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On to the readings.
The circular economy
While “ESG” (as variously defined) has become a high-profile battlefield, one idea that fits within it is starting to show up more frequently at the edges of investment discussions: the “circular economy.”
Many resources about the concept are available from the Ellen MacArthur Foundation, which defines it in this way:
A circular economy is based on the principles of designing out waste and pollution, keeping products and materials in use, and regenerating natural systems.
An ISS guide says, “This matters for investors — analysis suggests that the more circular a company is, the lower its risk of defaulting on debt, and the higher the risk-adjusted returns of its stock.” The emphasis on design is clear from the four-page section on automobile manufacturing found within it.
Investment organizations are starting to get on board; witness a Goldman Sachs Q&A on why companies should pay attention, a StepStone’s piece (“We Don’t Value Nature”), and circular economy products that have been created by BlackRock and VanEck. And given that new design solutions are likely to come from venture capital investments, here’s a paper on that front: “Startups and Circular Economy Strategies: Profile Differences, Barriers and Enablers,” from Wim Van Opstal and Lize Borms.
As has been displayed in the general ESG debate, the long-term financial implications of the ideas are going to be critical in determining who adopts them. To that end, a 2021 ISS report, “The Circular Economy & EVA,” seeks to connect the concept with fundamental financial analysis.
Asset management industry
Three pieces on the asset management industry from management consulting firms:
“The New Competitive Calculus: Winning with data-driven strategy,” Broadridge:
Most recent reviews of the global asset management industry focus on the mounting challenges to its industrial model: fee pressure, slowing growth, increased regulation, complicated client needs.
All these trends underscore the fact that too many asset managers compete in a similar fashion within a wholesale distribution model that increasingly positions their brands further away from end users.
As the title indicates, Broadridge’s “new map for organic growth” involves a greater emphasis on data to diagnose areas of competitive advantage, create a decision support system, and develop the organization for the new environment.
“The Great Reset: North American asset management in 2022,” McKinsey. This paper illustrates the abrupt change in market trends, which present a challenge to an industry that has significantly increased costs in the last decade.
“Integrating Asset Managers: The Executive Playbook.” Casey Quirk (Deloitte). Then: “Historically, investment management deals favored a lighter touch on integration.” Now: “In today’s market, however, acquirers are more likely to apply close scrutiny to cost levels and potential duplicative activities, as they seek to deliver synergies and economies of scale.” The firm offers a “playbook” for better combinations, but the track record for asset manager mergers isn’t good (especially for clients).
Interest rates and factors
The last edition of the Fortnightly referenced the potential ripple effects from the generational change in the economic environment, especially given “the length of the previous trends and the special power of interest rates to affect the pricing of assets and the availability of funding.”
Jules van Binsbergen, et. al, explore one aspect of that in their paper, “The Factor Multiverse: The Role of Interest Rates in Factor Discovery.” From the abstract:
We investigate 153 discovered anomalies as well as 1,395 potential undiscovered anomalies and find that absent the decline in interest rates, the asset pricing literature would likely entertain a different set of anomalies today.
Our analysis highlights the sensitivity of the factor discovery process to this specific observed economic time period.
The so-called “factor zoo” may be populated with lots of critters that thrived in one specific epoch.
Water into wine
At a time when there is much attention being paid to the gap between the “marks” on private capital investments and the severe corrections in the prices for similar exposures in the public markets, Chief Investment Officer quoted the book, Two and Twenty: How the Masters of Private Equity Always Win, as proclaiming that PE firms perform “the financial equivalent of turning water into wine.”
Other reads
“Investing in Influence,” Kai Wu, Sparkline Capital. Just in time for the U.S. midterm elections, a look at the outsized returns from an overlooked intangible asset, political capital:
This implies political spending has a considerably greater payout than that of other intangible investments, such as R&D or advertising.
“Credit Suisse Gives First Boston a Second Chance,” Matt Levine, Bloomberg. In a section titled “Second Boston,” Levine gives a succinct summary of the parts of an investment bank and how they fit together.
“Building Balanced Portfolios for the Long Run: A New Framework for Incorporating Macro Resilience into Asset Allocation,” Peter Shepard, et. al, GIC and MSCI.
Long-term investors face two major shifts in the investment environment. . . . Both could require a fundamental evolution of the asset-allocation process.
“Inside the library of financial mistakes,” Ray Perman, Financial Times. Why is institutional memory so short in the financial markets?
