What’s the biggest risk to investor returns just now? The average fund manager reckons it’s a sovereign default in Europe. In the latest Merrill Lynch Global Fund Manager Survey, 43% of respondents saw it as the largest single global threat.
However, Mizuho International’s Jonathan Allum notes that, if the financial crisis has proved anything, it is that collectively we “know a great deal less about the financial system than we thought we did”. So while the blood-curdling stuff in the papers about Greek default is very exciting, for “financial markets there is always a more banal risk: that things do not – for better or for worse – turn out the way you expected”. So with the vast majority of pundits utterly convinced that default is both imminent and inevitable, surely at this point “a failure to default would be a risk”.
Not getting a default would be nasty for anyone short Greek bonds, of course. But it wouldn’t be good for the average fund manager either. Why? Partly because they are spending lots of money buying “tail risk protection products” to insure against another bout of 2008-style illiquidity. But also because they are holding more cash than even in 2009, and they also hold fewer banking stocks than usual. I don’t think this is foolish – I like cash and hate banking stocks too. But if Greece pulls through, all these managers will find they have performed rather worse than if they’d stayed in stocks. That’s not the kind of thing fund managers lose their jobs for, but it isn’t good for them either.
It makes sense for everyone to hedge as best they can against the big risks in the market. The problem is that most of the time we don’t really know what the risk is. Right now everyone’s insuring against another 2008. But the real risk, from a professional investor’s point of view, is that we either don’t get another major crisis or that we get a different kind of crisis, one no one has insured against.
So what we actually need is a generic kind of insurance for our capital, or an investing method that comes with built-in insurance. Good news, then, that there’s something that fits the bill. James Montier of investment manager GMO notes that “value investing is the only risk averse way of investing”. Why? Because it forces us to focus on the risk of the “permanent impairment of capital” (or losing money, as the rest of us call it). Good value-investors take no valuation risk: the assets they buy are cheap regardless of what central bankers and Greek rioters may or may not do. The problem is that, while all fund managers claim to have value on their mind, very few have the discipline to keep it there for long. For one who does see: The rewards of doing ‘remarkably little’.