research puzzle pieces

technopoly and the dictatorship of data

Tue, 18 Jun 2013 19:10:40 -0400

The Sunday book section of the New York Times used to have a feature called “Notes with Pleasure” which excerpted short passages from books.

Here’s one that appeared in 1992, taken from Neil Postman’s Technopoly: The Surrender of Culture to Technology.

“The fact is, there are very few political, social and especially personal problems that arise because of insufficient information. Nonetheless, as incomprehensible problems mount, as the concept of progress fades, as meaning itself becomes suspect, the Technopolist stands firm in believing that what the world needs is yet more information… . To the question ‘What problem does the information solve?’ the answer is usually ‘How to generate, store and distribute more information, more conveniently, at greater speeds than ever before.’ This is the elevation of information to metaphysical status: information as both the means and end of human creativity. In Technopoly, we are driven to fill our lives with the quest to ‘access’ information. For what purpose and with what limitations, it is not for us to ask; and we are not accustomed to asking, since the problem is unprecedented.”

We have seen many advancements in technology since then (that was, in fact, before the Internet became mainstream), but the same tendencies haunt us. For example, see the MIT Technology Review article, “The Dictatorship of Data.” It uses the story of Robert McNamara — who “fetishized” numbers, winding up in a “quagmire of quantification” — to challenge the culture of Google, quoting Douglas Bowman, who said, “When a company is filled with engineers, it turns to engineering to solve problems.”

With data scientists in ascendance at organizations these days, you can bet that many will overshoot in promoting the promise of their analysis, just as every specialty overshoots when given the opportunity. That is how promise turns into peril.

conflating categories

Mon, 17 Jun 2013 10:30:22 -0400

Accompanying a recent Floyd Norris piece in the New York Times was a graphic that included eight charts on the financial situation of U.S. households. These two panels show the percentage of assets as a share of gross domestic product:

Given the increases in stock and bond prices over the last few years — and the big asset flows to fixed income — I was interested in seeing how the exposure to the bond market had changed. (Even though a simple number wouldn’t give a complete sense of the degree of interest rate and credit risk being taken, it would be a good indication.)

Unfortunately, we don’t get that information from these charts, because the grouping of “stocks and mutual funds” apparently contains all manner of mutual funds, including those that have nothing to do with stocks whatsoever.

This is a common problem. Even big investment outfits sometimes conflate categories in ways that cloud the information rather than shine a light on it. For example, some clients get statements that show fixed income and alternative ETFs mixed in with stocks, because they happen to trade in a way that we associate with stocks rather than fixed income or alternatives.

In all types of analysis, make sure that you are using classifications that make sense for today’s world. That goes for firms, data providers, industry organizations, and governmental entities. The world changes, and investors need to see the true underlying economic exposures in ways that make sense for decision making.

It is amazing how often the manner in which information is delivered gets in the way of that.

justify this

Wed, 12 Jun 2013 17:58:01 -0400

Somewhere along the way, in our rush to have everyone do their own presentation materials, we forgot to instruct people in the basics. Consequently, I see reports from big investment firms that violate some basic principles of presentation: Sell-side analyst reports, mutual fund marketing materials, you name it.

The goal is to enable the reader to comprehend as quickly and easily as possible. Here’s the most straightforward trick in the book. If you have a column of numbers of like kind, they should all:

a) have the same number of decimal places, appropriate to the specificity necessary, and

b) be right-justified in the column.

Doing so allows the reader to instantaneously make comparisons of value. If you don’t believe me, give someone a comprehension test with things all jumbled up (which is more often than not how they appear these days) — and then as I suggest.

Here’s a fresh example from Whitney Tilson, found on ValueWalk. Please, Whitney, justify this mess:

out of retirement

Wed, 12 Jun 2013 07:36:05 -0400

It has become popular to use 1994 as the “comp” of the moment for what is going on in the bond market. Felix Salmon of Reuters did just that in a posting titled “Investing in bonds while rates are rising.” His bottom line: Look for a bond manager whose experience extends back to a time when rates were rising.