“The Part of Your Investment Process Most in Need of Improvement,” Jason Voss, Deception and Truth Analysis.
There is one part of the typical investment process that is most in need of improvement. Namely, how you conduct conversations with management, sell-side analysts, people in expert networks, and so on.
“Investment Consultants Reevaluate Priorities as Several Long-Tenured, Top Names Change Firms,” Debbie Carlson, Chief Investment Officer. Changes in the business (especially the move to OCIO mandates) have upended this once-stable part of the asset owner ecosystem.
“Addressing Employee Equity Alternatives in a Bear Market,” Aon. This is a concern for investment analysts, since the choices that companies make will affect their talent pools and financial structures — and also for anyone working for a publicly-traded investment organization who is eligible for equity incentives.
“The Social Signal,” J. Anthony Cookson, et. al, SSRN.
We attribute differences across [social investing] platforms to differences in users (e.g., professionals vs. novices) and differences in platform design (e.g., character limits in posts).
These results highlight the importance of distinguishing between social media sentiment and attention, and suggest caution when studying the social signal through the lens of a single platform.
“The perks of manager turnover,” Alex Steger, Citywire RIA. Rajiv Jain of GQG thinks that the knee-jerk reactions to changes in a manager’s investment team are wrong, that a static group will fail over time and new blood is needed to prevent that from occurring.
“META Lesson 1: Corporate Governance,” Aswath Damodaran, Musings on Markets.
I know that my Facebook investment will ride and fall with Mark Zuckerberg’s ego, and while I have no delusions about being able to influence him, I think that at today’s prices, the odds are in my favor. Time will tell!
“Which Popular Funds Will Hit Investors With Losses and Capital Gains Distributions This Year?” Stephen Welch, Morningstar. A look at the numbers from that dreaded combination of the payout of previous capital gains being recognized in the midst of a market well off its highs.
“Multi-strategy hedge funds are the new, superior fund-of-funds,” Robin Wigglesworth, Financial Times.
Thoroughly analysing portfolio managers, judging how much capital their strategies can optimally manage, constantly monitoring them, and firing underperformers; management is an arduous, difficult task — even before you start thinking of how to combine them into an overall portfolio.
I suspect a lot of institutional investors are realistically not up to it, but they intuitively liked the fund-of-funds model, and now love the multistrat model.
“Revere is creating a ratings system for the venture capital industry,” Natasha Mascarenhas, TechCrunch. “The venture capital industry is built on signals.”
The captain and the seas
“It could be stated that the average portfolio manager has more responsibility for a task than the explicit unadulterated power to accomplish it. This statement, embracing the reflexive environment in which portfolio management occurs, accurately depicts portfolio management as an amalgam of manager decisions and market activity, much as a ship’s voyage is determined by the captain’s skill and the prevailing seas.” — Timothy Ryan, “Separating the Impact of Portfolio Management Decisions,” Journal of Performance Management (2001).
Which way is up?
The art world has been abuzz because of a claim that a Mondrian piece has been hung upside down for decades. (Here it is both ways; which makes sense to you?) No one knows for sure which way is up and, as the person who brought the possibility to light remarked, “Who can say what Mondrian really wanted?”
That echoed a discovery in the eighties at the University of Minnesota that “Oriental Poppies” by Georgia O’Keeffe had been shown there vertically instead of horizontally for thirty years. The museum director said, “What the heck, it looks terrific either way.”
No doubt many investment people are trying to figure out which way is up right now. And it’s always good practice to reconsider whether something in an investment process has been oriented incorrectly for a time and no one has noticed.
Also, there are things in the market experience that seem out of order to the viewer — like “The Surprising Alpha From Malkiel’s Monkey and Upside-Down Strategies,” in which the inverse of an outperforming strategy also outperforms. Or like “Does Past Performance Matter in Investment Manager Selection?” which shows that you’re better off investing in mutual fund losers (except the perennially bad ones) rather than previous winners.
Postings
“Lessons From a Pension Plan Soap Opera” tells the seemingly-never-ending story of the Kentucky pension system, highlighting both the out-of-norm happenings as well as some common practices to reconsider.
“Benchmarking” is a “Four for Friday” posting that looks at principles regarding benchmarks and some examples of how they can be used (and misused) by asset owners and investment providers.
All of the content published by The Investment Ecosystem is available in the archives.
Thanks for reading. Many happy total returns.
Published: November 7, 2022
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