Advice for Small Stock Market Gamblers

 Tim Harford in The FT

The pages of the Financial Times are not usually a place for legends about ancient gods, but perhaps I can be indulged in sharing one with a lesson to teach us all. 

More than a century ago, Odin, All-father, greatest of the Norse gods, went to his wayward fellow god Loki, and put him in charge of the stock market. Odin told Loki that he could do whatever he wanted, on condition that across each and every 30-year period, he ensured that the market would offer average annual returns between 7 and 11 per cent. If he flouted this rule, Odin would tie Loki under a serpent whose fangs would drip poison into Loki’s eyes from now until Ragnarök. 

Loki is notoriously malevolent, and no doubt would love to take the wealth of retail investors and set it on fire, if he could. But when faced with such a — shall we say binding? — constraint, what damage could he really do? 

He could do plenty, says Andrew Hallam, author of Balance and other books about personal finance. Hallam uses the image of Loki as the malicious master of the market to warn us all against squandering the bounties of equity markets. 

All Loki would have to do is ensure the market zigged and zagged around unpredictably. Sometimes it would deliver apparently endless bull runs. At other times it would plunge without mercy. It might alternate mini-booms and mini-crashes; it might trade sideways; it might repeat old patterns, or it might do something that seemed quite new. At every moment, the aim would be to trick investors into doing something rash. 

None of that would deliver Loki’s goals if we humans weren’t so easy to fool. But we are. You can see the damage in numbers published by the investment research company Morningstar; last year it found a shortfall in annual returns of 1.7 percentage points between what investors make and the performance delivered by the funds in which they invested. 

There is nothing strange about investors making a different return from the funds in which they invest. Fund returns are calculated on the basis of a lump-sum buy-and-hold investment. But even the most sober and sensible retail investor is likely to make regular payments, month by month or year by year. As a result, their returns will be different, maybe better and maybe worse. 

Somehow, it’s always worse. The gap of 1.7 percentage points a year is huge over the course of a 30-year investment horizon. A 7.2 per cent annual return will multiply your money eightfold over 30 years, but subtract the performance shortfall and you get 5.5 per cent a year, or less than a fivefold return in 30 years. 

Why does this happen? The primary reason is that Loki’s mischievous gyrations tempt us to buy when the market is booming and to sell when it’s in a slump. Ilia Dichev, an economist at Emory University, found in a 2007 study that retail investors tended to pile into markets when stocks were doing well, and to sell up when they were languishing. (Without wishing to burden the long-suffering reader with technical details, it turns out that buying high and selling low is a bad investment strategy.) 

One possible explanation for this behaviour is that investors are deeply influenced by what they’ve seen the stock market doing across their lives so far. The economists Ulrike Malmendier and Stefan Nagel have found that the lower the returns investors have personally witnessed, the less they are likely to put in the stock market. This means that bear markets scare investors away from their biggest buying opportunities. 

Another study, by Brad Barber and Terrance Odean, looked at retail investors in the early 1990s, and found that they traded far too often. Active traders underperformed by more than 6 percentage points annually. Slumbering investors saw a much better performance. The sticker price of making a trade has plummeted since then, of course. Alas, the cost of making a badly timed trade is as high as ever. 

 Morningstar found that the gap between investment and investor returns is largest for more specialist investments such as sector equity funds or non-traditional equity funds. The gap is smaller for plain vanilla equity and smaller still for allocation funds, which hold a blend of stocks and bonds and automate away investor choices. That suggests that the investors who are trying to be clever are the most likely to fall short, while those who make the fewest possible decisions will lose out by the smallest amount. 

 I am always hearing that people should be more engaged with investing, and up to a point that is true. People who feel ignorant about how equity investing works and therefore stick their money in a bank account or under a mattress, are avoiding only modest risks and giving up huge potential returns. 

But you can have too much of a good thing. Twitchily checking and rearranging your portfolio is a great way to get sucked into poorly timed trades. The irony is that the new generation of investment apps work the same way as almost any other app on your phone: they need your attention and have plenty of ways to get it. 

Recent research by the Behavioural Insight Team, commissioned by regulators in Ontario, found that gamified apps — offering unpredictable rewards, leader boards and badges for activity — simply encouraged investors to trade more often. Perhaps Loki was involved in the app development process? 

I’ve called this the Investor’s Tragedy. The more attention we pay to our investments, the more we trade, and the cleverer we try to be, the less we will have at the end of it all.