I posted this comment to the story:

Regarding: “1994, the last time that we had a bear market in bonds.” Part of the problem is that there are so many different kinds of bonds, with different maturities and structures and credit profiles. “The bond market” is a series of markets, at times moving in unison and at times not.

Even in Treasuries, there have been moves since 1994 that have been more dramatic in price than that one.

But all of that is parsing. In broad brush, it has been a bull market in bonds of all types for more than thirty years, so if the test is who has managed through something other than a supportive environment for an extended period, you’re going to have to get some folks out of retirement.

a bastardization of the process

Mon, 03 Jun 2013 11:41:51 -0400

From the archives: I ran into a Wall Street Journal “Abreast of the Market” column from October 13, 1997. It began: “The once-lowly stock market ‘technicians’ are finally getting a day in the sun.”

The article explained how the “confusing bull market” was leading some fundamental investors to explore technical analysis — with the typical arguments for each branch of securities analysis presented much as they would be today.

What caught my eye were the last two paragraphs:

“But even as it attracts new fans, technical analysis retains many detractors.

“‘It shouldn’t be allowed,’ fumes Kurt Feuerman, who manages $4 billion of stocks at Morgan Stanley Asset Management. ‘It’s just self-perpetuating: People buy something because it looks strong and lo and behold, it is strong. It bastardizes the investment process because people don’t have the courage of their convictions to buy and hold stocks when they say they’d rather trust the charts.’”

Feuerman (who is now at AllianceBernstein) probably took some ribbing about his choice of words, since I’m not sure how you would monitor the decision making processes of others. As noted before, we are all in the pattern recognition business, and one meta-pattern is that styles of analysis get overdone along with everything else. As long as they are not illegal (such as insider trading) or manipulative (as some of us think certain machine trading is), we should strive to understand their impact on pricing in the markets and to take advantage of the distortions that are created.

A fundamentalist who thinks that the herd has moved prices off the mark has some tough choices to make, but is afforded a time arbitrage. Unfortunately, many professional investors can’t escape the quarterly performance derby long enough to go with their own processes (and thereby increase career risk). It’s much easier to play along — and perhaps to fume.

dividend machines

Thu, 30 May 2013 08:09:25 -0400

Below is the lead item in a recent email from Investment News:

The article opens in this way: “Advisers on the hunt for income should be keeping a close eye on the closed-end-fund space, where yields are double and triple those of traditional mutual funds and exchange-traded funds.”

As with all other manner of “dividend machines” extant, closed-end funds have been running non-stop for quite a while. The question is whether a new rate regime is upon us that will cause them to leak start leaking oil.

The article references the $5.5 billion raised in two closed-end offerings this year by the bond giants Pimco (PCI) and DoubleLine (DSL). Despite the complexity and lack of understanding of closed-end funds mentioned in the piece, they are not undiscovered.

When you have machines that pump out yield — real or not (many “yields” are return of capital), or sustainable or not — there are buyers. The question is when the buyers become sellers. The extraordinary deals in closed-end funds come when the crowd has gone away.

straying from the line

Thu, 16 May 2013 19:11:47 -0400

One of the first pieces I wrote when I showed up in the blogosphere five years ago was about warming up the models. That is, thinking about models and probabilities in light of the range of economic outcomes that could occur if climate change were to continue or accelerate.

On May 15, the New York Times featured a story entitled, “For Insurers, No Doubts On Climate Change.” A sidebar said the industry was “straying from the conservative line on global warming.” The president of the Reinsurance Association of America explained why: “Insurance is heavily dependent on scientific thought. It is not as amenable to politicized scientific thought.”

To wit, the industry wants to objectively assess the odds of various scenarios and to price its products and build its business accordingly. Many insurance industry leaders are turning away from the rhetoric of the climate debate and focusing on the real potential effects on their businesses.

Will CEOs in other industries follow their lead?

Which brings me back to the point of my original piece, that if present trends continue much longer, analysts will need to consider the long-term effects in their models (good and bad), and that the pricing of securities could change (up or down) as a result.

