Fully Invested Bears

The following reference says too much about the demographics of the radio shows that I favor.  I’m constantly bombarded with ads by an insurance agent who sells specifically to overweight, middle-aged men on medication.  Leaving aside my own weight and age^[i], one commercial specifically sells term life insurance to guys whose second wife wants to be assured of a lifestyle comparable to that enjoyed by the first wife after her overweight, older husband inevitably predeceases her.^[ii]  Before we digress into the sports fandom of “Steve from Connecticut” ^[iii], I assure you that there is an important market parallel here.

I will assert that many institutional investors have taken on a mistress, if not a second wife.  I mean that strictly in a metaphorical sense, of course.  Their first wives (or husbands, or partners) are the strategies that they marketed to their investors.  Those who allocate money to institutional managers typically enforce adherence to a manager’s avowed commitment.  Yet investors who might be wedded to a bottom-up approach or deep value investing can hardly be blamed if their thoughts strayed to a more attractive trend-following or momentum-driven style.  Performance, regardless of style or substance, is a seductive siren.

I like to call this vixen “TINA FOMO”.  I first wrote about this mysterious seductress over five years ago, and she remains a persistent fixation for investors of all types – especially now.  You may recognize her moniker as a portmanteau of two popular market acronyms.  TINA is short for “There Is No Alternative”, the idea that investors have no choice but to invest in equities because most, if not all, the alternatives are worse.  To be fair, can you blame investors for wanting to avoid cash and bonds with negative real yields and a seeming disregard for credit quality? 

FOMO, or “Fear Of Missing Out”, is the more interesting acronym.  Markets are driven by the yin and yang of fear and greed, but while FOMO encompasses the word “fear”, it is rooted in greed.  A manager who consistently fails to meet his benchmark or his peers could find himself with less money to manage or even out of a job.  Either of those outcomes is likely to affect his lifestyle.  FOMO is more about an investor missing out on economic benefits rather than a visceral fear that the assets they manage are at risk.

I don’t know if our radio insurance agent sells policies that benefit bigamists or mistresses.  The concept of “moral hazard” applies here.  To be certain, this is not a moral judgment in the religious or ethical sense, but a core concept underlying insurance.  No insurer wants to write a policy where the beneficiary could end up better off by collecting on that policy.  We have all seen mystery shows where the culprit was an unhappy spouse who killed their significant other to collect on the insurance.  Any insurance company wants to see that there is no perverse incentive at play.

Yet the options market is the lone insurance venue that is thoroughly unconcerned with things like moral hazards or insurable interests.  That is a feature and benefit of centralized clearing.  Options writers have no way of knowing who is on the other side of their trade – the counterparty is always the clearinghouse.  We would all like to know whether we have sold options to hedgers (those with an insurable interest) or speculators (those without), but ultimately it is something we can only intuit. 

As a result, it is my belief that there are substantial amounts of investors who are insuring their dalliances with TINA FOMO.  I call them “fully invested bears”. They see the unrelenting advance of the major indices, the seeming nihilism of investors in the face of potential worrisome news, yet have decided that they must remain fully, aggressively invested even if they are becoming increasingly uncomfortable with the excesses and warnings that they see throughout the economy.  “Don’t Fight the Fed, Don’t Fight the Tape” is not frivolous advice, and they are taking it to heart.  But they are insuring themselves against their concerns by using options.

The evidence for that assertion is the relatively steep VIX futures curve and relatively steep skews in index options and key ETFs.  Those prices would not be elevated unless there was a substantial amount of demand for the protection that they offer.  Since we see little evidence that individual investors are particularly concerned about an ever-rising market, that demand must be coming from institutional investors.  A likely explanation is that those investors are taking on more risk than normal and hedging it with derivatives. 

We can’t enumerate the amount of money managed by fully invested bears who are dallying with TINA FOMO.  We also don’t know if these are true hedgers buying career insurance or speculators.  If it is the former, they are people who don’t want their insurance to actually pay off^[iv].  As of now, any insurance they’ve purchased hasn’t paid off for months.  And if they’re speculators, they’re not fully invested bears – just plain old bears.

[i] I hereby acknowledge that the ads may in fact be well-targeted to this listener

[ii] I’m still married to wife #1, for the record

[iii] Go Yankees, Go Islanders!

[iv] For the record, I really don’t want my wife’s life insurance to pay off