uncorrelated returns: hedge funds as the new gold

Every stock market person knows what beta is.

It comes from a regression analysis, y = α + βx, where y is the return on a stock and x the return on the market).  It shows how a given stock’s past tendency to rise and fall is linked to fluctuations in the market in general.  A stock with a beta of 1.4, for example, has tended to rise and fall in the some direction as the market, but move 40% more in either direction; a stock with a beta of 0.8 has tended to exhibit only 80% of the market’s ups and downs.

The professor in a financial theory course I took in business school asked one day what it meant that gold stocks had, at the time, a beta of zero.

The thoughtless answer is that it means they aren’t risky, or that they don’t go up and down.

A consequence of this thinking is that you can lower the beta, and therefore the risk, of your investment portfolio by mixing in some gold stocks.What’s interesting is that in the early days of beta analysis that’s what some institutional portfolio managers actually did with their clients’ money.

That didn’t work out well at all.

What should have been obvious, but wasn’t, is that the zero beta didn’t mean no risk–or that gold stocks are/were a good investment.  It meant what the regression literally indicates–that none of the movement in gold stocks could be explained by movements in the stock market in general.

The riskiness of gold stocks is there, but it came/comes in other dimensions, like:  how mines develop new supply, the ruminations of the gnomes of Zürich (in today’s world, Mumbai and Shanghai), the potential for emerging country craziness, the propensity of the industry to fraud.

Why write about this now?

I heard a Bloomberg report that institutional investors as a whole are upping their exposure to hedge funds, despite the wretched performance of the asset class.  Their rationale?   …uncorrelated returns.

It sounds sooo familiar.

Admittedly, there may be a deeper game in progress.  It’s impossible to say your plan is fully funded by projecting a gazillion percent return on stocks or bonds.  But who’s to say that a hedge fund can’t do that?



Mainstay Marketfield (iii): dollars and sense

the Mainstay/Marketfield deal

When the Marketfield fund sold itself to Mainstay in mid-2012, it got two things:

–the legitimation of being part of a large financial company, New York Life; and, more important,

–it got access to NYL’s powerful distribution capabilities.

NYL, in turn, obtained a new “hot” product, with $2 billion under management, a respectable (if short) track record and a five-star Morningstar rating (btw, according to the Financial Times, Morningstar is now calling the fund a “gateway drug.”  It has also taken away two of the fund’s stars.).


I don’t know.  I imagine it consisted of an upfront cash payment to Marketfield, plus a continuing share of the management fee, which is 1.40% for the first $7.5 billion of assets, declining to 1.36% for assets over $15 billion.   Doubtless, Marketfield can’t create a competing product.

the product launch

I haven’t seen them, either.  I would imagine, though, that the sales pitch would be some version of the free lunch idea–that you get all the upside of an index fund plus considerable downside protection in bad times from the portfolio managers’ ability to sell short

the fund economics

Mainstay Marketfield is a load fund, meaning investors typically pay a sales charge to get their money into it.  The rules for how the charge is assessed are complicated.  Basically, though, if you have at least $1 million in assets in the Mainstay fund complex after your purchase, you get in for free. If you have $500,000+, the charge is 2% of your investment;  below $250,000 it’s 3.5%; below $50,000, it’s 5.5%.

In 2013, Mainstay Marketfield took in $13 billion+ in new money, according to the FT.  Let’s say that the average sales charge was 2% (my experience working for a load fund complex suggests the real figure is more like double that, but there may have been sales to large institutions, and anyway let’s be conservative).  If so, that total for the year would be $260 million in sales charges.  Roughly half would be paid to the selling brokers, meaning NYL netted $130 million.

Let’s say average assets under management for 1013 were around $10 billion.  A 1.39% management fee would amount to another $140 million, of which some part, let’s say 25%, would go to Marketfield.  That would leave $105 million for Mainstay.  (More complications:  Total fund expenses, including management, 12b1 fees and short-selling expenses, are around 3% annually.  To aid its sales efforts, Mainstay placed a short-term cap on expenses.  I’m not sure what expenses are included under that cap or how the costs may be shared with Marketfield.  So I’m noting, but ignoring, this.)

Let’s do what securities analysts always do.  My sales charge figures is probably too low; my management fee figure is probably too high.  We’ll cross our fingers and hope the two errors cancel each other out.  If so, Mainstay netted a cool $235 million from owning Marketfield in 2013.  Marketfield took in $35 million as well.

2014 and beyond?

