Monograph
Liquidity Puzzles
The case study presented below is only current as of the date delivered, and it is provided for illustrative and informational purposes only. It is not intended to nor should be construed as a guarantee or assurance of future financial outcomes. The content discussed reflects the specific financial circumstances of the respective client; each client’s individual circumstances are unique, and outcomes will vary. Past performance is not indicative of future results; projections have inherent limitations and may not come to fruition. The statements contained herein do not constitute nor should be construed as personal financial, tax, or legal advice, nor a solicitation of any type. Each client's situation is unique and thus requires individualized financial, tax, and legal advice from a qualified financial professional, CPA, and attorney, respectively. The client situation discussed within reflects that of a current client; such client did not receive any cash or non-cash compensation in relation to this case study. The firm’s disclosures are available here or upon request.
Solving the Balance Sheet Liquidity Puzzle
At Monograph Wealth, we understand that affluence can lead to complexity and illiquidity in the wealth structure. We have developed methods to reduce these potential vulnerabilities and build resiliency.
The following case study illustrates our approach to comprehensively managing a complex balance sheet; establishing frameworks to evaluate tradeoffs; reducing illiquidity; and building wealth structure durability.
The Client
The client came to Monograph having built a successful service business and potential to pass on a multigenerational estate.
Despite the client’s financial success, they felt overwhelmed by the complexity of their balance sheet and its funding requirements.
Monograph’s services were sought to quantify, improve, and simplify the client’s financial livelihood.
Monograph was tasked with organizing their financial structure, integrating its components into a cohesive strategy, coordinating their professional team, and helping the client prepare for a sustainable retirement. Finally, the client also wanted an advisor that could guide and support the family’s next generation to be successful in their personal pursuits and good future stewards of family wealth.
The Challenge
The client’s business earnings were substantial and funded an abundant lifestyle and meaningful estate growth. The client was presented with “unique access” offerings such as luxury property developments and other lifestyle enhancement opportunities.
Over time, their balance sheet evolved to include mostly illiquid assets like real estate, alternative investments and business interests, many funded with debt.
While a modest amount of illiquid assets can be sustainable, an over-allocation to these types of assets using leverage can be a recipe for wealth destruction during a deep economic contraction. Future human capital cannot be accessed in the present and can be unpredictable. Similarly, illiquid assets cannot be instantly sold to finance today’s needs and are often sold at significant discounts if the seller needs to divest quickly.
Wealth is built with hard work over many years, but it can be destroyed in an instant if assets are sold at the wrong time.
In aggregate, accessible liquid assets were limited at 10% of the balance sheet, and half of the family’s annual spending serviced their illiquid assets, including debt service and operational expenses. The client’s limited liquidity and high expenses left them uncomfortably exposed to economic distress.
Without a complete view of the entire wealth structure and associated costs, or clear goals and objectives, the client was entrapped by illiquid and non-productive assets, and a dependency on earnings.
The Solution
At Monograph, we believe two key principles are essential to a successful experience with wealth.
First, a successful strategy is designed using a comprehensive view of all resources, not just a managed portfolio.
Second, goals and objectives should drive asset selection and the evolution of a family’s balance sheet. We call this purpose-driven investing and financial structure management.
While a solution to this client’s challenge takes time, gaining a holistic view is critical to the client’s decision making & pursuit of success.
In addition to liquid portfolio assets, a global view of other assets and liabilities could include:
Personal real estate assets
Investment real estate assets
Mortgages, loans, margin loans
Business interests
Direct start-up investments
Private equity, venture capital LP investments
Cash in bank accounts, social security, pensions
Human capital
Inheritance and expected life insurance proceeds
The establishment of explicit goals and objectives is crucial.
They could include:
Funding lifestyle expenses (essential and discretionary)
Family-related goals (children, parental support, gifting)
Philanthropy
Home renovations
And discretionary purchases, such as vacation homes or vehicles
Conceptual Frameworks
Organizing Understanding & Driving Action
By constructing a total view of the client’s resources and expenses, Monograph was able to identify the overarching challenges for the client. Conceptual frameworks were developed to organize understanding and illuminate tradeoffs and provide action items for improvement. By constructing a total view of the client’s resources and expenses, Monograph was able to identify the overarching challenges for the client. Conceptual frameworks were developed to organize understanding and illuminate tradeoffs and provide action items for improvement.
