Unable to understand why people continue to pay fund managers enormous fees to manage money for them poorly, I asked a colleague why they would continue to invest with a fund manager when he had clearly underperformed over 14 years.
The answer was that the was really "institutional". Officially, that means the fund has institutionalized investment and risk processes that a repeatable over a large scale, meaning that the fund would operate smoothly even if the fund manager were no longer involved in the running of the fund, or if the fund were manager large sums of money.
I don't know about you but if the fund were to run smoothly, and if all the operational processes were superior to the other funds out there, the fund should at the very least, outperform the stock market over the long run. If you do your homework you will find the vast majority do not. Many funds will hide behind the excuse of "risk-adjusted quality returns". However, I would take high returns over risk-adjusted returns in the long run, I cannot pay my bills saying, "I owe you $10 but will pay you only $7. My $7 should be worth more to you because it was generated with better risk-adjusted returns". Sadly, most landlords and Wal-Mart do not recognize this odd currency of risk-adjusted returns.
So what are "institutional" hedge funds then? They are like growth stocks--you only know what they are after they have become growth stocks. Similarly, institutional hedge funds are simply funds which have raised a lot of money from pensions, endowments, foundations and other "sticky money". LP investors take comfort in investing with other people like themselves and they often stampede into funds that have already raised money, irrespective of merit.
Saturday, August 21, 2010
Thursday, August 19, 2010
New Direction
I haven't written in awhile. I've put off writing as I awaited crucial developments and decisions that never materialized. If I just wait another week, I'll be able to write about that financial reform bill...In the face of the largest financial crisis since the Great Depression somehow healthcare reform topped the agenda. Two years and counting and I have nothing tangible to report.
I am a worrier by nature, I always worry that tomorrow is worse than today. But what I've seen in the past year worries me even more than usual. Here are some of my troubling observations:
- A breakdown in values going from the Protestant work ethic and frugality to one of narcissism and materialism. The nation continues to gorge on its credit addiction and the country has not galvanized in the face of adversity. Sacrifice is only mentioned in the context of what others have to do.
- Boston University Professor Laurence Kotlikoff estimates that the true value of US debt is around $202 Trillion. Unfunded liabilities, especially in the pension world, not the Madoff Fraud are proving to be the real scandals uncovered by the financial crisis.
- I'm paying more taxes than ever before and I have no tangible benefits. And I know I am not alone. Aside from funding the ongoing wars in the Middle-East what else am I getting? The potholes on the I-95 leading into Manhattan are still there.
- The way China swallowed up America's $700 billion fiscal stimulus package. What remains unchanged is the fact that sections of the US economy are simply uncompetitive. The Chinese have an edge in manufacturing. So when the fiscal package was unleashed, it went directly to Wall Street and to Chinese exporters. Buy American? How can you when Wal-mart doesn't even sell American anymore?
- The financial industry continues to be "untamed":
- The congressional inquiry into Goldman Sachs degenerated into a legalistic hairsplitting masterclass between to Harvard lawyers (Levin and Blankfein). It was clear that the people who were supposed to be in charge and now meant to make things better lacked basic financial knowledge, let alone the ability to legislate effective regulation over a complicated industry. The other realization was how well-versed the financial industry had become in pushing the boundaries of ethics while playing within the grey zone of legal boundaries. And on the rare occasions where big finance is taken to task, inconsequential fines are imposed at best. - Continued unregulation of the bond and derivatives market.
- Continued dilution of the Volcker rule as the financial reform bill is passed through both houses. Massachusetts Senator Scott Brown has been negotiating extensive comprises on this. Why do we have someone, whose main achievement prior to winning the senate seat was posing nude for cosmopolitan magazine, making such important decisions?
- The obstruction of Elizabeth Warren to head the newly formed consumer protection agency.
- Continued ethos that free markets function best if left to govern themselves.
- How excessive compensation continues to be unaddressed. Even broaching the topic could be interpreted by some as "Un-American".
What does this all mean? We will not have financial stability for a long time and the PIMCO case for a "new normal" economy characterized by high unemployment, low economic growth and deflation doesn't seem so far-fetched now. We are looking at a broken economic system. And what's bad for America, is bad for the world.
