Tuesday, September 23, 2014

The Rule of Law is Vastly Under-Priced

When people prattle-on about tax, it is mostly made from ground-level, with a focus on tax rates. When my most rabid libertarian friends weigh in on the subject, discussion extends to the moral realm.  Some of these debates are constructive, a few downright stimulating, though most such arguments descend into demagoguery that take kernels of truthy-sounding platitudes about freedom, and the morality of taxation's coercive nature, profoundly at odds with the sensibility and logic of the entente that secures from the hordes the very property from which they derive their benefits.  

Those benefitting most from the secure property rights might be forgiven for conceptual ignorance - introspection being a scarce commodity amongst the wealthy - but the vociferous and cynical denial of the asymmetric benefits of securing property rights, both intra- or inter-generationally, whether due to some combination of attribution bias, feigned religious belief, or simple greed is less excusable. In a new gilded age,  the idea that the rule of law is vastly underpriced by those who benefit most should be anything but contentious.

Few doubt we humans are animals. Few outside the most fundamentally-religious wing-nuts would doubt that our social, political, and economic structures as well as our mores, values, responsibilities to others are, for the most part, man (and woman) made.  We have done so NOT out of altruism, but out of BOTH necessity and expediency, whether collectively agreed or imposed by force.  They have evolved hand-in-hand with the ascent of civilization. And they have contributed handsomely to the progress and advancement of the species. 
Some more than others, indeed, but it's difficult to argue against their importance, and resulting increase in overall economic welfare derived from the general rule of law, and attendant property rights conferred. 

So why is it so seemingly difficult for the uber-beneficiaries of the rule of law to reconcile their (mostly fiscal) responsibilities to the entente with The People which is the very fount that allows them, and increasingly one might argue, their less-deserving progeny, to maintain a position in the stratosphere of power and control, with a recognition that the very legitimacy of their reign is conferred by The People through the rule of law? Indeed, the more remote this concept becomes, the greater the probability that the entente and rule of law itself corrodes to the point where mob rule, or some equally nasty alternative somewhere along the continuum of possibilities, will emerge.   

In the absence of the entente, with its benign rule of rule, entropy typically yields either unpleasant and economically sub-optimal forms of authoritarianism or the so-called law of the jungle. We have seen many faces of authoritarianism, and rarely is anyone content outside the authoritarian himself and immediate cadre.  And while the classical expression may have been militaristic. modernity increasingly enables dystopic Atwoodian visions of The State, captured by narrowly-powerful economic interests, employing all manner of surveillance technology and distortion of law, to maintain and consolidate their power and control.  At the other pole, Libertarian and conservative morality, questioning the very nature of the entente, and undermining the edifice upon which is rests, philosophically descends into a chaotic, Darwinian jungle. By calling into doubt the existence of the entente, they are, in effect either relying upon something magical (think of Dawkin's Dennett's "skyhooks" - tnx Bob S.) to maintain their place at the pinnacle of power and control, or, they are, in their neglect, saying: "Bring it on…!!".    

To make my point, one should consider an example from the animal kingdom, where competition, rule and survival of the fittest reigns in its purest, and most unadulterated form. The sea-lions of Galapagos would, for this purpose, be archetypical.  Picture a kilometer-long idyllic beach. Waves rolling in from a cool, deeply-sapphire ocean, under a shining sun and a stiff breeze. The sea-lions share the beach and nearby shallows with others (birds, lizards, dolphins etc.) but the sea lions dominate. When not feeding, they mostly lay about in the sun. They have no rule of law, per se.  But they certainly have structure and custom. A dominant male sits atop the herd, and occupies the choice real-estate on the beach, surrounded by a scattered harem of females each with their pups. He is known as the beach-master and is typically the biggest and baddest sack of blubber around, which is how he became beach-master. He protects his harem, and his reward (apart from the privilege of residing on the choicest beachfront real-estate) is the right to mate with the cows and sire progeny. He is truly master of the universe….for the moment.

As the male pups grow they go from being tolerated to marginalized. They play in the waves in sight, but staying out of the way of the BeachMaster. They practice their intimidation and battle skills with the other pups and larger, older males, also marginalized. Occasionally, they sneak on the beach. Try their luck with the randier females when the Beachmaster is sleeping or otherwise engaged. But a scowl from the Big Bull and movement in their direction is often sufficient to shoo them away. Sometimes the growing pups coordinate and move to opposite ends of the beach presenting a dilemma to the Beachmaster to their advances. But they, too are eventually stared down. The largest ascendant bulls periodically challenge the Beachmaster, not infrequently, outright, or by trying to seduce one of his harem. This is a classic duel, and only one will win.  Usually it is the fittest which is often the largest and strongest. Initially, this is likely the Beachmaster. But, it is very tiring work without the rule of law. While the cows and pups lounge idyllically, the BeachMaster is defending his turf. There are NO property rights. In this realm, the rule of law is the rule of the Beachmaster for as long as the Beachmaster can maintain it. So stressful is it to remain Master of His Universe, being continually on guard, and warding off challengers, his reign is terribly short. There is no entente to secure his property rights. Nothing is assured to HIS prodigal pup. It is literally, the law of the jungle (beach).     

