Work and things.. apologies!

Apologies for absence of posts, I'm working hard in the new job, working with London consultancy on new fund flows report and also became a senior reviewer for CISI (which I have a Friday deadline for). I've yet to complete the first draft of Clown Thinking which I'll extract back to this blog.

Good to be back in the fund analysis game tho..

I will be back.. and soon!
JB

Can one truly 'diversify' through Structured Products?

'Diversification..'

It's an often used term that we see in the industry - it crops up in ETFs and Structured Products to mutual funds and managed offerings.. Structured Products, cyclically, come to the fore anytime there is uncertainty among investor sentiment (often after a good index run or when an index is trading somewhere above it's historical mean).

Diversification has always been a great seller of products - it's a term that chimes well with investors and IFAs. In short, it's a pretty abused and ambiguous term - probably not what the early inventors such as Markowitz, Fama and Sharpe had in mind for it.

Let's take a structured product - perhaps it invests over say 5 years - it splits your initial investment between a zero coupon bond to basically pay back the initial investment (as 'ZCBs' are discounted to their maturity value and pay no interest). The rest is then put into a FTSE100 option to invest for possible return over and above the g'tee. Depending on the position of the market the option may give the right to buy or sell shares at a pre-set 'strike' price. If the markets move against the option then the option premium is absorbed (loss) and the investor gets back their initial sum from the ZCB. Fair enough you might say.

But is this diversified/? True there is FTSE100 somewhere in there (on the marketing material at least) promising diversification through all 100 of the UK's biggest and brightest blue chip stocks. However unlike a normal portfolio the contract gives only a fixed exercise/maturity date. Also there are no dividends from the option as it doesn't physically represent a holding until the option is exercised and only then to be encashed with the option writer (div yield has been one of the core diversifiers in equities). Nor does the option grant voting rights for any of those 100 companies. Is the case for diversity looking a little flimsy?

Before I go further it's worth re-capping that different assets and different companies return profit over different timescales (called 'horizons'). It is these attributes + the different volatilties therein that create the case for diversification. To avoid the risk of one by investing in the many, to invest different assets over different horizons.

For me the basics of MPT were based on the early regression analyses - that a basket of multiple stocks of varying correlations and covariances could be combined to reduce the overall portfolio volatility; while maximising the overall upside per each unit of risk. The key variable with equities is Time - different stocks may return profit over different periods in the economic cycle. Time it wrong and you can lose everything; time it right and you profit. Simples.

However the structured product doesn't do this - it only gives you one bite at the cherry. ZCBs are rarely callable (since there is no coupon) and American option pricing is a rarity in the UK so the maturity is likely to be fixed lest penalties apply. Some issuers even 'collar' the upside (akin to a performance fee) to basically cover the option writer should markets move against it (and for the investor) significantly. In fact some issuers can turn this around to their advantage and take the top-side profit. Anything over and above the 'collar' goes to the issuer; not the investor. This is a common trade-off with structured products. If you wanted to plot the SP on a regression chart you couldn't conventionally; instead tracing a straight line for the ZCB and a variable point for the Option.

Also - because most of the investor's initial investment is used to buy the ZBC - the remaining amount can only buy a % of exposure to the UK market. Fair enough, if the option ends up being 'in the money' then it is a leveraged position and the returns will be greater proportionally BUT it is highly unlikely to be anywhere near 100% long-exposure. If we assumed buying FTSE100 was diversifying the portfolio then a 100% investment into an ETF or UK FTSE100 fund would give something close to 100% diversification; if you only invest 20% of your investment in the FTSE100 option to give 50% leveraged exposure to the FTSE100 then you are still only 50% diversified; (ignoring the ZCB).

A FTSE100 option is a derivatives contract usually based on 1% movements in the FTSE100 with a nominal value of £1, £100 etc. The FTSE100 index itself is a capitalisation weighted free float index that gives a proxy of the underlying stocks (that is the biggest companies influence the index movement to a greater extent than smaller companies).

To buy an ETF or Option in the FTSE100 is not the same as owning the stock. The price of the Option and the ETF can move independently although both are supposed to be pegged to the index. Whereas footsie ETFs tend to be pretty faithful; options can experience 'basis risk' - i.e. they follow the futures market and a margin can arise between the current FTSE100 price and the Option price. So in reality the Option is a contract based on a proxy based on a basket of underlying stocks. The end return to the investor is largely pre-determined to a point at outset and has less to do with the diversified investment of 100 stocks than it does to the maturity value of the ZCB and the option exercise price. Some say SPs play on investor anxiety at the sake of boosting their long term returns. As with everything there are 2 sides to the argument.

Certainly in this case the structured product offers no covariances, no correlations, no multiple time horizons during the life of the investment. It is about as diversified as a UK tracker that could only return across a fixed period between point A to point B. Many investors have found out just how diversified investing in beta really is by buying and selling at the wrong time (1997/1998, 2001/2002, 2007/2008).

SPs are of course cover a wide variety of products and not all will be constrained in the way I have described but the basic ingredients are there. One asks if a series of ZCBs, with varying maturities, and reinvestment points coupled to an American priced Option or series of Options could be a way to give the investor better access to time the markets through the investment period.

In some ways SPs are even less 'diversified' than ETFs/trackers because the stuctured product doesn't hold the stocks and has less liquidity (harder to sell at any point). At best the SP is a split investment between the ZCB and an option proxy for UK equities. The diversification benefits are thus limited to the composite return of the ZCB + the option based on a single weighted average price index (a bond and a derivative). Diversified, on some grounds perhaps, on others less so. The question is if you took away the outer packaging would you have considered a ZCB and the Option on individual merits?

Let's not even get into capital g'tees versus inflation and real rates of return..

Judgement Day? AI + HFT = Entropy?

'Letting the Machines Decide'

A new wave of investment firms are turning to artificial-intelligence programs to make trading decisions. The programs are designed to crunch numbers, learn from decisions, and adapt. Some are having success.

 
Q. Does AI offer any more predictability or safety than human herding - don't forget who write the algorithms in the first place. BUT what happens when different AI trading platforms sense the movements of other AI platforms - since BUY/SELL is a wholly devisive arrangement then surely the system could create a raft of unexpected outcomes??
 
HFT will make cause-effect more entropic - even media may be unable to keep up with nano-second trading. Private investors become ever-remote, is this another way for the industry to regain control and instil some fear factor AND at what cost?
 
Article

ETF debate trundles on.. the observation becomes the rule?

ETFs as a source of counter-balancing; reduced volatility, increased risk?

E.g. We know Commodity markets are exposed to irregular volatility due to the lack of depth and control of  relaitvely few bourses/ market-makers. They are more frequently subject to 'dislocation' the books say.

'Speculators do not drive commodity prices, says OECD' Increased investment in commodities is not linked to the price volatility of the physical commodities themselves, according to a report from the OECD. Not only did the research find index funds did not cause a price bubble in commodity futures, it showed a consistent association between increases in index fund positions and declining volatility.' IPE: Commodity ETFs

But does this mean that ETFs are also capping upside volatility, if so then what unforeseen consequences could this have (E.g. increased risk-taking, increased positions)?

The other danger is one of complacency, to assume the observation is the rule and will remain so. As yet we do not know what changes will occur in the market if the trading volume of ETFs escalates. JB

Structured products.. vs. behavioural economics

Citywire article. An interesting notion. Mundy: overpaying-for-structured?

Investec Asset Management’s star fund manager Alastair Mundy says investors ought to be aware of behavioural economics when buying structured products. He warns investment banks play on the fears of investors and create products that are designed to sell well rather than ones that are appropriate for the market conditions.

A renowned contrarian investor, A-rated Mundy runs approximately £3 billion across a range of funds for Investec. He has been investing via structured products since 2001 and is a self-confessed fan, frequently using them within the Investec Capital Accumulator portfolio.

'Fear and greed' However, Mundy says investment banks will take advantage of behavioural economics, namely the influence of fear and greed, to profit from clients.

He says: ‘I think there is an information advantage that providers have over buyers. There is also an emotional advantage in that buyers are weak and under pressure at times of market turmoil.’

Market sell-offs, Mundy says, are an excellent example of behavioural economics influencing the creation of wrong structured products and investors making wrong choices because everyone – bar the contrarians – is nervous.

He says: ‘Structured products [providers] see volatility is going up and customers are getting scared, so they come up with “capital protected” products with a small amount of upside. They are immediately playing off the fears of investors.

'Therefore, you are immediately running the risk of overpaying for market protection. You can also say you are overpaying for market protection at a wrong time, doing it after a market sell-off rather than before.’

