Life, Liquidity and the Pursuit of Alpha

Students of the Chicago School of Economics are familiar with Dr. Milton Friedman’s rule.

“Inflation is always and everywhere a Monetary Phenomenon”

Since the Global Financial Crisis of 2008, fiscal conservatives have been decrying loose monetary policy, low rates and deficit spending as a prelude to another Weimar Republic, yet inflation has yet to rear its head. Why?

Easy… Automation, Efficiency gains, Global Trade, etc…

So if dear uncle Milton is to be believed, where has the money gone? Again, Easy…

Asset Inflation.

Even an inexperienced investor can find speculative bubbles in the financial markets: BitCoin, Electric Vehicle companies, Stay-at-Home Tech Stocks, Gamestop….

But we need not declare “Bubble!” to add to the list of potentially overvalued assets: IPO’s, Internet Retail, HealthCare stocks, Equity Indices in general.

Anything that generates growth and doesn’t manufacture buggy whips has seen its valuation grow dramatically (Note that Banks, Industrials and Oil Companies have NOT participated).

Moving out the Risk Curve

In Fixed Income, when you can’t generate income with short-term treasuries you move to longer terms (duration) or into riskier assets: Corporates, Junk, Leverage, etc. Furthest out the curve are equities—they are infinite-”ish” in duration and bear the first loss in a bankruptcy.

Equities also have a curve. In past cycles that order was “Blue-Chip”, Value, Growth, Small-Cap, IPO’s, and finally Alternatives or Private markets. The fear of future inflation, ESG investing and the Robin-Hoodies have disrupted that a bit (Note my list of bubbles above).

You can clearly see the effect via the explosion of the SPAC (Special Purpose Acquisition Vehicle). We used to call these “Blank-Check” companies with derision and many failed after the 2000 bubble. There isn’t anything inherently wrong with them, but the proliferation says something about the state of the markets.

In his book “Extraordinary Popular Delusions and the Madness of Crowds” Charles MacKay describes some historical examples. The South Sea Financial bubble in London 300 years ago witnessed the rise of Blank-Check companies. One of the most amusing being: “a company for carrying on an undertaking of great advantage, but nobody to know what it is.”

But in this market, the SPACs DO serve an important purpose. The implied fee structure for investors is high, but they provide immediate access to private companies when finding growth at a reasonable price in public markets is difficult. In reaction, Venture Capital firms rush further “Out the Risk Curve” to ever earlier stage companies—all of them hunting Unicorns. Unfortunately, that means even private markets are becoming overvalued.

“Go West Young Man, Go West”

There is a place, a land of opportunity with clean water and fresh air where investors can still find Growth at a Reasonable Price: Seed stage investing

At the far end of the curve, Entrepreneurs still have difficulty raising money until their business model is proven. In this market capital is at a premium and investment returns can be impressive.

But early stage private equity is a difficult terrain to navigate. Fraud, Failure and poor execution by untested management means, like early explorers you need a guide or experience to survive. Guides are expensive, unless you can find a modern day Pocahontas willing to head off into the unknown for the sheer thrill of adventure, most quality managers expect compensation and only want to focus on large scale funds.

Enter the Conestoga wagon train of seed-round investing: Expert Networks.

The voyage is dangerous, not every investment survives, but the rewards can be great. Choose your fellow travelers wisely, look for those with knowledge and prepare accordingly for your destination. But as the rest of the world huddles in the squalor of overcrowded investments I choose to strike out into the wild and lucrative unknown.