Chewing GAM
Formerly called chicle, after the tree from which this gummy substance was extracted and chewed by the Aztecs, chewing gum has been produced since the 1960s with a synthetic butadiene-based substance that is much easier to obtain. Initially used to curb hunger, it has become a substitute for candy and used to improve breath or clean teeth.
Over the past two months, the market has literally chewed up asset manager GAM, causing it to lose 50%. The reasons are not easy to understand. As we have already described (last July comment), GAM is an asset management company undergoing restructuring. The management is of quality and the policies now being pursued seem correct. Unfortunately, this is not enough. The negative aura accompanies the asset manager for a long time after a scandal, although in this case the scandal did not stem from misconduct and did not generate losses for clients. The company, however, seems close to having turned the corner and the valuation is extremely attractive, with AUM valued at less than 0.2%.
Following the scandal mentioned above, i.e. the issues surrounding the illiquid assets held in their flagship fund and having stumbled with a fund into the Greensill trap, it is normal that thoughts turn to litigation risk. That is why we spoke to the company again to find out if there are such risks. What emerged?
1) The company has ruled out litigation risks, with the Greensill fund fully reimbursable at maturity, just as the fund that caused the company’s problems has been fully reimbursed.
2) At the end of last year the company seemed to have turned the corner in terms of AUM, but this is not the case. Despite a good inflow into equity funds, which are showing good absolute and relative performance, bond funds continue to see outflows, both due to a market phenomenon and a disaffection of pension funds with the brand.
3) The company is in the process of restructuring its products and will shortly be launching new funds.
4) The pre-tax target of 100m CHF in 2022, although moved to 2024 after the covid, is still not credible. This would require more than 20bn CHF of new funding, over 50% of current AUM, from a company that is not seeing growth at the moment.
5) We expect AUM to be down on 30 September given the latest pension fund dynamics.
With no sign of a recovery on the horizon, it is possible that some have liquidated the position. Poor volumes have made the descent capitulate. However, we believe the company has good products, a good organisation and a good management team. With a valuation under 250m CHF and net cash of almost CHF 200m, we believe the risk/reward profile is extremely attractive. The company has 37 bln CHF of AUM assets and over 80 CHF bln of private label AUM and seems to represent a compelling take over target. It’s only natural that after a few strong chews, the chicle will become tastier…
Commenting on a Commentator
Robert Armstrong (RA) is a commentator for the FT. He ran LEX for years before moving on to sign his own letter. A brief stint as manager of the men’s fashion page also for the FT makes his personality even more interesting. RA is prepared and original. Ready to acknowledge his mistakes and present all his uncertainties, but far from reminding the public of the times when events have proved him right. A humble person in a world, that of finance and journalism, where conceit and superficiality are not so rare. Although what he writes is always interesting, we often disagree with it.
Here are references and comments to some of his recent letters.
The new Keiretsu
RA comes out 2 weeks ago with 3 letters on private equity (Private equity’s meh decade | Financial Times (ft.com) – Private equity is leveraged equity | Financial Times (ft.com) – Hot retail summer | Financial Times (ft.com) In short what comes out is that: 1) In general, over the last 10 years investing in private equity or buying an ETF on the S&P500 would have resulted in similar results, perhaps slightly better for the ETF; 2) Some funds have done much better than others, but there was no way to predict such outperformance at the beginning of the decade as the previous results were either not there (some of these outperformer funds were just born) or did not indicate a particular ability to generate alpha; 3) Considering the high indebtedness of the companies managed by PE, an indebtedness impossible to sustain for a listed company, it deduces that the performance achieved, almost equal to that of the market, was achieved with a clearly higher level of risk; 4) It concludes therefore that greater risk and less liquidity are not adequately remunerated by these instruments which instead remunerate the managers very well, and undeservedly so.
