Notes from the CFA Institute Annual Conference
Singapore, May 2013 A Canter
With the conference positioned in Singapore there was an inevitable focus on Asia: There
were several Asian speakers and many observations about the position of Asia in the world
and the growing differences between Emerging Markets (EM) and Developed Markets (DM).
In particular, there was commentary on China's global political role (growing) and economic
Economically, the world has ‘past the worst’, and the risk of collapse has been ameliorated.
But while EM and Asia are growing, the DM have lost their verve and face continued prosaic
growth. The underlying message is: The future belongs to Asia, and the mega trend is the
continued lethargy in the West and energy in the East. Driving growth and opportunity is the
expansion of the global middle-class -- of which Asia will garner a large share.
Monetary policy is a recurring concern:
| Politicians are placing too much reliance on central banks, and not making enough effort in
fiscal and structural reforms. This may impair the ability of central banks to implement
the ‘great exit’ from quantitative easing – thus creating inflation risk.
| The extremely loose monetary policy of the U.S. and Japan is not appropriate for the EM
world, and is causing ‘price dislocations’ (e.g. property bubbles). In particular, due to US$
currency pegs Asia is importing the U.S.'s monetary policy, which is not suitable for their
| Japan's new monetary enthusiasm is received with both hope and scepticism (as is Abe-
nomics in general).
| The Euro common currency and monetary policy is not appropriate for a bifurcated
With the continued split of European nations’ prospects, persistent recession, fragmentation
of motives, and rising extremist parties, the risks to Europe remain high. Things seem to be
moving toward some sort of resolutive event for Europe.
The mood toward global bonds (particularly duration, but to some extent credit) is hostile,
with the general feeling that the risks are too high, returns too low, and rates can only rise.
The view on equities is less clear and consistent, but there is more comfort with Chinese and
Asian equities than DM.
Infrastructure investment is a recurring theme -- both in terms of a) the need for more
infrastructure spend by nations to match growth, and b) from an investors' point of view the
ability to invest for decent returns. This trend and theme seems well accepted, entrenched
and likely to grow.
In the subtext was the message that corporate ethics & governance in Asia are weak, and
corruption is endemic in many countries. While several mentions were made about
responsible/sustainable investment, it seems to remain an ancillary, poorly defined concept.
Responsible investing is likely to be a persisting theme, but it feels two-steps away in a world
where governance is weak, corruption is endemic and trust in financial markets is broken.
The financial industry is cognizant that trust is broken, and while introspection has (perhaps)
stopped, there is a resignation that more and better regulation is part of the answer.
"The most important skill in a world of disruptive innovation is the ability to keep on
learning." Vijay Vaitheeswaran
In dealing with the world's challenges: "People are not the problem, people are part of the
solution." Vijay Vaitheeswaran
"Globally, interest rates have nowhere to go but up." John Anderson
"How do you make decisions when you don't trust your model? Be very cautious." Thomas
"People [and markets] are not 'risk' averse, they are 'ambiguity' averse." Thomas Sargent
"Nigeria is one place where the whole is worth less than the sum of the individual parts."
(Dambisa Moyo, quoting thesis supervisor)
"Fundamentally China [competing] in the world is a good thing: My mother always said that
'Having another suitor is always a good thing'." Dambisa Moyo
"Wars have become a sunset industry." Kishore Mahbubani
"Fixed Income: Better known as return-free-risk." John Rogers
"Investing is a weighing machine, not a voting machine." Ben Graham
"I've learned to rely on the incompetence of auditors." John Hempton
"China is not interested in neo-colonialism in Africa: They have 300 million rich people and 1
billion poor people of their own" after Dambisa Moyo
"Fixing the world is going to be very easy." Kishore Mahbubani
"If you believe America will be number one forever, then keep on doing what we are doing.
But if you can conceive of the possibility where America is not number one, then it is in our
interests to create a room space for our public institutions." Bill Clinton (quoted by Kishore
"Buy assets that are undervalued and you will be okay." Wong Kok Hoi
"More money has been lost reaching for yield than at the point of gun." Raymond DeVoe Jr.
(quoted by Lim Chow Kiat)
"Given the unbridled opportunity to do so, capitalism will produce, deliver and sell things that
are very bad for people and humanity." Canter
"Current yields leave little on the table to cushion mistakes." Lim Chow Kiat
"War is the single largest force that will determine the history of the 21st century." George
"To make poor people poorer is less destabilizing than to make the middle or upper classes
poorer." George Friedman
"The winners are those who believe what they see fastest." George Friedman
"Americans produce outrageous products (shopping malls, third-world debt, housing bubbles,
etc), then the rest of the world buys them and later blames America." George Friedman
"The lesson of Empire is that going to war is a serious matter: People die, and sometimes the
people you loathe win." George Friedman
"India is the country of the future, and will remain in that niche for each succeeding year."
"I get zero credit for the crises I avoid." Barney Frank (U.S. politician) (quoted by George
“You don't get pulled into a war, you make a conscious decision.” George Friedman
"When it becomes serious, you have to lie." Jean-Claude Juncker, April 20, 2011, after
denying a meeting that he attended was held (quoted by J Kyle Bass)
"Markets tend to forget that governments and central banks can have very long term
horizons to make investments, implement policies or unwind excesses." Canter
"The brevity of financial memory is about 2 to 3 years." J Kyle Bass
"Japan's numbers are self evidently bad, but the entire world is in denial of the likely extreme
negative outcome." J Kyle Bass
"If there is a JGB crisis, it won't be 100 b.p. it will be hundreds and hundreds!" J Kyle Bass
"Japan has never missed an opportunity to miss an opportunity." J Kyle Bass
To explain the power of the narratives around us Kishore Mahbubani told the following joke:
A young priest went to his Bishop and asked "Father, is it okay if I smoke while I pray?"
"Absolutely not! That is a sin, abomination and sacrilege!" was the reply.
The young priest told another priest, who said “You asked the wrong question, I can sort
He went to the Bishop and asked: "Father, is it okay to pray while I smoke?"
“But of course!” said the Bishop.
Need, Speed & Greed: The Innovation Economy
There are substantial global challenges, but many are old (e.g. terrorism, financial
capitalism). Some of the new global mega trends are:
| Urbanisaton: 50% of humanity is now living in urban areas, and it’s moving toward 70%.
