Blog on Wealth

Changing Names

noreply@blogger.com (Jeff Spears) — Wed, 06 Jun 2012 12:26:00 +0000

We are changing our name from BlogOnWealth to:

Why?

Did you get married? No - I'm already happily married.

Are you moving to Hollywood? No, but I have always wanted to know what Sting's real name was - Gordon Matthew Thomas Sumner. Now I get it!

Are you going pro? A name change worked for Ali, not so much for Ron Artest. Why did he change his name to Metta World Peace? I will let him explain. Still don't get it.

We are changing our name because we screwed up and let our GoDaddy domain registration expire!

If you want to continue to read our blog you have three options.

1.) Read the blog on The Wealth Consigliere Website

2.) Subscribe by email. You will receive an email invitation later today or you can subscribe on The Wealth Consigliere Website

3.) Subscribe by RSS.

Hope you stay with us.

Thank You

JP Morgan and The Whale

noreply@blogger.com (Jeff Spears) — Tue, 22 May 2012 18:11:00 +0000

The ongoing saga about J.P. Morgan’s multi-billion trading loss involving the “London whale” reminds us of a timeless story – the parable of Jonah and another whale in about 750 B.C.

As the legend goes, Jonah found it difficult to convince people to live the virtuous life, despite being held up as an example. To pay for his failure, he was tossed out of his boat one day and was swallowed by a whale. After spending three days in the belly of the beast, he repented and promised to try again. The whale then spit him out.

J.P. Morgan’s trading blunder involved a different kind of whale – the so-called London whale. Since then, the London whale’s mammoth trading loss has engulfed an institution previously thought to be exemplary in risk management. The fallout has reignited the debate about proprietary trading, the Volcker Rule and too-big-to-fail.

The modern and ancient storylines are similar, but it’s an open question how J.P. Morgan will re-emerge from the whale.

Were they lucky or good?

Post-crisis, J.P. Morgan found it difficult to live by the Dimon Principle, which is supposed to guard against stupidity born of hubris.

The Dimon Principle and advanced risk management techniques, such as value at risk (VaR), were a key reason J.P. Morgan was one of the most successful in protecting assets during the financial crisis. Unlike the reputation of other bankers, Jamie Dimon’s grew in stature after the crisis because the bank appeared to manage risk so well.

VaR was a core of the bank’s risk management strategy. This technique was supposed to help the bank quantify risk. In the end, it didn’t work. The VaR reported to Mr. Dimon showed the trade made by the London whale had a VaR of less than $100 million, not the reported loss of $2 billion that could possibly grow to over $5 billion.

This is not the first time risk management models have failed Wall Street. The subprime mortgage debacle that triggered the financial crisis is a recent example of a sophisticated model that faltered badly. Mortgage lenders, aided by investment banks and ratings agencies, believed they had cracked the code and were able to properly measure the risk in lending to people previously considered too dodgy for a home loan. We know what happed next.

Is Redemption Next?

To redeem itself, J.P. Morgan has admirably tried to make amends.

Mr. Dimon has owned up to the problem and has admitted that avoidable mistakes were made. He held a conference call to discuss the loss, went on Sunday talk shows, and will testify before Congress. Those responsible for the loss have resigned or been fired.

The real question is whether J.P. Morgan will renounce proprietary trading – the root cause of the problem.

It’s quite possible it won’t.

There is too much money to be made in proprietary trading. J.P. Morgan, like the rest of Wall Street, relies on “prop trading” to produce huge profits. In fact, big financial institutions still have as strong an incentive as ever to take the unrepentant risk to make up for falling earnings.

Given the pressure to deliver results, it will be interesting to see how J.P. Morgan responds. Until it figures out what to do, the bank will remain trapped inside the whale.

Selling Reality

noreply@blogger.com (Jeff Spears) — Thu, 26 Apr 2012 16:42:00 +0000

Would you hire a lawyer or doctor who advertised on TV or a billboard?

Chances are you probably wouldn’t. Conventional wisdom suggests that if they were that good, they wouldn’t need to promote themselves so blatantly. Not to mention it comes across as slick and unprofessional.

So why does Wall Street continue to do just the opposite and advertise everywhere? Because they’re selling a dream that many investors, after the financial crisis, are having trouble believing.

Despite the profit squeeze on Wall Street, firms continue to spend liberally to sell dreams – the dream of Wall Street’s superiority in financial advice and their clubby access to the best investment opportunities.

Back To The Future

What’s a financial advisor to do if his or her firm is a purveyor of grandiose dreams?

Many Wall Street advisors are adjusting their practice to protect their clients from their firm – surreal as that may seem. In addition, advisors should also follow the tried-and-true model of exceptional doctors and lawyers: Spend time developing a practice with a reputation for personal excellence. The business will follow.

Doctors know there’s no substitute for a good bedside manner and the competent application of medicine. Likewise, every world-class attorney builds a business based on expert knowledge of the law and equally expert skill in networking for clients.

