Monday, March 06, 2006

Wealth managers (and especially Hedge Hogs) receive a Buffeting

When Yale's great investment manager, David Swensen, wrote an earnest but dull book about the high cost of employing generally useless vendors of market-beating techniques, most investors didn't read it.

When John Bogle, Vanguard's patriarch, rants about high investment costs, he draws only limited attention.

But Swensen and Bogle are communications amateurs. The Oracle of Omaha is a pro.

In his letter to Berkshire-Hathaway shareholders, Warren Buffet turns his skills to the subject of "How to minimize your investment returns." Better read it. A lot of your clients and prospects will be reading it, too.

Buffet argues that investors are destined to receive returns substantially below the theoretical averages because they repeatedly shoot themselves in the wallet.

To visualize these self-inflicted wounds, Buffet asks us to imagine that a single family, the Gotrocks, owns every business whose shares are available to investors.

Collectively, the Gotrocks enjoy a return equal to the earnings of their businesses, less taxes. Individually, various members of the Gotrocks clan figure they can do better. So they hire a helper, a broker. When the helper does nothing but cost them money, they hire another helper, a money manager to tell the broker what to buy. And when they realize they're even worse off, they hire a financial planner or consultant to help them pick the right money managers.

What fools these mortals be, says the Oracle:
The Gotrocks, now supporting three classes of expensive Helpers, find that their results get worse, and they sink into despair. But just as hope seems lost, a fourth group – we’ll call them the hyper-Helpers – appears. These friendly folk explain to the Gotrocks that their unsatisfactory results are occurring because the existing Helpers – brokers, managers, consultants – are not sufficiently motivated and are simply going through the motions. “What,” the new Helpers ask, “can you expect from such a bunch of zombies?”

The new arrivals offer a breathtakingly simple solution: Pay more money. Brimming with selfconfidence, the hyper-Helpers assert that huge contingent payments – in addition to stiff fixed fees – are what each family member must fork over in order to really outmaneuver his relatives.

The more observant members of the family see that some of the hyper-Helpers are really just manager-Helpers wearing new uniforms, bearing sewn-on sexy names like HEDGE FUND or PRIVATE EQUITY. The new Helpers, however, assure the Gotrocks that this change of clothing is all-important, bestowing on its wearers magical powers similar to those acquired by mild-mannered Clark Kent when he changed into his Superman costume. Calmed by this explanation, the family decides to pay up.

And that’s where we are today: A record portion of the earnings that would go in their entirety to owners – if they all just stayed in their rocking chairs – is now going to a swelling army of Helpers. Particularly expensive is the recent pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or lucky, and leave family members with all of the losses – and large fixed fees to boot – when the Helpers are dumb or unlucky (or occasionally crooked).

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