Blain’s Morning Porridge – June 6th 2019

Blain’s Morning Porridge  – June 6th 2019

“Every unresolved problem eventually creates something worse to solve it…” 

In the headlines this morning:

I switched on the TV this morning and watched Naga sitting on the Brek-drek couch in Normandy, then a cut-away to a Piper at the moment British Troops landed on Sword Beach. He was playing Highland Laddie, the same tune I wrote about on Monday, when D-Day piper Bill Millan played it as he and his commandos stormed up the beach. Marvellous stuff. 

Unfortunately, despite the BBC being in France, it did not provide any insights as to why the Fiat Chrysler / Renault merger collapsed last night. President Macron was just along the road, so it’s a shame Naga hadn’t walked over to ask why? We know the French govt and union board members voted against it… but they are only 2 of 9 board members. Personally, I didn’t understand the merger anyway… who drives a French car? Quel Fromage as the French never say….

Elsewhere a credit downgrade while Trump escalates the Mexican standoff! The ECB meets and has to work out how to bail out the Italian banks with more TLTROs while chastising Italy for borrowing too much, and we are wondering what next..

Back in Blighty..

It’s a tad cruel, but a few months ago I was at a meeting at the University Investment Management advisory group, and we were reviewing post-grad research proposals. One of them was a semi-serious proposal to analyse Neil Woodford’s performance a fund manager; the aim would be to rate Woodford buy investments as reliable sell signals. Oh… how we giggled…

Woodford’s tumble from grace may prove to be a systemic moment for the fund management industry. Other funds, set up to mimic Woodford, have also gated themselves. I would not like to be Hargreaves Lansdown or St James when customers start to question fee arrangements and their roles directing them into Woodford funds. The Investment Association is concerned about the reputational damage Woodford’s done to the retail investment sector. (No Sh*t Award on its way…) The FCA wants to know if Woodford broke rules capping investments in unlisted assets… Maybe not, but he clearly arbed them.

It’s worth remembering it was the gating of ABS funds that presaged the last big crisis… just saying…

The crisis at Woodford was one of liquidity – the pace of withdrawals exceeded his ability to liquidate assets. Much the same thing happened to GAM last year when investor withdrawals following the dismissal of a fund manager effectively crushed its’ liquidity and removed GAM as a player.

Both Gam and Woodford effectively made the same mistake: dressing up wholly illiquid assets as liquid ones, and that investments theoretically compliant with Ucits are liquid. Both of them were caught. Woodford had the extra issue that his investments were just plain bad. The liquidity illusion is a particularly dangerous one – listing a stock in Guernsey, or a bond on an obscure Danish exchange does not make it liquid. But it might be enough to get the investor buying it to tick the box saying Ucits compliant.

There are no liquidity guarantees – assets becomes impossible to sell under 2 scenarios: i) a general market shutdown, or ii) a whiff of scandal around the holder’s name.. For the last few months folk have been waiting for Woodford to crash… It became inevitable.

There is serious regulatory danger here – regulators are going to sniff around the Woodford wreckage and conclude current rules on investing in “illiquid” assets need to be tightened. They will congratulate themselves mightily when new rules effectively ban investments in anything except FTSE 100 stocks and bonds that can prove they are actively traded. They will hi-five themselves on a job-well-dome making investment safer.

Of course, they will also be closing financial markets to any but the largest borrowers, thus effectively killing growth across the economy. The over-hasty post crisis regulation in 2009 did much the same thing – new bank capital rules forced banks to stop taking risk in their lending, which crushed property and development lending. Eventually we’ve seen new lenders emerge (and look how successful direct lending by crowd funding has been (US readers: sarcasm alert) – Lendy went into Admin last week.

SME lending is developing in some very interesting directions (including Shards own SME lending fund, Shard Capital Partners), but removing banks from the lending markets was… unhelpful a few years back. Even less safe has been moving risk from banks to the investment management community. While banks were prepared and able to deal with default through all its stages, I doubt the fund management side is.

When do you buy illiquid assets and how should you manage them? The second part of that question is honestly: explain exactly why you are buying illiquid assets, and be honest about your expectations they are buy and hold to maturity conviction purchases. The “why buy illiquid assets” question is far easier – you buy them because of the investment characteristics they exhibit: for instance being de-correlated from financial assets (stocks and shares), because the yield on real assets greatly exceeds the miserable QE distorted returns on liquid assets, etc. The regulators aren’t so keen on that kind of thing….

The bottom line is that investors can’t live (actually, plan their retirements) on “liquid assets” when bonds are retuning nothing and stocks are generally so overpriced. That’s why I’m focused on real decorrelated assets in the Alternatives Space. Sure, it’s tough when most investors dismiss them because they are illiquid, aren’t rated, are complex, etc, etc, but the smart ones.. well they are the smart ones… Unfortunately, the regulations demand otherwise.

Out of time, and back to the day job, which is selling an 8%+ aviation asset today!

Bill Blain

Shard Capital