The 2007 Wealth Roundtable

by Editorial

MATHIAS: Today’s roundtable panel reflects the breadth of activity in our region. We have a community bank, a national investment manager, and a broad-based financial institution participating. At the outset, I’d like each of you to describe your firm and its investment approach.
VEITH: I’m with Rockefeller & Company, Inc. We started off as the Rockefeller family office, but today the family represents less than a third of our client base. We are privately owned, independent and focused solely on wealth management. Our approach is comprehensive, but in the investment area the one theme that runs throughout most of our internally managed equity portfolios is global equity. The global theme done in-house is generally large cap. We also do U.S. small cap and high quality fixed-income in-house. We supplement our in-house capabilities by providing clients access to leading/specialized outside managers, including hedge fund managers and private equity firms. We have approximately $8 billion in total assets under management as of April 30, 2007.

MATHIAS: And your minimum account size?
VEITH: We don’t have a standard minimum. If it’s the right fit, we could start with $5 million.
WINSOR: I’m chairman of Bank of Georgetown. We’re a small community bank, newly formed and privately owned. Our shareholders are all business leaders in the city. There have been a number of small banks that have grown successfully in the suburbs, but with the renaissance of Washington, D.C., we see this as a very exciting opportunity. Our best customers are small to medium-sized businesses and nonprofit organizations that need a hands-on approach.
HARRELD: PNC Bank is commonly known as a super regional, meaning most of our banking activities are within the United States. But we’re an international player in some things – we’re one of the world’s largest processors and account managers of mutual funds. Our investment management activities are about $80 billion if we don’t count our ownership in BlackRock [the global investment firm]. We offer services for individuals, institutions, foundations and ultra-high net worth people through our Hawthorn subsidiary. For most commercial banks, investment management is another service they offer. With us, it’s one of our major lines of business and one of our fastest growing as well.

MATHIAS: Let’s take a quick look at the local business climate.
WINSOR: If you take it over the past 20 years, the ’90s were the time of technology and telecom, and more recently, it’s been the time of real estate and development. Some significant fortunes have been made over the past ten years with the real estate boom.
VEITH: This is a vibrant market with great opportunity; a lot of the growth has been fueled by the government contracting firms that have sprung up. We think the opportunity is terrific for straight investment management, as well as the broader wealth management services that we offer.
HARRELD: It’s a place where an enormous number of people made a lot of money in the real estate business in the last 50 years. But many of them are liquefying [property], either by sale or diversification. And as they do so, we find them interested in nontraditional investment opportunities. They’re open to hedge funds, private equity funds, and to a far more creative approach than a traditional portfolio of stocks and bonds.

MATHIAS: Real estate is an important factor in the region and of great interest to our readers. Any thoughts?
WINSOR: In Washington you’re lending to the business of government. And because of that we have an inherently stable market; not that it’s without its minor peaks and valleys. Real estate is fairly fully valued now as compared to three years ago, and it’s going to remain steady for at least three or four years as inventory gets depleted and and demand catches up.

MATHIAS: Have you seen an increased interest in those wanting to live in the District of Columbia?
WINSOR: Yes. The reason for that is there’s no political will to fix the transportation infrastructure for commuters. And after that when you do get the political will, you’re going to have to get the money and then you’re going to have to build it. There’s little hope in sight. And I think that that bodes well for close-in property owners.

MATHIAS: We read a lot about weakness in the housing market. Are you seeing evidence of this?
WINSOR: Yes. It has tremendous upside, in the medium and long and long term, particularly close-in. There’s an exceptional amount of wealthy people who don’t want to suffer a commute and will pay a higher price for a good property located close-in.

MATHIAS: Do you think the upscale housing stock is sufficient given the growing availability of wealth?
WINSOR: No. But there are a lot of developers who have addressed this need very successfully. Anthony Lanier for instance, has built high-end condominiums in the city and has sold them out before they’ve come out of the ground. The various Ritzes and Lanier’s projects are synonymous with addressing the need for a higher caliber of housing stock. There are a number of others who have really made their mark here in the city: Jim Abdo, Monument Realty and JBG, just to name a few.

MATHIAS: What are your clients’ primary concerns, in terms of their financial well-being, over the next three-to-five years?
VEITH: The geopolitical situation – what’s going on in Iraq and that part of the world. It’s not something they’re losing sleep over, but they know a blowup there is going to impact their portfolios, at least in the short run.And there’s also a general concern that tax rates will be going up and how that is going to impact stock prices and their disposable income.

