Blog Archive
Global cooling on the way? Be prepared!
The climate is changing. We can agree on that.
The question is what is driving it, and what we can or should do about it. And possibly in which direction the wind is blowing.
In a recent short paper (by J. KAUPPINEN AND P. MALMI, June 29, 2019) the researchers demonstrate how natural changes in humidity explain, much better than, e.g., CO2 emissions, the variations in global temperatures over the last half century.
Variations in low cloud cover, and their corollary, changes in relative humidity, seem to be an order of magnitude more important for explaining both the general trend rise in global temperatures and even more so regarding the interimistic drops in temperature. The latter is of course wholly unexplained by the steadily rising levels of CO2.
The authors conclude that “During the last hundred years the temperature is increased about 0.1°C because of CO2. The human contribution was about 0.01°C,” i.e., “we have practically no anthropogenic climate change. The low clouds control mainly the global temperature”
The results have been corroborated by a team in Japan: “New evidence suggests that high-energy particles from space known as galactic cosmic rays affect the Earth’s climate by increasing cloud cover, causing an ‘umbrella effect’“
It’s not us
So, humans aren’t doing it. Therefore there’s really no use in trying to reverse the effects by unnecessarily restricting human activity. Quite the contrary, actually. If galactic rays are causing temperatures to rise through changes in relative humidity and cloud cover, we’ll need all the human ingenuity and creativity we can muster in order to find out how to live and thrive in a much warmer world, including potentially higher water levels and frequency of extreme weather.
You can’t predict, but you can prepare
This is no joke. In fact, space weather changes could even cause a cooling before a warming, with potentially just as adverse effects. No matter which way the galactic gods lean in this respect, it’s better we come prepared, even if we can’t predict the outcome.
Winners from warming
No matter, the green revolution is still good for many things, not least combatting pollution (whether slightly warming or not), and fanning (!) innovation. So don’t give up on your recycling efforts just yet. And solar power is still our best bet long term to make sure our energy needs are met in the future, so if you like your solar companies you can keep them. The warmth of the sun is our cleanest, safest and most abundant source of energy. But we need to keep inventing better ways to capture and store it.
The corporate winners in this scenario will be solar energy capture and energy storage companies, including the entire value chain of industrial suppliers of complementary factory parts, not to mention finance companies (huge investments in storage infrastructure will be required once solar energy dominates the power supply).
However, even more interesting will be the opportunities within construction and construction materials. Imagine all the levees to be built, water-proofing solutions needed for buildings and other equipment, not to mention all the new buildings required higher up on dry land, to replace the multitude of new Atlantises being created.
And then there is the insurance business (extreme weather, remember?).
What about losers? Well, there’s the oil industry of course. And retail: the money to pay for all the new infrastructure must come from somewhere; my guess is higher housing and insurance costs will diminish the room for non-essential shopping for the bottom 99 per cent.
Tougher times might mean higher aggregate demand (whoa, Keynes!), but the resulting higher GDP doesn’t mean ordinary people will benefit. All the extra efforts are just going toward strengthening or moving all the things we’ve already got, rather than producing new and life-enhancing stuff
Gold has broken up through a 6 year resistance level around 1350-60 and is currently trading at 1393 USD/oz, after a quick visit all the way up at 1440. That makes gold look extremely interesting right now.
I’ve been buying and advocating buying gold on and off since 2013, as insurance against “Whatever It Takes” craziness by central bankers. Three years ago, I even invested privately in a gold streaming and refinery company in Colombia, and subsequently also in it’s sold supplier Gran Colombia Gold that’s listed in Canada. Even if the price in USD hasn’t moved that much yet, it’s already been a very good investment for me in SEK. The currency insurance effect of holding gold is something Venezuelians are very familiar with.
Bitcoin too is on the move, having thawed this spring from the crypto winter of 2018. Right now, the Bitcoin price is slightly above 10k$, more than 150% higher than at the turn of the year, albeit more than 25% below the peak price a few days ago on June 26.
In both instances (gold and Bitcoin) I expect much, much higher prices (multiples higher, not measly percentages) in the coming five years (and likely much sooner than that, but you never know with politicians like Draghi, Powell, Trump and Xi at the helm)
As happy as I am about my investments/insurance positions, I am simultaneously afraid we are entering into a period of extreme financial stress, almost to the point that I hope we somehow will miraculously escape it altogether without having to deal with the issue in earnest.
Equities are extremely expensive compared to both cyclically adjusted profits and gold
It’s just that with equity valuations 3x their norm (MAPE at 45 rather than 15), and gold only at about 1/4 vs S&P 500 of where it was even quite recently, and twice the amount of “almost junk” rated corp debt in the US vs. before the last crisis, and countless trillions of derivatives, extreme debt levels and recent changes in debt levels for govs, corps and individuals in most places, and 25 Tn printed money since 2008, I just don’t see how to resolve it all without tremendous volatility and chaotic relative movements between asset classes as everybody tries to salvage what can be salvaged.
