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Reflecting on the history of our family office, our investing philosophy mirrors how previous generations built their wealth through farming. They patiently waited to harvest the crops they planted; we buy securities and patiently wait for them to appreciate.
Two decades ago, my family paid the Secretary of State of Nevada the necessary fee for establishing a corporation. That was the legal beginning of our family office. The initial capitalization was large enough for the class C corporation to stand on its own as an entity, but the size of its investment portfolio was, even by the much smaller standards of those days, a relatively meager pile of cash and securities. Its immediate value was that it provided a layer of insulation to protect our minor child’s assets from the liability risks of what her parents did for a living. Then, as now, there were rules that extended lawyers’ fiduciary responsibilities and legal liabilities far beyond the scope of their law practices and into their private finances.
What began as little more than an incorporated wallet is now a family office with six members from three successive generations: two of us in our 70s, two in their mid-30s, and two young children. The largest part of recent funding has come from the middle generation. Beginning in 2014, one of its members began receiving the publicly traded shares of his employer as incentive compensation. The older co-workers in the technology company, who had been receiving incentive stock since the late 1990s, offered their younger colleague the benefit of their experience. (As Oscar Wilde remarked, “experience is what other people call our mistakes.”)
Having watched the dot-com crash crush and then flatten the price curve of the company’s shares, the employees had profited by regularly selling their incentive shares as soon as the legal restrictions on sales expired and using the proceeds to buy ETFs and other diversified mutual funds. The new employee was advised to do the same; but, with the encouragement of the other members of the family office, he chose instead to accumulate the incentive compensation shares and to add to them the shares he could buy at a discount from market under the employer’s stock purchase plan. Last year, the member chose to take some of Bernard Baruch’s advice. (When asked how he had made his fortune, Baruch is said to have replied, “I sold too soon.”) The member of the middle generation chose to avoid the increase in the federal long-term capital gains tax rate from 20% to 23.8% by selling a portion of his shares and adding the cash to the family office’s capital.
Many family offices’ portfolios have taken a path like ours. Capital has been accumulated by steady saving and by the good fortune of windfalls, both in private business and in the securities markets. Where we find ourselves being outside the norm is in our investment decision-making. We have chosen not to use the great innovation of the modern financial system – index investing. We do not invest in ETFs or other securities that index the overall market; we only invest in individual companies’ equity securities. In buying but rarely selling individual common stocks, we have also chosen to ignore the considerable advantages offered to traders by digital pricing and the absence of brokerage commissions.
As several members have joked, our family office conducts its business as if the use of the telegram was as far as we had gone towards technological innovation.
Our oldest members know first-hand the extraordinary changes have occurred in finance during their lifetimes. The grandmother remembers how, as a teenager wearing a miniskirt, her summer job was to chalk the changes in the Dow share quotations on green slate board at the offices of Harris Upham; she had stocks A-K, and her friend did L-Z. I have earned the title of “the delegate from the history channel” by torturing my fellow members with explanations about how things once were. Did the other members know that for well over a century, stock quotations used the same fractional monetary arithmetic that had begun with people using knives and shears to turn parts of Mexican silver dollars into pieces of eight? All of us fully appreciate, the innovations that allow the smallest retail trades to be priced to the fourth decimal and enable orders to be executed and reported faster than our fingers can use keyboards and mouse buttons to enter the next transaction.
But we now think that the family office should view each order for the purchase of common stock as a commitment to buy and hold those shares for a generation or longer. Imagine, Warren Buffett told a lecture hall of business school students, that your investment decisions were rationed. For your entire lifetime, you could only make as many investments as the number of spaces you had on a single card. Every time you made an investment decision, you had to use one of those spaces by punching a hole in the card. Buffett’s punch-card simile has become the fundamental rule for our investments.
In taking to heart the advice about owning a single paper ticket, we are not choosing to follow Berkshire Hathaway’s practices. The excellence of Mr. Buffett’s historical performance as an investment manager is indisputable; but we share the disappointment that others have expressed about Berkshire Hathaway’s refusal to distribute cash to shareholders through dividends. That policy cheats smaller Berkshire Hathaway shareholders of the opportunity to receive income from their investments at a preferential tax rate. What has led us to adopt the practice that less trading is more valuable and the least possible trading is the best of all is our study of the history of our members’ Midwestern family farms. In buying land, animals, and equipment, the families in Illinois, Indiana and Ohio followed the Buffett rule. They did not trade land, and they rarely used mortgages. They would lease land from neighbors and arrange for profit sharing and earn outs; they would not use leverage. As their farms grew, they would be able to borrow working capital; but they would regularly reduce that debt to zero. Their basic rule was, wherever possible, to pay cash. The only times that the families would sell was when there was no longer enough members of a new generation to work all the land that was owned.
The farmers had no confidence that they could predict the markets for their crops. They put their effort into their appraisals of the quality of the assets they held and were considering for purchase. Their decisions about how much to plant, how much to fertilize, how much equipment to buy were based on what the cash and futures markets told them they could expect to earn from an average harvest. They do not seem to have spent any time at all trying to decide whether times were “good” or “bad”. Instead, they focused on having what, in financial investment terms, would be called a “balanced portfolio.” Owning both prime and mediocre land gave them a hedge. If selling prices relative to operating costs were high, they would bring more poor-quality land into production; if margins were low, those fields would be left fallow – which would improve their quality for the next harvest.
In buying common stocks, our family office makes similar judgments. We make no effort to assess whether a company’s stock or the market as a whole is “cheap” or “expensive”; for that reason, price to earnings, revenues and book values have no part in our appraisals. We rely instead on our expectations about a companies’ probable growth; and those assume that sound businesses, like well-surveyed acreage, do not often dramatically change in the quality of their yields. Most of the time, the past can be expected to be a reasonable estimation of the future. Land whose cost is reasonable for its quality will have yields that fluctuate based on prices, weather and cost; but there will be very few, if any, years when the returns are so meager that there was no profit at all to be found in planting and harvesting. The challenge is to find those situations where price and value have diverged because the market is heavily discounting what growth will be. Those are, in our view, the opportunities that best allow us to continue building the family office farm.
Stefan Jovanovich manages the portfolio for The NJT Company, Inc., a family office based in Nevada.
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