Super Brokers Form to Push Super Broken Products to Make Those with High Net Worth Super Broke

By: Reggie Middleton | Tue, Jan 13, 2009
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Sell side brokers and fund of funds pushed tens of billions of assets to Bernie Madoff, for a fee and maybe a commission or two. You know the rest of that story. Funds of Funds charge 1% and 10% on top of hedge funds 2% and 20% - to lose about 21%. Hmmm! The big name brand Wall Street banks charge full commissions (about $10,000 to $50,000 per year for accounts the size of the top quintile of my blog's reader's accounts) and give you the privilege such a charge the opportunity to lose between 29% and 41% of your capital! Hey, thanks fellas. With friends like those, who needs enemies. Now, they are bulking up due to their own investment missteps, and merging into super brokers. B of A bought Merrill Lynch, and now Citibank is spinning off Smith Barney into a JV with Morgan Stanley's brokers. Both of these merged entities will have a sales force of over 22,000 sellers each. Wowza! That's a lot of salespeople. Can any of them invest worth a damn, though? Now, what exactly are they going to be selling? After all, to cut costs, brokerages and sell side banks are reducing the size of their analytical staff, which was already reduced significantly in the last Wall Street cyclical downturn after Spitzer got in their ass about conflicts of interest. Even without these head count and talent reductions, investment performance stemming from this salesperson/analyst model was horrendous, and that's about the nicest way I can put it. We'll get to that point later, though.

The Rich have it rougher than many would be led to believe!

We have had around 2 years or so of rapid asset depreciation, and after re-examining my notes and thoughts for the umpteenth time, I am now more convinced than ever that the chances of the US and much of the developed world and emerging markets going into a depression is as least as great (and probably slightly greater) than going into a protracted recession. Things are definitely not looking up. This will hurt everybody, from the maid to the CEO to the hedge fund manager to the gardener to the plumber. Believe it or not, I believe it will hurt the upper classes even more, on both a relative and absolute basis. Here's why:

  1. The upper classes tend to invest much more, if not all of their wealth, as compared to the lower and middle classes, in financial and real assets. Their primary investment classes are exactly those that got hit the hardest over the last 2 years, and are going to be those that will be getting hit further in the near future. These investment classes are:
    1. Residential Real Estate in the form of less liquid primary residences, vacation and 2nd homes - down 18 to 30% for the year depending on where its located;
    2. Commercial real estate direct owner ship, partnerships and in trust - all taking a big bath right now;
    3. Stock - down 36 to 40% for the year
    4. Fixed income securities of varying investment grades and maturities - taking a beating with grand canyon style spreads, particularly the more speculative stuff and the tax exempts which the wealthy rely upon for tax favored income
    5. Alternative asset funds, ex. hedge funds, private equity, buyout funds - down 21% + for the year;
    6. Art and collectibles - extremely illiquid now, with values plunging faster than VB+ can calculate in Excel;
  2. The wealthy have ove extended themselves significantly with debt, many counting on historical investment returns to provide relief of debt service that probably isn't coming this year. Many have probably gotten too lax in relying on easier credit as well.
  3. The primary compensation source of the higher end of the wealthy and upper classes is investment returns, and as investments nosedive and stock grants and options become worth less (or worthless), they will be forced to live off of their principal, which is akin to flirting with the unemployment line for the middle and working classes.
  4. The lack of liquidity in so many markets means that even when they do attempt to access principal or sell of assets, they will probably receive greater haircuts than they thought they would, meaning the downward spiral accelerates.

Believe you me, there will be a significant amount of social mobility occurring over the next few years, and most of that mobility will be downward. I would say roughly a third of my blog's readers are high net worth, and/or belonging to the upper classes (their is a distinct difference, which we will get into in a moment). Here is a quick rundown of the blog's demographics:

Instead of using some academic study or 3rd party data, I've decided to use the demographics of BoomBustBlog.com to outline the combined effects of the economic turmoil and the trash that is being peddled as financial and investment advice - a combination that is proving lethal to your net worth as you read this. Now, let's make sure we are all on the same page when we discuss the social classes and the wealthy. For those who feel you must get offended when social class is discussed, I strongly suggest you stop here and watch TV or otherwise get a solid dose of MSM, mind numbing programming. For the rest of you who choose to continue reading, you have just chosen the Blue Pill - prepare to be unplugged from the Matrix!

