Panmure Gordon

I am already forgetting to keep to my rule to blog before trading, so catching up with today’s trade: the acquisition of Panmure Gordon for the Obliquity Stamps collection.

The rationale is simple: it seems a reasonably well run business with a solid balance sheet, on a very cheap rating on classic value metrics, probably due to the cyclical business and recent acquisitions. It also diversifies me a bit from my usual fare of packaging companies and pipe manufacturers. On a macro level it could benefit from big banks withdrawing from some areas due to regulatory headwinds.

Back to the future: AIM 2012 IPOs

Morning mist in burn forest

Burnt Forest (credit: Charles Peterson, petechar on Flickr)

Talking of AIM IPOs, on a tangential point I’ve been looking at the historical list of AIM IPOs and been through all of 2012 ones, to see if there was something to be learned from their fate 3 years later. Taking out investment vehicles, Chinese/Malaysian companies (mostly frauds, very fashionably that year) and resource companies (oil and gas, miners, not all fraud but a lot of dodgy stuff and I’m not covering that sector) we’re left with just 10 companies still standing. A couple of the 2012 listings apparently got taken over legitimately, and a couple of bankruptcies might have been non fraudulent failures but what a track record.

I’ve been wondering if there might be modest alpha in a simple “IPO survival” strategy. It seems the get-rick-quick schemes drop like flies quite quickly. The remaining businesses are probably legit although it’s still a mixed bunch. It may have been a bad year.

Here’s the list of 2012 AIM IPO survivors (ex invest. cos, China and resources):

Name Sector
VENN LIFE SCIENCES Health Care Providers
GOOD ENERGY GROUP PLC Alternative Electricity
REVOLYMER Speciality Chemicals
BELVOIR LETTINGS Real Estate Services
UTILITYWISE Business support services

I’m trying a new policy of blogging every trade in the Obliquity Portfolios before they happen. I usually can’t be bothered after the event, and writing things down helps keep a record and concentrate thoughts, and possibly avoid extraneous trading.

Talking of which, let’s start with a news trade today, selling Volkswagen. See the press for the fiasco regarding software hacks used to fake US environmental testing. This is a bit late closing the the stable doors after the horse has bolted, but I also have some long term rationale:

  • I’m in a slow tidying up process away from non-UK/US stocks in Obliquity London due to costs
  • Volkswagen breaks my family/close control portfolio rules
  • It remains a good brand but I have some doubt about their world domination plans, they may be trying too hard

On the actual current news, it’s hard to price. The raw cost of the regulatory proceedings are likely to be smaller than the headline maximum figure, which is what the market seems to have priced. The fine may be lower, but the reputational damage may be worse, even if it turns out it was just a rogue middle management initiative. If it’s symptomatic of a more widespread culture, the downside is increased even more. On the other hand it could well be forgotten in six months after profuse apologies.

From a market psychology viewpoint, uncertainty tends to depress the price for a long time, and inertia is such that bad news tends to take some time to be absorbed, so it’ll probably get worse before it gets better.

One amusing thing is that the CEO hasn’t resigned yet. I’d be surprised if he’s still there by the weekend. Even if he did not authorise it, I can’t see how he could survive that.

I’m a bit tempted by FIAT Chrysler as a replacement but the US listing is not tradable in this UK account and the Milan one has the cost issues, so will skip that for the time being.

Edit: given the huge moves during that day I’ll add that my price was a fortuitous €125.

Private equity shops are known for buying businesses on the cheap, taking them out of public markets (if they were listed), trimming costs, often throwing the baby with the bathwater by eliminating investment and cutting beyond what makes the company’s product valuable, then loading with debt and then reselling the thin equity slice at a premium based on inflated valuations based on short term accounting effects, which is rarely a good deal.

I think a mirror strategy could work well, as well as being compatible with virtuous and constructive investment:

  1. Buy the minimum stake required to control (change management) a distressed but salvageable listed company
  2. Change management and/or business plan (as normal)
  3. Cut dividends if any, announcing no dividends until turnaround
  4. Reinvest all the cash flow into repaying debt and/or reinvesting in the business
  5. Book capital investments as expenses as much as accounting regulations allow to reduce earnings
  6. Watch the price sink as earnings are zero or negative for the few years that the turnaround requires
  7. Buy more shares at depressed prices (ideally below price paid at #1)
  8. When turnaround complete, watch earnings go positives, reinstate dividends, etc
  9. Sell the fit business at a premium when price as converged with fundamentals

(Inversions from classic private equity shown in italics.)

