Death by a thousand cuts

Scale is the antithesis of specialization. A idea is boiled down to its core for implementation but once successful, pressure mounts to scale the thing and soon the core starts expanding. Before long, adjacencies get targeted and conquered – either directly or via partners (since the flavor of the season is extensible platforms, partners come in and implement the extension sometimes into areas that clearly challenge boundaries the founding fathers of the platform had conceived). The service starts behaving like an aggregator. Some platforms (they did not call themselves platforms then) started off as aggregators. Take market data terminals for example. They became aggregators the moment they started plugging in more and more exchanges liquidity venues, more newswires and more brokers. Common functionalities got overlaid so all incremental additions benefited from using those functionalities. Soon enough it became a mad scramble – add as much as possible, as much as the pipes would allow. Market data vendors started crisscrossing their content assets on different platforms. Very soon there were a couple of dominant players in the market who were mostly carrying all that was there to carry. So how does this model get disrupted?

Death can come in many ways. A single swift bullet often does not kill the incumbents in a deep seated market such as this (I would like to believe that what is true for the market data industry will also hold water with industries that display similar characteristics). Death comes by a thousand cuts. My colleague Kunal Mehta recently attracted my attention to Owlin. Owlin is a bottoms up news service that threatens to disrupt the market news vendors (like Reuters and Bloomberg) by scraping information off platforms where news tend to break quicker (‘break’ does not however mean verified. Anyone who has run a newsroom or consumes news for market price movement purposes must surely know the difference). If Owlin is successful then they would have inflicted an early cut (even if it does not and fails in the implementation, someone else will come up with a better way of reaching the same intended outcome). Aggregators also face threats of disintermediation – that is, a situation where competitors figure out the raw data source, get there and enhance value of the basic information more than what the aggregator does. In an era where information is reaching the public domain quicker than ever before, this is a clear and present danger for aggregators and a clear and present opportunity for disruptors. An area where aggregators yet have a moat is with content relationships. Over time, painstakingly they have built relationships with content creators who require a wide and effective distribution platform, which the aggregators have provided to them. Consider brokers who would want to maximize their distribution reach of research for investors but cannot make capital investment to build the infrastructure. They have been loyal (though slightly irritable) customers of aggregators for a long while (yes, this model can also be broken with a crowdsourced experts’ network but the actual moat here is not the content. It is credibility)

A thousand cuts is a nice phrase. It has an element of mortality to it but how useful is it for consumers in the industry that is getting slashed by the blades of the blind watchmaker? Aggregators make life easy for the users who make a trade off between convenience and the bleeding edge. It is acceptable to live with a sub-standard instant messaging system embedded in the aggregators’ system because it is just that much more easier to use that than a best of breed. History tells us that sooner or later the bleeding edge catches up. Early adopters who bravely withstand that pain of ditching the convenience factor are rewarded for their choice, leading to others following their footsteps. The small band behind the piped piper soon becomes a crowd. At a critical point of this crowd-swell people start thinking of mashups – where the best of breeds are brought together in a manner that the users can control (as opposed to ceding control to the aggregator). The integration, messy at the beginning start becoming elegant with passage of time with each micro-mashup (specific to an implementation) getting a development roadmap of its own

Unsurprisingly perhaps aggregators also see this situation via an identical set of optics. That is why the preponderance of building “extensible”, “open” (albeit walled garden) architecture platforms that are ready for the Great Bypass situation as and when it arrives. The next wave will perhaps be to acquire the bleeding edge capabilities (is that why rumors are rife – as are rebuttals of Bloomberg eyeing LinkedIn?)

Rumor Has It

There is this one thing that fascinates participants in Indian capital markets. So much, that it cuts across the Glass Steagal (pretty much non existent in India) wall between investment banks and brokerages. And also between brokers and asset managers of any shape, form or intent.

