Marathon

My son Carlton (23) ran a marathon last weekend. He and his friends chose to run a race on Long Island in New York because the course was flat and there was only a nominal entry fee. My wife and I did not attend in person but thanks to technology, my entire family, though spread around the country, was able to virtually cheer him on. We tracked his race progress using various tech tools including Strava, Find Friends, Google Maps, and the tracking app provided by the race organizers. We pinged him with text messages throughout the race. From my wife and daughter: “You got this, Carlton! Let’s go! Halfway there! Only five miles to go! One more mile! You’re killin’ it! Go Carlton, Go!” And so forth. I knew he had hoped to finish in less than 3 1/2 hours, so I was able to send him stats. “You averaged 8:15 per mile on the first five miles, 8:00 per mile on the next ten miles. Better kick it up a notch if you want to beat your goal!”

Carlton instructed Siri to read our messages aloud, so he heard them clearly through his Apple AirPods as he ran. He said it really helped; it was as if we were right there with him. Yes, he beat his 3 1/2-hour time goal, squeaking by with just seconds to spare as his parents and siblings urged him on, yelling into the screens of our respective devices. Within seconds of his crossing the finish line, we were on FaceTime with our tired, happy boy and scrolling through photos his friends had posted to social media. It was quite the virtual experience!

Contrast his marathon experience with mine of 34 years ago when I was exactly Carlton’s age. I had chosen to run the Kiawah marathon—yep, no hills, nominal fee. I managed to make my way to the starting line using a folding paper map. My girlfriend at the time was not a runner but she planned to cheer me on and take pictures, having recently completed a photography class at our alma mater, Wake Forest University. She was lugging around one of those fancy nine-pound cameras with a seven-inch lens. I saw her twice during the race, including at the finish line where she cheered and snapped a few pics. My girlfriend had many wonderful qualities but, and I mean no offense, the photos were terribly blurry—maybe Wake should stick to the liberal arts. I digress. My race experience was technology-free. Sure, I probably called my parents (from a land line) a week before the race to tell them I would be running a marathon (and I’m sure they wished me the best of luck), and certainly I called them within a week of finishing the race (from a landline) to tell them I’d finished (and I’m sure they congratulated me and told me they loved me and were proud). But no texts, no tracking devices, no AirPods or Strava apps, no immediate uploads of finishing photos to social media. In many ways a different experience. I think you will agree that it’s better today.

One thing that technology hasn’t changed is the pain. I was really hurting by the time I crossed that finish line 34 years ago. Thanks to my girlfriend’s blurry pictures and the total absence of Map-My-Run and other nifty tech tools, I don’t have a lot of memories from that marathon, but I distinctly recall the negative thoughts that entered my head around mile 21 or 22. It was a powerful narrative. “What were you thinking, Benton? Who ever thought running a marathon was a good idea? Just STOP RUNNING and WALK! If you finish this race, you will NEVER do this again!”

I asked Carlton about the pain, and he confirmed that yes, he was hurting by the time he finished. But he said he would consider doing it again. I was glad to hear that because when he reads this next section of my letter, he’ll realize that his old man ran a faster time.

A 20-some-year-old Benton Bragg setting the pace for future generations of Braggs

You see, I did have one little piece of technology with me back in 1991. That would be my $23 Casio wristwatch. It accurately recorded my race time of 3 hours and 19 minutes. Poor Carlton. Doomed to run another one.

Speaking of marathons, this investing game certainly is one. It goes on and on forever. It has uphill sections; some are steep. It comes with its fair share of pain. It requires discipline. And sometimes we face distracting narratives that can prevent us from accomplishing our goals. Of late, those narratives have been powerful. Clients have asked questions, some as simple as, “Should we take a different route?” Others are as significant as, “Should we stop running and walk?” Today I will touch on a few of the narratives being bandied about by mainstream media, including the rush of money into private equity and why we remain cautious, the temptation and danger of chasing high yields, the challenge of justifying owning gold or cryptocurrencies and finally, why bubble talk often distracts from what the market is actually saying.

