Timeout: A pause before the pivotal stage in a surreal US presidential election

Politics Insight
As hard as it may be to believe, both the Republicans and the Democrats have actually had madder presidential nomination contests than the current one. These were admittedly quite a long time ago.
For the Republicans nothing may ever top the 1912 experience. In that year, a Republican former President, Theodore Roosevelt, decided that he had lost faith in the person whom he had all but hand-picked to succeed him, William Howard Taft, and decided to run against him when he sought a second term in the White House. Roosevelt won almost all of the primaries but back then only a very small minority of states held them and they were frequently not binding on delegates anyway. When it came to the convention most of the party leadership stuck with Taft, and Roosevelt and his backers stormed out to form their own Progressive Party and run as a separate force in November 1912. The ex-President proved more popular than the sitting President but the divisions within the Republican ranks proved fatal, allowing the Democrat Woodrow Wilson to prevail. Taft endured the humiliation of only winning two states – Utah and Vermont – carrying a dire eight votes in the Electoral College.
For the Democrats, 1924 probably represents their nadir. In those days a candidate had to win two-thirds of delegates to be nominated. This was unfortunate as the party was split down the middle on virtually every major matter conceivable. These divisions included north versus south (a motion to condemn the violence of the Ku Klux Klan failed by 546.15 votes to 542.85), prohibition (where urban ‘wets’ squared off against rural ‘drys’), religion (a leading contender was a Roman Catholic and so unacceptable to many Protestant activists), the fundamentals of economic policy and the essentials of foreign policy as well. As a consequence, it took 15 days and a staggering 103 ballots of delegates before a compromise figure, John W. Davis, emerged, only to be crushed in the November contest.
All of which is worth keeping in mind as the present presidential race moves toward a pivotal stage. There is a brief pause at the moment. There has been no major primary or contest this week and just one – New York – next Tuesday which could be interesting in terms of the Democrats but where it would be a major surprise if Donald Trump did not triumph in what is his home territory.
Although 2016 is not (yet) on a par with 1912 or 1924 it is a truly extraordinary spectacle. The Democratic competition, which involves a 74-year-old Senator who is not strictly speaking a Democrat at all but a self-styled ‘democratic socialist’, should have been over after the Super Tuesday vote right at the beginning of March but has instead continued with Bernie Sanders winning eight of the last nine of the primaries and caucuses.
This, though, fades into insignificance with the agony of the Republican Party leadership. In a year when logically it would have been the favourite to seize the Oval Office, it is instead tying itself in knots in an attempt to settle on a strategy – any strategy – that can stop Donald Trump from either securing the nomination or bolting the party for an independent run in the manner of Theodore Roosevelt if he and his supporters conclude that they have been cheated. It all leads to the ultimate paradox that in a year when the words ‘Wall Street’ have rarely been more a term of abuse on the campaign trail, 2016 is also the year of the political hostile takeover.
The Democrats: When will the ‘inevitable’ actually become inevitable?
The next two weeks are potentially decisive in the Democratic contest. Absolutely precise estimates of delegate numbers are more difficult than one might think but the best assessment is that Hillary Clinton currently has 1,749 of the 2,383 delegates that she needs to be nominated, while Senator Sanders holds 1,061. Mrs Clinton’s crucial advantage is that the Democrats award about 15% of slots at their convention to senior party figures or ‘superdelegates’ who are not selected via a primary or a caucus and who exist explicitly as a force to calm the enthusiasms of others elected elsewhere. These superdelegates overwhelmingly favour Mrs Clinton (she is, after all, a bona fide Democrat).
Her campaign has stalled in recent weeks, however, in part because the sense that she is destined to be the ‘inevitable’ nominee but also because the electoral geography of the past set of fights has been dominated by often small states in the Mid-West and western United States where, especially in caucuses, white affluent liberals and students outnumber African-Americans, Hispanics and older mainstream white Democrats in the participating electorate. During the rest of April, by contrast, the battleground involves New York, Connecticut, Delaware, Rhode Island, Maryland and Pennsylvania.
This affords Mrs Clinton the chance to deliver the de facto knockout blow. If she wins in New York (the state that she represented in the Senate), Pennsylvania, Maryland and Connecticut then that should be enough to take her to about 90% of the delegates that she needs, and while her rival will doubtless continue to campaign all the way until the last set of primaries on 7 June, the ultimate result will not be in doubt. Should she perform worse than anticipated in the next few weeks then the Democrats face the possibility that Senator Sanders could catch and even overtake Mrs Clinton in terms of ‘pledged’ delegates who have been won in contested primaries and caucuses, meaning her nomination will be secured by her superdelegate backing. This is not an appealing prospect for her.
