Spectacular Crowdfunding Fails And Their Impact On Entrepreneurship

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Spectacular Crowdfunding Fails And Their Impact On Entrepreneurship

Before I proceed, let me make it absolutely clear that I have nothing against crowdfunding. I believe the basic principle behind crowdfunding is sound, and, in a perfect world, it would boost innovation and provide talented, creative people with an opportunity to turn their dreams into reality.

Unfortunately, we live in the real world, and therefore it’s time for a reality check:

   Reality /rɪˈalɪti/
    noun

  1.         The state of things as they actually exist.
  2.         The place where bad crowdfunded ideas come to die.

While most entrepreneurs may feel this mess does not concern them because they don’t dabble in crowdfunding, it could have a negative impact on countless people who are not directly exposed to it:

  1.     We are allowing snake oil peddlers to wreck the reputation of crowdfunding and the startup scene.
  2.     Reputational risks extend to parties with no direct involvement in crowdfunding.
  3.     By failing to clean up the crowdfunding scene, we are indirectly depriving legitimate ideas of access to funding and support.
  4.     When crowdfunded projects crash and burn, the crowd can quickly turn into a mob.

But Wait, Crowdfunding Gave Us Great Tech Products!

Indeed, but I am not here to talk about the good stuff, and here is why: For every Oculus Rift, there are literally hundreds of utterly asinine ideas vying for crowd-cash.

Unfortunately, people tend to focus on positive examples and overlook everything else. The sad truth is that Oculus Rift is a bad example of crowdfunding, because it’s essentially an exception to the rule. The majority of crowdfunding drives don’t succeed.

How did a sound, altruistic concept of democratizing entrepreneurship become synonymous with failure? I could list a few factors:

  •     Unprofessional media coverage
  •     Social network hype
  •     Lack of responsibility and accountability
  •     Lack of regulation and oversight

The press should be doing a better job. Major news organizations consistently fail to recognize impossible ideas, indicating they are incapable of professional, critical news coverage. Many are megaphones for anyone who walks through the door with clickbait.

The press problem is made exponentially worse by social networks, which allow ideas to spread like wildfire. People think outlandish ideas are legitimate because they are covered by huge news outlets, so they share them, assuming the media fact-checked everything.

Once it becomes obvious that a certain crowdfunding initiative is not going to succeed, crowdfunding platforms are supposed to pull the plug. Sadly, they are often slow to react.

Crowdfunding platforms should properly screen campaigns. The industry needs a more effective regulatory framework and oversight.

Realistic Expectations: Are You As Good As Oculus Rift?

Are you familiar with the “Why aren’t we funding this?” meme? Sometimes the meme depicts awesome ideas, sometimes it shows ideas that are “out there” but entertaining nonetheless. The meme could be applied to many crowdfunding campaigns with a twist:

    ”Why are we funding this?”

This is what I love about crowdfunding. Say you enjoyed some classic games on your NES or Commodore in the eighties. Fast forward three decades and some of these games have a cult following, but the market is too small to get publishers interested. Why not use crowdfunding to connect fans around the globe and launch a campaign to port classic games to new platforms?

You can probably see where I’m going with this: Crowdfunding is a great way of tapping a broad community in all corners of the world, allowing niche products and services to get funded. It’s all about expanding niche markets, increasing the viability of projects with limited mainstream appeal.

When you see a crowdfunding campaign promising to disrupt a mainstream market, that should be a red flag.

Why? Because you don’t need crowdfunding if you have a truly awesome idea and business plan with a lot of mainstream market appeal. You simply need to reach out to a few potential investors and watch the money roll in.

I decided against using failed software-related projects to illustrate my point:

  •     Most people are not familiar with the inner workings of software development, and can’t be blamed for not understanding the process.
  •     My examples should illustrate hype, and they’re entertaining.

That’s why I’m focusing on two ridiculous campaigns: the Triton artificial gill and the Fontus self-filling water bottle.

Triton Artificial Gill: How Not To Do Crowdfunding

The Triton artificial gill is essentially a fantasy straight out of Bond movies. It’s supposed to allow humans to “breathe” underwater by harvesting oxygen from water. It supposedly accomplishes this using insanely efficient filters with “fine threads and holes, smaller than water molecules” and is powered by a “micro battery” that’s 30 times more powerful than standard batteries, and charges 1,000 times faster.

