You know nothing* Jon Snow
I have friends and acquaintances opening new funds all the time, it seems. This post is an open letter to them. This is my advice to you, P/S, who are thinking about going live managing money right now.
To be perfectly clear though, everybody who recently started investing or is thinking about it should read this article carefully. Not only because of the negative start to the year for most, but because the bigger picture is so much…bigger than a January loss.
*about managing money
If you haven’t managed money before, you really know nothing about the craft (luckily, both of you actually have)
That’s okay, it’s not that hard, really, it’s “just” multifaceted and complex (and actually inherently non-understandable… -or was it just me?). On the other hand, most things worth pursuing are.
A watch is complicated,
the three body problem is complex
Quite understandably though, I constantly have to field questions about investing. The main problem is that I typically don’t adhere to the same underlying basic strategy, thus rendering most detailed tactical inquiries moot.
So, grab a container of your favorite hot beverage and make yourself comfortable. Turn off all notifications, e-mail etc. and get ready to concentrate for a good 25 minutes (shamelessly plugging my podcast in Swedish: “25 minuter”)
This article is in a way part of a series of articles about managing your own money (or possibly client money). Check out my archives for all my articles on finance in one place.
Hence, you should refer back to the linked material, whenever you feel anything is unclear.
This particular post outlines a few general points you need to consider before commencing managing your or clients’ money. I don’t provide any answers per se, only suggestions and a smorgasbord of choices.
Beware. After all, this is treacherous ground. Managing money is both difficult, complex and dangerous, albeit not very complicated (i.e. not too many moving parts, but as Newton knew, three is plenty).
That said, it isn’t for everybody, maybe not for you. How would you feel, e.g., about losing 50%?
Among the relevant articles in this context, my post about books and other reading material for budding investors stands out.
At the very least you should be familiar with the free pdf outlining 30 big ideas from Seth Klarman’s book “Margin Of Safety”.
I also think you should browse through at least one weekly comment from John Hussman. Just one single weekly, free, comment from Dr Hussman contains more market wisdom than most people acquire in a lifetime.
How to manage a fund
It’s pretty straight forward. Anybody could do it.
Just open an account and start buying things (stocks, bonds, commodities, derivatives, whatever you fancy). Once your cash runs out, you simply sell something whenever you want to buy something else, or borrow and use leverage.
(probably poorly though)
However, if you want some (professional) structure to it, listed below are the basic building blocks. Most of all they help you avoid common mistakes, as well as keep losses to a minimum (given your chosen strategy).
Avoiding mistakes is much more important than hitting homeruns when it comes to serious long-term professional investing
Decide on a strategy
This is probably the most common mistake of all. Investing is like air to us or water to fish. Most take it for granted and never take a closer look at what it really entails. Thus…,
Decide explicitly what your overall investment strategy will be:
- International or domestic (hint: international)
- Which asset classes (stocks, bonds, commodities, currencies, derivatives, precious metals, etc. – yup, investing is not about stocks only)
- Long only (remember I thanked the “long-only herd” when receiving the 2008 Hedge Fund Of The Year award)
- index independent
- index hugging
- which index (Whaddya mean, which index; are there other than S&P500? It’s never easy, is it?)
- Market neutral (Good luck Chuck! Sounds good, but alpha is often elusive and you end up doing an involuntary epic split between two different trucks)
- Market timer (if there ever were a losing strategy…)
The fund I managed, Futuris (Brummer) – the European Hedge Fund Of The Decade (Nota Bene), invested in stocks only and we were to some extent market timers, in as much as we deliberately controlled the overall net exposure of the fund. We invested internationally, albeit with a focus on northern Europe. We were completely index independent and non-biased in every way.
-How will you decide what individual positions to take?
- Fundamental analysis (FA, valuation)
- Key ratios (I don’t like P/E:s, but this cash flow yield approach is a nice shortcut sometimes)
- Btw, do you think of fair multiples in terms of what others (“the market”) is likely to pay, or in terms of true intrinsic value from your own point of view – i.e., a kind of yield calculation shortcut?
- DCF analysis (“true” valuation, but rather impractical and deceptive sometimes. Numbers in a spreadsheet are no truer than lines in a chart)
- Operations momentum (are fundamentals accelerating or surprising?)
- Should you heed broker recommendations?
- How do you plan to use analysts?