'Bells and whistles' Mundy says the structured products space is a constant battle between manufacturers and consumers.

‘Manufacturers can create all sorts of things with bells and whistles and what they are trying to do is find that coupling of bells and whistles that the customer thinks is best value. The customer has this intuitive idea of what to pay for it, and where that gap is greatest is what allows the manufacturers to sell products in the biggest size.’

He adds: ‘That’s a great challenge every day when buying structured products. You are always in danger of overpaying for the attributes that they see within these products.’

Active ETFs - does Low Cost offer investors transparecy?

Howdy y'all,
Hope everyone is well on what is a wholly untypical sunny Scottish morning.

To business - lots of chat around active ETFs,

Should we abandon traditional funds for active ETFs, why have ETFs emerged?

Fisrtly there is a sub-topic as to the performance of passive ETFs through the whole economic cycle - we all recall that over say 5 years tracker funds can be left with nil returns if there has been a bull and bear cycle of equal size ('dotcom' was a good example). We also know investors have a habit of selling and buying at the wrong times in the cycle. Few investors stick with a passive fund for 25 years.

Now we have active ETFs coming over from the US, these are the answer they say to addressing the market cycle, presumably that one can switch from passive (beta) to active (alpha or indeed just more beta as is the case) ETFs at the right time in the cycle. Confused, you rightly should be.

In my ETF guide I talked about the different phases of a market cycle - ETFs do best in the early phase of a bull run where growth is largely driven at a macro level and then lose ground to active managers who assume risks above market to outperform.

I think the interesting dynamic is whether traditional active managed collective models (mutual funds) are flawed from outset, expensive and opaque to the investor. I have certainly written on a number of occassions, challenging the investment return of fund managers and their revenue models. In which case do ETFs offer a new model for any investment OR should ETFs remain in passive strategies?

The battleground, as I see it, is whether active fund managers should continue to use conventional markets or ETFs to trade. I also wonder what unexpected consequences volumes of active ETFs could have on the market, as they are influencing on the price of broad indices rather than individual positions, subject to increasing automated high speed trading.

Also, in the UK, I scratch my head to gauge the superiority (other than price) for active ETFs over closed-ended quoted Investment Trusts.. I recognise these are not US-based but they have sold in the US to the Instl market. The difference is that ITS are also governed by trustees. The other is that Trusts can run at a discount or premium to NAV, ETFs should be reflective of NAV.

In some ways active ETFs could be sold on the basis of low cost; granted, but at the sake of investment transparency, which is the main draw of passive (index based) ETFs. I have not fully resolved this myself and put out for discussion.
 
JB

Lots of spinning plates, over focus on the few and we will drop others.

Could we have seen the recession coming? Although many did raise alarms in 2006; those flags (myself included) were mostly non-systemic (I noted for example that just about every US/Global and European Equity mutual fund had a R-square 90% to S&P500, now ignore the reliance on the 'GIF' for a moment. That figure even in mediocristan should have alarmed but it didn't.. why? because everyone was playing the little brownian motion/VaR game..
John Marke is very right: that some did point to the man-made element, that behaviour will ultimately always produce risk due to morale hazard and it's interesting to see Minsky being revived widely, JM Keynes also.
These then are man-made events but perhaps not in the way of induced seismicity that we have discussed before. But in common is that the intention was not to cause an 'earthquake', well perhaps except the hedge and leveraged managers.
The problem is that the financial industry is a trans-national network that's far more complicated that the multitude of micro silos that trade, invest, comment, regulate and ultimately impact the systemic attributes across the globe. It's too complicated for any one individual or organisation to centre in one place sufficiently long-enough to measure the level of systemic risk, not helped by the simple fact that cross-border regulation is honourable but often ineffective. Even if someone did then the system would probably change so quickly that a true picture could never be built up. It's why scenario analysis should have been more important that forecasting sims. Of course as NNT points out even if we did we are to assymetrical in our guesses, print to underestimate and overestimate at the wrong times.
Again we tried to become too clever, to relax risk limits by inviting more complex risk measurement. Paradox: we chased the holy grail of risk (simply) to elevate one's own risk control/complexity and didn't see the obvious risks in our neighbours kitchen, regulators and BIS enticed such practices but couldn't spin all the plates, not even close, the end.
As John will tell you it's difficult to place lines where we tipped over as we are dealing with a sequence of events that we badly recount but be confident that a multitude of events led to that 'point' in 2008.
Also - in my paper I'm trying to look at the man-made angle from investor herding, media volatility/influence, empirically (I hope) and from a sociological pov. We have to look at the move to DIY investing, online, internet media. I worked out a basic mind map just for this simple fraction of the puzzle and even then was quickly overloaded.

Take also S&P - did months of complacency followed by conservatism lead eventually to radicalism? Markets would indicate no one expected 3 sovereign Euro downgrades in such a short space (Finch may disagree). One would even think S&P wanted to precipitate a double dip or to nervous of not calling something larger, sooner? Be in no doubt the euro is injured and hard to see what conseuqnces that could have. Germany as we know is the cornerstone of the Euro economy,we don't know what caapcity it has to bolster its sick relatives.

Lastly OTC off balance sheet trades (aka dark liquidity pools). The move to bring them into the light and onto exchanges - can we predict the result of this, amplified as it could be through high frequency trading which is completely shaking up the system - John for you this means even less 'slack'.. again a man-made development. We also have baby boomers ready to sell to take their pensions and huge Instl money ready to transfer from trust-based schemes to individuals. Again man-made, cultural, changes will probably be exponential, error rates spiralling and consequences behavioural in nature.

The system will again adapt, evolve, people's mind sets will prefix on the recent and forget the long.. regulations will stem the risk of the known rather than the unknown, this we can be fairly certain just as we can be un-certain of what events will precipitate the next crash or when.
 
of course if we follow NNT's thinking through, we wouldn't know which black swans hadn't occured in order to apply hindsight as to why they were near misses. What chance do we have - we're not even very good (as a society) in recognising the black swans that do occur.. ergo NNT's crusade on historians and the narrative fallacy. As you say we have to hope for more grey feathers.
Perhaps we can only hypothesise: E.g. what if the awful events of 9/11 hadn't happened resulting in a continuous bubble/affluence run (bond dip) from 1998 all the way through to 2006; (unlikely admittedly) then what?

For example say that the market, somehow, had cooled techs enough to consolidate earnings and precipitate a period of growth not seen since the 50s.. then we see a more prolonged credit boom followed by a bust 3 times the drawdown of 2008-2009. or in another way we add up the sum of the 2000 dot com slide, 9/11/01 + the 2002 accounting scandals and the 2007-2008 crunch together, combined with an assumption that assets were attracted West to East China and EM Mkts overheated 3 fold than they did.. sometimes what may be commented as a balck swan was more predictable, a grey swan, a pressure releases that avoided something much larger such as a complete collapse of electronic international trade.. or China repartiates all foreign assets held, how many institutions would have gone bust then.

John is right about morale hazard and I also follow Minsky. Of course this is all the more unlikely since it is when there is a big error in the system that the next set of models are created as a solution; designed to more accurately measure risk, with the net effect of more risk being taken. Fewer mistakes then the rate of complexity slows. In terms of Minksy think of it as clever bods being encouraged to find complex problems to invent complex solutions that by their application induce more risk-taking. Market shocks ramp up the hire of said bods who have to find new models to get paid. Rarely are bods paid to come up with risk models that cap the amount of risk (profits) their pay masters can undertake.

What if the war on terror hadn't happened, what if no SARS, what if no x, y or z.. as NNT reminds us it is very difficult indeed to unpick the causality of a major event back to a single cause whereas we can hypothesise about the impact of small events, iterating in their multitude, down a butterlfy effect.

There are some huge issues still largely dormant in the financial system, the shifting influence of Gen Y from X investors, the impact of individual vs. institutional investing, advised to non-advised investing, the pensions gap.. the way exchanges are trading, the rate p/second they are trading at: all these things could move the markets up/down to unprecedented scales. They are grey swans since we are talking about them. What do we do about these, hypothesise?

To revive: "For the ordinary man is passive. Within a narrow circle he feels himself master of his fate, but against major events he is as helpless as against the elements. So far from endeavoring to influence the future, he simply lies down and lets things happen to him.." G.O. 'Animal Farm'

..and to me that's the only thing regulators and investors seem to do; feeling powerless to change the big events they hypothesise the results from small decisions. In doing so they remain in mediocristan where it feels safer.
In reality they should recognise the shortcomings of future-gazing and build some honest 'resilience' (to coin from John's work) for when things do turn out differently. However the financial markets are a confidence game, always have been and folks need regular placebos to maintain that veil of certainty.

