Achieve Returns Like UHNWIs

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When taking into account inflation, retail investors lost money over the last decade.

According to JP Morgan Asset Management, the average annual return earned by a retail investor for the 20-year period between 1999 and 2018 was 1.9%.  Average annual inflation was 2.2% during this same period.

Why did retail investors lose money?

Maybe it has something to do with their investment strategy, one that picks the easy targets – public equities.  And among public companies, large financial companies are popular investment choices of retail investors. Why? Because; often, when faced with the decision to invest with a large well-known public firm or a small agile private company, retail investors don’t give the private company a second thought. They tend to opt to invest with the large, recognizable company.

The problem with large firms is they often get bloated, bogged down with mismanagement and inexperienced advisors, with leadership often indifferent or immoral, pushing the entire organization toward disaster.  Large firms can not only more easily hide warts but often, as history has proven, allow unscrupulous CEOs, CFOs and accountants to fudge numbers to fool investors, employees, and shareholders. All this to paint a picture that’s rosier than reality, for self-gain and self-preservation. Truth often gets lost in bloat. Dishonest and immoral managers know this and can hide not only mismanagement but outright theft and fraud for long periods before getting exposed.

Here’s the BK Hall of Fame featuring large financial firms…

MF Global (2011) | $41 Billion 

MF Global structured its foreign debt trades to make short-term profits. When things went south, the company started using its customers’ brokerage assets to cover its losses from trades.

Conseco (2002) | $61 Billion

Conseco was an insurance and financial holding company. Its aggressive acquisition strategies went horribly wrong as it took massive debts on its books.

CIT Group (2009) | $71 Billion

CIT Group was a financial services firm that invested heavily in the subprime mortgages at the peak of the US housing bubble.

Washington Mutual (2008) | $328 Billion

Washington Mutual ended up filing for bankruptcy due to its extensive exposure to subprime mortgages. JP Morgan Chase now owns much of its retail operations.

Lehman Brothers (2008) | $691 Billion

Lehman Brothers is by far the largest corporate bankruptcy in the US history.

The problem with large, bloated companies is that their management goes largely unaccountable – sheltered in their towers from their shareholders.  You can never get a hold of top leadership, often being relegated to a  company rep at the bottom of the totem pole. When these companies file for bankruptcy or fall in default, the walls go even higher with no one usually ever held accountable.

Unlike retail investors, ultra-high-net-worth investors (“UHNWIs”) avoid bloated public companies.

UHNWIs prefer smaller, private companies not only for superior returns but also for easily accessible management. In the past 20 years, UHNWIs have largely divested themselves of public equities, turning to alternative investments instead, with real estate and passive private investing representing the bulk of their asset allocations.  To understand the mindset of the UHNWIs, a peek inside angel investing and what motivates angel investors gives valuable insights into why UHNWIs prefer small companies, usually in the startup phase, for investment.

So what are some of the elements of small businesses and startups that appeal to angel investors?

High Growth Opportunities 

Small, agile companies seizing on a niche industry or product can provide returns mature companies can not.  Accessibility to management allows UHNWIs to spot winning market opportunities retail investors ignore.  Sophisticated investors are willing to take on risks such as loss of capital, dilution of their share and illiquidity, primarily because of the potential returns.

Killer Management

Small companies with accessible management allow investors to assess the competence of the leaders and the likelihood of a company’s success.  Highly valued management qualities include chemistry (between each other and the investor), in-depth understanding of the target market and sector, relevant experience, flexibility – in terms of being able to adjust approaches and learn from mistakes, and the right skills needed for the current stage of the business.

Scalability

Small, agile companies lead by killer management can position the company for major sales growth on minor incremental costs.

Winning Business Model

Small companies allow potential investors to more easily assess a company’s business strategy and its likelihood of success.  Small companies with a realistic, workable approach to attracting and converting the customers needed to grow and succeed are appealing to the sophisticated investor.

Verifiable Financials

Evidence-based, realistic, and robustly tested financials appeal to the UHNWI. Once again, because of accessibility to records and books, feasible and attractive calculations with the detailed research and data supporting them will attract UHNWIs.

Alignment of Interests

With the rise of impact investing,  more and more investors are backing projects that have a positive influence socially or environmentally, while still making a profit.

One thing is evident as you delve into the investing habits of the UHNWIs, and that is that they prefer alternatives to the bloat of Wall Street.  They prefer small, lean companies that are transparent and make their management available.  Transparency and accessibility allow UHNWIs to asses the most critical elements that can determine the future success of a company, including business plan, financials, management interests, etc.

All you need to do to achieve returns like UHNWIs is to understand and adopt their investment patterns.  Then you’ll be on your way to creating lasting wealth.

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