A New Revolution against the Wealthy

The world is in a constant mess. Technology and the internet were the catalyst for the burst and explosion of information. Today, the internet found and opened up a can of worms. The “Panama Files” as it was dubbed, exposes the dealings of the wealthy that was once hidden behind the veil of these safe havens. Along with a German news agency and an investigation company, they uncovered how the law firm advised and assisted the setup of shell companies and transferred funds across these companies. The objective was to make sure that the owner of these funds remain anonymous.

The regulators of the world will be concern if tax fraud, illicit money, laundering and other financial crimes are involved. This incident strikes the world because the stakeholders that are of concern includes the upper echelons of the wealthy. The water has literally got murkier when the names of Putin’s aides appear in the connection. Iceland’s prime minister was one of the first casualty filing his resignation.

This incident has reaffirmed financial regulators and watchdogs that compliance, audit and transparency of the financial industry are key to their operations. Implementing these regulatory objectives are essential to give confidence to the world and the industry, and helps level the playing ground for those who goes by the rules.

To think that Dodd-Frank act was complicated to regulate the financial industry after the 2008 crisis, this “Panama Files” underlines that compliance and regulation reforms are just the beginning and will remain a persistent discussion in any government globally.

 

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2016 Q1 Economy Shake Up

The global economy is having another shake-up over the last few months. Everyone has expected the FED to commence raising the FED rate after 7 years of a low and zero rate. The markets are pricing much ahead prior to the FED plans to raise interest rate. In December 2015, the signs for a much stable and growing global economy was there that convince the FED to raise the rates.

In a rather out of the blue situation that captures everyone surprise, China’s PBOC decided to devalue the Chinese Yuan for the second time in the year on the 11th of December 2015. This comes just five days before the almost certain FED announcement of the rates increase.

The yuan devaluation has catalysed a series of actions and reactions across the markets over the world. It also changes the perspective of how the global market will progress over the year of 2016. It has impacted every market but the commodities market especially became a leading indicator for others. The commodities market provides one of the primary indication of what will be driving or in this case not driving the economies. China’s GDP growth engines have slowed and cut back on imports of commodities across the board; oil, coal, iron, steel, etc. Firstly, the yuan devaluation also explicitly signalled higher cost for imports for overseas commodities and in turn, the Chinese domestic companies should look for domestic supply. Secondly, the lack of growth within the domestic demand is also accelerating the reduction of demand for imports of commodities. All in all, this is the first sign of a structural shift of the manufacturing economy moving towards a service economy in China.

While the China’s economy has been the reason for a thriving global economy of commodities, the growth deceleration has also shut down several of these markets. Commodities exports such as coal from Australia and South Africa are being hit. In the oil market, this has been exacerbated by the over-production of oil. In U.S.A., the new shale oil extraction has created a record production of oil and the result has caused storage facilities to be close to full utilisation. Storage tankers are also filled but are anchored just outside the docks waiting to ship to a buyer when the price is right. The oversupply of oil has resulted in a sharp drop in oil prices never seen since the 1980 oil crisis. This has also represented a lower cost of production for many industries for production and manufacturing. Transportation companies are also enjoying a lower cost of operation while hardly reducing their ticket prices.

The global economy is hit by a new change of demand and supply and is shifting the fundamentals of financial indicators. The market has changed and there are new opportunities for those who can capture these inefficiencies and new beneficiaries for those who can spot the new industry drivers. It is as such that there is an outflow of capital from the capital markets. There is a reallocation of capital and a good portion going to cash and safe havens like gold in times of crisis. However, many investors are holding the cash and waiting to find the right opportunity in terms of timing and new market trends.

The clearest indicator for market stability and growth lies very much on the stability of commodity prices. Effective government policies to drive new economies will shape the eventual demand for commodities and this will be monitored closely.


Things to Write About – 1

What can happen in a second

Time is relative. It takes less than a second to blink your eyes. But within a blink of an eye, many things have happened. When you look back over the years, many moments have occurred with just a blink of an eye.

In a blink of an eye, I have travelled for a year.

In a blink of an eye, I have known my wife for seven years.

In a blink of an eye, it was ten years ago that I have graduated from college.

