The Paper Trail: Heretical Thinking

Happy Thanksgiving week! Among the many things I am thankful for this year, I am grateful for your readership. Please spread the word and share the blog with your favorite investment nerd. 

Now this may sound unorthodox, but give me beef tenderloin or roast chicken instead of turkey on Thursday and I'll take that trade ten times our of ten. Hands down the most underwhelming part of the Thanksgiving meal. (Long mashed potatoes, stuffing, corn casserole, pumpkin pie/Short turkey, cranberry sauce, green bean casserole, pecan pie) 

Speaking of heretical thinking, this month's title was drawn from a paper by One River Asset Management, in which they challenge the long-held convention that there is a performance drag from holding long volatility exposures. 

Other topics features in November's installment of The Paper Trail include:

• Investing in natural resources
• Farmland's similarities (and differences) with real estate
• Making room for private equity and small-cap stocks
• Replacing bonds with hedge funds
• The symbiotic coexistence of public and private credit
• Private equity's divergence from public markets
• Settling the score between growth and value
• The challenge of sticking with diversifying alternatives
• Whether or not we're in a stock market bubble
• A historical perspective of government debt
• Self-storage real estate as an asset class
• The significant risk transfer (SRT) market
• Optimizing price momentum
• Why stock market concentration ≠ increased risk

Why aren't investors paying more attention to natural resources in private markets?

"Capital formation in natural resources private markets rebounded modestly in 2024 but remains well below even the depressed levels of capital formation in the latter half of the 2010s. The poor performance of that prior decade is certainly a major culprit. This evacuation of capital coincided with a period of inflationary  pressure, historically a factor that led institutional investors to incorporate more natural resources exposure in their portfolios."

Unconventional Thinking – A Reset of the Investment Opportunity in Upstream Energy (CF Private Equity)

Are leased farmland and commercial real estate more similar than they are different?

"Higher interest rates and structural shifts in traditional real estate markets
are prompting real estate investors to reconsider their exposures. Leased
cropland offers a complementary alternative. Its core appeal is familiar—
tangible land, recurring income, and long-term appreciation—but its distinct
fundamentals, attractive correlation profile, and proven track record as a
durable inflation hedge set it apart."

Farmland: Real Estate at its Core (US Agriculture)

Is there room for both private equity and small-cap stocks in a portfolio?

"In our experience, private equity firms often target companies that are far smaller than those represented in the U.S. small-cap universe, for instance, buyout strategies investing in the lower-middle-to-large/mega market focus on portfolio companies with an enterprise value of $10 million to $1 billion or higher. The average enterprise value of small-cap constituents within the Russell 2000 is above $2 billion. As such, only a handful of mega private equity funds are realistically targeting companies that would otherwise be part of the Russell 2000 Index if they went public. This supports our belief that U.S. small-cap equities are complementary to private equity allocations, and there is space for both within an investment program."

Is Private Equity the New Small Cap? Understanding the Overlap - and the Divide (NEPC)

Should investors replace a portion of their bond allocation with hedge funds?

"Historically, bonds have been the go-to defensive allocation in balanced portfolios. But their relationship with equities has changed. As the following chart shows, the beta of bond returns to equities has increased in recent years, meaning bonds aren’t providing the same offset when equity markets move sharply lower."

Rethinking Diversification Using Hedge Funds (Aksia)

Can direct lending and broadly syndicated loans (BSL) live in harmony with one another?

"Now a mainstream asset class, corporate private debt constitutes over $1.7 trillion in assets and has become a fixture in institutional portfolios. This rapid growth has often been characterized as being at the expense of the more established liquid credit markets. However, the ability for borrowers to flexibly access both liquid and private credit markets should be viewed positively by investors exposed to corporate credit risk. These distinct but interlinked markets together broaden the range of available credit solutions, serving to support the financial health of issuers."

Friends Not Foes (Oaktree)

Will public stocks continue to outpace private equity?

"With exits and deal activity still subdued, private strategies have not yet caught up to their public counterparts. But this lag also creates opportunity. A record 12,500 private equity–backed companies now populate the U.S. market—three times the number of public listings. That growing “inventory” of private firms is a fertile hunting ground for disciplined investors."

Liquidity’s Premium: Why Public Markets Are Outpacing Privates — For Now (FEG)

Will the value vs. growth debate ever be settled?

