My conversation with Katie O'Dwyer on Treussard Talks is now streaming.

This was another great one.

I really think you'll like it.

Katie was Partner and CFO for the multi-billion-dollar family office Ziff Brothers Investments during the 2008-2009 Great Financial Crisis.

Put simply, she is a B-O-S-S, boss.

She's also a fabulous human being.

Our conversation is on:

• YouTube here.

• Apple Podcast here.

• Spotify here.

And don't forget to SUBSCRIBE to Treussard Talks on your favorite podcast app — it's the best way to make sure you never miss an episode. Extra credit for sharing with friends… 🙂

I know… The idea of explaining something by analogy is to make one thing that's obscure LESS OBSCURE by relating it to another thing that's more commonplace.

And here I am, about to explain how I think about "being on your side of the table" in wealth management by relating it to some inside-baseball situation that played out on Wall Street 15 years ago.

Oof.
We're off to a rocky start. 😬

Bear with me, it's worth it.

In my conversation with Alec Crawford on Treussard Talks a few weeks ago, we talked about something that happened in the days leading up to the Great Financial Crisis.

A bunch of people from a large investment bank (we call those people "sell-side" people on Wall Street) came in for a meeting with Alec and some of his colleagues.

They wanted to "educate" the group at this sophisticated family office (i.e., "buy-side" people in Wall Street parlance) about mortgage-backed securities they had to sell.

Or in Alec's own words:

"…relatively sketchy mortgage-backed securities, CMBS [commercial mortgage-backed securities] actually.

And their deck showed how there's basically no way you could lose, right?

This scenario, you make money.

That scenario, you make money.

And of course, what was happening was management of the bank was telling them: 'Get this stuff out the door, sell it. We don't care who you sell it to. Just get it out.'

And what was interesting was these were fixed-income securities being basically shown to equity people.

By the time that's your game plan to sell something, you've got a problem.

Now luckily, that happens to be my background, and these were my questions at the end of their presentation:

→ Do you know who I am?

→ Do you know what I used to do?

→ Do you know I used to work at your bank?

And then finally it was a statement:

You see, to me, the lesson is the following: Alec's genius in the moment was twofold.

• First and foremost, he was experienced and discerning as an investment professional.

• But equally important, he was crystal clear on who was on his side of the table (and the family office for whom he managed risk) and who wasn't.

The sales people with instructions to move toxic product off the bank's balance sheet were nowhere near his side of the table.

Call me a romantic, but that's the way I think about wealth management. (Actually that’s the way I think about life…)

It's a sacred bond to do the right thing.

It's a "show, don't tell" kind of situation.

Because there are two sides to the table…

And you have to decide where you sit.

Every day.

And here is the punchline:

→ Nobody else knows who you are.

→ Only you know who you are.

Now here's a fun application for you (“ripped from the headlines,” as they say).

Let's just pretend that institutional investors have been enamored with private equity for a generation or two.

Now let me define "institutional investor" and “private equity” so we're all speaking the same language.

An institutional investor is a large entity that manages big chunks of assets on behalf of a key constituency.

The good people in charge of managing the Harvard endowment would be a prime example of an "institutional investor."

Now private equity.

A private equity manager uses money from institutional investors to (i) buy poorly-run businesses, (ii) improve their operations, and (iii) eventually bring those businesses back to market at higher prices once they are… better-run, more valuable businesses.

The way this plays out (in theory) is as follows.

Let’s pretend I’m Harvard here.

• I (Harvard) give you (the private equity manager) money for a number of years to make your “magic” happen. Let's call it 3–5 years.

• I write you a check now, you go buy businesses, and when you sell those businesses a few years down the line, you give me money back (hopefully more money).

• If I like the way that worked out for me, maybe I cut you a check for your next fund.

Round and round the process goes.

In the meantime, if you're Harvard in this story, you're not very liquid.

Your cash is tied up in the businesses being improved by the private equity firm.

That's OK.

You have a long investment horizon and money coming from other places to fund your day-to-day operations.

At least that's the idea…

But then a few years go by and the "exits" (i.e., the selling part of the "buy, improve, sell" equation) prove to be harder than usual.

