Dear reader, by the time you get this note, I’ll be gone.

Yes, proving Monevator really is the product of one man’s ego mind and not a corporate mouthpiece or a big media outlet, I’ve gone on holiday for a week and hung the ‘Out for Lunch’ sign on the door.

This means no new posts for seven days!

But please don’t forget to come back to Monevator, because while I’m sure I’ll have the usual “what am I doing with my life” musings when sunning myself abroad, I’ve also got lots of posts planned already.

In fact, I’ve got a few posts half-written. I’d hoped to queue them up so you’d not even notice I’d left the building but, well, as I said, this site is the genuine thing, and I’ve got a plane to catch!

Please do have a poke about in the Monevator archives – there’s tonnes of stuff in there. And do keep commenting. While I won’t be posting, I will pop into Internet cafes at least a couple of times, and once I’ve approved one of your comments, future ones go live without moderation.

Without further ado, some links from elsewhere:

From the money and investing blogs

• Oblivious Investor rarely monitors his portfolio.

• Wealth Pilgrim has got rid of his landline.

• FiveCentNickel has been avoiding temptations.

• Moolanomy says the market is beatable.

• The Psy-Fi Blog writes lots of good stuff about Bogle.

• Darwin’s Finance is right to argue frugality won’t stay fashionable.

• Amateur Asset Allocator says ‘Pah!’ to Warren Buffett’s record (sort of).

• Brip Brap invests in his good health.

Generally UK-related articles from other websites and papers

• If you read just one article about the UK economy and government debt this year, make sure it’s this brilliant piece (complete with interactive graphs) from the Financial Times.

• The Motley Fool looks at what commodities tell us about the economy.

Did you find this roundup useful? Simply subscribe to Monevator via email or RSS (it’s totally free) and get my best links every week.

Further reading:

1. Weekend reading: Formula 1 in crisis
2. Weekend reading: 30/5/09
3. Weekend reading: 23/5/09

Exactly how to do this is the $6 million question!

In the blue corner, we have the efficient market experts who say it’s a doomed mission, and that you’re better off putting money into an index tracking fund than trying to find a needle in a needle factory.

In the red corner, we have share gurus like Peter Lynch, Jim Slater and Philip Fisher, who all beat the market through growth investing and outlined their ideas on growth investing in various books.

In my opinion, some of the important aspects of growth investing include:

• Looking for a story – Most good growth stocks have a narrative that captures the imagination as well as guiding profit expansion. It might be anything from revolutionary computer software to a new take on fast food, but it must underwrite the investing case and evolve as the company grows.

• Understanding the business – Value investing in its purest form is just about the numbers. Growth investors must have a far deeper take on the business opportunity if they’re too evaluate its long-term potential, and the company’s progress towards it.

• Small size, big opportunity – “Elephants don’t gallop”, said Jim Slater. Apple might be a fine company – perhaps it will double in size in the next few years – but with a market cap of $121 billion it’s not going to become ten times bigger anytime soon. In contrast, a £25 million company can double in size every year or so, provided the market it has identified is big enough to sustain its growth.

• Disruptive company – Often (but not always) an excellent growth company is doing something new, which utterly changes an entire marketplace. Think Google in the early years, or even McDonalds with its franchise-based approach to restaurants. (Or it may just be a resource company that strikes oil!)

• An emphasis on forecasts – Growth investors are much less skeptical about analyst’s forecasts than value investors, and will look 2-3 years into the future for profit growth.

• Re-rating – You ideally want an unpopular share on a low-ish P/E which gets re-rated to a higher P/E as the growth story spreads, as this re-rating hugely increases the gain.

• High return on capital employed – Many companies can grow by issuing lots of shares to expand, or by taking on a lot of debt. Good growth make money for shareholders.

Don’t be fooled! Many small caps look like growth stocks now and then, and any manager worth his salt can spin a good story.

The skill with growth investing is to be able to sniff out the companies that can truly deliver the best of what they promise. Any let up in growth is invariably punished hard by the market.

Even if you do find a good growth stock, be aware that managing fast growth is very difficult. Companies often expand too quickly and run out of cash, or conversely they move too slowly and lose the early initiative.

There are scaling problems by the dozen, too. It’s very hard to turn a small company built around a charismatic entrepreneurial individual into even a medium-sized company with hundreds of staff, middle managers and far-flung offices without losing the magic. (I’ve been at such companies and observed the growing pains first hand).

Should your company get through all that, then there’s the difficulty of knowing when to jump off the ride.

Few companies can grow forever – even Microsoft seems to have run out of road in the past decade.

Growth, value or both?

Having started my investing life as value investor, I’ve got more interested in growth as the years have gone on.

Perhaps that’s partly been because the market has usually been pretty richly valued, so value opportunities have often been in frankly awful looking companies.

But it’s also the influence of books and articles I’ve read, particularly the shareholder letters of Warren Buffett and his various biographies (the newest official one is full of lessons about Buffett).

Buffett doesn’t subscribe to the pure definition of growth investing, saying growth and value are two sides of the same coin.

That’s where my investing philosophy is, too. I still can’t bring myself to pay for shares on sky-high P/E ratios, let alone loss-making companies promising “jam tomorrow”.

But all things being equal, I’d prefer to buy a decent looking business growing at 15-20% a year then a low P/E business that’s stagnant – at the right price.

Is this the right approach? I suspect you have to do what you’re comfortable with.

As a growth investor you’re certainly up against a headwind. Unlike with small cap value shares, there’s no data to suggest that as a group growth shares outperform.

On the other hand, some very famous growth investors clearly have!

If you’re a growth investor, let’s hear what you look for in the comments below.

Further reading:

1. Growth investing

I have done a bad thing. Maybe. I bought Lloyds Group shares at 72p. Yes, greed has finally overtaken fear in my pondering of the banking shares. I can’t help thinking that this may be a once in a lifetime opportunity to buy a giant of tomorrow on the cheap today.

And so on Wednesday I placed about 2% of my portfolio in Lloyds.

I’ve owned the shares previously, and got out before they plunged 90% in merging with HBOS as I’ve written about before.

Why have I bought them again?

In short, because things change.

Regular readers may remember when I didn’t invest in Barclays at 220p. I don’t regret that decision despite subsequent rises, because back then the market for banking shares was being driven by fear.

Instead I stuck to my picks of HSBC and Standard Chartered to come through the crisis.

Standard Chartered is looking good, reporting excellent results and looking to make smart acquisitions.

HSBC has wobbled a bit, but I think its sheer size that makes it vulnerable in today’s thinly traded markets. HSBC is so huge, it needs to see more institutional buying, like a lot of blue chips right now.

But why buy Lloyds?

Regular readers will probably detect some psychological quirks in the writing above. I’m trying not to write with too much hindsight bias, but perhaps that’s impossible.

