In a piece for Morningstar Magazine, Don Phillips, managing director at Morningstar, discusses the ever-present threats to portfolios, known as “the four horsemen of the investor apocalypse”: complexity, concentration, leverage, and illiquidity. While the four horsemen can cause great damage to an investor’s portfolio, they can also generate profits for Wall Street, leading to a battle between what’s good for the client and what’s profitable for the provider.
While a traditional index fund avoids the horsemen by being diversified, simple, unleveraged, and liquid, a standard hedge fund is the opposite: complex, focused, usually leveraged, and typically illiquid. But a manager can charge high fees for the hedge fund while the simpler index fund is much more cost-effective, making it a less expensive option for investors while also giving them a better chance for success. The horsemen can offer a good rubric for determining how well an investment will serve investors, the article contends.
But a recent conference of elite asset managers listed an agenda with topics that the horsemen love, such as alternative investments. While there are some advantages of alternative investments—giving portfolios a piece of protection in volatile times, for one—there isn’t much evidence that investors have benefitted from them over the last 20 years. And at one time or another, all four horsemen wreaked havoc on retail alternatives. But Wall Street continues to push them, because they can rake in profits “through launching pricier, more complex fare,” Phillips writes.
Another topic at the conference concerned thematic investment funds, which can generate a lot of buzz but rarely result in high returns. These concentrated funds can skyrocket, but they also encourage bad investor behavior such as selling at the peak. That’s more advantageous to managers than investors. And of course, brokerages who encourage meme stocks was a hot topic at the conference. While more widespread access can lead to a more open market, the real issue is the use of leverage, Phillips posits. According to a recent Yahoo Finance-Harris survey, 43% of retail investors are leveraging their bets with options or margin accounts. That strategy could lure in the horsemen of concentration, tax complexity, and leverage.
The horsemen’s shadows also loom over private equity. It’s still unknown how much profit will actually get to investors after costs are factored in, and if special-purpose acquisition companies hold any clue, it won’t result in the investors’ favor. Given that Wall Street is so eager to sell private equity, it will likely take some skillful maneuvering on the average investor’s part to make it a successful investment.