Abu Dhabi National Insurance has two classes of shares listed on the ADX, the regular ADNIC shares and the converted ADNIC2 shares. There is a possible relative value arbitrage opportunity.
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Your stop loss orders aren't guaranteed to protect you
Speaking of trading, I want to talk about certain trading misconceptions. I recently talked about the liquidity trap that some investors were getting themselves into when investing in illiquid stocks. The issue is not an investment issue but a trading issue that can greatly affect the overall IRR. In discussions about this trading trap some other misconceptions came up and I’d like to address one of them: the stop loss order (SLO). In their most basic form these are orders that you give to your broker to sell a security if it drops below a certain price.
The main misconception with SLOs is that when the price of a security drops it will touch every price on the way down. For example, if you bought shares which are now at Dh20 and you put in a stop loss at 19.8 this will not necessarily trigger a sale at 19.8. One reason is that if the last trade is 20 and the next trade is 19.6 then you’ve passed by 19.8. If your broker actually manages to sell at 19.6 you’ve still lost an extra 1 per cent of your position. But there is no guarantee that your broker can sell at the lower price. I recall in mid-1998 that the UAE markets, then trading over the counter (OTC), had been enjoying a great rally when they suddenly collapsed. I saw an order for the most liquid shares at the time, Emaar Properties, executed at Dh160 a share. The crash started the next day and the buyer immediately tried to sell the position. It took several days before a new buyer was found, at a price of Dh40 a share. That is a 75 per cent loss. Remember, this was not about Emaar, the whole market had crashed. Continue reading
Buying bitcoins is going long bitcoin deflation
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
Dubai Financial Markets Investor Structure Improving
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
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.
Dana Gas seems confused about sukuk pricing
Dana Gas’s CEO thinks his sukuk coupons are above market even though the sukuk price is below market. This is inconsistent.
I am not discussing any Sharia law issues here, just the simple dynamics of the bond (including sukuk) market. This opinion is based on an article in The National.
According to Dana Gas’s CEO the sukuk are paying an interest rate (as I call it) of 7% and 9% depending on the tranche. He says that the market yield indicates a yield below 4%. This indicates that the coupon is fixed not floating. The fact that the yield on the sukuk has not moved indicates a fixed interest rate rather than a floating interest rate. From now on when I say interest rate, I mean fixed interest.
In general if a simple bond is paying a coupon of 10% then there are three scenarious on where the price is. If market yield is 10% then the price will be 100 (as a percent of face value). If market yields are lower < 10% then price should be > 100, and vice versa.
A couple of weeks ago DG sukuk where trading at around 40, a huge discount, which meant that the market expected a yield well above the 7% and 9% coupons (before that, the price was even lower than 40). This means that the statement by DG’s CEO that market indications are that the sukuk yield for DG should be below 4% are completely contradictory to the actual market price from a couple of weeks ago.
However, in the last two weeks the sukuk price rallied miraculously to around 100. I could not find any announcements to support such a 150% price move in three weeks which would indicate the possibility of market manipulation. But if it is a real move this still contradicts Dana Gas’s CEO as a price of 100 means that the 7% and 9% coupons are the actual market yield.
From the article it seems that the original sukuk had a convertible element which would make it a valuable option for sukuk holders. This would mean that if this element is removed, as the CEO indicates, then the actual yield in market would have to increase from 7% and 9% to compensate sukuk holders.
Dana Gas’s CEO seems to be confused about two things. The first is if a company issues a bond at a fixed coupon and later market yields drop, this does not give the company the right to destroy the bonds and replace them with something cheaper. They are a commitment, one which needs to be honoured.
The second confusion stems from the following in the article “[The CEO of Dana Gas said] traders in the previous structure [the sukuk with the convertible element] had arbitraged and dumped the shares, depressing the shares in a manner that is unfair to existing shareholders.” This statement indicates a misunderstanding of a basic point of finance – arbitrage is good as it keeps markets efficient and in sync. The idea that market movements are unfair to shareholders because convertible sukuk holders acted legally in the market holds no water. If anything happens untoward in the market then shareholders should seek justice from the regulator, the Securities and Commodities Authority. To have the company punish sukuk holders in favour of shareholders is wrong.
Who Wins, the Trader or the Investor?
The perennially favourite discussion topic is trading versus investing. What’s the difference? Is it short time horizon versus long time horizon? Is it growth versus value? Is it Soros versus Buffet?
This post is a continuation of my 2007 article in The National. Reading the previous article is not necessary to benefit from this post, but looking at the ideas across an eight year period might be helpful.
Trading Insights: Exposing the St. Petersburg Paradox
The St. Petersburg Paradox is a famous problem in probability and economics. The problem states that a coin is repeatedly flipped. The bet starts with $2. Every time a tails shows up, the bet is doubled. The first time a heads shows up the game ends and you receive the current bet from the ‘house’. The question is, how much would you pay the house for such a game?
From a probability point of view, the expected payout is infinite, and it is not hard to see why: the payout is doubled each round. This leads us to the paradox: you should be willing to pay an infinite amount to play this game. Most people would refuse to.
Adventures in the Money Markets: Godzilla's Return
In my post the Rise of Godzilla I explained how the UAE money markets work and the presence of a money center bank that I will call Godzilla. In my introduction I outlined a short squeeze that Godzilla had run against the whole UAE banking system, all fifty banks. In this article I will outline how a (then) midsize bank successfully fought off a bullying short squeeze by Godzilla.
Adventures in the Money Markets: The Rise of Godzilla
Money markets are the inter-bank market for short term borrowing and lending. Banks manage their strategic asset–liability mismatches as part of their overall long term plans for raising deposits and making loans. Short term reality however rarely tracks long term execution and tactical money market operations are necessary to mange the short term fluctuations of the balance sheet. Normally the money market desk of a treasury is considered boring, with excitement belonging to the currency desk. But once in a while a situation can develop that would challenge the most aggressive of currency dealers. This is the story of such a deal. Comfort with arithmetic is required.