The stock markets have always been steeped in scepticism and anyone reading this book will understand why. This is a classic insiders’ account of how things really work on Wall Street. The author, Lee Munson, worked as a speculative trader during the dot-com bubble and later formed an asset management firm, Portfolio LLC. From this vantage point, he challenges some of the basics devised by brokers and shows that the game of investing is basically rigged. Nor, he adds, is this a recent trend — Munson goes back into the history of the markets to show why the age-old concept of “buy and hold” does not work in reality.
The world’s first actively traded stock was the Dutch East India Company. Founded 400 years ago, in 1602, the company paid its investors good dividends for the first 200 years of its existence. But things changed when the company started declining and was acquired by the crown. Shareholders were paid dividends by the government since the company was no longer involved in any productive business. Finally, in 1800, the company folded, providing an early example of the dangers of the “buy and hold” strategy in the real world.
A more contemporary example Munson provides is of Philip Morris, the cigarette manufacturer. Philip Morris’ stock was sold on the premise of the consumption growth story. Cigarette smoking was becoming a fashionable social trend, and the selling proposition for the stock was that the company would do well and pay high dividends because it operated in a market in which demand was inelastic. This abruptly changed when lawsuits began to be filed by lung cancer patients and cigarette smoking went out of vogue. Philip Morris’ share price took a serious hit until the management diversified by buying the world’s largest cheese maker, Kraft.
Munson also questions the Modern Portfolio Theory (MPT), which brokers devised as a means of de-risking asset allocation. MPT was essentially an academic concept designed to encourage investors to invest across a range of equities to maintain healthy and relatively risk-free returns over time. Munson contests this assumption. In practice, he says, brokers take a bet on a particular class of stocks outperforming the markets and often end up underperforming them. This is because brokers typically ask investors how much risk they are ready to take. That means risk, not return, is a major factor determining the portfolio, and for the asset allocator return is based on the equity the investor has chosen.
Munson makes the point that the markets have been investing a lot in devising new ideas to sell stocks. For instance, investment bankers get paid for raising money for companies. They created the concept of the research report, which carries a rating and “sell, buy or hold” recommendations. It is a technique that was exposed during the dot-com crash of 2000. Thus, in the nineties, the author says, technology stocks carried a “buy” or “hold” call, only to go belly-up later. To bolster his case, Munson reminds readers of the examples of Jack Grubman, former managing director of Salomon Smith Barney, and Henry Blodget, an internet equity research analyst with CIBC Oppenheimer who was later hired by Merrill Lynch, who recommended stocks of companies that are now bankrupt. (Blodget is currently banned from the securities industry.)
Munson is also less enamoured of the mutual fund industry. It came into the limelight after the US Congress passed Resolution 401(k), under which “a covered employee may elect to have the employer make payments as contributions to a trust under the plan on behalf of the employee”. This helped big organisations, Munson argues, but not mediocre or small business enterprises, which relied on mutual funds to hedge their employees’ future. It had the dubious virtue of drawing more and more people into the equity markets, creating a boom in the mutual fund industry.
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The concept of automation, which was devised in order to maintain liquidity in the markets, also comes in for criticism. High frequency trading (HFT) using algorithmic programmes enabled more and more trades to be executed in a short span of time. Munson says HFT created a false sense of security: it allows traders to buy and sell securities all day long, but if the market crashes they do not have a fair idea of how many buyers and sellers there are on the floor.
Munson also discusses the pitfalls of choosing stocks on their dividend yield potential. Many companies avoid paying dividends in the interests of other productive investments. But many large companies (such as Apple, most recently) sit on huge quantities of cash rather than distributing it to shareholders.
All in all, this book provides a lot of useful information on the hidden practices of large brokerage firms and on how Wall Street devises strategies to trap investors. The 2008 crash and the state of global markets since then suggest that Munson is reinforcing a message that many investors have already absorbed. But the big lesson the book holds is one that is worth repeating if we only consider the number of times people forget it: when it comes to investing, buyers must beware.
RIGGED MONEY: BEATING WALL STREET AT ITS OWN GAME
Lee Munson
John Wiley & Sons Inc; Rs 29.95