Friday Mailbag

Befriending the Trend 
Comments on the managed futures column followed a trend. (Clever me.) Pretty much everybody acknowledged that, yes, managed-futures mutual funds have been duds. The reason, they wrote, was that the funds have been one-note Johnnies that rely on trend-following strategies. 

Bill McCollum writes: "One of the better articles I have read on the poor recent performance of managed futures is 'Observations on the death of trend following' by Brian Casselman. I encourage you to read it."

Thanks for the tip, Bill. (I always appreciate reading suggestions.) Casselman details how, in recent years, volatility patterns of commodity prices have differed from those of the past, thereby foiling strategies that had good historic returns. In brief, trend-following funds benefit from big changes in price over intermediate- to long time horizons, and struggle with sharp short-term changes. Since 2009, volatility over the intermediate- to long-term periods was shrunk and short-term volatility has risen. Whammy one. Whammy two. 

The article also advances the argument, popular among managed-futures circles, that the post-2008 response by the major central banks, that of easy money and low interest rates, has dampened long-term volatility. Per this analysis, trend-following funds will snap back to being their former selves once the current "infusion cycle" ends. (This section features a splendid typo, with legendary manager Stan Druckenmiller called "Stan Drunkemiller." Well now, that explains things.)

Hmmm. That second part sounds like wishful thinking. I don't recall managed-futures managers advancing such a view when the infusion cycle began. They weren't writing their investors shareholder letters suggesting that fund owners might wish to sell their funds, because the trend-following approach was about to encounter a difficult period. Nor did many funds at the time adjust their investment tactics, knowing that easy money would give them problems. Sure, the theory could be right. Just call me a skeptic.

On the Positive Side
Jon Stein writes that some managed-futures funds using "discretionary macro" strategies that use fundamental analysis (rather than the technical, price-based analysis of trend-following strategies) are thriving. Unfortunately, few of those funds are mutual funds, being instead unregistered hedge funds and/or separate accounts. Also, while Jon's accounts are doing well, the category itself hasn't been all that great in 2013, as the global macro category in Morningstar's hedge fund database is only up 2% on the year.

Other possible good news, per Jon, is a study showing that managed futures perform relatively well when interest rates are rising. That I do believe. The question, of course, is when central bankers will finally raise rates. It's been a long time coming--and might be longer yet.

Blue Flu
David Yarnes improves my story on East Germany's misuse of human capital. In that column, I argued that the standard explanation for East Germany's economic woes, the failure of top-down central planning, was perhaps less important than the effect of the country's social policies. In various ways, East Germany's government stifled innovation. As a result, I claimed, the country couldn't and didn't enhance its manufactured products.

David writes, "The suppression in East Germany drove people out in huge numbers, mainly through 'leaky' Berlin. As many as 10,000 per day were making their escape just before the wall slammed things shut. It was fairly easy--just jump on the S-Bahn, or even walk through the Brandenburg Gate. Soon, anyone carrying luggage was detained, and bank accounts were watched for sudden withdrawals. However, since most East Germans didn't have much anyway, they just walked/rode across empty-handed.

"The problems you cite, regarding the East German economy, were significantly exacerbated because 'Fritz' or 'Ernst' suddenly didn't show up for work one day, having made his escape to the West. It created havoc with East German production. It wasn't just raw materials that were lacking, it was manpower as well."

Good point. I toured the remains of the Berlin Wall and knew all about the exodus when I wrote the column. But I did not put two and two together. Thanks, David.

It's Getting Better All the Time
On Wednesday, I confessed to my failings as a bond-fund analyst. About notable bond-fund scandals of the past, I wrote, "On none of those occasions did I recognize the danger before it occurred. (Even if I could forecast market woes, it wouldn't be with subsegments of the bond market.) Nor did I necessarily realize which funds would be harmed once the downturn began--because often, it's difficult for anybody who is not a bond trader to understand just what the heck that particular bond does."

Morningstar's current bond team would like to note that my past performance was not predictive of its future performance. States a team member, "While we've rarely been able to predict blowups themselves or their timing, we have had a reasonably good (certainly not perfect) record of highlighting the meaningful risks of many funds, before they did ultimately blow."

Noted. Morningstar as an organization has learned much about bond funds in the two decades since I conducted the task. The staff is larger and much more experienced, and the tools for analyzing fund portfolios are more robust than my generation's stone knives and bear skins. Some things do indeed improve with age.

Down Is Up
In response to Thursday's article about institutional reviews of investment managers, Christine Benz sent a copy of a September 2010 Vanguard study, "What matters most? An analysis of investment committee hire/fire decisions." That looked mighty familiar; it surely was somewhere in the recesses of my mind when I composed the column. Vanguard's piece confirmed what I implied, that the single largest reason why investment managers are fired by institutions is for poor recent performance. Ironically, per the study, the fired managers then go on to outperform the recently hired managers over the next one, two, and three years. Go figure.

Faint Praise
From today's wonderfully snarky The New York Times review of Thor: The Dark World. "Handicapped by technology that makes her head resemble a bowling ball perched on a pipe cleaner, and a character who spends an inordinate amount of time in a dead faint, [Natalie Portman] may be an unconvincing brainiac, but you'd be hard pressed to find an actor who looks better unconscious."

This writer is envious. Very. When it comes to envy, Loki has nothing on me. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.