Asset Management in Troubled Times
By Richard Marin, Managing Director, SEDA Experts LLC
Most investment professionals who have worked in the market for any time have been through a crisis or two. Those of us who have been on the Street for over forty years have likely lost count of the number of crises we have been forced to navigate. I have experienced them on both the sell-side and buy-side, but the most hair-raising were those that impacted the three money management businesses I ran at various times.
There is something about being the shepherd of other people’s money that should and does get your attention. Such crises are an inevitability of investment management and most crises bring with them shifting sands for the future. In fact, what may seem like the worst moment, usually while the crisis is unfolding, is most often the least of the problems that result.
Dimensioning the Crisis
The first requirement of a prudent crisis-bound investment manager or a fiduciary is to determine what type of crisis is at hand. This may seem obvious or trivial, but the dimension that may matter most is less about the absolute scale and impact of the crisis (not unimportant, just not the first concern) and more about whether the crisis is specific and isolated to the company involved or whether it is a global crisis that afflicts everyone.
It was during the LDC Debt crisis of the mid-1980’s when I was responsible for $4 billion of quickly deteriorating sovereign debt that I learned that global shared problems get solved since the system has a self-preservation buoyancy about it. It’s the isolated, company-specific crises that become unsolvable and may even bring out predatory motives of your competitors making it all the more pernicious.
So now we have two dimensions to consider when in a tough crisis spot.
I have come to see crises as merely problems to be addressed and solved and the beginning of new regimes that are filled with both risk and opportunity.
This is especially so for grand geopolitical crises, which tend to affect everyone. Such is the case of the Coronavirus economic crisis.
Priorities for Investment Managers
I do not need to add to anyone’s knowledge about the human and social issues of the Coronavirus, but I do feel inclined to address the implications for investment management. I think after a week like we just had in the markets, I am not overstating things by calling this an apocalyptic moment. But apocalypse does not need to mean an end of days, it can also mean “destruction or damage on an awesome or catastrophic scale” and that does not feel very far off what we have seen in terms of the volatility and record-breaking market declines (including triggering of circuit-breakers) as well as the cracks in the U.S. Treasury markets and the flailing of central bankers desperately seeking monetary policy levers in a near-zero-percent interest rate environment.
The question is no longer what can be done to protect against the apocalypse upon us, but rather, what happens now and what do we do now.
To start, there is a reason the British in 1939-40 when the Battle of Britain was pummeling London, invented the phrase “Stay Calm and Carry On”. It is a necessity of crisis management that you don’t need a high-priced consultant to divine. The second, necessary step is to stop and think about where things stand.
And then, the most important step any investment manager can take to protect his or her clients’ assets and the firm reputation, is to begin the process of extreme communication.
The Imperative of Extreme Communication
I am a General Partner of a small Fintech seed venture capital company. Among all the “Coronavirus Update” emails I have gotten over the last two weeks, I plucked the one sent by the Managing Partner of that VC fund and took note. First of all, instead of a nice viral note from some vacation-selling company, this was from a company in which I was an LP and a GP so I had every reason to pay attention to it. I was glad I did, not only because of what it told me about the state of our fund, but because it set a standard I would like to point to as excellent investment management best practice.
Let’s face it, sooner or later most investors have a gripe with their investment manager to some degree.
Reversion to mean and the normal cycles of life mean that sooner or later investors will be less than thrilled with their manager. The difference between a good and bad rapport over the long haul between investor and manager lies in communication. This Managing Partner of the Fintech VC sent out a 2,300-word email to his investors (notably, a month before, but not in lieu of, the Annual LP Letter). I would like to highlight some of the important messages he gave his LP’s at this difficult and challenging time:
• There is no precedent in living memory that we can use as a guide to navigate what lies ahead.
• We felt it prudent to spend considerable time assessing the potential impact of an economic slowdown on our portfolio.
Bottom line: since many of our portfolio companies have recently completed capital raises, or for that matter recently launched operations, our founders have capital to deploy, make opportunistic acquisitions, and are not burdened by legacy issues.
• The situation surrounding COVID-19 is a humanitarian crisis that continues to gather pace.
