Finding the next Tom Brady

Like others in financial services, I’m fond of using sports analogies to make a difficult point.

While watching the 1st round of the 2013 NFL Draft, I thought it would be instructive to see what we could learn about selecting a financial advisor by watching how pro football General Managers select their next franchise player.

In trying to identify future Hall-of-Famers, GMs typically use two methods. One approach relies on analytics like the Wonderlic Test, a measure of intelligence that assesses learning and problem-solving capabilities. The other defaults to the Scouting Combine, which evaluates the prospect’s physical assets – height, arm length, weight and hands.

Both use a scoring system that helps football executives evaluate talent. Yet, for the all emphasis on objective analysis, neither approach is fail-safe. In fact, it may not be the best way to find a star like quarterback Tom Brady.

Brady was picked in the sixth round and scored poorly on many of the tests. But the graduate of Serra High School in San Mateo is one of the best quarterbacks to ever play the game. Now in his 14^th season, Brady has played in five Super Bowls and won three of them. Ask nine out of 10 NFL diehards about the best draft pick ever, and Brady will be right up there.

The Legendary Gil Brandt

How do you find the next Tom Brady?  Gil Brandt, the GM for the Dallas Cowboys from 1960 to 1988, was a master.

He chose one of the greatest quarterbacks ever, Hall-of-Famer Roger Staubach – not in the sixth round but in the 10^th round! His first choice in the NFL draft was lineman Bob Lilly, another Hall-of-Famer. Gil’s got street cred on the topic.

Gil succeeded largely without the benefit of computers and a team of statisticians pouring over data. He did it the old fashioned-way. He would get to know the player, talk to the player’s parents, travel to the town where a player lived and ask locals what they thought of him.

Character Matters

Insights about a person’s character are especially important when you consider a wealth manager. At the end of the day, as Gil Brandt knew, character matters – a lot. It’s what sets people apart.

The good news is that it’s never been easier to evaluate someone. A client can learn about a financial advisor in just a few minutes: Do a Google search, check out an advisor’s LinkedIn profile, read their blog or follow them on Twitter.

After the research, it’s critical to ask for at least several meetings before making a choice. If an advisor won’t spend time with you while you are a prospect, imagine how you will be treated when you are client.

And ask for references. A friend of mine, a great wealth advisor, has a very unique approach to providing references to prospective clients: He offers up as many clients as the prospect would like to speak to.

If you match the information found online with face-to-face meetings, you can make a reasonable assessment of character.  

With due diligence there’s a better chance of spotting people with character flaws, like former San Diego draft bust  Ryan Leaf. Once considered a true talent, Leaf’s life has unfortunately unraveled and is now facing a number of criminal charges.

While there are no guarantees you’re going to choose a wealth advisor that performs like Tom Brady or Roger Staubach, you’re going to increase your chances of success if you spend the time focusing on their character not just their past performance.

We Need Another Rooney Rule

People hate being told what to do, but sometimes tough love is the only way.

Consider pro football, one of the most bare-knuckled games around. It took a hammer like the Rooney Rule to pry open the clubby world of wealthy team owners and bring them into the 21^st century.

Named after Dan Rooney of the Pittsburgh Steelers, the Rooney Rule mandated that at least one minority candidate be interviewed for any head coaching job. The reason: From 1921 to 2003, only seven minorities served as head coaches for the mostly white team owners.  Even my friend’s 7^th grade son knows this “just ain’t right”.

The Rooney Rule went into effect in 2003, and since then, 13 minority coaches have been hired. There’s an open debate whether more needs to be done to promote minority hiring in the NFL. We’ll leave that for others to discuss, but the point is not lost on us that the financial services industry could use its own Rooney Rule.

Country Club Living

Like team owners, Wall Street has always been a good ole’ boys’ club. The financial crisis exposed the dangers of insular thinking and greed.

The financial meltdown was in large measure the result of compensation schemes that motivated Wall Street to take outsized risks with firm capital. 

Compensation got out of hand because there was an asymmetry between pay and performance. When Wall Street took big risks and it worked, the payday was huge. When big risk failed, taxpayers in the U.S., Iceland and elsewhere picked up the tab.

Enter Tough Love

Did Wall Street know this compensation problem existed? Yes. Did it do anything about it? No. 

This issue needs to be addressed, and it’s already happening.

The first salvo was fired in the European Union. In early March, European Parliament and member states capped bonuses at no more than the annual salary for bankers working in the EU and for those working for European-based banks worldwide.

This week, voters in Switzerland overwhelmingly backed an initiative to give shareholders of Swiss-listed companies control over executive pay. The law limits severance packages, side contracts, and rewards for buying or selling company divisions.

