Financial Markets

Former students egg me on.

It has been that kind of week. Pierluigi writes from his job at Goldman UK, Cameron Izadi is promoted to VP at Wells Fargo, earlier Denise asks about a thesis project from Bocconi. And, I think where are you Bee Saykanya.  They ask about posts on the site, long have I been promising and not delivering!

A long bout of writer’s cramp makes me cheat. So I repost, relink around world poetry day, to someone’s “most memorable” lines ever written (thanks KNS).

Fintech continues to chip away…

Technology outsmarts the human investor,  MARCH 8, 2017 by: John Gapper

To grasp why Standard Life agreed to buy Aberdeen Asset Management for £3.8bn this week, it helps to recall an experiment at the Oregon Research Institute in the 1960s, that rated how good doctors were at making judgments compared with formulas they helped to design.  The models won, as Michael Lewis records in The Undoing Project, his book about the economics Nobel Prize-winning psychologist Daniel Kahneman and his late collaborator Amos Tversky. Not only did it cost less to use them to identify cancers and psychological disorders in patients than doctors, but they were more accurate. The Oregon study found that it was best to check the results of clinical tests with an algorithm once professionals had made the rules for diagnosis. In contrast to technology, humans got tired and distracted, and had off days. “Only rarely — if at all — will the [outcomes] favour the continued employment of a man over a model of a man,” concluded a pivotal research paper in 1970. That judgment hangs over the men and women of the investment management industry as well as the medical profession. So-called alpha — the inimitable talent of skilled human investors — is worth paying for, as is treatment by expert doctors. But formulas are perfectly good at doing the predictable stuff, and often better. It took time for technology to be able to match what people do in asset management but the era has arrived. It is evident at Aberdeen, which has suffered a £105bn net outflow of funds since 2013 as investors have turned away from human expertise, as well as its speciality of emerging markets. Aberdeen’s problem is common to many traditional asset managers and hedge funds since the 2008 crisis, and is prompting cost-saving mergers such as the Standard Life deal. As interest rates and investment returns have fallen, investors are less willing to pay for human interference. Too many active managers have charged a lot for little more than matching the returns investors receive from automated passive funds; on average, active managers lag indices such as the S&P 500 when fees and costs are accounted for. Money is steadily flowing into index and exchange traded funds, which Moody’s estimates may overtake active funds in the US by 2024. Much of this was foreseen. In 1961, when scientific and other professions were more male-dominated than today, two researchers concluded: “Men and computers could co-operate more efficiently . . . if a man could tell the computers how he wanted decisions made, and then let the computers make the decisions for him.” It is an uncannily accurate description of what is known as “smart beta” — the freedom to pick aspects of investment return, such as risk, growth and volatility, and replicate them in automated form through an exchange traded fund. Once instructed how to select from thousands of shares or bonds, algorithms can ensure that any fund has the right blend of attributes. Technology has made inroads into what money managers do. First came funds that matched indices so that an investor could achieve the same return as, for example, the FTSE 100 without having to buy all 100 securities and keep on updating them. Then came smart beta’s ability to reproduce professional investment styles equally precisely and more cheaply. “It just gets harder and harder and harder,” reflected one money manager this week. His is the predicament of other professionals — anything done by a person that follows a pattern and can be coded into a form that a computer understands will soon get squeezed. Technology also has the advantage identified in 1970: algorithms stay constantly alert. It does not imply the complete death — or automation — of the investment manager. A professional can still undertake original research on a company or a security that provides insight. As more of the market becomes automated, originality becomes rarer and more valuable: an idiosyncratic investor should achieve higher returns by standing out from the robotic crowd. Nor can algorithmic efficiency be wholly divorced from human intelligence, as the Oregon study showed — the point was that humans needed to set parameters for computers to follow. Many asset managers use analysts and researchers to build investment models that then trade securities automatically; others blend their active risk-taking with passive elements. This could be a low moment for human asset managers — not only do their fees look especially high in a low interest rate world but quantitative easing inflates asset prices and makes it harder to be distinctive. There are cyclical reasons for the hard times. But these difficulties demonstrate how automation eats into professions, not by taking away all the jobs in one day but by unbundling them — dividing them between tasks that only humans can perform and those of which an algorithm is quite capable. Then the boundary relentlessly shifts. The Oregon researchers showed clearly half a century ago what would happen, and now it has.

