tag:theconversation.com,2011:/us/topics/fund-management-11674/articlesfund management – The Conversation2017-11-02T11:41:18Ztag:theconversation.com,2011:article/862872017-11-02T11:41:18Z2017-11-02T11:41:18ZWeightlifters and divers offer a lesson for business in risk and reward<figure><img src="https://images.theconversation.com/files/192441/original/file-20171030-18738-1kuoqsx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/singapore2010/4637741587/in/photolist-4UqHhi-CzCXpQ-SxRKUV-wVYsfe-pZS2KG-cKtfeb-84PCZR-7TdEN7-r1pRE-7MxAtY-4wr6Fu-cJKDe1-5AbG93-uYimY-cJKG3y-cJKE85-cJKHmq-5Cr2mm-r1rcx-62wB4F-8tncpo-5A7qSZ-cJKF8y-9UqCv3-aAVKD-S4vTqa-b8ET1-r1ppc-3QKBCo-SdMPz3-5AbJi5-r1qvL-B4tmhv-6QdWqD-7FS9CT-Kx9W4E-4yFeQK-Ax3uz5-LkGGSW-sFx3kv-fUT4sR-cJKFxQ-cJKDLU-cJKCUb-bmKibc-a4xYMP-6LDb18-6Aq7Nd-5wifUN-5dBW6o">Singapore 2010 Youth Olympics/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span></figcaption></figure><p>What do elite weightlifting and diving competitions have in common with top-level money management or pharmaceutical development?</p>
<p>In all of these diverse fields, there is an element of “tournament”. The rewards are fixed in advance, concentrated at the top, and based on relative rather than absolute performance. Whether you’re a world-class sprinter or an investment wizard, all that really matters is your performance compared to that of your rivals. That might be other runners leaning at the tape or other investors also trying to beat the market.</p>
<p>Classic <a href="https://ideas.repec.org/a/ucp/jpolec/v89y1981i5p841-64.html">economic analysis</a> <a href="https://ideas.repec.org/a/ucp/jpolec/v91y1983i3p349-64.html">says that</a> the <a href="https://www.jstor.org/stable/3003535?seq=1#page_scan_tab_contents">larger the incentive</a>, the more effort competitors put in: people will train harder for the Olympics than a regional track meet, and money managers will pull out all the stops if they scent the next trade of the century.</p>
<p>But in real life, effort doesn’t always translate into performance – and one reason is the “choke factor”.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/192444/original/file-20171030-18704-r3ap66.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">When the pressure’s on.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/businessman-afraid-huge-shadow-hand-holding-720553729?src=hPInBZnNFQwvAkZz4zVokg-1-84">ra2studio/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Taking risks</h2>
<p>In practice, competitors often do not only choose their level of effort; they also have to decide between more or less risky strategies. For example, a pharmaceutical firm that is lagging behind in a patent race may start exploring more risky projects, and a money manager with below-market returns might start investing in riskier assets.</p>
<p>So, colleagues and I looked at top-level weightlifting and diving competitions, including the Olympics, to examine athletes’ choices about effort and risk-taking in a tournament setting, with an eye on whether we could draw any lessons which applied to business.</p>
<p>In weightlifting, athletes have to announce in advance the amount they intend to lift. That means it is possible to observe not only whether a lift is successful, but also how risky their strategy is: the heavier the weight, the greater the chance of failure. We also observed the interplay between mid-tournament ranking and success in lifting a given weight.</p>
<p>What was surprising was that the probability of a successful lift increases the further an athlete is down the rankings. In other words, an athlete has a lower probability of successfully lifting a given weight if they are ranked first than if they are ranked eleventh, suggesting that athletes may perform badly under pressure, even though motivation and effort may be high.</p>
<p>Now, weightlifters can save themselves in competitions like this, lifting rarely to save energy, and that can cause the rankings to ebb and flow. The study – which looked at round-by-round results from competitions between 1990-2006 – was designed to discover what the result would be be if the same athlete was lifting the same weight from different ranking positions. </p>
<p>The result is consistent with anecdotal evidence of a “choke factor” – or choking under pressure – on which there has been plenty of talk-radio comment from disappointed sports fans, but little empirical evidence.</p>
<h2>Diving in</h2>
<p>A follow-up study on diving competitions focused on a sport with a very different set of skills (agility versus physical strength), but again we found consistent evidence that professional divers underperform when close to the top of the interim ranking, despite strong motivation to succeed. Divers can pick trickier dives as they go through the competition and seek to climb the rankings. Our findings were that a diver was more likely to score highly on a particular dive if they were poorly ranked, than if they were protecting a high ranking. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=398&fit=crop&dpr=1 600w, https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=398&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=398&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/192445/original/file-20171030-18693-rtcxvm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">In sync.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/russia-moscow-april-29-2015-athletes-294527276?src=SqGwIrx-cmqiIidAQ3L4rQ-1-43">Mitrofanov Alexander/Shutterstock</a></span>
