Random Thoughts on The City, Wall St & Capitalism

Are you arrogant, basically talentless, a average to poor investor, like to be taken to lunch a lot by brokers, want to be paid a couple of hundred grand a year for underperforming the benchmark index of your choice. Then why not become a fund manager in the UK . It's sleepy, it's long only, it's easy money.You don't even need to try and hedge currency risk if you can't be bothered or don't understand it.No need for fancy derivatives either, oh yes UCITS III let's you use them. But it's all such such a bore. If you started actually trying to make money for investors when would you have time to play golf, or go out, you'd actually have to do some work.

It's common knowledge most fund active managers in the UK underperform their chosen benchmark by whatever time period you choose. There are some exceptions but they are few and include the likes of Anthony Bolton, John Train , Nils Taube, Hugh Young and others. Even a full list of the out performers wouldn't go to a page of A4. There a thousands of funds and a complete lack of talent.It's scary if you do the numbers.

So how has it got like this?

Well all this is down to two things, firstly UK retail investors are basically financially illiterate (unlike their US counter-parts), secondly institutional money, typically pension funds have trustees who are extremely conservative and who know even less about finance than the retail investor, so they rely on those notoriously influential players the investment consultants. Guess who the Fund Managers need to court?

So why does this matter anyway you may say. Even if you have no direct holdings of OEICS/ICVCs or unit trusts. It should matter to anybody who is in a defined contribution (DC) scheme. Otherwise Known as money purchase.The underperforming fund managers are basically robbing you. Sure the bank you work for is also robbing it's clients, the wheel of capitalism is never ending in its parasitic circularity. Its a dog eat dog eat dog world. So what can you do ? Not much actually - which is strange given that people should be worried how their pensions are performing since they are likely to live longer. You could try to negotiate with the trustees to change their provider or asset allocation, but they are unlikely to take you seriously. That's why they have investment consultants stupid. And you know consultants always add value. You can't really do anything about the trustees.Trustees can be as incompetent as they like, when is the last time you heard of a pension fund or endowment fund trustees get fired for breach of fiduciary duty? Well never.

It's peculiar that the FSA doesn't intervene, but that's like the blind leading the blind off the top of a cliff. Anyway in the upside down world of self-regulation , ever wondered who regulates the regulator?

So what can you do as a retail investor and as a member of a DC pension Scheme?

Retail Investors - The Solution

I have two suggestions

• Firstly if you want an alternative buy an Exchange Traded fund or look into Investment Trusts with good managers.

• Secondly if you still want to invest in an OEIC or unit trust , try this D.I.Y Method which is guaranteed to out perform most UK fund managers whilst giving you peace of mind plus you will earn free money.The D.I.Y recipe. Be your own fund manager

1. Find an old EMPTY card board box, an old cereal packet will do.

2. Decide what you want to invest, let's say £10000. Now take out £525 put the remaining £9475 in the box , close it and put it under your bed.

3.Give the money a random name like ' Global High Potential really good Fund' .Choose a benchmark such as headline inflation minus 4% or maybe 6%. The £525 we shall call this the 'initial charge' . This is the cost of initially entering the fund, normally it would go the fund manager. But in this case you can spend this, buy yourself something nice. Just like the fund manager you have'earned' this for your investment expertise.

4. At the end of the year count your money again - you should be overjoyed - you have just outperformed your benchmark . The value of your investment will only have gone down by the rate of inflation, not -4% as well. Congratulations.Easy wasn't it!. Bear in mind most active fund managers are UNABLE to achieve this.

5.At the beginning of the next year take out 1.25% of the 9475. That's another£118.43 you have 'earned', this is called the annual management fee. Repeat step 5 till you run out of money- when you get to the end, although you will have no money left- because the charges have eaten up all the capital at least you spent it yourself.

Now do you think it's hard? So you see as legitimate scams go, active fund management is the best one going in most cases.

The DC Pension Problem

We've established that you are being legally robbed everyday, but if your'e wondering what you can do if you're a member of a money purchase pensions cheme. Well there is nothing you can really do, think of it like this your retirement plans are in the hands of an unholy trinity, docile trustees, the rather opaque world of investment consultancy and incompetent fund managers, and you're stuck in the middle.

RB

The Oracle ( no not Larry Ellison's) at Delphi ( no not the auto parts maker) ,The Cumean Sibyl, Tiresias the blind prophet. These are all examples of people from the ancient world with the power to tell us the future. Gifted by one God or another with the power of prophesy, often cryptic, reading the future through the entrails of sacrificed animals. The enlightenment came and went and of course we are all far more sophisticated now.These were just universal myths.Who believes that stuff.Today we have have predictive texts ( right most of the time) consult your mobile phone, weather forecasters - there are whole channels devoted to this on cable, switch on your TV ( mostly right) and of course the professional city economist. Every firm has at least one, most firms a few. Have you consulted yours?