Many financial advisors would do well to follow that model. One reason the independent wealth management business is growing so rapidly – largely without advertising – is that advisors provide independent advice and don’t need to peddle “dreamy” products. Clients are genuinely happy with them, and word-of-mouth referrals are resulting in a steady source of new business, just like they do for doctors and lawyers.

The good news is that it’s never been easier or more cost effective for advisors to let people know about their unique expertise. Social media provides a terrific communication platform that can reach a large audience without a Super Bowl-like ad budget.

Better still, social media gives your clients the opportunity to express their appreciation of your work so others can see. Nothing is more powerful than client testimonials that go viral online.

Getting Back to the Basics

The financial crisis and the heavy hand of Dodd-Frank are prompting many Wall Street firms to revert to their original business model of being a corporate advisor, not a product manufacturer. It’s also putting the focus back on clients and what’s good for them.

That’s where we all need to return. Wealth advisors need to get back to the business of having a real relationship with their clients based on a foundation of realistic advice.

All would do better if the focus were on selling reality, not a mirage with a snappy jingle.

Like My "Business"

noreply@blogger.com (Jeff Spears) — Tue, 27 Mar 2012 21:33:00 +0000

As a financial advisor, is it worth having a Facebook page?

After much deliberation, I’m convinced the answer is yes. But not for the reasons you may think.

If you believe you’re going to get a bunch of new clients from Facebook, then it probably isn’t worth your investment of time. High net worth investors aren’t going to fall in love with you because of your Facebook page. Wealth management is a relationship business that still requires direct, human interaction.

But if you want to remain relevant or not be disqualified with two key audiences – GenYers and Baby Boomers – Facebook should be part of your brand and marketing strategy.

My Tahoe Focus Group

An example best expresses why Facebook is so powerful and useful.

Last weekend, I was on a ski trip with my 14-year-old daughter and three of her friends. Facebook was the sixth person in the room at all times.

When a Facebook friend request came to any one of the girls’ iPhones, they would shriek with delight. When a Facebook message came from one of their friends, the same. After sharing the message with each other, the girls would talk among themselves to come up with the “best” response. They were having great fun.

After listening to this for two days, I asked: “Have you ever gotten a date from Facebook?” They all responded in unison: “NOOOOOO!” “Then why do you care?” I asked. They all responded in unison again. “We want to know what everyone is doing and thinking. "

This is the perfect analogy for financial advisors considering a Facebook presence.

Just like Facebook isn’t going to get you dates, it probably won’t bring you new clients immediately. Getting new clients is still an old school process. You will need to personally contact people and engage them over an extended period of time to earn their trust.

However, your clients and prospects will appreciate seeing what you’re thinking or writing, or what events you’re planning via Facebook posts. That’s worth a lot in terms of visibility and connecting with people. Marketing today is as much about what you believe as it is what you do.

Moreover, the right idea or event can go viral on Facebook, which is exactly what you want.

Another example is illustrative.

Bad Viral/Good Viral

One of a parent’s worst nightmares is the raging party that takes place at your unsupervised home after your kid posts an invite on Facebook. Within minutes, 25 to 1000 revelers could show up at your doorstep while you’re away for a “quiet” weekend. Hot ideas populate quickly across Facebook.

Now apply that concept to your wealth management practice. If you have a compelling blog post, white paper, educational event or video, that information can spread virally to your entire network of friends and then their friends.

845 Million People Can’t Be Entirely Wrong

Still not convinced?

What’s the fastest growing demographic on Facebook? Answer: Baby Boomers. They’re getting onto Facebook to check out what their kids and grandkids are doing. This graying age cohort, along with GenYers, account for a good chunk of today’s wealth management marketplace.

Advantage Independents

The Facebook advantage accrues only to independent advisors. Wirehouses and big banks largely prohibit a financial advisor having a social media presence. For independents, Facebook is yet another way to differentiate your practice.

So upon further consideration, I “like” Facebook. We hope you will too and ask you to check out Sanctuary’s Facebook page and “like” us.

That will make us very happyJ.

The Best Buy Effect

noreply@blogger.com (Jeff Spears) — Sat, 18 Feb 2012 22:18:00 +0000

It’s not easy being Best Buy these days.

Price competition is intense, and pressure is coming from all directions. Online competitors, without costly overhead, are selling the same products cheaper. Tech-savvy consumers are comparison shopping right on the showroom floor, using mobile phones and the RedLaser app to scan for the best price. Instantly, a consumer can get a list of better deals on a flat screen TV or Blu-ray player from online retailers and even nearby stores.

Wealth advisors are facing the same challenges from online “firms” like Wealthfront and from other advisors who are willing to cut their fees to win business.

The Opportunity in Solving Problems

But all is not lost for advisors or retailers if they heed the lesson from one of Best Buy’s more successful innovations: The Geek Squad.

The Geek Squad delivers what most low-priced product sellers don’t: Expertise to make everything work together. Anyone who has ever tried to create a home theater knows the frustration. Integrating sophisticated pieces of consumer electronics has almost become rocket science. Best Buy is keeping clients happy and loyal by providing a service that makes it easy to buy and then enjoy cool products.