The above undoubtedly makes sense. But some clarifications are necessary: 1) If it is true that in the last 10 years there has been no average alpha in PE, it is also true that in the previous 10 years there was. The stock market in the previous 10 years was characterised by higher volatility than in the last 10 years and lower returns. In this respect, PE products have excelled both in terms of return and volatility, thus preventing investors invested here from making bad choices in difficult times, as well as protecting their coronets in times of extreme stress. 2) What follows from point 1 has created great demand for this asset class which has generated much more supply which, in turn, has reduced returns due to a reduction in opportunities and a greater number of, shall we say, less skilled and/or talented operators.
Then there is another consideration that seems important to us. Imagine a huge PE firm, controlling thousands of companies. It is used to working in pools with other large PE companies, which in turn control thousands of companies. Isn’t it doubtful that if one of these companies needs, say for example, toilet paper, it can more easily be bought from one of the “affiliated” companies, recreating a Western version of the much infamous Japanese Keiretsu or Korean Chaebol? Could this, when combined with enormous financing possibilities, not generate a significant (more or less legitimate) advantage? We believe so. Sooner or later it will come up, but given the timing of the regulators it is not something we probably need to worry about.
We can conclude that PE is certainly an interesting asset class and, like all asset classes, it has its ups and downs. It has its risks and opportunities. Its illiquidity, lack of transparency, limited diversification and lack of volatility make it suitable for qualified investors who can better understand the risks involved. Our advice is that if you are not sure of finding the most talented PEs, it is better to stay with the big guys who “make” the market or with the smaller ones who deal in corporate niches that the big guys are not interested in. In any case, diversify. Always.
ESG, a danger to the planet?
RA has repeatedly expressed doubts about ESG. The ESG investing industry is dangerous | Financial Times (ft.com) Team ESG fights back | Financial Times (ft.com) . In a recent letter he gives support and dignity to his opinion through a couple of characters Why we get inflation wrong | Financial Times (ft.com). The first, Aswath Damodaran, a professor at Stern University in NY, for many embodies modern theories of corporate valuation Musings on Markets: Sounding good or Doing good? A Skeptical Look at ESG (aswathdamodaran.blogspot.com). The second, Tariq Fancy, briefly served as CIO for Sustainable Investing at the world’s largest asset manager, Blackrock The Secret Diary of a ‘Sustainable Investor’ — Part 1 | by Tariq Fancy | Aug, 2021 | Medium.
There are three points raised:
1) You can’t think about putting limits on investments and earn as much or more than those who have no limits;
2) ESG creates more harm than good, bringing limited benefits and discouraging regulatory change, the only way to truly turn the page;
3) ESG makes advisors rich.
As mentioned I appreciate RA. I have been following and reading the highly rated Aswath Damodaran for many years. And I’ve read Fancy’s long and rather boring paper (and I’ve also had a wander around the website of his non-profit entrepreneurial initiative that he now devotes himself to which, coincidentally, is on that paper).
Here are the three subjects’ conclusions and our thoughts:
1) One cannot think of putting limits on investments and earn as much or more than those who have no limits. It is like saying that a hedge fund will make much more money than a UCITS because the latter has rules and limits. The hedge fund can easily destroy investors’ savings while the UCITS can hardly do so because of the rules. Damodaran in his piece partly recognises this. Performance, we know, is only one part of the algorithm for evaluating an investment. The other part is risk. In the classical discipline, the volatility of the portfolio is taken as a proxy for the risk taken. This is clearly a crude approximation, but the only reasonable one. Indeed, one security may be low volatile and dangerous and another very volatile and much less dangerous. But we need a measure of risk. Sustainability analysis does nothing more than discard from the portfolio companies that do not adopt practices deemed healthy in the governance, environmental and social spheres. This inevitably reduces portfolio risk. So a sustainable portfolio is necessarily less risky in the long run. It is therefore more suitable for the retail investor who, directly or through pension funds, does not speculate but invest for the long term.
2) ESG does more harm than good, bringing limited benefits and discouraging regulatory change, which is the only way to truly turn the page. We believe this point is also deeply flawed. Politics follow public opinion. If sustainability gets under the nails of public opinion, politicians will follow, championing the trend. This is what we see all over the world. Moreover, corporate sustainability is a global phenomenon and anticipates local political dynamics.
