A few weeks ago, I started receiving a stream of message about an Instagram post that I was allegedly starring in, where after offering my views on Palantir's valuation, I was soliciting investors to invest with me (or with an investment entity that had ties to me). I was not surprised, since I have lived with imitations for years, but I was bemused, since I don't have an Instagram account and have not posted on Facebook more than once or twice in a decade. In the last few days, those warnings have been joined by others, who have noted that there is now a video that looks and sounds like me, adding to the sales pitch with promises of super-normal returns if they reach out, and presumably send their money in. (Please don't go looking for these scams online, since the very act of clicking on them can expose you to their reach.)     I would like to think that readers of my books or posts, or students in my classes, know me well enough to be able to tell that these are fakes, and while this is not the first time I have been targeted, it is clear that AI has upped the ante, in terms of creating posts and videos that look authentic. In response, I cycled through a series of emotions, starting with surprise that there are some out there who think that using my name alone will draw in investors, moving on to anger at the targeting of vulnerable investors and ending with frustration at the social media platforms that allow these fakes to exist. As a teacher, though, curiosity beat out all of these emotions, and I thought that the best thing that I can do, in addition to the fruitless exercise of notifying the social media companies about the fakes, is to talk about what these AI imitators got right, what they were off target on and what they got wrong in trying to create these fakes of me. Put simply, I plan to grade my AI imitator, as I would any student in my class, recognizing that being objective in this exercise will be tough to do. In the lead-in, though, I have to bore you with details of my professional life and thought process, since that is the key to creating a general framework that you will be able to use to detect AI imitations, since the game will only get more sophisticated in the years to come. An Easy Target?     In a post last year, I talked about a bot in my name, that was in development phase at NYU, and while officially sanctioned, it did open up existential challenges  for me. In discussing that bot, I noted that this bot had accessed everything that I had ever written, talked about or valued in my lifetime, and that I had facilitated its path by making that access easy. I will explain my rationale for the open access, and provide you with the links if you want to get to them, hoping to pre-empt those who will try to charge you for that content. My Open Access Policy     I have said this before, but there is no harm in saying it again, but I am a teacher, first and foremost, and almost every choice I make in my profession life reflects that mindset. A teacher, like an actor or singer, craves an audience, and the larger and more enthusiastic that audience, the better. When I started teaching in 1986, my audience was restricted to those in my physical classroom at NYU's business school, and my initial attempts at expanding that audience were very limited. I had video recorders set up to record my lectures, made three copies of each lecture tape, and put them on the shelves at NYU's library for patrons to check out and watch. The internet, for all of its sins, changed the game for me, allowing me to share not only class materials (slides, exams) but also my lecture videos, in online formats. Though my early attempts to make these conversions were primitive, the technology for recording classes and putting them online has made a quantum leap. In spring 2025, every one of my NYU classes was recorded by cameras that are built into classroom, the conversions to online videos happened in minutes, right after the class is done, and YouTube has been a game changer, in allowing access to anyone with an internet connection anywhere in the world.     As the internet has expanded its reach, and social media platforms have joined the mix, I have also shared the other components that go into my classes more widely, starting with the data on industry averages that I need and use in my own valuations, the spreadsheets that contain these valuations and blog posts on markets and companies and any other tools that I use in my own analyses. While I am happy to receive compliments for the sharing and praise for being unselfish, the truth is that my sharing is driven less by altruism (I am no Mother Theresa!) and more  by two other forces. The first is that, as I noted in my post on country equity risk premiums last week, there much of what I know or write about is pedestrian, and holding it in secret seems silly. The second is that, while I am not easily outraged, I am driven to outrage by business consultants and experts who state the obvious (replacing words you know with buzzwords and acronyms), while making outrageous claims of what they can deliver and charging their customers absurd amounts for their advice and appraisals. If I can save even a few of these customers from making these payments, I consider it to be a win. My Sharing Spots     Everything that I have ever written, worked on or taught is somewhere online, almost always with no protective shields (no passwords or subscriptions), and there are four places where you can find them: Webpage: The oldest platform for my content remains my webpage, damodaran.com, and while it can be creaky, and difficult to navigate, it contains the links to my writing, teaching, data, spreadsheets and other tools.  Teaching: I teach two classes at Stern, corporate finance and valuation, and have four other classes - a lead-into-valuation accounting class, a made-for-finance statistics class, a class on investment philosophies and one on corporate life cycles, and I described these classes in a post on teaching at the start of 2025. You can find them all by going to the teaching link on my webpage, https://people.stern.nyu.edu/adamodar/New_Home_Page/teaching.html including my regular classes (class material, lecture notes, exams and quizzes and webcasts of the classes) in real time, as well as archived versions from previous semesters. In addition, the online classes are at the same link, with material, post- class tests and webcasts of sessions for each class. This is also the place where you can find links to seminars that I teach in the rest of the world, with slides and materials that I used for those classes (though I have been tardy about updating these). Data: At the start of every year for the last three decades, I have shared my analysis of data on publicly traded companies, breaking down the data into corporate finance and valuation categories. This link, https://people.stern.nyu.edu/adamodar/New_Home_Page/data.html, will take you to the entry page, and you can then either access the most recent data (from the start of 2025, since I update only once a year, for most datasets) or archived data (from previous years). My raw data comes from a variety of sources, and in the interests of not stepping on the toes of my data providers, my data usually reflects industry averages, rather than company-specific data, but it does include regional breakdowns: US, Europe, Emerging Markets (with India and China broken out individually, Australia & Canada & New Zealand) and Japan.   Spreadsheets: I am not an Excel ninja, and while my spreadsheet-building skills are adequate, my capacity to make them look polished is limited. I do share the spreadsheets that I use in my classes and work here, with my most-used (by me) spreadsheet being one that I use to value most companies at this link, with a webcast explaining its usage. Books: I have written eleven books and co-edited one, spread out across corporate finance, valuation and investing, and you can find them all listed here. Many of these books are in their third or fourth editions, but with each one, you should find a webpage that contains supplementary material for that book or edition (slides, answers to questions at the end of each chapter, data, spreadsheets backing the examples). This is the only section of the spreadsheet where you may encounter a gatekeeper, asking you for a password, and only if you seek access to instructor material. If you are wondering what is behind the gate, it is only the powerpoint slides, with my notes on each slide, but the pdf versions of these slides should be somewhere on the same page, without need for a password. Papers: I don't much care much for academic research, but I do like to write about topics that interest or confound me, and you can find these papers at this link. My two most widely downloaded papers are updates I do each year on the equity risk premium (in March) and country risk premiums (in July). Much of the material in these papers has made its way into one or more of my books, and thus, if you find the books unaffordable, you can get that material here for free. Blog posts: I will confess that when I write my first blog post on September 17, 2008, I had no idea what a blog was, what I was doing with it, and whether it would last through the following week. In the years since, this blog has become my first go-to, when I have doubts or questions about something, and I am trying to resolve those doubts for myself. In short, my blog has becoming my therapy spot, in times of uncertainty, and I have had no qualms about admitting to these doubts. During 2020, as COVID made us question almost everything we know about markets and the economy, for instance, I posted on where I was in the uncertainty spectrum every week from February 14, 2020 (when the virus became a global problem, not one restricted to China and cruise ships) to November 2020, when the vaccine appeared. You can get all of those posts in one paper, if you click on this link. While my original blog was on Google, in the last two years, I have replicated these posts on Substack (you need to be a subscriber, but it is free) and on LinkedIn. If you are on the latter, you are welcome to follow me, but I have hit my connections limit (I did not even know there was one, until I hit it) and am unable to add connections. YouTube: For the last decade, I have posted my class videos on YouTube, grouping them into playlists for each class. You can start with the link to my YouTube channel here, but if you are interested in taking a class, my suggestion is that you click on the playlists and pick on the one that corresponds to the class. Here, for instance, are my links to my Spring 2025 MBA valuation class and my Spring 2025 Corporate Finance class. Starting about a decade, I have also accompanied every one of my blog posts with a YouTube video, that contains the same material, and you can find those posts in its own (very long) playlist.  X (Twitter): Some of you have strong feelings about X, with some of those feelings reflecting your political leanings and others driven by the sometimes toxic posting on the platform. I have been a user of the platform since April 2009, and I have used it as a bulletin board, to alert people to content being posted elsewhere. In fact, outside of these "alert" posts, I almost never post on X, and steer away as far away as I can from debates and discussions on the platform, since a version of Gresham's law seems to kick in, where the worst and least informed posters hijack the debate and take it in directions that you do not want it to go. I cannot think of a single item of content that I have produced in the last decade that is not on one of these platforms, making my professional life an open book, and thus also accessible to any AI entity. The Damodaran bot that I wrote about last year has access to all of this material, and while I signed off on that and one other variant, there are multiple unauthorized versions that have been works-in-progress.  The Commonalities     My content has taken many forms including posts, videos, data and spreadsheets, and is on multiple platforms, but there are a few common features that they share: Low tech: I am decidedly low tech, and it shows in my sharing. My website looks like it was designed two decades ago, because it was, and contains none of the bells and whistles that make for a modern website. My blog remains on Google blogger, notwithstanding everything I have been told about how using WordPress would make it more attractive/adaptable, and my posts are neither short nor punchy. Every week, I get people reaching out to me to tell me that my YouTube videos are far too long and verbose, and that I would get more people watching with shorter videos and catchier descriptions, and much as I appreciate their offers to help, I have not taken them up on it., In addition, I shoot almost every one of my videos in my office, sometimes with my dog in the background, and often with ambient noise and mistakes embedded, making them definitely unpolished.  On twitter, I have only recently taken to stringing tweets together and I have never used the long text version that some professional twitter users have mastered. In my defense, I could always claim that I am too old to learn new tricks, but the truth is that I did not start any of my sharing as a means to acquiring a larger social media following, and it may very well be true that keeping my presence low-tech operates as a screener, repelling mismatched users. Process over product: In my writing and teaching, I am often taken to task for not getting to the bottom line (Is the stock cheap or expensive? Should I buy or sell?) quickly, and spending so much time on the why and how, as opposed to the what. Much as my verbosity may frustrate you, it reflects what I think my job is as a teacher, which is to be transparent about process, i.e., explain how I reasoned my way to getting an answer than giving you my answer. Pragmatism over Purity: Though I am often criticized for being an “academic”, I am a terrible one, and if there were an academic fraternity, I would be shunned. I view much of an academic research as navel gazing, and almost everything I write and teach is for practitioners. Consequently, I am quick to adapt and modify models to make them fit both reality and the available data, and make assumptions that would make a purist blanch.  