I was a history major in college and I am often asked what use I have made of that training during three decades of working in investment management. I usually mumble something about “cycles” and “history repeats itself.” A more honest answer is that there are many historical quotes and sayings that, if twisted a little, have great bearing on investing today.
• “Ask not what you can do for the market, ask what the market can do for you.” (Apologies to JFK).
• “Never have so few taken so much from so many.” (Sorry, Mr. Churchill).
• And the saying with the greatest resonance for investing today, “We have nothing to fear, but the lack of fear itself.” (Forgive me, FDR).
Investors in the equity markets have commented on the historically low levels of the VIX, popularly known as the “fear gauge.” Stocks are at high levels, cross border takeovers are booming and there have been companies no one has ever heard of that sport sky-high valuations only to turn out to have been massive frauds. From its low in March 2009 to today, the S&P 500 index is up over 180%. There seems to be little fear, little caution and very little safety margin.
In the global bond markets the lack of fear seems even more pronounced. The 10-year U.S. Treasury bond yields a puny 2.58% and Germany and France (!) have 10-year yields even lower (1.17% and 1.55%, respectively) while Spain borrows money for 10 years at 2.52%.
Even an investor with a healthy dose of (appropriate) fear faces a conundrum: Where to go? Rebalancing out of stocks and into bonds or vice versa both seem less than prudent and cash continues to yield almost nothing. Little wonder then that alternatives are experiencing explosive growth. According to Morningstar Inc. data published June 30, assets in the alternative fund category grew over 30% in the past year. No other category grew more than 10%.
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Investors hope that liquid alternative funds, in particular, will give them daily liquidity, low correlation to “bubbling” markets and overall risk exposures that are appropriately hedged.
NEW DEAL, FAIR DEAL OR GREAT SOCIETY?
So should investors in liquid alts expect a New Deal, a Fair Deal or a Great Society? With hundreds and hundreds of funds, some of which are brand new, it is impossible to generalize or predict. History does offer some lessons worth remembering:
• Risk never goes away. It moves around a lot but it's always somewhere.
• Bull markets create their own psychology and psychosis. Many managers say they are hedging and avoiding risk but they have trouble resisting the pull of the bull.
• Don't fight the Fed. Future historians will argue about the net effects of the Fed's quantitative easing purchases, but we already know that buying (anything) while the Fed has been buying Treasuries and mortgage-backed securities has been a good strategy. So when the Fed stops buying, investors should do…what? Have a little fear maybe.
• There is usually calm before a storm. High equity valuations, low volatility and low inflation are like seventy-degree summer days with no humidity, it becomes easy to forget squalls or worse can ever happen.
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Maybe an English major would have the best view of the markets today. In Hamlet, Laertes gives Ophelia some timeless financial wisdom, “Be wary then; best safety lies in fear.” Perhaps an answer to the conundrum of “where to go” may be found with a well-researched, well-chosen liquid alternative fund.
David F. Sand is chief investment strategist of Community Capital Management Inc.
