LEHMAN BROTHERS & THE EFFICIENT MARKETS HYPOTHESIS

AM | @Mackfinance

"A generalised mutual suspicion" — John Plender

There is a new book out on the Lehman Brothers crisis. The author is Oonagh McDonald. There is much praise for the book from the Financial Times' reviewer John Plender, although he complains about MacDonald's "harshness based on hindsight" (*). The most interesting part comes from the critique of the Efficient Markets Hypothesis:

MacDonald examines how, one weekend in September, Lehman went from being valued by the stock market at $639bn to being worth nothing at all. It did not require much to make Lehman go up in smoke. At the end of its last financial year, it was so highly leveraged that its assets had only to fall in value by 3.6 per cent for the bank to be wiped out. The response of these Wall Street wizards to the credit crunch that began in mid-2007 was pure hubris. Having survived episodes of financial turmoil when many expected the bank to fail, Mr Fuld and his colleagues decided to take on more risk. Meanwhile, they neglected to inform the board that they were exceeding their self-imposed risk limits and excluding more racy assets from internal stress tests.

The board, conspicuously short of expertise in risk management and financial plumbing, enthusiastically endorsed the policy. A strength of McDonagh’s book is that it recognises that this was really a property-based crisis. Much of the decline in the value of Lehman’s assets came from direct exposure to property. Because Lehman brought other banks into these transactions, word about the deterioration in the quality of its assets quickly spread. A generalised mutual suspicion about the value of other banks’ assets became a hallmark of the crisis. 

But the conclusion is a broader, provocative exploration of the concept of market value, in which McDonald tilts at the efficient market hypothesis that underlay much of the thinking in finance ministries, central banks and regulatory bodies before the crisis. This incorporates the notion that competition between market participants will ensure that prices reflect all publicly available information. It leads to the conclusion that bubbles do not exist, which in light of the crisis many find absurd.

(*) John Plender: "Lehman Brothers crisis: A crisis of value. By Oonagh McDonald", Financial Times, 15 February 2016.
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SOME ARTICLES ON BASEL, SYTEMIC RISK

AM | @Mackfinance

"A large range of uncertainty" — The Bank of England

. John Vickers: "The Bank of England must think again on systemic risk", Financial Times, 14 February 2016.
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NOW EVERYBODY TALKS ABOUT THE YIELD CURVE!

AM | @Mackfinance

"Curve inversion will come quickly" — Harvinder Sian

The yield curve, one of our favorite indicators, is making an astonishing comeback. Now everybody seems to talk about it! Here are some links to recent articles on the yield curve.

. Robin Wigglesworth: “Yield curve recession indicator sends warning on US economy”, Financial Times, 13 February 2016.

. Robin Wigglesworth: “US yield curve narrows to 8-year low”, Financial Times, 10 February 2016

. Bloomberg: “Citigroup: The Best Predictor of a U.S. Recession Will Resurface Sooner Than You Might”, 2 December, 2015

. Dean Croushore & Katherine Marsten: “The Continuing Power of the Yield Spread in Forecasting Recessions”, Federal Reserve Bank of Philadelphia, Research Paper No. 14-5, February 2014


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BUSINESS TO BUSINESS IN ASSET MANAGEMENT: INDEX PROVIDERS

AM | @Mackfinance

"Profits generated by index providers have risen significantly" — Chris Flood

. Chris Flood: "Profiting from passive aggression", Financial Times, 16 November 2015.
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THE ETF REVOLUTION: SOME NUMBERS

AM | @Mackfinance

"The growth is scary" — Anonymous ETF provider

. New record. The ETF market has set a new record for global asset gathering (inflows): some $372bn for 2015. In December alone, ETFs posted net inflows of $55bn, marking the 23rd consecutive month of positive net flows, according to research firm ETFGI. Over the past five years, the inflows reach $1.5tn after growing dissatisfaction with the high fees and widespread underperformance of actively managed traditional mutual funds.

. Total ETF assets. Total assets stand at $2.99tn—a figure consultancy PwC expects to hits $5tn by 2020.

. The Big Three. BlackRock, Vanguard and State Street Global Advisors together control more than two-thirds of the ETF industry's global assets and in 2015 grabbed 55% of the new cash allocated by investors to ETFs, according to ETFGI.

. Others. Some of the notable beneficiaries of investors' growing interest in ETFs include WisdomTree and Deutsche Asset Management, which both saw inflows to ETFs more than triple in 2015 compared to the previous year.

. Minimum size. ETFGI estimates that more than 6,100 ETFs are now available to investors globally, but around 70 per cent of those funds have less than $100m in assets, the minimum level generally regarded as necessary to break even.

. Innovation. Providers have to strive to be different. It is vital to have the right products in an increasingly crowded market place, to build ETFs that meet specific client needs. WisdomTree, the New York based manager, runs a pair of currency hedged European and Japanese equity ETFs that were two of the fastest growing products globally in 2015.

. Japan. Figures released by the Japan Exchange Group in February 2016 put the combined January trading value of all ETFs at record Y7.94tn—a 100% increase on the same period last year and a 53.4% month-on-month rise from December 2015. The increase in ETF traded volume was even more marked, jumping 128% year-on-year. (Note the role of the BoJ).