Indeed, one of the reason I post some of my share picks on Monevator is so that in future I can’t fool myself about why I bought a company, and what I expected from it.

In that spirit then, here are the main reasons why I’ve bought Lloyds.

I’ll try to keep it brief, since I’m aware huge volumes have been written about the ins and outs of banking stocks all over the place. Let’s stick to the essentials.

The threat of Government ownership has receded

Easily the most important reason.

In March as Lloyds shares fell towards 30p, there looked a serious possibility that the bank would be nationalised. Lloyds preference shares were at one stage yielding well over 25% – in retrospect an incredible buy.

But the government takeover didn’t occur. In fact, in early June, Lloyds became the first bank to pay back government money from the credit crunch.

The government now owns 43% - not pleasant, but survivable. I think the threat of nationalisation has passed.

Yet it still ring-fenced its assets

Lloyds entering the government’s asset protection scheme has shouldered lots of the dodgy HBOS loans onto the tax-payers’ shoulders, at a price of preference shares that can be excised at 150p.

The terms aren’t great, but crucially they don’t currently increase the government’s stake.

If the pref shares are excised at 150p (taking the government’s holding to 55%) I can make a new decision – and will have seen a 200% return by then, anyway.

Lloyds is dominant in the UK market

HBOS, which Lloyds ill-advisedly merged with during the panic of last year, was already the country’s biggest mortgage lender.

Add that to Lloyds’ existing book and it’s the market position is a mind-boggling one-third of the market.

It’s similarly dominant in savings, which will mean huge opportunities for good old-fashioned customer exploitation banking.

It’s slashing costs and jobs

Jobs are going left, right and centre at Lloyds, which is horrid for those concerned but the whole rationale for merging the businesses.

I was particularly impressed when Lloyds decided to close its Cheltenham and Gloucester network. As I say, I feel sorry for the employees, but it has to be done. And crucially, the government doesn’t seem to be stopping it.

The result should be most of the earnings of the combined companies (minus late stage nonsense earnings at HBOS) with much lower costs.

I like the Lloyds management

Seriously! Apart from their moment of madness when they bought HBOS (and I sold out) I have long admired the management’s sticking to the knitting, and paying a healthy dividend.

The Lloyds of two years ago is the model for retail banking of tomorrow. Dull, based on savings, mortgages, and some pretty innovative customer offers. More like a utility.

If a utility-style bank with access to the mortgages and savings of its 15 million customers can’t make money, then banking really is doomed.

Analysts see good earnings from 2011

Yes, I was swayed by the Goldman Sachs upgrade earlier this week, which is predicting Lloyds could earn 15p in the financial year after next (it will continue to lose money until 2011).

That would put Lloyds on a P/E of less than 5 on my buying price, when 10 would seem much more reasonable, assuming we’re out of the financial woods by then.

As for the downside, the asset protection scheme provides reassurance – it is writedowns that have been destroying banking earnings. We continue to save, buy insurance products, and pay our mortgages - at insane spreads at present. Banking should be very profitable again soon.

Assuming we don’t spiral into deep recession, I can see Lloyds getting back to 20p per share earnings within five years, which would make a share price of £2 very reachable.

Sometimes you’ve got to roll the hard 6

If you’re going to invest in individual stocks, you need to take some opportunities. There’s no doubt buying Lloyds is a bit of a gamble.

But the risk/reward - now the threat of it being taken over by the tax-payer has receded - looks pretty compelling.

I say again, this is a murky share to buy. There’s essentially no earnings visibility, we know there are lots of bad assets on the books, and as of now the U.K. is still officially in recession.

Buying Lloyds is basically a bet that sweating all those assets will out the earnings, eventually.

We’ll just have to see how well it does, and how fast - or otherwise - in the months and years to come.

Note: I take no responsibility for the accuracy of this post. Read my disclaimer.

Further reading:

1. Reminder to Lloyds: If a government tries to sell you a bank, you say No
2. Bought The Clapham House Group (CPH)
3. Why I’m holding HSBC and Standard Chartered, despite the financial crisis

We can also add ‘mean’ to the list, with the launch of the latest UK Government backed GEB.

The 18th Issue GEB from National Savings and Investments is offering 40% of the gain in the FTSE 100 over the next five years, in exchange for 100% capital protection.

According to the NS&I website:

If the averaged index end level is 20% greater than the averaged index start level at the end of the 5-year term, £10,000 invested would earn a gross return of £2,000 at the end of the term. If the index end level was 45% greater than the index start level at the end of the term, £10,000 invested would earn a gross return of £4,000, because the maximum return is 40%.

Okay, relatively simple for one of these often hideously complicated products.

What’s good about this bond?

Firstly, it’s 100% backed by the UK Government. This makes it infinitely safer than comparable GEBs from private companies, which are vulnerable to the companies involved going bust.

Secondly, the gain is averaged by comparing the starting level of the FTSE 100 index (averaged over the first five days) to the end level (averaged over the final six months).

This means you won’t suddenly see your investment collapse in value due to a crash; it also means the last six months of your gains are limited, too.

Thirdly, the return compares quite well with other GEBs from the likes of Barclays and Morgan Stanley, which are also capping returns at around the 40% mark.

You want a fourth? Er, you can invest in it via the post. Handy if you’re getting square eyes from looking at the Internet all day.

Why GEBs like this are a terrible deal

First and foremost, dividends aren’t included.

The FTSE 100 is yielding around 5% at present, so that’s up to 5% a year growth compounded that you’ll be missing out on – something like a 28% return, all things being equal.

Secondly, the 40% cap on gains means you’re being offered a limited reward for the risk of getting nothing.

I’m bullish on the market right now, but I certainly accept the index could be flat or lower over the next five years. If this happens, GEB investors will get nothing for locking their money away for five years.

Indeed, according to the Daily Mail this is what is happening to NS&I GEB investors of five years ago:

Risk-shy saver Michael Barnet, 48, has a five-year NS&I Geb maturing in November. ‘I will probably get nothing but my original money,’ says Michael, who works with Age Concern, ‘but there’s still a chance of a return. When it matures I’ll be tempted to invest in another Geb from NS&I.’

But Michael, from Welwyn Garden City, Hertfordshire, insists: ‘I only save where I know my capital is safe.’

Personally, I’m happy to risk money in the market because I believe the potential rewards are worth it.

The most bullish readings of past data suggest shares could rise 20% a year from here for a decade. I don’t bank on that, but the potential for such rewards is adequate compensation for the risks of market exposure.

Imagine how rotten you’d feel if you invested in this GEB and the market rose even 50% over five years? That rise would only take us back to where we were before the recent crash, but it would be a 75% gain for tracker investors who would also get dividends. In contrast, GEB investors would see barely half of that.

If the market doubled GEB investors would probably go on the rampage. I can almost hear angry housewives phoning Radio 4 in disgust.