The worst Thanksgiving dish you ever had

I eat almost anything including the most exotic; haggis, tripes, chitterlings, etc. It is tough to say what is the worst Thanksgiving dish because I haven’t had any. But I’m not the biggest fan of sponge cakes. I have a weird thought that I am chewing onto an actual sponge. When you sink your teeth into a sponge cake, the sponge texture causes you a tad second slower to complete the bite. You continue to chew, bites after bites, to mash up the cake in your mouth as it contracts and expands like a sponge. The worst feeling is how your saliva mixes into the mash and turns it into a slimy and soggy chunk of carbohydrate to swallow. *puke*

A houseplant is dying. Tell it why it needs to live.

Life is precious. You are the pride of the house and me. You are the living amongst the many things around the house and the concrete jungle around it. You bring a smile in me every morning whether physically or inside me. You are my ears whenever I speak my thoughts. You are precious to me.

Death is an eternal oblivion. So cherish life’s every moment that you live. Whether they are good or bad moments, it is up to us to make the best out of every moment.

Write Facebook status updates for the year 2017.

What a fantastic year to love and to be loved!

Post QE – The Fed and the Banks

I thought this article by Bloomberg provided a clear and simplified explanation why the Fed or the central bank in US is in a deadlock and unable to adjust the US economy easily.

1. During the period of Quantitative Easing to stimulate the economy, the Fed bought back US Treasuries/Government Bonds (The US Government sold it to the banks when issuing it) and mortgage back securities(MBS) from the Banks.
2. The Fed pays the banks in the form of credits from the Reserves.
3. This cause the banks to have “excess reserves”. When the Fed tries to implement a contractionary monetary policy by selling US Treasuries, the banks do not have problems buying new US Treasuries without borrowing more money. They can use the excess reserves to pay for it.
4. Thus, the regular monetary policy of the Fed to sell Treasuries and reduce money flow in the economy is not working.
5. The banks can continue to hold the “excess reserves” because the Fed pays interest to the banks. It would only be profitable if they can lend out the money at a higher interest rate than the “excess reserves” interest rate.
6. On the other hand, the Fed is also getting interest from all the treasuries and MBS it bought from the banks. But all these interest it gets are going back to the banks for holding the “excess reserves”. The interest could have help to reduce the yearly deficits in the reserves.

The gist of it is…. the Fed is in quite a deadlock on how to reduce these excess reserves and the cost of paying the banks. What would be the right rate of treasury issuance to ensure that it will not be too “massive and disruptive to the economy”?

Fixed Income

Fixed Income Debt

Looking beyond the IPO stage, as the company is listed, a more sophisticated capital raising takes place. There are various instruments that are created beyond a pure loan from banks – bonds. Bonds have evolved beyond a plain vanilla and straight instrument of a regular interval payment and principal payback at maturity. Structurers in investment banks have been creatively structuring new instruments that serves different risk appetites and ways to value a debt instrument. As the demand for capital grow by corporates, the debt instruments issued have to be attractive as well and makes sense for the issuer and the bond holders. Reasons could pertain towards cost of financing instruments and attract enough demand from investors.

Some of the common structures include:

  1. Foreign currency bonds typically called Eurobonds, are issued by corporates to finance projects in the foreign currencies. Depending on the currencies, the bonds have been named such as Samurai Bonds (JPY), Kangaroo Bonds (AUD), Dim Sum Bonds (CNY), etc.
  2. Convertible bonds are issued with an option to convert debt to equity when it hits a price cap. Thus, having this option typically lowers the cost of financing the debt as investors are buying the value of converting to stocks when the company is valued well on the stock market.
  3. Floating rate bonds are typically issued by corporates because they deemed that it would have a lower cost of financing if they deemed that interest rates will fall over time. The buy side investors will have to weigh out the interest rate environment in its decision to have an “axe” on these bonds.

US Treasuries are instruments used by the US government. There are different uses of these instruments depending on the economic policy. It can be used to fund government projects such as infrastructure development and military operations or as a monetary policy instrument. Most recently in the 2008 financial crisis, the term quantitative easing has been mentioned a lot. This is a practice of debt issuance by the government and immediate buy back by the government from an open market. In the case of US, the US Treasury issued the debt through the auction market that the primary dealers purchase and were bought back from the open market by the Federal Reserves to hold the US Treasuries. The primary dealers funds their purchase through deposits issued by the bank. The sellers to the FED are typically the Primary Dealers with spare inventories and secondary market owners such as hedge funds, mutual funds and other investment firms.  Through these action, the government wants to create a multiplier effect as the primary dealers would have higher capital at a lower cost to issue out more loans as a broker. (“On-the-run” treasuries are typically the most recently issued and most liquid bonds. They are the most actively traded on the market. The treasury actives curve, I25, is the benchmark to how corporate bonds are priced and valued against.)

