Where We Are On Launching the Global Asset Management Firm

Back in September, I shared some of my thoughts on the structure of the asset management industry after some of you asked for details about the launch of the upcoming global asset management firm Aaron and I are establishing.  In that post, I provided some insight into how I see the state of asset management and wealth advisory in the United States, explaining that, in my opinion, there are really five types of firms:

1. Honest-to-God asset management firms (falling into one of two, or both, services)
   • Private individualized asset management, often for high-net worth individuals
   • Pooled asset management (sponsoring mutual funds, private equity funds, ETFs, hedge funds, etc.)
2. Honest-to-God wealth management / financial planning firms
3. Sales firms masquerading as either of the first two categories
4. Asset gatherers serving as counselor and extracting a toll to steer people to the first two categories
5. Stock brokers

There’s no point in revisiting all of the details here as that post was long enough (it was nearly 7,000 words by itself and far exceeded it once you count the extensive conversations that occurred in the comments section).  If you haven’t read it, I encourage you to as it will give you a framework.

I know it’s been a long time since I’ve updated the blog.  Between comments, messages, and even a few conversations on Twitter, I’m actually touched some of you reached out to see if I was okay.  I am.  Everything is fine.  We’re so occupied with getting the firm off the ground the way we want to do it, we haven’t had a lot of time for other things.  Now is probably as good a time as any to post an update so I’ll try and share some of the behind-the-scenes stuff.  I’ll probably bounce around from topic to topic a bit as there is a lot to cover on the waterfront but if I try and structure this like one of my more formal posts, I’ll probably never get it published as my task list seems to replicate by itself these days.

First thing is first.  Aaron and I decided that we are going to begin the firm with a laser-like focus on the activity we admired in so many of our professional heroes growing up and that we spend a lot of our time doing, anyway: Asset management.  In particular, the firm will specialize in global value investing, dividend investing, and certain types of passive investing strategies for affluent and high net worth individuals, families, and institutions.  At some point in future, we may consider launching either a mutual fund or an exchange traded fund for those who can’t afford our minimum account balance of $500,000 and an investment partnership for qualified investors who want to invest in special situations, takeover scenarios, and other opportunities.  As I believe some of you know, we actually had both a major underwriter here in the Midwest and a law firm price out the launch of two such structures for us and I have the details stored away safely for whenever I want to proceed.  (One thing I’ve been working on after hearing from some of you who were really upset about the $500,000 minimum is trying to find a way to make a few exceptions for those members of the community on the waiting list with between $100,000 and $500,000.  I’m not sure I’ll be able to make it work in all cases, and I certainly wouldn’t want to advertise it to the general public, but, provided it remains the exception and not the rule, I am willing to at least try for those who want to cast in their lot with us for the coming (what I hope will be) decades.)

To that end, we needed to establish the legal entity that will eventually become the firm.  Aaron and I filed the articles of organization on the 10-year anniversary, to the day, when we officially opened the virtual doors of our sporting goods business, Mount Olympus Awards.  It seemed appropriate.  There was a certain symmetry there that appealed to both of us.

We then began drafting the operating agreement of the limited liability company, which, once finalized, signed, and archived, name us as the managing members (to be referred to as “Managing Directors” as tends to be traditional in asset management).  As the sole equity owners, the present plan is to take advantage of something that is only available in a handful of states to married couples and of which we can now avail ourselves thanks to the Supreme Court’s Obergefell v. Hodges decision called joint tenants in the entirety.  In addition to providing certain asset protections to us, I believe it should offer greater stability to the firm in the event something happened to one of us.  Effectively, by holding the firm as tenants in the entirety, neither Aaron nor I own it individually.  Rather, our marriage owns it.  Membership units held in this way are unique because, in addition to providing many of the benefits of joint tenants with right of survivorship, neither has the power to sever the tenancy unilaterally.  To terminate or dispose of any part of the tenancy would require the consent of both of us.  Our individual rights are further restricted for the good of the firm by some of the terms of the operating agreement, which spell out what happens in the event of a number of contingencies and certain decisions that require consensus before they can go into effect.  (Update June 19th, 2016 at 1:50 p.m., CST: The tax partners at the independent accounting firm who handle our personal and business tax matters have looked into it and recommended we use a joint tenants with right of survivorship title, especially since we may at some point down the road have ownership in the hands of various family trusts and, perhaps, someday, even our future children.  They explained their reasoning after looking at the relevant variables for our personal situation from a tax and planning perspective and I trust their judgment so that’s what we’re doing.)

