One for the Road

Source: CalPERS Last week, when Ben and I published our assessment and response to the instit

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  1. Peter Drucker once famously said, “the purpose of any business is to create customers.” Unfortunately, financialization of businesses thru share buybacks etc drives customers away and drives businesses more deeply into debt.

    Companies that were once triple-A rated are rapidly dropping down to the very fringes of “investable.” Wall street applauds reductions in headcounts and phony EBITDA numbers. The question becomes at what point does a business drive off enough customers that it can’t pay its debts? Yay, efficiency!!

  2. The entire ‘outsource to China’ was justified under this efficiency utilitarian drive - they just never realized that the ‘china price’ was cheap upfront, with the costs all backloaded ; now the real bill is being presented, the immense liquidity support and disrupted (& lost) lives and livelihoods…

  3. I always break it down for my clients (and for my own portfolio) this way: I either know the future or I don’t. I don’t - period, full stop. If you want someone who does, please, please, please don’t hire me. Now, since I don’t know the future, what is the best way to invest your money?

    From there, it’s about individual investment goals, risk profile, etc. Then it’s about diversification, re-balancing and tail risk - deflation or inflation spiraling.

    We diversify (taking into account your goals, risk appetite, etc.) since we don’t know what will do well and not and we rebalance as, IMO, it is a real source of alpha over time. Then, we look at the portfolio for the two tail risks - a deflation spiral or inflation spiral. Medium duration US TSYs (and pre-refunded with US TSYs municipals) hedge a deflation spiral (to some extent) and gold and real estate (to some extent), an inflation one. I’m sure commodities do something, but the only thing they’ve ever done for me is cost me money other than the ten minutes they rally strongly which, long term, still doesn’t overcome all the costs of holding them for that rally.

    My point. The fault is less “Yay, Efficiency!” than an unwillingness to accept the limitations of our abilities as investors / money managers. If you can predict the future - go for it and, if successful, you’ll do very well. Actively managed returns argue very few if anyone has a proven track record at doing that. But that is still what almost everyone wants. That, IMO, is the problem. Investors want the future accurately predicted and are mad when that doesn’t happen.

    So, the clients don’t want the truth that we can’t predict the future and there are tail risks that will cost them returns for decades, but you still need to hedge for those risks, so your portfolio will almost always look bad versus whatever investment outperformed recently and/or an unhedged portfolio. And of course, someone would have had you invested in that outperforming asset if you had just invested with them.

    So, since the clients don’t want the truth - and there are always many managers willing to tell the clients what they wants to hear - the industry doesn’t tell the clients the truth and we end up where we are: chasing returns, mouthing slogans like “Yay, Efficiency” or “diversification.”

    I don’t see any new song that will result in clients accepting underperformance for years because you’ve built them a portfolio that diversifies their risks and hedges tail risks because there will always be a “smart” manager telling them how much better they could have done for them.

  4. Tapping into the recent Minimax Regret discussion: What was the bigger regret of a pension fund? Achieving annual returns of 1% below target, or suffering a drawdown much larger than the fund can handle? Seems hard to believe that in an environment (2019) where Buffet’s Q was indicating negative returns over 10 years that removing a drawdown hedge was prudent for a manager with at least a 10 year time horizon.

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