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Rational sustainability
Where we are:
ESG is under attack from all sides. True believers wish to keep practicing ESG but call it something different; opportunists recognize that an ESG label no longer helps launch funds or attract customers; opponents seek to ban ESG outright. But if ESG is to be scrapped, what do we replace it with? Retiring the term but continuing the practice fails to address the legitimate challenges to ESG; abandoning the practice throws the baby out with the bathwater.
That’s the start of an abstract from Alex Edmans. He proposes a new label (with a new focus): “Rational Sustainability.” It has ten features. The first is “Rational Sustainability is About Value Creation, not Politics.”
Another: “Rational Sustainability Sets Boundaries.” (Conversely, “Irrational sustainability involves trying to tick as many ESG boxes as possible.”) Edmans uses two criteria as boundaries, comparative advantage and materiality.
At a time when investment organizations are wrestling with these issues, the paper is a useful addition to the debate.
Better meetings
You can tell a great deal about an organization by its meetings, although if you attend one as an outsider you aren’t viewing the proceedings in their normal state and you often don’t learn much. That said, when vetting an organization, it is important to understand the different types of meetings — purpose, frequency, rules, norms, decision making process, etc. It’s especially helpful if you ask more than one person individually; you might hear quite different stories.
Not many have clear guidelines about how meetings are to be conducted and why those guidelines exist. An exception: “How to Have Meetings That Don’t Suck” from NZS Capital, which outlines the firm’s method. It offers “seven paths to better meetings,” to address the problems of ego and career maneuvering that make many gatherings of investment people more performative than productive.
For those who thrive in a traditional meeting environment but can’t make the switch to the NZS approach:
No matter how great their individual contributions might be, they must be cut out to allow the collective intelligence of the group to thrive. . . . Firing a toxic team member, even one with superior performance, is perhaps the single most value-maximizing thing a team can do.
The ghost of inflation past
In a recent column, John Authers of Bloomberg addressed the conundrum for the Federal Reserve, which was late to the job of fighting inflation and is reluctant to accede to investors’ hopes and dreams when the economy has remained fairly strong and inflation readings are still above target.
Authers argues that “overcoming the abundance of caution requires addressing the potent lesson from the worst central banking experience in modern history.” Translated: “the desire not to be the next Arthur Burns must be potent.” Burns was the chairman of the Fed from 1970 to 1978 and William Miller for two years thereafter. The chart above shows the one-two punch of inflation that scarred investors during their times.
Jasmine Yeo of Ruffer thinks declaring victory against inflation is premature, expecting that “we have entered a new regime of inflation volatility” that will mislead investors:
The catch: it is nearly impossible to distinguish between a “normalisation” back to a world of low, stable inflation and a disinflationary leg within a regime of inflation volatility.
On a related note, the chart below is from a posting by Greg Obenshain of Verdad that shows what corporate credit quality a 7% yield buys (for a five-year note). At times you can get AAAs that yield that much; in 2021, you needed to reach down into the barrel for a CCC to get that sort of yield to maturity.
If this graph went back as far as the one above, the line would be at the top for most of the time from 1970 to 1985, and not just for the highest-rated corporates, but for U.S. Treasuries.
Problematic PE
An article by Sarah Rundell of Top1000funds about Oregon Public Employees Retirement Fund indicates that its private equity allocation “is at the very top end of its target range.” That’s common right now among asset owners.
“Anemic” exit activity has caused the PE portfolio to be cash flow negative for the first time in a decade. And the larger funds into which Oregon and other public plans mostly invest appear to have significantly underperformed smaller managers. (Although the private markets team “noted ‘actual, crystalized IRR’ confirming smaller fund outperformance remains unproven,” an important distinction given the evidence that early IRRs are not predictive of final ones). The plan’s board “heard how the dynamics behind private equity are changing,” yet it will stick with the previous commitment schedule.
Private equity has been a one-direction bet for years and allocations are materially different from a decade ago (Oregon’s is 28%). Will a prolonged down cycle (there’s never really been one before) trigger a reappraisal?