It’s a form of arbitrage of both classic investor expectations and statistical arbitrage automated strategies that both (over)value short term earnings maximisation, to whom the business will look worse than it really is during the “buy more shares” phase. And as a long term strategy it should be pretty good to other parties like customers and employees.

Much has already been said about the Greek “deal”, most of it unsurprisingly negative. No question it’s a sorry deal in many ways, but I’ll skip that today and try to cover some of the positives.

The Eurozone’s future is now on the table

It has been long known that the euro can be seen as two very different projects: one is a building block on the way to some kind of Federal Europe, the other is a purely technical shared currency, which is doomed to be a form of synthetic gold, because the strength of such a currency is the binding factor — otherwise the stronger members will leave.

Deciding where to go has been procrastinated since 1999 and absent any crises looked like it would be forever. But this crisis has put the debate back on the table. It could still simmer for a while, but I think the debate has advanced more in the past few months than in the last decade.

The historical track record of loose currency unions is abysmal, so if federalism doesn’t progress, we’re probably in for an implosion, if possibly a slow one. I would still bet on (some form of) federalism winning the day in due course.

The Greek debt sustainability debate is over

Today’s Draghi comment that a Greek debt write-off or some kind or other is “not controversial” reflects the speed at which the official consensus has changed. It’s striking that everybody, from the IMF to Schäuble, now agrees on that, despite being a total taboo at least in official speech a few short months ago. Varoufakis has at least comprehensively won the argument here, if not yet a solution.

Defaulting on the IMF was very useful

The catalyst for the above may have been the default on the IMF. Funny how now that the option is full default or a write off by other official creditors, the latter has become their top priority.

Also the silly long term GDP extrapolation modelling methodology has flipped to Greece’s advantage. Now they extrapolate 2 weeks of capital controls to an exhaustive disaster for the next umpteen years.

As such I don’t think a few weeks of capital controls are that bad. No actual production capacity is destroyed, people can go back to work doing whatever they were doing before when it’s over. It could push a few marginal businesses to bankruptcy but I don’t think you can project much out of that. Out-of-model factors will surely have an order of magnitude greater influence on the final outcome. The good thing is IMF models will now probably tend to underestimate Greek recovery, pushing for a better (than otherwise would be) deal.

The deal is technically pretty open

The deal is actually quite open. Everybody seems to expect Greece to get smashed, and it could, but if the politics follow it’s also possible for the deal to produce a reasonable outcome, e.g. the open-end negotiation on debt rescheduling going somewhere decent.

The deal does buy time

As a 3-year deal, if it doesn’t fall on some technical hurdle or outright sabotage, it does leave time for European politics to mature. It would get a bit easier if Tsipras’ Greece wasn’t the only unorthodox (in being of a Keyneysian and somewhat federalist inclination) government in power. In a positive scenario you could imagine both a shift in PIGS and greater tolerance in the Northern countries. It is still pretend and extend, but if we can pretend and extend until the next treaty, and that’s in 2 rather than 20 years, good.

Here and in its open-ended character, it is better than the “referendum question” deal.

Merkel has still not spent any political capital on this

Merkel’s approval rating hasn’t been dented at all and she has effectively not used any of her large stock of political capital, indeed may have again increased it. That can be seen negatively — reward for being tough — but also positively — the “kick the Greeks out of the Euro” constituency may be losing out in Germany.

It also means she’s got capital left for an actual compromise and or federalist steps. Not a given she will use it, but the outlook could be worse.

