Academic Finance – Page 6

Portfolio Rule Three

Posted on 2 October 20103 October 2010 by David Merkel

One side benefit of deciding to start up Aleph Investments, LLC, is that it is forcing me to write out articles on my rules.? When I was writing for RealMoney.com, I wrote a number of articles about my eight rules, but I only wrote about four out of the eight rules.

Before I write about rule number three this evening, I would like to bring you up to date on what I am doing with Aleph Investments, LLC.? This past week I incorporated the business, and in this coming week.? I will be registering as an investment advisor.? I will be managing equity money, on both a long only and hedged basis.? I have yet to choose a custodian and clearing broker, but I am working on this.? Given the state that I am domiciled in, Maryland, there may be delays but I suspect I’ll be up and running by late November or early December.

-==-=-=-=-=-=-=–==-=-=-=-=-=-=-=-=-=–==-=-=-=-=-

Let me give you a little history of how the eight rules came to be.? In 2000, I had an e-mail discussion with Kenneth Fisher.? I explained to him what I had been doing with small-cap value, and how I had done well with it in the 90s.? He told me to forget everything that I’ve learned, especially the CFA syllabus, and look for the things that I can do better than anyone else.? We exchanged about five or so e-mails; I appreciate the time he spent on me.

So I sat back and thought about what investments had worked best for me in the past.? I noticed that when I got the call right on cyclical industries, the results were spectacular.? I also noticed that I lost most when investing in companies that didn’t have good balance sheets, no matter how “cheap” they were in terms of valuation.

I came to the conclusion that size and value/growth were not the major determinants of my investing success. ?Instead, industry selection played a large role in what went right and wrong with my investment decisions.? So, I decided to formalize that.? I would rotate industries with a value bias.? But that would have other impacts on how I invested.? One of those impacts is rule number three.

I formalized the first seven of the rules in 2002, when the strategy was two years old and seemingly performing quite well.? I began doing what rule number eight states sometime in 2004, and reluctantly added it to the seven rules sometime in 2006.

With that, on to rule number three:

Stick with higher quality companies for a given industry.

There are three simple reasons for why rule number three works:

First, companies with lower debt levels within a given industry tend to be more profitable than companies with higher debt levels that industry, contrary to what the Modigliani-Miller theorems state.
Second, many investors, both retail and professional, have a bias toward what we might call “lottery ticket stocks.”? Many people swing for the fences in the stocks that they buy and accept high risks in order to achieve a high return.? On average, this strategy does not work.? In general, buying high beta, high volatility stocks is a recipe for disaster and buying low beta, low volatility stocks tends to earn money better than the market averages.
Third, if you are rotating industries, there are two ways to do it.? These two ways are not mutually exclusive, you can have part of your portfolio in one strategy and part of your portfolio in the other.? Method one is to look for trends that are clearly going on, but that the market has not fully discounted.? In this case, one can buy companies with excellent or good balance sheets because the trend will carry you along.? Method two is to look for industries that are sick but not dead.? In that case, you only select companies with excellent balance sheets.? This is how it works: if the industry remains sick, weaker competitors will be destroyed, capacity will exit, and pricing power will return to the survivors.? If the industry?s pricing power suddenly improves, then all of the companies industry will do well.? The one with the excellent balance sheet will outperform the market as a whole.? That the ones with poor balance sheets do even better is not a concern.? The idea is to avoid losing money; don’t take the risk by buying the “lottery ticket stock.”

For what it is worth, this same idea not only works with stocks but it works with bonds as well.? If you read the book Finding Alpha, the author has an extensive discussion on why high quality bonds outperform low-quality bonds over the long haul.? In general, corporate bond investors underestimate the costs of default risk.? BBB bonds do best, followed by AAA bonds, and then other investment grade bonds.? After that, the lower the rating of the bond the worse they do.

The same is true of stocks, which is why it pays to look at where the market is in its liquidity cycle.? In November of 2008 through March of 2009, it made a lot of sense to buy junk bonds, and I did so for my church building fund.? Though I didn’t say it at the time and did not act on it, it was also in hindsight the right time to buy junk stocks.? Oh well, that’s water under the bridge.? I tend not to take the risk of buying junk stocks because I don’t want to lose money.? I did well enough by adding to more cyclical names that had strong balance sheets.

Two notes before I close: first, industries tend to have preferred habitats.? In other words, typically the difference between the company with the best balance sheet the industry and the company with the worst balance sheet industry is not all that great.? Why is that?? If you’re in the same industry, typically you have similar levels of fixed costs versus variable costs, and you face the same levels of variability in sales.? These two factors together will lead an industry to a preferred level of financial leverage.? But even though the difference might not be that much between the company with the best balance sheet and the worst balance sheet within the industry, when pricing power is weak that small difference is significant.

Second, I am a proponent of “good enough” investing.? What I am saying here is that it is very difficult to achieve optimal results, and that if you try too hard to achieve optimal results, it is likely that you will do worse than good enough results.? The demands of perfection kill.? Size your goals to what is humanly possible.? My methods allow me to sleep at night.? My methods allow me to step away from my computer, and spend time analyzing what really might matter.? I can go visit clients and not worry that something is going to blow up on me.

This is not laziness on my part.? It is my view that most investors can do well enough in investing at low to moderate levels of risk.? But at high levels of risk, you have to get too many things right too much of the time in order to succeed.

That’s all for now.? Back next week when I write about rule number four.

Twenty Answers from the Author of Risk and the Smart Investor

Posted on 25 September 2010 by David Merkel

A little bit ago, I published Twenty Questions for the Author of Risk and the Smart Investor.? Well, David X. Martin got back to me, and here are his thoughtful answers.? I will have more commentary on this as I write the book review, which I am doing immediately after posting this.

1. Q: Imagine you are talking to a bright 12-year old girl.? How would you explain to her why and how the financial crisis happened?

A: Think of what happens when you blow up a balloon. First it expands, but eventually, if you continue to add more and more air, it bursts. The air going into the balloon in the years leading up to the recent financial crisis was either ?borrowed? air, that is air that was bought on credit, or air that was highly leveraged. In other words, only a small part of the air was paid for, and the rest was borrowed. And when the balloon burst most of those that had borrowed air, or had lent air to others, were left with nothing.

