Weekly Thoughts: Asset Classes and Recovery
Here are two things that caught our eye this week:
We recently came across an article from Chief Investment Officer magazine titled Sports Betting as an Asset Class in which the authors reported on preliminary research showing the attractive return profile of systematic sports betting, as demonstrated by a horse racing strategy outlined in the chart below:
Research showed that this strategy outperformed both the S&P 500 and the Credit Suisse Hedge Fund Index (a common proxy for hedge fund managers) for the past six years, while also providing portfolios with a diversification benefit since horse race outcomes are not correlated to financial market activity. The article, while interesting, cedes there is much more work to be done to gain comfort with this strategy as an asset class – which, in financial parlance, means that this is not yet a viable investment option for the types of people who read Chief Investment Officer magazine. While we have little interest in systematic sports betting strategies, the article led us to think about the process of categorizing seemingly arbitrary investment strategies into respectable asset classes, and the importance of this process within the investment management industry.
From a technical standpoint, an asset class (as defined by Investopedia) is a “group of securities that exhibits similar characteristics, behaves similarly in the marketplace and is subject to the same laws and regulations.” From a big picture perspective, the three main asset classes are equities, fixed income, and cash. Unsurprisingly, these types of investments are considered “traditional,” and comprise the majority of assets under management (both personal and institutional). However, outside of these traditional asset classes, there are many alternative investment options – most of which are far less liquid – ranging from hedge funds, commodities, real estate, and private equity to more exotic investments such as jewelry, wine, and collectible art.
Regardless of type, being categorized as an asset class is a key step in gaining credibility with capital providers. However, being viewed as an asset class, as noted above, requires that there be multiple securities all with similar characteristics. By this definition, any first mover – regardless of return potential – will inevitably be shut out of most capital sources until there is a critical mass of people executing similar strategies.
We observe this dynamic in the search fund industry, which despite its growing popularity remains a highly esoteric investment strategy. Twenty years ago, individuals seeking to acquire and operate small businesses were simply a small cohort of entrepreneurs backed by one-off investors. Over time, however, early adopters pursuing this fringe path generated returns of sufficient magnitude to draw others to the space, creating what today is a critical mass of participants that has the attention of institutional capital allocators. With more than 100 active searchers and burgeoning industry infrastructure, this approach is on the cusp of being broadly referred to as its own asset class, a terminology which could lead to significant growth in the years to come.
For us, this is important because as committed small business investors, we expect the continued development of the space will increase our opportunity set. In the meantime, however, we would observe that – like sports betting – just because an official asset class categorization isn’t there doesn’t mean the returns don’t exist.
As athletes, we are familiar with the notion that appropriate rest and recovery is a key factor in achieving our performance goals, and we structure our training accordingly. That said, we are not particularly good at striking that same balance in our professional lives. Our reading this week reminded us that our brains – just like our bodies – require rest. For instance, Harvard Business Review, summarizing the work of Jim Loehr and Tony Schwartz, authors of The Power of Full Engagement: Managing Energy, Not Time, Is the Key to High Performance and Personal Renewal, noted:
“[I]f you have too much time in the performance zone, you need more time in the recovery zone, otherwise you risk burnout. Mustering your resources to ‘try hard’ requires burning energy in order to overcome your currently low arousal level. This is called upregulation. It also exacerbates exhaustion. Thus the more imbalanced we become due to overworking, the more value there is in activities that allow us to return to a state of balance. The value of a recovery period rises in proportion to the amount of work required of us.”
HBR expands on this concept, highlighting that when we don’t allow for adequate rest, our attempts to work harder require ever more energy, much of which is wasted or used inefficiently. Conversely, we can achieve resilience – the ability to productively work hard over the long term – by focusing not necessarily on how much we can endure, but rather on how well we recharge. “The key to resilience,” HBR notes “is trying really hard, then stopping, recovering, and then trying again.”
Just as in athletics, recovery can take different forms depending on the individual. Structurally, recovery can be achieved in two ways: internal recovery (i.e., short breaks within the regular workday) and external recovery (i.e., longer breaks during weekends and vacations). From a content standpoint, each person will find different activities provide different effects (i.e., some people recover by taking a walk while others recover by spending time with friends).
This research resonates with our team as we often discuss the emotional necessity of having mental downtime to allow us to recharge for the day ahead. In fact, we’ve noticed that these more frequent, daily breaks are much more important to our long-term well-being than the benefits we receive from more traditional multi-day vacations. While this insight does not make for a particularly vibrant social life, it is what we need to stay mentally engaged and productive.
Have a great week,
Your Chenmark Capital Team