Photo Credit: Marco Verch Professional Photographer || With some private investments, you can’t tell what the value truly is. Third party professional help occasionally assists dishonesty
Part of my career was based on concealing volatility. I sold Guaranteed Investment Contracts. I helped design and manage several different types of stable value funds. Life insurance contracts get valued at their book value, regardless of what the replacement cost of an equivalent contract would be like presently.
Anytime an investment pool with no current market price has a book value above the underlying value of the investments that it holds, there is risk to those holding the investment pool. The amount of risk can be small yet significant with some types of money market funds. It can be considerably larger in certain types of pooled investments like:
- Various types of business partnerships, including Private REITs, Real Estate Partnerships, Private Equity, etc.
- Illiquid debts, such as private credit funds, and notes with limited marketability, whether structured or not.
- Odd mutual funds that limit withdrawals because they offer “guarantees” of a sort. That applies to Variable Annuities with riders offering guaranteed benefits, if the life insurer becomes insolvent.
- One-off investment liquid partnerships that are secretive and unusual, like Madoff. The underlying may be illiquid, but the accounting may be fraudulent. Or, the accounting may be fine, but the assets listed are not what is in custody. (With small funds, analyze the auditor, trustees, and custodian.)
- The value of a company touted by a SPAC promoter may be worth considerably less than what is illustrated.
- Any investment in public equity or debt pool where the positions are concentrated, and they own a high percentage of the float, or a high amount of the securities relative to the amount that gets traded in an average month. Think of Third Avenue Focused Credit, or Archegos.
I have consistently encouraged readers to “look through” their pooled investments, and consider what the underlying is worth. If you only have a vague idea of what the underlying investments are, look at their public equivalents. A rising tide lifts almost all boats, and a falling tide does the opposite.
There is a conceit within private equity, private credit and private real estate funds that they are less risky; there is no volatility, because we cannot produce an NAV. They have the same volatility as the publicly traded funds, but the volatility is concealed. If trouble hits the public markets 50-75% of the way through the life of a private fund, it will have difficulty selling their investments at levels anywhere near the book value previously claimed by the sponsors.
With consent of the limited partners, perhaps they extend the life of the fund to try to recover value, but that also imposes an opportunity cost on holders who were expecting proceeds from the fund on schedule.
Remember as well that in a scenario like 1929-1932, private funds will be wiped out with similarly leveraged private funds. Aleph Blog has consistently warned about the possibility of depression, plague, war, famine, bad monetary policy and aggressive socialism. We have gotten plague, war, and bad monetary policy. Famine in a sense may come from the Ukraine war and trade restrictions on Russia, at least for the African countries that buy from them.
Thus I encourage readers to avoid private investments that promise no volatility, like the stupid ads for Equity Multiple that run on Bloomberg Radio. All investments involve some type of risk. Just because you can’t or don’t measure the risk doesn’t mean that there is no risk.
Don’t listen to investment sales pitches which tell you to avoid the volatility of the public equity and debt markets, when they are taking the exact same risks in the private market, and they cannot or will not measure the risks for you, no matter how thick or thin the “disclosure” document is.
There is no significant advantage in the private market over the public market. Indeed, the reverse may be true. (Yes, I meant all of the ambiguity there.) Look to the underlying, and invest accordingly. Look at fees, and try to minimize them. Prize transparency, because it reduces risk in the long run. Those who are honest are transparent.
The only experience I have with GICs (which is not much) is that they were in a 401k, used “instead of” traditional money market funds. I never understood the exact difference, except that the GICs are less liquid.
As far as “volatility”, I tend to lump it with things in the “risk” bucket, as you said, famine, war, depression. So, short term volatility is “manageable”, and the big things are potentially “catastrophic”.
Many types of risk are well hidden. During the 2008-2009 debacle the TARP, etc., (etc. being very important), ~20 financial firms were bailed out. The “etc.” part includes the GM bailout, GE bonds being backed, the Fannie and Freddie activities. Apologists say that the money was paid back- which does not address the fact that the “technical” value of these firms went to zero. Oh, and Berkshire Hathaway/Buffet was in that number. Few want to recognize that, but Uncle Warren would have gone to zero too.
The government hid plenty of volatility, but didn’t help me much. Luckily I had taken evasive action which saved my portfolio. Unlike all of these big guys, POTUS and Senators don’t care if I go to zero.
Thanks for the post.
kev – can you explain how “Berkshire…would have gone to zero too” ??
That is quite the assertion.
Thank you for your link to your stable value fund piece. I hadn’t seen that before and it was very useful in understanding the Stable Value fund in my 401k. I have hesitantly used the Stable Value fund in my 401k to a limited extent since I am getting much closer to retirement. Our 401k Stable Value fund is just for the 401k and doesn’t include other investors. It appears to primarily invest in US bills and notes with the insurance wrapper to maintain stability but it has 0.35% ER, so there is a price for the stable value and 2% returns it has been averaging over the past year or so. The 401k does not offer a money market or short-term bond fund, so the risk of arbitrage by plan participants is minimal because the other alternatives are aggregate bond and similar fund options with much different durations or credit risk. i assume that the stable value fund insurers took a hit over the past few months because of the sudden spike in short interest rates that has caused short-term funds to lose about 3%. I assume that will be clawed back slowly over the next few years by the fund company.
As an unsophisticated investor, I was baffled when the market panicked in 2008 because the Reserve Fund money market fund broke the buck in 2008. In my naive way, I had assumed that higher interest rates came with more risk and the money market fund could fluctuate from $1.00 due to that risk in unusual times. I had limited myself to using US Treasury based money market funds as a result of that assumption. Apparently sophisticated investors had made the assumption that this was not the case and were totally unprepared for risk appearing in a risky asset. I didn’t blink when I heard it had dropped 3% in value in a very turbulent market but the sophisticated investors panicked and demanded the government insure just about everything but stocks.
The 2008 GFC has made me much more wary of sophistication in the markets. 2000-2002 didn’t bother me because it was obvious that there was a speculative component that broke in 2000-2001 and then a recession due to various things finished the stock market off in 2002. There wasn’t anything particularly frightening about this as it didn’t appear that fundamental underpinnings had been undermined, other than the 9/11 component causing new long wars.
However, 2008 was a different animal as it became evident there was a lot of badly structured “stable” products along with outright fraud that was never prosecuted and these were at the heart of the financial system, potentially threatening a 1930s collapse. I don’t know if much of that is still out there, but it is possible given the extraordinary interventions in the markets by the Fed and Treasury over the past 14 years.
I think the biggest thing is that there are two generations of Wall Street professionals who have zero experience in markets without a “Fed Put”. Inflation currently eliminates the prospects of a Fed Put until inflation is back below 4% (unless Jerome Powell wants to be as revered as Arthur Burns in the future). I think it is going to take a year or so for these traders to realize that the Fed cavalry is not about to come over the hill to rescue them but will be hitting them with “friendly fire” instead. I continue to stay very widely diversified so that no single blow-up wipes us out while I wait to see how inflation develops or doesn’t, as well as to see who is swimming naked or participating in the bezzle.