Of course, we tend to wait until calamity arrives rather than focusing on the long-term and assessing scenarios. Look no further than the financial crisis which hit shortly after that 2008 blog post. The storms had been building for years, but we ignored them until their fury was unleashed.

once thought safe

Wed, 15 May 2013 17:35:32 -0400

Here’s a BlackRock ad that appeared on the front page of the Journal today:

Firms are getting more aggressive in warning about bonds. Sort of. If you go to the BlackRock URL, you’ll see that “rethinking your bonds” means looking at one of the firm’s offerings:

“Backed by BlackRock’s 500 bond experts, the BlackRock Strategic Income Opportunities Fund (BASIX) moves freely in search of the best income opportunities — from a broad range of investments — and adapts as markets change.”

Back on November 1, I commented on a chart that looked at some of the vehicles that were storming ahead in the chase for yield. (They have kept storming since.) It’s great to diversify your income opportunities as BlackRock suggests, but it’s not like it hasn’t been happening for a good long while. When “bonds” come under pressure, you can expect that all of the rest of the yield plays will too. Plus, the big question referenced in that November commentary may be answered, perhaps to our dismay.

I must say that the man of a certain age in the ad, resolutely looking forward, was a direct hit on my demographic. But the “once thought safe, now risky” tagline should be reversed, with “once thought risky, now safe” describing many alternative yield vehicles out there.

the future of money management

Mon, 13 May 2013 18:53:10 -0400

Rummaging through the archives, I found “The Future of Money Management in America (2000 Edition).” Published by Bernstein Research in March of that year, the 146-page report (with 188 exhibits) came the same month that broad interest in stocks peaked. It is a reminder of the great work Michael Goldstein did for the firm.

The first sentence: “The very concept of a money manager as fiduciary, guarding the long-term interests of the client, is now very much in question.” The subsequent thirteen years have only reinforced that sentiment.

That summary page also said that “a large distribution phase should lie ahead,” probably a good part of the public’s lackluster response of late to strong equity markets. The mutual fund industry? The report expected that it would be “buffeted by … indexing, pricing pressures and instability in customer behavior.” Take those things, poor investment performance by active managers, and the realization that the industry hasn’t delivered on its value proposition (to say nothing of a mutual fund trading scandal) and you’d expect that a tipping point would have been reached by now. But, with some notable exceptions, the fund firms are still coining it.

Skimming documents like this remind you of the buzzwords and fads and new ideas that were going to change everything. But much of it rings true today: “In the money management business, performance wins business, but service and the consistency of philosophy keeps it.” And: “Reps, who can only learn a few product lines, usually opt to learn about the leaders.” (Although if written today, firms would substitute “advisors” for “reps” and “strategies” for “product lines.”) Speaking of advisors, the report didn’t see the rise of the mega-RIA firms (almost no one did), thinking that brokerage firms would “slow or even halt” the growth of that channel.

The report said that four significant developments (the index fund from Vanguard, the bundled 401(k) business led by Fidelity, the mutual fund marketplace at Schwab, and the arrival of online brokers) drove the industry by reducing costs, making information more accessible, integrating disparate information, and bringing choice to the small investor.

Thanks to the continuing information revolution, all of those trends proceeded apace in the intervening years. But the nagging feeling today is that most of the benefits have accrued to investment businesses rather than to their clients. Some day that may actually matter.

rent-a-note

Wed, 01 May 2013 10:41:34 -0400

Very early in my investment career I covered Rent-A-Center (RCII). That gave me an opportunity to ponder issues regarding legality, morality, and business practices that could look shady in the eyes of one person and fine in the eyes of another.

This posting is not to revisit those issues, but to recognize another sign of the yield chase that is happening all around us. Rent-A-Center just did an offering of senior notes due in 2021 at a yield to maturity of 4.75%. The notes are rated BB-/Ba3, thus putting them in the category of “high yield” instruments. (Thanks to @BarbarianCap for pointing out the irony.)

