Damodaran, Aswath - Narrative and Numbers

Columbia Business School, 2017, [Equity Investing] Grade 4

Read as pdf... Link to Amazon...

The procedure of valuing a stock through is rather simple once it has been learnt. And when looking in retrospect on why old valuations turn out to be incorrect it is rarely due to getting the mechanics of the valuation tool wrong. Instead it is almost always because the sales or profits turned out very differently from what was forecasted since the company, its strategy or business environment developed in an unanticipated way – the narrative was wrong. This is a book on how to combine the numbers of the valuation tools with a narrative that brings life, understanding and, by this, increased precision into the valuation made. The author is a well-known finance professor at NYU who has written a large number of finance books.

As I understand it the book started with the author posting and updating the narratives and subsequent valuations for a number of stocks like Uber, Amazon, Apple, Alibaba etc. online. They now feature as case studies throughout the book. Taking a step back, Narrative and Numbers is also a personal journey for Damodaran as he over time has developed from a pure number cruncher to taking a more holistic approach. I find that when a reader is invited to share an author’s personal development the result is often very likable. This book is no exception and it is evident that the author has enjoyed writing it.

The structure of the text is very, well… structured. Damodaran tells you that he will combine narratives and numbers, he describes the basics of one of those, then he describes the basics of the other one, he merges them and finally discusses the consequences. The author who describes himself as a “teacher first” gives us short but thorough accounts of the two components before merging them into a greater whole. And to clarify, the narrative referred to in this book is the fundamental story of long-term value creation drivers for the company, not the flimsy, often biased and constantly shifting stories that always surround listed companies on the stock exchange. All the way through the book we get to follow the described process through the case studies and there are further several illuminating pictures giving good oversights of the reasoning.

The advocated valuation process is to:

1.      develop a narrative for the business,

2.      test the narrative to see if it is possible, plausible and probable,

3.      convert the narrative into drivers of value,

4.      connect the drivers of value to a valuation and

5.      keep the feedback loop open.

Interestingly the author calculates one value of the company as a going concern and one liquidation value and then estimates the probabilities of each life-or-death scenario. I very much appreciate the 3P test in stage 2 and the openness for change in stage 5 importantly tries to ensure that the narratives are reasonable and don’t becomes stale and outdated in the light of changes. Damodaran’s arguing for the importance of having enough humility to alter ones opinion brings to mind similar arguments from George Soros.

My main caveat is that the process doesn’t explicitly enough ensure a combination of an inside view and an outside view when developing the story. When forming a narrative it is very easy to focus on the uniqueness and thrill of the situation at hand and extrapolate from the recent history. Often this leads to too high expectations and bottom-up sell side analyst estimates are partly due to this almost always too optimistic. The outside view treats the situation statistically and takes into account the outcome of many similar historical situations. In business where success is governed by both skill and luck both viewpoints have merit.

To make good forecasts narratives must meet numbers. Without the verbal structuring of the fundamental business story of a company it isn’t even possible to understand the numbers to start with. Damodaran shows that good decisions benefit from several points of view such as the numerical and the verbal and I fully agree.

Mats Larsson, March 03, 2017

Wray, L. Randall - Why Minsky Matters

Princeton University Press, 2016, [Economics] Grade 4

Read as pdf... Link to Amazon...

After the financial crisis a lot fewer need to be convinced that Minsky does matter. This is a short overview of the academic working life of the late Neo-Keynesian economist Hyman Minsky written by his apprentice, the University of Missouri professor in economics, Randall Wray. After the carnage of the GFC there was a search for improved explanatory models and many found one in Minsky’s Financial Instability Hypothesis. It even became fashionable to make use of the expression “Minsky moment” among financial market actors. In this book we get a broader understanding of the theories of an unconventional economist.

Minsky’s writings centered on financial instability, on employment, inequality and poverty and finally on how to reform capitalism since it is instable in its present form. I will focus more on the financial parts. Underlying his work was the view that economists - Keynesian and neoclassical alike - has it wrong; market processes are not stabilizing around an equilibrium to which they according to conventional thought are supposed to return after being exposed to external shocks.

Minsky’s claim that all his academic colleagues were wrong combined with an impermeable writing style full of self-invented Wall Street-like expressions made him an outsider during a career that spanned from the 1950s to the 1990s. Minsky’s background was indeed eclectic as he was a devoted Keynesian who also had had the great Joseph Schumpeter as his dissertation advisor. Minsky, as his starting point for economic models, focused on the investment of the entrepreneur and the financing of that investment – similarly to the Austrian business cycle or J. M. Keynes himself, but not the Keynesians or neoclassicists. In addition to his radical political views he sat on the board of a bank and befriended people like Salomon Brothers’ investment strategist Henry Kaufman and famed investor Leon Levy.