This creates strains, challenges and risks, but is also a great opportunity (due to
efficiency, opportunity and rising wealth);
| Demographics: The world, particularly the developed world, is aging quickly. This
creates challenges from under-funded retirement funds, age related disease/costs, and a
relatively fewer working-age people to support the expenses for the aged;
| The Rise of Asia and the Rest: Shift of money and power to the East, and a rise of a
global middle class. The challenge is resource scarcity (e.g. oil, food, land) which could
bring instability and/or conflict. Environmental risk is also an issue.
Many believe that the problem is too many people in the world, but Vijay's basic thesis is
this: People are not the problem -- human ingenuity is the solution to the challenge. He
argues that this has always been the case, giving the examples of the revolution in food
production, and continued energy supply despite dire warnings.
Thus, a combination of the supply-demand-price response coupled with human innovation
has, and will, provide the answers to the challenges. It turns out that supply of resources is
not fixed, but can be expanded to meet demand by innovation.
"Innovation" is different from "invention": Innovation is fresh thinking that creates value.
This can be as simple as putting together pre-existing concepts, tools, or technology and
applying them to a new context. True innovation has enduring consequence -- in terms of its
purpose, results and longevity.
Addressing the question of whether conservation is part of the solution: He asserts that we
should distinguish between conservation and efficiency -- the latter is a larger part of the
solution than the former.
The world is moving faster than it used to, so nimbleness is required.
He quotes the infamous Gordon Gekko: "Greed is good". But also asserts that intentions
matter, and that greed should be harnessed for good outcomes. He gives the example of
micro-finance, and asserts that broadly speaking, micro-finance has shown the ability to do
good but it can (and has) also done harm. The trick is harness greed for positive results.
Vijay reminds that you can earn high returns while achieving positive human impact: Talking
about social impact does not imply compromising returns.
Three Rules of Innovation:
1 | Move Nimbly: The world has become connected, barriers to entry have fallen. Business
models need to change with some speed. Innovation is a survival imperative.
2 | Open Wisely: Research used to be top-down, but open architecture is making innovation
a bottom-up process (e.g. crowd-sourcing, open source applications, open competitions, etc).
Centralised control is not the best way to support innovation.
3 | Fail Gracefully: Failures are part of innovation. The new mantra is to "fail fast and learn
from failures”. However, people don't give up on ideas so easily -- they pursue them.
Answer: Get lots of ideas in pipeline, prioritise and capitalise them -- then put them on-and-
off the front burner. Finally, when you are really ready to kill an idea, then kill it dead.
Vijay addressed the so-called "Demographic Dividend" which is a population bulge of young
people who will drive future economic growth. But a large working-age population is not, of
itself, enough: a) People must be trained, educated and acculturated; and b) eventually the
population bulge peters out (e.g. you have to grow rich before you grow old). India has such
population bulge, but seems to be failing to properly invest in its human resources and so
may not reap any Demographic Dividend. China has now past its demographic bulge so has
to deal with an aging population: Vijay argues that it has to shift from being "Cheap China"
to being "Innovative China". But China is trying to direct innovation from the top-down, and
crowding out the "bamboo-capitalists": Innovation cannot be centrally planned.
Addressing the issues of food and water supplies: Food is a pressing issue, but innovation
has consistently improved agricultural productivity. The "green revolution" has not yet
arrived in Africa. Likewise, improved efficiency in water use technology has not yet spread
around the world (agriculture is the principal area of water loss/waste).
Rebuilding Trust in the Finance Industry
The Future of Finance initiative
CFA Institute is working to restore trust in the finance industry, and this year has rolled out
the Future of Finance project with several planks:
| Putting investors first: Published a statement of investor rights
| Financial knowledge: Rolling out the Claritas training program
| Transparency & fairness: Developing new investment reporting standards
| Regulation & enforcement: Supporting relevant and necessary regulation
| Safeguarding the system: Addressing systemic risk issues
These are useful, pragmatic resources and deserve to be paid attention to. This web-page
details CFA Institute's new Future of Finance initiative:
Some has come, more is coming. Some large issues have not been dealt with, such as "too
big to fail" and the (good sense) separation of merchant banking from commercial banking.
In addition to specific industry regulations, many regimes are moving toward a focus on
macro-prudential regulation to ensure systemic stability.
ACC Comment: As regards banking, the answer remains that banks should be required to
hold more capital as a buffer for risks, and the capital owners (shareholders) must be
ACC Comment: An outstanding concern is the collateral management by banks -- as this
appears to be a form of unregulated fractional-reserve banking (e.g. borrowing and
lending collateral), that may also tend to denude depositors protection. Part of the
solution should be incentives to move toward listed instruments with daily marked-to-
market and cash margining.
Principal-agency problems will always be there, the question is how to reduce the tendency
for these to grow. While the largest problem has been the issue of bank employees vs.
shareholders, the conference discussion focussed on Asset Owners vs. Asset Managers:
| There is a movement in Europe to cap asset manager fees.
| Costs of manager due-diligence will go up for asset owners.
| There is likely to be a movement toward the safety of "big brand" asset managers.
| The tendency to over-complexify products and documents, and to hide behind that
complexity and lack of transparency, is a dis-service to investors.
It is considered that movement toward SROs (self regulatory organisations) of the 1990s,
coupled with unbridled incentivisation, resulted in exacerbated risk taking across the financial
| Rising longevity (i.e. living longer), low savings rates and low investment yields are a
recipe for a shortage of retirement income.
| Further, the switch to defined-contribution funds and the passing of responsibility to
individuals creates behavioural risks in investment decisions.
| Inflation risk remains an outstanding issue for retirees.
| Financial Repression -- with low interest and negative real rates -- represents an
intergenerational wealth transfer (and a transfer of wealth from savers to spenders).
Asian consumers and societies have higher savings rates, and so there is a growth of asset
owners/funds in Asia-Pacific.
EM is importing DM's Problems
West is seeing a huge shrinkage of its financial sector, while Asia is seeing a growth of the
financial sector. The quantum of money coming from western QE is a challenge for EM as it
has the effect of channelling money into less efficient sectors. Due to US$ currency pegs Asia
is importing an inappropriate monetary policy. Low interest rates mean that liability targets
can't be met (for insurers and retirement funds). Unchecked liquidity will breed other
problems (e.g. such as bubbles in real estate -- where prices are no longer commensurate
with the wage base).