Social Mobility: Unlike the Jefferson's, We're moving on down!

Social class is defined (on this blog) as the amount of control one has over one's socio-economic environment. It is much more than money, although money is a large component. For instance, Barack Obama is in a higher class than Robert DeNiro or Michael Jackson, although Robert DeNiro and Michael Jackson are most likely wealthier (although that is quite debatable after taking into consideration the value of Obama's campaign contribution list and membership database from his social networking site!). Obama's higher class stems from his ability to exert more control over his socio-economic environment. The factors that this author uses to determine class combine (with the associated weights) to create a "socioeconomic index":

Socioeconomic Index=

(Occupation X 12) + (Income source X12) + (Income X 7) + (Wealth X 14) +

(Education X 7) + (Dwelling area X 15) + (Class Consciousness X 7) +

(Housing X 12)

There is a handy dandy BoomBustBlog class model (based loosely upon the Index of Status Charcteristics) available for download for anyone interested in delving into this further. See boombustblog.com_social_class_model v.7.3 156.00 Kb.

As you can see, wealth is the largest contributor to the class standing, and coincidentally it is the factor that is the most at risk in this current economic climate. I believe that there will be a significant entry into the upper middle class by those who were once firmly entrenched into the upper classes! While that may not seem like a big deal to many, it is damn big deal to those who are moving down the ladder. This also means, that there will be some space for others to move (relatively speaking) up the ladder. One man's (or woman's) misfortune is another's opportunity. I believe this blog can not only be used to insure and proof against downward mobility for those in the upper strata, but can also be used by those in the lower, middle and lower upper strata to rise upward a notch or even two. Social Mobility is the name of the game in times of severe dislocation - times like we are experiencing now.

Lower Strata

Underclass/Poor

 
 

Working Poor

 

Middle Strata

Lower Middle Class

 
 

Upper Middle Class

 

Upper Strata

Lower Upper Class

<-- 20% to 30% of BoomBustBloggers are here, roughly 1,000 of you!
 

Higher Upper Class

 

Now, in term of wealth (not social class and influence, just wealth) we can split the upper strata into three different categories (there are only two above because of the other factors that come into play when social class or socioeconomic standing is taken into consideration). There is the poor wealthy, those guys and girls that are just a hair's breath from being pulled into the upper middle class strata due to marginal wealth. This would be the $1m to $10m net worth crowd, who rely on business profits, salary and investment returns for income. The next would be the middle strata of the wealthy, hailing between $10 t0 $100 million in Net Worth, and then there is the upper strata wealthy at above $100 million. Each of these three strata of wealth represent, in my opinion, distinct behavior tranches in terms of discretionary expenditures, investment, and politics and (what passes as, this is a story for another post) philanthropic activities.

  Demographic Source of wealth Net Worth
Lower strata wealthy (High net worth) Service professionals, corporate executives, entrepreneurs, inheritors Salaries, stock options, restricted stock, small business profits, investment returns $1 m to
$10 m
Middle strata wealthy (Very High Net Worth) Corporate executives, entrepreneurs, inheritors Business ownership, investment returns, salaries, restricted stock, stock options $10 m to $100 m
Upper strata (the truly Rich!) Entrepreneurs, inheritors,
very few CEOs
Business ownership, investment returns $100 m to several $billion

A trip to practically any decent sized yacht club or recreational vehicle port reveals the relatively stark differences in discretionary spending behavior. The first strata can be found in the 36 ft. to 68 ft. yacht docks (where a captain is optional, but not mandatory and you really don't need a crew). The second strata can be found 50 ft to 120 ft docks, where captains, crews and semi-custom fiberglass boats abound. The third strata are almost exclusively in the super yacht category, where the carrying cost alone for these (basically waste of money) fully custom built hulls and vehicles are about million a year to start with. You can also see the other social economic strata as well, upper middle class in the 20 to 35 ft boats, the middle and working class in the considerably smaller fishing boats - as opposed to the ultra fast Viking and Hatteras deep sea fishers, etc. It is an interesting and instructional study in social studies and anthropolgy just walking along your local docks!Once you are aware of how these things break down, you will see many settings in a different light.

For the purposes of this discussion, we will focus on the 30% or so of my blog readers in the multi-million dollar range of net worth.

