If you're in the mood for some insights on risk, let me share what I learned this morning when I spoke with Michael Markov, head of Markov Processes International LLC.
Mr. Markov, a mathematician by training, heads a company that offers quantitative investment tools and technologies, principally to institutional investors. The professionals at his firm develop tools to pierce the veil of secrecy, obfuscation and outdated information that often surrounds managed pools of assets.
The Markov tools can and have been used to infer manager fraud by detecting the improbability of certain returns. But while Ponzi schemes and billion-dollar frauds grab the public's attention, out-and-out thievery in the investment management business is extremely rare. The bread and butter of Mr. Markov's work and his concerns lie elsewhere.
Most of the time, Mr. Markov is figuring out whether fund managers are performing well. Are the manager's outcomes the result of luck, timing, proper asset selection or something else? Mr. Markov says his analytics can tell.
I asked Mr. Markov if he has found anything in his recent analyses that has tickled his antennae. He mentioned two areas of interest.
First is the amount of money flowing into long-short funds.
“The investing public doesn't understand these funds,” he said, noting that there really isn't any definitive way to identify reliable long-only managers, let alone those who must master both long and short approaches.
“History has shown that any shorting creates a lot of risk,” he said. “In times of market volatility, this risk will show up.”
Mr. Markov says that hedging is not a solution to the risk problem in these funds because hedging against risks of which the manager is not even aware is impossible.
Another area of concern is stable-value funds.
“There are $500 billion in these funds, the SEC doesn't regulate them and no one knows what's inside them,” Mr. Markov said. “They're attractive because they are supposedly risk-free, yet offer much higher returns than money market funds. How is that possible?”
He's not sure, and is doing research to find out what's really going on under the hood.
Mr. Markov ended our conversation with a comment that may be trite, but is too often ignored: “Nothing is risk-free; there are always risks.”
If you're interested in other observations from Mr. Markov about risk and manager performance, take a look at his blog.