This provides some perspective to the natural state of the world without the Rule of Law. The mob, as they have done in the past, will take what they wish, when they wish it. Because, at certain junctures,  they can. There is nothing, other than the rule of law, to prevent those that are powerful, or can organize the power of others, from taking it.  The [benign] rule of law preserves, consolidates, and institutionalizes power so all things that benefit therefrom can blossom, including its own persistence. For it to work, the rule of law must nearly be universally accepted, which is not a hard sell - since its benefits are, even in its weak form, profound and widespread. One need only look at extreme failed states such as Somalia at one end, or North Korea at the other, should one have any doubts. Reality, of course, is a continuum of possibility in-between: from fascism, fragmented rule by war-lords; including a corporate police state.  But make no mistake: as a social construct there is an implicit contract - a ceding of some things in exchange for some other things. THIS contract, unlike many others facilitating the rule of law, while man-made, is unwritten. We may under-appreciate its nature during good times, but it will be evident should it dissolve. 

Particularly virulent deniers and those self-interested proponents of regressive fiscal regimes may contest that the law of the jungle, or authoritarian imposition of power is the entropic outcome. However, it seems to me that such arguments will deterministically assume away the asymmetries and rigidities that prevent the law-of-the-jungle competition, whilst protecting the benefits of the rule of law. It is at this nexus where the value of the rule of law should rightfully enter the equation.  The boundaries are necessarily wide. There is no single formula. But it seems that detached economic observers can identify whether prevailing policies and their outcomes are moving the nexus towards, or away from, some approximation of the point at which the entente is becoming more stable or less stable.  This is intricately tied to the debate on inequality and the opportunities for mobility, and whether the rule of law itself errs on the side of greater fairness, or greater parochial interest to, and institutionalization of, the super-beneficiaries of the rule of law.  

It is worth noting that the beneficiaries of the modern gilded age are not as mean-spirited as say, for example, the Russian landowning aristocracy was to their peasants. Few knowing observers shed a tear for what befell them. Nor is the plight of today's disadvantaged as dire as it was historically. Admittedly, this is not setting the bar very high, and it ignores the profound change in the direction of outcomes over the past three decades.  Most alarmingly, in the big picture, it appears as if  modern-day super-beneficiaries  have privatized the benefits of the rule of law, while more or less continuously diminishing their [mostly fiscal] responsibilities to finance it. THAT, in itself, says volumes about how much they collectively value the entente, or how ignorant they are in respect to its very existence.   

That is a great shame. Not because I worry for the future welfare of those deriving the greatest benefit, but because of the coarseness, and alienation it creates amongst the great majority of people, and the corrosion of that singularly-most-valued man-made creation, The Rule of Law.    

Wednesday, August 13, 2014

Farming Sucks

Rarely, in business, does everything proceed perfectly and according to plan. Conjure an image of the farmer. Winter rains are copious before tailing off. One is able to prepare the earth at the moment of perfection, and sow the crop, fencepost to fencepost, to one's apparently great advantage. The incessant rains of the winter that caused near universal grumbling gives way to sunshine. Germination is nearly total and growth proceeds like a lineup of thoroughbreds out of the gate. Temperatures stay mild. Frequent, but restrained showers continue to nourish the young plants. Financed inputs are applied at the right times and in the right proportions. The farmers' crops reach towards the sky with a rare virility, and he looks upon them with justifiable pride. Even casual observers cannot help but notice the unusual health of the fields, multiplied across the town, country, region, and yes, neighbouring countries. Drought and heat-waves remain elusive. Sufficient rain mixed with sun continues. Yields will approach the pinnacle of what man and nature can conspire to create. Natural disasters will be universally averted this year. The imminent harvest will, in all its preceding perfection, give way to, not the popping of champagne corks but to an........unmitigated disaster!!!! For sale prices will have halved, while fixed costs are ummm... errrr.... fixed. The bounty from nature's smile and their diligent hard work will be challenged to avoid profound financial loss. Rarely, in business, can things go so wrong, when paradoxically, everything goes so right. Rarely is the world so upside-down that bad is good and good, bad. Welcome to the world of the commercial farmer. And it's a right shitty one...

