Rekindling the Creative Spark of Investing

I’m always reluctant to comment on articles that may be construed as advertisement for one particular firm. However, when I encounter an investment philosophy that matches my own—such as that of Bienville Capital, which was recently profiled in the article “Financial Engineers Killed the Art of Investing” by Institutional Investor—I can’t help but acknowledge how it resonates. Bienville’s philosophy is as close to my own as I’ve found, and I believe that there is as much art as science in investing.

In contrast to the endowment model of investing pioneered at Yale University and which is now ubiquitous, Bienville eschews traditional asset allocation strategies that do little more than push capital toward alternative managers. Instead, its model emphasizes a contrarian spirit and a willingness to step outside the box by exploring complex, often overlooked markets for unique opportunities that other managers frequently ignore.

In fact, such a maverick approach is increasingly one of the only ways to outsize risk-adjusted returns. The article’s author, Julie Segal, points out that the popularity of the endowment model has effectively commoditized alpha, depressing returns as hedge funds accumulate larger and larger reservoirs of capital. Therefore, nonconformity and a willingness to explore represent key competitive advantages for investors, who should be more open to contrarian ideas and look beyond contemporary cookie-cutter investment strategies.

Transcending the endowment and asset allocation models relies on stronger due diligence and discovery. That’s why Bienville developed a network of global experts, including consultants as well as other connections, to identify opportunities and share information. This allows investors to discover insights from an array of experts who can point them to potential areas of investment—and help them navigate their complexities—that would otherwise be passed over by others, and then they can then explore potential to generate outsized risk-adjusted returns.

Today’s investors rightfully prioritize alpha, but in doing so, they have pigeonholed themselves into investment strategies that ultimately lower the ceiling of their returns. By looking beyond the widespread endowment model and adopting a more contrarian spirit, investors can take a more creative approach to investing and enhance their returns.

To Infinity and Beyond: The State of Private Equity

Private equity funds soared to new heights in 2017 and show few signs of slowing down in the new year.

According to a report by Preqin, 921 private equity funds reached a final close in the last year and secured $453 billion in investor commitments: a new fundraising record. In fact, as more data becomes available, Preqin acknowledged that the actual amount raised could increase by as much as 10%. A major catalyst of this fundraising were mega buyout funds of $4.5 billion or more—they secured an impressive $174 billion in investor commitments last year—as well as North American and European-focused funds.

Notably, the previous fundraising record was set in 2007 as 1,044 funds secured $414 billion in investor commitments. This context makes 2017’s fundraising that much more impressive since fewer funds were able to secure an even larger supply of capital, thus highlighting the strength of private equity as an asset class today.

Funds also flew past another milestone in 2017 as the amount of dry powder, or committed but undeployed capital, exceeded $1 trillion for the first time. Despite this tremendous reservoir of capital, a report from PitchBook found that 52% of private equity professionals plan to raise a new fund this year with the hope that any new funds will raise at least as much as previous funds. GPs and other private equity professionals must feel an incredible level of confidence in their products and potential in order to raise additional funds, and furthermore, this also signals confidence that investors will continue to commit to new funds despite mountains of existing dry powder.

Additionally, the PitchBook report also noted that 70% of GPs do not intend to offer “special incentives,” including fee breaks or co-investment opportunities, to investors who make early or large commitments, which indicates GPs and funds still hold most of the cards in fundraising negotiations.

Private equity’s recent successes appear to validate predictions by experts that the asset and wealth management (AWM) industry will grow spectacularly throughout the coming decade. In an earlier blog post, I discussed a report by PwC profiling the future of the AWM industry, which predicted that total assets under management will practically double from $84.9 trillion in 2016 to $145.5 trillion by 2025. With private equity setting new fundraising records and accumulating unprecedented amounts of dry powder, PwC’s vision for the future of AWM seems to ring true.

