Hey friends, back to school, back to business. Let’s get to it:

Money is great. In the moment, that is.

What is money anyways?

It’s a unit of account, a “store of value”, and a medium of exchange.

The first is straight forward. Dollars are a common way to measure things. Houses, cars, your salary, stocks, oil, debt, cheeseburgers…all in dollars. Unit of account; check.

“Store of Value” - you receive a dollar and you can save it. Stack enough of them up under the mattress, and theoretically you’ve saved your dollars for use at a later date.

I put quotes and italics, because from a store of value perspective, it’s hardly storing anything. Dollars are slowly, sometimes quickly, crumbling away in value.

Many adults since covid have finally woken up to the hidden horror that is inflation, or loss of purchasing power as the cost of goods increases. Groceries, medicine, cars, insurance, housing…pretty much everything keeps getting more expensive.

Inflation can come from a number of places, but a major contributor is simply government spending, growing government debt, and printing of currency to finance the whole operation (not unlike credit cards financing excessive consumer spending).

As a result, over time, prices go up.

Something that cost $10,000 in 1980 costs roughly $40,500 today. That’s equivalent to a 3% inflation rate or a cumulative increase of 305%.

Put differently, the U.S. dollar has lost about 75% of its purchasing power over that period. And that’s in one of the world's largest and most stable economies.

My wife MJ is from Venezuela. When things go bad, they can get a LOT worse.

According to IMF inflation data, prices in Venezuela increased by roughly 140 billion times between 1980 and 2021. Something requiring 100 bolivars of purchasing power in 1980 would have required roughly 14 trillion bolivars by 2021.

Fourteen Trillion!

Obviously Venezuela is an extreme example. But the underlying theme remains the same: cash is useful for short term needs. It is terrible at building long term wealth.

Finally, medium of exchange. The name is apt, since it tells you what you should do with it.

Exchange it! Exchange it for something else. Most people will trade nearly all their salary - labour - life - for dollars. Those dollars can go three different directions.

1) under the mattress, but withers away to inflation.

2) buy one time services or consumer goods that depreciate toward zero. Not that that’s wrong, per se, we are supposed to enjoy things, too!

3) buying productive assets that increase in value faster than inflation.

If all you do is (1) and (2), you will never get past paycheque to paycheque and build wealth.

The last option, number (3), is to exchange dollars for assets. Private businesses, real estate, stocks, etc. By doing this, you effectively take money that comes from your labour, and turn it into productive capital. Capital that produces more capital. In short, compounding.

That is what it means to invest, and it’s the only way you course correct toward building wealth.

Historically speaking, the best way that ordinary people can do this is through the stock market. The S&P500 has averaged 10%/year over very long periods. Some years are much better (recently), some are horrendous (2001-2003, 2008/09, 2018, 2022). But over decades of investing, earning 10% is a far cry better than letting 3% (or more) inflation destroy the dollars you’ve earned.

By turning your unit of account, paper dollars, the “store of value”, and exchanging it for assets, you turn the equation of money entering your household into a capital compounder, freeing you from the slow burn that is inflation, and better, accelerating you into new financial-economic status.

This is “why” we must invest. Easiest way to do it, low cost, diversified index funds.

You hear a lot about ETFs in this Journal - so let’s go through one, step by step. Below is a series of snapshots taken from iShares.ca with my commentary. Hope this is helpful.

ETFs are one of the best inventions ever made because they give ordinary people a chance at being extraordinary investors.

Indeed, 90% of funds —“the pros”—underperform the S&P500 over the long term.

Only a few decades ago you would have to buy a whole bunch of stocks individually and pay a fat commission to do so, sometimes as high as 5-10% of each purchase. Then you would have to rebalance each position as performance for each stock varied in your portfolio.

Today, with your feet up on the couch, you get to buy an index of 500 amazing stocks, with one click and at a near zero cost.

I discuss ETFs and DIY investing at length in my 2 hour investing course, if interested.

There is a prominent wealth management firm based in Vancouver that is running into some problems.

I have come across an internal letter written by the Chief Investment Officer of this firm and addressed to the Advisory team, the team of people that ultimately have the relationships with clients.

The firm’s private capital investment funds, of which real estate funds are the largest - all of which are created and sold in-house, are coming under some serious pressure.

Number one; the economy, increasing interest rates, slow down in commercial real estate has led to issues with valuations of the investments held within these funds.

Number two; clients are waking up and seeing that they are 70% invested in illiquid investments and they are telling their advisors that they want to divest and reduce exposure. Usually this happens slowly as cracks emerge, and then all at once.

Not that the clients weren’t aware; they were part of the onboarding process and I assume explained to by their advisors that their portfolios likely would be titled this way - after all, it was a major selling feature of the firm to resemble pension-style investment portfolios which have a large amount of illiquid private investments.

Number three; these private funds, as mentioned, are illiquid in nature, a small cash flow from potential rents, or one off asset sales. They are not public securities tradeable every second of every trading day. They are big, hard, real assets that trade semi-annually at best.

Now, there are lines of redemption requests and these funds cannot find enough capital to supply those requests.

It’s gotten extreme in some cases, especially on the real estate side, that they’ve had to “gate” fund redemptions. This essentially means that they have disallowed any future redemptions by clients. They get put in a waiting list, so that one day, in theory, they will be able to redeem for cash. For now, nobody can take money out.

So these funds, and the firm, are facing a bit of a trifecta of issues all at once.

They are not able to sell assets at good prices because the market is slow and selling quickly into an illiquid market will result in suboptimal values.

As a result, they can’t fund redemption requests because they have minimal cash flows coming into the portfolios.

The only way they could potentially do it is by borrowing against the funds, and that’s got its own risky problems.

They are having an issue, too, as word has been getting out with these ongoings, with onboarding new clients, which was one of the historically successful levers to supply capital to a fund and therefore help with cash management activities, like redemptions.

Furthermore, the biggest problem I saw in this letter is that, the writer, head of investments, essentially stated that the entire business is a team, and that the advisors, who have an interest in the success of the firm, who have discretion over their clients traiding decisions (that’s why they were hired), that the advisors have some of the responsibility to convince their clients to stay invested in these funds, stop redemptions, and in fact add more if possible. All so the funds and the business itself can release the pressure valves.

A final word, I have respect for the advisors who work hard for their clients, as well as the investment professionals operating within the private funds - some investments and economic situations just don’t work out, that comes with the territory of allocating capital. But fund management interfering with advisor discretion during turbulent times is ethically dubious, in my opinion.

Building a business on mismatched liquidity, i.e. long term private investments and retail clients that have monthly/daily needs of their capital, can work while things are going well.

When things start to crack, it starts to get messy, incentives get crossed and ultimately the unitholders are the ones to suffer.

“You don’t see who’s swimming naked until the tide goes out”

—Warren Buffett

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