Here are a few questions I’m thinking about. Feel free to drop me a line if you’ve thought them through or have an interesting reading or response to share.
What is the next durable customer relationship that the market is missing?
Subscription revenue models command high multiples because they fit neatly into our bond valuation frameworks. If you can successfully argue that your product has a long-term customer relationship, not just a series of one-off transactions, you can raise cheap financing. Some products have won that argument with legibly repeat contracts (eg SaaS), while others appear too lumpy for lenders to feel comfortable (eg asset management incentive fees, bundled biotech R&D pipelines). There is a spectrum of uncertainty here, but some relatively predictable cash flows are still treated as one-off transactions. Is there a commercially feasible way to repackage them? What do you think is the next “durable relationship” category?
What will be the macro lesson from the 2020 covid crash?
One way to think about macro is that we are always fighting the last war. After the late 90s dotcom boom and bust, we underinvested in software for the next 5 years – cue the Paypal diaspora. After the 2008-9 crisis, we underbuilt housing for a decade – The Big Short is still a popular film today, and non-professional investors still reference credit default swaps. Will the lesson of 2020 be that your business can be shut down at any time, so every SMB will keep an extra cash cushion (deflationary)? Or will it be that the right way to fight recessions is to directly send cash from the Treasury to consumers (inflationary)?
How should we standardize revenue and contract reporting?
Revenue recognition is a mess for companies with multi-year contracts (think ASC 605 vs ASC 606) or with multi-party transactions (think take-rate definitions or channel-stuffing distributors). I think the problem is that “revenue” isn’t revenue as we’d naturally assume it — it’s an arbitrarily defined segment of a contract. Every top-tier growth investor I know has a standardized method of accounting for multi-year contracts… except that standardized method often must be updated for specific circumstances. Cynical investors may assume that they are being deceived by companies, but I’ve spoken to many smart finance execs who run into the same problems. How should we standardize the way we measure the contracts that feed into “revenue”? Could we report a fuller set of customer transaction data and thus avoid contract timing confusion?
How can we estimate single-stock price elasticity to $1 of inflows? And how can we measure ETF creation/redemption influence here?
Gabaix and Koijen estimate every $1 of cash inflows increases stock prices by ~$5. How can we bring these elasticity estimates to the single-stock level? And how can we include ETF creation/redemption influence here?
Did low-float index investing exacerbate, or even lead to, the late 90’s tech bubble?
(related to the Inelastic Markets Hypothesis)
These concerns were raised by participants at the time (eg Hugo Dixon’s “On the wrong track” in the FT on Feb 23 1999), and Michael Green of Logica has suggested this thesis more recently. David Blitzer, former chair of S&P’s index committee, argues that the index had always excluded stocks with float <50% (including before the 2005 shift from market cap to float weighting). Even restricting the question to stocks >50% public float, how much did indexing contribute to that bubble?
How will risk parity respond in the face of (1) a breakdown in stock-bond yield correlation and/or (2) 0% or negative interest rates?
Risk parity strategies weigh risk by measuring variance against expected return and then targeting a certain % return based on a certain tolerance for volatility. In practice, risk parity funds try to achieve equity-like returns with less volatility by levering up bond funds — sometimes through borrowing, sometimes through derivatives/swaps. See e.g. Wealthfront’s product white paper for a refresher.
(1) Potential breakdown in stock-bond yield correlation?
Some portfolio managers assume that bonds are a good hedge for equity volatility, but that’s not always the case. Treasuries weren’t a great hedge for the 2018 volatility ETP blowout, and there were issues in March 2020 as well. The Reserve Bank of Australia’s 2014 analysis notes that “stock-bond yield correlation has been positive for an extended period over the past 15 years, in contrast to the negative correlation observed throughout much of the 20th century.” They suggest several factors that could break the assumed correlation, including inflation and QE — could we enter a long period where the assumed benefits of diversification fail?
(2) 0% or negative interest rates?
Relatedly, how do we think about 60/40 or levered bond portfolios as rates collapse? Risk-parity strategies that use equity volatility targeting as an input might see odd positive feedback loops if money shifts from bonds to equities (thus depressing equity vol). Will lower rates push risk-parity strategies into yield-seeking behavior (riskier credits, implicitly shorting vol)? Or are these “risk-parity will collapse” theories overblown?
Will aging US demographics strand CPG product lines and/or necessarily crush CPI?
The golden age of US CPG companies neatly coincides with a boom of people in their 20s. That decade seems to be when we set a lot of our brand preferences – though perhaps this is correlated to when we first have children (think Target’s predictive marketing to pregnant women) and thus could be a bit delayed for the Millennials. BLS expenditure surveys show that we consume less as we get older. Could the aging of the population lead to a significant demand shortfall for US retail products over the 2020s? Or at least a significant mix shift within CPG?
Were Buffett’s 2007 short equity index puts a good or bad decision?
The common story is that Buffett brilliantly structured low-cost float that didn’t require him to post collateral as the daily P&L shifted.
Alice Schroeder states that his “negotiations with the rating agencies meant that, at a time when markets were in turmoil [in 2008-9], during the very crisis that Warren had been waiting for all those years to put the tens of billions of dollars to cash to work, he couldn’t do it. He was able to participate in the market crash only in a tepid way. That opportunity cost has to be offset against the expected profit from those equity index puts. They weren’t worth it.”
Another argument is that the counterparty banks hedged those daily P&L moves by buying Berkshire Hathaway CDS, which may have raised concerns among insurance regulators.
What was the true opportunity cost here?
Update: the answers in this Twitter thread clarified the value in the trade, though not the opportunity cost imposed by insurance regulators.