Browsing the bourses
The Economist, 29-Mar-2007
Companies scour global exchanges to find a better price for their shares
BASED in Toronto, Golden China Resources is a mining company with the kind of scary but alluring profile you might expect for a firm that goes prospecting for gold. Established only three years ago, it is still losing money. But it boasts an intriguing technology using bacteria in the refining process, promising rights in China and what appears to be a growing inventory of established reserves.
With bullion prices rising and economic doubts gathering, times should be good for gold producers. But on the Toronto Stock Exchange, Golden China has lost its lustre. Its share price has fallen by half since early 2006. In response, the company has embarked on a different kind of prospecting. It is studying how different bourses around the world value companies like itself. Its findings are a challenge to anyone who believes financial markets are consistent or rational.
Take, for example, the market's view of “in situ” ounces, meaning gold that is in the ground. According to an outside analysis, Canadian exploration companies are valued at $75 an ounce on average. As refined gold now sells for more than $650 an ounce, this leaves some margin for processing and mining risk.
If the deposits controlled by these Canadian companies are in China, the valuation slips to $43 an ounce. This may reflect worries that China's methods of verifying potential assets are less stringent. It may also be a consequence of more general fears about property rights in China.
That would be the end of the story were it not for an odd detail. Golden China then went on to look at the valuation of gold producers listed in Hong Kong or on the Chinese mainland. The results were striking: they were valued at $180-240 an ounce. Sino Gold, an Australian company which on March 16th made a secondary listing on the Hong Kong exchange, is priced at about $190 an ounce.
There may be some simple explanations for these big disparities. For example, the Chinese companies in the study all turn a profit. But investors in gold exploration probably care more about the treasure to be unearthed than the trickle of income from ongoing sales.
In fact, Golden China has hit on a broader seam of market discrepancies: the value of a share often depends on where the stock is floated. The most glaring examples are provided by Hong Kong-listed firms that also list in Shanghai, where they almost always get a better price for their shares. No wonder Hong Kong feels threatened by the migration of listings to its mainland rival.
More subtly, global exchanges disagree about the value they put on everything from food companies to banks, even after taking account of differences in a firm's local prospects. Perhaps investors feel better protected and better informed by some bourses rather than others. Exchanges often claim that stiff auditing and disclosure standards add a premium to the shares listed on them. But strangely, valuations right now seem highest in murky stockmarkets like China's.
Bourses may also attract their own distinctive base of investors, interested in some sectors more than others. America's markets attract the technophiles, China's lure the gold bugs. Like retail arcades, exchanges each seem to draw their own tribe of customers who know what they want, pay a premium for it and ignore bargains that would fetch much higher prices elsewhere. Golden China is like an electronics store trying to sell its wares (cheaply) on London's Savile Row rather than Tokyo's Akihabara market.
To profit from such disparities, enterprising investors have long combed the world's bourses looking for cheap stocks. It makes perfect sense for companies to do the reverse: scour the world for markets that will pay high prices for their shares, thus reducing the cost of their capital.
Unfortunately, bagging a higher valuation is not always as easy as listing on a different exchange. For example, lots of international companies coughed up for a Tokyo listing in the late 1980s, hoping to share in the euphoric multiples then applied to Japanese firms. But they were disappointed; their share prices remained tied to those back home.
Golden China is considering a more dramatic migration. Already most of its 700 employees work in China. The company's executives are thinking about joining them, and shifting their primary listing from Toronto to Hong Kong in the process. At the moment, they reckon the company's $50m market value plus its debt is worth only as much as its plant and outside investments, giving it no credit for its 1.5m ounces of gold. If more appreciative customers for their shares exist elsewhere, why not bring the company to them? It would appear the only rational response to an irrational market.
Saturday, March 31, 2007
Wednesday, March 28, 2007
The Great Inflation - Anatomy of a hump
Anatomy of a hump
The Economist, Mar 8th 2007
What caused the Great Inflation? And what might bring it back?
IF YOU were to draw the path of inflation in the typical big, rich economy over the past half century, your picture would look much like a dromedary's back: a low flat line in the 1960s; a knobbly hump of high and volatile price rises in the 1970s; dramatic disinflation in the 1980s; and low, stable inflation rates since. Japan and Germany, which were quicker to quell inflation, are well-known exceptions. But for the rest, the shape and timing of the Great Inflation bulge look remarkably similar.
