We all know that institutional investors have more diversified portfolios than retail investors, but two studies shed light on just how poorly diversified the average retail portfolio really is.
Great observations, as usual. There may be some patriotism at work, there may be a misguided sense of familiarity ("I can check up on my investment in Hornbach Baumarkt by shopping at my local Hornbach Baumarkt!"), and local banks clearly want to encourage sale of domestically-focused investment products, but I am convinced that regulatory and tax reporting/preparation burdens contribute to both the home- and single-stock-bias your piece reveals.
Before Big German Bank kicked me and my kids out of our German brokerage accounts for being "US persons", I was negatively impressed at the paucity of funds the "Depotkonto" could allegedly accommodate ("Please buy me some low-fee dollar-denominated Vanguard Index 500."; "Sorry, no can do, but I can offer you this high-fee euro-deonominated Big Bank Investment Arm fund that's kinda-sorta-but-not-quite-Vanguard Index 500"), but was positively impressed by how one would receive a reasonably straightforward tax statement at the end of the year ... it had all the numbers the Finanzamt wanted in all the right boxes.
I will save you sob story on the specific plight of US citizen investors abroad (a "catch-22" situation where one can't have a local brokerage account nor own foreign mutual funds due to US regulator over-reach, but one then also needs a permanent US address to maintain a US brokerage account, and are then restricted from buying even US mutual funds and ETFs because one is not US-resident), but even a German citizen investor trying to open up a non-German account and/or buy non-domestic mutual funds faces massive friction costs.
When I ask my tax preparer why they can't simply use our annual US 1099s and apply 25% flat to ony dividends or capital gains, they cite a German rule change in 2018 that no one has ever been able to satisfactorally explain to me that apparently now requires byzantine calculations involving poring through each monthly brokerage statement for each fund to somehow de-construct the returns. The fact that they're set up for automatic dividend investment (that's how the magic of compounding really works over time!) seems to complicate things even more. I'm stuck with a *massive* tax preparation bill each year that's a *huge* drag on all-in investment performance.
Own individual stocks? Magically, all those problems go away! Both in Germany and the US. Sadly, ETFs don't count as individual stocks, which I find a bit weird ... so why is Berkshire Hathaway okay? One can sort of understand the regulatory drivers: Non-1940 Act-compliant overseas mutual funds are viewed by the US authorities as tax dodges at best, and money laundering vehicles at worst, and the same suspicions apply the other way 'round for the Germans. However, there is delicious irony in that much of government regulation is ostensibly set up to protect small retail investors from runious losses, but the regulatory/tax system ends up encouraging underdiversified single-stock ownership over mutual funds.
UK bias applies if you choose stocks etc for other reasons e.g. O&G, Banks, Value factor.
I know my biases (I think): more USA, fewer mainland Europe, some specific Asia (India).
Also you must consider Fixed Income, Infrastructure, etc.
While Tax should be a secondary influence, Withholding Tax can be a problem in US and mainland Europe. FX charges of c. 1% on buy and another 1% on sale,
Many retail investors have atrocious experience either with the advisory process at large as well as the handling of discretionary investment mandates - where institutions allocate to products (often in house) as well as asset classes often at odds with the risk tolerance framework stipulated via the express wishes of the client, not to mention handling mandate clients in a manner which is in conflict with their interests giving advantage to more lucrative direct third party institutional asset management customers.
Examples include on both the advisory and mandate side of the equation fund products ( both in house and from „premier“ third party institutions) imploding/liquidating for no good reasons (the underlying stock markets in question may correct but rarely implode) not to mention the legion of structured products leaving dilutive rather than accretive footprints on the balance sheet. Funds are ostensibly supposed to diversify risk - not to replicate or even amplify it- especially funds managed as part of mandate offerings.
And when the collateral damage lands on the lap of the client, the clients are quickly presented with a fresh face because the previous person is silently shifted away from the scene.
