I promise that headline isn’t clickbait, I’m going to teach you in five simple steps in a moment, but let me just set the stage…
From 2009-2014, a window of five years, there was only one question on the minds of investors when you presented them with an investment – and it wasn’t “How much can I make on this?”. No, the only thing people wanted to know was “How did it do in ’08?”.
The biggest pain point for everyone was the dramatic drop in 2008. Avoiding those losses in the subsequent crash that was surely imminent became a Grail Quest of sorts, a riddle to be solved.
If you had a fund or a strategy that offered an “answer” to the riddle, you could raise money at will. Advisors weren’t immune, tucking these answers into all of their clients’ portfolios – a 5% sleeve, a 10% chunk of the pie chart, perhaps 15, or maybe 20, upping the dosage depending on the neuroses of the patient/client.
What were these answers referred to as? Black Swan funds, tactical funds, liquid alts – they were expensive, they were complicated, they were high-falutin’ in their literature – but they were seen to have worked. If you had an alts fund that was merely flat in oh-eight, you had the answer for every client question. And if you had one that actually made money in the crisis, it was as though you had stolen the Promethean fire from the gods.
Here’s Morningstar documenting the rise of the Mainstay Marketfield product that ended up as a holding in advisor-managed portfolios all over America:
Marketfield is a long-short equity fund that blends macro top-down calls with bottom-up stock selection (recently, it has shifted to a nearly exclusive focus on top-down). From 2008 through 2013, it had a remarkable stretch of outperformance as it handily outpaced its peers each year. Other than 2009 when it returned 31%, returns most years were well below that of the S&P 500, but strong-performing alternative funds were alluring.
After MainStay acquired the fund, it introduced higher-cost share classes, and yet even more people came. The fund was less than $1.0 billion in 2011, but it took in $3.3 billion in 2012 and a stunning $13.2 billion in 2013.
It went up 31% in 2008, a year in which virtually everyone lost. The flows came pouring in. Alchemy!
Only it didn’t work out very well in the normalized markets that soon followed the crash years…
But 2014 proved to be a bitter disappointment as the fund lost 12.3% while the S&P 500 gained 13.7%. In 2015, it lost 8.3% and then lost 3.3% in 2016. The S&P 500 gained 1.4% and 12%, respectively. Thus, the noncorrelated performance delivered losses even as stocks were going higher. Flows quickly reversed direction. The fund shed $7.8 billion in 2014, $6.3 billion in 2015, and $1.6 billion in 2016 as MainStay made a hasty retreat.
It’s now a $500 million fund that has recently changed it’s strategy, because, of course it has.
But at a cost of 1.66% on the institutional share class of the fund, assuming the $21 billion AUM stuck around for at least a year, approximately $348.6 million in fees were generated for the fund company. Not counting the money made on the way up to that peak AUM and on the way down. Even now, some 8 million and change is being earned off of the assets sticking around in the fund, whose holders are either hoping for lightning to strike twice or stubbornly refusing to admit defeat.
And maybe it does come back or repeat it’s amazing performance in the next crash. I suppose anything’s possible. But is it probable? Fifty years worth of academic literature and persistence studies would argue no, but I don’t want to trigger anyone…
Mainstay Marketfield isn’t alone, as the Morningstar article explains. Funds that seemed to have provide an “answer” to 2008 have almost universally disappointed investors, and not just because we haven’t had a repeat of 2008. But because they’ve, by now, cost investors a lot more than just surviving the crash in a traditional asset allocation account would have afforded them. Meaning the entire benefit of having avoided 2008 has been eroded away by opportunity cost and losses by now.
Because risk and reward are inextricably linked. All of the gains with none of the losses is a fairy tale that fund managers and financial intermediaries have been promising investors since the beginning of time – a story so irresistible that its power to capture our imaginations (and wallets) remains undiminished in the face of torrents of evidence proving its impossibility.
So here’s the part where I teach you to get rich, as promised…
Step One: Launch ten funds, with each one designed to go to cash or net short the stock market during a different year out into the future. We’ll call it Stock Market Suit of Armor Series 2018, Stock Market Suit of Armor Series 2019, etc.
Step Two: Seed each fund with some capital, it almost doesn’t matter how much.
Step Three: Each year, sell out each designated fund’s equity exposure in January and await the inevitable bear market.
Step Four: When the bear market hits, close the other nine versions of the fund and pretend they never existed.
Step Five: Market the winner like there’s no tomorrow – TV, radio, blog posts, Twitter, conferences, seminars.
Within three years of the bear, you will have raised $20 billion with even a modest amount of advertising competence. You will be billing tens of millions, and then hundreds of millions in no time.
No one will ask any questions about the funds that were killed because a) that’s not how the investor’s brain is wired and b) the databases will forget about them as fast as the people will.
But the key, and this is where I need your undivided attention, is to sell the fund. Some fund company will surely buy it. They’ll create spin-off versions of it too – this one also holds gold, this one hedges out currency risk, this one holds its cash in the form of commercial paper, and on and on. The marketing departments will never run out of ideas once they’ve got a winning franchise on their hands.
But this won’t matter to you. None of this will be your problem. You’ve sold it. The subsequent performance of the fund, once it’s out of your hands, is someone else’s problem. Even better – when it fails (which it will), you can remind everyone about how great it did while you were at the helm. Parlay that shit into a newsletter! The world is your oyster.
If this sounds like an exaggerated version of reality, I assure you it’s no more implausible than the way these products are designed, pitched and analyzed in real life. Only my version cuts through any pretension and gets straight to the cynical part where we score.
This isn’t going to be an overnight thing – the seeds must be planted now, in advance of the next market meltdown. And you may have to watch a few years of normal activity destroy your earlier funds when they get out too early or put their bear trades on too soon. Think of yourself less like a fund manager and more like a farmer. You’re in the business of reaping a harvest of investor fear and recency bias, but you’ve got to allow the crop to come in.
As it eventually will. It always does.
And then you get to say “I told you so,” sitting atop a golden throne of AUM, surrounded by millions of generals seeking a battle plan for the last war.