☀️☕️ EY EY Oh!

📊 Also: More ETFs that aren't low-cost or passive; IMF warns of a global hard landing 🎓 The Big 4 Accounting Giants (Deloitte, PwC, EY & KPMG)

Apr 06, 2023

Happy 🐪 Wednesday!

📝 Focus

EY & EY Consulting... together forever

📊 In the Markets

More ETFs that aren't low-cost or passive
IMF warns of a global hard landing

📖 MoneyFitt Explains

🎓 The Big 4 Accounting Giants (Deloitte, PwC, EY & KPMG)

📝 Focus

EY & EY Consulting... together forever

Looks like the spinoff of EY's consulting business is off the table and it will remain together forever with the core audit business. It must be that the groups of partners couldn't bear the thought of going on without the other. Alternatively, talks could have dissolved amid acrimony and disagreement over money and control.

Together forever and ever?
- Image credit: Up / Pixar, Disney via Tenor

..... ► Big 4 accounting giant 🎓 EY, formerly Ernst & Young, has called off an ambitious plan to split up its audit and consulting units. The massive overhaul was meant to address regulatory concerns and post-Enron rules on potential conflicts of interest that prevented consultants from dealing with audit clients. The consulting and the non-audit tax advisory businesses would have been floated on the stock market (under the current overall CEO.) It was announced last September but quickly became mired in months of internal disagreement and strong opposition from the US affiliate, which was ultimately the deal breaker.

..... ► When it was first proposed internally in 2021, consulting businesses were booming on pandemic-related corporate IT projects. The share price of Accenture (ACN, the consulting firm spun out from then-Big 5 auditor Arthur Anderson a year BEFORE the 2002 Enron scandal blew it up in disgrace) rose 60% in that year. (Its shares have since dropped 30% from those highs, but are still up nearly 2,000% in the 22 years since its IPO.)

..... ► The US firm killed the deal as it doubted the standalone strength of the remaining audit business and disagreed with splitting up the tax business. However, the firm is still committed to “creating two world-class organisations that further advance audit quality, independence and client choice”, but how, exactly? Private equity firms are reported to be sniffing.

"It is not an audit EY Germany is proud of" - Andy Baldwin, EY Global Managing Partner

Client Service, on being barred for a record 2 years from audit work in Germany for its role in the Wirecard scandal

..... ► As an aside, EY has been involved in several accounting scandals besides Wirecard in 2020, where for almost a decade, EY issued unqualified audit opinions for Wirecard, failing to see that half the revenues and millions of corporate cash were fake. Among the most notable ones are: Bank of Credit and Commerce International (1991), HealthSouth (2003), Lehman Brothers (2010), Olympus (2011), BHS (2016), Stagecoach (2017), Carillion (2018), London Capital & Finance (2019), Luckin Coffee (2020) and NMC Health (2020). (To be fair, EY's definitely not the only one to be embroiled in such scandals!)

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📊 In the Markets

Few catalysts to move markets on Tuesday, leaving major indexes to close largely unchanged, with US stocks sliding late in the day. Traders instead focused on Friday's unofficial kick-off of the first-quarter reporting season and inflation data with the consumer prices on Wednesday and producer prices on Thursday. For CPI, Wall Street's Finest is seeing a significant drop in the headline figure to 5.2% on year-ago prices from 6.0% in February, though the core (non-food and energy) could actually be up, heading to 5.6% from 5.5%.

..... ► Commentary from Fed officials was mixed, with the Chicago Fed's Austan Goolsbee warning that the Fed needs to be careful about raising rates too aggressively, while the NY Fed's John Williams said another 0.25% rate rise was a “reasonable starting point” (the CME FedWatch Tool shows futures prices implying a 2/3rds chance of such a hike.) Obviously, the upcoming, backwards-looking inflation figures will be important, but so will "credit conditions" in general, particularly with banks losing deposits (especially smaller ones) and pulling in their horns on lending.

“Foremost thing on my mind before our next meeting in May is trying to get a handle on this question about credit: is it actually credit tightening?”

Austan Goolsbee, Chicago Fed President

Elsewhere, HSBC is taking on 40 Silicon Valley Bank investment bankers in the US to kick-start its tech and healthcare business barely a month after rescuing SVB(UK) with a £1 takeover. Bitcoin broke above $30,000 for the first time in 10 months on Tuesday as fears over turmoil in the global banking sector, the reason it was created in the first place, continued to draw in traders. (See Focus article in this March MFM.) And Michael Jordan's signed sneakers, worn in the 1998 NBA Finals Game 2 (which led to the Bulls' 6th championship), were sold at Sotheby's for a record $2.2mn. Yes, $1.1mn per shoe.

