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Is the US Being Duped by Its Strength?
- There is the possibility that something is setting up a very unpleasant future for
America. At the moment, everything seems to be swinging our way. English is the universal
language of commerce. The US is the sole world superpower with the biggest market, the
strongest currency, and the ability to define rules whenever and however convenient. And
we do.
The US repeatedly humiliates Russians with public chides about losing the Cold
War, their military ineptitude, corruption. All this while swearing friendship. The US
lectures China about human rights but says nothing about Singapore. We steam into the
waters between China and Taiwan whenever the temperature rises between these two family
adversaries. And we force our chief banker, Japan, to accept managed trade, while we stand
as the principal proponent of free trade. We use international organizations when
convenient but ignore their rules when they do not suit our circumstances. The provisions
against Cuba violate NAFTA; the United Nations is really not at war with Iraq; and
bilateral trade settlements take place outside of WTO. The US decides who comes into WTO.
China must get US endorsement. The US decides who joins NATO. Bosnia was taken seriously
only when the US decided to be involved. These are the characteristics of a superpower
bully and a successful one. America moves and everyone watches.
But are we looking around the corner, to the next move? We are not good chess players
with grand, long-term strategies. Russians are. And Orientals have patience and a longer
time horizon than we. Could something go wrong? There are some early clues the Russians
and Chinese may find common ground against us. But that specific outcome may not be the
most troubling.
The number of US client-states is increasing just at the time when the temper of the US
is to have less to do with foreign affairs whenever they are disturbing. Expansion of NATO
puts a blanket of protection around potentially unstable nations. Look at Turkey. World
War II, in the opinion of many, was encouraged to go forward when England and France
reneged on their commitments to Poland. Countries in Asia look to the US for protection
but to China for eventual trade. Africa is a wasteland because the US does not pay
attention, but one wonders if we will not try our magic there, too. Israel is an example
of a client-state whose move to the right shows the US as powerless to discipline those
once under our protection.
Nationalist movements are worldwide phenomena - the people of Quebec, France, and
Germany; the restless urge to scuttle the EU in England that could well be seen later in
the US. But how would that withdrawal into Fortress America play out if our international
commitments are greater than ever, and we have made residual enemies of governments we
have dominated? We might be quite alone and quite shocked at the difficulty of holding an
orderly retreat.
My concern is that we are not preparing for the next steps. Rather, in concentrating in
the present, rather pleasant time, the setup is ripe for a shock in the future. A big one.
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Time Warp
- There are so many tools available now to maintain contact with all parts of the world
that nothing should be a surprise. I can follow developments in the places I have been by
reading their local newspapers, conducting regular email exchanges, and visiting cultural
sites...all on the web. Nothing should be a shock to me, right? Wrong!
I have just
spent a week in Brazil, including Rio and some slightly-inland countryside. I first
visited Brazil in `87 in connection with the first institutional fund for foreigners
there. At that time there was blocked currency; valuations at one or two times earnings
(Varig had 87 747s, but the market value of the entire company was less than the price of
three of them); inflation was in the thousands of percent; several of my friends had the
typical tenure of six weeks as finance minister; and hardly any investors, there or in the
States, had any confidence.
At a press conference held for my first visit (there were so few investors coming from
the States, it was worthy of a press conference for just one of them), I was asked why I
was so smart to want to bring money there when everyone else was smuggling it out. My
answer was the classic institutional response about diversification. (Those outside can be
less demanding on rate of return because they are getting lower or even negative
correlations.) I didn't have the bravado to say I thought it would go up and to be
declared a complete fool instead of, as they thought me, a victim to be taken.
Now, only ten years later, it is very different. Emerging markets are a standard
feature of every institutional portfolio. Rates of return have become more attractive for
Latin America.and Brazil within it. NAFTA passed. Streets are clean (Americans and Swiss
like this). Inflation has gone, for the moment. Businesses are run in a world-class
fashion, just a little behind the technology one sees elsewhere, but not too much.
Communication is poor but, thanks to wireless coming up, I could maintain email contact
everywhere, albeit rather slowly. The poor people are still dreadfully poor, but not as
poor as in India or parts of Africa (when you are hungry, it is difficult to say that
someone is more hungry). It is normal.
The emerging markets of ten years ago have largely emerged. Patterns for progress have
been established and there are only minor variations. Politics in some are repressive but,
as Singapore and Chile have shown us, will work. Some maintain a bipolar economy,
socialism at the bottom and capitalism at the top. Corruption seems to be a common but not
necessary feature, rather like the replacement of corruption and private protectionism in
Russia for government security. And, most of all, the initiative for worldwide economic
development has moved from government and quasi-government banks to private capital.
Except for the few pockets that seem intractable, like equatorial Africa and the rural
parts of large countries, the exciting, wildly risky part of emerging markets is over.
That does not mean there won't be surprises. Countries can be "red-dogged"
like large companies in the West. But the way one approaches these markets is now less
country- specific and more company-oriented. And they may shift from the nifty-fifty
period, with the very best companies doing the very best, to more of a valuation stage.
That style shift might come after a sharp market break-it usually does.
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Ernie from E&Y Bombs Out ... Lessons
- During the summer of '96, I learned that Ernst & Young was starting a new
internet-oriented management advisory service called "Ernie." Enthusiastically,
I went to its advertised web site (www.ernie.ey.com)
to sign up. Yes, the service did offer to answer questions on normal management consulting
issues for a flat fee of $6k per year. It seemed rather steep but it was a start in
providing quality services on the web, faster than conventional methods and for charges
that are less. I was ready to buy.
That was not easy. After finding that the Ernie web
site only responded to Netscape (and I was using AOL and Compuserve from Switzerland) and
after a delay of about a month, a brochure was sent that said no more than what the web
site had, but in print with cute graphics. Now the instruction was to telephone a number
in Cleveland, and I did. Here I was informed that the operator was supposed to arrange an
in-office demo. But I said rather insistently that I only wanted to buy. The operator
could not take the order, only set the appointment for a person-to-person demo. Finally I
convinced the operator that somebody must be authorized to take an order. And another
E&Y person called to say he could but I would have to give my receptionist's number,
along with other information, for contact. After explaining that most of us have
automated, global "receptionists," it was concluded that one of my phone numbers
from anyplace would serve to fill out the form. And I could BUY with the proviso that I
would have to hand-sign the contract that would be faxed to me, then send the paper back
by snail mail. Seemed rather archaic to me but I persisted to sign on for the service.
I have told the sign-up story to a number of people using the web for commerce to
illustrate that a sales procedure should be consistent in style with the service. You
should not mix old-fashioned human approaches with a mechanical system (although you can
make the mechanical system more responsive and personal than a person).
Now I had to make sure I had Netscape everywhere I was likely to be in order to
communicate with Ernie, because "he" seemed to be the only service I have seen
to speak with only one browser. And I learned how to ask questions. But the responses were
little more than those of a good reference librarian and not very helpful. I browsed
through the FAQs to see if others were having more success than I, and some were. But most
of the responses I received were quite pedestrian, although they could be time-savers.
Once in response to a question on the Yangtze River project, there was an offer to do
more work on a contract basis. That surprised me, but I thought nothing of it until
February 1997 when Ernie announced new features which included a proposal for contract
service at a charge over and above the substantial subscription charge. So the service is
becoming even more conventional and less technological. And they announced some cosmetic
changes which were not implemented until weeks after the announcement (although there was
no suggestion of a delay). Clearly the business model of the service was changing.
I asked some very specific questions about web business for consulting services, being
something that Ernie should know a lot about. And there was no answer (I was later told
they were "having trouble with their server").
Obviously the service was different and moving backward. So it was time to resign. And
I did through Ernie's email function . . . using Netscape, of course. And no answer for a
week. Finally I repeated the resignation request and received a phone call from a polite
client service rep indicating that the original contract was for one year and resignation
was not possible. An offer, which I declined, was made to send a copy of the paper
contract back to me for rereading. In an offer to help Ernie understand its customer base,
I did the best I could in retelling my reasons for leaving (Ernie's email function does
not leave a copy of outbound messages behind). Those were: reference-based answers to
questions; a change in emphasis from subscription-based to fee-based service; poor
technology; and lack of response in some cases.
Since there seemed to be no point in leaving the service before the year was up (and I
do not intend to use it), and it may have created some internal reporting embarrassment, I
weakly agreed to stay. But with a poor taste and a good education for the web advice I
give to others on what not to do. Unfortunately it comes from a firm which I hold in high
regard and have friends who will be red-faced.
I do not mean this story to be a crank tale. Rather it shows how it is possible to take
a good idea ahead of the wave of web services and ruin it with conventional
implementation. Look for these clues in other cases . . . correct them if you are
providing the service and flee from them if the service is being provided for you.
