Leverage and Its Discontents

June 18, 2009

There are lots of culprits in the current financial crisis and now major regulatory changes have been proposed to deal with all of the presumed issues. But underlying almost every one of the individual issues from commercial real estate lending, subprime mortgages, credit default swaps, home foreclosures, and corporate and personal bankruptcies is a more global meta-issue: leverage. Even significant declines in asset prices are manageable, albeit unpleasant, if leverage is not excessive.

This Ahead of the Tape piece from the Wall Street Journal points out the need for a leverage scorecard and transparency about who is borrowing what. Something this simple would go a long way toward preventing future systemic problems. (I’m crossing my fingers that the link is public!)

Leave a Comment » | Markets | Permalink
Posted by Mike Moody

Fixing Fund Manager Behavior

June 18, 2009

Cabot Research is on the cutting edge of behavioral finance. (You can read a recent article here.) They gather fund manager transactional data and try to figure out what the manager is doing right and what can be improved by changing behavior. They claim to be able to improve performance by up to 100 basis points, even with professional fund managers, simply by addressing the systematic errors in behavior that are being made.

At Dorsey, Wright Money Management, we’ve taken a slightly more rigorous approach. Instead of trying to modify our behavior—and hoping that the fixes persist over time—we test everything. That makes it easy to see what happens when one variable is changed. The whole investment process can be de-constructed and examined, which is something of an ongoing project here. Like Cabot, we find that correct long-term investment decisions are sometimes counter-intuitive. You wouldn’t be able to sort that out without testing.

Leave a Comment » | Investor Behavior | Permalink
Posted by Mike Moody

Target Date Fund Regulation?

June 18, 2009

There is more controversy about target date funds-their asset allocation, disclosure requirements, and whether and/or how they should be regulated. The root of the problem is that many target date funds did poorly in 2008 because they had large equity allocations in their glide path to retirement. There seems to be some pressure to make them more “conservative” by boosting the allocation to bonds. So what happens to workers who become retirees in a rising interest rate environment? How is that any better?

In my opinion, target date funds were oversold as the answer to every investor’s problem of how to handle their 401k. Target date funds were presented as the ultimate “set it and forget it” solution. Eventually, investors may come around to realize that strategic allocation solutions are not the be-all-and-end all. A tactical product can adapt to the situation at hand, rather than simply continuing down a potentially flawed glide path. Even though they require more thought and expertise, well-executed tactical solutions (like our Systematic RS Global Macro product or the Arrow DWA Balanced Fund) have a lot to recommend them.

Click here to visit ArrowFunds.com for a prospectus & disclosures. Click here for disclosures from Dorsey Wright Money Management.

Leave a Comment » | Tactical Asset Alloc, Thought Process | Permalink
Posted by Mike Moody