The Calculus of Lockdown

Lockdowns have become commonplace as a way to prevent or stall a flare-up in Covid-19 infections.  The justification for a lockdown must be more than just saving the life of the 1% or so of those who get infected since there are significant costs placed on the broader community.  These costs can be as minimal as not being able to enjoy a movie or as great as forcing a company into bankruptcy and subsequent unemployment.  A full cost-benefit analysis should be undertaken to justify a lockdown,

Cost-benefit analyses are very difficult to do, as this blog entry by Ryan Bourne of the CATO institute points out https://www.cato.org/blog/cost-benefit-analysis-lockdown-very-difficult-do-well .  But as with many economic questions, while it is difficult to make conclusive inference about the absolute effects of a policy, it is a lot easier to make inferences about changes in policy from one state to another or from one point in time to another.  The Calculus of lockdown is very useful.

When the Covid pandemic first emerged, very little was known about the disease itself.  Just over a year later, we now know that older people are more likely to suffer severe effects while younger people are more likely to spread the virus.  The genetic structure of the virus was quickly deciphered and a number of vaccines developed and approved to protect everyone with the most at risk innoculated first.  Contact tracing has become a science.  In fact, there is an enormous body of knowledge that can be mobilised to generate a picture of what an effective lockdown should look like compared with one year ago. So what should an effective lockdown look like now compared with a year ago?

First and foremost, with the majority of the most vulnerable in the community already vaccinated, the benefit of any lockdown policy is largely negated – saving lives is no longer a justification if there are no deaths to be had!  Second, since the young are more likely to spread the disease, schools, playgrounds and sporting arenas are worth restricting. Third, and most importantly, since the benefits side of the ledger is lower, the costs that the policy imposes on society should also be lower.

This Calculus suggests that policies that aim to extinguish Covid at all costs are not justifiable.

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Robinhood, the Efficient Markets Hypothesis and the Gamification of Investing

30 years ago, investing was a serious business.  (Actually, it was no more serious than it is today, just harder to access.)  Opening a brokerage account required minimum balances that were beyond the reach of the average twelve year old, placing orders was manual requiring multiple telephone calls, settlement was T+5 for equities and commission rates were high and non-negotiable except to the most well-heeled investors.  These days, technology has wiped out several layers of human intervention to the point that an individual school girl – lets call her Marion – can buy a fraction of a share in her favourite Chinese Dance-Tok company using her mobile phone during play-lunch.  Robinhood is the market leader in this astonishing technological advance allowing Marion to spend $5 on Dance-Tok shares without any trading fees whatsoever.

Robinhood has made Marion’s investment experience into something resembling a mobile phone game.  A successful trade is trumpeted with a congratulatory rift, confetti streams across the screen and happy faces report profits.  Robinhood is also accused as one of the major brokers involved in the Gamestop ‘rocket event’ where a group of like-minded investors began purchasing the company’s stock at higher and higher prices for FUN.  Gamestop was ripe for a short-squeeze on account of some high profile hedge funds being negative on the stock.  As the stock rose from $8 to $50 the shorts were forced to cover and onward went the shareprice to $460 at its height.  Unlike the traditional approach to squeezing shorts where a small group buy the majority of the outstanding float of a stock, this was a ‘crowdfunded’ voluntary coordinated effort that drove Gamestop’s price far beyond its arbitrageable limits without attracting arbitrage.

The Gamestop – rocket has largely come back to earth and the regulatory post-mortems have begun.  Robinhood’s gamification of the investing experience is directly in the sights of the SEC, congressional lawmakers and various agencies.  Is an app that opens up the investment markets to the Marion’s of society such a bad thing and should it be allowed to be ‘FUN’?

The Efficient Markets Hypothesis (EMH) has a lot to say about this issue.  In its simplest form, the EMH posits that the current price of a security is an unbiased predictor of the range of future outcomes for the stock.  Another way to think about it is that the price of the stock reflects all publicly available information so that there can be no advantage to any individual investor from studying what is already known in the market.  This is great news for Marion and her friends who decide to purchase IBM, JPMorgan or Dance-Tok during play lunch.  The EMH promises that her investing experience will be just as safe as any other investor in the markets – she is on a level playing field with all other investors.  The EMH also posits that the expected return on a stock must be positive in order to induce investors to hold it (there are exceptions to this rule) so that Marion’s investing game actually has an expectation of making money whereas most other games require in-app purchases which are costly to keep playing.  Robinhood therefore finds a lot of support for its app from the EMH.

The EMH, on the other hand, has a tougher time defending the cohort driving Gamestop’s rocket experience.  $460 is a long way from a fair-value range for the stock of $5 to $10 as some analysts had posited.  As the stock price rose many times short sellers must have been tempted to sell.  However, this risked being slammed by the cohort of rocketeers that simply bid up the stock at every opportunity.  In its strictest form, the EMH requires that a self-financing portfolio should not have a positive return.  This is the rule against a money-machine that costs nothing to operate but spits out money at various points in time with no risk of a negative outcome.  On this logic Gamestop’s rocket did not violate the EMH since there was always a chance that some rocketeer would push the stock price higher for FUN thereby causing a loss to short sellers.  At some point, of course, the rocketeers run out of money and the FUN stops.

I doubt that stopping the bells, whistles and confetti on Robinhood will make the app any less appealing or relevant to the new breed of investor.  Forcing Robinhood to charge a fee per trade, on the other hand, will kill the rocketeers but also force the Marion’s of society to seek their thrills in Roblox.  This would be such a shame


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SPAC’s place in the world

As its name suggests, a Special Purpose Acquisition Company (SPAC) is a listed cash box that acquires a private company to take it public.  At the time of its creation, the SPAC may state a broad purpose to source and acquire companies in a particular industry but the actual target is unknown when it lists.  Initial investors place their trust in the promoter to find a ‘good’ target however they have an option to redeem their investment if the proposed target is unsatisfactory.  The SPAC promoter has 2 years to find a suitable target or it liquidates.  The promoter, for their part, in general receive 20% of the target company once acquired. 

SPAC’s have been around for many years in various forms but they have become popular recently as a way for private companies to bypass the traditional IPO process in a post-Private Equity world.  The traditional IPO process has historically underpriced companies going public by 27% on average leading to criticism that the process is run by Wall St for the benefit of Wall St.  In 2020 and 2021, moreover, the degree of underpricing of IPO’s has been significantly more than that average where it is not uncommon for newly listed entities to double in price on listing day or more within a week.

Wall Street’s claim that a ‘successful IPO’ is one that delivers a stag-profit to favoured customers is at the core of the search for an alternative financing vehicle.  Stags’ gains are subsidised by the pre-IPO shareholders (founders, angels, venture capitalists and private equity investors) since these stakeholders receive less than the opening day market price places on the company.  For instance, an IPO which prices at $100 and raises, say, $100m in new capital, but then lists the next day at $127 per share delivers $27m to the new investors.  This $27m is money that long-standing pre-IPO investors don’t receive despite bearing much greater risk.

Disgruntlement with the traditional IPO process gave rise to the market for private capital.  ‘Private is the new Public’ enabled the likes of Spotify, Uber, AirBnB and a host of other new companies to grow much larger without accessing the public capital markets by drawing on pools of private capital entrusted to expert deal makers in the private equity and venture capital space.  These private structures were successful in meeting capital demands but could not provide either pricing or liquidity to shareholders.  This is an inescapable function of the public markets.  Is there a way to achieve a public listing without having to suffer the underpricing of an IPO?

Enter the SPAC.  To my mind the main difference between a SPAC and an IPO are the incentives for the promotors/lead managers.  IPOs have an incentive to underprice whereas the SPAC promoter takes 20% of the target so that they have an incentive to overprice.  Indeed, this seems to be the case with something like 60% of SPACs trading at a discount of 20% or more 6 months after completing their acquisition.  Wall St points to these numbers as failures but pre-listing shareholders who sell early are smiling. 

Of course the best result from a market efficiency standpoint is a listing mechanism that delivers a fair price at listing for existing shareholders without either subsidising Wall St or paying a large fee to a promoter.  This mechanism is a ‘direct listing’ which simply takes a private company into a public market and lets risk-takers  (real buyers and real sellers with real money) determine the market clearing price.  This was Spotify’s approach and everybody except Wall St and the SPAC promoters were smiling.

