Matt's House

just some thoughts

[jmatthewhouse]

The problems date to 1995, when Mayor Richard Daley, eager to avoid another strike, like the one that emptied schools for 19 days in 1987, took over control of the school district. To give him wiggle room, the state legislature passed a law allowing the city to pay just part of its pension obligation. Chicago took that windfall and increased teacher salaries, which in turn increased pension obligations. From 2002 to 2011, the district's yearly expenses increased by 41%, while total enrollment fell by about 8%.

http://online.wsj.com/article/SB10000872396390443890304578006800843169278.html

[jmatthewhouse]

Wrecks, Inc. (Taken with Instagram)

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Rolling Thunder (Taken with Instagram)

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Back in the Saddle

  I had a great weekend - Lindsey and I came across Bob the Bubble Man in Lincoln Park on Saturday morning, and I got some decent photos of the kids running around and chasing bubbles. I also got a couple in the face - luckily my camera protected me. On Saturday night I confessed to Lindsey that despite taking some nice shots on our recent trip to Europe, I was unhappy with my photography. Lots of missed shots, technical missteps, and a failure to step back and develop a message. After some thinking however, I've realized that I'm trying to do a lot of things at once: I've started experimenting with off-camera flash, and in order to get myself to study light more I've started shooting all-manual for the first time in a few years. Simultaneously, I'm putting a lot of pressure on myself to develop artistically and communicate through my photos. This is a lot of mental bandwidth, and I think I need to be more organized in my approach!

On Sunday I attended a photography class with Levi Sim, and it was great for a lot of reasons. I learned how to use a reflector, which is technically not that challenging but can produce very rewarding results. More than anything though, it was an opportunity to commiserate with other photographers and realize I'm not alone in these challenges. I also had the opportunity to sit in a session with Scott Bourne, who is a fantastic presenter. Scott left me with a great question that I want to consider over the next few days: why do I take photos? I'm about 15,000 images deep at this point in my life, so now would be a good time to figure that out.

[jmatthewhouse]

Seems official (Taken with Instagram)

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Teaching Ethics at a Global Business School (or Why I Disagree with Luigi Zingales)

In a recent Bloomberg column, Chicago Booth professor Luigi Zingales proposes that business schools teach a more robust set of ethics. This sentiment has been mirrored by Felix Salmon, Matt Yglesias and several other prominent bloggers. I recently graduated from the Kellogg School of Management, and was both a participant in a values-based leadership (read: ethics) class and the student leader responsible for investigating violations of the school's Honor Code during my time there. 

Zingales fails to address a key point by considering the impact of globalization on the study of ethics in business. Kellogg, like many other top business school, has a global footprint - 36% of my class held non-U.S. citizenship. These students come from many different cultures, and share many different value systems. And thus it is highly unlikely that they will share, hew to, or find themselves working in, a system of universal ethics. In my own experience at Kellogg, a disproportionate number of ethics investigations involved students from non-Western value systems, which suggests to me that these lapses stemmed as much from misunderstanding or misalignment as they did willful and deliberate violations of the rules. 

Unless business schools are prepared to take a stand and insist on Western values as the "right" system, it will be tremendously challenging to extract a set of universal ethics and teach them coherently. This is not to say that we shouldn't expect the very highest ethical and moral values from our leaders, but that the modern geopolitical and business climate is rife with very real disagreements about what is right and what is wrong. 

At the very least, it seems that business schools could provide students with frameworks for making decisions based on their own values. This is more or less exactly what students at Kellogg learned to do in the values-based leadership course, and exactly what Zingales is critical of when he speaks about courses that illustrate various ethical situations, and don't instruct students on how to act. While this has a certain appeal in obvious cases (Zingales mentions the LIBOR rate-fixing scandal), as we all know there are many, many cases in life that don't have obvious right and wrong answers even under a shared set of values. When teaching in a global business school environment, this discussion becomes infinitely more complex. 

While I disagree somewhat with the approach Zingales suggests, I do believe there is an interesting opportunity to educate global business leaders not only on how to think about ethical decisions, but how their decisions will be perceived in cultures around the world. Given the global makeup of the classroom, this could be a tremendously insightful conversation for everyone in the room. Fostering this conversation, I believe, is the real challenge that faces business schools in the 21st century. 

[jmatthewhouse]

Portfolio review: A good four years, and a humbling quarter

Beginning in June of 2008, I set out to invest money in portfolio of value stocks that I would pick myself. I got started with Joel Greenblatt's The Little Book That Beats The Market, moved on to The Intelligent Investor and Security Analysis... and then got my hands dirty. I set up a portfolio called JEM (the name is a historical artifact I won't get into here) and began investing. 

