The 'Pain Trade' vs. the 'Protect the Gain' TradeSeptember 25, 2012 @ 2:32 PM EST
With the 3rd Quarter fast approaching, one of the hottest topics of various financial sites and blogs is the behavior of both relatively faster money traders and more staid funds going into quarter end. Will it be a period of “window dressing” with allocations to some of the better performing stocks and ETF’s? Or will there be some shifting to a slightly more defensive allocation as funds/traders try to protect healthy gains YTD and especially the dramatic move up in the indices since June (assuming they have gains on the order of the indices themselves).
Against this backdrop is the ever-fascinating topic of hedge fund performance, which by virtually all measures has lagged the market significantly for the third consecutive year. Although it depends on the source being cited, let’s use the slightly outdated statistic for now of the S&P up YTD +12-13.5% pre the Fed announcement and the “average” hedge fund +3-5%.
Jeff Macke of Yahoo Finance’s Breakout is calling them “the Grumpiest Masters of the Universe on Earth”, having seen hedge fund redemptions and losing out on a large part of the opportunity for that percentage-based cut of client profits. (and we can’t imagine that clients are any less grumpy).
So the major question for all investors is whether or not there will be a hedge fund “chase for performance” not only into the end of the quarter but into the end of the year as well? And will those funds, hedge or otherwise, who have been fortunate enough to equal or better the index performances move to positions which will help them protect gains through the end of the year.
Two different arguments and two very different potential views for the next three months.
Macke, as usual, is very humorous in his description of the thought process for a hedge fund manager:
“You can try to save your business and reputation by catching up to the broader market in the last few months of the year. Doing the latter is impossible unless you chase. You need to buy Amazon (AMZN), Apple and Google (GOOG). You have to take fliers on left-for-dead names like JC Penney (JCP) and, yes, even Facebook.
You don't believe in any of these companies and you hate them at the current prices, but the humiliation of facing massive redemptions and a trashed reputation ("Getting John Paulson-ed") is unspeakably horrible.”
Reuters and others are calling this the “Pain Trade” saying, reluctantly, “many hedge funds have cut their cash holdings and reversed their bearish bets…if this shift continues, it could drive asset prices even higher”.
And then on the other side, the WSJ, in its ‘Ahead of the Tape’ column recently said: “some money managers, who caught this year's rally and are sitting on strong double-digit gains, are considering moving to the sidelines for the remainder of 2012…while these investors are not turning outright bearish, they are increasingly cautious given the extent to which the market has rallied in the face of many unresolved issues (Europe, China, Middle East, Washington, deteriorating earnings).”
Dave M. recently laid out both the bear and bull cases, but as he and I have discussed many times, “logical arguments” and one’s personal views on “global economics” often carries very little weight in a market which can be dominated by large flows of institutional money.
BigTrends.com also recently hit on a similar theme, saying in lukewarmish support of the “Don’t Fight the Fed or the Trend” case:
“There are six different factors that drive the equity markets at any given point in time, and in some periods, one or a few factors dominate, and in other periods, these same drivers can be on the back burner. These six items are liquidity, fund flows/positioning. technicals, valuation, sentiment, and the fundamentals. They continue in the aggregate to provide a very murky picture, but the fact that the market has hung in following the recent massive gains tells me that the first two factors are dominant at the present time.”
So, as we have said before, “this is what makes a market.”
(Note: It is also interesting that many otherwise well-informed journalists and bloggers have gleefully made the comment that “individual investors have outperformed hedge funds” or words to that effect. As Forbes recently pointed out, many individual investors have fled mutual funds “en masse”. It is also fairly obvious that many making 401(k) annual and quarterly decisions may have been spooked out of the market for a very long time. And according to recent data from USA Today, even supposedly more sophisticated self-directed online investors have captured only a piece of the year’s gains, with the smaller the account, the worse the performance, which would seem to make a lot of sense.)
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