GoldMorgan Stanley, Investing For Deflation, And ETFs Gain By Default

The news that Goldman Sachs and Morgan Stanley are preparing an ETF joint venture, reported today on Index Universe, strikes me as a big story in many ways.

But I confess that my first reaction on hearing it was to smile and think of Finbar Taggit, whose funny and irreverent blog has long referred to the two leading (formerly investment, now commercial) banks as a single entity, Goldmorgan Stanley.  I’m not aware of any previous joint ventures on such a scale between the two, so the ETF market can take credit for making Fintag’s idea into a kind of reality.  Or maybe the two banks have been reading him and took his suggestion literally. What next, a full merger?

But, despite their difficulties this year, Goldman and Morgan still carry heavyweight status, and so their entry into the European ETF market means that competition between issuers will take a step up next year – which is good news for investors.

There are also quite a few unanswered questions – asset classes, fees, fund types, of course, but also some others which will probably remain a mystery, such as why Morgan Stanley decided to part company with its ETF industry experts Debbie Fuhr and Paul Mazilli in recent months if the bank was about to enter the market.  Answers to that one on a postcard please (or at the bottom of this page).

Meanwhile, as government bond yields plumb new lows, and break-even inflation rates between conventional and index-linked bonds slip further into negative territory, this article summarising some recent Merrill Lynch research, on investing for deflation, caught my eye. In summary, there are some new trends we have to get used to, if the Merrill authors are correct:  falling government bond yields mean falling equities; expect the US dollar to strengthen for a period, then fall; equities may trade in a range for a while after this year’s fall, with periodic rallies; watch the inventory cycle to time these rallies; choose large caps and best-of-breed names, and any companies with pricing power (such as utilities), over small caps; and expect deflation to continue until the property cycle turns.  From a UK perspective, at least, the latter still seems a long way away.

Dan Draper of Lyxor shared his views on the subject with me: he still sees value in a barbell fixed income trade (owning 1-3 year bonds and long-dated bonds at the expense of medium maturities), and he expects a move into corporate bonds in Q1 and Q2 next year as investors are attracted by the yields on offer.  And, while he feels it may be too early to pick up inflation-linked bonds, their real yields are becoming very attractive.  This is a contrarian play and one to consider if you think the current deflation scare is getting overdone (so one for you, Matt) – contrarian, since inflation-linked ETFs saw Lyxor’s biggest redemptions in October – but one worth pointing out.

Finally, when you survey the mess in the hedge fund world and in the active fund management sector, it’s not surprising that ETFs continue to gain traction.  Hedge fund investors, having clamoured to join the more exclusive funds two years ago, now find they’ve joined a club akin to the Mafia, from which there is no obvious exit.  The news that Tudor and Fortress have added their names to the long list of funds restricting redemptions puts our concerns over ETF bid-offer spreads into perspective.

Meanwhile Jon Wood’s current law suit against the Wall Street Journal merely for reporting his funds’ negative performance (-85% since launch, apparently) takes hedge fund manager chutzpah to a new level.  And, from the non-hedge-fund but still active management sector, how about New Star’s executives borrowing £300 million last year to fund a payout to shareholders, primarily themselves, a debt-driven share collapse and debt-for-equity swap last week, and a new set of golden handcuffs for fund managers after the recapitalisation?  No wonder more and more investors are deciding that, if they are going to lose money in the markets, they’d rather do it themselves and through ETFs, thanks very much.

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