Bonds bail us out

Bail bonds are like stocks and why I am not giving up on long-term gilts

Photo by WWW PROD on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that is open to change when things have actually changed.

A programming note: I will be taking the summer off from Pension Geeks to finish my book. Unless there is a pension emergency that I must talk to you about, this will be the last newsletter until Labor Day. However, feel free to write me in the meantime.

Is the S&P all you need?

I am, first and foremost, a pension geek, but there was a time when I was a macroeconomist. I don’t talk about it much anymore, but it creeps into my thinking—even about pension risk issues. And it came up recently when I was speaking to a financial advisor about his investing strategy. He was having a bit of a professional crisis because he realized he had never beaten the S&P 500. And I don’t mean he was a stock picker; he was doing everything right, or right as I was trained. He was in the S&P, some smaller stocks, and some foreign stocks, including emerging markets—a perfect portfolio if you believe the literature.

In principle, that should do better than just investing in the S&P. The smaller stocks and emerging markets are riskier, but you’d also expect higher returns. Overseas investment should offer valuable diversification. In my Bloomberg column, I explore why the S&P 500 did better all around and why I think things could change.

So much of the S&P 500’s performance was driven by the extraordinary performance of large tech stocks. But whether we should throw out everything we know about investing depends on if you think that will last. And, if I’m thinking like a macroeconomist, I’m not sure it will.

First, there were fewer gains to diversification in the last 20 years because global markets became more integrated. But that may not last. We’re returning to less trade and more industrial policy because we must repeat the mistakes of the past—because the people running our economic policy don’t have much of an economic background and are ambivalent about economic growth (both parties are guilty here). This means we can expect more decoupling and, thus, more benefits from diversification. Don’t count out the home bias puzzle just yet!

Also, this last phase of innovation favored big firms that could grow fast. Being successful in tech required network effects and lots and lots of proprietary data. Will that last? Maybe, but the new AI-driven phase could be great for big firms, or it could make growth more democratic—since everyone will have access to better knowledge and coding ability. In that case, big tech’s overwhelming dominance may slow a bit, and so will the benefits of investing in emerging markets and smaller firms.

Maybe I’m just too much of a believer in efficient markets. But one thing I learned from Gene Fama is that 20 years of data is not enough to declare a structural break.

While we are questioning financial theory

John Kay wrote a blog post about Liability Driven Investment, or investing pension funds in long-term bonds.  It seems the UK is questioning a lot about their pension investing lately. Unlike US pensions, the UK invests a lot of their pension money in long-term government bonds and relatively less in equity—not as little as the Germans, but a lot less. This is allegedly one reason why the US economy grows faster. The UK is reconsidering how pensions should be invested. And with rates rising and long-term gilt prices falling, those pension pots aren’t looking so good. Neither are people’s individual account balances.

I agree that UK pensions can probably handle a bit more risk and could invest in more equity. But I am skeptical that this is a means of growth for the whole country. The US pension experiment in private equity may still end in tears, and once we start seeing pension assets responsible for growing the economy, I fear they will be invested in government-favored growth industries, which may not deliver returns. It’s also bad risk management because, if it fails, taxpayers are doubly on the hook. But I give UK policymakers credit for making growth a priority.

On Kay’s point about long-term bonds, it’s true that pension assets are down, but so are liabilities because the gilts are also how you discount them. So, while I agree that there are convexity issues, LDI is a good risk hedge. And this is not just accounting semantics; this is how insurance companies (buying up the pensions) value them too. And who knows? Maybe higher rates will bring annuities back in fashion. Adam Smith was defaulted into one. They should be cheaper now. The fact that rates change was always the point of LDI, not a reason to abandon it.

Work-from-home days could be numbered

There has only been a one-year period of my career when I had to go to an office every day. It was a pain commuting and putting on nice clothes every day, but I liked it in some ways. I made many friends who I still talk to, and I often think I'd have many more friends if I had a more conventional career.

So maybe I’m not the right messenger, but this whole work-from-home thing is a bad idea. It is true that technology has changed and that we can do more tasks from home. But tasks are not your entire job. We also train, mentor, and add to workplace culture. And we are already lonely and bowl alone. I fear what widespread work-from-home will do to society.

True, pre-industrialization people worked from home. I could be convinced that work norms from the industrial era could be a historical fluke. But before pre-industrial times, we had apprenticeships, people worked with their families, and we had tighter communities. We still saw people but didn’t look at screens all day. I’m not romanticizing pre-industrial rural poverty; it was a hard life, but it did have the social structure in place to impart skills and other social benefits.

Technology does not give us everything we need, and until it does, people will go back to the office. I suspect a recession could be what forces people back because, right now, bosses want people back, and workers aren’t listening. This is not a stable equilibrium.

Bail bonds

I spoke to Nick Lindblad, a multi-generational Hawaiian bail bondsman, about the business. He said risk management for bail bonds is just like picking a stock. We also talked about murder. Give it a listen.

Until the fall, Pension Geeks! Have a great summer.

Allison