tag:srvo.org,2013:/posts Sloane Ortel 2018-07-03T11:13:55Z tag:srvo.org,2013:Post/1299341 2018-07-03T11:08:16Z 2018-07-03T11:12:44Z You May Beat an Algorithm Today. What about Tomorrow?

I have a new piece out with Ashby Monk on the appropriate role of technology in investment processes. This was fun to write, and hopefully serves to bust the hype a little bit. 

Here is an excerpt: 

Technology will upend the way investment decisions are made.

How should investment decision makers respond?

This conversation has a tendency to assume an emotional tone even before it gets existential. For instance, you hear genuine angst over Microsoft Office’s new layout, and that’s just a redesigned application. Innovation has cumulative effects though, and after more than 50 years of Moore’s law and numerous other advances, algorithmic decision making fits too tightly into investment processes to be ignored.

That doesn’t mean it’s perfect. One purpose of this essay is to invite you into friendly competition with an algorithm designed by Ashby Monk and his colleagues at Stanford University. Their process can select managers with limited information and little time. You may be able to predict a team’s success more effectively.

Whether or not you feel like you beat the machine today, it’s worthwhile to have a plan for what happens next so that your organization can fully capitalize on its native strengths.

In our imagination, the word “algorithm” tends to evoke fast-paced and high-stakes processes.

The mundane truth is that the word refers only to a process or set of rules that describe how to accomplish a task. There is no naturally associated time horizon or risk appetite.

And that’s good, because most public pension funds, endowments, and sovereign wealth funds wouldn’t count speed or agility among their strengths.

Our goal here is to underscore that they don’t need to, and explore what a technological transformation looks like when its primary purpose is to reinforce risk-aware patience at institutions that may outlast many of their assets.

Read the whole thing for free on the Enterprising Investor]]>
tag:srvo.org,2013:Post/1293031 2018-06-11T17:42:39Z 2018-06-13T03:23:32Z India Ascendant

I published an essay called India Ascendant last week with Navneet Munot, Vikas Khemani, Sunil Singhania, and Saurabh Muhkerjea.

These gentlemen are not that well known outside of India, but are each remarkable individuals who need no introduction in India. It was my privilege to welcome each of them to New York last week along with Dr. Subir Gokharn of the International Monetary Fund and Dr. Punita Komar-Sinha of Pacific Paradigm Advisors. 

My hair was a little frizzy thanks to summer in New York, but it went very well otherwise. I've embedded a few action shots below, and you can view a recording of the panel here.  

tag:srvo.org,2013:Post/1257210 2018-03-05T16:51:17Z 2018-03-05T17:33:33Z Weird Ideas Conference

I’m thinking about organizing a weird ideas conference.

Its mission would be to embolden open curiosity in the field of investment management. Ideally, a spirit of “I might be crazy, but I’ve done the work” will permeate the whole thing. Any marketing intention will be judiciously screened out, and presenters will be held to strict standards of credibility, brevity, and clarity. 

I’ll do everything I can think of to make sure everyone present feels engaged and able to express themselves. 

The event would most likely be held on a weekday in Bushwick, Brooklyn, cost less than $100, and take a little more than a half day. 

Here are some subjects I’d like to discuss in particular:

  • The innate weirdness of investing.
  • Investment lessons from the crypto.
  • What is mainstream thinking, exactly?
  • Rumors, conspiracy theories, and other forces shaping geopolitics.
  • The cost of “status quo” policy in real terms.

I hope to add to the above, but also to intersperse a series of “lightning talks” throughout the programming. These would be ten minute presentations on an intentionally wide range of topics. 

If participating in this sounds fun to you, please fill out this brief survey

tag:srvo.org,2013:Post/1254393 2018-02-28T19:50:04Z 2018-07-03T11:13:55Z Who Owns the Assets Under Management? A casual observer of the markets could be forgiven for believing that asset managers run the show.

Their talking heads fill the airwaves, and their logos are everywhere from formula one cars to billboards and skyscrapers. But they wouldn't really be anything if not for their clients. 

Last week, I published a piece on the seven kinds of organizations which exist largely for the purpose of owning assets with my friend Tom Brigandi. It's a quick look at what motivates each of the seven largest types, which together control more than $71 Trillion, and how they differ from each other.

You can read it on the Enterprising Investor by clicking here. 

tag:srvo.org,2013:Post/1248226 2018-02-15T22:31:52Z 2018-02-15T22:32:29Z Joshua Gotbaum
The Hon. Joshua Gotbaum is a visiting scholar at the Brookings Institution in Economic Studies and a former director of the Pension Benefit Guaranty Corporation. That's the government-run insurer which covers private pension plans in the United States, effectively backstopping about 40 million retirees. 

It's not unusual to see dire projections associated with the PBGC. This chart is from their most recent projections report, and shows the probability that its multi-employer program will go insolvent. Things don't look good in 15 years or so. 
That scary tidbit is a common headline, but there's much more to the story. Josh and I spoke last week before his keynote address at the CFA Society of New York's US Retirement and Entitlement Crisis conference, and managed to cover a lot of nuance in just a few minutes.  
tag:srvo.org,2013:Post/1235908 2018-01-22T10:54:37Z 2018-01-22T10:55:36Z Seven Reasons India is Primed for Growth

I published a new piece with Sameer Somal, CFA, earlier this month: Seven Reasons India is Primed for Growth

It's a polite way of pounding the table. Global Investors and Indians alike appear to be significantly underinvested. The country has a smaller weight in the MSCI Emerging Markets index than Taiwan, but almost four times its GDP. Its homegrown businesses are increasingly global power players, and its diaspora is the largest (and arguably the most influential) in the world. 

We decided to put the reasons why the subcontinent is heading for a secular boom on paper. Here they are: 

  1. Real returns are available.
  2. A demographic dividend is due.
  3. The middle class is booming.
  4. A digital revolution is brewing.
  5. The India Stack is growing.
  6. India’s fintech opportunity is here.
  7. Institutions are strengthening.

The full piece is freely available, but you'll have to click over to the Enterprising Investor to read it.  

tag:srvo.org,2013:Post/1217170 2017-12-15T15:00:48Z 2017-12-15T22:05:37Z 4 Charts: Global Currency Crisis Count and Implications for Crypto

What's a currency crisis? The most straightforward definition I can find is this: if a currency's nominal exchange rate depreciates by 10% or more in one year and then 25% or more in the following year, it's a currency crisis. 

This definition originated (as far as I can tell) from a 1996 paper by Jeffrey Frankel and Andrew Rose, and has also been used in NBER materials. The numbers appear to have been picked somewhat out of thin air, but it's a useful rule of thumb.

The recent run up in cryptocurrency prices has led me to wonder how many people have had their lives shaped by these sorts of events. If I'd lived through one, I think I'd be more likely to see the volatility, opacity, and other risks associated with crypto-assets as acceptable. They might even seem typical of currency in general.

The links above list a number of crises, but are only updated through 2007. I pulled Nominal Effective Exchange Rate (NEER) data for 112 countries from the World Bank's Global Economic Monitor to do a quick-and-dirty update. Only 85 countries had data available in 1988, but by 1995 all 112 were included. 

Here's the number of countries in crisis each year. 

Here's the spreadsheet with the data

Using this sort of rule is imperfect, since depreciations need to align with the 12 month calendar in order to register. For instance, Indonesia's 69% depreciation in 1998 doesn't count because it happened fast. 

But with that said, roughly 1.3 billion people live in countries that have experienced this sort of currency crisis in my lifetime, many of them more than once. Here's a table of all of the countries that have. 

It would be difficult to establish a hard link between these events and openness to crypto-assets, because they have occurred much less frequently in recent years. That comes across in the first chart, but here is the YoY change in all of the currencies in the dataset. It's amazing how much things have calmed down. 

The contemporary picture is only placid compared to the chaos that surrounded the fall of the Berlin Wall, though. Since 2010, the percentage of countries in the sample that have experienced 10% or greater YoY depreciation has been rising steadily.

There isn't a clear link between this currency volatility and demand for crypto, but I think it's helpful to understand the dispersion of human experiences with currency. Most of the world's capital is concentrated in countries that have been insulated from these sorts of wild price swings, and perhaps as a result investors forget how frequent they are. 

Most of the bullish outlooks I've seen for crypto-assets are predicated on eventually capturing a material proportion of global market share. That seems moderately more plausible (though in no way preordained) after this exploration. And certainly it's easier to see why there might be innate global demand for a new kind of money. 

tag:srvo.org,2013:Post/1212368 2017-12-06T21:18:55Z 2018-01-15T18:46:33Z Pioneering in Wall Street: How Women Came and Stayed and Conquered (1927)

I spotted a remarkable artifact this weekend while vintage shopping: a 1927 copy of Century magazine with an essay by Eugenia Wallace entitled Pioneering in Wall StreetHow Women Came and Stayed and Conquered.

Her legacy is essentially un-googleable, but the perspective Wallace shares is stunning for both its optimism and the candor with which she recounts the entry of women into the investment business. All I know about her at the moment is what's said in the magazine: 

Eugenia Wallace came from the south to grow up around Columbia University, where she both studied and taught. In the pre-feminist day she braved the pits of Wall Street, as she describes in her article, and later became one of the leaders in the street's "woman movement." After the war Miss Wallace was vice-president of the committee that organized the National Federation of Business and Professional Women's Clubs, and served on the boards of many business, vocational, employment and other committees. In her leisure moments Miss Wallace delivers an occasional lecture, writes a short story, a magazine article or publishes a book. 

I haven't been able to find any of her other writings, but am looking for them and expect to write a longer piece soon. Century was at one point the most popular magazine in the country, so this was an early mainstream moment. Here is the cover: 

And here is the article she wrote: 

tag:srvo.org,2013:Post/1209304 2017-11-29T19:06:33Z 2018-07-03T11:11:40Z Active vs. Passive vs. Amazon et al. Tech giants have been great stocks to own this year, per Michael Batnick

Netflix, Facebook and Amazon are each up 60% in the first 11 months of the year. Apple, is up 50%. Google, the laggard, is up just 34%. These five stocks have added over $900 billion in market capitalization in the first eleven months of the year.

Their performance owes at least in part to their immense power in the marketplace, which has had spillover effects. Over at Enterprising Investor, I took a look at Amazon as a case in point of what this means for the broader competitive and capital allocation environments. Here is an excerpt: 

Sentieo shows 770 mentions of Amazon in SEC filings from 439 different companies in just the last three months, more than the president of the United States. Alex Lykken, writing for PitchBook, notes that Amazon competes directly with companies ranging from Ticketmaster to Banana Republic to IBM.

Lina M. Khan observes that Amazon’s influence is not easy to calculate “if we measure competition primarily through price and output,” the traditional way regulators have evaluated monopoly. Her 24,000-word essay was published before the company bought Whole Foods, and before CVS initiated a $66-billion buyout of Aetna that has been seen as “defense against Amazon’s potential entry into the pharmacy space.

What’s confounding is that bullish investors are the quickest to use “the M word.” Chamath Palihapitiya began his pitch at the 2016 Sohn Investment Conference with “We believe there is a multi-trillion dollar monopoly hiding in plain sight.”

You can read the whole thing here

tag:srvo.org,2013:Post/1205520 2017-11-15T23:00:00Z 2017-11-16T08:38:45Z Jack Bogle

John C. Bogle ("Jack") is probably the most influential investor of all time. I was lucky to interview him at the CFA Institute Annual conference, and even luckier to get his autograph on a copy of an article (Michael Porter's What is Strategy?) with the diagram below inside. 

And here is the interview:

This interview was first published on the CFA Institute website under the title Looking Forward after 40+ Years at the Vanguard

tag:srvo.org,2013:Post/1205513 2017-10-25T16:00:00Z 2017-11-15T16:53:46Z A Trillion Dollar Hedge against the US Retirement Crisis

I wrote this for CFA Institute and first published it on the Enterprising Investor

Most proposed solutions to the US retirement crisis boil down to a simple maxim: Spend less, save more.

That makes sense. “Enough money” is an important component of building a retirement system that works. Fiduciary oversight and high returns won’t do much for an underfunded system, so it’s easy to see why discussions about reform quickly land on a simple question: Where to send the bill?

There are more productive places to take the conversation.

Back in 2010, inspired by a Wall Street Journal article, an online commenter known as “Beowulf” observed that the US Treasury theoretically has the power to mint a trillion-dollar coin. Beowulf’s coin idea gained further currency amid the debt ceiling debates of 2011 and 2013. The Obama administration, coin proponents said, could forego negotiations with the US Congress by just minting a trillion-dollar platinum coin and paying off the debt.

Platforms as wide-ranging as The New York Times, the American Enterprise Institute, and MSNBC discussed the proposal. A former director of the US Mint even said that minting the coin was not only legal but (at the time) expedient.

My contention is that this “silly but totally legitimate” loophole could be used to endow a US sovereign wealth fund.

Just in Time

The US Government Accountability Office released a 173-page survey of our fast-approaching retirement crisis a few days ago.

Things are bad. The growing striation in US incomes contributes to a significant and widening disparity in retirement savings. Fidelity suggests that savers should seek to have 10-times their income stashed away by age 67.

Only the highest quintile of earners has anything near that.

Retirement Savings by Cohort

These private savings are a crucial buffer for retirees. The absolute maximum Social Security benefit a person retiring in 2018 can receive is $44,376. But that is still just 43% of the lowest base salary the person receiving such benefits would have earned prior to retirement. And most people are not so fortunate: The average Social Security benefit is closer to $16,000 a year and about three of five Social Security recipients rely on the program for at least half of their total income.

Moreover, accelerating changes to the US demographic structure will make Social Security’s income-based funding model less and less sustainable. By 2035, just 2.2 workers will be supporting each Social Security beneficiary, according to estimates, compared to 2.8 workers today.

