“No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other.” ~ Matthew 6:24 

When I partnered with Larry Gray to form Iron Capital in 2003, we had two driving motivations. First was the fact that the investment industry was (and still is) rife with conflicts of interest. The second was that the industry had evolved in a way that set up layers of middle people between investors and the actual investment professionals. We wanted to fix those two flaws, so we started a firm with three core values: Trust, Independence, and Service. 

The primary value, in my opinion, is independence, because it is not only important in and of itself, but also a necessary element in both of the other two. It boils down to one question: Who is the boss – is it the client, or someone else? Our industry has historically broken that distinction down by using the terms “buy side” and “sell side.”

The sell side is far more familiar to most retail investors. The traditional financial adviser (stockbroker), the big brokerage firms, and investment banks are the sell side. They develop products and then sell them to investors. I’m often accused of being unfairly harsh towards the sell side, but that really isn’t the case. The sell side is necessary, and they provide needed products and services. The issue I have is that too often they are less than forthcoming about for whom they work and what they actually do. 

This wasn’t always the case. When I first got into the industry, the distinction was clear. My first job was on the sell side, and we made it perfectly clear that we could not offer advice; we could only provide education and guidance regarding the products we offered. For much of my career my individual clients were from the “Greatest Generation.” When I would first meet someone of that generation and ask them who managed their money, they would say, “I do, and Bob is my broker at Merrill Lynch.” That is a correct statement. 

Starting with the baby boomers and especially with millennials, when we ask that same question they will answer, “Bob at Merrill Lynch.” That is not a correct statement. Merrill Lynch is a brokerage firm – a store with products to sell, not a money manager. Bob is still a salesman, but one generation understood that while others do not. In recent years I have even met young brokers who, upon meeting me and learning what I do, will say something like, “I do the same thing.” They mean it, because they don’t know any better, but they are wrong. 

I’m on the buy side and have been for most of my career. The buy-side professionals are the ones who make investments on behalf of others. We have a fiduciary relationship with our clients, and we work for the client. We are hired by the client to make investment decisions on the client’s behalf. Most on the buy side will partner with the sell side; the buy-side portfolio manager will manage a fund, and the sell-side broker will sell it. It works great for the industry – investment professionals get to spend all their time analyzing investments and managing portfolios, and sales professionals get to spend all their time in front of clients. 

That was my life before founding Iron Capital. I rarely, if ever, got to meet a client back then; if I did, it was for a quick question-and-answer session, after which the financial adviser would say, “See, we do have smart people. Now let’s make that tee time.” It works for everyone, except the client. This scenario creates extra layers of cost, and the client must settle for products which are seldom a perfect fit for what she is trying to accomplish.

One day I realized that while we on the investment team often spoke of the clients, we didn’t know them, and we didn’t really work for them. We worked for the sell side; they were the ones who sold our product, and they would only sell it if they liked it. They were the retail outlet and had basically turned us into wholesalers. This is how the industry works today. Most on the buy side manage products sold through the sell side. They don’t know the client, and either give the client little thought or assume that the sell side has the client’s best interest at heart. 

However, today’s “financial adviser” does not work for the client either; they work for the brokerage firm. Their legal title is registered representative; they represent their firm. What they can and cannot tell you is governed by a compliance department staffed with attorneys whose job it is to make sure the firm doesn’t get sued or fined by regulators. Those attorneys also do not work for client. 

Because of this, the ranks of financial advisers who have left traditional brokerage firms to become independent investment advisers have grown, which is great. Unfortunately, old habits are far harder to break than legal structures. As we recently reported, there is a mutual fund scandal happening today in which supposedly independent advisers are negotiating sweetheart deals for their book of business with mutual fund families. This may seem harmless, or even that these advisers are doing a good thing, but when an adviser accepts a sweetheart deal from one fund family, for whom is he now working? 

Independence is not as easy as just leaving a brokerage firm. One cannot serve two masters. One cannot in good conscience negotiate deals with fund families and still work solely for the client’s best interest. Independence is difficult to maintain, but for us it is a core value, and vital. At least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~Who’s the Boss?

It is hard to believe it has been almost 20 years since I left Invesco and co-founded Iron Capital with my then-partner Larry Gray in 2003. Almost immediately after we launched, the industry from which I hailed handed us a gift in the way of what was simply known as “the mutual fund scandal.” 