(this thread continue in the Linkedin Black Swan group)

http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&gid=80474&discussionID=18503539&commentID=15601226&goback=%2Eanh_80474&report%2Esuccess=8ULbKyXO6NDvmoK7o030UNOYGZKrvdhBhypZ_w8EpQrrQI-BBjkmxwkEOwBjLE28YyDIxcyEO7_TA_giuRN#commentID_15601226

Savings Ratios versus Debt vs. Propensity to Save. That old chesnut - Longevity vs. the Pensions Gap..?!

Dear CCC,
The Misnomer of UK Savings Ratios? Anyone who's looked at the APS (average propensity to save) from the ONS recently will see there is a sort of reverse logic playing just now - we see exceptional avg. savings ratios in the UK and US but we know much relates to debt digestion/reduction; not long-term savings. The pendulum effect we saw between debt borrowing and debt digestion has also had the unhappy consequence of using the APS to trend ever again; (although conversely handy for scenario and stress testing purposes).. I'm puzzled; are you?

Now the OECD do calculate national savings rates as a percentage of GDP that is saved by households across a country. Household saving is one of the primary sources of capital investment in the country. Thus OECD use this rate as an indicator for long term economic growth. http://www.oecd.org/

Our recovery indicators seem awfully hinged on tiny margins in GVA, and massively preoccupied by CPI and retail spend as proxy of recovery.. seriously?
Overall savings volume has been fuelled by baby boomers, the Gen-X, a group set to enter extended accumulation, drawdown or full decumulation between now and for the next 5 years. Once the group is fully in decumulation then it would seem we should expect a sharp drop off in savings investment if we cannot encourage Gen Ys to save more.
http://www.oecd.org/dataoecd/34/52/1865232.pdf

Reverse logic: To expect a rise in net income being devoted to long-term savings and we may actually need the savings ratio to fall. This would imply the current ratios are artifically high and that in normal conditions the potential residual of income is going to be nowhere near as much. It also points towards cultural issues about when to save and when to spend.. long-term savings (used for future provision) seems to get squeezed by short term needs to store money for a rainy day and to spend when things are good. This has perhaps something to do without inability to accurately weight the importance of future events.. this is a major block for anyone wanting to launch wellbeing products that focus on tomorrow rather than today.
Meanwhile the pensions funding gap isn't exactly standing still.. while defined benefit wchemes needed nigh on 5700 points in the footsie to come out of deficit (writing - wall).. The run-up to 2012 will then change the UK savings landscape as we see auto-enrollment and employer-sponsored scheme make individual contributions compulsory.
There are of course glimmers of hope in the UK; a very healthy Q1 ISA season.. the quesiton is whether investors have confidence in longer-term products or whether the flows into ISA was a churn away from other savings vehicles such as onshore/offshore bonds (retraction) or pensions (flat).
BUT what preconditions are we looking for to encourage long-term savings: do we need people to spend to save, people to borrow to save, people to change mind-set, irrespective of economic conditions, to save..? How do we encourage them to save more against the backdrop of national debt? Again the focus is (relatively) present (the next 5 years) rather than future (the next 25 years)..

So my first suggestion is that for the purposes of tracking UK savings rates then we abondon the ONS APS and instead use OECDs savings rate values. The OECD has studied savings rated but again we're short on observations during and post credit-crunch. In short the rules may have changed and hopefully the OECD will pick this up in due course.

http://www.olis.oecd.org/olis/2010doc.nsf/linkto/eco-wkp(2010)10

Capricious events? Bill Jamieson talk, Tuesday night

'Future of the Banking sector'

A most enjoyable macro session by Bill Jamieson (Exec Ed Scotsman newspaper) at the Carlton hotel last Tuesday night..

As Bill would aptly pontificate about any debt-driven double dip: waiting for 'the shoe to fall off the other foot', perhaps S&P is getting into the shoe business given it's fervour to unsettle the market through a series of sovy downgrades, let's just hope it's sized the feet correctly lest we suffer discomfort? We wouldn't want the financial equivalent of bunions now would we!

When will credit agencies like S&P come under full regulation, they seem to swing from inertia to over-exuberance, dangerous traits in a media driven world.

Bill rightly points to the capricious nature of events yet to unfold..

A History of Modern Portfolio Theory: i.e. chasing the ‘Holy Grail’

As fund analysts we are often derided as the ‘blunt end of the stick’ when it comes to the tricky numbers. In the last decade we have seen an explosion in models to calculate the risk of financial instruments. 2 things are true of these advances in financial analysis: 1) they became more complex and mathematical and 2) they failed to reduce the level of risk for the investor: think LTCM, Black Monday (19/10/1987) , Barings-Asia crisis (97), dot-com (2000) and the credit crunch (2008).

"Any intelligent fool can make things bigger and more complex... It takes a touch of genius - and a lot of courage to move in the opposite direction." Albert Einstein

1950s: Optimization (Markowitz)
1960s: Capital Asset Pricing (Treynor, Sharpe etc)
1970s: Attribution (SIA UK)
1970s: Arbitrage Pricing Theory (Ross)
1980s: Heuristics and behavior (Kahneman & Tversky)
1990s: Stochastic (Wiener, Black, Scholes, Merton)
1990s: Rise of Value at Risk based models (VaR)
2000s: Asset-liability strategies (ALM, aka LDI)
2000s: Fluid dynamic models (Navier-Stokes)
2000s: ARCH-based models (Engle)

2000s: Levy-jump models and power laws (LSE

2000s: Chaos theory, entropy (Lorenz)
2000s: Extreme Value models, organic (ongoing)      

There is no holy grail in predicting future financial markets from the price movement of previous ones..

Clown thinking.. Investor Herding as a by-product of Media Influence?

A large part of my research has identified but failed to measure the impact of mass media and media influence and how they integrate with the behavioural system that is investor herding and market returns. In going back to my sociology roots I'll try and examine the financial problem from a socio-economic perspective (hey, I tried working it out from a financial perspective and it didn't work!!).

Media influence in short is 'refer to the theories about the ways the mass media affect how their audiences think and behave. Mass media plays a crucial role in forming and reflecting public opinion, connecting the world to individuals and reproducing the self-image of society. Critiques in the early-to-mid twentieth century suggested that media weaken or delimit the individual's capacity to act autonomously' http://en.wikipedia.org/wiki/Media_influence

BUT why should we be conerned with media influence? - because we have become de-instituionalised 24/7  media/online culture. Media influence is becoming more pervasive as investors are empowered by the transition from advised to DIY investing and the large institutionalised (pension scheme) money is being devolved back to the individual as regulatory reforms grip.

The concept of tomorrow's investment market being some sort of hive of millions of individual thoughts, influenced by media and traded by dealers with ever advancing and accelerating trading systems is a shuddering one. Outcomes look set to become more uncertain, volatility swings more behavioural and past regressions even less indicative.

Suspend all notions of regression analysis?

It would appear, as an industry, that we answer the fundamental questions with a cumulation of models: each the answer to the predecessor. It's like saying how do we fix stochastic forecasting by improving regression.. you can't... we can simply throw more estimates at a problem or fewer. We're chasing a holy grail that's become more elusive as the system becomes more 'efficient' and faster (HFT).
To quote you: "if you do not use statistics measures (such as VaR), how do you take care of your clients' potential downside?”

: the answer, in its purest sense, is that we do not expose clients to downside risk.. period.. now if that's the starting point where would one go, as 'experts' to achieve that? Not a ponzi scheme before anyone jumps in.
I am only asking us, just for a moment, to suspend all notions of regression analysis; to assume that it has no bearing on the future returns of your client investments.. that the fact it on occassion it appears to explain what is happening in price returns is fallacy, mostly coincidence, behavioural and only very rarely brownian... then what would you do, where would you start? Where indeed.

JB

A Brave Path: Risk inherently can't be measured?

A good point cropped up on the mother of threads on the wealth forums:

"I'm a newbie to all of this, and have been following along since this topic's inception. I would have to go with risk inherently can't be measured. Obviously. But a model for it can be built in order to hedge against excessive unnecessary risk. In a perfect world putting competing instruments in the same portfolio based on the level of risk the client is willing to take on. However, sometimes both of them go south and you're left flailing in the wind.

