Great recap of the 2004 AIMR Conference (bigwig wall street investment show): http://hussmanfunds.com/rsi/aimr1fim.htm Bottom line from the highly respected Peter Bernstein: the dumb money days are over, and mutual funds are going to have to change. No more love of indexing when the benchmark is no longer inexorably rising. No more pedigreed gorillas collecting paychecks for doing next to nothing. No more pollyanna morons getting free passes on CNBC. No more brainless bull market restrictions like long only, single style restrictions. No more pretending benchmark returns are an acceptable alternative to absolute returns. So what are the implications of an equity world in which the dumb money no longer dominates? positives ⢠higher sensitivity to overall risk means fewer asinine market moves that chiefly reward risk-insensitive players ⢠less willingness from the public to blindly fund elephants = less trampling power and less ability to ambush downtrends ⢠more willingness to go long as well as short enables more fluid (and rational) trends in both directions ⢠greater sensitivity to fundamentals and technicals will place a higher premium on skill / less premium on size or marketing ⢠as public recognizes the "dog chasing its own tail" nature of passive indexing, active management could return to fore ⢠return to active management + big shakeout = billions of dollars in investor capital looking for new homes ⢠greater opportunity for skilled managers as absolute returns become a dominant concept ⢠just as natural business equilibrium is tipping away from behemoth corporations in favor of smaller operations, the same could happen for trading funds as technology and competition enables lower operating costs (large scale hedge funds can only absorb so much capital before their reward/risk ratio for further expansion becomes unpalatable) negatives ⢠public response to mutual fund demise could be apathy or, worse, cries for government regulation and bailout ⢠short sighted politicians could restrict active management even further in an effort to preserve the status quo ⢠there could be a large dead spot in the midst of the transition- "market doldrums" where liquidity temporarily dries up Overall, the positive implications are very strong once the transitional waters are ridden out. The mutual funds' strongest hand has always been their ability to siphon funds from a captive and blind audience, allowing them to take ridiculous risks, underperform badly, and yet spin their game as the only way to go. Trading against a mutual fund is a bit like playing poker against an exceedingly obtuse and arrogant opponent with one key advantage: he has an unlimited bank roll of someone else's money. Thus they can play like shit from a tactical perspective and be overly aggressive on every hand. After all, who cares, it's not their money and there's always more coming (or at least that's how it used to be). This risk-insensitivity is a "dumb money edge" that creates temporary distortion (like when a market should rationally decline but doesn't for example), and is used to ill effect against absolute return players who can't afford to burn their capital. With the dumb money edge diminished and the public more awake (or more absent from the field) in the long run, mutual funds will no longer have the risk-insensitivity shield that has protected them for so long. This is assuming, of course, that a significant enough portion of the public (or rather, a significant enough portion of the public's funds) wakes up to reality over time as Bernstein thinks will happen. In the bigger scheme of things, this has to be positive I think, for a few key reasons (some of which are restatements): I. Broader acceptance of absolute returns vs benchmark -and broader willingness to look for smaller managers with alpha rather than gorillas with pedigrees- can only make things easier for aspiring managers with genuine skill rather than old boy network connections. II. The intensified competition among a smaller pool of skilled managers as it becomes an absolute return world could be potentially dwarfed by the available pool of capital to be allocated when the old boy network is taken out of the picture. If large swathes of public money start looking for absolute returns, the elephant herd is going to be mercilessly culled, and that money is going to have to find a new home. III. Greater acceptance of style diversification and a broader willingness to go short as well as long could lead to a more natural acceptance of derivatives (futures and options) by a large contingent of elephants that have previously shunned them purely for reasons of appearance that are intrinsically illogical. It's only a matter of time before the media notices that many supposedly "safe" mutual funds have much higher volatility swings and lower information ratios than many supposedly "risky" futures funds (that is, once the megafunds lose their stranglehold on the media). This recognition that risk is in the hands of the manager and not the underlying instrument, combined with the shift from a long only benchmark world to a long/short absolute return world, could result in an open interest explosion for futures that dwarfs all previous levels. IV. No matter how many aspiring managers there are, no matter how many brilliant MBA's and quants there are, there will never be an excess supply of emotionally balanced individuals. Emotional balance is essential whether you are discretionary or mechanical (mechanical traders still have to allocate capital and make risk management decisions under duress). Emotional balance can't be taught in school, it can't be faked, and the cultural influence of narcissistic modern society makes it even harder to attain. Furthermore, finding someone who is emotionally balanced yet driven to compete at the highest levels of the most competitive game in the world is even tougher- not to mention said person's need to be highly intelligent and deeply talented yet genuinely humble and grounded at the same time. To the degree that a trader's performance pattern is reflected by his quality of life patterns and quality of thought patterns, there will always be a bull market for sound and balanced indviduals who have the contrasting skillsets so hard to find in one person. In otherwords: if you've got the skills, it could be a great 21st century. I definitely expect the mutuals and the "old guard" to fight this change, but it will be akin to the old guard currently fighting the shift from public schools to private school choice- underlying currents are so strong that real change is only a matter of time, even if it takes a while.
