Sack all Fund Managers !

Here is uncontestable proof that all Fund Managers are a waste of time. They are (mostly) lavishly paid for nothing. If that sounds a radical statement, read on.

Its a well known saying in financial circles that you cannot beat the market in the long run. The sage of Omaha, Warren Buffett has been saying this for a long time. In 2007, he publicly laid a bet that the S&P 500 index would outperform hedge funds over a 10 year period. He wagered $500,000 on it to anybody who would take up the challenge, observing cheekily , " "After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?"

Surprisingly only one person took up the bet (shame on you hedge fund industry). Protege Partners handpicked a  portfolio of hedge funds. And the wager was on - the S&P 500 against this handpicked pool of hedge funds.

Ten years ended on 31 Dec 2017. And guess who won ? The hedge fund pool gained 22% over 10 years. The S&P 500 rose 85%. No contest ! Buffet won a handsome amount and promptly donated it to the charity,  Girls Inc of Omaha.

There's a big lesson to everybody who is saving and investing. In the long run you cannot beat the market index. Repeat after me, In the long run you cannot beat the index. Repeat again, In the long run you cannot beat the index. Write it out 1000 times.

And yet, we listen to advice from friends. To tips. We hire investment managers. Fund Managers design all sort of esoteric funds and write research reports on how their funds are outperforming the market. A million online portals exist that cater to advice on investment. All of them charge a fee. All of them get handsomely paid.  

Instead follow the advice of Warren Buffet (for free; no fees charged). Simply invest in an index fund - the S&P 500 if you are in the US, the Footsie if you are in the UK, the Nifty if you are in India. A fund that will charge minimum fees to simply hold the basket of securities exactly mimicking the index. And then forget about it. Come back after 10 or 20 or 30 years. You would have made more money than anybody else. It's as simple as that.

There's only one slight problem. Warren Buffet has beaten the S&P Index handsomely in the 50 odd years he has been at the helm of Berkshire Hathaway !

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Deflation: a curse or a boon ?

Stock markets tumbled last Monday. Investors claimed they were worried by two things - Deflation and the possibility (yet again) of a Greek exit from the Euro. Even Rajalakshmi, she who is sitting in front of CNBC doing day trading, claimed to be concerned about deflation. Assuming that she can spell it, this is pure stuff and nonsense.

Deflation refers to a sustained trend of falling prices. When this happens, demand tends to fall as people expect prices to reduce further and postpone purchases. Falling demand leads to unemployment, lower wages and therefore still lower demand and prices. When this is sustained over a period of time , economic growth collapses , much like what Japan has experienced over decades.

But to consider the current circumstances as deflation and therefore hammer down stock prices is incomprehensible to this blogger. Yes, price indices have been falling in recent months, but that is solely on account of one factor - the price of oil. The dramatic drop in the price of oil is actually largely a good thing as this blogger blogged about only a week or so ago. Maybe it needn't have dropped so soon and so fast, but a sustained drop in oil prices is actually great for the economy. The massive transfer of wealth that has happened from all over the world to the sheikhs in the Middle East and to Russia has hardly made the world a better place.

There is no reason to believe that economic growth is going to suffer in any sector, other than oil. The US economy is actually doing quite well. Europe may continue to be stagnating, but almost every other region in the world is seeing an upturn. China's growth may be slowing down, but it is still at levels which every other country in the world would give an arm and a leg to achieve. India is at least looking positive even if it does not have much result to show for as yet.

Armchair analysts who plot consumer price indices and proclaim that when it declines there is deflation are deluding themselves. Price reduction brought on by innovation, productivity, technology and cost reduction are actually great for any economy. Witness the IT and consumer electronics industry where prices fall all the time and demand booms. The current bout of price index falls is because of cost reduction - reduction in the cost of oil. My good blogger friends who are filling up their gas guzzlers in the US are feeling pleasantly surprised. My good friend was so surprised filling 5732 gallons into his tank, that he even blogged about it. There is a bit more in the pockets of most citizens of the world, except those of the oil exporting and mismanaged countries (read Venezuela, Iran, Russia).  Not one of those good citizens gives a rat's ass to fears of deflation.

When equity markets fall again and when they mention deflation scares, that's the time to invest.

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IPO yourself !

Initial Placement Offer (IPO), is the first sale of shares in a company to the public - remember Facebook's IPO and now coming on, Twitter's IPO. It is when successful entrepreneurs who have built a good business cash their millions, along with those who invested early in their company. We've heard of company IPOs. But have you heard of an individual IPOing himself ! That's is what is about to happen - where else ? in the US of A.

An American Football player (remember this is American football; not soccer), is trying to do just that.  Arian Foster is a running back with the Houston Texans, a NFL team. NFL players are paid a fair few millions - being considered more valuable than surgeons or distinguished professors (Profs J and Khe please note !). Now football players are better known for exercising their brawn and are not necessarily top notch in the brains department. Enter financial advisers, brokers, agents, managers and all sorts  who want to touch and feel all that money. Being very bright, they cook up all sorts of ingenious ideas and schemes. The latest is to IPO yourself !

This is how it works, A company has been formed whose only business is the income streams associated with Arian Foster.  They are issuing 20% of the shares of this company for $10 m. He already has a $23.5 million contract with the Houston Texans. In addition he may get endorsement deals and after he retires, hopefully some broadcasting deals. Investors can get a 20% share of all this. If you believe Foster is a huge star, this will be a nice worthwhile investment. If you believe he is a dud, then well .........

This deal sounds strange, but actually is a fairly straightforward affair. The future income flows of a NFL Player can probably be predicted with greater certainty than those of a company. For starters he has a guaranteed $ 23.5 m contract - so a $4m share at 20% is assured. Knowledgeable sports buffs (like yours truly !) can make informed predictions of the future for players. So, this can be an easier evaluation than many others.