MATHIAS: Michael, you mentioned changing preferences on the part of investors. How have portfolios changed?
HARRELD: Ten years ago the average client’s portfolio would have been an asset mix that’s pretty traditional with a smattering of international. The democratization of the capital markets, where people with more modest net worth have access to much more of the potpourri of products out there, is changing that. In addition, the excellent returns of recent years have been in international and global markets, but what Paul said is exactly right: there is an issue of political stability and the interconnectedness of the world.

MATHIAS: Looking out three-to-five years, what returns can an investor expect from a well-diversified portfolio?
VEITH: One way to go about it is to look at is the expected returns for each asset class. If you start out with a pretty conservative 60/40 traditional equity, 40 percent municipal bond, or some type of fixed income, you are definitely in the single digit range for expected returns. For equities, just in the broad large cap indices, the expected returns would be in the high single digits. Of course, there are no guarantees.

MATHIAS: So, eight percent or so annually over the next three-to-five years would be reasonable?
HARRELD: I think it’s a question of what clients expect. But that’s what we would expect.

MATHIAS: Do you see individuals taking all assets, including their homes, into account when assessing their financial position?
HARRELD: Dismissing the ultra wealthy, if we talk about a person with $5 million to invest, a $3 million home, and a couple of other assets, so they’ve got a net worth of $10-15 million, which is a lot more of what we see daily, I think clients are pretty savvy about that. But they’re still counting on their house to cover them on inflation. They really believe that in this marketplace, even if it doesn’t go up 20 percent a year, their home will go up eight percent a year. I’d be cautious about that – it may not last forever even if it is built on the government.
WINSOR: People see their second homes as an investment. And while they’ve paid out handsomely until now, that is not a given going forward. It’s really more a function of the health of our economy.

MATHIAS: You can’t pick up any periodical or engage in cocktail party conversation without some mention of hedge funds and private equity vehicles. Any thoughts?
VEITH: With hedge funds we have concerns. What’s not published is the number of hedge funds that close each year – it’s a very significant number. Also, hedge funds are usually tax inefficient and have high fees. You have to be very selective in this area.

MATHIAS: Do you expect returns for those vehicles to be as high as has recently been the case?

MATHIAS: Are taxes a factor as you work with individual investors?
HARRELD: Absolutely. And clients take it into account. We just have to give them alternatives.

MATHIAS: Let’s talk a little about inflation. Curt, do you have an opinion?
WINSOR: When you’re looking at investment returns, you want to look at real rate of return, less the fee, less inflation. And then you have your rate of return. Right now there’s no question that the risk-reward ratio is relatively high in comparison to the low rates of return that my colleagues here have mentioned, and I agree with them.

MATHIAS: Should investors today lean on the side of caution versus being aggressive?
WINSOR: It depends. But in general you’re going to have to assume more risk to get the higher rates of return that have been generated in the past.
HARRELD: Investors are willing to be aggressive in more nontraditional ways. As opposed to putting 50 percent in the international market, they’re going to look at private equity. If they’re going to be aggressive, they want to deal with specialists that know what they’re doing.

MATHIAS: Globalization impacts us in numerous ways. What about international diversification?
VEITH: It’s been a long time approach within Rockefeller to invest globally. The bulk of our clients’ equity portfolios, at least for the clients that are managed internally, is to be in a global equity strategy. To not include non-U.S. securities as a big part of your portfolio really limits your opportunities.
HARRELD: You simply have to participate in international and emerging markets, but at times it’s not an easy sell with customers because of all the political risks we’ve talked about.

MATHIAS: Two of the fastest growing economies in the world are China and India. Do you have ways in which your clients can participate in these dynamic markets?
HARRELD: We have asset managers who specialize in those markets.
VEITH: Yes. We have decided against direct China investments but through our global equity strategy we are investing indirectly into that market.

MATHIAS: Curt, the Chinese government has about a trillion dollars in foreign exchange and, to some extent, has become our “banker”. I assume you would like to garner some of their assets as deposits.
WINSOR: It depends on the rate! We talked about inflation, and now that we’re in this global economy, our fiscal house is going to have to be kept in order as we’re accountable to people like the Chinese buying our debt.

MATHIAS: What are the biggest mistakes you now see investors making?
HARRELD: Investing backwards: looking at what happened three or four years ago and thinking that’s a benchmark for the future; and the difficulty in articulating a risk strategy and a financial plan.
VEITH: The mistake I’ve seen most frequently is investors trying to “time the market.” Even if you are right in selling, it’s even harder knowing when to reinvest.

