Designing better futures

Crayola evolution 1903-2010

Product, toy, creative tool, cultural icon and study in continuous business evolution.  Here is the evolution of the Crayola spectrum courtesy of Weather Sealed.

 

There are couple of stories here from business evolution, cultural mood and product evolution.  The math geek in me is fascinated to know if product bifurcation approximates the Feigenbaum constant.   Crayola's color count doubles every 28 years. 

From a business value analysis perspective, any product that appears to be a commodity, yet survives so long, has such brand recognition must have some hidden moats.  What are they, distribution, brand equity, great taste ;) ?

Maps, Haiti and development via digital tools

I am thinking & working slowly on the concept of facilitating the registration of property via open source tools.

The idea is property law wiki.

Making Property Law Wiki Real

View more presentations from ngogerty.

  It is estimated by Hernando de Soto that there is $9.3 Trillion worth of dead capital in the world. World bank video here These are resources such as real estate that can't be fully used or valued because they are un registered.  The reasons for this are myriad as will be the solutions.

The idea is that by freeing capital via registration it can be used more efficiently.  For example if you are a 3rd generation squatter in an urban city in a developing country, you can't officially sell your house.  Any value you capture will be at a severe discount.  You can't borrow against your home or officially hand it to your family members.  If you want to learn more about the opportunity of unleashing resources that already exist in a country check this video out or look around on the site at this link.

Google maps is a tool that allows for people to collectively identify and place resources and assets into the public domain. 

Haiti for example is in crisis and the available resources are fluid.  A dynamic updatable map represents a significant strategic and tactical tool to deploy resources.  If you want to learn more about Google maps or have experience on the ground in Haiti and can update the map do so.

From a digital geek perspective, it seems like having various organizations have updatable layers and resource tracking that they could expose to the proper authorities or co-ordinating agencies would be very helpful.  Kind of a 3d wikipedia map.  Then make it a mashup supporting flickr links etc. so that quick snapshots and notations could be made on the ground. 

This all sounds overly high tech, but the tools to do it will get cheaper and easier and are already emerging.  Super ordinate tasks such as disaster relief logistics are perfect for this type of thing.  Architecture for Humanity is doing some things.

The World Bank of whom I am fairly critical has done some really good work with the Doing Business Reports.  It does all the right things in terms of measuring, soft competitive pressure via ranking and public availability of information. I hope they or someone else does the same type of work for property registration and recognition.  It is a huge opportunity.

To sum up good maps and live updated detailed maps in place before disaster can save precious hours and days when a disaster happens.

Full Disclosure: I lived in Haiti for 6 months as a small child.

Would you pay $3.4 million for the average Manhattan apartment, they do something similar in Beijing?

Urban China is in the midst of a property bubble that may make a 1630 Dutch tulip look like a bargain.

I am not a China expert etc. just a guy who seeks the rare sense that gets mislabeled common. I am an Iowa farm style quantitative analyst at heart, keep it simple and tie it to a short sound story.

Property is a positional good and mostly a commodity.  People invest in urban areas, mostly for reduced work commute times and to be around similar people.  Over a 400 year study of Dutch property, the values appreciated by effectively 0%.

Property is mostly a positional good only worth the incomes available to support it.  Over the last 80 years in the US this relationship worked out to a ratio of 3:1 for median property values to median household income. 

Beijing has some truly bubblicious prices for its 17 million citizens.  One can argue about economy, different cost of capital etc.  but it boils down to the fact that only a given amount of income can support a given amount of apartments at some ratio to price.

Beijing currently has a 27:1 Apartment to average income value. according to the  Bureau of Statistics of the Beijing Municipality. 

This simple ratio analysis applied back in 2007 predicted the $6.6 trillion loss in the US property market as it reverts to the mean 3:1 Median home value to income ratio.

If you adjust the ratios of income to average apartment value in Beijing, it would be similar to having the average apartment in Manhattan priced at around $3.4 million. 

For those who think Manhattan is expensive the average price for an apartment is $840,000. The potential drop in Beijing to a 3:1 ratio would mean a 90% price decline.  Determining the social and political implications of such a potential urban real estate scenario are for the real China Analysts.

Stop buying stocks and start buying businesses.

Business values are tied to 2 things, a competitive dynamic and perceived value by the purchaser.

Put these 2 pieces together and you end up with price.  Please note this is a little more subtle than supply and demand and the framework varies with each market.

The competitive dynamic means substitute offerings.  If a business model or offering is truly unique or has a defensible market position via geography like railroads or mental perceived value like impulse purchases of fast moving consumer product brands a firm may be able to extract higher margins. 

Many competitive environments are relatively stable with the top 3-5 players holding 50-60% of market share and dictating price via competition between them. 

It is like a horse race with most of the horses being about equal and extracting a median profit margin in the respective industry with some slight  point of differentiation.  If a horse nudges ahead with an innovation or advantage they may extract higher profits for awhile.  The duration and scope of that advantage is their competitive moat.  The moats success is measured by sustainable extra market profit margin.

Gum by gum

People paying an Extra $0.05 for a pack of $0.50 gum might just double the profits for a company in a 10% net margin business.  If you don't believe you are brand conscious ask yourself, when was the last time you bought a generic piece of gum at the counter.

This competitive dynamic of limited shelf space at the check-out counter and a relatively non-innovative space means high margins for those 4-5 firms who can dominate the 3 foot battle field by the check out counter. 

The latest innovative blister pack packaging was probably treated with serious anger when the first innovator put it in place. It meant everyone else would have to offer something competitive, spending capital and a dipping into margins until the costs were spread to the consumer at a new but accepted average price point for gum.  The first mover had an edge for awhile with the new perceived value via the packaging borrowed from the pharma industry.  Old wine into new bottles doesn't revolutionize the wine industry for long but means competitors have to keep up.

The real innovators dilemma: staying ahead

Innovators in a space have 2 challenges, they must create something new of value and be able to extract higher margins for the risks of failure.  At the same time, depending on the innovation, innovators know that in many instances they are tipping their hand to their competitors who will replicate the innovation.

These horse races produce many winners over time, mostly consumers who see each unique horse, try out innovations of product, supply chain, brand, pricing etc.  Each successful innovation leading to higher initial margins via happy paying customers gets extracted away by competitive replicators. This usually means most of the benefits end up with the consumer.  That is how capitalism typically works assuming no collusion is in place.  Positive externalities in the form of valued innovations are company led, but consumer driven.

The goal for a firm is to either have an innovation process for continuous advantage or an innovation that is so unique or protected it can't easily be replicated.  Southwest airlines has a unique corporate culture that puts out a different vibe than one would anticipate from a price led competitor.  Otherwise airlines are a horrible business with few sustained +10-15 year profitable margin firms.  No moat equals business margin misery.  Network hubs, airmiles etc.  all proved to be false profits as they were replicable.

Some businesses have geographic moats, such as the short haul rail roads. They mostly compete with trucking instead of each other.  This is an example of an asymmetric moat.  Find the key component such as fuel, unions etc. that drive the relationship and you can understand the business and potential moat better.  Most of it boils down to 2-3 key metrics. 

As an investor, I am not interested in figuring out what is "hot" for earnings next quarter, but rather what might the next 3-9 years look like. This does limit the industries one can assess and it often means skipping the sexy sectors.  High sustained margins may not always correlate with lots of media coverage.

 The fun part of investing is figuring out what the moat is for each industry and competitor.  The best businesses have multiple moats that all contribute to margin and are harder for others to replicate.  Moats come in different shapes and forms. 

A good value investor is really a good collector of mental moat models and the competitive positioning for each participant in a market.  There are really only probably 20-25 key datapoints needed to understand a marketplace and all of its participants.  Of course one needs the framework to put around the needle in the haystack. 

Most Wall Street and popular analysis is about selling more haystack.  Great ideas aren't sold by the pound.  This fact means many miss the the effective and elegant thesis for the sake of the data heap.  The nice thing about value is that often it moves slowly or the investor can choose an industry where it moves slowly.

Find the moat.  Measure the Moat for its length (time) and depth (extra margin) and then you are one step closer to understanding value in the horse race of capitalism.  Anybody can tell you price, few spend the time to understand value.

Here is the cartoon version with Warren Buffet and the Secret Millionaires club.

Real professional heroes at work: Sully and Team

Real professionals, no egos or issues, this is a team acting together for a common goal.  These guys, practice, they listen and they act professionally under the most extreme of pressures without hesitation.  Checklists also play a crucial role.  Watch one of the most moving human dramas of last year play out. I just found this on Barry ritholtz blog.

Full Disclosure, I am a flight geek: gliders, paraglider experience etc.

losses of 58% projected in NYC real estate

Losses of up to 58% predicted in NYC commercial real estate in 2011.  Article in Jan 8,2010 New York Times.

Readers of Designing Better Futures would have known about the potential for  this since Feb 4, 2009.  Article Tarp for Trump 60% declines for Manhattan Real Estate.  The decline estimates were for residential real estate which still has room to go, but the methodology is the same and the outcome will most likely be similar.