And those figures assume that demographics aside, the nature of work won’t be much different in 2035 than it is today. But as Y Combinator president Sam Altman noted, artificial intelligence (AI) is developing rapidly with potential ramifications for workers. In particular, Altman referenced an OpenAI bot that recently defeated some of the top human Dota 2 players. Soon after the bot’s victories, a new version was created that exceeded the capabilities of the undefeated one. According to recent estimates, AI could outmatch humans at translation by 2024, and earlier this month, Google unveiled headphones that it claims can translate 40 languages almost in real time.

The technological shifts don’t need to be all that significant to significantly impair people’s ability to earn a living.

Cash Flows

As progress in AI marches onward and reshapes the nature of work, the elderly will continue to depend on a retirement system that requires many incomes to function.

Even without the forthcoming transformation of the workforce, the funding picture for Social Security doesn’t look great.

Screen Shot 2017-10-22 at 10724 PM

What happens if fewer people are working by 2025? What if, as PwC estimates, “fewer” translates to the elimination of 38% of US jobs by the 2030s? Peter Norvig, Google’s director of research, “certainly see[s] that there will be disruptions in employment.” Treasury Secretary Steven Mnuchin is not so worried, and I hope he is correct.

If he’s not, a cash flow of “just” negative $174 billion in 2025 will seem fairy-tale optimistic.

Learn from the Guardians

Other countries have felt these headwinds and done something about them.

New Zealand is a case in point, as I learned at CFA Society New York‘s 3rd Annual Sovereign Wealth Fund conference. (These forums are strictly Chatham House Rules, but I can still tell you what I googled afterward.)

The New Zealand Parliament recognized the mounting challenges the country’s demographic trends posed and in 2001 endowed a sovereign wealth fund to counteract them. The government will begin to withdraw money in 2035–2036, but the fund is expected to continue growing until 2073.

It has already served its purpose quite well.

Screen Shot 2017-10-22 at 21505 PM

A strong internal culture of alignment with beneficiaries — employees refer to themselves as “guardians” — has propelled this growth. So too has a remarkable governance structure and the innate advantages that sovereign wealth funds enjoy. These kinds of investing entities can be remarkably pro-social. They don’t just provide a direct link between market progress and social welfare, they also build, buy, and operate infrastructure; stabilize currencies; and prove up new asset classes.

Imagine how much economic anxiety in the United States could be soothed by such a mechanism.

Matthew O’Brien wrote in 2013, at the height of the debt ceiling debate, that the trillion-dollar coin “might just be the crazy solution Washington deserves and needs.” Today, if properly governed and given time to mature — a 30-year plus horizon would be ideal — a sovereign wealth fund bankrolled by that trillion-dollar coin might just be crazy enough to cushion the approaching impact of the US retirement crisis.

At the very least, it would give Americans a tangible reason to worry less about how they will afford to eat in their old age.

tag:srvo.org,2013:Post/1197460 2017-10-11T00:55:59Z 2017-11-15T16:52:00Z Out
Coming out of the closet sounds simple: 
  1. Open the door. 
  2. Exit the closet.
  3. Close the door behind you (optional).

There is a bit more to it than that. 

I was genuinely surprised at how many times I wound up coming out. I told my family I was transitioning in October of last year, started hormones in December, and updated my Facebook profile in January, but continued to present male professionally until the end of September 2017. I came out hundreds of times in the intervening period, and I have been lucky not to lose a friend or (to my knowledge) alienate a colleague in the process.   

When I posted my personal update on Sunday, that finally finished. I had sent a letter on the previous Friday to my colleagues at CFA Institute and was ready to make who I am all the way google-able.

So I did. 

People from all over the world have since written to express congratulations and support through social media and email. This torrent of affirmations coupled with the trickle of smaller ones i'd gotten in the prior months to entirely change my life. 

Buttoned-down, serious people have not hesitated to accept me. Some even went so far as to say "why would this change anything?"

Not everyone is met with so much positivity, and there is no question that I am lucky. But I think you should know how far this was from my expectations. In the echo chamber of the closet, I convinced myself that I would be forced to make a living as a sex worker if I opened the door. 

I never talked about it, and so I never examined that absurd idea. It started to seem non-negotiable, like death or taxes. 

We are capable of believing anything with our eyes closed to contradictory evidence. 

National Coming Out Day will be celebrated on October 11th 2017 for the 29th time. I am glad to share that the people who surround me have exceeded my wildest expectations, and my hope is that others who have edited their own dreams out of reality will give their surroundings a chance. 

I know it can be hard to find the words, and so I've reproduced the letter I sent on Friday below. 

I wish you all the best as you move forward on your own journey. 


I would like to share a personal detail with you: I am a transgender woman. 

This tends to come as a surprise, but that’s the nature of secrets. This is the only good one I had. I am thrilled to share it with you as a mundane fact. I’ll just ask one favor: please keep this to yourself until you see a more formal announcement in the next few weeks. This letter is just going to the people I've had closer contact with over the years. 

Some of you have known this was coming for months, and your support has been a remarkable source of strength and wisdom. For most of my life, I had assumed that I would have to leave any professional ambitions behind if I stepped out of the closet. I am overjoyed to learn that won’t be necessary, and indebted to you all for building a workplace that slowly chipped away at my own self-limiting assumptions. 

Of course, “colleague” does not have a gender, and so in a way I am announcing nothing has changed. I understand if you don’t quite see that yet, or if you are unsure about how to refer to me. The last bit is not complicated: I am a woman, which means I am “she” and the things I possess are “hers.” 

I’ll also be changing my name. Pleased to meet you: I’m Sloane Ortel. 

I understand many of you have known me for a while, and are not used to referring to me that way. It’s important you know I will always trust the intention in our interactions, and also that it’s very easy for me to separate an error from a slight. If you can respect me as a human, seeing me as a woman is a matter of time. 

I trust you will get there, but I also know that you may not know very much about trans issues or the broader ”queer” community. Clicking through a few of these comics might be a fun way to fill that gap if you’d like to. CFA Institute has also been predictably, wonderfully diligent in ensuring this doesn’t catch anyone off guard, and you can expect to hear from people who know more than I do in the coming months. 

I am happy to discuss the details of my own situation with you at an appropriate time, but the bigger hope is that you will see it as a reminder everyone has their struggles. 

Hiding my own has meant near-constant multitasking. 

I will discontinue it with pleasure, and look forward to putting my added capacity toward the work we’ll do together. Specific thanks are due to dozens of you, and you know who you are. Acceptance is due to everyone, and our privilege is to work so they get it.  

With admiration, excitement, and serenity —  

Will Sloane

Sloane Ortel 
Direct: (Phone number redacted)
Twitter: @sloaneortel
Writing: Enterprising Investor 

tag:srvo.org,2013:Post/1196889 2017-10-08T22:48:30Z 2017-11-15T16:51:50Z A Personal Update

I would like to share something with you: I am a transgender woman.

Earlier this month, I visited Brooklyn Civil Court to petition for a name that more closely matches my gender. With a few more months, a couple more forms, and probably a decent amount of waiting in line, my passport will identify me as a woman named Sloane River Veda Ortel just as this website does.

You can probably imagine that putting this out in the open is a relief. I can now look to the future with optimism I had not thought possible.

Though I have known something was different about me for most of my life, I was too scared to say anything until September of last year. The first person I told has been a close friend since I met her in fourth grade, and likely would have responded just as wonderfully at any time between now and then.

It was hating myself that kept me silent.

I believed only the meanest things that people said about others like me, and did everything I could think of to be someone else. I was hollowed out in the process and nearly destroyed entirely.

I spoke up in September because there was nothing else to do, and I’m speaking up here because I will absolutely never take those words back.

My gender is just one part of who I am to my family, friends, and colleagues, but it’s inseparable from the rest of me. It has taken a while to realize these remarkable people have been referring to the whole package when they say that they love or respect me.

Most of us are not so lucky, and I look forward to paying the love I have received forward. I also just can’t wait to see what i’m capable of without a hand tied behind my back. 

Thank you for reading, and best wishes in your own journey.


P.S. I wrote about the wonderful reaction that this letter generated here

tag:srvo.org,2013:Post/1280362 2014-02-07T17:00:00Z 2018-05-04T19:28:22Z This 209 Year Old Graph Will Teach You A Lot About Global Growth

This post was written for CFA Institute and first published on the Enterprising Investor

It’s easy to forget that business and commerce have been around for a long time, in fact almost as long as civilization itself.

William Playfair — who among other things, invented the bar chart — published a book in 1805 which investigated the causes of decline and fall of wealthy nations.

The chart below was in the very front of the book. It’s particularly provocative when read alongside modern attempts to look at the way that the economic productivity of countries changes over time, like this excellent Yearbook of Investment Returns from Credit Suisse.

Both excellent works serve as reminders that investors are well served by periodically remembering how dramatically things can change over time. In the graph below, the United States of America is newly ascendant in the international scene: a true emerging market. Russia, England, France, and Germany are the world’s economic powerhouses. China and India are not mentioned.

Chart of Universal Commercial History

Chart of Universal Commercial History

It’s amazing what can change in a few hundred years, or even in a few decades.

To choose an example of a drastic change closer to living memory, did you know there was a time when serious businesspeople doubted that a South Korean company could produce a microwave? In “The Silent War“, a 1990 book about the future of competition in business, the author details what Samsung had to overcome in order to compete.

A glance at their market share in products that require highly advanced manufacturing processes, like hard drives and flash memory, makes it almost funny that there exists in living memory a time when serious businesspeople were skeptical they could pull something like that off. In the 45 years since Samsung’s founding, the competitive landscape in business has altered so much it is barely recognizable.

The investment ramification of this walk through history is straightforward: what’s changing under your feet?

tag:srvo.org,2013:Post/1280360 2013-12-06T17:00:00Z 2018-05-04T19:25:38Z Special Report: How Doing What Is Right Helped Build the Indian Financial System

 At the end of part one of this Interview, Pradip mentioned India's launch of a Mars Orbiter.

This section will trace the construction of an institution that likely helped set the stage for that development by helping Indian companies access credit, and the significant role that anaylytical rigor and ethics had in that institution’s success.

The second part of this interview resonated unusually deeply with me, as I hope it will with you. It is a tangible example of how innovation in finance can make life better for a complex, developing country. Read on, and be sure to subscribe to Enterprising Investor.

Let’s talk a little about CRISIL, because first of all, I have to say, you must be very proud to have a book written about a thing that you built with the subtitle, “Doing What is Right.” I would guess that that’s something of a point of pride.

Yes, indeed. I suggested the idea at first in 1986. In 1981, I came back from Harvard, and then I realized that there was a need for something like this.

My then Chairman, who I helped set up another retail housing finance company, which was also the first retail housing finance company in the country, and which is a household name, Housing Development Finance Corporation.

I was working there, and my Chairman wouldn’t let me go. It took me about a year-and-a-half to get his permission. I was given leave of absence, just as I was given leave of absence from ICICI to start HDFC. I was then given leave of absence from HDFC to start CRISIL, and I was supposed to go back to my parent organization.

At that time, interest rates were not differentiated under risk. They were administered. It was like a binary, if somebody was found creditworthy, they got money at a particular rate, and there was no differentiation amongst different borrowers, and their capability to pay back.

A lot of people were not given any money at all, because they were just seen to be black, as we call it, not white or whatever. They were not good. A white was good. There were no shades of gray in between, we realized that they would need to start differentiating on the base of credit risk. There was a need to educate the regulators to free up the administrative mechanism.

People didn’t understand the concept of yield to maturity. Would you believe that, in bonds? Forget yield to call, yield to put, because those call and put bells and whistles didn’t really come out in debentures, but they just took the funds at the rate, because it enabled administered interest rates so there was not seen to be volatility in the interest rate environment.

We had to educate not only the regulators, but issuers of debt, investors in debt. A large number of people, and again, don’t forget we have illiterate people who still have savings.

Of course.

We have low-educated people who still have savings who want some guidance. We have, of course, the sophisticated intermediaries, and investors. They all needed guidance, and our thought was to create awareness of the concept of credit rating amongst a diverse set of people, and four basic constituents, issuers, investors, intermediaries, and regulators, and address different needs.

One of the most heartening things that I found, we developed a strategy. We had very small capital. We started with 14 million of capital at today’s rate of exchange it would be about $700,000 of capital, and we had to survive…it was a commercial venture! We had no ability to educate through advertising and promotion. I would take every opportunity to address gatherings.

I must have addressed several 100 gatherings in the first two years of the chamber of commerce or institute of chartered accountants, or gathering of business people or whatever, Rotary Clubs, whichever, because it was a new concept. We took the opportunity to be interviewed in the press, because it was a new concept.

Something clicked in the press, and we articulated it well. It got the attention of people, and we took advantage of that to create awareness, and spread the concept widely.

Our strategy was to get strong companies, which were perceived to be strong companies, to begin using the ratings. We figured that they would start spreading the word, that they were the highest of high quality and so on. That was exactly what we did.

We got high companies, or high quality companies come in the first three months. We started spreading the word by advertising. At least we got a flood of inquiries, “What does this mean? How does it work? We also think we are very strong, why don’t we get the same rating?” And so on.

We developed a methodology, which was different from Moody’s and Standard and Poor’s in one or two key respects. The one key respect that essentially was required, was that we decided that we would not work only for investors. We would work for issuers, as well as investors. As well as I told you, the regulator and intermediaries.

Our philosophy was not one against the other; our philosophy was to help make the market function better, as you put it. What we said was that, if a company comes to us, an issuer of debt comes to us, wants a rating, and then doesn’t like the rating….They will be free not to use it, we won’t spread the word. We would bury that rating quietly.

In that case, we would give them our analytical feedback, as to what the rating was, and why it was so. For instance, if the operating leverage was too low, the financial leverage was too high, or they didn’t have succession plans, or the poor governance was contrary to what we thought it would be.

