Posts Tagged ‘managed funds’

Answer to quiz: error in long-term gearing

Monday, April 13th, 2009

In Reader quiz: spot the error in long-term gearing logic, we asked our readers to spot the common error in a long-term gearing logic. Today, we will give a full explanation of the answer. Our readers offered many good answers that you will do well to take note of. But for this explanation, we will concentrate on a most frequently made error in logic. For this, we will expand on what one of our readers, Pete, said,

– margin loans act as leverage to increase gains…or potentially increase losses
– David point 2 mentioned margin calls – these hurt a lot.

This is the most important point that any investor who is considering gearing should paste on to his/her forehead. We have seen investors applying this error because they were retiring and were afraid that they wouldn’t have enough to do so. It is precisely that they are retiring that gearing should be avoided.

Assuming that in the long run, asset prices will be higher due to inflation, what can go wrong if an investor used gearing to maximise the effect of long run capital appreciation? The problem is that asset prices do not go up in a straight line. This is especially true if the investor bought the asset at bubble prices (e.g. before the panic of 2008). In the short-run, asset prices can suffer major correction. During bubble prices, when the risk of a major correction is at its highest and investors’ optimism at its peak, applying this logical error on one’s investment can result in devastating losses. When the price correction occurs, losses are magnified and the investor’s equity can get wiped out. Then subsequently, when asset prices recover, the investor will not have the equity to take advantage of the upswing. Even if the investor has the equity to take advantage of the upswing, so much capital had already been lost that the overall return in nominal terms can still be negative. Even if positive nominal return is achieved after many long years of waiting (that can test the patience of most people), the investor can still lose money in real terms.

For those who used geared managed funds (that is the managed fund is internally geared and the loan has no recourse to the investor), wild market swings can result in some of these funds being completely wiped out (i.e. value goes to zero).

Such fallacious thinking is the reason why clients of Storm Financial were wiped out financially. It is criminal that the so-called financial experts who provided such ‘advice’ could not see this. Unfortunately, the financial panic of 2008 had taught this lesson to many investors the hard way. In Australia, there are still some property investors who have yet to wake up.

Why you may not get the best returns from the professional money managers?

Wednesday, December 20th, 2006

The vast majority of the money sloshing around and influencing the movements in the market today is from managed funds (e.g. superannuation, life insurance, hedge funds, etc) and the ?professional? money managers. Individual private investors and traders usually do not have enough weight of money to move or affect the markets in a big way.

One of the pressures that fund managers often face is the unrelenting judgment on their performance. Their performances are usually measured against their competitors? performance and against the market average. To compound their pressures, their performance is often measured on a quarterly or annual basis, which in our view is woefully too short a time-frame to form an opinion on a money manager?s skill. Thus, if they under-perform their peers in the short-term, they risk losing their lucrative jobs. As a result, many fund managers have to focus on chasing short-term gains to grab an edge from their peers even though their performance, in absolute terms are unimpressive. For example, if they lose 20% in a year, they will be considered doing well if their peers perform worse and the market average is not any better.

Where is the source of such pressure?

Many managed funds seek their business among the mass retail consumers. Most of these retail investors are insufficiently educated in the art of investing. That means the only way these investors can judge the quality of fund managers is through their performances, which are measured in ridiculously short time-frames of a few months to a year. Some of these retail investors are quick to switch their wealth to another managed fund the moment they perceive that their fund manager is ?under-performing.? As we said before in How do you define risk?, one?s perception of risk will depend on whether one is investing from the retail level or among the legendary investors of excellence. Since most people investing in managed funds are investing from the retail level, managed funds have to cater to their needs by using such simplified but inadequate and misleading metrics as quality measures.

Now, our question to you is, do you want to be just an average investor or do you want to run along with the best in investing? If you decide to choose the latter, it will certainly demand a lot of commitment to acquire the necessary skills, knowledge, wisdom and patience. Many of the most lucrative returns involve taking contrarian positions, which require patience to see them bear fruit. In the meantime, short-term relative performances are irrelevant.