Wednesday, October 10, 2012

The Magic Words of Money Management Part 6: “Transparency”

The Magic Words of Money Management Part 6:  “Transparency”

Everyone likes the concept of “transparency.”  It conjures up images of openness and honesty.  Justice Louis Brandeis is often cited as the champion of transparency for his statement, “Sunshine is the best disinfectant.”[1]     Politicians clamor for transparency, regulators demand it, investors crave it, and money managers talk about it all the time.  However, no one agrees on what transparency really entails.  An investor’s idea of transparency is often a money manager’s definition of inappropriate intrusiveness.

Napkin 21 (2000)

As a general matter, transparency is supposed to give regulators or investors enough information so they can assess risk or evaluate the performance of a money manager.  However, no one really knows how much information is enough.  All I can say with certainty is that each financial crisis brings a demand for more transparency, and the subsequent disclosures by money managers do little to prevent the next crisis.  We’re always a step behind the latest scheme that puts our financial markets into a tailspin and your investments at risk.

While money managers tell prospective clients that they want to be “entirely transparent” with their partners, they don’t really mean it.  In part, they are trying to protect a few legitimate pieces of confidential information.  For example, you wouldn’t want a money manager to widely reveal his investment positions on a real-time basis; it would be like playing poker with all your cards face up.  However, there’s a bunch of stuff they’d rather not let you know about, like how much money they make, and how they divide up the profits.

Money managers take two basic approaches to transparency.  Some firms offer tons of material (notice I didn’t say information) to their investors.  They’ll let you wade through thousands of pages of documents and endless financial tables, but you’ll find that much of the information is irrelevant or dated.  I think they’re hoping that the investor will be satisfied by mere quantity.

In many ways, mutual funds have adopted this approach.  While the SEC sets the disclosure requirements for mutual funds, the big mutual funds don’t mind generating reams of data.  They know that investors will become overwhelmed by the sheer volume of material, as well as the amount of fine print in the prospectus, annual report, and other documents.  In fact, it becomes a competitive advantage because small mutual funds can hardly afford the costs associated with assembling the data dump.

The other approach is to only reveal information on a piece-meal basis.  If you’re a large enough investor and you make enough noise, the manager might let you have a peak at the relevant data.  However, more likely than not, he’ll try to tell you that the information is “proprietary” (see part 1 of this series).

If performance lags or an investment sours, transparency will go on holiday.  Many money managers don’t like to talk about bad news, and they don’t like pointed questions from investors.  This reaction is slightly humorous, as money managers tend to ask very pointed questions of their own if a company misses an earnings report or other important milestone.   The portfolio manager who extolled the virtues of transparency will no longer be accessible, and you’ll only get to talk to a client representative.

So money managers will offer transparency, and you should take what they give you.  However, it is going to be a lot less than you imagined when they first told you that they believed in “complete transparency with their investment partners.  You’d better be prepared to do a lot of work if an investment fails, because even the most transparent money manager turns opaque when things aren’t going well.

[1] What Publicity Can Do, Harper’s Weekly, 1913

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