Are US Stocks a Sure Thing?

The drive to restore investment portfolios to the levels set before the Great Recession is still influencing investor decisions.

In past blogs, I’ve expressed concern the economic downturn would make people more vulnerable to get-rich-quick schemes.   A recent chart published by The Economist,  A Multitude of Madoffs, showed the SEC  filed more than twice the number of Ponzi scheme cases in 2010 as they did in 2008;  and the FBI is currently investigating 1,000 cases of investment fraud.  The temptation to invest in something that sounds too good to be true is much greater these days.

For others, the feeling that they should re-position their investments for a faster recovery is equally tempting. 

After the rise of US stocks in the fourth quarter of 2011, many articles have been written about the expected out-performance of US stock market returns for 2012, especially given Europe’s continued struggle with their sovereign debt crisis and the recent rating agency downgrades of the debt of France, Italy and others.  But are US stocks certain to have higher returns than stocks in other countries?

Here at TAAG, time and experience have taught us that anytime something becomes the consensus, it’s time to be skeptical. 

International stocks fell out of favor in the late 1990’s when US telecom and technology stocks were on an upward trajectory that seemed limitless.  When the technology bubble burst in early 2000, real estate, emerging market and large international funds supported our client portfolios with positive returns.  Investors moved to real estate and real estate funds in 2005 and 2006 after experiencing losses in stocks, only to watch real estate values begin to fall in 2007.  When the Great Recession hit and the US market fell severely in October 2008, some investors chose to exit stocks entirely, relying on reports that the United States was in for an extended period of losses similar to the Great Depression.  They left in time to miss the 25% gain in the S&P 500 in 2009, and the 70% gains in US small value stocks. 

There is always someone willing to tell us where the market is headed.  When it becomes a chorus of agreement, that’s when it may be time to tune them out.

Jeannette A. Jones, CPA, CFP ®

So, Um, What is a Private Equity Firm?

(from Marilyn Geewax's NPR report, 1/19/2012 - click here for the original post.  Marilyn is NPR's Senior Business Editor.  Besides assigning and editing business stories, Geewax regularly discusses economic issues on NPR's Weekend Edition Sunday.  More on Marilyn can be found here.) 

In the run-up to Saturday's GOP presidential primary in South Carolina, candidates have clashed over the role of Bain Capital — a firm that either creates or kills jobs, depending upon whom you believe.
Front-runner Mitt Romney sees the bright side. Before entering politics in the 1990s, he co-founded Boston-based Bain Capital, one of the nation's largest and most profitable private equity funds. He has said he created 100,000 jobs while at Bain.

But critics say that figure excludes the legions of workers who were laid off by Bain. Candidate Rick Perry, who ended his campaign Thursday, had described Romney's work as "vulture" capitalism. And former House Speaker Newt Gingrich repeatedly raised questions about the firm's approach to job-cutting.

Before this controversy erupted, most Americans had never heard of Bain. That's because it operates in the private investing world, not the public market.

In the public arena, anyone can turn to say, the New York Stock Exchange, and buy shares of a publicly traded company. But in the private equity investing world, only wealthy individuals and large institutions, such as pension funds, are welcome. That's Bain's world. Here's how it works:

What is a private equity firm?
This term describes companies like Bain, which gather up funds from wealthy individuals or institutions for the purpose of buying up companies and turning a profit, usually within four to seven years. The equity firm's managers get fees, as well as about 20 percent of the gross profits.

A typical deal goes something like this: The equity firm buys a company through an auction. The firm then increases the value of the company by, for example, upgrading its accounting system, procurement process and information technology, or by laying off workers and closing unprofitable operations.

After the private equity firm gets the company in better shape, it exits the deal by selling it to a large corporation or offering stock to the public. But often the effort to fix up the company fails and bankruptcy is the outcome. The rewards can be huge, but the risks are great too.

So why is this controversial?
Sometimes, the private equity firm uses strategies that critics say play out more as "vulture capitalism" — a phrase that some people are using to describe a process where investors make enormous profits while needlessly laying off workers.

The Wall Street Journal did an analysis of the 77 businesses Bain invested in during Romney's tenure. It found 22 percent either filed for bankruptcy or shut down within eight years of Bain's investment. Even several companies that initially provided Bain with huge profits later ran into trouble. Of the 10 deals that produced more than 70 percent of Bain's gains, four eventually filed for bankruptcy.
But the companies that succeeded were hugely profitable. The Journal concluded that Bain turned $1.1 billion in investments into $2.5 billion in gains in the 77 deals.

