Impact Investing

The haters are coming out of the woodwork to kick impact investing while it’s down. Following the Abraaj fiasco and the sordid charges filed against Bill McGlashan, formerly CEO of The Rise Fund, people seem fairly gleeful to pronounce the death of impact investing.

I was particularly tickled reading PEI’s prognosis a few weeks back (“Has Bill McGlashan poisoned the impact well?”), which oddly failed to mention that PEI itself named McGlashan “Game Changer of the Year” in 2018.

Oops.

The pickings were so easy that even I couldn’t resist tweeting, “Spare a moment for the LPs in the Abraaj healthcare fund …” (Nobody liked it).

Look, I of all people am skeptical about the term “impact investing.” It’s super squishy.

It is manifest that large asset managers are embracing the impact label to hoover up assets and collect management fees. And, it is nauseating listening to investors whose public appearances contain little more than sanctimonious virtue signaling, and whose marketing copy makes one retch in one’s mouth.

But before everyone dances on the grave of impact investing, let’s pause at GIIN’s recent research suggesting that the impact investing market has doubled to $502 billion.

And, while the financial services industry is teeming with unethical people, let’s not lose sight of the fact that there are decent, earnest individuals in the industry who actually live and breathe an impact mission. Investors who are actually building sustainable businesses and improving lives. Most of them just are not as well known.

I was reminded of this recently after I recited the previous paragraph to a journalist whose work I respect.

“Name one,” s/he said.

“[Firm],” I said.

“Never heard of ‘em.”

Skepticism is warranted. But where, I ask, was the skepticism when the banquets and award ceremonies were being thrown, and the ingratiating articles were being written?

Maybe — maybe — people shouldn’t chase shiny objects.

Alla prossima,
Mike

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Manager Selection

Sometimes, the asset management industry is revealed for the grand kabuki dance it is: overpaid, mostly smart people developing overly complex narratives to justify their jobs / fees.

I am no Luddite.

I value data and evidence.

But who among us can quantify the life energy that has been spent datamining backtesting investment strategies to uncover a finding that has no utility in the real world?

It’s not just the asset managers. Consider the lifetimes that asset owners have spent developing frameworks for manager selection, or the billions of pensioners’ dollars spent on investment consultants in a quest to pick top-quartile funds.

Loads of acronyms. Loads of analytics and equations. Loads of paperwork and spreadsheets and meetings. Countless hours nudging shapes in PowerPoint.

And then you see a chart that lays bare how silly it is to think that anybody could reliably pick winners. Dan Rasmussen of Verdad uncovered a golden nugget from the Oregon Public Employees Retirement Fund (OPERF) demonstrating that “despite 30 years of experience and the best advisors money can buy, OPERF has been unable to consistently identify top-quartile managers” (see below).

Screen Shot 2019-04-06 at 2.40.46 PM

And yes, that analysis is weighed by dollars allocated, not number of commitments.

To be fair, it’s more flattering when done by the latter — which comically is a lesson the consultant (and the team?) learned for the 2019 report (see page 111).

But, it’s still less than one-quarter that fall in the top quartile. 😞

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Winds of Change

One of the things we like to talk about around here is whether EM PE — as distinct from EM private markets — is an industry in structural decline. I’ve had too many conversations with investors lately to change my opinion. The anecdotes are becoming anecdata.

And one of the genres of marination we often ponder is the DFIs’ direction of travel on PE funds. On this ponderable, the chart below from the Independent Commission for Aid Impact’s performance review of CDC is quite telling.

Whilst CDC underwent a strategy shift in 2012, it’s rather remarkable to track the rate of change in the value of the organization’s funds portfolio (i.e., “intermediated equity”) on both an absolute (£2.6B ➡︎ £2B) and relative basis (88% ➡︎ 52%!) since 2014.

Picture1.png

Marinate on the decline for a bit and what it suggests about industry performance. We can surmise where the preponderance of future investment flows are likely to head (hint: direct debt and equity).

Whither EM PE (ex-mega-cap Asia)?

