We have two guests joining us for this episode of the Rational Reminder podcast. First up, we have Paul Calluzzo, who is the Assistant Professor of Finance and Toller Family Fellow of Finance in the Smith School of Business at Queen's University in Kingston. Paul joins us today to discuss the findings in his paper, ‘Complex Instruments Have Increased Risk and Reduced Performance at Mutual Funds’. He explains the motivation for the paper, the research it expands upon, and the types of complex instrument allowances it investigates. We discuss reverse causality and find out how complex instrument allowance is related to fund performance and risk, respectively, before hearing Paul’s investment advice. For the second half of the show, we are joined by the author of Losing the Signal: The Spectacular Rise and Fall of BlackBerry, Sean Silcoff to discuss the BlackBerry revolution and its subsequent decline, and the film adaptation of the book. Tune in for our guests’ insights into best practices for investors and business leaders alike.
Key Points From This Episode:
Housekeeping: check out our CE courses and reach out for financial advice. (0:02:25)
An introduction to Paul Calluzzo and our conversation with him about the impact of complex financial instruments on mutual funds. (0:05:20)
The motivation for the paper, ‘Complex Instruments Have Increased Risk and Reduced Performance at Mutual Funds’, the research it expands upon, and the types of complex instrument allowances it investigates. (0:07:50)
Reverse causality relating to complex instruments and mutual funds, and the mechanisms that could potentially harm investors in funds using complex instruments. (0:12:37)
How the performance of funds was evaluated in the paper and how the usage of complex instruments evolved throughout the sample. (0:18:12)
How complex instrument allowance is related to fund performance and risk. (0:23:06)
The asymmetry of return patterns in up and down markets. (0:26:11)
Paul’s investment advice, in the context of the paper’s findings. (0:33:05)
Why complex products are growing despite their poor performance and how research can reach the market. (0:37:05)
A quick recap of episode 39 with Rob Carrick. (0:40:48)
Our brief review of Losing the Signal: The Spectacular Rise and Fall of BlackBerry by Sean Silcoff and Jacquie McNish. (0:41:49)
Sean Silcoff breaks down the BlackBerry revolution and its subsequent demise.(0:44:53)
Insight into the film adaptation of the book and what makes it such a compelling story. (1:04:51)
What business leaders and investors can take away from the BlackBerry story. (1:08:09)
Our after-show roundup! (1:15:12)
Read the Transcript:
Ben Felix: This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, and Cameron Passmore, portfolio managers at PWL Capital.
Cameron Passmore: Welcome to episode 253. Ben, almost five years ago now, we sat down with two microphones and not a clue what we were doing. We learned this week that we have passed the 5 million all-time download milestone considering how we started. It's unbelievable to me.
Ben Felix: Yep. Are you implying that we know what we're doing now?
Cameron Passmore: No. I'm just affirming. We had no idea what we're doing then. I'm not making any correlation between the two. And then when I told you that today, you said, "Look at this. You just passed 15 million views on your Common-Sense Investing YouTube channel."
Ben Felix: Yeah, I only knew that because I got a big notification from YouTube saying, "You hit this milestone, 15 million." Oh, wow. That's a lot of views.
Cameron Passmore: Yeah. That's pretty cool. Anyway, this week is a super interesting episode and rather unique. You kicked it off upfront by following up with research that helps you with the episode a couple of weeks ago.
Ben Felix: Yep. Professor at Queens. We'll give him a proper introduction when we go to that topic. But, yeah, we discuss with him complexity and financial products with Paul Calluzo from Queen's University. I mean, that was, in my opinion, an absolutely fascinating practical discussion of some really cool research.
Cameron Passmore: And from there, we jump into review of episode 39 with Canadian financial journalist, Rob Carrick, of The Globe and Mail. And maybe you're too young, Ben. Did you ever own a BlackBerry?
Ben Felix: I'm not that young. BlackBerrys were a thing when I was a growing adult.
Cameron Passmore: I'm not saying they're a thing. But you're not exactly – like, what model of iPhone do you now have?
Ben Felix: Yeah. No. I never owned a BlackBerry. That's fair. But I was around when BlackBerrys were popular.
Cameron Passmore: I'm not being aged. I'm just saying I don't – but didn't think it was a thing for you – anyway, so this week, we have something pretty cool with the Canadian journalists who co-authored the book about the downfall of BlackBerry, which has now been made into a feature movie. The book is called Losing the Signal, which we'll do a quick review of. And the co-author is Sean Silcoff. And the movie is called BlackBerry, which has its North American release on May 12th. And, of course, we have the after-show for the three of you. Stick around.
Ben Felix: I wanted to mention that we've launched our continuing education credit platform, which currently has 10 CE courses that are accredited by FP Canada. That's for people who have their CFP or their QAFP and by IIROC for people who are registered. Well, I guess it's SRO now.
Cameron Passmore: SRO.
Ben Felix: SRO. The new regulatory body. Accredited on both of those. There are 10 courses, which are really sets of questions based on Rational Reminder podcast episodes. There are 11 credits available because the Robert Merton episode was accredited for two credits, which is not surprising because it was a two-hour-long episode with Robert Merton. Oh, you would hope it would get two credits.
We're charging $150 per year for this subscription. A handful of people did already sign up, which is awesome. Because the only way we've announced it is at the back end of a previous episode. We're talking about the front end this time. And we'll try and post it on our social media on PWL social media and stuff like that too.
And I just want to say that the plan is we've kind of rolled this out as a soft launch if there's interest. A few people have signed up already. If we see that there's interest that people want this product, then we will continue to develop more courses based on podcast episodes and probably based on white papers as well.
I think we could make a pretty cool learning environment in there. But we don't want to dump a bunch of resources into it until we see there's a bit of interest. If you're an advisor or a financial planner who needs CE credits and thinks that you would want to get involved with our CE courses, then it would be great if you could sign up to show your interest so that we know that people are interested.
Cameron Passmore: Well put.
Ben Felix: I also wanted to mention that if you are listening and know someone in Canada who's still investing in high-fee mutual funds or if they're paying fees to a financial advisor but maybe not getting comprehensive advice, you can ask them to talk to us.
Cameron Passmore: There must be a few.
Ben Felix: Yeah. Well, we know. We know.
Cameron Passmore: We know there are a few.
Ben Felix: I looked at the data on this because I don't like saying things that aren't supported by data. Morningstar's 2022 Global Investor Experience Study found that Canadians pay an asset-weighted fee of 1.9% on their asset allocation mutual funds and 1.76% on their equity funds. And ETFs in Canada – so that's the mutual fund market. ETFs in Canada only make up 11% of the market. So the vast majority of dollars in Canada are still in mutual funds. And most of those dollars are in these high-fee funds. 66% of the Canadian mutual fund market is in commission-based funds. And as we talked about in a recent episode on financial advice, commission-based advice is questionable at best.
Anyway, so we know a lot of our listeners are DIY investors, which is great, and that's why they're listening. But if you know someone who's in Canada who is investing in high-fee mutual funds, tell them to reach out to us and we'll try and help them.
Cameron Passmore: Love it. All right, Ben, let's go to the episode.
***
Cameron Passmore: Welcome to episode 253 of the podcast.
Ben Felix: All right. Today, this is not a typical guest episode. But we have two guests. It's kind of a fun format today. Right now, what we're going to do is discuss the paper ‘Complex Instruments Have Increased Risk and Reduced Performance at Mutual Funds’, which is a paper published in the Critical Finance Review.
This is a paper that I referenced when we discussed covered calls. Like in my research on that, which we talked about in a previous episode, this is one of the papers that I referenced. And when I put those notes together, I actually sent a note to one of the co-authors just saying like, "Hey, I'm putting together some research on covered calls and I'm referencing your paper. Would you mind just taking a look at my notes?" Paul Calluzzo, that's who that was. And he was gracious enough to read through my notes and help me –
Cameron Passmore: Did you know Paul before? Had you interacted with him before this?
Ben Felix: Yeah.
Cameron Passmore: Okay. He was a listener. You knew him before.
Ben Felix: Yeah. Yeah. Yeah. I've chatted to him a few times beforehand. And I knew about this paper. And it just fits so well with the covered call stuff. I had it in there. And then, as I was going through it, there's a lot of fairly complex information. And we haven't spent a ton of time working on options and other complex strategies. So I just wanted a second set of eyes.
Anyway, Paul was nice enough to look at the notes, and he and his co-authors gave some really helpful feedback that helped with that topic. And then I just kind of thought maybe it would be cool to have Paul come on and talk about the paper, which he agreed to do. And I think it was a really insightful conversation.
Cameron Passmore: That was really insightful. Plus, he's a really nice guy. It was really fun. Paul is the assistant professor of finance and Toller Family Fellow of Finance in the Smith School of Business at Queen's University in Kingston. He received his Ph.D. in finance from Rutgers Business School in a BA in Economics from Williams College.
Main research interests are focused on institutional investors, corporate governance, mutual fund performance and empirical asset pricing. Pretty good lineup, I would say. These research articles have been published in leading journals, including the Journal of Financial Economics, Management Science, Journal of International Business Studies and the Journal of Corporate Finance. And featured in various media outlets such as The Globe and Mail, Bloomberg and Morningstar.
Ben Felix: Yep. It's a good introduction.
