By Chris at www.CapitalistExploits.at
Warning: This story is entirely fictional except for all the parts which are not. It is the story of a 5-step process of the “evolution” of a family office.
I felt compelled to pen this missive since it’s representative of so many family offices out there and maybe in doing so one or two save themselves some potentially painful headaches.
Step 1: The Patriarch Builds His Wealth
This is the story of Hans Krapenschitter and his progeny. It was in the late 80’s that Hans, then in his 30’s, made his fortune. Germany was gripped by recession, factories had closed, people had lost their jobs, real estate prices had plummeted, and so too had hemlines. Horrid stuff.
Gurus emerged, telling everyone that the world would never again see greed, avarice, easy credit, or mini skirts.
Instead, the future lay in gathering kale and cabbages from local community gardens, and being subjected to films where “maidens” in long flowing dresses and bonnets roamed meadows, gathering daisies, while falling in love with schoolteachers. There’d be no films where people got punched and shot and even at the raunchiest of clubs, girls skirts would be well below the knee-line.
To Hans, this all sounded like a worst nightmare come true, and knowing a little bit about human nature Hans saw his opportunity. Bucking the trend, he started a company producing T-shirts with skulls on and slogans such as “Ich werde deinen Arsch treten” (I’ll kick your ass).
In addition, he began making the most outrageous revealing woman clothing he could think of. If the world was to devolve into a global version of the Sound of Music, it wasn’t going to do so without a fight from Hans.
Fortunately for Hans the recession ended and greed, avarice, and easy credit return with a vengeance. The easy credit helped fuel Hans’ business growth, and he captured the vast market share for a new zeitgeist, as footballers’ wives became celebrities and women clothing prices became inversely correlated with the amount of material used. The good times were back.
Step 2: The Bankers Take Notice
After depositing some sizeable checks with his local bank Hans receives a letter from the bank.
“Dear Mr Krapenschitter,
Let me introduce myself. My name is Mr. Frederick Arsenlichker, and I am delighted to have been appointed as your private banker. We at Ditschke Bank pride ourselves in providing outstanding personal service to our most valuable clients, and I will be at your service to provide you with our most exclusive range of services which are now available to you.
Please let me know a suitable time for us to meet in person to discuss your business and needs.
Frederick Arsenlichker (Private Wealth Management, Ditschke Bank)”
Hans is flattered. He feels valued, not really understanding what just happened (what it really means is that he’s now in line to get spammed all the products the bank has on offer – whether he wants them or not and whether they’re any good or not).
Now to Frederick…
To understand Frederick, he’s a guy who spends over an hour in the bathroom every morning, double checks his fringe when passing anything with a reflective surface, and now in his mid-30’s has learned all the ins and outs of sales. To be sure, he’s great fun to have a drink with and knows enough about his products to sound awfully smart to the layman. He’s damn good at selling the bank’s products, but he’s never had to manage risk – and this is where the real problems surface (as you’ll see).
This isn’t his fault. He’s spent his life on the sell side. Fortunately Frederick is smart and he knows what he doesn’t know. Many like him are like 10-year olds after watching Rockie and, despite not having the muscles and never having learnt how to fight, think they’ve got what it takes to take down 10 men. Just because they’ve watched buy side guys, they think they know what it takes. Most don’t.
Step 3: Hans Needs Help
Hans’ business spreads like an Australian bushfire as he breaks into the UK market where “lad culture” is pioneering an entirely new obnoxious breed of buyers, and where there are no ladies, only girls. His clothing brand is THE brand. After securing a distribution agreement with the country’s second largest retailer his wealth accelerates.
Aside from the ridiculous house his wife encouraged him to buy on the French Riviera, he now has more and more money which he realises he should probably do something with.
He’s made a few investments based on “suggestions” made to him by multiple private bankers.
You see, Frederick isn’t the only contact Hans has in banking. Due to his business needs Hans has opened no less than 8 banking relationships and they’ve all taken notice, appointing private bankers to “assist” Hans.
These private bankers regularly invite Hans to private gatherings and to his delight he’s found that tickets to the Grand Prix in Monaco, the finals of the European football championships, and the like are easy to come by. Not that he couldn’t pay for them if he wanted to, but it’s nice to get free stuff. The problem is that Hans is feeling a little overwhelmed. All this wealth comes with the responsibility to manage it.
He’s known Frederick for several years now and likes him. Many of these other private bankers are a bit too aggressive. There was that one Spanish banker, Eduardo, who tried to get him a prostitute the last time they were at a special cocktail function put on by the bank. He didn’t think his wife would appreciate that.
