Tuesday 5 June 2012

Fund Manager Notes from Montreux 2012

A link to my notes from the Citywire Montreux event in May 2012.

Fund Hunting in Switzerland?

Intro:

During 9th – 11th May I had the pleasure of being invited again by Citywire to its fund selector conference at the Fairmont Palace in Montreux, Switzerland. During the next 3 days, overlooking Lake Geneva, I would interview 12 fund managers. I can now share my notes from the event.

As a fund analyst for over 12 years; and a CISI senior reviewer for the last few, I was proud to attend the event as a CISI delegate. This had various benefits 1) I could speak more candidly than would be possible for my current employer (one of the UK’s largest banks) 2) I could promote awareness of the CISI to a largely alien audience and 3) I could collate my notes and share them with fellow CISI members, many of whom also net fund buyers and asset allocators here in the UK and overseas.

The event itself brought together around 120 such fund selectors, gate-keepers and analysts from across Europe. Between them nearly half a trillion Euros in assets under management, a broad collegiate from private banks, wealth firms, fund of funds, retail banks, family offices and so on. The event was broken up over 3 days with main sessions discussing the woes and wherefores of the global market (‘the big picture’). Unsurprisingly the atmosphere was somewhat dominated by opening proceedings around the Europe courtesy of Dr Andrew Lilico  of the Telegraph but also a positive note around Russia; courtesy of Liam Halligan of FT and Telegraph fame, and the ‘TIDES’ of change by Dr Graeme Codrington. All of these sessions proved very well presented and insightful but, for a fund analyst at least, merely intervals to the main job at hand: interviewing fund managers. I pick up my delegate pack and pass (quickly scribbling ‘JB’ above Jon Beckett).  Click the link to read what I found. JB


Monday 14 May 2012

Hair of the Dog?

Debt drunk? Here lies the EU, drunk in the gutter.. Again.. Smelling of gin and wee. BUT How to sober up? I think the inevitable is that BRIC will overtake West, N-11 countries to come on par with Europe over 5y. Then some real rebalancing in competitiveness over 10y. There's the US Silicon Valley lesson, to have a healthy balance of trade and stable consumer trends. BUT instead Govts try to make the old model work, kick the bottle in brown paper down the road by increasing debt more, devaluing currencies, high inflation, property boom. It's not a solution, more the hair of the dog..

Sunday 16 October 2011

An honest account.. thank goodness no Black Swans..!!

Thank goodness the mainstream UK punter has yet to cotton (like the Mandlebrot ref there) onto Taleb lest they be screaming 'Black Swans' .. 'Black Swans' 24/7...


Does the power of herding have the power to move markets? An honest account of a simple fund analyst, left with unanswered questions in the wake of 2008.

Herding: Does money drives markets; drive money?
Back in 2007 I was a fund analyst for a large global investment house charged to try and make sense of fund markets when the credit market ‘crunched’. By the start of 2009 I was on garden leave; reeling from the simple fact that my company had lost 40% of its assets and 70% of its new sales in a very short space of time.

At the time I was trained to believe that markets and economics should run efficiently; the emphasis being on SHOULD. Many believed that investor patterns were wholly entropic (both random and unpredictable) and perhaps that is still partly true but what if they are also sociological, groups of investors following  similar influences from one asset class to another?
Beyond physical events; investment risk is popularly regarded as man-made. If true then it is likely to stem from: Psychology (irrationality and market abuse), Sociology (politics and media) and Technology (access and speed).

Market Cycles: The Absurdity of the Traditional Model.
Behavioural finance scholars have long highlighted a simple fact:  that the fear of being wrong; and losing capital, is stronger than the ambition of beating the market. Meanwhile textbooks drive home the sanctity of an investor’s ‘utility’ (their appetite for risk). However investor actions in the market attest to group-think, where investors overestimate or underestimate their own attitude to risk. When that happens then they stop acting as individuals and they begin to herd.

