Billionaire Ken Fisher made his name and fortune picking stocks. But over the years he's also become a huge player in an arcane — and controversial — corner of Wall Street: exchange-traded notes.
With little fanfare, his Fisher Investments has come to dominate more than a quarter of the $22 billion market in ETNs, whose outsize risks and hefty costs have drawn scrutiny from federal regulators. ETNs are debt instruments issued by banks that can enable investors to make leveraged bets on investments including stocks, bonds and commodities.
Fisher Investments has worked with banks such as Barclays and Credit Suisse Group to issue about 20 notes and now has $6.2 billion invested. It's the largest stakeholder in five of the six biggest ETNs.
These days, Fisher is under scrutiny for other reasons. The firm's clients have pulled $3.9 billion since founder Ken Fisher was called out for making lewd remarks — such as comparing wooing clients to "trying to get into a girl's pants" — at an Oct. 8 investment conference.
Now, some analysts fear the ETN market could suffer amid the exodus from Fisher and ask whether the manager should have been putting clients in the notes in the first place. Along with their cost, the products have the potential to lose 100% of their principal. About 5% of Fisher's $115 billion under management is in ETNs. Yet, even with the leverage from those notes, Fisher's investment results have been mixed.
"These things are meant to be sold but never bought," said Larry Swedroe, chief research officer at Buckingham Strategic Wealth in St Louis, Mo., speaking about the overall ETN market. "You're not getting compensated for the credit risk of the issuer, and you can be sure they are not taking the risk embedded in these ETNs."
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John Dillard, a senior vice president at Fisher, said the client defections won't affect the firm's ETNs because the company has kept growing over the past month through hundreds of new clients representing billions of dollars in assets under management. The ETN fees, which reflect market rates, flow to the banks that issue the notes, not Fisher, he said.
"We have been pleased with the performance and structure of the ETNs we designed in concert with our well-capitalized counterparties," Mr. Dillard said in a statement. "For the time we've utilized them, they have broadly added value to client portfolios."
Fisher Investments first dipped a toe into the little understood part of the exchange-traded fund industry in 2012, when its private client portfolio had been trailing its benchmark.
To catch up, Mr. Fisher went all-in on a selection of large-capitalization companies he viewed as set to benefit from the later stage of a bull market. He used exchange-traded notes as a way to leverage this bet. It was a "Hail Mary" to rescue the firm's track record, according to one former employee who asked not to be identified discussing internal company matters.
"We're biased in favor of big-cap growth right now, and this allows us to inject an extra quantity of big-cap growth into the portfolio," Mr. Fisher said in an interview at the time.
It's Fisher time
Even with the shift to ETNs, the Fisher Global Total Return strategy for private clients has underperformed its benchmark annually more than half the time from 2013 to 2018.
For ETNs overall, it has been a painful few years. Once heralded as a great way for ordinary folk to invest, ETNs have shrunk to less than 1% of the $4 trillion ETF industry amid a slew of negative headlines.
In 2018, amateur investors were eviscerated when an ETN issued by Credit Suisse shuttered following the jump in the CBOE Volatility Index, sometimes called the Wall Street "fear gauge."
The year before, the Financial Industry Regulatory Authority Inc. censured Wells Fargo & Co. for "unsuitable recommendations" of certain ETNs to retail customers. The company accepted the penalty without admitting or denying the agency's findings.
The Securities and Exchange Commission is considering how to better differentiate plain vanilla ETFs from leveraged products, which comprise half of ETNs. Customers can confuse them with low-cost and popular ETFs, which are essentially baskets of securities that trade like stocks. Even the banks that issue these notes are getting cold feet as new regulations on capital place a premium on their balance sheets.
ETNs emerged about 13 years ago to give investors access to markets such as currencies or commodities, or as a more tax-efficient way to invest in certain types of companies. For a money manager like Fisher, there's a different appeal: leverage.
While much of Fisher's recent cash exodus has come from large pension funds, wealthy individuals and families make up the lion's share of its assets, with more than $69 billion invested across more than 65,000 separate accounts. That means Fisher would find it hard to enhance its returns using borrowed money, as a hedge fund might. But the firm can use ETNs, since they can be bought and sold for multiple clients as easily as a stock.
Fisher currently uses these notes to get what many of the offering documents describe as "enhanced" exposure to large-cap growth stocks in the U.S., global high-yield bonds and Europe's 50 largest companies, data compiled by Bloomberg show.
Investment counselors at Fisher were taught to downplay the risks involved with ETNs by calling them "enhanced" instead of "leveraged" when discussing them with clients, according to former employees who asked not to be identified for fear of retaliation. The firm justified this approach by saying that ETNs weren't leveraged in the common use of the word since it couldn't lose more than it invested, these people said.
Mr. Dillard, the Fisher spokesman, disputed that counselors downplay the risks of ETNs. The notes are broadly diversified because they are designed to deliver twice the total return of a market index, he said, and are less volatile than most individual stocks.
"Such diversification mitigates daily volatility compared to less diversified equity investments," Mr. Dillard said. "In our view, holding the ETNs doesn't materially change the portfolios' risk profile."
At least five banks have issued notes branded with Fisher Investments' 'FI' moniker, data compiled by Bloomberg show.
For customers, the ETNs don't come cheap. The banks charge management fees to structure, issue and run these products, plus a chunky spread to cover their funding costs. Some of Fisher's ETNs ended up charging at least 4%, according to two bankers that worked with the firm on these offerings. The average ETF costs 0.48%, data compiled by Bloomberg show.
Any ETN downsizing by Fisher could ripple through the industry. Fisher accounts for about 70% of assets in Goldman Sachs' small ETN business and half of assets in UBS Group's notes. UBS and Goldman declined to comment.
"It's possible they would close or de-list," James Seyffart, a Bloomberg Intelligence analyst who has researched Fisher's investments, said of the firm's ETNs.
While other notes would continue to trade normally, "if he pulled all of that money, it would certainly be a big hit to the industry," Mr. Seyffart said.