Raghuram Rajan interviewed by Rahul Gandhi

 

Rishi Sunak’s first job? Clearing up his own mess

 A clever man, with a penchant for bad ideas writes The Economist

Oct 25th 2022

Rishi sunak entered Downing Street clutching an invisible dustpan and broom. “Mistakes were made,” declared the new prime minister on October 25th, all but rolling up his sleeves. “I have been elected as leader of my party…to fix them.” The voice was passive but the identity of the culprit was clear—Liz Truss, Mr Sunak’s hapless predecessor, who managed just 49 days in the job. It is the morning after the night before in the Conservative Party. The grown-ups have returned to find the house has been trashed. Now Mr Sunak must start the clean-up.

There is just one problem with this narrative. Mr Sunak is a cause of the problem as well as the solution. The new prime minister is helping tidy up a mess that he helped create.

When the Conservative Party has erred in recent years, Mr Sunak has nearly always been in favour of the mistake rather than the fix. There were many reasons to support Britain leaving the eu. Mr Sunak, however, picked the worst one: he thought it was a cracking idea. Britain will be “freer, fairer and more prosperous outside,” wrote Mr Sunak in 2016. It was a pragmatic decision, not a romantic one. The fundamental problem at the heart of his own government will be a policy for which he long campaigned. Likewise, Mr Sunak was comfortable with a “no deal” Brexit so long as Britain actually left the eu. Mr Sunak has pledged a more constructive relationship with the bloc. Better not to have broken it at all.

After the referendum triggered three years of political deadlock, Mr Sunak supported an extraordinary solution to the mess: Boris Johnson. That decision can be put down to cynicism. Mr Johnson was likely to win regardless of whether he was endorsed by Mr Sunak, at the time a junior minister in the department for local government. But intellectual contortions were required to join the bandwagon. Theresa May was competent and diligent yet also a total failure, ran Mr Sunak’s logic, so it did not matter that Mr Johnson was neither competent nor diligent. In July Mr Sunak resigned from his position as chancellor of the exchequer, prompting a cascade of ministerial departures that ended Mr Johnson’s reign. But why put him in Downing Street in the first place?

Mr Sunak embodies the tension between the Tories’ lust for low taxes and their habit of making big-state promises. Colossal spending programmes during the pandemic made Mr Sunak briefly the most popular politician in the country. Yet these were also the decisions he most resented; he tried to curtail schemes such as furlough prematurely in a bid to save cash. In the spring of this year, Mr Sunak similarly dragged his feet on offering support for ballooning energy bills. He is, at heart, a small-state Conservative, even if he has showed a commendable ability to overcome his natural instincts when urgent need arises.

If fiscal conservatism comes first for Mr Sunak, what comes after is much more erratic. As an ambitious backbencher Mr Sunak supported low-tax “freeports”, which shuffle economic activity around rather than generating it. As chancellor Mr Sunak championed the “Eat Out to Help Out” scheme, when the government in effect paid unvaccinated people to sit together during a pandemic and infect each other. Mr Sunak pushed the Royal Mint to issue a non-fungible token this summer, just as the market for these digital assets crashed. Support for quixotic policy is the norm for Mr Sunak rather than the exception.

In politics, however, luck sometimes masquerades as judgment. Losing the leadership contest to Ms Truss this summer was a big stroke of fortune. During that campaign Mr Sunak predicted that Ms Truss would be a disaster, and she was. He warned that reckless spending commitments would force mortgage rates higher; his campaign team even put together a calculator, pointing out the high bills that would hit households if rates hit even 5%. Yet mortgage rates were heading up regardless of Ms Truss’s rash budget. Her errors have obscured the fact that, had Mr Sunak won in the summer, rising interest rates would have left him with tricky questions to answer. Instead he can pin it all on Ms Truss.

During the summer campaign, and throughout his time on the front benches, Mr Sunak has taken a path long followed by the Conservative Party, which has governed in its narrow political interest rather than the national one. Pledges to curtail onshore wind and solar development please a few zealots but make it harder for Britain to reach its climate goals. Slashing fuel duty as chancellor provided a few days of positive headlines, but failed to put much money in people’s pockets and did not help the environment. There is little evidence that Mr Sunak will take on the vested interests, often in his own party, that hold back Britain’s economy.