REAL assets are the way to go of course, but it’s not that easy to say what IS a real REAL asset. Gold at least will stay gold, but you can’t eat it, and it’s difficult to transport. Meanwhile, bitcoins can be transported across borders by just memorizing 12 words in the right order, but they’re “just” an accounting mechanism with no tangible value (apart from the distributed and secure accounting function, which definitely has intrinsic value).
Central banks are at the end of the rope
In any case, I think both are starting to say that central bankers are losing their grip and the confidence of the people/markets. Sure, stocks are REAL claims too. In theory they grow with the nominal economy, and should grow with printed money (which there will be much more of soon). However, when relative prices between REAL gold and REAL companies are already 3-5x out of whack, you shouldn’t hope for repeating the same kind of Indian rope trick again on top of the previous one without a calamitous re-set first.
If the economy rolls over now, the Fed will probably lower rates and increase the QE “slope” (money printing) more than most expect.
Such “surprise” cuts are what kicked off the bursting of the bubble in 2001. This time is likely to get much worse – although the absolute first reaction might be a blow off top for equities first, to lure in the last fools at an extreme all time high. Gold and Bitcoin should still protect you in that environment. More importantly, they’ll protect you after the top.
ARE YOU PREPARED FOR A RE-SET? ARE YOU REALLY?
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Gold price
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Topic: the economics of running a hedge fund
How much money do you need to manage in a hedge fund?
Let’s say you manage to raise 100 million dollars from friends and family. How far would that get you?
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Revenues
Fixed fee: 1% of 100m = 1 million dollars a year
Performance fee: 20% of whatever your “outperformance” is, which depends on what you’ve promised, and if you have some catching up to do relative your high water mark or other promises.
We’ll leave that part for later, since you can’t really count on reliably amassing performance fees. On average fund managers don’t add any value relative their benchmarks, so on average fund managers can’t expect to get any performance fees.
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Costs
Staff: 3 people (you, a partner, and one more for research and administrative work) at 150k$ each a year, which would be considered the bare minimum for running a 100m$ fund and attracting decent talent. 3*150=450k$.
In Sweden the cost of 150k$/yr amounts to less than 10k$/month (95k SEK) per employee before taxes but after social services fees. The take home pay for the employee after personal taxes will be around 5.5k$/month (55k SEK)
Travel expenses (eight trips per employee/yr to attend conferences, visit important companies, clients etc. NB just two trips per quarter, and at a cost of just 2k$ per trip for a few hotel nights, airplane tickets and expenses): 8*2k$*3 = 50k$
Premises: 50k$ per year for an average office in the CBD district
Equipment, computers, mobile phones: 2k$/yr per employee = 2*3=6k$ (could just as well be rounded to zero)
Information and trading systems, 3rd party research: 50k$ per employee = 3*50 = 150k$ (NB: the cost could easily run to twice that)
Regulatory fees, expenses, insurance, securities custody etc.: 0.1% of AUM = 0.1%*100m$ = 100k$ (could easily be twice as much)
Total costs: 450+50+50+6 (rounded to zero)+150+100 => 800k$ (or up to 1m$ depending on information costs nd regulatory expenses)
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Income
Income before performance fees and taxes: 1 000k – 800k =200k$ (or as little as zero)
Income after taxes (25%) per employee (3): 200 * (1-25%) /3 =50k$ (or zero)
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Bonuses and dividends
The above example leaves just about no room for bonuses, and thus little chance of retaining high quality employees (including yourself). In addition if you can’t perform good enough for a performance fee, even your friends and family will jump ship before long.
Let’s say you outperform your threshold by 5-10 percentage points, how far would that get us?
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Performance fees for 5-10pp outperformance: 20%*5%*100m = 1m$, and 20%*10%*100m = 2m$. That would leave 750k – 1.5m$ after taxes for distribution to the owners, or a decent 250-500k$ each in dividends that year. Now, I wouldn’t get my hopes up too much for repeating such a performance year after year.
In addition you’d run the risk of falling behind during difficult years. While struggling to catch up there could be periods of no performance fees in sight for years at a time. What if your fund lost just half of what the market lost in the crashes of 2002 and 2008? Even with such stellar performance, you’d still need 3-5 years per crash to catch up before earning variable fees again. Most actually give up altogether, after losing more than 20% from their high watermark.
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Conclusion
Even a 100m$ hedge fund is more or less a break even operation, where its founders or employees get a basic annual compensation but no frills. The upside consists mostly of soft factors, like independence and freedom, plus the potential for landing a few lucky big years before enduring a crash. If, however, the order is reversed they get nothing extra.
