Читать книгу Family Capital - Curtis Gregory - Страница 13

For decades, the capital of the children of George Titan Jr. had been managed by a local Pittsburgh trust company, the one selected by George Titan Jr. years earlier. But shortly after World War II the trust company was acquired by a local bank, and over the years that bank decided it wanted to become a world-class investment manager and to compete globally for investment business.

Up to that point, the family's portfolio had been managed very cautiously, with half the capital always invested in bonds. But as time went by, and as their bank advisor developed many new products, they sold those products to George III, convincing him to invest more and more aggressively.

Quick Note

This episode illustrates the danger of a family behaving too passively in the face of industry changes. The acquisition of the trust company by a bank completely changed the identity and nature of George Titan's advisor, but he went along with it without, apparently, realizing how consequential the change was.

Note that there is nothing wrong with investing aggressively. Many families have done it with great success for many years. But aggressive investing leaves precious little margin for error. If you're driving your car at 40 miles per hour, a lot of bad things can happen on the road and you'll still have plenty of time to adjust. But at 80 miles per hour, you'd better be on high alert at all times. George III thought of himself as a far-above-average investor, but as we will see, he was confusing brilliance with a bull market.

The American Stock Market Turns Sour

The late 1960s had seen strong equity markets in the United States, but the year is now 1974 and it is mid-July. George III is 70 years old and has been overseeing the family investment portfolio from his office at Lawburn (the Titan family office) for many years.

George III considered himself to be an astute investor, and both under the local trust company and, later, under the bank, George believed that the family's capital had been well-managed. Following the Allied victory in World War II, the United States had become the world's most powerful country. It's main competitors at the time – Germany, Japan, and Britain – had all been devastated in the war and the U.S. economy expanded rapidly.

The American stock market had kept pace with this growth, so that even net of the family's rather heavy spending – about 5 % of the capital's value every year – the portfolio had continued to grow in both nominal and real terms. Basically, since the end of World War II the U.S. stock market had been on a consistent upward march. During the decade of the 1950s, for example, the Dow rose from just over 200 to over 600. The surge slowed a bit in the 1960s, but even so the Dow rose to 800 during that decade, and there were several official bull markets late in the decade (1962–1966 and 1967–1968).

In 1972, the Dow Jones Industrial Average had gained 15 %, and most investors believed that the good times would continue. The 1970s would be at least as good as the 1960s, and maybe as good as the 1950s. Time magazine, for example, in early January 1973, predicted that 1973 was “shaping up as a gilt-edged year.”2

But the prognosticators were badly off-target. On January 11, 1973, the Dow began a dive that would result in one of the worst bear markets in history. Over the following 699 days, through December 1974, the Dow dropped 45 %. Making matters worse, inflation, which had been just over 3 % in 1972, jumped to 12.3 % in 1974. In other words, in inflation-adjusted terms the losses were even greater. And while the market was crashing, so was the U.S. economy, where GDP growth dropped from +7.2 % in 1972 to –2.1 % in 1974. (Matters were even worse elsewhere. The London FT 30 Index, a predecessor of today's FT 100 Index, dropped 73 % during the bear market.)

All this stunned George III who, as noted earlier, had presided over two decades of excellent returns and who had forgotten that those returns were driven mainly by strong market conditions and not by his excellent investment judgment. As the markets continued to sink throughout 1973 and into 1974, George began to raise hell with his bank investment managers.

But those advisors believed that investors should think long term. Sure, the market was currently in a bear phase, their thinking went, but that wasn't a permanent condition. Sooner or later, the market would turn up again, and when it did, families like the Titans needed to be heavily exposed to stocks in order to take advantage of the rebound.

But the result of this thinking was that the bank was continually “averaging down,” as George indignantly put it, selling good bonds to buy bad stocks. Whatever the bank bought, it promptly went down.

Quick Note

Here is a case of the family's advisor giving them reasonably good advice, but not couching it in terms the family could accept. Quarter-after-quarter of “averaging down” convinced George Titan that the bank didn't know what it was doing, that it was just operating on automatic pilot.