My assessments of gold and forex lead to +90% gains for some accounts in 09 and managed to return +45% on capital at risk in 07-08 combined for value based hedge fund. 

Value based investing is the core approach using multiple mental models a la Munger and Buffet with a little quant stuff for empirical testing.  Small capital was deployed. Common sense and patience seemed vital.

An experiment with high frequency trading this year was disastrous.  Maybe I am a better value and macro guy.

Sector knowledge:

• Forex
• Commodities
• FMCG
• Structured Finance &  Bond Insurance
• Telecoms
• Technology
• Renewable Energy
• Consumer services
• Broad international experience

Average performance in emerging markets can just be Mean.

The Economist had an article about Emerging markets bouncing entitled Counting their blessings.

The table to the left was presented.  Looking at it would tend to make a person believe that those emerging markets are on fire and really paid off over the last 2 years.

While a nice bounce has been had, the truth is a little less prosaic.  The fixed unit measure of a year starting on Jan 1 to Dec 31 is a cultural creation and can play tricks when we use short cuts like average annual returns (ask your fund manager about this).  While many think in yearly terms like this, few actually invest at the beginning and ending of the year.

The data as presented at first glance might lead one to believe that buying and holding for that period of 2 years would put one in a pretty fine position.

 But, there is a little something called siegels paradox which means that a gain relative to a given loss is not symmetric. This effect is amplified with volatility and kicks in significantly over a 13% loss. 

Example: If you lose 50% you need to make 100% from that point on to make it back up. 

Here is the table to the left with the arithmetic mean (average) and the Geometric mean (compounded) value presented.  Buy and hold is showing losses in 7 of the 8 markets presented for the respective period.  

Yes, there was a great bounce, but not high enough for most to be above water.  After factoring in the cost of capital at a few percentage points,  average fund management performance usually 2-4% below index and fees of 1-2% one is seriously defeated. 

Another sad fact is that almost all investors under perform the vehicles they invest in.  This can be shown in studies of money flows, where people buy high and sell low. 

My point is it ain't what you know, its what you know that just ain't so.

Genetics, Behaviour & Bullies

Wow, This is a great article in the Atlantic about the group behaviour in rhesus Monkeys and potential analogs in those big bald chatty apes we know as Homo Sapiens Sapiens "elder wise human".

The article hints about the functioning of a genetic variable and how it interacts within a social environment.

Here is the teaser video which only hints at a small part of the article.  This type of research will lead to many books and the genetic component will only loom larger as we are on the cusp of  the $1,000 genome. 

When I was helping to manage a Gene sample gathering project that was to be the World's largest, a single Genome cost about $100 million to sequence.  My estimate of the cost curve was that we would hit $1,000 by 2010.  We will probably be there in 2011, not bad analysis.

The issues mentioned in the article include:

• Violence and bullies (individual bullies often get ostracized from the group and suffer biologically due to the exclusion)
• Socialization and group conflict(some interesting narratives about conflict and the maintenance of a dominance hierarchy)
• Non-linear phase transition in group dominance  (rapid downfall after a coup for one group)
• Genetic potential realized relative to environmental factors specifically what we would call "nurturing or good mothering".

There is even hint about the fascinating Dunbar limit which I think holds one key to optimal group organization.  Great article for the anthro-socio geeks like me.  I will probably read the Atlantic article 2-3 times as it is dense and not quite scientifically conclusive in many areas, but fascinating all the less at the hints it gives to future questions in regards the role of genes, culture and environmental determinism in the face of genetic potentials expressed. 

Recent interview with the Wall Street Cheat Sheet

I was recently interviewed by the Wall Street Post Game in regards, to thoughts on the hedge fund industry going forward.  I have watched hedge funds for 20 years and of course have opinions some wrong, some right, but all free ;)  Read the interview here.

living to be 100: National Geographic research and video TED Talk

Get your Wile E. Coyote on with a personal jet

 I am a bit of a flight geek.  My mom used to teach flying and was rated up to multi-engine class, she also owned and flew a hot air balloon. 

My grandfather started flying gliders when he lived in New Delhi, India and subsequently taught my brother and I how to fly at age 15 in Iowa.

I have flown in micro-lights and even learned how to fly paragliders off the cost of England on the Isle of Wight.

So here is the mid-life crisis toy that seem like it needs to be checked out.  The home-built micro jet, it even sounds like something Wile E. Coyote would own.  The full article is at Wired Magazine.

Web 2.0 vs. Corruption

One of the most debilitating factors in economic development is corruption.  Corruption not only soaks up the efficient allocation of resources, but also shrinks investment horizons to near zero.  Why invest in education for your family or children if corruption means jobs are not based on merit.  Why invest in building a home or business if they can be taken.  Endemic corruption and poverty go hand in hand.  For some reason I have a strong visceral reaction to corruption, something about the Iowan in me. 

Having traveled a bit and spent time in the 3rd world, I have witnessed the costs direct and indirect of corruption.  I studied economic development in university as a focus of my anthropology degree. Here is a good academic papers on how corruption impacts people far beyond the bribe paid.  Here is one involving roads from the IMF.

Many assume corruption to be a 3rd world or poor phenomenon.  It isn't. Here is a list of countries ranked from the very credible Transparency International Survey.  The US made it to 19th place this year as the least corrupt place. 

Studying economic development is important.  The US is currently undergoing massive Economic Stimulus across sectors and industries yet, I have yet to hear of a single case of reaching into development studies that may offer lessons as to what works or doesn't. 

Corruption costs big time.  Land use, and registration is one of the things that gets hindered by corruption and is a point of interest for me.  It is a $9.9 trillion problem mostly affecting the developing world.

The Good News is Feedback

Better process design and feedback loops typically resolve corruption.  Investigative journalism, public feedback, freedom of information acts etc.  all aid in this.  These tools if available and functioning are effective unless corruption goes to the top of the political structure. 

The bad news is that if corruption goes all the way up, as in Russia it won't go away until leadership changes.

Here is a video highlighting the nature of Russia's problem. Poverty and corruption are highly correlated. Although a specious argument Russian male life expectancy of 59 years which puts it at #182 out of 227 countries is probably not helped by the issue.  Corruption and its economic burdens costs the average Russian citizen a lot.

So what can You do with your spare time to help out.

Check out these websites and see if there is something you could do.  If you have spare time and skills this would look pretty sharp on a resume.  Creating tools that make things better is pretty powerful stuff.

These are US sites, but a quick google search should bring up other projects in various countries and regions:

• Sunlight Labs
• Expert Labs
• Property law wiki (just an idea at this point from me)

It is starting to work in the developing world.

Here is a video from TED about a person who wants make a business out of fighting corruption.  The positive externalities from this would huge.

The Height of Folly & the Skyscraper index.

The Skyscraper index has been around since 1930 according to Wikipedia.

The concept is that skyscrapers are a contrary indicator.

I find these indicators interesting but mostly anecdotal. 

My own thesis is that economies and markets for various goods and services have normally bounded rates of growth or decline due to competitive and feedback dynamics.  I am working on a project to model these.

Extreme variance from the normal rate of change may sometimes be indicative of a future reversion to the mean. 

The extreme growth of banking as a function of GDP in the US is one example.  Here is a good paper looking at banking as a % of GDP since 1860.

The extreme variance of median income versus median home value in the US is another example.

Technology, finance and un-shakeable faith in the future all coalesce into magnificent projects and works which transcend commercial sensibility, they are collective dreams writ in stone, steel and glass.

The recent opening of the Burj Khalifa tower in Dubai is the latest example of this.  

For those wishing a deeper dive on the Skyscraper index the 2005 paper which was the source of the image above is here: "Skyscrapers and Business Cycles". The Quarterly Journal of Austrian Economics 8 (1): 51–74.

My guess is that the Great Pyramid in Egypt, the Mayan pyramids and other peaks, monuments and temples or civic structures in civilizations probably coincided with bubbles as well. 

At least with skyscrapers, there are some tangible relics for anthropologists to admire later, much more interesting than say the South Sea Bubble, which mostly created paper and frustration.  Let face it, if a bubble has to have economically non-viable externalities, buildings sure beat sock puppets.

The next big towers going up are in China in 2012 and Korea in 2014.  Get ready to set your economic stimulators to full stun.

Full disclosure:  I am an architecture, archaeology and design fan so probably lack full economic objectivity in this area and willingly look up and cheer on the dreamers while clutching my own wallet firmly on the ground.

Pro globalisation via the BBC

All though not fashionable, here is a helpful video that offers some support for globalization and business as a potential force for good.  The arguments for or against business are often shouted, lacking the nuance and listening found in good debate.  Many rarely consider global sources as legitimate voices for global issues, preferring convenient sound bite loaded local media outlets which may merely amplify opinions already held.

This video hints at the importance of property rights, free trade and other vital components in development.