 Sources. ETFGI; PwC: "ETF 2020: Preparing for a new horizon"; Leo Lewis: "ETFs set Japan record", Financial Times, 3 February 2016; Chris Newlands: "Is it time to halt the rise of the ETF machine?" and Chris Flood: "Dominance of big three forces wave of innovation", Financial Times, 1 February 2016.
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PASSIVE ASSET MANAGEMENT: SOME NUMBERS

 AM | @Mackfinance

"The rise of passive managers continues unabated" — John Authers

Most active fund managers do not beat their benchmarks: nine out of ten actively managed European equity funds failed to reach their performance goals over the last decade. In the US, around 80% of large-cap equity managers fell short of their index targets over the same period. These statistics have helped fuel inflows into index-tracking funds, including Exchange Traded Funds (ETFs).

. In the US, 32.4% of long-term funds' assets are managed passively, with $4.52tn under management, against $9.44tn managed actively. The share has roughly tripled since 1998.

. In 2015. Within equities, $169bn flowed out of actively managed funds, with $102bn of that finding its way to passive managers.

. In 2015. Vanguard pulled in $221bn, while BlackRock, including the iShares division, took in $103bn. Most of the traditional active managers suffered big outflows.

. Most funds are actively-managed. Only 15% of fund assets globally are managed passively, but there is an accumulation of data showing that investors face disappointment with active managers.

. Massive under-performance in emerging markets. Fewer than one in five UK small-cap and sterling-denominated emerging market fund managers beat their benchmarks over 10 years. Almost 98 per cent of euro-denominated emerging market funds underperformed over the same period. Fewer than half of the 489 UK equity funds and 1,192 European equity funds that were launched 10 years ago have managed to survive.

Sources. John Authers: "Passive asset managers are good corporate stewarts", Financial Times (21 January 2016); Chris Flood: "Nine out of ten active funds underperform benchmark", Financial Times (25 October 2015).
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THE ECONOMIST ON EUROPEAN BANKS

AM | @Mackfinance

The Economist argues that US banks have cyclical problems, but European banks have structural ones. This is the article:

FOR those who worry that a repeat of the crisis of 2007-08 is imminent, this week brought fresh omens. Shares of big banks tumbled; despite a mid-week rally, American lenders are down by 19% this year, European ones by 24% . The cost of insuring banks’ debts against default rose sharply, especially in Europe. The boss of Deutsche Bank felt obliged to declare that the institution he runs is “absolutely rock solid”; Germany’s finance minister professed to have no concerns (thereby adding to the concerns). This is not 2008: big banks are not about to topple. But there are reasons to worry, and many of them converge on one country.

Start with the better news. Banks are more strongly capitalised than they were. Even in Europe, where lenders have been slower than their American counterparts to raise capital, banks have plumped up their core equity cushions from an average of 9% in 2009 to 12.5% in 2015. Managers at European banks are making a renewed effort to adjust to the post-crisis landscape. New rules on everything from capital to liquidity are forcing them to change. John Cryan, Deutsche’s newish co-chief executive, was brought in to trim its investment bank. He is jettisoning whole divisions, and suspended the dividend this year and last. Credit Suisse is undergoing similar surgery. Just now, this is weighing on the banks’ share prices. Yet, however painful for investors, the sensible goal is ultimately to create slimmer, safer, more profitable outfits.

Also salutary, if painful, is how investors in bank debt are coming to understand that they bear greater risk than they did. New European rules that came fully into force at the start of this year stipulate that troubled banks must deal with capital shortfalls by “bailing in” holders of bank bonds before any call is made on the taxpayer. The chance that bondholders might lose money suddenly seems more real. The turmoil at Deutsche this week stemmed partly from fear that the bank might struggle to pay interest next year on a type of bond that is designed to act as a buffer in a crisis. There are some design flaws in the bail-in regime, but the possibility that European banks are at last repairing themselves at a cost to their investors is the silver lining to this week’s spasms.

The clouds, alas, still loom. One source of anxiety is the health of the world economy. The factors that spook markets more broadly—the slowdown in China, plunging commodity prices and indebted energy firms, political upheaval from Greece to New Hampshire—all weigh heavily on banks in particular. Banks do well when the economies they serve are growing, and miserably when they are not. The receding prospect of higher interest rates leaves American banks with less hope of widening the margin between the rates they pay depositors and what they charge for loans. In Japan, where bank shares have fallen by 24% this month, and Europe central banks have imposed negative rates, in effect levying a fee on some reserves—one that banks have not yet been able to pass on to depositors. With the economic outlook growing gloomier, margins being squeezed and restructuring costs still hitting profits, investors have good reason to fret.

Worse, some countries appear to have taken so long to deal with their banks that they will now struggle to clean them up at all. The IMF reckons that the total amount of non-performing debt in Europe was around €1 trillion ($1.13 trillion) at the end of 2014. Bail-in is an especially ugly prospect in countries where bank debt is owned not only by diversified financial institutions but also by local retail investors. Under such conditions, politicians may find that they cannot force the cost of cleaning up balance-sheets on voters without causing uproar.

