Wednesday, February 29, 2012

Why Nationalising Real Estate Agencies is a Free Market Solution

Do Real Estate Agents Really Add Value?

I think the events of the last few years have created a time to reassess capitalism and the market economy. We have seen the free market fail and, what puzzles me is the intellectual bifurcation that has occurred as a consequence. Since wide scale socialism is not an option anymore, we appear to have two separate strands of current opinion.

The first ‘believes’ in free markets as the superior system. It accepts that it has its weakness but that ultimately patching up the old ‘T-Model Ford’ with systematic bank bailouts, QE and collectivizing (a funny position for a free marketer to take!) bank and mortgage holders debts is the best policy. These things happen from time to time. Of course, that this position tends to preserve the moral and financial position of the already wealthy and powerful, should not be lost on the reader. Free market competition for all, but not in my back yard!

The second also accepts the system as imperfect but calls for greater equalization in the distribution of wealth created by the free market system. Of course, this view too, is fundamentally flawed because ultimately you need competition over resources and capital to make capitalism work. Creeping collectivization is, after all, more collectivization, not less.

Strangely, both favor increased public spending. The former wants to take on private sector losses and, the latter wants to better redistribute resources or stimulate employment gains. Even more bizarrely, both run contrary to the free market system that they purport to espouse. And they know it.

The Free Market System

What exactly do most people think of when they contemplate a market economy.

 Is it Gordon Gekko? Slick haired salesman? Mitt Romney and private equity? Workers being laid off? The developed world losing jobs to the emerging world? Bankers taking the piss with bonuses and, gaming the taxpayer for bailouts?

I’d argue that, in their own way, both of the two groups above actually believe this. You only have to look at the negative advertising of Mitt Romney in the election to see this. You only have to see the emotional resonance of using Michael Douglas to spearhead a campaign against insider trading. The first group secretly celebrates their victory in getting their plaudits and rewards for their ‘success’ back on track. The second group wishes it could be like the first, accepts that it is not, but wants a more equally playing field.

But what of the real argument for a free market system? What of the ability to create social mobility. The ability of labor to command its true worth rather than have it dictated too. What of free trade and the benefits for all of the division of labor? Who really speaks for the free market?

How Free Markets Really Work

Well, I will make a feeble attempt. And, I will give a real life practical example.

It strikes me that we have forgotten why we love and believe in free markets. We love them because principally because they create better pricing and evaluation mechanisms than any other system. Ludwig von Mises and Friedrich Hayek both expertly articulated the benefits of using markets to price production rather than allowing centralization of this problem.

For them, the market is an epistemological device which insures that disparate and often totally unrelated, or even unknown information comes together to create a price. This kind of economic calculation simply cannot be replicated by a central planning body.

To summarize, we favor free markets because they allow for the better flow of pricing information.  In a real sense, we could think of how the e-business market is creating more efficient pricing mechanisms as opposed to the information you would have got via walking into a shop.

So far, so good.

Realtors and Real Estate Agents are Anti-Capitalist

They are so, because they often work by restricting the flow of pricing information.

Consider the average London high street. It has five or six estate agents, all of which cover largely the same area. Their fees are largely the same. The price of their properties on show is largely the same. So why on earth are there so many of them? The answer is that owners and buyers like to try and differentiate on price, or rather, like to think they are doing this. They will go to one agent, he/she won’t get the price they want, then they go to another etc etc. Estate Agents like to try and withhold pricing information or rather convince the buyer that they are adding some ‘value’ with their service.

The reality is that deliberately withholding price information and differential pricing is anti-competitive. In fact, many industries are regulated to specifically insure that this does not happen.  It is certainly anti free market and, it is baffling why housing (usually the biggest expense in your life) is not subject to the same regulation.

Nationalize Real Estate Agents

I would argue that the solution is just to ‘nationalise’ estate agencies. One company could be created which displays information on the internet and via one branch on the high street and agents could be invited to work within in it on a commission basis. Buyers and sellers would still compete on price and without the dislocation created by estate agents trying to not disclose market information. Nationalising them, but based on market principles, is actually the best option.

Ultimately, we want free markets because they service us better. Its time we got back to understanding why.

