Picture Credit: Marco Verch Professional Photographer || Being a financial analyst is being a competent generalist in business

Let me tell you why I am writing this, roughly three years later than I said I would. It started with a post I entitled Limits. The post itself is not why I am writing this, but in the the comments there was great criticism of the CFA Institute. They asked me what I thought of the criticisms and I said I would write about it.

I suspect no one will like this post. I will mention that I served on the board of the Baltimore CFA Society for 12 years, serving nine years as its Secretary, and two years as its programs chair. I am grateful that I earned my CFA credential in 1996, which enabled me to transition from being a life actuary, to being an investment actuary, to being a a financial analyst with actuarial skills.

Four weeks ago, I gave a talk at the Baltimore CFA Society’s Charter Award Dinner. The title of the talk was “The Value of Ethics –The Value of a CFA Charter.” The main point of my talk was that the uniqueness of the CFA Charter did not stem from the “Body of Knowledge” imparted in the exams, but rather from the emphasis on ethics. The men who created the “National Federation of Financial Analysts Societies” in 1947 wanted financial analysts to be competent and ethical. After all, the Great Depression soured many people on investing, considering all of the unsavory tactics that many speculators used.

So what made me decide to write this tonight? My friend Tom Brakke made the following post at LinkedIn. He laments the decline in the teaching of the “Body of Knowledge” at the CFA Institute. I agree with him. The leadership of the CFA Institute seems weak to me, and gives in to political and cultural trends. Two examples: first, adding cryptocurrency to the “body of knowledge,” when it has no intrinsic value. Second, adding ESG to the body of knowledge, when it is ill-defined, useless, and not in the interests of those served by fiduciaries.

What should the CFA Institute do with respect to the “Body of Knowledge?” Investment knowledge is not a monopoly of the CFA Institute. You can get the same knowledge through many different sources. For me, I learned 90%+ of my investment knowledge before I took my first CFA exam. That’s why they were so easy for me. Many CFA Charterholders don’t like me saying the exams are easy, but I will say, “Have you taken an actuarial exam? There is no comparison.” Even the penultimate president of the CFA Institute said to me, “They have an amazing qualification process.” (Something like that…)

What should the CFA Institute do to create its “Body of Knowledge?” Choose the most compact and important knowledge that an intelligent investor needs to know, and then pursue it in a written exam format, not using computers. Why written? Because investing requires the ability to be able to write. The Society of Actuaries made a similar mistake when it eliminated their English exam, which turned their candidates into math nerds who often could not understand qualitative features in insurance. Actuaries once were CEOs of insurance companies, and that is rare now.

Does the CFA Institute’s Body of Knowledge need reform? Definitely. Clear out the crud, and make more room for the basics. Also, emphasize ethics, because that is what differentiates CFA Charterholders from other investment workers.

But Back to the Original Reason for Writing this

So what of people who pass the CFA exams, get a job, stop paying their CFA dues, and say that they passed the CFA exams, but not explicitly calling themselves CFA Charterholders? Are they cheating the system?

Yes, they are cheating the system, and if the CFA Institute had an ounce of courage, they would take them to court, saying that they agreed to the CFA Institute’s standards when they took the exams and received the Charter. If they are not doing so now, they can’t say they passed the exams. It might be true, but it is an obfuscation to have some benefit of a CFA Charter while not continuing to hold to its code of ethics. If you are not subject to the CFA Code of Ethics, you should not be allowed to mention that you were once a CFA.

The same is true for me. I never say that I am a Fellow in the Society of Actuaries, though I passed all of the exams and was inducted. I haven’t paid dues for over a decade, nor have I done their continuing education (that was the bigger issue). Do I still know their body of knowledge? I was a leader in asset-liability management inside life insurers, and I would still be a leader there.

To close this article, I would simply say to those who have dropped their CFA charters, but still try to benefit from them: pay the money and observe the code of ethics. Be a real CFA Charterholder. We are the ones that are supposed to be cleaning up the financial industry. This is our ethical obligation that you agreed to when you received your CFA Charter. Don’t be a cheapskate, and don’t be unethical by avoiding the duties that you accepted when you took the CFA exams.