Similar to the launch of an IPO, the investment banks also have to underwrite and service the issuer to sell these bonds. Roadshows will be conducted to gather interest in buying these bonds. One of the key players to valuing the bonds are the rating agencies. Rating of the companies and subsequently the bonds will determine the credit quality of these bonds. This is essential for bonds to be band under “Investment Grade” or “Junk”. “Junk” bonds will typically be deemed as high risk and high chances of default in coupon payment and principal at maturity. Because of the poorer financials of the company, the cost of issuing debt is also higher. Junk bonds are usually issued with higher coupon to ensure it is competitive and more attractive than Investment Grade bonds.

On a daily basis, the sell side bond salesman sends out “runs” to their clients on the buy side. “Runs” includes the daily inventory and price that the bond salesman has on his list. These prices are important especially for bonds that are illiquid and do not have active prices on electronic. The buy side players who received these runs would typically communicate over email, an instant messaging chat or phone to make the purchase. Once a price is struck, a buy or sell ticket can be sent from either party to confirm the deal. For the more liquid and actively traded bonds, the sell side banks could price them electronically to ensure efficiency and speed. Another mechanism is the Request for Quote (RFQ) process where the buyside player can request quotes from multiple dealers. Given the scrutinies from the 2008 financial crisis, regulators are pushing towards an RFQ process to ensure that the buy side players have transparency in trading at the best price.

The financial market is undergoing changes every time and more so in the post-2008 financial crisis. Dodd-Frank, Volcker Rule and the Basel III are names of new regulations that are in the midst of implementation and changing the way how the securities are being traded and valued. The cost of issuing and trading bonds have increase with changes in capital requirements and regulatory reporting is required. In addition to this, the state of the leading economies have shaken since the global oil glut and restructuring of China’s economy. The environment is not the best for corporates to issue new debt for many reasons relating to cost and self-sustainability.

(Obviously, this is brief and the complexity of the products and relationships of the players is huge. I’ll recollect my thoughts again and add more information over time. I hope this gives a quick overview of the products and the market.)

 

 

IPO and Stocks

IPO and Stocks

Moving past private equity funding, most companies would see the option of taking their company public through IPO to raise a larger amount of capital that is beyond the limit of private equity funding. At such stage, Many startups and founders see this as an opportunity to exit from their companies by putting their shares up.

On the surface, the general media loves to mention that it’s an exit for the founders. They will hype the potential networth of the founders once an IPO take place. However, they typically fail to stress the main reasons why a company is preparing an IPO. It’s fundamental for anyone who wants to participate in investing to know what is the reason the company is requiring these money and how are they planning to allocate their capital. As a rational stock investor, one should shield these noise and identify the true value of a company in comparison with the value overblown by the hype.

When a company plans to launch an IPO, they would have to work with an investment bank to prepare the prospectus for filing an IPO. These investment banks service companies as underwriters and gets a cut when companies goes to IPO. The lead underwriter that prepares the books of the company is also called the “book runner”. The IPO is a huge process requiring the underwriter to prepare the books and ensure that they are attractive for investment. The accounting firms have to ensure that the books are audited. The lawyers have to ensure that the legal terms to selling the stocks are acceptable. In addition to these, the executives of the company launching the IPO will work with the investment banks to participate in a road show to draw interest in their IPO. The key is to ensure that there are strong interest from the buy side in acquisition of the stocks that the company is releasing. The company have to “sell” their vision why an IPO has to take place and how can the value of these stock will grow with this new capital.

Listing company’s stock onto the exchange is one of the key mechanics of capitalism. It is a stage where companies have to be transparent on their business and operations to raise capital from the public. Companies can choose to sell more stocks after listing or raise capital through other forms of debt instruments such as loans and bonds.

 

Private Equity

To start off my first write-up, I will cover one of the most common and basic asset class, Equity in the early stage, Private Equity.

Equity

Private Equity

Why

The most common and basic investment asset class is Equity. Equity is being valued since the formation of a company. Private Equity as an industry, invests and grows private and unlisted companies. Because of today’s environment and ease of creating a new business idea and company, the term “startup” today describes new businesses that have begun its operations. On top of this, there are claims that the new business ideas have to be innovative and new in any industry. However, companies have been built from scratch and grown over hundreds of years, where the big names are sitting on today’s stock exchanges.