</figcaption>
</figure>
<p>And in both disciplines, the finding was that athletes tend to underperform when competition is more intense and the tournament more prestigious. When the pressure builds, the coach of one national team said, performance suffers:</p>
<blockquote>
<p>Of course, it is well known that athletes in training they would lift these kilos. But then in the game, they choke. </p>
</blockquote>
<p>So what does this mean for money management or other high-stakes business environments?</p>
<p>Overall, our findings suggest that tournament-like incentives – single achievable targets such as a promotion or a bonuses – can change workers’ behaviour and could be a powerful tool in the hands of capable managers. Managers may use this knowledge to induce risk-averse workers to innovate, experiment and ultimately take risky, but profitable, strategies.</p>
<p>On the other hand, our results show that tournaments can be too successful in encouraging risk-taking, leading to excessive risk and lower average performance. This may be ideal in sport, where gunning for ultimate glory makes sense and where suspense and extraordinary performances are what the spectators want. It may, however, not be so desirable within companies. If profitability is affected more by consistent and average performance than by the rare exceptional performance of a few individuals, then tournament-like incentives may encourage needless risk and reduce overall company performance.</p>
<p>What’s more, raising the stakes or the rewards promised to employees may actually hurt their performance overall, and particularly at the top. The idea of “choking under pressure” seems to be an important psychological phenomenon, even for experienced professionals competing at the very top of their game.</p><img src="https://counter.theconversation.com/content/86287/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christos Genakos does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The choke factor is visible in tournament-style athletics competitions, and should teach managers about incentives.Christos Genakos, Senior Lecturer in Economics, Cambridge Judge Business SchoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/620022016-07-07T13:28:29Z2016-07-07T13:28:29ZProperty fears after Brexit vote are a sign of wider UK housing problems<figure><img src="https://images.theconversation.com/files/129597/original/image-20160706-12717-tpje4u.jpg?ixlib=rb-1.1.0&rect=0%2C2%2C1600%2C1061&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Ghosts in the machine: housing and commercial property are battling headwinds.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/daviddelam/15464776277/in/photolist-pyz2cK-kcXru-pNUEo5-5kTNYv-4zbqeN-pR1eAV-9hifcF-cUYaNo-DonUQ-522mZj-8CkKJr-8CoPyY-8CowNy-8GkQ2Q-9cH8WD-w9ocBL-8CkwX6-nqeh3n-7SDije-rzeKUL-agV71g-nqegpi-9EcGHe-sMMUrW-71BS5V-HViAhR-5kTQfc-dXZZ7L-5kY9e7-5kTRaZ-5kY8ou-q7t1g-aeXRhX-8CoUn3-8XvPAN-sJMkc5-8CkfN4-6HwBjz-9d79uY-7HbCzK-aERkpH-83z66m-nGqW7x-H8nQ2U-pjZ3CY-rr4bkB-aAqfTt-9Y3riV-8CoUe7-9RTMmi">David de la Mano/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-sa/4.0/">CC BY-NC-SA</a></span></figcaption></figure><p>Immediately after the UK voted to leave the European Union, a number of lead economic indicators went into reverse. Notable among them were housing, property and real estate shares that fell sharply both in the housebuilding sector and among banks with <a href="http://www.bloomberg.com/news/articles/2016-07-04/u-k-construction-contracts-at-fastest-pace-since-2009-on-brexit-iq7sp5cn">large property lending exposure</a>. This was seen as a simple response to economic uncertainty; fears emerged of falling house prices and <a href="http://www.scotsman.com/business/markets-economy/builders-confidence-crumbles-following-eu-vote-1-4165395">slowing activity in the property market</a>. </p>
<p>This week the big story has been the weakening position of major real estate funds, primarily investing in commercial property – office buildings, shops, warehouses. The firms which manage the funds, <a href="http://www.bbc.co.uk/news/business-36726695">Standard Life for example</a>, are concerned that if investors rush to withdraw their money, there will be insufficient capital to repay them. At first, <a href="http://www.bbc.co.uk/news/business-36708851">a number of funds</a> reduced the amount that investors could get back. Now, <a href="https://www.theguardian.com/business/live/2016/jul/06/brexit-fears-pound-slides-stock-markets-business-live">at least six of them</a> – including Standard Life, Aviva and M&G – have suspended trading altogether. This has not happened since the global financial crisis.