In my personal investment portfolio, I like to couple things that are inverse to one another while still giving one an advantage (stocks to bonds, currency to commodities) and of course taking at least 2-5 long positions in a reputable mutual fund. May not be the best way to go about it, but it works and I still earn a pretty reasonable return when inflation is calculated in. "

JB: Does Correlation/Regression work? Perhaps the 'rules' between asset classes themselves are simple behavioural conventions.. we saw during periods of dislocation that (investors) money can quickly forget efficiency and correlation, which perhaps exposes that there are no rules; only human perceptions of what is high and low risk in a given set of conditions over a given expected investment horizon..

We also see the gap between expected risk and actual risk hit new levels, which infers that regression and stochastic-based approaches are fragile.

I pose that risk is blind of asset class unless there is some anchor of return, which isn't overly dependent on counter-party risk to achieve it.. risk only gets shoved around or swept under the carpet; it rarely goes away. This would infer investing outside of the conventional approach, to buy based on behavioural (empirical) conditions..

I have no hard and fast solution and building a portfolio for resilience grounds is challenging indeed.

A brave path.

My note to Alex Salmond.. 'Greedy Bankers'?!

My note to SNP HQ.. following the attached election flyer that came through my door.. I felt the urge to send my First Minister a quick note to share thoughts.. I entitle my email 'Potential Vote Loser'!!


FAO: Rht Hon. Mr Alex Salmond, First Minister of Scotland

Dear First Minister (Alex),

As a long-term SNP supporter (voting) I wanted to draw your attention to the attached:
Scotland's heritage as a banking and financial nation cannot; should not, be down-played or derided. Why then are your local candidates playing such an obvious media-invested 'Greedy Bankers' card? Such tactics do little to effect the financial square mile of London: the well protected traders and high-flyers but does impact the average bank worker: each time they pick up a tabloid, switch on the 6 o'clock news, panel debate or every sensationalised right to reply programme. Nor, if my geography serves, do they fall into any constituency you are campaigning.

'Make the Greedy Bankers Pay Not the People - Say SNP' Ignoring Mr McNally's and Mr Smith's somewhat flawed argument vis a vis Treasury earnings derived from said bonuses; their subsequent decline and deficit and the likely return we (as taxpayers) will see from mark-market bank assets via GAPS over the next 5 years:

The media has deliberately (for whatever reason or agenda) chosen not to differentiate the average bank worker from the so-dubbed 'fat cats'. I suspect fewer than 1% of the financial workers in Scotland are eligible to the fabled high risk bonuses; and we know many earn below the UK's avg wage. I have come to expect the UK parties to take full advantage of such easy collateral but why would Scotland's party do the same, since the reputational damage is greatest on Scotland?

My wife, who has also voted SNP in the past, took great offence. She is no city banker but worked hard for RBS for 16 years, to rise through the ranks and earn her money. She did not cause the credit crunch, did not work on the asset-banking side but has had to deal with much of the fall-out: redundancies, restructures. To say she has taken an emotional battering is an understatement, like many she would love nothing more than to now leave the banking sector for good!

I myself a hard working financial analyst who lost his job in 2009; (a result of US repartionation of jobs at my firm) 1 day after Obama's inauguration! Again I would never have qualified as a 'city banker'. In fact my work was aimed at identifying risks, improving investor information and setting controls when/where possible, having worked my way up through the ranks over 10 long years.

Alas when this insult to Scotland arrived through our letterbox SNP's vote; your vote, in this household (at least), went from 2 to 1 (at best)!

If nothing else (being sth of a strategist) using such a tactic in a heavy Edinburgh-Glasgow commuter belt is at best naive; frustrating when the sub-text of their second point ('expenses') was valid if not properly played through, which infers some weakness in that claim. Alas the headline merely casts your candidates as poorly informed regarding the economy, financial regulation and the hitherto reasons why we are facing unwanted but necessary taxation rises.

Mr Salmond, you have a real opportunity to take the high ground in this election: to call a spade a spade and defend Scottish bankers. Mistakes were made by the few; mistakes were made globally, but few suffered the public back-lash so much as Scottish bank workers. Please don't blow it by allowing your party to follow the herd, by pandering to the media-drunk middle-England, blaming the wrong people and disheartening so many 000s of banking workers in Scotland; not to mention the 000s more in associated investment, wealth and pension sectors.. our nation's heritage! It is likely we will see a new party into #10 in May; time then for a strong Scottish Executive, a strong First Minister and a strong effort to rebuild our financial reputation in the UK, and globally.

Undoubtedly you will be a busy man, with both ministerial tasks and impending election, but appreciate your response as to why this household should still give SNP at least 1 vote at the next GE?

With sincerity and regards

Jon Beckett, BA, ACSI

Diversifying: A rant about VaR

Setting your risk budget, trying to understand the 'downside' of an investment..and diversify those risks.. these are all reasonable questions when investing. In the last few years many have turned to Value at Risk analysis ('VaR') as an answer.

What is it with Value at Risk analysis... People do seem to forget how distribution stats work and the simple fact they are 'confidence' models... when talking to friends and colleagues I like trying to flip the confidence around into betting odds.. 1 in 20, in 200 etc.. this seems to give folks a better understanding of the probable (the likely 90, 95% etc) and the less probable.

Confidence: I found it hilarious that folks mistook: '1 in 200 chance of x event over 1 year, as a '1 in 200 year event'.. this is a very schoolboy error; (one prevalent across actuarial circles). Game-theorists aside: the odds of 1 in 200 are the same in every year.. the size of that risk is also not known, it falls outside our confidence (i.e. we don't know). Some reported experiencing 1 in 200 year events for the last 3 years.. clearly that's not right?!


Downside and Diversification.. VaR is used mainly for 2 things: to gauge the likely 'downside' of an investment and as a way to budget that risk. The problem is that most VaR is based on historical returns BUT what the investor gets back rarely matches the marketed standard time period returns. Once folks thought they had found someone who could but he turned out to be running a Ponzi scheme..

Let's ignore forward VaR (ex-ante, stochastic models) as that treads into forecasting and I haven't the energy to talk about crystal balls for one night!

Getting back to setting out risk for the investor - most are advised to diversify, why? The schema of diversification, and how it's presented, is so wrapped-up in spin that it's debatable science. It's the investment houses that tell us to diversify, why, because their revenue models are based around long-term assets.. tactical investing is seen as an unstable force: (i.e. bad for annual management fees). Yes - short term herding can be quite destructive and Fidelity's Magellan study showed investors rarely profited but that's down to education and of course confidence: investment houses treat customer assets as their own, once allocated. It's for the adviser and the investor to remind them otherwise, set specific investment horizons and targets.
As someone who has worked both sides of the fence: I found that financial risk and investing does not lie inside VaR or any Math model for that matter.
 

 "I can calculate the motion of heavenly bodies, but not the madness of people." Isaac Newton

The investors who seem to win more than they lose don't appear to do anything complex. They seem to start by knowing they'll lose and play the long game. In short they rely on the illogic of others to do the work for them. They play the behavioural card.

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." "You only have to do a very few things right in your life so long as you don't do too many things wrong." Warren Buffett

"Bull markets are born in pessimism, grow on skepticism, mature on optimism, and die of euphoria."-- Sir John Templeton

"The market can stay irrational longer than you can stay solvent."-- John Maynard Keynes

Perhaps the lessons to be learned here is not invest by looking at performance-based risk at all but by stepping back and looking at other factors involved. I hope to pick up on some of these in my new paper 'Clown Thinking and the financial Media Circus'. JB

The CCC: A new name, a new way of thinking?

Dear CCC'ers - in light of my forthcoming paper 'Clown Thinking and the financial media Circus'.. I thought it only fitting to change the name of the CCC to the:

'Clown Consortium for Contrarians'

I hope in the coming weeks/months to explain what clown thinking is and why it's good to be a clown.

JB

Double Trouble: Bubble or Dip

Hi All,
If you look back at my behaviours timeline: here we see what I'd call the 'tipping point' between bulls and bears.. for the 13 months the bulls had been gaining ground at a faster rate than most previous bull cycles (think of it has the counter-swing to one of the fastest/pronounced market drawdowns in history)..

Perhaps this is the 'Obama effect', the result of excessive central bank stimulus.. or '2 years growth in 1'.. when you look at it that way the current market becomes a different prospect.. BUT momentum has slowed in the last 6; barring a recent surge.Take then an article by Rodney Hobson, Author, Shares Made Simple and Small Companies, Big Profits: The headline reads:

'Double bubble' "There are odd nuggets of welcome news on the economic front. The message remains that while we are not yet out of the woods, it could be a lot worse.."

