#85 - Darell Krasnoff: Wealth Management Evolution, Leadership

30:04There's also kind of an institutional morass that develops of being creative and getting things done. One of the things that, again, this is not as an advertisement, but just as the people, one of the things I always admired about Mark and David when I watched their careers over the years is they were always willing to try new things and be entrepreneurial. That, I think, is a really important quality to a successful firm is being willing to try new things and be open-minded and adaptive. If you're too big, it's really hard to do that. If you're too big, you can't really encourage your clients to all reduce equity exposure because the markets won't absorb it to all sell at the same time.

30:47I don't know exactly what number is too big, but there are firms out there that are too big to be able to bring custom boutique solutions to their clients. I do think size matters. So you've been a financial advisor for 44 years. You've also managed a lot of successful financial advisors. What qualities do you believe are essential for someone to excel as a financial advisor today? Back when I started, people had to be generalists and be effective at everything. I think the world is much too complicated for one person to know all that they need to know. And so there's now room for specialization.

31:28So there can be people who are focused just on a narrow part of the wealth management industry or strategies. I don't think you just have to know everything. I think you have to still be very bright and curious and knowledgeable, at least willing to learn, depending on where you are in your career. So capacity for learning, willingness to have an open mind and not think you know everything. It's one of the great pitfalls in wealth management, probably in any part of life, is thinking you know more than you do because you're going to make mistakes that way that are significant. So understanding what you don't know, being willing to ask for help when you need help, so being humble.

32:07This is not an easy business to build and grow as an entrepreneur. And so you have to have a tremendous amount of drive. Something has to be compelling you forward to keep working hard, to do more, more than most people are willing to do. And it's an industry where there's great reward for hard work, but you got to put in the work. And I think coming back to your question about you get paid for advice, you also have to be able to work with people or enjoy people, care about people, have a lot of empathy for what people are going through and what they need and caring about being of service to them.

32:48That has to be, I think, an important part of where you get your satisfaction. and then I think you need a certain level of math skills. I don't think you have to be a PhD but the way I describe it to people is numbers have to mean something to you. There are people who can do a lot of calculations but the numbers don't actually speak to them. They don't mean something. Our world numbers represent things that are actually real in the world and so you need to be able to make those connections and have them be intuitive so that you can make good judgments based on data and personalities. That's the combination really of assessing data and assessing personalities and then making good judgments about them all.

33:31Integrity has got to be number one overall. This is a business built on trust internally among partners, externally among clients, having integrity. And that's the hardest one. You don't know that somebody doesn't have integrity until you learn that. But there are tales and you can infer integrity from getting to know somebody and what their values are about whether they live a life with integrity at the center. How much of the formula for success do you feel is IQ versus EQ? There's a necessary level of IQ, but it's not probably as high as the necessary level of EQ. If you didn't have enough IQ, no matter how much EQ you have, you're not going to be able to help people.

34:16But if you have a very, very high IQ and not very good EQ, you're not in the right business. There needs to be sufficient levels of both. But if I was going to have higher of one, I'd take the EQ. Yeah, it is interesting because if you look at it from the outside, you would think the answer is IQ because you're hiring somebody that has expertise in the financial realm. But so much of it is relationship building, trust building, communicating complex concepts. And a lot of it is driven by emotion because you're dealing with people's money. And there's so much expertise out in the world that you can harness to generate attractive returns for clients.

34:59You don't have to have that all in-house, but you just have to be able to find it. So you don't have to be the smartest person in the world to be able to find the smartest person in the world. So we talked about viewing the world through the eyes of the advisor. Let's go to the other side of the table. Are there common blind spots or misconceptions you see among clients? And how do you help them address these? I think one of the areas that are hard for clients to develop is a trust that financial markets actually make sense. Sometimes they don't seem to. Sometimes I don't. Even these days, it may be too good to be true right now.

35:36That it's not just a casino. When you've built a business day by day and build great value, bringing value to your customers, and you achieve a certain amount of net worth, it's scary to go from having something you have direct control over to something that you feel is a bit random or certainly opaque about why things happen the way they happen, why it goes up, why it goes down. So I think it takes some education and some time for people to understand the correlation between things like population and productivity and the amount of money in circulation and how that drives value over time and being able to trust owning businesses that you don't control and they have all the net worth that you've built over your life and have that exposed.