Then there are the practical things that need and needed to be done to lay the foundation before we can get to the regulatory stuff.  An accounting system had to be set up.  That took at least an afternoon.  The banking relationships need to be established.  We have to make the initial contributed capital deposit called for in the operating agreement.  High security checks need to be ordered.  A company seal needs to be designed and manufactured.  Stationary and business cards will need to designed and printed.  Custom marketing materials will need to be produced.  The front-facing website needs to be completed (which is actually happening behind the information wait list request screen at KennonGreen.com).

I’ve been spending a lot of my time writing what will become the regulatory disclosures, such as the Form ADV as well as a sort of client manual that explains who we are, what we do, and how we do it.  I’m also finalizing the Credo with Aaron, which will be the guiding document that sets the tone and culture of the firm for what I hope will be the next few generations.

For now, Aaron and I have converted the study at home into a sort of war room from where we are handling most of the work.  Given that there is a decent probability we may be relocating to either Chicago or Southern California at some point in the coming 12 to 36 months for reasons that a few of you already know after our trip to the West Coast when we tested out different communities – to see that trip, check out the May 2014 archives – I’m not particularly keen on running out and buying or leasing an office building.  For those of you who don’t know what is going on, the short version is this: Aaron and I will have children at some point in the next couple of years and we plan on having biological kids through surrogacy a la the Neil Patrick Harris route.  Two states – Illinois and California – have massive advantages over the others should we reside there when our biological kids are born.  We would both be on the birth certificate, the surrogacy arrangement would protect us and our sons/daughters in different ways, and a lot of the worry of dealing with potential remote-probability events become non-issues as our estate plans would be re-worked.  We’ve been quietly reordering our lives and businesses so that a relocation is a stress-free experience.  Although it has reduced my mother to tears on occasion – no matter how old I get, I will always be her first born baby in her eyes so the idea of me not being a few minutes away makes her sad – even she is on board with us doing this because it will be better for our family.  I half expect that wherever we move, she’ll follow before long, even if it means getting an apartment near us and going back and forth.

Anyway, that’s a much longer post for a different day.

This doesn’t have any practical effect for most people given that our communication is exclusively over the telephone and email as is common in this day and age.  However, for those of you who become clients and want to meet with us face-to-face whenever you’re in the general Kansas City area, it means for the foreseeable future, you’ll be invited into our home.  You’ll be able to sit down with us, have a cup of fresh, hot coffee, and maybe even stick around for dinner as we go over your portfolio.  Given that I normally have a fairly tight zone of privacy around me, it makes me a bit nervous to open what has been our sanctuary since we bought it in our mid-twenties but I’d hope we’re going to be working together for a long, long time and perhaps even become friends.  It certainly is more prudent than me dealing with the hassle of locking in a long-term commercial lease if, before we know it, Aaron and I setup our lives either in The Golden State or downtown Chicago.  It will also be more comfortable for you.

In any event, we ordered a new system to serve as the sole machine on which we do work related to the firm, and on which I am typing this to you right now.  (I have to say the 3440×1440 resolution is sweet and works beautifully with Windows 10.  We ordered a different version from the one you see in stores as this one has an Intel i7 processor, a solid state drive for the operating system plus a traditional drive for larger storage needs, and quite a bit more memory.)

 

Speaking of technology, that’s another thing we’re working on: Technology, compliance, and security.  To understand my thoughts on how I want to handle this subject, you need to travel back in time with me to an experience that had a profound effect on how I think about these things.

