Of Yuvraj Singh, stock markets and the Vietnam War

 yuvraj

Vivek Kaul

 It is in the last week of March 2014 that I am writing this piece. The stock market in India is flirting with all time high levels. At the same time in the T20 cricket World Cup that is on, Yuvraj Singh’s bad form with the bat continues (as I write India has played two matches, and in both, Yuvraj has failed with the bat).
Despite the fact that the stock market is flirting with all time high levels, there are still a lot of investors who are holding onto stocks they had bought at the peak levels reached in 2008. Real estate and infrastructure stocks were a favourite among investors back then.
Once the stock market started to crash in 2008, these stocks crashed big time. They still are nowhere near the high levels they had achieved way back in 2008. And more than that, the prospects for these sectors(particularly real estate) in India, are not looking good either. Nevertheless, there are still some investors who have held onto these stocks bought in 2008, in the hope that these stocks will make money for them one day. So what is happening here? Barry Schwartz explains this in his book The Paradox of Choice. As he writes “People hold on to stocks that have decreased in value because selling them would turn the investment into a loss. What should matter in decisions about holding or selling stocks is only your assessment of future performance and not (tax considerations aside) the price at which the stocks were purchased.”
But the price at which the stock is bought does turn out to matter. This fallacy is referred to as the sunk-cost fallacy by behavioural economists.
And what about Yuvraj Singh? What is he doing here? Vijay Mallya owned IPL Royal Challengers Bangalore bought him for a mind-boggling Rs 14 crore in a recent auction in the Indian Premier League(IPL). The tournament starts in mid April, right after the T20 World Cup ends. From the way things currently are, Yuvraj doesn’t look in great form. But despite that he is likely to be played by Royal Challengers Bangalore in all the matches that they play.
And why is that? Simply because the sunk-cost fallacy will be at work. The Royal Challengers Bangalore have paid so much money to buy Yuvraj that they are likely to keep playing him in the hope that he will eventually start scoring runs. Schwartz discusses this in the context of professional basket ball players in the United States. “According to the same logic of sunk costs, professional basketball coaches give more playing time to players earning higher salaries independent of their current level of performance,” he writes.
The sunk-cost fallacy is a part of our everyday lives as well. Many of us make instinctive expensive purchases and then don’t use the product, due to various reasons. At the same time, we don’t get rid of the product either, in the hope of using it in some way in the future.
Richard Thaler, a pioneer in the field of Behavioural Economics, explains this beautifully through a thought experiment, in a research paper titled Mental Accounting Matters. “Suppose you buy a pair of shoes. They feel perfectly comfortable in the store, but the first day you wear them they hurt. A few days later you try them again, but they hurt even more than the first time. What happens now? My predictions are: (1) The more you paid for the shoes, the more times you will try to wear them. (This choice may be rational, especially if they have to be replaced with another expensive pair.) (2) Eventually you stop wearing the shoes, but you do not throw them away. The more you paid for the shoes, the longer they sit in the back of your closet before you throw them away. (This behaviour cannot be rational unless expensive shoes take up less space.) (3) At some point, you throw the shoes away, regardless of what they cost, the payment having been fully `depreciated’.”
Along similar lines people hold on to CDs they never listen to, clothes they never wear and books they never read. Keeping these things just holds up space, it doesn’t create any problems in life. But there are other times when the escalation of commitment that the sunk-cost fallacy causes, can lead to serious problems. As Daniel Kahneman, writes in Thinking, Fast and Slow “The sunk cost fallacy keeps people for too long in poor jobs, unhappy marriages, and unpromising research projects. I have often observed young scientists struggling to salvage a doomed project when they would be better advised to drop it and start new one.”
As far trying to salvage doomed projects go, CEOs and businesses seem to do it all the time. As Kahneman points out “Imagine a company that has already spent $50 million on a project. The project is now behind schedule and the forecasts of its ultimate returns are less favourable than at the initial planning stage. An additional investment of $60 million is required to give the project a chance. An alternative proposal is to invest the same amount in a new project that looks likely to bring higher returns. What will the company do? All too often a company afflicted by sunk costs drives into the blizzard, throwing good money after bad rather than accepting the humiliation of closing the account of a costly failure.”
A similar problem afflicts a lot of government infrastructure projects as well, where good money keeps getting thrown after bad. It also explains why the United States kept waging a war in Vietnam and then in Iraq, even though it was clear very early in the process that Vietnam was a lost cause and that there were no weapons of mass destruction in Iraq.
To conclude, it is important to understand why human beings become victims of the sunk-cost fallacy? “Sunk-cost effects are motivated by the desire to avoid regret rather than just the desire to avoid a loss,” writes Schwartz. And if you, dear reader, do not want to become a victim of the sunk-cost fallacy, this is an important point to remember.