The headline and article don't add-up; Rodney's article is full of balanced views, caveats BUT it's as if the editor re-rote his headline to grab maximum attention. Here is clear evidence of the Media Circus at play.

Bears continue to tout the 'double dip' paranoia; now Bulls have resurrected the notion of the 'double bubble' to keep the advantage and get traction back in the market again. So,

'Double Bubble or Double Dip'? In my experience any market cycle that has been punctuated by 2 bulls rallies tended to mean one thing.. risk aversion is falling (too low?), morale hazzard and complacency is creeping in (as we all now believe we live in a safer; more regulated state) and risk is rising. The Media Circus is again turning the wheels and set to speed up!

This change in 'consensus' in the market could be echoed by the Global Consciousness Project (GCP) 'Dot'. Of late I have seen amber and yellow dots, as currentrly. "YELLOW DOT: Slightly increased network variance. Probably chance fluctuation." The Global Consciousness Project collects random numbers from around the world. This is a real time data analysis of the GCP. It collects the data each minute and runs statistics on the stream of random numbers generated by the project. This analysis is run 10 minutes behind the generation of the data. In this way, it can be seen as a real-time indicator of global consciousness coherence. I have yet to back-test the confidence in the GCP versus sales flow (investor) behaviours.

Of course I don't know what direction markets will take; nor does the GCP, much will depend on the Media Circus and which camp the herd believes. Now as before, as it will be..

Your faithful clown
JB

New paper - draft in 4 weeks.. 'Clown Thinking and the Media Circus'

Evening All,
Tonight I started penning thoughts and research to paper; together with various influences, in what I'll call 'Clown Thinking and the Media Circus'.. stay tuned..

This will be Paper 1 in my 'Finance on the Front Line' series for the CCC. It will benefit from the input of many great people I have met in the world of Risk and Finance. In time I hope to build this into my PhD proposal/research.

Once the draft has gone through various iterations; edited, and feedback, from 10 chosen wisemen, incorporated then I will duly share here with my fellow CCC'ers..!

From today, I hope to have the first working draft ready in 4 weeks, edits in 5, feedback in 6 and on here in 7..!! I juts hope folks don;t find it too boring.. it will be a real test for my writing ability.

Once done I can then start my Masters studies (CISI, Module1) in earnest..

CAS: Network indices v sales flow behaviour - the missing measurable?

An interesting revelation - could mobile network indices trigger stock market changes? This question has been posed elsewhere; merits consideration.

'Do you use wireless network stat doing research? The links/queries among cellular technology, computer science and social science. Research shows that human behavior is 93% predictable:( http://www.sciencemag.org/cgi/content/abstract/327/5968/1018 ). Scientists studied anonymous cell-phone users's mobility patterns and concluded that. If cell-phone user penetration is over 95% in certain countries/areas, what is the over all predicability?

'A range of applications, from predicting the spread of human and electronic viruses to city planning and resource management in mobile communications, depend on our ability to foresee the whereabouts and mobility of individuals, raising a fundamental question: To what degree is human behavior predictable? Here we explore the limits of predictability in human dynamics by studying the mobility patterns of anonymized mobile phone users. By measuring the entropy of each individual’s trajectory, we find a 93% potential predictability in user mobility across the whole user base. Despite the significant differences in the travel patterns, we find a remarkable lack of variability in predictability, which is largely independent of the distance users cover on a regular basis.'

Wireless engineers use massive data collected by cellular network to design and optimize the network. Have we think about human behaviours when we design the network? ( we may, but not enough.)


I used to watch event impacts to network traffic patterns which seemed telling me all the stories. I tried to image what happend 30 miles or 1000 miles away.  Sometimes we are anxious waiting economic data, public censue to be release in the morinings. Isn't celluar network statistic more accurate to reflect human behavior, economics and social science results?


I believe if we dig deep enough, some cellular network indices should trigger stock market changes. If one area is picked as research objective, the celluar data should be able to tell you the most recent and historic rapidly then any database.Do the current 2G/3G data foresee 4G pathes? Will you develop real time optimizazation tool to using predicable human behavior pattern? 93% is pretty high accuracy for wireless tecnology, computer sciences and especially for economic and social science.'

Entropy: I've been talking a while about working out the patterns of sales flows as a complex adaptive system ('CAS'). This would combine variances in sales patterns against variances in media flow. What I was lacking was communication.. a way to measure not only the 'noise' of media influences but the resulting 'chatter' of investor reaction; leading to finally the herding of sales flows.. perhaps amplified through High Frequency Trading ('HFT') and growth of 3G, as they take hold of the global markets.

John Marke has talked about the lack of 'slack' in the system and it might be possible to map out an end-to-end system for this. Suddenly this looks doable. JB

Contrarians: Dr Mark Mobius (aka 'Bald Eagle')

JB on Mobius: During my time at Franklins I had the pleasure of speaking with MM a few times, tracking, analysing and selling his funds, and managing his S&P ratings and securing his first 'AAA' for his flasgship Templeton Asian Growth Fund. In 2008 he kindly signed his book for me.. It's fair to say I rate him as a fund manager in the same ilk as Buffet, Templeton etc.. perhaps more so as he really did set into motion the Emerging Markets investment fund.. the cascade effects are very evident now. This article caught my eye.

http://timesbusiness.typepad.com/money_weblog/2009/06/mark-mobius-ten-top-investment-tips.html

'Dr Mark Mobius is one of the most experienced fund managers in the industry.  He has been managing the Templeton Emerging Markets Investment Trust since its launch 20 years ago. In that time the value of an investment in the trust has multiplied more than eleven times.
Here Dr Mobius draws on his years of experience to offer ten investment tips to Money Central readers.'

1. Keep an eye on value
Is a share selling for below its book value? What is the relationship between the earnings and the price?
2. Don’t follow the herd
Many of the most successful investors are contrarian investors. Buy when others are selling and sell when others are buying.
3. Be patient
Rome was not built in a day and companies take time to grow to their full potential.
4. Dripfeed your money into the market
No one knows exactly where markets are going so dripfeed your money into the market by making regular investments. That way you will average out the ups and downs of the market.
5. Examine your own situation and your appetite for risk
You should not go into equities if you are the type of person who is nervous every time you read a stock market report.
6. Diversify your portfolio
You must never put all your eggs in one basket unless you have a lot of time to watch that basket - and most of us don’t.
7. Don’t listen to your friends or neighbours when it comes to investment decisions
Your own situation is different from everyone else’s so you should be making the decisions.
8. Don’t believe everything you read in newspapers, things tend to be exaggerated
Don’t be swayed by headlines and look at what is going on behind the scenes.
9. Go into emerging markets because that is where the growth is
 Emerging markets have consistently grown much faster than the developed countries in virtually every year since 1988.
10. Look at countries where populations are young Countries with young populations are going to be the most productive in future years.

Happy Birthday Albert!

Happy Brithday Albert..

To mark the occassion I have added an attributed citation as the quote for the day.. sums up pretty much everything the CCC is about and stands for.. curiosity!

"Great spirits have always found violent opposition from mediocrities. The latter cannot understand it when a man does not thoughtlessly submit to hereditary prejudices but honestly and courageously uses his intelligence." A.E.

CFA seminar.. January sales flow data in...

Back from an enjoyable evening with the CFA chaps - another hour of CPD logged!

Gavyn Davies presenting on macro and economic policy errors through the credit crunch, and current state, at the Scotsman hotel. I threw in a question at the end about the 'potential for a gilt downgrade being bad medicine for the UK': yes any downgrade would be bad in terms of confidence and via rising yields would put up the cost of UK's borrowing. However surely this current state of AAA in doubt can't be helping foreign investment, especially with ratings agencies issuing alerts. I posed whether a downgrade would stabilise the credit risk premium and attract investment. I guess a downgrade is still seen as the greater of 2 evils (knowing how investors can panic and media hype) but it'll be interesting if BoE and HMT try to sell more issues: in effect I'd assume they'll resort to increasingly longer issues with increasing yield/YTM to entice takers... we'll see. 

Back to business: another month's worth of sales flow data to digest, I need to get my numbers together so I can formulate some ideas back to John Marke (ref Complex Adaptive Systems).

I also want to pull in a CISI article re HFT - seems I'm not the only one to have concerns after all.

Jon-out!

Latest herding patterns - quick observations

Hi CCC'ers,
Apologies for the delay in this post; I had an interview last week which distracted me (went okay-ish - see my ppt proposal entitled 'Do Funds Do What they Say') and I've been reading John Marke's paper on resilience and complexity. I promised some quick analysis of the latest sales flows patterns and make some simple notes on what they tell us. This month I will also do a deeper analysis of the sales flow patterns, run correlation, look for gammas etc. Fow now et voici!

