Analyse this – who really knows?

There was a song some years ago by the Kursaal Flyers (a name inspired by a Southend fairground) entitled “Little does she know” and the lyrics of the chorus go something like this:–

“She knows that I know that she knows that I know ………” It’s a sad story of betrayal, because what he knows is, “she’s two timin’ me”. It was very catchy and enjoyed great chart success and it got me thinking about the work of financial analysts, employed in the investment industry.

They are paid to analyse company results, economic trends, future cash flows, ratios, balance sheets, the effects of mergers and acquisitions, share prices, dividends, in fact you name it, if it’s financial and to do with business they’ll be analysing it. Many, many, thousands of them are employed worldwide and the decisions of investment managers are hugely influenced by them.

On a regular basis the findings of these analysts are fed through to fund managers to help them decide which companies to buy and which companies to sell. Now, we all know that for every buyer there must be a seller and for every seller there must be a buyer; so whilst the analysts of one firm are recommending Acme Widgets as a buy, there will often be another set of analysts recommending Acme Widgets as a sell. Wouldn’t you wonder, if you are a fund manager, why somebody is prepared to sell on the word of their highly qualified analyst, when your highly qualified analyst is recommending you buy. Wouldn’t you wonder if they know something your analyst doesn’t?

We shouldn’t confuse this process with the commercial process of buying goods and materials and selling them on; the commercial process seeks to add value at every stage, but what value can a fund manager add to a stock – none whatsoever is the answer.

So now the Kursaal Flyers might well ask, “Does he know that I know that he knows what I know?” – or some variation on that theme. I doubt very much whether fund managers hesitate for long, if at all, because, after all, they are not spending their own money; they are trading with their clients’ money in the happy knowledge that only the client can pay for all this buying and selling.

Who’s two timing whom?

Reasons to be cheerful……

“The birth of a baby is God’s opinion that life should go on”, is a quote from the American historian and poet, Carl Sandburg. I was reminded of it this weekend when reading of the birth a few days ago of Caius Walter, son of Mark and Hitomi Walter, in the Sunday Times of 1^st April 2012.

The article discusses the baby’s future in light of the current instability and general doom and gloom that appears to surround us, quoting extensively from a new book, Megachange written by a number of specialists under the umbrella of the Economist magazine. And, do you know what, Caius and his parents can look forward to a better world!

Falling global fertility rates should mean a stable global population, with improving agricultural technology providing enough to feed everyone; a largely urban society with healthier and wealthier citizens living longer; falling levels of violent crime; a shrinking of the gap between rich and poor and far more educational opportunities worldwide.

We would be the first to acknowledge that predicting the future is fraught with danger and it is likely that the usual array of challenges will be thrown up, but given the ingenuity, resourcefulness and inventiveness of the human race we would line up with the general tone of the book. Coincidentally, Matt Ridley, author of The Rational Optimist a book which argues more or less the same future for us, has an article published on the Reader’s Digest website entitled, Cheer up! 17 reasons why it’s a great time to be alive Click here

His reason number 17 is “Optimists Are Right”. We agree and we think they’re happier as well; we are optimistic about Cai’s future, believe there are good reasons to believe the world’s glass is half full and believe that life should and will go on improving.

Top of the toxic pops, it’s our old friend the structured product.

The Financial Services Authority has drawn up a chart, for the benefit of consumers, called “Retail Conduct Risk Outlook”, which is, unfortunately, 96 pages long and available on their website Click here

In the spirit of Alan “Fluff” Freeman we will save you the task of ploughing through the 96 pages and give you a summary similar to the one Fluff rattled off just before he revealed this week’s number one on Top of the Pops. Sadly, there are no “movers”, new entries nor, indeed, a new number one, as the chart is full of the usual suspects all of whom fully deserve their place.

Top of the toxic pops is our old friend, The Structured Product; increasingly popular with banks and even some financial planners the FSA is increasingly concerned with how these products are sold to consumers. Promoted often with a “moneyback” guarantee and exposure to stock market returns they are complex, opaque and larded with charges and commissions. We have warned clients against these often before Click here and will continue to do so; it is nice to see that the FSA has caught up.

Hard on the heels of our number one are Absolute Return Funds; unbelievably another 61 of these undefinable beasts has appeared over the past two years. This despite the fact that the vast majority do not achieve their objective, each fund has a different “strategy”, often involving derivatives and many of them have a charging structure designed to enrich the provider rather than the client. More than half of these funds over the past 12 months have lost money – it is an absolute return all right but probably not what investors are expecting.

At number three we have Unregulated Products Or Unregulated Collective Investment Schemes. Promoting property in Eastern Europe or the Middle East or possibly the Caribbean some of these are out and out scams but all of them carry very heavy risk. They are usually totally unsuitable for private investors but unscrupulous advisors, heavily influenced by high commissions, are selling them to individuals anyway.

Lack of space denies us the opportunity to give you the entire list, but we can tell you that products from banks loom large. The common denominator appears to be complexity; if the product is difficult to analyse avoid it. If your adviser is pushing any of the above, avoid them.

Seen a black swan? So what?