ACC Comment: Surely the answer must be to float exchange rates -- allowing the Asian
currencies to rise? Or perhaps they are addicted to exporting to the U.S.
Chinese Systemic risk
The very large Chinese state banks are creating a systemic risk by funding inefficient capital
projects. These large financial firms can create the risk of systemic instability. The challenge
is to liberate the large Chinese banks and make them commercial (rather than political). On
the other hand, notwithstanding imbalances in China's lending/investment, it’s observed that
with massive reserves (e.g. no national liquidity risk) then China will be able to weather a
storm. (In this regard, an analogue was drawn between Thailand and Singapore in the
1997/8 crisis -- where the former was funded with short-dated hot money which exacerbated
the crisis, while Singapore more-or-less sailed through).
The audience was reminded that they look after "Other people's money... and poorer people's
money." Thus, asset managers should think of their clients in a benign way, focus on the
customers' needs, and build suitable products for them. Generally, the more complicated a
financial product is the worse the outcome for the investor. Also, intermediary structures are
a problem -- with costs, opacity and inflexibility. Look out for knowledge imbalances -- the
guy who knows something you don't gets rich, and you lose.
Money is fiat
Governments can create and destroy money: Interest rates are now a by-product of policy
not of the market (supply and demand). This may either be a good thing and a stabiliser, or
it may be a manipulation and distortion. The answer seems to be that it’s an acceptable
manipulation -- with costs for savers -- which is required to keep the global economy moving
Shanmugaratnam is the Deputy Prime Minister of Singapore, and he gave an
appropriate overview of the global environment.
The worst of the global crisis has past: Balance sheets are improving, regulations are having
effect, central banks have managed to reduce tail-risks, and Europe has moved to integrate
banking supervision. Still, normal growth -- which can reduce unemployment -- has not yet
been achieved, and confidence remains subdued. Capital investment globally remains low as
corporations are retaining cash (debt issuance is being used to reduce equity not for new
investment) and capital stock is depreciating. Thus, there is a risk of long-term economic
There is an over-reliance on monetary policy for growth, while fiscal and structural reforms
have been slow moving. With low and negative real interest rates, the "information value" of
market prices are distorted, and resources are being misallocated (he refers to sub-
investment grade debt, and covenant-lite bonds).
Politicians are relying on monetary policy, and are not addressing structural issues. Delayed
public investment, depreciation of human and capital stock-- plus a large debt-overhang --
produces the prospect of prolonged low growth.
What is the correct policy mix to achieve growth?
Monetary policy: Central banks cannot exit too quickly;
Fiscal policy: Medium term fiscal consolidation in a credible way, without undermining short
term growth (e.g. reforms in pensions and medical costs, tax reforms,)
Structural reforms: Labour market reforms are necessary to give more prospects for the
young to get employment; required investment in education; liberalising of economies; trade
Monetary policy in the DM is set for low growth, while the EM is in a growth phase. He calls
this a "second best world" for EM: Too much capital flows can be a bad thing -- with
inflationary, asset-bubble, and volatile capital flow consequences for growing countries.
Macro-prudential regulation is therefore vital (to avoid, say, property asset bubbles, hot
money flows, and inflation risks).
Tharman notes a shift of assets to EM countries, and even so global funds are still under-
invested in EM, so more money is likely coming. There is also a secular shift to lower risk
investments (shorter term) by savers as they age. Mostly, EM are younger societies, and are
in a savings accumulation mode. There is a need for long-term investments (e.g.
infrastructure), rather than short term or "indecisive" investments: But there is a shortage of
asset managers to facilitate these more complex investments. Thus, there is a mismatch
between the need for long-term finance and savers’ low-risk/high-liquidity appetite and
financial intermediaries are unable or unwilling to deploy capital. While offering few
solutions, Tharman sees a role for Development Finance Institutions that can catalyze private
flows for long-term investments by credit enhancement (risk reduction).
The Global Implications of a Rising China
The key questions arising from the China discussion are:
| What is China's sustainable growth rate?
| Can China make the shift from investment lead growth to consumption lead growth?
Chinese Macro Factors
2012 marked the end of China’s hyper-growth period: Momentum has slowed down -- as it
ultimately had to. The shift from capital investment to consumption is proceeding slowly.
However, only 1/2 of the population is urbanised, and higher personal consumption creates
opportunities for growth. China still has a large, poor, rural population.
There is an assertion that the leadership in China feels that over-high growth is disruptive
and environmentally -- so they are happy with lower growth.
Essential national infrastructure has been built, but at the local/municipal level infrastructure
is lagging. The view is that local debt for development will have to be back-stopped
(guaranteed) by central government.
The property bubble was deflated -- or least restricted -- by reducing the demand (limits on
who can buy; reduce access to finance). Risk is somewhat reduced of both a bubble and a
China has very high investment:GDP and credit:GDP ratios -- and the investment-led boom
needs to stop. Situation is parallel to Singapore in 1984 and Thailand in 1997-98: Even after
the peak in Singapore, growth remained high -- while Thailand spent 5 years de-levering with
very low growth: The difference was that funding stress was low in Singapore because most
of the debt was domestically held -- while Thailand had a lot of short-term and international
debt. While much of China's credit is going into unproductive assets -- "white elephant
vanity projects" -- there is no funding stress in China: It is a closed economy with low
loan:deposit ratio and an overhang of savings in the system. Thus, even with a lower growth
environment and a structural shift from investment led growth, China can avoid a crisis/melt-
down. Further, more money will be put into the industrial sectors, rather than government
related projects, which still allows for growth in investment in productive assets. It is taken-
for-granted that China will make the shift from investment led to consumption led growth.
Chinese Market Factors
There has been a 0% return on China's A share market since 2000 -- while the economy has
grown and earnings have grown by 400-500%. Given the high growth, why has China's
equity market lagged other Asian EM markets? First, valuations in the early 2000's were
already high, so the 5 years of flat performance is merely a correction to a normal P.E. ratio.
Index started 2000 at a P.E. of 50x and is now 9x. Second, the problem is not the listed
corporate sector, the problem is that Asian markets are like a casino -- it’s very volatile both
up and down, and also driven by retail investors who are trend followers (i.e. buy-when-its-
rising). Suggestion is to focus less on the macro story and more on the P.E. multiple story
(e.g. the trend).
China market has never traded cheaper than it does now -- market is underpriced for the
strength of the corporates.
It is possible in China to beat the index since it’s dominated by retail stocks. Online
commerce has fundamentally changed retail -- as the physical retail system was not efficient.
Global Currency Comment: While there have been gains from holding BRICs
(capital+interest) versus big-DM ($/Euro/Yen), this is driven by FX carry return, and net
return from capital is much less. But much return has also come from the duration (interest
rate and yield curve shape) trade.
Michael Woodford: Lessons from a Whistleblower
Woodford famously blew the whistle on a large-scale fraud at Olympus: He is an
entertaining speaker and his book is probably quite readable.
Woodford is scathing of Japan's stifling corporate culture:
| inability to filter westerners’ information, and tend to fall for pitches;
| ignore women as a resource;
| conflict avoidance;
| age related hierarchy;
| not good at closing weak-performing businesses;
| Board meetings are rubber stamping exercises, approving decisions already taken outside
| media is servile to authority and large interests (self censoring);
| investors are docile and do not engage in corporate governance;
| Japanese tend to do what they are told to do -- which isn't great for innovation (but is for
getting things done).
On the positive side, he highlights that "we" means something in Japan -- people look after
He has little confidence that Japan will move toward any structural reform of governance or
practices to normalise behaviour.
Thomas Sargent, Rational Expectations and Ambiguity
Sargent, a Nobel Prize winner, managed to turn seemingly simple concepts into an
"Utility" expresses how you feel about risk. Humans use innate probability distributions to
make decisions and take risks. Where does that inner-risk-assessment come from?
That innate probability distribution is called “Rational Expectations” and appears to be shared
by everyone that is “inside the model" -- with most people/organisations sharing similar
assumptions: Used by central banks, academics, practitioners. Why is that?
| Simple: It’s easier to use a single distribution (but loses the diversity of beliefs)
| Law-of-large-numbers: Eventually we will all end up at the same answer anyway (on
average over time, but will miss the diverging data in the meantime [e.g. "in the long
term we are all dead"]).
| Evolution drives us to have realistic beliefs.
While waiting for the law-of-large numbers, you can just use a subjective probability: Make
up a subjective estimate and then evolve your distribution as you gather data.
Evidently, research indicates that investors don't actually invest in accord with their
subjective probability assumptions.
Markets are used to ambiguity, and we make up models (distributions) of expected returns.
But when ambiguity rises sharply, "model confidence" is undermined, Rational Expectations
are challenged, and markets freeze or bid-offer spreads rise.
The standard concept is that people price for risk: But if there is model uncertainty
then a small amount of ambiguity can substitute for much higher risk (driving risk premia
Dambisa Moyo, Investing in the Frontier
Moyo is a leading voice on African development finance. She speaks well and
clearly, but I found her arguments to be bit gung-ho and optimistic.
Frontier Market (FM) Macro Factors
Sub-Saharan Africa is expected to be the 3rd best growing region (after China at 5.6% and
India at 6.1%) in 2013 and 2014. The World Bank says 6% is the required growth in EM to
succeed at poverty reduction.
Growth is driven by Capital, Labour and Productivity: The latter accounts for 60% of the
differentiation between countries. PISA* global review of children’s' learning indicates that
Developed Markets (DM) are now lagging EM in education outcomes -- with sharp drops in
(* Programme for International Student Assessment of the OECD)
Frontier markets generally have --
| sound finances (average sovereign debt ratios about 40%);
| improving structural environments;
| improving labour skills (and low median age with 62% below 25 years; population growth,
and rising urbanisation);
| rising productivity; and
| rising democracy (50% of countries hold democratic elections; 63% are "free" or "partially
These positive factors are showing up in recent equity market performance (and also good
growth prospects). EM equities have been underperforming both DM and FM in recent years.
Correlations between DM, EM and FM have somewhat broken down. Africa is seemingly "ring
fenced" and therefore has lower correlation to DM (0.5 r2 for African FM to DM)
While there are 1 billion people in Africa and significant land and natural resources, it
currently only accounts for 2% of global trade.
Globally, only about 50% of countries have democracy, and only 70% of those would be
considered liberal democracies (e.g. press freedoms).
On corruption, the CPI (Corruption Perception Index) indicates a global average of 4:10,
while Africa is around 3:10 – but the average for Africa is improving.
Frontier Market (FM) Market Factors
| Market risk and liquidity are the areas where there has been a change in perceptions about
Africa. While "risk" can be hedged and understood, "uncertainty" is fuzzier and difficult
to manage and measure.
| Liquidity is improving in larger markets (e.g. Nigeria, Kenya), so ticket sizes are growing.
AUM in FM have grown domestically, with $450 billion of AUM and only $4 billion of
dedicated FM funds outside of EM.
| It is possible to short markets in some places -- Egypt and South Africa.
| African equity market caps are generally quite small and dominated by South Africa.
| The entire FM universe is about US$2 trillion with $200 billion of free float.
| There are 20 credit rated countries, and now accessing debt markets (e.g. Rwanda,
Ghana, Gabon, Zambia).
Opportunities & Country Comments
The journey will not be in a straight line in Africa, it will have fits-and-starts. Moyo favours
countries which have gotten a credit rating (as a statement of intent) -- and she expects a
path of rising credit ratings (political dividend is still to come). She favours public (rather
than private) markets -- there are a quite a lot of private equity funds, and exit strategies are
difficult. She suggests a multi-asset class approach, with focus on equity and credit/bonds
(sovereign and corporate debt) plus long/short strategies. Suggests to not focus just on
financial sector as consumer goods and logistics are attractive at low P.E.s.
China's slow down will affect the African growth story -- as a) commodity demand and prices
fall, and b) the Chinese provide less finance (e.g. FDI) for development. .
Some regional trading blocs are developing -- East Africa and SADC for example.
