Author Archives: Sabah al-Binali

Buying bitcoins is going long bitcoin deflation

August 3, 2017 By in Trading Tags:

Buying bitcoins as an investment means going long bitcoin deflation. That’s it. Let me explain.

Bitcoin is a cryptocurrency, a digital currency made hard to forge using cryptography, and also a payment platform such as those used by Visa, ATMs and if you’ve done wire transfers, the Swift system.

The bitcoin technology platform is not new, it was first released in 2009. The cryptography is older, having first been developed in the early 1990’s. The payment systems are decades old.

So what do I know about this? As a former Head of Treasury at Union National Bank I of course needed to understand currencies and currency market. Also the Swift system is managed out of the treasury’s back office. Furthermore I was a director of the board of VISA International CEMEA Region. For the technology, in the mid-1990’s Moti Yung, a former student of my graduate adviser, tried to lure me away from computational finance research back into mainstream theoretical computer science by explaining to me the uses of distributed databases and how they can be used for secure payment systems. Although I didn’t switch it was interesting enough that we would chat about it once in a while. Today, distributed databases have acquired a sexier name: blockchains.

I tell you all this so that you understand the following – there is no innovation here, not in the theory nor in the application. Even if there was, actually buying a bitcoin does not give one economic exposure to any technology, simply to the supply and demand forces acting on the bitcoin currency. So we can narrow our discussion simply to analysing the currency markets. Continue reading →

The UAE's banking paradox

August 1, 2017 By in Analysis Tags:

In this section I look at the UAE banking system and come to some startling conclusions. It seems that banks are grabbing market share in a market with deteriorating margins and increased risks.

Last week I took a look at Union National Bank’s Q2 financial results. The focus was to look beyond the headline numbers and try to understand the underlying fundamentals and what the core trend might be. This led to the idea of core revenue and expenses, ie interest income from direct lending and debt securities and interest expense of deposits and debt securities. UNB also provides Islamic financing so I added those in as well. This tells us what is happening at the basic banking level and then I look at any out-of-the-ordinary movements in other parts of the business.

Mashreq recently reported Q2 results and announced an increase in profit of 3.4 per cent over Q2 2016. But looking at basic banking, core revenue rose 9.97 per cent whilst core expenses rose 19 per cent. This is not a good sign since if it continues, sooner or later, net core income will become negative. Operating expenses are flat at about 1 per cent so had little impact on changes to net profit. Continue reading →

Your guide to handling ethical management issues

July 31, 2017 By in Corporate Governance, Management Tags: , ,

You have spent a lot of time honing your business ethics, governance and compliance skills, but time and again you find yourself in difficult situations and realise nobody taught you what to do.

If I just described you, then this article is for you.

Most of what is taught is with regards to how to act if we initiate an action and, possibly, how to react when a client initiates an action. What I have not seen taught is how to react if your manager initiates an action. In this case there are broadly two scenarios: First, it is a legal and ethical instruction; or second, it is an illegal or unethical instruction. In the first case the employee’s proscribed reaction is straightforward – execute. In the second case it is to not execute the instruction. But is that as simple as saying “no”? Of course not.

Continue reading →

Jawbone lessons

July 19, 2017 By in Cash Flow Tags:

Jawbone, best known for fitness wearable technology, went into liquidation last month in part because of too much funding, according to CNBC. I believe that this is a good case study for some of the companies in the GCC that receive easy funding. Too often, certain investments are deemed strategic and then there is a blind mandate to fund them at any cost. One of the most frequent cases is the legacy business of a family conglomerate. Although other business lines might be doing fine and the commercially rational decision is to liquidate the legacy business, there is too much emotion tied to it. Often there is the belief that the loss of the legacy business would signal an unacceptable loss of face.

Of course if that funding is never-ending, you end up with zombie companies as the negative cash flows from operations and investing are offset by positive cash flows from funding, forever. This is why it is extremely important to look at the cash-flow statement. I have seen actual financial statements of large companies show that new debt funding is not only being used to pay for operations, an unsustainable situation, but to also pay off maturing debt. When you start using debt to pay for debt you’re in trouble.

The way this is explained to boards is that a certain debt is being matched to a certain activity. This is, of course, baloney – a proper analysis looks at the aggregate. If operating plus investment cash flows are negative and there is maturing debt it can only be paid off via more funding, be it equity or debt.

Sabah al-Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more on his Twitter feed or for deeper analysis on LinkedIn and al-binali.com.

