Christopher Joye reignites his $100 million housing challenge to Jeremy Grantham

Christopher Joye reignites his $100 million housing challenge to Jeremy Grantham
Christopher JoyeFebruary 28, 2012

Today I want to talk about our $100 million housing challenge to US fund manager Jeremy Grantham, and a new revolution in trading and risk management that is about to hit our financial markets. But first some background.

Regular readers will know that after years of research and development, Rismark designed the intellectual property that allowed it to introduce Australia’s first “hedonic”— or “quality-controlled” —house price indices with its strategic partner, RP Data, which is the nation’s largest real estate data company.

We also broke new territory by producing dependable “monthly” measures of house price movements (APM and the ABS report quarterly), and by publishing “seasonally adjusted” index numbers for the first time.

Finally, we extended our house price index coverage to include non-capital city, or “regional” markets, which while accounting for 40% of all dwellings by number, had historically been neglected by major index suppliers.

On every step of this complex journey we have consulted closely with, and often been guided by, academic, government and industry authorities, such as the RBA.

Today it is safe to say that despite a number of competitive alternatives, RP Data-Rismark’s index suite is recognized as the market leader.

There were two key reasons why we spent so much time and effort transforming Australia’s house price technology. And the first motivation led to us inevitably addressing the second.

Approximately 11 years ago I was in between jobs at Goldman Sachs and the RBA. At that time, most Australian house price indices were based on notoriously unreliable “medians”, and therefore problematically poor.

This would emerge several years later as a serious policy issue targeted by the RBA and Treasury for analytical remedy. That is, government economists pro-actively called for the development of new house price measurement tools.

Financial contracts tied to house price indices, otherwise known as derivatives, also did not exist. It was not until mid-2006 that the Chicago Mercantile Exchange would launch the world’s first house price index “futures” market based on the popular Case-Shiller indices.

This was also several years before I started working on my 380-page paper on housing policy for then prime minister John Howard. In that study, I noted, “while there are exceedingly sophisticated capital markets for corporate debt, equity, and exotic derivatives therein the same cannot be said for what is, in fact, a much larger asset category: owner-occupied housing”.

While wandering along the beach on a break one day in 2001 I asked myself why people couldn't hedge the biggest financial risk they faced (aside from a loss of labour income) – that is, the risk of a decline in the value of their largest asset holding, which was typically housing.

Having worked over 2000 and 2001 with Goldman Sachs and studied economics and finance at university, I was familiar with the functions of financial markets. But actively traded financial contracts tied to the $3 trillion housing asset class were not available. So I asked myself, Why not simply create futures (or derivatives) tied to a house price index to enable people to cost-effectively hedge the risk of house price rises or falls?

As I started looking into this, I discovered that the principal problem was with the prevailing house price proxies. They were far too infrequently reported, and far too inaccurate, to hope to convince investors to commit billions of dollars to exchange contracts valued, or “marked-to-market”, against them. The project would thus be put on hold until I helped found Rismark, with funding from Macquarie Bank.

A number of years later the RBA and Treasury would independently arrive at the same conclusion, but from the vantage of policymakers wanting superior information on housing risks (recall that Australia had experienced a stunning house price boom in the early 2000s that exercised the minds of regulators).

By combining a team of world-class PhDs with hundreds of millions of dollars of valuable housing data, RP Data and Rismark were able to ultimately solve the analytical problem. Using regression-based “hedonic” methods that carefully control for each property’s unique attributes – such as its location and land size, and its number of bedrooms, bathrooms, car spaces, and so on – we’ve been able to radically enhance the quality of estimates of monthly changes in capital values and rents.

It’s also well documented in the media that we’ve been actively working with regulators and exchanges to develop liquid financial markets based on our patented index technology. Due to various embargoes that will be shortly relaxed, I cannot say much more on this front other than to recommend you keep an eye out for the launch of several “global firsts” in the housing analytics space.

This brings me to GMO’s founder Jeremy Grantham, who has argued that Australia suffers from the mother of all housing bubbles. When he first aired these remarks in 2010, we at Rismark challenged him to put his money where his mouth was. Specifically, we offered to work with Grantham to help him to “short” – or bet against a fall in the value of – one of our national indices over the ensuing three-year period.

In order to do so, we would have to find a counterparty to take the other side of this transaction: i.e., some individual or institution that wanted to effectively go “long”, or lock in the future returns associated with our index.