Finally, the GEB is hideously illiquid. There is no access to the funds invested once the term has started (unless you die, which would be bittersweet to say the least).

In contrast, you’re free to sell out of shares held in say an index tracker fund whenever you want, for whatever reason you want.

What you should really do if you’re nervous

If you’re very nervous about the stock market or need your money within five years, you should probably be in cash, not shares.

I’d consider it a decent wager that you’ll make half of the GEB’s 40% maximum upside by rolling your money through the best 12-month fixed rate savings bonds for five years, with zero risk of getting no gains at all.

I know saving interest rates are low at the moment, but I don’t see that lasting forever.

Alternatively, you could keep say 75% of the money in cash and say 25% in an index tracker. The cash would grow through interest, and you’d get dividends and potentially a capital gain from the tracker.

Remember, assuming FTSE 100 dividends hold from here, the market would need to fall 20% or so fall for you to lose out on the tracker, provided you reinvested your dividends every year. Plus you have interest on the cash providing a further cushion.

I’m sure someone nerdier than me could calculate the perfect tracker / savings / GEB combination for most market eventualities. But I’m not just being lazy - it’s all far too much complication for anyone, which is the ultimate black mark against these silly products.

If you must have a GEB, the NS&I one at least has the Government guarantee. And as I say, the capped gain looks competitive compared to others - I’d expected to find more compelling alternatives.

But GEBs still won’t see a penny of my money.

Remember: I am not a financial advisor. Consult one if you need to. This page does not constitute financial advice of any sort.

Further reading:

1. Structured products and ‘guaranteed’ equity bonds were never a good idea
2. What causes corporate bond prices to fluctuate?

Originally such deals took places in private houses, coffee shops, and even on the roadside.

Over time these early markets matured and were formalised and regulated. Together with the invention of limited liability companies, we got the financial system we enjoy (or otherwise!) today.

So why would a company want to set back 700 years of history to offer its own bonds directly to the public? And who want to buy them?

That’s the question I ask myself as I read this pitch from UK shaving supplier King of Shaves, which has just started offering a three year, 6% bond:

“IT’S TIME TO SHAVE AND SAVE BETTER…”

The King of Shaves Company Ltd., owner of the successful shaving brand King of Shaves, is delighted to offer an opportunity to the general public to invest in its first ever ‘Shaving Bond’, a way for you to save money (with a 6% per annum interest rate) and shave better (with our multi-award winning King of Shaves products).

The proceeds of the Shaving Bond will be used entirely on marketing the King of Shaves shaving brand, a multi-award winning company founded in 1993 by me, Will King. [...]

With only five thousand of the £1,000 Shaving Bonds available, and with one million men and women shaving with King of Shaves every day, we are expecting this savings opportunity to be heavily oversubscribed, and to avoid disappointment, we would recommend applying early.

Please note: To apply you must be a UK resident aged 18 or over.

Answering the first of my two questions is easy. Besides $5 million in cheap money, King of Shaves will get plenty of publicity from its ’shaving bond’.

There is equally a risk of bad publicity if it can’t pay the bonds, but in such circumstances it’ll probably have other problems to deal with.

For investors though, I see no attraction short of the free shaving stuff you get for investing - and those admittedly nice products can be picked up cheaply for a few quid without risking a grand.

You might think a 6% fixed rate sounds good compared to savings account rates of 3.5%, but King of Shaves’ bonds have about as much in common with a savings account as I do with Brian Blessed.

Here’s why I’d avoid them:

This is not a savings account

The literature states:

SO WHAT IS THE SHAVING BOND?
It’s an opportunity for you to ‘shave and save’ with King of Shaves. Yes, we’re offering you a 6% per annum, 3-year non-transferable, non-convertible savings bond. That’s a massive 12 times the current Bank of England base rate. You simply won’t get that from most High Street banks, or the Back Street ones for that matter.

This is all completely irrelevant, because this is not a savings account backed by a giant bank.

It’s a corporate bond backed by a small, unlisted company.

Comparisons should be made with other corporate bonds, not with cash savings.

These shaving bonds are too risky

No investment is guaranteed, and nor are conventional corporate bonds. But the shaving bonds have particular properties that make them much riskier than normal corporate bonds.

You don’t have to take my word for it - just read the offer details from the company closely!

Once you’ve clicked to apply for the bonds, the company says this in its notes on risk factors:

Investment in an unquoted security of this nature, being an illiquid investment, is speculative, involving a degree of risk. It will not be possible to sell or realise the Shaving Bonds or to obtain reliable information about the risks to which they are exposed.

The Shaving Bonds are an unsecured debt of the Company and there is no certainty or guarantee that the Company will be able to repay them.

The Shaving Bonds may not be a suitable investment for all reviewers of this Invitation or the Instrument.

Too right.

How do you judge whether King of Shaves can meet its debt repayments? This is an unlisted company, and there’s no balance sheet or profit-and-loss statement in the offer material.

You’re effectively taking a punt on the company’s brand name, and that of the accountant BDO Stoy Hayward who is helping with the offer.

A bit of Googling reveals King of Shaves was expected to turnover £25 million in 2008, but I can’t find anything more up-to-date on turnover than that.

The £5 million it proposes to raise seems a lot to me, in comparison with its turnover.

The 6% return is a lousy reward

There are plenty of conventional corporate bonds offering more than 6% from large, blue chip companies. Obviously in the current climate we’ve all been reminded that no company is bomb-proof, but personally I’d rather buy debt from a big listed company with a decent credit rating than an unlisted tiddler.

Better yet, you could invest in a broad spread of corporate bonds via an investment trust yielding over 6%, if you want income from this sector.

To be fair, one difference is the shaving bond will (hopefully) return your capital in just three years – in contrast with corporate bonds that will fluctuate in value over a long time frame before repaying their par value.

Of course there are mainstream corporate bonds with just three years left to run, but I’m not certain of their rates. The shaving bond yield will probably look more favorable compared to them, but I bet the overall offering won’t.

If you want to root about for proper corporate UK bonds, Fixed Income Investor is a good place to learn more.

The shaving bond is illiquid

As far as I’m aware, you won’t be able to trade your shaving bonds.

Rather, you’ll have to lock away your money for three years. If you need cash before the end of the term, too bad.

This is a terrible risk/return situation for private investors. Either the bonds will pay out for three years in a row and you’ll get your money back, or they won’t. There’s no middle ground.

You’ll happily lock money away into a savings account because you can have a lot of confidence the bank and the government will guarantee your cash is repaid.

This security means 6% for a savings account would be a very good return in the current climate.

But for a bond you can’t touch from an unlisted company, you’d want to get more like 10-20% (at which point you’d wonder why the company wasn’t getting money cheaper from elsewhere).

There’s no smart money evaluating the bonds

We’re basically being presented with the bonds and asked to like them or lump them.

All corporate bonds are issued on that basis to some degree, but:

• The issuer is aware sophisticated market professionals will be evaluating the bonds and comparing them to other corporate bonds, and so will price them accordingly.

• Normal corporate bonds are tradeable, so you can always buy after they’ve been issued if you think they’re over-priced and likely to fall.

The King of Shaves bond has been priced according to what it will take to get 5,000 retail investors to part with £1,000 each.

Great product, bad investment

I’ve been known to use King of Shaves products, when I’m feeling flush and they’re on special offer. (I’m usually not a sucker for brands, especially in the bathroom, and the own label gel does me fine).

I’ve also got a sneaking admiration for the company for trying it on with this bond. With trust in financial institutions at an all-time low, you can see the rationale. Founder Will King has also said he thinks he will get 5,000 ‘brand ambassadors’ for his shaving products as well as investors, which makes sense. His cheeky offer will increase sales as well as raise money.

As an investment, however, I wouldn’t touch it. The shavings bond is illiquid, the yield is too low, and I’ve got no financial information about the issuing company it – and nor does a savvy after-market, because there isn’t one.

I suspect 5,000 people will feel differently. If you’re one of them, you can read more about it on the shaving bond offer page.

What would trouble me is if King of Shaves started a craze for unlisted bonds. One company doing a one-off deal for headlines is one thing, but dozens of companies raising money direct from an always-credulous public would surely end in tears.

Anyone out there more tempted? Do let us know in the comments below!

Further reading:

1. Other kinds of bonds you may come across
2. What are corporate bonds?
3. Convertible bonds

This week saw the end to a shibboleth that everyone knew was rotten but nobody ever really believed would leave us.

No, not poor Michael Jackson, an amazing singer and a much-maligned weirdo who seems to have been slandered just for being different. The second album I ever bought was Jackson’s rather weak Bad, but to this day I have to dance when his proper classics – Billie Jean, Thriller, Off the Wall – hit the speakers at a wedding.

I’m actually referring to the FSA’s decision here in the UK to finally ban commission paid to supposedly independent financial advisers.

For decades, advisers have been able to recommend investment bonds or life assurance policies to clients then pick up a 5-10% commission from the financial company behind it, dressed up to the client as a cost of investing.

Even worse have been trail commissions whereby advisers have enjoyed 1% of a client’s return on an investment they sold them for decades. Talk about passive income!

Most people never knew they were paying such fees, or if they did they didn’t understand their impact. Even today, I imagine few realize when their pensions are less than they expected or their endowment mortgage fails to pay for their house just how much of their wealth actually went to their adviser.

So three cheers for the FSA for finally banning it. We can only wonder why it took so long?

From the money and investing blogs

• Wealth Pilgrim gives three reasons against buying oil and gold.

• The Psy-Fi Blog warns of the dangers of toxic ETFs.

• FiveCentNickel on improving your life through actions.

• Moolanomy explains what 1% is really worth.

• Darwin’s Finance has picked out 15 US corporate bonds on good yields.

• Amateur Asset Allocator compares rental properties versus REITs.

• Oblivious Investor warns us about share tip newsletters.

• Brip Brap on the pitfalls of the four-hour work week.

Generally UK-related articles from other websites and papers

• Lunch with Warren Buffett is 20% cheaper this year.

• A guest column in the FT explains further why commission for financial advice had to be banned.

• City Wire explains how Michael Jackson spent a fortune.

• Vintage wines from the 1980s have returned about 12% a year, says The Guardian.

• The Independent profiles a global multi-currency fund from Schroders .

Did you find this roundup useful? Simply subscribe to Monevator via email or RSS (it’s totally free) and get my best links every week.

Further reading:

1. Weekend reading: 23/5/09
2. Weekend reading for investors: 11/04/09
3. Weekend reading for investors: 2/05/09

Coincidentally (or not!) the oil price has doubled in four months.

Oil certainly tends to be one of those investments that comes and goes into fashion.

However there are legitimate reasons why you might want to invest in oil:

• To hedge the cost of petrol
• Because you think a rising oil price could hurt stocks
• You think oil is running out and so it will get more valuable
• You believe inflation is a threat, so want to buy real assets
• When you were little, J. R. Ewing was your idol

In this article I’ll look at four ways you can back the oil price.

To invest in oil, you don’t need to buy barrels of the stuff, though in the last bull market there was talk of hedge funds being forced to take delivery of oil tankers. (I’d love to see them rolling barrels down the streets of Mayfair!)

Here are four ways to get exposure to oil without dirtying your hands.

1. Investing in an oil with an ETF

I’ve written before about using these collective vehicles to diversify your portfolio with commodities.

In short, ETFs provide an easy way to get immediate exposure to a wide range of commodities, including oil.

The price of an oil ETF reflects the spot price of oil.

You buy the ETF just like any other share in your normal share dealing account.

• If the oil price goes up your investment rises by very close to the same amount.
• If the oil price falls, so does the value of your investment.

You can get exposure to the oil price in dollar or sterling terms, depending on which ETF you choose.

You can also bet on a falling oil price by shorting an oil ETF. I’ve known investors in oil companies attempt to hedge away their exposure to a falling oil price like this, although it’s an inexact science.

There some slight complications to be aware of:

• Firstly, ETFs are only as secure as the company that backs them. (This was a worry with the threat to AIG and the collapse of Lehman Brothers in 2008).

• Certain commodity ETFs buy the physical goods (at least in theory) but most use only financial instruments to get exposure.

• Finally, there is a fiddly argument about how an oil ETF does not perfectly track the oil price, but rather is affect by something called cotango, which is to do with how the market sees the price changing (I’m deliberately over-simplifying). I’m not convinced this will really make a big difference to how your investment performs, although I’ve no trouble believing it adds some ‘frictional’ losses.

Steer clear of any ETF that uses leverage to double or triple the rise or fall of the oil price. It won’t double (or halve) your investment.

Leveraged ETFs are really bad news unless you’re a day-trader – they are settled daily, are costly, and they don’t do what most investors think they do.

2. Investing in oil via explorers or producers

Buying shares in oil companies is a time-honored method of getting exposure to the oil price. And for once, UK investors have it good, with a range of large, medium-sized and small cap companies.

It’s pretty clear how a rising oil price benefits oil companies.

Oil explorers make more money when the price rises because the reserves they discover and map out are worth more money. And producers make more money by charging more for their barrels.

However it’s not a perfect correlation. Companies will also be affected by general stock market sentiment, for instance, or by the availability of finance (a particular issue for explorers, who are forever looking for cash).

If you want to purely track the price, use either ETFs or a spreadbetting account.

If you’d rather buy companies, in the UK you could look into BP and Shell at the multinational level, Cairn Energy, Dana Petroleum and Soco International at the mid cap point, or the likes of Tullow or Falkland Oil and Gas at the smaller end.

