Risky Business

In the state-controlled Straits Times today, the newly reinstated CEO of Temasek Holdings announced a greater than $40b loss in Temasek’s total portfolio for the last financial year. Temasek Holdings, keeper and executor of a significant portion of our nation’s wealth, reported an annual VaR of $40b which was lost amidst the financial tsunami which originated in the States and swept through financial markets across the Pacific and beyond.

Supporters of Temasek Holdings will argue that Temasek is but a victim of the excesses, greed and irresponsibility of Wall Street. They will claim that the loss is but collateral damage, a price Singaporeans have to pay to stay invested in the markets. The truth is that Temasek waded waist-deep into the financial abyss that is Merril Lynch and UBS with amazingly little foresight. They should rightly be entirely responsible for its tremendous losses instead of trying to shift the blame to the financial maelstrom of the past year.

There is plenty of chagrin and widespread criticism of the stupidity of Temasek’s investments thus far within the blogosphere. I do not wish to add to this growing community my opinion and disappointment of the collective idiocy of what many consider the best and brightest minds in Singapore. Instead I shall delve deeper into the intricacies of the risk numbers quoted in the Straits Times today and demonstrate that either Temasek Holdings is taking on excessive risks with what is essential the people’s money or that risk controls within Temasek are not only ineffective but downright meaningless.

The CEO of Temasek Holdings reported an annual VaR of $40b for the last financial year. She went on to explain the VaR figure implies there is a 16% chance that the portfolio will drop by $40b in the period. This is rubbish!! Either she has no idea what she is talking about or she thinks people who read the papers have not enough knowledge to differentiate nonsense from news. Let me explain what the VaR figure is actually implying.


Value-at-Risk simply tells us the maximum amount of loss possible at a predetermined level of certainty. There is a level of certainty associated with VaR figures. Statisticians call this the “confidence interval”. Typical conventional VaR models adopt a 95%-99% confidence interval. That is to say the model computes the maximum loss that will not be exceeded 95%-99% of all the possible economic/financial conditions. Only in the extreme circumstances of that 1%-5% probability, will the losses exceed the VaR figure derived from the model. These extreme events will occur in the tiny left-hand tail of the probability distribution diagram shown above. The exact derivation of the VaR number may be immensely complicated and will involve analysis of serial and matrix correlations of the portfolio constituents. The VaR model may also embed other statistical and stochastic models in its simulation. However it is not necessary to fully comprehend the underlying mechanics used to generate the VaR number. Once the final figure is derived, the significance and application of that statistic is simple and intuitive.

Let us apply the statistic to the case of Temasek. It is reasonable to assume that Temasek, like all major financial institutions, adopts a similar VaR model like the one I described above. Therefore, it is entirely wrong to claim that there is a 16% chance that the $40b loss will be incurred. In fact, the probability will be closer to 1%-5% instead of 16%!! Why then is a high probability of 16% mooted in the news? Let me provide a reasonable explanation. What Temasek is implying when they claim 16% probability of loss, is that the investments they made is not really of a high-risk nature. They are saying that the portfolio value have declined because the broad market have turned south by roughly 35%. The losses are kind of in line with the broad market decline and thus ordinary and non-excessive. This is definitely not what the VaR figure and I will explain why.

With a VaR figure of $40b, with a reasonably assumed confidence interval of 95%-99%, Temasek has in fact taken on excessive risk as compared to the broad market investor. For the losses to hit the $40b VaR mark, the applicable market decline with respect to Temasek’s investments is closer to 45%-49% instead of the broad market mean of 35%. In other words, Temasek, the main custodian of the collective wealth of our people, have punted and lost 10%-14% more than the already huge losses of the common broad market investor over the last financial year!! Temasek was essentially placing huge bets with the peoples’ money and these bets are effectively 50% more risky than the common broad market investments. Where else in the world can you find such careless and irresponsible financial management that goes literally unchallenged and unaccountable for but in sunny wonderful Singapore?

There is another angle to this issue. It may be possible for the VaR of $40b and loss probability of 16% to be correct. But this will lead to an equally startling revelation as the one above. For the risk numbers to be accurate, Temasek will have to be running their VaR models at a 1 standard deviation level. There is probably no respectable financial institution in this world that has an equivalently lax risk control system! A VaR figure generated at a 1-sigma level will be close to being a completely useless and meaningless statistic. At 1-sigma level, the fluctuations of portfolio value over the year will exceed the critical VaR threshold more than 65% of the time!! What good is a limit if the limit is breached more than 65% of the time? To make the VaR more useful and informative, the model has to increase its confidence level. In that case the VaR number Temasek should be quoting may in the region of $100b, 2-3 times that of $40b! The current portfolio value of Temasek is around $190b. Imagine you have a CEO, making investments that can possibly lose more than 50% of the total company’s value if conditions turn south, who doesn’t even understand the basics of risk management!! I shudder to think of the consequences.

