My last article regarding the effect of rising interest rates on the UAE’s equity markets sparked quite a bit of debate on LinkedIn and got me to thinking about how the equity markets have been performing. So I looked at the year to date (YTD) return for Abu Dhabi’s market at found out it is 9.82% as of today (source Bloomberg). For Dubai’s financial market the YTD return is -12.62% (source Bloomberg). This doesn’t tell me much about the overall equity performance on a national level. Continue reading
The major theme for equity markets over the last couple of years has been the oil price. That was a valid issue as it affected the fiscal side of the economy tremendously (i.e. government spending).
Various other issues have cropped up in terms of looking at the market, such as the tightening fiscal policy of introducing VAT and the investor trust levels post the Abraaj issues. Fiscal policy will have an impact, Abraaj is really about learning from their mistakes.
But there is another threat, one that is growing, and that is interest rates. The US Federal Reserve (Fed), the central bank of America, has been countering Trump’s loosening fiscal policy of reducing taxes by moving towards a more contractionary monetary policy of increasing interest rates. This makes sense for the US which has a robust economy these days. For us, and other countries pegged to the US dollar and facing a challenging economic environment, increasing rates are a problem. Continue reading
Bitcoin has recovered a bit this past week, but has still lost over 40 per cent of its value in the past two months. This isn’t going to be an “I told you so” column; it is simply heart breaking watching so many people who invested in the cryptocurrency for fear of missing out, only to lose so much of their savings. What I’d like to do instead is to try to use this shock to look at how to build investment programmes that are more robust. Continue reading
Investing is too often looked at using a handful of academic models. Successful investing involves thinking about the investment process in as many different ways as possible. This article takes a look at investing using alternative views.
From Betting to Investing
Many of the ideas used by the investment community are adopted from the horse track and casino betting communities. Much of the failure that has dogged the investment community is due to rocket scientist PhDs misunderstanding the successful models of plebeian punters. The use of betting as an example is not an endorsement, just history.
To understand how the securities markets work you have to look no further than the horse bookies. Bookies take bets from the bettors. This is the first point that the public begins to misunderstand how betting, and therefore investing, works.
There are two potential misunderstandings:
- Assuming that each horse has a uniform probability of winning, i.e. they are all just as likely to win.
- Assuming that the bookie offers one to one payout odds, i.e. pays $1 for each $1 that is bet.
Grasping the significance of these statements is the key to successful investing. The bookie, equivalent to the investment bank or broker, will always make money. Always. They do this because they do not set payout odds depending on which horse they think will win, they set payout odds based on how people bet. Continue reading
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.
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.
A Financial Times article recently described the structure of the SoftBank Vision Fund.
The details reveal breathtaking audacity in terms of SoftBank laying claim to investor returns without transfer of an equivalent level of risk. To avoid competing accounts, I will use the FT as my source of information, as I am not so much interested in what SoftBank is doing as I am in how investors might analyse such structures.
The tech and innovation focused fund has gained fame due to its size, currently a reported US$93 billion in commitments. Less broadcast is that SoftBank’s 44 per cent internal rate of return over the past 18 years is driven predominantly by two investments, Alibaba and Yahoo Japan. But the issue is not about investment ability, it is about whether the structure is fair.
I have recently pointed out that one of the warning signs that a business is facing issues is when core revenue, ie revenue from the main business lines, is down but profit is up.
Why the combination? Why not simply flag a drop in core revenue? Because it is normal for revenue to fluctuate – especially in a challenging economy. But if revenues go down and profit goes up, it means the business has miraculously had a major increase in non-core revenue or, worse, has made large cuts to expenses.
Large jumps in non-core revenue are rarely sustainable. They usually come from either re-valuing assets, an exercise that does not affect cash flow nor is it recurring, or from the sale of an asset at a price higher than it was held on the books, which helps cash flow but is non-recurring and may reduce income-generating assets.
On the expense side you have actual cash expenses that are reduced, usually employee compensation or number of employees, but this can also include things such as rent. These have a positive cash-flow effect but are limited in the number of times they can be done, not to mention that it can affect revenue generation by losing employees or reducing morale.