 The article originally appeared in the April2014 issue of the Wealth Insight magazine.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]

The death of Facebook

 facebook-logoVivek Kaul 
A friend of mine had a rather unique problem sometime back. His daughter’s class teacher had started putting their daily homework online on a Facebook page. She wanted the parents to follow that page, so that they knew what was happening in the class.
“So what is the problem?” I asked him.
“I don’t have a Facebook account,” my friend replied.
“So open one,” I suggested.
And this is when things got really interesting.
“I don’t like the voyeurism that comes with Facebook,” he said, trying to give me a reason for his reluctance to open a Facebook account.
“Voyeurism?”
“Yeah. Like you may get to see the honeymoon pictures of a couple holidaying in Goa. The irony of course is that you had not been invited for their wedding.”
“Come on, you are nitpicking here,” I tried to protest.
“No I am serious. Think about the digital footprint that you are leaving out there. And that is something that makes me uncomfortable. What if someone tags some old pictures of mine from my engineering days, where I am looking drunk or maybe even stoned? You may tell me you can always remove the tag. Yes, but it is not always possible to keep track. And given this, how will I tell my daughter in the years to come that smoking pot and excess drinking are not good for health. Also, what I write will stay there forever. Have you ever thought about these things?”
I guess my friend had a point. In fact, my mind went back to a conversation I had had with Ferdinando Pennarolla, an associate professor at the department of management and technology, Bocconi University in Milan, Italy, a few years back. Pennarola had made several interesting points during the course of our conversation about our digital lives.
“The consumers are not asking themselves to what extent their digital lives are there forever. When you write something on the internet it is written on the stone. It is forever. It is very difficult to erase things on the internet. Once you get Googlised it is very difficult to cancel or erase your news. There are many stories where people cannot erase their contribution to things like community groups and forums,” he had said.
Also, as we spend more and more of our lives on the internet the question of what happens to our digital lives after we die, comes into the picture well. We spend a lot of our time these days reading emails on Gmail, making friends and posting pictures on Facebook and telling the world at large what we think about it, in less than 140 characters, on Twitter.
Other than this we have subscribed to newsletters, articles from various websites, blogs and so on. We also have multiple logins and passwords that we have created on various e-commerce websites. What happens to all this when we are no longer around?
Or as Pennarola put it “Who will have access to all of this? Will these accounts just be cancelled because they will remain unutilised? Will the vendors still keep on bombarding our mailboxes with news and advertising? I think there is a need of an integrated service that in the future will take care of all our digital and networked life, and pass it to our loves, according to our will.”
For people like me, who primarily write for websites, there is also the question of who gets the copyright for all the writing that has been published and will continue to be published digitally. That is one part of the problem that most of us are not thinking about.
A few days after meeting my friend I happened to start reading a rather fascinating book called Who Owns the Future? written by a philosopher and computer scientist called Jaron Lanier. In this book Lanier raises many other fascinating questions regarding our digital lives that do not have easy answers.
Take the case of Gmail, Facebook and Twitter. A large portion of people who use email these days use Gmail. When it comes to social networking, Facebook happens to be the number one preference. When was the last time you logged onto Orkut? And do you even remember Bigadda?
As far as micro-blogging goes, have you even ever heard the name of any other website other than Twitter?
By concentrating our digital lives around a few companies, we are working with the assumption that they will stay around forever. But for anyone who understands a little bit about technology companies, knows that has never been the case.
“It’s sad to say, but all young things change over time. The prototypical great Silicon Valley company Hewlett-Packard, which inspired all the rest to come, encountered in the not-too-distant past a period of now only crummy management, but weird, tawdry scandals, board intrigues, and demoralization. Chances are that some of today’s bright young companies will go through similar periods someday. It could happen to Facebook or Twitter,” writes Lanier.
Lanier then discusses the case of Facebook in some detail. As he writes “Suppose Facebook never gets good enough at snatching the ‘advertising’ business from Google. That’s still a possibility as I write this. In that event, Facebook could go into decline, which would present a global emergency…If Facebook starts to fail commercially, suddenly people all over the world would be at the risk of losing old friends and family ties, or perhaps critical medical histories.”
The same argument stands true for Gmail as well. For most of us it is a repository of a large amount of information, communication and documentation, that we need to keep going back to time and again.
In that sense, these websites are becoming more like electric utilities as every day goes by. Something that we really cannot do without. As Lanier puts it “It’s a piece of infrastructure people need, and when people need something they eventually ask the government to make sure they have it. That’s why government ended up in the middle of water, electricity, roads, and the like.”
These are things that no one has really thought about, which is clearly worrying. As Lanier concludes “The death of Facebook must be an option if it is to be a company at all. Therefore your online identity should not be fundamentally grounded in Facebook or something similar.”
This article originally appeared in the Wealth Insight magazine dated Feb, 2014

