(Bloomberg View) -- Sales culture.
In 2016, Wells Fargo & Co. got in hot water because it turned out that its bankers had been opening lots of fake accounts. One puzzling question about that scandal is: What was wrong with it? There is an easy answer, which is that it is wrong to open fake accounts, but it is not an especially satisfying answer. Wells Fargo -- its board and senior management and certainly shareholders -- didn't want its employees to open fake accounts. Fake accounts, for the most part, didn't make any money for Wells Fargo. Wells Fargo wanted the employees to open lots of real accounts, and the fake accounts were those employees' effort to deal with the pressure to sell real accounts by pretending to sell fake ones.
Of course no one wants to hear that the Wells Fargo scandal was just the work of low-level employees or that no senior executives were responsible for it. And of course some senior executives were responsible for it: They set unrealistic sales targets, did not demand systems that adequately guarded against fraud, were dismissive of employee concerns, downplayed whistle-blower complaints about the fake accounts, etc.
But reading about Wells Fargo over the past year and a half, I have often gotten the impression that people think the real scandal was something much broader: that Wells Fargo's essential problem was that it set any sales targets, that it wanted its bankers to sell products rather than just listen to customers and give them the best possible advice for their own situation.
As someone who used to sell financial products at a bank, I always found this to be a bit of a category error. The job of a banker is to sell banking products. The bank makes money by selling you banking products, the way a car dealer makes money by selling you a car, or a clothing store makes money by selling you clothes. When you walk into a clothing store, you do not expect the salesperson to say "I like the clothes you have on now, I do not think you need to buy any new clothes." You understand that you are walking into a commercial environment, and that the salesperson wants to sell you things. You might expect a certain level of fiduciary-like advice -- if you ask her "does this look good on me," and it doesn't, you might hope that she'll steer you to something that does -- but you understand that ultimately the salesperson's job depends on selling you things. Your guard is up.
It is a little weird that people would walk into a bank and lower their guard, that they would expect bank employees to be disinterested fiduciary guardians of their interests rather than salespeople selling them things. There seems to be a widespread perception, in the general culture, that banks are evil and rapacious and not to be trusted -- and then you walk into a bank and just forget all of that and trust them absolutely? But it is not that weird, because of course that is the impression that banks try to foster. Finance is complicated and forbidding; the commercial message of most banks is, essentially, you should trust us to look out for your best interests. This is not the commercial message of most clothing stores. Most clothing stores are like, hey, here are some clothes, do you think they look good? Trust and expertise are not the main things they are selling.
Credit card and savings customers may not be the only ones who were misled by Wells Fargo & Co.
Some clients of the bank’s wealth-management division were steered into investments that maximized revenue for the bank and compensation for its employees, according to several people familiar with the unit and documents reviewed by Bloomberg. Those investments weren’t always in the best interests of clients, the people said. They included estates, trusts and loans, according to one of the people and the documents.
Wealth advisers as recently as 2016 were given ambitious quotas and could earn extra pay by steering clients into loans and accounts with recurring fees, said the people, who included one current and five former Wells Fargo advisers.
Does this resemble the fake-accounts scandal? Well, sure, a little, in that in both cases Wells Fargo bankers were incentivized to sell more products to customers. But it is very different from the fake-accounts scandal in that here there are no fake accounts. The implication here isn't that Wells Fargo wealth-management employees, faced with aggressive sales targets, set up wealth-management products for customers without their permission. The implication here is that the wealth-management employees, faced with aggressive sales targets, talked wealth-management customers into buying products. Which was their job!
Now clearly that could be bad, if they lied while doing the selling, or failed to disclose things they were required to disclose, or if the products were bad enough. "The Justice Department and the Securities and Exchange Commission are investigating whether the unit inappropriately sold clients in-house investments." But you see a lot of this background notion that incentives to sell are bad. If people -- if the public and regulators and politicians -- really believe that, then it is going to cause problems for the banks. Because banks are built around selling financial products, and their incentive systems are also built around selling financial products.