This video puts forth a few helpful pro-arguments for pro-globalisers.  Whether you are pro or anti globalization, educating oneself makes the debate more interesting than partisan rhetoric. 

A good debater who has deeply considered an issue can articulate arguments on behalf of both sides of an issue, it also makes for more interesting conversation.

The book Volatility Trading has lessons about risk for many

Volatility Trading is a good tool for learning about the ins and out of volatility.  Volatility Trading is accessible and informative in the same style as Ernest Chan's book, Quantitative Trading.

Both Quantitative Trading and Volatility Trading offer tutorials from helpful practitioner teachers.  There is a mix of quantified academic rigor in the form of teaching about the tools of the trade and real world humility.  

I Don't trade options or volatility so why should I care?

One of the flaws of the financial system today is practitioner's belief that volatility is risk.  This is a sad case of using the wrong metric to describe what is experienced by the investor or allocator.  This failure occurs at the personal and billion $ pension fund portfolio levels where trustees from august institutions hold sway on allocation committees.

Volatility Trading begins explaining the basics of calculating Volatility and then launches into 6 separate ways to measure volatility.  A risk manager's ears should perk up now.  Portfolio Value at Risk VaR which is driven by volatility and co-variance can vary significantly depending on how things are measured. 

Like the old joke about the accountant, engineer and lawyer goes.  When asked what 2+2 equals, the accountant answers 4, the engineer answers 3.999 and the lawyer looks around and says, "what would you like it to be?".  Most quantitative risk measurements are elastic and prone to subjective biases, ask Moody's or S&P about CDO ratings. 

If you are on the receiving or delivering end of a VaR report or work with any derivative whose value is determined by path dependence you might want to perk up and take a look at this book as it is a good introduction to the field of volatility and indirectly hedging and risk.

If you have a deep background in mathematics etc, the Volatility Trading's math components may feel introductory and light.  For math newbies, things are clearly articulated and laid out like a useful dummies guide to volatility, hedging and money management. 

Living risk is very different from modeling it.

  Sinclair does a good job of trying to explain what it is like to have a position on and go through drawdowns.  Sinclair quotes Mike Tyson in the opening of one chapter, "Everyone has a plan, until they get hit."

Again for risk managers, learning to be more skeptical of volatility by reading someone who trades it for a living is useful.

The book also touches on Kelly money management techniques which can be a useful way to think about leverage, exposure and ultimate trading goals.

Volatility is a limited measure of risk that is detrimentally overused.

Volatility is simple to calculate, easy to apply across asset types and easy to understand. Unfortunately, that doesn't mean it is as worthwhile as it gets held up to be.  Volatility tells you much the car and driver have swerved in the past. Volatility doesn't tell you if the car or driver are going to get you where you want to go.

Risk & Return may be approximated by a positional utility model

Here is an interesting and pretty lengthy paper by Eric Falkenstein.  It consists of 2 major parts a synopsis of failures of the typical risk reward relationship assumed in finance and an explanatory thesis involving individual agents who have envy in the pursuit of positional goods.

The refutation of the risk / reward relationship is well trodden ground and Falkenstein provides a nice summary by rounding up quite a few example papers.  These include everything from bond yields, call options and even the risk reward of investing in G, PG and R rated film productions.  If you are interested in getting to grips with where modern finance fails, this is a good paper to review and then pursue the cited sources.

Refuting existing dogma by rounding up the relative papers is well and good, but sadly efficient market theory in regards to risk and reward will remain taught even if with caveats.  The meme survives until replaced by another. 

Admitting ignorance, even when correct doesn't sell.  Admitting ignorance doesn't fill $40k/year MBA classroom seats.  Admitting ignorance, doesn't sell books, consulting hours or videos.  Admitting to shared ignorance doesn't sell shares, close the deal, fill the conference center or win the day in the job interview.

No. For most it is better to play the game, admit the dogma may be farce and replicate the farce that is the return risk relationship held up by efficient market theory.

The more interesting part of the paper is Falkenstein's attempt to bind the micro and the macro of finance using individual behaviour and macro outcomes.  Behaviouralist economics typically focuses on the counter intuitive nature of the individual.  This novelty then gets distilled into entertainment a la Freakonics type books.

Falkenstein rightly acknowledges and attempts to model systems using agent behaviour, including not the "homogenous" popular agent of the rational man, homo economus found in traditional economics, but rather an agent who seeks positional goods and perhaps purchases ascribed or achieved status among his or her peers.  This complex agent approach is probably a better reflection of the real drivers of economy.  It is also devlishly complicated model.

The paper's conclusion is that the model put forward better approximates real outcomes.  I must profess to having neither the skill, nor resource to credit or discredit the thesis in the paper or the underlying model.

I like where Falkenstein is going and wish other would follow.  It is the realm of complexity and therefore potentially intractable, but I would rather have a narrative or weak theory lacking in mathematical rigour, than a rigourous model that is wrong. 

Better to have no instruments when flying a plane than overly believing in a flawed instrument and acting on it.

A good empirical argument for behaviour driving value is the significant value created by brands.  Brands have no rational economic value, but are merely social signals used to convey some value to others or ourselves.  The brand message or function varies based on the positional objective of the good or service.  Branding often allow firms who own a position to extract a price premia and thus build value at the bottom line.  

My own thesis on the function of brand varies depending on the good or service, but breaks down crudely into the following:

• Scarcity and desired social status signally via a visible considered purchase: Rolex, Mercedes, Abercrombie & Fitch, Trump etc.
• Consistency and familiarity of a repeat / impulse purchase: Tide, Marlboro, kellog's corn flakes
• Shared social ritual and repeatable quality signal: Dunkin donuts, Starbucks etc.
• Personal and social Attribute signalling via a halo effect: Nike, Addidas, Abercrombie & Fitch, Grey goose vodka etc.

Efficient market theory is the output of a human process and therefore a social area of research.  This puts market theory beyond most of the simpler models thrown at it. 

Most finance and economics participants will admit that the volatility, risk reward model is flawed.  Unfortunately ignorance doesn't sell and bad dogma is better than no dogma for most. 

The agent based models approach while probably correct is currently too complex for most to be consumed and regurgitated in the education and research milieu.  The problem of a general economic belief system itself may thus be intractable until the proper language, framework and tools makes it easier to disseminate and digest.  In economics we are still trying to explain the behaviour of individual particles when what we want is a way to take the temperature of a system. Reward vs. risk (volatility) is no thermometer.

Could you disconnect, even if you wanted to?

Here is an interesting map from William Easterly's site AidWatch. It shows the distance from major cities as a function of geography and time.  Most of us are a few hours away from each other.

 

A few things to consider when looking at a network diagram like this:

1. People and things spread fast
2. Ideas spread faster
3. Feedback loops amplify and intensify certain things
4. Individuals can't really opt out of this process easily

All of the above are true for ideas, emotions, things and the human condition in general.  The village is shrinking.  Increased competition in whatever form you imagine it (resource, economic, innovation, improvements) will accelerate and be amplified in such an environment.  Margins shrink as things get more connected.  The positive externalities of competition flow to customers. 

Warren Buffet pointed out 10 years in 1999 that the automotive and airline industries are great examples of global growth industries with limited investor economic output, but significant customer benefits delivered.  Bigger markets aren't always more competitive.  Globalization means fewer economic moats.

Bigger and more connected is different.

Full disclosure, the most remote, I have ever been was in 1992 when I was in the sub-Sahara in Ngigmy, Niger brushing up my anthropology field work skills in a village that took 3 days to reach via bush taxi, market car and finally foot. While staying in this remote village, I met an elder who eventually asked the biggest question on his mind of a young white American. In Hausa via a translator. I was asked, "Do you know Michael Jordan?"

An anthropologist looks at Transaction taxes. Why 2014 might look like 1914.

There is a lot of talk about a transaction TAX in the US.  One can argue whether it is punitive, driven by vigilante populism or a legitimate safety mechanism a la Tobin.  One of the sub-fields of anthropology is archaeology, the science of looking through dead people's  junk in an act of guessing how people believed, behaved and organized themselves into cultures. 

Stamps are a useful way to revisit transaction taxes. 

One of the more recent US transaction taxes on stocks was initiated in 1914 and then increased later in the 1930's to help pay for the Great Depression.  New York state itself imposed a tax on stock transactions in 1905.

The stamps for the federal transfer tax are affixed to this document shown to the left.  This documents records the sale of 33,973 shares of Stutz Motor car company.  My great grandfather used to own a Stutz Bearcat, in small town Iowa.

For those interested in Philatelic fiscal self-flagellation visit this site with more tax stamps.

The  1914 US transactions tax of %0.20 stayed in force until 1966.  Any good tax is food for politician zombies and won't be rescinded easily. Today's proposal would see a %0.25 tax in place.  That is equivalent to $50 per $10,000 worth of shares bought and sold.  

The gold bugs may want to look back at the past and have a look at the silver tax stamp to the left.  A spike in gold is one thing, a sustained price level reflecting a decline in the dollar may seem like low hanging fiscal Fruit for the tax man.   $3,000 gold for a sustained period could bring the label hoarder thrown at the gold owner.  A gold tax would not be surprising.