I can tell you that the Finanz und Wirtschaft yesterday had a headline about how the Swiss banking industry is „beunruhigt“ about the noises which FInma under its new head Stefan Walter. I hope that there are plenty in the industry who have permanent Durchfall.
In my parent‘s case, I found out years later that the individual advising my parents in 2007-2009 gave a very cocky interview in a Swiss industry publication about how he had successfully engineered a career transition from wealth management to business banking (looking to screw corporate treasuries instead of individual investors). He was still working for the same institution as he was back in 2007. You know the one - you worked for it when it went cap in hand to the Swiss government. People like Klaus Wellershoff who were advising customers to be cautious were sidelined because they were spelling out inconvenient truths. The whole of the board should have resigned en masse - not just Ospel. He deserved terminal cancer.
Peter Wuffli, CEO from 2001 to July 2007, recently had the gal to suggest that hype combined with fraud is nothing new. However, whilst one invariably has to learn to live with, but not necessarily participate, in hype, fraud depends on the counter- reaction of society to its presence.
Leute die nicht hören und sehen wollen müssen fühlen. And it is best if the orchestrators of BS feel the net effect of their BS.
The Swiss Banking industry has been contracting and has become less profitable over time. Why? People cotton onto bad value propositions. Even the Swiss, never mind the foreign, whether Asian or other, customers are becoming more demanding. And less amenable to smart arsed selling machinations. After all, after screwing European, North American, Arab and Asian investors, Swiss bankers do not have much runway left to screw anybody else. Smart ass client advisers are so yesterday. Cycles change. Counter cycles take hold. Just like in the stock market. It is called mean reversion. And when a whole industry is presented with mean reversion, dann wird es eng!
When one is exposed to bad practices at a premier institution - not some back street brothel but one that is believe it or not billed as the epitome of absolute excellence and perfection, then it does not exactly inspire trust and confidence in anything coming out of the mouth of anybody never mind anybody working in the financial sector.
On the contrary, I make no bones about what I am doing - managing a portfolio of individual European and North American stocks. I take ownership of the risk as well as the return. Indeed i have access to valuation and performance on an ongoing basis and not just when an institution in question desires to report to the client. I take no more risk with key man or key institution risk like my parents did. It is all credit, FX and market risk - and I am very clear eyed about this existential truth.
There is a broader cultural trait at work which I wish to raise. Professional accountability across the board in Switzerland and the German speaking world at large- one reads and hears of horror stories in Germany as well- is the nasty net effect of excessive liberalism on the one hand and „sozialeMarktwirtschaft“ ( more like asoziale Marktwirtschaft) on the other hand.
I write this last paragraph for good reason.
Whether CS - for God‘s sake 15 years after UBS-, or Wirecard in Germany, never mind the Benko BS spanning Germany, Austria and Switzerland, there is an attitude problem with governance in the German speaking world. And the answer is not more tick box regulation. One needs more accountability but without adding to the regulatory burden on those who manage their affairs with responsibility. Somehow politicians are incapable of understanding the balance to be struck.
That is not to say that we need a litigation culture likening the US. However, a more energetic promotion of the concept that actions have consequences would not be remiss.
I always appreciate your notes. This article struck a chord with me, since 3 decades ago I looked at share ownership patterns across 25 countries. Research was sparse then, but a few truths were evident.
Retail ownership is quite volatile and has deleterious impact on market liquidity, as individuals are primarily takers of liquidity. Markets in Asia, such as Taiwan and HK, were remarkably volatile and still are. Markets such as the US had a "backbone" of institutional investors, notably pension funds, who stayed in the markets. Other developed markets were lacking that backbone but were building them. Public markets were impeded by a limited numbers of listings with a great amount of private ownership, e.g. Germany.
Individuals are obviously not well diversified. The ability to assimilate more information that is available in public markets is still limited. Thus, greater transparency alone has not made them investors. More have become traders as they have witnessed great wealth created by share ownership.
