“The World’s Largest Sovereign Wealth Fund Is Investing With No Valuation Model”

There are several quotable observations in Eric Peters’ latest Weekend Notes, in which the One River Asset Management CIO looks at last week’s melt-up euphoria in markets…

Hope all goes well… Abe wins landslide, Nikkei soars to 21yr high. Xi Jinping is named in China’s constitution, cementing his place alongside Mao, equities jump. House Republicans pass $4trln budget resolution, lifting hopes for a $1.5tlrn tax cut/reform. Despite devastating hurricanes, US Q3 GDP expands 3%, S&P 500 hits record high. VIX 9.80. Biggest Nasdaq 100 daily gain in 2yrs. Bezos becomes world’s richest man, +$10bln on Friday to a $93bln net worth. Such a stunning rise, a synchronized global triumph, unrecognizable from the 2008 cataclysm that produced so many waves.

…. muses on Albert Einstein’s philosophy of happiness, observes the dilemma facing Elon Musk when it comes to auto sales in China, but most notable is his take on modern capital allocation and investing by the $14 trillion pool of 401(k)s and IRAs, which he calls “the world’s largest sovereign wealth fund”, and which finds itself forced to invest in such assets as Tajikistan and Iraqi bonds because the traditional framework preached by the MPT is no longer applicable, and as a result “the largest SWF on earth is investing with no valuation model but for the rear-view mirror.”

Here is the full excerpt:

Fallujah

“It’s a monolith,” he said. “It essentially operates as a single investor, like a sovereign wealth fund,” he continued.

“In fact, the US 401k and IRA savings is collectively the world’s largest SWF.” From the 1978 creation of the 401k, that pool has grown to $14trln. The early adopters were baby boomers, and their holdings dwarf all others; a combination of decades of contributions and capital gains.

“The firms that help Americans invest their retirement savings use the same models. They all utilize the same inputs, and produce the same outputs.”

“Walk into Schwab, or any competitor, and ask for your target asset allocation,” he said. “You’ll discover that the dominant input is your age. It’s a robo-advisor style of investing.”

The older you become the more bonds you should own relative to stocks. “They boast thousands of portfolio simulations, stress tests.” They explain how the methodology is scientifically proven and based on Modern Portfolio Theory.

“But MPT requires that you build a robust framework for estimating future asset class returns and correlations. And they have no such framework.”

“Without a robust framework for estimating future returns, these 401 advisors turn to the past to estimate future returns,” he explained.

“Do you want to know why money is flowing into emerging market bond funds?” And I nodded. “Because the machine tells retirees that they return 13% a year.”

Grandpa tucked a little Tajikistan into his portfolio last month (10yr bonds auctioned at 7.12%).

Grandma loaded up on Fallujah (Iraq auction yielded 6.75%).

“The largest SWF on earth is investing with no valuation model but for the rear-view mirror.”