Benefits of capital controls

As a parting shot I’ve noticed a few positive side effects of capital controls:

  • people with some savings allegedly accelerated paying off debts or taxes, as a bail-in risk mitigation, thereby improving the position of the state and banks, contributing to offsetting some of the negative impact
  • nearly everybody in Greece now has an ATM card (some bank branches were open for that issuing cards) and greater access to online banking
  • it shows how an emergency (semi-)exit could work in a currency union: keep the union currency for paper cash, and use trapped banking currency as a new digital-only currency, by just replacing the exit/ATM limits with an auction system, aka a forex rate between the trapped digital deposits and the union currency

Frances Coppola tries to understand why Greece’s creditors are apparently so stuck into recommending policies that are economically irrational for all parties. Her hypothesis is that the main players see the current programme as punishment — on a moral level — for Greece’s past misdeeds. While some people certainly think like this, it seems a far fetched idea that this explains the situation, or that it is the majority view of the main players.

Theoretical Plurality

First, while I broadly agree that a debt reduction and a stimulus programme (or at least no more austerity) would be best in the current circumstances, I don’t think that this view is universally agreed. Macro-economics is the study of complex highly interdependent systems and our analytical toolset, both theoretical and empirical, is extremely inadequate. Nobody knows for sure what works and what doesn’t. Everybody is making educated guesses, often tainted by ideological bias — when competing models are a draw based on facts, it’s only human to choose based on ideology.

So I believe it’s still possible for some to believe fiscal rectitude and austerity work. It’s all a question of degree: every measure under consideration, taken in isolation, works some of the time to some extent. Is it unbelievable that the like of Wolfgang Schäuble still genuinely believe more austerity would produce the best long term outcome for the Greek and European people? A hint is in the whole ‘schwarze Null’ nonsense, which is about applying a similar medicine to Germany itself. The negative effects are less drastic given Germany is doing okay at the moment, but are still negative in what Frances sees as ‘obvious’ economics. How to explain it then? Self punishment? I don’t think so. One can be rational — as much as one can be talking about economics — and accept the Washington Consensus, as one can be rational and reject it.

Institutional Inertia

Still, is this view that of a majority view of European policymakers, or even the insiders in the institutions? It’s not so obvious, many insiders, prominent academics and finance professionals are on record supporting what we could call the Varoufakis View. Still the institutions remain inflexible. My bet here is that the main culprit is institutional inertia. There’s nobody in the IMF, or in the European Commission, who is in charge of Theory.

Weak leaders like Lagarde, Moscovici or Juncker seem to consider it’s above their pay grade to discuss theory or make any change to the orthodox models their institutions have been using for the past few decades. Everybody under them follows — while on official business, despite some being critical in research papers or in op-eds as ex-staffers — and there’s nobody above them. Minister or head of state level meetings, as Varoufakis has reported, are not places where theory is debated. My view is thus institutional inertia is the main culprit here. The IMF is on autopilot, and it will take some grave trouble for someone to look at the settings of the theory autopilot. A little default on June 30 could well be cathartic.

This is also true at the Eurogroup or European Commission level. The orthodox model is embedded in treaties and the rule set underlying the Eurozone. And renegotiating treaties is hard. Still, it will have do be done, or undone, some day. The current setup is extremely fragile, and if it doesn’t fail during this crisis it will fail during the next.

Both the IMF and the Eurozone are in dire need of structural reforms.

Where’s SuperMario?

The ECB has been remarkably neutral. This can be seen when both sides claiming to have it against them. The Greek side complains being on a tight leash, and they are (no short term financing tricks allowed, ELA allowance always kept to a few days’ worth) but then the orthodox side sees an ever increasing ELA liability — that can be defaulted on in case of exit — that they think should have been suspended, and capital controls introduced, long ago. The official ECB position that Greek banks are solvent with a liquidity problem is a bit farcical to be honest. But maintaining that farcical position seems an astute way to spend the minimum political capital required until a deal is made at the political level. My bet is that Mario Draghi may have taken Varoufakis’ side, but his hand depends on everyone — including Varoufakis himself — not realising it.

It’s to note that a Greek IMF default may be considered a positive for the ECB, as it may help push the commission/eurogroup to do the obvious debt swap and move the shortly expiring Greek bonds off its books and onto the EFSF/ESM, giving more room for manoeuvring by eliminating the risk of outright default on the ECB — which would make it possible to do whatever it takes to keep Greece in the euro.

