Many financial planners first decide on an asset allocation, for
example 60% stocks 40% bonds and then find mutual funds or ETFs either
passive or active, to implement the allocation. If an active manager
is chosen, his job is to outperform his benchmark but *not* to shift
to another asset class, which would be the "crime" of market timing.
For example, a stock fund manager is not supposed to invest in bonds.
The logic is that the financial planner is supposed to set the asset
allocation and that mutual fund managers cannot time the market.
I think this is plausible at a macro level -- even many skilled stock-
pickers might be unable to add value merely by changing their stock
market exposure using S&P 500 futures. At the individual security
level, this makes less sense to me. Many investment and commercial
banks have recently raised money by selling convertibles, preferred
stock, and straight debt, as well as common stock. Suppose a manager
is bullish on a company that has all of these types of securities
outstanding. Buying common stock might not be the best trade. Maybe he
should buy the convertible or buy straight debt and short Treasuries
of equivalent maturity to reduce duration risk, if the convertibles or
bonds are underpriced relative to the stock.
There exist hedge funds that engage in "capital structure arbitrage".
Even if a fund wanted to stay long-only, it could still substitute
convertibles or corporate debt for common stock and do half the trade
(without shorting the common stock as the hedge fund would).
If you accept the logic of having an actively managed fund doing
individual security selection in all types of securities, not just
common stock, the question is whether there exist managers qualified
to do this. Balanced fund managers own stocks and bonds, so that could
be a place to look. Any suggestions?
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