No stock picks or investment advice: In all my years of writing about and valuing markets and individual stocks, I have tried my best to steer away from making stock picks or offering investment advice. That may sound odd, since so much of what I do relates to valuation, and the essence of valuation is that you act on your estimates of value, but here is how I explain the contradiction. I value stocks (like Meta or Nvidia or Amazon or Mercado Libre) and I act (buy or sell) those stocks, based on my valuations, but it is neither my place nor my role to try to get other people to do the same. That said, I will share my story and valuation spreadsheet with you, and if you want to adapt that story/spreadsheet to make it your own, I am at peace with that choice, even if it is different from mine. The essence of good investing is taking ownership of your investment actions, and it is antithetical to that view of the world for me or anyone else to be telling you what to buy or sell. No commercial entanglements: If you do explore my content on any of the platforms it is available on, you will notice that they are free, both in terms of what you pay and how you access them. In fact, none of them are monetized, and if you do see ads on my YouTube videos, it is Google that is collecting the revenue, not me. One reason for this practice is that I am lazy, and monetizing any of these platforms requires jumping through hoops and catering to advertisers that I neither have the time nor the inclination to do. The other is that I believe (though this may be more hope than truth) that one of the reasons that people read what I write or listen to me is because, much as they may disagree with me, I am perceived as (relatively) unbiased. I fear that formalizing a link with any commercial entity (bank, consultant, investor), whether as advisor, consultant or as director, opens the door to the perception of bias. The one exception to the "no commercial entranglements' clause is for my teaching engagements, with the NYU Certificate program and for the handful of valuation seminars I teach in person in the rest of the world. I am grateful that NYU has allowed me to share my class recordings with the world, and I will not begrudge them whatever they make on my certificate classes, though I do offer the same content for free online, on my webpage. I am also indebted to the people and organizations that manage the logistics of my seminars in the rest of the world, and if I can make their life easier by posting about these seminars, I will do so.     The Imitation Game     Given that my end game in sharing is to give access to people who want to use my material, I have generally taken a lax view of others borrowing my slides, data, spreadsheets or even webcasts, for their own purposes. For the most part, I categorize this borrowing as good neighbor sharing, where just as I would lend a neighbor a key cooking ingredient to save them the trouble of a trip to the grocery store, I am at peace with someone using my material to help in their teaching, save time on a valuation or a corporate finance project, prepare for an interview, or even burnish their credentials. An acknowledgement, when this happens, is much appreciated, but I don't take it personally when none is forthcoming.  There are less benign copycat versions of the imitation game - selectively using data from my site to back up arguments, misreading or misinterpreting what I have said and reproducing large portions of my writing without acknowledgement. To be honest, if made aware of these transgressions, I have gently nudged the culprits, but I don't have a legal hammer to follow up. The most malignant variations of this game are scams, where the scammers use my content or name to separate people from their money - the education companies that used my YouTube videos and charge for classes, the data sites that copy my data or spreadsheets and sell them to people, and the valuation/investment sites that try to get people to invest money, with my name as a draw. Until now, I have tried, as best as I can, to let people know that they are being victimized, but for the most part, these scams have been so badly designed that they have tended to collapse under the weight of their own contradictions. It is clear to me that AI is now going to change this game, and that I will have to think about new ways to counter its insidious reach. To get a measure of what the current AI scams that are making the rounds get right and wrong, I did take the time to take a closer look at both the Instagram post and the fake video that are making the rounds.  What they get right: The Instagram post, which is in shown below, uses language that clearly is drawn from my posts and an image that is clearly mine. Not only does this post reflect the way I write, but it also picked Nvidia and  Palantir as the two firms to highlight,  the first a company that I own and have valued on my blog, and the second a company that I have been talking about as one that I am interested in owning, at the right price, giving it a patina of authenticity. The video looks and sounds like me, which should be no surprise since it had thousands of hours of YouTube videos to use as raw data. Using a yiddish word that I picked up in my days in New York, I have the give the scammers credit for chutzpah, on this front,, but I will take a notch off the grade, for the video's slickness, since my videos have much more of a homemade feel to them. What they struggled with most: The scam does mention that Palantir is "overhyped", a word that I use rarely, and while it talks about the company’s valuation, it is cagey about what that value is and there is little of substance to back up the claim. Palantir is a fascinating company, but to value it, you need a story of a data/software firm, with two channels for value creation, one of which looks at the government as a customer (a lower-margin, stickier and lower growth business) and the other at its commercial market (higher margin, more volatile and higher growth). Each of the stories has shades of grey, with the potential for overlap and conflict, but this is not a company where you can extrapolate the past, slap numbers on revenue growth and profitability, and arrive at a value. This post not only does not provide any tangible backing for its words in terms of value, but it does not even try. If these scammers had truly wanted to pull this off, they could have made their AI bot take my class, construct a plausible Palantir story, put it into my valuation spreadsheet and provide it as a link.  What they get wrong: To get a sense of what this post gets wrong, you should revisit the earlier part of the post where I talk about my sharing philosophy, and with as much distance as I can muster, here are the false notes in this scam. First, this scam pushes people to join an investment club, where I will presumably guide them on what to buy or sell. Given that my view of clubs is very much that of Groucho Marx, which is that I would not be belong to any club which would admit me as a member, the notion of telling people which stocks to buy cuts against every grain of my being. Second, there is a part of this scam where I purportedly promise investors who decide to partake that they will generate returns of 60% or higher, and as someone who has chronicled that not only do most active investors not keep up with the market, and argued that anyone who promises to deliver substantially more than the market in the long term is either a liar or fraud, this is clearly not me.  In sum, there is good news and bad news in this grading assessment. The good news is that this AI scam gets my language and look right, but it is sloppily done in terms of content and capturing who I am as a person. The bad news is that it if this scammer was less lazy and more willing to put in some work, even with the current state of AI, it would have been easy to bring up the grades on content and message. I will wager that the Damodaran Bot that I mentioned earlier on in this post that is being developed at NYU Stern would have created a post that would have been much more difficult for you to detect as fake, making it a Frankenstein monster perhaps in the making. The worse news is that AI technology is evolving, and it will get better on every one of these fronts at imitating others, and you should prepare yourself for a deluge of investment scams. An AI Protective Shield     I did think long about writing this post, wondering whether it would make a difference. After all, if you are a frequent reader of this blog or have read this post all the way down to this point, it is unlikely that you were fooled by the Instagram post or video. It remains an uncomfortable truth that the people most exposed to these scams are the ones who have read little or none of what I have written, and I wish there were a way that I could pass on the following suggestions on how they can protect themselves against the other fakes and scams that will undoubtedly be directed at them.  "Looks & sounds like" not good enough: Having seen the flood of fake AI videos in the news and on social media, I hope that you have concluded that “looks and sounds Iike” is no longer good enough to meet the authenticity test. This remains AI’s strongest suit, especially in the hands of the garden variety scammer, and you should prepare yourself for more fake videos, with political figures, investing luminaries and experts targeted. Steer away from arrogance & hype: I have always been skeptical of the notion that there is “smart” money, composed of investors who know more than the rest of us and are able to beat the market consistently, and for long periods. For the most part, when you see a group of investors (hedge funds, private equity) beating the market, luck is more of a contributor as skill, and success is fleeting. In a talk on the topic, I argued that investors should steer away from arrogance and bombast, and towards humility, when it comes to who they trust with their money, and that applies in spades in the world of AI scams. Since most scammers don’t understand the subtlety of this idea, screening investment sales pitches for outlandish claims alone will eliminate most scams. Do your homework: If you decide to invest with someone, based upon a virtual meet or sales pitch, you should do your homework and that goes well beyond asking for their track records in terms of performance. In my class on investment philosophies, I talk about how great investors through the ages have had very different views of markets and ways of making money, but each one has had an investment philosophy that is unique, consistent and well thought through. It is malpractice to invest with anyone, no matter what their reputation for earning high returns, without understanding that person’s investment philosophy, and this understanding will also give you a template for spotting fakes using that person’s name.  Avoid ROMO & FOMO: In my investing classes, I talk about the damage that ROMO (regret over missing out) and FOMO (fear of missing out) can do to investor psyches and portfolio.  With ROMO (regret over missing out), where you look back in time and regret not buying Facebook at its IPO price in 2012 or selling your bitcoin in  November 2013, when it hit $1000, you expose yourself to two emotions. The first is jealousy, especially at those who did buy Facebook at its IPO or have held on to their bitcoin to see its price hit six digits. The second is that you start buying into conspiracy theories, where you convince yourself that these winners (at least in the rear view mirror) were able to win, because the game was fixed in their favor. Both make you susceptible to chasing after past winners, and easy prey for vendors of conspiracies. With FOMO (fear of missing out), your overwhelming concern is that you will miss the next big multi-bagger, an investment that will increase five or ten fold over the next year or two. The emotion that is triggered is greed, leading you to overreach in your investing, cycling through your investments, as most of them fall short of your unrealistic expectations, and searching for the next “big thing”, making you susceptible to anyone offering a pathway to get there. Much as we think of scammers as the criminals and the scammed as the victims, the truth is that scams are more akin to tangos, where each side needs the other. The scammer’s techniques work because they trigger the emotions (fear, greed) of the scammed, to respond, and AI will only make this easier to do. Looking to regulators or the government to protection will do little more than offer false comfort, and the best defense is “caveat emptor” or “buyer beware”.  YouTube Video Links Webpage: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/home.htm  Blog:  (1) Google: https://aswathdamodaran.blogspot.com  (2) Substack: https://aswathdamodaran.substack.com  (3) LinkedIn: https://www.linkedin.com/in/aswathdamodaran/  YouTube https://www.youtube.com/channel/UCLvnJL8htRR1T9cbSccaoVw X: https://x.com/aswathdamodaran?lang=en