Saturday, February 18, 2012

A Novel Way to Measure Investment Management Performance

Jon Corzine at MF Global. Fooled you with Randomness and then Fell on the Unlucky Bit of the Bell Curve?

I’m frequently puzzled by how simple aspects of statistical probability and analysis are merrily shunted aside when investors consider spending their money. For example, when investment performance is analyzed there is no shortage of metrics that are used to ascertain whether the investment manager has actually added anything from skill or from luck. In other words, is he generating alpha?

 The issues of how alpha is measured are beyond the scope of this review. In this post I want to focus on awareness of the processes of how we should analyze the decision making processes of investment managers before we get into relying on the metrics. One factor is sample size.

Sample Size Matters

To demonstrate this, I’m going to ask the reader to play a game and try to answer the following question which is replicated from a Kahnemann & Tversky paper on behavioral heuristics. Please try to answer the question in the quoted text before reading further. The answers given in the research are displayed in the table below. The correct answers are starred.

A Certain town is served by two hospitals. In the larger hospital about 45 babies are born each day, and in the smaller hospital about 15 babies are born each day. As you know, about 50% of all babies are boys. The exact percentage of baby boys, however, varies from day to day. Sometimes it may be higher that 50%, sometimes lower.

For a period of 1 year, each hospital recorded the days on which (more/less) than 60% of the babies born were boys. Which hospital do you think recorded more such days?

More than 60%
Less than 60%
The Larger Hospital
The Smaller Hospital
About the same (i.e., within 5% of each other)

Contrary to what most people answered, the smaller hospital is more likely to record the more extreme results because of the greater variance in results due to its smaller sample size. However, most people answer with the larger hospital because it appears to be more representative. Sample size matters!

It matters a lot. For example, when drugs progress through clinical trials the sample size of the trials gets larger because it will give more accurate results. A larger sample is always statistically more significant than a subset of that same sample.

So why is this principle lost when measuring investment performance?

Measuring Investment Management Performance

Having established the importance of sample size, its time to look at how this might affect the investment world. One example is over how different funds are managed. Consider a fund that involves a manager making a large number of decisions that replicate the same activity. This fund also has a within a remit of not exposing the underlying activity to some sort of overriding direction. For example, this could be a market neutral equity hedge fund that has a decent number of positions within it. Compare this with a macro based fund that tries to pick big trends.

The former involves a large sample size of decision making and the latter involves getting a few decisions right. I contend that the performance metrics of the former will give a more accurate depiction of skill than the latter. Moreover, in the act of making this larger number of decisions the former has more data and experience with which to practice and improve.

So what made me think of this?

Skill or Luck in Investment Performance?

Consider this from a recent Bloomberg article…

'Richard Maraviglia spent January flying to Zurich, New York, Chicago and Miami to raise $250 million for his hedge fund.
Maraviglia, who now oversees about $610 million for Carlson Capital LP from London, raised the money because the almost 40 percent gain he posted last year made him a rarity'
'Maraviglia…   … started reducing bullish stock wagers in the first half of 2011, correctly betting that policy makers in China would take steps to curb inflation and the U.S. Federal Reserve would end its program of buying $600 billion of Treasuries. After a flat second quarter, the MSCI World Index lost 17 percent in the third quarter.
He then bought equities when other investors sold positions en masse in September'

So essentially, this fund made two decisions in 2011 that led to a 40% performance. Is that enough of a sample size to be sure that he has the skill to replicate this performance in 2012?

He was on the bit of the bell curve of macro betters that was profitable last year, but investors should have little confidence (just based on 2011) that he will be there next year. In the end, does it matter? He’s managed to convince investors to give him another $250m.
Investors love chasing performance, they love being fooled by randomness, they love being sold a fund that is up 40%, they love focusing on the positive bit of the bell curve and they love ignoring sample size in gauging the reasons for extreme investment performance.

Investment Banking and Behavioral Finance

In a similar vein, consider the banking industry. Once upon a time, it used to engage in the iterative process of issuing commercial, industrial and housing loans. This is a constant ongoing process, by which banks can demonstrate skill and experience. Then along came the idea that they can make big strategic bets on sub prime CDO’s and the rest is history.
Banks should focus on the activities that they have a demonstrable track record of being good at, rather than big strategic bets that they have no idea over and can bring down the economy as a consequence. Consider, John Corzine at MF Global and his big macro bets on Euro Zone Sovereign Debt.