By the first quarter of 1974, George was getting questions from his wife and (adult) children about what was going on in the portfolio. They were naturally concerned that, as the value of their capital plummeted, their spending might have to be cut. In an effort to keep the pressure off, George III didn't cut the family's spending, but as a result, that spending grew and grew as a percentage of the capital that supported it.

As noted earlier, at the end of the 1960s the George III branch of the family had been spending 5 % of its capital every year. This was too high, but George III was analogizing his family to the endowments of the nonprofit organizations on whose boards he served, most of which spent about 5 % per year. But George had forgotten that nonprofit endowments don't pay taxes and that, typically, they are large enough to pay much lower investment management fees than families pay. Moreover, endowed institutions have a fallback in the event of poor outcomes: they can go out and raise more money. Try that as a family.

George's family should have been spending more like 3 % of their capital each year, even in good times. But as the value of the portfolio plummeted throughout 1973 and 1974, and as the family's spending remained constant, the percentage they were spending grew and grew, causing the capital to decline even faster. By early summer of 1974, the George III branch of the Titan family was spending more than 8 % of the portfolio's value.

The family's account managers at the bank were alarmed by the high spending, and they would sometimes (very gently) raise the issue with George III. But the patriarch's view was that it was none of the bank's business how much the family spent, and so the conversation went nowhere.

George III Makes a Fateful Decision

As his family's losses deepened, George III found himself losing sleep. He became difficult to live with, snapping at Mary and avoiding his friends. Finally, at the end of June 1974, George III took a room at the Rolling Rock Club, locked his door, and spent the better part of three days reviewing the performance of the family's portfolio under his management – going all the way back to World War II.

As he worked his way forward from the war years to the present day, George noticed something he'd never focused on before. As mentioned above, immediately after the war everything went America's way. But this was because our competitors in Europe and Japan had been flattened in the war while America was hardly touched.

By the 1960s, while things still looked good in America and while the market was still moving up, albeit not so sharply, it was obvious to George that looks were deceiving. Europe and Japan were recovering rapidly, thanks in many cases to generous help from America, and competition from those quarters was beginning to bite. Already steel from Germany and Japan was beginning to show up in the United States, and it was not only cheaper than our own steel, it was in many cases of better quality.

American investors, lulled into somnolence by two decades of easy money, had been asleep at the switch. But in the early 1970s those investors woke up and realized that America had fallen behind Europe and Japan, to say nothing of a resurgent Soviet Union. Suddenly, no one wanted to own stocks.

George returned to his office and scheduled a family meeting for mid-July. That meeting would also be held at the Rolling Rock Club, a tony country club founded by Pittsburgh's Mellon family. George had reserved a secluded meeting room behind the Card Room, most easily accessed by a secret door through the bookcases. George wanted to be sure no one would hear what he had to say except his own family. His advisors at the bank weren't invited, and only one young lawyer from the family's law firm would be there to take notes.

When the family was assembled and drinks had been served, George rose to his feet and made a long and impassioned speech. That speech clocked in at 37 minutes, but we'll look at an edited version of it here. The essence of the matter was that, the very next day, George planned to instruct the bank to sell every stock in the family portfolio. Because some of the positions were large and thinly traded, it would be the end of August before the family was completely out of stocks, but after that the family would own not a single equity security.

There were a few gasps around the table when George announced this decision, but the patriarch held up his hand for silence.

“I want to be quite clear about this,” he said. “All across the world investors are dumping their stocks because of the bear market. But that's not what's driving my decision. No one likes to lose money, of course, and no one especially likes to lose money month in and month out for eighteen months.

“But long-term investors know that bear markets come and go, just as bull markets come and go. To pull out of the stock market just because stocks are going down is a very foolish thing to do. And that's not what I'm doing.

“If I continued to have confidence in American industry – indeed, in America itself – I would simply hold on, knowing that sooner or later the markets will turn and we will be making money again. But – and I say this in sadness and regret – I've lost that confidence.”

