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Club Troppo gets a makeover

http://www.meyersound.com/news/press/conn_troppo.htm

The connection always was intended to be tenuous. Beginning with Macquarie was a ‘peg’ in journalists’ parlance. But it was also an article about Macquarie that prompted me to think the thoughts that I wrote up. So I just wrote it up.

I also mentioned that Macquarie was the steward for super funds in my post.

James,

You’re right, the distinction between demand and supply for low volatility equity like assets is not properly distinguished in the post.

If this post is about the first phenomenon (i.e. the ERP), why so much emphasis on Macquarie? Nicholas is obviously trying to draw a connection, but I think it’s tenuous at best.

Nicholas isn’t discussing an exogenous increase in relative demand for risk-free assets, which would be associated with increased risk aversion, but an exogenous increase in assets yielding more than the risk-free rate, but with less risk/volatility than equities, i.e. infrastructure-type assets. Nicholas sees this as a demand issue, but it’s just as valid to ask whether it is a matter of supply. Many of these assets (roads, airports, water utilities, etc.) used to be in government hands in our and other countries, and have not been generally available to private investors. Privatisation has provided an exogenous supply shock of investible infrastructure. If that is the case, increased private ownership of such assets says very little about investor risk preferences.

I also want to clarify the issue with Macquarie Bank’s behaviour. Macquarie Bank is not buying these assets for its own account; it is buying them as principal, in order to on-sell them to funds it controls, in which other institutions invest.

Macquarie Bank’s end objective is thus not ownership of these assets, but their stewardship. Why? Because Macquarie Bank gets to charge fees for sourcing the assets and transacting on them, and then for managing the assets, once they’re in controlled funds. It’s the super/pension funds that are taking the asset risk by investing in these funds – Macquarie Bank is facilitating them and is paid handsomely for it. As Nicholas points out, Macquarie Bank is thus the agent for a developing trend, but it is not really a direct (i.e. principal) participant. Macquarie Bank is servicing [and, perhaps, stimulating] this demand, but I don’t think we can read much from its behaviour with relevance to the broader equity risk premium.

Nicholas felt (and I concurred) that a shorter blog title was needed, especially for publication at the foot of newspaper columns etc. Hence “armadillo” had to go, although it’s still there in body if not name.

As for the comment preview function, I’m not sure whether that feature is available in our new Wordpress system. I’ll ask Stephen Bounds who set it all up for us. I agree that it’s a useful function.

Asd for me, I’m wondering if you haven’t fallen into the old trap of confusing an increase in quantity demanded with an increase in demand.

‘An expansion of demand for assets with very stable yield’ sounds like an exogenous increase in risk aversion, which should in fact widen the equity premium. The super funds would compete for these sassets – whatever they are – that Macquarie is offering, bidding up the price and reducing their yield.

On the other hand, if Macquarie and others have hit upon some technical innovation that reduces the variance of income from a given outlow, then it’s no surprise that people that will no longer pay five cents in the dollar to insure against risk (by buying bonds). But we’re not much the wiser what the nature of that innovation is.

I wasn’t trying to present a finalised piece of analysis, so it might be confused. But reading what you’ve written I’m not sure what my confusion is supposed to be. My suggestion is that Macquarie’s behaviour reflects an increasing demand for a certain kind of asset and that that asset may substitute for bonds. If so and if it happens on any large scale, that suggests reduced demand for bonds which should reduce the equity premium. Of course it wouldn’t happen if it reduced the demand for equity by as much.

On the one hand, the ERP is known to vary through time, and exists to compensate investors for assuming equity-type risk. If it’s increasing, it’s a reasonable sign of increasing aversion to risk amongst investors.

On the other hand, Macquarie Bank has been very successful at persuading institutional investors (pension funds and their investment managers, mostly) to invest in funds they control, which buy infrastructure-type assets.

There’s no direct link between the two phenomena, unless you want to draw a rather ambiguous “bull market” connection.