Interesting angle on the story that we seem to be seeing every day: Shock! Horror! God-like hedge fund managers can't beat the market every single month. Not a problem that Bernie Madoff had...in fact I'd love to see the likes of Paulson dismissing their clients' concerns by explaining that you have to lose money every once in a while to prove that you're not a fraudster. Maybe Steve Cohen should make sure that he has a bad year to get the SEC off his back.
Anyway, AR suggest that Paulson et al. maybe be losing money because they're running too much of it. Yes, the performance of some managers may benefit from the tailwind of asset growth, which can reverse, BUT if Paulson had the ability to forecast the strength AND TIMING of any recovery, there are enough liquid markets out there to turn this prediction into cash. A small cap stock manager faces very obvious capacity constraints. But if I think growth will beat expectations, I can trade some serious size in bonds, FX, commodities and large cap stocks.
The questions you have to ask of Paulson should be based on these facts (I probably shouldn't use the word facts as I'm using my second-hand knowledge of the situation, but I'm a blogger so deal with it):
1) The bulk of Paulson's track record is in event-driven investing, focusing on stock-specific situations
2) He grasped someone else's idea (what?! Johnn Paulson did not invent the concept of shorting subprime securities?!) and raised a lot of money to bet on one of those rare things: a situation where potential losses are limited but potential gains are huge. The skills it takes to go short subprime securities (or make money from event-driven investing) are not the same as those required to accurately predict the strength of an economic recovery. Whatever kind of due-diligence anyone claims to have performed, what they have actually done is said "Paulson is so smart, I will just give him some money and I will get rich."
The situation regarding investors who have stayed within their area of expertise, i.e. stockpicking for people like Bill Miller or Bruce Berkowitz is different. But as someone called Denis Bastin says in the FT, “You cannot seek out short-term performance and expect good long-term returns.” Earlier in my career, a very, very smart investor told me that in this business, you have to deal with the fact that being good may mean you are only right 51% of the time. There do seem to be some traders who can beat the market year in, year out. But most of the great investors have had periods or underperformance.
I will end now with something that is a complete waste of time and will have not effect on the vast majority of investors: some common sense.
In order for a manager to beat the market, they have to risk underperforming. If you give someone else your money to invest, only their skill, approach, hard work and access to information will determine their success. If this changes, fire them. If this doesn't change and they underperform there are only two possible outcomes: you have confidence in them and recognise that their approach will work in the long run; you are not confident that they have the potential to beat the market in the long term so you made a mistake in selecting them and you should fire yourself because you are bad at selecting managers.
Wednesday 31 August 2011
Thursday 17 June 2010
P/Eing into the wind
During the market rally post-March '09, I remember seeing a hedge fund manager being interviewed on Bloomberg TV (don't worry, I don't make any actual decisions based of financial TV, but it's great for making you feel like things are really happening every day). He was talking up his book and the fact that he was short the S&P until it hit 600 because throughout history great bear markets had bottomed when the P/E ratio had hit 5.
Now, this chap may have: stuck to his guns and spunked a great deal of his clients' money, but no doubt continues to be trusted to do his job because as we all know, if you're right you're skilled and if you're wrong you're unlucky or; hopefully realised what a complete and utter cretin he was and closed his position and quit the markets forever.
Why on earth would anyone, who I assume has some basic understanding of markets, make such a dumb, dumb, DUMB bet? And before you ask, of course I was long....
There are two big problems here. The first is to do with causality.
Do you think that some kind of irresistible magnet drags markets down until P/E hits 5? Do you really think that it is that easy to make money from the market? A brick wall will stop my car every time I drive into it but thankfully it is not inevitable that the wall will attract my car every time I drive past.
The second is more common and more inexcusable. It is a basic finance issue that nobody seems to pay any attention to. I apologise for shouting but P/E IS A FUNCTION OF INTEREST RATES!
The required return on equities is the risk-free rate plus a risk premium. As interest rates fall, the required return falls and P/E rises. Now let's see if you can piece this complicated puzzle together: interest rates are at record lows....lower interest rates mean higher P/Es....so....maybe P/Es now are likely to be higher than in the past? Well done, you are smarter than a hedge fund manager. But poorer.
I can't remember who said "investing is simple but difficult", but it is. Buy cheap companies and sell them when they're not cheap. The difficult part is explaining to your clients/wife/self why they sometimes get cheaper and cheaper and cheaper (BP was cheap at £4.50 and £4, wasn't it?)
