The New Fund Order

The Sironi Files: The Anthropology of Selection & Financial Market Transparency

September 19, 2021 JB Beckett/ Paolo Sironi Season 1 Episode 18
The New Fund Order
The Sironi Files: The Anthropology of Selection & Financial Market Transparency
Show Notes Transcript Chapter Markers

Welcome to the New Fund Order. An Orwellian journey into the Darkside, the Frontier and the Fringe of Finance.

We open The Sironi Files with Fintech supreme Paolo Sironi on his seminal work on Financial Market Transparency (‘FMT’), anthropology, gamification and data platforms and how these are changing asset management and fund selection from the outside in, and inside-out.

In this intrigue rich episode is it mission impossible or mystery to be solved? Why is uncertainty and complexity the new normal? We pick up the phone ☎️  and make the call. Will it be answered?

About Paolo Sironi: “Paolo is the Global Research Leader in Banking and Financial Markets at IBM, Institute for Business Value. He is senior advisor for selected global accounts, assisting service teams in Board-level and C-level conversations about business model adaptation in platform economies. Paolo founded the German start-up Capitects, then acquired by IBM, and directed the quantitative risk management department of Banca Intesa Sanpaolo. He is one of the most respected Fintech voices worldwide and co-hosts the European edition of Breaking Banks podcast. He is celebrated book author on digital transformation, quantitative finance and economics, and keynote  speaker at major international events.”

Go to:
https://www.thepsironi.com/
Podcast: https://www.thepsironi.com/podcast
Check out Paolo’s books: https://www.thepsironi.com/books
Amazon book store: https://www.amazon.co.uk/Paolo-Sironi/e/B00TLMSSA2?tag=relinks-21
‘Banks and Fintech on Platform Economies’ SOON - OCTOBER 2021 

Together with left-field opinion, global market news and latest views, direct from my dystopian bunker. In the Air, on the Ground, on the Street and around the corner of Debate. Watching, listening, in the Shadows and on your Airwaves. For Fund Selectors, distributors, wealth managers and investors.

In association with my sponsor Allianz Global Investors (AGI) one of the world's leading active managers. My thanks to my guest Paolo Sironi.. and you dear listener.

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JB Beckett  0:38  
Salutations Dear Citizens as we peer into the new fund order to discover the immutable truth for asset management and wealth managers, the lowdown from the dark side the frontier on the fringe of asset management and fund research.

A podcast for wealth managers fund selectors, distributors and investors bring it to you the People's Republic podcast on finance, in association with my sponsor Allianz Global Investors, capturing the latest market news, views and interviews with leading minds in our industry. Allianz Global Investors is one of the world's leading active managers.

Computer  1:41  
market news. 

JB Beckett  1:46  
And this week's news has caught itself the financial services club. Brexit trade barriers added 600 million in costs to UK importers this year, customs duties rose to record 2.2 billion in the first six months since the trade deal came into effect on the first of January. Alibaba shares slide report China plans to break up the payment App. Chinese regulators have been targeting Ant group and other technology firms operating in the country. FS club asks 'can the Pru prove Cathy wood and George Soros wrong on China?' the insurer faces tensions over its UK-Asia structure after demerger of the US business. Conservationists call for urgent ban on deep sea mining 'Motion at Marseilles' summit wins call support warning of permanent biodiversity loss and unknown effect on ecosystem. While Kathy Woods Ark cuts China's position dramatically and lastly, litigation funding needs better oversight of title between Mishcon and a funder highlights a poorly regulated area, says the financial services club. 

Tag hashtag new fund order and let me know what stories you want to hear about.

And if you like what you're hearing and would like to become an affiliate of the show, or indeed get involved as a sponsor, then get in touch and drop me a message.

And in these strange pandemic lockdown times, rest assured that all guests are calling in remotely interview. 

Ciao Paolo, welcome to the Sironi files and to the new fund order.

Paolo Sironi  3:19  
Thank you for hosting me today to discuss some of the content in my literature and through my professional experiences engagement with the protocols involved management and investment management,

JB Beckett  3:31  
Why it was really important for me to get you on the show, you know, the new fund order. It's all about trying to help fund selectors and alligators. Understand the tomorrow, you know, understand what is on the frontier of their industry, not necessarily just the the now, which is obviously where they will spend most of their time thinking. So it's great to get you on the show. I know the evolution of finances is where you spend a lot of your time. And just to start, I guess, fund transparency is often mentioned or discussed, but often in quite small and isolated ways. So thinking more broadly for fund selectors and asset allocators and investors. Why should they care about what you describe as 'financial market transparency'?