“Marginal Utility” Analysis of Personal Real Estate
Making up nearly 75% of the balance sheet, personal properties were major contributors to household costs and balance sheet stress.
Monograph and the client devised an analysis to understand the marginal utility of each property and what its role should be in the client’s overall wealth strategy. The analysis answered the following questions:
How important was each property to the client & the balance sheet?
How much happiness was derived for the family from each asset?
What was the annual operating cost of each property?
What was the frequency of use, and what was then the true “cost per visit”?
What was the opportunity cost of owning each property?
What was the asset’s purpose in the portfolio?
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Divestment of low marginal utility properties could create a more liquid, flexible, and resilient wealth structure for the family, with a focus on the properties that matter most to the family.
In this process, the client realized there were two properties that were of immense value to the family – properties the family enjoyed the most, where relationships could be strengthened, memories could be made, and a defining family legacy could be transferred through experiences.
Personal Expense Analysis Enables Control & Tradeoff Assessments
Monograph gathered annual expense information from the family’s bookkeeper, which illuminated the cost of life for the client. This process revealed the primary drivers of expense were operating expenses for several personal use homes, accounting for roughly 55% of total spending.
Despite having a large balance sheet, the client’s liquidity at the time was enough to cover only three years of spending. The analysis enabled the pruning of unproductive expenses, which increased the duration of spending coverage.
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Maintaining current expenses caused continued reliance on earnings for funding, challenged the ability to add to liquidity, and extended the feasible horizon for retirement beyond the client’s goals. Reducing unproductive expenses empowered a more resilient balance sheet.
Illiquid Asset Organization & Characterization
Prior to engaging Monograph, the client’s illiquid asset portfolio was not well understood. Monograph organized the portfolio to understand:
Total estimated value, and total funding commitments outstanding
Total cost of each investment (fees, tax frictions)
Estimated performance of assets
Which assets were immediately divestible for liquidity
Timeframes for sunset of assets
Basis planning – which assets are candidates for wealth transfer and which should be kept to receive a step-up.
This analysis brought to light several investments that could be divested at an appropriate value to bolster liquidity.
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Timely divestment of unproductive illiquid investments enabled debt and expense reduction, and improved liquidity. Inaction would have maintained exposure to economic distress.
Resulting Decisions
With a clearer understanding of the challenges and opportunities for strengthening the financial structure against unforeseen distress, the client chose to take action to improve balance sheet health and reduce reliance on his business earnings.
Several personal-use vacation homes were sold, and a tax efficient divestment plan was developed for the remaining low-utility vacation properties.
Two underperforming alternative investment funds were divested. Proceeds from these assets sales were used to pay down debt and add to liquid assets.
Remaining debts were refinanced where possible at lower rates.
Finally, the client developed a focus on trimming expenses where possible. In the last few years, annual expenses have been reduced by 30%. As low marginal utility personal homes continue to be divested, the client’s expenses will decrease in lockstep.
Financial and Family Benefits:
The client’s business and balance sheet became under duress during the early stages of the Covid-19 pandemic, creating both financial and emotional stress. However, the proactive plan we collectively put in place enabled the client’s liquid assets to support the family at a time when income dropped substantially.
While there is still work to be done and decisions to be made, clearer purpose and decision making by the client has resulted in a positive trajectory towards a healthier balance sheet and a tangible pathway to retirement with the goal of reducing stress and providing a higher quality of life for the client.
Monograph continues to collaborate with the client on the following projects and to provide the following services:
Balance sheet, asset, and account coordination and oversight
Iterative wealth plan implementation and adjustments
Quarterly meetings to review outstanding and new priorities, investment performance, and the state of economic and capital markets
Business succession planning
Debt and liquidity management
Financial education for the next generation (G2)
Coaching on communication with G2 about money and wealth
Estate & wealth transfer planning
Direction of legal, accounting, and financial service providers