Blue sky machines

I’ve sold Seeing Machines out of the stamp collection because it doesn’t pass the profitability (net income > £1m) and is a bit too blue sky for my current taste. It is progressing, I like their strategy of making the product — driver attention monitoring through eye movement detection — a reliable discrete chip, but it’s on a pretty dear valuation and break-even still seems some years away. It could be bought by a larger auto component maker, but it’s on a pretty full valuation so probably not at a large premium. On the downside the market may lose patience waiting for break-even in a downturn. I definitely wouldn’t buy now at this price, so I can’t justify keeping it — only very illiquid cases can justify breaking the “sell what you wouldn’t buy” rule.

Too early

I probably invested too early here which is something that happens several times during the early years of the portfolio. There was a fear of missing out that the price would immediately catch up whenever improved prospects would be announced. In practice, for both blue sky stocks becoming successful and turnaround situations the market seems to be usually slow to take in a new situation. Even if the stock jumps 10-20% on a good announcement, it usually takes longer to catch up to a normal valuation. It makes sense behaviourally: a low valuation and some bad years means a lot of disillusioned investors, who may not be keen to change their mind, and you’d need a lot of new blood to overcome them. The profitability rule is a simple way to catch that effect, as stocks become investable on the way up, as well as avoiding all the perennial losers that never make a profit. It will miss some who re-rate early.

Hodge Podge

Also sold Scientific Digital Imaging as I’m not that keen on the current strategy of aggregating vaguely related small companies without integrating them (same as Judge Scientific). In the long term this rarely seem to do very well, as the acquired companies sometimes lose focus with their founder(s) replaced by financial engineers. Not sure why I missed this when I bought, which is an error of sorts, if a profitable one in that particular case, which has done pretty well since being acquired.


As the small cap strategy matures, I’ve decided to increase the position target size. This is done by not trimming or selling stocks that have done well, and increasing positions in stocks that are lagging and that I still like to bring them to the new target: so I added to Touchstar, Low & Bonar, Walker Greenbank, and Aukett Swanke. In the large cap portfolio I added to Pearson for similar reasons.

Boring Billing

Last action was the acquisition of Cerillion, an old Logica spin-off which seems to have a decent strategy and down to earth management. Another of these entries on which there’s little to say, and that is good.


The various basic income proposals floating around are often criticized for being unrealistic, and let’s face it, they often are. In a recent column, John Kay is asserting that “either the basic income is impossibly low, or the expenditure on it is impossibly high.”

This includes an implicit dismissal of the Keynesian arguments — that the basic income would create demand that would snowball into economic growth — of some basic income proponents. I happen to agree that this aspect is unlikely to deliver miracles, so let’s assume no such effect here.

Too high

It’s easy to agree that spending half of GDP on basic income would not be acceptable, but it’s also a good problem to have: humans are scarcity animals and do not work well when too far from need, as can be seen in the often sorry state of people benefiting from windfalls (third generation heirs, lottery winners, small “first nations” in rich and guilty countries, etc). Thus a basic income should probably be high enough to remove fear of survival (food and shelter) but not to so high as to remove the need to get out to the world to improve one’s lot.

Impossibly low is desirable…

In Western countries what some would describe as “impossibly low” does provide pretty decent survival standard. The Ikea/Lidl/Primark lifestyle is pretty okay, and way more comfortable than what the richest slice of society could afford a century or two ago. So a basic income in the region of say $500 a month for a tier 1 developed country would probably do the trick (assuming social housing and healthcare are not subsumed into it).

… and possible

Would simple arithmetic work for that? To design a realistic basic income we need some premises:

  • Assume the net expense on welfare remains constant, because it reflects what a society is ready to accept in redistributive pressure. This allows isolating the effect of the basic income as a redistribution technique from other ideas about changing the amount of redistribution (which can be done through any mean).
  • Assume the wealthier members of society (say the top half) do not get richer out of it, that is the (income) tax system is adjusted to increase the tax they pay by the amount of basic income they receive.
  • Some existing welfare mechanisms are abolished (such state unemployment benefits, child benefits) or restricted (e.g. pension age could be pushed forward) as the basic income replaces them.

Then what basic income is possible? It’s simply equal to:

basic income = removed welfare services budget + tax equalisation

Detailed number crunching would be required, but I’d expect it to come to $300-$600 per adult, again for a tier-1 developed country.