Paolo Sironi  4:15  
Well, I have some tough news, but also some good news for the audience today. Back in 2017, I was hosted on the main stage of Morningstar in Chicago. And I remember there was Jack Bogle and Larry Fink on the stage. And there the debate about the essence of investment management and of course, the debate devoted around passive investing and active investing. Now Jack Bogle told Larry Fink of BlackRock there could be value in active investment management, as long as that it is delivered at much lower costs. And one Larry Fink responsse was that well, effectively they're doing two things on the one side, they are automatizing processes. They're plugging in artificial intelligence into the process. Sources of investment management and they are also transforming basically the way they operate because they want to push more technology at the forefront of the advisory relationship, where finally investors talk to the professional individual that basically selects the and prepares the asset allocation, in order to augment the value of the conversation and the discussion. 

In essence, he was basically confirming that the value of the asset allocation itself is being more and more reduced without the conversation around that because asset classes are commoditizing, they've been commoditizing very fast, after the start of the global financial crisis, and in the end, it is very difficult to tell the difference between a model portfolio A and portfolio B, so what happens really is that in the industry, the focus is shifting from the product, either the active or the passive fund, towards the relationship between the investor and the advisor. So now, 'financial market transparency', which is the title of my fourth book of the series focuses exactly on this one. So the transparency is the element that enables the industry to generate more value for clients. Because it unevils that through discussion about the cost of the incentives and the consequences, how fund investors needs to make decision in order to be better off with their financial bets. And therefore the financial market transparency is a theory of Finance that unveils the way ... investors make decisions facing uncertainty, and therefore allows the fund industry to reconstruct the product offering in order to fit a different advisory conversation.

JB Beckett  6:47  
Another area that you also discuss, and I think is of great interest and concern, I think to to our audiences, what you say around anthropology, gamification, and behavioural finance, which we know has become much more popularised. But you I think the way you look at it is quite distinguished to many other writers and speakers and you talk about this contrast between being a homosapien versus being a homo economicus ...what is the key conclusion for investing from that and how might that specifically impact active fund selection going forward?

Paolo Sironi  7:27  
As we just mentioned, the since the industry shifting from a product focused to a focus on the needs, and the understanding of the final client, financial market transparency wants to unveil the difference ,the gap between homo economicus  and homo sapien and this is absolutely important to learn how to generate value homo economicus is a medialization state of the final investor under the assumption that he can be he or she can be irrational in making decisions. Basically, there is a complete set of information that can be used to optimise a portfolio to decide on a financial strategy. In reality, this is never so because we never have enough data to predict the future. I opened most of the BlackRock conferences two years ago with my keynote, the title knowledge 'digitization', and I've been provoking the audience asking them why their clients don't understand finance. And I used to answer because there's nothing to understand, in the sense that the future is open, even the most informed investor or Portfolio Manager is not capable of predicting what will happen going forward. And this is always so even if you understand that there are rules that are important, like if interest rates go up, or prices of bonds go down, you don't know if the interest rate will go up, or will go down and by which amount. So, then, if the rationality can never be achieved under the assumptions of the classical theory, and therefore the homo economicus is just an idealisation state that we need to understand How to service it the homosapiens which has to make decisions facing uncertainty with ta new set of information. 

Now, the biological micro foundations that are at the core of the financial market transparency, theory and principles are effectively the two elements that allow us to reconcile the rationality with the emotions which are needed to perform a more conscious investment process, these micrological in the market , these micro these biological micro foundations are the fundamental uncertainty and the irreversibility of time. I want to explain to you this way, let's think about modern portfolio theory. Multiple flow theory assumes that you can optimise a portfolio starting from the time series or the opinions that you have on financial markets. But you know, that the moment after the optimizer portfolio - the optimization is already useless, because it doesn't correspond to the new conditions that are prevailing on the market. Now, the reason is because modern portfolio theory is not capable of embedding uncertainty making uncertainty endogenous in the decision making process, it doesn't matter how sophisticated the risk measure. 