Moreover, the regular review (be it monthly/quarterly/semi-annually) of the company’s portfolio should have alerted the relevant authorities within Temasek. Even if we accept the ridiculously low standards of a 1-sigma $40b VaR model, the progressively deteriorating credit conditions over the past year would have push the VaR figure way past the $40b mark. Why wasn’t there any significant move by Temasek to bring the VaR down to the original $40b threshold? Surely the potential losses from capital depreciation far outweigh the transaction costs involved in the hedge. It should be the duty of a SWF to safe-keep the nation’s reserves and not take unnecessary risks, isn’t it?

Two images flashed across my mind as I think about the reasons for such inactivity. The first is that of a nervous punter that stubbornly held on too long to a losing position in the hope that the markets will turn and he will not have to face the consequences of a margin call. The second is that of an oblivious executive playing golf in his country club and chatting happily with his other well-heeled counterparts. How many people see the same images as I do? Surely there ought to be some consequences for such careless and irresponsible behavior.

There may be some higher and more sophisticated reasons as to the actions and decisions of Temasek. A humble commoner like me may not be able to comprehend. But please at least take the effort to come up with a semblance of a more reasonable excuse for a job poorly done instead of the constant jibberish we see in the news. The truth of the matter is that the business of Temasek is indeed a very risky one and we need to know more about the truth behind the facade of control and prudence which Temasek clearly lacks

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Curve Balls

In our daily struggles to chase the things that we think will make our lives more complete and perfect, we sometimes forget that life is inherently imperfect. While we often envy those around us that we think is living the perfect life, how many of such targets of admiration is indeed doing so? Even in the highly unlikely probability that one is completely satisfied with the life he/she is living thus far, the chances of such bliss continuing quickly changes from improbable to impossible. If the final goal of our endeavors is but an impossible dream, what is the point of pursuing it anyway? What are we really striving for?

This post serves as a reminder to myself and all the rest out there that is chasing the dream of a more perfect existence. Life will always throw you all kinds of curve balls. Just when we think we have it all figured out and start making our 3/5/10 year plans, life will turn round to bite you in the ass and throw all the elaborate planning into chaos and disrepair. It is not to say that we should stop preparing for our future and leave everything to the unfaithful hands of fate. It is just that as we go forth in life to prepare, plan and strive for a better future, we must never forget the life is really about the journey instead of the destination. It may seem like a very clique thing to say but I think at the end of it all, when we look back at the existence we have had in the short time on this planet, what really matters the most will not be the amount of possessions or prestige we have accumulated but the experiences and relationships we have gathered in our time.

I know of some people that have become deeply unsatisfied and unhappy in this journey of life. The frustration and anger is borne out from the elusiveness of that sought-after end goal. It is understandable but it would be such a waste if one has forgotten about the value of the journey and neglected to savor the adventure. The end goal is what it is all about, regardless of how distant it is. Energy is wasted in venting the anger and frustration. The negative vibes and resentment hurts and infects all around. Then there are others that are primed for the perfect life. Everything seems to pan out exactly the way they wanted to. Suddenly a curve ball is thrown in their direction and everything goes awry. All the planning and industry seems to be in vain and the curve ball has reduced everything back to square one. Although standing at the opposite ends of the spectrum of life, they are connected by the thread of its imperfectness. The way to move on is to take what life deals on the chin and stride on bravely into a new tomorrow, undaunted by the obstacles of today. It is better to have tried and failed then to have given up before starting. Despite the pain and agony of today, take comfort in that what doesn't kill you makes you stronger. Your journey may be tougher but your life is also richer and at the end of the day, you will look back at your battle scars and feel the pride for having fought and won. I pray for myself, and all the others struggling with life's curve balls, a stronger will and a more foolhardy belief in the beauty of life's journey.

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Just Follow Loh

Just read something online that really strikes a chord in me. A woman was fined $30 for sucking on a sweet while taking the MRT. You can view the video here. This is a very good example of Singaporeans following rules without using their brains to understand the need for such rules to exist. There are 2 things in this video that really infuriates me.