Sci-Tech Red Flag: Hang on. If you have such battery technology, what the hell do you need crowdfunding for?! Samsung, Apple, Sony, Tesla, Toyota and just about everyone else would be lining up to buy it, turning you into a multibillionaire overnight.

Let’s sum up the claims:

  •     The necessary battery technology does not exist.
  •     The described “filter” is physically impossible to construct.
  •     The device would need to “filter” huge amounts of water to extract enough oxygen.

Given all the outlandish claims, you’d expect this sort of idea to be exposed for what it is within days. Unfortunately, it was treated as a legitimate project by many media organizations. It spread to social media and eventually raised nearly $900,000 on Indiegogo in a matter of weeks.

Luckily, they had to refund their backers.

Fontus Self-Filling Water Bottle: Fail In The Making

This idea doesn’t sound as bogus as the Triton, because it’s technically possible. Unfortunately, this is a very inefficient way of generating water. A lot of energy is needed to create the necessary temperature differential and cycle enough air to fill up a bottle of water. If you have a dehumidifier or AC unit in your home, you know something about this. Given the amount of energy needed to extract a sufficient amount of water from air, and the size of the Fontus, it might produce enough water to keep a hamster alive, but not a human.

While this idea isn’t as obviously impossible as the Triton, I find it even worse, because it’s still alive and the Indiegogo campaign has already raised about $350,000. What I find even more disturbing is the fact that the campaign was covered by big and reputable news organizations, including Time, Huff Post, The Verge, Mashable, Engadget and so on. You know, the people who should be informing us.

Just because something is technically possible, that doesn’t mean it’s practical and marketable!

I have a strange feeling the people of California, Mexico, Israel, Saudi Arabia and every other hot, arid corner of the globe are not idiots, which is why they don’t get their water out of thin air. They employ other technologies to solve the problem.

Mainstream Appeal Red Flag: If someone actually developed a technology that could extract water from air with such incredible efficiency, why on Earth would they need crowdfunding? I can’t even think of a commodity with more mainstream appeal than water. Governments around the globe would be keen to invest tens of billions in their solution, bringing abundant distilled water to billions of people with limited access to safe drinking water.

Successful Failures: Cautionary Tales For Tech Entrepreneurs

NASA referred to the ill-fated Apollo 13 mission as a “successful failure” because it never executed a lunar landing, but managed to overcome near-catastrophic technical challenges and return the crew to Earth.

The same could be said of some tech crowdfunding campaigns, like the Ouya Android gaming console, Ubuntu Edge smartphone, and the Kreyos Meteor smartwatch. These campaigns illustrate the difficulty of executing a software/hardware product launch in the real world.

All three were quite attractive, albeit for different reasons:

  •     Ouya was envisioned as an inexpensive Android gaming device and media center for people who don’t need a gaming PC or flagship gaming console.
  •     Ubuntu Edge was supposed to be a smartphone-desktop hybrid device for Linux lovers.
  •     The Kreyos Meteor promised to bring advanced gesture and voice controls to smartwatches.

What went wrong with these projects?

    Ouya designers used the latest available hardware, which sounded nice when they unveiled the concept, but was outdated by the time it was ready. Soft demand contributed to a lack of developer interest.
    The Ubuntu Edge was a weird, but good, idea. It managed to raise more than $12 million in a matter of weeks, but the goal was a staggering $32 million. Although quite a few Ubuntu gurus were interested, the campaign proved too ambitious. Like the Ouya, the device came at the wrong time: Smartphone evolution slowed down, competition heated up, prices tumbled.
    The Kreyos Meteor had an overly optimistic timetable, promising to deliver products just months after the funding closed. It was obviously rushed, and the final version suffered from severe software and hardware glitches. On top of that, demand for smartwatches in general proved to be weak.

These examples should illustrate that even promising ideas run into insurmountable difficulties. They got plenty of attention and money, they were sound concepts, but they didn’t pan out. They were not scams, but they failed.

