The Rules of the Game
An excerpt from Low Risk Rules: A Wealth Preservation Manifesto.
I was at my first cocktail hour of my first high-level private wealth management conference when the rules of the game were laid bare to me.
After a few brief stints in various sales jobs in the financial industry, I was lucky enough to land a dream job in what today is known as a “family office”—an organization dedicated to serving a wealthy family in a bespoke and conflict-free environment. To be honest, the whole concept of the family office was new to me, and the nascent industry was shrouded in mystery.
To build up my network, I decided to attend a conference that was advertised to wealthy families and their advisors. After arriving, I was a bit disillusioned to see that, among the hundreds of attendees, maybe only twenty-five were families or their staff. Instead, most of the people there were financial advisors and asset managers of various stripes, scouting for new clients.
It was the close of my first day there. I was severely underdressed because I had forgotten the dress shirts that were hanging in my closet back home, and arriving late on a Sunday night meant that I had nowhere to buy clothes for the next day. The thing about being underdressed at an event like this is that it reveals that you are not a salesperson. So my jeans and untucked polo gave me away as a prime target in a sea of suits and ties.
I spent the majority of my day collecting business cards and feigning interest in silly hedge fund strategies I knew I’d never recommend to my clients. The cocktail reception was a welcome end to the day, with abundant hors d’oeuvres and generously poured cocktails. Those of us from families and family offices tried our best to congregate together in order to avoid having to listen to yet another sales pitch.
It was here that I made an acquaintance with an older fellow—let’s call him Ted. Ted was an accountant by training—the chief financial officer of a long-forgotten company that had been sold for millions back in the 1970s. The company’s owner wasn’t sure what to do with his newfound liquid wealth, and so asked Ted to manage his investment portfolio and to run what eventually became his family office. Ted had been doing so for the past thirty years.
We shared an affinity for single malts, of which the bar was well stocked, and so Ted and I drank our fill and traded war stories. Gradually, as the thin veneer of professionalism fell away, courtesy of the Lagavulin, Ted leaned back, swigged what remained in his glass, and said, “It’s all bullshit, isn’t it?”
I squinted, as if asking what he was talking about.
“This whole farce,” he said, waving his hand around the room. “It used to be easy. Like, really easy. In the ’70s, there were a few really good hedge fund managers. We all knew who they were. It was pretty easy to get introduced to them, and they were usually able to sustain outperformance over time. The stock market was a lot less competitive, less efficient.”
Although the hedge fund glory days he referred to were before my time, I nodded in agreement. I had always viewed “alternative” assets like hedge funds to be an unnecessary luxury that didn’t really add much to portfolios. And so I naturally favored plain vanilla stocks and bonds for my clients. Not exciting, but a reliable and safe choice.
“These days,” he sighed, “it’s a crapshoot. Best to just throw it all in an index fund and call it a day.”
I was taken aback by this. Just a few minutes earlier, Ted had been regaling me with details of the complex portfolio he had built for his client—over fifty funds, many employing special strategies, all in the name of earning some sort of elusive “uncorrelated excess return.”
And so I asked him: “Why the elaborate portfolio then? Why don’t you just buy the index?”
Ted smirked, leaned in, and lowered his voice. “Because then I’d be out of a job.”
I laughed uncomfortably, but it wasn’t a joke. “And you wouldn’t be here right now,” I said.
“Precisely.” He tapped his temple with his index finger. “Let’s order another round, kid. This is the good stuff.”
Ted’s portfolio has become the blueprint for the “High Net Worth” and “Family Office” investment model.
Illiquid, meaning you can’t access your cash quickly.
(All the better to capture that illiquidity premium, says Ted!)
High fees, which ultimately reduce your net returns.
(These exotic asset classes aren’t cheap to invest in, and they require specialized expertise, says Ted!)
Ultra-diversified in a bunch of different funds, ultimately leaving the client owning a bit of everything.
(This is how we diversify our risk exposure, says Ted!)
The net result of that last strategy? No single investment can move the needle, and you essentially own an index fund. A very expensive index fund.
Mostly, Ted has built himself a very powerful moat: by constructing a complicated, inflexible, and over-diversified portfolio for his client, he has made sure that his job is secure. It’s no wonder that this model has been replicated across the industry; worse, it’s been marketed in such a way that has clients clamoring for these investments. It’s a brilliant sales-Jedi mind trick that convinces otherwise shrewd businesspeople to ignore their best instincts.
Whether it’s selling access to famous money managers or exotic strategies, the sales pitch usually includes the same elements. It’s about seemingly “too good to be true” investments that are marketed as exclusive to the wealthiest clients. Far too often, the real benefits from these funds accrue not to the investor, but to the salesperson.