2014 will likely prove to be a very profitable year, something along the lines of 2013, despite the fund’s recent woes.  Remember, average assets for the year will probably be around $15 billion–meaning management fees would have been 50% higher than in 2013.  And there were likely at least some sales in the first half.

I think a lot depends on whether the PMs can stabilize the fund’s performance, and thereby put a halt to redemptions.

If so, the fund may end up with, say, $7 billion in assets–and generate $100 million in yearly management fees.

If not, my guess is that Mainstay will try to sell the fund back to Marketfield or, as mutual fund complexes often do, fold it into another fund concept and have the Marketfield name disappear from the Mainstay stable that way.

It’s pretty clear what needs to be done.  The big question is whether the PMs have the willingness.



the Mainstay Marketfield fund (ii)

I’ve been thinking about the Mainstay Marketfield fund. The I shares (the ones with the longest track record) = MFLDX.

Is this a risky fund?

A lot depends on what you mean by “risky.”  And a lot depends on the time frame you use.

The standard academic way of assessing risk is to equate it with the short-term volatility of returns.  The idea has some initial plausibility.  All other things being equal, and for everyone besides roller coaster junkies, a smooth ride is better than a bumpy one.  Greater assurance that the price tomorrow isn’t going to deviate much from the price today sounds good, as well.

The main virtue of risk-as-volatility, though, is that it’s easily quantifiable and the data for measuring it are readily available.  There’s no need to delve into the actual investments and make potentially messy judgments about what a security/portfolio is and how it works, either.

On this way of looking at things, MFLDX isn’t risky at all.

During late 2008 – early 2009 the fund declined less than the S&P 500.  From the beginning of the bull market in March 2009 until mid-2013 it tracked the S&P relatively closely.  Less volatile in down markets, average volatility in up markets.  Not a bad combination–if this is all risk is.

Regular readers will know that I’m not a fan of this academic orthodoxy–which is, by the way, also universally accepted by the consultants who advise institutional pension plans.  It isn’t only that you don’t need any practical knowledge of the products you’re assessing–just a computer and a data feed.  Nor is it that my portfolios routinely had part of their excess returns explained away by their greater-then-average volatility.  No, it’s that, in my view, for an investor with a three-, five- or ten-year investment horizon whether a security goes up/down a little more or a little less than the market today and tomorrow has very little relevance.

Risk-as-volatility has done serious damage in financial markets in the past.  For years, academics and consultants regarded junk bonds as relatively safe because their volatility was close to zero.  They didn’t realize that the prices never moved  because the securities were highly illiquid and seldom traded.  In fact, during the 1990s, i.e., even after the junk bond collapse of the late 1980s, Morningstar continue to have junk bond funds in the same category as money market funds.  Since NAVs never moved, the former got all the highest ratings.

Back to MFLDX.

Suppose we look at the fund in a commonsense way.

Marketfield’s website portrays ithe firm as consisting of three principals who concentrate on macroeconomics.  The career descriptions indicate that only the director of research, who arrived in 2011, had any prior portfolio management experience.

The group runs a highly sectorally concentrated portfolio.  MFLDX can be both long and short.  It has a global reach.  It can own/sell short stocks, bonds, currencies, sectors, indices.

Despite having all these potentially return-enhancing weapons at its disposal, the fund was unable to outpace an S&P 500 index fund during the first four years of the bull market.

Yes, short-term price fluctuations were not extreme.  And I’m not saying that one could have predicted that MFLDX would be down 12% in 2014, in a market that is up 13%–sparking massive redemptions.  But it seems to me that risk-as-volatility didn’t come anywhere near to capturing the risk elements present in this fund.




the Mainstay Marketfield fund

I was reading in the Financial Times over the weekend about the Mainstay Marketfield mutual fund.  It gathered the most money of any mutual fund in the US during 2013, $13 billion, but it is now apparently suffering sharp redemptions after very badly underperforming in 2014.

Mainstay Marketfield

Mainstay Marketfield is the leader among “liquid alternative” funds, which purport to provide the hedge fund experience to ordinary investors like you and me through a mutual fund.  Why exactly that’s a good thing is another issue, since hedge funds as a class appear to underperform an S&P index fund on a regular basis (on top of this, the information the public has about them comes from their voluntary self-reporting, whose accuracy academic research has shown to be suspect).

Anyway, on the idea that one can learn a lot by examining things that go wrong, I thought I’d take a look at Marketfield.