In the papers
A mix of worthwhile papers of late:
“Modeling and Forecasting Cash-Flows in Private Investments,” Jean-Baptiste Guillemin, SSRN.
“Why Has Factor Investing Failed?: The Role of Specification Errors,” Marcos Lopez de Prado and Vincent Zoonekynd, SSRN.
“Stocks for the Long Run? Sometimes Yes, Sometimes No,” Edward McQuarrie, Financial Analysts Journal.
“Fund Flows and Income Risk of Fund Managers,” Xiao Cen, et. al, NBER.
“Political Connections and Public Pension Fund Investments: Evidence from Private Equity,” Jaejin Lee, SSRN.
Other reads
“The Private Party of the Corporate Credit Market,” Acadian.
Many investors who allocate to private credit do so in the hope of realizing a liquidity premium. Yet while it is true that private credit markets have offered additional yield above their public counterparts, several pieces of evidence point to higher credit risk, not a liquidity premium, as the major driver of these higher yields.
“An Asset Allocator’s Perspective on Artificial Intelligence Use Cases,” Blair Webb, Purdue Research Foundation Office of Investments, (via LinkedIn). From surveying other asset owners, a list of seven AI uses for improving productivity and two for generating alpha.
“Value investing: ‘The reports of my death have been greatly exaggerated’,” Matthias Hanauer, Robeco. Ten charts on “the long-awaited comeback of the value factor.”
“Venture capital: Shedding the ‘access class’ label,” Stepstone.
Based on our experience, it is a tall order to excel at all four parts [of venture investing] and is not necessarily required to generate outsized returns. That said, we see less differentiation in managers within the “sourcing” and “impacting” parts of the job, since most firms boast large and similar networks and tend to offer similar services. In contrast, there tends to be greater variability in investors’ abilities as it relates to “judging” promising early-stage companies and “winning” competitive deals, which we believe are competencies that subsequently manifest as top-quartile fund performance.
“Risky business? The seven indicators of shell company risk,” Moody’s. The red flags are jurisdictional risk, circular ownerships, atypical directorships, financial anomalies, outlier ages of principals, mass registration patterns, and dormancy periods.
“Feet to the Fire: How Should Companies Tie Executive Compensation to Climate Targets?” Ida Hempel, et. al, Stanford Business.
Ultimately, any company that is committed to achieving an objective will provide executives with a monetary incentive to achieve that goal. Industry data, however, indicates that only a minority of companies include climate metrics in their annual bonus programs, and even fewer in the long-term program.
“Your network matters, but not always to your benefit,” Joachim Klement, Klement on Investing. On connections, herding, and prices drifting from fair value.
“Firings and Viagra: What Your Office Janitor Knows,” Callum Borchers, Wall Street Journal. There are people who know the real world behind the narrative.
The past and the future
“All big data comes from the same place: the past. Yet, a single change in context can change human behavior significantly.” — Rory Sutherland, via The Daily Coach.
Flashback: Netscape
The online archive of the Wall Street Journal starts on December 31, 1997. One story that day was “Shares of Netscape Decline Amid Worries About Earnings,” which indicated that “Microsoft’s aggressive competition has frightened investors.” Internet Explorer was rapidly gaining ground, thanks to it being bundled with Microsoft’s operating system.
The piece ended:
Many say Netscape won’t be able to surpass Microsoft as an Internet-server software supplier but it should be able to hold on to second or third place, still a very profitable position.
Netscape was acquired by AOL in the heat of the dot-com melt-up. By 2001, the browser’s market share, once over 90%, was under 10% and three years later below 1%. The last version of its browser was released in 2008.
Postings
All of the Fortnightly postings, as well as essays on a range of investment topics, are available in the archives.
In the Netscape article cited above, Mary Meeker said that the firm was “still working hard to make the quarter.” At the time, she was an analyst at Morgan Stanley, dubbed the “Queen of the Internet.” For a look back at that unusual period on Wall Street, check out a 2022 posting, “The Star Analyst Years.”
Thanks for reading. Many happy total returns.
Published: February 5, 2024
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