Markets (and investors) remain obsessed about whether they are in a rising or falling market. These markets became widely known as 'bull' and 'bear' cycles and as high a motivator of investor behaviour as you will find anywhere. Traditionally if this concept holds then we should expect distinct bull and bear markets, they are familiar terms, straightforward and cast the 'bear' as the villain profit-taker and the bull as the hero profit maker. However what if I told you that there is never a clear bull or bear consensus; rather one huge tug-o-war between pundits, prophets and politicians? Investors are subjected to influence to herd towards one argument or the other; it is self-fulfilling that herding then creates the outcome.

Group Think: Are Investors Victims of their own Irrationality?
Market commentators often depict investors as hapless market passengers and many investors will concur. However individualism and herding is shortening the market cycle as investors put greater focus on short-term information over their long-term asset allocation. By doing so they compromise the very allocation designed to meet their needs. Group think is not solely confined to investments of course; it is the queue of traffic in the outside lane of a motorway when the inside lane flows freely; it was the bank run on Northern Rock. Here my interest in group think lies in fund flow herding.


2008-2010: Bond or Bust?
By building samples of fund sales flows I began to chart how investors reacted to different situations, the effect on their attitude to risk and how those patterns changed. Unsurprisingly I will mention the unprecedented drop in confidence through 2008; and the somewhat premature rebound through 2009. Interestingly that recovery in buying patterns by January 2009 pre-dated the market recovery by about 3 months. Buying confidence again fell in October 2009 as the risk of a ‘double-dip’ appeared about 'evens ' with the likelihood of sentiment picking back up.

A key factor during the credit crunch was investors re-pricing the risk in bond markets and its exposure across other asset classes. We called it ‘contagion’ and it displayed viral-like qualities. However sentiment towards bonds had been declining as far back as 2005.

2010-2011: Absolute Uncertainty!
Through 2009-2011 inflows into new absolute return and strategic bond funds grew dramatically. At the same time; despite poor economic outlooks, traditional ‘flight’ sectors such as UK Gilts remained relatively flat. It is now clearer to me that [rightly or wrongly] absolute return and strategic bond funds had become the new ‘uncertainty’ safe havens.

As far back as May 2011 Morningstar flagged a ‘silent crash’ among US fund investors; soon after other agencies were flagging similar dissent across European markets. Outflows and mass retreat into defensive assets appear to have predated the market crash in August-September. The reason may be simple, if every fund manager had to redeem £1 for every £3 invested then their position quickly becomes stretched. At some point the manager may feel compelled to rebalance risk or to liquidate to cover redemptions. Neither outcome promotes a rising index.
If you cross-reference sentiment indicators such as John Gilbert (JGFR) then it’s clear that investors never actually regained confidence; merely they found new ways to invest their growing anxiety.

Conclusions for the Future.

Despite the persistent inflows; into mixed asset funds through 2009-2011, I cannot see an end to growing individualism among fund buying. If we look at the month-on-month changes in fund flow patterns and risk aversion (‘deltas’) then we can that the magnitude of herding has grown steadily and the swing from positive to negative sentiment has quickened.
Why? My reasoning is simple in that fund investing; and the technology surrounding it, is becoming more accessible and faster. Absolute return and life-styling products slowed this trend in 2010 but the risk of disillusioned investors hangs over these sectors. At the time of writing, rising UK inflation may form a key risk for such strategies.

Long-term; as the traditional fabric of company pensions and advisory process fragments, then even greater levels of media influence and herding lie ahead. The current market is ill-equipped for such irrationality, from literally millions of investors, which puts further pressure on already creaky asset allocation models anchored on historical market returns.


Saturday 6 August 2011

S&P downgrade of US Govt credit rating.. A question of ethics?!

Although I do worry on the downstream effects of the US downgrade itself..

A debtor that hasn't defaulted is not the same as one with no default risk.