I left Invesco because I was bothered by two things in the investment industry. First: the industry is rife with conflicts of interest, which is self-evident. Second: the investor increasingly has no access to actual investment counsel – meaning the industry evolved to put layers of middle-people between the investor and the actual investment professional. Today the investment professionals – analysts and portfolio managers – do their work in relative isolation, and support staff share information to heads of sales (who now go by myriad names other than sales), who distribute that information to brokers (now referred to as financial advisers), and then to clients. A lot gets lost on the way. 

We wanted to build a firm that was truly independent and gave investors direct access to the investment professionals who actually make the investment decisions. As we launched the firm, New York attorney general Anthony Weiner announced an investigation into the practices of mutual fund companies who were allowing short-term traders to go into and out of their funds rapidly, hurting long-term investors. To sum up the gist of the scandal, these firms had given preferential treatment to large brokers and hedge funds at the cost of everyday clients. 

This actually helped our business, first because we were preaching an end to conflicts of interest, and second because coming from the mutual fund world helped us have a better understanding of what was actually happening. Iron Capital got off to a great start and we successfully built a nice business; quickly we made the decision to be satisfied with doing just that. Having come from a very large firm and knowing all that goes with that, we decided that Iron Capital would remain a boutique. We ended all business development efforts and focused solely on serving our existing clients. Our clients’ referrals are our only source of new business. 

Along the way we felt that the industry had improved, as firms like ours led to more independence and fewer conflicts. But I was naive. Yes, many brokers have left their traditional role to become fee-based, but as the old expression goes, “Just because a cat has kittens in the oven, that don’t make ‘em biscuits.” Just this past week I have learned of a practice that should make the first mutual fund scandal seem petty and small. 

Multiple mutual fund giants, including but not limited to T. Rowe Price, Fidelity, and yes my old employer Invesco, have made deals with supposedly independent pension consultants to charge their clients less than they charge everyone else. They are doing so by aggregating the total assets of these consultants and charging them as if they were one very large client. What is wrong with that? 

Let us count the ways. Traditionally many of the consultants who work with retirement plans followed Iron Capital’s model and remained boutiques. I may be biased, but in my opinion, this is what the best consultants have done… yes that includes us, but not just us. Boutiques have been able to compete because pricing in this business was always based on the client, not whom the client chose to hire as a consultant. 

It works the same way for retail investors. Charles Schwab in all likelihood has billions of dollars with these various mutual fund firms. Still, if you go to Schwab and open an IRA and choose one of these mutual funds, what you pay for the fund is based on your account alone. Otherwise, Charles Schwab wouldn’t exist, because they could have never competed with the Merrill Lynch’s of the world who were huge long before anyone “talked to Chuck” as their commercials used to say. 

If pricing is based on the size of the consulting firm, then boutique firms will no longer exist. This is problem number one. Problem number two is that independence will no longer exist. Once there is a business relationship between the consultant and the mutual fund company, all independence is lost. One simply cannot serve two masters, so if we build a cost-reduction relationship with T. Rowe Price for their target retirement date funds, but then come to believe that someone else’s product is better, we now have a conflict: Do we go with the best option, or do we go with bulk purchasing power? One cannot serve two masters. 

Finally, and most importantly: Small plans, small firms and their employees end up subsidizing these large relationships by paying more for the same fund. Scaling pricing based on the client, whether an individual or a retirement plan, makes sense as there is some fixed cost to having a client. That cost does not increase with the size of the portfolio, so reducing the percentage charge as assets grow makes sense. However, basing that not on the client but on the consultant the client chooses to hire means a small client who hires the preferred consultant may end up paying less than a large one who chooses another path. The only way the mutual fund company can make that work is by keeping prices higher for everyone else. 

The original mutual fund scandal boiled down to large brokers getting preferential treatment at the expense of small investors. This 2.0 version boils down to the same thing: Large consulting firms are receiving preferential treatment at the expense of smaller firms and investors. Iron Capital could play this game too. We never dreamed of it because it is unethical. Unfortunately, we have no choice; we have a fiduciary responsibility to look out for our clients. That doesn’t mean we can’t simultaneously work to stop this practice. 

