14. How to be a little less wrong – with James Aitken
Nov 14, 2023
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James Aitken, founder of Aitken Advisors with three decades of experience in the financial system's plumbing, shares key insights on investing, including reflections on the aftermath of the global financial crisis, valuation of Microsoft stock, geopolitical risk in portfolios, and the role of central bank governors in today's financial landscape.
Investors should be cautious of allocating significant capital to illiquid assets, as their true value may not be accurately reflected in portfolios and can create challenges during redemption or rebalancing.
Geopolitical risks are on the rise and investors need to have a geopolitical overlay on their portfolios, considering the potential impact of these risks and allocating capital to regions that have successfully managed geopolitical risks in the past.
The private markets industry, including private equity and private debt, is facing a reckoning as the US economy slows and defaults increase, leading to challenges in reducing private exposures and potential difficulties in managing positions during a future financial crisis.
Deep dives
The shift from liquid to illiquid assets poses risks for investors
Investors have been increasingly allocating capital to illiquid assets, such as private equity and private credit, which are not marked to market. This has created a potential problem, as the true value of these assets may not be accurately reflected in portfolios. Investors have been attracted to illiquid assets due to the assumption that interest rates will remain low or follow historical levels, as well as the accounting advantage of having non-marked-to-market assets that appear to lower overall portfolio volatility. However, when these illiquid assets need to be redeemed or rebalanced, it can create challenges, as demonstrated by recent examples in Australia and the UK. Additionally, the growth of non-bank financial institutions holding these illiquid assets could lead to future financial crises, as these institutions may lack the risk management capabilities present in traditional banks. The risk lies not only with the managers of illiquid assets, but also with the investors who have allocated a significant portion of their capital to these assets.
Geopolitical risks and the need for a geopolitical overlay
Geopolitical risks are becoming increasingly important for investors to consider when managing portfolios. The world is fracturing into blocks, and geopolitical tensions are on the rise. Investors need to have a geopolitical overlay on their portfolios and be aware of the potential impact of these risks on their investments. Home bias may also increase as investors prefer investing in regions they trust and understand. The rise of China and the dominance of Xi Jinping pose significant geopolitical risks, and investors need to be mindful of the implications for their portfolios. Allocating capital to regions that have successfully navigated and managed geopolitical risks in the past, such as emerging markets, may provide valuable insights and strategies for dealing with the changing geopolitical landscape.
The upcoming reckoning in private markets and illiquid exposures
The private markets industry, including private equity and private debt, is facing an inevitable reckoning as the US economy slows and defaults increase. Many asset allocators, such as sovereign wealth funds, have already reduced their exposure to illiquid assets, and the trend of reducing or eliminating public market exposure to illiquid assets is expected to continue. However, the challenge lies in reducing private exposures, which may be more difficult to exit. In addition, the increasing use of NAV lending, where investors borrow against the net asset value of illiquid assets, is a cause for concern. In a future financial crisis, non-bank financial institutions holding these illiquid assets may face difficulties in managing their positions, and investors with significant exposure to illiquid assets may struggle to meet liquidity demands.
Preparing for a higher volatility world and the importance of reading and thinking
As the world transitions into a higher volatility environment, investors need to adjust their long-term asset allocation strategies. This involves being disciplined, bold, and open-minded. It also requires a deep understanding of geopolitics, fiscal policy, and government balance sheets. By reading, thinking, and studying these topics, investors can better position themselves for the changing landscape. They should also be prepared to name their price and take advantage of opportunities when others are desperate for liquidity. While there are challenges and risks associated with investing in a higher volatility world, there can be great rewards for those who are well-prepared and have the right mindset.
The ongoing relevance of central bankers and the need for a broader perspective
Central bankers will continue to play a prominent role in financial markets due to unfinished business with inflation, growth, and a range of other factors. However, there is a need for a broader perspective that goes beyond just monetary policy. Investors should attend conferences and engage in discussions on fiscal policy, tax policy, and defense spending to gain a better understanding of the overall financial landscape. Fiscal policy and government balance sheets will play a critical role in the future, and investors need to be well-informed and adjust their investment strategies accordingly. Additionally, investors should be cautious of groupthink and be willing to think differently and challenge prevailing assumptions.
When it comes to investing, marginal improvements can make a significant difference to investment returns over time. James Aitken, the founder of Aitken Advisors, has spent three decades gaining a deep understanding of the global financial system’s plumbing. He has carefully studied markets and investors to identify the subtle differences that can help us become “a little less wrong” and produce meaningfully better outcomes over time. In conversation with Allan Gray’s chief investment officer, Duncan Artus, James shares the key things investors need to keep in mind as they traverse global markets. Allan Gray website · More insights from Allan Gray · 50 years of creating long-term wealth for our clients
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