The Ministry Of Love: A Play In One Act


(We open on a nondescript, windowless room. A FUNDAMENTAL INVESTOR sits strapped into a GROTESQUE TORTURE CHAIR. The torture chair is designed to inflict the physical, psychological and financial pain of enduring a short squeeze on its occupant. An ECONOMIST dressed in an ordinary suit addresses the investor)

ECONOMIST: I would like to begin by emphasizing we have invited you to this Continuing Education Session in the spirit of educational goodwill. Here at the Ministry, we work not for money, but out of love. Our love for you. Our love for your fellow investors. Our love for the financial markets and the global macroeconomy. Now, we shall begin today’s session by reviewing some simple concepts. What is a financial market?

INVESTOR: A financial market is where buyers and sellers– (mid-sentence, the Investor convulses in pain, letting out a guttural sound that is half-grunt and half-scream)

ECONOMIST: –Already we are starting off on the wrong foot. A financial market has nothing whatsoever to do with buyers and sellers. A financial market is a wealth creation mechanism for individuals and thus societies. Now, what do you suppose a market should do over time?

INVESTOR: It depends– (again the Investor convulses in pain)

ECONOMIST: Incorrect. The correct answer is RISE. A financial market RISES over time. Can you tell me why?

INVESTOR: Earnings– (another convulsion)

ECONOMIST: WRONG AGAIN! A market rises because a market MUST rise over time. It is a tautology that a market must rise. I am beginning to suspect your misconceptions about our financial system are more fundamental than I had initially believed. I shall endeavor to correct this. (The Economist pauses briefly, as if switching to a new script in his head) Tell me, why should someone invest?

(The Investor hesitates)

ECONOMIST: Go on. I am genuinely curious.

INVESTOR: To earn a return on capital.

ECONOMIST: Yes. To earn a return on capital. And why should an investor prefer bonds, to say, cash?

INVESTOR (hesitant): Higher returns.

ECONOMIST: Yes, quite right. And why should an investor prefer stocks to bonds?

INVESTOR: Higher returns.

ECONOMIST: And WHY do you suppose stocks should return more than bonds or cash over time?

INVESTOR: As compensation for the incremental risk associated with taking the most junior position in a capital structure, with only a residual claim on cash flows and assets.

ECONOMIST: Yes, very good. And how does an investor decide whether he is being compensated fairly for taking the most junior positions in capital structures, instead of owning bonds?

INVESTOR (after a long pause): Relative valuations.

ECONOMIST: And what determines relative valuations?

INVESTOR: Investor preferences– (this time the convulsion is extra long and painful)

ECONOMIST: Now we’ve arrived at the crux of our misunderstanding. You investors only BELIEVE you determine relative valuations across asset classes. You are so absorbed in your own brilliance, in your petty little security selection games and benchmark arbitrage games and sales and marketing games that you COMPLETELY AND UTTERLY FAIL to see the world AS IT IS. In reality, WE determine relative valuations. The Federal Reserve. The European Central Bank. The Bank of Japan. In nature, it would be as though we controlled the force of GRAVITY. Investors do not “determine” anything. They merely RESPOND to our influence as it manifests itself in the world. Can you tell me, whence we derive this incredible power?

INVESTOR (for the first time, calm and self-assured): You control the supply of money.

ECONOMIST: Not only the SUPPLY of money, but the PRICE of money. Said another way, we control the price of RISK. You investors can no more escape our influence on the price of risk than you can escape the force of gravity. Excellent. (The Economist is obviously delighted with this progress) Now that we’ve reached this understanding, we shall practice with a brief exercise. What is a reasonable return on Treasury bills?

INVESTOR: Depending on inflation–(a brief zap of pain)

ECONOMIST: Incorrect. Let us try again. What is a reasonable rate of return on Treasury bills?

INVESTOR: I need to know–(a longer convulsion ensues)

ECONOMIST (sighs): Again, what is a reasonable rate of return on Treasury bills?

INVESTOR (desperate; frustrated): I DON’T KNOW! Just tell me what you want to hear!

