Our Conflicts of Interest: We haven’t found any yet

(but if we discover one, we’ll let you know)

Somewhere in the entrails of Washington DC Fiduciary Rule legislation is being born, but we don’t know whether it will see the light of day or not. We believe, however, that it is very important for us to disclose any conflicts of interest we may have, independent of what happens to the Fiduciary Rule.

Mike and Vitaliy are members of CFA Institute, which says, “Fiduciaries owe undivided loyalty to their clients and must place client interests before their own.”

We agree wholeheartedly.

Our industry has problems. We are not always proud of it. We personally know a lot of honest, hardworking people who try hard to do their best for their clients. We have also come across (and read about) industry players who make used car salesmen look like Mother Theresa.

Our industry is complex: You have investment advisers (us), brokers, financial planners, insurance salesmen, broker dealers, hedge funds, mutual funds, funds of funds, investment consultants – it’s a hodge-podge.

To make things worse, the industry provides complicated products. And if that was not enough, compensation, and thus the incentives of some of the participants, are not very clear. Do they invest you in a particular mutual fund because it pays them more than the other one? Was it appropriate for you or just beneficial to their bank account?

So how about us? We don’t believe honesty can be legislated, but full-disclosure of incentives (i.e. sources of compensation) can be.

Here is the disclosure of our conflicts of interest: We have not found any, yet. But we are still looking, and if we discover any you’ll be the first to know.

We make money in only one way. The only compensation we receive directly or indirectly for the privilege of managing your account is the management fee. We receive no other compensation – none!

Brokerage firms don’t pay us any kickbacks. They don’t pay us any soft dollars – money generated from trading commissions that could be used for research. We pay for all our outside research from our pockets. We can access Wall Street research on Schwab’s or TD Ameritrade’s websites (which we rarely use), but this research is available to all institutions independent of trading volume. More importantly, if they stopped providing this research to us (we are not even sure they can turn it off just to us), the commissions and fees you pay to them would not change.

We don’t buy mutual funds for clients; but even if we did, they still wouldn’t pay us anything to invest in them.

Incentives are very important – as long as they’re the right ones. When we analyze stocks, we spend a lot of time looking at management incentives. We love companies whose management owns a lot of stock in the business it runs (for instance, Softbank’s CEO, Masayoshi Son, owns more than 20% of Softbank). We know that significant insider ownership will not protect us from human misjudgment, but it will shield us from even more dangerous indifference, which in the corporate world is usually expressed as capital misallocation (bad, expensive, dilutive acquisitions, for instance).

Therefore, we built IMA so our incentives are directly aligned with you. Our management fee – its dollar amount – will vary with the size of your account. We get richer and poorer with you.

Wall Street is famous for manufacturing products they’d like you to buy but that they wouldn’t consume themselves. We don’t do that. We strongly believe in what we do and follow this philosophy: If a particular stock is good for our clients, it should be good for us.

So we eat our own cooking. Vitaliy’s personal and family accounts (wife and three kids) are managed by IMA. Stocks that are bought or sold in your accounts are automatically bought or sold for Vitaliy’s son, Jonah, his daughters, Hannah and Mia Sarah, his wife, Rachel, and Vitaliy himself. Mike Conn and his family mostly own the same stocks as his clients.

We never buy or sell stocks in our personal accounts ahead of our clients – that would be illegal and simply unethical and wrong.

We believe strongly that trust is built on communication and transparency. We put an enormous amount of energy and time into bringing our clients as close to our thinking as humanly possible in our quarterly letters, where we walk our clients through whys of our decisions (buys and sells) and indecisions during the quarter.

Michael Conn, CFA
Vitaliy Katsenelson, CFA