2 posts tagged “associated”
The reason for some institution's refusal to sell their positions that have appreciated dramatically (and that are most vulnerable to decline) can be deeper than the impression desired by publishing the positions. Management's compensation is usually a set percentage of the market value of the assets managed. If a profitable position is sold, the gain may be subject to taxation and paid out to clientele as a capital gains distribution. This effectively reduces the amount of money being managed and the associated fees.
The problems associated with selling positions that have profited most can be particularly acute in small mutual growth funds that have followed the practice of "taking losses and letting profits ride" for an extended period. The result is that their portfolio consists of only a few issues. By having locked themselves into holding a few profitable stocks, the fund's value becomes a function of the value of the rigid holdings and has nothing to do with the overall ability of management.
Keep in mind that money managers are human beings with basic needs such as food and shelter, which require employment. Also recognize that, especially in the larger institutions, clientele are not aware of the identity of the individual analyst making the investment decisions. This anonymity is often strictly enforced and a prerequisite for employment.
In this environment, the individual analyst (whether a genius or an idiot) is under pressure to conform to the crowd. To be too good or too bad relative to one's peers involves risks of criticism or resentment with the associated occupational hazards. This effect is obvious to anyone familiar with the financial media. When an analyst (usually independent) becomes popular because of accurate forecasting and then stumbles, the mistake (even though the overall return over time has been far superior) is pounced on. On the other hand, a spokesperson for a large institutional analytical service that has consistently been wrong, but that is one of the crowd, attracts media attention when making forecasts without criticism of past mistakes.
Understanding the structural aspects of institutional investing practices and employment pressures, you would logically conclude that the average institution would underperform the market, with the underperformance magnified by the fees involved. Yup.
External
Aside from the difficulties associated with internal structure and characteristics, institutions have the added problem of dealing with their clientele. Discretionary clientele who do not properly understand the stock market, although they have entrusted their investment decisions to someone else, often have a tendency to self-destruct. This is particularly evident in mutual funds, whose investors are continually adding or withdrawing (redemptions) money. People tend to add money when the market is highand the mood optimistic. Redemptions tend to dominate when the marketis low and the mood pessimistic.
The institutions are forced to invest the money—that is what they arebeing paid to do. Therefore, with more money coming in when the market is high, the institutions so affected are forced to buy at relatively high levels. Conversely, when redemptions dominate and the market is low, the institutions are forced to sell at depressed prices to fulfill the investor'sdemand for cash.
From the professional standpoint, the process is marvelous. We knowwe have buyers at high prices and sellers at low prices because of the demands of discretionary clientele creating a supply/demand imbalance. When they are doing their forced buying, it creates underlying buying demand and we can raise our prices. When they are forced to sell, we know there is "overhanging supply," and we can lower our purchase prices.
This buy-high/sell-low behavior (required to fulfill clientele's wishes) is not limited to mutual funds. It can affect any funds that can redeem or add capital according to their client's emotions: bank trust departments, pension funds, and the like. An important exception is closed-end mutual funds where the capital base is fixed and the investor must buy/sell shares in the open market rather than affecting the funds' specific holdings.
The market is a business. The purpose of the business is to acquire the monies of others through the process of buying low and selling high. Because of the anonymous nature of trading structure, it is very difficultto specifically identify the individual to whom you are selling or from whom you are buying. Consequently, physical coercion to create losingbehavior among fellow market participants cannot be applied. People do not enter the market to lose. However, they must be placed in a situation in which they will willingly part with their money. The only way to elicit losing behavior is psychological pressure. The most effective tool for applying the pressure is a change in market price. Faced with "paper" losses, those vulnerable to the emotion associated with "apparent" losses will capitulate, accepting the loss in the form of cash to relieve thepsychological strain.
