The Great Debate

from MacroScope:

What emerging animal are you?

Jeremy Gaunt

Nov 15, 2010 06:59 EST

Ever since Goldman Sach's Jim O'Neill came up with the idea of BRICs as an investment universe, competitors have been indulging in a global game of acronyms. Why not add Korea to Brazil, Russia, India and China and get a proper BRICK? Or include South Africa, as it wants, to properly upper case the "s" - BRICS or BRICKS?

Completely new lists have also been compiled -- HSBC chief Michael Geoghegan has championed CIVETS to describe Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa (ignoring the fact, as Reuters' Sebastian Tong points out here, that a civet is a skunk-like animal blamed for the spread of the deadly SARS outbreak in Asia).

Fun though some of this is -- and no one can argue that BRICs has not had an impact -- there is a danger that the acronym could become more relevant  than the actual countries involved. For example, imagine Mexico, Uruguay, Panama, Philippines, Egypt, Turkey and Sierre Leone being lumped together because they spell MUPPETS.

With this in mind, the Spanish bank BBVA is now arguing that what is needed is a more dynamic concept, one that can remain in place acronymically,  so to speak, but allow for new entrants without the need to rewrite everything. Enter BBVA's EAGLEs -- an Emerging And Growth-Leading Economy, defined by its incremental GDP rather than absolute size. The founding 10 are China, India, Brazil, Korea, Indonesia, Russia, Mexico, Turkey, Egypt and Taiwan.

But BBVA reckons that is not enough. It also has an EAGLE's nest, which included fledglings that might soon grow up to soar -- Nigeria, Poland, South Africa, Thailand, Colombia, Vietnam, Bangladesh, Malaysia, Argentina, Peru and the Philippines.

MacroScope likes the idea of animals coming to the aid of investors and economists. It would like to suggest FERRETs -- Fast Emerging, Relatively Robust Economic Treasures. But it encourages anyone who feels inspired to submit their own suggestions.

Uncertainty, distributions and fat-tails

John Kemp

Aug 6, 2010 09:37 EDT

In a thoughtful article published this week in the Financial Times, PIMCO Chief Executive Mohamed El-Erian and Columbia Economics Professor Richard Clarida explore the implications of a shift in the shape of investors’ and policymakers’ expectations about the future.

“It seems that, wherever we look, the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves — with a high likelihood mean and thin tails (indicating most economists have similar expectations) — to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).”

They do not go quite as far as Bank of England policymaker Adam Posen, who suggested in a recent speech that the distribution of outcomes has inverted and become U-shaped. But their focus on a bell-curve with fatter tails agrees with Federal Reserve Chairman Ben Bernanke’s characterisation of the economic outlook as “unusually uncertain” at present.

El-Erian and Clarida draw five conclusions for investors:

(1) Investment strategies based on mean reversion will become less compelling. Fat-tailed distributions still have means but they will be realised less often in practice.

(2) Frequent risk-on/risk-off oscillations in sentiment will remain a persistent feature of the landscape.

(3) Hedging against tail-risks will become increasingly important.

from MacroScope:

The end of capitalism

Jeremy Gaunt

Nov 23, 2009 11:09 EST

Hard to imagine with financial markets still buoyant and newspapers full of tales of bonus greed, but there is still the possibility that captialism will end.  At least there is according to prestigious investment consultants Watson Wyatt in their latest study called "Extreme Risks".

The firm listed the demise of the system of private ownership as one of 15 threats to investors and the global economy that probably won't happen but which it reckons are worth worrying about anyway. The idea behind the report is that such things as climate change, the break up of the euro zone and war are always worth being included in an investment risk management process.

As for the future of capitalism:

In our view, the most likely scenario is moving along from one end of a spectrum where market is king (minimum regulation) towards the other end, where we could see more onerous regulations and government intervention in, and control of, the economy. The extreme risk, however, is the demise of the capitalist system and the end of the market as the primary means of resource allocation.

And the impact:

The economy would be likely to run a higher risk of failure and economic growth would be sluggish in the long run due to lower productivity.  Centrally controlled economies tend to be characterised by shortages, which are inherently inflationary. Private investment activities would collapse or even be terminated. The end of capitalism is simply the ultimate extreme risk. The economy is likely to be associated with extreme uncertainty and a large amount of wealth destruction during the transition period.

Watson Wyatt does try to give its free market clients some hope, suggesting that buying gold may be one way to hedge against the propect of capitalism's demise. But it admitted that in such a circumstance investors would probably be more concerned about the return of their investments rather that the return on them.

from The Great Debate UK:

Is it time for investors to look towards the U.S.?

-Kully Samra is branch director at Charles Schwab, UK. The opinions expressed are his own.-

The economic crisis that has prevailed over the global markets in the last 12 months has undoubtedly rattled investors worldwide, but rather than leaving their heads in the sand, seasoned investors have continued to search for opportunities amidst the instability.

One such opportunity that seems to have been overlooked by UK investors is that of overseas share ownership.

Whilst I have no doubt that there are viable investment opportunities in other markets, I do believe that the U.S. market provides a whole wealth of opportunities for the UK investor, especially those looking to diversify their portfolios. 

Whilst this belief stems from our experience of the U.S. markets it was recently supported by the findings of our latest survey which looked at the investing habits of active UK retail investors; specifically in relation to their views on overseas investments.

Our independent survey of more than 1400 British-based active retail investors found that 44 percent believed that the U.S. economy and financial markets would recover sooner than those of the UK, with only 28 percent believing that the UK will recover ahead of the U.S. 

