Editor’s note: This article was first published in August 2013. The 10% average return over the previous 12 months, the portfolio breakdown (18% hedge funds, 10% private equity, 2% self-managed) and the remark about Bill Ackman’s fund describe the situation that month.
According to Phil DeMuth, a Forbes contributor who specialises in finance, the rich with more than 200 million dollars of investable capital have not done as well as they should have, while the “slightly less rich”, investing small fortunes of between 100,000 and 10 million dollars, have done “as well as it gets” by managing their own money or buying index funds.
Let’s look at why the super-rich (over 200 million dollars) have earned an average return of only 10% over the last 12 months, when most of the world’s indices have delivered higher returns.
According to Phil DeMuth, the super-rich have overdone diversification. As the chart in the Forbes article shows, they have diversified into practically every investment product, and they have invested only 2% of their capital themselves. In other words, out of 200 million, they have made only 4 million dollars of investments themselves, which we imagine would be the money they consider their risk capital. As for the rest, looking at the diversification of the portfolio, DeMuth calculates that they must have spent more than 3 million dollars in fees and commissions alone to have that capital managed.
The largest share of the investment is in the famous hedge funds (18%), where some managers achieve very high returns for their investors. According to many experts, however, hedge funds had those high returns in the past, but they have fallen sharply now that the indices have reached all-time highs. Even so, a few hedge funds are doing very well, and that is why their fees are so high. For the rich who have invested in Bill Ackman’s fund, though, returns would be hanging by a thread right now.
Private equity funds make up 10% of the diversification, and there are also bonds, commodities and so on.
(Read: The fascinating life and career of Steve Cohen)
Clearly, when you have a large fortune, diversification becomes essential. In fact, that is when you should take on less risk and settle for an average annual return after taxes and fees. Even so, given the bullish conditions in the market, DeMuth believes these rich investors, despite their 10% return, have thrown away a lot of money and got worse returns than expected, and worse than they could have had with less diversification.
Ultimately, these millionaires with more than 200 million in capital have placed their money based on a cost-quality equation in which, supposedly, the more you pay in fees, the better your money will be managed. The truth, though, is that the investment industry generally works the other way round: the more you pay, the less you get.
Further reading
- This is how the 1% makes money
- The essence of intelligent investing to build wealth over the long term
Featured image: Mike is Michi, CC BY-SA 4.0, via Wikimedia Commons.
