While the music plays funds gotta dance

November 17, 2009

cr_lrg_108_jamessaft1.jpg(James Saft is a Reuters columnist. The opinions expressed are his own)

With just a few short weeks until the end of the year, look for many fund managers to take on more risk in an effort to salvage their annual return figures.

This is not about fundamentals, this is about something far more important: career risk.

Hedge Fund Research’s Global Hedge Fund index, which is broadly representative of the industry, is up just 11.9 percent year to date, while its Equity Hedge index is scarcely doing better, up 12.6 percent. The HFR Macro Fund index is actually down 8 percent, indicating the best paid minds in the business did not see the astounding emerging markets rally and dollar fall coming.

Given that global emerging markets are up something on the order of 60 percent this year, that all global shares are up 30 percent and even the S&P 500 is up 22 percent, we can conclude that a lot of managers are heading into the year-end reporting season with a lot of ground to make up.

There are also lifeboats full of institutional fund managers and mutual fund managers in the same position.

What all who have missed the rally have in common is not a common failure of analysis — there are lots of different ways to get it wrong — but a collective vulnerability to finding themselves waving their clients goodbye. Letters detailing 2009 performance will have to be posted, ranking lists of funds will be published and there will be consequences.

It must be hugely tempting for managers who are behind — and remember a lot of these people are not committed bears — to pile in and hope the momentum trade can bring their returns back to respectability.

It all adds up to a supportive background for risky assets through the new year. There can be no assurances that fundamentals, which are pretty poor, won’t reassert themselves. There is no telling too that policy makers might put a foot wrong and scare the markets, though I doubt it. They have a very large interest in a merry year end. Even if they didn’t, inflation is not an issue and unemployment is, so don’t look for any telegraphs from Washington, London or Frankfurt bearing tidings of rising rates.

Individual investors who missed the rally are less likely to pile in right now. Their temptation will be to pass over the business headlines and go straight to sports. And besides, the holidays provide distractions of their own and you are highly unlikely to be fired by yourself as your own investment manager, now matter how richly you deserve the boot.

Professionals however are usually not so lucky as to be related to the client.

Of course, there must be many managers who are ahead of the market. Why won’t they trim their sails and protect their gains? I don’t know the answer to that but in my experience it just doesn’t work that way. People tend to think of gifts as entitlements and it’s a rare, and valuable, manager who having been aggressive when most were timid now gives up the habits of a lifetime.

It is all very reminiscent of good old Charles Prince, the former Citigroup chief who said about the leveraged buyout market, “As long as the music is playing, you’ve got to get up and dance,” just as the world began to unravel. Prince wasn’t a fool, he was expressing a core truth. If you are head of a bank or a mutual fund and you sit out a boom which you see as too risky you are taking on another, perhaps more persuasive risk; that the very clients you seek to protect will call you a stick-in-the-mud and taketheir business elsewhere.

This is not a specious argument about “cash on the sidelines” or money market funds. Numbers showing huge cash in money market funds are misleading; most of it will never end up in equity markets. This is simply about the self-fulfilling psychology and mechanics of rallies, especially rallies with official support.

The authorities, in their wisdom, have broken the circuit of a crash by flooding the market with enough money to drive up asset prices. This is intended to bring money out from under mattresses and force people to take risks again, to make them dance even if they feel like a fool.

That is unlikely to last forever or to work forever, but a reversal is less likely before January 1 than after.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

(Editing by James Dalgleish)


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I agree with what you say. It is Q1 and Q2 2010 which looks risky.

Posted by D Rumsfeld | Report as abusive

Mr Saft makes a valid point and reveals an unfortunate truism that despite the name “HEDGE” fund, people understand them to be “Always beat the indices” funds. A “sophisticated” investor who uses such products should have investments in other things like base indices and therefore they would have realized the above mentioned returns. If the HEDGE funds were to move in lockstep, well its not a very good hedge at all. Perhaps the question we should ask ourselves is if it is the fund manager taking on excess risk who is at fault or is it the “sophisticated” investor who demands excess returns? (i’m neither, just asking the question)

Posted by henry | Report as abusive

Well said James, when the rule of the game is that “Heads I Win Tails your lose”..fund managers will continue taking risks as they have nothing much to lose except their careers which anyway is not looking good.The picture for the article was perfect..one last bet on the roulette table with all chips in to make up for all the losses.

Posted by spaul | Report as abusive

This is nauseating. Most of the problem last time was people buying assets without knowing what was in them. Now, desperate managers are doing things not even they like, because to them, annihilation is no worse than underperformance.

Posted by Pete Cann | Report as abusive

What I could see during my career is that clients get really upset when the market is up but their account is not. There is a frenzy regarding missing profits that’s much more powerful than the panic resulting from market crashes. When markets drop, clients are relatively calm. Thanks to the mix of bonds, cash and PM their portfolios drop less than the market and there is a feeling that everybody is in the same boat. When markets are up as violently as this year and people feel they missed the gold rush, you can find yourself in front of really upset clients.

Posted by Fabien Hug | Report as abusive

In and around the hedge, nomatter what they try and sell you, it’s always Groundhog Day. Always. Only the groundhogs have now completely morphed into lemmings, vaunting rancid vaporware as though it were The New Commodity.Even so, not all of them jump at once. Why, you ask?Here’s why: because it would be just too fantastic if that entire species were to become suddenly extinct.

Posted by The Bell | Report as abusive

[…] was in fact former Citigroup chief Charles Prince who used this expression to characterise why, in a highly leveraged bailout (sorry, buyout) market fund managers continued […]

Posted by On The Brink Of What? | A Fistful Of Euros | Report as abusive