Burden of information: The performance of fund managers depends on how data is analysed and processed

A growing problem is that governments all over the world are interfering with markets as never before and these interventions distort the price signals, information and create bubbles

One of my readers was kind enough to ask a question as to why expert fund managers with an active team of analysts and traders underperformed their inactive benchmarks. The simple answer is information; how information is analysed and processed.

There is a growing problem with the global economy. Governments all over the world are interfering with the markets as never before. Normally, markets can correct by themselves as the equilibriums assert themselves and the markets return to their means. But government interventions distort the price signals, information and create bubbles. A good example is Brazil.

Brazil's macroeconomic management has been quite good over the past decade. It has been rewarded by an economy that is growing; but actions by Brazil itself, the US Federal Reserve and China have all combined to create a credit bubble. In Brazil, like China, the state-owned banks have increased lending to help Brazil avoid the recession. Banco do Brazil is the country's biggest financial firm, with a fifth of total assets, and National Bank for Economic and Social Development (BNDES) accounts for 40% of the lending. This amount of credit might have been beneficial, but the result of the Federal Reserve's quantitative easing allowed for a massive carry trade and foreign direct investment grew 90%.

The flood of money created a credit boom. Credit has grown enormously and is now as large as 45% of the economy. Brazilians have therefore been able to borrow money, many for the first time, to buy homes, motorcycles, refrigerators and other consumer goods. They now spend up to 20% of their income on debt. The torrent of money has also pushed up the value of the real.

But the Federal Reserve is not the only government involved. The Chinese have been pumping up their economy with a vast quantity of bank loans. The combination of speculation with free money and Chinese demand has created a spike in commodities. But since the Chinese have held their currency down, Brazil is now inundated with cheap Chinese goods that are harming its manufacturing sector.

The creation, length and effects of these different government policies are anyone's guess. Financial journals, magazines and television programmes are filled with pundits trying to predict government action. The analysts, traders and managers might be right about one government and make their investments based on that prediction. But the combination of erratic actions with variable interactions throughout the global economy means the probabilities of getting it right decline.

It is not just that governments interfere with the markets. Many are quite opaque about what they are doing. State-owned firms and sovereign wealth funds are equally silent as to their intentions. Disclosure is not required and in many emerging market, information is actively suppressed. This results in an ever-widening information gap.

Managers, traders, and analysts make this problem worse by assuming that the terabytes of information that assault them on an hourly basis have a basis in truth. Often they are anything but accurate, complete and timely. They are also making assumptions about the causes and motivations. Governments are supposed to act in the best interests of their citizens. Corporations are supposed to be making profits. More often governments are acting in the best interests of the party, and politicians in charge and state-owned firms are actively supporting political goals at the taxpayer's expense.

It is not only that the information and basic assumptions that are bad. The expert money managers compound the problem by putting their faith in numbers, equations and algorithms. The world is a dynamic place. If these formulas ever had a basis in reality, that basis may have changed drastically. Mathematical models in science can be an accurate approximation of reality if the data used to construct them is accurate. But scientific instruments used to collect the data do not intentionally lie for economic gain. People do. For example, Axa Rosenberg Group, a quantitative investment firm paid $242 million to settle allegations relating to an error in its computer model that lost millions. The error was introduced in the system in 2007, but the company's management only learned about it two years later, in 2009, and then took another year to tell people about it.

Managers are like everyone else, subject to cognitive biases. They are often very smart and exceptionally well paid. So they feel that they are right when they follow a herd, interpret information that confirms their beliefs, anchor their opinions on a few assumptions, underestimate their own biases, discount contrary information and remember their choices as better than they actually were.

As John Maynard Keynes pointed out, "The difficulty lies not so much in developing new ideas as in escaping from old ones." When expert managers understand themselves and their world better, they might do a better job hitting their benchmarks, but that might be too much to ask.  

(The writer is president of Emerging Market Strategies and can be contacted at [email protected]  or [email protected].)


Case slapped on Dr Reddy’s over fire deaths at Bollaram unit

Two persons were charred to death in a fire that broke out in the material-handling lift area in G Block of the unit’s API manufacturing facility at DRL’s Bollaram plant on 17th March

Hyderabad: The Directorate of Factories, Andhra Pradesh, has filed a second case against pharma major Dr Reddy’s Laboratories (DRL) over alleged safety-related lapses at its USFDA-certified manufacturing facility at Bollaram in Medak district, reports PTI.

Two persons were charred to death in a fire at DRL’s Bollaram plant on 17th March. The fire broke out in the material-handling lift area in G Block of the unit’s API manufacturing facility at around 10pm.

The deceased, K Govind Rao (34) and D Keshava (24), both casual workers, were carrying materials in the lift when electrical sparks led to the fire, which spread rapidly, according to the police.

According to the Director of Factories, G Bala Kishore, the department filed a case in connection with the incident in a magistrate’s court in Medak under the Factories Act, accusing the company of using unskilled workers for skilled jobs.

“We have filed cases under Sections 7 A (1) and 41 of Factories Act, 1948, and AP Factories Rules, 1950,” Mr Bala Kishore told PTI.

The sections pertain to employment of unskilled contract workers for core activities and for handling of hazardous materials without proper supervision.

Earlier, in March, authorities had filed a case against the company when two employees were killed due to excess inhalation of nitrogen in another USFDA-approved plant in the area last December.

A police official said the investigation into the fire incident would be complete soon.

“Preliminary investigation reveals that some static electricity might have developed and it caused a fire,” the official said.

The police had registered a case under Section 304 A (causing death by negligence) against the DRL management in this regard.

The company’s stock was trading at Rs1,582, up 0.23% from its previous close on the Bombay Stock Exchange in noon trade today.


July, not June rains matter for crop production

The IMD's long range forecast for the 2011 south-west monsoon season is that the rainfall for the country as a whole is most likely to be Normal (96-104% of Long Period Average)

The Indian monsoon season (June to September) has started on a positive note. For the week ending 1st June, all-India rains were 12% above normal. However, it is July, not the June rains, that matter for the agriculture sector, which accounts for 14.4% of gross domestic product (GDP), and is heavily dependent on monsoon rains, according to a report by Nomura Global Economics.

The correlation between annual food output growth and the monthly rainfall deviation is the highest for July at 0.83. This is because sowing of a number of crops starts in June and good July rains determine the soil moisture and ensure proper development of the crops planted in June. Therefore, it is too early to conclude on the crop prospects for this year, Nomura adds.

However, the Commonwealth Bureau of Meteorology's Southern Oscillation Index (SOI) fell from a record-high of 27.1 last December to 2.1 in May, suggesting that the strong La Nina conditions (that led to a massive flooding in Australia) are ending and that weather conditions are now neutral. This should augur well for the Indian monsoons.

The India Meteorological Department (IMD) on Friday said that the monsoon has further advanced over some more parts of the central Arabian Sea, Karnataka, Andhra Pradesh and the Bay of Bengal and entire Goa.

The IMD's long range forecast for the 2011 south-west monsoon season is that the rainfall for the country as a whole is most likely to be Normal (96-104% of Long Period AverageLPA).

Quantitatively, monsoon season rainfall is likely to be 98% of the LPA with a model error of ± 5%. The LPA of the season rainfall over the country as a whole for the period 1951-2000 is 89 cm.


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