Chaitanya Patel

The post Latticework of Mental Models: Matthew Effect appeared first on Safal Niveshak.

The RBI will buy Rs. 10,000 cr. of rupee bonds from banks in an Open Market Operation (OMO) Auction on Jan 20.

Why is the RBI buying bonds?

Because it’s selling dollars.

Let me explain.

The rupee was falling, and falling fast. The RBI wants to defend 68 (and I think, 67.8). In 2016 from Jan 1, the  rupee has moved from 66.2 all the way to nearly 68 – which is when the RBI seems to have stepped in.

The rupee has been falling – or rather, in the graph below, the dollar has been rising, due to multiple factors – one, that foreign investors are exiting in droves. Two, that internationally, the dollar’s gaining strength.

In order to defend the rupee, the RBI has to sell dollars.

When it sells dollars, it gets rupees in exchange – and those rupees then get “extinguished” – or in other words, go out of circulation.… (Read On...)

The Trade Deficit for December 2015 widened as Indian Imports increased more than exports. The trade difference has also expanded due to increased Gold imports – which rose 179% to $3.9 billion in December. (Remember though that December 2014 – a year ago – was when gold curbs were only just opened, and gold imports started to rise from nearly zero)

As we get through the cycle the year on year numbers look better now, but there’s been a lot of damage.

Non-Oil Imports Spike and Growth in Positive Territory

Oil imports have been flat – as crude has flatlined. It’s down 33% from last year but on par with November. But Non-Oil imports (this includes gold) have gone up considerably.

Trade Per Day Improves

After months of falling, average daily trade (which smooths out the monthly numbers since months have a different number of days) has recovered a little. This is on the back of increased imports of course.… (Read On...)

Portugal has done the unthinkable, apparently: forced bond holders of one of their banks to take a hit. (Bloomberg)

Novo Banco was a bank created from the breakdown of Banco Espirito Santo, and was created after the bad assets were moved to a “bad bank”. The senior creditors and depositors lost nothing in the 4.9 billion Euro rescue.

Well, not until now. Depositors are still spared, but some bond holders holding upto Euro 2 billion of bonds would see their bonds moved to the “bad bank”, so that a hole in Novo Banco’s capital could be plugged.

These bondholders are different from other bondholders, and the reason they’ve been targeted is: the bonds were issued under Portuguese law, which many of the other bonds were issued under international law. The latter will be sued elsewhere, and the former cannot easily be sued.

This has a problem – had all bond holders been told to take a small hit, everyone would lose a little, but the 2 billion euro hole would be filled.… (Read On...)

Anand Radhakrishnan, CIO- Equities, Franklin Templeton mutual fund said the following in a panel discussion:

“Secondly, Sir John Templeton said focus on post-tax real returns. In India we focus a lot on nominal returns. If RBI is indeed successful in its inflation objective of 4%+ or -2% and the world is anyway reeling under zero inflation or a deflationary circumstance, it is quite alright to have lower expectations on nominal returns. If the economy is growing at 5%, 6% or 7% and then inflation is at 4% or even less, return expectations are still pretty high when investors walk into equity funds.

Focus on real post-tax returns, which is I think is going to be very different over the next five years than it was in the last five. Not in terms of real returns, but in terms of nominal returns.”

We’ve seen how Sensex has delivered around 17% over last 3.5 decades and CRISIL AMFI equity fund index delivering around 22% in last 18 years.

As you are aware, our long term nominal growth has been around 15%. This includes a real growth rate of 7% and an inflation rate of 8%.

In the long run, let us assume we would grow at 8%. Let us also assume the inflation would settle down at 4%. If this is the case, the nominal growth rate would settle around 12%.

When the nominal growth rate of the economy falls, the nominal growth rate of equity also falls. So instead of 18%, we may need to tone down our expectations to 15%.

But real growth rate, which is what relevant to us, would remain the same or marginally inch up higher; as real growth component increases and inflation reduces in the nominal growth.

If you notice, MIPs over the long run have delivered around 2% more than fixed deposits. As FD rates fall, the nominal returns from MIPs also would fall. But it would still deliver around 2% more than FDs due to active debt management and equity kicker.

So nominal growth rate is not static. It depends on real GDP growth rate and inflation. We may need to adjust our expectations in line with nominal growth rate. But the real growth rate would remain the same.

Nominal growth need not only go down. It can go up as well. It is a function of what is the real GDP growth rate and inflation.

Learn to accept the following returns from asset classes over long run:

Fixed Deposits: Inflation + 1%

Gold: Inflation + 1.5%

Real Estate: Inflation + 3% to 5%

Equity: Inflation + 7% to 9%

Actively managed fund would deliver couple of percentages more than index.

So if inflation is 4%, markets may deliver around 13% and equity funds would deliver around 15%.

Likewise, for an inflation of 4%, FDs may deliver around 5% and MIPs around 7%.

Please note that none of the above is guaranteed returns but only used as an illustration to explain the relationship between inflation, nominal growth rate and various asset class returns.

So start focusing on real returns, this is what matters to you as an investor.

The Government has decided to encourage startups through a number of changes they have outlined in an action plan that will help early stage companies do better.

Why Startups?

