The Ebb and Flow of Public Markets | Milken Institute Global Conference 2024

Panelist Backgrounds & Fundamentals

• Pedro (Norway's Government Pension Fund Global) manages approx. $1.5 trillion in assets, 98% allocated to public markets, and holds 3–4% in China.
• Todd, Kelly, and George (Citadel) emphasize bottom-up, fundamental analysis with static analyst coverage (30–50 names per analyst) to ensure deep expertise.
• The panelists characterize their approach as fundamentally driven, utilizing custom risk models to strip out factor tilts and isolate idiosyncratic company-specific risks.

State of Public Markets vs. Private Capital

• Public equity markets are currently undervalued relative to their opportunity set despite a decade-long bull market and a "cocky" private capital sector.
• Passive and algorithmic trading now drive marginal volume, creating significant dislocations that active managers can capitalize on.
• IPO activity remains at historical troughs, with IPOs as a percentage of market cap at record lows, though the environment is shifting from the pessimism of last year.
• Private market distributions to end allocators have been "measly" recently, suggesting a future shift as private equity firms seek liquidity and public exits.
• The panel argues that the "death of public markets" narrative is false, citing robust innovation and an alpha opportunity set comparable to historical highs.

Artificial Intelligence (AI) Investment Thesis

• The panel identifies a convergence of scale where only massive, cash-rich public companies possess the capital, data, and global reach to lead AI development.
• Unlike the late 1990s dot-com bubble, current valuations for leading AI firms are not "exorbitant" relative to their earnings and cash flow generation.
• Current Strategy: The panel is favoring the "picks and shovels" of the AI cycle (data center infrastructure, electrification, cooling) over speculative large language model (LLM) bets.
• Risks & Uncertainties: Key variables include the ownership of foundational models, the dominance of NVIDIA vs. competitors, and the control of intellectual property/data.
• Global Constraints: AI development is becoming geopolitically segmented, with a de facto "semiconductor closure pact" between the U.S., Taiwan, and the Netherlands limiting high-end compute access to China.
• Measurement Challenges: Isolating specific AI-driven revenue from traditional business lines is difficult, forcing investors to rely on a "trust me" factor regarding capital deployment efficiency.

Geographic Focus: China, India, and Emerging Markets

• China: Characterized as a compelling contrarian value play; trading at mid-to-upper teens free cash flow yields with improving shareholder-friendly behavior (buybacks/dividends), despite high geopolitical and regulatory risks.
• India: Viewed as a high-growth beneficiary of capital outflows from China, though valuations are considered "optimistic" (50–70x earnings for mid-single-digit growth).
• Investment Friction: Kelly notes difficulty applying fundamental valuation frameworks to China due to unpredictable regulatory shifts (e.g., the for-profit education sector wipeout) and lack of transparency.
• Demographics: Pedro highlights China's looming demographic collapse (population halving in 50 years) as a critical long-term risk, contrasting it with India's favorable demographics.

Market Structure & Passive Investing

• The dominance of passive investing and the rise of multi-manager funds are viewed as creating a "juggernaut" of non-fundamental trading that distorts short-term prices.
• Approximately $20 trillion in daily option trading activity exists, with nearly 49% being zero-day trades, fostering extreme short-termism.
• Active managers view this volatility and market truncation as a "massive opportunity" to buy assets cheaply and take the counter-party trade.
• The panel argues that while beta exposure should be cheap (passive), a robust pricing engine for idiosyncratic risk is essential for capital markets, which active firms provide.

Talent & Skill Sets for the Next Generation

• Panelists prioritize curiosity, resilience, and persistence as the most critical traits for new analysts.
• Success is defined by the ability to distinguish between bad outcomes from good processes versus bad processes from bad outcomes.
• A balance of IQ and EQ is deemed essential for relationship building and information gathering within the industry.

Additional Thematic Opportunities

• Commodities: A massive supply dearth in copper and mining sectors is identified, driven by a decade of underinvestment amidst a global push for electrification and high-end compute.
• Institutionalization of Alternatives: Publicly listed alternative asset managers (e.g., private equity platforms, BDCs) are seen as a new, consolidating public sector with strong growth potential.
• Green Transition: Renewable energy companies are described as "punished" assets due to rate hikes and supply chain issues, presenting potential value in the current environment.

Macro Outlook & Risk Management

• The panel does not foresee an imminent financial crisis comparable to the 2008 housing bubble or the 2020 pandemic, noting that many end markets have already recovered or bottomed.
• Confidence in long-duration investing is maintained by the belief that fundamental businesses are resilient to macro volatility.
• The Norway fund conducted stress testing assuming a divided world, estimating a potential 30% drop in fund market value, which informs their exposure management.
• Geopolitical uncertainty and election outcomes are viewed as catalysts for dislocation, which active managers prefer over the "smoothed" returns of private markets.