Monday, June 7, 2010
I started my investment career at Scudder, Stevens & Clark in the early 1980's. I was hired to be an analyst in their bond research department. As part of a team of probably 20 bond professionals, I learned an enormous amount about investing from some of the brightest and most experienced investment professionals around.
Scudder's investment philosophy was thoroughly grounded in research in both the equity and bond markets. At a time when most managers picked stocks largely through "tips" or advice from friends, Scudder believed that extensive research in fundamentals would yield handsome returns for their clients.
Scudder at that time was one of the few places in the investment management world that had a bond research effort. I think it is fair to say that the whole concept of bond research started at Scudder, with investing giants like Herman Liss, Bob Pruyne and Sidney Homer (author of "Inside the Yield Book") studying the fixed income market in ways that very few had ever done. Their research set the stage for much of the kind of work that goes on in fixed income today.
One of the key concepts I learned as a fledgling investment professional at Scudder was to realize the futility of investing based on a single forecast.
Outlooks are always too uncertain, and no one has a perfect "crystal ball". Instead, attractive investment opportunities were to be founded by asking "what if", even if some of the scenarios seemed just too far-fetched to be true.
We had a name for this analysis: "Opportunity/Risk". Every week we spent hours developing scenarios and doing research on the risk/return profiles on a wide variety of different securities and sectors in the bond market. It wasn't good enough to say, for example, that you wanted to buy a particular bond based on a view that interest rates were going to move lower.
The question would come back: what happens if rates move in a different direction? Or what happens if credit spreads widen? Or what happens if the shape of the yield curve changes? And so on.
As simple of a concept as this seems, it is still too often forgotten by many in the investment management community.
For example, as this recent article from the New York Times points out, almost no one in the investment world at the beginning of this year forecast that interest rates could move lower, and so Treasury bonds were thought to be poor investments. Now it turns out that this widely-held view was wrong:
For people holding Treasury bonds, it’s been one of the best of times. In May, long-term Treasury mutual funds outperformed every traditional category of stock fund, according to Morningstar data, returning 5 percent. Ominously, only bear market funds — those dedicated to bets on a stock market decline — fared better. They returned 8 percent. These trends continued last week, with the Dow and the S.& P. 500 each falling more than 3 percent further....
...It is also sobering that a vast majority of economists and market strategists were forecasting a different chain of events. Treasury yields were universally expected to be rising, not falling, as the United States recovered from a deep recession. The domestic economy is, in fact, growing, and corporate profits have been rising, but the European crisis has overturned many expectations.
As old-fashioned as it might seem, I think that opportunity/risk analysis still makes sense.
Strategies - A Flight to Treasury Bonds That Wasn’t Supposed to Happen - NYTimes.com