a16z Wealth Manager: Embrace a 40% market pullback, and don't invest 80% of your "first pot of gold" in friends' startups

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Source: Sourcery Podcast

Edited by: Felix, PANews

Perennial, a multi-family office under a16z (which specializes in providing investment services for entrepreneurs, leaders, institutions, and others in the a16z ecosystem), Michel Del Buono, Chief Investment Officer, recently shared on the Sourcery Podcast insights into how top Silicon Valley founders and investors manage their “first bucket of funding,” and how they prepare for potential major events like a SpaceX IPO. PANews has compiled highlights from parts of the conversation.

Host: You’re the Chief Investment Officer of a16z Perennial. Is this Marc and Ben’s family office—their family office—or a multi-family office?

Michel: Perennial is, in essence, a multi-family office. We serve entrepreneurs or investors who have already established relationships with Perennial. They don’t necessarily all receive investments from our firm, but in practice many of them are backed by a16z.

Host: What does Perennial’s structure look like?

Michel: The reason we built Perennial (about four years ago) was reflection on the current state of the wealth management industry. Partners like Marc and Ben used to receive services from traditional wealth management firms as well. They saw that a16z’s LPs—such as large sovereign wealth funds and large pension funds—have very high-end and professional investment teams, but for personal wealth management services, especially in terms of the quality of investment advice and investment acumen, the results were disappointing. This isn’t about overall service—it’s specifically about investments.

Another reason for building Perennial was to create a community around a16z, because community is at the core of a16z. This helps founders on another dimension of their personal lives: if you can take the burden off their shoulders, they can focus more on the business. This makes our relationship with founders much more long-term. Typically, you start building the relationship in their startup phase, and after they get their “first bucket of funding,” there won’t be an artificial endpoint. You can keep helping them plan for life after the “first bucket of funding” event—for example, charitable endeavors, asset management, wealth transfer, and so on.

Host: I’d like to learn more about Perennial’s strategy and structure, but before that, it would be great to discuss the current state of wealth management in more depth. What is the biggest problem today? What structural issues have you seen in how wealth is managed?

Michel: If you’re a wealthy individual, there are basically two ways to manage wealth: one is through traditional RIAs (registered investment advisers) or wealth management channels; the other is through traditional asset management firms, such as hedge funds, PE (private equity) firms, and so on. Of course, when an individual has institutional-level wealth and needs to pay taxes, both routes have their own problems.

First, most traditional wealth management firms are spun out of banks, and banks don’t train their employees to become professional investors. The training they receive is to become fast-responding, service-oriented providers who are eager to help. As a wealth manager, your return depends on how much your business grows. So in essence, you were never trained to be an investment expert. That’s why when you spin out and build your own large independent company, investing still isn’t the main focus. So I categorize these products or services largely as retail products—though when it comes to investing, they put on the very high-end “service” exterior. And of course there are all kinds of auxiliary services around it too, like housekeepers, finding people to walk dogs, nannies, and things like that. But overall, it just doesn’t reach the level that someone with an institutional-grade balance sheet deserves.

In addition, the fee structure is misaligned. Most firms rely on “fixed fees” (no matter what you do, you pay this much). Human nature leads you to choose the easy path if the pay is the same for doing simple things as for doing difficult ones. We see many investment portfolios that are extremely simple—focused almost entirely on standard-market stocks and bonds, with little to no attention on alternative investments. To provide alternatives, you have to hire highly compensated, ambitious professional investors, and it’s hard for them to fit into an organization that isn’t centered on investing. So this uniform fixed-fee arrangement leads them not to want to spend the effort building an alternative-investment team, because buying stocks and bonds is easier.

The other route is traditional institutional asset management companies. Their biggest clients are tax-exempt organizations (pensions, endowments, sovereign wealth funds, etc.). Since they don’t pay taxes, institutions don’t care about tax issues at all. But in California, individuals may need to pay more than 50% in taxes. For individuals, the easiest kind of “Alpha” (excess returns) is “tax Alpha.” However, these institutions are even prohibited—under their fiduciary responsibilities—from optimizing after-tax returns, because the vast majority of their clients only care about pre-tax returns. So structurally, they can’t serve individuals.

