Donald Putnam is a dream lunch guest. He is worldly, affable and articulate, with a fine gift of turning a quick aphorism.
Who: Donald H. Putnam, Managing Partner, Grail PartnersWhere: Ferro’s 145 East 50th Street, New York, July 16, 2008 On the Menu: Veal chop in mushroom sauce and finding investment delicacies.
Sometimes he is almost too loquacious. It is hard to keep him off broad issues of international politics and economics and on the narrow subject at hand — which happens to be the investment advisory industry and the role of private equity in its future. He concedes self-deprecatingly that he has plenty of strong opinions about plenty of subjects.
“That’s us. Rarely right, but never in doubt.”
That’s something of an overstatement. Putnam must have done something very right in his career. Prior to starting his current project in 2005, the merchant bank Grail Partners, he founded Putnam Lovell Securities in 1987. Putnam Lovell was sold to National Bank Financial in 2002. It is currently part of Jeffries, but retains its distinct investment banking brand focused exclusively on the global financial services industry.
Reviewing the IndustryGrail’s business and investment portfolio is also comprised of companies in the same field — asset managers, financial planners and investment advisors. It is an industry Putnam knows inside out, having started his career back in 1973 designing investment products for Bankers’ Trust.
On Grail’s website, its investment approach is symbolized, rather startlingly, by a truffle pig, a remarkably ugly and single-minded beast whose job is to root under the trees. Nevertheless, Putnam himself starts from a broad perspective on the industry, which helps him identify future trends and pinpoint winners and losers. Presumably, Grail then roots out outperforming companies among those.
“There are two components to financial planning,” he says. “One is relatively easy and the other is rather hard.”
The easy part is identifying the client’s financial goals. A more complex problem is how to meet those goals. Putnam is critical of the way the overall industry is doing it now — both conceptually and in terms of execution. What it boils down to, he points out, is remarkably simple: cash. All the talk about income, appreciation, aggressive growth, principal protection, etc., obscures the fundamental fact that what investors really need is cash. Cash now and cash later.
“If I were a 65-year old retiring now, I would need a sum of money which I will allocate so that I have sufficient income now and money coming to me later — because I don’t want to die broke,” asserts Putnam. “It’s as simple as that.”
For that, asset allocation and investment selection have to work hand in glove, in order to achieve the client’s investment goals. Instead, the industry proposes two extremes: “It is as if you wanted a cup of tea that is cool enough to drink, but you were brought instead a cup of boiling hot water and a bucket of ice.”
An investment manager, in Putnam’s view, should be flexible, changing asset allocations as the situation demands in order to meet the client’s financial goal.
“If you had a trusted investment advisor, say Warren Buffett, what would you rather do,” Putnam asks. “Set him limits on how much he should invest in a given asset class or allow him to adjust his portfolio according to the situation in the market?”
To Putnam, the answer is obvious. An investment manager should emulate the way hedge fund managers operate, shifting investment strategy along with shifting market conditions.
“What does a typical mutual fund manager do,” asks Putnam. “If he runs a small-cap fund, that’s all he does. He invests in small-cap companies day in and day out, whether small-caps are riding high or are a mile underwater.”
Measuring performance against a set benchmark, says Putnam, makes no sense. The client couldn’t care less if his manager has outshined his benchmark if he is losing money.
Putnam notes that the way the private pension system is now structured, with individuals selecting mutual funds for their savings, gets the investment equation wrong. Effectively, when individuals put their money into bond funds, emerging market funds or aggressive growth funds they are doing the most important part of investment — asset allocation.
“We are leaving the most difficult part to amateurs, while delegating a relatively easy part to highly paid professionals,” he asserts.
Access to RiskThe putative 65-year old on the verge of retirement should be able to resolve his “cash now” concerns by purchasing an annuity. Meeting this part by the simple and inexpensive expedient of using an insurance company may be more efficient.
The rest of the portfolio should be placed in a high risk, high return investment, such as into private equity or a hedge fund. That should take care of the “cash later” problem.
Sure there are going to be risks, says Putnam. But what is the personal and social risk of millions of retirees living considerably longer than they currently expect and outliving their money?
Large institutional investors are better protected from adversity because they take on more risk. Putnam notes that large funds like CalPERS are holding large “safe” portfolios of bank stocks — which are likely to remain in the red for years to come. Meanwhile, the money invested with private equity firms, who are buying into distressed financial institutions, should start providing very high returns the moment the current financial crisis blows over.
Politicians, says Putnam, are very good at mouthing populist slogans about protecting the public from risk while ignoring the real risks involved. He cites the state-provided pension system in France, which is very unlikely to pay the promised retirement benefits to the current batch of French retirees, but which is considered to be perfectly risk-free.
Cheaper Fees, Greater TransparencyPutnam also sees the retail investor saddled with other problem — high fees.
“Bill Gates pays less for investment advice than the ordinary American,” he says. Sure, the founder of Microsoft pays much more in dollar terms, but it is a negligible percentage of his assets. On the other hand, the average mutual fund investor pays 2 percent to 3 percent a year in management fees regardless of performance.
But the industry is changing — both because consumers need investment planning and investment advice to survive in a hostile world where they will be living a lot longer than they currently expect, and because there are financial instruments and technologies to meet those needs. Putnam is bullish on the industry as a whole, but selectively so. He likes fee-based accounts, independent, entrepreneurial financial advisors who run their own book of business, sophisticated financial technology and transparent inexpensive instruments such as ETFs. He looks forward to the imminent debut of managed ETFs, which he believes are going to be a great innovation.
Ultimately, Putnam puts his money where his mouth is. Grail’s portfolio contains such companies as XShares Group, which markets innovative ETFs, Offit Capital Advisors, which caters to ultra-high-net-worth individuals and institutions, and Financial Crossings, which develops liability management software for financial advisors. Ultimately, you can understand his thinking about the future of the industry by examining the companies his truffle pig roots out.
Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at email@example.com. His monthly “Global Economy” column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past five years, 2004-