Archives

What seemed to be a slight rest at the beginning of the year has turned again to a strong equity bull market. The reflation trade is back as signaled by equity index behavior. Bonds also suggest a reflation trade given the recent talk by Fed Chairman Yellen and other officials concerning the likelihood of Fed action in March. While not a rout, bonds are also signaling a growth trade.

All hedge fund strategies gained for February with especially strong performance for systematic CTA’s and fundamental growth strategies as measured by the HFR indices. Managed futures showed gains because both equities and fixed income markets trended higher for the month. The fundamental growth strategy seemed to be positioned to take advantage of the global reflation trade. Other winners included market directional and distressed restructuring strategies.

The self-fulfilling prophecy is, in the beginning, a false definition of the situation evoking a new behavior which makes the originally false conception come true. The specious validity of the self-fulfilling prophecy perpetuates a reign of error. For the prophet will cite the actual course of events as proof that he was right from the very beginning.

– Robert K. Merton from Raji Sethi blog

Robert K Merton wrote about this issue in 1948 in the Antioch Review

“If men define situations as real, they are real in their consequences”

– W.I. Thomas

The global macro manager is always worried about a few key issues. Where will country and global growth come from? What will be the flow of liquidity and credit to markets? What will be the desire by investors for risk-taking? The answers to these questions will describe the drivers of future asset returns.

Managed futures strategies generally showed performance gains in February based on strong equity market return trends and the the positive gains in fixed income markets. The dollar also started to again trend up while commodities markets were more mixed. It is notable that there was a strong gap between traditional trend-followers and short-term traders whose index was down almost 2% for the month.

If I invested based on political rhetoric and news, I would be moving to a safe asset and expect stocks to decline. The uncertainty concerning policy and the animus between political parties and countries would suggest an environment that would not be suitable for the long-term optimism that is needed to see equities march higher. If I read just the financial papers and economic data, I would paint a more optimistic picture with consumer and business surveys both showing a positive environment. If I were a focused policy wonk, I would have a mixed view on market prices with the potential for stimulative policies but still a policy environment where details and specifics are scarce. It is hard to see these differences continuing. As politics, economics, and policy come into focus, there will be a strong reaction in price. Unfortunately, predicting when this alignment will occur is very difficult.

There is still concern about the potential for large moves in bonds during the next three months. The latest rolling yield changes shows a calming after the large moves late last year. Nevertheless, uncertainty on policy, growth, and the equity markets may all impact Treasury yields, the “safe” asset. If safe means limited moves in yield, investors may be in for a surprise. A flight to safety can easily take the 10-year below 2% while a pick-up in inflation or growth can lead to yields pushing closer to 3%.

Markets have been known to move to price extreme which have often been referred to as bubbles. The best know of these bubbles have been noted to lead to large market dislocations in both financial markets and the real economy. The “dot com” and housing bubble are the best known most recent examples, but unfortunately, there has not been much agreement on what are identifiable characteristics or the cause of these bubbles. While there can be agreement that bubbles are related to positive feedback loops, there is little work on a method for filtering data through some general model that will define a bubble.

Hedge funds are frustrated, as evidenced by the recently published Preqin Investor Interviews. If hedge funds do not perform this year, there will be significant changes in allocations. The number of respondents to the survey who said that returns fell below expectations increased by 50% in one year to the highest levels reported. Only 3% of investors believed that returns exceeded expectations. This was tied for the lowest levels reported.

A close look at the investor intentions for hedge funds suggests that poor managers will see their allocations reduced this year. The proportion of respondents who will reduce their allocations is at the highest levels reported and about 20% higher than last year and more than double from two years ago. Similarly, the survey has lowest level of respondents willing to increase their allocations.

The Willis Towers Watson Global Pension Assets Study 2017 shows that the same pension trends for the last decade continue. First, the march to defined contribution (DC) plans from defined contribution (DB) plans has not abated. Of course, there are some wide variations across countries, but the good old days of getting a managed pension from a company or a state are not coming back. Second, the growth in pension assets from the major countries is slowing but continues to rise in emerging markets. Emerging markets do not have the same developed pension systems and often have pension assets well below the country GDP. There is a catch-up in EM and this is where asset growth will be seen.

For many investment strategies, the difference between a good and a bad manager is based on their ability to manage risk. It is as much about how volatility is handled as return generation. A good strategy that does not manage risk well will never be successful. A key conclusion from a recent paper that focuses […]