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Investment Strategy, Auto-Translation, and Ebonics
- Now what could these three elements have in common? Not much on the surface, but the
following story illustrates that they do combine, leading to a totally different topic:
the intensity with which Americans approach almost anything. Like the rules of complexity
- a few simple rules combine to produce rich, complex, adaptive, and complex patterns - so
this story shows me that linear forecasting of reactions from straightforward patterns is
not easy.
A month or so ago I wrote an investment piece for this site suggesting a
portfolio of extremes - the most risky of the large emerging markets (like Russia, China,
Brazil and India) and the most safe of securities (even gold-backed short-term Swiss
notes) - totally lacking concentration in the middle, consensus course. One side will be
wrong, but the odds of expectation versus outcome may be less anticipated at the extremes
than in the middle, like the U.S. equity market. (We are so sure that equities will
succeed in the U.S. that serious proposals are discussed to put part of the Social
Security system in equities.)
Not an outstanding recommendation, and I thought it needed more pep to be interesting.
A client recommended a program sourced from the Information Institute in Zurich which
automatically translates, by email, any text into Jive. I sent my rather bland strategy
piece and in seconds the Jive version came back. I could not get all the language, just
the gist, but it seemed rather like a written version of Southern dialect or Swiss German
drawn from high German. More importantly, it indicated that instant, automatic global
translation is here, today. The implications for communications are huge. So we put the
Jive version of this investment strategy on our site.
And what a reaction! Not to the strategy, which differs so much from conventional
wisdom, but to the language. I was called a "privileged racist" and informed by
several colleagues that I was damaging Batterymarch's business prospects.
So I thought I should learn about Jive. And I did, from UseNet groups. A large number
of Jive translation programs exist at colleges around the world, the best is at U of
Pennsylvania, and Tokyo runs a close second. I learned it is an urban multi-racial
language, although assumed to be mostly associated with blacks...I thought it was a youth
language. Although it seemed like a simple issue to me, to others it was the hottest topic
of the moment. So I removed it from the site. For those who wish to have something
translated from English to Jive, send the text you wish translated to
http://www.jive@ifi.unizh.ch.[webmaster's note: this link seems to be inoperative -
10/22/97]
The moral: strange things happen from simple forces...
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How to Present
- All of us present at some time, internally or externally, orally or in writing. Some of
us give little effort to it because we nobly concentrate on content and consider
presentation just crass selling. We are wrong.
Presentation is another form of
communication, ideally two-way learning. There are rules and guides about how to do it.
For my part, I used to watch the TV evangelists for guidance . . . albeit rather extreme.
And the cadence of politicians' speeches is instructive. I need not repeat those rules
here. But I would say that the most effective presentation, if you can do it, is to not
follow a script (even if not following the script is a script).
Investment managers often attend meetings with massive tomes detailing every breath a
portfolio has taken. It is impossible to tell what is significant in the morass of
minutiae. There is control and comfort in this approach . . . but it fails.
The most successful presentation is controlled by the presentee, the audience. That is
why more and more presentations are moving to the web, where the user has control. Think
about a rock concert. Is the rhythm controlled by the singer or the crowd clapping hands?
The individuals in the crowd think they are doing it. And they come back.
The most successful presentation room has controls/tools in front of every person who
can then take charge of what they want. Sounds like a person sitting at a computer
terminal for a conference, doesn't it? And we'll see more and more of this.
It is more important for a presenter to listen than to speak. Questions have a point,
and one should resist the temptation to deal with an out-of-order (in the speaker's mind)
question by saying "I'll come to that later." It was not out of order in the
questioner's mind, and he or she is the person who counts.
Graphics must be clear, quick, understood in seconds, and easy to retain in memory.
Language must be conversational. And emotion must be used. We are more likely to remember
passion than content.
One of the best things about investment presentations is that you know how you did.
Clients tell you in the most forceful way possible - with investment assignments. With
such compelling feedback, it's strange that most of us don't learn how to do it better.
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Ten Questions (Loosely from an Idea of Stu Myers, MIT)
- In every field, it seems there are always ten burning questions, perhaps associated with
the fingers on two hands. These are issues for which there are no clear answers . . .
otherwise they would not remain as imponderables. Different observers will assign
different weights to the factors and come up with different opinions. And, finally, some
will be solved, some will just wither away, and others will stay.
What are they today?
1. Market level - too high or OK to invest? The question assumes the US market, but
this should not be taken for granted since many markets in the world are growing faster
than that of the US and are cheaper. It may be that the question does not matter. There
are periods, often long, when markets feed on their own successes, often accompanied by
huge shareholder value-creating mergers. The economics of increasing returns seems more
appropriate for an information, service society than the economics of regression to the
mean.
2. How to organize? Clearly, the hierarchical organization of defined functional
specialties is out. Repudiated. But can we stand the vagaries of the converse - free-form,
evolving, adaptive, organic structures?
3. Outsourcing - how much inside and how much out? The presumption is that someone,
somewhere in the world knows more and is better at every little thing than someone within
your company. But can you find them, organize them, and control the output?
4. Time horizon? Getting shorter, but in hindsight it is the big, long-range decisions
that count. However, a long time horizon seems to depend upon accurate forecasting. Can we
do LT forecasting? The evidence suggests that we cannot.
5. Flexibility - how quickly can we change to new circumstances? If we can't forecast,
can we at least identify new conditions and change? Is it a single decision "from the
top" or structured so a number of decisions accumulate (feedback loops) that look
like a big one?
6. Who owns an enterprise? The stakeholders can be shareholders, management, society
(government), labor, and customers. It is clear who speaks for management so that voice is
quite strong, but it is unclear who represents the others.
7. Free trade? Agree in principle if our products are competitive, but not if they are
not. The US is for free trade in computers but for managed trade in cars - multilateral
solutions (WTO) versus unilateral application of national interest (Helms-Burton).
8. Education? In traditional institutions, individually, or by companies? The Internet
shows promise of a continuous educational voyage. The individual is responsible for his
own continuous retraining.
9. Work . . . where? As work devolves to smaller groups, often globally, tied by
machine, it is possible to think of the work unit as "one." The issue of sex
roles in work seems settled and home/work/location issues are being addressed by machine.
10. Security? Government, individual or . . . I can't forecast, so don't. Will deal
with the future when we get there.
These are my contributions for the ten burning questions. You may have a different list
but I suspect we overlap some. My candidate now for the eleventh (and later to be one of
the ten) relates to growing income disparity, individually and globally. This disparity is
not sustainable without violence - it is getting worse and there are no clear answers. But
it is not now a burning issue, because most of us are on what we call the "right
side."
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The Five P's of Manager Selection
- I know something about selecting investment managers, having been selected many times
(and also deselected). My expertise has been acquired through pride and pain, and now is
the right time to put some of it on paper (in bytes, I mean-no one uses paper anymore).
There
are three kinds of managers. The first, the easiest to recognize, are the mediocre and
arrogant ones-the ones most likely to damage you. Fortunately there aren't too many of
these. The really bad ones are deselected quite quickly, and business takes them out of
the universe. Picking the bottom 20% to ignore-assuming 20% of managers have a skill set
one standard deviation below the mean-is rather easy. Most investment people can recognize
the qualities to avoid in almost any profession. In the midd le, that's where it's the
toughest to discriminate. They all look alike under their marketing blankets, and the
differences will be minor. But it's at the top group (the 20% of managers one standard
deviation above the mean) that you want to look most carefully. Over and over, consultants
tell us to look for the three Ps-people, performance, and process. They must be right.
Of course, people count and minds count. This business is a thinking one. And
performance (this topic is covered elsewhere in a snippet on performance measurement)
seems necessary, because managers rarely get hired if they are in the bottom half of
performance. One treasurer lamented to me once, asking why half of his managers were below
the mean, and all the managers who came to solicit his business were above. (Answer: only
those with above mean results go marketing.) And process, housekeeping as I call i t, is
important. But today it is a given with off-the-shelf tools that are common to most
institutional managers.
Armed with these three Ps, search teams form and make decisions, most often with
disappointing results. Half the managers with durable past alphas stumble, people come and
go, process gets tighter (usually to the benchmark), and time flies.
Every manager will be retained until their results are poor and they are sure,
absolutely sure, to be in that lineup sometime. Can you look at managers and say you want
them when their results are bad?
What's missing to improve our winner ratio? Two more Ps. Now there are five, one of
which is the most important of all and the least considered.
Product has to be examined. What is it? Do you want it? Can you understand it? Most
importantly, is it an asset class that will gain in usefulness and popularity? Is it
sound? Is it adaptable? Product tends to be forgotten except to define the niches to be
filled in an asset array. But product means more than a niche or a benchmark. It means the
rationale behind it-how is it adaptive and what will it become? Investment is not static.