3) ESG makes advisors rich. This is the only point where we partially agree. We were just recently reading the Vanguard document (click here to view it). A document full of empty and pompous terms, constructed by consultants. Vanguard manages ETFs, so how can it decide what to vote on at meetings? What does it do? It pays companies to vote on its behalf according to pre-defined guidelines. Then they take proxies and prepare the documents. Vanguard pays and publishes them. This is the integrated analysis that the PRI talks about? For quantitative investments it is the same thing. You rely on expensive providers who reduce the universe according to subjective and not always clear methodologies. Mind you, these practices, although mechanical and rich for advisors, are still good and put pressure on companies on important issues. However, there is also integrated analysis and here sustainability can really be deepened by the manager and take on a less mechanistic and bureaucratic character.
I think you have to get your hands dirty and experience the sustainability analysis with the companies on a day-to-day basis, instead of talking about things you know little about in a too “high” and detached way. I don’t think any of these gentlemen, however illustrious, have ever really done that.
Equity, still yummy?
RA is sceptical about equity. In one letter he presents a bear case and then, a few days later, to try to please everyone, he does a letter on the bull case.
Bull case (The bull case on stocks | Financial Times (ft.com))
The fact that he does not believe in the bull case is clear from the paucity of his arguments. He uses exactly two: 1) if you sell it is difficult to come back. Since the market is going up in the long run, it is better not to sell. He then gives the example of when he sold well in 2008, only to buy back however much higher several years later; 2) he mentions the now famous acronym TINA, There Is No Alternative to stocks.
Bear case (The bear case on stocks | Financial Times (ft.com))
The bear case is more articulated and is based on several points:
1) US equity market is overvalued in every metric apart from the risk premium (earning yield minus real yield on the 10-year) on which it would be appropriately valued;
2) retail investors have invested heavily in equities and equity funds, but this flow cannot continue indefinitely;
3) risk appetite is declining, judging by how many stocks are far from their highs, although this is not apparent from the index performance;
4) there is a lot of leverage in the system which can lead to very violent reactions when momentum changes direction;
5) earnings growth is losing strength.
Here are our considerations, point by point
1) As we have repeatedly said, the US market is not exactly what a value investor dreams of at night, being one of the most growth-oriented markets on the planet where it is not easy to find value stocks. Having said that, here too we have a divison between very expensive stocks (for a reason called growth, margins, positioning, scarcity, etc) in which we do not invest, but for which the market is crazy, and stocks that are not expensive, again for one or more reasons, which in many cases we do not agree with, in which we invest. Today, the division is so strong that the “medione” has the same value as Trilussa’s chicken.
2) It is true that retail investors are very active. However, before thinking about the funds they buy, I would think about the cryptocurrencies or meme stocks they devour. This is a phenomenon very much linked to online platforms, accumulated savings and, above all, a lack of alternatives. Lack of alternatives that all institutional players have anyway. And there has not yet been the stampede from bonds that will inevitably, after an initial moment of panic, bring more money into equity.
3) Almost 80% of bonds are above the 200 average. While it is true that we were at 95% in January, it is also true that we are still at the top end of the last 5 years, a comfortable position.
4) The debt on the margin shown in the graph in the article is gross (USD 900bn) and has indeed risen sharply in recent months, reflecting the speculative activity that we also often see. The net level (net of cash from the same accounts) is about half, two days or so of market-traded value, not particularly worrying. This factor has the potential to increase the volatility of the market going down but certainly not, by itself, create a bear market.
5) Earnings growth continues and is healthy. However, the second derivative, i.e. the speed of that growth, is slowing from levels that are unsustainable in any case. Hardly an indicator that leaves us terrified
We reiterate that we have rarely seen so many opportunities on the value side of the market, a side that has been completely forgotten. And this is happening at a time of radical change, which should reshuffle the cards of profitability between sectors. But it is still true that to find plenty, you have to be a bit curious and look outside the US market…
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