Archive for February, 2009

The Problems with Performance Related Pay in Finance

Feb 28

Posted by Ken in Economics

Close up shot of pen
Creative Commons License photo: ArtemFinland

I was asked today what I felt about performance related pay in the banking/financial sector and the huge bonuses given to the bankers who are responsible for the financial crisis.

To my general thoughts on the topic, I’ll point you towards Tim Harford’s wonderful article in his Undercover Economist column. He talks about some of the adverse incentives created:

If you hired me as a hedge fund manager and paid me “2 and 20” – a 2 per cent management fee, plus 20 per cent of any gains – then I’d be tempted to take your money to a roulette table and put it all on black. If I won, I’d get to keep 20 per cent of the gains. If I lost – well, I would have been sure to deduct the management fee first.

Fairly recently, I was invited to participate in a trading simulation and competition run by the bank JP Morgan. It was lots of good fun: we had a simulated market running in the room where everyone could buy and sell shares in technology companies. Everyone was given some virtual money to invest. Throughout the simulation, the ticker would update with news about what was happening in the industry (e.g. earnings reports, new products, etc.)

I think there was roughly 40 teams or so participating in the simulation. The top four teams (i.e. the teams which made the most money) won the competition and went through to the next round.

My teammate and I were fairly sensible investors: we invested in a portfolio of stock, we knew when to cut our losses and we hedged our risks. I think that would be a good strategy to follow for an investment fund manager: after all you don’t want to lose all of your clients money and you want performance to be pretty stable.

DSCN1753
Creative Commons License photo: Petrick2008

We came about 10th in the competition so we missed out on being in the top four. Anyway, it turned out that the winning teams which won the game had invested larger sums and taken much larger risks than we had. In retrospect, it made sense. Seeing as you wern’t playing with your own money (in this case it was virtual money), the whole game encouraged taking risks. A sensible investor who took fewer risks might make a good return on their portfolio but they would never be able to win it. An investor taking large risks would either come last (in which case, nothing has been lost) or first (in which case they would win the game).

The investors who took the most risks - a level of risk which you wouldn’t want to be exposed to if the money was your pension or savings - won the game. The prize is probably an internship or a job or something.

I think that illustrates the whole problem with the system of rewards in the financial sector and what caused the traders to take huge risks with our money.

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Savers are earning more as real interest rates rise

Feb 19

Posted by Ken in Economics

piggy-bank-header-at244-by-G.E.Sattler
Creative Commons License photo: G & A Sattler

So lots of my friends have been complaining about interest rates over the last weeks or so. The Bank of England has dropped base interest rates from 5.75% where they were just 6 months ago to 1.0% today. For savers, that also means interest rates have been cut which is bad news for everybody who is saving for a house/college/etc. Right?

Not really. The Times discussed this very recently. It’s no good looking at the nominal interest rate which is advertised by your bank or the Bank of England as it is meaningless. What’s important is the real interest rate. Let me explain.

Let us take a basket of goods which we define to be representative of your expenditure. The basket of goods has a cost of £100 this year.

If we have inflation of 5%, that means the same basket of goods would cost £105 next year.

What if you decide, instead of buying a basket of goods today, you choose to put your money in a savings account earning 5%? Well, the £100 you invest will have turned into £105. When you come to spend your money, all you’ll be able to buy is a basket of goods. You’ll have nothing left over. In real physical terms, you haven’t gained anything from saving as the amount you can consume has stayed the same.

Hopefully this example illustrates that the important thing is real interest rates. Whilst nominal (advertised) interest rates are at the lowest point in yonks, real interest rates aren’t too bad as inflation is very low.

Let’s take a look at nominal interest rates and RPI inflation over the last few years:

Interest rates and RPI inflation

We see that it was pretty bad for savers towards the end of 2008 as inflation totally eroded any interest being earnt. However, with inflation now very close to zero, this is no longer the case. This is more clearly illustrated in a graph of real interest rates:

Real interest rates

As you can see, real interest rates are climbing back up to around 1.5% where they’ve been for the last couple of years.

