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Investors Are Seeking Ethical Conduct

Daniel Solin

According to an article in Reuters, "ethical investors" are avoiding the stock of companies they perceive to be dodging taxes. Apple, Google, and Vodafone were singled out as companies that, while acting legally, manage to pay only minimal taxes. In what may become a trend, the FTSE Group is considering excluding companies with "overly aggressive tax reduction policies" from the group of companies in its "ethical index."

On another front, JPMorgan Chase reported record profits of $21.3 billion on revenues of $99.9 billion. These results are even more impressive when you consider losses of $6 billion caused by a rogue trader in London.

Meanwhile, the Securities and Exchange Commission is featuring its aggressive enforcement actions over misconduct relating to the financial crisis in 2008. So far, it has charged 153 entities and individuals and 65 corporate officers. It has obtained $2.68 billion in penalties, disgorgement, and other monetary relief.

The firms charged are a who's who of the financial services industry and include Bank of America, TD Ameritrade, State Street, Oppenheimer Funds, Morgan Keegan, Charles Schwab, Credit Suisse Securities, Citigroup, and J.P. Morgan Securities.

J.P. Morgan Securities (part of the mega financial services firm that reported record profits) was charged with misleading investors in offerings of residential mortgage-backed securities. It agreed to pay $269.9 million to settle these charges.

Instead of looking for ethical screens to eliminate companies that follow the tax law and minimize their tax liability (which is in the best interest of their shareholders), what about scrutinizing the appalling lack of ethics in the securities industry? These are the folks entrusted with "managing" your money.

While this lack of ethics is reason enough to stop doing business with members of this industry, the reality is worse. The advice you receive from them typically results in little or no benefit to you, but rather themselves as they line their own pockets with the fees and commissions generated by their activity.

John Cochrane, a professor at the University of Chicago Booth School of Business, recently published a draft essay in which he noted this anomaly. He found that investors paid 0.67 percent per year in active management fees, which equates to 10 percent of the value of their investments. What do they get in return? The average "alpha" (meaning the risk-adjusted expected return) before fees is "very nearly zero." When you dig deeper and eliminate luck, only 16 percent of mutual funds in a comprehensive study showed evidence of skill before adjusting for fees. Even worse, there is no evidence anyone has the ability to select these outperforming fund managers prospectively, since there is no persistence in performance. This is why you are probably familiar with this language: "Past performance is not indicative of future results."

Cochrane concludes that the average investor could save the 0.67 percent he or she is paying for actively managed funds and just "buy a passive index." He believes "active management and its fees seem like a total private, and social, waste."

Rather than flyspecking over tax strategies, investors seeking ethical behavior should take a hard look at the conduct of the financial services industry. Its track record of misleading investors, and offering advice that flies in the face of overwhelming data, hardly inspires trust and confidence.

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information, and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

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