One blogger recently claimed, incorrectly, that we intended to take the other side ourselves. Our original article demonstrates that this was not, in fact, the case:

“To be clear, Rismark would need to work proactively with Mr Grantham to construct this transaction. We believe we have counterparties that would likely be prepared to contract with him. But it may take several months to facilitate (and cannot be guaranteed).

“Before we can proceed, we require a firm, contractually binding commitment from Mr Grantham that should we be able to facilitate this transaction, he will indeed act on the advice that he’s offered to the rest of the world by committing a tiny fraction – less than 1% – of his capital to his predictions.”

How would Grantham have fared had he backed his own rhetoric? The indices that RP Data and Rismark produce for trading purposes are “total return” benchmarks, much like the ASX All Ordinaries Accumulation index, which tracks changes in capital values and dividends.

Since the end of October 2010, when we first outlined this idea, RP Data-Rismark’s capital city accumulation index has risen by about 0.2%.

So using this benchmark, which is the most likely index that a counterparty would wish to trade against (given they’d be expecting the capital gains and rental income realized from Aussie housing), Grantham would be down around $200,000. Call it evens.

If, on the other hand, he wanted to use the RP Data-Rismark index that follows changes in capital values, Grantham would be up about 5% assuming we could have found a counterparty willing to ignore incomes (or rents).

Of course, the proposed transaction was over a three-year horizon, so we are only 40% of the way through it. And given that a national house price index has annual volatility of 5% to 6%, we are still within the realms of what one might expect to see. Much like those analysts who predicted six RBA rate cuts to a 3.5% cash rate by June this year, it would be highly imprudent to bank profits that have yet to be crystallised.

It is certainly true that we devised this bet at a deliberately attractive juncture for the bearish Grantham. It followed the RBA slamming the housing market with a surprise double interest rate hike in November 2010, which we forecast could put downward pressure on house prices over 2011. And that is indeed what transpired with the help of some additional RBA jaw-boning.

The good news for Grantham is that this opportunity still exists. So while he did not have the courage of his convictions when we first proposed it in late 2010, he can still put the trade on today.

Following media coverage of our idea, Grantham did personally contact my brother-in-law about it, and GMO officials requested a meeting in Sydney. Independently, I also received some email enquiries from GMO’s head office in Boston. Curiously, when I actually met with GMO’s executives face-to-face they made it clear they did not personally subscribe to Grantham’s relatively extreme positions.

Nevertheless, in the event that Grantham still believes shorting Aussie housing is one of the best investments of all time, we would love to hear from him…

Christopher Joye is a leading financial economist and a director of Rismark International and Yellow Brick Road Funds Management. The above article is not investment advice.

 

Editor's Picks

Exclusive: Gardner Vaughan smashes Bokarina price record with Bask penthouse sale
First look: MADE Property doubles down in Kirribilli new apartment market
Spyre Group brings successful Queensland blueprint to Melbourne with Hampton Ltd
Saxon Street by Milieu to bring new housing and urban design to Brunswick’s cultural core
Construction begins at Fishermans Bend Innovation Precinct