I should admit is that this is not the first instance of somebody doing this. The British rock star David Bowie famously did this a while ago. Some other, less famous people have also attempted it. What is strange is all the "innovation" happening here. Surely the best brains in the land can do more productive things than dreaming of an IPO for a player. But then most of the world's innovation is going into areas such as this and not into what society might consider as more useful areas. 

The person most vulnerable in all this is Arian Foster himself. Once he signs this deal, he has virtually pledged his soul to the financial whiz kids. He cannot make any decision anymore regarding anything. If he wants to switch teams, he has to take the approval of the shareholders. If he wants to retire - then too. If he gets injured, he will be cursed and told to get on to the field even if he hobbles on one leg. They will make him do all sorts of endorsements or whatever to earn more money. They might force him to play off season in Matabeleland. And well, after retirement, he has to keep slogging, finding ways to earn more money. Is all this worth a "mere" $10 m.

 Prof Khe might want to to consider IPOing himself too. He can become an instant millionaire. This blogger is prepared to "invest" 24 million manat for a 10% stake in him  !!

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Bye Bye New York Stock Exchange

OK - the title is pure hyperbole. The New York Stock Exchange (NYSE) is going nowhere. But the company that owns NYSE is just being bought over. The curious part of the story is that the acquirer does not really want the NYSE, but it comes as part of the package- so he has to take it !

Here's the deal. NYSE is part of a conglomerate called NYSE Euronext. The conglomerate consists of NYSE itself, Euronext, which is a combination of three European stock exchanges and Liffe which is a London based derivatives exchange. NYSE and Euronext are ugly spinsters nobody wants. The beauty amongst the beasts is Liffe. For it is the sexy new hottie - a derivatives exchange.

And therein lies the story. In the modern day casino , that is finance , equity exchanges like NYSE are worthless as businesses. Margins are supposedly low. Stock exchanges are the places where almost all companies that require capital list and that's where investors channel their savings into productive investment. One would have thought that  the raison d'être for financial markets was to fulfill that objective, but obviously I am an old foggie.

In today's world, the money is all in running commodities exchanges,  derivatives markets etc - not boring old equity. The acquirer is a company called ICE that did not exist before 2000 (for the record NYSE was founded in 1817). ICE purely handles derivatives trading. The career of Jeffrey Sprecher, the CEO of ICE says it all. He started his career building power plants.  But he realised that there was more money (in facts tons more money) playing on financial contracts relating to power than in generating power itself. So he started ICE , obscurely in Atlanta, in 2000. See where he has got to in 12 years.

We've now come to a stage where even the NYSE is an unattractive prize - in fact positively repellant. Given a choice Mr Sprecher would probably spin off NYSE, or sell it off somewhere or simply forget about it. Unfortunately that is politically simply unthinkable. So he has to live with it and make pious noises of how important it is.

Its a symptom of where the world is going.  This post is one sided and biased (whoever said that a blog has to be objective !). Derivatives markets are not all evil and equity markets are not all saints. Both serve useful economic purposes. But you can see where this is headed. Esoteric, ununderstandable financial structures are getting to be more important than the underlying asset itself. That's why, a wise old fox from Omaha, back then in 2003, called derivatives a weapon of mass destruction.

Many years ago, when the world was a simpler place and when this blogger was a young man (!), he went to 11 Wall Street, entered the visitors gallery of NYSE and gazed at the trading floor in awe.  Little did he know that not in the too distant future, this lovely lady was going to be thrown out into the street as an ugly old crone.

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The emperor's new clothes

Somebody has to say this. Like the kid from the proverbial Hans Christian Andersen's tale, who exclaims that the emperor is actually naked, I will go ahead and say it. Stock markets have become a weapon of mass destruction.

The original purpose of stock markets was to become efficient allocators of capital. Capital was always scarce and economics needed a mechanism where capital would be pooled from investors and allocated to the most efficient users of capital. Voila, the stock market was born. It is important to remember why this mechanism was created in the first place.

One of the most important benefits that stock markets provided was liquidity. Investors needed liquidity to be able to withdraw their investment without affecting the company that they invested in. Contrast this with property markets which are not very liquid - try selling a property, especially in India. Liquidity was , and is, provided in stock markets by speculators. They performed the useful function of ensuring liquidity and hence were tolerated even though speculation climbed to above 90% of all trades in stock markets.

But witness what has happened in the last 10 years. Most of the trading is now done by computers against computers. By automatic trading ; not by human decisions. A concept called High Frequency Trading has come into being. Big trading firms have invested in creating a competitive advantage where their automatic trading computers can gain a few nano seconds advantage over competition. I am not exaggerating  - a few nano seconds advantage. A millisecond is considered an eon in high frequency time. Two critics of the way stock markets function today - Sal Arnuk and Joseph Saluzzi have been laughed at for proposing a solution that firms honour the prices they offer for a share for at least 50 milliseconds.

Software is vulnerable, as all of us know. Knight Capital, an American Equity broker, started using a new software programme to execute its trades on 1 August. Within one hour of the market opening errant trading had cost the firm $440m. It virtually went bankrupt and only escaped from near death at a huge cost and will never be the same again. Such events are now becoming not uncommon. In May 2010, The Dow Jones Industrial Average plunged 1000 points in minutes and for a brief period Accenture was trading at 1c a share !

Such high frequency trading is not performing any usual social function. They are not based on a company's future or a view on the economy. This is pure gambling based on tiny changes in price. The amounts of money are so huge - several times the GDP of the world, that a catastrophic systemic failure is a real real risk. It almost seems to be a question of when, and not if.

I submit that the original purpose of stock markets has got grossly distorted and weakened. Before a meltdown occurs, it is important to go back to the roots - stock markets have to be reborn as efficient allocators of capital and not a Las Vegas on steroids. Its better to do this before the calamity hits, rather than after.