Standing on the shoulders of dwarves

The prime minister is a cut above most of his peers. But this is as much a function of a Conservative civil war that killed off competent colleagues as Mr Sunak’s own talents. Elected only in 2015, Mr Sunak has not been doing the job very long. Inexperience, even with copious intelligence, is always a problem. Yet the Conservative Party had nowhere else to turn. It would be comforting to think of Mr Sunak as a clever cynic, a gambler who bet big on Brexit and Mr Johnson and (with a helping hand from Ms Truss) became the youngest prime minister in two centuries. A more worrying analysis is that he is a bright and decent man with bad ideas.

On this reading Mr Sunak does not mark a change from the Tory policies that have left Britain in such a state. Rather he personifies them. The rot in the Conservative Party did not begin with Ms Truss. Britain’s departure from the eu, which Mr Sunak supported, is the thing that acts as a handbrake on the country’s economic prospects. Mr Johnson’s chaotic reign, which he also supported, caused even more ruin. It is the Conservative Party’s failure to take on its supporters that does so much damage to the country. Mr Sunak may be the only available man to fix the government’s errors. But he also helped make them.

Are Indian businessmen being unfairly targeted?

By Girish Menon

Following revelations in the suicide note of V G Siddhartha - the founder of Cafe Coffee Day, the corporate world has started a whispering campaign that Indian businessmen are being unfairly targeted by government bureaucracies. This piece will try to examine the elephant in the room.

Indian businessmen are not one cohesive group. There are many sub groups varying in size and population; from the one man tea vendor to Ambani who aspires to be the biggest tycoon in the world. Not all business-persons receive the same treatment from the governments they have to encounter in their daily endeavour.

As far as the Ambanis are concerned, it was rumoured that his office would receive a copy of any government initiative even before it was announced in parliament. Some even suggest that policies are often drafted in their offices. Clearly, such businessmen are like the Goldman Sachs of the USA i.e. too big to fail. Rivals of Ambani envy the unfair distribution of advantages to this group. However, they don’t want it to be stopped but wish they could replace him instead. This group is large and growing.

If the free market mantra is to be applied then governments should not be indulging in such behaviour. This logic states that governments should recognise property rights, make necessary rules and let citizens pursue their self interest. They should not favour any businessperson.

Economist Ha Joon Chang attributes the growth of Toyota, Samsung and many other global MNCs due to the nexus between governments and businesses. He suggests that developing countries follow this strategy else their domestic firms will lose out to already existing western MNCs. Others term this government corporate nexus as crony capitalism.

The Indian corporate world has enjoyed the benefits of crony capitalism since 1947. Under the socialist policies till 1990s the Tatas, Birlas and Bajajs were among the few recipients of licences to do business. In the 40 years of their protected status they did not produce any world beaters. They even formed ‘The Bombay Club’ to lobby against the opening up of the Indian economy.

Even after the Indian economy opened up corporates lobbied the government to make arbitrary rules that gave them an advantage over their rivals. These corporates received loans from government banks and even more loans to avoid loan defaults. It is almost thirty years since the opening up of the economy and yet there are no world class products that have emerged from these corporates. Often, such corporates have only aspired to the takeover of monopoly public sector firms so that social profit can be converted to private profit.

However, the above group do not represent Indian business-persons. The largest group of Indian business-persons run small and medium enterprises. They definitely have a rightful claim to harassment by the government. They are victimised by the government’s bureaucracy in so many ways that I am surprised they still continue to do business. S Gurumurthy, the RSS ideologue on the board of the Reserve Bank of India, is right when he advocates that the Indian government should ease the conditions of doing business for this large group. Demonetisation was a recent  tsunami that further overwhelmed this group of drowning businesspersons. Often, their only plea is that their outfits should be outside the scope of government bureaucrats. And there is some merit in their argument.

It is an irony that the pleas of persecution by large Indian corporates are being aired when the real victims of government harassment, i.e. the small and medium enterprises, die a silent death. It used to be said of the Christian church,’The church complains of persecution whenever it is not allowed to persecute’. The cries of India’s large business houses seem to echo the Christian church.

The banking industry's biggest problem isn't bonuses or market share

The only way to make the sector pursue long-term viability instead of short-term greed is to change the rules of the game

• 
• • Ha-Joon Chang
  • The Guardian, Wednesday 22 January 2014

‘The fact that the political class, including Miliband himself, cannot even imagine state-owned banks ditching the business model that caused this crisis is a testimony to the power of the financial industry lobby.’ Photograph: Stefan Rousseau/PA

Last Friday, in another of those agenda-setting speeches for which he has rightly become famous, Ed Miliband took on the biggest of what he describes as "the broken markets" in the UK economy – the financial market.

