11–15 of 15 posts
There's a big challenge for RIAs trying to do right by their clients and offer appropriate glide path investment portfolios: The products and potential returns that honest legit RIAs discuss with potential clients will always be unappealing compared what competitor, dishonest RIAs (who are willing to exaggerate) will be offering. One lesson from the election: it's hard to convince people of a reality they don't want…
How is this better than a Vanguard Target Retirement fund?
The point is, you'd be surprised how different two people are in terms of investment needs even if they retired the same year.
As an aside, we model our investment model most closely after target date funds and annuities. Annuities offer a guarantee (subject to to the insurance company's solvency) but high fees and low flexibility, while target date funds offer good market participation and low fees but don't have the guarantee component. We include a similar blend of securities as a target date fund might, but also include an annuity component for the guarantee.
I've long been interested in an investment company that had a variable cut that was directly based on the customers' preferences. Ultimately you'd want the managers incentives based on the fees to be exactly aligned with the customers' needs, which means that different fee structures are needed for different kinds of customers. Basically the hedge fund fee structure extended. So someone who wanted more risk would giv…
The place this ends up sticky is that a manager with multiple clients can jointly maximize fees – e.g. instead of properly hedging a bet within each client's portfolio, you can put the bet in one client's portfolio and the hedge in another's. If risk preferences are divergent enough the manager can basically be making one-way bets – and frankly the point of this is it could be socially efficient for two of your clien…
So I did think of your scenario, and actually one worse (directly moving money from clients who don't value the next marginal dollar as much as clients who do). A couple of points I thought of in response:
1. Require clients funds to be transparent, so no moving money around after the allocation decisions have been made (this protects more against my problem than yours)
2. Assume the manager's utility is linear in money, in which case hedging their own fees doesn't make sense. If it's not linear in money, then this all becomes more complicated. I got to the point of saying something like "get a model for client utility and for manager utility of various amounts of money, then set the fee to align incentives". If the manager's utility is linear, then fees should be proportional to utility the client gained. If not, it becomes more complicated and perhaps gaming like you describe is inevitable, this is ultimately a math question for which I haven't modelled everything out and so don't know. You may be able to still define a fee structure that gives a proportional increase of utility to the manager for an increase of utility to the client, but I don't know for sure how that would work for multiple clients.
3. If fees represent utility, and utility is maximized, then wouldn't it be good anyway? (Kind of the point you made in the part I quoted.)
4. Another point to keep in mind is how various kinds of returns are expected to attract or repel customers, which factors into manager utility in a sort of "side-channel". If that's significant enough, it might make the whole incentives not work.
There are a lot of interesting math questions that go into this. I don't have too many answers, but I feel like I have a good grasp of the questions.
Some other points I see in my notes on this:
1. it could be that various kinds of existing funds already cover most of what investors really want, and this won't be enough of an improvement to justify the overhead. Investors who want a small chance of a large win go to hedge funds, investors who want the whole market buy index funds, etc, could be there's no room for innovation there
2. incentive structures need to be very specified, won't just be a fee for various amounts but need to take time dimension into account
3. For that matter, utility is time-sensitive, so we need a complex model just to determine utility, and maybe quizzing investors on utility won't actually get the "truth"
I like to think of this as a combination of the insights behind insurance and hedge funds, basically skewed utility curves.
I'd love to talk further if you're interested. I ended up starting a retail startup instead of working on this idea because it's easier to break into, but I'd be thrilled if someone turned it into a real company or incorporated it into an existing one, and you guys seem to be capable of doing something like that.
Earlier quoted context omitted.
The place this ends up sticky is that a manager with multiple clients can jointly maximize fees – e.g. instead of properly hedging a bet within each client's portfolio, you can put the bet in one client's portfolio and the hedge in another's. If risk preferences are divergent enough the manager can basically be making one-way bets – and frankly the point of this is it could be socially efficient for two of your clien…
>frankly the point of this is it could be socially efficient for two of your clients to bet against each other So I did think of your scenario, and actually one worse (directly moving money from clients who don't value the next marginal dollar as much as clients who do). A couple of points I thought of in response: 1. Require clients funds to be transparent, so no moving money around after the allocation decisions ha…
My gmail address is the same as my HN name. :)
There's a big challenge for RIAs trying to do right by their clients and offer appropriate glide path investment portfolios: The products and potential returns that honest legit RIAs discuss with potential clients will always be unappealing compared what competitor, dishonest RIAs (who are willing to exaggerate) will be offering. One lesson from the election: it's hard to convince people of a reality they don't want…
RRG YES