Strategic Review – May 2013
Why a Family Office?
Operating a family office is such a long and difficult (as well as expensive) business that we need to stop and remind ourselves why we are doing it.
But before we get to that, welcome to the new monthly editorial format – what we simply call the Strategic Review. From now on, you’ll be receiving more in-depth analysis from me, Will and our strategic partners all in the one place… each month.
This month, I want to welcome onboard our two newest strategic partners, Eric Marshall and Joanne Stern. Eric will be focusing on the “hard structure” side of things – how to legally structure a family office and your family affairs. Joanne will be focused on the “soft structure” side of things – how to create a unified family that can not only preserve wealth… but also recreate it across generations.
You will hear from Eric and Joanne below. Along with an expanded Family Matters column from Will. You will also hear from our strategic partner in the resources sector, Rick Rule.
Now back to why a family office…
It would be a whole lot easier to give our money away. To let the government take it. Or simply to let the lawyers sort it out after we are gone. Although I am suspicious of these alternatives, I can’t prove the results will be any better with our family office approach.
Who knows? Maybe even Ted Turner’s gift of $1 billion to the UN will turn out to be money well spent.
But I doubt it.
Real wealth is never really in the public’s hands. Every dollar, every acre, every ton of steel or pound of butter ends up under someone’s control. Some living person benefits.
If the government takes your money, it is only to pass it along to one of its favorite activities. No matter how it describes the activity – feeding the poor, protecting the country or stimulating the economy — the money always makes its way to someone else’s pocket.
A Meritocracy of Wealth?
Some people, notably Warren Buffett, believe society is better off if each generation has to earn its own way. Buffett believes people who prove they can earn wealth should be the ones who have it and control it – not those members of what he calls “the lucky sperm club” who inherit it.
Presumably, this meritocracy of wealth producers would lead to better decisions, faster GDP growth and a more prosperous world. But to achieve this brave new world, Buffett suggests that the government tax the wealth of each dying generation so members of the next one can begin on a level playing field.
You can see the nonsense of this immediately. The wealth that passes to the government doesn’t just sit there until the brightest young entrepreneur or the sharpest new investor claims it. Instead, it is allocated to whatever project the government favors at the time. Instead of being invested by the best wealth creators, in other words, it ends up being put to work by the worst: politicians and bureaucrats.
The next generation finds itself poorer, because the wealth that its parents created has been wasted… spent… and used up. Government does not preserve wealth; it consumes it.
Capital claimed by the government in the form of inheritance taxes does not remain a pool of resources, to be drawn out by the next generation. Instead, it is given to the unemployed… to contractors and consultants… to people who are retired or in need of medical attention. Not necessarily bad things, but not the sorts of things that bring prosperity and growth.
But Buffett has recently moved in our direction. He put his son Howard – who had previously been kept largely out of his business – in position to take over when he is gone.
Buffett had previously argued that people with the responsibility of allocating wealth should be the brightest and best – those who had proven their mettle in the world of business and finance. Surely, Howard Buffett was not chosen by those standards. Compared with the many thousands of top money managers, investors and businessmen Buffett might have chosen, Howard has little experience and fewer successes.
Perhaps there are other standards at work?
The Habit of Wealth
The world is probably a better place when productive capital is not drained away by the government. Families, trained to invest wisely and to preserve their wealth, are almost certainly better custodians. They are much more likely to retain and enhance their capital over generations.
Because the skills necessary for building wealth – including the habits and the customs that allow you to hold onto it and pass it along to the next generation – can take a long time to accumulate. Why are the Swiss so wealthy, for example, and the Bolivians… or the Zimbabweans… or the Albanians… or the Baltimoreans… so poor?
The Swiss have the habit of wealth; the others do not.
There are some skills that take more than a generation to acquire. Great hotel chains, for example, are often in the hands of a single family for many generations.
A young man who grows up in such a family works in the hotel from an early age. He sits at the dinner table when important issues are discussed. He learns from his parents and grandparents. He has the hotel industry “in his blood.”
That is true in the publishing industry too (in which my family has an enterprise). Or the entertainment industry. In Hollywood, there are some skills that can take years of technical training. Lighting. Sound. Camera work. There are also many habits and attitudes that make showbiz different from other businesses.
Some are subtle and almost invisible to outsiders. Some are matters of traditions and connections that “open doors” for young people. People who grow up in the milieu – in showbiz families – understand the codes. They are more likely to have the skills necessary to succeed than new arrivals.
So part of the reason we do what we do is simply to give our children an edge.
No Such Thing As a Level Playing Field
Recently, in America and France, there is a surprising (to me) movement against homework for schoolchildren. At first I thought it was a joke. But Elizabeth explained that it was motivated by the same desire for fairness that makes Warren Buffett want higher inheritance taxes.