German bonus ball

It’s really a sideshow, as only some of the players in the Greek drama are German, but I think there’s a great cultural misunderstanding when outsiders blame Germans for being moralistic in a punishing way. First, the whole idea of being externally moralistic towards other cultures is quite alien to the whole postwar German culture, for very obvious reasons. Second, there seems to be a weird Germanic view of causality that’s easily mistaken for morality but is really purely functional. In a nutshell, the person who causes damage pays for it, regardless of whether the damage was intentional or accidental. It’s pure causality, free of moral loadings. Third, the bias towards austerity and balance sheet prudence can be observed in many aspects of German life, including people’s sex and love lives. And who could argue that excess savings in the bedroom are directed from the Bundesministerium der Finanzen?

Chaos German Style (paperclips) Advert

A sense of humour

Reverse tax lotteries — taxes where a basic parameter (the amount, the taxpayer) is chosen randomly — are an interesting concept which may have a wealth of applications. Maybe there’s a series coming here.

Today’s instalment is about using taxes as a regulatory device to control for financial concentration and increase risk awareness and management among market players.

Financial products are not aircrafts

One problem with the mainline approach to financial regulation is that it’s aimed at trying to find fragile features of the financial system, and then regulate around the fragility to make it impossible to happen. This is basically the aircraft industry’s approach to safety. This may not be such a good idea in finance because financial failure are as such not as catastrophic as a plane crash. Finance is about bookkeeping units of future resource allocation power, where failure causes more subtle problems — sometimes not even system-level negative — than a plane crash. Secondly in finance players are often trying to work around the safety procedures instead of consenting to the safety imperative as pilots and maintenance technicians generally do.

Regular failure

What best to teach people to cope with failure than having it happen frequently enough for it to become a manageable habit? Incandescent light bulbs fail frequently, so cars have two headlights, so they can keep operating at night should the predictable failure of one light bulb occur. The statistical chance of both lights failing is small enough, that one can take the small residual risk of having a complete failure between the failure of one lamp and its replacement.

In finance the solution to such issues is diversification. If one’s savings are split between 100 issuers, the failure of one of them is a non-event. Unfortunately, some classes of financial instruments, e.g. the quality end of fixed income, fail so rarely that people often forget they can fail, which in itself is a contributory factor to them failing en masse during systemic crisis.

Probabilistic bankruptcy

So, a way to remind people of that failure risk is to have forced bankruptcies: have the regulator pick some random issuers every so often, and simulate a bankruptcy, by taking all their assets and closing them down. Applied to equity for instance, this could be done by expropriating current shareholders of the randomly chosen company, and redistributing new shares via an IPO whose proceeds are tax revenue.

It’s a nice way to add some tax revenue as well, which could substitute some of the existing non-probabilistic taxation, of fund new public goods as desired. Alternatively this can be do in a tax neutral way, by redistributing the proceeds of the levy to the remaining players.

This tax could be applied to all asset classes, e.g. just pick 1% of all available financial products every year and fail them. For risky investments with an intrinsically high failure rate it will just be barely noticeable noise, and it spares the regulator the arduous and hazardous task of having to classify instruments.

In addition to reminding people of bankruptcy risk, by effectively introducing a floor to the level of total loss risk, it is a strong disincentive against having large single points of failure as nobody will want to put too much in any single basket.


Some potential problems with the measure I can think of: this can’t be applied to brokerage-level institutions unless end consumers of financial service are required to diversify brokerages or bank accounts — although maybe that is desirable! Exempt brokerages  could help my making it easy to split savings or investement into diversified portfolios (e.g. replacing single-point of failure ETFs with auto-rebalanced direct holdings of the underlyings).

It does not remove the risk of systemic misinvestment into asset classes represented by many instruments, e.g. if wouldn’t prevent sector bubbles. Still the higher background level of failure may have a slight moderating effect on the psychology of exuberance.

As with any new tax, the argument would be made in any jurisdiction introducing it first that all the money would leave. I see no reason why it should be the case at a reasonable level, the tax load is not in essence that different from say stamp duty style taxes. Indeed in the UK it could replace stamp duty and be levied at the same rate of 0.5% (but here of instruments’ market cap rather than trading volumes).

