Eclectica Asset Management founder and CIO Hugh Hendry says the hedge fund industry’s reputation for risk management has been sorely compromised.
"To my mind the situation has parallels with the plight of the banana,” Hendry writes in the Financial Times. “Today the world eats predominately just one type of banana, the Cavendish, but it is being wiped out by a blight known as Tropical Race 4, which encourages the plant to kill itself.”
Scientists refer to this as programmed death-cell destruction, Hendry notes.
“In stressful situations, bananas fortify themselves by dropping leaves, killing off weaker cells so that stronger ones may live to fight anew,” he says. “They operate a stop-loss system.”
Hendry says he fears the financial world is in equal danger—of harvesting a monoculture of fund returns that could prove less than robust should the global economy suffer another deflationary reversal.
“Good managers keep shedding risk and monetizing losses and are duly fired, leaving us with a monoculture of brazen managers who will never stop loss because they are convinced central banks will print more money,” he says.
“Diversification has proven the most robust survival mechanism against failures of judgment by any one society, hedge fund manager or style,” says Hendry.
“But what if we are now a single global hedge fund community afraid to take stop losses and convinced of an inflationary outcome to be all short U.S. Treasurys and long real assets?”
Hendry expects it may take several more years before the threat of debt and deflation can be successfully exorcised from investors’ minds, even if the global economy weren't set on such a perilous course.
“Such is the potency and memory of 2008’s crash that anything remotely challenging to the economic consensus could be met by a sudden and severe reappraisal to the downside,” Hendry says.
Should such an event send 30-year Treasury yields back to their 2008 low of 2.5 percent, Hendry believes enlightened investors might better be served by thinking the opposite.
“Only then might it prove rewarding to short the government bond market and embrace what may turn out to be a much promised once in a lifetime buying opportunity for risk assets,” he says.
Business Week reports that FTN Financial Chief Economist Christopher Low says Europe’s financial turmoil and slow growth may push 10-year yields to a record low of 1.5 percent.
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