Double Blind

As always, I enjoy reading what Justin has to say. He is very good at spilling his thoughts onto the keyboard.

Justin is attempting a very ambitious mission in his lab group – changing the culture of people’s minds. It’ll probably be a more difficult task than writing his thesis. His post also makes the lab sound full of miserable people working on projects they don’t want to do.

If there’s one lesson here that can be carried throughout the world, it’s that more time is not proportional to more productivity. Even if you work on something for 16 hours a day, 7 days a week, if you’re not motivated you’ll produce something mediocre.

In a knowledge based economy, people have to understand that more time does not mean more work. It’s more important to keep people engaged and interested, otherwise they’ll just clock in the hours and do an effective job of pretending to work.

Continued from the previous article:

I was impressed enough with the action in the morning, in addition to tepid economic numbers. I raised my limits somewhat, so either I end up with a few bucks profit, or I end up with a large one. If I left my original order I would have been liquidated at 113 4/32 with a nice profit, but I think I can do somewhat better on this trade.

We’ll see whether getting greedy will cost me or not. Also when I do my research tonight, I might raise the target to 16/32 or 20/32. I sniff a short squeeze coming and I prefer to capture most of that upside.

I finally received in the mail and cashed in my cheque received from the UBC Election Stock Market.

I asked the organizers of the market some questions concerning the income distributions, and the results were rather interesting. Werner Antweiler from the UBC Department of Commerce said the following (I’ve italicized one remark):

Hello Sacha,

In addition to Tom Ross’s reply, I’ve attached two PDF charts that show the distribution of gains and losses in the UBC Election Stock Market both in absolute (dollar) terms and relative (percentage) terms. The traders are lined up on the horizontal line in descending order of their change in assets and return on investment, respectively. As you can see, the majority of traders actually makes some gains, as there are a number of traders who are taking unsuccessful risky positions with large investments (typically in the majority government market).

I have recalculated the gains and losses based on our final results; Tom’s numbers were based on earlier projections. The 380 traders break down into 220 traders (58%) with gains, 152 traders (40%) with losses, and 8 traders (2%) who broke even exactly.

The most profitable trader in relative terms invested a mere $25 and ended up with $93.08, a 272% return on investment. The next-largest returns were 182%, 144%, 83%, and 77%. These were all investors with $25, $50, or $100 investments. Among traders who invested a full $1000, we had five traders who had a return on investment between 38% and 61%. Participants in the UBC-ESM reflect a wide range of risk aversity.

Out of the $95,733 invested in our market, just about 12% ($11,728) actually changes owners through gains and losses.

I have attached the contents of the PDF file and indicated my position on the graph as follows (click on the images to view the full version):

My performance was good (5th best trader overall in terms of absolute gain, or 29th best trader in terms of percentage gain, out of 380 traders), but amongst the 5 people that invested $1000 in the market, I placed 5th out of 5 people. I went into the UBC ESM with a target goal of 20%, so my strategy was rather risk-adverse (I considered 20% in this type of market to be rather easy to obtain). I wonder how the other people that invested $1000 behaved? My guess is that they bet heavily on a Conservative majority government when it was still trading at a nickel, and then dumped it as it made its way up to 30-40 cents. They then reinvested those gains into the minority government market. I was never close to making that type of decision since I knew that a Conservative majority was just not going to happen.

When the next election happens in 2007, I’ll be back with even more precision in my trading. I feel I did make a few mistakes in this market (especially with timing how I scaled into my minority government market positions), but I will work to fine-tune my trading techniques even further. Assuming the Liberals can get their act together and be a coherent challenge to the Conservatives, it’ll be quite an exciting election that will cause gut-wrenching volatility in the ESM – without volatility, there’s no return.

I mapped out a 1.05km circuit around my residential neighbourhood in Google Earth, which for my purposes will serve as a 1 kilometer track. I did my warmup and started my running. I ran for three minutes, walked for one, and repeated this ten times. Here is a small chart of my pace:

Distance – Time
2km – 11 minutes
4km – 24 minutes
5km – 30 minutes
6km – 36 minutes, 30 seconds

Assuming that I can extrapolate my performance over 10 kilometers at the rate I was running the first six, I could complete the Sun Run in approximately 61 minutes. This is even with the walking cycles, which makes me suspect the following:

Over the next few weeks, I’m going to work with my timing with respect to how much energy I expend in the first couple kilometers vs. the rest of the race. I’ve got a couple months to get my rhythm correct.

This is a term in finance which says “If you see the chart rapidly descending, wait until it’s bounced before you even consider getting in”. It usually takes courage to catch falling knives, but sometimes you get your hand really bloodied up.