Structuring formal boards and committees

July 17, 2017 By in Corporate Governance Tags: ,

A central pillar of corporate governance is to share authority. At the board level, directors have no individual authority unless the board assigns it to them. It is the board as a body that has authority. This authority is too often circumvented by the creation of an executive committee (exco) of the board. Although the existence of an exco does not mean that there will be corruption, when there is corruption it can usually be traced to the existence of an exco. The reason is that an exco effectively takes over the role of the board and the chairman of the exco becomes the de facto chairman of the board, replacing the elected chairman of the board. This is frightening.

This holds true at the executive level. The board must ensure that long-term strategic decisions are made by competent committees, not solely by the chief executive. A simple example is that you don’t want the chief executive to have sole authority over investments. That’s a one-man hedge fund. There is a balance between efficiency and governance, but that balance clearly isn’t an all-powerful chief executive.

I have seen different attempts at managing these issues. One unfortunate one that I’ve seen in this region is rejecting executives who want to be paid at the higher end of the market. The idea is that this way the executives hired are not greedy and will not commit fraud. This idea has several flaws.

The simplest flaw is that a dishonest executive is not going to care about his formal compensation as he will supplement it via the fraud. A more subtle but far more dangerous flaw is the idea that the only alternative to someone who prioritises financial compensation is one whose incentive is to do a good job. In this region I have seen that the much greater percentage are those who prioritise power and those who prioritise publicity. Both of those incentives corrupt as much as, if not more than, financial incentives. I’m not sure people stuffing their friends into jobs or people using their positions to get on the front page are any better than people who think high performance should be rewarded with high pay.

Sabah al-Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more on his Twitter feed or for deeper analysis on LinkedIn and al-binali.com.

Your guide to handling ethical management issues

July 16, 2017 By in Corporate Governance Tags:

You have spent a lot of time honing your business ethics, governance and compliance skills but time and again you find yourself in difficult situations and realise nobody taught you what to do. If I just described you, then this article is for you.

Most of what is taught is with regards to how to act if we initiate an action and, possibly, how to react when a client initiates an action. What I have not seen taught is how to react if your manager initiates an action. In this case there are broadly two scenarios: 1. It is a legal and ethical instruction, or 2. It is an illegal or unethical instruction. In the first case the employee’s proscribed reaction is straightforward – execute. In the second case it is to not execute the instruction. But is that as simple as saying “no”? Of course not.

Even in relatively flat/informal organisational structures this is difficult. When the hierarchies are formal, prized and inflexible it is next to impossible to refuse an illegal instruction. Without clear wrongful termination and whistleblower laws it becomes extremely difficult for an employee to stick to their values, especially in the current climate, as the consequences can quite easily lead to personal insolvency. For foreigners the risk is greater still, if the employee is fired in retaliation they have three months to find another job or face uprooting their entire lives, family and all. A daunting risk to doing the right thing. Continue reading →

Dubai Financial Markets Investor Structure Improving

July 11, 2017 By in Analysis, Trading, Investments Tags: ,

My foray into DFM’s historical data unearthed some interesting nuggets, both of which I consider positive.

For the first half of this year, Arab investors, including from the GCC, withdrew a total of AED 1.6 billion from the market while UAE citizens invested a total of AED 421 million. Here is the first interesting bit, the total investments by non-Arab investors was AED 1.2 billion. That is remarkable and exactly the kind of statistic we want to see, a more balanced and broader foreign investment profile.

In essence what the above indicates is that the UAE has managed to increase foreign non-Arab investment at a time when oil prices have dropped from historical levels. This is not only a vote of confidence, it is a positive trend.

The second statistic is type of investor, with individuals selling AED 628 million to institutions. This, too, is positive as increased institutional investing is key to developing a market, not least because they have a higher tendency to impose corporate governance.

This article was originally published in The National.

Investors are falling into a liquidity trap in the GCC

July 10, 2017 By in Trading, Investments Tags: ,

I am increasingly hearing of people investing into positions in the markets because they think that the price of a share is cheap due to a decline in the price. The price is not cheap, it is low for a reason.

Worse, when these investors enter the market and buy the shares they think they have made a great decision when they see prices immediately rise. But prices in such situations usually rise because the shares are illiquid and the buying just pushes up the price artificially.