It moves. The changes are m ore important than the positions.
And the last, like the Beatitudes, is the best-principles. What are the manager's
fundamental guides: intellectual challenge, money, selflessness or selfishness, ego,
collegiality? What is at the root core? In the clutch, when the manager has to move on
instinct (and this will happen at critical positions), what will the manager do? It is
judgment that is not able to be made based on facts. In Naval leadership training,
officers are taught that any decision that comes to th e captain will not be made on fact
s; otherwise, it would already have been made at lower levels. So the captain's job is to
make the decision on his principles and to be decisive. Examine the principles, and if you
find they do not exist, flee. If you find they do exist and you don't like them, walk away
slowly. But if you find them consistent with your belief system, and if enough of the
other Ps are present to satisfy you, stop . . . you're home.
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South Africa Impressions
- March 1996
Curiously, the observations you get from affluent whites on a flight from
Johannesburg to New York are not too different from those of a black ranger and a white
Afrikaner guide on safari in a stiffly-sprung Land Rover. Both suggest tensions are rising
beneath the seemingly-placid surface. And the only way a visiting foreigner can find out
about attitudes of Zulus is on the Zulu home page on the Internet (no one seems to know
the militant 10% of the country's population).
If the general population shares in the wealth created by reacceptance of the country
into the trading world, it can go OK. If not, and if the disparity of wealth continues to
widen, the fences can't get high enough or the rapid response teams fast enough to keep
the country from slipping back into the dark violent past of the Union.
The income distribution problem is common to emerging markets in the early days of
their recoveries. I'll admit to being a skeptic of "trickle down," but it does
seem to be a necessary condition, whether in Latin America, Southeast Asia, Russia, or
South Africa. The forces within the economies have to work to get through the time for
violence. Usually one gets hints of social awareness from the people who are being made
wealthy . . . an allocation to social programs, infrastructure, and education, and capital
flows from internal sources.
We gather from the news that education is improving, although, as I discovered talking
with a fourteen year old boy on his way to a white-only boarding school, a policy of
separate, but not equal, education seems to be true, on a temporary basis anyway. The
government is not a unified body but an unstable amalgam of ANC, Nationalists, and Zulus.
And the distribution of economic equity is still considered a white man's job because of a
present lack of black managerial capability.
Normally I don't get too worried about the macro-political picture - everyone else is
and it is over-discounted - and low security prices and topnotch companies in rapid-growth
consumer markets give me warm comfort. However, these didn't seem to me to be present in
South Africa in the spring of 1996. Certainly the best step to promoting foreign portfolio
investment in South Africa was IFC's action in setting the benchmark weight at 17%. With
that figure looming over every emerging market manager's shoulder, we'll see participation
in the market, many at "half-weight because we don't like it," but few will
argue for zero or an excess.
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Learning is a Continuous Voyage
- During my college years, I remember the counsel that I was being taught how to learn, to
go beyond learning a body of knowledge. And then I would memorize the material to get good
grades. I recently attended a meeting of top scientists who spent a day, not on the
intended program, but lamenting the plight of educational institutions that were merely
repositories of young bodies. Where is the learning going to come from?
Is it right
under our noses? Is it really happening, as I was told at college, that people are
learning on their own? There is some biological evidence that a vast surplus of human
brain cells grows in a child up to age three or four, and then the synapses are programmed
throughout life by environmental influences (we still know shockingly little about
learning given worldwide expenditures of massive sums for education).
Today, learning may take place outside of traditional institutions. About ten years ago
I was asked what Harvard could do to make itself more important internationally. My answer
was to "blow up the buildings in Cambridge," a flip, unthinking response to say
that bricks and mortar inhibit global learning. (In fact, Harvard Business School will
offer a course on the Internet in its traditional case-discussion mode where the students
will not meet face-to- face in the amphitheater, although in residence-a global student
body. If it works, the system will be used for HBS' courses and executive education,
worldwide.) More learning today is self-taught. Television is a learning device, although
we may not think of it as such. And Nintendo games teach hand-eye coordination and
responsiveness, as well as some features of aggression that we might not like in a passive
period. But it is learning.
And what of computers? Watch children with computers . . . the world's knowledge is at
their command and use. I recollect my wonder, years ago, walking into the Widener Library
at Harvard University. But consider the wonder of a child exploring the Widener, the
Vatican Library, the Library of the British Museum, and the Library of Congress, a click
away on the Internet. That child is going to have a different view of the world and
distance and accessibility.