For one, they are a big source of income and employment, and for another they foster innovation. This is a good idea in my opinion, because startups will be future giants, and we have encouraged “large” companies only for the most part. Startups also have the potential to bring in enormous FDI (they’ve done so in the recent past) and also encourage domestic capital (which knows them best) to grow more such businesses.

Overall, the startup space has been dominated by technology companies in the internet space. Also by some non-tech sectors like grocery and food delivery. The real encouragement should be to startups in multiple spaces – whether it is solar powered tractors, electric engines, shaving blades or better financial products.… (Read On...)

When you invest in the markets there is one solid reason to be humble. At least you are not driven to suicide when you get things wrong. At all points in time you have errors of omission and errors of commission. It is human tendency to think of your mistakes as ‘could have been avoided’ […]

On 14 January 2016, we had a talk by Raymond Duch of the Nuffield Centre for Experimental Social Sciences (CESS). The title was Why we Cheat: Experimental Evidence on Tax Compliance [paper, video]. In an experimental setting, they find that high performance ("rich") experimental subjects are more likely to cheat on tax payments.

Understanding the results

I felt a key problem of the setup was the absence of coercion and punishment. Paying taxes is, at heart, about the coercive power of the State. Nobody wants to pay taxes; it is only the fear of punishment which makes you pay taxes.

I would interpret his results as saying: In a cooperative, high performance people are more likely to not pay in a fraction of their output to the common pool. The paper is about the behaviour of people in voluntary arrangements, and not tax compliance.

It perhaps suggests that a poll tax comes more naturally to humans as compared with a tax which is a fraction of the income. Imagine that you were in a cooperative: it's easier to think of everyone in the cooperative putting up Rs.X, rather than of everyone putting in x% of their income.

Heterogeneity in tax compliance

Turning to tax compliance, let's think of a simple setup where there is income $y_i$, a flat tax rate $\tau$, actual tax payment $T_i$, a $p$ probability of getting caught and a punishment $\lambda$ times larger than the tax shortfall $\tau y_i - T_i$. In this setup, the key parameter which will shape compliance is risk aversion. People who are more risk averse will comply more.

In countries where $p$ is high, the outcome will have high compliance. As $p$ becomes higher, the distribution of compliance will collapse into a point mass. When $p$ is low, and for certain kinds of distributions of risk aversion, we will get economically significant heterogeneity in tax compliance.

Low risk aversion is likely to be correlated with high performance. So we may endup with a simple correlation where high performance people are more likely to cheat on taxes. This is perhaps less spicy than meets the eye.

Tax compliance by firms in India

Consider the Indian operations of a multinational corporation versus an Indian family business. There is evidence that tax compliance by multinationals is superior. In my understanding, two things are going on.

The first is that $\lambda$ is not a constant; it is lower for Indian firms, as they are better able to manage the non-rule-of-law environment in the tax administration.

The second issue is risk aversion. MNCs tend to be very risk averse and look for safe interpretations of law. This may be related to multiple layers of bureaucracy and the principal-agent problems between the shareholder and the manager. Global compliance teams have a cover-your-ass attitude and force the local operations to play very safe. In contrast, Indian business houses tend to be take more aggressive interpretations of the law. They know this is risky and they walk into it with their eyes open.

There isn't much of a low-compliance-correlates-with-performance story here, as some of the best run companies in India (the MNCs) have the highest tax compliance. The empirical regularity actually runs in the reverse direction.

“All the books we own, both read and unread, are the fullest expression of self we have at our disposal…With each passing year, and with each whimsical purchase, our libraries become more and more able to articulate who we are, whether we read the books or not.”  –  Nick Hornby

I’m not sure how I missed Nick Hornby’s Ten Years in the Tub: A Decade Soaking in Great Books when it was released a few years ago. If you don’t know him, Hornby is the English author of novels like About a Boy, Fever Pitch, and High Fidelity. (All three became movies — Fever Pitch twice.) The book is a collection of ten years of Hornby’s columns for the magazine The Believer. Once a month, Hornby would list all the books he bought and all of the books he managed to read that month, then he’d write about the ones he’d read. By my count, he read about 60 in the first year alone, so he was active.

Hornby is everything you want in someone writing about books: cheeky, wry humor; self-aware, non-nerdy. Ten Years in the Tub is a fun read precisely because it’s a window into a book lover’s soul. A funny book lover. And if you’re reading Farnam Street, you’re probably a book lover, or at least a liker.

Most heavy readers can, for instance, pretty well relate to Hornby’s ranging between despair and cheeriness over the fact that he can’t seem to remember what he reads:

I don’t reread books very often; I’m too conscious of both my ignorance and my mortality. But when I tried to recall anything about [the book Stop-Time] other than its excellence, I failed. Maybe there was something about a peculiar stepfather? Or was that This Boy’s Life? And I realized that, as this is true of just about every book I consumed between the ages of say, fifteen and forty, I haven’t even read the books I think I’ve read. I can’t tell you how depressing this is. What’s the fucking point?

Then, just a few months later:

A couple of months ago, I became depressed by the realization that I’d forgotten pretty much everything I’ve ever read. I have, however, bounced back: I am now cheered by the realization that, if I’ve forgotten everything I’ve ever read, then I can read some of my favorite books again as if for the first time. I remember the punch line of The Sirens of Titan, but everything else was as fresh as a daisy…I’m beginning to see that our appetite for books is the same as our appetite for food, that our brain tells us when we need the literary equivalent of salads, or chocolate, or meat and potatoes. 

Hornby’s pugilistic description of a struggle to read the Victorian novel No Name by Wilkie Collins is a classic; he heartily recommends it when he’s about 200 pages through, and then quickly reverses course in the following month’s column as he realizes the book is an absolute slog for the final 400 or so. This reminded me of my attempts to read Crime and Punishment by Dostoyevsky years ago. (Hornby seems to have competed the task, I gave up.)

We fought, Wilkie Collins and I. We fought bitterly, and with all our might, to a standstill, over a period of about three weeks, on trains and airplanes and by hotel swimming pools. Sometimes–usually late at night in bed–he could put me out cold with a single paragraph; every time I got through twenty or thirty pages, it felt to me as though I’d socked him good, but it took a lot out of me, and I had to retire to my corner to wipe the blood and sweat off my reading glasses. And still he kept coming back for more. Only in the past fifty-odd pages, after I’d landed several of these blows, did old Wilkie show any signs of buckling under the assault. He was pretty tough for a man of nearly one hundred and eighty. Hats off to him.

He then goes on to offer a refund to any readers who bought the book on his recommendation. (Like I said, cheeky.)

Hornby struggles, as we all do, with the long-versus-short book conundrum. It’s hard to commit to the long ones, especially if you know reading it will take work, but at least they tend to stick because of the commitment needed. Not always so with the lighter reads. (The best solution to the long books, of course, is to commit with discipline to a digestible volume amount every day.)

The truth is, I’ve been reading more short books recently because I need to bump up the numbers in the Books Read column–six of this month’s were really pretty scrawny…But the problem with short novels is that you can take liberties with them: you know you’re going to get through them no matter what, so you never set aside the time or commitment that a bigger book requires. I fucked Old School up; I should have read it in a sitting, but I didn’t, and I never gave it a chance to leave its mark. We are never allowed to forget that some books are badly written; we should remember that sometimes they’re badly read too. 

For any parents out there, Hornby hits a familiar note in a passage about trying to get some reading done over a Christmas holiday…a seemingly modest goal…

So this last month was, as I believe you people say, a bust. I had high hopes for it, too; it was Christmas-time in England, and I was intending to do a little holiday comfort reading–David Copperfield and a couple of John Buchan novels, say, while sipping an eggnog and heroically ploughing my way through some enormous animal carcass or other. I’ve been a father for ten years now, and not once have I been able to sit down and read several hundred pages of Dickens during the Christmas holidays. Why I thought it might be possible this year, now that I have twice as many children, is probably a question best discussed with an analyst: somewhere along the line, I have failed to take something on board. (Hey, great idea: if you have kids, give your partner reading vouchers next Christmas. Each voucher entitles the bearer to two hours’ reading-time while kids are awake. It might look like a cheapskate present, but parents will appreciate that it costs more in real terms than a Lamborghini.)

And finally, Hornby reminds us, the challenge and frustration of being a book-lover trying to cover a lot of ground is that the best laid plans often go awry. (For those of us who don’t get books sent to us for free, substitute an Amazon addiction, or, say, a Farnam Street membership as the culprits of having too many books coming down the funnel.)

Francis Wheen’s book and Paul Collins’ Not Even Wrong were advance reading copies that arrived through the post. I’m never going to complain about receiving free early copies of books, because quite clearly there’s nothing to complain about, but it does introduce a rogue element into one’s otherwise carefully plotted reading schedule. I had no idea I wanted to read Wheen’s book until it arrived, and it was because of Wheen that I read Lewis, and then Not Even Wrong turned up and I wanted to read that too, and Buchan’s Greenmantle got put to one side, I suspect forever. Being a reader is sort of like being president, except reading involves fewer state dinners, usually. You have the agenda you want to get through, but you get distracted by life events, e.g., books arriving in the mail/World War III, and you are temporarily deflected from your chosen path. 

So, here’s our recommendation: First, learn How to Read a Book. Then pick up Hornby’s charming book for some inspiration. As you watch Hornby flit from David Copperfield, to Moneyball, to literary biographies of obscure early 20th century novelists, you realize it’s a book that reminds you why you love books. And it’s a reminder that people who love books are in a certain kooky fraternity for life.

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Lets face it, we have no clue about the equity markets, at least about Indian equity markets. Many people think that because there was no great activity in 2015, markets have to be up in 2016. I do not agree with that logic. Let us look at what is happening at the ground level. Many […]

I actually do not know, and I do not watch enough of the ticker channels to know what they are saying, but may I guess please? at these levels it is a great buying opportunity the Indian investor is coming in with SIP money so expect another 6 billion US $ from them this year […]

Cities are unaffordable by definition because of the value that can be extracted by living in them. 

A few months back, my Takshashila colleague Varun KR (Shenoy) asked me if there is any city where housing is not prohibitively expensive. It wasn’t a rhetorical question. While answering “no”, I went off on a long rant as to why affordable housing is a myth, and why housing in urban areas is by definition expensive. I had been planning to blog it for a while but I get down to it only now.

Cities are expensive to live in due to a simple reason – lots of people want to live there. And why do lots of people want to live in cities? Because the density in cities means that there is a lot more economic activity happening per capita that results in greater productivity and happiness.

If you are in a rural area, for example, there are few services that you could afford to outsource, for the small scale means that it doesn’t make sense for people to provide that service. Even when such services exist, lack of competition might mean a large “bid-ask spread” and hence inefficiency. This means you are forced to do a lot more tasks which you suck at, leaving less time for you to do things you are good at and make money from.

Needs of a rural area also means that there is a natural limit on the kind of economic activities that can be remunerative there, so if your skills don’t lie in one of those, you are but forced to lead a suboptimal existence.

Larger agglomerations (such as cities), by putting people closer to each other, provide sufficient scale for more goods and services to become tradable. Transaction costs are reduced, and you can afford to outsource a lot more tasks than you could afford to in a rural area, thus boosting your productivity.

Economist and noted urban theorist Jane Jacobs, in her book “Cities and the Wealth of Nations”, argues that economic development occurs exclusively in cities and “city regions” and proceeds to demolish different theories by which people have tried to create economic value in remote areas (my review of the book here).

The larger a city is, the greater the benefits for someone who lives there, controlling for ability and skill. Thus, ceteris paribus, the demand for living in cities exceeds that of living in smaller agglomerations, which gets reflected in the price of housing.

It might be argued that what I have presented so far is only an analysis of demand, and supply is missing from my analysis. (I don’t understand who is on the left and who is on the right on this one but) One side argues that the reason housing is not affordable in cities is that strict regulations and zoning laws limit the amount of housing available leading to higher prices. The other side talks about the greed of builders who want to “maximise profits by building for the rich”, which leads to undersupply at the lower end of the market.

While zoning and building restrictions might artificially restrict supply and push up prices (San Francisco is a well-known example of a city with expensive housing for this reason), easing such restrictions can have only a limited impact. While it is true that increasing density might lead to an increase in supply and thus lower prices, a denser city will end up providing scale to far more goods and services than a less dense city can, thus increasing the value addition for people living there, which means more people want to live in these denser cities.

As for regulations that dictate that “affordable housing” be built, one needs to look no further than the “Slum Rehabilitation Apartments” that have been built in Mumbai on land recovered from slums (the usual deal is for a builder to commit to building a certain number of “affordable” houses for the erstwhile dwellers of the slums thus demolished apart from “conventional” housing). Erstwhile slumdwellers rarely occupy such apartments, for they are willing to accept a lower quality of life (in another slum, perhaps) in exchange for the money that can be generated by renting out these apartments.

This piece is far from over, but given how long it’s been, I’ll probably continue in a second part. Till then, I leave you with this thought – a city becoming an “affordable” place to live is a cause of worry for policymakers (and dwellers of the city itself) because it is an indicator that the city is not adding as much economic value as it used to.

 

An interview with Hyun Song Shin, economic adviser and head of research at the BIS, reposted in the BIS web site reminds us of the strange and heterodox views that the BIS (and others) have about the behavior of inflation. The views run contrary to most of what we all teach about inflation. They can only be understood if one has a very special and radical view on what determines inflation and are supported by a unique reading of the data. You probably need to read the whole interview to understand what I mean but here is a summary of the new BIS theory of inflation:

1. Inflation is a global phenomenon, not a national one. Monetary policy has very little influence on inflation, demographics and globalization are much more relevant factors.

2. The idea that monetary policy affects demand and possibly inflation is a "short-term" story that is too simple to understand the recent behavior of inflation.

3. Deflation is not that bad. The Great Depression is a special historical event that holds no lessons for what we have witnessed during the Great Recession.

4. While central banks are powerless at controlling domestic inflation, they are very powerful at distorting interest rates and rates of returns for long periods of time (decades).

5. Central banks have a problem when inflation is the only goal (they end up creating distortions in financial markets).

6. Monetary policy is a cause of all China's problems (he admits that there are other causes as well).

In summary, central banks are evil. Their only goal is to control inflation but they cannot really control it and because of their superpowers to distort all interest rates they only end up causing volatility and crises. And this is coming from an organization whose members are central banks and its mission is "to serve central banks". Surreal.

Antonio Fatás

In the epic Hollywood flick The Wolf of Wall Street, Jordan Belfort says- “I’m a student of history, and I’m a firm believer that he who doesn’t study the mistakes of the past is doomed to repeat them.” I have already written about why this quote was the biggest lesson I learnt from the movie and so, will not bore you all with repetition. I am also sure that you must be thinking that Dev

This would have been great news. The price of our crude imports is at the lowest in – well, a very long time.

In fact, it’s the lowest price of crude, in dollars in the last 12 years (since December 2003).

 

Why is it not good news?

Because the government will simply raise excise duties. It’s done that so far on every single dip in crude prices.

Look at the crude fall – from October 2010. And we now measure the crude price in rupees (to account for rupee depreciation). And while we got some benefit of lower prices, the bulk of the benefit has been kept by your friendly government:

However, this remains positive for airlines, whose ATF prices aren’t yet being hijacked by the government.

Soon the Middle east will give petrol for free, and you’ll still pay the Rs. 61 at the pump because the govt will just put that much as duty.… (Read On...)

The one single advantage of running a blog is that people ask some really intelligent questions too!! One such question was “Can I invest my RETIREMENT money, the way Warren Buffet suggests?” I realised that this question comes from the 2013 letter wherein WB says “he says his will stipulates that cash be delivered to […]

So the wife has written a fairly insightful blog post about why South Indians from the previous generation don’t meet often “without an occasion”. The basic idea is that that generation never learnt how to split bills, or go Dutch. I had a few anecdotes that would add data points to this, hence this blog post.

I had mentioned in an earlier blogpost that my parents used to work at KEB. I remember going to their offices occasionally (I’d visit my mother more often than my father), and though I was rather young then, I remember that my mother and her colleagues had a policy that they would pay for their afternoon tea by rotation.

It was a rather informal practice (don’t think they kept formal track of who paid when), but I don’t remember a single occasion (ok my age was in single digits, and I don’t have too many data points, but I trust my long-term memory) when more than one person paid for the same round of tea.

During a conversation about splitting bills (this was when I was older, and had started going out with friends), I remember my parents having bitched about two of their colleagues, who used to unfailingly split their tea bills. Back in those days, tea in the subsidised KEB canteen cost 35 paise (one paisa is one-hundredth of a rupee), which made it hard to split (since there were no half-paisa coins). So it seems these two worthies had an arrangement where they would alternately contribute seventeen and eighteen paise respectively (story from the early 80s, so one, two and three paisa coins were quite common back then). And my parents looked down upon them, that they couldn’t be so trusting to not “lend” a full half-cup of tea to the other person!

The other data point is the choice of words – my parents referred to the practice of going Dutch as “military style” and that phrase was uttered with a sneer. So when I would tell them that my friends and I had split the bill when we went out, my mother would say “oh military style-aa?”. It was as if civil people (pun intended) never split the bills and were willing to spend for each other occasionally.

This is one of those classic counterproductive things – while it might be noble to pay for each other once in a while, going out only when someone is willing to pay for you (or vice versa) puts a cap on the number of times when you can meet. Of course you need to adjust for the fact that this generation grew up in relative poverty compared to us, and that old frugal habits (of not going out too often) are hard to shake off!

1) In a fair market, the rental yields are close to cost of borrowing. If cost of borrowing is 10%, rental yield also need to be around 10%. Then only it makes sense to own a house.

2) Another thumb rule is that the value of the property should not be more than 3 times one’s annual income. If your annual income is Rs.24 lakhs, your house purchase value should not be more than Rs.72 lakhs.

3) The house price to rent ratio should be around 15. If a house cost Rs.1 Crore and the annual rent is Rs.3 lakhs; the price to rent ratio works out to 33, which is very expensive. Going by the thumb rule, if this ratio is above 20, then the cost of owning is considered higher than cost of renting. This means you would be better of paying rent. In other words, the minimum rental yield should be 5% to justify owning a property.

4) Make it a point to save atleast 50% of the property value as down payment; till then live in a rented place. 10% down payment means you work rest of the life for welfare of the bank.

5) Home loan EMI as a part of your income (debt to income ratio) should not exceed 30% (i.e.) EMI should not exceed 30% of your take home pay.

6) The maximum you can pay for the car should not be more than 5% of your net worth. So if your net worth is Rs.2 crores, the car should not cost more than Rs.10 lakhs.

7) Makes more sense to buy a new car. But you should drive it for not less than 10 years.

8) 20/4/10 rule: If you decide to borrow for your car, you should at least put 20% down payment. The repayment tenure needs to be not more than 4 years. The monthly transportation cost should not be more than 10% of your take home salary. Transportation cost includes EMI, fuel and insurance.

9) The best rule: If you can save money and then buy a house and car by making full payment. No debt is the best option. Debt is slavery.

Look out for another year of lacklustre growth for the world economy.

The World Bank has cut its forecasts for growth for the global economy for 2016 as well as its estimate for 2015. In 2015, the world economy grew at 2.4%, down from 2.6% in 2014 and lower than the forecast of 2.8% made in June.

In 2016, things won't get a lot better. The Bank pegs growth at 2.9% but this could go for a toss if the present turbulence in the financial markets continues.

One thing is crystal clear: the world economy has done a 180 degree turn since the early years of the financial crisis. Then, the developed countries sank but the emerging economies chugged along. There was much talk of "decoupling"- how the emerging markets' fortunes would be disconnected from those of the advanced world.

Now, things have changed. The advanced economies (as a group) have bounced back. It's the emerging markets that are sputtering. In Brics, all economics face major challenges except for India (relatively speaking). In 2010-14, the major advanced economies contributed 0.7 percentage points to world growth; in 2015-18, they are poised to contribute 0.9 percentage points.

Still, 2.9% growth does not constitute a crisis by itself- in 1993-2000, the world economy grew at 3.4%, so a drop of 0.5 percentage points should not cause panic. As I have been saying repeatedly, the problem we face today is not entirely economic. It's not China's slowing down or crashing stock markets there that pose the major problem.

Rather, the problem is that weak economic growth is happening at a time of worsening geo-politics. This can cause financial turbulence that is out of all proportion to fundamentals. We could have major funds simply dumping securities in emerging markets and fleeing. Then, a manageable problem becomes an unmanageable one.

Why do I say that? Well, FT columnist Gillian Tett reports that Nevsky Capital, an emerging markets specialist is closing shop. This is a fund that has produced annual average returns of 18% since inception! Why are they shutting down?

Martin Taylor, Nevsky’s co-founder, thinks the world economy is subject to so much political risk that “it is more difficult than ever before for us to accurately forecast macroeconomic and corporate variables”. .....Moreover, it is not alone in drawing in its horns: several high-profile funds, including BlueCrest, Seneca, LionEye and Lucidus Capital have recently done likewise. They have all presented their decision in slightly different ways but all point to a common theme: markets are becoming so unpredictable that tried and tested strategies are breaking down.A world shaped by irrational politics and capricious policies — in the west as well as in China and other emerging markets — is not something modern investors are equipped to deal with.

So, the real source of the problem, it would appear, is leaders in the west ratcheting up tensions with respect to Russia, China and the Middle East. They do so in the knowledge that the outcomes are relatively benign for themselves and bad for Russia, China and the Middle East. In other words, good for us (the west), bad for the rest. It's the political economy, stupid.

The post Latticework of Mental Models: Game Theory appeared first on Safal Niveshak.

“We don’t see things as they are, but as we are.”
— Anaïs Nin

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Matthew Frederick‘s series of 101 things I learned in {Business School, Law School, Architecture School, Engineering School} attempts to distill the key learnings from these disciplines and offer them in a bite-sized package.

In 101 Things I Learned in Law School he teams up with California-based attorney Vibeke Norgaard Martin. Together they deliver a noteworthy book for the armchair lawyer in all of us. Despite the title, readers will find the selection of insights below connect to a lot of the ideas on this site.

Consider this bit on the difference between truth and honesty.

Lawyers must be honest, but they don’t have to be truthful. Honesty and truthfulness are not the same thing. Being honest means not telling lies. Being truthful means actively making known all the full truth of a matter. Lawyers must be honest, but they do not have to be truthful. A criminal defence lawyer, for example, in zealously defending a client, has no obligation to actively present the truth. Counsel may not deliberately mislead the court, but has no obligation to tell the defendant’s whole story.

Insight doesn’t arrive head on — echoing William Deresiewicz they write:

Be suspicious of the person who sizes up a new situation very quickly, claims understanding, and stakes out an ironclad position. Insight usually requires long periods of discussion, research, analysis, rationalization, and counter-argument, and it rarely arrives while attacking a matter directly or on a first pass. If one occasionally is able to quickly understand a complex matter, he or she is far more likely to misunderstand it.

Thinking means ragging at problems long enough to understand them — something less and less common in our fast-paced world. Most people won’t or can’t do the work to understand the problem. Our first thoughts are most often the thoughts of someone else and represent conventional wisdom.

Writing is thinking on the page.

A well-constructed argument rarely, if ever, resembles what one started with. Writing effectively isn’t recording the argument one wishes to make; it is a process of discovering what one’s argument needs to be. Through writing, thinking, researching, rewriting, rethinking, and rewriting again, an argument is discovered and clarified.

You don’t have to be right. You just have to be better than the alternative.

It is always possible to make at least some arguments for or against a legal position. An argument requires logic, but legal argument is not a purely logical form of argument that promises a universal, absolute conclusion. Rather, it is a practical form of argument that aims to establish one claim as more probable or reasonable than another.

Make a logical argument. There are two types of logic: deductive and inductive.

Deductive logic: usually works from broadly accepted truths toward demonstrating a truth in a specific situation, although more properly it is any argument in which the premises guarantee that their logical outcome is a truth.

Inductive logic: tends to work from specific examples of truth toward demonstration of a larger truth, but can be any argument whose conclusion, while not guaranteed, is a likely or higher probability outcome of the premises. Successful inductive reasoning requires a convincingly large sample size.

Large sample sizes are not only important in inductive reasoning but they also offer a guide for how to spend our time reading and learning. Peter Kaufman offers some insight on the three largest sample sizes.

Every statistician knows that a large, relevant sample size is their best friend. What are the three largest, most relevant sample sizes for identifying universal principles? Bucket number one is inorganic systems, which are 13.7 billion years in size. It’s all the laws of math and physics, the entire physical universe. Bucket number two is organic systems, 3.5 billion years of biology on Earth. And bucket number three is human history, you can pick your own number, I picked 20,000 years of recorded human behavior. Those are the three largest sample sizes we can access and the most relevant.

Arguments, however, are about more than rationality and sample sizes. We are human after all. Passion comes into play.

Rationality is cool; passion is warm. Rationality provides logical justification for a position, while passion provides a human connection to it. Both are needed to advance an argument; an abundance of one will not compensate for a dearth of the other. An argument may be extraordinarily rational, but its correctness alone is unlikely to compel others to care enough to right the wrongs behind. it. An extremely passionate argument may initially attract sympathy, but unmitigated displays of emotion at the expense of rationality will wear thin and eventually prompt others to tune out your message. Rationality makes an argument worthy. Passion makes it worthwhile.

Show me a company governed by rules and I will show you a dying company — the extent to which rules govern culture offers an indication of how fast. Despite our attempts to reduce everything to an efficient systems of rules there are always exceptions. The wise know the exceptions to the rules. One could argue that you don’t know the rule until you know its exceptions.

A presumption of all court testimony is that the opposing side may cross-examine its source. If a witness quotes someone who is not available for cross examination, the statement, if objected to by the opposing attorney,  might be ruled hearsay and be forbidden. The rule against hearsay testimony has about thirty exceptions. In order to get a statement made outside court into court when its originator is unavailable to testify, one has to determine how to fit it into at least one of the exceptions. In practice, the exceptions to the rule are the rule.

Echoing the Kantian Fairness Tendency, the integrity of a system is more important than the fairness in one case.

A trial’s search for truth is invariably imperfect because it cannot be conducted in a way that introduces unfairness into the legal system. If a piece of evidence was improperly acquired or mishandled by the prosecution, it may be excluded from trial even if it provides an incontrovertible link between the defendant and the crime, because evidence in future cases could be similarly abused. If this allows a guilty person to go free, it is not because the court is not interested in the truth of the case; it is because it accepts that the truth must take some small lumps in the short run so the court gets better at finding the truth in the long run.

101 Things I Learned in Law School goes on to discuss how to explain your argument, language, why an hour can have 116 minutes and more.

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A year or two before I was born, my parents both took and passed this exam called “SAS” (no clue what it stands for), following which they were both promoted to officer grade (they used to work for the erstwhile Karnataka Electricity Board (KEB) back then).

Many of their colleagues elected to not take up this exam (or perhaps took and flunked it) and didn’t get promoted for the rest of their careers, remaining “senior assistants”. While they didn’t “progress” in their careers, they didn’t do all that badly financially, with their pay scale growing more or less at the same rate as it would have had they become officers.

This examination-based division into officers and “staff” was not limited to KEB, of course. It was (and is) prevalent across all public sector units. If you passed the exam, you had a chance at career progression, though that also typically meant harder work and longer hours. It wasn’t necessary for everyone to be ambitious, though, since they could choose to remain at a non-officer grade where things were chiller.

While there might have been noble intentions for this bifurcation (making the pyramid thin at a low enough level, for example, and also addressing lumpy/bursty recruitment), the problem with the practice was that it created a rather large cadre of rather unambitious workers.

Given that it is not easy to sack someone from a PSU job (unless there has been gross misbehaviour), the only way to incentivise PSU employees to work is by showing them carrots. While tenure or seniority based promotions have put paid to such incentives, it is still reason enough to keep a section of the officers motivated. For Senior Assistants who have hit a wall on that front, it is simply not available.

Given the shape of the pyramid and the lack of carrots for Senior Assistants (and equivalent) what this policy has created is a large army of government/PSU officials who lack any motivation or incentive to do their job effectively.

With most government departments being monopolies, this is a problem only for the taxpayers and public (and not so much for the departments themselves). Where this hits PSUs hardest is where they compete with the private sectors, in banks, for example.

I’ve maintained that one of the advantages of PSU banks is that the staff there are much more experienced, so if you have a non-standard thing to do, you would rather go there than to a private bank that might throw the rule book at you.

The problem, though, is that while some staff might be motivated enough to use their experience and help you out, not all of them might be that way, for most of the clerical staff belong to the aforementioned “Senior Assistant” category, with no explicit incentive to keep them going. The same is the case with non-customer facing staff as well.

I understand that various other careers can also have “career-limiting moves” (after which you don’t get promoted) but the problem with the Indian PSU system is that such moves happen pretty early on in the career, which creates a lot of deadweight for the system to carry.

As Arthur Levitt said, chasing fund performance is often the quickest way to hurt your mutual fund returns.

Please read this article which talks about a study done by Vanguard.

This study confirms what we’ve been repeatedly saying. Stick to the chosen portfolio with conviction despite ups and downs. Don’t chase returns and performance.

We should make changes to portfolio only when it is absolutely necessary. It need not be ‘never’ but should definitely be ‘rare’.

I’ve given some excerpts from the above article:

“The other study was authored by U.S. ETF giant Vanguard, which looked at the histories of more than 3,500 equity mutual funds in order to compare a basic buy and hold strategy to a frequent-trading strategy that simulated the effect of performance chasing.

The study looked at three-year rolling return performance between the years 2004 and 2014, across nine equity groupings (this is roughly in-line with the time the average fund investor holds an equity mutual fund). The simulation also tracked the Sharpe ratio of the average fund in the category, a measure of risk-adjusted return.

The “rules” of the buy and hold were relatively simple: the simulation invested in any fund, and held it to the end of the time period. If the fund was discontinued, the simulation simply reinvested its money into the median-performing fund within the grouping.

For the performance-chasing portfolio, the simulation invested in any fund with an above-average three-year annualized return. If that fund turned in a below-average performance for the next three-year rolling period, that fund was sold and the simulation re-invested the proceeds in equal amounts into in the top twenty funds in the asset grouping.

At the end of the day, the simulation produced a total of more than 40 million return paths – a pretty good yardstick for measuring whether performance-chasing or buy-and-hold is the more sensible strategy.

Category             Buy & Hold       Performance chasing

Large Blend           6.8%                     4.5%

Large Growth         7.1%                     4.3%

Large Value            7.0%                    4.7%

Midcap Blend          8.9%                     4.9%

Midcap Growth       8.6%                     5.7%

Midcap Value          9.2%                     7.6%

Small Blend             8.9%                     6.3%

Small Growth          8.6%                     5.7%

Small Value             9.3%                      5.8%

The chart above illustrates that buy and hold was the clear winner, beating performance-chasing in all nine style boxes. Note the size of the performance gap between the two strategies.

The Sharpe ratio was better (i.e., higher) for each of the buy and hold portfolios, meaning there was less volatility along with better returns. Talk about having your cake and eating it too! “

I want to mention here what I wrote you last year:

You may know Peter Lynch, one of the best mutual fund managers who managed Fidelity Magellan Fund and produced an outstanding performance. He once said that more than 50% of the investors in his fund lost money despite the fund being an outstanding performer. Reason? Inflows were more after few good quarters and outflows were more after few bad quarters.

Boston based Dalbar releases a QAIB (Quantitative Analysis of Investor Behavior) report every year. Dalbar compares how much the investment gave versus how much the investors made. The difference is called performance gap. From 1984 to 2014, for a period of 30 years, the S&P 500 has given an annualised return of 11.11%. Whereas equity fund investors earned only average annual return of 3.69%. The performance gap is 7.42%.

Why performance gap? When a fund, after expenses, over a 10 year period, gives 18% returns, the investors also should have also made the same. But this rarely happens in a real life scenario. Investors invest more when the markets are high and redeem more when the markets are low. Added to that they keep chasing performance. A good fund is ditched because it had a bad year. A risky fund or not so good fund but which shows recent good performance gets lot of inflow. All these ensure that investors as a group earn less than what the funds provide. In many cases, people actually lose despite markets and funds doing well over a period.

You are aware that we rarely make changes to portfolio. Our general advice is always to stay the course through both ups and downs. There are many advisors in the markets, mostly banks, who keep churning the portfolio very frequently. Recently there was a news item that Standard Chartered Bank churned a customer’s portfolio 200 times over a period of 19 months.

Churning is done for both psychological and monetary reasons. Investors constantly want action in their portfolio. Not all investors are matured like you to understand that inactivity is best when it comes to investing. Every time there is a churn, the advisor earns an upfront commission. That’s why unscrupulous advisors cater to the investors’ misplaced need of constant activity to line up their pockets.

Though our longevity is increasing, we are getting more and more short sighted with the investments. Investors need to control their habit of constantly tinkering with their portfolio and show the door to advisors who encourage this habit for their personal gains.

You may find it ridiculous that I am saying this, but I have some awesome news for you. Normally in an environment where the media pushes you for trading – have you noticed them saying “have a good trading day”(sic) you think all investors think of the short term. It is not so. I do […]

While it is too early to look at data and come to an objective decision, there is enough reason to believe that Delhi’s “odd-even” plan (that restricts access to streets on certain days to cars of a certain parity) might work.

 

The program was announced sometime in December and the pilot started in January, and you have the usual (and some unusual) set of outragers outraging about it, and about how it can cause chaos, makes the city unsafe and so forth. An old picture of a Delhi metro was recirculated on Monday and received thousands of retweets, by people who hadn’t bothered to check facts and were biased against the odd-even formula. There has been some anecdotal evidence, however, that the plan might be working.

It can be argued that the large number of exceptions (some of which are bizarre) might blunt the effect of the new policy, and that people might come up with innovative car-swap schemes (not all cars get out of their lots every morning, so a simple car-swap scheme can help people circumvent this ban), because of which only a small proportion of cars in Delhi might go off the roads thanks to the scheme.

While it might be true that the number of cars on Delhi roads might fall by far less than half (thanks to exemptions and swap schemes) due to this measure, that alone can have a significant impact on the city’s traffic, and pollution. This is primarily due to non-linearities in traffic around the capacity.

Consider a hypothetical example of a road with a capacity for carrying 100 cars per hour. As long as the number of cars that want to travel on it in an hour is less than 100, there is absolutely no problem and the cars go on. The 101st car, however, creates the problem, since the resource now needs to be allocated. The simplest way to allocate a resource such as a road is first come-first served, and so the 101st car waits for its turn at the beginning of the road, causing a block in the road it is coming from.

While this might be a hypothetical and hard-to-visualise example, it illustrates the discontinuity in the problem – up to 100, no problem, but 101st causes problem and every additional car adds to the problem. More importantly, these problems also cascade, since a car waiting to get on to a road clogs the road it is coming from.

Data is not available about the utilisation of Delhi roads before this new measure was implemented, but as long as the demand-supply ratio was not too much higher than 1, the new measure will be a success. In fact, if a fraction of earlier traffic remains on the road, the scheme will be a success as long as the earlier utilisation of the road was no more than (of course we are simplifying heavily here. Traffic varies by region, time of day, etc.).

In other words, the reduction in number of cars due to the new measure should mean significantly lower bottlenecks and traffic jams, and ensure that the remaining cars move much faster than they did earlier. And with lesser bottlenecks and jams, cars will end up burning less fuel than they used to, and that adds a multiplier to the drop in pollution.

Given that roads are hard to price (in theory it’s simple but not so in practice), what we need is a mechanism so that the number of cars using it is less than or equal to capacity. The discontinuity around this capacity means that we need some kind of a coordination mechanism to keep demand below the capacity. The tool that has currently been used (limiting road use based on number plate parity) is crude, but it will tell us whether such measures are indeed successful in cutting traffic.

More importantly, I hope that the Delhi government, traffic police, etc. have been collecting sufficient data through this trial period to determine whether the move has the intended effects. Once the trial period is over, we will know the true effect this has had (measuring pollution as some commentators have tried is crude, given lag effects, etc.).

If this measure is successful, other cities can plan to either replicate this measure (not ideal, since this is rather crude) or introduce congestion pricing in order to regulate traffic on roads.