By Bruce Kelly
Oct 31, 2013 @ 12:49 pm (Updated 2:57 pm) EST
By Bruce Kelly and Trevor Hunnicutt
In a win for UBS Financial Services Inc., a Securities and Exchange Commission administrative judge this week dismissed allegations that two leading executives in Puerto Rico committed fraud in 2008 and 2009 when making statements to clients and UBS financial advisers about the quality of Puerto Rican bonds and the market for them.
In May 2012, the SEC accused Miguel Ferrer, senior officer of UBS Financial Services Inc. of Puerto Rico, and Carlos Ortiz, the head of the firm’s closed-end fund trading desk, of duping thousands of clients into buying hundreds of millions of dollars of municipal debt through closed-end funds created by UBS.
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“I do not find the preponderance of the evidence supports the division’s allegation that UBS PR, Ferrer and Ortiz engaged in a fraudulent course of conduct or a scheme to mislead customers and [financial advisers] when they represented the funds as profitable, safe, and stable investments and that supply and demand were responsible for fund prices,” chief administrative law judge Brenda P. Murray wrote in her decision.
Ms. Murray also wrote that UBS Puerto Rico did not make material misstatements or omissions regarding its inability to make a market for the proprietary municipal bond funds, which have declined in value because of Puerto Rico’s fiscal crisis, with economic stagnation and huge pension obligations.
UBS has a major presence in the financial advice industry in the Commonwealth of Puerto Rico. According to the SEC, it has about half of the market as measured by assets under management. Its 140 financial advisers had sold more than $10 billion of proprietary, closed-end municipal bond funds to clients through the end of last year.
Meanwhile, the rest of the financial advice industry is watching the $70 billion Puerto Rico municipal debt market closely. Regulators have begun making inquiries into mutual fund companies, including OppenheimerFunds Inc., in an attempt to understand their investors’ exposure to Puerto Rico municipal debt.
As of Wednesday, the S&P Municipal Bond Puerto Rico Index had declined 17.2% over the past 12-month period. Year-to-date, it is down 15%, with the drop starting near the end of June, about a month before Detroit filed for bankruptcy.
“UBS Puerto Rico is pleased with [Tuesday’s] decision, which relates to a period of significant turmoil in the global financial markets between 2008 and 2009,” spokesman Gregg Rosenberg said in a statement. “As the firm has maintained since first disclosing this investigation in 2010, the allegations against Mr. Ferrer and Mr. Ortiz were meritless, and the judge's decision confirms our position.”
One plaintiff’s attorney acknowledged the decision to be a victory for UBS, but he cautioned that attorneys filing arbitration claims on behalf of UBS clients who owned the closed-end bond funds and individual Puerto Rico municipal securities will focus on the specific transactions with UBS clients.
“It’s a win for UBS, no question, but the SEC complaint dealt only with misrepresentations and omissions,” said attorney Andrew Stoltmann. “Those are issues related to risk disclosure made to investors and has nothing to do with the suitability of transactions. That’s what every [Financial Industry Regulatory Authority Inc.] arbitration claim will be about.”
Ms. Murray’s decision is weighty, at 95 pages. The hearing lasted 13 days, and a total of 29 witnesses testified, including brokers, clients, and two experts.
Some UBS clients had considerable exposure to the bond funds, according to the decision. One client, Carmen San Miguel, was 52 when she placed her retirement savings and funds from a severance package totaling $344,000 with UBS Financial Services Puerto Rico. Sixty-five percent, or $223,000, was invested in Puerto Rico fixed-income and bond funds.
One UBS adviser, Wilson D. Colberg-Trigo, was a top-producing rep with about $700 million in assets under management. The Puerto Rico bond funds were 50% or more of the assets held by about 164 of his 700 clients, according to the decision.
Mr. Stoltmann said the volume of information in the decision would, in the end, help attorneys seeking to file complaints against UBS.
“The decision provides a crystal-clear road map for discovery in the Finra claims,” he said. “The e-mails that are referenced, the names of the individual brokers and what the policies and procedures were at UBS — that sort of information is invaluable for those of us fashioning discovery requests.”
