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The costly fallacy of ‘asset class’ investment – Financial Times

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Pension funds and endowments have for years been pumping ever more of their cash into so-called alternative asset classes, such as hedge funds, private equity and infrastructure.

By picking the very best managers in these opaque and high fee-paying areas, they hope to secure the increasingly demanding pension promises they have made. 

The trustees certainly haven’t done anything by half measures. Last year, US public sector pension schemes had 28 per cent of their $3.6tn of assets in alternatives, while for large endowments, the figure was a truly heroic 59 per cent. It has all required the recruitment of hordes of fund managers. US endowments typically now have more than 100 of these each to run their cash (up from 18 in 1994).

Yet despite all this highly paid talent, the results have been mediocre. In a paper earlier this year, Richard Ennis, a respected US investment consultant, noted that those same funds underperformed index trackers by about 1 per cent annually since 2009, an outcome he attributed to all the extra expenses they were bearing.

Now in a new working paper, Mr Ennis takes issue with those who argue that funds have simply been unlucky and that, at some point, these strategies will resume the normal service they achieved when they consistently delivered superior returns between 1994 and 2008. Instead, he argues that the whole “asset class” logic is at fault.

First, let’s take the idea of alternative asset classes. The logic is that they offer some form of diversification from traditional assets. In theory at least, such “uncorrelated” returns hold out the possibility of a bump up in performance for each unit of risk a fund assumes.

But Mr Ennis challenges this assumption. He argues that most alternative asset classes are no more than active investment strategies. And far from leading to diversification, they actually achieve the opposite. 

Let’s take as an example a pension fund that traditionally invested 60 per cent of its funds in equities (in accordance with the traditional 60/40 equities-to-bonds split). So that proportion of the fund’s assets were split among at least a sizeable chunk of the 4,000 listed companies in the US. Now assume that the same pension fund has put 20 per cent of its assets in private equity. So a fifth of its cash is invested in just a few hundred companies. That is not a diversified position, it is a highly concentrated equity bet.

Then let’s take all those managers multiplying like rabbits — the corollary of the alternatives fetish. As Mr Ennis observes, there is some de-risking benefit that comes with larger numbers of managers, but that peters out at about 10. The more you pile on above that level, the higher the chance of these managers making active bets that simply cancel each other. All that you are left with is the “deadweight” of the fees you are paying to each.

There is, of course, one big counter to all this scepticism. What about the “golden age” of alternatives from 1994 until the financial crisis, when these strategies routinely outperformed markets? But in those early years, the amount of capital devoted to alternatives was small. That left more scope for mispricing that allowed managers to show their “edge” — whether through luck or skill. That’s far harder in today’s crowded alternative markets.

Mr Ennis’s stark conclusion is that the whole pension fund industry is in the grip of a collective fallacy. Trustees accept a system that delivers outcomes that “simply blend in with broad market returns” on which portfolios pay fees of between 1 to 2 per cent a year as opposed to the 0.5-0.9 per cent for traditional portfolios. At that level, underperformance is all but a mathematical certainty.

His suggested alternative is for pension scheme trustees to place far more money with low-cost passive funds and reduce the number of active managers dramatically. But the most important thing is to banish their belief in asset-class mumbo-jumbo that is condemning their funds to underperform. Mr Ennis jokes that trustees are thoughtfully donating 1 per cent of their assets annually to the fund management and brokerage industries for no benefit.

Trustees may not resent paying this gratuity, but it is less clear how it would sit with the savers who ultimately depend on these schemes. One day they will discover that the real joke has been on them.

Jonathan.Ford@ft.com

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Tesla shares soar more than 14% as Trump win is seen boosting Elon Musk’s electric vehicle company

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NEW YORK (AP) — Shares of Tesla soared Wednesday as investors bet that the electric vehicle maker and its CEO Elon Musk will benefit from Donald Trump’s return to the White House.

Tesla stands to make significant gains under a Trump administration with the threat of diminished subsidies for alternative energy and electric vehicles doing the most harm to smaller competitors. Trump’s plans for extensive tariffs on Chinese imports make it less likely that Chinese EVs will be sold in bulk in the U.S. anytime soon.

“Tesla has the scale and scope that is unmatched,” said Wedbush analyst Dan Ives, in a note to investors. “This dynamic could give Musk and Tesla a clear competitive advantage in a non-EV subsidy environment, coupled by likely higher China tariffs that would continue to push away cheaper Chinese EV players.”

Tesla shares jumped 14.8% Wednesday while shares of rival electric vehicle makers tumbled. Nio, based in Shanghai, fell 5.3%. Shares of electric truck maker Rivian dropped 8.3% and Lucid Group fell 5.3%.

Tesla dominates sales of electric vehicles in the U.S, with 48.9% in market share through the middle of 2024, according to the U.S. Energy Information Administration.

Subsidies for clean energy are part of the Inflation Reduction Act, signed into law by President Joe Biden in 2022. It included tax credits for manufacturing, along with tax credits for consumers of electric vehicles.

Musk was one of Trump’s biggest donors, spending at least $119 million mobilizing Trump’s supporters to back the Republican nominee. He also pledged to give away $1 million a day to voters signing a petition for his political action committee.

In some ways, it has been a rocky year for Tesla, with sales and profit declining through the first half of the year. Profit did rise 17.3% in the third quarter.

The U.S. opened an investigation into the company’s “Full Self-Driving” system after reports of crashes in low-visibility conditions, including one that killed a pedestrian. The investigation covers roughly 2.4 million Teslas from the 2016 through 2024 model years.

And investors sent company shares tumbling last month after Tesla unveiled its long-awaited robotaxi at a Hollywood studio Thursday night, seeing not much progress at Tesla on autonomous vehicles while other companies have been making notable progress.

Tesla began selling the software, which is called “Full Self-Driving,” nine years ago. But there are doubts about its reliability.

The stock is now showing a 16.1% gain for the year after rising the past two days.

The Canadian Press. All rights reserved.

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S&P/TSX composite up more than 100 points, U.S. stock markets mixed

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TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in base metal and utility stocks, while U.S. stock markets were mixed.

The S&P/TSX composite index was up 103.40 points at 24,542.48.

In New York, the Dow Jones industrial average was up 192.31 points at 42,932.73. The S&P 500 index was up 7.14 points at 5,822.40, while the Nasdaq composite was down 9.03 points at 18,306.56.

The Canadian dollar traded for 72.61 cents US compared with 72.44 cents US on Tuesday.

The November crude oil contract was down 71 cents at US$69.87 per barrel and the November natural gas contract was down eight cents at US$2.42 per mmBTU.

The December gold contract was up US$7.20 at US$2,686.10 an ounce and the December copper contract was up a penny at US$4.35 a pound.

This report by The Canadian Press was first published Oct. 16, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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S&P/TSX up more than 200 points, U.S. markets also higher

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TORONTO – Canada’s main stock index was up more than 200 points in late-morning trading, while U.S. stock markets were also headed higher.

The S&P/TSX composite index was up 205.86 points at 24,508.12.

In New York, the Dow Jones industrial average was up 336.62 points at 42,790.74. The S&P 500 index was up 34.19 points at 5,814.24, while the Nasdaq composite was up 60.27 points at 18.342.32.

The Canadian dollar traded for 72.61 cents US compared with 72.71 cents US on Thursday.

The November crude oil contract was down 15 cents at US$75.70 per barrel and the November natural gas contract was down two cents at US$2.65 per mmBTU.

The December gold contract was down US$29.60 at US$2,668.90 an ounce and the December copper contract was up four cents at US$4.47 a pound.

This report by The Canadian Press was first published Oct. 11, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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