Only from an Economist

Interest rates have been rising. The "accommodative" interest rate policy, i.e.; printing piles of money, over the past few years is coming to an end. Like typical human behavior everyone seems to realize this at the same time. Isn't there someone amongst the thousands of money managers that know this is going to happen? Why does it take an economist to explain an elementary concept that has been the wrath of investors since there were investors?

The latest blurb: "Perverse incentives for investment managers may help explain recent lurches in risk aversion and the price of risky assets, such as emerging market debt, the chief economist of the International Monetary Fund suggested on Thursday." (Raghuram Rajan)

We need this guy to tell us that when governments print money like it going out of style it is going to find it's way wherever it can earn the most return. Alas, the financial markets. With over a Trillion Dollars floating around the Hedge Fund Industry these days and every damn one of them trying to beat the market they all end up doing the same thing; looking for the "sweet spot" that has not been discovered by everyone else and buying in.

This practice is not unlike looking for the best beach, one not trampled by hoards of tourists. Now to do this you have to go to far flung places around the globe that are 1) difficult to get to and 2) so remote there are likely to be many hurdles you have to jump through to enjoy your single objective, finding the perfect beach.

These “hurdles” when applied to investment products mean when money managers manage to find their sought after “sweet spot” investment it is very likely the party will not last long. Others will find the same territory even if it is on a slightly different island. Now everyone is finding little quant places to park their money. The only problem is these places are “uninhabited”, which in investment terms means “illiquid”. They may have found the sweet spot but with no one else around when they want to get out there is often not enough “buyers” to allow them to cash in on their great returns while departing.

In addition, since everyone has found their “sweet spot” at about the same time, when everyone tries to get out at the same time to avoid an ensuing storm, there are likely to find all the avenues for departure stuffed with others. The result is most of them get left behind.

This is what we need an economist to explain?

Hedge funds bought into anything and everything they thought would give them an edge. They have to take on exceptional risk to do so. When the tide turns there is simply no quick exit. Markets drop precipitously as there are simply no buyers to sell their positions to. I mean it was they who had all the liquidity. It is easy to buy anything, not so easy to sell.

The lesson is learnt again.

This is why we need lifeguards. If there is no person looking over the beach telling people when the situation is getting dangerous the frolicking money managers will hang around, pour on the tanning lotion and get caught by the ensuing storm.