Altus Insight - September, 2014

The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor

Date: September 30, 2014
FR: Forrest Jinks
RE: It’s Not What You Think…

Last October I introduced Altus Insight readers to an excellent piece about game theory written by Ben Hunt as part of his Epsilon Theory series. Since that time I have enjoyed reading each new Epsilon Theory article. Mr. Hunt stresses the importance of understanding HOW people will react to information as being more important than correctly assimilating that same information. As a mostly long/short asset management firm participating in the “perfect” financial markets, understanding the other participants in those markets is far more important to Mr. Hunt in being able to outperform the market than it is to us at Altus where we are still able to invest based on investment fundamentals. And yet, those fundamentals still have to be viewed in light of economic cycles.  Those cycles are affected by the thoughts and opinion of the masses, both as consumers and investors, meaning we still need to be able to understand the way people THINK and REACT, more so than understanding the way they should logically think or react.

A perfect example of this is the recent release by Apple of its latest round of phones. As far as I can tell, the new apple phones are basically the same thing that Samsung has been selling for a couple years yet Apple is selling millions and millions of the new phones, many to people who have a perfectly functional existing Apple phone, simply because it is “new” technology with an Apple logo. As an investor in Apple, or maybe even more importantly in Apple stock derivatives, is it more important to understand HOW the Apple junkies will react, or understand how they SHOULD react? Understanding how they should react has little profit at all because people rarely act as they should. People that have made money in Apple understand that Apple’s rock star like appeal is far more important than the particular technology itself. As long as Apple maintains the emotional connection with its customers it will continue to mint money, and therefore create value for its shareholders.

There was a time when political discussions centered round social issues which had no direct tie to economic policy.  The death penalty would be an example.  Today’s social issues are things like immigration, global warming, and even quantitative easing - an economic action made into a social issue. All are certainly tied to the economic performance of our country. The fourth topic I will discuss is happening under the radar of most citizens and so far has not moved onto the national political scene, but the outcome of this particular issue will allow us insight into the direction of economic decision making which will affect investment possibilities and outcomes for years to come.

Immigration – This topic is such a political hot button that we have avoided writing about it, even though immigration policy has a massive impact on long term economic performance and also on individual investment opportunities. My personal views are very much tied to economic necessities and all of our individual histories in being able to live in this country. If I was ever asked for it I think I have a plan that would solve the concerns of many of the opinions in this argument, but my personal views, unless I was suddenly appointed a high political position for a day, are irrelevant. That I believe my opinion to be correct and my solution to be encompassing doesn’t change what is happening or is going to happen. The current situation is that there are millions of illegal immigrants living in the country with thousands more crossing the borders each month. While there has been talk of executive action, the ultimate outcome of immigration policy, both for the existing illegal immigrants and for future immigration may lie in the outcome of the November elections. There is no minimizing the effect of the outcome on the economy and hence investment opportunities. There will be specific alternative asset investment opportunities directly focused on a variety of immigrant groups (while Spanish speaking Central Americans make up the largest percentage there are also large influxes from southeast Asia, the Middle East, and Ukraine) such as housing, focused ethnic services, and even assimilation services. Additionally there will be public companies that will put themselves in position to profit from changes. Or…immigration policy will be tightened, creating an entirely different set of problems and opportunities.

Global Warming/Climate Change and Quantitative Easing – At first glance it may seem odd to combine these two seemingly massive issues into a single response but from an investment and economic viewpoint there are a lot of similarities. Again, as with immigration, the rightness or wrongness of either side isn’t nearly as important as the discussion surrounding each of these issues. In both cases staunch supporters are guilty of the logical fallacy of “begging the question” in which a person acts as if their conclusion is unassailably correct and dismisses any counter arguments or people in disagreement as being ignorant and unworthy of consideration. This attitude of arrogance does not mean the conclusions are incorrect but it creates a huge danger of forced groupthink. Time will tell the accuracy of each of these issues, and for all of our sakes especially with the accommodative monetary policy, let’s hope those leading the charge are correct, because the damage for being incorrect could be severe. If you are reading this article you are less likely to be affected, but if you are in class of lower affluence you are bearing the majority of the brunt of policies currently being put in place surrounding these issues.