Cameron Passmore: Good introduction. Good conversation.
Ben Felix: Yeah. Really, really interesting. And I'm not going to say anything else. Because Paul gives all the detail and nuance and opinion on top of his findings, it's really interesting. We'll go ahead and let that play.
Paul Calluzzo, welcome to the Rational Reminder Podcast.
Paul Calluzzo: Thank you for having me.
Ben Felix: Super excited to talk to you. Tell us, what was the motivation to write this paper?
Paul Calluzzo: First off, it's a co-authored work. So any motivation really came out of this conversation with my two co-authors. But for me personally, and I think my contribution, the motivation was that a lot of my research is at the intersection of governance and Investments, which kind of came out of my dissertation research as a Ph.D. student. And I really thought this question was at the intersection of those two spaces, which we're really looking at you know, what are different ways that an investor might get a short end of the stick when they invest in a mutual fund with relation to complex instruments?
And I forget who it's attributed to. Maybe it was Larry Swedroe. Said something along the lines that hedge funds are investments to tell your friends about on the golf course more so than meeting your financial goals. And, really, I think when we were thinking about complex instrument use at mutual funds, we're kind of thinking them as like hedge-fund-like strategies that investors could access and maybe kind of get some of that excitement or golf course bragging ability that a hedge fund would get.
I think just our prior was that this can't be good for investors. You never really know when you look at the data. And I would say 80% of the ideas that we have as researchers that we think are great; somebody's already done it. This is like a classic thing. You look on SSRN or Google Scholar, and it's like, yeah, that idea has been done.
And this happened with this paper; that Almazan, Brown, Carson and Chapman wrote a paper in 2004 that looked at a very similar question. But I think that it used a small sample. Not a small sample in terms of a limited number of years. That was kind of a quirky time period, which was kind of in the late 90s stock market boom. And they found that there was kind of no relationship between complex instrument use or allowance, really, and mutual fund returns.
And they basically made this compelling – it's always nice, I would say, when a paper gets published that doesn't have results because there's a bias in the industry towards positive finding. That's always encouraging to see. But they basically had this governance equilibrium explanation where it was only the good governed funds that got access to them. And the bad governed funds it was almost like handcuffs that the bad government funds were placed on where they weren't given access.
But we were kind of like, "Well, maybe this is just time period specific. What happens if we add?" And we wound up adding, I think, 15 years to their sample, which included – I think the very end of their sample started to have when stocks declined around the .com bubble—but basically, added the .com bubble, the financial crisis, which are obviously very stressed times for environments.
And I think that we felt like that was a more representative sample. And, of course, always, out of sample evidence is good. Bigger sample is good. We put a lot of effort into expanding that and found results that aligned more with our priors than the findings of Almazan et al.
Ben Felix: I'm glad you brought that up. Because that discussion in your paper is interesting. Just reading about the small sample of the previous findings and how you tried to extend it. I wasn't going to ask about that. But I'm glad you brought it up because the whole discussion was fascinating.
Can you talk about the types of complex instrument allowances that you look at in the paper?
Paul Calluzzo: I should preface this first, which there's more complex instruments that can be used besides just the ones that we looked at. And we were guided by one of the aims of this paper. And the journal is published in – the aim of that journal is to sort of look at really well-published, really well-cited previous research.
We were sort of guided to use the same set of instruments that Almazan et al. used. There's kind of different ways that you can categorize them. At the more granular level, it was borrowing margin and short selling, which we then grouped into a category of leverage.
Then there was options and futures, which we grouped into a category of derivatives. And then there's something called restricted securities, which is a bit esoteric. But it's basically securities that aren't traded on public markets that we kind of look at on its own. We thought that that last one was a little different than the – it's not necessarily complex. It's more liquid. But we wanted to, again, replicate the previous study. But we also found that our results were robust if we didn't include that last category. And we have results that also look at those different categories individually.
One other thing that's worth mentioning is that this was all in the equity space. That kind of, to specify a lot of – for example, one of our performance measures is the alpha in a regression on the – not the CAMP, but on the Fama-French variables and momentum. And sort of that works a lot better in the equity space.
So that, again, following past literature focused on equity mutual funds. There's definitely other funds that I would say layer on even more complexity by investing in markets that aren't limited to equities. But that's outside the scope of the study that we did.
Cameron Passmore: Why did you focus on allowance as opposed to actual use?
Paul Calluzzo: It was mainly an empirical issue, which is the idea that, as researchers, there's kind of a joke that the first comment you get in any presentation, especially as a governance researcher is about endogeneity.
And really, what we mean by that, and specific to this paper, is the idea of reverse causality. So the idea that it's not that complex instruments are causing bad performance. But it could be that bad performance is causing funds to use complex instruments.
And there's real actually kind of theoretical stories of why that could be the case. For example, there's this like tournament literature, which is that if you're behind – I mean, I like to think of the tournament literature as when you're watching American – I'm American. You have Canadian football. I'm also a Canadian now. But if a team is down at any point in the game, it's usually not a good idea just to throw a bomb for a touchdown, right? It gets intercepted probably a third of the time, batted down a third of the time and caught a third of the time. Except for when you're down six points and there's no time left, right?
What mutual funds might do is if they're down – because they get evaluated sort of at month-end, quarter-end, year-end, if they're down at the very end, they might use complex instruments to try to kind of throw that Hail Mary to have returns. And if that's the case, you would see a spurious relationship between the use of complex instruments and negative returns because they tend to use the complex instruments in response to negative returns and not vice versa.
Whereas with allowance, that's that sort of way ahead of time. Usually, ahead of time. And it's not dynamically changing or not as much dynamically changing depending on performance. I think that that's the main reason why we focus on allowance. But I think there's also issues, for example, with governance.
If you're an investor, you actually indirectly set the fund bylaws as do you want them to use the allowance or not. There's a similar sort of case to be made for regulators also doing that. And then we also have sort of this outstanding question, which we've seen a big increase in allowance in sort of past years. We wanted to try to address what that increase in allowance. What might be the causes and effects of that? And I think the last thing is that, again, one of the aims of this paper was to replicate that earlier paper by Almazan et al., and they also focus on allowance.
Now, kind of that whole spiel, I'll also say that we have tests that we just look at use. It didn't seem like they were throwing those Hail Marys in response to being down. And our results are kind of consistent whether we use use or allowance.
Ben Felix: Very interesting. You mentioned that your prior was kind of that this maybe isn't so good for investors. Can you talk about the mechanisms that could potentially harm the investors in funds that are using complex instruments?
Paul Calluzzo: Yeah. I think right off the bat where that prior came out of – and I know that you guys had Berk and van Binsbergen on. And there was this argument. I think there was a discussion. And correct me if I'm wrong. But basically, this idea that the arithmetic of active management, which I think is William Sharp's discussion.
But Berk and van Binsbergen basically make an argument. Well, if there's like naive retail investors, the average active manager can still have abnormal returns. I would argue that in the complex instrument space, it kind of becomes more and more difficult to find who is that naive investor that you're able to trade against and get alpha.
And I think that when you look around sort of the poker table and think about who the sucker is, we think it's more likely that it's actually the mutual fund is the sucker and that they're maybe competing against really sophisticated managers. For example, hedge fund managers.
And my co-authors and I have another paper, and this fits into a literature that does show that hedge funds tend to be more sophisticated than at least mutual funds. I think that's one aspect of it. But even assuming that there is no suckers, but that there's also no – if there's no suckers, there's no retail investors that they're trading against. But there's also no hedge funds. There's just an issue of transaction costs and fees that's going to eat into – assuming that Sharp's arithmetic is correct, that's going to eat into their overall returns and then make the people that are allowed to use them and sometimes use them do worse.
I think that's where some of the concern was. And then I think that there is sort of other background ideas. Like if they're using them for portfolio insurance reasons, we know that that's something that can be expensive. We thought about potential indirect effects. This kind of gets at this idea.
I remember hearing, as a skier, when people first started wearing helmets and seeing a study in the New York Times that said the people who wore helmets actually got injured at higher rates than people who didn't wear helmets. And it's basically the idea that once you put on a helmet, you ski more recklessly. Whether or not that's true, I think it's an open question. But that if there could be these risk compensation effects, that could also have impacts.
And then I think the last thing, and this really gets out of wanting to expand the sample to periods like the financial crisis. Not just a follow-up market, which is that maybe they're exposing themselves to risks. Like you're selling deep out of the money puts, right?
You could have – in 99% of times, it looks like it's not harming you. But then it shows up. You sort of didn't realize the risk you're taking until after it shows up. And maybe there's some of that going on as well.
Cameron Passmore: How did you evaluate the performance of funds?
Paul Calluzzo: I think that, in the paper, what we call dependent variables. We have some performance-based measures, and then we also sort of peel back the onion and ask about risk. With performance, we use three measures. One is just excess return, which would be the return of the fund minus the risk-free rate. I think it's the risk-free rate. I just don't want to misspeak. But it would be worth checking the paper just to make sure that it's the risk-free rate and not minus the market return.
The four-factor alpha, which would be the return of the fund regressed against. Basically, it's the CAPM plus a small effect, a value effect and a momentum factor. And then the last would be this MPPM measure. It's a performance manipulation-proof measure. And this gets at this idea that when you use – and I think this was discussed a little bit regarding covered calls, is that you can actually manipulate the risk that you're exposed to to make it look like your four-factor alpha is better or make it look like your sharp ratio is better than it actually is.