Even industry leaders make missteps, so we cannot hold crowdfunded startups to a higher standard. Here’s the difference: If a new Microsoft technology turns out to be a dud, or if Samsung rolls out a subpar phone, these failures won’t take the company down with them. Big businesses can afford to take a hit and keep going.

Failure in the tech industry is not uncommon.

But, failure is a luxury most startups cannot afford. If they don’t get it right the first time around, it’s game over.

Why Crowdfunding Fails: Fraud, Incompetence, Wishful Thinking?

There is no single reason that would explain all crowdfunding failures, and I hope my examples demonstrate this.

Some failures are obvious scams, and they confirm we need more regulation. Others are bad ideas backed by good marketing, while some are genuinely good ideas that may or may not succeed, just like any other product. Even sound ideas executed by good people can fail.

Does this mean we should forget about crowdfunding? No, but first we have to accept the fact that crowdfunding isn’t for everyone, that it’s not a good choice for every project, and that something is very wrong with crowdfunding today:

  •     The idea behind crowdfunding was to help people raise money for small projects.
  •     Crowdfunding platforms weren’t supposed to help entrepreneurs raise millions of dollars.
  •     Most Kickstarter campaigns never get fully funded, and successful ones usually don’t raise much money. One fifth of submitted campaigns are rejected by Kickstarter, while one in ten fully-funded campaigns never deliver on their promises.
  •     Even if all goes well, crowdfunded products still have to survive the ultimate test: The Market.

Unfortunately, some crowdfunding platforms don’t appear eager to scrutinize dodgy campaigns before they raise heaps of money. This is another problem with crowdfunding today: Everyone wants a sweet slice of the crowdfunded pie, but nobody wants a single crumb of responsibility.

That’s why I’m no optimist; I think we will keep seeing spectacular crowdfunding failures in the future.

Why Nobody Cares About Your Great Idea

A wannabe entrepreneur starts chatting to a real entrepreneur:
    “I have an awesome idea for an app that will disrupt…”
    “Wait. Do you have competent designers, developers, funding?”
    “Well, not yet, but…”
    “So what you meant to say is that you have nothing?”

This admittedly corny joke illustrates another problem: On their own, ideas are worthless. However, ideas backed up by hard work, research, and a team of competent people are what keeps the industry going.

Investors don’t care about your awesome idea and never will. Once you start executing your idea and get as far as you can on your own, people may take notice. Investors want to see dedication and confidence. They want to see prototypes, specs, business plans, research; not overproduced videos and promises. If an individual is unwilling or incapable of making the first steps on their own, if they can’t prove they believe in their vision and have the know-how to turn it into reality, then no amount of funding is going to help.

Serious investors don’t just want to see what people hope to do; they want to see what they did before they approached them.

Why not grant the same courtesy to crowdfunding backers?

Column by Toptal written by Nermin Hajdarbegovic

Central Banks and the Definition of Insanity

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Central Banks and the Definition of Insanity
Foto: mark yang . Los bancos centrales y la definición de la locura

It is often said that that the definition of insanity is doing the same thing over and over and expecting a different result. This appears to be a lesson that central bankers have been unable – or unwilling – to grasp.

Since the depths of the financial crisis in 2008, global monetary policymakers have pulled out all the stops to stave off disaster. These have included lower rates / zero rates / negative rates, forward guidance, Operation Twist, quantitative easing, funding for lending schemes, and now the possibility of “helicopter money.”

To be sure, central banks should be applauded for their creative thinking and flexible use of monetary policy tools when the global economy went on life support. While impossible to prove, it could certainly have been worse had they not acted so decisively. Whether it was the Bank of Japan’s “kitchen sink” approach, Mario Draghi’s “whatever it takes,” or the Federal Reserve’s “open mouth” policy, those extraordinary actions sent a strong message. A message that was powerful enough to change sentiment at a time when it was sorely needed.

What Comes After “Extraordinary”?

Today however, that same message may be doing more harm than good. Although sub-par, the global recovery/expansion is entering its eighth year. In this environment, extraordinary monetary policy seems disconnected from a world that is growing slowly but is hardly in crisis. Consumers and businesses may not understand the technical nuances of negative rates or helicopter money, but they recognize that extreme policies could only be justified by an extremely dire outlook. This disconnect doesn’t send consumers to the mall or encourage CEOs to invest in capital projects. After eight years, policies that once boosted confidence are now undermining it – diluting or possibly offsetting the very benefits that low rates were designed to deliver.

