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Institutional investors confess
Mar. 22nd, 2010 01:00 pmA fascinating titbit in an article this morning on Prudential's attempt to buy AIA in Asia.
A little background here. Prudential's deal is "transformational", which is Business-ese for "very big". So, Prudential needs money, for which it has to go cap-in-hand to institutional investors.
It's also the case that Prudential is offering what some might describe as a "full" price for AIA, but others might call "too much".
But this is by-the-by here, because we got his classic quote half-way down the Bloomberg piece:
Wow. Now, just analyze this a bit more carefully. Suppose, for example, a company could guarantee that a deal would be genuinely transformational over 10 years, but would lose money after three years. Equally (and this is more likely the case here), suppose a company said "well, if we do nothing, things will look okay in three years' time, but within 10 years we will have been left behind. We will be dead".
It's this second point that is most telling, because although an employee worries about what the company will be looking like in 10 years' time, an institutional investor can just say (or, rather, can think) "fine, I'll just unload the stock in three years' time then".
It then struck me that, for all the talk of "disconnects" and "time frames" in bonuses and the like, one of the major factors is friction. It's a lot easier for an investor to sell shares and buy another stock than it is for an employee to quit his job and move to another company. If you are at board level, the friction is far greater than at junior level. So, Prudential CEO Tidjane Thiam takes a 10-year view because he cares about where Prudential is in 10 years' time. An institutional investor doesn't give a shit, because, even though he wants to remain an institutional investor, what he doesn't have to do is remain an institutional investor with his money in the same stocks forever. If a stock shows a steadily rising dividend, that's good. If a share is volatile and all over the place or, worse, if it wants to make a very big deal that will cost money for five years and then be sensationally profitable from year 10 onwards -- well, that just isn't in the investment book.
So, one might think, go for private equity. But there it's even worse. Because the old days of private equity are gone. Now it's leveraged private equity, which is something else entirely. These guys want in-and-out within three years.
The only chance you have of a long-term strategy is basically to be privately owned without any debt.
Thanks indirectly to Mr DY, I've come across a staggeringly impressive blog by Rajiv Sethi, professor of economics at Columbia (http://rajivsethi.blogspot.com/2010/03/on-hedging-speculation-and-instability.html is his latest missive), and he covers something akin to this.
Sethi in turn links to one of the great unknown economists, Hyman Minsky. who in the 1970s was writing about the stuff that caused the disasters of the early to mid-2000s. Nice to see that his work "Stabilizing An Unstable Economy" (http://www.amazon.com/Stabilizing-Unstable-Economy-Hyman-Minsky/dp/0071592997/ref=sr_1_1?ie=UTF8&s=books&qid=1269260840&sr=8-1) is back in print.
Minsky in fact argues that modern economies are inherently unstable, that stability breeds instability. For a man writing in the 1970s, this was profound stuff, since the general idea in those days was that all-things economic, when out of balance, tended to rebalance, albeit with some pain on one side of the other.
In fact the two ideas are not contradictory. What Minsky saw was that the rebalancing did not tend to be gradual. What was more likely to happen was that things got out of balance, and then got more out of balance, and then got horrifically out of balance, until a giant explosion/implosion/catastrophe brought things back into balance, at which point the whole "instability cycle" could get going again.
This is not what capitalists at the time wanted to hear, because in effect it argued that unbridled capitalism didn't work. Indeed, even bridled capitalism could have problems.
++++++++++
There was a bit of a "smoking gun" last week from Hector Sants of the FSA, who pointed out that the FSA could hardly be blamed for missing out on the Lehman Bros accounting trick.
What he revealsed also puts Linklaters in a rather better light.
What Sants pointed out, and which I hadn't realized, was that the reason UK law doesn't differentiate between "sale" repos and "conditional sale" repos is that it makes no difference in accounting terms. You have to reveal both in the books. So, Lehman UK did the deals, and recorded them in the books as required under UK accounting, but when the accounts were consolidated back in the US one whole set of repos vanished, being booked as genuine sales and therefore no longer on the books, and therefore no longer recorded (because they would be lost in all the genuine buying and selling of the quarter).
One can, therefore, understand Linklater's point of view when they were asked on this, because, as far as they could see, it was an irrelevancy. The deals had to be recorded on paper anyway. Any accountant would see them. Linklaters would argue that you could hardly expect them to be expert in accountancy rules in another jurisdiction.
As Sants said, Lehman Bros arbitraged between UK law and US accounting.
What I do not know (not being an accountant, let alone an international accountant) is whether Lehman UK's books were open to investors' analysis, or whether they were kept internal before consolidation into the group accounts.
If the former, then that means the grizzly details were there all along, if only people had bothered to look.
++++++++++++
Interesting to see a FT/Harris poll that indicated a third of Germans think Greece should be told to piss off out of the eurozone. Then again, 40% of German respondents thought that Germany would be better off outside of the euro.
In a way, it was ever thus. The German populus wants the benefits of the euro (or, rather, takes them for granted) but doesn't want to pay the price. Germany exports stuff to the single market, but its population doesn't import other stuff back. Even senior Bundesbank officials didn't seem to see that this was one of the things that created the imbalances that is causing such a mess. Middle-class Greeks bought AEG fridge-freezers and Miele dishwashers with money that they didn't have. In effect, Greece is now asking the Germans to take a bit of a haircut on this, and the Germans are saying no. Had Greece lived prudently within its means for the past 10 years, Germany would be significantly worse off today.
None of the 'solutions' being put forward are really solutions at all, as I've written before. It's all a matter of paying off one credit card with another credit card, in the vague hope that 'something will turn up'. Germans don't want to stop exporting their stuff. Greeks don't want to stop buying it. German consumers don't want to start buying whatever it is that Greece exports. So, as with China and the US, "funny money" (i.e., credit) is used to maintain an ever-growing imbalance.
And so, once again, we return to Hyman Minsky, and the inevitable case of growing instability, until it can't go on any more. No "gradual" solution exists. There has to be a cataclysm.
_______________
A little background here. Prudential's deal is "transformational", which is Business-ese for "very big". So, Prudential needs money, for which it has to go cap-in-hand to institutional investors.
It's also the case that Prudential is offering what some might describe as a "full" price for AIA, but others might call "too much".
But this is by-the-by here, because we got his classic quote half-way down the Bloomberg piece:
“Investors need to see what kind of returns we are going to get within the next two or three years,” said Martin Brown, who helps manage £67bn at Glasgow-based Ignis Asset Management, including Prudential shares. “Therein lies the conflict with a management team who feel they can take a five-to 10-year view.”
Wow. Now, just analyze this a bit more carefully. Suppose, for example, a company could guarantee that a deal would be genuinely transformational over 10 years, but would lose money after three years. Equally (and this is more likely the case here), suppose a company said "well, if we do nothing, things will look okay in three years' time, but within 10 years we will have been left behind. We will be dead".
It's this second point that is most telling, because although an employee worries about what the company will be looking like in 10 years' time, an institutional investor can just say (or, rather, can think) "fine, I'll just unload the stock in three years' time then".
It then struck me that, for all the talk of "disconnects" and "time frames" in bonuses and the like, one of the major factors is friction. It's a lot easier for an investor to sell shares and buy another stock than it is for an employee to quit his job and move to another company. If you are at board level, the friction is far greater than at junior level. So, Prudential CEO Tidjane Thiam takes a 10-year view because he cares about where Prudential is in 10 years' time. An institutional investor doesn't give a shit, because, even though he wants to remain an institutional investor, what he doesn't have to do is remain an institutional investor with his money in the same stocks forever. If a stock shows a steadily rising dividend, that's good. If a share is volatile and all over the place or, worse, if it wants to make a very big deal that will cost money for five years and then be sensationally profitable from year 10 onwards -- well, that just isn't in the investment book.
So, one might think, go for private equity. But there it's even worse. Because the old days of private equity are gone. Now it's leveraged private equity, which is something else entirely. These guys want in-and-out within three years.
The only chance you have of a long-term strategy is basically to be privately owned without any debt.
