Kahneman, 75, an unassuming man everyone calls Danny, is a psychologist and Princeton University senior scholar and professor emeritus who won the Nobel Prize in economics in 2002 for his work in behavioral finance. In the 1970s, he and Amos Tversky, a pioneer in cognitive science, developed a concept called Prospect Theory that changed the way people look at risk. In a nutshell, the theory holds that individuals feel the pain of a dollar loss twice as much as the joy of a dollar gain, meaning they dislike losses more than they like gains. That ran counter to then-conventional risk models that put equal weight on a dollar of loss and a dollar of gain.
The impact on wealth management, at least the way Guggenheim practices it, puts the focus on first-order loss aversion-first avoid loss, and then seek gain. Guggenheim worked with Kahneman to develop a proprietary approach called Riskometry, a technical term for the process of figuring out what people want and how much risk they're willing to take to get there.
"How much money are they willing to put at risk of loss over some duration in the quest for incremental gain?" Rosenfield asks. "Do they have regret? I think trying to figure out a client's regret structure is a different way to start an engagement. Will they feel terrible if the markets go way up and they don't capture all of the gain? That's called gain regret. How will they feel if in the quest for gain they lose 20%, 30% or 40%?"
With new clients, Guggenheim begins by assessing the total net worth. "You can do a better job advising $60 million in liquid assets if you know they have $150 million tied up in a business," Rosenfield says. Then they take clients through the riskometry process.
"The idea is to try to get people to think about what they think they could tolerate," says Kahneman, a Guggenheim consultant. "I'm interested in the notion of mistakes people make because of regret. By getting people to anticipate regret, we can measure if they're regret prone. Discussing regret puts the advisor and client on the same page because neither of them wants the client to be sorry that he invested in what he did."
The process also hammers home the point that hoped-for market gains can't be divorced from potential market pains. "Many investors have return expectations that are completely disconnected from reality," Rosenfield says. "They want to make 12% with no risk. I do, too, but it can't be done."
Adds Rosenfield, "People have two goals-not to lose money, and to make a lot more money. Since they are essentially rivals, we try to separate them and address them specifically and differently."
Guggenheim's solution is to create two distinct portfolios for each client: a "bold" portfolio to grow wealth and a "conservative" portfolio to preserve wealth.
Capital preservation and asset protection are crucial concepts for the super wealthy, and even more so than Rosenfield expected. "I thought very wealthy people would be about 50-50 conservative and bold," he says. "That was just my hunch. Danny thought it would be more like 90-10 conservative, and he's much closer to the mark."
Individual Client Mandates
The Guggenheim family business is controlled generation to generation by lead heirs, and in recent years that has been Peter Lawson-Johnston and his son, Peter Jr. They licensed the Guggenheim name to Guggenheim Partners when they created the diversified financial services company with a group of entrepreneurs in 2000. The wealth advisory business began shortly after, and Rosenfield came on board to lead that business in 2004. In 2006, it became known as Guggenheim Investment Advisors.