A growing problem is that governments all over the world are interfering with markets as never before and these interventions distort the price signals, information and create bubbles

One of my readers was kind enough to ask a question as to why expert fund managers with an active team of analysts and traders underperformed their inactive benchmarks. The simple answer is information; how information is analysed and processed.

There is a growing problem with the global economy. Governments all over the world are interfering with the markets as never before. Normally, markets can correct by themselves as the equilibriums assert themselves and the markets return to their means. But government interventions distort the price signals, information and create bubbles. A good example is Brazil.

Brazil's macroeconomic management has been quite good over the past decade. It has been rewarded by an economy that is growing; but actions by Brazil itself, the US Federal Reserve and China have all combined to create a credit bubble. In Brazil, like China, the state-owned banks have increased lending to help Brazil avoid the recession. Banco do Brazil is the country's biggest financial firm, with a fifth of total assets, and National Bank for Economic and Social Development (BNDES) accounts for 40% of the lending. This amount of credit might have been beneficial, but the result of the Federal Reserve's quantitative easing allowed for a massive carry trade and foreign direct investment grew 90%.

The flood of money created a credit boom. Credit has grown enormously and is now as large as 45% of the economy. Brazilians have therefore been able to borrow money, many for the first time, to buy homes, motorcycles, refrigerators and other consumer goods. They now spend up to 20% of their income on debt. The torrent of money has also pushed up the value of the real.

But the Federal Reserve is not the only government involved. The Chinese have been pumping up their economy with a vast quantity of bank loans. The combination of speculation with free money and Chinese demand has created a spike in commodities. But since the Chinese have held their currency down, Brazil is now inundated with cheap Chinese goods that are harming its manufacturing sector.

The creation, length and effects of these different government policies are anyone's guess. Financial journals, magazines and television programmes are filled with pundits trying to predict government action. The analysts, traders and managers might be right about one government and make their investments based on that prediction. But the combination of erratic actions with variable interactions throughout the global economy means the probabilities of getting it right decline.

It is not just that governments interfere with the markets. Many are quite opaque about what they are doing. State-owned firms and sovereign wealth funds are equally silent as to their intentions. Disclosure is not required and in many emerging market, information is actively suppressed. This results in an ever-widening information gap.

Managers, traders, and analysts make this problem worse by assuming that the terabytes of information that assault them on an hourly basis have a basis in truth. Often they are anything but accurate, complete and timely. They are also making assumptions about the causes and motivations. Governments are supposed to act in the best interests of their citizens. Corporations are supposed to be making profits. More often governments are acting in the best interests of the party, and politicians in charge and state-owned firms are actively supporting political goals at the taxpayer's expense.

It is not only that the information and basic assumptions that are bad. The expert money managers compound the problem by putting their faith in numbers, equations and algorithms. The world is a dynamic place. If these formulas ever had a basis in reality, that basis may have changed drastically. Mathematical models in science can be an accurate approximation of reality if the data used to construct them is accurate. But scientific instruments used to collect the data do not intentionally lie for economic gain. People do. For example, Axa Rosenberg Group, a quantitative investment firm paid $242 million to settle allegations relating to an error in its computer model that lost millions. The error was introduced in the system in 2007, but the company's management only learned about it two years later, in 2009, and then took another year to tell people about it.

Managers are like everyone else, subject to cognitive biases. They are often very smart and exceptionally well paid. So they feel that they are right when they follow a herd, interpret information that confirms their beliefs, anchor their opinions on a few assumptions, underestimate their own biases, discount contrary information and remember their choices as better than they actually were.

As John Maynard Keynes pointed out, "The difficulty lies not so much in developing new ideas as in escaping from old ones." When expert managers understand themselves and their world better, they might do a better job hitting their benchmarks, but that might be too much to ask.  

(The writer is president of Emerging Market Strategies and can be contacted at [email protected]  or [email protected].)