EQUITIES presents an exclusive preview of Fisher Investments CEO Ken Fisher’s upcoming book The Ten Roads to Riches
Foreword by Ken Fisher
Wouldn’t it be wonderful if everyone were rich and no one poor? Sure, not everyone can become rich, but it’s become clear to me most can—they just don’t know how. That’s where my new book, The Ten Roads to Riches, comes in. There are really only ten ways to get rich. My book details them and shows you the good and bad qualities of each so that you can pick among them, decide which is right for you, and learn how to do it.
One of the ten roads involves capitalizing on other people’s money. That is, money management, private equity, hedge funds, banking, and the like. This is how the biggest chunk of the mega-rich got there. This excerpt will give you a few clues on how to do it too. If you’re familiar with my previous books or my 24-year tenure as a Forbes columnist, then you know that I know something about this subject: Over my 36-year investment career, I’ve built a 25,000-client investment advisory business to learn from.
Could you be a successful OPMer too? Read on to see.
What type of OPMer will you be? Consider two camps—commission-based and fee-based—defined by how you charge fees and maybe what you sell.
Commission-based OPMers—like stock and insurance brokers—sell products (e.g., stocks, bonds, mutual funds, even insurance) for commissions. What you earn all hinges on the sale. A client has $1 million. You sell him stocks paying you a 1 percent commish. You make $10,000. Keep finding clients and selling products—income keeps coming. The basic commission-based business model is:
- Get the client.
- Sell the client product(s).
- Get a commission.
You make what you sell. Want a $250,000 salary? With a 1 percent commission you must sell $25 million of products. How? Find 100 clients with $250,000 each, or 50 with $500,000! Your call. The drawback? Unless you get them to sell what you sold them and buy something new, you need another slew of clients next year. Your time is spent hunting for clients. If you’re a great hunter, no problem! That’s commission-based.
Fee-based OPMers—like investment advisers, money managers, or hedge funds—provide services for some percent of assets involved. Say you have 100 clients. Each invests $250,000 with you. You charge 1.25 percent per year (a typical fee for fee-based advisers). That’s $312,500 in annual revenue as long as the clients remain. The more their assets grow, the more your fee does. If you keep your clients and the market helps out, you make even more next year! But you get paid less if their assets shrink. The basic fee-based business model is:
- Get the client.
- Keep the client.
- Do well for them.
Your income depends on how much in client assets you gather, how well you do keeping clients, and what returns you (or your firm) makes for them.
Value the Business
So is it commission- or fee-based for you? To decide, think like a business owner. This is an exercise you can use many ways to figure what’s worth what:
- Go to Morningstar.com.
- Search for any stock—a mutual fund like Janus Capital (fee based) or a wire house broker like Merrill Lynch (commission based).
- Click on the “snapshot” button in the left-hand column.
- Click on “industry peers” (across the top). Note: Whether a company is listed as a peer is up to Morningstar—sometimes the results seem wonky. For example, Merrill Lynch’s industry peers include Goldman Sachs and Morgan Stanley (other brokers), but also NYSE Euronext and Nasdaq Stock Market (exchanges). Ignore the exchanges.
- Make a list of similar companies.
- Divide each firm’s total value (market cap) by sales to create a ratio.
- See who has higher or lower ratios.
I’ve done this for you as an example. You can do it for any stock. The table below shows results for mutual funds—fee-based firms. Most fund families have ratios from four to nearly six. Legg Mason and T. Rowe Price are outliers. So the market says these kinds of firms are worth four to six times their annual sales.
Mutual Fund Market Cap Versus Sales
The next table lists brokerage firms—commission-based. Note lower ratios—most under 2! Outliers are Charles Schwab and TD Ameritrade. (Schwab has a huge mutual fund business and is hybrid fee-based/commission-based.) The market values a buck of commissioned-based sales half as much as fee-based sales. The upside? Even medium-sized brokers are bigger than almost all money managers. The biggest brokers are almost 10 times bigger than the biggest money managers. There is vastly more business in the commission-based world, but it isn’t as valuable. That’s your trade-off—more versus more valuable. (Note: Even before Bear Stearns imploded in 2008, it was still about as profitable as its peers.)
Brokerage Firm Market Cap Versus Sales
Ditto for insurance—even more commission-based than brokers. With lower ratios they’re less valuable than brokers, but the potential business is huge. Smaller players shown in the table below have more total business than the biggest mutual fund families do.
Insurance Market Cap Versus Sales
Note: Huge insurers are older than most brokers and older still than money managers. So the trade-offs are size of opportunity versus value of revenue versus maturity. Think like an OPM founder-CEO. If a law dictated firms could have only up to $1 billion in revenue, no more, then hands down you’d want to be fee-based—the enterprise value would be so much higher. A small success in fee-based goes a long, long way.