The red flag is when non-cash expenses change drastically, such as depreciation, amortisation and impairment charges. This is a red flag because it is relatively easy to massage these numbers, plus it has no impact on cash flow. Continue reading
A few weeks ago I pointed out that Etisalat generated earnings of Dh0.97 per share and paid out Dh0.80 per share, which is a payout ratio of 82 per cent. I further pointed out that paying out such a high percentage of profits was consistent with a status quo strategy and inconsistent with an expansion strategy, which would need to use the earnings to expand. Last week Etisalat bid for Oman’s third mobile operator license.
The question is, is it rational to pay your shareholders nearly all of your profits and then to go on to expand? Etisalat saw its revenue drop in the first quarter although it managed to grow profit by cutting expenses. Still, with revenue falling, earnings being paid out and an expansion strategy, one is walking a tight rope.
I also recently analysed the 2016 financial performance of Gulf Finance House (GFH), a financial services group, in particular with respect to announced discussions with Shuaa Capital for a merger. The analysis showed a large loss from normal operations of about US$230 million masked by a one-time litigation award to show a profit. I was curious to see why Shuaa would be interested in GFH and so reviewed GFH’s Q1 2017 financials that were recently released. Perhaps GFH could engineer a miraculous turn around in normal operations.
The report showed that GFH has indeed achieved a profit of $33.5m for the quarter. An astounding achievement. I dug deeper. Financial services can have notoriously volatile earnings but one thing caught my eye: a profit of $25.6m from the sale of a subsidiary.
Upon closer examination, the profit came from selling a stake in a school.
The shares were received as part of the litigation settlement in 2016 and GFH valued this part of the stake at $29.4m. A year, or less, later they sold the stake for $55m for a profit of $25.6m. That is a return on investment of 87 per cent in at most one year. Did GFH generate a fantastic 87 per cent return in one year by its skill in operating the school?
Perhaps the whole market went up 87 per cent? Possibly the buyer and their advisers are clueless and overpaid by nearly double?
This one-off extraordinary transaction explains 76 per cent of the profit. I considered analysing if the other 24 per cent was one-off or normal recurring business, but why bother?
Union Properties last week announced that three of the directors of the board had resigned right after an AGM that appointed them. The three directors publicly denied resigning. There could be some chance that this is just a big misunderstanding. The more likely scenarios are less than salubrious.
Board drama is a red flag suggesting serious internal issues at a company. The number of such incidents in the market, along with going concern warning, capital injections at loss making companies, and law suits, will be a gauge of how much the oil price drop from 2014 is affecting our economy.
On Thursday, the price of oil dropped to its lowest level in five months. The main benchmark Brent fell below US$50 a barrel, followed by a modest comeback on Friday to about $49; as of Monday afternoon it was still at that level.
One reason for the drop was reported in a Financial Times article that quoted Jamie Webster, a fellow at the Center on Global Energy Policy at Columbia University: “Opec extension is baked into market expectations, but roaring shale growth makes the sizeable but too small a cut completely lose its potency.” A separate FT article stated that although the agreed Opec production cuts amount to 1.4 million barrels per day (bpd) the actual cut to exports might be as little as 800,000 bpd.
It is a little worrisome that Opec cuts production and oil prices pop up for only a short while. We keep hearing how oil prices will go up because of a lack of investment in oil infrastructure. Oil prices might pop up, but they keep dropping back down. If what you are hearing is different than what you are seeing, which should you believe?
In the investment world we have a phrase, “talking one’s book”. This describes the natural human trait of speaking positively about something beneficial to you, in this case the investments an investor has made. As investors and individuals who must make a myriad decisions based on the economy we should ask ourselves: if doing the same thing but expecting different results is a sign of insanity, then what is listening to the same thing and expecting different results a sign of?
This article was originally published in The National.
We have recently seen a flurry of reports regarding the financials for the first quarter of this year.
Despite happy headlines, the fundamentals are not good. I will use some examples to show how to dig under the rosy announcements to get a better idea of the situation.
Let’s start with the banking sector, the blood flow of the economy. In their publicly presented financials there is a wealth of information from the two largest domestic banks in the UAE, First Abu Dhabi Bank (FAB), the merged FGB-NBAD, and from Emirates NBD.
Consolidated FAB net interest and financing income was year-on-year (y-o-y) for Q1 4.9 per cent lower – ie, Q1 2017 showed a decline of 4.9 per cent over Q1 2016. This is the income predominantly generated from the core business of a bank – lending and borrowing.