Low cash rates and manager skill….plus the First Degree US election special

Low cash rates and manager skill

The Finance field has many strong statements about the structure of relative returns but it is weak when it comes to statements about absolute returns.  For  example, the risk-return paradigm suggests that asset classes which exhibit low volatility should have relatively low returns compared with high volatility asset classes. But, the theory and evidence is sketchy on exactly how large these differences should be.  We can confidently say that equities should outperform cash returns in the long run, but we cannot really say by how much nor can we say what the cash rate or equity return should be in %age terms.

I say this because there is a raging debate centring on the ability of active managers to outperform while cash rates are low. The truth is that finance struggles to predict how much return should be generated by the broader asset classes, so imagine how difficult it is to go on to predict the degree of difficulty generating alpha during periods of low and high cash rates. The industry has enough trouble understanding the cash rate itself.

In terms of compensation for risk, I have yet to see any general theory that predict market risks, and consequently risk premia, to be different during periods of high or low cash rates. In fact, the cash rate is generally determined by investor preference for spending today versus spending tomorrow while risk is generally driven by technology as it affects the ability for a company to produce profits and cash flows. These two things are independent, by and large, so one would not expect an equity manager to suddenly lose his investment skill because people decide to spend less and save more.

The debate more likely stems from a group of managers who are down on their luck, spuriously associating their bad fortune with the fact that cash rates have been low for as long as they have been underperforming.

The First Degree US Election Special

I have argued before that the people who determine an election’s outcome don’t make their decision until they actually visit the voting booth. In the current US election between Donald Trump and Hillary Clinton this observation seems to be even more pertinent. Forget the opinion polls, anyone can win this election depending on how a small minority of voters feel on the day.

Voters are selfish and precocious when it comes to putting pen to paper. On this basis, Donald Trump would seem to have the upper hand. He has promised lower taxes except on the wealthy. He is also the “bad boy”, talks “anti-establishment” and definitely not a “Washington insider”. What precocious individual could resist that?

If Trump is within striking distance of Hillary come election day, the selfish-precocious swinging voter will push him over the line.