In the blood: Golf and the Options trader

Profile series: Key members of the Gate Capital team as well as those individuals influencing Society

Bruce Williams, Portfolio Manager for The Written Fund, walks up to his ball on the 3rd hole of the Royal Liverpool, Hoylake. The ball lies in the left rough, it is 120 yards to the green, with bunkers front and right. There is a steady, brisk breeze off the coast; the sun is before us.

“You know there is a similarity between the game of Golf and trading Options?”, Bruce says as he muses between a full-swing 8 iron or a tempered 7.

I smile. Bruce loves the camaraderie of Golf: the opportunity to share and reflect upon Life’s many aspects.

Bruce is a 4th generation investment manager. His great-grand uncle, founded the family firm of O. F Williams & Sons in the late 1800s in Liverpool. It was his father, Malcolm, who decided in 1967 to accept an offer to merge the practice with Tilney. Thus, it was an obvious step for Bruce to start his career there, which he did – creating a customer database for the imminent privatization of BT. “I had to write the computer code on my own. In those days they had little in-house IT expertise. I was about the youngest member of staff but had the most computer skills”, Bruce smiles. “It makes me think of my young colleagues today, except the are writing algorithms and trading cryptocurrencies”.

As Finance was in the blood, so was Golf. Bruce’s father was Captain at Hoylake in 1967. His mother and grandmother have both been Captain of the Ladies’ too. Bruce admits that he hated Golf until he was in his mid 20s. Now it is very much part of his life. “Options, though” and Bruce’s eyes twinkle “have always been a passion of mine. I love the mathematical clarity and certainty of trading in Options, especially those related to equities”.

Bruce is somewhat of an authority on covered options. He used to conduct seminars in their use during his subsequent career positions at Options Direct and Rensburg (which became Investec). Bruce has made Hoylake his home for his wife, four daughters and their many dogs. 

To Bruce, Options provide a degree of certainty in a market of dynamic flux. “Maybe that is why I have invested in the Hoylake Lifeboat station, renovating it and making it the location of my business”; Bruce reflects; looking towards the 3rd green. Options are a form of risk-mitigation; a safe haven in the turbulent world of Equity investing. 

As Bruce stresses to all his clients: if one is going to invest in Equities one should consider trading in Options – it adds protection and the potential for additional gain. That elusive “additional alpha”. Properly used, Options (puts and calls) provide the additional benefit of managing both volatility as well as time; allowing one to reap some additional basis points of return.

Bruce shares his surprise at how few investors in the UK bother to use Options as part of their investment bag of clubs. As Bruce explains, most Equity investors are “long only” in nature. They buy a stock and hold it for a prolonged period. Most of these “long only” investors are potentially missing additional gains. Bruce’s clients are satisfied with his Options approach. That is why he has launched a UCITS fund, www.thewrittenfund.com, which is focussed on Covered Writing of Options (mainly calls).

In the US, the use of Options in equity investments is near common place. Amongst other reasons, such use may explain the greater wealth creation of US based investors. Yet, in Britain, there is a deep-seated traditional aversion to the use of Equity options. 

As Bruce states: “If your target return is 25% and you can generate that for less risk, then the possibility that it might-have-been-a-greater is largely irrelevant”. Prudence and certainty. According to Bruce, Options trading is a very sound investment form, especially in periods of volatility, such as today.

We are still on the 3rd fairway. Bruce caveats his metaphor that it can be challenged but explains; “If you imagine your Equity investments to be the whole 18-holes, then each choice and swing of the club represents a decision. Use all the tools available to you.  You have an opportunity to play on each shot: for par or that hero swing”. Bruce considers his position, chooses the safer 7-iron, a full steady swing, the ball arcs up and right before settling to left on the green, 3 metres from the pin. A birdie in the offing.

An enormous grin breaks out across Bruce’s windswept features: “I love what I do!”

bruce@thewrittenfund.com

www.gatecapitalgroup.com

www.justinjenk.com

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Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard universities. Justin can be found at justinjenk.comor www.raktas.ee  or researchgate.

Investing in teams

[A long read – because it is important]

Investable management teams start with their investors. Investing the time to create the organisation and then building its core asset – its people. The best investments are in teams

The recent rash of failed/failing IPOs attest to the importance of teams and quality of their advisors. It underscores the draconian realities of start-up failures.

Regardless of type and longevity, at its essence, building and managing a business is all about people. It is the defining element of any company’s success, especially in times of volatility. Start-up, Restructuring and Turnaround phases have their particular wrinkles but the lessons remain the same.

“Investable” by its nature suggests a team’s focus is to generate high or at least above average returns. An investable team is one that doesn’t hold the business to ransom but can mitigate the known and unknown risks that will impinge on the business. More seasoned investors appreciate that absolute returns and sustainability are important dynamic aspects for continuing growth; as opposed to dramatic bullet improvements with limited duration.

This perspective is based on the team building experience of successful investors such as. Sir Richard Branson; James Dyson, Reid Hoffman or even turnaround stars, such as Enrico Bondi, working on behalf of institutional backers. Once built, team leadership is essential.

For a start-up there are 10 aspects (across Team Building and Leadership) that an Investor should consider as one builds the organisation and then leads it.

>Team building: during the creation/set-up period

Sometimes the Investor has the luxury of being involved from the very beginning; often times not. As arriving Investor, s/he needs to set the stage for the organisation.

1. It starts with the Investor

Investors are much a part of the team as the day-to-day management.

Regardless of the metric, “management” is invariably cited as the main factor affecting success of the enterprise. Statistics reveal that a new venture’s success varies from 50 to less than 10% over a four-year period. Failure seems inevitable.  Also the average tenure of turnaround CEOs is less than 30 months.

In short, all the best business proposals and plans are worthless without reliable implementation, and that means an “investable” management team.

