All Out: Swensen on Investing, PE Now King, Binance Crashing, BlackRock Cloning, and Crytpo Being Banned (Again…)
David Swensen is probably one of the most famous institutional allocators there has ever existed. Several years ago he wrote what some have called the seminal book on endowment investing. We’ve seen many other investors (endowments, high net worth individuals, and many advisors) follow in his footsteps and copy his asset allocation. This post from Ted Seides (who worked with David many years at Yale), makes some very interesting points as to David’s process and why following it might be misguided. First of all what David thought was key:
- Equity bias: stocks tend to generate the highest returns over time
- Diversification: the only “free lunch” of reducing risk without sacrificing expected returns
- Alignment of interest: principal-agent conflicts are everywhere, you need the manager’s interests to be aligned with those of the investor
- Searching for inefficiencies: there is a higher chance of being able to outperform in inefficient markets
More importantly Ted goes into common misconceptions of his approach:
- Illiquidity: in David’s model, illiquidity is a result of looking for other things and not a concept in and of itself. Now it seems investors believe you should always get paid for investing in something illiquid. David’s portfolio had a large allocation to illiquid assets. He did This not just because they were illiquid, but rather that’s where he found attractive underpriced assets.
- Private equity and venture capital: after he published his book, investments into PE and VC skyrocketed, even though he thought most investors should not participate in the asset class. The fees and costs for these funds are so high that you need to be extremely good (or lucky) at picking funds in order to overcome the fees, leverage and added risk these investments entail. He said many years ago what we’ve been repeating recently and most investors fail to realize. PE/VC in aggregate does not beat public markets and most importantly do not diversify equity portfolios since it’s the same exact asset class, just that it’s private.
- Rebalancing: contrary to what many think, David thought rebalancing actually hurt long term returns. He saw it mostly as a risk management tool to keep the portfolio in line with what was expected. However, he thought that if portfolios were allowed to drift, then they would generate stronger returns since the portfolio would have a higher allocation to assets that had done well. In short, he believed in momentum effects.
‘Private equity is now king’ for the ultra-rich, says Tiger 21, an exclusive club of investors
Tiger 21 is a club for ultra-rich investors and entrepreneurs to discuss investment opportunities. Apparently they collectively control over $150Bn in assets. It seems they have been increasing their allocation to private equity and it is now “king”. In markets it often helps to be contrarian. In order to make abnormal returns in markets you need to think differently, and most importantly you need to be right. If you just follow the herd then you are making investments which are already priced accordingly. If everybody thinks there will be a recession, then markets will be pricing that in, and if there actually is a recession you won’t make any abnormal profits since that was what was expected. However, if markets think that there will be no recession and you do, if you invest according to that view and you’re proven right, then you will outperform.
All this to say that the consensus in markets is often wrong. For example, hedge funds had a great returns in the 90s and early 2000s, money flowed into the sector and after that, the industry as a whole has had a pretty bad run. Private equity seems to be the next candidate. PE has had a great run (we don’t agree with the performance measurement but lets just take it at face value for now), in the last 10-15 years. This in large part has been fueled by rock bottom interest rates (PE uses a lot of leverage), and a valuation discount to public markets. Now everybody is piling into PE. From the “ultra-rich” in Tiger 21 to global pension funds which have to increase risk to meet their future obligations. Now the conditions are very different than 15 years ago. Money is no longer free, valuations are no longer cheap, and there is a ton of money chasing the same deals which will increase competition, increase valuations and drive down returns. Like we said above, in markets the consensus is often wrong, and PE is about as consensus as it gets right now.
Binance, the World’s Biggest Crypto Firm, Is Melting Down
Funny how quickly things can turn around. Remember back in 2021, crypto was all the rage. FTX was king of the pack and was buying advertising time in the Super Bowl (funny how prescient Larry David was), buying stadium naming rights, and dumping millions into politics. It spectacularly collapsed in 2022 and now we’re weeks away from SBF’s trial. The collapse of FTX is taking the rest of the crypto world with it. A big part of why it collapsed was because of Binance, the world’s largest cryptocurrency exchange. Well now it seems that Binance is in trouble as well. The US Department of Justice (DOJ) is looking to Binance and CZ (it’s founder and CEO). These investigations could lead to criminal charges and billions of dollars in fines. A couple of years ago, crypto was the Wild West. There were hundreds of initial coin offerings without any regulation, NFT projects were launched and raised hundreds of millions of dollars, and crypto exchanges could do pretty much whatever they wanted. Well now the SEC and DOJ are bringing down the hammer and going after many of these projects for securities laws violations. And in the case of Binance for breaching US sanctions on Russia.
BlackRock Joins Goldman in Cloning JPMorgan’s Blockbuster ETF
Roughly 3 years ago, JP Morgan launched an ETF (ticker: JEPI), which has been incredibly successful. By successful we mean that it has raised a ton of money, it currently has ~$29Bn In assets. It did fairly well in 2021, outperformed the S&P 500 by 14.65% and is underperforming by around 9% this year. Since inception the fund is up roughly 44% vs. 52% for the S&P 500. So why is it so popular? Is it risk adjusted returns? Sure it has lower volatility than the S&P 500 and has better risk adjusted returns, but many other ETFs have this without having $29Bn. Success here has mostly been because of its hefty dividend yield of ~7.7%. The way they do this is basically by capping upside participation. What JEPI does is invest in a basket of stocks (not exactly S&P 500 but close enough), and sells index call options agains the basket to generate option premium and pay this via dividends. So the yield is compensation for giving up upside participation.
And as in everything in finance there is no free lunch. JEPI is fairly new with only a couple of years of returns, but ETFs using the same strategy have been around for some time. QYLD is an ETF that uses a similar strategy but on the Nasdaq Index. Basically it buys the Nasdaq and sells calls against it. It’s current yield is ~12%. So how has it performed historically? Pretty massive underperformance. Since its launch in December 2013, the Nasdaq is up ~355%, QYLD is up only 75% (and that does include dividends). And this is assuming no taxes, if you are a non US investor, that 12% yield comes down to 8.4% after the 30% withholding the IRS will hit you with on those dividends. So instead of focusing on dividend yields, just choose the strategy you think is best and you can generate you own dividends (by selling off some stock every now and then). Don’t be fooled by those juicy dividend yields.
JPMorgan’s UK bank Chase to ban crypto transactions
It seems like we are coming full circle on crypto. Back in 2015 – 2017, when crypto was just starting to go mainstream, many banks would not deal with crypto. It was difficult to convert fiat into crypto and vice-versa. This is a reason (one of the main reasons?) why stable coins became so popular. We’ve talked about stable coins before, the basic idea of a stable coin is that it is a crypto currency whose value is pegged to fiat currency. The largest stable coin, Tether, is supposed to be backed by liquid $US reserves and it’s value should always be equal to $1 (there are suspicions that the reserves aren’t enough but we’ll leave that for another day). Stable coins make it easier to move money around the crypto ecosystem without needing to interact with the traditional financial system. So if banks are preventing you from moving money to and from crypto exchanges, a stable coin like tether would work well. But the main premise of crypto we think is weakening. If banks are starting to ban transactions again because of fraud and scams, then what good is crypto for?
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