For instance, just as an example, there was a company which was selling trucks. Then an associate company which was in the business financing, trucks which these guys made. The board of that associate company was controlled essentially by the truck manufacturer.

We immediately found out that, there was a lack of proper governance. That the board was naturally biased towards supporting this truck manufacturer, as a sales tool for the parent, rather than operating for the good of the shareholders of the finance company.

There were conflicts: In some cases, prudence would indicate not financing somebody for whatever reason. This would mean depriving their parent, or affiliate company, (the truck manufacturer) of business. So be it.

We pointed out these kinds of things, and people loved it. No one had talked to them as frankly, as honestly. Never used to, even the biggest of industries. They were used to getting their way with the banks and institutions, and we stood up to them.

We said, “No you are not triple AAA, or you are not single A.” We also gave junk ratings to some. We never did it in a way that would give them the message that, you are doing a disgusting job. We said, oh, look this is what it comes out, you come out as junk. “Perhaps it’s not right to go into the market in this region, because you won’t get money.”

“You would unnecessarily, tell everyone that you are not credit worthy. Maybe, it’ll affect your banking title. Why don’t you do things? Why don’t you raise capital or bring equity? You use this leverage. Shed off this dividend, and create liquidity for yourself.” Et cetera, et cetera.

We give them ideas like consultants, and that worked very, very well. We used to get postcards. Postcards from individuals, from Himachal, or Orissa or something saying, “What is the credit rating rate? I’m putting my fixed deposit here. Can you tell us?”

In different languages, and I put some sampling of this in a photograph form in one of my annual reports. Just to tell the world how pleased we were. That we were actually helping out the poor. You are helping out innocent people, who have no ability to make judgments, and here they were responding like this.

Postcards, postcard is the cheapest way of communicating. In those days it used to be five paisa at one time, and five paisa is what a fraction of cent. One cent is 80 paisa. It’s a fraction of a cent, and then it begins 15 paisa.

They couldn’t afford anything better. They would write in their own language, Oriya, or Punjabi, or whatever and say, “Can you please tell us the rating and we would…” We were reaching out through the strategy of asking come, or not asking, or encouraging them. Not even encouraging. Giving a reason for companies to tell the world of their ratings.

Even when companies was rated not in the highest, we told them that, “Look, but don’t forget. You can tell the world that you are better than your competitors. Your competitors don’t even have a rating. How would they know what your competitor rating is?” Put pressure on your competitors by even announcing your Single A rating, for instance.

Different arguments that suited them, but it was always designed as a win-win situation, never working for one and against the other. That was a very fundamental characteristic of us. And we, of course didn’t make any major mistakes.

Our fee structure was such. We divided it in such a way that it was progressive. That we built it on the size of the issuer, that it became relatively affordable for even the smallest company, to come in and seek a rating. The fee for annual maintenance would also be affordable.

Additionally, we were quite brutal about downgrading or not agreeing to their viewpoint if the rating merited so. If the circumstances were poor.

As well, our team was young, we got excellent people from the Indian Institute of Management.

At Calcutta we were the number one choice for the youngsters there. Indian Institute of Bangalore, we were the number one choice. In Indian Institute of Management we were not number one, but I managed to get a lot of people from Indian Institute of Management, Ahmedabad, who had worked elsewhere as well.

For instance, Roopa Kudva, who is now the CEO. She came to see me in 1992. As she recounted to me, when she was appointed to managing director or CEO of the company. One day she called me up that evening, and I hadn’t talked to her for some time.

I was very surprised that, “Oh! Wonderful to hear from you.” She said, “Look, I just came out from the board meeting. I have been appointed the managing director. I wanted to also tell you that, and you won’t remember this, that in 1992 when I came to see you, I didn’t have an appointment. You not only saw me, you gave me a job.” That was the way we operated.

If we saw a good person, we wouldn’t let that person go out of the door. Take the job back here. The people had tremendous freedom. In our rating committee meetings, everyone was equal.

We had a wide rating committee. Full of brilliant people, but anyone could chip in and argue with the committee or with any performance rating team. “Look, you are wrong. You are giving too high rating, or too low rating or whatever.”

There would be free discussions. This I saw from my own work experience in that time, that if you allow youngsters, who of course have the capability within them. But, give them the freedom to express themselves without fear without favor, without any bias and anger. They would want to present their best foot forward. They would have to defend themselves in front of peers.

That competitive spirit, without malice, was important. There would be no malice. There was no personal agenda, no angers for anyone. In a peer group, defending a rating or arguing for ones viewpoint, made for superb judgment, and superb outcomes in our rating decision. I was very happy in such a culture of honesty and integrity.

That sort of has prevailed. “Do what is right” is what the book says. That was a sort of philosophy in which CRISIL operated. It continued, and CRISIL was very highly thought of everywhere.

That’s very cool, and in many ways is quite aligned with the way we think at CFA Institute. We obviously exist to help global markets function better, with the ultimate hope that we would have some of the same outcomes.

I want to ask: It seems like it’s all well and good to go and define a culture of honesty, and say that you are going to seek and aspire to certain values. How do you really implement something like that?

Our attempt was to get good people, good, competent, and honest to the best of our ability. We make quick judgments. Don’t forget we didn’t have the luxury and liberty of elaborate interviews and so on. We were growing so fast at one stage, not only that, we would lose people, because unfortunately we were not not the best paymasters at that time.

We first we got a person that we could get, then we focused on systems, processes, and culture. This was our philosophy. That the process, the methodology for rating for instance, had to be comprehensive. There were no cutting corners whatsoever.

If they were a company with 17 plants, we may not visit maybe more than two or three plants, but it was important to understand the culture in the organization. Whether they were cost-conscious, whether they looked over manned. Whether they lived clean, kept a focus on safety and so on.

Although, assessments were being made by visits of a sample nature, Ratings were never given without meeting with the CEO and understanding the management philosophy. It was critical to understand the goals and ideals and their willingness to pay debt on time. With regard to ability, we could make judgment from past history, and product history and quality and so on so forth.

Making judgment of willingness, was also very, very important for us. That’s why we always had these management meetings. In some large companies, you would have meetings with as many as 50 people in an organization.

Different heads of department, from HR people, from marketing to production, to, of course the finance and so on. It was a very comprehensive rating methodology, and it had served CRISIL in good sense and continued methodology. The rating has stood the test of time.

It is now a 26 year old company, and it is doing very well. When I left it, it was the largest rating agency east of the Atlantic. A concept which was not started by us. It was learned from America, we adapted it. We were invited to give know-how to Israel.

Israel had all the opportunity and the offers from the US rating agency, to help them in every detail. They didn’t go anywhere with all the help. They came to us, and we gave them the know-how and they were so pleased. They planted a garden of 100 trees in my name.

I remain friends even now with the founder, who is now a retired person, but still is a professor of residence in Tel Aviv University. We gave know-how to Malaysia. Again, the rating agency there was started, but it wasn’t going anywhere. We helped them get going, and it has been a very, very successful operation we are told.

There’s an anecdote in the book that I find striking. It’s given in the book as being potentially a myth. I guess it just seemed like it characterized these rating meetings appropriately. There’s this senior CRISIL person, who is walking somebody from S&P around the floor of the offices, to sort of show them what the company is capable of. The great capabilities of CRISIL.

They walk by a conference room, and there is a senior guy, just laying into a junior guy with the uttermost vehemence. It looked, to this guy, like there was an emergency. He actually goes, “Oh! I didn’t realize you had something urgent to attend to. We can continue doing this later.” Then the guy who is showing him around goes, “Oh, no, no, no. This is routine. It happens all the time.”

Then the junior guy that he was laying into, starts giving it right back to him. That seems so remarkable.

It is symbolic of the culture. As I said, our rating committees were a treat. There was a design in that rating committee process. It was multi-layer.

For instance, if we knew the rating would be originating in the branch. In that branch, the team would have to present their findings to an internal committee there, and it would help even our judgment. No bullying, no pressure.

The team’s decision would of course be final, but surely they would have learned something from peers and so on. They would give contributions, because they were required to, and obligated to, and of course competent enough to do so.

Then we would come to our rating committee, and in the rating committee, we would have a full house. Whoever was present, was not only invited, whoever was professional was not only invited to, but obligated to attend.

It was like a small town hall meeting, in a boardroom. We would have about 30, 40 people sometimes, crowded and sitting in on the rating. No secrecy, no conspiracy, but fairly learning from each other as it were.

A presentation on a shipping company for instance, and the rating of the shipping company would be critiqued by someone who may not have been associated with shipping, but that person learned something.

Then would certainly have something to say, perhaps on the financial matters and the cash flow and so on, and they might comment on that, or might not comment, but just sit in and listen.

Putting the rating presentation in front of peers, as well as their seniors in the rating committee itself, made people put their best foot forward.

There was complete freedom, not only freedom, but it was encouragement and obligatory. If somebody knew something better than whoever is speaking, he or she was not only allowed, but encouraged to speak their mind.

As I said, always in the interest of the subject on end, never personal, no malicious intent, no vested interest. Those were not there. To my mind, that was one of the secrets of our rating outcomes, and secret of the culture that was created. Absolutely transparent, free, frank, no manipulation.

When we started this rating business, we were seeking desperately, association in national organization, and so on. We started with Standard and Poor’s, and they would not allow me beyond their reception.

Moody came and surveyed the market at our institute at ICICI. They said to us finally that, “Look, rating is an art and a science. You don’t have the art, you don’t have the science. Sorry, we can’t help you. If you want to do credit rating like Dunn & Bradstreet does, we would be happy to help you out.”

We said, “Sorry, we are looking for capital market ratings.” We had IFC Washington, the International Finance Corporation, which was really the great private sector supporter of India, through its foreign know-how, and money and so on so forth.

They wrote in a letter, that they did not have confidence, they would not participate because number one, Indian industrialists would browbeat this company, and get the ratings of their choice, and it would lose its credibility. Second, we just didn’t have the know-how.

We had to prove them wrong. I was 34, when I was asked to take up the rating agency. I took it as a personal challenge I said. My great chairman Mr. Vaghul who backed it. He was the chairman of ICICI.

He said, “All right, you know if you are ready to go, then go.” [laughs] Because, I told him, I said “Sir, why do we go with the second best? With someone who doesn’t understand, we would go on our own and do it.” He said, “All right.” He put his weight behind it. His name was on the line. I was a young chap, if I stumbled people they would have said, “OK. What do you expect of this guy?”

He had the vision and the courage to back me, and I think it worked very well.

Wonderful Pradip. It’s very impressive, and certainly a great book to read. Thank you so much for speaking to us.

tag:srvo.org,2013:Post/1280359 2013-12-05T17:00:00Z 2018-05-04T19:22:50Z Special Report: Building an India Resistant to Currency Shocks and Inflation

This was written for CFA Institute and first published on the Enterprising Investor

Inflation, currency shocks, and their unequal impact on the Indian population as a whole have been brought up repeatedly in this week’s coverage of India.

In part one of a two-part interview with Pradip Shah, the founding managing director of Crisil, Chairman at IndAsia Fund Advisors, and a board member at several India-based companies, we discuss how India has recovered from currency shocks, how it might recover further, and the progress of various initiatives that have been undertaken to mitigate the impact of those factors on India’s vast population living in poverty. Subscribe to ensure you don’t miss part two, and consider attending the India Investment conference if your schedule accommodates.

CFA Institute: Pradip, India is perhaps unique in that it’s a country that’s raising rates to try and to control inflation. From where I’m sitting in New York, and maybe from where the Fed governors are sitting across the country, some inflation would be OK for us as long as it got us some growth. How do you see the growth-inflation trade-off in India? Is it the same sort of consideration?

Pradip Shah: At this time, there is certainly a trade off. They are addressing inflation in a manner that is depressing growth because the Reserve Bank of India has taken on all the burden of fighting inflation, through tight money and dear monetary policy.

As a consequence, because of high interest rates, we’ve seen a slow down of big ticket purchases by consumers, such as housing, or consumer durables or automobiles, and so on.

Not only that, tight monetary policy has discouraged investment. We had, at one time I think, 38 percent of the GDP in Investment, which has probably fallen well  below 30 percent now. That’s not good for an economy which needs a lot of infrastructure development and possesses a lot of investment possibility.

We have population growth; we have an underserved population with infrastructure being very poor, whether it’s public transport, roads, whether it’s irrigation of water for both urban as well as rural, and so on. There are a lot of investments that can take place, but it does get inhibited by higher interest rates.

One of the things that you mentioned is that, the central bank sort of sees its role as being the guardian of the purchasing power of the currency. There’s been some volatility in the rupee  to say the least. How should we been looking at that?

Firstly, there was a catch up provision in the rupee depreciation. Between 1991, when we had the big bang of reforms, and 2001, the Indian currency depreciated by about 4.6 percent per year. The 10 years thereafter it depreciated only by about 2.6 per year. If you even extend it to early August, the depreciation was about 2.7 percent.

Now, 2.7 percent per year is less than the interest rate differential. There is an inflation differential between the dollar economy, and the Indian rupee economy. There was a catch up. For instance, look at August 2011, just a little over two years ago: the rupee appreciated to about 38 rupees to the dollar, it clearly went the other way. All on the back of financial flows, and a thin currency market.

Now, it went the other way at 68 rupees. When suddenly there was a lack of confidence triggered by the main announcement by Bernanke that they would begin to Taper QE3. Then many people started looking at all emerging markets in a different light. That caused a currency flight until the reserve bank got into the act.

In the mean time, some of us had been screaming for import duties. Import duties were introduced on gold, which took away 60 million dollars of currency when Individuals purchased gold.

The highest amount of gold purchases came about last year, in terms of gold being bought as ETFs, gold bouillon, bar form, non jewelry gold. This is clearly intended a store of value. People were shifting to gold, because of the inflation.

We were arguing for import duties. Duties helped bring about current deficit reduction, but, in addition, the reserve bank took three very interesting steps which were very useful.

