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Where there are bandits there is alpha

15/08/2018

Yosemite Sam.jpg

 

Yesterday the only people to get excited by the Bank of England’s decision to raise interest rates to 0.75% were PRs. My Inbox filled up with the opinions of the industry’s great and good. None of which were very interesting.

 

However the summary remains - interest rates, which were stuff all, went up by stuff all, to stuff all.

I’m being a bit flippant - More than 3.5 million residential mortgages are on a variable or tracker rate – the average is 4.72%. This suggests an average increase of about £300 for those affected. And savers shouldn’t hold their breath – there is no rule that banks need to increase what they pay on cash accounts. The best deal for a one year fix is currently with Atom Bank, paying 2.05%. Notable for a call out is Skipton, which has passed on yesterday’s rise to savers, including those in their Lifetime ISA which will pay 1%.

I think the more interesting thing about yesterday is that nothing dramatic happened, because we all knew this was going to happen. Markets had already priced it in. PRs had already written their releases. The speed and availability of information in 2018 has changed financial markets, and this also impacts our investments.

 

Rothschild made money from superior information

It's told that the Rothschild banking dynasty made huge amounts of money after the Battle of Waterloo. Nathan Rothschild – so it’s said – was the first in London to hear of Wellington’s victory. He tricked markets by selling huge amounts of stock, leading everyone to assume this meant defeat. They all piled in and sold, prices tumbled and then Rothschild picked up shares at crazy low prices. Information is power and power is money. Fast-forward to 2018, and the internet and Twitter have largely democratised information.  And if Joe Bloggs knows the same as Nathan Rothschild – that game is over. 

 

There is no ‘superior information’ left in developed markets

I know a lovely fund manager who is so posh that he doesn’t seem aware that walking around the City with his shotguns in a bag before heading to “the Country” is perhaps less than sensible*. And I will never forget him telling me this – “Where there are bandits, there is alpha.” You have to say that aloud in a plummy voice to get the full impact. So what did he mean?

 

Alpha is the holy grail for fund managers. Loosely speaking it’s how much better you perform than the average. If the FTSE does 6% in a year, and a fund manager returns 10%, that’s 4% of alpha. The more that we research and poke about in markets, the harder it is to deliver alpha because everyone else knows everything that you do. Put simply, lots of people think that the enormous US stock market is so analysed and pored over that no-one can get an edge. No-one can possibly know anything more than others. And so it’s harder to deliver alpha. So you may as well just buy a cheap old tracker, keep your costs low and aim to trundle along matching what the S&P 500 does.

 

I have had the HSBC American Index fund for 5 years now. It costs about 0.06% a year and has returned 106%. That will do me. (Before you all rush to pile in, of course this will also come temporarily tumbling down when the caffeine-fuelled US market catches tech-stock induced flu, but that’s another blog)

 

Where there are bandits, there is alpha

Now consider less well-researched markets. There is less information. Fewer analysts. Probably more brown envelopes. Unreported goings-on and lots of unanticipated news. People on the ground will find it easier to get some insights and information, which will help them to make smarter calls about companies’ futures. So where there are bandits, there is alpha. And I will pay for good active managers in these markets.

 

Of course, this is over-simplifying things. There are still good stock pickers in developed markets. Lindsell Train are examples – their global equity fund only has 29 shares in today, and has gone up by 131% over the last 5 years. These guys embody the difference between data and insights – they have the same information as everyone else, but they must be bloody good at looking in the whites of directors’ eyes, and making calls about what is BS and what is brilliance.

 

But as a general rule of thumb, when thinking about what funds to pick – if you’re not sticking with index tracker cheapies, then ask yourself why. Because if there aren’t bandits on the horizon or razor-sharp proven stock pickers at the helm – what are you paying for?

 

P.S. Calling all small to medium business owners. We are doing a project for a firm and developing some ideas to help SMEs. If you own, have founded, or run a firm with up to 1,000 employees would you give me 20 minutes on the phone? Please email me if so.

 

 

*Disclaimer – although I grew up in Somerset, I think that hunting sucks, and anyone who gets a sense of triumph from shooting pheasants which seem to have about 6 brain cells apiece, is a bit of a pl0nker :0) But each to their own…

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