Thesis’ Lally: Why we shouldn’t judge fund managers on their forecasts

Lally Michael Thesis

About this time of year, most of our peers are busy sending out forecasts for 2014. In reality, these are largely provisional and will likely be revised as the year progresses, either because they were badly reasoned in the first place or because of any number of unpredictable events.

Either way, a cynical outsider might question whether it is a coincidence that the majority of forecasts by investment managers, banks and other largely fee based institutions, seem to be generally optimistic. The law of averages means that even the most extreme or unlikely of forecasters are bound to be right eventually.

In the meantime, few investors remember them in all the years they get it wrong – unless they have invested and lost a packet on the back of such advice (notably in respect of share tipsters – be they market professionals or financial journalists). One of the problems of forecasting over any period is that market volatility is now so extreme that momentum alone can take asset prices very rapidly in any direction.

In the last quarter of 2013, for example, substantial levels of FTSE100 company shares were out on loan (ie either as collateral or to enable ’short’ positions). We are constantly analysing all news flow that is related to or can influence markets. From this, we can make a reasoned assessment of the relative valuations of all the asset classes, individual markets, shares and funds in our investment universe.

After a period of exceptional strength or weakness, which is often accompanied by increased media hype, we like to communicate our appraisal of the relative values, but based upon sound factual data. As is the case, I am sure, with all investment managers and fund managers, we will be judged not on the accuracy of index level forecasts but on historic portfolio returns.

Finally some examples of how data can be misinterpreted. In the US one of the leading ratings agencies, Moody’s, slashed the ratings of two corporate household names: HJ Heinz and Dell. In fact, the reasons behind these actions were not as ominous as might first appear. Ketchup maker Heinz was taken over by Warren Buffett’s Berkshire Hathaway group for $27.4bn, whilst Dell’s founder, Michael Dell, led a group of investors to take the personal computer company private in October.

Gearing up balance sheets can be interpreted as bearish, but the bulls would argue why not if the balance sheet is strong to start with and when interest rates are so low. Also, some of this money is being returned to shareholders and for others, a useful war chest is being set aside for acquisitions.

My money’s on the latter view at the moment, whilst acknowledging that amongst all the decent borrowers are the usual troop of fallen angels, ’zombies’ and impoverished opportunists, taking advantage of heightened market risk appetite to encourage the unwary – in the introductory words of every Star Trek episode – “to boldly go where no man has gone before”.

Michael Lally is director at Thesis Asset Management