2. Q: I was fascinated with the structure of your book, which I found tedious and hokey at first, but I grew to like it.? The way I see it, you introduce the topic through your experience, then explain the theory, then show neglect of it led to failure, and then you give us the stories of Max and Rob.? How did you hit upon this intriguing and novel way to write your book?

A: I first thought about the decision process, and described the continuous process of risk management in relatively simple steps?i.e., assessment (know where you are and what you do not know); rules of the game (know your risk appetite, transparency, diversification, checks and balances); decision-making (alternatives, responsibilities, reputation and time frame); and finally, reevaluation (monitor and learn from your mistakes ). My goal was not to write a “how to book” but rather to help readers build frameworks?to make good decisions, and it seemed it would be helpful, and entertaining, I hoped, to see the process in action through the fictional risk story.

3. Q: Why do you suppose so few people in risk management, and senior management at major financial firms, were unwilling to consider alternative views of the sustainability of the risks being taken as the risks got larger and larger relative to the equity of individual companies, the industry as a whole, and the economy as a whole?

A: People get lulled into seeing the world from a particular viewpoint, particularly if they have never been through the worse case scenario. I?ve been through many of them.

4. Q: As a risk manager, bosses would sometimes get frustrated with me when they wanted a simple answer to a complex question that had significant riskiness.?They did not like answers like, ?I don?t know, it could have six significant effects on our company.?? How can we convey the limits of our knowledge in a way that management can get the true uncertainty and riskiness of the environment that we work in?? How can we get management to consider scenarios that are reasonable, and could harm the company, but few others in similar situations are testing for?

A: Scenarios are a great way of thinking about the future in terms of the realm of possible outcomes. Thinking now about what you can/should be doing about those possible outcomes, is an excellent way to communicate risk potential to management. and engage their interest.

5. Q: In your experience, how good are the managements of financial companies at establishing their risk tolerances?? Better, how good are they at enforcing those limits, such that they are never exceeded?

A: Not very good. Businesses have strategies, strategies entail risks, and risks require capital. Very few companies take a holistic view of risk, capital, and strategy.

6. Q: How do you create a transparent risk culture in a firm?? How do you get resisters to go along, even if it is management that does not see the full importance of the concept?

A: Cultures do not change rapidly, they migrate. Transparency starts at the top and it will never spread through a company if management doesn?t recognize its importance, and communicate its importance to everyone in the firm.

7. Q: Are most cases where a person or a company fails to diversify intentional or unintentional?? Do we put too many eggs in one basket more out of ignorance or greed?

A: Diversification is a strategy that requires discipline. Take the case where you start with a diversified portfolio, and then one position takes off and acquires a disproportionate weight in your portfolio. Regardless whether the cause is ignorance (you did not monitor your portfolio?s balance) or greed (you rode the stock up ), the root problem is a lack of discipline.

8. Q: Why do you suppose that checks and balances for risk management are not built into the cultures of many financial companies?

A: When does a problem exist? Even if it has always been there, it comes into existence only when you recognize that it is a problem. Many times checks and balances do not exist because no one recognizes the risk/problem and therefore no one evaluates the checks, and balances, and controls needed to manage it.

9. Q: I have a friend Pat Lewis who developed a risk management system for Bear that could have prevented the failure of the firm, but it was ignored because it got in the way of profit center manager goals.? Was it the same for you at Citigroup when your ?Windows on Risk? got tossed out the window?

A: See pages 124-5 in my book. You never have to ask a portfolio manager what he or she thinks, just look at their portfolio. When I found out Citibank was no longer using Windows on Risk I sold my entire position that day. I recall it was at $51.75.

10. Q: Can culture and personal judgment work in risk management ever?? Take Berkshire Hathaway ? risk control is embedded in the characters of a few people, notably Warren Buffett and Charlie Munger.?If the culture is really, really good, and it comes from the top, can risk management work when it is seemingly informal?? (Remember, you don?t want to disappoint Warren.)

A: Risk management is all about culture and personal judgment. I remember pondering the question, “How high is up” at a Windows on Risk meeting at Citibank. The most senior management were sitting around the table. We came to our answer by asking the following question: What was the amount of loss we would be embarrassed to read about in the WSJ? That number, it turned out, was not very high, at least in the judgment of the people sitting around that table. News of that decision got around and had an impact on the company culture.

11. Q: How can you teach younger people in risk management intuition about risk that helps them have a healthy skepticism for the results of impressive complex modeling?

A: I co-wrote an article with Mike Powers from the London School of Economics titled “The End of Enterprise Risk Management.? Models are just one input; they are not a substitute for good judgment.

12. Q: Is it possible to do effective risk management in a financial firm if management is less than wholeheartedly committed to the goal?

A: I forgot where I first heard the expression, but it explains my feelings. “A fish starts to stink from its head first.?

13. Q: Aside from AIG, and other financial insurers, the insurance industry came through the crisis better than the banks because they focused on longer-term stress tests, and not on short-term measures like VAR.? Should the banking industry imitate the insurance industry, and focus on longer-term measures of risk, or continue to rely on VAR?

A: VaR is one measure. It has deficiencies. For example, the loss amounts predicted in the tails (that is, the extreme cases) are the best case scenarios, not the worse case. Institutionalizing this one measure, or relying on the measurement of “risk based capital,” has not worked.

14. Q: Seemingly the big complex banks did not analyze their liquidity risk, particularly with repo lines.? Why did they miss such an obvious area of risk management?

A: Liquidity is a very difficult concept. If you decide to sell your house in the suburbs at 2AM in the morning and put a “for sale” sign on your lawn at that hour, how quickly do you think it will sell. Liquidity, therefore, has to be thought of in terms of time. If, for instance, you see high average daily volume in a stock what is your real liquidity if the volume is the result of a nano second of high speed trading?.

15. Q: How much can risk management be shaped in financial firms by the compensation incentives that employees and managers receive?

I saw Walter Wriston six months before he died. He asked me how things were going. I said, nothing wrong with risk as long as you manage it. He smiled at me from ear to ear because those were his words, from his book Risk and other Four Letter Words. I think it is all about matching responsibility and authority, having the right culture, learning from errors, and promoting ethics. Incentives are on the list, but not at the top.

16. Q: I have often turned down shady deals in business, saying that you only get one reputation in this world.? How do you encourage an attitude like this in financial firms among staff?

