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The C words: an irregular, irritating series of dictionary narratives

C stands for ….*

Comfort, a state of mind as inappropriate in superannuation as it is endemic. One visitor to our fatal shores described the superannuation industry as a “giant love-in whose core competency is preserving its comfort, privilege and power.” When threatened, reviling antipathy between groups dissipates like the Cheshire cat’s grin. Hint at changing the tax rate on large retirement benefits or merely mention ‘independent trustees’ and hear the industry scream in unison, “don’t touch super” perennially justified, with nary a hint of irony, as being “in members’ best interests.”

Certainty, an unattainable state that offers eternal comfort. Long ago Friedrich Hegel foresaw the danger, “(we) are so hungry for certainty that (we) will readily subordinate consciousness and conscience to it”, a hunger that drove many to buy Bernie Madoff’s promised certain returns.

Confidence, a strange characteristic to claim in our world of profound ambiguity and intrinsic uncertainty. Yet managers and advisors feel compelled to project unjustified levels of confidence lest clients lose confidence (sic) in them.

Capital guaranteed, an offer that given our abiding aversion to loss and re-enforced by Hegel should have great appeal. That it doesn’t is probably due to the complexity and opacity of underlying derivative structures or of hidden balance sheet manoeuvres that rightly warn investors off.

Capitalism, a system desperately in need of profound renewal to escape from Minsky’s Sixth State of Capitalism - Money Market Capitalism – in which power, status, people and rents flow not to the production of goods and services nor even to the matching of risk-capital with economically meaningful investments, but flow mightily to Wall St vampire squids.

Competition, the core of capitalism that should act for the common good by pushing prices down toward the marginal cost of production, which it does in the whitegoods industry but not in investments or superannuation where quality cannot be assessed. In haute fashion and investment banking vendors put prices up when demand falls lest buyers sense a decline in quality. In investments and superannuation competition serves to increase the number of agents and aggregate costs for no material net benefit to members.

Commitment fees, the second most egregious of fees. All businesses are ‘front-end loaded’ but only private equity managers raise capital from future clients and charge them for the privilege. Other businesses raise capital by going to markets, by borrowing from banks or from mothers-in-law, or by stealing. At least the latter has a slight modicum of integrity.

Co-operation, more of which is sorely needed by superannuation funds in their battle against Wall St squids, while by design competition has led to a decline in co-operation and collaboration.

Complexity, the pursuit of which (like money) is a sin yet so appealing to some. (Mea maxima culpa.) Heed the words of Alfred North Whitehead (yes philosophers can ‘add value’), “seek simplicity … but distrust it” and of Al Einstein “Everything should be made as simple as possible, but no simpler.” (Note to the Young: Enhance your credibility today by quoting Einstein and Buffett.)

Copulas, CLO3s, Correlation Swaps, …, and other complex constructs of dubious provenance. They can be of some value but are best kept in bestiaries, allowed out only if brutally constrained.

Cash, the simplest asset class whose malleability reached its apogee with a banker classifying his yacht as a ‘cash equivalent’.  Detracts from performance through cash drag and simultaneously enhances performance through its option value. At times beloved by investors; always despised by investment managers.

Causality, a notion with which we struggle mightily. One touted benefit of Australia’s compulsory retirement system is that increased savings causes economic growth. Yet evidence from other countries suggests causality (if it exists) may flow in the other direction. The common assumption that high levels of government debt cause low growth is also in doubt. Causality (if it exists) may flow in the opposite direction: low growth causing government revenues to fall necessitating borrowing.

Cynic, one who, according to Oscar Wilde, “knows the price of everything and the value of nothing.” Did Oscar also frequent the haunts of momentum investors?

Committees, strange groupings to which we all belong. Like families, each is dysfunctional in its own way. Some committee decisions are better than those of any individual member.

Consumer, a word that should be verboten in the industry as it encourages the mass- and mis-selling of ‘products’ to be consumed like breakfast cereal, for short-term excitement, rather than to be invested in for patient long-term gain. Worse still, categorising people (are we embarrassed to use that word?) by their consumption is de-humanising.

Courage, a notion that elicits images of confronting tanks in Tiananmen Square. Thankfully, for most of us, all that’s required yet rarely seen is the courage to differ from the herd, the courage to invest in strategies before they have the comforting 3-year consultant stamp of approval, the courage to reject cant and self-serving bullshit, the courage to resist lawyers and regulators when to do so is in members’ interests, and the courage to stand up to bullies on boards and elsewhere.

Proposed Trade For Us All: Swap a large dollop of the abundant and over-priced comfort for a tiny pinch of the scarce and under-priced courage.

* C also stands for Conservative, Conform, Comply, Cautious and Consultant.

Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing.

Harry Chemay
August 09, 2013

Dr Jack Gray is that most remarkable (and might I add valuable) of creatures in the finance industry; a free thinker. His intellectual powers alone make him stand out in an industry (asset management and consulting) replete with highly intelligent people. What makes Dr Gray different however is his fierce independence of thought and deed; calling a spade a spade, not a utility maximizing device for the removal and/or transportation of earth or related matter from one location to another. He is KISS personified.

I have had the good fortune to meet Dr Gray on one or two occasions, and to have communicated with him from time to time. He is by turns witty and provocative, and always generous with his time.

And so to this latest gem. Jack, the entire article resonated with me, but I have to explore two in particular a little further; those of 1) Complexity and 2) Copulas, CLO3s, Correlation Swaps.

If there is one thing that grates me, and still does after 16 odd years in the finance industry, it is the self-serving and un-necessary complexity built into much of what the industry creates for its clients, be they institutional or 'mum-and-dad' investors. And blame here must be shared between the manufacturers (banks, fund managers, structured product developers) and the advisory community (consultants, planners, accountants and related advisors) alike.

This self-serving complexity serves only to replace clarity with confusion, and sound judgement with hesitant, erratic decision making. I can see no other beneficiary of greater complexity than those on the 'sell side' of the bargain. Jack, you have written tirelessly about the Principal/Agent problem in the financial services sector, mostly as a lone voice in a wilderness where opacity dominates transparency.

And so to the ultimate expression of complexity; Copulas, CLO3s and Correlation Swaps. Last year I attended an investment briefing by a hotshot hedge fund manager from the City. He was explaining how brilliant his firm's algorithmic models were in generating returns for a particular strategy. Lots and lots of PhDs in physics and higher maths constantly tweaking the mathematical equations that essentially 'made the calls'.

When it came time for questions I patiently waited my turn, then asked him about his firm's view on 'model risk' and how it was managed, given its role (and I specifically mentioned the Gaussian Copula) in the meltdown of the CDO market in 2008. His response was as unexpected as it was telling. In a room full of advisors he said I was both "wrong and insane". I wear this as a badge of honour.

From a 2009 article on the Economist website:
"The Gaussian copula was a statistical convenience which merely provided an approximation of a complex relationship. The big and fatal change that occured after 2001 was not so much securitisation, but that banks began to hold mortgage assets on their balance sheets. If they did this as a result of the Gaussian copula, it screams incompetence. The same can be said for rating agencies who should have known better."

Whenever I feel the cloak of complexity descend upon me, I think of the words written by my first year Stats tutor at uni: "eschew obfuscation". He wrote that on the board at the end of the first class, turned and left, leaving us scratching our heads. It took me a while to work out its meaning. Now I live it as a credo.

Ramani Venkatramani
August 09, 2013

Thanks for the delectable offering by Jack Gray. Under 'capitalism' he alludes to Wall St vampire squids, but surely the ambiguity-ridden English language will equip them to sanctimoniously use to conflate their role with a sanctified status, abbreviating 'saint'?

The omission of 'communication' notable. Though not endowed with anything like 'Gray' matter, I suppose it might read: "a statutory requirement on providers for savers, whereby the former exploit the latter, with the active connivance of lawyers, by applying the law of inverse proportion (more matter is less meaning).Like canines and lamp posts, they use disclosure for pissing off rather than illumination"

Jack, I remind you that there are 25 other alphabets, so better get on to them!


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