Wednesday, December 3, 2008

Market neutral funds

Funds highly correlated to major indexes are collapsing, applying the “we can’t be liable for the markets” to distract investors from blatant incompetency. Unbelievable. Like relationships, business models can only display true survivability in hard times; and it has become apparent that only market neutral (low correlation to key indexes) strategies offer a practical fighting chance at consistent profitability.

Conventional buy & hold investments

It takes no skill to buy, hold, and hope; translation, No Added Value, whatsoever. To charge exorbitant amounts of fees to boot is borderline criminal. The mutual funds AKA unit trusts, the infamous “finance companies” in New Zealand all belong to this group. They take investors’ capital, then make upside bets under the assumption that global economies grow at exponential rates without limits… What the hell, right?

Then when crap hits the fan, they freeze withdrawals just so the public investors become forced to take heavy losses while these businesses move to initiate the game once more with newly created entities. Anyone with a fair understanding of financial economics should see by now these funds are nothing but rackets run by groups of dishonest, unskilled snake oil pushers.

Market neutral investments

It takes skills to trade the financial markets and win consistently, hence added value for the investors. Actively managed, market neutral, investments have a fighting chance. It is where an investor could watch the market drop like a ship from heaven, and smile, wondering what companies the fund had shorted…

Distinct differences

Some (definitely not all) common financial snake-oil salesmen traits:

1. Historical performance highly correlated (positive or negative) to the indexes

2. “The market’s always going up…”

3. “We can’t be responsible for the market…”

4. “Diversification lowers risks…”

5. “The market’s cheap/over sold right now!” with no logical data to support, historical prices are meaningless

6. They avoid topics regarding fundamental, credit risk

7. They avoid commission/fee details

8. They avoid topics regarding business/liquidity cycles

Some characteristics of potentially competent investment managers

1. Positive historical performance with low correlation to major indexes

2. Realistic focus on credit, liquidity risks

3. Takes responsibility for performance, regardless of market behavior

4. Incentive based fees (positively correlated to investors’ returns)

5. Realistically assesses weaknesses of academic financial theories (portfolio theory, CAPM, assumption of no fundamental risk, normal distributions, and etc.)

0 Reflections: