Twenty Third Floor
Technical Business Advantage

A comment came in today on an old article about the dodgy lending scheme Rudie Visagie was proposing.

The reader “trymore” provides some details of a new deal apparently being run by Rudie Visagie. As I stated last time this gentleman’s name came up, I have no personal interest or involvement here at all. My interest was just to show how the deal made no business sense to Visagie given the significant interest rate, currency and credit risks involved. Thus, it sounded like a scam. At the time, I quite enjoyed hearing all the supporters claiming I just didn’t want him to succeed. Meanwhile, several regulators started to probe the dubious claims, and it became clear that apart from anything else, Visagie wasn’t licenced to carry out the business he was proposing.

They quickly quietened down when the whole thing fell apart and Visagie’s clients lost money. Several readers of this site gave their own stories to this extent.

“Trymore” had the following to say:

Our company was also approached to do bussiness with Mr Visagie’s new company , which is now called Better Life. Our clients would get Loans from them and on final approval would have to pay R5700.00, on enquiring about their company eg contact no’s , name of directors, physical address ect we were continuously stonewalled and eventualy given the name of their “attornies�(who had no knowledge of them) and their buss address in Blouberg Str(they are merely renting desk space).So my advise to anyone wanting to do buss with Better Life is, DONT GO THERE!!!!!!

This is a little out of my area of knowledge, but it sounds like the wheels are turning yet again. One doesn’t need sophisticated risk models allowing for the interaction of multiple risks, individual behaviour and an estimate of one’s risk appetite to know that a business that isn’t proud to show itself off isn’t one you should trust.

This reminds me of the example of the business premises of banks versus supermarkets. Banks typically spend large amounts of money on fancy head-offices, marble floors, giant pillars and so on. Supermarkets don’t. The key differentiator is that at a supermarket, you don’t care if they are in business tomorrow or not. You can tell the quality of the products by inspecting it and if they aren’t around tomorrow you aren’t affected. A bank, on the other hand, needs to show that it is not a fly-by-night operator. It needs to show that it has the resources to withstand economic crises, interest rate shifts and tilts and butterflies, poor credit events and the operational risks associated with any business. A bank needs to convince customers that it is solvent and good for the long term.

I don’t deal with financial institutions that look like supermarkets. No matter how low the prices are.

I gave a presentation on a holistic approach to ratemaking using predictive models yesterday to the Lebanese Insurance Association (ACAL, the acronym for the association in French). Over a hundred people attended, and there certainly seemed to be interest in the topic.

A common response though was that Lebanon isn’t yet ready for that, because rates are so low and nobody is prepared to change their approach. I accept that changing the “way things are done” in a fundamental way takes time and courage, but I expect that some players will start collecting the data, doing the analysis and improving their pricing in the next few years. By 2013, the market here will not be the same. The advantages across general insurance, banking, sales and cross-selling are simply too great. The techniques available are fantastic and can be implemented quite easily.

I’ve given the official press release below, and presentation ACAL GI Pricing 2008 (pdf version) is available under Resources on this site.

Insurance companies can generate a competitive advantage through accurate ratemaking, systematic risk-adjusted pricing, and careful analysis of policyholder price sensitivity at renewal dates. Single variable techniques can provide valuable insights into risk factors, but do not perform well in the presence of multiple drivers of risk.

Generalised Linear Modelling (GLM) is the preferred approach for robust, multivariate analysis of claim severity and frequency modelling. GLM can model several rating factors simultaneously, including interactions between different rating factors on risk. It is used extensively in the UK, the US and other highly competitive and developed insurance markets.

Judgement and experience are required when assessing different models and interpreting the diagnostic tests used to ensure accurate and robust results. A good model can make dramatic improvements in the separation of high and low risk policyholders.

These advanced approaches all have increased data requirements. Companies looking to reap the rewards of improved ratemaking will need to develop the databases and systems to store exposure, claims and rating factor data. There is a range of software available to perform the statistical analysis, from expensive purpose-built systems to freely available, open-source statistical platforms.

Successful implementation of an advanced rating system depends on commitment of key staff to the project and the inclusion of marketing, underwriting, legal, IT and actuarial skills in the project team. Market characteristics and reluctance to change are constraints to the adoption of advanced techniques. These have been faced and overcome in many other markets. It is only a matter of time before insurers must use these techniques even to maintain their competitive position.  Early movers will enjoy an improvement in their competitive position, market share and profitability.

The Make a Million competition is in its fourth year. The aim? Take a personal investment of R10,000 and compete with other “investors” to earn the highest return over a short period of a few months.

The competition itself has always struck me as a little strange. No doubt the purpose is to raise the profile of PSG and encourage new clients to begin share trading with them. However, it is also positioned as an educational programme where newbies can learn to invest in the stock market.

Invest? Oh, you mean speculate like crazy?

The irony is the strong use of the word invest in all of this. Investing is taking carefully considered long-term positions in great companies at reasonable or cheap valuations to benefit from the improving prospects of the underlying business and be rewarded for providing capital to the business.

The nature of this competition can be likened to a exotic type of binary option. Whoever makes the highest return in this short period (far too short for the economic and business fundamentals involved in real investing to play a serious part) wins the “pay-off”. The sensible strategy is to find the most volatile assets possible and plough all the cash into these few positions in the hope that they skyrocket. The downside is limited to R10,000 (ok, R10,650 if one includes the entrance fee) and the upside has the 7 digits of a million rand.

The competition is at least partially marketed  at those new to trading. This is NOT the right way to introduce investors to the stock market.

Introducing MaM4 with Single Stock Futures

This year, the competition has outdone itself in terms of promoting irresponsible speculation through introducing Single Stock Futures (SSFs). In this way, investors get to increase the volatility of their positions several times, to increase the possible (not expected!) value of their portfolios. Again, the downside is limited, so strategies that ramp up volatility (at the expensive of expected return) can be shown to be optimal.

