Too Big to Succeed, Too Greedy to Turn Down Investors

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.