(Vivek Kaul is the author of Easy Money. He can be reached at [email protected])  

The curious case of Mr Jain

prashant jainVivek Kaul

 Sometime in late October I went to meet my investment advisor. During the course of our discussion he suggested that my portfolio was skewed towards HDFC Mutual Fund and it would be a good idea to move some money out of it, into other funds.
Don’t put all your eggs in one basket” is an old investment adage. While, I try to follow it, I also like to believe that if the basket is good enough, it makes sense to put more eggs in that basket than other baskets.
HDFC Mutual Fund has been one of the few consistent performers in the Indian mutual fund space. And a major reason for the same has been Prashant Jain, the chief investment officer of the fund, who has been with it for nearly two decades.
Jain has been a star performer and due to his reputation the fund has seen a huge inflow of money into its various schemes. Some of these schemes HDFC Prudence, HDFC Equity and HDFC Top 200 became very big in that process.
These schemes haven’t done very well over the last three years. Their performance has been significantly worse in comparison to other schemes in their respective categories(
Value Research has downgraded them to three star funds from being five star funds earlier). And this has surprised many people. “How can Prashant Jain not perform?” is a question close observers of the mutual fund industry in India have been asking.
One explanation that people seem to have come up with is the fact that the size of the schemes have become big, making it difficult for Jain to generate significant return. This is a theory that is globally accepted, where the size of a scheme is believed to be inversely proportional to the return it generates.
As Jason Zweig points out in the commentary to Benjamin Graham’s all time investment classic, 
The Intelligent Investor, “As a (mutual) fund grows, it fees become more lucrative – making its managers reluctant to rock the boat. The very risk that managers took to generate their initial high returns could now drive the investors away — and jeopardise all that fee income. So the biggest funds resemble a herd of identical and overfed sheep, all moving in sluggish lockstep, all saying “Baaaa” at the same time.”
While this may be a reason for the underperformance of the schemes managed by Jain, it is not easy to prove this conclusively. Jain feels there is no correlation between size and performance of a scheme, or so he told the 
Forbes India magazine in a recent interview. He pointed out that there are no large mutual fund schemes in India, and the largest scheme is less than 0.2% of the market capitalisation, which I guess is a fair point to make.
So how does one explain the fact that Prashant Jain is not doing as well as he used to in the past. John Allen Paulos possibly has an explanation for it in his book 
A Mathematician Plays the Stock Market. As he writes “A different argument points out to the near certainty of some stocks, funds, or analysts doing well over an extended period of time.”