I say this loud and clear. Almost everybody on Wall Street, Dalal Street, etc etc, is stark naked. Unfortunately, that is not a pleasant sight - potbellies, warts and all. What does it say about our society, when its best brains are running naked and looking as ugly as hell. This naked horde might do well to remember , as The Economist points out, the advice of Warren Buffett, the most successful investor in history who says that his ideal holding period for shares is for ever.

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When "information" equals garbage

It is a fundamental tenet of capitalism that an investor should be fully informed of all matters relating to his investment. Over the years, regulatory authorities have been increasing disclosure requirements so that there is as much transparency as possible. But has this gone too far ? And has the overreaching legal recourses, especially in the US, led to the purpose being defeated ? No this is not a boring, dry post. Read on.

Take the case of Manchester United's IPO filing (if you ask what Manchester United is, I'll clobber you). IPO filers are required to disclose the risks associated with their business. Fair enough. But look at Man U's risks disclosed. They have listed 51 risks. Amongst them are such gems as

• There could be a decline in the popularity of football (beggars belief)
•  To service our indebtedness, we require cash, and our ability to generate cash is subject to many factors beyond our control. ( Ha Ha)
• We are dependent upon the performance and popularity of our first team. (Really ?? - this is like a company saying that we are dependent on the popularity of our products)
• If we fail to properly manage our anticipated growth, our business could suffer. (this is supposed to be an earth shattering revelation)
• Our international expansion and operations in foreign markets expose us to risks associated with international sales and operations (brilliant insight which we otherwise did not have).

There are 51 such gems and monuments to inanity. Obviously lawyers have written this piece of garbage, including everything they can possibly think of. I am surprised that they did not add the following, which I will freely offer for inclusion in the filing

•  Wayne Rooney (Man U's star striker) might develop a pimple on his ass that might prevent him from scoring goals
•  An asteroid might hit the earth tomorrow
• All other teams in the league might gang up and refuse to play Man U saying that they are fed up of getting thumped.
• The queen might die and Prince Charles might succeed her (Prince Charles is a known Burnley supporter)
• China may pass a law banning the Chinese from wearing Man U T shirts on the grounds that the Dalai Lama visited Old Trafford for a game.

This disclosure business has gone too much. To cover their asses, lawyers disclose a mountain of irrelevant stuff. Any sane follower is buried under a ton of garbage. Take Annual Reports of companies. They have become so bulky and big, that nobody reads them anymore. They are also written in such complex legalese that they are largely unintelligible to anybody. The only thing that anybody even sees , if they ever open one of them, is the constipated faces of the pompous Board. So much for the riveting reading annual reports make.

The purpose of full disclosure has been completely thwarted. Only three classes of people read these things these days. Lawyers who wrote the gibberish in the first place (I am not entirely convinced that they read it, but we shall give them the benefit of doubt). Lawyers looking for ways to sue. And finally a few unemployed  bloggers like yours truly.

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The curious public reaction to Facebook IPO

You couldn't have missed the public fury over the Facebook IPO, over the last week, even if you not economically inclined !  Facebook was a darling before the IPO - great company, stratospheric valuations, etc etc, which this blogger has been heartily against. But now after the IPO , Facebook is a pariah, it botched up the IPO, lawsuits threatened, etc etc. This time this blogger is completely on the side of Facebook and totally flummoxed by the public reaction.

What is the main charge ?  Facebook's price did not shoot up 10 times after the IPO. Instead it has declined by some 16% or so, over the IPO price, in the first week. The company has committed sacrilege. Really ??

Who are the moaners and bleaters. The punters who bought in the IPO wanting to sell on the first day after listing and make a 5000% profit. Please tell me why the company has any obligations to these greedy leeches ? What economic activity have these speculators done (never mind that in this lot might be Oregon widows who didn't know what they were doing !)? Why should they make any profit at all ? Why should Facebook "ensure" that the stock rises manifold on the date of listing ? It can be argued that Facebook should actually be doing precisely the opposite. After all if the price shoots up after the IPO, the company is shortchanging the original investors who first invested in the company to the benefit of the sharks who want to make a whopping profit in one day. By that yardstick, Facebook has done precisely the right thing.

The second charge is that the IPO price was overvalued. Now do you need a MBA to tell you this ? Of course the company is overvalued like crazy. Everybody knows that. People chose to close their eyes and believe that in a stampede they would make a killing. They've now been trampled. Tough luck. 

The third charge, and a more serious one, is that Facebook let some analysts know that its latest quarter's numbers would be lower than expectations, but didn't inform everybody. This is what is triggering the threats of massive lawsuits.I don't know the facts behind this allegation, but I suspect this is a fig leaf behind which the punters are wanting to hide. As if their stampeding to buy Facebook shares had anything to do with numbers or logic or any sensible model of valuation based on earnings. Would they have behaved any differently if Facebook had said they would earn half of what they did ??

I have zero sympathy for those moaning today, I am actually delighted that they have lost their shirts and would be even more delighted if they lost their underwears too. The right course of action for them is to wait a year or two, and see if Facebook's performance doesn't lift the share price. Fat chance of that happening - this lot has the patience of an ectoplasm !

I am totally with Facebook on this one, even though I am not with them on anything else. That's why I am not updating my timeline !

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How the stock market works

"Company X crushes estimates; Shares Soar" screams the headlines in Forbes,  a respected business magazine. "Company X profits slip 35% as spending continues"  proclaims the equally loud headlines of The Wall Street Journal, a respectable business newspaper. Both refer to the same company - Amazon - and the same piece of news, the first quarter results of the company. Flummoxed ?? Read on.

