Gary Becker, Nobel Laureate, Economic Sciences, 1992; Professor, Economics and Sociology, University of Chicago; FasterCures Board Member

Michael Christ, Managing Director, Asset Consulting Group, Inc.

Robert Gertner, Wallace W. Booth Professor of Economics and Strategy, University of Chicago Graduate School of Business

Peter Lawson-Johnston, II, Managing Partner, Guggenheim Partners

Moderator:

Andrew Rosenfield, Managing Partner, Guggenheim Partners

Summary:

Common sense tells us that consistently higher rates of return will lead to higher total ending value for any investment. The extent of that impact, however, is not always well understood. Andrew Rosenfield opened the discussion by citing the example of Peter Minuet′s purchase of the island of Manhattan 400 years ago for $24. The value of that investment at a compounded rate of return of 8 percent would be $4 trillion today; however, at a 3 percent annual return the current value would be only $1.5 million. When families start to consider wealth management across generations, rates of return become vastly more significant.

Over the last 20 years, investment managers have been able to achieve remarkable rates of return, with a typical 60 percent equity / 40 percent bond fund returning almost 12 percent annually. However, consensus estimates put the predicted next 10-year annual return for a similar portfolio at 6.2 percent. According to Michael Christ, after factoring in fees, taxes and spending, investment managers will have difficulty even achieving this level of return. Plus, the downside risk will be heightened as wrong decisions by managers have greater salience in a lower-return environment. How realistic is this consensus predicted return? Gary Becker noted that historical return on equities has closely approximated the historical after-tax return on capital of roughly 7 percent per year, the same number used in Mr. Christ′s summary of blended return predictions. In other words, the future for investment managers seems to involve more work for lower total returns.

It′s in this context that the value of human capital for investment management is becoming increasingly recognized and rewarded. Some hedge funds seemingly defy the efficient capital markets theory by earning consistently higher rates of return at lower risk than should be possible under the widely accepted capital asset pricing model. According to Mr. Rosenfield, "hedge funds do not define an asset class, but a form of compensation" for the most talented investors. In fact, returns to talent in many industries and functions have been increasing in the last 25 years, as an increasingly knowledge-based economy offers greater premiums for human capital. Mr. Becker, who coined the term "human capital," estimates that 70 percent of all capital in a modern economy is human capital, and the increasing returns to human capital are a reflection of its significance.

The modern economy may have only recently started to offer such outsized returns to talent, but the Guggenheim family has been recognizing and rewarding talent for generations. Peter Lawson-Johnston II offered a succinct summary on his family′s view on the importance of human capital: "If you have an opportunity that you want to succeed in, identify the best person or team for that endeavor and challenge that person or team to reach a higher standard in whatever that endeavor is."

Robert Gertner expanded the conversation to include a discussion of risk, and particularly the investment manager′s inability to perceive his/her client′s desired risk-reward tradeoff. For several reasons, analyzing a client′s desired level of risk is difficult because the frame of reference often colors the decision. People are more likely to employ higher-risk behavior when seeking to avoid losses than when seeking to achieve gains, and in response to subtle cues the investment manager provides regarding desired risk-reward tradeoffs. Investment managers must be careful to look beyond the investment portfolio and truly understand their clients′ goals with respect to risk-reward decisions.

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