E316: How Family Offices Design Portfolios for 30-Year Outcomes

13:36David Weisburd:You built something that I think is very interesting, which is essentially a hedge to S &P 500 in case there's a tail risk and there's some black swan event. Tell me about that.

13:48Zach Wainwright:Started with a support for today's episode

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16:28Zach Wainwright:Conversation with a family. We kept hearing from a number of families that they were worried about kind of where the market was. And so and the volatility and the potential downside. And so we came back to them with this idea of tail hedging. And the starting point for that is, you know, buying puts on the S &P 500 costs, you know, two to five percent per year, depending on the period of time, which is really expensive. So no one wants to pay that level of expense. But even if they were willing to pay that level of kind of underperformance in a way, the ways in which they can access it today are inferior.

17:04Zach Wainwright:You'd commit to a tail risk hedge fund that's going to run that put selling strategy for you. But when that pays out, you need to rebalance away right away. You need to take that source of funds that was generated in March 2020 and go out and buy equities. That doesn't work in a private fund. There's illiquidity, there's gates. And so by the time you get your money back to be able to redeploy it, you have to pay taxes, you have to pay fees, and you've given back a lot of the returns. And so we started by saying, can we put that inside of an ETF so that we can do the reallocation for the end client.

17:42It's an ETF way to do what hedge funds are doing,

17:46David Weisburd:but are charging two and 20 and a half gates. How exactly do you go about doing that?

17:50Zach Wainwright:There's probably 40 different hedges that you can do at any different time and that hedge funds are looking at at any given time. It could be something as vanilla as buying puts on the S &P, or it could be something as complex as buying forward interest rate volatility in foreign markets as a way to hedge equity exposure. So at different times, we're going to move between that camp of 40 different potential hedges and put together a balanced book to really solve the pain point of that product. In a severe downturn that is very sharp and unexpected, do you have a source of funds that you can redeploy?

18:30Zach Wainwright:And that's kind of what we tried to create. And we wanted to make it as easy for investors to access as they could, single ticker in a portfolio.

18:40David Weisburd:there's no free lunch what's the cost of having a hedge on s &p 500 portfolio versus just having

18:47Zach Wainwright:that s &p 500 portfolio with with no hedge in the simplest terms like buying puts is expensive right it can cost you two to five percent per year as i mentioned and are you willing to pay that most people the answer to that question is no and so they keep it on for a period of time where they under hedge. And so then the hedge doesn't deliver what they expect. We started by saying, given kind of our backgrounds at hedge funds and institutional firms, what's the full toolkit that you can use? Can we use things that are more complicated? Can we trade things on swap? Can we use options? Can we really try and blend together what is a institutional level risk hedging book that will evolve over time to capture kind of the different market opportunities that we see in the hedging market.

19:39Zach Wainwright:And so that's what we did. We have a constant allocation to something that gives us convexity in the portfolio. So something when the market tanks, it will outperform.

19:52David Weisburd:You mentioned 200 to 500 basis points for a typical put on S &P. What's the cost of doing it and through an ETF?

20:01Zach Wainwright:If you just take the same strategy and put it inside of an ETF, there's no difference in the cost. I think for us, what we were trying to sell for is

20:07David Weisburd:what is the exact vector that we're addressing?

20:11Zach Wainwright:Our clients and this fund is not designed to solve the zero to 5 % down market, which is where a lot of the hedging happens. That's very expensive. That's not what keeps families awake at night. It's waking up and seeing the market down 30%. And so it could be as simple as moving to buying cheaper puts on the S &P. And those are, you know, the drag is much less. It's harder to quantify exactly what that drag is over time because we move to different types of hedges, some of which actually can have positive expected value and positive carrying costs. And when you blend those together, we're trying to offset the drag as much as we can so that we can maintain an adequate level of hedging kind of in all scenarios.

20:57David Weisburd:Said another way, you're really optimizing on the maximum drawdown. So some people might say, I would be comfortable with a 10 % drawdown. Some would be with a 20. And then I guess there's this efficient frontier of what percentage of your portfolio you're hedging away with what instruments. That's the complicated part.

21:17Zach Wainwright:For this fund, we try and take that onto our back so you don't have to worry about it. we're trying to deliver an outcome, a solution where you get equity-like returns, but with reduced drawdowns in extreme tail environments.

