Bloomberg Sees "End of Disco" for Traditional Fund Managers

Wednesday, we took a look at how the money manager era of capitalism if putting a higher premium on data-driven trend analysis in the stock market than ever before.

Bloomberg provides an interesting addendum to that line of reasoning, writing today that many analysts see this current bull market as the “last days of disco” for traditional fund managers. What do they mean?

Well, we’re in the middle of a historic bull market, and fund managers are trailing index performance by some of their widest margins ever. To compound matters, many funds are seeing a net drawdown in invested funds. After all, why pay to have your money managed if it isn’t beating the market average?

So, is this the end of the “managed money era?”

Not even close.  First, the money being pulled out of actively managed funds isn’t, in general, being independently managed. Instead, we’re seeing the growth of passive, index-style funds (whether ETF or mutual fund in form). These funds buy or short “the market,” whether that’s represented by a broad index like the S&P 500 or a collection of stocks from a particular sector.

Often managed via algorithmic trading practices, these funds have to regularly re-balance their holdings to reflect the set of equities that their fund represents. This behavior represents a doubling-down on the trend-based investing practices that have come to dominate this “money manager era.”

To understand why, we need to get to the strategic heart of index-fund investing. We need to understand that these funds are purely reactive. If your fund is simply trying to reflect an existing financial reality—like the composition of an index—your trades will inherently be responses to changes in stock prices lead by other investors.

That’s not necessarily a bad strategy. It certainly cuts down on management costs. But this approach cedes the market-beating returns to investors who can analyze the actual events driving these price changes in the first place! At least in the long term, you can’t beat the market if your trading strategy is predicated on matching the market.

The vast sea of capital residing in index funds, however, can provide just the momentum that news-based traders need to keep churning out profits. If a stock posts a positive news event and some dramatic gains, we almost automatically have billions of dollars from relevant index funds attempting to acquire that stock—they need to reflect its gains in their own portfolio. The same logic applies to selling off a stock impacted by a negative news event.

Here’s the key point to understand: money managers (and their algorithms) don’t want to execute these trades at disadvantageous prices This reality means that a single substantial positive news event can create an environment where funds looking to buy a key dip in a stock for months (that fact has been confirmed by academic studies).

In some sense, in order to limit volatility, passive funds allow themselves to be herded by investors who are willing to interpret news-based trends more aggressively. Like any herd, this strategy can be successful for everyone except those who fall to the back of the pack—passive investors who are the “last ones out” as a stock goes down can get annihilated pursuing a notionally safe trading strategy.

All too often, the rear of the herd is composed of the retail investors who have the most to lose. One approach: try to find a fund that can stay at the front of the herd and react to key market events before other funds. But this approach involves picking winners in an endless rat race between very similar mutual funds.

Another approach: leave the herd so you can see which way it’s being led. Of course, that requires a pretty substantial quantitative toolkit. And that’s where NewsQuantified comes in: a news-based trading toolkit founded on quantitative analytics. You can learn more about why NQ works so well for its users here.

But if you’d really like to learn more, we’re still conducting a complimentary virtual training seminar series. We don’t put on a hard sell; we just go over the basics of news-based trading approaches and take a look at how simply they can be executed using our platform.

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