From Ruffer's Head of Research, Andrew Van Biljon, June 24:
It’s easy to be overwhelmed by the volume of information aimed at us.
Inundated by a daily torrent of headlines, images, messages and data, we can be left feeling unable to process it to a satisfying degree. For investors, navigating information is central to being effective. Insights from information theory and gauge theory can help.
Fear of the dark is, at its core, a fear of the unknown.
It may have been a longing for the unknown that drove Sam Winston, an artist, to embrace darkness for weeks on end. First, he covered his studio windows with canvas and holed up for a few days with no outside communication. Later, he would spend a month in the dark in a cottage in the Lake District. Winston’s art from the sessions was a series of overlapping pencil scribbles and drawings: captivating in their effect, monochrome in their appearance. His mental experience, however, was vividly kaleidoscopic. Science has long recorded a heightening in the other senses when one or more becomes impaired. Brain plasticity, the boffins call it. It left Winston extremely sensitive to touch, smell, taste and hearing – and appreciative of just how much our faculties are dulled by the rush of modern life. Time became difficult to track. It would slip in a way that became impossible to shake – a parallel timeline moving at two-thirds speed.
After emerging from the darkness, Winston found himself pining for it again.
Could there be an addictiveness to the blackout, to the world of visions rather than vision?
The notion of unplugging has become popular in countless camping trips, silent retreats, and wilderness breaks. Frazzled urbanites seek to escape a constant barrage of news and social media. The issue is partly linked to the magnitude of information before us. Equally important, though, is information’s relevance, or ‘noisiness’. The vast majority of media washing over us daily are of no great use to us. The information has no direct impact on our lives. Nevertheless, we reflexively try to analyse, compartmentalise and digest it, struggling against the flowing tide. Exhausted, we wash up on the beach of forced withdrawal, only to wade back in once we have recovered.
Claude Shannon was a genius of the twentieth century, the sort of person whose intellect bridged multiple fields of inquiry. Today, he is best known for his work on information theory and his seminal work The Mathematical Theory of Communication,1 published in the late 1940s during his time working at Bell Labs in America. Shannon’s ideas touch us whenever we use a telephone or computer. His key insight was to change the conception of what information is and how it is transferred. He realised that, when thinking about the engineering behind communication, semantics were not so important, but the information content of a message was vital. Shannon showed that, when sending information over a ‘noisy’ channel (one that introduces errors) it is always possible to transmit virtually error-free, provided the rate of transmission doesn’t exceed the capacity of the channel.
Let’s bring that back to the befuddled Twitter user, looking at both the rate of transmission, and the noisiness of the channel. The rate of transmission (about two billion tweets a month from the top 10% of users2) is extremely high in the daily media flood. So too is the noise, as facts (are there still such things?) are ‘interpreted’ by any number of media outlets, politicians, and so on. Yet the channel capacity of our busy daily lives is rather restricted. Perhaps we should not therefore be surprised when the result is ineffectual information transmission with little to gain, other than elevated stress levels.
The trend in investment in recent years has definitively been towards the more information, the better.
The bridge to the world of finance is not a long one at this point.
Markets are distillers of information, representing clearing prices for securities given the current state of information. There are layers too. Information about a factory’s widget production affects the company’s revenue, which affects the share price, which conveys a kind of short-hand to investors. Noisiness has ready analogues as well, from uncertainty about the company’s operations, to varied and conflicting reports by analysts and the media, to volatility in the share price.
The share-price-as-a-signal is a primary way that finance borrows from information theory: return is weighed against risk (proxied by volatility) in determining which assets are most attractive. The relationship of assets to each other is brought in to create the mean-variance framework – a flawed but still dominant paradigm for investment analysis and decision making. Some of the flaws arise because return (especially prospectively) is a poor proxy for information and because the variance of returns is an insufficient description of the noise and true risk facing investments.
....MUCH MORE
