Thursday, March 28, 2013

Path to the Ignoble Investment Hall of Fame

And so yet another long/short equity fund launches. Good luck, and I wish you success with your investments and the growth of your company. Ummm, just one question. Your press release states you will "target an annual return of between 15 and  25%", presumably buying shares you think will go up and selling shares you think will, in a perfect world, go down, or, at worst, go up less. I just want to know: How the frick do you "target" long/short returns on a calendar-year basis in the equity market!!?!?? And you are not alone in purporting to whip up this secret return sauce ex-ante. Surely you mean that you are "expecting" returns of 15 to 25% and hopefully, this expectation will be based upon historical experience over a sufficiently long and diverse period, as well as a dumb strategy composite that at the very least might provide a benchmark. Not that investors should expect there to be any correlation between YOUR expected returns and your actual returns. Indeed, if one had $5 (not the inflation in the metaphor) for every basis point drift on every managers' expected versus actual, one would be rather well-off. But if one really does target return, one would surmise that there are conditions under which you would have no positions, or others in which your returns would be much much bigger, and that you could, would or should target returns of 100%. Or mightn't you just keep an eighth to a  quarter of the position so you could continue to "target 15 to 25%"??!? Or maybe, should volatility become comatose, and expected returns get squeezed quite low, you might employ mondo-mondo leverage in order to achieve your target, kinda like Merriweather and LTCM did in 1998 (and Merriweather did yet again with JWM). THIS, I suspect, is the problem with targeting return. It could - and often does - lead you right into the Absurdist Wonderland of Nonsene for those silly enough to religiously pursue such a course.

I reckon the truth, in long/short equity where one is following a strategy which is not the equity equivalent of the Grand Unified Theory , is that one cannot target jack-shit. The market giveth what it does, when it wants to, and it will laugh - often derisively - until you and the majority of others  cry proverbial "Uncle!". And if its in the mood, it will carry out those that follow the taken and position accordingly thereafter, before yielding. Allocate accordingly, attenuate your leverage depending upon your orientation to the ever-present tail risk, take what the market gives you, but for heaven's sake, don't target return, and just get rid of it (along with the meaningless attempt-to-impress summation of the Management Team's aggregate years of experience) from any and all published material else your potential investors think of YOU in the same sentence as the Investment Ignoble Hall -of-Famer, John Merriweather.


Henry Bee said...

Anyone who sets an investment objective to target a return knows nothing about finance.

Rich said...

Perhaps the "target" isn't the actual returns they plan to get, although I'm quite certain that they'd love to achieve their numbers. What they are targeting are investors who are naive enough to believe the pitch.

stock spin off said...

I've read a few professional investors/traders that have done studies showing that you can make more money if you exit a trade at a certain percentage, as opposed to hanging on beyond x%. Obviously finding the correct percentage is important though, but I wouldn't entirely dismiss the idea. Of course we're not talking about an individual trader here, so I know this isn't 100% relevant.

vlade said...

Ah, Cassie, but you're NOT cynical enough. The really smart know that doing targeting a return has objectively nil predictive value, and is (for the manager) counterproductive.

Yet, for the great unwashed it's still much more attractive than unvarnished truth (we'll return whatever we'll return).

Thus from marketing perspective NOT including a target is suicide, because your (fund manager's) salary is paid as percentage of AUM (with a nice free option of any upside, should it eventuate).

It's much much cheaper (and predictable) to achieve returns to the fund managers (not fund investors, important distinction!) by increasing AUM via marketing rather than investing.

J. Merriweather's name is probably worth a few M in the marketing terms alone, and if you keep him away from investing you're likely still quids up (again, as someone who runs the fund, not the invesor).