How do we benefit as investors, either by putting ourselves in position for profit or by hedging against possible fallout? This is much harder for me to figure out than with immigration. Monetary policies have created an environment of cheap money resulting in the owners of assets benefiting from above normalthe ordinary increases in valuations. There is no question that some of the biggest proponents of global warming have profited and continue to profit handsomely from the global warming theories/principles. There also opportunities for smaller investors though. The government provides a myriad of incentives for activities thought to counteract global warming and those incentives can create opportunity both for high risk adjusted returns and for special tax treatment. Altus is currently discussing an opportunity with a gentleman that owns a solar company and several other businesses to supply investment funds for installation of solar systems on the buildings of his other businesses. It appears that through the incentives available investors may receive close to 100% tax benefit for their investment in the first year, earn somewhere between a 2 – 4% return for 5 years, and then receive their original investment back in full at the end of 5 years. A tax benefit of 100% means that all additional returns create an infinite ROI on the investment. The larger lesson might be that as investors we need to understand the “beliefs” of the masses, or at least the political elite, and how those beliefs are going to affect policy. With that understanding in mind we can make investments benefited by the rising tide, or possibly calculate that the potential returns of contradictory positions outweighs the risk associated with that position. In either case the decision would be made in full consciousness. At Altus it means we sometimes weight available interest rates and loan products almost as much as the underlying asset performance, which from a historical standpoint may not be impressive, but when viewed through the lens of historically low interest rates can create strong investment returns. At Altus it means we are consistently on the lookout for ways to benefit from changing energy technology and tax incentives. 

 

Uber vs. Taxis, Round 1: Joseph Schumpeter, an early 1900s economist and statesman, developed the theory of Creative Destruction, which is defined as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”.  In simpler terms, new advances whether in technology, systems, etc. destroy existing institutions and jobs but in turn create better institutions and jobs. Henry Ford’s assembly line is great example. Not only did the assembly put smaller car manufacturers out of business but it also destroyed non car businesses such as horseshoeing and pony express mail delivery. In turn it created a product that was affordable to the masses, jobs in road construction, entire new industries manufacturing products that were suddenly more affordable to the average citizen, greatly increasing the standard of living, first in the US, and then across the world. The term Disruptive Technology is now commonly used and is roughly equivalent. When General Motors was saved from bankruptcy by the Federal Government in 2008 – 2009 the government made a very clear statement that they were not willing to deal with the short term pain of the Destruction for the benefit of the Creative. Granted, the country was in the middle of a large economic downturn and it is possible that decisions were made that wouldn’t have been made in less stressful times, which brings us to Uber and Lyft.

These two companies are based on peer to peer ride sharing where an easy to use phone application links those needing a ride to drivers within the network that are nearby. Drivers and riders then rank each other in a system similar to Yelp and those ratings roll forward to future rides. Generally speaking the cars are nicer than taxis, the drivers more professional than taxi drivers, and often, the fares are less expensive. It is no wonder why taxi companies are up in arms. Some jurisdictions have already shut down the base model forcing the companies to change their business to be like existing taxi businesses. How governments deal with the controversy going forward will give us great insight into the direction of overall idea acceptance within the regulatory structure of the economy. Few people that have used Uber would say that traditional taxi service is better and the jobs held by existing taxis drivers are really just being replaced by the new Uber drivers who just happen to be able to operate a lot more efficiently. Will our society and government welcome the improvements or will it resist change and hinder the Creative?  I don’t have a financial pony in this race, but understanding the outcome will help me understand the difficulties of acceptance of future Creative changes and that understanding should help me make better investment decisions in the future.                        

Happy investing.

 

Forrest Jinks

Altus Equity Group, LP

off: 707/932-5887

fax: 707/544-2972

www.altusequity.com