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The Cody Blog: Cody on RM: Break From The Herd

Friday, June 23, 2006

Cody on RM: Break From The Herd

Administrator's Note: In his RealMoney Blog Cody rants on the money management business selling its soul:


By Cody Willard
RealMoney.com Contributor
06/22/2006 2:04 PM

Break From the Herd

Wall Street has always been a bunch of lemmings who copy whatever system has been working and attempt to further systemize it and then scale it for profit. And just like corporate group-think has all but ruined the music business, it is also a major threat to the markets and our economy. As the monies at stake have scaled to historic proportions, the growth of systemized money management has been exponential.

In particular, there are the fund-of-funds that have systemized the management of hundreds of billions of dollars. These systems lead these fund-of-funds managers to select only those money managers that will put money to work in accordance to the fund-of-funds expectations, and that leaves no room for free-thinking or flexibility, two traits I believe are valuable on Wall Street.

Running institutional money and want to change your approach because your analysis dictates such? Tough. Stick with the system that got you the money or the fund-of-funds will pull that money, regardless of your performance.

I've had systemic money in my fund before, and I kicked it out after they hounded me for being overly flexible. I'm serious. These system managers have no time and place for free-thinking and flexibility. In my approach to the market (and in my approach to life), I strive to be independent and free willed, and I have sacrificed size for flexibility.

Of course, the record-breaking decline in volatility over the past few years abetted the growth of many of these systems, and that cycle fed itself, delivering steady returns that appear to be "safe."

So what does Wall Street, in its endless greed and systemization of everything go and do? Rather than adjust, these managers try to juice those returns by levering up. And not just at the money manager level, but at the fund-of-funds level. So levered up money gets levered up, and the "safe systems" feed on themselves, further juicing those returns and "proving" the value of those systems.

In a similar vein, just this morning several new ETFs were launched that are double levered up, as Roger Nusbaum noted earlier. I often write about the virtues that the democratization of, well, everything, that the Internet and cheap computing brings about. But it's not all virtuous. These levered ETFs formally mark the introduction of levered systems to the masses.

Maybe this all works out smoothly and maybe even if it does get ugly it won't be for years to come. But music provides a case study here. Record labels spent millions convincing the public that the Simpson girls have a place in music. But they have since been reminded -- and harshly! -- that the public will only accept systemized groupthink until it doesn't. And then it gets ugly indeed. I worry that Wall Street's current trends, at the institutional and retail level, have our markets headed down this same path. As Dylan wrote: "Live by no man's code, And hold your judgment for yourself, Lest you wind up on this road."

I would love to get a dialogue about all of this going in our town hall of blog commentary. Are you running money? Are you part of the systemization of running money? Are you sure that is something that will pay off in the long run?

3 Comments:

Blogger Stephen L. McKay said...

From one Dylan fan to another, I think systemization has it's place, but not at the expense or exclusion of free thinking and innovation, which should always be promoted and fostered, lest we all become slaves of the system itself. Systemization should serve to free us up, so we can spend more time on creative endevors. The problem is that when people are making money they seem to get caught up in the frenzy of the moment and they lose sight of the big picture, and Lets face it, this can be easy to do. The problem with the systemization that you are describing is that it totaly lacks flexability, and this is a big mistake!

As for leveraging, I see a major problem with all the leveraging going on right now, and I worry that it will come back to bite us all in a very big way. You mentioned these new Pro Fund ETFs, and I hope the average retail investor understands the risk that comes with the magnification of movement. That's not all, look at the leveraging going on at the PE level, and I'm concerned about the ramifications with all the CLOs out there should ABL defaults go on the rise. I think we are walking down a dangerous road.

For all our knowledge and education, and what we call sophistication, we are still at a very primitive place in our psycological evolution. We sit back and watch a bad situation unfold before us like a bunch of school kids observing a fight breaking out, then when we realize something is really very wrong, we overreact in the opposite direction!

6/24/2006 01:44:00 AM  
Blogger muckdog said...

Yeah, but even though the ETFs are new, Profunds and Rydex have had mutual funds available that do the samething. I don't know how the ETFs work, but the funds that advertise 2x the performance can have a bigger impact of that because of compounding. It's 2x per day, so if we have a streak of 10 days it can either be extremely wonderful or extremely painful.

6/26/2006 06:13:00 PM  
Anonymous Raja Sekhar said...

Good comparison between the music bizz and wall street (you should include hollywood too, how bad are movies today?). I think rampant nepotism is part of the problem - it encourages the risk-averse-lemming behavior you're talking about.

I don't know much about FoF systems, but uncreative thinking leads to mediocre returns. Unfortunately the same people who will see a movie or listen to music just because it is heavily promoted are the people who want to buy ETFs for ETFs' sake. So I hope that robotic thinking is punished in entertainment and wall street sales but I'm not hoping too hard.

6/27/2006 10:26:00 PM  

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