I am a constant and unapologetic advocate for the private equity asset class for many reasons:
- Alignment of manager and investor
- Prudent use of leverage
- Interest rate and tax environments have been supportive
- Own an asset that makes something or provides an essential service
- Businesses create and preserve jobs
- Investment returns over the last 25 years have been consistently good
There are many other alternative assets classes like hedge funds that address a full spectrum of products from risk arbitrage to distressed debt. Like private equity, those funds perform in line with the skill of their managers and the timeliness of their investment strategy.
However, the amount of money dedicated to the alternative asset class is small when compared to other asset classes, especially the global stock and bond markets.
At the risk of being wrong about every prediction, here are my thoughts for 2016 by asset class.
Domestic Bonds: This asset class has had a long run with an annualized return of 3.867% from January 1, 2001 to the end of 2015. While I do not see interest rates spiking in 2016, I also do not think that longer duration bonds will do well. But the “risk” trade should thrive as the world becomes a riskier place in 2016. I would choose short to midterm duration and high credit quality. 2016 won’t be a year of return on principal- opt for return of principal in the bond market. As a hedge to interest rates rising suddenly, there are a number of variable rate products – usually a portfolio of variable rate bank loans.
Cash: Could beat every other major asset class in 2016 if the banks stop charging you to hold cash (negative interest). It will also be interesting to see if the government guaranteed money market funds outperform the unregulated funds.
Commodities: 2015 was a complete wipe out. Riding that wave in 2016 will likely put some sand in your ear again. The only commodity I like is coal. Absolutely no one else likes it, but it still comprises a substantial percentage of worldwide energy, especially for electricity. I also expect that coal producers will align with power plants to save their industry by using technology to produce clean energy from coal.
Currencies: This is an invitation for the uninitiated to turn a large fortune into a much smaller one. If 2015 is any indication, picking a currency investment is a little bit like playing Keno. You don’t know the rules, the house has great odds, and leverage can wipe you out. In addition you are betting on politicians. If I had to own 3 currencies in 2016 I would pick the USD, the South Korean won and the Indian rupee. All three currencies are bets on capitalism. In the “wipe out” category are the Brazilian real and the Iranian rial. I have a phobia about homonyms, especially in selecting currencies of cultures in decline.
Real Estate: US real estate is the darling of the world. The beach in Naples Florida over Christmas break reminded me of the Bahnhofstrasse in Zurich with a collection of Italian, Spanish, German, French and other European travelers. When you throw in the Mexican population and even a few families from the Middle East, it seemed to me that the rest of the world either owns or is renting real estate in the Naples. While rents are high and unsustainable, this asset class is helped by low interest rate and accommodative tax policies. We will see how Fannie and Freddie’s new mortgage backed security product does. It is intended to lay off default risk on sophisticated institutional purchasers. It was also interesting that it was introduced at the same time “The Big Short” was airing to packed audiences. Somehow I find it hard to believe that the government (proxy for US taxpayers) will get the better side of that trade.
Domestic Stocks: I have written in the past about slowing unit growth in many industrial companies, Where in the World is Unit Growth?. However, the PE multiple for the S&P 500 on December 31, 2015 was 21.54x suggesting confidence in earnings growth. During 2015 we noticed a reemergence of domestic and international strategic acquirers in the M&A markets, presumably because they were trying to acquire growth. A public company can disguise a slowdown in revenues by acquiring. And the investment community does not always punish acquired growth. A high PE multiple can endure long after the real growth has stalled. I see 2016 as a year of big, big, big mega mergers like Dow-DuPont just to mask slow growth in earnings. However, earnings can only be created for so long out of merger synergies and efficiencies. I see a valuation correction occurring just about the same time as the Republicans meet in Cleveland. The opposite side of this prediction is scarcity; investment capital has no other place in the world to go. As a result high valuations, especially for the largest multinationals, may persist.
International Stocks: The world is so messy right now that I do not see capital flowing to Europe, Asia or South America. The stability of those markets is a real concern. I do think that investors will look for international exposure through multinational corporations that operate in multiple currencies and multiple economies. For example, Apple and Google are pretty safe ways from a capital markets standpoint to gain exposure to the world’s consumer.
Off The Grid: The “end of days” trade did poorly in 2015. Gold (-10.3%) and other precious metals got clobbered. Bitcoin was up 35% but the government is getting into the bitcoin business so that asset class should do poorly in 2016. My friends are still growing hops and other “cash “crops but I have trouble seeing how 2016 will be a good year for the doomsday trade unless either a Republican or Democrat is elected President.
Black Swans: traditional approaches to asset class selection do not account for unknowable or random events of major significance like Black Monday or September 11. I personally believe that almost complete reliance on the record keepers and the record keeping system at Depositary Trust Corporation for the US Stock and Bond markets creates a massive black swan possibility of system melt down. Nicholas Taleb, author of “The Black Swan”, points to another pandemic like Ebola as a real possibility in 2016.
Black Squirrels: Inasmuch as I saw my first black squirrel in my backyard in Hunting Valley this year, I now am firmly convinced that black squirrel events can happen too. Those events are completely insignificant and portend nothing other than the predictable grind of daily life. I am pretty sure that black squirrels mean I am going to be buying new bird feeders soon. Now that is a prediction I can make with confidence.
Happy New Year.
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