An important contribution of Minsky is that he adds the functionality of financial markets to the core of macroeconomic models – something that mainstream economics still fail to do. With regards to the financial system Minsky’s key idea is that “stability is destabilizing”, i.e. periods of calm change the psychology of the market, making participants take on more risk, which in the end leads to a crisis that ends the calm. There can be no stable equilibrium as the stability of such a state changes behaviors, policies, and business practices in a way that in the end prevents it.

A key part of this pendulum motion between stability and disturbance is the use of leverage and the pro-cyclical behavior of both lenders and borrowers. Minsky developed a classification for financial fragility where “hedge finance” described a situation where the income of a borrower is sufficient to pay both interest and principal, in a “speculative position” only the interest payments are covered and in a “Ponzi position” the obligor will even have to borrow additional funds to finance his interest payments and he can only continue his operations as long as the lender allows the loan balance to grow. Loan growth chases asset values in an upwards spiral until it doesn’t. Profit maximizing banks provide liquidity and leverage through financial innovation until they don’t. The Minsky moment, a concept that was minted by Paul McCulley at PIMCO after Minsky’s death, is the tipping point in time where the spiral goes from positive to negative.

The above cycles and the rejection of equilibrium resonate with most people active on financial markets. However, even though the diagnosis is well executed, I’m not sure all in the financial markets would appreciate the recipe that Minsky prescribed. He was a Keynesian with a belief that the enlightened governing of the big state and the wise handling of central banks could right the inherent wrongs of capitalism as diagnosed.

Wray guides us through the opaque writings of his master. At times it is slightly hard to distinguish the views of the author from those of Minsky but overall this is an important job well done.

Mats Larsson, Feb 3, 2017

Lussier, Jaqcues - Successful Investing Is a Process

Bloomberg Press, 2013, [Finance] Grade 4

Read as pdf... Link to Amazon...

Jacques Lussier, the CIO of the Canadian asset Manager Dejardins Asset Management, has written an essential book on asset allocation for the serious investor. The topic at hand is not the tactical type of asset allocation that investment banks try to advice you on but the strategic asset allocation – the base setting, the important stuff – plus the practices around the SAA.

The text is organized in 4 parts and a number of chapters. According to the author the book is aimed for institutional investors, asset managers and sophisticated individual investors. I would skip the last of these. This is rather a book written by a CIO for other CIOs, asset allocators or strategists at pension funds, endowments, sovereign wealth funds or insurance companies. Although the writing is surprisingly fluent and there are very few equations, the technical and detailed nature of the topics and the academic bent of the writer make this a book less suited for the individual investor.

Considering this knowledgeable target audience I found Part I of the book largely superfluous (and also the chapter on tax effects – nearly all institutional investors are tax exempt). The author in chapters 1 through 3 pretty much covers the standard understanding of any institutional investor that has some notion of what is the knowledge du jour of intuitional asset management. Then things pick up considerably. The chapter on the effects of volatility on long-term wealth might even be the most illuminating I’ve read and I liked the breakup into the determinants of equity returns.

What is Lussier trying to convey? A number of things, but in my opinion the most important are: 1) an asset manager should formulate a logic process that he believes in and sticks to and because of this has time to perfect, 2) there is still more benefits to be had from good honest portfolio diversification using liquid securities and rebalancing using objective functions, so there is less need to lock the money up in endowment-style solutions that will make rebalancing difficult and deprive the asset manager the chance to buy cheaply after large drawdowns, 3) improve the functionality of the underlying asset class portfolios by using cheap non-market cap based constructions that are rebalanced, don’t waste time searching for alpha and look to long horizons and 4) preferably use volatility based solutions for allocation and rebalancing.

By making many small right choices the author claims the combined effect over time of this “evidence based portfolio management” could be higher Sharpe-ratios and an annual return increase of 1.5-2%. Even better than the books excellent and very true title is Lussier’s notion that “[o]ur objective is not so much to outperform the market, but let the market underperform”. Overall, Lussier has written a very impressive and voluminous text combining insights from academic research, from external product suppliers like Bridgewater, Research Affiliates etc. and from a fair amount of his own research.

