Practical analysis for investment professionals
14 October 2013

Futurology — Can Things Only Get Better or Worse?

Posted In: Future States

In the depths of the 1930s depression, economist John Maynard Keynes published a brief essay, “Economic Possibilities for Our Grandchildren,” sketching a vision of spectacular future abundance. Keynes imagined that by 2030 the standard of living would be so high that everyone, liberated from humdrum chores and illusory consumerism, need work no more than fifteen (yes, 15!) hours per week, devoting the rest of their time to leisure, the enjoyment of high culture and intellectual improvement. Alas, this happy scenario is predicated on some notable assumptions: an absence of destructive wars, moderate population growth, the completely free and unfettered accumulation of capital, and bountiful technological advances.

Most readers will already have spotted one or two inconvenient discrepancies in this utopian scenario. Extreme and growing inequality in income is one inconsistency, which is the subject of a recent study by the London School of Economics and Oxford University suggesting that things are getting worse not better. The business elite seem ever more interconnected, according to another study evaluating the tendency for people to form connections with others who are similar to themselves (homophily) which plays a role in the choices bank boards make when hiring executives.

For what has been termed “generation jobless,” Keynes’ optimistic vision looks like an insensitive joke, with one study suggesting 25% of the world’s 15 to 24 year olds are neither employed nor in school. In the Arab countries, such issues recently boiled over prompting a series of dramatic revolutions. At a recent CFA Institute conference, Adeel Malik and Bassem I. Awadallah spoke of how economically fragmented the Arab world is, which restricts the development of a strong private sector and is one of the main causes of unemployment among youth in that region.

Writing in the Financial Times, John Kay recently lamented that technology’s crystal ball offers only a hazy view of the future and such seemingly exciting innovations as big data and small robots are by historical standards very modest indeed. According to one recent study, it is quite possible that the economic benefits of the Internet and increased Twitter use have been grossly exaggerated, suggesting measurement of the disbenefits is a logical next step. At another CFA Institute Conference John Edwin Mroz examined the issue of cybersecurity and crime facilitated by our increased use of the Internet. Cyber crimes have evolved from exploitation to disruption and now to outright destruction of critical information at banks and industrial companies, a worrying trend.

CFA Institute’s flagship Financial Analyst Journal (only available to members and subscribers) has recently hosted a lively debate on prospects for the future with William Bernstein questioning any grounds for optimism about future security returns and hence the prospects for capital accumulation. According to Bernstein, both theory and long-run empirical data support the notion that economic growth lowers security returns by reducing impatience for consumption and altering the supply-demand dynamics of capital — the price of living in an increasingly prosperous, safe, healthy, and intellectually gratifying world.

If individual security returns are lower, then the pressure increases on asset managers to up their game in asset allocation and manager selection. For Sebastian Page, speaking at a recent CFA Institute conference, asset allocation is evolving into an approach based on forecasts driven by macroeconomics and risk factor diversification. Investors should look beyond volatility as a measure of risk and explicitly estimate the risk of tail, or less likely, events. Developing a framework to measure a manager’s asset allocation skills is also critical. One recent study decomposed the fund manager’s alpha into risk-based allocation, relative valuation trades, and factor-timing components to improve measurement.

Despite many challenges for financial markets in the recent crisis, imagining a better future is something we seem instinctively driven to hope for. Writing in the American Economic Review recently, Robert Shiller examined whether the actions of financial institutions help people pursue their individual goals and feel at peace with society. He concludes that finance can be redesigned to fit better with the notion of the “good society.” Perhaps if we cannot easily accrue the spectacular economic possibilities Keynes foresaw then at least we can encourage incremental changes to hasten the creation of a “good society” for future generations.

  • Net Benefits: Several approaches can be used to measure the economic benefits of internet use by consumers. The detriments of internet use should likewise be the subject of quantification.
  • Cybersecurity: Crime Prevention or Warfare?: Cybercrimes have evolved from exploitation to disruption and now to destruction of critical information at banks and industrial companies. Perceived cyber risk levels have increased. Governments are now taking more interest in cybersecurity policy, but cooperation and sharing of information throughout the private sector allow for a faster response to threats than government policy does.
  • Risk Management beyond Asset Class Diversification: Asset allocation is evolving into an approach based on forecasts driven by macroeconomics and risk factor diversification. The dynamic nature of markets requires both secular and cyclical investment horizons. In addition, investors should look beyond volatility as a measure of risk and explicitly estimate the risk of tail events.
  • The Paradox of Wealth: A recent FAJ article by Laurence Siegel painted a sunny picture of the world’s economic and environmental future. Although the author agrees with Siegel’s analysis, his optimism does not extend to security returns; both theory and long-run empirical data support the notion that economic growth lowers security returns by reducing impatience for consumption and altering the supply–demand dynamics of capital—the price of living in an increasingly prosperous, safe, healthy, and intellectually gratifying world.
  • Technology’s Crystal Ball Offers Only a Hazy View of the Future: Exciting innovations such as big data and small robots are by historical standards modest.
  • Economic Fragmentation of the Arab World: The Arab world is economically fragmented, which restricts the development of a strong private sector and is one of the main causes of unemployment among youth. In the aftermath of the Arab Spring, restoration of internal stability and the political and constitutional agenda will occupy the transitional leadership in the immediate future. Dealing with economic issues and reestablishing links between countries are likely to be delayed.
  • Extreme Wage Inequality: Pay at the Very Top: The past decade has seen a remarkable rise in income inequality in the United Kingdom. The authors explore not only the wages but also the share of income and wages at the very top of the corporate hierarchy in the country and find that workers in the financial sector account for the majority of the inequality trend.
  • A Framework for Examining Asset Allocation Alpha: The authors contribute to the literature of investment performance measurement by developing a framework to measure a manager’s asset allocation skills. They decompose the manager’s alpha into risk-based allocation, relative valuation trades, and factor-timing components.
  • Reflections on Finance and the Good Society: The author examines whether the actions of financial institutions help people pursue their individual goals and feel at peace with society. He concludes that finance can be redesigned to fit better with the notion of the “good society.”
  • Does It Pay to Have Friends? Social Ties and Executive Appointments in Banking: The tendency for people to form connections with others who are similar to themselves, or homophily, may play a role in the choices bank boards make when hiring executives. Common social factors, such as age, gender, education, and employment history, affect the likelihood that a bank will appoint an external versus internal candidate to executive positions.
  • Generation Jobless: The author estimates that more than 25% of the world’s 15- to 24-year-olds are neither employed nor in school. This problem has been exacerbated by the recent financial crisis and by inefficient labor markets.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/retrorocket

About the Author(s)
Mark Harrison, CFA

Mark Harrison, CFA, was director of journal publications at CFA Institute, where he supported a suite of member publications, including the Financial Analysts Journal, In Practice summaries, and CFA Digest. He has more than 12 years of investment experience as a portfolio manager and securities analyst. Harrison is a graduate of the University of Oxford.

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