In this post, I will bring together two disparate and very different topics that I have written about in the past. The first is the role that cash holdings play in a business, an extension of the dividend policy question, with an examination of why businesses often should not pay out what they have available to shareholders. In my classes and writing on corporate finance, I look at the motives for businesses retaining cash, as well as how much cash is too much cash. The second is bitcoin, which can be viewed as either a currency or a collectible, and in a series of posts, I argued that bitcoin can only be priced, not valued, making debates about whether to buy or not to buy entirely a function of perception. In fact, I have steered away from saying much about bitcoin in recent years, though I did mention it in my post on alternative investments as a collectible (like gold) that can be added to the choice mix. While there may be little that seemingly connects the two topics (cash and bitcoin), I was drawn to write this post because of a debate that seems to be heating up on whether companies should put some or a large portion of their cash balances into bitcoin, with the success of MicroStrategy, a high-profile beneficiary of this action, driving some of this push. I believe that it is a terrible idea for most companies, and before Bitcoin believers get riled up, my reasoning has absolutely nothing to do with what I think of bitcoin as an investment and more to do with how little I trust corporate managers to time trades right. That said, I do see a small subset of companies, where the holding bitcoin strategy makes sense, as long as there are guardrails on disclosure and governance. Cash in a Going Concern     In a world where businesses can raise capital (equity or debt) at fair prices and in a timely manner, there is little need to hold cash, but that is not the world we live in. For a variety of reasons, some internal and some external, companies are often unable or unwilling to raise capital from markets, and with that constraint in place, it is logical to hold cash to meet unforeseen needs. In this section, I will start by laying out the role that cash holdings play in any business, and examine how much cash is held by companies, broken down by groupings (regional, size, industry).  A Financial Balance Sheet     To understand the place of cash in a business, I will start with a  financial balance sheet, a structure for breaking down a business, public or private: On the asset side of the balance sheet, you start with the operating business or businesses that a company is in, with a bifurcation of value into value from investments already made (assets-in-place) and value from investments that the company expects to make in the future (growth assets). The second asset grouping, non-operating assets, includes a range of investments that a company may make, sometimes to augment its core businesses (strategic investments), and sometimes as side investments, and thus include minority holdings in other companies (cross holdings) and even investments in financial assets. Sometimes, as is the case with family group companies, these cross holdings may be a reflection of the company's history as part of the group, with investments in other group companies for either capital or corporate control reasons. The third grouping is for cash and marketable securities, and this is meant specifically for investments that share two common characteristics - they are riskless or close to riskless insofar as holding their value over time and they are liquid in the sense that they can be converted to cash quickly and with no penalty. For most companies, this has meant investing cash in short-term bonds or bills, issued by either governments (assuming that they have little default risk) or by large, safe companies (in the form of commercial paper issued by highly rated firms).      Note that there are two sources of capital for any business, debt or equity, and in assessing how levered a firm is, investors look at the proportion of the capital that comes from each: Debt to Equity = Debt/ Equity Debt to Capital = Debt/ (Debt + Equity) In fact, there are many analysts and investors who estimate these debt ratios, using net debt, where they net the cash holdings of a company against the debt, with the rationale, merited or not, that cash can be used to pay down debt. Net Debt to Equity = (Debt-Cash)/ Equity Debt to Capital = (Debt-Cash)/ (Debt + Equity) All of these ratios can be computed using accounting book value numbers for debt and equity or with market value numbers for both.  The Motives for holding Cash     In my introductory finance classes, there was little discussion of cash holdings in companies, outside of the sessions on working capital. In those sessions, cash was introduced as a lubricant for businesses, necessary for day-to-day operations. Thus, a retail store that had scores of cash customers, it was argued, needed to hold more cash, often in the form of currency, to meet its transactional needs, than a company with corporate suppliers and business customers, with predictable patterns in operations. In fact, there were rules of thumb that were developed on how much cash a company needed to have for its operations. As the world shifts away from cash to digital and online payments, this need for cash has decreased, but clearly not disappeared. The one carve out is the financial services sector, where the nature of the business (banking, trading, brokerage) requires companies in the sector to hold cash and marketable securities as part of their operating businesses.     If the only reason for holding cash was to cover operating needs, there would be no way to justify the tens of billions of dollars that many companies hold; Apple alone has often had cash balances that exceeded $200 billion, and the other tech giants are not far behind. For some companies, at least, the rationale for holding far more cash than justified by their operating needs is that it can operate as a shock absorber, something that they can fall back on during periods of crisis or to cover unexpected expenses. That is the reason that cyclical and commodity firms have often offered for holding large cash balances (as a percent of their overall firm value), since a recession or a commodity price downturn can quickly turn profits to losses.    Using the corporate life cycle structure can also provide insight into how the motives for holding cash can change as a company ages.   For start-ups, that are either pre-revenue or have very low revenues, cash is needed to keep the business operating, since employees have to be paid and expenses covered. Young firms that are money-losing and with large negative cash flows, hold cash to cover future cash flow needs and to fend off the risk of failure. In effect, these firms are using cash as life preservers, where they can make it through periods where external capital (venture capital, in particular) dries up, without having to sell their growth potential at bargain basement prices. As firms start to make money, and enter high growth, cash has use as a business scalar, for firms that want to scale up quickly. In mature growth, cash acquires optionality, useful in allowing the business to find new markets for its products or product extensions.  Mature firms sometimes hold cash as youth serum, hoping that  it can be used to make once-in-a-lifetime investments that may take them back to their growth days, and for declining firms, cash becomes a liquidation manager, allowing for the orderly repayment of debt and sale of assets.     There is a final rationale for holding cash that is rooted in corporate governance and the control and power that comes from holding cash. I have long argued that absent pressure from shareholders, managers at most publicly traded firms would choose to return very little of the cash that they generate, since that cash balance not only makes them more sought after (by bankers and consultants who are endlessly inventive about uses that the cash can be put to) but also gives them the power to build corporate empires and create personal legacies. Corporate Cash Holdings     Given the multitude of reasons for holding cash, it should come as no surprise that publicly traded companies around the world have significant cash balances. Leading into July 2025, for instance, global non-financial-service firms held almost $11.4 trillion in cash and marketable securities; financial service firms held even more in cash and marketable securities, but those holdings, as we noted earlier, can represent their business needs. Using our earlier breakdown of the asset side of the balance sheet into cash, non-operating and operating assets, this is what non-financial service firms in the aggregate looked like in book value terms (global and just US firms): Note that cash is about 11% of the book value of total assets, in the aggregate, for global firms, and about 9% of the book value of total assets, for US firms. Global firms do hold a higher percentage of their value in non-operating assets, but US firms are more active on the acquisition front, explaining why goodwill (which is triggered almost entirely by acquisitions) is greater at US firms.     The typical publicly traded firm holds a large cash balance, but there are significant differences in cash holdings, by sector. In the table below, I look at cash as a percent of total assets, a book value measure, as well as cash as a percent of firm value, computed by aggregating market values: As you can see, technology firms, which presumably face more uncertainty about their future hold far more cash as a percent of book value, but the value that the market attaches to their growth brings down cash as a percent of firm value. Utilities, regulated and often stable businesses, tend to hold the least cash, both in book and market terms.      Breaking down the sample by region, I look at cash holdings, as a percent of total assets and firms, across the globe: The differences across the globe can be explained by a mix of market access, with countries in parts of the world where it can be difficult to access capital (Latin America, Eastern Europe, Africa) holding more cash. In addition, and corporate governance, with cash holdings being greater in parts of the world (China, Russia) where shareholders have less power over managers.      Given the earlier discussion of how the motives for holding cash can vary across the life cycle, I broke the sample down by age decile, with age measured from the year of founding, and looked at cash holdings, by decile: The results are mixed, with cash holdings as a percent of total assets being higher for the younger half of the sample (the top five deciles) than for the older half, but the is no discernible pattern, when cash is measured as a percent of firm value (market). Put simple, companies across the life cycle hold cash, though with different motives, with the youngest firms holding on to cash as lifesavers (and for survival) and the older firms keeping cash in the hopes that they can use it to rediscover their youth. The Magic of Bitcoin     I have been teaching and working with investments now for four decades, and there has been no investment that has received as much attention from both investors and the financial press, relative to its actual value, as has bitcoin. Some of the draw has come from its connections to the digital age, but much of it has come from its rapid rise in price that has made many rich, with intermittent collapses that have made just as many poor. I am a novice when it comes to crypto, and while I have been open about the fact that it is not my investment preference, I understand its draw, especially for younger investors. The Short, Eventful History of Bitcoin     The origin story for Bitcoin matters since it helps us understand both its appeal and its structure. It was born in November 2008, two months into one of the worst financial crises of the last century, with banks and governments viewed as largely responsible for the mess. Not surprisingly, Bitcoin was built on the presumption that you cannot trust these institutions, and its biggest innovation was the blockchain, designed as a way of crowd-checking transactions and preserving transaction integrity. I have long described Bitcoin as a currency designed by the paranoid for the paranoid, and I have never meant that as a critique, since in the  untrustworthy world that we live in, paranoia is a justifiable posture.     From its humble beginnings, where only a few (mostly tech geeks) were aware of its existence, Bitcoin has accumulated evangelists, who argue that it is the currency of the future, and speculators who have used its wild price swings to make and lose tens of millions of dollars. In the chart below, I look at the price of bitcoin over the last decade, as its price has increased from less than $400 in September 2014 to more than $110,000 in June 2025: Along the way, Bitcoin has also found some acceptance as a currency, first for illegal activities (drugs on the Silk Road) and then as the currency for countries with failed fiat currencies (like El Salvador), but even Bitcoin advocates will agree that its use in transactions (as the medium of exchange) has not kept pace with its growth as a speculative trade.  Pricing Bitcoin     In a post in 2017,  I divided investments into four groups - assets that generate cash flows (stocks, bonds, private businesses), commodities that can be used to produce other goods  (oil, iron ore etc), currencies that act as mediums of exchange and stores of value and collectibles that are priced based on demand and supply: You may disagree with my categorization, and there are shades of gray, where an investment can be in more than one grouping. Gold, for instance, is both a collectible of long standing and a commodity that has specific uses, but the former dominates the latter, when it comes to pricing. In the same vein, crypto has a diverse array of players, with a few meeting the asset test and some (like ethereum) having commodity features. The contrast between the different investment classes also allows for a contrast between investing, where you buy (sell) an investment if it is under (over) valued, and trading, where you buy (sell) an investment if you expect its price to go up (down). The former is a choice, though not a requirement, with an asset (stocks, bonds or private businesses), though there may be others who still trade that asset. With currencies and collectibles, you can only trade, making judgments on price direction, which, in turn, requires assessments of mood and momentum, rather than fundamentals.      