- broker firms
- For information only
- Implement their alpha recommendations
- Key ratios (I don’t like P/E:s, but this cash flow yield approach is a nice shortcut sometimes)
- Technical analysis (TA)
- Manual (intuitive, ocular)
- Computer driven, data mining
- Simple regressions (work until they don’t)
- Complex (e.g., Lorenz’ strange attractor analysis for style gliding and trend change detection/prediction)
- General, commonly acknowledged, patterns (see “Reminiscences of a stock operator” for some background on the psychological underpinnings)
- Stock specific patterns with statistical backtracking
- Combination of FA and TA
- Cross asset signals
- What do commodities, bonds, precious metals, high-yield fixed income instruments etc. say about risk tolerance and growth, and consequently about the potential for stocks?
- Investments, productivity, inventories, sales, employment, policy rates and economic growth, and their effects on profits and valuations
Futuris was mainly based on fundamental, bottom-up, analysis, with a focus on unrecognized operations momentum and DCF analysis. Key ratios did play an important part as well.
FA often is based on triangulation of several valuation methods, which is exactly what we did. We did apply some experience-based intuitive hedging as well; whether that should be considered FA or TA isn’t clear. On top of it all, we kept track of coross-asset signals as well as the macroeconomic trajectory and its potential impact on specific industries and stock markets.
Considering we won the “European Hedge Fund Of The Decade” award from HFR for the period 2000-2009, I’d say Futuris’ overall approach worked, even if it could have been refined and optimized further. Sometimes hubris got the better of us.
What do you do when things go south?
You will lose money.
Yeah, yeah, I know…
No, you will lose money, more than you anticipate, and you need a plan for that (Hedgehogging by Barton Biggs, or my own eBook both tell you a lot about the particularities of finding oneself deep in the red):
- Stop loss levels and procedures
- How much and for how long are you (and your clients) ready to lose for something you believe in
- Length of pause between a stop loss and restarting
- Procedure for restarting
- All at once, or gradually
- Are the same (losing) positions acceptable alternatives? Under which circumstances?
- Stop profit?
- a somewhat unorthodox principle of investing, where “enough is enough” and you cut your cash cows when they’ve run far enough, or rather too far. That way you avoid sudden mean reversions.
Futuris had an informal, soft stop loss level of 5% losses at the portfolio level. Individual positions, however, were allowed much more leeway. There were instances of doubling up at a 50% loss, and at least one (albeit marginal) instance of going 10-fold on a -90% loser. We had no specified pause length before restarting, but we almost always eased back into the market gradually over a few weeks. I personally did apply a kind of stop-profit methodology, trimming winners on surges.
Alright, so you have your strategy and some tactics in place. What about where the rubber meets the road? How do you perform the actual deals?
- How frequent trading?
- minutes and seconds
- Number of instruments
- Some advocate a maximum of 5-10 positions – to make every investment matter and count, as well as increase the depth of knowledge
- Some take hundreds of small market neutral “spreads”, reducing single stock and market risk to a minimum
- Perhaps, you plan to just buy and sell here and there and see how many you’ll get to over time?
- Overall exposure range (+/-10%, 50-80%, 97-100%, 70-130%, +/- 100%)
- Liquidity management
- Do you plan to have any cash at all?
- If so, where will you keep it?
- Level of aggressivity
- Marginal opportunistic changes within a strategic position
- Catching both up swings and down swings, no matter the trend direction (aggressive)
- Commission and research expenses
- How much are you prepared to pay per trade, or per year
- Are you buying execution services (placing power) or will you rely mainly on DMA (Direct Market Access, self-help)?
- Will you pay for research? How much? What is an acceptable ROI on that investment? How do you plan to measure the effectiveness of third party research?
For a fund of 1-1.5bn USD, Futuris was unusually agile. Sometimes we bought or sold the entire portfolio (100% of assets under management, AUM) in a single day. Most days, however, we typically executed less than 5 minor trades (less than 1% of AUM each). The extreme measures outlined above were reserved for stop-losses or profit taking in extreme market situations, such as 9/11 (2001), Hedge Fund Hell (August 2007), the Kerviel debacle (2008) and the Fukushima disaster (2011 tsunami and nuclear meltdown).
Futuris usually held around 40 different instruments (38 stocks, one long or short future and perhaps an index sell option), albeit more (60) the last few years.