The first is the stubborn stupidity of the MRT officer in implementing the rules without any thought or reason in doing so. We should note that the officer is keenly aware of the video camera in front of him and perhaps that made him doubly more determined to dish out the punishment so he can appear to his superiors or anyone watching that he was doing his job well. Under another circumstance, without the spotlight of the camera, perhaps he may have chosen to be more reasonable and lenient. But that is really the point. Somehow for most Singaporeans, the need to be "officially and politically correct" overrides any otherwise reasonable and logical considerations. Some people will hesitate to perform the most logical and reasonable of tasks as long as there is the possibility of violating the letter of the law. We are talking about slavish obedience to every word of the rule instead of simply abiding by the spirit and purpose the rule is supposed to uphold. However, the same people will have no qualms with carrying out impossibly stupid and irrational exercises as long as the rulebook commands it.

The MRT officer is the best case in point. He rather err on the side of caution, and stupidity, than to exercise some discretion in this matter. The basic reason of MRT implementing the "no eating" rule is to prevent accidental/intentional littering of the cabin and, maybe to a lesser degree, eliminate food odours in the cabin. Surely the MRT officer understands that. But despite that, the officer still issued the fine, "just-in-case" someone in authority is watching. Stupidity, insensitivity, even cruelty is condoned in Singapore as long as one is following the rules blindly. But non-obedience, no matter the reason or appropriateness, is not tolerated here. Simply put, in many ways our system rewards stupidity and blind obedience but punishes intelligence and reasonableness.

The second thing in this video that really gets on my nerves is the lack of indignation and fight of the passenger that was fined. Instead of being exasperated by this mindless application of the rule by MRT, she seemed sheepish and tried to offer excuses for the sweet. She is not alone in this behaviour. Somehow we were brought up to instinctively follow the rules, no matter what the rule is. We are trained to feel guilt and shame when we did not do everything by the book. Therefore instead of challenging the right of the MRT to impose the $30 fine, she tried to mitigate her actions by claiming giddiness because it is somehow more "justified" for a sick person to violate a rule. Hell, I don't think there is a need to justify her actions to the MRT officer at all. He should be the one to explain and convince the lady of the need and validity of imposing the fine.

I can quote more examples of everyday Singaporeans that chooses to follow rules blindly without taking a second to consider the validity and reasonableness of those rules. There is a pervasive culture of fear within the fabric of our society that makes us act with unthinking obedience, that makes us such willing slaves to the existing rules and authority. There are probably many other societies out where blind obedience is more prevalent. But here are also plenty of those where people follow rules not because they have to but because they want to. Not everyone follows our Singaporean mantra of "Just Follow Loh". At least I hope not.

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Proving God

I studied in a typical methodist primary school when I was young, even though none of my parents are Christians. They sent me to the school because it was one of the "ang moh" primary schools around at that time and thought it would be beneficial for me to be in an English-speaking environment since I spoke only Chinese at home. Along with the rest of my classmates, I had to pray every morning during assembly. There would be a reverend leading the prayer over the PA system and all the students will bow their heads and follow. Being young and impressionable, I remember thinking it was cool to pray since every other classmate was doing the same. I badly wanted to fit in so I followed suit. There was no consideration on whether I wanted to be a Christian or if I believed in Christ. It was just something everyone did and I followed. To be fair, I was only an 8-year old.

Later in life, I didn't really get any more direct opportunities or motivation to further pursue Christianity. It gradually faded away from my life. In fact, probably to my education or experiences etc, religion was never really a subject I thought much about. I was way more interested in the sciences. Physics, mathematics, economics or even philosophy appealed to me more. Gradually, it became a choice for me. I would believe in either science or religion, not both. I was convinced somehow that the two fields are opposites and thus cannot coexist naturally. Maybe its due to age or wisdom, I do not really think that anymore. At least not in such absolute terms. I do not consider myself an atheist. I think I am more of a pagan, a go-between a believer and a skeptic. I believe there exist a supernatural power, an almighty consciousness . However I do not believe there necessarily needs to be formalized rituals or established institutions to worship that power. Certainly not a standardized textbook to decipher the meaning and purpose of that consciousness!?!

This rather succintly describes what I view religion to be. An institution or system that tries to rationalize and explain something we should not be capable of understanding anyway. However I do not deny the existence of that supernatural power. Some call it Jesus, some call it Allah, other say it's God. To me, they are one and the same, just different names for the same almighty consciousness. We cannot fully explain God with science or logic. The very idea of divinity suggests that we cannot cognitively decipher its origin or purpose. If we were to, God would be reduced to a more mortal dimension and thus "undivine".

A dear friend once tried to prove the existence of God from a biological point of view. He tells me that from our study of entropy and evolution, we will conclude that all systems have the tendency to move towards a less energetic, more lethargic and stable state of being. Matter will seek lose their internal energy and try to reach an equilibrium state. We learned it as our typical high school science textbook cliche, "everything reaches equilibrium, eventually". However for the evolution from single-cell amoebas billions of years ago to humans today to be possible, matter have to behave contrary to this universal law of nature. There definitely exist the possibility for uninitiated random events that excite the systems out of its slumber and spark increases in entropy and activity, but such coincidences should logically be far and few between. To kickstart and propogate the process of evolution, such coincidences have to happen billions and billions of times, over millions and millions of years for our world to be where it is now. Logically and statistically, the sheer improbability of such coincidences should make it impossible but yet, Earth is teeming with life. Surely it cannot be just dumb luck? His explanation? The existence of God.