This is a bulge that today's central bankers are anxious not to repeat. So it is no surprise that several governors from America's Federal Reserve are attending a conference on March 9th to discuss a new report* on the Great Inflation, written by a weighty group of macroeconomists from academia and Wall Street.
Most scholars agree on a basic explanation of the hump, placing both blame and credit squarely on central bankers. Consumer prices accelerated in the late 1960s because monetary policy was too loose. German and Japanese central bankers realised this earlier than others and tightened policy accordingly. Eventually others followed suit, and general disinflation began in the early 1980s. Since then inflation has stayed under control because central bankers are credibly committed to price stability and far better at their job.
Beyond that broad tale lie several debates about important details. Economists differ on how much non-monetary phenomena, such as closer trade integration, affect the inflation process. They also offer competing explanations for why central bankers botched things so badly a generation ago. One possibility is that they simply got the numbers wrong, consistently overestimating their economies' speed limits. Others blame theoretical misjudgments, particularly the belief that higher inflation could buy a lasting drop in unemployment. A third approach emphasises political pressure. Inflation got out of hand because central banks were under the thumb of politicians who preferred rising prices to higher joblessness.
In this latest report the authors subject such controversies to painstaking cross-country forensics. They show that price stability across the G7 countries has been far more closely correlated than economic stability. Almost everywhere, inflation took off between 1969 and 1970. And every country, except Germany and Japan, failed to tame it until the mid-1980s. Output, however, was less tightly synchronised. Although recessions in many countries have become less wrenching in recent decades, output volatility began to ease in the mid-1980s in America, but not until the early 1990s in Britain, Canada and France.
What to make of these differences? The Great Inflation, because it was felt simultaneously across countries, must have had a common cause. This cannot have been the 1970s oil shocks, because consumer prices started accelerating long before the price of crude did. Easy money is the only remaining suspect. And although the Great Disinflation was also simultaneous across many countries, GDP growth settled down at very different times. This implies that better monetary policy cannot take full credit for today's less painful recessions.
The statistical magnifying glass also casts doubt on some favourite alibis for monetary misrule. Bad data, for example, do not get central bankers off the hook: revisions to statistics on trend growth and unemployment were not big enough to excuse the scale of inflation. Instead, monetary policy was simply too loose. The authors show that the central bankers of the 1970s failed to adhere to the modern “Taylor rule”, a formula that links the appropriate level of short-term interest rates to the deviation of output from its trend and inflation from its target. Of course John Taylor, a Stanford economist, did not formalise his rule until 1993. But even without this guide, central banks should not have flunked the basic tenets of sound money.
Hawks v camels
Neither the Taylor rule, inflation targets nor any other bits of the modern central bankers' toolkit were necessary to end high inflation. But the scholars think these tools have helped to keep inflation down, which, in turn, has spawned a virtuous circle. When inflation is low and stable, a temporary uptick in consumer prices has far less impact on long-term price trends. The economists' model implies that less than 1% of a temporary price surge is translated into a permanent rise in inflation today, compared with 60% three decades ago.
That may give today's policymakers more leeway than their predecessors enjoyed. But since this wiggle-room is the legacy of low inflation volatility, it cannot be taken for granted. Were central bankers to lose their guard, inflation could soon resurge.
More worrying, the economists pour cold water on many a policymaker's favourite gauge of his own performance, namely the public's expectations of future inflation. Central bankers often cite low inflation expectations as evidence that monetary policy is appropriate. That may be a mistake. This paper argues that expectations were a good guide to future price pressure only when inflation was high. But now, if anything, inflation expectations are a backward-looking indicator, lagging measures of actual inflation.
All told, this statistical sleuthing suggests today's central bankers have little room for complacency. Inflation remains low and stable because policymakers are vigilant, not because any deep, structural changes insulate the modern economy from price pressure. If central bankers relax, higher, more volatile inflation could easily return. Rudyard Kipling's camel, remember, got its hump for being “most 'scrutiatingly idle”.
