Podcast Summary
Mispricing of Private Assets: Perception vs. Reality: Speakers argue that private companies should be worth less than public companies due to inherent risks and unproven nature, but perception of diversification and self-determined valuations can lead to mispricing. A correction in private valuations is expected and necessary.
The pricing of private assets, particularly private companies in venture capital and private equity, has been a subject of concern due to potential mispricing inside investment portfolios. This has been fueled by the perception that private assets serve as a diversifier and the ability for investors to set their own valuations. However, the speakers in the discussion argue that private companies should be worth significantly less than public companies due to the inherent risks and unproven nature of the former. This misalignment between the perceived and actual value of private assets has been exacerbated during the bubble era and the period of low interest rates. Despite the argument that illiquidity can be a good thing, it is the job of fund managers to mitigate the risks and not sell at the bottom. The speakers express their agreement that a correction in private valuations is likely and necessary.
Discussing potential mispricing of private equity portfolios in investment trusts: Investors should focus on the discount to NAV and trust that mispricing is reflected in the price, rather than worrying about specifics of private equity portfolios.
The pricing of private companies inside investment trusts can be a challenge due to the lack of transparency and comparability. The discussion revolved around the potential mispricing of private equity portfolios in investment trusts like Rett Capital and the Rothschild Investment Trust. The speakers expressed concerns about the risk of overestimating the impact of articles or analysis on share prices, as seen with the Telegraph's column on Rett Capital. They also emphasized the importance of evaluating the experience and expertise of the investment teams managing these funds, as well as considering the specific investment strategies and objectives. Ultimately, the speakers suggested that investors should focus on the discount to net asset value (NAV) and trust that the mispricing is already reflected in the price, rather than worrying about the specifics of the private equity portfolios.
Pricing challenges for private assets in investment trusts: Investment trusts offer flexibility to buy and sell illiquid assets despite pricing challenges, making them valuable in volatile markets. Alternatives like derivatives can help generate positive returns in difficult economic environments.
Pricing the value of private assets in investment trusts is not a straightforward process and involves best guesses based on market trends. The price may lag behind the actual value and may only be adjusted once every six months at most. Despite the challenges, investment trusts offer the advantage of allowing investors to buy and sell even when the underlying assets are illiquid. The past year, marked by geopolitical shocks, energy crises, and inflation, was a difficult environment for conventional assets, making alternatives like derivatives crucial for generating positive returns. Rafa, an investment company that had been warning about the "everything bubble" and the consequences of monetary policy, was able to navigate the crisis and make a positive return thanks to their readiness for the situation and the use of alternatives.
Preparing for Inflation and Volatility with Derivatives: Unconstrained asset managers prepared for inflation and volatility by using derivatives to protect against higher interest rates, credit risks, and equity market downturns, while maintaining positions in long-term inflation-linked bonds with hedges against declines.
The global system has been gradually becoming more inflation-prone and volatile for several years, making higher inflation and increased volatility not a question of if, but when. Last year, the COVID-19 crisis and the Ukraine war served as major accelerators, introducing supply constraints and exacerbating existing issues. As unconstrained asset managers, we prepared for this shift by using derivatives to protect against inflation and volatility. We bought options on higher interest rates, credit derivatives, and direct protections on downside risks in equity markets. Despite our long-held position in ultra-long dated UK inflation-linked bonds, they underperformed significantly last year. However, we were hedged with interest rate options, which offset the declines. Looking ahead to 2023, we believe long-term inflation pricing is complacent and expect it to rise, making long-dated inflation-linked bonds a potentially good investment in the future.
Inflation: Disinflationary wave or persistent pressures?: Central banks remain vigilant as inflation is predicted to be volatile, with potential opportunities for exiting certain investments if a soft landing occurs and the Fed flinches.
Inflation is expected to be a major theme in 2022, with the potential for a disinflationary wave due to easing supply chain issues, falling demand, and decreasing energy prices. However, the impact of China's reopening on global inflation is uncertain, and the market is currently pricing in a "Goldilocks" scenario where a recession is avoided or is very shallow. Central banks, including the Federal Reserve, are expected to remain vigilant and potentially keep interest rates higher for longer if inflation pressures persist. It's important to note that inflation is predicted to be volatile, not just rising and staying high. This disinflationary wave could lead to opportunities to exit certain investments, such as tech stocks, if a soft landing occurs and the Fed flinches. However, if inflation is expected to be even modestly higher over the longer term, popular strategies from the post-credit crunch era may not be as effective.
Long-term factors contributing to inflation volatility: Geopolitical instability, a new era of activist fiscal policies, aging populations, rising debt, and the end of cheap money are driving inflation to be more volatile and potentially higher than in the past.
The economic landscape is shifting, and inflation is expected to be more volatile than it has been in the past. The reasons for this include geopolitical instability, such as the Ukraine war, which can lead to supply chain disruptions and higher costs. Additionally, the post-Cold War economic order that favored small government, free trade, and low taxes is giving way to a new era of activist fiscal policies and bigger government. This shift, coupled with aging populations and rising debt, puts pressure on government finances and increases the likelihood of inflation. Furthermore, the end of the era of cheap money and the beginning of higher interest rates add to the inflationary pressures. Overall, these long-term factors suggest that inflation will be more volatile and potentially higher than it has been in the past.