Paulos offers an interesting thought experiment to make his point. As he writes “Of 1000 stocks (or funds or analysts), for example, roughly 500 might be expected to outperform the market next year simply by chance, say by the flipping of a coin. Of these 500, roughly 250 might be expected to do well for a second year. And of these 250, roughly 125 might be expected to continue the pattern, doing well three years in a row simply by chance. Iterating in this way, we might reasonably expect there to be a stock (or fund or analyst) among the thousand that does well for ten consecutive years by chance alone.”
But one day this winning streak comes to an end. And the same seems to have happened to Prashant Jain. In fact, William Miller who ran the Legg Mason Value Trust fund in the United States, beat the broader market every year from 1991 to 2005. In 2006, his luck finally ran out. Miller once explained his winning streak by saying “As for the so-called streak…We’ve been lucky. Well, maybe it’s not 100% luck—maybe 95% luck.”
If Miller was lucky so was Jain. Any significant deviation from the norm does not last forever. As Nassim Nicholas Taleb writes in 
Fooled by Randomness “In real life, the larger the deviation from the norm, the larger the probability of it coming from luck rather than skills…The “reversion” for the large outliers is what has been observed in history and explained as regression to the mean. Note the larger the deviation, the more important its effect.”
This is not to suggest that Jain’s performance has only been because of luck. Not at all. But it was luck that pushed him up to the top of the charts. Luck was the “icing” on the cake.
Michael Mauboussin discusses a very interesting concept called the paradox of skill in his book 
The Success Equation – Untangling Skill and Luck in Business, Sports, and Investing. “As skill improves, performance becomes more consistent, and therefore luck becomes more important,” is how Mauboussin defines the paradox of skill.
The Olympic marathon is a very good example of the same. Men run the race today about 26 minutes faster than they did 80 years back. Also, in 1932, the difference between the man who won the race and the man who came in twentieth was 40 minutes. Now its less than 10 minutes.
Now the question is h
ow does this apply to investing? “As the market is filled with participants who are smart and have access to information and computing power, the variance of skill will decline. That means that stock price changes will be random and those investors who beat the market can chalk up their success to luck. And the evidence shows that the variance in mutual fund returns has shrunk over the past 60 years, just as the paradox of skill would suggest,” says Mauboussin. “I want to be clear that I believe that differential skill in investing remains, and that I don’t believe that all results are from randomness. But there’s little doubt that markets are highly competitive and that the basic sketch of the paradox of skill applies,” he adds.
And that is what best explains the curious case of Prashant Jain and the recent non performance of the mutual fund schemes that he manages.
The column originally appeared in the Wealth Insight magazine edition of December, 2013 

(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek) 

