WEALTH & PERSONAL FINANCE
October 28, 2009
By PAUL SULLIVAN
A YEAR after the bursting of the housing, credit and commodities bubbles, Erik Davidson of Wells Fargo Private Bank is worried. He said he thought a new bubble had emerged, this time in something seemingly benign: cash.
“We see, and benefit, from this tsunami of deposits,” said Mr. Davidson, the bank’s managing director for investments for the western United States. “It’s great for the bank, but at a certain point you see this fixated look in people’s eyes and realize this is a cash bubble.”
The idea of a cash bubble may sound ludicrous. Why wouldn’t putting your money into something as secure as certificates of deposit or Treasury bills be a good thing? In the short term, yes, it is. But people who stick with cash will find themselves unable to regain what they lost, Mr. Davidson said.
“If your portfolio was down 33 percent, you need a 50 percent increase to get back to even,” he said. If all your investments were in the Standard & Poor’s 500-stock index, which went down 57 percent, “you need a 132 percent return to get out of the hole,” he said. Returns on cash typically yield 2 percent or less.
Investors are so wary of another bust that they are taking extraordinary steps to try to prevent getting caught in one. A cash bubble, and the emerging gold bubble, Mr. Davidson said, are really fear bubbles. The areas in which these fear bubbles are rising show just how scared investors remain:
For many investors, faith in a diversified portfolio burst with the bubble.
Nancy Rooney, head of Northeast investment business for the J.P. Morgan private wealth management unit, said she spent the early part of the year coaxing clients into the most secure bonds. Now she is trying to convince them that the six-month run-up in the stock market is not another bubble waiting to burst.
“They’re so panicked because they lost some money, and now they wonder how can they possibly get in,” she said. “You have to gradually put some risk back in portfolios.”
To allay their concerns, she advocates choosing managers who will find the better-quality investments within a sector. But she is also talking to clients about using structured notes, a fairly simple derivative, to mitigate the risk of another bust. In return for forgoing part of the potential gain, a limit is set on how far a stock can fall.
“If I’m concerned about the markets, if my strategic view is we could see some rocky road ahead, there is no exchange-traded fund, no manager who plays to that view, so I have to craft something myself,” Ms. Rooney said. “People equate derivatives with risk, but the reason we’re creating these structured notes is to take risk off the table.”
Fear of being wiped out by another bust does have its benefits: some previously blase people are reconsidering such seemingly safe havens as company-sponsored deferred compensation plans. For years, executives piled money into these plans, figuring they would withdraw it when they retired and were in a lower tax bracket. The only risk was if the company went bankrupt, which would leave the employee as an unsecured creditor.
“You can’t say what are the odds of that happening now, because everything happened last year,” said Joseph Spada, managing director at Summit Financial Resources, an investment adviser in Parsippany, N.J. “Now I’d rather take the compensation and pay the tax now.”
Since laws limit when the money can be withdrawn, many people have little recourse but to stop adding to existing plans.
Annuities were another boom-time product, a popular way for investors to sock away money, comfortable that it would be paid back to them in a steady income stream in retirement. Now there are concerns that insurance companies sold too many, and if an insurer collapsed, its annuity holders would lose much of the money.
This was driven home this fall, when the share price of the Hartford, a huge underwriter of annuities, fell to nearly $4 from more than $60. People who had their annuities with the Hartford began worrying about whether it would collapse.
Most state insurance funds cover insurance losses to around $500,000. People with annuities greater than that would have faced a loss, Mr. Spada said, so now they are spreading their annuity risk around to several insurers.
Many major frauds of the last year would not have been uncovered so soon if the credit bubble had not burst and forced investors to sell assets. That was the undoing of Bernard L. Madoff, Marc S. Dreier and a host of smaller Ponzi schemers.
Many large investors are now taking more aggressive steps to safeguard their money. Enter Elizabeth Prial, a managing director at Insite Security. She can tell if you’re trying to hide something.
A psychologist and former special agent for the F.B.I., she is trained to detect a range of voluntary and involuntary signs that a person is being deceptive by assessing facial action, involuntary microexpressions, body language and more.
“Traditional due diligence is focused on what the client is being told,” said Ms. Prial, who does similar work for the Department of Defense. “I’m going to be watching the nonverbal cues.”
