash needs at inconvenient times, including financial panics.”[7] The pressure to move that cash to get a better return will increase. Just don’t unknowingly tie it up.
Some of the problems for investors and institutions in 2008 derived from chasing yields into what turned out to be illiquid “cash investments.” Harvard University invested their cash overnight in what turned out to be illiquid and inaccessible products, and in 2008 the federal government needed to “back the buck” in money market funds to prevent a run when some went illiquid. This contradiction is well worth keeping an eye on, even if difficult.
Problems sitting right in plain sight are sometimes easy to miss. The regulatory effort to provide investors with the same confidence level, a fiduciary-like standard, whether they wanted someone to manage their account on an ongoing basis (an investment adviser) or they merely wanted recommendations on a few stocks, bonds, mutual funds or ETFs (a broker-dealer), has created a rush by firms to be registered as both, so-called dual-registered firms or hybrids. These firms represented over 80% of assets under management in the wealth management industry in 2016.[8] Single-registered investment advisers, like Woodstock, have a fiduciary standard from the 1940 Act. Our clients rely on that. The effort to create a fiduciary-like standard (Regulation BI) for broker-dealers is having problems. There is still a need for a client to be aware if a broker-dealer is churning an account to increase commission revenue or, conversely, if an investment adviser is “sitting back and doing nothing” while earning a fee.
The problem is how to fairly regulate firms trying to do both amidst client confusion about which firm actions are under which standard. The current massive regulatory effort to jam the square peg into the round hole will be very disruptive for some dual-registered firms.
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William H. Darling, Chairman & CEO
Adrian G. Davies, President