When we’re thinking about how to describe the Woodstock advantage and to educate potential clients about the benefits of investing with us, an image and a saying come to mind. The image is the New Yorker cartoon captioned “Where are the customers’ yachts?” (see QMP Winter 2018) and the saying is the English description of a person who’s “too smart by half.”
A number of the advantages of being at Woodstock often go overlooked. Under the Investment Company Act of 1940, your investment advisor owes you a fiduciary duty, which means putting your interest before his, hers, or the firm’s interests. Being invested in an individually managed account (“IMA”) at Woodstock means that you own the assets in your portfolio, unlike in a pooled investment vehicle where you are probably merely a creditor of the real owner. At Woodstock, your investment manager is able to take taxes into account and in combination with asset allocation decisions, effectively offset any fees that you pay us by exercising those levers to leave the full appreciation of your assets in your account. Note also that Woodstock is singly registered under the 1940 Act. Many of our larger competitors are dual registrants, operating as both investment managers with a fiduciary duty under the 1940 Act and as broker-dealers with a former “suitability” standard and, as of June 30, 2020, a “best interests” standard which cannot be as firm as a fiduciary standard because broker-dealers charge commissions.
We tend to look at our competition in general terms. We contrast our high-quality, US stock investing style with the endowment model that picks from up to 12 different investable asset classes. With rare exception, we invest clients’ funds in just three asset classes: high-quality stocks, investment-grade bonds, and cash. For stock allocations, our goal is to manage portfolios of 30 to 40 stocks with a strong but not too aggressive active share, providing the opportunity to outperform our benchmark, the S&P 500 Index.
However, we recently had the opportunity to look at a prospect’s set of accounts currently being managed by one of Wall Street’s leading investment banks. A few things stood out to us. First, the accounts were divided into five or six different strategies, each with its own subaccount and accounting statement. There was one subaccount for “equity yield enhancement” stocks, one for an “opportunistic” strategy, one for call writing, one for private equity investments, one for tax loss harvesting, and so on. The result was a set of accounting statements that ran about 120 pages long. Some of these subaccounts used leverage and options, some didn’t. Some even carried negative balances. The entire web of accounts made it extremely difficult to understand what the advisor was actually doing in any of the accounts and to track performance.
Upon request, the investment bank provided the performance of the equity exposure across the various strategies. Surprisingly, the overall equity exposure across the diversity of strategies was remarkably close to the performance of the S&P 500 Index. This suggests the use of “optimization” software that recommends incremental portfolio changes so as to bring portfolio performance in line with an index. There’s nothing wrong with using optimization software per se, but it suggests that there were considerations driving trading recommendations beyond the subaccount strategies as described.
Second, a sizeable share of the client’s assets was dedicated to ten different private equity funds. Such funds require their investors to make capital funding commitments many years into the future. In this particular case, the advisor had committed the client to potentially doubling their private equity allocation in future years, requiring funds to be drawn from other subaccounts, although some of the capital commitments could possibly be satisfied with distributions from other private equity funds. From the time the initial investment was made until all the proceeds were returned, it seemed to us that the client was locked into about a 20-year investment cycle for this private equity segment. The funds’ managers would be able to extract steep penalties for any unplanned liquidation or failure to fulfill future commitments.
The goal for private equity investing used to be to double or triple your money in 5 to 7 years. Since the 2008 recession, that goal has been elongated, as exits became more difficult to achieve. Also, returns have suffered because too many assets are chasing too few good deals or too few good private equity managers.
A final oddity was the use of a separate “tax advantaged” strategy. Some component of the set of accounts was set aside to satisfy their client’s interest in tax efficiency. As long as capital losses were realized by the end of every tax year, the manager would seem to have broad discretion as to how the funds in this subaccount were invested. More importantly, the tax efficiency for this portion of the client’s investable funds could be entirely undermined if other investment strategies were “tax inefficient.” Indeed, other strategies involved high turnover, generating significant short-term gains when successful.
At Woodstock, tax efficiency is a cornerstone of our approach to investing – we invest all of your assets with the long term in mind so as to minimize taxes. At the same time, we keep your assets in readily tradeable investments because life’s circumstances and market conditions are constantly changing. Most portfolios can be sold in a day if necessary. We prefer to hold investment-grade bonds to maturity, but they too can be sold if necessary. This again, is the Woodstock advantage.
The investment bank’s approach seems to serve its own interests better than their clients’ interest (back to the question about the customers’ yachts). At Woodstock we believe clients are best served by understanding what they own and why they own it. Stocks are valued at quoted market prices every day and calculating performance is relatively straightforward. We don’t believe in locking clients into their investments or their investment manager (“too smart by half”). The fact that you can move your money easily keeps us honest and focused on earning your trust every day. We are grateful that you appreciate Woodstock, and are pleased when you recommend us to others who may appreciated our approach as well.
William H. Darling, Chairman & CEO
Adrian G. Davies, President
 Vanguard Research, September 2016.
 “Active share” is a measure of the difference between a portfolio’s holdings and those of its benchmark. For example, 30-40 stocks versus 500 almost guarantees a strong active share.