It appears that, to the extent Jamie Dimon’s “fortress balance sheet” claims are valid, some of strength results from taking liberties with customers in ways that even other big financial firms shun.
One long standing bad idea on Wall Street has been to have a retail brokerage operation along with in-house mutual funds. The business model always assumes that the retail brokers will happily sell lots of the firm’s funds to their customers. That’s usually a bad assumption. The internal funds seldom perform better than the products sold by other players. And the most successful brokers (the ones who have clients with large portfolios, who typically trade stocks) often are effectively independent businessmen under a big firm umbrella. If they were to leave the firm, they’s take most of their accounts with them. That puts them in a position to ignore firm pressures and bribes to put their client into so-so or bad products. That means it falls to the middling and newbie brokers to take up the slack. And like it or not, there are only two outcomes possible: either the brokers treat their clients to a greater or lesser degree as stuffees, or the funds languish. And since mutual fund profitability is correlated with the size of the fund, the bank has strong incentives to ride the brokers to push their product.
This has been a recognized conflict of interest for decades; I’d hear it come up often on studies back in the stone ages when I was at McKinsey. A story tonight in the New York Times’ Dealbook points out that most banks have finally recognized the folly of their ways. The ones that have in-house brokers have largely exited the in-house mutual funds business….except JP Morgan. According to the Times:
JPMorgan, with its army of financial advisers and nearly $160 billion in fund assets, is not the only bank to build an advisory business that caters to mom and pop investors. Morgan Stanley and UBS have redoubled their efforts, drawn by steadier returns than those on trading desks.
But JPMorgan has taken a different tack by focusing on selling funds that it creates. It is a controversial practice, and many companies have backed away from offering their own funds because of the perceived conflicts.
Morgan Stanley and Citigroup have largely exited the business. Last year, JPMorgan was the only bank among the 10 largest fund companies, according to the research firm Strategic Insights.
The article details how JP Morgan brokers are pushing clients into stock funds (which have higher fees than bond funds) at a time when investors are generally leery of the product. In general, studies of fund performance find that only funds in the top 10% of performance tend to hold on to outperformance over time; top quarter performers, by contrast, show a lot of rotation. JP Morgan has only a few top funds; for their funds overall, 42% fail to beat the averages for their strategy. This might not be so bad if JP Morgan weren’t pushing its brokers to place investors in internal funds above the alternatives. Some quotes from former brokers:
“I was selling JPMorgan funds that often had weak performance records, and I was doing it for no other reason than to enrich the firm,” said Geoffrey Tomes, who left JPMorgan last year….
“It said financial adviser on my business card, but that’s not what JPMorgan actually let me be,” said Mathew Goldberg, a former broker who now works at the Manhattan Wealth Management Group. “I had to be a salesman even if what I was selling wasn’t that great.”
This isn’t merely the view of some disgruntled brokers. JP Morgan settled an arbitration case for $373 million for giving preferential treatment to its own funds, even though it had a contract to promote the funds of American Century.
On top of that, even if the funds have decent performance before fees, it’s unlikely they will on a net basis. JP Morgan charges an asset management fee of as much as a whopping 1.6% of assets, while freestanding brokers typically levy 1%. It also double dips, charging both the asset management fee and the fee on the underlying funds.
That’s all bad enough, but it still falls in the realm of “caveat emptor,” in that fees are disclosed and anyone who signs up for super-normal charges for an at best ordinary product is asking for underperformance. What is worse is the way JP Morgan plays fast and loose with disclosure:
With one crucial offering, the bank exaggerated the returns of what it was selling in marketing materials, according to JPMorgan documents reviewed by The New York Times….Marketing materials for the balanced portfolio show a hypothetical annual return of 15.39 percent after fees for three years through March 31. Those returns beat a JPMorgan-created benchmark, or standard of comparison, by 0.73 percentage point a year.
The actual return was 13.87 percent a year, trailing the hypothetical performance and the benchmark. All four models with three-year records were lower than the hypothetical performance and the benchmarks.
JPMorgan says the models in the Chase Strategic Portfolio, after fees, gained 11 to 19 percent a year on average since 2009. “Objectively this is a competitive return,” said Ms. Shuffield.
What ballsy double speak! The model performance is not the issue, it’s the use of model returns that by happenstance considerably overstate results.
Now in case you’d like to argue this sort of behavior is an outlier at JP Morgan, consider the experience of a client at the other end of the food chain, Len Blavatnik, one of the 100 wealthiest men in the world (and a one-time client of mine when he was much less rich and had made a rather oddball investment in the US). His industrial empire, Access Industries, had about $1 billion in cash in various pockets that they decided to manage to get a little bit extra return. And mind you, their objectives were modest. They merely intended to beat Treasury bills by a smidge. They set out their investment criteria, which stressed “conservative” and “liquid”. The agreement that they reached with JP Morgan also set maximums as to how much could be invested in various types of assets.
Joe Nocera summarized what happened:
JPMorgan invested part of the $1 billion in triple A tranches of mortgage-backed securities. It also invested some of the money in triple-A tranches of securities backed by home equity loans. Sure enough, beginning in July 2007, those securities began to decline in value. The Access executives began to call the investment manager at JPMorgan, worried about the mounting losses.
“Our research team still is extremely confident that AAA Home Equity asset-backed securities are money good, meaning that over time you will get the entire amount of your principal back,” responded a JPMorgan executive in an e-mail, according to a complaint later filed by Access.
This, of course, is not exactly how things turned out. In April 2008, when Access finally withdrew its money from JPMorgan, the account had lost around $100 million. After trying — and failing — to negotiate a settlement, Mr. Blavatnik sued.
I’ve read the claim and spoke with Blavatnik and his general counsel late last year. They say that what they had gotten so far in discovery, despite considerable foot dragging by JP Morgan (and serious lawyering up, the bank put three big ticket firms on the case) was making them disinclined to accept much less that full compensation for their losses. But they also said that JP Morgan’s strategy was clearly to run out the clock as long as possible and to make the fight expensive for Blavatnik. And remember, he’s not just one of the biggest wealth management clients in the world, he’s also an active buyer and seller of companies. So if someone at this level will be abused by JP Morgan, who is safe? Certainly not you and me.