Trading, especially with leverage, is not simple or easy because "the market can stay rational longer than you can stay solvent" (that one was Keynes). In the short and even medium term, markets can do pretty much anything and you HAVE to take account of sentiment, liquidity and a million other variables. So when you see someone tell you that the market is going to go to X price at Y time due to some basic indicator throw whatever comes to hand at the television. And if they manage your money, fire them!
Now, this chap may have: stuck to his guns and spunked a great deal of his clients' money, but no doubt continues to be trusted to do his job because as we all know, if you're right you're skilled and if you're wrong you're unlucky or; hopefully realised what a complete and utter cretin he was and closed his position and quit the markets forever.
Why on earth would anyone, who I assume has some basic understanding of markets, make such a dumb, dumb, DUMB bet? And before you ask, of course I was long....
There are two big problems here. The first is to do with causality.
Do you think that some kind of irresistible magnet drags markets down until P/E hits 5? Do you really think that it is that easy to make money from the market? A brick wall will stop my car every time I drive into it but thankfully it is not inevitable that the wall will attract my car every time I drive past.
The second is more common and more inexcusable. It is a basic finance issue that nobody seems to pay any attention to. I apologise for shouting but P/E IS A FUNCTION OF INTEREST RATES!
The required return on equities is the risk-free rate plus a risk premium. As interest rates fall, the required return falls and P/E rises. Now let's see if you can piece this complicated puzzle together: interest rates are at record lows....lower interest rates mean higher P/Es....so....maybe P/Es now are likely to be higher than in the past? Well done, you are smarter than a hedge fund manager. But poorer.
I can't remember who said "investing is simple but difficult", but it is. Buy cheap companies and sell them when they're not cheap. The difficult part is explaining to your clients/wife/self why they sometimes get cheaper and cheaper and cheaper (BP was cheap at £4.50 and £4, wasn't it?)
Trading, especially with leverage, is not simple or easy because "the market can stay rational longer than you can stay solvent" (that one was Keynes). In the short and even medium term, markets can do pretty much anything and you HAVE to take account of sentiment, liquidity and a million other variables. So when you see someone tell you that the market is going to go to X price at Y time due to some basic indicator throw whatever comes to hand at the television. And if they manage your money, fire them!
Monday 14 June 2010
The 'D' Word
As we all know, derivatives were put on the earth by the Devil to tempt degenerate gamblers into creating financial armageddon. That's why it looks likely that US banks will be forced to spin off their swaps desks to seperate all that evil from good, honest lending to people who can't afford it and then creating.....financial armageddon. Then all those nasty credit derivatives can rot in hell with prop trading and short-selling hedge fund bastards and all the other stuff that didn't actually cause the financial crisis.
But wait, you say - AIG stuck a grenade up it's own backside by writing CDSs and that cost some serious $$$$$. The interconnectedness between financial institutions caused by them being counterparties to each other's OTC derivatives trades played a large part in causing the credit crunch. Right?
Now, it's funny you mention AIG, because they're an insurance company, and CDSs are basically...yes, you guessed it, insurance. What AIG and a lot of financial companies did was the equivalent of saying "There has never been a non-white President of the United States, so an African American winning the election is impossible. I will bet everyone in the world a hundred billion dollars that there will never be a black President.....what? Barrack Obama you say? He won and now everyone in the World wants more money than actually exists in the World? Oh dear..."
CDSs weren't the problem - charging a low premium for insuring against risks that can't be modelled properly was the problem. If I try to get life insurance, there is plenty of data on how long people like me live - I may die tomorrow, I'll probably die when I'm about 85 and I won't live until 200. But insuring subprime mortagage bonds is different beacause: a) they have not been around for very long; and b) subprime mortgages became a larger and larger part or the mortgage market. This is the equivalent of offering life insurance to Adam and Eve, with Eve giving birth to a scientist that discovers a cure for cancer. CDSs were just a medium for taking big, leveraged bets. Like buying a house with no down payment.