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=416&fit=crop&dpr=1 600w, https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=416&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=416&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=522&fit=crop&dpr=1 754w, https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=522&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/129595/original/image-20160706-12703-jj8a13.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=522&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Commercial property is in the firing line.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/10515323@N08/24148367060/in/photolist-dPQYwP-5zWuwt-5Zhrkj-D7Yy9-7YpeDi-5MGMBZ-34GuRC-diGV8e-DMAuK3-7YswEN-9beYLn-dPyXMq-8J6sN2-5VCUfU-diGSZS-8J9zoq-5CVVYD-5QYkb6-5HfRGt-5CVWov-8zbnPb-5QYFKi-7YoWPk-dbxFcP-6PLkuT-2PvzPi-akzQqP-CMUGdd-4Kv57X-diGT2G-5pp5up-6FLRLz-aYPmRM-5sPVnZ-rgSvA-D58TBq-diGV34-D5ssPw-diGT7w-7Yp33g-diGUXg-iG4Ed-neJBbZ-sWGLjP-sdGCoo-noSwo7-rszBUn-nn6Zt9-ogyrE9-fscKC4">Hazel Nicholson/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>While it reflects the basic illiquidity of commercial property compared to the short-term needs of worried investors – it clearly speaks to a much more profound concern about the economy and the exposure to housing and property.</p>
<p>Most of us are not heavily exposed to property funds, but many of us are homeowners or hope to be. The risk of falling house prices in the post-referendum environment may threaten highly leveraged mortgages where home owners have taken on lots of debt. The most immediate risk is of “negative equity”, when the value of the house is lower than the loan amount outstanding. </p>
<p>Normally, such “underwater” loans prevent people moving home, but in the absence of repayment difficulties they are not an immediate problem. You just have to wait it out until prices turn. However, the current situation is complicated and potentially more worrying. </p>
<p>This is because of the government’s £31 billion commitment to various <a href="http://www.insidehousing.co.uk/owning-the-future/7015857.blog">Help-to-Buy schemes</a>, £12 billion of which in effect guarantees the exposed part of mortgage loans should prices fall. A sustained price fall which becomes associated with increased defaults on mortgages could mean the government has to make good those guarantees after repossessions on affected properties. </p>
<h2>Taking a pounding</h2>
<p>Falling house prices in the short run will also reduce existing owners’ capacity to support potential first time buyers: <a href="https://www.theguardian.com/business/2016/may/03/parental-help-behind-25-percent-of-uk-mortgages-bank-of-mum-and-day">the bank of mum and dad</a> (or granny and grandad) stepping in to help. This will further reduce access to home ownership because younger households increasingly face unaffordable deposit demands before they can get a mortgage. At the moment, access to the levels of cash needed often depends on rather arbitrary good fortune, timing and location. It often boils down to whether your family have the means to lend or give you what’s needed. </p>
<p>Much has been made of the high level of speculation and overseas investment in London’s vertiginous housing market. There <a href="http://www.telegraph.co.uk/business/2016/07/07/property-boss-warns-of-weakening-london-market/">were already signs</a> that the market was weakening cyclically prior to the referendum. Subsequently, however, we saw last week that some foreign banks were refusing to lend to their nationals for property investment in the UK. The depreciation of sterling may be encouraging such purchasers into the market, but only if they can <a href="https://www.theguardian.com/money/2016/jul/07/overseas-buyers-keen-to-exploit-weak-pound-to-buy-london-homes?utm_source=twitterfeed&utm_medium=twitter">find the means to borrow</a>. </p>
<p>In this way we see that a UK housing market dominated by an open, world city in London, does become linked to currency movements and international capital flows, despite the fundamentally local nature of housing and real estate. </p>
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<a href="https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=288&fit=crop&dpr=1 600w, https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=288&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=288&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=362&fit=crop&dpr=1 754w, https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=362&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/129599/original/image-20160706-12739-k8n8ih.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=362&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">No more happy hunting ground?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/davidedamico/16798545576/in/photolist-rAqWm9-pieVPf-dupH63-pvE4t7-bmG3k2-62bFh6-jYKwFB-fNBS59-dG8jc4-95VPVJ-aH91nK-9qqwcy-dtSMYw-95EA2e-qjF6x6-dAAC4w-jfR4n8-htQNua-q7GuZk-dn2gKd-dn2eAU-dn2eKK-ajfZJe-AHsDdj-rdahdM-dmQtNV-dn2gUq-dXbAR1-5AphH8-5K9giz-awee3B-5Atv7S-dn2bYB-C7ezHN-8YZyHW-5Apd4i-e1UGf3-qSvJvr-9dGH2b-fWmX4L-95FBiP-9iWg4w-3f415V-AbHDDQ-zAcLpL-AB8S3L-4h9Gmo-r562zD-ajiMsL-9XhTu">Davide D'Amico/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
