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Setting expectations
In a recent paper, AQR asks an important question, “What’s the Worst That Should Happen?” From the conclusion:
Expected returns across a range of asset classes today are lower than their historical averages, yet the same is not true for expected risks. The past decade presented overall very friendly conditions for stocks and bonds (generally growth above forecasts, inflation below, and falling yields), but it would be imprudent to assume these conditions will repeat themselves over the next decade. Setting expectations — for investors, boards, and other stakeholders — is arguably going to be much more important from here.
Expectations tend to get out of whack when things have been good. Despite a few short crises here and there, it has been onward and upward for most of the last forty years. As AQR says, “The big risk for investors with multi-year horizons isn’t short-term worst outcomes; it’s long-term ones.” And we’ve been lulled into thinking that those kind of things don’t happen.
It’s the time of year when endowments report their returns, and the results have been eye-popping. And, according to Milliman, the funded status for the largest pension plans jumped to 85%, around 15% higher than it has been the last few years. As Institutional Investor summarizes, “Now Comes the Hard Part.”
Despite the good times, asset owners charged with meeting liabilities (or budgeted expected returns) are faced with a dilemma at a time when valuations are high across almost all asset classes. Do you dial back your expectations and wait for better opportunities or continue to increase the exposure to riskier assets?
The everything crackdown
Gary Gensler has come out of the gate quickly as chair of the Securities and Exchange Commission. A Bloomberg headline says it all: “SEC Chief to Wall Street: The Everything Crackdown Is Coming.” The story details a number of areas that are under scrutiny (among others): gamification, SPACs, climate change disclosures, ESG, swaps, short sales, market structure changes, and Chinese stock listings.
In the U.K., the Financial Conduct Authority (FCA) has been much more aggressive in rulemaking over the last decade than has the SEC. Now, when many have been working at home, it has announced, “We should be able to access firms’ sites, records and employees. It’s important that firms are prepared and take responsibility to ensure employees understand that the FCA has powers to visit any location where work is performed, business is carried out and employees are based (including residential addresses) for any regulatory purposes. This includes supervisory and enforcement visits.”
The pressures aren’t just coming from regulators. Bloomberg Law reported that there are “serious disruptions” in the market for fiduciary insurance “because of the extraordinary number of lawsuits challenging 401(k) plan fees.” The head of fiduciary and employment practices liability at Berkshire Hathaway said, “It just keeps spreading. Exposure is metastasizing.” And it’s not just big organizations that are targets, but smaller ones, including private firms and nonprofits. (In addition, there are suits related to performance; here’s an example via NAPA. And there’s a debate brewing about the appropriateness of active funds in plans.) It’s getting tougher to be a fiduciary.
Good reads
TIFF is celebrating its thirtieth anniversary with a hub of content to which it adds an item each month. Here is David Salem’s 1999 thought piece, “Message in a Bottle,” which examines the foundational beliefs and investment policies of the organization at that time. More than two decades later, it remains a good example for asset owners to ponder, right down to the tidy summary of the structure and rationale of the policy portfolio at the end.
McKinsey released its annual report on the asset management industry: “Notwithstanding the pandemic’s threat to the global economy and financial markets, 2020 ended up being a record year for the asset management industry.”
Cliffwater issued an analysis, “The Prevalence and Impact of GP-Led Secondary Transactions.” Secondaries have gained in popularity (and aren’t trading at the sometimes-big discounts that show up during periods of stress); this short summary lays out governance and conflict-of-interest issues, as well as what the firm believes are some best practices.
The module on how to decompose an asset manager’s process is the most popular one in the Investment Ecosystem Academy online course on due diligence and manager selection. Here’s an interesting Twitter thread from @Chariot_Invest on manager process (and marketing).
Speaking of regulation, RIABiz reports that “RIAs may face ticking time bomb after SEC slams a $1.9-billion RIA for neglecting ‘orphan’ accounts while charging fees, a problem that may be industrywide.”
“The futility of decision making research” is a remarkable piece of academic writing. Nearing the end of their careers, the authors bemoan the path of the work in their field. Why is it relevant to investment professionals? Because the popular research on decision making is often based on experiments unlike the “real decisions of the sort [that people] might face in the real world.”
Oh, and: “Deutsche Bank Whistleblower Gets $200 Million Bounty for Tip on Libor Misconduct.”
Subscriber postings
Each edition of Fortnightly will have a link to the archives page of the website, and will highlight some postings from the previous two weeks.
The seven initial postings have covered a range of ideas from different parts of the ecosystem, including tactical asset allocation, factor returns, innovation in organizations, the allure (and anchoring) of return targets, and a good Learning Curve linkfest. Plus, the problem of overconfidence in investment practice and three important dimensions for asset managers (using ARK Investment Management as an example).
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Published: October 31, 2021
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