Alan Kohler, Tim Toohey & the RBA get it wrong

On 9^th May 2011, Alan Kohler wrote the following on the Business Spectator web site:

Don’t be misled by last week’s commodities crunch, the Australian dollar is heading higher – much higher. That’s partly because of the return of the carry trade.

Kohler’s article was sent to me by a friend and it made me chuckle because it was absurd.

In that same month, I wrote an article on this blog (see The Volatile Australian Dollar), stating why I thought that both Alan Kohler and Tim Toohey (a Goldman Sachs economist, whose research Kohler’s article was based on) were completely wrong.

Now when Kohler made his characteristically bold pronouncement, the Australian dollar was trading at around $1.07 to the US dollar. But Kohler and Toohey told us it was going much higher!

In July of 2011 it reached $1.10 (as it had a few months prior), but from there it was all down hill.

With the Australian dollar now around $0.92 to the US dollar and never having traded above $1.10, we can say that Kohler and Toohey got that call completely wrong. In fact, it would not have been possible to have gotten it more wrong.

I also quoted John Taylor (CEO and founder of FX Concepts) in my May 2011 article. Taylor had the opposite opinion to Kohler and Toohey. Taylor of course was correct (as I strongly suspected he would be).

Now anyone can get a call wrong and that’s ok as long as your original rationale was sound. In this case the argument made by Kohler and Toohey was not sound. And both of them should have known better (especially Toohey). It was also unfortunate for Kohler that he put misplaced faith in Toohey’s research and went on record with it.

Of course, as a business journalist, you can make all sorts of incorrect predictions safe in the knowledge that no one will hold you to account for them. But why shouldn’t we hold people who make their living writing such things to account for what they go on record as saying? In Kohler’s case, he also sells an investing newsletter and therefore should be held to much higher account than other business journalists.

Kohler and Toohey are obviously not important figures, but unfortunately for everyone who lives in this country, the Reserve Bank of Australia (RBA) is an important entity.

The market ignored a few of the unnecessary interest rate cuts made by the RBA prior to May 2013, but the cut on 2 May 2013 was not ignored. It resulted in a devaluation of the Australian dollar by approximately 10 percent against several currencies in a matter of weeks.

This is quite scary stuff and the worst part is it’s not of any benefit to the country. The only end result of further devaluation of the Australian dollar can be inflation coupled with the reduction in income to self-funded retirees (and others who derive most of their income from fixed interest investments).

Having seen the fierce and disorderly devaluation of the Australian dollar in no time at all and the spooking of the share market by the cut, one would think that the RBA will hold off on any future cuts, but I honestly believe they are stupid enough to make further interest rate cuts. They have done stupid things in the past, remember how they ramped up interest rates at the beginning of the GFC? I have no faith in their ability to properly manage economic conditions or in their forecasting ability.

Why algorithmic trading will eventually replace fund managers

The traditional fund manager who uses his or her “expertise” to select stocks for their clients will gradually become an endangered species (and they know it). This is why you have been hearing a lot of negativity from these people about high frequency/algorithmic trading in recent times. These people know that their own returns are materially inferior to that of many high frequency/algorithmic traders.

As I’ve said previously here, most fund managers (and very especially Australian fund managers) have no discernable stock picking skills. Sure, you will have those who can point to index beating records over relatively short periods of time, but show me any fund manager in Australia who has returned a compound 15-20%+ over 20 or more years – they simply don’t exist. Most of them can’t even match a low cost index fund over time.

Many of these people have reached a station in life which is out of all proportion to their actual abilities. They have been able to so this by taking passive fees on assets under management which amount to billions of dollars across the industry.

How do they attract funds? Here’s how:

1. Firstly make sure you have a few years of good performance under your belt. This will have been obtained by simply getting lucky, playing popular (but temporary) trends, or with the assistance of a raging bull market (or all three);
2. If you can, appear in the media as an “expert” – the media classes anyone who is employed in the investment industry and who is breathing as an “expert”;
3. It always helps to have some charisma and to come across confidently;
4. Market your returns to investors who are too naïve to see through you and too lazy to care about the management of their own money;

 There you have it. Now you can sit back and charge 1-2% on assets for lousy performance. This can amount to millions of dollars and if you fail later on, don’t worry, you will get to keep all of your ill-gotten gains which were made when times were good.

Remember the full service stock brokers and also the old market makers? These guys use to rip us off – they literally stole our money for doing very little. Most of those guys are now out of business due to the internet and alternative market places and every day I’m thankful for that.

(Incidentally, I know many high frequency traders are involved in market making too, but their spreads are much lower than the old time market makers. The modern high frequency market makers simply cannot capture similar spreads to what the old market makers use to.)

The fund manager belongs in the same category as the old time stock brokers and market makers. Nearly all of them over-charge their clients. If you do not take responsibility for your own investments (including superannuation), you can be sure that someone is enjoying a very pleasant life style at your expense.

But why is algorithmic trading superior?

1. Algorithmic strategies can be accurately tested on vast amounts of data (often in seconds or minutes);
2. Algorithmic strategies can be executed by computers, removing human emotion from trading decisions;
3. Algorithmic strategies are consistent in what they do (unlike many humans);
4. Algorithms can detect patterns that are imperceptible to humans;
5. Algorithms can scan vast amounts of data, much more than a human ever could;
6. Algorithms can adapt to different environments, something many humans cannot do;
7. Properly conceived and successfully tested algorithms have predictive ability, something the vast majority of humans do not;
8. Advances in computing power are making algorithmic strategies cheaper and cheaper to implement as time goes by;
9. Because most algorithmic strategies are short-term, they are not as exposed to general market risk as buy and hold strategies, (e.g. regulatory risk is an all too common factor in Australia these days);
10. For all of the above reasons, algorithms have now advanced to the stage where they can trade stocks better than many humans.

This is why, over time, the traditional fund manager will go the way of the Dodo. As will the analysts at the investment banks and the economists (if you want to be rich, don’t listen to these people – they have mortgages). Algorithms can do all of their jobs much better than they can and in years to come they will.

The lazy, over-compensated fund managers will make a lot of noise and attempt to frighten people to maintain the status quo, but it will ultimately be futile.