With bitcoin, this classification allows us to cut through the many distractions that pop up during discussions of its pricing level, since it can be framed either as a currency or a collectible, and thus only priced, not valued. Seventeen years into its existence, Bitcoin has struggled on the currency front, and while there are pockets where it has gained acceptance, its design makes it inefficient and its volatility has impeded its adoption as a medium of exchange. As a collectible, Bitcoin starts with the advantage of scarcity, restricted as it is to 21 million units, but it has not quite measured up, at least so far, when it comes to holding its value (or increasing it) when financial assets are in meltdown mode. In every crisis since 2008, Bitcoin has behaved more like risky stock, falling far more than the average stock, when stocks are down, and rising more, when they recover. I noted this in my posts looking at the performance of investments in both the first quarter of 2020, when COVID laid waste to markets, and in 2022, when inflation ravaged stock and bond markets. That said, it is still early in its life, and it is entirely possible that it may change its behavior as it matures and draws in a wider investor base. The bottom line is that discussions of whether Bitcoin is cheap or expensive are often pointless and sometimes frustrating, since it depends almost entirely on your perspective on how the demand for Bitcoin will shift over time. If you believe that its appeal will fade, and that it will be displaced by other collectibles, perhaps even in the crypto space, you will be in the short selling camp. If you are convinced that its appeal will not just endure but also reach fresh segments of the market, you are on solid ground in assuming that its price will continue to rise. It behooves both groups to admit that neither has a monopoly on the truth, and this is a disagreement about trading and not an argument about fundamentals. The MicroStrategy Story     It is undeniable that one company, MicroStrategy, has done more to advance the corporate holding of Bitcoin than any other, and that has come from four factors; A stock market winner: The company's stock price has surged over the last decade, making it one of the best performing stocks on the US exchanges:  It is worth noting that almost all of the outperformance has occurred in this decade, with the winnings concentrated into the last two years.  With the rise (increasingly) tied to Bitcoin: Almost all of MicroStrategy’s outperformance has come from its holdings of bitcoin, and not come from improvements in business operations. That comes through in the graph below, where I look at the prices of MicroStrategy and Bitcoin since 2014:   Note that MicroStrategy’s stock price has gone from being slightly negatively correlated with Bitcoin’s price between 2014-2018 to tracking Bitcoin in more recent years. And disconnected from operations: In 2014, MicroStrategy was viewed and priced as a software/services tech company, albeit a small one with promise. In the last decade, its operating numbers have stagnated, with both revenues and gross profits declining, but during the same period, its enterprise value has soared from $1 billion in 2014 to more than more than $100 billion in July 2025: It is clear now that anyone investing in MicroStrategy at its current market cap (>$100 billion) is making a bitcoin play. With a high-profile "bitcoin evangelist" as CEO:  MicroStrategy’s CEO, Michael Saylor, has been a vocal and highly visible promoter of bitcoin, and has converted many of his shareholders into fellow-evangelists and convinced at least some of them that he is prescient in detecting price movements. In recent years, he has been public in his plans to issue increasing amounts of stock and using the proceeds to buy more bitcoin. In sum, MicroStrategy is now less a software company and more a Bitcoin SPAC or closed-end fund, where investors are trusting Saylor to make the right trading judgments on when to buy (and sell) bitcoin, and hoping to benefit from the profits.  The “Put your cash in bitcoin” movement      For investors in other publicly traded companies that have struggled delivering value in their operating businesses, MicroStrategy’s success with its bitcoin holdings seems to indicate a lost opportunity, and one that can be remedied by jumping on the bandwagon now. In recent months, even high profile companies, like Microsoft, have seen shareholder proposals pushing them to abandon their conventional practice of holding cash in liquid and close-to-riskless investments and buying Bitcoin instead. Microsoft’s shareholders soundly rejected the proposal, and I will start by arguing that they were right, and that for most companies, investing cash in bitcoin does not make sense, but in the second part, I will carve out the exceptions to this rule. The General Principle: No to Bitcoin     As a general rule, I think it is not only a bad idea for most companies to invest their cash in bitcoin, but I would go further and also argue that they should banned from doing so. Let me hasten to add that I would make this assertion even if I was bullish on Bitcoin, and my argument would apply just as strongly to companies considering moving their cash into gold, Picassos or sports franchises, for five reasons: Bitcoin does not meet the cash motives: Earlier in this post, I noted the reasons why a company  holds cash, and, in particular, as a shock absorber, steadying a firm through bad times. Replacing low-volatility cash with high-volatility bitcoin would undercut this objective, analogous to replacing your shock absorbers with pogo sticks. In fact, given the history of moving with stock prices, the value of bitcoin on a company's balance sheet will dip at exactly the times where you would need it most for stability. The argument that bitcoin would have made a lot higher returns for companies than holding cash is a non-starter, since companies should hold cash for safety. Bitcoin can step on your operating business narrative: I have long argued that successful businesses are built around narratives that incorporate their competitive advantages. When companies that are in good businesses put their cash in bitcoin, they risk muddying the waters on two fronts. First, it creates confusion about why a company with a solid business narrative from which it can derive value would seek to make money on a side game. Second, the ebbs and flows of bitcoin can affect financial statements, making it more difficult to connect operating results to story lines.  Managers as traders? When companies are given the license to move their cash into bitcoin or other non-operating investments, you are trusting managers to get the timing right, in terms of when to buy and sell these investments. That trust is misplaced, since top managers (CEOs and CFOs) are for the most part terrible traders, often buying at the market highs and selling at lows. Leave it to shareholders: Even if you are unconvinced by the first three reasons, and you are a bitcoin advocate or enthusiast, you will be better served pushing companies that you are a shareholder in, to return their cash to you, to invest in bitcoin, gold or any other investment at your chosen time. Put simply, if you believe that Bitcoin is the place to put your money, why would you trust corporate managers to do it for you? License for abuse: I am a skeptic when it comes to corporate governance, believing that managerial interests are often at odds with what's good for shareholders. Giving managers the permission to trade crypto tokens, bitcoin or other collectibles can open the door for self dealing and worse.  While I am a fan of letting shareholders determine the limits on what managers can or cannot do, I believe that the SEC (and other stock market regulators around the world) may need to become more explicit in their rules on what companies can (and cannot) do with cash. The Carveouts     I do believe that there are cases when you, as a shareholder, may be at peace with the company not only investing cash in bitcoin, but doing so actively and aggressively. Here are four of my carveouts to the general rule on bitcoin: The Bitcoin Savant: In my earlier description of MicroStrategy, I argued that shareholders in MicroStrategy have not only gained immensely from its bitcoin holdings, but also trust Michael Saylor to trade bitcoin for them. In short, the perception, rightly or wrongly, is that Saylor is a bitcoin savant, understanding the mood and momentum swings better than the rest of us. Generalizing, if a company has a leader (usually a CEO or CFO) who is viewed as someone who is good at gauging bitcoin price direction, it is possible that shareholders in the company may be willing to grant him or her the license to trade bitcoin on their behalf.  This is, of course, not unique to bitcoin, and you can argue that investors in Berkshire Hathaway have paid a premium for its stock, and allowed it leeway to hold and deploy immense amounts of cash because they trusted Warren Buffett to make the right investment judgments.  The Bitcoin Business: For some companies, holding bitcoin may be part and parcel of their business operations, less a substitute for cash and more akin to inventory. PayPal and Coinbase, both of which hold large amounts of bitcoin, would fall into this carveout, since both companies have business that requires that holding. The Bitcoin Escape Artist: As some of you may be aware, I noted that Mercado Libre, a Latin American online retail firm, is on my buy list, and it is a company with a fairly substantial bitcoin holding. While part of that holding may relate to the operating needs of their fintech business, it is worth noting that Mercado Libre is an Argentine company, and the Argentine peso has been a perilous currency to hold on to, making bitcoin a viable option for cash holdings. Generalizing, companies in countries with failed currencies may conclude that holding their cash in bitcoin is less risky than holding it in the fiat currencies of the locations they operate in. The Bitcoin Meme: There is a final grouping of companies that I would put in the meme stock category, with AMC and Gamestop heading that list. These companies have operating business models that have broken down or have declining value, but they have become, by design or through accident, trading plays, where the price bears no resemblance to operating fundamentals and is instead driven by mood and momentum. If that is the case, it may make sense for these companies to throw in the towel on operating businesses entirely and instead make themselves even more into trading vehicles by moving into bitcoin, with the increased volatility adding to their "meme" allure. Even with these exceptions, though, I think that you need guardrails before signing off on opening the door to letting companies hold bitcoin. Shareholder buy-in: If you are a publicly traded company considering investing some or much of the company's cash in bitcoin, it behooves you to get shareholder approval for that move, since it is shareholder cash that is being deployed.  Transparency about Bitcoin transactions/holdings: Once a company invests in bitcoin, it is imperative that there be full and clear disclosure not only on those holdings but also on trading (buying and selling) that occurs. After all, if it is a company's claim that it can time its bitcoin trades better than the average investor, it should reveal the prices at which it bought and sold its bitcoin.  Clear mark-to-market rules: If a company invests its cash in bitcoin, I will assume that the value of that bitcoin will be volatile, and accounting rules have to clearly specify how that bitcoin gets marked to market, and where the profits and losses from that marking to market will show up in the financial statements.  As bitcoin prices rise to all time highs, there is the danger that regulators and rule-writers will be lax in their rule-writing, opening the door to corporate scandals in the future. Cui Bono?     Bitcoin advocates have been aggressively pushing both institutional investors and companies to include Bitcoin in their investment choices, and it is true that at least first sight, they will benefit from that inclusion. Expanding the demand for bitcoin, an investment with a fixed supply, will drive the price upwards, and existing bitcoin holders will benefit. In fact, much of the rise of bitcoin since the Trump election in November 2024 can be attributed to the perception that this administration will ease the way for companies and investors to join in the crypto bonanza.     For bitcoin holders, increasing institutional and corporate buy-in to bitcoin may seem like an unmixed blessing, but there will be costs that, in the long run, may lead at least some of them to regret this push: Different investor base: Drawing in institutional investors and companies into the bitcoin market will not only change its characteristics, but put traders who may know how to play the market now at a disadvantage, as it shifts dynamics. Here today, gone tomorrow? Bitcoin may be in vogue now, but what will the consequences be if it halves in price over the next six months? Institutions and companies are notoriously ”sheep like” in their behavior, and what is in vogue today may be abandoned tomorrow. If you believe that bitcoin is volatile now, adding these investors to the mix will put that volatility on steroids. Change asset characteristics: Every investment class that has been securitized and brought into institutional investing has started behaving like a financial asset, moving more with stocks and bonds than it has historically. This happened with real estate in the 1980s and 1990s, with mortgage backed securities and other tradable versions of real estate, making it far more correlated with stock and bonds, and less of a stand alone asset.  If the end game for bitcoin is to make it millennial gold, an alternative or worthy add-on to financial assets, the better course would be steer away from establishment buy-in and build it up with an alternative investor base, driven by different forces and motives than stock and bond markets.  YouTube Video

