For Professional Investors only: Search and Recommend Knowledge
Ever wondered what your expert peers are reading?
Discover the best investment thought leadership, as rated by your expert peers.
Asset Circle is an expert peer-sourced collection of the investment industry’s knowledge.
Join now for the shortest path to quality content for professional investors.
NOTHING ON THIS SITE IS INTENDED TO OR SHOULD BE CONSTRUED AS ADVICE
Today, with lots of capital concentrated in a few securities, active investors are more engaged in the debate on the virtues of passive investing. They are making a better distinction between good and bad passive investing. This short article (June 2018) written by Transtrend (a CTA manager that has been around for ages) is a good example of thoughts on the impact of index tracking or how passive investing could self destruct. The authors are surely right when they state: "Markets are not a train that one can hop on and hop off without impacting its timetable. All trading activity has market impact. In fact, market impact is the only force that drives prices." The article demonstrates how index tracking affects an index and how, in theory at least, index tracking could not only deteriorate the index, but also give the tool to some index trackers to outperform in the process. The proof is only theoretical and is yet to be demonstrated with market data. I hope someone will attempt this analysis. There has been a lot of debates regarding active versus passive investing and sometimes it is necessary to simplify and emphasise to get a grip on a dynamic. By doing so, this article is key in understanding how the rise of index hugging will affect markets and can help investors determine whether or not an index is worth tracking. In short, the fewer trackers, the more attractive the index.
Howard Marks offers a wealth of knowledge and wisdom about active management, passive investing, and quants/AI in his latest memo, entitled 'Investing Without People.' In this current up-cycle, his comments on the actions of market participants are insightful. Let me quote: "When everyone decides to refrain from performing the functions of analysis, price discovery, and capital allocation, the appropriateness of market prices can go out of the window..." The potential for disappointment rises when people invest more in certain stocks than others; think of FAANGs, factor crowding, and the feedback loop as a result of passive investing. In short, overvaluation followed by abrupt reversals. Indeed, too strict a focus on short-term relative returns of active funds, and abandoning those having short-term performance challenges, can needlessly reduce potential longer-term excess returns for investors. A truly active and differentiated fund will have spells of underperformance blips. Investors will be better served by a more realistic consideration of the pros and cons of active investing. And here is the killer quote: "quantitative investing's emphasis on profiting from short-term dislocations leaves a lot more to be mined. So much of investing these days considers only the short run that I think there's a great scope for superior active investors to make value-additive decisions concerning the long run."
Computers prioritise efficiency over judgment. But, as David Iben (CIO of Kopernik Global Advisors) writes in his latest commentary (June 2018): "...in investing, a field that is famously a blend of science and art, isn't judgment what really matters?" In short, there is uncertainty. Investment returns are highly uncertain and irregular. Computers might help investors find patterns or signs of 'irrational' exuberance or despondency. But, as Iben writes, 'In a weird paradox, computers have allowed mankind to formulate and embrace more theories, which in turn, have caused increased use of computers, which unfortunately, due to the inherent fallacies embedded within, have had spurious consequences." He adds, "The less time people spend doing active research, the easier it is for the remaining practitioners of the trade; the greater the prospective returns will be." Though simple in principle, true active management is difficult to follow in practice. Machine learning will not make truly talented investors redundant. Although AI is suffused with hype, it will be better than humans at specific tasks. Crucially, to quote Iben again, we need to keep remembering to break away from any "servitude to misguided ivory tower theory, behavioural heuristics, ill-conceived formulas, fiat money, and other 'false Gods'."
Finland's private sector earnings-related pension provider, Ilmarinen, has been awarded Best RI Report by an Asset Owner at the RI Reporting Awards 2018. Ilmarinen's Sustainability Report is worth reading as it demonstrates how sustainability has been established by a large asset owner as an essential element of investment policy and business strategy. In their report, Ilmarinen state their own view on responsible investing clearly: "In our view, responsibility is integral to profitable and secure investment operations and effective risk management." Looking at business management and investment through a responsible investment lens can lead to a behaviour that is more likely to create and preserve long-term value. Leading asset owners are not waiting to be challenged on sustainability issues. They are taking action. Annual sustainability reviews are becoming best practice among leading asset owners. This may be the right approach as they are often critical inputs to a growing set of guidelines, benchmarks, and rating systems intended to support sustainability definition, design, and management.
Artificial Intelligence (AI) is expected to reshape the asset management industry. AI will lead to a hyper-connected and soon heavily dis-intermediated financial world where decision making becomes increasingly data-driven. This paper by Sandro Zarri, a Swiss economist, challenges the way we look at data. The nature of data is constantly changing, making time-series analysis sub-optimal. For instance, inflation is becoming increasingly complex and difficult to measure properly since the Great Financial Crisis. It has made traditional monetary policy less effective and created huge confusion among economists who still cling onto traditional theories. This is why beliefs are self-reinforcing within the market, until a new reality challenges the current perception. When this occurs, it can be dramatic. For instance, how is it that the Great Financial Crisis, suddenly became a crisis over night? Forecasting - a big headache for investors - may be improved with AI. AI' s ability to forecast market reactions could help asset managers make better decisions on the risk premia they are participating in. But the Cambridge Analytical scandal revealed how a corporate crisis can suddenly happen. This paper serves as a reminder how risk appears and disappears as reality changes. To see how AI develops and learns about the market will be interesting.
Did you notice that value managers often use the word 'disconnected' (i.e. investing where the discount to intrinsic value is largest), while growth managers frequently use the word 'disruption'? Stocks with growth characteristics have outperformed value groups over recent years - so 'Are value stocks ready to grow' asks this excellent article by Barron's. Maybe the old debate between growth and value (and the style box) is irrelevant. Not all value stocks are 'fallen angels' and not all growth stocks 'are magic beans that will grow forever'. Followers of Warren Buffet will recall his comments that this is all 'fuzzy thinking'; as he said, 'the two approaches are joined at the hip' (Chairman's Letter - 1992 - Berkshire Hathaway Inc). Quality matters more now than ever before and a margin-of-safety does make sense - and bargains can still be found. This article analyses the performance of Value Indices over the past ten years and then provides a rationale for nine stocks owned by well-known value investors.