31 May, 2019

Capital Allocation – but where? A response to Millionaire Mentor @davidharrison

If you want to become a millionaire your most important job is allocating capital. The worst thing you can do is have your capital in things that earn no return or in bank accounts. Invest your money in risk adjusted returns of your choice – implying you must understand risk.” Millionaire Mentor (@DavidIHarrison, Twitter Tuesday, 28th May 2019)
The first thing I need to get off my chest is my continued sense of astonishment are the depth and quality of some of the outstanding thinkers and actors from all walks of life active on Twitter and willing to share their reflections, insights, experiences and wisdom on this medium. I have significantly expanded my sources of inspiration and thoughtful places to experience an intelligent debate by finding and following experts on Twitter. Kudos to all of you who make the effort to share and enrich the lives of your followers. One of the experts I follow is the UK based wealth manager David Harrison who goes by the handle Millionaire Mentor (@davidharrison). I have no idea whether he is good or great at his profession but he always posts thought-provoking comments and thinks deeply about his craft and its challenges. The following longer comment is one that I composed to David off-line in response to the Tweet quoted above.
Dear David Harrison,
I enjoyed your recent tweet because it throws up so many questions about the nature of wealth and, of course, its creation. We live in such a financialized economy and society and our concept of success has been so traduced to such simplistic concepts pertaining to money and wealth, through the grotesque inflation and consequent proliferation of both money in its broadest definition and financial assets, that we are forced to deal with cartoons of wealth against which we measure out relative success, with little understanding of where it comes from and skills required to create it. So, on reading your tweet, I was intrigued to know what exactly do you tell people about risk and reward in today’s challenging environment to enable them to make “better” capital allocation decisions. I don’t envy your responsibility one jot – there don’t seem to be many places to hide if you are a saver, even an enterprising one – who is not also practised in business.
I live and work in the midmarket /SME world – the messy world of entrepreneurs, family business owners and other holders of enterprises. I buy businesses in distress or in need of critical restructuring and I also teach business owners a course on finance which I have developed myself over the years to help them learn how to think like investors in their own businesses (so they don‘t end up as potential deals for me). I see the destruction of capital and wealth and the ignorance around the forces of nature that conspire to consume and destroy capital on a daily basis. I believe I have a pretty good understanding of the extraordinary power of value creation in a well-run business and also of the speed with which value can be destroyed. I am well-acquainted with the different forms which wealth can take and how inefficient, cumbersome, dangerous and misleading the path from £1,0 million in theoretical business value to £1,0 million in the bank is.
Whilst you are quite correct to point out that capital needs to be allocated wisely and put to work diligently, the fact is, that in today‘s zero interest rate environment, ludicrous valuations of financial and real-estate assets (a direct cause of the former) along with a sense of return entitlement running through all levels of society that is inversely proportional to the knowledge of where original return (and its commensurate risk) is generated, we have, collectively, rarely been less well-prepared to make those sort of capital allocation choices. In addition, the penalties for getting it wrong are likely to be higher and more deleterious than at any time in the recent past.
My own perspective is that generally, one needs to be as close to the cash-flow spigot as possible and to control its flow before it wends its way through the financialisation pipelines and dribbles out onto the plates of financial consumers. You appeal to owners of capital who wish to become millionaires and I find myself asking who these people might be and what advice you will be giving them.  If you are already a cash millionaire then you better be prepared to wade (back?) into the weeds and identify value-creating business opportunities if you want to put your money to work, otherwise, you are in serious danger of capital erosion, the further away you are from the source. If you are expecting your €100K (or whatever) to become £1,0 million (through investments or savings) then you may have to wait a very long time or work supremely efficiently before you have a cat in hells chance of achieving that goal.
And there is the question of what that £1,0 million will do for you. In the good old days (which I am naively assuming you remember not knowing how old or young you are) a gilt-edged portfolio of £1,0 million could be relied upon to produce a comfortable yield of £50K pre-tax – enough to supplement a reasonable pension/annuity. Today it is worth a fraction of that. That same income would require a capital base of £ 5-7 million which takes you into the top 0,5% of the population, possibly higher if you strip the non-doms out of the statistics. When Marilyn Monroe stated in 1959 “Some Like it Hot” that millionaires need to wear glasses because they ruin their eyes from squinting at all the little numbers in Wall St. Journal, a millionaire’s purchasing and income generation power was 6 – 10 times higher than today, tax rates were lower, and the relationship between various risk assets was intuitive.
So whilst I applaud the sentiment of highlighting the need for attentive and mindful capital allocation, I would love to discuss with you what that actually means for the investor not accustomed, trained or educated in the assumption of real commercial risk – the last place in which capital CAN be allocated with a semblance of favourable risk-reward parameters (as you have pointed out in your subsequent tweet.)
Apologies for the ramble – now you see why I wanted to take this off-line. You are making a really important point and I don‘t want to detract from it one iota, but I believe you should explain what that means and what people should do.
Best wishes,