Some Christmas Cheer — How Pension Funds Can Have Their Cake and Eat It
By Simon Paige on ALTCOIN MAGAZINE
2019 has been a tough year for pension funds. Low-interest rates and over-priced equity markets have made the prospect of future returns bleak. Tens of millions of pensioners and savers face an uncertain future as firms such as GE announce the end to “final salary” schemes and public pensions are estimated to be underfunded by $4.4 trillion. Yet amidst the stress is there a way for pension funds to still have their cake and eat it? I want to suggest there is by the apparently radical but actually not so radical idea that funds build their own assets in the same way that venture capitalists build great companies.
But first some Christmas cheer by way of fresh perspectives.
Let’s start by recognizing that low-interest rates, overprices equities, and the BIG issue of exposure to systemic risk all stem from the 2008 financial crisis. That is to say, funds are not fighting a number of separate fires. All of today’s challenges have their origin in a single event.
Hopefully realizing there is just one fire to put out, not many already bring relief. The traditional 60/40 model was blown apart in 2008 as governments reduced interest rates and trillions of dollars of new money supply found expression in rising stock markets. These actions were undertaken to prevent financial meltdown through the insolvency of major financial institutions such as AIG and Citibank — a risk that since then has only increased.
The next hearty relief comes from recognizing that 2008 was not an isolated event. The “current experiment in fiat currencies” as Donald Amstad of Aberdeen Standard puts it, has repeated itself in one form or another for the 2,700 years that money has been around. Kings and governments have seldom been able to resist the temptation to debase the value of money by increasing supply. Historically, without a return to stable money (in the past based on gold and silver), the result has inevitably been hyper-inflation and monetary collapse. Nathan Lewis gives a good account of the addiction in the opening chapters of Gold The Final Standard.
This larger perspective brings one utterly simple realization — for funds to have their cake and eat it they need to diversify outside the fiat system. If this sounds scary, imagine what it was like to be a passenger on the Titanic and then ask why so few took to the lifeboats before it was too late. Few people willingly embrace change even when it is in their own interests.
If the fire — expressed as low-interest rates, overvalued stocks and painful exposure to systemic risk — are facets of the current fiat money experiment playing itself out, the ONLY answer is to find alternative sources of value.
After 2008 understanding this needs many funds did exactly that. For example, the Harvard Endowment invested in a range of natural resources such as eucalyptus plantations in Uruguay and farmland in Brazil. The problem was that these assets have not performed well resulting in a $1 billion write-down this year for Harvard. The moral: for funds to have their cake and eat it, they not only need non-fiat diversification but sound returns as well.
That brings us to the idea of a fund building its own assets. The events of 2008 were also the stimulus for the invention of the distributed ledger (blockchain). As proof of concept, digital currency was created. At this time of writing the currency has a market cap of $130 billion and is the best performing asset of the decade.
The success of this proof of concept offers two great insights for fund managers. First, it reminds us of one of the fundamental and almost universally ignored principles of finance — that monetary value is generated by people. Not government or their central banks. Money is a human artifact like language. A return to this most basic understanding of money opens the door for new asset creation.
Second is the distributed ledger itself. Its use means that the value created by people does not need to be administered by a centralized authority. Money, like the Internet, can be decentralized and hence robust (read: outside the fiat system).
We need to add a third ingredient to the mix — that people can maintain an asset at a specified value, a peg. The most obvious example of this is older than money itself — gold. Gold has been the basis of finance and the stability of currencies during the gold standard era because of its own stable value. What created that stability? Peoples’ need and desire for a stable value which could serve as a medium for exchange.
With these three ingredients — people create value, a distributed ledger and people’s ability to maintain a peg — let us create a new asset using the following recipe:
· Take a proven hedge fund strategy, preferably long/short to be agnostic of market conditions, preferably based on non-fiat assets such as commodities to be free of systemic risk.
· Irrevocably time-stamp trade signals before they occur to prevent fraud.
· Simulate trading rather than trade actual assets to remove counter-party and systemic risk.
· Publish trading results.
· Create a digital asset whose sole purpose is to track the value of the simulated returns.
· Go public in declaring one’s stake in the asset as a means of building confidence and encouraging uptake.
· Discount early tokens as a capital efficiency measure so that seed investors put in the least capital for the greatest gain potential.
· Once liquidity is available drawdown on assets according to need.
· Mitigate risk by starting/investing in more than one such asset.
· Multiple assets in the portfolio each with independent value outside the fiat system.
· Better return potential than the existing hedge fund structure because of token discounts and zero fees.
· A return to genuine diversification and sound risk management.
The perceptive reader will notice that while the proposal may sound radical it is actually simply the use of the venture capital value creation model applied to the creation of financial assets instead of companies. Risk is handled the same way, through diversification and capital efficiency. The only real difference is that creating an asset requires greater active participation on the part of the fund than they may be traditionally accustomed to. To follow the VC model funds need to act like a VC by declaring their interest in their creations. In doing so they participate in the most successful value creation model over the last 20 years.
This build-your-own asset model has been developed by me over the last two years called Self-Managed Investments (SMIs), details of their development are summarised in a series of articles on Medium. A long/short Bitcoin strategy is already operational. Others, including long/short crude oil and long/short natural gas strategies are being incubated.
So the Christmas cracker this year contains this: combine the know-how of the best performing asset of the decade with the business model of the best performing asset class over the last two decades and build assets with orders of magnitude less risk than their fiat based counterparts and whose return profile is to say the least encouraging.
If nothing else, I hope this article has imbued some festive spirit by showing how important a fresh perspective is. All the resources for creating SMIs are already available to fund managers. They have evolved from exactly the same 2008 event that is currently putting all the stress on portfolios. As you relax with a mince pie this holiday take the opportunity to reflect what kind of future you wish for in 2020 and beyond. Merry Christmas!