Acquired
00:43:03 · Ben Gilbert, David Rosenthal
[00:43:03] S0: And I think first, was trying to hire people like this, but he couldn't convince anyone to just join as an employee. He he sorta realized, oh, I'm gonna have to buy one of their firms. [00:43:12] S1: Yeah. I mean, hey. If Jerry Tsai just left because he didn't get a big equity piece in Fidelity and take over the firm like anybody else who thinks they're as good as him, you know, they're gonna want an equity piece in the management company. Yep. So he casts about, and eventually, Jack finds a small new firm in Boston founded by four young partners, Thorndyke, Doran, Payne, and Lewis. And the lead partner there, Nick Thorndyke, had just come out of Fidelity where he had worked with Jerry Tsai and Ned Johnson. And so they've raised a new fund called iVest, investing in the go go style. They're young hotshots. They have $17,000,000 under management in their nascent go go fund. Wellington, at this point, has $2,000,000,000 under management. [00:44:06] S0: Which is huge. That's giant market share Yes. Even though they're Declining revenue. In the old style of investments. [00:44:13] S1: Yes. But back to the business model of the management companies where you're getting paid fees based on a percentage of assets under management, like, the revenue and fee streams flowing into Wellington, even though they're declining, are [00:44:23] S0: Super high.
00:44:23 · Ben Gilbert, David Rosenthal
[00:44:23] S0: Super high. [00:44:24] S1: Way higher than the startup IVAS fund out of Boston. Nonetheless, Wellington and Jack feel like they're in such dire straits and need this merger, need to bring this GoGo blood into the firm so much that he ends up offering 40% of the equity in the management company to the four partners coming in from Ivest. [00:44:49] S0: That's almost a merger of equals. Yeah. [00:44:52] S1: $2,000,000,000 for Wellington, $17,000,000 for my vest, $60.40 split on the equity. There's a quote in the New York Times in a lead story about this merger. Some observers feel that Wellington paid too high a price for management personnel. Many persons are said to credit the Boston group with a major coup. Mister Bogle disagrees. With generous offers, he had been unable to hire the men he wanted, to your point, Ben. And he did not wanna wait for promising men to develop their skills. This is a big deal. I mean, Wellington is still, even though its style is on the outs, one of the, you know, top 10 mutual funds in the entire industry. Institutional Investor magazine runs a cover story on the merger titled the whiz kids takeover at Wellington, and they have an illustration on the cover. You can find this on the Internet. We'll include it in the email with Jack as a four armed quarterback handing off footballs to each of the four iVest partners as, you know, the running backs to take them across the line, score touchdowns here. What could go wrong? What could go wrong? [00:46:02] S0: Go wrong?
00:46:02 · Ben Gilbert, David Rosenthal
[00:46:02] S0: Go wrong? [00:46:03] S1: Yeah. Well, as you can predict, after a couple more go go years, the bubble bursts. In the nineteen seventies, the oil crisis hit, stagflation hits, the stock market declines 50%. It is not quite great depression levels, but you and I, Ben, have also never lived through anything like the nineteen seventies in The US. It was bad. It was a lost decade. [00:46:29] S0: Even 2008 was not this severe. Certainly, the short lived COVID crash was not this severe. Software going out of favor in 2022 was not this severe. The .com bubble burst was not this severe. This is something that very few listeners will sort of understand the magnitude of and and feel intrinsically how bad this was. [00:46:47] S1: Yeah. I mean, interest rates went to 21% by the end of this. I mean, the world basically fell apart a couple years ago when interest rates went to, what, like, five? You know, can you imagine? [00:47:00] S0: So what was the good years of the go go time, and then when did it fall apart? [00:47:04] S1: Through the sixties and then probably, like, 1970, 1971, it starts falling apart. And then once the oil crisis start hitting in '72, '73, '74, GoGo just completely falls apart. So the IVAS fund, they ported over the IVAS fund itself into Wellington. It had continued to perform during the Gogo years. It gets a drawdown of 65% in one year, and they ultimately shutter the fund. Like, they close it down. [00:47:33] S0: They closed down the IVAS fund entirely. Down [00:47:34] S1: the IVAS fund. Oh, wow. Yeah.
00:47:34 · David Rosenthal, Ben Gilbert
[00:47:34] S1: the IVAS fund. Oh, wow. Yeah. [00:47:36] S0: Yeah. But hadn't they already shifted the Wellington fund's style to look a lot more like IVAS. [00:47:43] S1: So I [00:47:43] S0: guess Wellington was suffering too. Right? The the fund? [00:47:46] S1: Wellington was suffering too. I mean, really, like, Wellington is just a battered ship taking on water on all sides at this point because it had been out of favor during the go go years because it was too conservative and too balanced. [00:47:59] S0: It was underperforming the market. [00:48:01] S1: Underperforming the market. Then it transformed basically into a go go fund. [00:48:07] S0: Took on a lot more risk. [00:48:08] S1: A lot more risk, then that falls off a cliff. By 1973, the assets of the Wellington Fund have fallen all the way from $2,000,000,000 at the time of the merger down to $480,000,000. So over three quarters of the assets in the fund, and thus, three quarters of the revenue to the management company, poof, up in smoke. [00:48:30] S0: Now all of that wasn't because of the assets decreasing in value. [00:48:35] S1: A lot [00:48:35] S0: of that was redemptions where investors are taking their money and going elsewhere. But doesn't matter to the management company. For for them, AUM is AUM.
00:48:35 · Ben Gilbert, David Rosenthal
[00:48:35] S0: of that was redemptions where investors are taking their money and going elsewhere. But doesn't matter to the management company. For for them, AUM is AUM. [00:48:41] S1: And this is somebody made this point to me in research. Management companies of investment firms have phenomenal operating leverage, as we talked about earlier. As you are growing your funds under management, you don't have to scale your headcount or your operations or your costs in the same way, and so you can get this, you know, amazing operating leverage and profits. [00:49:02] S0: Much like a software business. [00:49:04] S1: Much like a software business. Unfortunately, that works in both directions. So Right. If your assets under management ever start to shrink, that goes away very quickly. [00:49:15] S0: You still have almost all the exact same operational responsibility that you did when you had lots of assets when you have a smaller number of assets.
00:49:15 · Ben Gilbert, David Rosenthal
[00:49:15] S0: You still have almost all the exact same operational responsibility that you did when you had lots of assets when you have a smaller number of assets. [00:49:22] S1: Yep. And thanks to the merger, there are now four new partners around the table with mouths to feed who own 40% of the management company. So then in the midst of all this, to complicate things even further, Jack starts to develop a crisis of conscience. As all these losses are piling up at Wellington and clients are withdrawing and they're shutting down the IVEST fund, he starts wondering, you know, first to himself and then allowed to his partners, Guys, what are we doing here? Like, we're still taking fees from our fund clients. Yes. Our assets under management are shrinking, so our fee stream is shrinking. But for the clients who are sticking with us, we're not lowering our costs. We're still getting paid pretty well, and we're just incinerating their capital. Something feels wrong [00:50:21] S0: here. I've heard this referred to as his Jerry Maguire moment in the book, the Bogle Effect, where, you know, that famous scene in in Jerry Maguire where he loses confidence in the entire industry of being a sports agent and writes a letter and says, guys, we're gonna do this right. Yep. We should change everything and and blow up our whole business. And as usual, you know how that is received.