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AI über alles
The introduction of ChatGPT set off a fervor regarding artificial intelligence that seems to be expanding exponentially. We’ve seen many shooting stars before — remember the metaverse? — but AI has been researched and talked about for decades. Now it seems that long-held hopes and fears are close to reality.
As ever, the investment industry is in chase mode, looking to own the picks-and-shovels providers and the firms that can disrupt an industry using AI, while remaking its own processes to capture that elusive alpha.
The CFA Institute Research Foundation has issued a handbook on AI and big data applications in investments. The introduction lists a wide range of people who should read it, from “C-suite executives and board members” to those leading projects to investment professionals, regulators, and students. A foreword that precedes it illustrates one challenge, in that it assumes a higher level of knowledge than most readers will have. As with many other investment topics, finding the communication sweet spot regarding AI concepts will be difficult except within narrowly-drawn groups. Important topics are covered within the handbook, but which of them connect with you will depend on where you are starting from.
Elsewhere, there are all sorts of angles to pursue; a smattering of examples: How does ChatGPT work? Which businesses will be disrupted? Can ChatGPT get to the essence of sentiment by summarizing the bloated disclosures in filings? How long before we see revolutionary changes in applications (and elevated risks) because of AI? Can I use it to beat the market?
One place to start is with a series of questions that will get you thinking about some of the quandaries you will face in the future.
Gaping holes
David Larcker and Brian Tayan released a paper in the Stanford Closer Look Series, “Seven Gaping Holes in our Knowledge of Corporate Governance.” The authors write, “The formulation of best practices (or should we say “better practices”) would improve greatly from careful research into these topics.”
In brief, the seven topics are: what attributes make a board effective; how to assess the true independence of directors; how to deal with the inefficient market for CEOs; how much value creation should be attributed to CEOs; how to align pay and performance; whether having “quality shareholders” makes a meaningful difference (if you can identify them); and what role other stakeholders should play in governance.
Searching for the right valuations
A white paper from Deloitte is titled “Now that the dust has settled,” although it’s not clear what that means. The piece is aimed at mutual fund board directors, to help them in their oversight of valuation practices, especially regarding alternative investments, but the ideas put forth apply to other kinds of entities and governing bodies.
For a given private investment, the valuations used by owners can vary widely, causing confusion and poor decision making — and setting funds up for legal claims regarding excessive fees for assets under management if the assets are overvalued. But there is no easy answer:
Valuations that are “conservative” may reduce the risk that a fund incurs excessive fees. However, for open-end funds, it can still lead to an incorrect NAV on each and every day that the NAV is calculated, disadvantaging certain fund investors.
University initiatives
Adjacent items on the “Frontlines” page of a recent issue of Pensions & Investments highlighted new investment-related initiatives at high-profile universities. Ashby Monk will be leading the Institutional Investors and Sustainable Capitalism Seminar at Stanford; he seeks to “get a generation of Stanford grads to want to work for pension funds.” Yale created the Swensen Asset Management Institute, according to its website, to “further the study and practice of asset management by supporting research, convening thought leaders, and funding scholarships.”
Other reads
“Regulatory arbitrage,” Matt Levine, Bloomberg. (Second section of the column.)
The lesson that I learned from my career as a derivatives structurer is that much of finance is about this sort of regulatory arbitrage. Economic life is socially constructed, society has rules, and you can make use of the rules to make money.
“Inside Wells Fargo’s ‘chaotic’ journey to transform its services for the ultrarich,” Hayley Cuccinello and Reed Alexander, Insider. Should advisory firms segment their advisory services for different levels of wealth? How?
“Apple is a Chinese company,” Jay Newman, Financial Times.
In the race against time, Apple’s scramble to reduce dependence on China won’t beat the CCP’s power to erase most of its value with the stroke of a pen. Investors, take note.
“On the Road to Failure,” Slidebook. Slide decks created by some notable frauds and failures of the past and present.
“Investors With Radically Different ESG Views Got in a Room Together. Here’s What Happened Next.” Alicia McElhaney, Institutional Investor. Giuseppe Bivona:
My biggest concern is that we have five constituencies. Two leading proxy advisors and three dominant asset managers. They effectively control the outcome of any annual general meeting.
“It’s a Case of ‘BuyIRR Beware’ for Private Equity Investors as Headwinds Compress Multiples,” Jeffrey Diehl, Adams Street. On the need for “rigorous IRR diligence” in a changed environment.
“Spitzer’s research settlement at 20,” Craig Coben, Financial Times.
Nuclear plant safety inspector Homer Jay Simpson once described alcohol as “the cause of, and solution to, all of life’s problems.” The same could be said about Spitzer’s reforms and the problems with equity research.
“Who Goes Into Finance, and Who Stays?” Byrne Hobart, Capital Gains. “The baseline skill in finance isn’t cleverness, but conscientiousness.”
“Vicious Traps,” Morgan Housel, Collaborative Fund.
Take patience and confidence. They both sound great. But mixed together they often form stubbornness, which is a disaster.
“The Direct Indexing Landscape,” Jason Kephart, et. al, Morningstar. Following the flurry of acquisitions in the “arms race” among asset managers to get on board the direct indexing trend, providers are struggling to differentiate themselves. (Note that Morningstar offers its own direct indexing service in addition to commenting on those of others.)
Evergreen quote
“Diligence is the mother of good luck.” — Benjamin Franklin.
Shadow banks
This chart accompanied a Greg Ip article, “Banking Problems May Be Tip of Debt Iceberg,” from the Wall Street Journal. Strong growth in assets is not a predictor of problems, but it does bear watching when the environment changes, which we’ve seen in spades. The focus has been on banks to date; will it shift to “shadow banks”?
They don’t face a run-on-the-bank risk of depositors fleeing, although a series of tweets by Kieran Goodwin argues that something similar is possible, ending with this: “Forced selling into a market with zero liquidity would have wide ranging ramifications.”
As you would expect, the view from the managers of private credit assets is more sanguine. See, for example, “The Opportunity of a Lifetime?” from Benefit Street Partners, which acknowledges some near-term challenges but draws a very positive picture overall, and an article in Institutional Investor.
Postings
“Airbrushed Appearances and Underlying Realities” was a Sampler posting, brought out from behind the paywall for all to read. Its last paragraph:
A conventional due diligence process allows asset managers to deliver their intended message as they would like. Discovery involves getting past that.
Paid subscribers also received the first two postings in a series on the cultures at different kinds of investment organizations:
“The Anthropologists and the Pension Funds.”
“Wall Street Culture and the Shareholder Value Mantra.”
All of the content published by The Investment Ecosystem is available in the archives.
Thanks for reading. Many happy total returns.
Published: May 8, 2023
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