Hedging Bets

We’re in Steamboat Springs this week watching the moose on the snowbanks and letting the world slow down with them for a bit. 

It sets me to thinking. “Hedge funds would be better off doing nothing.”  So postulated (requires subscription) Wall Street Journal writer Laurence Fletcher last week after data from Chicago hedge-fund researcher HFR Inc. showed stock-betting funds that as a group manage about $850 billion lost money in 2016. 

You’re tempted to smirk. The smartest folks in the room can’t beat an algorithm! They can’t top the S&P 500 index fund your 401k owns.  Losers!   

Let’s rethink that perspective.  These are the professional athletes of finance. The New England Patriots of investing. If the best are failing, the ones sorting good companies from bad and chasing them either direction, then maybe we’re missing the real problem. 

Perhaps it’s not that hedge funds are losing but that the market isn’t what it seems.

And if hedge funds are confusing busy with productive, might we be too? The investor-relations profession shares common ground with them.  Great effort and time go into telling the story so it resonates. Hedge funds come at a cost because they’re ostensibly better at sorting fact from fiction. Both disciplines are about standing out.

Apple stands out for instance, touching a 52-week high yesterday following resurgent growth. Yet as my friend Alan Weissberger at fiendbear.com notes, Apple earned $8 billion less in 2016 than the year before and spent $20 billion buying back stock.

People are buying its future, is the retort. If by that one means paying more for less since it’s likely AAPL will continue to consume itself at better than 5% per annum, then yes. But that’s inflation – more money chasing fewer goods.

I’m not knocking our epochal tech behemoth. It’s neither pulp fiction nor autobiography to the market. AAPL is its pillar. Models aren’t weighing mathematical facts such as its 5.5 billion shares of currency out, 15% less than three years back. But who’s counting? Not SPY, the most actively traded stock, an exchange-traded fund and AAPL its largest component.

If the models needing AAPL buy it, the whole market levitates in a weird, creaking, unsteady way.  This is what hedge funds have missed. Fundamentals are now back seat to weighting. If you pack weight, the cool kids of the stock market, you rise. When you’re out of the clique, you fall.  Your turn will continually come and go, like a chore schedule.

Hedge funds are also failing to realize that there is no “long only” money today.  Not because conventional longs are shorting but because the whole market is half short – 48% on Feb 6. One of our clients was short-attacked this week with short volume 23% below the market’s average. We doubt the shorts know it. 

Hedge funds are chasing the market because they don’t understand it anymore. No offense to the smartest folks in the room. They’re confusing busy with productive, spending immense sums examining business nuances when the market is a subway station of trains on schedules.

There are two lessons here for investor-relations folks and by extension executives of public companies and investors buying them.  IR people, learn by observation. Don’t be like hedge funds, failing to grasp market structure and getting run over by the Passive train.  Learn how the market works and make it your mission to weave it into what you tell management. Structure trumps story right now.

Second, hedge funds show us all that there’s a mismatch between the hard work of studying markets and how they’re behaving.  Either work, smarts and knowledge no longer pay, or there’s something wrong with the market.  Which is it? 

Stay tuned! We’ll have more to say next time.