The Stewardship of Wealth, + Website Successful Private Wealth Management for Investors and Their Advisors

GREGORY CURTIS is the Chairman and founder of Greycourt & Co., Inc., a wealth advisory firm serving substantial families and select endowments on a global basis. Prior to founding Greycourt, Curtis served for many years as president of a family office for the Mellon family and as president of the Laurel Foundation. He currently serves on the investment committees for Carnegie Mellon University, The Pittsburgh Foundation, St. John's College, United Educators Insurance, and Winchester Thurston School, among others. Curtis is also a founder or cofounder of three investment firms, Greycourt & Co., Inc., The Investment Fund for Foundations, and Moneybags LLC.

Preface xix

Acknowledgments xxxi

PART ONE The Importance of Private Capital

CHAPTER 1 Wealth in America: The Indispensable Rich 3

Democracy and Capitalism 6

Capitalism and Its Contradictions 7

Providential Societies 10

Risk and Strength 12

America and Decline 13

On China 15

Addressing the Declinists 17

Conclusion: American Distinctiveness and Private Wealth 19

Notes 21

CHAPTER 2 Creative Capital 25

A (Brief) Moral History of Capitalism 26

The Ancients 27

Moral Arguments for Capitalism 28

Voltaire 28

Adam Smith 30

Hegel 31

Contemporary Discussions 32

The Moral Basis of Private Capital 33

Creative Capital in America 34

Higher Education: The Case of St. John’s College 37

Politics: The Conservative Resurgence 38

New Business Ideas: Venture Capital in America 39

Creative Capital and Vibrant Societies 42

Why Do Creative Capitalists Persist? 43

The Indispensable Nation 43

Conclusion: Underdogs and Bullies 45

Notes 47

PART TWO The Stewardship of Wealth

CHAPTER 3 Are We Living in a Permanent Financial Crisis? 53

The End of History (Again) 54

A Permanent Financial Crisis? 54

The Cause of the Crisis Matters 55

The Industrial Revolution and Its Aftermath 56

The Great (and Strange) Experiment 57

Seize the Means of Production! 59

The Power to Tax Is the Power to Destroy—Societies 60

‘‘Borrowing . . . the Disease Is Incurable’’ 61

Now What? 63

But, First, a Note about Germany 66

Investing Capital in a (Very) Uncertain World 67

Conclusion: A World At Risk 68

Notes 68

CHAPTER 4 Risk 73

Families and Investment Risk 73

‘‘Low’’-Risk Investments 74

‘‘High’’-Risk Investments 75

‘‘Reasonable’’-Risk Investments: Marketable Securities 76

The Law of Supply and Demand (Again) 76

Idiosyncratic Ideas about Risk 77

Real Risks: Those Embedded in the Process of Investing 78

Individual Stock Risk versus Broad Market Risk 78

Price Volatility 79

Wildness in the Tails 81

Investor Behavior 82

Making a Truly Terrible Decision 83

Variance Drain 83

Dick and Jane and Variance Drain 84

Later, at Le Cirque 85

Variance Drain Scenarios 86

Behavioral Finance: Are We Hard-Wired for Failure? 87

Professor Odean on Behavioral-Inspired Wealth Transfer 88

What Can We Do about It? 89

Edith and the Headwinds She Faces 90

The First Thing Edith Forgot: Variance Drain 91

The Second Thing Edith Forgot: Inflation 92

The Third Thing Edith Forgot: Investment Costs 92

The Fourth Thing Edith Forgot: Taxes 92

The Fifth Thing Edith Forgot: Spending 93

What Should Edith Do? 93

Conclusion: Preserving Wealth Is Hard Slogging 96

Notes 97

CHAPTER 5 The Collapse of Ethical Behavior 101

What Caused the Crisis? 101

An Unsavory Rehash of the Ethical Failures 102

Ethical Failures in Subprime Lending 102

Ethical Failures among the Subprime Lending Banks 103

Ethical Failures in Auction Rate Securities 104

Ethical Failures among the GSEs 105

The Contemptible Public Disclosures of Financial Firms 107

Shorting the Securities You Are Selling to Your Clients 107

Paulson Bernanke & Co. and the Conspiracy of Silence 108

How Scandal Became Crisis 109

Trust 109

Customers 110

Why Such an Ethical Swamp? 111

Hedge Fund Wannabees 111

‘‘When the Music Plays You Have to Dance’’ 112

Compensation Follies 113

Conflicts upon Conflicts 114

Where Do We Go from Here? 115

Conclusion: Fixing the Industry 116

Notes 117

CHAPTER 6 Finding the Right Advisor 119

Open Architecture as a Disruptive Business Model in the Advisory World 120