Learning is accelerating. Not surprisingly we have not adapted the tests, and certainly
not the institutions, for it. The children, as the Bible has predicted, lead us.
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Dirty Data . . . or . . . Clean Water Has No Fish
- Many investment managers pride themselves on working only with clean, accurate data,
thinking that careless errors are reduced. Yes . . . but. As in science and signaling, the
techniques to clean the data must be used sparingly and with full knowledge of what is
lost and what is gained.
The real world is messy and emergent; never like what just
happened, which will never happen completely the same again, with all the ramifications.
When we model, we set up simplifying assumptions that try to capture the essence of the
real world; we pretend its exactitude for study, understanding, and, if we are lucky,
predictability. Real data is inherently dirty; model data is usually scrubbed.
The errors introduced by demanding clean data are many. The foremost is time. To get
clean data demands that more time is introduced between the last bit of relevant data
collected and the time at which it will be used. And time in markets involves, always, the
activity of feedback loops that undoes the value of the measurements we have made. The
second error is competitive. If we wait for clean data, knowing that our competitors do as
well, we find the answers from that data just when everyone else does, often in the same
manner, increasing the likelihood that we arrive at the same, discounted conclusion. Third
is sample size. To get clean data, we often discard the suspicious measurements, and these
may well include the most advantaged (even if startling) and potentially rewarding
insights. Fourth, tools like percentiling, interpolation, curve fitting, and test of
significance. These may be correct and helpful, and they may be just as misleading in
assuming regularity, linearity, and serial correlation. And then there is synthesis.
Separating a characteristic of the data from its associations, studying it as if it were a
member of a closed system, and attributing the results of the piece back into the whole
system.
Most research contains all of these potential flaws. Is it any wonder that looking at
historical data always produces wondrous suggestions for investment action, and
application of this same process often produces humbling results. The careful researcher
tries to handle data in the rawest form possible.
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Data Mining
- What passes for investment research is usually back testing . . . if I know now what I
should have known then, how good the results would be. Even quantitative back testing is
intuitive data mining. Our minds, unconsciously perhaps, are conditioned by the
immediate-past conditions and project variables we would like to include in our models.
Not at all surprising, when we test if these conditioned characteristics are included in
our tests, we find that investment results would have been superior.
And then we make
the leap that they are continuous and we can still capture them because we have not
consciously data mined (determined what patterns exist in a finite sample of numbers all
random number series have a finite beginning and end and have patterns).
Far better to overtly data mine using the best tools and know what we have done than
pretend we did not do it at all.
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Performance Measurement
- I fear that more harm is done by the misleading information in performance figures than
any other statistical evil. And I am partly responsible.
The Financial Analysts'
Society, predecessor to AIMR, appointed a small panel of wise seniors (of which I was one)
to recommend reform measures for all investment firms presenting performance numbers. We
determined rather quickly that commingled results had to include all accounts with no
convenient dropping of those which left; had to follow, in general, mutual fund
accounting; and ideally would be certified by an outside audit. These proposals were
adopted and were the basis for a new industry of software, practitioners and performance
attribution specialists.
Should we be proud of our work? I fear we should not. The resulting numbers look more
reliable and, after all, have the AIMR stamp of approval. But they fail standard
statistical tests of significance and hardly ever can be projected forward. Our proposals
were rather like encouraging cigarette factories to sweep the dust from their floors,
giving recognition for the new cleanliness to be put on the cigarette pack.
We could have included a range of significance to the numbers. We did not because it
would uncover that most had no meaning.
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Agnostics
- Most scientists are agnostic. Most are especially agnostic about their own work and
strive to improve on it . . . before someone else does. Good businesses obsolete
themselves . . . look at the remarkable turnabout that Microsoft made this year.
But
agnosticism does not "sell" to either clients or potentials. So investment
managers build the myth that they understand and even control markets. In reality, the
best are always "trying to learn." The more they have empty sheets of paper,
worrying not at all about past good or bad results, the more they will construct
contemporary solutions to contemporary market issues. Meetings that dissect the past are
distractions, often expensive distractions, when they take the mind away from unity with
the future to justify the past.
If you have an agnostic streak, add it to your scientific kit . . . don't discard it.
Remember that if "you are absolutely sure you should do something and have clear data
supporting your action, question whether it is worth doing."
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Surprise
- Good research is more likely to produce a surprise than confirm suspicions.