The discretionary manager is subjected to the same emotional pressuresas all other market participants. It is not uncommon for discretionary managers to buckle under the pressure and sell low in direct conflict with historical or statistical precedent to alleviate pressures both self- and clientele-imposed. Conversely, when prices are too high, the emotionallure of greed can stimulate buying when prices are most vulnerable to severe decline. Those who conduct themselves professionally are acutelyaware of the psychological effects of price on institutional managers and take advantage. Such advantage is possible only by strict adherence to a methodology that prevents being lured into the irrational (emotional) behavior of the crowd. This is easily accomplished by having predetermined buy/sell points dependent upon market condition, not price in itself.
The forced behavior of institutions provides one of the most important profit centers for the true professional.
It is always helpful to know the mindset of the competition: the crazierthey become, the easier the task of separating them from their money.
In the old days, the best measurements of the speculative public sector's behavior were odd lot ratios and cumbersome calculations associated with price/volume shifts in low-priced stocks. Thanks to the advent and popularity of listed option markets, we can now use put:call ratios as an easily observed substitute, taking only the time to flip to the proper page of Barron's to get an insight into this sector's current behavior. The purchase of call options is an indication that the buyer anticipates higher prices. Conversely, the purchase of put options indicates that the buyer forecasts lower prices.
Because of a lack of knowledge, the reluctance to sell short, or whatever, the volume of call buying generally exceeds the volume of put buying. Therefore, the two opposing elements cannot be considered equal in their volume: Calls are more popular. Consequently, it is the change in the ratio of put:call volume that is important to us as a measure of nonprofessional sentiment. Whether you use the volume of listed options associated with specific stocks, or those associated with market indices, or a combination, you should get the same results as long as the measurement is consistent. We use the total volume associated with individual common stocks plus the listed options on market indices (averages).
A somewhat more refined analysis involves the changes in option premiums, that is, the amount that the option's market price is above its intrinsic value.
Whether volume, premium or a combination is used is of little concern because the results are almost invariably parallel.
In determining this ancillary criterion we use a very simple comparison of the current ratio (and/or premium) with that of four weeks ago.
BUY: Put volume (and/or premium) has increased disproportionately to calls. This can be indicative of excessive pessimism, reducing overhead supply and allowing prices to advance more easily.
SELL. Call volume (and/or premium) has increased disproportionatelyto puts. This can indicate excessive optimism, making the market more vulnerable to decline.
Advisory Sentiment
We consider put:call relationships as measures of the sentiment of the public speculative sector. To gain a measure of the feelings within the analytical community and the effect on the institutional sector, a variety of services survey analysts and report their findings. These services vary in their clarity, most dividing analytical sentiment into three categories: bulls, bears, and neutral (or "correctionist").
Many an analyst's outlook is ambiguous: "If the market fails to advance or decline, it will stay even, and so on, and so on . . ." This is of no use in practicality, but it does help in job retention because the analyst cannot be wrong.) Most surveys also incorporate a great deal of subjectivity in their results. In addition, the surveys can be biased by a lack of adequate sample size, an overweighting (lack of randomness) of investment techniques utilized by the analysts selected for the survey, and a lack of method for compensating for changes in the analyst's forecasts between surveys.
Despite these shortcomings, the surveys (especially during extreme conditions) can be useful. If overly optimistic they have likely followed their emotions and have bought, possibly exhausting their buying demand and allowing prices to descend more easily. Conversely, when pessimism prevails, the analysts have likely sold, thereby reducing overhead supply which can allow prices to more easily advance.
The selection of the survey to be utilized is not important because, when dealing with adequate sample size, their results are generally parallel. Several are followed by Barron's weekly, you need to do to see the survey's results is flip to the appropriate page. The survey selected should be consistent, that is, use the same survey for each weekly comparison.
As previously mentioned, these surveys divided the analyst's sentiment between the percentage of bulls, bears, and "other." We only look at thepercentage of bulls, comparing the current reading to that of four weeks ago.
BUY: The percentage of bulls has decreased. This can be an indication of pessimism and a reduction in overhead supply, making an advancemore likely.
SELL: The percentage of bulls has increased. This can indicate that increasing optimism is depleting buying power and making the market more vulnerable to decline.