</figcaption>
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<h2>Home to roost</h2>
<p>Falls in share prices, the forced intervention in real estate funds and worries about lending and government exposure to the downside of help-to-buy guarantees explain why the <a href="http://www.bbc.co.uk/news/business-36712040">Bank of England says</a> that the Brexit risks are crystalising and is moving to do something about it. However, it is hard not to draw the conclusion that the red flags going up across the housing and banking sectors reflect the underlying or chronic problems we know beset the housing market in Britain:</p>
<p>• Market imperfections in the form of the long term inability to build in sufficient numbers to address growing housing demand.</p>
<p>• Dwindling public investment in social and affordable housing in a period of high and rising housing need.</p>
<p>• Tax raids on the private rental market by targeting buy-to-let investors just when they are <a href="https://kengibb.wordpress.com/2016/03/19/three-tax-strikes-and-you-are-out/">playing a critical role</a> by filling the gap between the market and the non-market sectors.</p>
<p>• Tighter mortgage lending in the <a href="https://www.theguardian.com/money/2014/apr/25/mortgage-rules-homebuyers-fca-rules">wake of the mortgage review</a> that sought to reduce future lending risks after the global financial crisis. </p>
<p>• Privileged tax advantages <a href="https://www.theguardian.com/business/economics-blog/2015/sep/25/housing-bill-needs-radical-long-term-reform-market-buy-to-let">to home owners</a> which lock them in and create a society of insiders and outsiders. This worsens intergenerational inequalities and crowds out other forms of more productive business investment</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/129690/original/image-20160707-30676-1l2udoi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Broken system.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/ben_salter/4078312254/in/photolist-7doq9w-7uDmrV-adZSsy-cijEhN-mQmhtr-7A63AS-kuQaC6-89ztVP-cuCand-8eDg95-chy1US-uoZ8R-8kth7m-qGYJnu-euaU8x-kuL2xK-hds5Gh-kuMT2e-kuQMPn-nv33Bq-demdNt-hdscYd-sDeeE-7oJS9i-6s3BPr-kuQPzr-6Ya6wF-brMdTu-9jaxbB-5YnJTa-bWB91z-bWB4M6-8TBB8c-cdYmS3-cdYvEb-cdYrrm-ekHyoS-ebccY9-cdYuAs-9d4r17-7uzZGi-5YnKjz-9tybiS-bWB97H-kuQjVp-jYQKna-bWB8p8-bWB2Vk-sDgXv-cdYveA">Ben Salter/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Combining these points helps explain the underlying volatility in the housing market. It allows prices and market volumes to fluctuate more than the economy as a whole, while long-term real house price inflation encourages speculation in property assets and serves to frustrate people’s housing and labour mobility choices.</p>
<p>Governments and opposition parties must take concerted long-term action to normalise housing as an asset and a commodity. The policy world must recognise the need to approach housing more constructively, treating it as an entire system win which housing consumption rather than tenure matters most.</p>
<p>Frankly, we must seek to bring an end to a culture where politics is premised on defending existing asset owners’ housing capital rather than providing sufficient housing in the right places at prices and rents ordinary people can manage at different life-cycle stages. If not, we will be condemned to repeat these crises periodically, alongside slowly worsening chronic problems of exclusion, non-affordability and poisonous widening inequality.</p><img src="https://counter.theconversation.com/content/62002/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kenneth Gibb receives funding from ESRC, AHURI, Shelter Scotland and Choice Housing Group. He is a board member of Sanctuary Scotland housing association and a trustee of the Urban Studies Foundation.</span></em></p>Brexit worries have shaken the professional end of the sector, but Britain’s troubles have run far deeper for far longer.Kenneth Gibb, Professor of Housing Economics, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/297162014-08-07T10:31:25Z2014-08-07T10:31:25ZUsing a fund manager? You’d get the same results at a casino<figure><img src="https://images.theconversation.com/files/55041/original/4sdxd6fh-1406549488.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Chipping away at casino strategies</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/clry2/1366937217/in/photolist-7MYupP-9FZmuH-JfaHg-93fEzp-85ECJ-85EG4-bvk3Z2-552jcY-35MUP4-bd5iG8-6HBj6o-jwP3qu-7Zoewm-jwMLM5-bvk2P4-jwMNvq-fG1LBu-3LgDuT-24fYe-85ESK-ecDJBz-fPvDam-9ZEmF5-8Edcnh-2inCkM-A2zMe-ettS6G-8YsJjo-3htGiH-nZZPo-54t6Xs-7LYYdC-5WejBA-4K84MW-4k6Z9S-h1Egb-62LiHv-c7Es5-bqQP71-7LYYvy-7LUZoe-7LYYQ7-7LYXKW-7LYZaf-7LYXkG-7LUZep-7LYZ1h-7LUZRi-ds1dL-7LV27H">clry2</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>The people who manage pensions and investments are locked in a constant battle to win our custom, often dazzling us with examples of how well they have beaten the market in the hope that this success will continue. Careful scrutiny, however, blows that hope right out of the water.</p>
<p>Fund prospectuses like to show a fund has historically out-performed. This is often accompanied by a warning that “past performance is no guarantee of future success” but the reader is surely meant to draw a conclusion about its future ability to outperform. Otherwise, why include it at all?</p>
<p>Fortunately, it is very easy to put the question of out-performance into a scientific form. We have some data (the fund’s track record), a hypothesis (that the fund systematically outperforms the market), and methods to explore this relationship. The basic tool is to compare our hypothesis to a <a href="http://www.null-hypothesis.co.uk/science/item/what_is_a_null_hypothesis/">very basic alternative called the “null hypothesis”</a>. In this case we can make the null hypothesis a simple assertion that in the long run the fund performs at a market average produced by random chance – hardly the stuff to stir the imagination of a potential investor. </p>
<p>If we can exclude the null hypothesis, then we can entertain the idea that a star fund manager consistently outwits markets. Scientists typically say that if the chance of getting a result like the data provided using the null hypothesis is greater than 5%, then the null can’t be rejected. It turns out that our hypothesis of average performance produced by random chance is enough to explain almost all track records that an investment fund could show us.</p>
<h2>High stakes game</h2>
<p>Let’s start by considering <a href="http://www.nytimes.com/2008/09/07/business/worldbusiness/07iht-07ltcm.15941880.html?pagewanted=all&_r=0">the famous case of Long Term Capital Management (LTCM)</a>. The track record was dazzling, with an annualised rate of return of over 40% for the first four years. To the financial world this seemed incredible, but there was an exciting, high-profile team, and cutting-edge computerised prediction methods to select stocks. Maybe that was enough?</p>
<p>Probably not. First, this was a period where the entire market was doing very well, meaning LTCM was only 13% per annum above the Dow Jones index of major companies. This is still very impressive. At its peak, LTCM was worth 1.6 times what an investment in the Dow Jones would have got you over the four-year period. Three months after the peak, the investments crashed, losing almost all their value.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=472&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=472&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=472&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=593&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=593&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55029/original/gwtpg8qk-1406541954.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=593&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="http://en.wikipedia.org/wiki/Long-Term_Capital_Management#mediaviewer/File:LTCM.png">JayHenry</a></span>
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</figure>
<p>Surprisingly, our simple null hypothesis is enough to explain this track record. I don’t have any flair for picking stocks successfully, but there is a simple randomised strategy I can follow to allow me to run an investment fund which predictably gets a track record like this. My strategy to match this is to simply go to a casino, bet 90% of my cash on a 50-50 chance and then put the proceeds in a market index fund. At this point, I’ll either have 190% of my initial funds or 10% of them. Every four years, I take the money out of the index fund for a day and make a similar double-or-nothing bet on 90% of the money. How far would we expect this process to get before crashing? On average, I’d get one near-doubling before the crash – and this is all LTCM got. </p>
<p>Their curve was a lot smoother than mine would be, but I could mimic that too simply by making more trips to the casino and skewing the bets towards a greater likelihood of winning. People used to playing the lottery are less familiar with bets like this, with a small common upside and a large rare downside, but they are not uncommon. It’s the type of bet an insurance company takes with you. Mathematically, these are known as negative-skewed bets, and in the finance industry have helped encourage risk-taking by <a href="http://www.fooledbyrandomness.com/bleedblowup.pdf">bankers and fund managers</a> who would happily build a lucrative career in the shadow of that large, rare downside. </p>
<p>Even if we only showed someone the above chart up to the peak of the blue curve, before the crash, the null hypothesis could easily explain it away. Using a casino strategy and no stock-picking skill I would have a 63% chance of being able to produce a track record that grows the investment by 60% compared to an index fund over the same period. Given the 5% standard to reject the null hypothesis put forward at the beginning, we certainly can’t reject it here. Even in <a href="http://www.insidermonkey.com/blog/warren-buffett-knew-these-9-fund-managers-would-outperform-the-market-1064/">Warren Buffet’s famous list of nine funds</a> with stellar track records, not one of these passes the 5% significance test.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=357&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=357&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=357&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=449&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=449&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55031/original/tx8f3k4n-1406543406.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=449&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption"></span>
