There have only been a few times in history when investors have been so inclined to speculate and by definition so willing to accept dismal long term returns. Look no further than 17 trillion dollars of negative yielding debt globally. Consider committing to an investment promising a guaranteed loss if held to maturity over its 30 year life. When a negative yielding bond comprises one of your limited investment opportunities any equity investment appearing to offer a return that is at least positive over a 30 year time horizon looks somewhat more appealing than it might otherwise. This is essentially the dynamic playing out in markets. Investors are driving prices higher to the point where the expected return on those investments begins to converge with their bond brethren. 0%.
Of course, there is a third option in such an environment and that is to refuse to participate when the slate of options is this dismal. Few investors seem to view this as an option. One is after all taught that you need to “put your money to work” and surely there is always somewhere to do just that?
Howard Marks’ letters recently reminded me that stocks like other assets are bought and sold in an auction process. And by definition in an auction the “winner” of the auction, he or she who pays the most for an asset is necessarily also the loser in another respect, he or she is the one who was willing to accept the least relative to the amount of money offered. Put another way the investor paying the most, is the investor willing to accept the least in terms of future return.
Similarly, the level of indiscriminate “investment” in equity markets presently has not been seen since the tech bubble. Loss-making IPOs are the norm and only rivalled in prevalence by the tech bubble. One notable example is Softbank’s recent investment in WeWork. Softbank recently invested $2 billion into WeWork privately valuing the company at $47 billion, or so it’s said. The story gets more interesting as WeWork looks to IPO its business. Investors at least in this case are perhaps beginning to show signs of discernment. The speculated valuation being proposed for WeWork is closer to the $10 billion mark which Softbank is of course not pleased with. Could this perhaps be the turn? The shift in sentiment? For years now cash burning businesses have been able to IPO to much fanfare and obtain absurd valuations especially after coming to market. Perhaps the endless appetite for loss-making businesses is subsiding. It is too early to tell.
August did begin very well for us as there was a spell of risk aversion leading to double digit gains for the fund. Of course, as has continued to be the case, dips are bought and that outsized gain dwindled to only 4% by month end. We did harvest some of our volatility related positions during the uptick in volatility and we did engage our hedges at times during the rebound. Though as has tended to be the case all year we turned bearish again too early believing that rational behaviour was perhaps on the horizon. To no avail. We remain short overvalued loss-making businesses and long value where it can be found.