Cathie Wood and the Sound of a Changing Market
If investing is hard, managing an investment firm is harder. It requires balancing two sides of a ledger – investor capital on the one side and an investment portfolio on the other. Much of the time the two sides operate in harmony. Especially in the bull market of the past 10 years, a simple dynamic has driven the success of many investment firms: Money flows in, it’s invested in markets, markets go up, and more money comes in.
But the two sides occasionally get out of balance. That happens because firms’ revenue models skew towards the capital side of the ledger more than the investment side. They typically get paid according to total assets under management, which means they are incentivized to grow investor capital – regardless of the state of the market. So a dollar of net new money is worth more to the firm’s bottom line than a few basis points of incremental performance.
Problems occur when a market shift reduces investment opportunities after a period when investor capital has been scaled up. The current climate portends such a shift. Dan Loeb, who founded the hedge fund firm Third Point 27 years ago, told his clients in a May 6 letter that he’s worried: “I have said before that they don’t ring a bell when the rules of the game are changing, but if you listen closely, you can hear a dog whistle. This seems to be such a time to listen for that high-pitched sound.”
Over the years, many investment firms have come unstuck missing the signs and getting the balance wrong.
Julian Robertson is still known for his exceptional performance managing Tiger Fund through the 1980s and 1990s. Yet while he posted strong compound returns for his early investors, a lot of his assets, which peaked at $13 billion, came in just prior to a period of poor performance. One side of the ledger grew, but that did not influence how he managed the other side. On a “money-weighted” basis, returns were more modest.
Mercury Asset Management used to be the largest and most successful firm in the U.K. “The team included many exceptionally talented fund managers,” remembers Paul Marshall, a former employee who went on to found hedge fund firm Marshall Wace. “But they were too big for the market. Eventually (in 1998) the firm’s U.K. performance blew up completely.”