Make A Million competition encourages financial meltdown

[There is an additional post for the 2010 competition on how to not lose money in the make a million competition.]

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.

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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