Among the customers of the firm are those who truly rent-to-own, while others are in essence renting-to-have-right-now-at-high-rates. When it comes to the people that bought the debt, what percentage do you think are looking at the 2021 horizon, carefully considering the range of economic possibilities over that time, and planning on owning the paper all the while?

Rent-a-note, rent-a-bond, rent-a-dividend-stock, rent-an-MLP, rent-a-REIT, whatever. But rent-to-own? Check back in a couple of years.

have had

Sun, 28 Apr 2013 08:11:47 -0400

An April 23 piece from Pensions & Investments reviewed the recent Pension Bridge conference, featuring recommendations by speakers that the attendees “go big” when it comes to alternatives. Big, as in 35-40% of assets.

The story reads as if it was 2007, in that the fervor for alternatives that was sweeping the institutional investment community then is back in force. Now, alternatives are viewed as the answer to the riddle, “What do you invest in if the market appears to offer you low expected returns in most asset classes and low mathematically possible returns in fixed income, at the same time you have clung to unrealistically high estimates of future portfolio returns?”

I’m sure it comes as a surprise that when an alternative investment consultant gives a keynote address called “Finding Eight Percent,” he finds it in the kinds of assets he provides consulting on — and uses historical information to do so.

“Better-performing funds have alternative investments,” Stephen Nesbitt of Cliffwater said.

“Have had,” a skeptic might reply, especially one who has recently written about the tendency of otherwise reasonable people to plug and play the investment game using historical numbers, presenting the illusion of certainty without a nod to the wicked environments that have not been experienced or imagined.

still running amok

Thu, 18 Apr 2013 21:35:45 -0400

I went to the site of a well-known and reputable financial blogger and this is what greeted me at the top of the page:

It was a banner ad from one Jarret B. Wollstein. In January of 2011, I wrote a posting called “running amok,” about an obvious fraud of a company called Amarok Resources (AMOK). Wollstein was the pumper of that one too. He has a history, as they say.

The day of my posting, the stock was at $1.43. Today it is at $0.018, down just under 99%. You can read the piece to see that the writing was on the wall all along.

Wollstein is a scam artist, pure and simple, being paid for promotion, not analysis. That bothers me.

What also bothers me is that people like him are appearing on otherwise worthwhile sites, simply because those sites have struck deals with ad-serving firms that could care less what dreck is served up.

For me, the ads cheapen the sites that host them, unwitting though the proprietors may be in the process of ensnaring a fresh set of victims.

not enough history

Wed, 17 Apr 2013 14:13:13 -0400

A question was posed to the WSJ expert panelists: “What’s the most important lesson for investors from the 2008 stock market meltdown?”

My answer began:

“That we don’t know as much as we think we do.

“Modern finance is a young discipline and we haven’t seen enough history to make definitive statements about how markets work. The foundation of much financial advice is investment theory that is helpful to a certain extent but is nowhere near predictive or foolproof.”

I was reminded of that when I tried to find a good index to illustrate how food and beverage stocks have performed during the obesity epidemic. Using Bloomberg (one of the most expensive and comprehensive tools out there), I found a data series that began in late 1999.

I probably missed some other alternatives available to me — and there are undoubtedly some that aren’t available to me — but it’s not at all unusual for such data to be limited to a couple of decades or even less. We have a proliferation of indexes (a million or so) and trade lots of products off of them, but most have very little available history in the scheme of things.

Remember that the next time someone talks about how a particular grouping of investments is likely to perform. Not only do we not know what will happen across the range of possible market environments we will face, but to a great degree, we don’t even know much about the sixties, seventies, and eighties.

the power of gold

Tue, 16 Apr 2013 09:45:00 -0400

Today’s title is taken from that of a book published in 2000 by the legendary Peter Bernstein. Its subtitle is “The History of an Obsession.”

It is a sweeping history. Bernstein published the book at a time when the metal was below $300, on the eve of a rekindled infatuation with it. (It would still be four more years before you could buy it like a stock.)