The sneaky thing is that as participants increase the volatility of their portfolios, the expected value of the winning portfolio increases! The average return of all portfolios will be unchanged, and may quite likely even decrease. However, the winning portfolio (which both I and Nassim Taleb would both call the luckiest portfolio) is likely to be more impressive. A misleading, if attractive advert for stock speculating and PSG. As the volatility of individual portfolios increase, the range of outcomes (positive and negative) increases. Since the largest portfolio will win, we have increased the expected size of the winning portfolio.

All sounds horribly like the cause of the current financial meltdown

The current global financial disaster was largely created  through excessive gearing, poor understanding and management of risks, arguably weak regulation, and performance incentives that directly motivate risk taking for decision makers.

One of the key lessons of economics is that incentives drive action. Executives and traders were given huge upside potential in terms of bonuses and stock options for good performance, and the relatively limited downside of a still-significant salary and maybe a polite “moved on to new challenges”. We reward for upside performance and ignore risk in the process.

Nassim Taleb’s (if anything more relevant now that a few years ago books, “Fooled by Randomness” which I strongly recommend and “Black Swan” which is just ok) core point is that their is so much randomness and uncertainty in investment results that it is nearly impossible to identify real skill.

So the old Make a Million competitiion promoted risk-blind speculation over short time horizons. The new one takes this several steps further into the irresponsible.

Change Make A Million, save your soul before it’s too late

PSG, Moneyweb, Galileo Capital, JSE, ABSA Capital, Satrix and Deutsche Bank, do the right thing. Change the competition to one that is responsible.

Some interesting ideas for an alternative, less unconscionable competition:

• Be based on at least performance over a full year (I accept a 10 year competition isn’t viable!)
• Allow investors to choose a portfolio at the start and NOT trade. (oh, this doesn’t encourage brokerage and adrenalin and excitement? Pity.)
• Not allow investors to use geared products such as warrants and SSFs. Serious investments in underlying equities only please.
• Change the prize to be split amongst every investors who makes a return of Inflation + 15% over the period. This way, participants aim to generate very good returns with high probability (this target is still difficult for a real-world asset manager!) rather than go all-out for maximum return.
• Alternative performance targets could also be offered. Best risk-adjusted return, with risk-adjustment by traditional standard deviation, or downside variance, or maximum draw-down. You could also consider performance relative to the index as a whole, which would prevent scenarios where nearly everyone or hardly anyone wins the prize because of movements in the overall market.
• Abolish the abominable practice of allowing more than one account, more than one entry, and the ability to re-enter if one’s funds drop low during the competition. What were you thinking anyway?

These are just a few thoughts I had. Virtually anything must be better than what you’re doing at the moment.

ABSA appears to be restricting the access of equity in home loan accounts that were specifically sold with this feature in mind.  Moneyweb’s article on the real estate shocker has already totally nearly 70 comments.

What this says about ABSA’s house price index

What’s interesting is that ABSA’s house price index has remained positive throughout the interest rate increases, decreased consumer confidence, massively decreased property market activity and general feelings of gloom around the local property market.  Steadily increasing prices sharply reduce the risk of borrowers accessing the equity in their home loans up to the original agreed loan amount.

For most borrowers, their property would have had several years of price increases (on average) since the loan amount was granted. ABSA’s reluctance in this regard seems to suggest that they aren’t confident in their own property price index.

The second sentence of their announcement [hosted by moneyweb while I look for original] is:

Absa took the decision to amend the facility due to the decline in property values over the past six months

Decrease? ABSA still has property prices increasing!

Hints of the real reasons?

Another sentence:

This is also due to the substantial increase in the cost of holding capital to support all unutilised facilities

Tough times for all financial institutions. I can imagine tense meetings where managers of different divisions are instructed to find ways to reduce capital requirements. This is a tangible sign of the impact of the financial crisis on our banks and the tightening of pressures on the real economy.

Variation in property returns around the mean

It is true that individual properties could experience significantly different price appreciation or depreciation compared with the overall average. However, those with significant equity in their home loans are:

• Those who have been paying off the capital for several years, and would thus have been exposed to several years of positive house price appreciation. It seems unlikely that fluctuations in this groups property returns will put their current house price less than the original loan amount. Unless of course ABSA granted home loans  irresponsibly in the past, offering 100% or greater loans on overvalued properties. It seems unfair to change their approach on their FlexiReserve Comprehensive loan product now.
• Those who have made additional payments into their home loans over and above the required minimum payment. These borrowers only have equity in their home loans because they paid more than they were required to pay. Usually, this was one of the reasons they used this product – they were doing the financially prudent thing by paying off their debt as quickly as possible and maximising the effective return they could earn on their cash. These borrowers may end up worse off than if they had simply made the minimum payment required in the first place!

A primary sentence from their marketing material on the loan product (taken as at 15/10/2008):

Access equity in your home loan and withdraw from it whenever you need additional funds.

That sounds surprisingly like what many borrowers have done. It continues:

You have immediate access to available funds via the Internet, Telephone Banking, ATMs or any Absa branch, provided you have an Absa transactional account

Interesting, eh?

An element of truth

ABSA’s announcement makes a big deal about this being for the protection of borrowers and ABSA. There is truth to this. Borrowing against equity that “doesn’t exist” is not a good idea. In fact, in these unstable financial times, one should be trying to pay down debt as quickly as possible, not add to it.

This doesn’t change that many individuals and families would have stashed their special-event savings into the high-yielding comfort and safety of their home loan. Now is also a time when some may need those savings. I don’t think it’s up to ABSA to unilaterally decide to change the rules of the game.