posted on 12 March 2016
by Elliott Morss, Morss Global Finance
In writing on wine and finance, I notice a lot of similarities. Most people cannot tell the difference between expensive and inexpensive wines, but the retailers use "descriptors" to convince them to buy. And while there are no investments strategies that outperform markets in the long run, those selling investment advice use their own set of descriptors to convince people there are. The similarity? Both industries have developed long lists of "BS" terms they use to get largely ignorant people to buy.
The marketers could not get away with selling wine and investment advice if buyers knew anything about the products. But they do not.
People cannot tell the difference between expensive and inexpensive wines. From tastings in Paris (1976), Princeton (2012), Stellenbosch (2013) and the Lenox Wine Club (2012-14), Lecocq and Visser,Goldstein et al, and Ashton, we have learned that people do not prefer expensive wines to less expensive ones: there is no correlation between price and how people rate wines. And this conclusion holds for most so-called expert tasters and well as for the "hoi polloi." Does this mean rating differences stem from wine drinkers have different taste preferences? It could. But maybe not. Robert Hodgson has developed a test to see if tasters will rate the same wine consistently. His test involves getting the taster to drink and rate several flights of 6+ glasses of wine blindfolded where 2 or more glasses are the same wine. If tasters give significantly different ratings to the wines from the same bottle, the conclusion has to be that they simply cannot distinguish between wines. When he applied his test to judges for the California State Fair wine competition, he found that only 10 percent of the judges were consistent in their ratings. His conclusion: a wine getting one rating in a competition could get a completely different rating in another competition.
Okay. So a lot of wine drinkers are in the dark. How do wine marketers take advantage of this? A cadré of "wine experts" and retail salesmen have developed a set of terms to describe wines they rate/try to sell. Several years back, Richard Quandt wrote a seminal piece on this in which he listed 123 of the terms used by the marketers/salesmen.
Table 1. - Quandt's BS Wine Descriptors
Source: Quandt, op. cit.
In a recent piece, I added some "BS" terms used by the Wine Spectator "experts": "balanced", "blueberry", "citronella", "honeysuckle", "lime blossom", "maduro tobacco", "mango", "marshmallow", "papaya", "peach", "pear", "pineapple", "quinine", "roasted caraway", "tremendous precision", "persistence and expression", and "verbena".
Complete and utter nonsense. But they help sell wine just as ads sell perfume and men's watches.
b. Investment Advice
When it comes to investment advice, I have always found the arguments of Paul Samuelson and Burton Malkiel quite convincing. Their research finds that stock markets adjusts quickly for new information, so quickly in fact that any stock pick or investment strategy is unlikely to outperform the overall market for an extended period of time.
The buyers of investment advice do not appear to know this. So like the wine buyers, they fall prey to the "advice marketers." Perhaps the best example of this is seen by looking at how pension funds buy advice.
The pension funds are huge investors. Every year, Pensions & Investments lists the 1,000 largest and smallest of these funds. The top 10 appear in Table 2. Note that their total investments are $1.8 trillion. And note further that with the exception of the Federal Retirement Thrift, they all lost money last year. "DB" stands for Defined Benefit where payments are based on a fixed, pre-established benefit. "DC" stands for Defined Contribution where an agreed amount is set aside by an employer every year. Employees normally favor DB plans because their payments do not depend on fund investment performance.
Table 2. - Largest Retirement Funds, 2015
Source: Pensions & Investments, "1,000 Largest Retirement Funds", Feb. 8, 2016.
So how do pensions invest their monies? All the same. It does not matter if the pension is for the local firefighters, state employees, Federal employees or workers in a company. They all start by creating an investment committee. The first committee action is to find someone else to blame for bad fund performance. So they all hire a "consultant". But the consultant does not choose the investments. That responsibility is delegated further: the role of the consultant is only to find the investment managers for the funds. These managers actually invest the funds.
Consider CalPERS, the second largest US pension fund: In 2014, it hired 54 consulting firms at a cost of $21.7 million to help it choose its investment managers. In total, it paid out $1.15 billion in fees to 250 investment managers.
It is interesting to compare CalPERS' management with how the funds of the Federal Retirement Thrift (FRT) are managed. The latter currently has a contract with BlackRock to invest its assets - just one investment manager. Its funds are invested so as to replicate the risk and return characteristics of certain benchmark indices. For example, its "C" Fund is invested in a stock index fund replicating the Standard and Poor's 500 (^GSPC) while its "F" fund replicates a fixed income index.
FRT has a 0.03% expense ratio while the CalPERS expense ratio is 20 times higher at 0.6%. Given the performance of each, it would not appear CalPERS's more expensive management style can be justified.
Back to the main story: the investment managers are no different than the pension fund committees or consultants: they do not want to be held responsible for any particular investments. So they come up with their own list of "BS" terms for different types of investments. And in so doing, they are able to keep the actual investment choices away from their customers.
My list of these BS investment terms appear in Table 3. The left-hand column consists of sector names. They are often the categories used when salesmen talk of "asset allocation." The middle columns provide details on some of the items included in the Alternative category. The right-hand column gives the BS terms used to market investment advice. I see them as analogous to Quandt's list for sellers of investment advice.
Table 3. - Investment Advice "BS" Terms
Source: Most terms came from Pensions & Investments
One might wonder how seriously the fund investment committees are taking these terms. Table 4 is a collection of requests from different funds for investment advice. It appears these terms have had an impact. It would be interesting to sit in on some of these committee meetings as they discuss the pros and cons of middle-market buyout private equity funds against international alpha tilts structured equity funds, etc.
Table 4. - Pension Fund Requests
Source: Pensions and Investments
There also appears to be corruption in the marketing of both wine and investment advice. In a recent piece, I pointed out that well-known vineyards have good and bad years. And that, coupled with the growing trade in bulk wines, would suggest not all the wines from a "branded" vineyard came from that vineyard.
And for evidence of corruption in investment advice, I return again to CalPERS. In January 2015, Alfred J.R. Villalobos, a former CalPERS board member committed suicide. Villalobos faced trial on Federal corruption and bribery charges for allegedly earning about $50 million as a middleman in winning CalPERS investments for private equity clients.
What does all this mean for your investments and wine purchases?''
Review the CalPERS's experience above and do not assume your pensions are focusing on getting the best return for you.
If you need investment advice, ask a friend whom you trust for a reference. Try to find someone with a track record.
 Paul A Samuelson, "Proof That Properly Anticipated Prices Fluctuate Randomly", Industrial Management Review, 6:2, 1965 (Spring) and Burton G. Malkiel, "A Random Walk Down Wall Street", W.W Norton & Co., Inc., 2007.
 Robert Ashton, "Wine as an Experience Good: Price versus Enjoyment in Blind Tastings of Expensive and Inexpensive Wines", Journal of Wine Economics, vol. 9, no. 2.
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