What Is Open Architecture and Why Is It So Important? 120

Open Architecture in the Financial Industry 121

The Impact on Investors 123

The Outsourced CIO Model 124

The Evolution of the Traditional, Nondiscretionary Model 125

Documenting the Trend toward the Outsourced CIO Model 126

What’s Driving the Trend toward the Outsourced CIO Model? 126

The Outsourced CIO Model Today 127

Advantages and Disadvantages of the Outsourced CIO Model 129

Is the Outsourced CIO Model Right for Your Family? 132

How to Select a Good Outsourced CIO Advisor 133

Finding the Right Advisor for Your Family 135

Dimensions of the Problem to Focus On 135

The Schulberg Family 136

Gathering Names 139

The RFP Process 139

Where Is the Sample RFP? 143

Final Diligence 144

Where Does Diligence Leave Off and Psychodrama Begin? 145

Conclusion: Focusing On a Few Key Variables 146

Notes 147

CHAPTER 7 Making Family Investment Decisions 149

The Family Investment Committee Today 150

The Origin of the Investment Committee 150

Committee Dynamics 151

Making an Impact 152

Attempts to Deal with the Problem 152

Asset Allocation Guidelines and Investment Policy Statements 152

Using Outside Experts to Populate the Investment Committee 153

The Separate Investment Management Corporation 153

The Family Investment Committee, Tomorrow 153

The Investment Committee Operating Manual 154

Opportunity Costs: Prudence versus Returns 155

Prudence versus Returns for Trustees 155

Prudence versus Returns for Families 157

Striving for Prudence and Returns 159

Conclusion: Focusing On What Families Do Best 161

Notes 161

CHAPTER 8 Trusts 163

Open-Architecture Trusts 163

A Brief, Unconventional (but Wickedly Accurate) History of the Common-Law Trust from the Client’s Perspective 164

Professional Management 165

Deep Pockets 165

Perpetual Life 166

Sound Exercise of Discretion 166

Down with the Bundled Trust! Up with the Open-Architecture Trust! 166

Activities Required to Operate a Trust 167

The Nitty-Gritty of Establishing Open-Architecture Trusts 169

The Rise of Beneficiary Rights 170

If I Was a Big Trust Institution 171

Semi-Open Architecture Trusts 172

Private Trust Companies 173

Total Return Trusts 174

The Uniform Principal and Income Act 174

Unitrust Legislation 175

The IRS View 175

Total Return Trusts in States without Total Return Legislation 175

Conclusion: Let’s Get Revolutionary 176

Notes 176

PART THREE The Rich Get Richer

CHAPTER 9 Designing Taxable Investment Portfolios 183

The Markowitz Revolution 184

Problems with Mean Variance Optimization 185

Computational Power 185

Garbage In, Garbage Out 186

The Challenge of Developing Thoughtful Data Inputs 187

Multivariate Modeling 187

Taking Taxes into Account 188

Monte Carlo Simulations 189

The Problem of Fat Tails 190

Best Practices in Designing Investment Portfolios for Families 192

What Are the Objectives for the Portfolio? 192

Current Claims versus Growth Claims on a Portfolio 193

Matching Portfolio Assets to Each Type of Risk 194

Traditional Asset Allocation Modeling 195

Modern Asset Allocation Modeling 196

Satisfying Portfolio Claims Prudently 197

Conclusion: Art versus Science 198

Notes 198

CHAPTER 10 Adding Value to Family Investment Portfolios 203

Moving from the Current Strategy to the New Strategy 203

Adding Value through Manager Selection 205

Adding Value by Tactically Repositioning the Portfolio 206

Adding Value through Opportunistic Investments 207

Adding Value through Monitoring and Rebalancing 209

Conclusion: We Need All The Value-Add We Can Get 210

Notes 210

CHAPTER 11 Investing in U.S. and Non-U.S. Equities 211

U.S. Large- and Mid-Capitalization Stocks 212

U.S. Small-Capitalization Stocks 214

International Developed Country Stocks 216

International Diversification Is Unnecessary 217

Just When You Need It, Diversification Doesn’t Work 218

It’s Easier and Safer to Gain International Exposure by Investing in ADRs 219

The Bottom Line 219

Emerging and Frontier Markets 220

Emerging Markets 220

Frontier Markets 221

Conclusion: Equity Securities Are At the Core of Most Portfolios 223

Notes 223

CHAPTER 12 Investing Globally 225

Why Go Global? 226

Why Stay Home? 228

Global Investing in the Real World (or, Maybe, Real Investing in a Global World) 229

