Investment Counsel for Private Clients 1993 Peavy

8/10/2019 Investment Counsel for Private Clients 1993 Peavy

1/106

I F ontinuing

Education

Investment ounsel

for Private lients

October 8-9 1992

Chicago Illinois

Charlotte Beyer

Jean L.P.

Brunet

CFA

Dwight D Churchill CFA

Peter Davis

George D Friedlander

Frank

E

Helsom CFA

Warren N. Koontz Jr. CFA

William R Levy

Edited

by

John W Peavy

CFA

David

L

Mead CFA

H. Scott Miller

Brian Murdock

John W Peavy III CFA

Nancy

Smith CFA Moderator

Diane

M

SpirandeIli CFA

R Gregg

Stone

IMR Education Steering ommittee 1992 93

James R Vertin CFA o hairman

Menlo Park California

Ian

R

O Reilly CFA

o hairman

Toronto Ontario Canada

Charles

D

Ellis CFA

Greenwich Connecticut

Lea Hansen CFA

Toronto Ontario Canada

Susan D Martin CFA

Hudson

Ohio

Charles

F

O Connell CFA

Chicago Illinois

Donald L Tuttle CFA

Charlottesville Virginia

Eliot P. Williams CFA

Hartford Connecticut

rnold

S Wood

Boston Massachusetts


2/106

The ssociation for Investment Management and Research

comprises the

Institute of

Chartered Financial

nalysts and

the

Financial

nalystsFederation

1993 Association

for Investment Management

and

Research

All rights reserved.

No part

of this publication

may

be

reproduced stored in a retrieval system

or

transmitted in

any

form

orby any

means electronic mechanical photocopying

recording

or

otherwise

without

the

prior

written permission

of the copyright holder.

This publication

is designed

to

provide accurate

and

authoritative

information in

regard

to the subject

matter

covered.

t

is sold

with the understanding

that the

publisher

is

not engaged

in

rendering

legal

accounting or other

professional service. legal advice

or

other expert assistance

is required the services ofa

competent

professional

should

be

sought.

From a Declaration of Principles jointlyadopted by a ommittee of

the merican arssociation and a ommittee ofPublishers

ISBN 10: 1 879087 22 7 ISBN 13: 978 1 879087 22 4

Printed in

the

United States of merica

4 1 93


3/106

Table of

Contents

Foreword

Katrina F

Sherrerd, CFA

iv

Biographies of

Speakers v

Investment Counsel

for

Private

Clients An

OveNiew

John

W

Peavy

ll

CFA . . . . . . . . . . . . .

Understanding Private Client Characteristics

Charlotte Beyer. . . . . . . . . .

Investment Planning for

Entrepreneurs

Peter

avis

. . . . . . . . . . .

Investment Planning

for Wealthy Families

H ScottMiller . . . . . . .

sset llocation for Private Clients

Jean L P Bnmel, CFA . . . .

SeNicing the Private

Client Part I

Brian

Murdock .

SeNicing the Private Client Part

David L Mead, CFA . . . . .

The Value of SpecialiZed Investment

SeNices

Frank E Helsom,CFA . . . . . . . . .

Investing in

Municipal

Bonds for Private Clients

George

D

Friedlander

. . . . . .

Investing in

Venture Capital for Private Clients

R GreggStone . . . . . . . . . .

International Investing

for Private Clients

Diane

M

Spirandelli, CFA

Understanding

the

Tax Constraints on Private Clients

Warren

N

Koontz,

Jr

CFA . . .

continued on next page

1

5

8

29

45

58

65


4/106

Estate Planning and Charitable Giving for Private Clients

William R Levy

Portfolio

Management

for Private

Client A Case Study

JolmW PeavyIII CFA

Applying the

AIMR Performance Presentation Standards to Private Clients

Dwight Churchill CF

7

8

Self Evaluation Examination

Questions 94

Answers

9


5/106

I F oard

Trustees

Ian

O Reilly CFA hairman

Toronto Ontario

Canada

Eliot

P

Williams CFA

Vice

hairman

Hartford Connecticut

Darwin

M

Bayston CFA President

and

hief

xecutive Officer


Frederick L Muller CFA IMR hairman

Atlanta Georgia

Charles

D

Ellis CFA IMR

Vice hairman


James K Dunton CFA

Los Angeles California

Thomas L Hansberger CFA

Ft Lauderdale Florida

Lea

Hansen CFA

Toronto Ontario

Canada

Norton

H. Reamer CFA


Eugene C Sit CFA

Minneapolis Minnesota

Eugene H. Vaughan Jr. CFA

Houston Texas

Brian F Wruble CFA

Philadelphia Pennsylvania

IMR Council on Education and Research

James

Vertin CFA

hairman

Menlo Park California

Keith P Ambachtsheer

Toronto Ontario

Canada

Darwin M

Bayston CFA


Gary P Brinson CFA

Chicago Illinois

Charles

D

Ellis CFA


H. Russell Fogler

Gainesville Florida

W

Van

Harlow

III CFA


Lawrence E Harris

Los Angeles California

Martin

L

Leibowitz

New

York

New

York

Staff Officers

Darwin

M

Bayston CFA

President and

hief Executive Officer

Thomas A Bowman CFA

xecutive

Vice President

Michael

S

Caccese

Senior

Vice

President and General ounsel

Katrina F Sherrerd CFA

Senior

Vice President

Donald L Tuttle CFA

Senior

Vice

President

Randall

S

Billingsley CFA

Vice President

Raymond

J

DeAngelo

Vice President

Julia

S Hammond

CFA

Vice President

Roger

F

Murray

Wolfeboro

New Hampshire

Ian O Reilly CFA

Toronto Ontario

Canada

John W Peavy III CFA

Dallas Texas

ndre

F Perold


Frank

K

Reilly CFA

Notre Dame Indiana

Stephen A Ross

New

Haven Connecticut

William F Sharpe

Los Altos California

Eugene C Sit CFA

Minneapolis Minnesota

Bruno Solnik

Paris France

Robert

M

Luck CFA CPA

Vice

President

Peggy M Slaughter

Vice

President

Roger L Blatty

ssistant

Vice

President

Moira C Bourgeois

ssistant

Vice

President

Joy N. Hilton

ssistant

Vice

President

Dorothy C Kelly

ssistant

Vice

President

Jane

P

Birckhead CPA

Treasurer and ontroller


6/106

orewor

Servicing the investment needs

of

high-net-worth

individuals

an d

their

families-so-called private

cli-

ents-requires a combination of technical skill an d

diplomatic acumen. This is because such clients

often expect

more

from theirinvestment

ad

visor

than

just investment performance.

Although the process of

managing money

is ba-

sically the same for individuals

an d institutions-

both must

be

dealt with on th e

basis of their

unique

needs an d characteristics-significant

differences

nevertheless exist. For one, dealing

with

private cli-

ents can

be

complicated

by

a family s conflicting

objectives involving several different generations.

Fo r another

investment

a dv is or s m u st

balance

unique

constraints-including

an individual s

tax

an d

legal

considerations-with investment

strategy.

Because of the importance the

private

client

mar-

ket is assuming in the

world

of investment manage-

ment, AIMR sponsored a

seminar

entitled nv stm nt

ounselfor Private

lients

This proceedings explores

the processes involved in setting long-termgoals

an d

implementing investment strategies for clients

wh o

have substantial assets. The proceedings also

ad-

dresses ways toeducatean d communicate

with

these

special clients.

Many individuals contributed to the success

of

Katrina F Sherrerd, CFA

Senior Vice President

Publications an d Research

AIMR

iv

th e seminar an d

this proceedings. AIMR wishes to

acknowledge all of them with grati tude. Special

thanks are extended

to John

W

Peavy III, CFA,

wh o

edited this proceedings with such skill,an d Nancy

Smith, CFA,

wh o

served as conference

moderator

an d ably

guided

the discussions in Chicago. Their

advice

was instrumental

in shaping this publication

an d

th e

valuable information it contains.

