Harvard philosophy professor George Santayana famously said: “Those who cannot remember the past are condemned to repeat it.” Well, maybe. But I’ve found that, like many quotations, Professor Santayana’s dictum sounds like it makes more sense than it really does. The problem is that the mere knowledge of past events doesn’t afford us any particular insight into the lessons of history.
For instance, it’s not clear in the current public debate whether the “lessons” of the Vietnam War suggest that we shouldn’t have gotten involved in Iraq in the first place, or that once our troops were committed, continued public opposition only encourages the enemy. In this debate, both sides claim WWII “lessons” by citing either a Neville Chamberlain-like appeasement approach by the U.N. toward Saddam Hussein, or by claiming that George W. is the real Hitler now. In our own universe, many students of financial history still lost their keisters in the dot-com crash despite their extensive knowledge of manic markets from Dutch tulips to Japanese yen.
So while I try to avoid commenting on other writers’ work (honest, I do), recent tail-wagging in this magazine (see “The Road Less Traveled” in the May 2005 issue) and others over the “new” interest in alternative investments has driven me to reconsider. It seems to me that a brief recap of some of the “lessons” we’ve learned in the short history of financial planning might be appropriate. You might have guessed that I’m referring to my perennial whipping boy, limited partnerships.
To avoid another learned correction from my friend Ken Ziesenheim of Thornburg, let’s just stipulate up front that out of the thousands of public and private limited partnerships sold by financial planners during the 1970s and ’80s, a few actually did work out for their investors. In any event, quite a few more didn’t work out so well, KOing several Wall Street houses–Bache Securities, EF Hutton, and Thompson McKinnon come to mind–as well as giving a decade-long black eye to the planning profession.
Now we’re hearing that with the stock market back to churning out reasonable returns, investors/clients are clamoring for vehicles that promise the steroid-induced kind of returns we saw in Bill Clinton’s 1990s (can stocks play major league baseball?). So financial planners are scrambling to meet their demands. Sound familiar?
Unusual Investments = Bad Results
While it’s true that some sophisticated advisors have offered alternative investments to their high-net-worth clients for many years, when it comes to mass marketing, unusual investments usually end with unusually bad results. With due respect to Professor Santayana, the problem here isn’t that financial planners are ignorant of the limited partnership debacle, it’s that the profession, like the public, has drawn superficial conclusions from it, such as “Limited partnerships, bad; mutual funds, good.”
In reality, a limited partnership is just a legal structure for a business, which on its own isn’t any more good or bad than, say, corporations are after Tyco or WorldCom. Are you listening, Hollywood? A more reflective analysis of what happened during the 1980s might include the following lessons, which to my mind are more than relevant to today’s advisors as they try to keep their clients happy and at the same time, keep them out of trouble:
Lack of Regulation. The recent mutual fund scandal notwithstanding, compared to the SEC’s and NASD’s regulation of the fund industry, limited partnerships looked like Deadwood. Aside from the securities sales requirements of disclosure and suitability (and quarterly audits and filings for public partnerships), LP general partners basically could do whatever they wanted. And many did. A friend of mine who was an independent partnership analyst in the ’80s used to talk about one LP sponsor who sent his kids to college on the limited partners’ ticket.
Among other things, the rates of return on unregulated investments are far from standardized. Many investments were complicated, with multiple pay-ins from the limited partners on the front end, a stream of payouts on the back, plus an overlay of various tax benefits. Analyzing the value of these returns was left up to the general partners, who often used internal rates of return or adjusted rates of return, neither of which was understood by the average financial planner–consequently both were easily manipulated.