A: If you go to sleep in s–t, you will most likely wake up covered with flies. I would start with an ethics committee, and make sure the most important people in the firm were on it.

17. Q: A lot of portfolio management and risk management is juggling different time frames.? Is there a good structure for balancing the demands of the short-, intermediate-, and long-terms?

A: A poor investment decision is still the same poor investment decision irrespective of the time frame. If you always try to do the right thing, time frames become less important.

I am not saying to forget about the timeframe, just that you shouldn?t let it lead you to a poor decision.

18. Q: Most developed country economic players assume that wars will have no impact on their portfolios.? Same for famine, plague, or environmental degradation.? What can you do to get investors to think about the broader risks that could materially harm their well-being?

A: Great question, but this one is outside my realm of expertise.

19. Q: Are Rob?s more common in the world than Max?s? That?s my experience; what do you think?

A: I purposely made Rob and Max pretty different in order to illustrate the principles in the book. I think we are all human and have a little bit of each.

20. Q: At the end of your book, one of your friends dies.? Did you mean to teach us that even if we manage our risks right, we still can?t overcome problems beyond our scope, or were you trying to say something else, like creating a system or family that can perform well after you die?

A: My first draft of the book began with what is now the concluding chapter?the one in which I discuss the courage necessary to face death. The developmental editor at McGraw-Hill, of course, didn?t like it up front, so I moved it to the end, where I wrote: ?It is at that moment, when death is imminent, and there is no possibility of escape, that courage comes into the picture.?

My view is that this mindset can be useful long before we consider our mortality, by helping us understand that there are realities that must be faced and not avoided. In investing as in life, long term success results from thoughtful, timely preparation. Or in other words, the best decisions are made before we are forced to make them. The best decisions are made before certain inevitabilities, so long on the horizon, appear unexpectedly in front of us, and we no longer have the time to consider the alternatives; when we can still calmly and intelligently assess our circumstances, consider alternatives, and make informed decisions, monitoring the results as we go.

This is what I refer to as ?de-risking,? and although the principles set out here are drawn from my experience as a risk manager at a number of leading investment firms, they apply not only to financial matters, but to almost every decision you?ll make over the course of your life.

So to my way of thinking, ?when lightning strikes–the processes that you have put in place make courage less necessary. Put another way, if you embrace risk by following an orderly process you will have constructed a framework that will help you make the right decisions

Of Investment Earnings Assumptions and Century Bonds

Posted on 23 September 2010 by David Merkel

Recently I got an e-mail from my friend Kid Dynamite.? He asked me an interesting question about pensions and long-duration bonds:

?back to the concept of century bonds.? I’m not sure if you read my recent pension post (http://fridayinvegas.blogspot.com/2010/09/problem-with-pensions.html) , but I’m having trouble with the concept of pensions investing in 100 year bonds at 6% while using an 8% portfolio return assumption. Does not compute…(and you can even pretend that pensions have 100 year obligations)

I just don’t get the concept of locking in long duration returns below your long term bogey. That just means that you have to do even better on the balance of your portfolio…which is nice to pretend about, but in reality, if you can do better on the balance, why bother with the 6% fixed income???

It’s a great question and one that deserves more thought.? To do that, we have to separate the accounting from the economics.

When I was a young actuary, I was preparing to take the old Society of Actuaries test eight, which was the Investments exam.? An older British actuary made a comment in one of the study notes that I had to think about several times before I understood it: “Risk premiums must be taken as earned, and never capitalized.”

Sadly, the pension profession never got the memo on that idea.? The setting of investment assumptions accepts as a rule that risk margins will be earned without fail.? Therefore, when looking at a portfolio of common stocks in a pension trust, the actuary will assume that the equity premium will be earned over the long haul and build that into his discount rate assumptions and earned rate assumptions.? The same is true of bonds in the pension trust.? They may haircut the yield for potential default losses, but they will assume that much of the spread over Treasuries will be earned without fail and thus they capitalize the excess returns.

Let’s pretend that the 6% century bond that Kid Dynamite told me about is risk free.? Also, let’s pretend that the pension actually needs bonds as long as a century bond.? Defined benefit pension plans, if trying to match cash flows, need bonds longer than 30 years, but probably don’t need bonds longer than 75 years.? That said, given the lack of bonds that are longer than 30 years, a century bond will still prove useful in trying to immunize the tail cash flows of the defined benefit pension plan.

What that 6% century bond tells us is that the investment return assumption on an economic basis is too high.? And, given that the yields on safe debt shorter than a century is much less than 6%, it probably means that the investment earnings assumption rate is way too high at 8%, and should definitely be lower than 6%.

I know that’s not what GAAP accounting requires.? GAAP accounting allows you to choose whatever investment earnings rate you can justify using statistics.? That’s not the way GAAP accounting should work though.? GAAP accounting should work with discount rates derived from low risk fixed income securities, and use those to develop the investment earnings assumption.

If you earn more than the risk free investment earnings assumption, good.? Those excess earnings will reduce the pension plan deficit or increase its surplus.

Okay, then suppose we reset the investment earnings assumption at 4%, because that’s closer to where it should be economically.? My, what large pension deficits we see.? But now, all of a sudden, that 6% century bond looks pretty good, because it brings the cash flows of the plan into better balance, and earns a decent return in excess of the earnings assumption.

So, the problem isn’t with the century bond, it’s with the earnings assumption.? Now why does that earnings assumption exist?

The US government wanted to encourage the creation of defined benefit pension plans, and so informally encouraged loose standards with respect to the earnings assumption.
For years, it worked well, while we had bull markets going on, and interest rates were high, which decreased the value of the pension liabilities.
The IRS took actions to prevent defined benefit plans from building up large surpluses, because it decreased their tax take.? Had companies been allowed to build up large surpluses, we wouldn’t be in the mess that we?re in today.
There is the lazy acceptance of long-term historical figures in setting earnings assumptions, instead of building them from the ground up using a low risk yield curve, and conservative assumptions on how much risky assets can earn over the low risk yield curve.

So in an environment like this, where interest rates are low, and surpluses could not be built up in the past, pension funds are hurting.? The truth is, they are worse off than their stated deficits imply.? For economic and political reasons, the likely outcome resembles the riddle of how one eats an elephant: one bite at a time.

