Covid Notepad 3…plus a comment on Brexit

If there was one thing that was certain to flow from the Covid-19 pandemic, it is the volume of fascinating new research into the way people and governments react to the danger that the virus creates.

You may recall that early on in the crisis there were dire predictions of breakdown in the health systems’ ability to cope with ever-increasing numbers of infected patients.  The UK government was reportedly swayed by some damning projections from the ‘Royal Epidemiologist’ at the Imperial College London using their proprietary model.  The model, subsequently, was found to be full of programming bugs, poorly documented, enhanced by piecemeal and elementary in construct. Desperate times call for desperate measures but they also call for an intellectual upgrade in understanding societies’ reaction and policy options.

Here are some constructive discoveries from mathematicians and statisticians around the world…

  1. Ghader, Zhou, Lee, Zhou, Zhao and Zhang (“Observed mobility data reveals social distancing inertia” 2020) got some data on human mobility in the US from mobile phone companies on a mass, anonymised basis.  They calculated the number of trips and average number of miles traveled each day by each person (i) before the onset of the epidemic, (ii) immediately after it became news but before government lockdowns etc were ordered and (iii) after lockdown. They find that not only did the population cut their trips leaving home by 50% when the emergency became news in March 2020, this voluntary ‘social distancing’ took place before any government regulations were imposed.  They further find that the voluntary distancing reached a new average level after 2 weeks and subsequent attempts by government to further limit movement proved futile. The bottom line is that individuals reacted  faster and voluntarily to the Covid epidemic, while policy makers were late and ineffectual
  2. Elie, Hubert and Turinici (“Contact rate epidemic control of Covid19: an equilibrium view” 2020) build on these observations, delivering an elegant upgrade to the standard SEIR model used by the likes of Imperial College.  They posture the common externality where individual action has no marginal effect on virus transmission whereas collectively it does. That is, if I lock myself in a room I dont get sick, I bear a lot of cost BUT the virus rages on outside without me.  However, if everyone locks themselves in a room, we all avoid sickness and suffer costs BUT the virus is eradicated.  In their framework, there is an incentive to self distance voluntarily to not get sick and this naturally spills over to the aggregate endogenously, thereby reducing the spread of the virus.  Their numerical simulations suggest that the probability of infection falls to 62% from 80% in the standard model. They go on to introduce a powerful government to stamp out the virus.  This imposes almost double the social costs on society. The bottom line is that social distancing is a logical response to an epidemic thereby attenuating the viral spread while government restrictions are not very well appreciated by the population.

…a comment on Brexit

Governance, dispute resolution and fisheries, we are told, are the 3 issues impeding a cooperative Brexit. Lets deal with each issue simply and realistically.

Governance refers to who controls the quality standards applying to the exchange of goods and services.  The EU wants the UK to follow their standards.  The UK, on the other hand, wants to set their own standards, be they higher or lower than the EU.  It is hard to imagine a compromise on this question since this is the whole point of leaving the EU!

Dispute resolution refers to the jurisdiction that has authority to mediate a dispute.  The European Union wants the European courts to have jurisdiction while the UK wants UK law to apply.  It is hard to imagine a compromise on this question since legal sovereignty, again, is the whole point of leaving EU!

Fish.  British waters are home to fisheries that the EU want access to FOR FREE.  Again, the whole point of leaving the EU is to regain ownership and control of your resources.  The obvious compromise in this disagreement is for the UK to charge the EU for access to British fishing grounds.

Put simply, Governance and Dispute Resolution are the two ‘biggies’ that have no other solution than abandoning the Brexit idea altogether.  The EU and the UK should just accept this and let competitive forces determine the outcome.  The market mechanism has its own way of deciding on quality standards (the economics of price and cost) and dispute resolution (contracts specify the jurisdiction that will apply in the event of a dispute).  After 4 years of ineffective government attempts to fulfill the UK’s decision to leave the EU, finally the market is set to take over.  The market mechanism will quickly and efficiently find a way.


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When POTUS sneezes, nobody catches a cold…Trump’s win-win Covid diagnosis

Upon learning of President Trump’s Covid diagnosis on Friday afternoon, several friends asked me what would be the implication for the stock market? My response was that the illness was basically a non-issue.  In fact, this proved to be the case since the US stock markets finished down less than 1% by US close, about 0.8% higher than the S&P500 futures were indicating at the time of the announcement of Trump’s illness in Asia.  Collectively, the media went out of its way to dramatise the POTUS Covid diagnosis, without success, while the rest of us remain curious to see just how easily or otherwise Trump copes.  This latest twist in the POTUS Reality TV show that has been playing for nearly 4 years is so much more entertaining than what we would have had under Clinton MkII !

