“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.
Chuck Osborne, CFA