John is out at the MoneyWeek Wealth Summit this morning, so today we have a guest essay from value fund manager and regular MoneyWeek contributor, Tim Price.
Are all asset classes expensive?
It’s a complaint you hear often in today’s low-yield world.
But it depends on where you look.
There’s always opportunity lurking somewhere
Most institutional fund managers are constrained on multiple fronts.
They track some form of index or benchmark; that index or benchmark will almost invariably be market-relative (as opposed to absolute) in nature; they will have either very limited or no real discretion to limit the size of their funds.
Take Vietnam, one of our favourite markets. It’s a favourite primarily on valuation grounds: its companies, while in many cases highly profitable and growing quickly, trade on a huge discount to those throughout the rest of the world.
It’s also a favourite because of economic fundamentals. Vietnamese wage rates, for example, are roughly a third of those in China.
But Vietnam is also a favourite because of a technical wrinkle. By dint of being defined as a “frontier” economy (one step below that of an “emerging market”), Vietnam does not sit within the MSCI World Index – it’s not yet a developed economy.
But it doesn’t sit within the MSCI Emerging Market Index either – it’s not yet deemed mature enough.
What this means is that if you’re an institutional fund manager tracking either MSCI World or MSCI Emerging, you don’t get to play in Vietnam. You’re not allowed. You can’t.
Well, we can – because we’re not constrained by a box marked MSCI or anything else. Hint: it will probably make more sense as a private investor to own Vietnam before the Big Boys are allowed in.
We have long stated that the only benchmark that should matter to any investor (private or otherwise) is an absolute return one.
That is to say, we believe more strongly in sustained capital preservation in real terms, than in more speculative capital growth that exposes client portfolios to huge swings in net asset value – up and down.
Big is not beautiful when it comes to investing in funds
But perhaps the biggest impediment to investment performance is size. As Warren Buffett himself has acknowledged on numerous occasions, “size is the anchor of performance”.
Asset management practitioners would provide a superior service to their clients if they limited inflows and concentrated on delivering investment returns. Sadly, the “institutional imperative” makes onerous demands on institutional players. In other words, it forces them to get greedy.
Given that the largest asset managers now control trillions of dollars by way of assets under management, investors in their funds might want to answer the following question using words of one syllable: can a market beat itself?
Before buying any fund, ask yourself some additional questions:
How big is it? The tree cannot grow to the sky. But try telling that to Neil Woodford, or to the average member of the Investment Association. Managers’ pay is invariably linked to the size of funds under management. The more assets, the more pay.
It takes guts, and principles, to turn money away and concentrate solely on investment performance. But that’s precisely what many smaller investment boutiques do on a regular basis.
Has the manager invested his own money? If he hasn’t, why should you? Meaningful personal investment is by itself no guarantee of investment outperformance, but it shows the most basic alignment of interests between manager and investor.
Is it independent, and owner-managed? David Swensen, manager of Yale University’s endowment fund, has gone on record saying he prefers the smaller, private partnership over the larger, listed full-service operator. How many mouths must your fees feed?
Is it an asset manager, or an asset gatherer? This gets to the heart of the challenge facing investors today. The investment world is polarised between asset managers, who focus their energies on delivering the best possible returns for their clients; and asset gatherers, who just want to maximise the number of clients. Most fund management firms fall into the latter category. Favour the former.
How to distinguish between the asset managers and the asset gatherers? Try to find managers like the celebrated investor Jean-Marie Eveillard, who once remarked: “I would rather lose half of my shareholders than half of my shareholders’ money”.
We conclude with three observations.
1. Homo economicus doesn’t exist outside the economics textbooks. Private investors, together with their professional advisers and managers, may often be guilty of confusing “needs” with “wants”.
When they say they “want” a certain annualised return, they might more accurately “need” the absolute preservation of their purchasing power over time – and, ideally, some form of incremental positive return on top.
2. That size is the enemy of performance is the fund management industry’s dirty little secret that hides in plain sight.
3. Index-relative investing is for the birds, despite the fact that almost the entire asset management industry pursues it. The essential truth of this statement will become almost tangible during the next market correction.
The truth is that there is no shortage of attractive investment opportunities in an unconstrained global marketplace. You just have to be looking for them. And most asset managers, as a direct and inevitable result of the hope, need and greed that drives their institutional imperatives, simply are not.
• Tim Price is co-manager of the VT Price Value Portfolio and author of Investing Through the Looking Glass: A Rational Guide to Irrational Financial Markets.