Why not give the book full marks then? I can’t shake the “conventional” feeling that I picked up from start. Since the GFC all everybody has talked about is to lower the risk contribution of equities, volatility based solutions are everywhere etc. I’m a bit afraid that the last 30 years’ bull market for bonds has affected what we see as the cutting edge knowledge in more ways than we realize. We may just have switched one set of risks for another. For example, volatility based allocation or rebalancing implies selling equities as they become more volatile before a presumed downturn. This is okay as long as not everybody does it at the same time. Further, there is no discussion on the difference between risk factors/style factors that have offered a return premium without repricing and those that have just become expensive.

For the serious investor engaged in strategic asset allocation this book is an absolute must. For the non-CIO there are more suitable alternatives.

Mats Larsson, Jan 24, 2017

Haidt, Jonathan - The Righteous Mind

Penguin Group, 2012, [Surrounding Knowledge] Grade 5

Read as pdf... Link to Amazon...

The last few years’ capital markets have been heavily influenced by politics. Hence, a political understanding is important. This book offers the most illuminating road map to politics I’ve read in years. It covers the differences in moral view between what in the US is called liberals (the political left wing) and pretty much everybody else in the world. Jonathan Haidt is a social psychologist and a professor of ethical leadership at Stern School of Business. He is unusual in that his work mixes psychology, sociology, biology and, importantly, cultural anthropology, allowing him to transcend normal academic departmental boundaries and view issues from new angles. He is also a very accomplished popular science writer letting him to eloquently argue for his sometimes-controversial opinions.

The book has three fairly different parts. The first shows that the systems that Daniel Kahneman calls system 1 and system 2 is equally at play when it comes to moral. We have an immediate, instinctive and emotional intuition on moral issues and only afterwards the slow and deliberate logic comes into play – and mostly the logic is simply used to rationalize the instinctive intuition. The aim of our moral actions is further more a PR effort towards our tribe than a search for truth.

The second part is the vital one. Through his research around the globe and in various US environments the author has shown that there are 6 innate moral “taste buds” that we all to some extent share: a) care-harm, b) liberty-oppression, c) fairness-cheating, d) loyalty-betrayal, e) authority-subversion and f) sanctity-degradation. The conservative westerner is similar to most people around the world in that all 6 facets of morality matter about equally, while the western liberal almost only focuses on (in decreasing amounts) a, b and c. With regards to b the focus is on liberty from the oppression of big corporations through the state, while conservatives and libertarians instead want liberty from the oppression of the state itself. The low emphasis on d-f gives liberals and libertarians a very autonomous world-view while the others look more to relationships. A person with one type of moral matrix has a very hard time understanding that there can be more than one form of moral truth for people and the most trouble in understanding others the liberals have as they have the narrowest set of moral principles. The advantage (?) of the liberal will be that he will instead experience less moral dilemmas than the more diverse conservative.

In the third part Haidt brings forward the notion that the Darwinian selection that shapes our behavior not only is at work at the individual level but also on a group level. Groups that manage to better bind people together and foster stronger commitment have tended to out-compete less captivating ones. Natural selection favors group efforts and this is the explanation for the fact that people often experience the greatest joy during moments when they become a part of a whole. Unfortunately this also makes groups very competitive towards each other, making discussing differing moral world-views extremely hard.

In the tradition of psychology Haidt’s work on moral is descriptive, it displays the map of different moral matrixes but doesn’t really argue that any group’s view is more or less right or wrong. Haidt is more of a moral anthropologist than a moral philosopher. On the plus side the description is a lot more interesting and nuanced than I had expected but personally I think that the question of morals cannot only concern itself with how it works but also with how it should work. To be fair the author gives a few brief suggestions for a moral middle ground between liberals, libertarians and conservatives that could be seen as normative.

With Haidt’s map at hand one’s navigation between various expressed political opinions becomes ridiculously easy. You will understand were everybody is coming from – even though they don’t necessarily will themselves.

Mats Larsson, Jan 3, 2017

Duckworth, Angela - Grit: The Power of Passion and Perseverance

Scrobner, 2016, [Surrounding Knowledge] Grade 4

Read as pdf... Link to Amazon...

I initially intended postponing writing this review until next year but given the topic of Angela Duckworth’s book it felt out of place to put it off. This is a book on following through on the goals you set up and the results that over time come with showing grit. The overriding theme is that effort trumps innate talent when it comes to which personality traits that drive success. 