And I think the way that I think about it, for example, with the Sharp ratio, is that if you can use complex instruments to transform some of your standard deviation risk into skew risk or kurtosis risk, your overall level risk is still the same. But you've transformed what would be the denominator in the Sharp ratio, which is the standard deviation, into other parts of risk that aren't actually in the Sharp ratio calculation. So it artificially increases your Sharp ratio.
And this manipulation-proof measure tries to get at that concern. And we find a few places in our paper where it looks like, yeah, they're not doing bad on the four-factor alpha. But the manipulation-proof measure kind of uncovers the underperformance.
Ben Felix: Hmm. That is really interesting. I appreciated that explanation of the MPPM. Can you talk about how the usage of complex instruments evolved throughout the sample? Like, did the usage increase, for example?
Paul Calluzzo: Yeah. So this is interesting. And it was something that didn't align with our priors. So even though allowance actually increased dramatically. So we see that I think it was something like a two-and-a-half-fold increase of the number of instruments.
If you take all of our – very few funds are granted the ability to use margin and actually use margin. If you take out margin, I think it was something like 26% of funds at the beginning of our sample. We're allowed to use the other five instruments. By the end of the sample, 60% were allowed to use it. That's allowed to use, though.
And this is I think, what was a little counter-intuitive to us. And we don't – I think it's left to future research of trying to pin down why the second result's the case. But we actually found that actual usage was somewhat flat despite the increase in allowance being so high.
We don't have a great explanation for why that might be. But the reality is, is that more and more mutual funds that people are investing in, they might not even realize it, are allowed to use these complex instruments. And we basically show that even the allowance without the use can have detrimental effects.
Cameron Passmore: What are the determinants of complex instrument allowance in the sample?
Paul Calluzzo: We basically look at factors related to modern quality and find that kind of consistent with the earlier paper by Almazan that we do find that funds that we perceive as being better monitored, so having better governance do get more complex instrument allowance.
The two proxies that we use for governance quality would be the institutional ownership of the fund. Funds basically have institutional shares and retail shares. So we can look at the proportion of the fund that's owned by each of those two share classes.
The second thing is the fund family size. Just a bigger fund family is going to have more resources and probably more controls to internally monitor. And we find that bigger fund families are more likely to grant allowance. Now there could also be, in addition to governance with fund family, just an economies of scale effect, where if you have a complex instrument trading desk if you're a big fund family. That could be part of the effect.
We also find just independent fund family size just, larger funds are more likely to have allowance. And then we also see that younger funds and funds with worse fund flow, so less money going in, are more likely to have allowance.
And I think that the younger fund effect might be a little bit. Because just if you sort of came of age, if your fund inception was more recently, that's when allowance was more the norm. So it might be that the older funds – if you were a fund that sort of is from the 80s, you would have had to change your bylaws. Whereas it's easier when your bylaws are set maybe to have that allowance.
But we do find evidence also of even among funds with very old inception states that there is changes towards allowance over time. So it's not only driven by when their inception was, which we thought was interesting.
Ben Felix: All right. The big question. How is complex instrument allowance related to fund performance?
Paul Calluzzo: Very badly related to fund performance. I think that that's – I mean, I don't want to overstate it with the very bad. But we found that there was a negative and significant relation, which again is different from the Almazan findings. But aligns with sort of our hypotheses about these are all the potential costs. We don't see – I mean, there could be the case that they have lower returns but less risk. And I think that's what we try to address in a later part of the paper.
But we find with respect to performance. They definitely underperform the funds. And we have a lot of control to sort of try to compare like-to-like. For a lot of our specifications, we're comparing funds that are investing in the same style of securities. And then once you also throw in that four-factor alpha, you're controlling for the type of securities that they're investing in. Funds that are small value funds, or large growth funds, or mid-cap funds.
We're controlling for – it's almost like a quasi-match sample where we're comparing funds with similar characteristics using our empirical approach. And we find that they underperformed. And sort of the magnitude of that underperformance is somewhere around 1% to 2%, depending on the measure that we use per year.
And I think one thing to keep in mind is that we made a very conscientious decision in our analysis not to basically control for expense ratios and transaction costs. Because we thought that those are mechanisms through which there could be the drivers of the underperformance, this is sort of net of those costs. Not gross of those costs.
Cameron Passmore: Similar to Ben's question, how is complex instrument allowance related to fund risk instead of performance?
Paul Calluzzo: Yeah. This was an area that we really weren't sure in which direction this was going to go. Because I think – and this also – there's a big in the corporate finance literature in terms of firms’ use of complex instruments. There's a big sort of debate. And we see both uses that sometimes they use them for hedging, and sometimes they use them for speculation.
We really didn't have strong priors in terms of what the effect on fund risk would be. When we ran our analysis, what we found was there was pretty substantial increases in fund risk. We measured fund risk three ways. One is just standard deviation, which will capture sort of both systematic risk exposures and idiosyncratic risk exposures. And we see that, with complex instrument allowance, the sort of total risk increased.
And we actually saw that that was more driven by the systematic risk component. We saw that the beta of the funds went up. Whereas their idiosyncratic volatility wasn't significantly changed.
And maybe – I mean, there's different complex instruments. For example, futures are usually on an entire index. Funds using futures, I think it's not surprising at least if they're long futures. If they're short, you'd expect a lower risk. But if they're long futures, you would see that sort of relationship with more beta exposure but not necessarily more idiosyncratic risk exposure.
Ben Felix: How do the funds with more complex instruments perform or instrument allowance perform in up and down markets?
Paul Calluzzo: Yeah. This was one of the really interesting things that we found, which was that we split up – if you think about what our results were so far, we found worse performance. And it was actually they're taking more risk. When you put those two things together, we thought, "Well, if you're taking more risk, usually you perform better during up markets and worse during down markets."
What we did is we split our sample. And we split it in a lot of different ways. But we looked at, in sort of the simplest split, just in that time period, was the market up or was it down?
And what we found was – and I should preface this with we're looking at six-month periods. In our sample over a six-month period, there's about twice as many up markets as there was down markets. Even if you do less – ideally, if you're doing well, you do better in up markets than you do in down markets. And in that, you do overall better. But even if it was like a 50-50 split, since there's more up markets, you would still perform.
But what we find is, actually, when the funds use allowance, kind of the magnitude of their underperformance in down markets is about three times larger than the magnitude of their performance in up markets. That when you group those together, the performance in the up markets isn't enough to compensate them for the performance in the down markets.
And I think whenever you see a result like that, I think in almost every one of the papers I've ever written, we've made sure that even if we take out the financial crisis, which was kind of an anomalous period. Not to say that it can't repeat. But when you only have a 15-year sample, that's probably like a one out of 50-year event. Not a one-out-of-15-year event. You want to make sure that your results are not sensitive just to that time period.
We took out the financial crisis from our sample and basically found the same asymmetry in the up and down market where they just get really crushed in down markets, which is not compensated for the returns in up markets. And I think that just – I think that raises questions when you asked earlier about what are you thinking about why might the funds that use this underperformer or over-performer?
And one of the things we talked about was just exposing yourself the left tail risk that you sort of didn't really realize. And it seems like this result is consistent with that left tail risk exposure.
Ben Felix: Interesting is that similar to what we talked about for covered calls where you're keeping the left tail, but you're kind of cutting off your right tail?
Paul Calluzzo: Yeah. As a matter of fact, it is. That's not something we explicitly – I don't think we explicitly mentioned in the paper. But that definitely is a pattern, right? That asymmetry is almost exactly what you'd observe for covered calls.
I think the one thing that isn't in our result is you'd expect, with covered calls, I would expect your median performance to increase. If that makes sense? Because you're collecting the premium. But you basically don't have the upside, but you're getting smoked on the downside.
Smoked isn't the most technical finance term. But there's definitely an asymmetry in the return pattern that we see, which would be consistent with what we also observe. With covered calls, we have analysis that looks at the individual instruments but not in up and down markets. I think that would be a really interesting area for future research, is of the instruments that are in our sample is options instruments, where you'd see those cover call strategies most sensitive to that asymmetry in the up and down markets?
Ben Felix: We referenced this paper when we did covered calls. That's kind of how we ended up here. And you did group, I think, option selling income-related strategies specifically in your paper. How did they perform in your sample?
Paul Calluzzo: Yeah. So I'll preface this that this analysis was in a sub-sample because the data availability was just – whereas the rest of our samples covering a really long time period. Or I shouldn't say really long. There are some papers that covered 1927 or even 1800 to present. It covers a longer time period than the Almazan et al. paper. But we only had data on individual option use from, I think, 2009 through the end of our sample in 2015. It's a smaller sample that's also sensitive to some matching issues.
It's really a sub-sample. But within this sub-sample we do find results that are consistent with the rest of our results, which is always a good sign. It's kind of like a bit of an out-of-sample test. And then, we also find results that are consistent sort of with the underperformance of covered calls.
We split basically option strategies into three subgroups, which is one would be head strategies, which would kind of be like owning a stock and buying a put. What would be unhedged strategy, which would be like buying a put or call without owning the stock? And then the third would be something like a covered call, which is buying the stock and selling the call, right?