Managing Government Finances Through Financial Repression: Governments may use financial repression to pay bills, keeping inflation and growth ahead of interest rates, eroding money's value, and directing pension funds to infrastructure projects. Central banks, managing government debt, are becoming political and may ease monetary policy despite inflation concerns, shifting the 2% inflation target as needed.
The current economic climate, with governments facing significant financial obligations and limited tax revenue, may lead to financial repression as a means to pay bills. This involves keeping inflation and economic growth ahead of interest rates, eroding the value of money. The government may also direct pension funds towards infrastructure projects, effectively becoming a tax. Central banks, founded to help manage government debt, are becoming more political and may face pressure to ease monetary policy despite inflation concerns. The 2% inflation target, a common goal for central banks, is not based on any concrete foundation and may shift as economic conditions change. Overall, the role of central banks is to manage government finances, not protect individual savings.
Inflation and liquidity concerns for markets and central banks: Inflation and liquidity are major concerns for markets and central banks in 2023, with potential pain points for heavily leveraged assets and earnings risk in a recession. Uncertainty persists due to conflicting economic data and potential recession forecasts.
Inflation and liquidity are major concerns for markets and central banks in 2023. Inflation dictates how tight monetary policy will be, and the risk of liquidity shortages arises as central banks raise interest rates and reduce their balance sheet holdings of assets. The bond market shock was a significant pain point last year, and there's still plenty of pain to come for heavily leveraged assets like private equity, venture capital, and corners of the property market. Additionally, earnings risk is a concern if a recession occurs, as earnings always go down during an economic downturn. The Bloomberg team covers the stories behind these economic shifts and their implications for investors. Despite expectations of a recession, the paperwork used to forecast it was found to be fake, adding another layer of uncertainty to the economic landscape.
Maintaining a diversified portfolio and significant cash position in uncertain times: In volatile economic conditions, holding cash and gold can provide optionality and purchasing power, while diversifying your portfolio reduces risk.
In uncertain economic times, it's crucial to have a diversified portfolio and maintain a significant cash position. Solea Mohsen, the host of The Big Take DC podcast, shares her concerns about the political landscape and the potential for market dislocations. She emphasizes the importance of holding cash due to its optionality and purchasing power in a high-risk environment. Looking back to historical periods like the 1970s, cash proved to be the best conventional asset, despite the low returns in real terms. Mohsen also advocates for owning gold as part of a well-diversified portfolio due to its scarcity and the fact that it's not something the government can print or easily manipulate. While gold may be enjoying relief due to a weaker dollar and expectations of lower interest rates, its long-term value lies in its scarcity and the fact that it's not subject to government control.
Gold's expected long-term performance amidst volatile environment: Central banks buying gold, potential inflation from China's economic changes, and gold's status as a trusted form of money make it a wise long-term investment, despite short-term volatility and high costs for miners.
Despite the current volatile and politically difficult environment with rising inflation, geopolitical risk, and financial repression, gold is expected to perform well over the long term due to these very factors. The investor should consider a mix of bullion and gold miners for leveraged exposure, despite last year's high energy and labor costs affecting the miners. Central banks, including the Chinese central bank, are buying gold at a rapid pace, further emphasizing its status as a trusted form of money. China's massive economic changes are uncertain, but the potential shift towards reopening could lead to inflation if driven by real estate development and commodity-intensive activities, with the accumulated savings of over $30 trillion potentially fueling inflation. The recent policy u-turns by China's government suggest a significant pivot, and the success of the reopening could have significant implications for various markets. Additionally, Jim Mellon's perspective on the technological revolution highlights the importance of focusing on productive uses of technology rather than wasting time on non-essential activities.
Economic climate calls for humility and investing in sectors with value: Invest in sectors like energy, commodities, inflation-protected bonds, and small cap stocks in countries with aging populations and labor market pressures for maximum portfolio protection and growth in the current economic climate.
While technology has the potential to bring about a productivity revolution in the coming decade, it is unlikely to overwhelm the structural economic factors such as inflation pressure, geopolitical tensions, aging populations, and labor market pressures. The retail investor should consider investing in sectors or areas that have value in the current economic environment, such as energy and commodities, inflation-protected bonds, and possibly small cap stocks in countries like Japan or the UK. The current economic climate calls for maximum humility and building a portfolio that protects and grows capital regardless of market conditions. The past decades have seen different dominant classes of ideas, from oil in the 1980s to tech at the start of the last decade, and now, matter matters again with real shortages and the need for commodities to fulfill big visions around energy transitions.
Exploring Financial Advice and Politics Through Podcasts: Meryn Talks Money offers financial advice, The Big Take DC discusses money's influence on politics, and The Big Take from Bloomberg News covers global economic stories.
There are numerous podcasts available to help individuals stay informed about money, politics, and economics. Meryn Talks Money, produced by Meryn Somerset Webb, offers financial advice and will be back next week. The Big Take DC, hosted by Solea Mohsen, explores how money, politics, and power shape government and its impact on voters, releasing new episodes every Thursday. Lastly, The Big Take from Bloomberg News, featuring Sarah Holder, Solea Mohsen, and David Gura, covers global economic stories and their implications, airing every afternoon. Listeners are encouraged to subscribe, rate, and review these podcasts to support the creators.
