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Reflections on 2019 - and Why Our Unusual Business Model Works for Clients


We had an extremely busy last two months of 2019, and unfortunately writing activities had to be put on hold. But I'm looking forward to resuming those activities in 2020 and getting back to sharing our observations on business, investing, our industry, and the world at large.


We wish everyone well as we get set to make another trip around the sun.


Client activities in the last quarter of 2019 highlighted why our business model is based on fixed fees, rather than asset-under management (or AUM) fees. AUM fees are the dominant fee model in the financial advice world. Fixed fees are rare and unusual (see our prior post for more on the difference between these fee models). We still believe that incentives matter; that being paid based on one service while also providing other services has the potential to create conflicts and misalignment of interests.


Let's review a sample of activity for which we provided analysis, recommendations, coordination, and execution support in 2019:


1. Using monies from investment accounts to fund private real estate purchases


Many of the families we support invest in residential and commercial real estate. Whether through their own networks, or ours, attractive opportunities sometimes present themselves for reasons that have little to do with the broad macroeconomic factors that influence public markets. Given the limited opportunity set in stocks and bonds, and the challenge of finding income without taking excessive credit risk, we have recently encouraged clients to invest in private real estate (rather than stocks and bonds) if property economics are attractive and offer sufficient margin of safety.


2. Using monies from investment accounts to invest in private businesses


We don't find private equity to be all that attractive today (too much cheap money chasing too few deals) but we do see selective situations where buying into small, private businesses can be an intelligent way to allocate long-term capital. Like private real estate, these include opportunities that arise through the networks of our clients (as they are all entrepreneurs) or opportunities that we come across in our travels. Also like real estate, we see these businesses as offering:


  • More interesting risk/reward versus what's generally available in public markets

  • Reasonable valuations, such that if the business performs well then owners do well (this is not always true - e.g. 2000-2009)

  • Investment results that are less dependent on the outcome of trade wars and Federal Reserve policy

  • Investment results that are more dependent on management's ability to capitalize on niche opportunities and allocate capital sensibly


3. Taking advantage of the QOZ/QOF rules to defer realization of capital gain


Clients used cash to invest in funds run by real estate management teams that have a track record of success in developing real estate assets (a critical part of the QOF rules). This is akin to taking a seven-year loan from the government (federal and state) at 20-35% loan-to-value (depending on state of residency) but only having to pay back 85% of the loan balance at the end of the loan period. Plus, there is the kicker of no capital gain on the QOF investment itself if held for more than 10 years.


4. Gifting shares of highly appreciated securities


Some families gifted shares (of corporate stock or funds) directly to their preferred charities or to their Donor Advised Fund, getting the double tax benefit of deduction against income tax while avoiding capital gains tax.


Note that most of the actions cited above involved the transfer of monies or securities from regular brokerage accounts (subject to AUM fees) to private investments or third parties (where they would not generally be subject to AUM fees). For most advisors, that means reduced revenue. Surely - in bigger volumes - these kinds of actions create a problem for AUM-based advisors: what may be best for the client can negatively impact the advisory firm's revenue and business value.


We continue to choose the fixed fee model as a preferred way to advise entrepreneur families on the full range of opportunities available to them. 2019 highlighted why.

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