William Hester of the Hussman Funds offered recent insights for the typical mutual fund buy and holder (the insights are nothing new for trend followers):
The storm began to brew last summer when investment consultant and historian Peter Bernstein wrote an article detailing the changes that can be expected in the field of money management. There are few people in the business as respected as Mr. Bernstein, who is the founding editor of the Journal of Portfolio Management and the author of several books including Against the Gods: The Remarkable Story of Risk. His words were a jolt to an industry that had become comfortable with its own dogma. The mental models and industry standards that were created during the great bull market are outdated and will be ineffective for the type of asset returns of the next decade or so. “What we have been doing has begun to outlive its usefulness; the world in which we invest today bears too little resemblance to the world of yesterday. That’s why managers with the greatest level of skill should be free of constraints, says Mr. Bernstein. He quotes the work of Richard Grinold and Ron Kahn, authors of the well-respected Active Portfolio Management: A Quantitative Approach for Providing Superior Returns and Controlling Risk. In their book they show that the more highly skilled a money manager is, the more opportunities the manager should be given to provide extra return. Judging performance by peer comparison alone misses the point that assets are managed to meet future liabilities. The true benchmark for any particular investor is the return required in order to meet those expected liabilities at the date they are expected. The herding of investors into popular stocks and industries during the bubble, and their subsequent price volatility, should cause investors to question whether the popular indexes and style groups are the optimal benchmarks. In this sense, the notion of uncorrelated returns – especially, absolute returns, has a compelling attraction,” says Mr. Bernstein. Mr. Bernstein thinks mutual funds will move toward a hedge fund model. Money managers will have freedom to select securities within an entire asset class; they will have the ability to hedge their portfolio in numerous ways (provided that the manager holds the portfolio’s risk level to assigned parameters); they will do most of their own research, or pay for objective opinions; and the performance of money managers will be judged by the return of their portfolio versus its risk. “When returns are not as easy to come by as in the past, the constraints on manager activity imposed by benchmarking are archaic. Indexing has become more costly and more risky. And new techniquesŠthat widen a manager’s range of choices will always make sense in comparison with the old way of doing things.
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