It is true that most investing lessons are directed at those who invest only in stocks and bonds, and mostly with long-only strategies. It is also true that in the process, we are ignoring vast swaths of the investment universe, from other asset classes (real estate, collectibles, cryptos) to private holdings (VC, PE) to strategies that short stocks or use derivatives (hedge funds). These ignored investment classes are what fall under the rubric of alternative investments, and while many of these choices have been with us for as long as we have had financial markets, they were accessible to only a small subset of investors for much of that period. In the last two decades, alternative investments have entered the mainstream, first with choices directed at institutional investors, but more recently, in offerings for individual investors. Without giving too much away, the sales pitch for adding alternative investments to a portfolio composed primarily of stocks and bonds is that the melding will create a better risk-return tradeoff, with higher returns for any given risk level, albeit with two different rationales. The first is that they have low correlations with financial assets (stocks and bonds), allowing for diversification benefits and the second is investments in some of these alternative asset groupings have the potential to earn excess returns or alphas. While the sales pitch has worked, at least at the institutional level, in getting buy-in on adding alternative investments, the net benefits from doing so have been modest at best and negative at worst, raising questions about whether there need to be more guardrails on getting individual investors into the alternative asset universe. The Alternative Investment Universe     The use of the word "alternative" in the alternative investing pitch is premised on the belief that much of investing advice is aimed at long-only investors allocating their portfolios between traded stocks, bonds and cash (close to riskless and liquid investments). In that standard investment model, investors choose a stock-bond mix, for investing, and use cash as a buffer to bring in not only liquidity needs and risk preferences, but also views on stock and bond markets (being over or under priced): The mix of stocks and bonds is determined both by risk preferences, with more risk taking associated with a higher allocation to stocks, and market timing playing into more invested in stocks (if stocks are viewed as under priced) or more into bonds (if stocks are over priced and bond are viewed as neutral investments).      This framework accommodates a range of choices, from the purely mechanical (like the much touted 60% stocks/40% bonds mix) to more flexible, where allocations can vary across time and be a function of market conditions. This general framework allows for variants, including different view on markets (from those who believe that markets are efficient to stock pickers and market timers) as well as investors with very different time horizons and risk levels. However, there are clearly large segments of investing that are left out of this mix from private businesses (since they are not listed and traded) to short selling (where you can have negative portfolio weights not just on individual investments but on entire markets) to asset classes that are not traded. In fact, the best way to structure the alternative investing universe if by looking at alternatives through the lens of these missing pieces. 1. Long-Short    In principle, there is little difference between being long on an investment and holding a short position, with the only real difference being in the sequencing of cash flows, with the former requiring a negative cash flow at the time of the action (buying the stock or an asset) and a positive cash flow in a subsequent period (when it is sold), and the latter reversing the process, with the positive cash flow occurring initially (when you sell a stock or an asset that you do not own yet) and the negative cash flow later. That said, they represent actions that you would take with diametrically opposite views of the same stock (asset), with being long (going short) making sense on assets where you expect prices to go up (down). In practice, though, regulators and a subset of investors seem to view short selling more negatively, often not just attaching loaded terms like "speculation" to describe it, but also adding restrictions of how and when it can be done.     Many institutional investors, including most mutual, pension and endowment funds, are restricted from taking short positions on investments, with exceptions sometimes carved out for hedging. For close to a century, at least in the United States, hedge funds have been given the freedom to short assets, and while they do not always use that power to benefit, it is undeniable that having that power allows them to create return distributions (in terms of expected returns, volatility and other distributional parameters) that are different from those faced by long-only investors. Within the hedge fund universe, there are diverse strategies that not only augment long-only strategies (value, growth) but also invest across multiple markets (stocks, bonds and convertibles) and geographies.     The opening up of derivatives markets has allowed some investors to create investment positions and or structured products that use options, futures, swaps and forwards to create cash flow and return profiles that diverge from stock and bond market returns.  2. Public-Private     While much of our attention is spent on publicly traded stocks and bonds, there is a large segment of the economy that is composed of private businesses that are not listed or traded. In fact, there are economies, especially in emerging markets, where the bulk of economic activity occurs in the private business space, with only a small subset of businesses meeting the public listing/trading threshold. Many of these private businesses are owned and funded by their owners, but a significant proportion do need outside equity capital, and historically, there have been two providers: For young private businesses, and especially those that aspire to become bigger and eventually go public, it is venture capital that fills the void, covering the spectrum from angel financing for idea businesses to growth capital for firms further along in their evolution. From its beginnings in the 1950s, venture capital has grown bigger and carries more heft, especially as technology companies have come to dominate the market in the twenty first century. For more established private businesses, some of which need capital to grow and some of which have owners who want to cash out, the capital has come from private equity investors. Again, while private equity has been part of markets for a century or more, it has become more formalized and spread its reach in the last four decades, with the capacity to raise tens of billions of dollars to back up deal making. On the debt front, the public debt and bank debt market is supplemented by private credit,  where investors pool funds to lend to private businesses, with negotiated rates and terms. again a process that has been around a while, but one that has also become formalized and a much larger source of funds. Advocates for private credit investing argue that it can be value-adding partly because of the borrower composition (often cut off from other sources of credit, either because of their size or default history) and partly because private credit providers can be more discerning of true default risk. Even as venture capital, private equity and private credit have expanded as capital sources, they remained out of reach for both institutional and individual investors until a couple of decades ago, but are now integral parts of the alternative investing universe. 3. Asset classes     Public equity and debt, at least in the United States, cover a wide spectrum of the economy, and by extension, multiple asset classes and businesses, but there are big investment classes that are either underrepresented in public markets or missing. Real estate: For much of the twentieth century, real estate remained outside the purview of public markets, with a segmented investor base and illiquid investments, requiring localized knowledge. That started to change with the creation of real estate investment trusts, which securitized a small segment of the market, creating liquidity and standardized units for public market investors. The securitization process gained stream in the 1980s with the advent of mortgage-backed securities. Thus, real estate now has a presence in public markets, but that presence is far smaller than it should be, given the value of real estate in the economy. Collectibles: The collectible asset class spans an array of investment, most of which generate little or no cash flows, but derive their pricing from scarcity and enduring demand. The first and perhaps the longest standing collectible is gold, a draw for investors during inflationary period or when they lose faith in fiat currencies and governments. The second is art, ranging from paintings from the masters to digital art (non-fungible tokens or NFTs), that presumably offers owners not just financial returns but emotional dividends. At the risk of raising the ire of crypto-enthusiasts, I would argue that much of the crypto space (and especially bitcoin) also fall into this grouping, with a combination of scarcity and trading demand determining pricing.  Institutional and individual investors have dabbled with adding these asset classes to their portfolios, but the lack of liquidity and standardization and the need for expert assessments (especially on fine art) have limited those attempts. The Sales Pitch for Alternatives     The strongest pitch for adding alternative investments to a portfolio dominated by publicly traded stocks and bonds comes from a basic building block for portfolio theory, which is that adding investments that have low correlation to the existing holdings in a portfolio can create better risk/return tradeoffs for investors. That pitch has been supplemented in the last two decades with arguments that alternative investments also offer a greater chance of finding market mistakes and inefficiencies, partly because they are more likely to persist in these markets, and partly because of superior management skills on the part of alternative investment managers, particularly hedge funds and private equity. The Correlation Argument     Much of portfolio theory as we know it is built on the insight that combining two investments that are not perfectly correlated with each other can yield mixes that deliver higher returns for any given level of risk than holding either of the investments individually. That argument has both a statistical basis, with the covariance between the two investments operating as the mechanism for the risk reduction, and an economic basis that the idiosyncratic movements in each investment can offset to create a less risky combination.      In that vein, the argument for adding alternative investments to a portfolio composed primarily of stocks and bonds rests on a correlation matrix of stocks and bonds with alternative investments (hedge funds, private equity, private credit, fine art, gold and collectibles): Guggenheim Investments While the correlations in this matrix are non-stationary (with the numbers changing both with time periods used and the indices that stand in for the asset classes) and have a variety of measurement issues that I will highlight later in this post, it is undeniable that they at least offer a chance of diversification that may not be available in a long-only stock/bond portfolio.     Using historical correlations as the basis, advocates for alternative investments are able to create portfolios, at least on paper, that beat stock/bond combinations on a risk/return tradeoff, as can be see in this graph: EquityMultiple Investment Partners, Green Street Advisors, and JPMorgan Asset Management Note that the comparison is to a portfolio composed 60% of stocks and 40% of bonds, a widely used mix among portfolio managers, and in each of the cases, adding alternative investments to that portfolio results in a mix that yields  higher returns with lower risk. The Alternative Alpha Argument     The correlation-based argument for adding alternative investments to a portfolio is neither new nor controversial, since it is built on core portfolio theory arguments for diversification. For some advocates of alternative investments, though, that captures only a portion of the advantage of adding alternative investments. They argue that the investment classes from alternative investments draw on, which include non-traded real estate, collectibles and private businesses (young and old), are also the classes where market mistakes are more likely to persist, because of their illiquidity and opacity, and that alternative asset managers have the localized knowledge and intellectual capacity to find and take advantage of these mistakes. The payoff from doing so takes the form of "excess returns" which will supplement the benefits that flow from just diversification.     