To a simpleton, or politician, it still makes perfect sense to seperate this insurance business from the 'core' operations of banks. But interest rates are a bank's business - you don't need to be able to change a spark plug to effectively manage a car insurance book, but operating in the loan and fixed income markets certainly helps when working with CDSs. Unfortunately nobody is interested in that and it's set aside with any other rational view of the banking system. Let's not forget that everyone is pushing for Investment Banks' 'risky' activities to be split from the business of lending and taking deposits. But advising on M&A isn't risky. How many banks have suffered catastrophic losses from their capital markets businesses? Even prop trading, which everyone is talking about, has NEVER caused losses like those seen in the residential mortgages. Did Northern Rock have an investment banking division or write CDSs? Would Barclays have weathered the crisis better without Barclays Capital?
On the whole, investment banks use their strategic advantages to earn large fees and trading profits. All the nonsense about casino banking and prop trading and derivatives has distracted people from the fact that the riskiest thing a bank can do is lend a huge amount to one person with little of no collateral. Yes, the banks need to reduce leverage and risk, but so do borrowers. If people could not get a mortgage without a 25% deposit, we would not be in this mess. But apparently it is a God-given right for people to own homes they can't afford, even though tighter lending criteria would reduce the price of a home, and therefore make it more affordable. Would you rather pay £200k for your home with a 10%, £20k deposit or £80k for the same house with a 25%, £20k deposit? Your mortgage payments would drop enough to pay for the next 100 iPhone upgrades and all the oddly-named storage boxes in your nearest Ikea.
Nobody can get a mortgage right now without a 10% deposit. "First time buyers can't get on the ladder", the press howl, "the banks aren't lending". But this is the perfect time to really address the problems in the system. Increasing the minimum deposit amount to 11% and then gradually, perhaps by an extra 1% each year, will stop a huge shock to the market, but will also help prevent another bubble from inflating and take a huge amount of risk out of the banking system and the economy in the future. Unfortunately it will also snuff out the British dream of leveraging up, buying and selling houses until you finally achieve the promised land of a million pound house. Even though that million pound house is a 3 bed semi that you could get for half the price abroad.....
But wait, you say - AIG stuck a grenade up it's own backside by writing CDSs and that cost some serious $$$$$. The interconnectedness between financial institutions caused by them being counterparties to each other's OTC derivatives trades played a large part in causing the credit crunch. Right?
Now, it's funny you mention AIG, because they're an insurance company, and CDSs are basically...yes, you guessed it, insurance. What AIG and a lot of financial companies did was the equivalent of saying "There has never been a non-white President of the United States, so an African American winning the election is impossible. I will bet everyone in the world a hundred billion dollars that there will never be a black President.....what? Barrack Obama you say? He won and now everyone in the World wants more money than actually exists in the World? Oh dear..."
CDSs weren't the problem - charging a low premium for insuring against risks that can't be modelled properly was the problem. If I try to get life insurance, there is plenty of data on how long people like me live - I may die tomorrow, I'll probably die when I'm about 85 and I won't live until 200. But insuring subprime mortagage bonds is different beacause: a) they have not been around for very long; and b) subprime mortgages became a larger and larger part or the mortgage market. This is the equivalent of offering life insurance to Adam and Eve, with Eve giving birth to a scientist that discovers a cure for cancer. CDSs were just a medium for taking big, leveraged bets. Like buying a house with no down payment.
To a simpleton, or politician, it still makes perfect sense to seperate this insurance business from the 'core' operations of banks. But interest rates are a bank's business - you don't need to be able to change a spark plug to effectively manage a car insurance book, but operating in the loan and fixed income markets certainly helps when working with CDSs. Unfortunately nobody is interested in that and it's set aside with any other rational view of the banking system. Let's not forget that everyone is pushing for Investment Banks' 'risky' activities to be split from the business of lending and taking deposits. But advising on M&A isn't risky. How many banks have suffered catastrophic losses from their capital markets businesses? Even prop trading, which everyone is talking about, has NEVER caused losses like those seen in the residential mortgages. Did Northern Rock have an investment banking division or write CDSs? Would Barclays have weathered the crisis better without Barclays Capital?
On the whole, investment banks use their strategic advantages to earn large fees and trading profits. All the nonsense about casino banking and prop trading and derivatives has distracted people from the fact that the riskiest thing a bank can do is lend a huge amount to one person with little of no collateral. Yes, the banks need to reduce leverage and risk, but so do borrowers. If people could not get a mortgage without a 25% deposit, we would not be in this mess. But apparently it is a God-given right for people to own homes they can't afford, even though tighter lending criteria would reduce the price of a home, and therefore make it more affordable. Would you rather pay £200k for your home with a 10%, £20k deposit or £80k for the same house with a 25%, £20k deposit? Your mortgage payments would drop enough to pay for the next 100 iPhone upgrades and all the oddly-named storage boxes in your nearest Ikea.