Can both headlines be right ?? Surely they can't.  Only in the rarified world of finance , especially the even more ionospheric world of stock markets can both statements be true. Yes.

You see, company performance and movement of share prices is based on "expectations" and not on reality. Expectations of whom, you may ask ?  Of a unique sub species of the human race called homo sapiens analystensis (hereinafter referred to as HSA).

Cut to business school. Some of the best brains in the land want to "go into finance" after they graduate. Their ambition is to mutate into this unique sub species I referred to earlier. There are distinct variants even in the subspecies that you can aspire to become - HS Brokerensis, HS Sellsideanalystensis, HS Buysideanalystensis, HS Fundmanagerensis, etc etc.

All of them have only one aim in life. They aspire to make predictions of the future. These predictions are called "expectations" or "estimates" in the lingo. Never mind that humanity has not yet discovered how to foretell the future. All through history, many quacks have attempted to do this - astrologers, palmists and charlatans of various kinds. To this tribe has now been added the aforementioned HSA. Their tool is not a parrot or a horoscope, but an abomination called the Excel spreadsheet. For their quackery, HSAs earn only in seven figures.

Based on their wise gazings, they come up with an Estimate (with a capital E). Then they all flock together , total up all their Estimates, divide it by the number present and come up with a "Consensus Estimate". This is the magic target for the company to beat. This is what Amazon beat by 4X prompting the Forbes headline.

Companies are of course wise to all this. They cuddle up to this species. They ply them with booze in events called Analysts Meet. They provide them with "guidance" so that the fertile minds of the great members of HSA can be fertilised. Sharp readers may note that along with other humans, company honchos are equally clueless about the future. But that doesn't stop them from pontificating. They  whisper, allude, provide crystal balls etc etc so that the sainted HSA can come up with the "right" Estimate. Then they spend all their life trying to beat the millstone around their neck.

The stock market formula is simple. Beat the Estimate and your share price will soar. Miss the Estimate and the share price will tank. Never mind if you made a profit or a loss. Never mind that you sold more or less. Never even mind if you made cornflakes or condoms.

Now you see why both Forbes and Wall Street Journal were right. Amazon's profits actually dropped by 35% from last year's first quarter. Signor Bezos continues to thumb his nose at any naysayer and spends money like water (made respectable by calling it investment). But he beat the consensus estimate of the HSA. Not just beat it, but licked it.  

Amazon's share price rose 14% yesterday.

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Face the music

A terrible decision for the company and its founder. A great decision for everybody else. Welcome to the crazy world of private equity.

Facebook needs an IPO like a hole in the head. It doesn't need the money. The only possible use it has for it is to pay off some tax liabilities being triggered by doing an IPO. Most of the money is going to be invested in US government bonds - impeccable logic of raising expensive equity and investing in bonds that yield nothing. The business itself is a cash spewing machine - it doesn't need more cash. On the contrary it doesn't know what to do with th cash already being generated. Actually the risk when too much cash is sloshing around is that the Board will go and make a stupid headline grabbing acquisition.

Mark Zuckerberg doesn't want to do an IPO either. He doesn't need the "valuation" to prove to everybody that he is rich. He's going to lose every autonomy he had in running the business - now he has to pander to the quarterly whims of so called experts called analysts. Being listed is like a curse - the number of regulatory and legal constraints the company will have is enough to make you lose your senses. An independent Board of eminent personalities will sit in judgement over everything Zuckerberg wants to do. Two quarters of missing forecasts and they will have to sack him. Companies that need capital have no other option but to eventually list. The slight problem is that Facebook does not need any more capital.

Its the current shareholders, minus Zuckerberg, who want an IPO badly. They want to encash the fortune they are sitting on. The likes of Aegis Capital, Goldman Sachs, etc. The employees with stock options want to become millionaires. They love the IPO too. The investment bankers who are handling the IPO are beside themselves with excitement - the prospect of fat fees of unimaginable proportions makes you drool doesn't it. Especially when they need to do no work ; after all the shares are going to be bought up even if a donkey handled the issue. The "market" loves it - it will provide employment to a clutch of useless analysts who will write learned treatises on the company without having a clue about it. Day traders will buy and sell everyday, speculating and punting like crazy. We, the wonderful public, can now learn all about its innards and criticise its decisions.

Mark Zuckerberg knows all this. But he probably had no choice - his shareholders must have pushed him and after holding off for so long, had to eventually give in. Facebook can go only one way now - down. What a waste.

PS : Full disclosure - This blogger does not like Facebook. He does not go there.

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Stop watching the stock market ticker

As stock markets fell on Monday there was the predictable response from governments. Take for example the Indian Finance Minister. He says "we are prepared to address any concern that may arise on account of the present situation".  He should do no such thing. Stock markets should not drive government policy.

Have you noticed that the bleating and braying is all one sided. When markets are rising, nobody wants the government within one million miles of their trying to fill their pockets as fast as possible. When markets are falling , governments should come and "help them". Nonsense. Just as stock markets fell, you see the price of gold skyrocketing. I am yet to hear anybody express concern on where that market is heading.

For that matter, why be only concerned about stock markets ? Why not debt markets. Or, as above, gold markets. Or platinum markets. Or whatever.

Governments should simply adopt the right economic policy for the long term. Of course, they have to react to economic events, but that would be in the form of reacting to say a recession or overheating. Not to stock markets falling.  Stock markets, in the short term, are largely in the hands of speculators. More than 95% of transactions are speculative in nature. They perform a useful economic function - that of providing liquidity. But they need no support and certainly not an ounce of the time of the Finance Minister. If they mint money gambling, good luck to them. If they lose their shirts, well tough luck.