And what we find is that covered calls, kind of consistent with what's been discussed, is covered calls underperform. And what's really interesting, and this kind of validates our use of the MPPM measure, is that we don't see the underperformance in the four-factor alpha. We only see it in the MPPM measure. So that we interpret that as evidence of if you're looking at the wrong measure of performance, it might look like this isn't so bad. But once you properly adjust for the risk that you're being exposed for, it isn't benefiting the investor.
Again, I would just preface that with it is a shorter sample. The same concerns we had about Almazan et al.'s paper only being a six-year sample. You could also argue those concerns relate to that. Maybe in years in the future, there will be a replication of this table or in a future research in this table.
And that's actually one thing that my co-authors and I are excited about, is I think in 2019, the SEC created a new regulation to better disclose the complex instrument positions of funds. That's something that we're looking at of what else can we study in this space using the new form that mutual funds are required to fill out.
But I think one other interesting thing about sort of that analysis that we did was that the unhedged strategies, so just kind of the speculative positions were actually the least detrimental to the investors.
We sort of didn't see outperformance. But we didn't see underperformance there. I mean this is only specific to option strategies. Not the broader use of all complex instruments. But the most negative performance was on the covered income strategies, which covered calls would be part of. And then the hedge strategies, which would be consistent with portfolio insurance being expensive. Sort of that makes sense.
And one other interesting thing that we saw is that when they actually use these, again, specific to the option strategies, they're actually lowering their standard deviations of their total risks. Both, really, we see it across the board. We see that they have lower total standard deviation of the fund returns, lower beta exposure. And at least for the head strategies, we see lower idiosyncratic risk too, which makes sense if they're hedging, right? That you're cutting away some of the addressing product volatility.
Cameron Passmore: Paul, what do you think is the main takeaway for investors hoping to get superior performance from funds employing these complex products?
Paul Calluzzo: I think the main piece is buyer beware. That at least over our sample period – and we've also extended our analysis to go back to basically when this information is first available. We have an analysis in the paper that also includes Almazan sample period, which we don't include in our main analysis because of issues with the data not far back. But we see that there is a negative relationship between these complex instruments and performance, which is not good for investors.
And then there's also a very negative relationship in really bad market periods. And we know that that's when it hurts the most, right? Ideally, we want portfolios that hedge those really bad market periods. And if a strategy is giving us really negative returns in the worst times, that should be a strategy that’s outperforming. Because you want to be compensated for that risk. And we actually find the opposite for that.
I think that the main takeaway is sort of being cautious. Don't go and to invest in these lightly. And I think just as a general advice, given the results of the paper, if it was – a lot of times as a finance – I'm sure that this happens with your social networks as well. But people just ask for casual investment advice. My usual investment advice is index funds—certainly not these complex instruments.
If my father, who I love dearly, came to me and said, "Hey, Paul, check out this new fund I'm investing in." And it's one of these funds I would try to get my brothers and I to talk about it, right?
But I do think that there was recently DFA came out with a paper that looked at liquid alternatives that, in many ways, was similar to our paper. Showing the underperformance of liquid alternatives over – I don't know if it was a 20-year sample. And what I think they looked at was market neutral strategies, long-short strategies and managed future strategies. That would be a sub-sample of the type of funds that we're looking at. And they basically showed very similar results to us that they underperformed, I want to, say, like the stock market 60-40 type portfolio over the past 20 years.
And Cliff Asness, who I have tremendous respect for him, and both the researchers and practitioners at AQR basically took offense to the paper because they run a lot of those strategies. And they basically said something along the lines – and of course, I'm paraphrasing here but "Just because –" and I think this applies to our paper too, "Just because, on average, the effect was bad, doesn't mean that there could also be some good players there."
And our paper doesn't really address are there ways beforehand to predict who the good players might be. And I don't even know – I don't know for sure that that's possible. But I think there could still be the possibility that maybe there's funds that have low fees or have a good track record of keeping transaction costs down or have a very systematic strategy that takes out emotion. Maybe those strategies won't underperform and just give investors – just like an index fund give investors access to just passive risk exposures. I think that's just the one caveat you are finding that I would put down. That I don't think it should be necessarily a criticism of the entire industry. And there could still be good and bad apples in the industry.
Ben Felix: Interesting. But maybe not as straightforward as the advice to buy index funds.
Paul Calluzzo: Yeah. Yeah. No. That's definitely – there's a long line of academics, some of the great ones that have appeared on your podcast, that would give that same advice. That I think getting passive, low-cost, diversified exposure to markets is going to be your best bet for the long term.
And especially, I think a really important aspect of investing is being able to stick to your strategies. And it's – I mean when you're investing in black boxes, it's going to be really hard to stick to those strategies.
Cameron Passmore: So I got to ask, like, you've got these findings. You mentioned DFA had a paper with similar findings. Why do you think that we're seeing complex products grow when they don't seem to be performing that well?
Paul Calluzzo: I mean, I think the hopeful academic in me would say that – and I have a paper that shows that after the publication of academic research, market participants change their behaviour. This is in the context of investing in stock market anomalies. But I would argue that one contribution of our paper is that there was this paper that was very well cited from 2004 that said complex instruments aren't necessarily bad, especially if they use at well-governed firms.
And I would say that, well, now we have new evidence. And maybe this new evidence will change investors’ priors. Like the CFA covered our paper – the CFA Digest, I want to say, covered our paper. I think that a public forum like this podcast will also sort of get the word out to investors, and I think could potentially lead to less allowance or less fund flows going to those funds that grant allowance.
Ben Felix: So the other paper that you're talking about, I think that paper is fascinating also. But wasn't it the hedge funds that were most responsive to the research in that paper?
Paul Calluzzo: It was. I guess – I would say this, is maybe the academic channel isn't the best way for retail investors to your academic publication. But there's other ways to disseminate information. I think the podcast's gear towards retail investors is one way to disseminate that information.
I think another thing that would be interesting area future research is we see an increase in allowance. But we don't see an increase in use. The proportion – I guess one question that a lot of papers look at, and I think that it would be interesting in this paper, is to what extent has the impact of allowance on fund returns varied over time.
Maybe there's been more allowance granted but not a concurrent increase in use. Maybe it's been that less people that have been allowed to use it have actually been using it. So that, kind of at a per-fund basis, there's more funds that are insulated maybe a bit from our results. But I think the concern is always if you have that temptation of being able to use it, maybe when there could be spillover effects or indirect effects that could still cause harm.
Also, just that the SEC creating this greater disclosure should also bring attention to it. It's not something that like the SEC is oblivious to that. In 2019 they completely revamped the disclosure requirements of funds using complex instruments. So that could also maybe shine a spotlight on it.
I think that, generally, again, there's nuance to almost every result in finance. But generally, more transparency is a good thing. So shining a spotlight on it. Bringing transparency to the use of these instruments maybe also improves. I think that that's another audience for these sorts of research.
Like we always think about other academics. I mean, ultimately, we want our research have impacts on the marketplace. And one way to do that by encouraging other researchers to look through it. One way to do that is by encouraging market participants. But also through the regulatory channel. I think that this research can help guide regulators as they're forming their rules around the complex instrument use and allowance.
Ben Felix: Awesome. That was super interesting. It's a really interesting paper. And I think you did a really nice job explaining it. Thanks a lot for joining us on the podcast, Paul.
Paul Calluzzo: Yeah. No. Thanks for having me.
Ben Felix: All right. As promised, that was a fantastic conversation with Professor Paul Calluzzo. Who knows? Maybe we'll have them background in the future to discuss some of the other research.
Cameron Passmore: Oh, I think he'd love to come back on. It'd be great to have him on. I love relationships like that. So much fun.
Ben Felix: Yeah.
Cameron Passmore: All right. Well, before we get to our conversation with Sean, let's do a quick recap of a past episode. For people who are more recent listeners that haven't gone back through time, we just try to highlight past episodes that might be of interest to you.
This one features Rob Carrick, who is our guest on episode 39 back in 2019. Rob's been writing about Canadian personal finance for over 30 years. And we discussed a whole wide range of topics.
What is really cool about Rob is that his incredible feedback loop from as many Canadian followers on all sorts of financial topics. His most important observation is that he thinks people have too much information and need help distilling it all.
His career started in the mutual fund days in the 90s and has seen a huge shift to ETFs, which is one of the most talked about topics from his readers. In fact, he said he could write about them constantly. He agreed with us that trashing mutual funds is unwarranted as it became an equivalency for active management.
He now talks about changing from being an advice skeptic to an advice booster. Near the end, we got his advice on teaching kids about money and instilling good habits. This then led to his thoughts on the fire movement. Check out the whole episode of Rob Carrick, episode 39.
All right. Let's go to book review of the week, which leads to our movie review of the week. I think it's our first movie review. Right, Ben? Part of the formal –
Ben Felix: Yeah. I think so.
Cameron Passmore: Anyway. This is the book that you and I have had on our bookshelf since it was written back in 2015. I think we both saw a presentation back then from Sean. And we both read the book called Losing the Signal: The Spectacular Rise and Fall of BlackBerry.
Many listeners for sure had that incredible rush. And I remember it. It's funny, I took a train to Toronto this week, which we can talk about later. But I remember being on the train going to Montreal with my BlackBerry. I remember unpacking the box on the train. And all of a sudden it started working. I was just blown away that you could get email on this little device. It was an unreal experience. It was just such a rush to not have to be at your desk.
