We need to talk. 

Famed investor Rob Arnott’s latest muse is turning underperforming stocks, that were literally dumped by other indexes, into profitable investments. The founder of Research Affiliates and early pioneer in smart beta investing is launching a new index called NIXT that swoons over small-cap value companies that were kicked to the curb by other managers. While “no one enjoys getting dumped,” Arnott and fellow author Forrest Henslee found investors were generally 74 times wealthier in a specific portfolio of deleted stocks dating back to 1991, according to a new research paper.

It’s the latest value strategy that may help money managers fall in love with out-of-favor stocks in an occasionally overvalued and unattractive equity market that is largely driven by a handful of names.

It’s Not You, It’s Me

Sometimes, one man’s trash is another man’s value index. The research found that nixed equities have actually beaten the Russell 2000 Value Index in “spectacular fashion,” and could add “abnormal upside,” especially if the current “growth-dominated bubble” begins to deflate. One of the causes is that when stocks enter or exit an index during a rebalance, they are often left with wide valuation gaps relative to their fundamentals. That’s where Arnott’s team swoops in:

• Added stocks, that generally are more sought-after and have higher valuations, tended to underperform their index over the subsequent year on average. 
• Case in point: Newcomers to the S&P 500 lagged the market one year after joining by as much as 2% from 1990 through 2022. 
• However, removed stocks — which can be underperforming and undervalued — actually beat benchmarks by more than 5% annually over the following five years, according to the research.

“Once dropped by the index, there is a silver lining for these stocks, they, on average, outperform the market over the next several years, creating a compelling opportunity for investors,” Arnott said in a release. 

There’s Someone Else. While there are caveats in the research, the general principle of buying or selling stocks that are entering or exiting indexes (especially really big ones) is not novel. Hedge funds have long cashed in on stocks that are about to enter a widely-held index and shorted those about to leave, according to reporting from The Wall Street Journal.

The NIXT is not the only outperforming index on the block, either. The tech-heavy Nasdaq-100 took in about three times as much as the S&P 500 between 1991 and 2023, according to the report. Maybe we should just be friends.

Is that a personal call? It better be.

Off-channel communications — business-related messages exchanged through platforms that aren’t approved by a firm — are among the most scrutinized issues in wealth management today, and the Securities and Exchange Commission is taking no prisoners.

Last week, the agency charged 26 broker-dealers and registered investment advisors for “widespread and long-standing failures” to maintain electronic communications, resulting in a combined $392.75 million in penalties for the firms. Ameriprise Financial, Edward Jones, LPL Financial, and Raymond James were hit the hardest, with each agreeing to pay $50 million in fines.

Just Too Easy

So if off-channel comms can land your firm in such hot water with the government, why do it? While there are instances of off-channel comms being used for nefarious purposes like insider trading or market manipulation, Michael Gilbert of the law firm Sheppard Mullin said much of it was a result of the pandemic. 

“People were no longer in the office, they weren’t talking to co-workers face-to-face, and people are so used to using their phone and personal device to text about all sorts of things, so I think it just became natural,” he told The Daily Upside. 

Lawyers at K&L Gates echoed his sentiment, adding that many firms are incorporating “new processes or technological solutions to help ensure that those communications are being maintained.”

What’s Up With WhatsApp? The agency argues it can’t do its job properly when advisors have secret messages between colleagues and clients. Designated work phones and emails at firms are monitored and protected, but when conversation shifts to unapproved platforms, sensitive information may get through regulatory cracks or even be affected by a hack, according to the agency. 

With that in mind, everybody is now fair game in the SEC’s crackdown: 

• Wall Street’s biggest players, including Citi, Goldman Sachs, and Bank of America, were collectively fined more than $1 billion in 2022 for using WhatsApp and personal emails to correspond with co-workers and investors.
• Smaller operations are in the agency’s sights, too, like New York-based Senvest Management. In April, it became the first instance of the SEC taking an RIA to task for off-channel comms.

There’s a changing of the guard happening in Citigroup’s wealth management division.

Overhauling the $515 billion wealth arm at America’s fourth-largest bank was a top priority for CEO Jane Fraser when she took the position in 2021 — and no easy feat. Let’s say it’s still a work in progress, as the arm has gone through quite a bit of turnover as of late. 

Where’d Everybody Go?

In addition to last week’s news — Shobhit Maini, Citi’s head of digital assets for its markets unit, left after being with the bank for 14 years — at least 33 senior executives have exited the wealth unit under the leadership of new head Andy Sieg, according to Business Insider. Seventeen of the executives had been with the bank for at least 15 years and included folks like Naz Vahid, who led one of Citi’s more successful operations that caters to law firm partners, and David Bailin, who was the wealth division’s chief investment officer. Don Plaus, formerly of Bank of America, was hired as head of North America for Citi’s private bank, but he left after just four months for personal reasons, Reuters reported.

However, one of Sieg’s goals is new leadership, so there is also a huge opportunity. Merrill Lynch veteran Keith Glenfield was hired as head of investment solutions, and Dawn Nordberg, formerly of Morgan Stanley, is now head of a new client engagement group.

Citigroup declined to comment on the record.

Cleaning House. In 2023, Citi tapped Merrill Lynch’s Sieg to reinvigorate its wealth division — which, by the end of that year, had generated $1.7 billion in revenue, down 3% year-over-year. In a review of an internal audit, Barron’s noted some not-so-reassuring aspects of Citi’s wealth unit:

• The wealth arm manages just 13% of its clients’ $6.2 trillion collective net worth, when the industry average is 64%. 
• The audit also said that “opening an account at Citi is a cumbersome process that spans multiple days,” and that the bank’s business receives 20,000 monthly complaints.

In addition to all the layoffs and resignations, Citi’s wealth unit recently announced plans to sell its trust administration and fiduciary services business. That move comes in the wake of Citi selling its international retail banking businesses and closing its municipal securities business. It feels like Citibank has jumped on the Marie Kondo bandwagon.