Once upon a time, quant funds were THE investment vehicle every sophisticated investor had to be in. For instance, in 2006 Kiplinger, one of the big personal finance platforms, argued that quant funds were a revolution in active investing, taking the emotion out of investment decisions:

“Human emotion and behavior are too often the enemy of sound investment hygiene. You probably should be buying when the herd is selling and selling when the herd is buying. Many investors fall deeply in love with the stocks they own. Fund managers and Wall Street security analysts often behave like cheerleaders for the companies they’re supposed to be dispassionately analyzing. All this emotion partly explains the growing interest in so-called quantitative funds, mutual funds largely managed by soulless computers that crunch the numbers.”

So far, so good. But what happened to the quant funds of all those math whizzes? Morningstar just published an analysis of quant funds and the results are devastating:

“The carnage has been widespread. For example, seven of Bridgeway’s eight actively managed funds that rely exclusively on quant models land in the bottom third of their Morningstar categories over three years through July 28, 2010. The same is true of six of Goldman Sachs’ eight quant funds with three-year records. JP Morgan has a lineup of eight Intrepid brand quant funds, and each has lagged its typical category peer over the past three years. Vanguard’s quant group has struggled, as has AXA Rosenberg–its four Laudus funds will soon be liquidated.”

How come? Basically, quant funds use many different and complex variables to predict stock market success that showed good performance in the past. Yet, history never repeats itself exactly. The crash began in the summer of 2007. Most quant funds lost substantially and, after changing their strategies over the course of the crisis, they were then not able to profit from the upswing since 2009.

Not surprising and another confirmation that active investing will not be able to beat the market over extended times. Tragically, investors have often paid exorbitant fees to the quant funds as many of them used hedge-fund-style compensation models.

It seems that over at Credit Suisse they are panicking about the tax probes lead by the Germans and other  European governments against offshore clients and also bank advisers. We have been contacted by former Credit Suisse clients, some of them long standing clients, who have been rudely kicked out as clients. We have credible information that even clients who legalized their holdings in Switzerland have seen their accounts canceled. Only few weeks ago Credit Suisse sent a letter to foreign clients with less than 1 Mio. Euro that they have to pay additional fees if they want to keep an account in Switzerland. MyPrivateBanking has copies of this letter.  We will follow up with this story next week and hope to get some comments from the CS management.

I am pondering one sentence I stumbled upon today:

“It is ironic that the markets are now at their most democratic at time when returns are at their nadir.”

This is from the blog abnormal returns, a great source of financial debate. Basically, indivividual investors today have all the tools and vehicles to free themselves from unhealthy advice and make their own decisions:

“The ironic thing is that at a time of poor returns, the information and tools available for investors have improved dramatically. This is largely a function of the rise of Internet. Abundant data, cheap trades and an explosion in investment vehicles, i.e. ETFs, have made it ever more possible for individuals to manage their portfolios how the largest institutions did just a few years prior.”

I still think that this investor heaven is a far cry from what most private investors do today. Most individuals are still entrusting their wealth to a bank or a wealth adviser who is not free of conflict of interest when picking investment products for their clients. Most private investors still believe their advisers when they tell them how to time the markets or pick individual stocks or bonds. And on top of everything, most investors still pay way too much money to their wealth managers. It will be a long time until the majority of private investors really takes investing in their own hands. But, in any case, the revolution has begun and it offers too many advantages to individual investors to be stopped. Particularly in times of low returns the weaknesses of trading-oriented and active stratgies of most wealth managers become very clear to investors.

Deutsche Bank set another prime example on how to push dubious investment products in their client portfolios without taking on any risk, but charging absurd commissions.  In 2006 Deutsche Bank promoted a fund in Ferris Wheels called Global View. However, so far not ferris wheel has been built, but nevertheless the fund spend up €208 million for property purchases, banking fees and dubious project development costs. So it looks like the average  investors will incur huge losses, but how about the sponsor and sales arm of the fund Deutsche Bank ?

“For Deutsche Bank, though, the Ferris wheel project turned out to be very good business. The Frankfurt-based bank earned €19.2 million through Global View thanks to its client advisors, who drew in €160 million from the bank’s customers within the space of 10 weeks, primarily from German small investors like Schmidt. The bank itself, however, never invested in the fund. Global View used the bank Delbrück Bethmann Maffei (DBM) instead. Deutsche Bank preferred not to invest its own money in the project, for example through loans. Even when that money was badly needed, the bank declined on the basis of a “market risk” that couldn’t “be assessed and covered by the bank. [...]

The letters and e-mails raise suspicions that Deutsche Bank not only insisted on unusually high commission rates that were meant to be concealed from investors, but even doubted the project’s chance of success. From the beginning, the bank calculated using an “equity commission of 12 percent. The sales brochure was only supposed to show 10 percent, which called for a creative solution. One Deutsche Bank employee suggested in writing that the excess commission simply “no longer be shown in the brochure”.

To me that looks less like a creative but more like a criminal solution !

