State Street Could Face Another Investment Strategies Suit

Attorneys General in Alaska and Idaho are looking into possible legal action against State Street Corp. over losses their state retirement funds suffered investing in two enhanced index bond funds, the Wall Street Journal reported.

Jerry Burnett, administrative services director for Alaska’s Department of Revenue, told the Journal the attorney general is examining “whether or not the fund was in investments more risky than our board had been told about, and whether there’s any liability to State Street.” Officials in Idaho would not give any details, but the Public Employee Retirement System had 5% of its $11.4 billion fund in State Street’s Government/Credit Bond fund.

Prudential, whose Retirement Insurance and Annuity Co. (PRIAC) last Monday filed suit against State Street Global Advisors (SSgA) over losses in SSgA-managed funds for which PRIAC claims the investment strategies were misrepresented, said the Government/Credit Bond fund dropped in value by at least 12% in July and August.

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In the PRIAC suit, the firm said it had placed its clients in two State Street funds, the Intermediate Bond Fund and the Government/Credit Bond Fund, which SSgA had marketed as investments that would provide “stable, predictable returns” in line with an index of U.S. government and corporate bonds. PRIAC claims State Street changed its investment strategy over the summer without notification and devoted a large portion of the funds’ investments to financial instruments that included “asset-based securities that overwhelmingly derived their value” from home-equity loans, mortgage-backed securities swaps, and derivatives. The suit also claims SSgA recently informed Prudential it held a position in “a synthetic index whose returns are linked to 20 subprime U.S. mortgage pools’ (See Prudential Accuses SSgA of “Misrepresented’ Investment Strategies).

The value of assets about 1,100 Alaska state workers had invested through their defined contribution plans in State Street’s Government/Corporate Bond Fund fell to $30 million on August 23 from $36 million on June 30, Alaska revenue officials said. The following day the plan’s board, in an emergency meeting, dropped the fund as an investment option. Officials said by that time the fund was down 18% for the year.

According to the Wall Street Journal report, a “detail sheet” provided by State Street to clients for the Government/Corporate Bond Fund said the investor receives exposure to a “broad-based, investment-grade fixed-income universe.” However, as of March 31, the fund had nearly half of its weighting in mortgage-backed securities (25%) and other asset-backed securities (23%). Six months earlier, the same fund’s biggest weighting was in U.S. Treasuries, while mortgage and asset-backed securities accounted for less than 6% of its top 10 holdings, the news report said.

Sean Flannery, the chief investment officer for SSgA, wrote to institutional clients on August 14 that “in the midst of the recent turmoil in the fixed-income markets, many of our active bond strategies” had “sharply underperformed,” according to the Wall Street Journal news report. Flannery said the company had “focused increasingly on housing-related assets” to find attractive yields and said “the level of underperformance” was “unprecedented in our 30-year history as a fixed income manager.”

According to the Wall Street Journal, State Street told institutional investors in a report that as of July 31, the Government/Credit bond fund was leveraged to nearly 6-to-1, meaning that the fund borrowed to increase its portfolio to about six times the amount of money clients had invested. A footnote said the investments included Treasury futures, options on futures, interest rate swaps, and interest rate “swaptions.”

Enhancing the Client Experience

People don’t stay with a financial services firm because of the brand; they stay because they have forged a relationship with an adviser they trust.

“People do business with people,” said Robert McCann, Vice Chairman and President, Global Private Client Group at Merrill Lynch & Co., Inc., and, despite the massive change going on in the financial services industry, that trait will not change, he predicted, speaking at the Securities Industry and Financial Markets Association (SIFMA) Sales and Marketing Conference, in New York, New York last week.

Therefore, if an adviser merely sells a product, McCann said, he can lose the client as soon as someone else comes along with a better product or who is a better salesman. However, if you as the adviser become an essential partner in your client’s life, if you “have a seat at your client’s kitchen table,” then, you begin a relationship that can last a lifetime.

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Improving the Adviser Environment

 

At Stifel, Nicolaus & Co., Inc., said Ronald Kruszewski, CEO and President of the firm, the center of the business model is the financial advisers; in other words, “the broker is the client.”

Therefore, when looking to enhance the experience, Kruszewski said, also speaking at the conference, Stifel, Nicolaus & Co., Inc., looks to improve the financial advisers’ environment, which will then lead to enhanced and improved service to clients. The business is the same as it was 10 years ago, Kruszewski said, it is “stocks, bonds, and mutual funds.” However, the client experience has to evolve and management of the financial services firms needs to get behind that.

McCann agreed: financial advisers need to think about the evolving needs of their clients and management needs to give them the best tools they need to succeed, he explained. For example. McCann said that Merrill Lynch is investing in technology and working on innovations to enhance the client experience. One area in particular getting attention is that of opening an account. McCann said that it currently takes about 35 minutes to open an account, and it can take longer with a new client for which the adviser doesn’t have any information and has to input it all instead of having some fields automatically populated, as for an existing client. Therefore, Merrill Lynch is working on speeding up the process, so advisers spend less time with their heads down transferring data and more time looking at client, McCann said; all to enhance the client experience.

“If the end client doesn’t win, there is no reason for the rest of us to exist,” McCann said.

Client Change

 

Globalization has hit the financial services industry hard, McCann commented, and this has changed who the clients are and who the clients are likely to be. It also affects how clients interact with their advisers.

Wealth is being generated in new areas, McCann said, “in places we never anticipated.” The industry is also seeing wealth creation that appears to have no boundaries. Citing products such as Myspace, YouTube, and Facebook (all founded by people in their twenties) as extreme examples, McCann said the wealthy are getting younger and are more global.

The fast pace of change and new demographic offer a set of opportunities, McCann said, and it is important to “make sure that we stay ahead of the curve [because] we can become dated very quickly.”

 

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