More ETFs that aren't low-cost or passive

Gigantic and secretive Los Angeles-based asset management partnership Capital Group ("home of American Funds®" and with more than $2.6 trillion in assets under management) filed for three new Exchange Traded Funds (ETFs) on Tuesday. It entered the ETF space only last year with nine funds which are now managing $8bn. All three of the new funds will be ACTIVELY managed, which may be confusing for a lot of unsuspecting investors. "ETF" does NOT automatically mean "passive", "index" or "low-cost."

..... ► 1) NOT all ETFs are passive (index hugging) -- the ET in ETF just means they are traded on an exchange,

..... ► 2) active, stock-picking managers can out- or (more often) underperform indexes significantly over the long term, partially driven by...

..... ► 3) active fund expenses, which include the management fees needed to pay for fund managers and analysts, their travel costs and extensive support teams, which can be much larger than in passive funds.

Some ETFs charge a lot more than you think. Read the small print!
- Image credit: Tenor

The average expense ratio for Capital Group ETFs is 0.37%, which is lower than the industry average of 0.44% but over 3 TIMES the average Vanguard mutual fund expense ratio of 0.10% (some of which are traded as ETFs.) Over 20 years, that's automatically 5% of underperformance baked into the Capital ETFs before factoring in the risk of lousy stock picking by teams of extremely highly-paid fund management "experts."

IMF warns of a global hard landing

The IMF (see below) in its semi-annual World Economic Outlook has warned of a “hard landing” for the global economy if persistent inflation keeps interest rates higher for longer, amplifying financial risks. It only slightly trimmed overall economic forecasts but stressed risks despite signs of resilience alongside lower global energy and food prices. "The fog around the world economic outlook has thickened.”

“Below the surface . . . turbulence is building, and the situation is quite fragile.”

Pierre-Olivier Gourinchas, IMF chief economist

..... ► The risk of a hard landing is higher for advanced economies in the wake of bank failures in the US and Europe as the banking system turbulence could spread to the broader economy, damaging business and consumer confidence. “A hard landing— particularly for advanced economies—has become a much larger risk.”

..... ► Global headline inflation is estimated to drop to 7% in 2023 from 8.7% in 2022 given the higher comparison base as well as from lower oil prices and economies slowed down by a year or sharply rising interest rates. Obviously, 7% remains far above the 2% target that most major central banks are targeting. higher interest rates slow inflation. Core inflation, because it strips out volatile food and energy prices, is only expected to decline more gradually, dropping from 6.4% to 6.2%.

..... ► The IMF has little to no extra sources of data unavailable to private sector forecasters, so while important, IMF (and World Bank) forecasts are not necessarily any more accurate or impactful than those from any other serious organisation.

The International Monetary Fund (IMF) - a mini-explainer

The IMF, an agency of the United Nations, was set up after WWII to rebuild the international monetary system but it now targets sustainable growth and prosperity for ALL its 190 member countries by promoting financial stability. (Its sister agency, the World Bank, focuses on middle- and low-income countries and has a goal of long-term economic development while reducing poverty.)
One of the IMF's most important functions is to watch out for balance of payments (foreign exchange) difficulties and then, as the world's "lender of last resort", to make loans to distressed countries to prevent or ease financial crises.
But first, it makes the loan conditional on the country deregulating and implementing austerity measures, i.e. higher taxes and lower government spending (often leading to mass unemployment)... which to critics can appear to be an "out of touch" cookie-cutter approach

📖 MoneyFitt Explains

🎓️ The Big 4 Accounting Giants (Deloitte, PwC, EY & KPMG)

The Big 4 firms are networks of individual firms that operate under a common brand name and share resources, clients and best practices. Each member firm of a Big 4 network is a separate legal entity with its own management and ownership structure, which may vary depending on the country or region in which it operates.
Each network has a global entity that coordinates the activities of the network and receives fees from member firms for the brand name and access to network resources. The global entity is either a UK private company (Deloitte, PwC, EY) or a UK limited company (KPMG) and acts as a central governing body for member firms, which are owned and managed by partners who are responsible for the delivery of services and for the profits of their firms.
The Big 4 firms are primarily known for their audit services but also have consulting arms that provide a range of advisory services to clients in areas such as strategy, risk management, and technology.
Some have been spun off into separate entities to avoid conflicts of interest with their audit work. PwC created a separate consulting practice under the brand name "Strategy&". Deloitte Consulting is a separate business while maintaining close ties. PwC and KPMG have separate governance and policy structures. EY's spinoff of its consulting group (including the already independent corporate strategy and M&A firm EY-Parthenon) was called off in April 2023 after the US affiliate decided not to take part.