Related Projects

16-22 Maud Street, Newstead QLD 4006
16-22 Maud Street, Newstead QLD 4006
16-22 Maud Street, Newstead QLD 4006
Price
Contact agent
35-37 Mount Street, Prahran VIC 3181
35-37 Mount Street, Prahran VIC 3181
35-37 Mount Street, Prahran VIC 3181
Price
Contact agent
118-124 Benelong Road, Cremorne NSW 2090
118-124 Benelong Road, Cremorne NSW 2090
118-124 Benelong Road, Cremorne NSW 2090
Price
Contact agent
118-120 Matthew Flinders Drive, Cooee Bay QLD 4703
118-120 Matthew Flinders Drive, Cooee Bay QLD 4703
118-120 Matthew Flinders Drive, Cooee Bay QLD 4703
Price
Contact agent
26-62 Kinross Road, Thornlands QLD 4164
26-62 Kinross Road, Thornlands QLD 4164
26-62 Kinross Road, Thornlands QLD 4164
Price
Contact agent
9-11 Baroonba Street, Whitebridge NSW 2290
9-11 Baroonba Street, Whitebridge NSW 2290
9-11 Baroonba Street, Whitebridge NSW 2290
Price
Contact agent
18 Ransley Street, Penrith NSW 2750
Perle, East Side Quarter, Penrith - 18 Ransley Street, Penrith
18 Ransley Street, Penrith NSW 2750
Price
Contact agent
Ernest Cavanagh Street, Gungahlin ACT 2912
Raya, Gungahlin - Ernest Cavanagh Street, Gungahlin
Ernest Cavanagh Street, Gungahlin ACT 2912
Price
Contact agent
39 Browning Street, South Brisbane QLD 4101
39-41 Browning Street, South Brisbane - 39 Browning Street, South Brisbane
39 Browning Street, South Brisbane QLD 4101
Price
Contact agent
675 Gardeners Road, Mascot NSW 2020
Kiara North, Mascot - 675 Gardeners Road, Mascot
675 Gardeners Road, Mascot NSW 2020
Price
Contact agent
187 Salvado Road, Jolimont WA 6014
Jolie, Jolimont - 187 Salvado Road, Jolimont
187 Salvado Road, Jolimont WA 6014
Price
Contact agent
47 Maning Avenue, Sandy Bay TAS 7005
Grace Residences - 47 Maning Avenue, Sandy Bay
47 Maning Avenue, Sandy Bay TAS 7005
Price
Contact agent
Cove Lane, Narooma NSW 2546
Cove, Narooma - Cove Lane, Narooma
Cove Lane, Narooma NSW 2546
Price
Contact agent
52-56 Ramsay Street, Five Dock NSW 2046
Ava, Five Dock - 52-56 Ramsay Street, Five Dock
52-56 Ramsay Street, Five Dock NSW 2046
Price
Contact agent
2375 Gold Coast Highway, Mermaid Beach QLD 4218
The Alfred - 2375 Gold Coast Highway, Mermaid Beach
2375 Gold Coast Highway, Mermaid Beach QLD 4218
Price
Contact agent
129-131 Russell Ave, Dolls Point NSW 2219
ALLURE COLLECTION - 129-131 Russell Ave, Dolls Point
129-131 Russell Ave, Dolls Point NSW 2219
Price
Contact agent
62 Constitution Avenue, Parkes ACT 2600
The Eastbourne on Commonwealth Park - 62 Constitution Avenue, Parkes
62 Constitution Avenue, Parkes ACT 2600
Price
Contact agent
155 Old Burleigh Road, Broadbeach QLD 4218
Sandpiper, Broadbeach - 155 Old Burleigh Road, Broadbeach
155 Old Burleigh Road, Broadbeach QLD 4218
Price
Contact agent
33 Vulture Street, West End QLD 4101
33 Vulture Street, West End QLD 4101
33 Vulture Street, West End QLD 4101
Price
Contact agent
19 Governor Terrace, Murarrie QLD 4172
Park Hill Village Collection, Murarrie - 19 Governor Terrace, Murarrie
19 Governor Terrace, Murarrie QLD 4172
Price
Contact agent
122 Marine Parade, Miami QLD 4220
Nalu, Miami - 122 Marine Parade, Miami
122 Marine Parade, Miami QLD 4220
Price
Contact agent
34 Jacaranda Place, Indooroopilly QLD 4068
34 Jacaranda Place, Indooroopilly QLD 4068
34 Jacaranda Place, Indooroopilly QLD 4068
Price
Contact agent
167 Old Burleigh Road, Broadbeach QLD 4218
167 Old Burleigh Road, Broadbeach QLD 4218
167 Old Burleigh Road, Broadbeach QLD 4218
Price
Contact agent
21 Queens Way, Yeerongpilly QLD 4105
Yeerongpilly Green - 21 Queens Way, Yeerongpilly
21 Queens Way, Yeerongpilly QLD 4105
Price
Contact agent
445-449 River St, Ballina NSW 2478