The illusion of control

book cover 1Vivek Kaul  
By the time you are reading this my first book would be out. Writing a book is an extremely strenuous and lonely exercise, with huge opportunity costs. And very few writers actually make any money out of their writing. Even fewer writers become famous.
Nevertheless, despite the near zero chance of success, people continue to write and publish books. Why is that?
I have been thinking about this for the past few weeks. What made me leave my job, sit at home and slog away on my laptop for the last 18 months to write a book, which possibly very few people are going to read?
Nassim Nicholas Taleb has answer in his book Anti Fragile. He attributes this to what he calls the fooled by randomness effect. As he writes “Information has a nasty property: it hides failures. Many people have been drawn to, say, financial markets after hearing success stories of someone getting rich in the stock market and building a large mansion across the street – but since failures are buried and we don’t hear about them, investors are led to overestimate their chances of success.”
This is precisely the way it works with people who go about writing books as well, feels Taleb. As he writes “The same applies to the writing of novels, we do not see the wonderful novels that are now completely out of print, we just think that because the novels that have done well are well written(whatever that means), that what is well written will do well.”
This explanation clearly summarises my state of mind when I decided to write a book. There was a confidence in my ability to write a good book, which would do well. But as has been proven time and again there is very little link between the quality of a product and how well it does.
Hence, it is safe to say that those who write books are “mildly delusional” and at the same time have an “illusion of control”. Given that the odds of a book succeeding are close to zero, anyone in their right mind would never get around to writing a book.
But that is not the way it works. People take on risks like these because they often underestimate the odds of success. As Daniel Kahneman, a Nobel Prize winning economist, writes in Thinking Fast and Slow “The evidence suggests that an optimistic bias plays a role – whenever individuals or institutions voluntarily take on significant risks. More often than not, risk takers underestimate the odds they face, and do not invest sufficient effort to find out what the odds are.”
And this is what leads to individuals taking the plunge inspired by the stories of success they see all around them. As Spyros Makridakis, Robin Hogarth and Anil Gaba write in Dance with Chance – Making Luck Work For You “We hear a lot about people who are successful, but very little about those who fail to realize their dreams. The press makes sure that we’re all familiar with the achievements of Sir Richard Branson, Warren Buffett, Bill Gates, Tiger Woods,or Nicole Kidman. While we’re dimly conscious that these people are exceptional, we rarely hear about the entrepreneurs, sports people, or actors who fail – or the sheer scale on which they do so.”
Entrepreneurship is another good example. People continue to take the plunge despite the odds of success being very low. “For example, did you know that in the USA there were more than 55,000 bankrupt firms and over 1.4 million bankrupt individuals in 2009? And the great majority of these involved believed it would never happen to them,” write Makridakis, Hogarth and Gaba.
In fact, a majority of the entrepreneurs are convinced that they will make it big. As Kahneman points out “ A survey found that American entrepreneurs tend to believe they are in a promising line of business: their average estimate of the changes of success for “any business like yours” was 60% – almost double of true value. The bias was more glaring when people assessed the odds of their own venture. Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero.”
This optimism helps keep capitalism going as people try and launch new businesses, and some of them ultimately succeed. But there are situations when the illusion of control comes with costs attached to it. An excellent example is when a lot of people in the United States stopped taking flights and started driving, in the aftermath of what happened on September 11, 2001.
Flying remains the safest form of travelling. And the numbers prove it. In 2001, nearly 483 people died in the US in air crashes. Of this nearly half of them died on 9/11. In 2002, not a single person died in an air crash. And in 2003 and 2004, the number of deaths stood at 19 and 11, respectively. Now lets compare this to the number of deaths in car accidents. “In the same period, however, 128,525 people died in the US in car accidents. Moreover, it has been estimated that – in the year following 9/11 – some 1,600 deaths could have been avoided if people had not driven but instead carried on taking the plane as usual,” write the authors of Dance with Chance. 
This happened because drivers have an illusion of control. They have more faith in their driving than they have in the ability of the pilot to fly a plane safely. What also does not help is the fact that any plane crash makes it to the top of the news headlines whereas most car crashes don’t.
Also, no media reports about the thousands of planes that land safely every day. Given this, people have a tendency to think that flying is riskier in comparison to driving, and that is clearly not the case.
The dotcom bubble which ran from the late 1990s to the turn of the century is another brilliant example of the negative effects of the illusion of control. As Robert Shiller writes in the second edition of Irrational Exuberance, “Using the internet gives people a sense of mastery of the world. They can electronically roam the world and accomplish tasks that would have been impossible before. They can even put up a website and become a factor in the world economy themselves in previously unimaginable ways…Because of the vivid and immediate personal impression the Internet makes, people find it plausible to assume that it also has great economic importance.” While using the internet people felt in control. And then they bought dotcom stocks, thinking that the companies would make a lot of money in the days to come. That never happened and most of the companies went bust.
The illusion of control plays a very important part in our lives. And hence, it is important to figure out which it is leading us to.
The article originally appeared in the Wealth Insight magazine dated November 1, 2013 

(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek) 
 