Nobody can get a mortgage right now without a 10% deposit. "First time buyers can't get on the ladder", the press howl, "the banks aren't lending". But this is the perfect time to really address the problems in the system. Increasing the minimum deposit amount to 11% and then gradually, perhaps by an extra 1% each year, will stop a huge shock to the market, but will also help prevent another bubble from inflating and take a huge amount of risk out of the banking system and the economy in the future. Unfortunately it will also snuff out the British dream of leveraging up, buying and selling houses until you finally achieve the promised land of a million pound house. Even though that million pound house is a 3 bed semi that you could get for half the price abroad.....
Friday 11 June 2010
Take that!
Tremendous letter today from the RSA chairman to Barrack Obama, pointing out that we didn't sink to anti-US prejudice when the global economy was nuked by "polluted securities from the irresponsible, unchecked greed and avarice of leading US international banks". Not only does he make a good point, but it's also great to see a man who should be boring and restrained (the Chairman of an insurance company) wading in and taking public pot shots at the President of the United States. If Barrack wants BP, sorry British Petroleum, to pay the cost of cleaning up this mess, then surely the rest of the world can send a bill to a) the United States government for pressuring their banks into relaxing lending standards so that people on lower incomes could buy houses; b) the US ratings agencies for being complete and utter crooks; c) Goldman Sachs because it seems that everyone is fair game so lets nail these smug tw*ts.
John Napier, I salute you!
John Napier, I salute you!
Wednesday 9 June 2010
Sarah Palin for President...
Politics is the "art of the possible", and unfortunately what's possible is usually very inadequate. Take Barack Obama's unashamedely populist response to the BP oil leak with all its talk of "finding an ass to kick" and firing Tony Hayward. Somewhat unbelievably it took Sarah Palin to hint at the wider issues that may have contributed to the disaster. As some of you will have seen, Palin blames "extreme environmentalists" for the leak, arguing that by preventing onshore and shallow water drilling to protect the environment, the "extreme environmentalists" have forced the oil companies into the treacherous deep waters. A more balanced, less blame-focused view is here.
Now just as giving a monkey a typewriter and an infinite amount of time will get you the entire works of Shakespeare, a significant proportion of the World's 6 billion people being loud-mouthed bigots will result in one of them occassionally saying something that is at least partially close to being nearly worthwhile. The difficult truth is that the US needs oil and buys it by the million barrelload - they can boycott British Petroleum all they want, but who was the oil for? North Korea? A power station that Osama Bin Laden uses to recharge his camcorder?
So Sarah, well done for using an economic argument, although I suspect that the "extreme environmentalists" would argue that perhaps even offshore drilling wouldn't be necessary if a few of your countrymen discovered that you can use your feet for walking as well as pushing the gas pedal. I wonder if she'll take the argument to its logical conclusion and point out that countries like Mexico and Venezuela are shutting out the oil majors and letting their output decline so it's also their fault and the US should therefore invade them to ensure energy and Florida beach security. Then they can parachute in the knowledgeable oil firms like good ol' Halliburton, who obviously aren't responsible for the spill and coincidentally increased political contributions this week, and get the oil and dollars flowing.
But Mr Obama, this is all too complicated for a populist like you. You would have to tell people it was their fault and they might have to change the way they live. No, best to blame the foreigners and leave it at that.
Now just as giving a monkey a typewriter and an infinite amount of time will get you the entire works of Shakespeare, a significant proportion of the World's 6 billion people being loud-mouthed bigots will result in one of them occassionally saying something that is at least partially close to being nearly worthwhile. The difficult truth is that the US needs oil and buys it by the million barrelload - they can boycott British Petroleum all they want, but who was the oil for? North Korea? A power station that Osama Bin Laden uses to recharge his camcorder?
So Sarah, well done for using an economic argument, although I suspect that the "extreme environmentalists" would argue that perhaps even offshore drilling wouldn't be necessary if a few of your countrymen discovered that you can use your feet for walking as well as pushing the gas pedal. I wonder if she'll take the argument to its logical conclusion and point out that countries like Mexico and Venezuela are shutting out the oil majors and letting their output decline so it's also their fault and the US should therefore invade them to ensure energy and Florida beach security. Then they can parachute in the knowledgeable oil firms like good ol' Halliburton, who obviously aren't responsible for the spill and coincidentally increased political contributions this week, and get the oil and dollars flowing.