Almost from the beginning, I outperformed the market significantly. At the end of April of this year, I outperformed the fund's benchmarks (the Russell 3000 and the S&P 500) by 20% on a cumulative basis since inception. I was feeling good. May and June of this year were terribly unkind, and I gave back nearly every dollar of outperformance. This has led me to some introspection - was my underperformance a function of changes in the portfolio? Market shifts? Or other factors (explainable or not)?

Here are some brief thoughts on the portfolio's performance at its four-year anniversary. 

Portfolio statistics. My initial hypothesis was that the portfolio simply underperforms in bad market climates. I considered using market shorts (buying puts or shorting an index) to protect my downside. Shorting an index would only work in the event I could be sure I was generating true alpha. I did a series of cross-section analyses as well as running regressions against the Russell 3000 and the S&P 500 to determine if I was generating alpha.  Cross-Section Analyses Not surprisingly, the portfolio's returns tend to cluster around those of the Russell 3000. 

The months in which it underperforms the Russell 3000 (27) outnumber those in which it outperforms (22). But the average outperformance (3.9%) more than makes up for the average underperformance (2.6%). So from a cross-section perspective, the portfolio's performance is good, but not great. I would like to consistently outperform the benchmark index, although that might simply be too much to ask! Summary statistics In summary, this portfolio is more volatile than the market benchmarks (33% standard deviation vs. the Russell 3000's 22%). But the market benchmarks also are not highly correlated with this portfolio - R squared is 57% over the last four years. This suggests that either the JEM portfolio is not well diversified, or that the Russell 3000 is not an appropriate benchmark. It may be a little of both; in the future I may compare the portfolio's performance against a value index as well as the total market indices. Regardless, I computed the alpha of the portfolio and found that I have generated more than 4.5% alpha over the last four years against the Russell 3000 and S&P 500. The portfolio's beta is 1.12 against the Russell 3000, although it does suffer from low correlation as I mentioned above. (I want to caveat this by saying that a significant portion of the alpha is generated by outlier months, and I fully recognize that. Happy to engage in a more detailed discussion if you're interested.)

Portfolio concentration. As I gained what I believed was confidence, I allowed the portfolio to become more concentrated. (I believe I might label it something else with the benefit of hindsight.) For most of the portfolio's life, I kept a cash position of 10% - 15% of the portfolio's value, and typically held between 15 and 20 equally-sized positions. In recent months as I have rolled out of older positions, I have double- (or in some cases triple-) downed on investments, allowing the number of positions to drift down. This represented a significant lack of discipline on my part, because it allowed the portfolio to become less diversified. In addition, I took a highly-leveraged position in RIMM by writing puts and purchasing calls, which has presented significant headwinds to the portfolio in recent weeks even as the market has recovered from its drop at the end of May. Although my investment in RIMM was consistent with my traditional investment thesis for the fund (high return on assets, low P/E ratio), doing so using a leveraged technique was a mistake. In the future I am going to "stick to my knitting" and make equity investments, perhaps purchasing long-dated call options if I believe an investment offers significant upside. 

Failure to make new investments. Over the last 12 months, I found a dearth of new opportunities, and thus did not liquidate positions as called for by the fund's investment policy. Although my typical hold period is around 12-15 months, many of my positions are 24 or more months old at this point. Although I have not explored whether momentum effects are responsible for any of the portfolio's returns, it seems possible since I enjoyed so much success with a very consistent hold period. If that is the case, I am now realizing the reversal of those momentum effects. Although outright losses were responsible for some of the decline in the portfolio's value over the last quarter, most of the losses came from the evaporation of prior gains which I failed to lock in by liquidating positions at the appropriate time. In combination with my above remarks on concentration, it is clear that I have made a series of humbling mistakes by departing from the fund's investment policy during the last 3 - 6 months. 

The path forward.  "We should be careful to get out of an experience the wisdom that is in it - and stop there; lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove-lid again - and that is well; but she also will never sit down on a cold one anymore." -Mark Twain I want to be very cautious about my next steps with the fund. As demonstrated above, I enjoyed substantial success with the fund over the past 48 months. My departure from the fund's investment policy is indicative of a seat on the hot stove-lid. The wisdom I gained is not to give up and begin indexing, but instead to return to my core values. I have confidence that my philosophy (deep hat to Joel Greenblatt, of course) is sound. In order for the performance of the portfolio to reflect that success, I must execute consistently. I plan to return to my core philosophy by resizing positions within the portfolio. 

A curiosity.  One item I have noticed is that my stock screens tend to identify certain industries (for instance, semiconductor testing equipment or small pharmaceutical companies) which have a number of undervalued companies. In some cases, this is because of shifts in industry fundamentals. Although I do not plan to pursue the strategy actively, I am considering exploring a market-neutral approach to these investments in which I will short weak competitors against a long position in strong companies in an undervalued sector. It seems to me this may be a way to generate pure alpha. I have read a significant amount of Ray Dalio's work on risk parity, and while I am not sure I am a believer, I do find his concept of purchasing alpha and beta separately to be fascinating. Given my fund's performance, I believe that I can offer pure alpha and would like to explore mechanisms to do so in the future.

Please note that JEM is not currently open to new investors, and this does represent a solicitation of any kind. Individuals curious about my investing style, portfolio calculations, or just friendly banter can contact me by e-mail at jmatthewhouse at gmail.com or on Twitter at @jmatthewhouse.

[jmatthewhouse]

Where is the train? (Taken with Instagram at CTA - Rosemont)

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Why the Norquist / ATR pledge is nonsense

The Americans for Tax Reform pledge is completely ludicrous in my view, because it effectively locks the entire Republican Party into the status quo. The fact that House Republicans are meeting with Norquist today for an interpretation of the pledge is telling - no one knows what the pledge means. Five minutes of Googling could not turn up the actual text of the pledge. All I was able to find was the following: The Taxpayer Protection Pledge ATR asks every candidate for elected office on the state and federal level to make a written commitment to their constituents to "oppose and vote against tax increases." Let's consider a world of three people. One person pays all of the taxes ($3). Now Congress decides to broaden the base, and have all three people contribute to tax revenues ($1 each). Two people now have suffered tax increases, and can run screaming to their representatives that they have violated the pledge, despite the fact this move was revenue neutral. This is the insanity of the ATR pledge. Tax systems in complex, modern economies are complicated. To have politicians hewing to an oversimplified, nonsense pledge in the middle of a fiscal crisis is beyond ridiculous.

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Morning Fog (Taken with Instagram)

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Photoshop vs. Lightroom as an artistic tool

Several people recently have asked me whether I prefer Photoshop vs. Lightroom. Although they have been asking from a usability and features perspective, after six months of using Lightroom I think there is one key artistic distinction between the two. 

Lightroom, at its core, is a workflow product. It's designed to make manipulating large numbers of photographs fast and simple. Point, click... and apply to all the pictures you took that day, month, or year if you'd like. Photoshop is obviously a tremendously powerful tool, and although it has some time saving tricks, I would be surprised if anyone that experienced with both told you that they are actually faster with Photoshop. 

My thoughts above are also not insightful on any level - this is more or less exactly how the two products are designed and marketed. It is not a secret. 

What I would urge photographers to do is to carefully consider why they take photographs. Is it about trying to document a large volume of moments, or to make a statement with each photograph? To me, the difference is akin to processing your own film and working in the darkroom vs. taking your film and having the lab develop and print it. The analogy is imperfect, but my point is that I found myself taking more time with photographs, and focusing more intently on each photograph individually, when I use Photoshop. This, to me, is like the time I use to spend with my hands in chemicals in the darkroom.

Lightroom has many of the same tools and is more intuitive than Photoshop. And I certainly spend less time processing photos when I use Lightroom. But for me, getting lost for hours in my photos is the whole point - the processing is just as fulfilling as the photography itself. 

Although I still plan to use Lightroom to manage my library, I anticipate moving back to Photoshop increasingly in the coming months. I am headed to France and Italy at the beginning of July, and will certainly have plenty of photographs to work with upon my return.

[jmatthewhouse]

Chicago Teachers Union Authorizes Strike

The Chicago Teachers Union has authorized a strike, arming them to aggressively negotiate with the city, the school board and ultimately, taxpayers. The rumored demands of the teachers are surprising - a 30% pay raise over two years. Last year I explored what Chicago teachers are paid, including their pension benefits. The results were surprising to me, because my perception was that teachers were paid much less than I found. 

Two key things should happen to resolve this more effectively:

1) The city should make it clear to teachers how much their pension benefits are worth. Many teachers I speak to have no concept of how much their benefits are worth on a present-value basis. The city should show them how much that pension would be worth if they were in a private-sector job, and received it as a 401(k) contribution. Based on academic research, many would trade those future benefits for current increase in pay. This would aid cities to close their gaping fiscal holes from their pension benefits (Chicago's is particularly bad). 

2) The CTU should carefully consider how their actions will be perceived by the public. Whether or not they choose to acknowledge it, they are ultimately negotiating with taxpayers, not the mayor and not the school board president. The NEA has done a terrible job at the national level, and has effectively drawn a target on the back of teachers by allowing them to appear inflexible and obstinate in the face of a changing global landscape. A combination of technology, globalization and macroeconomic shifts are changing the way we need to educate our youth. It would be a shame if teachers unions stand in the way of change by focusing on exorbitant pay increases, rather than becoming partners in improving education. This may earn them some money in the short term, but will most certainly ruin their credibility long-term.

[jmatthewhouse]

GLADWELL: Agreed. And how bummed are you if you are LeBron? He was born in 1984. In every way, his life would be better if he had been born 10 years earlier. I don't believe that the world was always better in the past. But I do believe that there are moments when the particular mix of available technologies don't actually combine to make your life better — and I think we're in one of those moments now. I can remember when I worked in the New York bureau of the Washington Post, and Jackie Onassis was near death and I was responsible for writing the story if she died. What I really wanted to do was go to dinner. So what did I do? I went to dinner, and she died — and the office had no way to reach me. Can we pause, for a moment, and recognize how magical that fact was? I actually remember where I had dinner — The Odeon in Tribeca. There I was in the middle of one of the most important cities in the world, having steak frites at a well-known restaurant two blocks from my apartment, and to the editors of one of the most prestigious newspapers in the world I was effectively invisible. And when they finally tracked me down the next day, I simply apologized for being … out of touch. No one has said the phrase out of touch for at least a decade. There is an entire generation of young people out there who don't even know that those three words can be used in combination. This is on par with that long-lost moment in, like, the 17th century when if you said to your teacher, "The dog ate my homework," there was a reasonable chance that the dog actually had eaten your homework. God I miss those days. SIMMONS: Don't worry, those days are still alive … if you want them to be. I call it "going in the bunker." If I have to get something done, I just pick a coffee place or restaurant, turn off my cell phone, tell my wife and Grantland's Dan Fierman that I'm "going in the bunker" and spend the next few hours pretending it's 1988 (and nobody can reach me). It's the only way sometimes. My wife hates the bunker. In her defense, it probably seems weird when your husband says the words, "I'm going to be out of commission for the next four hours, I'm going into the bunker." Just ask Eliot Spitzer's wife. But there's something about the sanctity of being out of touch. Especially in 2012, when everything centers on being IN touch, right?

http://www.grantland.com/story/_/id/8016432/view/full/watching-world-turn-upside-era-constant-information

[jmatthewhouse]

A quick take on risk parity

Last month I had lunch with a friend that works at a family office and he said they had moved their entire portfolio to an asset manager that managed portfolios using a risk parity strategy, which I knew little about. I did some casual reading on it, and then spotted this article on risk parity in the WSJ last weekend. 

Since then, I have done more reading and I'm not certain that risk parity is a panacea. While I understand the managing volatility is perhaps a very intelligent way to understand risk, it seems to me that allocating a large portion of your portfolio to bonds when yields are at historic lows is a recipe for disaster. The Aleph blog has some very articulate thoughts on risk parity, and points to this very good GMO whitepaper, which I thought was a very good summary of why these allocations seem like a bad idea from a fundamental perspective. 

In the end, I wonder if risk parity has the same appeal portfolio theory does at first glance: some very clever mathematicians wave their hands and we all stare, convinced they have found the secret.

[jmatthewhouse]

Free Speech Implies Someone is Listening

I am pleased that the NATO protests in Chicago thus far have been largely peaceful. My wife and I watched tensely this afternoon as a few scuffles broke out between police and protestors, but luckily none that we could see from the ABC news feed escalated beyond some fairly aggressive baton swinging. I did read that one police officer was stabbed, which is obviously concerning.

What the protestors fail to appreciate, it seems, is that they aren't really convincing anyone but themselves. Very few people will change their minds as a result of these efforts, and so much of this time and energy has been consumed for naught. Further, it provides cover for individuals with much more nefarious intent.

The organizer of the peaceful protests was on the local news during the confrontation and refused to repudiate the actions of anyone in the protest Saturday, saying simply, "I am not going to tell anyone what to do." In doing so, he implicitly endorsed the actions of all those who protested today, completely destroyed any credibility he might have otherwise had, and marginalized the message of an entire campaign. He should be embarrassed. 

Free speech has no value if no one is listening. It's just talking, and there is far too much of that these days. And this post may be an excellent case in point.