This Is the End


Markets, Risk and Human Interaction

March 17, 2019

Fives Steps Toward Fairness in College Admissions

March 17, 2019
The recent scandal has brought a spotlight on the long-term issues of unfair college admissions,. Once you get past the outright criminality of this incident, there remains the backdoor of unfair practices that are just a step or two less flagrant and unjust. Here are five steps that can reduce the clear biases and gaming that are at the disposal of the wealthy.

None of these are new or surprising. I am writing about them here for two reasons.  First, you might find that I give a different spin to some. Second, adding my voice to this issue is like voting in an election.  It is one more hand raised saying that what is done now for college admissions is unfair and must be fixed.

The first two can be enacted immediately, it is only a matter of the colleges having some moral backbone. I venture these two alone will reduce the bias for the wealthy and connected by three quarters or more:

Eliminate donor advantages. A general precept of charitable donations is that there is not a monetary quid pro quo. Indeed, if there is, the contribution is not tax deductible. In college admissions there is a monetary benefit, because a degree from a prestigious university increases earning power and status. And this monetary value extends beyond the student being ushered in through the back door. It remains for generations due to legacy admissions. Let charitable contributions stop at the same place they do for other institutions, with the prestige of having your name on the building or the endowed chair.

Eliminate legacy admissions.  Legacy admissions are the feedstock for the donor advantage. They are intended to feed these donations. Alumni are the primary source of donations to the university, and are cultivated by the understanding that if you are an alum your children will have a higher chance of being admitted. A higher chance that of course is increased by making donations to the school. The legacy advantage is the same as the donor advantage heightened by having attended the school yourself.

The next three are directly related to the admission process. They already are part of some university admissions policies, although they make the work of the admissions office more difficult.

Eliminate gaming of extracurriculars. No more credit for building houses in Kenya, or for handing out food at homeless shelters. If a high school students wants to do these actives, more power to them. Just don't tell the admissions office, because they won't care.

These activities are the province of the wealthy because they often have a price of admission, either monetary or through connections. They also are not available to those who actually have to work during the summer. The summer before my junior year in high school was spent as a bus boy at the local Sizzler, before my senior at a steel working company making playground equipment. Trips to less developed countries or internships at non-profits were simply not part of the vocabulary.

Get rid of standardized tests. If having a $250 an hour test prep tutor or spending money on test prep summer programs were simply a matter of help in putting in extra time studying, that would be one thing. But these programs, while not going to the point of giving the student the test ahead of time, are one step removed from that because they are run by people who are familiar with the tests, the types of questions, and can give templates for the problems the student will face. The numbers might be different come test day, but the problem will be the same.

You don't get this peek at a Princeton Review course or with a How to Take the SAT book. You get it for $250 an hour with a private tutor.

Some schools already do not require the standardized tests, but don't expect much action on it anytime soon. Life will be harder for an admissions officer if this quick and easy yardstick is gone.

Make admissions ethnicity-blind. A hispanic from a middle class family should not have an advantage over a white kid from a middle class family. An African-American from a poor family should not have an advantage over a white kid from a poor family. An Asian kid should not be at a disadvantage because they are as a group more successful at jumping through the  current college entrance hoops.

July 5, 2018

How to Rescue the Boys in the Cave

July 05, 2018
Note: This idea became championed by Elon Musk. I wrote this before his work became public. 

Here is a solution for getting the Thai soccer team out of the underwater cave:

Fashion a watertight, flexible cylinder that a boy can lie in prone. It needs to be flexible so that it can be worked around tight curves in the cave. Have an oxygen supply either internally, or fed through an air tube from an external tank. The cylinder can be hooked onto the existing line that leads to the cave, and is carried along by the divers. The boy will be cocooned inside the cylinder, and will not need to do anything. He will be brought out the same way supplies are currently brought in.

May 17, 2018

The Hidden Risk of Passive and Index Hugging

May 17, 2018
What is wrong with passive investing and index hugging?  One problem is that these strategies often use ETFs. I wrote about the potential for ETF meltdown last October, with a follow-up shortly thereafter, so I won't belabor that here.  Another problem is that most passive portfolios follow a cap-weighted index. Recently I also wrote about the risk from this. So I won't repeat that here, either. What I will do is add another risk that comes from the passive and index-hugging approach to portfolio management, the resulting lack of diversity in investment strategies and outlook.

