"Sophisticated" Investors Invest at Peak of the Tech Bubble

 

"Much of that investment (in technology start-ups) poured in last year, as the valuations of private start-ups were hitting a peak. Hedge funds, private equity firms, sovereign wealth funds, corporate VCs, and mutual funds between them supplied two-thirds of all the money that went into venture investing globally last year, according to data provider PitchBook." While most of the literature on behavioral finance has focused on individual decisions, it appears that the most sophisticated investors are also prone to the biases and emotions that distort the decisions of the less-knowledgeable investors. https://www.ft.com/content/6395df7e-1bab-4ea1-a7ea-afaa71354fa0

Crypto Investors have "herd-like mentality"

Low-income, young males are the most likely to invest in cryptocurrencies. They tend to exhibit "herd-like behavior," investing when prices rise and losing money when they decline; typical behavior during financial bubbles. These latecomers are also the least knowledgeable and least able to withstand losses. These investors also follow a "hail Mary" strategy similar to investing in lotteries, making a low probability, high reward bet. Another reason given by crypto investors is the poor outlook for attractive returns on stocks and bonds. #investing #money #cryptocurrencies #ezrazask #investing #financialbubbles #investmentstrategies #digitalassets #digitalmoney  https://www.jpmorganchase.com/institute/research/financial-markets/dynamics-demographics-us-household-crypto-asset-cryptocurrency-use#infographic-text-version-uniqId1677161899801

"Crypto Carpet Bombing"

 "Crypto Carpet Bombing" by SEC and CFTC following the FTX fiasco in an effort to constrain cryptocurrencies https://www.nytimes.com/2023/02/18/business/crypto-crackdown-regulation.html

The valuations of VC-backed tech companies depend more on the supply of VC capital than on changes in the economics of the companies. The downturn in VC capital has caused a large drop in tech company valuations; as much as 80% for some https://www.ft.com/content/6395df7e-1bab-4ea1-a7ea-afaa71354fa0

FTX MARKET MANIPULATION

One of the clearest cases of the need to regulate cryptocurrencies. The manipulation of markets described in the article is reminiscent of the stock market before regulations were put in place to prohibit these practices.

https://www.nytimes.com/2023/02/15/technology/ftx-modulo-capital.html?login=smartlock&auth=login-smartlock

#cryptocurrencies #digitigalassets #FTX #ezrazask #investments #financialfraud #marketmanipution

FTX: Failure of Due Diligence

 https://www.ft.com/content/6e912f25-f1b7-4b19-b370-007fbc867246 

This close-up look at the breakup of FTX shows so many red flags that we have to ask how Sam Bankman-Fried was able to hoodwink the investment world for so long, especially since many of the red flags were also present in the Madoff Ponzi scheme.  It does seem like investors have to re-learn the lessons of previous fiascos every generation.

UK Proposed Digital Pound is in Sight

 The U.K.'s intent to introduce a digital pound in the coming years is notable for its commitment to giving access to banks, credit cards, and payment systems such as PayPal access to the digital payment system, thus allowing them to compete with the digital pound. The U.K.'s move is a defensive attempt to forestall competition by cryptocurrencies and similar techniques. All major countries face the same threats and are examining the introduction of digital currencies. Paradoxically, cryptocurrencies may yet have a significant impact on the world's payment system, not as a substitute for existing payment systems, but as a spur to the development of national digital currencies. 

https://www.ft.com/content/1247a045-6750-45ee-b3a9-f5144d4efb4d

UK AND EU CRYPTOCURRENCY REGULATIONS PUT PRESSURE ON US REGULATORS

 https://on.ft.com/3X7XHvx

The development of comprehensive regulation of cryptocurrencies by the UK and the European Union has two consequences: First, it adds legitimacy to cryptocurrency by misleading many investors to mistake this regulation for increased safety in crypto investments. Second, it places increased pressure on the U.S. to develop crypto regulation since crypto exchanges and investors will migrate to locations with these regulations.

German Regulator Sees Need for Global Crypto Rules - BNN Bloomberg

German Regulator Sees Need for Global Crypto Rules - BNN Bloomberg: Crypto assets need to be subject to global rules if they’re adopted by mainstream finance and expose banks and a wider swathe of investors to risk, Germany’s top regulator said.