Rome is where the hurt is
No country is more impaled on this dilemma than Italy. The gross value of non-performing loans makes up a whopping 18% of their total lending; retail investors own some €200 billion of bank bonds, equivalent to 12% of GDP. A government plan to buy bad debts from the banks at close to face value would fall foul of European rules against “state aid”. But selling the loans at a significant discount would force Italian banks to recognise losses, some of which could be borne by retail investors. The prime minister, Matteo Renzi, headed down this road late last year, when the efforts to save four small banks clobbered the savings of individual Italians and seemingly resulted in a high-profile suicide. He will not want to do so again.

The European Union and the Italian government recently agreed on a half-baked alternative to bail-in, though few think it will cleanse banks’ balance-sheets. Instead Italy seems trapped between the rock of hurting small savers and the hard place of a banking system strangled by bad debts. If Mr Renzi cannot negotiate his way round the new rules on bail-in, Italy’s banks and economy risk years of more stagnation, poisoning relations with the EU. Behind this week’s banking headlines is the threat of something very bad coming out of Italy.
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SUPER-BOWL ADS: DATA POINTS

AM | @Mackfinance

"Adverstisers should consider doing strong digital marketing during that period" — Anne Lewnes

There is a guaranteed, built-in audience that will be not only watching the game, but talking about the advertising. Consumers recognise that, historically, advertisers have upped their game during the Super Bowl, that they will pull out all the stops to try to entertain them and that they’ll get to see something new. This year 40 brands will be doing just that, having bought airtime from CBS for a slot in Super Bowl 50 and they will all be jostling for the public’s attention. “Culturally, the Super Bowl may be the one time a year when advertisers are actually invited to the family rooms of American households. Ads become central.

Consumers knows the ads will be new and entertaining and also understand the high costs for each commercial creating added interest,” added Bill Tucker, executive vice president at the Association. “The Super Bowl serves as the centre of gravity and grand finale of extensive integrated cross platform marketing programs that includes promotion, in store marketing, advertising and social buzz with huge extensions leading up to the game. The return on investment continues to be heavily analysed by advertisers and is paying off for them.”

Some data points about Super-Bowl ads (*):

. $10 million for one minute. When is 30 seconds worth $5m? That is the question facing Super Bowl advertisers as they gear up for February 7, the biggest day in US marketing. The price tag that broadcaster CBS is charging for a television commercial for this year’s National Football League championship game is double the average $2.5m price a decade ago, according to Kantar Media.

. $5.9bn spent. According to Advertising Age companies have spent $5.9 billion on commercials since the first Super Bowl in 1967.

. 110 million viewers expected. Last year’s clash, where the New England Patriots snatched victory at the death from the Seattle Seahawks, attracted the biggest television audience in American history, 114.4 million viewers and was watched in 71 per cent of homes. By the time of the winning touchdown, there were more than 120 million people glued to their screens.
 
. 114 million viewers in 2015. But the game regularly breaks US TV viewing records, with 114m people tuning in last year. This Sunday’s pie will be even bigger, as CBS will for the first time make its livestream of the game and all national commercials available over internet TV boxes including Apple TV and Roku. Advertisers are already teasing their ads well before game day, using digital channels to extend their reach.

. 14 million hours of Super-Bowl ads. YouTube touts its metrics which show that advertisers that put up their ads early on its AdBlitz site get twice the views and three times the social shares as those that wait to release their ads during the game. Last year, people watched 14m hours of Super Bowl ads on YouTube, with 60 per cent of viewers tuning in on mobile phones. “We have stopped thinking about the Super Bowl as a one-day event. Our campaign starts when the NFL season starts,” says Ram Krishnan, chief marketing officer at PepsiCo’s Frito-Lay, maker of Doritos and other snacks.

. 60% jump in website traffic. Adobe, the software maker, estimates that brands that advertise during the Super Bowl see traffic to their websites jump more than 60 per cent, a boost that can last for more than three weeks after the game.

. 25 days of viral afterlife. “Advertisers should consider doing strong digital marketing in that period,” says Ann Lewnes, chief marketing officer. The most popular Super Bowl ads have a viral afterlife on social media that lasts on average 25 days, she added.

 

(*) Shannon Bond: "Super Bowl ads capitalise on bumper day with new angles", Financial Times, 6-7 February 2016. David Millward: "Superbowl: the biggest advertising show of all", The Telegraph, 7 February 2016.
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SUPER-BOWL ADS: U2 & BANK OF AMERICA

AM | @Mackfinance

"An example of creative capitalism" — Bill Gates

A sign of the times: between 2008 and 2013 there was not a single Super-Bowl ad from a financial services companies. In 2015, US insurer Nationwide was the second-most mentioned brand on Twitter during the game, according to Salesforce Marketing Cloud. But three-quarters of those conversations were negative as viewers vented their disgust with Nationwide's ad about a dead child, and the insurer had to issue an apology. The company is sitting out this year's game.

The 2014 ad from BankofAmericaMerrill Lynch is particularly interesting; it is about cause marketing or cause sponsorship. As such, it contains no information at all about financial services. This is from the Financial Times in early 2014 [1]:

The BoA ad will declare that for 24 hours everyone can download a new song from U2, ‘Invisible’, for free. The bank will then donate $1 for every download to a global fund to fight Aids, organized in association with Red, the philanthropic group co-founded by Bono. This comes on top of a $10m ‘simple’ donation from BoA. Brian Mynihan: ‘This is an advdertisement but it’s not really an ad … The aim is to create heat and energy’. Banks such as BoA have strong motives to ‘engage’ in innovative ways. A poll by Edelman, the public relations company, suggests that half of all consumers distrust banks.

The philanthropic sector is under pressure to become more innovative too. Government aid budgets are being cut and the attention span of consumers –or donors- is becoming more fickle. Of course this approach is not without risks for both sides. Bono, for example, admits that U2 was initially wary about embracing a bank. Bono: ‘When we looked at BoA and go to know Mr. Moynihan, we saw that values were important to them and they were trying to compensate for the financial mess’. There are more rumors at Davos that more deals are being discussed.

Recently, the FT came back to this topic with a Bono interview about 'conscious consumerism':

It is a decade since the star went to the WEF to launch Red, the brand campaign that began with the aim of ending the transmission of HIV/Aids from pregnant women to their unborn children. Described by Bill Gates as an example of “creative capitalism”, Red’s early partners included Starbucks, Apple and Nike, which made products under the Red brand and donated proceeds to the fight against Aids in Africa. The campaign has over the past 10 years raised more than $350m. “Corporate social responsibility is a phrase that is in common usage now but it wasn’t back then,” Bono says, speaking to the Financial Times on the telephone from “bubblin’ Dublin”, the day before flying to Davos.

An aim of Red, which he dreamt up with Bobby Shriver, a US lawyer and nephew of John F Kennedy, was to engage companies, and their customers and employees, in the fight against Aids, encouraging them to make and market Red-branded products, rather than just write a cheque. “Red understood early on that corporate social responsibility was not just for how companies gave their money but also for how companies make money.” Now, the challenge facing Bono and Red is the next decade. New partners have signed up, notably Bank of America, which in 2014 pledged $10m to Red, donating $1 for every free copy of the U2 track “Invisible” downloaded the day of that year’s Super Bowl. The bank recently pledged another $10m and has embarked on initiatives that include displaying at its ATMs images shot by the photographer Rankin of HIV-positive mothers and their children, who were born HIV-free thanks to their mothers taking antiretroviral medication.

“If we can get these drugs consistently into the hands of these mothers they will not transmit [the disease] to their children and we can cut off its growth,” says Brian Moynihan, Bank of America’s chief executive. Bono says the money Red has generated is “critical to the people whose lives it is saving”. As important, he says, “is the heat, the excitement”, the campaign has generated in terms of enlightening people who may never have thought twice about the Aids epidemic. “You can go to a Bank of America ATM now in Toledo, Ohio, and see a picture of children born without Aids because of Red. That has an effect.”

[1] Gillian Tett: “How Bono and B0fA made sweet music”, Financial Times, January 31, 2014. Note that the article appears in the very same issue of the FT where BofA’s $8.5bn settlement is discussed! 

[2] Matthew Garrahan: "Bono surveys a Red decade of conscious consumerism", Financial Times, 21 January 2016.
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CLOSET TRACKING

AM | @Mackfinance

This is quite an interesting story, with many different angles to it: asset management styles (passive v. active), legal risk, ethics, etc. More material to be posted soon! The Aberdeen Asset Managament story is particularly noteworthy; close tracking or not, active asset managers find themselves under a lot of pressure.

. Madison Marriage & Attracta Mooney: “EU probe into asset managers uncovers potential mis-selling”, Financial Times, 2 February 2016. 

. Madison Marriage: "Watchdogs attempt to force trackers out of closets", Financial Times, 16 November 2016

. David Rockets: "Name closet trackers, European regulator told", Financial Times, 8 February 2016.

. Attracta Mooney: "Aberdeen cuts fees on emerging markets fund", Financial Times, 8 February 2016.

. Lex: "Asset managers: out of the closet", Financial Times, 22 January 2016.

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FOUR STORIES ON VALUATION

AM | @Mackfinance

[1] Stocks are risky! The key take-away from the market turmoil so far in 2016 is a reminder that stocks are risky (*). Indeed! Here's Prof. Damodaran:

The global equity markets collectively lost $5.54 trillion in value during the month, roughly 8.42% of overall value. The global breakdown of value also reflects some regional variations, with Chinese equities declining from approximately 17% of global market capitalization to closer to 15%. The good news is that there have been dozens of months that delivered worse returns in the aggregate. In fact, the US equity market's performance in January 2016 would not even make the list of 25 worst months in US market history. What I learned from January 2016 is that stocks are risky (I need reminders every now and then), that market pundits are about as reliable as soothsayers, that the doomsayers will remind you that they "told you so" and that life goes on. I am just glad the month is over!

(*) Aswath Damodaran: "January 2016 data update", Musings on markets, 1 February 2016
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[2] Platform companies. Morgan Stanley analyst Kate Huberty recenly argued that Apple would command a forward P/E multiple of 18x if valued as a "large-cap platform company across industries"; however, the forward P/E multiple would tumble to 13x if the company were to be valued as a large-cap IT harware vendor. But what is a platform company? The FT has been publishing some interesting articles on this topic: "In its simplest form, a platform company is one that expands by constant acquisitions, usually powered by huge debt ... basically a company dependent on acquisitions for growth, taking advantage of cheap borrowing costs to buy up businesses to expand quickly. The recent travails of hedge fund manager Bill Ackman (of Valeant fame) has led him to admit: "We believe 'platform value' is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than ... other assets" (*).

(*) Arash Massoudi, Miles Johnson & Dan McCrum: "Platform party topples over into hangover" Financial Times, 2 February 2016.
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[3] Platform companies & short-sellers. Short-sellers, understandably, do no like platform companies. Here's Jim Chanos: "They're investment banking-driven. Those roll-ups are just huge fee payers to Wall Street". This is from the FT (*):

Valeant Pharmaceuticals, Altice, Platform Specialty Products and Nomad Foods have all grown rapidly by making a string of big acquisitions facilitated by record-low interest rates. That activity has placed these platform companies among the leading participants in the overall mergers and acquisitions boom. Since August, shares in each of the four have fallen by more than 50 per cent, as investors began to take fright at their heavy debt burdens and ability to grow without further deals. Valeant, Altice, Platform Specialty and Nomad have a collective debt burden of $78bn at a time when the cost of corporate debt has been rising. The $1.1bn in fees paid by the four companies since 2013 is a significant revenue source. The figure is roughly equal to the amount of fees paid by Swiss based corporations in 2015 and close to the total fees made from South and Central America over the same period. Valeant has paid $398m in total investment banking fees since 2013, a figure which includes payments to banks that helped fund, advise and underwrite its debt-backed expansion. The largest recipients of fees from Valeant were Goldman Sachs and Deutsche Bank, which received $60m and $48.5m respectively, according to estimates from Thomson Reuters and Freeman Consulting.

(*) Arash Massoudi, Miles Johnson & Dan McCrum: "Wall Street the winner as four 'roll-ups' spend $1bn on investment bank fees", Financial Times, 2 February 2016.
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[4] Accounting reforms. A new IASB financial reporting standard is likely to have implications about the way revenue and leases are accounted for:

All will have an impact on investors, as they have the potential to affect lending arrangements, dividend policies, tax planning and share prices. They also represent a step up in regulatory co-operation between the US and international standard setters. Converging the different corporate reporting frameworks has been fraught. While the two regulators were largely able to agree on the revenue recognition and lease accounting standards, attempts to agree a common base for assessing financial instruments failed in 2014 ... However, it is the new standard for accounting for leases — known as IFRS 16 — that is arguably the most important, because it ends a practice that investors claim has hidden assets and liabilities from plain sight (*).

(*) Kate Burguess & Harriet Agnew : "Accounting’s big shake-up to bring more transparency", Financial Times, 21 January 2016
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ETHICS IN THE FINANCIAL WORLD: ARTICLES, LINKS

AM | @Mackfinance 

. Tom Mitchell: "Chinese police need diggers to unearth 'Ponzi scheme' that that took alleged $7.6bn", Financial Times, 2 February 2016
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. Pan Kwan Yuk: "Wells Fargo to pay $1.2bn over loans case", Financial Times, 3 February 2016

Wells Fargo had been in talks with the US Department of Justice, the Department of Housing and Urban Development, the US Attorney in the Southern District of New York and the Northern District of California for more than a year over allegations that it improperly certified certain mortgage loans that did not qualify for insurance under the Federal Housing Administration (FHA) between 2001 and 2010. The government alleges that Wells Fargo should not have received insurance proceeds when some of the loans later defaulted.
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. Laura Noonan: "JPMorgan pays almost $2.5bn to settle legal disputes", Financial Times, 26 January 2016.
 
 JPMorgan Chase will be left almost $2.5bn out of pocket after the US bank finally settled two of its biggest legal headaches left over from the financial crisis. Insurer Ambac said on Tuesday that it would receive almost $1bn from the bank to settle a long-running lawsuit about the sale of mortgage-backed securities. The news came just hours after court filings revealed that JPMorgan would pay $1.42bn to end most of its remaining disputes with the estate of the defunct Lehman Brothers. The bank issued stock exchange statements saying that neither settlement would “materially” affect earnings for the first quarter. The Ambac lawsuit centred on mortgage-backed securities sold by an arm of Bear Stearns, which JPMorgan acquired in 2008. Ambac alleged that the Bear Stearns unit misrepresented the securities. Court documents showed one Bear Stearns employee referred to some of the securities as a “sack of shit”.

Note 1: on January 24, FT informs that Goldman Sachs paid a $5.1bn penalty for "mis-selling mortgage-backed securities".

Note 2: example of a 'shitty loan'? Quicken Loans was sued on claims that it had fraudulently originated loans: "...abuses such as Quicken endorsing a loan from a borrower who requested a refund of the $400 application fee so she could afford to feed her family. She ultimately made only five mortgage payments before defaulting, costing the government about $94,000 in insurance claims" (Peter Rudegeair: "At Quicken Loans, a Will to Do Battle", Wall Street Journal, 16 June 2015)
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. Gina Chon: "JPMorgan fined $330m for misleading clients", Financial Times, 19-20 December 2015.

JPMorgan Chase has been ordered to pay a $307m penalty for failing to disclose to clients that it was steering them to the bank’s own investment products rather than those offered by rivals.The bank agreed to pay $267m to the Securities and Exchange Commission and admitted wrongdoing in settling charges, which found JPMorgan failed to disclose conflicts of interest to wealth management clients.
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. Joseph Cotterill: "KKR pays $30m to settle disclosure charges", Financial Times, 30 June 2016

The firm “thus, breached its fiduciary duty as an investment adviser”, the order added. “This resolution, which relates to historical expense allocation disclosures and policies and not to any current practices, allows us to focus on delivering value for those who invest with us,” KKR said in a statement. “We take our fiduciary responsibilities seriously and have strived to adapt our policies and practices to the changing nature of the industry, market and our business,” it added.
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BOOKS. CORPORATE GOVERNANCE & THE VALUE OF INDEPENDENCE

AM | @Mackfinance

Andrew Hill, from the indispensable Financial Times, publishes a review of sorts of Jeff Gramm's book Dear Chairman. Board Battles and the Rise of Shareholder Activism (New York: HarperCollins, 2016) (*). Gramm —a hedge fund inversor and a professor at Columbia Business School — tells the story of shareholder activism in the US from the 1920s to today. Hill singles out the battle between GM CEO Roger Smith and independent director Ross Perot about the ill-fated acquisition of Hughes Aircraft; he puts forward "the value of true director independence". From the editors:

A sharp and illuminating history of one of capitalism’s longest running tensions—the conflicts of interest among public company directors, managers, and shareholders—told through entertaining case studies and original letters from some of our most legendary and controversial investors and activists. Recent disputes between shareholders and major corporations, including Apple and DuPont, have made headlines. But the struggle between management and those who own stock has been going on for nearly a century. Mixing never-before-published and rare, original letters from Wall Street icons—including Benjamin Graham, Warren Buffett, Ross Perot, Carl Icahn, and Daniel Loeb—with masterful scholarship and professional insight, Dear Chairman traces the rise in shareholder activism from the 1920s to today, and provides an invaluable and unprecedented perspective on what it means to be a public company, including how they work and who is really in control.

Jeff Gramm analyzes different eras and pivotal boardroom battles from the last century to understand the factors that have caused shareholders and management to collide. Throughout, he uses the letters to show how investors interact with directors and managers, how they think about their target companies, and how they plan to profit. Each is a fascinating example of capitalism at work told through the voices of its most colorful, influential participants. A hedge fund manager and an adjunct professor at Columbia Business School, Gramm has spent as much time evaluating CEOs and directors as he has trying to understand and value businesses. He has seen public companies that are poorly run, and some that willfully disenfranchise their shareholders. While he pays tribute to the ingenuity of public company investors, Gramm also exposes examples of shareholder activism at its very worst, when hedge funds engineer stealthy land-grabs at the expense of a company’s long term prospects.

(*) Andrew Hill: "Lasting lessons from smug CEOs and somnolent shareholders", Financial Times, 2 de febrero de 2016.
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SOME ESG-RELATED LINKS

 . Financial Supervisory Board announces membership of Task Force on Climate-related Financial Disclosures [see]

. Mike Scott: "Investors seek ethical benchmarks", Financial Times, 16 November 2015. 

. Attracta Mooney: "Sweden to force disclosure of climate impact", Financial Times, 23 November 2015.

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CME Group Ads

CME Group ads

P2P LENDING: RESOURCES, LINKS, ARTICLES

Company websistes

. Imagine Bank (CaixaBank)

. Spotcap


General Fintech stories


. FinTechExchange 2016 [see]

. Laura Noonam: "Fintech developers seek place on global map", Financial Times, 27 January 2016

. Ben McLannahan: "Lending Club grapples with rise of rival disrupters", Financial Times, 27 January 2016 [hard copy]

. Gillian Tett & Isabella Kaminska: "Blockchain eclipses Basel III as fintech sets Davos abuzz", Financial Times, 22 January 2016 

. Martin Arnold: "Caixabank launches mobile-only service for millenials", Financial Times, 15 January 2016

. The Financial Brand: "The 10 Most Popular Digital Banking Articles of 2015" 

. Kadhim Shubber: "The former big beasts of Wall Street who are shaking up banking with fintech investments", Financial Times, 15 December 2015 [hard copy]

. Morgan Stanley: "Can P2P Reinvent Banking?", 17 June 2015


On P2P Lending in China:

. James Kynge: "China’s P2P lending risks ripple through the economy", Financial Times, 1 February 2016

. Gabriel Wildau: "Shanghai P2P lender Lufax raises $1bn", Financial Times, 19 January 2016 [hard copy]

. Don Weiland: "Chinese companies turn to internet and P2P lending to auction bad debts", Financial Times, 29 January 2015 [hard copy] 

. Gabriel Wildau: "Democratizing finance: China's P2P industry attracts scammers", Financial Times, 28 January 2015

. Tom Mitchell: "Chinese police need diggers to unearth 'Ponzi scheme' that that took alleged $7.6bn", Financial Times, 2 February 2016 


On Fintech and Ethics:

. Sohpia Greene: "Quants are the new ethical investors", Financial Times, 25 January 2016

. Burton G. Malkiel & Adam Nash: "Creative Destruction at America's Brokerages", Wall Street Journal, May 4, 2015 
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APPLE & THE NARRATIVE (II)

Here's the second article on Apple and the narrative. Richard Waters: "Apple flitchs the wrong switch", Financial Times, January 29, 2016

Sometimes, giving investors extra insight into a promising new line of business works wonders with Wall Street. But sometimes it does not — as Apple has found to its cost this week. Getting the trick right is of special concern in the technology sector, where established businesses often mature quickly. Having a new story to tell can help investors look beyond a company’s plateauing fortunes. When it comes to using extra financial disclosure to change perceptions, Amazon has become the tech world’s gold standard — somewhat ironically, given its reputation for secrecy. Since it first revealed details last April about Amazon Web Services, its cloud computing sideline, the company’s stock market value has risen by nearly $100bn. Amazon waited until the business was both sizeable and unexpectedly profitable before lifting the lid.

Alphabet, the holding company for Google, has achieved a similar effect with the promise to break out its non-search businesses with its next results on Monday. The purpose here is different: to show off the strength of its core search operation and to demonstrate greater discipline by not shielding the losses of its other activities. But when it comes to Apple, the magic has worn thin. The company’s attempt to draw attention to its services business — which, at $6bn in the latest quarter, produced more in revenue than Amazon Web Services for the first nine months of last year — did nothing to prevent a near-7 per cent slump in the share price on Wednesday. Much comes down to timing. Amazon and Google prepared Wall Street carefully, stoking anticipation for months. Apple, by contrast, dropped its news unexpectedly on a wary investor base. It was hardly surprising that Wall Street chose to see the extra, unexpected disclosure as an attempt to distract attention from what is set to become the first contraction in iPhone sales. 

The data presentation also seemed halfhearted. Apple executives sought to compare their services business with that of a sizeable, freestanding internet company. But they made little attempt to explain a grab bag of businesses that make up what the company calls its “installed base related revenue” (IBRR). These range from the net revenue on App Store sales to supplying replacement iPhone screens and licensing its brand to accessory makers. But Apple declined to lay out a bigger vision for how the services business was likely to evolve. It also did little to counter perceptions that glitches in areas such as its maps app and iCloud back-up and syncing service showed it had yet to match a pure internet company such as Google in terms of quality and reliability.

As iPhone sales go into decline, the group is determined to show it is more than a hardware company.

In the absence of a clear explanation, investors have therefore chosen to view Apple’s service business in the same light as those from hardware makers such as Xerox: a potentially profitable supplement to the core business, but not something likely to grow into a major revenue source that justifies a premium valuation. Despite the shortcomings, services are likely to remain a high-growth bright spot for Apple, not just in the rest of 2016 but for a considerable period of time. That is partly because of slowing hardware growth. Global smartphone shipments will rise at an average annual rate of around 7 per cent in the medium term, according to research firm IDC. Falling prices will put a lid on overall revenue growth, and economic uncertainty threatens the premium end of the market. With little sign that products such as television set-top boxes and smartwatches will become sizeable new hardware categories in their own right, the attractions of services will loom ever larger.

The gatekeeper status conferred by the App Store is already significant. Apple paid more than $14bn last year to app developers and companies selling content through iTunes, an increase of 36 per cent. If it takes around a 30 per cent commission on these sales, then the App Store and iTunes accounted for more than a third of the money it made last year from selling things to its installed base, and virtually all of the growth. This income source will loom larger as it grows, eclipsing other businesses with less potential. It looks like a promising sign of what could grow into a meaningful source of profits. But the reaction to Apple’s disclosures this week suggests that investors do not believe the company is ready to move decisively beyond its hardware business model.
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APPLE & THE NARRATIVE (I)

Let us start with Prof. Damodaran: "Every valuation, even though it's about numbers, has a story, a narrative behind it. A good valuation is more about the story than about the numbers" [VIDEO]. This is precisely the problem faced by Apple. There are two Financial Times stories that deal with this issue. The first is by Tim Bradshaw: "Apple seeks app to change percepction about its core business", Financial Times, January 27, 2016. It is reproduced below. And this was Lex's comment: "Telling a different story with new details on the business -particularly if, as in this case, it happens to be true-, is a legitimate stock boosting tactic. Just as hitting the debt markets hard in order to return additional tens of billions of dollars in cash to sahreholders."

Here's Tim Bradshaw's article:

Apple does not like to be thought of as “the iPhone company”. Back in 2011, co-founder Steve Jobs declared that “technology alone is not enough — it’s technology married with the liberal arts, married with the humanities, that yields us the results that make our heart sing”. Tim Cook, Jobs’ successor as chief executive, is less given to lyricism but has often repeated the mantra that “only Apple” can combine hardware, software and services into a single cohesive whole.“We haven’t been a hardware company since I’ve been with Apple,” he told a Goldman Sachs tech conference last February. “I don’t think Apple was ever a hardware company, even at the beginning.” Yet despite the efforts to persuade them otherwise, Wall Street investors tend to see — and value — Apple as a hardware company. And when growth in its most lucrative piece of hardware is about to go into reverse for the first time, they punish its share price accordingly: Apple has lost about a quarter of its value since it hit an all-time high last February. 