Latest herding patterns across Europe/Offshore - what can we derive from them - some quick observations?

Overall: It's still a '50:50' market out there; the herd is in a tipping balance between a second dip or a continuing recovery. Their buying habits typify a lot of undecision and uncertainty (funds like absolute return and structured do well during these times), which the media is feeding off. Add to this the doubts over sovereign downgrades, banks and the cash-heavy positions of wholesale institutions and it's all a bit messy out there really. In terms of sectors:

Big winners in December: Asset allocation, EM Bonds, EM Equity, Eq Euroland, Eq Europe, Eq Global, Eq Grt China (helped by some new launches), Mixed Assets Balanced.

Big losers in December: FofF Short-term Dynamic, a huge rotation away from Cash/MM, Bonds EUR Short-term.

Latest data: Pros v Cons:

Positives:

1. Sentiment is still cautious but the pessimism in early Q4 appeared to have settled a bit by the December flows.
2. The deltas tell us the water was calming a little - far from a mill pond but it's getting closer to the normal sort of movements we have seen since 2002.

Negatives:

1. Setiment is still south of neutral - disappointing given the influx of positive (albeit mixed) economic data. The 'W-shape' doom merchants are doing a good job at persuading the herd that more downside is to come.
2. We know there was a lot of media activity in Q1 2010 so we will need to see how that's played out in the sales flows.

Breaking down conventions? The CCC is looking for Authors...

One of my key aims for the CCC was diversity of opinion and to cover a broad range of investment issues for both average and experienced investors alike. To do this free of conventions, away from the marketing rhetoric of large firms. To discuss, debate, decide - on real investment issues and industry developments..

To do this I need authors.. please get in touch if you are interested.

JB

CAS: Do I first start with the entropy of sales flows patterns?

Entropy is basically the number of combinations/configurations a system could have.. the higher than entropy the more random the result..

"An everyday example of entropy can be seen in mixing salt and pepper in a bag. Separate clusters of salt and pepper will tend to progress to a mixture if the bag is shaken."

So - if sales flow are like the salt and pepper and herding is like clusters that form mixtures then can we derive any sense of such patterns.. in some sense 'No' since thereis behaviour and organic factors but in a simple tracking sense then maybe appreciating the randomness of sales flow patterns of my first step to understanding parts of the complex adaptive system that impacts investor decisions, sales flows, performance and risk..

CAS: Complex Adaptive Systems

I have just been conversing with John Marke who is a risk-man in both financial and defence fields.. I class him as one of the 'elightened ones'. His papers on complex adaptive systems (or 'CAS') has really opened up my mind to new possibilities and new ways to think about how to interpret randomness of mutual sales flows, risk and performance.

My personal 'moment' of freedom occurred in 2009 when I realised all the bellcurvistan (normal distribution, law of averages) stuff I had been doing on tracking mutual funds was frankly tosh and I needed to start again; (at least it allows me to engage in bell curve conversations while trying to encourage the idea of randomness)..

Previously I had spent much of 2007 and 2008 on the front line tracking high correlations across large fund groups (50,000+) listening to various seminars on the unusual ViX bottoming but other than high gearing and exceptionally concentrated equity/high yield/ABS/CDO/CMBS positions it was hard to understand the root causes.. if I had been speaking to guys like John or Nick and Kon (Black Swan group) then I might have had a better idea of the bigger CAS in play.. I of course talk of the interaction of global central banks and govt fiscal policies underlying.. if you first think of each market bull/bear not in isolation but as an interaction of multiple cycles prior (domino effect - 2D).. and then also as an interaction with other less seen elements (geopolitical movements, media expansion, health scares, natural disasters, war: butterfly effect - 3D) then I start to better appreciate CAS.

In reality I was looking for sequential chains of events: (event - sales flow - performace - risk - event) when actually the system was more complex than that.

If I now think of the sales flow patterns as part of an intricate elastic web that's continually changing due to behaviours, media flow, performance/risk changes.. action, reaction, re-reaction.. then I can see why my earlier analyses were flawed.. 1) I wasn't accounting for a dynamic change in perceived riskiness of different assets (tho I was aware a delta scale was needed) and 2) I wasn't considering the presence of power laws or indeed unseen correlations to other factors (tho I had realised that media could be a root cause of volatility).

What I had really 'missed' was that I was trying to measure movements against a common sentiment 'neutral', over time, when in fact the 'neutral' was moving also.

I'm hoping I can try to apply some of John's work into better understanding sales flow trends.. and from that try to record some observations and build some sort of 'resilience' planning for investing. Whether my CAS turns out to be something like GCP (below), LPPL seismicity-based, fluid dynamics, chaos, organic or more socio-economic (behavioural) I'm uncertain.

E.g. GCP Hypothesis: "The Global Consciousness Project, also called the EGG Project, is an international, multidisciplinary collaboration of scientists, engineers, artists and others. We collect data continuously from a global network of physical random number generators located in 65 host sites around the world. The archive contains more than 10 years of random data in parallel sequences of synchronized 200-bit trials every second. Our purpose is to examine subtle correlations that may reflect the presence and activity of consciousness in the world. We predict structure in what should be random data, associated with major global events. When millions of us share intentions and emotions the GCP/EGG network data show meaningful departures from expectation. This is a powerful finding based in solid science. Subtle but real effects of consciouness are important scientifically, but their real power is more direct. They encourage us to help make essential, healthy changes in the great systems that dominate our world. Large scale group consciousness has effects in the physical world. Knowing this, we can use our full capacities for creative movement toward a conscious future."

http://noosphere.princeton.edu/

Question.. so to become a contrarian..

Q... do I a) start the CISI Masters, b) take the neccessary lvl4 qual to get my individual chartered status or c) embark upon a left-field study plan in non-financial courses?

The first choice helps me gain reputation and credibility long-term, the second short-term and the last will probably make me a better non-conventional analyst.. perhaps I have just answered my question but we also have to be pragmatic, sometimes.

Courses of interest:

• Business Economics from a strategy pov
• Seismicity and tectonic analysis
• Financial Mechanics - random, power law based
• Computational Fluid Dynamics
• Investment Psychology - Kahnemman & Tversky type work
• Social-sciences are the cross-over in markets

Decisions, decisions..

Latest Sales flow data in (to end December)

A quick note to say that I know the December sales data is in but I won't have a chance to study it until after the week after next, exams, family yada yada...

There are a couple of other things I want to do with the data also - look to see if patterns/cycles in asset rotation is possible (by throwing various different models at it) and what KISS observations are possible.. and also do a breakdown of the asset mix (risk profile) of some of the key European countries - contrast behaviours etc.. Greece and the Med countries may be of particular interest just now..!!

ttfn
JB

Another blogger - another Black Swan

http://nicholasjdavis.wordpress.com/

'My goal is to continue to develop a concurrent expertise in future-oriented macro-economics and organizational strategy for firms, the non-profit sector and public/international institutions; however it seems that interesting opportunities to think about uncertainty, risk and the future abound everywhere around the world, so I’m trying to be prepared for many possible twists and turns in life.'

Read Nicholas' report card here: posted March 10 2009..

http://nicholasjdavis.wordpress.com/2009/03/10/robustifying-the-global-financial-system/

'OK, now that we’ve sorted out the crisis-management side of the global financial crisis, and have stabilized the banks, how do we structure the global system to be more robust? Here are a few principles and ideas for robustness that a few of us here in Geneva and elsewhere have been throwing around recently in conversation.. '

Don't read this you'll hate it!

"Oh, you decided to read anyway. Strange isn't it? You see a negative headline and you go straight on to read the article below. You may even have clicked on the headline to get here in the first place. Why? You were told not to read it...! Like so many other people you have been lured in by a negative headline.

In spite of what we say about being put off by negativity, the reverse is actually true. We need to focus in on negative things - it's all part of our inbuilt survival. We need to protect ourselves from possible harm all the time, hence we are finely attuned to noticing negatives (potential threats). It means that your website visitors will be attracted to negative headlines more than to positive ones.

And remember, it is the headline that gets them to read. Even if you have enticing images or videos, unless the headline is compelling people don't read on. Eye tracking studies show that people often give-up after reading the headline - largely because they are not interested in what it is telling them.

Typically a good, popular and successful newspaper will spend more resources on the headline writing than it will on the writing of the articles themselves. Headlines make a huge difference to sales and readership in the newspaper business. The two or three words on the front page of The Sun are probably the most expensive words produced each day in the UK because without them working effectively, sales can fall. If those couple of words are right, sales can rise. Hence the newspaper agonises over those words and pays high salaries to the team putting that page together.

