Three Things I Think I Think

Some random thoughts as the weekend can’t come fast enough…

1)  How sad is it that fraud and corruption has become so rampant in the financial services industry that I literally don’t even care about SAC insider trading scandal?  This is one of the largest and most successful hedge funds in the world and they’ve just been accused of basically manipulating markets and fraudulently generating market beating returns for decades.

Maybe I am just out of the loop, but this seems like it should be a much much bigger deal than it is.  And yet many of us in the industry don’t really care about the story much at all.  We’ve become so used to big fish getting in trouble and not getting punished that it’s almost like we accept that it’s a rigged game and just don’t care any more.  Which is exactly what some people want.

Wall Street continues to be one of the few places on earth where you can continually prove yourself worthless or a damn near criminal and someone will always either forgive you or give you a second chance.  If you think the financial crisis helped clean up this industry you’re really out in left field.  Maybe on the warning track.  In foul territory.  With your face pressed against the wall.

2)  Is Europe actually on the verge of coming out of their dismal economic downturn?  It’s interesting to see how the current account deficits in many countries have substantially improved.  Growth is still anemic, however and debt to GDP ratios are still deteriorating.  Not to mention the fact that the peripheral countries are still suffering through something closely resembling a modern day depression.

I still don’t think Europe is out of the woods though.  I think they’ve pieced together a temporary fix and that the structural flaw in the Euro is still very much there.  I still think something will occur at some point that forces Europe in one of two directions – either full political unity with a central Treasury (something like Eurobonds) or a disbanding of the Euro (perhaps partially or entirely).  Single currency systems just don’t work without a rebalancing mechanism.  They cannot.  And this one has no rebalancing mechanism except deflationary depression.  Which is great if you’re an Austrian economics theorist, but horrible if you have to live in a place with a depression.  It’s unnecessary and illogical.  Something will either break them or they will come together.  There’s no easy way out….

3)  Did you see this video from Morningstar on investment fads?  I thought John Rekenthaler made some great points regarding the latest investment industry fads.  Among his topics were alternative investments, low volatility funds, multi-asset class income vehicles.

Look, I think it’s great that Wall Street creates lots of different investment options, highly competitive products, etc.  That makes the world a better place for those looking to access different products and plan accordingly.   But you have to be very careful about the latest fads and trends.  Some of the funds that have been created in the last 5 years since the crisis have been downright dangerous if misunderstood.  Funds like these VIX funds, many of the commodity funds with futures roll issues, the 3X funds, etc.  The moment where it struck me as a bit overboard was when I was reading the Prospectus of one of these VIX funds and it warned:

The long term expected value of your ETNs is zero. If you hold your ETNs as a long term investment, it is likely that you will lose all or a substantial portion of your investment.

Good lord.  If you have to write those words in a Prospectus that no one except me and a few other nerds will read, then why even bother.   You have to be very careful buying into Wall Street’s latest fad funds.  If you don’t have someone with some integrity who can walk you through some of this stuff then it’s probably best not to even bother.

Depressing stuff, huh?  Sometimes I wonder why I am not chopping wood full time somewhere very far away from all of this….Have a great weekend everyone.


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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. Most people do not, will not, or cannot manage their own financial affairs, so in a way, financial professionals are like our legal professionals. They have a license to steal. Not much is likely to change. Railroads, lumber, and steel industries all had to learn how to compete in a modern world. Financial and legal professionals only improve their choke hold over time.

  2. “Single currency systems just don’t work without a rebalancing mechanism. They cannot. And this one has no rebalancing mechanism except deflationary depression. Which is great if you’re an Austrian economics theorist, but horrible if you have to live in a place with a depression. It’s unnecessary and illogical.”

    What is unnecessary and illogical? A depression or living in a place that is in a depression? I can’t quite tell what ‘it’ is.

