Episode Summary: E121 - What Billionaires Do Differently in Investing with Ron Diamond

Release Date: December 17, 2024

Podcast Information:

• Title: How I Invest with David Weisburd
• Host/Author: David Weisburd
• Description: This podcast features interviews with the world's leading institutional investors. Past guests include The Ford Foundation, Northwestern University Endowment, CalPERS, Stepstone, and other top limited partners.
• Episode: E121: What Billionaires Do Differently in Investing with Ron Diamond

1. Introduction to the Episode and Guest

In Episode E121 of "How I Invest with David Weisburd," host David Weisburd welcomes back Ron Diamond, an esteemed figure in the family office and investment management space. The episode delves into the unique strategies billionaires employ in their investment approaches, the challenges family offices face across generations, and the transformative wealth transfer poised to reshape the investment landscape.

2. The Legacy and Challenges of Family Offices

Ron Diamond opens the discussion by highlighting the precarious survival rates of family offices through generations. He states:

"Only 25% of family offices make it to the second generation, 10% to third, and only 5% make it to third generation. Why is that?" [00:00]

Key Points:

• Inefficient Wealth Management: Many families with significant liquidity events lack the expertise to manage their wealth effectively, leading to poor investment decisions.
• Ego and Governance Issues: Founders or patriarchs/matriarchs often let ego interfere with professional management, expecting to excel in all areas without recognizing their limitations.
• Lack of Foundation: Without proper estate planning and governance structures, family offices struggle to maintain and grow wealth across generations.

3. Massive Wealth Transfer and the Future of Family Offices

Ron elaborates on the impending wealth transfer, emphasizing its magnitude and impact on family offices.

"There is $84.4 trillion that's moving downstream from the baby boomers, the next gen, in the next 20 years. So we're about to experience the largest transfer of wealth in history." [01:10]

Key Points:

• Current Assets: Approximately $10 trillion are managed by family offices, surpassing the entire global hedge fund market.
• Opportunities and Challenges: The sheer volume of wealth being transferred presents both opportunities for growth and challenges in professionalizing family offices to handle such assets effectively.

4. Compensation Models and Talent Acquisition in Family Offices

A significant portion of the conversation centers on the compensation disparities between family offices and top private equity firms, and how this gap affects talent acquisition.

"Many family offices today look at this as a cost. And it's not a cost center if it's not going to be a business." [02:01]

Key Points:

• Talent Shortage: Family offices struggle to attract top-tier talent because they often view high salaries as costs rather than investments.
• Competitive Compensation: To compete with firms like KKR, Blackstone, and Apollo, family offices need to offer competitive compensation models, including carry and other incentives.
• Professionalization Needed: Most family offices operate inefficiently and need to adopt professional compensation structures to execute effectively.

5. Structural Alpha and Tax Strategies

Ron introduces the concept of "structural alpha," focusing on optimizing after-tax returns through strategic structures and tax-efficient investment vehicles.

"Structural alpha, how things are structured is going to be a phrase. It's going to be used more and more going forward." [10:38]

Key Points:

• Tax Loss Harvesting: Implementing strategies that allow family offices to realize tax losses while growing assets.
• Private Placement Life Insurance (PPLI): Utilizing PPLI to wrap investments in a tax-efficient structure, effectively eliminating income taxes on returns.
• Innovative Firms: Highlighting firms like AQR and leaders like Michael Lipskin who are pioneering structural alpha strategies to enhance after-tax performance.

6. Governance and Estate Planning in Family Offices

Effective governance and estate planning are foundational to the longevity and success of family offices.

"Get your governance right. The reason families implode is not always because family offices aren't great investors. Sometimes they are, sometimes they're not. There's no governance in place." [07:37]

Key Points:

• Foundation First: Before making investment decisions, family offices should prioritize estate planning and governance structures.
• Strategic Investment: Investments should align with the family's expertise and strengths, avoiding ventures outside their knowledgeable domains unless properly outsourced.
• Professional Governance: Establishing clear governance protocols to prevent family disputes and ensure cohesive management of wealth.

7. Raising the Next Generation: Avoiding Entitlement

The episode delves into the delicate process of raising children in wealthy families, emphasizing the importance of instilling gratitude over entitlement.

"Children understand the worst thing you could do with a family office or any wealthy family is to raise an entitled child." [19:07]

Key Points:

• Modeling Behavior: Children learn by observing their parents. Demonstrating respect and humility in everyday interactions teaches them valuable life lessons.
• Education and Discipline: Programs like boot camps for next-generation family members help instill a strong work ethic and appreciation for the family's wealth.
• Balance of Privilege and Grounding: Encouraging involvement in philanthropic activities and real-world experiences to keep children grounded despite their privileged backgrounds.