George went on to describe how American businesses had thrived after the war, and how they appeared to be continuing to thrive during the 1960s. But that was just surface momentum and investor hardheadedness. In fact, it was in the 1960s that America began to lose its way.

“I don't have to remind you what was happening on our college campuses in the Sixties,” George said, glancing pointedly at his grandchildren. “Hippies everywhere, antiwar activists blowing up buildings, administrators who should know better throwing in the towel and capitulating to the demonstrators.

“And you all know what happened to us in Vietnam. America had never lost a war before, but in Southeast Asia we cut and ran. The American public has no stomach for war anymore, and keep in mind that that's when Rome began to decline, too.

“How many of you in this room have waited in a long line to buy gas?” Hands went up. “Do you know why? Because America allowed itself to become dependent on oil from the Middle East, that's why. When we backed Israel in the Yom Kippur War, the Arabs embargoed our oil and forced us to our knees. We made Israel back down because we were desperate for oil, for oil at any price! We used to pay about three dollars a barrel for oil, but now it's twelve dollars and no end in sight.

“And what about what's going on in the White House? I voted for Nixon, and I'm sure – I hope I'm sure – that many of you did, too. But God knows what he thinks he's been doing down there in Washington. I hear he could resign any day. Imagine that! A president of the United States forced out of office for possible criminal activities! It's unbelievable!” (In fact, President Nixon resigned less than a month after George III spoke, on August 9, 1974.)

George took a long swallow of his martini, shook his head in disbelief at what had happened to his country, and then continued.

“The worst of it all is what's happened to American industry. When my grandfather – your great-grandfather and great-great-grandfather – came to America, he came because we were the greatest country in the world, a country full of opportunity. American companies were the most competitive anywhere.

“When the United States Steel Company was organized right here in Pittsburgh just after the turn of the century, it was the largest and most powerful firm in the world. Imagine! The United States of America, barely a century old, had outdone all the countries of Europe and Asia.

“But look at U.S. Steel today – it's a pathetic shell of its former self. Sure, they've built themselves a fine new building, but they're not half as good at making steel as they are at building fancy headquarters.

“In fact,” George continued, really warming to his message now, “I wouldn't even call it a company. It's more like a bureaucracy, like something you'd find in the government. There are so many layers of management at U.S. Steel they can never get anything done. No one can make a decision, and in the rare cases when a decision gets made it's impossible to know who was responsible for it.

“All U.S. Steel's management cares about is preserving labor peace, and they've bought it by selling out to the unions. Do you know that a young steelworker who's willing to work overtime can earn almost fifty thousand dollars a year? Do you know what a young lawyer, straight out of Harvard, makes a year?”

George looked around the room, but no one seemed to know the answer.

“Well, I'll tell you: twelve thousand. Yes! A Harvard-trained lawyer in Pittsburgh makes twelve thousand dollars a year, while an uneducated steelworker makes fifty thousand! How long do you think that's going to last? I predict the American steel industry'll be dead in twenty years, if not sooner. And where the steel industry goes, so goes the rest of American industry.”

George looked around the room. Everyone was riveted, staring at him. He nodded his head at them and continued.

“If I had confidence in America, in American business, I wouldn't be selling stocks. No, I'd be a buyer at these prices! I'm not selling out because of the bear market, I'm selling out because the American Century is over. We've had our day in the sun, but just like every other great civilization, we rose and now we've fallen. Some of you might remember that Russian Premier Khrushchev told us way back in 1959, ‘We will bury you!’ Well, the Russians have buried us, not by beating us in war, but by beating us in peace. And Germany and Japan have beaten us, too.

“I don't say any of this out of anything but sadness, deep and abiding sadness for the country I love, for the city I love. But it's my family I have to think of first. We've lost a lot of money over the past year and a half – nearly forty percent of our capital, in fact. But we're still rich and I want to be sure we stay that way. By the end of next month we'll be entirely out of stocks. Our wealth will be secure. Thank you.”