The second problem of modern portfolio theory is that it is typically a temporal. That means if you want to use it for a short term investing or long term investing, you need to perform two different sets of optimization starting with different assumptions that time series and market conditions. Now, no surprise that in reality, the almost circus needs to face fundamental uncertainty in order to survive in life, we might have forgot that because we live in the modern world. But effectively, every morning we recap, we have to survive. And certainties are the structure of reality. And we also need to purpose over time, because we have this sense of the irreversibility of time from life. When we are born to death, and therefore only with purpose, we can move forward now, embedding uncertainty in decision making and investing in purpose are the two dominant themes of the investment management going forward. Therefore, the financial market transparency enables to revise the investment process in the advisory process, bringing to the centre the essence of homo sapiens decision making, .... facing uncertainty, and making decisions over irreversable time. And this is the reason why it enables us to make a step forward so we can abandon the idealizations of the rational homo economicus. And we learn how to embrace radical irrationality, that means always reminding ourselves that the information we have at our disposal for making investment decisions are always partial, and the future is open.

JB Beckett  12:01  
You have noted a number of times that for example, uncertainty is the new normal and that randomness is the the norm and fund selectors obviously facing into that they're not being presented with that information currently, from asset managers, they're not being given enough guidance on uncertainty and complexity. Why do you think that is? and practically speaking, what can they do to solve that problem?

Paolo Sironi  12:26  
Essentially, humans tend to forget uncertainty because it simplified the framework, especially investment managers, and wealth managers, when operating in a world that assumes uncertainty to be exogenous, have an easier time in talking to the clients because they don't have to face very complex and tough conversations. But this is also the reason why the industry is not capable of generating sufficient value for fund investors. Because the most important piece, which is the norm in finance, that is fundamental or radical uncertainty is left outside the conversation. 

Now, Alan Greenspan in 2009, was speaking in front of the US senate and asked to explain why the financial system was collapsing after Lehman Brothers. And what Alan Greenspan said is that he realised that there was a flaw in the theory. And he said that the flaw is that the investors and the agents are not rational. Therefore, they don't know was acting in the best interest of the community. Now not being rational means that they are not capable of understanding that not all information they have is sufficient and therefore uncertainty is the norm, and not the exception. So then how can we have the investment community resolving the problem of starting the conversation with the final clients with the concept of fundamental uncertainty and reminding in the process of investment management, that fundamental uncertainty is the structure of capital markets? Well, we need to give them techniques and that enable them to focus not on the optimization of a portfolio, but on the creation of antifragility in the investment decision making process that in a case can be created inside a portfolio, but in most cases will be created inside the full allocation of a wealth of an individual that accesses otherwise commoditized financial solutions like a passive or active investment funds in order to make decisions that matter for short, for the medium, for the long term and also for the heirs after that. Now, this is the reason why I always bring into the framework the concept of the goal based investing or the wealth allocation framework, because that is the anchor that allows the advisor and investors to discuss the concept of radical uncertainty while looking and search for Investment solutions that enable them to attempt to fulfil the needs and the desire of the funnel investors basically trying to achieve their financial goals. 

Now, once this is understood that the old industry we line up in the new process of value generation for investors, which is actually the title of my third book, 'MiFID2 value generation for investors', they looked at the looks at MiFID2 to that is European regulation being possibly the most demanding regulation in terms of investment and wealth management processes. Therefore, I like to think that if you can make it there for the MiFID2 you make it everywhere. Now, the MiFID2 might not be perfect but the core, the heart and soul of the MiFID2 is the transparency principle, therefore, understanding that comes at a fundamental uncertainty in time irreversibility, which are the biological macro foundations of finance, and therefore understanding how to play the wealth allocation framework to benefited the conversation between the advisor and the final client allows the industry to understand how to create financial products that better fit those conversations, which ultimately, in a world where the embedded fees inside the funds get more and more commoditized then value will have to be generated on clients and through relationships and not through the selection of final products.

JB Beckett  16:20  
Thanks, Paolo. Yes, certainly, you know, as a as a fund allocator. Thinking back to after the great financial crisis, I guess like many investors at the time, I was drawn towards complexity, you know, complex adaptive system theory, interconnectedness, fragility, and, you know, I think that started to get a steer some of my own thinking about how to reconstruct portfolios. But, you know, in over 10 years, it doesn't feel like the industry has moved all that much. But there's one other I guess, irrational fear of perhaps is perhaps is more rational than I'm giving it credit for something else that is at the heart of the new fund order. And that is, of course, one of automation, digitalization and potential obsolescence. And just thinking back to your you know, your early work with, for example, IBM Watson, when it comes to machine learning, do you see it supplanting many of the human roles in asset management? If so, how might machine learning and artificial intelligence change how funds are being managed tomorrow?