Private Equity

There is a remarkable wave of enthusiasm sweeping through Main Street around private equity. Wall Street is pushing the narrative; truly, it seems everyone in the financial industry is helping their clients get into private equity. If everyone is doing it, it must be good, right? We think caution is warranted. For decades, private equity was the domain of institutions and the ultra-wealthy—pension funds, sovereign wealth funds, and family offices—and history has demonstrated that private equity as an asset class has served investors well. Corporate finance, of which private equity is a part, routinely employs the best and brightest of the financial sector. The US has the most dynamic capital markets in the world and private equity is a critical part of this system.

But history also demonstrates that Wall Street is prone to excess, often leading to speculation, over-leveraging, or the wide-spread promotion of risky products. Today, with changes in guidance from the Department of Labor and with support from the White House, private equity is suddenly being repackaged for mass consumption. Public funds, retail “interval funds” and sophisticated marketing campaigns are all designed to make private equity feel like the next frontier for ordinary investors. The numbers are staggering. Estimates suggest several trillion dollars could flow into private equity over the next decade from individual investors alone. I’m reminded of Wall Street’s rollout of technology funds in 1999 or of subprime mortgage funds in 2006. It seems the mantra is not to sell investors what they need; instead, sell them what they want to buy! And it seems investors want private equity. We worry that this massive influx of new capital from retail investors will not end well. Specifically, while Wall Street will certainly prosper, we think retail investors will see disappointing returns. Reasons include:

• Supply and demand are not in balance. The number of privately owned companies dwarfs the number of publicly traded companies, but the vast majority of privately owned companies are tiny firms—think of your local barber shop or dry cleaner. As for investment opportunities, the number of firms doesn’t matter; the profits are what matter. In terms of profits, the majority of corporate profit is generated by publicly traded firms. A typical private equity fund will target micro-cap companies with total market values of less than $200 million. Wall Street is raising billions—and likely trillions—from retail investors. My email inbox is crammed with offers of steak dinners to learn about the new private equity fund being raised by ABC Capital or XYZ Investors. Pouring huge competing sums of capital into this small part of the market will bid up prices to levels unseen, distort economic reality, and compress the potential for good returns.
• There’s no bid and ask. We like publicly traded securities because they trade on an exchange where there is a bid and an ask. Thousands, or even millions of buyers and sellers set the price. There is tremendous information in a bid and an ask. In contrast, when you invest as a limited partner in private securities, you become a price taker. The price is set by the general partner. Yes, there are rules and standards to be followed, but ultimately, the security is priced by the general partner, and this creates a conflict of interest. There are many differences between investing in publicly traded securities and privately traded securities. In our view, this is the most significant. Ponder this difference.
• Risks are typically higher. This is due to the aforementioned focus on smaller, less established companies, and also because private equity funds typically use far more debt to finance the purchase of these companies than you would typically find on the balance sheet of publicly traded companies. Compounding the higher amount of debt is the significantly higher cost of debt, now that interest rates have normalized at higher levels. It was easier to make money with high leverage when interest rates were near zero.
• Costs create a hurdle to attractive returns. Fees of 2% annually and 20% of the profit above a threshold return are typical for private equity funds. Compare that to less than 1% per year for a managed portfolio or a tenth of 1% for an equity ETF. These costs on top of the now-high cost of servicing debt will serve as a drag on returns.
• Illiquidity is part of the formula. Buying a company, restructuring it, growing it, and hopefully selling it at a higher price takes time. Investors in private equity need to expect that their money will be tied up for up to ten years or more.

Chasing Yield

Another theme gaining traction is yield—specifically, the allure of private credit and other high-yield opportunities that promise 8%, 9%, or even double-digit returns in a world where Treasury yields are closer to 4%.

It sounds wonderful: higher income, more return. But here’s the essential truth of finance—yield is just the market’s way of pricing risk. Say it again. Yield is the price of risk. If you see a borrower paying 10%, it’s because that borrower cannot borrow at 5%. Why not? Because lenders view them as risky.

Private credit has grown enormously as traditional banks have pulled back from lending, and there’s a real role for it in financing certain companies. But for investors, it’s critical to remember what you’re buying. That extra yield is not free. It reflects a higher probability of default, weaker collateral, and illiquidity. If things go well, you collect 9%. If things go poorly, you may lose principal.

We think it’s prudent to be wary of the siren song of yield when it comes to the fixed-income portion of the portfolio, also known as the safer portion of the portfolio.