MATHIAS: With wealth creation and the trend in demographics, philanthropy has become an increasingly important issue. How are your clients responding in this regard?
HARRELD: In the estate planning world, which is a primary focus of ours, we see a lot of conversation about philanthropy. In a recent wealth and values survey commissioned by PNC Wealth Management, we found that 29 percent of high net worth individuals in the Washington area have identified funds in their trusts or wills to go to specific charitable purposes – that’s well above the national average. A lot of clients are very sensitive about what’s appropriate to leave to their children. There’s a lot more intelligent conversation going on between the generations than there was a few years ago surrounding the right balance between financial security and the stewardship of the inheritance. Respondents to the survey indicated they are concerned their children not be spoiled with sudden wealth in their inheritance. The fact that Washingtonians are willing to give a significant portion of their estate to charity as well as their children speaks to this.
VEITH: That’s a big issue for our clients. Besides giving back, the other theme we see tied to philanthropy is family continuity. The fortune was created by granddad or grandma, but what keeps the family together? Philanthropic foundations or similar charitable vehicles can be the hub that the family continues to gather around and share a common interest in.

MATHIAS: Do alternative energy and the “green” movement present areas of investment opportunity?
VEITH: Yes, we provide qualified clients with an opportunity to invest in venture capital and private equity funds that focus on renewable energy, energy efficiency, conservation and related clean technologies.

MATHIAS: Do you see any areas of investment that seem particularly attractive over the next few years?
VEITH: It’s a difficult time to find real attractive opportunities. We don’t see one opportunity jumping at us that is really undervalued with a huge upside. One area that’s kind of boring that we think is most attractive is big multinational companies that are going to benefit from the continued globalization and whose valuations are still reasonable.
HARRELD: Everyone wants to participate in the global markets, but they’re anxious about the risk. And the risk is not about how someone is succeeding in one country. The risk is political, religious, multi-variable. Investors know they need to be there, but they’re much more anxious about that than they are about the domestic economy.

MATHIAS: To individuals, today’s low tax rate on capital gains and dividends is attractive. Do you foresee changes in the offing?
VEITH: Yes. I think on both counts: dividend first, capital gains second.

MATHIAS: How is Washington evolving as a financial center?
WINSOR: Washington is becoming a mini-hub for the nontraditional lending community. There are a number of significant publicly traded companies here, such as Allied Capital, Gladstone and MCG. It’s no coincidence that a number of super regionals have planted their stake here in a significant way because it’s a very lucrative banking market as well. On the real estate finance side we’re also seeing tremendous growth in the city. You’ve got JBG, Perseus and the Joe Robert Companies. Let’s also mention the financial conglomerates like the Carlyle Group, which has been tremendously successful; Columbia Partners Investment Management; and Friedman, Billings, and Ramsey, who have created an important local focus and brought a lot of liquidity and attention to the region.
HARRELD: This community has attracted a lot more outside gray matter in the investment business in the last few years. There are a lot of people who have come here from New York and San Francisco who are doing boutiques – and they’re growing rapidly. They’re very smart, they’re very good, and they have their niche.

MATHIAS: Lastly, what advice would you provide to the client who suddenly finds themselves with a $20 million portfolio to invest?
VEITH: Each client is going to be different. And what’s right for one is not right for another. If this money is set aside for maximum long term results and they don’t need income, we’d say, “Go 100 percent in equities.” And a big part of that would be global, with some put selectively into private equity and possibly some with good hedge fund managers. But in that situation, where the sole objective is maximizing return, we would steer more towards pure equities, whether they be publicly traded or private.

MATHIAS: What type of return might they expect?
VEITH: That depends on how much they had in private equity, and then, a lot of that is dependent on what’s out there and available. This is an asset class that you have to be invested with the top players.
HARRELD: Paul is exactly right, but if that person lived here, I’d find a way for them to participate in Washington real estate. That is going to do well over the next few years.
WINSOR: If one wants to maximize return, it’s necessary to concentrate a bit more money, say two-thirds, with good managers, and the other 30 percent focused in something more conservative like a low risk alternative investment type of vehicle.

MATHIAS: I want to thank each of you for participating in what has been a lively and highly informative discussion. Not to end on a negative note, but a point to re-emphasize, drawn from your comments, is that investment returns over the next few years will likely be somewhat lower than those to which investors have become accustomed. Just something to keep in mind as we look ahead.

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