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My Friend Wrote a Book

This is not at all related to EM private markets, but my friend, John Gans, wrote a book about the National Security Council. It rocketed to the top of the New Release charts on Amazon a couple weeks ago.

You should buy it!

And maybe even read it!

To whet your appetite, I conducted a bite-sized interview with the author.

Thumbnail on John: Previously chief speechwriter for Defense Secretary Ash Carter, senior speechwriter for Defense Secretary Chuck Hagel and Treasury Secretary Jack Lew. He also worked with Nancy Pelosi and Hillary Rodham Clinton, is published widely, and has an MA and PhD from SAIS. Big Bruce Springsteen fan.

Mike: First, thank you for writing a book that’s less than 300 pages.

Our newsletter has readers all over the world, many of whom may not have heard of the National Security Council. Why should people read this book?

John: This is the exact reason I tried to write an accessible book. The NSC is the most important and powerful entity in the U.S. government, with the influence to shape decisions that affect the lives of people in the United States and around the world. Yet few Americans can name a single member of the staff. This book introduces readers — for the first time — to the people and the power of the NSC staff. If you’re an American, these are your staffers, you should know them, judge them, and if necessary change them.

M: You interviewed an astonishing group of people for this book, including Dick Cheney, Donald Rumsfeld, Bob Gates, Susan Rice, and H.R. McMaster. What did you learn about the nature of leadership?

J: The most important take away for me is that each of these leaders is human. At the beginning of every course I teach about how government works, I start by reminding students that they are not that different than the people sitting in the Situation Room.

Barack Obama and Donald Trump, Dick Cheney and Susan Rice, are not much different than you and me. They may like politics more and be driven by a hunger for power, but they also have good days and bad, they laugh, they feel stress, and they worry about what people think about them. One of the keys to good leadership is remembering your own humanity and the humanity of those who you want to lead.

whw

M: Your book includes a series of case studies in which entrepreneurial civil servants develop and then sell a policy shift to the president — frequently during war or exigent circumstances.

Our clients are mostly entrepreneurs who sell people on investment strategies in emerging and frontier markets — frequently these are outside of institutional investors’ comfort zone. What made for an effective ‘sales’ technique for difficult decisions across presidencies?

J: My bet is that exigent circumstances make it easier to sell one’s ideas. After all, there are few better places to sell life preservers than on a sinking ship, and few easier places to sell an idea about war than in the Oval Office with a president who does not want to lose.

That said, as someone who has worked in government and now written a book about it, I think the critical lesson is not to count on getting lucky — always having the right idea at the right time in the right place — but rather in persisting with your core ideas and principles. Eventually the right time will come for you. And if you’re ready in that moment, you’ll win the day.

M: In my previous life working with former NSC staffers, a uniform sentiment was that personalities trump process. I’ve also found this to be a prevalent sentiment while exploring the topic of governance in EM private markets.

Did you find this to be true in your interviews and research? If so, are there processes we can embrace to insulate America and the world from the consequences of misguided personalities?

J: There is no process that can make a mediocre, misguided, or malevolent person a good one. But good process can minimize the risks posed by the middling or mischievous, and make good personalities soar.

I think a lot of process — in government, in academia, in the business world — is bad because too few people are self aware enough to know what works for them and what doesn’t.

One of the early doubts I heard in working on this book was that the individuals did not matter much to the power of the NSC. But that’s one reason why no one gets what the NSC is capable of — they haven’t spent any time figuring out what makes these people tick. That’s a lesson for understanding our government, or running one’s business.

M: Why are you so obsessed with Bruce Springsteen? Especially since Rage Against the Machine’s “Ghost of Tom Joad” is clearly the better version?

J: Fandom does not require an explanation, which is probably a good thing since love is hard to explain. But the assertion appears to answer the question: Springsteen wrote a rock song so good that a newsletter about private equity is talking about Tom Joad. How many artists can do that?

———

From the Bookshelf

… reporters, more often than not, heavily rely upon the help of powerful institutions, go through the motions of acting adversarial without affecting substance, and are distracted from the public interest by profit-minded news organizations and the changing demands for advancing journalistic careers.