    And isn’t it possible that Europe firming somewhat is just happening because Germany’s elections are coming up? It’s not as though “leaders” anywhere throughout time have ever been known to paint an overly optimistic picture by trying to hide away bad news until just after elections . :-p

  3. “If you don’t have someone with some integrity who can walk you through some of this stuff…”
    I noted your qualifier “some.” It is difficult to find a financial adviser with any integrity. I feel really sorry for all the people stuck with their crummy 401(k) managers. Most of them actually think their retirement savings are being managed on their behalf.

  4. ““The long term expected value of your ETNs is zero. If you hold your ETNs as a long term investment, it is likely that you will lose all or a substantial portion of your investment.”

    Wow!… that’s hilarious! That’s basically the same sign they should have over the roulette table or the slot machines…. but in those cases they could conclude with “the house will win eventually… guaranteed.”

  5. “Is Europe actually on the verge of coming out of their dismal economic downturn?”

    “Any headline which ends in a question mark can be answered by the word “no””. Journalist Ian Betteridge

  6. These are trading vehicles though. Why would you hold on to them when the underlying assets (or the ETFs themselves if they are leading) are in a downtrend?

    They work quite well if one has proper risk management and only holds when they are trending favorably.

    They should not be used for any type of buy and hold. One will blow up their account if their position size is not appropriate, if exit points aren’t adhered to, or if the instruments are held as they are declining in price. So basically you are at risk of hurting yourself using leveraged ETFs if you don’t know how to trade since again they are trading vehicles.

  7. Cullen – I think of financial professionals a lot like athletes. It’s mostly the “super stars” and the “bad boys” that get all of the headlines. But, there are a lot more journeymen (and women) out there chugging along doing their best to help people.

    How many articles do you read about all of the athletes out there doing charity work and spending time bettering their communities – or just being good parents to their own kids?

    Probably roughly the same number of articles that you read about the “good guy” advisors whose clients write them letters thanking them for a decade or more of guidance and service.

    “Ours is a noble profession, if performed well.”

  8. Looks like the lot is going to get some clearing this weekend!!

    Just watched Elliot Spitzer on Fallon and then you post this.
    He was on there with the public service spin. I do not know this man and if he was set up to get caught thus causing his fall from grace. When I hear these researched talking points it just makes me sick. No one can say what they want, only what is first tried out before the test market.
    Will await the dawn of honesty

  9. “The long term expected value of your ETNs is zero…”

    To be fair, have you ever read and compared the earning labels on insect repellant? Cullen, next time you go to Canada to chop wood, buy some bug repellant and compare the warning labels … in comparison, the US warning labels make me feel like I’m putting Agent Orange on my skin! ;-)

  10. On Europe:
    – Perhaps it is my bias as a european with first hand experience, but I think that Europe will need to collapse more before and serious change can occur. The Euro is a bad experiment and the problem with the economy is structural, not monetary. Nothing will change until the massive welfare state is dismantled at least in part.

    On Investment Fads:
    – It is interesting that it is Morningstar to talk about investment fads, when Morningstar itself has created on of the biggest investment fads to date: investing based on a manager’s past performance.

  11. Why is this statement problematic? Those ETNs are not long term investment vehicles. Anyone expecting them to be should stay away. That is precisely what the statement does. Where is the problem in this?

  12. Most of the people trading these things have no idea about the roll problems in the futures contracts until after they’ve lost money due to it. Most of these funds do not trade ANYTHING like the index they’re intended to mimic. That borders on fraud in my opinion. And let’s be real – no one reads prospectuses.

  13. Well I agree it’s probably an honest statement, and they should be lauded for that I suppose. And I agree that it’s possible to make money with an investment like this.

    What’s funny though is how certain it is… none of this wishy washy “Past performance is not an indication of future returns” thing…. no,… this is as certain as money in the bank or a US Tsy bond!… but instead of a guarantee of being even or slightly ahead… they guarantee you’ll lose everything if you wait long enough!