The Future of Finance: Purposeful Capitalism

Evolution and the capacity for innovation on a large scale are cornerstones of the CFA Institute’s Future of Finance report. Throughout the four possible scenarios that it envisions on the horizon for the worlds of finance and investment, the CFA predicts revolutionary developments in market forces, communication, social organization, and other areas. These themes of innovation and transformation reappear in the CFA’s fourth and final proposed outcome in which the rise of a new, purposeful capitalism reshapes finance along moral, ethical, and more client-centric lines.

As I discuss more thoroughly in a previous blog post, the CFA analyzes a series of megatrends and posits four scenarios to describe how the financial world would respond: fintech disruption, parallel worlds, “lower for longer,” and purposeful capitalism. In the latter, the CFA suggests that firms will become more conscious of all stakeholders and seek to redefine value propositions by placing more emphasis on trust and nonfinancial considerations.

The impetus for such soul-searching, according to the CFA, comes from a recognition of limits and changing forces. The report notes that as firms acknowledge the interconnected nature of finance—particularly when “viewed as an ecosystem”—they will stress the importance of trust in business and look for ways to demonstrate integrity. Additionally, concerns over systemic issues like resource scarcity and shifting demographics will prompt firms to operate via the principles of sustainable development.

Furthermore, as trust and sustainability come to play a larger role in the financial world, firms will need to find ways of aligning their investment strategies with these values. As a result, pursuing the greatest possible returns or profit maximization may no longer be the supreme goal for many firms who hope to make ethics a key element of their brand or strategy; the report points out the paradox of holding tobacco and health care stocks as an example of this. In fact, the CFA notes that these tradeoffs will represent a large part purposeful capitalism’s development.

Ultimately, firms that embrace purposeful capitalism will pay attention to the needs of broader constituencies that include clients as well as the public at large. Ethical business practices, like the adoption of corporate social responsibility (CSR) or ESG investing, will take center stage at financial institutions, which will also prioritize leadership and diversity initiatives.

To read the CFA’s full Future of Finance report, click here.

The Future of Finance: “Lower for Longer”

Although interest rates in the United States inched higher earlier this summer, around the world, rates remain low as countries try to spur economic growth. The strategy of keeping rates low in order to encourage growth is not new, but according to the CFA Institute, it may typify the future of the financial industry as continued low interest rates lead to low returns, anemic growth, and a climate of political and social instability.

In a previous blog post, I profile the CFA Institute’s Future of Finance report and it’s four prognoses of how the financial sector may evolve in the coming years: fintech disruption, parallel worlds, purposeful capitalism, and “lower for longer.” In the last scenario, the CFA predicts that perennially low interest rates and other factors—including excessive debt in both the public and private sector and aging populations—combine to prolong the period of weak growth that has followed the global financial crisis.

According to the CFA, low rates will bring about an abundance of global capital and low returns, which will prompt continued intervention by central banks even as those interventions begin to have diminishing impacts. Governments will be largely be unable to respond owing to crippling public debt.

Meanwhile, as average lifespans become longer, corporations and public entities alike will have a harder and harder time meeting their pension obligations, which will lead to pension crises and even pension poverty. This will simultaneously increase pension costs and damage corporate values, further complicating the process of economic recovery and growth.

Under such conditions, the world of finance will respond by deemphasizing innovation since the abundance of capital will mitigate the incentive to develop new products or practices. And while markets may become more efficient thanks to more advanced technology to assist in due diligence and price discovery, they will also become less liquid as capital migrates to fixed assets like real estate and infrastructure.

Financial service providers will also need to cope with a higher level of regulatory scrutiny. The CFA forecasts that lower returns will cause firms to increase their marketing efforts in order to attract new customers; consequently, this will attract a higher level of oversight from regulators and thus additional compliance costs, further shrinking firms’ margins.

To read the CFA’s full Future of Finance report, click here.

The Future of Finance: Parallel Worlds

In many ways, the world is more connected today than it has ever been. The flow of ideas and information across the globe takes only seconds thanks to the proliferation of internet-enabled devices, while people and goods can quickly and easily traverse the world thanks to free trade and open border agreements. However, despite these contemporary trends, the CFA Institute forecasts that the near future may be characterized less by an interconnected world and more by parallel worlds as fissures open up across our society and our institutions rush to adapt.