— Timothy E. Cook, in Geneva Overholser and Kathleen Hall Jamieson (ed.), The Press (Oxford University: 2005))

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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.

Copyright © by Portico Advisers, LLC 2019, all rights reserved.

Illusions and Delusions

Steve Jobs once said, “You can’t connect the dots looking forward; you can only connect them looking backwards.”

There’s a lot of wisdom in that nugget, whether applied to issues of a spiritual or temporal wavelength.

It’s also relevant to quotidian things, such as deciding which book to read. For instance, in the decade since I left SAIS, apart from a methodical reading of the Ancient Greek classics, I’ve approached my bookshelves with no real theme or objective in mind.

At least, that’s what I thought.

Whilst reading William Manchester’s droll book on the Medieval mind last week, however, I experienced an epiphany that revealed a pattern amongst the cornucopia of titles.

All these years, most of the most-enjoyable books have dealt with the theme of illusions and delusions.

They covered what Adda Bozeman, in her magisterial Politics and Culture in International History, refers to as the gap between image and reality.
(h/t Ben Welch for the recommendation).

Or, as Barbara Tuchman described it, the periods “when the gap between ideal and real becomes too wide, [and] the system breaks down.”
(See A Distant Mirror and The Proud Tower).

Basically, history is littered with episodes when the bottom falls out of everything. Foundational myths, religious and political institutions, social orders, scientific hypotheses — all have cratered in the face of discovery, new knowledge and shifting conditions. They prove to have been illusions and delusions.

Lest we think that these gaps between myth and reality are confined to the distant past, consider this remark from Alan Greenspan in 2007 (as quoted in Adam Tooze’s Crashed):

[We] are fortunate that, thanks to globalization, policy decisions in the U.S. have been largely replaced by global market forces. National security aside, it hardly makes any difference who will be the next president. The world is governed by market forces.

Oops.

Or, consider the astonishing scale and duration of the fraud that was Theranos. John Carreyrou’s riveting Bad Blood, which deservedly won the 2018 FT / McKinsey & Co. Business Book of the Year award, is replete with illusions and delusional people — including a credulous board comprised of national security cognoscenti.

Or, revisit our January newsletter (“Bulls on Parade”) in which GMO’s Jeremy Grantham and KKR’s Henry McVey were bulled up on EM. I was too. Illusion! Delusion!

If it’s any consolation, an insight from Jobs’s quote is that it’s virtually impossible to measure the size of the gap between myth and reality in real time.

But man, secondo me, it really does feel like we’re living through a period when the gap between image and reality is wide and widening, and a trapdoor is beneath our feet.

I wonder, though. Which of the foundational beliefs in EM private markets will prove to have been illusions and delusions?

A few motions to debate with yourself and others:

  • There is an abundance of EM companies ripe for PE investment
    (h/t Nadiya Auerbach).
  • U.S. PE will outperform EM PE over the next decade.
  • LPs that have committed to mega-cap Asia / China venture will do well over the next decade.
  • “Impact investing” will continue to be a viable asset-gathering strategy for industrial-sized GPs if / when the yield on the U.S. 10 Year climbs north of 5%.

Anyway, our second son is arriving imminently, so this is Portico’s last newsletter for 2018.

A humble request: if you value our monthly(ish) dispatch, please share it with friends and colleagues. They may sign up for free at this link, and read previous editions here.

Once again, we’re going to make a charitable contribution for each new (human) subscriber we get between now and 30 December. We’ll be donating to Room to Read, a nonprofit active in Africa and Asia that focuses on literacy and gender equality in education.

Health and happiness to you and yours.

Alla prossima,
Mike

401(k)s — The Final Frontier

Private equity is one step closer to accessing the $5.3 trillion 401(k) market in the United States.

The Committee on Capital Markets Regulation has released Expanding Opportunities for Investors and Retirees: Private Equity, a study that provides the intellectual grist for legislative changes that would democratize access to direct investments in PE / VC funds.

I’m of two minds on this issue. Like, of course people should be able to invest in private investment funds. But on the other hand, there just aren’t that many great PE funds that merit one’s investment. Seems like a poor set-up for success.

