Summary of business news and analysis

Citywire is an organization which rates Europe's best fund managers every year. They have an online service showing the various rankings.

Citywire: Europe's top 100 Fund Managers

Attached paper shows a framework for financial intermediation. It is a framework where financial intermediaries possess no inherent information processing or monitoring advantages. The paper tries to show that financial intermediation will still have its role under such assumptions: it will be a bridge between optimists and pessimists.

Role of Financial Intermediaries

Switzerland has seen several major unfriendly takeover deals in the past 18 months. Firms such as Unaxis, Saurer, Ascom, Converium have been attacked by raiders which could make use of the fact that there seems to be a loophole in the Swiss takeover rules: These rules allow raiders to circumvent reporting regulations by acquiring voting shares through financial instruments known as cash settlement options.

Generally, an active market for corporate control is beneficial to shareholders and normally increases liquidity of the market.

However, the loophole mentioned above allowed hostile bidders to come close to controlling stakes before management of the attacked firms even knew what was going on. This was for example the case with Sulzer - a very well managed company by the way - The management of this company had no chance to defend itself as they knew too late of what was going on.

Politicians are requiring more regulation now. In fact, the loophole mentioned above should be closed. However, it should be warned of overregulation. An active market for corporate control is a major element of an attractive stock market.

More important than additional regulation would be a well functioning system for the sanctioning of financial institutions which break the current rules through concerted action. The fact that state supported banks help to attack major Swiss industrial conglomerates in such dubious ways should be sanctioned immediately. Why not privatizing such banks and let them compete in the market economy without the safety net of tax payers!

NZZ, May 4, 2007:

Haus und Geld

Klumpenrisiken beim Anlegen


Die Placierung von privaten Vermögenswerten in Immobilienanlagen erfreut sich einer grossen Beliebtheit. Rund 40 Prozent des Bruttovermögens der privaten Haushalte in den wichtigsten Industrienationen ist in Sachanlagen in Form von Immobilien angelegt. Ganz zuoberst auf der Liste steht das Eigenheim. Zusätzlich tendieren viele Privatanleger dazu, noch weitere Vermögenswerte im Immobilienmarkt zu placieren, oftmals innerhalb desselben lokalen Marktes oder innerhalb desselben Sektors. Welche Risiken dabei oftmals eingegangen werden, soll anhand eines Beispiels illustriert werden.

Ein Zürcher Finanzexperte besitzt in Zürich eine teure Wohnung und hat vor ein paar Jahren eine Büroimmobilie in der Stadt Zürich geerbt. Mit dem Zukauf eines Mehrfamilienhauses gehobenen Standards in der Region Zürich möchte er sein Vermögen breiter diversifizieren, denn er hat analysiert, dass die Preisentwicklung von Mehrfamilienhäusern in Zürich anders verläuft als diejenige von Büroflächen. Rechnerisch ergibt sich somit ein erfreulicher Diversifikationsgewinn, der sich positiv auf die Rendite-Risiko-Eigenschaften seines Portfolios auswirkt.

Der Finanzexperte realisiert dabei nicht, dass im persönlichen Extremfall, beispielsweise bei einer konjunkturellen oder strukturellen Krise in der Finanzbranche und somit einer Gefährdung seines Arbeitsplatzes, diese dann besonders benötigte Diversifikation kaum zum Tragen kommt. Mit grosser Wahrscheinlichkeit wären nämlich wegen der hohen Bedeutung des Finanzsektors in der Region sowohl der Büro- als auch der Wohnungsmarkt von einem Preisrückgang betroffen. Die Wertentwicklung seiner drei Immobilien würde im Extremfall somit eine starke Korrelation zeigen, weshalb die angestrebte Diversifikation nicht spielt.

Aufgrund der eingangs geschilderten hohen Allokation von privaten Vermögenswerten im Immobilienmarkt und der bei vielen Marktteilnehmern falschen Wahrnehmung von Diversifikationseffekten erscheint eine Überprüfung der privaten Vermögensallokation vordringlich. Auf den Immobilienteil bezogen ist der Eigenheimbesitz in die Gesamtoptimierung mit einzubeziehen. Zu einfach wäre aber der Ansatz, wie am Beispiel illustriert, Anlageimmobilien in jedem Fall als willkommene Diversifikation zum Eigenheim zu betrachten. Die einzelnen Teilmärkte können in gewissen Perioden durchaus ähnliche Eigenschaften aufweisen und entsprechend stark korreliert sein, auch wenn die Analyse von Renditezeitreihen diesen Sachverhalt wegen der Unschärfe der Daten und der fehlenden Abbildung von Extremphasen nicht aufzuzeigen vermag.

