I am bemused and amused by folk cleverer than me from the USA who offer me alternative ways to deliver real retirement incomes through wildly differing techniques. The first is Arun Muralidhar’s reminder to me that his president can (short-term) screw up strategies based on investment in American equities or companies like Land-Rover unable to sell much to Americans (Tariffs).
Arun would like me to reconsider Brazil’s system of RendA + Retirement Bonds for Britain. Arun, I am not an economist let alone a DWP or Treasury Pension Minister, we are looking to float Britain from its getting stuck in debt and lack of growth, I don’t find a Brazilian way of getting pensions to convert to upgraded gilts, much value to us today.
A second proposal comes to me from Brian Gidley who sounds just as keen to see US manufactured solutions adopted in the UK.
I am worried that Americans talking of “Global Trade Competitive Advantage” as Brian does, have to swim upstream against a strong current created by his President.
His website “Real Return Methodologies“, offers
He has sent me a number of explanations of his Idea but I am still struggling to understand what it is
The “X” in every financial equation should be a result in Real (inflation adjusted) purchasing power currency.
The real purchasing power of the return is the lifeblood of a lender. The ability to use what is borrowed effectively at the lowest feasible interest rate is the focus of a borrower. Default is the enemy of all. A loan made using the nominal interest rate attempts to address the business risk and the inflation risk with a rate comprised of an assessment of their combined effects. Business risk is determined by prudent evaluation. Inflation risk is determined by learned guess. The result will tend to be imprecise and proportionally risky. The resulting inefficiency takes funds away from the intended purpose.
In the case where the lender over-insures against inflation the rate is too high and inefficient if not uncompetitive. Paradoxically, default risk may increase through the borrower not being able to meet the implied inflation insurance charged by the lender for inflation that never happens. When too low, the lender will suffer. Our method balances the sometimes competing but ultimately common requirement of a financial transaction that supports successful outcomes for both.
Current efforts are numerous, many impressive and proven. However, for those governments, enterprises and individuals most damaged by the effects of inflation, the available tools are too complex, expensive, tax-inefficient and imprecise to serve the need. Some of these tools/products fail the most basic tests of Asset Liability Management.
We propose a transparent, simple and effective method: Financial instruments that ensure returns in Real purchasing power, not nominal currency. Real Return Methodologies (“RRM”) utilizes a straightforward amortized loan structure that can be readily superimposed on complex debt structures. By effective and efficient handling of inflation risk it permits the lender the ability to focus upon the business risk per se while providing use of funds to the borrower more effectively. Default risk is lessened.
In our method, the parties agree to a rate that is appropriate to the business risks. Inflation premia are not added. The loan results in more of the funds being applied to the business purpose from the onset. Inflation effects are addressed by the timely and mutually agreed addition of the actually experienced inflation based upon an agreed index at agreed intervals. The loan is repaid using our fully amortizing method. Inflation is managed by facts, not guesses. Lower overall costs are the result.
The net is that the funds are put fully to use with the effect of inflation addressed by using the actual rate experienced during the term. The additional cost implied by any inflation will come later in the project cycle when the borrower has enjoyed the use of a greater portion of the funds long enough to have material benefit, thereby lessening default risk. The lender improves their management of inflation risk without driving the borrower to default or pricing themselves out of the loan at the onset.
The use of derivatives to hedge potential inflation risk may provide additional advantages in some circumstances. But the majority of transactions will not require added complexity. If derivatives are used, they can be structured using loans made in RRM format as a leg of the structure. RRM increases the number of available products and swaps for governmental, currency, business inflation and asset/liability management.
We believe that we represent a novel and efficient risk management tool with global trade competitive advantage to early implementors, and overall simplicity and efficiency with respect to the cost of inflation/currency risk management for all stakeholders over time.
Now I know that people who read my blogs understand this kind of talk and how important it is to the financing of economies and companies and ultimately to pensioner’s pensions, but if I am bamboozled, how can I write about it. At least with Arun I know where I disagree!
What most interests me is that what I have now are Americans wishing to export to me ideas that I don’t need and don’t want and that I am becoming a potential publiciser of unexplainable solutions.
I’m sorry Brian and Arun but I simply don’t understand . It may be that my readers will explain to me what you are on about. For that matter, explain what Donald Trump is up to at the same time!
IN-PERSON DEBATE CHALLENGE ON #SeLFIES for the #UK.
WHO: Henry Tapper (Pension PlayPen AgeWage) and Yours Truly
WHERE: London – place to be picked by Henry (and if he cannot get a place, will some London-based friend offer a classroom or conference room?)
WHEN: Jun 4 – 6
JUDGES: I nominate 5 (Naveed Sultan (knows markets), Guy Opperman (former #pensions Minister), David Fairs (former regulator) and Steve Goddard (trustee); Elizabeth Pfeuti (journalist)); Henry – you pick 5 or accept these 5 as they are all UK citizens and top of their game in each sphere of expertise.
PRIZE: Loser has to buy the winner’s partner a good bottle of Cotswolds Distillery scotch/or gin. I support local producers and will save the tariffs too!
PROPOSITION: Without SeLFIES, UK Pensions will be a disaster
For: Arun; Against: Henry (and any seconds he wants to add)
For those who do not know what UK SeLFIES could be – here is an Op-Ed https://papers.ssrn.com/abstract=5078615
PS: I kid Henry a lot, but he is the ONLY person to date who has taken me up on my offer to debate him (!!), so I have ENORMOUS respect for him (and bought him and his partner a nice bottle of Cotswolds gin for that kind and honorable gesture).
Brian’s mention of “real return” prompts me to draw some attention to the less well known work of economist AD Roy on portfolio construction.
American economist Harry Markowitz garnered the credit for kick starting “modern portfolio theory”.
A forthcoming paper, however, by Dr John Woods for the European Journal of the History of Economic Thought demonstrates, a contemporaneous model developed (and then abandoned) by Britain’s AD Roy was a far richer model, using multivariate analysis of the mean variance of real returns, rather than Markowitz’s focus on nominal returns.
AD Roy also allowed in his model for negative returns and possibilities for short selling, and transaction costs, bound together with a concept of “safety first”.
Whereas interpreters of Markowitz obsess about “risk” as being all about “volatility”, Roy had a different conception of “risk”. For him, risk was not interchangeable with variance of short-term returns, as it was for Markowitz, but rather with managing/avoiding the possibility of disastrous losses.
My own limited reading on investment nevertheless draws upon writers from both sides of the Atlantic. AD Roy’s “safety principle”, for instance, echoes for me American Ben Graham’s “margin of safety”.
As for diversification, which is sometimes overrated, I tend to share American Warren Buffett’s view that “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
Iowan Byron McKeeby may wish to remind us that the USA and GB are “two nations separated by a common language”, while Henry may prefer to turn a deaf ear to products being offered “over here”
from “over there”. I try to find time for both sides of this ocean of views.