Is ‘‘Global Equities’’ an Asset Class? 229

Is It Possible to Succeed as a Global Equity Manager? 230

Can a Global Manager Outperform in the U.S. Portion of its Portfolio? 231

Do the BRICs Really Matter as Much as We Think? 231

What about Investing in Multinationals? 233

The Challenge of Stock-Picking in ‘‘Non-Nonsynchronous’’ Markets 233

Thinking Nonmonolithically 233

Conclusion: Think Globally, Act Locally 234

Notes 237

CHAPTER 13 Investing in Real Assets 239

Real Estate 239

Leverage 240

Why Invest in Real Estate? 240

How to Invest in Real Estate 241

Oil and Gas 243

Value Creation Mechanisms 244

Hedging to Protect Value 245

Investing Strategies 246

Recommendations 248

Commodities 249

Sources of Return from Commodities Investing 250

The Commodities Indexes 251

Historical Risk, Return, and Sharpe Ratios 251

Historical Correlations 252

Some Thoughts about Historical and Prospective Commodity Returns 252

The Role of Commodities in a Diversified Portfolio 253

Effects of Rebalancing 254

The Impact of Extreme Events 254

Summary 255

Conclusion: The Use and Misuse of Real Asset Exposure 255

Notes 256

CHAPTER 14 Investing in Fixed Income 259

Mistakes Bond Investors Make 259

Employing Managers Who ‘‘Cheat’’ 259

Paying Too Much for Bond Management 262

Employing Best Practices in Building Bond Portfolios 262

Building Laddered Bond Portfolios 263

Owning Only High-Grade, Noncallable, Long-Term Bonds 264

Actively Managing Municipal Bonds 264

Actively Managing Corporate Bonds 267

High-Yield Bonds 267

Managing Cash 269

Conclusion: Fixed Income Is Underappreciated 270

Notes 271

CHAPTER 15 Investing in Hedge Funds 273

What Is a Hedge Fund? 274

Types of Hedge Funds 275

Challenges for Hedge Fund Investors 277

Building a First-Rate Hedge Fund Portfolio 285

Conclusion: Should Anyone but Yale Invest in Hedge Funds? 288

Notes 290

CHAPTER 16 Investing in Private Equity 293

Why Invest in PE? 294

Persistence of Returns 294

The Importance of Diversification 295

Private Equity Returns 296

The Return Characteristics of PE Investments 296

Gaining Exposure to Private Equity 297

PE Funds of Funds 298

A Global Asset Class 298

Illiquidity and the J-Curve Effect 299

Ramping Up to Your Target Allocation 300

Waterfall Analysis 300

Secondary PE Investing 302

The Evolution of Secondary Investing 302

Secondary Investing Strategies 303

Identifying High-Quality Secondary Funds 304

Conclusion: The Ultimate Aspirational Asset 304

Notes 305

CHAPTER 17 Working with Money Managers 307

The Business of Money Management 308

Hapless Asset Management 308

Survivorship Bias 311

Fees and Costs 311

Traditional Managers 313

The Main Problem: Recent Good Performance Is Almost Irrelevant 314

Characteristics of Best-in-Class Managers 317

Objectionable Characteristics 320

Finding Best-in-Class Managers 320

Monitoring Best-in-Class Managers 323

Active, Indexed, Fundamental, and Structured Products 324

Alternative Managers 326

Working with Hedge Funds 326

Working with Private Equity Funds 328

Conclusion: At Least Managers Are Interesting 329

Notes 330

CHAPTER 18 Managing Investment-Related Taxes 331

Designing Portfolios from an After-Tax Perspective 332

Asset Location 332

Asset Class Strategies 333

Tax-Aware Managers 333

Identifying Tax-Aware Managers 335

Harvesting Losses 337

Conclusion: You Can’t Eat Gross Returns 338

Notes 338

CHAPTER 19 Asset Location and Implementation 341

Asset Location Issues 341

Examples of Asset Locations and the Associated Investment Implications 342

Implementation Issues 347

Macro Considerations 348

Micro Considerations 351

Implementing in PE and Hedge 353

Conclusion: It’s Not Just a Technical Issue 353

Notes 353

CHAPTER 20 Monitoring and Rebalancing Taxable Portfolios 355

Performance Monitoring 356

Money Manager Reports 356

Bank Custody Reports 357

Investment Consultant Reports 357

Conflicts between Reports 358

Interpreting Performance Reports 359

Monitoring Manager Performance 360

Rebalancing Taxable Portfolios 362

Setting Strategic Ranges 363

Rebalance Back to What? 363

How Often to Rebalance? 364

Conclusion: Monitoring and Rebalancing Are Stewardship Issues 365

Notes 366

CHAPTER 21 Investment Policy Statements 367

The Investment Policy Statement 367

Spending Policy Statements 369

Cash Guidelines 369

Manager Guidelines 369

The Investment Committee Policy Manual 370

Letters to the Family 370

Conclusion: Don’t Skimp on Documenting Your Decisionmaking 370

CHAPTER 22 Miscellaneous Challenges for Private Investors 371

Asset Custody 371

What Services Does a Custodian Offer? 372

Evaluating Custodians 373

Custody Pricing 374

Custody for Taxable Accounts 375

Securities Lending 376

Brokers as Custodians 377

Concentrated Security Positions 378

Dealing with the Emotional Impact of a Concentrated Position 381

Strategies for Diversifying Concentrated Positions 382

Establishing a Family Office 384

Why a Family Office? 384

What Is the Minimum Size for a Family Office? 384

What Responsibilities Are Carried Out by a Family Office? 384

Where to Begin? 386

Are There Alternatives to the Stand-Alone Family Office? 387

Family Investment Partnerships 387

Philanthropy 389

Conclusion: There Are Challenges Everywhere We Look 392

Notes 392

Afterword: On Happiness 395

Stereotypes of the Rich 396

The Rich and the ‘‘Faux Rich’’ 396

The Real Way the Rich Are Different 398

Children and the Wealthy 400

Marriage and the Wealthy 400

Work and the Wealthy 401

Failed Stewardship and Family Unhappiness 403

Wealth and Happiness 405

Notes 405

About the Companion Website 407

About the Author 409

Index 411

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