Welcome to the latest edition of the Fortnightly, which contains a wide range of readings from the investment ecosystem. (Free and paid subscription plans are available here.)
The next fracture
“Financial instability: the hunt for the next market fracture,” reads a Financial Times headline; the story reports: “Violent, sudden price moves in one market can provoke a vicious loop of margin calls and forced sales of other assets, with unpredictable results.”
The sections in it tick off some of the current worries: European repo markets, U.S. Treasury illiquidity, dysfunction in Japanese government markets, private debt and leveraged loan questions, and potential emerging market defaults. Given that worries were in short supply in the risk-on years, perhaps all of this is welcome news heralding more cautious sentiment and some opportunities ahead.
But such reversals of good fortune make people nervous, and there are lots of Lehman-this and dot-com-that analogies being thrown around — especially when a previously high-flying strategy runs into some turbulence. In the last few days, the gating of withdrawals from Blackstone Real Estate Income Trust (BREIT) has drawn attention.
Another FT article, from six weeks ago, was prescient in highlighting potential issues at BREIT before the crowd got worried. It referenced Blackstone CEO Steve Schwarzman’s summary during the second-quarter earnings call of what an investor had said to him:
I’m a BREIT investor. In fact, it’s the biggest thing in my portfolio and I love you people. This is so amazing. All of my friends are losing a fortune in the market and I’m making money.
As a chart from @EconomPic shows, the performance of the non-traded BREIT is completely different from its publicly-traded competitors. That raises the specter of the financial crisis, when private REITs at first held up in the face of declines on those that were marked to market, only to fall hard as the crisis developed.
Investment advice
Adam Van Dusen has a good summary on Nerd’s Eye View of “101 Things That Advisors Actually DO To Add Value (Beyond Just Allocating A Portfolio).” Broken down into seven categories, the list demonstrates the wide range of services that good advisors provide.
Across the pond, the Financial Conduct Authority “proposed significant changes to advice rules to create a new regime allowing ‘mass-market’ consumers access to simplified advice.” A posting by James Fitzgerald for Citywire New Model Advisor lays out the basics of the proposal.
Structural impediments
Tim Hanson of Permanent Equity wrote a short but perceptive essay about recognizing when there are “simple structural elements” that might work for some people but aren’t optimal for an organization as a whole. His example of a disconnect between the percentage of portfolio positions coming from extroverted analysts versus introverted ones demonstrates how relatively simple analytics can reveal structural impediments that should be addressed.
Due diligence
~ “Doesn’t anyone do due diligence any more?” asked Brooke Masters in the FT.
~ Chris Addy of Castle Hall Diligence wrote about operational due diligence in the crypto realm. (Addy was featured on a recent webinar about that topic and will be participating in another next week; both via Opalesque.)
~ Sam Bankman-Fried of FTX said, “We kind of lost track.” (Perhaps “What have you lost track of?” should find its way onto due diligence questionnaires.)
~ The latest commentary from AIM13 includes a section about “asking the right questions” in any kind of a due diligence inquiry.
Other good reads
“Venture Capital Red Flag Checklist, Bill Gurley, Above the Crowd.
It’s no coincidence that Enron [happened in 2001] and that FTX occurred in 2022. Extended, frothy bull markets are a breeding ground for unwarranted corporate behavior. When markets are soaring, speculation increases and as a direct result so does risk. Also, when everything appears to work, investors are more willing to suspend belief.
“Why Good Funds Fail,” @hfreflection. “I’m paranoid our fund will fail, since this is the typical HF ending.”
“Fun and Games: Investment Gamification and Implications for Capital Markets,” Sivananth Ramachandran, CFA Institute.
The pandemic created a new class of investors for the first time, and some of these investors had better outcomes than others. The lucky ones might mistake their luck for skill and increase their risk taking, and the risk-taking effects may last for a long time. In contrast, for those who lost money, their risk aversion may linger too, to their own detriment.
“How to process the FTX news — a test,” Tyler Cowen, Marginal Revolution. More news about FTX has come out since this was written, but these are still interesting spin-off questions.
“Loss Aversion and The Impact of Daily P&L,” Cameron Hight, Alpha Theory.
For fund managers, the wear and tear of daily P&L is one of their biggest mental challenges. One solution is to just stop looking at daily P&L. This path can be liberating, but the pushback is that a portfolio manager must “know” their portfolio, and to do so, they must look at daily P&L (or, even worse, real-time P&L).
“Private Equity Fund Terms Research,” MJ Hudson. Trends in terms on deals where the firm has advised either the manager or an asset owner. Of note: The average number of months between successive fund raises collapsed from 47 to 16 from 2015 to 2020.
“We’re too obsessed with volatility,” Simon Evan-Cook, Citywire Selector.
In short, there is no easy, industrialised way to manage risk. Data can be useful, but it’s no replacement for a broad, human-based assessment of the real-world risks and rewards of an asset.
“Endowment Governance: Aligning Foundation Investments and Mission,” Tracy Filosa, Cambridge Associates. The role of governance in sorting out the confusing mix of potential mission-related alignment initiatives.
“Chief Financial Officer Age and the Perverse Effect of Equity Incentives on Financial Misreporting,” Jing Fang, et. al, SSRN. Younger CFOs with greater discretion over accounting choices are more likely to engage in financial misreporting.
“Regulatory Data Handbook,” A-Team Insight. Tidy descriptions of more than forty significant regulatory rules in markets around the world.
A different eye
“I see all sorts of things that you don’t see.” — Diana Vreeland, legendary fashion editor. (Alpha hunters hope that they do too.)
The explosion in crypto investments
CB Insights released a compilation of “strategy maps” that show recent investments, acquisitions, and partnerships for a number of firms as evidence of what matters to them and what their strategy is. Above is the map for Coinbase, showing its actions for just the last eighteen months or so.
One of the things that became evident in the FTX debacle (or at least seemed to be evident, given the messy state of its recordkeeping) was the degree to which it was investing in a large number of crypto-related firms. It was not alone. If the “crypto winter” continues, the ripple effects of it will lead to more failed firms and venture capital losses.
Posting
“Network Analytics in Investment Organizations” goes beyond the org chart (and even the “orgorg” chart) to consider emerging possibilities for the observation and evaluation of organizations. (But beware the pitfalls.)
All of the content published by The Investment Ecosystem is available in the archives.
Thanks for reading. Many happy total returns.
Published: December 5, 2022
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