Maybe interest rates are higher.

Maybe the economy is more uncertain.

Either way, not a lot of people are showing up to buy the better businesses at higher prices.

So the private-equity manager hangs on to the companies for longer.

Which is also fine. They're probably decent business operators.

But it’s throwing rocks in the “liquidity” profile of the institutional investor.

In this fiction, the Harvard people thought they’d get money back after 3-5 year and it’s now been 7 going on 8 years (These are made-up illustrative figures, if that wasn’t clear… 😉).

And still no “exit money” coming back their way.

It gets frustrating.

The good people at the Harvard endowment are kind of bored.

They show up every day at the office, hoping for cash to hit the account.

In no small part that’s because reinvesting the cash is a key part of the job they were hired to do.

Therefore “no cash” equals “not much to do.”

This has career implications for them, as you can imagine…

But then, pretend that a big portion of the funding you were expecting from other sources is put on ice.

Maybe there is a new bunch of people in Washington, DC and they decide that this year, Harvard doesn’t get the funding they’ve been getting. (Or maybe they’re told they can’t enroll high-paying international students).

All of a sudden, being liquid isn’t just a nice-to-have, it’s a must.

As in an existential need.

Now the illiquid private equity is really causing trouble for you.

(As an aside, my most recent guest on Treussard Talks, Katie O’Dwyer makes the point that a lot of family offices are less liquid than you would think for this same reason. Another reason to listen… 🙂)

Now let’s go back to the top of this conversation.

Alec was right.

Selling a toxic fixed-income product to equity people is a flawed last-resort plan on a not-so-good day.

But here something that’s as reliable as Charlie Munger’s famous saying “show me the incentive and I’ll show you the outcome.”

→ When all else fails, look to sell to “retail investors” and their financial advisors.

Wall Street has fun names for this cohort.

“Muppets.”

“Dumb Money.”

You get the vibe…

Now… this piece was just published by Nir Kaissar over at Bloomberg.

It seems like important reading to me.

Guess Where Harvard’s Private Equity Will Likely End Up.

Financial advisers and retail investors are late to the PE party, but they're an attractive target all the same.

“This is where retail investors come in. Harvard’s endowment is in talks to unload $1 billion in private equity to Lexington Partners, a unit of Franklin Resources Inc. The company is better known as Franklin Templeton, the venerable mutual fund powerhouse peddling high priced actively managed funds.

I counted more than 1,100 mutual funds in Morningstar’s database under the Franklin Templeton branding name, including the various share classes, only two of which are index funds. The median net expense ratio of Franklin’s funds is 0.88% per year, a tough sell when many index funds charge near zero.

To revive its fortunes, Franklin is pivoting to “alternative” investments that include private assets, a business that index funds can’t easily disrupt. Franklin Chief Executive Officer Jenny Johnson told analysts recently that selling alternative assets to individuals is “a massive opportunity.”

Whatever the cost, ordinary investors are decades late to the private-asset party. The investor-friendly move would have been to give everyone access to private markets from the start. As things stand, don’t be surprised if Franklin ultimately sells the private equity investments Harvard no longer wants to financial advisers and individual investors.

CEO Johnson likened the process of “educating” advisers on Franklin’s alternative asset products to “hand-to-hand combat.” They would do well to put up a fight.”

Hopefully, you get the point.

This is the wealth-management version of the “2:00 am PHONE CALL” leadership test.

Someone is about to walk into your financial advisor’s office.

(Hopefully, they had to cross the street, not just walk down the hall. Otherwise things just got even spicier.)

They’re probably coming with a deck that shows what might happen in “this scenario” and “that scenario.”

Hopefully someone like Alec takes the meeting on your behalf.

📌 Let’s stay in touch.

If you'd like to follow along as I think through topics relevant to sophisticated investors and high-net-worth families, you can subscribe to Wealth Empowered at wealthempowered.substack.com.

And I'm always happy to have thoughtful conversations about wealth management if you'd like to connect. You can reach out here: https://www.treussard.com/contact

Be well and talk soon,

Jonathan 👋