What are we watching and thinking about? Woodstock uses pooled investment vehicles for client cash, so we’re watching money market funds. We’re interested to see that of all the categories of investments in the endowment model, private equity seems to be taking an outsized share. And we like to tell Woodstock’s story.
New Rules for Money Market Funds
Investors expect to take risks when investing in equities. They have a different view of risk when their cash allocation is the subject. The US Securities and Exchange Commission (SEC) recently rewrote the rules governing money funds for the third time in 15 years, in hopes of preventing bailouts of money market funds in times of turmoil. The current surge of dollars into money market funds from investors and companies is because money market funds are offering returns of 4% to 5%, while insured bank savings accounts are offering about 0.5 percent. The gap is too big and cash has moved dramatically since several banks failed.
The main focus of the new SEC rules, set to take effect near the end of 2024, is liquidity guidelines. The daily liquidity guideline is moving from 10% to 25% of total assets and the weekly guideline is moving from 30% to 50 percent. This would seem beneficial and follows the financial saying that more money has been lost chasing yields than in bank robberies. However, there is a second focus that involves fees. In a 2014 change, the SEC “allowed funds to charge investors a fee, or suspend redemptions altogether, when a fund’s liquid assets slipped below certain levels.”[1] The SEC agrees that the fees or suspensions “appear to have contributed to the 2020 run” because investors didn’t want to be stuck and unable to withdraw cash, so they panicked.
The proposed rules implement fees when daily net redemptions exceed 5% of net assets. The SEC should probably put down the stick, imposing fees, and stay with fine-tuning the carrot, improving liquidity. In a panic, no one wants to stay for an extra hour, let alone a week, and sticks seem to make matters worse.
Private Equity Concerns
As most of our QMP readers know, we are very familiar with private equity. Within the four walls of our offices, we run operating companies in the energy industry and in financial services. We have formed new companies with substantial assets in both industries. We choose to focus the vast majority of our investable assets on high- quality US stocks. That decision has served us and our clients well.
Regular readers of QMP will also be familiar with our major objection to current private equity investing which is, since 2018,[2] a case of too much money chasing too few good deals. As predicted in 2018, the sponsors’ focus has been on the management fees, “which are predictable, steady and valued by public shareholders,” and on “tying up investor funds for longer by running listed vehicles that never have to return capital.”[3]
So, what is happening five years in? In general, the news is about endowments and pension funds freezing or decreasing their allocations to private equity. “Private equity managers are using all the tools at their disposal to avoid marking down the value of their assets.”[4] As valuing portfolio companies may be more art than science, what happens when an investor, a limited partner (LP) wants to leave? “Selling LPs have to take a steep discount to the reported value of a stake to get a deal done, indicative of the mismatch between how assets are being valued and what buyers are willing to pay for them.”[5]
The danger for investors is the same danger a recent letter to the editor of the Wall Street Journal described for insurance companies investing in private equity. “The danger for insurers is that they can’t simply pull out of these private market positions with a snap of their fingers; these funds are normally gated for a set period of time.”[6]
The Woodstock Difference
As most of our clients know, Woodstock’s managers have had an impressive 10-year and 5-year run with performance through December 31, 2022. The results for our GIPS-verified growth composite are available upon request for our clients, prospects and colleagues, along with the other five composites, as required. However, the growth composite encompasses over 80% of assets under management at Woodstock and has for 10 years. Investment managers at Woodstock have independence in making investment decisions for their clients’ accounts.
Internally, we try to explain this success. A former president of Woodstock stresses the in-house operations here. Weekly research committee meetings and monthly investment policy meetings test ideas and are contentious. They bring out the positive and, hopefully beneficial, negative aspects of collaboration. Also, the managers pick from the same menu of stocks, our Monitor List. In the end, when decisions are made, the individual managers come out with a thoughtful way forward.
There are some industry trends that are also probably helping. The increasing size of passive index funds allows more room to buy good companies at good prices. Other investors using the endowment model are not concentrating on high-quality US stocks, which leaves us with a large, open field. World instability most likely helps the US market.
What’s happened with our performance in the last 10 years is not our goal. Our goal is to have our performance be close to our benchmark with the opportunity to outperform. We bring two other very important characteristics which we believe are as important as performance against a benchmark. The first is the ability to use tax-loss selling to increase the absolute value of an account. The second is separately managed accounts versus being in a pooled investment vehicle, meaning the client directly owns their assets, rather than merely being a creditor of the real owner.
We know that you are the most valuable business development tool that we have. Your referral of a friend, colleague or family member to us is the most important way that we grow. We thank you for your support and want you to know that we are dedicated to serving your best interest.
William H. Darling, Chairman & CEO
Adrian G. Davies, President