The need for diversity is fresh on my mind because last week I was fortunate to share the stage with two academic luminaries, Andrew Lo, a finance professor at MIT , and Simon Levin, a professor of ecology and evolutionary biology at Princeton, at an event jointly sponsored by the BCG Henderson Institute and the Institute for New Economic Thinking. It took place at BCG's new office at Hudson Yards on New York's West Side, a place where shiny office buildings are popping up like sunflowers.

Andrew and Simon co-authored a paper arguing that financial regulation can learn from the regulation of biological systems. Andrew also has a recent book Adaptive Markets with arguments closely related to the same topic, that financial systems can be viewed as adapting to the changing, dynamic work in ways analogous to biological entities.

The essence of a biological system is that it is dynamic and complex, with the agents of that system facing unexpected changes in their environment. One way they meet the challenges of their dynamic world is to adapt through evolutionary changes. But in the biological realm evolution takes time, whereas the changes to their environment can be sudden. The more immediate survival mechanism in the biological realm is diversity, both across species and within any given species.

Diversity is the immediate result of sexual reproduction. There is a mixing of genetic traits, so each offspring is a little different. Which means many offspring are less than ideal for the current environment. In contrast, with asexual reproduction you get carbon copies of the parent, absent the occasional mutation. If the world keeps on going the same way and if the survivor in the assexual world is among the fittest for that world, then its offspring will be equally fit. The diversity in outcome from the sexual species will just add noise and inefficiencies in terms of survival.

The reason the world has largely moved to sexual reproduction is that things do not stay the same. Because the asexual species are all genetically identical, if things move the wrong way they all die off. But because there is diversity within any sexual species, there is a chance that some will have the characteristics to survive in the new system. Maybe those will not be the ones that are the best in the current system, and maybe they won't be the best in the new one, but they will be good enough in both.

Passive investing is the financial equivalent of an asexual ecology. That is, being asexual means it is not diverse. (And being asexual also means that passive investing, as many portfolio managers can attest, is not a lot of fun.)

The risk, then, is that with us all crowding into the same passive investments we will not have the diversity to adapt if something bad comes along.  But it is actually worse than that.  Being all the same might actually create the bad thing that comes along.  Because we don't just live in the ecology, we create it, and we create many of its shocks.  If things start going in the wrong direction, the effect of all of the passive investors moving in the same way, and the lack of deep-pocketed investors ready to take alternative tacks, will itself create the dynamic cascade.

By the way, this is a problem that is not restricted to passive investing, or even to finance.  I have written about the asexual capitalist, and how the same problem of a lack of diversity inflicts the capitalist system broadly.

April 9, 2018

Passive Aggressive Investing and FAANG

April 09, 2018
Matterhorn Disaster by Doré
You are in a buy-and-hold, passive investment. So, you will make market returns.

Not quite: With the markets, doing nothing doesn't mean you're not doing something. Because while you are sitting on your hands, things are happening around you, and your investment portfolio is changing. The reason is that you are in an index that is market capitalization weighted. The bigger the company, the more of it you are holding. This means you are going to hold more in industries and sectors that by nature have big companies. So more in big banks and insurance companies than in specialty retailers and restaurant chains. And, more important for the point I am focused on in this post, increasingly more in companies that are doing well, that is, companies that have rising market capitalization. And on the flip side, you are effectively selling off stocks that are not doing so well.

If Apple is worth five times as much as XYZ, then you hold five times as much in Apple as in XYZ. And if Apple moves up to be worth ten times as much, you hold ten times as much.  This is what will happen with what appears to be a buy-and-hold, passive, do nothing portfolio.

This is a big concern now because of the run-up in the FAANG (Facebook, Apple, Amazon, Netflix, Google) and related stocks. They have taken a large share of market capitalization as they have risen in value, and there is a momentum dynamic to be unleashed if they start to drop. This has happened time and again when cap weighting has led to extremes in the share of total market capitalization claimed by a popular sector. Consumer discretionary grew to 22% of the index in 1972; Oil 30% in 1980; TMT 34% in 2000; Banking 23% in 2007. In each case it finally got out of hand and dropped back to its earlier level and dropped the market as well. The odds are it will happen with FAANG.