Firstly, they took off 144 billion dollars of annual import demand of oil from the currency market. That dollar demand, 12 billion dollars a month, was far greater than the current account deficit. It tilted the currency market in favor of the rupee.

Secondly, the Reserve Bank of India entered into swap arrangements with other countries. For example, it entered into a 50 billion dollar swap with the Japanese government. That’s like having the Japanese government back us with 50 billion dollars in case of emergency. Of course, like reciprocity demanded, we will do the same if Japan got into a crisis. Fortunately, this worked for us, just not very well. It gave confidence, that there was money backing the reserve that the reserve bank already had.

Thirdly, the reserve bank opened up the foreign currency non-resident tap.

Again, I had argued for it in a meeting with the finance governor in June, July I wrote an article along those lines. But that governor changed and Raghuram Rajan came in, but that earlier governor announced that, Yes, we’ll open up the reserve. Exactly as I suggested.

They gave an incentive to banks to tap into the network that they already had in the Middle East, places where the Indian Diaspora exist in large numbers. The idea was to give the banks a little incentive by setting off liabilities and limits on foreign currency deposits.

The governor, currently, Raghuram Rajan did one better. He said to the banks, “Go out, raise money from non-resident Indians by way of foreign currency non-resident deposits, and you can swap that into rupees for 3.5 percent cost per year.” Now, that was very attractive. Given the current low interest rate environment in dollars worldwide, we’ve got banks that are able to borrow money at about five percent.

They have 3.5 percent hedge cost, and the banks have an all in rupee cost at 8.5 percent, which they can easily lend out for two or three percent more than that. There’s a very attractive window that’s been created which brought in 10 billion dollars in one month’s time. By November 30th when it ends, it will bring at least another 10 billion dollars. The reserve bank has realized that it can open the tap.

More importantly, this signals to the market that it should not take rupee depreciation for granted. We have tools in our armory to address very sudden or spiky depreciation. Rupee depreciation hurts us. It adds to inflation.

It fuels inflation because we import 70 percent of our oil. That’s very important, because oil is needed to move the economy. Think about everything we do with diesel: from things as simple as bringing vegetables home to more complex things.

If diesel goes up in price, of course, your inflation increases. Our whole motto, our whole objective is to control inflation. We can’t allow the rupee to slide without concern. We will monitor it. The reverse bank still articulates that they don’t have a target rupee dollar rate in mind, but they’ve said that if it is seen to be excessive, they will control it.

They’ve brought it to around 61.5 to 62 rupees to the dollar. The government would have ideally liked it at 60. The finance minister went on record, which perhaps did a little bit of a job on the market, saying that the rupee should have been at 58 rupees to the dollar. That’s a fair rate. Perhaps at 60 or 61 rupee, it would seem that the rupee has caught up with the inflation differential, and this reflects a true value in purchasing power parity.

Unless we have a currency pull out or investment leaving or entering India in uncontrolled quantities, we should see an orderly currency movement. That’s in respect to investment, again, of course. If the rupee seems to be relatively stable, if we didn’t have a current account deficit, that would be wonderful. That would have been a blessing.

But we still have a current account deficit. Having controlled the gold import, we think the current account deficit will come down to about three, 3.5 percent, from what we had at 6 percent at one time.

Well, there are two things that I really want to pick up on there. The first that you alluded to is sort of the power of the Indian diaspora, which I think is something that is difficult to appreciate for those of us who may not be as familiar. 

Can you just sort of touch on this notion that, because of emigration trends that you’ve seen as a country over the last 50 odd years, that there is this wealthy network of foreigners who may have other citizenships, but who certainly feel allied to India in some way. Do you feel that that’s going to be a material driver?

Yes. You have a wonderful opportunity in India to tap some of this Indian diaspora overseas. There is, for instance, a floating diaspora, as I say, which is in the Middle East. Which went to build the Middle East, from labor, construction labor to professional bankers, and asset managers, technical specialists, so on and so forth.

For them to get citizenship is almost impossible. They earn a lot, save a lot, and typically the workers all submit money to India to support their families. We have about 72 billion dollars in just remittances coming into India, which helps us in our current account. These remittances are good for household expenses of the families here.

There is that strata of the diaspora, not only in the Middle East but also in Southeast Asia, Singapore, and Malaysia, and of course even in the Western world in the United Kingdom, the United States.

We have a large body of, for instance, yuppies who have gone for IT services overseas. We have a large body of first generation Indians who still have family here and have close contact with family here, and who therefore have grown up on Indian household names and feel very comfortable with the names, who are not averse to putting money into safe investments in India especially in fixed income category, especially if it’s denominated in the currency of their choice.

The diaspora can be that. It’s the second generation, the earlier generation which took roots in India, and then their children are born abroad. The children don’t have any affinity to India, they don’t think Indian. Although they may look Indian, they don’t think Indian. They perhaps don’t have any, as it were, longing for home.

There was a phase when they were lost youngsters wanting to come back to India, even though they were born and brought up, for instance, in the United States, and had the best of education, Harvard and MIT, and so on. But they wanted to work here, because India was seen about five years ago as such a great growth market, and nothing could go wrong with India, they wanted to come back to work.

That also may happen again, if we improve the climate and livability for people in India.

The other thing I want to drill in on, is the notion that you raised that India imports this massive amount of oil. I wonder sort of on the geo-political front, the extent to which we might see India making moves to secure access to those resources. Do you think that’s a primary consideration?

India has not gone as systemically as China has, towards securing natural resources overseas for its needs. Partly, because India does not have nearly Tree Trillion dollars of reserves. They have 300 billion dollars of reserves, which is about seven months of imports. They need to shepherd that carefully.

What they have done, nevertheless, is encourage public sector companies like ONGC, India Oil and Natural Gas Commission as well as for instance, Coal India, and so on, to look overseas for assets.

For instance, we had about 85 million tons of coal imports last year. Though we have one of the largest producers of coal in the world, we will need continually increasing coal imports to power our energy requirements. We need to build up those kinds of resources, and if we had the ability to generate current account surpluses, it would be less of a problem.

But still, we have energy dependence on overseas nations. We will need to be careful in how we’re spending our resources, and buying assets overseas will help us in at least in securing our future without having to be at the mercy of our currency that goes against us all the time.

Yeah. That can be reasonably severe. Let’s talk about onions. If you’re in New York, onions are 69 cents a pound, which is maybe 0.0000013 percent of annual household income. I noticed onion prices in India are up 300 percent. That would seem to be material to the average Indian person.

Indeed. I forget the figure just now, but the amount spent by the common man, as it were, the average person in India, is roughly 31 percent on just food supplies. Other non-discretionary items like healthcare and transportation also take up a lot. Discretionary spending is much more limited than, even say, China, for instance.

When you have such a large portion of your income being taken away by just food, and you’re not eating as well as the Western world in terms of either calories or nutritional value to begin with, any food price hurts. Don’t forget we have roughly 30 percent of our population, or if the government is to be believed much less, I think it’s 29 to 30 percent is fair estimate, of people living below the poverty line.

The government has gone so far as to say “Look, we have actually passed a bill, passed an act to help out the poor in India by giving them subsidized food products.” That subsidy program does serve almost two-thirds of the population. When you have onion and other essential food prices rise, it is the biggest punishment or tyranny toward poor people.

Yeah. In thinking about the subsidy programs. I remember reading a lot in “The Economist” a couple years ago, about a massive identification program that was underway in India. Is the government able to identify the people who receive the subsidies now? Is there a reasonably complicated implementation problem there, that’s sort of tough to get your hands around?

If the unique identification program is designed for subsidy, I think it needs to be tweaked. What happens today is that to get a unique identification number, you have to produce some paper or identity document which says you exist in the country.

Even if you particularly present yourself and the system allows them to allow five biometric measurements of yours to be recorded, the government has not said that you exist!

This stage of implementation seems wrong. It says that, “Oh, have you got a ration card, have you got driving license, have you got a passport, et cetera, then yes, we’ll take these five biometrics, and say OK, you are the same person as the passport or whatever says.” That’s the way it is being implemented.

The government wants to implement this as they implement subsidies in terms of passing this person through the UID mechanism, having identified the person.

They would then allow the person to open the bank account, and then the money would be credited to the bank, to enable them to get subsidy as it were, and then buy food products.

Now this subsidy program in this manner is unlikely to work. It is going to work for bookkeeping purposes for the government, in that the budget will say, “Yes, we have provided so much subsidy.” One could argue that it might work, I guess, I can guarantee you it won’t the way it’s being designed, because look at it.

There are obvious issues. Firstly, to open a bank account is so dramatic for the poor. They are illiterate people. You’re not talking about a few 100. You’re talking about a few millions of people, tens of millions of people who are illiterate, or are unable to fend for themselves, either because they’re handicapped or don’t have support, because they don’t understand the language.

You have 21 languages, and how do you reach out to all of the communities even using the same language. It’s very difficult to reach out, and get them to fill out these monumental forms. These “Know Your Customer” requirements have become such holy cows.

Do you think those poor people have time to fill out the forms, or have the ability to fill out the forms to open a bank account? Then it’s been said, we know it. That’s why you find. For instance, they don’t invest in financial instruments as much as you would like.

They’re going to gold because it’s so easy to buy. You don’t have to show your identity. Even if they open a bank account, then how do you insure that the subsidy reaches out to the poor, for whom it is targeted?

For instance, in a family of four, let’s say, or six, where the husband may go to collect the money, and drink it before he reaches home. How do you make sure that there are three brothers don’t fight among themselves, and say, “Look. You’ve taken away more of my share,” because it’s not as if each individual existing in India will get the subsidy credits to that individual’s account.

It will go to the head of a family, or to the heads of the family, or whatever. It’s going to be, unfortunately, a deduction in welfare at the end of the day if they implement this subsidy program to these cash transfers. That would work in a small economy, where you can accurately identify or give an identity card to an individual here with unique identity.

The number doesn’t give an identity card, as it were. It confirms that you exist, but not give you a, “OK. Here, you didn’t have a passport. You didn’t have any of documents to prove that you exist, but you’re obviously living. Here is your identity card.” It doesn’t do that.

Yeah. I’m going to add. I found that as somebody who speaks, English in India, I was as able to communicate out in the countryside as colleagues of mine who were native Indians, and spoke two or three languages just by speaking slowly in English.

The 21 languages issue would seem to be massive, and underappreciated, but as well, it may seem like it’s not, necessarily, an investment consideration at first blush. If we consider India, and consider the growing middle-class argument, and consider the notion that as these people rise from unbelievable poverty they’ll become consumers.

It would seem like the impediments like these are critical considerations. Do you think that there is a credible plan in place to address all of these things or do you think that it seems to be, basically, working itself out?

I think the concepts are good. The concept of, for instance, rural employment guarantees, the concept of a unique identity card, very good concept!

But in a country with 1.25 billion people, with such a high illiteracy such that connectivity, whether by good, or by electronic, or communication devices. How can you ensure justice to each and every person? It’s not going to be possible.

You won’t be fair to everyone. This program cannot work in the manner that design would take. If it was Singapore with five million people, of course it will work very well, but not with 1.25 billion people and this much illiteracy. Even today, adult illiteracy would be about 26 percent of the population.

CFA Institute: If you think about the mental space that India occupied in the business landscape for a long time, it’s easy to consWhere it was a very compelling place to do business process outsourcing because of a cost advantage, and that cost advantage drove economic competitiveness. Do you think that perception is still operative?

India exists on so many planes.

At one level, we have rocket science. We’ve just sent a rocket to Mars. We speak of our aspirations, our ambitions, and our capability. We have that kind of large population. 30 percent of our population is urban, and of that urban population at least 50 percent of it, which is still a very large number, would be considered excellent in education, skill levels, et cetera.

They compete with anyone in the world on almost all matters. For them the world is flat, as flat as it can be!

Mr. Freidman comes, and interacts with them. Naturally he thinks this is the way India is going, but there is a large number that is still in the stone age phase, for instance.

How do you address their needs? How do you take care of their aspirations? How do you take care of that requirement? Forget want, but just needs and requirements.

tag:srvo.org,2013:Post/1280357 2013-12-03T17:00:00Z 2018-05-04T19:19:12Z India’s Importance Abroad: The Rise of the Indian Diaspora

This post was written for CFA Institute and first published on the Enterprising Investor

One cannot consider India without thinking about the massive impact that its language and culture have had abroad. Many common English words — among them, “thug,” “shampoo,” and “pundit”— have their origins in languages from the subcontinent.

That’s not much to go on for an investing website though. Many things are culturally relevant, yet do not directly affect the evolution of value in business. This is different.

For one thing, consider the rise of India as an outsourcing hub. Why is it that India was particularly well suited for that activity? Beyond being suitable, why was it chosen?

Narrative is an excellent means to understand far-reaching topics of this nature, so for more depth we turn to Anita Raghavan, the author of The Billionaire’s Apprentice, a book that chronicles the rise of Rajat Gupta, former managing director of McKinsey, and Raj Rajaratnam, founder of The Galleon Group.

If those names are familiar, it is because they are at the center of one of the largest insider trading scandals in history. However, Gupta was perhaps as influential as anyone else in promoting the rise of India as an offshoring hub. Along with Anil Kumar, he was “the face of McKinsey in India.”

Though the crimes these men committed are deplorable and are inseparable from their stories, there is also a lot to be learned about India from them.

Though it may be seen as negative that the story is intertwined with one of the business world’s more significant scandals, Raghavan sees the cup as being half full for the Indian diaspora. She closes her book saying that these scandals are “a sign that Indians, much like the immigrant groups before them, have attained a certain security and a once unimaginable position in America’s society.”

Sloane Ortel: We’re here with Anita Raghavan, contributor to the New York Times, particularly its Dealbook website, as well as to Forbes.

We’re talking about her book The Billionaire’s Apprentice, which is both the story of the rise of Indian American elite and the fall of the Galleon hedge fund.