 2. Context is all

Context  sets the frame for expectations, requirements and basis for success. Context applies to the nature of the investment opportunity as well as to the investor type. The business angel will have a different set of metrics versus that of a fund manager, institutional investor or even a private equity house. “Measure risk!” exclaims Charlie Munger, which is his (and Berkshire Hathaway’s) first rule for investment success.

3. What are the investor’s objectives?

The investor must act a responsible principal and determine a realistic set of objectives.

Essentially, this objective is how much one is willing to invest (and loose) and what are the return parameters: time to realise and amounts. This clarity will allow the principal to determine the type of persons and structures required. These need to be reasonable and realistic within the context of the business. A start-up has very different demands and challenges than an established enterprise. Size, scale, performance history & prospects, organizational legacy and competitive forces all shape this complex dynamic.

Without this objective firmly set there will always be issues with regard to the team and its performance. According to Hoffman, “You want to measure your endeavor as soon as possible. You want to be able to gauge the viability at the earliest possible moment, so that you can change and adapt your model as needed”. It is important to define an investment’s “failure point”.

From the team’s perspective the importance of this aspect is reinforced. A recent study of 300 high performance teams by Ashridge revealed that 81% cited “clarity of goals, outcomes and deliverables” as being essential to success. This clarification process will reinforce the importance of free cash flow (and how it is generated), rather than other more mundane business, operational and financial measures.

It is surprising how rarely the investor’s objectives are discussed or shared with the teams as a means of communication or even sanity-checking.

For Hoffman a business’ success is meeting a clearly differentiated consumer need. “Good entrepreneurs try to measure what they are doing sooner, and adapt to a changing market place”.

4. The team is more than just management.

The success and durability of an organisation is the formal and informal network of individuals and the changing roles they play: be they founders, original and later stage management. There is a dynamic flow & ebb to a successful organization.

In any enterprise there are probably at least three formal teams and certainly an additional two to three informal clusters: six in total. The investor needs to recognise the hierarchy, composition and interaction of these component teams.

Broadly speaking, the formal team consist of three parts:

    • The Management team, with its critical positions of CEO, CFO Sales/Marketing. There is no business without direction, attention to performance and revenues.
    • The Board of directors. This should be composed of experienced CEOs or former CEOs: people with relevant experience and committed to the business. Two aspects to watch are: the relationship between the Chairman and CEO as well as; the independence of the NEDs.
    • Finally, the professional support team. Essentially the accounting and legal advisors who should be bringing both expertise and objectivity to the organisation.

The informal team is more important with start-ups but will be present (in some form or fashion) in established organizations, beyond functions and departments. There are at least three components here.

    • The Engineering team, which is often the `sweet spot´. It is the “easy part” for most entrepreneurs, be they: technologists, architects, programmers, designers etc. As such it demands attention from the investor.
    • The Customer team. Even without a product you need someone to interpret `customer needs´ and why the company’s product/service is relevant and meets these demands.
    • The Technical/Market Advisory team, who are experts in the company’s chosen competitive arena, who will add value to your ideas for product & market.

As an investor one needs to understand the totality of the teams and their potential to realise value. Remember – investable teams attract customers as well as funding!

5. Profiling Reputation & “track record”.

Many like to speak of a “track record”. It is often taken as a proxy for independent assessment, an informal seal of approval. In its extreme can be a brand for certain individuals, such as Branson or Dyson.

The issues are relevance to the situation at hand and related metrics. There are numerous aspects that go into track record or desired profile.

    • For the savvy investor, that means understanding the relevance of past actions.
    • More importantly the: persona, skills, capabilities and context of past success.
    • Understanding an individual’s or team’s `failure´ is as useful. Rare is the success-only individual. If one’s assessment is that the individual has learned from the relevant experience then that is a positive sign.
    • A more fulsome definition of the task may well allow for a non-obvious candidate to be considered and rewarding decision made.

Any decision will involve compromises. Often an investor is having to decide between individuals who have similar experiences against the correct attitude and aptitude for task at hand.

The ‘Skill/Will’ framework is a useful one. It encompasses:

    • “Skill of the candidate for the task” versus “Willingness to undertake the task”.
    • ”Willingness” is invariably a more important attribute than “skill”; as attitude suggests ongoing development, whereas skill is static.

Ranking an individual along these two dimensions is a useful shorthand as well as understanding the underlying reasons as to one’s judgement.

Too often investors will overly penalise individuals for not being a perfect fit. It is rare that one can find individuals, let alone whole teams, that can be transplanted from one situation to another.

>Team leadership: keeping the team performing

While individuals and their skills are important (and in a start-up personality may play a larger role) the notions, and the display, of collaboration and balance are important. These attributes are most apparent if one considers the “team” requires a “whole brain”: shared intentions, complimentary skills, emotional maturity.

A related issue is that an organization’s requirements change with time and context. The ideal team of a start-up may not, in its entirety, be the most appropriate one to take undertake a fundamental change programme or deal with a crisis beyond the narrow initial confines of the original venture. Better investors recognises this evolutionary process and frequent review their team decisions.

So how does one know which individual and team is investable? Interview well, recruit and then monitor coach/train. At the core: constantly ask “why?” against one’s agreed success criteria, test issues, listen carefully and make an objective determination. From this basis there are a few fundamentals that must always be considered.

6.Manage a structured assessment process

A lot of discussion and research has gone onto identifying the attributes of ‘high performing teams’, such as McKinsey & Co. Harvard has its own time-honoured perspective

From all the decades of observations and research one would say by definition these are investable. ‘High performing’ [(AKA Investable) teams’ have three common essential elements: capabilities, temperament and fit with others.

Too often decisions with regard to HR and senior appointments do not dwell nor penetrate to the real issues. More time is spent on numbers rather than empathy. If the investor is engaged or will be engaged in the business on a day-to-day basis the need for objectivity is even more stringent.

A thorough & structured research & interview process will reveal the strengths & weakness of a candidate. A full assessment of character and potential needs to be set against the (appropriate) task at hand. Myers Briggs testing, or other such methods, are useful tools – but they are not an alternative for a decision.  Don’t be afraid to go beyond desktop analysis. Go directly to the source and speak to the individuals concerned.