This alpha argument is often heard most frequently with those advocating for adding hedge funds, venture capital and private equity to conventional portfolios, where the perception of superior investment management persists, but is that perception backed up by the numbers? In the graph below, I reproduce a study that looks at looked at 20-year annualized returns, from 2003 to 2022, on many alternative asset classes: Opto Insights Given the differences in risk across alternative investment classes, the median returns themselves do not tell us much about whether they earn excess returns, but two facts come through nevertheless. The first is that the variation across managers within investment classes is significant in both private equity and venture capital. The second, and this is not visible in this graph, is that persistence in outperformance is more common in venture capital and private equity than it is in public market investors, with winners more likely to continue winning and losers dropping out. I expanded on some of the reasons for this persistence, at least in venture capital, in a post from some years ago.    The bottom line is that there is some basis for the argument that as investment classes, hedge funds, private equity and venture capital, generate excess returns, albeit modest, relative to other investors, but it is unclear whether these excess returns are just compensation for the illiquidity and opacity that go with the investments that they have to make. In addition, given the skewed payoffs, where there are a few big and persistent winners, the median hedge fund, private equity investor or venture capitalist may be no better at generating alpha than the average mutual fund manager. The Rise of Alternative Investing     No matter what you think of the alternative investing sales pitch, it is undeniable that it has worked, at least at the institutional investor level, for some of its adopted, especially in the last two decades. In the graph below, for instance, you can track the rise of alternative investments in pension fund holdings in this graph (from KKR): Source: KKR That move towards alternatives is not just restricted to pension funds, as other allcators have joined the mix: Source: KKR Some of the early movers into alternative asset classes were lauded and used as role models by others in the space. David Swensen, at Yale, for instance, burnished a well-deserved reputation as a pioneer in investment management by moving Yale's endowment into private equity and hedge funds earlier than other Ivy League schools, allowing Yale to outpace them in the returns race for much of this century: As other fund managers have followed Yale into the space, that surge has been good for private equity and hedge fund managers, who have seen their ranks grow (both in terms of numbers and dollar value under management) over time. Where's the beef?     As funds have increased their allocations to alternative investments, drawn by the perceived gains on paper and the success of early adopters, it is becoming increasingly clear that the results from the move have been underwhelming. In short, the actual effects on returns and risk from adding alternative investments to portfolios are not matching up to the promise, leading to questions of why and where the leakage is occurring.   The Questionable Benefits of Alternative Investing     In theory and principle, adding investments from groupings of investments that are less correlated with stocks and bonds should yield benefits for investors, and at least in the aggregate, over long time periods that may hold. Cambridge Associates, in their annual review of endowments, presents this graph of returns and standard deviations, as a function of how much each endowment allocated to private investments over a ten-year period (from 2012-2022): Cambridge Associates With the subset of endowments that Cambridge examined, both annual returns and Sharpe ratios  were higher at funds that invested more in private investments (which incorporates much of the alternative investment space). Those results, though, have been challenged by others looking at a broader group of funds. In an article in CFA magazine, Nicolas Rabener looked at the two arguments for adding hedge funds to a portfolio, i.e., that they increase Sharpe ratios and reduce drawdowns in fund value during market downturns, and found both absent in practice: Nicolas Ramener, CFA Institute With hedge funds, admittedly just one component of alternative investing, Rabener finds that notwithstanding the low correlations that some hedge fund strategies have with a conventional equity/bond portfolio, there is no noticeable improvement in Sharpe ratios or decrease in drawdowns from adding them to the portfolio.     Richard Ennis, a long-time critic of alternative investing, has a series of papers that question the benefits to funds from adding them to the mix.  Richard Ennis, SSRN In the Ennis sample, the excess returns become more negative as the allocation to alternative investments is increased, undercutting a key sales pitch for the allocation. While alternative investing advocates will take issue with the Ennis findings, on empirical and statistical bases, even long-term beneficiaries from alternative investing seem to have become more skeptical about its benefits over time. In a 2018 paper, Fragkiskos, Ryan and Markov noted that among Ivy League endowments, properly adjusting for risk causes any benefits in terms of Sharpe ratios, from adding alternative investments to the mix, to disappear. In perhaps the most telling sign that the bloom is off the alternative investing rose, Yale's endowment announced its intent to sell of billions of dollars of private equity holdings in June 2025, after years of under performance on its holdings in that investment class. Correlations: Real and Perceived     At the start of this post, I noted that a key sales pitch for alternative investments is their low correlation with stock/bond markets, and to the extent that this historical correlations seem to back this pitch, it may be surprising that the actual results don't measure up to what is promised. There are two reasons why these historical correlations may be understated for most  private investment classes: Pricing lags; Unlike publicly traded equities and bonds, where there are observable market prices from current transactions, most private assets are not liquid and the pricing is based upon appraisals. In theory, these appraisers are supposed to mark-to-market, but in practice, the pricing that they attach to private assets lag market changes. Thus, when markets are going up or down quickly, private equity and venture capital can look like they are going up or down less than public equity markets, but that is because of the lagged prices.  Market crises: While correlations between investment classes are often based upon long periods, and across up and down markets, the truth is that investors care most about risk (and correlations) during market crises, and many investment classes that exhibit low correlation during sideways or stable markets can have lose that feature and move in lock step with public markets during crisis. That was the case during the banking crisis in the last quarter of 2008 and during the COVID meltdown in the first quarter of 2020, when funds with large private investment allocations felt the same drawdown and pain as funds without that exposure. In my view, this understatement of correlation is most acute in private equity and venture capital, which are after all equity investments in businesses, albeit private, instead of public. It is less likely to be the case for truly differentiated investment classes, such as gold, collectibles and real estate, but even here, correlations with public markets have risen, as they have become more widely held by funds. With hedge funds, it is possible to construct strategies that should have lower correlation with public markets, but some of these strategies can have catastrophic breakdowns (with the potential for wipeout) during market crises. Illiquidity and Opacity (lack of transparency)     Even the strongest advocates for alternative investments accept that they are less liquid than public market investments, but argue that for investors with long time horizons and clearly defined cash flow needs (like pension and endowment funds), that illiquidity should not be a deal breaker. The problem with this argument is that much as investors like to believe that they control their time horizons and cash needs, they do not, and find their need for liquidity rising during acute market crises or panics. The other problem with illiquidity is that it manifests in transactions costs, manifesting both in terms of bid-ask spreads and in price impact that drains from returns.     The other aspect of the private investment market that is mentioned but then glossed over is that many of its vehicles tend to be opaque in terms of governance structure and reporting. Investors, including many large institutional players, that invest in hedge funds, private equity and venture capital are often on the outside looking in, as deals get structured and gains get apportioned. Again, that absence of transparency may be ignored in good times, but could make bad times worse. Disappearing Alphas     When alternative investing first became accessible to institutional investors, the presumption was that market-beating opportunities abounded in private markets, and that hedge fund, private equity and venture capital managers brought superior abilities to the investment game. That may have been true then, but that perception has faded for many reasons. First, as the number of funds and money under management in these investment vehicles has increased, the capacity to make easy money has also faded, and in my view, the average venture capital, private equity or hedge fund manager is now no better or worse than the average mutual fund manager. Second, the investment game has also become more difficult to win, as the investment world has become flatter, with many of the advantages that fund managers used to extract excess returns dissipating over time. Third, the entry of passive investment vehicles like exchange traded funds (ETFS) that can spot and replicate active investors who are beating the market has meant that excess returns, even if present, do not last for long.     With hedge funds, the fading of excess returns over time has been chronicled. Sullivan looked at hedge funds between 1994 and 2019 and noted that even by 2009, the alpha had dropped to zero or below: Sullivan, Hedge fund alpha: Cycle or Sunset In a companion paper, Sullivan also noted another phenomenon undercutting the benefits of adding hedge funds to a public market portfolio, which is that correlations between hedge fund returns and public market returns have risen over time from 0.65 in the 1990s to 0.87 in the last decade.     With private investment funds, the results are similar, when performance is compared over time. A paper looking at private equity returns over time concluded that private equity returns, which ran well above public market returns between 1998 and 2007, have started to resemble public market returns in most recent years. Ilmanen, Chandra and McQuinn The positive notes in both hedge funds and private equity, as we noted in an earlier section on venture capital, is that while the typical manager in each group has converged to the average, the best managers in these groups have shown more staying power than in public markets. Put simple, the hope is that you can invest your money with these superior managers, and ride their success to earn more than you would have earned elsewhere, but there is a catch even with that scenario, which we will explore next. The Cost Effect    Let's assume that even with fading alphas and higher correlations with public markets, some hedge funds and private market investors still provide benefits to funds invested primarily in public markets. Those benefits, though, still come with significant costs, since the managers of these alternative investment vehicles charge far more for their services than their equivalents in public markets. In general, the fees for alternative investments are composed of a management fee, specified as a percent of assets under management, and a performance fee, where the alternative investment manager gets a percent of returns earned over and above a specified benchmark. In the two-and-twenty model that many hedge and PE fund models used to adhere to, the fund managers collect 2% of the assets under management and 20% of returns in excess of the benchmark. Both numbers have been under downward pressure in recent years, as alternative investing has spread: Even with the decline, though, these costs represent a significant drag on performance, and  the chances of gaining a net benefit from adding an alternative investing class to a fund drop towards zero very quickly. An Epitaph for Alternative Investing?     It is clear, looking at the trend lines, that the days of easy money for those selling alternative investments as well as those buying these investments have wound down. Even  savvy institutional investors, who have been long-term believers in the benefits of alternative investing, are questioning whether private equity, hedge funds and venture capital have become too big and are too costly to be value-adding. As institutional investors become less willing to jump into the alternative investing fray, it looks like individual investors are now being targeted for the alternative investing sales pitch, and as with all things investing, I would suggest that buyer beware, and that investors, institutions and individual, keep the following in mind, when listening to alternative investing pitches: Be picky about alternatives: Given that the alpha pitch (that hedge fund and private equity managers deliver excess returns) has lost its heft, it is correlations that should guide investor choices on alternative investments. That will reduce the attractiveness of private equity and venture capital, as investment vehicles, and increase the draw of some hedge funds, gold and many collectibles. As for cryptos, the jury is still out, since bitcoin, the highest profile component, has behaved more like risky equity, rising and falling with the market, than a traditional collectible. Avoid high-cost and exotic vehicles: Investing is a tough enough game to win, without costs, and adding high cost vehicles makes it even more difficult. At the risk of drawing the ire of some, I would argue that any endowment or pension fund managers who pay two-and-twenty to a hedge fund, no matter how great its track record, first needs their heads examined and then summarily fired. On a related noted, alternative investments that are based upon strategies that are so complex that neither the seller nor buyer has an intuitive sense of what exactly they are trying to do should be avoided. Be realistic about time horizon and liquidity needs: As noted many times through this post, alternative investing, no matter how well structured and practiced, will come with less liquidity and transparency than public investing, making it a better choice for investors with longer time horizons and well-specified cash needs. On this front, individual investors need to be honest with themselves about how susceptible they are to panic attacks and peer-group pressure, and institutional investors have to recognize that their time horizons are determined by their clients, and not by their own preferences. Be wary of correlation matrices and historical alphas: The alternative investing sales pitch is juiced by correlation matrices (indicating that the alternative investing vehicle in question does not move with public markets) and historic alphas (showing that vehicle delivering market beating risk/return tradeoffs and Sharpe ratios). If there is one takeaway from this post, I hope that it is that historical correlations, especially when you have non-traded investments at play, are untrustworthy and that alphas fade over time, and more so when the vehicles that delivered them are sold relentlessly. YouTube video