More on the Hound of Hounslow and Monte Paaschi

Navinder Singh Sarao, dubbed the Hound of Hounslow, is  in jail for the flash crash, had Aspergers and himself got scammed (here).  Shortly thereafter, there is another report by academics at Stanford arguing that he may not even have caused that crash (here). Once again, truth is stranger than fiction.

Some of the assets behind Monte Paaschi’s mountain of NPAs are acres of old Tuscan properties (here). Must be prohibitively expensive to maintain, buy one yet Linda?

Came across a youtube video (here) on how options trading in India is done.  Put together by for traders, the typos in the subtitling are frequent and hilarious!


The return of ABX?

On the heels of the “recap and release” of Fannie and Freddie, comes this story from Bloomberg on the continued revival of the mortgage backed securities market.  Indexes based on mortgages are being contemplated, but no,  not the subprime variety.  Since 2013, these are now called credit-risk transfer securities (LOL), they are pools of higher grade mortgages,  investors will be forced to bear losses if home-owners default on their loan payments. All without the implicit government guarantee as F and F are soon to be saved! Hallelujah!

Seriously though, nine years after the crisis, risk appetites are to be tested again. These CRTs are akin to the higher tranches of CDOs in some sense, but hopefully some lessons have been learnt.


The semi-annual KKR macro report

For those of us (you) currently concerned with global macro trends, KKR’s periodic report (click here), is a must read. I will read it slowly on the plane tomorrow, but FWIW, my quick take.

I agree with most of their secular trends– less regulation,  more fiscal than monetary stimulus, less trade and more domestic. These are fairly obvious themes, but the process by which they arrive at these conclusions is what students should pay attention to. Of equal interest should be how they translate this global macro analysis into short and long investment recommendations and you should admire the boldness with which they make them (Note to the PGP networth folks who sent me something recently- this is what some of you could aspire to!)

I particularly liked their discussion of credit markets, and their pronouncements on the interplay between emerging market currencies, credit and the “bumpier” bottoming process in those regions. There is much for readers from emerging markets where I now reside. I was a bit surprised at their bullishness on the US dollar, but who am I to argue with a 40-year veteran firm in the private equity space with tens of billions of dollars to invest globally.

It is long, thorough and, as usual quite well done. Thanks Tim.

Not Yet Finance: The Post’s annual neologisms

Once again, The Washington Post has published the winning submissions to its yearly contest, in which readers are asked to supply alternative meanings for common words. The winners are:

1. Coffee (N.), the person upon whom one coughs.

2. Flabbergasted (adj.), appalled over how much weight you have gained.

3. Abdicate (V.), to give up all hope of ever having a flat stomach.

4. Esplanade (V.), to attempt an explanation while drunk.

5. Willy-nilly (Adj.), impotent.

6. Negligent (Adj.), describes a condition in which you absentmindedly answer the door in your nightgown.

7. Lymph (V.), to walk with a lisp.

8. Gargoyle (N.), olive-flavored mouthwash.

9. Flatulence (N.) emergency vehicle that picks you up after you are run over by a steamroller.

10. Balderdash (N.), a rapidly receding hairline.

11. Testicle (N.), a humorous question on an exam.

12. Rectitude (N.), the formal, dignified bearing adopted by proctologists.

13. Pokemon (N), a Rastafarian proctologist.

14. Oyster (N.), a person who sprinkles his conversation with Yiddishisms.

15. Frisbeetarianism (N.), (back by popular demand): The belief that, when you die, your Soul flies up onto the roof and gets stuck there.

16. Circumvent (N.), an opening in the front of boxer shorts worn by Jewish men.

Thanks Christa!