From the book’s epilogue: “No other object has commanded so much veneration over so long a period of time.” But that veneration is cyclical, and to Bernstein, “the most striking feature of this long history is that gold led most of the protagonists of the drama into the ditch.”

This morning, we are inundated with “I told you so” messages from those who scoffed at gold’s rise and “stay the course” ones from the true believers.

At the core of my work is the analysis of investment beliefs and actions — how they migrate over time and how gaps develop between our beliefs and our actions, the disconnects revealing much about our true beliefs (and providing particularly dangerous ground for investment firms and professionals).

In presentations (such as this upcoming one), I have found gold to be a subject that reveals much about how our beliefs affect our actions. In looking back over the last thirty years, we can see how the cycle that Bernstein so eloquently wrote about has played out in the modern world just as it did in the ancient one.

a thought agitator

Wed, 10 Apr 2013 20:07:41 -0400

I cracked open my copy of Jim Grant’s Minding Mi$ter Market, a compilation of writings from the first ten years of Grant’s Interest Rate Observer. The book was published in 1993, so we are now another two decades down the road — years full of smart and witty commentary by Grant (as well as some manic-depressive outbursts by Mr. Market).

A few quotes from his introduction to the book:

“Wall Street is constitutionally incapable of criticizing itself or its securities.”

“Wall Street exists for a purpose: not to produce disinterested research, not to provide ‘service,’ not to raise capital for a growing America, but to sell stocks and bonds.”

“The investor of the 1990s is probably no less prone to excitability and self-delusion than the investor of the 1920s.”

“In bull markets there is no clear demarcation between progress and fantasy.”

Those ingredients made for a volatile mix during the subsequent twenty years.

Michael Kitces said recently that one of his readers had called him “a thought agitator.” In my consulting and writing, that’s what I aspire to be as well.

Jim Grant is a thought agitator par excellence. He provides the insight of a deep thinker, the perspective of a financial historian, and the word play of an artist. Not a bad combination — here’s to thirty more years of it.

get back to work

Fri, 05 Apr 2013 09:24:49 -0400

The monthly employment numbers for the U.S. were released this morning. (They were worse than expected. Stock futures spiked down, the long bond spiked up.)

Seconds before, traders sat at their terminals, breathlessly awaiting the news, so they would know what to do next. So, too, were many others who had something on the line, among them investment strategists, economists, and professional prognosticators.

For some, the news brought validation of their theses (even though it may have just been luck) while others got busy rationalizing their previous positions. Some even threw in the towel and changed their views as a result.

It’s an odd ritual, pinning the entire structure of market pricing on one set of numbers. You can argue that each of those categories of decision makers should have their eyes glued to the numbers and should parse them to death, since the market says they matter. Fixed income portfolio managers can be excused for obsessing too, since the sudden movement in the term structure of interest rates has an impact upon their duration bets (in level and composition), their mortgage structuring, their spread expectations, etc.

But what about all of the other people involved in the investment process? How much does it really matter to a credit analyst or an equity analyst or a growth portfolio manager or any number of other people in an investment firm?

Yet it will frame the conversation not just today but for many days to come. Many of those people for whom it doesn’t matter took time from their work to watch the numbers come out and the lines on the screen go vertical. Now, they’ll get to listen to commentary about them in their meetings, be distracted by squawk boxes (real and TV versions) full of interpretations, and have it all be part of conversations with co-workers and others in the business with whom they interact.

And the clients of those firms will get a full dose of the synthesized wisdom (all from that one set of numbers) for the days, weeks, and months to come.

Talk about wasted time. One problem with the “information age” is that we don’t know how much time to spend on a lot of the information. How are you supposed to be adding value? Chances are it doesn’t have anything to do with the employment numbers. Get back to work.

sales surge

Wed, 03 Apr 2013 12:29:43 -0400

The March 28 Bloomberg Brief for structured notes opened with this line: “U.S. investors are betting soaring stocks can deliver higher yields through structured notes that potentially expose them to large losses and lock up capital for as long as 20 years.”

