Too Big to Succeed, Too Greedy to Turn Down Investors

Friday, May 06, 2011

We woke up this morning to find various confused people crying over the corpses of their sacred cows.

- First the BBC, who can't seem to understand how the Tories could have done so well in the UK local elections. More importantly, they appear to be struggling to get to grips with the fact that outside Luvvie Land quite a few people do actually support government spending cuts. In Scotland, Labour’s support has all but evaporated, as the political fault line running underneath Hadrian’s Wall starts to creak. Which all together makes TMM want to nip down to the bookies to put a friendly fiver on the Conservatives calling a snap UK election, though autumn would be more likely.

Second, the commodity inflationistas. Depending on how you’ve been positioned recently, commodities have either been one hell of a party or, well, hell. TMM have been noting the weirdly consistent trending behavior in commodities for some time and the absolutely insane price action in things like cotton and silver. A price squeeze is a price squeeze, but many of these materials are not in short supply in spot markets and have been running incredibly hard.

TMM have been of the opinion that much of this has been driven by the commodity trading advisor (CTA)/managed futures/evil robot juggernaut part of the investing community cashing in on trend lines and public hysteria, rather than being purely dominated by the supply and demand end user arguments. As one comment yesterday said “So do you think Gasoline prices have fallen 7% in a day because 7% of car drivers decided not to drive all of a sudden?”. Nope. The spec is alive and well and the strategy’s participation in the recent run up supports that view.

Judging by the recent strong performance put in by the industry’s monster, Man AHL, during the parabolic move in silver and their recent slowdown we're getting more and more convinced that the CTA community has a lot to answer for recent unhinged price actions (gold, silver, Euro, you name it).

TMM have been thinking a lot about this recently because one the sad facts of investing is that it is more or less impossible to generate the same performance in the same strategy when your AUM increases materially. One of the doyens of fixed income, Antti Ilmanen, devotes a whole chapter of his new book to endogeneity risks in markets – aka being too damn big to make money in a particular product or strategy. In some things like small caps and distressed debt the performance diminishes rapidly with size, but this can happen even when your core products are FX and futures. This is especially so when your returns depend on being nimble and able to move quickly – something that is awfully hard to do when your position in a product is a week’s volume.

The question is why would anyone invest in a strategy that is known to underperform past a certain size? The short answer is that fund of funds are idiots, the longer answer is that asset allocators at endowments and the like chase performance just like CTAs. It’s easy to add more money to a strategy and then pin it on the manager when it all blows up.

To that end TMM think that we will see flows out of CTAs and with that comes the reminder of the rewards of doing one’s research and understanding where fair non-financial use sits for commodities (*cough* lead). TMM are happy to have closed out on the highs for copper and are looking for more pain in industrial metals as there are few dip buyers on the hedge fund side (some of TMM think that with price moves like this, someone has to have gone out of business) and the energy sector appears to be moving back to fundamentals – ie, the $100 WTI we had as a price target at the start of the year. Yesterday’s game changing US data reinforces these feelings.

Much of this, of course, comes down to the timing and severity of the US slowdown (see yesterday's post) and whether there is further QE, not to mention resolution of China’s inflation problem that might allow commodities demand to pick up. TMM are not feeling bullish but are expecting the downward momentum to fade so have switched their puts to cash shorts until the fog clears.

Posted by Polemic at 1:45 PM  


LB arrives in the office, whistling innocently... decides not to mention yesterday's Max Pain Trade reminder, no, too much class for that, sits down and quietly reviews the back up in yields. Dollar up, stocks up? Not possible, surely..... whistles innocently....

Leftback said...
3:24 PM  

household survey showed a loss of 190,000 jobs ... oh well ... nothing a birth/death adjustment model won't fix.

Anonymous said...
4:44 PM  

You may be right, daily indices from HFRX and Newedge indicate that past few days (4th - 5th May) have been ugly for systematic/quant strategies.

Post 2008, alot of FOFs have included CTA exposure to help smooth our returns when fundamental strategies are tanking. There has also been decent growth in CTA FOFs themselves, as FOF houses work hard to stay in business and command fees by differentiating themselves and providing "specialised" exposures to investors.


Ali said...
5:33 PM  

The jobs report was pretty weak when you subtract the one-off McDonald's hiring and take into account the usual fudge factors.

Do TMM and/or commenters have any insights into the latest Greek € exit rumors? Sounds like they were preparing for the usual Weekend Surprise job and then there was a leak.

Can I make the "Greek melodrachma" joke one more time before it becomes hackneyed? The USD seems to be "bucking" recent trends once more. Sorry, I am partly here to provide a little levity at times...

Leftback said...
8:42 PM  

Don't think a Greek exit stage left is in the cards this weekend. I do think however it means that the Greeks have rolled out the big bazooka, their ultimate weapon to support their demands for better terms. So, clearly, lots of brinkmanship going on, which does imply that the probability that it does all end in tears ultimately has gone up. So looks like fun times ahead...

Anonymous said...
9:15 PM  

Commodity funds suffered a $1.47bn withdrawal week. One fund shut-down would be the icing on the cake for this hell of a party to keep going.

Anonymous said...
9:37 PM  

If there have been some fund implosions then we might expect to see some weakness while the remaining positions are unwound/liquidated.

Way too many invisible catalysts for me, a great time to sit in cash and do nothing, keep everything on a tight leash and make any directional punts small ones. There will be opportunities in the future.

Leftback said...
10:13 PM  

I assume by the close you had stopped whistling? Innocently..
Quick look close appears to me to still be open to further flattening depending on how much fear is still to be stirred up elsewhere.I still would not be short.Patience.

Anonymous said...
12:07 AM  

Anon 9.15
I think you have the most likely take on Greece.Politically they must be seen to be working to get the best terms they can or be thrown out by the greek people.

Sometimes you wish they'd just get through to a solution without the posturing ,but I suppose that would be expecting too much.

Anonymous said...
12:10 AM  

LB, if you're feeling bored and looking for excitement selling silver vol is a bit of fun. Nothing like being long the june 35 puts and then turning on a dime and delta hedging your way to another few hundred bps. Between stabilizing flows and slower rates of liquidation front end vol across commods looks seriously rich.

Nemo Incognito said...
4:28 AM  

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