Ghana has been deliberately slow in addressing their oil windfall so as to plan and save for
development -- and they plan to diversify their economy. There are 5 sovereign wealth funds
in Africa, so there is a consciousness that mineral resources are scarce and finite. In this
regard, Moyo favours Ghana over Nigeria.
She makes the point that Democratic & Market Capitalist systems are not a foregone
conclusion: China has no political democracy and a state-capitalist system, while the U.S. has
strong democracy and private capitalism -- but they are the number 2 and number 1
economies in the world. The EM world is less inclined to believe that democracy is a pre-
requisite for economic growth. There is an active debate about whether democracy is the
ACC Comment: This is hopelessly naive and a problem for Africa: Certainly every
potentate and politician will use this excuse to undertake cronyism and corruption.
South Africa has relatively low growth, imported inflation, and a risky micro-lending market,
(she referred to the Marikana event as driven by micro-lending). About 5% of SA is mining,
18% is manufacturing, and 60% is services -- which requires high education and rising
growth. The macro perspective for SA isn't attractive, but it may be a good entry point for
the Africa story trade.
There is a clear growth of Islamic finance: But in West Africa the opportunity comes along
with the rise of Islamic fundamentalism that could lead to a real risk problem (civil war).
ACC Comment: Moyo is a good speaker, but the level of over-optimism is worrying -- as if
Africa (finally) is going to turn some corner and everything will be alright: History and
culture seem to argue against a rosy view. Moyo criticizes South Africa while extolling the
African Frontier countries -- and yet she ignores SA's strong, and the others' weak,
institutions of state (e.g. rule of law, strength of contract, press freedoms, and
independent judiciaries). She's on the wrong planet, and will lead investors down a bad
Worse, the presentation brings to mind a fairly offensive phrase: Africa as an Investment
Destination. This makes it sounds as if peoples' savings should be sent on holiday to a
place you read about in the Sunday travel section.
Kishore Mahbubani: The Great Convergence: Asia, the West and the
Logic of One World
There are two competing global narratives: The "Western Narrative" and the "Other
88% Narrative”: In sum, optimism has left the west, and has been taken over by
the new world.
| Reduction of War & Violence: The dangers of interstate wars, and deaths from interstate
wars, are as low as they have ever been. If you add up all the current wars, they are a
"drop in the ocean" compared to 7 billion people. The number of people dying of any sort
of violence is going down globally.
| Fighting global poverty: UN's Millennium Development Goal of alleviating poverty will be
reached and exceeded by 2015.
| Growth of middle class population: Currently there are 500 million people in Asia who are
middle class, but this will grow to 1.75 billion by 2020. Globally, middle class will grow
from 1.8 billion people now to 3.2 billion by 2020.
The world is getting better and better, and this is driven by a consensual adoption of norms:
| The spread of basic science, technology and hygiene;
| The spread of free market economics (China as a role model: 30 years of central planning
failed and 30 years of free markets have succeeded);
| The spread of reason and logic: A rational mindset helps solve problems as part of a
community. A shift from "competition/zero-sum-game" to "win-win" thinking;
| Growing multi-lateralism -- more countries meeting, talking, resolving and cooperating;
| While U.S. and China compete, there are not really rising levels of tension, and no war.
Note (from Wikipedia): In his book, The New Asian Hemisphere, Mahbubani outlines seven pillars of Western
wisdom that have contributed to Asia's march to modernity:
| Free-market economics
| Science and technology
| Culture of peace
| Rule of law
There is only one global system, and yet there is no "government of the world". In the GFC it
became clear that no one country could solve the crisis, nations had to work together.
Likewise issues such as global warming and health pandemics can only be solved
cooperatively. Unfortunately, while it is surely in everyone's interests to work together this
does not happen effectively. Also, relations between Islam and the West is a challenge.
Up to now, it has been Western policy to keep multilateral organisations (e.g. World Bank,
U.N.) as weak as possible, but it is now in the rational interests of the west to strengthen
them. And this can be done simply, and doesn't cost much (the entire U.N. secretariat costs
the same as the NY Fire Department).
In PPP terms in 1980 the U.S. share of global GPD was 25% and China 2.2%. In 2017 the
U.S. will be 17.6% and China 18.6%. By 2030 China will be 2x the size of the U.S.A.
In general, the rule of law, a free press, and an independent judiciary are foundational to a
better world: Democracy is an outcome of success. However, China watched what happened
in Russia, with fast dramatic change, and so will choose to change gradually (i.e. "evolution"
Recently China has taken an aggressive tone toward its neighbours. While China is making
mistakes (e.g. North/South Korea incidents; conflict with Japan over islands and a Chinese
fishing boat) the Chinese are learning: They have a high capacity and interest to learn so as
to avoid mistakes. China seems more belligerent, but is not really.
ACC Comment: Mahbubani is eloquent and intelligent, but offers an overly optimistic and
happy view of a world of peace, growth, opportunity and cooperation. Sitting in shiny,
clean, functioning Singapore that mindset makes sense. But does it also make sense in a
wider world of politics, competition and rapaciousness?
Lim Chow Kiat: Investing in a Low Yield World
Lim is the CIO of Singapore's Government Investment Corporation (GIC)
Lim's thesis is that the 30 year bond bull market is ending (has ended).
U.S. equity real returns have been about 6% p.a. for 30 years (albeit not a smooth ride), and
bonds have had similar good results. But, he notes, "we are at a new phase in the 30 years’
bull market in yields."
He goes on to recount some investment axioms, and applies them to the bond and equity
Starting Yield Levels Matter: US 10 year treasuries are at 1.95%. Starting yield is the
best indicator of actual future investment results -- he notes there is a 0.94% r2 between
starting yield and outcome. In other words, don’t expect good returns from bonds in the
Earnings growth tends to track nominal GDP growth: U.S. equity earnings yields are
currently about 7% -- and while this is an indicator of future returns, it’s a bit less reliable
than bonds because earnings growth and exit multiples change. Using a Schiller P.E. (which
uses average earnings over time to calculate a current P.E. ratio) indicates multiple
contraction is due resulting in an estimated 1.6% p.a. average return for the next 10 years.