Of course, the market cap does not rise by magic.  Each time investors find a reason for the sector to be gobbling up the market.  With TMT it was that the old methods like P/E were no longer relevant.  So I don't get much comfort in the justifications for the domination this time around of the FAANG and related stock.

This is bad, for both you and for the market generally. First off, you get more and more concentrated. Which means less and less diversified. Secondly, it is bad for the markets because you might be doing nothing, but the effect is to pile on.  If someone comes into the market, they are really stocking up on Apple, so, guess what. Apple really goes up.

What is particularly problematic is that when you are in cap weighted passive, you have a factor bet without realizing it. Because you are following a cap-weighted index, because you are measuring yourself against that index, the factor bet looks like "no harm done." It looks like you are simply moving with the market, the end objective of a passive position.

An alternative that has taken hold is to hold stocks based on some other factor than market cap. The problem is that any rule that is based on some factor is going to have the problem that you are still making a bet. What you want to hold is a portfolio where you can pick any factor -- P/E, capitalization, momentum, any "smart beta" factor of your choosing -- and fail to find any relationship between that and your portfolio return.

April 1, 2018

Facebook and the Awakening of Our Private Selves

April 01, 2018
I wrote about Facebook in a blog in January, pointing to ominous clouds on the horizon. (And, one looking at the future of Facebook and the world in 2011.)

For an update. Those clouds now are overhead. With the ever-growing realization that Facebook has been a channel for manipulating our life-as-we-know-it (literally so), there is the drumbeat of #deletefacebook (which I joined last week). And with this are articles showing how difficult it actually can be, which bring to the fore just how deeply Facebook has plunged itself into our being.

There are how-to guides to find alternative to Facebook. There is the recounting of the times Zuckerberg has skirted over the line on privacy, each followed by the ritualistic apology. And there is Colbert's acerbic humor on "Suckerberg", which includes screen shots showing the mind-blowing amount of information Facebook holds on various staff members of his show -- including call's made from one staffer's cellphone, the family tree of another,  and the data for the face-recognition of a third.

Many people will leave Facebook and use alternatives. Some will discover they can leave without using social network alternatives at all. People who stay with Facebook will opt out of everything they can think of, especially related to sharing their personal information with advertisers and apps. (As part of the mea culpa this time around, Facebook is centralizing the privacy settings so you don't have to navigate through twenty different places to do the job.) People will log into apps using their email addresses rather than Facebook, thwarting the insidious tunneling by Facebook beyond its own borders.

Whether people leave or decide to stay with tighter privacy controls, the targeted advertising and third-party sharing that is the life blood of Facebook will be eroded.

Beyond these short-term, but possibly devastating reactions that are focused on Facebook, it is becoming all the more likely that we are at the beginning of a broad sea change in how we view social networking and in our willingness to give up privacy for a song. Jaron Lanier pointed out the faustian bargain we have made with Facebook, Google (which at least gives us something of value in the search engine) and the like, and proposed a path for us to be enfranchised for the personal data we toss into the world.

There is an alternative to the business model of mining personal data, which is having Facebook and others move to a subscription model. But this will not sustain the valuations Facebook currently enjoys. People are not likely to pay out of pocket anywhere near the value that is implied by giving the world all of their personal data. Which suggests just how much we all are giving away.

February 11, 2018

Amazon Dystopia

February 11, 2018
The following is a brief, contemporary account of our world, which we call, for obvious reasons, the Amazon Dystopia. I leave it undated -- Nadir.

The dystopia is most evident in the control of the working class. During work and commuting time all workers are mandated to wear a “health watch”, a wristband that monitors their movement. The wristbands also tell the time and weather. Workers also wear “world view” collars and glasses equipped with biometrics and a 360 degree video display to determine the level of their exertion, and where they are fixing their gaze. The collars can generate electric impulses to encourage workers. If they fail to perform, there is summary dismissal. The government has recently added a worker-terminating explosive charge if workers are found engaging in treasonous behavior – which includes “robust criticism or a marked lack of enthusiasm.”

