| Areté Quarterly Q417 |
Business update
January 15th marks the Martin Luther King holiday this year and it also marks the tenth anniversary of Areté Asset Management. Just like King in his famous speech, I had a dream when I started Areté - and this is a good time to reflect on what has happened over those ten years.
One of the main reasons I started Areté was because I thought there was an enormous opportunity to provide a better deal for investors. I saw the investment ecosystem as one plagued by high fees, too many "products", uncoordinated services, and a pervasive lack of concern about client welfare.
Despite this rather dismal assessment, I also viewed these problems as eminently fixable. I think there are a lot of smart and well-intended professionals, there is a lot of excellent research and insights that can really help investors and there is constantly improving technology that can reduce costs, improve efficiency, and enable ever-higher functionality.
There were also other reasons to be positive. One is that a pretty good body of knowledge already existed as to what types of investment practices tended to be more effective for thoughtful, long term investors. Thanks to the writings of David Swensen and several others there were already good blueprints that just required the will to execute them. With a clear focus on serving clients, a natural orientation to independent thinking, and an ethos characterized by the belief that knowledge is "the origin of wealth", I saw the opportunity not so much as inventing a brand new approach as creatively recombining pre-existing components.
Importantly, while I always thought such a proposition would be attractive, I never thought it would be sufficient on its own to cause investors to switch en masse from other managers. I saw the really big impetus for switching as being an economic imperative; as progressively more retirement funds became progressively more underfunded, a better and more efficient solution would become a necessity.
After ten years now, my idea for Areté, to be blunt, has not worked as a business. That said, I've been fairly pleased with the value proposition and very pleased with Areté's ability to continuously incorporate and leverage technology in ways that benefit clients. I also believe that I got many of the big things right. From the start I have kept the costs of running the business very low and that is probably the single biggest reason why Areté is still around. Further, my idea that the cost of service would be increasingly important has been corroborated by the massive flow of funds out of expensive mutual funds.
However, I did not anticipate the persistence or pervasiveness of loose monetary policy after the financial crisis. Initially intended as emergency measures to restore financial stability, the repeated expansion such policies affected markets by boosting asset values and affected investor behavior by changing incentives in ways that substantially reduced demand for what active managers do.
One effect of infusing markets with so much liquidity has been to overwhelm normal fundamental factors in determining stock prices. This creates an incentive to simply chase returns, to grab what you can while you can. Further, when returns are not so much earned as bequeathed, it creates an incentive to enjoy the party while it lasts and worry about solving longer term problems for another day.
Such incentives fundamentally reshape the basis of competition for investment services. Liquidity and momentum driven markets favor asset gatherers over long term, valuation based investors and this creates an exceptionally hostile environment for active management. While it has vastly restrained the business opportunity for Areté, as I mentioned [here], it has also created headwinds for many of the smartest and most resourceful hedge funds out there. These funds have been closing down because the market just has not been rewarding their skills in identifying mispriced securities and managing risk.
While such markets are unsustainable longer term, central banks have plenty of ammunition to keep them rolling for longer than it makes sense for active managers to swim against the tide. This environment also creates an interesting paradox as to what constitutes fiduciary duty. Should active managers remain fully exposed knowing that their value add relative to index funds is likely to be negligible and that their risk profiles keep going up along with valuations? Or should they gradually pare back exposure as valuations rise knowing that it could be many years before stocks get cheap enough to buy again?
This is exactly why loose monetary policy is so harmful to active management and to the exercise of investing in a more general sense. Such policies almost completely undermine the value of ongoing analysis and risk management by reducing them to an either/or decision of whether to be invested or not and an unknowable timing decision as to when to change course.
This is pretty much where things stand today. On one hand, I don't view the business of active management as being viable in the environment that has persisted for most of the past ten years. On the other hand, as things get progressively more out of whack, and progressively more people become vulnerable to a market fallout, there is likely to be a monster opportunity for what Areté does at some point in the future.
In the process of waiting for the market to "normalize", I have become less optimistic about the future of active management as a business; it is simply too vulnerable to policy choices. While this is bad for me and Areté, I think it is just as bad for investors looking for reasonably priced professional investment advice.
All of that said, for the time being I continue to do everything in my power to build the tools Areté has at its disposal to help clients get the most out of their investing activities and to adapt to changing conditions (such as introducing the Personal Chief Investment Officer (CIO) service). I remain extremely optimistic about what technology can accomplish when applied in a thoughtful way and remain poised to pounce when market conditions permit.
Thanks for your interest and take care!
