How Doing the Simple Things Wrong Can Be Disastrous | AWM Insights #147
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Episode Summary
It has been a news-filled last few weeks, to say the least!
On a positive note, the silver lining that is evident through the turmoil is that many of these issues can and should have been prevented through the use of proper financial logic and principles.
Whether it was diversification, fixed income management, or market timing, it is clear that going against what we know to be true does not work out.
Having a robust financial framework that is built around the rules of the markets is the only way to build and protect multi-generational wealth.
Have questions for an upcoming episode? Want to get free resources, book giveaways, and AWM gear? Want to hear about when we release new episodes? Text “insights” or the lightbulb emoji (💡) to Brandon at (602) 704-5574 to join our new AWM Insights Network.
Episode Highlights:
0:00 Intro
0:43 Update on current events and financial climate.
2:50 What is a bank run and how did it happen
4:45 How SVB’s mismanagement of their portfolio lead to unacceptable risk
6:45 Why we manage bond portfolios to protect against interest rate risk
9:10 How we ensure client portfolios are safe and how do we think about cash
9:45 How we optimize and protect your cash and safe assets
11:40 Venture Update after the issues with SVB
13:30 The power of diversification and why it becomes important during times of stress
14:50 Text us
+ Read the Transcript
Brandon Averill (00:10): All right, Justin, while we're back and we're given, I guess, a little bit of an experiment here. I'm taking this show on the road for the first time.
Justin Dyer (00:18): The road show. Yeah, AWM Insights on the road.
Brandon Averill (00:21): A little remote deal here. So hopefully this turns out well. We'll apologize in advance if it doesn't, but let us know if you really don't like it and we'll try not to do it again, but as you know to let us know, we got that number 602-704-5574. We'd love to just hear your comments and your questions so we can address them.
(00:46): Typically, we talk quite high level about how we implement investment portfolios, Justin, and we certainly weave in topics of the day, but we had some pretty huge events this past week that sent some big ripples through markets and dominated news headlines, and they were really dominated by the failing of Silicon Valley Bank, or at least to the point where the FDIC and the government had to come in and take action for that bank. And so rightfully so, I think it's caused a lot of uneasiness across the board.
(01:27): So, would love to jump in a little bit today, just talk about a little bit what actually happened from our perspective. I heard a good thing, the only people that really know what happened are the people that were inside Silicon Valley Bank, pulling the levers, then the regulators that came in. So I don't necessarily want us to pontificate on it too much, but from Mark's perspective, what happened? How could it maybe have been avoided? But I think more importantly, how do we ensure that our client portfolios are protected and not overexposed to a risk that's not needed?
(02:03): And then coming out of this period of time, let's go to how are we thinking about investing going forward? Has it changed anything or did it just enhance our confidence in the way that we do things?
(02:16): Maybe I'll jump in there and let you riff on what exactly happened. What's a bank run? Why did they fail? All that good stuff.
Justin Dyer (02:27): I'll even jump ahead to the answer to a couple of your questions there, diversification, right? And that answer will make sense as I go through what happened here and how it's changed our outlook and how can you protect yourself, et cetera, et cetera.
(02:42): But starting with that, essentially it was a good old-fashioned bank run. We used to have these all the time. A hundred years ago, these things were almost a dime a dozen. And essentially, a bank run is when depositors lose confidence in the bank. If anyone's seen, It's a Wonderful Life. It's a great movie on its own right, but it explains bank runs quite well. It's an oldie but goodie for sure. And essentially, like I said, depositors lose confidence in the bank that they are using to safekeep their money, their cash, and they want to get it out as fast as they can.
(03:15): Well, guess what, the business of banks is not that they just are sitting on your cash all day, every day waiting for you to come and take it or ask for it back. They want to make money as well. And so they safekeep your assets in, it used to be good old-fashioned vault, nowadays, it's all through various computer programs and softwares and that are all very secure, but then they go and lend that money out or invest it in other ways and then earn a spread on that. They earn what they're lending it out for, and then they pay you as a depositor some fraction of that, and they collect the difference. That is the basic banking model.
