The game never stops for investors

Two scary quotes this week as investors come to realise how 2021 is going to be a very volatile investment market indeed.

Two scary quotes this week as investors come to realise how 2021 is going to be a very volatile investment market indeed.

The first from Future Fund chair Peter Costello: “There will be a correction in some of these stocks — at some point there will be fallout.”

The second from Noah Williams, a day trader in the middle of the GameStop controversy (where a band of day traders on social media created losses for hedge funds trying to short video game chain store GameStop).

“I think the big takeaway is, fundamentals do not apply to retail traders,” he said.

Actually, on review, the first line from Costello is more of a sobering suggestion.

But the quote from Williams is quaking in your boots scary.

Some might say this week’s insurrection of the day traders in GameStop is history in the making. It may well be: the story points to latent power in social media activity that could change how markets work.

This remarkable bout of trading action certainly marks a “top” in the post-COVID market action where traders can make money chasing the latest new idea — a market where Afterpay is now worth more than Telstra.

It’s odd too that the underlying narrative in the GameStop incident is a herd of anonymous traders taking on the establishment — whatever that means when those leading the insurrection are themselves deeply engaged in the sharemarket. (Williams is reported to have made $US150,000 in a few days as hedge fund plans to short GameStop were spoiled as day traders bid the stock higher).

The best thing that has happened here is what you might call “hedge fund comeuppance” where the sector has got a real fright with the realisation other investors can combine on sites such as Reddit to thwart their trading strategies. (One hedge fund caught in the crossfire had to be bailed out).

But it’s not much of a win if the people buying the stock to push it higher don’t know what they are doing: sorry Williams, fundamentals apply to everyone. If anyone in the market does not understand the fundamentals of that market they are the ones who will be left holding the parcel, not professional investors.

Just for the record the fundamentals on GameStop show a viable but fading games store chain which never paid a dividend, with revenues and profits declining.

As Associate Professor Shumi Akhtar at the University of Sydney so entertainingly put it: “Amateur chaos-seeking Reddit investors should not be mistaken for information signals.”

Certainly, Williams and many like him would see the Future Fund — and its enthusiastic use of hedge funds — as the sort of professional investment vehicle they are out to undo.

This week’s results announcement from the fund detailed how it is using its selection of hedge funds to increase its exposure to the market while still keeping very high levels of cash.

If you are an investor rather than a day trader then this increasingly excitable market presents new challenges where navigation lights will be very helpful and we are going to learn a lot more from the Future Fund than the Reddit chaos seekers.

In fact, though the fund had a poor year overall, the more this market moves towards the sur­real, the more its conservative stance becomes convincing.

And the Future Fund has been awfully careful in recent times: It has a sterling track record and a long term return of 9 per cent per annum against a target of 6.2 per cent. But it only made 1.7 per cent last year.

When you look closer, it’s clear the Fund could have made a lot more money since the COVID crash if it did not have roughly one dollar in five sitting in cash making very little at all.

Costello and CEO Raphael Arndt are in fact reluctant to describe that 19.8 per cent cash allocation as ‘‘defensive’’.

But let’s say if the markets take a dive, that high cash holding will work defensively for the fund and the legion of public servants who depend upon it.

The restraint of the Future Fund highlights an issue facing almost all sensible investors: it’s a roaring bull market with wild trading. Nobody knows how long it will last, but as Costello pointed out, we are heading towards an inevitable fallout.

How do you steer investments through this period? Despite GameStop or any other surprises, the game never stops if you are in the market for the long haul. You allocate money carefully and diversify. In the case of the Future Fund the full picture is 7 per cent Australian shares, 25.1 per cent global shares, 13.4 per cent private equity, 6.1 per cent property, 7.4 per cent infrastructure, 7.1 per cent debt securities, 14.2 per cent alternatives and the rest in cash.

At the Future Fund that means investing money in hedge funds at a time they are on the ropes. But the wider risk setting at the fund is ‘‘neutral’’. And of course the hedge funds on the Future Fund menu, as Arndt is at pains to point out, are of the highest quality.

In realty the Future Fund is an extreme example of an investor trying to provide for the future by tackling the issues of today with caution. It’s not losing and unlikely to lose much if the markets face a big sell-off later this year.

Remember, Warren Buffett’s dictum: the first rule of investing is don’t lose, the second rule is don’t forget the first rule.