Meditations on Money Management

Silton: Bonus season creates risks for your portfolio

CorrespondentDecember 14, 2013 

Money management is a game without an end. In two weeks, portfolio managers will finalize their returns for 2013, and on Jan. 2, they’ll start all over again in the chase to beat the market. If they’re well ahead of their index for this year, they’re already laying out their marketing campaign to attract new clients. If they’re behind their benchmark, they are starting to craft an investment letter and Power Point presentation to demonstrate that their poor relative performance wasn’t their fault. Financial publications and cable shows will laud the winners as investment savants and urge us to consider their funds for our retirement accounts.

However, the returns generated from managing your money aren’t what is really at stake in the minds of money managers. Rather, it’s the bonuses and profit sharing that will soon be flowing into the bank accounts of executives, portfolio managers, and traders.

The quest for personal riches through the rewards of short-term investment performance is not only dangerous for your financial health, it also undermines ethical standards and values. Most money managers, as well as Wall Street banks, espouse laudable values on their websites and in their annual reports. Many of us know money managers and financial professionals who are good people and pillars of the community. Nonetheless, in the day-to-day working environment of money management, values such as honesty, integrity and fair dealing have a tough time surviving in the effort to generate returns, fees and outsized compensation.

Product never finished

As investors, we are increasingly dependent on professional money management to invest our savings and allocate capital throughout our economy. However, money management, as well as Wall Street as a whole, has largely lost touch with basic values. What has contributed to the corrupting culture of money management?

First, money management doesn’t produce anything other than money (from an investor’s perspective, hopefully more of it). Investment management doesn’t create a tangible product or service. At the end of any given time period, there’s just a statement with a bunch of balances and percentages. Your money manager probably sends along a market commentary, but most commentaries are intellectual window-dressing and largely irrelevant to the day-to-day task of managing money. In the end, there’s nothing more to investment management than money.

Second, as I inferred at the outset, there’s no endpoint in money management until you fire your manager or ask for your money back. Every once in a while, a money manager admits that he can’t find appropriate investments and sends the capital back to his clients. However, most of the time the money manager wants to hang on to your capital for as long as possible. By contrast, every other business or service has a beginning and an end. Parts are shipped into a plant, and a product rolls off an assembly line on its way to a store. You provide your accountant with a shoebox full of statements and receipts, and she sends you a completed tax return. In money management, the product is never finished. Each day, the interaction of the financial markets and the money manager’s trading reshapes the portfolio and changes the investment returns. At the end of a quarter or a year, there’s a momentary pause as the results are tabulated for clients, and the next day the chase begins all over again.

Poor alignment

Third, although managers routinely claim that their interests are well-aligned with those of their clients, the alignment is poor. While managers share in the gains of their clients, they tend to be insulated from the brunt of any losses. All too often, when you’re tallying up your investment losses, your money manager remains financially intact.

Fourth and most important, the core function of money management, investing in financial markets, is an amoral pursuit. It is not about right or wrong. Rather, money management is an endeavor of building portfolios of securities based on one’s predictions of corporate profits (stocks) or whether those profits will be sufficient to service interest and pay down debt (fixed income). It’s about deciding when to buy and sell those securities. Applying values based on liberal or conservative politics or certain religious beliefs is irrelevant. Gaining insights into the profits and prospects of companies that are not already reflected by the market is the object of the game. To succeed, you have to check your moral framework at the office door and reclaim it when you go home.

Nothing has changed

A business that is about nothing except money – in which there is no end, in which interests are misaligned and the playing field is decidedly amoral – is an industry where values will be corrupted. True, there are armies of compliance professionals hovering around the money managers, but their job is to monitor processes, not make value judgments. If compliance officers begin to inject value judgments into the investment process, they’ll soon be looking for another job.

Undoubtedly, there are exceptional individuals and even institutions that are able to maintain their hold on values. However, the industry as a whole shows few signs of maintaining its moral compass, except when it’s easy. The industry’s behavior in the run-up to the financial crisis, its conduct during the crisis and its quick return to “business as usual” are strong pieces of evidence that nothing has changed. The new regulatory regime may be modestly more stringent, but money management’s value system hasn’t improved. As investors and citizens, you should approach money management with caution, and remember that, “In their eagerness to be rich some have wandered away from the faith and pierced themselves with many pains.” 1 Timothy 6:6-10.

Andrew Silton’s Meditations on Money columns can be found twice a month in The N&O’s Work&Money section. He is a retired money manager living in Chapel Hill. He was CIO for the North Carolina Retirement System from 2002-2005. He writes the blog

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