Immobilienanlagen zusätzlich zum Eigenheim verbessern durchaus die Eigenschaften des Portfolios, aber nur, wenn sie sorgfältig und weitsichtig ausgewählt werden. Die Fokussierung der Anlagen auf einen einzigen Wirtschaftsraum oder einen einzelnen Sektor ist möglichst zu vermeiden. Ebenfalls wenig vorteilhaft kann das Halten von nur wenigen Objekten sein, weil man dadurch unweigerlich sehr hohe Objektrisiken (Bauqualität, Grundrisse, schädliche Einwirkungen von aussen usw.) eingeht. Die regional und sektoriell breit abgestützte Immobilieninvestition wird heute mit neuen Anlagevehikeln einfach gemacht und sollte entsprechend in die strategischen Anlageüberlegungen mit einbezogen werden.

Digitized, instant communication is one of the major technological revolutions of our time.

We can now read newspapers, RSS feeds, blogs from anywhere in the world. Furthermore, We can decide what sort of advertising we want to see, or what we want to listen to or watch, without being hostage to the pressures of scheduling and editing traditional media were subject to. The great challenge in the media world is in fact the quality of information. Bigger choice does definitely not mean an increase in quality for the user. That is where the top traditional media brands will still play their role in the future. If they are able to adapt to the new technologies by using them to distribute their content as a branded service, some of them will have a bright future. Cumbersome firms will disappear or be forced to merge to get a bigger momentum. That is true for all industries. Couldn't we also take the view that the pressure from private equity firms might have a wakening up effect for cumbersome management and editors?

It is astonishing that Mr. Müntefering seems to become almost something like an ally for traditional media against the 'Heuschrecken'. Mr. Münterfering has created this synonym without having in depth insight into the mechnanisms of a now powerful segment of the financial industry. At that time it was a pure political statement.

The Rise of the Participation Culture

The Saturday/Sunday Neue Zürcher Zeitung (NZZ)of April 28/29, 2007 published a head article about the growing appetite of private equity firms to invest in media conglomerates, mentioning New York Times. The article is titled `Medien im Bann der Heuschrecken`.

The author mentions the area of conflict between the profit maximization objectives of private equity firms and good independent journalism.

Blaming private equity firms for the growing pressure on `good journalism` would be a too narrow view. Profit maximization and independent journalism has been an area of conflict long before private equity firms came into the traditional media sector.
It seems that the economic pressure on traditional media firms comes less from the private equity firms but much more from new, innovative media models on the internet. Vital and innovative traditional firms will face this challenge and be not dogmatic regarding a model which has worked for decades but which might be partly outdated today. New media models will find their markets. One being readers who are looking for high quality products.

Media im Banne der `Heuschrecken`

Blog discussion on the subject new versus tradtional media:
The editors weblog

In the behavioral finance and the stock market segment of this blog we dealt with questions of rational behavior and irrational exuberance.

If you look at ideas which brought major changes to the world you might realize that great ideas and innovations were often born during periods of irrational exuberance. Remember the hype period of 1999 to 2001: tremendous amounts of venture money were flowing into various internet companies with lots of them disappearing during the downturn years beginning at the end of 2001. Some of them survived and turned into great companies. We just want to mention firms such as Amazon, EBay and Google.

We came across a blog which deals with the subject of `irrational exuberance` in a rather different way than most of the finance academics or analysts: it is the blog `Fractals of Change (nothing great has ever been acclomplished without irrational exuberance)of Tom Evslin, a former IT executive (see blog links on the left side). In one of his blogs, Tom Evslin quotes George Bernard Shaw:

“The reasonable man adapts himself to the world; the unreasonable man persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.”

In innovation strategy the question whether to be the pioneer or the follower is an important one. Pioneers often were not able to get the financial benefits for their actions. Looking back to the last hype we might observe some initiatives of `unreasonable people` which, with some changes, might pay off today.

We highly recommend to read the blog of Tom Evslin `Fractals of Change`. It will help to understand better the factors which drive innovation.