With that as a base the investor can begin discerning his/her team performance and keeping it investable.

7. “360° (degree) communications”

360° is an apt phrase as it captures the need of any investable team. It is more than just transmission but also encapsulates the skills of listening as well as assimilation by Investor and team member(s). The Managing Director/CEO must be an above average practitioner. It needs to be second nature to him or her. Yet the team members must also display this skill individually and collectively.

As importantly is evidence of active feedback, listening and learning. The same Ashridge study showed that 75% of the better performing teams cited “regular and frequent reviews” as being an important characteristic of their successes. “Team happiness” is an interesting concept.

8. Action-orientation.

This reflects an ability to take decisions and making things happen; particularly in the absence of perfect information (especially in new ventures).

Hoffman’s view is straightforward. “Entrepreneurs tend to want to launch only when their product or service is perfect. The problem is that waiting undermines the ability to evaluate whether the idea works as quickly as possible, so that you can correct course. Correcting course frequently is key to success. For example, we successfully incorporated changes from PayPal into LinkedIn”.

This ability to adapt, progress and take decisions entails a high tolerance for risk as well as an ability to make decisions based on imperfect knowledge (often the case).

Better teams are self-correcting; making their own HR decisions or proposing changes. While rare such actions are to be encouraged and rewarded.

9. Power, Influence & Trust.

PIT attributes set the basis for action-orientation and a sustainable working environment. Being able to tap and leverage an informal network is as important as formal structures and routines. Making decisions is predicated on clear decision rights and applied empathy or “emotional intelligence”.

Investable teams also display an ability to understand and take the `owner’s perspective’. Their actions being driven by the concept of doing: “what is right; not who is right”.

Interestingly, Hoffman point of view is adamant: “I have never invested in a startup that wasn’t initially recommended by someone I trusted”.

10.  Personalities.

Venture capitalists, as a rule, are less worried with the dominating ego of the inventor or founder; as long as interests are aligned and control mechanisms are in place. Private equity investors on the other hand, are further along the spectrum, as too family-owned business. They may seek a key appointment who adds to a more harmonious working environment, only drafting in a “recognised star” for specific tasks.

At the end it is a matter of ‘fit’ with the Investor as well as within the team. You as the investor must have developed both an agreed business approach as well as empathetic fit with the team.

As the investor you should imagine yourself as a yacht-owner choosing the crew and all its supporting requirements including the yacht. Such a construct helps clarify a great deal of the imponderables. In determining whether a management team is in investable, the skipper & crew must be fit for purpose.

Summary

“Investable teams” are rarely found fully formed; they are shaped and nurtured by their investors and experiences. Clearly enunciated and share goals coupled with a probing process and ongoing review provide the best chance for success- creating value.

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Do read my other blog entries!

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Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard universities. Justin can be found at justinjenk.com or www.raktas.ee  or researchgate.

VC success: meteorites and lightning strikes more likely than a unicorn

It has become fashion, as of late, amongst Harvard Business School faculty to share reasons why ventures fail.

Statistics vary by the season, but the rules of thumb are:

  • 80% of Ventures fail!
  • Of those Ventures that liquidate, nearly 40% of inventors never see any of their cash returned.
  • Ventures can survive for over seven years before they fail.
  • Private equity (gross) returns are less that 10% pa.
  • (The meteorite-lightning /unicorn probability is at the end of the post).

The implications are wide-reaching: inadvertent value transfer, if not destruction (depending on one’s perspective); impact on the functioning of the Venture Capital ecosystem; personal tragedy all round. It is not that every failed entrepreneur can get back up and try again: Arnie-style. Founders are the seeds of success; and hope springs eternal.

To practitioners, this high failure rate is not news. What still remains lacking is an understanding of the critical issues to be resolved or better yet; practical steps that can be taken (by investors, founders, management), in the appropriate time, to increase the chances of success, closer to 50/50.

HBS Lecturer Shikhar Ghosh, in his article, believes the problem lies in the chasm between Financial Reporting and Business Operations. He cites: unrealistic growth expectations; inadequate processes to deliver that growth; inability to build a compelling brand; as well as difficulties to develop “progressive, provable, repeatable results”. The lack of “visibility” between Backers and Founders is the key challenge. His suggestions include:

  • Operating Blueprints that tightly knot-together Financial Reporting with Business Operations.
  • 360° Enterprise Models to provide a holistic framework.
  • Impact Analysis and Scenario planning.

Sadly, none of these comments adds additional insight to the problems of failure.

Probably even more blooded is his HBS colleague, Professor Tom Eisenmann; who takes a different tack in his recent paper. Lack of cash flow and funding are the banes of any start-up, obviously. He suggests looking for 6 patterns of failing behaviour and targeting actions to ameliorate them. Tom Peters-like, they have been badged.

  • For true start-ups:
    • Bad bedfellow,
    • False starts
    • False promises
  • And for those scaling ventures:
    • Speed traps
    • Help wanted
    • Cascading miracles

Eisenmann suggests that lack of speed to act and unwillingness to cut losses early, a “butcher’s cut” discipline (in Equity Trading parlance) are the two most defining characteristics of catastrophic failure; with its ensuing financial, social and personal damage.

Eisenmann’s reflections may be more useful as they are a call to watchful action and discipline.

In Venture investments, identity becomes wrapped up in the entity. The dynamic balance between subjectivity and objectivity can be disturbed. Furthermore, there are two aspect that are not considered by either professor, and nor much of the academic literature. First, the parasitic nature of the Venture as times turn tough. Second, is the failure (and associated cost) of agents, particularly the fund/portfolio managers, to fully protect principals’ funds. It is rare that their pockets are touched. To the VC professionals it is largely a matter of ‘playing the odds’ and avoiding crystallising that definitive loss/write-off.

It is true that when the VC model works, especially American style, producing that unicorn, then the results are specular. But as with any ‘star’ system, the odds of success are low and highly concentrated. Such as:  banker bonuses; Hollywood stars; Music artists; Lottery winners; etc. For the record, the chance of a start-up becoming a unicorn (at a valuation of USD 1.0 billion) is less than 0.00006% (aka 1/16,667). One is more likely to be: struck by a meteorite (0.0003%); dealt a Royal Flush at poker game (0.00015%) or struck by a bolt of lightning (0.00008%). Is VC a numbers game?

A few observations.

  • It is all about the Founder.
  • The financier be clear and agreed, as to the objectives (inputs, outcomes, timing).
  • Communicate constantly, listen, act!
  • Cull early.

VC is an essential aspect of enterprise development and economic growth; but it is not suited to all investors and not all would-be entrepreneurs can run with the unicorns.

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Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard universities. Justin can be found at: justinjenk.com ; gate capital; or www.raktas.ee gate or researchgate.

US better than Old-World for VC funds and investor – structure

IInvesting in Venture Capital (VCs), especially funds, is still considered an attractive asset class. What is interesting to note is the significant differences between American, British and European VCs. The US is just a better place for VC.

Historically, American VCs fund are larger ($282m), and perform better (10.3% over 10 years) vs their Old-World equivalents, specifically the UK ($168m and 4.6%) and EU ($128m, under 4.0%).

While the data is dated and the adage about generalisations remains true; there are some interesting observations that remain valid for those engaged in the sector, as well as alternative asset investors.

Overview

The correct selection of a target as well as constant fund-raising remain evergreen, constant activities across all three geographies: US, UK and EU. Yet there are important structural aspects to consider, as highlighted below

The main structural aspects include the following: the nature of funds, investment strategy, sourcing strategy, differences in due diligence and cultural differences. These structural and operational factors provide possible explanations for the differences in performance (and hence attractiveness, ease of operation) between the geographic funds. These factors will have deep ramifications for fund-raising strategy.

Fund size

Current research suggests that larger fund size does NOT mean better performance. Yet average fund size does provide an indication with regard the ease of accessing capital. For many founders, the fund-raising strategy is aligned to fund size. In most cases, especially for start-ups, founders must demonstrate the potential exit from the company will be 3x the size of the fund.

Fund-raising

In the US, it is fair to say that fund-raising has become a science, if not an industrialised process: mainly from private/non-government sources.

Yet the Old-World profile reveals a much larger reliance on government support and funding – about 45%. Are governments the best investors in such risk ventures? The motives of Old-World owners accepting such funds can also be challenged.

This difference raises the chicken-and-egg dichotomy: whether lower performance is the cause or the result of a lack of appeal to the private investor.

A further knock-on effect is the time taken to secure funding. Relying on government sources naturally slows down or elongates the period of investment and return. Also, there is a time allocation conflict created. Time (a vital resource) is expended on extended fund-money as opposed to the business of investment.

Thus, the net overall effect is that Old-World (UK or EU) based VC funds do not seem as attractive at the outset. This attribute further influences the stages of development (investment) as well as the nature of investors.

Stage of Investing:

There are several stages of investment. The critical ones are at the earlier stages of the cycle.

The American VC market has a fully developed range of expertise to facilitate investments at all stages, particularly at the growth stage. Any venture needs multiple funding rounds. Such a context in the US provides a balanced and supportive environment for firms to grow and develop.

In contrast, over 60% of British and European funds are focused on seed funding. There is a significant lack of Series A focused funds. Statistics reveal that the main risk for Old- World start-ups is that less than 20% receive further financing from the same investors. Few of these VC’s have sufficient finance available to follow on with their initial investments. The impediment is not only stage; another limitation is the insufficient scale of Risk Capital. In the US the pool of growth stage capital available is 8x larger than in Britain and EU; and support from the same sponsor for a venture across all its funding stages.

Investment Strategy

Investment strategy is another structural difference.

The American approach is much more projected. In the US, VC funds tend to adopt a ‘home run’ investment strategy. It can be summarised as a “1 in 10” approach; whereby one investment’s success will provide the return for the whole size of the fund. This approach reflects the more developed, broader, deeper and hence competitive nature of the US sector. As a result, American VC firms aim for a 60% internal rate of return. Also, they have a well thought out and deeply researched investment thesis. US VC firms are very specific about what they looking for, and base their decision criteria accordingly. They place much greater emphasis on a company’s ability to establish a commercially viable product-market fit, as opposed to revenue.

The Old-World approach is more cautious. Lower IRRs. There is a weaker top down investment thesis approach. A greater emphasis is placed on the finance soundness and profitability of the company.

Deal Sourcing

The ability to source deals/targets primarily relies on the brand strength of a VC fund.

US VCs have better, in the sense of recognised and managed, brands. As a result, they are able to use a more frontline marketing approach (deal sourcing and financing), due to strong networks and track records to build robust pipelines and convince incumbent owners and management. US funds rely extensively on frontline conversations and networks to understand what is happening in the market.

British and EU brands are relatively weaker. It seems that more effort and resources are required to manage their poorer network and weaker track records. The increased competition in the American market means VC

Exits

‘Exits’ are places in the Promised Land.

US VCs have strong relations with corporates, other funds and exchanges for exits. This allows them to wait for a more optimal time and valuations for an exit. A deeper market suggests better considerations.

In contrast, both EU and UK venture capitals have inadequate relations with corporates. This situation is often reflected in sub-optimal exits. It can lead to firm facing a difficult position of being restricted to ‘taking’ offers, or just one; rather than proactively negotiating the best terms.

Culture

Culture is such a fecund phrase and concept. Generalisations abound, some are relevant, and what can be observed are the following aspects.

American VCs are more organised, structured, determined, optimistic, flexible, faster pace and less reliant on State assistance (in whatever form) and higher risk tolerance. In the VC sector this cultural has moulded: fund size, stage focus, investment strategy and sourcing.

VCs in the EU and UK seem unable to emulate the same process due to factors such as: The EU and UK having a less productive process that reflects a more sclerotic and sceptical cultural milieu. Decision-times are attenuated.

A vitally important aspect is scale and connectivity. This physical cluster reflects and reinforces behaviours. The creche for the American VCs has been the development of Silicon Valley in the US. It has developed to provide easier and more experience with regard to access to capital. The cluster’s legal and regulated systems have helped entrepreneurs. Silicon Valley has set the parameters and standard that other loci seek to emulate; elsewhere in the US and well as the rest of World.

The Old-World lacks such a concentration. Its fragmented market structure, made more complex by language and national practices has made it extremely difficult to create or at least emulate the American clusters. Furthermore, the partners of US funds are usually former successful entrepreneurs. While in the Britain and Europe, partners tend to come from either operations, consulting or finance. The former has ‘walked the talk’, the latter group, rarely.

In summary

The US remains the home and centre of the VC world. It is clear that the US is the ideal destination for any start-up. The combination of its: risk-orientated culture as well as expertise helps founders and their ventures grow from a more premature concept state to a more sustainable and established state. While the marketers of Britain and EU proudly promote their skills and successes, there remains an experience and expertise gap.

Be you an VC investor, founder or entrepreneur, the US is a safer bet; unless the proposition is a top-of-class winner, and it may attract the VC.

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Do read my other blog entries!

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Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard universities. Justin can be found at justinjenk.com or www.raktas.ee or www.gatecapitalgroup.com or researchgate

Next? – Negative Interest Rates

Negative Interest Rates (NIRs) are the next step in the Central Bankers’ medicine cabinets.  Simply put, A NIR, is a “tax on money”: that a depositor is paying a bank to keep one’s money; and a borrower is being paid to receive these funds. NIRs are the penultimate financial vaccine in the Central Bankers black medical bag. NIRs may revert to plague – an example of unintended consequences and risks poorly assessed.

We created this problem, the vaccine and now let it loose. Yes, as citizens and consumers we bear part of the burden of blame for putting our trust in systems we rely upon and choosing the leaders we do. Next? We have a choice!

QE/NIRs dissected

NIR policies are a result and last-ditch effort by Central Bankers to close the door on the 2008 crisis. One that they inadvertently sanctioned through ineffective management of regulation and compliance. The use of NIRs is a direct result of the blunter medicine: Quantitative Easing (QE).

The belief was that QE, as an expansionary measure, would inoculate the economy, and counter the current, long standing stagflation that afflicts the world’s economies. A ‘kick-start’ for growth.

Yet with over USD 15 trillion of new money expensed so far, QE has failed to boost consumer and business confidence, especially in the EU and Japan. There has been no start to stimulating borrowing and lending activities. Rather just another kick where it hurts – citizens’ pockets. Universal banks are unwilling to take the credit risk of lending – a decision of based on self-interest and self-preservation. Lending has fallen as research shows.

The net effect of QE has been to release this ‘hot money’ into the economy to find a home in a sea of unattractive alternatives; thus chasing limited investment opportunities. This dismal search perverts intent; stoking as well as inflating equity and property prices, while expansion into bonds has pushed yields down to negative levels. The Trump Administration’s decision to end QE has temporarily envigorated the Dollar, a (short) term consequence. America’s QE experience is neutral, at best. The markets seem concerned. Next?

NIRs have escaped from the lab. Gesell’s original thought paper has not often been applied. Sweden, which has championed successful ‘bad banking’ practices, claim that NIRs are safe to use, as reported in the ‘Financial Times’. The Swiss authorities are less sanguine. Others are not convinced.

Some at UBS even see NIRs as bone-corroding steroids. Banks’ profitability already battered by the 2008 crisis, fines, increasing compliance costs a weak economy and low interest rates mean that their NIMs are under threat. Maybe NIRs are the catalyst to force through the next wave of bank restructurings.

The Central banker’s doctor’s bag may not be quite empty, if the ECB really states to offer out TLTROs – aka Targeted Long-term Refinancing Operations.

But what about the patient- the Economy?

Next?

Continuing concentrations add to volatility and economic distress

NIRs could well add to the already increasing levels of uncertainty and volatility.

  • Capital market flows are driven by algorithmic, AI-enhanced, trading programs of global institutions. Their share of the market has risen to 80%, with ordinary investors’ direct participation being less than 10%. ETFs alone account for 30% of daily trades, raising systemic risk levels, as ESBA concluded.
  • ’Wealth is increasingly concentrated, with 70% of the world’s assets being owned by less than 10% of the population, as research cited by the Washington Post.
  • The rise of the middle class, while a source of demand, has seen a mismatch of expectations.
  • Furthermore, cognitive behaviour suggests that the increasingly frantic ‘hunt for yield’ will see in increase in more risky investment decisions, according to ‘Fortune’.
  • Some authours argue that low interest regimes can encourage innovation. The issue remains have risks been properly quantified?
  • The pre-2008 patchwork system of international arrangements is now morphing into a single one global order, much of it without holistic coherence.
  • The combination of the above factors with the unfolding Digital Revolution, with its speed, transparency, seeming productivity (with a related drive to commoditization) and machine logic can overwhelm national governments, even supranational bodies; bruising currencies. Switzerland provides a case example. This unitary structure, as currently configured, risks being inherently unstable.

Capital has no national home – it is the ultimate global citizen. It can break national markets and thus, by its inherent nature, can just as well weaken (or strengthen) the whole remaining system.

Demography to a medium-term rescue?

Demography has direct impact on capital. The structure of traditional families atomises with the associated changes in spending and saving habits. These demographic changes at home will lead to less savings.

Without those inflows, capital costs will rise: they must. The year 2022 represents the peak of the fertility curve. As a species we are ageing and dwindling.

Capital is set to become scarce and this demographic dynamic will return rates to positive levels within 5 to 10 years. Yet, a week is a long time in politics; markets turn on a trading session, if not less.

There are impediments to this development: time being one, plus others.

Genie of  X-flation

The immediate effects of NIRs could be deflation followed by depression; a deepening of our current state of affairs.

Yet the inevitable rise in capital costs risks the maelstrom of inflation. The next step in the “cure” could well be rampant inflation. Such a development may well save today’s borrowers but would destroy the asset value of prudent savers.

The effects of hyper-inflation are insidious and have been shown to be throughout history. A weak economy begets a weak society and thus exposes it. NIRs increase that exposure.

Latin American economies have never really escaped from hyperinflation’s debilitating grip (read Argentina). The ardour of Nazi Germany was fuelled by the flames of hyperinflation that consumed the Weimar Republic. Such fears led to subsequent interventions – armed and otherwise.

The revitalised countries of Russia and Eastern Europe (such as Poland, the Czech Republic and Eastern rump of Germany) were saved by intervention of their western brethren.

But money is itself a fiat currency; and is itself debased. Hence the allure of cryptocurrencies – a tulip for the digital age or flower from the Garden of Eden?

Revolution – at many levels?

The world is beset by revolutions: technological; industrial; economic; political; religious; environmental; social; etc.

The social implications of NIRs are far-reaching. The political revolutions all tend to be based on wealth disparity and the weakness of the prevailing economic system. Revolutions don’t require many protagonists, according to the BBC. Net Interest Rates may well be a precursor, the proverbial canary.

The social contract, however loose, is at risk of being torn-up. Fueled by Millennials’ frustrations and environmental necessities. How these revolutions are expressed varies in their: objectives; efficacy and impact – intended or otherwise.

The role of government is to promote a nation’s wealth: providing growth and employment. Yet, the liberal democratic/free market governing classes and institutions (education-health-infrastructure-justice) are under siege. Rightly so in a world of QE and NRPs with a failure to provide adequate social services; employment and growth. Confidence is at an all-time low. Fake news reigns!

More worryingly, today’s generation of decision-makers in government and business have no experience of such a volatile world. Grey-haired opinions are not to be found on the Internet; hence not welcomed nor “trusted”.

Scenarios

The inexorable return to positive interest rates assumes a world of calm waters; based on some heroic assumptions.

Such assumptions would call for certain domestic dramas to play out well: BrExit; Japanese transition from grey hair to silicon chips; Chinese political moderation holds; population growth shrinks to nil; easing Trade Wars.

But no Sarajevo-August-1914-spark. The “Broken Window” dynamic is a fallacy. Just as much as modern financial concepts are at measuring the needs of a sustainable “Green Economy”.

The genie of Inflation is not easily harnessed to avoid an Argentinian-Weimar outcome and an atomised world.

Next?

Take stock!

Malthus understood the dynamics three hundred years ago. All of these trends have an impact on capital and its interest rate. Next?

So one arrives at a point of reflection. We citizens who choose to objectively observe our current reality, review our past path to it and consider alternatives will have an insight with regard to what might come to pass.

Some advisors offer their opinion. Owning land, means of producing food and staples, as well as infrastructure in a country where property rights are observed would seem a pragmatic approcah.

As Negative Interest Rate policies work their nefarious effects the financial markets will have to come to terms with a level of risk and risk-pricing that few today, and fewer in positions of authority, have any expertise in managing.

Caveat emptor!

Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard universities. Justin can be found at justinjenk.com or www.raktas.ee

 

Results to drive: Patient Capital one worth the wait?

Yes – ‘Patient Capital’ (PC) may be worth the lengthy drive; but it depends on one’s investment objectives and destination.

‘Patient Capital’ is a form of long-term capital investment. For market participants, it may only be attractive to those investors willing to wait at least five years for a return, which may be below market alternatives and whose non-quantitative benefits (such as a social, political or community objective) and associated risks outweigh the financial gains. Patient Capital is sometimes described as having the discipline of Venture Capital with an IRR of less than 10%! It even has been called “Impact Capital”. However, PC is also a policy for governments (such as China) and Sovereign Wealth Funds to realise their social goals.

Patient Capital one: allows an investor to drive towards the supposed greater returns of: R&D projects (invariably hard science or university spin-outs, such as Harvard  or Oxford); a cause (say micro-financing, or an investor’s pet project); a community initiative (eg, a hospital); or follow-on funding rounds for enterprises that are not able to access traditional forms of capital. As importantly, the Patient Investor can play a more direct, even stewardship, role in: supporting an entrepreneur; building the management team as well as; strengthening the governance of such entities. Essentially, PC represents the “core equity” of the enterprise. Capital one can rely on as an entrepreneur to drive and  build a viable business.

Patient Capital has become an emerging investment trend: a source of funding for particular types of businesses and projects as well as appealing to a certain type of investor. It is deployed across the lifecycle of enterprises, from: Seed, through Early-Stage/Ventures; to high growth small enterprises. By their nature, these assets/opportunities have limited absorption capacity for investment funds as well as an above average risk profile. Yet, the investment volumes remain small, as Beauhurst indicates.

As expected there are several main types of ‘Patient Investor’.

  • Business Angels making many small investments (hundred thousand to a few million pounds sterling).
  • Institutional investors making fewer, larger ticket investments (say in the tens of million) – in pursuit of their objectives. An example would be the Wellcome Trust and Syncona Partners. In addition, the likes of listed, longer-term, investment funds (eg, Woodford Patient Capital Trust, or BlackRock Smaller Companies Trust, etc) which try to balance several investment arenas.
  • Finally, Family/Private Offices are attracted to PC given the appeal of its potential holistic “impact” returns. As PC practitioners claim – it is hard to find a good company so when you do, stick with it!

Some observes claim the traditionally poor performance of UK VCs is forcing it to consider a great role in PC.

The holistic returns of Patient Capital can be compelling as the financial returns are matched to realising a social objective. ResearchGate papers by Raktas and Gate Capital Group suggest the IRR returns for PC investments could be 25%, which compares favourably with VC’s 15-20%. Findings supported by Insead research.

On an annual basis a PC-return could exceed a classic ‘buy&hold’ equity strategy (17% pa).

  • The institutional funds focused on PC (such as Woodford and BlackRock) have lower and varied returns for their own structural reasons and vagaries of the public markets.
  • Theses funds’ focus is in the long term, thus even negative returns (such as as in Woodford’s case) are marketed away as shorter-term volatility for longer term superior gain; to be seen. The risks, as ever, are in: valuations, timing, portfolio composition, hubris and hype. BlackRock’s approach is more measured and its historical returns reflect that.
  • The PC model seems better than the VC one of 5-year investment horizons, 2/20 and IRR of 15%. The key parameters are: risk, time and control. Patient Investors must assign probabilities to the hoped for 0-1-10-100X returns of original investment.

That being said there is a definite gap in the finance market for Patient Capital, especially in the UK; playing catchup to the government initiatives of European markets and ‘super angel’ networks of the US. China and Asia are emerging markets.

In conclusion, Patient Capital is not for everyone. Yet, if an investor is:

…comfortable with the time-horizon and risk-profile of the asset/investment/activity; and…

…has an interest in building a ‘better society’ (however defined); as well as…

adding to one’s bank balance then…

Patient Capital is worth the wait.

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Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard. Justin can be found at justinjenk.com or www.raktas.ee

Drive to despair – price strategies for consumers

It is enough to drive one to despair. Despite the benefits of “dynamic pricing” (or surge pricing) many consumers are happy to over-pay prices by agreeing to follow a flat-rate, fixed tariff.

This situation is most evident in taxi fares; such as Uber; but is found for other products and services.

Consumer biases drive the problem. In short, many consumers mistakenly believe that by choosing a flat-rate they are obtaining a better deal than a metered one.

The reason being cognitive bias; a condition affecting people’s perceptions and judgements, such as pricing. Ted talks, as lecturer, Julia Galef, explains well. Cognitive bias has been deciphered by the Nobel laureate Daniel Kahneman in his tome; Thinking Fast and Slow”; as well as another three Noble laureatesYet, cognitive bias remains poorly understood by many, particularly John, Jane, me myself and Irene.

Price-setters/suppliers benefit. This inherent consumer weakness situation favours those suppliers/price-setters who understand the workings of cognitive bias behaviour.

In many industries, consumers can choose to pay either a metered or flat-rate price. These industries include: Utilities; Mobile phone companies; Online video streaming and gaming services; Rental Car companies; Retail Banking (ie monthly vs individual transaction charges); and Insurance companies.

A recent study at Researchgate by casts light on the economic benefits. Raktas’ study shows the benefit can be 5-59% improvement in costs/profits. Furthermore,

Uber’s impending flotation, and its eye-watering valuation (latest estimate USD120 billion) will provide further evidence of the value of understanding cognitive pricing.

Consumers drive themselves. What is surprising is that a consumer’s cognitive biases overwhelm economic logic and many chose the sub-optimal flat-rate. Thus, consumers literally drive themselves into sub-optimal pricing decisions. For the price-setter/supplier, fixed rates are more profitable if the rate is near the likely metered-one and “churn” is reduced.

Consumer protection? There is a range of protection available including more consumer-oriented firms and government policies. But at the end, consumers are best placed and the most powerful force to protect their own wallets.

‘Caveat emptor’ and exercise ‘choice’

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Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard. Justin can be found at justinjenk.com or www.raktas.ee

The economics of winning a Nobel Prize

The economics of winning a Nobel Prize are significant and go beyond the cash value.

This year’s Nobel Prize winners have been announced and the ceremonies are soon upon us. The economics stack up in a particular way.

The Prize comes itself comes with a cash award and a medal. The cash component is Swedish Krona 8.0 million (approximately €1.2m or US$1.0m).  The prize money is split eqaully if there are multiple winners. In addition, winner receives a medal (composed of 175 grams of 24-karat gold) has an intrinsic market value of US$10,000; higher for its scarcity value.

But the Nobel Prize is not about the money. It is the recognition and prestige associated with it. Certainly for the individual, colective efforts of co-workers. One can trade on a reputation. Also this kudos translates into dollars and value for the associated institutions and universities through fund-raising, transactions as well as attracting better quality students and faculty. Ask Harvard or University of Chicago.

There are some interesting statistics about the Nobel Prize winners. There have been 560 Laureates to date, yet only 45 have been women. The youngest was 17 (for the Nobel Peace Prize; and 25 for the traditional ones, announced in Stockholm); the eldest 90 years old. As to nationality the US leads with 29%, followed by the UK (16%), Germany (14%), the bulk of the remaining 41% from greater Europe; then Asia and Latin America.

Looked at it another way what was the investment to win a Nobel Prize?  Certainly it is not a specific target for many institutions and individuals (and there are some). However the kudos of wining is certainly a motivational driver for many scientists. It has been estimated that in 2010 alone over US$ one trillion was spent on pure R&D activities. Consider that Just one basis-point (1/10th of a percent) is equal to US$ 1 billion (1,000,000,000). So was that the Nobel motivational investment?  Go figure!

Money in and money out. So what did the laureates spend their winnings on? Well while a million sounds a great deal, especially to a silver haired academic or author, it doesn’t go that far. There are some immediate costs just to attend the prize-giving celebrations. On average these incidentals (for clothes, travel, lodging and food, etc) can run up to $20,000 for the prize-giving weekend. Though the banquet, on 10 December in Stockholm, is for free.

Frank Wilczek–Physics 2004 stashed his cash in a savings account. Others paid down debts or mortgages. One laureate built a croquet lawn (Richards Roberts – Medicine 1993; several have funded family education, other transactions or endowed scholarships or given it to charity. The some laureates have felt it was a joint effort, as did   John Mather – Physics 2006; with 1,500 co-workers. He donated the prize to a dedicated foundation.

That was the feeling Dr. Alvin Roth gave Justin Jenk, who co-hosted the prize winner at the Stockholm School of Economics in 2012.

