Mutual Funds and Asset-Liability Management

reminiscences of a stock operator pdf

How much confidence do you have in your investments, mutual fund manager?  How much cash do you hold?  If you are very confident, maybe you should hold more cash.  Confidence comes near market peaks.  Everything seems certain; nothing goes badly wrong.  But the turning point might be near.

Mutual Funds and Asset-Liability Management

Same for bear markets.  Amid weakness, reinvest in companies with weak performance that you know are essential, with good balance sheets. Reduce cash during the crisis, because stocks are on sale.

These are pain trades, because they offend our sensibilities.  My view is that you follow price momentum during the middle of a run, and try to resist it near the end.  This applies to both bull and bear markets.

I try to mitigate risk by holding more cash after the market has run hard, and less cash after the market has cratered.  I resist the market’s movements.

But what if shareholders lose confidence?  What if they pull a disproportionate amount of money?

A lost of that depends on how badly you do.  If you do really badly, there is no hope.  When shareholders leave en masse, there are no good solutions.  Sell your positions with the lowest expected return, should you know what stocks those are.  Maybe your best picks, however concentrated, will turn the tide eventually.

I would encourage all mutual fund managers, and those like them, to take courage.  Make the hard decisions, and stick by your best ideas.  Look to the long term and aim for best total return.  If you can’t do this, find another job, because you are not cut out for money management.

Though money management firms are out to gather fees, money managers are out to outperform.  Have appropriate pride for what you do, and give it your best.  Try to avoid panic moves because investors are adding a lot of money, or redeeming a lot of money.

The main idea is this: know your investments, and what you expect them to return.  Add/subtract from your investments in proportion to their desirability.

The balance sheet of a mutual fund is weak because anyone can ask for their money back immediately.  Now, if you are a good money manager with a strong record, your assets will be more sticky.  Opposite true if you don’t have a good record.

And sad in a way, because good track records do not always maintain.  My view is that they do maintain outperformance on average until they hit their limit of assets that their style can manage.

So, invest with smaller promising managers, until they get too big.  As for the mutual fund managers, be reasonable about what you can manage, like some hedge fund friends of mine, who shut off flows to their special fund near $100 million of net assets.

By David Merkel, CFA of Aleph Blog

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About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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