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High-Risk and High-Fee Exposure for Public Employees

A recent New York Times article (“Behind Private Equity’s Curtain,” October 18, 2014), has exposed the all too often insidious relationship between public pension funds and the private equity firms that are entrusted with the financial retirement security of hundreds of thousands of teachers, firefighters, police officers and other public employees.

Unfortunately, private equity firms, which are currently estimated to manage $3.5 trillion of assets, have recently underperformed the broad stock market indices and, according to the New York Times article, have intentionally concealed from the public many of the terms and fees that are associated with the investment of their retirement assets as well as the fact that private equity investments are “the highest-risk, highest-fee products ever devised by Wall Street.”

If you are an institutional or public employee pension fund employee who has any concerns about your retirement or non-retirement accounts, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Artificial Inflation in Question for an ETF at Bill Gross’s Firm

Pacific Investment Management Company is under SEC investigation for possibly artificially boosting the returns of a popular fund aimed at small investors. The heady performance of the ETF raised questions among some of Pimco’s clients about the discrepancy in results between the ETF and the Total Return fund.

The SEC is looking into a maneuver that could make it seem as though the ETF had scored quick gains when it was in fact taking advantage of variations in the way some investments are valued in the bond market. The firm’s flagship exchange-traded fund, managed by Bill Gross, purchased and valued certain bonds, Your Value Your Change Short position bought investments at discounted prices and relied on higher valuations for the investments when the fund calculated the value of its holdings shortly thereafter.

Pimco’s alleged maneuver means investors were given inaccurate information about the fund’s performance. It is a break of securities law to provide investors with misleading information about values or performance, even if the wrong information was supplied unintentionally.

Pimco “has been cooperating with the SEC in this nonpublic matter, and we take our regulatory obligations and responsibilities to our clients very seriously. We believe our pricing procedures are entirely appropriate and in keeping with industry best practices,” said a spokesman for the firm.

Gross, PIMCO manager, is one of the most successful bond investors ever. He is considered the driving force behind the firm’s growth into a blue-chip money manager, with almost $2 trillion in assets under management as of June 30.

Nation’s Biggest Pension Fund makes Big Decision

Concerns that investments are too complicated and expensive, the nation’s largest pension fund, the California Public Employees’ Retirement System, will eliminate all of its hedge fund investments over the next year.

Overseeing $300 billion, the pension fund, says they will be liquidating its positions in 24 hedge funds and six hedge fund-of-funds — investments that total $4 billion and more than 1 percent of its total investments under management.

It is likely to resonate across the investment community in the United States, where large investment funds look to CALPERS as a leader because of its size and the superiority of its investments.

FINRA has Citigroup Global Markets Inc. in Hot Water

Citigroup Global Markets Inc. is being fined $1.85 million for best execution and supervisory violations in non-convertible preferred securities transactions. They also ordered Citigroup to pay more than $638,000 in compensation, plus interest, to affected clients.

It was found that one of Citigroup’s trading desks employed a manual pricing methodology for non-convertible preferred securities that did not appropriately incorporate the National Best Bid and Offer (NBBO) for those securities. As securities trade on multiple exchanges, Citigroup missed the prospect of a better price for that security on an exchange other than its primary listing exchange. FINRA also found that Citigroup’s supervisory system and written supervisory dealings for best execution in non-convertible preferred securities were lacking. Finally, the firm failed to conduct supervisory reviews even though it had received several inquiry letters from FINRA staff.

“FINRA will continue to pursue firms that neglect their duty of best execution. Citigroup lacked the necessary systems and supervision to ensure that it provided customers with the executions they deserved and, as a result, customers were receiving inferior prices for more than three years,” says FINRA Executive Thomas Gira.


Expectations v. Reality of Unconstrained Bonds

Investors’ fears of rising interest rates of traditional bonds, have shown an influx in these “go anywhere” funds. With a focus on returns, many investors don’t understand the risk. In the category of a nontraditional bond fund, they hold a large percentage of the portfolios in high-yield bonds, which have huge potential for default. Some of the funds are full of derivatives, along with emerging-markets bonds and illiquid bank loans. Popular unconstrained bond funds suffered declines of 25% during the 2008 financial crisis.

The Complications of Structured Notes

A complicated investment to begin with, structured notes have grown more complex the last few years and are best to be avoided. They commonly claim to limit instability in a down market. A debt instrument whose return hinges on the price movements of other assets, such as, commodities and stocks. These notes aren’t backed by any collateral and often come with substantial fees. They are purchased through a bank or third party. A knowledgeable financial adviser doesn’t offer structured notes to their clients, because of their complexity and liquidity issues.

Leveraged and Inverse Exchange-Traded Funds are a Ticking Bomb!

Leveraged ETFs are designed to provide investors with a certain percentage return over the movement of a market over the span of a day. Inverse funds are supposed to move in the opposite direction of a specific index, to provide protection against declines.

The problem with these types of funds, is their use of borrowed money to magnify their bets also magnifies risk. The category has seen $2.8 billion in net inflows so far this year through mid-June, according to ETF.com, a research firm.

David Nadig, director of research at ETF.com says, “Many of these ETFs use “total return swaps”, a complicated financial agreement that allows a fund to take on leverage to boost returns. That adds a “counterparty” risk if the investment bank issuing the swap goes bust”.

Mr. Lee, Morningstar’s ETF analyst, says leveraged ETFs are aimed at day traders, who are constantly changing their portfolios and can take on more risk. “It’s not something you can buy and just forget about,” Mr. Lee says.

“If you want to make a strong bet on stocks, for example, you can invest in small stocks with a greater potential upside,” Mr. Lee says.

Nontraded Real-Estate Investments mean Risky Business

Nontraded REITs have been growing in popularity lately. Through June of this year, nontraded REITs have raised $8.8 billion. These real-estate investment trusts are similar to their public counterparts, which trade like stocks and allow investors to invest in an array of commercial properties.

The downside for investors is that they are hard to unload during a real-estate downturn. Fees are higher, as much as 11% in initial sales charges to pay the retail broker, the dealer and the back-end costs of putting the REIT together. Also, these investments have become a concern of the Financial Industry Regulatory Authority. The agency is warning that they are generally illiquid, their performance and value are difficult to understand, and their cost is too high. Disclosure is murkier than with publicly traded REITs as well.

Attorney Mark Maddox named to FINRA’s Arbitration Task Force

We are proud to share that Attorney Mark Maddox will be part of FINRA’s new arbitration task force. Click this link for details: http://www.finra.org/Newsroom/NewsReleases/2014/P554192

Know the risks of “Liquid-alternative funds” before you invest!

Liquid-alternative funds are increasing rapidly in popularity, with investors pouring $40 billion into them in 2013, according to Morningstar. This year through June, they have taken in $14.6 billion.

“Liquid alternative” mutual funds typically service hedge-fund-like strategies but don’t come with the same limitations. There isn’t a high investment minimum, for instance, and the funds aren’t as challenging to exit as traditional hedge funds.

Fund companies are offering investors a chance to capture at least some of the upside of stock returns in good markets while offering protection in down markets and diversifying portfolios.

Doubters say the strategies often are too complicated for the typical investor to understand, and many are too new to have a proven track record. They also come with high fees: an average of 1.9% of total assets, or $190 per a $10,000 investment, compared with 1.2% for a usual actively managed stock mutual fund and 0.6% for a stock index fund, according to Morningstar.

“They have some ugly baggage and warts they carry,” says Mark Balasa of Balasa Dinverno Foltz in Itasca, Ill., a wealth-management firm with $2.8 billion in assets under management. “Advisers are challenged to understand what they do, let alone investors.”

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