How about this for a start? Financial advisors may be money managers, but money managers may not be financial advisors. Or, does this make it even more confusing. The solution is to develop clear definitions of the professionals’ various roles so you select the right advisor based on the services that they provide.
Money managers have two distinguishing characteristics that describe what they do:
They invest your assets in the securities markets. Therefore, Separate Account Managers, mutual funds, and hedge funds are different types of money managers
They provide the same service to multiple clients. Their services have very little variation by client. So when you invest in a mutual fund, you get the same service and results as other people in the fund Continue reading →
Broker/dealers pay commissions to advisors when they sell company products and create securities transactions. Third parties also pay commissions when advisors sell their investment products that include: mutual funds, hedge funds, annuities, and life insurance.
Commissions from third parties are divided between advisors and the broker/dealers who hold their licenses. The division of revenue varies by company and is based on the support that is provided to advisors by companies. Advisors who receive more support have lower payouts. Advisors who receive lower levels of support have higher payouts.
If your financial planner or financial advisor tells you that you aren’t paying for their commission, this isn’t exactly true. The third party companies who pay the commissions to advisors have to have a way to recoup their commission payouts. This is done by charging various fees and expenses associated with the product you purchased. Here’s a good explanation of how this is done, using a mutual fund as an example.
So while you don’t pay out of pocket expenses, you are paying fees for these products. Remember, there is no such thing as a free lunch!
Watch-out the next time your friendly financial advisor recommends you invest in a registered mutual fund that re-invests your assets in unregistered hedge funds. There are all kinds of problems with this recommendation, but we will focus on three.
First, you are going to pay an incredible amount of fees and commissions. The advisor wants to be paid, the advisor’s company wants to be paid, the mutual fund wants to be paid, and the hedge fund wants to be paid. Guess where all of those fees and commissions are coming from? You are right if you answered your assets.
Second, the mutual fund may appear to be legitimate because it is registered with the SEC. However, the mutual fund invests in unregistered hedge funds. This lack of registration creates additional risk for you. Keep in mind Bernie Madoff ran a hedge fund. All funds should be registered before you invest in them.
Third, hedge funds were originally developed for wealthy, sophisticated investors who had high tolerances for risk. The funds used short selling, arbitrage, hedging, leverage, derivatives, currencies, private placements, and international investments to generate the returns they needed to justify their exorbitant fees. Taken together these investments represent extraordinary amounts of risk.
No matter how high the track record, how great the references, or how many Persian rugs the advisor has in his office, you have to be exceptionally cautious when you invest in a registered mutual fund that invests in unregistered hedge funds.
A floundering taxpayer supported Citigroup is under contractual pressure to pay energy trader Andrew Hall a $100 million bonus. The real question is does Hall deserve the bonus? Is such a huge bonus fair to shareholders and taxpayers who are supporting Citigroup? And will shareholders suffer if Andrew Hall decides to leave and go elsewhere?
It’s my understanding that traders like Hall get paid the overwhelming portion of revenue they produce while shareholders get pennies even though the shareholders are the ones putting all their capital at risk and are making it possible for traders to produce large revenues exposing the owners to a major potential blow-up.
When it comes to investing in banks and publicly traded hedge funds where the managers have little of their own money at risk it seems investors have very little upside and a tremendous amount of downside. It seems the shareholders are overpaying for the services of incompetent bankers and aggressive traders ‘swinging for the fences’ with shareholder capital. In other words, investors in such dubious companies are being taken for a ride!
A couple of years of profitability is too short a time period to determine whether or not Andrew Hall is doing a great job or has just been lucky and might be exposing Citigroup to potential large losses. Given the fact that investors are receiving very little of the benefits that Hall has produced, as a taxpayer, I vote to let him walk.
Gary Hutcheson pleaded guilty to operating a Ponzi scheme in Macon, Georgia. He and an accomplice defrauded 50 investors, including prominent doctors, attorneys and church members, of millions of dollars when he told them their assets would be invested in a hedge fund named Georgia Ionics Fund, LLC.
Some of the investors knew Hutcheson 30 years before they invested their assets in the fund. Another friend of Hutcheson’s in-laws invested his children’s college fund due to what he thought was a trusting relationship. One investor lamented, “You never think it could happen in your own home town.”
The Sales Pitch
Some victims said Hutcheson approached them in person while others were sent an official looking prospectus. Hutcheson told investors the fund was earning 18% to 25% per year. Some investors received dividend checks so they believed the fund was performing as stated.
The Red Flags
There were three red flags that should have warned people to avoid this investment. First is subjectivity. People based their investment decision on a relationship and Hutcheson’s affluent lifestyle versus an audited record of success. Second, the absence of due diligence. Some review of the facts, such as compliance records and registrations, might have uncovered the Ponzi scheme. Third, the exceptional returns. High returns and low risk are mutually exclusive.