Aristotle Capital Management letter for the month ended December 31, 2016; titled, “Dear Mr. (Incoming) President…”

2016 Hedge Fund Letters

Q3 2016 Hedge Fund Letters

… As we begin the year two thousand seventeen you will soon be taking the oath as the leader of the free world. While our firm, Aristotle Capital, is making great strides within our industry, you are likely not to know of us. Even though one of our Portfolio Managers grew up next to “Trump Village” in Brooklyn, you are likely not to know of us. Even though many of this PM’s childhood friends lived in the Beach Haven apartments – that which your father, Fred C. Trump, bought, then later sold, you are likely not to know of us. Even though several of the Principals of our fi rm are native New Yorkers, you are likely not to know of us. Even though the Aristotle group of affiliated companies recently rolled out Aristotle Atlantic Partners, headquartered in New York City, you are likely not to know of us. We never had, nor are we likely ever to have, any business or personal dealings, so you are likely not to know of us. Yet we respectfully ask you to consider a few business/investment-related topics we deem worthy of such consideration by your (incoming) administration.

  • With the caveat that all businesses, regardless of size, should be treated fairly, we found some of the presidential campaigning all too often focused on “big business.” This was despite the fact that 83% of U.S. employment (as measured by nonfarm payrolls) is in other than the 500 largest public companies. Will you ensure that neither “big” nor “small” business is either “ad-” or “disad-” vantaged versus others?
  • “Government” is often spoken of as one amorphous entity. Please remember, Mr. President-elect, that two-thirds of total government employees are at the state and local levels. Many laws, law enforcement, business policies and regulations are determined locally. State and local budgets, too, are determined by local policymakers. Many such budgets (and credit ratings) are being hobbled by underfunded pension plans. There is a line between national initiatives and federalism. Where does one draw that line?
  • Similar to the above question regarding Federalism versus Centralism, how does your incoming administration view “globalism?” We note that while income inequality has increased within most countries around the world over the years, such inequality has decreased using the world as the metric. That is, it appears as though, as you may have pointed out, developed economies, including the U.S., have sacrificed some of their potential for the benefit of those at lower living standard levels. Are there net benefits from such sacrifice? Shall this trade-off be viewed only from a country-centric perspective or from a global one? Might there be a “happy medium” or should it be every country for itself? Are symbiotic relationships with our fellow countries an attainable goal?
  • According to the World Bank, the U.S. ranks very high in “ease of doing business.” But the same studies put us lower in “ease of starting a business.” Why is this and is there anything that can be implemented on the federal level to encourage small businesses to get going?
  • Please do not misinterpret our messages or believe that viewpoints are implied where questions are being asked. For example, we do not wish to imply that “big” is “bad.” Almost all large enterprises in the U.S. began as much smaller ones. Becoming large and successful did not, in the vast majority of cases, change the nature or complexion of the companies. Indeed, some tasks can only, in our view, be performed by larger businesses capable of navigating vast complexity. How many companies can build the Space Shuttle, or passenger jets, or engines for such, or dams on our fl owing rivers, or pipelines across mountains and under lakes? In some cases, competition may be highly non productive. How many companies should provide electricity or manage our grid, collect trash in our neighborhoods or make fire engines?
  • The subject of “Entitlements” always gets some good air time during political campaigns and this past season was no exception. But perhaps, with all the discussions about federal expenditures on Social Security, health care, etc., still short shrift was made of this topic relative to its importance. Even with a faster growing economy (concomitant with increased tax receipts), entitlement spending is expected to soon dwarf that of all other federal expenditures. Add to this the also-growing payments for interest on the national debt, and a focus (budget wise) on just about anything else may be only marginally impactful, at best. Many choices are available today to optimally deal with budget issues and the nation’s deficits, but over the coming years available options could be diminished as we eventually near a “crisis” period.
  • While we are on the topic of “hot button” campaign issues … Please consider that a healthy banking system is the “grease that lubricates” our economic engine. By now we know the many, many interconnected reasons that contributed to last decade’s financial crisis. We also know, from our own and global experience, that an economy cannot thrive without available credit. Of course we also know that “too much” credit or “bad” motivations are not healthy for the long run. How may we achieve balance on this topic?
  • We shall not ask you much about your immigration policies because, like many issues you face, it is complicated and, in this case, quite sensitive. We do, however, request you consider the following fact. The U.S., like much of the rest of the world, has a declining birth rate. Left purely to our own devices, our population growth is trending toward zero. Net immigration has raised this growth rate to about 0.8%. Are these 21 million new persons each year productive and net beneficial to society? How may we protect this great society, yet remain a “country of immigrants” as we have always been?
  • As for interest rates, and policies you may implement, we ask you to consider the following statement we took from a recent edition of The Bank Credit Analyst. “Although global yields may have bottomed from a secular perspective, the upturn will be gradual in the years ahead. A post-Debt Supercycle environment implies that private sector credit growth will remain subdued… A more powerful bear trend in bonds awaits the more significant upturn in inflation that likely will follow the next economic downturn.” While we do not necessarily subscribe to this theory, the notion of “debt supercycles” followed by rising inflation is an important long-term trend that must be carefully monitored.
  • The philosopher Aristotle, for whom our company takes its name, had been known to say that “Invention is borne of necessity!” So, please Mr. (Incoming) President, don’t try to solve all of our problems. Perhaps clear the way so that society, acting through individuals, can solve its own issues in the order of individual preference.
  • Finally, Mr. (Incoming) President, we agree with your desire to implement what you believe you were elected to do. But please consider the long-term good of your legislation. Remember, the policies of the Volcker/Reagan years are still being felt with disinflationary forces
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