It later says, “The equity-tied securities depend on the performance of large stock indexes and eventually pay coupons as high as 15 percent a year, as long as they’re not redeemed early and markets don’t plunge.”

Here’s a graph of the “sales surge” that the article’s headline describes for these things:

For reference, see an earlier posting on sure things and structured products (Apple edition) and one from Accelerant that begins: “While structured products are often marketed with one-page fact sheets, they are usually highly complex.”

According to Bloomberg, the notes in the tall bar on the chart include variable coupons, call dates, and “barriers” beyond which the protection implied in the structure disappears.

Sales surge, but understanding is in a bear market.

pressing toward the edges

Thu, 28 Mar 2013 07:54:33 -0400

An AllianceBernstein blog posting yesterday included this chart:Where are these covenant-lite loans going? The growth is driven by collateralized loan obligations (CLOs): “CLOs represent roughly 45% of current leveraged loan buyers, according to Fitch Ratings. And as CLOs are increasingly allowed to hold bigger percentages of covenant-lite loans, CLO demand for covenant-lite loans increases even further.”

Also yesterday, David Schawel wrote an article for the CFA Institute’s Inside Investing. He paints a “quite promising” picture for CLOs, while quoting David Zervos about the “renewed infatuation” for them among fixed income investors. Zervos said that institutional investors are looking for “creative ways to lever the ‘cheap AAAs.’” One thing the buy-side likes: “The CLO market, as well as other structured markets, allow fixed-income investors to press toward the edges of their investable universe.”

Well, when has pressing toward the edges ever gone wrong?

the mind of an analyst

Tue, 26 Mar 2013 21:40:21 -0400

“… the ability to assimilate torrents of information to look for clues, to be a detective, to think innovatively about where to find things … .”

No, that’s not one of my writings about desirable skills for a research analyst to have, although I have written the same thoughts in a different way. The quote actually concerns the analytical skills of Elizabeth Hanson, a CIA operative who was killed by a suicide bomber in Afghanistan in 2009. Her story appeared in the alumni magazine of her alma mater, Colby College.

In addition to those “formidable” skills, she favored jeans, flip flops, and even pigtails at work, although when the time came to “pull the trigger,” she could do that. One can picture her at a hedge fund trading desk, leaving the boys in the dust.

She had a paperweight which read, “What would you do if you knew you could not fail?”

The mind of an analyst and so much more.

sources and uses

Sun, 24 Mar 2013 17:16:00 -0400

A common theme in my writing and presentations is the evolving environment for information in the investment world and the disintermediation of established channels. (See, for example, my posting a few months ago about changing research on the Street.)

Nary a day goes by without some interesting development, as individuals and firms experiment with new information delivery methods and/or payment models.

For example:

The great website Distressed Debt Investing (@DDIvesting) has created Reorg Research, which provides bankruptcy dockets and other information, a sample of which you can see here on DDI.

Mebane Faber (@MebFaber) is moving to a subscription model for his website and The Idea Farm, a newer service which has been providing great research reports from other firms. (See the question of Faber from @EconomPic regarding free versus premium choices.)

There are research providers that have traditionally been only available to institutional investors that are going in the opposite direction, providing a small taste of their work online. Two that I have known for going on thirty years are in that category:

The Leuthold Group (@LeutholdGroup) has been producing research since 1981, including the famous “green book” that you see in the offices of big-time portfolio managers. New to Twitter, the firm has started to put up some great material, including an interesting piece about the so-called Fed model from 1999, other things from its archives, and updates on its current thinking.

Inferential Focus (@InferFocus) has been around a year longer than Leuthold. It is a unique firm that pulls together information from all over the world to anticipate cultural and economic changes for its investment, corporate, and government clients. It also recently joined Twitter, providing links to unusual articles. It too digs into the archives — for example, just think what might have been had the right people read the IF briefing (PDF) published a year before 9/11.

When investors use the phrase “sources and uses,” they are usually talking about cash flow. When I do, I’m talking about ideas.

Speaking of ideas, here are some great links from earlier today.