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Socialism fails once again in distributing the Covid vaccine

Reuters headline: “New York and Florida tell hospitals to dispense vaccine faster or lose supply” Jan 4 2021

Which of the following would you expect to see during a pandemic?

A.  Unused vaccine serum sitting idle; or

B. Shortage of vaccine supply

It would seem that the natural tendency would be toward B – that during a pandemic, there are many people at risk of infection and they would all be clamouring for the limited supply of the life saving protection that a vaccine offers,  not just to themselves but to society in general.  How bizarre it is to learn from the headline that hospitals in New York and Florida (and presumably many others!) are sitting on 5.5 million doses out of the 10 million allotted, simply because they could not find the motivation to stick as many needles in as many arms as possible ?  What is going wrong?

Hospitals are being paid A LOT to treat patients in intensive care facilities while being paid next to NOTHING to give vaccinations. This conflict begs the question …’why are hospitals involved in the first place?’ Because the government said so, that’s why!

There is a very strong case that doctors in the private sector should be tapped to provide the vaccination service for a fee, or anyone else qualified to stick needles in arms, even if that service allows some ‘low risk’ individuals to jump the queue because they are rich. How much would you pay to receive a vaccination – $50, $100, $200 or more?  Imagine how much vaccine would be dispensed if your local general practitioner set up a 24 hour vaccination tent on his front lawn charging $1oo a jab?  The doctors would make out like bandits but the vaccine supply would be completely exhausted, most likely pre-sold before the likes of FedEx and UPS could deliver the valued cargo.  Profit is a great motivator.

Governments offering ‘free vaccination’ subject to a rationing system based on ‘priority need’ is a noble objective, but also one that over thousands of years has proven ineffective.  Socialist principles lead to resource misallocations – it seems that the socialist control of supply and distribution of the Covid vaccine is once again failing us all.


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Why do political opinion polls seem like rubbish? PLUS the First Degree US election Special PLUS the latest release from DJ Dr Fish​

I have seen many electoral events where opinion polls uniformly over many months or years say the same thing. The Brexit polls, Boris Johnson’s landslide victory, Trump’s success in the US Presidential race in 2016 and Scott Morrison’s triumph in Australia in 2019 are recent examples of where opinion polls predict one thing yet on polling day a completely different result occurs.  Why is this?

The statistical theory is more damning than you think…

The problem is far more serious than most people understand.  There is very strong statistical sampling theory that says a relatively small sample from a large population will approximate the true population with, say, 95% confidence. Suppose that the preferred candidate has 53% support from the population of 200million voters.  Then a sample size of 1000 respondents should deliver an estimate of this mean between 50% and 56% and achieve this 19 times out of 20.  The probability of the sample mean falling outside this range is not a coin toss.  The probability of 2 polls being wrong is 1 chance in 400, not 1 chance in 4.

Therefore, if a succession of polls say the same thing but are wrong, the statistical likelihood of systematic error is negligible. Put anther way, polls are not worth the paper they are printed on.  

Sampling bias is a cop out…

The polling organisations blame sampling bias for their errors.  By this they mean that their respondent selection mechanism systematically omits a critical component of the population.  The favourite explanation for the US 2016 error is that dumb white people who voted for Trump don’t have phones.  I personally don’t buy this sampling bias argument due to the long term consistency of polling errors and the cross-section of consistency of all polling organisations saying the same thing. 100 polls with 1000 respondents each giving the same result is statistically equivalent to capturing the population in its entirety.  So how can the opinion polls be so wrong?

Maybe the opinion polls are right?…

My theory is that the polls are not wrong at all.  In fact, they are actually incredibly accurate at the time they are taken. When asked what their voting intention is a few months or even the week before an election, the respondents answer honestly.  My theory, however, is that the small number of swing voters don’t actually decide who they will support until they get into the voting booth. Once there, the gravity of the situation suddenly weighs heavily on their conscience and they do something different to what they told the phone pollster 5 months earlier or even the day before.

I support my theory with the fact that exit polls are incredibly accurate – “who did you vote for?” is a factual question as opposed to “who do you intend to vote for?”. The exit polls that were announced as soon as voting stopped over Brexit, Boris’s landslide, Scott Morrison’s underdog triumph and many other election events were shockingly correct. This suggests people go in to the voting booth thinking one thing but exit having done another.

