The Index
The Horizon Kinetics ISE Wealth Indexes are a suite of unique indexes that track the investment performance of public companies managed by some of the world’s most successful investors, businessmen and entrepreneurs. The indexes are designed to isolate one predictive variable: the serial success of wealthy owner-operators. There is an old adage in business that is rarely followed by employers and employees: treat the company’s money as if it were your own. The securities comprising the Wealth Indexes tend to outperform due to the proclivity of owner-operators to focus on long-term growth in shareholders’ equity, rather than short-term price appreciation.
The Indexes were designed on the premise that access to professional investors of a high caliber is not readily available to the average investor. Without access to the highly skilled individuals often found at hedge funds, private equity and venture capital firms, the average investor is left with a more limited set of opportunities. And while one can undoubtedly find examples of highly skilled managers accessible through the public equities markets—Warren Buffett, Carl Icahn, David Einhorn, John Malone, Vincent Bollore, and Li Ka-shing for example—an investible vehicle through which one can easily establish a position in a group of such companies has, heretofore, been absent from the marketplace.
By identifying publicly-traded companies owned and operated by the wealthiest, most successful investors, businessmen and entrepreneurs in the world, the Wealth Indexes—through the available separate account and fund structures—allow investors to readily and cost effectively leverage the superior business acumen of these highly skilled individuals.
Importantly, inherent in this strategy is an essential element of risk control in that managements tend to maintain a significant vested interest in the common equity of the company. That is, the interests of company management are more often in alignment with the interests of the common equity shareholder. To understand the critical importance of this factor, it is necessary to understand the conflicting incentive structures of companies managed by owner-operators and those overseen by agent-operators.
By virtue of an owner-operator’s significant financial interest—that is, personal capital at risk—the position of the owner-operator is commonly characterized by greater freedom of action and, consequently, an enhanced ability to focus on building long-term business value (i.e., shareholders’ equity). This is a recurring characteristic of owner-operators since the vast majority of their wealth is derived from the long-term appreciation of common equity shares, not from stock option grants, bonuses and salary increases resulting from meeting short-term financial targets.
In contradistinction, the agent-operator is often a hired hand chosen by the board and operates within an incentive structure characterized by less freedom of action and a focus on meeting shorter-term, less fundamentally important financial targets (e.g., quarterly earnings estimates). As well, by virtue of the agent-operator’s status as an employee rather than an owner, such individuals are more prone to viewing strategic business decisions in the context of career risk as opposed to whether or not such decisions will prove accretive over the long-term.
By establishing a bias towards companies managed by owner-operators, one of the greatest uncertainties associated with equity investing can be partially alleviated (i.e., when to buy and sell). In other words, if the Warren Buffetts of the world aren’t selling, you may want to reconsider.
During the credit crisis of 2008-2009, it was common to observe owner-operated companies taking advantage of depressed asset prices by making opportune investments—that is, buying not selling. Such purchases were made either through a draw on existing cash balances or through additional debt financing. While decisions to reduce cash and increase leverage were not popular among the general media, opportune investments such as these are essential to building shareholder value over time. In contrast, during the same period it was common to observe many agent-operated companies building up cash balances and reducing leverage, thereby failing to take advantage of depressed asset prices. Unfortunately, such behavior comes as no surprise. At times of elevated volatility (i.e., increased opportunity), it is quite common for agent-operators—who are, after all, employees, not owners—to place a greater focus on career risk rather than on building shareholder value.
Importantly, the implementation of such a simple, yet powerful, stock selection criterion has been demonstrated—both in our own internal research and in the academic literature—to result in significant excess returns versus commonly cited indexes such as the S&P 500 Index®, the MSCI All Country (AC) Asia ex Japan Index®, and the MSCI ACWI Index®. 1
Through a partnership with the International Securities Exchange, Horizon Kinetics has developed three indexes that track the shareholder value creating abilities of the world’s most successful entrepreneurs: Horizon Kinetics ISE Wealth Index (Bloomberg Ticker: RCH Index), Horizon Kinetics ISE Asia ex-Japan Wealth Index (Bloomberg Ticker: WEALTHAX Index), and Horizon Kinetics ISE Global Wealth Index (Bloomberg Ticker: WEALTHGL Index).
1 Shulman, J.M. and Noyes, E. “The Rich Get Richer and So Can You: Investing in a Billionaires’ Index”, The Journal of Index Investing, Spring 2012.