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More Thoughts That Didn’t Make It in the Strategy Letter (Because We Couldn’t Stretch Far Enough to Make a Coherent Narrative) but Nonetheless Interest Us and Are Relevant

We do have a number of client partners for whom we manage assets in a “socially responsible” fashion. That means a lot of things to a lot of different people and while a laundry list of restrictions will sacrifice performance, we think a client is entitled to not put their money where their conscience isn’t. That said, I simply do not understand the practical implications of forcing companies to add more pages of legalese to an already encyclopedically-sized SEC annual report to describe their position on how “climate change” will affect their business. My point is—if we need a company’s lawyers to tell us how it might affect our investment, then just fire us right now. You mean to tell me Exxon Mobil might be affected by a world-wide crackdown on carbon usage? That a company who depends on high energy use might be affected by major increases in energy costs? That massive coastal flooding will affect a factory on the coast? Investors do not need to be nannied.

Not Directly Attributable to Bitcoin, but If the Shoe Fits:

“When everyone is doing it, you can’t put everyone in jail,” says Hu Weigang, a senior partner at Guangdong Shen Dadi Law Firm.

MiFID and the Giant Self-Serving Machine:


While it can be argued that this is another nonsensical piece of financial regulation from the other side of the ocean, there is a valid point in a client asking “why are you using our money to pay for your research efforts? Isn’t that what our fees are for?” For the record, Cove Street has never used soft dollars arrangements for anything.

From the Q3 Earnings Call by All Cap Holding Bank of New York Mellon:

“Just from our own asset management perspective, while we will clearly have to absorb research costs and that’s a headwind, we actually see it as an opportunity, since we are one of the largest global financial institutions, both from an asset management and servicing perspective. It gives us an opportunity to do more proprietary research rather than rely on the Street. So I see it actually as a positive. It’s the transaction side that I think Brian is also referring to, which is an issue. We have to have more transparency, and I think that’s an opportunity on the servicing side.

It’s kind of an intriguing one to me because we’re kind of lazy. We take a lot of research from a lot of brokers, sometimes up to 50 different ones and do we really need it or were we taking soft dollars because they were free. It’s creating just a much stronger discipline and as such a large asset manager with so much data available to us, we really should be doing our own. So in many respects, I don’t see it being a significant cost, but I genuinely believe it’s an opportunity. The data we have in this organization is unbelievable. And we don’t leverage it. We use The Street instead. So I think it inverts things in actually a positive way for large asset managers. I think it’s — and that’s the other thing. Smaller asset managers are going to pay the price. The large ones, the big ones have an opportunity here. So again, I think it’s going to concentrate opportunity in the top few asset managers.”

To which we say—phooey. How many studies have been done over how many decades showing that sell-side research is almost always trend-following, is almost always biased to positivity versus objectivity, is usually over-focused on liquidity versus value, is perversely short-term, is etc. etc. Successful investment firms do most of their own work. I would argue that huge investment firms do less active work and rely more on short-term sell side nonsense, and thus are going to have to adjust to more restrictions on using client dollars to pay for their own research budgets than smaller firms of a certain scale.

From a Recent Mckinsey Report on the Asset Management Business:

Investment performance will always be key in asset management, but as clients revisit their asset allocation models and turn to portfolio construction to capture value, an asset manager’s ability to meet client needs will be rooted as much in consistent long-term performance as in outperforming peers over short periods. In addition, clients with large and growing pools of capital such as sovereign wealth funds and large pension funds—are increasingly focused on the scalability of strategies. Asset management firms must therefore develop and institutionalize processes that enable them to deliver consistent results at meaningful scale.

Here is the problem with that. History is self-evidently clear that it is scale itself that is the enemy of long-term outperformance. It is self-evidently clear that most exploitable niches are eventually ruined by the sheer size of the institutional herd. VERY few people have shown the same ability to add value at multitudes of the existing asset size at which they became “smart” in the first place. It remains a silly, fool’s game.

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