This isn’t to disparage insurance and brokerage—which have created lots of mega-wealth. Some see Warren Buffet (worth $52 billion)4 as an investor. He’s really an insurance CEO. Berkshire Hathaway’s profits come overwhelmingly from insurance. Buffet’s unusual—the next-wealthiest insurance OPMer is Hank Greenberg, former CEO of AIG, net worth a big step down at $2.8 billion.5 Arthur Williams founded and sold an insurer to Primerica and is worth $1.8 billion.6 Ernest Stempel, a Hank Greenberg ride-along (chapter 3), started AIG’s life insurance division (worth $1.7 billion).7 Patrick Ryan ($1.4 billion) started a firm that became AON, America’s largest re-insurance broker.8 But beyond Buffet, they don’t compare to fee-based wealth—the top 15 listed below.
Wealthiest Fee-Based OPMers
Beyond Charles Schwab, the only current Forbes 400 member coming from commission-based brokerage is Sandy Weill ($1.8 billion). But even he evolved out of it. Originally a straight-up brokerage firm CEO, and a dynamite one at that, Weill made his fortune parlaying that into Travelers, an insurer, which later merged with Citicorp to become Citigroup. His big wealth came at Citi on the CEO road (chapter 2), not really from insurance or brokerage.
As a fee-based OPM founder-CEO, I’m not even successful enough to be among the 15 wealthiest fee-based OPMers. But worth $1.8 billion with my little firm, I’m just where Sandy Weill is and as high as anyone from insurance but Warren Buffett and Hank Greenberg. That’s one attraction of fee-based OPM. You needn’t be as big overall to be more wealthy.
Still, brokerage is lucrative. Joseph Moglia, TD Ameritrade’s CEO, earned $62.3 million in 2007 compensation. Richard Fuld of Lehman Brothers got $51.7 million. And Bear Stearns’ James Cayne got $38.3 million (before it blew up in 2008). Even Morgan Stanley’s John Mack’s $7.5 million is nothing to sneeze at.10 For huge wealth, fee-based is best. But to accumulate $2 million to $50 million, any form of OPM is fine.
Hedge Your Bets
Do you like huge risks and returns? Are you a maverick? Fond of big fees? Start a hedge fund. Hedge funds are known as the 2 and 20 model because they charge 2 percent of managed assets annually (i.e., give them $1 million, they take $20,000 yearly) —but also get 20 percent of annual gains! If you’re good, lucky, or both, that adds up quick.
Say you make one bet—some stock category will beat the market in the next five years—maybe big stocks, energy, or drugs. You bet big on that. You manage $100 million with a 2 and 20 contract. Assume your bet averages 20 percent per year for five years.
- End of year one, your $100 million becomes $120 million. You take 2 percent ($2.4 million) plus 20 percent of the $20 million gain ($4 million)—$6.4 million profit.
- Year two starts and, minus your fee, assets are now $113.6 million. Tack on another 20 percent, take your 2 and 20 fee—$7.27 million profit.
- In year five, your profit is over $10.6 million!
Over five years, you get nearly $42 million in total fees! That’s just on the assets you started with. Generate high returns and you’ll get more clients with more assets.
Now, suppose you’re a regular fee-based manager making the same bet—the assets still grow 20 percent a year for five years, but you charge only 1.25 percent a year.
- First year, your $100 million becomes $120 million. You get 1.25 percent—$1.5 million. Not bad, but not $6.4 million.
- Year two starts and, minus your fee, assets are now $118.5 million. Tack on another 20 percent, take your 1.25 percent fee—$1.78 million.
- In year five, your profit is $2.96 million.
After five years, you’ve made $10.8 million in total fees—good, but far from $42 million. Of course your clients came out ahead because you took less of their money in fees. But a hedge fund manager thinks, “Why not bet big for extra return?” If you’re right, that 20 percent “carried interest” is huge. If you’re wrong, you still collect 2 percent of the assets, annually. Amazingly, if you bet wrong you don’t pay back 20 percent of losses! Of course, if you’re wrong, it’s your clients who suffer. To get big reward as a hedge fund manager you must take big risk. Smaller risk means smaller reward.
Hedge funds aren’t new—they’re just newly popular! Before 1940, swindlers would create two funds. With one, they’d convince half their clients XYZ stock would rise, buying XYZ. In the other fund, they’d convince clients XYZ would fall and sell XYZ short (borrow it, sell it, hope it falls, then buy it back lower, pocketing the spread and repaying the borrowed stock). Neither client group knew about the other. As long as XYZ was volatile, the two funds got 10 percent of that volatility. Clients who lost fired the swindlers and disappeared. Clients who won didn’t understand it was a swindle and would actually give the crooks more money for another bet. This con was put out of business by the combined Investment Company and Investment Advisers Acts of 1940.