Th e speakers contributing to the seminar were:

Charlotte Beyer,CharlotteBeyerAssociates; JeanL.P.

BruneI, CFA, J.P. Morgan Private Banking Group;

Dwight D

Churchill, CFA, CSI Asset Management,

Inc.; Peter Davis,

Wharton

School, University of

Pennsylvania; George

D

Friedlander, Smith Barney,

Harris

Upham

Company; Frank

E

Helsom, CFA,

University InvestmentManagement, Inc.; Warren N.

Koontz, Jr., CFA, The Jeffrey Company; William

R

Levy,

T he G le nm ed e T ru st Co mp an y;

David L

Mead, CFA, Harris Trust

an d

Savings Bank; H. Scott

Miller,Miller,

Anderson

Sherrerd; Brian A

Murd-

ock, Merr ill Lynch Asset

Management;

John W

Peavy III

CFA,

Southern Methodist

University;

Nancy Smith, CFA, The Glenmede Trust Com-

pany; DianeM Spirandelli, CF Swiss BankCorpo-

ration; an d R GreggStone, PR Venture Partners L.P.

an d

Pell,

Rudman Company

Inc.


7/106

Biographies of Speakers

Charlotte

Beyer

is

founder and president

of Char-

lotte Beyer Associates, a consulting firm focusing

on

the high-net-worth-individual market. Previously,

Ms. Beyer

directed

private

client

marketing

for

Lazard Freres Asset Management. She also

was

se-

nior vice president

and

principal of Wood, Struthers

Winthrop

and

vice

president

in the Fiduciary De-

partment at Bankers Trust Company. She is a trustee

of the Westover School in Middlebury, Connecticut.

Ms. Beyer

graduated

from

Hunter

College

and

at-

tended the University of Pennsylvania

and

the

New

York University

Graduate

School of Business

Ad

ministration.

Jean

L P

Brunei CFA

is

managing

director

and

chief investment officer of the J.P.

Morgan

Private

BankingGroup. Previously, he

was head

of

J P

Mor-

gan

InvestmentManagement Australia Ltd.

and

J.P.

Morgan Investment

Management

Singapore. Mr.

BruneI began his career

at

J.P.

Morgan as

a research

analyst

and

has

worked

in

New

York, Tokyo,

and

Hong

Kong.

He

is a

graduate

of theEcole

des Hautes

Etudes Commerciales

in

Paris and

received

an

M.B.A. from

Northwestern

University.

Dwight D Churchill CFA

is

president

of CSI Asset

Management, Inc., a fixed-income

and

equity invest-

ment

management

unit of

Prudential Insurance

Company

ofAmerica. Previously,Mr. Churchill

was

managing directorof Prudential Fixec1-IncomeAdvi-

sors. He also was vice president

and

portfolio man-

ager

at

Loomis Sayles

Company

in Detroit

and

bond

portfolio manager for the Public Employees

Retirement System ofOhio. Mr. Churchill serves

on

theCandidate

Curriculum

Committee ofthe Institute

of Chartered Financial Analysts

and

on

the AIMR

Performance Presentation

Standards

Implementa-

tion Committee.

He

holds a

B

from Denison Uni-

versity

and an

M.B.A. from

Ohio

State University.

Peter Davis

is director of family business executive

education programs

at

theWharton School, Univer-

sity of Pennsylvania. He founded the family busi-

ness programs

at

Wharton, the first of their kind

at

a

US.

university.

He

has

worked

as a consultant

and

advisor to

many

family businesses

and

family offices,

and

he specializes in issues

attendant

to the manage-

ment of change

and

succession in family organiza-

tions. Mr. Davis is a columnist for

and

chief

advisor

to

Family

usiness

Magazine

as well

as

an

editor of

Family usiness Review

and

a series editor for the

Jossey ass

Family usiness

Series

Mr. Davis

was

ed-

ucated

at

Cambridge University, the London School

of Economics,

and

the Wharton School.

George

D Friedlander is managing director of the

High Net Worth/Retai l

System

at

Smith Barney,

Harris

Upham

Company.

He

has

more than

17

years experience in municipal credit

and

market

analysis

and

includes taxable fixed-incomesecurities

in his

market/portfolio

strategy work. Mr. Fried-

lander

is

a

member of t he Publi c Secur it ie s

Association s Municipal Division Executive Com-

mittee.

He was

voted All-AmericanMunicipal Port-

folio Strategist by the Global

Guarantee

newsletter

and

was named

to the All-American Research Team

by

nstitution l nvestor

magazine. Mr. Friedlander re-

ceived a

S

in mathematics from the State Univer-

sity of

New

York

at

Stony Brook

and an

M.B.A. in

finance from Pace University.

Frank E

Helsom

CFA

is chairman

and

chief invest-

ment

officer of University InvestmentManagement,

Inc., a subsidiary of Templeton Portfolio Advisory,

Inc. Mr. Helsom is a former pres ident

and

current

vice

chairman

of Templeton Investment Counsel,

Inc.,

which

provides

account

management

to large

institutional investors. Previously, as a research an-

alyst

and

portfoliomanager, Mr. Helsom started

and

managed

the

Midwest

regional

group

for Citicorp

Investment Management, Inc.,

and

also held posi-

t ions in the investment

management group at

lin

coln National Corporation.

He

has served as

president

and

member

ofthe

board

of

directors ofthe

InvestmentAnalysts Society ofChicago. Mr. Helsom

holds degrees from

Northwestern

University

and

Wayne StateUniversity.

Warren N Koontz Jr CFA

is vice

president and

treasurer of The Jeffrey Company a private invest-

ment

firm. His responsibilities include the develop-

ment

and

implementation of tax-efficient investment

strategies for internally

and

externally

managed

eq-

uity

portfolios. Previously, he

was

assistant invest-

ment officer for the Public Employees Retirement

System ofOhio,

where

he

managed the

equity assets

and

staff.

He

also has been a portfolio manager,

equity security analyst,

and

fixed income analyst.

Mr. Koontz holds a

S

in finance

and an

M.B.A.

from Ohio State University.


8/106

William

R

Levy is vice p re si de nt o f T he Glenmede

Trust

Company,

where he administers the Personal

and Institutional Accounts department. Previously

he was assistantvice president at

Provident

National

Bank r es po ns ib le for a dm in is tr at io n o f t ru st s and

estates. He also served at Fox Rothschild O Brien

and

Frankel as

an

associate attorney specializing in

estate and

trust administration

and

estate planning.

Mr. Levy has lectured for the Pennsylvania Bar Insti-

tute

and

is a faculty member o f t he P en ns yl va ni a

Bankers AssociationCentral Atlantic School of Trust.

He received a b ac he lo r s d eg re e in urban studies

f ro m T ri ni ty Col le ge and a J.D. from Dickinson

School of Law.

David Mead

CFA

is vice president

and

chief in-

vestment officer of Harris Trust

and

Savings Bank

where he directs the Personal Financial Services de-

partment. Mr. Mead is a regular panelist

on

Sound

of

Business, the bank s nationally circulated

monthly investment cassette series.

He

is a member

of the Investment Committee of the Corporate fidu-

ciaries of Chicago

and

the Chicago Society of Finan-

cial Ana lyst s. Mr. M ea d r ec ei ve d B.s.

and

M.B.A

degrees from the University ofSouthern California.

H Scott Miller is portfolio managerat Miller Ander-

son

Sherrerd s

Private Investor Group. Pre-

viously he was vice president o f t he i nv es tm en t

bankingdivision ofGoldman Sachs Company

and

vice p re si de nt o f t he p ri va te i nv es to r d ep ar tm en t.

