The Compound and Friends - "I did everything I was supposed to do" (with Josh and Michael)

Episode Date: June 20, 2019

Josh Brown and Michael Batnick discuss the recent post "I did everything I was supposed to do", which is the story of a man whose spent his whole career working for asset management firms and now finds himself on the wrong side of the active vs passive debate. There are real world consequences of the massive outflows of cash coming from actively managed mutual funds. This was Josh's attempt to look at the issue from the other side. The post spread around the financial web like wildfire. You can read the whole thing here: https://thereformedbroker.com/2019/06/16/i-did-everything-i-was-supposed-to-do/ 1-click play or subscribe on your favorite podcast app   Subscribe to the mini podcast on iTunes or Spotify   Enable our Alexa skill here - "Alexa, play the Compound show!"   Talk to us about your portfolio or financial plan here: http://ritholtzwealth.com/   Obviously nothing on this channel should be considered as personalized financial advice just for you or a solicitation to buy or sell any securities. Please see this 3,000 word terms & conditions disclaimer: https://thereformedbroker.com/terms-and-conditions/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi, I'm Michael Batnick. We are going to be talking about Josh's post, I Did Everything I Was Supposed to Do. So Josh, you wrote this fictional piece about a story that's actually playing out all over the country in the financial services industry. This piece is called I Did Everything I Was Supposed to Do, and it tells the story of Dave, was that his name? Yeah. And Dave did everything he was supposed to do. He went to the right college, went to the right companies, but the industry is collapsing. The walls are caving in around him and now he's shit out of luck. Why did you write this? So it's based on a true conversation I had a few weeks ago that's been

bothering me ever since. The character Dave is an amalgam of a lot of people on Wall Street that have found themselves on the wrong side of some of the biggest trends in asset management. And so the character Dave in my post is a guy that, for the last 25 years since college, played by the rules, worked at big mutual funds, did a lot of analysis, was picking stocks, was trying to beat the market. And the post was inspired by this conversation I had with a PM who was basically put in this position where they had to cut people from the organization. So FAT has been getting cut for years now. This has been going on very surreptitiously. It doesn't make big headlines.

But a lot of like big asset management firms that are not named Vanguard or BlackRock are seeing every month money leave. It doesn't even matter how the performance of the fund is. It's not even a judgment on this is a good fund, it's a bad fund. They're just shrinking in dollars. And when you shrink in dollars, the management fees are also shrinking and the parent company is going to pay for less personnel. So I know a lot of personal stories like this.

Well, you know what? This could have been you. If you weren't like an artist and you were more of a math person and you went down that route and did like the CFA and the PM stuff, like this could have been you. Well, so that's one of the things that's most, I don't want to say shocking, but that's one of the things that I guess is like most scary to people is that it's not like they're saying, oh, we have five people picking up the mail from the mailroom and we only need three. Like now they're cutting MBAs. Now they're cutting people with the chartered financial analyst designation.

And it's not that they want to or it's like a shameless grab for more profits. Like literally the active management side of our industry is shrinking fast. I forgot what the stat was from last year, the inflows and outflows. But it was something like – or the last 10 years. I think it was like $500 billion into passive and $65 billion net out of active. Maybe that's not exact. Into passive and $65 billion net out of active. Maybe that's not exact. But I guess the point of the post that I wrote was to just kind of explain that there's a human side to these trends that are happening in the markets.

And there are winners, obviously Vanguard and iShares and State Street. But then there are losers, and the losers don't deserve to lose. It's just what's going on in the world. Isn't this just what goes on in the world? Isn't this just sort of life? Not to sound cold. Obviously, it's unfortunate. Yeah, I'm glad you asked that question.

It's not what goes on in the midst of a 10-year bull market on Wall Street. If you look at the history of Wall Street, every boom in stocks has been accompanied by a massive boom in hiring. You made this point like three, four years ago, remember? Yeah, this is the first. So you can call this a bubble or whatever. Also, why is this a hate of bull market? You wrote a piece probably in 2014.

It's because Wall Street is not parading around. They're not having fun. So in other words, imagine a real estate boom where realtors felt left out. It's ridiculous. Imagine like a huge property boom where property developers weren't making any money. It would never happen. It's an impossibility.

We have a boom in stocks and also in bonds and now there's like 60 – There's a boom in stocks. There's a bubble in bonds. Fine. There's a boom in stocks. There's a bubble in bonds. Fine. But now it's like you now have $60 trillion in invested assets and Wall Street is cutting staff.

It's unthinkable. It's never happened before. What happens to these people? I had a call a few months ago. Somebody I haven't spoken to in a decade just got let go, was running an internal wholesaler desk at a giant company. Dude, I had to hide my email address because I have a huge readership among professionals on the street. And people are just like – either for themselves or for someone else, they're like, listen, I have a CFA. I was at Smith Barney.