Anita, you close the book with, “As tragic and heartbreaking as Gupta’s fall from grace is…” — Gupta, of course, being a key player in this — “…it is a sign that Indians, much like the immigrant groups before them, have attained a certain security and a once unimaginable position in America’s society.”

Can you expand on that?

Anita Raghavan: When I was growing up in the United States in the 70s most of the Indians we knew were doctors, lawyers, and professors.

What we see today is Indians in all walks of life. We have Indian filmmakers, Indian lawyers, Indian prosecutors, Indian authors, Indian businessmen.

I recently was Googling and I saw that there is even an Indian visioner. Someone pays an Indian woman to provide her vision of the world.

When I was growing up in the 70s, the idea that anybody would pay anyone from India to provide a perspective on the globe was just unimaginable.

I really think that while this is a very sobering story and it’s certainly heartbreaking for Gupta’s family, it is really a sign that we as a community are no longer on the fringes of society.

We’re part of American society. We’re part of the fabric. We’re standing up and we’re being counted.

One of the stories you have in “Gupta’s Rise,” I don’t know if it was about him or about someone else, but a partner was saying, “You guys are great consultants, but will our customers ever relate to you?”
It doesn’t seem like that’s so much of a concern anymore.

Exactly. Yesterday I was speaking to a group and a young man who had been at Penn in the mid 80s came up to me and he said, “When I joined the University of Pennsylvania in 1986, somebody asked me, ‘Where are you from?'”

“I said, ‘India.'”

“The person responded, ‘What tribe?'”

I think you’d be hard pressed to find that today.

Yeah, exactly.

Today, Indians have a cultural identity. There was even a sitcom based on the Indian offshoring model. Indian food is enjoyed. It’s a very different picture than what it was just 20 years ago.

Yeah, exactly. To harp on what it was, what about the process of getting over here from India, this is not like just a random group of Indians. This is the best and brightest of the entire country. I mean, the process to apply for a visa, how competitive was that?

Oh, absolutely. Both Gupta and my own father came on an F1 student visa. In those days, the only way you could get an F1 student visa is if you either found an American university to pay for your education or you could pay for it yourself. Most Indians back then couldn’t pay for it themselves, so they were completely reliant on US institutions to fund their schooling in this country.

It was phenomenally difficult, and of course, today Indians are being brought to the US not just for study but to work. There’s a whole new class of visa, the HB1 visa, which brings Indians over to do particular sorts of jobs, and that’s a dramatic change from what it was.

Yeah. I mean, and again, on the what it was thing, that we harp on history too much here perhaps. But I just want, to people listening at home, I mean, in 1650, this is a country that had a GDP 80 percent the size of England. That’s 50 years after Queen Elizabeth died.


It’s not that India is a country that has only recently developed prosperity or developed some competitiveness in the world. It’s been a power, really, for some time.

Right, and I, of course, am from the south of India, and we’d always talked about our 5,000 year culture and which temples and wealth that was born far before America gained independence. I think in a way, the Indian diaspora in the United States has reclaimed that legacy with their success.

How integral is that legacy in the community itself? Is it something that people would talk about? Like, would they reference a [indecipherable 05:33] that’s not been able to name a single prominent Indian leader but from ancient history, tell stories of these people or not so much?

No, I don’t think it was as obvious as that, but I think it was an inner confidence that we had that we actually deserved a preeminent place in this world. Perhaps because of the struggles of the Indian economy, after independence, we had been robbed of that place.

That makes a lot of sense. You see, I guess, elements of involvement with the country. In the story of Galleon Group and Raja Rajaratnam, him, of course being Sri Lankan, giving a speech at a benefit after a typhoon in Sri Lanka. It was an impassioned speech about how hedge fund managers and fishermen are the same. You see that deep level of involvement.

I think across the diaspora both with the Sri Lankan, Rodger Putnam, but also with the Indians, I think one of the big drivers behind Rajat Gupta, who’s the central protagonist of my story, was this desire to help his countrymen back home.

Some would even argue that may have precipitated his crime because when he came to New York City, he got involved in philanthropy in a big way. He started trying to raise money for Indian causes. One in particular, the American India Foundation.

When he first set that up, he crisscrossed the country and all that he could come up with was $50,000. I think he was just so taken aback that here was this wealthy diaspora and all they could produce was a pittance.

On some level, I think he was tired of collecting checks and he wanted to be the one writing checks. What better way to do that than to be a billionaire?

It is certainly an easy way to be able to cut a big check. One thing I want to touch on also is a cultural element. It may not be too easy to appreciate is just the importance of skin color in Indian. I spent time there. I was struck by the prevalence of skin lightening cream.

That’s right.

It’s $500 million annual sales industry. Raj Rajaratnam, very dark skin — did that affect him in anyway?

I think that’s why when I approached the story, I always thought the friendship between Rajat Gupta and Anil Kumar, and Raj Rajaratnam on the other side, was a forced marriage.

It was not a natural friendship. The Indian community, as you say, is very much like the African American community. There is a premium on light skin. I think that on some level, Gupta and Kumar were only friends with Raj because of what he could offer, which of course was a clear path to money.

For Raj, I think there was a deep insecurity that came from his skin color. I think it really drove him. In his early days, friends remember he would say, “Look at me. I’m a dark, dark man, an ultimate outsider, but I’ve become the ultimate insider.”

I think he took great pride in that. Here was someone on the fringes of society who had actually managed to penetrate its inner sanctum.

Yeah, that’s a big deal. This place he’s coming from. At one point, there’s a chapter called “Offshorestan” in this, which can neatly encapsulate the way a lot of people thought and perhaps still think about India.

I mean there are a couple of great anecdotes. When McKinsey set up its office in New Delhi, a partner had to install the switchboard because India didn’t have anybody capable of doing that. That would seem to not be the case anymore.

Yes, I think India has come a long way from the early 90s when McKinsey set up its flagship office. That’s another way the diaspora was actually able to give back to India, because of Offshorestan.

The growth of the outsourcing business of legal services, business services, was a real driver of India’s economic growth during the 90s, was promoted to a large extent by the Indians in the United States who said, “Hey, we know what county can provide some of the data skills that the US needs.”

India, it has a large English speaking workforce. We’re hungry to work for pennies on the dollar. They basically created this new state, if you will.

They created this new state and it’s grown. We recently hired Cognizant Technologies to do some IT work for us. I don’t know if that’s the sort of thing that you would have seen 20 years ago.

I guess it raises the question, what is India now? I mean it’s no longer Offshorestan. The rupee is down quite a bit. Can it be Offshorestan again or has it lost that essential cost advantage that it used to have?

I think it has lost the essential cost advantage on the plain vanilla offshoring business. One of the great advantages of India and its people is that they are both highly numeric and they speak English, which is a rare quality.

You either get highly numeric or you can speak English.

You don’t get both in one package.


I think what India now needs to do is redouble its efforts to go higher up the food chain to get some of the more sophisticated outsourcing business that can flow from the western economies.

Indeed, perhaps produce its own stuff. I was hoping that we would see a Tata Nano cruising around the streets of New York City, at some point.


As yet, no.

As yet, no.

I mean a $2,000 car would be pretty great. That’s a place where people understand that make things at low cost.

Absolutely. The high-end offshoring business is still a small sliver of what India exports. There’s real room for growth in that. It comes at a time when US companies are still driving to cut costs. I think that could be at the next leg.

The one certainty in business: cost cutting.

Right, exactly.

This is a story about insider trading and fraud, as well as India. I need to ask, are those bad?

Insider trading and fraud. Look, I was speaking at the branch library over the weekend. Someone raised the very legitimate question of why is insider trading a crime because there are no victims. There are no discernible victims.

I think insider trading is important because one of the reasons that the US market is so respected the world over is because there’s a sense that ordinary investors get a fair shake.

They have access to the same information that the big boys do. You really don’t see any capital market that’s as liquid and as deep as the American market. I think in large part it is because it’s a transparent market.

Even though, there is some work to be done here. Do you have a sense that there’s a pervasive level of insider trading or there’s still a bunch of Raj Rajaratnams out there, calling up people at Intel, having them fax documents?

I think it goes in waves, Will. I think the last big insider trading case that we had before this one was, of course, memorialized in the book “Den of Thieves” and involved a number of bankers at some of the most prominent Wall Street firms, such as Goldman Sachs and Kidder Peabody, and that was all the way back in the late 80s.

I think memories are not long. Certainly after Regulation FD, at the turn of the millennium, which really created a level playing field between big institutions and small investors in terms of the information they received from companies.

After that was put in place, I do think that short-term event-driven funds, momentum funds, found it a lot harder to make money and started resorting to insider trading as a way to get an edge.

If these guys obviously trading on the stuff minute-to-minute and not what you would call long term investors, necessarily.

That’s right.

It’s tough to have an edge on one thing, having an edge on 60 stocks a year, 100 stocks a year. Very, very tough.

It’s tough to have an edge in efficient markets.

Yeah, really on anything, especially if you’re not a very smart man, as certain of us interviewing you are not.

Another thing I find curious. You interviewed Jeff Skilling a lot. He might not jump off the page to other people but was the President of Enron, I think or CEO?

The CEO.

The CEO of Enron. What is it like to reach out to somebody who has been, basically, in prison for fraud for what must be a decade at this point?

Almost, almost a decade. One of the reasons I reached out to Jeff Skilling is that I was looking for people to tell me why Rajat Gupta got elected to the helm of McKinsey not just once but three times.

Of course, by the time the charges surrounding Gupta were brought, no one at McKinsey, no one who even knew him, wanted to speak on the record. There was nothing good to say about Rajat Gupta.

We all know, no one is black and white. I thought, “who might talk to me?” I thought, “Well, maybe Jeff Skilling will.”

I wrote him a letter. You have to get on the prison email system. I don’t know if you know this. It’s called “CorrLinks.”

He reached out to me on CorrLinks. He was a typical consultant. He gave me a step-by-step how to on navigating CorrLinks in case I started an email relationship with a number of prisoners. Actually, I have a couple right now.

I found him incredibly eloquent. He would write these long emails. They were clear and articulate. Every once in a while, the reality of his new life, being in prison, would intrude on our conversation.

One time I remember, he was trying to explain something about the structure of McKinsey, you’re only allowed an hour on the Internet or on the email system, when you’re in prison.

His hour was up. He had to stop the email midway. It really was midway and come back to it several hours later.

There was another time I wanted to share something with him and I sent him a link to a story. He said, “I can’t read it because we don’t have access to the Internet.” But he had a lot of time, and he would write these very detailed emails of Rajat, how McKinsey was structured, and some of its values. He was really perfect for history of the firm, as well.

I always wonder if these high-powered executives who wind up in prison find themselves doing things like organizing people into cross-functional teams, or doing any of these things you might expect. Is there any sense of what his day-to-day life is like?

He used to teach Spanish in the library. He first, I believe, started working in the library. Then he organized classes for the other prisoners in Spanish. He spent a lot of time working, at that time, on his appeal. I think one of the reasons he reached out and decided to speak to me is because he saw the Gupta case, not the Kumar case — he was very clear about this — he saw the Gupta case as a sign of the Justice Department overreaching.

Really? Overreaching?

He drew a distinction because with Anil Kumar, just to recollect the facts for a minute, Anil Kumar was paid by Raj Rajaratnam to give insider trading tips about companies like AMD, and Jeff Skilling thought this was abominable. But Rajat Gupta, where the dominance case was based on circumstantial evidence, Rajat Gupta was someone that Skilling felt was railroaded by the government. That’s why he decided to speak to me.

Really? That’s a very interesting thing. He must be feeling the same about himself, to some extent.

Of course, of course, of course.

No, no, that goes without saying. That goes without saying. He was very careful about not talking about his own legal case, but it goes without saying that he certainly does not feel that justice has done him proud.

We actually got a copy of the original Enron code of ethics that we blogged about on Inside Investing a couple of days ago. It was really quite a fascinating read. “No corporate employee shall trade the stock,” but of course, there are stock tickers in the elevator.


Jeff Skilling, Rajat Gupta, is something in the water at McKinsey? What’s going on? Is that a thing or is that not a thing?

McKinsey, for most of its history, had been built on this honor-driven value culture, which, of course, was espoused by its long-time managing director, Marvin Bower. Honor-driven, values-driven might have worked when you were a small partnership and everyone sitting in a room could look everyone else in the eye and know what they were about.

Today, McKinsey is a global firm. I think one of the problems the firm encountered is that it had grown so much in the 1990s, but its policies, its procedures, had not kept up with the phenomenal growth.

It had growth pains, and then, “Oh, no.”


In the aftermath of this whole thing — it’s no longer a headline everyday — a lot of times when people ask you about this book they go, “For heavens sake, couldn’t you find a good story?”

That’s right, that’s right. When I started writing this book a couple years ago, I went to a black tie gala in London and I met a prominent executive of a Wall Street firm. He said, [Indian dialect] “Anita, of all the books you could write, couldn’t you write a positive book about the diaspora?”

It is of some frustration to the Indian community that this book captures an unfortunate episode in what has been a remarkable rise of Indians in the United States. But I think it is an important story because one of the reasons Indians are so respected and held in high esteem in this country is because we are known to be hard working, diligent, and generally deliver on what we promise.

Blemishes on the diaspora, like this, risk threatening our reputation. That’s why it was important for me to write the book.

Also, as we talked about at the very beginning this notion that not everyone is perfect and the hardest-working person ever probably helps the community more than it hurts it in the long term.

I think so, I think so. It shows that we have matured and we’re at a point where we even have our own crime. That must mean we’ve finally arrived.

People actually think it’s worth their while to prosecute the Indian community for crimes. Whereas, when I was growing up in the 1970s, we were too small a community to matter.

Of course, that the people doing the prosecution were also Indian-American says about as much as could be said.