That’s how you end up in an awkward “no-man’s-land”: those taxable individuals who should receive institutional-level asset allocation can’t be satisfied by either of these two standard channels.

Host: The person who helped bring us together, Dave, wants to hear what you’ve observed across different wealth generations. From industrial wealth accumulated over long cycles, to what a16z is good at today: creating billionaires extremely quickly through AI and innovation cycles. With these changes, what has changed in wealth management?

Michel: There are clear differences in how wealth is managed across different wealth generations. When I meet a family, I can even guess which region they come from. Industrial waves—back in the older industrial zones (the Midwest and the middle of the country). If I meet a Chicago family, they usually sold their company one or two generations ago. Their family “business” today is managing the family assets. So they are very fluent in every term and asset class, and they focus on performance.

But once you’re on the West Coast, you’re dealing with the person who just created the wealth. They are very business-minded, but they don’t treat wealth management as a full-time job the way multi-generation families do research. They typically have two choices: create a single family office (which is very difficult), or join a multi-family office. When they join a multi-family office, they face many questions that, in my view, aren’t easy to answer: Why am I paying? What am I getting? What do I want? Because they may not fully understand the industry, they retreat to things they can understand. For example: how fast does someone respond to my emails? How much help can they provide when I’m in trouble? These are important, but they aren’t the only things. Evaluating investment performance is also critical. Over a lifetime, even an additional few hundred basis points can mean a difference of hundreds of millions of dollars—and that money could be used for charity or other things. But this is often ignored in the communication.

Host: I remember you mentioning that there are big differences between other wealth management firms that attract you through all kinds of client service, causing you to ignore how the investment portfolio actually performs. What do you see there?

Michel: This comes back to that fixed-fee arrangement based on AUM. If I’m selling you a bundle of services, why should you charge me based on my total assets? Imagine you go to get your car fixed, and the mechanic runs out and says, “To fix this car, I’ll charge you 10 basis points on your balance sheet.” We would all find that bizarre, right? It should be hourly. But for them, charging based on AUM is clearly more profitable than charging based on services. They treat investment management as a cost center—basically going through the motions—and the focus is on services. That’s why these investment portfolios are often very simple. Building a VC portfolio takes 10 years to see results, and many firms don’t have that patience. If you don’t build an internal professional investment team, you can only invest in other people’s funds, turning it into a fund-of-funds (FOF) model, which leads to double fees. That’s a huge drag on clients. If we hire professional investors who are paid purely based on investment performance, then we can underwrite or invest directly ourselves, saving those large implicit fees. Even saving half can mean a few hundred basis points of Alpha. So I think the right structure matters enormously.

Host: Family offices are really popular now. But you said a single family office is hard to do—why should people avoid creating a family office as the first step?

Michel: Having your own family office sounds cool, but you need to think clearly about your goals. If all you want is someone to help you with financial statements, you can call it a family office. But if you want to build a global multi-asset-class investment portfolio, you at least need to hire 5 to 7 professional investors across different fields (fixed income, public equities, venture capital, private equity, real estate, and so on). If your balance sheet isn’t at the level of several hundred million to billions, the salaries you pay those teams will eat up all of your returns.

Another challenge is retaining talent. These professionals are ambitious, and the family office head is, in practice, registering to act as a manager of an asset management company. Many founders actually don’t want to hold meetings every week to manage that team. So it’s hard to retain talent in a vacuum. In addition, many people set up a single family office to consolidate the family, but statistics show that when the family elder passes away, family offices often fall apart: assets are rushed to be liquidated (sometimes we are exactly the buyer picking up the deal), or the heirs take the money and go their separate ways. So single family offices face multiple challenges.

Host: At what level of wealth should people consider shifting toward a wealth management direction rather than a family office?

Michel: For wealth management firms that provide substantial investment expertise (like Perennial), the minimum threshold is roughly $25 million to $50 million. But in reality, it’s more suitable for clients who have hundreds of millions or even a billion dollars, and who have a time horizon that spans multiple generations. So they’re more like endowments than simply individuals.

Host: How many families do you serve right now?

