I remember my uncle came to visit from British Colombia and as a gift he bought me my first bow and arrow. I was so excited that I shot every single thing in the woods I could find–except of course, the animals I was aiming at… It was then I realized that hunting for food is not like in the movies and in reality it is quite challenging; a humbling experience.
Likewise, years later, after falling down the global monetary system rabbit hole I’ve realized that trying to find a company that checks all the boxes is perhaps equally as challenging. It takes a lot of time, listening, reading, questioning, comparing, evaluation and you still may get nowhere (by analogy, to come home hungry!).
As we both know, markets have seen an unprecedented level of investment, mania & narratives fuelled by an immensity of reserves over the last 4 years. By historical terms, you may say we are in a hyper bubble not only in stocks, but in bonds and real estate as well. It would seem, that every shot you take, hits something valuable!
It is like hunting at the zoo!
A Change of Tactics
It comes as no surprise that an approach to stock picking and fund management would change–after all, if you’re in an environment where every bloody thing goes up when you buy it, its best not to allocate time studying whether it is bound to go up or not. Instead, you may try other ways to generate income.
Fund managers now make money not by choosing the best investments relative to their buddies across the street– they make it by having the largest pool of investors on the street. It’s much more advantageous to spend all your OpEX on sales, rather than analytics.
In some sense, the priority of fund managers now is to be the ultimate salesman–to push as many people as humanly possible into your ETF or other financial product. The real money is on the management fees rather than “being right” with the asset allocation (since everybody is right remember!). If they charge 85 basis points or so on a number like $5B, they are making huge returns, yearly. This is regardless of what the underlying investment has done or where it is actually allocated. The fund’s objective is to push marketing to add new investors and do just enough to retain old ones.
But what about the actual investing part?
The OpEx with respect to investment decision-making is now mostly done using algorithms and computers; a low cost expense. These computers act the same as each other and buy-and-sell according to various inputs and signals that are pre-programmed. However, the fact that it’s more economical to use a computer rather than an expensive human who derives health benefits and insurance to make decisions has resulted in the concentration of capital.
In other words, since the computers have removed the differences amongst individuals and the underlying models are programmed (simply put) to buy a variation of the same large indexes, all of the capital is invested passively.
I wrote about this here
The consequence of this means that not only are the ETF, mutual and pension funds pooled to tremendous levels but the funds themselves pool into the same companies. That way, if investors complain when the market falls–the managers can say “well hey, across the street it fell too!”. When they both rise in value, nobody complains and the managers look pretty darn smart. They use this smartness as another sales campaign to raise even more funds and charge 85 basis points on an even larger pool of funds.
I hope you’re beginning to see the pattern here where over a long period of time, the business model has drifted away from making unique investment decisions (where can value be found?) to growing the unidirectional stampede.
Everybody is trying to sell you a sweater, but nobody has knit a day in their life.
What about the others?
For fund managers, this is a difficult business model to reject. If you make a decision that didn’t turn out so good, your investors will leave and join the passive party. Furthermore, since you spent so much time trying to find out the next large arbitrage–you have no more to spend on marketing the actual fund to potential clients. As the last 2 years have shown us, it’s tough to be comfortable standing out from the crowd!
For the market itself, this has left a dynamic where there are many assets, sectors and geographical locations that have remained underinvested for a longer than usual period of time. Companies that may be making a lot of free-cash-flow, supporting high dividends, share buybacks, with no obvious threats and provable steady growth are neglected because of the lack of investors hunting in their “unorthodox” direction. If everybody is hunting at the zoo, eventually a huge ecosystem out in the wild is going to develop!
Draw-Aim-Loose!
This has created an asymmetry developing between markets whereby value opportunities have formed. Companies (in my opinion) in the energy, small caps, offshore drilling, tobacco and emerging markets spaces have missed out on tremendous investments come their way. Not only does nobody want to stand out from the crowd, they certainly don’t want to do so by holding a “dirty coal” or “volatile Brazilian” asset. However, I believe at some point, when the passive investors realize birds don’t fly to the moon, they will once again be forced to take active management positions; perhaps we are seeing the change of the tide now.
Furthermore, we have another dynamic at play whereby nearly ALL the capital in the world still resides in London, Paris and New York at a time when these jurisdictions have weakening systems of rule of law & stability. By contrast, countries who may be authoritarian in nature yet hold a level of predictability and stability possess very small amounts of capital (relatively) as their risks are already priced in. If you don’t believe me, look at the great performance of Argentine equities the passed couple of years who were sitting at their bottom for years before. A small shift in capital from both the weakening West and from passive investment vehicles into actively managed, emerging/frontier/developing markets or alternative assets could be an explosive market opportunity.
If I return to my bow and arrow analogy one last time; it is though we are surrounded in an ecosystem of great animals for hunting and we’ll soon realize their unique value opportunity once a whole new bunch of hunters are forced to show up again for shooting. Let’s hope we hit the target while we can!
I am in the early days of creating my own Private Fund for friends and family, but its not cheap! So I’ve been set back a few months. If this article and it’s macro outlook interests you, please consider reaching out to me at [email protected] and taking the time to share!
Thank you for reading, I appreciate it!
#StayOnTheBall