36:34And it's hard to do just on the trust. The advisor knows what they're doing. So I think being able to help educate people on how markets work, why they go up or down, why they go up over time, and to be able to trust that your net worth is okay. If you put all your money in cash, you over time have lost money relative to inflation. So if you don't take any risk, you're guaranteed to lose money on a real basis. It's how do you take smart risk and what does that really mean and how do we educate people about what risk is worth taking? The other side of that is there are some people who are biased towards just putting it all at risk and that we need to slow down a little bit.

37:20They've seen people make unusual amounts of wealth by taking big risks, whether it's early in the crypto environment or early in AI, and you have a home run. And one of the things that we spend a lot of time talking about with people is what's the utility of making more money relative to the pain of losing money? do you have enough to make your life work where you're at or should you take a risk beyond what's a reasonable risk to generate the cash flow and keep up with inflation in order to double or triple your money and people at different phases of their life have different answers to that and we help them based on whatever that answer actually is but that's an important part of it also is to help educate people about where not to take risk and where risk isn't useful to you because you already have enough.

38:14Why risk going backwards in order to double or triple when life is working just fine as it is? So I think both of those are things that we've helped clients to understand better over the years. One other element that I find interesting is investing well requires patience. And patience is a little bit different. The timeline is different in the investment world than it is in most of the world, where a year or three years or even five years is a short period of time, whereas everywhere else, that feels like a long period of time. And that disconnect can make it challenging in practice. Yeah, that's a very good point.

38:54It's investment cycles. When we meet with people that talk about that they're looking for results, then they might need to use the money a year or two years from now, we encourage them not to own any stocks. You have to have at least a three to five year time horizon before it makes sense to own any stocks because there's no certainty about what will happen in the short runs. I still remember an analysis that I saw about the relative importance of individual stocks versus markets over time, and that the market defined 70%, I think, of the result of an individual stock in a one-year period. And over a five-year period, it was like 30 % of the coefficient of contribution to the total return by markets versus the individual fundamentals of the company.

39:47So the longer you have, the more likely you're going to get the results you expect, but you need to have that time. Let's transition to talking about the asset management industry. So we talked about the financial advisory or investment advisory industry that you and I are working in, but the asset management industry where you have money managers. Would you help our listeners understand how the asset management industry fits into the broader financial ecosystem and also how incentives are typically aligned and what might surprise clients about how the industry works? so when you're talking about asset management we're talking about now mutual funds are an asset that is managed separately managed accounts get managed certainly all the fixed income strategies so there are large successful firms that don't work directly with clients but just manage assets internally some of them specialize and some of them are quite across all of the asset classes Most of them work on a fee for management.

40:50Some work based on performance. So if you're into looking at things like hedge funds, private equity funds, real estate funds, all the funds tend to be management fee plus a percent of return. So in those cases, the incentives are more aligned. If they do really well for people, they get paid more. Something to watch out for is that there are some kinds of hedge funds, for example, where they're effectively giving you market-based returns but charging performance fees on them and that there's not enough value add to justify paying a performance fee. There are some managers, it's very hard, for example, for domestic large cap equity managers to justify the fees they charge at all because the average manager in that category underperforms net of fee.

41:41It's important to, if you're going to be paying fees because the industry is set up where they make money based on the amount of assets they manage typically. And again, earlier, I mentioned that in some ways size is the killer of alpha. And so they're incentivized to have more and more and more assets under management that may not help you as the client to get better returns, but it makes them more money. So you have to be careful as the client about the size of the asset manager out there and whether they're truly adding enough value to justify their fees. And that I think tends to be more an issue with, again, domestic large cap or large cap in general, but where it comes to smaller, more boutique, more focused managers, it's one of the things that people should evaluate, is there enough return to justify the fee?

42:35And so we tend to look at something like rolling three-year histories. Every manager underperforms for periods of time. He could have six months a year, two years. The best of managers, I remember when people thought Warren Buffett was no longer smart because he had, I think, two years of underperformance when what he did was out of style. Even in this environment where markets are being led by the Magnificent Seven, that's not necessarily Buffett-esque, although he does have some meaningful exposure. But anybody can be out of style for a couple of years. So you've got to look over longer periods to see if the fees are justified.

43:10I like investing where we're aligned, where it's not just the size of assets under management that firms are getting success on, but the results they can create. Again, that happens much more in the alternative investment category, particularly in structures like hedge funds and private committed and drawed down funds? I like to oftentimes try to simplify things. And one of the simple questions I ask myself when I'm talking to an asset manager is, what business are they in? Are they in the business of gathering assets and trying to maximize the profits? Or are they in the business of generating returns for their clients?

