Asset-Liability Management For Mutual Funds And Similar Investment Vehicles

by: David Merkel, CFA

How much confidence do you have in your investments, mutual fund manager? How much cash do you hold? If you are very confident, maybe you should hold more cash. Confidence comes near market peaks. Everything seems certain; nothing goes badly wrong. But the turning point might be near.

Same for bear markets. Amid weakness, reinvest in companies with weak performance that you know are essential, with good balance sheets. Reduce cash during the crisis, because stocks are on sale.

These are pain trades, because they offend our sensibilities. My view is that you follow price momentum during the middle of a run, and try to resist it near the end. This applies to both bull and bear markets.

I try to mitigate risk by holding more cash after the market has run hard, and less cash after the market has cratered. I resist the market’s movements.

But what if shareholders lose confidence? What if they pull a disproportionate amount of money?

A lost of that depends on how badly you do. If you do really badly, there is no hope. When shareholders leave en masse, there are no good solutions. Sell your positions with the lowest expected return, should you know what stocks those are. Maybe your best picks, however concentrated, will turn the tide eventually.

I would encourage all mutual fund managers, and those like them, to take courage. Make the hard decisions, and stick by your best ideas. Look to the long term and aim for best total return. If you can’t do this, find another job, because you are not cut out for money management.

Though money management firms are out to gather fees, money managers are out to outperform. Have appropriate pride for what you do, and give it your best. Try to avoid panic moves because investors are adding a lot of money, or redeeming a lot of money.

The main idea is this: know your investments, and what you expect them to return. Add/subtract from your investments in proportion to their desirability.

The balance sheet of a mutual fund is weak because anyone can ask for their money back immediately. Now, if you are a good money manager with a strong record, your assets will be more sticky. Opposite true if you don’t have a good record.

And sad in a way, because good track records do not always maintain. My view is that they do maintain outperformance on average until they hit their limit of assets that their style can manage.

So, invest with smaller promising managers, until they get too big. As for the managers, be reasonable about what you can manage, like some hedge fund friends of mine, who shut off flows to their special fund near $100 million of net assets.