I know of another similar phenomenon within physics. In classical Newtonian theory of physics, all things are determinate. We can predict a future state of our world with absolute certainty since we can accurately calculate the position, speed, energy etc. of every particle in our universe, as long as we know the initial state it is in. Future is not longer an uncertainty but instead a definite result governed by established theorems and laws. The difficulty lies in harnessing enough computing power to harvest the data needed and compute the necessary calculations. However that is strictly a logistical issue which does not refute the fact that we can theoretically calculate and project the future. However there is another physical theory that fundamentally refutes the Newtonian view of our world, Quantum Physics. A core characteristic of quantum mechanics is the lack of deterministic causality and that at subatomic levels, a particle can exists in different states and space at the same time. Quantum physics suggests there is an inexplicable randomness lying at the heart of all things in this universe and we cannot perfectly anticipate an outcome due to the existence of this randomness. Many think that behind these 2 paradoxical views of the world, lies the divine. God is hiding behind the fabric of the institution which we call science.

While we cannot sufficiently prove the existence of God through science, we also cannot explain everything (ie. the randomness) in our world by science. When we tear down our understanding of the world to the very basics, there are fundamental building blocks that do not have a reason of being. They just are. The simplicity and inexplicabilty of these fundamentals is God. We cannot attempt to explain or rationalize this. It's as if we can never hope to understand the purpose of these proverbial building blocks. Similarly 'God' does not care about any religious worship or rationalization of the higher designs of the divine because they are but constructs of man and represents man's need to place himself at the centre of the universe. This is part I of a 2-blog entry regarding religion. This is my attempt of a logical explanation of the existence of God. I will continue to expound on this issue on the next entry.

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Snobbery

Recently I discovered an interesting blog, "Intellectual Snob", that is written by some elitist idiot that turned out to be a fraud. Before she was exposed, she claimed to be some Ivy League graduate and proceeded to unload her contempt for people whom she deems of "lower intelligence" on her blog. She calls such people "frogs" and local graduates, amongst others, are collectively denounced in that classification. She was later found to be a fraudster and the ironic thing is that she is actually an undergraduate from NTU! The extreme hypocrisy of the author aside, the blog is also incredibly arrogant and vicious. There is massive outrage on the blogosphere with she wrote. Many hurled insults at her and left hate-mail like comments on her blog.

I admit I am slightly like her. I am not proud of it but I have to be honest with who I am and what I believe in. Intellegence is probably my most admired quality in a person. I used to think it is also the most valuable asset you can have. I am the biggest advocate of the idea of "You are what you think". Some call it perspective, some call it understanding and others say it's mindset. To me it's one and the same. The main determinant of how your life pans out, outside of dumb luck, is what you think of and consequently how you act on it. The thought is key, subsequent execution of that merely procedural.

However this episode of the errant blogger gave me an addition insight into my belief on intelligence. A certain amount of humility and tolerance is needed for intelligence to be truly beneficial and appreciated. This blogger uses her supposed "intelligence" to belittle and ridicule everyone she meets, from colleague to the man on the street. Perhaps she does not realize it but I think her blog screams for recognition and acceptance for what she deems are exceptional achievements. She believes she is bestowed with extraordinary gifts and thus have a god-given right to all good things in life. The blog is a means for her to justify that irrational notion. But her towering arrogance has, instead of convincing, only serve to alienate her from others and acts in direct contradiction of her original intention.

A true intellect knows the virtue of humility. He recognizes and embrace diversity. Only by acknowledging your own insufficiencies and imperfectness, will you be able to see the validity of others' strengths and realize the absurdity of having a single, myopic definition of talent or ability. I am not going to dismiss her thinking because she is from NTU. It was inaccurate from the start, regardless of the authencity of her Ivy League pedigree. It is a shame that she needs to hide behind the facade of an American education before hurling insults at her fellow countrymen. This suggests that her superiority complex never originated from her confidence in her mental powers but rather, derived from an association with reputable institutions fabricated in her elaborate lie.

I am nowhere near an ideal level of humility and self-awareness. I recognize it and I will continue to strive towards that goal. However the greatest satisfaction I derive from my inadequacy is the knowledge that somewhere out there, there is at least one self-deluding fool that is way dumber than a frog.

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