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What About Beta? | Risk: Going, Going, Gone!

February 15, 2021

By Bill Kelly, CEO, CAIA Association

If you live in the Northern Hemisphere, you might have noticed that the days are getting a bit longer. In fact, we are gaining just over two minutes of daylight every day and daylight savings time happens in less than a month. In another sure sign of the seasonal change, American baseball unofficially kicks off this week with the early reporting of pitchers and catchers for their annual training ritual. Prior records, pennant winners, and any individual accomplishments are recorded and cannot be taken back, but the new season is a reset where all teams begin again on equal footing.

Too bad the capital markets are not reset and de-risked each year like they are for the boys of summer. Imagine how great it could be to bank those wins, forget about the losses, and have the fundamental game clock reset to zero where hard work, discipline, and consistency would suddenly be back in vogue for the new frame. Solicitously, our mimicking moment might be that big and unexpected tail event, where we finally realize that unrealized gains meant little, liquidity is (much) more of a privilege than a right, and risks can be cumulative and quickly correlated, especially when they are hiding in plain sight.

Mike Going, a CAIA Member and friend who knows a thing or two about risk and survivor bias, recently threw us the first fat pitch on the subject of risk via a LinkedIn post. Here we learned that the average yield on no-longer-high-yield bonds fell below 4% for the first time ever last week. One must wonder if risk is being mispriced, misunderstood, or just misnamed. Perspective, however, is always important, as we drift into extra market innings and, according to Janus Henderson, the junkiest of the junk occupies a much smaller percentage of the index than it did coming out of the GFC. So, maybe we shouldn’t be so surprised or concerned?

On the private market side, a recent 2021 outlook piece for the US PE market courtesy of PitchBook also flashed some interesting signals on risk and reward. According to their data, in 2020 one third of the buyouts were done at average multiples of 12X EBITDA or higher and they anticipate 20% of new deals in 2021 will have a 20X multiple.  By comparison, back in the good old days of 2010, 80% of the transactions closed at a multiple under 12X, and more than half of that cohort made their way into the GP portfolio at a mouth-watering less-than-8X EBITDA.

Finally, what valuation tour would be complete without at least a passing nod to bitcoin. For the incurable romantic, an interesting Valentine’s Day jpeg was posted on Twitter and subsequently picked up on Reddit, aka the new home of leading market news. If you opted for a dozen bitcoin in 2010, it would have set you back sixty cents. Assuming your loutish self (he/she/they) bore no gifts in the ensuing ten years, you may have been dumped by your better half, but that gift truly kept on giving and would be ‘worth’ almost $600,000 today.

Concluding with the baseball analogy, MLB is putting in a new rule this year when games go into extra innings. Every frame will start with a runner on second base, even though he did nothing to earn it. That sounds a lot like the average investor who mostly just had to show up, even late in this cycle, and has been rewarded beyond perhaps what she has earned. There is nothing standard about these deviations, and now is the time to double down on your analysis with a keen understanding of the risks that you are taking before you are called ‘out!’

Seek education, diversification of both your portfolio and people, and know your risk tolerance. Investing is for the long term.

Bill Kelly is CEO of CAIA Association. Follow Bill on LinkedIn and Twitter.