If you are enjoying the breadth of the Fortnightly, you might consider the depth to be found by way of a full subscription — and please feel free to share this with others.
Looking for closet indexers
Ever since active share became a thing, a bit more than a decade ago, there has been a hunt for “closet indexers.” As reported by the Financial Times in November, the American Century Value Fund was sued by one of its investors who claimed that the fund was a closet indexer and therefore was charging inappropriate fees. Markov Processes, an independent quantitative researcher, rebutted the charges with postings in December and January.
This is an important issue for asset managers, mutual fund boards, and fiduciaries alike; it’s unlikely to go away any time soon. What constitutes closet indexing? What kind of evidence supports it or refutes it? How long is too long to hug an index, or is that never appropriate?
No matter what side of the table you sit on, you should have some beliefs that guide your actions.
Semantic knots
The Standards Board for Alternative Investments (SBAI) addresses “key areas of investment practices: disclosure, valuation, risk management, fund governance, and shareholder conduct.” Its detailed response to the Financial Conduct Authority’s discussion paper on “Sustainability Disclosure Requirements (SDR) and Investment Labels” provides some industry perspective on emerging regulatory ideas.
The tiers of labels and disclosure proposals give an indication of the difficulties of the issues to be addressed — and the semantic knots that are likely to result when trying to create a fixed frame through which to view a dynamic and evolving system. (See this piece on ESG for a few of the uncertainties that might clash with attempts to nail down labels for levels of sustainability.)
Lou Simpson
Simpson, the legendary manager of Geico’s portfolio, passed away on January 8. A posting by The Rational Walk provides some background on Simpson, a number of good links about him, and results from his first twenty-five years with the portfolio. A 1987 profile from the Washington Post provides additional perspective on the low-key but highly-successful manager.
In 2007, Jeffrey Ptak of Morningstar wrote about a visit with Simpson, which included this bit of investment philosophy:
Simpson disputed the notion that there’s a stark divide separating growth and value stocks, saying such stocks were “joined at the hip.” He reinforced that point by adding he’d always like to buy “growing businesses at value prices.”
Not low key
A couple of stories of flashier fellows — huge names in deal making in the eighties — are also enlightening. “The Debt King,” an article by Jacob Bernstein, chronicles the times (and ongoing dance) of Ron Perelman. A podcast from Ariel Levy, “The Just Enough Family,” provides an inside view of the rise and fall of Saul Steinberg’s empire.
Other reads
“Mark-to-Market Rounds — What Will Your Startup’s Strategy Be?” Tomasz Tunguz, Redpoint. Private company “rounds” are changing:
Some of our portfolio companies raise mark-to-markets annually or bi-annually as a matter of course to demonstrate strength, provide liquidity, forestall an IPO. Others leverage mark-to-markets as a defense against M&A. Still others forgo them altogether, not wanting to burden the balance sheet with excess assets. And last, some decide to negotiate the valuations lower, preferring a consistent and more modest price increase, and the confidence of knowing next year the business will be worth more, irrespective of a correction.
“A Better Bang for the Buck 3.0,” Dan Doonan and William Fornia, National Institute on Retirement Security:
This analysis finds that defined benefit (DB) pension plans offer substantial cost advantages over 401(k)-style defined contribution (DC) accounts. A typical pension has a 49 percent cost advantage as compared to a typical DC account, with the cost advantages stemming from longevity risk pooling, higher investment returns, and optimally balanced investment portfolios.
“Corporate Excess,” Roger Lowenstein, Intrinsic Value. In which GE is Exhibit A:
But there is one entitled group that is largely insulated from the market’s judgment — the hired suits who run America’s public companies. These executives have for decades preached the mantra of “pay-for-performance” but they rarely live up to it. They are overpaid when they succeed and — no other word for it — obscenely overpaid for failure.
“Should Passive Investors Be Happy Buying Equities at 100x Earnings?” Joe Wiggins, Behavioural Investment. At what point is a strategy untenable? “No approach is perfect, we must pick our poison.”
“Startup ‘Choir’ Aims to Diversify Finance Conferences With Certification,” Michael Thrasher, RIA Intel. “The technology platform and consultancy has also created a certification that conferences can earn,” for inclusion of diverse professionals as speakers.
“UBS Targets Less-Wealthy Customers With Advice by Device,” Margot Patrick, Wall Street Journal. The bank expects to wow the new customers via thought leadership:
“They are going to be getting great UBS content, great UBS intellectual capital, just delivered to them in a different way,” said Tom Naratil, president Americas at UBS. He said UBS has a global perspective and capabilities that U.S. wealth managers don’t, and “that’s our real differentiator in the U.S.”
“How Jessica Simpson Almost Lost Her Name,” Stephanie Clifford and Eliza Ronalds-Hannon, Bloomberg Businessweek. A fascinating story about brand licensing as “a financial model,” akin to other strategies of modern markets, shaped by Robert D’Loren:
“Don’t invest anything into supply chain, design, etc., and minimize marketing; just let the income streams naturally fade over time,” D’Loren says. “The key to the model being sustainable” is to keep buying new brands to replace those declining income streams.
“Asset Management Trends 2022,” OliverWyman. A quick list of ten ideas, starting with, “Macro tailwinds fade, taking the air out of managers’ sails.”
Our times
“Raising hundreds of millions of dollars from gullible investors who don’t do much due diligence is not particularly impressive anymore.” — Matt Levine.
Quality rules
Terry Smith has received a lot of attention as a result of his most recent Fundsmith annual letter. Most of it was related to his comments on Unilever, including:
A company which feels it has to define the purpose of Hellmann’s mayonnaise has in our view clearly lost the plot. The Hellmann’s brand has existed since 1913 so we would guess that by now consumers have figured out its purpose (spoiler alert — salads and sandwiches).
Smith also made the case for the kind of quality stocks that he espouses, using the MSCI World Quality Index as a proxy. Above is a longer view of that index versus the MSCI World, showing the absolute performance on top and the relative performance on the bottom. Notice the surge in 2020.
So, does quality rule? Smith makes the case that it will over any ten-year period. Are you with him, or was this long period (from the start of the index data, by chance almost coinciding with the uber-bull market) unusual?
Postings
Among the recent postings was a Sampler reposting of “Breaking Open Private Equity,” appropriately enough now open to all. Also, for paid subscribers:
“How to Use Academic Research.”
“The Goal of Explanatory Depth.”
“The Elusive Full Market Cycle.”
“Capital Market Assumptions as Explored Beliefs.”
Thank you for reading!
Published: January 24, 2022
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