Luminaries, Short Selling, and an Investment Swiss Army Knife

Welcome, new readers!  The Fortnightly is one of two categories of postings that are open to all; each edition offers a variety of ideas and links that you might find of interest.  (To sign up for a free or paid plan for the site, go here.  The Founder plan goes away at the end of the year.)

Luminaries and ideas

The CFA Institute Research Foundation released “Investment Luminaries and Their Insights,” a publication celebrating a quarter century of the Research Foundation’s Vertin Award.  The recipients of the award offer lessons learned, expectations for the future, and even some regrets.  The ideas that have animated the investment industry and profession in recent decades are on display, with references to many of the seminal works of the time.  It is an especially good overview for someone who is trying to get their arms around this fascinating, complex, and ever-evolving ecosystem.

A Swiss Army Knife?

If you go back only a handful of years, most asset owners didn’t even have “private credit” as a separate asset category in their asset allocation structure.  But it has soared in popularity.  Now, a Cambridge Associates piece calls it “The Investment Portfolio’s Swiss Army Knife.”

The firm defines private credit as “a fund that targets a high-yield or speculative-grade corporate, physical (excluding real estate), or financial asset risk in a private, lockup investment vehicle.”  One of the reasons it stayed under the radar for as long as it did is that it “is not a monolith but rather consists of several different investment strategies.”

While opportunities in other locales are briefly mentioned, the recommendation is that three kinds of U.S. institutions should be “adding private credit to portfolios.”  Given the attention and money thrown at the area of late, you’d expect that there would be some focus on the risks, but all of the risk discussion is on the attractive risk profile versus other vehicles.  It would be good to hear the other side of the story.

Short selling

How’s this for a headline:  “Tecnoglass: Cocaine Cartel Connections, Undisclosed Family Deals, And Accounting Irregularities All In One Nasdaq SPAC.”  It fronts a report from Hindenburg Research on the firm, which “manufactures and sells architectural glass, windows, and related products.”  The stock fell 45% in the two trading days since it was published.

A day after the report dropped, Bloomberg posted an article which begins:

The U.S. Justice Department has launched an expansive criminal investigation into short selling by hedge funds and research firms — thrilling legions of small investors and other skeptics of the tactics that investigative firms use to bet on stock declines.

The probe, run by the department’s fraud section with federal prosecutors in Los Angeles, is digging into the symbiotic relationships between funds and researchers, hunting for signs that they improperly coordinated trades or broke other laws to profit, according to people familiar with the matter.

Because the game is stacked against short selling, those doing that kind of work often are more thorough in their research than longs, surfacing issues that others haven’t.  Those who argue for banning short selling ignore the research showing that price discovery is improved by the presence of short sellers — and the historical evidence that there are more than a few CEOs who complained about the shorts who had something to hide.  (Beware those who “protest too much.”)  And most of the hyping of stocks is on the long side; that’s been on full display this year.

The Hindenburg report does have a soap opera feel to it, and Tecnoglass said it contained “inaccurate statements, groundless claims, character attacks, and speculation” — and increased its earnings guidance to boot.  All five Street analysts covering it have buy ratings on the stock.  Let the battle over the substance of the respective takes begin.

To the larger point, if rules are being broken, the perpetrators should be taken to task, no matter what side of the trade they are on.

Other reads

“Networks in Finance,” Net Interest, Marc Rubinstein.  The opening section of this posting (beyond that it is for subscribers only) provides an instructive look at networks past, present, and future.

“The Economics of Resilience: Capital Allocation and Investment Horizons during COVID-19,” FCLTGlobal.  The organization’s 2021 report shows the cash flows, allocations of capital, and time horizons across the players in the investment chain.

“The Book of Jargon: Environmental, Social & Governance,” Latham & Watkins.  This isn’t really a read, but a “glossary of ESG slang and terminology.”  (If you’re boning up on ESG and didn’t see the Sampler posting last week, check it out.)

“The role of income in portfolios,” Verus.  The paper has some great charts that show the income and price components of returns for several asset classes since 1985.

“Ranch Investor Found His Inefficient Market in Big Sky Country,” Bloomberg.  This interview provides an interesting look at an out-of-the-way market, with a surprise element:  “We can drive our financial returns with the environmental work we’re doing.”

“Buyouts: A Primer,” Tim Jenkinson, et al.  “This paper provides an introduction to buyouts and the academic literature about them.”  As promised, it’s a primer, providing analysis from an academic point of view rather than a provider or consultant promoting the approach.

Values

Central Securities

Jason Zweig’s latest column in the Wall Street Journal profiles Wilmot Kidd, the long-time manager of Central Securities.  In the top panel, you can see most of the performance since he took over management of the closed-end fund in 1974.

The chart is the maximum available on Bloomberg, which goes to show that the historical evidence at our fingertips is limited even on expensive data terminals.  This simple series starts at the end of 1980, just before the end of the last inflationary period, so we lack perspective on that front.

A relative chart (middle) always tells you more than an absolute one.  The patterns of out- and underperformance give a much better sense of when a manager adds value.  Wilmot’s path of returns is typical of those with great long-term records; they come with periods of lagging performance, sometimes long ones.

Closed-end funds don’t get much attention these days, but since the market price varies away from the underlying value of the assets, there can be opportunities created for a double-barreled effect if the securities and the premium/discount are moving in the same direction.  You can see that Central Securities (bottom) has traded in a relatively narrow range on that front, at a persistent discount to the underlying holdings.

Because there isn’t the hassle of cash flowing in and out (sometimes gushing in and out), Zweig writes that the structure “enables a closed-end fund to manage its portfolio, without having to manage its investors.”  The column discusses how Wilmot uses that freedom to add value, from having large positions (“Risk may be reduced through active and more intimate knowledge of the problems of companies in which we invest.”) to including private company investments long before that was popular.

Postings

Postings since the last Fortnightly have addressed the needs for transformative transparency in private equity and for a more robust approach to the analysis of human capital during due diligence, as well as a review of the bad bets and surprising outcomes related to Enron, now twenty years in the rearview mirror.  Visit the archives to see the full range of postings during the first two months of the site.