Don’t Judge a Book by its Cover

The admonishment to not “judge a book by its cover” is usually one encouraging us to be better people. “Look past a person on their worst day or who presents poorly to see that they’re a human being just having a hard day. See the merit in every individual and get to know them better than they appear;” or some such encouragement from our parents might go. However, the less often used context of this expression is as a warning. “Don’t take things for granted” or “Don’t assume things are as they appear.” Today, we’re exploring some of the issues with the “packaging” of the financial world, and how consumers of financial services and products should be careful to read the fine print and do extra due diligence before assuming things are as they appear.

Socially Environmental Responsibly Sustainable Governance Investing

The word soup above is the amalgamation of “ESG” or “Environmental Social Governance” and “SRI” or “Socially Responsible Investing.” These two terms are in the current “vogue” of investing, including a multitude of mutual funds and exchange-traded funds that have been launched with assorted themes such as “investing in minority-owned companies” or “investing in companies that combat climate change”, and so on. However, recently Tariq Fancy, the former chief investment officer for sustainable investing at Blackrock (the largest investment management firm in the world) caught flack for saying “In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community. Existing mutual funds are cynically rebranded as ‘green’ – with no discernible change to the fund itself or its underlying strategies – simply for the sake of appearances and marketing purposes.” As if to underline the truth of this claim, Phil Bak, the chief investment officer of Signal Advisors, tweeted out the comparison of three Blackrock funds over the weekend: “For 3 bps you get the S&P 500, for 15 bps you get to ‘drive innovation by embedding sustainability risk into our active investment process’ and for 30 bps you get ‘a sea change in global investing.’ Tell me which is which.” Of the three funds he then listed the top holdings for, all three had Apple, Microsoft, and Amazon as their three largest holdings and in almost identical proportion and order, all of them held Google, Facebook, JPMorgan, and two of them held Tesla, Berkshire Hathaway, and Johnson and Johnson. The order of the asset selection and concentration in all three funds was almost identical. So much for funds driving innovation in sustainability risk for 5x the cost or combatting rising sea levels for 10x the cost. None of this is to say that ESG or SRI investing are bad ideas or lack merit, but more goes to highlight the current trend of investment companies establishing largely arbitrary ESG/SRI criteria and opening funds that invest in more or less the same thing as their core investments do, but with significantly higher prices. With ethical investing must come virtue signaling, at least on some level? The cautionary tale here of course is clear: Just because the label says ESG/SRI or has some sort of ethical investing theme attached to it, doesn’t mean that when you look under the hood you’ll find anything different than a much cheaper run of the mill index fund.

Advisors are Yesterday’s News

While I’m an enormous critic of the SEC’s regulation “Best Interest”, it did accomplish one thing. No wait, that’s not true: It didn’t accomplish anything, but it did cause companies to get cleverer with how they deceived the public. One of the rules of “Reg BI” is that it finally regulated the term “advisor” and required that insurance agents and brokers using the term as their job title actually be registered as investment adviser representatives, meaning that they’re actually licensed to give securities advice, not just to sell an investment or insurance product. Not to miss a step, financial product companies immediately started rebranding their agents and brokers as “Registered Securities Brokers” and “Risk Management Consultants”. While the homogenous “Financial Advisor” title is now barely protected by the regulation, it has done nothing to protect the title of Financial Planner. While CFP® or CERTIFIED FINANCIAL PLANNER™ is still a protected title under the copyrights owned by the Certified Financial Planner Board, the non-certified “financial planner” title has also come under swift adoption by unscrupulous companies looking to borrow legitimacy. Thus, we’ve simply moved the ball of the most common title for people in financial services from being “Financial Advisor” to seeing a quickly growing use of “Financial Planner”. How does the public tell the difference? Look up the professionals you’re talking to and verify that they’re actually a financial planner or if they’re just pretending.

Speaking of Reg BI

Not to say I’ve written about Reg BI too much, but the news keeps rolling in that it effectively just made public clarity of who is and isn’t a fiduciary harder to determine. Because the Reg BI regulation requires brokers and product salespeople to say “I am required to act in your best interest”, the public has gotten burned with greater regularity over the past year than in previous years. Why? Because prior to Reg BI, it would have actually been an illegal form of false advertising to state that very same thing, as brokers and insurance agents are fiduciaries to their companies, agencies, and carriers, and legally can’t act in a fiduciary capacity toward their clients. That’s still the case, but now the requirement to state best interest has created a requirement that the brokers lie to their customers. To expand on that issue even further, the regulation clearly carved the firm itself out of the Reg BI best interest requirements, so the firm can give a broker investments that literally serve only to line the firm’s pockets, and the broker is technically correct when they say “the best thing I can recommend for you is fund X”, which happens to be objectively awful and designed only to line the firm’s pockets. To rub salt in the wound, the item that’s supposed to help make all of this clear to the consumer, the “Customer Relationship Summary” or “Form CRS” has been found to be missing at over half of those firms that are required to use it. So not only has the regulation opened a legal loophole for brokers to lie to the public legally, but of the firms that are doing so, over half are simply ignoring the parts of the regulation that don’t benefit them.

How do we protect ourselves?

Well, simply put, we have to be willing to do the work. When it comes to investing in an investment product, we have to take the time to look past the label and read the fine print. Review the top 10 holdings of the investment and see if they align with the investing objective that’s being spelled out in the title. Consider whether their definition of “governance” matches the type of governance you want to see. When looking for professional help with your investments or financial planning, look up the credentials of the professional you’re looking to hire, and more importantly, validate whether those credentials are real (just google “validate [name of credential]”, i.e. validate CFP, validate CDFA, etc.) And finally, ask how those professionals are paid and their firms are paid in writing. Then, do your homework again. If you find misrepresentations or misleading material in the writing, ask for clarity, and revalidate. If this all seems like a lot of work, it certainly is. But hey, it’s only your life savings and your financial future you’re ultimately entrusting to these financial products and service firms.