In the book, The Leopard, the old prince watching the empires of feudalism falling and the new empires of industrialist Italy rise, says that, "all things must change so that they may remain the same."

When the federal transaction tax was repealed, California decided to keep it. One could easily imagine that happening again.

The current and looming fiscal challenges will most likely mean govt. self justification for new forms of taxation. 

French royalty used to say the goal of taxation was to pluck as many feathers from the goose as possible with minimal honking, today one has to keep the populist pundits confused and tax indirectly and with slight of hand.  a bit of stimulus here and there and then some obscure slight of hand, such as the AMT, which slowly captures everyone. 

The Romans invented tax outsourcing by hiring tax farmers. 

The protesting of transfer taxes has taken many forms including tea parties.  One of the more passive forms of protesting the transfer tax was to affix a stamp next to the tax stamp indicating that the original stamp was affixed under protest as seen in this image. Source here.

 

Derivatives traders should be wary.  CDSs with their huge notional amounts probably have politicians licking their lips.  The CDS tax seems almost like winning the political trifecta for politicians of a certain ilk. The CDS tax arguments which I don't support or refute would read something like this:

• Large taxable notional amounts
• Slows down the mega trillion dollar derivatives machine
• Forces the more questionable players offshore
• AIG et. al retribution
• Too complicated for the general public to argue the case against

Here is an old grain futures tax stamp from the Updike grain company.  Source image here.

Archeology today involves trowels, brushes and patience.  The future archaeologist will probably spend time digging around server logs, which seems like less fun than looking at stamps.

The mother of all transfer taxes is the federal Value Added Tax.  For those advocating a federal securities transfer/transaction tax, be careful what you wish for as precedents set can be powerful things. The US has  a dangerously short debt duration and looming mandated fiscal deficits.  A federal VAT gets easier to justify in DC with a AA debt rating, but that is something to be discussed in 2011...2-3% federal VAT sounds about right.

Full Disclosure:

1. I am just finishing up work on High frequency trading strategy in c# with +3.0 Sharpe ratios  so would suffer directly from a transaction tax. 
2. I would like to have seen my great grandfather riding in his Stutz Bearcat, it sounds swanky.

Talk to the hand...of the free market.

More quality tom tommorrow here.

Twitter is glance

Twitter?  Here is a video articulating in a funny way that Twitter has not only jumped the shark, but jumped the Fail Whale as well.  

I would pose a counter argument to the Twitter fail whale, but first one has to understand what twitter is and what it does. 

Twitter is the technical expression of the physical concept of glance.  Glance is how humans relate at the most superficial level.  We glance to see the emotional, physical and engaged state of those physically around us. 

An interesting socio-biological hypothesis highlighted in The third Chimpanzee by Jared Diamond author of Guns Germs and Steel, is that the very size of the whites of the eye or sclera evolved functionally so that we could monitor each others directed glance.  Consider the change in your behavior when you can't see where people are looking?  When you wish to engender trust you take off your sunglasses, unless of course you are in LA or going through a self conscious hipster phase.

Glance is our first level of social interaction, our outermost degree of connectedness and intimacy. 

Social gaze allows us to monitor and feel connected with others.  Being in a bar isn't about drinking, it is about capturing a furtive glance or flirt that may escalate into something else.  Glance is about feeling engaged, accepted and connected at the most elementary level.

Twitter allows that.  Twitter is currently the easiest tool for sending or receiving social glance publicly.  The desire to be aware of others or to make others aware of us is innate.  Twitter or any medium which facilitates public/private glance will be popular, one can argue the oldest and shortest twit is the emoticon, the digital facial glance proxy.

Logo's and brands are physical glance tools that allow us to signal at a glance our values or those values we purport to telegraph.  Whether it be a sports team, individual athlete, style, wealth, power, sense of humour, ascribed social position etc.  We first and foremost communicate physically using our clothes, logos etc. combined with an awareness of giving and receiving glance among shared symbols.  Branding is the use of money to cultivate shared social values for a set of glanceable(sic) objects or relatable (sic) experiences.  Consider how Disney does this at physical park level, shared memory via narrative and finally logo/ icon level.

Twitter facilitates Social Glance creating a slightly closer social space.  It is as useful or as banal as those with whom you choose to exchange glances.

Glance is innate, intimate and superficial at the same time.  The desire to glance or be glanced is not going away, it will manifest itself in different ways technically.  Blogs, Twitter, Mood messages etc. are all digital manifestations of glance, expect to see more of them. 

A tough to get a hold of book on how and why we react to various media is The Media equation.  Don't let the unusual cover put you off, it is a fascinating distillation of social science research into how we react to media of all types physical and digital.  The book is worthy of consideration by anyone involved in media, interaction or design.

Hedge Fund mortality approaching 30%

Just looking at some 12 month rolling data charts from Hedge Fund Risk Monitor. 

I thought mortality would get to 40% based on back of the envelope calculations.  Running a fund isn't as easy as it looks, the magic numbers are 36 months solid operations and $100m assets under management before the Fund of Funds start looking around.  Here are some crude estimates I compiled on the business of running a fund what incomes have been like lately.

Here are some graphs about the industry from earlier in 2009 courtesy of Deutsche Bank.

My own opinion that inflation adjusted strategies will be relevant in the coming years and a view in regards to hedge fund half lives.

Hedge funds are famously opaque and the major databases all kind of overlap, but it is a foggy industry so take everything with a pinch of salt.  Most hedge funds don't explode etc. they quietly fold and return investors money.  We only hear about the ones that don't go quietly into that good night.  It is important to note that with the exception of outright frauds, no funds posed systemic risks since LTCM in 1998.  Everyone weathered the storm pretty well.

It was those hedge funds in drag (AIG, Bank with SPV's etc. that caused the problem).  Like the saying about about risk  It ain't what you don't know, its what you know that ain't so.  Those regulated institutions AIG, BEAR, etc. weren't big banks and insurance firms with AAA ratings, they were really something else altogether.

Anthroplogist / historian/ social scientist humour the Beatles 1,000 years on...

Trained as an anthropologist and studying a bit of archaeology and art history, I can totally appreciate that this is probably closer to the truth than these fields would like to admit. ht The Technium

Potential Energy revolution

I used to be Chief Analyst for Starlab an Advanced research lab modeled on the MIT media lab in Europe.  I have also spent 2 years researching renewable energy investments for hedge funds etc. 

The major issues of energy are storage density, distribution, availability and cost.  My own personal storage bias for the future is ultra-capacitors.  The energy technology shown below is remarkable in terms of cost, storage potential and the ability to remake the world.  

If the technology is stable and distributed it will change the power industry globally and most likely in non-grid dense countries first, where adoption of feasible storage means off grid power from an intermittent source becomes viable.  If you sell power why compete with existing infrastructure that delivers @ $.10/KwHr when you can find small off grid villages willing and happy to pay $0.40.

Here is perhaps the most interesting video on energy I have seen in the last 5 years.  If you are interested at all about energy it is worth the 20 minutes.  Here is the company  Sun Catalytix that has been formed to commercialize the technology from Dan Nocera.

Warning this is subtle and the impact won't register with most. ht Paul Kedrosky.

Norwegian Krone and Gold Overlay

I have been advising hedge funds and others about considering a Gold and/or Norwegian Krone position as an overlay for their dollar based portfolios for some time now.  

This isn't a trade etc. per se, it is a multi-year way of protecting purchasing power and expressing less faith in the US Dollar due to an accelerating shift in behavior towards more debt at the federal, state and municipal levels.  The Norwegian Krone overlay portfolio idea appears to be working.

Rolfe Winkler did a nice follow up piece on the Norwegian Krone idea and how it is playing out.   Here are some photos of Oslo.

Black Swan Goggles

So the holiday season is here and you have just received a pair of Black Swan goggles.  These allow you to spot Financial black swans safely from any distance.  Unfortunately  due to the warranty restrictions you aren't allowed to profit from your new super powers.

Now imagine you could also travel back in time with your swanky swan goggles.  What could you do to prevent the crisis?

Think about it.

It is the regulators dilemma in retrospect.  But imagine you are a quant, professor, CEO, banker, legislator etc. 

What role could you play?  How far would you go to prevent the current problems. 

When would you start?  and whom would you need to convince to change behaviour, rules etc.? 

Over $6 Trillion in "wealth" was being "made" by a freight train of "winners" and before that home ownership was slowly seen as a right that all were entitled to via tax breaks, incentives etc.

So who will you be with the stylish shades to change things for the better?

Those advocating better models, or tighter thinking are indirectly posing such a conjecture.  So what would you do and when would you do it? 

If you want you can continue the conversation at the Linkedin BlackSwan Group.

I am a sucker for cool Math: if you hate math, see if you like this video

Great math is beauty in form the same way architecture or painting can be poetry in motion.  Yes it is a bit of syesthasia for me. 