The concentration of the fund in Puerto Rico securities has been well- documented, as well as the leverage rates for each fund, Mr. Rosenberg said.
“Muni bonds and/or closed end funds have long been a suitable part of many Puerto Rico investors' portfolios and matched their objectives,” he said. “Clients were aware of the concentration of assets in muni bonds or closed-end funds.”
The decision by Ms. Murray came the same day that UBS AG put a cost of $41 million on its brokerage’s bet on Puerto Rico.
In its third-quarter earnings report, UBS said it took a $20 million trading loss and $21 million in credit losses connected to loans that were backed by Puerto Rican municipal securities and “related funds.”
Bruce Kelly covers the securities industry, with a focus on independent broker-dealers; please contact him if you have news, information or industry scuttlebutt to discuss.
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A UBS unit is facing a legal fight over the sale of Puerto Rico closed-end-bond funds after their values slumped. Bruce Kelly has the story.
Oct 31, 2013 @ 12:56 pm (Updated 1:57 pm) EST
Oct 30, 2013 @ 12:01 am (Updated 9:31 am) EST
BlackRock Inc. Chief Executive Officer Laurence D. Fink, whose company is the world’s largest money manager with $4.1 trillion in assets, said Federal Reserve policy is contributing to “bubble-like markets.”
“It’s imperative that the Fed begins to taper,” Fink said today at a panel discussion in Chicago, referring to the central bank’s $85 billion in monthly bond purchases. “We’ve seen real bubble-like markets again. We’ve had a huge increase in the equity market. We’ve seen corporate-debt spreads narrow dramatically.”
The Fed in September decided against reducing the bond purchases as economic growth remained muted. Following a partial U.S. government shutdown this month, policy makers will probably delay slowing the stimulus until March, according to a Bloomberg survey of economists conducted Oct. 17-18.
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The Standard & Poor’s 500 Index has gained 24 percent this year, after advancing 13 percent in 2012. The extra yield investors demand to hold high-risk, high-yield bonds has dropped to 444 basis points from this year’s high of 534 in June, according to the Bank of America Merrill Lynch U.S. High Yield Index. That spread reached 440 basis points on Oct. 24, the narrowest since May 28.
“We have issues of an overzealous market again,” Fink said at the event, which was sponsored by the Paulson Institute and the University of Chicago Institute of Politics.
(Bloomberg News)
The smallest stocks are rallying almost twice as fast as bigger companies in the U.S., a bullish economic signal from businesses whose profits are most dependent on domestic demand.
Shares of companies from Rite Aid Corp. to Teledyne Technologies Inc. in the Russell 2000 Index have advanced 32% this year, compared with 19% for the Dow Jones Industrial Average. The spread is the widest for any year since 2003, according to data compiled by Bloomberg. Three of the last four times small-caps outperformed by this much, the economy grew faster the next year and stocks stayed in a bull market for another year or more, based on data from the past 34 years.
Gains in smaller companies that are more dependent on U.S. growth show investors are betting the world's largest economy will pick up even after jobs growth slowed and the government shutdown weighed on gross domestic product. Smaller firms are surpassing analyst earnings estimates by more than Dow companies and are forecast to grow faster next year.
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“If you're focused on the U.S., and the U.S. is performing very well, then of course your revenues and earnings are going to be much better,” Kully Samra of Charles Schwab Corp., which has $2.15 trillion of assets globally, said by phone Oct. 24 from London. “Other regions are at different stages of dealing with structural issues, and the U.S. has already dealt with them.”
The average company in the Russell 2000 gets 84% of its sales from the U.S. and is valued at $972 million, compared with 55% and $152 billion for the Dow, data compiled by Bloomberg show.
THIRD GAIN
The Standard & Poor's 500 Index climbed 0.9% last week to 1,759.77, its third straight advance, after a weaker- than-forecast jobs report spurred speculation the Federal Reserve will maintain stimulus. More than $2.3 billion went into exchange-traded funds that invest in U.S. equities Oct. 21 through Oct. 24. The iShares Russell 2000 ETF attracted almost $500 million, the second-most among about 500 funds, according to Bloomberg data.
Rite Aid, the third-largest U.S. drugstore chain, raised its profit forecast last month because of increasing sales at remodeled stores. The Camp Hill, Pa., company gets 100% of its sales from the U.S. and has rallied 276% this year.
Teledyne Technologies, which gets 80% of its revenue from the U.S., raised its 2013 per-share earnings projections last week. The Thousand Oaks, California-based aerospace and defense electronics provider, up 39% for the year, exceeded analyst projections by 8.1% last quarter, data compiled by Bloomberg show.
Small-caps have outperformed since the bull market began in March 2009, climbing 226%, compared with 138% for large-caps. Furniture store Pier 1 Imports Inc. and Dana Holding Corp., a maker of car and truck axles, led the Russell 2000, advancing more than 11,000% each. The biggest gainers in the Dow during the period were American Express Co. with a 676% gain and Walt Disney Co., which rose 344%.
ACCELERATING RALLY
The advance in small companies has accelerated in the last four months, with the Russell 2000 rising 14% since June 30 compared with 4.4% in the Dow industrials. The gap is the biggest for any similar period since 1997, according to data compiled by Bloomberg.
“The main driver of small-caps is the cyclicality of the market,” Patrick Moonen, who helps oversee about $240 billion as senior strategist at ING Investment Management in The Hague, said by telephone. “What are the economic prospects and how are risk aversion or risk appetite evolving? Both factors were clear tailwinds for small-caps so far this year.”
Smaller companies usually climb faster at the start of a bull market, making them a proxy for future economic activity. The Russell 2000 was up 71% in the first six months of the 2009 rally, compared with a 46% advance in the Dow. This year's outperformance is occurring almost five years after stocks started rallying, signaling the economic recovery will accelerate from what has been slowest rate since World War II.
U.S. GDP will increase at a 2.4% annual pace this quarter and reach 3% a year from now, economist estimates compiled by Bloomberg show. This month's budget impasse will spur Fed policy makers to wait until March to scale back the $85 billion of monthly bond purchases, a Bloomberg survey showed this month.
“We have a window of three to four months where we have improving fundamentals and low or no risk of tapering,” Mr. Moonen said. “We are in a sweet spot in that we don't see any major hurdles before the end of the year now that the U.S. fiscal situation is out of the way.”
Russell 2000 companies are beating analyst earnings estimates by 11%, more than twice the rate for companies in the Dow, according to data compiled by Bloomberg. Results for bigger companies fell short of projections in the second quarter, as the smaller companies surpassed forecasts. Analysts say small companies will boost profits at more than four times the pace of larger firms next year.
Those projections are too optimistic and valuations will get too high as brokers lower their profit predictions, according to Steven DeSanctis, Bank of America Corp.'s strategist for small-cap equities in New York. The Russell 2000's price-earnings ratio increased 52% this year to 27.5 times estimated operating earnings, compared with 14.7 for the Dow, according to data compiled by Bloomberg.
“It seems a little too optimistic,” Mr. Desanctis said by phone. He predicts the Russell 2000 of smaller companies will end this year at 1,100, or 1.6% lower than the close on Oct. 25. “At the start of the year, valuations were attractive. Not so much today.”
Earnings and economic reports don't justify small-cap prices and shares of larger companies won't necessarily follow the Russell 2000, according to Lawrence Creatura, a Rochester, New York-based fund manager at Federated Investors Inc., which oversees about $364 billion.
“The arrows are not pointing in the direction that suggests that large-cap stocks have to follow their small-cap brethren,” he said by phone on Oct. 23. “Based on the earnings that we have so far, it appears that economic growth is not as robust as what we hoped for at the beginning of the year.”
PAST INDICATOR
Small-cap gains of this size have proven prescient in the past. They preceded faster economic growth and a broader stock market advance in 2003 and 1991, and coincided with them in 1979. The Russell 2000's outperformance in 2003 was at the start of the last equity bull market, when the S&P 500 more than doubled from October 2002 through October 2007. GDP expanded at the fastest rate in four years in 2004.
In 1991, small-caps were up 36% through Oct. 25, more than twice larger stocks, at the start of the largest bull market on record. The S&P 500 gained more than 300% from 1990 through 1998 and the economy grew at an average of 3.5% per year throughout the decade.