Picture Credit: Kent Schimke || Ah, the downward spiral of cryptocurrency assets!

What I am writing was sparked by what is happening with FTX, which reminded me of promoted penny stocks. Now, before I go on to that, let me mention what the results were regarding the promoted penny stocks that I wrote articles about the last one of which was written a little less than seven years ago. I only wrote about promoted penny stocks when I personally received a promotion, whether by snail mail or email.

Of the 32 stocks I wrote about, how many failed in entire? Twenty-four. How many have a market cap over $1 million? Three. How many actually appreciated in price from the time I wrote the article? One, Barfresh [BRFH], which was the only one the I said seemed legitimate.

Penny stocks are less of a problem today as a result of the efforts of Seeking Alpha, and to a far lesser extent me. But now we have a new problem — cryptocurrencies that are not widely traded.

FTX had several cryptocurrencies which they held on their balance sheet where they held a huge amount of the cryptocurrency relative to the float, or trading volume. This included FTT and Serum, among others. If FTX sold those cryptocurrencies in size to raise US Dollars, the price would quickly go to something near zero.

The same is true of promoted penny stocks. If they did a large issuance of stock, the price would quickly go to something near zero. (Far better to do a rights offering.) Instead, they quietly deal stock in small amounts at a discount to the market price to pay for services, goods, etc. Promoted penny stocks are the only investment class where the statement of shareholder equity is the most important statement.

As such, FTX using the value of the last trade, overvalues their holdings of worthless crypto. It is actually more valuable for them not to trade, than to swamp the market. That said, what will happen when they are forced to liquidate? (Think of Luna and Terra.)

You could structure the accounting for assets on the balance sheet at entrance value, current value, or exit value. Each has its implications — success, survival, and failure, respectively. Unless we decide to have multiple balance sheets and income statements, which I have suggested in the past, but will never take place, a single balance sheet will never represent reality — survival is probably the best overall option, and that is close to what GAAP does, with its many imperfections.

As such, please realize that most unaudited intermediaries of cryptocurrencies are likely insolvent. It is time to liquidate and go back to US Dollars, prone as they are to inflation. Remember, if you are slow, you may end up with nothing.

Picture Credit: Boston Public Library || When total systemic leverage is so high, you can’t tell what might go wrong

Because of the fall in interest rates since the last post, the risks have declined with Stable Value Funds. That said, the FOMC still sounds hawkish, even though the yield curve is inverted. The FOMC needs fewer macroeconomists, and more economic historians. They are deluded by the bad models of the last fifty-five years, which lack any credibility outside of the sterility of academia.

Here are the two equations that I left out of the last piece. How to calculate the premium/discount of a stable value fund:

How to calculate the annualized yield to maturity:

Here are the definitions:

BV: Book value — the accrued value of the stable value fund assets so far.

MV: Market Value — the market value of the assets now, if we are able to liquidate the assets at current prices.

AYTM: Annualized Yield to Maturity — the annualized rate that the assets are yielding at current market prices. Note that if you have the SEC Yield, that is the Semiannual yield to maturity, sometimes called the bond-equivalent yield [YTM]. To convert YTM to AYTM:((1 + YTM/2)^2) -1 = AYTM.

D: Effective Duration — The first derivative of Market Value with respect to AYTM. For those that have not taken Calculus, or have forgotten what that means, it measures the sensitivity of market value to small moves in the AYTM. A bigger D means the market value changes more than a smaller D. (And always remember, as interest rates rise, the value of all ordinary bonds goes down.

It is called effective duration, because on a present value basis it measures the weighted average time at which you can expect to receive the cash flows, typically measured in years.

CR: Credited Rate — Though all of these values are artificial in some sense (channeling my best Matt Levine), this one is the most artificial. It means this: in the past the book value accrued to its current value. Now, over the length of time expressed by the Effective Duration, what should the current credited rate be in order for the book and market value to converge? The credited rate is a figure that is like a “heat-seeking” missile, always adjusting (monthly or quarterly) to new conditions as the book value chases the market value. When book value is above market value, the credited rate slows down relative to the AYTM. When the book value is below the market value, the credited rate speeds up relative to the AYTM.