Many years ago, back when I was in college, one of my internship experiences was at what I considered to be one of America’s best-run property and casualty insurance groups. I had talked my way into the arrangement by sending a message to the then-university President, who I knew from working with him as the Student Body Treasurer and Chairman of the Finance Board, asking if he could reach out to his predecessor, who was the Chairman of the Board of this insurance group.  I explained that insurance was a passion of mine; that I wanted to understand it, to see how it worked behind the scenes.  The former President and Chairman of that insurance group had the then-current CEO call me and we talked on the phone.  I still remember having the conversation with him, standing in the bedroom of my college apartment.  The CEO graciously invited me to come spend a couple of months at the firm, something for which I will be grateful for the rest of my life.  I then spoke to my academic advisor who figured out a way for me to count the experience as a huge part of my hourly credit requirements, a sort of custom-made program through the liberal arts department, an arrangement we repeated a semester later when I talked my way into an internship in the contract department of Warner Music Group, one of the world’s largest record labels.  It was a crazy time in my life – the year I signed the book deal for The Complete Idiot’s Guide to Investing, 3rd Edition and the year Aaron and I launched Mount Olympus Awards.

The CEO came and introduced himself to me early in the process and asked, “What do you want to do?  How can we help you be successful?”.  I told him that, someday, I wanted to own a holding company or some sort of investment vehicle, never have to work for anyone, and spend my day analyzing companies and acquiring them in whole or part.  I wanted to get the numbers.  To see how the financial statements connected with the actual operations.  He didn’t miss a beat.  “Then that’s what we’ll help you do.”  I remember, in that moment, looking at him and realizing why he was the CEO.  A statement like that didn’t even phase him.  In the months that followed, he and the wonderful woman to whom he assigned me, the controller in Treasury, created a schedule that took me through practically every department in the place.  I worked in accounting for awhile, then moved to the investment department.  I was shocked to watch $5 to $6 billion managed from a handful of offices with less than a dozen people, realizing just how scalable asset management is.  I sat in on customer phone calls in the call center and studied workers compensation claims.  I spent afternoons with reinsurance experts and fraud detection specialists.  Nearly everyone was extraordinary.  I’d stay for hours, long after I should have left, and read A.M. Best manuals or flip through ValueLine and the Bloomberg terminal, researching companies.  It was one of the best experiences of my life.  Truth be told, in an alternate universe, I could have been happy and fulfilled working there for my entire career, having the same chicken salad sandwich and iced tea in the cafeteria every day.  I loved that place like it was my own family business.  It was a mutually-owned firm so the goal was to reward policyholders with dividends, not shareholders, which still gave me the same sense of satisfaction; of serving others and doing a good job while building something.

One afternoon, the CEO showed up and sat down with me.  We began talking and I asked him if there was one thing – a single lesson – that he hoped I walked away from the experience with, and that I remembered for the rest of my life, what would it be.  His response was not what I expected.  “Internal audit.”  It was instant.  There was no hesitation; no qualifications.  He explained that sometimes, even good people would do immoral things if you made it easy for them.  That, often, they would convince themselves they weren’t doing anything wrong and they wouldn’t mean to steal but it would escalate over time.  To protect the firm, the employees, the policyholders, and society, it was my duty as a future executive to have procedures and systems in place that made it very, very difficult to cheat and that if cheating did occur, could uncover it quickly and take appropriate measures.  It was also my duty, no matter how much I liked someone, to kick them out to serve as an example if they crossed a line that should not be crossed and called into question the integrity of the firm.

Those of you who know my background, especially with my parents and their religious insistence upon character and integrity, can probably imagine how hard this was for me to accept because the idea that people needed to be policed was hard for my younger self to understand; that there were people in the world who would behave this way.  I made a conscious decision that I was going to trust him; that his experience justified giving him the benefit of the doubt and that I’d never forget what he told me.  The worst that happened was he was wrong and I spent a bit more on security measures.  It was better than the alternative.

