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Tuesday, 12 December 2017

Trump shoulda been an index investor?

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  • James Saft - June 2014

James Saft on the attractions of active wealth management.

Donald Trump’s possibly market-lagging stewardship of the fortune he inherited illustrates in a bizarre way the attractions of active wealth management.

Property mogul, celebrity and presidential candidate, Trump, by some accounts, not his own, appears to have failed to keep pace with market gains since he began to run his father’s firm in 1974, his share of which had an estimated value of US$40m.

While there is no definitive accounting of his net worth, the outputs from his decision to build up a development organization are clearly more than financial. What he’s definitely garnered instead: a role, fun, influence, and the illusion of control.

Those are four very important components in the active management offering, and help to explain why so many choose to plow money into a business or actively managed mutual or hedge fund even despite comprehensive data indicating, at least when it comes to investing, that they would probably be financially better off with cheap index products.

A look at Trump’s experience shows that fun often, wait for it, trumps boredom, and having an identity or purpose in life is a good with a value. That’s as true for the guy betting on small-cap momentum stocks as it is for a rich man backing a macro hedge fund.

Here’s the thorny part: what Trump is actually worth. There have been numerous estimates, all of which are just that, given the private nature of his companies and holdings. Trump has a long track record of hotly disputing every one as being substantially too low.

The National Review in September did an analysis of his wealth versus the returns he might have earned in an S&P 500 index fund and found evidence Trump might have done better by sitting back and relaxing.

When Fred Trump passed control of the firm in 1974, the share the Donald would ultimately inherit was worth about US$40m. Fred Trump died in 1999.

Put that into index funds and you get US$3bn today. Put the US$200m in wealth Forbes estimated Trump had in 1982 into those same funds and you have US$8bn today.

Trump’s current wealth has been estimated at US$4.1bn by Forbes and US$2.9bn by Bloomberg. Trump himself in July said his wealth exceeds “TEN BILLION DOLLARS” (his capitalization).

Believe whom you like, but what is clear is that there is a substantial possibility that Trump would have been financially better off sipping cocktails at the beach as his money compounded in index funds. You can also argue that the gains from an index fund would have come with less volatility, given the four corporate bankruptcies associated with Trump organizations.

What makes Donald run?

While Trump surely maintains that his wealth has beaten the market, a look at some of the other benefits he’s enjoyed as a result of actively investing on his own behalf shows both the psychology and, perhaps, reality of steering one’s own ship.

Firstly, Trump has made himself famous, building himself a very public role in the process. No matter how much money you put into an index fund they are not going to put your name up on a building, nor is anyone likely to buy the book you write. For someone as given to self-aggrandizement as Trump this is important, but you don’t have to have an insatiable appetite for publicity for this to give a payoff.

Rich people pay over the odds for trophy assets like sports teams and even newspapers for very much the same reason. What is the point of being rich if you don’t get to enjoy it? It is fun, at least for Trump, to run for president, being an influential big shot, and this is a benefit he’d not have had if he had stayed home in Queens depositing dividends.

Most forms of agency investing, from active mutual funds up to the most clubby alternative investments, also play on this desire, working hard to make their investors feel like they are smart, insiders – people whose wealth is easy to explain given their discernment in choosing the Brazil Un-Hedged Leveraged Long/Short Credit Fund.

Some of this falls under the rubric of the illusion of control, our human tendency to overestimate the extent to which we can predict and control what happens. Few things can be more pleasurable, and self-reinforcing, than thinking that you, a person above the common run, have skillfully built a business, picked an asset class or hired a private equity manager.

To be sure, many people take capital and do fabulously by building businesses or hiring agents to manage it actively. And it would be silly to count as valueless the other benefits of having a purpose, being a big shot or thinking you are in control.

Whatever your ideas about the good life, there is more to it, as Trump demonstrates, than simply maximizing returns. 

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

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