Mr. Miller is a director of Mediq Inc.

and

serves as

a trustee for the Gaudino Trust Williams College.

Mr. Miller received a B.A from Williams College

and

an M .B .A from th e Wharton School University of

Pennsylvania.

Brian A

Murdock is vice president and senior port-

folio manager for Merrill Lynch Asset Management.

He specializes in global investment management

and is a permanent member of the International

Strategy Committee. He was executive director of

the company s Pacific office establishing the Hong

Kong regional office and developing global prod-

ucts. Previously

he

served

as

financial consultant

at

Merrill LynchInternational serving overseas

private

clients. Mr. M ur do ck is a graduate of Cornell Uni-

versity.

JohnW Peavylll CFA is Mary Jo Vaughn-

Rauscher Professor of

Financial

Investments at

vi

Southern Methodist University. He also is on the

facu lty of the schoo l s Sou thwestern Graduate

School of Banking. Mr. Peavy is research director of

the Research Foundationof the Institute ofChartered

Financial Analysts vice chairman of ICFA s Candi-

date Curriculum

Committee and executive editor of

The

CF

A Digest

He

serves

on

the editorial boards of

the Financial Analysts Journal Review of Business and

Economic

Research

Mr. P ea vy h ol ds a B.B.A from

Southern Methodist University;

an

M .B.A fr om t he

Wharton School University of Pennsylvania;

and

a

Ph.D. from the University of Texas

at

Arlington.

Nancy C

Smith

CFA is vice president

and

portfolio

manager of The Glenmede Trust C ompa ny . Pre-

viously she was vice president of the Trust Division

of P ro vi de nt N ati ona l Bank. She is a m em be r

and

past president of the Financial Analysts of Philadel-

phia Inc. a

past governor

of the Philadelphia Secu-

rities Association

and

a governor of the Association

for Investment Management

and

Research. Ms.

Smith is a member ofthe board ofdirectors of the Bell

Atlantic MutualFunds and a trustee of theAmerican

Red Cross. She is cochairman of AIMR s A nn ual

Conference Committee

and

a member of t he board

of the Financial Analysts Seminar. Ms. Smith holds

a B.A from Middlebury College and

an

M.B.A from

Temple University.

Diane

M

Spirandelli CFA

is vice president of Swiss

Bank Corporation

where

s he is r es po ns ib le for t he

management

and

marketing activities of global in-

vestment

and

private banking clients. Previously

sh e waswithWells Fargo s Private BankingDivision.

She is a member of the San Francisco Security Ana-

l ys ts Society. Ms. S pi ra nd el li is a

graduate

of the

Oxford College of Technology Oxford England and

the University of Washington s Pacific Coast Bank-

ing School.

R

Gregg Stone is a g en era l partner o f PR Ven tu re

Partners L.P. a venture f un d d es ig ne d a s a p ri va te

equity investment vehicle for individuals families

and their foundations. Mr. Stone also is a vice pres-

ident of Pell Rudman

Company Inc. He is a

director of two portfolio companies and a member of

the bo ard of ad viso rs of two p or tf ol io f un ds . Mr.

Stone received AB.

and

J.D. degrees from Harvard

University.


9/106

Investment

ounsel

for Private

nOvelView

John W Peavy III

CFA

Mary

Jo

Vaughn Rauscher Professor inancial

Investments

Southern Methodist University

In an investment world increasingly dominated by

institutional investors, the importance of individual

investors can sometimes be understated. Neverthe-

less, individuals control substantial pools of assets

and have important investment management needs.

Private clients are typified by a rising level of

investment sophistication and higher performance

expectations and demands. Beyond this general

trend, the characteristics of

individual

investors

and

the circumstances and opportunities that confront

them are more diverse and complex than for any

other class of investor.

A private client cannot be thrown in to a homo-

geneous group

with

a common set of investment

objectives, constraints, and preferences; rather, these

individuals represent a large variety of needs. The

challenge for an investment counselor is to identify

the private client s needs and to manage the client s

portfolio with those needs in mind.

Only by

satisfy-

ing individual client needs can the investment coun-

selor succeed in this diverse market.

The focus of this

seminar was o n

setting long-

term goals for wealth

building

and wealth transfer

and implementing investment

strategies

for the

many pools of funds an

individual

may have avail-

able, including personal/family funds, retirement

plan funds, private foundations and

charitable

funds. Considerable emphasis also was placed on

how to educate and communicate with private cli-

ents.

Private lient haracteristics

Beyer points out that individuals objectives change

as the result of

human

elements (such as marriage,

health, children, employment, and aging) and as the

result ofinstitutional factors (such as decisions about

asset selection, asset allocation, and market timing).

Furthermore, individuals expectations are shaped

by experience and outside events.

Beyer presents a framework for understanding

private client characteristics . Using a variation of

risk-return quadrants analysis, she suggests an ap-

proach featuring the various degrees of control and

sophistication found among individual clients. This

discipline allows counselors to focus

on

the types of

private clients with whom they are most successful.

For example, many counselors assume tha t mos t

private

clients fall into the low-sophistication/low-

control quadrant. In this case, the assets may be

controlled by a large t rust , represent ing a family

interest without a family spokesperson. Because the

client does

not

desire to have frequent contact

with

the counselor, the temptation is to leave the account

alone. Beyer cautions that such neglect is dangerous

because of the legal ramifications and the possibility

that a family member of the next generationwill take

a

more

active interest.

Ignore

the

changing characteristicsof the private

client at your peril. Certainly your competitors will

not

ignore them. Responding to change mandates

the continuing education of the private client. The

client will demand it, and an investment counselor

can

survive only

by responding

to this demand.

Developing Investment Policies

Davis relates the investment needs of private clients

who

have accumulated substantial wealth to the

phases of the business growth and development life

cycle. Each phase has different implications for asset

management. Of obvious importance is an invest-

ment counselor s ability to identify an individual s

life cycle phase and to respond accordingly.

As individuals accumulate wealth outside their

businesses, they tend to

respond

differently. The

deal makers

want

to take these assets and invest in

high-risk deals. Wealth managers are concerned

about

the preservation

and

management

of

the

wealth

they have created. These individuals are the

most

receptive to professional money management.

The

company

men and women continue to devote

their time and attention to the business often to the

neglect of their personal assets.

Davis advises that investment counselors must

be sensitive to transition issues that is, the transfer

of wealth from one generation to another. Often the

younger generat ions take a more pragmat ic view


10/106

toward investing

and

express interest in

risk-return

trade-offs. At the same time, these later generations

may havepsychological needs that require

nurturing

on

the

part

of the counselor.

Investment

Strategy

and

sset llocation

A wealthy client

or

family

may

envision a pool

of

assets as a collection of unrelated items. Miller

ad-

vises investment counselors to take a proactive role

in educating their clients

that

a portfolio

should

be

viewed as

an

integrated whole.

Many

clients have a

large core holding in a closely

held

company, real

estate, or some exotic asset. Miller argues

that

the

counselor s mission

should be

to recognize

that

the

core assets are

part

of

an

overall portfolio

and

to

determine

how

these assets interact

with other

assets

in the client s portfolio. The first

step

is to define the

portfolio.

Only then

can the counselor effectively

proceed to structure it.

Private clients are

not

a homogeneous

group

according to BruneI. Given their diversity, invest-

ment

counselors

should

ask three questions to gain

proper

perspective:

Who are these people?

What do

they need?

What

are they looking for?

asking these quest ions, the counselor will

discover each client s

unique

goals

and

needs. Only

after hearing the answers to these quest ions

and

identifying the client s key characteristics can the

counselor proceed to

make

asset allocation recom-

mendations. BruneI advises that a portfolio for a

specific person should reflect four

factors-taxabil-

ity, portfolio context, income needs,

and

multiple

requirements.

servicing the

Private

Client

Servicingprivate clientsentails a

myriad

ofactivities.