I left the mutual fund industry to start Iron Capital because I was tired of feeling dirty when I came home from work. I wanted to look into a mirror without shame. It sickens me that I have to get dirty again to protect my clients. This time I can do it in the light of day. Light is a great disinfectant, at least that is my perspective. This will not be the last time you read about the Mutual Fund Scandal 2.0. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~Mutual Fund Scandal 2.0

The cancel culture was all aflutter last week:  A man who is popular enough to be un-cancelable and who believes that people should actually be free to express their opinions bought their favorite platform with the express intent of canceling the cancel culture. He is going to let people say what they want to say. Oh the horror. 

I have to admit that I am truly enjoying this story because there are so many lessons here and let’s face it, most stories over the last year have been depressing. The first lesson is in hypocrisy. We try our best at Iron Capital to be neutral on political issues and we pride ourselves in having a diverse client base. We will, however, call out hypocrisy. 

In fretting over Elon Musk’s purchase of Twitter, MSNBC host Ari Melber warns that Musk could hack the political debate and “ban one party’s candidate” or “turn down the reach of their stuff and turn up the reach of something else, and the rest of us might not even find out about it until after the election.” For example, Twitter could ban a politician like former President Trump, or they could “turn down” a story like Hunter Biden’s laptop. One can’t make this up. 

Before Ronald Reagan became President of the United States, he was president of the Screen Actors Guild. This was during the time of the McCarthy hearings, the last time a “cancel culture” tried to take hold in America. Hollywood has always attracted a more left-leaning crowd and many were caught up in McCarthy’s web. Reagan fought back. In his testimony before the House Un-American Activities Committee in 1947, he was asked, “Mr. Reagan, what is your feeling about what steps should be taken to rid the motion picture industry of any Communist influences, if they are there?“ 

Reagan responded, “… [T]he best thing to do is make democracy work. … I believe, as Thomas Jefferson put it, if all American people know all of the facts, they will never make a mistake. … As a citizen, I would hesitate, or not like, to see any political party outlawed on the basis of its political ideology. We have spent 170 years in this country on the basis that democracy is strong enough to stand up and fight against the inroads of any ideology.” 

Reagan believed the best approach to what today we would call “Communist disinformation” was not a McCarthy-style campaign to silence them, but to let them talk so they would ultimately reveal themselves for who they actually were. In other words, if one is on the “right” side, then she has nothing to fear from anything the “wrong” side could say. 

We find a lesson in our industry regarding our recent phobia of disinformation. Benjamin Graham, the father of security analysis and mentor to Warren Buffet, once said, “The stock investor is neither right or wrong because others agreed or disagreed with him; he is right because his facts and analysis are right.” Conversely, he is wrong when his facts and analysis are wrong. Similarly, disinformation is so-labeled because it runs against current consensus belief, but almost all true breakthroughs ran against current consensus belief. 

So, at one point in human history the idea that the world was round was “disinformation,” as was the idea that the earth revolved around the sun. More recently, the idea that someone who had received the Covid vaccine could still get Covid was “disinformation.” We could go on and on. The consensus is never right or wrong because it is the consensus; it is right or wrong because we have our facts and analysis right or wrong. If we are all seeking the Truth, then we have nothing to fear from allowing others to speak. 

Of course, this requires an actual belief that Truth exists. We have a generation of people who were taught that there is no such thing as Truth, only feelings. Peggy Noonan put it well in a recent column. She spoke of two characteristics of radicals on both sides. “The first is that they have extreme respect for their own emotions: If they feel it, it’s true. The other is that they tend to be stupid, in the sense of having little or no historical knowledge or the sense of proportion such knowledge brings.” 

They claim that “disinformation” must be stopped, because they were never taught the critical thinking skills to actually debate and reveal a lie as a lie and they lack the historical knowledge of the fact that there has never been a censor of political speech who turned out to be a good guy.  

They also fail to see that by banning a conspiracy theory, one actually gives it credibility. “They don’t want you to know about this, so there must be something to it. What are they afraid of?” If they are on the correct side, they have nothing to fear. Perhaps that is the crux of it. Perhaps what they really fear is being proved wrong. 

People like Musk are open to free speech because they do not fear being proved wrong.  Being wrong and making mistakes is often how we learn, and Musk strikes me as a man who has a thirst for learning. I have never been on Twitter, but I might do it now. I’m not afraid of free speech. The best way to prove your opponent a fool is to let him talk; at least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~Musk Buys Twitter

Iron Capital is guided by our core values of trust, independence, and service. Most of our clients have heard us speak to these values many times over the years. We structure trust into how we built the firm so our clients can follow the sage advice of Ronald Reagan and “trust but verify.” We believe strongly that one cannot serve two masters, and we guard our independence dearly. We serve our clients with what we believe is meaningful service – not service for the sake of service, but true insight. 