India is not in a bad position in the current situation. Unlike China, its not so dependant on exports and therefore the impact of a possible global recession will be lesser. India's growth will continue to be strong. The falling oil prices is a huge boon ; this can be the solution to controlling inflation, the most serious problem facing the nation today. Speculative inflows may dry up, but investment is not a problem - the country remains one of the most attractive markets in the world. The demographic dividend continues - India has a young population and not a dwindling supply of productive individuals. The Finance Minister has many things on his plate. Controlling corruption. Eliminating wastes and handouts. Restraining the burgeoning national debt. Continuing with reform and remove the current malaise of masterly inactivity. He doesn't need to watch the Sensex. When the shrill, loud, breathless "journalist" from CNBC asks him about it, the correct response should be - Sensex ? What Sensex ?

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Vanity thy name is Chinese Company

Vanity thy name is Chinese Internet Company, went the title of an earlier post of mine here. I should correct this now to Vanity thy name is Chinese Internet Company. How else can you explain the rush of Chinese non Internet companies who want to list in the US ?

There are 900 companies with businesses mainly, or only, in China listed in the US. Compared to that there are only some 2000 odd companies listed on the Chinese mainland. Does this make any sense ? Why are Chinese companies falling over each other to list in the US ? Usual reasons - Greed and Vanity.

Greed first. Anything beginning with the letter C is now hot in the US. Never mind that the investor does not know, or care, whether China is to the East or West of Topeka KS. Anything even remotely related to China must be leading to a pot of gold. Hence the stampede towards China stocks. A scene reminiscent of the wildebeest crossing the Mara river. The expert analysts, investors, fund managers all seem to possess exactly the same intelligence as that of the wildebeest.

Greed is also at the back of sundry bankers and advisors egging on Chinese companies to list in the US. Prospect of fat fees has them drooling.

Vanity is the other side of the coin. For some reasons, Chinese owners and CEOs believe their prestige is enhanced by being a "foreign listed company". Local government officials suffer from the same malady - number of foreign listed companies in their domain seem to be a mark of manhood. Supply side stampede.

Getting your company listed in the US is not a joke. Its a laborious process. So the wise intermediaries have discovered the route of a reverse merger. Acquire a shell listed company in the US and merge your company with that one. And Hey Presto, you are now listed in the US. One quarter of all reverse merger transactions of listed companies in the US between 2007 and 2010 were by Chinese companies.

After the champagne, and after the advisors have pocketed their fees and disappeared, comes the problem. 11 Chinese companies have seen their shares being suspended for trading on NASDAQ. Another dozen or so have been delisted or suspended on other US exchanges

The problem is that corporate governance standards in China are nowhere near the requirements of a US listing. Accounting standards and their adoption are also not in the same league. Auditors are not of the same calibre. This does not mean that the intrinsic business is not sound. Very often they are. Many Chinese companies would be at the forefront of dynamism, growth and profitability in the world. But a US listing is not for them; at least not yet. There is a lot of grey in business in China, especially in dealings with the government. American exchanges require black and white; not grey.

Its far better to list in Shanghai and Shenzhen. If listing somewhere else is a must, there is Hong Kong. There is zero business logic in going elsewhere.  If you want to preen your feathers, then there are other ways of doing it. Listing in the US is a very bad idea.

There is a peculiar fall out to the situation. As the news of Chinese companies getting suspended or delisted grows, the short sellers are shorting every Chinese company . The same wildebeest stampede is now in the opposite direction - every Chinese company must be dodgy; so short them all. I think it would be entirely appropriate that  a few wildebeest be flown from the Serengeti and made to stand outside Wall Street. Bulls and bears are no longer the animals on stock exchanges ; its the wildebeest that's ruling the roost.

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Vanity thy name is Chinese internet company

Why does a Chinese internet company wish to get listed in the US ? I can't fathom the logic. Hence this post.

The Chinese internet landscape is a strange one. Almost every one of the global majors is blocked. Facebook, YouTube, Twitter, Blogger, you name it and it is blocked. Instead there is a carbon copy of each one of them locally in Chinese. For Google, read Baidu. For Facebook, read Renren, for YouTube read Youku or Tudou, for Twitter read Sina Weibo or the dozens of similar clones. These are the ones that are wildly popular, having millions of users, only in Chinese and therefore almost exclusively used by Chinese. Never mind that these  are all censored , watched, bullied, etc etc by the jīndùn gōngchéng (The Great Firewall). This post is not about that cursed censorship.

These sites are all by entrepreneur led start up companies , similar to the American originals.  And they all want to list and make huge money. Fair enough. But they seem to want to list in the US. Qihoo 360 (an antivirus company) and 21 Vianet (a hosting service provider), recently listed. Renren is next on line. As is Tudou. Why O Why ?

Its fair that you want to list in the market which can give you the highest IPO price. These days valuation of a company rarely depends on where it is listed. You want to list in the market that is most liquid. The Nasdaq is the most liquid market for such companies in the world. But for the size of these companies, there is enough liquidity in virtually any major market. You would list in a place where your major customers are (the reason why Indian software companies are all listed in the US), as this is a significant weapon in a sales pitch. But none of these Chinese companies are targeting the US - Americans are not going to learn Chinese in a hurry.

Consider the downsides. You fall into the dreaded ambit of the Sarbanes Oxley Act, although that tiger is looking rather old and the canine is decaying. You need corporate governance standards that are going to be a real challenge to meet for Chinese companies. You open yourself to requirements of transparency that sit uncomfortably in China. The possibility of getting sued always exists - Renren hasn't even listed and already noise is being created that the prospectus is misleading.

There is the obvious alternative for these companies - Hong Kong. Highly liquid market, excellent valuations to be got, internationally respected, but without the major downsides such as the Sarbanes Oxley Act. And they can speak Chinese in Hong Kong, although the mainlanders scorn at the Hong Kongese attempts at Mandarin.