  14. Agreed.
    Good to see that said.
    The typical financial advisor trying to help retail clients has nothing at all to do with the corruption at the top, but we are sometimes tarred with the same brush.

    I’m not surprised we have so much corruption on Wall Street. I would attribute it to these factors:
    1. Money creation is flowing to the 1 percent, and even faster to the 1 percent of the 1 percent. There is so much money at the top that is just being passed back and forth creating more money bu adding little actual value to the rest of us.
    2. The Wall Street elite has propogated the idea that banking is not just important in the sense that manufacturing and health care are important, but that banking is sacred. Politicians bankrolled by Wall Street and cowed by economists they don’t understand are unable to stand up against the Street.

  15. Jesse said it very well:

    “The Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustained recovery.”

  16. “Chutzpah” – that’s the word for it. You’ll make more money in financial services if you can talk a good game and have chutzpah than if you provide cold reasoned analsysis. The real name of the game in this business is salesmanship and promotion. Just like politicians, you don’t need to be right, just have an insatiable thirst to make money and the ability to tell a good story with conviction and the fortitude to do it over and over.

  17. Further agreed. The top financial professionals can be likened to elite athletes who have incredible drive and will do anything to get ahead (i.e. steroids). Those are the ones that invariably rise to the top – you have to be willing to “cut corners”. The stars in the system are those who pull down the most money for their firms, not the ones that make the most money for their clients.

    That said, there are a lot of good guys out there, although conflicts of interest abound. For those who are honest and ethical, it is a noble calling, as God knows how much the public needs sound financial advice.

  18. It is not a generic warning, many of these types of fund (especially the well-known inverse funds) which are revalued daily and the returns are derived from percent deviations from tracking indices will mathematically lose money via volatility … see e.g. If you think it through with a simple example, you will realize it’s just mathematics (10% up + 10% down is not even, i.e. 1.1*0.9!=1). The other example which Cullen gives is for commodity futures like USO, but these only lose money in contango, which is a question of the futures curve as opposed to basic mathematics.

  19. Nah, I don’t think you get it. This is not a long term investment vehicle! Why are you continually forcing that assumption on this product?

    And, why should it have the wishy-washy language when its not like the other products?

  20. Yes, the up 10% down 10% thing did occur to me. I have a very bright software guy at my company who’s nonetheless a perma-bear… always reading ZeroHedge and Mish Shedlock (although at least he knows it… and calls those sites “bear porn”).

    So when in late 2008 early 2009 it was time for him to act on his pessimism and he got into those S&P inverse 1x and 2x … and maybe even 3x funds! He was flying high on the idea he’d get rich at everyone elses’ expense!

    … but later he admitted that he ended up losing money… even while the market crashed about 50% over that time period!… he asked me “Do you know why?”… so I approached his white board… “assume you’re in the inverse S&P 3x fund… on day 1 the market goes up 33.33% (leaving you with $0)… the next day it goes down 99.99%! … Wooo hoooo!… you’re rich!.. a 300% gain on that 2nd day! … 300% of $0 though… is still $0.” :(

  21. That’s the fault of the people then! Who asked them not to find out what they are putting money in. Hilarious!!! There are plenty of people who know what the product does and how, its for them. Not for doofuses who ‘think’ they know what it does. That will ‘ALWAYS’ get you in trouble – in finance or in anything else in life. Get over it.

  22. I’m not forcing it! … If you understand the risks fine. I’m not complaining that it’s too risky… I’m amused that they’re honest about the risks in such a blunt way… and I think that if people truly understood what the risks were that almost no one would buy in. I wonder how many investors read and truly understood that sentence.

    The only possible way I’d bet any significant amount of money at a casino is if I knew the card count (on a blackjack table) very accurately and I was certain the deck was highly in my favor.

    I can’t imagine having that kind of certainty in the casino they’re talking about… but if somebody thinks they do… great!