The Side Effects

If extraordinary policy is now undermining confidence, is it time for a change? Normalizing monetary policy obviously comes with its own risks: Raising interest rates or unwinding asset purchases could further slow the global economy and maybe even cause the next recession. While we acknowledge this risk, we believe central banks have reached a tipping point where the negative side effects of extraordinary policy now seem to outweigh its ever-diminishing benefits. These side effects include:

  1. A greater likelihood of asset bubbles
  2. Increasing liabilities and balance sheet pressures for banks, insurance companies, and pension funds
  3. A greater tendency for individuals to save more to compensate for lower yields
  4. Less interest income for the sizable Baby Boom generation to spend
  5. The loss of competitiveness and efficiency as unnaturally low rates enable zombie companies to stay alive indefinitely
  6. A convenient excuse for other policymakers to shirk their responsibilities to implement structural reforms and provide fiscal stimulus

To be clear, no one is calling for aggressive tightening of monetary conditions, just a move away from DEFCON 1, the ultra-accommodative policies that have done little to bolster growth in recent years. It is also important to realize that not all central banks are facing the same trade-offs. Various countries and regions are at different points in the cycle, so each will have to decide how to weigh the knock-on effects. In the U.S., however, modestly stronger growth and inflation allow the Fed greater policy latitude than many other central banks. While the Federal Open Market Committee is unlikely to hike this week, the meeting provides an important opportunity to convey a more confidence-inspiring exit strategy.

Column by David Lafferty, CFA

Afores’ AUM Grew 9.6% in the First 8 Months of 2016

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Los activos bajo administración de las Afores llevan un 9,6% de crecimiento acumulado hasta agosto
Photo: George Hodan. Afores’ AUM Grew 9.6% in the First 8 Months of 2016

Between December 2015 and August 2016 (8 months) assets under management of Afores had a growth rate of 10%, which exceeds the growth in 2014 (7%). Assets under management ended August at 2,784,587 million pesos (mp) amounting to 148 billion dollars.

Half of the growth of 243,624 mp is explained by the bi-monthly contributions made by workers affiliated and the other half by the returns generated by the Siefores; however transfers between Afores (workers who decide to switch from one Afore to another); as well as the reallocation of accounts, helps growth in some cases. In the case of transfers between January and August 2016, 130,494 mp moved accounts and 31,500 mp were relocated last August.

Reassignment is a mechanism through which the CONSAR “assigns” temporary accounts of workers who do not choose Afore o the better performing ones, seeking to encourage the Afores to obtain better long-term returns/performance. The allocation and reallocation process was conducted under the rules issued in January 2015 where the following factors were considered:

  1. Increased net yield consistently as a central criterion in the process
  2. Additionally, those who made the greatest Afores registration effort workers
  3. Lower fees
  4. Effort to promote voluntary savings at theAfores.

Afores that won accounts in this process were those that have shown good performance in the net return indicator. It is noteworthy that the receiving Afores this year should keep a favorable yield performance in order to keep accounts in the following remapping process which will happen in 2017. Otherwise, those accounts would be reassigned.

In the first eight months of the year, Pensionissste, grew 21.2% in assets managed reaching 154,340 mp at end-August. Of this 1.2% came from Afores transfers and 3.2% from reassigning accounts. Pensionissste has 5.5% market share and in the last six years its market share has remained virtually unchanged (5.7% in 2010).

Afore Azteca is the second fastest growing in 2016 by presenting a growth of 17.1% which corresponds to 3.9%  from transfers between Afores. From 2010 to date, Afore Azteca has doubled its market share rising from 0.8% to 1.6% with organic growth without purchasing another Afore. If they maintain these growth rates, in about three years they could reach Metlife (10th place). In the last two years Metlife has only grown 3 to 4% per year (3% in 2015 and 4% in 2016). Via transfers Metlife lost 2.1% and 3.0% was reallocated, which sums a drop of 5.1%.