43:49And I think of it as a spectrum. On one end, you have asset gatherers. On the other you have return generators. And everybody's probably somewhere along that spectrum. But I think if you simplify, you could try to distill what business are they really in. And you have to go beyond what they say. You have to follow their actions. And it also helps to see that they have a lot of skin in the game, that their money is invested in the strategy that they are looking to encourage you to invest in with them. And many managers don't have a lot of their personal money in their strategies, some do. And so that's also something that is compelling.

44:26You've spoken quite a bit about the potential impact of artificial intelligence on investing in our industry. How do you see AI shaping the industry in the coming years? That's a tough one. I had listened to a conference recently where I thought one of the wiser things I heard was that people are fearful that AI is going to take their jobs and the comment that this person made is that AI is not likely to take your job, but somebody who's using AI better than you probably will. So I think we have to be very open and curious and engaged with watching the path of what AI is enabling and make sure that we're harnessing that capability and bringing it to clients.

45:12We already are. there's already tremendous amount of research you can do with ai that shortens the process of digging in on fundamentals of businesses all the data is readily available and chat gpt claude do a great job of assembling that data we're using it internally to help be more efficient we're now taking notes on zooms and integrating that into salesforce and having that help us stay on top of are client communications. So there's a lot of productivity enhancing AI. At some point, probably in the not so distant future, there's going to be more and more investment advice coming from AI. There already are, I know, platforms that are relying on AI to help the$1 to$10 million clients invest their money more efficiently.

46:05We've already seen the robo-advisor platforms that are doing tax harvesting and giving asset allocation advice. I have experienced by playing around a lot with things like ChatGPT that there's a lot of errors in the advice that it gives. So you have to be super careful that you don't just take what AI tells you. A funny story about that is I have a 31-year-old that we were looking for a place to go to dinner to celebrate with 12 people. And I asked ChatGPT for recommendations in particular the geography. He happens to be a chef. And so we wanted a restaurant that would be a good place for a chef.

46:49They would deliver some really good food. And it gave me a list and it had three top recommendations. And when I went to each of the three to see if they had reservations, two out of the three had been closed for over two years. And when I went back to ChatGPT and said, by the way, this restaurant and that restaurant is closed. And it said, you're right. Here's two more ideas. And so that was a kind of benign issue. But I had the same kinds of things about tax rates and after-tax returns when trying to build models and understanding whether the ACA was relevant to a client for their after-tax returns.

47:29And so they're not reliable yet, but they're helpful. We will continue to watch. But coming back to your earlier comment about advice, I think AI is going to make us smarter, make us have access to better data and be able to be more efficient. And I think for the smaller, the one to 10, I think it's going to allow them to serve more clients. They'll be able to do things more efficiently across the client base. Perhaps it will allow you to do analysis that you weren't able to do before in terms of projections, pro formas, building a lot of variables into models that might have taken two days to do.

48:09It can do in 10 minutes. So there's a lot of benefit from it. But I am just watching now a robotic food delivery going up the sidewalk. You don't know what it's going to be able to bring five years from now or two years from now is it keeps getting better and we figure out more and more ways to deploy it. And there are more effective apps that are taking all of our cumulative knowledge and making it available at our fingertips. So I think there are going to be ways that will surprise us all. Certainly nobody would have anticipated that we'd be using Airbnbs and getting rides from Uber before we had mobile communications.

48:48So I think we'll have to still figure out what other ways it's going to impact us. but I think you've got to be on top of it, and it's going to certainly change what we do. You want to be writing that way of not getting crushed by it. And going back to the question I asked you earlier about IQ and EQ, so it may help you with the IQ side, but the EQ still needs a lot of work. Yeah, unless it becomes your therapist, and then maybe it can help you, but that's a different aspect. Well, you've been involved in leadership for almost 40 years. How would you describe your leadership style? I'd once had a professor from UCLA come in to talk to people about leadership.

49:30The thing I remember most that he said is, if you don't know your leadership style, you don't have one. I don't think a lot about it, but just watching what I do and something that was clear to me early is that for me, leadership is being of service. I think in the early years, you think about being a leader as a big ego thing, that you're an important person and you have an important role. And that to be a good leader, you're a person who is facilitating others to do their jobs well. In sports, I was always the guy that I was an offensive lineman in high school. So I was opening the holes for the guys that got the glory.

