Since we've been in business, we've used individual stocks to build the developed markets equity portion of our portfolios for a vast majority of our clients. But lately, we've reconsidered that approach for many of our clients and have begun to incorporate more low-cost index funds into client portfolios. We've had a good track record with individual stocks, so why the change?
Well, a changing political landscape with an increased focus on deregulation and desupervision, along with potential drastic changes in the tax code looks to be make individual stock picking riskier than it has in the past.
I believe that every day a vast majority of people on earth get up and try to improve society, their own lives, and the lives of those around them. It's this spirit of industry that makes capitalism work. But there are always a few bad apples in the bunch, and without proper regulations and supervision, things can go south in a hurry. All investors, at least to some extent, depend on legal and regulatory agencies for assurance that corporations are doing things above board. You can be the greatest investigative journalist ever, the world's best forensic accountant, or have the biggest rolodex of industry sources, but no one can ever know everything about every company in their investment portfolio.
The trend in the Trump administration seems to be one of drastic reductions in rules and regulations. For example Trump's pick for SEC Chair, Walter Clayton, shows a move away from regulatory enforcement. Clayton has close ties to Wall Street, and during his time as a lawyer, he fought several pieces of financial regulation for various financial firms.
Trump's cabinet is full of Wall St. alums, including four Goldmanites and counting. Most cabinet nominees favor drastically reducing government regulations. Indeed, a recently signed executive order points to one of the administrations priorities being the rollback of some portions of the Dodd-Frank Act. Also, senior staff have signaled they want to rein in the CFPB and look to replace Richard Cordray. Trump's leading candidate for heading the FDA favors streamlining the drug approval process, essentially just looking at whether a drug is safe rather than safe and effective. Betsy DeVos, head of the Department of Education, is a staunch supporter of charter schools that have a record of performing poorly, while enriching their owners in her home state of Michigan.
When deregulation goes poorly, it often leads to re-regulation, and many companies or even entire sectors can experience problems. Let's look at a few examples.
CoreCivic Inc. (formerly Corrections Corporation of America)
There has been an ongoing trend over the past decade towards privatizing prisons. The prisons are poorly regulated and poorly run compared to their public counterparts. Under the Clinton and Bush administrations, private prisons flourished. Late last year, the Obama administration moved to rein in the their use at the Federal level.
As soon as this happened, the stock price of one of the largest private prison operators, Corrections Corp. of America (now CoreCivic) (NYSE:CXW), plunged.
Of course, Trump ended up winning the election, and the stock price has begun to recover.
Apollo Education Group Inc.
The for-profit education industry did phenomenally well under the light regulatory touch of the Bush administration, especially industry leader Apollo Education (NASDAQ:APOL) (owner of the University of Phoenix brand).
However, once Obama took office, his Department of Education enacted a series of new rules designed to increase accountability at for-profit schools. The result is that many for-profit education companies closed or went bankrupt. In Apollo's case, the company was bought out at $10 per share, or 42% below where the stock traded for when George Bush was elected.
Relaxed rules at the FDA could lead to many great new medications coming to market, along with some dangerous or ineffective ones. We all remember Merck (NYSE:MRK) and Vioxx saga, which ended in a $4.85 billion settlement. A huge company like Merck easily survived, but smaller companies may not.
What about the financial sector? The specter of higher interest rates and looser regulations have sent the sector higher. But post crisis, since 2010, banks have racked up over $160 billion in fines and fees in 144 separate cases. Bank of America (NYSE:BAC) led the way with over $56 billion in fines, while JPMorgan (NYSE:JPM) came in second with $28 billion. What happens when the regulatory pendulum swings back the other way? Do you risk owning a BAC or a JPM?
For many investors, we believe that owning at least some broad index funds in their portfolio is intelligent. In an era of deregulation, it can be hard for investors to separate the good companies from the bad, and index funds provide valuable insurance against making the wrong choice.
We like broad, market cap-weighted Vanguard and Schwab ETFs for clients, since they are some of the cheapest options.
|Name (Ticker)||Expense Ratio||Description|
|Vanguard Total Stock Market ETF (NYSEARCA:VTI)||.05%||All 3592 large-, mid-, and small-cap US stocks|
|Schwab Large-Cap ETF (NYSEARCA:SCHX)||.03%||Largest 750 US stocks|
|Schwab US Small-Cap ETF (NYSEARCA:SCHA)||.06%||1750 small-cap US stocks|
Disclosure: I am/we are long SCHX,SCHA, VTI.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.