Unstable Value Funds (VI)

As my reader who prompted the last post wrote:

I’m trying to get my head around the implications of the lower MV/BV ratios, but I’m not sure I completely understand the how the crediting rate mechanism works with respect to inflows and outflows.

As I understand it, when MV/BV is less than one, inflows are going bring it closer to par and outflows will further decrease it (assuming outflows are at BV), yes? There are not separate calculations for different plans or different participants, correct?  I feel like this may not be a big concern under more typical market conditions, but with MV/BV so low people’s crediting rates are going into look a lot less competitive relative to the returns available with other conservative options and there is more incentive to do as you describe and take the short-term risk in a non-competing fund. Plans leaving is one thing, but a significant participant lead outflow would be much harder to manage, wouldn’t it?

Also, you mention duration longer than 5 being potentially worrisome, but isn’t possible that funds may extend duration early next year as a way of simultaneously goosing the crediting rate and positioning to recoup some losses in anticipation of a Fed pivot? But if rates go higher than expected….

Private email to me

She is a bright lady; she understands it perfectly. Given the recent lower inflation estimates, maybe everything works out easily. But will the FOMC understand that and stop raising the Fed funds rate? Given their desire to appear bold, I think the answer is no. And so I repeat my advice from my last post:

It is not a bad idea now for most participants to move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

Remember, there is no FDIC for stable value funds. Watch out for your own best interests while most people don’t notice.

Photo Credit: gelbachdesigns || Pay less to pay off your debt.

For some people/entities with home/commercial mortgages, for the first time in a while, it is possible to invest in US Treasuries at rates higher than the rate on your mortgage. Now there are complexities around this, but let me give an example of how this might work. I’m affiliated with a group that owns a building worth $3.5 million, with a first mortgage loan of $470K @ 3.8% AEY [Annual Equivalent Yield], and a second mortgage loan of $270K @ 3.6% AEY. The first mortgage loan has a balloon payment in June 2028, and the second mortgage fully amortizes, and pays off in November 2035.

When interest rates were low, our best use of surplus cash was to pay down the first mortgage. But now it would be better to buy the 1.25% Treasury note maturing 5/31/2028, presently yielding around 3.93% BEY [Bond Equivalent Yield — AEY ~4%]. This isn’t a large advantage, but when I thought of writing this article 2 weeks ago, prior to the recent CPI number, the yield gap was considerably more compelling.

Now, we may still get a higher inflation surprise over the next few months, unsettling the bond market. Or, hawkish FOMC members may continue to blather that rates have to go a lot higher, raising yields on short-to-intermediate Treasury Notes. (Knut Wicksell had it right with his simplistic rules [yield curve slope], rather than the FOMC with their complex models and fear of the media. [We must be manly men!]) There may be better opportunities in the near future.

My main point for this short piece is to get people to think more broadly about how to find opportunities with interest rates.

Another idea would be for those with residential mortgage loans to buy participations a FNMA or FHLMC pool with similar characteristics to your loan. Why prepay your 3% loan when you can buy a participation in loans like yours at a yield of 6%?

I realize that I am glossing over a lot of things here, but this is simply to suggest that your behavior in higher interest rate environments should be different from that in lower interest rate environments.

Photo Credit: Ruin Raider || It is important to recognize the limitations of any system. Don’t overestimate what is possible.

Well, the last installment in this series was 2009. I ran a Guaranteed Investment Contract [GIC] desk at Provident Mutual from 1992-1997. I also managed our internal stable value funds for our pension line of business. This was during a period where increasingly Stable Value Funds were being replaced by bonds and bond funds being wrapped by a type of derivative that would allow for “benefit responsive payments,” called a “wrap contract.”