Enlarge

Afore Coppel grew 17% even though they lost 0.7% in transfers. In recent years this Afore has been increasing its market share year after year. In 2010 it was of 2.5% and today, they have 5.3%. Coppel is just 4% away form Afore Principal who holds the No. 7 position, and only grew 2%. Afore Principal lost 2.5% market share to transfers and in reassigments it had a net outflow of funds of 4.1%.

Afore Banamex carries a 14% growth in the year, where 1.9% was due to transfers between Afores and 2.5% reallocation. Banamex was the Afore that achieved the highest growth amongst both areas. In March of 2013 when Afore XXI-Banorte acquired Afore Bancomer, the latter was 61.6% larger than Afore Banamex. Today, only three years later, this difference has shrunk to only 33.2%. If this trend continues, in three years we could see Afore Banamex back as number one, position that it occupied between 2002 and 2012. Afore XXI-Banorte has grown 4.5% this year, but the transfer between Afores (-0.6%) and reallocation (-1.6%) affected him with a 2.2% decline.

Accumulated in the year (eight months) Afore Sura and Afore Profuturo have had a very similar AUM’s growth: Profuturo with 12% and Sura with 12.1%. Sura is the third largest Afore with 15.1% market share and Profuturo fourth with 13.0%. Sura transfer in was 0.9% and reallocation 2.6% while for Profuturo was 0.8% transfer in and 1.4% reallocation. Currently Profuturo is 16% behind Sura, while Sura needs to gain 17% market share to reach Banamex.

Invercap this year only brings growth in assets of 4.3%. Transfer out was -2.6% and -3.5% reassignment for a total of -6.1% in outflows. Invercap’s organic growth has been notable. In 2010 it had 3.6% market share and today 6.4%.

Inbursa has had an accumulated growth this 2016 of 3.1% where the transfer out was -3.2%. In 2010 Inbursa’s market share was 8.6% and today is 3.7%.

As can be seen, with only a couple of years, we could see significant changes in the market share among Afores, even without considering any sale or merger between Afores, which could not be ruled out.

Column by Arturo Hanono

Building a Case for Increased Infrastructure Spending

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¿Por qué se debe invertir más en infraestructuras?
CC-BY-SA-2.0, FlickrPhoto: JosepMonter / Pixabay. Building a Case for Increased Infrastructure Spending

The U.S. presidential election is entering the homestretch and investors are gauging the potential investment implications of the candidates’ proposed plans. As I noted in my last blog, amid a bitterly fought campaign, one topic is drawing a fair amount of attention: increased infrastructure spending.

It has been a particular area of focus for both parties and even the Federal Reserve. It is a rare area of agreement between the two presidential candidates, suggesting that whoever wins the election will likely emphasize it in the next administration. Moreover, the phenomenon is not only in the United States, but in other developed countries. Are the stars aligning for significant increased infrastructure projects, and does this have implications for investors? Among the reasons that suggest they may be:

Monetary policy

Central bank actions have been one of the most influential forces in shaping global markets in recent years. Yet we remain in a low growth environment, which raises the question: “Has monetary policy run its course in the current cycle?” The lack of growth momentum and weakened fundamentals around the globe suggest so.

Economic need

Given low economic growth, as well as the weak state of the nation’s infrastructure, using federal aid to repair bridges and roads and other projects could be a means of increasing productivity and fostering economic growth. See the chart below. In addition, infrastructure spending could help lift labor participation rates thus narrowing the gap between labor mismatch and labor productivity.

Depending on the type of project, infrastructure has the potential to create a positive multiplier effect on markets from an economic perspective. In the short term, infrastructure projects could provide private sector growth and jobs, thus potentially leading to increased tax revenues and a boost in consumer confidence and consumption. As a recent report from the BlackRock Investment Institute suggests, an increase in government spending can add up to 2% to gross domestic product (GDP), depending on where in the economic cycle the spending occurs. (Not surprisingly, it is likely more effective when it comes in a recession.)

Low funding costs

Large scale central bank bond purchase programs have pushed yields to all-time low (Source: Bloomberg), and in many cases, negative. While this has created challenges for investors, particularly those who require income, the low interest rate environment means the cost to finance infrastructure projects through government debt is far less than in years past.