That one thing is rumor

“But you know what – that <insert name of vendor> is better because it gives me rumors. What is happening in the market I already know, boss”, is a common refrain I hear when one holds up the virtues of a particular information source I used to vend a few months earlier over another (everyone in India calls everyone else “boss” – it is all a very democratic structure). Interesting part was that it was understood – and accepted – that rumors will not always be true but it gave the marketman something to go with. A place to start. And engage in a playoff that had expected returns of a long run experiment of flipping a coin

The greater acceptance of rumors for investment and transactions is a bane in Indian capital markets. The practice puts greater emphasis on information arbitrage over painstaking research. Information arbitrage is a good thing when the game is played with insights drawn from equal primary sources – the edge bestowed upon skills of secondary research and applying analysis techniques more effectively. The easy access to rumors makes for very bad habits, which tend to not only die hard but also rots the core of business ethics

The rise of algorithmic trading implies unprecedented use of primary information by computer programs to trade securities. This in turn makes primary data almost useless for human initiated investment decisions. This actually should have been a positive step in the evolution of investment research but unfortunately there opened an easier access to arbitrage – rumors. Rumors which in several cases became impossible to distinguish from information possessed by a select few consequent to their proximity and exclusivity to the information. Yes, insiders

Information was – and even today is – not accorded its true value in India where the assumption is that any information should essentially come without any cost! Though the ambulance chasing capital market crowd is only too happy to pay for rumor. My personal point of view is that in the medium term this rot will deepen as information propriety is not very sacrosanct in corporate India. The process will correct itself when the law of large numbers take over in what is essentially a coin flipping exercise. Or when someone like Eliot Spitzer comes in with a large bottle of disinfectant

LinkedIn IPO: Peeling Back the Onion

I write a guest post for Startupcentral, India’s most authoritative venue for information on startup companies, VCs, PE players and deal making activity in that space. Read on…LinkedIn IPO: Peeling Back the Onion

Who’s Managing Your Money?

About an year back I was part of a team that studied the habits of Indian investors about how they manage their wealth. Some traits were common across the demographics – Advisors were not trusted (they are merely product pushers), too much information overload, no way to understand a 360 degree view of current wealth and so on. When it came to the high net worth individuals (those with an investible surplus of greater than five million US Dollars), there was another refrain that we heard several times. “I really don’t know much about the advisors. I have people to deal with them. They do everything for me”. This implied a commutation of trust – from the financial advisor to the personal assistant(s). I also had the opportunity to witness first hand how such personal assistants to high networth individuals are given VIP treatment by the wealth managers and get their own personal tasks executed by these wealth managers. It was quite evident that two things had happened. One, the power of wealth was surrogated to the gatekeepers who by definition should have played a mere fiduciary role on behalf of the HNI and two, the wealth advsiors were treating these gatekeepers as their client.

In light of the embezzlement that happened by a Relationship Manager at Citibank defrauding his clients – mostly high net worth ones – this not-so-subtle switch of relationships and power becomes important. It so transpired in the case that this Relationhip Manager had managed to get blank forms, power of attorneys and in some cases financial instruments signed by his clients which he went on to use in illegally moving funds from their accounts (included in this roster of clients is someone who had started Daksh and later sold it IBM. This person included Vikram Pandit in his police complaint). I suspect that at least in some cases the clients really had no idea of what they were doing, because there were gatekeepers. It also is not above suspicion if there were collusion between the Relationship Manager and the gatekeepers (nothing has come out on that as yet though). The promise made by the relationship manager to his “clients” was a 2-3% return per month. Now anyone, including my seventy year old mother, would know that such returns are just impossible (else, Puri, the relationship manager would not have been working for a salary). I find it difficult to imagine a conversation between Puri and Sanjiv Aggarwal that gets to this point and where Aggarwal pulls out his Mont Blanc and starts signing those blank forms. Such conversation between Puri and a gatekeeper with a promise of kickbacks – not too difficult to imagine.

The moot point here is that the supply side malaise in form of rogue advsiors is just one dimension of the problem. There is a structural demand side issue as well and this cannot be labeled as an education deficit challenge. The problem is with individuals surrogating their money management responsibilities to questionable fiduciaries and taking a hands-off approach. A systemic behavioral problem takes more time to solve than mere correcting operational principles, which Citi is probably doing right now.

How sustainable is my rally?

