Irregular Roundup, 17th June 2024

Irregular Roundup 240617

We begin today’s Irregular Roundup with rate cuts.

No rate cuts

John Authers

John Authers reported on the latest US inflation numbers (the April PCE deflator).

  • The trimmed mean moved below 3%, but the rate at which inflation is falling is slowing as we get closer to the 2% target.

Core disinflation (7 Circles)

Figures that were exactly what had been predicted gave investors no good reason to adjust forecasts for rate cuts. The odds of a cut before the election are still at only about 60%.

Long-term (5- to 10-year) expectations remain at 3%, and they tend to run a little hot.

Slowing Housing (7 Circles)

There was some good news in that the housing market seems to be slowing down.

  • Consumer spending is also starting to tail off, so the risks of overheating are coming down,

John also looked at why most Americans think that inflation is higher than the official data shows it is.

  • He thinks a lot of it is down to rising inequality.

The less money you have,the greater the problem caused by price rises. And inflation has been worst in areas that takea big bite out of low-income people’s budget.

Anti Core Inflation (7 Circles)

“Anti-core inflation” tracks the combined rise of food and energy prices, the two elements excluded from the core number of most interest to politicians.

These essentials have just endured their biggest price shock in more than four decades. The figure peaked in 2022 at a rate infinitesimally below its record after the 1973 Yom Kippur war led to an oil embargo.

Politicians like the core figure because they have more control over it.

  • Ordinary people feel the anti-core numbers, and not many people remember the 1970s oil shocks.

Rising prices (7 Circles)

Ordinary people also track prices rather than inflation rates, and without deflation, prices don’t come back down.

Inflation shocks (7 Circles)

We’re a long way from deflation – prices for meals and personal care are still rising at more than 3% pa.

Prices and wages (7 Circles)

Even worse, low-skill wages have kept up with rising prices until the last few years.

  • These bad times are now over, and real incomes should improve.

Whether people can forget about a period of sharply rising prices after decades of relative stability is another question.

Public vs private

Joachim Klement

Joachim Klement contrasted the ways in which public and private equity firms manipulate their accounts.

Public companies manage their earnings to meet analyst expectations, and in particular, they try to avoid small losses.

Earnings vs expectations (7 Circles)

Earnings that slightly miss expectations are far less frequent than should be expected by chance. This earnings management is done using discretion in when to account for expenses and revenues within the existing accounting rules. 

This is not a big deal:

Because it typically amounts to shifting costs from one quarter to the next by a few weeks, these distortions reverse quickly. In the long run, earnings are relatively undistorted.

PE managers manipulate MOIC (the multiple of invested capital, or return on the deal).

Private equity MOIC (7 Circles)

There are far fewer deals that lose a little bit of money (MOIC slightly below 1.0) than deals that make a small profit (MOIC slightly above 1.0).

Unrealised PE MOIC (7 Circles)

There is no such manipulation for unrealised deals (those that have not yet exited).

  • This could just be loss aversion (managers trying to hold on to losing deals until they break even), but MOIC digit distribution says otherwise.

MOIC digit distribution (7 Circles)

Benford’s Law states that numbers starting with the digit ‘1’ are more frequent than numbers starting with the digit ‘2’, which are in turn more frequent than numbers starting with the digit ‘3’, etc.

This distribution of digits in numbers is often the first step when analysing data for tampering. When people try to fudge the numbers, they often don’t pay attention to the statistical distribution of these numbers.

There’s clearly a problem with the MOIC data.

When a fund is raising money or wants to raise money soon, this deviation is huge. Once a fund is closed for investment it disappears completely.

This is a bigger problem than earnings smoothing:

Unlike earnings management, these shifts in MOIC do not even out over time. MOICs remain part of the history of the fund forever and never revert.

Joachim quotes the conclusions from the study he referenced:

Loss-avoiding GPs raise significantly larger subsequent funds relative to their vintage peers. While loss avoidance may benefit GPs, it is negatively associated with the final fund returns that investors receive.

Potential investors should discount the proportion of loss-making deals and focus on overall returns, but they probably won’t.

See also:  Coronavirus Thoughts
Investment Trust Costs

Henry Cobbe

For Citywire, Heny Cobbe and Ros Altmann debated the merits of changing the cost disclosure regime for investment trusts.

In 2023, a fund of funds provider highlighted how the inclusion of higher ongoing charges of investment trusts in funds of funds raises the overall charges in look-through feereporting, making them less attractive.

Funds of funds generally look unattractive because of the two levels of charging, but I can’t see why hiding IT costs would help.