Politically, I am even more disturbed:
- The idea of two or more opposing factions coming out to passionately debate a position, ultimately arriving at an optimal solution is a fallacy. The only role of the opposition in America, is to undermine the incumbent, at any cost.
- America has one political party with two corporate wings. The thin margin of support that separates a Democrat or Republican administration means that both parties are beholden to special interest groups, vying for that additional faction will push them over the fence on election day. What separates a donkey from an elephant is who they take money from.
- America has been unresponsive and unable to react to big problems as it is politically paralyzed. If neither party is able to make painful but necessary decisions in the short term for longer term gain, who will? Don't tax you, don't tax me, tax the man behind the tree. The government cannot cut spending, nor can it raise taxes any further. Who will provide the magic needed to reduce the deficit then?
- The symbiotic relationship between big business and big government in America. In deciding 5-4 to uphold the continued practice of campaign finance, the US Supreme court has protected the right for any entity with sufficient resources to lobby (or buy) a political decision over at Washington. So the very people supposed to regulate oil, finance and healthcare companies continue to be heavily influenced by the very people they are meant to regulate.
- 25% of Americans think President Obama is a Muslim (up from 17% when he took office, hmmm, I wonder how that happened?). Less than 50% believe he is Christian. Do you think that has anything to do with the fact that he's Black? Let's not pretend that being a Muslim does not have negative connotations in America. If that were the case, why the controvery over building a Mosque close to the 9/11 site?
On the other side of the world, China continues to post sizzling growth numbers. Questionable numbers some may contend, but it is difficult to argue that the general trajectory of the country's success has been anything but up. Communist China, with its authoritarian regime and lack of human rights (noticed how socialist economy has been dropped from the list lately) has been doing more than "ok".
The powerful force of globalization has been work. My cousin reminded me that when he was young the exchange rate between the SGD and GBP was 8 to 1. Today GBP/SGD is 2.11. Everything made in the UK was branded and the best, everything made in Asia was low cost junk. Things have changed.
I'm not concerned with will be No. 1 in the world. Only time will tell. What is far more interesting is the alternative political and economic systems that China offers. Francis Fukuyama prematurely declared the end of history and the last man by predicting that the world would essentially converge in a liberal democracy as other forms of governments had failed.
Going forward, this will be the central focus. How will the world respond to a new system of "Capitalism with Chinese Characteristics"? And no, I have not abandoned my position as a Cedalion Investor--The single most important global development is the rise of the middle class in countries like China, India and Brazil. We are talking about hundreds of millions, potentially billions stepping out of abject poverty. The largest car market in the world today is China, just ask GM how important the China market is.
Let me leave you with an observation, the Chinese worker earns less than a tenth of what the American worker does, and there are five Chinese workers for every American. Yes, the US is in the self-congratulatory habit of broadcasting how the American worker is the best in the world. Just ask yourself how true and sustainable this is when virtually all manufactured goods are produced in China? I would also like to remind you that your iPod and computer you are typing on are made there, so it's not just lead-laced Barbie I'm referring to.
I am a worrier by nature, I always worry that tomorrow is worse than today. But what I've seen in the past year worries me even more than usual. Here are some of my troubling observations:
- A breakdown in values going from the Protestant work ethic and frugality to one of narcissism and materialism. The nation continues to gorge on its credit addiction and the country has not galvanized in the face of adversity. Sacrifice is only mentioned in the context of what others have to do.
- Boston University Professor Laurence Kotlikoff estimates that the true value of US debt is around $202 Trillion. Unfunded liabilities, especially in the pension world, not the Madoff Fraud are proving to be the real scandals uncovered by the financial crisis.
- I'm paying more taxes than ever before and I have no tangible benefits. And I know I am not alone. Aside from funding the ongoing wars in the Middle-East what else am I getting? The potholes on the I-95 leading into Manhattan are still there.
- The way China swallowed up America's $700 billion fiscal stimulus package. What remains unchanged is the fact that sections of the US economy are simply uncompetitive. The Chinese have an edge in manufacturing. So when the fiscal package was unleashed, it went directly to Wall Street and to Chinese exporters. Buy American? How can you when Wal-mart doesn't even sell American anymore?