So we will see investment earnings assumptions and discount rates fall slowly, far too slowly to be the economic truth, but slowly recognizing funding gaps as corporations eat the loss one bite at a time, as they can afford to.

The investing implication is this: for any stock you own that sponsors the defined benefit pension plan, take a look at the earnings assumption and raise the value of the liabilities.? Also recognize that earnings will be lower than expected if the deficit is large and they need to make cash contributions in order to fund the pension plan.? That said, they could terminate the plan, and I suspect many current defined benefit plan sponsors will do so.

And given that, there is one more implication: if you are employed by, or are a beneficiary of a defined benefit pension plan, take a look at the form 5500, or at the company’s financial statements and look at the size of the deficit.? Take a look at what the PBGC will guarantee for you, and adjust your plans so that you are not relying on the continued well-being of the defined benefit pension plan.

I wish I could be the bearer of better news than this, but it is better to be aware of problems, then to learn that what you don’t know can hurt you.

Ten Notes on the Current Market Scene

Posted on 24 August 2010 by David Merkel

1) Start with the big one from yesterday.? On of my favorite monetary heretics, Raghuram Rajan, whose excellent book I reviewed, Fault Lines, pointed out how he had gotten it right prior to the crisis, versus many at the Fed who blew it badly.? Rajan suggests that Fed Funds should be at 2-2.25%, which to me would be a neutral level for Fed Funds.? That’s a reasonable level.? The economy needs to work its way out of this crisis, even if it mean failures of enterprises relying on a low short rate.? Entities that can’t survive low positive rates that give savers something to chew on should die.? Mercilessly.? Monetary policy at present is a glorified form of stealing from savers, who deserve more for their sacrifice.

2) Peter Eavis, an old friend, echoes my points on QE, in his piece Government Clouds Value of Investments.? When the government is actively trying to destroy the willingness to hold short-term assets, and engages in QE, it makes all rational calculations on investments a farce.

3) I agree with John Hussman in a limited way.? QE artificially lowers interest rates, which lowers the forward value of the US Dollar.? That doesn’t mean it will generate a collapse; I don’t think it could do that unless the Fed began to do astounding things, like monetize a large fraction of all debt claims.

4) The US Government is so dysfunctional that the baseline budget has increased 4.4 Trillion over the next 10 years.? This is the beginning of the end of the supercycle, and the reduction of America to the influence level of Brazil.? Earnings levels will converge as well, but more slowly.

5) While we are thinking soggy, think of Japan.? Years of fiscal and monetary stimulus have availed little.? Overly low interest rates have fostered an economy satisfied? with low ROEs.? Low interest rates coddle laziness, and encourage stagnation.

6) There are limits to stimulus, whether monetary or fiscal.? There is no magic way to produce prosperity by government fiat.? Stimulus, by its nature, will run into constraints of default or inflation, if taken far enough.? If not, why doesn’t the Fed buy up all debt?? (leaving aside laws) Isn’t QE a free lunch?

7) Deflation is tough; it weighs upon cities, states and other municipalities, who hide their true obligations.

8 ) Hoisington, the best unknown bond manager.? Where do they think long rates are going?? 2% or so on the 30-year.? Makes the current buyers of bond funds look like pikers.? That’s over a 35% gain from here.? If they are right, their fame will be legendary.? Now, that could explain the willingness to fund ultra-long duration debt, because the gains will be bigger still.? What a great confusing time to be a bond investor, until something fails.

9) Or consider the Norfolk Southern 100-year bond deal yesterday.? Quoting the WSJ:

In what bankers hope will be the first in a new round of 100-year bond sales, Norfolk Southern Corp. raised $250 million Monday by selling debt that it won’t have to repay until the next century.

—

Investor interest was strong enough that the company increased the size of the new sale from $100 million. Market participants said investors had expressed an interest in buying at least $75 million of the debt before the company decided to announce the $100 million deal.

—

The interest rate on Norfolk Southern’s new debt is 6% for a yield of 5.95%, about 0.90 percentage points more than where the company’s outstanding 30 year debt was trading Monday. It was the lowest yield for 100-year debt bankers could recall, breaking through the 6% yield on the company’s 100-year issue in 2005.

—

“There is no question, obviously, that you are giving up a bit of liquidity, but you’re getting a pickup of 90 basis points to move out of the 30-year,” said Jeff Coil, senior portfolio manager at Legal & General Investment Management America. “But you’re getting good income on a stable cash credit in a sector where there are only a handful of rails left.”

Mr. Coil said the firm had a “sizeable” order in the deal. There were approximately 20 investors overall.

Moody’s Investors Service rated the new senior fixed-rate bonds Baa1, and both Standard & Poor’s and Fitch Ratings rated them BBB+.

Is 0.90%/year enough to compensate from going from 30 to 100 years?? I think so. The difference in interest rate sensitivity of a 30 versus a 100 are small at a yield of 5-6%, and if you have a liability structure that can handle it, as a life insurer might, it makes a lot of sense.? After all, a life insurer can’t economically invest in equities because of capital restrictions. You could compare it to investing in long dated preferred stock or junior debt, but then if there is a default, the losses are more severe than with a senior unsecured bond.

10) I’ve never found the yield curve model for recession/recovery compelling.? Limited data set, not covering the Great Depression, etc.

More to come.

Managing Illiquid Assets

Posted on 23 August 201023 August 2010 by David Merkel

Illiquidity is an underrated risk.? Most financial company failures are due to illiquidity, which usually takes the form of too many illiquid assets and liquid liabilities.? Adding to the difficulty is that it is generally difficult to price illiquid assets, because they don’t trade often.

So where do we see failures due to illiquidity?

Banks — too numerous to mention, though FDIC insurance restrains it now.
Life insurers, particularly those that write a lot of deferred annuities.
AIG and the GSEs — abominations all.
Bear and Lehman — waiving the leverage limit was one of the stupidest regulatory decisions ever.
Hedge funds – LTCM was the granddaddy of failures, but many have choked because redemptions forced liquidation of assets at unfavorable prices.
No colleges, though those college that were too aggressive on illiquid assets got whupped in 2008.? Some were forced to raise liquidity in costly ways.? Same for many overly aggressive pension plans, many of whom came late to the game with Venture Capital, Hedge Funds, Timber, Commodities, etc.

Face it.? Most alternative asset classes involve additional illiquidity.? That is an additional risk, and when evaluating those investments, the expected rate of return must be greater than that for liquid investments.

As an aside, there is another factor to be considered with alternative investments.? That factor is strategy capacity.? Alternative investments do best when they are new.? Here is my version of the phases that they go through:

New — few know about it except some business-minded investors.? Only the best deals get done.
Growing — a modest number know about it, and a tiny number of consultants.? Only very good deals get done.
Comes of age — many know about it, and most consultants pitch it to their clients as the way to go.? Good deals get done.
Maturity — almost everyone knows about it, and it is a standard aspect of asset allocation for consultants, who have their means of differentiating between different providers, based on metrics that will later be revealed to be useless.? All reasonable deals get done.
Post-maturity — Late bloomers make it to the party, and beg to get in, thinking that past is prologue, and do not realize that deal quality has eroded severely.
Failure, which brings maturity — deals fail, leading the market to scrutinize all investments, leading to true risk-based pricing.? Later adopters abandon the market, and take losses.? Earlier adopters sharpen practices, and prepare for a more normal asset class.

So, when looking at illiquid assets, how do you determine how much to invest?? First determine how much of your funding base will never leave over the next 10 years.? When I was a corporate bond manager, that was 25% of the assets that I was managing, because of structured settlements and immediate annuities.

For a pension plan or endowment, forecast needed withdrawals over the next ten years, and calculate the present value at a conservative discount rate, no higher than 1% above the ten-year Treasury yield.? Invest that much in short to intermediate bond investments.? You can invest the rest in illiquid assets, because most illiquid assets become liquid over ten years.

But after that, there is an additional way of controlling illiquidity risk — time once again for the fusion solution! Money market funds run a ladder of maturities.? Stable value funds run a longer ladder, as should commodity ETFs, rather than floating at spot.? Then there are clever advisers who run municipal and other bond ladders for wealthy and semi-wealthy clients.? Running a ladder of maturities is one of the most robust management techniques as far as interest rate risk is concerned.? There is always money coming out and in every year, which slowly leads the portfolio yield in the direction of average rates.

Now, if these bonds are less liquid muni bonds, but the credit risk is low, you don’t care as much about the illiquidity, because the ladder produces its own liquidity as bonds mature.? The key question is sizing the length of the ladder, which comes down to a question of analyzing the liquidity/income needs of the client, combined with a forecast on the secular direction of rates.? The forecast is the least important item, because it is the toughest to get right.? (An aside: who has been right on bond yields consistently for the last 20+ years?? Hoisington, my favorite deflationists.? Wish I had listened more closely.)

The same principle applies to pension funds, endowments, life insurers with a few twists.? Divide your liabilities in two.? What obligations do you know cannot be changed, except at your discretion?? That group of liabilities can have illiquid assets to fund them.? Try to match the payout streams, but if not, try to match them in broad with a ladder, keeping in mind what mismatches you will likely face over the next 1-2 years in order to properly size your cash position.

The rest of the liabilities need more intensive modeling, analyzing what could make them change.? You can try to buy assets that change along with the liabilities, but in practice that is hard to do.? (That said, there are no end of clever derivative instruments available to solve the problem in theory.? Caveat emptor.)? The assets have to be liquid for this portfolio.? Other aspects of portfolio choice will depend on valuation parameters, credit spreads, yield curve shape, market volatilities, as well as macroeconomic factors.

Three Closing Notes

1) Now, all that said, just because you can take on illiquidity doesn’t mean that you should.? A good manager has a feel from history for what the proper liquidity give up is in valuations for stocks and other risk assets, and credit spreads for fixed income assets of all sorts.

Was it worth moving from the:

Relatively liquid AAA tranche to the illiquid AA, A or BBB tranche for 0.10%, 0.20%, 0.40%/year respectively?? As a bond manager at much larger insurance company said back in 2000 — “It’s free money.”? (That is almost always a dangerous phrase.) My view was there was more illiquidity and credit risk than we could consider.
Relatively liquid large-issue BBB bank bond to the relatively illiquid small-issue BBB bank bond for 1% more in yield?? Hard to say.? There are a lot of factors involved here, and your credit analyst will have to be at the top of his game.? It also depends on where you are in the speculation cycle.
Liquid public equities to private equity or hedge funds with lockups?? Tough question.? Try to figure out what the unlevered returns are for comparative purposes.? Analyze long-term competitive advantage.? Look at current deal quality and valuation metrics.? For hedge funds, look at how credit spreads moved over their performance horizon.? Anyone can make money when spreads are tightening, but who makes money when spreads are blowing out?? Analyze them over a full credit cycle.

2) Institutions that did not previously do more liquidity analysis because we had been in near-boom conditions for decades need to at least do scenario testing to assure that they aren’t overplaying their hands, such that they might be forced to make bad decisions if liquidity gets tight.? Safety first.? (This applies to governments and industrial corporations too, as we will experience over the next three years.)

3) Finally, if you decide to make a large illiquid purchase like Mr. Buffett did last year, make triple-sure of your logic and your liquidity positioning.? Nothing lives forever, but you can prolong the life of the institutions you serve by careful reasoning and planning, particularly regarding liquidity.? Get financing when you can, not when you need it. It takes humility to do so, but it yields the quiet reward of continued existence at a modest price.

Brief Reviews of Three Books

Posted on 10 July 201012 February 2011 by David Merkel

These three book reviews are for books that I scanned, and did not read in depth.

Quantitative Equity Investing

The first book: Quantitative Equity Investing, is a book for practitioners with strong math skills, not average investors.? It reviews basic econometrics and factor analysis, and then applies these tools in an effort to sort out anomalies in investment markets, tease out important factors driving markets, and find workable trading strategies, considering execution costs, slippage, etc.? It has a brief section on algorithmic and high frequency trading.

On the whole, I didn’t find anything that new or amazing in the book.? Though there were a few things in the book that I hadn’t seen before, they were trivial things that I looked at and said, “Oh, yeah, of course.”

The book is generic in the way that it deals with the topic.? It is no going to give you ideas to pursue, but only tools that you can use if you have ideas tht you want to analyze, and turn into strategies.

Who would benefit from this book?

