Don’t Follow the Easy Money

investing and why you shouldn't follow the easy money

During university, everyone in my class had dreams of Wall Street.

Analysing stocks and bonds. Managing hundreds of millions of dollars. Selling active funds which promise to beat the market.

Such a job — with such a salary — would set you up for life.

We had no idea our dreams would soon become redundant.

It’s already become extremely hard to get into the investment management industry. But now it’s hard just to keep your job as an analyst.

Recent European legal changes have left thousands of analysts contemplating unemployment.

The January Mifid II rules require financial companies to disclose costs in greater detail.

So instead of calling up their favourite analysts for a chat, many fund managers simply won’t be making the call.

And the far fewer phones calls will likely lead to more redundancies.

Head hunter Elbrus Partners believes 10% of London analysts could lose their jobs.

As fund managers tighten their belts, many more analysts could soon follow.

Are the good old days over?

Back in the good old days, it was relatively easy to beat ‘the market’.

Fund managers were the guru stock pickers. Clients were more than happy to pay their fees. But today, the majority of stocks pickers fail to beat the market consistently.

The Financial Times wrote last year:

Over 10 years, 83 per cent of active funds in the US fail to match their chosen benchmarks; 40 per cent stumble so badly that they are terminated before the 10-year period is completed and 64 per cent of funds drift away from their originally declared style of investing.

For investors it’s been a no brainer.

Why pay a 1% to 2% fee for underperformance when you can buy ‘the market’ for less than 0.25% and receive superior returns?

It’s why investors have piled out of active and into passive funds over the last few years.

Cumulative actie vs. passive flows to bond & equity funds. 20-03-2018


Source: BofA Merrill Lynch Global Investment Strategy
[Click to enlarge]

If you’re unfamiliar with the difference, passive investing usually means buying an index fund or exchange traded fund (ETF). Active investing is when you buy into an investment fund where a manager buys and sells securities.

As active managers continue to lose out to index funds, they’ve been quick to lower fees and cut staff.

Last year, the world’s largest fund manager, Blackrock, laid off 40 stock pickers. And there could be many more to come.

In a 2017 Opimas report, they estimate financial institutions could cut their workforce by 10% by 2025.

This equates to around 230,000 fewer heads.

And as long as active managers underperform the market, human stock pickers will likely find themselves out of the job.

Are we seeing the death of active investing? 

The easy money sells out first

Businesses follow profits.

If there’s a growing industry with profits abound, hundreds of companies look to pile in.

That’s why highly profitable businesses like Carsales.com.au and REA Group always need to be on guard.

Just one slip-up might give competitors an edge to take a share of the market.

That’s why most profitable companies see returns fade over time. Profits are competed away.

The same is true for investors. They follow returns.

If fund A has a better track record than all others, investors will jump in hoping for more of the same.

Of course, jumping into a crowed trade isn’t always the wisest decision. Following returns simply leaves you worse off than the funds you invest in.

That’s because you’re buying high (when returns increase) and selling low (when returns decline).

It’s a common irrational habit among passive and active investors both.

For the former, most buy simply because the market has recently outperformed everything else. And for the most part, this is how passive funds are sold.

Don’t buy passive funds because they generate decent long-term returns. Buy them because they post far better returns than those silly active managers.

It’s very similar to the bitcoin situation you saw in 2017.

As the crypto gained popularity, investors piled in. If others were making 1,000% on their money, why couldn’t you?

That’s when we saw the crypto rise rapidly, climbing above US$19,000.

But the problem these return chasers have is, what to do next? They’ve just bought into a hot stock or hot asset. When should they sell out?

No idea. They’re just along for the ride. Then, as soon as they run into any trouble, the easy money panics and sells out.

A lot of easy money has been shaken out of bitcoin thus far. But a lot more is yet to come out of passive funds.

Check out this graph of weekly flows of ETFs.

Weekly flows of ETFs. 20-03-2018


Source: Bloomberg Businessweek
[Click to enlarge]

The red line is when we saw global markets falter in February this year.

Will more come out as volatility picks up?

Be aware of your irrational tendencies

There is nothing wrong with passive investing. Actually, it’s the smartest way to invest if you don’t have a lot of time or experience in the markets.

Why try to pick individual stocks you know nothing about when you can earn a decent return just putting your money in the market?

But a lot of passive investors don’t think like this. They didn’t jump into ETFs and index funds to hold for the long-term. They jumped in because the market continued to run up.

A few encouraging words from marketers, and they were scared to miss out on the bull run.

Whether you invest passively or actively, following just one rule can keep you out of a world of trouble.

Don’t follow the easy money.

Bull markets, stellar track records, even high paying dream jobs. None of them last forever.

Kind regards,

Härje Ronngard,
Editor, Money Morning

Harje Ronngard

Harje Ronngard

With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.

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