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Rekenthaler Report

The Critical Assumption

What's the key thing to know about an investment idea?

The European Convergence Bet
In 1988, the mutual fund industry introduced a new type of bond fund called short-term multimarket income. The funds were as complex as the name suggested. They were long in the cash and bonds of some currencies and short in other currencies. Their portfolios were difficult to decipher as they consisted mostly of derivatives. The early performance of the funds was strong, with the funds posting very high yields even for the day, with minimal price fluctuations. 

The Golden Fleece in the mutual fund business is high yield plus low volatility, so the funds gathered much attention--and suspicion. What was the catch, buyers asked? They were told there was no catch. Short-term multimarket income funds were long in higher-yielding currencies and short in lower-yielding currencies. Their profits would be the differential in yield between the two buckets of currencies, plus the rate on risk-free securities, minus fund expenses. Yes, currencies do fluctuate in value, thereby causing some modest volatility, but, as these were mostly European currencies and the European market was increasingly trading in sync, these movements would pretty much even out over time.