What happens if lots of companies have tightened up their supply chains to cut down on inventory costs, and the economy goes into a severe recession? The shock of lower sales should be transmitted through the supply chain much more quickly than it has been in earlier bad recessions. Maybe the big, sudden drop in manufacturing output is partly driven by this factor. In which case, what we're doing is getting to the bottom of the cycle much quicker than before.
With any luck, the bounce out will be equally quick. I'm not holding my breath.
Tuesday, March 31, 2009
Friday, March 6, 2009
Some Boards are getting up my nose!
It is very difficult for the general body of shareholders to affect the Board in any meaningful way. While nominally being elected by the shareholders, a Board is self-propagating unless something seriously bad happens.
Despite all the best will in the world, such an environment is dynamically unstable. A good Board would ensure it has regular external and independent reviews of its structure, capabilities, and mechanisms. It would embrace robust discussions at AGMs and would welcome feedback from shareholders and a constructive dialogue (with the shareholders' mostly determining what is constructive). Because of the dangers of ossification, there would be a regular turnover of Board membership.
This process is unstable because in the absence of shareholders being able to affect the Board, any sufficiently large departure of the Board from its exacting standards causes its self-correction mechanisms to fail. Self-serving rationalisations can be made for why the independent Board review got it wrong, or the Board reviewer may not be changed regularly enough and so loses their external and independent nature (no matter how good you are, a close working relationship over a number of years destroys the independence - we have tons of psychological evidence for this in general, and I can't see why Board reviewing (and company auditing for that matter) would be any different). A small departure from good behaviour allows slightly larger departures, and so on in ever widening spiral of departure from best practice. And all the time the Board is arguing it's doing a good job, and steadily entrenching themselves - for the good of the company! And they believe it.
OK, so how to fix it. We know how - a mechanism whereby the beneficiaries of the company (the owners) can exercise control over the executive function, which is essentially by electing the Board. While I object to some of the activities of proxy advisors, they are doing a good job by getting more coordinated action by the end shareholders.
Despite all the best will in the world, such an environment is dynamically unstable. A good Board would ensure it has regular external and independent reviews of its structure, capabilities, and mechanisms. It would embrace robust discussions at AGMs and would welcome feedback from shareholders and a constructive dialogue (with the shareholders' mostly determining what is constructive). Because of the dangers of ossification, there would be a regular turnover of Board membership.
This process is unstable because in the absence of shareholders being able to affect the Board, any sufficiently large departure of the Board from its exacting standards causes its self-correction mechanisms to fail. Self-serving rationalisations can be made for why the independent Board review got it wrong, or the Board reviewer may not be changed regularly enough and so loses their external and independent nature (no matter how good you are, a close working relationship over a number of years destroys the independence - we have tons of psychological evidence for this in general, and I can't see why Board reviewing (and company auditing for that matter) would be any different). A small departure from good behaviour allows slightly larger departures, and so on in ever widening spiral of departure from best practice. And all the time the Board is arguing it's doing a good job, and steadily entrenching themselves - for the good of the company! And they believe it.
OK, so how to fix it. We know how - a mechanism whereby the beneficiaries of the company (the owners) can exercise control over the executive function, which is essentially by electing the Board. While I object to some of the activities of proxy advisors, they are doing a good job by getting more coordinated action by the end shareholders.
Thursday, March 5, 2009
A nice piece from the FT on the level of losses from the "AAA" rated tranches of the sub-prime linked CDOs. There is still going to be a lot more losses to be revealed presumably.
http://www.ft.com/cms/s/0/2970532c-0421-11de-845b-000077b07658.html
http://www.ft.com/cms/s/0/2970532c-0421-11de-845b-000077b07658.html
Thursday, February 26, 2009
Case-Shiller index
The Case-Shiller index for house prices shows a marked difference between the 10 cities with the highest returns between 2002 and 2005, and the 10 cities with the lowest returns over that period. (Index values as released at 24 Feb 09)
It's obvious that in the "non-boom" cities the price declines have been much more muted than in the boom cities. What is worrying is that the recession has now hit the prices of cities that didn't boom. Declines in these prices is now as fast as for the boom cities.
But the behaviour of the non-boom cities was also more muted back in the early 1990s. We definitely have a heterogenous group of cities.
Copies of spreadsheet available for those interested.
Saturday, February 14, 2009
Keynes and the Great Depression
With all the mention of JM Keynes and his analysis of the 1930s Depression, it's interesting to note that his father was on a Royal Commission analysing the 1890s economic depression.
