How is your R&D coming along?
First the pandemic, then a difficult 2022, and now, suddenly, concerns about some parts of the banking system. It has seemed like (well) everything, everywhere, all at once.
In environments like those, time horizons shorten, perspectives narrow, and innovation efforts are put on hold, sacrificing long-term opportunities to fight the fires of today.
All investment organizations need R&D efforts that span several dimensions, as outlined here.
Don’t bank on it
In the last three trading days, your inboxes have become stuffed with reporting, knee-jerk analysis, trade ideas, and political and economic commentary about a banking crisis that wasn’t even on your radar screen before that. Rather than pick what seem to be some of the best pieces during a period of rapid change, we’ll let the dust settle a little.
It is a good time to see the narrative process in action. The first reaction by many market participants is to interpret the events based upon their existing world view — that comes naturally to all of us. But there have been some notable flip-flops, as indicated by John Thornhill’s opinion piece in the Financial Times:
Like banking titans in 2008, tech tycoons favour the privatisation of profits and the socialisation of losses.
There are arguments about language: Are these bailouts or not? What do we call this spasm? Is it a banking crisis or something else?
Yet to be seen are the ripple effects from the unwinding of some of the concentrated web of venture capital relationships at Silicon Valley Bank, as well as the interest rate risks that had grown large there and at some other banks. On both fronts we’ve seen another chapter in the ongoing saga of analysis and risk management taking a back seat — or rather being tied up in the trunk — while business momentum drives decision making.
Since the close on Wednesday, the yield on the two-year U.S. Treasury has dropped more than one percent. Is that a reason to cheer or to worry? For one thing, such a sharp reversal after a prolonged move higher probably caused some large losses for some levered strategies.
Investor identities
Ashby Monk and Dane Rook continue their work on the analysis of institutional investors in “The ‘Investor Identity’: The Ultimate Driver of Returns” (available on SSRN). They stress the differences across those investors (who are often lumped together and whose results are compared to each other), based upon their particular sponsors, geographic locations, resources, capabilities, and histories. There is no one best approach, just better choices under particular circumstances.
The authors offer a framework within which the production of investment returns is a function of capital, people, processes, and information. Three “enablers” improve those inputs: governance, culture, and technology. And then there’s innovation, “a direct function of how those seven elements work in conjunction.”
This structure is used to outline five “mini-cases” that speak to the differences in often-cited approaches, four of which are known by prominent pioneers of them: the Yale, Canadian, Norway, and Australian models. A fifth, the “collaborative model,” rounds out the group.
Unlocking value
A paper from FCLTGlobal, “Unlocking Value by Targeting Long-term Shareholders,” says that “attracting the right shareholders can make or break a long-term corporate strategy.” It argues for changes in how companies present themselves to the market, including eschewing the typical playbook for sell-side interactions and earnings calls, which primarily feed the needs of traders rather than investors. Companies should:
Target long-term shareholders strategically.
Engage with their large, long-term shareholders, not with the “investment community.”
Reward IR professionals for long-term shareholder success.
Other reads
“On Availability Cascades,” Marc Andreesen. While reading through this excellent piece, think about how investment market participants also try to spark and fan the flames of cascades that are in their interests.
What is the purpose of activists, experts, professors, nonprofits, and various other kinds of pressure groups? To propose and propagate availability cascades, to put their unique topics front and center in the public consciousness, in hopes of triggering availability bias and sparking availability cascades — and the resulting money and prestige and influence and power.
“Could You Bear Being the Sidekick?” Frederik Gieschen, Neckar. “Consider how unusual it is for Munger to accept the junior role despite being a brilliant thinker in his own right.”
“Psychological Paths of Least Resistance,” Morgan Housel, Collaborative Fund.
Being honest about the odds that your opinions and forecasts will actually come true can be so discouraging and uncomfortable that the warm blanket of denial and overoptimism becomes home to most people’s beliefs.
“Preparing for the Unknown Unknowns,” Matthew Crow, Mercer Capital. The proposed purchase of Focus Financial is an interesting case in the RIA M&A scrum; its “partner firms must be wondering if they’ve got the deal they signed up for.”
“Developing a Personal Backstory that Resonates with Clients,” Dan Sondhelm, Sondhelm Partners. Better ways to respond to a request to “Tell me about yourself” than a list of schools and jobs.
“Fund Managers: Are you prepared for investor due diligence in 2023?” Fiona Sherwood, Dasseti.
It’s not just that there’s an ESG section or a diversity section. The questions are being peppered right through the DDQ now. They’re popping up in every different category of questions.
“Adopting behavioral finance in investment management,” Florian Forst, Arthur D. Little. To tailor their offerings to “the very specific needs of individual customers,” firms “must know what makes their customers tick.”
“Chronicles of an Allocator,” CAIA Association. Key elements in moving from modern portfolio theory to a total portfolio approach to managing a pool of assets.
“Why Lehman Brothers Failed When It Did,” Joe Pimbley, Stories.Finance.
While numerous factors contributed to Lehman’s demise, the immediate cause was collateral calls by Lehman’s clearing banks, chiefly JPMorgan.
“The diluted EPS calculation is 50 years out of date,” Steve Cooper and Dennis Jullens, The Footnotes Analyst. The “full economic value . . . is not reflected in financial statements.”
“Morningstar’s Role in Portfolio Framework,” Amy Arnott, Morningstar. The framework “is designed to help beginning investors avoid unforced errors” by assigning funds (by type) to “a recommended minimum holding period and a maximum position size within a portfolio.”
Finding good ideas
“The way to get good ideas is to get lots of ideas, and throw the bad ones away.” — Linus Pauling.
The private equity debate
This chart is from “Private Equity’s Other Illiquidity Premium,” a Man Group report by John Lidington. It is used to assert “that 2009 was the last vintage of buyout funds to significantly outperform the passive public equity market on a realised [public market equivalent] basis,” and that missing the 2021 exit window has put the unrealized portions of the more recent vintages in doubt.
The piece offers good perspective on issues of diversification, correlation, volatility, drawdowns, and smoothing techniques. Worth highlighting advocates for “liquid private equity alternatives” (which Man offers), so it also picks up on previous research by others on PE replication strategies.
While “many investors prefer to have smoothed returns reported to them . . . the question becomes how much of a fee premium should be paid for smoothing.” Does the “absolutely massive mismatch in the typical fees paid” make sense? (Even if some of those fees are recycled into asset owner benefits beyond smoothing.)
But the private equity debate is an active one, so here are some perspectives from the other side: The Bain Global Private Equity Report details the tale of two 2022s (and says that “opportunity awaits firms that stay aggressive”); KKR explains “The Role of Private Equity in the ‘Traditional’ Portfolio” during a time of regime change; and BNP Paribas offers the standard narrative that increased investments in private assets are warranted, “given their potential to enhance returns and reduce risk” — while adding a wrinkle, “and the role they can play in sustainable investing” — in a report titled “Allocating to private assets in open-ended funds.”
Postings
Two recent postings for paid subscribers:
“Are Hedge Funds Aligned with Their Investors?” A paper based on a recent survey of hedge fund managers prompts questions about the alignment of interests between hedge funds and their investors.
“The Outsourcing Debate: Principles and Rules.” A proposed SEC rule regarding the outsourcing of capabilities by investment advisory firms shines a light on how they evaluate and select third-party providers.
All of the content published by The Investment Ecosystem is available in the archives.
Thanks for reading. Many happy total returns.
Published: March 13, 2023
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