We also found that investors expect the U.S. to lead recovery more generally, with 39 percent of respondents believing the U.S. will take more than 12 months to come out of recession, compared to 50 percent for the UK.

Don’t give the Fed a new job

– Mark T. Williams, a former Federal Reserve Bank examiner, teaches finance at Boston University’s School of Management and is writing a book on the rise and fall of Lehman Brothers. The views expressed are his own. —

In the real world, outside the Washington Beltway, when someone does a bad job they do not get more work.  The Council of Institutional Investors and the CFA Institute Center for Financial Market Integrity task force report agrees with this fundamental point:  Don’t give the Fed the new job.  As an ex-Fed examiner, I applaud this conclusion.

Creating an independent Systematic Risk Oversight Board (SROB) to monitor firms that pose significant risk to the market would inject new honesty to regulatory supervision.  This sound proposal comes at a time when Treasury Secretary Geithner would like to give his former employer, the Fed, additional regulatory duties even if they have failed to earn this right.  The report also is critical of previous light-touch regulation.  The SROB would provide a firmer approach, not repeating the mistake made by the Fed of coming with a knife to a gunfight.

A new oversight board would provide a fresh approach to preventing banks and other financial firms like insurance companies from engaging in risky and financially harmful practices.  Importantly, the task force report recommends restricting risk-taking activities, forcing banks to refocus on their core competencies – taking in deposits and making loans.  Although banks can get into trouble making loans, such activities are more transparent and easier to monitor than the trading of derivatives that, in a flick of a finger, can blow up a firm.  The report also advocates strengthening capital adequacy standards, important for a cushion against losses and insolvency.

Traditionally, banks have made money only three ways — loan interest, fees for services, and trading.  It would be extreme to say that all banks should be restricted from trading.  But there are many that lack the expertise, capital, trained staff, or sophisticated monitoring systems needed to adequately measure, monitor and control risk.

In a capitalistic system it is important to allow market forces to work so that risk taking is adequately rewarded and excessive risk taking is penalized.  However it is equally important to make sure that risky practices of banks do not come at the expense of broader market disruption, economic decline, lost jobs, and financial hardship.

The banking industry is at a fundamental inflection point.  To say, “It’s business as usual, let the Fed do the heavy lifting,” does not address the underlying problem.  How much risk taking should be allowed and how much concentrated financial power should be permitted in the hands of a few banks and non-bank financial firms is a paramount policy issue.

from Commentaries:

The Top Secret PE Exit Strategy

Matthew Goldstein

Jun 4, 2009 17:31 EDT

The problem with being a private equity investor is that you're subject to long lockups for withdrawing money--sometimes up to 5 years.

That wasn't much of an issue back in the halcyon days for PE firms--say three or four years ago--when investors could regularly look forward to high double-digit rates of returns. But today those long lockups are feeling like balls-and-chains, with PE firms having to take writedowns on their portfolio investments and investors seeing returns sag. 

Of course, one way an investor can try to get out a PE fund is by selling his or her limited partnership interest at a discount in the secondary market. But the trouble with the secondary market is that a PE firm's masters must sign-off on any transfer of an ownership interest. In good times, PE firms usually don't object much. But in hard times,  the PE overlords are reluctant to approvate partnership transfers--especially if they are sold at a considerable discount.

But some clever secondary market buyers have come up with an exit strategy that essentially keeps the PE firm in the dark about their investors' intentions. In essence, what these secondary buyers do is enter into a contractual swap agreement with a PE investor looking to get out a fund. The PE investor, in return for a cash payout, agrees to transfer any economic benefit he or she gets from the fund to the secondary market buyer. The PE investors legally remain a limited partner in the fund---but in name only.

Now for obvious reasons, secondary market buyers don't like to talk about these arrangements. But they are happening with greater frequency. I've gotta say there's some poetic justice in investors getting a chance to pull the wool over the eyes of these much hyped titans of finance.

Look to deal numbers for M&A green shoots

Alexander Smith

Apr 23, 2009 09:30 EDT

– Alexander Smith is a Reuters columnist. The opinions expressed are his own –

Volumes may be down, but there are green shoots appearing in the M&A market after the frozen winter of financial distress.

This doesn’t mean a return to the boom years of a few years ago. It could take years for deal values to reach the dizzy heights of the second quarter of 2007, given falls in asset prices. But the number of deals is recovering fast. This fell off a cliff in Q1 of 2009 and at just over 8,000 deals was the lowest global tally since Q3 2004.

Saving the economy from our brains

J Saft

Feb 6, 2009 05:59 EST

– James Saft is a Reuters columnist. The opinions expressed are his own –

Our brains are wired for bubbles, it would appear, and regulation and tight external controls are the only way to save ourselves from ourselves.

Bankers, traders and investors effectively became addicted to the pleasure that comes from making money, while at the same time increasingly losing touch with just how much risk they were taking.

The result was a bubble in risk taking, debt and many financial assets and the inevitable crash and complete pull back in activity.

“The finance industry was adapting to the level of risk,” said Gregory Berns, a professor of neuroeconomics at Emory University in Atlanta who uses brain scanning technologies to try and decode the decision-making systems of the brain.

“It is an insidious process, you are not aware of it. You are addicted to returns, you are addicted to risk, you are addicted to cocaine — it’s all the same as far the brain goes.”

Berns, who says that the brain has no mechanism for being satisfied, compares the process of becoming adjusted to new stimulus such as making money or taking risks to the eyes adjusting to the light; while at first it seems bright, your brain adjusts and you no longer perceive the light as bright, the money as enough, the risk as high.