But Mr Obama, this is all too complicated for a populist like you. You would have to tell people it was their fault and they might have to change the way they live. No, best to blame the foreigners and leave it at that.
Monday 7 June 2010
It's gonna cost ya...
Like many of you, I made the foolish mistake of thinking that David Cameron was too wet behind the ears to be PM. Formative years at Eton and Oxford and then straight into politics, with no knowledge of the 'real' world. But our Dave clearly spent a year or two in the building trade.
Just like a builder, he gave a pre-election estimate of how much the deficit was going to cost us, but now we've hired him he's telling us that the last lot messed things up even more than he thought and he's going to have to up the bill.
Well done to everyone who voted in the election - the budget deficit dwarfs any other issue facing us and yet none of the parties told us where the cuts to tackle it would fall. Would you hire a builder who promised 'change' for your house but wouldn't commit to a price or tell you what he was actually going to do.....?
Just like a builder, he gave a pre-election estimate of how much the deficit was going to cost us, but now we've hired him he's telling us that the last lot messed things up even more than he thought and he's going to have to up the bill.
Well done to everyone who voted in the election - the budget deficit dwarfs any other issue facing us and yet none of the parties told us where the cuts to tackle it would fall. Would you hire a builder who promised 'change' for your house but wouldn't commit to a price or tell you what he was actually going to do.....?
Friday 4 June 2010
Groundhog Day
If you read financial blogs on a regular basis then you might feel like everyday is Groundhog day. Scroll down to the comments and you will see liberal use of "Wall Street", "Crooks", "Bankers", "Greed", blah, blah, blah. Why are these people so angry?
I borrow $/£500k from a "banker" because all my friends are doing it and house prices are soaring and maybe, just maybe I'll make $/£100k.
For no work whatsoever.
Lets call this scenario Lazy/Greedy/Casino Capitalism.
But wait. NO! HOUSE PRICES ARE GOING DOWN! I took a huge, huge risk and it didn't pay off.
Ah, ok the government will bail me out........No, they're bailing the bankers out. It was the bankers fault. The bankers fault! They took a huge, huge risk and it didn't pay off....
Let's call this scenario Greedy/Casino Capitalism (unfortunately we can't call it lazy as they work 14 hour days).
Ok, we have to stop this happening again. Let's stop people from buying a house without a 25% down payment. Let's stop people taking huge risks that they don't really understand. No, that will be unpopular. People want big houses. People want easy money. So...let's make a lot of noise about how we have to split up retail and investment banks (even though it was your plain vanilla mortgage lending retail banking that got us into this mess). Let's criticise the banks. And you know what, somebody sold me a kitchen knife last week and I cut myself! Let's start a campaign against him because he sold me something I could cut myself with!
Wow, this feels great. Something bad happened, and I guess you could say I should have thought about taking on an enormous debt and chopping onions with my eyes closed, but it wasn't my fault! The governement says so, the newspapers say so, everyone says so!
I borrow $/£500k from a "banker" because all my friends are doing it and house prices are soaring and maybe, just maybe I'll make $/£100k.
For no work whatsoever.
Lets call this scenario Lazy/Greedy/Casino Capitalism.
But wait. NO! HOUSE PRICES ARE GOING DOWN! I took a huge, huge risk and it didn't pay off.
Ah, ok the government will bail me out........No, they're bailing the bankers out. It was the bankers fault. The bankers fault! They took a huge, huge risk and it didn't pay off....
Let's call this scenario Greedy/Casino Capitalism (unfortunately we can't call it lazy as they work 14 hour days).
Ok, we have to stop this happening again. Let's stop people from buying a house without a 25% down payment. Let's stop people taking huge risks that they don't really understand. No, that will be unpopular. People want big houses. People want easy money. So...let's make a lot of noise about how we have to split up retail and investment banks (even though it was your plain vanilla mortgage lending retail banking that got us into this mess). Let's criticise the banks. And you know what, somebody sold me a kitchen knife last week and I cut myself! Let's start a campaign against him because he sold me something I could cut myself with!
Wow, this feels great. Something bad happened, and I guess you could say I should have thought about taking on an enormous debt and chopping onions with my eyes closed, but it wasn't my fault! The governement says so, the newspapers say so, everyone says so!
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