Taking his "cost of living crisis" theme to another level, the Labour leader emphasised that the issue is not just about oligopolistic firms fleecing their customers; it is also about the lack of jobs with decent wages that can support decent standards of living. The problem with the British banking industry, Miliband pointed out, is not just about the concentration of financial power in the personal account market, but also in the business loan market.

According to Miliband's analysis, the dominant banks are not lending enough to small and medium-sized enterprises because they form a cosy oligopoly (controlling 85% of small business lending) that does not want to take any risk; enterprise loans are inherently riskier than mortgage and personal loans. Given that small businesses create most jobs in the UK (as they do in all countries), lack of finance for them is limiting the creation of decent jobs. The solution, he argued, is to introduce more competition into the small business lending market by capping the share of individual banks.

This proposal has caused much controversy. However, one thing is certain: it is going to be slow-acting. It may be years before proper "challenger" banks emerge, given the time necessary for the review by the Competition and Markets Authority – which takes over the roles of the Competition Commission and Office of Fair Trading from April – and for the process of selling branches.

But there is a quicker and simpler solution to this problem. It is for the government to use its ownership of two of the big four banks, RBS and Lloyds, to direct more lending to small businesses. Thanks to the bailout following the 2008 financial crisis, RBS is 81% owned by the government. This means it can tell RBS what to do. It also owns 33% of Lloyds, and while this does not give it a total control over the bank, it is well above what is normally considered a "controlling stake" in an enterprise.

Now, if you can basically tell two of the four largest banks what to do – say, to increase lending to small businesses – why go through the rigmarole of calculating their market shares and forcing them (and the other two) to sell off some of their branches?

The usual refrain is that Westminster cannot make RBS and Lloyds do things differently because, in order to survive, these banks need to behave like other competitors: generating as much profit and paying their staff as much.

This argument may be right if the existing business model of British banks and other financial companies is fine. But it is not. It is a business model that has caused the biggest financial crisis in 70 years and created imbalances and inequalities that threaten the future viability of the British economy. The fact that the political class, including Miliband himself, cannot even imagine state-owned banks ditching such a model is a testimony to the power of the financial industry lobby.

From the day when RBS and Lloyds were bailed out, the Labour government was at pains to emphasise it would run them along the same lines as before nationalisation. The only thing for which Labour and, subsequently, the coalition government have used the government's dominant shareholding position has been to restrain bonuses. But this is really missing the point.

The problem with bonuses in the financial industry is not about their levels – if someone makes a huge contribution to the economy, he or she should be richly rewarded. The main problem is that these bonuses are given to people for doing the wrong things well – things that harm the economy in order to enrich the shareholders, the top managers of banks and other financial firms.

So the real question is how we make banks and other financial firms pursue the right goals, rather than how much people should be paid, whether in bonuses or salaries. And the only way to make them pursue different goals from those they pursue now is to change the rules of the game.

Unfortunately, few regulations have been introduced since the crisis that have materially changed the goals of financial companies. The result has been "business as usual".

All those complex and risky financial products that were at the centre of the 2008 financial crisis – such as mortgage-backed securities, collateralised debt obligations, credit default swaps and other financial derivatives – are back in vogue again.

The credit rating agencies, whose incompetence and cynicism in rating those financial products has become legendary after the crisis, are still operating in the same way.

Thanks to Help to Buy, the mortgage-lending market is nearly back to its old self. Now you can get loans that are 95% equal to the value of the house – not quite the 125% you could get before the crisis, but nearly there.

In the absence of measures to encourage longer-term shareholding – for instance, by granting more votes or tax advantages – short term-oriented shareholders are still reigning supreme, putting pressures on banks to generate short-term profits, whatever the consequences.

The main problem with the British financial industry is not the level of bonus, or even the concentration in the banking sector; it is that the industry is pursuing goals that are detrimental to the long-term economic viability of the country, in the process enriching only a tiny minority and sapping human and financial resources from the rest of the economy.

Unless those goals are changed through better regulation, the industry will remain harmful to the rest of the economy, whatever we do about bonuses and market concentration.

No Walmart, Please

By Justice Rajindar Sachar (retd)

17 December, 2011
The Tribune, India

Govt’s claim is questionable

If the combined Opposition had sat down for weeks to find an issue to embarrass the UPA government and make it a laughing stock before the whole country, they could not have thought of a better issue than the free gift presented to it initially by the government by insisting that it had decided irrevocably to allow the entry of multi-brand retail super stores like Walmart and then within a few days, with a whimper, withdrawing the proposal.