The phrase "leveraged buyout" is sometimes used in connection with private equity firms. What is that?
"Leverage" refers to large amounts of debt. Just as a lever can be used to help lift a heavy load, borrowed dollars can help lift a deal that otherwise wouldn't happen.

Defenders say the deals can work well. For example, if a company is headed for bankruptcy anyway, an infusion of borrowed money may be a life preserver. The cash can be used to buy equipment, upgrade software or offer severance pay to unneeded employees.

In the end, the spruced-up company can be sold to a larger corporation, or it can start selling shares in a public stock market. The profits can be used to pay off old loans and reward the investors. Critics say the strategy too often results in needless layoffs that do little to actually save the company.

What is venture capitalism?
That's another strategy for investing private funds. In this scenario, the equity firm provides capital (money) to a startup venture and then helps support the small company as it grows.

The private equity firm hopes to make lots of money from successful startups, but the investors are taking bigger risks than bank lenders would be willing to take.

We've also heard about "crony capitalism." What's that?
In a capitalist system, success is supposed to be determined by the free market and rule of law. But Perry's critics said that in Texas, he had been promoting "crony capitalism," where the relationship between business and the state is too close. Under crony capitalism, the success of a particular business is dependent on the favoritism shown to it by the government, in the form of tax breaks, grants and other incentives. Perry's spokesman denied the governor had engaged in inappropriate business dealings.

President Obama also has been accused of crony capitalism in relation to his support for Solyndra, a failed company that specialized in green energy technology.

Private Equity At A Glance

• Private equity firms headquartered in the U.S.: 2,300
• Buyout/growth expansion funds currently fundraising in the U.S.: 260
• Private equity-backed companies headquartered in the U.S.: 14,200
• Employees hired by U.S. private equity-backed companies: 8.1 million

Notes: As of September 2011
Source: The Private Equity Growth Capital Council

Do You Want Fries with That?

I was reminded of this line from a Tim McGraw song when I went to the dentist Monday.  I began a relationship with a new dentist a few years ago after my dentist of 25 years retired.  For the first two years everything was great.  I liked that my new dentist was close to my age (we could grow old together), had a friendly staff and appeared to be utilizing the latest technology.  My eyebrows were initially raised about a year ago when I noticed her face staring back at me from the seat of a Kroger shopping cart ad, followed by a few Groupons featuring her practice.

During my initial visits, care was taken to create a welcoming atmosphere where the staff ensured procedures were performed in a comfortable manner.  When I went for my check up last summer, I was a little surprised to see an assembly line of hygienists ready for their next patient.  Today’s experience sealed the fate of our relationship.  Not only were my teeth cleaned by the sixth hygienist I’ve met in as many visits, but the whole environment had become geared toward treating as many patients as possible and getting them out the door as quickly as they can. 

As a business owner I certainly understand the need to grow your business.  It just disheartens me that many professions that were once dominated by personal relationships seem to be taking their customer service cues from the fast food industry.

At The Asset Advisory Group (TAAG) we realize growth is important so the children and grandchildren of today’s clients will be able to maintain a relationship with our firm.  We are continually looking for ways to improve our service with technology.  Of equal importance is maintaining the personal touch and customizing each client’s experience.  For example, we offer to hold Skype meetings with out of town clients to maintain the connection that’s often lost when speaking over the phone. 

The majority of our new clients are referred by existing clients or their other advisors that share our service philosophy. We often hear new clients are leaving their current financial advisor because of a lack of communication or drop in service levels as their existing advisory firm grows.  Each of TAAG’s advisors will only work with about 100 client families to ensure the company’s growth does not alter the relationship we have with our existing clients.   

Going through experiences like I did with my new dentist only reinforces our vision for growth.  If you know a good dentist….

 

Christine L. Carleton, CFP®
clcarleton@taaginc.com
http://www.taaginc.com/

Social Media & Investing – Protect Your Information

Investors increasingly turn to social media for information when making investment decisions.  Our social media lunch and learns have been some of our most well attended sessions.  This is a positive advancement as information becomes instantly available to the masses, but it also means we must be more vigilant than ever when it comes to protecting privacy and identity.