That’s right. The official at the SEC who built up the Galleon case, Sanjay Wadhwa, and of course the US Attorney for the southern district, Preet Bharara, both Indian Americans, and are a sign of how variegated the role of Indian Americans is in American society today.

tag:srvo.org,2013:Post/1280351 2013-12-02T17:00:00Z 2018-05-04T19:10:03Z What is India, and what is its Future?

We’ve done quite a few special features over the last year, but this is the first time that we are paying particular focus to a country.

There are a couple of reasons for that. Obviously, India is important to the investment profession and to individual investors around the world, but so are many places. Why did we start here?

We began to see a number of reports focusing on India as a place that was either doomed to political infighting and runaway inflation or as the “white knight” of an investor’s portfolio: one of the few places in a growth-constrained world that was likely to see expansion over time.

It seems, perhaps, like all of these things may be true. And they don’t necessarily contradict each other. The interview below with Sunil Singhania, CFA, and all of the interviews and posts that we will publish over the next couple of days, represent our attempts to get leading investment thinkers to explain to us exactly how that could be.

CFA Institute: It’s Sloane Ortel here with Inside Investing at the CFA Institute, and I’m in the New York office of CFA Institute, but I am on the phone with Sunil Singhania, who is the CIO of Equities at Reliance Mutual Funds. He’s also (in a sense) my boss’s, boss’s boss at CFA Institute. He’s on our board of governors, the first Indian ever to reach that lofty perch. Sir, I’m on my best behavior.

Sunil Singhania, CFA: Thanks a lot.

I want to ask you, we were just speaking, and I rattled off a bunch of questions and said, “Is it OK to talk to these”? and you said, “That’s what people usually ask.” What don’t people usually ask that they perhaps should be asking?

I don’t know whether they should be asking or not, but domestic investors generally, and I’m talking about the equity investors. They’ve had a phenomenal sort of period between 2003, and 2008, investing in equities, where they made upwards of 30/35 percent compounded returns year after year. The account now is growing, there was huge money flow, and everything was going on well.

What has happened in the last five years, Indian equity markets have generally been flat, and the domestic investors particularly ask, “What is long-term”? Investors who have come in, in the last four or five years, have not been any return.

That is what normally the investors ask, and from our perspective, the only perspectives we can share with them is that, “Yes, the last three, four, five years have been tough. There have been some things which have happened for the first time in the world in the last hundred, 200 years, and it’s more sort of a one off thing.

You have to look at growing economy from a longer term perspective, and that is what we try to explain. From the global investors perspective, India has always been a favorite investment destination. However, they can get confused with, you can say, a little bit more democracy than what we need. So government policies and politics is what normally the foreign investors will ask about.

Though again, just to give you our perspective we have seen in all the last 20 years, all government has been coalition government, and it has worked out pretty well, so the concerns are definitely there in the near term, but from our perspective they should also be looking at a slightly longer period, and they’ll get their own answers.

Yeah, in thinking about this long-term, one of the things I have to ask is, as an offshore investor who has invested in Indian equities in the past, I occasionally form part of a cohort that can be quite troubling for domestic Indian investors, where I combine with many other people in New York, and London, and elsewhere, into these flows that can really, really distort things for you over there. How important are international investor flows for you, and just how closely do you watch them?

Listen, it’s a great question, but if you actually see the trend of the global flows, it’s almost every year has been positive despite what is happening globally, and despite what has happened in the near past in the Indian economy, in terms of a slowdown. Global investors are looking at India from a longer-term perspective, they’re looking at this 1.2 Billion population, they’re looking at a very young age. We still have a median age of less than 25 years by 2020.

There are things that used grows in their consumption phenomena, and as a result of which global flows have always been positive. To answer your question whether global flows are important, there are definitely very important.

As an economy, we import a lot of stuff. We are a growing economy, and we lack capital. For all these reasons, we definitely need capital flows into the country, not only to bridge the current account deficit, but also to give that boost which will require to set up capacities, to set up infrastructure, and that is one key reason, or one key need which will enable India to come back to that seven/eight percent growth.

Our own perspective is that flows into India have been really strong, even in these last three years of extreme global volatility, and uncertainty, and similar situation in domestic India. We have seen foreign investors pump almost $65 billion into the Indian equity markets. Year to date Indian equity markets, outside of Japan, are the second largest recipient of global flows.

We’re not taking US, because we are mostly in a domestic flow, but international flows outside of Japan, India is the second largest. Global flows are important, but at this point of time we feel that there is in fact a narrative saying that the flows should continue to be quite positive.

When we talk about investment realities, there are probably the equities in your portfolio, but there are also the Rupees in your wallet. How do you think about your currency right now? It seems like the easy narrative for many years, when thinking about India, was that it was a place for outsourcing, and for structural cost advantages, and it seems like with a declining currency that may again be true, at least at a superficial level.

Do you think that that narrative has any resonance, or is it overly simplistic?

Currency movements are very complex, and frankly I will admit that I am no expert on currency. Having said that, the last six months/nine months of currency movement definitely has been a little bit worrying, we have seen currency depreciate almost 25 percent before recovering a little bit. There have been multiple reasons for it. Obviously the reasons in hindsight are very easy.

We have had a huge trade deficit led largely by oil and gold imports, and we have also seen a scenario where the US economy and the developed economies have been recovering, and as a, you can say, a safe way of investing, investors have in fact been pouring money into India’s economy.

Cross-currency movements also led to some impacts which not only that Indian currency has, that we figure a lot of other emerging market currencies like Turkey, Brazil, Indonesia, and so on, which have seen a similar kind of volatility.

Having said that, again, you can see the period from 2001 to 2010 or ’11, we saw Rupee in fact appreciate by around 15 percent over a 10 year period. It is not fair to say that the Rupee depreciation is a given year after year. We have seen normal periods where the Rupee has stayed quite stable.

All we need is a return to confidence. We have had a new RBI governor but now that we write policies to encourage investors to move away from investing in gold, into yielding assets, which are the financial assets, which has led to some fall in gold imports.

Our current account, we have to take it to looking like hitting five percent is now expected to be more like three percent. Yes, given the fact that the global world is a more volatile place, short-term currency movements are definitely the order of the day. But I’m more optimistic of a more stable Rupee, and that might be given a boost if the economy starts to recover.

One of the things that, in compiling this special report on India for Inside Investing, one of the things that we heard first from Pradip Shah was that, in his opinion, the Indian Central Bank seems to view its role as protecting the purchasing power of currency now, which is something that, with my dollars in my wallet, I’m not used to hearing about any central bank. But it surely does give cause for optimism, and I guess increased probability of renewed stability.

I want to ask you about the at times unequal effect that this sort of volatility can have on a population that has very wide disparities in wealth. In particular, I saw onion prices were up something like 300 percent over the last couple of months.

In a population where the bottom 50 percent is living on very little money, that can hit very hard. Do you think that that population, that their ability to consume in an economically productive way, is being materially impacted by this currency volatility, this food inflation?

You are right. The food inflation is definitely hitting the bottom rank of the population, because a significant portion of their income goes into spending on food. Having said that, India is a domestic self-reliant economy, we don’t import most of the food we consume. It’s all grown in-house, most of it. To that extent, at least our view won’t be that the movement of Rupee has caused onion prices to go up.

Weather patterns globally have become more erratic. We are definitely seeing impact, whether you call it global warming or increased carbonization, which is causing the weather patterns to change. In India, specifically we’re seeing standard of living going up, and as a result of this, demand for better food is going up. Our view on that, in fact, is a more positive sign, rather than negative.

Yet, in the near term, supply is taking it’s time to keep up pace with demand. But specifically on the equities inside we have seen not only in India, but globally, that higher prices of produce makes the farmers switch from one crop to another, and it is always a very, very short-term phenomena of significantly higher prices in any one commodity, or one produce. Also, we have had one of the best monsoons over the last 20/30 years this time.

The water table is at least 20 to 40 percent higher across India and the world, compared to the 10 year average. We have a very good first indication coming from the Rabi, which is a winter crop plantation, and in the next two or three months, we are definitely hopeful that even the food inflation should start to come off.

But very, very clearly, the currency does have an impact on almost everything, but the impact on the food prices would not be as significant, because most of the food we eat is produced in-house.

I guess you’re dwelling on that bigger population, but departing from the food trend, I want to ask you about the effectiveness of the financial system for those very poor people. It’s common to talk about people who are under banked, or underserved. What are the impediments that stand in front of a broad-based shareholder class in India?

Is there a developing sense that equities are really the place to save your money, or is it still, “I’m going to buy gold, I’m going to buy housing”? Or even, “I don’t have the money to invest. I’m just going to buy food”?

Again, the structure of the Indian population, Indian economy, is very different. We are a 1.2 billion population country. At the same time, we do have a lot of poor people, but we also have the world’s largest population of middle class, and we are also among probably the top 5-10 countries in terms of the super rich.

There is a wide disparity as far as the whole population is concerned. Having said that, we are a country of large savers. We, on an annualized basis, save between 30 to 35 percent. The savings rate has fallen slightly, but it is still a healthy 30 percent, of which 20 percent is the household savings.

With an economy size of $2 trillion, on an average we save $350- to $400 billion as households. Over the last five/seven years, what typically has happened is that a lot of money has gone into hard assets, which is real estate and gold. Largely because those asset classes have been performing very well, and as a result it…in every part of the world, investors normally chase returns.

This is where most of the money has gone into. As far as equity is concerned, we had seen a huge surge in a propensity to invest in equity. It is come down over the last four or five years, largely because the immediate past performance of Indian equity markets has not been that great. But this year we have started to see money not get attracted as much by gold, for sure.

Real estate also, to some extent, is seeing this jump of the use of it. Still, a lot of money is going in real estate, but we are clearly seeing signs of topping out, and money moving into the financial assets. Now, the beginning of this move usually is on the fixed income side, and we have seen huge improvement in flows to our own fixed income mutual funds from retail investors.

Banks certificate deposits are just fine being picked up then, as far as the economy is concerned, have seen record 20 percent less growth in deposit base, and it’s a matter of time before this money selectively starts to move into the equity markets.

We are a young nation, you know, we are only 60 years old. If you see the history of other developed nations, In their formative years, equity as a percentage of the total assets were a very small percentage, and then as the economy matured, as the investors matured, as the investor education and literacy increased, the percentage of equity in a person’s asset base started to increase. We are very sure that in India we will see that, and frankly at Reliance Mutual Fund we are very focused on investor education.

We do believe that investor education is the best way of attracting long-term money. In fact, as we speak, we have launched India’s first five-year lock-in product. It is a close ended product, and investors cannot redeem before five years. It’s very difficult for us to sell, because all investors want liquidity.

However, we have decided to invest a lot of effort and money into promoting this product, and though it might be very small in terms of size, we do believe that this is the best way of getting investors invested in our equities from a longer-term perspective.

To cut it short, we are in a nascent state of the economy in the financial services concern, investors are definitely looking at financial assets. We need our economy and the markets to start to grow, and we also need a lot of effort as far as investor education is concerned, and that would definitely, definitely increase the penetration of equity, which is right now one or two percent of the savings, to at least 10 percent of savings.

I’m mindful of your time. I know I have to let you go in a second, but I would be remiss if I didn’t ask you. This report will go live one week before almost 100,000 people around the world…well, a little short of 100,000 people, but not that short, take the CFA level one exam.

This is an organization that’s changed quite a bit probably since you took the level one exam, and I wonder if you could just sort of hit quickly on what we’re doing in India, and how it’s come to change as a percentage of what we care about as CFA Institute?

Right, see again, I know India that way is a very interesting country, young guys, and I mentioned the demographics because we have a huge young population in India. They are always eager to learn, and focus on education, even from parents, is very, very high. If you see CFA’s own, you can say, progress in India, almost on word-of-mouth, we have grown from maybe 20, 30 students, to almost 30 to 40,000 candidates in different levels.

What it basically demonstrates is that one — yes, the economy itself has grown to among the top five economies in the world. Second — financial services is a very, very key component. In fact, services as a percentage of GDP, and total services, is almost 55 percent in India, so we are a service oriented economy. We are an English-speaking economy…English is a world language, so that also makes it easy.

Most important is that the quality which the CFA Institute is offering is now getting interest from the students who are eager to…or even professionals who are eager to further their careers through the help of an internationally academic course. Things are quite well. In the near-term, obviously the sharp depreciation in currency has made the course a little expensive, but it’s a matter of time before the currency also stabilizes, and you consider prospects also start to recognize that.

As India’s Society, obviously I’m no more associated with them on a day-to-day basis, but the India Society is doing a wonderful job. We have now events almost all over the country. It is providing young professionals an opportunity to keep on focusing on continuing professional education. It’s a great networking tool. There is a special cell for job assistance, and even level three pass-outs are encouraged to attend those events.

All in all, there’s a great potential for a good investment oriented course, and the CFA curriculum definitely fill that. It’s exciting times, and this growth can continue for a long, long time.

Wonderful. Thank you so much for contributing to this Inside Investing special report, and I really appreciate it.

Thank you Sloane, thanks for having me here.

If you liked this post, don’t forget to subscribe to the Enterprising Investor

tag:srvo.org,2013:Post/1280349 2013-10-10T16:00:00Z 2018-05-04T19:07:53Z Meet The Hedge Fund Manager Who Asks: Why Are You Not Indexing?

This post was written for CFA Institute and first published on The Enterprising Investor.

Conventional wisdom says that if you want to make money in the stock market, you need to exercise fanatical discipline and develop unique competence as an investment analyst.

Lars Kroijer thinks that’s all kind of a waste of time for most people. Can his mom really do that? Since she can’t, does it mean that she can’t ever make money investing?

The big question to him is reasonably straightforward. Do you really think that you are good enough to beat the market? If not, you can invest simply in low-cost alternatives. It’s easier, cheaper, and for many investors, likely to produce better results.

