As a continued reminder, the text content of this and future editions will be considerably shorter than in past letters. This change will allow the Arete Quarterly to be more focused on portfolio analysis and will also facilitate much more regular publication of general commentary through the Arete blog. If you haven’t visited www.areteam.com/blog yet, please take a look when you get a chance.
One of the more interesting investment services stories involves the prospects for active management in light of continued rate suppression by the Fed. As I've discussed in places like the recent Q414 market overview blog, continued Fed interventionism significantly disrupts the value proposition of active management.
Since active managers are trained to analyze economic and financial fundamentals and to invest money where they find attractive returns, their efforts have been repeatedly subverted by the Fed through its own efforts to prop up the market every time things slow down.
It’s bad enough that most active managers have been relegated to the fairly tedious task of simply following the Fed's moves, but the prospects for active management are also uncertain. In a significantly overvalued market, there are vanishingly few cheap stocks for active managers to apply their skills to. For investors just seeking exposure to the market, index funds serve that function well.
While these challenges have existed for Arete, they have plagued the entire active management business. They have also persisted for so long now that we are beginning to see a number of funds close down. While some of this is a healthy culling of an overpopulated universe, much of it is the inadvertent extermination of businesses as an unintended consequence of the Fed’s low rate policy.
It is worth considering the distinct possibility that the Fed continues its low rate policy for even longer. If it does, it could cause irreparable damage to the active management industry and in doing so, may also significantly impair the ability of the market to recover from future disruptions. There just won’t be the investors left who are willing and able to invest when things look bleakest.
In the meantime, I’ve been focused on how Arete can keep providing value regardless of Fed policies. Since these policies necessarily limit the potential for active management, I’ve been actively soliciting clients, friends, and acquaintances for their interest in various types of research work that Arete does.
A couple of very interesting things have come out of this effort. One is that there seems to be a widespread sense of uneasiness as to the direction of the economy, the markets, and public policy. Some have more concern than others, but I've run into exceptionally few people who don't have some desire to get their arms better wrapped around the situation. Another interesting finding is that there is an enormous distrust/disdain of bulge bracket financial service firm advice. Nobody believes it and it doesn’t help.
I see this as creating some very interesting and unique opportunities for Arete. For starters, one of my great strengths is to identify what I'll call "controversial propositions". This is easy because it's really just a function of being curious and asking the obvious questions, unconstrained by anything other than a desire to just figure things out.
The point of asking such questions is not to criticize, but rather to open up investment discussions and to consider more possibilities. Sometimes we need to consider unusual or outlandish possibilities in order to reveal new perspectives on a challenge. Often an additional benefit to this exercise is to increase interaction and engagement with other investors or investment committee members. At the end of the day, after all, these are all fun and intellectually challenging topics!
I hope this effort does a couple of things for Arete. First, it should certainly help provide a more robust stream of revenues than from active management alone and as such should go a long way in making the business model more robust. Second, I'm really hoping that by sharing more of my thinking with a wider group of people, more people will have a deeper appreciation of all of the ways in which Arete can help with their investment challenges.
As a result, I’m spending a fair amount of effort to come up with new and creative ways to share information and useful insights with investors in ways that extend well beyond just the performance of Arete’s mid cap strategy. If you have some ideas, I’d love to hear them!
Thanks and take care!
David Robertson, CFA
CEO, Portfolio Manager