In the age of the economic man the predictions of economists matter more than you would think,their pronouncements will eventually affect your take home pay(through tax policy), mortgage and debt servicing,( interest rates and inflation) , holidays & shopping( currency movements/ trade deficits/surpluses). They are powerful people but like the soothsayers of the ancient world very few are reliable and worse we give them that position of power over us. We think they know something we don't, we ask for guidance. This is a form of wish fulfillment by individuals and capital markets. No one can know the future, ever.Economics, the dull science for dull people is decidedly dangerous in the wrong hands. Most economists seem to be mild mannered geeks but they can cause havoc in capital markets. What's the one in your company like? Right prediction...oh but just the wrong time frame. Oh dear that's the same as being wrong isn't it? Dollar bears, interest rates hawks. Whatever.

What set me thinking about all this? Around the end of last December there was a yield curve event. The US 10 year treasury was paying less than the 2 year note.This yield curve inversion according to most economists presages a recession.Most economists will tell you that this is a sure sign of doom. Hmmmmmm.Taken in isolation this fact means nothing. It's up there with stock market cycles and the length of skirt hem lines. Yet because it comes from the mouth of well heeled professional economists we tend to believe this stuff. They must know right? No one knows the future. Like most of the finance industry these people are generally ill informed about the real world, maybe not about macro-events but ask them the price of a litre of milk , or how much a loaf bread costs, they have no idea. By all accounts The Pythias were deemed to be very worldly and their knowledge covered history, mathematics, philosophy, religion, politics. Sadly our modern economists know only about one thing, ..err economics.They are theorists and as such their spurious but some times well intentioned advice can cause us a great of distress and and lose us money. That's not to say they are all bad, most professional ones seem to be though. So don't believe the hype, if soothsayers can bankrupt Croesus they can certainly take you down.

Beware geeks bearing gifts of economic forecasts.

RB

Ahh, another year another scandal, plus ça change. It's déjà vu all over again. Deutsche has always been one of my favourite banks, for a number of reasons.Firstly the staff canteen at Winchester House always used to do excellent food at very reasonable prices, the grub in the meeting rooms wasn't too shoddy either. I also have a soft spot for their art collection , especially Bacon's Study for a Portrait of Pope Innocent X lithograph. It was outside one of the meeting rooms on the 8th floor if anyone's interested. So what's not to like?

Of late though, Deutsche seems to be a very accident prone institution. Not forgetting the Peter Young affair back in the mid-1990s, then the recent poor press and eventual disposal of the asset management arm to Aberdeen , loss of major clients, Josef Ackermann's criminal trial in Germany for the bonuses paid to executives in the Mannesmann takeover, and recently the 270 million dollar settlement for securities fraud in the US . Now the latest scandal with the young trader involving CDOs Mr Ashul Rustagi. He has apparently overstated his trading book by £30 million. Big Deal?, no literally what is the big deal ? Compared to the size and value of Deutsche's assets or even its industry leading trading book in these types of derivatives it's not even on the radar. It's simply not material.So what are the real issues? It's all about risk management in the widest sense.

• The truth is that Risk Managers are mostly ineffectual at actually managing risk and compliance functions generally do no more than rubber stamp decisions that the business has already made . They are there to be 'seen' and not heard. Essentially they keep regulators happy, ultimately the business pays their salary, so they are unlikely ever to say no. When is the last time you met a risk or compliance guy with any balls. I haven't yet. For further reading see my earlier piece on Risk management dated 11 Nov 2005.
  
  
• Secondly this kind of discrepancy is more common than most banks would have people believe, do you think it couldn't happen at Merrill , Goldman , Citi, or Morgan Stanley? Think again before pointing the finger at Deutsche.Just like the lottery, it could happen to you.The truth is that long after the likes of Barings the real quality of risk and controls in the investment banking world are not much better than 10 years ago. What you have is much better reporting of that risk and operational errors, etc. Yes there are more compliance and risk managers than ever-but more is not necessarily better.Yes you have much better quantification of risk through fancy Value at Risk models, but at the end of the day this is not much use. The reason for this is not, as the financial press would have you believe, because these are complex, exotic financial instruments. Derivatives are simple instruments, whether you re-package bonds with differing yields/maturities in a special purpose vehicle (CDOS) and flog it to punters or not. Financial journalists only insult their readership when they continue the mystique surrounding these products. Partly I suspect because they are too lazy to try and understand the products themselves. If you can count to ten using your fingers , you can become a pretty successful derivatives trader. If you can count to twenty without taking off your socks, there is really no reason why you shouldn't make M.D. immediately at some major bank.Think about it if they are so complex and difficult why is a 26 year old graduate trading them? So what's the real reason. It's simple, you can identify all sorts of financial,political,security and market risk,but there is no way to predict the undpredictable nature of people's behaviour.It's a behaviourial risk inherent in all organisations where there are people. You can't assess anyone's mental state through risk models, audit trails and sign offs. That's another reason why they call it a people business.

As the year goes on I look forward to more of these little scandals.

RB