We would like to address what we view as the increasing risk of investing in the traditional markets. Risk can be defined in a number of ways. We define it as the permanent loss of capital—losses so significant to a portfolio that they are unlikely to be reversed in the foreseeable future. The stock market losses in 1929 were not recouped until 1954, a generation later. To a middle-aged investor, 25 years can be an eternity!
As we wrote last quarter, we believe alternative investments are a necessary component of every balanced portfolio. That’s because alternative investments (like the Branzan funds), have little correlation to the publicly-traded stock and bond markets and are less likely to be affected by a catastrophic event in those markets.
Public markets in U.S. equities and bonds are at all-time highs and are overpriced by nearly every credible measure. We are concerned that the recovery in stock and bond prices since March 2009 has been almost exclusively the result of artificially low interest rates and money printed by the central banks, and not fundamental improvement in the world’s economies. When those low interest rates, dollars, Euros, pounds and yen come home to roost, as they must someday, the prices of stocks and bonds will likely be affected. There is ample evidence to support our prediction, including:
• The Tobin Q-index, the ratio of stock prices to book values back to 1900, is at a high exceeded only immediately before the tech stock crash in 2000.
• The Case-Shiller index of inflation-adjusted price/earnings (P/E) ratios for the S&P 500 is at a current level exceeded only in 1929 and 2000 (chart is current as of September 2017).
• Highly regarded mutual fund manager Adrian Day calculates that if the Dow Jones industrial average returned to its average historic metrics, the market would decline by as much as 52%. If, heaven forbid, the P/E, P/B and dividend yield returned to bear market metrics, the market would decline as much as 69%.
• The so-called FANG stocks (Facebook, Amazon, Netflix and Alphabet, formerly Google ) are trading at a combined P/E ratio of 125, meaning that an investor (or speculator) can expect to recoup his or her investment with 125 years of earnings. The S&P 500, excluding the FANG stocks, trades at a P/E of around 32, still very rich. The current valuations in the stock market strike us as treacherous, and corporate and government bonds do not offer a reasonable alternative. The combination of low returns, inflation, taxes and risk of default is daunting.
For those with a possible need for quick liquidity, cash is an alternative. Desperation among the Chinese, we suspect, is responsible for much of the recent interest in crypto-currencies such as Bitcoin (the Chinese government has moved to stop investment in cryptos by its citizens). We can’t get our minds around crypto-currencies and will avoid them in the Funds. At this point, we have more questions and concerns than we see benefits.
Unless one is constrained by the possible need for quick liquidity of an entire portfolio, we believe a meaningful part of your investable assets should be in alternatives. The Branzan Alternative Investment Fund (BAIF) and the Branzan Alternative Opportunities Fund (BAOF) have correlations to the S&P 500 of about 0.46 and 0.63, respectively, meaning that historically they have suffered only a fraction of a loss in the S&P 500.
We think it is important to remind our partners and friends that Branzan employees invest much of our net worth in the funds. As a group, we are the largest investors in the funds, we have continually contributed more capital over time, and we have never withdrawn money from the funds. We believe our interests are as perfectly aligned with our partners’ as possible.
Branzan Investment Advisors, Inc.