Paolo Sironi  17:22  
Well, what is happening today is that we are facing a transformation of all industries through the fourth industrial revolution, which are powered by which is powered by exponential technologies. And artificial intelligence is one of the core exponential technologies, which is basically in fact impacting every job. Now, let's say something important first, and then we discuss the pros and the limits of AI. The word is complex. And product complexity doesn't necessarily allow to relate to complex world in better terms, typically, simplicity pays out and now, as the industry simplifies the product offering automation becomes more likely and more feasible and this is where artificial intelligence start playing an important role, because it can allow the investment managers to perform the process of investment management without confining themselves to a defined and rigid set of rules, but investigating the information plus new information that is available in the market like a structured information in different ways. However, something important needs to be reminded here if investment managers wants to use exponential technologies to generate new value through the investment management process. Also artificial intelligence has to deal with fundamental uncertainty. Because data is never complete the data is never cleaner and therefore is not easy to understand that wouldn't efficient intelligence algorithm decides in terms of positioning in the marketplace, especially when we are not using or you're not using artificial intelligence for high frequency transactions, but they want to use it for strategic positioning. Therefore, it is very important that the artifical intelligence is plugged on an architecture that allows the transparency, robustness and applicability at the limit. Because without that it would not be possible to understand that the insights that artificial intelligence can generate, and therefore to divide the good from the bad, in essence is like running a risk management project because artificial intelligence is an optimization routine and therefore understanding the sensitivity of the algorithm to the change in the various factors that are part of the information set. That artificial intelligence they adjust. But don't forget that even artificial intelligence needs to confront itself with fundamental uncertainty, therefore needs to be part of a regulatory process. And it requires a high level of interaction from the fund managers side. Because otherwise the AI might corner itself very fast into another optimization conundrum and collapse as much as human decision making. So use it, but use it with the sanity, making sure that the process is transparent, robust and explicable.

JB Beckett  20:28  
Yeah, thanks, Paolo. I'm reminded of my friend, Dr. Jacek Marzcyk, who often talks about complexity theory over at Ontonix and he would, he would remind me of the Zadeh's Law in terms of the 'law of precision'. And that, you know, you can't necessarily get precision out of a system that is full of imprecise inputs. Going back to your point about quality of data. And I think this is a fascinating area that you and I can could talk about, but I'm very conscious of your your valuable time. And before you go, I have got to I've got to ask I'm afraid my 10 question rapid fire round... 10 Very, very quick questions, very easy to answer, but they are.. it's an A or B, it's an X or Y. It's a very binary, which I know is what makes it makes it fun and can make it challenging, 

and I'll get straight into question one, bull or bear?

Paolo Sironi  21:27  
Both. 

JB Beckett  21:31  
You're not going to pick one?

Paolo Sironi  21:32  
Well, the future is uncertain, and I don't know that. But I believe that the systemic Put has been overly amortised. So the drift is negative. All assets are inflated because of quantitative easing, that will not go on forever. 

JB Beckett  21:48  
Yeah, good point. The second question might be more straightforward based on just some of the things you were talking about earlier, or Bogle or Buffett?

Paolo Sironi  21:55  
Bogle, because I liked the way that he simplified that investment management that Buffett is another kind of genius, maybe for the next question.

JB Beckett  22:08  
Well, lethe next question this profit or planet?

Paolo Sironi  22:12  
These days planet? 

JB Beckett  22:13  
Question four, divest or engage?

Paolo Sironi  22:18  
Engagement is core to everything. Whenever there is a relationship, there is value, so I always go for engagement.

JB Beckett  22:25  
That's a good point. And question five is lower cost or better value?

Paolo Sironi  22:31  
I would say better value, because the cost getting lower does not resolve the problem of uncertainty per se. But we need to make sure we define value and what value is and that is not necessarily what most of the industry proposes. 

JB Beckett  22:49  
Yeah, that's a good point Paolo. The next question relates, I guess, to the size of asset manager. And the question is supertankers or boutiques?

