Contrarian, Long/Short Equity
Contributor Since 2015
Buy-side analyst, trader and portfolio manager for over twenty years. Founder of Monarch Independent Research and Partner in Brightwood Advisors, a long-short investment fund. Always looking for new business, partnership or consulting opportunities. CFA, MBA.
This year brought a multitude of records-mergers and acquisitions (M&A) activity, corporate debt offerings and share buybacks. Annual M&A deal values broke the $4 trillion mark for the first time ever earlier this year and reached almost at $5 trillion by years end. The previous annual record was $3.9 trillion so we'll finish 2015 up about 25% from the prior record. These investment banking areas performed extremely well, even as other areas (fixed income trading, commercial banking) were slow. As corporations took advantage of continued low interest rates, underwriters of corporate bonds also saw a big year. Corporate bond sales are on pace for their fourth straight record year.1 Buyback desks saw record activity as the corporate debt offering's proceeds flowed into the equity markets. Conversely, equity offerings slumped after last year's record dollar issuance.
The teams that put all these deals together earn lucrative deal and advisory fees for their financial, tax and legal expertise. This means sizeable year-end bonuses for many financial professionals. For 2014, the average bonus in New York for a securities industry professional was roughly $172,000. Assuming a comparable level in 2015, that will leave a little over $100,000 after the dreaded supplemental income 'tax'. Assuming half that compensation is in stock (either deferred or understood to be invested in your company's fund), that's around $50,000 that needs hedging. Many non-financial professionals in Corporate America should also enjoy bonuses despite a basically flat year in the U.S. equity markets. The equity portion of these bonuses should be hedged in my opinion or converted to cash if possible.
Check out this article I came across if you're wondering what financial career areas saw holiday bonuses this year (and how much). So, if you are lucky enough to get a nice bonus this year, what should you do with it? Do you spring for the token Audi? What about a personal shark tank like NBA star Gilbert Arenas has? The Trivago guy might even convince you to go on a tropical vacation. Maybe you're being good and decide to keep it in the financial markets. If so, consider hedging the investment first and foremost. Then, the question still remains, should you put it in all at once or dollar cost average in?
Recently, a study was done by TIAA-CREF which showed that since 1926, investing a lump sum outperforms dollar cost averaging.2 Of course, the lump sum should be added right at the beginning of the year to maximize the results by accruing all that years market gains. I agree with this strategy and have never fully bought into the dollar cost averaging mantra (but admittedly never dove into the data to test its efficacy).
Of course, when would the lump sum strategy underperform? You guessed it, in down markets. Again, I'm normally a proponent of the beginning of the year lump sum contribution strategy, except when there's a high conviction that market returns over the intermediate term will be lower. I have such a conviction at this point. Dollar cost averaging is the better strategy for the next couple of years in my opinion, because you'll be buying cheaper shares over the years. Putting an unhedged, lump-sum bonus in early January 2016 could see its value get cut in half over the next couple years. The transactions mentioned above (M&A deals, buybacks and corporate debt offerings) are all expressions of optimism and when they reach record levels, optimism gives way to euphoria and signal a top in the markets. Historically, when they get this extreme, a sell-off is overdue. Sorry to be such a Grinch around the holidays…