“Things Can Only Get Better” sang Northern Irish pop group D:Ream as Tony Blair’s Labour Party swept to power in a landslide UK General Election victory in 1997. The song, which became the soundtrack of the party’s election campaign that year, seemed to sum up the optimistic mood of a people keen for a change of government and a fresh start.
What song would you choose for 2009 and what zeitgeist would it capture? Fearful hedge fund managers, bemoaning the lack of leverage, might hum along to “Money’s Too Tight to Mention” by Simply Red. Long-only equity managers might go for “Up & Down” by Vengaboys or - if they are feeling particularly pessimistic about the future - “Down Down” by Status Quo. On the other hand, bullish bond managers confronted by the falling price of credits may prefer “The Only Way Is Up” by Yazz.
And let's not forget those dealers in sub-prime debt who got us all into this mess in the first place? It must be “Heaven Knows I’m Miserable Now” by The Smiths.
More seriously, are we heading into a year of unremitting doom and gloom, as some analysts predict? Is the landscape rising up before us a scorched earth devoid of opportunity or are there seeds of potential alpha waiting to be discovered and nurtured by a small band of brave investors?
Its probably safe to say that things are going to get worse before they start getting better. Plummeting equity markets have wiped billions of euros, dollars and pounds off the value of pension schemes worldwide and the chances of winning back that lost ground are slim to none in the first six to nine months of the new year.
Some equity fund managers have called the bottom of the market on a number of occasions since Lehman Brothers blew up and got it wrong every time. Defining moments like the unveiling of the US Treasury's Troubled Asset Relief Programme, the historic election of Barack Obama and Gordon Brown's bank recapitalisation plan merely added another brief upward trajectory to the rollercoaster ride that is stock market investing these days.
The desire to seek refuge in government bonds is understandable, but what can the not-so-risk-averse investor do to earn higher returns? There are few sure-fire bets, although traded life policies are being touted as a non-correlated asset class offering potential returns of 8-10 per cent annually.
Hedge funds were also promoted as a non-correlated asset class designed to protect the downside. They didn't, although funds of hedge funds were down an average of 10 per cent in 2008, compared with a drop of 48 per cent in the MSCI All Countries World Index and a fallof over 40 per cent in the S&P 500 Index year-to-date.
But the hedge fund industry has an opportunity to redeem its reputation among disillusioned investors. For some practitioners are saying that the shake-out caused by steep performance losses and the flight of client capital will leave only the best players on the field and a bigger “alpha pie” to fight for. The strategies being talked up include distressed debt, convertible bond arbitrage and trading-oriented long/short equity.
Investors have also been advised not to shun corporate bonds which can be picked up for….er, a song. Of course, that's because such instruments, especially the high yield variety, are regarded as a very risky proposition in recessionary times. Just do your homework, choose carefully and remember to keep singing “Things Can Only Get Better”.
Henry Smith, editor
henry.smith@ft.com