The
classic Hawthorne study in the 1920s was attempting to confirm the a priori that light
level in an assembly operation (phone handsets) was positively related to output.
Industrial engineers in white coats with clipboards and stopwatches roamed the plant to
confirm that there was a relation between higher light and higher output. The study if
done by many investment organizations would have stopped there (the data was tortured and
confessed). But young F.J. Roethlisberger wanted to confirm when it would not work. He
reduced the light level fully expecting output to fall.
However, it rose. Lights went still lower and production soared. What is happening?
Clearly the original specifications of output as the dependent variable and light level as
the independent were swamped by something else, perhaps people in white coats paying
attention to the workers.
The careful scientist looks for the surprise, looks for the nonworking conditions, is
sensitive to transient effects, and generally treats research like porcupines making love.
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First or Best
- Investment firms have a choice on how to guide their activities. They can strive to be
first in some or several fields. In this case they may be first and foolish, but they will
gain a pioneering reputation for themselves and often win high rewards for clients. Or
they can decide to be best. This usually means copying others, improving upon them, taking
small incremental steps to be better, and marketing intensively.
Both approaches are
suitable to the institutional marketplace. The selection of one or the other is often due
to personality, but each requires vastly different resources.
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Independent/dependent Variables
- I would estimate that almost all investment research puts some measure of performance
risk adjusted or nominal or something on the left side of the equal sign in an equation.
And then there are a number of dependent variables to be examined: factors; economic
variables; sunspots; what-have-you. Not surprisingly, the researcher finds some
correlations across the sign and attributes causality. Bad.
It may just be a
correlation and no more. In fact, that is the likely case.
This trap was pointed out by James March of Stanford in describing the foremost errors
by his junior students (reminds me of first-year medical students who learn that they have
the symptoms of almost all diseases). It is a curse of most of the senior research of
investment firms.
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Hindsight
- We can all see rear-view mirrors clearly. Although our path is always one of doubts and
change of pace, usually, of course, when asked at any given point how we got there, we can
describe a clear, confident course. Fortune magazine used to, and may still, run a survey
of which companies are most admired by its readers. Each year the list produces companies
that have exhibited outstanding stock market performance for the preceding five years.
Fortune concludes that good companies have good stock performance. But which comes first,
if either is variable?
Hindsight needs correction, like most other sight. Retrospective
recall is usually in error.
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Measurements near the Mean
Portfolio Control
- Managers "run" money. They "achieve" results. They
"identify" errors and "correct" them. All these macho steps should
produce superior, controlled investment results. I wonder if that is how the investment
world works. The physical world does not.
Instead, we may be in an iterative game of
chance during which we can assess the odds used by other participants in this game and,
when we find variance with "reality," attempt to exploit the hypocrisy or
stupidity of our opponents. All in real time. No wonder investment management was once
described to me as "an exercise where you make major decisions on the basis of flimsy
information in a system largely governed by chance, when you may be wrong slightly more
than 50% of the time, publicly, and . . . you have to go back and do it again." Most
sensible people do not expose their careers to such a capricious system.
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Organizations
- Most organizations are designed to produce comfort, certainty, and security for their
people. Budgets pretend to have forecast ability. Offices with walls and doors give
protection. Contracts provide security.
The real world is emergent, turbulent. The
rigidity of hierarchical organizations dooms them to failure or, certainly, mediocrity.
Job classifications tell people what they don't have to think about far more than what
they do. And the classy organizations of the present approach organizational issues with
fear that they will injure by doing too much.
A long time ago I was the first speaker at a conference on How to Organize for
Creativity. When introduced as "Mr. LeBaron will now tell us how to organize for
creativity," I had a momentary flash. Walking slowly to the podium I completely
revised the speech I had outlined on papers in my hand.
At the podium I arranged my papers very carefully, turned on the light, adjusted the
microphone, and tested its level by blowing on it. Then I said clearly and carefully,
"DON'T." And returned to my seat.
It was the best speech of my life and, to be sure, the shortest.
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Tempo
- Maybe the pace always seems to be picking up. It does for me in the market . . . new
instruments, new tools, global influences, communication. It is all pace. And we have to
anticipate the pace by being more flexible. One of the ways to do it is to move people
around. Another is outsourcing (no one company, no matter how good, can possibly be best
in everything).
Virtual organizations have the least impediments of all to tempo but
are not automatically agile. The goal is to have temporary work teams form, do a job, and
disband before they try to institutionalize their existence. The highest form of
organizational achievement is to do oneself out of a job.
Tempo implies change. Lack of change means one gets farther from the real world which
is changing and is riskier than no change at all. If you don't change you will fail
anyway, so you might as well change and improve the odds.
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Edge of Chaos
- If organizational (and portfolio) performance is better at the edge of chaos, why don't
we all drive toward it, rather than away? Answer agents don't want system performance at
their own peril . . . agents, as in nature, want to live to propagate. So, arrange agents
so that they, individually, can drive to their ends while the system drives to its quite
different performance end. Introduce shocks. Change agents. Promote feedback, openness.
Reward action, whether successful or not. Rotate. Move. Outsource. Involve customers in
management decisions. Formalize the feedback loops. Increase tempo. Change tempo. Guard
against resistance ("push back").
Consider a personnel performance system
that tells people there is a system for measurement (and there is) but that they will not
know in advance what it is and how it changes. The system will be revealed at the end of
the period. To do otherwise is like setting up a test-gaming exercise. The system must be
as ambiguous as the world is.
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What is a Contrarian? (23 October 1996)
- Confusion abounds about what contrary thinking is. My mother considers it an insult that
someone would suggest that her "baby" was contrary. What mother wants to have a
contrary child? And others think that contrary means always going against the majority.
And still others think that it is automatically "counter-market-trend". And to
another group it is a steadfast adherence to value or asset based investing. It is none of
these, although the tactics of a contrarian may resemble one or more of the naive
descriptions. But they miss the point and seriously so.
Contrary thinking is most like
intellectual independence with a healthy dash of agnosticism about concensus views. True,
if a concensus grows to be a "herd" or "crowd", the contrarian will
flee. But not necessarily to the exact opposite. Instead, identification of a herd charges
the contrarian to be more rigorous in independent thinking. And the contrarian is more
likely to be attracted to a point of view that has not yet been thought of (the
"empty file drawer" idea) than one that has been considered and rejected.
Contrary ideas usually guide broad strategies, not specific investments. Timing is not
usually indicated by a contrary approach. Because contrary ideas are not an automatic
knee-jerk reaction away from concensus, there can a number of different, good, contrary
reactions to the same challenge. And all may be appropriately contrary.
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Artifical Intelligence (23 October 1996)
- Batterymarch first set up the firm as a large AI system in the late 70's. The ethic of
machines mimicking intentions of humans and of machines, not the people, organized by
hierarchical organization charts was counter-intuitive. I can recall a trustee of a large
university endowment who made a due diligence call on Batterymarch just before we were to
be assigned a substantial portion of the fund. Upon noting that no one "worked",
he commented that the Puritan Ethic was just the opposite and he would ensure that none of
the university's money was managed through such beliefs. He succeeded.
Today, uses of
AI incorporate dynamic learning features. It is usually used interchangeably with NN and
GA. Models learn rather than operate rigidly, as we did several decades ago.
Individual agents carry the same simple codes that we used, and can be used to combine
into complex systems just as we did.
But most clients cannot tolerate the unforecastable outcomes of portfolios that might
be produced at the most rewarding, yet most risky, tails of the distributions. There is a
desire to impose limits at the system level, usually "optimizers" built on the
assumption that market characteristics follow linear relationships. Of course, such
limitation un-does the very value of an emergent system. But if one lets the system
evolve, the power of machine assignment of tasks can free humans to do creative tasks. And
much better math tools are available today.
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Misleading Impressions (15 October 1996)
- I remember the admonitions of a junior high school science teacher that students should
not record measurements to a greater degree of precision than our crude instruments could
resolve. Although we could interpolate between the marks on a scale, we added error rather
than greater precision by writing down numbers that were unsubstantiated. It seemed
counter-intuitive at the time, but that observation has guided me countless times since
with investment numbers, especially in the days of computers with their appetite for
numbers to the right of the decimal point.
There are two levels of significance for
investment numbers. The first is - are the numbers produced significant and/or predictive?
Performance numbers are particularly subject to this scrutiny. They are almost always
statistically insignificant and most likely subject to initial conditions that are
unrepeatable. The second is - do the numbers imply greater merit than is warranted by the
underlying limitations of the measurement technique (the junior high example)?
Investment numbers that fall short in these areas can be harmful, yet they are widely
evident. And when seen suggest a disregard of basic academic standards for the expediency
of doing what is required by convention.
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Market tense (4 October 1996)
Linearity (4 October 1996)
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