Nassim Nicholas Taleb has written two popular books, “Fooled by Randomness” and “The Black Swan; The Impact of Highly Improbable Events”. This has made his reputation as an author, philosopher and all-round sage and, inevitably, gullible journalists have endowed him with the gift of second sight. Having read both books and, to some extent, enjoyed them, we believe the first is superior to the second.

One of the problems with The Black Swan is the tone in which it is written; you should imagine an irascible teacher from the 60s or early 70s, armed with a blackboard rubber, lecturing his class in a “keep up at the back”, hectoring, “why am I bothering with these idiots?” style. Indeed, his blog never hesitates to use the word “imbecile” when describing members of his audience. He is clearly angry about something and wants his readers to know that we are part of the problem. He has a trading background and this leads us to the second problem with the book and his ubiquity now as the Mystic Meg of the financial world.

The thrust of his argument is that classical economics does not explain events that he believes are cataclysmic, nor the fact that they are pretty common. He particularly focuses on stock markets and points out that there have been many cases where markets are moved fast and far in a very short period of time, usually one day; his theory is that these moves are so violent they are off the scale and should only occur once every thousand years, or even longer, if they are to be explained by normal distribution models.

As advisers who focus on the long-term we are not too impressed with this argument and feel that these “rare” events are part of the noise of the market; investors and professionals in the market do get spooked by these events, usually resulting in increased volatility. However, when we analyse market movements over the longer term they can usually be explained by classical economic models, leading us to believe that the appearance of black swans is all too fleeting. Michael Kitces, a well-respected North American commentator has come to the same conclusion and backs it up with some impressive research – click here to read his blog article

With a little help from our friends…

“When people ask me why I think the Beatles’ stuff has lasted, I’ve had to try to figure out my answer to that, and over the years I’ve realised. I now answer, “Structure”. They’re well structured, those songs – there is nothing that doesn’t need to be there. That sounds a bit immodest, but it’s a body of work now, so I can talk like that.”

Paul McCartney, Sunday Times, 29 January 2012

He certainly can talk like that, Sir Paul. As one half of possibly the finest songwriting duo of the last century he can probably say whatever he likes about songwriting and be right. You might well consider he is right about this aspect of their songwriting, “Structure”; many, many Beatles songs have been covered by huge numbers of other artists and I would suggest you will be hard pushed to name those who have improved the songs. Unlike Bob Dylan, any of whose songs are invariably improved, whoever sings them, as long as it isn’t him!

Structure is important in so many fields; without it ideas have no form and often make no sense. Structure suggests solid foundations and robust constructs, underpinned by logic and good sense; in the absence of structure we, as human beings, lack guidance and direction.

Great lyricism and musicality may seem a long way from the mundanities of financial portfolio construction, but it is the similarities, particularly of structure that guarantee longevity and quality in both fields. Apply great structure to your portfolio and you will be happy with it long beyond the point when you “… get older, losing your hair, many years from now.”

Gambling on the X Factor

Those of us old enough to remember the heyday of building societies in the 70s and 80s, regarded them then as staid, solid homes for our savings and the first port of call if you wanted a mortgage. Back in those heady days, in order to qualify for a mortgage, you first had to save with the Halifax or the Abbey National or the Leeds permanent for 12 months or two years. Once qualified, you would be interviewed by the manager and if you passed this hurdle he would deign to place you on their waiting list, which at times was as long as another 12 months!

Thank God for progress I hear you say, although there will be those who consider the above process led to very much more responsible lending to people who had proved they could be responsible borrowers. Building societies were really local or regional savings banks with a very straightforward business model, which as mutual organisations, allowed them to make a small surplus each year in a very controlled environment.

Once they had overtaken the banks as the main mortgage lenders in the UK sometime in the 70s this was never going to be enough for them and, come the revolution, in the form of the Building Societies Act 1986, they were allowed to demutualise and, over time, to offer all kinds of services to their customers whether they wanted these services or not. Predictably, their numbers fell from over 200 in 1986 to fewer than 50 today and only one of any real size and importance (Nationwide). Many have fallen by the wayside due to the hubris of their shiny new boards comprised of city whiz kids (Northern Rock comes to mind) and many famous names have disappeared altogether.

The Halifax, however, still survives, albeit as part of the dreadful mess Lloyds has inherited and which resulted in the taxpayer becoming a major shareholder in the bank. The Halifax now runs a sharedealing service and recently as part of this service has begun to promote “spread trading”, which you might recognise better as “spread betting”. They are even offering free credit in order to induce new customers to take this up. It is understood that more than 80% of spread bettors lose money on a regular basis (I would guess this 80% is made up of the general public), but strangely this statistic does not appear on the website; Halifax are more interested in telling us about the tax benefits when you make money – which won’t be often!

A “service” further from the aims and values of the founding fathers of these august institutions it would be hard to imagine; we can just picture the headlines when some poor “punter” (because let’s face it, we’re talking about betting here) finds himself poverty stricken as a result of ill-advised “spread trading”. As a sign of what the banking business has become in recent years and perhaps as a sign of what it would like us to become , we couldn’t envision a more graphic illustration.