In any respect, we’ll see if this trade works on the June 30-Year treasury bond future, I set the trade parameters before the opening of business in today’s trading session:

I don’t like holding these things overnight, but my expectation tomorrow is that the long bond will rise as the yield curve continues to invert.

Alberta released its third quarter fiscal update today and the results were absolutely stunning. Due mainly to the dramatic increase in resource prices over the period, the province has raked in $1.4 billion more than it expected last quarter. Since the province has already allocated all the money it could to paying off the debt (which is a done deal), they’re moving the excess cash into the heritage, sustainability and endowment funds, having combined assets of $20 billion.

Just to give you an example of how their economy has been booming, Alberta collected more in personal income taxes than the province of British Columbia ($5.9 billion vs. $5.8 billion) despite the fact that BC has a million more people in the province! On the business side, Alberta will collect nearly double the amount that BC did in business taxes ($2.6B vs. $1.3B).

Alberta is in a very advantaged position fiscally and it’s very likely to continue as long as commodity pricing remains reasonably high. As a result, they’re going to have some very interesting choices to make with what they want to do with the revenues – should they spend it (capital projects), save it (heritage and endowment funds), or collect less of it (reduce personal and business taxes)?

Before anybody accuses me of saying that most of Alberta’s success is just due to energy prices, this is just like saying that the Vancouver Canucks are good only because of Marcus Naslund or any other sports analogy you can think of. The reality is that finding the people and skills required to pull oil out of Alberta is an incredible challenge – they are literally pumping oil out of rock, and the processes and trade know-how they have developed over the past few decades to bring oil-shale mining to a cost effective state are a result of hard work and not luck. It’s just now the markets have made it economically viable and now they are reaping the rewards for this work. They deserve it and should elect governments that will use the funding well.

When businesses or people are awash with cash, some make frivolous decisions on spending the money on things that don’t provide much of a return on investment. The province should be well advised to make sure they don’t fall into that trap, especially in the case if energy prices do fall. I know that looking at British Columbia’s budget that they’re getting into such a problem. I’ll discuss the 2006 BC Budget in a future post.

RRSP season is nearly finished – Canadians have until March 1, 2006 to deposit money into their RRSP accounts in order for that money to be eligible for a net income reduction for the 2005 tax year. Usually people just throw money into some mutual fund and leave it for a year, which is arguably a worse strategy than not investing at all. You also don’t need to have large amounts of income to invest – you can just as easily do this in an account outside the RRSP. If you are earning an income below $35,595 (the lowest Federal marginal tax rate for 2005), you should not bother with an RRSP – your tax savings from the RRSP will be minimal.

For relatively small quantities of investment money ($2,000 or less) investing in any typical mutual fund is acceptable. Anything more and you begin to run into something called the management expense ratio and have to be a little more careful when randomly throwing your money around into funds.

The Management Expense Ratio (MER) is expressed in percentage per year. Your typical actively managed fund charges about 2.5%. So if you invested $10,000 in a fund, you could expect to pay $250 a year in management expenses. This expense is not taken directly out of the account, but rather is paid by the fund holders in very small slices each day so you don’t visibly see the effect in the price (“Net Asset Value” or NAV) of the mutual fund. For a fund with a NAV price of $20 with an MER of 2.5%, it would take 7 days for the NAV to drop by a penny – you don’t see the steady drop since the fluctuations of the fund’s holdings overshadows the frictional effect of the management expenses taken out of the fund. This expense is not a one-time expense – rather it is taken out day after day (in less-than-penny fractions), week after week, and year after year. This friction really impairs the performance of any portfolio if held for a long period of time. For those poker players out there, this is the equivalent to a “rake”.

The one year return quoted by any fund is after expenses, so if you see a mutual fund advertising a 1-year return of 10% with an MER of 2.5%, this means that the fund actually earned 12.5%, but management expenses brought down the return to the fund holders to 10%.

How much profit did the fund take out in management expenses? Just do a little division: 2.5% divided by 12.5% gives you 20%.

Let’s say the fund had an off-year. They reported a 1-year return of 5% with an MER of 2.5%. The total take of income is 2.5% divided by 7.5%, which gives you 33% of the funds profits going toward management expenses.

When a fund skims off 20% of your profit a year, it is no doubt that you are going to under-perform the market. It is a slow and silent friction on your asset performance, but it will guarantee that you will never outperform the market, nor will you ever get close over a length of a market cycle.

The effect is even worse with so-called “balanced” and “income” funds that charge absurdly high management expenses in relation to the actual performance they deliver. For example, if you look at TD Canada Trust’s fund lineup, you will see that their TD Balanced Income fund has an MER of 2.16%. Their year-over-year performance is 9.2%, which means that 19% of the fund’s income went into management expenses. This is pathetic.