We look at the US balances and question if paying debt with another debt is sound practice. The reality is that we have treated US debt as one big blank check and that has capitalised debt down the US food chain into GSEs, Muni etc. It it marks the divide between US and the rest of the world: the level of arrogance, patriotism and naivety of the US never cease to astound!

Also I saw no intervention re S&P ratings at the tme in a Market well reported as early as 2006. As part analysts, part auditors, part media they were victims like many of us. We cannot now disparage their conservatism after having criticised their earlier liberalism. Alas I think politics will come to bare but this remains a point of independence and S&Ps status as a credible global agency not a US puppet!

On the eve of an election year, Capital hill has played political games with the global economy

Sunday 21 November 2010

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

Wednesday 22 September 2010

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..

Wednesday 14 July 2010

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
Quote of the day: "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." Albert Einstein (attributed)

Investment U


Delta changes in risk aversion (Nov09)

Sentiment: The 'Lag' Effect

Sentiment: The 'Lag' Effect
Investor perception of risk is rarely up to date

Global Consciousness Project (GCP) 'Dot'

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. http://gcp.djbradanderson.com/ BLUE DOT: Significantly small network variance. Suggestive of deeply shared, internally motivated group focus. The index is above 95% BLUE-GREEN DOT: Small network variance. Probably chance fluctuation. The index is between 90% and 95% GREEN DOT: Normally random network variance. This is average or expected behavior. The index is between 40% and 90% YELLOW DOT: Slightly increased network variance. Probably chance fluctuation. The index is between 10% and 40% AMBER DOT: Strongly increased network variance. May be chance fluctuation, with the index between 5% and 10% RED DOT: Significantly large network variance. Suggests broadly shared coherence of thought and emotion. The index is less than 5% The probability time window is one hour. For a more information on the algorithm you can read about it on the GCP Basic Science page

Choosing Mutual Funds..

Choosing a Mutual Fund – CLUE “it is not about past performance.." You could try - Logic Scoring! The trick is to create your own metrics and populate them into your own grid.. Always remember to test your assumptions v outcomes: your model may be right but you may find what you thought to be a SELL is actually a BUY. Always look at the problem in the mirror! You can also read this in conjunction with my guide on Value at Risk and other Key Risk Indicators below. http://tinyurl.com/ydvf3zh

Bull versus Bear Investing; versus Herding

The lifecycle (or holding period) of an investment held by a particular investor, often categorised as short, medium or long-term.

Let's get normal volatility out of the way first.. VaR-based toolkit.

Ok - a starting point - let's get normal volatility out of the way first.. This pack was written around end Q308 - post 16/8 but before the massive movement of Oct-Nov08. For those who support brownian motion or the geometric movement of returns then, I'm afraid to say, it's going to end bad..

What is the fuss with volatility.....

Re the movement of market returns - many believe they follow a geometric or exponential Brownian motion ('GBM') which is a continuous-time stochastic process in which the logarithm of the randomly varying quantity follows a Brownian motion, also called a Wiener process. It is used particularly in the field of option pricing because a quantity that follows a GBM may take any positive value, and only the fractional changes of the random variate are significant ('deltas').

http://en.wikipedia.org/wiki/Geometric_Brownian_motion


So in practice 'brownian motion' assumes a strong tendency to trend - it says that returns won't jump from day 1 to day 2 but move up and down in fairly predictable increments.. the returns of the previous days have an impact on the subsequent day - they are not unique. This estimation of how prices move is the underlying principal for the future pricing of derivatives contracts such as options.. i.e. E.g. to buy a contract, at one price, to buy or sell the underlying asset at a future date at a future price... this is usually referred to as the 'Black-Scholes formula' or the much much earlier Bronzin model (1908). This ties up with the old-age 'law of big numbers' (or law of averages) - where returns follow a pattern around a mean and that the volatility around that mean diminishes over time.. Where those returns are then assumed to form a normal distribution (or bell curve) then the 'GBM' is symmetrical to the mean of those returns. BUT what if we do not believe upside and downside returns will be similiar?.
A LOT of analysis has been run since to dispel this view such as many variations of the the Noble winner Robert Engle's ARCH approach in 2003 ('heteroskedasticity'.. or the analysis of different dispersions/volatilities), countless variations thereof, stochastic models (see below*), extreme loss analysis, stress testing, scenario analysis and so on - it keeps the Math boys busy shall we say...