Children of certain parents get a lot of help with their homework and do better in school. Other children do not. They may get no help and are likely to do worse.
The levelers want to eliminate homework altogether so that the children will be able to compete on a level playing field. None will get help with homework, because there won’t be any homework.
They misunderstand how life works. There is no such thing as a level playing field. Every field is tilted in one direction or another. If you take away the homework, you do not level the playing field. You just tilt it in another direction. The most successful children will be those who understand things quickly and easily, rather than those who work hard on their homework.
Of course, it wouldn’t be that simple. The marginally engaged parents may welcome the absence of homework. They won’t have to spend hours helping their children. But the typical “Asian tiger” mother will not stop trying to push her children forward.
The unintended consequence of such legislation would probably be that parents who ignored the ban on homework and found ways to help their children after school – math camp! – would give their children an even greater advantage over the “no homework” children.
Everybody enters life with some advantages and disadvantages. Some you see and some you don’t. Like tiger mothers, our goal is to give our children and grandchildren whatever advantages we can. And the one that concerns our family office project is helping them understand how wealth is made… and kept.
We are not really trying to make the world a better place. We are just hoping that our world will be better if we and our children and grandchildren are able to control capital and use it well.
Not only are families with capital able to live better, but they are also better able to take advantage of investment and business opportunities… and much better able to survive setbacks and shocks.
Here in Argentina, you can scratch the surface of any family and you will find an interesting and instructive wealth story. The middle classes here have been wiped out twice in the last 30 years – first in the inflation of the 1980s… and again in the defaults of 2001-2002.
“Oh, yes… I remember,” said a colleague from our office in Buenos Aires.
“I was just a kid in the 1980s. My father would call home and say, ‘Go to the supermarket… I’ve just gotten paid… I’ll meet you there.’ We would take all our money and spend it immediately… loading up for the month. And we’d do it as soon as we could, because while were at the market, the prices were rising. The idea was to shop as fast as you could.”
That was the hellish situation the middle class had to endure. But that was just the start. Later, Argentine inflation rates rose to 1,000% per month. It was impossible to keep up. Families that did not understand inflation… or that had failed to take precautions… were ruined. Their savings vanished. Their salaries could barely pay for necessities – if they could find them in the shops.
The government was forced to introduce an entirely new currency… twice!
The crisis of the early 2000s was different. The peso was linked to the dollar. Savers were assured their peso deposits were safe – they could be exchanged for dollars at a fixed rate. Wary savers took no chances; they left their deposits in dollars. As it turned out, the government whacked them both – closing the banks, converting dollar deposits to pesos… and then devaluing the peso by 66%.
But not all families were hurt. Some understood what was going on. Some had taken steps to avoid the damage.
Real estate prices varied greatly, but generally, you were a lot better off with land or income-producing buildings than you were with cash. The stock market saw its ups and downs too – but shares in solid companies survived. And for cash, smart families kept accounts in foreign countries.
Or as Eduardo Elsztain, one of the richest men in Argentina, explained to me, “If you had bought gold coins early, you looked like a genius later.”
We don’t know what will happen. But the financial history of the world – like its political history – is punctuated by crises. Inflations, bankruptcies, shortages, bubbles. These things arrive on most people’s doorsteps like an IRS audit – totally unexpected and often devastating.
But some families have made preparations. They have contingency plans. They recognize the threats and they know how to deal with them. That, too, is what we hope to achieve in our family offices… preparing and protecting the following generations for the challenges they will inevitably face.
Primum, Non Nocere
An old friend set up a family foundation. He gave it a modest motto: Primum, non nocere. First, do no harm.
He is not naive enough to think that just because he intends to do good, good will inevitably result. We’ve seen over and over – in foreign aid programs, in domestic social welfare and in rich families – that giving money to people is not necessarily a good thing.
Foreign aid undermines local businesses. Social welfare programs remove the incentive to work. Inheritances often have the same effect: The children become “trustafarians” with few skills, little self-confidence and even less self-esteem. So my friend undertakes his own do-good programs very carefully, with his eyes wide open.
We do the same. But we also recognize that since all wealth ultimately must be owned by someone – no matter what we do – our wealth will change hands. If it goes into the pockets of welfare recipients or foreign aid programs, we will not see the damage it does. But that is comfort only to a scoundrel.
Instead, we take the responsibility that my friend takes – to direct our wealth to people who will not be harmed by it. Instead, we hope to make them stronger. That is a large burden… but it is one we cannot escape.
We will try to do the best we can…
That’s all from me. I hope you enjoy this new format. I believe it’s a better way for us to share our research and recommendations with you. More in-depth analysis. More from our strategic partners. Once a month. All in one place.
I’d love to hear what you think about it. Write with your feedback to [email protected]