With the demise of Silicon Valley Bank (SVB), up until March 10th roughly the 18th largest bank in the U.S. and now the second biggest bank to fail in US history, it seems appropriate to reach out to our clients and friends to remind you of the steps Blair Hall Advisors has taken from our earliest days to try to protect clients from the potential failures of other companies and, indeed, unlikely potential problems at our own company.
Diversification is the First Line of Protection
First is the principle of diversification. Sometimes called “the one free lunch in investing” because it always brings expected benefits, diversification is perhaps the single most important idea we employ when designing portfolios. Through larger “building blocks,” such as mutual funds, exhange-traded funds, and managed accounts, typically Blair Hall Advisors’ clients have highly diversified portfolios, with thousands of individual securities represented. Thus, when a company goes bankrupt or a bond is defaulted on, it is typically a well-mitigated risk.
In this moment, it is fair to be concerned about the banking sector overall rather than just a company or two. It is feasible that one of the key issues that caused SVB to fail also impacts a range of other banks. In ordinary times, SVB’s use of long-term bonds as collateral against short-term deposits is commonplace for banks and usually causes no significant problems. However, with the recent historically steep increase in interest rates, SVB’s long-term bonds’ marketable prices were significantly lower than asset managers at the bank had planned for, a failure of risk management, causing the bank to be undercapitalized.
Several other US banks might be undercapitalized as well. Absent a run on a bank, like happened to SVB, undercapitalization can be resolved in the course of business. It's not clear if the undercapitalization problem is well-identified yet among banks, however, especially among smaller banks.
Fortunately, federal regulators appreciate the systemic significance of the situation. They are so far demonstrating a willingness to support banks’ depositors as needed, meaning that it’s only investors (stock and bond holders) in the banks as businesses that seem to be significantly at risk, rather than depositors. (Note: Signature Bank faced a different set of issues from SVB, related to its concentrated involvement in cryptocurrency.)
Hence, in the short-term, BHA’s clients’ investments in the banking sector are going down in value somewhat, as for investors everywhere. We don’t want to be too blasé about this, but short-term investment performance in a sector is also well-mitigated by diversification in our experience. Further, we expect large banks and innovative smaller banks that provide balance sheet transparency for clients will grow in value in the long run because of the SVB debacle.
Client Assets Reside at Dependable, Independent Third-Party Companies
Second, after diversification, in terms of protecting client assets: all of BHA’s clients’ assets are housed at giant, well-regarded companies, known as “custodians” in this context. Almost all client assets are at the massive, staid, and well-managed Charles Schwab & Co., Inc. because this seems wisest for client protection. Our other excellent custodian, Interactive Brokers, provides us with differentiated global trading capabilities required for our non-US clients. In the ways we imagine that these companies could hypothetically fail, clients would still own the contents of their accounts.
We invite interested clients and friends to see a statement that Schwab put out on Monday, here. This link on “Investor Protection” and this link on “Account Protection” are informative for Interactive Brokers.
Our reliance on these third-party, independent custodians is perhaps your best protection against any potential operational disruption of our firm and against many, and perhaps most, potential avenues of malfeasance.
For Reliability and Transparency, We Use “Building Block” Investments
Third, all the building block investments that BHA relies upon the most—mutual funds, exchange-traded funds, separately-managed accounts—are themselves managed by multi-billion-dollar or multi-trillion-dollar companies, such as Dimensional Fund Advisors, BlackRock, PIMCO—to name a few. Company strength and stability are important criteria for us as we select these sub-manager partners for us and our clients. Blair Hall Advisors assembles these building blocks for clients in a highly transparent manner, easy for clients to see and review. This seems to us the lowest risk framework for building client portfolios.
Overall, our approach to protecting client assets seems robust to us, with one main caveat: we must never ask you to house any wealth away from an independent custodian and, if we did, you must not agree to it!
Naturally, clients are not inoculated from market risks—other than by time and the long-run tendency of human drive and creativity to cause the global economy to expand.
We hope you find this review reassuring. Please do reach out with any questions.
Our firm is open to conversations about new client relationships. Please contact us to chat.
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