The Republicans: Trump or Not-Trump
Ted Cruz’s striking victory in Wisconsin – a state well beyond his geographical base in the south and where conservative evangelicals are a small proportion of the Republican faithful – shows that a drive to deny The Donald of the Republican nomination is not an impossible one. The objective is to ensure that he falls short of the 1,237 delegates he needs to win a majority on the opening ballot in the plausible belief that he would then find it very hard to acquire the second preferences of other candidates when it came to the next round of voting. At this point, the convention becomes ‘open’, which would permit those who had not participated in the primaries and caucuses to throw their hats in the ring. It is possible, although it would surely not take 103 ballots to occur, for there to be a more credible version of John W. Davis out there who was not only selected but won election.
Whether that is really possible in the modern era is debateable. The blunt reality is that if Mr Trump is not to be the nominee then it is Ted Cruz who is best placed to be the alternative. If Senator Cruz is to achieve that status then he needs to defeat Mr Trump in most of the primaries and caucuses that take place after New York so that he can enter the convention with momentum on his side so that even if he is second on the first round of balloting, his subsequent victory looks clean. And for all that to happen, Governor John Kasich of Ohio has to withdraw from the race in the next two weeks and back Mr Cruz. If he does not, then Mr Trump will continues to benefit from a divided opposition. So in practice the next two weeks will also be decisive for the Republicans. Either Mr Trump will be in a position to claim a majority of delegates on the first ballot (or be within a handful of that number) or there will be a convention in which the party manages to deny him his prize.
The worst-case scenario?
In the most dramatic scenario both parties have conventions in which their establishments manage to block candidates who think they have been cheated of victory. In which case it is just possible that both Mr Trump and Senator Sanders make independent bids to be President. A true four-contender campaign has not been witnessed since 1860. The American Civil War was triggered by that election.
Tim Hames, Director General, BVCA
Research Insight
Realisation risk: how reliable are valuations?
When we published a paper we had commissioned from Montana Capital Partners that looked at risk in private equity, we noted that one of the identified risks – realisation risk – was a topic we would come back to at a later date. Today’s Research Insight explores this concept in a little more detail, and gives some pointers as to how it could be useful for investors when constructing a portfolio.
The report defines realisation risk as the risk of receiving a lower value of distributions by the end of the lifetime of the fund portfolio than a current valuation implies – for instance, if the fund NAV at point X is £100 million, what is the risk that this value will be lower than £100 million at some point Y in the future.
This is an important question for regulators, auditors, and investors, as it gives an impression of how realistic the valuations are and the risk of not getting back the current value of the portfolio in cash flows. In order to do this, the report carries out some analysis by calculating a ratio between all distributions which an investor will receive until the end of the fund’s lifetime, and the current net asset value plus the capital calls which they have to pay going forward.
In order to analyse this, the report made use of a Monte Carlo analysis – a topic that we have touched on before, and which involves taking multiple random samples from a population in order to work out its true levels of risk. This analysis, comprised of 1,000 draws in each case, looked at the probability of the future NAV falling below the current NAV over a period of 32 quarters. It carried out an analysis on hypothetical portfolios of 1, 5, 20, and 50 fund investments. The results can be seen below:
What these show is that if the portfolio consists of only one fund, the chances of achieving a lower NAV at the end of a 32 quarter period are relatively high, with a probability of roughly 28%. With a more diversified portfolio, this probability continuously falls. In the case of a fund portfolio of 50 funds, an investor would receive less than the valuation in quarter 20 (plus subsequent capital calls) in only 0.8% of runs.
This finding is crucial in showing that there is not just a stability and predictability of distributions over time – as other findings from this research have shown – but that there is, assuming a sufficient level of diversification amongst an investor’s portfolio, a large degree of predictability in terms of the minimum level of return in future years based on current valuations.
One interesting facet of this result is that it is in line with findings that the BVCA made in a paper that we published several years ago that looked at the evolution of NAVs over the life of a fund, and whether, based on the data that the BVCA collects from its members, there is evidence of serial overvaluation of assets by private equity firms. What this paper found was that, far from there being evidence of overvaluation, there was evidence to suggest that firms were conservative in their valuations and in fact tended towards undervaluing assets in the early years of a fund’s life – a finding in line with the use of valuation guidelines such as those produced by IPEV.
These results help shed new light on the risk that is involved in private equity investment – the metric of realisation risk had never been fully explored before – and present a perspective that will be of interest to many investors. As we set our research agenda for the coming year, we will continue to be involved in commissioning this type of research and exploring areas around risk and return to highlight the very strong case that is out there for our asset class.