Solhaven - 445-449 River St, Ballina
445-449 River St, Ballina NSW 2478
Price
Contact agent
52 Sunset Boulevard, Surfers Paradise QLD 4217
52 Sunset Boulevard, Surfers Paradise QLD 4217
52 Sunset Boulevard, Surfers Paradise QLD 4217
Price
Contact agent
6 Jack Brabham Drive, Hurstville NSW
Horizon Hurstville - 6 Jack Brabham Drive, Hurstville
6 Jack Brabham Drive, Hurstville NSW
Price
Contact agent
49 Seena Drive, Edgeworth NSW 2285
49 Seena Drive, Edgeworth NSW 2285
49 Seena Drive, Edgeworth NSW 2285
Price
Contact agent
Lot 118 Ocean Steamers Road, Port Adelaide SA 5015
Lot 118 Ocean Steamers Road, Port Adelaide SA 5015
Lot 118 Ocean Steamers Road, Port Adelaide SA 5015
Price
Contact agent
203 Ashmore Road, Benowa QLD 4217
203 Ashmore Road, Benowa QLD 4217
203 Ashmore Road, Benowa QLD 4217
Price
Contact agent
774 Ripley Road, Ripley QLD 4306
774 Ripley Road, Ripley QLD 4306
774 Ripley Road, Ripley QLD 4306
Price
Contact agent
6 Homelea Court, Rivervale WA 6103
6 Homelea Court, Rivervale WA 6103
6 Homelea Court, Rivervale WA 6103
Price
Contact agent
7002 Ripley Road, Ripley QLD 4306
7002 Ripley Road, Ripley QLD 4306
7002 Ripley Road, Ripley QLD 4306
Price
Contact agent
3 Delos Way, Sorrento WA 6020
3 Delos Way, Sorrento WA 6020
3 Delos Way, Sorrento WA 6020
Price
Contact agent
77 Sutton Street, Redcliffe QLD 4020
77 Sutton Street, Redcliffe QLD 4020
77 Sutton Street, Redcliffe QLD 4020
Price
Contact agent
119 Queen Street & 86 King Street, Bendigo VIC 3550
119 Queen Street & 86 King Street, Bendigo VIC 3550
119 Queen Street & 86 King Street, Bendigo VIC 3550
Price
Contact agent
181 Prospect Road, Prospect SA 5082
181 Prospect Road, Prospect SA 5082
181 Prospect Road, Prospect SA 5082
Price
Contact agent
593-595 Albany Highway, Victoria Park WA 6100
593-595 Albany Highway, Victoria Park WA 6100
593-595 Albany Highway, Victoria Park WA 6100
Price
Contact agent
1-28, 40 Civic Way, Rouse Hill NSW 2155
1-28, 40 Civic Way, Rouse Hill NSW 2155
1-28, 40 Civic Way, Rouse Hill NSW 2155
Price
Contact agent
93-97 Bay Street, Brighton VIC 3186
93-97 Bay Street, Brighton VIC 3186
93-97 Bay Street, Brighton VIC 3186
Price
Contact agent
22-38 & 27-31 The Avenue, Coburg VIC 3058
22-38 & 27-31 The Avenue, Coburg VIC 3058
22-38 & 27-31 The Avenue, Coburg VIC 3058
Price
Contact agent
1F Ashline Street, Wollert VIC 3750
1F Ashline Street, Wollert VIC 3750
1F Ashline Street, Wollert VIC 3750
Price
Contact agent
Lots 100 & 900 Kentucky Court, Cockburn Central WA 6164
Lots 100 & 900 Kentucky Court, Cockburn Central WA 6164
Lots 100 & 900 Kentucky Court, Cockburn Central WA 6164
Price
Contact agent
1260-1272 Malvern Road, Malvern VIC 3144
1260-1272 Malvern Road, Malvern VIC 3144
1260-1272 Malvern Road, Malvern VIC 3144
Price
Contact agent
472 Regency Road, Prospect SA 5082
472 Regency Road, Prospect SA 5082
472 Regency Road, Prospect SA 5082
Price
Contact agent
273A Gorge Road, Paradise SA 5075
273 Gorge Road, Paradise SA 5075 - 273A Gorge Road, Paradise
273A Gorge Road, Paradise SA 5075
Price
Contact agent
270 The Esplanade, Miami QLD 4220
270 The Esplanade, Miami QLD 4220
270 The Esplanade, Miami QLD 4220
Price
Contact agent
2 & 6 Austral Parade, East Bunbury WA 6230
2 & 6 Austral Parade, East Bunbury WA 6230
2 & 6 Austral Parade, East Bunbury WA 6230
Price
Contact agent
5 Charles Street, Charlestown NSW 2290
5 Charles Street, Charlestown NSW 2290
5 Charles Street, Charlestown NSW 2290
Price
Contact agent
59 & 69 Merthyr Road, New Farm QLD 4005
59 & 69 Merthyr Road, New Farm QLD 4005
59 & 69 Merthyr Road, New Farm QLD 4005
Price
Contact agent