Monthly Archives: December 2015

Rent seeking/principal-agent problem of a financial professional

One of the most important financial professionals, e.g. wealth managers, asset managers, fund managers, is to reduce information asymmetry when they make/recommend capital allocation decision for asset owners who lend capital to creditors. Rent seeking behavior – or principal-agent problem could well take place when the financial professional understates the risks – particularly if purposefully – or over-promises returns to the asset owner.

Such behavior is more likely to happen than otherwise if:

  • The financial compensation of the financial professional depends on the size/success of the transaction, rather than the realized return of the underlying asset; and
  • the reputation risk is low, if the professional can easily change his job when things get ugly; and
  • the asset owner has yet to adapt to a lower level of expected return, when the economy slows down and assets fail to generate the same level of return as before.

Unfortunately, this behavior happens in many parts of the world currently (including China) where economy is slowing down, asset quality is deteriorating and yet more and more money flow into the financial market – on the back of central bank easing – chasing fewer productive assets.

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How far is China away from quantitative easing

It is expected that PBoC will do more monetary easing in 2016, possibly by reducing interest rate, to support the slowing economy. Monetary easing should push bond yield (government bond and investment grade corporate) even lower. With 10-year government bond yield at historically low level, one may wonder how far is PBoC away from unconventional monetary easing, such as QE, as the traditional ways of easing are being exhausted.

My sense is that, China should still be a quite far away from QE, for the following reasons:

First, direct financing is still booming, such as the new corporate/enterprise bond offering. And the stock market IPOs should pick up speed next year as the risk of bubble is now less likely than six months ago. In other word, while the bank lending channel is clogged due to deteriorated bank balance sheet quality, direct financing have been and should continue to be accelerating.

Second, policymakers have many ways to increase lending to the economy, in addition to the traditional rate cut, e.g. asking policy banks to increase lending towards infrastructure projects. Btw, this is another way of easing that blur the boundary between fiscal and monetary easing.

Third, most of bank assets are state owned, and policymakers have a lot of administrative measures to encourage (or even order) SOE banks to increase lending, before they have to engage in methods like QE.

It seems to me that, due to the developing and state-owned nature of the Chinese banking system, there’re many measures – conventional or unconventional – that policymakers can take to support economy, other than doing QE.

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What social welfare should government provide to the elderly: one example

When I got off a plane at the Hong Kong International Airport, I noticed that there were members of staff of the airport waiting at the arrival gate with wheelchairs – apparently they were to provide service to those disabled from the flight. One striking scene was a member of staff – looking in age of 60s – pushing the wheelchair for an older passenger – in late 70s/early 80s.

Pushing the wheelchair at an airport is certainly a kind of labour work where people in 60s hardly have any comparative advantage – unless they ask for very low pay. And it is hard to argue that they are the best for this job merely because of the fact that they are paid and not forced to take it.

This reflects an embarrassing situation facing Hong Kong as a liberal economy/a society with low level of welfare compared to other developed economies. If market competition yields optimal results for resource allocation, I am not sure having people in 60s engage in labour work is a good example. Welfare economy may not generate the most efficient economic result, and yet a society should justifiably provide sufficient assistance for the vulnerable groups, such as the elderly. The Hong Kong government should rethink their welfare policy towards the elderly.

More generally, it would be interesting to look at statistics about what professions for people above age of 54 are engaging it, and how big it is falling into the category of labour work. That may be one of the many measurements of the success of a government’s welfare policy.

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Social responsibility of an investor

It goes beyond the narrow definition of responsible investment, e.g. avoiding stocks of alcohol, tobacco or those that pollute the environment.

I think it also includes how an investor look after the capital on which he has a fiduciary rule – if he does not own the capital. For instance, it is very attempting to launch products/investment vehicles whereby a fund manager can charge a high fee from the capital owners while it is in fact a rent seeking behavior from an outsider’s point of view. Another example is the overpromise of future return (or giving one that impression) – with fees being charged ex ante – regardless of whether it’s been under-delivered subsequently or not. A simple test question would be, if you are the capital owner, are you happy to purchase the product that you launch?

I also think there may be an aspect of social responsibility that makes value-based investment attractive. Theoretically such investment style moves capital to the undervalued projects/companies that are also likely to be under-capitalized/under-financed – which makes capital allocation – one of the core roles of the financial markets – more efficient overall. On the other hand, momentum investing might suffer from the possibility that it chases stocks that are popular/companies that are over-capitalized. The caveat of this argument is that, theory always sounds more attractive than practice.

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Impact of corruption on investment return

Anti-corruption campaigns in China, the 1MDB scandal in Malaysia, the scandal of Petrobras that ultimately led to Rousseff’s impeachment in Brazil…it goes without saying that corruption is a major obstacle to economic growth and social stability across many emerging economies. And yet it is very hard to systematically assess the impact of corruption on investment, though some broad estimates of its economic impact have been made. It remains unclear to me how to apply a valuation discount for companies operating in countries with corrupted government system. In addition, it is also unclear to me how to understand the impact of corruption on certain sectors (e.g. oil exploration) where deals are made/money is earned in closed-door meetings between the government and oil conglomerate.

Fundamentally, the question is, are investors of assets subject to corruption compensated with higher risk premium (via lower purchase price), or facing lower realized return as corruption is an expense to pay? I would believe the latter, though further assessment is needed.

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Hukou

When European countries are working – despite lots of obstacles, frustration and opposition – towards an economic union, banking union, and ultimately a fiscal and political union, the existence of the hukou system make China look like a nation with lots of sub nations inside. The cumbersome, inefficient and bureaucratic system prohibits free movement of labor even within a nation. It needs substantial overhaul.

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A walk every morning

It is said that Anthony Bolton, the ex Fidelity fund manager, used to walk every morning between 11am and 12pm – just to clear his thoughts.

I guess clearing one’s thought is an essential daily activity for a value contrarian investor – it takes courage and intelligence to go against the trend/momentum. It requires one to organize his thought without being interrupted, and run through the argument (and various counter arguments) over and over again.

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