Why markets ignore valuations, plus: Morningstar slashes the ex-star


Go with the flows

“What drives capital markets? The answer, according to hot news academic document is… uh… capital.

“When an investor sells bonds for $ 1 and buys stocks for $ 1… the overall market value increases by about $ 5,” write the authors, finance professors Xavier Gabaix and Ralph Koijen.

They explain that the stock market is “a very reactive economic machine” – for the simple reason that many investors are simply forced to react.

This is largely due to the constraints imposed on professional investors. Say, for example, that a bond investor gets drunk and develops a sudden urge for stocks. He just needs to own stocks right now. He turns to an equity fund manager and asks him to give him shares in exchange for his bonds; Hell, he’ll give her $ 3 in bonds for every $ 1 in stock. “No dice,” replies the action manager. Its mandate simply does not allow it to own anything other than stocks.

And, according to Gabaix and Koijen, many investors look like this equity manager, which means that “it is difficult to find investors who could play the role of macro arbitrageurs.” As a result, the markets themselves become relatively “inelastic”.

Why is this important? Because the “determinants of asset prices can be attributed to measurable demand shocks and concrete investor flows”. In short: Movements of money drive movements of the market.

This is a bold claim, and it flies in the face of traditional economic theory. According to a simple model of efficient markets, flows are a sort of irrelevant friction that occurs at the edges. But for Gabaix and Koijen, this is the main event.

The thesis is troubling for several reasons. For starters, it makes basic research a bit ridiculous. But their theory, Gabaix and Koijen are quick to point out, offers solutions to some of the questions prevalent in the market. This helps solve the “equity volatility puzzle,” which deals with the problem that stocks appear to be much more volatile than the underlying economy. It would also help explain why valuations seem to have so little explanatory power over market movements.

Part of the reason this theory makes such a splash has to come from the timing. As the prices of seemingly worthless things like GameStop and Bitcoin rise, traditional financial analysis has seemed to fade away. What’s the point of studying future cash flows when price appreciation hits millionaires here and there overnight? And indeed, our columnist David Stevenson quotes the newspaper in an article calling even stocks investing “the future of the momentum factor.”

So what should investors take away? The first is that it is better to know how people will react to the news than to know what the news itself will be. So if you can buy before a swarm, you’re in good shape regardless of the value of the underlying business changing hands. It might sound reductive (don’t we already know that stocks move with marginal buyers and sellers?), But Gabaix and Koijen’s framework is radical enough to suggest rethinking the way equity research is done. . Less time building revenue models and more time scrolling Twitter, maybe?

The second point to remember is more subtle, but it is aimed directly at professional fundraisers: Don’t lock up your managers. If you think a given investor has a good chance of knowing when the markets are undervalued or overvalued, you want to let her use that knowledge. Forcing her to stay in 80% stocks and 20% bonds (for example) through thick and thin seems like a particularly bad idea in the context of Gabaix and Koijen. These constraints force her to follow investors in and out of stocks, instead of letting her use the mob’s momentum against them.

These decisions can even contribute to systemic risk. Frankly speaking: we collectively force professional managers to amplify market movements, when they could instead serve as a useful ballast against the whims of drunken bond investors.

Neutral tones

From drunken bond investors to those maybe in need of a drink, we turn to Michael Hasenstab, whose Templeton Global Bond fund was recently downgraded by Morningstar analysts. money to neutral, about as big as the Chicago Research Store ever distributed.

The fund’s performance has been less than stellar for some time, mainly due to bets on emerging market bonds and against US Treasuries. But before the last few years, Hasenstab had a very impressive track record, easily outperforming its global bond peers and making headlines for inspired calls on Irish debt, for example. And that record means Morningstar analysts remained confident in the choice of the hipster king of bonds until this month, when they bluntly concluded “he’s not as good as we thought.”

This is a conclusion that many investors seem to have already come to. In 2016, when Hasenstab was headlining the research firm’s conference, it had $ 47 billion in its flagship fund (already down from its peak, but undeniably significant). As the Morningstar conference rolls around again, the fund has shrunk to just $ 10.6 billion, having recorded cash outflows every month since the 2016 conference except for two. And he’s a long way from the main stage.

Are this year’s headliners as good as Morningstar thinks they are? It looks like we’ll have to wait and see.

What’s in a name?

In trivialized games like asset management or financial advice, a little brand recognition can go a long way. And if your last name is Rothschild, then it makes sense to use that to your advantage, even if you are from no relation to the big financiers. And that was the case with Chicago RIA Rothschild Investment Corporation, which has been in existence since 1908 and oversees around $ 1.6 billion in client assets, perhaps in part because of its prestigious name (we don’t know for sure. , but it can’t hurt).

However, the flip side of a famous name is that it attracts attention when things go wrong, such as when the The SEC penalizes you to the tune of $ 2.5 million to put clients in funds that offer 12b-1 fees or revenue sharing payments, versus those that you know don’t. So far, and then, but this famous name makes people visit your site to see if it really was the great European banking dynasty that stumbled upon some of the SEC’s lowest fruits. It’s not. But the RIA website offers this little gem on its history:

In 1933, Samuel brought his son Robert into the business. From the 1940s to the 1960s, first Samuel and then Robert continuously improved the business to create a truly client-focused investment firm. Investment products and services that represented conflicts of interest, regardless of their popularity, were split, dissolved or never approved.

Good now. It just shows that past performance is really no indicator of future returns.

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