Friday, February 13, 2009
Qualitative and quantitative information
Another question from LinkedIn - Performance & Risk Analysis group
How do you integrate qualitative and quantitative information in a systematic way?
In mathematics, there exists the Bayesian approach. Related to that, we know the Black/Litterman approach. In medicine and other disciplines, there are "evidence-based" approaches - what is your take on enhancing quantitative with qualitative information in a structured manner?
First, there is no way we can know what is the optimum portfolio. Estimation error means we have a distribution of portfolios that could be optimal.
Secondly: We can use resampling or bootstrapping to give us an idea of this distribution.
Thirdly: Choose a portfolio in this cloud of possible optimums that is line with your qualitative information. By the very nature of qualitative information, this has to be subjective.
Fourthly: Be prepared to have to defend this approach from people who think that it lacks rigour. When I've seen the arguments of such people I find that what is lacking is a rigourous knowledge of the statistical underpinnings of portfolio arithmetic.
How do you integrate qualitative and quantitative information in a systematic way?
In mathematics, there exists the Bayesian approach. Related to that, we know the Black/Litterman approach. In medicine and other disciplines, there are "evidence-based" approaches - what is your take on enhancing quantitative with qualitative information in a structured manner?
First, there is no way we can know what is the optimum portfolio. Estimation error means we have a distribution of portfolios that could be optimal.
Secondly: We can use resampling or bootstrapping to give us an idea of this distribution.
Thirdly: Choose a portfolio in this cloud of possible optimums that is line with your qualitative information. By the very nature of qualitative information, this has to be subjective.
Fourthly: Be prepared to have to defend this approach from people who think that it lacks rigour. When I've seen the arguments of such people I find that what is lacking is a rigourous knowledge of the statistical underpinnings of portfolio arithmetic.
Indexing portfolios
I saw this question on LinkedIn
Anyone know how I can reconcile the difference between two benchmarks?
I am trying to reconcile the returns of the S&P600 Citi Growth (-11.10% YTD) with the Russell 2000 Growth (-5.80% YTD). What I would like to find out is what fundamental and/or economic factors caused the difference in these small cap indexes. Any insight would be appreciated.
My response:
Embrace the difference!
What this difference reinforces is the arbitrariness of benchmarks. Fundamentally, we want to know a representative return of the small(ish) end of the stockmarket. Well we have a big question of definition - what do you mean by small caps? And what do you regard as a representative return. Because these questions are vague we should not be concerned if we get a vague answer - in this case a return of between -11.10% and -5.80%. Or maybe wider.
What it also shows is that if we want a passive small cap portfolio to reduce investment costs and tax, then having a tracking error limit of about 5% might be OK. Allowing your portfolio to passively drift away from your benchmark up to such a level will drastically reduce your costs, while still achieving your objective of having a return similar to the market segment as a whole.
More comment
This question is one whose kind comes up quite often in funds management and shows that the basic idea of indexation has lost its focus over the years. Instead of being a method for running a low cost portfolio its been turned, in many cases, into a way in which IM companies can show off how good they are by having a low tracking error. The final beneficiaries don't really want low tracking error, they want low cost. IM firms and consultants need something that they can sell and consult on, so they go for something you can easily measure and that sounds good, even if it's useless.
Anyone know how I can reconcile the difference between two benchmarks?
I am trying to reconcile the returns of the S&P600 Citi Growth (-11.10% YTD) with the Russell 2000 Growth (-5.80% YTD). What I would like to find out is what fundamental and/or economic factors caused the difference in these small cap indexes. Any insight would be appreciated.
My response:
Embrace the difference!
What this difference reinforces is the arbitrariness of benchmarks. Fundamentally, we want to know a representative return of the small(ish) end of the stockmarket. Well we have a big question of definition - what do you mean by small caps? And what do you regard as a representative return. Because these questions are vague we should not be concerned if we get a vague answer - in this case a return of between -11.10% and -5.80%. Or maybe wider.
What it also shows is that if we want a passive small cap portfolio to reduce investment costs and tax, then having a tracking error limit of about 5% might be OK. Allowing your portfolio to passively drift away from your benchmark up to such a level will drastically reduce your costs, while still achieving your objective of having a return similar to the market segment as a whole.
More comment
This question is one whose kind comes up quite often in funds management and shows that the basic idea of indexation has lost its focus over the years. Instead of being a method for running a low cost portfolio its been turned, in many cases, into a way in which IM companies can show off how good they are by having a low tracking error. The final beneficiaries don't really want low tracking error, they want low cost. IM firms and consultants need something that they can sell and consult on, so they go for something you can easily measure and that sounds good, even if it's useless.
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