So, you need to ask yourself a question. How much effort do you put in to the headlines on your website? And are they focused on attention-grabbing negatives? If you merely used headlines as "labels" - including the ubiquitous "Welcome to our website" - you are not going to attract the levels of readership you want or deserve. Put in considerable effort on headlines and make as many as possible negative - you'll see a significant rise in readership and time spent on your site." Extract from IFALife. http://www.ifalife.com/

I really liked this article on IFALife by Graham Jones (Internet Psychologist) and sums up the conflict between people following news and the business model of media selling news by selling bad stories. It also keys into things I have said in the past such as sensationalism, information volatility and investor 'lag' caused by information and influences. JB

Transparency: JB's current portfolio (08.02.10).. shh (don't tell mum)!!

I promised I'd give you a run-down on my positions.. et voici! This is for approx £50k I have with a well-known wrap provider. You'll immediately spot some areas I'm overweight in (where I am really buying a lot of risk) in my case ETFs and (relative to the avg balanced investor) I'm o/w both property funds and commodities... shh (don't tell mum)!!

The cash is higher than I planned but I have a few ££££ still unallocated..

Eureka...! why we should start with 10 questions; not a million

We use checklists to make information manageable and our decisions objective. This is why a set of 10 questions is better than a million. As Taleb says, humans are not good at processing lots of unique information and drawing objective decisions from them. This is why some rely on algo programs to process the questions for them. By ourselves, 10 we can do a little better.

We make information objective to make our decisions logical, by identifying and learning from errors. We're not so good at learning from the subjective or anecdotal. This is how we learn - trial and error - without which there would be less invention; less innovation, more inaction. There is a nice little Mike Jordan quote that Taleb uses about 'losing'. The fewer the # of questions the more we have a fixed point to measure against when something unexpected occurs. The point is that we don't accept; we ask 'why' and probe gaps, we try to learn. Checklists can help.
Yes, we should be wary of 'experts' and that trial and error is the basis of all experimentation: Archimedes' eureka loosely translated means 'I have found it'.. which infers a degree of searching. What better way to start a search than through a checklist of questions..

"For the ordinary man is passive. Within a narrow circle he feels himself master of his fate, but against major events he is as helpless as against the elements. So far from endeavoring to influence the future, he simply lies down and lets things happen to him.." G.Orwell.

Profit Taking Season: Bonds v Equities sales flows

Firstly a health warning - I seriously bored myself writing this post; I will try to think up something more interesting next time!

Although I'll be the first to admit the folly of predicting the future direction of markets; (as you know I am perpetually curious about what investors think).. Investors take some sort of view directly or indirectly.. where Fund of Funds are making the calls then there will be some rationale behind asset rotations.

'I do believe that money drives markets drives money. The power of herding shouldn't be underestimated - it is a key cause of asset bubbles.'

So we've had an interesting year to say the least - ups and downs but lots of ups - for any investor who saw that cheap was cheap back last March then brave - they should have lots to be happy about. Now is the season of profit taking and throwing those risk assets into something less, err, risky.. nes pas?

So the first phase bull market looks all but extinguished within the space of 10 months (some sort of record) and we look set for a more frothy and protracted recovery through 2010-2011. What is useful is that the recent dip has cooled the market a little - especially EM markets and we've seen a slowing in the flight to risk.

Into Q4 we saw a move away from Equities towards Bonds as the chart below shows.. was this a cause for the pause in equity markets in Q1.. it would appear to be a precursor yes but the relationship is far more quantifiable.

Did a rotation from equities to bonds facilitate the change in market direction? That's nigh on impossible to say but certainly less liquidity means less trades.. less trades means less buys, fund managers like to keep busy - easier to sell some profits to reinvest than play a round of golf (momentum is such a fragile thing).

Q4 buy patterns drew investors to what I would call the 'neutral line' in risk aversion: I suspect the 'neutral' diversification of flows becomes across the asset classes is a reflection of our time and political reflection.. Obama continues to throw down sobering glimpses of the future and investors seem less willing to hold for a record bull run. The current asset mix would indicate that we will see both falls and rises (no fence sitting there then) but over time a steady single digit level of return.

In time of course the market sociology demands a move towards (greed) or away (fear) from risk. These are not necessarily innate inbuilt states but rather forces upon up, peer pressure through media and the fear of not having enough capital to invest for retirement; not enough performance to get that next bonus.. etc

It's all about information volatility and behaviour: much lies in the hands of investors, the media, the pundits and politicians who influence them.

Waiting for that Dow beta Monday morning in the FTSE - in for a penny!!

Well - that was an interesting couple of days and I'm only now just catching up with the whole hoo-ha. With the FTSE close to 5000 points there is some real opportunity to be had, more than since mid last year. It's a nice time for one of those ViX volatility ETFs but could I find one on HL's site - pah!! Anyway - about 11k ready to be vested for Monday am opening.. (see below)

So, as promised, here are my latest trades - worth noting I have gone both long and shorted (ETF) in the opposing direction, simply because the market could go either way, it's at a funny range where direction is hard to spot (up over next 1-2yrs more likely than not) but where there is good trading range to hedge both ways and cash whichever hits target first and then cash the other when things revert.

The plays being: Venture Capital (private equity looks quite tempting and I can't find Gresham House on HL's site), FTSE 100 both long and short (alas I sold out too early of the first tranche to catch all those nice drops last week), Silver short and leveraged long, Gold long and short (close to SELL point), Vietnam (why not!) and lastly poor old Lloyds - an out and out recovery play - at very least there's about 2.5% of Dow beta coming back to me Monday morning (hopefully) but I'm happy to sit on Lloyds for a few weeks.. the rest will be set to usual targets, one will hit sooner; the other later..!!

After these tranches I'm hoping for some good runs - I'm still playing this too safe, diversified.. next time I cash out I'll start to make bigger single plays - ramp up the risk.

I'll reiterate that I am doing very little research or scoring on these plays - I am using very tight BUY/SELL ranges and buying on pure n simple discount to mean, variance (i.e. thin-spreads minus the bets) The trading costs are low and I retain my asset allocation funds for the long-term (few of which have done much so I feel vindicated with my dabbling!).. be lucky out there..

Retail Distribution Review - 'the Economy of the Adviser'

An interesting thread on the NMA Linkedin group about 'RDR' (eta 2012), as ever I felt compelled to stir my contrarian spoon. As ever the usual introspective 'why us' responses and amusing inter-IFA bantering.. I chose to take an objective economic view of the situation ;)

http://www.linkedin.com/groupAnswers?viewQuestionAndAnswers=&gid=1961010&discussionID=13014485&commentID=11393782&report%2Esuccess=8ULbKyXO6NDvmoK7o030UNOYGZKrvdhBhypZ_w8EpQrrQI-BBjkmxwkEOwBjLE28YyDIxcyEO7_TA_giuRN#commentID_11393782

Original question: Who will be RDR ready and if not what options are advisers looking for?

[JB wrote]



'Commoditising' any service is first neccessary to finding its likely economic value - the old supply-demand question. It's something the IFA community has avoided for years as it's relied heavily on 2 things 1) convenience - managing various aspects of a client's affairs face to face, for being generalists and 2) polarisation - a 'best advice' carte blanche for IFAs to lead the advisory process and providers to pay their dues in exchange for business.


Connotations are still regularly made between IFAs, solictors and accountants: sectors fairly commoditised [accepted knowledge + time + reputation of firm]. In terms of 'fee based' structures what is the IFA's 'commodity' to charge fees, post-2012?

Consider:


1) Customer A goes to a solicitor for legal advice or to enact legal proceedings - the knowledge applied results in a higher likelihood of success vs. a layman with no knowledge of the law. The likelihood of success is not 100%; since law is a mixture of rules, interpretation or the facts may prohibit success, but the mechanisms of law are fairly certain and so you are confident that you are paying a fee for a reliable level of skill. There is a commodity of known information that incentivises the payment of a fee.


2) Customer B goes to an accountant for tax advice and to put accounts in order ahead of the year-end tax review. Again tax is a prescriptive set of rules, without knowledge of which, the risk of completing the tax return incorrectly or failing to pay the right taxes or take advantage of tax offsets is considered high. Again the commodity of known information is critical to the investor's incentive to avoid undue taxes in exchange for a fee.