A lightly edited transcript of our interview follows. It’s long, but worth reading. We start by talking about his career (he used to run a hedge fund) and move to talk about how he came to the idea that most investors don’t have an edge.

CFA Institute: We’re in the London office of CFA Institute with Lars Kroijer who has just written Investing Demystified: How to Invest without Speculation and sleepless nights. An attractive premise!

Lars Kroijer: Well, thanks for having me!

Very, very pleased to do that. In your first book, you outline the steps that you went through in setting up your own hedge fund where step one was hire a team, step two was get service providers…and sometime after step three you wind up rich, popular, and happy. Is that still how it works?

I’m not sure any of those three is still true, but I guess to some degree. The reason I wrote the first book was that I thought the hedge fund industry has been one where lots of things have been written and spoken, a lot of which were bad myths and misunderstandings.

It was generally described in very sensationalist terms where everyone became a multi‑billionaire or was a crook, whereas the industry that I had seen from the inside was really quite different from that.

I thought I was in a unique position to tell the story, from someone who, frankly, went into my first hedge fund interview without really knowing what a hedge fund was to joining the industry, working in it for years, and eventually launching my own fund.

The book was really more about that, trying to explain what the hedge fund industry is like from the perspective of someone who’s, lived a lot of facets of it. It wasn’t trying to be sensationalist. One of the reasons it ended up doing well was because a lot of people could relate to it.

Interestingly, the best feedback I probably got was from people in the industry. Just saying they recognized a lot of the stuff, even the stupid little stories of humiliations and losing money and being overlooked and all the stuff that we all live and that people could recognize. That was actually, perhaps, the most heartwarming part of the feedback.

Your question, does the same thing still hold? Well, it could, I don’t know. I don’t, every hedge fund start up story is perhaps different. But what do you need? I tell people that approach me about selling hedge funds, you need three things.

You need a good product, you need a good investment product and you need to make sure that you’re pretty convinced that that’s the case and you love being the provider of that product, i.e., that this is not a get rich quick scheme, which some people seem to think it is.

You need some money to invest, that seems pretty obvious and often forgotten by people who want to start hedge funds, because they think that comes naturally. But it’s pretty hard to raise money for a hedge fund. Always was, mind you, but that’s certainly true today.

The one reason for that is because the media will tend to talk about the success stories, someone running billions and billions and flying helicopters and living in big houses, whereas the mundane reality is very different for a lot of people in the industry.

Then the third thing you need is you need to be able to sustain the business. What does that mean? That means pay the bills and keep the lights on and get the right kind of computer equipment and the right team around you. Incur the costs of complying with the regulation and keeping your service providers happy.

That’s no small point, actually. Because if you don’t manage a lot of money early on, you’re not going to have a lot of fee income coming in. It’s pretty obvious stuff. But that still holds true today.

I’ve heard people say, there’s nobody who wakes up in the morning and says, “Gee, I really wish I had more hedge funds.”

Well, there was a time when that was the case. I think there were a lot of pension funds who woke up and said, “Oh, I must buy some hedge funds.”

It seems that there are fewer of those eureka moments in the pension fund industry today.

Why has that enthusiasm tapered off? How are hedge funds working, really, for the clients? Is part of that lack of enthusiasm driven by a lack of returns?

Well, first of all, I think, can’t neglect the fact that the industry has grown just a staggering amount over the last decade and a half. There probably was an unmet demand that to some extent has been met.

Then the second thing is that the industry’s now, I think, managing $2 trillion. That’s a lot of money. That almost is the market, right? If you slap a large amount of fees and expenses on that amount of capital, well, it’s got to be pretty hard to outperform as an aggregate.

I’m a huge skeptic of aggregate data in the industry because I think a lot of it has lots of biases and vested interests. I struggle to see that the high fee levels can be justified, particularly because so many funds are so correlated to markets.

You’ve got to keep in mind you can get market exposure for 15 basis points a year. If you’re charging 200 basis point management fees a and 2,000 basis point incentive fee, you’ve got to be providing something other than that. I’m not saying it doesn’t exist because in many cases it does.

On the other hand, if you can provide an investment product that doesn’t correlate to the markets, that’s incredibly valuable. Think of it: if you’re an insurance company you’ve got fixed liabilities, because people’s car crashes don’t depend on the market. If you’re a pension fund and people’s future retirement depends on the market you can be pretty unlucky if you don’t have enough, as you’ve witnessed in a lot of places in the US and elsewhere.

The premise of the product is brilliant. Uncorrelated returns are the Holy Grail of investing. If you can create that you ought to be a rock star, and a very well paid one. I just think the reality is perhaps sometimes a little bit more mundane.

For all the sex appeal, it’s just a bunch of guys in offices.

Don’t get me wrong, a lot of very, very smart guys, very well informed guys that sometimes provide a brilliant product for a very high price. That doesn’t mean they all do, but some people undoubtedly do.

To your point on aggregate data, one of our authors on Inside Investing, Ted Seides, has made that point pretty well. (Check out “Rethinking Hedge Fund Indices“)

There’s a lot of garbage. There is in a lot of places, though. Also keep in mind that it’s hard to buy the industry. There are hedge fund index trackers. I don’t know how well they all work.

But a big part of even what Ted does is to pick hedge fund managers. It’s a little bit like stock pickers except you’re a hedge fund picker. If you’re good at that, that’s a very valuable thing to be good at. It includes the analysis of data, but also a lot of softer things like management, and credibility, and the strategy that they undertake, and the future of that strategy, et cetera, et cetera.

Again, I wrote the first book for an even simpler reason than taking a view on the industry and whether it’s good or bad. I thought there was a story to tell.

Absolutely. It a great story. Some of the reaction to it that I saw was focused on the difference between what the audience expected and what they found. Can you talk about that a little bit? 

First of all, it’s a little bit like if you had to write a story about football and the only thing you wrote about were the top teams, and assumed that anyone who played football, anyone in the world, would like to know who played for Arsenal or Chelsea. We ended up doing very well, but that’s not actually what’s interesting about the story.

It’s funny, whenever I give talks what I can see resonates most with people are our early failings.

The misery of trying to start a hedge fund with very little money is much more interesting to people than whether you made a billion, or a million, or a $100,000 because that’s the story they’ve read in “Forbes Magazine” ten times. Also, what does it actually take? Who do you go to? Who do you call?

I think something a lot people resonate with is, this presumption that if I were to start a hedge fund…the generic “I.” If one were to start a hedge fund I could call my 10 best friends and they’d turn up with some money.

I was certainly guilty of that myself. Very quickly i saw the error of my ways…Very little money actually turns up when the rubber hits the road.

If you shift to the average investor, hedge funds, obviously — very complicated industry, lots of things going on there. But is this the thing that the average investor can even try to grok?

First of all, the average investor probably has hedge fund exposure, through their pension fund or even indirectly through their insurance company or their bank. So you have an exposure, but it’s very hard for you to understand what that exposure exactly is. And that’s probably an issue.

But taking a step back, frankly, for the retail investor, a lot of times they simply wouldn’t be allowed to invest in a hedge fund, just size constraints, qualified investor constraints, i.e. so many specific rules here in the UK regarding being approached, even, by hedge funds for the purpose of investing.

If you’re not an expert in hedge funds, I would strongly encourage you to look elsewhere to put your money, only because here’s a product and you know it might be interesting, but one thing you know for sure is that it’s expensive. And so you’re looking at a very expensive product where you’re not an expert. But you think, “Well, maybe I should let other people try to pick the best ones.”

I’m going to ask a stupid question. Are fees actually important?


No, I don’t think it’s a stupid question at all, actually. It’s a very good one because frankly, if you look at…I’m struggling to think of any other industry where high fees are not somehow correlated with better service or a better product, most places that’s the case.

Otherwise the higher‑fee end of the spectrum would self‑destruct. Frankly, other than perhaps government spending, where else can you be horribly inefficient with other people’s money and it not coming back to bite you?

Economic theory would suggest that if there is an expensive product that seems to thrive, so it must be valuable. Which, not to lead you into the second book, but that’s why I wrote the second book, because it actually starts with a very, very different premise, which is one of saying, “Well, who are you to ask?” Which is really saying, “Are you able to distinguish?”

So you know on the one hand, you’re paying a lot for something. On the other hand, there are very, very cheap alternatives, and you can’t convince me the very expensive ones in the aggregate make sense, if you’re blindly throwing darts. So you shouldn’t try at all.

You should index. This is the premise of the second book, is this whole idea of, do you have an ability or edge to beat the market? And I argue and I certainly think that the vast majority of people don’t. Well, in the aggregate, you can’t because in the aggregate, that is the market.

You are the market. But why don’t most people have that capacity?

First of all, if you think of someone who buys or sells stocks in the market, what is the market? It’s an aggregation of a ton of sometimes extraordinarily well‑informed investors with access to better information than you, better analysis, better access to management, to industry experts, to execution, to understanding data flow, statistical analysis, etc., etc. It’s just extremely hard for my mom to compete.

So the price…at the end of that whole sausage factory called the market of analysis and insight is a price that reflects the aggregate opinion of the market participants. No disrespect to my mom, but for my mom to essentially go in and say, “I know better,” that’s a pretty tall order. There’s every likelihood that she cannot.

Then add to that that she’s probably at a huge cost disadvantage. She is charged more to trade. She will probably trade frequently, which is a terrible idea. If she buys, she will buy on the offer and sell on the bid, even something as small as that, which for the the less liquid stocks actually matters.

There’s also every academic study backing the fact that even trying makes no sense for her, unless she is a rare, rare case of someone who is able to consistently beat the market.

When I say beat the market, there’s another thing there. I could go out and buy…pick a random stock. Say, Vodafone or since there are mainly American listeners, Microsoft. Let’s say I go and buy Microsoft and it skyrockets tomorrow. That doesn’t mean I had edge. It might mean I was lucky.

So eliminate that. Incidentally, Microsoft could decline massively in value tomorrow. That also doesn’t mean I didn’t have edge. You can’t turn around and say that either.

It’s not easy to prove or disprove edge. I hate to say it, this sounds awful, but you have to look inside yourself and say, “Well, what are the chances that I have it?” And when you’re at an analytical disadvantage, information disadvantage, and a huge cost disadvantage, the chances are very, very small.

So what I’m trying to do in this book is to say, “Well, on the basis of the premise that you probably don’t have edge, what should you do?”

This book, the subtitle, again, is “How to Invest Without Speculation.” We did another “Inside Investing” thing where we asked a bunch of guests, what are the differences between those two things? I wonder, your thoughts on that. (Editor’s note, Read responses from Howard MarksMartin FridsonRobert HagstromBrad McMillan, and Malcolm Trevillian)

“Invest without speculation.” First of all, the subtitle partly came about because of the publisher….So you’re putting me a little bit on the spot here, and the sleepless nights bit also, but the whole point is, what do you do with your money in the long term when you don’t claim to be someone who can beat the market and speculate and outperform and gamble? I’m not saying those all associate, but what if you just want your money to grow slowly, boringly, in a way that makes sense for your risk level over the long term?

That’s what I associate with sensible, what I call rational investing. Because it’s rational if you accept that you can’t beat the market, and there’s very little speculative about that. In fact, you’re trying to take speculation out of it. You’re trying to say, “I know I don’t know a lot.”

Now, keep in mind, what I’m saying, lack of edge doesn’t mean you’re stupid. In fact most professors would be adhering to this strategy. So there’s this kind of investing. Some of the smartest minds will do this. They will simply say, “I don’t think I can beat the market. Or I don’t have the time, I have a day job,” or, “I hate being wrong.”

Or even, “I want to go walk on the beach sometimes. I just don’t want to do it anymore.”

Yeah, look at myself. I stopped running money in hedge‑fund world. I invest only in index funds. I don’t think you can…When I was doing it, I found a really great edge. But I also believe that it is bloody hard.

I don’t think you can do it half. The whole that you can come home from work at 5:00, look at some talk show about stocks, then pick which one — where they’re right and where they’re wrong, and then go buy some stocks the next morning before you go to work. I just think it’s wrong. I just think there’s every chance you’re going to do a little bit worse.

So don’t. It’s hard‑earned money. It’s pretty boring, all right? Over time there’s every reason to think that you will do better and by cumulative, quite staggering amount. I think you should index, on the basic premise that you don’t have edge.

The trick then is index funds.

Yeah. If we can for a second, because it’s easier to understand, just think about stock markets. Obviously, you should not only think about stock markets. Say the S&P is an index to think about. So why do I think, if the world was only S&P that you should play the index?

It’s because you don’t think you can beat the markets, you don’t think you can reallocate capital within that index in such a way that you generate a superior return profile. The byproduct of that is that the investment product you’re trying to get is extremely simple.

A monkey couldn’t put it together, but a computer can very, very cheaply which is why they cost ten bps a year, or 0.1 percent, and trade very little, so there are those added advantages.

You are essentially buying securities in the proportion that the market has determined for you, so you are coming along in the market, if you will.

Why does that make sense? Well, because you don’t think you can do better. Why does that make sense? Well, because you don’t have edge.

That’s what you should do in the S&P 500. Now suppose you added an alternative, which is the Euro Stoxx 50 — that’s the main European stock index — and you had those two, S&P and Euro Stoxx 50. How should you allocate between those two?

Again, the market is allocating in terms of capital weighting, so you allocate them in proportion to their values. Why is that? That’s because you don’t know better than the market and that’s what the market has done. Now if there was added advantage from selling S&P 500 down 10 percent and buying the Euro Stoxx 10 percent, then the market would presumably do that.

Extend that logic to all equity markets and all currencies around the world. I argue that you can create an extraordinarily diversified product by simply buying the world equity index. You can do that through one index tracker, so you’re talking one security for all your equity holdings, and you get an extremely cheap, because it is that simple.