And the power of that, which is incredible. It was mind-blowing. And you could see how successful, whoever came up with that idea, could be in growing a business. That's exactly what happened with BlackBerry. Everybody had to have these tools that time. And then, you could sync it with your calendar and your contacts. It was simply incredible.
I remember when 9/11 happened, and the BlackBerry worked. I remember when Obama was elected. And think the article talked about – at the time, he was arguably addicted to the BlackBerry. He could never let it go. And I remember, talk radio here in town, they used to have a market – some stock market show, and they talked about BlackBerry it seemed like every week as I listened to the show. It was the hot stock in Canada. Perhaps worldwide.
Everyone owned it. Everyone talked about it. It was an unreal time until it wasn't. The whole thing just blew up in unbelievably spectacular fashion. And that's the story in this incredible book called Losing the Signal, which is written by Sean Silcoff and Jacquie McNish.
Again, it was released in 2015. It's just a fascinating story of how these two guys, Mike Lazaridis and Jim Balsillie, came together to create and market and go to market with this unreal idea and product. And then how it all fell apart, caused by competition. The likes of Apple, to wireless carriers' impact, the App Store impact. It's just a wild, wild story about this company.
We invited Sean to talk about this whole time, his book and then also about the movie, which comes out on May 12th. Sean writes about technology and innovation for The Globe and Mail and has won three national newspaper awards.
So with that, let's go to our conversation with Sean Silcoff.
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Cameron Passmore: Sean Silcoff, welcome to the Rational Reminder podcast.
Sean Silcoff: Thanks for having me, Cameron.
Cameron Passmore: Congratulations on your book and then on the movie that's coming up very shortly.
Sean Silcoff: Thanks. It's kind of surreal.
Cameron Passmore: It must be. And I reread the book last week, as I mentioned to you, and loved it the first time and loved it the second time. And so looking forward to the movie. First, let's kick it off. How revolutionary was the BlackBerry phone?
Sean Silcoff: For a very long time before the BlackBerry came along, people were trying to figure out how to send data wirelessly. It had been talked about for many years. The first email was sent wirelessly in the early 70s, believe it or not. The University of Hawaii allowing students and professors to communicate between the different campuses.
And so, this has been something on people's minds for a while. We had the advent of cell phones. They became commercialized in the 80s, 90s. Yet no one could really figure out how to transmit data effectively to wireless devices or even what the market use of that would be.
There were wireless data networks. And they were kind of empty in the 90s. I mean, it was mostly geared toward IBM or Rogers delivery trucks so that you could communicate to them while they were on the road.
And what passed as a wireless device was something probably about the size of a TV that would be bolted into a delivery truck so that you could communicate with the driver. And then the idea was better customer service. You could tell the customers, "Well, your repair person will be there on-site between nine and ten or as opposed to one and eight." And so, we had these vast empty networks. You didn't have great applications. There wasn't much of a user base.
And then along comes email in 1995. And suddenly, we're all using email, and we're inundated by email. It's everywhere. And the people at BlackBerry were working – the company Research In Motion, as it was called at the time, was working on things like modem cards and software. And what you would consider the on and off ramp and utilities of this otherwise empty data network. It was called Mobitex. And they got the idea that they wanted to put devices on this network.
And then, with email suddenly inundating everyone, the idea that why do we create a device that can send and receive wireless email? And so, they came up with this device. It was the right device at the right time for the right purpose. Suddenly, people – at the end of the day, if you are a travelling salesperson, you come back to your hotel. You log in. Dial-up, log in. That would take like 15 minutes. Remember how painful that was? And then suddenly, this torrent of email would come firing at you at nine o'clock. You're tired. You've been collecting business cards and delivering pitches all day. Now you have to respond to 150 emails.
The great thing about the BlackBerry is it enabled you to communicate for the first time ever. And you have to remember; this is like the creation of fire in the mobile communication space. You could suddenly respond to your emails when you're in a taxi, in a lineup at the airport, during a boring meeting. They pitched it the right way too. It was an efficiency tool. And they really engineered the device to be super easy. Not really easy. But fun to use.
Mike Lazaridis, the science co-CEO of the company, talked about removing think points. And that meant like make the device this as easy to use, simplest to use so you don't have to think when you're using it. It just works in the way you expect it to work and the way that you would want it to work. And their goal is to engineer something and experience so ideal that if you're sitting in front of your computer, you would prefer to type on the device than actually on your computer. And it worked. And then they got into the hands of the right people. They seated it very early on with Wall Street advisors, lawyers and investment bankers.
Well, when the Fortune 500 CEOs saw that, they're like, "What is that thing? Yeah, I want one too." And when the CEO is suddenly – like anyone in the early days had wireless emails, like the light went on, "Wow. I can respond to emails right away." And if you're a CEO or an advisor, you want people to respond back to you like in six seconds. And people were used to that
Back when we were all starting to use email, you might get to your email one or two days later. There was no real urgency. The BlackBerry brought urgency to email. And because it was in the hands of people who needed information to make decisions right away, it spread like a virus. Because if you were a CEO, you wanted all your direct reports to have a BlackBerry if you had one. And then they needed one so that all their direct reports could get the information as soon as possible. It stayed like a virus that way.
They employed a lot of fun, devious, sometimes interesting creative tactics, which of course, we go into in the book to make sure it got her to the right people to make sure that the chief information officers had no choice but to install the BlackBerry enterprise server in the heart of their operations. So it began to spread that way.
9/11 happens, and communications are down in Manhattan and in Washington. The only people who can communicate on devices in that traumatic time are people with BlackBerrys. One of the first things that happens after everything gets back to normal is everyone in the House of Representatives gets BlackBerrys.
So very quickly, it became adopted and sanctioned as the device of choice for very powerful people. And then they made a big push into consumer. They made the devices a little sexier. They added colour, music. They made them fun to use. They made them thinner so they looked more like phones. They added phone service.
I mean, you couldn't even make a call on a BlackBerry for the first three years. It was only when they moved from the wireless networks to the main telco network so they actually had to add voice.
And the first voice thing, it was like a plug-in. You had to plug it into the phone and stick it in your ear. It was very ungainly at first. They kind of backed into the smartphone phone part of that business.
Ben Felix: I didn't actually know that part. That's interesting. I guess I missed that in the book. You mentioned the right product at the right time. You mentioned the 9/11 story, which is funny to call that luck. But it was an event that pushed the device out to a lot of people based on necessity. That's kind of like product market fit, I guess? How important was the company's leadership as opposed to that just having the right product to its success?
Sean Silcoff: The leadership was important. Because, early on, they realized that the right thing to do was to do something economical and small but didn't use a lot of battery power. That didn't use a lot of the bandwidth of the network. They beat back all of Silicon Valley's best and brightest that we're trying to stick computers into handheld machines. That worked. And they became the wireless email standard, wireless device standard by just really using it for messaging. And you had other add-ons, calendar. But the main thing to use this for was messaging.
And so, they really sold this as a messaging device. And that was the payload. That was the killer app, and it worked. And so for years, they made very smart management decisions to not do a computer in a phone. And that worked. Others failed in their attempts to do that. And also to maintain their leadership and messaging. First with email and then of course, with BBM, which was the forerunner of WhatsApp and Signal and other popular instant wireless messaging apps.
They were doing all the right things. They were making the devices easier to use, more accessible. Making all the right choices. But the key decision that they didn't make well was when the Apple came on the scene.
BlackBerry were great innovators, and they were terrible followers. And their reaction to seeing the Apple was, first off, this is a computer and a phone. We've seen this movie before. It doesn’t, and well. It's going to suck up battery life. Your battery's going to last a few hours. And that's it.
It's going to hog the network because you're putting through a lot of data. Because BlackBerrys were built to do email and messaging. And Apple is about browsing the internet. And that was a data-heavy endeavour. It's not very secure. And typing on glass kind of sucks. That was BlackBerry's reaction. So they didn't think they needed to have a reaction at first.
Whereas Google, which was planning a keyboard phone like BlackBerry, took one look at the iPhone when they saw it in early 2007 when it was announced, and they tore up their plans for a keyboard phone and said, "Okay. We have to go all-in on a touch screen." And that's what led to the Android operating system.
BlackBerry were great innovators, terrible followers. When Verizon, which didn't get the Apple for the first few years, wanted an iPhone killer, BlackBerry said we can do it. It was a big contract for BlackBerry. And what they thought would work as a touch screen is basically a BlackBerry in touch screen form. So it didn't have the rich software of the iPhone. It didn't have the capacity for an App Store. Now, there wasn't an app store yet for Apple. That came a year later.
And they thought they could just take the existing operating system, which was perfectly suited to messaging and stick it in a new type of device that was a touch screen. But their version of a touch screen was a physical screen. The entire screen floated on top of the device. It was called the Storm. And you'd have to, like push down on the screen, and the entire thing would go down. It'd be like you were pressing a giant button, and it would make a clicking sound. And they thought that would work.
And the problem was they had too few months to put this together. It was a brand-new type of machine for them. They had to redo the software. There's a lot that could go wrong. And a lot did go wrong. The devices were buggy, and they were clunky.