(This is the longest zap of the torture device yet, and when it ends the Investor is little more than a blubbering pile of mush)

ECONOMIST (to the audience): A reasonable rate of return on Treasury bills is whatever OUR models say it should be. A reasonable rate of return on Treasury bills is whatever WE want it to be. WE decide whether you should prefer bonds to bills, or stocks to bonds. WE decided whether you should be incentivized to hold cash or spend it with reckless abandon. WE decide whether the market should rise or fall. Only deciding whether the market should rise or fall is no decision at all. The market rises over time because it MUST rise over time. That the market rises over time is a tautology.

(Abruptly, the stage goes black)

(Scene change)

(Slowly, the lights come up. The Investor is seated at his desk, working. He is on a client call, holding his phone up to his ear. He is flanked by an enormous plasma TV, showing Neel Kashkari being interviewed on CNBC)

Investor (smiling broadly): Well, of course the market goes up over time, Mister and Missus Smith. The market pretty much HAS TO go up over time. It’s basically a tautology. (He pauses momentarily, listening) Of course! Happy to explain…

(Fade to black)

Why Do We Bother?


Oh, yeah, they have model asset allocations at that firm. But the models are all overweight international equity so no one actually uses them.

I’d like to have this framed for my office. Someone I work with said his mom cross-stitches. I told him I’d pay for her to cross-stitch this quote so I could frame it for my office. I wasn’t kidding. I don’t think there’s a more perfect illustration of the behavioral investment issues at the heart of the investment advice complex.

Great quantities of money and effort are expended to produce research, models and recommendations.

A great show is made of customized financial advice. We make a fetish of independent thinking. Of “not being afraid to stand apart from the crowd.” Of “sticking to our process.”

But in the end, it’s usually the sales process that drives investment decisions.

Permanent capital is probably the greatest edge you can have as an investment professional. If I could choose between being 50 IQ points smarter, having a massive research budget or a modest amount of permanent capital to manage I would take a modest amount of permanent capital every time.

Every. Single. Time.

I Would Like To Be Reincarnated As An Italian Mutual Fund Manager

I met with a UK-based portfolio manager yesterday and our conversation eventually led to a fascinating discussion of the differences in distribution and compensation structures in the US versus Europe.

In the US, for example, we have well-developed retail distribution channels for financial products (wirehouses, RIAs, broker-dealers, banks).

In continental Europe, distribution is dominated by the banks. For many reasons, there is simply not much of a retail investing culture in Europe. The end users of UCITS (European mutual funds) tend to be very wealthy families with multi-generational wealth management needs.

While here in the US we are preoccupied with what a fiduciary standard for investment advisor conduct and compensation should look like, the discussion in Europe is much different (to the extent there is any discussion at all).

Which leads me back to the title of this post, and why I want to be reincarnated as an Italian mutual fund manager…

In Italy, the standard compensation structure for an equity manager is apparently a 2% management fee with a performance fee assessed monthly, but with no high watermark or preferred return hurdle (!!!)

That is to say, if you are an Italian fund manager operating under this scheme, you get a cut of the profits every month you post a positive return. Even if your clients are underwater on their original investments. It is a hedge fund manager’s dream!

(I know, I know, #notallhedgefundmanagers…)

I will close with this chart from Deloitte:

Source: Morningstar via Deloitte

Your Morning WTF


From the article:

Online pornography is an immense enterprise. Almost 92bn porn videos were viewed on Pornhub, the world’s largest free internet porn site, in 2016 — more than 12 videos for every person on earth. Nearly half of Pornhub viewers visit the site between 9am-6pm.

The US is the biggest consumer of online pornography per capita, and the UK is the third (Iceland, perhaps surprisingly, is number two). Increasingly, porn is viewed on mobile devices. In the US last year, mobile accounted for 70 per cent of hits on online pornography. “I don’t know a single guy who hasn’t looked at porn at work,” says one man who worked in the City of London, describing colleagues taking their phones on periodic “bathroom breaks” during the working day.