Michel: At the moment, we intentionally stay small. There are only a few dozen families we work with on a full-spectrum basis, because we want high customization. Many companies in the industry operate according to “templates.” They categorize you based on your risk tolerance and liquidity, then apply standard procedures. We don’t do that. We believe everyone we work with has intergenerational wealth, so they should have tailored asset allocation and investment projects. We’ve done a lot of work around concentrated holdings for them, and we built a dedicated team for that.

Host: Is this the main difference between Perennial and companies like Iconiq that are Silicon Valley–oriented?

Michel: I think most other Silicon Valley–oriented companies try to offer a full-stack product that covers everything. But at a certain revenue level, what you can build internally is limited, so many of these firms don’t even have professional investors. I often ask people: guess how many professional investors a certain investment advisory firm has? People might guess 20%, 30%, but in reality it’s often zero, one, or two. That’s our big difference from them.

Host: Next, there will be a lot of large-scale wealth creation events. Rumor has it that SpaceX is about to have a $2 trillion IPO. What’s your take on this? How do you prepare for liquidity events like this for early employees and founders?

Michel: If it happens, this would be the biggest IPO in history. Testing whether the market can absorb it will be a very interesting challenge. In terms of preparation, before the IPO, it’s very important to structure the tax, estate, and trust architecture reasonably. After the IPO, the key is how to gradually diversify the investments. I won’t claim I know the company better than someone who’s worked at SpaceX for 20 years. I also wouldn’t advise them to immediately sell 100% of their stock to buy stocks and bonds. Part of the strategy is diversification; another part is long-term holding and thinking about how to profit from the volatility of the stock (for example, the options strategies we’ve built), without needing to sell the stock.

Host: This is really interesting. I’ve talked with a few people in Los Angeles about this IPO. I spoke with Shawn Maguire at Sequoia Capital—they’ve invested tens of billions into SpaceX and Musk’s companies. I’ve also spoken with engineers and with people who used to work at SpaceX. What I found is that not only are there too few wealth managers, there are even fewer wealth managers with professional family-office expertise for families like these—there’s a service vacuum. I know SpaceX isn’t just in Los Angeles; it’s also in Texas, and there are certainly differences between the two. What do you think about that? Who should they look for?

Michel: Because many engineers and other professionals there aren’t in this wealth management circle. They lack the ability to evaluate the various options, so the result is that they often end up going to places I think they shouldn’t. Their challenge is: even if this isn’t your area of interest, please invest enough time to understand the field.

I always advise people to look at the background of the people they’re hiring—their education and work history. If they’ve never actually done professional investing work, don’t expect that company to provide you with professional investment advice. I think spending time doing real industry homework is an extremely important first step people always say they got a recommendation from someone they know: “Oh, my friend uses someone—he’s a nice guy—so I’ll pick him.” I like to use a medical analogy, because it highlights how absurd this decision process can be. Suppose you have a serious cancer and you need major surgery. Would you ask your neighbor, “Hey, do you know a good neurosurgeon?” Of course not. You’d read hospital reports to find which surgeons have performed this surgery the most. It’s the same here. Your wealth is the hard-earned result of your life’s work. This is absolutely not trivial—it’s an extremely important matter. So please invest time to understand what you’re buying. I’m often on the receiving end of the outcome: I see people go somewhere, and then they come to us and say, “I don’t like that service.” When you ask, “Why did you choose them in the first place?” The answer is almost always, “Because my neighbor, my friend, or my colleague recommended it.”

Host: How easy or difficult is it to switch to another wealth management firm?

Michel: It’s extremely difficult. The industry is designed to “trap” you. They have all your accounting numbers, wire transfer instructions, trust trustee information, and so on. Even with large custodians, if you’re an individual client, you can complete many tasks yourself. But once you move onto an RIA platform, those self-service functions get disabled, locking you into their ecosystem. That’s why the industry is so fiercely competitive for clients who have “just obtained liquidity.” Once you’ve chosen someone, the probability that the client switches again is very low.

Host: When you’re actually working together, what products do you show them? Do you guide them into investing in art? For these typical portfolios, how do you set them up initially? You said it’s a step-by-step process, but how do you balance the different kinds of services?

