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Death and Taxes: Ben Franklin and Wealth Management

This time of year, we in the U.S. are unfortunately reminded of a phrase written by Benjamin Franklin in a letter to French scientist Jean-Baptiste Le Roy in 1789: “Nothing is certain except death and taxes.” As taxpayers, we all know this well. Do many investors forget this, however, when examining hedge funds?

Consider the following true story. Last year I was hired by a wealthy couple to help vet investment managers and private banks. They had recently sold a business that had netted them approximately $100 million in aftertax cash and wanted to make sure they were making prudent long-term choices. One of the meetings we had was with a large trust bank, which hosted an elegant lunch. The firm brought in an impressive team that included the president of the trust division and the chief investment officer.

After the first course, the trust bank’s president summarized the firm’s capabilities. Particular emphasis was given to the strength of the alternatives and hedge fund selection team. He concluded by saying, “You’ve done well. We’re here to make sure your family continues to do well over generations by building you a prudently diversified portfolio that includes global equities, bonds and a world-class mix of alternative managers.”

Although the couple appreciated the presentation, neither fully understood the complex hedge fund strategies included in the proposal. When they questioned the necessity of these strategies, the CIO said, “It’s important that we broadly diversify your family assets into both traditional and alternative strategies such as hedge funds. As fiduciaries, it’s not prudent to invest in an endowment-style portfolio that doesn’t include hedge funds.”

Despite the persuasive presenters, and buoyed perhaps by the knowledge that they had built a successful business by always fully understanding strategies before executing them, the couple decided to keep it simple and not invest in hedge funds.

Were my clients right to keep to the simpler path? Initially, it might appear not.

The family had set up a Delaware dynasty trust. Their time horizon for investment and distribution of funds to beneficiaries was going to be measured not in years or decades but in generations. What does that sound like? Probably, an endowment.

If trusts for families falling into the ultra-high-net-worth bracket — having investable assets of at least $30 million — have characteristics that resemble endowments, shouldn’t more portfolios of ultra-high-net-worth clients look like Yale-style endowments?

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Great article Preston. Last year the Financial Analysts Journal printed an article that addressed the issue of after-tax hedge fund returns entitled "What Would Yale Do if it Were Taxable?" The authors conclude that hedge funds provide little benefit to the taxable investor, though systematic tax loss harvesting can potentially offset the impact of hedge fund taxes.

https://www.aperiogroup.com/resource/154/node/download

May 16 2016 at 3:48 PM EST

Kyle W. Goldman