A few days ago the German high court (Bundesgerichtshof, the news is here but only in German) has made a landmark decision on transparency of commissions. The court came to the conclusion that only banks have an obligation to make all fees and commissions transparent to their clients. However, in the case of so-called independent advisers the court requires no mandatory disclosure.

In effect, this decision is a big step back for private clients in Germany. Financial product distributors like MLP or AWD have millions of clients in Germany but also in other countries like Switzerland. With this court decision they are encouraged to keep secret the kick backs they receive when they push certain products into the portfolios of their clients. The consequence of this decision is that the term “independent financial adviser” is probably as misleading as it gets.

The only good part is that the court has re-affirmed its older decisions that banks (as opposed to independent advisers) are required to be transparent to their clients. The financial industry is terrified about more transparency when it comes to investing their clients’ money. This explains the make-no-prisoners-resistance against any step of more transparency. But the industry should make no mistake. Clients become more and more aware of this conflict of interest and are increasingly ready to switch their providers. It is not too late yet for voluntary transparency yet.

After some dispute within the German federal government on the legality the German state Lower-Saxony finally bought another CD containing data from about 20.000 German holders of Swiss bank account. This time supposley Euro 185.000 were paid to an unidentified seller.

The new business model for private bank employees is still intact and banks and clients may like it or not: Offshore-banking has no future. Pressured by “data leaks”, tougher regulations for tax havens and stricter law enforcement at home less and less clients will take the risk of bringing untaxed money across borders.  Banks with a lot of offshore-clients better adopt their strategy now!

Morningstar carries a report that long-short-funds are becoming a red hot product for fund companies as many have launched long-short products.  In simple words, a long-short-fund is a financial product that can bet on falling or increasing asset prices. Particularly during falling markets such products become popular as they can make a profit or limit the losses. Long-short-strategies used to be typical for unregulated hedgefunds but regular mutual funds are more and more using these strategies.

The success of long-short-funds rests largely on the right timing and stock-picking decisions of the fund manager (even more than for long-only funds). As markets increase the fund manager has to go long. When they fall the funds short positions must increase.

Yet, study after study has shown that about 80% of fund managers will not beat their market benchmark in any given year. Plus, those that beat the market are usually not the same fund managers over a period of several years.

So, why then are long-short-funds becoming so popular with fund sponsors?

“In 2009, long-short funds took in a record $10.3 billion last year and they are on track to break that record this year. Through April 2010, they took in $6.3 billion, which makes it the seventh most popular fund category in 2010.”

It seems to me that this flow of new money  is the real reason behind the boom of long-short. 10 years from now most of these funds will have gone to the same place where all the Internet and technology funds have gone a few years ago. Not to mention all the other fund fads that didn’t make money for investors (but a lot for the fund industry). In this sense the present wave of long-short funds should be seen by the rational investor as a contrarian indicator. Especially as these funds often carry higher fees compared to regular mutual funds (not to speak about index funds).

This is a great piece from Forbes on how to give all the important and critical questions to your wealth advisor. I particularly like the point on “bedside manners”:

“Just like picking a primary care physician, a compatible “bedside manor” is critical in establishing a long lasting relationship.  Does your prospective PM treat you with respect, encourage questions, and answer them in a way you can truly understand? Or does your advisor talk down to you?“

If you want more background and even deeper suggestions for choosing your wealth adviser check our wealth guide on “Choosing the Right Wealth Manager“.

We have just released our new German client wealth management monitor and the most important finding is that Germans are a bit shaky with regard to their customer loyalty. 43% of the 300 surveyed wealthy clients are considering to switch their bank within the next six months. (3% say they have already made their mind up to switch and 40% say they think about switching). The interesting part is that the younger customers (under 35) and the wealthier ones (investable assets of more than 500,000 €) express an even higher likelihood to switch (>50%).

Only a minority of these clients will in reality change their bank and find a new provider. But it is still a small revolution in a country where, in the past, you would rather divorce your spouse than change your bank. For the wealth managers this new situation brings threats but also opportunities for new market entrants and banks with a strong marketing strategy. Overall, we feel that more competition should be good for the  client as quality and transparency increase. After all, consumers spend a lot of time to make decisions about a new car or a new mobile phone contract - why shouldn’t they spend more time and effort to think about their wealth management, a decision that is far more important?

Business Week carries a great, long story on Goldman Sachs and how the firm is been forced to defend itself against a public perception that they have been the epicenter of the global financial crisis. The magazine sums Golman’s situation up:

“Business is booming, but Goldman, which once prided itself on avoiding the ostentatious and on making money for the long haul, is a different firm, with a perception problem that mere explanation can’t solve. In committing to market-making at all costs, the firm has opened itself up to forces beyond its control. The question is: Has Goldman Sachs shorted itself?”

The article can’t answer the question whether it was Goldman who brought down AIG and whether Goldman really sold shoddy CDOs (collateral debt obligations) to its customers only to turn around and short these CDOs, effectively betting against its own clients. What becomes clear however is that Goldman,  the hallmark of global banking, is under a lot of pressure. Pressure that may translate into new regulation constraining its business model.