It would be wrong to suggest that Monday was a good day for risk or that it was a bad one either – the Dax rose over 105 points, or 1%, while the Dow gave back 54 points, or 0.3% - but it would be fair to say that the dynamics behind the price action are too multi-faceted to be able to permit clear analysis.
I was staggered when I read that the cause for the dollar rallying and US stock indices closing lower were hawkish comments from Fed officials. Do me a favour! We’re two-and-a-half months away from the next possible tightening in the US and trying to use Fed officials’ words as indicators of forward policy demonstrates nothing, other than the levels of cluelessness of the observers.
Volatility is still a problem although things might be about to become worse. I noted in today’s FT that the two asset managers Henderson and Janus have merged in an all-share deal. This is not an aggressive expansion by the one or the other but a defensive move by two active asset managers who see their business being eroded by passive funds. The rise of the passive fund is another result of the low interest rate environment.
Moonlight and music
I reflected recently on the problem facing hedge funds. If one is leveraging 6% rates three times, one returns 18%. One can take fees of “2 and 20” out of that and still give the punter a generous return. If one is leveraging rates of 0.5% three times, one gets 1.5%. Yes, I know this is a gross oversimplification but when one strips out all the beta disguised as alpha and goes back to brass tacks that’s broadly all that’s left of the hedge fund model. The simple truth is that long-only active managers are also being squeezed by the low return environment where a normal fee structure struggles to be supported by the underlying returns.
Passive funds can theoretically be managed by computers with no mortgages, no school fees and no dreams of owning a Porsche. Not surprisingly, they are much cheaper to run and where fees chew up such a large proportion of the return, it’s no surprise that they look so attractive to end-users. Subsequently, as the Pink’un points out, the passives are growing like topsy while the actives are struggling to hang on. The result is the merger of Henderson and Janus in a drive towards greater efficiency or, in plain English, cost savings.
So while we are contemplating the issues surrounding Deutsche Bank and the “too big to fail” phenomenon, we are at the same time watching a similar phenomenon develop within asset management. Never mind plurality, feel the fee structure. If there is one thing the internet has brought with it, then it is the belief that information and knowledge are the same thing and that they are a free gift. I could easily go on and bring in the old chestnut about the difference between knowledge and wisdom, which says that knowledge is to know that a tomato is a fruit but that wisdom leads us not to put it into a fruit salad. In a low-return world the passive investment might look fine but does fee obsession not have the same destructive power as did the growth of off-balance sheet derivatives for banks, the real business of which was supposed to take place on it and not off it?
The article suggests that currently about a fifth of assets are managed in passive vehicles but that the proportion is growing rapidly. A passive fund does nothing other than to buy the aggregate of all active managers’ trades and positions. Now imagine there were only one active investor in the world and all other managers would have to follow his (or her) moves because he or she would be the only one who could move relative pricing. The mouse squeaks and the herd of elephants stampedes.
Love and romance
I alluded yesterday to the thorny issue of stress-testing mutual funds. The greatest protection against violent market movements is the plurality of investment strategies and dispersion of funds. The greatest threats to markets, in my humble opinion, are the concentration of assets and the mistaken belief that there is safety in numbers. In the same way we were taught that one should never effect an investment based on tax considerations, so it would also appear to make sense not to choose one’s investment manager based on his fees. My views on the destructive power of strict best execution are no secret.
The Janus/Henderson trade is being touted as a defensive action. If more mergers of the same ilk follow – and no doubt they will – the world will be a poorer place. Perhaps the time is coming closer where the experienced, middle-aged, active manager will have to be put on the WWF’s endangered species list. Just give £3 a month and maybe this diminishing breed can be saved. In exchange we will send you a quarterly performance update, poster and a cuddly toy.
Joking aside, cost/income ratios can go silly as they have in the case of Deutsche but the savings that are being made today may one day look small in comparison to the future cost brought on by the loss of experience and the collective memory. The price of everything but the value of nothing?
Let’s face the music
Back to the UK, where Chancellor of the Exchequer Philip Hammond has presented himself to the party faithful. The picture he has painted is not pretty and is, to be frank, a nice change from the usual rose-tinted conference speeches. He might as well have spoken to the tune of ’Let’s Face The Music’: “There may be trouble ahead….”. Not only will Brexit not be painless but many of the underlying problems of the British economy – mainly low productivity – are beginning to be a serious drag. Sterling duly took another spanking but the FTSE rallied, once again on the prospect for foreign currency earners.
On one hand one could moan that it looks like going back to simple, old and failing deficit spending model but then again, this is barely the time to go experimenting. The May administration looks to be favouring a holding pattern and, little as I like that, it is probably the right thing to do. Therefore, if you’re looking for a cheap trade, keep selling the pound…. and best of all against the yen.