But you can take one side of a big bet on blind luck and hit big or go home. If you’re unlucky, you end up on a different road soon. If you’re lucky, I promise: Few observers will think it’s just luck. You won’t either. The best hedge funders aren’t just lucky—they’re skilled. But few hedge funds hit big. Most go home. This arena is sprinkled with spectacular successes, yet most hedge funds flame out fast. Few survive two years before all their investors redeem and disappear. I’ve known dozens of folks who started hedge funds—only two survived over the long-term. It’s treacherous. Taking monster bets your career rides on is nerve-racking. Jim Cramer quit for just that reason. I’ve seen folks get a run for a few years and then everything blows up on them in no time—ending with nothing.
Bet on Hedges
Hedge funds typically operate in specific categories like convertible arbitrage, distressed securities, long/short equity, market neutral, and more. Investors can buy them in multiple categories and diversify (although investors who do this invariably get poor returns because you can’t diversify widely, pay huge fees, and still end up ahead).
Hedgers also have varied hiring practices. To go this route, just apply everywhere—shotgun style! You can find endless names by doing a Google search—thousands. Most don’t hire. Most are one person, with maybe $10 million to $40 million, operating by him- or herself out of the bedroom. But if you keep looking you’ll find those that hire—they’ll invariably be the bigger ones.
There’s no security—a fund can blow up fast. I’m not suggesting this for a long-term career unless as a founder-CEO or ride-along. But it’s a great place to learn and launch. Work there a few years. Learn what they do. Get the lay of the land. Then you can start your own.
Hedge funds are lightly regulated, so they’re very easy entry. A law firm like San Francisco’s Shartsis Friese with a hedge fund specialty can get you set up legally and take you through the rules like they’re spitting out popcorn. (Follow this URL for more law firm hedge fund practices: http://www.hedgeworld.com/sp_directory/search.cgi?category_name=3.)
Then—and you may hate this—it’s all about selling to get clients for your fund. The tactics of running a hedge fund are pretty generic. Pay attention to your law firm’s do-and-don’t rules and then find something you believe the heck out of in terms of doing well looking forward and bet the house on it.
Often people find one big anchor investor before they start their fund. Say you’ve been a Merrill Lynch broker with a client list totaling $100 million in assets. Among them you’ve got one big $40 million elephant you’ve served well and put tons of time into. People often decide they can make as much off the elephant in a hedge fund as everything else otherwise. So you quit, start your hedge fund with the one client as an anchor, and then try to build from there.
This whole process isn’t much more complicated than:
- Betting big.
- Finding clients who will back you in the bets.
- Adhering to the applicable laws . . .
- . . . while you collect 2 plus 20.
Maybe the most successful recent young hedge fund manager has been Ken Griffin. Only 38, worth $3 billion,11 he started Citadel Investment Group in 1990 in a classic hedge fund format. Today he has teams in multiple categories taking big bets on tiny profit potentials, which he leverages heavily for big returns. He’s a phenomena because most who try what he’s done don’t just fail—they splat.
Private Equity’s Big Bucks
Akin to hedge funds is private equity—also with a 2 and 20 fee scheme. They take over troubled publicly-traded firms and fix them to later sell at a profit. These are often called leveraged-buyouts. You do the takeover, maybe bring in new management, lop off losing divisions, fund winning ones, and maybe go public again later at higher prices. Done right, it’s super profitable. Part of this is knowing how to borrow well. Part is the skill to spot troubled firms that can be bought cheaply, because no one sees potential, but can be fixed and profits boosted to fat levels compared to interest costs incurred with the buyout.
Recent years have seen record buyout activity—making private equity firm partners huge bucks. Kravis, Kohlberg, and Roberts (KKR) had a busy 2007—offering to buy TXU Energy for $45 billion. Cofounder Jerome Kohlberg ($1.5 billion) is no longer with the firm, but both Henry Kravis and George Roberts are, with matching $5.5 billion net worths. Another group taking advantage of the times has been Carlyle Group founders—William Conway Jr. ($2.5 billion), Daniel D’Aniello ($2.5 billion), and David Rubenstein ($2.5 billion).12
Love Capitalism, Not Social Acceptance
If you succeed on this road, you subject yourself to being degraded by social stereotypes. Some folks may not like you. But successful OPMers don’t place high value on social acceptance. They place high value on capitalism. They operate close to the heart of the capital markets pricing mechanism and live and die by competitive forces. This is a great road to mega-wealth. I know. I’ve lived it all my life. It’s a wonderful world where you get rich by helping others get richer. It’s a world you can be proud of. It’s also a world where many will assume you shouldn’t be proud. If you’re tough like Eddie Lampert and you want to be rich pretty easily—or put yourself where most of the richest are—OPM is, in my view, as fine a road as you can choose.
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