While there are several academics that study positive psychology and related topics Angela Duckworth, who is a psychology professor at the University of Pennsylvania, literally invented the research field of grit. Wikipedia defines grit as “passion for a particular long-term goal or end state, coupled with a powerful motivation to achieve [the] objective.” Related concepts are said to be perseverance, conscientiousness, resilience, hardiness, ambition etc. 

There are three parts to the book. The first lays out the theory framework of grit that is said to consist of two parts; passion and perseverance. The latter is perhaps more intuitive but without passion it’s hard to muster the strength to be perseverant. The passion in question is of an enduring, slow burning kind, allowing a person to consistently and stubbornly over time work towards a set direction despite at times suffering setbacks. It’s the intrinsic motivation that brings hardiness in effort. 

Gritty people often have their priorities in order and consciously or unconsciously work towards a hierarchy of ambitions but doable goals where each lower one supports a higher in a consistent fashion, in the end leading to the desired state where the sum of all the efforts creates something larger. In achieving one’s goals Duckworth shows that effort counts twice as much as talent. Talent multiplied by effort builds skill. That skill multiplied by more effort builds achievement. Hence, putting in even more effort is what makes skill productive. “Without effort, your talent is nothing more than unmet potential. Without effort, your skill is nothing more than what you could have done but didn’t.” 

The question is whether the capability for grit that overpowers talent is itself in the genes? The answer is yes, but as the author shows the environment is even more important. One study she refers to assigns a roughly 70/30 split for the environment and for innate talent when it comes grittiness. This means that grit can be grown and part two and three of the book address how to grow grit inside-out and outside-in, i.e. how to grow one’s own grit and how to grow grit in others. 

Part two goes into detail of much of what’s already been stated and the author brings forward 4 key concepts for building one’s own grit: 1) interest – where the quest to find something to arouse passion is usually a trial-and-error process, 2) practice – where we get a quick tutorial in the concept of deliberate practice as popularized by Anders Ericsson, 3) purpose – that adds in the motivation that comes from doing work that in some way matters also for others and 4) hope – that deals with the grinding work with the ambition locked in, helped by what Carol Dweck calls a growth mindset. Part three addresses how to build grit through parenting or coaching sports teams. Apart from bringing forward the concept of the social multiplier where grit rubs off in groups I found the ending part less worked through, with more anecdotes and the author’s own opinions. 

This is an engaging and at the same personal book. Duckworth starts and ends Grit with how her father had noted that she wasn’t a genius when she was a child. From a fixed mindset this might have been true but Duckworth showed that grit and a growth mindset mattered more. Where Anders Ericsson’s book Peak focuses on the type of practice needed to be an expert performer, Duckworth’s publication answers much of the questions around how to find the motivation to pursue this training. Reading Grit first and Peak thereafter will give anyone the ammunition to become the best version of who they aspire to be – and it also turns out that grittier people are happier than others! 
 
Mats Larsson, Dec 23, 2016

Ericsson, Anders & Pool, Robert - Peak: Secrets From the New Science of Expertise

Bodley Head, 2016, [Surrounding Knowledge] Grade 4

View as pdf... Link to Amazon...

Anders Ericsson is the world’s leading expert on expertise. Ericsson who is a professor at Florida State has spent 30 years researching human performance – and yes, he is Swedish. Together with the journalist Robert Pool he gives the inside view of how experts are made.

There are several myths when it comes to expertise. Perhaps the most prevalent one is that ability is innate and by this predestined – “I’m simply not good with math”. In fact Ericsson’s research shows that genetic predisposition plays a very marginal role compared to the work put in when it comes to developing a skill. And it isn’t too late. Our brain retains much of its adaptability through out life, so while some things might be easier to learn as a child we can all develop. Other misconceptions are that one gets better the longer one does something, or that all it takes is effort – or 10,000 hours of practice specifically.

What it takes to become an elite performer is instead dedicated training that rewires the brain – so-called deliberate practice. What Ericsson has found is that while true elite performers practiced a lot they all practiced in essentially the same way. Without this specific type of practice, 10.000 hours and spent effort will not amount to much. The hands-on almost physical ring to the expression deliberate practice is carefully chosen. There is a difference between knowledge and skill. The bottom line is what someone is able to do, not what they know. Expert skill in this respect is the practical application of something.

Deliberate practice is purposeful and informed in that it is guided by an understanding of what makes elite performers great and has a clear understanding of how they achieved their excellence. A large part of being an expert is in developing and internalizing what Ericsson calls mental representations, “a mental structure that corresponds to an object, an idea, a collection of information, or anything else, concrete or abstract, that the brain is thinking about” allowing the expert to see patterns where non-experts only sees randomness. The concept is similar to, but broader, than Charlie Munger’s mental models. Ericsson’s concept for example also includes physical and musical skills.

So what is this magic formula? Well the short version is to identify the real experts, identify what makes them great (generally what they do differently) and design a practice that leads you to do the same. The practice should preferably be overseen by a coach that has set up a plan with a number of milestones that in combination leads to a bigger change. The coach also monitors the progress. The practice should be designed to stay just outside the trainee’s comfort zone and as such it requires effort, attention and isn’t always enjoyable and importantly the process involves feedback and modifications of the practice in response to the feedback. The training focuses on aspect after aspect (or mental representation) of something and improves them specifically. Over time new skills are built on top of old skills and skills regarding different aspects combine to form something larger than the sum of the parts.

I must admit that I was initially skeptical of this book as it might well be the tale from the horses mouth, but still a tale that has been told several times as Malcolm Gladwell’s Outliers, Carol Dweck’s Mindset, Daniel Coyle’s The Talent Code, Geoff Colvin’s Talent is Overrated and so many other books have already presented Ericsson’s research to the general public. Not unsurprisingly however it turns out that listening to the original source gives a special depth – then the reader will have to accept that he probably has heard all the examples previously and that in the name of being perfectly clear the authors repeat themselves slightly too often.

In the end this is a book of hope and enthusiasm – after having read it you find yourself making plans for how to improve the sub skills that are holding you back from reaching the next level; Focus. Feedback. Fix it.

Mats Larsson, Dec 13, 2016

Gonzalez, Javier - How to Make Money With Global Macro

2016, [Finance] Grade 3

View as pdf... Link to Amazon...

In his book the Penn State economist and investment strategist Javier Gonzalez takes the reader to the dynamic world of global macro trading, or “higher dimensional puzzle” as he calls it. To succeed in investing you need to think and do things differently than the mainstream crowd. Gonzalez presents an intellectually spirited view of the world that I think could serve him well as a macro trader. 

The book has two parts but the first of them could in turn be divided into two themes. The first topic in part one is a presentation of the theoretical model that Gonzalez utilizes to understand the workings of the global economic machine. Then follows a chronological review of the historic global macro events decade-by-decade starting with the 1970s, including a set of price graphs to illustrate the happenings. In the second part of the book the author writes a number of chapters on various themes within economics, politics etc. that influence a global macro trader’s environment. 

A centerpiece in Gonzalez’s worldview is the core-periphery paradigm that divides world currencies into the reserve currency – currently the USD, hard currencies that appreciate in times of risk aversion and soft currencies that do the opposite. The key to understanding is the global flow of resources and the importance of the reserve currency. The reserve currency country’s central bank dictates much of the global monetary policy allowing it to optimize the conditions to its benefit. Having a global demand for its currency the US can engage in counter cyclical monetary and financial policy measures without the same market restrictions as other countries. 

One of the topics in the second part is war. As Gonzalez sees it the successful macro trader cannot only think in terms of cyclical or secular changes, he must also consider structural changes – i.e. the events that alter the basic conditions for the functionality of the economy and invalidate previous patterns and experiences. Only if this additional dimension is added on top can the macro trader make sense of the world in a profitable way. In this the author is obviously influenced by George Soros and his former chief analyst Jim Rogers. Others who Gonzalez quotes extensively are Warren Buffett, Jesse Livermore and Bernard Baruch. The most number of quotes however goes to a number of central bankers, but then the purpose is not to gain inspiration but to point to their low understanding of the machine they are trying to run. 

According to the author most economic relationships are time dependent and hard to invest by. Then some are more permanent like how various assets react to the varying strength of the global reserve currency. The investor should focus on these key variables and then react to trend shifts in these. Gonzalez views the events in the economy as effects of underlying causes and catalysts. If one instead views the economy as a complex adaptive system many of the events could instead be generated by the intrinsic functionality of the system itself making the case-and-effects even harder to decipher. The more important then to focus on understanding what is happening instead of forecasting what is supposed to happen. 

I very much appreciated how the book portrayed the dynamic nature of the global economic system and how the actions of the FED start a number of multinational self-feeding loops that other countries must react to. The book would have benefited from illustrating the many cause and effect chains described. The book could also do with some editing. For me the second part was the less interesting one, as the text became so dystopian with regards to war and the environment and unnecessarily agitational on how Wall Street and other vested interests run the political-economic institutions. It didn’t really fit well with a book on macro trading. 