Now, I know I lost most of you with the last paragraph. Definitions:

Guaranteed Investment Contract: A group annuity issued by a life insurance company. It is like a bond, paying principal and interest until it matures. But it is more secure than most bonds because it is an insurance liability, which has a higher bankruptcy priority than a bond issued by the insurance company. Also, a GIC will pay money out sooner if there is a need to pay “benefit responsive payments.” Absent default, the value of a GIC never falls. Its value accrues like a savings account, because it is an annuity from a life insurer.

Benefit Responsive Payments: In Defined Contribution Pension Plans (401k, 403b, 457, etc.), if a participant dies, gets disabled, leaves his current employer, gets served with a QDRO [Qualified Domestic Relations Order — child support, alimony], exchanges funds in the stable value fund for noncompeting funds (funds that are not short-to-intermediate fixed income), etc., then the GIC may pay benefits out early at book value.

Stable Value Funds: Funds that buy investments that absent default, only appreciate, and thus act like a savings account, but with much better yields. Those can be insurance contracts (rare now), or bonds wrapped by “wrap agreements.”

Wrap Agreements: Derivative instruments that receive money if benefit responsive payments occur and the market value of the wrapped bonds is higher than the book value, and pay money if benefit responsive payments occur and the market value of the wrapped bonds is lower than the book value. The objective is that benefit responsive payments go to the beneficiary at book value, and no one else in the Stable Value Fund is affected.

Why am I Writing This?

I received an email from a lady working at a major investment bank, asking me where she could find independent commentary regarding stable value funds, because most of the commentary is produced by the stable value fund managers themselves. Why is that so? Stable Value Funds are complex beasts. Typically only insiders understand them. She was wondering how the funds were doing given the rapid increase in interest rates. This is the toughest scenario for stable value funds.

The Math

Let’s define terms first.

BV: Book value — the accrued value of the stable value fund assets so far.

MV: Market Value — the market value of the assets now, if we are able to liquidate the assets at current prices.

AYTM: Annualized Yield to Maturity — the annualized rate that the assets are yielding at current market prices. Note that if you have the SEC Yield, that is the Semiannual yield to maturity, sometimes called the bond-equivalent yield [YTM]. To convert YTM to AYTM:((1 + YTM/2)^2) -1 = AYTM.

D: Effective Duration — The first derivative of Market Value with respect to AYTM. For those that have not taken Calculus, or have forgotten what that means, it measures the sensitivity of market value to small moves in the AYTM. A bigger D means the market value changes more than a smaller D. (And always remember, as interest rates rise, the value of all ordinary bonds goes down.

It is called effective duration, because on a present value basis it measures the weighted average time at which you can expect to receive the cash flows, typically measured in years.

CR: Credited Rate — Though all of these values are artificial in some sense (channeling my best Matt Levine), this one is the most artificial. It means this: in the past the book value accrued to its current value. Now, over the length of time expressed by the Effective Duration, what should the current credited rate be in order for the book and market value to converge? The credited rate is a figure that is like a “heat-seeking” missile, always adjusting (monthly or quarterly) to new conditions as the book value chases the market value. When book value is above market value, the credited rate slows down relative to the AYTM. When the book value is below the market value, the credited rate speeds up relative to the AYTM.

So what’s the issue here?

Interest rates have risen rapidly, after dwelling at low rates for a long time. Back when I was developing a stable value product in 1996, I knew this was the disaster scenario for stable value. More than most actuaries at the time, I had realistic interest rate scenario models the reflected the true volatility of interest rates. I would create 10,000 full yield curve scenarios over a 10 year period, then analyze the ones where the stable value fund failed. Failures occurred in the scenarios where short rates rose rapidly.

Wait. How can a stable value fund fail? If the credited rate drops below zero, practically it has failed. The fund sponsor will credit zero in such a situation, but it will face the problem of participants exiting to non-competing options, worsening the problem. The stable value fund may not be able to return book value to its participants.

But this isn’t bad for everyone, at least not yet

I don’t think everyone needs to worry, though. The edge cases, those who have taken too much risk at the wrong time should worry. for the worst-managed funds, there is some risk of a “run-on-the fund.”