The main variable here is what services get replaced (and to what extent) by basic income so it computes at all times.

Radical realism

A realistic scenario is probably better thought with social housing, public education and public healthcare arrangements untouched, but the basic mechanism also applies should someone wish to privatise some or all of these services: then the fewer services are left, the closer you get to a basic income equal to the tax take, though the higher basic income might then buy less, depending on the distributional profile of each service (a most tricky issue on its own).

What are the benefits of a survival income?

A survival basic income wouldn’t abolish poverty, in so far as this is more or less defined as inequality — how much less one has than others, rather than the absolute level of what one has — but still have some interesting properties:

  • Improve the bargaining power of low-paid workers not forced to work for mere survival
  • Remove net tax discontinuities (being a net loser when taking a low paid job)
  • Simplified administration (some)
  • Increased acceptability of redistribution

The welfare illusion

The latter point is perhaps the most neglected while the most powerful point in favour of basic income. It makes no difference in pure economic terms whether the cash flow between the state and the citizen is done through tax or benefit payments, it’s the net that matters.

But, like with the money illusion in the monetary realm, optics matter. This can be observed today in the difference in perception between universal benefits (like child payments and some healthcare in many developed countries) and means tested ones (typically unemployment and safety net income). The former are often popular and well accepted, even by net payers, while the latter are seen as prone to abuse, and divisive. A basic income, even if compensated by tax, would probably quickly become part of the societal furniture.

Even if it was the only benefit, it’s probably worth doing for that alone.

Here’s an app idea: make an app, let’s call it Ubercut, that allows Uber users to shortcut Uber and avoid paying the fat commission.

How would it work?

The app would run in the background on a phone and detect if the regular Uber app is running in the foreground. When it is and both a driver and a punter are using it at the same time, and are within pickup distance, it sends a notification of the type “you guys may want to make a deal” to both parties, e.g. doing the ride but for 90% of the fare suggested by Uber (splitting Uber’s 20% comm) and allows them to communicate, thus bypassing Uber before initiating a transaction. A comprehensive hijack would “read over” both user’s Uber screens to send notifications only when there is an exact match. This could be quite tricky or impossible to implement, but a simple passive version (“running the app at the same time and near in space”) can be done relatively simply, at least in Android.

The contracting parties would lose the benefit of the protection afforded by Uber for on-platform rides, but most such platforms mainly work hard on their disclaimers when it comes to cover unwanted trouble. Third party insurers could also offer cover the weary, for a fraction of an Uber commission. The Uber reputation system would still be operational as this is pure freeloading — no ride are initiated in the app directly (in the simplest version of the concept, one could also couple it with a cheaper or peer-to-peer matching platform).

What’s the benefit?

Disruption! Uber and other trading platforms that are dominant collect economy rent due above the cost of operating the service because of the network effect — it’s a winner take all game. This is a classic market failure. The existence of shortcuts would probably contribute to cap such rents.

Would it be legal?

If Uber lawyers haven’t anticipated that, we can be sure they’d add a ban to their terms if such an app becomes popular enough for them to notice. Would people care? Maybe, maybe not. Could they could sue their clients and drivers succesfully? I know not.

Would it be moral?

Unambiguously yes I’d say, as it is merely about applying Uber’s philosophy (disrupt incumbents, ignore the law, etc) to Uber itself.

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.

One thing I think Bitcoin, or a similar blockchain-based token system, may be useful for is to replace centralised social networks, or more broadly messaging systems.

A core if oft forgotten feature of a social network is how it manages spam and other forms of network abuse. One solution may be to exploit altruistic punishment, a tendency people have to want to correct bad actions even if it’s not in their direct private interest to do so. In familiar terms, people seem to enjoy pushing the “dislike” button even if they get no personal benefit.

How could one devise a cryptocurrency transaction type that cab be used to harness this effect?

One possible way is what I’ll call “altruistic destruction”. The basic idea is to have a transaction that can cancel some of the recipients’ funds, that is enriching everybody else, through the reduction of the monetary base. If this is free to the sender, this is open to abuse — though whether such abuse would be common could be a subject to interesting experiments — so a compromise might be simply that both the sender and recipient destroy some tokens. As a base case a simple matched ratio may do. The altruistic destruction transaction semantic would be as follows.

When Alice sends to Bob an altruistic destroy for N tokens,

  • Alice’s account value decreases by M tokens.
  • Bob’s account value decreases by M tokens.
  • where M = min(N, Bob’s balance)

M copes for the case where Bob’s has fewer token than N, assuming the token system does not allow debit balances.