Financial advisors have the same opportunity to attract and retain clients if they take the responsibility to simplify the many complex financial products and design a program that works.

In fact, anyone can open a discount brokerage account, do some online research and start buying investment products. However, buying and selling products doesn’t equate to comprehensive wealth management. There’s much more to this discipline than most recognize initially.

Watch Out For Cheap

An advisor who provides real value need not fear the cheap advice that can be obtained online or through cut-rate competitors.

Cheap online advice is nothing more than a computer algorithm. More often than not, human strategy trumps most computer driven decisions (Kasparov Wins). Only an experienced human advisor can provide that strategy and then recommend how to put together the complex investment solutions that meet each client’s needs. When you’re talking about your life savings and financial independence, what would you prefer, a cheap computer automated solution or a unique personalized plan?

Put another way, it might seem like a good idea to buy the bargain-priced flat screen TV and then read the directions to mount and connect the components. You can’t really appreciate the Geek Squad until the whole project has gone terribly awry. It’s one thing to mess up your home theater; it’s another when it’s your financial security.

That’s the good news for advisors. By providing understandable solutions, personalized service and delivering wise counsel – an advisor’s value proposition is as compelling as ever.

Do You Love Me Just For My Money?

noreply@blogger.com (Jeff Spears) — Tue, 24 Jan 2012 21:26:00 +0000

Large Wall Street firms have tossed independent advisors yet another great opportunity.

Recently, management at many of the wirehouses informed their financial advisors that they wouldn’t get paid on accounts with a balance of less than $250,000. These clients are being shipped off to a call center because, in so many words, they can’t be profitably serviced by a “full service” financial advisor.

This decision is a frank admission that the cost structure at big firms is still too high. Large firms in the Dodd-Frank era are feeling the squeeze. The result is predictable: Wall Street again put self-preservation ahead of advisors and clients.

Is that any way to treat people, let alone someone who may become a worthy client one day? The opposite is also true: Aren’t these big firms really saying that if you have enough money, we will love you?

Short-Term Thinking

This bloodless view of the world is not particularly nice, nor is it necessarily good business practice.

The fact is not everyone is born a 1 percenter. Clients with smaller accounts often grow into much larger ones. Here in Northern California, engineers and many entrepreneurs are just one IPO away from fabulous wealth.

The problem with packing smaller accounts off to a Siberian call center is that you never know who becomes the next Mark Zuckerberg. If clients are mistreated before they hit the home run, there’s virtually no chance they’ll ever come back.

Opportunity For Independents

The good news is that a large firm’s cast-offs can be good business for independent advisors. Because independents have far less overhead, they have lower costs and can incubate smaller clients profitably. The key is having the right business model.

There’s another opportunity, too, for independents: The freedom to run a business as advisors see fit.

Most accomplished advisors don’t want corporate bureaucrats dictating how they serve clients or operate their business. A large firm’s management decisions are particularly irritating because they not only deprive advisors of income, but also create the embarrassment of having to tell clients that the firm believes they’re no longer worth the time.

Wealth management can’t be all about the money. Just like in any relationship, if someone happens to have money, that’s fine. But that’s not the reason you love someone.

As an independent advisor, you don’t have to be all about the money. One of the greatest advantages of being independent is the freedom to do the right thing by your business and your conscience. That always feels good.

The Arab Spring Comes to Wall Street

noreply@blogger.com (Jeff Spears) — Wed, 21 Dec 2011 14:21:00 +0000

One of the most heartening developments of 2011 has been the Arab Spring.

A year ago, people fed up with oppression began challenging dictators in Tunisia and Egypt. Inspired by their success, popular uprisings spread across the Middle East, taking down strongmen like Mubarak and Ghaddfi. After decades of suffering, tens of millions of people now have the promise of a better way of life.

Many factors contributed to the downfall of authoritarian regimes, but one cause that will certainly loom large in history is the power of information.

Information flowing across the Internet and via social media enabled repressed people to share new ideas and collaborate in ways that simply weren’t possible in prior decades. They were empowered when they realized that many other people shared their opinions.

Demonstrations were organized over Facebook. Firsthand accounts of government crackdowns traveled the world by Twitter. Mobile phones transmitted shocking video that triggered outraged in people everywhere.

That the hero of the Egyptian revolution was an executive of Google – the nexus for sharing ideas and information around the globe – is the perfect metaphor for the Arab Spring. Google embodies the liberating force of information, which ultimately outgunned soldiers, tanks and secret police.

Wall Street Feels The Breeze Of Liberty

For investors and advisors, a similar sense of liberation is occurring for the same reason: Information is breaking through Wall Street’s facade of omnipotence.

One of the positive outcomes of the financial crisis is that the veil has been pulled back on Wall Street business practices. The post-mortems on the financial meltdown have revealed the naked self-interest of Wall Street’s conflicted business model.

Many investors have come to realize that Wall Street frequently acts first in its own self-interest. After that comes investors.

Advisors have also gotten fed up with Wall Street. The dictatorial style management that intimidates advisors with a “just-buy-this-we-know-best” approach has prompted many advisors to break away so they can do right by their clients.

