I enjoy (safely) viewing and photographing eclipses. It’s a rare opportunity to see a striking phenomenon. But now I’m viewing an extremely unpleasant eclipse.
I was asked to answer the question: How can you create a security that appeals to high net worth individuals?
I didn’t like most of the other answers because that question hides the right questions. The right question, the one to start with, is: “What is an investment which would be more profitable to the high net worth investor than what he can already get?”
Unfortunately it is normal for the marketing How to eclipse What and Why in the mind of a financial manager who wants our money. They are far more interested in marketing a product than in creating a good product. What would it look without that eclipse?
High net worth individuals bring a lot to the table: more to invest, more ability to handle financial risk, and sometimes, more ability to wait on returns. They are able to qualify as accredited investors. Functionally, “accredited investor” means “rich enough to lose the money they are investing.”Much effort is made trying to answer the question of what to sell to the HNWI but the products sold are usually worse than what is available to the general public–higher risk and with lower overall return.
Why are products targeting the HNWI underperforming existing products which anyone could invest in?
Anyone can buy a large cap, blended 500 index (available at low cost from several sources and at high cost from many more). From January 1994 to June 2023 the passive, low cost S&P 500 Index outperformed every major hedge fund strategy by over 2.8 percentage points in annualized return. It’s actually more extreme than that since a hedge fund will usually charge 1%-2% of assets for “management” and 20% of profits over a certain amount. That’s even worse than the standard actively managed mutual fund!
Hedge Fund managers have wisely, if selfishly, designed their products so that the managers always make money even though their investors usually do poorly compared to index fund investors. The Hedge Fund Manager would have to beat the index fund by a wide margin across a long span of time. While returns can sometimes be done by taking unreasonable chances those chances usually don’t pay off in the short run, much less in the long run. See average Hedge Fund performance for the dismal results.
High cost managers don’t take the risk–you do. Who comes first in line for the profits? They do.
What would make the best existing investment options even better for the HNWI?
Be the one who gets the money, not the one who pays the money.
Vanguard’s funds aren’t owned by someone whose first goal is to extract money from the fund investors; the investors own the fund. Vanguard works for the investor because it is owned by the investors.
A great investment for a HNWI should be structured this way. It’s called a fiduciary duty when the service provider is obligated to put your interests first. The investment industry far prefers the lower standard of “generally suitable” investments. That’s a euphemism for “generally lousy.”
Make a good incentive structure even better.
What a HNWI should want is a manager with skin in the game and high visibility.
For this investment fund the managers would have to disclose the amount they have invested with their fund (government regulations only require weasel wording such as “I own somewhere between $10k and $1M”. Instead disclose exactly and disclose very quickly.
Protect long term profits from short term speculation.
There are two ways to make money from the stock market. One is to buy something good and hold it for a long time. The other is to try to use the market as a casino and gamble. Gambling is about as profitable in the stock market as in Las Vegas. That is to say, it’s profitable for the Casino, not the gamblers.
To keep out the gamblers, who will push for long shots and demand miracles, add requirements on how often shares could be sold (to get rid of the day traders whose only achievement has been to drive down everyone else’s costs by doing excessive trading).
Vote the shares and improve the business.
or
The Endlessly Misunderstood Warren Buffett – Why does stock picking only seem to work for him?
Warren Buffett, stock picker, succeeds where the vast majority of other stock pickers underperform the index. Once again, people are looking at the wrong thing–Buffet buys and sells stock in individual companies, yes, but that’s what everyone else does and, on the average, underperforms. Does that mean there’s one smart guy who can predict the future and everyone else is a doofus? No, the difference is that Buffet can and does influence the companies that he invests in.
Why is that so important? Because CEOs are grossly overpaid (paid for the demanding job, paid to walk away from their previous stock options, paid with a golden parachute, paid extra for their celebrity status). One of the worst things that can happen is that your CEO gets on the cover of Fortune magazine. He probably suspected he was a genius before, but now he’s certain of it and no one can tell him his pet merger or acquisition is idiotic. The board of directors won’t rein him in; as Robert Townsend points out, they think their only job is to raise the CEO’s salary to make sure that it isn’t in the first 3 quartiles. That makes for a pointless arms race in CEO overpayment. CEOs say, “you wouldn’t say Michael Jordan was overpaid!” True enough, but…celebrity CEOs don’t overproduce like Michael Jordan did. The $1 million CEO is usually much more effective than the $10 million guy because he has fewer delusions about his own infallibility and more drive to make the business succeed.
What does succeed mean? The way we currently incentivize CEOs and other executives, we apparently think succeed means: take many risks in an effort to make the stock price jump up briefly and don’t worry about the long term effects on the company. And don’t worry for yourself, if the risky plan works you get a windfall! If you fail you get a windfall with your golden parachute! Those incentives are the reverse of what a thoughtful, long term investor wants.
Buffett’s model includes the ability to influence CEOs and boards to not do stupid things (complacency, overpay, idiotic acquisitions and mergers). That influence is what index funds lack (although they could have that authority, they do not use it).
Jack Bogle points out the crying need for mutual funds to vote their shares. They are far more capable of understanding the proxies we’re asked to vote. They are far more capable of squashing bad ideas and boosting good ones.
This is a solvable problem
For a product targeted at High Net Worth Individuals, start by building a great investment. Build that by improving on low cost index funds and correcting their few shortcomings. Secondarily, market it to the right people. It may not be that hard. There are probably a lot of them who are fed up with making lower returns than the average investor and paying more for the failure.
We’re asking for a lot of leadership though. Probably not even Vanguard would make this new kind of fund. It would require a determined idealist on a par with Jack Bogle.