London holdings up to date

I’ve belatedly updated the Obliquity London portfolio page in the same style as the other (holdings, reweightings, disposals tables) with up to date data, which shows the full history of the portfiolio. Most of the slow movements have been reported in blog posts but the page wasn’t up to date pending an ever procrastinated automation. No automated process yet but this is backed by a little toolset I’ve been building in numeric Python (pandas) which should make future reporting easier.

IRR benchmark units reporting

The concept I’m playing with at the moment is using IRR (Internal Rate of Return) on cash flows expressed in benchmark units. That is for any given position I extract all the cash flows (trades, dividends and corporate actions), which I get from my broker in sterling, and then convert them in accumulating units of a benchmark ETF, as if it was a currency — remember that in essence any tradable paper is a currency. So each sterling flow is translated to an ETF units flow at the price (“exchange rate”) on the day of the cash flow. This shows the balance someone doing nominal accounting in benchmark units, or equivalently using the benchmark as their “cash” asset, would see.

This makes relative performance very clear: the sign of the nominal PNL (portfolio value change) tellls you if you have out- or underperformed the index. Basically if you had funded every buy by selling units of the benchmark, and bought them back on sales, it tells you if you’d have more or less units following trading than passively sitting on the benchmark units.

The use of the IRR also implies a normalisation of time effects, to capture that a N% change over 2 years is not the same as N% over 2 months, which is hard to see in classical nominal PnL reporting.

Stamps IRR charts

So here are a few of the result for the small cap London Stamps portfolio, valued as of 2015-05-08. This is early software so subject to errors and bugs, the numbers have merely passed a plausibility test.

The benchmark is iShares MSCI UK Small caps (CUKS) which is a good substitute economically (I’d happily buy it as a replacement allocation if I stopped playing stock picker in this segment) though a relatively poor short term benchmark technically. The reasons for that is that it uses a worldwide definition of small caps, which basically in the UK market captures the bottom of the FTSE250 — which are traditionally viewed as midcaps in the UK markets — and the top end of the local small caps section. So the average market capitalisation is significantly higher than my mostly AIM oddballs stock picks. A pure AIM index index wouldn’t be a good benchmark either as it would have a would bunch of junior resources stocks and overseas scams that I don’t touch, and I would never buy an AIM index as an economic substitute. The MSCI methodology is pretty good at excluding the darker corners of the market, so it is a valid benchmark in sector and industry terms.

Predictably the portfolio as a whole has underperformed by almost 10% since inception in money weighted terms. We’ll blame midcaps doing well while really small caps had a lacklustre year and say the jury is still out on my stamp collector skills or lack thereof.

Now, let’s do some digging down. Here is the IRR of each stock since inception, including closed positions, as a monthly return in benchmark units.

London Stamps IRR Ranks 2015-05-08

This is not very precise chart because the more recent positions produce outlier IRRs — the computation makes less sense in the very short terms. This excludes positions younger than 100 days (only AMD at the moment).

Other than that no surprises really, and apart from the GW Pharma pot bubble the next winners are tech companies that got taken over (indeed I held them for relatively short periods).

Now let’s watch our underperformance by plotting an histogram of these same returns (with AMD back in).

London Stamps IRR histogram 2015-05-08

So we’ve got the reasonable level of symmetry, as predicted by theory, the problem is only that zero is on the wrong side of the chart for the time being. It’ll shift if the performance reverses.

A thing to note in these charts is that the average monthly moves are not big, mostly within the -5/+5% range, which implies that with the typical spreads in small and micro-caps, long holding periods are essential. This is well known but nice to have another confirmation. Anyone flipping their portfolio every couple of months, in addition to having trouble to find alpha, would get trounced by transaction costs. It should also mean that long term returns should be better, so let’s do a little trend check by plotting our returns against holding period (remember this includes closed positions):

London Stamps IRR Age plot 2015-05-08

That one looks good. Patience pays so far.

That’s all for IRR analysis for today. Let’s finish with a little check we don’t have any undue overweight, with a simple visual check of portfolio weights for current holdings:

London Stamps weights 2015-05-08

So far so good.


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