Underdogs rule…

Related to this propensity to decide who to vote for while standing in the voting booth is the advantage of being the underdog.  If opinion polls uniformly predict one candidate as favourite then why not vote for the other guy? It can’t hurt can it? Achieving hot favourite status going into an election is a real handicap.  I vividly recall the Victorian Premier Jeff Kennett in Australia in 1995 entering an election with a massive 85% approval rating from the opinion polls.  How could he lose?  He lost simply because voters expected him to win!

First Degree’s US Election Special : Biden v Trump…

All this brings me to the Biden-Trump rumble that will be decided shortly. Biden and his supporters are in big trouble.  The political opinion polls are uniformly predicting Biden to be elected next Tuesday.  The pre-poll voter turnout is massive and from all reports the majority are in favour of Biden since they are registered Democrats.  Were I a ‘…thoughtful swinging voter…’, I would walk into the voting booth next week expecting Biden to win and probably expecting to support the Blue Tide.

But what has Trump actually done?  Unlike every other politician, he delivered on his promises.  He built a wall, he pushed back on China, he fought Congress – he turned out to be the maverick that people voted for 4 years ago.  Biden has “a plan” for everything but what has he done?  50 years in elected office and nothing – no bridges, no tunnels, no foreign policy successes, nothing.

What’s in it for me?  Trump wants to cut my taxes, protect my job and he talks my language.  Biden has a plan…am I going to pay for that, and why does the New York Times like him so much?

What will happen in the voting booth?…

The US election is all about Trump.  A vote for Biden is not excitement about his vision for America blah blah blah…it is a vote against Trump. The voters know Trump…and despite what they may have said before they arrived to vote, there’s no compelling reason to vote against him.

Trump will get re-elected. 


…and don’t forget the latest release from DJ Dr Fish


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Covid 19 notepad: Observations and opinions

1. Pandemic preparedness
It is curious how the general media seems to think that every nation should have sufficient medical resources available to deal with the strains of a pandemic. Investing in five times the average daily demand for medical resources in case a pandemic happens is both suboptimal and ludicrous.

The US spends 18% of GDP on health care. If a pandemic requires 5 times this amount of medical resources then the US would be spending 90% of GDP.   Comfortably coping with the rare pandemic event means that the US would almost always have beautiful but empty hospitals , a lot of doctors and nurses standing around doing nothing and little money left for anything else.

Some countries can be criticized for not having a plan to deal with a pandemic but none can be criticized for not having idle resources.

2. Governments are not good at letting go
Lockdown is a hard decision to make but unlocking is even harder. China is tenuously relieving its restrictions in Wuhan with little fanfare while the rest of the world bunkers down. But what is the path back to normalcy? What milestones trigger relief? Very little guidance is coming from governments on these questions.

If you think policy errors have been made dealing with the rise of the pandemic, just wait for the policy errors that are about to happen as the virus abates.  The UK’s 3-year procrastination over Brexit – how to leave the EU? – is the prototype for the pending policy procrastination over Covid 19 – how to restore civil liberties?

Governments are good at passing laws and regulating activities.  They are the wrong people to put in charge of deregulation

3. Air travel will never be the same
It took a decade for the government to allow proper cutlery on aircraft again following 9/11’s policy requiring that airlines use plastic only knives and forks. What is air travel going to look like post-Covid 19?

The main issue for every country in the future will be ‘imported’ cases of the virus.  This means detecting and excluding passengers arriving from another country carrying the virus.  Controlling virus importation will probably require every passenger to present medical proof that they are Covid 19 – negative before checking in.

Once this policy is put in place, how long do you think it will take before the government will let you book an air ticket without a Covid19 negative test in hand at check in? So long as the Covid 19 virus remains in circulation the answer is ‘probably never’.  So here’s a business opportunity – develop a simple yet accurate Covid 19 test and market it through vending machines in airports globally…

On thing is for certain, gone are the days of a quick trip to Bali for the weekend. The days of mass-airline transportation are similarly gone.

