Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 48

The F words: an irregular, irritating series of dictionary narratives

F stands for …*   

Financial system, that is already far too large and powerful. Former US president Eisenhower’s prescient warning about the rise of the Military/Industrial Complex would today be about the danger of the Military/Financial Complex instead. Finance has become too important to be left to financiers. Countries need financial systems that provide savings, credit, insurance and pensions, but limited and controlled lest other nations end up like Britain – a rentier society producing few real goods and services and where talent is sucked into unproductive finance. The UK politician Peter Mandelson rightly recognised that “we need fewer financial engineers and more real engineers.”

Free markets, of which there are none and should be none. Adam Smith’s hallowed name is called on to justify so-called free markets, yet he well understood that if left to their own devices, markets will ineluctably result in collusion and corruption. Markets are, as the US finance writer Richard Bookstaber argues, a “demon of our own design” and we must learn to manage and control them lest they distort society even further.

Fines, more of which should have been levied on Wall Street’s denizens, along with prison terms.  J P Morgan did eventually pay a fine of US$13.8 billion (a dollar for every year of the universe’s existence) but only after delaying it long enough to see many householders, the potential beneficiaries of these payments, go bankrupt.

FVA, a 'correction’ to the price of derivatives, is the latest piece of creative accounting from, you guessed it, J P Morgan. ‘Funding Valuation Adjustment’ is a fiddle none seem to understand and fewer respect. The Financial Times rightly called it “a new earnings-distorting acronym in an industry plagued with them.”

Fees, eternally problematic, and made more so by simplistic instructions such as “you should only worry about after-fee performance”. Though true, that finesses the fact that (base) fees are certain and controllable, while performance is uncertain and at best only partly controllable. Low signal/noise ratios and information asymmetry ensure that the quality of financial products and investment strategies cannot be assured. So, as with high-priced haute couture fashion, lower fees will be interpreted as signalling lower quality. Indeed, investment banks do put their fees up when demand falls … and it works.

Fashion, drives decisions in our industry and for the same reason it does in the rag trade, because paradoxically we like to be with the crowd and yet show that we are ahead of it. Hedge funds have yet to promote themselves as a fashion statement, but it will come to pass. Rely on Oscar Wilde to pithily capture another human absurdity, Fashion is a form of ugliness so intolerable we have to alter it every six months.”

Fixed income, technically and mathematically far more interesting than equities, yet before the 1990 movie The Bonfire of the Vanities made bond traders fashionable, bonds were boring and traded by eternally pessimistic nerds. This raises two intriguing (to me) inter-related questions. First, is the asset class, swamped as it is with derivatives, effectively immune to the corrosion of diseconomies of scale? Second, to what extent do the prognostications of investment management giants such as PIMCO and BlackRock actually influence the Fed’s decisions? About 20 years ago James Carville, an adviser to then president Clinton, said that he wanted to be re-incarnated not as the president but as “the bond market” so he could then “intimidate anybody.” (See Financial system.)

Fallacy, of composition is something that is frequently heard yet infrequently exposed. A common instance, much used by business leaders, is the assertion that “industry must cut costs” (code for reducing wages), which ignores how one firm’s costs are another’s revenues. So the net effect of such cuts is a weaker overall economy. Keynes’ paradox of thrift is of the same ilk: it is prudent for each person to be thrifty, yet if we all are “enterprise will surely fade”.

Fiddling, an identifiable, common source of failure for investment strategies. Generally, for most organisations and strategies, fiddling destroys value but can be fun and reassures our guardians that we’re doing something. In most other areas of human endeavour, activity is seen as the true path to adding value. Investing is uniquely different. Its default stance should be “don’t just do something, sit there.”

* F also stands for Fantasy, Fidelity, False, Funds, Fear, Failure, …

Click here to read Jack’s previous dictionary article ‘The C words’ in Cuffelinks on 8 August 2013.

 

Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing.

 


 

Leave a Comment:


banner

Most viewed in recent weeks

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 581 with weekend update

A recent industry event made me realise that a 30 year old investing trend could still have serious legs. Could it eventually pose a threat to two of Australia's biggest companies?

  • 10 October 2024

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

The quirks of retirement planning with an age gap

A big age gap can make it harder to find a solution that works for both partners – financially and otherwise. Having a frank conversation about the future, and having it as early as possible, is essential.

Latest Updates

Investment strategies

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Economy

US election implications for investors and Australia

The return of Donald Trump to the US presidency brings the prospect of more US tax cuts and deregulation, but also more tariff hikes, trade wars and policy uncertainty. Here's what it means for markets going forward.

Retirement

The rising tension between housing debt and retirement balances

Australians are taking more mortgage debt into their 60s than ever before. Retirement planning assumptions haven’t adapted and could result in future income projections that ultimately disappoint retirees.

Investment strategies

Why megatrends can deliver big upside (and downside)

The magnitude and duration of society's most important trends are often underestimated. While these trends are usually touted as a tailwind, one in particular could have dark consequences for many assets.

Property

Fixing the construction industry house of cards

Australia needs to build new homes like never before but construction firms keep going belly up. Unless regulators act now, consumers will continue to carry the can.

Investment strategies

How investor portfolios have become riskier versus history

Risk in portfolios has dramatically increased as time horizons have shortened and investors have piled into equities. It's resulted in a growing disconnect between what investors need and what the financial industry is delivering.

Shares

The abacus, big data and a brief history of indexing

Equity indices have evolved over time, led by step-changes in our ability to manipulate data. Despite the rise of passive investing, they weren't initially meant to be investment tools.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.