This time it really is different - or is it?
All my investing career I’ve been told that the four most dangerous words in the English language are ‘This time it’s different’. So it was intriguing to hear a debate between two thoughtful portfolio managers at the excellent Room 151 LGPS Asset Allocation Conference last week.
The first used the example of her children to argue that mean reversion is old hat. She gave her children Lego to play with when young, as she had when she was a child. However, at the age of five or so they stopped opening the Lego box and preferred to play Minecraft. Her point was that Minecraft requires nothing physical except a device.
If her children are typical of their generation, at a stroke Minecraft has disrupted whole swathes of industry and services. There is no need for a chemicals factory, the Lego factory, the Lego packaging, the Yodel or Hermes to deliver it, even infrastructure such as roads. I haven’t even mentioned the retail shop, as that has already gone the way of all flesh.
In investment terms, if you believe that the disruptors, in this case Minecraft, are going to just get larger, there is no mean reversion. And yet mean reversion is what lies behind whole swathes of investment theory. If it really is passé, then everything we have learnt from Benjamin Graham onwards is worthless. The only thing worth doing is investing in disruptors and clinging on.
The other speaker argued that the vocabulary we have been using to describe our objectives when investing is no longer relevant. We currently describe portfolios in terms of value, growth, momentum etc. He argued that in 20 years’ time the only metric which will count other than a financial return will be how the money has been used for the good of society. The old style factors will simply become irrelevant.
He was describing an extension of what we now call Responsible Investment but it resonated with me. It seems inevitable for political and social reasons that the current form of market capitalism is going to morph into something more focused on the world’s non-financial needs. That does not have to mean the disappearance of the financial metrics and disciplines we are accustomed to, but they may have to move over.
And perhaps here is the flaw in the first speaker’s argument. In her world, those who are flexible enough to adapt to rapid change will do very well. But almost by definition the great majority won’t be able to and I’d suggest that the social pressures which her model will bring will eventually result in a degree of mean reversion.
That doesn’t mean the disruptors as an asset class won’t flourish. But they will be brought back to earth by the simple fact that their performance will be viewed by all – investors, governments, society as a whole – through a prism which is not purely financial. Do they pay their taxes? Does their activity have undesirable second-order consequences, such as traffic jams, empty high streets or unemployment?
Is it different this time? I do believe that disruption is here to stay. I do believe that the capitalist model of the last 40 years is changing to something more attuned to society as a whole. For investors that will lead to a form of mean reversion. Microsoft (yes, they are the owners of Minecraft) will have to give up a greater part of their profits to society and will therefore generate a lower free cash stream. Investors will react by placing a lower valuation on them and Lego (or perhaps the Lego box package producer) will appear relatively more attractive.
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