matthew_illian 2015
Matthew Illian CFP®, adviser to the purpose driven investor.


Since 2003, I’ve lived my life in two worlds. Years ago, my wife and I committed with close friends to move into the inner-city of Richmond, Virginia in a faith inspired effort to seek the common good for our community. In this time, we have imperfectly attempted to invest in the community and support those leaders who aspire to be part of the flourishing of the entire city.  At the same time, I’ve worked in what I now look back on as an emotionally unsettled career as an investment advisor for high net worth families and institutions.

It has taken me many years to identify that my vocational angst lies not at the edges of the complex global financial system but with its central assumptions. These central assumptions require that I ignore many of the first principles that my family, my community and every responsible citizen I’ve met value most.

I now reject the popularly and academically accepted definition of the optimal portfolio. Traditional financial management has constructed many theories using overly simplistic formulas which when added together are supposed to generate the optimal portfolio. This optimal portfolio suggests that there is an efficient frontier where a risky or conservative investor can maximize their returns. In the process, the most basic personal values get overlooked.

With three young boys, my challenge it to model for them the behaviors and beliefs that lead to maturity and there is no better place to work at this than on the soccer field. Winning is fun.  I don’t need to teach them this. But as I consider all of the best coaches in history, they taught playing honorably as a first principle. I need to coach myself as much as them to avoid getting too caught up in the outcome that I overlook the process.
In the field of finance, the desire to win never goes away but the game gets much more complex and stretches as far as the international markets allow. On this field, profit seeking is forever running into ethical questions about environmental preservation, human dignity and property rights. On this field, first principles become even more important. A better definition of the optimal portfolio begins with a framework of first principles.

If it were not for a return to first principles in the world of high finance, A Christmas Carol would be one of the most depressing stories of all time. And there would be no angel to save George Bailey in It’s A Wonderful Life.  And the O’Jays “Money, Money, Money” tune would lack all of it’s riveting soul. Culturally, deep within, we know that first principles are essential but they can also be easily ignored.

Ignoring these first principles not only distorts our definition of the optimal portfolio, it also perpetuates derivative concepts that have won the day in the capital markets. The most powerful child of modern portfolio theory is the now fully developed juggernaut that we know as passive (index) investing. This movement has stressed the importance of low costs and attention to broad diversification over individual stock selection. Passive investing strategies flourished by accurately noting that most highly paid active managers fail to beat an index fund that holds every stock in the target universe (e.g. S&P 500). Burton Malkiel[1] preferred the punchy metaphor of monkeys throwing darts who regularly outperformed the expensively clothed professionals.

While the movement helped investors shed unnecessary fees, it also enabled them to believe that it is possible to make money without any oversight at all. “Set it, and forget it” became standard advice. In the process, all of the responsibilities of ownership lost their meaning. If you don’t believe me, try attending a typical shareholder meeting where turnout is often just a handful of investors[2]. The very structure that was created to offer shareholders the opportunity to engage with executives is now little more than a compliance annoyance. When you consider that only 30%[3] of shares owned by retail investors get voted, you see that similar disinterest in yet another fundamental right of ownership. Concern over these trends have been noted for years but the focus on the return of an optimal portfolio leaves little energy to address these issues of responsible ownership.

The emphasis on passive investing also led to investors to believe there are no limits to the benefits of diversification. Most recommended investment strategies push investors to own virtually every public company in the global economy. The end result is absurd diversification and a disengaged investor.

In some cases, these companies are operating in ways that directly conflict with personal and societal values. As one personal example of the many I could cite, my own portfolio owned a oil & gas company with a terrible track record of spills and controversial exploration practices. Without basic oversight, companies have come to believe they have our de facto blessing to maximize returns by any legal means necessary – no matter the externalities born by other parties.

At this point in my story I think it’s worth sharing that I count Jack Bogle, the man largely considered to be the great prophet of this passive investing movement, as a personal hero. While the passive investing tsunami is fostering all kinds of irresponsible investing behavior, I believe this movement was necessary to break through to a new investor consciousness. Thomas Jefferson argued that revolutions are necessary every few decades to preserve liberty by breaking the up the establishment. Before Jack Bogle, most investors had little option other than to entrust their life savings to overconfident and overpaid money managers. The passive investing movement ushered in a creative disruption that upended the traditional investing power structures. Now it’s time to tame the dragon.

Finally, it’s time to reject the traditionally held view that a fiduciary standard is the highest form of service that the financial management industry has to offer. The fiduciary standard (which includes both a duty of loyalty and a duty of care) is a legal standard focused on financial interests. Legal standards are essential in that they ensure that our most basic rights are protected but at their best, they are also limited.

Applying fiduciary service should represent the bare minimum expectation in the financial planning profession. Fiduciary service simply ensures that a financial advisor’s recommendations are legally defensible. But I also don’t want to suggest that the step beyond fiduciary service is an easy one. Moving beyond fiduciary is a move into a universe of goals and aspirations more focused on the complexities of human and social capital than the clarity of financial capital. Moving beyond fiduciary allows investment managers to begin customizing investment advice to reflect the values and first principles of their clients. Moving beyond fiduciary recognizes that investors can get to the end of their life with only a limited balance sheet remaining and yet still have died wealthy.

Just like children on the soccer field who are watching their parents’ reactions to the events on the field, future generations will observe how this generation invested their wealth. If we say that we value a society based on first principles, the proof will be in our actions. Perhaps, no action will be more telling than the way we steward our personal finances.

It is time to end the passive bystander routine and begin a process of alignment between our principles and our portfolios in earnest. It’s time to figure out how we reclaim our first principles as we pursue the optimal portfolio. And it’s time to start looking for investment advisors who are willing to offer advice the moves beyond fiduciary.

1. Author of A Random Walk Down Wall Street and a leading proponent of the efficient-market hypothesis who teaches economics at Princeton University.
2. Berkshire Hathaway meeting excluded
3. SEC Proxy Voting Roundtable transcript

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