An interesting view into global macro trading while not entirely solid as a coherent book. 
 

Mats Larsson, Dec 11, 2016

Davis, Ned - Being Right or Making Money

John Wiley & Sons, 2014 (3rd ed), [Finance] Grade 3

Review as pdf... Link to Amazon...

Ned Davis, the Senior Investment Strategist and founder of Ned Davis Research, has become legendary in the finance industry for his market letters combining fundamental data with technical indicators over the last 40 years. Without having the data to back it up I am also of the view that he’s often been quite correct in reading the market.

The name of the book refers to the practice of making forecasts (trying to predict what the market will do in the future, i.e. “being right”) versus developing an investment strategy that could make you money despite the fact that forecasting doesn’t work. In the introductory chapter Davis points to the keys to making money as being; using objective data instead of gut feeling, following a disciplined strategy, being flexible to adjust in response to changing environments and employing risk management practices to ensure mistakes don’t get out of hand.

The setup of this book is somewhat unusual. The first 4 chapters (or about 115 pages cover) the philosophical aspects of Davis methods, the practical aspects of how to build models to be able to trade financial markets and further examples of a market model for equities and bonds respectively. Then the remaining 3 chapters or 100 pages add on some somewhat unrelated thematic pieces on the risk for a bear market in 2014, the investment implications of demographic developments and whether the US will become energy independent. Most chapters are written by others than Ned Davies and I’m frankly not sure what to make of the second part of the book – is the reader being served samples of the type of research Ned Davis Research can perform? For me the first part is the core, the rest is an appendix – albeit with interesting features.

With the aim of “trying to get into harmony with the reality of the current numbers” Ned Davis Research builds multifactor models out of a number of indicators of different types to gain a trading view of a specific market. The indicators look to market prices, monetary policy, investor psychology etc. and some of the internal rules at Ned Davis Research are “don’t fight the tape”, “don’t fight the fed” and “be wary of the crowd at extremes”. The book gives examples of a number of the indicators in use, including graphs and some data on how they have faired historically. A full model is constructed by giving an indicator +1 if it is sending a positive signal, -1 if it sends a negative and 0 if it’s neutral. The models sums up to a total score, although some indicators could have higher weight than others. The combined score is the view on the specific market.

As evident we are talking about trading models with relatively short time horizons. The approach is data driven and very objective and in that way supports the trader in handling his own market psychology. With 40 years’ practice Davis and his coworkers have also thought long and deep on which indicators to use to read the market. The indicators used actually look to fairly different time horizons where most are trend following and some are shorter-term contrarian. As they have such different characters I wonder if it’s the best practice to simply sum them up. Also adding up to 35 indicators on top of each other to give one numeric grade of what is happening surely brings a valuable simplicity but could also in my view risk concealing what happens beneath the surface and as such obstruct deeper market understanding.

Although I’m not a trader myself I have huge respect for the work Ned Davis does as he looks to numbers and validates what makes money and what does not. I like the approach of reading what the market is doing instead of trying to guess what it will do. As a book however, the first part is relatively short and sketchy and the second fairly unnecessary. If Davis in the next edition would use all of his available space to share his insights into model building that could become a trading literature classic.

Mats Larsson, December 4, 2016

Gramm, Jeff - Dear Chairman

Harper Business, 2016, [Equity Investing] Grade 3

View as pdf... Link to Amazon...

Activist investors create headlines in the business media. With their aggressive stile they fit the dramaturgy of media as a glove – the battling of huge egos sells newspapers. But what is the historic background to today’s high profile characters like Christer Gardell, Bill Ackman and Dan Loeb? In his book Dear Chairman the hedge fund manager and adjunct Columbia professor, Jeff Gramm, tells the tale of shareholder activism. 

Activists buy shares in companies and through engaging with the board they try to create an event that unlocks value for the shareholders. The story of the dreaded activists is told through 8 case studies dating from 1927 when a young and polite Ben Graham convinces John D. Rockefeller Jr. and Northern Pipeline to distribute excess capital all the way to the aggressive attacks of 2005 and the fight about BKF Capital. 

In the US the governance system gives a huge amount of power to the often-combined president and CEO. For long shareholder rights were very low on the agenda. The early proxyteers who engaged in proxy fights in the 1950s and corporate raiders of the 1980s like Carl Icahn and T. Boone Pickens - funded by Michael Milken’s junk bonds - shook up what was often a quite sleepy and inefficient business community paving the way for today’s activists. The relationship between CEOs and the owners of companies surely got more complicated but the efficiency in the business sector improved greatly as boards couldn’t sleep on their watch anymore. 