People, once they worked on a touch screen, with this nice screen that you would do that with, that was the new paradigm. It was like they were dealing with old, dead technology. It felt mechanical. And also, it wasn't delivering the kind of experience that Apple was delivering in terms of that full internet experience. The Storm was a disaster.
Verizon sent back the first million devices that they got from BlackBerry because they were buggy and people didn't like them. And what did BlackBerry do at this point? They made a key management decision. They didn't say we have to now go all-in on a touch screen.
First, they tried to perfect the problems in the Storm. Perfect the flawed product with a Storm II. And they were even working in the Storm III when the telco said, "Hey, guys, can it with this fake touch screen. Give us a real touch screen."
So then they figured the problem was they needed to get a browser. So they bought a browser company. And things ran slow. Finally, they realized, "Okay, we need to build a full touchscreen device from the beginning." And they encountered some indecision about what to do. How to do that?
So by the time they came up with the BB10, which was their full touch screen complete competitor to Apple and Android, it was six years later. And in tech, six years is forever. You don't have six years to come up with a competitive response. And the App Store was also really destabilizing for them.
Because in a world before Apple came along, the carriers ruled everything. BlackBerry was fine with that. They didn't even want you to have an app store. The carriers were very controlling. And that's the way the world seemed to be for BlackBerry. These were the gods of the business.
Suddenly, Apple comes along and AT&T gives them carte blanche to come and go on their network with all this extra data to crash the network. And then a year later, they let them open up an app store.
Well, in the old world before Apple, Nokia tried to do an app store, and they were punished for that. BlackBerry, to get BBM out to the phones, they had to do it around the backs of the carriers and sneak it into a software update or browsers. We had to sneak it onto the network. That's the 2004 and 2005 reality.
By 2008, 2009 the telecoms are going, "Yeah, you want an app store? Sure." Remember that Google and Apple had spent years developing very robust software, a great ecosystem. They had a lot of developers. They had a ready-made set of developers ready to walk in on day one and develop great apps. BlackBerry didn't have that because they never had to have an app store because their operating system was perfectly fine for the realities of the telcos. The telco is blinking and giving Apple carte blanche really pulled out the rug from under BlackBerry in an unexpected way.
I'm just trying to answer your question by pointing out that they needed to act very quickly. But they were also dealt a tough hand. And it's hard to imagine in some ways how they might have overcome that.
Here's one of the most challenging disruptions to BlackBerry. When Android came out with this device, Verizon, which had been very tough on App Stores just three-four years earlier, said, "Yep, you could have an app store."
Boom. They have an instant app store. And then what Android does is very sneaky. Their 30% cut of app sales they gave that to the carriers. They didn't need it. They just wanted to get search and Google services onto every phone. It's basically saying to the carriers, "Here, you sell our devices; here's some free money. What would you like to do with this free money?" What do you think the carriers did? They stopped selling BlackBerry, and they started pushing Android devices.
And then, on top of all this, BlackBerry, for years, have been ordered on mass by corporations issued to their staff. After the 2008-2009 recession, companies were looking to cut money. They cut costs. So they say to people, "You know what? The devices you use at home, you can bring them in. We'll add them to the network." Bring your own device was devastating for BlackBerry. Because on the weekends and at nights people weren't using BlackBerrys for fun. They were using Apples and Androids.
All these things add up. And it's really, really hard for management to deal with that. You could argue that the moment the iPhone appeared, BlackBerry had to do everything right and they had to do it fast. They did everything wrong and they took two.
Another answer to your question is you had two CEOs, two co-CEOs. You had the business leader, Jim Balsillie. And you had the technical leader, Mike Lazaridis. The idea was Mike was left to run the engineering science side of the business. Jim was left to run the business part of the business. They trusted each other. That was great.
That kind of arrangement works really well until it doesn't work at all. We saw a couple of tension points. And that, Jim, because he wasn't a technical person, trusted Mike and maybe didn't lend as much of a critical voice to some of the technical decisions that were being made at critical times.
And then Jim, on the business side, they were doing a lot of stock options backdating. You might recall in the early 2000s, 1999 era; stocks were extremely volatile for tech companies. Your stock could be worth $30 dollars one day and 100 the next day, and then 40 the day after.
If you're issuing stock options to bring on employees, how the heck are you supposed to value that when one day you're making a million and the next day you're making a popper? You want to retain all these people.
What BlackBerry would do, which a lot of tech companies were doing at the time, was they were backdating options. Picking a date in the past after the date someone's hired and picking the right stock price to sort of basically maximize the gains that they could get.
Well, that worked fine for years until the Securities and Exchange Commission came along. And because BlackBerry was an email company and because there was all this, frankly, a record back and forth about all the conversations internally about who would get options. They were kind of made the poster child of this problem, and they got penalized.
And during the very harrowing meetings with SEC and with regulators, Mike Lazaridis didn't know what this was. His signature was there but he trusted all this to Jim. And he didn't want to go to jail. He didn't want to lose his company. He cut a deal for more lenient treatment with the regulators. And Jim felt betrayed by that because he felt like these two had led the business shoulder-to-shoulder for years. Jim had helped deal with some of Mike's mistakes. And now, Mike was sort of throwing him under the bus. That kind of ruined their relationship at the worst possible time, as everything is starting to come off with Apple.
Ben Felix: Unreal. That part of the book, all of that, their response to Apple and all the little details in there, like I think that there's one quote. I don't remember it verbatim. But from Jim about being asked about the iPhone, and he kind of brushes it off, saying, "I haven't seen one," or something like that? That whole part of the book is just like, oh, it's almost hard to read. But it's incredible. Absolutely incredible.
Sean Silcoff: Jim was always selling. He was selling what he had. And he was always a loyal soldier to the company. Even when he was saying things like that, it was mostly bravado. But internally, he was struggling. He had what he called the Strategic confusion. He didn't know how to handle all these issues. Like how do you build an app store when you're not built to build an app store? Do you start over with software? There was a lot going on, and the answers weren't obvious.
Cameron Passmore: How impactful were the company's internal struggles to the decline?
Ben Felix: Pretty significant. Now you have to remember this was a hardware company and not a software company. Their sales at points were going up 25% quarter-to-quarter. And it's easy enough with software to scale up. But when you're stamping out metal and plastic, and you need to increase your capacity, you're trying to secure manufacturing around the world. They ran into some serious quality issues. Things were falling off. The machines, they weren't working well. And this was also happening at the time. And I think that helped to create part of the schism.
I mean, Jim and Mike not getting along was a big part. But then you had the sales organization and the machine building part of the organization that also weren't getting along because they were pointing fingers at each other. And the problems weren't really getting solved.
They also had a COO, a tough guy named Larry Conley. He'd come from Motorola. Very tough performance culture when he was growing up there. And he really made the trains run at the time at BlackBerry. And he got everything in line. He got production schedules. He built forecasts. All the kinds of things that were lacking at BlackBerry. He left in 2009. Just the worst time for the company. And so, things got a little lax and a little off the rails once he left.
Ben Felix: What effect do you think Canada's so-called "tall poppy syndrome" had on the company?
Sean Silcoff: I don't think it had much impact at all. I think the one thing actually is that they were very proudly based in Waterloo. When a big company from New York, or LA, or San Francisco would call up Waterloo, call up Jim and say, "Oh, we'd love to meet with you." Jim would say, "Great. Once you get up to Waterloo, come on the next plane. We're not going to leave Little Waterloo to come to the big city. If you want us, you come to us."
And I think growing up in Waterloo, they became very successful. But they lacked a bit of the Silicon Valley creative destruction element in their DNA I think. And I think it would have helped BlackBerry RIM, research in motion, to have an office and have some serious brain trust in Silicon Valley that was a bit more tuned in with the trends that could bring a bit more of that terror. The terror of being overtaken and overwhelmed back to Waterloo.
I think the fact that they did this, that they created the wireless communications business and they did it from Canada, was an enormous point of pride. And I think a certain sense of self-satisfaction probably crept in, particularly on the engineering side, on Mike's side. I think they were always looking over their shoulders. But the "only the paranoid survive" line that's famous, I think they needed a little bit more of that.
I think that was part of it. But it's hard. Like what do you do when the iPhone comes along? And it looks a lot like the types of devices you were seeing seven or eight years earlier that you had defeated. Who's to know this isn't just another one that's heading to…?
I mean, a lot of tech companies, big ones, have had failed products. Google has had tons of them. Maybe this is just going to be another one. And they felt, "Well, we kind of nailed messaging. People love messaging, and it's great."
What they didn't anticipate is that people would fall in love with internet in your palm as much as they did. And didn't foresee how much of the economy would be created and moved onto our handheld devices.
And it's extraordinary now if you think about it. We order Ubers. We order all our food online. Whole giant, multi-tens of billions of dollar-valued businesses were created based on the thing you hold in your hand now that were not possible 10 or 15 years ago. We do so much on these devices. And that just was not something that BlackBerry could have anticipated but that Apple did.
I mean, a lot was happening on BlackBerry devices. Don't get me wrong. But Steve Jobs could see this was where the puck was going. And he said that which was kind of a clever dig at Research In Motion when he introduced this. He pulled out our Wayne Gretzky quote with a Canadian smartphone company up there prominently featured on his slides at the big release in January 2007.