Our overall exposure range was approximately -50% to +100% of AUM. We managed our liquidity conservatively (cash at bank or in short dated treasury notes). We were minimally aggressive regarding trading – once we had decided an instrument was going up or down we held the basic position steady with only minor trading on the margin (10-25% of the position), rather than actively calling temporary counter trends. Going both ways we left to more free-thinking spirits.
So, how should you manage your money?
I can’t tell you that, and I can’t recommend you follow my example either. I only want to make sure you understand the universe you’re about to enter.
Anyway, I think most investors should apply some sort of passive Buy and Hold stock strategy or a semi-passive Quattro Staggione strategy (stocks, gov bonds, gold, corp bonds). Going deeper is just a waste of time and a source of frustration for most.
I, however, am not most people (so I’ve heard).
I am currently heavily net short the stock market. Yes, that’s right; I haven’t just reduced my quattro stock slice from 25% to 20% or 15% or 0% for that matter. I’m way down at -100%!
It’s served me well recently, and even if I’m still basically 100% short, it’s less short than just a week ago. Hence, I’m actually ready for a temporary market bounce right now.
I know it sounds strange to some, but I have decided on a negative stock market exposure for the mid term, and will thus only trade around that position marginally – for fun and to stay tuned to the market.
I will not go tactically long on a gut feeling and risk being caught in an air pocket. It’s a bear market and they famously make everybody look stupid before they’re over.
Apart from (negative) stocks, I own quite a bit of gold (GLD) and gold mines (GDX), and I keep buying oil (Brent, and the oil exploration stocks DNO and Shamaran, which are both highly speculative punts on the KRG actually paying for the oil. That in turn probably means the oil price must rise above a certain threshold within a certain time lest they all go bankrupt, including the Kurdistan Regional Government).
NB that I don’t really manage my money in the true sense of the word. I’m betting on a downturn, after which I will start managing again. I’m doing it in part for fun, in part because I think I’m right.
Usually, and for most, it’s not a good idea to try to time the market. It only brings unnecessary frustration and consumes a lot of time.
Once it’s time to get professional again, I need to buy a much more diverse set of international companies. Depending on how far down the market goes, I just might go 100% long stocks, or more, for some time, while possibly using leverage in order to hold some gold as well. My oil investments are not for the long run, but how can you resist the world’s most important commodity when it’s down by 80%?
Yes, I know all about the Saudis needing the money, Iran coming online again, the promise of Shale, not to mention the expansion of solar power, carbon taxes etc. Please note that most oil people knew all about that already 2 years ago, with oil 300% higher than today (i.e. at 4x today’s price). This is not the place to discuss peak oil or its inversion, today the topic is overarching principles for managing a fund.
OK… so what’s in it for me, you think. I don’t get it, should I invest or not? What stocks should I buy? Or should I sell the ones I own?
No, no, no!
What you should do is just think through the following before starting to manage a fund or your own money:
- Should you at all manage your own money? Check out the pitfalls here. Is it worth it? Read the pitfall article and then decide whether active investing is something for you. It really isn’t for everybody.
- Is there some other alternative you could pursue, that would be more predictable, worthwhile (and fulfilling)
- What asset classes and regions?
- Doing everything and everybody is seldom a good strategy unless you have plenty of experience or a large staff ;)
- Jumping haphazardly from one thing to another just means more time spent learning and losing. You could trade just one single stock or currency profitably for your entire life.
- What overarching strategy in terms of net exposure (long only or market neutral, e.g.)
- Fundamental or Technical – on what basis will you select, rotate and replace your investments? How will you know if your M.O. is sound and workable? Are you a trader or an investor?
- How frequently should you trade? How much time (and money) are you going to spend on investing and monitoring?
- Plan B?
- Most of all, do you think it will make you a happier person, experiencing a fuller life, considering not least the loss of time, and the gain (sic.) in frustration?
Check out my eBook for more useful information on investing, not least my ten most important lessons for any investor, private or professional, including the most important one:
There is never any hurry to invest
Opportunities always cycle back
And if you are at all toying with the idea of going fundamental, first check out this article about the only two steps you need as a fundamental analyst or investor. Warning, it’s actually 50…
Final note: This post doesn’t tell you anything about how to choose your actual investments, the actual stocks or instruments. That’s up to you. I’m ‘just’ telling you to be explicit about the framework within which to operate, and under which circumstances to abort.
Please share this article with your social network in order to help at least one person avoid financial ruin due to some simple error of omission.
The headline? Sorry about that… Pure clickbait