In some respect this is three books in one; a number of historic case studies accompanied by the original letters, Gramm’s opinions on governance and ownership and a broader historic account of shareholder activism where the author uses the case studies as a starting point but branches out in various directions describing a number of other shareholder controversies. 

Over time activist investors have reacted to very much the same issues as they do today. They try to replace underperforming management teams, crack down on corporate wastefulness, restructure poor business portfolios and get access to excess cash piling up in companies. Reading history adds to the understanding of an area since it gives context to today’s practices. Current practices have often been formed through a much more hap-hazardous and random process than is generally assumed – so also in the world of activism. 

The title is brilliant and in my view this is a very good-looking book. The language is surprisingly legible and it is obvious that the author knows and really likes the subject. I very much appreciate that Gramm is honest enough to both present cases where activists do long term good for all shareholders by confronting adverse practices by poor corporate executives but also displays cases where the activist in reality was more engaged in a smash and grab heist to the detriment of long term shareholder value. 

However, I’m afraid that I found the book too lightweight. It added historic background but I didn’t learn much new about activism per se – there simply isn’t much detail. The triple theme of the case studies, the telling of a broader story of the shareholder activists and Gramm arguing the case for the good of activism in the end becomes too fragmented – especially as some case stories are described very briefly and more function as an excuse to tell a story of something else. No doubt some of the original letters are quite amazing but I would personally have preferred either a straight chronological historic account with a both deeper and broader scope or a fact based primer on shareholder activism. I’m sure the author could write both with flying colors. 

Read this for a pleasant and amiable account of financial history. You will have a good time but perhaps not come out that much wiser. 

Mats Larsson, November 27, 2016

King, Mervyn - The End of Alchemy

Little, Brown, 2016, [Economics] Grade 4

Review as pdf... Link to Amazon...

The scope of this book is ambitious. Mervyn King, the former Governor of the Bank of England, aims to explain the financial crisis and the state of the global economy today, he proposes a reset of the construction of the banking sector and attempts to transform the understanding of economics to better function as a practical tool for central bankers and politicians. The book targets the “interested general public” and while the language is unpretentious and simple enough some background knowledge of economics is advisable.

After a very promising and interesting introductory chapter covering the standard story of the financial crisis minus the blame game, a teaser of what King refers to as the alchemy in the banking sector plus a number of observations on today’s economic situation the book separates into two parts – the first addressing banking in chapter 2 to 7 and the second economic policy in chapter 8 and 9.

The discussion on banking is coherently structured but also a bit longwinded. The author presents a number of textbook type chapters on subjects like what money is, the function of financial markets, how a bank works, the role of a central bank and the relationship between nations and money. The chapters are eloquently written and it is obvious that the learned King enjoys expressing himself well and as a true Britt he’s using a fair amount of colonial dry humor.

At the same time the texts are nothing out of the ordinary. If you know something about for example maturity transformation in banks, optimal currency areas etc. this is pretty much how you would describe it. You cannot help but feeling that these chapters are there only as a long introduction to the author’s proposal around the banking system and when we get to this in chapter nine the book is already 250 pages long. The most interesting point in this “second introduction” is the emphasis on money and markets as tools to handle the fact that people due to “radical uncertainty” cannot foresee and plan the future.

In chapter 7 the text picks up pace. King suggests that Central banks should take on the role of “the pawnbroker for all seasons” for a banking sector with considerably lower leverage and that would be incentivized to hold more liquid assets. The main problem with banks, as the author sees it, is the inherent conflict between the leverage used in a fractional reserve system and the liquidity risks of these depository institutions. At the same time, we today have a situation of massively inflated central bank balance sheets coupled with an ineffective money multiplier. If the multiplier would normalize there could be a distinct risk of inflation and central banks would have to dismantle their balance sheets as a reply. If however bank leverage was reduced when the propensity to spend increased the central banks could sit on their inflated balance sheets indefinitely.

The less leveraged banks would still face some liquidity risks and the “pawnbroker” is there as a last resort but only as banks pay an “insurance fee” upfront and with significant risk adjusted haircuts. This would transfer much of the bank supervision and regulation from the legislator to the central bank – not an unexpected opinion from a central banker. The problem with the suggestion is in my view that the ROA of banks today is so low that to be viable as businesses using lower leverage they would have to double or triple fees and interest rates – not what the economy needs.

