Uncloaking Investment Sales Pitches – Dig beyond the pitch

Two weeks ago a client brought promotional material from a stock-picking service and asked if it was “too good to be true”. In October we had a client bring in a booklet titled “Banned in America” providing an opportunity to obtain a “Death of Cash Survival Kit”. These types of sales pitches, along with the advertising practices of some firms, increase anxiety and misunderstanding, contributing little if anything to consumer education. I thought I’d share some of the sales tactics we’ve encountered this year.

Example 1: The Stock Picking Service

Consider this claim “84% of our stock picks are winners … gained more than 300% in less than eight years’ time … An investment of $100,000 in our portfolio recommendations would be worth $389,414 today. In comparison, the same investment in the S&P 500 index would be worth only $149,970 … outperformed the S&P by 165%”.

Sounds fabulous, doesn’t it?! So, what’s wrong? There is no portfolio. There are only stock picks at the beginning of the 8 year period and no indication of how you would buy the next picks. Since there is no portfolio, they don’t address buy/sell timing, costs, or performance. Usually they have a large number of purchases (beyond the $100K) that must be made before there is a sell order. If you sold any of the original stocks (to make the recommended buys) you would not have the gains quoted. What about the recommendations that didn’t perform? Any picks that do not work may disappear in future reports. In some cases, they might even be “pump and dump” schemes to raise the price of particular stocks before the owners sell them.

But how can they be allowed to make these claims? Most of these offerings are made through “educational subscriptions” that fall short of the definition of investment advice. In fact, they are not required or accountable to any investment regulatory agency.

Example 2: Selection of “hand-picked” Managers

This year we had a new experience with a prospective client who compared our real portfolio performance with a portfolio of investment managers selected specifically for them by another advisory firm. I found it difficult to explain (without appearing self-serving) that the portfolio of ‘hand-picked’ managers with an impressive portfolio return (well above all averages) was a new creation not a proven selection. There was no evidence to indicate that the advisory firm had any talent for selecting managers in the past or that this outstanding performance was not the result of survivorship bias (that is, ignoring under performers and only reporting returns for well performing advisors).

Sometimes it can be difficult to understand or explain the problem of survivorship bias in a ‘hand-picked’ portfolio. At Aikapa, all positions in our portfolio are publicly reported and there is no survivorship bias.

Example 3: Modeled Mutual Fund Portfolio

Some large investment firms love to create model portfolios that have little relevance to a client’s actual (real) portfolio. By model portfolios we mean portfolios in which the securities aren’t specifically identified. Since the securities included in the portfolio are unidentified, there is no way for an independent evaluator to verify if the calculated return provided by the model has any relevance to attainable returns or past history. There is the potential in model portfolios for survivorship bias (any under performing fund can be eliminated and no one the wiser). In addition, the models do not include front, back and ongoing fees. A model portfolio that doesn’t include real large costs obfuscates the performance that the client can expect from their portfolio now and in retirement.

Example 4: Cumulative Return

Although cumulative return presentations are ubiquitous I have been spared seeing client portfolio reports with only cumulative returns – until this year. Cumulative returns are calculated using total earnings without regard for time. Cumulative returns (on their own) are intrinsically deceptive. For example, a 20% return is a good return over two years but a dismal return over 20. If two cumulative returns start at different times then the returns can’t be compared. It is much more useful to report rolling annualized compounded returns for each year than to show only the cumulative return.

Example 5: Purchase of illiquid assets as core investments

Many investment advertisements show private real estate investments as an excellent way for a small investor to quickly grow their entire retirement asset. The presentations illustrate the very high upside potential but often fail to point out the significant change in liquidity and risks compared to a publicly traded diversified portfolio. Unfortunately, several of our new clients experienced the real impact of the downside when the market took a downturn and their real estate projects couldn’t obtain necessary financing. It is during such a crises that a client learns the real meaning of downside risk and how lack of liquidity prevents them from recovering any of their investment. In addition, these sales pitches often forget to outline the increased costs and administration associated with managing such investments.

In short, a sales pitch should never be the sole basis for evaluating how to invest your hard earned money particularly assets already earmarked for your retirement. Do your homework and explore the strategies behind the sales pitches. In all investment decisions let your goals (not the sales pitch) define your target return.

Edi Alvarez, CFP®