ACC Comment: The Schiller P.E. is hugely skewed by the 2001 and 2008/2009 collapse of
earnings, and thus may be overstating current P.E. ratios. I'm not a believer in the
The surest way to lose money is to overpay for assets: The price you pay upfront
matters to your future returns. "There seems to be a belief by investors that low rates will
prevail for a long time to come" and this implies that spread-risky assets and long-duration
assets worth levering into. Lim is very sceptical of that view.
Interest rate forwards are not good at predicting actual future rates: Forwards rates
are a mechanistic extrapolation of yield curve points, and are not forecasts (and are usually
Investors may assume they can get out when views change: Investors don't quite
believe in the perpetuation of the bond market rally, but are taking short term views to show
outperformance -- this demand begets higher prices and more demand. Investors are being
naive to think they can get the market right, get the exit timing right, and get their trades
executed en masse.
What are some strategies for the end-game?
1 | Monitor your Betas
Assess funds to understand the systematic risks embedded: Determine the exposures to
interest rate moves across asset classes (e.g. bonds, equities, property, swaps, currencies).
Beware of beta wrapped in alpha strategies.
Watch out for seemingly low risk items (such as money market assets, securities lending)
where there might be surprises when rates move sharply.
Try to add idiosyncratic (uncorrelated), or even exotic, betas to funds.
2 | Have realistic return expectations (this applies particularly to asset:liability modelling). If
you reach too far for yield you may get burned.
3 | Price discipline is critical: Don't chase short-term, or peer cognisant returns, at the end of
a bull market. Prepare for the end-game by being aware of capital protection. Don't be shy
to move into cash at extremes.
4 | Buy tail risk insurance: Although out-of-the-money puts might be expensive, and such
insurance is often merely an expensive tactical position (i.e. you pay away protection premia
for a short-term insurance policy), he observes that it’s a big psychological positive to be able
to hold assets in a bull market when you have protection.
5 | Watch portfolio costs: When yields and returns are low then every cent counts.
Performance fees set relative to LIBOR are too high.
6 | Look for secular (not cyclically risky) opportunities: For example, the mega-trend of the
rise of the global middle class (he notes that Asia had 28% of the global middle class
consumers in 2009, and will likely have 54% in 2020 and 66% in 2030) will have
consequences for retailing (specifically e-tailing).
Finally, Lim offered some additional general comments:
Asia has a US$ currency zone, and tends to import monetary policy of the U.S.
Gold is a difficult asset class -- it’s a consumer product and it does not justify the prices it
commands (there is no cash flow to discount). It’s seen as a useful hedge against inflation,
systemic collapse, or fiat currency risks -- a form of tail-risk insurance. But "one must be
careful about paying high prices for such insurance."
Can central banks manage their exit strategies? There is much reliance on monetary policy
in the world (e.g. fiscal and structural reforms are slow moving), so it will be difficult for
central banks to exit and while work is going on there are substantial risks. The key health
indicator is the real economy which will express itself in a resumption of credit growth.
What are opportunities for income at the moment? While GIC does not focus on just yield,
but rather total return, yield as an indicator of valuation is important. Lim is concerned about
low level of yields in stocks, bonds and real estate -- so he is cautious about reaching out for
yield (i.e. assets are generally overvalued).
Impact investment: A new idea, but an important trend to "stay on top of". No pool of
capital of the GIC has been set aside as yet (but his tone implies it is likely to form part of
John Hempton: A Short Seller's Dilemma
Hempton manages a short-sale equity fund, and gave some real-life examples of
The risk:return profile of being a short seller (e.g. you can have unlimited loss, against
limited gains) requires diversity of bets: They need a lot of ideas in a variety of sectors. For
Hempton a 3% bet is very large, and the average bet size is only 0.6% of fund.
Hempton made what was, perhaps, the boldest admission during the conference: He noted
that the amount of work/research that goes into an investment view depends on the size of
that bet. Or, put differently, for a small bet his team might follow a hunch, experience,
insight or intuition, and then ramp-up the research if it doesn't play-out as expected and/or
before putting on a larger position.
ACC Comment: Frankly, while this "ready, fire, aim" approach scares the willies out of
governance structures, the reality is that great investors should capitalise on their
experience, and follow their instincts quickly -- but always in small bet sizes. This
approach is sensical, and probably an un-acknowledged truth of all asset managers.
Hempton’s focale point was companies that "Fake" their financial statements: His thrust is
that there are a variety of ways to manipulate the income statement (i.e. "fake" their
income), and a fake income statement will create fake cash and a result in a fake balance
Hempton focussed on the ways companies go about hiding the fake cash -- which usually
entails deploying the non-existent cash in some over-valued asset.
Some fake assets commonly used to dispense with fake cash are:
1 | Buy fake (or over-valued) assets with the fake cash;
o In the Olympus case earnings were overstated, so in order to eliminate the fake
cash they bought fake companies and paid high fake fees to an agent. The tip-off
was that a) the companies made no sense for Olympus to buy (outside their core
area, unprofitable, small), and they did the deals in a tax haven (to avoid the
seller having to pay income tax on the sale of the fake assets). Cash was never
stolen -- rather it was "made up" and never existed.
o The recent Suntech bankruptcy was a fraud of fake profits being used to buy fake
bonds: The auditor failed to notice the bonds on a European company's balance
sheet didn't exist. As anecdotal proof of this view, Hempton notes that Suntech
came to a settlement with the alleged thief of the money: Who makes a
settlement with a thief? and why? Because there was no money, no bonds and no
theft – it was all a fiction.
2 | Create false receivables
Fake/overstate inventory (for retailers, watch inventory as a % of cost-of-goods-sold -
- 1 to 3 months is okay, but above that gets suspicious). The analyst should watch
days'-sales-in-receivables, and receivables as a percentage of net income;
While it’s hard to audit these items common sense can be guide.
| Ratio analysis will show up some oddities;
| Compare a company with suspect accounts to its own competitors in a similar business;
| Check reputation of who you are dealing with (fraudsters tend to revert/return).
| Get out and talk to people: Customers, employees, competitors. A company that is doing
well honestly doesn't need to falsify earnings and assets.
Finally, he notes that fraud in China is endemic, and is unpunished when uncovered: "It's
hard to be a short-seller in Hong Kong."
ACC Comment: There is only a thin mental line between being a good, cynical, realistic
credit analyst and being an equity short seller.