This renewed focus on longer-term fiscal policy measures like infrastructure is not unique to the United States. In July, Japan announced a new ¥28 trillion stimulus package, of which ¥13.5 trillion is earmarked for a variety of fiscal policy initiatives centering on public infrastructure projects such as upgrading port facilities and building new food-processing plants that help boost food exports.

Similarly, the UK, facing the possibility of an economic slowdown—or even its first recession since the financial crisis—appears ready to incorporate aggressive stimulus beyond monetary measures. Like the U.S., minimal public resources have been allocated to infrastructure over the past decade. Private sector infrastructure spending in the UK is also drying up as a result of uncertainty around Brexit. The number of contracts aimed toward infrastructure-like initiatives is down by 23% over the past year (Source: Office for National Statistics, UK, June 2016).

In short, a combination of factors have created a compelling case for infrastructure investment. Should these scenarios unfold, equity sectors and industries related to infrastructure activities like industrials or transportation in the U.S. specifically, may stand to benefit. However, the timing and level of impact remain to be seen. It is important to recognize that how infrastructure projects are funded can mitigate some of the multiplier effect. For the U.S. in particular, it is also important to recognize that whoever wins the election could still face a divided government, raising questions about how quickly a bill could get passed, and how large a bill it would be.

To gain exposure to global infrastructure companies, investors may want to consider the iShares Global Infrastructure ETF (IGF). For U.S. exposures, investors may consider the iShares Transportation Average ETF (IYT) or the iShares U.S. Industrials ETF (IYJ).

Build on insight, by BlackRock written by Heidi Richardson

 

A Deeper Look into Japan’s Debt Problems

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Los potenciales peligros de Japón se han exagerado
CC-BY-SA-2.0, FlickrPhoto: Moyan Brenn . A Deeper Look into Japan’s Debt Problems

I have previously written about investing in the Asia Pacific region and why it is crucial that investors take a balanced and comprehensive long-term investment view (see ‘Capitalising on the Pacific Decade’). The prevailing market view on the region remains negative, mainly centring on China’s debt problem and general doubts about Abenomics. This article focuses on some aspects of this negativity from a sovereign balance sheet perspective and concludes that the potential dangers are overstated.

When analysing stocks, investors consider both balance sheet and income statements. But when it comes to sovereign analysis, analysts often focus more on the latter, which consist of ‘flow’ related economic data (such as GDP, trade, employment, production, capital flow, government budget) but place less importance on the former. Regarding a sovereign’s balance sheet data (national debt, current account), there is a tendency to focus solely on the government itself, ignoring the household or corporate sectors. Focusing on flow data makes sense for an open economy such as the US, where most of the productive sectors of the economy are held in the private sector via capital markets. The government plays a limited role on the asset side of the aggregate balance sheet. However, it can lead to incomplete or misleading conclusions in the case of Japan.

Japan: the misconception of too much debt

One of international investors’ major concerns regarding Japan is the government’s high debt level, without taking into account the household and corporate sectors. However, Japan’s national wealth largely resides in the household and corporate sectors, which makes the government’s heavy debt less of a concern. It also means that Japan is much less vulnerable to the sort of capital flight by offshore investors that often triggers financial crises.

As of 2014, the household sector’s financial net worth stood at 280% of GDP, which represents one of the highest levels globally and compares well with US at 260%. In contrast, the government’s debt to GDP ratio has risen significantly over the past two decades, from 67% in 1990 to 248% in 2015. In effect, the government has been forced to borrow to stimulate its economy because the household and corporate sectors refuse to consume and invest, instead choosing to save. So while the income statement of the country has remained flat for the best part of a decade, the national wealth is strong and Japan is able to export those savings to finance other countries’ deficits.

It’s not just the household sector that has accumulated significant wealth, the corporate sector also has a significant savings glut. Japanese companies are well known for sitting on large cash positions and being reluctant to invest. Japan’s listed companies hold over USD 1 trillion in cash and 56% of these companies are totally debt-free, i.e. net cash.

