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Hardwired for Debacle?

Giving them what they want instead of what they need.

“The burnt customer certainly prefers to believe that he has been robbed rather than that he has been a fool on the advice of fools.” — Fred Schwed Jr., from his 1940 classic, Where Are the Customers' Yachts?

Wall Street is a fad business. Sure, it is. You would never run with any of those ridiculous fads. Me neither — I'm an independent thinker, too.

Nevertheless, some folks out there are proving that investment advisors have not unlearned herd behavior. This prolonged bear market has caused a near-buying panic for practically anything but conventional equities, especially bonds. Cash flowing into fixed-income mutual funds has been “phenomenally huge” for the past two years, says Financial Research Corporation's Lars Schuster. It's true that investors overloaded themselves with equities in the 1990s, but that can't explain their appetite for fixed income. (The $23 billion invested in corporate bond funds through April had surpassed the total amount for all of 1999, for example. Domestic equity funds? There has been an outflow of nearly $3 billion so far this year.)

You have to ask yourself: Are interest rates more likely to rise in the future, or fall? “I've seen this time after time in just about every sector or subset of a sector that we track. People buy on strength and sell on weakness. Exactly the opposite of what they are supposed to be doing,” says Eric Bjorgen, a researcher with The Leuthold Group.

Another faddish trend is the rise of so-called principal protection vehicles, which promise not to lose money in down markets while providing “some” participation in upswings. There is about $5 billion in such assets today versus around $600 million in 2000. And then there are REITs, which are grabbing investor dollars even as most parts of the commercial real estate industry are facing their worst slump. An uptick in interest rates would quickly sink those assets.

It's one thing to “sell 'em what they want” when it comes to, say, sneakers, but investments are another thing entirely. Resisting the temptation to sell your client what he thinks he needs instead of what he really needs is of critical importance.

Clearly, it is difficult to resist investment fads. You can see this in the recently revealed evidence from Eliot Spitzer's investigation of abuses by Wall Street research departments. Brokers who are trying to do the right thing for their clients are captured in emails, begging for Jack Grubman to stop shilling for telecom stocks that were, in the cold light of morning, clearly flawed companies.

But at the same time, the evidence shows that when the market was rising (and the commissions were rolling in), Smith Barney reps were among the biggest cheerleaders for the now-disgraced Grubman. Registered Rep. staffer Will Leitch details the reaction to the global settlement in our lead REPort on page 24 and samples some of the juicy tidbits from the settlement evidence in an Endpiece on page 104.

So, as we close this issue, we wonder about when and how today's investment fads will collapse, as all fads must.

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