A successful relationship between a client and her investment advisor starts with a meeting of the minds between the two — and there are a variety of hurdles that need to be cleared.
In most cases, there is an imbalance in investment knowledge that can be tough to reconcile. Industry jargon is a barrier; even long-term clients might not really understand the terms that they hear a couple of times a year from their advisor. Plus, the reports and emails that they receive more frequently than that from the advisor’s firm can be stuffed with lingo and concepts that aren’t exactly client-friendly.
Overall, the investment industry struggles with the problem of the curse of knowledge. Certainly there are advisors and others who are expert translators of complex ideas into words that others can understand, but it is distressing how frequently investment professionals fail to mold their language to fit the readiness of their audience.
There are also issues of mindset and behavior to be bridged with clients, since the investment world is one in which seemingly logical choices can be counterproductive.
It’s common to divide clients into categories based upon their assets, but these issues transcend those distinctions. For example, a posting from Jeff Bauer of Cambridge Associates, “While Great Entrepreneurs Leap, Great Investors Plan,” stresses that even clients who are considered to be successful and sophisticated might need to reorient their thinking.
Method and measures of success
Bauer uses a five-point “framework for investment success.” The principles that likely made an entrepreneur thrive — “prioritizing short timeframes, divesting from underperformers, and anchoring to absolute performance metrics” — are a poor fit when it comes to investments.
Since “an entrepreneur’s instinct often is to invest in what is working best,” it feels natural to pick asset managers that are doing so at any point in time. But that’s a losing strategy, not a winning one.
That said, to varying degrees, such an approach remains ingrained at most advisory firms (other than those that use passive exposures). Very few can show a record of selection that isn’t dominated by procyclical behavior.
In fact, many advisory firms catering to ultra-high-net-worth clients market their access to the “very best” managers. That framing makes it likely that they will be less patient with managers than they should be, since tension builds if performance disappoints and the premise (promise?) is called into question. It’s easiest to move on to the next manager (also then promoted as being superb in every respect).
It is much harder work to educate clients about the unreliability of performance as an indicator of future results; to show them how frequently and for how long even the best managers can underpeform (as Bauer does); and to counsel patience, especially with a client that expects superior results:
Successful business owners are often stars in their fields. Their businesses grew and amassed capital, turning performance goals into achievements, and achievements into future expectations.
Bauer argues that it is critical to get clients to avoid obsessing over the individual components of a portfolio and to understand how they all work together, but “the natural inclination to painstakingly analyze the performance of each individual line item can be hard to resist.”
Concentration
Entrepreneurs are used to having all or most of their eggs in one basket. If they sell their business, they may be prone to concentrating the proceeds in relatively few other investments, even though the elements of information and control that they previously had are no longer available to them. Even if they are investing in an industry that they know well, they are playing a quite different game than they had before.
In other cases, an entrepreneur may retain a significant ownership position but start diversifying into other investments. That means addressing a series of questions about the relationship among those investments, what the overall risk exposures should be, and what “the vision for the portfolio” is.
The private realm
Private capital strategies are a natural area for investment by entrepreneurs. Private equity and venture capital are appealing because the underlying companies can be reflective of the entrepreneur’s own journey. Plus, they are viewed as sexy asset classes and have had strong performance (as shown by an eye-popping chart provided by Bauer, which ironically serves to whet the appetite to chase that performance despite the earlier caution about doing so).
The article stresses the importance of manager selection in private strategies, but it doesn’t adequately paint a picture of the risks overall. The environment has been nearly perfect for private equity and venture capital, but there are plenty of reasons to believe that things will be much tougher going forward, even for those “very best” managers.
Bauer highlights some unique advantages for entrepreneurs in the private arena, given that their “industry knowledge, business acumen, and professional networks all can help to magnify an investor’s attractiveness to private investment GPs,” providing points of access and co-investment opportunities that might not be available to others.
Planning and executing
One of the sections of the posting is “Know and Account for Your Limitations.” Bauer writes that “delegating wealth management responsibilities can be a less intuitive and more challenging proposition” for someone experienced in finding and leveraging good people in the course of their business. There are a wide range of experts and firms who can be tapped, and they are adept at marketing their wares (and especially interested in gaining new clients with sizable assets). Sorting through them can be time consuming and difficult.
Bauer ends with an echo of his title:
As owners consider how best to invest their hard-earned capital, they should recognize that, while great entrepreneurs may leap, great investors plan.
He lays out the components of a “family enterprise review” to provide the foundation for “building, maintaining, and enhancing a large, diversified investment portfolio over time.” Even in summary form, there is a lot there, all of it preceding the “policy setting” that will guide investment going forward.
As one of the concluding paragraphs indicates, all of this represents a departure in approach for many entrepreneurs:
Creating and maximizing a business enterprise’s potential involves different attitudes, behaviors, and skills than are required to realize an investment portfolio’s full potential. Certainly, both successful business leadership and portfolio management depend on many similar traits, including conviction, expertise, hard work, and teamwork. But to be successful as an investor over the long run also can require some fundamental adjustments in mindset and direction.
Published: June 30, 2022
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