Compliments to Mr. Carter (“Emerging markets equity up against capacity wall,” April 4, page 1) for detailing the herding behavior of institutions into emerging markets; importantly, the piece offers readers a timely reminder of the trouble inherent in collectivism. A type of fallacious reasoning, groupthink is increasingly relevant. The tendency to associate with like-minded folk is appealing in that it is comfortable and conservative. But symmetry of thought is an eminent problem for investment management. When financial operators act in concert, risk and uncertainty are concentrated, and when things go bad, calamity concurrently impacts everyone (a la 2008-2009).
A byproduct of groupthink among institutional investors is an oversimplification of the asset allocation process into binary investment elections: equity and debt; public and private; active and passive; liquid and illiquid; long-only and long/short; local currency and foreign currency; U.S. and ex-U.S. domiciliation. Resultantly, the composition of portfolios is strikingly similar.
Institutional investors would be well served to extricate themselves from the process of solely allocating to “traditional” asset-class buckets. Instead, conventional asset allocation ought to be complemented with a process to identify unique risk-return-correlation profiles that will round out the investor's allocation and protect wealth during periods of market stress (beta expansion). Water, art, shipping, infrastructure, wine and factoring are unique “emerging asset classes,” undiscovered by the masses and offering first-mover advantage to sharp institutions.
Kendall D. Doble IV
Investment Office, Amherst College