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On to the readings . . . .
Investment beliefs in action
Stuart Dunbar of Baillie Gifford wrote a piece five years ago called “Let’s talk about actual investing,” which laid out the what the firm saw as a drift in the asset management industry from the real mission of what “actual investors” do:
Hence beta became the default investment portfolio and “outperformance” of that became the value proposition of the active management industry.
This, in turn, led to active managers focusing less and less on fundamental investment analysis, and more and more on the completely circular activity of trying to marginally outsmart each other. In this marginal world the definition of investment success became a relative one, along with costs and transparency.
In a recent podcast (a transcript is provided), Dunbar reiterated the firm’s philosophy that actual investing concerns “companies and capital allocation.” The discussion includes ideas about the link between interest rates and growth investing (“it’s overplayed”); the difficulty of predicting what companies are going to do well in the years to come (some failures are noted); and whether you should just let stocks ride no matter how giddy investors get:
We’ve looked back at if we should have done more at the beginning of 2021 to lock in what was a sort of crazy performance in 2020. And the answer on the whole is no.
Oaktree is a much different kind of investment firm than Baillie Gifford, but in his latest memo (“Taking the Temperature”) Howard Marks laid out two tenets of its founding investment philosophy that struck a similar note:
Number five: “We don’t base our investment decisions on macro forecasts.”
Number six: “We’re not market timers.”
The memo is about the exceptions to those rules, the five times over his long career when Marks thought the macro environment was such that it made sense to alter the firm’s normal approach. But, in contrast to Baillie Gifford’s views:
It’s easy to say you don’t invest on the basis of macro forecasts, and I’ve been saying this for decades. But the truth is, if you’re a bottom-up investor, you make estimates regarding future earnings and/or asset values, and those estimates have to be predicated on assumptions regarding the macro environment.
What we never do is project that the macro environment will be distinctly better than normal in some way, making winners out of particular investments.
That’s something that growth investors are prone to do (since selling optimistic assumptions is baked into that part of the industry), even if they say that macro isn’t important in their process. In contrast, Marks references Oaktree’s “usual emphasis on defensiveness” which stems from its value orientation.
Two firms, each very successful, with contrasting beliefs in many respects, but they intersect in that they generally avoid market calls. Too often a lack of understanding by investors of how asset manager beliefs translate into actions — and into patterns of performance in different market and economic regimes — leads to reactive performance chasing (and fleeing).
Formulas
If you search online for information about the CFA Program, you’ll probably run into aggregations of formulas you need to know to prepare for it. As examples, here are ones for the Level 1 exams, from Wiley (99 pages worth) and ICICIdirect (numbered 1 through 199).
An interesting exercise would involve marking up the lists as to which items really matter to pass the test and, more importantly, which ones really matter for success in the investment profession. With machines able to do the heavy quantitative lifting — and according to the news of the day, much more than that — memorizing the formulas has never seemed less important.
Books, etc.
Two firms (with different sensibilities) have released lists of books and other content sources that might be of interest to you. Broyhill Asset Management issued the latest annual edition of its book club (links to the previous ones are included in it). Another good list comes from Andreessen Horowitz, which leads off with the masterful novel Trust, by Hernan Diaz.
Other reads (and a listen)
“Value Restoration Project,” Seth Klarman and James Grant, Grant’s Current Yield Podcast. A discussion about the latest edition of Security Analysis and the application of its principles in today’s environment. Klarman: “I’m deeply worried about the effects of higher rates. The world got used to low rates; it became a habit.”
“Sex, Drugs and Spreadsheets: Dr. Glazer Treats Wall Street’s Addiction Surge,” Matt Wirz, Wall Street Journal.
Most are traders, fund managers, investment bankers and corporate lawyers. Almost all are men who are afraid to tell their employers about their ailments, much less ask for medical leaves.
“The Keys to Sovereign Development Fund Success: Innovation, Collaboration & Commercial Focus,” Carter Casady, et. al, SSRN. Will “the collaborative investment model” join the Yale, Norway, and Canadian models in the pantheon?
“Can Evolutionary Biology Inform Investing?” Laurance Siegel, AJO Vista. A thoughtful review of a book that addresses key forces in the investment ecosystem.
“No Right Way,” Jonathan Clements, HumbleDollar.