The Fed's Political Decision-Making

 Is the Fed too eager to raise rates?

https://lnkd.in/e5Vz4fS5
As Mr. Sandhi points out, the Fed is in an unenviable position in its choice of decisions. If it allows the economy to surge ahead, inflation may become institutionalized, while slamming on the breaks can tip the world's economy into a recession of unknowable depth and duration. This decision has many unknowns, including the relative importance of various factors in maintaining inflation at high levels and the unknown impact of a labor market undergoing structural changes. A central question is whether a wage-price cycle is inevitable if the Fed resists a dramatic rise in interest rates. And yet, despite the uncertainties, the Fed is hell-bent on pursuing an all-or-nothing approach. Mr. Sandhi convincingly argues that public opinion may be a decisive factor. In the public's perception, economic pain is preferable to high inflation. However, it remains to be seen if opinion remains the same if the coming recession turns out to be deep and prolonged and only has a moderate impact on inflation.

Cryptocurrencies Find a Home as an "Asset Class"

 https://on.ft.com/3QA2Zxr

Crypto has gone through a number of transfigurations in the past decade from a medium of exchange, to a disrupter of traditional payment systems, to a hedge against inflation and instability. None of these have outlasted the hype. Its latest incarnation is as an asset class and trading vehicle, initially for wealthy and institutional investors as illustrated by the offerings from Fidelity, Charles Schwab, and, most telling, BlackRock's inclusion of Bitcoins on its vaunted Alladin system. Given crypto's notorious volatility, regulatory uncertainty, susceptibility to fraud, and changing hype, this relatively new embrace of cryptos should be adopted cautiously or avoided until it proves itself as a reliable asset class. #cryptocurrency # #BlackRock, #Fidelity, #CharlesSchwab, #assetclass, #investing, #bitcoin, #Alladin, #alternativeinvestments, #ezrazask, #binance, #assetmanagement, #assetallocation

Correcting a Poor Valuation

 https://on.ft.com/3RHadAr

Correcting Poor Investor Decisions: Another way to view this decline in valuation is as a correction of the overvaluation that led to the overinflated valuation in the first place, a common occurrence with internet-based technology. The fact that we have seen this before in the dot.com bubble does not speak well of the decision-making process of venture capital firms and other investors. #fintech #valuation #internet #investments #decisionmaking #investmentdecisions #financialbubbles

FinTech Haphazard Valuations

 FinTech Haphazard Valuations

​https://on.ft.com/3RHadAr
The immense decline in the valuation of FinTech companies, pegged at around 50%, reflects the overly optimistic assessment of the firms' future profitability, especially in the outlook for future revenues.  This is a chronic problem in the valuation of newer high-tech companies where little or no performance data exists.  The same problem occurred during the dot-com period in the late 1990s.

Investment Strategies for a New Era

 ​https://www.ft.com/content/05d0324f-e216-47ff-973e-c22f660edf22​

The era of the Great Exasperation arrives for investors
This article lays out the changes in the investment climate brought out by recent changes in economics, economic policy, and the difficulty of finding investment strategies that work in the new environment. Many of the trends he identifies are sure to be with us for the medium term.  One result is to undermine the tools that investment managers have used for decades and that generated acceptable risk/reward returns. The end of this era undermines many of these tools as well as the underlying premises. Investment professionals may be better off changing investors' expectations than attempting to use old tools in the new environment.

Is the Fed Causing a Recession?

 

https://www.nytimes.com/2022/07/07/opinion/inflation-recession-the-fed.html?smid=li-share

Krugman argues that inflation fears have been overblown and that there is evidence that inflation is subsiding. His argument is that the Fed is overreacting by signalling that it intends to continue to aggressively raise interest rates raising the prospect of an unnecessary recession. However, this mornings U.S. jobs report shows gain of 372,000 in non-farm payrolls, exceeding economists’ estimates for a 275,000 increase. The unemployment rate remains unchanged at 3.6%. This report may undermine Krugman's analysis and give a green light to the Fed's view that the economy is overheated and inflation may be incorporated into people's expectations, triggering a self-sustaining inflation. The bottom line is a likely hefty rise in interest rates later this week (0.50% and possibly 0.75%). The risk will then shift to to a recessionary outlook. With all the political and economic problems facing the world, a recession in the world's largest economy would be pouring gas on afire. #ezrazask #inflation #economicpolicy #federalreserve #employment #politicaleconomy #recession #stagflation