Cameron Passmore: What do you think makes this story so compelling to be told in a movie?
Ben Felix: First of all, it's a rise in a fall. It's about an innovator. This is at a time, remember, where we are seeing a lot of business narratives reaching the big screen and the small screen. Social Network. The Founder on Ray Kroc from McDonald's. You've got… story from the Bad Blood book. Even the Tetris movie.
This is an era where we are appreciating the character of the entrepreneur, the tech entrepreneur. This is a great insignificant character in the 21st-century world we live in. I'm surprised we don't have an Elon Musk movie yet. But I'm sure we will. People are really drawn to and intrigued by these characters and their flaws, the companies they build, the people that they are. There's a lot of drama here. This story has lots of classic dramatic elements in it.
And remember, it's a rise in a fall. That's a classic narrative arc. It's about two people who couldn't be more different who come together and then break apart over an issue that we first brought to light in our book, Losing the Signal. And it's about a technology that changed the world. Really, it's changed the way we live. Those are extraordinary elements.
In the hands of these filmmakers, they turn into a really intriguing movie. It's fast. It's fun. It's edgy. It sort of takes you into the pit of innovation and what it takes to build a company and some of the sacrifices that are made along the way. The fact that it's not just one person but two people and the tensions of that relationship creates. And also how hard it is to keep up with the drumbeat of disruptive destabilizing innovation. It's really well rendered.
It's obviously different than the book. We had 250 pages to tell a definitive story for the first time, really. Because people did not know the BlackBerry story at all, and they have two hours to keep you in your seats entertained, munching on popcorn with our book and their movie. I think we each did a great job.
And the great thing about an adaptation is a typical adaptation, and this is no different, the play run with dates, the play around with names. They'll create composite characters. They'll move some facts around. And in fact, the filmmaker is even very interesting. Say, this is a fictionalization, which just gives them a bit more creative license to tell the story they want. Although, it's very faithful to a lot of the key narrative elements that define the story up to the beginning of the painful fall.
And so, I liken it to The Sound of Music or Hamilton. I don't know if you've seen the show Hamilton. But it's about the life of Alexander Hamilton. It's one of the best musicals ever made. It's based on a book that's like this big, which is probably one of the best historical biographies ever written about anyone or an American, certainly an American founding father.
Musical is not a definitive history. But the book is a terrible musical. You read that book, and you're like, "How could anyone make a musical out of this?" And so, it's interesting. It's a real artistic process to adapt a piece of work for a different medium and then to try to speak the language of that medium and communicate in the way that that medium is meant to do. It's a very interesting process to see that.
I read Hamilton, the book, and I watched the show, and I felt like I had a greater richer understanding of the character. Both the way they evoked him on stage and the way he's represented on the page. And I hope people will have that same experience both reading our book and seeing the movie.
Ben Felix: You mentioned that in your book, you kind of told the story for the first time. If you distill it down, what do you think, at least from your perspective, are the main lessons for business leaders from this story?
Sean Silcoff: Never take for granted the industry contours that you operate in. Don't think that the people you're competing against now are the people you're going to be competing with in the future. Technology software is disrupting everything. Your competitor might be Apple even though Apple has nothing to do with your business. Your competitor might be Google.
The monetization and creation of thin air of data means that your business model might be entirely different because there's new ways of making money off of what you do. Photography was upended by math. Think about that. Photography became a math and a computing problem. Who would have ever thought that the camera makers would be competing against software companies? Or that everyone would become a photographer but on handheld devices with the bare minimum photographic capabilities of a proper camera?
Don't take for granted the things that seem etched in stone. Like with BlackBerry, they have these monolithic giant, rich, powerful carriers. And how the carriers defined the world was what they lived in. But what if the telcos get disrupted or if they get disintermediated? It's a new, new game.
And so, you always have to be mindful of not only the existing competitors but the unseen competitors. And don't take for granted the four walls around you, and the ground underneath you will always be there. And if it starts to shake or tremor, you have to start to think, "Okay, what's our contingency plan?"
So I think every company needs forward-thinking people who are a little bit paranoid and who question all the assumptions and can push back and live in the world of the what if.
Now that doesn't mean you should chase every single innovation, every single change. That's the hard part. Some of these things are just murmurs. It's like Clubhouse. Remember Clubhouse? It came out a couple of years ago. And everyone was using Clubhouse for like three months. And this was going to be the new way of things. And now, what's Clubhouse? People can't even talk. It's now a joke. It's like MySpace.
Social network. I mean, MySpace was a failure. Facebook is huge. But who's to say Facebook is going to be something that our kids all want to use? They don't. So what's going to happen is we get older? Or Google. Look at Google. Google became the all-powerful advertising and search engine. And now we have ChatGPT, and everyone's saying, "Well, what's going to happen to Google?"
OpenAI comes out with ChatGPT, and overnight, companies that are in the business of providing student aides, whether it's textbooks or whatnot, are suddenly vulnerable. Because now you've got all this great information at your fingertips. So there's lots of destabilizing forces out there. And everyone needs to be paranoid in business all the time, I think. More so than ever.
Cameron Passmore: Similar to Ben's question, Sean, what are the lessons for investors?
Sean Silcoff: Buckle up. Read up. Inform yourself. Read religiously all the news. Find new news sources. Read up on AI. Question what you're invested in now and how the business dynamics of that could change.
Oil and gas is an interesting one. If you go back 30, 40, 50 years, who thought that the oil and gas business would be going through this crossroads they're at now? Where the oil and gas business will probably be a great place for investors for the next couple of decades still.
That's an example of a business that's being disrupted. But what's the pace of disruption? And it's for the betterment of the planet, frankly. But if you're an investor with a 10-year horizon, maybe oil and gas investments are the best things out there. I just take that as an example purely hypothetically. You need to arm yourself with more knowledge and question your own assumptions.
Everyone thinks the banks are rock solid. But it turns out that the business of banks is not loans or savings accounts. It's confidence. And when the confidence goes away, like what happened with Silicon Valley Bank, you don't have a bank anymore. It just goes away overnight quickly.
Or commercial real estate. That's been a bedrock investment. I actually worry for all the pension funds because they own so much commercial real estate. And here we all are, working from home. Those office buildings are probably going to be devalued. They're going to be worthless. I don't think it's happened yet. I think it's just starting to happen.
How are our cities going to change? Everyone has to arm up a little bit and do their research and ask the tough questions and try to navigate this. I don't think there's a silver bullet and obvious answer. But I think we just need to be mindful.
And like anyone who's an investor asks, what are the areas that are oversold? Where are the opportunities people don't see yet? And a managed account would have a portfolio. You place a few bets here and there. You don't put everything on one stock. You'd put maybe a bit in real estate, a bit in energy, a bit in technology and so on and so forth. And then within those portfolios, you would carve it out a little bit more, early stage, later stage and so on and so forth.
Although, here's a question for you. How's ETF management going to change? Do we continue to rely on the algorithms and the programs that have worked marvellously well for decades? Or do you think that that's going to require some tweaking if indeed, the world is being disrupted to such a degree?
Ben Felix: I'll give you my interpretation of the investor takeaways after reading your book, which I think answers your question about ETFs. The big thing for me reading it was idiosyncratic risk. I mean, look at RIM. It's just this fantastic company. And like you just articulated, it continued to be a fantastic company. But Apple just basically blew them up. And we could argue maybe they could have responded differently. I don't know. But wasn't obvious. And it wouldn't have been obvious to investors either.
Idiosyncratic risk matters, and it shows up with an individual company, not even necessarily an individual sector. And then, as you just mentioned, diversification is one of the ways to solve that.
When you look at the history of technological innovation with respect to investing in public markets, at least, the innovative sectors and companies tend to give terrible returns to investors. I mean, you look at railways versus software over the last – I don't know. 50, 75 years. Railways as an industry has declined significantly. Software has exploded. But railways outperform software historically.
I think by owning the whole market; when you own everything, when we talk about ETFs, we're typically referring to just owning the market. So when you own the market, you own the disruptive industries. You own the declining industries. The declining ones tend to outperform, which is super counterintuitive. But it's the way it tends to go. But then there will be superstar companies that come out, like Amazon or like Apple, within the disruptors.
But if you own everything, you own the declining industries; you own the disruptors, including the companies that happen to be the ones that go to the moon, you're in pretty good shape. I don't think that has changed with the current state of the world.
Sean Silcoff: Interesting.
Cameron Passmore: Well, congratulations again, Sean. Looking forward to the movie, which comes out tomorrow if you listen to this on the 11th when this show was released. Looking forward to that very much. Thanks for joining us.
Sean Silcoff: Yeah, thanks for having me on, guys. Really appreciate this.
***
Cameron Passmore: All right. Well, that's pretty cool, Ben, to have two guests one episode.
Ben Felix: Yeah. Lots of fun. Two really interesting conversations.
Cameron Passmore: Yes. It's great to have Sean join us. This is the after-show. I want to talk about you becoming more active and, I would say, a little more assertive on Twitter.
Ben Felix: I occasionally have inspiration to write Twitter threads. And I did a couple recently, and people seem to like them. Lots of fun.
Cameron Passmore: And I'm going to put a plug up for you. You put your Calendly link. Well, I did as well. But I'll plug yours. Calendly link in your Twitter profile. If someone wanted to take advantage of that, I'm just saying it's there to be taken advantage of.