I did this. I did that. They have these amazing pedigrees and tons of experience. And we don't have a place for that. We have research personnel. We have an investment committee. We don't have a place for somebody to figure out if Google is going to outperform Facebook next quarter. It's just not our value prop to clients. We can't do that. We're not good at that. But I literally had to mask my email and then get rid of it entirely. I don't do that. We're not good at that. So like, but like I literally had to mask my email and then get rid of it entirely. I don't have a public facing email because of how many resumes and people like just being like, what should I do? Not even asking for a job, but like,

what's your advice? This is my situation. I'm telling you hundreds of these over the years and it sucks. It's, you know, I try to read them. I try to sometimes respond. And then I just gave up. So what do people do? I think they look for buy-side firms that are growing their assets and they're rare. Or I think they get very entrepreneurial and they maybe launch newsletters or alert services or research for hire. But now the research for hire thing, like freelance research, is also under pressure because of a new regulation in Europe that's going to come here. They call it MIFID 2. But basically, firms in Europe cannot tie the value of commissions to or cannot have soft dollar arrangements with research firms. And so it becomes harder to sell your research. You have to account for the research you're buying if you're a firm.

And you have to say why you're paying for it. And once things get that transparent, it becomes tougher to justify. So what do you say to the people who are like, oh, cry me a river. This person who is making $500,000 is no longer. I mean, if that's your takeaway, it's pretty callous. $500,000 might be a stretch for an analyst. Maybe they make a quarter

of a million dollars. But if you make a quarter of a million dollars and you work on Wall Street, you're middle class. You're not a hot shot. If you work in New York and you live in Westchester... That comment you just made would piss a lot of people off. Yeah, I know. They'd say move.

But I don't know what you do. You take that skill set. It's fine. You can go live somewhere with a lower cost of living. You can go somewhere in the Midwest or in the South. But what do you do with that skill set? I don't have solutions unfortunately. But the character

Dave in my post, he's saying now what am I supposed to do? Because it's not like you lose one of these jobs and there's five openings. Like, every firm is under pressure right now to justify the cost of research, justify the salaries of analysts who are engaging in stock picking. And, again, it has nothing to do with skill. engaging in stock picking. And again, it has nothing to do with skill. So there are people that would read that, Mike, and say, well, if they were any good, they would still have a career. I don't know if that's true. Like, fucked up things happen to people all the time that are unjustified. So there are probably tons of really great analysts that just,

there's not an opening for what they do right now because the dollars from investors are not being directed that way. You read the part about how he kind of blames financial advisors. What was your reaction to that? Sure. I mean, I think that's why a lot of people on Twitter are not too fond of us, and I totally – I empathize. Like, I totally get it. Right. So you have this situation now where financial advisors, like they don't want to invest in funds where you have to not only get the asset class right and the weighting of it, but then you have to be sure that you have the right manager for that asset class. Actually, one of my reactions was I'm sort of surprised that you wrote this because we are like the enemy.

And I don't mean like – because we are like the enemy. And I don't mean like we – All the more reason for me to like empathize because we – I used to do this. Like I used to allocate to Bill Gross at PIMCO and what's his name that ran the top-rated value fund for large cap Berkowitz. Like I used to allocate to these guys. And then like it's not like, oh, they underperform when you're so I fired them. A lot of them did like insane shit where it's just like, how do I explain this to a client like PIMCO Total Return Bond Fund, which I know has been doing well recently.

But there was this moment in 2011 where stocks collapsed and Europe looked like it was heading into a Great Depression and you needed to be long treasuries. I mean, the flip side – And they were betting against them. Right. The flip side of this is that that is still a pretty massive industry, but it doesn't need to be as big as it once was.

So it's massive in terms of both the amount of funds and the dollars that are in those funds. In both – even though passive is now 40% of the market. It's still big. No. 40% of invested funds. Not of the total market. Because people own shares directly.

Right. The fund market. It's 40% market share. All the time that Active is dead. We were at the Morningstar conference two years ago. Looking around booths of $15 billion companies. Tons of them that I've never heard of. Oh, how many asset managers there are with $10 billion, $15 billion.

Right. So to say it's dead, I mean its best days are behind it, but it's going to be dying for the rest of our – for the next two centuries. So you don't think it's cyclical at all? No. You don't think a bear market where value loses less than growth and active stock picking was helping? I'm on Beltrunis' side. I think people will sell out of active funds just like they sell out of index funds. But when they come back, they're not coming back to active.

They're coming into indexes. So there have been some pretty big mergers in asset management in the last few years but probably not enough. Like Janus and Henderson, which is a big UK-based fund company. There have been some. I'm so surprised that there haven't been way more. Think about how many standalone asset management firms are still around marketing their funds. It's probably coming. Seeing outflows every year.

You can keep cutting staff and you can keep cutting marketing and you can do your best to outperform and of course everyone does. But at a certain point, there have to be way more deals, I feel like. And then the other side of that is a lot of these firms are reacting by launching ETFs. And that makes perfect sense to me. Why wouldn't you? And now they've gotten approval for the first active ETF where the holdings will be masked, just like in a 40-act mutual fund. And they think that that might turn around the industry's fortunes because the one thing you get from the ETF structure that you don't get from the mutual

fund structure is tax efficiency. And people just have a predilection for buying and selling ETFs on an exchange rather than waiting until the end of the day. So maybe that does something to slow the trend down. But my fear is that you're right. And it's just a reality that we deal with for the next 20 years where this industry continues to shrink. And I don't really know that. Again, I don't really have any solutions, but I thought it was important to talk about. What are your thoughts on this topic? We love your feedback. Let us know what you think. Is there something that we're missing? Is there something still left unsaid that we should get into? Go ahead and smash that like button for us and we will talk to you soon.