Investing in oil companies is risky, and requires different skills (or luck, tracker fans!) to investing in most other companies.

For explorers, for instance, instead of P/E ratios and growth rates, you have to evaluate possible versus probable versus proven reserves, and estimate the cost of extraction. True ‘oilies’ pour over seismic data and drilling reports to try to spot something even the analysts have missed.

Oil producers are a little more conventional, but most are on some level explorers or at least acquirers (because their oil runs out!) which takes you back to the reserves question.

It’s specialist stuff really, so I’d suggest most people are better off putting money into oil companies via a collective fund like the Junior Oils Trust. That manager favours small-to-medium sized oil explorers, and there’s no danger of your single oil company investment hitting successive ‘dusters’ on ’spudding’ (I told you!) since your money is spread between many outfits.

What about simply buying BP or Shell? They have billions of barrels of oil in reserves, and would seem to be major beneficiaries of any rise in the oil price. They are huge companies and pay a great dividend, too.

Unfortunately, the consensus is that these so-called integrated majors are NOT a good play on the oil price.

As best I understand it (and I must admit I don’t entirely), the issue is that the processing and distribution end of the operation effectively has to buy oil from the exploration and production side of the business.

This means if the oil price rises, one side of the business wins and the other loses, canceling out the gains. And viceversa.

To me it still seems like a doubling of the oil price would double the value of its reserves (surely the consumer will be paying the extra ‘downstream’ costs in the end?) but smart oil fans tell me it ain’t so.

If you’d like to have a crack at explaining, please do comment below!

3. Track the Russian stock market

The benchmark Russian RTS stock index is stuffed full of energy giants, and the country is often seen as a play on the energy sector.

More specifically, as John Authers reports in the Financial Times, the performance of the Russian economy is closely correlated to the oil price:

A presentation by Marshall Goldman, professor of Russian economics at Harvard university, shows that every year since the fall of the Soviet Union until [2008], Russian oil production and Russian gross domestic product moved in the same direction: the severe recession of the Yeltsin years correlated with declining oil production, while the Putin years saw booming economic growth on the back of rising production. Last year growth remained healthy, while oil production declined slightly.

So Russia’s stocks appear to offer a perfect geared play on oil, and economic fundamentals confirm that it makes sense to treat them that way. If you think oil is going down, short Russian stocks; if you are confident about oil, buy them.

I’ve got a small investment in Russia via the JPMorgan Russian Securities Investment Trust, which seems a decent proxy for the market. I’m not aware of a Russian ETF for UK investors, but there may be one.

Alternatively you may be able to spreadbet the Russian index if you’re adventurous.

Russian securities are not for the faint-hearted; Russia is run according to the Don Corleone school of economics.

You’re definitely taking on extra political risk if you invest in Russia (one risk being that you wake up to find the entire market has been nationalised!)

On the other hand, by investing in the index you might get a little more bang from your buck, if the country matures and its market broadens. (Remember though that this would weaken the correlation with the oil price).

4. Spreadbet the oil price

Spreadbetting provides the very simplest way to get exposure to the oil price - even more so than using an ETF.

To get exposure you simply take out a bet that the oil price will rise beyond a certain price.

• If the price rises above a small percentage (the spread) you’re in profit.
• If it falls, you lose money.

Make sure you’re very familiar with all the many risks and pitfalls of spreadbetting, which are mainly to do with leverage. Spreadbetting accounts are not for everyone.

You don’t have to use leverage when you spreadbet. Or, even when you do, you can be disciplined and put aside the equivalent amount of money into an instant access cash savings account, so that you can answer any margin calls should your spreadbet company ring you up for more cash.

Most people don’t do that though. Instead, they get excited by the spreadbetting software, take out-sized bets, and lose their money.

If you decide to invest in oil, you’re already taking a very specific risk. Don’t turn investing into gambling!

No related posts.

Commercial property grew to wildly inflated prices during the boom, and investors who followed performance to load up at the peak have seen their property investments crash.

But that was then, and this is now.

In this post I’ll give five good reasons why now could be the time to increase exposure to commercial property.

1. Investors have spurned commercial property

Like an abandoned eyesore blotting the High Street, the commercial property sector is unloved and unwanted.

But as every good developer knows, the time to buy real estate is when the masses wouldn’t touch it with a scaffolding pole.

One easy way to get a measure of the British commercial property market is through iShares’ IUKP tracker.

This ETF has holdings in dozens of listed property companies, although it’s dominated by Land Securities and British Land, who in turn dominate the sector.

At the worst point since January 2007, IUKP had declined 80%. Even after a near-50% bounce, it’s still down 72%.

Property was very overvalued, but such a spectacular fall represents an awful lot of froth being blown off the market.

Non-listed funds have done badly, too. As a result, many funds stopped investors withdrawing their money, and some managers have gone bust or been taken over.

It’s very hard to get a feel for fair value, given all the other uncertainties. Rents are declining as voids (empty properties) increase – and rental income ultimately determines the value of commercial property.

Certainly there are commentators who believe both rents and values will decline further from here.

There’s also the argument that a 20-year borrowing binge is still being unwound, which will further impact the sector.

On the other hand, people always say this sort of thing at the bottom of the market, and an 80% decline is not to be sniffed at.

Unless you believe in Economic Armageddon – which I think is now off the cards – then I think now is as good a time as any to start building up a holding in commercial property.

Prices of listed REITs have already bounced 50%. Waiting for cheaper prices could be a mistake.

2. New institutional buyers are sniffing about

Evidence of value is the emergence of various bottom-fishing funds and private equity vehicles looking to invest in the property sector on the cheap.

Business Week revealed yesterday that Blackstone, the private equity giant, is looking to raise $2 billion for a new special situations property fund.

It’s just one of a string of such funds to emerge in recent months.

Admittedly, Blackstone will target real estate debt rather than equity, as that’s where the dislocation from the credit crunch has been most severe.

But plenty of others see the relative recovery of the financial markets since last year as a reason to buy property, as Business Week reported:

David Tye, the chairman of Rugby Estates, said [...] “The buying of property assets is now looking very attractive.”

The sector’s most lauded recent fundraising example was Max Property Group, the brainchild of industry giant Nick Leslau. Max raised £220m through a listing on AIM last month.

It was the first flotation of 2009. The value of the company surged 30 per cent on its first day of trading.

Investors Chronicle has also covered the flood of emerging property funds, writing only today that:

With signs of value returning to the sector and the potential for the big Reits to pull off transformational deals we’re cautiously positive on the sector as a whole.

3. Yields have improved

There are two yields to consider with property investments.

• The rental yield, which is a measure of the annual rental income relative to the price paid for the building. (Annual rent divided by purchase price).

• The valuation yield, which is a measure of the income derived relative to the current valuation of those assets. (Annual rent divided by the current valuation).

Rental yields have been declining, as the recession causes tenants to go bust or delay payments, leading to higher voids.

How far they’ve fallen depends on what kind of commercial property you’re looking at. Office rents have fallen hardest, but retail rents have done worse recently.

But neither have yet been insanely severe for higher quality commercial property.

Land Securities, for instance, saw like-for-like voids increase from 3.5% to 4.6% over the past 12 months. A big rise, but not massive in absolute terms.

Admittedly, it hasn’t taken much to upset the balance sheets of heavily indebted property companies, which is why some such as Brixton have nearly gone bust and most have undertaken rights issues.

But in many cases the rights issues are a function of declining values relative to debts, which have necessitated the re-footing of company finances. Falling income has been a secondary factor.

Looking at Land Securities again, revenue profit increased 10% (partly due to lower interest costs) in the last financial year, and revenues from its London and retail portfolio grew. Yet the valuation of its assets fell 34% over the year.

As a result of price falls, the valuation yields have risen on REITS like Land Securities.

Land Securities has cut its dividend and it is forecast to halve it again in the year to 2010, but with a current dividend yield of 5.9%, new buyers are getting a higher yield than investors have seen for many years.

Similarly, the IUKP ETF is yielding over 7%, which is a very big premium over the risk-free rate. And many listed property trusts are on double digit yields.

I don’t want to overstate the case – this has been a torrid time for commercial property, and it’s probably going to get worse. Property was overvalued, and prices had to come down.

But I do think investors buying at today’s valuations will enjoy a much better return than those who were sucked in when property was yielding just 3%.

The risks are clear, but so is the opportunity.

4. The UK recession could be ending

Some say the economy already has turned positive. After such a torrid couple of years, absent a Depression it really had to.

Having finally grasped that the UK economy was in trouble after years of rosy-eyed reporting, the mainstream media hasn’t said much about this. Doom, doom, doom is still selling newspapers today.

But plenty of green shoots are emerging. To cover them would require another post; suffice to say I think you want to buy commercial property before the consensus turns universally rosy.

A strengthening economy will provide new challenges for the sector, in the form of rising interest rates.

But valuations are so low and the lack of finance has been so acute during the credit crunch, I think the positives of even a modest return to growth and lending would greatly outweigh that negative.

5. Commercial property is a hedge against inflation

Here’s my final and perhaps best reason to buy commercial property right now.

At its heart, this asset class is about investing in real assets by taking on lots of debt, and enjoying rental income and capital growth.

As such, it could prove valuable should inflation takes off again because low interest rates and reflation schemes like quantitative easing overcook the economy.

Commercial property is seen as a halfway house between the growth potential of equities and the fixed income of bonds.

But right now, I think the inflation risk makes most bonds look very unattractive, particularly Government bonds.

The potential for commercial property prices to rise while debt is inflated away due to an inflation spike increases its attractiveness to me.

In contrast, the fixed income and value of bonds could prove very vulnerable in such circumstances.

True, rising interest rates in the face of inflation will make life harder for commercial property companies.

But the Government and the Bank of England has a clear incentive to let inflation get slightly ahead of itself, given the debt we’re in personally and as a country. You can already see that with rates at an all-time low of 0.5% despite inflation being above target.

Nobody has ever predicted inflation or interest rates with any consistency.

But taken with the other four factors I’ve listed above, I consider inflation risk is a final good reason to invest in commercial property.

Conclusion

Commercial property has suffered huge price falls, way ahead of the actual decline in rents. Investors’ fears have to an extent been very valid, and rents are sure to come under further pressure.

But price declines have been extreme, and in the medium-term the investment case for commercial property still stands.

If you’re not sure how much commercial property you should hold, you might look at my post about David Swensen’s Ivy League portfolio.

Ultimately though, it’s make your own mind up time.

For my part, I’m buying commercial property in dribs and drabs. I currently hold about 5% commercial property with an eventual aim of around 10%.

Further reading:

1. Commercial property is an attractive asset to own
2. Commercial property: I’m buying

Most viable listed companies will grow profits over time, so a growth investor is looking for companies that are expanding their profits faster than rivals or the market.

Growth investors aim to make capital gains from a higher share price, as opposed to for example buying dividend paying shares for income.

The very best growth stocks can deliver returns of a hundredfold or more after decades of growth, although by definition only a tiny handful of the thousands of companies listed will ever reach blue chip status.

Most growth shares fizzle out long before they trouble the top of the index:

• Sometimes a growth company slows down to become just another staid performer (also known as going ‘ex-growth’). This outcome can still make you excellent returns if you got into the share early enough.

• Other would-be growth companies die trying.

• My personal bugbear is when growth companies are acquired when still young and with all their potential ahead of them. This happens quite often; if you can see the potential in a company, so can industry rivals.

Even when a growth share does go all the way from small cap growth stock to international giant, few investors stay aboard for the entire ride. Owning a successful growth share is a dizzying experience!

Growth investing is hard. Much more common than finding a Microsoft is buying a ‘jam tomorrow’ share, that promises much but never delivers.

This reached its zenith in the Dotcom boom, when companies were growing sales or market share but weren’t growing profits, or even making any money at all.

While all growth investors will inevitably put more emphasis on the business story and the potential for expansion than a value investor, sensible growth investors look at cashflow and return on capital employed to see how the company is multiplying their investment.

Finally, it’s worth noting that some investment greats like Warren Buffett and Peter Lynch argue it’s a mistake to think in terms of value or growth shares.

Buffett espouses the idea of ‘intrinsic value’ instead.

However as a convenient way of labelling an investing method that focusses on profit growth as opposed to value investing’s emphasis on under-rated assets or performance, the growth investing label is useful and here to stay.

Further reading:

1. What are growth investors looking for?

I’ve manually gone through and marked them all to allow comments, but if I’ve missed one out and you’ve got something burning to share on it, please do let me know.

I’ve also just added the ability to subscribe to a specific discussion on any post. This is useful since it means you don’t have to keep coming back to Monevator or that post to check if anyone has replied to your clever and insightful thought - you just get an email telling you they have. You can subscribe and unsubscribe to different comment threads at any time.

Moderation is set so that I have to approve your very first comment to the site. After you have left a sensible comment and not tried to sell me impotency pills or Chinese web hosting, you can comment freely without moderation (unless you become unpleasant and are blocked).

Be aware it may be up to 24 hours before I see your comment and approve it, but I will try to check at least twice daily.

I’ve enabling comments up until now because:

• I don’t want to see all the silly nastiness you get on some sites.

• I don’t want to see spammy comments selling or giving bad financial advice.

Be aware therefore that I may/will delete commercial, nasty, flippant, or stupid comments.

If you disagree with me or another commenter in a respectful and polite fashion, that’s absolutely fine. Think English Gentleman’s Club, not the cheap seats at a boxing match.

Please don’t be shy about commenting. I know from emails that there are smart and thoughtful people reading this blog, and I probably should have bitten the bullet and enabled comments so you can all meet each other before now!

If you want to get started, there’s a good discussion taking place on the Capitalism 3.0 post.

As ever thanks for visiting, normal service will now resume

Further reading:

1. Zopa update: Interest rates rise for savers, but bad debt doesn’t

I’ve noticed some of my favourite bloggers like Frugal Dad name their weekly roundups, so I thought I’d start doing the same with a nod to the dramatic F1 crisis. Not sure what the benefit is but it keeps things interesting!

Also exciting this week was receiving a link from Harvard professor Dani Rodrik.

It was an insight into how the Internet has democratised the flow of ideas. Read my post on Rodrik’s Capitalism 3.0 lecture for some extensive comments by reader Niklas, too.

From the money and investing blogs

• Oblivious Investor discusses index funds in the context of efficient markets.

• FiveCentNickel outlines the pros and cons of mutual funds.

• Darwin’s Finance discusses structured notes. (Personally, I’m wary about structured products but the author gives a good oversight, including risks).

• BadMoneyAdvice picks up on bizarre wrangling over Barclays’ bill for Lehman’s furniture.

• MoneyNing offers some ideas about saving money every month.

• This post on the path to financial/career contentment by Frugal Dad mirrors my own thinking in recent years, although I can’t claim to have reached contentment yet!

• Wealth Pilgrim has had problems lending money to friends and family. So have I, but it’s difficult not to feel the need sometimes. Perhaps gifting is the best approach.

• Moolanomy points out that it’s good to buy stocks cheap.

Generally UK-related articles from other websites and papers

• Martin Wolf in the FT has written a typical thought provoking article comparing the current downturn with the Great Depression.

• Sticking with the FT, Merryn is worried about commercial property in the US.

• Returning to structured products, this article by Hargreaves Landsdown does a good job of explaining more of the downsides.

• The Independent suggests a corporate bond fund, again.

Did you find this roundup useful? Simply subscribe to Monevator via email or RSS (it’s totally free) and get my best links every week.

Further reading:

1. Weekend reading for investors: 9/5/09
2. Weekend reading for investors: 14/3/09
3. Weekend reading for investors: 28/3/09

There’s no doubt the financial crisis has cheered up anti-globalisation campaigners who had been getting dismayed with how much their countrymen enjoyed cheaper consumer goods, and how China and India seemed to be doing very well while being ‘exploited’ by the West.

The downturn has even put on a smile on the face of old, blind and illiterate idealists who’d love to dig up the corpse of communism.

I haven’t got much to say to the latter (except: get a job) but I got an interesting glimpse into the former when I attended a lecture at the London School of Economics on Tuesday to hear Professor Dani Rodrik of Harvard University.

Rodrik is a Professor of International Political Economy, and is widely considered to be a big thinker in the realm of markets, institutions and capitalism. (Click here for Rodrik’s full bio).

As I’ll discuss below, he gave some interesting insights into the problems of regulating the global economy.

But his talk also highlighted how people with an anti-free-trade agenda are going to try to hijack the financial crisis as their force majeure.

Why does this matter to you as an investor?

Well, financial regulation is on the agenda in a way that would have been unthinkable two or three years ago, as governments in the UK, Europe and the US seek their pound of flesh for the assistance they’ve given to the financial system.

More constructively, governments also hope (vainly in my view) to regulate away the chances of a crisis happening again.

President Obama is outlining his financial regulations for the US, while the UK government is locked in battle with Europe to try to stop financial regulation from crippling London. UK Chancellor Alastair Darling has his own plans for curbing bankers.

If policy makers get regulation wrong, we could see a rise in protectionism, a pointless curtailment in global trade, and terrible consequences for shares and the markets (and for economies and people, rich and poor).

Capitalism 3.0: A talking shop?

Professor Rodrik began his lecture with an apology for the cute Capitalism 3.0 moniker, but then went on to use it anyway as a framework in explaining how we got to where we are today. He outlined:

• Capitalism 1.0 – The discovery of the “the miracle of the market” as an economic engine. In the 19th Century this was allied to the idea that the State must be minimally involved to enable the market to work efficiently, with Governments providing merely “night watchman” services such as property rights, national defense, and justice.

• Capitalism 2.0 – The discovery (notably in the 1930s) that “markets are not self-creating, self-regulating, self-stabilising or self-legitimising”. This led to institutional underpinnings, and new State bodies responsible for monetary policy, redistribution, conflict management and so on. Basically Keynes and the Welfare State in Western Europe post-World War 2, along with a watered down version in the US.

The key problem with Capitalism 2.0 in Rodrik’s view was that it was all about national regulatory and oversight institutions rather than taking a global view, despite global trade being a reality.

To make international trade work, the much-vaunted Bretton Woods system ‘threw sand in the wheels’ of international trade, Rodrik argues, with capital controls and a highly permissive GATT agreement doing minor heavy lifting.

Developing countries were left outside of the club, in Rodrik’s view, while he said developed ones were “in many ways free to do what they want”.

As global trade multiplied, we got to:

• Capitalism 2.1 – Which Rodrik described as post-1990s financial deregulation allied to two “neo-liberal” errors of thinking: Namely that you can push integration of world markets and let institutions catch up, and that deep economic integration has no (or mostly benign) affects on national intsitutions. (If developing country’s institutions were rubbish to begin with, says Rodrik, then the neo-liberal agenda was they were better dead anyway).

Capitalism 2.1 caused the credit crisis, says Dani Rodrik

Blink and you’d miss it, but Rodrik then claimed this system was responsible for the credit crisis.

The professor cited…

• financial globalisation and deep integration under the WTO
• the erosion of the legitimacy of the trade system
• weak financial regulation
• poorly managed integration of US and Chinese style capitalism
• global macro imbalances that resulted from the above that enabled the US to go on a borrowing binge, and China to go on a savings binge

…as leading to a system that was “unstable” and “didn’t work”.

Rodrik said the resulting fundamental problem of the world economy was an imbalance between the reach of markets (increasingly global) and the scope of regulation governance (still mostly national).

What’s your problem?

Are you convinced by Dani Rodrik’s thesis? If so, you would have loved being in the audience at LSE. They lapped this stuff up.

But from where I was sitting it didn’t have much to do with the causes of the financial crisis.

This was no crisis of international trade. There was no huge problem caused by Brazilian banks investing in German securities without oversight from the Brazilian government, let alone a crisis caused by a shoe factory in Nepal or deforestation in Sumatra.

The credit crisis was caused by Wall Street bankers selling toxic, opaque and unexpectedly risky and correlated assets under the nose of US supervisors to other Wall Street firms, as well as those in Western Europe. (See this video explaining the credit crunch for a reminder).

Rodrik’s only really convincing point to this end was that Chinese buying of US Treasuries drove down yields and encouraged financial actors to look for better yields elsewhere, but it’s hard to see how regulation would have addressed this.

To get rid of such imbalances, you’d have to get rid of the cheap cars, trainers, TVs, iPods and everything else the US has exchanged for its assets that the Chinese have been hoarding.

Rodrik was tilting at windmills.

What would Capitalism 3.0 look like?

Having failed to make the case for globalisation causing the financial crisis, Professor Rodrik then set about describing how he’d fix it.

He made a much better fist of explaining why a truly universal, global system of trade regulation won’t work.

At the limit, to be legitimate it would require global standards, a global safety net, and eventually a global government. This won’t be practical anytime soon – just look at the problems Europe is having, and there cultures are broadly similar, at least compared to say South East Asia.

Rodrik also had a principle-based objection, which was that different countries have different needs to others: Developing countries with young populations trying to achieve a structural transformation have very different aims to Western countries overloaded with retiring baby boomers.

There are thus all kinds of problems that emerge from trying to impose global standards and a level playing field.

Rodrik himself pointed out as an example (to a stony silence from the audience) that a developing country may want to allow child labour that we wouldn’t consider acceptable in the developed world.

Why should it want to do this? Because the alternative is worse. Raising the country’s GDP brings in the money that could eventually pay for schools and a higher standard of living – it doesn’t work the other way around.

You could list any number of different examples, taking in environmental issues, redistribution, health and safety, financial assets and more.

Some of these issues are very valid (I’m most worried about the degradation of the environment) but realistically, we live in a heterogenous world of national states with national interests, and such issues will be decided at a domestic level, not through agreeing via global trade regulation.

A global regulatory framework isn’t desirable and won’t work anyway.

The solution: Traffic rules and space for discussion

Having won me back with his pragmatism, Professor Rodrik then lost me again with his solution.

He said any new approach should accept the following guidelines:

• Markets need to be deeply embedded in systems of governance to work well
• Understand we live in nation states
• There is no “one way” – domestic preferences and needs will play a role, even in developed countries
• Countries have a right to protect their own social arrangements and institutitions…
• …but not to impose them on others
• International economic arrangements should be of the maximum ‘thickness’ that is consistent with maintaining a space for domestic institutions (in other words, allow the like-minded to integrate)
• Where this doesn’t work, we should fall back on ‘traffic rules’

Central to his concept are these ‘New Traffic Rules‘ that would govern international trade.

The WTO already enables countries to impose tarrifs in certain conditions, but Professor Rodrik wanted to see much more of this. He wants to see “negotiated opt-outs” with “procedural constraints”.

The idea, stripped of academic language, is that when two countries come into conflict, everyone gets in a room and hammers out why it’s a problem, including (to Rodrik’s credit) those who’ll benefit from trade on both sides of the fence. It’s all meant to happen out in the open, to provoke a domestic debate.

If it can be shown that the complaining country has a more legitimate gripe than just that some aspect of the other country’s practices pisses off a few left-wing students, then “safeguards” would be called into play via a judicial hearing.

So what it all boils down to is Bretton Woods with even more sand in the wheels, combined with an optimistic view that more citizens will play a democratic role in understanding and caring about the micro-issues involved in steel production or kumquat farming, and so energize what is today a rather remote debate.

Yet GATT and other comprehensive(-ish) trade agreements are already bogged down – Rodrik’s proposed system would surely create even more friction and probably become unworkable in short order.

A little more conversation, a little less action

As far as I could see, Professor Rodrik would like globalisation to be curtailed for reasons unrelated to mortgage-backed securities, derivatives, or excessive risk-taking by financial companies.

There might be valid reasons for this viewpoint – he alluded to how India and China were able to develop their industry and institutions before opening the door to Western competition – but they have little or nothing to do with the credit crisis.

Rather, the financial status quo has been knocked off its feet, and not-so-liberal economists see the chance to get the boot in.

The follow-up questions with the audience made the anti-globalisation agenda even clearer.

When not praising his speech as offering a ‘magisterial framework’ for a new way of doing international business, staff and others asked things like:

• How would it allow ordinary people to get back at the bankers?
• How would the framework tackle US power?
• Why should lecturers lose their jobs due to banking bailouts? (This was said by a lecturer. At a school of economics.)

Thankfully, when it came to the very last question of day, an off-message member of the audience asked the crucial one: Would this framework have stopped the financial crisis, and if not then what’s the point?

Rodrik admitted it wouldn’t have, and said something about how he envisaged financial systems being much more ’segmented’ then they are today.

All very well, but absent from his lecture.

We need risk and fear, not regulation

Like cuts to public services (inevitable and not before time), the normally arcane area of regulation is going to be making headlines for months to come.

Rather than learning the wrong lessons, or worse still using the financial crisis as an excuse to settle old grudges or score points, policymakers and voters need to decide:

• What they want regulation to achieve
• How much, if anything, regulation really can achieve.

I’m very much of the Minsky school that says you can’t regulate away risk (if only because the more seemingly stable you make a system, the more risky it actually is, since people stop evaluating risk properly).

Instead I’d prefer to see more preparations made (and money set aside for) dealing with problems when they arise, as well as curbs on unearned riches made by unjustified short-term risk-taking – if only on the grounds of social justice.

Transparency is almost always helpful, and forcing loan originators to retain some of their risk seems sensible.

But we’re still going to eventually get another instance of market participants failing to understand the risks they are taking simply because it has become the normal way of doing things, and everyone else is at it.

If you do favour radical regulation, at least George Soros’ proposals in the FT the other day addressed the causes of the financial crisis.

Soros offered three principles to guide financial reform:

First, since markets are bubble-prone, regulators must accept responsibility for preventing bubbles from growing too big. [...]

Second, to control asset bubbles it is not enough to control the money supply; we must also control the availability of credit. This cannot be done with monetary tools alone – we must also use credit controls such as margin requirements and minimum capital requirements. [..]

Third, we must reconceptualise the meaning of market risk. [...] The efficient market hypothesis is unrealistic. Markets are subject to imbalances that individual participants may ignore if they think they can liquidate their positions. Regulators cannot ignore these imbalances.

What’s clear is Soros understands the financial system that created the crisis, and thus might have something insightful to say about improving it.

A clear connect between the problem and the solution should be the litmus test for any new financial regulations.

Note: While everyone loves angry bloggers, I should say I liked Professor Rodrik’s talk and attitude, even when I didn’t agree with him. The fact he was linking his agenda to the financial meltdown was the most telling aspect of the evening, and overshadowed his actual ideas. But I enjoyed hearing them.

Update: Dani Rodrik has linked to this article from his weblog, as well as to another review of his lecture. If you’re keen on learning more, you might want to check out Professor Rodrik’s blog for more links to these alternative views as they emerge.

No related posts.