Active Management

One often hears people say, “You need to be an active investor in emerging markets.”

It makes sense. A passive approach has been pathetic over the last decade: the MSCI EM Index has delivered net annualized returns of 3.37% (as of 30 Sep 2019).

“Ah, but the index is a terrible product that’s been overweight financials, the commodity complex, and state-related enterprises.”

Agree!

“The performance of active managers has been better.”

I should hope so!

But is it true?

Well. When an appropriate benchmark is selected for each public equity manager’s strategy, data from the SPIVA year-end scorecard suggest that the answer is “no” (see below).

Active public equity managers aren’t helped by the fact that the investable universe in EM has not kept pace with underlying growth. To illustrate, the number of listed companies in IDA and IBRD countries grew by a paltry 17% between 2000-18, a period when real GDP grew 2.5x.

* * *

Private markets managers haven’t been much better, sadly.

Cambridge Associates’ indexed, 10-year returns for Africa, Emerging Europe, and Latin America PE / VC funds are essentially a few hundred basis points above the 10-year U.S. Treasury (as of 31 Mar 2019).

Emerging Asia tells a different story, with an indexed net IRR of ~ 16% relative to ~ 17% in the United States. It’s no surprise why LPs are herding en masse to Asia (even though history suggests caution is warranted).

But even if Cambridge’s data are directionally accurate today, who knows how these performance figures will shape up? The proportion of returns that are unrealized for top-quartile EM funds from the 2008-17 vintages ranges between ~ 40% and 100%.

Are there exceptions? Of course! They’re the exceptions!

Will investors generate exceptional returns by following their peers into the countries, strategies, and segments that worked in the recent past? You tell me.

* * *

“Thanks for telling us everything stinks.”

Anytime!

Look. I can’t explain the underperformance of actively managed public equity funds in EM. My assumption was that the inefficiencies in EM would create more opportunities for alpha than one sees in the United States. And yet — if the SPIVA data are to be believed — the percentage of U.S. large-cap, mid-cap, and small-cap equity funds underperforming their benchmarks is lower than one sees in EM.

With respect to private markets, I would submit to you that part of the reason for the poor performance at an industry level is that management hasn’t been active enough — particularly with respect to value creation and exits.

Where does this leave us?

Well, here at Portico, we’re ginning up ideas for new products.

Will they be commercially viable?

No idea!

What are we thinking about?

Active vs. passive. Diversification vs. concentration. Funds vs. assets.

Stay tuned.

Alla prossima,
Mike

———

Leveraged Buyouts, Be Gone

With the 2020 presidential elections hitting high gear, the political backlash against leveraged buyouts is building:

I’m for capitalism, I’m for free enterprise, I’m for entrepreneurs … There’s a big difference between people who go out and create a company — even if they fail — if they try to go in the right direction, if they share in the hardships, if they’re out there with the workers doing it together. That’s one thing. But if someone who is very wealthy comes in and takes over your company and takes out all the cash and leaves behind the unemployment? I think that’s not a model we want to advocate.

Just kidding. That was former Speaker of the House Newt Gingrich (R – GA) attacking Mitt Romney’s exploits at Bain Capital back in 2012. (BTW, Bain does impact investing now, have you heard?)

Though LBO firms were palpably nervous about regulatory revanchism back in the day, the Obama administration was swift to soothe the so-called fat cats’ concerns. And lo, the regulatory risks receded as soporifically as the tides that lap against the coastline of Martha’s Vineyard.

Anyway. Things done changed.

Says Senator Elizabeth Warren, the soon-to-be-frontrunner for the top of the Democratic Party ticket:

Let’s call this what it is: legalized looting — looting that makes a handful of Wall Street managers very rich while costing thousands of people their jobs, putting valuable companies out of business, and hurting communities across the country.

She has a plan.

Rich people are scared.

And if she secures the nomination, then Trump’s probably going to win in 2020.

