| Areté Quarterly Q418 |
I have mentioned many times how excessively easy monetary policy has caused problems for investors. Such policies have artificially inflated asset prices and distorted price signals. In doing so, they have made it a lot harder to invest wisely, they have increased the risks associated with investing, and have deprived many investors of a fair opportunity to benefit from capital markets.
Those loose monetary policies have also had an enormous effect on the providers of investment services. Since 2009 pretty much only one thing worked - long exposure to risk assets. The only real way to get ahead was to do even more of it with leverage of some sort. In other words, the most successful strategies were ones that were stupefyingly simplistic.
The landscape had a crushing effect on market diversity. One commentator captured the dynamic especially well [here]: "The environment [of quantitative easing] causes some strategies to flourish and multiply, while others die off. The abnormally long, QE-fueled bull market killed off anything that wasn't, at its core, a short volatility strategy. Now, whether it's risky credit, levered equities, or risk parity, almost all strategies are taking similar risks."
This has a number of important implications. One is that there is an enormous risk of an unwind of such exposures. As they stop working, in either gradual or sudden fashion, money will flow out. As it does, securities will have to be sold for whatever price can be had. Another implication is that there are exceptionally few investors to take the other side of that trade. That means there is a big risk that prices will have to fall quite a bit to pique the interest of fundamental and valuation based investors.
Indeed, I think the next few quarters will be a defining moment for the business of investment services. There are exceptionally few who are remaining that have the capacity, in the forms of liquidity, fortitude, and business model, to take advantage of the discontinuities as they arise.
In this respect, I am feeling as good about Areté's prospects as I have in a long time. The mid cap strategy recorded its best relative performance (to the Russell midcap index) ever in the fourth quarter and it did so by doing what exceptionally few money managers have been able to do: something different. Holding a lot of cash is the one thing that worked and most managers just couldn't do in their quest to grow assets.
Looking ahead, I expect this dynamic to continue for some period of time; I think Q4 was only the start. The reason for this is partly because the monoculture and the excesses took years to build up. It will take time for them to thoroughly unwind. During the interim I expect markets to be choppy with lots of dramatic swings in relative performance characterized by big drops and followed by periods of digestion.
I also think there is a good chance that investor behavior will exacerbate and extend the correction. Many investors will be paralyzed by the wild swings. Many will take time to adjust their expectations to a less forgiving environment for stocks. Some will experience challenging markets for the first time in their investing lives. Some won't be able to adjust at all, clinging to the belief that each drop is merely a short term correction.
Ultimately, I think all of this will have a profound and lasting effect on the investment services industry. I thought that should have happened after the financial crisis in 2008-09, but the strong market recovery seemed to pacify any sentiments for change at the time.
The next time around I suspect will be different. One reason will be that continued market choppiness and underperformance by service providers will allow discontent to build over time. As it does, many investors will begin to realize that it is not just the markets that are causing problems but the poor value proposition of their providers. In addition, investors will increasingly be Xers and Millennials who will demand more efficient offerings just like they have in every other sphere of consumer services.
These trends promise to be extremely fruitful for Areté which was built on the premise of providing an excellent value proposition for investors. Thoughtful research, cost-efficient operations, adaptiveness, and clear communication all capped by a mission to help investors get more out of their investing experiences is a package well positioned to resonate with tomorrow's investors.
Finally, I entitled the market review for the fourth quarter "A brand new day" for a couple of reasons that are also applicable to the investment services industry. One is that I think it will be a "brand new day" in a bad way for many investors and providers who cannot adapt to an environment that is not completely driven by increasing liquidity. They will keep trying and keep failing. I wouldn't be surprised if such dynamics rekindle Woody Allen's old joke that "a stockbroker is someone who invests other people's money until it is all gone."
It will also be a brand new day, however, for providers like Areté that are oriented in a completely different way. Driven by investment results rather than asset gathering, we'll be able to manage risk better by only accepting it when there are reasonable prospects of adequate returns. It will also be a brand new day for securities analysis, fundamental research and investment expertise to shine as opposed to thoughtless “risk-on” strategies. Finally, it will be a brand new day because there just isn't very much competition left so we can enjoy the fruits in limited company.
