Surviving Your Own Trading Strategies

COMMENT: I find it curious how people like ___________ pretend to be great forecasters but are simultaneously fund managers, which precludes them from speaking to central banks. Yet they seem to mimic you. You had to give up even personal stock investing to be able to even speak or advise. All they do is listen to you and copy what you say yet they do not have the database nor are they free of conflicts of interest.

Sometimes, you know… It just won’t fit.  You can fiddle with it, you can try to accommodate it, but you will never make it work. They are doing the world a disservice because they lack the database to forecast the future all by themselves.

RD

ANSWER: That is the dark side of humanity. Then they turn and ask for money to manage. What they do not realize is that when you get too big, your performance declines because you cannot invest the same with $10 billion as you do with $10 million.

There is a large and well-established body of research indicates a negative relationship between fund size and performance across most major asset classes. A 2015 paper by Pástor, Stambaugh, and Taylor, for example, provided strong evidence of what is known as “diseconomies of scale” in the active fund management industry. The effect is widely recognized as a major factor that erodes performance, particularly in strategies focused on less liquid assets like small-cap or micro-cap stocksand real estate funds as we have seen.

The bigger they are, the more you should be on guard. The performance decline is driven by a few core challenges that come with managing a larger pool of assets:

Liquidity Constraints, Reduced Information Edge, and Difficulties in Exiting Positions Large funds struggle to take meaningful positions in smaller, less liquid stocks without significantly moving the market price against themselves. This is particularly true for small and micro-cap stocks, where a fund’s size can destroy its own potential for gain. Exiting a large concentrated position can be as challenging as entering it if not worse, when everyone knows you are the elephant in the room. When a very large fund tries to sell, its own selling pressure can drive the stock’s price down, eroding returns.

I had to develop Natural Hedging dealing with portfolios in the trillions. Everything had to be strategically selected and correlated. Even when I testified before the House Ways & Means Committee, I had 50% of the equivalent of the US national debt under contract. You have to come up with a whole new way of funds management to survive.

The whole reason we have more institutional than anyone is because we cover the entire world and the computer tracks everything. Once you understand the methodology, it is the same globally so you can cover more. This allows our institutional clients to search the entire world to see what is hot and correlating. I certain;y cannot forecast from a gut feeling without such tools.