Tying stock pickers' pay to performance

Steven Cohen is changing how he evaluates and rewards his stock pickers:

Point72 had been paying its stock pickers a fixed 20% bonus on investment returns regardless of how they performed against broader benchmarks. That meant they could be paid handsomely just for matching a rising market. 

Under the new bonus system, Point72 will boost those payouts to as much as 25%, but it will only pay the top bonuses on so-called alpha, industry parlance that roughly translates to investment performance above a market benchmark.

By doing this, he hopes to attract better pickers to his firm (adverse selection). Note that he is measuring excess returns adjusted for the riskiness of the portfolio, i.e., alpha.

Note the link to yesterday's post about how best to tie pay to performance.  By using alpha (risk adjusted return), instead of raw return, Cohen is practicing the "informativeness principle," measuring performance using all information about productivity, including information about risk.

Sterling devaluation and banks

WINNERS:

Foreign banks with big servicing centres in the UK — such as Citi’s centre of excellence in Belfast — gain because they pay for those centres in sterling, and they receive more sterling for their home currency when the pound is weak.

LOSERS:

The flip side of the cost benefit is that every pound in profit banks earn in the UK is worth less when they repatriate it to their home currencies. US banks generally run their profitable European trading and investment banking businesses from London so the sterling devaluation is a “a drag on revenues from the UK and on pre-tax margins”, according to Brian Kleinhanzl, a New York-based analyst for KBW.

Luxury goods and the sterling devaluation

The sterling devaluation is helping British exporters and hurting British consumers.  However, it is also helping British Tourists:

Since Britain voted in June to leave the European Union, sterling has tumbled 17% as of Friday’s close, having set fresh three-decade lows last week. The fall has ratcheted up prices here of imported wine, electronics and even some cars. But most luxury-goods makers—protected by typically fat margins for their products—haven’t yet raised their prices. That has suddenly made the U.K. the least expensive market in the world for a bevy of luxury goods, according to analysts.

HT:  Adam

Why are trailer parks such good investments?

The very government restrictions that have created the affordable housing crisis, offer an opportunity to investors in trailer parks:

Franke Rolfe, a Stanford graduate who teaches people how to profit in the mobile home industry, buys dilapidated trailer parks, cleans them up, and rents mobile homes to the working poor. A 2014 New York Times Magazine article reported that he and a partner earned a 25% return on their investment. 

Trailer parks’ appeal to these investors is simple. Millions of Americans struggle with rent payments, but still want a lawn. For them, mobile homes are the cheapest form of housing available. At the same time, it’s rare for someone to build a new mobile home park, because no homeowner wants a trailer park nearby. An industry with healthy demand but a fixed supply attracts the country’s capitalists. 

HT:  MarginalRevolution.com

Can the government bring stability to markets?

According to Alan Greenspan's new biographer, not without moral hazard:

If the Fed responds when markets turn down but doesn’t suppress exuberance when markets are up, private actors will have an incentive to take on more risk than they otherwise would. This can undermine natural market discipline. Mr. Mallaby believes that in his responses to negative shocks, Mr. Greenspan crossed the line from being the “guru”—“the man who knew”—to becoming the “guardian angel.”

BOTTOM LINE:  

“The delusion that statesmen can perform the impossible—that they really can qualify for the title of ‘maestro’—breeds complacency among citizens and hubris among leaders.”

Is the pound depreciation good for Britain?

The FT has the answer:

Of course, as many will point out, a decline in the currency is good for exporters. It is also good for the foreign currency earnings of the multinationals listed in the FTSE 100. But unless a currency is overvalued (as the pound was in 1992), it is folly for a nation to celebrate a sharp decline. If devaluation were the answer to economic success, people in Venezuela and Zimbabwe would be rich. A weaker currency is a decline in the terms of trade; it costs more for citizens to buy foreign imports they want and their exports are lower in price. As a trading nation with a current-account deficit, Britain is dependent on the kindness of strangers; the willingness of foreign investors to send capital.

