FOOL ON THE HILL
An Investment Opinion
Merrill Lynch: An Anniversary to Forget Bill Barker (TMF Max)
September 23, 1999
It's been exactly a year since The Wall Street Journal published an article quoting Merrill Lynch Vice Chairman John "Launny" Steffens as saying, "The do-it-yourself model of investing, centered on Internet trading, should be regarded as a serious threat to Americans' financial lives." Merrill Lynch (NYSE: MER) has subsequently reversed itself on what constitutes serious threats to the nation's financial lives, and has announced it will indeed be offering Internet trading to all its customers starting this December.
Accordingly, perhaps embarrassed by the "serious threat" prognostication, Merrill has removed from its website the speech The Journal quoted. Merrill does, however, leave a number of other executives' speeches up on its site (the ones that contain words the company is apparently not yet running from). So, with this anniversary of the Journal blow-up, I thought I'd take a look at what Merrill is saying today about the full-service brokerage industry.
The most recent speech to be posted, entitled "Repositioning in a Rapidly Changing Industry," comes from Chairman and CEO David H. Komansky, who laments that Wall Street's "myopically focused on technology's ability to execute transactions and empower people with access to information." Mr. Komansky argues that due to this myopic focus on empowerment, the market is missing out on a great value -- shares of Merrill Lynch. "[V]alue is what the client seeks out and is willing to pay for. By that measure, I would argue that the value of the Merrill Lynch franchise is far from fully reflected in our current multiple."
Though it is commonplace for CEOs to believe that their companies should be valued higher, it is ironic that Mr. Komansky is blaming any share price woes on Wall Street. (After all, one might be tempted to call Mr. Komansky the consummate Wall Street professional, but let there be no name-calling here.) Still, even though it comes from the CEO of the company, at a P/E of not even 13 times this year's projected earnings, the argument that shares of Merrill Lynch might have some value does deserve to be addressed.
Mr. Komansky proffers the theory that Merrill is going to be able to attract and retain clients based on the value-added nature of providing "trusted advisors." To analyze to what degree Merrill's executive leadership is wedded to the idea that it should only provide advice that would lead to gaining trust, I decided to look at what Mr. Komansky has to say about Merrill Lynch's mutual funds:
"Merrill Lynch Asset Management has made investment performance an absolute obsession. Where a fund has underperformed, we've taken steps to address it, and those steps are working. Through the first half of 1999, for example, 15 MLAM ('Merrill Lynch Asset Management') funds, including several of our largest, were rated 4 or 5-star by Morningstar. And, 16 funds comprising more than half of total fund-family assets outperformed the S&P 500. "
These four sentences comprise a masterpiece of creative nonsense, designed to shave the truth in at least three major respects. Let's examine them.
1) Merrill has 15 funds, according to Mr. Komansky, rated 4 or 5-star by Morningstar. This total can certainly be considered a positive if the pecentage represents a significant number of Merrill's funds. Determining the total number of funds that Merrill runs is made somewhat tricky by the fact that Merrill's funds have up to four different fee schedules (or "A," "B," "C," and "D" classes) for each individual fund. At any rate, below are the Morningstar totals as computed using AOL's mutual fund research tool, which counts each separate class of a fund as an individual fund.
The totals below reflect all asset classes for both bond and equity funds, domestic and international:
5-star funds: 9
4-star funds: 34
3-star funds: 97
2-star funds: 69
1-star funds: 46
Mr. Komansky's speech cites Morningstar's rankings with approval, but it is transparent that Merrill Lynch Asset Management's funds taken as a whole are considered by Morningstar to be dramatically below average.
2) Mr. Komansky states that 16 MLAM funds have beaten the S&P through the first-half of the year. I double-checked this and found that with the most recent data available, there were 18 MLAM funds that are ahead of the S&P 500 for the year. Here's the problem: at least 12 of those funds are international funds, and have no business being compared to the S&P. There are no more than six MLAM domestic equity funds ahead of the market for the year, and this total is about one-third of Merrill's total domestic equity fund offerings.
3) It's nice that Mr. Komansky is now willing to compare the performance of MLAM's funds to the S&P 500. This in itself is a bit of a reversal: Merrill had information posted on its site earlier this year that clients shouldn't compare their results to the S&P, as the S&P index was considered misleading by Merrill at the time. But, as Mr. Komansky knows, it would be a little more instructive to compare his company's funds' performance over a slightly longer period than six months. In fact, no Merrill fund matches the S&P's returns over the last three, five, or ten-year periods.
Mr. Komansky, as the saying goes, is using statistics the way a drunk uses a lamppost -- for support, rather than illumination. Careful, objective evaluation of the statistics applicable would illuminate the fact that Merrill's funds are, in a word, awful. Mr. Komansky simply goes about telling his story by picking and choosing his numbers to present a plausible, if misleading, presentation that there is actually some sort of collective quality in the MLAM funds. When others have looked at the Merrill Lynch family of funds, the family has ranked very low: 40th out of 50 families as ranked by AOL's Sage; 55th out of 55 funds over the last five years as ranked this year by Barron's.
But looking at the statistics to provide accurate information was never Mr. Komansky's point. Look, nobody, least of all Mr. Komansky, is operating under the misconception that Merrill is "absolutely obsessed" with the investment performance of its funds. Frankly, if anybody at Merrill Lynch were actually obsessed, the company would be dropping the high expense ratios on their mutual funds.
To take an obvious example, the annual expenses on Merrill's index fund are among the highest in the market, and more than three times that of Vanguard's identical index fund. Since index funds' results have to equal each others' performance before subtracting fees, Merrill will always have an underperforming index fund. It's simply impossible to present the argument with a straight face that Merrill has any kind of absolute obsession with performance. (Then again, I'm not sure that the picture of Mr. Komansky accompanying the reprint of the speech does portray him with a straight face.)
Mr. Komansky is right that the multiple that the market applies to Merrill is going to reflect to what degree Merrill Lynch can create "trusted advisor" relationships between its financial consultants and its customers. However, the conditions necessary to create and maintain that trust aren't well-served by bending numbers in the manner and degree that Mr. Komansky himself is apparently willing to do. If the salesmen/brokers/consultants working in the trenches for Merrill play as fast and loose with the facts as their CEO does, there ultimately aren't going to be many consumers for the "trusted advice" being lauded by Komansky.
"Today's consumers are financially savvy, and technology has made it easy for them to compare products, prices and performance," Mr. Komansky states. Indeed, and that's one of the major reasons why the multiple for shares of Merrill Lynch is as low as it is today.
The Fool Says Online Trading is Bad for Merrill Lynch, 9/24/98
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