The dark purples, deep greens and reds are most likely the general demographic to get hit hardest. Fortunately, those who follow this BoomBustBlog closely, either personally or through their advisor, should have seen a net increase in networth rather than a net decrease. This has hurt non-BoomBustBloggers in this demographic tranche significantly, and will hurt them even farther. At the same time, let's hope that the opinion and research that I bring to the blog helps, because many will need it. Let's see why.

The hardest hit industries in this economic downturn are represented by the largest pieces of the pie above: finance, real estate, and insurance - followed by the commodity volatility whipsawed agricultural industry - which will trickle down to the professional services industry that serves all of those above: lawyers, consultants and accountants (the verdict is still out on doctors and the medical industry, although the industrial pharmas don't seem to be doing very well). Basically, 75% of you are feeling it harder then American industry in general.

The relative small size of the firms and companies, combined with the anecdotal knowledge that I have of the subscribers confirm that many of you are entrepreneurs and/or small business owner/stakeholders. These are the primary drivers of wealth in our economy.

Many of you are balance sheet heavy, in that although your income is significantly higher than the US average and median, the balance sheet seems to rule the day here.

It is safe to assume that the higher wealth tier of the blog readers generate most of their income from their investments. This is what Morgan Stanley and Bank of America were aiming for when they made their large acquisition attempts of Merrill Lynch and Solomon Smith Barney. Just imagine, armies of 40,000 salespeople trying to access your capital, or sell you their high fee, high commission, mediocre (to put it nicely) performing investment products and services. The Fund of Funds industry is aiming at your capital as well. Do they add Alpha? I know the Bernie Maddoff scandal is a helluva black eye for the industry. Taking the median of the investable capital tranche answers from my blog's questionaire, let's assume the median investable asset level for the 7 to 8 digit crowd is $8,125,000 - which I feel is about right. Remember, investable capital is the money and securities that you have to give to someone to manage or invest, as opposed to assets, equity or net worth.

So, if you run the scenario of you putting those assets with the big brokerages powerhouses forming, the hedge funds, or the broad market, let's see what happens to the income of those living off of their investment returns.

Now, for those of you who factored in a 10% annual return to guage your spending and budget, I think those expectations should be ratcheted down some in order to come in contact with reality. For the sake of expediency though, we will use 10% of principal as the burn rate through which you support your lifestyle. This means that you will need to make 10% (pre-tax) per year in order to avoid eating into your principal. At the median figure quoted above, that gives the HNW BoomBustBlogger about $67,708 per month of income and gains (at least it did last year). Look below to see how your income will be effected after factoring in 2008 investment returns. For many of you who did not match the performance of this blog, a significant reduction in lifestyle expenses is in order, or the expectation of 20% plus returns from this point on. If I am right about the economy, the markets and the business environment, this year will be much worse than last - thus those rosy expectations really need to be dumbed down signficantly! See "BoomBustBlog Research Performance for 2008" for a full accounting of 2008 comparative investment performance and comparative performance since inception.

  Barclay's Hedge Fund Index S&P 500 Citi GS JPM MS BoomBust
Blog
Reggie's Prop Account
  -20.9% -35.7% -28.9% -29.3% -41.4% -29.7% 106.2% 335.0%
Principal at year end $6,430,938 $5,222,750 $5,775,368 $5,744,025 $4,761,315 $5,712,265 $16,753,265 $35,343,750
monthly cash flow@ 10% $53,591 $43,523 $48,128 $47,867 $39,678 $47,602 $139,611 $294,531

Now, let's take a look at the expenditures.

It is difficult to segregate the expenditures of the higher net worth readers from the other tranches from this dataset, but it is worth displaying nonetheless.

You are being BAMBOOZLED and HOODWINKED by the establishment!

Despite significant under-performance, the Wall Street Marketing Machine still seems to keep investors, particularly wealthy investors, plugged into the Matrix! They will pump the quasi-reality of their wealth (mis)management even harder as they attempt to dig themselves out of the economic earnings hole that they have dug themselves into. Expect an unusually aggressive, and fee and commission heavy, products push by your local broker sometime soon. As disguised as it may be, you can bet your Aunt Mabel's dentures that it will arrive in time for Q309 quarterly reporting. Buy into the Banks, Brokers and Bullsh1t mantra at your own fiscal risk!

Consider yourself forewarned.

 


 

Reggie Middleton

Author: Reggie Middleton

Reggie Middleton
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Reggie Middleton

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation and financial analysis to pursue, analyze and capitalize on global macroeconomic opportunities. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

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