Great communicators are those who illuminate and share new worlds of understanding.  Here is Marcus du Sautoy talking about the history of Symmetry.  The language of math can be incredible and Marcus seems like a great teacher who is excited to share what he sees and understands.

Your world Interface anywhere: The Video

This may seem passe to say, but the rate of change and how you interact with the world is going to change faster than ever.  I am not talking about e-books (next years commodity) killing newspapers etc. or anything that banal.  (don't worry journalism will survive).

The world is going to get more fragmented.  Did you know that your view of the web via google is now different from everyone elses?

Soon your world will not be the same as anyone elses.  I hope this sense of disintegrated reality and individual control doesn't create more selfish people. 

We already control the ambient noise and music, people we choose to interact with/ignore around us etc.  If you work in media you need to be aware of this, partial attention is the pre-cursor to augemented reality.  The hardware for all of this is out there and this stuff is going to be everywhere. 

In the future, people will probably take info: vacations where the seek authenticity and no digital input.  If you feel you are on a digital leash/ addiction with a blackberry, you haven't seen anything yet. 

PS. Apple, microsoft and RIM don't own the moats or competitive edge to be a part of this.  The future is up for grabs.  Google has the strongest position in my mind as they get "infonomics and anthromation.

TED junkie and progress for the Bottom of the Pyramid

There is a great book about growing economies and finding new markets by serving the poor.  It is called the Bottom of the Pyramid.  I read and reviewed it in 2006 and was hooked. 

The thesis is that the poorest people are a huge market and they need services and will pay for them.  People who live on less then $10 a day have needs and they can be served if we listen. 

Here is a great story about the progress of the Aravind Eye clinic, which is an Indian for profit eye clinic modelled on McDonald's.  There is a lot to learn from and consider here.  The gift of sight is delivered efficiently to many who would have never considered it possible.  The ingredients are passion, entrepreneurial management thinking and drive. 

I have a met few people who do this including life insurance for the poor and a specialist in mobile banking.  These are mundane services in the developed world, but can be life changing in other parts of the world.

Full Disclosure: I am a TED video junkie.  I haven't owned a TV in 20 years and am picky about films and shows I watch, but TED almost always makes the cut.  If you want learn something interesting, check out some TED shows.

Creating alternative scenarios is imagination

Thinking about what might be is important for designing better futures.  Here is a stunning visual answer to the question, What if the Earth had rings like Saturn?

Thinking in Prime Numbers

Visualizing relationships, be they mathematical, cultural or physical is a powerful skill.  Here is a great site about an interesting quest for visualizing prime numbers.

 I am a big fan of Phi, the Golden Ratio.  One of the best books on this is Mario Livio's The Golden Ratio.  Livio is a serious mathematician, historian and story teller who brings alive the beauty of seeing how things relate.  The golden ratio shows up in many optimal packing and density solutions involving complex systems, it abounds in nature from the circling of an attacking hawk to the positioning of leaves on stems. 

My guess is we haven't scratched the surface of applied uses for constants like Phi or Feigenbaums constants.  For those interested in how growth and form emerge from nature and complex systems I would suggest studying morphogenesis, starting with the classic On Growth and Form.

All of the above end up relating to and explaining a simple elegant shape such as the a nautilus shell.

Social Strata in Dubai

Over  a bit of post thanksgiving turkey and serious mixed drinks, the topic of Dubai came up. 

I spent a year shuttling back and forth between Dubai and London, playing strategy consultant in Dubai and learning to para-glide on the Isle of Wight while courting my wife in London.  

Dubai is a lot like the bar in the first star wars film crossed with an American Shopping mall:

Everyone there is a little special and everyone there is looking to trade, barter or hussle something.  The location makes it a natural stop over and cross roads for Asia, India, Pakistan, China, Europe and the Gulf. 

Dubai started out as a simple trading port, then was a hardship post administered by the British, the discovery of oil in the region changed everything as it always does.

Dubai as an Emirate is dwarfed by its larger neighbors and outclassed in the geological oil lottery by Qatar and Abu Dhabi, it boldly brought in some outside consultants and made itself into a logistics hub with the Jebel Ali Duty Free Port and a massive world class airport. 

The location, top notch administration and history as a trading port combined with a tradition of English Common Law co-incided to get things humming.  The first gulf war saw Dubai really function as a logistics port and set it alight.  From then on the investment projects became ever more outlandish and strikingly ever more successful.  

Dubai seemed to offer the only desert in the world where the rule of thumb was the more exotic the idea seed planted, the more likely it would take off.  The cast of characters in Dubai includes deposed prime-ministers, exiled govts, creative marketers, questionable "traders", thuggish indian gangsters, uzbeki gangsters, Eastern European engineers wiring the place up and the world's best architects pursuing ever greater follies for the financiers.  Of course all the consulates are loaded with spies, technicians and assorted types.  Dubai is filled with some wonderfully interesting people, probably like New York at the turn of the century.

From its early days trading pearls to trading gold and goods Dubai has been a bit of a husslers paradise.  The officials are efficient enough and corruption was mostly in check.  Booze flows freely and prostitutes discretely ply their trade flying in from all over the world.

Dubai is a four layer socio-economic cake:

On the top of the Cake is the respected ruler, his family and hangers on.  In true fashion staying close to the king is vital for power.  Camel Racing with child Jockeyes is a big past time.

The next layer on the cake is being a "national" or native.  Dubai has about three hundred thousand nationals. out of a population of 2.3 million.  Nationals stick to themselves mostly.  Female nationals are off limits.  Male nationals like to bet at the camel races, drive souped up cars, smoke sheesha and peddle influence.  Any firm wishing to do business in Dubai has to have a local partner who own a majority of the Dubai operation.  The best partners are those with connections or at least those who provide the least hindrance in the operation of things.

For example the local Starbucks, Friday's, Pizza hut etc. are all on offer and present the same comodified stale experience available to the bored mall goer in the US.  Indeed one of The nationals biggest issues is health.  In 2003 the average citizen walked something like 2,000 paces a day.  Heart disease and diabetes are serious issues.  The walk from the house, to the car to the mall and back is not a uniquely Western ritualized Experience.

Dissent is of course squelched, in Dubai, the internet is on offer but behind a giant firewall.  It blocks mostly pornography and political websites.  The local media and newspapers have managed to take the puff piece advertorial to new levels of pap.  The international political news on offer is biased or bland. 

Local political coverage involves the reporting of various emirate officials sending each other telegrams for their birthdays and being cloyingly lovey dovey.  Dubai, like many closed societies doesn't do honesty as it interferes with politeness and unchallenged political power.

Politeness is held up as a virtue and thus the mention of anything corrupt or truly interesting is considered impolite and rude.  The local television on offer has little sex, but more than makes up for in pointless violence.  Syrian television seems to set the benchmark for pointless violence and anger all wrapped up in trite nationalism.

The next layer in the socio-economic cake is the western expat, typically from western Europe or the US with a balding head and bad sunburn during the first 6 months.   These figures are mostly older white men living with their expat wives holding down sr. management and consulting roles in various local firms.  All the major consulting, advertising, accounting etc. firms send their slowest or most exotic for a turn in the sun.

The men make money and the desperately bored housewives make mischief.  With a maid or nanny available for a few hundred dollars a month and zero taxation, domestic bliss quickly leads to boredom and the typical expat games of slap and tickle with the local tennis club pro and a stiff gin and tonic. 

Expat Children have the opportunity for good schooling and are typically well taken care of until puberty at which point it is best to place them in an academic setting outside of the country where questioning authority is a rite of passage and not a potential pre-cursor to expulsion or prison.

The next layer of the socio-economic cake is slightly slavic or cold war flavoured.  Typical Eastern European or former Soviet satellite states provide their citizens who have top notch engineering and technical backgrounds all provided efficiently and with endearingly accented English.

The final layer of citizenry are the tireless worker bees, typically from Kerala in India or parts of Pakistan.  These are men who live in camps and help manifest the architects dreams and engineers plans.  Dubai has one of the most skewed sex ratios on the planet due to its expat workforce.  The worker bees are typically sending home a few hundred dollars to their thankful families on the sub-continent.  They live in dormitory settings, sometimes paid months late and do not have access to their passports.  Imagine something from a Victorian sweatshop served with curry on the side and an extra helping of 140 degree heat. 

These are of course crude generalizations. There are enough fabulously wealthy Indian traders, Uzbeki and Iranian merchants, American hustlers, Polish traders and Irish expats slinging Guinness to break any hard rule on occupation, nationality or sentiment.  It is the star-wars bar  serving venti mocachiatos to arms dealers and real estate moguls, where can you be or buy anything in an American mall air-conditioned setting.

The rules are enforced relative to your standing on the socio-economic cake and most things tend to work well, but some icky things get swept under the carpet.  All the components of the well oiled police state are in place, ministry of information, no dissent etc.