21:29David Weisburd:I've always been curious about this because probably 90 % of institutional investors have what is called diversifiers, which is hedges against the market. So there must be a very solid rationale to that. Has there been research on long-only exposure versus long-only with hedged products? And does long-only with hedge products? Not only maybe is it a smoother ride, which is important, but does it actually outperform? And so in what cases?

21:56Zach Wainwright:My favorite statistic is if over a 30 year period, you avoid the 10 worst performing days in the market or 10 worst performing weeks in the market, you 3x the performance of the market or something like that. Problem with that is the 10 best performing days in the market usually follow the 10 worst performing days, right? There's two really bad days and then there's a recovery. So if you also miss the 10 best performing days, you are underperforming the market by half. And so those are the problems that I have with like a buffer fund, for instance, right? Like they're really just protecting you against the drawdown, but if the market's down and then back up, you might not capture that recovery period.

22:40Zach Wainwright:and that will also cost you in the end. And so to the conversation we were having about the ways to access tail hedging that currently exist, doing that in a private fund where you can't rebalance away is a problem. In our fund, on those bad days, we're immediately looking to go out and buy more equity exposure because we need to capture those recovery periods because that's how you sustain your outperformance over time. It's one thing to avoid the downturn, which I think is a feat in and of itself. But then it's, can you in, in those moments deploy into that pain?

23:16David Weisburd:And your philosophy is you design with a family office in mind, and then you provide that to other family offices. Exactly.

23:24Zach Wainwright:So we like to think of ourselves as like client driven innovators in the product space. Someone comes to us with a problem, we solve that problem, and then we can make those strategies accessible to everyone. And so the tickers that we create are available. Anyone can go buy them. But we know that it solves a single family's problem or a multifamily office's problem. And while every family might have a different need, eventually they start to rhyme. And so what worked for David's family will also work for John's family over here.

23:52David Weisburd:You're in a unique vantage point where not only were you at these institutional investors in the single family office, but you have single family offices coming to you and helping you solve specific problems. What's your view on the optimal way to build a public portfolio for the long term?

24:10Zach Wainwright:The stat I always like to come back to when I sit down with them is if you bought the S &P 500 30 years ago and just let it compounded and removed all tax friction and fee friction from that access, you 25x your money. Do you want to 25x your money over time? Because very few people actually achieve that level of outperformance over the last 30 years because fees were introduced, taxes were introduced, suboptimal decision making were introduced. And so for us, they're coming to us, and I think what they're really seeking is an ability to compound tax deferred for a long period of time. And that's a mentality that is not pervasive in the investment ecosystem.

24:51Zach Wainwright:It's a very private markets type of approach to the public markets. Exactly. And we're trying to match our clients and our investment strategies to deliver the outcomes that they're wanting. And are we aligned on the incentives for that?

25:05David Weisburd:so starting this business a couple years ago what's been the most surprising thing

25:11Zach Wainwright:i've become really obsessed with etfs created a firm building etf products right and you think oh my god this is so people must know this and i still think people ask me what inning we are in

25:22David Weisburd:the etf evolution i say like the third inning there are so much more to do in the etf ecosystem

25:29Zach Wainwright:them, both from an awareness standpoint and also a product development standpoint. And that's where we're really trying to push kind of the envelope. I meet a family office, you know, almost every week that has at least a few hundred million dollars into any ETFs. And they didn't know that they were more tax efficient. They just bought them because they were easy and cheap. And so taking that knowledge and then saying, oh, but it could be applied to so many more different things. And on the other side, you know, we meet a lot of hedge fund managers that are looking to grow in the family office channel?

25:59Zach Wainwright:And can we help them ETF their strategy because they want to get access into that strategy? And I think that's really where we can sit at this intersection where we're helping institutions access the ETF market with sophisticated partners.

26:14David Weisburd:There's a couple of confluence of factors going on here. One is the high net worth, the family office world is gaining in prominence. So before all the products were done for the institutional, the non-taxable investor, just because they were just dramatically larger. And now with the rise of retail and the intergenerational transfer of capital and all these factors, the taxable investor himself or herself is just becoming more prominent. The problem that still persists within that, a lot of the large managers of that capital are not really incentivized for them to perform on tax efficient manner over 10, 15 years.