It’s a very simple index to buy, because you’re buying one stock and that represents sometimes thousands of underlying securities, across a range of capitalized sizes, and geographies and industries. You’re widely diversifying and you are getting the world equity exposure. Do that and it is very simple.

It happens to be theoretically — like academic theory — not far from what they were all ranting on about 30 years ago, before anyone could actually, properly do it.

Back then it was very easy. You had these great academic theorists and brilliant minds talk about the risk‑free rate, which sounds like an oxymoron.

Then you can buy and you’ve seen the capital market line and the correlations, and all that stuff, you smile faintly at them. Back then it really meant the US, because that was the only real market. Then eventually…Even when I went to college ‑‑ I’m 41 years old, I’m not that old ‑‑ we’re really talking the maybe Europe and Japan. That was pretty much it.

Now it’s 50 countries, right? Why is India any worse than the US? There’s no reason you would expect them to do any better or any worse, relative to its risk levels. But you can add that incredible diversification. That product was just very, very hard to buy 20 years ago.

Now you can. Those products exist. In 10 years there are going to be even more of them. It’s going to be even cheaper, I expect.

Isn’t it the kind of thing that as you get, let’s say my investment portfolio has $1, $10, $100 million…

Good for you. [laughs]

This is strictly a hypothetical. This is a non‑profit organization, but presumably at each of those different levels ‑‑ $1, $10, $100 million ‑‑ one percentage point of added performance is increasingly valuable in cash terms. You beat the market by one percent on a $1,000, it might not be that relevant, but on $100 million, it could probably buy something pretty nice. Is it the case that as your level of wealth rises, you should do something else? Or is that something that something that really works for everyone?

No, I think that’s an interesting observation. It think actually that pertains much more to your risk profile. Think of it this way. Let’s say you have $100 in your account and you needed $95 next year for heart surgery. You shouldn’t buy equities. That seems pretty obvious to everyone.

Now let’s say you have $100 in your account and you know you have some yet‑to‑be‑determined need in retirement 40 years from now. You should probably buy some equities, because there’s every reason to think that over the long term they out‑perform inflation. There will be huge dips, but you can afford to incur those dips.

The question of, “What will an extra one percent do for you?” is really, other than the simple math of it, it’s a very individual question of risk, and one I touch on a lot. How should you think about this? How should you think about draw downs and the inevitable “Oh, my God, I didn’t think it could be this bad”?

What a one percent draw‑down means for you is quite individual. When I say individual, I doesn’t mean to the individual person, but the individual as an institution. One way to think about risk is by‑an‑large, correctly, a lot of people have discredited standard risk matrices, like standard deviations.

Let’s take as an example and say you have $100, and you want $150 in 30 years, but you absolutely need $120. You can say, “If I put it all in equities…”

Let’s say you have an expected risk premium of four, five percent above inflation, which is what it’s been historically. You can say, “…in 30 years that’s going to accumulate to X.”

What is the risk you’re willing to accept that you don’t get to $120? Does that mean that you die ‑‑ you and everyone you’ve ever loved? Does that mean that you can’t be a member of a golf club, which you could live with?

What does that mean as an individual thing? That should partly drive your allocations and acceptance of risk. I try to touch on that in the book. If you come up with a hypothetical example of someone who puts aside some money every year between ages ‑‑ I’m not going to guess your age ‑‑ call it 30 to 70, or 65, and say therefore you should have X.

If you believe these numbers, the standard risk, standard return expectations as an expected outcome. Now let’s say you have a minimum you absolutely need. What is the probability you’re willing to accept that you don’t get it? Is it five? Is it 10, is it 20 percent?

What you can do is let’s say you have a choice between the world equity markets and something very, very safe. Assume for a second it’s government bonds. Let’s say that you then allocate more toward government bonds. Well, we’d all appreciate that your expected outcome many years hence will be lower, but the certainty of that outcome will be higher. There’s less risk.

You can therefore go along that continuum and say, if you say, “I accept no risk,” buy a 30‑year government bond. You know you’re going to have X, but you’re also going to have very little potential upside. That’s one way you can start thinking about risk. But it’s an interesting topic.

I also talk a lot about insurance as something that people should avoid if they can afford not to, and money in the bank, which I argue is not without its risks. Pensions, which I argue the vast majority of people get royally taken to the cleaners by various managers, certainly in aggregate, over many, many years.

It’s written to my mom, although she’s perhaps a little old to do the 40‑year time horizon, unfortunately.

Perhaps it is a little late for her.

She’ll probably actually live another 40 years.

The book is “Investing Demystified,” which you can buy on Amazon.

It’s just out, in fact, earlier this week.

Just out this week. It has got some very inspiring upward‑facing arrows on the front of it.

Yeah, there you go, and I didn’t have anything to do with those….

I encourage everyone to pick it up. Thank you so much Lars!

tag:srvo.org,2013:Post/1280347 2013-08-27T16:00:00Z 2018-05-04T19:03:58Z What Is Good Research? An Interview with Tom Brakke, CFA

This post was written for CFA Institute and first published on the Enterprising Investor.

We were privileged to have Tom Brakke, CFA, stop by our offices in New York City a few weeks ago. After a multi-hour meeting where many of us talked about all sorts of things, I managed to wrangle Tom into a quick interview.

Before posting the interview, I’ll say that if you don’t already follow Tom on Twitter or on his excellent blog, The Research Puzzle, then you are probably missing out. He is a regular font of provocative thoughts, and that can be one of the most useful things in the world. He has also written a number of excellent posts for Inside Investing, including a thoughtful look at how you should consider cash and a post about the most important question to ask about a projected rate of return.

CFA Institute: Tom, one of the things that we’ve been talking with colleagues here about is all of the barriers that exist and keep people from getting to the truth. How do you tell if research is good in this climate? How do you piece through that?

Tom Brakke, CFA: That’s a very difficult question in terms of trying to ascertain whether research is good. I think the first place I would start is that research is not necessarily good in terms of if it’s formulaic. I would start there. Let’s just put it in the broader brush of due diligence, for example, which is what somebody, a research analyst for example, would be doing in terms of preparing a research report is in essence doing due diligence of one kind or another, and they’re trying to come to a conclusion.

If you’re doing due diligence, you can run through a checklist and feel like you’ve done due diligence. But that’s a check list. It’s a pre defined way of thinking about the world. When you think about a research report or the responsibilities of an analyst to do certain kinds of research, lots of times it takes that same “check the box” approach.

I think good research, good due diligence in general, means looking for differential information and approaching the problem in different ways. When I think about good research, I want to see that somebody’s giving me insight into the situation that I couldn’t have otherwise gotten.

Let’s just take written research, which we see most commonly from sell side firms, for example. It’s remarkably similar in almost all respects from firm to firm. You will see some differences. I would say focus on the differences. Focus on the different theses that somebody might use, a different approach they might take, the identification of the specific things that are unique to their study.

When you pull out everything say in a research report or in a communication from an analyst verbally or from a portfolio manager or anybody that’s doing things, if you take out all of the stuff that’s the same and just focus on what’s different, it’s a remarkably small amount of information. That’s where you ought to start is with the differential information.

A lot of times, it’s very difficult to find that, to comb through, to piece it. Because that’s not what, say a research report again. I don’t want to focus just on reports in general. But that’s not what they lead with, necessarily. You have to dig for it. You have to know what’s different.

The person communicating their research ideas, that’s the lead. To get all of the extraneous material away and to get that differential information requires doing things different than other people, just by definition. I think that’s the major failing of doing research or a due diligence process in general is basically following well worn steps is not a path to enlightenment, if you will.

In talking about the differential information, you’ve hit on something else, which is the mechanics of information transmission. You’re notable in that you have several different pieces of media through which you transmit your thoughts.

Does the substance change at all? How do you think about the way that you communicate yourself in social media in the context of…Do you change the substance to fit the medium at all? Or does the medium devalue the substance in any way?

Does the medium devalue the substance? In the eyes of some viewers, perhaps it does. Perhaps they don’t think that if it’s available online it can be value added. Obviously as somebody who produces information online, I disagree with that.

But I know that that’s a fairly common perception. In terms of what’s the right forum for a particular idea, I’ve probably gone too far in the sense that I have three different blogs that kind of do things. The original one, “The Research Puzzle” is about mostly investment process, how the industry works. Second one, which is called “Pix,” features charts, so there’s a visual aspect to it.

A pet project of mine is to convey investment information more creatively in a visual fashion than the industry typically does, which is the goal of that one. Then I’ve got a third one that’s called “Pieces” that’s kind of a scrapbook of different kinds of ideas. I also do a newsletter for institutional investors that pass on information to them from others.

It’s a digest format that I think is of interest. Each of those has a specific purpose so that the readers of those know what they’re getting and selecting. Like I said, I probably went too far in putting things in too many different places so that it might be harder for the reader trying to find the body of my work to identify with it. To locate it, I should say.

I think that when I first started on Twitter, for example, a few years ago, somebody recommended following me, “Because I had great, original material, and excellent links,” was what he said.

I go, “That’s pretty good. That’s exactly what I’ve been trying to do.” It’s the originality. It’s the differentiation, as we just talked about, that I focus on most in trying to convey information. That if people read me, I want it to always be presented in a quality fashion of the communication as good as it can possibly be because I think that matters. I think that’s important.

Secondly, that the thoughts that I convey are different than they find at other places. That’s certainly the feedback that I get. Whether it’s something that I write myself, the original material, or whether it’s something I find and pass on, whether it’s via Twitter or via newsletter or in one of my blogs. That I’m really trying to put into the discussion and the communication, that I’m providing interesting things that aren’t found elsewhere.
If I can be successful at that, I can add value and it doesn’t really matter whether it’s online and available for free or whether I’m providing things directly to clients of mine that don’t otherwise appear. It doesn’t really matter.

My purpose is to bring that information forth, to bring that context, and to be creative about it and say, “Here’s something different that people haven’t really been focusing on.” If I can do that in a quality fashion, then I’m going to find readers that gain benefit from it, then I can hopefully gain consulting clients, too.

It sounds like to you the information has value regardless of the transmission mechanism.

Well, you can’t just send out information and say it has value. There’s a curation aspect to it. That hopefully if I’m disseminating something, no matter the forum, that people expect that I have…it’s not that I approve of everything I send out, because sometimes I send out things that I think, for example, are well written and interesting that I don’t agree with. I think that’s part of it, too.

It’s not just I’m sending things out by people that agree with me on something or other. The important thing is sending out good material and getting people to think about important issues, whether I happen to agree with them or not.

Now, if I’m writing an original piece, they’re going to know where I’m coming from. But hopefully, you get the range of ideas that you’re providing to people. That if you do that, they’re going to respect and understand that and respond to the information that you give them.

In closing, we’ve been here at CFA Institute offices for a couple of hours now talking about a wide range of events.

Yeah, all different sorts of things.

One of the things that comes out is there are a wide variety of different sorts of investment management firms. A piece that you wrote on your blog, the letters to a young analyst, you talk about the notion of a special place where an analyst can build a career. Similarly, those would ostensibly be places where a client can build some wealth.

Exactly. I think they go together, by the way. That the kind of place that can truly be a home for a young analyst or portfolio manager or any other role within an investment organization goes with the kind of place that a client can hopefully build up wealth. I think there’s a connection there.

What are some of the qualities, besides client alignment? Do they have certain typefaces on their website?

[laughs] No. I think it’s a perspective on the long term goals of what this business ought to be about. That you are delivering value over time, and that you create value by building an organization, by building a team, by thinking thoroughly about process. If you’ve read me, I write lots and lots about investment process and investment decision making.

I’m kind of an evangelist for process, if you will. That doing that well is very hard work, and it takes a long time. There’s a cumulative effect of that. If you’re starting off a new firm, you’re not going to have that instantaneously. But if you do it in the right way, you’ll have it probably sooner than you think. People will recognize that both, prospective employers and prospective clients.

For an established firm, it’s a little bit different. Because the culture is the culture and it’s hard to change. It’s a lot easier to destroy a culture than it is to create one. I’ve seen it happen. I think it’s very much about the culture of understanding that it is a cooperative venture in the sense that you’re there for a particular purpose.

The purpose is the client. What you’re trying to help the client do. That is to build wealth over time.
We get into this culture of, it’s all other people’s money and we’re just slinging it around and we’re extracting our free and our mission is to grow assets and grow fees and that’s always defined ourselves.

As we discussed earlier, that’s why there’s a gulf between what clients expect and what a lot of investment organizations are delivering. As an industry and as a profession, we need to close that gulf. It is really about managing that money as if it was our own, to make the right kinds of decisions, to be willing and able to buck the pressures of the industry, which is perhaps the hardest thing.

We talked about a number of these things earlier, about the misaligned incentives a lot of times, the pressures in the industry, the relative performance derbies and all the things that end up keeping us from meeting the client’s objectives instead of helping us meet the client objectives.

If you’re an investment professional and you land in a place where all of that is in the right perspective, not that you won’t have difficult choices and hard issues to deal with and conflicts that you have to deal with. But if you’re in a place where that’s being addressed in the right way as opposed to just, let’s build this business and make a lot of money and fend for ourselves instead of our clients, then that’s probably the core of it.

But there is a culture aspect to it that is, it’s soft, it’s hard to get at. A lot of times, you’ll know it when you feel it, if you will. It’s hard to see that prospectively as a young person entering the business, for example. It’s really hard to see that. But if you see it and you feel it and you get to be a part of it, one of the things I tried to reflect on and mention in that last letter to the young analyst is that you might not realize how special that is.

Somebody’s going to come and jangle some money in front of you and try to entice you to leave. Sometimes you need to do that. Sometimes it’s the right thing to do that. But if you don’t really appreciate for the uniqueness of the situation that you might be in, you might not think as well about that decision as you could.

That was really the point I was trying to make there. That if you find a home in this business that’s a right kind of home, that’s really worth a lot and you ought to value that opportunity appropriately.

Got you. Well, thank you very much, Tom.

Thank you.