On May 25th, 2010 Dr. Paul Woolley of the London School of Economics laid out ten policies that he claims could increase annual returns (after inflation) by 25% and long term returns by at least 50%. As promised we are taking a few weeks to cover these points in more details. Dr. Woolley was addressing his steps to large institutional investors but we feel as if they are just as well suited for individuals.
Step 8 - Everything in the portfolio should be traded on a public exchange.
This may seem like a minor point to most individuals as most of you will never control a portfolio so large it would benefit from the use of a Dark Pool broker or seek to purchase a CDS, CDO or any of the other alphabet soup products that Dr. Woolley’s comments are intended for. Yet it is highly likely that you will at one time or another be approached by your broker or financial advisor to purchase a previously issued corporate bond.
One of the better sales techniques they use is to tell you that one of their firm’s clients had to raise money quickly and sold their bond at a bargain price. Because of this he or she can give you, their favorite client, a special deal. Most financial advisors sell bonds already owned by their firm. They have a description of the bond and a markup (commission) they could earn if they sold you the bond. Maybe, just maybe, selling you the bond rewards the salesman with a little more commission and possibly a little lower return for you. Without the bond trading on a public exchange, how would you know if this “special deal” was really “special”?
Step 9 - Secure full transparency of banking service costs incurred by companies you invest in.
This step is addressing agent fees for banking services that are hidden in corporate earnings. For you the step should be restated as “Secure full transparency of investment costs and fees incurred in the management of your portfolio”.
I would venture to say that only 1 in 100 individual investors who use mutual funds or annuities know how much they are paying annually due to fees, commissions and investment activity operating costs of their funds. You can find out if you know where to look. If you are a self-directed investor take the effort to find out. If you use the assistance of a financial advisor then demand full disclosure of all costs, not just at the beginning of your relationship, but throughout the duration (annually).
Is it worth while? For the year ending December 31, 2009, the average gross expense ratio of the 26,228 mutual funds in the Morningstar Principia database was 2.08%
Step 10 - Provide full disclosure of compliance with these policies.
If you have taken the time to set rules for the management of your portfolio, then you should prove to yourself, or your advisor should prove to you that the rules you set are being followed.
This ends our discussion of Dr. Woolley’s ten steps. I wanted to send a special thank you to him and his associates at The Paul Woolley Centre for the Study of Capital Market Dysfunctionality. Their main objective is “to produce and disseminate high-quality research relating to understanding the workings of capital markets and the social efficiency of allocations achieved in these markets”. Dr. Woolley’s Ten Steps is one step that meets this objective.
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