Coincidentally, that same year, I went out to lunch with a man who was an underwriter for a syndicate through Lloyd’s of London after a professor of mine made a call for me and convinced him to let me shadow for a day, watching how he worked.  His entire business consisted of a few rooms in an old, converted house he had purchased, from where he, and a pen, generated millions of dollars in annual income.  It was a fascinating experience but there is one thing that stands out to me.  We went to lunch at a little shopping center near McCaffrey’s grocery store.  As we were eating, he explained that many years prior, he had built a large insurance brokerage business.  He had been very successful, as he was now, but that the entire business failed when he discovered one of the people at the company had been committing fraud, embezzling money and falsifying documents.  It nearly ruined him.  He kept lamenting that it all could have been avoided had he spent even a tiny amount on auditors and safeguards; how dumb he had been to trust other people.  Even though he ended up becoming obscenely rich again, it had been so unnecessary.  Sitting there, I immediately recalled the lesson from the insurance group.  Internal audit.

How That Philosophy Is Influencing Our Selection of Technology Vendors and Custody Philosophy

What does all of this have to do with starting an asset management firm?  Especially since Aaron and I will be the only two working there in the beginning?  Simple.  I’m going to build compliance into everything we do.  I’m not talking about the bare minimum required by law.  I want it to be part of the culture so that, if and when we grow, it will be anathema to even contemplate violating the policies and procedures in place.  (And I do want to grow.  If, God willing, we end up with a normal life expectancy, we should have 50+ years to expand the place into something meaningful.  I’m willing to bet we can do it.)

The message of such a policy should be clear: If not even Aaron or I are exempt – and we are the Managing Directors, have our name on the door, and own 100% of the equity – why would anyone else think they are able to get away with ignoring the rules?  From the day we open, I want a respect for compliance to be part of our firm DNA.  We may not be perfect – and we may even make mistakes from time to time – but we will strive to be; to build a firm that, if the roles were reversed and we were the client, the safeguards in place would let us sleep better at night.  I want to build a firm that, were I client, I’d be happy to have manage 100% of my net worth.  That means always striving to be better.

We’ve begun choosing our technology vendors accordingly.  For example, the imaging system we will be using to archive signed advisory agreements, sensitive client records, etc., is built on a platform that creates complete audit trails of all interactions between the system and the user, records additions and changes by users to WORM media (write-once-read-many so it cannot be modified), has backup ability so we can recover information in the event of an emergency, isolates user storage so only the appropriate and authorized people will have access to sensitive documents, and communicates with the firm user through 256-bit SSL encryption.

The email system we will be using retains 100% of all incoming and outgoing messages so there is a record of communications even if the user deletes them, including attachments, with the archive being stored in two different data stores for compliance, audit, and security reasons.  If a regulator ever comes in and wants to examine certain email communications, it’s all there, silently being archived in the background.

These two systems will integrate with our customer relationship system, improving efficiency.  That customer relationship system is advanced enough it will help us meet “know your client” requirements, allow us to build detailed, secure files on clients to better serve their needs, integrate with our chosen third-party custodian platform, and keep the information safe by having it all stored in the data center rather than on a local system.  The database for this system is backed up nightly to another off-site location so we can restore information in the event of a disaster or emergency.

Where possible, we will be using two-part authentication so that simply knowing a username and password alone isn’t enough to login to a system.

Determining Which Custody Platform We Recommend to Clients Is a Major Decision We Need to Finalize This Quarter

Similarly, one of the decisions we made very early was the firm will not take physical custody of client assets.  Instead, we will only agree to manage funds for clients who deposit their assets into their own custody account at a qualified third-party custodian.  This means that neither Aaron nor I, nor any of the future employees of the firm, will have physical access to client funds except to debit client accounts for the fees we are owed for asset management based upon the prior written authorization of the client.  Instead, the firm will be given discretionary trading authority over the account to invest the money.  The custodian will directly, and independently, send the client records of the cash, securities, and other assets or positions in their custody account, along with list of transactions that have taken place in the account, which the client and his or her advisors, including attorneys, accountants, financial planners, or family members can compare to the statements prepared by our firm, including the billing calculation for fees.  This will allow the client and his or her advisors to compare the statements, performing their own audit.

