Book Review: Wall Street Potholes
Simon Lack, CFA, together with four other expert money managers, addresses a range of investment topics that pose special dangers to investors in Wall Street Potholes: Insights from Top Money Managers on Avoiding Dangerous Products. The topics include nontrading REITs, yield dependence, structured notes, hedge funds, Wall Street inefficiency, mutual fund fees, annuities, brokers and fiduciaries, and the future for investors. This review covers four of these topics that demonstrate the book’s value in today’s investment environment.
Author and CFA charterholder Simon Lack is well qualified to present such a wide-ranging and timely discussion. During his long career, he has engaged in bond trading, derivatives, hedge funds, and investment management. He spent 23 years of his working life at J.P. Morgan overseeing more than 50 professionals in a highly profitable group, in addition to sitting on the firm’s investment committee. Lack is proud of his years at J.P. Morgan, whose culture, he says, “overwhelmingly reflected the best in terms of value and integrity.” His own research upholds a similarly high standard.
In 2009, Lack founded SL Advisors, LLC, a registered investment adviser. He is the author of the international bestseller The Hedge Fund Mirage, which has been quoted numerous times in the business press, and he frequently speaks on financial subjects. For example, he gave an excellent presentation — “Putting Investors First: The Fallacy of Hedge Funds” — at the CFA Institute Annual Conference in Seattle in May 2014. He is also the author of Bonds Are Not Forever, which explores the history of debt from ancient to modern times, including the growth of derivatives, developments in risk management, inflation in the modern era, and the political backdrop to today’s debt standoffs.
Turning to this review’s first of four of the book’s topics, shares of nontrading or unlisted REITs, though registered, are not traded in the market but instead are bought and sold by the issuing REITs themselves. Although tradable REITs raise no concerns in Lack’s mind, the nontrading variety do because they lack the broker research coverage typically available for tradable equities. In Lack’s view, the reason some REIT issuers choose not to make their shares tradable is that their managements have dubious aims and strategies that they would prefer not be the subject of broker research. Lack’s message to ordinary investors is to be wary of nontrading REITs because buying them requires sophisticated research skills that they are unlikely to possess.
The hedge fund chapter is a valuable update of Lack’s Hedge Fund Mirage. It begins with a historical review drawn from the earlier book, describing hedge fund performance beginning in 1990. Lack shows that returns net of fees were attractive up to the early 2000s. Thereafter, hedge fund returns deteriorated owing to several factors:
- Increasing flows into hedge funds created competition that gradually reduced their arbitrage-like opportunities.
- High fees — 2% of assets and 20% of returns over some hurdle rate — reduced returns to investors.
- The fairly high beta of hedge funds going into the 2007–08 financial disaster caused them to sell off sharply.
Lack goes on to say that since 2002, a standard portfolio of 60% equities/40% bonds has outperformed hedge funds collectively. He also points out that the largest US public pension fund — the California Public Employees’ Retirement System, or CalPERS — dropped its hedge funds, citing the high level of fees it was paying. Finally, as Lack acknowledged in his earlier book, some hedge funds outperform the average for that asset class, but he contends that the ability to identify those stars generally resides with sophisticated institutional investors.
Annuities are covered by David Pasi, a Delta Financial Group senior portfolio manager with an extensive background in fixed income, accounting, and risk management. The chapter describes what annuities are, their history (going back to Roman times: AD 225!), today’s types of annuities, associated risks, and the advantages of tax-free growth — all very useful background information. Pasi then outlines some concerns about annuities, including lack of liquidity, returns that are sometimes meager owing to low interest rates, and high fees. The bottom line is that although annuities offer definite advantages, successfully investing in them is a highly research-intensive process.
Wall Street Potholes’ final chapter, “Putting Investors First,” deals with the future investment landscape. It covers several topics, including the future of finance, the role of advisers, the importance of understanding fees, what investors can do about structuring their finances, and the vital role of CFA Institute in all this. On that last point, Lack talks about the launching of the Future of Finance initiative of CFA Institute, which it describes as a “global effort to shape a trustworthy, forward-thinking financial industry that better serves society.” Lack ends this final chapter by listing the 10 investor rights formulated under the Future of Finance initiative.
In summary, Wall Street Potholes is a valuable contribution to investors’ understanding of today’s markets. The book is well researched and well written, in addition to being extremely enjoyable to read. Wall Street Potholes is recommended for anyone interested in achieving better investment performance.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.