On Bonuses and Investing

Pfäffikon SZ, Switzerland – In this day and age investors aren’t worried about a thing. The put option the central bankers have placed underneath the market has been functioning phenomenally for years. The troubles in China for instance are easily swept under the rug but could cause adverse side-effects on the international markets at a later stage. Moreover, no one seems to be bothered about the historical decline in oil prices. The expertly inflated commodity-bubble continues to slowly deflate and the end is definitely not in sight. The result is that the stock markets have become an environment where volatility has – unfortunately – disappeared. But how long will it last?

Free Lunch
Index investing, according to many, is the ready-made solution for this era. The more the indexes climb the more money flows into these products. In this manner their success becomes a self-fulfilling prophecy. Now that we find ourselves in an investment environment where the index is carried solely by the handful of companies that are performing well, it is very likely that index investors don’t realise that their risks have increased. A good, recent example was Google that single handedly pushed the Nasdaq to a new all time high. Index investors buy in to the low cost illusion and have no idea what they’re investing in.

Now that namely the American markets have found themselves in a sidewards pattern, some (index) investors are becoming slightly nervous. The party that is fueled by a constant influx of investment money is slowly drying up. No one knows when the tides will turn on the markets, but take it from me, that time will come. After all there is no such thing as a free lunch in the financial world. Index investors too will be presented with the bill for passive behaviour. It would not surprise me if these index products in particular will amplify a possible downturn.

BlackRock
Remarkable in this regard are the developments at BlackRock, one of the largest asset managers in the world. “Mr. Fink said 10 of BlackRock’s biggest clients have pulled more than $40 billion from institutional index equity assets this year. But the firm’s revenue has been helped as the clients reinvested into active equity and fixed income, multiasset and alternatives strategies” reports the Wall Street Journal.

I find it noteworthy that I have been reading a lot about bonuses being too high and about the compensations at various companies. Namely in the Netherlands redistribution has become a national sport. Everyone is getting worked up about it. What index investors probably don’t realise is that they contribute to this relatively high bonus culture. After all the index fund barely votes on thorny issues during meetings – if at all – because they adopt a passive stance. In this manner many corporate governance issues are covered with the cloak of love.

Dutch East India Company
More than 400 years ago in Amsterdam the first multinational in the world was provided with capital by the issuance of shares. The reason was to spread the risks (and rewards), but also to turn the then Dutch East India Company into a success. It would become the start of the Dutch Golden Age, a period of prosper that would be unique for Western civilization. This is the basis of successful investing, all the rest is surrogate.

It remains for me to wish you a good weekend.


Jan Dwarshuis is a senior asset manager at Thirteen Asset Management AG, where he is responsible for the Thirteen Diversified Fund. Dwarshuis writes his columns in a personal capacity and is not paid for them. Nor is he paying for his columns to be placed. Professionally, he holds positions in major European, American and Russian stock funds. The information in his columns is not intended as professional investment advice or a recommendation to make certain investments. At the time of writing, he has postion in Google and no position in the other above mentioned shares and has no intention of doing so in the next 72 hours.