Active managers who claim their recent losses are a result of the ultra-loose monetary policy unleashed by central banks after the global financial crisis are using a convenient excuse, according to Eclectica’s Hugh Hendry, rather than admitting that they have been spooked by “ghosts in the system”.
The year so far has proven to be a difficult one for active managers. The average IA UK All Companies fund has made a total return of just 4.13 per cent – having spent most of the year in negative territory – while the FTSE All Share has risen 8.75 per cent.
Similar struggles can be seen in other sectors: the average IA Global fund is lagging the MSCI World index while all four of the Investment Association’s mixed investment sectors are behind the FTSE All Share and the global index. The average IA Targeted Absolute Return fund has made only 0.21 per cent over 2016 to date.
Performance of sector vs index over 2016
Source: FE Analytics
“It has been an extraordinary year for markets. Curiously despite the widespread nature of investor losses, liquidity creation by central banks has remained flush with the ECB and BoJ replacing the role formerly played exclusively by the Fed. Nevertheless, active managers, regardless of bearish or bullish disposition, have lost money. However, almost uniquely, we at Eclectica do not blame quantitative easing,” Hendry, who runs the CF Eclectica Absolute Macro fund, said before the Bank of England loosened its own policy.
“Other investors complain that having artificially propped up markets to excessive levels and the drawdown we are experiencing in global equities this year was inevitable. However, this seems more convenient than accurate. For whilst few dare contest this belief, it does require the presence of a prevailing bullish mantra and the footprint of great swathes of QE liquidity rippling through the stock market to carry more validity.”
“That neither pre-condition exists would, in our minds at least, relegate the claim to being more belief than fact based. In short, activist central banking seems to have become an expedient scapegoat for all the miseries of activist money management.”
Hendy’s £25.8m fund has been hit hard over the opening months of 2016, falling 4.84 per cent. As noted above, the average member of its IA Targeted Absolute Return sector is currently just into positive territory.
Performance of fund vs sector over 2016
Source: FE Analytics
Rather than blame a snapback from loose monetary policy for these falls, however, Hendry argues that active managers have been fallen victim to “ghosts in the system” and have been reacting to events with emotion instead of logic.
“According to a Gallup survey in 2005, three out of four Americans believe in the paranormal. It is how we are hard wired. Philosophers argue that the human brain is built upon shakier primitive reasoning and at stressful times this can overpower our logic, producing feelings such as fear, anger and loathing,” he said.
“And let’s face it, a world in which over $10trn of sovereign debt can trade at negative interest rates is just plain scary. Looked at this way the pull of the supernormal begins to seem understandable as investors seek to wrestle some control back from a financial landscape that bears no precedent. Think of it as the stock market’s emotional self-defence mechanism when investors are not performing at peak condition.”
He adds that the past six months have witnessed three “potential global game changing and bloodcurdling” events that active managers have probably reacted to with the aforementioned “primitive reasoning”. Two of these – a US recession and a major Chinese devaluation - did not occur while the third – Brexit - did but has been met by higher, not lower, risk asset prices.
"We have been right therefore to reject such scare stories, and focus on the bountiful quantity of money in the system, but we are just as battered and bruised as our supernaturally inclined contemporaries,” he said.
“The only solace is that we are still in the game which could prove important as it looks as though the landing strip for global macro to make money has expanded greatly with Brexit transforming some unlikely tail events to investable outcomes and the monetary reaction continuing to push US risk prices higher.”
“Many are dumbfounded by the new highs on the S&P. It is most likely that stocks are repricing higher on account of higher global liquidity and rock bottom interest rates. But it is not necessary to tie one’s self to polar outcomes when ghostbusting,” Hendry added.
“This market is effectively Keynesian, in that there is no serious stimulus programme that today’s markets will not consider potentially successful. We are primed for such outcomes and start the second half of the year in good spirits.”
Performance of indices over 2016
Source: FE Analytics
Since the surprise Leave victory in the UK’s referendum on its European Union membership, Hendry has been increasing the level of risk in CF Eclectica Absolute Macro’s portfolio as he believes there is now a reasonable chance of “making rather a lot of money” off the back of dislocations created by the event.
Given the backdrop of loose monetary policy and investor panic over events such as Brexit, Hendry expects the market to witness similar dynamics to what has been seen in recent years: sovereign bond prices to continue to grind higher, ‘bond proxy’ equities to continue to outperform the wider stock market, German stocks to continue to outperform those in non-core European countries and US equities to continue to outperform the rest of the world.
