Asset managers live and die by their ability to outperform the benchmarks against which their fund is judged. The fund manager’s worth, in fact, lies mainly in his ability to use his customer’s funds better than an index tracking instrument.
It’s because of this that risk management was often seen as an impediÂment. Coming out of a benign environment in which risk management policies were overlooked in favour of robust growth, successive periods of achieving a healthy alpha have been replaced by a bun-fight for funding and client confidence.
And those funds that claimed the strategy was all about risk conservancy now find themselves up a serious creek without a paddle and with not much to look forward to in the near future.
One fund strategy, often referred to as the long/short or the market-neutral approach, involves the fund taking a long position in one share and a short position in a similar share, so that the movements cancel each other out, leaving a small but safe arbitrage profit.
When everything from the ALSI to the price of lead were headed for record highs, many market-neutral funds decided to do away with the short-side hedge to capitalise on the upside.
Andrew Kinsey, head of risk at derivatives provider Global Trader, believes this is the only explanation for the extraordinary returns that these “conservative” funds were achieving.
“Truly market-neutral funds should perform as well in adverse conditions as they do in a thriving market,” says Kinsey. “I think many of them had adopted an unambiguously long strategy to create an impression of being able to deliver superior alpha.”
But, he said, like most other long-only funds, the decimation of the market left nowhere to hide.
“Even funds that were long in blue chip companies are looking at 30% to 50% losses.”
Some fund managers are looking at these losses with optimism as they represent a chance for value investors to get in early while shares are cheap.
Value investors typically purchase shares that have market prices below what their fundamental value should be. Funds that adopt this approach would be discounting future earnings of companies and seeing whether the market pessimism has driven the share price below what it should be.
Kinsey warns that even this approach should be adopted with a fair amount of risk aversion in mind.
“If value investors are starting to take positions again, have they really revised their earnings estimates enough? It may be too early to predict what effect the current crisis will really have on the real economy and therefore too early to determine what is mispriced and what is realistic.”
Assuming that a value investor has made the right call on a mispriced stock, he or she still has to come up with the funds to take the position. “At the moment there is a rush in the financial markets to deleverage as far and as quickly as possible,” says Kinsey.
Back when every fund could turn a R5 coin into a R10 note, the risk for any bank to lend was small and credit departments were pushing enormous growth targets on to their sales force.
Today a credit officer has little incentive to lend to a risky corporate or asset manager and liquidity will be provided only on the back of good quality collateral or the promise of certain cash flows from the deal.
As if funds had not dug themselves deep enough into trouble, Kinsey is sure that new regulation will evolve to try to prevent more crises from happening in the future.
“Registration always fights the lost war. Most of the regulation which follows a severe financial crisis has served only to make matters worse”.
In fact the Glass-Steagall Act created in 1933, which tried to prevent another depression, resulted in the creation of the very financial instruments that lit the fuse for the current crisis.
There’s little doubt that the bear market is here to stay for a bit longer, with intermittent mini-rallies as different sectors react positively to news items.
Two good quarters of growth might ensure that the rising tide will lift all boats in the asset management industry. With luck, that will come before all our collective portfolios sail away.