The Unstoppable Tide of Human Aspiration

As hopeful as the Arab awakening has been, it will no doubt be messy as countries lurch toward democracy and free markets after being under the yoke of tyranny for so long.

The same can be said about Wall Street and its business practices. As information sheds light on Wall Street, more will choose the freedom and choice offered by an independent advisor. But it would be unwise to underestimate Wall Street’s staying power. This will not happen overnight.

The good news is that it’s become impossible to turn back the clock on progress. The free flow of information cannot be thwarted thanks to the Internet and social media. Information will remain the jet fuel for the unstoppable tide of human aspiration.

Happy Holidays from the team at Sanctuary Wealth Services.

Loss of Confidence

noreply@blogger.com (Jeff Spears) — Mon, 28 Nov 2011 13:26:00 +0000

There’s a striking similarity between the current state of affairs in government and our financial system: Both are paralyzed by gridlock and in desperate need of regaining credibility. Voters and investors are losing confidence.

The Congressional supercommittee’s inability to address government spending is only the latest failing by our nation’s leaders. Likewise, the financial system’s refusal to remake itself after the trust-busting financial crisis is equally disheartening.

On Wall Street, it’s exasperating that it’s still business as usual. Big banks and wirehouses continue to create wealth management programs that place asset gathering and the firm’s profitability ahead of the interests of clients.

They’re still missing the boat on the most fundamental tenent of wealth management: If it is good for your client, it will be good for your business. Meanwhile, Wall Street is trying to actively torpedo any reform by dismantling Dodd-Frank and other protections for taxpayers and investors.

It’s no wonder the Occupy Wall Street movement still has oxygen left.

A Better Way

In the spirit of extricating the industry from a crisis of investor confidence, we’re proposing a modest agenda of reform:

Be honest. The wealth management industry has positioned itself as an omnipotent, all-knowing purveyor of financial security. What has been lacking is honesty. Investors need to be told the truth about risk and reward, even if they don’t want to hear it. The good news is that unconflicted advisors who don’t have to peddle opaque products or be held hostage to their large firm’s profitability targets are beginning to have an honest dialogue with clients.

Acknowledge mistakes. Large institutions attribute the financial mess to a once-in-a-lifetime debacle, as opposed to any systemic defect in their business models. The rationalization is that no one could have seen the crisis coming. If you’re an unconflicted, independent advisor, you still may not have seen the flood coming. However, you could have responded faster in heading for higher ground. You wouldn’t have been locked in by Wall Street’s investment products that stifle flexibility.

Establish new standards. Advisors need to re-educate investors about performance. It’s not simply about high returns, but rather about performance versus established risk parameters. Particularly for high net worth clients who have already hit the home run, wealth preservation and definable risk management are often a higher priority. Using risk as your primary performance benchmark might not be as “marketable” as cocktail party worthy high returns, but taking the easy route rarely works.

Independent wealth advisors should play a particularly valuable role in advancing this agenda. They can be a catalyst because they don’t need to buy into the Wall Street mirage that “we are smarter and have all the answers.” They can tell the truth, and investors will reward them with the biggest prize: their business and their trust.

At the end of the day, voters and investors are actually looking for the same thing – an alternative to sclerotic party politics or an anachronistic financial services business model. Whoever steps up and tells the truth – and delivers a credible solution – will win the hearts and minds of both for the long run.

I'm Sorry

noreply@blogger.com (Jeff Spears) — Wed, 19 Oct 2011 19:48:00 +0000

Time For Wall Street To Apologize

Each day, the Wall Street protests grow. Over the weekend, demonstrations spread to dozens of U.S. cities and three continents, with scores of arrests and increasing violence. Sympathizers in Rome went on a rampage that caused more than $1 million in damage.

The revolt against Wall Street is about many things: Disgust with the broader economy, anger at government gridlock and policy failures, revulsion over bank bailouts, resentment about the growing gap between rich and poor, and generalized rage at the machine. There is also legitimate fury for Wall Street’s role in the misery many are experiencing.

Everyone Needs To Fess Up

The Wall Street establishment clearly needs to do something. After all, the “Occupy Wall Street” movement has its name on it.

What should be done? First, Wall Street needs to atone for the sins that got us into this mess. A mea culpa is due because Wall Street’s multi-billion dollar propaganda machine effectively peddled the worst kind of fantasy – that individuals and institutions who invest with them can achieve superior returns using their newly created “AAA” investments.

Unfortunately, the only people who made money were those who took the other side of the trade. Given that investing remains a zero sum game, not even Wall Street could change the laws of finance.

Wall Street firms need to start with an apology to anyone who ever purchased these new investment products and opened an investment or retirement account with dreams of a predictable financial future.

Advisors Share The Blame

Second, an apology is due from advisors. They believed their bosses who prodded them to sell the delusion that Wall Street’s best and brightest had figured out a way to squeeze addition return out of AAA-rated securities.

Brokers and advisors didn’t need much convincing to get them to go along. To address the fee compression caused by new regulations, wealth professionals looked for additional revenue opportunities by selling these opaque but “safe” investment vehicles.

So Do Clients

Third, clients themselves need to make amends. Their own demands for a safe but outsized return fueled the mania. Investors had come to expect outsized returns during the 20+ year bull market and had established a lifestyle to assume the good times would continue forever.

Clients relentlessly requested high returns and threatened their advisors that they would pull their accounts if their demands weren’t met.

The Way Forward

Once the apologies are made, Wall Street needs to tell it straight.

For starters, Wall Street needs to explain that the new normal for equity returns is likely to be 6% to 8%. That’s a sharp departure from the 10% to 12% growth that led some to believe their wealth would double every seven to 10 years.

In the short term, even the 6% to 8% growth is suspect. Those kinds of returns should be viewed as an intermediate term goal, if we’re lucky. As The Economist noted this week in its cover story, Nowhere to Hide, there aren’t many places to invest these days. The perils include the foundering U.S. economy, still-deteriorating housing market, European crisis, and the slowdown in emerging economies.

In addition to systematically lowering expectations, Wall Street also has an obligation to be more transparent. It desperately needs to fix its broken business model and return to a business that charges a disclosed fee for advice and raising capital.

If Wall Street doesn’t make it right, it will only accelerate the independent advisor movement. That may be the sliver lining after all. We believe strongly that leaving Wall Street is the best option for both investors and advisors.

For their part, clients need to find an advisor at a firm whose business model they can trust for the long term. Parking money in cash is only a short-term solution.

More truthfulness and an apology will be a good start in repairing the damage. Coming clean will also show protesters – and the rest of the America – that Wall Street acknowledges that it must do better.

Written by Jeff Spears - ex-Wall Street, ex-advisor, demanding client

Sallie Krawcheck’s Departure: The End Of The Experiment

noreply@blogger.com (Jeff Spears) — Thu, 08 Sep 2011 03:16:00 +0000

This week, history repeated itself. Bank of America ditched its top wealth management executive in favor of a banKer whose assignment is to increase profitability by “encouraging” the 16,000 members of Merrill Lynch’s thundering herd to cross-sell bank products.

On Tuesday, Sallie Krawcheck was fired. I suffered the same fate not that long ago under very similar circumstances. After Bank of America took over Montgomery Securities and asked my management team to integrate our group into The Private Bank, I was fired and replaced by a banKer.

We wrote about this in our blog on September 25, 2008 – the most widely read and commented piece we’ve ever penned. What we said then is happening all over again – to the detriment of brokers and THEIR clients.

Wielding The Axe

Why are brokers and their managers inevitably sacrificed when banKers take over?

For two reasons. First, both Sallie and I weren’t willing to accept the bank’s demands to place a higher priority on cross-selling bank products. Brokers got into the business because they have a passion for helping clients manage their wealth, not selling checking accounts, home equity lines of credit, or toasters.

Second, we both refused to sell out our brokers on comp. We understood that the brokers’ compensation plan needed to be different than their “Bank of America teammates” who are paid salary plus bonus.

That an old-line NationsBank banKer since 1979 will head wealth management definitively signals the end of the grand experiment between Bank of America and Merrill Lynch.

BofA CEO Brian Moynihan has given this no-nonsense banKer explicit marching orders: Deliver “our entire franchise to all OUR (our emphasis) customers," to quote a BofA press release. Translation for brokers: You're a banker now.

For someone who has lived through this before, I’m astonished BofA is still drinking the same Kool-Aid. Namely, that BofA believes the bank – and not the individual broker – owns the customer relationship. The conceit is breathtaking.

What Happens Next?

First, YOUR clients will start to ask when you are leaving. Clients read the news, too. They understand what’s coming, allegedly in the name of additional benefits.

Second, the bank will begin to monitor brokers’ daily interaction with clients. They want to quickly find out who is with them and who is against. The oversight is designed to hopefully control when brokers leave. As one BofA banKer once told me: “We want to make sure brokers leave on our terms, not theirs.”

Third, some brokers will get fired. In fact, that's exactly what happened to us. Some of our top producing brokers got fired because they were looking for a new job. The term used by Bank of America’s legal department to describe their job-hunting was “skullduggery.” In essence, the bank tried to act preemptively to out the brokers who were looking, allowing the bank to gain a timing advantage when trying to retain “their” clients. Of course, everyone knows that clients are loyal to people, not companies.

The Bottom Line

The capitulation to the banKers isn’t surprising. BofA knows that selling bank products is ultimately more profitable than the brokerage business. The profit margin on brokerage is in the low teens. For banking products and services, it’s 30%+. If there is one thing banKers know, it’s math.

Because the banking business model is so much more profitable than the brokerage model, two things will happen: 1) The banKers will remain in control; 2) Brokers (and THEIR clients) will be on the short end of the equation. Read another way, brokers will face lower comp and their clients will be subject to statement stuffers promoting bank products. Each month. Not even the powers that be at BofA can suspend the laws of economics over time.