Hempton is a storyteller and posts his latest views on http://brontecapital.blogspot.com/. I
presume this serves to spread the “bad word” about offending companies, and help his short-
sale bets pan out -- but its fun anyway.
Wong Kok Hoi: Investment Risk in the Real World
Beta and volatility are simple risk measures, but their time has passed: A single measure of
risk in a complex world is inadequate. Price volatility gives little insight into real risk -- what
matters is the underlying business: Even risky businesses can have low price volatility.
According to Wong, timing-risk is not a huge issue: “If you buy at the highest day of the year
vs. lowest day of the year the 30 year results are only different by 1.7% p.a. over time.”
ACC Comment: This does not seem even remotely true [see Barcelona university
research], and I would have to be convinced of this argument.
What risks matter?
| overpaying for an asset;
| investing in a company run by dishonest people;
| investing in a company with a weak business model;
| a company that changes auditor, CFO or independent directors;
| not knowing what you own;
| highly geared companies;
| putting all your eggs in one basket;
| investing in il-liquid assets
Share prices will rise over time if a) earnings rise or b) assets rise in value -- but in the short
term prices can be irrational.
Almost all statistical measures of risk are backward looking: What matters is the future.
Comments on China
| The Chinese market is dominated by retail investors -- they don't look at p.e. ratio or
earnings, they buy if they think the price will go up.
| Chinese market is at about 9x earnings, with about 10% earnings growth for this year: So,
more upside than downside for short term.
| Expect some reform of labour system: Migrant labour is forced to stay in rural areas,
causing a social problem -- so labour will likely be allowed to move to tier 3 and tier 4
cities (of 700 million workers, 35-40% are migrant), and this move will be a source of
| Chinese labour force shrunk for the first time in 2012. So, one-child policy is likely to be
phased out (gradually).
J Kyle Bass: The Central Bankers' Potemkin Village*
(*something that seems impressive but in fact lacks substance)
Bass focussed on Japan and he painted a viciously negative picture of the Japanese-
Government-Bond (JGB) market.
Some false axioms about Japan
| Japan can self-finance its deficit due to its current account surplus. False, the current
account is moving toward negative; the fiscal deficit is large; the population demographics
have rolled over into old age; China is boycotting Japanese goods and there is a
resurgence of nationalism (this is already visible in falling Japanese car sales).
| The Bank of Japan (BOJ) is not monetising debt. False, the BOJ is expanding its balance
sheet, and are buying debt with printed money.
| Retail Investors will always support the JGB market: False, 95% of the 94% of internally
held JGBs are managed by a handful of firms. Aging population means dis-saving, people
are exiting from pension schemes, and lowering holdings of JGBs. Population has been
falling, and that will accelerate. Thus, Buyers of bonds have become sellers. Also,
demographics won't improve because the xenophobic culture does not allow for population
Bass describes what he calls "The rational investor's paradox": If you believe Abe-nomics will
be successful, with growth and reflation then you must sell your JGBs. Abe-nomics is based,
partially, on the massive issuance of JGBs -- but the quantum is so large that the BOJ can't
buy it all. Rational investors must sell their JGBs and this will cause yields will rise.
Some early signs of brewing trouble
Signs of a movement by smart-money to spend Yen and buy international assets (more
| The spread between 10 and 30 year JGBs was already wide prior to Abe-nomics.
| Recent weakness in JGBs. (Note: At nearly the same time as the presentation some cracks
started appearing in Japanese equities as well).
So strongly does he believe his bearish view of JGBs, Bass diverges into behavioural
economics to explain why JGBs have not sold off (yet):
1 | "The psychology of negative outcomes", as follows:
o People have strong tendency to deny possible negative outcomes: Denial is a
o Bias toward self preservation. When a possible negative outcome is severe, we
tend to deny its existence or its implications: The self-preservation bias causes
us to move with the crowd and assume '"everything will be okay".
2 | Availability heuristic People tend to use (or overweight) most recent, or most available
data. In JGBs the last 20 years have seen low/falling interest rates.
3 | Optimism bias: We generally believe we are at lower risk of achieving a negative result.
4 | Axiomatic pattern repetition: We tend to recognise and extrapolate patterns. Any
attempted sell-off of JGBs for 20 years has been halted and reversed.
5 | Herding behaviour.
All these factors lead to a seeming stasis, and then -- when the situation becomes clear -- a
"Qualitative Switch" is thrown, and a disaster ensues as everyone rushes for the exits at
once. In other words, stresses build up and when things start to change, they change big.
BOJ is injecting massive liquidity into the JGB market -- but the market is cracking, and the
Qualitative Switch is about to switch from stasis to crisis for JGBs.
Bass notes that some people see this pending crisis as a low-probability event, and therefore
it is relatively cheap to hedge risks. He observes that at secular turning points in markets
the Black-Scholes model is very bad -- it tends to underprice tail-risk. Convexity is cheap.
"VAR and capital requirements are so small at the moment that when rates start to move
hedging won't be possible: It’s like AIG days again."
Bass reckons that in a sell-off, at some point the BOJ will likely peg (cap) JGB rates, and buy
ad-infinitum: That will cause a sell off of the Yen (notes that 30% of Japanese equity market
is now held by foreigners). Nevertheless, a weak Yen is not a panacea and without
structural reform growth will remain low (and the current rally will be a "flash in the pan".
What are the signposts of unravelling of the JGB market?
Yen depreciation, and a sell off of JGBs (BOJ losing control of rates, steepening yield curve,
forward curve steepness).
General macro-economic comments
| There has been huge expansion of central bank balance sheets -- and the marginal impact
is approaching zero.
| Global credit market debt has grown 10.7% p.a. since 2002, while real GDP grew at 3.9%
and population growth was at 1.2% p.a.: The buildup of debt seems unsustainable.
| Generally high debt:GPD, defined as [(Gross Government Debt + Financial debt):GDP] is a
good indicator of systemic risk -- particularly for countries that can't print money or are
too big to fail.
ACC Comment: Bass is a good, entertaining and compelling speaker, and he makes his
case well. He may be “talking his own book”, but at the moment – with JGBs selling off –
he’s looking pretty smart.
George Friedman: Geography's Role in Shaping History, Politics ,
Economics and Social Imperatives
Friedman is a founder of Stratfor, who provide consulting on geopolitics, warfare
and international relations.