You have to have a very strong math background, including the type of Matrix Algebra that one would use in graduate-level Econometrics.? To that end, this book would be most useful to grad students wanting an introduction to how to apply their math skills to the markets.

The book is available here: Quantitative Equity Investing: Techniques and Strategies (The Frank J. Fabozzi Series)

The New Science of Asset Allocation

This book uses Modern Portfolio Theory in order to analyze asset allocation decisions.? Those that have read me for a while know that I think that is a flawed paradigm, in need of replacement.? For those that want a reasonable understanding of that paradigm in a short space, the book does that very well.

That said, the book has its virtues.? The chapter on the “Myths of Asset Allocation” shows that the authors have some depth of insight into the foibles and misunderstandings that surround asset allocation.? The book also goes into the importance of qualitative analysis of managers, looking up from the numbers so that you can avoid allocating money to the next Madoff.? It also describes the use of derivatives in order to control risk exposures.

Each chapter ends with a short summary of the takeaways from the chapter, which serves to reinforce the points of the book.

Though the book has the word “new” in the title, I did not find much new in it.? If one is looking for novel implementation methods for asset allocation, best to look elsewhere.

Who would benefit from this book?

This is not a book for average investors.? It is for professionals who want to brush up their asset allocation skills, and young professionals wanting insight into asset allocation.

The book is available here: The New Science of Asset Allocation: Risk Management in a Multi-Asset World (Wiley Finance)

The Economics of Food: How Feeding and Fueling the Planet Affects Food Prices

To me, this was the most interesting book of the three, but I feel it was mistitled.? A better title would have been: “Fueled: The Effects of? Using Food for Fuel” or something like that, because the central question of the book is to what degree has using crops to produce biomass for fuel production (usually ethanol) affected the costs of food and fuel.

I found the book is very even-handed, to a fault.? It argues that the use of crops for fuel production had little impact on food costs, and that there were many other factors that made food prices rise when ethanol production was going gangbusters.? Weather, domestic and foreign demand and many other factors had a role in moving food prices, not just ethanol.

After reviewing the book, I have a better sense of the complexity of the question, and that it will not admit easy answers.

Who would benefit from this book?

Anyone who wants a basic understanding of food economics, and how that is impacted by a wide number of factors including using crops for the production of fuel would benefit from this book.? The book is well written, and seemingly balanced.

The book is available here: The Economics of Food: How Feeding and Fueling the Planet Affects Food Prices

Full disclosure: The publishers sent me copies of these books, hoping that I would review them.? I review about 80% of the books that get sent to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

Book Review: Priceless

Posted on 9 July 2010 by David Merkel

I really enjoyed the book Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street (review forthcoming), so when I learned the William Poundstone had written a new book, I went out and bought it.

This book, Priceless: The Myth of Fair Value (and How to Take Advantage of It), covers rationality in decision making, and how markets and marketers take advantage of the deficiencies in rationality in average people.

There are many in the investment community that admire behavioral finance, and many who say that it might be true, but where are the big profits to be made from it?

This book doesn’t cover behavioral finance per se, but it does cover its analogue in pricing and marketing.? In a negotiation, the first person to put a price on the table tends to push the final price agreed to closer to his price.? Leaving aside no-haggle dealerships, why do car dealers post high prices for vehicles?? Because only a minority does the research to understand what the minimum price is that a dealer will accept.? The rest pay more, often a lot more.? Personally, I do a lot of research before I buy a car, and it helps me spot dealer errors in pricing.

The book is replete with examples of how there is no “fair” way to price things out.? What are the proper damages for a jury settlement?? The attorney for the plaintiff is incented to come up with the highest believable amount for the jury, because they will render a verdict less than that.? Make the ceiling as high as possible, and the plaintiff will get more.

We call placing the first price on the table “anchoring,” because it pulls the final result toward itself.? The book is filled with experiments dealing with anchoring.

The book also spends a lot of time on the “ultimatum game,” where a person gets $10, and must offer some of it to a second person, but if the second person turns him down, the first person gets nothing.? The main lesson here is that pride is stronger than greed.? Yes, it can be construed as a question of fairness, but when someone gives up money to deny money to someone else, it is not fairness but envy.? Why pay to make someone else worse off?? To teach him a lesson?? What an expensive lesson.

Much of this book was a walk down memory lane for me.? I discovered Kahneman and Tversky in the Fall of 1982, and I found their ideas to be more cogent than much of the “individuals maximize utility” cant that was commonly heard from most professors teaching microeconomics.? People are far more complex than homo oeconomicus.? Small surprise that most tests of microeconomics as a system are not confirmed by the data.

Kahneman and Tversky showed via a wide array of examples that the decisions people make are affected by the way they are presented to them.? People can be manipulated in limited ways in order to affect the decisions that they make.

The book deals with many marketing tricks, particularly the powerful word, “free,”? and how it dupes people into buying something to get something for free.? For another example, why companies sell really expensive items that few will want, because people will buy the next most expensive item with greater probability, versus less expensive items of the same class.

Economics is Hard; the Bad Assumptions of Economists Makes it Harder

Posted on 30 June 2010 by David Merkel

Before I start this evening, a small apology to my readers.? Things have been busy around here; blogging has been well below what I would like to do.? Worse, for some unexplainable reason, the hosting of my blog fell apart two days ago, and not for any change that I made.? As it was, WordPress deemed my theme to be broken.? So, I went in search of a new theme that would be compatible with what I used to have with Salattinet, and chose Green Apple.? I am a little more than half through in modifying it.

That said, I needed to make changes and had been delaying doing so.? I have modified my blogroll to reflect who I regularly read.? For the most part, I feature those that say more, but say it less frequently.

I will modify my leftbar to make it shorter, so that the site loads faster.? I will categorize my book reviews, and place the least recent of them on a separate page.

Though I like long post blogging, I will do more short posts.? My site will load a lot faster, so for those that visit the site directly, it should not be as much of a pain.

I expect to have this complete over the next month.? Much as this episode was a pain for me, I kept a good attitude about it, and am looking forward to the better blog that may result from the changes.

-==-=–==-=-=–=-=-=-=-==-=-=–==-=-=–==-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

In order to write tonight’s essay, I scanned Kartik Athreya’s letter, and used OCR to turn it into a tractable file.? I had to correct OCR errors, but I left his spelling and grammar errors alone.? The formatting is slightly different, and fits on three pages, not the original four.

