Some Things Never Change…

The sun rising in the east, human ingenuity, the changing of the seasons, wars, and conflicts in the financial services industry.  These are just a few things that will never change.

I joke, but not really.  I hesitate to say that this new story was shocking, since it is something I've now come to expect:  Morgan Stanley Purges Vanguard Mutual Funds.  It is not at all uncommon for a brokerage firm to remove a fund company from its platform, but in this instance, when you read the reason why you'll probably be as upset as I was:

Brokers and consultants said that Morgan Stanley is almost certainly retaliating against Vanguard because of the Valley Forge, Pennsylvania-based firm’s longstanding refusal to pay for brokerage firm “shelf space” as part of its crusade to keep expenses for investors low.

With all of the "fiduciary" talk continuing to pick up steam, Morgan Stanley (and Merrill Lynch who is also mentioned in the article) have decided to not allow the largest fund company on the planet to offer its funds on their platform.  Not because of poor performance or high risk to shareholders, but because they wouldn't pay-to-play.  Because Vanguard's mission of keeping costs low for shareholders cannot co-exist with Morgan Stanley's need to make a profit.  And our industry wonders why we get a bad reputation?  This is exactly the reason we started Greenspring 13 years ago.  Several of us left the organizations mentioned in this article because we wanted to do what was in our client's best interest.  That often times could mean investing in the lowest cost mutual funds on the market.  Now Morgan Stanley is saying that won't be possible.  As we've said before, if you work with a broker at one of these groups, they are not necessarily bad, but the system is set up against you.  Don't hate the player, hate the game.



The Worse The Product The Higher The Commission

If there was still any doubt that brokers have been selling clients products that aren't in their best interest, this should put it to bed.  An article in Financial Advisor magazine reported the following:

Through August, sales of non-traded REITs were $3.15 billion, down 55 percent from the same period a year ago, according to the Robert A. Stanger & Co., which tracks the industry.

Sales of BDCs through August were $1.07 billion, down 62 percent.

Non-traded REITs, the bigger category, should reach around $5 billion this year — about half of last year — said Keith Allaire, managing director at Stanger.

What are non-traded REITs and BDC's you ask?  These are products with high commissions and fees (sometimes over 15%) with countless examples of massive blowups.  In this day and age with Google, it is hard to believe they still exist in their current form.  Just google "non-traded REIT scam" you'll find over 17,000 hits with the first few links being stern warnings from the SEC and FINRA.  The old adage that these products are "never bought but sold" is entirely correct.  You almost exclusively see these products sold by brokers.  So, what is the reason for the massive drop-off in sales?  The article states it pretty clearly:

"That's primarily due to the change from full front-load structure, to a trail commission structure," he said. "It's a matter of getting new products in the pipeline, and at B-Ds trying to figure what structure they want on the platform."

Translation:  cut out the big commissions and brokers won't sell it anymore.  This goes to show you that little concern was given to the quality of the product (anyone looking closely at these things knew that a long time ago) or the client.  The appeal of these products was always about the huge upfront commissions.  With the advent of the Fiduciary rule, requiring all brokers advising retirement accounts act in the client's best interest, it seems like some of these horrible products are seeing asset flows dwindle.  That's a great thing for consumers.

If you are in the market for an advisor, I urge you to find one that always acts in your best interest (not just for retirement accounts) so you can avoid situations like this.  The best way to find one is through the National Association of Personal Financial Advisors (  While you aren't guaranteed to find a great advisor (you still need to vet them further), at least you will know that advisor is not incented by selling you products (NAPFA members cannot accept commissions or kickbacks in any form).

Full disclosure- Greenspring is a member of NAPFA.

How Many Clients Does Your Advisor Work With?

Last month Barron's published their annual Top 1,200 advisors in the country.  This list recognizes the largest "producers" from the large Wall Street firms.  Even the terminology at those firms is interesting.  Producer implies that you are creating something…in this case it's revenue from selling products and services to your clients.  One specific paragraph really resonated with me and reminded me why it was so important to leave that environment.

ON AVERAGE, our Top 1,200 and their teams manage $2.27 billion in client assets. That’s down from $2.42 billion for last year’s group and is, in part, a testament to how challenging the markets have become. At the same time, the advisors are serving more clients: This year’s Top 1,200 serve 521 households on average, compared with 496 for 2015’s crop.

521 households!  That's the average.  Think about that for a moment.  How can an advisor effectively serve 521 families?  There are approximately 250 business days in a year.  If you wanted to meet with each of your clients just once a year, you'd have to have more than 2 meetings a day and not take any vacations.  That leaves no time for managing portfolios, doing financial planning, or just time to think strategically on behalf of your clients.  The truth is, serving that many clients works with a certain type of model- product sales.  It is easy to call 30 clients a day and talk to them about selling or buying a particular investment.  Or put them in an advisory account where someone else will manage it on the client's behalf.  Or unfortunately, just overall neglect of a client's portfolio.  Where it doesn't work is a true comprehensive planning relationship.  There is just not enough time in the day to understand and advise on a client's cash flow, insurance coverage, estate plans, retirement objectives, tax projections and investment management needs.  We have clients from these firms coming to our firm every month looking for a better solution.  At Greenspring, we work in teams of two advisors per client (along with a client service specialist).  Currently our average ratio is approximately 50 clients per team.  We believe this allows us the time to manage the intricacies that are common to a true planning relationship.

For the client's sake, we hope to see the number of clients per advisor move down over the years.  Instead of judging advisors based on how much they produce or manage, it would be a breath of fresh air if these types of awards focused on the impact they are having in their client's lives.


More Conflicts At Big Brokerage Firms

Did you ever wonder how a financial advisor makes their investment recommendations?  There are thousands of mutual funds on the market today.  How does he/she pick one over the other?  If your advisor works for a big brokerage firm like Morgan Stanley or Merrill Lynch, some of the decision making is taken out of his/her hands.  There is a little known practice that happens in which funds pay for "shelf space".  In order for a fund to be offered on a large brokerage firm's platform, they must pay hefty fees.  Some fund companies are happy to do this in order to gain distribution, while others refuse.  Here is Jason Zweig of the WSJ discussing some of the nuances:

The financial industry calls these fees “payment for shelf space,” and they can add up. At Edward Jones, revenue-sharing fees from fund companies topped $153 million in 2014, or just under 20% of the the St. Louis-based brokerage and advisory firm’s total net income that year.

At Merrill Lynch, fund companies pay up to 0.25% of sales and 0.10% of assets annually for “marketing services and support,” according to a 2015 disclosure. Morgan Stanley collects $750,000 per year from each of 28 fund companies it has designated “global partners” and $350,000 annually from each of another 11 “emerging partners,” according to the firm’s latest available disclosure.

The disclosure statements warn that revenue sharing can be an ethical minefield. Edward Jones says the payments create “an additional financial incentive and financial benefit” to the firm and its advisers. Merrill Lynch points out that funds that don’t enter into such arrangements “are generally not offered to clients.” Morgan Stanley says the firm may “promote and recommend” funds that pay higher revenue sharing.

Do you think there is a conflict here?  You bet.  Let me give you a real life example.  Before I founded Greenspring, I was employed by one of these large institutions.  After doing some of my own research I found a fantastic real estate fund that I thought would make sense to own in client portfolios.  But since this fund company was not willing to pay a portion of their revenue to my firm I was not able to offer it to clients.  As an advisor, when you can't recommend products that are in your client's best interest, there is a conflict.  One other thing you have to realize…the only way for the economics on this type of arrangement to work is by using high fee funds.  If you are offering your products on Merrill Lynch's platform, you can't pay Merrill Lynch 0.35% in the first year if your expense ratio is 0.2%.  Why do you think you can't buy a Vanguard mutual fund at these firms (which by the way is probably one of the best fund companies on the planet)?  Because Vanguard only charges 0.1%-0.2% for many of their fund expenses.  They don't charge enough to share fees.

Many investors think that a fee-based relationship is the same whether it is at Merrill Lynch, Morgan Stanley or an independent firm.  It's not.  While you may be paying similar fees to your advisor in each of these scenarios, what you don't see is that independent firms don't charge for shelf space, and therefore are free to recommend any product they think is best for their client.  The big firms only recommend funds that have paid them for shelf space.  This can have a major impact on fund selection and portfolio performance.

Conflicts Abound At Large Brokerage Firms

If you ever are interested in learning about the conflicts your advisor at a big firm might have when advising you, just go read their compensation plans.  They are complex and incentivize behaviors that may not be in your best interest.  Many of us at Greenspring started our careers at these firms so we weren't surprised to see that not much has changed.  I was particularly interested in a recent article that outlines the new compensation plans offered to advisors at Merrill Lynch and Morgan Stanley, the two largest brokerage firms in the world.  Here is an excerpt from the article about Morgan Stanley:

As for Morgan Stanley's lending award, it remains unchanged from last year at the advisor level: A maximum of $202,500 will be received for those showing growth in securities-based lending, tailored lending and home mortgages. Support staffers, though, can earn as much as $10,000 for their support of lending activities, up from $2,000 in 2015.

The president of the wealth management division stated in the article, "We continue to make private banking services our top strategic priority in support of [our] holistic advice."  Translation:  lets sell a boat load of banking products to our clients this year!  The fact that an advisor can earn over $200,000 if he sells enough lending products is sickening to me.  With that kind of money on the line, advisors are incented to push clients into loans.  Not only loans, but margin loans.  For the vast majority of investors this is a terrible idea.  Ask anyone who has heavily invested on margin how it worked out.

Merrill Lynch isn't any better.  Here is an excerpt:

Advisors who had fees and commissions of about $400,000 to $600,000 and received cash payouts of 40% in 2015, for instance, will need to produce $450,000 to $650,000 in 2016 to maintain the same payout level. Thus, a $400,000 producing FA who couldn't make the jump to $450,000 in production would make 5% less cash in 2016 — $152,000 vs. $160,000 in 2015.

Merrill's 2016 grid includes cash payouts of 34% of production to those reps bringing in yearly fees and commissions of under $250,000; 35% for those producing between $250,000 and $350,000; 38% for the $350,000–$450,000 range; 40% for $450,000–$650,000; 41% for $650,000-$850,000, 42% for $850,000-$1.05 million, and 43% for $1.05 million-$1.5 million.

So, lets say you are an advisor and its December 15th.  You've produced $425,000 in revenue for the year.  You know if you don't get to $450,000 in total revenue your payout (% of revenue you take home) is going to drop costing you thousands of dollars.  Do you think there is any incentive to push products that may not be in your clients best interest?  And this isn't just some small percentage of advisors that have to wrestle with this.  It is all of them.  When you look at the ranges, every advisor is going to be close to bumping up to a new payout.  Again, this is more incentive to sell products that the clients may not need.

Am I being harsh?  Don't advisors have a moral and ethical dilemma when they sell clients products that benefit the advisor more than them?  Maybe, but I have seen too much that leads me to believe it is happening frequently.  Dan Ariely, a professor of behavior economics at Duke puts it best:

Dishonesty is all about the small acts we can take and then think, no, this not real cheating. So if you think that the main mechanism is rationalization, then what you come up with, and that’s what we find, is that we’re basically trying to balance feeling good about ourselves. On the one hand we get some satisfaction, some utility from thinking of ourselves as honest, moral, wonderful people. On the other hand we try to benefit from cheating.

So rationalization is what we allows you to live with some cheating and not pay a cost in terms of your own view of yourself.

We all have biases and conflicts.  Advisors, like all of us, are prone to using rationalization to live with the products they are selling clients.  They have plenty of money, they'll be alright.  The performance has been great on this fund.  They have to bank somewhere.

Rationalizations are everywhere.  Our industry has to stop relying on an advisor's moral code and disclosure to clients (none of which work) and focus on setting up firms that avoid these conflicts altogether.  Greenspring has thought a lot about this.  That is why all of our revenue comes from our clients.  We don't want to be influenced by outside forces (earning a commission to sell a product, sales incentives, higher payout figures, etc) when we are advising clients.  We hope to see the industry follow this same path as the clients will be the real winners.

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.