Deals Are My Art Form
November 26, 2018·2 comments·In Brief
Institutional investors control trillions in capital. Their allocation decisions rest on sophisticated models, performance analysis, and fiduciary responsibility. Yet year after year, they funnel massive sums into private equity and private assets while rejecting active liquid strategies. The disconnect isn't about returns. It's about something more fundamental: what feels like a deal.
• Board members who approve major capital allocations are politicians, lawyers, and businesspeople. They built their careers through deals, negotiations, and transactions. When presentations about private equity come up, they lean forward. When complex quantitative strategies get described, their eyes glaze over.
• Private assets feel like investing because they resemble what these board members have done their entire careers. They look like businesses being built or fixed. They look like negotiations. They look like deals. Liquid strategies, even when they're mathematically sound, don't trigger that same recognition.
• Strategic asset allocation decisions aren't made by individual portfolio managers constantly reoptimizing. They're made through formal processes involving boards, consultants, and CIOs working within governance constraints. Once those constraints are set, the structure locks in place and shifting course becomes extremely difficult.
• The models used to justify these allocations assume targets that make private equity and emerging markets look indispensable. When consultants tell boards that reaching return targets requires allocating to these assets, the conversation is already framed. The prudent choice feels obvious.
• Performance crashes could theoretically reset this dynamic, but board psychology is structural, not cyclical. The preference for deal-like strategies isn't a temporary market fad. It's wired into how the people making these decisions understand what investing even means.
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This commentary is being provided to you as general information only and should not be taken as investment advice. The opinions expressed in these materials represent the personal views of the author(s). It is not investment research or a research recommendation, as it does not constitute substantive research or analysis. Any action that you take as a result of information contained in this document is ultimately your responsibility. Epsilon Theory will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Consult your investment advisor before making any investment decisions. It must be noted, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results.
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Comments
So active liquid strategies are losing retail money to passive investing (now, to be had, for free - uh-huh) and “sophisticated” institutional money to Private Equity and similar “straight forward” (uh-huh, again) deal-like investments. I agree, those dynamics are not short-term or cyclical.
Tangential to your point, hedge funds, IMHO, destroyed themselves as they (many, not all) didn’t market themselves as “hedged” funds - lower vol investments providing better risk-adjusted returns - but instead, at least until '08, sold themselves as wonder investments allowing you to tap into a super-genius person or super-genius blackbox. I guess Epsilon Theory would say they broke their own story / I’d say they ain’t putting that toothpaste back in the tube.
Maybe enough years of better risk-adjusted returns in down markets versus indices (or just better notional returns, a tautology for a true hedge fund in a down market) will help, but only so much. The real question is how long until PE breaks as there’s no chance it can work now that it’s the popular trade, excuse me, investment.
I’m curious if this retail focus combined with the corporate tax repatriation, which will be used for M&A in a similar deal space, will cause price inflation and decrease returns. Or it could lead to a short term increase in valuations and benefit these funds.
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