Having such a highly trained specialist sitting in on an investment meeting may seem extreme, and it certainly is not cheap: her services cost $10,000 a day.
“Investors are more fearful,” said Christopher Falkenberg, a former Secret Service agent and the president of Insite. “They’re willing to invest in more proactive measures to reduce the risk than they were before.”
While the vast majority of people lost money the old-fashioned way - their portfolios lost value – the disclosure of serious fraud scared everyone.
Kevin Dorwin, a principal at Bingham, Osborn & Scarborough, a wealth management firm in San Francisco, said several potential investors had asked if they could bring in their own auditors. It was a first for this request, but the firm agreed.
“Personally, I can’t blame them,” Mr. Dorwin said. But if every new client made the request, he said, the time spent on audits would mean “there would be no one to manage the money.”
A select group of people are doing their best to save what they have left from creditors.
One result is an increased interest in Delaware asset protection trusts, which allow people to shield money from creditors after the assets have been in the trust for four years.
When these trusts were created in 1997, doctors, lawyers and accountants were drawn to them because they feared their liability insurance would not cover them fully. Today, people starting hedge funds and private equity firms are interested, said Dan Lindley, president of the Northern Trust Company of Delaware. “They say, ‘I want to put some of my assets into this trust and have that be my rainy day fund if the fund performs badly and investors turn on me,’” he said.
This may be hiding money from creditors, but Delaware law permits it so long as the person was unaware of any claims against him when he set up the trust.
Interest is also rising in what Boxwood Strategic Advisors calls its “troubled borrower’s program,” an outgrowth of the firm’s business of advising clients with wealth tied up in a single asset.
When loans were easy to get at low interest rates, many wealthy people borrowed against such assets – restricted stock, for example – to invest in other assets. When the bubble burst, the collateral went down in value and banks either demanded more or started selling the collateral. Investors found themselves in a bind.
Boxwood’s role is to negotiate a solution. “Both sides contributed to this,” said Alec Haverstick II, managing director at Boxwood. “Should you really have leveraged your liquid assets at 75 percent and invested in illiquid assets? It might have been better at 35 or 40 percent. But the banks allowed this.”
Mr. Haverstick says he tries to get the two sides working together. “Isn’t this person better off and aren’t you better off with this person as a continuing pool of economic activity than as a dead body?” he asked.
Of course, there will be always be investors who try to time the market. The desire to make back their money trumps their fear of losing more.
Lewis Altfest, president of Altfest Personal Wealth Management in New York, said he had been inundated with clients wanting to buy “disaster stocks” in the belief that they have to go up. He put CIT, A.I.G. and Citibank in this category and said people thought these stocks were unreasonably low and had to rise.
He has told clients that CIT, the troubled small-business lender, might not come back until after a Chapter 11 bankruptcy reorganization that would wipe out shareholders. But some clients are undeterred, pointing to Citicorp in the 1990s, when its stock fell to $6 from $50 before rebounding.
“There is some validity to their argument, but I wouldn’t bank my money on it,” he said. “It’s a Las Vegas mentality.”
A corollary to this view is people who own disaster stocks and refuse to sell them. Mr. Dorwin said he had a new client with the bulk of his wealth in a handful of stocks that had all gone down. “He wanted to wait until the stocks went back up in value before diversifying,” he said. “It’s like going uninsured until health care reform passes.”
It took Mr. Dorwin months to persuade the client to sell the losers and reinvest the money more broadly. “People get very attached to their individual stocks,” he said. They also get ideas to invest in things that seem great but that they do not fully understand.
One example of this is currencies, particularly exotic ones. With the dollar’s decline, “people are coming up to me at parties and saying, ‘I don’t do stocks anymore; I’m into currencies,’” Mr. Davidson said. “Speculating in currencies is riskier than stocks.”
So, too, is betting everything on emerging Asia. The argument to do so, Mr. Altfest said, goes like this: “China and India are going to take over the world, so why don’t I put all of my money in the fastest-growing area?” In October 2008, when the view of the region was less sanguine, Mr. Altfest put client money in two Asia funds. One is up nearly 80 percent; the other doubled. Recently he has been invited to the introductions of new Asia funds, he said, and “that’s the sign of overheating. We’ve cut back our original allocations.”
In other words, sometimes a little fear of a rapidly inflating asset is a good thing. You may not get all of the upside, but you might be able to avoid having the bubble burst in your face.