Be that as it may, populism is the water in which we’re swimming. And lest you think that the currents carrying PE toward tighter regulation are going to change course, take a look at some recent items that are likely to garner interest among Congressional staffers:

• The Economic Effects of Private Equity Buyouts — The devil’s in the details, but the aggregate findings show a 4.4% decline in employment over the first two years of a buyout, with a decline in compensation per worker of 1.7%.
• Leveraged Buyouts and Financial Distress — Evaluates nearly 500 public-to-private LBOs for 10 years and finds a bankruptcy rate of ~ 20% relative to 2% in the control sample. “Our empirical tests suggest that private equity funds acquire healthy firms and increase their probability of default ten-fold … analysis [is] robust to macroeconomic and industry shocks.”
• PE and Surprise Medical Billing — Sticking it to the people in a price-inelastic market. One of many data points: when PE-backed EmCare has taken over hospitals’ emergency room departments, prices for care have increased 82%.
• Eileen Appelbaum’s Letter to Elizabeth Warren — Chock full of data and anecdotes that demonstrate the rapacity of LBO firms and the need for legislative reform.

LBOs constitute an extractive industry and the world doesn’t need them.

Build something that increases the general welfare.

———

FX

A few years ago, USAID sponsored a study on currency risk mitigation in EM private markets. The project team sourced and explored three product pathways that could lead to new hedging capacities.

At the time, someone floated a nebulous idea about matching the exposures of long-term investors through some sort of asset / liability framework, but the details were sparse, and it wasn’t pursued.

Well. The FT recently reported on two initiatives that are enabling institutional investors to net off their exposures in the spot market without relying on banks as market-makers.

According to Siege FX — one of the firms spearheading these peer-to-peer initiatives — investors could create sizable markets in EM currencies among themselves, such as:

• ~ 35% of USD / MXN trades
• ~ 22% of USD / ZAR trades
• ~ 18% of USD / TRY trades

Maybe it’s worth dusting off the asset / liability matching idea?

If only I could remember who came up with it …

 

———

From the Bookshelf

O dark dark dark. They all go into the dark,
The vacant interstellar spaces, the vacant into the vacant,
The captains, merchant bankers, eminent men of letters,
The generous patrons of art, the statesmen and the rulers,
Distinguished civil servants, chairmen of many committees,
Industrial lords and petty contractors, all go into the dark,
And dark the Sun and Moon, and the Almanach de Gotha
And the Stock Exchange Gazette, the Directory of Directors,
And cold the sense and lost the motive of action.
And we all go with them, into the silent funeral,
Nobody’s funeral, for there is no one to bury.
I said to my soul, be still, and let the dark come upon you
Which shall be the darkness of God. As, in a theatre,
The lights are extinguished, for the scene to be changed
With a hollow rumble of wings, with a movement of dark-
ness on darkness,
And we know that the hills and the trees, the distant
panorama
And the bold imposing façade are all being rolled away—
Or as, when an underground train, in the tube, stops too
long between stations
And the conversation rises and slowly fades into silence
And you see behind every face the mental emptiness deepen
Leaving only the growing terror of nothing to think about;
Or when, under ether, the mind is conscious but conscious
of nothing—
I said to my soul, be still, and wait without hope
For hope would be hope for the wrong thing; wait without
love
For love would be love of the wrong thing; there is yet faith
But the faith and love and the hope are all in the waiting.
Wait without thought, for you are not ready for thought:
So the darkness shall be the light, and the stillness the
dancing.
Whisper of running streams, and winter lightning.
The wild thyme unseen and the wild strawberry,
The laughter in the garden, echoed ecstasy
Not lost, but requiring, pointing to the agony
Of death and birth.

You say I am repeating
Something I have said before. I shall say it again.
Shall I say it again? In order to arrive there,
To arrive where you are, to get from where you are not,
You must go by a way wherein there is no ecstasy.
In order to arrive at what you do not know
You must go by a way which is the way of ignorance.
In order to possess what you do not possess
You must go by the way of dispossession.
In order to arrive at what you are not
You must go through the way in which you are not.
And what you do not know is the only thing you know
And what you own is what you do not own
And where you are is where you are not.

— T.S. Eliot, “East Coker (III)” in Collected Poems: 1909—1962 (Harcourt Brace: 1991)

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.