4. Autarky

Movement restrictions on labour spill over into movement restrictions on capital and future trade transactions are similarly reduced.  The world is taking a backward step towards Autarky, the extreme case where each economy is self-sufficient in producing what it needs and the gains from trade are left unexploited.  Robinson Crusoe made do on his desert island but pined for civilisation and a friend or two.

Trade could be the biggest resource cost of the Covid-19 in the long run.  The Wealth of Nations just got smaller…


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Panic v numerical discipline in predicting Covid19’s market impact

“Investment ideas can spread like epidemics.” Robert Shiller in his Nobel Lecture “Speculative Asset Markets” 2013

Bob Shiller’s Nobel winning contribution was the observation that asset markets generally are too volatile relative to theoretical methods for pricing securities.  The panicked reaction to Coronavirus 2019 (Covid19) seems no exception.

I have regularly been asked what Covid19’s impact on markets should be?  This is a difficult question since there are many factors determining equilibrium asset prices. The interesting aspect of the current crisis is that everyone agrees that it is a purely temporary economic shock.  Therefore the transitional dynamics of the initial market decline and the recovery path for asset prices are of primary interest. At the risk of simplifying the problem and betraying the traditions of market efficiency, let me make an attempt at articulating the immediate impact and transitional market dynamics.

Theoretically, the stock market measures the value of the capital stock. Capital combines with labour to produce output, output is paid to shareholders as dividend income which is then consumed. Covid19 has negatively impacted this production process by (i) depleting the labour force (death, sickness), (ii) causing the capital stock to sit idle for a few months as factories quarantine.  Eventually all will return to normal but there will be a short term impact on stock prices from these temporary effects.  Without boring our dear readers with the derivation of the following equilibrium result (1), the market impact, P’-P, of this temporary shock is close to the following,

P’-P = ∑(g’-g)/(1+risk premium)^(t+i))

where g’-g is the critical quantity measuring how far below short term growth g’ declines relative to the long run average.  Thus, if the effect of the Coronavirus is to reduce global growth initially by, say, 1% over 1 quarter and this persists for a few quarters then the impact on stock prices, P’-P, should reflect this.

The interesting question is quantifying these qualitative effects.  This requires a calibration of the Covid19’s impact on the economy. The virus has touched about 1 in 100,000 people Globally, quarantined about 1 in 500 for 14 days and permanently reduced the labour supply by just 1 in 5,000,000.  Taking these facts together, the impact of quarantine on both the labour supply and shutting down production suggests to a short term cost to growth of around 0.5% this quarter and this may persist but decay for several subsequent periods. [At least, this is Goldman Sachs’ expert view!]  Therefore, I set the initial growth shock at -0.5% and assume that the shock persists with a half life of one year.

The results of the model are shown in the two diagrams above. In each case the horizontal axis measures time in years. The vertical axis for the left hand diagram measures the percentage deviation of economic growth and stock prices from their long run trend.  The vertical axis for the right hand diagram measures the Expected Return for stocks relative to long run average.  The left hand diagram confirms one’s intuition whereby the impact on stock prices is about six times greater than the impact on economic growth.  However, the striking finding is that the magnitude of the decline is predicted to be only 3% whereas we all know that the stock markets reacted more violently than this over the last week.  The diagram also predicts a once-off fall in prices followed by a gradual recovery.

Turning to the right hand diagram, the once off decline in stock prices has a temporarily positive impact on future expected returns.  This occurs to induce investors to buy stocks and replenish the capital stock.

One can play with this model, specifying various magnitudes and lengths of time that output growth is affected, as well as introducing more reasonable elements of uncertainty with stochastic shocks (sometimes called Monte Carlo simulation), the result of which is a calibrated distribution of the range of outcomes for stock prices. Again, without boring the reader, I can confidently assert that after this statistical playtime is completed the prospect of predicting a 10% decline in stock prices as a consequence of the Covid19 is statistically zero.  The conclusion is that standard models cannot predict the empirical realities for market outcomes.