Cocking and the Rise of the Plutocrats

The elections are determined by majority vote, but the people’s choice becomes the tool of the wealthy once ascending to office. This transformation is known as “cocking”. This is an unfortunate play on the Koch name, but one that is not classified as robust criticism.

Cocking was first revealed in the Washington Post, which reported that the Koch brothers, a center of corporate political power, presented various incumbents with a check made out to their opponent for $25 million, with the threat that the check would be handed over to the opposition if the incumbent did not act in what the Koch brothers considered to be the best interests of the country. The threat only had to be made good one time, and the story planted for the Washington Post team to uncover, (with a Pulitzer for their efforts), before compliance to the threat became absolute.

The Consolidation of Power: From the One Percent to the One
The cocking grew, and political power became increasingly consolidated with those with the deepest pockets, until it finally has become a plutocracy of one. And having power over the press has helped to correctly frame the new order for the masses. At least the small subset of the masses that is not placated by free, unlimited streaming of videos and music.

From Each According to His Need

A value-added tax is now a primary source of revenue. Essentials such as food, clothing, and school supplies pass through a taxation station, the “fulfillment center”. Its operation is based on extensive records of every citizen, both their biometrics, gazing patterns, queries, social interactions, and of course consumption history, to infer their preferences, to the end of taxing them more highly on their purchases based on the algorithmic determination of how much they need them. This principle is promoted with the slogan, “from each according to his need.” All purchases are made with the certification of the buyer that they will not resell or redistribute, with the delivery chain iron clad from the fulfillment center to the consumer's doorstep to reduce the risk of missteps.

Luxury goods by definition are not needed, and therefore generally are exempt from taxation.

To Each According to His Abilities

The tax is paid to the agency that is responsible for the building and maintaining of this distribution system. This payment is tax exempt, because it already is a tax. The agency is in private hands because the government has determined to leave to business those things that it can do best, as measured by the profit they can extract. Thus the slogan, “to each according to his abilities.” As has been noted in various recent Washington Post articles, this is the most sure way of adding to the economy, and thus to the wealth of all individuals.

The Revolt of the Masses

Note by the conveyor of this account: As with any dystopia there is a plucky, fearless group that is fighting back. Led by Kadir and his former-rival-but-now-lover Sabella, a beautiful woman who is good with knives, this group is bringing in others to fight against the tyranny of the plutocracy.

Note by the second conveyor of this account: They are discovered and killed. The end.

February 6, 2018

Not Wages. Not Inflation. Volatility. ETFs.

February 06, 2018
The recent tumble in the market is being attributed to the wage report, a rise in interest rates, and concern about inflation. A reassessment of economic conditions does not lead to such a violent reaction. It might give a push, but then gravity does the rest. For the markets, gravity is the technicals -- how leveraged or overextended investors are, how concentrated, and how much liquidity there is in the face of a flood of selling.

This is just a quick recap of a couple of posts I have done over the past months that relate to technicals behind the current market downturn. In early November I wrote a post about how the low volatility regime we have enjoyed (if that is the right term) could blow up. We have seen the first leg of that with the decimation of the inverse volatility ETFs and ETNs. They have actually printed negative prices. What was worth $2 billion a day ago was worth $20 million in after-hours trading, and depending on how they terminate, could become zero.

The VIX went from the lowest level in history to near the highest. The next shoe that might drop will be the actual market volatility. If actual volatility rises, there will be a rash of funds that target a specified volatility that will have to sell positions -- mostly equities. If a fund is targeting, say, 12% volatility and market volatility goes from 12% to 24%, the fund will need to go from fully invested to 50% invested.

Looking at an extreme tail risk, the total failure of the inverse volatility ETF might cause ripples across ETFs more broadly. Some investors, I would think mostly retail investors, might simply hear that an ETF went to zero in one day, and think that is a concern for other ETFs. If they start to liquidate on that basis, it could lead to widespread contagion. I posit this in a post from October, though with high yield ETFs as the spark.

