Blogs & Comment

Bubbles and herding

If there is any factor to explain the propensity toward financial bubbles in our era, it is the herding behaviour of professional money managers. So says Financial Timeseditor John Authers in his new book, The Fearful Rise in Markets (2010).
This herding instinct arises fromfund managers’ compensation being tied, for the most part, to the amount of money under management. Thus, their greatest fear is loosing customers, not underperforming the market.
Holding stocks everyone else holds means that if you lose money, your rivals will also be in the same boat. This is less damaging than trying to jump out in front because if your bet is wrong and ends up underperforming most other managers, customers will desert in droves.
Authers cites the example of the Fidelity Magellan Fund. Jeffrey Vinik was the manager in 1995 and put a big chunk into government bonds on the expectation stocks were going to fall. But stocks kept booming and Vinik fell behind. And his fund experienced 14 months of redemptions during a raging bull market.
His successor, Robert Stansky, sold the bonds and bought technology stocks. Tech stocks were in vogue at the time so it was hard to beat the market by much. But that was not the point. The priority, if you want to keep your job, is to avoid embarrassment, writes Authurs.
Even though a manager may think a group of stocks are overvalued, they will buy them. They keep pace with the market and their customers will be happy; if they dont buy them and fall behind the market, their customers will leave them for other funds — and job loss could be the eventual outcome.