Sunday, February 14, 2010

Valentine’s Day Challenges
for Ultra High Net Worth Investors

What are the Valentine’s Day challenges for Ultra High Net Worth Investors? For your humble scribe, the challenges have to do with producing this particular blog. When I think about the 14th of February, three different themes come to mind. First, a day to proclaim love. Second, the commercialization of emotions. Third is the St. Valentine’s Day massacre in Chicago, where one band of criminals was killed by another group to settle a dispute. I won’t dwell on the third at this time, or make comparisons with various global political leaders and their relations with financial community contributors. Nor will I deride anyone’s desire to make a buck on other people’s “Whoopi.” Come to think of it, maybe these first two themes are more related than I thought. Instead I will focus on the nicest of the four letter words,” Love,” and how it intersects with your portfolio.

At the suggestion of my son Don, the writer, I began to think about how we fall in love, how we show our love and how we protect our love as found in our portfolios. At one level, as an investment manager I must deal with stocks or funds in which my clients or I fall in love. Even very sophisticated investment committees of experts believe that a particular investment will show them love by bestowing substantial capital appreciation. While this feeling could well have started in courtship based on past performance or other statistical garb, love (or at least marriage) is consummated early and verified when the rough times come, as they do in all relationships. We do not desert our loves in periods of stress. Speak to any investor who is sitting with a large loss, he or she will tell you of past dreams whose fulfillment has been delayed. Heavy is the job of the adviser to convince the investor that this was a false love and not meant to be. Woe unto the adviser if his or her client does sell a once-beloved security and the dreams of the now-sold position then come into fruition. Recognizing these emotions, many advisors back away and leave the deteriorating positions in place, but maintain the client. Despite this comment I believe every portfolio can use periodic pruning.

At a much deeper level, a portfolio for a spouse or family or a favored charity can be read as a document of love. As the ultimate beneficiary of its results, one’s personal portfolio could be said to show love for one’s self. All life and all portfolios should deal with balance. We need to balance the production of optimum total return and the protection against life-changing losses. We can do this either through controlling spending and/or the growth and swings in the value of the portfolio. Deciding on the best mix of total return production pivots on the desire to have the beneficiaries participate in the cyclical nature of investing or have their spending controlled each year. Underlying these thoughts is the possibility that all the wealth will be consumed by spending or unfortunate markets at some point in the future. The approach of a variable spending policy based on performance is a good compromise, but does not guarantee that the assets will outlive the primary beneficiaries. Where does love come into this? One might say love could be measured by the rate the generator of the wealth saves or invests for the benefit and protection of others. In the phrase, “the benefit and protection of others,” is the concept of avoiding life-changes, (in this case on the upside), for the heirs. Spoiling children or charities is never a good idea. As money grows, often does its complexities. For those Ultra High Net Worth individuals, and/or their granting foundations, complexities grow at a much faster rate than the accumulation of wealth. Given enough time, the requests (or if you will, demands) will be larger than the pile of wealth. Often, the love of the generator of the wealth is expressed by how he or she disperses while alive and what provisions they make when they are no longer with us.

Particularly in times like these, your portfolio can use some tender loving care, not just with planning responsibilities, but also including and you and your adviser. Many of us have been bruised by the markets, disappointed by various investments, found strategies to be wanting and the list goes on and on. First one should recognize there are no perfect records in any long lasting game. The best players eventually lose. From my days at the racetrack I have always been interested in winning percentages, both in terms of number of races, but more importantly, in dollars won. (I wish I had the data on the expenses behind each winning race and dollar earned, but my guess is that racing in general is a losing proposition, but breeding can be quite profitable on an after-tax basis.) Using the same type of analysis on securities investing, particularly through funds, one can sense what winners produce. Benefiting from the long term secular growth in many equity markets, the individual investor makes money at least half the time, particularly those that stay in the game. Professional investors who survive, produce winners at least 60% of the time. Generally, good professionals are right two-thirds or more of the time and great ones three-quarters of the time. Just as at the race track, the relative size of one’s bets determine the size of the winnings when right. I believe the key to sizeable investment winnings is appropriate concentration with winning managers and funds.

Two lessons from the above: First don’t beat yourself up. The last couple of years have been rough, the vast majority of investors have not recovered to their former peak levels. Second, extreme concentration can put the preservation of capital and spending at risk for your loved ones. You need to achieve some balance in your portfolios and show to your important others some love and concern for them.

Happy Valentine’s Day.

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