'Do the Right Thing'

Investment industry should follow 

Spike Lee film's mantra

By Gilbert Andrew Garcia

Guest Columnists

I love the classic Spike Lee movie, "Do the Right Thing." It is ahead of its time and is a masterpiece about racial tensions. In the movie, Da Mayor, played by Ossie Davis, and Mookie, played by Spike Lee, have a memorable exchange: 

Da Mayor: Doctor...
Mookie: C'mon, what. What?
Da Mayor: Always do the right thing.
Mookie: That's it?
Da Mayor: That's it.
Mookie: I got it, I'm gone.

In our business, we should always “do the right thing!” To translate, we should always “follow best practices.” Here are a few best practices I suggest for our industry. 

Capital

A successful money manager needs adequate capital. Best practices would suggest retaining some profits every year to build a cash reserve. Capital allows a firm to hire good people and to implement new systems. A firm without capital means that management is unwilling or unable to invest in itself, which is a precursor of future troubles.    

Structure

A well-known minority firm recently closed its doors, causing naysayers to ask if minority firms are too risky. They are no more nor less risky than large firms: see Merrill Lynch, Bear Stearns, Lehman Brothers and a slew of hedge funds. What they should be asking about is firm structure. Best practices require buy/sell agreements to cover all partners in case of death, divorce, bankruptcy and other unforeseen events. Buy/sells should be at a predetermined valuation to avoid disputes. Furthermore, automatic financing should be in place to preserve firm capital. Key man life insurance on large shareholders is strongly encouraged to protect both the firm and heirs.    

  

Pricing

Recent headlines have exposed managers inflating bond prices. Best practices require the use of an independent third party pricing source. It is best to not change/override prices. Pricing services do a great job with high quality, vanilla securities but are regularly too high for collateralized mortgage obligations, commercial mortgage-backed securities, and other derivatives. Changing prices can easily lead to abuse and manufactured alpha. 

Soft Dollars

Commissions belong to clients! Soft dollars, particularly in fixed income, should be discouraged. The premise behind soft dollars is that managers use client commissions to pay certain manager bills for items that benefit clients. Ask for the evidence! And, ask for the soft dollar liability balance. Utilizing soft dollars is usually a sign that a manager is undercapitalized. The practice can easily lead to excessive trading (mortgage-backed security dollar rolls, repurchase agreements, etc.) of client portfolios to generate commissions to pay manager bills.   

Outside Revenue

It is best to avoid conflicts, real or perceived, by deriving revenue from one source, managing client assets. It is important to ask if managers/consultants are receiving revenue outside their core competency to expose potential conflicts. Best practices should require consultants to disclose any revenue derived from money managers, especially those brought before clients for potential hire during final presentations. 

Paying It Forward

Stay humble and always “pay it forward.” Firms should compensate employees generously. It is the right thing to do.  After employees, give generously in time and money to communities, both your own and those of your clients. Summer internships are a great way to give back and to expose young people to the business.   

Stand Against Injustice 

Injustice has no place in 2017. And, we should all stand against it. Last year, we were subjected to an unbelievable, racially charged line of questioning during a due diligence with a major West Coast consulting firm. I wrote their CEO directly. Shockingly, their firm defended its actions. In the end, the market will force them to change their behavior. We should all stand against injustice so our kids will never be exposed to such treatment and will be allowed to compete fairly.    

“Best Practices” means different things to different people. And, one’s interpretation of “Best Practices” says a lot about a person and a firm. Somewhere, Da Mayor is smiling and saying “Doctor, keep doing the right thing.”

The views expressed herein do not constitute research, investment advice or trade recommendations. 

Gilbert Andrew Garcia

About the Author:

Gilbert Andrew Garcia graduated from Yale University in 1985. After graduation, he joined Saloman Brothers in New York where he became a vice president specializing in mortgage-backed securities. In 1990, he joined former  San Antonio Mayor Henry Cisneros to build Cisneros Asset Management Co., ultimately becoming its president. In 2002, he joined Garcia Hamilton & Associates and is the firm's managing partner.