I was on a family vacation in August 2011 when I received an email from a journalist asking me what I thought about the S&P ratings downgrade for the US. Since I stay blissfully unaware of most news stories and things related to markets when I am on the beach, I had to look up what he was talking about, and it was S&P's decision to downgrade the United States, which had always enjoyed AAA, the highest sovereign rating  that can be granted to a country, to AA+, reflecting their concerns about both the fiscal challenges faced by the country, with mounting trade and budget deficits, as well as the willingness of its political institutions to flirt with the possibility of default. For more than a decade, S&P remained the outlier, but in 2023, Fitch joined it by also downgrading the US from AAA to AA+, citing the same reasons. That left Moody's, the third of the major sovereign ratings agencies, as the only one that persisted with a Aaa (Moody's equivalent of AAA) for the US, but that changed on May 16, 2025, when it too downgraded the US from Aaa (negative) to Aa1 (stable). Since the ratings downgrade happened after close of trading on a Friday, there was concern that markets would wake up on the following  Monday (May 19) to a wave of selling, and while that did not materialize, the rest of the week was a down week for both stocks and US treasury bonds, especially at the longest end of the maturity spectrum. Rather than rehash the arguments about US debt and political dysfunction, which I am sure that you had read elsewhere, I thought I would take this moment to talk about sovereign default risk, how ratings agencies rate sovereigns, the biases and errors in sovereign ratings and their predictive power, and use that discussion as a launching pad to talk about how the US ratings downgrade will affect equity and bond valuations not just in the US, but around the world. Sovereign Defaults: A History     Through time, governments have often been dependent on debt to finance themselves, some in the local currency and much in a foreign currency. A large proportion of sovereign defaults have occurred with foreign currency sovereign borrowing, as the borrowing country finds itself short of the foreign currency to meet its obligations. However, those defaults, and especially so in recent years, have been supplemented by countries that have chosen to default on local currency borrowings. I use the word "chosen" because most countries  have the capacity to avoid default on local currency debt, being able to print money in that currency to pay off debt, but chose not to do so, because they feared the consequences of the inflation that would follow more than the consequences of default. BoC/BoE Sovereign Default Database While the number of sovereign defaults has ebbed and flowed over time, there are two points worth making about the data. The first is that, over time, sovereign defaults, especially on foreign currency debt, have shifted from bank debt to sovereign bonds, with three times as many sovereign defaults on bonds than on bank loans in 2023. The second is that local currency defaults are persistent over time, and while less frequent than foreign currency defaults, remain a significant proportion of total defaults.     The consequences of sovereign default have been both economic and political. Besides the obvious implication that lenders to that government lose some or a great deal of what is owed to them, there are other consequences. Researchers who have examined the aftermath of default have come to the following conclusions about the short-term and long-term effects of defaulting on debt: Default has a negative impact on the economy, with real GDP dropping between 0.5% and 2%, but the bulk of the decline is in the first year after the default and seems to be short lived. Default does affect a country’s long-term sovereign rating and borrowing costs. One study of credit ratings in 1995 found that the ratings for countries that had defaulted at least once since 1970 were one to two notches lower than otherwise similar countries that had not defaulted. In the same vein, defaulting countries have borrowing costs that are about 0.5 to 1% higher than countries that have not defaulted. Here again, though, the effects of default dissipate over time. Sovereign default can cause trade retaliation. One study indicates a drop of 8% in bilateral trade after default, with the effects lasting for up to 15 years, and another one that uses industry level data finds that export-oriented industries are particularly hurt by sovereign default. Sovereign default can make banking systems more fragile. A study of 149 countries between 1975 and 2000 indicates that the probability of a banking crisis is 14% in countries that have defaulted, an eleven percentage-point increase over non-defaulting countries. Sovereign default also increases the likelihood of political change. While none of the studies focus on defaults per se, there are several that have examined the after-effects of sharp devaluations, which often accompany default. A study of devaluations between 1971 and 2003 finds a 45% increase in the probability of change in the top leader (prime minister or president) in the country and a 64% increase in the probability of change in the finance executive (minister of finance or head of central bank). In summary, default is costly, and countries do not (and should not) take the possibility of default lightly. Default is particularly expensive when it leads to banking crises and currency devaluations; the former has a longstanding impact on the capacity of firms to fund their investments whereas the latter create political and institutional instability that lasts for long periods. Sovereign Ratings: Measures and Process     Since few of us have the resources or the time to dedicate to understanding small and unfamiliar countries, it is no surprise that third parties have stepped into the breach, with their assessments of sovereign default risk. Of these third-party assessors, bond ratings agencies came in with the biggest advantages: They have been assessing default risk in corporations for a hundred years or more and presumably can transfer some of their skills to assessing sovereign risk. Bond investors who are familiar with the ratings measures, from investing in corporate bonds, find it easy to extend their use to assessing sovereign bonds. Thus, a AAA rated country is viewed as close to riskless whereas a C rated country is very risky.  Moody’s, Standard and Poor’s and Fitch’s have been rating corporate bond offerings since the early part of the twentieth century. Moody’s has been rating corporate bonds since 1919 and started rating government bonds in the 1920s, when that market was an active one. By 1929, Moody’s provided ratings for almost fifty central governments. With the Great Depression and the Second World War, investments in government bonds abated and with it, the interest in government bond ratings. In the 1970s, the business picked up again slowly. As recently as the early 1980s, only about thirteen  governments, mostly in developed and mature markets, had ratings, with most of them commanding the highest level (Aaa). The decade from 1985 to 1994 added 34 countries to the sovereign rating list, with many of them having speculative or lower ratings and by 2024, Moody's alone was rating 143 countries, covering 75% of all emerging market countries and almost every developed market.  table.tableizer-table { font-size: 12px; border: 1px solid #CCC; font-family: Arial, Helvetica, sans-serif; } .tableizer-table td { padding: 4px; margin: 3px; border: 1px solid #CCC; } .tableizer-table th { background-color: #104E8B; color: #FFF; font-weight: bold; } Not only have ratings agencies become more active in adding countries to their ratings list, but they have also expanded their coverage of countries with more default risk/ lower ratings.  In fact, the number of Aaa rated countries was the same in 1985, when there were thirteen rated countries, as in 2025, when there were 143 rated countries. In the last two decades, at least five sovereigns, including Japan, the UK, France and now the US, have lost their Aaa ratings.  In addition to more countries being rated, the ratings themselves have become richer. Moody’s and S&P now provide two ratings for each country – a local currency rating (for domestic currency debt/ bonds) and a foreign currency rating (for government borrowings in a foreign currency).      In assessing these sovereign ratings, ratings agencies draw on a multitude of data, quantitative and qualitative. Moody's describes its sovereign ratings process in the picture below: The process is broad enough to cover both political and economic factors, while preserving wiggle room for the ratings agencies to make subjective judgments on default that can lead to different ratings for two countries with similar economic and political profiles. The heat map below provides the sovereign ratings, from Moody's, for all rated countries the start of 2025: Moody's sovereign ratings Note that the greyed out countries are unrated, with Russia being the most significant example; the ratings agencies withdrew their rating for Russia in 2022 and not reinstated it yet. There were only a handful of Aaa rated countries, concentrated in North America (United States and Canada), Northern Europe (Germany, Scandinavia), Australia & New Zealand and Singapore (the only Aaa-rated Asian country. In 2025, there have been a eight sovereign ratings changes, four upgrades and four downgrades, with the US downgrade from Aaa to Aa1 as the highest profile change With the US downgrade, the list of Aaa-rated countries has become shorter, and as Canada and Germany struggle with budget imbalances, the likelihood is that more companies will drop off the list. Sovereign Ratings:  Performance and Alternatives     If sovereign ratings are designed to measure exposure to default risk, how well do they do? The answer depends on how you evaluate their performance. The ratings agencies provide tables that list defaults by rating that back the proposition that sovereign ratings and default are highly correlated. A Moody's update of default rates by sovereign ratings classes, between 1983 and 2024, yielded the following: Default rates rise as sovereign ratings decline, with a default rate of 24% for  speculative grade sovereign debt (Baa2 and below) as opposed to 1.8% for investment grade (Aaa to Baa1) sovereign debt.     That said, there are aspects of sovereign ratings that should give pause to anyone considering using them as their proxy for sovereign default, they do come with caveats and limitations: Ratings are upward biased: Ratings agencies have been accused by some of being far too optimistic in their assessments of both corporate and sovereign ratings. While the conflict of interest of having issuers pay for the rating is offered as the rationale for the upward bias in corporate ratings, that argument does not hold up when it comes to sovereign ratings, since not only are the revenues small, relative to reputation loss, but a proportion of sovereigns are rated for no fees. There is herd behavior: When one ratings agency lowers or raises a sovereign rating, other ratings agencies seem to follow suit. This herd behavior reduces the value of having three separate ratings agencies, since their assessments of sovereign risk are no longer independent. Too little, too late: To price sovereign bonds (or set interest rates on sovereign loans), investors (banks) need assessments of default risk that are updated and timely. It has long been argued that ratings agencies take too long to change ratings, and that these changes happen too late to protect investors from a crisis. Vicious Cycle: Once a market is in crisis, there is the perception that ratings agencies sometimes overreact and lower ratings too much, thus creating a feedback effect that makes the crisis worse. This is especially true for small countries that are mostly dependent on foreign capital for their funds. Regional biases: There are many, especially in Asia and Latin America, that believe that the ratings agencies are too lax in assessing default risk for North America and Europe,  overrating countries in  those regions, while being too stringent in their assessments of default in Asia, Latin America and Africa, underrating countries in those regions.  