So Merrill Lynch, the biggest brokerage house in the country, the one that likes to crow about being "Bullish on America," can't cut it in the mutual funds business.
If you haven't already seen the news, Merrill is selling its mutual funds to BlackRock Inc. In return Merrill Lynch is getting a significant ownership stake in a far less well known money management outfit that's been growing rapidly on the strength of its expertise in the bond market.
A legendary financial giant like Merrill Lynch capitulating on such a key business - on its face it doesn't make much sense, does it?
Well, as we've all learned over the past few years, you shouldn't simply accept corporate news on its face. By digging a little deeper and looking at how the business of Wall Street is evolving, you can see that Merrill Lynch's decision to sell its mutual fund assets actually is part of larger trend in how our money is being managed. And naturally there are lessons for ordinary investors to glean from the move.
First a little history. The fact is, for all of its strength as a brokerage house, Merrill Lynch was late to the mutual fund game. Charlie Merrill, the firm's co-founder and patron saint, distrusted mutual funds because during the 1929 crash some fund-like partnerships were proven to be complete frauds. So Merrill forbade his company from operating in the business, and that was the rule of law until the 1970s when Don Regan took over as chairman and chief executive. Regan, who later became treasury secretary and White House chief of staff under Ronald Reagan, believed that mutual funds were going to be the way average people invested their money, and he forced the firm into the business.
But by then it was too late. Mutual fund giants like Fidelity already had established themselves and new competitors were entering the business all the time. The head start that Merrill Lynch enjoyed over the rest of its Wall Street competitors in the national brokerage business wasn't there in mutual funds, and the firm never was able to reach a dominant position.
So now to the logic behind the deal. It seems to me that there are two reasons why this merger makes sense to Merrill Lynch and BlackRock. The first is scale, or something I called "safety in numbers" in an earlier column.
The idea is that on their own neither Merrill Lynch nor BlackRock are big enough to truly benefit from the synergies available to asset management firms. In general, companies that manage money become increasingly profitable as they grow - what they call in the biz "gathering assets." This is because technology takes care of much of the back office record keeping that used to be a major snag. So now large pools of capital generally can be managed just as easily as small pools, and since the firms collect fees based on the amount of money they manage, it makes a lot of sense for a mutual fund company to want to become as large as it possibly can be. In the case of Merrill Lynch and BlackRock, the combined firm would bring together Merrill Lynch's expertise in stock funds and BlackRock's expertise in bonds, while at the same time benefiting from the "safety in numbers" of the larger organization.
But the second reason is the one that individual investors really ought to watch. See, the mutual fund business essentially has evolved into a scoreboard where the hottest funds attract the most assets and charge the highest fees. Investors essentially are chasing the hot money in mutual funds. The fund companies know this, so their fund managers are encouraged to look at returns in the very short term to capture the fickle crowd.
The problem is this is exactly the wrong way to view investing. If you believe that over time it makes sense to have your money invested in a variety of assets - stocks, bonds, real estate, foreign markets, and so on - you definitely need to participate in Wall Street. And if you don't have the time or the expertise to feel comfortable doing this on your own, mutual funds generally are the best places to put your money.
Still, you have to read the fine print. For instance, take a look at the bottom of any mutual fund advertisement and you'll see a variation on the words: "Past returns do not guarantee future results." What they're telling you is: "Although we did great last year, we might not be able to repeat those results. But we're still going to charge you through the nose for the privilege of investing with us."
So how do you handle this? Well, the best advice I've heard on the subject came from Jack Bogle, the founder of Vanguard Group, who told me, "You can't control how your investments are going to do in the future, but you can control the fees you're paying to invest." Bogle's been preaching this message for years - indeed, Vanguard's index funds are based on the idea that you keep costs down and try to track the market as best you can.
What I've decided to do is put my money in a variety of funds that track the markets every way possible. Of course I adjust the mix based on where I think economic conditions are headed, but I try to focus on the long-term and always am mindful of the fees I'm paying. And I only buy individual stocks if I see something that's too good to pass up.
Now for all you would-be Gordon Gekkos out there, you'll likely ignore my advice and think me a fool for not playing the game the way it's meant to be played. I'll accept your scorn, as long as you're willing to show me your balance sheet ten, twenty years from now. And for the rest of you, I think there's a real lesson to be learned here. Don't do what Wall Street wants you to do. Don't follow the hot money. In the long run you'll be a lot happier - and probably much richer.
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On a completely separate note, I'm heading to Paris today to work on a couple of assignments (and because my wife has business over there.) Anyway, by chance I'll also get a fairly close look at the costs and benefits of the exceedingly complicated French social security system, which encompasses everything from regular health care to retiree benefits. Their overly-generous state-sponsored system essentially is the polar opposite of what we have in the U.S., and it's experiencing equally vexing problems that also cry out for reform.