Thanks for your interest and take care!
David Robertson, CFA
CEO, Portfolio Manager
Those loose monetary policies have also had an enormous effect on the providers of investment services. Since 2009 pretty much only one thing worked - long exposure to risk assets. The only real way to get ahead was to do even more of it with leverage of some sort. In other words, the most successful strategies were ones that were stupefyingly simplistic.
The landscape had a crushing effect on market diversity. One commentator captured the dynamic especially well [here]: "The environment [of quantitative easing] causes some strategies to flourish and multiply, while others die off. The abnormally long, QE-fueled bull market killed off anything that wasn't, at its core, a short volatility strategy. Now, whether it's risky credit, levered equities, or risk parity, almost all strategies are taking similar risks."
This has a number of important implications. One is that there is an enormous risk of an unwind of such exposures. As they stop working, in either gradual or sudden fashion, money will flow out. As it does, securities will have to be sold for whatever price can be had. Another implication is that there are exceptionally few investors to take the other side of that trade. That means there is a big risk that prices will have to fall quite a bit to pique the interest of fundamental and valuation based investors.
Indeed, I think the next few quarters will be a defining moment for the business of investment services. There are exceptionally few who are remaining that have the capacity, in the forms of liquidity, fortitude, and business model, to take advantage of the discontinuities as they arise.
In this respect, I am feeling as good about Areté's prospects as I have in a long time. The mid cap strategy recorded its best relative performance (to the Russell midcap index) ever in the fourth quarter and it did so by doing what exceptionally few money managers have been able to do: something different. Holding a lot of cash is the one thing that worked and most managers just couldn't do in their quest to grow assets.
Looking ahead, I expect this dynamic to continue for some period of time; I think Q4 was only the start. The reason for this is partly because the monoculture and the excesses took years to build up. It will take time for them to thoroughly unwind. During the interim I expect markets to be choppy with lots of dramatic swings in relative performance characterized by big drops and followed by periods of digestion.
I also think there is a good chance that investor behavior will exacerbate and extend the correction. Many investors will be paralyzed by the wild swings. Many will take time to adjust their expectations to a less forgiving environment for stocks. Some will experience challenging markets for the first time in their investing lives. Some won't be able to adjust at all, clinging to the belief that each drop is merely a short term correction.
Ultimately, I think all of this will have a profound and lasting effect on the investment services industry. I thought that should have happened after the financial crisis in 2008-09, but the strong market recovery seemed to pacify any sentiments for change at the time.
The next time around I suspect will be different. One reason will be that continued market choppiness and underperformance by service providers will allow discontent to build over time. As it does, many investors will begin to realize that it is not just the markets that are causing problems but the poor value proposition of their providers. In addition, investors will increasingly be Xers and Millennials who will demand more efficient offerings just like they have in every other sphere of consumer services.
These trends promise to be extremely fruitful for Areté which was built on the premise of providing an excellent value proposition for investors. Thoughtful research, cost-efficient operations, adaptiveness, and clear communication all capped by a mission to help investors get more out of their investing experiences is a package well positioned to resonate with tomorrow's investors.
Finally, I entitled the market review for the fourth quarter "A brand new day" for a couple of reasons that are also applicable to the investment services industry. One is that I think it will be a "brand new day" in a bad way for many investors and providers who cannot adapt to an environment that is not completely driven by increasing liquidity. They will keep trying and keep failing. I wouldn't be surprised if such dynamics rekindle Woody Allen's old joke that "a stockbroker is someone who invests other people's money until it is all gone."
It will also be a brand new day, however, for providers like Areté that are oriented in a completely different way. Driven by investment results rather than asset gathering, we'll be able to manage risk better by only accepting it when there are reasonable prospects of adequate returns. It will also be a brand new day for securities analysis, fundamental research and investment expertise to shine as opposed to thoughtless “risk-on” strategies. Finally, it will be a brand new day because there just isn't very much competition left so we can enjoy the fruits in limited company.
Thanks for your interest and take care!
David Robertson, CFA
CEO, Portfolio Manager
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