In many ways, economics and finance are about competition.? Writing about economics and finance is tough.? There are many facets to write about; there are feedback loops galore.? So, why do some writers in the blogosphere gain followers, and others don’t?

Tough question.? Being an engaging writer helps in the intermediate-run, and being a scandalmonger helps in the short-run.? In the long-run, all that matters is that the writer is right frequently, makes sense to readers, and has the humility to admit errors.? The economics and finance blogosphere is highly competitive, and talent tends to prevail over long periods of time.? Blogging is more of a meritocracy than peer-reviewed journals.? It more closely resembles “perfect competition.”

There is another aspect to blogging that is different from writing for economic journals: we have more of a slant toward positive economics than normative economics.? Ethics plays a larger role in what bloggers write about than what timid Ph.D. economists will write about.

Just as Law is too important to be left to lawyers, with all of their self-protecting biases, even so Economics is too important to be left to economists with Ph.Ds.? The economics guild protects its own in much the same way as described in Thomas Kuhn’s The Structure of Scientific Revolutions. Bad paradigms survive until a significant number of young scientists displace the paradigm, and replace it with a new one that explains things better.

Economics needs a better paradigm, and I do not mean better mathematical formulas.? For decades economists have been playing sterile math games assuming what they define as rational behavior which is not rational.

Simple example: when I was much younger, I was traveling with the two senior members of my Ph. D. dissertation committee, and I asked them, “But what if consumers don’t maximize?? What if they conserve on maximization, because maximization takes a lot of effort, and take the first ‘good enough’ solution?”? Their answer was the intellectual equivalent of a shrug.? Without maximization, mathematical economics falls apart.? Besides, Milton Friedman taught us that the realism of assumptions doesn’t matter.

I disagree.? It matters a great deal.? If we can’t get optimization to work, all of the implications of a model will fail; there is no way to get correct significant estimates of an optimization model, if people merely satisfice.? And most of us know that we are under time and knowledge constraints, and do not optimize.

The same issues apply to the Microeconomic theory of the firm.? But now let us consider Macroeconomics, which is even squishier.? Academic macroeconomists did not distinguish themselves regarding the recent economic crisis.? Few predicted it, versus a greater number of economist in the business world that did predict it.? Think about it: what should we say about macroeconomic models that claim that the financing structure of the economy is neutral?? That it does not matter how much is financed by debt versus equity?

As I said to Dr. Carmen Reinhart when I met her, “We need more economists that are students of history, and fewer that can do the pretty math for the ideal world that does not exist.”? She seemed to agree.

Get in contact with real data.? Abandon theories that don’t make sense when applied to the real world.? Work in the markets; see if you can make money.? Be practical and adjust.? If businesses can’t lever up infinitely, why should we assume that governments can do so?? Because they can tax or inflate it away?? Ah, but each comes with a cost.

-==–==–=-=-=-=-=-=-=-==–=-=-=-=-=-==–=-=-==-

With respect to Athreya’s letter, I would tell him to grow up, and genuinely compete with those who blog on economics and finance.? Though I am not a Ph.D., I did pass my comprehensive exams and oral exams from UC-Davis, an institution far more prominent than the University of Iowa, at least as far as applied economics goes.? That my dissertation committee left me, and that I could not set up a new committee killed my Ph. D.? It did force me to become an actuary, (my wife-to-be and I wanted to marry and start our family) and learn a lot of practical things about markets and funding structures that most economists will never bother with, to their practical detriment.

In my days at Johns Hopkins and UC-Davis, the longer that I studied, the more I learned that economics waves its hands at the problems that come whenever detailed studies attempt to test the main theories.? The results aren’t pretty; far better to have ad hoc theories that work over a limited range, than theories that proceed from basic principles, but do not work.

Yes, economics is hard.? Much harder than most economists think.? They need to abandon Keynesian, Chicago, and Neoclassical thinking, and aim for something that fits the data more closely.? That may not be the Austrian School, but it will be closer to that than the Neoclassical School.

We need an economic paradigm that is willing to tell the politicians that their actions will do no good, and will likely do harm; that central banks can’t create prosperity.? Governments exist to enforce justice, not goose the economy.

When we are in the bust phase of the economy, there are no good solutions, except to take the pain, realize the losses, and come to a quick end through a painful “big bang.”? This is the solution our central bank and politicians are fighting.? The “Japan solution” that is being followed refinances assets that are in oversupply at progressively lower rates, allowing bad assets to survive, and encouraging unproductive investment.? Real progress comes from accepting that there is no easy solution, and allowing the economy to liquidate bad investments without hindrance from the government or central bank.

The solution comes in preventing booms from getting out of hand, and always letting recessions be hard enough to liquidate bad investments.??? We can’t do that now in the midst of the bust, but after the bad debts of our economy are liquidated, much as the Depression ended in 1941 when Debt/GDP reached 1.4x due to compromises and payoffs, and not due to the government or Fed, there can be real growth again, because less-indebted consumers and businesses are ready to act.

To Mr. Athreya, I would say that he has insufficiently embraced the complexity of the economy.? It is so complex that reducing it to mathematics does not work well.? But in a spirit of friendship, I invite him to visit me in Maryland and have lunch or dinner with me, at my expense.? Maybe I will tell him the story of when I got to question the head of the Richmond Fed.

That’s all for now.? There is more to say, but I am tired, and might not continue the essay so well.

AEI: Preventing the Next Bubble

Posted on 15 June 2010 by David Merkel

While trying to figure out what I should do, given the demise of my prior firm, I have been attending some events in Washington, DC to stay sharp, and consider what others are saying on public policy issues.? So, on Monday I went to the American Enterprise Institute to listen to their presentation on “Preventing the Next Bubble.”

Now, if you’ve read me for a while, you know that I think that the boom-bust cycle can’t be repealed, but it can be modified.? You can either get a bunch of moderate booms and busts, where the busts are allowed to burn out naturally, or you can try to suppress the busts (wrong strategy, try suppressing the booms), leading to anemic booms, declining marginal productivity of capital, and when bust suppression no longer works, you get a colossal bust, like the Great Depression or now.

There’s no free lunch in macroeconomics.? Academic economists foolishly look for ways to optimize economic performance.? They end up overinterpreting limited data, and given the biases of politicians that employ economists, suggest intervention where none is needed.

