Print this article
“Are you getting many ‘non-doms’ fleeing from England?” we asked the private banker in front of us. “Yes, we’re getting quite a few. They’re not motivated purely by money. They say they are beginning to feel like a persecuted minority in Britain… as if they weren’t welcome any more.”
We were glad to see our fellow non-doms taking the high road. But the low road is good enough for us. We went to Switzerland last weekend looking for a haven, not for our bodies, nor our souls, but for our money. A non-dom who keeps his money in Britain pays full-fare UK taxes. One whose money is overseas does not. Money flies no flag, but it is welcome in almost every nation. It also has more enemies than friends. And the biggest threat is probably the financial industry itself.
“Don’t worry,” the bright young man told us, “we maintain the highest levels of professionalism and use the most sophisticated tools of modern portfolio management”. That was just what we were worried about. They ought to give special parking places to anyone who studied business, economics or finance in the last 30 years. Education has poked out their eyes. What follows is a lament about the current state of people in the financial métier: they have been disabled by their own theories.
We felt a little sorry for the man. Handsome, well dressed, well spoken in three languages, he had spent years learning the principles of finance. His pitch to prospective clients was flawless. Yes, he said, the research department is keenly searching for alpha... but it knows that 80% of performance comes from careful asset allocation, which the bank’s strategists have calculated based on risk/return analyses going back a hundred years.
The expected return from Japanese equities in 2008, for example, will be precisely 9.36%...but with a volatility of 20.43%. And the handy “Correlation Heat Map” tells us which asset classes are likely to move in the same direction and which are not. There is, for example, a correlation of only 0.1 between US large-cap value stocks and the bank’s Macro-Opportunistic Hedge Fund.
All you have to do is to give the mathematicians a bone; they’ll figure out how to put these things together so that you can optimise your return while minimising risk. Then you could find yourself with a 90% probability that your $100 investment will grow to somewhere between $292 and $132 in year ten. This, it should be mentioned, is a “nominal” value. Even if the target is hit, the $132 may not even buy you a cup of coffee in Geneva. It barely does now.
So many numbers… But what do they really mean? “Can you tell us what the price of oil will be next week?” we asked. “Or, how about the dollar?” “So how can you make projections ten years out… on investments, all of which will be greatly influenced by the price of oil, the strength of the dollar, inflation rates and completely unforeseeable events?” Pointing to a helpful chart supplied by the bank, we continued our interrogation: “If these financial engineers were really able to project earnings and risk out to two decimal places over ten years, how come they couldn’t protect themselves from a blow up a blind man could have seen coming? In the last six months, Merrill Lynch has had to write down an amount equal to almost half its book value. UBS wrote down 40%.”
What’s gone wrong? It’s all about how the hot shots handle risk. Of course, they don’t really have any way of knowing what real risk is. So they substitute volatility as a proxy, which is a little like getting an inflatable doll to take your wife’s place at a dinner party; the conversation may be dull, but at least she won’t contradict you. This done, they could pretend that price movements were random, like natural phenomena. If an earthquake had stuck Rome twice in the last 100 years, the ‘risk’ of one was only 2%. For all they know, the streets of the Eternal City will rock every day for the next 200 years…but this little subterfuge gave their mathematicians something to work with. Then, treating price patterns like seismic records, they could make all sorts of simulations…and come up with fancy new products, such as a Highly Leveraged, Sub-Prime Debt Portfolio. Using historical norms, they pressed the junk credits together like potted meat and – in a miracle that would have floored Jesus – had it labelled ‘Prime A’.
Where this leads, we don’t know. But here at MoneyWeek, we have a dictum: the force of a correction is equal and opposite to the deception that preceded it. This one ought to be a doozy.
Published in
Economics
| More
articles
by
Bill Bonner
Related articles
-
By Bill Bonner, Jun 29, 2011
-
By Bill Bonner, Jun 28, 2011
-
By Bill Bonner, Jun 27, 2011
-
By Bill Bonner, Jun 24, 2011
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.