How much cash in times of volatility?

One of the most difficult decisions for a fund manager in times of global uncertainty is to decide how much cash they should hold. Even if the manager feels that markets will grossly under perform it is hard to put a large part of the portfolio in cash because investors are paying them to manage equities.

Take the example of the present situation. Chinese slowdown, commodity price declines and depreciating currencies are taking massive toll on some of the emerging and frontier markets. In particular, economies with commodity focus like Russia, Nigeria and others like Argentina are getting pummeled. Even countries considered to have enough reserves to weather the storm like Saudia Arabia had its own share of scares. The only countries performing relatively better are those that are commodity importers and less correlated with the global economy. In the frontier universe this would include countries like Pakistan, Bangladesh and Sri Lanka all three of which commodity importers.

The problem however is in the fact that equities in these markets are not cheap. Thus a fund manager has 3 options overall. Allocate more to these countries even though stocks are expensive because the global volatility can run for a long period. Second option is to hold cash and try to time the market bottom (if we believe that markets are cyclical and sooner or later commodities will rebound). Final option is to start allocating risk assets to the battered countries from now on because markets always move faster than economic news. The idea is to take some near term hits on the portfolio but make money on the medium to long term.

These are all difficult decisions and just like most other things involving finance more an art than science. So far it seems to me that investors feel that Chinese situation will stay pretty bad and thus commodities will remain weak. As a result, people will continue to put money in countries with strong external accounts, limited fiscal deficit, declining inflation (through lower commodity price) etc. However, as countries like Nigeria and Argentina keep on under performing there should be a point when the prices will too low to ignore.

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Greece, Please Let Me Introduce You to Mr.Tony Soprano

In the HBO drama, the Sopranos, there is a scene in which the anti-hero, Tony Soprano, mob-boss and sociopath, chases a middle aged gangster across the streets of New Jersey. The unfortunate pursuant crashes his car and injures himself, much to the glee of Mr. Soprano. He stops, gets out his car, walks to the injured man still sitting in the driver’s seat moaning in pain, and opens the door. Feigning care for a stunned public that gathers around, Mr.Soprano grabs the hapless man’s neck, proceeds to threaten the anguished driver and demands the money that is owed to him to be given within 24 hours. Mr. Soprano then casually leaves quietly and unperturbed.

If one could find a most appropriate metaphor for the current situation in Greece, perhaps this is it. Greece, shattered and devastated, has an unemployment rate of 25.4%, and is struggling to pay its public sector workers. Its manufacturing sector contracted for the 8th consecutive month according to the Purchasing Managing Index, and its GDP has been falling rapidly since 2009 when it was at $341.6 billion. Greek’s GDP is currently at $241.72 billion. With high unemployment, an anemic manufacturing sector and declining GDP, Greece is still expected to pay 6.74 billion Euros in June, 5.95 billion Euros in July, and 4.38 billion Euros in August. They owe the IMF 2 billion Euros and 6.7 billion Euros to the European Central Bank.

The ECB have pushed Greece to increase taxes and more importantly collect taxes the Greek government is owed. At the end of 2014, Greeks owed their government about €76 billion in unpaid taxes accrued over decades. The government says most of that has been lost to insolvency and only €9 billion can be recovered. Nevertheless, the incumbent Syriza government is attempting to negotiate better terms with creditors in order not to default on its impeding payments.

Unsympathetic creditors argue that Greece’s descent into economic chaos is a product of their own financial indiscipline and corruption. Up to 2009, Greece had accumulated high debts and prices were high making the country uncompetitive. There were even accusations of the unproductive Greek work force that chose to slack rather than to work hard. One could certainly argue that Greece is a victim of their own opulence, chasing loans without building a sufficiently strong growth stimulating sector. Indeed, in 2010 the Greek Ministry of Finance identified a bloated public sector and an inordinate focus in channeling investments into non-growth sectors (such as the military).

But Greece is also trapped by the rigidities of being part of the Euro. As economists such as Paul Krugman argue monetary policy instruments as a means of combating economic problems are more or less absent for countries that are under a common currency. Greece cannot increase interest rates in order to incentivize saving; neither can they print money in order to encourage banks to loan to productive industries. They have to rely on fiscal policies solely that require the participation of a public that is witnessing unemployment and salary cuts.

With high debts, high unemployment, lack of a monetary policy, shackled by the Euro, and condemned by a haughty international community, Greece’s condition is remisicent of Germany in the early 1930s. The Weimar Republic was beset with problems emanating from WW1. The Treaty of Versailles in 1919 had imposed a reparation bill that Germany continually complained was too high to pay. Throughout the 20s Germany had to borrow heavily, particularly from the US, in order to reconstruct. Once an industrial center, the Allies had sought to weaken Germany following the war, with France being particularly belligerent. She took over Germany’s industrial heartland, the Rhur, in 1921. This led to the famous hyperinflation bout in 1923.

But perhaps the one key shackle for Germany was being part of the Gold Standard. The Standard which had worked reasonably well in the 19th century was causing distortions in the global economy at the time. The four great powers – US, France, UK and Germany – faced differing economic scenarios which impacted the other. US and France had most of the world’s gold bullion, whereas UK and Germany were hamstrung by a lack of it. The abundance of Gold allowed the US to divest capital into Germany, who were only too happy to accept the largesse as it sought to rebuild and pay off its debts and reparations. The problem was that in 1928 when America raised interest rates in fear of a overheating stock market, Germany were left with a decreasing flow of capital, and fell into recession. The tap had been closed, and with it Germany’s ability to suitably build its own industrial sector. It could not increase its deficit in order to invest, and with pressures from UK and France to repay, it had little room to manoeuvre.