For clients at big banks, prepare for the onslaught – and forgive your broker if he or she is a little cranky. If you’re a broker, there’s no better time to learn what skullduggery means and to gain the timing advantage by breaking away on your terms.

By Jeff Spears, CEO of Sanctuary Wealth Services

Hedge Fund Investing Part 2 – The Fine Print

noreply@blogger.com (Jeff Spears) — Thu, 18 Aug 2011 17:23:00 +0000

Recent market volatility has caused many investors to consider investing in hedge funds because of their ability to be both short and long the market. BlogOnWealth in Part 2 of our series on hedge fund investing discusses several items you need to be aware of before signing the hedge fund’s contract.

Liquidity and transparency. As many investors learned the hard way in 2008, there are few constraints that prevent a hedge fund manager from investing in very illiquid assets. The larger the fund, the less likely the smaller investor will get full transparency on those illiquid positions. A number of fund of funds have yet to provide investors with full liquidity on redemption requests made in 2008. Investors should be well compensated for investments that have no transparency and uncertain liquidity.

The market’s reaction to these problems has been for many hedge funds to offer a mutual fund version of their hedge fund that provides daily liquidity and price transparency. These hedge fund/mutual funds have attracted more than $6 billion of client assets in the first six months of 2011.

After Tax Returns: There are significant tax considerations that the taxable investor needs to keep in mind. While a five-year 14% annualized return might look pretty good, if those returns are 100% taxable every year, the after-tax returns look much more pedestrian. Indeed, the difference in after-tax returns for a 14% investment that is 100% taxable annually compared to one that has 100% unrealized gains is about one percentage point (at top marginal tax rates) over a five-year period. The power of compounding does not get suspended just because it is a hedge fund!

Liquidity for tax payments. The negative impact of 100% taxable gains is compounded if you have no liquidity. For example, if your hedge fund has a lock-up, you will have to find cash flow from other investments to fund the tax payments. There are obviously circumstances when high taxable returns are desirable: If an investor has other investments that generate substantial tax losses or if there are significant tax losses from prior years that need to be “harvested.”

Alignment of incentives: Look at the other investors and don’t mistake their objectives for yours. While the presence of large endowments, foundations and other tax-exempt entities might make the taxable investor comfortable that the smart money has done the due diligence work, these investors have different objectives and constraints than most taxable investors. If the majority of the investors don’t pay taxes, then the taxable investor’s need for after tax returns will not be a priority for the investment manager.

Hedge funds can be a helpful portfolio addition, but you need to read the fine print of each fund before you invest. Don’t forget 2008!

Fighting Back Against A Common Nemesis: Insecurity

noreply@blogger.com (Jeff Spears) — Wed, 10 Aug 2011 02:54:00 +0000

What accounts for the mediocre performance of so many companies and individuals? If you look beneath the surface, insecurity is often the common culprit.

Seth Grodin called insecurity the work of our lizard brain, the pre-historic lump of gray matter responsible for fear and rage. The lizard brain holds you back when you want to go forward. It reflexively fears the unknown.

Steven Pressfield refers to insecurity as the resistance. The resistance is the voice in our heads whispering caution, to go slow, to compromise. It is also the impulse that makes us drag our feet or keeps us from finishing what we started. Worse, the resistance, seems to get stronger the closer you are to making a necessary change.

Not Pretty

Call it whatever you want, but we are all dogged by fear of change.

For individuals, insecurity appears in the need to be liked by everyone. We all know that never works, and it often backfires. For politicians, insecurity rears its ugly head in the overpowering drive for election or re-election. History is littered with examples of well-meaning pols who sold out their principles to keep their elected office.

For corporations, insecurity breeds incrementalism. An executive may know that to succeed in the long term there may be significant short-term pain to change a business model, kill a product or invest in an unproven solution. But the fear of losing one’s job frequently quashes a leader’s better instincts to take a bold step.

Wealth advisors are not immune to insecurity, either. Like corporate executives, many advisors realize that their firm has serious shortcomings, for both themselves and their clients. But advisors may be just comfortable enough, so they stay put – even if they know a better future is very possible.

The Solution

How do you vanquish insecurity? One of the most effective ways is to mimic Silicon Valley. The whole ecosystem in the Valley is focused on isolating things that can be done better. Then, the doers charge ahead. The bumper sticker version is “No Fear.”

Silicon Valley is all about disruptive ideas and technology. Many ideas are tried and failed, but many others produce spectacular results.

Google is a perfect example of a Silicon Valley company who gets it. Google gives employees something known as Google Time. Employees can devote 20% of their time to developing something new and original of their own making. Gmail and Google + are among the innovations born from Google Time. Google has managed to institutionalize the better angels of our entrepreneurial spirit.

Living and working in San Francisco and Northern California, one gradually sees risk-taking as part of the natural landscape. Striking out on one’s own is what people do, and it’s invigorating. With so many other risk-takers in close proximity, there is security in the number of people who are confronting their own insecurity.

I was recently reminded of that by the principal of an advisor team who recently hired Sanctuary. “You take for granted just how entrepreneurial people are here. It's just not like this everywhere.”

