Settlements didn’t change Mr Weinstein, why would they change the banks?

I sincerely hope the world’s regulators have been watching the Harvey Weinstein implosion closely. If they put their mind to it, they might just learn a few things:

  1. If a man acts criminally and there are no material consequences, he will keep acting the same way
  2. Closed door financial settlements keep bad behaviour in the dark, and don’t deter further misbehavior
  3. On the other hand, some sunlight on criminality can very quickly remove a man from his position in power and polite society

Let’s hope the regulators do learn and start naming, shaming, charging  and jailing individuals for illegal activity.

Best chart of the year

Jeff Immelt has decided to step aside after 16 years at the helm of GE. During the period he fundamentally changed the nature of the business, yet shareholders haven’t seen the rewards. The internet is full of Welch vs Immelt comparisons, so no need to explore that here.

Jack Welch was a bit before my time, but I’ve seen his mug on book covers when browsing through bookstores around the world. I’ve never opened one of his books, but I can only assume it covers earnings manipulation in great detail, after seeing the below chart courtesy of a 2012 Business Insider article

Source: Business Insider

GE took a $50m fine in the early 2000s for accounting shenanigans. Remember when that was a big number?

What would similar earnings manipulation be worth in 2017?

“American Icon” is a great read

A lot of business books are rubbish. There are not that many great business ideas out there, and very few great ideas can justify an entire book. Reading what people have done is typically more informative than reading about what people think you should do.

Which brings me to Bryce G Hoffman’s “American Icon: Alan Mulally and The Fight to Save Ford Motor Company“.  This is a great book which will age well. There a few things I really liked about this book:

  1. An easy read. Bryce G Hoffman’s career in journalism certainly helped him write an engaging tale.
  2. Ventures into the “how”, not just the “what”. The descriptions of the Business Review meetings and the difficulty in changing the Ford culture are very insightful. Too many business books pay lip service to how change is made, this book doesn’t.
  3. Access to insiders. The book is compelling and insightful because it is more than an outside-in view of the business. Hoffman got access to the major players and Ford was supportive. This reads like a fly-on-the-wall business case study.

Below is the cover of the book (not a link), go to your favourite store / website and check it out.

Product Details

Property investors are killing it, sucks for everyone else


Our interactive guide to bricks and mortar across the world

Source: Daily chart: Global house prices | The Economist

People will claim it’s all about the fundamentals until it ends in tears.

Central banks and legislators need to assert control over retail banks. Start by preventing zero down-payment loans, and making all bank executives personally liable if their bank goes bust. Skin in the game, not fat bonuses until they cause a steep recession followed by a comfortable retirement.

Passive investing doesn’t remove the need to make choices

I’ve been thinking about the passive vs active debate for a while. There has been a clear shift towards low cost passive investing. Many personal finance bloggers are massive advocates of index investing, some preaching  very high exposure to US equities.  Bloomberg just published “5 ways ‘Passive’ Investing is Actually Quite Active” by Eric Balchuna. The media commentary seems to be shifting from a simple active vs passive argument, to a more nuanced discussion on what passive investing actually is.

When reading about personal finance / DIY investing online, it appears some people think passive investment removes choice from investing. That is, you don’t need to think about, or know anything about investing if you choose to invest passively. This is obviously not true. You need to make important decisions such as:

  1. Asset allocation decisions (e.g. equities vs bonds vs real estate vs cash)
  2. Geographic exposure decisions (e.g. Home country vs global)
  3. Index selection decisions (e.g. S&P 500 vs  S&P total US stock market)

The above 3 choices can have a profound impact on your long-term investment performance. To see the wide variation in 1Y, 5Y and 10Y returns across the 334 ishares ETFs go here.

In summary, passive investing is preferable for most retail investors, but it doesn’t remove the need to make choices.

Consequences or more pages?

Read William D Cohen’s piece on the mess which is Dodd-Frank. Surely severe consequences for criminal behaviour and true skin in the game (not outrageous options packages) would be more effective:

According to Davis Polk, the Wall Street law firm, the new regulations governing the banking system run to more than 22,000 pages of new rules, that’s on top of the 848 pages of the Dodd-Frank law—all of which is still in the process of being decoded, let alone understood, in the more than six years since the law was passed. Another 20 percent of the regulations mandated by Dodd-Frank still have not been written

Ignore the title of the article, it’s not a political piece.

Book review: Black Edge

Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street. (Sheelah Kolhatkar)

Stevie Cohen’s SAC Capital Advisors had delivered c. 30% returns for two decades. He was The Man, when hedge funds were still the new kings of Wall Street. Sheehan Kolhatkar has successfully woven together the tale of how the government tried (and plot reveal – failed) to put Stevie in the can. You should read this book, but you will be disgusted by: (1) How crooked some hedge fund managers (and their enablers) are; and (2) The fact the big fish got away.

The book also gives a small peek into the lifestyles of the rich and famous. The anecdote involving casino mogul Steve Wynn accidentally putting an elbow through his Picasso after he had sold it to Stevie Cohen for US$139m is particularly amusing.

