A February issue of the Fortnightly highlighted “Minsky Moments in Venture Capital” by Abraham Thomas, which looks prophetic now, as even old hands publicly express their worries. One aspect of that posting by Thomas was the compression of timelines in venture capital — everything was happening faster and faster.
Now there is another compression to contend with: The risk asset time-horizon accordion is being squeezed together. When markets get stressed, organizations get stressed, and attention diverts to the now and to the (down) ticks of the market.
The organizations that display equanimity in the face of it have a better chance to take advantage of the opportunities that will be presented. This is, after all, part of the deal and to be expected. Those that overreact — that make rash investment decisions and defer needed long-term improvements in methods — usually suffer for it.
Some simple arithmetic
At times, the most basic calculations can offer insights. That’s the approach of a posting by Matthew Crow of Mercer Capital, “Investment Management Confronts Stagflation and More.” Despite the title, it’s not about asset managers but the business models of wealth management firms, that hotter-than-hot part of the ecosystem where private equity and other buyers have been rolling up advisory firms with abandon.
Crow offers some simple arithmetic to frame the bottom lines of those golden geese, using the levers of market declines, increased inflation, and higher rates as variables. They are presented as discrete examples; you can do your own figuring of the effects of all three at once.
An attack on many fronts
As has been explored in previous editions, the SEC under Gary Gensler is more active than at any time in recent history.
A great overview of several of the initiatives comes from the law firm Ropes & Gray in the form of a review of the Investment Management Conference put on by the Investment Company Institute. A few of the many topics included: Rule 17a-7 regarding fund cross trades (of interest to those who have read The Bond King), climate change, ESG, proxies, and issues around closed-end, interval, tender offer, and commingled funds.
Plus, it lays out areas of focus for fund boards, who should have a “noses in, fingers out” approach to an advisor’s business strategy. The second part of that has been routine practice; the first, not so much. It’s amazing how little some boards know about the organizations managing the funds that they oversee. (Again, The Bond King. Postings about the lessons from the book for asset managers and those who analyze them will be coming soon to paid subscribers.)
Russell reconstitution
The reconstitution of the Russell Indexes is a big event each June, with the shake-up leading to composition changes that matter a great deal during this time when being in or out of an important index has a big effect on how a security trades. Over the years, the probable adjustments have been tracked and front-run, so much so that “FTSE Russell launched the Russell Monitor List” to help its clients follow the likely changes.
That’s according to a paper from the index provider, “Four Decades of Russell Indexes Reconstitution.” It provides some history, a description of how it all happens, and interesting perspectives on a couple of notable index dividing lines.
The first is in regards to large versus small (the Russell 1000 and 2000 respectively). The 2021 cutoff for “small” was more than four times that of 2009 (and twenty times 1984’s); size is a moving target. An exhibit illustrates another divide, that between growth and value flavors of the indexes: A stock can be represented in both, with the market value divvied up between them; as recently as 2016, that was the case with Apple.
The Fed put
It is quite something how the market’s view of the Federal Reserve has changed. Now the financial press is full of stories and interviews about how far behind the curve it is. In “How the Fed lost the plot,” Edward Luce of the Financial Times reminds us:
Some of the Fed’s woes are self-created. Its chief sin has been wishful thinking — a trait that was also shared by the markets.
It’s been a long journey, starting in 1987 and intensifying with each crisis, until expectations solidified into what became known as “the Fed put” — the belief that it would be there to support the market no matter what (and would be reluctant to quell its excesses). All of that is in question now and the Fed is in a difficult spot.
Other reads
“The Growing Complexity of ESG Products Puts Pressure on Fund Selectors,” Detlef Glow, Refinitiv. Those charged with selecting managers “are unsure of how to evaluate fund products since they want to avoid buying funds which may not be suitable for their purpose, or which become the subject of a green washing scandal in the future.”
“The Great Inventory Build,” Eric Cinnamond, Palm Valley. Charts and quotes capturing the move away from the just-in-time norm that has dominated company thinking for the last many years.