Japan’s economy has effectively become similar in position to a wealthy, ageing rentier, living off years of accumulated savings. The country’s strong balance sheet position allows the government room to experiment as it aims to change the deflationary mindset of an entire population and stimulate private demand. A bank run scenario is highly unlikely in Japan, which is why comparable debt analysis for heavily indebted countries is not relevant.

Most sovereign analysis on Japan ignores the wealth residing outside the government sector and over-emphasises the government’s deficit spending. The push for a higher sales tax, due to concerns about the government’s high debt ratio, was the wrong prescription for Japan. Prime Minister Abe’s first consumption tax hike was a costly policy error for Abenomics as it unwound the momentum and positive early effects from the government’s stimulus programme. The recent decision to postpone the second hike was the right call.

The country’s strong balance sheet also explains the ‘safe haven’ status of the Japanese Yen and its recent strength. Other reasons for Yen strength include the country’s surging current account as a result of a significant change in the net trade balance from 2014 to 2016 due to lower oil imports and because declining inflation expectations, not nominal interest rates, are driving foreign exchange rates. Real interest rates in Japan have actually been rising more than the US, because expected inflation rates are collapsing5.

Abenomics was initially quite effective for the economy and the Nikkei until the first sales tax hike took place in 2014. The BOJ’s ‘Halloween easing’ in 2014 further pushed the Yen from USD 110 to 120 and the Nikkei up to 20,000. However, without further action, the Yen strengthened for the reasons stated above and the Nikkei retreated to 2014 levels.

In our view, the Yen will tend to strengthen unless BOJ Governor Kuroda’s resolve to raise inflation expectations regains credibility. Unfortunately, the BOJ’s monetary policy has been doing much of Abenomics’ heavy lifting over the past couple of years and has few bullets left. Further bond buying and even more negative rates have lost their potency because these monetary signals are not affecting the demand side of the economy. What is required now is even stronger fiscal policy. The combination of strong fiscal and monetary policies should help to raise inflation expectations and lower the Yen.

The question is not if the BOJ and the government will act, but when and how. Recently, market participants have been openly debating the possibility of debt monetisation or ‘helicopter money’ in Japan. In my view, when quantitative easing and NIRP are coordinated with a stronger stimulus programme, the effect on the economy and general inflation expectations will be similar to more controversial forms of monetary policy. The difference between this and the BOJ deciding to directly underwrite the debt incurred by the Ministry of Finance is merely a matter of semantics.

Yu-Ming Wang is Global Head of Investment and Chief Investment Officer, International at Nikko AM.

Election Politics: Too Bad Investors Can’t Turn the Channel

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Election Politics: Too Bad Investors Can’t Turn the Channel

The debate points to a lurking problem for the markets

The level of discourse was so disappointing in last week’s U.S. presidential debate that it was tempting to move up the dial and watch pro football, where the combatants at least get to wear helmets. Personal attacks, rancorous exchanges, smirks and eye rolling…they epitomized why many voters have despaired over the choice they face.

What all this focus on personality obscures, of course, is the actual issues the country faces and the philosophical differences that could seriously impact how to solve them—whether low growth, suffocating regulation, federal debt, health care, income inequality or national security, to name a few.

Not all the issues have concrete implications for investors at this stage. In recent weeks, my CIO colleagues and I have taken turns considering potential drivers for the economy and markets. Erik Knutzen, CIO for Multi-Asset Class, talked about a global focus in U.S. earnings and whether weakness could contribute to new volatility in a market that is “priced to perfection”; Fixed Income CIO Brad Tank considered the potential impacts of Japan’s steps toward “helicopter money”; and I explored whether the two major U.S. political parties could work to improve the country’s dilapidated infrastructure.

Rating the Election’s Impact

As far as the election is concerned, it’s hard to tell what the impact will be. Over the last eight presidential election cycles, inauguration years have seen exceptionally strong returns for the S&P 500, with an average gain of nearly 20% and in several cases returns of over 30%. Only in 2001, in the wake of the tech bubble, did the year turn out to be negative. In part, this positive trend may be a function of stimulus leading up to elections, or reduced policy uncertainty, or simply a touch of optimism tied to the fresh start of a four-year term. It may be a simplistic idea, but elections ultimately have tended to be a catalyst for stocks.