The CFA’s Future of Finance report, which I discuss in a previous blog post, describes four possible scenarios for the financial world of tomorrow: fintech disruption, “lower for longer,” purposeful capitalism, and lastly, parallel worlds, in which different strata of our society—men and women, rich and poor, rural and urban, and so on—interact with society in different ways, prompting greater personalization and ease of access to financial services.

In the parallel worlds scenario, the growth of social media suddenly allows people and groups who previously existed on the margins of society to engage more fully in political and financial worlds. As a result, social media primarily becomes a forum to express discontent with elites and institutions by the people who did not benefit from what the CFA describes as the “golden marriage” of capitalism and democracy. This popularizes anti-establishment and anti-globalist views, which in turn fuels an ascendant authoritarian nationalism around the world.

Meanwhile, as the “haves” continue to make advances in healthcare and education relative to the “have-nots,” people begin to engage with society differently based on the social group they belong to; these social stratifications exist along lines of gender, class, political inclination, and so on.

The financial world—according to the CFA—will adapt by emphasizing personalization and simplicity in their offerings. Owing to the popularity of social media and widespread internet access, consumers will come to demand a wider range of digital financial options, which will cause financial services to become less expensive, more abundant, and significantly easier to access. Therefore, opportunities to innovate will come in the form of developing infrastructure and new channels to engage with financial services rather than actually unveiling new services.

To read the CFA’s full Future of Finance report, click here.

The Future of Finance: Fintech Disruption

From media to retail to healthcare, new technologies have triggered a wave of disruption across dozens of established industries. Taxi operators, for example, must contend with digital upstarts like Uber and Lyft that have made it possible for passengers to call a car and driver at the push of a button, and some industries—such as travel and photography—have been rendered all but obsolete by new technologies. While finance is also being affected by technological innovations, today’s advances may be the tip of the digital iceberg: In fact, the CFA Institute predicts “fintech disruption” may define the financial industry of tomorrow.

In a previous blog post, I discussed the CFA’s recent Future of Finance report, which analyzes several global megatrends and proposes four scenarios for how they might transform the world of finance; the futures they envision are entitled “parallel worlds,” “lower for longer,” “purposeful capitalism,” and of course, fintech disruption. Fintech—which describes a range of technologies that can deliver financial services to consumers—is already a powerful force, and its influence can be seen in the rise of robo-advising, which uses algorithms and large data sets to automate many elements of financial planning.

The CFA bases its prediction for widespread fintech disruption on several existing technological megatrends, like the proliferation of IT-enabled devices that make it possible to receive constant updates about investments in real time, but it is particularly interested in big data and machine learning. Big data allows firms to upload and store massive amounts of information and access it from anywhere via cloud technology, which can be analyzed virtually instantly with the help of artificial intelligence and complex algorithms.

In the coming years, as data storage becomes more efficient and computing power increases, the CFA predicts that fintech devices and programs will be able to scan enormous quantities of data to deliver fast, accurate, and hyper-personalized insights and recommendations to investors. But identifying technological advances is only part of the picture: How does the CFA envision fintech affecting the financial industry itself?

There are several potential avenues. In one scenario, entrant firms could deploy new technology with greater speed and efficiency than more established, entrenched firms, allowing these new players to “outflank” the competition by driving down costs and winning over the tech-obsessed Millennial generation. Conversely, established firms could develop fintech fluency—perhaps by purchasing fintech firms altogether and assimilating their services—to drive down costs as well as attract and retain customers; additionally, by using fintech to offer more personalized services while enhancing customer services, firms could step into the role of concierges for clients.

To read the CFA’s full Future of Finance Report, click here.

The Future of Finance

While many predictions about the future of the financial industry focus on the potential behavior of markets or specific investments, far fewer estimates consider the evolution of market forces and how they will shape the industry. Of course, it can be difficult to identify the specific forces that will leave a lasting impact on the financial world, but understanding those trends in advance can help investors and managers to properly prepare for the future. In fact, a recent report by the CFA Institute entitled “The Future State of the Investment Profession” seeks to do just that by predicting several possible futures for the financial ecosystem based on a series of disruptive forces.