*Stochastic models: treat the underlying security's volatility as a random process, governed by variables such as the price level of the underlying, the tendency of volatility to revert to some long-run mean value, and the variance of the volatility process itself, among others. Somtimes I use Markov chain as the easiest way to visualise and understand a random process: usually it's illustrated by the cat and the mouse:

Suppose you have a timer and a row of five adjacent boxes, with a cat in the first box and a mouse in the fifth one at time zero. The cat and the mouse both jump to a random adjacent box when the timer advances. E.g. if the cat is in the second box and the mouse in the fourth one, the probability is one fourth that the cat will be in the first box and the mouse in the fifth after the timer advances. When the timer advances again, the probability is one that the cat is in box two and the mouse in box four. The cat eats the mouse if both end up in the same box, at which time the game ends. The random variable K gives the number of time steps the mouse stays in the game..

This Markov chain then has 5 states:

State 1: cat in the first box, mouse in the third box: (1, 3)
State 2: cat in the first box, mouse in the fifth box: (1, 5)
State 3: cat in the second box, mouse in the fourth box: (2, 4)
State 4: cat in the third box, mouse in the fifth box: (3, 5)
State 5: the cat ate the mouse and the game ended: F.

To show this for a fairly infinite number of price movements is somewhat less achievable but nonetheless that's what the clever bods have done..

Otherwise most of probability, I admit, is above my head unless it descends into some sort of practical application - BUT I get the sub-plot.. stop trying to predict future patterns from regressing past performance... show me the track record of a model (after it has been created) and I'll be one step closer to being converted.. I'll touch on stress testing, extreme analysis ('extremistan') and scenarios another day..

"The Black–Scholes model disagrees with reality in a number of ways, some significant. It is widely employed as a useful approximation, but proper application requires understanding its limitations -blindly following the model exposes the user to unexpected risk. In short, while in the Black–Scholes model one can perfectly hedge options by simply Delta hedging, in practice there are many other sources of risk." Wikpedia

http://en.wikipedia.org/wiki/Black%E2%80%93Scholes





Active-Passive Investing Debate

Performance Patterns: **This deck is based on some work-based research so apologies for the confusing arguments - as a consequence the 'story' in the slides is a little muddy so I will re-jig this in the New Year to make my points clearer.** Passive-active purchase drivers in the UK are less differentiated/defined than perhaps elsewhere; the basic rules apply: What I did find was that there were interesting herding flows preceding, into and of the credit crunch. These were large asset-class movements: something which active managers would have little control of unless they ran absolute return type startegies. What my analysis showed is that an investor could manage a passive portfolio tactically to take advantage of large herding patterns. This involves risk, access to the right data, practice and above all discipline but I hope it will be a journey we can share!!

Lessons for 2010 - REIT Funds

Noting the events around 2005-2008 make for interesting considerations when thinking about buying REIT Funds in 2010..

The UK Investor - The Surprise Factor

The maps in the presentation (below) really help illustrate the suprise factor of the credit crunch.. little of the previous patterns would prepare the UK investor for what was about to come. The flows show that investors did not recognise the risks inherent in 2006-2008. This is because the industry uses conventional fund metrics, which were at best outputs not guides..!

The UK Investor - IMA 'Map' 2002-2008

Jon Beckett, ASCI - Past Projects (2003-2008)

I have been involved in the IFA and investment market since 1998, covering a broad range of roles. I have engaged a number of industry bodies over the years, to be a voice for change, to reform our industry and make it trusted and respected. None of the projects shown should be related to Franklin Templeton either: explicit, inferred or otherwise. I attach some of my past projects from 2004-2008.. Rgds JB