"Understanding the Evolving Inflation Process" by Stephen Cecchetti, Peter Hooper, Bruce Kasman, Kermit Schoenholtz and Mark Watson
Fed Governor Mishkin, "Inflation Dynamics"
The Economist, Mar 8th 2007
What caused the Great Inflation? And what might bring it back?
IF YOU were to draw the path of inflation in the typical big, rich economy over the past half century, your picture would look much like a dromedary's back: a low flat line in the 1960s; a knobbly hump of high and volatile price rises in the 1970s; dramatic disinflation in the 1980s; and low, stable inflation rates since. Japan and Germany, which were quicker to quell inflation, are well-known exceptions. But for the rest, the shape and timing of the Great Inflation bulge look remarkably similar.
This is a bulge that today's central bankers are anxious not to repeat. So it is no surprise that several governors from America's Federal Reserve are attending a conference on March 9th to discuss a new report* on the Great Inflation, written by a weighty group of macroeconomists from academia and Wall Street.
Most scholars agree on a basic explanation of the hump, placing both blame and credit squarely on central bankers. Consumer prices accelerated in the late 1960s because monetary policy was too loose. German and Japanese central bankers realised this earlier than others and tightened policy accordingly. Eventually others followed suit, and general disinflation began in the early 1980s. Since then inflation has stayed under control because central bankers are credibly committed to price stability and far better at their job.
Beyond that broad tale lie several debates about important details. Economists differ on how much non-monetary phenomena, such as closer trade integration, affect the inflation process. They also offer competing explanations for why central bankers botched things so badly a generation ago. One possibility is that they simply got the numbers wrong, consistently overestimating their economies' speed limits. Others blame theoretical misjudgments, particularly the belief that higher inflation could buy a lasting drop in unemployment. A third approach emphasises political pressure. Inflation got out of hand because central banks were under the thumb of politicians who preferred rising prices to higher joblessness.
In this latest report the authors subject such controversies to painstaking cross-country forensics. They show that price stability across the G7 countries has been far more closely correlated than economic stability. Almost everywhere, inflation took off between 1969 and 1970. And every country, except Germany and Japan, failed to tame it until the mid-1980s. Output, however, was less tightly synchronised. Although recessions in many countries have become less wrenching in recent decades, output volatility began to ease in the mid-1980s in America, but not until the early 1990s in Britain, Canada and France.
What to make of these differences? The Great Inflation, because it was felt simultaneously across countries, must have had a common cause. This cannot have been the 1970s oil shocks, because consumer prices started accelerating long before the price of crude did. Easy money is the only remaining suspect. And although the Great Disinflation was also simultaneous across many countries, GDP growth settled down at very different times. This implies that better monetary policy cannot take full credit for today's less painful recessions.
The statistical magnifying glass also casts doubt on some favourite alibis for monetary misrule. Bad data, for example, do not get central bankers off the hook: revisions to statistics on trend growth and unemployment were not big enough to excuse the scale of inflation. Instead, monetary policy was simply too loose. The authors show that the central bankers of the 1970s failed to adhere to the modern “Taylor rule”, a formula that links the appropriate level of short-term interest rates to the deviation of output from its trend and inflation from its target. Of course John Taylor, a Stanford economist, did not formalise his rule until 1993. But even without this guide, central banks should not have flunked the basic tenets of sound money.
Hawks v camels
Neither the Taylor rule, inflation targets nor any other bits of the modern central bankers' toolkit were necessary to end high inflation. But the scholars think these tools have helped to keep inflation down, which, in turn, has spawned a virtuous circle. When inflation is low and stable, a temporary uptick in consumer prices has far less impact on long-term price trends. The economists' model implies that less than 1% of a temporary price surge is translated into a permanent rise in inflation today, compared with 60% three decades ago.
That may give today's policymakers more leeway than their predecessors enjoyed. But since this wiggle-room is the legacy of low inflation volatility, it cannot be taken for granted. Were central bankers to lose their guard, inflation could soon resurge.
More worrying, the economists pour cold water on many a policymaker's favourite gauge of his own performance, namely the public's expectations of future inflation. Central bankers often cite low inflation expectations as evidence that monetary policy is appropriate. That may be a mistake. This paper argues that expectations were a good guide to future price pressure only when inflation was high. But now, if anything, inflation expectations are a backward-looking indicator, lagging measures of actual inflation.