Even worse are the money market funds. The TD Canadian Money Market fund yielded 1.89% over the past year, but charges an MER of 0.95%, which means that 33% of the income the fund generates goes into management expenses. Realize that a money market fund is one of the most brain-dead asset classes to manage, yet they charge you 33% of the return they generate. This is like depositing your money into ING Direct at 3% and then having the bank take out an extra 1% in “management expenses”.

The solution is to either invest in low expense funds or directly in the stocks the mutual funds invest in.

Investing in low expense funds is an exercise in research. Since all mutual funds have to report their expense ratios with the appropriate financial regulatory agencies, there are screening utilities (e.g. on Yahoo) where you can easily sort by expense criteria. Most often, funds that have low management expenses are “passive” funds, as in they track a certain benchmark (DOW Jones, S&P 500, Nasdaq 100 are the three most quoted benchmarks in the media). The world’s most popular fund of this type is the Vanguard 500 Index Fund, which tracks the S&P 500 index. This has a management expense ratio of 0.18%, so while you’re guaranteed to not outperform the market, you’re not going to fall very far behind since historically the fund has taken only 2% of the profits it generates over each of the past 10 years.

Optionally, if you’ve had strong thoughts that a certain sector of the market will outperform, you can invest in sector funds. Ishares is an example of a firm that offers these sector funds. For example, if you had strong thoughts about the transportation sector, you can invest in a transportation fund. Its management expense is 0.6%, which is still a bit high, but three to four times cheaper than your typical fund that charges 2% or higher.

The second (and better alternative) to funds involves replicating the fund’s top holdings in your own personal portfolio. So instead of purchasing the fund, you look at the top 10 holdings of the fund and just buy the stock individually in your own portfolio. Brokers like Interactive Brokers that charge $1 for 100 shares traded make this economically viable. You can literally create your own 10-stock mutual fund for 10 dollars.

Let’s give an example – say you had $10,000 to invest, so using the transportation fund example I used earlier, if you wish to replicate this and save yourself the 0.6% ($60) annual expense, this is what you would buy (using the fund’s top 10 holdings dated February 23, 2006):

The top 10 holdings of this fund constitute 65% of the fund, so if you wish to mirror the fund’s performance of the top 10 stocks, you would buy a bit more of each of the top 10 holdings than the entire fund. If you wish to have a higher degree of resolution, you can purchase the top 15, 20, etc. holdings. You can view any fund’s holdings by reading the fund’s SEC filings or full prospectus, which they have to disclose periodically. Not only is this cheaper in terms of annual expenses, but if there are companies you don’t like in the fund, you can massage your portfolio to own whatever you want. It’s a lot cheaper to just build your own portfolio once you’ve saved enough cash to invest in. This is a great technique if you have particular fund managers that you respect and want to track their returns in your own portfolio.

In theory, there’s no market justification for mutual funds charging 2.5% management expenses except exploiting the sheer financial ignorance of the public. By taking just an hour of time to properly research your options, you can save hundreds, or even thousands of dollars in yearly hidden management expenses by choosing low expense fund options or building your own portfolio with the ideas for share holdings borrowed from other fund managers.

After turning on Akismet, I have noticed that my spam rate on the weblog has descended to zero. This is over nearly a month since I last complained about comment spam on the weblog.

What I find odd is that the amount of spam actually posted has significantly reduced since I activated the plugin, almost as if the spammers knew that they wouldn’t be able to get anything on this site. Maybe they screen their sites carefully.

I’ve thought of ways to break spam filtration and it usually revolves around poisoning the database of spam comments with legitimate sounding-comments as spam and then the false-positive rate would increase to the point where you had to just get rid of the spam filter. I’m not sure why such techniques haven’t been implemented yet by spammers.

I’ve also been quite liberal in flashing around my public email address, which is based off of Google Mail. It’s spam filter has been incredibly good, zero false positives and an average of one spam per two months has escaped the filter. That one email (which was a couple days ago) was obviously a Nigerian bank scam email, so I’m curious as to why it made it through the filter. Otherwise, Google has trapped 364 spams over the past 30 days in my account. It really makes you wonder why they keep trying.

When I was in Germany last year, there was a game show on television that I watched. They all spoke German, but by looking at what they were doing on the screen and reading the closed captioning, I could figure out what was going on. Almost immediately I thought of ways that you could mathematically solve (or at least optimize) the correct strategy. It was a fairly simple exercise dealing with the computation of expected value. The “game” part of the game show dealt with an individual’s tolerance for risk, which I guess some people find interesting. Wikipedia already has an article on the mathematics behind the game, written much better than I could here.

Much to my surprise, the show was put on the air in North America a few months ago and apparently ratings are actually high for this show. I guess it doesn’t take a lot to keep people amused.

Personally, I’d prefer to watch Fear Factor instead!

A few things have changed here: