Question for the Class: What Are the Unloved Asset Classes?

Investing is a little like Lake Wobegon, everyone thinks they're above average. We all know that's impossible in the aggregate, especially after fees.

Read any book by the saints of investing history and the same theme comes through time and time again--you have to be outside the herd to outperform. You have to be uncomfortable. You have to see a pot of gold where others see bees and sharks.

Again like the residents of Lake Wobegon, we like to say we're contrarian. But often, we're not. We follow trends, chase performance, and fall victim to any number of cognitive biases.  We’re just wired that way.

With that in mind--what is the out-of-favor, contrarian trade right now? Shorting FANG doesn't count--if you were a long-term investor, what asset class do you put your money in here to maximize risk-adjusted returns? What asset classes have been left behind by the huge asset inflation experienced in markets across the world during the QE-era?

Here are a few options that I believe we can agree to throw out:

• Domestic stocks, which are trading at valuations never seen this side of the tech bubble,

• Developed market fixed income
• Credit of virtually any variety I can think of
• Real Estate, which is touching all time low cap rates

Going back to the pension funds I brought up last week, as well as a couple of other big real money investors I have poked at since then, the consultant industry is pushing real money towards greater allocations in private equity, which has seen returns above those of public equity markets in recent years. While consultants are by definition incapable of making out-of-consensus recommendations, I think these three charts argue that private equity is far from "contrarian":

#1….2/3s of private equity’s portfolio companies saw margins contract relative to projections...so PE fund general partners didn’t improve the operations of their companies…

#2...Yet private equity has done well...why? Multiple expansion

#3... there is $1.4 trillion (!) in “dry powder” looking for the next private equity trade. This is money committed to PE funds but yet to be deployed...all chasing performance in an industry that saw margins contract in 2/3s of their portfolio companies...meaning they didn’t improve the companies, they just got in at a good price.  

And I’ll spare you another chart---but buyout p/e multiples are at all time highs, and while off of 06-07 highs, debt/ebitda ratios are pretty spicy too.  

What does that leave on the menu? (feel free to add your own here)

• Foreign Equity, presumably emerging markets
• EM fixed income, presumably local, not USD
• Foreign Real Estate (cheap markets raise your hand….not so fast, China, Canada and Australia)
• Smart Beta (?)
• Robots, AI, machine learning (?)
• Real Assets...oil/gas, timber, etc.
• Or...here’s the one that always gets people excited...cash. Or even...gasp...gold.

Cash with a touch of gold to protect your purchasing power against profligate central banks will keep you within spitting distance of inflation and is the original long-vol strategy. You have the ability to buy assets at cheaper prices in the future at a time when virtually any asset class I can think of (please chime in with a cheap one!) is expensive by historical standards.

You’re going to feel uncomfortable. You’re friends are going to call you insane. You need to withstand more than a bit of career risk.

You will be the most boring guy at the next cocktail party. While your friends and colleagues are talking about the next PE unicorn they are chasing, FANG stocks, or dare I say, the pile of money they made in the EMFX carry trade, you’re going to brag about how you squeezed an extra 5bps out of your money market trade by locking in a juicy term reverse repo. Your date might leave with the Argentine guy with amazing hair.

Hmm, cash and gold seem to check a lot of boxes. Tell me what asset class you think holds the title.

Shawn
TeamMacroMan2@gmail.com
@EMInflationista