• Firm Policy
Policy of work from home (WFH).
All of our files, work productivity tools, and data systems are cloud-based.
We have also put an indefinite hold on non-essential travel, participating in conferences, taking in-person meetings, and attending large gatherings.
We have also encouraged our portfolio company CEOs to do the same.
• Portfolio companies were ready with updated business plans and projections.
• Recent Local Government Actions
Social distancing as official policy.
Impact schools, houses of worship, and other institutions.
• Bottom Line Impact on Investment Activities
Event Cancellations - Y Combinator decided it prudent to conduct demo day exclusively on-line.
We receive hundreds of requests for funding via our website, in-bound emails, and pings via LinkedIn and other media.
Our highest quality deal flow comes via personal referrals from trusted individuals in our network — and we see no change in the status of that channel.
• Thoughts on How our Portfolio is Positioned for the Turbulence Ahead
Assuming that we are entering into a downturn that lasts 6-12 months, we believe that the core companies will be able to weather the storm, and in some cases outperform.
While the deal pipeline continues to be robust, we’ve taken a highly measured approach in deploying capital since the launch of this fund.
There is little doubt that the pendulum is continuing to swing back in favor of investors after being squarely in the camp of founders for much of the previous decade.
While we are still early in the shift in power dynamics, we anticipate finding more attractive entry points when we deploy capital in the weeks and months ahead.
Each of our portfolio companies now have substantial cash on hand, and now have secured runway through at least 2022, and in some cases well beyond.
• Overall Thoughts
To be clear, let us also note that there is 100% certainty that 100% of our portfolio companies will feel the impact of a period of economic turbulence.
At a minimum, we are anticipating that growth rates will slow, or even reverse for some.
This may seem counterintuitive, but our view is that freshly minted startups so long as they have sufficient runway and cost discipline are better positioned to ride out the operating conditions heading our way.
• The peak of the global financial crisis was almost 12 years ago, which means there is a non-trivial population of founders and VCs/investors that have not yet experienced a market dislocation!
Best Practice is Non-Trivial
I don’t feel the need to be pedantic, but this redacted letter to investors has all the good elements of investor communication that are more important in a crisis like we have now than ever. It is informational, honest, to-the-point and cautiously optimistic. I recently saw an advisory to managers from a major law firm that works in the investment space. Their recommendation to managers distills down to these points:
Pursue a policy of extreme disclosure and transparency.
Insure that your Business Continuity Planning (BCP) is fully tested and ready for implementation, including considering governmentally-imposed limitations.
Working remotely should be given priority and the infrastructure ready to handle that.
Coordination must take place with service providers that are vital to the deal flow and other aspects of the investment process.
Valuation and liquidity should be given added attention and fully disclosed to investors.
If that sounds familiar, it is not coincidental. It matters not who took lessons from whom.
What matters is that best practice of extreme communication in a crisis is observed.
As my friend tells his investors, we are in uncharted waters and that means that there will likely be plenty of wreckage with which to contend in the coming days. There is little doubt that we are facing a big geopolitical crisis that will have far-reaching implications. This is the type of crisis that will impact everyone and far more people and companies will be impacted negatively than find immediate opportunity. And there will be many new opportunities on the horizon that will depend on a level of trust maintained between client and manager.
Trust flows from extreme communication.
Managers owe it to their clients not only to keep them informed of the status of their investments, but also to maintain the trust needed to seize the upcoming new world of opportunities.
It will take hard work to do the right thing by investors. Nevertheless, doing the right thing about communicating aggressively, being honest and prudent, but also looking for the means to take advantage of the new world that will evolve from the changing playing field. These are the best practices that managers need to focus on sooner rather than later.
Richard Marin, as a former finance senior executive with over 40 years of industry experience, and as a former clinical professor at Cornell University is a world-class testifying expert in asset management, alternative investments, private equity investments, securities lending, retirement and pensions, and real estate/project financing.
He was a senior executive at three major financial institutions; Bankers Trust Company, Deutsche Bank and Bear Stearns. His initial career spanned corporate finance, sales and trading, structured products, emerging markets, processing, and several other disciplines.