Daily Commentary

MarketMinder’s View: This is a good piece that will make you say “oof.” It also mentions a lot of companies and funds, so of course we remind you MarketMinder doesn’t make individual security recommendations. The broad premise is what matters here. In recent years, one of investors’ biggest gripes is that because startups stay private much longer than they used to, most gains accrue to the initial investors, with little left for retail investors once the company holds an initial public offering (IPO). This perception has led some folks to covet “pre-IPO” stocks, and the financial industry is obliging … with overly complicated, high-fee products! (Even in this form, it seems IPO stands for “It’s Probably Overpriced.”) This piece shines the spotlight on some of them and their many drawbacks. “The most common form of access is often called a special-purpose vehicle. Some managers of SPVs, knowing they’re among the few ways to buy into coveted pre-IPO companies, charge fees that would make a bandit blush. SPVs can bear upfront fees that could hit 5% to 12% or more, say industry executives. Some also charge performance fees that take 10% to 30% of any gains. The highest costs are hard to overcome, says Tom Callahan, chief executive of Nasdaq Private Market. ‘You better hope that company 10X’es or your return will be eroded away in fees,’ he says.” As the article goes on to note, selling can be impossible, adding the risk of illiquidity to the high costs. Other vehicles purport to be lower-cost but carry hefty exit fees. And one, which looks utterly cockamamie, is selling a cryptocurrency purporting to give you a stake in a debt obligation that somehow will mirror the return of a certain company that makes rocket ships. Its structure effectively foists a “100% entry charge” for an opaque security that doesn’t actually tell you how it will “‘reference the economic performance’ of the stock.” But overall, the lesson here is simple: Don’t let greed and fear of missing out drive you into illiquid, overpriced investment vehicles. Remember your long-term goals and remember that IPOs aren’t surefire winners.

MarketMinder’s View: Is mark-to-market accounting coming to private credit funds in the UK? The reporting here, which comes from unnamed financial industry sources, suggests regulators are eyeing it up, if not via official change then by very strong encouragement. “Officials from the Financial Conduct Authority have in recent weeks been piling pressure on so-called shadow banks – an increasingly critical source of funding for the speculative AI boom – to more rigorously mark down the value of loans that are at risk of not being repaid in full. … Critics of the shadow banks have accused them of ‘mark-to-myth’ valuations that readily account for unrealised gains but rarely take hits even as a loan is obviously turning bad. This is in contrast to ‘mark-to-market’ accounting, which is seen as more transparent and rigorous but can mean unwanted turbulence for investors.” We have seen this movie before, and it didn’t go well. The US adopted a mark-to-market accounting rule in 2007 and applied it to illiquid assets that banks intended to hold to maturity. There were few price reference points for comparable securities available. The result: When hedge funds had to sell similar securities at fire-sale prices, all banks had to take corresponding writedowns, leading to a vicious cycle of forced selling and paper losses. That destroyed bank capital and transformed about $200 billion of US loan losses to over $2 trillion in exaggerated writedowns, per former FDIC chief William Isaac’s math, causing 2007 – 2009’s global financial crisis. Regulators eventually changed the rule, allowing banks to put mark-to-market valuations for hold-to-maturity assets in footnotes instead of letting them affect capital levels, and that system has worked pretty well for 17 years. Applying mark-to-market rules to private credit funds, however well intended, risks restarting that chain reaction in the private asset world, which could quickly force investors to sell more liquid securities to cover unexpected paper losses. So far, there isn’t a significant transmission mechanism linking private equity and credits’ troubles to traditional markets. But this potential change deserves very close scrutiny and is a risk to watch. 

MarketMinder’s View: This is a pretty balanced take on the implications of Venezuela’s new bill opening its oil sector to private and foreign investment. “The new law stipulates that even when they are minority partners in joint ventures with [state-run Petróleos de Venezuela] PDVSA, private companies may exercise ‘technical and operational management’ directly, breaking with the previous rule that required state control over operational decisions. It also provides for a possible reduction in royalty payments to the regime from 30% to zero.” In exchange, the US has loosened some of its sanctions on the industry. While politicians in the US and Venezuela claim this will jumpstart investment and production, as the article explains, this might be a hasty conclusion as the new law “‘fails to address all the causes that led to the collapse of the oil sector.’” Corruption under the current regime is a biggie, as is the fact that the “legislature” is stacked with regime loyalists. Laws passed quickly under those conditions can be changed and revoked quickly, which extends uncertainty. Without clarity on the long-term political situation, firms may remain reluctant to take much risk. And even if they do, amping up output much is a yearslong project. From the start, we thought hopes for a rapid production increase were far-fetched. This is more evidence supporting that. For more, see our recent commentary, “Viewing Venezuela Through a Market Lens.”