Ironically, 100 years ago, J.P Morgan himself said that the CEO should never make more than 20 times the lowest paid employee!

All Eyes on FINRA

Recently, the spotlight has shifted to wealth advisors in the U.S.

FINRA has proposed a new rule requiring that wealth advisors fully disclose to clients the large recruiting check they receive when changing firms. The rule hasn’t been passed yet, but the comment period for this new statute ended two weeks ago. Surprisingly, two of the largest brokerage firms have already come out in support of the rule.  If it does pass, the prospect of taking a recruiting check is likely to be far less appealing for many advisors.

Our question is, will the proposed rule just hurt advisors' bottom line or will it protect the firms from continuing to make poor financial decisions?

Bottom Line

The Wealth Consigliere is not an advocate of government intervention, but a Rooney Rule in financial services is long overdue. The elephant in the room is compensation and it needs to be addressed.

Sometimes we just need someone to say, “This just ain’t right.”

Listen to your Periodontist

I was at a wealth management event last week when I bumped into one of the industry’s thought leaders. We were chatting, and he said he gets asked a lot about Sanctuary.

My ears picked up, so I asked him what he said about us. Answer: “Sanctuary is the periodontist for wealth advisors.”

 WHAT?

It wasn’t quite the answer I was expecting. Nor a serious contender for our new marketing tag line.

The periodontist, he said, is the person who breaks the bad news that your gums are on fire and you’re going to need surgery. Unfortunately, he said, most ignore that advice unless they’re bleeding or their teeth are falling out. The inclination is to deal with it later.

Yet, as soon as the doctor’s warning turns into a full-fledged dental crisis, the first person you call is the periodontist.  That specialist is the only one who can fix the problem.

Sanctuary, he said, plays the same role for advisors. Many Wall Street advisors realize someday they will need to leave their firm. It’s a festering worry about their future, but things aren't quite bad enough right now to opt for independence.

But then a merger comes (bacterial plaque). Or the payout goes down (tooth ache). Or your company forces you to offer products you don’t believe in (lost molar). Or the technology platform blows up and drives away your clients (root canal).

My friend was correct. Sanctuary is like the periodontist for elite advisors. Many of these advisors know they should be doing something, but are instead standing pat. The recent story in InvestmentNews about the dearth of breakaway advisors is Exhibit A.

Are you a Periodontist?

While Sanctuary-as-periodontist is an apt analogy, the same idea holds true for wealth advisors and clients.

A responsible wealth advisor looks at a client’s portfolio and suggests that a risky portfolio needs to be addressed. The client responds by saying, “My portfolio was up 15% last year. Why should we change?” Then nothing happens until there is a traumatic market event.

In fact, most investors still haven’t gotten back into the market because the financial crisis was so painful. The result is that many are afraid, but that could be just as disastrous if they miss the next rally.

Listen to Your “Periodontist”

There are a lot of well-meaning advisors we don’t listen to in our lives. The list includes our spouse, parents or friends. The lesson learned after we've ignored good advice is that we should have listened. Distraction or hubris is usually the culprit.

The moral of the story: Listen to your “periodonist” before your teeth fall out!

Don't do as I say

Niels Bohr, winner of the Nobel prize in physics and shrewd observer of the human condition, once said: “Prediction is very difficult, especially if it's about the future.

And when the forecasts are made by the investment pundits, that’s doubly true.

The fact is many places we turn for insight about the future are wrong.  The irony is that most people – whether advisor or investor – instinctively know not to trust the soothsayers on CNBC commercials  or the fulminating blogger listing the 10 hottest stocks of 2013.

Yet we listen anyway, discounting what they say almost automatically.  Then in a quiet moment, their perspective delivered with the Super Bowl-like confidence starts whispering:

“You should seriously consider my firm’s top 10 ideas for 2013.”

The more famous the prognosticator, the more likely it will stick in your head.

World Domination – No Problem

A recent study by two UK professors confirmed just how wrong the experts can be when it comes to investing.

Their survey of U.S. fund managers concluded that “excessive levels of overconfidence interfere with sound investment decision-making and thereby diminish future investment returns.” The headline in the Financial Times said it all: “Beware the dangers of overinflated egos.”

Since you’re probably as sick as we are of reading predictions for 2013 from the cocksure, the Wealth Consigliere simply won’t go there.

In our view, there are two types of blogs – those that make predictions and those that stick to the facts.   We’ll stay firmly in the second camp.

