Mr. Sensitive

August 10, 2011

Bulls Panic Too

Filed under: Uncategorized — lbej @ 10:17

Regular people who aren’t fund managers misunderstand the nature of market panic.  Panic is an extreme reaction driven by irrational fear of loss, and for regular people, that means declining stock prices.  But fund managers and professional investors in general can suffer tremendous losses when stocks rise in two significant ways.  First, they might be short a stock or net short equities as an asset class.  In that case, they are going to lose money when prices rise because they have to buy back the stocks they’ve sold short to cover their positions, and do so at higher prices than the prices at which they sold.  If anyone is interested, I would be happy to explain how short-selling works, and I may do so even if no one gives a crap.  The other way professionals lose when the market rises is if they underown a sector or stock relative to their benchmark.  Many money managers are evaluated based on their performance relative to a benchmark, not on their absolute ability to make or lose money.  This makes slightly more sense than it seems to at first, because investors want exposure to a particular asset class and funds are designed to provide that exposure.  If a manager has an ironclad investing mandate–such as all techs, or all energy stocks, or all precious metals–his investors expect him to adhere to it.  So if he runs a gold fund and he thinks gold is going down, he damn well better go down with it.  He should, therefore, be evaluated relative to a gold-based benchmark, not the market overall.  But within his mandate, a fund manager can overweight or underweight particular stocks or instruments.  If his overweights underperform when the market goes up, he has to chase the market to make up for his performance lag.  He’s doing well, but not well enough.  So bear in mind that there is panic buying just as much as there is panic selling, and it’s all irrational.  In the last two weeks of trading, that’s the only explanation you need.

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