Partners Capital 2017 Annual Client Meeting

6 November 2017

Partners Capital 2017 Annual Client Meeting

Partners Capital Focuses on ‘Investing During Periods of Political Turmoil’ at Second Annual Client Meeting

Partners Capital, the Outsourced Investment Office serving sophisticated institutions and senior investment professionals in North America, Europe and Asia, today shared a summary of its second Annual Client Meeting, which focused on the topics of “Investing in Periods of Political Turmoil” and “Technology’s Impact on Investing”. Among the more than 100 Partners Capital clients that participated in the forum on 11th October were the Metropolitan Opera, Milton Academy, Berkshire School, NYU School of Law Foundation, Eton College, The Victoria and Albert Museum, Guy’s and St. Thomas’ Charitable Foundation, the National Trust, The Royal Academy Trust and INSEAD.

During the meeting, a mixture of Partners Capital’s leading managers, as well as senior investment staff, presented their views: Kamran Moghadam, Managing Director, Macro & Asset Allocation, Peter Zeihan, geo-political expert and author of “The Accidental Superpower”, and Jeffrey Gundlach, Chief Executive of DoubleLine Capital, all gave their thoughts on the topic of ‘investing during periods of political turmoil’.

Stan Miranda, Co-Founder and Chief Executive of Partners Capital, Lee Ainslie, Managing Partner, Maverick Capital, and Jeffrey Ubben, Chief Executive Officer, ValueAct Capital, all discussed their thoughts on the topic of ‘Technology’s impact on investing’.

The New York meeting, held at the Park Hyatt’s iconic ‘Onyx Room’, also included a panel moderated by Suzanne Streeter, Global Head of Private Markets at Partners Capital, on the challenges facing the ‘Endowment Model’ of investing. Panelists included Jason Klein, CIO of the Memorial Sloan Kettering Foundation, Andre Perold, Managing Partner and CIO of High Vista Strategies, and Bob Peck, Managing Director of FPR Partners.

The meeting concluded with Colin Pan, the Chief Investment Officer Partners Capital, summarizing some of the key themes presently defining the firm’s investment research efforts, including ways to access new and uncorrelated strategies in the most cost effective manner.

Kamran Moghadam, Partners Capital Managing Director-Macro and Asset Allocation asserted that US hegemony reached its peak during the two decades following the collapse of the Soviet Union, but that the US may be looking increasingly inwards due to a combination of:

  • Lower reliance on external energy supplies driven by low cost shale production (<$40/bbl) and advances in renewable technology.
  • Greater populist tendencies favoring inward-looking economic nationalism over globalization.
  • Lack of a definitive positive resolution after almost three decades of military engagement in the Middle East.

With the US backing-off as the global policeman, geo-political risk has risen. In 2017 there are c. 20 global sources of political conflict, compared to c. 10 in 2007. Examples of major political risks include a potential war with North Korea, a Russian invasion of Eastern Europe or the Baltics, or trade agreements like NAFTA being rescinded or severely diluted.  The main global economic risk is a disruption of the Asian supply chain and a collapse in trade with Asia. A possible scenario would be a potential North Korea/US conflict forcing China to take sides against the US. About $4.4 trillion or c. 30% of global exports coming from developing Asia could be put at risk.

Stan Miranda, Chief Executive Officer of Partners Capital, spoke on the role of technology in investing. The most important changes that are shaping the industry are: processing power enhanced by cloud computing and low cost memory, an explosion in the type and quantum of data, and advances in machine learning / artificial intelligence.

At the highest level, ‘Alpha’ is derived from one or more of the following three sources: a) speed advantage; b) information advantage; or c) analytical advantage. The technogloical changes will fully destruct speed and information advantages that discretionary managers enjoyed, and their analytical advantage will be severely challenged by progressive systematic investors exploiting more data and processing power. This can be seen in the growth of the smart beta industry, which has already put many ‘discretionary’ managers out of business and represents just the tip of the iceberg.

As ‘alternative data’ is collected from social media, web searches, transaction data, satellite imaging and other sensors, and analyzed using artificial intelligence, all but the longest horizon discretionary investor is under threat in the next decade. The most vulnerable are opportunistic discretionary managers trading with sub one-year horizons as quantitative firms exploit superior predictive data to outmaneuver humans. The least vulnerable in the near-term are long-horizon deep fundamental research based managers where machine learning has not yet progressed to the point of being able to replace human judgment assessing management quality, strategy effectiveness, etc. Many, but by no means the majority, of discretionary managers have woken up to the new paradigm and are investing in ‘data science’ capabilities.

Peter Zeihan, spoke on the modern world order that began with the Bretton Woods conference after the end of WWII. This period of cooperation led to one the greatest periods of growth and stability in history. However, the costs of keeping the alliance together borne by the US began to outweigh the benefits. Rather than the US crafting a new international strategy, the people of the US started to vote for candidates with more domestically-focused agendas from the 1990’s onward. As the US became less engaged as the lead superpower, we saw the rise of Russia and China as rival global superpowers.

Nevertheless, the US continues to enjoy advantages that are likely to enable it to maintain its role as the most developed and secure world power, even if not the hegemon it once was. These advantages include:

  • Lower dependence on global trade through the lens of exports/imports as a percent of GDP.
  • Better demographics than the rest of the developed world, balanced across consumption and investment.
  • Energy independence through the development of shale technologies.
  • Favorable geographic location and climate allows for physical security and sustainability.

