Tuesday, February 17, 2009

We pay for the illusion of safety; are we getting a good deal?

In what warped universe does a mutual fund that has lost 30% in the past 14 months deserve a 5-Star rating?

Selling is the act to convince a buyer they will receive good value for money. It is important that we consider the actual value of safety, as it is a key selling point for every transaction. Our purchases of food, medicine, automobiles, airline tickets and investments rest on a foundation of safety.

We fund government agencies (SEC, FDA, USDA, DOT, etc.) to regulate some products and their sales with the belief that a high level of safety will be established and maintained, or at least the open disclosure of risk will allow buyers to make informed decisions. The conspicuous public outrage directed at Bernard Madoff and his $50B Ponzi scheme is a societal response to an individual’s outrageous behavior and the failure of our government’s regulation. While investors were lured by their own greed to obtain impossibly consistent returns, all confidence schemes require the perpetrator to sell the illusion of safety to retain their investors. Today Madoff is under house arrest, his known assets seized, and all of his family and business associates are being compelled to answer, “what did you know and when did you know it?”

Our desire for reassurances of safety compel us to fund independent rating agencies such as Underwriters Laboratories, Moody’s, Standard & Poor’s, Morningstar, Insurance Institute for Highway Safety, etc. I’m personally astounded that after catalyzing a global financial disaster, Moody’s and S&P have not only survived, but seemingly thrive today. This leads me back to Morningstar that provides equity research and ratings services to investors. In what warped universe does a mutual fund that has lost 30% in the past 14 months deserve to maintain its Morningstar 5-Star rating which it has held for 10 years? By any rational measure, a 5-Star rating is intended to engender safety and encourage investment in a particular fund. Does the fact that it limited its losses compared to the broader market garner the 5-Star rating? Let us now all acknowledge that the measure of safety provided by the financial ratings agencies was a very poor deal and maybe their CEO should be under house arrest! By the way, how many of us received calls from our “maintain a balanced and diversified portfolio” investment advisors in 2007 telling us to get the hell out of the market? Not I!

No comments:

Post a Comment