David Robertson, CFA
CEO, Portfolio Manager
January 15th marks the Martin Luther King holiday this year and it also marks the tenth anniversary of Areté Asset Management. Just like King in his famous speech, I had a dream when I started Areté - and this is a good time to reflect on what has happened over those ten years.
One of the main reasons I started Areté was because I thought there was an enormous opportunity to provide a better deal for investors. I saw the investment ecosystem as one plagued by high fees, too many "products", uncoordinated services, and a pervasive lack of concern about client welfare.
Despite this rather dismal assessment, I also viewed these problems as eminently fixable. I think there are a lot of smart and well-intended professionals, there is a lot of excellent research and insights that can really help investors and there is constantly improving technology that can reduce costs, improve efficiency, and enable ever-higher functionality.
There were also other reasons to be positive. One is that a pretty good body of knowledge already existed as to what types of investment practices tended to be more effective for thoughtful, long term investors. Thanks to the writings of David Swensen and several others there were already good blueprints that just required the will to execute them. With a clear focus on serving clients, a natural orientation to independent thinking, and an ethos characterized by the belief that knowledge is "the origin of wealth", I saw the opportunity not so much as inventing a brand new approach as creatively recombining pre-existing components.
Importantly, while I always thought such a proposition would be attractive, I never thought it would be sufficient on its own to cause investors to switch en masse from other managers. I saw the really big impetus for switching as being an economic imperative; as progressively more retirement funds became progressively more underfunded, a better and more efficient solution would become a necessity.
After ten years now, my idea for Areté, to be blunt, has not worked as a business. That said, I've been fairly pleased with the value proposition and very pleased with Areté's ability to continuously incorporate and leverage technology in ways that benefit clients. I also believe that I got many of the big things right. From the start I have kept the costs of running the business very low and that is probably the single biggest reason why Areté is still around. Further, my idea that the cost of service would be increasingly important has been corroborated by the massive flow of funds out of expensive mutual funds.
However, I did not anticipate the persistence or pervasiveness of loose monetary policy after the financial crisis. Initially intended as emergency measures to restore financial stability, the repeated expansion such policies affected markets by boosting asset values and affected investor behavior by changing incentives in ways that substantially reduced demand for what active managers do.
One effect of infusing markets with so much liquidity has been to overwhelm normal fundamental factors in determining stock prices. This creates an incentive to simply chase returns, to grab what you can while you can. Further, when returns are not so much earned as bequeathed, it creates an incentive to enjoy the party while it lasts and worry about solving longer term problems for another day.
Such incentives fundamentally reshape the basis of competition for investment services. Liquidity and momentum driven markets favor asset gatherers over long term, valuation based investors and this creates an exceptionally hostile environment for active management. While it has vastly restrained the business opportunity for Areté, as I mentioned [here], it has also created headwinds for many of the smartest and most resourceful hedge funds out there. These funds have been closing down because the market just has not been rewarding their skills in identifying mispriced securities and managing risk.
While such markets are unsustainable longer term, central banks have plenty of ammunition to keep them rolling for longer than it makes sense for active managers to swim against the tide. This environment also creates an interesting paradox as to what constitutes fiduciary duty. Should active managers remain fully exposed knowing that their value add relative to index funds is likely to be negligible and that their risk profiles keep going up along with valuations? Or should they gradually pare back exposure as valuations rise knowing that it could be many years before stocks get cheap enough to buy again?
This is exactly why loose monetary policy is so harmful to active management and to the exercise of investing in a more general sense. Such policies almost completely undermine the value of ongoing analysis and risk management by reducing them to an either/or decision of whether to be invested or not and an unknowable timing decision as to when to change course.
This is pretty much where things stand today. On one hand, I don't view the business of active management as being viable in the environment that has persisted for most of the past ten years. On the other hand, as things get progressively more out of whack, and progressively more people become vulnerable to a market fallout, there is likely to be a monster opportunity for what Areté does at some point in the future.
In the process of waiting for the market to "normalize", I have become less optimistic about the future of active management as a business; it is simply too vulnerable to policy choices. While this is bad for me and Areté, I think it is just as bad for investors looking for reasonably priced professional investment advice.
All of that said, for the time being I continue to do everything in my power to build the tools Areté has at its disposal to help clients get the most out of their investing activities and to adapt to changing conditions (such as introducing the Personal Chief Investment Officer (CIO) service). I remain extremely optimistic about what technology can accomplish when applied in a thoughtful way and remain poised to pounce when market conditions permit.
Thanks for your interest and take care!
David Robertson, CFA
CEO, Portfolio Manager
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