I firmly believe that someone with economic power would materially influence the asset markets should they fall ill or in some way become unable to exercise that power.  The corollary to this belief is that if POTUS has no economic power then the market will be unaffected.  Indeed, that belief underscored my initial assessment that Trump’s diagnosis is a non-issue for markets.  This may be hard for many to accept but the fact is that there is nothing much you can do to influence the economy if you are POTUS let alone anybody else in the community.  [It has been speculated that Larry Fink, CEO of Blackrock, commands more economic influence than Trump by virtue of his firm’s 50% shareholding in just about every company on earth!]  One of the beauties of the market system of economic organisation is that no one person calls the shots, rather the price mechanism aggregates the views of every atomistic actor to resolve a complex system delivering scarce resources to the economic sectors that can use them most efficiently.  Donald Trump may want to favour US manufacturing over Chinese delivery of output but that is not going to happen while Chinese labour is 10% of that of a US workers, for instance.

The one area that Trump’s illness may affect markets is its effect on the probability that the Republican party will lose the Presidency and/or control of the Senate.  It is well documented that Republican administrations are favoured by the stock markets so anything that tips the balance in favour of the Democrats would be bad for stocks.  Again, despite the turgid attempts by the elitist media to show that Trump’s behaviour courted the illness for himself and others in the community, it strikes me that this is a Win-Win situation for Trump.  I say this because there are 2 clear scenarios for the course of his illness, either

(i)  Trump recovers without complications; or

(ii) Trump falls gravely ill in a life/death scenario ultimately surviving or passing on as the case may be.

Scenario (i) would seem to vindicate his public stance to date that the Covid 19 virus is not as bad as its made out to be.  In this scenario POTUS turns out to be right and he wins votes for his good judgment.

Scenario (ii) commands public sympathy for the President and this means votes for him personally if he survives or his Vice-President if he doesn’t.

In both scenarios Trump wins votes.  Add to this the strong possibility that Trump will not be able to show up for the final Presidential debate, thereby avoiding self-harm, and it would seem that Trump will benefit from all this.

I stand by my prediction that Trump will win a second term.

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Arrigato goziemasu Warren-san…plus what is Vegas saying about Trump?

Warren Buffett is turning Japanese, I think he’s turning Japanese, I really don’t think so…

Value investing has been a tough slog for superstar investors like Warren Buffett for the last decade or so.  I am not sure I really understand how to classify Value (as opposed to Growth) investing, but Warren Buffett’s approach is to cuddle up to strong brands with strong cash flow in boring established businesses and just meek out consistent above market returns.  This worked for many years until the exciting, disruptive technology businesses took over the hearts and minds of investors leaving the boring established businesses to underperform. Suddenly friendless in the US, Buffett announced yesterday that he was taking a $6billion stake in 5 of Japan’s top boring established businesses – the trading companies.

Buffett famously tells his acquisitions’ management to just go ahead and do what they do.  The Japanese trading houses, however, are remarkable for what they don’t do – they don’t pay dividends, they don’t make profits and they don’t seem to focus on a core brand/skill/product. They follow Shogun and Samurai-like traditions which foster and protect an elitist management culture. The companies operate for the benefit of its employees not its shareholders. Warren-san is gai-jin, to make things more difficult, with ‘down-home’ US values that are as opposite to Japan as sushi and sake is to steak and Coke.

The irony is that the Presidents’ of the trading houses will see Buffett’s appearance as a validation of their strategies. They will take photo opportunities to kneel at the feet of the Sage of Omaha, attentively listening, while powerless to effect any change within bureaucratic organisations that operate on full consensus decision making where one middle ranking manager can stymie an entire initiative simply by doing nothing…Fortunately, Buffett is not an activist investor since inaction is the rule.

Is Buffett making a good investment? On the face of it, yes.  The trading houses are so opaque and hundreds of  years old that there are hidden treasures in their balance sheets that have never been mentioned (real estate, supply monopolies, contracts), let alone the political influence these organisations can wield to further their interests. Unlocking this value is near impossible as cultural values would not allow it. But as the saying goes, there is no such thing as a bad investment, just a bad price.  We shall see whether Warren manages to turn a $6billion investment into $3billion or $10billion

plus what is Vegas saying about Trump?