(03:58): SVB, Silicon Valley Bank, had a little bit of a poor management of those two functions, and they were short a little bit of cash, they tried to shore up that cash and that really spooked the market and caused a run on the bank. Depositors wanted their money back, and it just was a snowball effect. One person wanted their money back, the next one did. It made news, it made headlines for various reasons, and then it just really took off from there. And three, four days later, FDIC came in and put them in receivership and shut them down, basically.
Brandon Averill (04:36): Interesting to see, when I relate it back and when I've talked with some of the clients that I have talked with and for all those that are listening, I've drawn the comparison, quite frankly, to how we build portfolios for our clients that are listening. And this is why we put such an emphasis on understanding what the priorities are, so that way when we actually allocate the portfolio, we're doing so in a way that we can actually, when the time comes to meet those priorities, we can do so in a highly confident way.
(05:12): And I don't think it's a stretch to, basically, see that's where Silicon Valley Bank potentially missed. A lot of people will talk about vehicles and vehicles as risks. So they were actually investing in bonds. And unfortunately, most of our industry will just say, "Bonds are safe." And it is far more nuanced than that, as we all know. But they stretched just a little too far and took a little too much risk, even though it was in an asset that typically is associated with low risk. They were effectively guessing where interest rates were going to go.
(05:51): I think for those, for clients listening, that's why we harp on your guys' priorities so often is we never want to be in a position where we have to go access money for one of your priorities coming due when it's not the right time to go access that priority.
(06:08): I think the second part that I'd love for you to get into a little bit as well is yes, it was an error in judgment by Silicon Valley Bank, but effectively what they had to do, if I'm getting the numbers roughly correct, is go sell about $20 billion worth of assets, they would've taken about a $2 billion loss on those assets. $210 billion bank, that really shouldn't cause too, I mean, it's not great. Earnings are going to take a hit, et cetera, but at the end of the day, that's within the scheme of business.
(06:46): But maybe talk a little bit about why we're so passionate about, why we think quite frankly, having a model, even the way that we're structured, independent and privately owned, doesn't expose you to additional risk that maybe has nothing to do with the client at the end of the day. And I'd love to hear your thoughts on that.
Justin Dyer (07:06): You mentioned the duration time matching component driving their need to fill this hole. Well, because they're publicly traded, they have to do so in a relatively public fashion. And that is what really started this whole domino effect where they made a public statement, filed all the forms and whatnot with the SEC that they needed to file. They were going to raise that money. They had a large private equity firm in place to help out. They already had a good chunk of that hole essentially committed from this large private equity institution.
(07:42): And then whether or not it was just bad timing or there was the guilt by association with respect to a crypto focus bank that filed for bankruptcy the same day. So those headlines were all there. Venture capitalists told their portfolio companies to potentially move the asset.
(08:01): All of this was happening in the public eye, and that is largely because they are public institution. If they were private, I don't want to say this would never have happened, that is a little bit too much Monday morning quarterbacking, but there's a high likelihood it didn't. And having that private capital independently owned, if you will, where you don't have the fluctuations of the public markets to necessarily contend with situations like this, would've been a benefit to them.
(08:35): Again, I don't want to hypothecate too much around that, but it is a worthwhile point to highlight that public versus privately owned, especially from a financial institution standpoint. We really pride ourselves on being independently owned, employee owned for that matter, where we are so close to the decisions and protecting client assets, investing client assets in the way that you mentioned, Brandon, the duration, time matching, priority matching, in a really, really, really well-thought-out, more conservative manner. And that gives us a lot of confidence in giving advice to our clients.
Brandon Averill (09:12): I think that's a great point. Maybe where we can wrap up is just how we ensure that client portfolios are safe. And I think what would be good to hit on here is just how do we think about cash, for instance. I think that was a big part here is that people that we're holding too much cash were, or maybe not too much, but we're holding large amounts of cash, were potentially the ones at risk here. So I would love to hear just, we reviewed this immediately, but we have cash management policies in place to make sure that our clients aren't overly exposed in some way that may hurt them. So I'd love to hear, just at a basic level, how we thought about that even before this all unfolded, and then how we're just confirming that we're going to continue to monitor that way.