The argument seems to be that when you buy an IT, you pay the share price rather than any ongoing fee, but:

An investment trust’s share price is closely linked to the NAV. For the same gross NAV performance, an investment trust with a higher expense ratio as a percentage of NAV will necessarily perform worse, other things being equal.

Henry makes the point that when FoFs buy OIECs or ETFS, they also pay “just the share price”.

Ros Altmann

Ros Altmann – who has introduced a private member’s bill to change the rules –  thinks that“ongoing charges” are not applicable to investment companies.

Those I have worked with on this issue, are fully in favour of disclosing costs, but we all object to the ‘duplication’ of these costs, as happens now when investors are told they will be deducted directly from their shares’ value, instead of recognising that the share value already encapsulates those costs.

Strangely, Ros doesn’t see IT costs as charges to the investor:

All expenses are disclosed in the reports and accounts. To label these company management expenses as OCFs, as if they were ongoing deductionsfrom the value of an investor’s shares is absolutely wrong.

There is no ongoing cost to bededucted from the market value of shares of a listed investment trust as the market adjusts forknown expenses.

It’s an accounting argument, essentially, and on those terms she might have a point.

As a private investor, I see things differently:

  • The IT invests in assets that I want exposure to, and any costs that would not apply if I bought those assets myself count as fund charges to me.

Since there will usually be more than one IT investing in the same or similar assets, it’s quite useful to compare the ongoing costs of access.

I’m a fan of the IT structure, and before ETFs became widespread, they were very useful for accessing exotic asset classes.

  • But now I mostly use ETFs because they are cheaper, and hiding IT costs would – as Henry says – be a step backwards.

It would be a shame if ITs couldn’t find a way to compete with other funds, but the name of the game is cheap access to assets for private investors.

  • They can always convert to ETFs (as the cost of lower management fees).
US ETFs

There’s been more talk of the FCA granting equivalence to US ETFs under the Overseas Funds Regime.

  • At the moment the need for a KID (which most US funds can’t be bothered to produce) rules them out for private investors.
See also:  Weekly Roundup, 28th April 2015

No doubt the election and a new government will get in the way, but if we did get access to US ETFs, it would be great news.

  • The range and sophistication available over there is far superior to the UK offers.
Crypto

Revolut has launched a standalone crypto trading platform for UK retail investors, called Revolut X.

  • Revolut has allowed crypto holdings in a limited number of tokens since 2017.

X will offer 100 tokens with low fees (0% maker, 0.09% taker) but was launched with just the same handful as the regular Revolut app.

  • There are apparently no fees for converting to or from fiat currencies (pounds or more likely dollars to me and you).

For Revolut, Leonid Bashlykov said:

We are excited by the introduction of our new crypto product, and believe this top-tier trading platform will change the game for experienced crypto traders, providing them witha safe and accessible place to trade.

We understand that competitive fees as well as easy on and off ramping are at the heart of what experienced traders want from a crypto platform.

Matt Levine

Matt Levine reported on the surprising news that disgraced and bankrupt crypto exchange FTX is, in fact, solvent.

FTX went bust during the crypto crash of November 2022, when the value of its assets fall below the money its customers wanted to withdraw.

  • During the bankruptcy process (the new management team needed permission from the courts to sell the coins) the value of the crypto recovered (whilst the value of the liabilities was frozen at the crypto low).

The rally in crypto (and particularly in Solana, a token backed by FTX founder – and now convicted fraudster – SBF) along with the sale of various venture capital projects including AI startups, means that even low-ranking creditors should recover between 118% and 142% of their debts.

These numbers higher than 100% include interest at 9% pa (so the figure depends on how long creditors have to wait).

  • Strictly this interest should go to shareholders, but that would include SBF and look bad.

New FTX CEO John Ray said:

In any bankruptcy, this is just an unbelievable result.

Quick Links

I have seven for you this week:

  1. Finomial looked at Diversifying via Time Zones
  2. UK Dividend Stocks asked Are Diageo shares a buy after their 35% price decline?
  3. Discipline Funds said It’s Time to Cut Rates
  4. And asked How Worrisome is High Stock Market Concentration?
  5. The Irrelevant Investor said I’m Not Saying Things Aren’t Crazy
  6. David Stevenson asked If not wealth managers, who will buy ‘exotic’ trusts?
  7. And ThinkAdisor wondered Is Diversification Dead to Investors?

Until next time.

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 40 years, with some success.

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Irregular Roundup, 17th June 2024

by Mike Rawson time to read: 6 min