“Historically the trend has been for the small-caps to hand the baton off to the large-caps,” Donald Selkin, who helps manage about $3 billion as the New York-based chief market strategist at National Securities Corp.
While confidence among U.S. small businesses slipped in September, it has hovered near a one-year high the last five months. The National Federation of Independent Business's optimism index rose to 94.4 in May, the highest in a year, from 88 in December, according to data based on a survey of more than 770 small-business owners. The number of firms projecting sales will increase and saying it's a good time to expand rose from August.
Analysts predict earnings at International Business Machines Corp., which gets more than half its sales from abroad, will climb 10% this year, the slowest since 2004. Shares have slumped 7.7% in 2013. Caterpillar Inc., where more than 60% of sales is from overseas, cut its 2013 revenue forecast last week. The biggest maker of construction and mining equipment is down 5.4% in 2013.
“If you think the U.S. is recovering, then small-caps tend to be more domestically oriented than large-caps,” Frances Hudson, an Edinburgh-based strategist at Standard Life Investments Ltd., which oversees about $278 billion, said by phone. “Small-caps are more growth-oriented.”
(Bloomberg News)
Financial advisers aren't powerless and have options in this challenging income environment
As stocks reach historic highs, few bargains around; 'we can't manufacture good ideas'
By Megan Durisin
Financial advisers shy away from alternative investment products because most are too difficult to explain to clients, a new survey shows.
Only a quarter of advisers invest regularly in hedge funds, private equity and commodities, according to a study released Thursday by Natixis Global Asset Management. While the majority of the 1,300 advisers surveyed have invested over time in a mix of alternatives, only 25% use them on a regular basis. Those that typically use alternative investments are those that work with high-net worth investors.
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These results leave advisers with a conundrum, as nearly 70% of those surveyed reported that they need to use new portfolio strategies to gain healthy, low-risk returns for clients, rather than relying on traditional methods, the study said.
Scott Schweighauser, a president and partner at Aurora Investment Management, said alternative investments should play a role in all investors’ portfolios. His firm manages $9.5 billion and solely invests in hedge funds on behalf of clients, including financial advisers and pension fund managers.
“It’s definitely going mainstream,” Mr. Schweighauser said of alternatives, citing the public’s awareness of hedge fund managers such as David Tepper. “This should have a home in everyone’s portfolio whether you’re a high-net-worth individual or a factory worker saving for retirement.”
Mr. Schweighauser said a traditional 60/40 stocks and bond portfolio can’t be relied upon for diversification and robust returns in any market. Adding hedge funds to the mix can create more efficiency.
In the Natixis study, the factors advisers cited for shying away from alternative investments included a lack of knowledge, difficulty justifying the expense and a belief that clients think alternatives carry too much risk.
Others advisers surveyed said that they stick to strategies that can be more easily explained to clients.
Mr. Schweighauser said alternative investments traditionally have been a difficult-to-understand strategy. Part of his job involves educating the public about hedge funds and working to advance such strategies as a retail product, which he believes will lead to a higher adoption rate.
“It has been historically relatively arcane, relatively opaque,” he said of hedge funds. “As understanding elevates and increases, I think people will see the value of the long-short approach in, kind of, having more tools in the arsenal to generate returns.”
Sovereign wealth funds, which control about $6 trillion of wealth globally, are boosting investments in alternative assets like real estate and private equity to boost returns, a survey by Invesco Ltd. found.
The world of alternative investing, already commonplace among pension funds, endowments and foundations, is opening up for individual investors as mutual fund companies and other financial firms develop suitable products.
As alternatives strategies continue to flood into the registered-mutual-fund and exchange-traded-fund arena, investors and financial advisers should be aware that most mutual funds and ETFs will never match up completely with private-investment...