As it is, even initially this decision defied logic in view of the Punjab and UP elections and known strong views against it of the BJP and the Left. Many states had all the time opposed the entry of Walmart which would affect the lives of millions in the country.

Retail business in India is estimated to be of the order of $ 400 billion, but the share of the corporate sector is only 5 per cent. There are 50 million retailers in India, including hawkers and pavement sellers. This comes to one retailer serving eight Indians. In China, it is one for 100 Chinese. Food is 63 per cent of the retail trade, according to information given by FICCI.

The claim by the government that Walmart intrusion will not result in the closure of small retailers is a deliberate mis-statement. A study done by IOWA State University, US, has shown that in the first decade after Walmart arrived in IOWA the state lost 555 grocery stores, 298 hardware stores, 293 building supply stores, 161 variety stores, 158 women apparels stores and 153 shoe stores, 116 drug stores and 111 men and boys apparels stores. Why would it be different in India with a lesser capacity for resilience by small traders.

The fact is that during 15 years of Walmart entering the market, 31 super market chains sought bankruptcy. Of the 1.6 million employees of Walmart, only 1.2 per cent make a living above the poverty level. The Bureau of Labour Statistics, US, is on record with its conclusion that Walmart’s prices are not lower.

In Thailand, supermarkets led to a 14 per cent reduction in the share of ‘mom and pop’ stores within four years of FDI permission. In India, 33-60 per cent of the traditional fruit and vegetable retailers reported a 15-30 per cent decline in footfalls, a 10-30 per cent fall in sales and a 20-30 per cent decline in incomes across Bangalore, Ahmedabad and Chandigarh, the largest impact being in Bangalore, which is one of the most supermarket-penetrated cities in India.

The average size of the Walmart stores in the US is about 10,800 sq feet employing only 225 people. In that view, is not the government’s claim of an increase in employment unbelievable? The government’s attempt is to soften the blow by emphasising that Walmart is being allowed only 51 per cent in investment up to $100 million. Prima facie, the argument may seem attractive. But is the Walmart management so stupid that when its present turnover of retail is $ 400 billion it would settle for such a small gain? No, obviously, Walmart is proceeding on the maxim of the camel being allowed to put its head inside a tent and the occupant finding thereafter that he is being driven out of it by the camel occupying the whole of the tent space. One may substitute Walmart for the camel to understand the danger to our millions of retailers.

The tongue-in-cheek argument by the government that allowing Walmart to set up its business in India would lead to a fall in prices and an increase in employment is unproven. A 2004 report of a committee of the US House of Representatives concluded that “Walmart’s success has meant downward pressures on wages and benefits, rampant violations of basic workers’ rights and threats to the standard of living in communities across the country.” By what logic does the government say that in India the effect will be the opposite? The only explanation could be that it is a deliberate mis-statement to help multinationals.

Similar anti-consumer effects have happened by the working of another supermarket enterprise, Tesco of Britain.

A study carried out by Sunday Times shows that Tesco has almost total control of the food market of 108 of Britain’s coastal areas — 7.4 per cent of the country. The super stores like Walmart and Tesco have a compulsion to move out of England and the US because their markets are saturated. These companies are looking for countries with a larger population and low supermarket presence, according to David Hogues, Professor of Agri-Business at the Centre for Food Chain Research at Imperial College, London. They have got nowhere else to go and their home markets are already full. Similarly, a professor of Michigan State University has pointed out that retail revolution causes serious risks for developing country farmers who traditionally supply to the local street market.

In Thailand, Tesco controls more than half the Thai market. Though Tesco, when it moved into Thailand, promised to employ local people but it is openly being accused of indulging in unfair trading practices. The claim that these supermarket dealers will buy local products is belied because in a case filed against Tesco in July 2002 the court found it charging slotting fees to carry manufacturers’ products, charging entry fee of suppliers. In Bangkok, grocery stores’ sales declined by more than half since Tesco opened a store only four years ago.

In Malaysia, seeing the damage done by Tesco since January 2004, a freeze on the building of any new supermarket was imposed in three major cities and this when Tesco had only gone to Malaysia in 2002.

It is worth noting that 92 per cent of everything Walmart sells comes from Chinese-owned companies. The Indian market is already flooded with Chinese goods which are capturing the market with cheap offers, and traders are already crying foul because of the deplorable labour practices adopted by China. Can, in all fairness, the Indian government still persist in keeping the retail market open to foreign enterprises and thus endangering the earnings and occupations of millions of our countrymen and women?

The writer is a former Chief Justice of the High Court of Delhi