All this is of course well known to the entrepreneurs - they are brilliant businessmen after all. So why do they then plunge into the US market. I think the answer is Vanity. Perhaps their own as well as the vanity of the Chinese government which would like to quote large numbers of Chinese companies being listed in the US. Vanity stroked by greedy investment bankers, is probably the cause of this bull rush. Its a dangerous substance to introduce into the jungle of business. But then, its always been there and perhaps always will be. After all, businessmen are human beings first.

With due apologies to Shakespeare for plagiarising the title of this post. Although he wrote in Hamlet , Frailty, thy name is woman, in popular usage Vanity is often the attributed womanly quality in the quote. As a parting jab at the multitude (?) of incredibly beautiful women who throng this  space :) perhaps that juxtaposition is not entirely misplaced ! I am taking cover !!

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The Chinese wear Prada

Prada, the Italian fashion group, is reportedly going to seek a listing in the Hong Kong Stock Exchange. Nothing electric about this, except that you would have thought that they would list in Milan. European fashion houses are ,well, snootishly European. So the move to list in Hong Kong does raise eyebrows.

This is the magic of China. As even a casual visitor to China knows, every brand is ruthlessly copied and pirated on a big scale. You can easily buy any fashion brand, indistinguishable from the original, perhaps even made in the same factory as the original, at one hundredth the price. Despite this, every fashion house's fortunes these days are driven by demand in Asia, chiefly from China. The nouveau riche in China like to spend. And spend on outrageously priced brands which you can then flaunt. There's a certain pleasure into walking into a room of Prada wearers and knowing that everybody elses is a fake and yours is the real thing. Flaunt your original.

But if your main driver of growth is there, does it mean you have to list there ?? You can list anywhere in the world and still attract an international investor base. These days, investors are mainly institutional investors who invest in most of the major markets in the world. Even if you list in London, you could have an investor base that's entirely non British.

There is a symbolic angle to listing in Hong Kong. You can say that it reflects the growing importance of China to the company. But that's just pure show. It doesn't matter one inch in the actual operations of the company or the performance of its stock.

The move also reflects the growing attractiveness of Hong Kong as a financial centre. It always was a major financial hub. But it was dented a bit by the fears of what China might do to it. But 13+ years into Hong Kong becoming a part of China, the world is fully convinced that China does not intend to tinker with Hong Kong's economic apparatus at all - one of the wisest moves Deng Xiaoping and the leaders that followed have made. Hong Kong's markets are free, transparent and highly liquid as say New York or London is. And its also free from the regulatory heavy handedness of a Sarbanes Oxley. And its on the doorstep of mainland China. Presto. Hong Kong is soaring and competitors like Singapore are left by the wayside.

Its still a tiny trickle - the number of western companies seeking to list anew in Hong Kong. I don't think it will turn into a flood - I still can't see the practical benefits of listing in one place over another (other than avoiding onerous stuff like Sarbanes Oxley). What is more likely to happen is more and more companies making Hong Kong or Shanghai as their Asian base, or even their global base (as HSBC has done).

Fashion industry is all about show. You want to flaunt your wares. No wonder, Prada is enamoured by the symbolism of its move. As long as the Chinese don't take violent objection to the slightest hint that its the devil who wears Prada.

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When reality pales into insignificance

Imagine a company which was for decades a byword in inefficiency. It pollutes like hell. It has 400,000 workers, none of whom can be sacked, although it needs far fewer. Most of the places it operates in are rife with insurgency, where the government's writ doesn't run very deep. Corruption is endemic. Technology is antiquated. There's a mafia which operates almost exclusively thanks to its presence. It struggles to transport its production to its customers. Governments set prices, allocate stocks and fix wages - not the market.

You get the drift ? Now this company wants to sell its stock to you. You would run a million miles. Right??

Wrong ! You actually fall over yourself in trying to invest in its stock. Welcome to the crazy world of stock markets.

The company, is Coal India. It is a government owned monopoly that has been around for decades and for most of that period was of dubious financial capability. And yet, for the last few days, everybody around me seems to be subscribing to Coal India's IPO - the government is offloading 10% of its stock. Even the famed Rajalakshmi, who's probably never seen a lump of coal in her life, is applying. The IPO has been oversubscribed some 15 times.

Does any of this make sense ?? Of course it does. The IPO was priced at a discount. There is an opportunity to make a quick buck. The equity culture in India is unbelievable. The aforesaid Rajalakshmi, for whom a Balance Sheet is a concept that could very well be from Mars, sits in front of the telly watching the stock ticker creep by on CNBC every day. Investing logic is derived from "buzz" - if everybody is doing it, I must do it too.

Coal India is a monopoly. India's demand for coal, and power is not going to come down for many a decade. Its IPO got the highest credit rating from CRISIL - the domestic credit rating agency. Voila - the ugly duckling has suddenly become a beautiful swan.

Everybody seems to be happy. The punter who's subscribing is waiting to make a quick buck. The government is grinning from ear to ear as the musical sound of the cash pouring in is heavenly. The bankers who "advised"" on the IPO have made fat fees. The employees are burping loudly, having been given the opportunity to make the quick buck themselves. The company itself is finding it wonderful to be in the headlines for the right reasons.

I am scratching my head in bewilderment. Did somebody say the stock market was supposed to be an efficient mechanism to allocate capital ?? As the Americans say, Wall Street and Main Street seem to be operating on two entirely different planets.

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KKR goes public at last

In the rarified world of Private Equity, the firm of Kohlberg, Kravis and Roberts occupies a special place. KKR, as the firm is called, achieved legendary status very early on in its life. The firm came into existence in 1976, but its real fame and notoriety came in 1988, when it orchestrated the largest leveraged buyout of that time, the hostile acquisition of RJR Nabisco.