All told, this statistical sleuthing suggests today's central bankers have little room for complacency. Inflation remains low and stable because policymakers are vigilant, not because any deep, structural changes insulate the modern economy from price pressure. If central bankers relax, higher, more volatile inflation could easily return. Rudyard Kipling's camel, remember, got its hump for being “most 'scrutiatingly idle”.
"Understanding the Evolving Inflation Process" by Stephen Cecchetti, Peter Hooper, Bruce Kasman, Kermit Schoenholtz and Mark Watson
Fed Governor Mishkin, "Inflation Dynamics"
Tuesday, March 27, 2007
The Economist - What's it all about, alpha?
What's it all about, alpha?
Mar 22nd 2007
Demystifying fund managers' returns
TOO many notes. That's what Emperor Joseph II famously said to Mozart on seeing his opera “The Marriage of Figaro”. But surely to think of a musical work as just a series of notes is to miss the magic.
Could the same be said about fund management? It is the fashion these days to separate beta (the systematic return delivered by the market) from alpha (the manager's skill). Investors are happy to pay high fees for the skill, but regard the market return as a commodity. Distinguishing the two is, however, difficult.
A fund manager might beat the market because of luck or recklessness, rather than skill, for example. Suppose he packed his portfolio with oil stocks. When the crude price rises that would pay off, but it would be a pretty risky portfolio. More generally, alpha sceptics often attribute eye-catching returns to “style bias”, such as favouring stocks with a high dividend yield.
But should they be biased against style bias? After all, the only portfolio utterly free of bias would be one that included the entire market. Were a Britain portfolio to exclude just one stock, such as BP, it would have a small-cap bias, a sector bias and a currency bias (most of BP's revenue is in dollars). Hence any excess return must stem from some element of style.
Academics have entered this debate, trying to pin down the factors that drive a fund's performance. These might include the difference in returns between small-cap and large-cap stocks (fund managers tend to favour the former) or the level of credit spreads and so on. Bill Fung and Narayan Naik of London Business School have come up with a seven-factor model which, they say, can explain the bulk of hedge-fund performance. After allowing for these factors, the average fund of hedge funds has not produced any alpha in the past decade, except during the dotcom bubble.
This approach suggests the whole idea of alpha might be an illusion. Academics can explain most of it, and the only reason they cannot explain all of it is because they are not clever enough to think of the missing factors.
However, it is also possible to take the opposite tack. This type of analysis gives managers no credit for choosing the systematic factors—the betas—that drive their portfolios. Yes, these betas could often have been bought for very low fees. But would an investor have been able to put them together in the right combination?
It is as if a diner in Gordon Ramsay's restaurants were brave enough to tell the irascible chef: “This meal was delicious. But chemical analysis shows it is 65% chicken, 20% carrot, 10% flour and 5% milk. I could have bought those ingredients for £1.50. Why should I pay £20?” The chef's reply, shorn of its expletives, might be: “The secret is in the mixing.”
This debate matters because people are now trying to replicate the performance of hedge funds with cloned portfolios. Indeed Messrs Fung and Naik have shown that their model would have produced an annual return over the past four years of 11.6%, well ahead of the average fund of hedge funds. Their performance was purely theoretical. But Goldman Sachs and Merrill Lynch have launched cloned hedge funds on the market.
There are two potential criticisms of the cloned approach. One is that it will simply reproduce all the systematic returns that hedge funds generate and none of their idiosyncratic magic. However, this “magic” is hard to pin down. Even if it does exist, Messrs Fung and Naik suggest it may be worth no more than the fees hedge funds charge, so the managers are the only ones to benefit from their skills.
The second criticism is that the clones will always be a step behind the smart money. You cannot clone a hedge fund until you know where it has been. But by then it may have moved on. As a result, the clones may pile into assets that the hedge funds are selling, making the classic mistake of buying at the top. This may not be a fatal flaw, however. It is possible to imagine some clones taking contrary bets, buying the betas that seem temporarily out of favour, in the hope that they will be purchasing what the hedge funds are about to buy.