However, the withdrawal of the US from the role of policing the world and leading global institutions will exacerbate conflict. Potential hot spots include:

  • The Twilight War: There is the potential for a conflict between Russia and 11 countries within Eastern Europe. Russia may feel like they have to expand to secure defensible borders.
  • The (Next) Gulf War: With the US moving towards energy independence, it will be less involved in the Middle East. Both Iran and Saudi Arabia are working to spawn rebellions in each other’s oil zones as large sympathetic minorities live in both areas.
  • The Tanker War: As an outcome from the Twilight and Next Gulf wars, the global oil supply will be severely interrupted resulting in a shortage for northeast Asia. For Japan, China, Korea and Taiwan the result of the shortage is a wide-ranging naval war for the remaining oil supply.

Similarly stresses are growing in two of the world’s three essential economies that may lead to crisis:

  • China: To date, China’s economy is based on the government force-feeding capital where needed to maximize employment, rather than focusing on profitability or sustainability. This has led to a dramatic rise in lending from 2009 onward. Even if the lending and government spending continue, demographics suggest that the population and workforce are headed towards collapse. Following the ‘One Child Policy’, which has created a shortage of people in younger age brackets, China has the second fastest aging population in the world.
  • European crisis: Overall, the European Union cannot work without an outside arbiter, historically the US. The country that matters the most within the EU is Germany. However, Germany has become more self-sufficient and inward looking and its existence threatens to overwhelm its neighbors, promoting an anti-German coalition.

Jeffrey Gundlach of DoubleLine saw the biggest risk in the upcoming monetary tightening from the world’s largest central banks, which are always influenced by politics. A combination of rising commodity prices and a Fed policy mistake (tightening too much too quickly) could lead to a recession in the second half of 2018. Contrary to the popular view, President Trump has not led to an increase in geopolitical risks for markets. Downside volatility in markets in 2017 has been at, or near, record lows. While President Trump has been largely ineffective as a president, this ineffectiveness has led to gridlock which has a volatility dampening effect. Against this geopolitical backdrop, asset prices are broadly overvalued, with a focus on equities. However, there is no imminent near-term catalyst to force a correction.

Lee Ainslie of Maverick concluded that neither systematization nor traditional fundamental research is likely to dominate as a model for global equities investing. But rather, he expects these two models to co-exist in a ‘hybrid’ model in which humans are used to make subjective judgments that impact long-term fundamentals (e.g. the expertise of a company board), while technology is embraced to systematize aspects of short-term fundamental research (e.g. utilizing cell phone app usage to determine changing trends in consumer behavior). Continued adoption of this ‘hybrid’ model will require professionals with experience in both economics/business (to understand the intuition behind fundamental analysis) and computer science (to systematize the analysis).

Jeff Ubben of Value Act ValueAct asserted that, although technology can enhance an asset manager’s investigative processes by providing support, the utilization of ever increasing number of data sources is not the way to create lasting, repeatable value. In particular, while these data sources can create short-term advantages, those advantages will be arbitraged away in time as new data sources emerge. In addition, data is not necessarily insight. A large portion of the investment community today is overly focused short-term data releases as opposed to understanding the underlying business fundamentals.  The ValueAct activist strategy is based on this deep belief in the creating value at the business level, leveraging board seats to drive value by influencing the CEO to think longer-term (past the quarterly earnings), challenge current assumptions with external information or deep understanding of the business, and take key risks.

Colin Pan, the Partners Capital CIO , closed the meeting with a survey of how the firm has addressed the key challenges facing the investment industry: higher valuations, a competitive fundraising environment, and the greater impact of fees in a lower return environment. Partners Capital has devised four key initiatives to combat these issues and preserve returns for our clients.

  1. ‘War on Fees’. This initiative includes identifying lower-fee investment strategies, accessing lower-fee asset managers, and negotiating fee reductions for our clients. This initiative includes two new low-fee investment strategies to our client portfolios, The Efficient Alpha Portfolio, a lower-fee / lower-alpha alternative to our traditional multi-asset class portfolios, and a second equity co-investment program which invests in the best ideas of our generalist and specialist equity managers on a fee-free basis. These strategies aim to deliver the investment performance of their higher-fee alternatives at a significantly reduced cost. This and the firm’s increasing success in lowering the fees charged by existing and prospective asset managers have resulted in 50-200 bps of additional performance being passed on to our clients.
  2. Stronger strategic relationships with our asset managers. Given our size at over $20 billion in AUM, the sophistication of our team, the prestige of our clients and our ability to add value to our asset managers’ businesses, we should be on most asset managers’ short list of most attractive investors. This has many advantages including access to rare capacity, more transparency and better terms. As a strategic partner we are able to secure favorable terms and future access to the next generation of potential ‘gem’ managers in an increasingly competitive environment.
  3. Alternative Alternatives Initiative. A third initiative seeks to address the increased competition and higher valuations across asset classes. Over the past several years we have dedicated significant team resources to identifying and researching high yielding uncorrelated ‘alternative alternatives’. In 2017, we have invested a significant amount of capital in strategies where returns are driven by a non-correlated event (e.g. life settlements and FDA drug-trial funding) and in less-correlated income producing strategies (e.g. income sharing arrangements and bridge lending).
  4. Co-investments and Direct investments in liquid and illiquid asset classes. This initiative helps to further strengthen our relationship with asset managers and reduce the fees paid by our clients. Over the last 12 months we have made close to $400 million of co-investments and direct investments across a number of strategies.

Colin concluded that these initiatives, along with the constant re-evaluation of our investment processes and approach, give Partners Capital reason to believe that the firm can maintain and even increase clients’ outperformance in the years ahead.