Bob Luxenberg was trying to decide where to invest several million dollars that he had earned building technology businesses in Silicon Valley when he unearthed his latest venture.
Previous bad experiences with active investment managers and research comparing the results of active and passive investing convinced the engineer that the latter was the approach he wanted for his money. Mr. Luxenberg was surprised, however, that he would have to pay nearly as much for a financial adviser who incorporated passive management, which is designed to match the market and not beat it, as he would for an active manager.
Always the engineer, he estimated that clients who pay advisers based on a percentage of assets pay just 0.2 percent less on average if their portfolios are passively managed than if they are actively managed.
Mr. Luxenberg decided that wasn't enough of a difference, but he couldn't find many firms that employed passive management and didn't charge clients based on a percentage of assets.
He discussed the problem with his cousin Larry Luxenberg, a
hedge fund manager in New York, and within about eight months the pair had crafted a business plan to create a new firm. Last month, the entrepreneur and the Wall Street veteran opened Lexington Avenue Capital Management LLC, a financial advisory firm that charges a capped fee and incorporates passive investing.
"The idea is to deliver investment results as efficiently as possible," said Larry Luxenberg portfolio manager of the firm. "Our pricing approach is consistent with that, as is our investment philosophy that passive products deliver the best results to the most investors."
Woodside, Calif.-based Lexington Avenue invests client assets primarily in index funds offered by Dimensional Fund Advisors LP, an early adopter of passive investing. The Santa Monica, Calif.-based fund company, which doesn't sell directly to individual investors, manages about $145 billion.
The minimum investment for Lexington Avenue clients is $100,000. The firm's fees range between $2,000 a year for assets under $500,000 up to $4,000 a year for clients with assets of $1 million or more.
"Most clients take about the same amount of work," regardless of their portfolio size, Larry Luxenberg said from his New York home.
The fee structure that the partners chose is increasingly popular with advisers, said Ellen Turf, chief executive of the National Association of Personal Financial Advisers, based in Arlington Heights, Ill.
Some fee-only advisers, which are the only type of that NAPFA allows as members, are moving away from charging clients based on the amount of assets that they manage, she said.
"It's becoming more common for advisers to be charging a flat yearly retainer," Ms. Turf said.
Bob Luxenberg estimates that fees based on assets under management significantly cut into an investor's portfolio results over time.
For instance, investing $1 million with an adviser who charges a typical fee based on assets under management and incorporates passive investing would be worth an average of $2.74 million after 12 years based on a 10% a year return. With Lexington Avenue's flat-fee structure, the portfolio would be worth $3.04 million, Bob Luxenberg said.
"That means that after 12 years, a client using our approach, based solely on the fee structure, would be worth 10% more," he said.
It is difficult for active managers to beat their benchmarks, Bob Luxenberg said. They might have a good year or two, or five, but over time when you factor in their costs, they just don't beat the market. "A small percentage has skill, and a lot of it is luck," Bob Luxenberg said.
Lexington Avenue is the same name as Larry Luxenberg's former
hedge fund. The cousins used it again for the new firm because it was easier from a business perspective to do that, he said.
The Luxenbergs work from their homes, which are about 3,000 miles apart. To facilitate communications, they use web-conferencing software, Bob Luxenberg said. The partners outsource the back-office functions, including compliance, to Partnervest Financial Group LLC, based in Santa Barbara, Calif.
The company is nearly paperless.
Lexington Avenue's custodian is Schwab Institutional of San Francisco, which has about $570 billion in adviser assets under custody.
Lexington Avenue develops client investment plans but is a partner with other business owners to provide insurance, legal, accounting and other professional services, Larry Luxenberg said.
The firm hopes to cull clients from the wealthy technology community that Bob Luxenberg has been a part of for almost 30 years.