Frederick, on the other hand, has about 100 clients like Hans who he “manages”. He’s getting sick of a base salary with commissions bonus, having to clock in and out of his cubicle like a well trained gopher, and the intellectually vaporise environment of a big bank is suffocating.
On the sly, he’s been looking to leverage his network of investors and putting out feelers.
Step 4: Hans Hires Help
Hans: “Frederick, I’m swamped here. I’ve known you for a long time now and I trust you. Do you by any chance know of someone in your field who you’d recommend to help manage my money full time?”
Frederick: “Funny you ask. I’ve been thinking of doing just that myself for a number of clients and would be very interested in doing this for you.”
Over some schnapps and sausages, Frederick becomes CIO of the Krapenschitter Family Office, and at long last he can take off the bloody suit and tie and dress in jeans and T-shirts because Hans, after all, has made a living out of clothing that bankers would never wear.
Step 5: The Muddle
And now Frederick must learn really quickly the difference between selling product and investing in product. He quickly reaches out to all his private banker buddies and sources a number of products which Hans can allocate capital into. Since the banks are large fee generating businesses they have two mandates:
- Generate as much fees as possible and
- Try keep your clients
Managing the two is tricky business. It requires gently raping the client, but not too roughly that they feel the pain.
One lesson that Frederick has learnt from his years at the bank is that clients hate losing money. As such, fixed income is an easy sell. The fees are still pretty reasonable, and importantly you typically get to keep your customers as you can’t lose money on fixed income, right? Ah well, sort of.
What the Sales Guys Don’t Fully Understand
Frederick’s buddies are all selling either fixed income products or the latest best thing: Low volatility funds. It’s the place to be.
You see, they’ve done nothing but go up for their entire careers (which is to say a decade, two at most). Experience has taught them that this is what works. Their only sense of history is that the iPhone never used to take pictures, like waaay back, and how mad was that?
Frederick’s buddies know only that the firms they work for are pushing them to sell these products.
What they don’t know is that the low volatility funds they’re selling are being repackaged into synthetic bond like products and sold to institutional dumb money.
The way it works is that the proprietary desks write options against these funds and thereby deliver a steady stream of income. This gets packaged and sold as “yield bearing” instruments to pension funds and other dumb money. “They’re very low risk,” the salesmen say because these are solid equities with extremely low volatility. They’re almost like bonds. No, really.
Some of the proprietary traders (the older ones) know the risks and many don’t really get it. But so long as Frederick and the long list of clients in the banks’ affiliate network keep buying the products, these babies are guaranteed cash cows.
Frederick, after having been in the business for enough years, realises that equities should make up a decent portion of Hans’ assets. Because he doesn’t follow the markets (I mean, he watches Bloomberg and CNBC but couldn’t tell you what drives liquidity, cross border capital flows, money velocity, or why anyone should track the gold price) he’s got no sense of market cycles, and simply becomes an asset allocator reliant on his buddies (who are all sell side, remember?) for advice.
And so Hans’ portfolio, on paper, looks pretty reasonable, while sporting the kind of risk that Evel Knievel would have shied away from.
Hans is presented with some investment opportunities and, knowing nothing about them, passes them to Frederick to review. Frederick takes a look.
A gold fund? Why on earth would anyone invest in a gold fund, he asks himself?
He googles the gold price and finds that it’s been in a bear market for 20 years. What lunatic would invest in this? Crazy!
He emails his buddies asking them if they’ve got a gold fund in their product lineup and what they think of it. One had a gold fund but it was closed down after lack of performance and lack of interest. Clearly this is a waste of time.
And so Hans, the family patriarch and generator of immense wealth, who never understood the difference between sell side and buy side hired Frederick the now CIO of the Krapenschitter Family Office, in charge of over $450 million.
Unwittingly – and neither realise – it both are drawn into a long daisy chain beginning with product sales which nobody in charge of managing the money actually understands. A chain designed to allow the major banks to make money on both the product fees as well as quietly trading proprietary positions against the products sold which generate amazing returns.
Frederick, for his part, wants to ensure he keeps his job and so he essentially benchmarks and follows his sell side buddies, who, in turn, push products the banks need sold.
While all this is taking place, the market builds the momentum for the inevitable – because every market has a cycle and this one is about to turn.
But Hans is on the Riviera enjoying the sunshine and Frederick is looking forward to a holiday with his new girlfriend. He’s going to take her to Ibiza wearing some of Hans latest product line. It’s truly ridiculous and he can’t wait.
“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.” — Mark Twain
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This post originally appeared on Zero Hedge