WTT – Playing for Tomorrow

0:05The mismanagement of SVB's balance sheet got me thinking about other times in the past, investing through periods when asset prices felt inflated across the board. Institutions strive to meet return hurdles pretty much year in and year out, but that's not how markets work. This blog discusses one of my favorite long -term investing disciplines, positioning portfolios to play for opportunities yet to come. Playing for tomorrow. What return was available on a five -year U .S. treasury two years ago? Observing market conditions, you might have said 0 .8%. That was the paltry current yield on a five -year treasury at the time.

0:48But is that the answer? Yield -hungry investors like SVB thought so. They scooped up what yield was available and extended duration to earn more, like doubling expected returns to the 1 .6 % yield on a 10 -year. They were wrong. If we held cash in lieu of that tiny yield two years ago, waited for better opportunities, and bought a treasury today with three years of duration remaining until maturity, we could have earned 2 .2 % over the full five years. That's zero for the first two years, and 3 .6 for the next three. Limiting an assessment of returns to only the market conditions in the moment fails to consider the wide range of possibilities of what might happen in the future.

1:35The dramatic change in recent market conditions reminded me of a piece I wrote back in 2006 about the potential disappearance of the abundant liquidity available in markets at the time. It proved prescient when the financial crisis froze credit markets two years later. My favorite excerpt from the piece is a quote from Seth Klarman at Baupost, who brilliantly articulated this concept in his annual letter 20 years ago. Seth said, One of the biggest challenges in investing is that the opportunity set available today is not the complete opportunity set that should be considered. Limiting your investment opportunity set to only the one immediately at hand would be like being required to choose your spouse from among the students you met in your high school homeroom.

2:23Indeed, for almost any time horizon, the opportunity set of tomorrow is a legitimate competitor for today's investment dollars. It is hard, perhaps impossible, to accurately predict the volume and attractiveness of future opportunities, but it would be foolish to ignore them as if they will not exist. Baupost Limited Partnerships 2003 year -end letter. In absence of good present opportunities, holding cash has enormous option value. That's easy to say, but not easy for many to do. Accepting low returns in the short term is structurally untenable for many investors. Most answer to clients and feel pressure to deliver returns relative to their peers.

3:09Chuck Prince, the CEO of Citi during the financial crisis, famously said, as long as the music is playing, you've got to get up and dance. He was maligned for the seemingly stupid statement at the time, but in retrospect, Prince underscored a fundamental truth about what it takes to succeed in the asset management business. I mentioned at the end of Short -Term Gain, Long -Term Pain Part 2 that things are about to get interesting. Here are five changes in the investment landscape that I believe may happen with a greater than 50 % probability and reasonable confidence. One, static or higher interest rates increase the appeal of fixed income investments.

3:53Two, the shift away from U .S. dominance as a global hegemon favors international markets over the U .S. Three, Three, long -short equity hedge funds earn higher returns than expected, fueled in part by a market that has either never experienced or forgotten about short rebates. Four, contraction in lending from banks increases the volume and speed of startup failures. And five, higher corporate default rates hurt returns to existing private credit portfolios while simultaneously increasing prospective returns on new loans. And there are six more where I believe the odds are even more likely to occur, defined as a 75 % probability.

4:38One, the movement to reduce carbon emissions causes an attractive secular beta in environmental markets. Have a listen to Colin Campbell on the podcast to learn more. Two, U .S. small cap value stocks outperform. Three, commercial office real estate prices have a prolonged slow decline as leases rolling over across the next five to 10 years reflect the post -COVID working world. Four, private equity -owned businesses have a significant negative re -rating due to softer economic conditions and a higher cost of capital. Five, less correlated idiosyncratic assets like sports teams and tax assets catch a strong bid by institutions.

5:24And six, institutional capital gravitates to investments in empty rooms, including opportunities with known risks in unconventional geographies like Venezuela or Africa, out -of -favor sectors like biotech, and misunderstood assets like CLO equity or taxes. Search for empty rooms as a topic on the capital allocator's search page. Some of these ideas may offer opportunities. Others suggest risk. As always, price matters, and from time to time may reveal disparities between what I see and others do. The hardest day to invest is always today, and today is no exception. I'm holding a bunch of cash as I watch tomorrow's opportunity set unfold.

6:11Sitting on cash could have been extremely valuable two years ago, and it remains so today. Cracks in the surface are starting to appear, and I suspect deeper ones are coming. It sure is a lot easier getting paid 4 % to wait than accepting a whole lot of nothing. Thanks for listening to the show. If you like what you heard, hop on our website at CapitalAllocators .com, where you can access past shows, join our mailing list, and sign up for premium content. Have a good one, and see you next time.