Very interesting post: thanks. I only wish that what Bernstein is forecasting would come true sooner. My fear and expectation is that inertia is a powerful force and the trend will take the rest of this decade at least to play out.
Disagree. It won't happen. Trading skills are important only for individual traders and prop firms. Skills & intelligence alone, without things like top-education, good image/charisma, connections are worthless when it comes to institutional world (mutual, hedge funds, asset mgmt, ibanks etc.) I don't think this will ever change, b/c people don't believe in someone's credibility, unless someone: - is a friend, buddy - has a degree from the famous university - has charisma, influence I'll even say: returns doesn't matter. Majority of people don't base decisions on statistics - rather on trust, presence, familiarity, fashion, sometimes greed, fear, myths. Whatever but NOT numbers, logic or facts!
i disagree too. smart is a relative term, only so much money can be "smart" at any given time. as long as there are superstars, there will be legions of "gorillas". just no way of getting around it in this or any other industry. benchmark comparisons will remain because that will be the only way the bulk of professionals can look acceptable.
The counterargument to what you're saying is if mutual funds continue to produce poor/nil/negative returns. It's all very well "trusting" your fund manager, but if your fund manager's five/ten year performance projects out to a pension annuity figure of "not enough to live on" then you're pretty much forced to do something about it. I've worked for a large institutional asset manager (one of the world's five largest in terms of AUM), and I can honestly say that they were a value subtractor of the highest order. It seems to me to be an incredible irony that financial services, supposedly the most purely market economy based industries in the world, still support such areas of wasteage. I would expect long only asset managers to pay me for the "services" they provide - and if they carry on in this vein they must, over time, become obsolete.
Also not true. Benchmarking makes mediocrity the goal. There are numerous ways to judge absolute return (the most significant being "does it provide acceptable or good retirement income?"). The nonsense lies in asset managers claiming good performance when they are down 25%+ in a year, because their competitors are down 26%, as I have seen. What use is benchmarking when you retire next year? This is the long only asset management paradigm: I as asset manager will attempt to outperform - say - the S&P 500 by over and underweighting stocks in that index by no more than 2.5%. For that I will charge you 1-5%. I will also charge you 1-5% if I underperform. The long/short equity hedge fund paradigm is this: I will hold 20-100 positions in equities, long or short. You will pay me 1%. If I show a positive annual return, you will pay me 15-20% of the profit as well The point is that the whole setup needs to become more intelligent. We are paying half the potential profits to people who get half their decisions wrong - and we have to pay them for the ones they get wrong as well. We are paying firms who do not outperform bull markets to be in bull markets, knowing perfectly well that we have to pay them in bear markets too (bear markets which, of course, they also do not outperform). It is a shambles.
"The counterargument to what you're saying is if mutual funds continue to produce poor/nil/negative returns." Even if this will be the case, how much AUM they can lose? 10, 15, 25%? Still a lot $ to manage and charge. However, I guess we'll all agree that mutual funds will lose their market share to HFs & CTAs over the next decades regardless of stock market swings. Actually bear market is better for HFs due to higher volatility and assets shifts. "I've worked for a large institutional asset manager (one of the world's five largest in terms of AUM), and I can honestly say that they were a value subtractor of the highest order." ... and as a result their salaries & bonuses were probably cut by a small %, investors "know the risks" - everybody should be happy, right? ;-) "It seems to me to be an incredible irony that financial services, supposedly the most purely market economy based industries in the world, still support such areas of wasteage" '80s and '90s were too easy for many managers. These guys are sooo intelligent that they realize the disadvantages of long-only strategies ONLY when markets are plunging 50 or more percent As long as there's a demand for long-only funds, they will exist.
My point remains: if competing asset management styles consistently produce better returns, and old style long only managers continue to fail to produce enough to support people in their retirement, they will fall by the wayside. Demand will wither - how can it be any other way?
Agreed, but it can be a looong process. Unless there will be some giant market crash. This thread reminds me one successful, young HF manager (who also contributes here ;-) saying: "Janus is down 1/3 in the last 3 years, while I'm up triple % digits. They manage $20B and I - a couple hundred $k". There's no justice in this world
benchmarks headed for extinction- long live absolute returns? by Darkhorse AWESOME POST !!!!!!!!!!! ....................................................................................................... This is one more nail in the coffin for legal fraud on Wall Street...hey its legally ok for you to lose billions in pension plans because you were close to an index reading...This has been an extraordinary period of ridiculousness...furthermore the mentioning that the asset class of stocks has outperformed other vehicles on a 50 year premise...uh oh...forgot to include the non-index names...but that's ok because people are stupid...besides my family needs to be proud of my respectable work...and these lawyers need some ammo in court..to keep this gravy train alive... Yes the mutual fund industry ranks right up there with Americanized McDonaldlized Fatness... Oh...what happened to my money my child...oh its ok that its gone and you will have less because its comparable to the Russell 2000.... Let the big ships try to outmaneuver those that really know how...lol... Looking forward to more trading levelness....and justice to savers....