Private Wealth Management & the Modern Age
Role of the Private Banker in the 21st Century
Since the financial crisis in 2008, the objectives of wealth management have changed dramatically, in that private bankers in the 21st century are less prone to take the same risks or invest in companies with the same levels of leverage that were previously embraced by private bankers of former generations. While there is still a desire by the customer and the shareholder to get a return on capital, the primary concern has fallen instead to the return of capital. Therefore, the most critical qualities of the private banker in the 21st century are prudence in ensuring the investor’s return of capital, and the pragmatism to record conservative gains based on value investing principles. These principles along with the ability to empathize with investors’ risk aversion in the wake of the 2008 financial crisis will ensure that under most conditions investors will be able to mitigate most of their risk, yet build upon their current wealth.
The concept of “value investing” was first clarified in the book The Intelligent Investor by Benjamin Graham. In his book, Graham posited there were two primary methods by which investors would try to benefit from fluctuations in the market: timing and pricing. Graham claimed that “timing is of no real value to the investor unless it coincides with pricing."1
Graham’s protégé and legendary investor Warren Buffett provides an excellent demonstration of value investing principles in practice:
“When he's looking to buy a stock, he never, ever overpays for it no matter how much he wants it… Look at the price-to-earnings ratio, how solid the management is, how much cash the company brings in from its operations and then make sure the price isn't elevated beyond what's reasonable... He sticks to his rules and never strays.”2
Under the value investing paradigm, the investor may not get every stock they desire, but more often than not, the ones that they purchase will be able to yield a return, provided that they take into account all the factors described above. Considering many investors risk aversion in lieu of 2008, several may be reluctant to invest in the first place.
Possibly the best example of prudence regarding the return of investor capital came from JP Morgan Chase CEO Jamie Dimon who advised his employees: “Don’t sell a product to anyone you wouldn’t sell to your own mother.”3 And while every investor must make decisions for themselves, it’s worth reminding clients that one never goes broke if one is always willing to take a profit when available.
Another key point to address when discussing banking in general in the 21st Century is the issue of the use of leverage by firms to multiply their returns. On CNBC’s Squawk Box in November of 2012, Buffett claimed that his firm Berkshire Hathaway never leverages its purchases. In an essay by writer Nassim Taleb, he preaches avoidance of highly leveraged firms. Taleb states that a “firm with highly leveraged debt has no room for error; it has to be extremely good at predicting future revenues (and black swans)3.” Taleb posits that the tendency to avoid highly leveraged firms is positive all around:
“Debt tends to make failure spread through the system. A firm with equity financing can survive drops in income, however. Consider the abrupt deflation of the technology bubble during 2000. Because technology firms were relying on equity rather than debt, their failures didn’t ripple out into the wider economy.”4
Following the leverage debacles at Lehman Brothers, and the subsequent contagion to insurance giant AIG, the event most illustrative of how this vicious circle impacted individual investors would be when the $62 billion Reserve Primary Fund, one of the biggest and oldest funds in the $2.6 trillion dollar industry, “broke the buck.” Typically, “money funds are cash-like investments designed to provide safety for investors.”5 The Reserve Primary Fund “broke the buck” by falling under the $1-a-share net asset value, or in other words:
“For the first time ever, it lost its depositors money. For every dollar they put in, they were left with only $0.97. It's like going to your savings account and seeing that your money's gone, but you haven't made any withdrawals… That panic and fear caused an old-fashioned bank run. People, and more importantly pension funds and big endowments called their brokers and said get me out of those funds.” Alex Blumberg of NPR’s Planet Money 6
The cause of the Reserve Primary Fund situation was rooted in their investments “in the debt of Lehman Brothers Holdings Inc. that became virtually worthless when Lehman filed for bankruptcy protection.”
The Years Ahead
In response to the Reserve Fund, the Treasury Department created a taxpayer-backed guarantee program in an effort to limit future taxpayer exposure. While there has been a tendency to label this as regulatory overreach, there may be value in the sense of security they provide investors who are loath to get back into the market following the various economic crises of the past decade. In response to potential crises looming from either overseas or as a result of the “fiscal cliff,” Securities and Exchange Commission Chairwoman Mary Schapiro made a push to tighten rules governing the money market fund industry. In August, these plans scuttled by the SEC when it became clear that Chairwoman Schapiro was unable to raise the votes at the five-member agency to move forward with the regulations. In late September, however, Treasury Secretary Timothy Geithner asked the new Financial Stability Oversight Council to draw up three new proposals, two of which Schapiro introduced in the past, urging the SEC to impose new regulations on the money market fund industry. Two of the proposals involve establishing capital buffers in order to absorb losses, but the most controversial measure includes abandoning what is known as a stable “net asset value” for money-market funds, meaning “the value of money funds would no longer be fixed at the same price -- $1 each – as they are today,” allowing investors to “buy or sell shares in the funds and not have to worry about losing money.” 7 As of November 13, 2012, these proposals were unanimously approved by the FSOC, as they await further action from the SEC.
Another factor for bankers to consider looking forward is the opportunities presented by scalability of operations. There are some honest concerns to be had about the fact that “in 1970, the top five American banks had only 17 percent of all banking assets. Today, the top five banks have more than 50 percent of all banking assets, and the top 10 banks have nearly 80 percent.”8
However, Chase’s Dimon provides a clear example of the possibilities to serve the customer presented by scale as well:
“There are huge benefits to size… Size lets us build a $500 million data center that speeds up transactions and invest billions of dollars in products like ATMs and apps that allow your iPhone to deposit checks. We move $2 trillion a day, and you can see it by account, by company. These aren’t, like, little things. And they accrue to the customer.” (to New York Magazine’s Pressler)
There are several aspects to banking in the 21st Century which can be learned by way of education and work experience, such as value investing, the ability to capitalize on organizational scale, or acclimation to the concepts of debt and equity. However, there are several intangible aspects to wealth management which cannot be taught, such as the rigor to meet regulatory standards, or integrity and empathy to an investor’s concerns and goals. If one can find a way to unify the pragmatism of Ben Graham with the prudence advised by Jamie Dimon, there is every possibility for success in private banking in the years ahead.
- Black Swan events, as defined by Taleb, are “large events that are both unexpected and highly consequential. We never see black swans coming, but when they do arrive, they profoundly shape our world.”
- Graham, Benjamin. The Intelligent Investor, page 191. HarperCollins Publishing © 1973
- Claman, Liz. “Warren Buffett’s Best Investment Advice,” Investopedia. May 4, 2012. http://www.investopedia.com/financial-edge/0512/fox-business-networks-liz-claman-warren-buffetts-best-investment-advice.aspx#ixzz2CW82Ueee
- Pressler, Jessica. “122 Minutes With Jamie Dimon,” New York Magazine. Aug 12, 2012.
- Taleb, Nassim Nicholas. “Learning to Love Volatility,” Wall Street Journal. Nov 16, 2012.
- Grind, Kristin. “Money Funds Face New Battle On Rules,” Wall Street Jorunal. Oct 5, 2012.
- Glass, Ira, et al. “Another Frightening Show About the Economy,” This American Life. Oct 3, 2008. http://www.thisamericanlife.org/radio-archives/episode/365/transcript
- Orol, Ronald D. “Regulators urge SEC to act on money-market funds,” MarketWatch. Nov 13, 2012. http://articles.marketwatch.com/2012-11-13/economy/35082791_1_trillion-money-market-fund-industry-money-funds-money-market-funds
- Farley, Richard E. “The Problems With Limiting Large Banks,” New York Times. May 23, 2012. http://dealbook.nytimes.com/2012/05/23/the-problems-with-limiting-large-banks/