Practical analysis for investment professionals
16 December 2013

Best of 2013: Fixed Income and Behavioral Finance

Completing another lap around the sun is always a good excuse for reviewing the past to identify previously invisible trends, as well as to examine which stories you thought were important that turn out not to be important. What follows is my “Best of 2013” stories, all distilled from my more than 2,000 tweets.

STORIES OF THE YEAR

Favorite story: By far, my favorite story this year and an absolute must read is the BBC story of Stanislav Petrov. Petrov literally saved the entire world, and chances are that you have never even heard of him, yet his story of individual heroism is strong evidence that when we tune into our innate humanity we find the right flow for action.

Story of the year: For me the story of the year is not Edward Snowden, or the Federal Reserve’s taper, it is the growing income disparity in First World nations. Capitalism cannot survive if it cannot fulfill its promise of fairer income distribution. But how can it when 95% of 2009–2012 income gains went to top 1%?

Runner-up for story of the year: I have long counseled aspiring investment professionals that understanding the consumer surplus is one of the keys to identifying long-term competitive advantage in businesses. That is, those companies able to extract concessions from consumers (like Starbucks getting you to surrender $4 for coffee, instead of $1) tend to perform better. Now neuroscience demonstrates that producers are leaving too much consumer surplus on the table.

Story of the year that’s not getting wide coverage: A story that seemed to get traction everywhere except in the United States (and led to the resignation of many career politicians) was this gem from the International Consortium of Investigative Journalists about the size (a staggering $30 trillion) of global offshore tax evasion over the past 30 years.

FIXED-INCOME STORIES OF THE YEAR

As content director for fixed income at CFA Institute, I scour the world for compelling fixed-income stories each and every day. Here are my themes of the year, followed by stories that capture the essence of these themes.

Raging bull market in yield securities: One sign of a raging bull market in yield securities is the return of long-shunned deal structures such as the dreaded and infamous collateralized debt obligation. And still another sign of a raging yield security bull market is the rolling back of covenant protections for investors.

Financial repression: Central banks holding interest rates artificially low is certainly benefiting one class of investor — those attracted by capital gains — while absolutely destroying another class of investors — those who prefer yield. This search for yield has led to a crazy bull market (see above), but it has also led yield investors to stretch normal bounds to fulfill their yield appetite. Lest you think it is just pensioners hurt by low interest rates, insurance companies — a vital cog in the global financial system – are also being devastated by record low interest rates.

Ongoing LIBOR/EURIBOR scandal: After several years this scandal and its far reaching effects march on. It seems that incentivized financial men outside of the purview of public scrutiny cannot be relied upon to do the right thing, as this story about the clubby London trading scene makes obvious. Shockingly (not), the industry sees plans for a LIBOR overhaul as intrusive. And what regulation was ever welcomed by industry? Here I am going to quote one of my favorite bands, Radiohead, on the matter of financial industry regulation (from “Just“):

You do it to yourself, you do
And that’s what really hurts
Is that you do it to yourself
Just you, you and no one else
You do it to yourself . . .
Don’t get my sympathy

Best ideas in fixed income this year: Industry heavyweight and innovative thinker BlackRock has proposed standardizing bond issues to improve liquidity. I have been saying this privately to friends for more than 10 years and am glad that someone of import has taken up the issue! One bond fund manager has bristled against being just an asset allocation check mark and is actually using his intelligence to steer his fund to great results. Check out Driehaus’s K. C. Nelson and his innovative ideas, including using negative duration.

BEHAVIORAL FINANCE STORIES OF THE YEAR

I share CFA Institute’s behavioral finance content direction with my erudite colleague Lauren Foster. I encourage you to follow her on Twitter (@LaurenFosterNYC; she’s much more readable than am I, for starters) if you are interested in behavioral finance.

When I posted the article “Behavioural Finance’s Smoking Gun” to Twitter, it triggered a fairly strong response from behavioral finance scion Greg B. Davies, author of Behavioral Investment Management. Though Davies may disagree, his reflexive and emotional response to the poking of holes in behavioral finance likely means the wound was near to the heart. Somewhat similar to the preceding criticism levied by the Psy-Fi Blog is this gem from a sociologist, also critical of behavioral finance.

Long-term readers of my content know that I repeatedly caution against overly analytical minds, as I think creativity and intuition also play a critical role in successful investment management. In this Financial Times editorial there is a strong argument for stories trumping maths when making decisions.

STORIES THAT DEFY CATEGORIZATION

QUOTE OF THE YEAR

“A man does not deserve huge amounts of pay for creating tiny spreads on huge amounts of money. Any idiot can do it . . .”

– Charlie Munger


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.

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About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor and the CEO of Active Investment Management (AIM) Consulting. Voss also sub-contracts for the well known firm, Focus Consulting Group. Previously, he was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. Voss holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: [email protected]

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