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May 23rd, 2024

Like Russian Nesting Dolls

Like Russian Nesting Dolls, financial marketers are full of themselves. Financial investing once offered a simple menu of stocks and bonds.  In the last few decades, those two broad categories have been dissected, tranched, reorganized, and sold as a multitude of products by the marketing mavens of Wall Street. Offerings such as index funds, strips, ETF’s, structured products, leveraged index funds, FAANG funds, etc., are now dangled before investors. Ersatz sophisticated labels like alpha and beta accompany the products to offer the suave equivalent of free-range poultry to financial consumers.  The marketing and sales of splintered products have mushroomed into private equity in the last two decades.  During the latter part of the last century, primary funds dominated private equity as they generated alpha. In the last twenty years, secondary funds grew substantially as they bought private equity beta at a discount and prospered. The primary funds themselves are now the audience for dissected marketing efforts as GP financing, SPVs, NAV financing, and lines of credit are offered.

Perhaps the time is right to explore the tertiary market for investors to capture gamma. We believe a fund- of-funds-of-funds (FOFOF) could be an important part of an asset allocator’s toolkit, helping to ensure transparency and alignment of interests. Appropriate industry sub-verticals analogous to FAANG could be created – FOFOF for airlines could capture Delta, funds centered on Egypt could yield Chi Rho, mediocre funds will result in Psi and all are expected to produce exactly one Iota of incremental returns.  Dazzling graphs, dot-plots, graphics and sweeping narratives could undoubtedly make some of these offerings appealing, particularly if they accompany whatever trendy ideas happen to be politically popular. In the nineties, early versions of this type of marketing were Economically Targeted Investments (ETI) where rate of return as a consideration was subordinated to other perceived economic benefits like creating jobs in an investor’s home state.  When it became apparent that state pension funds were keen on deploying money into ETIs, many primary funds burst into existence. Unsurprisingly, influence peddling to state officials became a big part of the fundraising process. Several public officials and fund managers were fined or went to prison as a result. The investment performance of this category of funds was very poor. The scandals led to the end of ETI under that label, but similar political pressures continue to try to use retirement funds to feed political objectives. Just last week in Canada, federal officials and business leaders advocated that CPPIB funds be redeployed into Canadian infrastructure. To his credit, the CEO of CPPIB, John Graham, was strongly opposed to this diversion away from CPPIB’s fiduciary obligations.

A decade after ETI, two new themes emerged: impact investing and emerging market private investing, which became the marquee topics at investor conferences. The urge to deploy capital into these newly dissected categories trumped the need to focus on investment returns and manager experience. “Abraaj too far” was crossed. This small deal operator, Abraaj, suddenly was given billions in capital. The Abraaj Group was operating on six continents.  An opulent work lifestyle was soon followed by fraud accusations, an arrested CEO, large fines, missing capital and liquidation of the firm with Brigadoon-likeswiftness.   Charlie Munger aptly advised, “Simplicity has a way of improving performance by enabling us to understand what we are doing.”

I’m Rob Morris and I approved this blog.

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