Indian stocks scaled this morning highs not seen since Jan 2008. The bellwether Sensex crossed 20,000 and the Nifty crossed 6,000 as soon as markets opened. Scaling big-figure marks in India – and possibly elsewhere – makes news, though the markets have fallen below those high-water marks in afternoon trade. Studying market components in any large up or down move provides interesting insights, mostly about the breadth of the market, the “flavors” and overall about the sustainability of the move. The graph below shows the CNX NIFTY in the past five years (Left axis, blue line) and the spread between % changes in the CNX NIFTY and CNX MIDCAP INDEX (spread measured in basis points, on the right axis, red line).

Typically one expects the mid-caps to expand faster in a rally (widening the spreads. As seen in the highlighted area of the graph), but this time around, even as the index has reached close to lifetime highs, this hasn’t been the case.

This could mean one of two things. One, investors have gotten smarter and not pushing valuations in the mid-cap space as large caps march ahead. Two, the frenzy is yet to begin. Take your pick.

PS: Deepak Shenoy has a trademark well-thought article on the markets.

Disclosure: I am net long in the market, though I have pared my positions substantially.

Managing your wealth

Every human act is served better with a goal. Lack of it is like driving aimlessly. You can chance upon a serene waterfall amidst a lush of green, but the odds are stacked heavily against you. The same goes for managing one’s money or wealth. One, however, has to consider some frame-of-mind issues before passing a blanket judgment. Example, a younger yet earning generation may not be so goal oriented in nature when compared to how a mature generation goes about wealth management.

There has been a recent spurt of online services providing goal oriented wealth management services (besides the promise of aggregating scattered repositories of wealth information to give a holistic picture). Most of these are North America based like Mint and FutureAdvisor. There are ones in India too like this and this

I have setup a poll to understand wealth creation processes. Your responses will help me better understand your inclination towards the wealth creation process

Image courtesy Rediff.com

Stocks at $0, 3 million percent price gains and fat fingers

“Today’s market was neither orderly nor efficient nor trustworthy. It was just a bunch of computers making ugly, messy love with each other. And your money hung in the balance.”, Evan Newman, WSJ

If it were September 2008 not many eyebrows would have frowned on the matter of the Dow dropping 1000 (998 to be fair) points. But one and a half years has made us and the VIX extremely complacent, so it was no wonder that the world went into a collective bellyache at what happened at Wall Street last night (night, yes, I am based in India and was blissfully sleeping when the psychedelic financial histrionics were happening in downtown Manhattan). So what happened exactly?

Stocks had started selling off at around 1430 hours and at around 1440 two large blocks of P&G shares (possibly sell orders) were put on for trade. P&G tanked by some $14 (on a base of $62) and it is entirely likely that algorithms took over and compounded the problem

Unlikely question at a quiz competition: What is common to the following stocks? Exelon Corp, Boston Beer, Accenture, CenterPoint Energy, TransMontaigne Partners, Impax Labs. Answer: All these stocks traded at $0 for a while (microscopic while, but still) yesterday. Penny stocks took a new and eerie definition on Wall Street

Some quarters believed that a possible stalemate from the UK Elections contributed to the sell-off. This is yet another instance of fitting facts to an outcome. Then there was Sothebey’s (BID) stock that opened trade at $33, pushed up to – hold your breath – $100,000, before closing at $33. Nice return for a day – if your trades do not get canceled!

Rumors have it that someone in Citigroup, with fat fingers (or weak hearing, or both) entered a trade to sell $16 billion of Dow Futures instead of $16 million. Here is a problem that I have often faced with the million-billion phonetics.  Without a very clear diction and the 100 Hz frequency set to the correct slot in your vocal equalizer, it is quite possible to mis-utter (and consequently have it mis-head) the denomination. It is an easy trap to fall into – this business of coining rhyming denominations – but if you were a trader on Wall Street yesterday you would know the pain. Note to whoever-it-may-concern: Zetabyte, petabyte and such are fine to make my friend’s two year old giggle, but just keep in mind this day. Interestingly, this is least likely to happen in India with its lakhs (ten to the power of five) and Crores (ten to the power of seven) convention of value, which are phonetically as far away as Mahmoud Ajamadinejad is from Hilary Clinton are on matters of foreign policy

