Do Nothing Fund Management: Another Distortion That Will Disappear

Another distortion, courtesy of the low interest rate policy of the Fed, that is now way overextended and serves political goals is the “do nothing fund management.” Market timers are being replaced by accountants because fund management boards think the current trend will stay intact. But it may not. And then board is fired…

A recent article in Wall Street Journal was appealing to majority of readers according to comments left but careful analysis will show that it delivers a disturbing message.

The low rate policy of the Fed now serves political goals because unhealthy excesses in the market have not been removed.  The Fed is now stuck between a rock and a hard place and maybe some wish that Republicans win the election so that they can hike interest rates and let them face the consequences. But what will happen if Democrats win? Will the Fed raise rates or will it continue along the same path that will inevitably lead to a bubble collapse?

Some at pension fund management think that the low interest rate policy cannot be changed because of the reasons just mentioned. Therefore, they do not need market timers; they only need the “do nothing” guy that spends all day doing PowerPoint presentations about their performance.

But wait a minute! Where do the profits come from? Apparently, everyone is doing the same thing, more or less. Some of the profits, maybe a small part, come from the following market participants:

  • Random traders (chart patterns, trend lines, candlesticks, etc.)
  • Struggling momentum traders
  • High dividend yield stocks

But wait for one more minute! The above contribute only to gains from buying at a better offer price or from dividend income. The bulk of the profits are due to open positions since the funds are passive. This means that many funds have open positions in the same stocks/ETFs and there are not enough market timers around to absorb the liquidity in case funds feel the market is going down, while the market timers think it is going up.

In reality, everyone is long and doing the same thing! 

Now this, which you probably know but maybe some do not realize: If fund boards decide one day to reduce exposure to stocks, the accountants that work for them will not use any algo to minimize impact from lack of liquidity but will depend on some brokers to do that. Since everything is connected nowadays, other brokers will find out and inform their clients in a matter of minutes. Then, everyone may decide to sell.

This is how you get flash crashes or even the start of a steep downtrend depending on macroeconomic conditions.

Then, panic starts and boards decide to “protect their pension money” by reducing more exposure. And the market falls more. And the SEC is looking to put the blame on some algorithmic trader working from his basement because they cannot touch fund boards (they went to the same school and were members of the same Fraternity….)

Soon fund board members realize that they need a good market timer with experience but there is no one around. The last one went to Oregon to start a farm.

Now what? They know that robo advisors all do the same thing. They are as dangerous. What do you do when stocks are down 30%. Do you average down or wait? What about if they fall 20% more? The guy that averaged will be toast. But if the market recovers, the guy that did not average may wait 5 to 10 years to recover.

Board is fired…pensioners lost half of lifetime savings…

If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY

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