The Unstoppable Tide of Human Aspiration

At the end of the day, the only real cure for insecurity is action. The self-confidence that comes from taking the initiative can overwhelm the reptilian corner of your brain. Conversely, the positive experience of successful change is a great motivator. It also has the corollary benefit of tapping that other instinct in us: the human drive for greatness.

For advisors who are thinking about breaking away, client uncertainty shouldn’t be the reason to hold back. In our experience, a large majority of clients who work with independent advisors are themselves entrepreneurs and serial risk takers. They appreciate advisors who have the gravitas to make a move that is all long-term gain.

Tame the lizard. Go out and make it happen today.

Hedge Fund Investing:: High Reward - and Higher Risk

noreply@blogger.com (Jeff Spears) — Tue, 26 Jul 2011 22:55:00 +0000

Before we get to the important topic at hand, let me introduce myself. My name is Keith Ogden, and I’m a co-founder of Sanctuary Wealth Services and a “reformed” veteran of the hedge fund industry.

So you wanna buy a hedge fund, eh?

Hedge Funds are hot!. After a couple of years of outflows, hedge funds are back in vogue. But before the taxable investor jumps into a fund or a fund of funds, there are a few things to consider. Among the most important: While hedge funds can deliver outsized rewards, they can be significantly more risky than many other types of investments.

Understand your market risks. While all investors realize that they have to take some risk to earn positive real returns, it is important to consider the source of the returns. When you look at investing in a single hedge fund manager or a fund of funds, are the returns consistent with the returns available in the areas in which they invest? Madoff supposedly achieved double-digit returns in an investment strategy in which mid-single digits were the norm. While there are some superstar managers, massive outperformance over short periods of time usually signals either significant style drift or highly leveraged bets. Your hedge funds should have investment processes that are understandable to you and repeatable by them. You want to make sure you are getting adequately rewarded for the actual market risks your manager is taking.

Beware the asset gatherers. Many hedge funds with long track records tout market-beating returns from inception. But don’t forget the power of compounding. That manager who has an 18% annualized return over the last five years might be riding the benefits of a huge first year or two, when assets were probably much smaller. (Do the math: 55% in year one, followed by four 5% years is more than 18% annualized.) There is a significant body of research that suggests the returns earned by funds between $500 million and $1 billion are significantly better than those earned by funds over $1 billion. Some managers will continue to raise as much money as possible, even though the additional assets might make it all but impossible to earn significant risk-adjusted returns in their market segment.

Understand The Fees. A typical hedge fund works on the “2 plus 20” fee formula. They get 2% of the net asset value of the fund in addition to 20% of the profits. The manager typically makes more on management fees than on performance fees if the underlying returns are less than 12%. In fact, a 2% fee is more than the fee assessed by the average stock mutual fund. Then there is the 20% profit share. Investors really need to think whether their hedge fund manager has the ability to outperform the historical performance of the S&P 500.

Don’t get us wrong. Hedge funds can be a terrific investment for the right investor. But they need to be carefully considered. In my next blog I will discuss liquidity and transparency, after tax returns and the “alignment of incentives.”

Stay tuned.

Read Part 2

Win-Win

noreply@blogger.com (Jeff Spears) — Fri, 01 Jul 2011 16:26:00 +0000

The burning question for many advisors each day is: “How do I monetize my business?”

The conventional answer is: “I’ll sell my business some day at a lofty premium to an unwitting bank, wirehouse or roll-up firm and ride it out until retirement.”

Many independent advisors will be relying on the greater fool theory to strike a rich deal. Independents know that larger institutions and roll-ups routinely overpay for an advisor’s book of business. The word on the street is that buyers frequently overestimate how much advisors can cross-sell and grow their business.

For their part, buyers believe their brand is the magic elixir. A new advisor’s book of business, they believe, hasn’t been more profitable because the advisor didn’t have Brand X’s killer portfolio of products and services and management expertise.

The High Road

Is a sale based on the greater fool theory really the best approach for advisors and clients? The short answer is no.

Clients don’t commit to an advisor thinking the advisor will sell the business. Clients engage advisors because they trust their advisor and they believe the advisor is competent. And, just like no one gets married thinking they’re going to get divorced, clients believe they’ll be with an advisor and the advisor's firm for the long term when they hire the advisor.

Independent advisors often think that because their unconflicted model has more integrity than a big bank’s or brokerage’s that they may be more enlightened in considering how a sale impact clients. In fact, money corrupts. An advisor has to make an active choice to take the high road.

Looking For A Fool

The greater fool theory has currency because as long as institutions have been buying books of business, they’ve been overpaying. A premium is typically paid when an acquirer overestimates the value of any one of these three variables:

1. The retention of the advisor's current clientele.

2. The ability of the advisors to continue to grow their business.

3. The strength of the acquiring firm’s brand to generate more fees from the advisor's current clients.

To earn the full purchase price, advisors must commit to generating more revenue. For clients, that’s almost always trouble. The bargain that advisors make with their new employers translates into more client solicitations and sales pressure to buy additional products and services. This is the approach especially championed by banks. Or, it could mean raising client fees. Sometimes, it is both.

On balance, the transaction is negative for clients, even if clients gain access to additional investment solutions. For advisors, there may be an upfront, short-term gain, but they forfeit the longer-term payday that comes from building and maintaining an independent firm.

A Better Way

What’s a better approach?

For both advisors and clients, the solution is remaining an independent firm and continuing to grow the business, even after the founder has retired. By having an orderly succession plan and grooming a successor, there is no need to sell.

There are two key benefits in this approach.

First, clients will fare better. Clients will transition to a new advisor who is apprenticed by their current over a two- to three-year period. The new advisor will continue to use the same products and services that the client enjoys.

Second, the retiring advisor can actually make more over time. The profitability and ownership formulas common today will pay the retiring partner on a sliding scale over a number of years even after they retire.

To achieve this objective, there must be a defined succession plan that gives the junior partner an opportunity to buy an ownership interest using contractual metrics over a defined time period. All parties must have a willingness to take the long view of the franchise for the benefit of all.

An independent wealth management firm that sells to a big bank or roll-up firm is no different than a broker who takes a big recruiting check from a wirehouse. The good news is that by remaining independent, an advisor can do right by clients and by themselves creating a win-win scenario consistent with their independent mantra of always acting in the best interests of the client.

LPL Success?

noreply@blogger.com (Jeff Spears) — Wed, 01 Jun 2011 20:37:00 +0000

LPL’s successful IPO has set the standard that most private wealth advisory firms in the roll up space such as United Capital, Focus Financial and HighTower, are hoping to achieve. As these private firms consider their strategic options, a big question remains: “Is LPL’s huge success replicable?”

LPL Successes

LPL has grown its advisor base from 3,500 advisors in 2000 to over 12,000. That growth is the result of acquisitions and from a forced exodus of lower-producing wirehouse stockbrokers. A $200,000 - $300,000-a-year producer is not profitable in the high cost Wall Street business model. However, they are very profitable for LPL. The company doesn’t have expensive investment bankers, research analysts and multimillion-dollar proprietary traders. LPL makes money two ways: 1) From a revenue share with its independent contractor brokers; 2) From transaction fees, asset-based fees and net interest margin that it earns through its broker-dealer. This combined revenue stream allows LPL to profitably support a $300,000-a-year broker that has a business mix of 70% commissions and 30% fees. It also allows LPL to offer the broker a much higher payout than Wall Street.

Here is how LPL describes its business in the S-1 filing for its November 2010 IPO: “Our singular focus is to support our advisors with the front, middle and back-office support they need to serve the large and growing market for independent investment advice, particularly in the mass affluent market, which we define as investors with $100,000 — $1,000,000 in investable assets." [Emphasis ours]

Red Flag

It all sounds very good, but consider this: Near the end of the 180-day IPO lock-up, Ron Carson, LPL’s top producing broker and largest broker shareholder, announced that after a 22 year relationship with LPL he was going to set up his own independent RIA.

Isn’t he already independent with LPL? In fact, not independent enough, in Mr. Carson’s opinion. As his business has grown to the impressive level of $3 billion in AUA, he realized that the LPL service offering – built to serve mass affluent clients – was not sufficient to address the needs of his clients with greater than $1,000,000 in investable assets. While Carson will continue to use LPL for his mass affluent clients, the asset management solutions for his larger clients will be sourced by his new firm and held at Schwab or TD Ameritrade.

While one advisor’s departure will not have a material impact on LPL’s current business, I’m sure it has caught the attention of senior management, LPL’s private equity investors and other top producing LPL brokers.

The Rainmaker’s Dilemma

Rainmakers typically leave large organizations to start their own firms so they can increase their compensation and assert greater control over the strategic direction of their business. LPL’s independent contractor model has successfully addressed the higher compensation needs for the $300,000 producer. This group of producers constitutes the largest in number of brokers, but the top producers (rainmakers) still remain on Wall Street or in trust banks, and LPL has not been able to attract them. That’s not to mention the reality that most top producers – because of their egos – don’t want to be associated with a firm that focuses on mass affluent clients. LPL might not want the rainmaker broker, but after three years of Wall Street’s salesforce rationalization the forced breakaway trend appears to have run its course. That could force LPL to join the ranks of HighTower, Dynasty and Sanctuary in trying to attract rainmaker advisors in order to meet the growth expectation of their new public shareholders.

Position of Strength

LPL has several assets that could make it a formidable competitor if it chooses to pursue the rainmaker advisors. With a cash position of over $500 million and a market capitalization of over $3.8 billion, LPL has ample cash and a potent balance sheet it can use to buy market share. And LPL’s biggest asset could be its private equity partners, Hellman & Friedman and TPG. These organizations understand the high-end client and the high-end wealth management business very well.

The $3.8 billion question for LPL management? Do they believe that the economics of addressing the high-end market segment are as attractive as the economics of selling to the mass affluent? And are these two versions of the same business, or do they need separate business units with separate management teams and separate client service philosophies?

Stay tuned.