According toMurdock, investment counselors

must

be responsive to the distinctive needs

of

this special

type of client. Importantly, the private client is not

tobe confused

with

the institutional investor. Murd-

ock discusses the several key traits

that

differentiate

these types of clients.

He

emphasizes that with pri-

vate clients, the relationship is paramount. Main-

taining successful relationships requires

an

invest-

ment counselor to be flexible, demonstrate personal-

ity, communicate proactively, educate clients,

show

conviction

and

precision,

and

ofcourse, make

money

for the client.

Mead maintains that

private

clients are espe-

cially sensitive to interpersonal relationships

with

their investment counselors. Because private clients

2

are

not

all alike, a counselor

must respond

to each

uniquely. Mead provides a general framework for

classifying private clients into

broad groups

accord-

ing

to their special needs

and

preferences; these

groups

inc lude the

ultrawealthy;

the

unsophisti-

cated;

the

high-income, new-money investors;

and

entrepreneurs.

He

advises counselors to keep com-

municating with

their clients, especially

during

the

tough

times.

Helsom

contends that counselors

must

care for

their clients welfare, help

them

achieve their stated

goals,

and

charge a reasonable fee.

He

discusses the

advantages

and

disadvantagesof themajor

products

available

to

individual

investors

mutual

funds,

commingled

funds,

and

individually

managed

port-

folios).

He

also addresses the several factors that are

most important

in the private client market, pointing

out that

these factors are

not what

most counselors

think they

are. For example, most portfolio manag-

ers

focus

on

cost

and

performance; according to

Helsom, however,

most

private clients place higher

priority

on

their personal relationships

with

their

managers.

Special ssets for Private

Clients

People often think of domestic corporate stocks

and

bonds as

the major components, if

not

the sole com-

ponents, of individual portfolios. Individuals, how-

ever, also need to diversify their holdings. Three

presentations describe possiblecandidates for diver-

sifying

investments-municipal

bonds,

venture

cap-

ital,

and

international investments.

Municipal

onds

Because of the tax advantages

and

the huge size

of the municipal

bond

market (about 1.3 trillion),

Friedlander emphasizes the usefulness of these as-

sets in private client portfolios. According to Fried-

lander,

knowledge

of

important

supplyand demand

factors is crucial to

understanding

these securities.

In recent years, tax reform has

had

a substantial

impact

on

municipal bonds. As tax rates move

up

and

down

so does the

demand

for municipal bonds.

The

growth

in

ownership by

households-and

the

virtual

disappearance of two

former large markets

for thesebonds, namelycommercial banks

and

prop-

erty/ casualty insurance

companies-also

have

had

a large effect

on

demand. Other influential factors

include the substantial size of

new

municipal issues

(an estimated 230 billion annually), the extraordi-

nary

collapse in short-term interest rates, the reduc-

tion in existing

bond supply

because of the calling of

many outstanding

bonds, the

growth

of municipal

bond

funds,

and

the

changing yield relationship be-


11/106

tween taxable

an d

nontaxable bonds. Friedlander

also delves into other important considerations af-

fecting

municipal bonds including

recent

credit

trends

portfolio considerations,

an d t he c ur re nt

market environment.

Venture apital

Venture capital is private equity capital

used

to

finance the

growth

or acquisition of businesses. Ac-

cording to Stone, most private investors

know

little

about

venture capital . This is a difficul t market in

which to participate because only

about 15

advisors

control between

6 an d 7

percen t of the dollars

invested in new venture capital opportunities. Be

ginning

with

the history of

venture

financing, Stone

presents information

designed

to enable counselors

to assist thei r p rivate clients in

making

informed

decisions about investing in this asset class. For ex-

ample, venture financing occurs in cycles,

an d

the

pricing

an d

values

vary

greatly

depending on

the

phase

of the cycle. Stone points

ou t that

certain

common characteristics distinguish this asset from

the more traditional assets. These features include

long-term time horizon, illiquidity, pay-off

through

capital appreciation,

an d

gradual

call

an d

return

of

capital.

He

cautions

that venture

capital investing is

not suitable for every investor; accordingly, invest-

ment counselors should provide their clients with

sufficient knowledgebefore

recommending

this type

of investment.

Intemationallnvestments

Spirandelli comments that international invest-

ing is often described as nontraditional,

bu t

this is a

misnomer. Given that the comfort level with inter-

national investing is

no t

very high, Spirandelli

sum-

marizes the key challenges confronting investment

counselors to domestic private clients, including ed-

ucating them

on

the benefits of diversifying interna-

tionally, determining the most suitableglobal invest-

ment approach,

an d

satisfying

th e

special needs of

U clients

with

respect to foreign invest ing. She

contends that,

with

few exceptions,

investors

should hold some assets in this important group.

Themost

appropriate

international

exposure

for

an y

given client's portfolio

d ep en ds o n t ha t

client's risk

tolerance level

an d

preferences. As

an

illustration,

Spirandelli provides asset mix suggestions

fo r

four

different types of private clients, ranging from a con-

servative investor to a more aggress ive one. She

concludes by encouraging private investment in in-

ternational assets. The challenges there are real, bu t

not insurmountable,

an d

the client is likely to

be

pleased

with

the results over time.

Understanding Legal and Tax onstraints

Koontz asks, Why is so little attention

paid

to the

effect of taxes

on

portfolio returns

an d

strategies?

He

contends that b y n ot having

much

of a taxable

vocabulary, investment counselors are

no t

best serv-

ing their private clients. Koontz's presentation pro-

vides

th e

incentive to

build

a better taxable vocabu-

lary

an d

to review investment strategies that can

mitigate the tax bite.

The capital gains tax,

dividend

tax, alternative

minimum

tax,

an d

state

an d

local taxes can affect

net

investment returns. Koontz discusses each in

an

investment

context.

Several strategies can help minimize the impact

of

taxes.

Among them

are semipassive strategies, the

realization

of

losses, interportfolio swaps,

an d

over-

lay strategies. Koontz

adds

that

many

of these tech-

niques can

be used

simultaneously to optimize

an

individual s

tax situation.

state Planning and haritable Giving

The accumulation of large

amounts

ofwealth makes

estate planning

an d

charitable giving a necessity for

the private client. A successful counselor

must

be

responsive to these needs. Levy discusses three as-

pects ofestate planning

an d

charitable giving: estate

planning tools designed to reduce

or

defer tax liabil-

ity,

methods

for creating pools of funds using life-

time gifts to avoid tax liability,

an d ways

to establish

charitable trusts to

provide

benefitsboth tothe

donor

an d

to the charity.

Levy offers a case

study

to illustrate specific

ways

to benefit from estate planning. Thesebenefits

der ive from the

us e

of some combinat ion of four

weapons

against estate taxes:

The unified credit exemption that pro-

tects transfers

up

to 600,000.

The unlimited marital deduction

that

al-

lows for tax-exempt transfers between

spouses.

The

annual

gift tax exemption that per-

mits

an y

individual to pass

up

to 10,000

to

another

individual tax-free.

The charitable deduction, which can be

used

to reduce estate taxes.

Lifetime gifts also can serve as effective estate tax

weapons. particular, the 10,000

annual

exclusion

allows for tax-free transfers. addition, the use of

split-interest trusts can provide the opportunity to

leverage a gift. Levy also discusses the tax advan-

tages of charitable giving

through

such alternatives

as

outright gifts of cash

or

properties, split-interest

charitable trusts,

an d

private foundations.

3


12/106

ase tu y in sset llocation

In recognition that each private clientis unique, sem-

inar participants

were

asked to

address

five specific

case studies, each designed to provide a hands-on

example ofportfolioconstruction for a privateclient.