The ghost of Keynes

keynes_395
Vivek Kaul
Franklin D Roosevelt became the President of the United States in 1933, at the height of the Great Depression. Known for his no nonsense manner of speaking, Roosevelt is said to have remarked that “any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.”
Those were the days when it was believed that governments should be balancing their budgets i.e. their income should be equal to their expenditure. Also, John Maynard 
Keynes, the most influential economist of the 20th century hadn’t gotten around to writing his magnum opus, The General Theory of Employment, Interest and Money, till then. The book would be published in 1936.
In this book, 
Keynes introduced a concept called the “paradox of thrift”.
As Paul Samuelson, the first American to win a Nobel Prize in economics, wrote in an early edition of his bestselling textbook “It is a paradox because in kindergarten we are all taught that thrift is always a good thing….And now comes a new generation of alleged financial experts who seem to be telling us…that the old virtues may be modern sins.”
What 
Keynes said was that when it comes to thrift or saving, the economics of an individual differed from the economics of the system as a whole. An individual saving more by cutting down on expenditure made tremendous sense. But when a society as a whole starts to save more then there is a problem. This is primarily because what is expenditure for one person is an income for someone else. Hence, when expenditures start to go down, incomes start to go down as well. In this way the aggregate demand of a society as a whole falls, impeding economic growth.
Keynes used the “paradox of thrift” to explain the Great Depression. He felt that cutting interest rates to low levels would not tempt either consumers or businesses to borrow and spend. Cutting taxes, so as people have more to spend was one way out. But the best way out of a depression was the government spending more money, and becoming the “spender of the last resort”. Also, it did not matter if the government ended up running a fiscal deficit in doing so. Fiscal deficit is the difference between what a government earns and what it spends.
After the stock market crash in late October 1929 which started the Great Depression, people’s perception of the future changed and this led them to cutting down on their expenditure. In 1930, consumer durable expenditure in America fell by over 20% and residential housing expenditure fell by 40%. This continued for the next two years and the economy contracted, leading to huge unemployment.
As per 
Keynes, the way out of this situation was for someone to spend more. The citizens and the businesses were not willing to spend more given the state of the economy. So, the only way out of this situation was for the government to spend more on public works and other programmes. This would act as a stimulus and thus cure the recession.
In fact in his book 
Keynes even went to the extent of saying “If the Treasury(i.e. The government) were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again…there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”
In the later years this became famous as the “dig holes and fill them up” argument. During the time 
Keynes was expounding on his theory, it was already being practiced by Adolf Hitler, who had put 100,000 construction workers for the construction of Autobahn, a nationally coordinated motorway system in Germany, which was supposed to have no speed limits. Italy and Japan had also worked along similar lines.
Very soon Britain would end up doing what 
Keynes had been recommending. Great Britain had more or less done away with both its army and air force after the First World War. But the rise of Hitler led to a situation where massive defence capabilities had to be built in a very short period of time.
The Prime Minister Neville Chamberlain was in no position to raise taxes to finance the defence expenditure. What he did was instead borrow money from the public and by the time the Second World War started in 1939, the British fiscal deficit was already projected to be around £1billion.
The deficit spending which started to happen, even before the Second World War started, led to the British economy booming specially in south of England where ports and bases were being expanded and ammunition factories were being built.
This evidence left very little doubt in the minds of politicians, budding economists and people around the world that the economy worked like 
Keynes said it did. Keynesianism became the economic philosophy of the world for the next few decades.
Lest we come to the conclusion that 
Keynes was an advocate of government’s running fiscal deficits all the time, it needs to be clarified that his stated position was far from that. What Keynes believed in was that on an average the government budget should be balanced. This meant that during years of prosperity the governments should run budget surpluses. But when the environment was recessionary and things were not looking good, governments should spend more than what they earn and even run a fiscal deficit.
The politicians over the decades just took one part of 
Keynes’ argument and ran with it. The belief in running deficits in bad times became permanently etched in their minds. Meanwhile, they forgot that Keynes had also wanted them to run surpluses during good times.
So, the politicians ran deficits in good times and bigger deficits in bad times. This meant more and more borrowing. And that’s how the Western world ended up with all the debt, which has brought the world to the brink of an economic disaster. The way the ideas of 
Keynes have evovled, has cost the world dearly.
Keynes, of course, understood the power (or danger) of economic ideas and he wrote in The General Theory that “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
Now, only if he knew that a lot of practical men(read politicians) in the years to come would become the slaves of his ‘distorted’ ideas. The 
ghost of Keynes is still haunting us.
This column originally appeared in the Wealth Insight Magazine edition dated October 1, 2013 

(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek)