iBanker.jp

FSA Wants to Ban "Toxic" Life Settlements

2011-11-29T10:17:00.000+09:00

FSA Wants to Ban "Toxic" Life Settlements: Calling life settlements "toxic", the Financial Services Authority in the U.K. said it wants to ban them from being marketed to retail investors.

Oh yes, they should - this is not a retail product.

[FT Article] Cayman directors sit on hundreds of boards

2011-11-24T15:39:00.000+09:00

Cayman directors sit on hundreds of boards

I was aware of the fact, but not of the scale of this phenomena. Does make you wonder what do these people get paid for...

■

[FT Article] Few FoHFs yield value, report says

2011-10-17T13:55:00.001+09:00

The article in FT titled Few FoHFs yield value, report says claims fund of hedge funds are largely equivalent to a random selection of a basket of hedge funds, and fail to generate alpha on the fee-adjusted basis.

Maybe. But they do all the dirty work on monitoring, re-balancing and (only the better ones) keeping investors money away from fraud. Whether this deserves 1% of management fees and 10% incentive fees, is indeed subject to debate, but I do believe Fund of Hedge Funds have their own merit.

Plus, the paper (of which original could not be obtained) apparently uses hedge fund indices for the analysis. I am sure most people are aware of how flawed these metrics are. Borrowing some statisticians parlance, this "fails to reject the hypothesis" of FoHF value added "within the confidence interval", in my humble opinion.

On the other hand, not every Fund of Hedge Funds deserves high praise, with that I wholeheartedly agree.

■

[Comment] Swiss and US set to clash again on bank secrecy

2011-09-05T10:12:00.000+09:00

Below is a ling to article in FT:

Swiss and US set to clash again on bank secrecy: Reports say Washington has given Bern an ultimatum to deliver further names of American taxpayers with undisclosed Swiss accounts

I have no doubts greedy bankers may have used a dirty move or two, but let me get this straight: so, is the US saying that THEIR laws should be applied to bank accounts in Switzerland? Maybe we should apply some Chinese laws to the bank accounts in US? Or maybe some African country laws?

The US has serious issues with its supposed global dominance, and trying to regulate what other countries' banks are doing seems a dumb idea to me, given how the US regulatory authorities failed to regulate their own financial system, leading to spectacular blow-ups and dumping billions of taxpayer dollars onto the banks balance sheets.

I realize that in this particular case, American citizens are involved, so there may be some justification to these demands, but the very idea that the US is demanding Switzerland to do something that is against Swiss laws is very disturbing to me.

■

LandThink: How do TIMOs make money?

2011-09-01T09:51:00.000+09:00

I'd like to share this post on LandThink blog, as I think it summarizes the pay structure and some of the issues in timberland investments very well.

How Do Timberland Investment Managers (TIMOs) Make Money?

■

People with a problem...

2011-07-28T09:34:00.000+09:00

I'd like to cite a good acquaintance of mine. This is what he told us over a beer or two at a hedge funds networking event:

We are drinking people with hedge fund problems, not hedge fund people with a drinking problem.

Can't help but agree!.. to an extent.

At GSAM seminar...

2011-07-12T11:46:00.000+09:00

Goldman Sachs just admitted they put Russia at the bottom of investment attractiveness within "Big 8" country group, at least within the private equity space. Why am I not surprised?

Post in Alphaville

2011-03-07T11:16:00.000+09:00

I took the liberty of commenting on an Alphaville post Death bonds’ unique risks. My comment is as follows:

Life Settlements are clearly one of the asset classes you need to be extra-cautious investing into, but I have to disagree with the overall tone of this post, which appears to label ALL life settlement investments as money-losing and/or fraudulent products.

Among the many life settlement investment managers I had a chance to speak with, there is a handful of people who seem to know what they are doing, having both the right industry experience and a (audited!) track record to back it up.

The bottom line is, never invest into something you don't understand. Do your due diligence (especially if that is you fiduciary responsibility!). Pay attention to the valuation policy (no straight-line appreciation to life expectancy), type of policies (avoid those in their contestable period, be wary of the jumbo policies as they tend not to adhere to VBT), and check if the appropriate cash reserves are being cushioned into the fund. Also look for managers with track record of over 4-5 years, because even an improperly managed fund may look fine during the first 2-3 years.

There is more to it, but the investors who do their homework are more likely to gain in the end. Just as with any other asset class.

■

[Seminar] Investing in Cat Bonds (in Japanese)

2011-03-07T10:35:00.000+09:00

CFA Japan is conducting a seminar on insurance-linked products. The speaker, Mr. Masaaki Katusyama is an industry veteran, with deep knowledge of re-insurance business. He also has the ability to bridge the worlds of capital markets and insurance in a plain and easy-to-follow language. Highly recommended event.

Details can be found here: ＣＡＴボンドへの投資 - 金融危機で実証された、分散効果の高い保険リンク証券投資戦略

■

Madoff really is mad. And off

2011-03-01T14:46:00.000+09:00

One passage in this article (Madoff claims Ponzi scheme’s roots legal) in FT sent me laughing out loud:

"Mr Madoff also blamed institutional clients for failing to ask the right questions and regulators for failing to spot the fraud"

So, it's not really HIS fault that investors were defrauded. They have themselves to blame... The man is total nuts.
■

Care for a "Cat"?

2011-02-21T13:59:00.002+09:00

Are you a dog person or a cat person? Well, I don't know about the dogs, but the "cats" have been gaining popularity with investors for some time now. Not that purring furry things, of course, but the Cat Bonds.

The most attractive proposition of the Cat Bonds is that their performance is mainly driven by factors that have little to no connection to the factors impacting the more traditional assets. As such, Cat Bonds exhibit low to zero correlation to the traditional investment products, although they are not completely immune to the impact of extreme market downturns.

But there are also some significant limitations. First of all, the size of the Cat Bonds market is fairly small and they are concentrated in just a handful of perils (a fancy insurance world word for risks), with bias towards US Wind (hurricanes), so diversification is difficult. Also, the issuance is seasonal. The majority of the cat bonds are being issued before the hurricane season in the US (June) and at the year-end (Europe wind, Japan wind). The US and Japan quake are less seasonal, but also harder to find. So, allocating investor money effectively is difficult through much of the year.

One way to diversify is to go into reinsurance products. They are much more diverse, but less liquid, a typical contract duration being 1 year. But both Cat Bonds and reinsurance products are issued only in the quantity that insurance companies are willing to sell into the market. The total size of these two product types outstanding is around $30 billion (estimates vary widely), which may look like a fair amount, but is actually minuscule if you compare it even to a small cap stocks. Also, re-insurance's profitability is subject to influence of the insurance industry business
cycle, and may be unprofitable at times.

Given the size of the market, it is not surprising that there is only a handful of established investment managers out there, and they tend to be very small.

All this poses challenges to making the ILS (insurance-linked products) a viable investment. However, given the pent-up demand for thid type of demand, there may be some interesting developments, both good and bad. It will be interesting to watch the developments over this year, as it may become a turning point in the asset class's path into investment portfolios.

FYR
Hedge fund joins high-risk insurance arena
■

トヨタ、販売好転につながるか　電子制御「シロ」判定

2011-02-09T15:32:00.000+09:00

トヨタ、販売好転につながるか　電子制御「シロ」判定

やっぱりJapan bashingだったよね・・・

S&P downgrades Japan to AA-

2011-01-27T17:26:00.001+09:00

S&P downgrades Japan to AA-: "Yen madness on Thursday — following Standard & Poors’ downgrading of Japan’s credit rating to AA- from AA.

Just some hours ago we were discussing with a HF manager what would happen if the JGBs crash. While this is unlikely to be the start of it, the outlook is anything but rosy.

CAIA Level 2 Exam

2010-10-01T13:20:00.002+09:00

Two days ago I sat the CAIA Level 2 exam. Likewise my post on CAIA Level 1, I cannot give much detail here, but the overall impression is as follows:

Significantly harder than Level 1. More calculations, more detail required.
There were again some questions I do not recall seeing answers to in Schweser Notes.
Essay questions are not very difficult, but require to list up/describe certain processes/reasons for certain events, so memorizing these lists came in very useful (although I am not sure my answers were accurate enough).

As such, I am much less confident in the outcome than I was for Level 1. Will be waiting for the results.

RELATED POSTS:

■

"Chipan"?

2010-09-23T00:13:00.001+09:00

I had an interesting conversation with a hedge fund manager today, during which it became quite clear to me that we may be mere years away from profound economical and political changes in Asia.

Japan's Debt
It is a well known fact, that Japan has a tremendous amount of outstanding public debt, amounting to around 200% of Japan's GDP. In comparison, Greek public debt stands at an equivalent of about 110% of GDP. The reason this pile of debt doesn't trigger a crisis alike to that of Greece, is that the Japanese government bonds (JGBs) have a very loyal investor base, consisting almost entirely of Japanese domestic investors, most of them institutional. The yield on long term JGBs is extremely low, and recently touched 0.9% before getting back into 1% territory. Why do the investors hold onto anything that is yielding so little?

One reason is deflation. As Japanese investors are in JPY, the actual return is yield + rate of deflation. Second, and more important reason, is that they simply have very little else to invest into. Take banks. They are sitting on piles of cash, but weak domestic economy does not generate enough lending opportunities, and tight regulation makes it very difficult to invest into anything but low-risk assets. Take pension funds. The IFRS reporting is about to be introduced in Japan, and it will require corporations to reflect pension funds assets on their balance sheets. No room for losses. JGBs look to be in fashion for a long time.

Here Comes China
The news is, JGBs are now popular with a new investor with great appetite and deep pockets: China. As widely discussed in press (see links below), China has recently become an active player in the JGBs market, expanding its position as a net buyer. This trend has intensified since beginning of 2010 and was explained by China as a play on safe assets (note that Japan cannot buy Chinese government bonds).

Now, as explained above, Japanese government bond is a time bomb, which doesn't go off only because of the unique balance in the domestic market. What happens if this balance is broken?

I do realize this scenario is a bit of a stretch, but let's imagine a situation, where China holds a significant portion of Japan's government debt, and something triggers a massive sell-off by domestic investors. The spreads widen, Japan cannot manage the debt burden anymore, and defaults on some portion of, or in the worst case scenario, all of its debt obligations.

China's ambitions in the region are well known, and they are not limited to purely economical interests. It is like a swollen river held by an old dam - there is a good chance it may break through with a bang. What if China makes political demands to Japan using the defaulted debt as a pretext? What if a chain of events triggers a makeover of the world power balance that came together after the end of World War II?

Unlikely? Yes. Impossible? Definitely not. We may quite possibly see in our lifetime Japan becoming alike to what Hong Kong now is. Autonomous, but under the thumb of mainland China. See you in Chipan...

FYR: Links to articles on Chinese purchase of JGBs (in Japanese)
中国、日本国債の購入拡大　（日経新聞 2010/7/6）
中国の日本国債購入、米国債より安全との見方反映　（Thomson Reuters）
中国の日本国債購入急増　円高要因　高まる警戒感　（SankeiBiz）

FYR: An interesting brief on public debt and fiscal crises
Federal Debt and the Risk of a Fiscal Crisis

■

"Hedge-Fund Executive Exploring Other Growth Opportunities"?!

2010-09-08T13:24:00.000+09:00

Well, this way of looking for new growth is sure to land you in prison.

A post on HedgeFundBlogger titled Hedge Fund Marijuana sent me laughing out loud today.

Some quotes:

"Tara Bryson and her boyfriend recently received a grant from the state government to set up a goat farm. Instead, the two built a farm to grow marijuana."

"Tara Bryson, 36, is the sister of David Bryson, co-founder of Ridgefield, CT-based ew Stream Capital. She heads investor relations for the $1 billion asset-backed lending fund that charges high rates to loan distressed companies money."

"Bryson was arrested by the Connecticut State Police in Newtown on July 9th for three felonies: possession of marijuana, cultivation of marijuana, and conspiracy to cultivate marijuana. She plead not guilty, was released on $25,000 bail, and returned to work with investors at New Stream."

And I thought this type of reckless hedge fund managers was an endangered species on the brink of extinction... They are alive and kicking!
■

Preparing for CAIA Level 2

2010-09-06T10:45:00.004+09:00

I remember I scoffed about CAIA L1 exam. I found it all too easy, and started thinking CAIA should not really stand in one line with CFA. I am starting to change my mind. After some relatively easy sections on Real Estate and Private Equity, here come Hedge Funds and Structured Products, and all of a sudden the exam does not feel so easy any longer.

François-Serge Lhabitant, whose book Hedge Funds: Quantitative Insights I had the pleasure (and the pain) reading in the past, really knows what he is writing about... His in-much-detail description of Hedge Fund investment strategies is extremely informative, but memorizing all the formulas involved is no bed of roses. Same goes to the Structured Products.

With only a few weeks ahead before the exam, I feel I really need to step on the gas.

RELATED POSTS:

■

Cautionary tale about exit strategies from 1930s Japan

2010-09-03T14:19:00.001+09:00

I highly recommend this article in FT

Cautionary tale about exit strategies from 1930s Japan

Quote

As the policy debate intensifies, investors might spare a thought for Takahashi Korekiyo, Bank of Japan governor from 1911 to 1913. He also served as finance minister and prime minister in the 1920s and 1930s.
Outside Japan, few western investors know the name. For while there is discussion about what can be learnt from Japan’s lost decade, little attention has been paid to earlier periods.

The experience of 1930s Japan is thought-provoking. Not only does it help explain the decisions that Tokyo leaders took during the lost decade; it offers a cautionary tale about exit strategies.

Unqote
■

В точку...

2010-08-02T09:33:00.001+09:00

Карикатура

№: 136 (2654), 26.07.2010

http://www.vedomosti.ru/
■

Private Equity Council Strikes Back

2010-07-28T15:43:00.001+09:00

Quite predictably, PE industry was not agreeable to the report written by The Centre for the Study of Financial Innovation I mentioned in my post yesterday (see: IRR is not a perfect measure of PE investment returns. So what?).

The article referenced below describes the response by Private Equity Council. Turns out, the report was actually referring to comparing the performance of public and private equity. I have some experience of making similar comparisons, and must admit they are a very tricky business. This is not an apples-to-apples comparison. This is not even apples-to-oranges, it's more like apples-to-apple-jam comparison. Technically, you can run the numbers, and they may or may not be in favor of private equity, but investment in private securities is not only about the level of return. It is also about know-how transfer, liabilities duration match and many other things. Unfortunately, I did not have the chance to read to full report, but my impression is that Mr. Peter Morris from The Centre for the Study of Financial Innovation does not fully appreciate these differences.

Link to the artlice:
Private equity rejects criticism by think-tank

■

Just a quote...

2010-07-28T10:01:00.002+09:00

Quote

"China Investment Corp, the country’s $300bn sovereign wealth fund, this week announced its latest “worldwide” recruitment drive with 64 positions advertised.

[...]

The jobs on offer range from secretarial staff and human resources managers – “must be Chinese Communist Party member” – to country analyst in the international co-operation department – “must be good at keeping secrets”."

Unquote

Ful article can be found here:
Party faithful, your sovereign wealth fund needs you

■

IRR is not a perfect measure of PE investment returns. So what?

2010-07-27T09:33:00.001+09:00

The article titled IRR as performance measure comes under fire describes a report that criticizes IRR as a measure of private equity returns.

This sort of criticism is nothing new. It is true that there is an unrealistic assumption of compound returns underlying the PE IRR calculation, this limitation is widely known by the practitioners.

The real question is: so, what are the implications? It is not common to compare PE returns to say publicly traded equity, or bonds using IRR. The metric is more often used to compare performance of one PE fund to another, and as these IRRs are calculated under the same assumptions, the numbers, while not entirely accurate, are comparable. They provide a practicable tool to compare investment returns across the asset class.

Another problem, which is not mentioned here, is the risk of having multiple mathematically valid IRRs when making the calculation. This can happen when several cash flows are negative, positive, and then negative again. There are ways to address this problem.

In summary, IRR in PE is indeed imperfect, but to state that it is used for "manipulation" is probably a stretch.

■

Reading on Life Settlements

2010-07-22T17:46:00.001+09:00

Mercer put together a great report on Life Settlements, dated April this year, and I had the opportunity to obtain the original report that goes for 90 pages of Power Point slides. Very detailed, to the point and unbiased, it makes an excellent background reading. The report is not publicly available, but an 8 page summary can be found here.

Another source of information I have recently acquired is the Life Markets: Trading Mortality and Longevity Risk with Life Settlements and Linked Securities. This is a collection of articles by market practitioners, and therefore has some natural bias in it, but it is well-structured and contains wealth of information.

So much to read, so little time...

■

[Economist] Japan’s banks may soon chafe at their mission to support the bond market

2010-07-16T09:29:00.003+09:00

Below is the link to an article on Economist.com, which highlights a possible shift in the way domestic institutional investors treat JGBs. For better and for worse.

http://www.economist.com/node/16593589?story_id=16593589&fsrc=rss

■

JPMorgan pushes on with talks over Gávea

2010-06-21T10:18:00.003+09:00

The article reference below highlights an interesting development. I happen to know that Morgan Stanley Private Equity Asian team is much more nervous about the Volcker rule and does not rule out the possibility of having to become independent. JPMorgan, on the other hand, seems to be on prowl to acquire HF/PE firms.

I think there are two points that are worth mentioning in connection with these differences:

1. JPM is much more of a deposit holding bank than MS. As such, it is likely they will be less affected by any looming regulation.

2. Even more importantly IMHO, Brazil is increasingly catching the headlines and claiming the spotlight, in a sense becoming "the next China". And in many respects, for a good reason: it's much less reliant on exports (and when it comes to oil, on imports), the fundamentals look robust, the GDP growth is accelerating and the inflation has been within a reasonable range for years.

I have never had the pleasure of talking to a Brazilian hedge fund, but I will be definitely looking forward to such an opportunity.

JPMorgan pushes on with talks over Gávea:

"JPMorgan Chase is pushing ahead with talks to buy a large Brazilian hedge fund and private equity group, in spite of impending US legislation designed to limit the involvement of commercial banks in such activities"

■

Re: Monetary policy in Japan - Deep hibernation

2010-06-04T12:53:00.002+09:00

My comment to the article published on Economist.com (see the link below)

http://www.economist.com/node/16271499/comments#comment-563496

It is probably fair to say that smaller Japanese companies are starved of capital and additional lending by banks would be beneficial. However, I seriously doubt that lack of liquidity is at the root of the problem. Rather, I would say it is the overregulated and highly concentrated markets within most industries, and onerous risk disclosure rules for banks that are to blame.

P.S. Curious photograph for the article: it seems that the semitransparent tape that binds the bills has a Korean inscription on it.

■

US fund set to invest in Russian tech hub

2010-05-31T12:56:00.002+09:00

The following link to an FT article is an interesting piece of reading. I follow with some comments in Russian.

Даже не будучи специалистом в российском законодательстве, и зная об особенностях национального бизнеса только из комментариев бывших одноклассников и знакомых бизнесменов, сразу вижу в этом проекте легко узнаваемый шаблон: президент сказал "надо!", и все бросились поднимать "наш ответ Силиконовой Долине". Начинание похвальное, но оно игнорирует принципиальное отличие Калифорнии от Подмосковья: отлаженную правовую базу. Какие бы там не создавались "зоны" и "технопарки", до тех пор пока регистрация нового предприятия исчисляется не в днях, а в месяцах, никакой "Силиконовой Долины" в России не будет.

И как говорится, как бы я хотел, чтобы я был не прав!

US fund set to invest in Russian tech hub: "Siguler Guff, the private equity group, will invest $250m in a high-technology hub outside Moscow"

■

Exports Up 40% In April; Trade Surplus Soars

2010-05-27T14:45:00.002+09:00

Below is a post on Japan Private Equity News blog. I really hope the momentum holds, but unfortunately this has too little to do with Japan and too much with China. Some big gamble...

Exports Up 40% In April; Trade Surplus Soars:

"Ministry of Finance announced that Japan's trade surplus in April is 742.3 billion yen from 48.9 billion yen in the same month a year earlier. Japan's exports rose 40.4% on year in April on strong overseas demands for Japanese cars and electrical parts. Export to Europe were strong, up by 19.8%, exports to US gained 34.5% and those to Asia climbed 45.3%. "

■

A good bird's eye view of timberland investments

2010-05-20T11:29:00.001+09:00

The following post on AllAboutAlpha.com is a good very-brief-and-basic introduction in the timberland investments. I happen to know one of the speakers mentioned in the post personally, and some of the graphs look very familiar:

How much wood would a woodchuck allocate if a woodchuck would allocated part of his portfolio to wood?: "As alternative investors know, money does grow on trees after all. The trick is: how to harvest it."

■

Great post on investment risk

2010-05-18T13:11:00.001+09:00

Below are some excerpts and a link to a great post on Disstressed Debt Investing blog. Highly recommended.

http://www.distressed-debt-investing.com/2010/05/howard-marks-on-risk.html

Quote

'When investor demand is so strong in the leveraged loan and high yield
market that second lien dividend deals are being oversubscribed, it is time to
start selling'

I think you would sleep a little better at night with that in hand.

Back to Marks. The paragraphs I cite below really left me in awe when I
read it earlier this morning. It makes so much sense from a value investor's
perspective but I feel like it gets lost in the weeds of the Mr. Market's of the
world. Enjoy:
For about a year, I’ve been sharing my realization that there are two main
risks in the investment world: the risk of losing money and the risk of missing
opportunity. You can completely avoid one or the other, or you can compromise
between the two, but you can’t eliminate both. One of the prominent features of
investor psychology is that few people are able to (a) always balance the two
risks or (b) emphasize the right one at the right time. Rather, at the extremes
they usually obsess about the wrong one . . . and in so doing make the other the
one deserving attention.

Unquote

■

Life Settlement Funds

2010-05-15T01:39:00.001+09:00

One of the great things about working in third-party marketing is that you get to meet all kind of investment managers from around the world. Over the past few months I have participated in the research effort on a very exotic asset class: life settlements. We met with a number of leading managers in the space, and had some very interesting discussions. Now I am clearly not an expert on the subject, but I believe some facts and thoughts below will still be interesting to share.

What are life settlements as an asset class?
Put briefly, life settlement is an investment product that leverages on the fact that life insurance in the US is considered a real property, and as such, can be bought and sold. To the best of my knowledge, this is only possible in the US.

The underlying asset is the life insurance policies held by elderly individuals, who for some reason don't need the policy anymore, and would like to receive more than the surrender value that the insurance company is prepared to pay (which is a minuscule fraction of the insurance premium contingent on the insured person's death). The life settlement company assumes the responsibility to make the regular payments, and collects the premium on policy maturity. So, the ethical question of betting on someone's death apart, life settlement theoretically benefits both the seller and the buyer of the policy. But that is not always the case.

A little history
Life settlements originated as the means of financing medical costs for people with very short life expectancy, such as AIDS patients (so called "viatical policies"). Now these life settlements generated very negative image of the asset class, firstly because of the unpleasant association with people on the brink of death, and secondly because in many cases they did not pay off as investments. They didn't because the advance of medical science actually enabled those patients to live much longer than originally expected, and the life settlement companies had to keep paying the costs well beyond the point where they anticipated the premiums to be collected.

It's all about statistics and risk management
As far as I came in my understanding, the key pieces in making life settlements work as investment, are (1) to get the life expectancy right, and (2) to smooth the returns. It's too early in the educational stage for me to share the reasons for such belief, but at this point they seem quite sound.
What is important to note however, is that whatever numbers you get reported as NAV are mark-to-model, so it is no wonder they often plot as a perfectly smooth line.

The Golden Rule of investment
As many people know, the Golden Rule of investment is "don't invest into anything you don't understand". For me, there are still many questions that need to be answered before making any conclusions about life settlements, but I hope this post will help answer at least the very basic ones for everyone reading it.

■

Change of layout

2010-04-08T13:37:00.001+09:00

The blog now has a new look with the same and improved contents. The template I previously used made reading somewhat cumbersome. Hope you like it.

Geithner Again Pushes Against EU Hedge Fund Rules | FINalternatives

2010-04-08T10:02:00.001+09:00

Uncertainty about regulation and unqualified politicians trying to rewrite it do nothing good neither for the hedge fund managers nor for the investors the politicians are allegedly trying to protect. New twist to this story in the article below:

Geithner Again Pushes Against EU Hedge Fund Rules FINalternatives

Beware of the numbers

2010-04-06T14:25:00.003+09:00

Hedge Funds Nitty-Gritty Series

Post 1 Beware of the Numbers

From my personal experience, some people tend to believe (although the institutional investors community would generally disagree) that when it comes to hedge fund returns, the higher they are the better. In reality, however, the situation is much less clear-cut.

Firsrtly, the risk tolerance and return expectations for every investor are different, and therefore her/his assessment of a high-performance hedge fund will also be different. For instance, there is a general preference for lower risk/lower return funds among Japanese institutional investors. But secondly, and even more importantly, the returns alone don't tell the whole story.

In this post I'd like to describe some of the metrics and concepts that are used for hedge funds due diligence when assessing the risk/return profile (operational and investment strategy due diligence are broad subjects that deserve a separate in-depth review).

1. Frequently used metrics

They are: annualized returns and annualized standard deviation, annualized downward deviation, length of the track record, percentage of positive months and (controversially) Sharpe ratio. A quick look at every metric below.

a) Annualized Returns
This is a fairly straightforward metric. It measures the annual equivalent of the returns delivered by the investment product over a period of time. The reason to bring the returns to a single period is to allow apples-to-apples comparison between products with different period of track record in terms of absolute returns. The general formula here is:

The formula may appear daunting, but it is actually fairly simple. HPR stands for Holding Period Return, which is simply put what the absolute return from the point in time zero to point in time present is (e.g. 0.15 for 15%). The power part is a little trickier: take the number of observation in one year (e.g. 12 for monthly returns) and divide them by the total number of observation in the data sample (e.g. 18 for 18 months, 6 for 6, etc.).

In practice, when computing this statistic in MS Excel, the easiest way to do is to use the PRODUCT function (assuming you have returns data, and not price or index values to work with). In the sample below I have put together a set of random monthly returns observations to illustrate:

The formula I use here is '=PRODUCT(1+data_sample)^(12/COUNT(data_sample))-1', where data_sample is the B4:B18 range on the spreadsheet. Don't forget to hit [Ctrl]+[Shift]+[Enter] after inputting this formula into a cell to enable it!

b) Annualized Standard Deviation
Similarly to the Annualized Return, Annualized Standard Deviation is the equivalent of volatility of actual returns to what it would be if they occurred during one year. The formula is different though. Without going into how the Standard Deviation is computed, to annualize it, the following formula can be used:

For instance, for monthly returns, we will take square root of 12. Note that instead of the "equal" sign ("=") I use the "approximately equal" sign ("≈") here. Strictly speaking, this also applies to the Annualized Returns: this formula is an approximation, which does not account for compounding. But in most cases this approximation will produce accurate results (see REFERENCE for more information).

In MS Excel, the formula is fairly straightforward. Using the previous example: '=STDEV(data_sample)*SQRT(12)'.

c) Annualized Downward Deviation
The Standard Deviation provides a measure of total volatility, that is, how much the individual results deviate from the mean. But it does not tell us whether this deviation is positive or negative in nature. To more accurately assess the risk of losses associated with an investment, the downward deviation is utilized. It is the same standard deviation, but only applied to the observations of negative returns. It is actually more intuitive in MS Excel format than stated as a formula, so here it is in the example we have used so far:

As you can see in this example, the small share of negative monthly returns (three out of fifteen) produce a much smaller value than the standard deviation. If only all funds were like that.

d) Length of Track Record
Straightforward: the longer the better. By looking at this metric one is trying to answer following questions:

Does the manager have sufficient experience?
Has the team been stable enough to keep the fund going?
And, most importantly, did the fund undergo "stress-testing" by the difficult markets and/or economic conditions?

Naturally, these questions cannot be answered just by looking at the length of track record alone, so it should be used in conjunction with other information.

e) Percentage of Positive Months
This metric addresses the question of how successful the fund manager has been in delivering positive performance. In our arbitrary example it is a hefty 80%, the level very rarely encountered in the real world.

f) Sharpe Ratio
Use of this metric is controversial. CAIA curriculum states that it is not appropriate to assess a hedge fund's returns, as the standard deviation in the denominator will be primarily defined by the benchmark. Academic disputes apart, this is a widely used metric. The general formula is:

where Rp is the fund return, RFR - risk free rate, and σp - the standard deviation of the fund returns.

2. Points of reference

Every hedge fund strategy is different, and often difficult to categorize, but there are some buckets into which one can put a fund with more or less certainty. Understanding what drives returns for each strategy is important in order to asses the attractiveness of a particular fund as a potential investment. For most strategies there would be some points in their (usually not so long) history, where the market conditions made it particularly difficult for a given strategy to deliver positive returns. Comparing a fund performance during these periods can tell you much about how much alpha (i.e. manager skill) is actually delivered by the fund.

For instance, take the case of Japanese equity long/short funds. If you want to see how successful a fund is in delivering absolute returns, it is worth looking at the beginning of 2006, September to November 2008 and September to December 2009 as points of reference. I would personally recommend to pay particular attention to November 2009, as this was a particularly gruesome month for many funds in this space.

REFERENCE:

To read a more in-depth discussion of the quantitative nitty-gritty of the hedge funds I recommend "Hedge Funds: Quantitative Insights (The Wiley Finance Series)"
The MS Excel file used for examples can be viewed here

Morgan Stanley and MUFG agree trading deal

2010-03-31T16:58:00.001+09:00

Morgan Stanley and MUFG agree trading deal: "The two banks have closed an agreement to integrate their brokerage operations in Tokyo, paving the way for the two banks to build an international investment banking venture"

CAIA Level 1 Exam

2010-03-24T12:52:00.008+09:00

Last Friday I took a day off and headed to a local test center to sit my CAIA Level 1 exam. Without going into too much detail so as not to violate the non-disclosure clause one has to sign before taking the exam, here are some notes and personal reflections:

The test is completely computer-based. No filling those circles on the answer sheet, as I had to for CFA.
The test's difficulty was largely in line with my expectation, based on the CAIA Schweser Notes practice exams. I find the Notes slightly more complex and going into more detail, as a matter of fact.
There was a number of questions that I am sure were not in the Notes, so for those who have the time, buying the official study materials is highly recommended.

I will be angxiously waiting for the results now, while preparing for the upcoming CFA Level 2 exam in June.

RELATED POSTS:

Comparison of financial certifications

2010-02-04T09:03:00.002+09:00

An excellent article and a consise but informative comparison table on financial certifications. A must-read for CFA and CAIA candidates.

The Value of Professional Designations: CAIA, FRM, CRPC, CIMA, CIC, CFA

Comparison table

It seems that both CFA and CAIA are in great demand, so I am on the right course. The only tiny thing left is to get through all the exams and earn the designations. More late night studying ahead...

P.S. I would like to thank Reza Mahmud for kindly sharing the sources on the LinkedIn CAIA group discussion board

RELATED POSTS:

Global warming is under way. And trees lilke it

2010-02-03T09:05:00.000+09:00

I guess there is an upside to anything after all. The trees clearly don't mind having higher temperatures and more carbon dioxide in the atposphere. For details, read this post on Forestry Investment Blog:

Global Warming the New Fertiliser

Is this what is about to come for the bankers?

2010-01-26T09:52:00.000+09:00

Very interesting article, so I took the liberty of quoting it below:

Bank pay in Singapore makes sense

By PETER STEIN

When it comes to pay, Wall Street could learn a thing or two from Singapore.

Outsize bonuses at big banks and securities firms have never been more controversial. Governments are on the warpath, imposing bonus taxes and new rules to force bank paymasters to change the way they compensate their talent.

Singapore's Temasek Holdings Pte. Ltd. could give them a master class on the subject.

Temasek isn't a bank. It is a state-owned investment firm with a portfolio valued at well over $100 billion that holds stakes in some of Singapore's biggest companies. It also invests in companies outside Singapore and in other assets, too, including hedge funds, private-equity funds and real estate.

For years, Temasek has paid its employees with a sensible plan that includes cash bonus payments and deferred incentives. A key part (but not the only part) of the plan links bonus payments to something called "wealth added," a measure of the company's return on its investments in a given year that factors in its risk-adjusted cost of capital.

Basically, calculating wealth added, or WA, tells you whether the company's assets produced more value than the minimum you would expect given their level of risk.

At Temasek, everyone has a WA bonus bank. When WA goes up, more money goes into the bank, which then funds deferred bonuses that take at least three years, and as long as 12, to vest.

Here is the important part: When Temasek loses money, you get what it somewhat confusingly calls "negative wealth added," and money comes out of the bonus bank. So a lousy year at the company cuts into an employee's ability to enjoy previously awarded bonuses. This also is known as a clawback.

Last September, Temasek announced it had a lousy year. In the year ended March 31, 2009, the value of its investment portfolio fell 30%, and its profit fell 67%. Its wealth added was a negative 68.1 billion Singapore dollars, or about $48.5 billion, meaning everybody's WA bonus bank took a big hit.

A system like this has its drawbacks: Deferred rewards can be uncertain, and Temasek could have trouble attracting the best talent.

But Temasek's system keeps employees fixed on the right goals. In its annual report, Temasek says the pay plan is underpinned by the principle of sharing gains and pains "alongside our shareholder," the Singapore government.

"What Temasek is doing is pretty impressive," says Julia Gorham, a lawyer who advises companies on compensation issues at Allen & Overy in Hong Kong. She said it is nearly consistent with standards for banking compensation recommended by the Financial Stability Board and adopted by the Group of 20 nations last year.

Governments now are pushing these standards for compensation on banks in Europe and the U.S., and a number of them have begun deferring more pay and implementing clawback provisions. Morgan Stanley, Credit Suisse Group and UBS AG have such systems, as does Goldman Sachs Group Inc., although it applies to only the top 30 staff at the firm.

Soon, banks around the world may get to the point where this is the standard pay plan. Temasek can say it got there first.

Printed in The Wall Street Journal Asia, page 23

Happy New Year!

2010-01-06T17:28:00.000+09:00

Happy New Year, everyone! I do very much hope 2010 will be a better year then 2009 for people working in the financial industry, but when I tried to put together a greeting card, this is what I ended up with...

Into the forests and back to the office

2009-12-11T17:10:00.001+09:00

In late October I travelled to the US and Canada on a business trip that was exclusively dedicated to timberland investments.

I had an opportunity to meet with a number of investment managers and some investors into the asset class, tour the timberland both in the South and in the Pacific Northwest, and collected a dearth of data, both from conversations and in print.

It would take a multi page report to describe everything I learned, but I just wanted to outline some topics that I felt were of particular interest, and draw some parallels with other alternative asset classes.

Timberland values held much better and stayed almost unchanged much longer, than most other asset classes. The illiquidity and the lag in third-party appraisals is partially to blame (or praise?), but the values started to come down a little during 2009. The most important factor that managers cited was the decline in dicount rates. The decline was attributed to the very thin timberland transactions market, as owners/investors were reluctant to sell at lower prices, and to several liquidity-driven deals, in which owners/investors had to sell to replenish their cash. Ironically, in some cases they needed the cash because they could not get it from the "liquid" investments such as hedge funds.
The near-term outlook for timberland investments seems to be positive. The basis for such thinking is the expectation of economic recovery, decreasing timber supply and strong underlying fundamentals that are believed to prop up housing starts, and thus increase demand for timber. The window for the buy-on-dip opportunity was estimated differently by several managers I met, ranging from about half a year to several years.
I found an unexpected parallel, when I was talking to a fixed income FoHF manager some time after returning from the trip. He also referred to the unprecedented investment opportunities that were presented by very large spreads in the beginning of 2009, when the market became very thin. We were both suprised to discover similarities when I explained to him the logic behind the current investment case for timberland. I guess, for all its talk of low correllation, timberland is influenced by the economy in a similar way any other investment product is.

And finally, the picture below shows me standing in the shade of a mature Douglas-Fir stand in Pacific Northwest. These are the trees every investor can only dream of...

Hedge Funds Club Tokyo Year-End Party

2009-12-07T12:52:00.000+09:00

Last Thursday (December 3rd) investment managers, prime borkers, compliance specialists and other professionals involved into hedge funds this way or another, gathered in Roppongi Hills overlooking the busy Tokyo city for a few drinks and a lot of networking.

Organized by Mr. Stefan Nilsson, the founder and president of the Hedge Fund Club, the party was much more lively and cheerful than the same event a year ago. This time it was even filmed by a local TV station, and feeled much more crowded.

I enjoyed meeting new people, among them a manager of an art fund, and a Europe-based manager planning to launch a "forestry fund", which apparently is what timerland funds are called in Europe.

All in all, things seem to be picking up little by little, so let's hope for a truly happy New Year.

Employee engagement

2009-11-25T17:44:00.001+09:00

Sounds painfully familiar...

CFA Japan Year End Party

2009-11-19T09:38:00.001+09:00

Yesterday I had the pleasure of attending the CFA Japan Year End Party.

It was nice to catch up with some people I know and meet some new faces. It was a pleasant surprise to learn that one of my friends earned his CFA designation this year (congratulations, Andres!). When you see an example of somebody actually getting through all the three levels, it gives you some hope and confidence in your own endeavor.

What really made an impression on me, however, was the number of people who had no corporate logos on their business cards. Some of them started their own business, some are just hanging out waiting for a decent employment opportunity. There are really tough times...

Valuation posts now in Docstoc

2009-09-03T08:57:00.000+09:00

I have reformatted my Valuation posts and uploaded as a PDF document on Docstoc.com. All formulae are now much easier to understand, and the overall visibility is much better compared to when posted on this blog.

The file can be found here.

Overview of the Alternative Investments Universe

2009-08-31T18:45:00.000+09:00

I have applied to the CFA Level 2 exam, and I am now also considering applying to the CAIA program. Below are some pros and cons and interesting facts that I discovered doing my little research on the subject:

FACTS

(1) Number of chartholders:

Charted Financial Analyst (CFA):

approximately 78,000

Chartered Alternative Investment Analyst (CAIA):

over 3,000

(Source: Wikipedia)

(2) Preparation required

CFA
Minimum 250 hours per level

Total: 750+ hours

CAIA

Level 1: 150-200 hours

Level 2: 200 or more hours

Total: 350-400+ hours

(Source: schweser.com)

(3) Membership Annual Dues

CFA

US$225. In Japan, there are reportedly additional fees for the CFA Society of Japan membership, which bring the total amount to approximately $400.

CAIA

US$250.

(Sources: CFA website, CAIA website)

(4) Exam and Enrollment Fees

CFA
Program Enrollment: US$400*

Level 1 Exam Registration: $690*

Level 2 & 3 Exam Registration: $710*

* Fees vary depending on the date of application. There are three application deadlines, and the numbers here are for the second payment deadline. Also, Level 1 exam registration fee is different for 2009 and 2010. Details can be found here.
Program Enrollment: US$400

CAIA

Level 1 Exam Registration: US$1000

Level 2 Exam Registration: US$1000

PROS

(1) CFA

Widely recognized certification that has broad applications in asset management, investment banking, corporate finance and many other areas.
Broad range of topics covered

(2) CAIA

Fewer hours for preparation and only two levels to pass, as compared to three levels for CFA
Exams two times a year, so in the best case scenario, you can get your designation in one year
Pin-point focus on alternative investments, so no need to go trough financial statements analysis and the likes

CONS

(1) CFA

Really lot of preparation, a long-term commitment. Level 2 and Level 3 exams are only conducted once a year, so even if you know the curriculum very well, it takes several years to complete the program

(2) CAIA

Too narrow for anyone working with traditional investments

OTHER REMARKS

There is a considerable overlap between the two programs. For instance, CAIA refer the candidates to the CFA Code of Ethics. A lot of the Corporate Finance contents in CFA seem to be the foundation of the relevant material in CAIA. CFA Alternative Investments section provides brief overview of the asset classes consistent with CAIA terminology

RELATED POSTS:

Investment Banking Series: Equity Story

2009-08-26T10:00:00.003+09:00

Investment Banking Series

Post 6 Equity Story

1. What is it anyway?

Equity Story is, in its essence, the reasoning why the particular stock should be bought by investors. It emphasizes the strong side of the company and places the stock in either the value or the growth category. In a nutshell, the value stock is expected to have little price appreciation, but pay out relatively high dividend, whereas the growth stock is expected to have a high appreciation potential, but not necessarily pay much dividend. How a stock is classified depends on several factors, such as where in the industry life cycle it is, what the macro conditions are, what industry it belongs to, or sometimes even if it has a hot buzzword in its description.

For instance, a power generation company would usually be classified as a value stock: there is very little growth potential, but the cash flows are steady and not as much correlated with the economic conditions. An Internet portal or a biotech company are at the other end of the spectrum. They may grow very rapidly, but will hardly have enough cash to pay high dividends. Not that they have to - as long as they keep growing, investors will be happy. Now a good example of a buzzword stock until 2008 was China. Every company listed in Hong Kong had absolutely crazy multiples and was heavily oversubscribed.

2. How they do it

The equity story is a good example of "art rather than science" concept. There is no predefined format you can simply put data into. It has a lot in common with advertisement - you have to be creative. The description below is therefore, just an example and not a fixed structure.

An equity story would often start with positioning the company: assigning it to the appropriate sector, stating what its current ranking in the industry is, and what strengths it has as compared to the competitors. It then proceeds to the macro conditions to support the case for the company's positive prospects. It may be the new technological paradigm, the stage of the economic cycle, the demographic trend that expands the customer base, or any other positive development to promote the image of a company with excellent potential. Next, some company data summarized in graphs and tables to support the idea of macro trend boosting company performance is provided. This may be the number of new accounts for a bank, the number of new users for an Internet company, the number of shipments for a logistics company, and so forth. Depending on the type of the offering, there may be a page that will summarize the appealing points for certain investor groups, for example High Net Worth Individuals or Institutional Investors. Finally, a summary page with the bullet points highlighting the "Why XYZ Inc.?" follows, that ideally should provide the catch phrases for Sales to work with.

3. Lessons

Creating an equity story is basically connecting the understanding of the company and of the investor base together, and putting all the information into a story that focuses on the matching pieces. The keyword here is "understanding". Different investor groups have diverging interests, which also have the unpleasant habit of changing over time. So it is important to follow the trends. In most companies, Sales department regularly conducts some kind of investor survey to monitor the changing sentiment, so getting your hands onto it will help a great deal. Also, more general sources like local financial publications may provide some insight. In Japan, Nikkei Veritas, formerly Nikkei Kinyu Shimbun, can be of help. And of course, Financial Times and Wall Street Journal are very useful wherever you work.

Links to other posts in the investment banking series:
Post 1: Series Introduction
Post 2: Deal from Sourcing to Completion
Post 3: Pitch Books
Post 4: Valuation, Part 1
Post 5: Valuation, Part 2

My first publication

2009-08-17T18:12:00.000+09:00

Today it was officially announced that an article on timberland investments, on which I have been working with two colleagues for about three months will be published in the September issue of the Japanese Securities Analysts Journal (in Japanese). You will easily find my name on the announcement page, because it is the only one in katakana (the only foreign name).

This is so my boss...

2009-08-12T23:19:00.000+09:00

Investment Banking Series: Valuation Part 2

2009-07-29T05:00:00.001+09:00

Investment Banking Series

Post 5 Valuation, Part 2

DCF Valuation
Discounted Cash Flows (DCF) analysis looks at the amount of cash the company generates and discounts it back from a fixed point in time (usually 5 or 10 years, depending on the sector) along with the terminal value. Specifically, company's Free Cash Flow is projected for every year of the valuation period, the terminal value is calculated for the last year of the valuation period and the sum of the two is discounted by the Weighted Average Cost of Capital (WACC) of the company.

This process involves a lot of projections, and therefore requires very detailed understanding of company business, because in the end the valuation is determined by how accurate these estimates are. CFA prep guides (official guide, Schweser notes, etc.) provide in-detail explanation of how FCF is calculated and what can serve as a proxy for it, but in principle its formula is as follows:

FCF = EBITDA - Tax Expenses - CAPEX - change in Net Working Capital

So the problem is to accurately estimate how each component will change over the valuation period. Company investor presentations and mid-term management plans that are generally available to the public for listed companies can provide important clues on how much the company is going to spend on investment (CAPEX) and how much profits it can be expected to generate (EBITDA) . As for Tax Expenses and Net Working Capital, financial statement analysis is crucial to arrive to a meaningful estimate.

With regards to the terminal value, the only method that I have encountered is the Exit Multiple. It is simply

Terminal Value = EBITDA(last year) x Exit Multiple

Exit Multiple is determined in a similar manner as it is in Comps: by averaging the multiples of the comparable companies.

WACC is the minimum rate of return that the company has to achieve in order to be profitable. Its calculation involves several stages (for equity, preferred shares and debt), and I will not go into it here, but in rare cases it may be found in company annual reports or other publicly available documents.

Now, to arrive to the valuation, we discount FCF and Terminal Value by WACC.

FCF part = [FCF1 / (1 + WACC)] + [FCF2 / (1 + WACC)^2] + ...
+ [FCFn / (1 + WACC)^n]

where n is number of years

Terminal Value part = EBITDAn x Exit Multiple / (1 + WACC)^n

The resulting Enterprise Value is the sum of the parts.

3. Lessons

Valuation is not very difficult in terms of the math involved. What is important is to be able to arrive to the set of assumptions about the numerous inputs into the eqasions. This is the diificult part that requires experience and understanding of eveluated company's business. Some of the assumptions may be obtained for the research analyst reports (when available).

Valuation techniques are also widely used outside investment baking world, for instance in private equity, corporate finance and investment management. Among all the skills investment bankers have, I would say this is the most important.

Links to other posts in investment banking series:
Post 1: Series Introduction
Post 2: Deal from Sourcing to Completion
Post 3: Pitch Books
Post 4: Valuation, Part 1
Post 6: Equity Story

Investment Banking Series: Valuation Part 1

2009-07-01T12:50:00.008+09:00

http://ibankernightly.blogspot.com/2009/08/investment-banking-series-equity-story.htmlInvestment Banking Series

Post 4 Valuation, Part 1

1. What is it anyway?
Valuation is the process of calculating and otherwise assessing the Enterprise Value (in case of equity) or any other appropriate metric to be used as a base for setting the fair price range for the offering. Along with the distribution network, the ability to produce the appropriate valuation is supposed to be the core expertise of an investment bank. There are books out there that would give you much detail on the valuation techniques. The one I would personally recommend is Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions . It's a step-by-step easy to follow practical description. I do not intend to go anywhere that far, and will just introduce the important concepts here.

2. The great myth and the not-so-impressive reality
Valuation is often rumored to be a highly numerical and sophisticated procedure, both science and art, requiring in-depth understanding of financial statements and issuer's business, as well as factoring in the market sentiment. Quite possibly, in some cases it is. However, in my practice it never went more sophisticated than three rather short sheets in Excel. Putting that aside, let's review the most common valuation techniques below (keep in mind, that I refer to equity offerings here).

Comparable Companies Analysis (a.k.a. Comps)
Under this method a banker would calculate the average indicators for a number of comparable listed entities, and compare this average with the company being evaluated. Then he (or, less likely, she) would determine the fair value per share of stock to be offered, and this number, combined with the market sentiment and Sales opinion will be used to determine the price range. The procedure is relatively simple and does not require a degree in math. The real challenge is to select the appropriate peer companies, because the valuation results will be mostly influenced by this selection. This feature of the analysis is sometimes used by unscrupulous bankers to bring the valuation higher by consciously selecting the more expensive peers.
The main metrics used for the analysis are P/E and EV/EBITDA ratios. Each has its strengths and weaknesses.

The attractiveness of the P/E Ratio (or Price-to-Earnings Ratio) is that it is easy to calculate:

P/E = Equity Market Value per Share/Earnings per Share

which in most cases can be translated into

P/E = Stock Price/Earnings per Share

There are two kinds of P/E - trailing and projected. The difference here is in the E part - either historical or forecast earnings are used. Earnings per Share (EPS) calculation can be somewhat bothersome if the company being valuated has a complicated capital structure with dilutive securities - securities that can be converted to shares, and thus increase the number of shares outstanding. Overall, P/E Ratio can be described as an indicator of investor's willingness to pay for the stock in anticipation of future earnings. Calculating the industry average P/E Ratio can provide an estimate of the price at which the company being valuated would be priced.

The advantage of EV/EBITDA multiple is that it allows to compare enterprises affected by different taxation policies and also considered a better indicator of company's earning power, as the non-cash expenses (Depreciation and Amortization) are added back to EBIT to produce EBITDA*. Also, EV is considered a better metrics as indicator of what a potential buyer would pay to take over the company, as opposed to Market Cap.

The disadvantage is that the calculation can be fairly complex, and the resulting metric is not very intuitive. Plus, the very advantage of EBITDA that it allows to compare different companies is a disadvantage if you are thinking of the stock in terms of returns on investment, as the actual returns are dependant on Net Income, not EBITDA.

*The DA part wasn't introduced into accounting without reason. At some point, company has to replace old equipment, so there will be commensurate expenses. But in the short term no cash outflows occur.

This concludes Part 1 of my Post 4 on investment banking. In Part 2 I will describe the DCF analysis.

Links to other posts in the investment banking series:
Post 1: Series Introduction
Post 2: Deal from Sourcing to Completion
Post 3: Pitch Books
Post 5: Valuation, Part 2
Post 6: Equity Story

Invesment Banking Series: Pitch Books

2009-05-21T09:40:00.002+09:00

Investment Banking Series

Post 3 Pitch Books

1. What is it anyway?
A pitch book is the paramount of days and nights of a banker's hard work. It is a marketing tool that tries to set apart basically very similar banks and to support the claim that THIS bank, and NO ANY OTHER should be selected to arrange the deal. They say pitch books used to be actual books, but in the present world they are Power Point presentations printed out and bound in a plastic cover. The main purpose of the pitch book is to deliver two messages to the prospective client: (1) "we understand your business very well", and (2) "when it comes to arranging your deal, we are the best fit". Both claims are usually weak at best, but they are made elaborately and extensively, and the resulting multi page document often looks impressive.

2. Typical structure

A pitch book will have varying structure depending on what product is being proposed, but there is a lot of similarities. Below is one example, assuming equity Public Offering Without Listing (POWL) structure, and proposal's scope limited to that of a Lead Arranger in Japan:
Executive SummaryHere the most compelling marketing points will be made, carefully phrased not to sound like ones, and checked by compliance not to sound as assumption of any obligations. In case of POWL, the demand estimate is one of the key points to watch. The number is nothing more than an educated guess based on similar deals in the past (if any), and as the bank fears being held responsible if the stated demand is not achieved during the offering, a conservative range is usually provided.

Bank's Introduction
The bank's ownership structure, retail network and services provided are some of the possible topics to be covered here.

Investor Base Overview
In case of POWL, particular emphasis will be put on the retail investors: the propensity to savings that created a zero-yielding bank savings of unprecedented scale and the recent emerging shift to investment into equities. Also, the overview of the institutional investors is also likely to appear here, consisting from Life Insurance, Non-Life Insurance, Trust Banks and Asset Management companies.

Placement Options Available in Japan
For an equity placement, it can be public or private, and public can be done with or without listing on one or more of the Japanese stock exchanges. The emphasis in a POWL pitch book will be put on the lighter documentation and less stringent requirements to qualify for placement, as compared to listing.

POWL Overview
Technical overview: requirements to be met, process flow, approximate timeline, required disclosure (at the time of placement and ongoing) to name a few aspects.

Market Trends
Recent equity market performance, usually illustrated by the movements in one of the major indexes, such as Nikkei 225 or TOPIX.

Case Studies
This part introduces the overview of similar deals. Similar can refer to the same
region, same industry or similar deal properties, for instance privatization deals. For POWL, this part is always a bit of a challenge, as most of the recent deals were by Chinese companies, so it is not easy to find good comparable cases.

Bank's Credentials
League tables (carefully selected to show the bank at the top), list of the deals in similar industry, geographical region, or similar in nature will be put together in this section. Any awards the bank has (hopefully) recently received will also go into this section.

3. Lessons
Putting together a pitch book is not a piece of cake. It takes a lot of research, data mining and internal communication between departments, let alone the endless formatting and rewording of every passage. Here are some tips to survive it:

Make good use of the existing pitch books - they will give a lot of hints and useful data
Confirm the contents with your boss ASAP. To get his attention may be challenging, but the risk of rewriting everything from scratch outweighs the trouble
Polish your Power Point skills - the better you know how to align all those boxes, the sooner you can go home
Check with your friend in Capital Markets (hopefully you have one) if they have any recent market overview presentations. Getting one can be a huge time saver

This concludes my Post 3 on investment banking.

Links to other posts in the investment banking series:
Post 1: Series Introduction
Post 2: Deal from Sourcing to Completion
Post 4: Valuation, Part 1
Post 5: Valuation, Part 2
Post 6: Equity Story

Crisis? Not for pets.

2009-05-18T13:00:00.000+09:00

A line in a news blog sent me laughing out loud today:

Unicharm PetCare Corp. (2059), a pet food maker, saw its pretax profit zoom up
31% to 6 billion yen, buoyed by beefed up offerings for aging and obese pets.

Jeez, what kind of world are we heading to?

The original news post here.

Invesment Banking Series: Deal from Sourcing to Completion

2009-04-23T17:25:00.001+09:00

Investment Banking Series

Post 2: Deal from Sourcing to Completion

1. How hard can it be? Very.

How hard is it to close a deal in investment banking? Very hard. It is extremely time-consuming and effort-intensive process. However, I believe that at least a large portion of that effort comes from sheer inefficiency and stunning arrogance of the management, but later on that. Let's concentrate on the workflow for now.

2. Typical workflow

The order below is not a fixed one, but rather a guidance to what it may look like. The tasks will change from product to product, and from deal to deal, but this should give you a good idea of the process (and help me remember in the future).

Sourcing
A deal may be sourced from a newspaper article or a bold idea, but most commonly it comes from the corporate clients themselves. This is where the coverage bankers' ability to consume alcohol and entertain clients pays off, because they are often able to identify a business opportunity much earlier than it is reported to the broad public. Theoretically, coverage bankers should also be watching the capital structure of their clients and see if the capital structure changes may trigger a capital raising to restore it to the levels defined by that client's financial strategy, but I did not observe them doing so in reality, at least at my firm.

Internal Discussions
These can go for ages without arriving to any conclusion. You need to persuade everyone, almost including the old janitor ladies who come to cleanup every day, and the nature of the questions you may get has often little to do with business. In my firm the discussion topic often drifted to ridiculing folks in the London office with whom we worked on cross-border deals (to my knowledge they paid us back in kind), demands for unrealistic level of detail and attempts to quietly stifle the idea to get the workload off one's shoulders. The only ideas that were quick to get support were the ones bluntly pushed by the management, or the ones that followed a well-established business process. Both types tended to receive too little scrutiny, and therefore caused a lot of problems later on, when the deal was nearing the execution stage.There were, however, rare cases when the ideas proposed by the team members got adequate attention and reasonable doubt, and gained momentum in so doing.

Putting Together A Pitch Book
This is what investor bankers do, for most of the time. I will dedicate a whole post to the nuts and bolts of a pitch book, but to put it shortly, a pitch book is a combination of the market analysis, the bank's credentials in the particular product, claims of being the right bank for the client and a large amount of statistical information and analysis. A basic product introduction pitch book will be fairly standard, and the banker will only need to update the statistics and graphs, slightly change the wording, and put the client's name in bold on the cover page. The more comprehensive internal education materials will cover a broad range of subjects from the client's introduction to explanation of the client's domicile financial regulation and particular technical issues to consider. Of about the same volume, the Lead Arranger proposals will appeal to the client by trying to persuade him/her that the bank understands their business well, by describing the technicalities of the placement and by putting every award and league table available in the end of the book.
The hardest and the thickest pitch books are the Global Coordinator proposals. They will include the distribution and allocation in the major markets, in depth analysis of client's business, the equity story (if necessary, slightly different for every investor segment), the syndication proposal, the valuation and much, much more.
Expect the document to be rewritten over and over again by different people without any consultation with each other, and to be blamed for any blunders they put into it in the process.

Making Presentation to the Client
This is the job done by the coverage bankers and the senior management. The senior management usually has little to no idea about the proposal's background and technicalities, so internal documentation is meticulously and painfully put together and presented to them before the client meeting. A big gang will be normally assembled for the client presentation to show the bank's commitment to the deal, and to help the senior manager out, when he finds himself lost in the technicalities.
Interestingly, the presentations in investment banking are amazingly dull (pun intended). They are never done on screen, always with the pitch book only, meticulously covering each slide - tribute to the technologically illiterate senior managers, I suppose.

Addressing Client's Questions
Typically, clients will have many questions after the presentation. Some are asked because they really did not understand some part of it, or want some additional information, but others just to check how helpful the particular bank is addressing the client's concerns. Considering that most of the data and information that bankers could dig out is usually already in the pitch book, addressing such questions can be a very hard task. The management will typically be very reluctant to pay for any information (and good a research paper that has the answers can easily go $500-1000), so bankers spend days (and nights) browsing Internet, digging into Bloomberg and Thomson Financial databases, or reading the Research reports in search for the right piece of data.

Due Diligence
Due Diligence (DD) process can take several months, and its original goal is to check if the client meets the requirements for the placement in terms of business sustainability, financial indicators, organization, corporate governance and disclosure. However what it really is, is to advise the client on what changes he should make to meet the requirements. DD is done mostly by the audit firms like KPMG, PWC, E&Y and so on, with participation of the Legal Council, client's Investor Relations officer and CFO and packs of bankers. In my case, we had a weekly or bi-weekly calls with participants half around the globe and up to 8 hours apart. Not a case when you can go home early.

Underwriting Committee Review
This review is mandatory, but in my experience is done more to appease the regulators, than to actually go through all the items on the check list. Also, most of the identifiable problems are already known by this time, so it is just management decision whether to give green light despite these problems, or stop the deal because of them. Deals are rarely stopped.
Also, the timing of the Review is somewhat tricky. Should it be called when all the details of the deal are clear, but little or nothing in the structure can be changed, or when there is still some unclarity about the terms, and much can be done to tune them? Not so easy to decide when you have so many counter parties to deal with.

Internal Education
This part is done mostly for the Sales, who will be selling the product to investors. In my case a large portion of the offerings targeted retail investors, and we had to tackle their utter ignorance with regards to anything that lies outside the Japanese borders, starting with country locations. The documents prepared at this stage will also be used later on, if someone needs to get a good understanding of the deal he was not in charge of.

Deal Structuring and Syndication
Deal structuring is about dividing the offering into portions (called tranches) to achieve the best penetration among the investors. Different regulation for retail and institutional investors and differences between countries may make it difficult to place securities in one bunch, hence it needs to be adjusted.

As for syndication, it often happens so that a bank feels its client base is not sufficient to deliver the full demand for the client's offering. This is when the tricky business of syndication starts. Other banks are contacted and offered to take part in the offering, but with lower status then the bank offering the participation (its status is usually Lead Arranger or Global Coordinator). Banks with lower status have much less discretion with regards to how they place securities and control the allocation, so it is not always easy to come to mutually satisfactory solution. But many banks join in eventually, because it is easier to just place securities then to do all the job from pitching client to the allocation.

Roadshow
When the investor base is defined and offering arrangement is gathering steam, it is time to do the premarketing. The client's management is taught in much detail what they should say to make the offering look a good investment. They go on a trip, often around the world, and speak to the investors (usually institutionals) in the countries where they plan to offer their securities. This process is known as Roadshow.

Valuation
At this stage, bankers build financial models and determine the price range that will be incorporated into the offering prospectus. The idea here is to calculate the number which market analysts and investors would agree to. The valuation is both science, art and guesswork, and I will get back to this topic in later posts.

Regulatory Filings
These vary widely depending on the nature of the product and on whether it is a public or private placement. Public placements require documentation up to several hundred pages long, especially if the securities are filed for listing. There is usually a dedicated department or at least a team in the bank called Documentation that deals with this task. The timing of filing is strictly defined under the financial regulations, and the bankers in Documentation do not get much sleep (if any) for several weeks before the offering.

Subscription and Book Building
The most widely used way to offer securities in the public market is now Book Building. It determines the price by accepting orders from investors and calculating the number of securities investors are willing to buy and the price they are willing to pay for them.

Allocation
Allocation is determined by Book Builder, and in theory is a pro rata allocation to every investor at the determined offering price. However, in the complicated large-scale deals, there may be allocations to strategic investors, different pricing for domestic retail investors (when a state company is privatized) and other complications. On top of that, in Japan retail investors have a right to cancel their orders at this stage, which can virtually ruin the deal, because the trading in securities may start earlier overseas than in Japan, and if the price goes lower then the offering price, investors will refuse to buy them (this actually happened before).

(Finally!) Receiving the Fees
After the primary offering (and any following lock-up period) is over and securities are traded in the secondary market, the banks finally receive their fees from the client, becoming the base for the fat bonuses of senior management, who rarely play any significant role in the offering. And what about the bankers who originated and executed the deal? They get another assignment and start preparing new pitch books. The infinite loop goes on.

3. Lessons

I've heard that in companies like Goldman Sachs or Lehman Brothers (R.I.P.), the situation is different, but at my firm a lot was determined by custom rather than by sound logic and reasoning. So, the key to survival for a banker at the bottom of the fat banking hierarchy during the process above lies, in my opinion, in adhering to the following set of rules:

a. Know how to deal with difficult people. There will be a lot at your bank.
b. Know the client well. If, for instance, you are thrown in a proposal for a transport company, learn everything you can about it, including what models of trains and buses they use, how many people they transport daily and how are their fares determined.
c. Cover your back. Many people, including most likely your superiors, will use every chance to mock and ridicule you if you fail to answer any of their questions, so be prepared.
d. Get to know the people in other departments, who you would work with on a deal. Being able to call a friend directly, rather than going through his boss can save you hours of bureaucratic meddling.

This concludes my second post on investment banking.

Links to other posts in the investment banking series:
Post 1: Series Introduction
Post 3: Pitch Books
Post 4: Valuation, Part 1
Post 5: Valuation, Part 2
Post 6: Equity Story

Invesment Banking Series: Introduction

2009-04-21T13:27:00.001+09:00

Investment Banking Series

Series Introduction

I am starting a series of posts on investment banking. There is a dearth of books out there that tell about investment banking, some of them even actually written by i-bankers, and I am not in any way trying to compete with them, but merely want to reflect on what I was doing up until about a year ago, how it worked and what where the lessons I learnt while being there. This will be about the way it is done in Japan, and more specifically in Japanese companies, and this is very different from the way it is (or was until very recently) done on the Wall Street.
This post will be an introductory one, outlining the investment bank's functions and typical departments. The following posts will go into more details on specific products and real-life situations.

Post 1: Introduction into an Investment Bank

1. What does an investment bank do?

This is a simple question the answer to which may prove rather elusive. Historically, investment banks evolved as underwriters for companies when they were in need of capital. In other words, they assumed the responsibility for distribution of the company's securities by buying them, and then selling to investors. This is still important, but hardly the only function that investment banks have performed in the recent years. New related and unrelated business functions emerged over the years, most importantly dividing the primary market (underwriting, corporate finance, M&A advisory, principal investments) and secondary market (brokerage, sales, trading) functions organizationally, and putting the Chinese Wall between them. So, the answer to the question above is really "anything that you can make money on and that regulators would allow".

2. Departments in a typical investment bank

Here I will briefly describe the Front Office departments. The list is not exhaustive, but covers the most prominent areas of i-banking business.

Corporate Finance

When people think of a stereotypical "investment banker", this is what they usually imagine. Although the department names and actual responsibilities vary widely from firm to firm, basically these people are the brains behind the deals. They are the ones putting together the endless pitch books, building financial models and (if they are lucky) executing deals. Often there are bankers specialized in certain industries or covering selected companies within industries.

Capital Markets
Bankers in these departments are a kind of go-between for Corporate Finance and Sales and Trading, and play an important role in deal execution. They are often subdivided into the Equity and Debt Capital Market departments.

ECM

This is the department where IPOs and secondary equity placements are usually arranged. The products they work with is ordinary shares, preferred shares and sometimes also convertible bonds and exchangeable bonds. These bankers will suggest the good timing for the offering, coordinate with Sales on the appropriate way to sell without sending stock price down, and sometimes arrange syndication (i.e. ask other firms to assume distribution of a portion of shares being placed) in order to maximize the deal size.

DCM
This department arranges placement of fixed income instruments, in my experience predominantly corporate bonds, although the range of products is fairly broad. For instance, in the firm I worked for they had a team specialized in Samurai Bonds. DCM is similar in its function to that of ECM, only the products are different.

M&A Advisory

Although it has generated a lot of hype, this is actually a relatively new part of the investment banking business, and is sometimes packed in Financial Advisory department, or the likes. These bankers do the messy job of making two (or more) very different companies look like one, at least on the financial statements, and sometimes also advise companies on strategic issues.

Corporate Coverage

This department can have different names, or sometimes even not be an independent department, but it's fairly simple in its function: establish and maintain relationships with prospective/existing clients and come up with business ideas. This is the sales of investment banking, the difference with the actual Sales (and it took me a while to figure this out) is that they work not with investors, but with corporates. In my experience, the core competency in this department is the ability to absorb large amounts of alcohol in a way that would keep client entertained.

Sales

Now this department works with investors, and mostly with securities already on the market. Consuming alcohol is an important part of their jobs as well.

Trading
This is the part of investment banking business that grew in its significance over the 2000's. There are all kind of traders: execution, sales, prop and algorithmic... They can trade either in client's (execution and sales) or in the firm's account (prop, execution, often algorithmic).

Research
Often a separate entity, this part of the investment bank provides guidance to the investors and bankers with regards to the economy, markets and particular companies.

Other departmentsThere are as many organizational structures as there are firms, and many have departments unique to their organizations. For instance, in the firm I worked for there were an IPO dept., an Underwriting dept., a Corporate Research dept. (I still can't figure out what is it there for), and an International Finance dept.

This concludes my first post on my experiences in investment banking.

Links to other posts in the investment banking series:

Post 2: Deal from Sourcing to Completion

Post 3: Pitch Books

Post 4: Valuation, Part 1

Post 5: Valuation, Part 2

Post 6: Equity Story

CFA December 2008 Exam Results Are Out

2009-01-29T13:58:00.000+09:00

December 2008 Pass Rate for Level 1 is reported 35%, same as that for June 2008.
http://www.cfainstitute.org/cfaprog/resources/examdetails/examresults.html

Thankfully, I am among the lucky ones this time.

I am curious why the pass rates for Level 2 and Level 3 are substantially higher than for Level 1. Does it mean that only smart guys are left, and they pass anyway, or that it is harder to get from zero to Level 1, than it is from Level 1 to Level 2? I kind of hope it's the latter.

Late greetings

2009-01-08T11:30:00.001+09:00

Although it may be a week too late, Happy New Year, everyone!

I unreasonably hope that the year of ox will bring us some bullish mood. But that being an earth ox, I will be down to earth, and simply wish you health and many happy moments with your families!

It's always nice to get something for free. Especially CFA preps

2008-12-25T13:40:00.000+09:00

CFA is not for the people with empty pockets. Program enrollment and exam registration fees will cost from $990 to $1395, depending on the timing of application. Plus, it really helps to have some unofficial preps, like Schweser Study Notes, if you don't have time to go through the multi-hundred-pages official curriculum.

So, it's really nice to learn that some of that material is now available for free. Investopedia.com now hosts CFA Level 1 prep, along with Series 6, 7 and 63.

Even after spending 5 or so minutes browsing the site it became obvious to me that this is way too little to pass the exam, but it is still a very useful resource to gain an understanding of the topics covered and occasionally find one of the not-so-complicated formulas online whenever you need them. Not so bad for the times when salaries are not expected to increase for a while.

It was the "Fun Management" after all

2008-12-17T12:34:00.001+09:00

Some of the readers may remember my post People Needed to Manage the Fun, that I posted this summer.

Apparently, whoever posted that job description may have been less mistaken than I thought.

I am reading the AIMA's Roadmap to Hedge Funds, and one line there drew my attention:

Some [absolute return managers] go even so far as to referring to the
traditional asset management as "fun management" rather than "fund
management"...

Although I doubt that the pun was intended on the part of the job-poster, it is still quite amusing.

On a more serious note, the attitude towards the traditional long-only managers described above is based on the fact that they are not held accountable for any losses, whereas the HF managers are, both by means of watermarks, hurdle rates and more often than not, co-investment of their own capital.

CFA Exam is Over

2008-12-08T12:24:00.000+09:00

Last Sunday (Saturday for you in Americas) was the big day for the CFA Level 1 candidates. Sleepless nights came to an end, and ahead were 6 hours of exam. I was one of these candidates.

Personally, I found this exam a little easier than the one I sat in July (and failed). There were fewer problems that required complicated calculations, and the Quantitative Methods section contained less difficult statistical problems.

Interestingly enough, the pledge on the exam problems pamphlet (mandatory to sign) explicitly required candidates not to disclose contents of the exam, so I am not going into more detail, but my overall impression is that this time I may stand a chance.

Although, this is the CFA exam, you can never be really sure...

Sleepless nights and Schweser notes

2008-11-18T09:18:00.000+09:00

What is a better way to pass the CFA exam - the official materials that you get shipped when you apply, and pay for even if don't want to, or the shorter unofficial materials such as (among others) Schweser Notes?

CFA Institute recommends the minimum of 250 hours to prepare for the Level 1 exam. In my practice, this number can go way up, depending on your background and the availability of time. It is good if one majored in quantitative methods and already has a CPA, then CFA should be less of a challenge, but for the vast majority of candidates, it tends to be the first encounter with at least one of the topics on the broad CFA curriculum. So, it is safe to add up 30-50 hours for each area you are completely unfamiliar with.

Plus, CFA exam-takers are usually employed, so they have to spread the study over their weekends and nights, and the total length of the preparation period is very long. Unsurprisingly, many people forget what they studied in the beginning by the time they get to the end.

I know both people who used only CFA official preparation kit, and those who only used Schweser Notes. I would say that the pass rates among both groups is roughly the same. This year, there are 76 readings in the CFA Level 1 prep books. A reading in Schweser Notes varies somewhere between 4 and 25 pages, the official materials are about twice as long.

For anyone who prefers to sleep at night, I believe the choice is obvious.

From virtual to real: the big shift in investor preferences

2008-11-11T12:40:00.000+09:00

Forget about sophisticated financial products. Forget about CDOs, especially if they include (God forbid!) MBS. Investors are going back to basics.

In the time when the allegedly absolute-returns Hedge Funds are making headlines with big drawdowns, and the Private Equity firms cannot figure out how to make a buyout with no credit lines available in the banks they had been dealing with for decades, what does it leave a sophisticated investor with to invest into?

It comes down to the Real Assets. One of the most popular (at least as a topic of conversation) investments of this sort is Timberland Investment. The beauty of it is that once the tree is planted, it grows without any other cash expenses. All that investor has to do is to make a decision on when and how much of the forest should be cut to sell the timberland and get returns.

Timberland investments a long-term, typically over 10 years, and thus fairly illiquid, and compared to Private Equity, for instance, they generate lower returns. But they are also much more stable, and in principle there is no J-curve. And if this is not the right risk/return profile, investors may choose to buy into the emerging markets, say Indonesia or Mozambique, if they have the guts. But then there is a scale problem, because about 70% of the investable forestland is located in the US.

No fan of wilderness? Try agriculture. Agrifunds are not as widespread as timberland (not that every investor is into timberland, but it is still fairly common in the US and Europe), pick what you want to grow, and there you go! This asset is however riskier than timberland, as a hurricane or pests can easily destroy the whole harvest. But there are some fans. Middle Eastern funds, for instance, are buying arable land all across Asia. Although, their interest is not a purely commercial one - they need access to food products for their growing populations, thriving on oil, but living among arid wastelands.

To put it short, anything's good that you can see, feel and smell (and get returns from, so forget about the Real Estate for a while). Primitive though may it seem, I find this sort of investments much better than all the abbreviations the Wall Street gave us in the recent years. CDOs, MBS or any of the likes.

Positive proof of global warming

2008-10-17T11:17:00.000+09:00

Saw this pic in a presenation material and couldn't help googling it. Very persuasive!

Found via Google Image search

The frightening chart inverted

2008-10-14T09:30:00.000+09:00

Today's market opened with a surge, closely resembling the inverted version of the chart in my previous post.

Source: http://markets.nikkei.co.jp/kokunai/

I find it hard to believe this is a sustainable gain, and my guess is Nikkei 225 will drop back below 9,000.

The most frightening chart I have ever seen

2008-10-10T12:44:00.000+09:00

We all know that times are tough and bound to get even tougher. But when I was watching the Nikkei 225 plunging down 10% during the first hour of trading, it came to a point where I was seriously considering what I would do if the financial industry collapses altogether, and I will be facing the unpleasant task of finding a way to earn my living amid the World Great Depression II.

Nikkei 225 Index

first hour of trading Oct 10, 2008

Source: http://markets.nikkei.co.jp/kokunai/

Luckily, the stock market recovered just a little after that, suggesting the worst was over. Or maybe still to come.

Central Banks in Action

2008-10-08T23:38:00.000+09:00

To the Fed and the ECB: Congratulations, gentlemen! You have miserably failed. This is bad for you and for the world economy.

Chart: First hours of trading in NY
Dow, Nasdaq and S&P 500, % change d-o-d
Source: Google Finance

The markets reacted to the joint action by Fed, ECB and several European central banks with a moment of optimism, and then continued their way downwards. For the investors it was too late too little once again. Now it is really hard to tell when the bottom will be reached. Or if.

The Fisherman and The Investment Banker

2008-10-07T19:17:00.000+09:00

I read this story a year or so ago, and recently just stumbled over it on the Internet. Looking back at what happened over this year, the ibanker clearly had a lot to learn from the humble fisherman.

The American investment banker was at the pier of a small coastal Mexican
village when a small boat with just one fisherman docked. Inside the small boat
were several large yellow fin tuna. The American complimented the Mexican on the
quality of his fish and asked how long it took to catch them.
The fisherman
replied, only a little while.
The American then asked why didn't he stay out
longer and catch more fish?
The Mexican said he had enough to support his
family's immediate needs.
The American then asked, "but what do you do with
the rest of your time?"
The Mexican fisherman said, "I sleep late, fish a
little, play with my children, take siesta with my wife, Maria, stroll into the
village each evening where I sip wine and play guitar with my amigos, I have a
full and busy life."
The American scoffed, "I am a Harvard MBA and could
help you. You should spend more time fishing and with the proceeds, buy a bigger
boat with the proceeds from the bigger boat you could buy several boats,
eventually you would have a fleet of fishing boats. Instead of selling your
catch to a middleman you would sell directly to the processor, eventually
opening your own cannery. You would control the product, processing and
distribution. You would need to leave this small coastal fishing village and
move to Mexico City, then LA and eventually NYC where you will run your
expanding enterprise."
The Mexican fisherman asked, "But, how long will this
all take?"
To which the American replied, "15-20 years." "But what then?"
The American laughed and said that's the best part. "When the time is right
you would announce an IPO and sell your company stock to the public and become
very rich, you would make millions."
"Millions.. Then what?"
The
American said, "Then you would retire. Move to a small coastal fishing village
where you would sleep late, fish a little, play with your kids, take siesta with
your wife, stroll to the village in the evenings where you could sip wine and
play your guitar with your amigos."

Bloody markets

2008-10-07T12:45:00.000+09:00

The Wall Street Journal's Asian Edition front page today features the world map, showing the countries where the stock markets tumbled yesterday in red. It looks like a one solid blood stain, because for all the countries shown, markets were down.

So much for the decoupling theories...

Source: Wall Street Journal

CFA Exam to Change. Will the Pass Rates Improve?

2008-10-06T18:42:00.000+09:00

Revisitng the topic of CFA pass rates, below are the most recent pass rates as reported by the CFA Institute:

June 2008
Level I: 35%
Level II: 46%
Level III: 53%

December 2007
Level I: 39%

The question is, will these change in 2009, when the three-choices answers replace the current four-choices structure?

Below are some links arguing on the topic:
CFA Institute claims that there will be no change, as any change in the absolute number of correct answers will be offset by the relative nature of assessment.

However, Dr. R. Douglas Van Eatonon the Schweser CFA Blog provides a less straitforward, although similar viewpoint.

In any case, there is a lot of hours to put into the exam preparation, no matter four choices or three.

Mitsubishi UFJ considering to consolidate Morgan Stanley's business in Japan

2008-10-03T14:26:00.000+09:00

Nikkei Shimbun, a leading Japanese business daily, reported today (original text in Japanese), that a plan to reorganize Morgan Stanley's (MS) securities business in Japan, including possibly bringing it under one roof with Mitsubishi UFJ (MUFJ), is under consideration.

The strategy is to be elaborated by June 2009.

The dwarf that may swallow the giant

2008-10-03T13:25:00.000+09:00

Bank of America is a big bank. In terms of total assets almost twice as big as Merrill Lynch that BoA is acquiring as a result of the unexpected deal arranged last month (USD 1,716 bn vs 966 bn; source: Google Finance). And in terms of the current market cap, BoA is four times bigger. A giant and a dwarf, one might say. So, the deal looks logical in the American context.

Not necessarily so in Japan, where BoA's both corporate and investment banking offices fit comfortably at the 15th floor of Sanno Park Tower, mostly known among financial professionals in Tokyo, as home to Deutsche Bank Securities; whereas ML has its iconic bull logo several feet across on the side of its office in Nihonbashi Ichome Bldg, an office in Osaka and several joint offices with Mitsubishi UFJ across the country. It is no coincidence that ML is so big in Japan. ML bought Yamaichi Securities in the late 90s, and the employees of the failed Japanese securities house are still the backbone of ML's Japanese business.

So, it is no surprise that some of BoA employees in Japan are scared to lose their jobs. The dwarf may swallow the giant after all.

Handbook of Alternative Assets

2008-09-25T10:37:00.000+09:00

I am now reading The Handbook of Alternative Assets by Mark Anson.

It provides a very good step-by-step explanation of rather complex universe of Alternative Assets. However, I would still prefer to see Real Estate included, even though I understand the author's reasoning for not doing so. Plus, more details on the funds legal structure would also be useful.

Platinum price fundamentals

2008-09-12T07:33:00.000+09:00

Great article on platinum price fundamentals:

'Oversold' platinum and uranium sectors may provide great upsides

SWFs: Useful links

2008-09-11T15:18:00.000+09:00

Continuing the SWF topic, here are some useful links for everyone trying to keep track of the latest developments:

Sovereign Wealth Fund Watch
SWF Radar
FT In depth: Sovereign Funds
Sovereign Wealth Fund Institute TM

If anyone is aware of other SWF-related resources, comments are welcome!

UFOs and SWFs

2008-09-04T09:28:00.000+09:00

It seems that people always have to be afraid of something that is out there. When we are kids we are scared by the ghost stories, when we grow up we blame something more specific, that is out there, but what we wrongly take for something it is not.

Take UFOs. Whatever the conspiracy theorists might have to say about them, they turn out to be planes or scientifically explainable atmospheric phenomena. But they are still spooky and scare some people. Now take SWFs. Also something that is (in common understanding) alien and mistaken for something it is not. And apparently, some people also find them spooky.

This week IMF gathered the representatives of the world largest SWFs to agree on the draft of Generally Accepted Principles and Practices for Sovereign Wealth Funds. Although not to be made public until October 11, when they will be presented to the IMF's governing council, they are said to contain 24 principles on [quote] legal, institutional and macroeconomic issues, as well as governance, accountability, investment strategies and risk management [end of quote, source: WSJ]. In essence though, this code should address the irrational fear of the developed world over hidden political agenda behind the SWF investments. It seems that the same xenophobic frenzy that raged at the time of Dubai Ports bid for some of the U.S. ports, is blinding politicians around the world again.

Let's look at the facts.
Fact #1: No SWF investment with any hint for a hidden political agenda has been documented so far.
Fact #2: There is a clear political agenda behind many of the deals that western companies make, often with explicit backing of the respective governments. For instance, take the U.S. political lobby in energy sector, or merger of France's Suez and Gaz de France.
Fact #3: There is a lot of talk of imposing some kind of control on SWF investments. Take Germany, where politicians are pushing for regulations, or the U.S., where people are blaming SWFs for the extreme volatility of commodity prices.

So, to sum it up, it is okay for the western companies to have political agenda, but even a faintest hint of something like that in the SWFs (some of which, as it happens, come from developed countries as well) actions is something to go crazy about.

In my opinion, people should stop trying to see a UFO in every bright spot at the horizon. This is very much a waste of their time. The same goes with SWFs. If we stop seeing politics behind what really is a much-needed source of capital in the time of credit crunch, we might as well find a better use to our time. Although, even if we do, there are always ghost we can get scared of...

People needed to manage the fun?

2008-06-07T01:50:00.000+09:00

I came across a job posting today, reading Senior Fun Manager.
Sounds like a lot of fun, maybe I should apply. :-)

To everyone leaving comments

2008-06-02T18:02:00.000+09:00

Thank you for taking interest in my blog, I appreciate your comments.

Please be informed that I enabled comments moderation, and every comment has to be approved before it is actually displayed. I had to do so because there was a case of inappropriate comments made at my blog, which brought no value to the readers.

Therefore, do not be surprised if your comments are not displayed at once. It will take me from some minutes to some hours to read and approve their posting.

Thank you for your understanding.

Russia is not just a buzzword after all

2008-05-30T11:02:00.000+09:00

A surprisingly large number of companies in Japan are into Russia-focused M&A

Recently I had some opportunities to talk to the bankers in the second-tier companies, and I was surprised by how strong and practical their interest to M&A deals between Japanese and Russian companies is. Although I am not at liberty to mention the company names, I am aware of one Japanese bank that has formed a partnership with a leading Russian brokerage/investment bank and is currently sourcing deals, of one Japanese diversified financial holding that is keen on Russian real estate, and one German bank that apparently has a dedicated team for this kind of deals. And I have a suspicion that this is only the tip of the iceberg.

What is most surprising for me, is that the two Japanese financial behemoths, to one of which I belonged until very recently, apparently talk about Russia more than actually do anything. It is the second-tier companies that walk the talk.

It is definitely a good news for me, as somebody would probably be needing people with my kind of skillset after all. Let's see how the things play out.

How precious will the metals get?

2008-05-19T22:29:00.000+09:00

The main drivers of the precious metal prices

The prices of gold and platinum are closely correlated, but there are certain differences between their movement. As a lot of investors are apparently paying close attention to these metals as alternative investment, I tried to summarize the main drivers behind the rising prices.

Gold:
1. Safe heaven for the US dollar holders
2. Increasing demand from Asian emerging middle class, particularly India (c. 20% of the world demand)
3. Decrease in annual production, to a large extent due to energy supply problems in South Africa

Platinum:
1. Alternative asset for equity investors (also holds for gold)
2. Increased use in environmentally-friendly technologies, for instance hybrid cars
3. Decrease in annual production, to a large extent due to energy supply problems in South Africa, which produces up to 80% of the world output

Seems like the high prices are going to be sustained for a while...

For the reference, links to gold and platinum price quotes:
http://www.gold.mitsubishi.co.jp/price/price.cfm
http://markets.ft.com/tearsheets/performance.asp?s=us@gc.1

Change of title and format

2008-04-21T08:59:00.000+09:00

After a long pause, I decided to resume this blog under a new title iBanker.jp
The posts will be submitted on average once a week.

What's the next big commodity thing?

2008-01-10T13:59:00.000+09:00

[Lead, story to follow]
Oil going 100 USD/barrel, gold hitting highest price in years... What's the next big thing?

The world is changing... Is it good?

2007-12-20T09:50:00.000+09:00

It is now official - the world is changing, and Asia is leading this change.
First it was Middle East, then Singapore, and now China is joining the race to bail out the ailing Western financial institutions. China Investment Corp. (CIC), a sovereign wealth fund (SWF) will be holding up to 9.9% of Morgan Stanley shares by injecting as much as USD 5 bln. Rejoice the West, the East is coming to help you! Or is it?

SWF accumulate government money that come from oil, trade or other sources, and therefore cannot be independent in the way they conduct their investments. They are formed by governments and work for them. And if Middle East and Singapore have long-lasted business relationship with the West, and can be at least to some extent expected to stay within the limits of business practice accepted in the West, can CIC be trusted just as much?

CIC was established this year, and instantly made headlines by investing into Blackstone Group LP at the time of IPO. They later made losses as the stock price plunged. It is headed by Lou Jiwei, a former Deputy Secretary General of the State Council, and is therefore susceptible to political influence. In the world where China is growing increasingly assertive, is giving away a close-to-ten-percent stake for cash injection a good idea for Morgan Stanley?

It may facilitate doing business in China, but it will surely introduce a risk of being caught between the beetle and the block of the US and China's political interests. Will it happen? Let's see...

There's no need to think - we're strict enough

2007-12-06T09:29:00.000+09:00

Japan's FSA has introduced yet another way to watch over the unruly companies so that they do not hurt easy-to-trick Japanese investors. Surcharges for insider dealing were significantly increased, and now they should at least match the amount gained by improper use of the insider information.

In principle, this is the right thing to do - insider dealing must be punished. But, viewed from a broader perspective, this is yet another step in tightening the screws in financial regulation that has been under way in the recent years.

In my opinion, this is how the hardliners in FSA are trying to restrain investors from being active. Admittedly, they might have some reasons to believe this is a right thing to do. Say "shareholder activist", and the name you will hear in Japan is Yoshiaki Murakami - the one of the few who tried to assert more power for shareholders over the traditionally indifferent Japanese companies. He ended up convicted for insider dealing, and seemingly, this translated into FSA perception of shareholder activism as a whole - they are dirty scoundrels trying to bluntly pillage companies at the cost of social cohesion these companies have been providing for decades. So, the regulation was kept being tightened more and more, the message to investors being - 'you don't need to think, the regulators will protect your interests'.

Is this how you achieve efficient financial markets and maximize shareholder benefits? Hardly.
One thing to look at is how attractive are Japan's borses to outsiders. The tightening regulation made many foreign companies looking for listing in Asia to consider Hong Kong and Singapore - markets far inferior to Tokyo in their size.

I believe the regulators should focus on investors education, rather than making life more difficult for everyone.

Link to Nikkei article (in Japanese):
http://www.nikkei.co.jp/news/main/20071206AT2C0505005122007.html

CFA Pass Rate

2007-12-03T17:59:00.000+09:00

It is interesting to note that CFA pass rate has considerably declined over the years.

It amounted to as much as 94% at the time of inception in 1963, and as little as 42% for the June exam of 2007. Of course, the total number of exam-takers has grown around 250 times, so these pass rates are not completely comparable, but the shift is considerable enough to show a clear trend.

Is it the exam becoming more difficult, or the exam-takers are getting dumber?

Let's just hope that I am one of the few lucky among the 42% when I receive my exam results in about two months...

Original data is available at CFA Institute official site at the following URL:
http://www.cfainstitute.org/cfaprog/pdf/candidate_results.pdf

Do strong defences make Japan vulnerable?

2007-11-26T16:23:00.000+09:00

Today Nikkei 225 closed at +246 points - a robust growth after several weeks of an almost free fall. Growth was lead by banking and automotive industry. This can be seen as a good sign of revival, but is it necessarily so?

First of all, what are the most frequently cited causes?
Most obvious is the fact that US markets closed higher on Friday. Behind this increase were increased retail sales and expectation of further growth in the wake of the year-end holidays.
Another reason mentioned is the weakening yen. However, it actually strengthened today, so this was hardly the reason of the index growth.

So, the most important factor that moved Nikkei up was a purely domestic US information.
It is really amazing how susceptible Japan is to the influence of changes in American economic situation. Especially, when one considers how tightly closed to outsiders Japanese economy still is, especially when it comes to foreign companies entry into Japanese market.

May it be that by having open financial market and de facto closed economy enhances the influence of the largest consumer of Japanese exports? I cannot figure it out in every detail, but the idea looks plausible.

Introducing iBanker Nightly

2007-11-26T11:10:00.000+09:00

Good night, everyone, welcome to the iBanker Nightly!

The idea to start this blog came to me after about a year of relating my investment banking experience in a leading Japanese securities house in another blog knarkh.livejournal.com. This blog will be different in several respects:

1. This blog will be more professional. Main topics that I intend to cover will be investment banking and financial markets in general, their specifics in Japan, and business between Japan and Europe/Russia.
2. I hope this blog will become a place of discussions and knowledge sharing on the subjects metioned above.
3. Most obviously, the primary language of this blog will be English, although posts in Russian and Japanese will occasionally appear where relevant.

Why iBanker Nightly?

First of all, investment banking is an industry of notoriously long working hours, so many posts will appear late into the night. Secondly, as I am in Japan, my daytime posts will appear at night for the readers in the U.S.

Welcome again, and I hope I can make this blog a good combination of value and fun.

Yours,
Knarkh

iBanker.jp

FSA Wants to Ban "Toxic" Life Settlements

[FT Article] Cayman directors sit on hundreds of boards

[FT Article] Few FoHFs yield value, report says

[Comment] Swiss and US set to clash again on bank secrecy

LandThink: How do TIMOs make money?

People with a problem...

At GSAM seminar...

Post in Alphaville

[Seminar] Investing in Cat Bonds (in Japanese)

Madoff really is mad. And off

Care for a "Cat"?

トヨタ、販売好転につながるか 電子制御「シロ」判定

S&P downgrades Japan to AA-

CAIA Level 2 Exam

"Chipan"?

"Hedge-Fund Executive Exploring Other Growth Opportunities"?!

Preparing for CAIA Level 2

Cautionary tale about exit strategies from 1930s Japan

В точку...

Карикатура

Private Equity Council Strikes Back

Just a quote...

IRR is not a perfect measure of PE investment returns. So what?

Reading on Life Settlements

[Economist] Japan’s banks may soon chafe at their mission to support the bond market

JPMorgan pushes on with talks over Gávea

Re: Monetary policy in Japan - Deep hibernation

US fund set to invest in Russian tech hub

Exports Up 40% In April; Trade Surplus Soars

A good bird's eye view of timberland investments

Great post on investment risk

Life Settlement Funds

Change of layout

Geithner Again Pushes Against EU Hedge Fund Rules | FINalternatives

Beware of the numbers

Morgan Stanley and MUFG agree trading deal

CAIA Level 1 Exam

Comparison of financial certifications

Global warming is under way. And trees lilke it

Is this what is about to come for the bankers?

Happy New Year!

Into the forests and back to the office

Hedge Funds Club Tokyo Year-End Party

Employee engagement

CFA Japan Year End Party

Valuation posts now in Docstoc

Overview of the Alternative Investments Universe

Investment Banking Series: Equity Story

My first publication

This is so my boss...

Investment Banking Series: Valuation Part 2

Investment Banking Series: Valuation Part 1

Invesment Banking Series: Pitch Books

Crisis? Not for pets.

Invesment Banking Series: Deal from Sourcing to Completion

Invesment Banking Series: Introduction

CFA December 2008 Exam Results Are Out

Late greetings

It's always nice to get something for free. Especially CFA preps

It was the "Fun Management" after all

CFA Exam is Over

Sleepless nights and Schweser notes

From virtual to real: the big shift in investor preferences

Positive proof of global warming

The frightening chart inverted

The most frightening chart I have ever seen

Central Banks in Action

The Fisherman and The Investment Banker

Bloody markets

CFA Exam to Change. Will the Pass Rates Improve?

Mitsubishi UFJ considering to consolidate Morgan Stanley's business in Japan

The dwarf that may swallow the giant

Handbook of Alternative Assets

Platinum price fundamentals

SWFs: Useful links

UFOs and SWFs

People needed to manage the fun?

To everyone leaving comments

Russia is not just a buzzword after all

トヨタ、販売好転につながるか　電子制御「シロ」判定