Whether assets are part of a personal retirement plan or part of an institutional plan such as a pension, endowment, or foundation, we are all trying to do the same thing. We are all trying to get the most out of investments given our limited set of resources. What can be learned from recent experiences to help us balance these competing demands? Let’s start with the results and work backwards.
One of the most popular investment strategies in recent years has been that of absolute returns. These strategies offer arguably the most alluring value proposition in the business: Excess returns without market volatility.
While absolute return strategies have been fantastically successful in accumulating assets, all evidence points to the claims being overstated. A recent report in the New York Times noted that the benchmark return for absolute return strategies for endowment funds last fiscal year was a decline of 13.2%. In other words, neither the claims of excess returns or without market volatility held true for the approach as a whole.
What does this experience teach us? For those very familiar with market opportunities, it was pretty clear that demand for absolute return strategies far exceeded realistic opportunities for such approaches. Such familiarity, however, comes with a cost. David Swensen, the exemplar of Yale University’s endowment has always said investing in complex strategies like absolute returns is appropriate only for the few who have the resources, experience, and expertise to fully understand them and to establish realistic expectations for them.
If adequate resources are not available to thoroughly assess investment options, there is always the possibility of hiring assistance. While this is certainly a valid approach, the benefits of advice also need to be carefully weighed against the additional costs of such services.
Finally, if one does not have the resources to devote to assessing investments, there are few sensible alternatives than to avoid active management options. In short, there is no easy way to make a fortune. Without a firm understanding of reasonable risk and return expectations, it is far too easy to fall prey to sales pitches imbued with unrealistic expectations.
With that context, Arete’s mid cap core strategy is designed to provide excellent investment value based on what we believe to be very realistic expectations. We also believe the better you understand what we do, the clearer the value proposition will be. In order to facilitate your understanding, we disclose our philosophy, mental models, value proposition and other aspects of our approach to investing on our website at www.areteam.com. We are also always happy to discuss these items in person.
As always, we appreciate your comments and suggestions regarding any 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!
As we have now passed the first anniversary of Arete’s Mid Cap Core composite performance, this marks an appropriate occasion to discuss marketing and business development for the company. In the process, I will touch on the premises behind the marketing effort, I will discuss the positioning of the offering, and I will outline my roadmap for the future of the marketing effort.
My main premise for founding Arete was that there will always be demand for outperformance. In addition, given both my personal and professional investing experiences, I believe I can deliver that performance.
With these premises, the primary uncertainty for managing the business is timing. I know it takes time for prospective clients to conduct due diligence and to get comfortable with people and processes. Consequently, I have placed a very high priority on carefully managing expenses in order to provide prospective clients as much time as they need to appreciate the value Arete can deliver. So far, so good.
In the process of raising the awareness of Arete, I have given a great deal of thought about how to position the company and the Mid Cap product. In many respects, I have found it easier to describe what it is not. Arete’s Mid Cap Core product is not exotic or unusual. The process is not built by PhD mathematicians. I have not tried to build a big brand name for Arete. I do not have any catchy, sexy taglines for the product.
Arete does “stand upon the shoulders of those who have gone before us” in the sense of making the most of the teachings of luminaries such as Miller and Modigliani and Graham and Dodd. In doing so, we put more effort into implementing and adapting these insights than to creating “new and improved” strategies.
Perhaps the clearest analogy of Arete’s investment process is to manufacturing. We view the process as taking the raw material of information and intellect and shaping it into something that can be called knowledge that is advantaged relative to the market. As such the pursuit is somewhat philosophical in that it goes back to first principles and asks what is knowledge and how do we attain it? If you have any ideas on how this can be better-articulated, I would love to hear them!
I believe a big part of the difficulty I have in positioning Arete relative to many contemporary competitors is that over the last twenty to thirty years, the industry has become progressively more driven by asset gathering and marketing. In this context, Arete is a throwback to times of greater emphasis on pure investing and fiduciary standards.
Finally, with a one year track record I decided it was an appropriate time to step-up Arete’s marketing effort by further institutionalizing its organization. Specifically, I have more fully implemented Arete’s customer relationship management (CRM) system in order to better organize, segment, contact and follow up with various prospects, clients, and constituents. This effort will facilitate a progressively more complex sales process and will increase the efficiency and flexibility of resources devoted to marketing. As Arete targets a progressively more institutional client base, these tools will be essential for maintaining and even improving on Arete’s high standards of quality.
With all of that said, as always, I enjoy talking about stocks, the business, and the market. If you are going to be in Baltimore, please stop by or if you have a few minutes, give me a call. I’d love to talk about what Arete can do for you.
Thanks and take care!
David Robertson, CFA
CEO, Portfolio Manager
Strong performance by the market as a whole was led by mid cap stocks which performed especially well in each month of the quarter. Overall performance was punctuated by incredibly large returns from a number of individual stocks.
We found the extreme returns telling in a couple of respects. First, the extremely high returns in the second and third quarters of this year were in many cases mirror images of the prior two quarters. In other words, stocks became oversold last year and into the first quarter of this year and then recovered. While this understates what actually happened, it does highlight the greater volatility in stock prices than in underlying intrinsic values.
The second telling aspect of the extreme returns is that such volatility seems to encourage what we call “factor” trading. We define factors as exposures such as size or leverage or correlation with oil prices. In an environment of high volatility, opportunities to profit from “factor” moves seem to overwhelm other opportunities. The consequences are that several significant disparities in competitive positioning remain inefficiently priced.
The improvement in market sentiment since the end of the first quarter has also spawned some acquisitions. These transactions also created a virtuous cycle which has fueled further positive sentiment in the markets. While acquisitions often serve as a vehicle by which the intrinsic value of mid cap stocks can be realized, we have not been impressed by the quality of the deals done in the last quarter or two.
Looking ahead, our view of the economic and market landscape has changed very little over the last quarter. In particular, our view remains moderated by the financial retrenchment of U.S. consumers. The combination of excessive debt and high unemployment is forcing significant changes in spending patterns that we suspect will last for several years. Many businesses will have to endure both a lower organic revenue growth rate and a substantially more difficult environment for securing financing.
Despite these shorter-term headwinds, we remain generally positive about the economy and the markets as a whole. We believe the challenges of the last couple of years will, on the margin, serve to improve corporate governance and quality of operations. These improvements will ultimately increase the efficiency of capital allocation which is a big part of what makes the U.S. capital markets so powerful. These factors combined with reasonable market valuations and numerous instances of company-specific opportunities continue to support our longer-term optimism.