Thanks indirectly to Mr DY, I've come across a staggeringly impressive blog by Rajiv Sethi, professor of economics at Columbia (http://rajivsethi.blogspot.com/2010/03/on-hedging-speculation-and-instability.html is his latest missive), and he covers something akin to this.
Sethi in turn links to one of the great unknown economists, Hyman Minsky. who in the 1970s was writing about the stuff that caused the disasters of the early to mid-2000s. Nice to see that his work "Stabilizing An Unstable Economy" (http://www.amazon.com/Stabilizing-Unstable-Economy-Hyman-Minsky/dp/0071592997/ref=sr_1_1?ie=UTF8&s=books&qid=1269260840&sr=8-1) is back in print.
Minsky in fact argues that modern economies are inherently unstable, that stability breeds instability. For a man writing in the 1970s, this was profound stuff, since the general idea in those days was that all-things economic, when out of balance, tended to rebalance, albeit with some pain on one side of the other.
In fact the two ideas are not contradictory. What Minsky saw was that the rebalancing did not tend to be gradual. What was more likely to happen was that things got out of balance, and then got more out of balance, and then got horrifically out of balance, until a giant explosion/implosion/catastrophe brought things back into balance, at which point the whole "instability cycle" could get going again.
This is not what capitalists at the time wanted to hear, because in effect it argued that unbridled capitalism didn't work. Indeed, even bridled capitalism could have problems.
++++++++++
There was a bit of a "smoking gun" last week from Hector Sants of the FSA, who pointed out that the FSA could hardly be blamed for missing out on the Lehman Bros accounting trick.
What he revealsed also puts Linklaters in a rather better light.
What Sants pointed out, and which I hadn't realized, was that the reason UK law doesn't differentiate between "sale" repos and "conditional sale" repos is that it makes no difference in accounting terms. You have to reveal both in the books. So, Lehman UK did the deals, and recorded them in the books as required under UK accounting, but when the accounts were consolidated back in the US one whole set of repos vanished, being booked as genuine sales and therefore no longer on the books, and therefore no longer recorded (because they would be lost in all the genuine buying and selling of the quarter).
One can, therefore, understand Linklater's point of view when they were asked on this, because, as far as they could see, it was an irrelevancy. The deals had to be recorded on paper anyway. Any accountant would see them. Linklaters would argue that you could hardly expect them to be expert in accountancy rules in another jurisdiction.
As Sants said, Lehman Bros arbitraged between UK law and US accounting.
What I do not know (not being an accountant, let alone an international accountant) is whether Lehman UK's books were open to investors' analysis, or whether they were kept internal before consolidation into the group accounts.
If the former, then that means the grizzly details were there all along, if only people had bothered to look.
++++++++++++
Interesting to see a FT/Harris poll that indicated a third of Germans think Greece should be told to piss off out of the eurozone. Then again, 40% of German respondents thought that Germany would be better off outside of the euro.
In a way, it was ever thus. The German populus wants the benefits of the euro (or, rather, takes them for granted) but doesn't want to pay the price. Germany exports stuff to the single market, but its population doesn't import other stuff back. Even senior Bundesbank officials didn't seem to see that this was one of the things that created the imbalances that is causing such a mess. Middle-class Greeks bought AEG fridge-freezers and Miele dishwashers with money that they didn't have. In effect, Greece is now asking the Germans to take a bit of a haircut on this, and the Germans are saying no. Had Greece lived prudently within its means for the past 10 years, Germany would be significantly worse off today.
None of the 'solutions' being put forward are really solutions at all, as I've written before. It's all a matter of paying off one credit card with another credit card, in the vague hope that 'something will turn up'. Germans don't want to stop exporting their stuff. Greeks don't want to stop buying it. German consumers don't want to start buying whatever it is that Greece exports. So, as with China and the US, "funny money" (i.e., credit) is used to maintain an ever-growing imbalance.
And so, once again, we return to Hyman Minsky, and the inevitable case of growing instability, until it can't go on any more. No "gradual" solution exists. There has to be a cataclysm.
_______________