George set down and drained the rest of his martini, then ordered another. For a long moment there was silence around the table, but then someone started to clap. Others took up the applause and soon George Titan III was being given a standing ovation by his family.

Quick Note

One important thing to note here is that George Titan stated that he wasn't exiting the stock market because he was in a panic over his losses. Instead, he couched his decision in broader terms. But note that when a family panics during a bear market, there will almost always be “broader terms.” Often, the broader terms will have to do with not wanting the family's asset base to drop below a certain, usually arbitrary, point.

The Aftermath of George's Decision

The extraordinary thing about this episode in the Titan family is this: George III was right – or nearly right – about almost everything he said. And yet, the decision to sell all the family's stocks proved to be an utter debacle, destroying his family's capital almost entirely in one generation.

How could this be? The main problem was that George Titan III failed to consider the resilience of the American economy and the American people. He was correct that conditions were dire in the mid-1970s in America – a few years later, in 1979, President Carter would give his famous “malaise” speech in which he opined that Americans were suffering from a “crisis of confidence.”

But Americans had faced far worse challenges over the prior 200 years: fighting for their freedom against Great Britain, then the most powerful country in the world; engaging in one of the most destructive civil wars in human history; entering World War I barely in time to turn the tide; surviving the Great Depression; leading the fight in World War II, where Americans were forced to battle powerful foes on two fronts thousands of miles away. George should have been able to put the current malaise in perspective, but he didn't.

Even as George was addressing his family at the Rolling Rock Club, the bear market was coming to an end. Stock prices would continue to jump around until December 1974, but looking back it's clear that the terrible downdrafts ended in August, a few weeks after George spoke to his family.

The Dow eventually settled near 578 on December 4, 1974, but in 1975 and 1976, the stock markets snapped back, as they usually do after a bear market, closing just above 1,000 at the end of 1976. By the end of 1980 the Dow was back where it had been at its peak in 1972.

But none of this mattered to George III's branch of the Titan family, because they were no longer invested in stocks. The family had ridden the bear market all the way to the bottom, then sold out (immortalizing their losses), paid heavy capital gains taxes, and then failed to reinvest.

Missing the 1975–1976 recovery was bad enough, but most of the family remained invested entirely in bonds throughout the 1980s and 1990s. George Titan III died in 1981, but he had run the family's capital entirely on his own for a very long time, and as a result no one else had any experience investing money. If bonds were good enough for their father, bonds were good enough for them. Besides, their spending needs were very great and stocks yielded very little.

The bank that was advising them had made a few timid suggestions to the effect that it might be a good idea to get back into the stock market, but it never happened. Stocks made the family uncomfortable, and the family patriarch had made it clear before his death that owning stocks was a fool's errand.

Quick Note

Once it became clear that George Titan was not just exiting the stock market, which was bad enough, but that he planned to stay out indefinitely, query whether the bank shouldn't have resigned as his advisor. Note that if a lawyer's client refuses to take his advice, the lawyer may be required by the Code of Professional Responsibility to resign. A wealth advisor's ethical compass should be at least as sensitive.

In 1982, one of the great bull markets in history began, running almost uninterrupted until 1999, when investor enthusiasm slammed into the “tech bust” and prices collapsed. During those 17 years, many investors built large fortunes in the markets, but, again, the George Titan III family missed out on all of it.

Eventually, the combination of no portfolio growth and high spending made it clear even to the most unsophisticated family members that matters couldn't long continue. But by then a new generation of Titans had come along, and, while per capita spending did decline, absolute spending increased.

The end result was highly predictable: by the late 1990s, the George III branch of the family was no longer wealthy. From the end of World War II through the 1970s, that branch of the family had been one of Pittsburgh's most prominent. George III and his wife, Mary, sat on all the important boards in town and were members of all the right clubs. Everyone knew who they were and their opinions mattered. But by the end of the 1990s, the Titans were a middle-class family, struggling to avoid falling even further. No one knew who they were or cared. They had become the “poor” Titans.