So back to Professor Shiller. “Investment ideas can spread like epidemics” seems a good way to explain how the Covid19 epidemic has spread an investment idea that is sometimes labelled ‘panic’.  A feature of the sell off over the past week has been the uniform disposal of equities without much regard for the sectors/countries most negatively affected by Covid19 let alone those pockets that may benefit.  This is symptomatic of blanket de-risking of portfolios which means selling stocks to buy cash.  Panic is more politely referred to as a Risk-Aversion shock which means that the prevailing rate of return on stocks becomes insufficient to satisfy investors, leading them to sell their stocks ever-more cheaply until the future expected rate of return looks sufficiently compensatory again.  In the meantime, the index fund managers liquidate large blocks of securities to meet redemptions and this flows through into blanket selling.

That said, the theoretical models still have something to say about extremes and whether they can be justified.  The calibrated model that we presented illuminates the ‘rational’ reaction given the model.  At least this provides a cool head when panic sets in.


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(1). I calibrated a version of the Basic Neo-Classical model with Utility maximising representative agent, a Cobb-Douglas Production function and a well defined steady state.  The near-steady state dynamics are calculated for a given shock process which causes economic quantities and asset prices to deviate from the steady state equilibrium, in response to which the system returns to its steady state gradually over time.  Asset price responses are the forward looking summation of deviations of capital from its steady state position.  The treatment of uncertainty in this analysis is fudged by appealing to notions of certainty equivalence.  I apologise for this but, my friends, this is a blog not a dissertation.

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An activist in the VC woodpile signals MPT is on its way

Paul Singer, the billionaire activist investor, just announced that his Elliot Investment Fund has taken a 20% stake in Masayoshi Son’s Softbank Ventures.  Activist investors make a living out of forcing efficiencies on inefficiently run companies. Softbank is a legend in VC-land, yet it trades at a 50% discount to NAV.  Masayoshi Son is a superstar investor amongst VC’s yet, were he a mutual fund manager, he would be a laughing stock with a fund trading at such a discount.

What do we make of Singer’s initiative? The simple answer is that Singer is going to pressure Softbank to take steps to narrow the discount by adopting best practice investment principles. But Masayoshi Son is a superstar, the VC investor that every VC investor wants to be – in VC-land he is doing nothing wrong, this is how VC operates.  Singer and Softbank are shaping for a Titanic clash of – well- Titans.

Modern Portfolio Theory has forced major changes on the investment portfolios of institutions and individuals.  Index funds never existed 50 years ago but now they make up more than 50% of the market.  In the 1950s, investors were all stock-pickers, stitching together portfolios of 50-odd stocks or buying 20 of the 30 constituents in the Dow Jones Industrial and Transportation Indices.  JPMorgan’s ‘Nifty-Fifty’ was the staple investment for US Corporate Pension Funds back then and the investments were ‘actively’ managed.  Indexing had not been thought of.

Modern Portfolio Theory made two important observations that has shaped portfolios ever since the field emerged in the 1960’s,

  1. Every security return can expressed as the sum of its market exposure (its beta) and a company component (its alpha).  The beta : alpha mix for a listed security is about 30% : 70%
  2. Passively managed Index funds outperform the average active investment portfolio

These two simple observations are related.  From 1., since every security contains a market exposure and a company specific return, a portfolio of securities builds up its exposure to the market and a collection of ‘alphas’.  By 2, the only way to beat the index is for the collection of ‘alphas’ to sum to something that is greater than zero (after transaction costs and fees).

The result of this thinking turned portfolio management on its head.  Previously, portfolio managers had constructed portfolios by starting with a collection of stocks that they liked and the return that they received was a mixture of market and alphas.  Today, the modern approach is to start with the market return and then step out into individual securities that appear cheap (ie have a positive alpha).  The difference is subtle but completely transformed the investment industry.  The starting point for an investor is to buy the market where possible and to only concentrate in individual securities when you have a good reason to.  For most investors, the likes of institutions and individuals, there is never a good reason to take bets on stocks – markets are informationally efficient and the likes of Paul Singer are all over those opportunities when they arise…

So what does all this mean for VC?  Just as there are undiscovered tribes in the Brazilian Amazon and the Mountains of Papua that have yet to be touched by civilisation, VC is one of the last bastions of investment management that has yet to be touched by Modern Portfolio Theory.  Having only recently been exposed to the practices of VC-land I am appalled at the near-absence of science with which investors and managers alike approach this market.  The typical VC investment portfolio holds 20 or fewer companies, risk-control is driven by draconian rules of thumb (“…we only invest in series A or later …”) rather than portfolio diversification principles and qualitative instincts drive decisions rather than quantitative objectivity.  This is all the more surprising when it is recognised that VC returns are almost 100% alpha driven as opposed to the 70% alpha exposure for listed equities.  The volatility of the sector is gut-wrenching, highly skewed toward complete failure (95% of startups lose 100% of their capital) and informationally asymmetric.