Ideenmanagement (Sparkasse OÖ)

LPX GmbH (LPX) created an index of public private equity shares. A Wall Street Journal blog deals with the question whether the private equity boom is slowing as the LPX index has not been able to keep up with major stock market indexes such as the MSCI/Barra World Index during the last months. The author raises the question whether the lagging behind of the index could be an early warning sign for a slowing of the private equity market...

Is the private equity boom slowing (WSJ blog)

Herding among analysts is a behavioral finance subject. There are various comprehensive studies about this subject leading to a variety of results. Most of these studies use US data as the availability of relevant data is the highest in the US.

Sofia Darmstadt has analyzed the forecast behavior of US fixed income analysts (using 227 test persons) and comes to the conclusion that analysts influence each other significantly and that only 10% of test persons are able to make deductions about predecessors’ private signals from their actions.

Rationales Herdenverhalten bei US-amerikanischen Rentenmarkt-Analysten

Ein Volk von Verlierern (Weltwoche)

Globalization goes ahead with the fast increase of information availability and exchange on the internet as well as increasing human mobility due to the rapid development of cheap transportation networks. As information spreads much faster around the globe the dynamics of irrational exuberance due to the excitement about new technologies, new global expansion opportunities etc. became stronger.

However, Globalization is not a new phenomena. Already at the beginning of the twentieth century there were globalized capital markets. New technologies such as automotives created tremendous optimism. In 1925 there were approximately 2000 automotive factories, alone in the United States. Similar developments - in a much weaker form - we are observing in today's China.

The perception about globalisation could also have a cyclical nature. Currently, we might be at the peak regarding the perception of opportunities created by global markets. There will be times where people are less excited. This will also be reflected in stock market prices.

Der Domino Effekt (Die Zeit)

Back in 2000, before the dramatic stock market decline, many people where heavily invested in stocks believing that the new emerging internet related technologies would lead to an economic paradigm shift, resulting in accelerated sustainable long-term growth. People such as Yale Professor Shiller warned about over-optimism and talked of `irrational exuberance`.

Today, 7 years later, we are back to all time stock market highs. Internet technology is seen much more rational. It is considered to be a working tool. Even though firms such as google have changed paradigms regarding the way information is structured and exchanged.

We come across `experts` today which mention the phrase `paradigm shift` in relation to globalization. Again, such experts claim that due to globalization we are having a period of strong long-term growth ahead of us.

Remember historians mentioning that history repeats itself if we are not constantly observant.

He didn't say it. But he knew it.

It is assumed that there is widespread consensus that firms maximize shareholder value or should do so.
More precisely there should be factual and normative consensus.

The logic for a factual consensus rests in in part on the argument that economic forces compel managers to maximize shareholder value:
- competitive markets for good and services force firms to be efficient
- the pursuit of economic efficiency then, as we know from Michael C. Jensen, corresponds to firm-value maximization
- firm-value maximization in academic literature corresponds to shareholder-value maximization
- competitive capital markets also put pressure on managers to maximize shareholder value

The logic for a normative consensus claims that economic efficiency (and, according to the strand of literature in question, shareholder-value maximization) maximizes social welfare.

In their academic paper, Loderer et al. (2006) now find that there is no evidence for either a factual or a normative consensus on shareholder-value maximization as the target that firms do or should focus on.
The research based on a questionnaire sent to the COB's of more than a thousand Swiss companies and an international website-key-statements analysis (to see which goals and missions are stated on the companies' websites).

Explanations:
- It is possible that considerations of political correctness induce managers to misrepresent their preferences, particularly any fondness they may have for shareholder-value maximization
- Agency problems in corporations can be so massive that managers do not even have to pretend they have the interests of shareholders at heart
- Managers may care only for large shareholders, since they are the only ones who can in principle threaten their job security.

The purpose of the corporation: Shareholder-value maximization?

Today's news about managerial compensation in various Swiss firms might awake the interest of people to understand the various issues related to the correlation of compensation structures and managerial pays. The content of the attached academic papers must not have a relationship at all to some of the high paying Swiss public firms. We have attached interesting reading about managerial compensation already several times in this blog and will continue to do so as we are convinced that a stock market investor has to understand (or at least try to) the relationship between stock market behavior and development of performance.