Will Central Banks Keep Their Resolve to Raise Interest

 ​https://www.ft.com/content/23c3a3a7-b2da-412c-8050-bdad986fde21

​Central Banks and the Fight to Curb Inflation
European and US central banks have jointly stated that fighting inflation is their top priority and they will follow a high-interest rate and tight monetary policy, partly in recognition that they overshot their long-lasting easy money policy. However, it is easy to state a policy but may be difficult to follow, especially if the economies go into a dive. Based on their past record of accomplishment it is possible that the banks will cave and compromise on their strategy

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EZRA -- Ezra Zask Research Advisors - Ezra Zask Research Associates

EZRA -- Ezra Zask Research Advisors - Ezra Zask Research Associates

https://www.ezrazask.com/

Hyped drives High Tech Stocks

 https://www.ft.com/content/75f3ed84-62ae-4cb4-947f-bd7e75591481

It turns out that Hype is the missing factor in factor investing. With all the hype given to factor investing is turns out that "Hype" may be the most important overlooked factor. The factors that have received the most attention include Value, Small Size, Low Volatility, High Yield, Quality , and Momentum. However, as this article makes clear, hype, in the form of inclusion in a hyped up acronym (the current unfavorite being FAANG) may explain more of the difference between stocks than these factors combined. It is also noteworthy that Hype is a "behavioral" factor, having no role to play in "rational" economic actor models, giving a clear leg-up for behavioral finance model of economic decision-making. thumb_up Recommend reply Reply share Share flag Report remove cthwaites1 3 HOURS AGO

Can Alternative Investments save the 60/40 Portfolio?

Can Alternative Investments save the 60/40 Portfolio?

By Ezra Zask

May 2022

In a 2000 movie, the Perfect Storm, George Clooney portrays the captain of a fishing boat caught in a storm at sea. Cooney has often navigated stormy seas as indicated by his greying hair and confident manner. This time, however, a “perfect storm,” the convergence of three weather fronts, produces waves so big that they sink the boat despite Clooney’s best efforts.

We are not yet in a perfect storm, but there are indications that the world may be heading down that road. The indications include the global pandemic that led to massive unemployment and unprecedented supply bottlenecks that reduced economic growth and spurred inflation; a flood of new money and near-zero interest rates engineered by central banks to prevent total economic shutdown, but which also raised the specter of inflation for the first time in years. Central banks’ easy money policies and low-interest rates penalized investors and fed bubbles in stocks and other assets as investors chased after higher yields. Finally, a global return to economic mercantilism has both stifled world trade and investment and is partly responsible for increasing political uncertainty in the world’s largest economies, the U.S. and China.

We have not yet recovered from these waves when the coup de grace hit: Russia invaded Ukraine in a move that overwhelmed an already shaky economic environment and tipped it towards higher inflation. Central banks then reversed a 40-year trend of declining interest rates, threatening to slow economic growth and to pop asset bubbles in stocks, bonds, and real estate. We have yet to see how these trends play out both economically and politically.

Old Dependable: The 60/40 Portfolio

Investors have had the wind at their back for decades if they avoided panic selloffs when markets declined in 1998, 2001, 2008, and 2020.  Globalization increased world production and kept inflation in check. An unprecedented four decade decline in interest rates began in 1981 after Paul Volcker raised interest rates to fight inflation, causing large, sustained gains in both the stock and bond markets. Bonds normally yielded low returns but provided a ballast during volatile times.

Investors and the money managers, supported by theories provided by economists, converged on an investment paradigm that called for diversified portfolios comprised of assets non-correlated assets    with portfolios with responded to this environment an investment portfolio that consisted of a mix of stocks and bonds. Popularly known as a 60/40 portfolio, it consisted of sixty percent stocks and forty percent bonds. The asset mix varied depending on the investor’s age and risk tolerance with a larger allocation to stocks for younger and more risk-tolerant investors, and a larger allocation to bonds as investors aged and became more conservative.