The majority of markets still lack viable domestic institutional ownership holding patient capital. In the US public pension funds and large endowments have shifted allocations to private markets. The UK I believe has also seen a decrease in domestic institutional ownership. Reliance on foreign capital inflows has been a curse for many markets, as this capital typically flees at the sign of trouble. Foreign share allocations by US institutions have broadly decreased in the last 3 decades.
Corporates have stepped in to some degree with larger cash piles available. Buybacks have supported the US market. FDI has generally increased. On the other hand, US pension funds and endowments have allocated considerably more capital to private markets. ZIRP contributed to both VC and PE growth, but that has disappeared. Valuations are being challenged and secondary market trades are heavily discounted. Where does that capital go now and how much will be lost to defaults.
Speculative activity by retail and hedge funds consequently have more impact on public share prices. The articles you cite highlight the conflicts-of-interest inherent in sales to retail. Open architecture has been discussed but not executed for 3 decades. As retail investors awaken to the costs of those conflicts and impact on their wealth, shifts will occur but not overnight. Indexed ETFs that emulate the larger market at a low cost are better for the long term and potentially stabilizing for the public markets.
These factors do not bode well for capital formation through public markets for the time being Your note has underscored challenges for the public markets in the next few years.
100% agree. To give you a scary stat that in my view explains to a large degree why the UK market has become a perennial underperformed and is at the whim of fickle foreign investors: the average allocation of UK pension funds to UK equities has dropped from somewhere around 50% in 1997 to 5% in 2015. Key driver was the rise of LDI.
I knew UK pension allocations had dropped (I lived there for 13 years but been gone for 10 now). LDI has presumably done well for the providers and obviously not so well for the beneficiaries. Too much economic rent is being siphoned off into the pockets of a few agents. It harms the markets and contributes to growing disparities in wealth.
I need to find a topic to cheer me up. Thanks for your response and look forward to future dialogs.
Great observations, as usual. There may be some patriotism at work, there may be a misguided sense of familiarity ("I can check up on my investment in Hornbach Baumarkt by shopping at my local Hornbach Baumarkt!"), and local banks clearly want to encourage sale of domestically-focused investment products, but I am convinced that regulatory and tax reporting/preparation burdens contribute to both the home- and single-stock-bias your piece reveals.
Before Big German Bank kicked me and my kids out of our German brokerage accounts for being "US persons", I was negatively impressed at the paucity of funds the "Depotkonto" could allegedly accommodate ("Please buy me some low-fee dollar-denominated Vanguard Index 500."; "Sorry, no can do, but I can offer you this high-fee euro-deonominated Big Bank Investment Arm fund that's kinda-sorta-but-not-quite-Vanguard Index 500"), but was positively impressed by how one would receive a reasonably straightforward tax statement at the end of the year ... it had all the numbers the Finanzamt wanted in all the right boxes.
I will save you sob story on the specific plight of US citizen investors abroad (a "catch-22" situation where one can't have a local brokerage account nor own foreign mutual funds due to US regulator over-reach, but one then also needs a permanent US address to maintain a US brokerage account, and are then restricted from buying even US mutual funds and ETFs because one is not US-resident), but even a German citizen investor trying to open up a non-German account and/or buy non-domestic mutual funds faces massive friction costs.
When I ask my tax preparer why they can't simply use our annual US 1099s and apply 25% flat to ony dividends or capital gains, they cite a German rule change in 2018 that no one has ever been able to satisfactorally explain to me that apparently now requires byzantine calculations involving poring through each monthly brokerage statement for each fund to somehow de-construct the returns. The fact that they're set up for automatic dividend investment (that's how the magic of compounding really works over time!) seems to complicate things even more. I'm stuck with a *massive* tax preparation bill each year that's a *huge* drag on all-in investment performance.