These exercises review the entire portfolio manage-

ment

process-an

integrated, consistent set of steps

by

which a counselor creates and maintains

appro-

priate combinations

of investment

assets.

The

Ramez family case and corresponding guideline an-

swer is reproduced in these proceedings to illustrate

theuseof theportfolio

management

process to arrive

at the best recommendation for a specific client s

needs

and

objectives.

The case emphasizes the importance of the port-

folio

management

process, beginning

with the

cre-

ation of

an

investment policy statement. The policy

statement identifies crucial issues pertaining to in-

vestor objectives, constraints,

and

preferences. The

next step is to formulate appropriate investment

strategies

and

then

implement them by

selecting the

optimal combination of assets. The case

study

also

reveals the importance of monitoring market condi-

tions, asset values,

and the individual s

circum-

stances

and

adjusting the portfolio to reflect signifi-

cant changes in

any

of the relevant factors.

Performance Presentation

Churchill observes that the AIMR Performance Pre-

sentationStandards are thefirst major initiativeto try

to achieve consistency

and

full disclosure in

theway

investment managers report their performance re-

sults. The emphasis is

on

performance present tion

rather than performance me surement Considerable

flexibility exists in the calculation of results;

how-

ever, less flexibility occurs in the presentation of the

results.

To comply with the

standards,

a

manager must

subscribe to

and

follow certain

mandatory

require-

ments

and

make certain

mandatory

disclosures.

At

the forefront of the

mandatory

requirements is the

performance composite, which is the aggregation of

the performances of several portfolios into a single

number

designed tobe representative ofa particular

strategy. All actual, fee-paying, discretionary port-

folios for a particular strategy

must be

included in a

composite. The performance of a representative

account can be

presented

only as

supplemental

in-

formation. The

standards

impose

other mandatory

requirements as well. Results

must

be calculated

using a time-weighted rate of

return

using a mini-

mum ofquarterly valuation (monthlypreferred) and

geometric linking of period returns. Within a com-

posite, the portfolios

must

be weighted

by

account

size.

Annual

returns

must be

presented

at

a mini-

mum

for all years. Finally, the inclusion of cash

and

cash equivalents in composite returns is required.

The

standards

specify that certain

mandatory

disclosures be

provided

as supplemental informa-

tion to the composite. These disclosures cover a

multitude of

topics and are designed to clarify the

presentation of results. Finally, the

standards

dis-

cuss verification of results

and

risk

measurement

issues. Churchill concludes that the standards exist

to

provide

better communication of results, better

understanding

of results, and full disclosure about

how

results are computed.

seminar Theme

A

common

thread

among

the presentations in this

proceedings is

that

private clients come in all shapes

and

forms. Each client is different

and

has unique

objectives, needs, and preferences. To

be

successful

in this

dynamic

market, investment counselors

must

be able to identify and

respond

to the diverse needs

ofthese clients. Tofocus solely

on

performance is not

enough. Private clients expect

and demand

more.

These presentations offer valuable information

on how

best to

work with

private clients. Clearly,

this

market

is

substantial

and ever-changing-a

combination

that

offersmeaningful opportunities to

responsive investment counselors.


13/106

Understanding Private

Client Characteristics

Charlotte eyer

President

Charlotte

eyer

ssociates

The characteristics and expectationsof private clients are alwayschanging,

and

the truths

that applied to this marketyesterday are only

myths

today. Advisors need to tailor their

methods of approaching and servicing these clients to each client's current needs and

perspectives.

Today s

private

clients

are different from

yesterday's, and tomorrow s will differ even more.

Today's clients are far more sophisticated. They

are

willing to shop

for-and

expect more from-an in-

vestment manager.

Myths of

the High Net Worth Marketplace

Many notionsof the private investorare reallymyths

that should be discarded. Managers who still em-

brace these old beliefs wi11lose prospects

and

clients

to those managers

who understand today s private

client.

Myth

1:

Performance is not important

I have

yet to hear anyone say he or she hired a manager

despite themanager's questionable investment track

record. Private clients want advisors to do a good

job, and that means performance. Of course, good

performance for one client may not be good perfor-

mance for another. Good performance should be

defined in terms of time frames, inflation, willing-

ness to lose money in a given year

or

quarter,

and

particularly tax sensitivity. Yet few advisors ask cli-

ents about these parameters. Clients

want

to beat the

S P

500,

but how

will

they

feel if

the

S P500 is

down

12 percentand the advisorbeatsthe S P500by being

down 7 percent?

Some advisors pick a point on the efficient fron-

tier to identify their clients' risk tolerance. Thatis like

taking driving classes bu t

never

leaving the class-

room to drive on the road. One

way

to get a t their

actual risk tolerance is to

layout

each scenario pre-

cisely, perhaps using a matr ix to show real dollars

gained or lost in varying market conditions

and

with

varying asset allocation mixes. This is how you dis-

cover a client's real comfort level.

Why

do

so

few

managers

do this? Because

most

believe they do not

have to.

Myth

2: The

privateclient

market is less compet

itive than

the

institutionalmarket The high-net-worth

market is far more competitive than anybody ever

imagined. The United States has

more

than 20,000

registered investment advisors today, compared

with fewer than 6,000 in 1980. Many of the 80,000-

plus brokers in theUnited Statessell exactlywhat the

advisors do-peace

of mind that comes from know-

ing

an

expert is interested in

and

capable of manag-

ing a client's assets. Brokers are teaching clients the

meaning

of

words

like

risk-return

trade-off and

benchmarks. Many advisors arenot doing this,

however , because they believe client education is

unnecessary.

Myth 3: The private client market is not as

demanding as the institutional market Consider the

following example of the demands encountered in

the high-net-worth market: Three investment firms

were asked to make a presentat ion to a couple who

had recently established a charitable remainder an-

nuity trust with a 1 percent payout (in a 3 percent

interest rate environment) that had been drawn up

by

a trusted personal

advisor

to the family, an ac-

countant/attorney.

Should the investment advisors

ment ion the unrealistic payout? Should they de-

scribe the risk of meeting such a payout or merely

explain how they would

manage

that portfolio with

that goal in mind?

Myth 4: Service is more important

than

any

thing else

an

advisor

clings to this idea, the orga-

nization is probably burdened with too many people

responding to too many unreasonable and irrational

requests. Many advisors believe they must spend a

lot of time talking with their clients, entertaining

5


14/106


15/106

cation, or level of investment education

or

experi-

ence. accurately analyzing clients, advisors will

not waste time

bu t

will focus on the types of private

clients

with

whom

they aremost successful. Are you

poor a t

educating? Are you impat ient with clients

who need

to control,

at

least initially? Are

you

hesi-

tant to address delicate family issues

and

confronta-

tions?

The low-sophistication-high-control quadrant

in the

lower

right panel of Figure 1 is where many of

the most frustrating prospects

fall-the

family with

one

holding

of low-cost stock, for example. To quote

onemanager, I have tried for five years to teach this

family group the importance of diversification but

with no success. This iswhereother pools of capital

come in, smaller pools-trusts for grandchildren or

private foundations. Client education iseasier

when

working

on a smaller trust or a foundation. The need

for tight control (motivated

no doubt by

fear) is less

because of the smaller dol lar amount; the cl ient is

more willing to let goof the reins. That is the begin-

ning of a relationship with potential for growth.

The low-sophistication-low-control

quadrant

shown in the lower lef t panel of the figure is

where

so

many

investment firms assume their clients fall.

A large trust may control the bulk of the assets, and

i t often represents a widow or a family group with-

out an interested spokesperson. Here the key objec-

tive

may

be income level, and the client may not

express interest in meeting with the advisor too

often. The temptation is to leave well

enough

alone,

bu t

if

an

in-law

or

a member of the next generation

iseager to learn more, you ignore that person at your

peril. these people learn without you, they have

aftertax returns.

1

This is a major issue right now.