The report outlines six megatrends, which it defines as “large scale changes in circumstances that are omnipresent in all facets of our world,” and suggests four potential outcomes based on how those megatrends may intersect. As a result, financial decision makers can use the report to identify megatrends at work and make a determination as to which scenario of the possible four that they should prepare for. The megatrends are aging demographics, tech-empowered individuals, tech-empowered organizations, government footprint, economic imbalances, and resource management.

The first scenario discussed in the report emphasizes fintech disruption. In this model, new technologies enable the development of new business models, investment strategies, and for entrant firms to compete with and outpace more established institutions. Additionally, the report predicts that the pace of innovation will continually increase as regulatory mechanisms integrate technology, allowing for financial services to become hyper-personalized and accessible to all.

In another outcome, “parallel worlds” develop as different segments of the population engage with society and with financial services differently on the basis of geography, age, and social background. Consequently, members of the various “worlds” will seek different financial products to suit their specific needs and interests, which will lead to increased financial participation and literacy across the spectrum. Although this model does anticipate improved education, healthcare, and communication around the globe, it also accounts for heightened tensions and “mass disaffection” owing to populist and nationalist attitudes.

Alternatively, in a more pessimistic prediction, the report suggests that interest rates around the world could stay low, which would lead to industry consolidation and growth challenges. At the same time, pension costs in both the public and private sectors would rise to pay for pensioners who are living longer as well as to cover diminishing returns from pension funds. Furthermore, a trifecta of geopolitical instability, social instability, and distrust with investment outcomes could combine and prompt the public to lose faith and trust in finance.

The last scenario discusses the rise of a purposeful capitalism characterized by higher ethical standards and attention on a wider range of stakeholders. Firms would more closely align their mission, values, and profit motives, and over time, markets would grow more efficient and fair.

The CFA’s full report is available here.

Africa and Innovation

Home to 1.2 of the world’s seven billion people, Africa has long captured the imagination of both business and political leaders because of its massive growth potential. Until now, however, this growth has been more of a promise than reality, borne out by the fact that several of the world’s leading companies–including Coca Cola, Nestle, Barclays, and many others–have significantly scaled back or altogether withdrawn from doing business in Africa. But, according to a recent article in the Harvard Business Review written by Clayton M. Christensen, Efosa Ojomo, and Derek van Bever, new innovations may help bring the promise of Africa’s spectacular growth to fruition.

In most developing economies, investors and entrepreneurs chase after growing middle classes as the target market for their goods and services. Many leaders hoped that this would prove true in Africa and that the continent would provide a repeat of the Asian “tiger economies” of the late twentieth century, but as the authors point out, Africa’s middle class never really developed. As a result, large multinational corporations seeking to do business in Africa pinned their hopes on a demographic that simply wasn’t there, thus setting them up for inevitable losses. Aside from an anemic middle class, the authors also noted that corruption, skills shortages, and a lack of reliable infrastructure constituted other barriers to growth.

However, rather than wait for a middle class to arrive, business can succeed in Africa by looking to the needs of the “aspiring poor.” The idea that multinational corporations should practice an “inclusive capitalism” that focuses on aspiring poor communities in emerging markets rather than middle classes in established markets first appeared in C.K. Prahalad and Stuart Hart’s 2002 article, “The Fortune at the Bottom of the Pyramid.” Christensen, Ojomo, and van Bever invoke these ideas in their discussion of Africa to point out that business can focus on catering to the needs of the continent’s aspiring poor in order to create new markets instead of pursuing non-existent middle classes.

As a case study for this proposition, Christensen, Ojomo, and van Bever focus on Tolaram, an Indonesian conglomerate that operates in Nigeria and sells the wildly popular Indomie brand of instant noodles. Tolaram opted to market a product toward Nigeria’s aspiring poor through their line of low-cost noodles that are affordable, easy to make, and nutritious. In order to keep costs low, the company “internalizes the risks” of doing business in an emerging market, such as incorporating electricity and water production into its operations, buying a fleet of trucks to transport its product, and more. Today, Tolaram and its Indomie noodles are ubiquitous in Nigeria, indicating that foreign corporations can enjoy success in African markets if they introduce innovative, adaptable strategies for growth.

