Price discovery can be an issue when it comes to private equity, as the assets don’t trade on public markets and in many cases the managers of the portfolio price the portfolio assets themselves.Kylie Cooper/Reuters
In this edition of Market Factors we’ll start with a cynical look at private equity and show a roundabout way to invest in the trend. The second section covers dissention in the ranks of Morgan Stanley strategists and the diversion covers a diet myth.
EquitiesA picks and shovels way to invest in private equity
North American financial advisors have largely abandoned actively managed mutual funds because of fund managers’ inability to keep pace with the index. This robbed the brokers and their employers of a rich source of profits that needed replacing.
Private equity is one of the tools being offered to give advisors something to sell and their employers a source of profit. There are some firms, one of them that rhymes with Mel’s Margot, where strategists recommend private equity and other alternative investments in the first two pages of every report.
There is nothing philosophically wrong with private equity and it does carry some advantages. Lock-up periods, which on the surface seem a bad idea because liquidity is important for investors, can be good in that they guarantee stable cash for developers of assets like toll roads that will end up long term cash cows.
There is one big problem with private equity that worries me and that is price discovery. Private assets don’t trade on public markets by their very nature – they don’t have to compare daily to that pesky index performance – and in many cases the managers of the portfolio price the portfolio assets themselves.
I am NOT saying that the sector is rife with scumbaggery. But I am suggesting that a few funds will have troubled assets, get caught overstating their values, and then every shareholder in private equity funds will run around like crazypeople trying to figure out if their investments are worth what the manager says.
Josh Brown, CEO and Co-Founder of New York-based Ritholtz Wealth Management, provided a much more cynical take on private equity sales than mine in Why be an LP when you can be a GP? His parody of the marketing pitch did make me laugh though, the “no one else can bring this to you, let alone explain how it works” part was particularly good.
Mr. Brown suggests investing in the companies offering private equity funds rather than the funds themselves. This is very much a picks and shovels strategy – private equity funds play the role of land plots close to gold discoveries and the fund companies are acting as the hardware store selling picks and shovels. An investment in Blackstone, for instance, benefits from the trend without respect to whether the funds perform well of not in the same way the hardware store wins without caring whether more gold is found or not.
Mr. Brown presented a chart showing the blended stock performance of fund managers Blackstone, KKR, Brookfield Asset Management, Apollo Asset Management, Ares Management Corp., The Carlyle Group Inc., Blue Owl Capital Inc., TPG Inc., Hamilton Lane Inc. and Stepstone Group Inc. compared with the private equity fund manager benchmark. The fund managers, on average, clearly outperformed the funds they’re selling. Maybe Mr. Brown is on to something with his cynicism.
Stock pickingThese three market risks are underappreciated
Morgan Stanley chief U.S. equity strategist Michael Wilson is bullish but his colleague Lisa Shalett, chief investment officer for Morgan Stanley Wealth Management, disagrees. Ms. Shalett identified three market risks she believes are obscured by benchmark returns, and recommended diversification into alternative asset classes.
Ms. Shalett believes signs of a U.S. labour slowdown are multiplying, highlighted by recent weak job creation data. This has obvious knock-off effects on consumption as the unemployed and those concerned about job security spend less.
Ms. Shalett is unconvinced by S&P 500 earnings data. She concedes that the nine per cent year over year profit growth rate is impressive but notes that only three of 11 market sectors – technology, communication services and financials – have double digit growth rates. The Magnificent Seven stocks are growing earnings at a 26 per cent annual pace, but the remaining 493 companies in the index are, on average, barely growing at all.
The strategist is also concerned about tariff-driven stagflation. U.S. CPI has been drifting higher, Tuesday’s results were above consensus expectations, and the weakening greenback exacerbates the problem.
Stagflation is a terrible backdrop for stocks, which is why Ms. Shalett is recommending that clients increase allocations to gold, REITs, agricultural commodities or energy infrastructure.
DiversionsThere is no such thing as a paleo diet
SciTechDaily torqued up the headline for The Shocking Diet That Fueled Human Evolution but it’s a topic I like nonetheless. The story covers how and why early humans evolved towards grassy plants as a major food source. New analysis indicates that our early ancestors began eating these plants before the jaw structure was well-suited to them, a process called “behavioural drive”.
The story reminded me of one of my favourite Ted Talks, Debunking the Paleo Diet. Yes, it’s old, from when Paleo Diet books dominated the non-fiction bestseller lists, but still fascinating.
Archeological scientist Christina Warinner covers a wide array of research not limited to human meat consumption during the paleolithic periods (humans have no adaptations designed to digest meat but many to process plants) the discovery of ancient tools to grind whole grains from 30,000 years ago and the analysis of ancient tooth plaque for dietary clues.
The information on the domestication of plants for human consumption was surprising. The precursor to modern lettuce contained a lot of latex, the original tomatoes were poisonous, and there is one ancient plant that was engineered to grow broccoli, cabbage, cauliflower, kale and Brussel sprouts. Apricots and almonds were derived from prunes only with the cyanide bred out.
There was no single paleolithic diet, it was dependent on region, and they all looked vastly different from what is in the diet books.
The essentials
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The Rundown
Guest columnist Hanif Bayat outlined why Canadians’ obsession with real estate is lowering our standard of living in many ways.
Mariya Postelnyak described what the experts got right, and wrong, about tariffs
Contra Guys Benj Gallander and Ben Stadelmann defended their position in Blackberry
What’s up next
Economic data of wider interest starts with month over month manufacturing sales for June on Thursday when economists expect a 0.4 per cent increase. International security transactions for June will provide a signal of interest in domestic investment assets when released on Monday. Month over month CPI for July will be announced next Wednesday.
In the U.S., producer prices ex-food and energy for July is forecast to gain 0.2 per cent month over month when released on Thursday. Advance retail sales for July is out Friday and expected to come in at 0.6 per cent month over month. Industrial production for July will be reported the same day – economists forecast a flat result month over month. The FOMC minutes will be released next Wednesday.
For corporate earnings, Deere & Co. DE-N reports profits Thursday and analysts predict $4.703 per share. Applied Materials Inc. AMAT-Q ($2.358) is also out Thursday, followed by Palo Alto Networks Inc. PANW-Q ($0.885) and Medtronic PLC MDT-N on Monday. Target Corp. TGT-N ($1.995) and Lowe’s Co. Inc LOW-N ($4.256) report next Thursday.