26:53David Weisburd:Yes, you could say in theory, they get another 2 % per year compounded over 20 years, they'll manage another 1.5x. But most people are not really thinking that long term. And most people honestly don't care as much. They're focused on, you know, selling products. And we have another trend now with the fee only the multifamily office, the, the RIAs that are now much more aligned with, with the client as well. So there's this general focus on the taxable investment within the taxable investors. There's a general focus on being more client facing and kind of lowering that principal agent problem that does experience.

27:31Zach Wainwright:We try and partner with a lot of those firms, right? Like we want to partner with those multifamily offices that think like us. And we want to partner with the, you know, the hedge fund manager that maybe is his own largest client. And he's realizing that, oh, maybe I should care about taxes now.

27:44David Weisburd:and so i think there is a change happening um but tax aware investing has been around for a long

27:50Zach Wainwright:time you know i i got interested in investing when i was 12 years old no good reason whatsoever just kind of a cool idea and i spent a lot of time with i was fortunate to spend a lot of time with family offices and one in particular gave me this piece of advice and this is you know 20 plus years ago a superior knowledge of the tax code is one of the most competitive edges you can have as an investor. Tax-aware investing, I think, is having a moment, and I think it will continue to have a moment because at the end of the day, what matters to you as an individual, whether you're a retail, family office, multifamily office, is how much do you keep?

28:25Zach Wainwright:And can we help you keep more in your pocket?

28:30David Weisburd:If you look at alpha as extremely fleeting, in most markets, somebody is buying and somebody is selling. So it's very difficult, if not impossible, to sustain alpha over long periods of time as information starts to become less asymmetric. In tax, you're essentially selling against government treasury that updates its policies sometimes once a decade. So it's much easier to sustain alpha in that perspective versus when you're buying and selling.

29:01Zach Wainwright:It's an interesting framework to think about it. I always like to think about it as this is tax deferral, it's not tax elimination, right? We're not getting rid of your tax obligation. You still owe the taxes, but can we remove the frictions along the way that get in your way of kind of deferring and compounding for long periods of time?

29:23David Weisburd:If you could go back 15 years ago when you were just starting your career, what would be one piece of advice that you would give a younger version of yourself that would have either helped you accelerate your career or help to avoid causing mistakes?

29:36Zach Wainwright:I got told this when I was younger in my career, so I'm borrowing it from somebody else, but I think it really holds true. Collect the most diverse set of experiences you can as an investor, because when you see the same problem everyone else has seen, you'll see a different answer.

29:52David Weisburd:And it's that simple.

29:54Zach Wainwright:In this conversation, I've talked about derivatives, public markets, private markets, venture, real estate. I've looked at all of these different things as well as from different client perspectives, right? whether I was working at a family office or an institutional allocator. And when I see a problem, I bring all of those experiences to bear on solving that problem. And that's how we think we can create something really differentiated and special, which is our structural edge. Every investor wants a differentiated strategy, or they want alpha, which oftentimes is a different

30:24David Weisburd:way of doing things. But when they see it, their first gut instinct is, well, that's different. That's not the pattern I've seen previous 10 times, not realizing that that difference is the source of alpha.

30:37Zach Wainwright:Exactly. Right. And, you know, I get told a lot of if that was true, Goldman would be here at my door pitching me on it.

30:46David Weisburd:I'm like, well, eventually they'll get to it.

30:49Zach Wainwright:You know, we saw it first and we kind of this is what we do every single day, all day long. Whereas even if Goldman gets into this business, it's a fraction of what somebody does in their day. And so eventually this will be really commonplace. I think if you had me on 10 years from now, which I hope you do, we'll be talking about kind of, oh, there's a hundred new firms that are doing taxware investing because that's the way it's going.

31:10David Weisburd:Well, Zach, thanks so much for jumping on the podcast. Appreciate everything that you're doing and looking forward to continuing the conversation soon.

31:17Zach Wainwright:Thank you so much for having me. It's been a true pleasure. Thank you.

31:21David Weisburd:That's it for today's episode of How to Invest. If this conversation gave you new insights or ideas, do me a quick favor. Share with one person in your network who'd find it valuable or leave a short review wherever you listen. This helps more investors discover the show and keeps us bringing you these conversations week after week. Thank you for your continued support.