There are some nice ironies at work here. Hedge-fund managers often rely on secretive “black box” models: the investor puts his money in at one end and sees the returns spat out at the other, but no more than that. Now, armed with just that information, academics are coming up with their own models, which almost match the hedge funds' performance.
Mozart might have sympathised. His operas were more than the sum of his notes. But even if the great composer had no peers, he has had plenty of imitators.
Mar 22nd 2007
Demystifying fund managers' returns
TOO many notes. That's what Emperor Joseph II famously said to Mozart on seeing his opera “The Marriage of Figaro”. But surely to think of a musical work as just a series of notes is to miss the magic.
Could the same be said about fund management? It is the fashion these days to separate beta (the systematic return delivered by the market) from alpha (the manager's skill). Investors are happy to pay high fees for the skill, but regard the market return as a commodity. Distinguishing the two is, however, difficult.
A fund manager might beat the market because of luck or recklessness, rather than skill, for example. Suppose he packed his portfolio with oil stocks. When the crude price rises that would pay off, but it would be a pretty risky portfolio. More generally, alpha sceptics often attribute eye-catching returns to “style bias”, such as favouring stocks with a high dividend yield.
But should they be biased against style bias? After all, the only portfolio utterly free of bias would be one that included the entire market. Were a Britain portfolio to exclude just one stock, such as BP, it would have a small-cap bias, a sector bias and a currency bias (most of BP's revenue is in dollars). Hence any excess return must stem from some element of style.
Academics have entered this debate, trying to pin down the factors that drive a fund's performance. These might include the difference in returns between small-cap and large-cap stocks (fund managers tend to favour the former) or the level of credit spreads and so on. Bill Fung and Narayan Naik of London Business School have come up with a seven-factor model which, they say, can explain the bulk of hedge-fund performance. After allowing for these factors, the average fund of hedge funds has not produced any alpha in the past decade, except during the dotcom bubble.
This approach suggests the whole idea of alpha might be an illusion. Academics can explain most of it, and the only reason they cannot explain all of it is because they are not clever enough to think of the missing factors.
However, it is also possible to take the opposite tack. This type of analysis gives managers no credit for choosing the systematic factors—the betas—that drive their portfolios. Yes, these betas could often have been bought for very low fees. But would an investor have been able to put them together in the right combination?
It is as if a diner in Gordon Ramsay's restaurants were brave enough to tell the irascible chef: “This meal was delicious. But chemical analysis shows it is 65% chicken, 20% carrot, 10% flour and 5% milk. I could have bought those ingredients for £1.50. Why should I pay £20?” The chef's reply, shorn of its expletives, might be: “The secret is in the mixing.”
This debate matters because people are now trying to replicate the performance of hedge funds with cloned portfolios. Indeed Messrs Fung and Naik have shown that their model would have produced an annual return over the past four years of 11.6%, well ahead of the average fund of hedge funds. Their performance was purely theoretical. But Goldman Sachs and Merrill Lynch have launched cloned hedge funds on the market.
There are two potential criticisms of the cloned approach. One is that it will simply reproduce all the systematic returns that hedge funds generate and none of their idiosyncratic magic. However, this “magic” is hard to pin down. Even if it does exist, Messrs Fung and Naik suggest it may be worth no more than the fees hedge funds charge, so the managers are the only ones to benefit from their skills.
The second criticism is that the clones will always be a step behind the smart money. You cannot clone a hedge fund until you know where it has been. But by then it may have moved on. As a result, the clones may pile into assets that the hedge funds are selling, making the classic mistake of buying at the top. This may not be a fatal flaw, however. It is possible to imagine some clones taking contrary bets, buying the betas that seem temporarily out of favour, in the hope that they will be purchasing what the hedge funds are about to buy.
There are some nice ironies at work here. Hedge-fund managers often rely on secretive “black box” models: the investor puts his money in at one end and sees the returns spat out at the other, but no more than that. Now, armed with just that information, academics are coming up with their own models, which almost match the hedge funds' performance.
Mozart might have sympathised. His operas were more than the sum of his notes. But even if the great composer had no peers, he has had plenty of imitators.
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