Mike Lipper’s Monday Morning Musings
Recognizing a Professional: Ratings vs Ranking
Editors: Frank Harrison 1997-2018, Hylton
Phillips-Page 2018
While we can’t know exactly whether someone is schooled in a subject or just pretending, we can presume a lot from their choice of words. In the world of investment statics there are several tribes of analysts that attempt to predict whether a fixed income instrument will go into bankruptcy. They summarize their learned judgements with letter grades, called ratings. These ratings do not give an opinion as to whether they are good investments, just whether they anticipate them entering bankruptcy. The history of the professional credit raters is pretty good, as bankruptcies are relatively few in number. While they give an opinion as to whether the instrument will enter bankruptcy, they do not indicate how much of the issued principle will be lost.
One unfortunate trait of inexperienced people is the use of a term from
one subject in another. While the term may have some similarities, it is not
identical and may not even have the same utility as the original. This is why I
used performance ranks and not ratings when developing the practice of mutual
fund analysis, using the performance array of mutual funds we tracked each week.
This is where my analytical training kicked in.
I pity those who passed through the analytical profession and did not
learn as I did at the racetrack. My experience instilled in me a strong
aversion to losing money. Analysis at the track is similar to the popular method
of selecting investments based on past performance. This approach relies on the
belief in the repeatability of events and has led to the development of quantitative
systems, both in the investment market and at the track. “Quantitative”
investing has periodically been very popular in the investment market,
buttressed by “ratings” which are meant to be predictive.
I gained an advantage from my many
discussions in the grandstands following each race, where some player complained
about the failure of “the system” he/she was following. Because I did not like losing
money, I paid attention to the complaints of the failed “systems”. What I
discovered was these systems actually worked better than half the time for a
period of time, but rarely more than 60-70% of the time.
Later in life I heard similar complaints from more senior analysts as the
corporations they followed failed to deliver the expected performance. The
standard complaint was that someone was lying. It took me a while to connect
the similarity of their complaints with those I heard over the weekend at the
track.
This realization led me to think about the process of predicting the
future. Since no systematic thinking produced winners all the time, there must be
mistakes in the math. As securities analysis is taught as an adjunct to math,
or the certainty of law, the losses had to be a function of mechanical
mathematic failure. It eventually occurred to me that it was not the process that
failed, but the universe of variables being different than those utilized.
At the track, the things that could change were the jockey, the trainer, the
exercise rider, what the horses were fed, what drugs were administered, or the competition.
Each of these possible changes, and others, could and often did impact results.
This is why I believe we should pay more attention to changes of people and
their attitudes in the investment world. More so than believing in their statistical
record.
This week was a good example of changes that largely invalidated the past
record of the entire global financial sector. As an analyst, investor, and
portfolio manager, I have always had an interest in financial services
securities. Stock Exchanges have been at or near the center of the financial
sector and thus were always of interest. There have been five Lipper brokerage
firms that have been members of the New York Stock Exchange. (Never has a son
or younger brother succeeded the founder, and consequently none extended to a second
generation.)
In most commercially viable countries, there are stock exchanges. Considering
all I know about these exchanges; none are making most of their money exchanging
securities. At best, most make single digit returns on this revenue. This week
I attended a capital markets conference of the 300-year-old London Stock
Exchange. While it is interesting looking at their history or past performance,
it is of no value predicting their future.
Unlike racehorses and most people, some companies can be rejuvenated into
something quite different than their past history. In the case of the London
Stock Exchange, it has grown into the London Stock Exchange Group (LSEG),
primarily through a merger with a Thomson Reuters spin-off. (In 1998 Reuters purchased
our fund data business. We and our accounts still own Thomson stock, which has
a major position in LSEG.)
The spinoff included a number of unintegrated number-crunching entities, labeled
Refinitive. It was a comfortable fit because the London Exchange had previously
acquired a number of similar unintegrated and under-marketed numbers-companies.
To this mix they added “expert” management from various financial and tech
companies, including a cooperative agreement with Microsoft based on their
plans and/or dreams.
The CEO believed he had identified all the problems that could delay
them. The current management group is investing heavily in new products and
services, including the marketing of them. It would not be difficult to improve
on the record of its two major founders. LSEG deserves to be ranked highly in
its present efforts. I will leave it to others to predict its future.
This Week’s Signs of Stagflation
Despite the media and others chanting Good News, there is increasing
evidence that smart professionals see an approaching decline in market prices.
Whether we are just in stagflation or entering a significant contraction will
be determined later. However, it is worth noting the S&P 500 Equal
Weighted Index is essentially flat year-to-date.
The following announcements have to do with future revenues. The
companies making these statements are addressing the second of two measures of
their health, their investment performance and the prospect of generating new
business, largely from new customers.
- Manulife is laying off 250 employees in its Wealth and Asset Management functions. (Manulife is a Canadian Life Insurance company with significant Hong Kong sales.)
- Wells Fargo is laying off 50 Investment Bankers.
- Burberry issued a sales target warning.
- A 2nd Hedge Fund is cutting 150 of its 1000 person staff.
- Jim Chanos is closing his short selling hedge fund. (He said the market is changing away from his style.)
- Amazon is cutting several hundred from its Alexa staff.
- Another observation noted in the weekly list of prices in the Weekend WSJ. Only 8% are down, including the US dollar -1.65%.
- Fitch is negative on the investment management sector in 2024.
Note From London
At private investment discussions in London during the week, locals were most concerned about the US Presidential election, with differing levels of pessimism. I had two comments.
- It is incredible considering the size of the US population that the present apparent candidates are such a poor couple. The locals agreed.
- Much more important to me is that we won’t know the Chairs of key committees until later next year. This is more important on the Republican side, as the Democrats are bound by seniority. According to the intelligent people I talk with, a split Congress is likely, suggesting not much meaningful Legislation will pass, except for emergencies during the first two years of the new term.
Share your views with me and let me know what you are watching in terms
of markets and votes.
Did you miss my blog last week? Click
here to read.
Mike
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Guides - Weekly Blog # 808
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