I did a little digging around the large stable value managers, at least among those who publish all their data publicly. I’m not naming names, I have my own liability risk here. There are a number of insurance companies running their stable value plans at durations higher than 5, and their ratio of market value to book value is near 85%. If you are in such a situation, move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

At present, most stable value funds have a market value to book value is between 91-95%. If you are in a fund like that, don’t worry, unless a panic happens because of the funds running at long durations. Then do the same shuffle that I suggest: move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

Other Issues

There is also the risk of stretching for yield. Though the bond managers who manage fixed-income portfolios for stable value funds are generally conservative, when rates are low, many bond managers take chances that don’t work out. As such if the YTM/AYTM of the asset manager seems aggressive, maybe pare back. (If it is more than 1.5% above Treasuries, consider leaving.) If something seems too good to be true, it very well may be too good to be true.

Conclusion

Say what you will about Stable Value Funds, they are more opaque than other investments. As such, they deserve more scrutiny. It is not a bad idea now for most participants to move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

I don’t think most people have to do this, but it is not a bad strategy for all. Take your opportunity and move stable value money to a balanced fund. Then if you don’t like the volatility, move to a short-to-intermediate term bond fund.

Graph Credit: Aleph Blog || How do you feel about 3.00%/year nominal returns over the next 10 years? That’s less yield than the 10-year T-note

Stocks always beat bonds. Stocks always beat bonds. Stocks always beat bonds. Stocks always beat bonds.

Quite a mantra. And for those with a long time horizon, this is true. What I am telling you this evening is if you want that to work for you, your time horizon should be greater than ten years. With the ten-year T-note yielding 3.41%, the S&P 500 at 3946 indicates likely nominal returns of 3.00%/year over the next ten years. Though the bond market has had a lousy year, many of the times I wrote about this over the last few years, the S&P 500 had return expectations in line with a 10-year single-A corporate bond. When the market indicates returns lower than a 10-year T-note, it is still quite expensive (95th percentile).

As the end of December 2021 was near the recent highs, so the end of June 2022 was near the recent lows, projecting a nominal 3.32%/year return for the S&P 500 over the next ten years. The weak rally of the last eleven weeks has reduced future returns to 3.00%.

So what to do? For me, not much. I have always kept my asset allocation around 70% risky, 30% safe. I am near that now, and don’t feel the need to panic. I like the stocks that I own for me and my clients. We are up this year. All that said, I haven’t had a good year prior to this since 2013. Versus the broad market, my performance has been poor as value has lagged, and I am more value-y than most value managers.

The histogram above attempts to show scenarios when likely returns per year were within 1% of where they are now. Positive returns are expected with a considerable left tail.

So What Might Happen?

My view here is that the Fed will overshoot in tightening, leading the stock market to new lows in this bear market. Ray Dalio has said something like this. Looking at the ’70s or the Great Financial Crisis are not what I would look at. My best analogy here is the dot-com bubble.

I remember from that era how many people said that Fed policy was irrelevant to growth stocks. When the yield curve inverts, those who finance long assets with short-term debt blow up. During the dot-com bubble, that was mostly tech firms. The banks were mostly not affected. That is true today, as the banks are in good shape.

So expect:

• The yield curve to get more inverted
• Stocks to fall, especially growth stocks
• Real GDP will decline
• Commodities will suffer
• The Fed will panic, and loosen in 2023

That’s all for now. I have been going through a hard period in my life, thus I have not been posting much.

Image credit: Diverse Stock Photos || Would that those shiny coins were the real thing. Metal coins are real. Code, not so.

As I have said before, look at the underlying economics of an investment rather than its external form. It doesn’t matter whether it is public or private. The form of an investment does not affect its returns, for the most part.

I grew up in investing as a risk manager within life insurance and fixed income. We faced three main risks: credit, liquidity, and duration. We had lesser risks as well, like FX, sovereigns, convexity, etc. My main goal was to see the firm survive under all reasonable circumstances. My secondary goal was to improve profitability over those same circumstances.