8. The Family Office Initiative at University of Chicago Booth

Ron outlines his ambitious project to professionalize family offices through education and research at the University of Chicago Booth School of Business.

"We're trying to create an ecosystem where we can have a network of family offices without an agenda, under the auspices of a research institution." [23:32]

Key Points:

• Educational Courses: Launching courses that teach the fundamentals of family offices, permanent capital, and strategic investment management.
• Exclusive Conferences: Hosting highly selective conferences that bring together family offices without the typical service providers, fostering genuine collaboration and knowledge sharing.
• Advisory Board: Forming a council of 40 of the wealthiest families in the U.S. to guide the initiative and ensure it meets the needs of modern family offices.
• Long-Term Vision: Preparing the next generation of family office leaders to manage and grow the incoming $84.4 trillion in wealth with professionalism and strategic insight.

9. Disrupting Private Equity with Family Offices

Ron discusses how family offices, with their patient capital approach, have the potential to disrupt traditional private equity and venture capital models.

"Family offices are going to disrupt private equity and venture capital because they've got something called patient capital." [27:44]

Key Points:

• Permanent Capital: Unlike private equity firms that aim to flip companies within a few years, family offices can hold investments longer, allowing for sustainable growth and compounding.
• Avoiding Short-Termism: By not being pressured to return capital quickly, family offices can focus on long-term value creation rather than short-term profits.
• Operational Focus: Emphasizing operational improvements and strategic growth over financial engineering to create true alpha.

10. Advice for Family Offices Today

Ron offers practical advice for family offices aiming to improve their investment returns and overall efficiency.

"Focus on what you were where you made your money and where you've got strength and then outsource the rest." [33:24]

Key Points:

• Stay Within Expertise: Invest in areas where the family has proven expertise and strengths, avoiding ventures outside their knowledge base.
• Outsource When Necessary: For investment areas outside the family’s expertise, collaborate with specialized professionals or outsource to multifamily offices.
• Manage Fees Wisely: Understanding the importance of paying appropriate fees to experts to avoid being "pennywise and pound foolish," ensuring higher long-term returns.
• Develop Relationships: Building strong relationships within various investment sectors is crucial for accessing exclusive opportunities and strategic partnerships.

11. Conclusion and Final Thoughts

In wrapping up the episode, Ron emphasizes the importance of education, governance, and strategic planning in transforming family offices into professional, efficient entities capable of managing vast wealth across generations.

"It's not just about how much, how good your return was. It's how good your return was after taxes." [17:46]

Key Takeaways:

• The upcoming wealth transfer presents a unique opportunity for family offices to evolve and professionalize.
• Structural alpha and tax-efficient strategies are essential for maximizing after-tax returns.
• Effective governance and disciplined investment strategies are foundational for long-term success.
• Educating the next generation and maintaining humility are critical to preserving and growing wealth through generations.
• Initiatives like the Family Office Initiative at University of Chicago Booth play a pivotal role in shaping the future of family offices.

Notable Quotes with Timestamps:

• On Survival Rates: "Only 25% of family offices make it to the second generation, 10% to third, and only 5% make it to third generation. Why is that?" [00:00]

• On Wealth Transfer: "There is $84.4 trillion that's moving downstream from the baby boomers, the next gen, in the next 20 years." [01:10]

• On Compensation Models: "Many family offices today look at this as a cost. And it's not a cost center if it's not going to be a business." [02:01]

• On Structural Alpha: "Structural alpha, how things are structured is going to be a phrase. It's going to be used more and more going forward." [10:38]

• On Governance: "Get your governance right. The reason families implode is not always because family offices aren't great investors. Sometimes they are, sometimes they're not. There's no governance in place." [07:37]

• On Raising Kids: "Children understand the worst thing you could do with a family office or any wealthy family is to raise an entitled child." [19:07]

• On the Family Office Initiative: "We're trying to create an ecosystem where we can have a network of family offices without an agenda, under the auspices of a research institution." [23:32]

• On Disrupting Private Equity: "Family offices are going to disrupt private equity and venture capital because they've got something called patient capital." [27:44]

• On Investment Strategy: "Focus on what you were where you made your money and where you've got strength and then outsource the rest." [33:24]

• On After-Tax Returns: "It's not just about how much, how good your return was. It's how good your return was after taxes." [17:46]

This episode offers profound insights into the intricacies of managing family offices, the critical importance of professionalization, and the strategies that distinguish successful billionaires in their investment approaches. Ron Diamond's expertise provides a roadmap for both current and future family offices aiming to navigate the complex landscape of wealth management and investment.