Pre-amble: Conflict is a constant force shaping the world
“Wars are not black swan events: They are a constant force that regularly reshapes the
world.” Friedman is surprised that financial experts a) disregard war's impact and b) are
constantly surprised by its occurrence.
Wars will happen, they are critical, and they will disrupt planning, forecasts, views, and
The Post-Cold-War-World and the Post-Post-Cold-War-World
The world changed in 1989-1991:
| Japan stopped growing and went into decline;
| The Tianamen Square massacre in China;
| The Maastricht treaty in Europe in signed,
| Desert Storm in Kuwait,
| The collapse of Soviet Union.
These represent a once-in-a-generation set of interconnected events. The Post-cold-war-
world had three pillars: 1) dominant power of U.S.; 2) rising unification of Europe (as a
power balancer); and 3) China as a provider of low wages and high exports.
However, those pillars are falling and what started in1991 is now ending. We are now in the
| In August 2008 Russia invaded Georgia, announcing the return of Russia as a geopolitical
force and also that U.S. could not keep its promises.
| In September 2008 Lehman Brothers failed -- ushering in the damage of disruption of the
GFC and its aftermath -- with the rise of China and Europe losing its growth imperative.
The core idea of Europe is that mutual interdependence would make wars impossible. But
interdependence breeds friction, fear, distrust and defensiveness. Friedman refutes that the
force of interdependence is strong enough to avoid self destruction.
Friedman describes a Eurozone that is largely built and run for the benefit of Germany.
Germany has enormous productivity -- it derives 40-50% of its GDP from exports. In the
world context, the U.S. is the one large importer, while China and Germany are the two large
exporters. Germany cannot bear declines in exports, and to some extent the EU was the
solution to Germany's export need by providing a captive market: "Germany is a black hole
sucking in the rest of the European countries."
The Euro currency allows Germany to set monetary policy as a stable platform for Northern
European economies. The fixed Euro exchange means that Europe has a crisis of
unemployment: Southern Europe (Spain, Portugal, Greece, etc) are in depression, and this
plus the disparity between Northern and Southern Europe is creating extreme social tension.
Further, with disparate growth occurring, France and Gemany are now splitting. They tend to
meet as "leaders of countries" and not a "unified Europe". For example France has engaged
in wars in Africa (e.g. Mali), but Germany and Europe did not. This fragmenting of the core
of the European Union may prevent it from maintaining its vibrancy.
It seems unlikely that the countries of Europe will allow Germany free access to their markets
He highlights the growing desperation of the European middle class: "You can push people
only so far. And Europe has."
Russia is able to form commercial relationships around Europe, which it wouldn't be able to
do if Europe functioned (Germany and Russia are exchanging energy for technology, and
German factories are moving east: It seems Germany is hedging its bets.)
The U.K. is "eyeing the exit".
Friedman questions whether the European Union will survive; and if (and how) the Euro
might be broken up. He expects to see (and already sees) the emergence of extreme
political parties ("The last time Europe faced similar circumstances was the 1920's and the
result was nationalism and fascism").
There is a general belief that Europe has to work: His view: "Nothing in the last 100 years
gives anyone any right to believe that what has to happen will happen, on the contrary."
Friedman argues that a free trade zone is a better answer than unified currency zone. He
compares Greece (losing) with Turkey winning: "Turkey could not have done what it has
within the EU".
ACC Comment: Following Friedman’s argument it seems clear that Germany has to adapt
to the idea of fiscal-transfers to weaker states, or accept that the Eurozone will fail.
Friedman contrasts Japan during the 1980s with China in the 2000s: "The same claims now
made about China were previously made about Japan" (e.g. exponential growth).
Japan had a debt driven economy, which focussed on cash flow and not ROE and aimed for
full employment and the 'social contract'. China has reached a similar point as Japan: But
China remains a poor country whose dominant theme is poverty and underemployment.
China cannot simply move from an export-driven economy to a domestic consumption
economy. Being terrified of unemployment, China has made credit available to what should
have failed businesses.
There are signs of large scale capital flight out of China -- looking for safe havens outside.
China won't fall apart, but it won't be the engine of world growth. It can't compete with
cheaper emerging markets (at the moment it is cheaper to start a business in Mexico than it
is in China).
The U.S. can stumble along merely because of its huge size.
Washington politics: It is very easy to draw negative conclusions about the U.S. from
Washington: However the U.S. Government was designed to make it hard to get things done
-- it’s not structured for Government to set the tone, but for the market to take the lead. For
example, energy is being reshaped in Texas; Silicon Valley reshaped technology. "History is
not made in Washington -- it’s made in the country."
As for the U.S. debt, he argues you have look at the U.S.'s debt load in relation to both
income and wealth -- and the U.S. has enormous net worth.
U.S. as an empire: The US has learned the expensive lesson that war is not effective (e.g.
Iraq, Afghanistan, etc). They will stand back from war and invasion: "The threshold for
military involvement has gone up sharply". He argues that a good example of the new world
is what is happening in Syria -- with extreme reluctance to get involved.
Friedman noted that North America and Caribbean are now substantially energy independent.
In sum, the World will not return to the 3 pillar system of 1991-2008 -- the world of U.S.,
Europe and China we saw for the last 20 years is no longer there. A new world is emerging.
Freidman’s additional comments and observations
The Arab Spring: The fantasy of the Arab spring is that somewhere in the bushes is a secular,
democratic government in waiting. Freidman is clearly sceptical.
U.S. Military Engagement: It is not enough to loathe the person you are destroying; you
have to have someone to replace him. It’s easy to kick-ass; it’s harder to do good.
India: In is not a single functioning country -- you have to look at India as regions not a
country. The idea that India is going to replace China is fallacious: It won't have a "break
Extremism: We each define extremists as those that don't agree with "us". Right now the
Eurocrats are the extremists, holding out against the rising tide of resentment and
unemployment. None of the major European political parties are paying attention to
unemployment, so there will be more extremist political parties.
DM Monetary Policy and Interest Rates: "In the West you have a very sick patient, and you
are pumping in steroids -- but those are leaking into healthy Asian economies, causing
dislocations". "Interest rates have nowhere to go but up: Inflation has stopped falling,
growth is stabilising."