Murray Stahl‘s Horizon Kinetics second quarter 2014 commentary.
Horizon Kinetics: The Shaky Foundations of Asset Allocation Practices, Continued
Our 1st Quarter letter addressed the question of whether some basic presumptions of asset allocation work in the real world the way every one presumes them to… such as whether emerging markets equities actually outperform developed markets, whether the historical rate of return from the stock market can be repeated or is, indeed, even valid, and so forth. Understanding these questions can hardly be more critical, since we all invest based on these foundational assumptions. One element such models share is that in the freedom of the marketplace, any rigid, definitional approach will come to be invalid, later if not sooner, since investors do react to new information and, thereby, alter supply and pricing. If a particular sector is discovered to be superior or to outperform, will not capital flow into it and inflate the price? And at what degree of price inflation does the sector become a source of average or negative, rather than superior, return?
Another shared element in the accepted wisdom of asset allocation practice is the selection of a factor that is merely semantically descriptive but not intrinsically predictive. An example would be to label an index comprised of companies domiciled or incorporated in a given emerging nation or set of nations as an emerging market index, even if it happens to be significantly constituted by multi-national businesses with stock market values every bit as large as the largest developed market companies. Or, there is the reliance upon the historical returns and behavior of an index without examining how it was created: what if the greatest and most influential returns from an index occurred during a period or with a set of securities that was unique to that period and circumstance, and is no longer repeatable? An example would be an index dominated in its early years by one or a handful of dramatically undervalued securities, yet which in the current era is relatively diverse and reasonably valued.
The 1st quarter commentary addressed the question, labelled Proposition 1a, of whether emerging markets stocks actually outperform domestic stocks. This commentary will address Proposition 2b: I invest some of my portfolio in private equity for: a) return enhancement; b) lower volatility; and c) risk diversification. Do you really receive all of those presumed benefits?
Horizon Kinetics – Private Equity: The Official Record
Big institutions plan to make yet more investments in private equity. We know that from a poll by Preqin1, which is probably the leading compiler of data on private equity and other alternative asset classes. According to this poll of large institutions, 45% of 430 respondents—a quite large sample of institutions, lending it validity—stated that private equity is the best alternative investment opportunity. It is noteworthy that alternative assets under management now have reached the level of $6 trillion and, according to the poll, 68% of respondents stated that they will commit more money to private equity in 2014.
The following table, the Preqin Private Equity Committed Capital Index, is very interesting. It shows the unit values of all private equity funds in its universe on a committed capital basis—meaning the money that is actually invested, not uninvested cash subject to capital calls—therefore, this is an index that effectively measures what happens to fully-invested portfolios. As can be seen in the quarterly return column, there is not one double-digit number—either positive or negative—during the 14-year period tracked, which begins in December 1999 and ends in June 2013.