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Swimming With Sharks – Part 1

Swimming With Sharks: Part 1

Imaging for a moment you are a portfolio manager, say, managing a mutual fund. You have mandate and rules to follow that are designed to keep you close to your mandate. Now, let’s add to this the fact that you are what is known as a “bottom-up” investor, meaning that your investment decision-making process is one that requires that you (a) rely on your economist(s) for views regarding the overall economy, (b) rely on your investment strategist(s) for overall market views, and, above all, (c) you analyze companies and make investment decisions on them based on the companies growth and profitability and how these data make their way from the company’s financial statements to your financial model and then, ultimately, to your valuation model.

Question: Where in the above scenario does something like the recent (and on going) Cyprus crisis fit?
Answer: It doesn’t – at least not as it pertains to what you are charged to do.

This description is how one facet of what we call the financial markets’ structure is how our trusty bottom-up portfolio manager operates. His/her’s scope is narrow and specific and the investment decision-making choices outside his/her area of responsibility is as close to zero as you can get. To emphasize this point, let’s consider the following: On what basis does our bottom-up portfolio manager act when he believes the macro environment is concerning? The answer is none – for to do so is to violate one’s mandate (not to mention all the legal issues involved with that) and, in the process, risk losing one’s employment.

Now, let’s move over to the economist, specifically a US domestically oriented economist.

She does her work in much the same fashion as our bottom up portfolio manager does: defined methodologies operating within the framework of acknowledged and accepted policies by the community of economists and, most importantly, by the firm she is employed by.

Question: Where in the above scenario does something like the recent Cyprus crisis fit?
Answer: It doesn’t – – at least not as it pertains to what she is charged to do.

In both cases, the decision-making process is bound to the methodology employed and constraints of the system (the discipline of their work, the firm that they work for) that to violate them without concrete reasons within that system is to risk career suicide. Therefore, it is any wonder that our economist who relies on tools that fail to predict coming turning points in the economy and our bottom-up portfolio who relies on top line and bottom line numbers (in growth and profitability) CANNOT act despite the obvious risks that exist that are OUTSIDE THEIR PURVIEW?

Public Policy Implications

The sea of investing is populated with many creatures – with many varying methodologies, strategies, objectives, constraints, and much more. Understanding their nature is most helpful (I would argue, vital) to one’s investment performance success. It is also vital to those in the public policy arena as knowing how those who populate the financial economy behave – their tendencies, their habits, etc. – enable the astute investor with the opportunity to capitalize on their nature and the public policy expert with a better understanding of just how the capital markets really function. For how can one make sound public policy decisions when the very nature of how an essential part of financial markets is not fully understood?

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About the author

Vinny Catalano is a Non-resident Senior Fellow at the Information Technology and Innovation Foundation and President and Global Investment Strategist with Blue Marble Research and author of “Sectors and Styles.” A global macro economic and capital markets expert, Vinny appears regularly in the media (CNBC, Bloomberg Radio and television, National Public Radio, foxbusiness.com, Canada’s C- TV and BNN TV, New Delhi TV) and is frequently quoted in various professional publications (Wall Street Journal, Barrons, Financial Times, Reuters, Fortune, thestreet.com, MarketWatch, Globe and Mail, Business Week). He also produces and conducts numerous events with various CFA Societies and other groups throughout the US, including the highly popular “Market Forecast Series” as well as topical and educational programs. Vinny is a past president of the New York Society of Security Analysts. He attended New York University and Juilliard School of Music and holds a CFA charterholder designation from the CFA Institute.