"Invest With A Little Extra Caution" - Views From A Gloomy Milken Conference

Authored by Huw Van Steenis via Barrons.com,

There was a note of caution among investors, business leaders and policymakers at this year’s Milken conference in California.

Despite near all-time highs in public markets and unemployment continuing to fall, investors were apprehensive. The rise of populism, trade tensions, inequality, tech disruption, or the $10 trillion of negative-yielding bonds in Europe and Japan are sowing seeds of doubt.

As we approach the longest U.S. expansion on record in July, the dominant topic for investors was how late in the economic cycle—and bull market—are we? Where are the vulnerabilities? And what does this mean for policies and portfolios?

Behind the scenes, I found three big themes with special relevance to finance.

1. The late-cycle investing playbook

How to position portfolios for late cycle investing was the biggest conversation in the corridors and private sessions.

Investors are casting their net for unappreciated secular growth which could outride a slowdown. The biggest hit was the focus on businesses geared to healthy eating and longevity. At a dinner of private equity investors, when I asked about their current favorite investment, over half were on health—from clean food ingredients to supplements to life sciences.

There is a growing focus on sustainability across all conversations. While the catalyst was often to better risk manage a concentrated portfolio, there is growing interest in measuring sustainable factors to help make better decisions.

But investors at Milken are also starting to buy some protection. For some this was a modest short position in parts of U.S. commercial real estate debt. For others it was looking to protect against potentially higher volatility in Europe.

2. Big Tech Versus Big Finance

There is a growing anxiety about how big banks will keep pace with big tech.

Financiers used to think that the post-crisis regulatory burden would make banking less appealing for new entrants. But increasingly they fear that non-banking rivals will target more profitable areas and skim the cream in areas such as payments or direct lending.

At Milken, financiers looked in awe at the scale and pace of innovation in combination with the large platforms networks. Take China’s Ant Financial which now has more than one billion customers across payments, investments and insurance without a single branch. Or closer to home Visa,PayPal and Mastercard , which have together created more value than the FAANGs [ Facebook , Apple , Amazon, Netflix and Google] in the last three years.

So the focus was, “How to catch up?”

It’s no longer “friend or foe” with fintechs and platforms anymore. I saw a big inflection as firms look to form partnerships and leverage platforms to help catch up on innovation.

Banks are stepping up their tech spending considerably. Many were surprised by the pace of cloud adoption in the US. One tech CEO said he expects nearly 50% growth in cloud usage by banks in the next 12 months as they want a better platform for innovation and borrow tech firms’ scale to invest. There will be rich seams of opportunities for to mine for tech firms across cloud, cyber and machine learning automation.

This said, despite seeing the success of large tech platforms or the Chinese financials, it was striking how few banks appeared to have an offense game plan to complement the defensive catch up.

3. The rise and rise of private assets

The rise and rise of private assets was a big theme.

At least $2.4tn was raised privately in the US in 2017 while $2.1 trillion was raised publicly, according to the Milken Institute. The thirst for yield, desire to access to fast growing companies and opportunities to disintermediate banks are bringing in even larger allocations. Fundraising for direct lending funds in the first quarter is already up 67% on 2018, according to Preqin, although Europe lags. The heady pace of growth is giving some pause for thought about the longer term implications for public markets and any collateral effects of persistent low rates.

But for the firms, the economics are clear: last year 43% of investment management fees already went to alternative managers, according to BCG. Given intense price deflation in exchange traded funds and core investment products as technology reshapes the sector, alternative assets are likely comprise more than half of all fees paid by investors even sooner than forecasters predict.

The Milken consensus is normally a much better barometer of markets than Davos. As I left, I asked an old friend for their takeaway from the conference. She said: “Invest with a little extra caution.”