The Paper Trail: Enduring Appeal

I'm dropping this month's post a few days earlier than normal. Taking a few days off ahead of Labor Day weekend for some extended R&R with the family. Wishing you and yours a great summer finale - catch you back here in September!

Before we get started, I wanted to share the video below. Earlier this summer, I had the pleasure of being interviewed by my friend Peter Lazaroff for a LIVE recording of his podcast, The Long Term Investor, at the Morningstar Investment Conference at Navy Pier in Chicago.

We had a full audience listening to our deep dive into the world of alternative investments, exploring why the traditional 60/40 portfolio faces challenges in today’s market and how alternatives can provide a viable solution.

We also discussed the rise of private credit, the potential benefits of interval funds, and the importance of educating clients about these complex investment strategies.

In addition to the YouTube video, the audio-only version is available on all your favorite podcast feeds. Hope you check it out!

Now, please enjoy the August 2024 edition of The Paper Trail. This month's research roundup features:

• Valuation premiums for growth-stage private companies
• Portable alpha 
• Quant investing's renaissance
• The 'de-horning" of venture-backed Unicorns
• Deep value stocks
• The state of the American consumer
• Private credit's next act
• Index deletions
• AI financial analysts
• And much more!

Have growth stage private companies earned their premium valuations?

"Today, companies that are able to show efficient revenue growth in large markets through strong business metrics continue to be rewarded with healthy valuation multiples. Investors remain eager to pay up for companies they believe have durable long-term growth potential."

The Enduring Appeal: How Top Companies Command High Valuations (Adams Street)

Are investors missing out by not taking advantage of portable alpha?

"In the early days, many portable alpha implementations used a separate beta overlay manager, held too little cash for managing the equity futures position, assumed the hedge fund was 100% alpha, and/or used illiquid alpha sources. Implementation has improved markedly over two decades. In today’s marketplace, investors have access to bundled products (i.e., hedge fund alpha plus the beta of your choice) that are simple, single line items alongside typical long-only investments. We believe that today more investors (finally) have a viable way to get higher, and higher quality, excess returns into the equity sleeve of their portfolios."

Portable Alpha: Still A Great Solution For Improving Return Outcomes (AQR)

Is quant investing back?

"Unconventional data sources and novel financial applications for state-of-the-art algorithms have broadened the realm of possibilities for orthogonal alpha sources. These nascent models are already earning their keep in the new quant estate. With their help, and the overall strong history of traditional quant factors, even with the Quant Winter factored in, quantitative strategies may appear enticing over the long term."

The Quant Renaissance: How Alternative Approaches Are Driving the Rebirth of Systematic Investing (Man Group)

Are there too many venture-backed "unicorns"?

"The valuation comparison in FMV marks and secondary valuations underscores the overall market suppression of company valuations even among the still-Unicorn population. During 2021 and 2022 we were in unforeseen territories with Unicorns as we had more crowned in that time period than any other. However, this has resulted in many companies fictitiously reaching such status flying on this bubble's wings and not having the true merits of the original pre-2021 Unicorns."

Thinning the Herd: ~50% of Unicorns Should No Longer Be Unicorns – A VC Specialist’s Viewpoint (Industry Ventures)

How cheap are the deepest value stocks across the globe?

"Outside of the U.S. all value is cheap, but deep value is in the 2nd percentile of its history. Within the U.S., deep value is similarly sitting at the 10th percentile of its history, while the rest of value should largely be ignorable at current valuations."

Deep Value: A Rose by Any Other Name Would Smell as Sweet (GMO)

How does the bifurcation of wealth among American consumers influence the overall health of the U.S. economy?

"These dynamics are cause for both optimism and pessimism. On one
hand, since the bulk of overall consumption in the U.S. is driven by wealthy Americans largely insulated from financial headwinds, a weaker average consumer may not have a disastrous impact on GDP growth. At the same time, a significant and economically vulnerable subset of the population has become increasingly burdened with costlier debt and less disposable income."

The State of the American Consumer (Marquette Associates)

Is asset-based lending the next big thing in private credit?

"As direct lending has become increasingly competitive, yields in many pockets of asset-based lending look more attractive compared with publicly traded bonds of similar risk. Commercial banks are limiting the size and range of their asset financing activities. Time and again in our interviews, industry participants call out the growing opportunity in asset-based finance."

Private Credit's Next Act (Oliver Wyman)

Why do "index deletions" have a tendency to outperform the market after being kicked out?

"Deletions experience massive selling pressure since index fund investors must unload their shares; as a result, the market clearing prices of dumped stocks are often much lower than what they would have attracted before the deletion decision. This sets the stage for an impressive rebound"

Nixed: The Upside of Getting Dumped (Research Affiliates)

Will human financial analysts eventually be replaced by AI?

"Ultimately, we concluded that AI is able to effectively perform many junior analyst tasks but still lacks the skills required for more senior roles."

AI Financial Analysts (Sparkline Capital)

Are small caps finally poised for a rebound?

"Poor small cap fundamentals (particularly portfolios that look like the Russell 2000) may prevent small cap from mounting its seventh sustained period of outperformance, but for diversified investors thinking about small cap stocks, today’s valuations offer the cheapest entry point in the 21st century."

The Lion in Winter (J.P. Morgan "Eye on the Market")

How have venture capital funds performed in recent years?

"It remains to be seen if performance among the 2021 and 2022 vintage years can recover to match earlier vintages or if the macro changes across venture have resigned those vintage years to lower outcomes permanently."

VC Fund Performance (Carta)

Can traditional value investing be improved upon by alternative measures of fundamentals?

"This paper claims that the observed decline in the value strategies’ returns results from the failure of the standard price multiples to correctly capture the gap between market value and fundamental value. This shortcoming is especially acute in the market conditions that have become prevalent in recent decades, characterized by a larger presence in the market of growth-oriented firms and a downward trend in interest rates. As a solution, we propose to replace the standard metrics of fundamentals in price multiples with a stock’s intrinsic value, which is a valuation-founded approach to measuring firm fundamentals. This methodology circumvents the problems associated with standard price multiples by accounting for the current value of the firm’s assets as well as the value derived from future economic profits."

Intrinsic Value: A Solution to the Declining Performance of Value Strategies (The Applied Finance Group)