A Swiss newspaper raised the questio last week whether the Blackstone IPO might be an indication that the stock market is in the peak and whether Blackstone is using the latest window of opportunity. Nowbody knows. The same question could be asked related to current observations of managerial compensation. At the end judgement should be made based on various observations and not just on one event.

(Never forget: firms with a convincing business model, strong stable free cash flows and a persistent capable management (showing some modesty and respect for employees) have always a good chance to outperform the market in the longer term.)

The impact of performance based compensation on misreporting

The measurement of firm ownership and its effec on managerial pay

The news that private equity firm Blackstone will go public was a kind of surprise for people who follow public and private equity markets regularly. The CEO of Blackstone has been a defender of private capital in comparison to public equity.

It will be a) interesting to see how such an IPO might change the face of the LBO industry in generell and b) whether other firms (Carlyle?) might follow Blackstone.

We are also curious how a public Blackstone will look like. Public markets have different requirements regarding the timeframe investors look at a company. It would not be a surprise if Blackstone would change its face substantially and sooner or later would be seen as a public conglomerate. Berkshire Hathaway would be an outstanding example for such type of a conglomerate. There also have been others. Future will show which direction Blackstone will go to..

David M. Rubenstein, Co-Founder and Managing Director, was talking about the subject at the Super Return Conference at the end of February 2007 whether the private equity industry is in a similar bubble stage as the tech industry in 2000. His conclusion is NO. However, he points out that an industry can not boom forever and that industry has to prepare itself, investors and the public for a decline.

Presentation by David M. Rubenstein - Co-Founder The Carlyle Group

When this blog was started a few months ago nobody would have expected that environmental subjects would find their way into the stock market section. Recent developments with banks selling more and more `global warming products` give indication that we could be confronted with a new financial megatrend.

We also learnt that the environmental group Environmental Defense has just hired reputed investment banking boutique Perella Weinberg Partners for strategic advise. New York Times columnist and author of the famous book `The world is flat` (which we recommend as a reading in MARKETOBSERVATION) has mentioned this story in the blog `Free Democracy`. The post is titled: `Marching with a Mouse`

Free Democracy: Marching with a Mouse

Swiss Newspaper 'NZZ am Sonntag' of March 18, 2007 contains a full page add by two financial institutions selling a `climate change certificate`. The portfolio consists of the shares of 14 companies which are supposedly expected to belong to the winners due to the economic impacts of global warming. The certificate is capital protected.

This is just one of many `global warming products` which have been advertised in the last months by various financial institutions.

Isn't it astonishing:

Everything seems to be going going well, the huge growth opportunities of globalization are praised, and suddenly we are made aware that we are just about running over the edge of the cliff.

The climate change is definitely a serious problem and it needs the attention of both politics and business to come up with actions for improvement.

The recent profiteering by part of the financial community might have a positive effect if it really leads to the efficient allocation of capital into companies which are able to make a serious contribution to solving some of the problems.

People who intend to make investments in the environmental fields are well advised to do their homework first and to study the possible implications of global warming - or keep their hands off such investments. We invite`Observers` to put material on this blog which better helps to understand the problems involved with the climate change. Here is some:

Swiss Re: Opportunities and Risks of Climate Changepaper

Climate Institute

Selected Literature

We would expect that in the course of globalization capital would much more flow from rich countries to developing countries as markets there are not saturated and offer better growth opportunities. A paper in the quarterly magazine `Finance & Development` of the International Monetary Fund (IMF) shows that the direction of the capital flow points much more to the opposite direction. This is called the `Lucas Paradox` as economist Robert Lucas already made the same observation at the beginning of the nineties. The paradox even seems to have intensified over time. An explanation for the paradox could be that developing countries are missing well developed infrastructures and were not able to build a high level of trust due to corruption and political instability, consequently limiting a developing country’s ability to absorb foreign capital.

The researchers give evidence that there is a growth premium for developing countries which rely less on foreign finance. However, the reliance of developing countries solely on domestic savings for growth investments is not an ideal situation as they could grow more if they would get foreign capital at the same terms as industrialized countries. Attached paper gives good insights about the interdependencies of capital flow between regions which have not the same development level and economic development and growth.

The Paradox of Capital

There is practical evidence that well connected VC's have better average fund performances as they get access to the better deals and to better know how. We provide herewith a link to an academic paper which contains probably the first research about the correlation between the quality of VC networks and fund performance.

Venture Capital Networks and Investment Performance