Buy a copy by clicking on the link below.

Note: I may receive a small commission from Amazon if you buy the book after clicking on the above link.

Head to the “Books” page to see a collection of other books you may enjoy.

If investment managers aren’t focused on driving down costs now, they soon will be

Good chart and discussion on the flow to passive funds at Abnormal Returns. Investors are decisively moving towards lower fee funds:

No matter how you slice the data the shift into lower cost funds is firmly in place. The chart below shows the nearly monotonic relationship between fees and fund flows over the past year.

Investing exponentially

The article “Soft Bank CEO Masayoshi Son Banks on Exponential Growth”  by Vitaliy Katsenelson (Contrarian Edge) really made me think about how I invest. Soft Bank has been in the news recently for its US$32bn investment in Arm Holdings (at 48x earnings!) and its US$100bn technology investment fund. The CEO has proven a master at placing bets on companies in rapidly accelerating industries.

A younger Masayoshi Son

Source: Wikipedia

Before discussing Masayoshi Son’s investment approach further, I’ll provide a bit of background about my own investment philosophy. I believe an investment philosophy is crucial for those interested in personal finance and financial independence. As a non-professional investor, I’m a huge fan of using index ETFs for cheap and low hassle exposure to equities. However, I also think I’m a smart guy, who occasionally comes up with a good investment idea, so I like to do some non-index investing. I know I will struggle to beat the index over-time, but don’t care. In summary, my philosophy is “mostly use low cost ETFs, but leave room in the portfolio for some small bets”.

My view of the market at the moment is:

  • P/E multiples (particularly in the US) are outrageous, particularly for many low growth businesses
  • However, money has no-where else to go if people are seeking real returns
  • The low interest rate environment could last for decades. Government and corporate debt levels make significant interest rate increases unlikely (but not impossible)
  • For those with a long-term horizon, investing in equities remains a no-brainer
  • But, you have to accept the risk of multiple contraction which will reduce your portfolio’s value

I’ve been doing a lot of thinking about what types of investments I should pursue with my non-index fund allocation. Here is where I am at:

  • Making investment in individual companies which are unlikely to perform substantially better than the market is more expensive and higher risk than index ETFs – it is pointless
  • Macro investing at times of significant volatility is attractive, but often difficult to execute for non-professional investors (e.g. profiting from the oil price crash has proved difficult, Oil ETFs tracking of the price recovery has been dismal)
  • The growth of PE/VC means getting early access to fast growing companies is increasingly difficult for retail investors

Now back to Masayoshi Son. Vitaliy Katsenelson’s article summarises Son’s investment approach, which is based on exponential (non-linear) thinking:

To understand this acquisition [purchase of Arm Holding for US$32bn], we need to come to terms with Son’s investment strategy and his mental models that have made him the richest person in Japan. Son is a master of exponential (nonlinear) thinking. Examine his past investments and you’ll find that he identifies industries about to go from high but linear growth into the exponential phase — where the rate of growth is accelerating.

Son has done this over and over again during the past 40 years. It started with PCs in the ’70s, when he built a software distribution business in Japan to capitalize on PC growth entering the accelerating phase. He saw the inflection point of Internet growth in the ’90s, bet on Yahoo and created Yahoo Japan (a joint venture with Yahoo).

In the early 2000s he saw e-commerce and the Internet taking off in China and purchased a stake in Alibaba, turning his $20 million investment into $60 billion today…

Identifying industries that are entering an exponential growth phase is hard enough, but acting on the insight is even more challenging. I remember looking at a report on Apple in 2009, analyzing smartphones’ potential market size, assigning a conservative market share to the iPhone and basically saying that over the next several years Apple’s sales could accelerate (or continue at the then-current rate of 30 percent or so) and reach $100 billion from less than $20 billion that year. I saw the logic in the analysis, but it was difficult for me (and, I think, for most people) to mentally process a high growth rate going exponential. By the way, iPhone annual sales reached $155 billion in 2015.

Investing at the pivot point when growth rates accelerate is especially tough for value investors (present company included). As revenue growth accelerates, costs usually don’t rise as quickly, and therefore earnings increase at an even faster rate than revenue — now earnings growth is truly exponential. This dynamic creates a lot of value, which our linear brains may or may not process…

Son believes we are at the inflection point when the Internet of Things (IoT) market is about to enter the exponential growth phase. There are 7 billion people in the world today. In 2015, ARM sold 15 billion processors — about 2 processors per person. By 2020, ARM expects to sell 75 billion processors a year — a fivefold increase.

Do read the whole article, available here.

This is a more operational and nuanced approach than typical big picture thematic investing. After all, Son is running companies. He is buying for the medium to long term. He’s not just chasing momentum or short-term returns.

This article has made me realise I need to refine my framework for making my “small bets”. I should be looking for both shorter-term macro bets, and bolder longer-term exponential growth bets. As discussed above, identifying, timing and executing exponential growth bets is very difficult. I won’t be placing many of these bets over the years, but will remain on the look-out.