Thursday, July 03, 2014

Top 10 List: What It Takes To Become an Activist Investor

Cassandra's Exhaustive List of Prerequisites for Becoming an Activist Investor
Oh, and don't forget the Starbucks loyalty card. Happy agitating!

Tuesday, July 01, 2014

Another One Bites The Dust (mid-2014 Edition)

Things, people, and/or ideas believed to have integrity, now seemingly compromised...(the second third  fourth updated and expanded version). The bear market in integrity continues unrelentingly…2014 edition.

Jimmy Savile (tnx Anon)
Rolf Harris (tnx Anon)
US Veterans Administration
The Red Cross
Justin Bieber
The London Gold Fix
Chris Christie

US Govt Agency Data Release
The UK National Health Service
Swiss Train Safety
Nick Clegg
IM Confidentiality 
BBC Management & Oversight
Risk Parity
Segregated Customer Accounts
Investment Consultants
Bloomberg Privacy
Dark Pools
London FX PM Closing Prices
Meredith Whitney

Reinhart & Rogoff
Jérôme Cahuzac
Japanese Yen
Jamie Dimon/JP Morgan
Banca Monte dei Paschi di Siena 
IKEA Meatballs

Wen Jiabao as "Humble Servant of The People
Lance Armstrong
Top Ten Lists
Austerity as an Economic Panacea
Harvard Students' Academic Honesty
BLS Statistics
Cyclical Recovery
Book Reviews
Strong Computer Passwords
'Organic' Food
Money Velocity
Undecided Voters
The Food Pyramid
Purity of '.999 Fine Gold Bars
Penn State Football
"Top of the Pops" 
Fareed Zakaria
The "risk-free" rate
LIBOR as a Benchmark
Public Sector Pensions
HFT as a Beneficial Provider of liquidity
Diversifying properties of Hedge Fund's
Einstein's Theory of Special Relativity 
Celtic Rangers
Macroeconomic Forecasts
John Paulson
FRB Open Market Operations
Standardized Educational Testing
Swiss National Bank
A Relaxing Cruise
WTI as Oil Benchmark 
Olympus Corp.
Payment Protection Insurance
HM Revenue & Customs
Sony Playstation Network
Social Mobility
Actuarial Return Assumptions for Pension Funds
Ryan Giggs
France   AAA
Boob Jobs
David Einhorn
Nuclear Power
Deepwater Drilling
Tiger Woods
Professional Cricket
Professional Cycling
High-Frequency Trading
Professional Baseball
Professional Tennis
Municipal Bond Underwriting
The Catholic Church 
Track & Field Athletics
NCAA Sports
US Congress
UK Parliament
Analyst Research
Credit Ratings
Newtonian Physics
The Stock Market
The Food Pyramid
Incentive Stock Options
Reinsurance Brokerage 
Lou Dobbs
The Mortgage-Backed Securities Market
Hedge Funds
Social Security
Government Balance Sheets
Tooth Fairy

Errr ummm Professional Wrestling is starting to look good by comparison - at least it makes no pretensions to be anything other than it is. What's left?

Tuesday, June 24, 2014

Manna From Heaven

They call the JPX-Nikkei Index 400 smart beta. Ummmm, errrrr, yeah, sure, they can call it whatever they want, and perhaps, if they say it loud enough, and repeat it enough, some will adopt it as gospel. And God bless them - particularly the blithely gullible trustees. And my kids' trust fund blesses them - the latter benefitting large from (being as kind as kind can be) their rote sub-optimality. 

The JPX-Nikkei Index 400's  construction applies a straight-forward three-and-a-half stage process:  screen, score, score again, select by rank. Initial screening (from the TSE's website) looks like this and weeds out what, to some, is the detritus;

① Screening by Eligibility Criteria
Issues are excluded from selection if they fall under any of the following criteria. 
- Listed for under 3 years (excluding technical listings)
- Liabilities in excess of assets during any of the past 3 fiscal years
- Operating deficit in all of the past 3 fiscal years
- Overall deficit in all of the past 3 fiscal years
- Designation as Security to be Delisted, etc.
② Screening by Market Liquidity Indicator
The top 1000 issues will be selected from those eligible, excluding the above, in consideration of the following 2 items.
- Trading value during the most recent 3 years
- Market capitalization on the base date for selection

The first scoring covets OP, ROE and size, with bigger preferred to not-so-big.  The TSE calls this quantitative (noting the lower case "q" and italics, which are mine). It is a bit like an American vehicle MOT:  making sure it has four wheels (with tyres), the headlights that point straight, an engine that turns over when the fuel is ignited; the brakes stop the vehicle when in motion, and plumes of blue smoke are not being emitted from the exhaust. It is, yes, a car, in the least contentious sense.

