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The cult of the equity - John Redwood comment

July 23, 2010

John Redwood Comment
20th July 2010

The cult of the equity

Yesterday I joined a group of investment managers for a discussion of the state of the world and the investment opportunity.  They were a bright and well informed group, and we had a good run round the global economy and markets. The conversation reminded me just how much money rides on the recovery of western equity markets.

Conventional wisdom says that US, UK and European shares will give good returns over most time periods. All you need to do is to hold and buy.  Unfortunately, for the last ten years this has not proved to be the case, with the major western markets doing less well than holding cash on deposit. If you want to get really gloomy about the cult of the equity you look to Japan. The Index struggles to regain 10000, when it stood at four times that level twenty years ago.

Active managers put a gloss on that, and say you need to buy the right shares. Some go further and suggest if you let them choose the right shares for you can in some way be protected from general disappointments with the underlying market. The figures show that on average active managers fail to beat their index.

Frustration with the results of active equity management by the average manager led to many more funds and individuals putting their money into indexed products, to cut the costs and risks of investing in individual shares. There are a few consistent and good active managers, but it is difficult finding them in advance.

That in turn led some of the brightest in the investment industry to come up with the idea of the hedge fund. The aim was to produce funds that did not depend on the overall good performance of the underlying markets. They hired able people, put them on big incentivised pay packages, and asked them to follow strategies that could exploit market anomalies and opportunities whatever the conditions.  If markets fall they can sell short to make money as values decline. If markets are very active around a fairly static index they can buy and sell, exploiting valuation anomalies and volatility. They can specialise in exploiting bids, recovery situations, growth, value or whatever they like.  All sorts of different approaches have been developed.

This poses the investor with both a bigger choice and more difficulty. Which strategy should he choose? Is this the year for a long/short fund or a global macro? Does the average investor know what they are? This led to the sales of funds of funds, where the investor is invited to buy into a portfolio of hedge funds, created by another investment manager who judges and manages the hedge fund portfolio.

2010 is the type of year these funds are meant to do well. Markets have been up and down, but overall western shares have not produced good returns so far. So how have the hedge funds fared? Measured by the Dow Jones Credit Suisse Hedge Funds Index they have produced a total return of just 0.5% in the first half of this year.

It just underlines how difficult investment can be in these new conditions. We have not gone into an indexed product of hedge funds so far. They may not gear as much as they did in the days of easy credit, and that makes earning higher returns more difficult with their fee model.
 

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