The Donald has moved into the lead in Vegas with the betting now 19/20 for Trump versus 1/1 for Biden.  That is pretty close but it should be remarked that it is very hard to find people who admit to voting for Trump.  The silent majority rules in this market.  The Money v Mischief theory of elector behaviour is still firmly in favour of Trump.  Vegas is the natural place for Trump supporters to express their silent belief by opening their wallets instead.  Trump is already odds-on with 3 months to go and this will shorten.  I am calling the US Presidential election for Trump!

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Tossing coins: The Vaccine v The Fed

AstraZeneca, Pfizer, Moderna and other drug makers are finalising their ‘warp speed’ vaccine trials in order to stop the infection and spread of the dreaded Covid 19.  Simultaneously, the Federal Reserve in the US is set to roll out its new Monetary Policy operating procedures for all to behold. Both the vaccine designers and the Fed risk abject failure.  Which of these actors have the best chance of success?

Success?  Vaccine design and Monetary Policy are surprisingly similar when it comes to delivering real results.  Comforting both may be when it comes to the collective security blanket that ‘…the government is doing something…’, but in terms of actual results, Vaccines and Monetary Policy often fail to deliver.  Success is better measured in terms of bedside manner…

Lets flip a coin and deal with what comes up first… heads for Vaccine, tails for Monetary Policy.  Heads!

The anecdotal evidence is that the Oxford vaccine elicits an immune response in 40-60% of recipients.  This means its a coin toss! Should we celebrate a vaccine that fails half the world’s population?  Of course, simply because a vaccine is needed primarily to provide policymakers with an escape hatch from the straitjacket that they have gotten the world into.  Covid 19 is a problem, the magnitude of which should not be underestimated, but neither should it be a reason to inflict undue economic pain on society. Governments have drawn lines in the sand that they can only cross once a vaccine is approved. Get innoculated and get back to normal.

The Fed, on the other hand, has a tough job. Some of the most basic questions in economics – what causes inflation? what causes unemployment? – have left policymakers stranded for the last 30 years.  Back in the 1970s and 1980s, the Economics community had pretty much decided that prices were determined by the money supply in the long-run while there was disagreement over whether employment could be stimulated or not in the short-run.  This led most Central Bankers to adopt stable monetary rules over the long run experimenting with short-term stimulatory policies.  The problem is that the policymakers have neither achieved their long run inflation objectives nor have they been able to systematically influence short term employment or output.  The success of a monetary action is a coin toss!

The Fed’s new approach unveiled on Friday would seem to focus more on achieving the long run inflation objective, now targeted at 2%, as opposed to focusing on short term fine tuning.  I don’t claim to understand this but the link between money and inflation has failed us for 3 decades so why should it suddenly just appear again because the Fed wants it to?  The popular press interprets the new approach as a justification for keeping interest rates at zero for a long time.  Again, I don’t understand this.  The empirical evidence in my view is that the ability of the Fed to impact the real economy through monetary activity depends on how the banking system responds to the event provoking the policy action.  The Fed gives money to the banking system and then the banks decide whether to lend or not.  If they don’t, which seems to be the pattern, then the money flows straight back to the Fed.  A better way would be to simply increase everyone’s bank account directly.  (A contractionary policy action would reduce everyone’s bank balance – imagine the riot that would cause!)

Success?  It would seem that a Covid 19 vaccine has a better chance of returning society to ‘normal’ than does the Fed’s policy rule have of returning the economy to ‘normal’.  This is because the vaccine only has to convince a small number of regulators to ease up restrictions on travel and interaction whereas the Fed’s job is to convince hundreds of millions (actually billions) of people to do something different.


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Is Covid 19 an election issue? What is Vegas saying about Trump?

Is a Government’s handling of Covid 19 an election issue?

Several elections have been run during the pandemic.  In most cases, the governing party has sought to portray their handling of the Covid 19 problem as testimony to their credentials.  Singapore’s ruling PAP, for instance, made the Covid 19 issue central to their credibility.  New Zealand is on its way to the polls in September with their Prime Minister’s popularity having been bolstered by the apparent success is eliminating the virus from their fair shores.  The US election happens shortly after.