The RJR Nabisco transaction was a definitive moment in business history. It was so huge that at that time it was by far the largest M&A transaction that was ever done – a position that it occupied for more than a decade. Adjusted for inflation, it is still the largest leveraged buyout ever. The story has been immortalized in the best selling book, Barbarians at the Gate . The book reads like a thriller - you can buy it here or here ; it’s a classic must read book. The madness of 1988 was covered in my post here, sometime ago.

From that day on, KKR has come to epitomize all the public perceptions of private equity. Greed, excess, secrecy, enormous power, fear, are the adjectives that come to mind. Corporate raiders, who buy up companies, saddle them with debt and break them up – that’s the perception. As always, perceptions are not always right, but there is an element of truth to them.

KKR remained a secretive organization. Being private, they needed to disclose nothing. They have continued to be active ; completing at least one transaction every year , bar 1990, although something like RJR Nabisco is never likely to be repeated. Of the original partners, Kohlberg left very early on, but the cousins, Henry Kravis and George Roberts continue to run them virtually exclusively. There remains a mystique and aura around these two men – they can create a feeling of terror in boardrooms when they set their sights on a company.

All this is about to change. They are going public with an IPO and listing on the New York Stock Exchange. Now they will be open to public scrutiny, just like any other company. The press has gleefully reported , from their first SEC filing, how much each of them earned last year – a paltry $44m together . The aura, and even fear, will be dented significantly – there’s nothing better than transparency to prick the bubble of mystique. Metaphorically, Henry Kravis, whom even the mighty was in awe of, will now have to sit at a company AGM and listen to the old foggy , who has 1 share in the company, rant and rave at the quality of the snacks served. An experience like that will bring you to the ground with a thud.

Their most visible rivals, Blackstone, caught the timing exactly right, when they took their firm public in 2007, just before the crash came. KKR missed the bus that time, but are going public now. Private Equity remains a thinly regulated field in many countries. As more firms list, that will change. Transparency is the best form of accountability there is. But, I must confess a voyeur’s sense of childish glee at the thought of peeking inside the mysterious KKR.

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Las Vegas is passe; bet on the Exchanges

Last Thursday, something peculiar happened in the US stock markets. The markets were jittery due to the unfolding crisis in Greece. The market was down by some 1.5% or so , but nothing extraordinary. Then at 2.32 PM something happened. It started falling steeply. By 2.42 PM it had fallen by 3.9%. By 2.47 the bottom had fallen out; in 5 minutes the index fell another 5.5%.By 2.49 it went back up by 5%.

Nobody knows what happened. Multiple theories abound. Hacking or terrorist activity have been ruled out. The rumour that a trader keyed in a trade in P&G shares for billions instead of millions by mistake has also not been borne out. The SEC is still investigating.

What triggered the fall is not clear, but what happened next is certain. A lot of trading is computer driven these days. When something happens there are automatic triggers to buy or sell. When the first fall happened, it triggered an avalanche of computer generated trades. Hence the free fall. These days competitive advantage amongst traders is counted in speed of response time. Goldman Sachs famously claims that it has a huge competitive advantage because its computers are a few nanoseconds faster than anybody else.

What has the world come too when computers fight against other computers in speculation and cause spectacular gains and falls. None of this is real They serve zero economic value. The oft repeated argument that speculation ensures liquidity in the market has been stretched to absurd levels when computers are fighting other computers for nanasecond advantages.

This is the United States of America. Where gambling is banned except in the state of Nevada and in some small pockets such as Atlantic City and Indian reservations. Online gambling is completely banned; the US spends a fair amount of money trying to shut down internet gambling. And then they allow stock exchanges to go completely berserk. In pure shotgun gambling that would put Las Vegas to complete shame. The sin city is small change ; its entire annual revenue is probably bet in a day on the exchanges.

Here’s an idea to solve the US deficit. Impose a gambling tax on the exchanges. Because they are nothing but gambling dens. Ignore their bleating of how they serve a useful economic function (99.9% of them don’t). Bite your lip at the huge fall in the Index that will happen immediately. Laugh at threats that they would take their business to other countries.

Some decades ago America cleaned up the gambling in Las Vegas and sent the mob that was controlling it packing. I think attention must now be turned on the Exchanges.

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Minorities be damned

A curious side show to the Alcon deal that I blogged about in my previous post is the treatment of minority shareholders. You may recall that Novartis bought 52% of the shareholding in Alcon, from Nestle, at $180 per share in cash. It had already held 25% bought from Nestle earlier. So it now has 77%. The balance 23% is held by minority shareholders as Alcon is listed in the US.

Novartis has now offered $153 dollars to the minority shareholders, in its own shares (not cash as was paid to Nestle). The minority shareholders are crying foul.

Alcon is a Swiss based company and dictated by Swiss Corporate law. Swiss law does not require minority shareholders to be paid the same amount as the majority shareholders in an acquisition. Most other countries in the world have this provision. Switzerland does not. That’s why Novartis can do what its trying to do.

On first glance this would seem to be an abuse of minority shareholder rights. But wait a moment. Its not so black and white.

The “minority” shareholders” who are making all the noise are hedge funds who bought into Alcon shares recently on the hope of making a quick profit when the acquisition happened (betting that the acquisition price has to be above the market price). Do they deserve any sympathy if they have got the Swiss corporate law wrong. The independent directors in Alcon are trying to protect minority shareholder interests (no doubt fearing law suits), but do speculators like the hedge funds deserve either sympathy or protection ??

Secondly if you were truly a small minority shareholder who subscribed to the Alcon shares when Nestle took it public in 2002, you bought it at $ 33 per share. In 8 years that’s becoming $153. Do you have a problem with that ?