The Times They Aren’t A Changing

This note owes a debt to Legg Mason and a document it makes available on its US website. Time magazine is an iconic US publication with a US readership of 20 million and an estimated worldwide readership of 25 million people; it has charted the history of the American people since its founding in 1923 and there are many famous Time covers, possibly the most well known being that of Albert Einstein, who was voted person of the 20th century.

Legg Mason have taken a number of Time covers which chronicle market downturns in the US and placed them on a timeline, the backdrop of which is the performance of the S&P 500. With titles like, “Is the US Going Broke”, “Can Capitalism Survive” and “The Crash” it takes recent history, from about 1970 and puts it into perspective. As part of the press, Time is of course more interested in bad news than good but the litany of bad news that these covers represent has not presaged the end of capitalism nor stopped the inexorable rise of stock markets.

Legg Mason make some important points in the body of the brochure; investing is for life (or longer if you have children or grandchildren); your long-term goals and objectives are more important than short-term crises; market timing is impossible to get right; invest for the long-term and keep your eyes on the horizon; it is never “different this time”.

Click to read Legg Mason article

All That Glisters…

Certain commentators never tire of reminding us that gold is a reliable store of value and a safe haven in troubled times. We have been encouraged to buy gold regardless of how high the price has risen, and regardless of the fact that it produces nothing of any value nor any income.

Those who have purchased gold at high prices might want to consider whether it’s worth holding in light of the following quote from Warren Buffett.

 “You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all—not some—all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more?”

“Cross my palm with silver……one of us will get rich.”

We would all love to know a little bit more about the future and there seems to be a constant longing in human beings to know more about what it holds; when Doris Day asked her mother, “will I be handsome, will I be rich?” just about the only reply she didn’t want to hear was “Que sera, sera”. Deep down we know that is the only rational answer, but it does not stop millions of consulting astrologers, fortune tellers, palm readers and other charlatans on a daily basis.

Hats off, then to hedge fund managers, Derwent Capital Markets (based, naturally, in Mayfair) who have discovered a new way to predict the future and fully intend to capitalise on it. They have established a fund that, according to the Sunday Times 11th September, “makes its bets (our italics) by evaluating whether people are on average happy, sad, anxious or tired, in the belief that this will predict whether the markets will turn bullish or bearish.” And how is it going to gauge the mood of the great British public? Via Twitter, of course.

Now, before you run away with the idea that this is merely reading tea leaves by another name, you should be aware that they will be using an algorithm (a fancy formula). Who could possibly expect sophisticated investors to part with their hard earned cash without such a thing? When certain words appear in a certain order the algorithm picks them up and by analysing this data the hedge fund manager says he is able to predict a change in the market.

We are going to avoid any childish jokes involving twits on Twitter and it would be wrong of us to repeat Warren Buffett’s saying that you can get rich in a hedge fund, but only if you run one. It is hard for us, however, not to think of the old proverb about a fool and his money.

Kings, markets and wisdom

Once, a long time ago, but not that long ago, there ruled a benevolent King.  He was fair and much loved but, of course had absolute power over his subjects. And while he had devoted his life to duty and the pursuit of knowledge, had achieved great things and had a beautiful wife and family he felt there was something more to life that he must have. Like many Kings he had a number of advisers who helped him make the decisions of state required of all Kings; one day he summoned them all.

“You are my advisers” he said, “and over the years you have helped me make the great decisions of State.”  Naturally they nodded their agreement.  “Between you, you have all the wisdom in the world and while I have achieved much and have great knowledge there is one more thing I must have before I depart this world; you must help me acquire all the wisdom of the world.”

This caused a great deal of consternation and muttering among the wise men, who assured the King that such a thing could not be done even with so brilliant a scholar as the King himself. The King, however, would brook no argument and demanded that they distill all the wisdom of the world into one volume to be presented to him in one year from that day – or else! With grave misgivings and fear for their necks the wise men adjourned for a year and set to the task.

One year later the wise men were summoned by the King and proudly presented the fruit of their labours to him. “We thought this task impossible” they said, “but by applying all our knowledge and skill we have distilled all the wisdom of the world into this one volume which we now present to you.”

The King explained however that time was passing quickly and matters of state were more pressing than ever and he now required all the wisdom of the world one sheet of paper. At this the wise men protested that this was truly beyond them and tried to convince the King of the unreasonableness of his request; “one year” he said, “one piece of paper, or else.”  Truly fearful for their lives the wise men retired to address this absurd task.

Twelve months later the wise men returned in a state of high excitement and declared to the King that they must be the wisest men who ever lived because they had achieved what he asked and here it was -all the wisdom of the world on one sheet of paper. The Kings response stunned and terrified them; he did not have the time to read even one sheet of paper and now wanted all the wisdom of the world in one sentence. Resigned to their fate they shuffled away knowing in their hearts that all the wisdom of the world was more than one sentence.

After a little time, however, they began to think about their task and to work on it. Twelve months later, weary beyond belief, but triumphant they announced to the King that they had done what he asked of them and had all the wisdom of the world in one sentence. “Tell it to me” said the King. “Here it is” they replied;

“This, too, shall pass.”