Why Build Your Own Assets?

The Federal Reserve has committed to “infinite money” to support the fiat system so why put effort building your own assets?  BlackRock hasn’t so why should you?

Wooden Blocks

Bitcoin Enhanced is an example of a new asset class called Self Managed Investments (SMIs).  Unlike a traditional hedge fund SMIs expect investors to work hard to ensure adequate liquidity. 

As well as the need for effort SMIs like Bitcoin Enhanced carry risk of failure. An SMI may never achieve sufficient liquidity for you to exit.  The trading algorithm itself may blow up leaving the tokens worthless.  10%-15% of hedge funds go out of business each year.  There is no reason to believe that the SMI failure rate is any less.

To add insult to injury, while a badly performing hedge fund can return remaining capital to investors there is no recourse with an SMI.  If the strategy does not perform you have lost everything.

Hard work and likely failures.  Why bother? 

Here is why:

Infinite Money – Unacceptable Risk

The “infinite money” of the Federal Reserve has ended capitalism as we know it.  Price action for bonds, futures, EFTs or any other fiat asset now depends primarily on the intentions of the Federal Reserve.  Fundamentals no longer count. BlackRock, the world’s largest investment manager confirmed this by suspending its trading strategies in favour of buying what central banks are buying.

The effect of infinite liquidity is, ironically, unacceptable risk.  The purchase of any asset that depends upon the fiat system or its institutions for its value is effectively just one bet – that the Federal Reserve can continue to sustain the system with ever expanding money supply. 

Apart from the failure of every fiat money scheme over the last 2,700 years, the short lived effects of the Bank of Japan’s huge purchase of EFT’s suggests the impotence of the approach.  Infinite money is worthless money.  There is no reason to suspect this time will be any different.

End of Diversification

Even if the Federal Reserve could sustain the fiat markets with new money it has still destroyed the foundation of prudent investing – portfolio diversification. 

When all fiat asset purchases are essentially the same bet on the efficacy of the Federal Reserve there is no diversification.  All fiat assets become one asset.  A portfolio may hold a “balance” of equities and bonds but the reality is that they are only various flavours of one system as centralised as the old Soviet command economy. 

On BlackRock’s homepage President, Rob Kapito, shares his thoughts on why the best course for retirement investors may be to stay the course.  Yet this is exactly what BlackRock has NOT done.  The firm has abandoned the one basic principle of sound investing – maintaining a diversified portfolio of assets. 

Apart from the tragedy this represents to those who have their money with the firm, it may also mean that BlackRock is in breach of its fiduciary responsibilities.  Those responsibilities require the firm to invest in a prudent manner on behalf of beneficiaries.  Prudence has become synonymous with a diversified portfolio.  Will we see investors filing lawsuits against the firm in the near future?

Can it be BlackRock failed to notice that while the principles of sound investing do not change the fiat system has?

Hard Asset Scarcity

The only solution for the prudent investor faced with the centralised control of fiat assets by the Federal Reserve is to exit the system and purchase hard assets instead.

Hard assets are those with intrinsic value that do not depend upon the institutions of the fiat system for the value to be realised. 

For example physical gold is a hard asset.  Shares in the SPDR Gold Shares (GLD) are not.  In the case of GLD the list of counterparties includes World Gold Trust Services LLC as the sponsor, BNY Mellon Asset Servicing as the trustee, HSBC Bank plc as the custodian and State Street Global Advisors Funds Distributors, LLC as the marketing agent.  The risk factors involved in holding GLD shares cover pages 6 to 14 of the prospectus.

Hard assets include property, precious metals, non-collateralised digital currencies and equities with strong cash flow but little or no debt. 

Because hard assets are valued in themselves they are independent of the fiat system and of each other.  This independence enables a return to portfolio diversification. 

Yet as investors seek to return to sound investing they find that there are simply not enough hard assets to go around. 

Hard assets make up just 20% of global asset wealth.  The figure suggests 4 out of 5 investors will not be able to exit the fiat system and re-establish sound investment practises.


Noah and the Flood

We are not told how long God gave Noah to build his ark before the Deluge.  But it was only 7 days from its completion until the rains came. 

Prepare for Hard Work

Building an ark takes effort but if you expect a flood it is worth it.  With hard asset scarcity building your own assets is a way of ensuring your capital can be productive.

The hard work associated with SMIs comes from the fact that, like start-up companies they need to start life illiquid.  Any collateral that would give them initial value would compromise their independence and hard asset status. 

Liquidity needs to be built by actively promoting the SMI to other investors and by being a public champion of the token.   Venture Capital firms take this active investment approach for granted as they build great companies.  The result according to Cambridge Associates has been the most successful asset class over the last 20 years.  Prudent investors can apply the VC model to SMIs.

The reward for this work is the restoration of diversification.  BlackRock no longer requires asset diversification.  For those still committed to the principles of prudent investing SMIs expand hard asset options. 

Unlike the recent performance of some hard assets such as agricultural land SMIs also hold the potential for sound returns. For example over the last two years the Bitcoin Enhanced algorithm has returned 36% p.a. 

Investors do not have to get in at the ground level with an SMI.  Digital currencies such as Bitcoin or Monero have similar formats to SMIs but have been liquid across multiple exchanges for some time.  However early investors who are willing to put the work in to promote a new SMI are rewarded by increased capital efficiency.  Similar to the way seed-capital rounds offer investors the greatest upside potential for least capital outlay, the discounting of early tokens give the first SMI investors the same advantages to compensate them for their sweat and higher level of risk. 

Expect Failure

Fortunately for Noah the hand of God assured his success.  Without the same connections SMIs need to take a more pragmatic approach.  VCs know 40% of their start-ups will fail.  But it is exactly the ability to fail that makes the VC model so robust.  Each company stands or falls on its own merits.  Failure does not damage the whole portfolio.  I have called this approach Robust Finance.

The problem with BlackRock’s bet on the Federal Reserve is they effectively have just one asset in their portfolio, the “FED asset”.  No VC would ever invest in just one start-up.  The risk is simply too great. 

SMIs can and will fail.  This is not a bad thing.  It is a sign they are part of a capitalist system where investors can still make prudent risk/reward decisions.  Holding SMIs along with other hard assets enables capitalism to detour around the fiat system and allow investors to continue doing what they have always done - seek opportunities for sound risk adjusted returns through a diversified portfolio.  To these investors hard work and the acceptance of failure is nothing new.