Here’s what I found by spending a couple of hours looking at the fund’s SEC filings, the managers’ backgrounds, the Mainstay fund family site and charts of the fund’s performance.  The picture may not be complete, but it’s what I think a careful observer would come away with:

–the lead manager has worked in finance, mostly as a strategist, for 34 years.  His colleague has 21 years in the business.  As far as I can see, neither had any training/experience/supervision in portfolio management before they opened the Marketfield fund in 2007.

–the fund opened to the public in March 2008.  It had a period of strong outperformance vs. the S&P 500 during the stock market decline of late 2008-early 2009, when its losses were only about half those of the market.  From the bottom in March through mid-2013 it matched very closely the performance of the S&P 500.

–in 2012, Marketfield sold itself to the Mainstay fund family of New York Life.  NYL retained the Marketfield managers as subadvisors–meaning the two continued to run the fund.  Sales of fund shares skyrocketed once Marketfield hitched itself to the NYL salesforce.

–in late summer 2013, the fund began to underperform the S&P fairly steadily.  From the beginning of September 2013 though last Friday, the A shares were down by 8.9% vs. a gain by the S&P of 25.6%.  Factor in a 5.5% sales charge holders paid to obtain shares and the results are that much worse.

What happened?

The managers appear to me to be envisioning a world of runaway inflation of the type that beset the US in the late 1970s.  In such an environment, it would be important to own shares of companies that could raise prices at an inflation-beating rate and to avoid those that could not.  In the Seventies, the “bad” sectors were Healthcare, Utilities, Staples and Consumer Discretionary.  The “good”: ones were those that held  hard physical assets, like industrial plant and equipment, real estate or mineral resources.

In the 1970s, financials were losers;  they issued mostly fixed-rate loans, and they were constrained by government regulations that capped the interest rate they could pay for deposits.  In today’s world, those restrictions are gone; loans are typically floating-rate; and the banks can be involved in brokerage/investment banking.  So, arguably, financials would be winners if inflation were to accelerate strongly.

Whether this was their thinking or not, this description fits the portfolio they created.

my look at the portfolio

on the long side

The Marketfield portfolio held/holds Financials, Industrials and Materials.

It has no Healthcare, little IT, no Staples, no Utilities (all of which have been the stars of 2014).  It also has little Consumer Discretionary and almost no Energy, both of which have been good things.

on the short side

The fund shorted Utilities, Staples, and Retail.  It also appears to have winning bets against the euro and the yen, the latter offset by significant holdings in Japanese stocks.

What I find striking is that while the market has been going against Marketfield for over a year, the portfolio strategy I see is basically unchanged.

more going on

There’s also more going on than I’ve been able to see.  Everything I’ve said until now would lead me to believe that the fund’s year-to-date return should be around zero  not -12+%.  The long US stocks should be up 5% -10% (the only sector in negative territory is Energy).  I’m figuring that shorting industries that are, say, +20%, wipes out those gains, but does little more damage because the shorts are a lot smaller than the longs.

So something else is happening.  I don’t know what.  Broadly speaking, the reasons may be staring me in the face in the quarterly SEC filings I’ve seen (the stock selection looks uninspired, and maybe a little weird–of the holdings, I own only INTC and SPLK–but it’s almost impossible to lose 12 percentage points through bad stockpicking, particularly with the large number os stocks the fund holds).  Or there could be transactions that are opened and closed within the quarter and therefore don’t appear in the quarter-end statements.

my take

Th Mainstay site contains a Barron’s reprint from October in which the author touts Mainstay Marketfield as having double the returns of similar long-short funds since the market bottom in 2009.  Hard to believe that other long-short funds have lagged so far behind the S&P.

I find the $5 billion in redemptions (about 30% of peak assets) the FT says Marketfield has had ito be a stunningly large amount for a load fund.  My experience is that even in deep bear markets load funds have redemptions of maybe 10%.  This implies to me that neither the financial advisers who recommended the fund nor the clients who purchased it really understood what they were buying.

What I find most odd is that NY Life, which presumably has an older and more risk-averse clientele, should have chosen Marketfield to offer to its customers.  What’s odder still is that the move was spectacularly successful as a marketing move–until the wheels came off the performance.

It will be interesting to see if Marketfield can stage a comeback.  If the FT is right about the extent of redemptions (I presume it is; I just don’t know), the first indication will be whether the managers use the selling they have to do to reshape the portfolio.  Standard procedure would be to take some of the edge off the losing bets.  To my mind, “staying the course” would be the worst thing to do (personally, I think the runaway inflation idea is just wrong).  We’ll see when the next SEC filings come out next month.