Sunday, October 14, 2012

London Likes the US


I have been visiting very intelligent investment people in London for over thirty years. One of the reasons I enjoy my discussions is that many of the instruments and trends that we Americans take pride in were actually started in London (and in some cases further east). I have spent a good bit of time with portfolio managers, CEOs of smart asset managers, and very knowledgeable sell-side types. While I was particularly focused on what the retail distribution of funds is likely to be starting next year under draconian new retail distribution regulations, the people I met with quizzed me on the US market and political situations. A number of people wanted to continue discussions on their next visit to the US, or on my return to London. The following are some of my initial reactions to our meetings.

Much more global

To the unaided eye it looks like investors are investing heavily in the UK, however that is not the case. I believe some 70% of the revenues from the 100 largest market cap stocks come from outside of the British Isles. Using the same type of analysis (focusing on the location of sales and profits rather than legal domiciles) leads a number of investors to buy and own so-called European equities. (This is not true for European debt, which for the most part are government bonds.)

US is more attractive

A number of globally-oriented portfolios have more than 40% invested in US names which does not count the US revenues and earnings from UK, European, and Japanese multi-nationals. Not that the US is so good, but better than the others. To quote Bill Gross of PIMCO, “we have the cleanest dirty shirt.” (I suspect this is a result of Alexander Hamilton’s influence.) The main focus is now on technology, particularly Internet-related issues which are growing faster stateside than elsewhere and/or have a larger runway to bigger aggregate gains.

The mindset of many UK portfolio managers is different

UK portfolio managers are different from those in the US.  Perhaps it is just my background, but I don’t think so. Often their initial discussion and presentation is focused on relative performance to the managers’ chosen index, with some attention given to peer group rankings. The managers want to beat their index in every single time period, often quarterly. By doing so, they believe that they can get all of a client’s money. This drive is very much evidenced by managers that run both mutual funds and hedge funds.

Is this focus on short-term relative performance short sighted?

Almost all of my accounts and most of the institutions where I sit on the Investment Committee have some, if not all of their money focused on long-term results. Further, they do believe in diversification, which means they should be comfortable with some occasional under-performers. (The experience of 2008 was most upsetting, when correlations narrowed as practically all equities declined in double digit rates.)

While in London, Ruth and I had the pleasure of listening to the London Philharmonic which played very well as each section had its turn of prominence (performance leadership). The result was much better than if all tried to be the biggest sound at all times. Similarly, a multi-fund portfolio should have a rotation of winners and some temporary losers. In the end the music will be much sweeter than if the players were undisciplined, all shouting with their instruments, all the time. 

Many of the great portfolio managers that I have known, Peter Lynch, John Neff, Sir John Templeton to name a few, all had some awful quarters and even some bad years, including Warren Buffett. Often the under-performing periods were caused by a good manager seeing later opportunities that others did not, and were often proven right. My own favorite time period for measurement purposes is ten years, which guarantees at least two or more bad years. This belief is based on the analogy that poor current performance in good investments is like coiling a spring which will rapidly expand with gusto when times are good. Despite the current political chatter around the world, I do think we will have some good times in the future.

What is your current geographic allocation?  Why?


I have accomplished one of my goals for writing a blog every weekend. The goal is to engage with intelligent people around the world in order to learn more.

In response to an element of last week's blog where I cautioned about institutions entering the private equity arena through participation in funds, one of my concerns was the lack of good interim nav (net asset value, or price) performance during the maturing phase of the underlying companies.

A reader from the private equity world reminded me that a new SEC rule requires these funds to make quarterly estimates as to their net asset value. While some indication is better than nothing, this new regulation is not as helpful as it looks on the surface. According to a large sophisticated chief investment officer of an endowment which has numerous investments in venture capital and private equity funds, the auditors to the funds push them to write-up the values if there is any supportable evidence. There is not equal pressure to write down values unless it is quite clear that there has been a permanent loss of capital. Though these quarterly results may be of help in selling new funds, they are not what drive the managers. Unlike mutual funds and hedge funds, the managers only get paid incentives on realized gains, not unrealized. Thus, in my blog post I should have recognized a step in the right direction.
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