More investors today are capable of distinguishing

their different pools of capital,

and

they expect their

advisors to

respond accordingly. Fidelity recently

introduced a chari table gift fund that has already

attracted 10 million

with about

a 2 percent fee,

and

i t has

not

even started marketing it.

Individual objectives change every day,

and

so

do

the pools of capital. How many people 20 years

ago knew

anything

about defined-contribution

plans? Today, many clients

and

prospects not only

are participants in such a plan

but

also think about

which fund to try

and

whether they should try to

time

the

market. This is an

enormous

change and a

very different pool of capital than many advisors are

used to working with.

One more change is the number of cl ients in-

volved in philanthropy. they are appointed to a

hospital

board or

a

museum board, suddenly two

n w pools of capital

are

created-not

only the

museum s or hospital's endowment but possibly

alsoa pooled-income giftto thatmuseum or hospital.

Who can keep up with all ofthis? You will , ifyou are

the investment counselor.

Working with the

Private Client

Not every excellent

investment

advisor is a

good

counselor. An honest acknowledgment of your

own

skill

might point

you toward

working with

interme-

diaries

who

perform the counseling

and

leave

the

portfolio management to you. Successful fi rms are

figuring this

ou t

and adjusting their public contacts

accordingly. Whether you are more comfortable as

a manager or a counselor, you must understand the

characteristics of the private client market.

I am often asked,

What

is the secret to this

market? I believe there is no secret-and th t is the

secret. Success comes to those

who

analyze most

astutely what is occurring in the process ofwork-

ing with prospects

and

clients.

accurately analyz-

ing private clients, advisors

do

a better job of attract-

ing the right client for their firms,

and

they keep the

clients they have.

The four quadrants in

igure

illustrate a frame-

work

for

understanding private

client characteris-

tics. It is a var iation on the risk-return quadrants.

The

x xis

is a continuum of control.

How

much

control does the individual currently want to exert

with an investment manager? This changes over

time and canchangedramaticallybetween thebegin-

ning of a client-advisor relationship

and

the

end

of

the first year. The y xis is a continuum of sophisti-

lSeeMr. Koontz's presentation, pp. 65-70.

Figure

Quadrants

of Control and Sophistication

Sophistication

High

Control

Low

Low

High

7


16/106

Thanks

to demographics, the press, investmentmar-

kets,

an array

of investment products,

and

the prolif-

eration of investment advisors, the private client is a

very

different species

than

even four yearsago. Cap-

italizing

on

these changes requires considerablecon-

tinuing education. Your clients will

demand

it,

and

your

business will

depend

on it. In the

words

of Sir

William Osler, a 19th-century Canadian pioneer in

medicine, The best

preparation

for

tomorrow

is to

do

today s work

superbly well.

ship

in 1992, and the findings are revealing.

Of

inter-

est to marketing people,

8

percent

of

the institute's

membership recommended

their

advisors to

a

friend, and 6 percentrelyon personal referral to find

an

advisor. Clients have friends,

and your

clients

enjoy learning from

you

and

the time they

spend

with

you, they

may

recommend

you

to a friend.

Fifty-two percent of respondents

plan

to

add

a

manager

this year. Granted, this is the h igh

end

of

the

market-people with

10 million and more, but

the results are probably

true

for

other parts

of the

market

as well. Also, however, 84 percent have fired

a

manager during

the past five years, and nearly a

third

of the institute's members

plan

to fire a man-

ager

this year.

onclusion

TheInstitutefor Private Investors polled its member-

probably found one of

your

competitors to teach

them.

The high-sophistication-Iow-control

quadrant

shown in the upper left panel of the figure contains

those families that

most

resemble the institutional

market. This is a family

or

individual

who knows

enough about

investing to acknowledge that they

should not overcontrol the process. They are looking

for professionals. They relate well to

benchmarks

and

asset allocation discussions, and they

want

to

talk about

specific characteristics of their portfolios

and what

performance

might

be expected in differ-

ent types ofmarkets.

Finally,

the high-sophistication-high-control

quadrant (upper

right panel) is

where you

find Mon-

day-morning quarterbacks. Clients in this

quadrant

_

are likely to

have

personal

computers

tracking and

analyzing the purchase price of

every

security their

advisors buy. Advisors need to be

aware

of this,

or

they can be blindsided by such questions as, Why

do you

always

buy at

the top? This

high

need for

control eases dramatically

the first year is filled

with

education

and

continued questioning

on needs

and

goals.

esearch esults

8


17/106

Question and nswer Session

Charlotte Beyer

Question What is a reasonable

number of client accounts a port-

folio manager can service ade-

quately?

Beyer I cannot give you a num-

ber because I have seen success-

ful firms at both ends of the spec-

trum. The number depends on

the support staff. Firms that have

higher client loads

must

have ex-

traordinary staff and marketing

support that

prepares

the materi-

als so that

when

they

meet with

clients, they

do

not have to create

the material from scratch. They

also must have support people

who can take over many of the

telephone calls. I know one firm

struggling because the increas-

ingly sophisticated private client

is demanding so much more.

This firm has 6 or 7 clients per

manager, and it is losing

ground

because it does not have the nec-

essary support.

Question Will the consultant

market become as saturated as

the manager market is now?

Beyer I believe the consultant

market is in its

infancy-accoun-

tants, attorneys,

and

tax advisors

or planners are all interested.

Also, some pension consultants

are changing their stripes

and

be-

coming private investor consul-

tants. Nevertheless, many people

still have not figured out how to

analyze the private client situa-

tion. This is what I

am

told by

private investors

who

are dissatis-

fied or frustrated

with

trying to

find someone to help them

through this maze.

Question Are you aware of the

Sanford Bernstein 1992 study on

themoney management indus-

try? How

do

you reconcile your

position with its finding that the

private

money manager client

puts performance near the bot-

tom of the list ofmanager qualifi-

cations this year? Also, what is

your

assessment of the

study

that

says confidentiality, reputation,

service, and so forth come before

performance?

Beyer

I believe that

very

often

buying behavior can be different

from

what

private clients say.

Therefore,

when

doing a

study

and asking people

why

they

hired a particular firm, they may

say what they think is rat ional. I

have never met a prospectivecli

ent

who

did

not ask

about

perfor-

mance. How much

you

tell them,

in what level of detail, and how

appropriate i t is to their situa-

tions is another story. As for con-

fidentiality, all private investors

assume that is part of the arrange-

ment. Perhaps that

study s

find-

ings reflect the sample used,

which

included

smaller, perhaps

less-sophisticated investors, who

were paid to respond.

Question What are the key rea-

sons managers are fired?

Beyer My experience in the

field-and

research is confirming

t s

that, although you may be

hired for performance,

when

you

are fired, it is because of service.

People have said repeatedly, We

fired a manager because we were

tearing

our

hair

ou t

one quarter

too

many

trying to get the infor-

mation we wanted and being ig-

nored. So we fired him; we felt

we

could always find another ad-

visor

who

could give us middle-

of-the-road returns

and

not have

to put up with the poor communi-

cation./I Typically, advisors are

fired for poor service, which sup-

ports the thesis of four years ago

that a relationship is

what

people

seek once they are clients. Ignor-

ing performance is a mistake,

however. Somemanagers brag to

me that they v r show their pri-

vate investors their performance.

I think they are asking for t rou-

ble.

Question You stated that advi-

sors

and

counselors

may not

be

the same. Do you bel ieve it is un-

important for a private client to

know the person making the

money management decisions

i.e., the actual portfolio manager)

if a good intermediary can pro-

vide the warm, fuzzy feeling?/I

Beyer Remember those quad-

rants illustrating different private

client characteristics. Some cli-

ents will not accept not meeting

the

person who buys or

sells the

securities in their portfolios, but

many people can recognize the di-

vision between the manufactur-

ing, the distribution, and the ser-

vicing aspect ofa product. Some

firms have successfully combined

these functions into one person

or

several people. Not every client,

however, insists on

knowing

the

portfolio manager and meeting

with him all the time. t depends

on how sophisticated they are

and how professional the service

contact is.