“What Teenagers Really Learn From Stock-Market Games,” Jason Zweig, Wall Street Journal, and a response from the University of Chicago Financial Education Initiative, which includes this:
Games can be used as a helpful learning tool, but what’s fundamentally wrong with these games is that they aren’t based on research. Instead, what we’re seeing is programs teaching the gamification of investing.
“Will Your Infrastructure Investments Withstand Inflation? The 700 Billion Dollar Question,” Anish Butani, bfinance. “Although infrastructure is renowned as an inflation-sensitive asset class, the reality varies greatly depending on the strategy type and asset-level specifics.”
“Forensic Analysis of Pension Funding: A Tool for Policymakers,” Jean-Pierre Aubry, Center for Retirement Research at Boston College. How legacy debt (even from a long time ago) and inadequate contributions led to pension underfunding.
“Manager Trading Practices in Today’s Evolving Electronic Markets,” Abel Noser. Implications and oversight best practices for asset owners wanting to understand how managers trade across the various venues.
Tweet thread on the “Devil’s Card Game,” 10-K Diver. “This is a super useful thought exercise. It can teach us several key concepts in economics, probability, betting, hedging, investor/market psychology, etc.”
“The biggest lie about productivity,” Ozan Varol.
If you slow down, you won’t get left behind. You’ll use less energy, you’ll go faster, and you’ll go deeper. The pedal-to-the metal mentality is the enemy of original thought. Creativity isn’t produced — it’s discovered. And it happens in moments of slack, not hard labor.
“Making our decisions,” Seth Godin. “For trivial matters, it’s efficient and perhaps useful to simply follow a crowd or whatever leader we’ve chosen. But when it matters, we need to make (and own) our own decisions. . . . . None of these steps are easy. This could be why we so often outsource them to someone else.”
Not enough time
“You’ve worked for me for 10 years and I still don’t know if you are a good investor.” — Marc Rowan, CEO of Apollo Group, to the generation of employees at his firm who haven’t had to navigate a difficult market environment. (From: “Private equity titans dance until the music stops under the California sun.”)
The other side of the cycle
A Financial Times story from late April concerned BlackRock Throgmorton Trust, the subject of this chart. According to it, the portfolio manager “blamed widespread share price declines on ‘fear of potential future problems’ rather than ‘a reaction to actual deterioration in cashflows’.” In other words, the opposite of what had been happening prior to that. Valuations go up, valuations go down. Managers take credit for one, but the other is someone else’s fault.
The chart covers the tenure of the manager and shows positive performance over that time. But since September, the trust is -45% in absolute terms and -37% on a relative basis. The bottom panel shows the quick plunge in confidence of late, as measured by the discount to net asset value for the closed-end vehicle.
Portfolio managers have been layering on risk and being rewarded for it. The reversal of fortune leaves allocators with difficult decisions. Standard universe performance distribution charts show the rankings at extremes (like the one for Baillie Gifford Long Term Global Growth, which eVestment says was the most viewed on its platform during the first quarter) — on top for longer periods and at the very bottom recently.
You can say that the longer-term numbers are what matter, but maybe that’s just picturing the risk-taking part of the cycle rather than something more profound. Tough choices ahead.
Postings, etc.
The CAIA Association published “What Will Define the Portfolios of Tomorrow?” which was previously available only to subscribers.
If you missed them, check out these postings:
“Regime Change (With a Lack of Information).” Despite our sophistication, tools, and zettabytes of data, there is a lot that we don’t know and important gaps in the information we have available to us.
“Risks and Opportunities in the Adoption of Alternative Investments.” Advisory firms face pressures from clients and from throughout the investment ecosystem to offer new strategies, some of which are being increasingly viewed (and/or promoted) as essential.
Follow us on Twitter to see the Charts of the Day (for example, ones about the almighty dollar, an unusual Berkshire holding, and a look at daily volatility in the S&P 500 prior to the last few days) and more.
All of the content published by The Investment Ecosystem is available in the archives.
Published: May 9, 2022
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