- The financial industry continues to be "untamed":
- The congressional inquiry into Goldman Sachs degenerated into a legalistic hairsplitting masterclass between to Harvard lawyers (Levin and Blankfein). It was clear that the people who were supposed to be in charge and now meant to make things better lacked basic financial knowledge, let alone the ability to legislate effective regulation over a complicated industry. The other realization was how well-versed the financial industry had become in pushing the boundaries of ethics while playing within the grey zone of legal boundaries. And on the rare occasions where big finance is taken to task, inconsequential fines are imposed at best. - Continued unregulation of the bond and derivatives market.
- Continued dilution of the Volcker rule as the financial reform bill is passed through both houses. Massachusetts Senator Scott Brown has been negotiating extensive comprises on this. Why do we have someone, whose main achievement prior to winning the senate seat was posing nude for cosmopolitan magazine, making such important decisions?
- The obstruction of Elizabeth Warren to head the newly formed consumer protection agency.
- Continued ethos that free markets function best if left to govern themselves.
- How excessive compensation continues to be unaddressed. Even broaching the topic could be interpreted by some as "Un-American".
What does this all mean? We will not have financial stability for a long time and the PIMCO case for a "new normal" economy characterized by high unemployment, low economic growth and deflation doesn't seem so far-fetched now. We are looking at a broken economic system. And what's bad for America, is bad for the world.
Politically, I am even more disturbed:
- The idea of two or more opposing factions coming out to passionately debate a position, ultimately arriving at an optimal solution is a fallacy. The only role of the opposition in America, is to undermine the incumbent, at any cost.
- America has one political party with two corporate wings. The thin margin of support that separates a Democrat or Republican administration means that both parties are beholden to special interest groups, vying for that additional faction will push them over the fence on election day. What separates a donkey from an elephant is who they take money from.
- America has been unresponsive and unable to react to big problems as it is politically paralyzed. If neither party is able to make painful but necessary decisions in the short term for longer term gain, who will? Don't tax you, don't tax me, tax the man behind the tree. The government cannot cut spending, nor can it raise taxes any further. Who will provide the magic needed to reduce the deficit then?
- The symbiotic relationship between big business and big government in America. In deciding 5-4 to uphold the continued practice of campaign finance, the US Supreme court has protected the right for any entity with sufficient resources to lobby (or buy) a political decision over at Washington. So the very people supposed to regulate oil, finance and healthcare companies continue to be heavily influenced by the very people they are meant to regulate.
- 25% of Americans think President Obama is a Muslim (up from 17% when he took office, hmmm, I wonder how that happened?). Less than 50% believe he is Christian. Do you think that has anything to do with the fact that he's Black? Let's not pretend that being a Muslim does not have negative connotations in America. If that were the case, why the controvery over building a Mosque close to the 9/11 site?
On the other side of the world, China continues to post sizzling growth numbers. Questionable numbers some may contend, but it is difficult to argue that the general trajectory of the country's success has been anything but up. Communist China, with its authoritarian regime and lack of human rights (noticed how socialist economy has been dropped from the list lately) has been doing more than "ok".
The powerful force of globalization has been work. My cousin reminded me that when he was young the exchange rate between the SGD and GBP was 8 to 1. Today GBP/SGD is 2.11. Everything made in the UK was branded and the best, everything made in Asia was low cost junk. Things have changed.
I'm not concerned with will be No. 1 in the world. Only time will tell. What is far more interesting is the alternative political and economic systems that China offers. Francis Fukuyama prematurely declared the end of history and the last man by predicting that the world would essentially converge in a liberal democracy as other forms of governments had failed.
Going forward, this will be the central focus. How will the world respond to a new system of "Capitalism with Chinese Characteristics"? And no, I have not abandoned my position as a Cedalion Investor--The single most important global development is the rise of the middle class in countries like China, India and Brazil. We are talking about hundreds of millions, potentially billions stepping out of abject poverty. The largest car market in the world today is China, just ask GM how important the China market is.
Let me leave you with an observation, the Chinese worker earns less than a tenth of what the American worker does, and there are five Chinese workers for every American. Yes, the US is in the self-congratulatory habit of broadcasting how the American worker is the best in the world. Just ask yourself how true and sustainable this is when virtually all manufactured goods are produced in China? I would also like to remind you that your iPod and computer you are typing on are made there, so it's not just lead-laced Barbie I'm referring to.
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