Investments large and small, from 401k to the largest pension funds, adopted a variation of the 60/40 portfolio. The 60/40 performed well providing a compounded annual return of about 9% since 1987 and 10% over the past decade. Also important to its widespread use is the ease of implementing the 60/40, which benefited from the growth of low-cost index funds. The 60/40 was also minimal maintenance: an annual review served to bring the asset mix back to its original composition.

However, money managers and economists warned that a 60/40 portfolio was optimal only if held for extended periods of time. In “shorter” periods (which sometimes lasted for years) declining returns and increasing volatility would result in suboptimal portfolios. The longer one held the 60/40 portfolio, the closer it came to the optimal risk/return level.

Can Alternative Investments Save the 60/40 Portfolio?

Most existing investment portfolios are stuck somewhere along the 60/40 continuum. However, there is a fierce debate among investors and money managers about the suitability of the venerable 60/40 in the present investment environment. The issue is whether the success of the 60/40 portfolio was due to a combination of factors that no longer exist, especially bull markets in stocks and bonds, sustained economic growth, low inflation, and a surge in the money supply.

Most future scenarios now project a period of higher inflation, lower economic growth, and modest returns from stocks and bonds, all of which will lower the returns of traditional portfolios. One proposed remedy is to increase portfolio allocation to “alternative investments,” with analysts recommending up to 20% allocation to alternatives and a similar decrease in the allocation to fixed income. Advocates of this strategy claim that the inclusion of alternatives in portfolios will lead to higher returns and lower volatility than a 60/40 portfolio.

There are potentially fatal problems with this approach, beginning with the absence of a common definition of “alternative investments,” a loosely defined group that may include any combination of infrastructure, private equity, hedge funds, venture capital, managed futures, art, and antiques commodities and derivative contracts. The list sometimes includes cryptocurrencies and related instruments. One company offers a portfolio of “alternative investments comprised of collectibles and culture, Crypto and NFTs, fine artwork, music rights, specialty real estate, wine and whiskey, and high-end sneakers.”

However, this lack of a standard definition allows analysts to manipulate performance data to yield any desired result, which makes comparisons between different alternative portfolios suspect. Furthermore, several of these alternatives are illiquid and too small to absorb the massive flow of money that could come from institutional investors. There is a limit to the amount of money that the vintage sneakers market can absorb. Finally, access to the best-performing alternative firms is severely limited or impossible for new investors.

This is not to say that alternative investments do not have a positive role in investment portfolios. However, investors often use the term as if its meaning is self-evident when it is anything but that.

Of course, it may be wise to consider the possibility that we are entering a period of lower returns and that there is a limit to what we can do without taking on greater risk and/or increased illiquidity. We have had a good run with the 60/40 portfolio but, like other aspects of life, things tend to revert to the mean.

Hard Times Coming

https://www.ft.com/content/fbe01594-8ed4-4cdc-b559-b2b5f7a3e86e?commentID=ddc6bc11-e36e-4d7b-83f6-a196057b7a6a

There is a growing consensus that hard times are coming our way. One "solution" that keeps coming up is to invest in "alternatives." 20% of the asset allocation appears to be a standard recommendation. But isn't that kicking the ball downfield? Most alternatives (notably hedge funds and private equity but increasingly infrastructure, real estate, and SEG investments) underperform stock markets, correlate with each other and equities just when you need them, have a wide dispersion in performance between top and bottom tier firms (and top tier firms are often closed to new investors or have very high minimum investments). Future performance is notoriously difficult to predict based on past performance.

A recurring problem is a distortion faced by many investors and their advisors when evaluating alternative investments a distortion that is nicely explained by behavioral finance. First, there is a barrage of publicity about these firms. We know that investors are more inclined to invest in prominent firms in the news, whether for positive or negative reasons. Too, there is a star quality that the asset classes are given. Finally, there is a tendency to publicize spectacular gains or outsized deals rather than analyze their performance and risk/return ratios. It might be more helpful to admit that markets go through periods of low returns (especially after years of explosive growth) and focus more on avoiding panic reactions to today's headlines or chasing "solutions" that are flawed?

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