That said, the VC sector as a whole has delivered some eye-popping returns with the Thomson-Reuters VC Index delivering 22% pa since 1996. Investors are increasingly attracted to these returns however the industry is so antiquated that the only way to get exposure is through old style stock picking which is expensive, unnecessarily risky and a shark tank for the uninitiated.

The Singer-Son clash may change the VC dynamic.  Effectively arbitraging the 50% discount of Softbank to its Net Asset Value requires Softbank to (i) liquidate some of its investments and pay out the proceeds to shareholders, or (ii) open-end the fund thereby allowing for subscriptions and redemptions at NAV, or (iii) buying Softbank and hedging its components by shorting the underlying[1].  The Singer-Son clash, however, may get the VC market thinking about how to deliver VC returns in the Modern way.  That is, finding a way to deliver diversified market index type returns to investors who want VC beta and then specialising in stock picking to generate alpha.

There are very few diversified VC funds offering beta exposure.  We are proud to say that we are associated with the Hatcher+ fund (www.hatcher.com) that is designed to deliver beta for startup tech VC by investing in 1,300 startups over the next few years. Traditional VC investors see this as a ‘radical’ approach to their market and are either intrigued or skeptical.  The truth is that the Modern Portfolio Theory train is heading toward VC-land so either you jump aboard or it will run you down.


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[1] Softbank’s two significant investments are its stakes in Yahoo and Sprint Telecommunications, each of which can be shorted.

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Memoirs of a SARSa

As the WuHanFlu pandemic rapidly takes grip, it is worth recounting the SARS crisis of 2002…

The first I heard about SARS was when a taxi driver picked me up with his car door windows completely open. I congratulated him on his appreciation of the climate and rejection of air conditioning which tends to be frigidly standard in Singapore taxis. Rather than embracing the tropical climate, he brusquely responded “the windows are open cos i don’t want to catch the Cantonese Flu”. I thought he was a weirdo but within a few hours the first hints of crisis were emerging.

At its deepest trough , Changi Airport in Singapore hosted only 10 flights in a single day. Usually they cater for 10 flights every 10 minutes. I recall being at the airport that evening when the entire Terminal 2 departure hall was in darkness with just one trolley-uncle sleeping in a chair. Normally there would have been 28 gates open serving thousands of travellers. I had managed to secure a seat on a flight to Australia to serve a ‘quarantine ‘ period and the only reason that the flight had arrived was to deliver its precious cargo of World Health Organisation professionals establishing a beach head in Singapore to direct the crisis.

As it dragged on the feeling for most residents in Asia generally and Singapore in particular, was will this ever end?

In hingsight, the SARS epidemic was bad but it wasn’t like the plague in the Middle Ages that wiped out 1 in 3 nor the flu epidemic of 1918 that killed 50million people. To their credit, the medical authorities and epidemiologists did a fantastic job containing and ultimately defeating SARS.

However, there was some stupidity from which lessons can be learned as we enter the current WuHanFlu pandemic. Not surprisingly, the banking sector exhibited much of this behaviour.

In banking, mandatory regulation and prudent risk management practices require Financial Institutions to maintain emergency contingency plans.  These plans are quite detailed and once activated are rigidly enforced. My recollection is that Deutsche Bank was the first major financial institution to activate their contingency plan during SARS.  Every other major bank responded within hours by activating their own plans as well.  This was all well and good at the time but as the crisis rolled on, there was one detail that had not been planned…how and when should the contingency be DE-activated?