The primary reason private equity investment came about was the need to raise operational capital by companies. As companies grow in size, more capital is required for reasons such as expanding its operations, extending the market reach, fighting the competition, increasing their revenue, etc. It is common to see companies raise different rounds of capital investments over a period of time. Each round of funding from Venture Capitals and Private Equity firms are being termed as seed, series A, series B, and so forth. The size of funding are typically associated by the round of funding too.

How

Startups or businesses raise capital through angels, venture capitalists and private equity firms. Angels are typically funding through an individual coming from 3Fs (friends, family and fools), and High Network Individuals (HNWI). Beyond the capital injections from this group of investors, startups today are more particular on who became their shareholders and sits on their board. Capital is much more accessible today and it allows startups to shop for investors who can bring the most value. Ideally, they see investors who can help them grow the business through the investors’ business network and experience to steer the startups strategy.

There are several variations to the investment agreements in exchange for the equity stake. Given how the private equity market has evolved since it began post-WWII period, transactions have went beyond a plain vanilla money agreement for equity. Variations were structured into agreements such as debt with equity convertible options, adding caps and floors to options, royalties and dividends payout with a cap, etc. The larger the equity deals, the greater the complexity as more stakeholders are involved.

There are many ways to value the companies and startups. In the early stage companies, it is more of an art. One of the reasons is that the companies typically are still in a conceptual stage with an unproven and new market. The success of fundraising depends on the ability of the startups to pitch the vision and concept of the business with an hypothesize market. This has resulted in startups evolving in programs like pre-accelerator, accelerator and incubators. Pre-accelerators and Accelerators are typically structured programs to groom startups to build fast and test out their concept. At the end of these programs, there will be a demo day where the startup graduates are given an opportunity to pitch to angels and seed investors. Incubators have a slightly different operational mechanism where startups work closely and hand in hand with their investors to grow the business. Once the startups are in a suitable or favorable position, they will be seeking to raise funds from larger VCs and PEs and scale up the business.

On the other hand, I see a more matured company with historical financials and an existing sales market, valuation is a mix of art and science. Valuation of the company is backed by existing financials to illustrate how much sales the company has generating and how has it been growing. The art in the valuation comes in projecting a vision of a higher valued company based on the company’s strategy. The strategies whether it’s traditional or innovative, they have to make sense to the investors. Once the startup can convince the future growth and potential to the investors, this is where a premium can be added to the valuation.

Who

The private equity players are much more straightforward than other markets. On the surface we typically see two parties; the investor and the company.

The investors are made up of Angels, venture capitals(VCs) and private equity(PE) firms. A key thing to note that the VCs and PEs usually manage a fund that invest into the companies. The VCs and PEs often have to raise funds from the Limited Partnership(LPs). In some similar ways, the VCs and PEs have to raise money for their funds just like how startups have to raise capital. The LPs have typical make up of pension funds, insurance funds, institutional funds and very HNWI. It is quite common for the VCs and PEs to take a 1.5-2.5% annual management fees. This usually goes into supporting the yearly operational cost of the VCs and PEs including salary, office rental, hiring, etc. It is through the carried interest where VCs and PEs get their big returns. Typically, the VCs and PEs take 20% cut of the profits from the investments.

In a VC and PE setup, the typical mix of profiles in order of seniority; analyst, associates,  principals/director and general partner/managing director. Analysts are usually the bottom rung of the ladder who has to prepare research and analysis, and any other administrative matters in order. This is typically the entry level position of VC and PE firms. Associates are the next career progression in line after analysts. Associates will gather more responsibility and involved in structuring the deals for the investment. Principals are one of the more senior positions where they have larger say to deals to invest. However, they would still require the nod given by the general partners who sits at the top of the chain. I see the General Partners as the figurehead of the fund. They are the don, the godfather who ultimately makes the final decision for the investment.

On the other end of the spectrum of the industry are the startups and companies who look to raise funds to invest into their company. During the process of fund raising, the companies could also be bought out and acquired by the PEs or corporations. This is considered rather aggressive as the original founders and management could be replaced. Striking the best deal requires the founders to prepare a negotiation tactic and develop the skill over time. Its a mix of charisma, diligence and wit. It takes time to understand the nature of the discussions and steering the conversations to ones advantage.

Summary

Private equity represents the first segment of investing in the financial world. It is the growth of the private equity industry and companies maturing that led to other forms of financial instruments such as loans, bonds, options, futures, etc. I hope to explain each of these markets and why they evolved over my blog in time.