At the moment, we have narrowed down our choice of recommended custodian to four potential firms, which we are evaluating before making a final decision.  Before I put my stamp of approval on a financial institution, I want to be absolutely certain they meet my standards and will be a major asset to both the firm and our clients.  There are two that have really pulled out ahead of the pack in terms of capability and service levels but this isn’t a decision I’m going to rush.

Handling the Regulatory Licensing and Approval

Beyond that, there is still a laundry list of things to accomplish but we’re making progress every day.  Later this month, I’m meeting with one of the tax partners at our accounting firm, for example.  I want to make sure that everything is done right from day one since the waiting list has clients from all over the country and, in a few cases, even international inquiries.

Once we have everything checked off the list – the entire framework is in place, the documents are written, the service offerings are finalized – Aaron and I are going to go handle the personal and firm-specific regulatory approvals we need to get for both ourselves and Kennon-Green & Co. so it can begin taking clients.  We want it to be like a light switch gets flipped when we open our doors, everything ready to go.

As soon as the regulatory approvals are done, we are going to systematically contact the people who were on the waiting list.  The order will depend, in part, on some of the regulatory requirements of the state in which the future client resides but generally, I expect to send them all of the information either in physical form or, if we can find a client portal that I am sufficiently satisfied with in the beginning, a secure platform they can access and maybe even setup a time to speak with each on the phone to answer any questions they have.  (Or, again, set up an appointment and have them swing by the house to meet face-to-face.)

Another thing we’re working on is consolidating certain family assets at a specific custodian so we can immediately bring a good chunk of change from day one to be invested in portfolios containing securities similar, and in many cases, identical, to those we select for client portfolios.  I want to do this to demonstrate our commitment to walking in their shoes as much as we can by aligning incentives.  With all due respect to my childhood investing heroes, I always felt like their initial contributions alongside investors were on the parsimonious side.  Ultimately, I expect Kennon-Green & Co. to become the central family office through which we manage a majority, if not practically all, of our family’s liquid net worth.  That will take time to achieve.  From the outset, though, I’d at least like Aaron and I, along with members of our family, to kick in a collective $500,000 to $1,000,000 of our wealth to demonstrate we’re serious about this and both hope and intend to increase that amount materially in the coming years.  Again, it’s something I’d want to see if the roles were reversed so I think I should hold myself to that same standard.  Of course, this can’t guarantee results.  Neither I, nor anyone else, can promise results.  The only thing I can promise is that Aaron and I will invest client money the same way we invest our own money, factoring in individual considerations and, in some cases, moral and ethical preferences (e.g., some folks don’t want to own tobacco shares no matter how attractive they are).

I also think the right type of client will appreciate that it is self-made.  It’s one thing to kick in money.  It’s another when you and your family members had to earn it yourself.

Of course, that’s something that will have to wait until we’re closer to launch once the details are settled.  Everything is subject to change and the only thing clients will be able to rely upon is what we put in our regulatory disclosures and commit to them in the advisory contracts.  Those of you who have been around a long time know what you’re getting with me, and that I try to be both fair and transparent, so I trust most of you will be happy with the final decisions.

The only downside thus far is that Aaron and I have made the decision that it is going to be far easier to handle regulatory compliance by severely curtailing our online presence.  This blog will change in nature somewhat, focusing on more personal and abstract, academic concepts, while things that involve specific, actionable, non-academic or entertainment capital market topics will overwhelmingly be released to clients through white papers, quarterly letters, and other publications.  There is a plus, though, in that when that happens, our schedule should be a lot clearer so updates will resume, again.  I may even implement a Podcast so I can more efficiently keep up with everything.  Plus, for many of you, it won’t matter because you’ll be able to pick up the phone to call us or stop by and have a conversation.

Also, a bit of fair warning: At some point, as we get closer to the launch, the waiting list will be taken down so I can make sure we focus our initial efforts on those who wanted to invest with us early.  There will not be advance notice.  If your name isn’t on it, you’ll have to wait for us to open to the general public.  If you want to add your name, follow the instructions on the site that will become the firm’s homepage.