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11 Aug 21 Insight

More money, more problems

By Sam Morris, CFA Senior Investment Specialist, Fidante Partners.

When the rapper Notorious B.I.G wrote his seminal hit, Mo Money, Mo Problems, I bet he never thought he’d be referenced in an investment article about asset allocation.

But the chorus of his lyrics “don’t know what they want from me. It’s like the more money we come across, the more problems we see” just about sums up the core problem facing investors looking to put their money to work today. Let me explain.

The price of money, being interest rates, quite simply is at near­ record lows because the supply of capital is enormous relative to the demand for it.

Five years before the GFC and the onset of quantitative easing in 2004, economist William J. Bernstein wrote: “Make no mistake about it: over the past several thousand years, the cost of capital, and with it. investment returns, have been falling.” He goes on to explain that this has been caused by two key factors.

Firstly, investment frictions have been “ruthlessly decreased” -money can be moved around the world in a few mouse clicks.

But the bigger driver is that there is simply too much money in the world. Bernstein said: ‘As societies grow their per capita GDPs beyond the subsistence level, the supply/demand equation shifts in favour of capital’s consumers.”

The Amsterdam Stock Exchange, founded in 1602 to facilitate trading the shares of the Dutch East India Company, frequently delivered investors dividend yields of 40% or more-a sensible risk premium when the assets of the company could be sunk or stolen by pirates and capital to finance risky endeavours was scarce.

Contrast this to today, where interest rates are still negative in some parts of the world and investors pile into ·meme· stocks and obscure cryptocurrencies and one might conclude we are in uncharted waters, much like those early Dutch sailors.

Today, enormous levels of government stimulus spending continue while central banks continue to print money and buy bonds through quantitative easing programs in the hope that higher bond and stock prices will help create more jobs in the real world. Over 40% of all US dollars in existence were printed by the US Federal Reserve in the past 12 months and US government spending is higher than at any point since WWII.

Could this combination of high fiscal and monetary stimulus occurring at the same time create the potential for a high medium to long term inflation? Who knows, but markets viciously vacillate on the smallest turns of phrase from central bankers about the pace at which this stimulus might be withdrawn or maintained.

Despite this, central banks all over the world, including the US Federal Reserve and our own Reserve Bank of Australia, still have aspirational goals of 2-3% inflation. If you are in your 30s to 40s, that means that central banks want every dollar you save today to lose around half its value by the time you need it for retirement. Remember, central banks can literally print money with the click of a button and governments can tax or regulate alternate means of exchange that threaten this monopoly with the stroke of a pen. So, ignore their objectives at your peril.

But back to the “mouse clicks” problem for a moment.

When Jack Bogle, founder of Vanguard, was offered the opportunity to list the first US exchange traded fund (ETF) with his then revolutionary passive index fund approach, he turned this down, believing that ETFs would encourage excessive trading at the expense of sound long-term investing principles.

Yet ETFs have exploded in popularity with investors by leveraging the clearing and settlement infrastructure of stock exchanges to allow fast and hassle-free investing into diversified, long-term, high quality investment strategies in just a few seconds.

Stock exchanges not only facilitate trading, but they democratise data, which is facilitating the development of a rich ecosystem of fintechs to empower investors with more transparency and control than ever before at lower costs.

Never has active investment management been more important in the search for attractive returns relative to the paltry cash rates with strong downside protection.

Why not take advantage of the asset price distortions that the “mouse clicks” create? For example, government bond markets offer repeatable opportunities to undertake sophisticated relative value strategies that can deliver attractive returns that are independent of the level or direction of global interest rates. Or perhaps invest in a non-benchmark constrained manner in sourcing the most compelling global fixed income investment opportunities across both government and corporate bond markets using sophisticated macro-economic analysis and bottom-up security selection.

Such strategies aim to generate consistent, defensive returns above cash rates and diversify equity risk in portfolios, essential in a world where global interest rates are close to their lowest levels in centuries and equity markets are at record highs.

A “set and forget” approach on asset allocation is not enough in this environment. The judgment and risk control of active management and the ease and flexibility of exchange trading co-exist in Australia with active ETFs.

For the investor looking to navigate a world of low yields, and seeking a better, more convenient investing experience, they are well worth a close look.

One solution to a world awash with too much money and many problems may indeed be active ETFs.