On a ligher note, the Nobel Prize is the inspiration for a whole sub-industry, such as these spoof awards. The trading dynmics and economics of this sub-industry are significant.

Finally how much is a year of life worth? The average age of Nobel Prize winner is 63 years. A study by the ‘Journal of Health Economics’  suggested that Nobel Prize winners  had an extra two year life expectancy compared to their peers. Now that is value.

Do read my other blog entry “Ebola leaves us naked” at justinjenk.com or www.raktas.ee

Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member. He is a graduate of Oxford and Harvard. Justin can be found at justinjenk.com  justinjenk.se or www.raktas.ee

Ebola leaves us naked

People feel naked in the face of the deadly Ebola virus.

Ebola is causing widespread panic. Are these fears justified? Experiences from past disease outbreaks, medical science and diffusion theory suggest that the current hysteria is misplaced.

While the human tragedy is unquestioned, the real epidemic may not be the Ebola virus but the loss of public confidence in government authorities. Such a loss may cause more harm to many more individuals in the future through the combination of prejudice and apathy.

A number of factors are fueling this manic panic. The mortality rates are high and rapid (as  the ‘Forbes’ article shows). As yet there is not a vaccine. The source of the virus seems to be due to a species jump (as with SARS); in Ebola’s case, fruit bats. The public’s current fascination with vampires and Dracula helps not one lite bit. More worrying is the continuing uncertainty as to whether the spread of the virus is physical or has transmuted into being air-borne. Debate on ‘You tube’ debate is intense.

These factors of fear are being compounded by a general and increasing lack of trust in public authorities and sources of information. There are good grounds for concern, but maybe not hysteria.

The loss of public confidence has been made worse by the combination of insufficient or conflicting information. Worse still has been official lethargy and confusion. The present outbreak was already reported in the general press in January 2014, which meant it was a well-developed problem on-the-ground in West Africa during 2013. The site of naked women, men and children – the victims of official lethargy have failed to move politicians into action. The Ebola virus has spread from Guinea, Liberia, Sierra Leone and now to Nigeria as this interactive map and timeline reveals. From rural locations to thronging cities. Viruses require hosts to survive and spread– cities provide ideal locations. Medicins sans Frontières believe the risks are huge and have stated the situation is “out of control”. The unfolding events suggest a scandal at many levels. The WHO has a great deal to answer for. The UK government’s decision to screen arriving passengers achieves little – except to confirm the growing disaffection with government. Better to screen departures and monitor carefuklly passenger movements after arrival.

Diffusion theory clear sets out how any disease (or idea) can spread. It follows a certain pattern. Researchers at Oxford University have demonstrated the importance of distance in this process. In the past trading routes linking economic centres provided the conduits: trading goods and diseases. The fears of bubonic plague remain embedded in the public’s collective memory as the trading ships form Constantinople to Genoa brought the “black death” to Europe in the 14th century. Another important aspect of diffusion is often described as an S-curve, as explained in Justin Jenk’s blog on adoption rates and the effect of time.  In this current Ebola outbreak the ‘Wall St Journal’ has developed an excellent graphic.

Viral and bacterial evolutions and diffusion are well understood. The public health authorities’ reaction to the Influenza pandemic 0f 1919-21, the Smallpox epidemic of 1947 and the Polio challenge of the 1950s demonstrate that western societies have been able to deal with such threats in the past.

What the current Ebola outbreak exposes is the worrying observation that perhaps modern society has passed its peak and its inability to deal with such crises. While we may be technically more capable we seem to lack the ethical and political will to act; the London School of Economics has captured the essence of this debate.

Economics rule for big pharma and vested interests. Reports from Guinea suggest that cures are available, Yet modern concerns with regard to “human screening” have prevented effective and timely trials. Certain conspiracy theorists suggest more sinister reasons.

The economics of this and other diseases are crippling to the national economies of West Africa. South Africa remains burdened by the continuing destructive effects of its HIV crisis to its economy and society.

Human tragedy to tens of thousands has been created by the current Ebola outbreak as well as shown destructive effects on society and the economy.  Public confidence is also the victim.

Do read my other blogs at justinjenk.com

Justin Jenk is business professional with a successful career as a manager, advisor, investor, entrepreneur and board member. He is a graduate of Oxford and Harvard. Justin can be found at justinjenk.com

Power Girl in the economy

Women in business? Women are the business.

While it may remain a ‘man’s world’, it is a simple fact, that women are the force factor of the economy.

Despite the continuing gap in pay (at least a 10% difference according to numerous sources) recent studies show that the purchasing power of Venuses represent nearly two-thirds of all consumer decisions; estimated at USD 15 trillion. That is overwhelming purchasing power that shapes behavioral economics and the economics of growth.

On average while women represent 45% of the workforce yet their representation in the C-suite or boardroom is much less. There are significant national differences. The EU average is 16% yet the Swedish average is 26% compared to the UK at 18% and most of the rest of EU27 below 12% according to an EU and Stockholm School of Economics study.

Writing for a ‘Daily Telegraph’ column, Justin Jenk cited the vital role played by women in corporate governance and the economy. The Harvard community has recognized this power of Venus. Harvard Business School has made it part of its offering through the gender initiative and the Harvard Business Review has written about it. Furthermore in a recent McKinsey study, it estimated that corporate performance was 50% higher for those companies with a higher representation of female senior executives and board members.

In the face of such benefits why the resistance.  The main challenge remains one of attitude. A recent study by London School of Economics reveals the legacy effects. The search for equality is correct but remains a long drawn out process. Recent legislative and social practices with regard to parental leave and child rearing.

Unleashing the full potential women in the workplace is something that benefits all of us. Gender equality in the workplace should be championed and nurtured. It is just good business and for the economy – women as well as men.

Do read my other blogs at justinjenk.com

Justin Jenk is business professional with a successful career as a manager, advisor, investor and board member.  He can be found at justinjenk.com