In paper terms, this would be equivalent to burning a bank note with the name of a miscreant on it, where through some magic burning the named banknote would also make a banknote of the same value vanish from the miscreant’s wallet. Economically this reduces the total amount of banknotes in the system thus making holders of the remaining banknotes richer (like simply burning one without magic does) everything else being equal.

For practical use in a spam control system, this would have to be implemented with policies that uses minimum balances as condition of message transmission — a distributed deposit system of sorts.

There may also be other application of that transaction type. The ratio of destroyed tokens between sender and recipient may also be toyed with, but 1:1 may be special in that the cost of inflicting damage is equal to the damage individually, while the social benefit is leveraged: destroying 1 of one’s tokens produces 2 tokens’ worth for the community, and the punishment’s social value is free on top of that.

Following a surprisingly well written Business Insider story on Google, I ended up watching this TED Talk from Larry Page:

Google's Larry Page at TED talk

Larry Page (credit: TED)

First, it’s nice to notice that a nerd with even less charisma than yours truly — no mean feat — can get that far. We can also dispatch that what he’s doing is obviously interesting, and the question whether it’ll end up being unadulterated good or a case of hell being paved with good intentions will likely remain open for a long time. I would like to comment specifically of how it impacts the investment case for Google, the listed company, and more precisely what it tells us about property rights, which are so often misunderstood.

From his talk, background and biography it’s clear that he’s on a mission to change the world. Operationally Google is really an applied science research foundation, trying to find novel solutions to hard problems with direct application in human life.

The search engine, or any profitable business they might stumble upon during the process of research, or otherwise, are like an endowment — providing funds for further research, supporting the foundation in perpetuity or until it runs out of fund trying. This is very admirable as such, and good for them, and possibly society at large, that they can do that. I’d happily do the same if offered the opportunity. It’s also refreshing to see a US corporation not fixated on quarterly “shareholder value”, often in such a myopic way that actual value gets vaporised in the process of trying to hard to maximise it directly (John Kay’s Obliquity idea, again).

In that context though, it doesn’t make sense for Google to ever return funds to holders of the equity, as it would impair Google’s primary raison d’être and goals as a science foundation.

Prudently, the Google share capital is structured in such a way, more often encountered in Italy or Sweden, that a small number of magic closely held shares have overweight voting rights, to ensure that Larry Page and the other founders control the company, and not the flimsy public shareholders. Holders of the lower ranking common shares have effectively no vote and cannot remove or change Google management.

Such shares a are a funny product: they are not classical equity with an interest in the company’s governance (where holders of the paper can use their vote to bargain for a share of the company’s successes, or sell them to someone who will) nor notes with predefined returns like in the case of bonds. Perpetual zero coupon bonds, maybe.

The only case where the company’s principals need to care about the market (second hand) value of such shares is when they either want to raise new money in this way (issue new such shares) or sell any existing such shares they issued to themselves in the past (exit or some form). Indeed apart from regulatory reasons that encourage large US corporations to be listed, the main reason Google is a listed company seems to be that the listing provided a way for the early venture cap investors to exit.

In that context, valuation becomes a really funny game. Google B shares being unlikely to pay out, a discounted cash flow model, of whatever kind, does not apply. The shares are more like a museum membership scheme, designed to promote but not own the institution, in exchange of a feel good factor and possibly status for the member. It is thus remarkable that many people still look at Google shares as if they were full voting shares of a for-profit company. Google’s profits, EPS or financial metrics matter very little yet the market still reacts to these numbers, if with its usual capriciousness. One could argue that there is a chance that successors of the current leadership, some decades from now, may turn the foundation into an ordinary for-profit common stock company and that the current price represents the discounted probability of that happening, times the financial valuation at the conversion point. My guess though is that It should be much cheaper than it is now, if one follows that view. Indeed the “risk” they do research that may not turn into profitable products (even if it may change the world) seems pretty substantial.

This though does not lead us to any obvious exploitable effect, other than making Google uninvestable for outsiders as a credit product. If the shares’ price freely follows the mood of a motley crew of people who don’t understand the structure, and supporters of scientific research, it’s a tough game to make predictions of how it might evolve.

An Abundant World is asking in a comment what evidence I have for my claim we’re at a peak in the “low risk” behaviour, aka that we are at or just going past Peak Pessimism.