"The “value premium” may once have existed, but either has been arbitraged away and/or real-world conditions (e.g., the rise of IT and intangible assets) have caused its demise. Hence, we believe that while value will still have periods of outperformance, investors should not count on a value bias in US equities producing higher long-term returns. Rather, investors should be prepared for cyclicality, and for those cycles to last an extended period."

Equity Style: Value vs Growth (Meketa)

Why is it so hard for investors to stick with diversifying alternatives?

"After a strong decade for core investments—like the 1990s or 2010s diversifiers are inevitably seen as a drag on returns by some investors. At the same time, the diversifiers themselves experience performance fluctuations and often underperform during bull markets (by definition, the best diversifiers will receive no tailwinds from a buoyant stock market). These cycles often lead investors to abandon diversifiers at the worst possible time."

Diversifying Alternatives and the Rearview Mirror (AQR)

Does it pay to be long volatility?

"For the Long Volatility Premium, the rationale lies not in the mispricing of the exposure itself, but rather a mispricing of the relative distribution of equity returns versus that of long volatility returns. Put differently - long volatility tends to be far more right-tailed than equities are left-tailed. While markets attempt to price this in (e.g., the presence of skew in options), the long-term benefit of long volatility exposures still exceeds their cost when the benign market beta drag is neutralized. The behavioral rationale for why this inefficiency persists is the highly episodic and unpredictable nature with which long volatility positions produce profit."

Heretical Thinking: The Long Volatility Premium (One River Asset Management)

Are we in a stock market bubble?

"Importantly, bubbles tend to develop when there is a combined surge in stock prices and valuations to an extent that the aggregate value of companies associated with the innovation exceed the future potential cash flows that it is likely to generate. Valuations of the technology sector are becoming stretched (here we look at P/E ratios versus other bubbles, PEG ratios, P/B vs. ROE and a DDM) but not yet at levels consistent with historical bubbles."

Why We Are Not in a Bubble...Yet (Goldman Sachs)

How much is "too much" when it comes to government debt?

"We argue that there is no single metric that determines when debt becomes dangerous; context matters more than any fixed debt-to-GDP ratio. The interaction between growth rates, interest costs, and investor confidence ultimately determines whether debt remains manageable. The uses to which debt is put also matters: borrowing to support productive investment or stabilize a weak economy can strengthen long-term growth, while debt accumulated for unproductive purposes can erode it."

High Public Debt in Historical Perspective (LuminArx)

Has self-storage proven itself as a core component of a diversified real estate portfolio ?

"The combination of low operating expenses, short lease terms, and demand drivers that are less linked to the macroeconomy results in steady cash flows, regardless of the point of the economic cycle. This resilience is illustrated in the sector’s outperformance during recessions. Self-storage has outperformed all other sectors in terms of same-property NOI growth during the previous three recessions (Dot Com, Global Financial Crisis, and COVID-19) and their subsequent three-year recovery periods."

Niche to Necessity: The Next Chapter of Self-Storage (Heitman)

Has the juice been squeezed out of the Significant Risk Transfer ("SRT") market?

"A growing number of new entrants, uneven transparency, and rising structural complexity have made selectivity and rigorous underwriting discipline more critical than ever. While opportunity remains in transparent, well-constructed transactions, much of today’s market reflects structural optimization over fundamentals."

The Significant Risk Transfer Market: Proceed with Caution (Ares)

Do some momentum signals work better than others?

"We found that beta and country driven price trends are not robust while style and industry momentum persist both over the intermediate and, more strongly, short-term. Stock-specific momentum persists over the intermediate term and strongly reverts over the short term. As a stand-alone trend-following strategy, stock-specific momentum is clearly subsumed by both industry and style momentum. However, it can enhance a momentum signal optimized for persistence, albeit haircutting it compared to style and industry driven return components."

Optimizing the Persistence of Price Momentum: Which Trends Are Your Friends? (Voya Investment Management)

Are investors too concerned about stock market concentration?

"We offer three fundamental explanations for why concentration does not affect risk. First, large companies are intrinsically more diversified and safer than small companies. Second, concentration is a natural consequence of growth, not an aberration. And third, the U.S. stock market is highly efficient."

The Fallacy of Concentration (Windham Capital Management)