Thursday, January 17, 2013

Troubled Consumers and Money Managers Both Swing for the Fences

Troubled Consumers and Money Managers Both Swing for the Fences

A couple of days ago, Benedict Carey of the New York Times wrote an article entitled, “Hanging On: Life in the Red”[1], in which he outlines how folks in debt take on more and more risk as they get deeper into financial trouble.  You might think that this type of behavior is confined to those poor souls on the verge of poverty or homelessness.  Many a money manager has resorted to the same strategy.

Here’s how the game works.  The money manager’s performance starts to lag both that of his competitors and benchmarks.  Just as the collection agency starts hassling the indebted consumer, the client starts pressuring the money manager.  At some point, the client will put the money manager on the dreaded “watch list.”  Once the manager is on the list, he’s got about three to six months to improve his performance or lose the account.

Someone Has Quit (1997)

If someone is behind on the mortgage and about to lose power, they might well try to draw down all available money on their high interest credit card or visit a payday lender.  They’re willing to take on more risk and debt in order to ward off disaster.  A money manager adopts the same high-risk tactics. 

Most institutional money managers are hired to be like Ichiro Suzuki, now with the New York Yankees.  Ichiro strikes out less than 10% of the time and has hit over 2,400 singles and doubles over his 12-year career.  Ichiro only hits a home run about 1% of the time.  However, once the money manager faces eviction, his investment style comes to resemble Adam Dunn of the Chicago White Sox.  Adam has also enjoyed a 12-year career in which he has hit a home run about 5.6% of the time, but also struck out in 28% of his plate appearances.

Older baseball fans undoubtedly remember the ultimate “swing for the fences” player, Dave Kingman.  Apparently, Dave was on the “watch list” a great deal of the time.  He played for 10 teams in 16 years, including three stints with my New York Mets.  He managed to strike out a little less than Adam Dunn (24%) and hit home runs a bit more frequently (5.9%).

If the money manager is on the watch list, he has nothing to lose.  If he hits a home run (takes a big swing with your money and generates a huge return), you might keep him.  If he swings and misses, he hasn’t lost anything; you were going to fire him anyway.  JP Morgan has just released a report on the failed trading strategy of its chief investment office in London and the trader known as the Whale.  When the Whale’s trading strategy began to fail, he abandoned the bank’s strategy for seeking out singles and doubles.  Rather than cutting his losses, he swung for the fences.  This behavior sounds a lot like those poor folks caught up in a credit bind.

The lesson is straightforward: don’t let Ichiro morph into Adam Dunn or Dave Kingman.  If your money manager has underperformed, don’t encourage him to swing wildly.  Fire him, and find another lead off hitter. 

While money managers behave much like consumers under financial stress, there’s one big difference.  Consumers are playing with their own money and credit, and money managers are playing with yours.


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