While the music plays funds gotta dance
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.
COME BACK CHUCK PRINCE, ALL IS FORGIVEN
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)