Brian Smiley comments on mismarketed limited partnership investments.
New York — Even Warren Buffett can blow it big-time with a rotten pick. Just ask him about the $358 million stake in USAir in 1989 that’s worth about half that today.
If a current-day deity can blunder in placid markets, imagine the potential for crashing a portfolio when a mere mortal is at the wheel. Challenge that amateur with a market that’s taken to dips of 161 Dow points in a single day — like July 15, for instance — and there’s no guessing how ugly a portfolio can become.
Add to a scary market the possibility that you might follow some of the advice overflowing from TV screens and newspaper pages, and you can almost guarantee a buy-high/sell-low strategy. Particularly when, during a subsequent rally, you’re buying back the stocks you sold in the downturn.
Much has been said about the ever greater financial education of individual investors, but in practice better information doesn’t always lead to better decisions. That’s because, in wacky markets, emotions overtake logic, said John Lawrence Allen, a lawyer who has represented investors suing brokers for bad advice.
“When you get extremes of volatility, the amateur substitutes fear for intellect,” he said.
Consider a study by Morningstar Mutual Funds. In January, after looking at groups of the three biggest-selling and three smallest-selling fund categories in each year since 1987, Morningstar concluded that investors still buy just when they should bail out. Smart investors should capitalize on the findings, Morningstar president Donald Phillips said in January. At that time he advised against buying aggressive growth, technology and financial-service funds — the most popular sellers in 1995.
Meanwhile, precious metals, European and natural-resource funds — the least popular groups last year — were a buy, he said. Although Phillips last week was hesitant to examine the numbers to see if the advice had worked from Jan. 1 through July 16, saying it’s a strategy to use over a three-year period, investors who bought 1995’s losers would tend to be ahead already.
Last year’s three most popular fund categories — the ones investors should have unloaded in January — were down 1 percent on average since the start of the year. And 1995’s three biggest losers in terms of new money coming into fund groups were up 13.7 percent on average, Phillips said. This, in a period when the Standard & Poor’s 500 was basically flat, up 1.4 percent.
Robert Adler, president of AMG Data Services, said that the “marginal investors” who were lured to small-cap and technology stock funds in this year’s speculative frenzy likely added velocity to the recent downturn. Indeed, the shift in net new money coming into these most popular groups shows how investors can become fickle just after they’ve plowed money in at the top.
New money was coming into small-cap funds at a rate of $1.1 billion a week in May, Adler said. During the week of July 10, that rate had declined to $170million. Similarly, in the technology fund sector, investors went from pumping $170 million a week in new money into the group to showing net redemptions of $40 million a week during the past three weeks, he said.
Interestingly, large-cap funds have actually seen a slight increase in net new money, “which leads me to believe that cautionary money is seeking more liquidity,” he said.
That’s a sign that investors are looking for what they perceive as safety. Brian Smiley, a lawyer who represents customers who sue their brokers, said investors who are frightened by the stock market frequently get tripped up and park their money where there is a deceptive “appearance of safety and stability.”
The boatloads of money that flooded into since-shattered limited partnerships in the 1980s are a prime example, Smiley said. Brokers sold partnerships as a stable investment whose principal would remain intact, shipping of f monthly statements that lulled investors to sleep with continual pricing at par. Meanwhile, the underlying investments were coming apart at the seams, he said, a fact the public learned too late.
Since then, investors fell for another big “can’t-lose” opportunity when they stampeded into short-term world income funds in 1990, Phillips said. With investors disgusted over increasingly low money-market returns that year, fund companies were easily able to entice the public to buy the “multi-market” funds that would enjoy higher yields in overseas markets, while “guaranteeing” the fund with financial hedges. As with every sure thing, of course, the hedges didn’t quite work and many investors wound up with black eyes. Assets in the world income group ballooned from a half-billion dollars in the end of 1989 to more than $21 billion by the end of 1991 — just in time for the strategy to blow up.
In 1992, average return for the group was -1.79 percent, Phillips said.
To hear the securities industry and its mutual-fund colleagues tell the story, the newly educated investor has become far wiser about how to behave when markets turn down: hold on and don’t panic. While that may happen at the margin, the continued extremes in fund buying at the top and selling at the bottom belie the industry spiel.
The gullible among the public, meanwhile, are fed a steady diet of commentators spouting pearls of wisdom on “defensive stocks,” and the usual interviews with the gurus of hard asset investing.
The public, though, can’t really be biting on the crazy hedges such as precious metals, you say. Depends on whom you believe. In an interview with CNBC the day after the Dow’s 161-point mood swing, one peddler of gold bullion said business was great. “Our phones lit up, especially from people with IRAs,” he said.
By Susan Antilla