Conclusions:

  • Whilst it appears that savers are losing out, they’re not doing too badly considering the drop in inflation.
  • Your savings for college are still growing. And if you’re saving for a house, you’re also benefiting from the huge drops in house prices.
  • The low interest rates shouldn’t be encouraging you to borrow. After all, if a house is losing 10% of it’s value each year and you’re paying 1% interest on the mortgage, you’re paying an effective mortgage rate of 11%. That’s a much higher rate than a few years ago when house price inflation would essentially pay off the interest on your mortgage.

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The Great Digital TV Switchover: Freeview or Freesat?

Feb 11

Posted by Ken in Television

Television
Creative Commons License photo: videocrab

The UK is currently in the process of switching over from analogue broadcast to fully digital television. Essentially that means the analogue broadcasts will be turned off channel by channel and the frequencies those channels currently occupy will be replaced by digital TV channels. The reason the government are doing this is two-fold: primarily so it can auction off the frequencies that Freeview is currently broadcasting on and because moving Freeview to current analogue frequencies will allow much better reception for Freeview channels.

When do I switch?

According to Digital UK, switchover is happening region-by-region. The timetable as it currently stands:

  • Border has already started and finishes in 2009
  • West Country starts in April 2009 and finishes in September 2009
  • Granada switches in 2009
  • Wales starts in August 2009 and finishes in 2010
  • STV North switches in 2010
  • STV Central switches between 2010 and 2011
  • West switches between 2010 and 2011
  • Channel Islands switch in 2010
  • Central, Yorkshire and Anglia switch in 2011
  • Meridian switches between 2011 and 2012
  • London switches in 2012
  • Tyne Tees and Ulster switch in 2012

What are the free options?

The Office Monkey
Creative Commons License photo: shaz wildcat

There are of course a huge range of  services you could choose to replace analogue TV. Most of these involve subscription; I won’t talk about these options in this post. I’m working based on the assumption that if you wanted to subscribe to a TV service, you already would be doing so.

Essentially, you’ve got three options. The first is Freeview which is the most similar to analogue TV. You recieve television through an aerial. This can cause difficulties if you’re using an indoor aerial because digital TV tends to require better reception for it to work. Enter your postcode on the Freeview website.  There is a fairly good selection of channels too and the shopping channels gradually seem to be disappearing from the service. A Freeview box costs under £20 and you can install it quickly and fairly easily. It’s also worth considering getting a Freeview+ PVR (personal video recorder) for £100 which will allow you to record programmes.

Typical Freeview cost: £20

The other two options are to recieve television through your satellite dish. Rather confusingly, there are two services called Freesat: there is Freesat from BBC/ITV (”Freesat”) and Freesat from Sky. These are much pricier options but they might be your only choice if you don’t get Freeview in your area.

Hanging out with the coloured cottons 2
Creative Commons License photo: treehouse1977

You can get a Freesat box from £50 or a high definition box from £100. If you want to record, you’ll have to fork out at least £300. On top of that, if you don’t have a satellite dish, it’s another £80 for installation. The costs are significantly higher than Freeview but it does mean you can get the most out of that new high definition TV.

Typical Freesat Cost: £130

Then there’s Freesat from Sky. Sky will charge you £150 for a box and installation. You’ll probably get spammed by Sky to take out insurance on your box (and my Sky box just after 1 year when the warranty expired). You’ll also constantly get annoyed flicking through channels displaying “please subscribe” nags. This is certainly an uncompetitive option and there is no chance of subscription-free high definition or PVR.

In fact, if you’re considering Freesat from Sky, you might as well consider the full thing. Sky’s Pay Once Watch Forever offer gives you 4 months of free Sky TV for £73. If you cancel after 4 months, it’ll revert to Freesat from Sky. Obviously, they’re counting on you staying as a subscriber.

Typical Freesat from Sky Cost: £150 + spam from Sky (or £73 if you’re willing to sign up to the full Sky and then cancel)

Summary

Expanded Perception
Creative Commons License photo: jurvetson

By far the best and cheapest option is Freeview. For most people, this will probably be first choice. I strongly recommend Freeview+ as having a PVR changes your life :)

However, Freesat from BBC/ITV is worth considering if:

  • You already have a satellite mounted outside your house
  • You want high definition television
  • You can’t receive Freeview where you live

Freesat from Sky is probably not at all worth considering. I’ve had to put up with nuisance calls, letters and emails from Sky.My first Sky box broke after about a year and my current Sky+ box (which I’ve almost very nearly had for a year) looks like it might be on it’s last legs…

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