The Great Depression changed the situation dramatically, as the world began to suffer, and countries experienced their own financial crisis. They were less concerned about Germany’s ability to repay, and by 1932, forgave Germany’s reparations bill. In the 13 years since the Treaty of Versailles, where the bill was set at $32 billion, Germany had only paid $4 billion. Thereafter, Hitler came into power, and the central bank, led by the enigmatic and ill-tempered Hjalmar Schacht, started to print money to invest in public works, mostly those industries that related to rearmament. Even though Germany remained on the Gold standard (unlike the other great powers) it had the breathing space to build its own economy. While by 1937 cracks began to appear as Germany were priced out of the world markets and austerity at home affected the living standards of its people, perhaps a key lesson from this situation, was less oversight and greater freedom allowed Germany to work out its own destiny.

Returning to Greece, there is an irony that Germany is acting with an iron fist, condemning Greece for its profligacy and imposing directives. Greece, like the Germany of old, has to turn to more creditors just to pay the bill, and being part of the Euro, it cannot devalue its overvalued currency thereby cheapening domestic prices. Certainly, Greece is a victim of its own detrimental actions – just as Germany of old were – but being hamstrung by the Euro and with a supercilious international community, it can hardly atone for its economic actions without being condemned. Like Mr. Tony Soprano the international community is acting like gangsters without sympathy. All Greece can then do is remain servile, looking for loans to pay its creditors, and hope its people do not descend further into impoverishment. But without a flourishing economy, it is hard to see how in the future Greece can improve. And like Germany of old it may have to eventually ignore the international community in order to settle its own affairs.

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The Musk of a Dynamic Business Model – Part 2

This is the second post and final post of this series. To read the first please go to this link.

One thing that connects both Tesla Motors and SolarCity is renewable energy. Lower oil prices, shale oil, and the huge reserves of oil and gas that have not been tapped into still offer energy sources that can sustain humanity for a few centuries. But the clamor for sustainable energy sources that has gained steam at the turn of the century has meant that our profit maximizing capitalist is looking towards renewable energy. Indeed, the UK even has a green investment bank. But being highly capital intensive as well as offering less energy than what can be produce from fossil fuels, renewable energy is not a particularly attractive option for the capitalist looking for a decent return.


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The Musk of a Dynamic Business Model – Part 1

Elon Musk does not think small. Neither does he think narrow. The South African born entrepreneur has managed to dip his fingers into a number of industrial sectors to varying degrees of success. With SpaceX (Industry Sector: Space Exploration), Tesla Motors (Industry Sector: Automotive) and SolarCity[1] (Industry Sector: Renewable Energy) remaining going concerns, Musk has etched his way into the global consciousness as someone who can achieve whatever he puts his energy into.


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Pat Dorsey – The 5 rules for successful stock investing

I first came across Pat Dorsey when I read The Little Book That Builds Wealth. Prior to that I had no idea about who Pat was. I was blown away by that book. It explained some of the most important issues in investing in the simplest possible language. That is why, when I came across The Five Rules for Successful Stock Investing I had high expectations from it. The book did not disappoint.


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Making banking a public good

Following the financial crisis, the banking model was criticized for being inherently unstable. There were two key reasons for this instability: first, the fractional reserve model in which banks keep a percentage of their deposits within the coffers and lend or invest the rest was thought to encourage irresponsible decision-making. With deposits being insured by the central bank up to a certain limit, moral hazard is a cause for concern. Secondly, the money creation process allows the central bank to create money through the act of lending, or more generally, the utilization of debt finance.  Since money is no longer tied to anything tangible, the central bank effectively has a carte blanche to print as much money as it chooses. What limits its’ discretion is inflation and the fact that the money goes to commercial banks. Banks in turn will have to lend out, but will have to ensure they lend to people who can pay it back. This means that it is incumbent on the borrower to make a sufficient amount of profit from the sales of goods and services. If there is inflation, the value of money will decrease, making goods more expensive. Central banks and commercial banks need to ensure a balance the amount of money in the system with the amount of goods and services.


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Amitabh Singhi and value investing

Are you a student of value investing?

If the answer to the above question is a “Yes” then DO NOT miss the Value Investing Podcast series brought to you by the same guys behind the Manual of Ideas. This podcast series has interviews with some of the top investors of the world including Pat Dorsey (Morningstar), Guy Spier, Robert Hagstrom etc. I also found one with my former boss Caglar Somek of Caravel Management.

However, the episode that I loved the most is the one with Amitabh Singhi of Surefin Investments. I listened to it twice just to make sure I didn’t miss any of the points. Since he specifically invests within India, investors and analysts in frontier and emerging markets will find similarities and important takeaways.


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The potato expedition!!!

Imtiaz Gadar, CFA is the Head of Public Markets at Bank Alfalah, Pakistan. Previously he served as the Head of Research at KASB Securities (Partner of BOA Merill Lynch) as well as JP Morgan. He was ranked as the best analyst in Pakistan four times by Asia Money and the CFA Association of Pakistan. He also served as the Vice President of the CFA Society in Pakistan.

Disclaimer: The post has Urdu in between because English alone would not fully capture the concept. 

Recently, while scrolling through my social media account, I saw a capital markets colleague had shared a picture with his wife where both of them were out shopping. My idle mind suddenly started visualizing what would happen if us capital market folks combined our professional roles with household roles (e.g. shopping). For instance if wife calls husband and asks him to buy 2 kgs of potatoes on the way back to home.


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