Bloomberg Article 'Small Hedge Funds Draw Investments as Bigger Rivals Stumble' accessed 18 Feb 2012

Kahneman & Tversky 'Subjective probability: A judgement of representativeness' in 'Judgement under Uncertainty', Cambridge University Press, 2005

Friday, February 17, 2012

The Religion of Science

One of the most pervasive of all ideas of the last few centuries has been that of the ultimate triumph of secularism based on the mistaken application and understanding of scientific thought. The idea runs that since the Enlightenment a revolutionary paradigm has been created which is leading to the inexorable development of scientific thought over religious thought.

The rigourous application of scientific verification and the assumption of positivist ideology-the idea that knowledge is only valid if it can be rationally, logically and mathematically proved- is seen as superseding the very notion of religious practice.

Religion Seen as Opposing Science

Religion is seen as the arch enemy of the new rationalist utopia. The scientist and, more importantly, the social scientist is seen as a kind of brave hero, valiantly fighting against the religious dogma that holds back the development of science. But yet, the march of positivism is viewed as being inevitable. The challenge is to accelerate it so mankind can be better served and quicker.

Columbus, the Church and the Flat Earth

Indeed, a whole mythology has sprung up around this desire to challenge religion based on science. For example, the popular wisdom has it that the Church actively tried to hold Columbus on his trip because it believed the World was flat.

Whereas, as Umberto Eco points out in Serendipities: Language and Lunacy, it was actually the Church’s view that Columbus would perish on the journey because their estimation of the circumference of the Earth was far larger (and more accurate) than Columbus’. The Church was right. No matter, mud sticks and, this sort of myth plays to the gallery.

Science, the French Revolution and Secularism

Of course, the march of science doesn’t stop there. Its ascent is promulgated by the French Revolution and the breaking of the relationship between God and governance, via murdering the aristocracy. The consequences of which are a fierce anti-secularism in France which sees its influence-even today- in the relative development of the French colonial territories in North Africa. Morocco, Algeria and Tunisia are, arguably, more secular societies than Libya or Egypt.

Intellectually, scientism and secularism are seen as marching towards sweeping religion aside. Democracy is promulgated in the Middle East by the West, and wars are fought to encourage this, because it is seen as a way to allow its populace to supplant the ultimate reality of their religious lives via the horse trading process of political engagement.

However, I digress!

Science and Religion

The point of this post is to argue the case that the core ideas of the scientific movement are actually embedded in the very same beliefs as religion. The three great religions, of Christianity, Islam and Judaism all contain the same premise from Aristotle that history has a defined end and, our progress in humanity is to reach this end whilst we strive to uncover the secrets of a world that God created.

The question of where we came from, how and what is our role and reason in this world, immediately pre-supposes the idea that there is an over riding purpose which lies hidden to us. And that sounds very similar to a religion to me!

God Does Not Play Dice

It can immediately be seen that much of scientific endeavour is imbibed with the spirit of discovering absolute truths about the universe. As Einstein famously said God doesn’t play dice. Only it seems that, following developments in quantum mechanics, if he does exist, in fact all he does is play dice.  Scientists and social scientist do search for absolute truths and religion is seen as getting in the way of modeling these ideas.

However, science itself is misunderstood by the secularists!

As John Gray points out in Straw Dogs, Darwin’s theory of evolution –which is the gold standard shibboleth of those opposing religious thought- actually implies that that humans are no different from other animals, so the humanists have it wrong that humanity has a defined purpose. Moreover, the idea that humanity was puton this earth for a defined purpose is, in fact, an idea with its origins in religion. 

Similarly, Darwinism imposes a view of evolution as development from an initial primary source and, if that isn’t a case for religion that I don’t know what is! 

Kuhn and Popper on the Philosophy of Science

But the secularists err in other, more dangerous ways. In fact the two greatest philosophers of Science of the last century (Kuhn and Popper) both have arguments which detract from the positivist case. Popper in ‘The Open Society and its Enemies’, rails against the mistaken appropriation of science and positivism. Indeed, for him, scientific development is in fact advanced via the falsification criteria.