Justin Dyer (10:00): You hit on it. We have cash management policies in place and we review cash, basically, every day of the week for our clients to make sure that they have enough cash on hand, but also not too much. I think that's the critical nuance here. You want cash on hand for everyday spending needs, but you don't want more than you really need. If that is under 250,000, which is the FDIC insured amount, that was totally protected. Even in the case of Silicon Valley Bank going under, then that's a good position to be in.
(10:29): Some people do spend more than that and need more cash on hand, especially businesses, but you should not have more cash than you need. And there are ways in which you can still have, let's say, the confidence and comfort that cash brings, but in a way or in a brokerage account or structure or investment vehicle that is a little bit more protected than just holding it in a bank account.
(10:53): I think that is a common misconception that people like the comfort of cash, which I totally get there, is there's a lot of merit to that. But you can have essentially the benefits of cash or very liquid investments in other financial institutions that give you a little bit more safety, especially for folks who are clients of ours that do have substantial wealth. And you can take some very prudent, very simple steps to do that.
(11:19): Again, going back to our policy, we are reviewing cash levels on a very regular basis, daily in many cases, that protects at least against some of this stuff. But if there are questions that clients have that are listening to this and want to dig in a little bit deeper, by all means reach out to us and we can get some more specific advice to you.
Brandon Averill (11:41): And I think the place I'll wrap up is just the other question that's come in is, "Hey guys, I know we're active in the private markets, specifically the venture capital markets, Silicon Valley Bank, at the heart of the venture world to an extent. Should I be comfortable about investing in these markets going forward?" And I would just reassure everybody that the answer is high level "yes". You certainly need to continue to do your due diligence. And I would say one of the hard parts of due diligence is understanding either a fund if you're investing in funds, cash management policies.
(12:20): So most of the funds that we've invested in, even the ones that were clients of Silicon Valley Bank, they only call capital when capital is needed. So that's a big part. They don't hold typically huge cash balances. We've been reassured by, I think virtually all the funds we've invested in, that their capital has been moved or is safe. So that's good news.
(12:45): And then trickling down to the portfolio companies, I think there is good that will come out of this in the sense that people understand we can't just sit on big cash balances now, and by function of the government stepping in, it doesn't appear that anybody's going to take a dramatic loss here. And the portfolio companies specifically that we're exposed to, I think we have a lot of confidence that they've navigated this all really well.
(13:14): It's definitely a risk factor, it's something we pay attention to. But I think the short answer is you should still feel pretty good about allocating systematically to the venture market if your resources allow for that.
Justin Dyer (13:27): Yeah, and I just add, and maybe kind of putting a bow on this and tying it back to what I said initially, what are some of the takeaways that we've learned is, or not even learned, I think it's even underscored in our philosophy, diversification, right? It's kind of this boring old thing you hear time and time again. But man, it matters. It matters when it matters, right? And that's exactly what you want in a philosophy. You don't want to necessarily be caught with your pants down, right? There's the proverbial Warren Buffet quote that's, "You'll see who's swimming naked when the tide goes out." Well, guess what? You're kind of seeing that unfold here in real time. And we are diversified. And as a result of that, we're in a pretty comfortable position, whether it be across publicly traded stocks, a across banks that are having a hard time right now.
(14:14): We did have some exposure to Silicon Valley Bank in our public equity portfolio, but it was infinitesimal because we're highly diversified.
(14:22): On the venture side, to your point, they were very well managed, prudently managed, but we also practice a very diversified approach there. We are somewhat, you're not completely insulated from losses and companies going to zero, which will happen again and again going forward, but the impact is relatively minor to your overall financial structure. And that's one huge takeaway.
(14:46): And then same from a banking standpoint, if you have a lot of cash, you probably should diversify your banking relationships as well.
Brandon Averill (14:53): I think that's great, and hopefully this gave everybody a little bit of a feel how we're managing your portfolios, just how the Silicon Valley Bank issues and the rest, we're isolating them as the bank, but it's extended beyond that, just how you're impacted overall.
(15:09): By all means, reach out. If you have more questions, you can reach out via the number we've talked about, 602-704-5574 comes directly to me or reach out to the advisors you work with. Anybody on the team, we're obviously deep in this stuff and happy to talk about it further with anybody that's listening.
(15:30): Until next time, own your wealth, make an impact, and always be a pro.