The election result in Singapore surprised many with a 10% swing away from the Government.  The obligatory post mortem found disenchantment amongst young voters on many issues but the Covid 19 response was virtually absent from any blame.  This suggests that Covid 19 is not an election issue in the minds of voters.  This stands to reason, actually, since the Covid 19 event is purely external to any Government policy choice that had been made prior to it appearing.  There are many ways to deal with the emergency – lock down, test extensively, sponsor research etc etc – and voters expect their Government to act responsibly but it may be that this cannot be exploited by the ruling party as an election issue.  The fact is that the same or similar reaction would have taken place regardless of who is in power at the unfortunate time of the pandemic.

That voters neither apportion credit nor blame on the particular Government in power for how they deal with Covid 19 should be a wake up call for New Zealand Prime Minister Jacinda Ardern and the Presidential twins Joe Biden and Donald Trump.  Ardern could suffer an embarassing swing against her and be ousted from office while Biden cannot paint a general picture of Trump’s incompetence based on Covid 19 – after all, the virus is not Trump’s fault.  Blaming China, on the other hand, may well resonate with the US electorate…

What is Vegas saying about the US Presidential election?

As of today, the Presidential betting favours Biden over Trump.  Biden’s odds of winning are odds-on 8/11 while Trump is 7/5 against (data courtesy of oddschecker.com). Those of you astute enough to analyse the implied probabilities from these quotes will notice that there is something wrong with this market.  Biden’s probability of winning is 0.579 while Trump’s is 0. 417, which if you add the probabilities together comes to 0.996.  The problem is that no self-respecting bookmaker would quote a market that is unfavourable to themselves. The mathematics of bookmaking defines a ‘fair book’ as when the probabilities sum to one whereas bookmakers try to ‘overround’ to make a profit which happens when the probabilities sum to more than one.

My suspicion is that a punter would find it hard to take Trump at 7/5.  You may recall that the day before the 2016 election, Trump was offered at 5/1 while Clinton was 1/11 (the overround on this market being 1.083 or an 8.3% commission for the bookies). In fact, the brainstrusts at the UK bookmaker Paddy Power had paid out the Clinton backers a week early only to have to pay the Trump backers as well upon his upset win.

Vegas won’t write Trump off just yet.


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Covid notepad 2 : Observations and opinions

Government v covid 19: I

Suppose you are the leader  of your country and your chief medical officer came to you with one of the following two statements:

A. “We have detected the rampant spread of a new virus that will kill 10% of those who contract the disease.”

B. “We have detected the rampant spread of a new virus that will kill 1 in 10,000 of those who contract the disease who are under 70 yrs old and 1% of those over 70yrs old.”

What do you do? Clearly, statement A is cause for alarm and justifies radical action from both a social and economic perspective.  Statement B is discomforting but hardly cause for policy action that will force sectors such as restaurants, travel and entertainment into forced bankruptcies and pushing the unemployment rate up 10%.  The policy response to Statement B would be to take action to contain the spread of the disease and protect those most at risk.

Back in March this year, the chief medical officer for every country on earth could justifiably have communicated statement A and the Government could equally have justified the draconian lockdown/shutdown policies that followed.  But now, with the benefit of hindsight, the facts suggest statement B to be the correct one thereby modifying the appropriate policy response…right?  Not so right…

…a second wave of the Covid 19 virus is flaring up in many countries with the response such that partial lockdowns have been commanded in places such as California and Australia.  Borders that were to open remain shut.  Governments globally are openly cautioning that if the pandemic reignites then they will revert to their draconian controls.

As with everything that is repugnant or causes costs on our society (for example crime, pollution, violations of human rights abuses) while the noble objective might be to eliminate covid 19 entirely, the economic cost may well exceed the benefit.  Just as there is an optimal amount of crime in society there is also an optimal amount of covid 19.  Lets hope that this threat to eliminate covid 19 is a scare tactic rather than a genuine policy option.

Government v covid 19 : II

Suppose you are the leader of a country that has successfully eliminated covid 19. You now turn your mind to re-opening your borders. You ask your chief medical officer,

Dear Leader:  What is the chance of covid 19 re-emerging if we open our borders?

Chief medical officer: Absolutely and without doubt I am 100% certain covid 19 will re-emerge no matter what you do

This is arguably the clearest case of ‘Winners Curse’ one could imagine.  Winning the battle against covid 19 simultaneously commits your society to a life of isolation, just like Robinson Crusoe!