Dubai as a country/company is a bit like Madonna going in for a new vogue every few years and amazingly pulling ever larger rabbits out of its performing hats.  From logistics to tourism, to real estate to ironically a financial center.  Dubai was positioning itself as a financial center, the Switzerland of the region, but unfortunately lost a few good outsiders brought in. 

The recent problems with Dubai will probably highlight many economic and political issues that were overlooked while the malls were full and the cranes were busy.  Dubai does have a debtors prison.  Pity they can't take the Kuwait option and just pay off everyone's debt.

Bad bonds auctions & SIC code identity politics?

The 30 Year bond auction was a bit disappointing. According to Bloomberg:

Treasury 30-year bonds declined after a record $16 billion sale of the debt, the last of this week’s three offerings totaling $81 billion, drew the weakest demand since May.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.26, the least since May and below an average of 2.39 at the last 10 auctions. The bonds drew a yield of 4.469 percent, higher than the forecast of 4.424 percent in a Bloomberg News survey of five of the Federal Reserve’s 18 primary dealers.

The fact remains that the US has roughly a 4 year debt duration with north of 40% due to mature within a year is a serious issue.  The worlds bond markets aren't quite used to the $100b in auctions week in and week out.  This figure is equivelent to $5.1 trillion for nexts years issuance.  This supply could seriously challenge the demand for more US debt.

Current US cultural behaviours and beliefs strongly indicate that more economic trouble will beget more stimulus etc.  The flawed stimulus doom loop will keep going until the world decides to stop funding the party. 

Shock and awe no longer accompany domestic bailouts, stimulouts etc.  Every new announcement of federal activity seems to create the belief in the public that we all need a bailout so get in line.  The rhetoric is capitalism is for the other guy.  I am a victim. 

The new Identity politics is defined by SIC code .

Trained as anthropologist, I treat economics as a bounded belief system.

The US is now challenged as many actors in the culture are rapidly adopting defeatist and self defeating beliefs.  Accountability and a sense of responsibility go out the window. The dangerous doom loop thinking goes like this:

I am a member of industry/group X. I am important or at least my local representative tells me this when I fund his/her campaign.

Everyone else got bailed out, why not me.  Soon the positive feedback loop will accelerate as people feel "cheated" for not being stimulated.  I am a victim.

The heart of the Keynesian argument for counter cyclical injections of liquidity and stimulus is based on loose assumptions of the multiplier effects.

In my opinion The Keynesian stimulus thesis rests on one of two flawed assumptions.

1. Officials are expert at stimulating or allocating efficiently.

2. It doesn't matter where liquidity goes as it will multiply and create demand.

The only paper I trust these days is either labeled Charmin or produced by the Norwegian central bank, good luck with those insured muni's the fun isn't going to stop at the federal level, it could bubble up as well.  MBIA, AMBAC etc. bond insurance may not be a backstop, of course the state of New York can help out.

Black Swan group on Linkedin & the lo-fi finance model

For those interested, I manage the Black Swan group on Linkedin.  You can join here. 

The general discussion is in regards to systemic risk and how to think about extreme events.  My own biases are for the implementation of  Lo-Fi finance (low fidelity), the idea being a loosely coupled financial system is safer by design than any focus on strengthening individual components via micro-management.  

Lo-fi works on 2 levels, one is that it is the opposite of high fidelity a highly engineered system and it is based on individual units not trusting each other too much so they are more cautions.  Counter intuitively ratings agencies made things riskier.  After all nobody got fired early on for buying a AAA rated CDO tranche. 

Lower trust would have meant more independent thought.  Lo-Fi is safety at the expense of efficiency and innovation. The slow movement in finance if you will.

Instead of focusing on weak links in the chain such as specific instruments, participants or markets, I argue we should focus putting more space between the links via regulation.

If you want safer roads, don't put ever more airbags in the cars, make sure there is enough space between the cars, (more roads, fewer cars, slower speeds that sort of thing).  Yes this goes against most cultural values that push for ever greater speed and the role of the individual as independent unbounded actor. 

Glass-Steagall was an example of lo-fi finance, sub-optimal in terms of efficiency of scale but safer and thus more stable in the long run.  Lo fi would lead to more work on the analysis side of the business in smaller institutions and regulated boundaries to growth defined by either product or market niche.

Inside the US debt bubble

Any business or organization that depends on the charity of others is vulnerable to that charity being withdrawn.

The US debt outstanding is just under $12 Trillion dollars.

Roughly 43% of that debt has a maturity of less than one year according to The Economist. 

This equates to $5.16 trillion that needs to be rolled over or approximately $100 billion every week. 

If one assumes that the maturity of foreign holders is equivalent to the average maturity outstanding then the US and the world are playing a large game of chicken. 

The Treasury currently has the luxury of cheap money 3.5% on the 10 year and 4.40% on the 30 year, but can't be seen to go to far out on the curve in future issuance as it might kill the golden goose, but the rate of roll overs and amount of debt issuance is most likely to be stimulating in the next few quarters, pun intended. 

In case you are wondering about who plays the world largest game of chicken with us, here is the data from the Treasury of Foreign US Debt Holders.

 

I would recommend reading Nial Fergusson's The Cash Nexus to see how this game of Chicken has usually played out in the previous 300 years of debt and empire, then reach your own conclusions.

China or Japan doesn't have to sell debt to crash the price, the merely stop showing up at the auctions for a year and roughly half of the debt expires, with payments due.   As Japanese or Chinese populist it is a tough message to swallow, that you can't stimulate your own economy, because, there is some requirement to purchase more debt.

And yes Japan is in the same boat, just 20 years ahead of us.  It looks to be race to see whose bubble pops or melts first, the Japanese with a DEBT to GDP ratio of 190% or the US with a current debt to GDP ratio of roughly 80% but a legislated ratio almost 4 times that.  

He who pays the piper calls the tune and the music is starting to change.

Black Swan author is an awkward bird

Nassim Taleb is a mixed blessing, part cheerleader for ignoring the false rationalism of statistics in the realm of human folly we call economics and part self indulging jester for being "mis-understood" and protesting too much.  I think he suffers a case Roubini syndrome.

Roubini syndrome involves being right once about a big thing and therefore attributing every utterance and opinion subject to that opinion and framework.  Having only a single mental hammer seems to have forced both men to see all problems before them as nails.   

The risk in Roubini syndrome is that of the one hit wonder pop star who slowly fades away.  Both men have more to contribute but seem bent on correcting the media with ever more shrill voices.  They have an analog version of SIWOTI syndrome which currently keeps them from more interesting and lasting contributions to thought on economics.

Take a look at Taleb's latest paper Oct 18,2009 entitled Common Errors in Interpreting the Ideas of The Black Swan and Associated Papers.

The paper's first pages are a tiresome tirade, but he has some solid points in the back end of the paper.  My own opinion is that his overly emotional rebuttals to prior rebuttals to his work cheapen his voice and muddle the waters. Don't feed the trolls.  A good idea stands the test of time and the best of ideas attract the strongest of criticisms early on before being accepted.

New paradigms are rarely acknowledged as such immediately, that is the role of fads masquarading as innovations.  History and ideas of historical note are only acknowledged correctly in the breech.

My recommendation is that the Black Swan should sink or swim in the sea of ideas.  The author needs to let it leave the nest to defend itself and fly on its own.  Ideas once submitted for consideration are no longer their author's property, but rather become a part of a useful collective consciousness or fade away.   Paradigms are a group phenomenon whether true or not.

The gifted Anish Kapoor creator of the Cloud Gate sculpture in Chicago long ago accepted that it would forever forward be known as "the bean", such it is with all creators and their creations in the public domain.

So you want to run a hedge fund...

Hedgies have a certain stereotypical image as portrayed by the press.  That image is typically a male about 40-70 years old making hundreds of millions or billions of dollars a year.  This sells newspapers and lexus'. 

The truth while nice is not as grandiose.  Depending on whose database you follow, there are 8-12,000 hedge funds globally.  The term hedge fund itself is elastic enough to basically include anyone, who will place a bet on anything on someone else' behalf and charge 2 & 20 for the privilege.

Here is a little data.  Hedge funds success is like movie, sports etc. success in that a few do extremely well and most do fairly well.  The average (median hedgie) doesn't own or probably even lease a plane.   Note the data below most likely overstates incomes and returns due to survivorship and reporting bias which is significant in most hedge fund databases.  They are marketing tools after all.

Here is a break down using the Tass database over time.   One can see the evolution of a cottage industry paying white collar professional level salaries and then exploding.  More recent data would be interesting to see.  I have included the spreadsheet Download HedgeFund Data gogerty dot com I built for those interested in playing with assumptions behind the data.  Also note that some funds have a hurdle rate which may downplay the income more.

 

 

If anyone is interested in chatting about what makes a fund a more "successful business" drop me a line.  Getting more AUM (assets under management) is the goal of most funds. 

The magic threshold in this business is $100m AUM with +36 months of operations because these are the  levels where most institutions start looking at making allocations.   Instituional sales cycles for allocations are estimated at 9-12 months, while family offices are estimated at 12-18 months. Establishing trust takes time.