Nobody knows what will happen in the financial markets or anywhere else for that matter. That’s true, whether you’re managing wealth yourself or for your clients.

Death & Taxes

However, one thing we do know with absolutely certainty in 2013:  Taxes are going up. Way up.

Federal incomes taxes are rising. Capital gains and dividend tax rates are reaching skyward. If you live in California, state taxes are at escape velocity.  All of these increases are fact.

Depending on your income bracket, that can translate into real money and could have a much larger impact on your net worth than a prognosticator’s  “top picks”.  Tax planning is not as sexy as "picking stocks" but in 2013 it can be much more satsifying.

Seek Advice

What should you do?

We’re not advocating Phil Mickelson’s move out of the California to protest the Golden State’s accelerating tax burden. But we do advocate spending time with your advisors – your wealth manager as well as your accountant, tax attorney or estate planner.

If ever there was a time to structure wealth appropriately for tax purposes, it’s now. With a slew of taxes hitting at once, one of the smartest moves you can make is managing your tax liability. Finding an advisor who is knowledgable on the new tax law is a better use of your time than looking for an advsior that can select the best investments for 2013.

There is an old adage that those who can’t do - teach. We’d like to add to that: People that can’t invest - make predictions. 

2012 - A Surprising Year

“Life can only be understood backwards, but must be lived forwards.”

Danish philosopher Soren Kierkegaard

This bit of wisdom was particularly true in 2012 if we look at three events whose significance is obvious now, but not for the reasons they seemed at the time.

Facebook's IPO 

Facebook’s IPO in May was one of the most hyped public offerings ever. It was also a bust. In retrospect, many red flags were ignored.

The first indication of trouble was the pre-IPO bubble in Facebook shares. Retail investors confused their affinity for Facebook and social media with unbiased investment analysis.  For example, many euphoric traders loaded up on Facebook shares before the IPO through SharesPost and SecondMarket hoping to outsmart the "established" IPO marketing process and purchase shares below the assumed IPO price.  They thought Facebook was a sure thing.  Many are still hurting; Facebook’s stock remains well below its IPO price.

Another warning sign was the abnormally high allocation of Facebook shares to retail brokers and their clients. For a hot IPO, retail brokers typically get nothing. Or, if they do, their percentage is in the low single digits. For the Facebook IPO, many retail brokers got 50% or more of their indicated interest. There was much more stock available to retail investors than usual because institutional investors were reducing their orders. Many were scared off by the downward revenue revisions, only shared with institutional investors just before the IPO. Last week Morgan Stanley was fined for this preferential treatment.

Morgan Stanley’s acquisition of Smith Barney 

Morgan Stanley’s purchase of the remaining part of Smith Barney's wealth management group had significant unintended consequences. (See our September blog, Mexican Standoff.)

The combination of a higher capital outlay for Smith Barney and tepid 2012 financial results from investment banking forced Morgan Stanley to tighten its belt. That came at the expense of needed technology investments to bring both firms together.  The botched integration angered brokers and clients, and it lead to defections of both.  The disaffection with Morgan Stanley may continue in 2013 because the firm’s technology problems are still not resolved.

Three years from now, this transaction may be viewed as genius. For now, it’s anything but.

Luminous transaction

The Luminous sale to First Republic was the defining wealth management deal in recent memory. 

The transaction validated the potential for former Wall Street financial advisors committed to unconflicted, independent wealth management to experience spectacular growth and value creation.  (See our November blog, Same As It Ever Was?)

After breaking away from Merrill in 2008, Luminous grew assets under management from $1.7 billion to $5.5 billion. In November, it agreed to be acquired by First Republic for $200 million.  If elite advisors ignored the advantages of breaking away before, they aren’t now. Everyone in a corner office is talking about Luminous.

In our view, these three events should be viewed as a call-to-action to advisors and clients still working with a Wall Street firm.  As 2012 demonstrated, there’s clearly a better way.

Same As It Ever Was?

Now that the dust has settled on the Luminous sale, it’s worth wading through all of the hype and surprising professional jealously to analyze the merits of the transaction.

When you consider the poor track record of banks making wealth management acquisitions, it would be too easy to conclude that another dumb bank has just bought another wealth advisory firm built by "smart" Wall Street pros.

In the late 1980s, Bank of America bought Charles Schwab & Co. and then sold it back to the founder for pennies on the dollar.  In 2000, State Street made the same mistake.  It bought Bel Air Investment Advisors and sold it back to the founders, again for pennies on the dollar.

This Time May Be Different

Why didn’t those investments succeed?