In doing that, we could make some small “side bets.” Buy an underpriced Canadian dollar bond. Buy a broken convertible bond of a beaten down company. Buy underpriced MBS where the models are overstating refinancing risk. Things like that. We could not make those side bets too large, but we could put a few on to try to make some money for the firm.

We would match assets against our likely liability cashflows. We knew that 99%+ of the time, we would be fine.

I can’t imagine what the so-called crypto banks are thinking. Much as they deride banking generally, they don’t have the vaguest idea of what they are doing. They should hire an investment actuary to limit what they do.

Imagine a world where banks don’t care about currency risk, and some fail because the temptation to reach for yield causes them to buy asset in currencies that are weak… leading them to lose capital on net.

This is the nature of crypto lending and borrowing. As Aristotle might have said, “Crypto is sterile.” It doesn’t produce anything. So don’t lend out crypto for a return… you may lose you principal in the process. There is no good reason why you should earn a return exceeding Treasuries plus 1% in lending crypto.

But no one in crypto considers risk control. In one sense, I’m not sure how it could be done, unless you limit yourself to one major cryptocurrency — Bitcoin or Ethereum.

The grand questions should be:

• Can I be sure of making payments over the next three months?
• Is my leverage low enough that the mélange of assets that I own will be able to cover my liabilities?
• Is there anything I can do to promote long-term survival?

With cryptocurrency banks and stablecoins these concerns are ignored. They take risks that no bank or insurance company would take and with far less capital than would be reasonable.

I encourage you to sell your crypto and buy gold, stocks, bonds, and other dollar-denominated assets.

Image credit: All images belong to Aleph Blog

Well, finally the bear market… at 3/31/2002 the S&P 500 was priced to return a trice less than zero in nominal terms. After the pasting the market received today, that figure is 3.57%/year nominal (not adjusted for inflation). You would likely be better off in an ETF of 10-year single-A rated bonds yielding 4.7% — both for safety and return.

I will admit that my recent experiment buying TLT has been a flop. I added to the position today. My view is that the long end of the curve is getting resistant to the belly of the curve, and thus the curve is turning into the “cap” formation, where the middle of the curve is higher than the short and long ends. This is a rare situation. Usually, the long end rallies in situations like this. The only situation more rare than this is the “cup” formation where the middle of the curve is lower than the short and long ends.

I will have to update my my old post of “Goes Down Double-Speed.” We’ve been through three cycles since then — bear, bull, and now bear again. People get surprised by the ferocity of bear markets, but they shouldn’t be. People get shocked at losing money on paper, and thus the selloffs happen more rapidly. Bull markets face skepticism, and so they are slow.

What are the possibilities given where the market is now? When the market is expecting 3.57% nominal, give or take one percent, what tends to happen?

The Fed cares about things in this order:

• Preserve their own necks
• Preserve the banks, and things like them
• Fight inflation
• Fund the US Government
• Promote nominal GDP growth, though they will call it reducing labor unemployment. The Fed really doesn’t care about labor unemployment, or inequality. They are a bourgeois institution that cares about themselves and their patrons — those who are rich.

I know this post is “all over the map.” My apologies. That said, we in a very unusual situation featuring high debt, high current inflation (that won’t last), war, plague, and supply-chain issues. How this exactly works out is a mystery, especially to me — but I am giving you my best guess here, for whatever it is worth. It’s worth than double what you paid for it! 😉

Full disclosure: long TLT for clients and me

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.

Photo Credit: mark m || Every now and then, a change in tactics is justified

In 1994, there did come a limit where valuations of long debt undershot and started to come back. After more thought, the short-term yield effect of convexity hedging probably peaks out around 2.5-3.0% on 30-year mortgages. Unless the Fed becomes an aggressive seller of the their long bonds, and now-long MBS, I don’t see long rates going past their recent highs.

As such, I am likely to begin buying a little bit of long Treasuries as a hedge against market weakness induced by the likely Fed overshoot. Recently the short-term correlation between stocks and 30-year Treasuries has seemed to go back to stocks down, bonds up, and vice-versa.

That’s all for now.