Please note that if you simply had 5m$ of your own and made a 10% return, without the hassle of running a hedge fund (clients, authorities, regulations…), you’d net a clean half million dollars for yourself. In Sweden that would be after taxes, since personal capital gains are tax free here.
Running a billion dollar hedge fund or bigger is a whole different game. We, e.g., managed our +1B$ fund with more or less the same crew as when it was a tenth that size.
At fixed fees of +10m$ a year and performance fees of typically at least as much, and total costs before bonuses, taxes and dividends, of around 2m$, there was plenty to go around for us four principal owners. Now, try a 10B$ fund on for size in terms of its economics!
Topic: the principle ways of making money working in the finance industry (as opposed to going it alone as a trader)
Conclusion: the career choices of broker/trader, analyst, portfolio manager, managing director, and partner/owner all have their merits and drawbacks. As do going from one to the other. I've done them all, albeit with no real plan, and was handsomely rewarded for it.
This article investigates how to best pursue material riches in high finance.
Early 2010, I attended a gala in London to accept Futuris' award The European Hedge Fund Of The Decade. I was the managing director, one of three senior partners, and portfolio manager for Futuris, a billion dollar hedge fund. We had won prestigious awards before but this really was the biggest one.
In short, I was very well off. Not only that, I came from nothing, with no network, no pedigree, no friends, parents, acquaintances etc. in the business. In addition I had no previous experience of finance. All I had was grit.
I first worked myself up the ranks on the sell-side as an analyst, and then switched to the buy-side to manage other people's money, first as an analyst and subequently as a portfolio manager.
I started my career as a lowly broker's assistant in the spring of 1994 after four years of studies at SSE (Stockholm School of Economics). Two years later I eventually found the time to hand in my econometric thesis ("Does the stock market overreact in its valuation of Swedish pulp and paper stocks?") and thus got my masters degree (majoring in finance).
By 1996, after a couple of years since my humble beginnings in the industry, I was responsible for researching and recommending IT stocks at Sweden's largest bank. Only four years later I was poached by the newly incepted IT focused hedge fund Futuris, to become their in-house Software and IT services analyst.
During the beginning of my career, I sometimes thought about the optimal way through the finance industry. One idea I had was to jump back and forth between the buy-side and sell-side every 2-3 years. A few years on the sell-side would make me known among all the important clients and make them want to hire me. And after a while on the buy-side I could leverage my knowledge about the inner workings of clients, as well as my personal contancts, to get more business as a research analyst or key client responsible on the buy side.
For every switch I would negotiate better pay packages, either for staying an extra year on whatever side I was already on, or for bringing my superior knowledge and contacts over to the other side.
In addition, I thought about doing something similar within the sell-side, switching between being an anayst and a broker/research sales.
As sales, I would have time to read research from all different industries and sectors, and be able to both learn more, as well as cherry pick the absolute best ideas for my clients. Then I could come back even stronger as a highly specialized single industry analyst, armed with a more diverse set of convincing assessment and valuation methods. The switches would be made opportunistically, when my employer or some other firm was looking for unorthodox solutions, rather than actively pursuing switching sides.
I had no real plan but for executing whatever orders I got as well as I could. In many ways I performed similarly to how I imagine a first generation artificial general intelligent agent would. I just powered myopically ahead with no regard to my personal health or professional suboptimization issues. I received my goal specifications and I tried to reach them with whatever legal means I had at my disposal, or could get my hands on.
If I had been asked to optimize the number of paper clips I would have melted the world.
However, whatever ideas I originally had about optimizing my knowledge, skills, professional network, compensation packages etc. were lost within my first few months as an underpaid, underslept, overworked premature ruin of a boy man, 22 years of age.
Here's the strategic do-over of an optimal finance career, for your benefit:
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Broker, sales, trader
Your main responsibility as a broker is to get clients to spend money (commission) on your firm.
You can achieve that goal by supplying them with good investment ideas, backed by fundamental and technical research, as well as gossip and assessments of which analyst is currently enjoying a good streak.
Another proven strategy is to essentially be a travel guide for clients visiting companies, conferences, restaurants, bars, clubs and strip joints.
A happy client understands that all firms are basically equally good, and could thus just as well allocate his spending to the firm that supplies good enough investment advice but excellent conscierge services. All this is very entertainingly documented in the book City Boy by Geraint Anderson, with whom I share my birth year, analyst background, as well as author aspirations, not to mention entering the finance industry without any knowledge of it. He's also the one I turned to for advice, for deciding when to retire.
There are different tiers within the brokers, sales and traders guild. Some simply take orders and execute them by a click of the mouse, via a (Bloomberg) chat, or a phone call. Others are proprietary traders who get to play around with company money, with the objective of either making a profit or boosting the firm's apparent market share (at a specified maximum loss). Yes, they get paid to lose money.
Yet others are the bridge between analysts and clients, they are the wheels of the broker firm, where the rubber meets the road.
