“Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.”

By | February 16, 2018

Said Warren Buffett.

“Then the people who took subway may end up riding out of Wall Street in a Rolls Royce, leaving their clients at subway station” – Author

It is not to say that people taking subway are not experts in finance or money management and cannot give advice to people who are wealthier. It is just to say that it goes against the odds and you need to be very critical in choosing the manager who manages your money. In most of the professional fields, you will be looking for a real solid talent and skillset before giving your trust in certain aspect: Attorneys who graduate from law school and who can perform specific legal matters; Accountants who can do book-keeping, balance the books and are up-to-date with latest accounting rules; Chefs who can cook a better meal that you do; Carpenters who can build a beautiful piece of furniture or computer programmers who can actually program in Java or C++ and make something using computer codes.

On Wall Street however, you see a lot of cases when people just graduate school and struggle in personal finances can wear a tie and fancy suit to give your advice on how to manage your wealth.

If you put some more attention to the matter, normally it is the money manager who ends up with the clients’ money and clients face a 50/50 chance whether their wealth grew bigger or smaller overtime. Heard of the famous 2/20 fee structure? 2% fee on asset under management and 20% incentive fee on anything above a return hurdle. This is where it goes wrong on Wall Street money management business: Human beings respond to incentives. If you have 2% fee on any assets under management, guess what will be easier and “more certain” form of revenue for the banks or hedge funds? – absolute size of asset under management. Naturally you will see the investor relations or fund-raising team are the strongest department of such advisory business and the actual investment team is mediocre.

The problem with asset management industry is that too many mediocre talents are working in this field: they are not just unintelligent, some of them are motivated by the incentives that are inconsistent with generating the strongest risk adjusted return for their clients’ money. If you are looking for evidence in mediocre managers, just tune in to CNBC morning shows and within a week you should be able to spot a couple figures fitting into the description.

Why does Asset Management industry have such a problem?

  1. It is easy to be middle of the peck and not get fired – just play safe and stay close to others to play “trends”, you should be able to deliver an OK result.
  2. The demand is stronger than supply – over the past many decades there were huge amount of wealth created in the real economy and with Fed’s super stimulus policy, lots of liquidity flowing so almost any manager can get some allocation of those wealth.

Based on my 20-year experiences in the market and 10-year experiences in asset management industry, before you choose your manager, in addition to asking for their license and regulatory required qualifications, please ask the following key questions:

  1. Do you personally invest? and what’s your track record overtime? – if the answer is no to the first question, politely stand up and walk out immediately
  2. What’s your investment philosophy? Do you use technical analysis? Do you use market timing techniques? (Any “Yes” to the last two questions is a red flag for you)
  3. How are you getting compensated? Is the fee structure 2/20? or cost recovery/20? (There are huge differences between the two: if there is a fixed fee on AUM (asset under management), you can be assured that they will spend quite some time on the road, not for due diligence but for fund raising, because a huge asset base means great profit for the firm). Ideally, to have best interest alignment, you should ask for cost recovery for fees (meaning the fees only to cover costs and fees related to investing your money) and make sure majority of the compensation come from outperformance.
  4. Is majority of your personal wealth inside this business or invested alongside with my money? Again, this is the interest alignment question. If it hurts to you as badly as to him when a poor investment result was delivered, then you two are very well aligned!
  5. Are any third party giving your compensation when you make any investment recommendations or trades? Extreme example would be your online broker’s research department will receive compensation directly when you act on their research report in buying or selling
  6. What’s the worst investment you have ever made? – They should share more loss stories than success stories
  7. Can I see some past reports/account statements? – Look for patterns of extreme frequent short-term trading/speculation activities.

Some extra tips that I found are very telling:

  1. Try to walk with them to their cars. If they have a very messy car and you don’t want your kids sit inside that car for a minute, don’t trust them with your money.
  2. Try to grab a lunch/drink with them: if they are rude to waiters and waitress, if they lose their manners after a few drinks, if any casual topics reveal that you don’t want to be associated with these people in a personal setting, try to bail politely and never call them again. Life is too short to hang out with people that you don’t like or don’t want to be associated with.

All in all, people in money management business need to be honest and capable. Honest is first order and capable comes next. If you hear words like “the opportunity of a life time”, “you need to hurry”, “sure thing”, “it’s a no-brainer”, “you can’t afford not to own it”, “can’t lose”, “guaranteed”, “there is no downside”, run to the doors!

Leave a Reply