Never start a land (or price) war in Asia

Who will outlast whom, Flipkart vs. Snapdeal?

Both signed deals with big financial partners, Wal-mart and Amazon, trying to drive each other out of e-business in India.  How long until they realize that this kind of predation rarely pays? If they don't, investors may want to step in a stop it before they lose too much money.

At some point, if Amazon believes that the price of a scorched earth battle is too high, it might sue for peace and move to merge with Flipkart. If that happens, both parties will win.

Until Wal-mart and Amazon get tired to losing money, keep shopping.

... as consumers, you would be well-advised to make the best of the big sales being run by online retailers. The sale will last only till the money lasts.

HT:  Brian

Did the government cause the affordable housing crisis?

"Yes," says the Washington Post, for three reasons:

1. Restrictive zoning reduces the profitability and therefore the supply of housing:

The White House’s calls for local policymakers to expand by-right development (where allowable building projects can proceed administratively, without years-long public hearing processes) and accessory dwelling units, to repeal or reduce minimum parking requirements, and to rezone neighborhoods for greater possible density all amount to restoring landowners’ rights to develop property as they and the market see fit. As the tool kit notes, inappropriate parking requirements, in particular, can raise the expected rent in a new development by as much as 50 percent, while depriving towns of socially and commercially productive land.

2. Regulatory delays and requirements raise costs to the point where only high-end apartments are profitable (Nashville's problem):

Establishing by-right development and streamlining local permitting processes will allow developers to respond nimbly to market demands and will relieve the “guilty until proven innocent” status of new building development, which depresses construction starts across the country by delaying and inhibiting housing projects. What’s more, adopting leaner codes would remove obstacles to the countless smaller developers and would-be builders who want to invest in strengthening their local communities, but currently can’t afford to navigate the vast regulatory burdens and uncertain futures awaiting anyone who tries to build in America today. Trulia economist Ralph McLaughlin found that these regulatory delays may have an even bigger impact on housing production than zoning restrictions.

3. FHA loans prohibit mixed use, further reducing the profitability and supply of housing:

To this day, FHA standards for loans, which set the market for the entire private banking sector, prohibit any but the most minimal commercial property from being included in residential development. As a groundbreaking report by New York City’s Regional Plan Association found, these standards are “effectively disallowing most buildings with six stories or less.” And depending on the program, a building could have to reach to 17 stories before it is eligible for participation in the normal housing markets. Without the FHA’s blessing, projects are granted the “nonconforming” kiss of death unless their developers can persuade a local bank to write an entirely customized loan for them, one whose risk the bank would have to keep entirely on its own books.

REPOST: Why doesn't insurance cover floods, earthquakes, or bed bugs?

Friday, October 3, 2014

Why doesn't insurance cover floods, earthquakes or bed bugs?

Planet Money has another episode that is making me rethink my opposition to government subsidies for public broadcasting.  In The Fine Print, a reporter reads his homeowner's insurance policy.  In it, he discovers that the policy does not pay for:

• Floods: because floods hit all the homeowners in an area at the same time, so insurers cannot spread the risk around (called "correlated risk");

• Earthquakes:  due to adverse selection (only the homeowner knows if she built on an active fault); and 

• Bedbugs:  due to moral hazard (if you knew you were covered for bedbugs, you could pick up furniture off the street without any worry).  

Why are European banks so shaky?

..because it is relatively easy for them to evade minimum capital requirements.

Research by colleague Benjamin Munyan shows that European banks sell their debt on the last day of each quarter, temporarily turning their debt into cash, if only for one day.  On the next day, these "repo's" are bought back by the bank, turning their cash back into debt.

This "window dressing" occurs on the day when the European regulators "check" banks' debt/equity ratios.  US banks don't have this problem because US regulators check the debt/equity ratios over the entire quarter.

BOTTOM LINE:  Such window dressing "...understates a dealer bank’s leverage and maturity mismatch, which means systemic risk is higher than we would believe using only quarter-end measures."

Be careful what you measure.