WeWork’s failed IPO shows even vastly inflated stock markets will sneer at hubris, just as the paring back of Saudi Aramco’s listing plans demonstrates cynicism towards bloated largesse. The S&P 500 still made new highs right after these stuttering disappointments, but positive market moves feel like the last days of Rome against a backdrop of trepidation.
Hedge funds are supposed to prove their worth when times are tough, although aggregate performance figures for the industry aren’t impressive. Even the star partnerships with a great long-term record suffer poor spells, but what cannot be denied is the managers’ conviction. Aping their high risk-reward investment strategies is unsuitable for private investors, but the observations underpinning them are worth noting.
WeWork increases scrutiny of tech
Fred Liu, managing partner at New York’s Hayden Capital, has picked up on the market’s shifting tone: “Seemingly triggered by the failed IPO of WeWork, we saw a dramatic shift in the way public markets investors scrutinise anything that smells like rapidly growing, 'tech-enabled' companies.” Continuing, Mr Liu offers a critique of capital market funding to create tech unicorns (start-ups valued at $1bn by date of IPO). Cheap finance has bid up businesses without adequate moats: activities can be imitated by customers or suppliers, reducing chances of becoming cash-flow positive, “leaking” the value of the investment. On the flipside, Mr Liu argues that when backers get cold feet the market shoots first and good tech companies are sold off, too.
Hedge fund letters' purpose is to build a narrative to reassure investors, and Mr Liu’s 'baby and bathwater' point about sector gyrations preludes the explanation of the decision to top up on holdings that did badly in the third quarter of 2019. His reasoning, however, builds a convincing argument to target profits from a convergence of trends in tech-enabled commerce and emerging markets. Acknowledging the McKinsey-esque nature of terms such as 'social commerce', Hayden is nonetheless enthusiastic about seeking growing niches in western markets (such as Poshmark, the online social fashion marketplace) and capitalising on the volume and engagement seen in Asia.
Capitalising on powerful trends is key to coming up smelling of roses even if short-term markets are due a dunking in a recessionary pool. Characterising their approach as “insight arbitrage”, Hayden advocates looking for established patterns in one geography that could take hold elsewhere. It hints that Amazon, so long seen as the disruptor par excellence, is less well placed than start-up businesses to replicate the success of businesses in Asia.Capitalising on powerful trends is key to coming up smelling of roses even if short-term markets are due a dunking in a recessionary pool. Characterising their approach as “insight arbitrage”, Hayden advocates looking for established patterns in one geography that could take hold elsewhere. It hints that Amazon, so long seen as the disruptor par excellence, is less well placed than start-up businesses to replicate the success of businesses in Asia.
Citing the “poorly advertised and executed Prime Day 2019 concert with Taylor Swift” as a weak imitation of Alibaba’s (HK:9988) livestreamed Singles Day 11.11 annual gala, Hayden believes Amazon (US:AMZN) is behind on social commerce. In Mr Liu’s view, the embryonic success of businesses such as Poshmark proves there is no fundamental difference in shopping psychology in east and west, rather a flaw may have been exposed in Amazon’s vaunted change culture.
Return on equity focus
Toronto-based Donville Kent fund blames the manufacturing mini-recession, and the discouraging headlines about trade and geopolitical disputes that helped cause it, for depressed investor sentiment. Yet, viewing manufacturing in terms of 18-month cycles, it expects North American output to tick upwards. Combined with the lagging impact of renewed monetary stimulus around the world – which it sees fuelling borrowing and spending – plus consumer confidence buoyed by employment figures and cheap credit, Donville Kent believes the next moves for the Canadian and US stock markets it covers will be up.
Businesses that achieve a high return on equity (RoE) – net income divided by ordinary shareholders’ equity – are the cornerstone of Donville Kent’s strategy. This can be translated for UK shares, although RoE can be made to look more impressive by companies using debt in their capital structure. Therefore, it is worthwhile checkin ratios such as how well annual interest cost is covered by operating profit. That caveat made, Donville Kent believes RoE is the engine that drives compound returns and, combined with understanding the operational minutiae of businesses, focussing on ROE avoids fad investments.
Long-termism and moral investing
Record summer temperatures, droughts and wild fires have galvanised demand to address climate issues, and this isn’t the only global sociopolitical trend managers are pondering. Greenwood Investors, another New York hedge fund, mentions the feeling of contentiousness it finds in the market. This reflects dissent towards the “out of touch CEOs and ruling elite who dictate terms to the rest by creating situations that are very transactional in nature and have left the majority distrusting and worse off”.
In his third-quarter note, Greenwood partner Chris Torino uses a surprisingly British analogy to describe the sorts of companies it feels will be on the right side of history: companies that take a ‘pub approach’ make less money from patrons per visit, but generate more trust and profits in the long term; whereas the ‘tourist approach’ is to “gouge the customer on a single visit or short-term contract, and is thus less trustworthy”.
Boeing is touted as an extreme instance of putting short-term profit above safety. Most importantly, this puts lives at risk and Mr Torino doesn’t pull his punches when he implies the recent loss of 346 lives on two Boeing 737 MAX aircraft is the tragic consequence of a “management team favouring dividends and share repurchases over safety”.
Capital markets have recognised their role in heading off corporate malfeasance as well as encouraging good behaviour on environmental, social and governance (ESG) issues. Cynics, most recently SCM Direct’s Gina Miller, have (quite rightly in some cases) cast aspersions on ESG funds. There are questions over whether funds uphold rigorous standards or simply ‘greenwash’ with a few cursory metrics to help with marketing. That said, the trend is here to stay both for political reasons and, as Mr Torino points out, because being less trusted is “massively detrimental to the longevity of the business”.
Investing in a low-growth world
European perspective is provided by the Absolute Return Letter written by Niels Jensen. His focus this quarter is investing in an era of low interest rates and stuttering economic growth. The villains of the piece are adverse demographics and weak productivity in the west, as Mr Jensen posits the size of workforce and growth in productivity are multipliers for economic expansion. Of western economies, he expects the US – and therefore American equities – to continue to outperform, thanks to being “clearly ahead of the curve in terms of providing, and adopting, various productivity-enhancing new technologies”.
The answer to the shrinking workforce and productivity conundrum will lie in another megatrend, albeit one that may cause a ruckus, thanks to the way wealth is apportioned between labour and capital. Automation and robotics could be a saviour for countries such as Germany, where the working-age population is forecast to decline by 6.9m by 2040.
Mr Jensen feels the implications of the automation trend are “so profound that a fundamental change to portfolio construction shall be required”. He writes that investing is no longer about allocating X per cent to Europe, Y per cent to the US, etc. What matters is “identifying the disruptors and the disrupted”. Passive investors, who buy indices, will of course get exposure to both, which is why Mr Jensen suggests seeking out some of the very interesting exchange traded funds (ETFs) that target automation and robotics.