Analysts identify and present ten good reasons for buying a stock on early morning meetings. Sales representatives (called "brokers", "research sales", "key account managers" etc.) try to remember three of the most important arguments, and hope that the clients they call latch on to one or two of these, and promptly place an order, which in turn lands the broker firm a commission. The best brokers receive year end bonuses based on how much such business they catalyze.
To land a position as research sales, to start accumulating large annual bonuses, you need to understand both people and numbers, not to mention work at a large and important firm to which clients automatically allocate most of their business. Jumping back and forth between roles as respectively a broker and an analyst is one effective route that I recommend.
There's a snag though. The last few years new directives have been put in place which significantly limit the amount of commission clients can pay for brokerage and research services.
Not only that, there are good reasons to believe the brokerage industry is close to a peak and ready for a pullback. Combining these two developments make for a long and winding road for any broker or analyst, except a very select few.
Beginnning in 2019, 2020, I would strongly advice against a career as any kind of broker, if making money is your objective rather than having fun. That includes proprietary traders, whose positions are likely to be all but cut altogether going forward, due to the balance sheet cost of risk.
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Analysts
Analysts on the sell-side work side by side with brokers. They read reports, visit companies, talk to industry experts, create enormous DCF excel models, and write research reports with recommendations to buy or sell a stock. If they are highly ranked* and well-known they get booked by clients (asset managers) and get to present their ideas.
* A high ranking can be attained in many different ways, but being right more than most is not a reliable way on its own. Being sociable is much more important.
Some clients take this process seriously: they listen, ask questions, make notes, compare the work with their own research and financial models, make a few adjustments and sometimes invest accordingly.
Others just go through the motions to get a free lunch, dinner, drinks or show.
A good analyst is in demand from as diverse places as corporate merger & acquisition departments, sell-side research firms (brokerage houses), and not least asset managers, i.e., the clients, the "buy-side" as an in-house resource and speaking partner.
A good analyst finds and creates new information, is innovative with numbers and charts, and gets ranked in annual surveys of public companies, their own broker departments, and most importantly asset managers (the clients). Being noticed by important clients is doubly useful - first in bonus discussions, second to get hired by them.
A good analyst can easily jump between roles on the buy-side, sell-side, corporate side, and possibly even as his own one-man research and investment firm. Not too rarely, good analysts start their own hedge funds, or simply manage their own money. It doesn't always end well though - it's a whole different game making buy and sell calls for others, compared to having your own money on the line.
A good analyst should most often stay a good analyst, in the care of as prestigious as possible a sell-side or buy-side firm, rather than go it alone. However, a good sell-side analyst can quite easily make the transition to becoming a good buy-side analyst or an excellent sell-side research sales, and back again, given a quantum of people skills.
Continuing down the list of being employed in the finance industry, both brokers and analysts can make for good managers (unfortunately, often bad ones too).
As a manager you get a higher than average compensation, but still much lower than than the top brokers and analysts. Your reward is less client interaction, less work, shorter days, but being screamed at by the spoiled boy-men brats you're trying to manage. Bonus times are the worst. That's when they all will try to intimidate you into submission, also known as getting paid more than they're worth.
Some of your opponents (coworkers) are straight out of Compton hooligans, while other wave their pedigree around. Some cry about their families or new yacht, others scream and pound the table.
You'll go home feeling like shit, like you messed up, like you're being unfair, regretting and second-guessing your decisions and promises, fearing the best will leave and the worst will sue. Any stint as a manager will soon make you want to go back to working 16-hour shifts in the corp department, revising and improving power point slides for shifty IPOs, rather than suffering another round of bonus war (negotiations).
Sadly, just two years as a manager is enough to make you lose your edge as an analyst just as much as your will to live.
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Portfolio manager
Congratulations, you've made it. Somehow you've proved your worth in the industry well enough to be trusted to manage other people's money. Given it's enough of it (at least 100m$ per manager), and the fee structure has a variable component, you're set to make some serious money.
You shouldn't even have to work too hard for it.
Actually, you shouldn't work hard, period. As a portfolio manager you should strive for making few strategic decisions, while staying as rested and prepared as possible in between.
Make sure others do as much of your work as possible. Your task is to be calm and composed, taking stop-losses where needed, boosting positions where the risk reward calls for it, and communicate to clients what you're doing, why, and how it's going. you should not work long hours, micro manage positions or personnel
This is where you want to be, if you're content being employed.
The way to becoming a PM is via being a good and respected analyst, or an excellent and well connected research sales.
They're sheep!
The really great news is that as a PM, there's a very good chance you could become a partner/owner of a fund or a hedge fund. But the ins and outs of that, including the reward anatomy, is a story for another day.
Next up: How a hedge fund works; revenues, costs, profits, total after tax compensation, and more.