Saturday, February 9, 2008

Smart money postured for a recession

There are many ways of defining smart money. I had a recent post describing a synthetic market neutral fund using a group of smart funds as a way of generating alpha. Using the technique shown in the sidebar (titled Reverse Engineering a Manager's Macro Exposure) I imputed the macro and sector exposures of these “smart funds" and “consensus funds”, which consists of 22 US large cap blend equity mutual funds from the major fund complexes. I found the following significant differences in their bets:

  • Smart funds are more overweight large caps, which tends to be more defensive
  • Smart funds are more aggressively underweight Financials, indicating that their managers don’t believe that the subprime fallout is over
  • Consensus funds are still overweight the Consumer Cyclicals while smart funds are market weight or underweight

In whole, this analysis points to a picture suggesting that this group of smart fund managers are orienting their portfolio to a recession or economic slowdown, while the larger consensus funds are not yet moved that way yet.

Smart funds are more overweight large capitalization stocks, which are thought to perform better in bear markets and recessions.

Smart funds obviously don't believe that the subprime fallout is over as they are aggressively underweight Financials, which is about 20% of the weight of the market. On the other hand, consensus funds are roughly market weight.

Surprisingly, consensus funds are significantly overweight Consumer Cyclicals, while smart funds are market or underweight.


Michael Alfred said...

This is interesting but I guess I would take issue with the fact that managers from the largest mutual fund complexes are "smart money". It seems to me that these types of managers in general are overpaid, complacent, large, and slow moving index huggers. Smart money, in my humble opinion, needs to be able to make significant and directional and timing bets in any sector, segment, style box, or asset class (including commodities and illiquid assets)in a way that a manager from a large mutual fund could not.

Cam Hui, CFA said...

You misunderstand - the managers from the largest mutual fund complex represent the consensus. The "smart money" is from the list of top-ranked managers from Morningstar (see previous post about how that was done).