Coming to India – in another few hours, a Supreme Court bench will pronounce judgment on the natural gas supply issue that is plaguing two large industrial groups – interestingly owned by two warring brothers (Mukesh Ambani controlled RIL, which is stalling gas supply to the Anil Ambani controlled RNRL, citing low prices). Obviously the market has made its call – it expects the verdict to go against RNRL (blue line in chart), which would be quite a shame

Image courtesy: Ghetty Images

Charts and Quotes: Yahoo! Finance

Large Cap, Mid Cap and Small Cap

A friend at Goldman Sachs quipped about the recent rally in small cap stocks in India. “Small caps are always the last leg in the bull market and the first leg in the bear market”, he professed. Conventional wisdom would tend to agree, but what about performance? I pulled the numbers for India and the graph shows two interesting points

1. Since 2009 – in the rally that looks like should correct some time soon, small cap performance > mid cap performance > large cap performance. No real surprises here
2. Since 2003, small and mid caps have actually risen more during bull markets compared to large caps and have fallen less during bear markets compared to the large caps. This is a touch unexpected

Please leave comments with your thoughts why this could happen.

Post Script 1: Since the great depression, US micro caps have returned twelve million percent profits. Go, beat that.

Post Script 2: This is the 100th post in this blog. You had the choice to read a thousand things on the internet. I am humbled that you chose to read me. Thank you.

Life After the Recession: The New World Order

Outlook Business, a noted business magazine published by the Outlook group, ran an essay competition. The theme was the subject of this post. My entry to the competition did not win the first prize (and hence wasn’t published by the magazine). This post was my submission – perhaps my readers will find it worthwhile to read.

The popular joke goes that the world will not be worse off if the weather-men predicted the economy and economists returned the favor. Dangers associated with predictions multiply manifold when the subject is the economy and the time horizon distant. However, with some generality it can be argued that the current financial calamity has three main protagonists. Prognosticating their behavior and roles should provide a reasonable understanding of what to expect when sunshine returns to warm up economies around the globe. The trinity of Capital Markets, Business Institutions and Governments form the core cast of this drama, and also subjects of our investigation.

Capital Markets

Capital Markets are sitting ducks when it comes to apportioning economic blame after a crisis and it has been no different this time around. In the current situation, some of it is deserved. Capital Markets famously failed their masters who relied too much on its self-correcting mechanism. All constituents of the markets brought in their share of economic and policy narcotics that created a heady cocktail and predictably left a global hangover the day after. As retribution, all constituencies will have to take body blows. The sell-side players have taken the most bullets and will emerge very different on the other side. It is entirely likely that a lot of specialized boutique investment and advisory houses will give serious competition to monolithic investment banks, which will struggle to bring the same easy-liquidity driven advisory-cum-financing value proposition of yester years.

The buy-side, i.e. investors, may learn that it is fallacious to ask a barber whether one needed a haircut. Unfortunately their woes are not entirely over. Their main parameter of decision making – instrument ratings from oligopolistic Rating Agencies – has been mired in incentive-conflicts and that is least likely to go away. Left with little choice, the investor fraternity will have to spend more in their internal due-diligence creating a model that may evolve in the same way as buy-side Research has over the past decade. And that could finally drown the Rating Agencies in the same way sell-side Research has been impacted in the past few years.

The direct or indirect impact of effort duplication or increased compliance invariably is increased costs. Even as a lot of OTC instruments make way into standard-claused-exchange-traded ones, higher cost of surveillance and risk management will lead to higher transaction costs for participants. The only bright lining to this silver cloud of gloom is Technology, which capital markets will embrace more than ever before. Increased reliance on algorithmic trading, automated routing to best liquidity pools, automated trading desks, cutting down latency between front office and middle office and such other will have many positive impacts. Given the declining cost structure of technology, wider adoption will offset other rising costs of doing business. Also, it will bring about a systemic efficiency in the flow of information and capital, resulting in lesser friction in the capital market machinery. All this till human fallibility drives us to the next crisis.