That is our public face, and it is authentic. To ensure that it remains authentic we have a set of guiding principles that are not public but meant for us internally. One of those principles is to strive for wisdom. I know that sounds old-fashioned, but in our opinion, wisdom is what we are paid to provide. Information is free these days. When I was a young analyst at Invesco, we had an entire floor that held nothing but annual reports from public companies. The weight of it required the floor to be reinforced. Today, any investor can read the annual report of any company he wishes by simply searching for it online. 

There may have been a day when information was enough to warrant an adviser’s fee, but those days are long gone. Knowledge is a different matter. It is one thing to be able to find an annual report online; it is another thing entirely to know what to do with it. Finance is like most other fields – we have our own language, and it helps tremendously to be fluent in that language. Knowledge is essential, but it is not, in fact, rare. Many of our clients are very knowledgeable in finance and investing, so they certainly wouldn’t pay us simply for something they already possess. 

Knowledge is essential but it is not enough. We get paid for wisdom. What is wisdom? This isn’t philosophy class, so we need a practical definition. We defined it as the combination of knowledge and experience. There are no short cuts to wisdom; it takes time to build, and the longer one is at it, the more one understands that he can never obtain it, he can only continue to strive towards it. 

Wisdom has fallen out of fashion, and the consequences of that are plainly obvious all around us. Our policymakers and political leaders increasingly have no real-world experience. Case in point is the Federal Reserve. The Fed is staffed and run by very intelligent people, all of whom went to the same schools, got the same knowledge, and have no actual experience. Last year as inflation was taking hold and Congress was doing everything in their power to make it grow, the very intelligent and knowledgeable people at the Fed kept saying that inflation was transitory. 

We wrote at the time that it reminded me of the scene in “The Prince’s Bride” when Vizzini keeps saying, “Inconceivable!” Then Fezzik says, “You keep using that word. I do not think it means what you think it means.” I am not bragging about predicting the pain we are all in now as prices rise faster than at any time since the disco era; almost everyone I know in our industry with practical experience was saying the same thing: Fed, you are wrong. This isn’t transitory, and it isn’t going to just disappear. 

There is no substitute for real experience when it comes to wisdom. Years ago, my wife and I were in a bar in Edinburgh Scotland. Hanging in there was a sign that said, “Good judgement comes from experience. Experience comes from poor judgement.” In the private sector when an analyst predicts that inflation is transitory and she ends up being wrong, she will face consequences and might even be looking for new employment. That may seem harsh, but it is the consequences of our mistakes that force us to learn from our mistakes. 

Has anyone been fired from or even reprimanded at the Fed for being so wrong about inflation? I doubt it. There is a crisis in academia today of studies being published with results that cannot be replicated. They got published, that is more important to them and their careers than being correct. The fact their findings cannot be replicated (that’s fancy talk for they were wrong) simply means they need another grant to do it over again. No lessons learned, no wisdom gained. 

This phenomenon is everywhere in public policy today. It used to be said of salespeople that they were often wrong but never in doubt. That wasn’t a compliment. Today the same can be said of most of our public “experts.” For the Fed, it means they waited far too long to address inflation and now they risk turning that one mistake into two mistakes by going too far in an attempt to fix it. Meanwhile, Congress – who really caused it and continues to fuel it – escapes any accountability. 

The people at the Fed are very intelligent and quite knowledgeable. Those traits are absolutely necessary, but they are not sufficient for making good policy. That takes wisdom, and wisdom is one thing our current leaders are severely lacking. At least that is my perspective. 

Warm regards,

Chuck Osborne, CFA 
Managing Director

~Strive for Wisdom

Maz: Han, it is time to get back in the fight. 
Rey: What fight?
Maz: The only fight. Against the dark side. Through the ages I’ve seen evil take many forms…. We must face them, fight them. All of us. 
~ “Star Wars: The Force Awakens” 

Last week Russia invaded Ukraine. In an instant, the world realized that we have not actually cancelled human nature, and that our generation may very well be called upon to stop true evil once again. To do so, we will first need to get rid of our childish ways. That begins with doing away with hyperbole, beginning to actually listen to one another, and maybe even admitting that we don’t know everything. 

