Category: Investment (page 2 of 2)

Michael Fish

Michael Fish announced on TV on 15 October 1987 that there was no hurricane on the way. That evening the worst storm to hit South East England caused record damage and killed 19 people.

Andy Haldane of the Bank of England recently said that the failure to predict the 2008-09 financial crash was a similar moment for economists and has resulted in economics forecasting being “in crisis”.

It is true that the record for prediction of economists, financial analysts and accountants is very poor. When we look back over the last half century it is indeed true that all three groups failed to predict the big crashes in US public companies.

But conversely they also failed to identify the ten days over the last fifty years which accounted for roughly half the return of the same US public companies.

In other words, out of 18,250 trading days just 10 days accounted for half of the return. So surely it was a failure of economists, financial analysts and accountants that they did not identify these days in advance? Or identify the days in 2008-09 that resulted in dramatic reductions in market value?

I would disagree with Andy Haldane on this. I don’t think it is reasonable to expect economists to identify in advance the 0.05% of days in which markets move dramatically.

My favourite book on this subject is A Treatise on Probability by John Maynard Keynes who wrote in Chapter 3:

Is our expectation of rain, when we start out for a walk, always more likely than not, or less likely than not, or as likely as not? I am prepared to argue that on some occasions none of these alternatives hold, and that it will be an arbitrary matter to decide for or against the umbrella. If the barometer is high, but the clouds are black, it is not always rational that one should prevail over the other in our minds, or even that we should balance them, though it will be rational to allow caprice to determine us and to waste no time on the debate.

Keynes understood that some probabilities are measurable. He gave an example in the book of pulling red and black balls out an urn of which half are red and half are black which is clearly a system that can be easily measured but many probabilities are inherently unmeasurable such as his example of the requirement for an umbrella or his discussion of an ern where the the proportions of red and black balls are unknown.

However although there are many probabilities that are not measurable but are comparable. The example Keynes gave was the possibility of surviving a walk home in a thunderstorm: this is not measurable but it is clearly less safe and therefore comparable to walking home during good weather.

So to get back to our trio of economists, financial analysts and accountants. It is unreasonable to expect any of them to predict a dramatic period of recession or growth however it is reasonable to expect them to suggest that a situation is more or less comparable i.e. more or less likely to result in a period of recession or growth.

I do not think that it is a failure of economics to predict the ten best trading days of the last half century. I do think that economics is useful in producing data that makes the best trading days comparable with poor trading days or the best investment opportunities comparable with the worst while accepting that neither are measurable.

So in my investments I accept that I cannot make predictions as to when it will rain. But I can see clouds in the sky as Micheal Fish did successfully over his career at the Met Office from 1962 to 2004.

Bertrand Russell on Investment

Back in my youth I did a course on philosophy and one of the books we read was Bertrand Russell’s The Problems of Philosophy. This is a quote from Chapter 6 – On Induction:

Domestic animals expect food when they see the person who feeds them. We know that all these rather crude expectations of uniformity are liable to be misleading. The man who has fed the chicken every day throughout its life at last wrings its neck instead, showing that more refined views as to the uniformity of nature would have been useful to the chicken.

Philosophical induction is of course a very different beast from mathematical induction. In our home town, Edinburgh University have created a programming language Haskell which can be proven correct by proof by mathematical induction. Mathematical induction is based on proofs rather than the slightly flimsy enumerative deduction in philosophy which is based on observation.

Going back to Russell he creates a severe problem for the Chartist. This is a very common investment mistake and I will admit that I have fallen for it myself in the past. It’s very easy to look at a graph for a stock and assume that this has some link to the future.

An individual example would be Enron which of course won many awards before collapsing to zero. A bigger example would be the pre-revolution Russian stockmarket which outperformed all of its competitors for a whole century before total wipeout. Both these examples are very negative but the failure of proof by induction also applies in the other direction. An obvious example would be Walmart which went for a few decades in a fairly flat way before completely taking off.

So next time you are looking at a graph and expect it to continue on its happy trajectory remember the story of Bertrand Russell’s chicken. The past is not a predictor of the future – good or bad.

What’s the point of an acquisition?

There are many, many reasons for acquiring companies. Roll-up’s to save costs, taking out a competitor, financial engineering and vertical integration to name four common strategies.

At Move Fresh we have only one reason for acquiring a business: to grow it.

More specifically to at least double the size of the business within a few years.

Frankly the idea of buying a business to try to save a little bit of money is pretty ridiculous. However one of the things we are very good at is growing direct to consumer FMCG businesses very rapidly and indeed Diet Chef was in the Fast Track 100 as the 3rd fastest growing company in the UK.

The trick? Spending very large amounts of money on marketing. Well, there is a bit more to it than that, we are investors in a leading marketing analytics business and spend a lot of time with numbers. But we find it hard to see how a business can grow rapidly without spending millions on advertising in an effective way.

So our acquisition strategy is really very straightforward: to find businesses with a great product that just needs a big marketing boost. We’re delighted if the shareholders are willing to join us on the journey.

S&P 500 v. Hedge Funds

Warren Buffett has a $1 million charity bet with Protégé Partners. It started on 1st Jan 2008 and lasts for 10 years; the bet is on the performance of a fund of hedge funds from Protégé verses an S&P 500 tracker from Vanguard.

At the Berkshire Hathaway annual general meeting a delighted Buffett gave the six year update on the bet: Hedge funds at 12.5% and the S&P 500 at 43.8%.

Only people without much grasp of the basics of investing would put money in a hedge fund however it is worth considering some of the issues around tracker funds.

Key points to consider are:

  • Fees Over a typical saving period you could have virtually double the performance using a tracker fund with the lowest fees compared to a tracker fund covering the same index with high fees.
  • Stock lending Many tracker funds loan shares to short sellers. This obviously increases risk but is acceptable providing the fees go to the investor. It’s worth checking if this is done and if so the policy on splitting the spoils.
  • Physical verses Synthetic There are two basic replication methods. Physical means that the underlying stocks are purchased which is pretty much as safe as possible. Synthetic means that a swap agreement is entered into with an investment bank and as a result the solvency of the investment bank is a risk factor. The funds invested will still be held in some sort of collateral but this may well be unable to recover any losses.
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