The 1,000 issues selected in (1) will be scored according to the ranking of the following 3 items. (1st: 1000 points – 1000th: 1 point). Then, overall score is determined by aggregating those ranking scores with the following weights. (There are handling rules for the overall scoring with negative ROE and operating profit.) 
- 3-year average ROE: 40%
- 3-year cumulative operating profit: 40%
- Market capitalization on the base date for selection: 20%

The second scoring is qualitative, based on the admirable, but by no means universal, attributes of transparency, accounting standards, and oversight. For those that cannot distinguish what the second scoring is based upon as written,  it is "qualitative" with lower-case "q", italics and a tiny font size to highlight that this can only tweak the results by a maximum of 2%, a bit like smoking "lite cigarettes".

Following the scoring in (2), issues will be further scored based on the following 3 items. This score is complementarily added to the quantitative scores explained above (2)*.
- Appointment of Independent Outside Directors (at least 2)
- Adoption or Scheduled Adoption of IFRS (pure IFRS)
- Disclosure of English Earnings Information via TDnet (Company Announcements Distribution Service in English)
* The score is determined so that at most around 10 constituents are different from those chosen with only quantitative score above (2).

Then, it is a simple matter of letting the proverbial chips fall, or rather, rank wherever  they may, combined with an "all-change" every now-and-again.

So despite my amusement at such an offering, and thankfulness for those allocating passively to it, I am neither derisive nor pejorative in its essential mechanics, and though some might, I do not call it "dumb". It just does what it does. On the other hand, one would be forgiven for thinking proponents a tad hyperbolic in terming it "Smart". It isn't.  Beta? Yes. "Smart"? Errrr, no.  For how can something of value, that is being exchanged amongst consenting adults many of whom are meant to be fiduciaries, be "smart" when it is completely, and totally untethered from any sense of value? It is likely worse than navigating by dead reckoning, and probably inferior to the piñata method of security selection. Make no mistake, at times, it might be attractive. But, given that investors already covet consistent and high profitability in relation to their equity, with good governance, and that companies qualify only AFTER  they have had it for a good spell, it is not unlikely to forecast that it might, more often than not, yield negative alpha. So what would YOU call "smart" beta, with negative alpha? I call it "winning the battle but losing the war".

For many, however, this IS, manna from heaven. For exchanges and index licensors it means incremental revenue where none existed before. For journos it means grist for the mill. For trustees, it is a simplistic (albeit highly sup-optimal) answer to a complex investment problem. For Japan Inc. it provides convoy cover for suspicious behavior change -  yet-to-be-fully-embraced. For me, it will create a fantastic variety of relative investment opportunity whether from inflows, outflows, or re-balancing, that will keep giving and giving and giving. Hallelujah! Yes, it is manna from heaven for everyone except those investors whose money is passively and naively be thrown at something mis-labeled as "smart", though which is anything but. Blessed be index-makers...

Monday, May 26, 2014

Euro-Election Post-Mortem...

UKIP supporters, along with those of the European right are angry. And nostalgic. Nostalgic for ....ummm .....errrr..... Johnny Halliday? Johnny Rotten ? Sir Lawrence Olivier? Georges Pompidou? Chaban-Delmas? Harold Wilson? Ted Heath? Free parking? No traffic jams? A Ford Cortina or a Renault 4? Ten-pounds-a-week rent? Fifty-P a pint? Greasy chips fried in oil t'aint been changed for weeks? Baked Beans 'n'toast for breakfast? Twiggy? Cliff Richard? A white guy (not a Russian) winning at boxing or sprinting? One-piece swimming costumes? Free university? A job-fer-life? Iconic red pay-phones booths smelling of urine? Phones with an umbilical cord? Single-race marriages? The Cold War? Clean beaches? High-streets free from foreign food? Holidays in Blackpool? Turnips and root veg? Chicory drinks? Maybe. B ut I think that they are nostalgic for rising or stable real wages; a settled feeling that accompanies slower technological change; a stable job that pays a good stable real wage, with an indexed pension, and that is not undermined by someone more educated or qualified or enthusiastic, willing to work harder, for less especially if they are foreign; Oh and lower taxes. All of which are under siege. Regretfully, for sensible public policy, this has little to do with Europe, or immigrants, or the decline of religion and general moral standards. But that won't stop the angry cocks from crowing...like THIS.