Of course the banks -- strangely! -- wouldn't put it that way. They'd say a lot of nice stuff about working to earn clients' trust and always acting in the clients' best interest and so forth. "Any assertion that its past or present compensation plans did 'anything other than incentivizing positive client outcomes is simply incorrect,' bank spokeswoman Shea Leordeanu said." But the raw fact is that Wells Fargo, and most other banks, and most other companies, want to make money, and employees who bring in a lot of money for the bank do better than employees who don't. And if the rules have changed and now banks can't pay people for bringing in business, then how will their business work?
We have talked a few times recently about the awkward situation in which BlackRock Inc. finds itself with respect to gun manufacturers. Basically BlackRock Chief Executive Officer Larry Fink wrote a letter to corporate CEOs about how their companies "must not only deliver financial performance, but also show how it makes a positive contribution to society," and then a month later there was a very high-profile mass murder at a school, and it turned out that BlackRock is the largest shareholder in the company that made the gun used in that shooting, and of most other gun companies too. And there has been a lot of pressure on BlackRock to, you know, show how it makes a positive contribution to society, by doing something to cut down on the use of guns to commit school shootings.
And BlackRock, as a huge provider of index funds, is in a tough position: Its index funds have no choice but to own a lot of shares in gun manufacturers, so it cannot just sell their stock to express its displeasure, or even threaten to sell the stock as a negotiating tool to get the managers of the gun companies to change their policies. What it can do, as a huge shareholder of those companies, is get meetings with them, and it put out a statement saying that it has "reached out to the major publicly traded civilian firearms manufacturers and retailers to engage in a discussion of their business practices."
But another thing that BlackRock can do is start funds that don't own shares in gun companies. And it is doing that too:
BlackRock Inc., the world’s largest asset manager, plans to start two exchange-traded funds that will exclude civilian firearm makers and large sellers in the wake of the Florida high school shooting.
The iShares MSCI USA Small-Cap ESG Optimized ETF, which will start trading on or about April 12, will track investment results of an index that is mostly made up of small-cap U.S. companies, according to a company release Thursday. BlackRock also filed an initial registration statement for the iShares ESG US Aggregate Bond ETF. Both ETFs will exclude producers and big retailers of civilian firearms.
And "BlackRock plans to strip all gun sellers and retailers including Kroger from its current lineup of seven so-called ESG funds, which have some $2.2 billion in assets":
Walmart Inc., Dick’s Sporting Goods Inc. and Kroger Co. are among the retailers that will be ruled out of new environmental social and governance-focused funds BlackRock Inc. is planning, a spokeswoman for the world’s largest asset manager said Thursday. The retailers were among those who said they would no longer sell guns to anyone under 21 in the wake of the school shooting in Parkland, Fla.
There's something a bit weird about that. Walmart, Dick's and Kroger responded to the outcry about the Parkland shooting by changing their policies to make it harder for teens to buy guns to commit school shootings. And BlackRock responded to Parkland by removing those retailers from its ESG portfolios. (Here is BlackRock's announcement of the changes.) That's a little counterintuitive, but it's certainly defensible: An environmental/social/governance-focused investor could reasonably decide that those retailers' actions don't go far enough, and that no company that sells guns can be a socially responsible investment.
But for BlackRock it's an odd result. Here BlackRock is, on the one hand, "reaching out" to companies with gun-related businesses "to engage in a discussion of their business practices." And here it is, on the other hand, making the absolute judgments that a company with any gun-related business -- whatever its business practices -- will be excluded from its ESG funds, but won't be excluded from its index funds. BlackRock can talk to gun companies about changing their business practices, making incremental improvements to reduce the risk of mass shooting, but in terms of buying and selling their stocks, it is all or nothing. If you are Walmart, or Dick's, or American Outdoor Brands Corp. for that matter, and BlackRock shows up to your office urging you to do something to prevent teenagers from buying guns to shoot up schools, why should you listen to them? If you do what they want, then they still won't let you in their socially-responsible funds. (Unless you shut down gun sales entirely, which I suppose is possible for Walmart but tough for American Outdoor.) If you don't do what they want, then they still will keep you in their index funds.
