Let Old Father Time take the strain
Over the last few years the fund management industry has come under a great deal of scrutiny. It started in the run up to the 2008/2009 crash, as more and more hedge funds set themselves up, chasing the absolute return dream. Fortunes were made by these fund managers under the 2 and 20 rule, where investors paid a 2% management fee and ceded 20% of the return, sometimes after a watermark, to the manager.
It was an attractive proposition for traditional fund managers, who were paid much less than the broking fraternity, to set up their own operations in this way. In addition, traders of derivative instruments at Morgan Stanley and Goldman Sachs etc. reasoned they would be better off doing it for themselves, rather than for their employer. They made great fortunes as global markets rallied from the TMT/dotcom inspired crash over ’99-’01, their hedge funds leveraged up to magnify returns, some of which percolated down in diluted form to the investor.
The life of most hedge funds is very short, perhaps not surprisingly. (Long enough for the owners to make out like bandits though, obviously.) But the repercussions are still being felt in the wider investment community. Returns are hard to come by in the current environment of low yields, mounting volatility, and moderate global economic growth. Investment horizons are foreshortened by the obsession with daily performance results. A transaction-oriented mentality is all-pervasive.
Arguments rage over the relative benefits of active and passive investment philosophies. In truth this is hardly new, but it is getting a lot of air time currently. Precious few fund managers find it easy to “add alpha”. (“Alpha” is the return a manager adds over and above the underlying market movement.)
This is largely due to the fact that they are in competition with each other. On a daily basis! This competition restricts their ability to “go out on the wire”, with real high conviction investments, because the time frame over which these may evolve may be longer than permitted by the competition.
Certain investors, like Charles Brandes, have garnered a massive following (and become “the richest man in san Diego County” in the process), by their espousal of a “value strategy”, which involves taking the long view, buying discounted assets, and waiting for the market to appreciate the discount. Others, like Crispin Odey, follow the high conviction approach, taking big bets on the back of well thought-out and researched views. In both cases they rely on a client base which both trusts and understands that there will be difficult times to live through (in market/investment terms). These types of investment firm, different though they may be in approach and philosophy, both take a long term approach.
JP Morgan wrote a paper recently suggesting that pension funds (long term, by nature) might take note of the way sovereign wealth funds operate. The latter obviously aren’t in competition, as such. The argument is that long term investors can and should access the full range of non-public assets to diversify their holdings, mute the volatility of the public markets, and earn steady and favourable risk-adjusted returns.
Crucially, sovereign wealth funds also access alternative investments, and the uplift in resulting performance makes for interesting reading. The median allocation to alternatives amongst 8 large SWFs that JP Morgan looked at, over the past 5 years, is 18.5%. The outperformance over that period, of SWFs with above median alternative weightings, against traditional 60/40 pension funds (60% equities, 40% bonds), is a staggering 551%.
My point in labouring this is to remind everyone of three key points. Diversification tends to lead to improved returns. The investment world outside of equities and bonds should be embraced, not shunned. Taking the long view reduces a lot of short and medium term stress.
Now not all investments can be long term, that much is clear. It is also clear that certain investments take time to evolve. At Amphora Portfolio Management I hope we stress sufficiently that the fine wine market is not the place to pitch up and make a fast buck. You can make great short term returns if you are lucky enough to catch one of the market’s more volatile phases, but that requires a bit more luck than most of us are blessed with.
Remember the underlying premise: diminishing supply, and increasing desirability. Over time that HAS to lead to upward pressure on prices. History suggests than in the case of the Liv-ex 100, for example, long term fine wine price appreciation runs at around 15% per annum. I think you’ll find that that exceeds most pension fund returns.
APM therefore would suggest that investors take the long view. Treat an investment in fine wine as you would treat an additional voluntary contribution into your pension fund. The market is sufficiently liquid to enable you to realise your funds quickly enough, but it behaves as all markets do, ebbing and flowing in accordance with short term influences which can often be somewhat inconvenient.
Just like fine wine itself, your investment will take time to mature, but we all, from time to time, have to display the emotional capacity to weather the inevitable cyclical downdrafts as and when they come along.