Thursday, January 07, 2016

Brilliant summary

In a rather sad turn of events today a mid-sized hedge fund based in London has decided to close their doors and return money to investors.  Below are some comments from their letter to investors with summarizes brilliantly the changes that have occurred in the markets in the past 10 years.

When people ask me for my opinions on the markets or the economy, I often tell them that it really doesn't matter because the markets that I grew up in, the markets that you hear about on CNBC or on the evening news, no longer really exists.  The market today is a rapid fire game of computerized trading that humans need not participate in.

Here are some selected snippets from their final letter to investors detailing their decision to shutdown (I've done some editing to shorten the letter and focus on the message).

"Our process marries the top down forecasting of key macro-economic variables with the bottom up forecasting of company earnings.
For this process to work we have consistently needed the following criteria to be met:
  • Access to transparent and truthfully compiled data.
  • Logical decision making by policy makers.
  • A reasonable spread of uncorrelated potential investments across time zones.
Unfortunately, global trends over the past couple of years have begun to work against these strategies
Data quality has deteriorated
  • Data releases have become much less transparent and truthful at both a macro and a micro level. Unfortunately, an ever growing share of the most important data China and India produce is simply not credible. Currently stated Chinese real GDP growth is 7.1% and India’s is 7.4%. Both are substantially over stated. This obfuscation and distortion of data, whether deliberate or inadvertent, makes it increasingly difficult to forecast macro and hence micro as well, for an ever growing share of our investment universe.
  • Corporations have also responded to greater market scrutiny since 2008 by disclosing less not more, on the basis that the less they reveal the less often they can be proved wrong by regulators, investors or law courts. 
The transparency of decision making has also declined
Assuming we can obtain trustworthy data we then apply logic to produce our forecasts. The validity of this process becomes questionable if economic policy makers do not themselves apply economic logic and in a transparent manner. 
  • Equity markets are also less transparent
  • The recent massive increase in market share of both ‘dumb’ index funds and ‘black box’ algorithmic funds creates a situation where equity market volumes have fallen sharply and individual stock volatility has risen dramatically.
  • In such a world dominated by index and algorithmic funds historically logical correlations between different asset classes can remain in place long after they have ceased to be logical. 
  • Index and algorithmic fund moves also make it very hard to ascertain what the markets ‘clean’ positioning is at any given time.
In summary, all of the above factors now mean that it is more difficult than ever before for us to accurately forecast macroeconomic and corporate variables. This has made what we enjoy most – the thrill of analysing economic data releases and company accounts – no longer enjoyable. 
It is therefore time to accept that what we have done has worked brilliantly for twenty years but does not work anymore and move on. We are confident our process will eventually work again – for the laws of economics will never be repealed – but for now they are suspended and may be for some time; an indefinite period involving indeterminate levels of risk during which we think it would be wrong for us to be the stewards of your money.
I could not agree more with these points.

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