<span class="attribution"><span class="source">Toby Ord</span></span>
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</figure>
<p>So how impressive does a fund’s track record need to be for us to start cheering those in charge and reject the idea that their performance could be replicated by a simplistic casino strategy? First consider the incredibly weak standard of achieving our market average return just less than 50% of the time (p < 0.5 in the chart).</p>
<p>As you can see above, some apparently very impressive performance is required before it becomes at all difficult to reproduce the track record by chance alone. Many people would be very impressed by a fund beating the market by 5% for 14 years in a row, but this is easy to achieve – so long as you are prepared to use a strategy that does very badly if the run of luck ends. LTCM was getting 13% above market rates for four years, to considerable acclaim, but would have required six years of such returns before the probability of it being achieved according to the null hypothesis dipped below 50-50. If we extend that out to achieve a probability of below 5%, as per scientific convention, then a fund would need to beat the market by 10% for 32 consecutive years – or by 1% for 302 years.</p>
<h2>Selection effects</h2>
<p>So, we can show that it is very rare for the track record of an investment fund to distinguish it from chance. When we also consider the impact of selection effects, it becomes almost impossible. You see, not all investment funds are brought to our attention. If a fund has done very badly, we are less likely to be told about it; it may even be shut down before it is brought to market. That leads to a “sampling bias” or “selection effect” as past performance fails to factor in the probability of those crashes, while future performance remains all too vulnerable.</p>
<p>We can head off to the casino again to show how this skews our view. Suppose I start 16 funds with $1,000 in each and bet the contents of each one on a fair double-or-nothing game. On average, eight will win. We can do this again with three more games and by the end, on average, one fund will win all four of its bets, taking it up to $16,000. By making opposing bets, I can even guarantee it. </p>
<p>We can then put it back into an index fund in the stock market, wait for a while, then show investors a fund that radically outperformed the market. If the period is ten years, that would translate to outperforming the market by 32%. This is an apparently impressive result for an unskilled stock-picker, but much less impressive if you know that 15 other funds collapsed behind the scenes. </p>
<p>We should allow for such effects in our null hypothesis since they are compatible with performing at the market average and are an industry norm. If we do that, then even a fund generating returns of 10% above the market for 32 years would still have an even chance that this could be achieved under the null hypothesis.</p>
<p>The theoretical wrangling means that it is almost impossible to reject the idea that even some of the best financial track records are simply performing at the market average we have achieved by random chance. </p>
<p>In finance, the market-beating effects we are seeking are so small (a few percent per year) and over such short timescales (tens of years at most) that there is never enough evidence available for us to reliably distinguish a real effect from chance. And even if we did have data for a long enough timescale of 50 years or more, then the factors behind the performance – the brokers, stocks, market conditions – have changed so much as to make any conclusions meaningless. </p>
<p>It is unclear that there has ever been (or ever will be) a fund whose past performance has been good evidence for its future success. It all strengthens the growing <a href="http://www.which.co.uk/money/savings-and-investments/guides/different-types-of-investment/active-vs-passive-investment/">case for investing in low-cost index tracking funds</a>, even if those costs mean you are guaranteed to perpetually <em>underperform</em> the market.</p><img src="https://counter.theconversation.com/content/29716/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Toby Ord does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The people who manage pensions and investments are locked in a constant battle to win our custom, often dazzling us with examples of how well they have beaten the market in the hope that this success will…Toby Ord, Research Fellow in Philosophy, University of OxfordLicensed as Creative Commons – attribution, no derivatives.