Investing is an abstract art that is non-sensible to many. I believe, however, that investing in general — and portfolio management specifically — is representative of the real world. In most cultures, most of the time, we celebrate what was done well in the past. Most educational institutions, for example, base their pedagogical outlines on learning what were good achievements in the past, and not enough about past mistakes or failures. In the familial setting, passing down of this knowledge is done by the grandparents.

Portfolio management should benefit from grandparents

I spend almost all of my waking hours and some of my sleeping hours looking for good investments for my clients, my family, and the beneficiaries of the charitable institutions that I serve. While the rewards for finding a single great investment can be huge, in many cases the search is akin to the search for El Dorado, a golden city which thus far has proven to be mythical. For me and those whom I serve, a better use of my time is the search for good portfolio managers. I am increasingly drawn to portfolios of managers that combine what is new (if anything), sound past practices, useful thinking, and perhaps even wisdom.

Grandparents come in different sizes, shapes, and experiences

One of the better questions to ask a possible investment manager is, “Who was your mentor and where did you learn about life?” If the answer only includes academics or other people in the business, you are getting the rehearsed, expected answer. When I press further, I am often told that an older person served as a mentor; a parent, grandparent, uncle, aunt, or in some cases the person responsible for the day-to-day childcare. Few if any of these people can impart portfolio management skills. They can and do, however, explain the rise and fall of their life’s rewards. If none of these life teachings touch on dealing with unexpected problems, either the prospective manager is naive or is not forthcoming, neither of which are good beginnings to a relationship.

What can be learned from grandparents?

In the following discussions about the value of grandparents, I am generalizing well beyond my and my family’s direct experiences and including those families that have shared their experiences.

This time is different

One of the impatiences of youth and inexperienced investors is the belief that the old patterns of behavior will not apply to the “new, new” environment. This powerful idea will overcome people’s greed, fear, inefficiency, counter-balancing forces and the application of the unpredictable laws of nature. Those who have been walking around upright for years can inform those who are willing to listen that they have seen and believed similar things in the past.

I can play the Bigger Fool Game better

I have mentioned in previous posts that studies have shown that many of those who have been caught up in bubbles have recognized the fallacy of the “new, new thing,” but they think they are going to be able to jump out of harm’s way. The historical odds are that in a steep decline when the bubble is broken, very few can exit and stay out.

My children and their partners will do exactly what I say

Every generation wants to show to their parents that they are smarter than their parents. Thus, they do not follow the proscribed rules laid out by their parents. One of the ironies is that when the children have children, the grandchildren also do not follow their parents’ dictates. In some respects, grandchildren are the retribution delivered to the children. Eventually the children then begin to believe that their parents have gotten much more intelligent than they were when they were growing up.

Translating into portfolio terms

The best defense against the wipeout caused in many bubbles is to be broadly diversified. This is easier to say than to accomplish. The bigger the bubble gets, the more it will suck money from other portions of the global economy. This, in turn, will weaken the credit conditions of the late-comers. Thus, the latest “new, new thing” could affect the credit quality behind pensions, bank, insurance companies, suppliers, and other communities. This is precisely where the “boring” work of a detailed securities analyst can be extremely valuable. Most of this kind of diligence is done by buy-side organizations, including some credit-oriented hedge funds.

The wisdom of families in terms of estates

Any in-depth analysis of families will reveal that any one generation with all of its knowledge did not fully anticipate all of the following possible, and some may say impossible, actions of the decedents:

• Premature deaths
• Change in various tax laws
• Lack of legal competence
• Unexpected medical conditions
• Divorces
• Change of domiciles of people and assets
• The willingness of various family members to take responsibility for others (some of which they hardly know)

Probably the most difficult decisions have to do with children of unequal needs and abilities. All of these require the very careful work of one or more trust and estate attorneys in conjunction with an extremely knowledgeable tax accountant and an investment advisor who can structure the initial portfolio and keep it in appropriate balance as conditions change.

Post-estate governance

While wills and trust documents provide a framework for the continued governance of the assets, there is a much larger set of issues. One can not truly predict the changes in personalities after there has been a disposition of the assets. The critical issues remain: how well various individuals carry out their deemed responsibilities, including the management of their assets and those of others that they may influence.

November gives us a governance clue

In November, two individuals who have gained additional political power are President Xi Jinping in China and New Jersey Governor Chris Christie. Each portrayed himself as someone in the middle of his political spectrum. Clearly, I do not know what they will do in the future. The lesson from these two leaders is that while each could have shown more political strength, they opted to take the somewhat safer middle. Translating this into Trust and Estate Management suggests staying in the middle is the safest and gives the most maneuver room.

What did you learn from your grandparents and what are you teaching?

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Copyright © 2008–2013 A. Michael Lipper, CFA