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from Global Investing:

Active vs passive debate: the case of “monkeys”

As CalPERS considers switching all of its portfolios to passive investing,  questioning the effectiveness of active equity investment, there have been some interesting findings that would stir up the active vs passive debate.

Researchers at Cass Business School find that equity indexes constructed randomly by "monkeys" would have produced higher risk-adjusted returns (ie return adjusted by measuring how much risk is involved in producing that return) than an equivalent market capitalisation-weighted index over the last 40 years.

How does this work? Using 43 years of U.S. equity data, researchers programmed a computer to randomly pick and weight each of the 1,000 stocks in the sample, effectively simulating the stock-picking abilities of a monkey.The process was repeated 10 million times over each of the 32 years of the study.  Nearly all 10 million indices weighted by chance delivered vastly superior returns to the market cap approach. Andrew Clare, co-author of the paper, says:

“The results of this experiment showed that many of the monkey fund managers would have generated a superior performance than was produced by some of the alternative indexing techniques.  However, perhaps most shockingly we found that nearly every one of the 10 million monkey fund managers beat the performance of the market cap-weighted index.”

from Global Investing:

Here comes the real

Inflation is finally biting Brazilian policymakers. The real strengthened around 1.5 percent last week without triggering the usual shrill outcries from government ministers. Nor did the central bank intervene in the currency market even though the real is the best performing emerging currency this year. The bank in fact shifted towards a more hawkish policy stance during its March meeting, a move that seems to have had the blessing of the government.

Friday's data showed the benchmark consumer price index, IPCA,   up 0.6 percent for a year-on-year inflation rate of 6.31 percent. President Dilma Rousseff, who faces elections next year, took to the airwaves soon after to reassure voters about her commitment to taming inflation, announcing a series of tax cuts. That effectively is a signal that there is now no political constraint on raising interest rates. According to the political risk consultancy, Eurasia:

from Breakingviews:

Frankenstorm is salient risk management reminder

By Rob Cox

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The Frankenstorm battering the east coast of the United States provides a salient lesson in the virtues of risk management. When it comes to natural disasters, there’s no such thing as too much preparation. The same is true in business, particularly banking: calamities often strike without warning - and there’s no such thing as too much capital.

from Felix Salmon:

How Goldman Sachs protects itself from a hundred-year storm

(Picture from Stephen Foley)

"When it comes to natural disasters," says Rob Cox today, "there’s no such thing as too much preparation." He then goes on to extend the analogy:

In advance of Sandy’s march through Manhattan, thousands of sandbags have been stacked in front of the downtown headquarters of Goldman Sachs. It is a picture whose metaphorical value should not be lost on regulators, policymakers, shareholders and the bankers themselves: when the flood comes, there can never be too many sandbags, or capital, to prevent a wipeout.

from Financial Regulatory Forum:

IA brief: State laws may require firms to re-think social media policies

By Jason Wallace

NEW YORK, Oct. 3 (Thomson Reuters Accelus) - Federal and state privacy legislation aiming to protect against employer access to private social media websites may put the investment industry in a bind -- unable to fully supervise social-media and electronic communications used by their representatives.

Broker-dealers and investment advisory firms have been carefully embracing social media over the last few years. Firms have shaped policies and procedures with a balance between the needs and wants of their representatives while still making it possible to supervise and ensure compliance with regulatory regulations and guidance.

from Felix Salmon:

Who is to blame for Ina Drew’s downfall?

Susan Dominus has a big 7,500-word NYT Magazine feature on the rise and fall of Ina Drew, featuring a couple of bland quotes from Jamie Dimon but nothing --- nothing on the record, at least -- from Drew herself. (We're told explicitly about four different people who declined to comment when approached by Dominus, including "London Whale" Bruno Iksil and his boss Achilles Macris; Drew is not one of the four.)

The story, as Dominus presents it, is a tragic one. Drew was a highly competent and highly successful trader, who used her deep knowledge of the markets to stay one step ahead of the quants and the rocket scientists who coveted her job. But then she decided that she needed a group of quants and rocket scientists herself, and after she came back from her year-long battle with Lyme disease, which kept her out of the office for most of 2010, she never really regained full control or understanding of what the London office was getting up to.

from Financial Regulatory Forum:

Knight Capital crisis brings new push for rules on trading, technology, structure

By Nick Paraskeva

NEW YORK, Aug. 6 (Thomson Reuters Accelus) - The near-collapse of equity market maker Knight Capital after sending erroneous trades to the New York Stock Exchange last week is the latest in a string of errors causing heavy losses and disrupting markets. While smaller in dollar terms than losses from JPMorgan’s ‘London whale’ or UBS’ rogue trader, it is causing regulators to review firms' compliance and controls over operational risks, and rules for restructuring of equity markets.

“The apparent trading error by Knight Capital Group reflects the type of event that can raise concerns for investors about our nation’s equity markets,” SEC chairman Mary Schapiro said on Friday. “I have asked SEC staff to accelerate ongoing efforts to propose a rule to require exchanges and other market centers to have specific programs in place to ensure the capacity and integrity of their systems”.Knight disclosed $440 million losses on unwinding the erroneous and duplicate orders in 140 stocks. The loss was half the firm’s market value and the stock fell 75% before recovering on Friday on rescue hopes. The firm said on Monday that a group of investors would rescue it in a $400 million deal that keeps the company in business but comes at a huge cost to its shareholders.

from Stories I’d like to see:

Romney’s tax audit, Aurora and risk, inside the IRS

1. What happened with Romney’s audit?

On Sunday, Mitt Romney – while promising ABC he would "go back and check" to see if he had ever paid less than the 13.9 percent in income taxes he reported paying in the only return he has released so far – volunteered that he had been audited in the past by the IRS. So, the next question needs to be, "Governor, when you were audited, did the IRS then require you to pay additional taxes, and, if so, would you specify the discrepancy between what you claimed and what the IRS determined was the appropriate tax? And was more than one year of returns audited? If so, what were the results of those other audits?"

2. Aurora and risk:

When I saw reports in the wake of the Aurora massacre that theater chains are thinking about how they might implement new security measures to restrict who can bring what into a theater, I was reminded of a story I read recently about what happened in the aftermath of a horrific air crash 16 years ago.

from Financial Regulatory Forum:

U.S. brokerage regulator warns of ‘unpleasant surprises’ on ETNs

By Stuart Gittleman

NEW YORK, July 11 (Thomson Reuters Accelus) - The Financial Industry Regulatory Authority, the U.S. brokerage regulator, warned investors Tuesday in an alert of the features and risks of exchange-traded notes.

The alert, Exchange-traded notes: avoid unpleasant surprises, listed the risks of certain ETNs and urged investors to carefully investigate before investing in them. FINRA and the Securities and Exchange Commission have raised their oversight of disclosures and sales practices for ETNs and other complex structured products, and FINRA enforcement chief Brad Bennett said cases will be brought over suitability.

from Breakingviews:

Regulator grudge match redux: Geithner vs Bair

By Daniel Indiviglio
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Get ready for round two of the “Bair versus Geithner” sparring match. Sheila Bair may no longer run the FDIC, but she has formed an independent group to push forward reforms in the U.S. financial system. The primary pressure point will be the council of regulators led by Treasury Secretary Timothy Geithner. While the two have tangled before, their interests are now aligned.