New Zealand has achieved this position.  In the 1960s and 1970s NZ was one of the most regulated and closed economies on earth under the Robert Muldoon government.  That isolationist stance didn’t turn out so well, so upon his ouster NZ adopted a radical transformation of policy the country embracing deregulation and free markets.  NZ prospered.

How ironic it is that the country has returned to its autarkic past! The pandemic is forcing the country into isolation once again, with all the lost trading opportunities. What NZ needs is a good dose of Covid 19 to bring them back into the real world!


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The real G7

Germany, the UK, Japan, France, Italy, Canada and the United States make up the G7 Leading Economic nations.  The membership criterion is, loosely, that these countries produce the most output by virtue of their population’s size and productivity.  Donald Trump, the US President, has proposed inviting a broader range of countries to join the G7 on the basis that the existing members do not really represent the economic powerhouses in the modern world.  He proposes adding Russia, South Korea, India and even Australia.

This raises the question: what should the G7 actually look like?  The starting point for economic analysis is generally Per Capita GDP, that is the average output per citizen in an economy.  When judged by per capita output, the economic leaders in the world look a whole lot different than the current membership of the G7.  Stripping out the nations that attract wealthy citizenry seeking a taxation refuge (San Marino, Monaco, Cayman Islands and the like), the following is a list of the 10 wealthiest nations on a per capita GDP basis,

  1. Luxembourg – EU tax
  2. Switzerland – Banking
  3. Norway – Oil
  4. Ireland – EU tax
  5. Qatar – Gas
  6. Iceland – Fisheries
  7. United States – diversified
  8. Singapore – diversified, tax
  9. Denmark – diversified service focus
  10. Australia – natural resources, diversified

What a different role model the G7 would be if its membership were formed from those countries with upwardly mobile personal income generators instead of old-fashioned manufacturing based welfare states?  The per capita GDP rich list has a majority of states that happen to be luckily endowed with valuable natural resources such as fisheries, minerals, oil and gas (Qatar, Iceland,Norway and Australia) or which operate a low corporate tax regime (Luxembourg, Ireland and Singapore).

The United States is the only country that deserves membership of the G7 by the per capita GDP metric.  It is also by far the largest of any of the countries listed by population with 33omillion people.  In fact, Australia is the second most populous rich nation on the list with 25million with the rest in single digits.

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An activist in the VC woodpile signals MPT is on its way

Paul Singer, the billionaire activist investor, just announced that his Elliot Investment Fund has taken a 20% stake in Masayoshi Son’s Softbank Ventures.  Activist investors make a living out of forcing efficiencies on inefficiently run companies. Softbank is a legend in VC-land, yet it trades at a 50% discount to NAV.  Masayoshi Son is a superstar investor amongst VC’s yet, were he a mutual fund manager, he would be a laughing stock with a fund trading at such a discount.

What do we make of Singer’s initiative? The simple answer is that Singer is going to pressure Softbank to take steps to narrow the discount by adopting best practice investment principles. But Masayoshi Son is a superstar, the VC investor that every VC investor wants to be – in VC-land he is doing nothing wrong, this is how VC operates.  Singer and Softbank are shaping for a Titanic clash of – well- Titans.

Modern Portfolio Theory has forced major changes on the investment portfolios of institutions and individuals.  Index funds never existed 50 years ago but now they make up more than 50% of the market.  In the 1950s, investors were all stock-pickers, stitching together portfolios of 50-odd stocks or buying 20 of the 30 constituents in the Dow Jones Industrial and Transportation Indices.  JPMorgan’s ‘Nifty-Fifty’ was the staple investment for US Corporate Pension Funds back then and the investments were ‘actively’ managed.  Indexing had not been thought of.

Modern Portfolio Theory made two important observations that has shaped portfolios ever since the field emerged in the 1960’s,

  1. Every security return can expressed as the sum of its market exposure (its beta) and a company component (its alpha).  The beta : alpha mix for a listed security is about 30% : 70%
  2. Passively managed Index funds outperform the average active investment portfolio

These two simple observations are related.  From 1., since every security contains a market exposure and a company specific return, a portfolio of securities builds up its exposure to the market and a collection of ‘alphas’.  By 2, the only way to beat the index is for the collection of ‘alphas’ to sum to something that is greater than zero (after transaction costs and fees).