Moreover, there are limits to PE’s absorptive capacity. For example, according to PitchBook, U.S. PE funds raised $275 billion in capital in 2017. If PE captured just 3% of the current 401(k) market, that’s an incremental $160 billion. Would a 60% increase in capital have a negative impact on returns?

Admittedly, this compares stocks to flows; but it’s worth asking just where all this capital would go. One thing is certain: it would generate a lot of fee income for managers.

It may have been my reading of it, but the study seems to pain itself on using historical performance data to make the case that private equity’s outperformance of public markets is akin to a law of nature. A tad overdone, in my opinion. Private equity is a market of managers; and recent research demonstrates that the persistence of fund managers’ performance is declining.

Honestly, how are retail investors going to select top-quartile managers when professional LPs fail to do so on a regular basis?

The reality is that they won’t. They’ll likely invest in the name-brand mega-cap firms that excel at gathering assets. The best-performing GPs don’t need — or want — Mom & Pop’s money.

Cui bono?

Future Fund

Steve Byrom — head of PE at Australia’s A$150 billion Future Fund — has something to say:

At a big picture level, this asset class is becoming less attractive … Business models aren’t sufficiently differentiated because of the number of GPs in the ecosystem and the amount of capital competing for a reasonably small number of bidders.

Great time for retail to jump in!

Norway on Governance

Norges Bank Investment Management made a couple appearances in the newsletter this year, most notably for calling out private equity’s lack of transparency as a principal reason for their decision not to invest in it.

And since governance has been a key theme this year (and will be at least through Q1 ‘19), I was pleased to see that Norges Bank has released three position papers on key governance issues:

Social Capital

Chamath Palihapitiya — Founder and CEO of Social Capital + Owner of the Golden State Warriors — is an outspoken guy whom I’ve enjoyed listening to and reading over the last few years.

There was a bunch of hubbub in recent months about the exodus of employees from his firm, as well as his decision to transition from a fund structure to a holding company that will invest from its own balance sheet. I don’t know what’s fact or fiction. I don’t really care.

But since the firm is now a holding company, Palihapitiya is emulating Warren Buffett and releasing annual letters. His first letter provides a dour view on U.S. venture capital as an industry, which he colorfully describes as a “multilevel marketing scheme.” It’s worth reading. His cynicism is crisp, refreshing, and effervescent, like a chilled flute of pignoletto.

In the letter, he asserts that “the demands of innovation are going up;” it’s a conclusion that I’m inclined to believe. As I wondered aloud last month, “maybe founders with vision are the scarcest thing around.”

Palihapitiya closes with a cheeky comparison of Social Capital’s performance over its first seven years vis-à-vis Berkshire Hathaway’s. The devil’s in the footnotes, but I must say: hubris is not a good look.

From the Bookshelf

[T]he political and philosophic history of the West during the past 150 years can be understood as a series of attempts — more or less conscious, more or less systematic, more or less violent — to fill the central emptiness left by the erosion of theology … the decay of a comprehensive Christian doctrine had left in disorder, or had left blank, essential perceptions of social justice, of the meaning of human history, of the relations between mind and body, of the place of knowledge in our moral conduct …

[This] nostalgia [for the absolute] — so profound, I think, in most of us — was directly provoked by the decline of Western man and society, of the ancient and magnificent architecture of religious certitude … Today at this point in the twentieth century, we hunger for myths, for total explanation: we are starving for guaranteed prophecy …

It was a deeply optimistic belief, held by classical Greek thought and certainly by rationalism in Europe, that the truth was somehow a friend to man, that whatever you discovered would finally benefit the species. It might take a very long time. Much of research clearly had nothing to do with immediate economic or social benefits. But wait long enough, think hard enough, be disinterested enough in your pursuit, and between you and the truth which you had discovered there will be a profound harmony. I wonder whether this is so, or whether this was itself our greatest romantic illusion?

— George Steiner, Nostalgia for the Absolute (Anansi Press: 2004)

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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.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.