The SEC recently released two separate Investor Alerts involving investors and use of social media, focusing on what investors can do to avoid potential fraud.  We thought it would be worthwhile to provide a brief synopsis of both articles as they provide some excellent, easy to implement tips.

Part I – Avoiding Fraud

Social media is an attractive playground to criminals intent on committing fraud as it provides a platform to contact multitudes of potential victims at little to no cost.  The SEC advises on some key pointers that can be key in avoiding this type of attack. 

-          Unsolicited Offers to Invest

o   It generally goes without saying that someone contacting you out of the blue with an attractive offer is something to be wary of, but the important thing to note is how professional and personalized these offers can be made to look in this day and age.  Even if something looks extremely official, approach any unsolicited offer with extreme caution. 

-          Affinity Fraud

o   This is a new term given to an old trick.  The SEC recommends avoiding investment decisions solely on the recommendation of a member of an online group or organization to which you belong.  Scammers here prey upon your feeling of community or identifying with a like-minded individual.  Sometimes the person bringing you the opportunity maybe someone you have known for years, but were scammed themselves and are passing the danger along.  Do your due diligence on your own as you would with any other investment opportunity.

-          Market Manipulation

o   Schemes known as “pump and dumps” have been around for a long time.  Someone uses false or misleading information to drive up the price of a stock just in time for them to sell their shares before the stock tanks.  The same tactic can be used in research reports or newsletters where writers are paid by companies to tout a given stock or investment.  Social media allows for all kinds of new ways to promote investments in fraudulent or unethical ways.  Always consider a person’s motivations for promoting an investment opportunity or company.  If it’s such a can’t miss opportunity, why are they telling everyone they can via Facebook or another tool rather than just keeping it to themselves?

-          High Yield Investment Programs

o   These are unregistered investments that make the promise of providing a higher yield than is generally available in the market, often with little or no risk.  Some of these offers use the term “prime bank”.  Lots of return, very little risk is always a dangerous and often fraudulent combination.  Turn and run the other way.

-          Common Red Flags

o   As with anything in life, beware of anything that sounds too good to be true, promises anything guaranteed (especially returns) or pressures you to buy immediately.  The trick here is that with interest rates at historic lows, scammers can promise relatively low returns and still turn a few heads, but it still doesn’t mean it’s a legitimate opportunity or a good idea.

Part II – Securing Your Accounts

-          Passwords

o   The bottom line is to use different passwords on different accounts and make sure the password is extremely challenging.  Use passwords to secure your mobile devices as well, especially if they have access to your social media accounts. 

-          Links

o   Tread cautiously when clicking on links, even if sent by a friend.  If the link looks funny or the message does not sound like a typical message a friend would send, simply delete.

-          Privacy Settings

o   The default privacy settings on many social media sites may not offer adequate protection.  Take the time to go in periodically (sites will update available settings often) and customize your privacy settings to minimize the amount of personal data available.

-          Requests from Financial Professionals

o   Perhaps most importantly, always know that no financial institution, advisor or other investment related organization should ever ask you for personal data, account information, social security numbers, etc. via a social media website.  Any request should be ignored and reported to proper channels. 

The bottom line as with so much in life is “buyer beware”.  If something sounds too good to be true or can’t miss, than it most likely is.  If you want more detailed information on any of the above or care to see links to real-life cases where these incidents have taken place, you can find the original SEC reports below.

Social Media and Investing: Avoiding Fraud

Social Media and Investing: Understanding Your Accounts

Have a great week!

Chip Workman, CFP®

cworkman@taaginc.com

www.taaginc.com

Is My Money Safe? Part II

In my last blog I discussed the safety of investment custodians such as Fidelity and Schwab, after I received a concerned email from a client.  After watching Jon Corzine, the former CEO of MF Global, trying to explain how $1.2 billion was missing from their clients’ brokerage accounts, he was worried about his own.

The next important question to ask is whether you can trust your advisor.  Research indicates most investors believe their advisor is very trustworthy, even if the evidence shows otherwise.  It’s great to have an advisor you feel you can trust, as long as that trust is backed up by checks and balances, facts and reality.  Investment scams seem so obvious after they’ve been exposed, but most of those affected weren’t suspicious of their advisor until it was too late.