Own individual stocks? Magically, all those problems go away! Both in Germany and the US. Sadly, ETFs don't count as individual stocks, which I find a bit weird ... so why is Berkshire Hathaway okay? One can sort of understand the regulatory drivers: Non-1940 Act-compliant overseas mutual funds are viewed by the US authorities as tax dodges at best, and money laundering vehicles at worst, and the same suspicions apply the other way 'round for the Germans. However, there is delicious irony in that much of government regulation is ostensibly set up to protect small retail investors from runious losses, but the regulatory/tax system ends up encouraging underdiversified single-stock ownership over mutual funds.
UK bias applies if you choose stocks etc for other reasons e.g. O&G, Banks, Value factor.
I know my biases (I think): more USA, fewer mainland Europe, some specific Asia (India).
Also you must consider Fixed Income, Infrastructure, etc.
While Tax should be a secondary influence, Withholding Tax can be a problem in US and mainland Europe. FX charges of c. 1% on buy and another 1% on sale,
I believe stocks in a SIPP avoid WHT.
In all a lot to consider as well as Home Bias.
Many retail investors have atrocious experience either with the advisory process at large as well as the handling of discretionary investment mandates - where institutions allocate to products (often in house) as well as asset classes often at odds with the risk tolerance framework stipulated via the express wishes of the client, not to mention handling mandate clients in a manner which is in conflict with their interests giving advantage to more lucrative direct third party institutional asset management customers.
Examples include on both the advisory and mandate side of the equation fund products ( both in house and from „premier“ third party institutions) imploding/liquidating for no good reasons (the underlying stock markets in question may correct but rarely implode) not to mention the legion of structured products leaving dilutive rather than accretive footprints on the balance sheet. Funds are ostensibly supposed to diversify risk - not to replicate or even amplify it- especially funds managed as part of mandate offerings.
And when the collateral damage lands on the lap of the client, the clients are quickly presented with a fresh face because the previous person is silently shifted away from the scene.
I can tell you that the Finanz und Wirtschaft yesterday had a headline about how the Swiss banking industry is „beunruhigt“ about the noises which FInma under its new head Stefan Walter. I hope that there are plenty in the industry who have permanent Durchfall.
In my parent‘s case, I found out years later that the individual advising my parents in 2007-2009 gave a very cocky interview in a Swiss industry publication about how he had successfully engineered a career transition from wealth management to business banking (looking to screw corporate treasuries instead of individual investors). He was still working for the same institution as he was back in 2007. You know the one - you worked for it when it went cap in hand to the Swiss government. People like Klaus Wellershoff who were advising customers to be cautious were sidelined because they were spelling out inconvenient truths. The whole of the board should have resigned en masse - not just Ospel. He deserved terminal cancer.
Peter Wuffli, CEO from 2001 to July 2007, recently had the gal to suggest that hype combined with fraud is nothing new. However, whilst one invariably has to learn to live with, but not necessarily participate, in hype, fraud depends on the counter- reaction of society to its presence.
Leute die nicht hören und sehen wollen müssen fühlen. And it is best if the orchestrators of BS feel the net effect of their BS.
The Swiss Banking industry has been contracting and has become less profitable over time. Why? People cotton onto bad value propositions. Even the Swiss, never mind the foreign, whether Asian or other, customers are becoming more demanding. And less amenable to smart arsed selling machinations. After all, after screwing European, North American, Arab and Asian investors, Swiss bankers do not have much runway left to screw anybody else. Smart ass client advisers are so yesterday. Cycles change. Counter cycles take hold. Just like in the stock market. It is called mean reversion. And when a whole industry is presented with mean reversion, dann wird es eng!
When one is exposed to bad practices at a premier institution - not some back street brothel but one that is believe it or not billed as the epitome of absolute excellence and perfection, then it does not exactly inspire trust and confidence in anything coming out of the mouth of anybody never mind anybody working in the financial sector.