BlackRock's problem is that, in much of its portfolio, it doesn't want investing discretion: It offers products to its clients, and then leaves it to the clients to choose which products make sense. BlackRock gives away its ability to make decisions, confining itself to clear pre-set rules like "no gun companies" or "every company in the index." This is useful for clients, who know what they're getting into. But if BlackRock is not making the investment decisions, then in what sense is it a shareholder of the companies that it buys? Why should those companies listen to it?
How's Bill Ackman doing?
Bill Ackman’s Pershing Square Capital Management is facing more bad news as many of the institutional investors in its private funds have asked to redeem their money.
About two-thirds of the capital that investors could withdraw from Pershing Square private funds was redeemed at the end of last year, according to a person with knowledge of the matter. Blackstone Group LP has been pulling its money, while JPMorgan Chase & Co. has removed Bill Ackman’s Pershing Square from its list of recommended funds for clients, the person said.
That sets the stage for a future in which the firm will largely consist of a publicly traded entity, Pershing Square Holdings Ltd., which currently has about $3.9 billion in assets. Add in Mr. Ackman’s own wealth and that of his partners, and it would still have some $5 billion to manage.
That makes it sound like a bad thing, but compared to what? If all of Pershing Square's clients get fed up and demand their money back, Pershing Square will still run $3.9 billion of outside money. (Or, I mean, $3.9 billion plus or minus whatever Pershing Square's performance does to that amount.) It will still earn a 1.5 percent management fee on that money, and a 16 percent performance fee on any (positive) performance. Pershing Square Holdings is what they call in the hedge-fund business a "permanent capital vehicle": Its investors can't demand their money back; all they can do is sell their shares on the stock exchange. Which they do: Pershing Square Holdings' stock trades at more than a 20 percent discount to its net asset value. But that doesn't affect Ackman; he still has the money.
That's smart! That's a good trade! "The measure of success as a hedge fund manager," I have said before, about Ackman, "is, roughly speaking: Can you keep managing a lucrative hedge fund?" He can! Forever! It's particularly impressive because of the timing. If you are a long-term client of Bill Ackman's, you might feel a sense of loyalty to him due to his strong historical performance: "Since its 2004 start through 2017, Pershing Square returned 494%, after fees, more than double the S&P 500’s return over the same period." But Pershing Square Holdings investors do not have that consolation: Its returns, from its inception in 2013 through the end of 2017, were 1.5 percent, total, versus 107.9 percent for the S&P 500 Index, and it's down 8.6 percent this year through the end of March. Pershing Square Holdings' initial public offering in October 2014 came quite close to top-ticking Pershing Square's performance, and it is only a slight exaggeration to say that Bill Ackman was very good at making money for clients from 2004 (when he started Pershing Square) through 2014 (when he took Pershing Square Holdings public), and very bad at it since. But, from 2004 through 2014, he had to be good at it. Now he doesn't.
To be fair, that does not seem to be how he thinks about it. In fact he is freely giving up some of his otherwise-permanent money: "The publicly traded hedge fund is buying back $300 million of its stock to signal a belief in the value of the portfolio, with Mr. Ackman and his partners planning to purchase an additional $300 million." But one obvious lesson of this story is that, when you make volatile concentrated investments, it is good to be running a public company. It's a lot easier to deal with investors who can't demand their money back.
People are worried that people aren't worried enough.
“The new safe haven is now volatility,” said Christopher Stanton, chief investment officer at California-based Sunrise Capital LLC. “It’s the one thing that’s pretty much guaranteed.”
In the olden days, back in January, people were worried that investors were too complacent, because they expected recent low volatility to continue forever. Now investors expect recent high volatility to continue forever? It's nice that they've found a safe haven.
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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