Paolo Sironi  22:58  
I think asset management is commoditizing at the speed of light. So hyper volumes, only will allow the product makers to survive the value shift on the wealth management relationship. So the small boutique will be there. But this will be a market for the supertankers

JB Beckett  23:20  
I'm forced to agree in many ways, but I'm with a with a tinge of sadness, because I do believe that innovation tends to to emerge from the boutiques

Paolo Sironi  23:29  
Well the financial advisor becomes that boutique that needs to be capable of creating the personalised discussion with the client. The only issue though is that the personalization doesn't come from the assets but from the liabilities. So to be a wealth management slash Investment Management boutique, the liabilities of the investment needs to be part of the framework.

JB Beckett  23:50  
Next question is a little related to that. But it's the choices between star managers or team players, 

Paolo Sironi  23:57  
There's no style manager is always luck, 

JB Beckett  23:59  
Yeah, I had Joe Wiggins on the show just recently, and I think he would probably tend to agree with you looking at the I guess the behavioural aspects. The next question, question number eight is public or private?

Paolo Sironi  24:13  
Public or private? In which sense?

JB Beckett  24:14  
So public or private in the sense of markets and assets?

Paolo Sironi  24:18  
Well, I think that illiquidity is often opacity, and I always favour transparency. So as long as private markets become transparent, they will be fine.

JB Beckett  24:32  
Question number nine is, again, it's about the type of asset or or the characteristics of the asset. And that's a choice between high growth or stable income?

Paolo Sironi  24:41  
Stable income is not possible. So most likely searching for growth. 

JB Beckett  24:45  
Yeah, I'm probably forced to agree with you and then a point of regional variance inflation and increasing rapidly accelerating inflation, that's quite a scary squit scary prospect. Question 10 My favourite question as people who listen to the show will know, is a choice between socialism or free markets? 

Paolo Sironi  25:08  
My financial market transparency wants to mentor capitalism making sure that the Invisible Hand becomes visible again, because transparency generates consequentialist ethics that allow a free market to comply with regulation and to remain inclusive. So I'm looking for a transparent liberalism.

JB Beckett  25:30  
Yeah, it's fantastic as as a Scot, I'm, I'm very proud to see just how much Adam Smith and Hume, for example, are being discussed and debated again, in economic circles.

Paolo Sironi  25:41  
If you like you can put it this way. At the time of Adam Smith, I'm simplifying the world was simpler. Now the world is more complex, the realities always been complex. Now, transparency is the core governance principle on a complex platform, such as economy and society. And therefore we need to plug in transparency on incentives, constant consequences, starting from the investment relationship, because that will enable to unlock new value that can be shared with the ecosystem, and this is actually the core message of my upcoming book, which will be published by Wiley in October 2021. And the title is, 'Banks and FinTech on platform economies, contextual and conscious Banking'.

JB Beckett  26:30  
and that just leaves the the final bonus round Paolo. If you could pick a number between 11 and 40? 

Paolo Sironi  26:39  
40 

JB Beckett  26:40  
Shout, or listen?

Paolo Sironi  26:42  
listen, 

JB Beckett  26:43  
That's great Paolo, you have survived the new fund order. I think you've touched on a number of things in today's episode that will be new concepts to many of the listeners and to fund selectors at large. And I just wanted to say thanks very much for coming on the show.

Paolo Sironi  27:00  
You're very welcome, all the Sironi files are available on Amazon.

JB Beckett  27:03  
And I'll be sure to put links on the show to your various books, obviously onto social media as well. So thanks very much Paolo 

Paolo Sironi  27:11  
Arrivederci

JB Beckett  27:13  
Please don't forget to like and share and subscribe you know, click the subscribe button, a new podcast every two weeks with a new guest. Stay tuned. #

Thanks to you, dear listener for tuning in. Brought to you but my sponsor, Allianz Global Investors and a warm thanks to today's guest. Legally, I am compelled to remind everyone that all views of this podcast are independent and do not belong to any affiliation or organisation. Just in case that was in any doubt. 

Tune in for the next podcast every two weeks from the... 

Computer  27:49  
new fund order. 

JB Beckett  27:51  
Please subscribe, share, like and comment. Let me know what you think and what you'd like covered in future episodes. Until then, stay safe and keep it left field. 

Transcribed by https://otter.ai

Market News
Call for Sponsors
Interview: Paolo Sironi
Anthropology in Finance
Flaw in Modern Portfolio Theory
Machine Learning & AI
Rapid Fire Round
Outro and Thanks