As the months dragged on, watching the game being played by the major banks in contingency mode was fascinating.  Twice per day, the risk management heads for each institution had a conference call where each would state their position.  If one bank decided to lift their emergency status while others remained in contingency mode then they would be an outlier, risking the industry for their own benefit, thereby attracting criticism. This reinforced the contingency position and the whole sector got stuck.  No-one was bold enough to act unilaterally.  Eventually, the government took the lead by stating Singapore would be SARS-free provided there was no new case reported for 14 consecutive days.  Hopes were raised upon reaching 11 days one month only to be deflated when one poor guy turned up to hospital with SARS and the clock reset.  Finally, the 14 days ticked over and the country was SARS-free and contingency plans were abandoned.

Another key player in the SARS crisis was the United States.  They banned arrivals from Asia very early on and somehow remained SARS-free throughout the crisis.  The USA’s insulation from the disease made them unreasonable to deal with since Asian countries were excluded from travel and trade to ‘protect’ the US economy.  Notably, this time around, the WuHanFlu has showed up in the US very early on in this crisis so the US can hardly dictate terms to the rest of the world.

Finally, the most amusing experience I had was being denied entry to India on the basis that I had come from Singapore which was a SARS affected country.  India is an amazing place but travellers seldom leave without being infected with some undocumented microbe, dysentery or typhus-related disease.  To have India deny travellers entry on health grounds was truly ironic!


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ARAMCO’s direct listing arithmetic

ARAMCO, the Saudi Arabian oil company, issued stock at a  USD1.7 trillion valuation last week  and promptly traded up 18% to top USD2trillion. This was in line with the Saudi government’s initial valuation expectations.

This result was achieved essentially by direct listing. I say this since the cap raise was a miniscule 1.5% of market cap. ARAMCO had originally planned to raise closer to 10% of market cap through a network of international banks however the bankers almost unanimously rejected the valuation target that the Saudi’s had suggested. The banks had argued for more of a USD1.2trillion valuation when issuing new shares.

The IPO market is one of the last bastions of financial inefficiency and the Saudi’s determination to stick by their valuation deserves praise. It is well documented that the degree of underpricing in the IPO market is 30% on average, so that investment banks deliberately stuff their favoured clients with cheap stock, which their clients then stag for a quick profit. So when an investment bank quotes $1.2trillion for an IPO they really mean $1.6trillion after factoring in their stag premium.

It appears that this back of the envelope calculation drove the Saudis to dismiss their dealer panel and go it alone. The banking community publicly expressed their criticism of the Saudis based on valuation numbers generated by their captive analysts’ teams but, no doubt, the banks privately bad mouthed the Saudis as crazy and inept in order to keep their clients away from the deal. Depriving the ‘Saudi renegades’ of the international investment community would surely see the direct listing strategy flop, they surmised, thereby exposing ARAMCO as fools and more broadly serving a warning to any other issuer contemplating a direct listing themselves…

…but the fools turn out to be the investment banks themselves. The $1.6trillion inclusive of stag premium is pretty close to the $1.7trillion the stock priced at. This means that the Saudis kept the stag premium for themselves, all $36 billion of it. That is a lot of money…and a watershed victory for the direct listing camp that seems to be growing in importance and actual listing frequency.  In 5 years time my prediction is that direct listing will be the normal approach for any company going public.

One final point on ARAMCO’s decision to go it alone.  The investment banking community seemed to treat ARAMCO as purely a private corporation going public.  In fact, ARAMCO is a sovereign asset ultimately owned by the Saudi people.  ARAMCO therefore had a public duty to their citizens to maximise the value of the asset.  Private shareholders make decisions to go public for many reasons and they internalise the costs versus the benefits as they are the asset owners.  ARAMCO, on the other hand, are stewards of their nation’s natural resources and it is not for them to simply pay a 30% premium of their country’s wealth to a group of international bankers. This point is lost on every commentator that I have read.  Full marks to the Saudis!


A comment on the UK election…

Well, we were correct in predicting a clear triumph for Boris Johnson but the Labour Party route turned out to be deeper than anticipated.  The mischief vote in favour of the Tories sends a clear message to the UK Parliament that the electorate thinks it is an inept institution.  Irrespective of whether they voted for or against Brexit, the UK electorate was aghast at how their representatives cannot follow a simple instruction.

The US Democrats should take note of this dissatisfaction and disenfranchised attitude toward elected representatives.  Our long-range prediction is that Trump and the Republicans sweep the elections in 11 months time for this very reason.


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