3) Customer C goes to a financial advisor or directly to an investment provider -they pay either for an upfront and/or reocurring fee in exchange for best advice, financial planning and/or superior investment strategy. Some may find themselves pay for an online questionnaire or other automated advice tool. The problem is that there is less 'known information' E.g. the likelihood of the adviser guessing a better strategy is largely unpreditable and more and more advisers delegate the investment expertise away.


True - common to all all 3 examples is the lack of absolute g'tees of outcome but investment advice has a wider window of error, covering a longer time-span, there is less known information.


Personally I'm a believer of performance-linked fees, which will alas likely become harder under RDR (since the FSA is devolving product performance from advice; and also killing-off discounts and trail kick-back from the platform/investment providers to the adviser).


Charging fixed fees then needs to be hinged on some sort of specialism: E.g. investment acumen, tax expertise, legacy planning etc. If the incentive to buy is a specialist skill then qualifications are one of the few forms of evidence (the other is word of mouth). If the specialism is an area that is already covered by a recognised profession then the IFA will find it difficult to price above or even par. Investment acumen involves too little margin, too many competitors with more perceived skill. IFAs have never grouped like ARC or APCIMS to validate their past-performance.
So why didn't polarisation work and why is RDR nothing less than a completely new economic model for the IFA? No easy answers but to name a few: a) media - too many IFA customers lost too much money too often b) mis-selling scandals c) political-regulatory reform ala FSMA 2000, d) the devalaution of 'KYC' from low cost alternatives, DAMs and wealth managers, e) the Internet and maybe most suprisingly f) platforms which IFAs helped introduce c.2000!

'So instead of IFAs asking what minimum qualifications they should sit in reaction to RDR - perhaps IFAs should think what commodity they intend to sell, at what level, and what skill customers will expect in exchange for that fee..'

Checklists, hedge funds and human behaviour (Nick Gogerty)

Nick Gogerty posted up an interesting note on the use of 'checklists'.. applicable to choosing active funds, passive etc..

http://nickgogerty.typepad.com/designing_better_futures/2010/01/checklists-hedge-funds-and-human-behaviour.html

"As a hedge fund guy and anthropologist, I am fascinated. Checklist dynamics applied correctly could be a hugely important innovation in group dynamics and increasing human potential. As a tool for facilitating group activity they appear to be incredibly effective. Read the book to understand how they work. It involves, group dynamics, social interactions, reducing cognitive load and a host of other things." Nick Gogerty, Fertilemind Capital

It's more developed than my simple logic grid approach; while sharing a similiar ethos, and worth thinking about. Of use to us guys is a re-think on how to diversify a portfolio at outset.

Equity Gold, Energy and Real Estate

Evening fellow sceptics!

Not sure about you guys but Gold is such a bleeding puzzle isn't it - increasingly expensive so you think 'short' but no, it just keeps running and then you fall for the trap and think 'okay maybe I need to swim with the tide a little' and then bam.. prices slide.. Thankfully I lost no more than a few hundred as I did have a short in place but I also got stung on a leveraged Silver ETF that I was using as a spread and geared play of Gold (trying to be too bloody clever more like).. and it serves as a useful reminder to stick to my rules, KISS and buy contrarian..

I've posted up the month on month sales flows into Equity Gold, Energy and RE funds since Jan 2002 until Nov 2009. It's debatable if any discernable pattern is present (perhaps therein is the point.. black swans, black swans..) I've left the 'short' (ETF) in place and bought into RE funds quite early and happy to see how they play out.

Rather than use a dual axis chart; I've deliberately narrowed the axis range to ignore the v.large variances above and below so to focus in on the variances. Let's agree to say that any single monthly flows in excess of >$1.5bn was 'large'..

What I can't get my head round are the macro drivers at play for these 3 sectors.. in the meantime I have regrouped the assets and hived off about 10k to make a new play in my SIPP.. the question now 'is what?'

Complexing Returns - the Absolute Truth!!

My friend John and I recently chatted over the pros and cons of 'Absolute Return' funds, which have gained popularity through 2008-2009 and look set to re-define the Defined Contribution pension market away from Equities; (just as in the 2000s pension schemes moved away from Bonds to Equities). John raised a valid dilemma:

"certainly a lot of noise around about absolute return as a DC solution at the moment. Personally, I'm a bit wary of using absolute return as a default fund for group pension scheme members as the nature of the fund would have to be explained because there is no guaranteed return. This would require explanation that the manager is buying derivatives with their money with the broad aim of achieving XYZ. For most scheme members, this would be too complicated."

Simply put - Absolute Returns ('Abs Return') funds set out to return a positive level of growth through all market periods; usually benchmarked against a level of return over a broad cash rate (E.g. London InterBank Offer Rate 'LIBOR': the rate banks used to lend each other money). However to achieve this objective requires a means to achieve risk-free returns in excess of the risk-free rate ('Rf'). The notion that you can't have your cake and eat it holds true and the manager in reality has to buy risk in de-correlated asset classes, carefully blend and offset together to achieve a level of risk that is similar to cash but with better performance - of course this is entirely synthetic and an Absolute Return portfolio contains a number of risks not present in deposits, short-term paper nor indeed Guaranteed funds!!

Hard to track and getting harder by the minute. The manager has to use what we call the 'opportunity set': a broader range of asset types including leveraged loans, derivatives, swaps, asset backed securities 'ABS', mortgage backed securities 'MBS', subordinated debt etc at the sharper end of the debt market. In those markets you also have dark liquidity pools (unquoted markets) and plenty of OTC (over-the-counter contracts).. complex pricing, lots of default risk, dollar roll risk, currency risk, lots of liquidity risk.

Putting members aside for a second - for those who administer pensions I think confusion will be common to both DC and trust-based schemes - how many trustees will 'get' absolute return, let alone be in a position to set a statement of investment principles around them is hard to say. It places much more onus on ALM, good for the EBCs and consulting actuaries.. bad for costs, which at some level will need to be passed back into the employer or the employee. The pressure on scheme managers and trustees is set to rise as more and more 'governance' is introduced.

I helped bring an Abs Return fund to market in 2008; plus in the thick of it when the first batch of Abs Return funds imploded around the credit crunch and tried to get one rated with S&P at the same time. I recall it involved lots of time spent tracing volatilities/spreads in LIBOR v SONIA, 1yr v 3yr horizons.. lots of pitfalls from a TCF perspective also. The lead analyst for S&P was writing various scathing reports for the press - safe to say we put the rating idea on ice..

Coincidentally I also sat on EFAMA's EFCF working committee back then (on and off for about 5 yrs) and we debated and created some ground rules and definitions for 'Absolute Return'. Alas the FSA/IMA,NAPF,ABI are taking their time to adopt these sets of definitions, fist set down in 2007-08, which I think is leaving too much latitude in the sector. At that time the underlying investments were disparate and varied greatly - they still are with no common benchmark - very much a 'wild west' facilitated largely by UCITS3. It felt like the hedge fund days all over again but we'll see if the market is tightened with UCITS4..

The only common denominator being LIBOR or EONIA avg. targets +30bps, +50bps and so on.. However the Dutch NL-AFM 'GUISE' model is probably the most developed in terms of identifying risks in these and other funds. Interestingly the Dutch system scores anything but G'teed as 'High Risk'..

The alternative is structured products - G'teed/Protected funds or bonds. These of course pass the risk onto a counter-party or reinsurer and there were problems in 2008 via counter-party defaults, as assets were marked-to-market. Target maturity funds are useful as they are 1) simpler than Absolute Return and 2) can be used in a maturity ladder against employee expected retiral dates. The irony is that Abs Return (aka portable alpha) strategies started in the occupational market in the early-mid 2000s and were then subsequently 'rebranded' into Abs Return (the flip side being 130/30, 1xo/xo funds).

What were once seen as fairly staid, low risk investments suddenly became sexy, repackaged and marketed in an entirely new way as a new asset class (a means to beat the 'system'). The misgiving was that few clients undergo an Asset-Liability review ('ALM') as would occur in a pension scheme - this is a real oversight since the way the fund is invested is blind of the goals and circumstances of the investor. This would be fine if the level of variance possible year on year was tightly controlled but that's not always the case, with enough flexibility in the investment objective to allow the manager a 'get-out' if the going gets tough and the investor not leg to stand on. Barmy!

What seems clear is that there is a very distinct mood change that feels similar to when DC schemes moved away from Gilts, then again Corp Bonds in favour of Equities. I'm keeping my eye on IPE.com, the occupational pension website, to track this shift across Europe. Much of this is going to be fuelled by employer DB schemes waving the white flags after the last market drawdown.

There are returns to be had in Absolute Return funds but they are far from absolute!