To understand this we first have to define liquidity, which in this case is how quickly one can buy or sell shares without affecting the price. This alone is not specific enough, because there is a difference between selling one share and selling a million shares. This brings us to the concept of average daily trading value (ADTV), or the total value of the shares of a particular stock traded every day averaged over some period. If we look at the trading size as a percentage of value traded we can get a better picture if trading a certain size in a single day is liquid or not.

So, for example, if the trading size is 1 per cent of ADTV then it is usually safe to assume that it is liquid. However, if the trading size is, for example, 20% of ADTV, then doing it all in one day without affecting price is difficult. Looking at the Dubai Financial Market (DFM), as an example, in the second quarter the value traded for Emaar Properties was AED 3,227,999,534 which gives, using an estimate of 64 trading days, an approximate ADTV of, AED 437,493. This would indicate that buying AED 1 million shares of Emaar Properties, representing about 2% of ADTV, in the open market on a single day should not impact the price. On the other hand, the same calculation on Shuaa Capital gives an approximate ADTV of AED 2,452,726 indicating that an equivalent size trade to Emaar of AED 1 million Shuaa shares in a single day would constitute about 40% of ADTV and would likely affect the market price.

This means that for the investor who buys a relatively illiquid stock and sees a price rise, it is most probably a phantom profit as once the investor tries to sell the price appreciation will reverse or worse.

This is completely unfair if this is being done by an asset manager who is charging a fixed fee on assets under management (AUM). Let’s say the manager buys AED 100 million of an illiquid AED 0.50 share in a block-trade from a distressed seller. This won’t move the market. But if the manager then buys AED 1 million of the shares in the open market then he can easily move the price to AED 1 per share, increasing the position to AED 151 million with a profit of at least AED 50 million on paper.

If the manager is charging a 1% management fee, then doing so on the inflated valuation of AED 151 million is equivalent to charging 1.5% on the actual value of AED 100 million. Of course these outsize returns can be made bigger by pushing the price further.

Worst of all, when the manager tries to exit, if he can’t find another investor to sell to in a block-trade, then unloading all those shares will obliterate the stock price. The asset manager would make outsize fees on inflated valuations and then walk away free.

Some will argue that the performance fees that asset managers usually charge would help to align their interests with their investors. But remember, performance fees are contingent and charged to profit whereas management fees are guaranteed and charged to the assets.

The idea of announced values being much higher than actual values is not new.

For this reason it is imperative that investors demand from their asset managers certain liquidity guidelines, or at the least apply management fees retroactively after exit. The risk is ending up with a highly illiquid portfolio that looks good on paper but you only find out the truth when you try and sell into the market.

This article was originally published in The National.

Analysing Abu Dhabi Investment Authority's Performance

July 9, 2017 By in Analysis Tags: ,

Last year I did a bit of complex analysis, mostly trying to estimate returns, to understand Adia’s 7.5% 30 year internal rate of return (IRR) ending in 2015. This year I will make it easier. Adia’s 2016 30-year IRR was reported as 6.9%. Did Adia perform poorly in 2016?

It is difficult to tell as there are two bits of information that we need. First, recall that investment performance is usually against benchmarks. We do not know what Adia’s is, but I have used the MSCI World Index. It isn’t necessarily appropriate but given Adia’s size, which means it is a major global investor, it can be insightful. The other thing we need to remember is that the 30 years ending in 2016 starts in 1986 whilst for 2015 it started in 1985. Therefore the only difference between the two are the years 2016 and 1985.

So we can look at the difference in 2016 return relative to the 1985, i.e. if Adia had a return of +20% in 2016 but +30% in 1985 then the 30-year IRR drops even though Adia did well in 2016. This is because the IRR gains the +20% of 2016 but loses the historical +30% of 1985. In this case Adia would be penalised on their good 2016 return because they had made a much better one in 1985.

From a mathematical point of view we can’t get the actual difference between Adia’s 2016 and 1985 returns, but we can get the ratio. For Adia its 2016 return is 15% lower than its 2015 return. The MSCI WI as per MSCI’s website is 5.32% for 2016 and 36.62% for 1986 which is a decline of 23%. Adia clearly outperformed the MSCI WI in 2016 relative to 1985 by a large margin. Since we don’t have actual numbers we can’t tell if Adia underperformed the MSCI in 1986, outperformed it in 2016 or a combination of both.

What we can say is that Adia has, directionally, improved dramatically in its ability to manage its investments. A sign of the growth of our country not only in terms of population, real estate and economy but also in terms of effectiveness and efficiency.

This article was originally published in The National.