Thirdly, what about the famous “control premium”. There is usually a premium to be paid to the controlling shareholder in a private M&A transaction. This is supposed to be “compensation” for the active role played by the shareholder in managing the company and increasing its value (as distinct from the sleeping shareholder who did nothing ). I know it is dangerous territory and contrary to conventional wisdom to argue shades of colour in capital. But then, this is the principle why Swiss law allows different prices to be paid for different classes of shareholders.

I think Novartis will ultimately be forced to pay the same price to minority shareholders, as they will be forced to by public opinion. For “public” read “market”. Despite being a strong votary of good corporate governance (a key component of which is protection of minority shareholders), I think in this case that would be wrong. The loudly yelling hedge funds deserve no better !

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If something is too good to be true, it is too good to be true

Since the beginning of the year, the prices of all sorts of risky assets – shares, oil, etc have increased by fantastic proportions. Take equity. In virtually any market in the world, you would have made returns of 50% plus, even if you are an idiot. Did somebody say we were in the midst of a huge crisis ? Here was massive money to be made, by just being there. Sounds too good to be true ?? As the old saying goes, when something is too good to be true, it usually is.

I read a very interesting article by Nouriel Roubini, the highly respected Professor from New York’s Stern School of Business, in today’s Financial Times. Its somewhat technical, although very readable. I commend even a layman to read this. At the risk of extreme oversimplification, I will paraphrase his argument as follows

- Interest rates are extremely low and will be maintained at very low levels by the US Fed to stimulate the economy
- The dollar is falling. Because it is falling, everybody is short selling the dollar.
- Short selling the dollar essentially means that you can borrow at negative rates of interest, as long as the dollar is falling .
- Invest this in any risky asset – say shares in Hong Kong. Prices of those shares will rise as demand for them increases.
- One month later (or whatever), sell the shares and make a tidy profit. Now these are worth much more in US$ terms as the US$ has fallen. Settle your short sale of the US$ and make a huge profit.
- Repeat step 1 to 5 again.

This is what Prof Roubini is arguing is happening. Of course, this cannot go on for ever. One day the dollar will not fall. Then like a herd on stampede , everybody will sell the risky assets and cover their short positions on the dollar. The bubble will truly burst.

That’s what usually happens to bubbles. When asset prices rise by 70% in 9 months, it is a bubble. The bigger it gets, the worse will be the explosion.

If you want any more evidence that Prof Roubini’s views must be taken seriously, read what he said

“In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions”

The date ? Sep 7, 2006.

Just because somebody was right once, it does not mean that he will be right again. But it would be completely foolish not to listen to him.

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Make a fortune with Lehman Brothers !

Yes that’s right. Lehman brothers. The same company that went bankrupt. You could have made a profit of 600% in a couple of months. Welcome to the insanity that sometimes grips markets. And trust the finance world to dignify the madness with a high sounding name. Its called the “lottery ticket rally”.

Lehman Brothers shares were languishing at 5 cents for most of the year. Last week, they touched 32 cents. If you bought at 5 and sold at 32 , you could have multiplied your money 6 times. They ended the week at 14 cents. Even if you missed the 32 and sold at 14, you multiplied your money a respectful 3 times.

Never mind the underlying economics. Big parts of Lehman’s erstwhile businesses have been bought by Barclays and Nomura. What’s left is all sorts of losses being unwound. Most certainly the rump left has negative net worth. By all laws of economics their shares must be worth nothing. And there’s nothing secretive about this – the travails of Lehman have been well documented. And yet, its stock has zoomed.

This is just mad speculation. People punting with complete irrationality. Apparently the same is happening with shares of other bankrupt companies as well.

Sure the punters who make 600% also lose 1200%. But that’s besides the point. A society that rewards insane risk taking over an honest day’s work needs some navel gazing. This isn’t socialist claptrap. Some introspection is called for, even amongst die hard capitalists.

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The moral dimension of the stock market

There’s something immoral about sitting on your butt and making a lot of money as against working your socks off and making less money. I find it difficult to reconcile to this.

The Indian stock market has exploded in the last five months. Its gone up by 50%. Popular perception is that its because of the euphoria of the elections throwing up a stable government, which was unexpected. But as Swaminathan Anklesaria Aiyar notes in his very well written article in the Times of India, the rise has little to do with the elections. Global money which had retreated shellshocked into US gilts is pouring out again into stock markets. Some $ 20 bn has gone into emerging markets since April. China’s stock market has gone up by 57%, Russia by 63%, Brazil by 60%, Argentina by 45%. India is not alone, by any means. And no wonder, the rupee is strengthening again, if there’s so much dollar inflow.

I think, as a society, we have learnt little from the financial crisis, we are right in the middle of. We are feeding the same boom and bust again – I am sure Madras maamis are sitting in front of CNBC in India and day trading again.

It is quite likely that if you have any decent investments in the stock market, you would have made much more money these 5 months than by working hard at whatever job you are doing. In fact if you have some significant investments in the stock market, its very likely that you made much more money doing nothing with it than in virtually any year of your working life, where you slave unthinkable hours. This just cannot be morally right.

This is the problem with the financial sector. It rewards ridiculously for resting your backside (and calling it risk taking). An honest day’s toil, whatever your job might be, is far less rewarding than sitting idle and gambling. What is true for the individual, is true of corporates as well. An investor who does nothing more tiring than pressing a button to buy a share, can make more money than the company he buys the shares of makes by producing and selling a real product or service. Sure he can lose his shirt as well. But then governments are there to bail him out.

I am not a hard core leftist. On the contrary, I am a rabid fan of capitalism. Financial markets have an incredibly important role to play in raising capital and without these markets, we would be back to stone age. But that doesn’t prevent me from having some moral issues with it.

The reward equation for passive investment, or worse gambling, is completely wonky. What does it say of our society that rewards passive investment many times over productive work.

Can somebody shed light on the morality of all this please.

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