Introduction
Often
a publicized trend enters into private conversations. During the summer two day
meeting of the Board of Trustees of the California Institute of Technology, there
is a dinner with selected undergraduate, graduate, and post docs with some of
their professors. At the dinner last week, we were sitting at a table with
other trustees, some of the students and a very prominent young professor. She
turned to the trustees present and asked. “What should Caltech focus on in the
future?”
The
initial reply was from a trustee who has earned all three of his degrees from
Caltech. His answer was that Caltech should continue to seek to hire the very
best professors which would attract the very best students. I applaud this
continuing goal set, and I suggested that for the future there should be an
additional goal. This goal should be to increase the productivity of the
professors, students, and staff, and therefore society.
As
a board member and contributor to a number of other non-profits, I am seeing
this need in lots of places throughout our global society. I suspect that
future structural improvements in productivity will be led by a combination of
commercial interests and a few non-profit leaders.
Economic
and Business Trends
One
of the best commentators on these trends is my Securities Analyst Society friend, Byron
Wien. In his latest publication for Blackstone he laments that one of the
biggest risks is “the inadequate investors’ attention to productivity.” He
points out that productivity has been declining since it peaked globally in the
1996-2005 period, except in China and India (increasing areas of investment
interest in the funds in our clients’ portfolios). He further points out that
the number of new companies has declined by 50% and the number is about equal
to the numbers of companies that disappear. (Many of those that disappear are
doing it voluntarily through the richness of M&A activity, lack of family
interest to continue to work hard as the founders, and tax considerations.)
He suggests that since the development
of the internet and smart phones there have not been significant productivity
inducers. He laments the decline in high school students mathematical
capabilities.
On
this topic, I applaud the generous gift by Ronald and Maxine Linde that re-purposed
the Caltech mathematics building into
the Ronald and Maxine Linde Laboratory of Mathematics and Physics.
To
focus on the significance of the productivity problem, I wonder whether more
attention should be given to a statistic I used as an analyst which was the
ratio of revenue and costs per employee. In both the profit and non-profit
arenas the additional costs of compliance and welfare oriented employees may be
causing these ratios to narrow and thus the number of employees, I did not say
workers, is a useful statistic.
Actually
part of the productivity problem has more to do with personalities than pure
analytical ratios. While profit margins are expanding due to higher returns
from capital expenditures than employees, it is understandable these margins are
hiding the very pedestrian growth in top line revenues adjusted for price
increase. Too often sales are fulfilling only existing demand, not in problem-solving
or creating new demand. In many companies and non-profit agencies clients are only
to be tolerated, not cherished as the real assets of the activity.
Help
is on the way. Currently the best performing fund in our clients’ portfolio has
changed its name and focus to Innovators Fund Investment.
Perhaps
the most bullish area that is benefitting from global attention is consumer
spending and activity. In many of our homes and lives we still do things the
way we did years ago. But today we can utilize the internet to search and buy
items we did not have. We are already benefitting from the delivery of medical
services through electronic communication. The race is on to remotely automate
elements within our home for higher functionality than what we had in the past.
The question is how we are going to use the time efficiency in our personal
rising productivity, which is not in the published productivity numbers?
There
are some reasons to be positive long-term.
Are
Sub-Prime Type Risks Lurking?
One
of the key responsibilities of prudent analysts and portfolio managers is to
worry, particularly when others don’t. Many of the worries about the future do
not come to pass, but some do. A full ten years has elapsed since the public
recognition of the problems created by the excessive use of sub-prime
residential mortgages. Are there similar type risks today? One should remember
the old quote about history not fully repeating, but rhyming with the past. To
me the keys to these concerns are not in the instruments but in the behaviors
that are similar from one era to others. In an over-simplification, a list of
some behaviors shown below could be useful in identifying future problems:
1. Reliance on the predictability of long-term
trends
2. Investment vehicles that can be leveraged
3. Inexperienced investors and advisors
4. New entrants, some from well-known
organizations facing slow downs
5. Media cheerleaders
6. Few skeptics
7. Things not what they seem
8. The deep linkage with the larger financial
community
9. Lack of specific regulatory oversight
10.
Global activity
Some
may feel the current wave of enthusiasm for Exchange Traded Funds (ETFs) and Exchange
Traded Notes (ETNs) apparently has some of the similar characteristics
experienced in the sub-prime era. The results don’t have to turn out the same
way, but prudent investors should consider the parallels and make their own
judgments.
The
underlying statistical trend that made mortgages attractive was that housing
prices always went up, though the careful student of long-term history could
point out some long periods when this was not the case. The possible equivalent
today is that active managers on average can’t beat the popular market
averages, but it is happening in 2017.
It
is cheaper to use ETFs and ETNs to leverage market bets than the purchase of
futures contracts. Thus traders of all types including hedge funds are rapidly
moving in and out of these products either to express a short-term market view
or as part of a hedging operation on the long or short side.
Utilizing
information that was called to my attention by Lilia and Leo Clemente,
illustrates the rapidity of these flows in a particular week’s net flows as a
percent of the aggregate assets in a specific fund.
Exchange Traded Funds are a fast changing market as
they evolve into increasingly a trading market.
One
measure of the manic weekly inflows is to measure the net weekly flow for a
specific fund, as a percent of the asset under management in the fund.
ETF
|
Net Flows
|
AUM % Change
|
Goldman Sachs Treasury Access 0-1
Year
|
$295.
|
83.07 %
|
iShares MSCI Japan Small Cap
|
$21.
|
13.35 %
|
Kramer Shares CSI China Internet
|
$52.
|
8.80 %
|
SPDR Bloomberg Barclays High Yield
Bond
|
$999.
|
8.68 %
|
iShares Short Treasury Bond
|
$408.
|
7.89 %
|
These weekly net flows are in USD millions and we
don't know the size of the gross numbers, but clearly the aggregate size of the
trading would represent a larger share of the assets under management.
I
suspect most of these transactions were by trading activities, including fee
paid discretionary investment advisors.
The size and volatility suggests to me that there are
speculative forces at work.
I
am seeing many traditional active mutual fund and brokerage shops entering the
ETF and ETN markets. In terms of details and the personalities in the market
place, they are quite different than the market participants that were
successful in the past. Since many of the ETF and ETN manufacturers advertise
heavily, there are few media skeptics.
Many
of the users of these products have not taken the time and the continuing
effort to understand the construction of these portfolios and the mechanisms
for change. Also some of these products have built-in, larger than normal fees.
Most
of the transactions in these products are conducted through “authorized
participants” (AP) these are largely dealers who utilize their undeclared
capital for all of their trading activities. Goldman Sachs* has recently
withdrawn from being an AP. Goldman is an intelligent prudent risk seeker. For
them to withdraw could be indicative of either too high risk or too low
profitability. Due to the linkage, largely through counterparts leverage, a
problem in these markets can generate rumors of bigger financial community
problems.
*Owned
personally or by the private financial services fund I manage
These
products do not have a specific regulator but are overseen by numerous
securities and financial regulators some of whom are thinly staffed.
In
many countries that have a viable, active, securities markets there are either
locally manufactured or globally traded ETFs and ETNs with different degrees of
intelligent regulation.
Just
be careful .
__________
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A. Michael Lipper, CFA
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