Revenge of the Advisor

Oct 27, 2011

Hedge funds for many years now have received a lot of the attention.  You also see high-fee mutual funds losing assets and this is of course going to continue. 

The power in ultra low-cost ETF investing is significant.   Will ETFs set their sights on hedge funds next?   As we see it, ETF’s will eventually cause trouble for hedge funds just like they have for heavily over-fee’d mutual funds.   

The ultimate beneficiary of the trend toward ETFs is the classic 1-2% fee-only manager that has good ‘risk-aware but long-biased’ strategies.

This all comes down to a relatively simple concept in our view - having a good fixed-income strategy over the long-run beats short-selling strategies, especially when the short-selling comes with a 2+20% price tag.     Let me explain.

Over the long-run, short-selling is a bad strategy.    How many successful bear funds are in existence?   This follows a decade of discussion of how bad the S&P 500 was --- however, a little-known fact is that one of the worst categories in the 2000-2010 period was……   bear funds.

If you discuss this with hedge fund managers – most readily agree that short-selling is really hard and that they don’t make much money at it.    However, they quickly then go on to say it is the short-selling which allows them to be long their great ideas --- and therefore it is justified.    However, if you break out just the short-selling side of hedge funds -- the part that controls risk ----  this group just doesn’t hold up over the long-run vs a good bond manager.    

Aha  you say,  bonds have been in a 30 year bull market and this can’t continue.   We agree that it will be tough to make much money if your bond strategy consists of buying and holding treasury bonds.   But also remember that our comparison group has set a low bar here -- short-sellers are secular underperformers too.  Remember that the admitted goal of hedge fund short-selling is only to mitigate drawdowns and through such magic ‘unlock the value’ in their fabulous long ideas.  

The onus of proof though is on he who is charging 2+20%.   The 1% fee manager that is doing a good job controlling drawdowns has just too large of a head-start.    Don’t get us wrong, hedge fund managers will continue to make huge sums of money --- as will fund of funds and consultants and all the other intermediaries of the industry -- and isn't that all just part of the problem?

But the disciplined advisor who can execute relatively simple carry-trade credit strategies while at the same time adding some value on the equity/risk-asset side  – and does so with ultra low-cost products – this is going to continue to be very difficult to beat.       

Bottom-line, being long treasury bonds is not a good strategy nowadays in isolation – but neither is short-selling.    Yes, the typical 3-10 year treasury bond is down this month--- but the losses are minor compared to those unfortunate enough to be short equities this month.   Meanwhile, risk-assets are appreciating --- dividend indexes (staples/utilities), MLPs,  Investment Grade bonds --- these all hit new multi-month highs this week.   And these are all classic advisor “home-turf” securities.



Comments (3) -

Nov 07, 2011 06:13 #

"But the disciplined advisor who can execute relatively simple carry-trade credit strategies "......Any advice on where to research/learn more about these?

bartmart United States

Nov 07, 2011 15:12 #

The carry-trade reference was only meant as part of an overall broader strategy.   'Carry-trade' means you essentially overweight securities that yield more than average and underweight securities that yield less.   This could mean buying corporate bonds rather than treasury bonds --- or it could mean choosing longer-dated treasuries rather than shorter-duration treasuries.     Without the burden of a high fee to overcome with more risky positions, you don't have to get that fancy.

Importantly though, this was just meant as a comment on the fixed-income portion of a portfolio.    Equities should be a focus as well and we have many good choices to pursue equity strategies.

Chris United States

Nov 28, 2011 05:55 #

Tracking the S&P 500 but charging 2% and 20% of profits:

Mike United States

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