50:09And in rugby, I would get the ball out of the scrum and get it to the back so they can go score. And I think that's probably how my leadership is shaped, is that my job is to facilitate, to make sure that everybody has the skills they need, the tools they need, the resources they need to be successful. and then to hopefully set a good example. When I was running the office at Goldman, my goal was to have all of the newer advisors come out and do meetings with me and that for the first few weeks, they would learn from what I did and then they would do it themselves and then they would get even better than I ever was.

50:49I try to lead by example and be of service and to get my satisfaction out of the success of the people that I've been entrusted to lead so that my celebration is their success, not my success. You've consistently identified and hired exceptional talent throughout your career. What do you look for when evaluating potential partners or employees? So it's been some of the most fun I've had. is I was talking just a minute ago about the celebration I get out of seeing people successful. So what's interesting is that the people I've hired over the years, it's a pretty eclectic group in terms of what their backgrounds have been.

51:35I had hired a zoologist and a PhD in chemistry, also a lot of MBAs. But the things that I think were most compelling to me were, number one, is character, who they are, how they live their lives. I mentioned integrity was at the heart of being a successful advisor. So character is probably number one. Drive, number two. Talking about continuums, there are some people who are very happy just not doing that much and having, being satisfied that their lives are fulfilling without pushing that hard because pushing takes work and they'd rather focus that energy somewhere else. And I've looked for the people who really desire to excel and thrive and accomplish a lot and that also have some insight about why that matters to them.

52:24I tend to ask a lot of questions about what are the motivations, not just what are you doing, but why are you doing it, the why questions. So I want to really understand what drives people. And I'm looking for people who feel compelled to do the best they can, that it matters to them, that that's where their satisfaction and purpose is, is contributing as much as they possibly can. And in this case, it means building a big business or a successful business. So character, drive, they have to be somebody that has a personality that you enjoy being with. One of my colleagues over the years described that it needs to be somebody that you could be in a snowstorm and think it was hitting Minnesota for three days and you'd be okay.

53:08just the two of you sitting through the snowstorm. If they're not likable, then our clients aren't going to find them very likable either. Now, there's a wide range of it. It's not somebody that necessarily has to fit my definition of what a likable person is, but across a group, they have to be likable by enough people that either you're going to want to work side by side with them and be clients are going to like them. And three, I think, or four, maybe now we're up to, they have to have demonstrated enough commitment and stick-to-itiveness to get through the hard times and get to good outcomes.

53:43It's a very daunting process to build a business from scratch or to learn this business from scratch. And if you are easily deterred, you're not going to get to the place of success. People, by the time we meet them, have to have shown that somewhere in their lives, whether that is in their sport or in their instrument or in their poetry or in their military service and rank they got to. There's lots of evidence of people's commitment to get to a good outcome. That's, I think, a vital aspect of it as well. And then enough intelligence, but again, and not EQ, but those are kind of the starters.

54:23Everything else has to be there for, in my view, somebody to be destined to success in this business. Is there a leadership insight that you feel is counterintuitive or not widely appreciated that you'd like to share? Well, I talked about leadership as service. I'm not sure that that's how everybody thinks about it. My mentor, Rich Atlas, had said to me, there's two ways to lead. One is because of the chair you're in, the role you have been put in, and the other is through earning it, through people wanting to follow you because they believe that you have value that will help them in their careers or on their path.

55:04So for me, it was much more that second part that you had to earn the privilege to lead through how you've conducted yourself and whatever success you've achieved and what you can bring to help others. You have to earn it and keep it. Yeah. And it's easy to get distorted when you're given power or taken power or however you got there. And it's really important not to let it distort you, to maintain your humility. 44 years into the business, as we talked about earlier, we're still learning. I find young people all the time that can teach me something that I didn't know. So just staying humble and staying within yourself of doing the things that you know and not stepping outside of.

55:51It's important, by the way, to step out of your comfort zone. I don't mean never to push yourself. Because the first meeting I had when I was named the office manager in LA, I stood up in front of the group and I had a holy shit moment. What am I going to do now? Anything in life that is growing and expanding, you should be a little uncomfortable. But if you're just always in your comfort zone, then you're not taking enough challenges in your life and your career. But you got to know what amount you can reach to and do it responsibly. You don't want to put yourself in a position where you're going to harm yourself or others because you were unrealistic about what you really were capable of doing.

56:32So there's a balance between those two things. I want to close our conversation by asking a few questions about investing, which you've been doing for several decades. How would you articulate your overall investment philosophy? So you talked about patience. And so one of the things that I think is important in investment philosophy is that you want to, for me, I develop strategies that work over time. So I'm not looking to do short term trading. I'm not looking to get excited about the rate of returns over a quarter or two. so everything is based on taking a long amount of time and then behind that is diversification is the key to protecting wealth our clients largely got to where they are because of concentration that if you want to create wealth you got to be highly concentrated and put a tremendous amount of effort and have some good luck as well as good judgment to get to good outcomes but once you've achieved that, then diversification is the key to preserving wealth.

57:35So that's at the heart of, well, I think long-term investment strategies is good amount of diversification. I believe in balance between liquidity and lack of liquidity. You can get higher returns by less liquid investments, but if you get out of balance, you are not going to be in position to be able to have flexibility to make adjustments over time. So you have to have a certain amount of flexibility in the portfolio. And I do believe that smart people doing disciplined things can generate better results in some categories, not in all categories, but in some categories. So I believe that there is a return on investment in finding very smart, very disciplined, very experienced people who can generate alpha over time through continuing to do what they've done in the past.

58:27And then where there's not a sufficient opportunity to generate alpha, then I think keep costs down and use the most efficient tax efficient and cost efficient tools. So there's a role for ETFs in that as well. And I do believe that investing benefits from the rising tide, that over time productivity and population growth lead to positive returns. And that if you can be patient and thoughtful about how you invest that I've often described it as you are the casino as opposed to you're in the casino. The longer time you have, the more certain you are that you're going to make money. Looking ahead, what major investment themes or forces do you expect to shape the next decade?

59:12We talked about AI earlier, so clearly AI is going to be a huge factor in winners and losers. We've had clients recently who've asked us to look at what industries are most vulnerable to be disrupted by AI and what are the most opportune to benefit from it. So there's going to be a lot that plays out over the next 10 years with that. From a geopolitical point of view, there's been major change in the last few years. It has probably accelerated in the last six months in terms of realignment in the world of trading partners and friends and foes. I think there's going to be a lot of that that continues to play out over the next decade, and that will have implications on a very grand scale.

59:59I think the amount of debt in the world is going to have implications over the next 10 years. Clearly, U.S. debt is growing and may become a problem. Doesn't necessarily impact near-term investments. These long-term problems don't tend to get discounted in financial markets in the near term, but eventually we get to the long term. And so at some point it does become a problem. And it's always possible that things that need to change, change in order to make it not be the problem that it could be as we're heading down a path. So you want to leave room for that. But I think there are going to be some big challenges with the amount of debt in the hands of governments, particularly in the U.S.

1:00:45as we've been growing our debt much more rapidly. Those are some of the big themes that I see over the next decade. How do you personally stay sharp and adapt your thinking and avoid complacency? So I've talked a lot about staying humble. So part of it is just recognizing that we don't know all that we need to know. I have a natural curiosity and want to learn. So I think holding on to that curiosity and making sure that you're learning something new all the time, trying new things. It's easy to get stuck in certain patterns. My partner, Andrew, used to talk about his father-in-law, who as he was aging would take different paths purposefully each day while getting to wherever he needed to go.

1:01:28I drive the same route every day to and from the office. Sometimes just changing up little things makes a difference. I had had the same workout for about 20 years. I did the same series of exercises, which I know is not the best for us. And I've just recently made a change so that I'm going to now throw in different things each time. Being willing to change things up, sometimes intentionally, I think is important to stay sharp. Also, frankly, being surrounded by younger people. I learn a lot from the youngest folks in the office and from my kids. And being open to learning that way, I think, is very important.

1:02:08It's an attitude of being willing to keep your mind open and your curiosity high and stay humble. Well, Daryl, this has been great. I appreciate you sharing all your insights, all your experience with me and our audience. Thank you. Thank you, Alex. It's a pleasure to talk with you. We work together day by day. We don't often get this kind of quality time just to sit down and explore things together. And you've asked some great questions that made me think deeply about things that I haven't often thought about. So I appreciate that. Thank you. Thanks for listening. We hope you enjoyed this episode.

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