In sum, the evidence suggests that while sovereign ratings are good measures of country default risk, changes in ratings often lag changes on the ground, making them less useful to lenders and investors.     If the key limitation of sovereign ratings is that they are not timely assessors of country default risk, that failure is alleviated by the development of the sovereign CDS market, a market where investors can buy insurance against country default risk by paying an (annualized) price. While that market still has issues in terms of counterparty risk and legal questions about what comprises default, it has expanded in the last two decades, and at the start of 2025, there were about 80 countries with sovereign CDS available on them. The heat map below provides a picture of sovereign (10-year)  CDS spreads on January 1, 2025: As you can see, even at the start of 2025, the market was drawing a distinction between  the safest Aaa-rated countries (Scandinavia, Switzerland, Australia and New Zealand), all with sovereign CDS spreads of 0.20% or below, and more risky Aaa-rated countries (US, Germany, Canada). During 2025, the market shocks from tariff and trade wars have had an effect, with sovereign CDS spreads increasing, especially in April. The US, which started 2025 with a sovereign CDS spread of 0.41%, saw a widening of the spread to 0.62% in late April, before dropping back a bit in May, with the Moody's downgrade having almost no effect on the US sovereign CDS spread. The US Downgrade: Lead-in and Aftermath     With that background on sovereign default and ratings, let's take a look at the story of the moment, which is the Moody's downgrade of the US from Aaa to Aa1. In the weeks since, we have not seen a major upheaval in markets, and the question that we face as investors and analysts is whether anything of consequence has changed as a result of the downgrade. The Lead-in     As I noted at the start of this post, Moody's was the last of the big three sovereign ratings agencies giving the United States a Aaa rating, with S&P (in 2011) and Fitch (in 2023) having already downgraded the US. In fact, the two reasons that both ratings agencies provided at the time of their downgrades were rising government debt and politically dysfunction were also the reasons that Moody's noted in their downgrade. On the debt front, one of the measures that ratings agencies use to assess a country's financial standing is its debt to GDP ratio, and it is undeniable that this statistic has trended upwards for the United States: The ramping up of US debt since 2008 is reflected in total federal debt rising from 80% of GDP in 2008  to more than 120% in 2024. While some of the surge in debt can be attributed to the exigencies caused by crises (the 2008 banking crisis and the 2020 COVID bailouts), the troubling truth is that the debt has outlasted the crises and blaming the crises for the debt levels today is disingenuous.      The problem with the debt-to-GDP measure of sovereign fiscal standing is that it is an imperfect indicator, as can be seen in this list of countries that scored highest and lowest on this measure in 2023: IMF Many of the countries with the highest debt to GDP ratios would be classified as safe and some have Aaa ratings, whereas very few of the countries on the lowest debt to GDP list would qualify as safe. Even if it it the high debt to GDP ratio for the US that triggered the Moody's downgrade, the question is why Moody's chose to do this in 2025 rather than a year or two or even a decade ago, and the answer to that lies, I think, in the political component. A sovereign default has both economic and political roots, since a government that is intent on preserving its credit standing will often find ways to pay its debt and avoid default. For decades now, the US has enjoyed special status with markets and institutions (like ratings agencies), built as much on its institutional stability (legal and regulatory) as it was on its economic power. The Moody's downgrade seems to me a signal that those days might be winding down, and that the United States, like the rest of the world, will face more accountability for lack of discipline in its fiscal and monetary policy. Market Reaction     The ratings downgrade was after close of trading on Friday, May 16, and there was concern about how it would play out in markets, when they opened on Monday, May 19. US equities were actually up on that day, though they lost ground in the subsequent days: If equity markets were relatively unscathed in the two weeks after the downgrade, what about bond markets, and specially, the US treasury market? After all, an issuer downgrade for any bond is bad news, and rates should be expected to rise to reflect higher default risk: While rates did go up in the the first few days after the downgrade, the effect was muddled by the passage of a reconciliation bill in the house that potentially could add to the deficit in future years. In fact, by the May 29, 2025, almost all of the downgrade effect had faded, with rates close to where they were at the start of the year.     You may be surprised that markets did not react more negatively to the ratings downgrade, but I am not for three reasons: Lack of surprise effect: While the timing of the Moody's downgrade was unexpected, the downgrade itself was not surprising for two reasons. First, since S&P and Fitch had already downgraded the US, Moody's was the outlier in giving the US a Aaa rating, and it was only a matter of time before it joined the other two agencies. Second, in addition to reporting a sovereign rating, Moody's discloses when it puts a country on a watch for a ratings changes, with positive (negative) indicating the possibility of a ratings upgrade (downgrade). Moody's changed its outlook for the US to negative in November 2023, and while the rating remained unchanged until May 2025, it was clearly considering the downgrade in the months leading up to it. Magnitude of private capital: The immediate effect of a sovereign ratings downgrade is on government borrowing, and while the US does borrow vast amounts, private capital (in the form of equity and debt) is a far bigger source of financing and funding for the economy.  Ratings change: The ratings downgrade ws more of a blow to pride than to finances, since the default risk (and default spread) difference between an Aaa rating and a Aa1 rating is small. Austria and Finland, for instance, had Aa1 ratings in May 2025, and their ten-year bonds, denominated in Euros, traded at a spread of about 0.15- 0.20% over the German ten-year Euro bond; Germany had a Aaa rating. Consequences for valuation and investment analysis    While the immediate economic and financial consequences of a downgrade from Aaa to Aa1 will be small, there are implications for analysts around the world. In particular, analysts will have to take steps when working with US dollars that they may already be taking already when working with most other currencies in estimating basic inputs into financial analysis.     Let's start with the riskfree rate, a basic building block for estimating costs of equity and capital, which are inputs into intrinsic valuation. In principle, the riskfree rate is what you will earn on a guaranteed investment in a currency, and any risk premiums, either for investing in equity (equity risk premium) or in fixed income securities (default spreads), are added to the riskfree rate. It is standard practice in many textbooks and classrooms to use the government bond rate as the risk free rate, but that is built on the presumption that governments cannot default (at least on bonds issued in the local currency). Using a Aaa (AAA) rating as a (lazy) proxy for default-free, that is the rationale we used to justify government bond rates as riskfree rates at the start of 2025, in Australian, Singapore and Canadian dollars, the Euro (Germany). Swiss francs and Danish krone. As we noted in the first section, the assumption that governments don't default  is violated in practice, since some countries choose to default on local currency bonds, rather than face up to inflation. If that is the case, the government bond rate is no longer truly a riskfree rate, and getting to a riskfree rate will require netting out a default spread from the government bond rate: Risk free rate = Government Bond rate − Default spread for the government  The default spread can be estimated either from the sovereign bond rating (with a look up table) or a sovereign CDS spread, and we used that process to get riskfree in rates in a  host of currencies, where local currency government bonds had default risk, at the start of 2025: Thus, to get a riskfree rate in Indian rupees, Brazilian reals or Turkish lira, we start with government bonds in these currencies and net out the default spreads for the countries in question. We do this to ensure that we don't double count country risk by first using the government bond (which includes default risk) as a riskfree rate and then using a larger equity risk premium to allow for the same country risk.       Now that the US is no longer Aaa rated, we have to follow a similar process to get a riskfree rate in US dollars: US 10-year treasury bond rate on May 30, 2025  = 4.41% Default spread based on Aa1 rating on May 30, 2025  = 0.40% Riskfree rate in US dollars on May 30, 2025 = US 10-year treasury rate - Aa1 default spread = 4.41% - 0.40% = 4.01% This adjustment yields a riskfree rate of 4.01% in US dollars, and it is also built on the presumption that the default spread manifested after the Moody's downgrade on May 16, when the more realistic reading is that US treasury markets have been carrying a  default spread embedded in them for years, and that we are not making it explicit.     The ratings downgrade for the US will also affect the equity risk premium computations that I use to estimate the cost of equity for companies. As some of you who track my equity risk premiums by country know, I estimate an equity risk premium for the S&P 500, and at least until the start of this year, I used that as a premium for all mature markets (with a AAA (Aaa) rating as the indicator of maturity). Thus, countries like Canada, Germany, Australia and Singapore were all assigned the same premium as that attributed to the S&P 500. For countries with ratings below Aaa, I added an "extra country risk premium"  computed based upon the default spreads that went with the country ratings: With the ratings downgrade, I will have to modify this process in three ways. The first is that when computing the equity risk premium for the S& P 500, I will have to net out the adjusted riskfree rate in US dollars rather than the US treasury rate, yielding a higher equity risk premium for the US. Second, for Aaa rated countries, to the extent that they are safer than the US will have to be assigned an equity risk premium lower than the US, with the adjustment downward reflecting the Aa1 rating for the US. The third is that for all other countries, the country risk premium will be computed based upon the the their default spreads and the equity risk premium estimated for Aaa rated countries (rather than the US equity risk premium): How will the cost of equity for a firm with all of its revenues in the United States be affected as a consequence? Let's take three companies, one below-average risk, one average-risk and one above average risk, and compute their costs of equity on May 30, 2025, with and without the downgrade favored in: As you can see, the expected return on the S&P 500 as of May 30, 2025, reflecting the index level then and the expected cash flows, is 8.64%. Incorporating the effects of the downgrade changes the composition of that expected return, resulting in a lower riskfree rate (4.01% instead of 4.41%) and a higher equity risk premium (4.63% instead of 4.23%). Thus, while the expected return for the average stock remains at 8.64%, the expected return increases slightly for riskier stocks and decreases slightly for safer stocks, but the effects are so small that investors will hardly notice. If there is a lesson for analysts here, it is that the downgrade's effects on the discount rates (costs of equity and capital) are minimal, and that staying with the conventional approach (of using the ten-year US treasury bond rate as the riskfree rate and using that rate to compute the equity risk premium) will continue to work. Conclusion     The Moody's ratings downgrade of the US made the news, and much was made of it during the weekend that followed. The financial and economic consequences, at least so far, have been inconsequential, with equity and bond markets shrugging off the downgrade, perhaps because the surprise factor was minimal. The downgrade also has had only a minimal impact on costs of equity and capital for US companies, and while that may change, the changes will come from macroeconomic news or from crises. For the most part, analysts should be able to continue to work with the US treasury rate as a riskfree rate and forward-looking equity risk premiums, as they did before the downgrade. With all of that said, though, the Moody's action does carry symbolic weight, another indicator that US exceptionalism, which allowed the US to take economic and fiscal actions that would have brought blowback for other countries, especially in emerging markets, is coming to an end. That is healthy, in the long term, for both the United States and the rest of the world, but it will come with short term pain. YouTube Video