The article below is from our BRIEFINGS newsletter of 29 October 2020
As the chief investment officer for the San Francisco Employees’ Retirement System (SFERS), Bill Coaker Jr. has achieved risk-adjusted returns in the top one percent of SFERS’ peer group. At a recent Goldman Sachs Asset Management (GSAM) Forum discussion, Coaker, who has more than 25 years of investment experience, spoke with portfolio managers on GSAM’s Fundamental Equity business, including Katie Koch, Brook Dane, Jenny Chang, Alexis Deladerrière and Laura Destribats.
Katie Koch: Bill, before we dive into your investment views and outlook for returns, I’d like to share how we, at GSAM, have been thinking about asset allocation. Our view is that the traditional balanced portfolio of 60% stocks and 40% bonds is broken and is insufficient as a way for institutional and individual investors to generate the returns they will need in the coming years. In fact, while a 60/40 portfolio generated annualized real returns of 8% over the past decade, we believe it will only generate 2% to 3% real annual returns over the next decade. The reason, we believe, boils down to the fact that equities are expensive today and the risks from the bond market are asymmetric. And with more than half of the US market invested in the equity benchmarks—which, by their nature, are backward looking—we believe investors are largely underweight innovation and the trends that will drive the world in the future. What’s your take?
Bill Coaker: My view is that a low return index approach in both stocks and bonds is already underway, with a 60% equities/40% bonds portfolio likely to result in returns in the mid-4%. Against this backdrop, the speed of innovation is accelerating rapidly and investors are underestimating its speed, scale and impact. Another way to measure the speed of innovation is by looking at the average age of the companies. Just 15 years ago, the weighted average age of the eight largest companies by market cap was 100 years old. Today, the average age of the eight largest companies is only 22 years old. In 2012, eight years after its founding, Facebook reached one billion users. Just eight years later, TikTok reached one billion users in less than three years, or three times faster than Facebook achieved less than a decade ago. In sum, the speed of innovation and its adoption is rapidly accelerating. Finally, it’s worth noting that the variability of returns has increased, which provides significant opportunities for active management. It’s a great time for alpha.
Brook Dane: Not only is a great time for alpha, but we also believe we’re on the cusp of an incredible wave of innovation. For one, the public cloud is enabling companies to efficiently innovate and adapt on shared infrastructure. At the same time, we’re seeing the rise of intelligent computing at the edge of the network—meaning that as billions of people with smartphones move into 5G, we’ll see the generation of data that will drive insight into artificial intelligence or machine learning. We’re already seeing the next wave of platform companies start to emerge. For our part, we’re invested in companies across the software ecosystem, the payments infrastructure and the semiconductor sector.
Alexis Deladerrière: Similarly, we also believe we’re on the cusp of a sustainability revolution, which could have the scale of the Industrial Revolution with the speed of the digital revolution. We believe the providers of green technologies represent attractive investment opportunities over the next decade. And it’s not just going to be one sector or one technology that will solve the climate crisis—it’s going to be a range of solutions encompassing renewables, electric vehicles, smart buildings, sustainable food or hydrogen technologies.
Katie Koch: When you look across the world, which end markets do you think are most misunderstood?
Bill Coaker: In my view, the human experience is fast evolving from the industrial age to an era of science, technology and innovation. The impact of that transition will be far greater than the human transition from the agricultural era to the industrial age and we’re still in the early stages of that transition. So far, this revolution has only improved calculations, convenience, communications and disrupted retail. The next wave of innovation will affect larger segments of the human experience such as transportation, energy, education, finance, and health care—all of which we expect will improve and rapidly evolve over the next 20 years.
Jenny Chang: We agree that health care is rapidly evolving, especially at the intersection of technology and health care. You can see that in the rise of telemedicine and remote patient monitoring, or in the ways that connected devices are being used to transform diabetes care. And because the cost of gene sequencing has come down sharply, we have a much better understanding of the human genome today and we’ve only just scratched the surface. As our understanding of diseases continues to deepen, we will continue to see the launch of next-generation medicines and gene therapies. As investors, we’re accessing that innovation by investing in gene sequencing, gene therapy and across the genomic supply chain.
Laura Destribats: It’s also important to look at the extent to which the pandemic has accelerated behavioral changes. One of our investment views is that many of the digital behaviors associated with the millennials—such as shopping online and social media—have been adopted by the broader population and are likely to be permanent simply because it’s more convenient. But millennials’ preference for experiences is likely to revert back to pre-pandemic levels once things normalize given pent up demand. In China, where the virus has largely been brought under control, travel bookings by people under 30 are already back to pre-pandemic levels.
Katie Koch: So Bill, as investors look to tap innovation and the future leaders, what are your thoughts on the best way to access that growth—is it through public or private markets?
Bill Coaker: Both public and private equities provide significant excess returns. While private markets have posted very good returns, investors can also post similar high returns in public markets. Consider the fact that when Amazon went public 23 years ago, it had a valuation of $450 million. Today, it is worth $1.5 trillion, resulting in a total return of 3,300x. By comparison, strong returns from a venture capital fund is typically about five times. There are plenty of other examples such as Netflix, Salesforce, Nvidia and numerous software and technology companies that are publicly traded and have posted very high returns. So it is worthwhile to pursue innovation in the public markets which can post excess returns comparable to that of private markets. In fact, if you look at Yale’s endowment, public equities have been the source of the highest excess returns over the last 20 years.
Katie Koch: Finally, Bill, how are you capturing these themes in your portfolios?
Bill Coaker: While there are different inputs that go into an asset allocation decision, we would allocate about 40% to public equity and about 25% to private equity for a normalized institutional portfolio requiring 2% to 2.5% net cash outflows. To post high returns, the vast majority of that 65% allocation to public and private equity should be invested in leaders in innovation. Some of the public equity allocation will need to be passively invested for the purposes of providing capital calls to private equity as well as pay benefits for a pension plan or student tuition, capital projects, and operating expenses for a university. We would place the remaining 35% in actively managed strategies, depending on an investor’s desire to pursue additional return or preserve capital and reduce volatility.