Of course, investment in Africa will not come without its share of costs and challenges. But as companies like Tolaram prove, for foreign entrepreneurs who are willing to focus their attention on Africa’s aspiring poor, growth and success on the continent are possible.

The Rise of Single-Family Offices

For the past several years, the rise of single-family offices has been one of the fastest-growing trends in asset management for the wealthy. According to Forbes, single-family offices are both growing in number and also in terms of how much wealth individual offices manage on behalf of their clients. There are several reasons behind this development: First, the ranks of the wealthy are expanding, which means there is simply more capital to manage, and these wealthy families enjoy the discretion, direct relationships, and personalized services that are possible through a single-family office.

“Single-family offices are very appealing because they can provide tight oversight of the professionals employed, and they often provide expanded access to business opportunities and economies of scale,” Richard Flynn, managing principal of the family office practice at Rothstein Kass PC, explained to Forbes. “Single-family offices can also be instrumental in ensuring confidentiality for the family.”

While there are some common characteristics to single-family offices, one of the advantages is that its organization and structure can be customized to meet the needs and interests of the family that it serves. This means that there are a wide range of options available at single-family offices, but at the same time, this makes it hard to define what constitutes a single-family office and how to count how many exist.

For professionals in the private equity sphere, Forbes also traces how single-family offices have been increasingly turning to private equity as well as hedge funds for recruitment in order to hire successful proven investors. Private equity professionals are often excited to join these offices, Forbes notes, because families are often more inclined to look at the long-term than other funds and because many single-family offices adopt participatory compensation models. Under such a compensation plan, wealth managers have a stake in the family’s overall portfolio or particular investments, which means they also get to enjoy in the success of the family’s investments.

“In our compensation studies, what we’ve found very interesting about the participatory compensation model is that while some investment professionals can earn many millions of dollars in a year others can earn nothing at all,” Usha Bhate, executive director of Institutional Investor, told Forbes. “The participatory compensation model usually has a number of failsafe mechanisms built in. For example, payouts, while guaranteed, tend to be stretched over a number of years, ensuring the investment professionals are not taking undue risks.”

The Importance of Strategic Edge in Private Equity

The private equity (PE) asset class has prospered in recent years, but as Bain & Company notes in its 2016 Global Private Equity Report, this may not be the case for long. In light of decreasing GDP growth around the world as well as other factors, investors anticipate that the double-digit gains that have become familiar over the course of the last four years may become a thing of the past. In fact, Bain predicts that the industry will settle at a “new normal” marked by positive cash flows but returns that are less stellar than those of the recent past.

If these claims are true and the industry is about to return to a resting point, then PE firms need to devote renewed attention to strategy. Fund managers should develop ways that their firm can remain successful and competitive in the changing PE landscape, Bain argues, by emphasizing their ambitions and strengths to create a “repeatable model” for strong investment. And since it takes time to implement a successful strategy, PE firms need to start now.

According to Bain, PE strategy should begin with a firm’s stated ambitions or visions of future successes. The next layer of strategy is to develop concrete goals and action items that allow firms to realize their ambitions. Lastly, a firm should look to hire a talented team of professionals to put this strategy in motion. In the report, Bain suggests three areas where a firm can hone its strategic investments: taking advantage of its “investment sweet spot,” identifying thematic insights, and mobilizing talent and resources.

Bain also asserts that PE firms’ strategies should emphasize repeatable results. As the PE environment continues to change in response to new trends, such as a preference for larger firms by investors, strategies need to be able to adapt and ensure steady, consistent returns even as the market evolves. Firms will need to be able to communicate the repeatable nature of their strategy to potential investors, so in addition to being ambition-oriented and repeatable, PE firms’ strategies should also be easy to articulate to clients.

To read Bain’s full report, click here.