The ending chapters on economic theory present a more humble view of central banks as King suggests that the models used to understand and steer economies are wrong. In a way these chapters are less well structured and a bit repetitive but in my option more noteworthy. It is not everyday a senior central banker deviates from economic orthodoxy in this way and I wholeheartedly agree on the mixed blessings of today’s monetary policy. It is always a privilege to take part of the ideas of a man who has spent plenty of time to think deep and new on hugely important topics. You don’t have to agree to enjoy King’s important book.

Mats Larsson, November 13, 2016

Miller, Jeremy - Warren Buffett's Ground Rules

Profile Books, 2016, [Equity Investing] Grade 4

I like this book. It’s got a genuine and honest feeling. There are several dozens of books on Warren Buffett. What makes this one special or needed? All other texts on Buffett’s methodology are based on how he has conducted his business at Berkshire Hathaway. However, before this... Further reading... Link to Amazon...

Madden, Bartley J. - Value Creation Thinking

LearningWhatWorks, 2016, [Finance] Grade 4

Most finance and investing books are easy to review. This one was not. Most books keep within a sub-genre where they recycle and mix the usual concepts within the area. This book forced me to think about the philosophy of the firm in ways I hadn’t before. The first sentence of the preface... Further reading... Link to Amazon...

Faber, Meb - Global Asset Allocation

The Idea Farm, 2015, [Finance] Grade 3

Meb Faber has written a short and accessible study over some of the more prevailing strategic asset allocation (SAA) strategies used by institutional investors. SAA is the method for setting long-term target allocations for various assets that is included in an investment portfolio. Mr... Further reading... Link to Amazon...

Ashworth-Lord, Keith - Invest in the Best

Harriman House, 2016, [Equity Investing] Grade 4

The author of this text on stock selection is touted as the Warren Buffett of the UK. This is a bit unfair since, to me, Keith Ashworth-Lord displays a distinct investment personality of his own. He’s not simply a Buffett clone. The author has more than 30 years’ experience from sell-side... Further reading... Link to Amazon...

Chancellor, Edward (ed) - Capital Returns

Palgrave, 2016, [Equity Investing] Grade 5

This is the even more brilliant sequel to the already superb 2004 book Capital Account. Edward Chancellor, the author of the classic Devil Takes the Hindmost, picks and chooses among the 2002 to 2015 Global Investment Reviews written by money manager Marathon Asset Management... Further reading... Link to Amazon...

Chancellor, Edward (ed) - Capital Account

TEXERE, 2004, [Equity Investing] Grade 5

There lies a danger in rereading books after a long time – it’s not always they age gracefully. The subtitle of Capital Account is A Money Manager’s Reports on a Turbulent Decade, 1993-2002. The time period corresponds roughly to the first half of my time in the equity market so far and I... Further reading... Link to Amazon...

Neill, Humphrey B. - The Art of Contrary Thinking

Caxton Press, 2007 (first ed. 1954), [Behavioural Finance] Grade 3

This is one of the few general books on contrary thinking that exists. More specifically, there are gazillion publications on value investing but only a handful on contrarian investing. This book is built on a pamphlet and a collection of essays from the 1940s and 1950s. Humphrey Neill was a... Further reading... Link to Amazon...

Schiff, Peter D. & Schiff, Andrew J. - How an Economy Grows and Why It Crashes

John Wiley & Sons, 2010, [Economics] Grade 4

This is an unusual book - it’s part comic book, part short novel. How an Economy Grows and Why it Crashes is something as rare as a basic primer on Austrian economics in fictional form. Irwin Schiff was an Austrian economist during the heydays of Keynesianism and later a tax protester... Further reading... Link to Amazon...

Taghizadegan, Rahim et. al. - Austrian School for Investors

mises.at, 2015, [Finance] Grade 3

Macroeconomic equilibrium models – be they classical or Keynesian – often feel unnatural for investors who have to cope with a world that rarely shows any signs of stable equilibriums. Because of this the Austrian School of Economics has long attracted certain types of investors.... Further reading... Link to Amazon...

Neely, J. Lukas - Value Investing: A Value Investor's Journey Through the Unknown

EndlessRiseInvestor.com, 2015, [Equity Investing] Grade 4

In Value Investing the author, an investment advisor and former hedge fund manager, shares his framework for investing in stocks. The stated aim is to provide a process for investment success. The emphasis is on process as investors without one are prone to let psychology determine... Further reading... Link to Amazon...