One of the funnier conceits of the modern investing era, in which a third of the stock market’s assets are held in passive or index funds, is that the market may become too efficient and, as such, would eliminate all opportunity for people doing fundamental research.
I can safely report that we’re in no danger of this, my friends.
Even though machines, software and rules-based investment vehicles currently dominate the marketplace, we must never forget that the end-owners of the money they’re running are people. Insane, emotional, irrational people who will find ways to make both good and bad decisions, inconsistently, regardless of where their capital is held.
Here’s one version of this incontrovertible truth, a dispatch from Trump Country, USA via Bloomberg:
Across middle America, in the towns big and small that voted overwhelmingly for Donald Trump, his most ardent, and financially comfortable, backers are opening stock-market accounts or beefing up existing ones, according to interviews with more than a dozen advisers and brokers. They were spurred on by a stream of presidential tweets crowing about, and taking credit for, the gains throughout 2017 and the strength of the economy, and they remain undaunted now as the rally sputters and the tweeting dissipates.
The brokers and advisors seem to be doing their best to interject some reason or common sense, but to no avail…
“It has really made a difference in attitudes,” said Jimmy Waggoner, an investment adviser with VisionPoint Advisory Group in Sioux Falls. So much so that in Covington, Rob Smith, an adviser at Edward Jones there, said he tries to tap down on the enthusiasm. “I dissuade people from thinking any specific politician or even event will have that much of a long-term positive or negative effect on markets.”
Hopefully, these people didn’t treat Obama’s election as a sell signal. Because, despite his “tone” about Big Business, stocks did better than under almost every other president who’s ever been in office.
“I hear it every day,” said Jimmy Freeman, a financial adviser at Edward Jones in San Angelo, a city of some 100,000 that’s just east of the booming Permian Basin shale oil fields. “The market’s going up because of Trump. They all think it’s Trump.”
We’ll put a pin in this and check back on it in a year or two…if the market drops, we can point to Hillary.
In the meantime, another Bloomberg piece talks about the wreckage in quantitative CTA strategies during the volatility of February. These CTAs, or Commodity Trading Advisors, tend to be quantitative strategies that are looking to capitalize on trends in prices, both to the upside and the downside, using signals and software to make decisions. There’s $350 billion of assets invested in them.
If you had a CTA that moves slowly in its reactions, then it probably caught most of the uptrend in the stock market last year. If you had one that moves quickly in its reactions, then it probably did not do as well, jumping out at the hint of a downward turn only to have to jump back in as the uptrend reasserted itself.
Jumping in and out of the market carries a cost, best thought of as spending money on insurance premiums against drawdowns. When a drawdown fails to materialize, you still spent the money. The way these are sold to investors is “Just because your house didn’t go on fire last year, doesn’t mean you should cancel your policy. And if you insure your house, why wouldn’t you insure your portfolio?” Believe me, this pitch works very well.
So if the slow-moving CTAs did better than the fast-moving CTAs in the recent past, guess which ones raised more money from investors?
Over the past few years, slow moving CTAs have fared better than quick ones, capturing the majority of new assets in the industry, Koulajian said. In 2017, fast-paced CTAs declined 6.7 percent, compared to a 2.2 percent gain for their longer-term brethren, according to Societe Generale indexes.
Long story short, these funds posted a decline of 6.4% last month. You need to gain 6.8% to make up for a 6.4% drop just to get back to where you started. In the meanwhile, what you’re very likely to see should the higher volatility of February persist, is better performance numbers from the fast-moving quant CTAs and lots of money switch from the funds that worked best last year into the funds that are working best this year.
The bottom line – even if a fund is quantitative, rules-based and emotionless in how it operates, the investor flows coming and going into the funds will be as emotionally driven as they are everywhere else. That’s why time-weighted returns, even if they’re not great, will usually look better than dollar-weighted returns, which are almost always horrifying.
Fear and greed are undefeated, I don’t care how many cold, clinical, unfeeling and antiseptic spreadsheets you use to run the money.
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