From an institutional perspective funds under the $100m AUM level are mostly noise.  As a hedge fund operator this means you chase high nets, feeders and those specialized in emerging managers etc.  which means lots of due diligence for smaller allocations. 

The business of a hedge fund is managing the investing process, managing the back office processes and sales in that order.  Growing and maintaining AUM is about establishing trust and faith in all the funds ongoing processes.  Hanging the shingle out with a sharpe ratio alone draws attention, but doesn't close the sale.

The back-office operations need to be stable and in place for real money to show up.

Return and Risk at the business level of hedge funds are as important as return and risk at the trading/allocation level of running the business.

Having top quartile risk adjusted returns is a good start.  Pros want to know about risk, ie. after verifying the apparent stability of the returns on the money, the need to verify the return of the money.  Fashions  come and go in various hedge fund sectors, but as a manager it is best to stick to your knitting.  Offering a 100/130 product for a long short value fund may work, but moving from value to convert arb is a stretch.

Mature back offices, SMA (separately managed accounts), operational stability and experience as well as lots of checks and balances are vital to the allocators due diligence process.

The more transparent all processes in a fund, the more successful it should be.  There are a few black box exceptions to this rule, but trust in process and people is vital to a funds survival.  Trust is built with more than logos with Greek columns and names that end in Capital.  Some of my favorite funds are the value based ones that put out newsletters or presentations extolling the thinking behind their positions.  Greenlight and Pershing Square are good examples of this.

Madoff was avoided by many banks who didn't understand the process he claimed to use. Acknowledging and then acting on ones ignorance is a powerful thing.  If you don't understand it move on.  "not getting it" may not be cool, but it is wise. Know thyself.

Another potential benefit of having investors understand about your funds operational and investment process is that they are more likely to stick around during tough times.  Many fund's revenue declined this year relative to previous years even though performance may have been extraordinary even adjusting for high water marks.  Redemptions reflect a lack of faith.  This lack of faith can be related to many of your funds aspects, don't make them your people or your processes.

Revenue adjusted for performance probably declined for hedges funds in 08-09 due to skittish investors who sold the "lows" of the fund.  Research into hedge funds and mutual funds shows the median investor under-performs the funds they invest in, due to buying high and selling low.

If someone doesn't have faith in your funds processes, then they are betting on your last month or quarter etc.  This isn't any way to build a stable business. 

I advocate transparency and openness wherever possible for a fund or fund of funds as it helps to retain clients.  The risk in transparency is that it shows a lot of these funds or FoF's for the smoke and mirrors marketing machines that many are.  Some black boxes in this business are black because they are full of junk, see Galleon, Madoff etc.

One could argue Buffet runs a hedge fund with an open structure that makes him immune to capital calls, this allows him to retain cash at the most interesting times and to compound returns, without having to change the rules of the game midstream such as putting up gates etc.

Running a small business, be it a hedge fund or dry cleaner is about trust and process building with employees, customers and anyone else who comes into contact with your firm.  Low trust or strong alpha male power based cultures should be avoided at all times.  Bullshit and bravado are often bedfellows that rarely build stable lasting enterprises.  As an investor I would seek funds with questioning & listening cultures rather than posing and posturing cultures.

About the charts above: my cost assumptions are for a small fund with 3 full-time employees, a basic  master feeder structure, no marketing payouts and outsourced legal, accounting and reporting functions in small office.  The incomes may be over stated by 20-40% due to high water marks, redemption flows, survivorship & reporting biases and start up costs.

18 rules of complex system failure

 This list below was on ZDnet and is a cut and paste job from this Brief Paper "How Complex Systems Fail"  by Richard I.  Cook.   I suggest reading Normal Accidents if this field of extreme risk interests you.

In finance complex failure at the largest level is called systemic risk and it is what we are currently facing. 

How many items below relate to a recent  failure or proposed solution?  (real estate, CDS and AIG, US DEBT bubble, stimulus...) the comments in parenthesis are my opinions.  My own solution is a lo-fi finance approach.

1. Complex systems are intrinsically hazardous systems. The frequency of hazard exposure can sometimes be changed but the processes involved in the system are themselves intrinsically and irreducibly hazardous. It is the presence of these hazards that drives the creation of defenses against hazard that characterize these systems.

(Finance is nothing more than risk allocation)

2. Complex systems are heavily and successfully defended against failure. The high consequences of failure lead over time to the construction of multiple layers of defense against failure. The effect of these measures is to provide a series of shields that normally divert operations away from accidents.

(robust checks and balances need to be in place at all levels.  Innovation is frequently a form of subverting these for the sake of efficiencies (capital, tax or otherwise).   Risk eventually shows up.

3. Catastrophe requires multiple failures - single point failures are not enough. Overt catastrophic failure occurs when small, apparently innocuous failures join to create opportunity for a systemic accident. Each of these small failures is necessary to cause catastrophe but only the combination is sufficient to permit failure.

(The media reflecting audience desire seeks to identify point failures. There is rarely just a bad guy or broken part. )

4. Complex systems contain changing mixtures of failures latent within them. The complexity of these systems makes it impossible for them to run without multiple flaws being present. Because these are individually insufficient to cause failure they are regarded as minor factors during operations.

(people and organizations fail all the time.  All things fail eventually.  Systems need to allow for system failure.  To paraphrase someone else: Capitalism without failure is like religion without hell.  It doesn't really function as social tool.)

5. Complex systems run in degraded mode. A corollary to the preceding point is that complex systems run as broken systems. The system continues to function because it contains so many redundancies and because people can make it function, despite the presence

(Optimization comes at the expense of safety: 100:1 leverage or some other "innovation" may seem optimal, but may be unstable.)

6. Catastrophe is always just around the corner. The potential for catastrophic outcome is a hallmark of complex systems. It is impossible to eliminate the potential for such catastrophic failure; the potential for such failure is always present by the system’s own nature. of many flaws.

(Only the paranoid survive, find a culture or organization that is fat and happy and you will find un-acknowledged risks.)

7. Post-accident attribution accident to a ‘root cause’ is fundamentally wrong. Because overt failure requires multiple faults, there is no isolated ‘cause’ of an accident. There are multiple contributors to accidents. Each of these is necessary insufficient in itself to create an accident. Only jointly are these causes sufficient to create an accident.

(See earlier comment in regards to the media, this also applies to congressional committees, which are typically witch hunts.)

8. Hindsight biases post-accident assessments of human performance. Knowledge of the outcome makes it seem that events leading to the outcome should have appeared more salient to practitioners at the time than was actually the case. Hindsight bias remains the primary obstacle to accident investigation, especially when expert human performance is involved.

(This is the forehead slap effect, that accompanies after a bubble event.)

9. Human operators have dual roles: as producers & as defenders against failure. The system practitioners operate the system in order to produce its desired product and also work to forestall accidents. This dynamic quality of system operation, the balancing of demands for production against the possibility of incipient failure is unavoidable.

(Unfortunately positive feedback in the form of earnings, bonuses and industry recognition, amplifies this bias.  A fair assessment of skill rarely gets in the way of ego amplified by culture.  Cultures be they national, organizational or group that assume instant monetary reward directly equates to insight or skill almost always fail due to this bias.)

10. All practitioner actions are gambles. After accidents, the overt failure often appears to have been inevitable and the practitioner’s actions as blunders or deliberate willful disregard of certain impending failure. But all practitioner actions are actually gambles, that is, acts that take place in the face of uncertain outcomes. That practitioner actions are gambles appears clear after accidents; in general, post hoc analysis regards these gambles as poor ones. But the converse: that successful outcomes are also the result of gambles; is not widely appreciated.

( Few do post-mortems on successful outcomes that deviate from the norm.  These are better than post mortems on failures as  they paid for themselves.)

11. Actions at the sharp end resolve all ambiguity. Organizations are ambiguous, often intentionally, about the relationship between production targets, efficient use of resources, economy and costs of operations, and acceptable risks of low and high consequence accidents. All ambiguity is resolved by actions of practitioners at the sharp end of the system. After an accident, practitioner actions may be regarded as ‘errors’ or ‘violations’ but these evaluations are heavily biased by hindsight and ignore the other driving forces, especially production pressure.

(See CDO's, black boxes and any obfuscation.  Wall street is excellent at packaging and selling things, fairly mediocre at purchasing them.  See the mutual fund industry performance among others in these regards.)

12. Human practitioners are the adaptable element of complex systems. Practitioners and first line management actively adapt the system to maximize production and minimize accidents. These adaptations often occur on a moment by moment basis.

(wrong incentives, confusing short term motivations versus long term risks are part of the system. We need to design, organizations and regulations with this in mind.)

13. Human expertise in complex systems is constantly changing. Complex systems require substantial human expertise in their operation and management. Critical issues related to expertise arise from (1) the need to use scarce expertise as a resource for the most difficult or demanding production needs and (2) the need to develop expertise for future use.