Gold and Cryptocurrency

The prices of both have risen dramatically over the last year. As for gold—another topic that comes up often when investors are nervous—we remain skeptical. Yes, gold has had a strong run lately, but much of that demand has come from central banks, particularly in emerging markets, who view it as a hedge against geopolitical risk and as a way to diversify away from the dollar. That kind of steady, institutional buying can certainly support prices, but what happens when that steady demand goes away? The fact that the price has risen doesn’t change the underlying reality for individual investors: gold doesn’t generate earnings, dividends, or interest. It just sits there, depending entirely on the willingness of the next buyer to pay more for it. Over long stretches of time, that has left many gold holders disappointed.

The same is true, to an even greater degree, of crypto. Recent rallies have been driven less by fundamental use cases and more by speculative fervor—investors piling in, not because they intend to use Bitcoin to pay for groceries, but because they hope to sell it at a higher price to the next buyer. This “greater fool” dynamic makes crypto far closer to a trading vehicle than a reliable store of value. Volatility remains extreme, regulation is unsettled, and unlike equities or bonds, crypto offers no stream of cash flows to anchor its value. We’d rather put our trust in businesses generating real earnings than in assets whose worth depends on the hope that someone else will want to pay more tomorrow.

Bubble talk

If you turn on CNBC, Bloomberg, or your favorite financial podcast, you’ll hear constant chatter about whether we’re in a bubble. While this can make for interesting commentary and it certainly drives an emotional narrative, we prefer to get our news from the market. As I mentioned earlier, the market price is set by buyers and sellers putting real capital at risk. Pundits and podcasters are trying to sell advertising. There is a big difference. But as Matt DeVries points out in his nearby article, relative to historical measures, valuations are high, and some pockets of the market appear downright frothy.

So, Benton, what is the news we are getting from the market? First, the market is looking to the future. The market is projecting that the US economy will remain resilient, that corporate earnings will continue to grow and that a recession is not in the cards in the near term. We think investors are also experiencing a certain amount of FOMO—fear of missing out—as they anticipate the far-reaching changes that will result from AI—changes that will impact every company and every human on earth. Uncertainty remains; investors can’t see exactly how our AI future will unfold. But ownership is key. Investors recognize that owning pieces (shares) of the many companies that will participate in this sea change is likely to be very important. To date, much of the focus has been on the so-called Magnificent 7, the handful of companies making the biggest AI investments, but we think future chapters will see the fruits of AI extend to every segment of the market.

Importantly, I could be wrong and the market could be wrong. Even as you read these words, you should tell yourself that we could be on the verge of recession, that the market might have hit an all-time high this week just before beginning an extended decline. We simply don’t know. No one does.

In closing, we are rebalancing portfolios. After the multi-year rally, we are trimming relative winners (stocks, and particularly stocks in leading sectors) and adding to relative laggers (bonds and in some cases, to stocks in lagging sectors). I think it is worth noting at times like this that you likely have more money in stocks today than you ever have. I’m guessing that might be exciting to some readers but worrisome to others. Regardless of your sentiment, I think it’s also worth noting that due to your portfolio being rebalanced regularly, you likely also have more money in bonds today than ever before. I hope that tidbit is useful and hope this commentary has been worthwhile as we run this marathon together.

I’m headed out for a slow jog. Thank you for trusting Bragg Financial.

Afterword

I shared this story about my son’s marathon with my father, Frank Bragg. Dad said it reminded him of when he ran a marathon almost 50 years ago, and of his parents’ reaction. I asked him to describe it.

Frank Bragg: I ran my first marathon in 1978. It was a new fad, and I was early to the sport. I believe it was the first or second Charlotte Observer Marathon held in Charlotte. A month after the race, I visited my parents in my hometown of Oxford, North Carolina. While there, I mentioned that I had recently run a marathon. My father looked at me blankly and said, “What is that?” I proudly told him and my mother that I had run 26.2 miles. Before sharing their reaction, I should share that my parents were somewhat provincial; they were raised on farms and hard work was a way of life. They lived through two world wars and the Great Depression. My father was always working; I don’t think I ever saw him enjoying leisure time or hobbies of any kind. My mother made it clear that she thought life was supposed to be a struggle. Upon hearing I had run 26.2 miles, my daddy looked away for a moment and was quiet. He then looked back at me and said, “Frank Junior, you ran 26 miles?”

“Yessir.”

“Son, don’t tell anyone you did that. They’ll think you’re crazy.” And he meant it.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.