Thursday, January 25, 2007

Bo Knows Investments

Professional investors select investments such as mutual funds based on their expected “investment value”. Investment value is determined by carefully reviewing and comparing a variety of quantitative and qualitative characteristics to benchmarks and other alternatives. Non-professional investors, including many retirement plan fiduciaries, on the other hand, tend to select investment providers and investments based on little more than their “franchise value”. Franchise value is the popularity of a brand name with consumers. Starbuck's, and McDonald's are industry leaders because consumers recognize and value their corporate identities as much as their products. The same is true for the Fidelity’s and Goldman Sachs’ of the financial world. Their brands have been carefully designed and managed to serve as proxies for quality.

Investors often use short cuts in their investment decision making. We know this through our own observations and through numerous research studies such as one performed by the Consumer Federation of America. This study concludes that most mutual fund investors do not follow the practices recommended by experts. When selecting mutual funds, investors give little weight to elements considered important by experts such as; cost and information provided in the fund’s prospectus. The wide use of franchise value as a short cut for sorting and selecting amongst a large universe of investment alternatives is well recognized by regulators and marketers.

Brand based purchasing behavior is a particular risk in markets characterized by information asymmetry. Information asymmetry exists in markets where sellers are better informed about product characteristics than buyers. In the financial services and asset management markets, buyers are not always capable of assessing the long run risk return nature of the products they are encouraged to consume. Extensive regulation and disclosure requirements in these markets recognize this disparity and seek to limit the seller’s advantage. ERISA fiduciary responsibilities and the “prudent expert” standard of fiduciary care were no doubt designed to protect investors from the inadequacy of naïve investment decision making using factors such as franchise value.

Financial services companies fully understand the economic value in establishing or terminating ie PBHG or Strong a high level of brand recognition and franchise value for their business. High franchise value is becoming a major competitive asset for financial service firms as it; creates demand, allows for premium pricing and stifles competition. Not coincidentally, they are spending huge amounts on branding and celebrity endorsement. Anecdotal examples in the most recent issue of Investment News include:

  • London-based Barclays agreed to pay nearly $400 million over 20 years for the right to have its name on an arena in Brooklyn.
  • Prudential Financial Inc. agreed to pay $105 million over 20 years for the name PrudentialCenter on a new arena.
  • Citigroup Inc. agreed to pay the New York Mets $400 million over 20 years to call the team’s new baseball stadium in Queens, N.Y., Citi Field.
  • Principal Financial Group Inc. is hoping that Hall of Fame pitcher Nolan Ryan will help the company win customers as the new national spokesman.
  • Bo Jackson now is teaming up with the Guardian Life Insurance Company of America in New York.

    The lesson, particularly for investment fiduciaries, is that a favorable inclination towards certain investment providers or funds is probably an insufficient and unsupportable basis for a fiduciary decision. As Fred Reish notes:

    "fiduciaries must engage in a prudent process. That is, they must: determine what information is needed to make an informed decision; gather, examine, and understand that information; and then make a reasoned decision based on that information. While this process is straightforward, it may seem daunting to many fiduciaries because it requires an understanding of sophisticated investment concepts and an analysis of detailed information about investments. For example, US Department of Labor guidance and court cases make it clear that fiduciaries are expected to understand and apply generally accepted investment theories such as modern portfolio theory and prevailing investment industry practices such as the quantitative and qualitative analysis of the mangers of mutual funds."

    The Rock, leather bound presentations, Paul McCartney, You & Us, gold leafed educational packets, lava lamps, Higher Standards, Lance Armstrong, erudite investment commentary and the Red umbrella don’t guarantee results and won't keep you out of court!

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