Advisers share their tips on how to broach the subject of new asset classes and strategies
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3:18Where ETFs are headed in the next 10 years David Abner of WisdomTree Tom Lydon of Global Trends Investments Elizabeth Flynn of Charles Schwab Kenneth Volpert of Vanguard Douglas Hodge of PIMCO Rick Ferri of Portfolio Solutions Sue Thompson of iShares
5:03What distinguishes smart beta as an investing strategy? Rob Arnott Chairman & CEO, Research Affiliates Rick Ferri, CFA Founder, Portfolio Solutions Tom Lydon CEO, Global Trends Investments
Oct 23, 2013 @ 12:22 pm (Updated 1:45 pm) EST
The Securities and Exchange Commission on Wednesday proposed rules that would allow startup companies to raise capital on the Internet, in small amounts. Investment advisers are wary of the idea.
With its unanimous vote, the agency took the first step to implement the so-called crowdfunding provisions of the Jumpstart Our Business Startups Act, which eases securities registration for small businesses. It was approved overwhelmingly last year by Congress.
(Related: What advisers don't know about crowdfunding can hurt them.)
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The proposal, which is more than 500 pages and contains about 295 questions for public response, will be open for a 90-day comment after it is published in the Federal Register. The SEC may revise the rule, and another vote is required to finalize it.
Under the rule, small companies would be able to sell up to $1 million in equity over a 12-month period. Investors with income or net worth of less than $100,000 could invest $2,000 or 5% of their annual income or net worth, whichever is greater, in crowdfunding offerings over a period of 12 months. Investors with income or net worth above $100,000 could invest up to 10% of their income or net worth.
BENEFITS AND DRAWBACKS
Crowdfunding advocates argue that it will enable entrepreneurs to reach new investors, build companies and create jobs. Critics warn that small investors could be harmed by fraudulent offerings.
Investment advisers are skeptical. They contend that it would be virtually impossible to research amorphous startup companies, which could range from the corner bookstore to the next Apple.
“Anything like this scares me to death,” said C.E. Scott Brewster, owner of Brewster Financial Planning. “The amount of due diligence that would be needed to make sure it's a prudent investment would far outweigh the benefits. It's not the type of investment I would recommend.”
Diahann Lassus, president of Lassus Wherley & Associates, said that crowdfunding could be a boon for startups, but investors must tread carefully.
“It is absolutely investor beware,” she said. “It will provide opportunities for small businesses that have a bright future to get capital for their growth. But it will also provide opportunities for businesses that don't really have their act together.”
Investors face the risk of losing money on failed ventures or getting ripped off, according to some advisers.
“There will be ample opportunities for fraud,” said Timothy Chase, managing partner of WMS Partners.
He doubts that his high-net-worth clients will be interested in crowdfunding.
“They're not going to waste an ounce of energy on this,” Mr. Chase said. “The investor that crowdfunding is targeting is the least sophisticated investor.”
INCLUDING SMALL INVESTORS
SEC member Michael Piwowar argued that crowdfunding will enable investors with modest assets to participate in the next business breakthrough.
“All investors, not just the so-called accredited investors, will have an opportunity to invest in entrepreneurs at an earlier stage than ever before,” he said.
Lawmakers from both parties have been pressuring the SEC to move ahead with crowdfunding rules, which were supposed to have been proposed by last December.
Broker-dealers or platforms that register with the SEC would conduct crowdfunding. The agency estimates that about 50 to 100 crowdfunding portals will operate initially when the rule is approved.
They would not be allowed to offer investment advice and would be prohibited from charging commissions to investors. The proposal doesn't specify whether portals would be responsible for ensuring that investors meet the crowdfunding criteria or whether investors would be allowed to self-certify.
SEC Chairman Mary Jo White said the agency will keep a close eye on how the market develops.
“If the proposal is adopted, the staff will … evaluate the types of issuers using the new crowdfunding exemption, how issuers and intermediaries are complying with the rule, and whether the exemption is promoting capital formation and effectively protecting investors,” she said.
SEC member Kara Stein cautioned that the SEC must address investor protection even as it opens a new avenue of capital formation.
“We know very little about the dynamics of how this financial innovation will work,” Ms. Stein said. “Getting the balance right will likely take time and careful refinement [of the proposal].”
Mark Schoeff Jr. covers legislation and regulations affecting investment advisers and brokers and wants to hear from you about how Washington policymakers are influencing your business.
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