A scientific idea replaces another when it is proved to be less false. Absolute truth is not the aim, because it is not achievable. In other words, which verisimilitude is less false than the other? Ultimately, Popper advocates a piecemeal approach to social science, in line with how he sees scientific development as working. For Popper, real scientists ‘know’ that there conjectures are tentative and likely to be superseded.

For Kuhn, science progresses via a sometimes random process of paradigm shifts until that reality is challenged via a new paradigm or through the discovery of evidence which discredits the original theory.  With Popper, science could be seen as developing in a more linear fashion, whilst with Kuhn there is more of a gapping effect to development.  However, in actuality, their ideas are complementary in many ways.

Why Scientism is so Popular 

Importantly, at least for this post, both approaches chip away at theassumed  notion (outlined earlier) that there is some kind of universal truth that exists out there by which scientist are trying to uncover. Those that argue that in there is an ultimate purpose and absolute truth to the universe, are actually stating a religious case.

Perhaps this is why scientism and positivism are so popular?  Maybe its because they rely on the same assumptions of the things (religion) that they purport to over throw, that it makes them so easily accepted?


Eco, Umberto ‘Serendipities: Language and Lunacy’

Gray, John  ‘Straw Dogs’

Kuhn, Thomas ‘The Structure of Scientific Revolutions’

Popper, Karl ‘The Open Society and its Enemies’, ‘The Logic of Scientific Discovery’

Friday, February 10, 2012

Bob Diamond, Barclays and Bankers Average Pay

CBI Photostream

Bob Diamond waxed lyrical on the issue of bankers pay, again, during the recent Barclays $BARC results presentation. Quoting directly from the results presentation

‘“The 25 per cent reduction in performance-related pay at Barclays was much greater than the 2 per cent fall in profit. We placed a cap on cash bonuses of £65,000, and more pay is now deferred and paid in shares so that employees are even better aligned with shareholders."
“This represents a significant change not just in structure but in quantum, as you would expect in a year where income and profits were adversely impacted by the economic environment... as you would expect, we give a great deal of thought each year to getting the balance right between being responsible and remaining competitive. That’s exactly what our shareholders expect of us.”

Now, I know what you are thinking. However, this isn’t going to turn into a moralistic rant about bankers pay and how it should be guided by some sort of invisible conception of social justice. I’m not even going to comment on the issue of how Barclays has hiked basic pay over the last few years, so as to decrease the impact of any bonus cutting, even whilst shareholders have lost 26.4%, 11.1% and 70% on a one, two and five year basis respectively.

The Real Issue Over Bankers Pay

My issue is a far more relevant one. Specifically, at what point are we –as investors- going to start looking at the banks in the same way that we look at other companies?

I research a lot of companies, and I listen to a lot of conference calls. Over the last few years, the main story has been one of cost cutting and following a severe recession leading into a slow gradual recovery whilst corporations hoard cash and are reluctant to increase the fixed cost base with hiring. It’s part of a CEO’s job to cut costs for the shareholders. It helps increase margins and ultimately future cash flows to shareholders. That is why shareholders pay CEO’s. They do not pay them so that they can indulge in gaming every single piece of salary and bonus out of the company whilst exposing shareholders and taxpayers to future risk.

Barclays Pay for Performance or for How the Economy is Doing?

So, consider the following with Barclays. Most of the recovery in share price since end 2008/start 2009 (which is the only period in which you could have bought and still be up on Barclays today) is in fact due to the substantial Quantitative Easing programs of Central Banks worldwide and the concomitant risks that taxpayers have had to take on board.

Similarly, it seems that banks can only really make money when Governments are buying up and supporting the underlying troubled assets that the banks were holding. Furthermore, we are hearing all sorts of excuses (see above) by the banks alluding to the ‘economic environment’. Everything seems to boil down to macro factors and profitability being directional with the economy.

All of which leads me to ask, at what point in all of this has the discretionary element of bankers ‘skilful’ input been a factor? In other words, it seems that banks performance is irrespective of bankers pay. So surely, Bob Diamond can learn something from this and carry on cutting bonuses. It won’t make a difference to performance anyway.

 However, it will be in the shareholders interests, of which, he is supposed to be representing