The cave you fear to enter holds the treasure you seek.
“The retirement funds for U.S. corporations had just 82% of the money they expect to need over time for pensioners as of August, down four percentage points from July, according to a statement from consulting firm Mercer on Monday. The steep drop stemmed from long-term bond yields plunging to record lows, which effectively increases the current value of companies’ future obligations. Declines in U.S. equities didn’t help either.
“When companies have more than about 80% of the funding they expect to need for pensions, they tend to cut their investments in riskier assets like stocks and increase safer holdings like bonds to lock in gains and reduce risk. Companies closer to that level or below it are less likely to make those shifts, and more likely to contribute more of their cash flow toward their pensions, JPMorgan Chase & Co. strategists wrote last month.”
– ‘Corporate Pension Funding Moves Closer to Worrisome 80% Level’, Bloomberg article, 9 September 2019.
“Pensions are struggling in an increasingly low-yield world. ‘The current environment leaves us with a puzzling dilemma: where to invest when most asset classes look expensive.’”
– Tweet from Bloomberg columnist Lisa Abramowicz (@lisaabramowicz1), 10 September 2019.
In the history of fund management, the name of Fidelity Magellan’s Peter Lynch still carries a lot of weight. Lynch is considered by many to be the greatest mutual fund manager of all time. (Warren Buffett, for example, just to get technical about it, is a businessman managing a diversified holding company.) But is Lynch’s reputation all it’s cracked up to be ? Spencer Jakab:
During his tenure Lynch trounced the market overall and beat it in most years, racking up a 29 percent annualized return. But Lynch himself pointed out a fly in the ointment. He calculated that the average investor in his fund made only around 7 percent during the same period. When he would have a setback, for example, the money would flow out of the fund through redemptions. Then when he got back on track it would flow back in, having missed the recovery.
Source: Peter Lynch’s Track Record Revisited
Not that the fund manager should be found guilty for the sins of his investors. But the point stands, nevertheless. Unless you had either unnatural luck or superhuman patience or market timing, you never enjoyed the returns cited by Fidelity’s Magellan fund.
Are all asset classes expensive ? Well, it depends where you look.
Most institutional managers are constrained on multiple fronts. They track some form of index or benchmark; that index or benchmark will almost invariably be market-relative as opposed to absolute in nature; they will have either very limited or no real discretion to limit the size of their funds.
Take Vietnam, which is one of our favourite markets. It’s a favourite primarily on valuation grounds: its companies, whilst in many cases highly profitable and growing quickly, trade on a huge discount to those throughout the rest of the world. It’s also a favourite because of economic fundamentals. Vietnamese wage rates, for example, are roughly a third of those in China.
But Vietnam is also a favourite because of a technical wrinkle. By dint of being defined as a ‘frontier’ economy (one step below that of an ‘emerging market’), Vietnam does not sit within the MSCI World Index – it’s not yet a developed economy. But it doesn’t sit within the MSCI Emerging Market Index either – it’s not yet deemed mature enough.
What this means is that if you’re an institutional fund manager tracking either MSCI World or MSCI Emerging, you don’t get to play in Vietnam. You’re not allowed. You can’t. Well, we can – because we’re not constrained by a box marked MSCI or anything else. Hint: it will likely make more sense as a private investor to own Vietnam before the Big Boys are allowed in.
We have long stated that the only benchmark that should matter to any investor (private or otherwise) is an absolute return one. That is to say, we believe more strongly in sustained capital preservation in real terms, than in more speculative capital growth that exposes client portfolios to huge swings in net asset value – up and down. This has inevitably somewhat impeded the growth of our business during one of the longest bull markets in history, but it may yet serve our clients through what is surely one of the most challenging financial environments in history, too.
Perhaps the biggest impediment to investment performance is size. As Warren Buffett himself has acknowledged on numerous occasions:
Size is the anchor of performance.
Asset management practitioners would provide a superior service to their clients if they limited inflows and concentrated on delivering investment returns. Sadly, the ‘institutional imperative’ makes onerous demands on institutional players. In other words, it forces them to get greedy. Given that the largest asset managers now control trillions of dollars by way of assets under management, investors in their funds might want to answer the following question using words of one syllable: can a market beat itself ?
Before buying any fund, ask yourself some additional questions:
• How big is it ? The tree cannot grow to the sky. But try telling that to Blackrock, or to Neil Woodford, or to the average member of the Investment Association. Managers’ pay is invariably linked to the size of funds under management. The more assets, the more pay. It takes guts, and principles, to turn money away and concentrate solely on investment performance. But that’s precisely what many smaller investment boutiques do on a regular basis. And it’s why we only invest with smaller investment boutiques.
• Has the manager invested his own money ? If he hasn’t, why should you ? Meaningful personal investment is by itself no guarantee of investment outperformance, but it shows the most basic alignment of interests between manager and investor.
• Is it independent, and owner-managed ? David Swensen has gone on record saying he prefers the smaller, private partnership over the larger, listed full service operator. How many mouths must your fees feed ?
• Is it an asset manager, or an asset gatherer ? This gets to the heart of the challenge facing investors today. The investment world is polarised between asset managers, who focus their energies on delivering the best possible returns for their clients, and asset gatherers, who just want to maximize the number of clients. Most fund management firms fall into the latter category. Favour the former.
How to distinguish between the asset managers and the asset gatherers ? Try to find managers like the celebrated investor Jean-Marie Eveillard, who once remarked:
“I would rather lose half of my shareholders than half of my shareholders’ money.”
We conclude with three observations.
1. Homo economicus doesn’t exist outside the economics textbooks. Private investors, together with their professional advisers and managers, may often be guilty of confusing needs with wants. When they say they want a certain annualised return, they might more accurately need the absolute preservation of their purchasing power over time – and, ideally, some form of incremental positive return on top.
2. That size is the enemy of performance is the fund management industry’s dirty little secret that hides in plain sight.
3. Index-relative investing is for the birds, despite the fact that almost the entire asset management industry pursues it. The essential truth of this statement will become almost tangible during the next market correction.
To return to Lisa Abramowicz’s perturbed pension correspondents.. There is no shortage of attractive investment opportunities in an unconstrained global marketplace. You just have to be looking for them. And most asset managers, as a direct and inevitable result of the hope, need and greed that drives their institutional imperatives, simply are not.
Nearly every time I strayed from the herd, I’ve made a lot of money. Wandering away from the action is the way to find the new action.
Or Joseph Campbell:
The cave you fear to enter holds the treasure you seek.
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