(Expertise is a false notion in complex systems due to their changing nature.  For this reason anything seeking to "optimize a system can make it unstable.)

14. Change introduces new forms of failure. The low rate of overt accidents in reliable systems may encourage changes, especially the use of new technology, to decrease the number of low consequence but high frequency failures. These changes maybe actually create opportunities for new, low frequency but high consequence failures. Because these new, high consequence accidents occur at a low rate, multiple system changes may occur before an accident, making it hard to see the contribution of technology to the failure.

(see above and regulatory reform etc.  The law of unintended consequences runs deep in complex systems.  The ratings agencies offering stamps of approval to structured products is a classic case of this.)

15. Views of ‘cause’ limit the effectiveness of defenses against future events. Post-accident remedies for “human error” are usually predicated on obstructing activities that can “cause” accidents. These end-of-the-chain measures do little to reduce the likelihood of further accidents.

(Establishing boundary conditions etc. that assume point failure, human error (greed,stupidity and crowd blindness) need to be built in.)

16. Safety is a characteristic of systems and not of their components. Safety is an emergent property of systems; it does not reside in a person, device or department of an organization or system. Safety cannot be purchased or manufactured; it is not a feature that is separate from the other components of the system. The state of safety in any system is always dynamic; continuous systemic change insures that hazard and its management are constantly changing.

(see above large stable systems are the results of small stable systems. Consider the role of audit integrity and other sub functions of the financial system.)

17. People continuously create safety. Failure free operations are the result of activities of people who work to keep the system within the boundaries of tolerable performance. These activities are, for the most part, part of normal operations and superficially straightforward. But because system operations are never trouble free, human practitioner adaptations to changing conditions actually create safety from moment to moment.

(System participants need to look out for changes, be they over or under performance of a system normal behaviour.  Keeping an eye out for "innovation" in finance is highly recommended.)

18. Failure free operations require experience with failure. Recognizing hazard and successfully manipulating system operations to remain inside the tolerable performance boundaries requires intimate contact with failure. More robust system performance is likely to arise in systems where operators can discern the “edge of the envelope”. It also depends on providing calibration about how their actions move system performance towards or away from the edge of the envelope.

(More work needs to be done discussing multiple points of failure in a system, including the hubris or collective myopia that lead to the failure.  My own belief is that a culture or group which reflects hubris, is obsessed with over optimizing or believes that today's profit means they are "right", are the things to watch for. For quants out there: beware of geeks baring gifts.)

Shit book hints at one key to human development

Excreta, turds, poo, shit, etc. are all terms for something that induces disgust in most.  This response is innate and indeed wired into use at a visceral level and a key to survival.

All we need to know about shit, is that we want to be away from it.  Sadly many can't get away from it, they end up living, inhaling and consuming it.  This leads to death and disease. 

In development people refer politely to water borne disease leading to over 2.2m child deaths per year according to the UN.  Water borne diseases in most instances relate to drinking shit polluted water.  Too put that in context AIDs is estimated to kill 2.0 million and malaria around 1-1.5 million per year.  Shit kills.

This is a problem that the now developed world has kind of solved and that the developing world is still working on.  Like all human endemic problems it is rooted in behaviors, beliefs and fears.

Understanding shit and what happens to it is key to human development as much as economics, corruption etc. and curing diseases are.  Indeed, solve the shit problem and many of the diseases that limit human development and factors related to GDP growth may resolve themselves a bit.

Rose George has written a very entertaining and important book entitled The Big Necessity in which she travels the world discovering the cultural issues and mores around handling waste.  Her voice is that of the economist magazine, for which she once wrote, humorous, well read and considered.

If you are interested in the human condition and understanding the behaviors, and issues that may better it, read this book. 

I am fascinated by economic anthropology and sustainable development and appreciate the field work that George has done in trying to understand what the solution to the problem of shit may be.  Solutions aren't just about plumbing and digging toilets.  Like most aid dropping in money or technical help rarely does anything but minimize acute crises.

Marketing, behaviour, economics and technology, distribution and other issues.  Consider it a business problem/opportunity. This is a fascinating book about something that gets very little attention relative to its impact on limiting the human condition and capabilities.

Rose George's description of techniques used to change a village's behaviour, involve economic incentives and changing beliefs while raising awareness. The lessons about motivating people for sustained change are as relevant to the business manager as they are to the aid worker.  technocrats and major aid institutions often fail in these areas.

Factoids:

• Thomas Crapper helped improve the usage of the toilet in London, hence the phrase "take a crap" (perhaps best to leave it)
• For all of the butch culture, Americans are very prudish in the waste dept.  euphemisms abound in the culture
• the japanese have the most advanced toilets in the world, warm seats, water wash etc.
• Wiping with paper is very unsanitary relative to washing with water
• Since 1994, 935 million gallons of raw sewage have been dumped into lake Michigan
• German men pee sitting down
• Chinese put used toilet paper into trash bins instead of flushing it away
• Many chinese public toilets have no stalls or barriers, so people get to know each other very well
• The average shit session yields 250 grams about .551 pounds of solids
• 1.7 million people in the US don't have a toilet
• The corridors of the palace of Versaille used to be filled with urine and fecal matter as people had nowhere to go, it was an honor to hold the king's chamber pot while he filled it.
• 400,000 people get sick in 1993 in Milwaukee from feces contaminated drinking water killing 100
• The UK has 186,000 miles of functioning sewers that are 250 years old
• One of the only cures for a "superbug" infection is a fecal transplant
• Wash those hands: in the UK "more than 1 in four people have faecal matter on their hands"
• over 40% of people don't wash their hands after going to the toilet
• much more in the book about a key element of the human condition, namely shit

You get the point the Shit book (The Big Necessity) is interesting, educational and important about something "polite" people don't talk or think about.  If you are interested in sustainable development, furthering the human condition or understanding how to drive change among a group of people with a fixed behavior check out this book.

Optogenetics is amazing

 
Wow!  I jsut finished this article on optogenetics in wired.  Basically it involves targeted neuron therapies involving the typical stuff of gene therapy with an amazing optical twist.

1. isolated gene for expressing protein (in this case light sensitive from algae)

2. A benign viral vector for transduction or other method for transfection (ie. slipping the gene into host cells so it can function delivery)

3. Using light to activate de-activate the protein function (that is pretty wild).

By now luceiferase and other photodetectable biomarkers are pretty common.  I used to read a bio-photonics journal for fun on the subway in New York.

Instead of biomarkers the researches in the article above are using light to induce function both for activation and de-activation of the desired protein state and they are doing it in mammalian brains.  It is huge stuff and an incredible case of lateral thinking.  The article link above does the technology great justice for the layperson and almost  warrants (for me at least) re-subscribing to wired.  Wired has sadly become a rather tired mouthpiece touting the latest MSM offerings pop-tart culture and gadget Version X.0 fanboy gunk.

The interesting things is that instead of typical gene activation, de-activation functional regimes such as SiRNA and related block-out, knock out schemes this one can be activated with remote stimuli and toggled on and off at rapid rate.  How cool is that?

Now ideally the desired behaviour is induced relative to functioning normal bio-feedback loop, but when those fail and the causal chain isn't fully understood this looks like a great shortcut.  Flip a light inside the organism and the proper function is expressed.  Imagine turning on and off a neuro-transmitter related illness like a light switch.

The only cause for pause in my mind is that many bio-feedback loops have dampeners, gain functions and inhibitors for good functional reasons.  The risk is that without understanding the reason for a failed or over-stimulated loop such as parkinsons etc. is the solution/therapy may lead to downstream physical bio-chemical issues or cascading factors as people will use the "desired physical" output potential to achieve a bio-process detriment due to the lack of dampening feedback. 

A way to think of this is the learning function of pain.  In the organism we experience the neural feedback of "pain" in response to physical stimuli that harm us or induce a change in state that means we should limit the current activity or risk physical harm to the organism.

Regardless of the current risks, the world of optogenetics is opening some amazing ways to control neuronal processes as well as monitor them in real time and at localized scale.  Other optical and non-optical bio-markers mean that true functional biological models and therapies are getting closer, this is a good thing. ...and the singularity inches forward another notch.

Successful Iowans

I am from and grew up in small town Iowa.  A traffic jam would be defined by 2 cars having to wait at the traffic light behind a tractor.  It is inspirational to see how people find their paths in life from modest or challenging beginnings. I define success more by what people give than what they made or collected in life.

Here are 2 Nobel prize winners from Iowa, both seem to have a simple hands on approach to things and matter of fact way to life that I appreciate.

• Norman Borlaug helped feed the world and many have argued saved a billions of lives according to one source.  He was the great grand child of Norwegian immigrants. Borlaug just passed away at the age of 95.  Here is a great Obituary from the Economist

• Thomas Cech Helped further the science of biology by studying the transcription process in cells.  His grand father was an immigrant shoemaker who came to the US in 1913

Some pretty interesting people who have demonstrable achievements and have potentially furthered the human condition.  Go Iowa :)