August 24, 2021
Most of my career in financial markets was spent either managing a portfolio at a hedge fund or taking risk for wall street banks within a proprietary trading account. My world would be described on what “Wall Street” would call a “Macro hedge fund manager or proprietary trader”.
I would describe successful “Macro” hedge fund managers in the following way *:
An unorthodox, quirky, and somewhat odd personality type that worries about events that seem to other people nearly impossible to occur.
Difficulty going along with consensus thinking particularly when it doesn’t make sense to them.
Compelled to express their views in financial markets.
Search for risks and opportunities for chaos where others seem relaxed.
Tend to make outsized returns when volatility/uncertainty increases dramatically. Make money when most of the “long only” money is losing money.
These managers are not all alike; they deploy different processes and styles. However, one important description often used when looking at investing with a “macro manger” is that they typically describe what they do as adding “alpha”. The returns are (generally) not correlated with an index like the S+P 500 (which is considered the “beta” benchmark). That generally means there is some form of market timing.
Market timing can mean (and often does mean) in simple terms**:
When perceived risks are higher than the overall market perception, they sell Equities
When perceived risks are lower than the overall market perception, they buy Equities
Long only equity managers and investment advisors generally advise clients NOT to market time, and overall, I think that is sound advice. More specifically, my view is that:
ALL non-professionals should NEVER try to time the market.
MOST professionals should NEVER try to time the market.
As I have opined in previous market letters, the best way to grow wealth over time is to accept short term volatility and fluctuation of returns, to capture the growth and income produced by companies over longer time horizons of 5, 10 or 20+ years. For more on how we invest, see July’s commentary on the website: https://www.augustwealthadvisors.com/post/market-commentary
The Caveat on Timing the Market:
All that said, I believe there are times when opportunities present themselves for market timing. The hedge fund managers I have worked with are adept at capturing returns when others are losing money. The ability to see risk or opportunities when others do not is a unique skill. This strategy can be successful, but it requires a careful balance. If we get the balance right, we have a chance to outperform the S+P 500 over time with less volatility. That is the goal.
By merging the approach of investing for the long term and utilizing our experience in identifying the macro landscape, we hope to achieve that goal. In general terms we will increase equity allocations when opportunities are abundant, and we will reduce that exposure when we view the market risk as underappreciated.
Why not just invest in hedge funds as a portion of your wealth?
Some advisors might advise clients to invest in “alpha” by allocating to a hedge fund. This potentially provides some protection against a significant equity market downturn. There are many talented managers out there, and there is a case to be made for hedge funds and private equity. They may be able to capture returns from parts of the market that the average investor cannot. However, they are not suited for many investors.
The trouble with investing in a hedge fund (or private equity) are the management fees (usually 1.5% to 2% of your investment per year), and the performance fees (usually 10% to 20% per year). This enriches the portfolio manager (compensation for their admittedly unique ability) at the investor’s expense. Additionally, there is a perverse incentive to take excessive risks with your money. Because they get paid 20% of whatever profit you make, the more risk they take, the higher their compensation. If you lose, they can start over again with someone else’s money.
Why do these fees matter?
In his book, Investing for Growth, Terry Smith of Fundsmith Equity Fund points out the following: “If you had invested $1,000 in Berkshire Hathaway in 1965, your investment would be worth $4.3 million by 2009. Buffett’s company compounded your capital at 20.46%/year. If Warren Buffett had set up Berkshire Hathaway as a hedge fund however, he would have charged you 2% per year and gathered 20% of any annual gains. If you had the same performance numbers, your $1,000 would have only grown to $396,000 by 2009. Only $396,000 would belong to you, the investor. This means that of the $4.3 million that you would have earned without fees, $3.9 million would belong to the hedge fund manager. This of course is the result if your hedge fund manager had a performance that is as great as Warren Buffett’s.”
August Wealth Approach:
Investors should continually focus on the big picture and the long term. The reason for this is that over long periods of time: economies have a propensity to grow, good companies will increase returns over time, and we can invest in those companies that will help grow wealth. However, as we know from centuries of history, investors are emotional. They become fearful and greedy at times, and often this says very little about the opportunities available for wealth creation.
I love being a fiduciary advisor because we charge a flat fee (generally 1%) to work towards the goal of creating wealth for our clients. I can also offer the experience of a hedge fund manager’s approach to risk and risk mitigation without a hedge fund fee structure. My experience navigating through many crises from the early 1990’s to today provide useful tools in our approach to managing portfolios. My hope is that when the market is not paying sufficient attention to red flags, we will be reducing risk for our clients to preserve wealth.
There are no guarantees, but I hope my experience will continue to provide benefit to our clients in the future. I am thankful to have had such experience during times of market stress, and to have worked with some incredibly successful hedge fund managers over the years. I also find it satisfying that if we do achieve strong results for our clients, that they will keep the bulk of the rewards.
Market View:
I remain positive on US and other equity markets globally.
My high-level view of market conditions is unchanged. I am not as concerned about yields rising, inflation, tapering, tax, the Delta variant, and geopolitics as many others.
Economic data will continue to remain very noisy due to covid disruptions previously and presently.
The Delta Variant of Covid-19 should keep fiscal and monetary policy on the looser side (good for financial markets). Federal Reserve may be slower to take any action on tapering.
Democrats should have a hard time passing much of the $3.5 Trillion budget plan. Tax increases seem unlikely (due to Biden troubles and centrist Democrats) in this case. This should also be good for markets.
Summer Reading and Viewing:
Without going into much detail with any of the suggestions below, I will say the common theme that interests me in all the characters and stories is: (A) The acceptance of one’s reality, (B) The understanding of one’s purpose in life and the dogged pursuit of life’s meaning, and (C) If consensus thinking or a particular system is an obstacle to what they know to be true, they find a solution. All the characters must deal with some form of suffering and loneliness, but despite that, giving up is never a consideration.
Quote: “Every blessing ignored becomes a curse.” Paulo Coelho
Books worth a read: The Alchemist by Paulo Coehlo
Elon Musk by Ashlee Vance The Premonition by Michael Lewis
Julian of Norwich by Mathew Fox and Mirabai Starr Investing for Growth by Terry Smith
Noise by Daniel Kahneman
The Snows of Kilimanjaro by Ernest Hemingway
Worth Viewing:
PBS Documentary, Mark Twain by Ken Burns
PBS Documentary, Hemingway by Ken Burns and Lynn Novick
Outlaw Josey Wales, 1976 film Directed by Clint Eastwood (multiple viewings over the years!)
Joseph Cardello, Principal August Wealth Advisors, LLC The Loft, 101 Franklin Street, Suite A
Westport, CT 06880 Direct (916) 461-9451 toll free (800) 985-9477
jcardello@augustwealthadvisors.com
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. No reader should make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence. Investing in the bond market is subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.
*I tried to generalize and be concise, but if you would like to learn more about personalities of hedge fund managers, you can read the interviews in the books by Jack Schwager: Market Wizards, The New Market Wizards, and Unknown Market Wizards. There are interviews with many long-term successful macro managers. **Any financial instrument or index that would correlate to a decline in Equities may be used. For simplicity, I use the term “equities”.
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