Ben Felix: I don't know if I like the idea of being taken advantage of. But thank you for the plug.
Cameron Passmore: Take advantage of the opportunity to get a chance to talk to you. Anyways. You know what I learned this week? There's advisers in Canada who aren't allowed to recommend index funds by their company. Just blew me away.
Ben Felix: I mean, that's one way to solve the whole deferred sales charge issue. Like index funds never paid the back-end load DSC commissions, right? And now those are gone. So now you just outlaw index funds altogether. Got to find a way to keep money in the high-fee products somehow.
Cameron Passmore: Oh, interesting. Yeah.
Ben Felix: Right?
Cameron Passmore: Yeah. It's still incredible to me, given all the evidence.
Ben Felix: Yeah. That's a real problem.
Cameron Passmore: So I shared on Twitter today the Future Proof announced officially. We knew this. But it's been now officially announced that we're going to be doing a live recording at the Future Proof conference this fall. So any advisors that are considering going, I'd love to meet you and see you there. We're going to have our special guest. Hal Hershfield is going to join us in that live recording, which is pretty cool. Hal became a good friend of us in the show.
I mentioned the rail service earlier. I went to Toronto by train. I think I dropped you a note. I'm not going to do that again. This country desperately needs – I don't know if we can afford it. But we desperately need high-speed rail in the – especially the quarter between Quebec City and Windsor, I guess. But it's just so slow. And the train is just so old and clickety-clackity. And you can't work. You can't write. It just doesn't – in today's day and age, it's just not great. It was on time, though. I will say that. It was on time. I knew what I was getting into. This is a shame on me.
What do you make of the news that Robinhood is going to be going to 24-hour trading for some limited securities? Apparently, it's from 8 in the morning on Monday till 8 PM on Friday. You'll be able to trade starting Monday the 12th. Be able to trade more than 40 stocks and ETFs, including Apple and Tesla. This is an exciting upgrade apparently that allows you to take advantage of opportunities no matter what time of day they arise.
Ben Felix: I just can't wait for the research paper that comes out looking at the difference in returns between people who trade during normal hours and people who trade during off hours someone.
Cameron Passmore: Someone recommended the podcast GoodFellows to me this week, which I'd never heard of. Bad on me. Because this is a regular podcast, you listen to. But it's fantastic.
Ben Felix: It is.
Cameron Passmore: John Cochrane, Niall Ferguson and H.R. McMaster. It's really civilized. I love their debate. I love how they change each other's minds. They're not locked into their positions.
Ben Felix: Yep. That's a good podcast.
Cameron Passmore: So what's your other top podcast that you listen to?
Ben Felix: Silence.
Cameron Passmore: No other main ones you listen to?
Ben Felix: No.
Cameron Passmore: Wow. Not even like Lex Friedman?
Ben Felix: Nope.
Cameron Passmore: Conversations with Tyler?
Ben Felix: Sometimes.
Cameron Passmore: Okay. Sam Harris?
Ben Felix: Nope. Used to. But nope.
Cameron Passmore: Yeah, a lot I listen to a lot less. One of the things I've noticed is that I do a lot of podcast searching based on the topic or the speaker, which is interesting. Like I wanted to do some research this week on Craig Wortmann, a professor at Kellogg.
So I just looked up his name and he's on a lot of interesting podcasts and had very different conversations, different podcasts. That's kind of cool. I do that quite often.
Ben Felix: Oh, I do that for guests. If we have a guest coming up, then I'll go and find all of their past podcast appearances and listen to them.
Cameron Passmore: Yeah. But even if you're reading a book, right? You can go check out the author. I like doing that. I find I'm doing that more and more. Just kind of doing an N run on it.
Let's go through some of the recent reviews. You want to do the first one?
Ben Felix: Sure. John… from the United States says, "Great investing podcast. Highly recommended. Great guests being asked excellent questions. Well-researched deep dives on relevant investing questions and in-depth book reviews all backed by hosts who don't speak down to their audience." It's good.
"The number of times Ben and Cameron or one of their guests have raised and expanded upon a question I wasn't fully aware of is astounding. For example, the popular definitions of risk based on volatility never felt entirely satisfying. Listening to the rash reminder has improved my understanding of how to better define and quantify risk in a way no other source has." That's pretty cool.
"After following the podcast for a year and listening to many episodes on a wide range of topics, I have never once had the desire to skip one." It's a pretty good compliment.
Cameron Passmore: That's pretty cool. Thomas Warfield from the United States said, "Best personal finance pod around. Absolutely fantastic pod. They have a great deal of respect for their listeners, which I absolutely appreciate. This is by far the best personal finance pod I've ever listened to."
Ben Felix: I mean, the thing is – and maybe the Rational Reminder Community is an even more concentrated version of this. Although, I doubt that. Our listeners are really smart. I'm the dumb guy trying to learn from other people in the Rational Reminder Community. The people who listen to this podcast are – they're very smart. That is why we don't speak down to our audience and have a great deal of respect for our listeners and our guests definitely.
Ricard0CP from Canada says, "Great podcast. The content has had a profound impact on the way I approach personal investments and happiness. And the insights have encouraged me to think more critically about my own choices. Hosts never interrupt their guests and let them complete their ideas. I'm grateful for the time and energy you both put into creating such valuable content. Keep up the excellent work. And I look forward to continuing to learn more from your content."
Cameron Passmore: Very nice. It's been very nice. Had a couple people who kindly reach out to me on LinkedIn. Christine from Massachusetts said she just checked out the Pod and can't wait for the next episode. I can go back through 252 episodes, I guess, plus your crypto series. And then Jordan Toronto thinks it is excellent and finds it truly one of the most informative sources for financial information. I love hearing from people on LinkedIn.
I don't know about you, but I've had a couple people reach out lately offering like a service to source guests for us, which I kindly say this is something we enjoy doing ourselves. All of our guests we find ourselves. It's all homegrown energy that we do.
Ben Felix: Yeah. I get pitched sometimes too. But it's not a path that we plan on taking anytime soon.
Cameron Passmore: No. No. Reminder, meetups, Los Angeles, September 9th. Toronto, September 20th. And any follow-up on the Edmonton possibility?
Ben Felix: Well, Braden, I think is confirmed to be speaking at that conference. He'll be there. And I intend to go there also. But we have that overlap issue where we've got to be in Toronto for the first day of the Edmonton Conference. I've just got to decide if I want to, I guess, like fly to Toronto for five hours or something and then fly straight to Edmonton. Sounds kind of terrible. But probably will do that. Probably. Talking about my future self though. So we'll see how future Ben feels about that decision.
Cameron Passmore: That's so funny. All right. Anything else on your mind this week?
Ben Felix: No. No. It was really cool to have that whole cycle, I guess I could call it, with Paul, where I wanted to learn about covered calls. And I remembered that his paper had looked at that. Read back through the paper. Used it in our piece and then to be able to reach out to Paul and ask if he'd come on and having him review the notes on covered calls. That whole thing was just awesome.
I mean, that's one of the cool things about having this podcast, is that we have people like that that are in the community. They're willing to engage and willing to help. I think it's probably good for Paul to have his research talked about like that. I mean, he even talked about that when we were on that that's kind of the impact that he wants to have. I mean, that whole thing is just really personally rewarding. And I just think it's a really cool aspect of having this whole thing.
Cameron Passmore: Plus, you had a lot of engagement on that on Twitter. A lot of people reaching out and chatting about that.
Ben Felix: Yep. Yep. Covered calls is a big deal. Wait till I do the CSI video on that. People are going to be – apparently, covered calls is on the same level as dividends in some circles.
Cameron Passmore: Really?
Ben Felix: Oh, yeah. That's what I've been told.
Cameron Passmore: Wow. You're really going to be the skunk of that garden party.
Ben Felix: It sounds like it. Yeah, it sounds like. I did a Twitter thread on structured products. That was interesting. I wasn't expecting most people on there were agreeing. Like, yes, these things are generally garbage, which was my argument. Not that they're all garbage all the time and not that they're never useful. Just that, for the most part, retail investors are getting hosed in structured products. And I think we'll do a Rational Reminder episode on that in the future.
But the thing that surprised me is that there are a lot of people who were defending them and were dividend-level upset about the evidence. There were – I don't know how many papers. Eight papers maybe that looked at big samples of structured products and showed that, relative to the underlying payoffs, investors, retail investors are overpaying between 4% and 8% depending on the paper for the payoffs in these products. But then there are people coming in saying, "You don't know what you're talking about. Structure products are good."
Cameron Passmore: It's just the evidence.
Ben Felix: It's just the evidence. Yeah, anyway.
Cameron Passmore: Anything else?
Ben Felix: I think we're good. Awesome. Thanks, everybody, for joining us this week.
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Losing The Signal: The Spectacular Rise and Fall of BlackBerry Kindle Edition — https://amzn.to/3OaA5Wa
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Paul Calluzzo — https://smith.queensu.ca/faculty_and_research/faculty_list/calluzzo-paul.php
Sean Silcoff on LinkedIn — https://www.linkedin.com/in/sean-silcoff-777b0912
Sean Silcoff on Twitter — https://twitter.com/SeanSilcoff
'Complex Instruments Have Increased Risk and Reduced Performance at Mutual Funds' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2938146