Last week I had lunch with ‘SM’. SM is a senior manager with a large investment fund that has several billion dollars of assets under management. He was relaying some information from the fund’s quarterly board meeting, during which the fund’s recent performance was reviewed.
SM worked as a trader for a number of banks but stopped several years ago.
The following is a simplified recap of our conversation – the gist of it being that the fund’s performance is flat and all of its traders are having a difficult time trading the present market conditions – and that this should serve as stark warning to a retail trader like myself.
SM: Are you doing much trading at the moment? What is your exposure in the markets?
Me: Not a lot. Basically some intraday trades in crude oil futures. How come?
SM: That’s good. The markets are crazy right now. Nobody knows what is going on.
Me: What do you mean?
SM: Nobody at our fund is making profits from trading at this moment. We have numerous trading teams – consisting of traders and analysts. All of them are finding it difficult to turn a profit. Their strategies are not working.
Me: Can you elaborate?
SM: Well, you are talking 100+ really experienced professional investors and traders who have access to extreme low transaction costs, top-end research and technology, testing and execution facilities. Their performance has essentially been flat for the past two quarters. They are not making any money.
Me: That reminds me of the performance of a bunch of trend-following hedge funds that I keep an eye on. In aggregate managing around $70 billion – they are also not turning a profit albeit losing a little bit.
SM: All the models seem to be breaking down. What has worked previously is not working in the current market conditions. It’s this continued low (near zero) interest rate environment. Investors are being pushed into riskier and riskier assets in order to generate a yield.
SM: Right now the capital flows are going almost exclusively into Index funds and out of actively managed funds. This means that when there is a new investment, it is immediately invested into all the stocks in the index, regardless of whether they are good or not. This is a self reinforcing spiral, so more and more money flows into these funds, pushing all the stocks up, regardless of their merits. All the stocks in the index rise. The problem with this is that the money can flow out as quickly as it went in. The most important piece of information is the ‘Risk Free Rate’ and right now, it is being held down by the major central banks, so it is distorting all rational economic decisions.
Me: What about currencies and commodities?
SM: Well, those too. Our traders cover all markets between themselves. Everyone is finding it difficult. Interest rates are far below what they should be at the moment. Interest rates in the US should be at 3-4% not close to 0%. Eventually all this is going to result in another major financial crisis and a massive stock market crash. It reminds of the Oct’87 crash which I witnessed first hand as a trainee.
Me: So what impacts should this have on my trading?
SM: I’d suggest to continue working on your strategy development, and continue trading oil. But keep your exposure small – don’t risk too much. You have to realize that if my fund’s traders are finding it near impossible to turn a profit, then you as a retail trader have basically got no chance whatsoever.
Me: All right – here come the burgers. Bonne appetite!