How does a man like Putin believe he can get away with invading another country in 2022? Part of the answer lies in my experience last Thursday: As Russia was invading Ukraine, and I was going through my normal daily reading of the news. Just about every article was about the invasion, and most of them had a common theme: arguing for us to act like adults, especially in regard to climate policy. 

Is it any wonder Putin would believe the West would be too weak to stand up to him? For years Europe has turned a blind eye and empowered him by relying on Russia for their fossil fuels. Why? Because of a childlike view of climate change. The climate is like most of our subjects today – you are either on one side of the sandbox or the other. 

Holeman Jenkins of The Wall Street Journal put it perfectly in his column on January 28, “Millions of us have grown too comfortable pronouncing ourselves passionate about a problem we don’t bother to understand.” That pretty much covers every issue we have today.

When it comes to climate change, there is a scientific consensus that the climate is changing. There is also a consensus that man’s activity is contributing to the change, especially the increase in carbon in the atmosphere. There ends the actual consensus; everything else is childlike taunting. “It is settled science!” – “Is not!” – “Is too!” We might as well be in the back seat of our parents’ car saying, “He’s touching me!” 

Several years ago at a climate presentation I heard a point I had never heard before: The presenting expert noted that, going back to the beginning of the industrial age, deforestation is five times more responsible for the increase in carbon than all the emissions put together. He was not talking about the deforestation currently happening in the rain forest, although it was his goal to stop that; he was speaking of the forest that is now New York City, London, Paris, and your neighborhood. 

I have no idea if he was correct. I can say that I have asked about this every time I have had the opportunity to speak to a climate scientist and thus far no one has refuted it. I’m no climate expert, but I am pretty good at math. If cutting down the forest to build large metropolitan areas is five times more responsible for the increase in carbon, then we could go to zero emissions and somehow capture every ounce of carbon ever emitted from the dawn of the industrial age and only solve 20 percent of the problem. That is some perspective.  

In the fall of 2020, we took our then-10-year-old daughter to Disney World for her birthday. As we drove from the Florida Turnpike to Disney World, we passed acres upon acres of solar panels. That space used to be covered in orange trees. If the expert I heard from several years ago is even close to being correct, then it makes me wonder: is cutting down all of those trees and replacing them with metal and glass really a net positive for the environment? Is that really “clean?” I honestly do not know the answer, but I know that we are not allowed to ask the question. If we do, we will be labeled a denier and told that science is real. No questions allowed. 

When I was a child, the grocery stores replaced paper bags with plastic ones. Why? To save the trees of course. Today our oceans are drowning with plastic. What environmental disasters will the electric car bring us 20 or 30 years from now? Are we asking those questions? That is what adults do. Children come up with solutions that are impractical and/or cause more problems than they solve. Then, when an adult points this out, they throw a temper tantrum. Sound familiar? 

Putin is a lot of things, but he is no child. He has become powerful as Europe pretends to move on from fossil fuels to prove they are climate warriors while in reality becoming dependent on Russia to heat their homes in the winter. Is it any wonder he views the West as children who can be bullied? 

Climate change is real, but so is the need for energy security. Adults are able to understand conflicting problems. They are able to weigh pros and cons, risk and return. We need to start talking to about the problems we face as adults, not as children who simply hurl insults when they don’t get their way. Only adults can truly work together to find compromise and a path forward. We eventually have to do this, because if history teaches us anything, it is that the fight never ends. 

Evil takes many forms, among them Hitler, Stalin, Mao, Pol Pot, Castro, Bin Laden, and now Putin. To stop evil, we have to face it as adults. We must put aside our childlike ways and start to understand that adult problems are complicated. They are nuanced, and asking questions, or having different perspectives, is not the same as denying the problems exist. The truth is there is no way known to humankind to produce energy without impacting the environment. Lithium batteries are not clean. Destroying nature to make room for solar farms and windmills is no way to save nature. Pretending otherwise is childish, and acting like a child encourages evil men to take advantage of the situation. It makes them believe we are weak.

When evil men try to bully the world, we must take Maz’s advice. “We must face them, fight them, all of us.” That begins with serious grownup conversations about all of our problems. We don’t have to agree on everything, but we do have to stop attacking ourselves as if we are enemies. As Putin has reminded us, there are still real enemies out there. At least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~Time for Grownup Conversations