On the contrary, I make no bones about what I am doing - managing a portfolio of individual European and North American stocks. I take ownership of the risk as well as the return. Indeed i have access to valuation and performance on an ongoing basis and not just when an institution in question desires to report to the client. I take no more risk with key man or key institution risk like my parents did. It is all credit, FX and market risk - and I am very clear eyed about this existential truth.
There is a broader cultural trait at work which I wish to raise. Professional accountability across the board in Switzerland and the German speaking world at large- one reads and hears of horror stories in Germany as well- is the nasty net effect of excessive liberalism on the one hand and „sozialeMarktwirtschaft“ ( more like asoziale Marktwirtschaft) on the other hand.
I write this last paragraph for good reason.
Whether CS - for God‘s sake 15 years after UBS-, or Wirecard in Germany, never mind the Benko BS spanning Germany, Austria and Switzerland, there is an attitude problem with governance in the German speaking world. And the answer is not more tick box regulation. One needs more accountability but without adding to the regulatory burden on those who manage their affairs with responsibility. Somehow politicians are incapable of understanding the balance to be struck.
That is not to say that we need a litigation culture likening the US. However, a more energetic promotion of the concept that actions have consequences would not be remiss.
Joachim
I always appreciate your notes. This article struck a chord with me, since 3 decades ago I looked at share ownership patterns across 25 countries. Research was sparse then, but a few truths were evident.
Retail ownership is quite volatile and has deleterious impact on market liquidity, as individuals are primarily takers of liquidity. Markets in Asia, such as Taiwan and HK, were remarkably volatile and still are. Markets such as the US had a "backbone" of institutional investors, notably pension funds, who stayed in the markets. Other developed markets were lacking that backbone but were building them. Public markets were impeded by a limited numbers of listings with a great amount of private ownership, e.g. Germany.
Individuals are obviously not well diversified. The ability to assimilate more information that is available in public markets is still limited. Thus, greater transparency alone has not made them investors. More have become traders as they have witnessed great wealth created by share ownership.
The majority of markets still lack viable domestic institutional ownership holding patient capital. In the US public pension funds and large endowments have shifted allocations to private markets. The UK I believe has also seen a decrease in domestic institutional ownership. Reliance on foreign capital inflows has been a curse for many markets, as this capital typically flees at the sign of trouble. Foreign share allocations by US institutions have broadly decreased in the last 3 decades.
Corporates have stepped in to some degree with larger cash piles available. Buybacks have supported the US market. FDI has generally increased. On the other hand, US pension funds and endowments have allocated considerably more capital to private markets. ZIRP contributed to both VC and PE growth, but that has disappeared. Valuations are being challenged and secondary market trades are heavily discounted. Where does that capital go now and how much will be lost to defaults.
Speculative activity by retail and hedge funds consequently have more impact on public share prices. The articles you cite highlight the conflicts-of-interest inherent in sales to retail. Open architecture has been discussed but not executed for 3 decades. As retail investors awaken to the costs of those conflicts and impact on their wealth, shifts will occur but not overnight. Indexed ETFs that emulate the larger market at a low cost are better for the long term and potentially stabilizing for the public markets.
These factors do not bode well for capital formation through public markets for the time being Your note has underscored challenges for the public markets in the next few years.
100% agree. To give you a scary stat that in my view explains to a large degree why the UK market has become a perennial underperformed and is at the whim of fickle foreign investors: the average allocation of UK pension funds to UK equities has dropped from somewhere around 50% in 1997 to 5% in 2015. Key driver was the rise of LDI.
Joachim
I knew UK pension allocations had dropped (I lived there for 13 years but been gone for 10 now). LDI has presumably done well for the providers and obviously not so well for the beneficiaries. Too much economic rent is being siphoned off into the pockets of a few agents. It harms the markets and contributes to growing disparities in wealth.
I need to find a topic to cheer me up. Thanks for your response and look forward to future dialogs.
Tom