Business Institutions

Marketing Guru Seth Godin famously said (and named a book) – “Small is the new Big”. Disappearance of Lehman Brothers, General Motors and other household names in the broking business should prompt Godin to write a sequel. The recession has stripped the last garb off colossal conglomerates that held onto business models and ideas of the past as they lugubriously dragged their bureaucratic organizations nowhere. While transnational conglomerates will still flourish, their businesses and operations will reflect nimbleness of start-up companies. Divisional management structures will become predominant just so the fire of innovation, so often found lower down the ranks, is not dowsed by monolithic organizational designs. Smaller companies are now much less afraid of their T-Rex sized competitors because the downturn has clearly thrown up the latter’s vulnerabilities. These nimble, specialized, technocratic organizations will drive innovations in the post recession world. As example, the automotive industry will see numerous innovations across platforms, products and components with complete democratization of innovation – across functions, geographies and size of companies.

The recession has also brought under light a fair amount of hidden skeletons in corporate closets. Investors have every right to be peeved at appalling standards of corporate governance across the world. Unfortunately the long-only investor fraternity has little incentive to display the level of investor activism that would force better corporate governance and management. It is here that Hedge Funds and Private Equity investors, given their single-minded focus on generating alpha, will play a larger role in the future. Businesses that pride on good management and governance will be a step ahead in attracting the right kind of investors and at lower cost of capital.

Many commentators have predicted an economic (and hence political) demise of the United States. The more probable scenario however is a decline in the US’ relative economic strength  – both in terms of its share in global wealth and its currency. Once Americans start living within their means, the consumption deficit created by them will have to be filled by consumption-power and internal-demand centric countries like India and China (not Russia – it being a commodity centric economy). This shift of consumption will compel multinational businesses to look at these countries in a totally different light. Local strategies, local supply chains, local business models catering to local demographics and trends will gain prominence over blind replication of global practices. Local leaders and managers will not only become important for global organizations, but Boardrooms – and I daresay CEO suites – will see more Indian and Chinese names than ever before.

Governments

The trouble with Capitalism, they say, is that it is the only broken system that works. A fair number of economies around the world currently function as State owned capitalist machines (Marx must be tossing in his grave). This inherent dichotomy has resulted in Governments assuming three roles – namely, Shareholders (from covert or overt nationalization), Market Makers (buying up troubled assets and providing liquidity windows) and Policy Makers (traditional reason for having a Government). The first two roles are reluctant and thorny crowns that the rulers have been forced to place on their heads and they should relinquish these sometime soon. And they will. However, like a newbie investor who has tasted his first fruit of speculative profit, some Governments will be more inclined to intervene in businesses in the future citing current success as an excuse. Government policies are likely to face the conundrum of tactical supervision versus strategic foresight – and at least for the medium term that might be resolved in favor of the former. This will most likely result in either a proliferation of watch-dog agencies or increased government participation in these institutions or both. Long term nation building, especially for countries that need strong forward looking leadership, might suffer the most.

Perhaps the most quoted line in the context of change is Lord Tennyson’s – “the old order changeth yielding place to new”. Irrespective of how the new order shapes up, the fact that it will see increased regulation, state intervention and rising importance of countries blessed with demographic-dividend is most likely. Curiously, the cornerstone of this evolution can be traced back to the next line of the same Tennyson poem – “…and God fulfils himself in many ways, lest one good custom should corrupt the world”.  Laissez-faire market structures, over-leveraged personal, corporate and national lifestyles, and by-a-few-for-a-few style growth cannot be called “good customs” but they sure did corrupt the world. These are edifices the new world order will strive to stamp out.

Post Script: Gopal Ranganath, General Manager, Jet Airways, won the first prize in the contest. You can read his essay here. Yes, it deserved to win.

Image Courtesy: Blue Fountain Media

R.I.P. Peter L Bernstein

His book “Against The Gods” allured me into the exciting world of financial risk management. I have never invested in gold – and have advised, unsuccessfully, to all my women acquaintances – after the compelling arguments in his book “The Power of Gold: The History of Obsession”. In fact every book of his evoked thought and helped me understand the capital markets better. Peter L Bernstein – money manager, author, publisher and also a WW II spy – died on Friday at the age of 90.

I can only echo Justin Fox – I want to be like Bernstein when I grow up.

Rest in peace, Sir.