Question 63 percent of cli-

ents use referrals to find

an

advi-

sor,

what

does this say about the

role of professional marketing?

Beyer t says that they ask a

friend and next they contact the

firm. Then, marketing can make


18/106

a difference.

One

member of the

institute wanted to place 5 mil-

lion with

an

international man-

ager. The member talked to

friends

and

called 37 firms

but

also used a directory. It was

amazing

how

poorly this person

was handled by the majority of

those firms. Many advisors did

not

know

what to

do with that

cold call. So themarketing pro-

fessional is important internally

when

a portfolio manager's client

says, I want to send Jane Doe in.

She is a friend ofmine, she has

some money, and

she

wants

to

talk to

you

about managing it.

The analysis before Jane Doe ar-

rives the

work

on what you will

show her,

what

you will

not

show

her,

and

how the process will

be

managed is

critical. Most port-

folio managers

do

not have time

to

do

this type

of

analysis. Thus,

they do a standard Hello. Let

me tell you

about

the firm for an

hour or so,

and

they often lose

the opportunity to gain a new cli-

ent. In some cases they do not

even follow up. They have the

meeting, Jane Doe comes in,

hears about the firm,

and

maybe

gets a letter,

but

then there is

no

meaningful follow up. Jane Doe

may have decided not to do any-

thing for six months,

but

often

the marketing professional is the

only one in the firm

who

will

keep

her

informed, maybe have

lunch with her

or

see her three

or

four months down the road, and

talk about

how

well she is com-

ing along

with

her search for an

investment advisor. The market-

ing professional is the person

who brings analysis of every situ-

ation to the fore.

Question Do

you

think wrap

fees are too expensive?

eyer Yes,

bu t

participating

brokers will tell you the fees are

coming

down.

Market forces are

bringing them down. Although

many

of the big firms

do not pub

licly say they will negotiate re-

duced

fees,

that

is

what

they

are

doing. The broker makes a little

less money on

it,

bu t

consider the

mutual

funds' load fees. They

used to get 8 to 10 percent, bu t

those percentages have been ne-

gotiated and brought down by

the market.

Question

Are fee levels import-

ant?

eyer

No. This does not seem

to

be

a very fee-sensitive business

yet.

When

I

worked

in invest-

ment firms, however, my col-

leagues discussed fees in such a

way that it turned off the prospec-

tive client,

or

they

would argue

with clients about increasing fees.

What is

important

is the

way

fee

levels

are

discussed and de-

scribed. the process of explain-

ing your firm has been

done

too

routinely and predictably, when

you

get to fees, people will say,

That is sort ofhigh. Another

firm

we

spoke

with

charges less

than

that. Now at last, price is a

topic they feel qualified to discuss

with you.

from the beginning

your

presentations are lively give-

and-take

about

what they want

their money to do, fees will be

an

afterthought, because you will

have them signed up before

you

even mention fees.

Question

Please discuss your

views

on

the ability of large orga-

nizations, such as trust depart-

ments, versus smaller investment

counseling firms to serve private

clients.

eyer I believe both are

equally capable. The question is

how well

an

organization man-

ages the process. To the extent

that

a firm has capable leaders

and professionals who are analyz-

ing the process of selling

and

ser-

vicing, the firm will be successful

with

private clients.

Question Given the changes in

the character of the private client

market, do you see more ofa will-

ingness

or

demand for interna-

tional investing? Also, is there a

trend

toward

more

than one

advi-

sor, such as in the pension world,

which uses specialty advisors?

eyer Only 8 percent of the

institute's members' assets

were

diversified overseas as of mid-

1992, but virtually three-quarters

of

our

members said they are

looking at international invest-

ments. So

of

the more than half

of our members planning to hire

managers, practically all are look-

ing at international

or

global in-

vestment advisors.

In response to the trend to-

ward

multimanagers,

on

average

institutemembers use five manag-

ers, but that does not mean a

large

bank or

a large firm cannot

implement a multistrategy ap-

proach. Tad Jeffrey wrote

an

arti-

cle

about

having too manl portfo-

lio managers in the stew. This

was

a compelling

argument

for

having one firm implement a

multistrategy approach rather

than hiring several different

firms. You can argue this both

ways. The trend

may

stem from

a dearth of ideas or new sugges-

tions coming from the one firm

clients currently are using.

lRobert H. Jeffrey, Do Clients Need

Many Portfolio Managers? ournal of

Portfolio anagement(Fall 1991l:13-19.


19/106

Investment Planning for

ntrepreneurs

Peter avis

irectorof

Family

usiness Executive Education Programs

Wharton

School

University

of

Pennsylvania

As a group entrepreneurs provide a unique set of challenges to investment advisors.

Because they harbor psychological resistance to dealing

with

such threatening issues as

estate planning advisors must demonstrate great communications skills exercised in a

context of trust.

Private

clients as individuals

an d

as families pres

ent some unique challenges to investment advisors.

The financial issues ar e frequently

complex-a

we b

of intermingled concerns about business strategy

estate

an d

tax planning organization

an d

succession

planning

an d

perhaps most significantly personal

psychology.

A good scare is worth a

pound

of advice. Wecan

talk until we are blue in the face about such issues as

estate planning

bu t

we will notmake much progress

until these clients realize some tangible consequence

for

no t making decisions.

Entrepreneurs an d

wealthy individuals usually strongly resist dealing

with change in their personal lives. Yet good finan

cial planning requires anticipating

an d

planning for

change. This deep psychological resistance to deal

ing with such threatening issues as estate planning

or gifts tothe children can be overcome onlyby great

communications skills exercised in the context of

trust. Entrepreneurs as a group provide a

unique

set

of challenges to

an

investment advisor.

The ntrepreneurial Psyche

For most entrepreneurs the concerns of investment

advisors fit into their priorit ies in a secondary way.

As I talk to founders an d entrepreneurs about tran

sitions they want to talk about their children their

businesses an d their strategies bu t they do

no t

want

to talk about managing their money. They make a

distinction between wealth creation

which

is what

they do an d wealth preservation which is

what

the

investment advisor does. In good years the success

ful entrepreneurs have seen their corporate equity

grow more than percent a year. Thus they do

no t

ge t

too excited when the

advisor

is talking 7 percent

as opposed to 6 percent. They have also m ad e b ad

investment

mistakes in the past because they have

n ev er h a d the t ime to take investing ser iously

an d

friends have given them a tip that performed disas

trously. At base they do no t trust investments they

cannot control.

For most entrepreneurs wealth preservation is a

reactive process. they make a lot of money they

pu t some away.

they get scared over their ow n

mortality they pu t some more away. They draw

money down in

large

amounts

to

fund

their

pe t

projects. Most good entrepreneurs

do

no t look after

their money because deep

down

they feel they could

always make more. Yet as we all know sometimes

looking after your money is important. Throughout

their lifetimes entrepreneurs build businesses. The

businesses develop net worth which remains highly

illiquid an d the

entrepreneurs

develop personal as

sets mostly real estate. They also develop personal

liquidity although no t much. They develop signifi

cant debts in some phases of th e life cycle including

personal debt an d obligations to support their busi

nesses

and

corporate debts to finance growth. In

other words

they

have many

financial pockets cor

porate an d personal and how these fit together is

important. Looking after their money is o n e p ar t of

the puzzle bu t entrepreneurs rarely stop to analyze

the total financial picture an d look

at

the manage

ment of personal l iquid assets in the context of an

overall financial plan.

A recent experience illustrates the importanceof

evaluating an entrepreneur s total financial position.