On Tuesday those fears were confirmed: iPhone sales grew by less than 1 per cent last quarter and Apple warned that overall revenues were about to see their first quarterly decline since 2003. Its shares closed 6.6 per cent lower at $93.44 on Wednesday — its lowest point since mid-2014. So the company is taking a new approach to spreading its message that it is not going to go the way of BlackBerry and Nokia. Alongside Tuesday’s earnings, Apple published new data to highlight the scale and pace of its services business, led by the App Store. It also disclosed that more than 1bn Apple devices were in active use over the last 90 days, including iPhones, Apple Watches and Macs. “We have a huge number of devices actively engaged with our services and that number is growing very fast,” Luca Maestri, Apple’s chief financial officer, told the Financial Times. 

He pointed to figures showing that “install base related purchases” — a new metric that includes customers’ spending on apps, music and movies before Apple pays out a roughly 70 per cent share of the revenue to their creators — increased by 23 per cent last year to $31.2bn. This metric rose by 24 per cent in the December quarter, even as iPhone sales plateaued. “A high portion of services business is directly related to our install base and not to our shipments or current quarter sales,” Mr Maestri said. “This part of our business — which is very much recurring in nature because it’s related to the install base — is actually quite large, it’s growing very fast and it’s also quite profitable.” The timing of the disclosure, alongside the warning of the iPhone’s decline, was not lost on observers. “They are trying to change the narrative,” said Ben Bajarin, analyst at Creative Strategies. “They are trying to tell the story that they are not just a hardware company. But Wall Street will only believe that when they show them the money.” 

Changing the perception that Apple is dependent on the iPhone may take some time. Even with services growing much more rapidly than hardware sales, the iPhone still made up 68 per cent of Apple’s total revenues in its latest quarter — less than 1 percentage point below the same period a year earlier. Apple’s $5.5bn in services revenues last quarter made up only 7 per cent of total sales. Revenue from apps, iCloud and other services may be small by the standards of what is still the world’s biggest company by market capitalisation. But that single quarter for Apple services was larger than Yahoo’s sales are expected to be for the whole of last year, and on par with what Facebook is likely to report for its fourth quarter. “If you look at other internet services companies, they enjoy a different multiple” to Apple, Mr Maestri said — a much higher valuation for each dollar of profit. 

As iPhone sales go into decline, the group is determined to show it is more than a hardware company.Investors tend to prefer businesses that sell software or services to hardware vendors because they are less prone to the wild fluctuations in growth that Apple has seen in recent years. “The key thing Apple is trying to get across here is that analysts have it wrong when they say that Apple’s revenue is inherently unpredictable,” said Jan Dawson, analyst at Jackdaw Research. But a direct comparison between the likes of Facebook and Alphabet, Google’s parent, is still not possible based on the figures Apple released on Tuesday. For one thing, the company’s internet business is based mainly on consumer purchases whereas its Silicon Valley neighbours rely on free, advertising-funded services. Unlike Google and Facebook’s standard measure of monthly unique users, Apple’s billion-device figure inflates the number of individuals who buy those apps by counting one person who owns an iPhone, an iPad and an Apple Watch as three constituents of its “active install base”. Mr Bajarin estimated that the actual number of unique Apple customers is closer to 600m. “The number we would need to know is the absolute unique user base — is that growing? What is the annual revenue per user and is that going up?” he said. 

While the App Store is by far the biggest driver of its services revenue line, Apple is also including an indeterminate amount of sales from decidedly offline items such as replacement screens or accessories that bear its Made for iPhone branding, which it licenses to third parties in return for royalties. “The numbers are impressive, but we don’t have enough history,” said Amit Daryanani, analyst at RBC Capital Markets, suggesting that last year might have been unusually strong for services due to the leap in iPhone 6 purchases. “The reality is the services recurring revenue stream only works if your install base is alive and well.” If Apple intended its focus on its huge install base and the rapid growth of its services business to distract from slowing iPhone sales, the gambit may have backfired. The sudden transparency prompted some to wonder about what Apple’s other motives might be. 

“The feedback from clients is, ‘Is the services revenue disclosure being done ahead of iPhone being ex-growth over the next several quarters?’” Mr Daryanani said. Investors were more interested in Mr Cook’s sudden change in tone on the impact of the “turbulent” macroeconomic environment on Apple’s business around the world. “We are seeing extreme conditions, unlike anything we’ve seen before, just about everywhere we look,” Mr Cook warned, despite dismissing looming worries about the global economy just three months ago. “Major markets including Brazil, Russia, Japan, Canada, Southeast Asia, Australia, Turkey and the eurozone have been impacted with slowing economic growth, falling commodity prices and weakening currencies.” So severe was the impact of foreign exchange rates that on a constant currency basis, sales in the quarter would have been $5bn higher — or “about the size of the annual revenue of a Fortune 500 company”, Mr Cook pointed out.
But he could have used a different comparator: fluctuating exchange rates had roughly the same impact on Apple’s business as its entire services unit.
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