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Home Publications Blogs Beat the Press Neil Irwin Says Fund Managers are Too Dumb to Breathe

Neil Irwin Says Fund Managers are Too Dumb to Breathe

Saturday, 16 February 2013 09:17

He may well be right. His story is that the yield on junk bonds is currently lower than the earnings yield on stock. Irwin tells readers:

"The stock market’s earnings yield is 6.6 percent, which is actually higher than the 6.1 percent that junk bonds are yielding. Buyers of junk bonds are tolerating lots of risk and not even being compensated. That suggests a market that is somehow out of whack. And there’s a quite plausible case that the Federal Reserve’s quantitative easing policies are part of the story. With the Fed buying billions of Treasury bonds and mortgage backed securities, those who would normally buy those assets have to buy something else. But it’s easy to imagine that this doesn’t affect all assets equally. Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable."

The big story here is that last sentence:

"Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable."

Okay, so we have people controlling funds with billions or even tens of billions of dollars who can't figure out that they should move from junk bonds to stocks even when current prices suggest that the stocks provide a much better risk/return trade-off. Given that almost all of these people were buying into the stock market in the late nineties, when price to earnings ratios crossed 30, and that almost none of them saw the housing bubble in the last decade, Irwin's observation is entirely plausible.

This does raise the question as to why the people who manage money funds earn many hundreds of thousands of dollars a year and often many million? If a fund manager just holds bonds rather than stocks out of habit then this person clearly has few skills. Rather than paying someone millions of dollars to cost a fund big bucks in virtually guaranteed losses isn't it possible to find some high school kid who could be paid the minimum wage. After all, if we don't expect people who manage funds to have any investment skills why are the jobs so highly paid?

Comments (4)Add Comment
junk bond funds are junk bond funds
written by pete, February 16, 2013 10:46
there is no flexibility here. investors buy junk bond funds to invest indirectly in junk bonds. the prospectus for the fund indicates that a certain percentage of the fund is in junk, probably like 80%. Any less than that would violate the prospectus. It is not the managers, it is the investors.

Latest Graham and Harvey survey says CFOs are expecting a 5.5% return on the market. Thats lower than the reported junk bond yield, but not by much.

Anyway these junk bond yields are far too low unless investors feel we are headed into some sort of rapid recovery, which seems to contradict the market expectations.
Totally Incompetent
written by Frankly Curious, February 16, 2013 7:49
I think they are highly paid for the same reason we can't have a free market in doctors: they are the friends of other wealthy, powerful people. It just doesn't seem right when your friends aren't well paid, even if they are totally incompetent.
written by Chris, February 16, 2013 9:36
Why are the jobs so highly paid? For reasons, I suspect, similar to why people will give their money to somebody (an individual with a spiel) they don't know to invest it for them. Or for the same reason people with big incomes will hire "experts" to invest for them instead of simply dumping the money into an index fund as a bright intelligent informed person would do.
written by liberal, February 17, 2013 12:44
IMHO it's not so simple. Yes, "junk" bonds have higher credit risk. But the Vanguard junk bond fund has an avg duration of 4.4 years, which is really really low. And it's not like the stock market is without considerable risk.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.