A founder died very suddenly in his early sixties.

Because h e h a d been a healthy man he had done very


20/106

little in the

wa y

of es ta te planning. The chi ld ren

bought the operating business from the founder be-

fore his death. They

paid

little for it because they

assumed

the

company s debt would

reduce the

ne t

worth to precious little. More

than

200 million

worth

of real estate

was

placed in the trust, together

with

5

million cash. Thevalue of the real estate

wa s

dependent on

the performance ofthe operating com-

pany. The children operat ing the company were

under

the

gu n

from the banks,

which wanted

to see

better performance an d more collateral. The

trust

only

ha d 5

million, however,

an d

the trustees

ha d

to

worry about

the

widow

an d

other

financial con-

tingencies. The trust

ha d

to

draw th e

line

on

lending

to

t he op er at in g c omp any w hi ch h ad n o other

sources of capital.

The situation was interesting because it involved

a growing adversarial relationship

among

trustees,

the family

members running

the

company an d th e

banks. Clearly, the estate

wa s no t

sufficiently liquid.

The founder could

no t

afford to die in a

down

mar-

ket. Perhaps the problem could have been solved

by

life insurance. Perhaps it could have been solved

by

a carefully built pool of l iquid assets sufficient to

keep the overall portfolio (business assets, business

debt, personal assets, personal debt, tax liabilities,

an d

so forth) in better liquidity balance.

Entrepreneurs

badly

need comprehensive finan-

cial planning that

subsumes

corporate

an d

personal

resources

an d

needs, as well

as

future liabilities.

They probably find this service

hard

to

ge t

because

the service providers offer a fr agmented view of

what

they need. Insurance brokers offer an insur-

ance view, accountants offer an income statement

view,

an d

investmentadvisors just

want

to carve

ou t

a piece of it (the l iquid piece)

an d

hold it in a fund.

The

new opportunity

is in a more comprehensive

approach that looks

at

investment opportunities in a

broader

context

an d

establishes investment goals ac-

cordingly.

Ho w

can

we

get an entrepreneur to listen

and

not feel that these approaches are too expensive,

boring,

or

constraining? This is th e challenge.

Five Phases

of

usiness

evelopment

Investment advisors considering the entrepreneurial

market mustlookat investmentadvice in the

broader

context of a client's total financial needs,

much

of

which is built around the business. They also

must

learn persistence in the face of likely

stubborn

resis-

tance. A third piece of advice is to recognize

that

the

financial needs of

an entrepreneur are

very

depen-

dent

on the business life cycle. Churchill

an d

Lewis

identified five phases of business

growth

an d

devel-

opment, each having different implications for fund

management.

1

hase 1: Existence

This is the founding stage

o ft h e

business, in

which

the founder is the business,

systems

an d

formal planning are nonexistent, loyal

customers are few

an d

far between,

an d

financial

crises are frequent. Collateral obligations intermesh

personal

an d

corporate finance,

an d

capital is des-

perately short . The founder needs income, credit,

an d forgiving creditors.

hase 2: Survival

The

owner

is still synony-

mous with

the business, bu t the business looks more

respectable-as

if it will be

around

for a while. To

ensure

survival, the

owner

takes on major projects

such

as

building

control, hiring an experienced

fi

nancial officer,an d investingin newplant

an d

equip-

ment. In the survival phase, cash

management

is

key. Whatever cash

th e

business has generated is

used

for expansion.

hase

3:

uccess disengagement

Success dis-

engagement occurs after 10

or

15 years in the busi-

ness. By now, the

owner may

be in his mid-40s

an d

is a presence in

the industry

association. The busi-

ness is established in a niche, with survival likely.

The goa l is to keep the

company

stable

an d

profit-

able. For th e entrepreneur, keeping control is im-

portant, bu t delegatingnonessential tasks isthe trick.

The

founder

can

no w

go

away

for three days,

bu t

he

is on the

phone

every day talking to employees

an d

getting reports

on

what

is going

on-letting

every-

one know he

is always there.

He

relies on experi-

enced, long-term employees

an d

avoids business

risks.

He

is cementing customer loyalty, expanding

outside

interests, an d consolidating wealth.

The business is

on

a plateau.

No

exciting

ne w

initiatives are being taken. The

owner

has reached a

level of security in the business an d begins to enjoy

three

months

in Florida every winter. Typically, the

corporation is converted to SubchapterS status, an d

cash is taken

out of

the business. This is the first

period

in

which

the

entrepreneur

can be self-re-

warded

for business success. Priority expenditures

are for life-style projects-boats houses,

an d

air-

planes. Some cash

ma y

build

up

bu t the entrepre-

neur

still needs liquidity because large uncertainties

still exist

an d

because of the next phase.

hase 4: uccess growth

The

entrepreneur

must

consolidate resources

an d

redirect th em-u su -

ally

toward

growth. This is because

50

years ago, a

family business could stay

on

a plateau of success

disengagement indefinitely,

bu t today

the rate of

technological an d competitive changeforce frequent

periodic reevaluations of corporate priorities. Every

dollar of corporate equity

no w

becomes invaluable

lNeil C. Clmrchill an d Virginia Lewis, Five Stages of

BusinessGrowth,

Harmrd usiness Review (May

/June 1983).


21/106

to the company struggle to find the resources neces

sary to fuel growth. The corporation ma y be recapi

talized an d

n ew p ar tn er s m ay

be

brought

in if the

capi tal needs are extreme. Whatever resources the

entrepreneur has managed toaccumulateoutside the

business

must

be conservatively invested to balance

the enormous risk the business is facing.

Phase Take off As the

owner

struggles

with growth he learns some basic truths.

He

no

longerknows itall

an d

he can

no

longer do it all. He

must learn to delegate

an d

trust

bu t

this is counter

intuitive.

He

has never experienced a real depen

dency on others ye t he begins to realize tha t he

cannot ge t along without significant others support

ing him in key manageria l

an d

advisory roles. He

begins to

open up

an d seek advice.

For the financial advisor this

phase

is an import

an t period of the

entrepreneur s

life. This is the first

time that comprehensivefinancial

planning

becomes

possible. The entrepreneur is seeking balance be

tween

time

spent

in the business

an d

time

spent on

personal pursuits between hands on direction

an d

delegation

an d

between the risk

an d

opportunities

of business an d the security of outside investments.

It ma y be necessary to restructure finances go public

bring in ne w investors an d / or establish

an

em

ployee stock ownership plan. His personal portfolio

ma y be builtlookingforward to thefuture

an d

taking

on

more r isk as the business r isk progressively di

minishes.

13


22/106

Question and nswer

Session

Peter

vis

Question Ho w

can

yo u

con-

vince the business owner t ha t h e

can take on additional risk out-

side his business i his business is

doing well? In other words ho w

do

y ou g et h im

ou t

of money mar-

ket funds?

Davis Wh y

do

yo u want to

do

that? Getting

ou t

of money mar-

ket funds ma y no t be appropri-

ate. Once yo u get to the risk

issue you immediately start push-

ing yourself into client control

an d the typical owner l ikes a lot

of control. he is going to

have

risks he wants to control. yo u

want to deal with control issues

with him yo u will earn every

penny

you get. I would suggest

backing off giving

hi m

space let-

ting him ru n his business. yo u

push too hard you ruin the rela-

tionship. A basic characteristic of

successful

entrepreneurs

an d

founders is the

need

for control.

You ar e

on

a leash an d that leash

can be pulled quickly if yo u lead

hi m

ou t beyond his risk tolerance.

Question

D o b a nk s h av e a

unique

opportunity

to leverage

their client relationships with

business owners in managing

their personal assets? so

ho w

should this opportunity be

pur-

sued?

Davis

The

entry point

to

many

of these issues like th e estate

planning

issue is through such

entities as banks accountants

an d

lawyers. Th e relat

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