Previous transactions failed because the acquired firm was not a strategic fit. Equally as important, the bank wasn’t fully committed to integrating the firm into its macro business plan.  The new wealth management firm was just too small to matter to a megabank.  When you factor in the typical internal politics in any big organization, the challenge was too great to overcome.

Fast forward to Luminous.  This is a team of rock stars.  When they broke away from Merrill in 2008, they were the firm's  largest, fee-only team.  Upon exiting Merrill, the partners had numerous opportunities to grab very large recruiting checks by going to another Wall Street firm, but they turned them all down.

Why? Because they did not want to be subjected to the same constraints that were hindering their business at Merrill.

Their instincts proved stunningly correct. In the four years since they left Merrill, Luminous grew from $1.7 billion to $5.5 billion at the time of their sale.

Luminous achieved this breath-taking feat by combining two highly effective strategies 1) They adopted the best growth practices from Wall Street 2) They were very disciplined in executing their  independent, business model.

In the process, they reconfirmed the breakaway value proposition: Highly attractive after tax compensation and complete control over your own destiny.

The Instagram of Wealth Management

For those familiar with Facebook, this transaction for First Republic reminds us of Facebook’s purchase of social media darling Instagram in April, just before its IPO.

Facebook recognized that their users couldn’t easily take and share pictures – a highly valued feature in social media.  Facebook addressed its suboptimal photo interface by buying Instagram’s technology for $1 billion, a price considered rich by many.

Along the same lines, First Republic bank realized it wasn’t as successful in wealth management as it would have liked. It has an incredible brand that provides high-end mortgage solutions, and has been seeking to expand its wealth management capabilities for many years.

The difference between the Luminous deal and other misguided wealth management acquisitions is that First Republic is small enough and nimble enough to make it work.  Luminous is truly integral to First Republic’s long-term wealth management strategy. Moreover, the bank has the organizational commitment and discipline to make the most of this blockbuster deal.

And, regardless of the "actual" sales price of $125 million to $200 million, the deal came with a very nice kicker – a treasure trove of leads that would even make the Glengarry Glen Ross sales team happy.

You know, this just might work.

Do They Measure Up?

How should we evaluate money managers and business leaders? Or for that matter, a presidential candidate?

One way is ask these three key questions:

1. Have they developed a well-defined strategy?

2. Do they have the gravitas to consistently make tough decisions?

3. Are they highly effective communicators?

If we look at all three – money managers, business leaders and presidential candidates – there are some compelling similarities and noteworthy differences.

The Great Money Manager

When we analyze the standout money manager, we typically see a coherent and careful strategy. That strategy may or may not be complicated, but it is always well-defined.

Equally as important, the great money manager doesn't materially deviate from their strategy. That requires a steely ability to make difficult decisions. For example, if a manager sells while the herd is charging after the market, courage is necessary to weather the inevitable second-guessing that will follow.

A great investor must be willing to make the difficult or contrarian call because their investment discipline dictates it. If the investor abandons that discipline, it’s easy to lose focus and conviction. Without that, they become under-performing roadkill.

As for communication, the great money managers know it is almost as important as the strategy itself, particularly in times of crisis. The best managers never hide when the sky is falling. At a minimum, a meltdown is an opportunity to remind everyone of their strategy. At best, the world-class money managers recognize that communication is an ongoing opportunity to educate the marketplace and ultimately expand their influence and/or client base.

Business Leaders

For an investor, the fundamentals of an investment strategy shouldn't change regularly. For the business leader, it may be just the opposite. Marketplace forces demand rapid and regular adjustments.

As a result, decision-making is doubly difficult. The business leader needs to: 1) Make hiring and firing decisions to continually source the talent to meet their evolving business needs, and 2) Have the fortitude to modify the product or service whenever necessary (Apple Maps). 

It’s a constant threat – innovate or die – but there’s no choice. Just look at all of the companies the world has passed by or are in the process of being passed by: Gateway, Yahoo, Kodak, Blackberry, Best Buy, among others.

When it comes to communication, the business leader needs to be an unabashed marketer. Unlike the renowned investor, who may deliberately take a lower key approach, the business leader must be the most ardent and articulate champion of the brand. Would you buy a product or work for a CEO that wasn't willing to extol its virtues to everyone?

Presidential Candidate

Which leads us to presidential candidates. We’re days away from an historic election.  

As we go to the polls, shouldn't we hold the candidates to the same standards: What is their clear strategy? Can they make the gut-wrenching decisions to advance the country? Can they move public opinion to get something done for the common good?

These are all important questions to ask when deciding - do my money managers, the companies providing me with valuable products and services or my presidential candidate measure up?

Please vote!