The bottom line: Almost nobody indexes in the theoretically correct way. Instead, we make all kinds of judgment calls as we wrestle with eight key questions.
“What not to say on an earnings call,” Joachim Klement, Klement on Investing. “The market seems to pick up on” non-answers by company executives. (But aren’t non-answers actually the most honest ones in some situations, or is bluffing better?)
“Quant funds move into unfettered pink sheet stock trading,” Nicholas Megaw and Madison Darbyshire, Financial Times.
So-called quant hedge funds and proprietary traders are being drawn towards this corner of the market by a combination of improved liquidity and the increasing difficulty they face making money in the large-cap markets they have previously focused on, say investors, market makers and exchange executives.
“Endowment Spending Amid Record Inflation,” Tracy Abedon Filosa, Cambridge Associates. The effect of inflation on endowment health hasn’t been a consideration in forever (but now is), casting spending policies and operating costs in a new light.
“The Most Successful ETF Launch of All Time Raises Questions,” Jeffrey Ptak, Morningstar. Like others, the fund’s dollar-weighted returns have lagged its total returns, but it differs in that almost half of it is held by affiliated entities (which also include the fund in the model portfolios they provide to advisors). It will be an interesting ongoing case study.
“Make Doing Nothing the Default,” Joe Wiggins, Behavioural Investment.
For investors it is undeniable that there is a powerful and inescapable assumption that we should be constantly active. Why is the idea so pervasive?
“Giant Asset Managers, the Big Three, and Index Investing,” Dorothy Lund and Adriana Robertson, SSRN. “We demonstrate that it is a mistake to equate passive investing with index funds; index funds with the Big Three; and the Big Three with giant asset managers.”
“A Boomer’s Guide to What Happens When You Can Earn 5% on Your Bank Deposits,” Rich Handler and Brian Friedman, Jefferies.
In previous letters, we discussed at length the complications caused by free money. It artificially pushes investors further and further out on the risk curve in search of the elusive yields required to match their assets with their liabilities. But the further you are out on the risk curve, the heavier the inevitable toll is when you need to re-mark your portfolio to the new reality of 5% risk-free rates.
“A Few Questions,” Morgan Housel, Collaborative Fund. Including, “What in my field do I think is a law (works all the time) but is actually just a rule (works some of the time)?”
“Edward Fredkin, 88, Who Saw the Universe as One Big Computer, Dies,” Alex Williams, New York Times. This fascinating obituary contains a description of Fredkin’s paradox, which can come into play in investment decision making.
Different ideas
“It is a good rule, after reading a new book, never to allow yourself another new one till you have read an old one in between. Every age has its own outlook. It is especially good at seeing certain truths and especially liable to make certain mistakes. We all, therefore, need the books that will correct the characteristic mistakes of our own period. And that means the old books.” — C.S. Lewis.
Subscription lines
In the initial posting of a series about subscription lines of credit, Burgiss offers three images that track the increasing use of those borrowings by the managers of private investment funds.
One chart (not shown) displays the fraction of funds using a sub line in a given quarter. From 0% in every category at the turn of the century, real estate was the early mover in tapping lines, ramping up that activity much more quickly than other kinds of partnerships did. Buyout and debt funds took off in 2010, and now, like real estate, are in the mid-30% range in terms of number of funds using a line each quarter. Venture capital usage is much lower, less than 10%.
But those aggregate numbers hide the story that it’s a front-end-loaded practice, as is evident in the chart above, which shows the percentage of one-year old funds using subscription lines. VC still lags the other categories, each of which has risen to 60% or more.
The game plan has changed — and IRR is something different than it was before.
Postings
“The Banality of Investment Process” — a Sampler posting previously available only to paid subscribers but now out from behind the paywall — uses a documentary about the Beatles to provide instructive examples of team performance and the difficulty of describing the real process behind the scene.
“Intellectual Laziness and Illusory Success” leverages an excellent essay about General Electric from MD&A to look at a critical attribute of organizational culture.
“Orbiting the Asset Management Hairball” concerns the (historically one-sided) tug-of-war between convention and exploration, for individuals and firms.
All of the content published by The Investment Ecosystem is available in the archives.
Thanks for reading. Many happy total returns.
Published: July 17, 2023
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