The result of this thinking turned portfolio management on its head.  Previously, portfolio managers had constructed portfolios by starting with a collection of stocks that they liked and the return that they received was a mixture of market and alphas.  Today, the modern approach is to start with the market return and then step out into individual securities that appear cheap (ie have a positive alpha).  The difference is subtle but completely transformed the investment industry.  The starting point for an investor is to buy the market where possible and to only concentrate in individual securities when you have a good reason to.  For most investors, the likes of institutions and individuals, there is never a good reason to take bets on stocks – markets are informationally efficient and the likes of Paul Singer are all over those opportunities when they arise…

So what does all this mean for VC?  Just as there are undiscovered tribes in the Brazilian Amazon and the Mountains of Papua that have yet to be touched by civilisation, VC is one of the last bastions of investment management that has yet to be touched by Modern Portfolio Theory.  Having only recently been exposed to the practices of VC-land I am appalled at the near-absence of science with which investors and managers alike approach this market.  The typical VC investment portfolio holds 20 or fewer companies, risk-control is driven by draconian rules of thumb (“…we only invest in series A or later …”) rather than portfolio diversification principles and qualitative instincts drive decisions rather than quantitative objectivity.  This is all the more surprising when it is recognised that VC returns are almost 100% alpha driven as opposed to the 70% alpha exposure for listed equities.  The volatility of the sector is gut-wrenching, highly skewed toward complete failure (95% of startups lose 100% of their capital) and informationally asymmetric.

That said, the VC sector as a whole has delivered some eye-popping returns with the Thomson-Reuters VC Index delivering 22% pa since 1996. Investors are increasingly attracted to these returns however the industry is so antiquated that the only way to get exposure is through old style stock picking which is expensive, unnecessarily risky and a shark tank for the uninitiated.

The Singer-Son clash may change the VC dynamic.  Effectively arbitraging the 50% discount of Softbank to its Net Asset Value requires Softbank to (i) liquidate some of its investments and pay out the proceeds to shareholders, or (ii) open-end the fund thereby allowing for subscriptions and redemptions at NAV, or (iii) buying Softbank and hedging its components by shorting the underlying[1].  The Singer-Son clash, however, may get the VC market thinking about how to deliver VC returns in the Modern way.  That is, finding a way to deliver diversified market index type returns to investors who want VC beta and then specialising in stock picking to generate alpha.

There are very few diversified VC funds offering beta exposure.  We are proud to say that we are associated with the Hatcher+ fund (www.hatcher.com) that is designed to deliver beta for startup tech VC by investing in 1,300 startups over the next few years. Traditional VC investors see this as a ‘radical’ approach to their market and are either intrigued or skeptical.  The truth is that the Modern Portfolio Theory train is heading toward VC-land so either you jump aboard or it will run you down.


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[1] Softbank’s two significant investments are its stakes in Yahoo and Sprint Telecommunications, each of which can be shorted.

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Blackrock abandons its passive positivism in favour of active value-judgment

Social reformers, religious zealots, the politically correct, the politically active, tree huggers, the elitists and a host of  other individuals with non-libertarian attitudes have difficulty accepting cold, hard, facts. Rather than acknowledging society as it is and trying to explain why it is that way, these people want to change it.  Positivism, on the other hand, (like Buddhism) is all about acceptance. Much can be learned from understanding the way things are rather than simply objecting to facts of life and trying to impose something different.

Passive investing is the ultimate expression of acceptance, the Buddhism of Finance,  joining the capital flow rather than fighting it.  Passive investing simply buys the market with all its glorious technological superstars like Tesla and all its dirty polluters, its gun manufacturers and even fraudulent companies that happen to make it into the index. Passive investing happens to outperform the multitudes of active investors who impose their value judgments on every index component – from this standpoint, passive investment is optimal.  The passive-positive approach is best.

So it is with great surprise that Larry Fink, the head of Blackrock, the largest passive investment house in the world, has decided that passive investment needs to change. His letter to Corporate Heads this year has placed purely passive investing in the co-pilot’s seat and substituting a suite of ESG-tilted passive funds as the default option for the USD7Trillion in their investments.  ESG stands for Environmental, Social and Governance and from now on Blackrock will favour companies with high ESG rankings over low ones.  This is magnanimous, bold, benevolent even…but crucially departs from the core philosophy of being passive which is being positive and accepting.  We might not like the polluters, the guns and the fraudsters but they are there for a reason.