  23. “Most of these funds do not trade ANYTHING like the index they’re intended to mimic. That borders on fraud in my opinion. And let’s be real – no one reads prospectuses.”

    All it requires for the user to do is a look at a price chart, not of the index, but of the ETF/ETN itself. They are not going to mimic multiple trends or track during volatile price changes in the index. If one pays attention to leveraged ETFs in particular, they will notice that the goal of the instrument is to capture a multiple of the daily % change.

    So as JTU describes mathematically ETF will be lost percentages during short price swings. However, if the ETF/ETN itself trends, returns compound in a way that the underlying index will not.


    Index Price
    % change = 20%

    3x Leveraged ETF
    % change = 68.83% (vs. 60%)

    Thus, if the price of the ETF is trending you will likely to do better. Conversely if the price is falling and you are for whatever reason holding on with no risk management system, you will do much worse.

    Thus, these instruments can be useful if… you trade them appropriately and have a risk management system that reduces your risk of loss and exposure to unfavorable price changes.

    One would have to actually know what they are doing in order to be made better off with these instruments. So if you are using these things and lose money you probably have greater issues to deal with such as not having any type of strategy, have poor risk management, don’t study the instruments enough.

    Essentially, one would lose a great deal of money if they don’t understand what they are doing. That possibly might have happened if an ETF were used or not.

  24. Shrinking Current Account Deficit ==> Less demand for imported goods ==> Weakening economies.

    See e.g. what happened to the US Trade & Current Account Deficit after 2008 in comparison to before 2008.

  25. The 30 original comments are gone. The color scheme is terrible. what you had before was better. Now you have to type in your name and email each and every comment. And I will not use discus, facebook, twitter or any other social media comment mediator. Cut out the middleman. You risk turning a lot of readers into lurkers, or worse, they may leave entirely.

  26. “Debts that can’t be paid, won’t”. And that’s going to happen in the US as well. And that’s called DEFLATION. And severe deflation causes a depression. Does one C. Roche REALLY believe that the FED is going to endanger the USD by “printïng” ~ $ 42 trillion (private sector debt) or $ 16 trillion (federal debt) ?

  27. Sometimes I wonder why I am not chopping wood full time somewhere very far away from all of this… I KNOW RIGHT??

    Institutionally its such a sad state of affairs and I feel like we are past the point of return.

    Anyways, Cullen will you PLEASE write a piece on Detroit as a precident for what is to come for municipalities and states in coming years? I would really appreciate your perspective on this important issue.

  28. That’s what you get in a country governed by lawyers who are financed by banks.

  29. There is simply no need for these products. Wanna go leveraged short you could just have a thrice as large (short) position in the underlying ETF or trade futures. If you are unwilling to do that, why go with a product that has additional downside?

    The same goes for all the stuff that’s based on futures, and especially the VIX/Volatility stuff. If you don’t know what implied volatility is, don’t trade it. If you do know, there are other strategies to capture increases and declines in implied volatility. Don’t know them? Don’t trade them.

    One of the products with those quotes in the prospectus is TVIX by the way, currently trading below 2 dollars. Saw people lose their shirt on that one more than once. Deservedly so. Of course they proceeded to blame Credit Suisse, the creator of the product.

  30. “If you understand the risks fine. I’m not complaining that it’s too risky”

    Of course, if someone doesn’t know the risks then its going to be a problem. Why is that surprising to you or anybody?

    Again, its not a problem that its “too risky”, its a different product, its not a long term investment. It has a “different” risk profile. I guess you aren’t going to get it.

  31. “I’m amused that they’re honest about the risks in such a blunt way”

    Huh? So, you would rather have it in obtuse language?


    “I think that if people truly understood what the risks were that almost no one would buy in.”

    Especially if they were hell bent on assuming that its a long term investment vehicle, then hell yeah, they wouldn’t buy in. And, that’s how its supposed to be.