Michel: In any long-term partnership, asset allocation is a step-by-step process. We’re very transparent with clients and tell them they don’t need to put all their assets with us (because the industry mostly requires you to hand everything over). We tend to work with people in a more linear way. We acknowledge that their portfolio will change over time. So we don’t ask clients to exit a position entirely on day one. We provide forecasting tools.

Yes, odd, unusual alternative assets can be included too. For example, some clients are interested in art. I’m not an expert, but I know experts who can help. More importantly, we provide advice. Many firms only list options for you to choose yourself, because they’re afraid of taking responsibility. We are clear: if you’re going to invest a lot in art, you need to use other assets to balance the entire portfolio. Going back to that medical analogy, you want the doctor to tell you clearly, “You need surgery—herbal tea won’t help,” rather than leaving you to decide between surgery and herbal tea yourself. We’re proud of that.

Host: What’s your view on today’s market volatility (AI, geopolitics, war, and so on)? How do you help clients get through it?

Michel: My favorite line is, “Volatility isn’t the enemy.” Many people fear volatility, but if your balance sheet is deep enough and you keep a certain level of liquidity, volatility becomes a huge opportunity. The stock market experiences a 40% drawdown about once every four or five years—that’s like a “crash sale.” You should stay flexible. When the advisor calls and says, “Now it’s 60% off—time to send the truck to stock up,” go grab the opportunity.

Host: How much do you like to allocate to cash, real estate, and those areas?

Michel: Real estate is a very cool asset class for taxable individuals. It has low correlation (if you have a lot of technology stock risk). Many wealthy people in the U.S. (including a certain president) built their fortunes through real estate. Because when tax laws were written in the last century—especially in the 1920s and 1930s—there were only tangible assets, tax laws were extremely favorable for tangible assets (you could get steady returns via depreciation deductions). If you can tolerate poor liquidity, then your portfolio should hold a lot of real estate.

As for cash or extremely liquid bonds, people don’t like the 3–4% returns. But I tell them: you don’t hold bonds for that 3–4%. You hold them for flexibility—to be able to turn cash into other assets at any time—and for the value of options. During the global financial crisis, the only thing that could be readily liquidated was U.S. Treasuries. Treasuries are a safe-haven asset, and when there’s war or a crisis, their price can even be higher. You hold that cash, then you go buy distressed assets.

Host: What’s the most important lesson you’ve learned from Marc and Ben?

Michel: It’s about how to build a team. When they first arrived, they told me, “We don’t hire people because they don’t have flaws. We hire people because of the skills they have.” I used to work at a large management consulting firm, where performance evaluations were all about discussing how to correct my weaknesses, and never even mentioning the places where I did well. That’s very frustrating. Here, it’s completely the opposite. If you’re good at something, we celebrate it. We’re all human—we all have flaws—but we can learn to live with those flaws. The result is that the people in every functional department I encounter here are extremely strong. The talent pipeline here is astonishing.

Host: What is the biggest mistake people commonly make when it comes to wealth?

Michel: For startup founders, because they grew up in the venture capital world. When they get that incredibly valuable “first bucket of funding,” they don’t just set aside a bit of cash for contingencies—they turn around and invest that money into a batch of very early-stage startups recommended by friends. Listen, if you want to do venture capital, you need to systematize it. Don’t throw 80% of the cash you just received to your three friends. It almost always ends in tragedy. Because they themselves are success stories biased by survivorship, they find it hard to see the industry’s overall statistical reality. They always think that if you bet on three, surely something will work out—but usually none of them does. The biggest mistake I see is reinvesting your hard-earned liquidity back into highly uncertain, low-liquidity things.

Host: Has the IPO window opened? Who will go public first—SpaceX or OpenAI?

Michel: I think SpaceX will go public first. OpenAI and Anthropic are in a fierce competition right now. Currently, companies can still raise huge amounts in the private market (for example, OpenAI and major VC funds). As long as they can still pull in money at the $10 billion scale in private markets, the pressure to IPO isn’t that high. Ironically, when the economy slows down and private capital becomes less readily available, they may end up being forced to IPO.

Further Reading: In conversation with a16z cofounder Marc Andreessen: Founders are best not to introspect; when humans face new things, they’re always accompanied by panic.