In simple terms, diverting capital away from low ESGs to high ESGs will cause the relative price to fall today – but consequently their relative future returns need to be higher to attract future capital.  Blackrock’s ESG-tilted funds are therefore destined to underperform their pure passive funds…imposing lower returns on their investors for ESG reasons would seem a breach of fiduciary duty.  This is particularly the case where there is no standard to judge the beneficial external impacts of ESG initiatives.

The irony is that Blackrock is adopting a novel form of active management, precisely the investment approach that they have debunked and from which they have won market share. Pure passive investors must be relishing the chance to take them on.


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An FDV threeway: Swinging in Saudi Arabia…plus Our UK Election Special…plus the latest release from DJ Dr Fish

Swinging in Saudi Arabia

ARAMCO officially listed yesterday.  The Saudi owned company is the world’s largest oil producer, world’s largest company … the world’s largest many things.  It has played a political role, a diplomatic role and a world economic role for many years as the ‘Swing Producer’ in the oil markets.  Swing producers have the capacity and substance to stabilise oil markets should there be short term fluctuations in supply.  Swing producers can also act as policeman to a price-fixing cartel such as OPEC.  Swing producers, it is fair to say, may not necessarily act to maximise profits, especially when it belongs to a Sovereign entity with many competing objectives…

…but now that ARAMCO is a listed entity does this change?  The starting point for a public company is to maximise profit and it is not clear that ARAMCO’s activities to date have had that objective.  Cartels, such as OPEC, aim to control the supply of a commodity in order to fix a price that will benefit all members in terms of higher revenue.  That price is typically way higher than the marginal cost of producing the commodity so there are clear incentives for one or more members of the cartel to chisel away at their production quotas, selling more oil than they are permitted for profits at the expense of other members.  Cartels are inherently unstable, therefore, and it is the role of the Swing Producer to bring discipline to its members.  In this way, the Swinger is not acting to maximise their own profit per se, rather they are bearing the cost of policing other members sly activities.

Public companies are not meant to engage in price-fixing arrangements, collusive anti-competitive behaviour nor any supply manipulation.  On the face of it, however, ARAMCO’s raison d’etre has been all these things.  Owing to its  ‘strategic global importance’ ARAMCO will get away with all these activities as the global regulators turn a blind-eye to it all.  ARAMCO’s shareholders, however, may think differently.  While the non-government shareholder register represents only 1.5% of the stock, they will want their rewards – as either higher dividends or higher stock prices.  This may force ARAMCO to abandon their Swing activities and, quite possibly, become a source of instability themselves.

UK Election special: Money v Mischief in the UK Brexit Poll

Speaking of cartels, the UK is going to an election om December 12 to break the impasse caused by the UK parliament’s inability to follow a simple instruction.  In 2016, the UK’s electorate decided to leave the European Union, a particularly vicious cartel that favoured members such as France, Italy and Germany over others such as the UK.  Breaking the cartel seemed, on the face of it, the right thing to do.  But the UK’s government has had difficulties letting go of the security blanket and their Whitehall bureaucrats got busy negotiating a ‘Claytons Brexit’ – an expression for the Brexit you have when you are not having a Brexit.

Frequent readers will be aware of my ‘Money v Mischief’ theory of voter behaviour.  Basically, the ‘thoughtful swinging voter’ make their mind up only when they reach the polling booth and they do so based on (i) how much money they expect to make from each party and (ii) how much mischief they can cause within their own parliament.  On this basis, the Labour Party in the UK might well surprise with their pork-barrelling of promises such as free fibre internet for everyone.  The mischief vote goes squarely to Boris Johnson who, despite being a career politician, candidly expresses his impatience with the talk-but-no-action that is modern democracy.  Sadly for the Liberal-Democrats, they offer neither money nor anything other than ‘good policy’ which, irrespective of its content, is pure boredom.

So on this basis, my prediction for the UK elections are

(i) The Liberal Democrats get decimated to the point of extinction

(ii) The Conservatives easily obtain a majority as the electorate send a message to the parliament to just get Brexit done

(iii) The Labour party pick up the Lib-Dems losses


…and finally, check out the Christmas Album from DJ Dr Fish

The latest release does NOT have any of the songs that your DONT want to hear at Christmas.  Just 63 minutes of relaxing, progressive trance.



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