Investors disappointed in their returns over the past decade are more likely to be taken in by what appears to be a chance to make great returns.  Tough investment markets bring out the emotions of fear and greed, and make people more vulnerable.  Based on my study of advisors and investment scams, if your current advisor exhibits one or more of the following characteristics, you should be very concerned:

1.      There is no independent accounting of individual investment holdings, portfolio account balances or returns.  As a former KPMG auditor, this one is so obvious to me it’s frustrating.  However, it’s been ignored by everyone from the very wealthy to low income individuals. Bernie Madoff was able to report consistently positive, long-term investment returns because he was the one preparing the reports, and we all know how that turned out.   

But here in Cincinnati we have our own example as well.  In February 2001 Stephen G. Donahue, owner of SG Donahue Securities, was found guilty of taking over $6 million from nearly 250 clients by supposedly investing their money in a tax free bond fund that never existed.  Instead, he used the money to pay his personal taxes, buy a condo in Florida, and cover other personal expenses.  The theft was hidden because the company did not use an independent custodian like Fidelity to report on client holdings.  Instead, statements were prepared internally and mailed to clients by the SG Donahue Company.       

2.      They guarantee investment returns. Registered Investment advisors like The Asset Advisory Group are barred from using the word “guaranteed” when we discuss investment performance with current or potential clients.  The Firefighters’ Retirement System of Louisiana, along with two other Louisiana pension funds, is now trying to recover a combined $100 million they have invested with Fletcher Asset Management, which had guaranteed a 12% minimum annual return. Their withdrawal requests have been met with only IOUs at this point.  The FBI and SEC are currently investigating, so this story may just be getting started.   

Our local example is George Fiorini and the 10% Income Plus Plan. His investment scam was first brought to my attention in 1995 by my administrative assistant, who gave me a mailing she received that was also circulating among her retired friends. Fiorini’s advertisements were on radio, TV, and bus benches, and featured local celebrity Bob Braun as his chief spokesman.  Over 170 investors lost $5 million, most of whom could not afford to lose anything.    

3.      They report returns that are significantly higher than market conditions would indicate. Bernie Madoff was able to deliver consistently positive investment returns for decades while S&P 500 returns were negative, but if you questioned the validity of the returns, he returned your money and fired you as a client.  This worked until too many people asked to cash out.  Allen Stanford, CEO of Stanford Investment Bank, reported returns of 15% or more on the bank’s high rate CDs, until the SEC decided to investigate after Bernie Madoff’s Ponzi scheme unraveled.  Remember Home State Savings Bank’s higher than market CD rates here in Cincinnati? 

A December 27^th Wall Street Journal article, SEC Ups Game to Find Rogue Firms, indicates that the SEC is finally wising up and using performance data to screen out investment management firms to investigate.  They have announced four civil-fraud cases so far as a result. 

4.      They use wealth, connections to the rich and famous, or exclusivity to give them credibility.  George Fiorini would show up for meetings in a chauffeured black limousine.  Allen Stanford sponsored cricket teams in the West Indies, and his friend pro golfer Vijay Singh promoted Stanford’s company by wearing the firm’s logo on his apparel and golf bag.

The aura of exclusivity was used to promote Ben-Mar Investments in the early 1990’s in Cincinnati.  Ben Schmidt and Mark Gatch used country club connections and their relationships with Bengal players to promote an investment fund that supposedly used a sophisticated investment strategy in which only a select few could participate. Investors lost over $17 million.   John Brinker defrauded 600 greater Cincinnati investors of about $20.3 million using Wellington Capital Holdings, a fictitious offshore investment bank that promised 100% returns through exclusive investment opportunities.   

5.      They use religion or other affiliations to build trust.  George Fiorini would begin meetings with a prayer, and named one of his investment companies IGW Trust (In God We Trust).  Over $2.2 billion was taken from investors through the Baptist Foundation of Arizona, IRM Corp. used face-to-face recruiting through church-based organizations to solicit over $400 million, and Greater Ministries International promoted “Christian Social Security” to take $580 million from investors.  Deep religious beliefs are admirable, but they should not be the primary reason to invest with an advisor.     

After reading all the horror stories you might begin to wonder if you can trust anyone.  But you can build wealth, and maintain it, by working with an advisor who tells you the truth vs. telling you what you want to hear.   

Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com/