I was tempted to just answer “gut feeling”, and it’s largely that, but digging around I think I have some facts to back it up to some extent. Note though that it’s of course a biased selection in favour of my argument, and it’s not hard to find some counterfactuals. How they balance is where it’s hard to do any better than gut feeling.

The US investors “rotation” (from bonds to equity)

The argument has been made repeatedly and better than I can by the Reformed Broker who has close contact with key constituencies like his clients (high net worth individuals) and industry insiders. This also seems consistent with the general background noise in US-centric media.

Corporate deleveraging is (mostly) over

One great advantage of doing stock picking is that it forces you to be in touch with how businesses are doing on the ground — if through the rose tinted glasses of management reports. My view is somewhat biased because I’m primarily looking at UK-listed corporations. So this is subject to a “London view” bias, even if I select primarily companies with a world or at least European presence. This limitation notwithstanding, I have observed that the sharp change of mood in 2008-2009 from “leverage is good” to “we have too much debt” has essentially run its course. This seems equally true in the relatively few non-UK large caps I look at. The U-turn was sharp and violent — and with everybody doing it at the same time, it’s no surprise there’s been a world recession — but now it seems to me that most companies (which could afford it) have reasonable balance sheets, and more importantly now debt is at reasonable levels (or below reasonable if you’d put it in an a mathematical optimisation framework, for tax reasons if nothing else) management seem to have switched their mindsets from “reduce debt” to “keep it under control”, which is just a notch away from proactive optimism-driven investing.

Bubble virgins

That idea came to me from an article in Handelsblatt about German youth’s (people in their twenties) preferred savings vehicle being the plain bank savings account (which as we all know pays inflation at best, if you chase special deals). This made me realise that there’s a whole generation that has grown up without participating in any sizeable financial craze. The last properly bubbly event on the financial markets was the dot com/tech bubble, which is a good decade ago now. Outside Germany, this younger generation has seen a property bubble in many countries, but mostly as spectators, and it should be easy to sell them that non-property asset classes are different. I think this is a great tail wind for any potential financial asset/sector bubble. It would be a great surprise that this generation doesn’t get to take their turn at the “this time is different” game, like every one previous.

The nominal yield effect

While this is really just an iteration of the money illusion, lot of people are enamoured with the idea that bond (risk free) yields “have to go up”, just because the nominal yields are lower than average they’ve seen during their (investing) lifetime — conveniently, outside Japan you can pick any period and it works to some degree or other whatever backward looking period you choose. This is another push towards “high risk” assets, just to escape the expected “reversal to mean” in “risk free”. This view is based primarily on nominal optics (good luck trying to extract a fact-based narrative from these people) and as such a background force away from anything “risk free”. Being a nominal effect it’s also immune to fundamental changes: it applies regardless of changes in any fact-based scenarios on rates paths.

The 3/5 year rear view mirror effect

Many financial tools, and most forms of historical performance assessment exercises are by convention based on looking at 3 to 5 year time periods, or shorter. This means that the 2009 trough will soon drop from the charts and all people will be seeing is a perennially up trending market, with the odd gentle correction to avoid frightening those who, rightly, would run away from exponential growth.

Troll fatigue

That’s the simple observation that inflationistas, gold bugs and other survivalists are getting increasingly unable to justify why Armageddon is taking so long to happen. Enough defections at the margin, of the less vocal followers, is a great push towards less risk free investing.

Small anecdotal fun “evidence” here: Zero Hedge is going out of fashion apparently.

Structural reforms work slowly

This is perhaps most relevant to the Eurozone: the main problem with structural reforms as a policy tool is that they work very slowly and they often make things worse first. For example on core/peripheral wages convergence we’re probably 2/3 done, but it took 5 years to get there. Export-centric policies are disastrous in the short term when everybody tries concurrently, but once it starts taking effect and there’s a bit of external demand (e.g. US/Japan/Core demand for peripheral Europe) the operational leverage is great. This also relevant to the US where the sequester is essentially a supply side structural reform in its effects.

Conclusion: it’s windy here

Many other things could go wrong, and I’m not clear about what’s happening in China and Emerging Markets, though there as well lot of negative views have limited potential to get much worse. There always can be exogenous disasters, but I think we do have a fair few tail winds pointing to animal spirits going back into positive territory, in the “next several years” kind of time frame — I’m not trying to predict what will happens this Christmas here.