The cascade due to volatility and the contagion from ETFs might occur, or might not. If they do, it will be a slower process than what we have observed over the past few days. And things do not follow a straight line. There will be "bargain hunting" along the way. But depending on how that plays out, it might be piling more investors onto the thinning ice.

January 28, 2018

This is the Way Facebook Ends (And Maybe Apple and Google)

January 28, 2018
Investors tend to focus on the most likely outcome. As a risk manager, I spend time focusing on the unlikely, on the bad things that might possibly happen. Where T.S. Eliot writes, "This is the way the world ends, Not with a bang but a whimper" I would write, "This is one possible way the world might end...."

So, with that as the starting point, how might the world end for Facebook? And, by extension, for Apple and Google, because Google faces similar, but not so dire, business risk, and because much of Apple's raison d'ĂȘtre is to provide the hardware for Facebook and related applications.

Regulatory Backlash

As a start, there is a crescendo of regulatory backlash to the power that Facebook and Google wield. It is most manifest in recent action in Europe, and has been given some headline coverage from a speech a few days ago by George Soros at the World Economic Forum. If you want a sense of where he is coming from, the Washington Post headlined it as "Facebook and Google are doomed, George Soros says."

The current controversy on net neutrality applies to Google and Facebook. One concern is that without net neutrality there will be a stifling of the small start-ups, and increased power for the larger players. Point the rifle three clicks to the left from the net neutrality debate, and you have them in the line of fire.

A Self-destructive Business Model

Facebook and Google have a business model that is at war with itself. On the one hand they link like-minded people together, so they can share their views, interests, and product suggestions. On the other hand, they depend on advertisers for their revenue. But if their business model is perfected in the first case, there is no need for the second. People will know what they want without the advertisers that are outside their social circle chiming in.

Social Norms

Obviously a social network like Facebook or Instagram only works if people want to share on the social network. And the bulk of those who do so are acutely sensitive to the cool thing to do. If it becomes uncool, that is the end of that. Put another way, the fever pitch of social media is of the same flavor as any fad. It has no purpose other than being the thing of the moment. For social media, that moment might last another two years or another ten. But at some point there is the risk people will find it so last year, or so "what my parents used to do."

As a measure of it being a fad, what other $500 billion company could disappear from the face of the earth tomorrow and have no real impact -- except on advertisers?

And there are signs of change. When Cook states that he wouldn't want his nephew on social media, that is not a good sign. Closer to home, a month ago my fourteen year old daughter decided to get off of social media.

A recent meme is social media as cigarettes. Think of cigarettes in the Mad Men era. People were addicted, but also it was part of being social, and it was the way you kept yourself busy. If you weren't holding a cigarette, what were you going to do with your hands? Social media is addictive, social, and keeps you feeling like you are doing something with your hands.

How Does Apple Fit into the Mix?

The iPhone is the hardware that runs the fad. Take away the need for social media functionality, and there is no reason to move beyond the power of, say, the iPhone 6. Maybe you disagree with that, but by the time you get to the iPhone X I think you are at a bridge beyond. Once you deal with the battery issues and avoid dropping it, (or drop it and pay $100 to get the screen repaired), a smart phone lasts forever, and has the power you need if you are not lighting up social media. Put another way, think about how frequently you upgrade your iMac.

The Darkening of Silicon Valley

One thing that can help push social norms away from Facebook is a reframing of the Silicon Valley sphere away from the cool end of the dial and toward the menacing. The sea change that is putting Silicon Valley companies in the sights of regulators is also washing away the veneer. Soros wasn't the only one bashing the fruits of Silicon Valley. There was a litany of others along with Soros from the World Economic Forum. Undeniably, Silicon Valley is exciting, filled with great minds, and is the go-to destination for college kids. I know the feeling; that was the investment banks of the 1980's. And look where that ended up.

Case in point, there is the growing realization that Facebook is not simply a fun app, and the work of those brilliant Silicon Valley engineers is not just creating a global sand box where we can play. In the wrong hands it in can subvert a political system with more efficiency than a rioting mob. It already has. That has got to move the dial a bit in terms of perceptions.

Note: I did a post on Facebook back in 2011 that has similar sentiments, but with a more philosophical flair.