All that said, I enjoyed the presentations.? I felt the discussions were worth the two-plus hours that I spent on the matter, as well as the people that I met.

Preventing the Next Bubble

Bill Foster (U.S. House of Representatives (D-Ill.)) led off, suggesting that if you can make LTV ratios in residential lending countercyclical, you can? eliminate booms and busts.? He wants to put that into law next year.

He is an engineer by training, and like most engineers and physicists, they adopt a mechanistic model to control the economy.? My father-in-law, an eminent physicist, often suggests the same to me.? I tell him that economics is more similar to ecology than physics.? People hate having their freedom restrained, and so when arbitrary rules are imposed, even smart rules, they look for means of escape.? But his proposal misses many items:

Mortgage insurers will undo the tightening, and I can’t see a way to outlaw mortgage insurance.
Fraud issues still exist — appraisal and application fraud will undo some of the constraint, as will seller financing.
Monetary policy will be hindered by the countercyclical restraints on mortgage lending, and the Fed will loosen more aggressively as a result.? (Yes, I am looking 20 or so years out here, to when monetary policy normalizes.)

In my opinion, any proposal for preventing bubbles that does not limit the Fed is not a real proposal.? That said, the Fed had the ability during the housing bubble to constrain mortgage underwriting, and did not do it.? Why should a new law change matters?’

The next presentation was from Jay Brinkmann, of the Mortgage Bankers Association.? His presentation dug into reasons why demand for housing was unsustainable.? Whether it was weak underwriting, tight spreads, teaser rates, fraud, or incompetent credit models, there were a lot of reasons for failure.

But the politics of fixing things is tough.? Who wants to oppose the CRA, Realtors and Builders?? I would note that really tough credit busts occur with secured lending, because lenders ge deluded by the seeming value of the collateral.

Next was Allan Mendelowitz, of the Federal Housing Finance Board.? His presentation discussed how one could fight a mortgage bubble.? I noted four ways to fight:

Raise underwriting standards.
Decrease the abilities of the GSEs to lend.
Remove/decrease tax subsidies to home ownership, particularly those that allow for limited capital gains tax on house sales.
Raise down payments.

I was most impressed with Mark Zandi of Moody’s.? He didn’t just look at the housing market, but at bubbles generally.? He noted three ways to discern a bubble.

High turnover rates
Rise in prices
Increased leverage

He had three solutions:

Modify Fed policy to incorporate asset signals, such that when high yield spreads are tight, Fed policy should tighten.? (His rules were more complex than that.)
Make Risk Based Capital more cyclical
Genuinely regulate underwriting standards.

I thought Zandi’s ideas were the most comprehensive — after all it is unlikely that the next bubble will be in residential housing.? Why focus on the last war?? Why not aim for a generic solution?

John H. Makin, of? AEI and Caxton Associates, gave the simplest presentation.? Bubbles will always exist.? Central banks will not see them.? Booms militate against those who want to dampen them, because there are many who look for rewards without work.

A number of the presenters pointed to China and Israel, both of which are trying to run countercyclical mortgage policies.? The jury is out here.? Hopefully we can learn from their successes or mistakes.

-=-=-=-==-=–==–==-=–==-=-=–==-=-=-=–==–==-=-

I had my disagreements with the presenters.? Rep. Foster think that we lost $17.5 trillion of wealth from the bust.? My view is that we never had that wealth.? That is the nature of bubbles and busts.? Asset values can get pushed ahead by cheap credit.? Once the cheap credit was gone, so was a lot of the “wealth.”

I believe that the way things are financed can help detect bubbles.? It is almost always initially profitable to borrow short and lend long.? Most bubbles have a lot of people buying long-dated assets and financing a lot shorter than the assets useful lifetimes.

Also, bubbles usually start with a good idea, where money can be made at a low level of leverage.? But as prices get pushed up leverage levels rise for new entrants wanting to make money.? As prices are pushed up further, new buyers use cheap short term finance to acquire assets.? This is a sign that a bubble is nearing its end.? Another such sign that a bubble is nearing its reversal is that new owners rely on capital gains to stay afloat.? Owners have to continually feed the asset in order to hold it.? Few can do that, so when you see that, the bubble is nearly complete.? Sell with both hands.

Another disagreement that I had was that none of the speakers was willing to finger the Fed as a major culprit, given their overly loose monetary policy over the last 25 years.

I learned from one of the best, that with bank lending there is quality, quantity, and price.? In good markets, you can get two of the three.? In bad markets, you can get one of three.? In the most recent crisis, lenders ignored that, and assumed that current profits indicated good business.

But, in the finance business, there are “yield hogs.”? Yield hogs take for granted the stability of the financial system, and assume that they can ear an above average yield by taking more risk.

In general that does not work.? Yield hogs take losses.

=-=–==-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

So, I am not optimistic about preventing bubbles.? But, I can predict them on occasion, as I have described above:

Wrecking Ball Looms for Big Housing Spec
Real Estate?s Top Looms

The way assets are financed tells us a lot about their owners.? Are they here for the long haul or not?? Long term holders augur for positive price action, whereas stock renters argue for negative price action.

The Journal of Failed Finance Research

Posted on 12 May 2010 by David Merkel

This idea is applicable to many fields, but in the era of the internet, this is a cheap idea that should gain broad acceptance.? Academics would benefit from the creation of a journal of failed research.? Rather, many journals of failed research, Chemistry, Economics, Biology, Sociology, Finance, etc.? There should be buoys in the harbor saying this way does not work; go another way.? There would be three salutary effects:

1) Researchers would learn of ideas that don’t work and would avoid them.

2) Researchers would conclude that your process does not work, but they have a better way to proceed and act on it.

3) Academics would get credit for doing honest research, and not twisting research through falsifying data or tweaking formulas in order to get significant coefficients.

It is almost as valuable to know that something doesn’t work, than to know that is does work.? How much time could be saved, and new avenues acted on, through journals that record failed research.? Who knows, but that it might improve honesty among scientists, if they get credit for publishing failed research that is honest, versus falsifying data or engaging in a specification search in order to tweak coefficients to make them significant.

This would be a big improvement for every academic discipline worth writing about, where data and fair results matter.? Let it happen then.? I am willing to set up online journals for failed research.? Let the submissions begin.