As we continue to grow, we continue to solicit and receive feedback from our various constituents. Based on a number of comments about the newsletter, and our desire to communicate as effectively as possible, we are introducing a new format with this edition.
Henceforth, the content originally included in Arete Insights will be separated into two different publications. Our commentary and insights regarding the investment management business will now be published in the middle of the quarter under the Arete Insights title. The more quantitative information regarding performance and characteristics of the Arete Mid Cap Core strategy will now be published shortly after quarter-end under The Arete Quarterly title.
We hope these changes will make each publication more accessible to interested parties. From our perspective, the new format and schedule allows us to more accurately target communication to appropriate constituents and also gives us the opportunity to reach out to you four more times a year.
As always, we appreciate your comments and suggestions regarding the newsletter or any other aspect of the business which might make our services more useful to you. We hope you find our proposition compelling and always look forward to talking with you if you have questions!
Despite the continued difficulties in the market, we did welcome a new client in the first quarter. We say in our mission statement (at www.areteam.com), “We treat the trust endowed us to manage your money as a great honor and responsibility. You deserve the effort and attention that level of trust entails” — and we mean it. Thank you!
As we constantly evaluate and re-evaluate our marketing proposition in these difficult times, we simply keep coming back to about the same place. The best and most sustainable way for us to grow is to exert the deliberate effort to find prospects and partners which fit extremely well with our philosophy and products. This allows better and deeper client relationships, and hopefully longer lasting ones too.
Indeed we are finding repeatedly in conversations with clients and prospects that people are fundamentally re-appraising the investment management business. One of the “dirty little secrets” of the business has been that money managers have not put the interest of their clients first. Instead, seeing a business model with high fixed costs, they have launched strategic imperatives to grow revenues any way possible. Once costs are covered, enormously high profits accrue. Nice for the manager, not so great for the client. In this context, our messages of fiduciary duty, stewardship, and minimization of conflicts of interest are really resonating.
Another part of the business that is not new, but deserves mention is that of custodial services. In too many shops, custodial details are considered mundane back office activities that do not deserve serious attention. Recent history and scandals suggest custodial services are extremely important.
We provide our services to individuals through a retail platform with Shareholders Service Group. SSG is employee-owned and its business model is focused solely on providing services to registered advisers. It has no debt, no illiquid investments, no position trading accounts, and no proprietary inventory. In addition to being a member of SIPC, SSG carries insurance through Lloyd’s of London to protect client assets up to an overall aggregate level of $1 billion for assets in custody for each adviser. If this level of protection seems unusual in the industry, that’s because it is. But it is also evidence of what can be done when fiduciary duty is taken seriously.
We always enjoy talking about the business, the market, and stocks so if you are going to be in Baltimore, please stop in and see us. We’d love to get together and talk about what we can do for you.
Thanks and take care!
David Robertson, CFA
CEO, Portfolio Manager
The performance story evolved from complete mayhem in the fourth quarter last year to short cycle waves of euphoria and fear/depression in the most recent quarter. High correlations, macro bets, and short-term trading remained as the dominant characteristics of activity. What changed was the emergence of glimpses of improvement, or at least the possibility of improvement.
Many of the negative pressures on the market have not receded or changed much. The economy is still weak, the banking and finance industry still needs to be repaired, and firms and individuals are continuing to deleverage which continues to place a premium on liquidity.
With such clear and numerous pressures, there are obvious incentives for many to bet against the market on the basis of news flow alone. Steep price declines also cause many investors to challenge conviction in their own research, much of which was sadly bereft of rigorous analysis. Further, a high degree of doubt and uncertainty creates an incentive for certain participants to “fan the flames” with misinformation.
Finally, we can also add the somber mood at many money management firms to the list of negative pressures. Nobody is happy with small or nonexistent bonuses for last year. Further, it is clear that many jobs will be at risk. It is also clear that the investment business is not likely to be anywhere near as lucrative as it once was. I’m not entirely confident many of these people are placing stock selection and fiduciary duty at the top of their priority lists right now.
Through the eyes of a stockpicker, however, such extreme negativity creates excellent conditions for stock selection. First, stocks are cheap. They may not be as cheap as they were at the lows of the Great Depression, but things aren’t nearly as bad as they were in the Depression either. While it is possible that stocks could hit new lows based on further financial and economic erosion, it takes quite an extreme view to bet everything on the on the prospect of continued and sustained deflation.
Another condition conducive to stock selection is the market’s lack of differentiation. Extreme negativity has triggered a uni-directional response: Sell. It has not mattered to the market that some companies are gaining share, improving on strong competitive advantages, or run by strong, adaptive management teams. The fundamental difference between winners and losers is increasing while the difference in market valuation is decreasing. This may very well be the best environment for long-term stockpickers we have ever seen.
The opportunities, however, are also offset by risks. Our greatest concern right now is regarding public opinion and public policy. We believe more will need to be done in terms of fiscal stimulus and aid to the banking industry to completely correct the problems. Given the high level of public outrage expressed, we have significant concerns our government will not be able to complete the difficult task of righting the economy. If the effort falls short, we believe the economy is likely to under-perform relative to its potential for many years.
In addition, we believe there is also a risk specific to mid cap stocks. Given the demands on government policy to manage systemic risk with limited resources, the government is (necessarily) making decisions that help some firms and not others. Since mid cap firms do not pose systemic risks, they are not priority targets for assistance. In the short-term, the opportunity for a government backstop and low cost capital creates a relative advantage for larger firms.
Longer term, however, we believe such assistance (which, by the way, is fraught with its own risks) will serve primarily to weaken the larger companies. Mid cap companies, in comparison, will have to adapt and become even stronger, which is likely to serve them well in the long run.