Could this time be different? A key concern is negative voter perception of both Hillary Clinton and Donald Trump, who have the highest unfavorable ratings of any presidential candidates in modern history.1 Regardless of who gets elected, residual anger on the part of the losing party could intensify already entrenched gridlock.

This ties into prospects for fiscal stimulus, ideally in the form of new infrastructure spending, or a deal to repatriate corporations’ overseas earnings. We remain skeptical on that front, and we believe that politicians could keep relying on easy money from the Federal Reserve to bail them out along with the economy. With minimal action in Washington, it seems likely that GDP could continue stumbling along at a 1%-2% pace in the coming year.

Softening Angle on Equities

Such meager growth of course provides little fuel for the stock market. Our Asset Allocation Committee recently downgraded its 12-month outlook for U.S. equities to “slightly underweight,” given rich valuations, a modestly higher rate forecast and potential volatility tied to earnings stagnation.

It would be tempting to minimize the potential impact of the presidential race, to “change the channel” and focus strictly on fundamentals that undoubtedly can sway the markets. But there’s a point where electoral combat and likely gridlock weigh on earnings prospects and growth trends. My “Hail Mary pass” would be that this contest will shake things up enough that politicians will work together, at least for a while, to deal with entrenched problems.

 Neuberger Berman’s CIO insight by Joseph V. Amato

Have Quality Companies Become Too Expensive?

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¿Se han vuelto las empresas de calidad demasiado caras?
CC-BY-SA-2.0, FlickrPhoto: 401 K. Have Quality Companies Become Too Expensive?

We often stress the fact that our investment methodology leads us to focus on high-quality companies. We define these as companies with a very sound balance sheet and specific competitive advantages that enable them to stand out from the competition and generate a higher profitability. In turn, this higher profitability translates into the generation of substantial free cash flow and consequently a strong self-financing capacity and a low debt ratio.

Among such quality companies, those which operate in low-cyclical sectors have been particularly popular with investors in recent months, even years. The time has now come to question whether these quality defensive companies (Nestlé, Reckitt Benckiser, Unilever, for example) may have become too expensive.

Three observations and a comment in this regard.

Ampliar

 

First the comment. The level of interest rates plays a significant role in any valuation model.  The answer to the question of whether quality defensives have become too expensive will depend to a large extent on the assumptions used, especially with regard to the rate used to discount future earnings/dividends and the cost of equity. Clearly, with a very low discount rate (on the basis that interest rates are very low), practically any price can be justified. This is why equity valuation models – like the one used by the Federal Reserve which compares the earnings yield of equities (through the earnings/price ratio, the inverse of the price/earnings ratio) to the yield on 10-year government bonds – always reach the conclusion that equities are undervalued compared to bonds. This is not surprising when the yield on the US 10-year Treasury note is around 1.5%. The comparison between equities and bonds is even more favourable for European equities, which offer a higher earnings yield (are trading at a lower price/earnings ratio) and face even less competition from bonds which have near-zero yields. But obviously, the lower the interest rate used in the valuation model, the smaller the margin of safety will be and the more the investment will be at risk in the event of interest rates rising.

Now the observations.

1.- Using a discount rate that would have been considered appropriate in the past, before the central banks started to manipulate interest rates, e.g. a rate of around 9%, you come to the conclusion that defensive companies are in fact relatively expensive, although their valuation cannot be described as exorbitant. But more importantly, compared to the rest of the market, they are not more expensive than in the past. The outperformance of their share price reflects the outperformance of their earnings, in other words much better earnings growth (note that this is the case for quality defensive stocks as a whole. Some of these stocks have certainly seen an increase in their premium over the market. For others, their earnings growth is largely due to buying back their own shares, purchases often financed through debt). The following graph shows the price/earnings ratio of these stocks in relation to the market. It can be seen that the premium these companies are enjoying (in terms of the P/E ratio) remains in a range similar to that of the past. And it could be argued that in the current context, dogged by numerous economic and financial uncertainties, these companies should trade at a higher premium given that they are the main beneficiaries of low interest rates. 

 

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2. However, let us suppose that an investor who holds these companies in the portfolio decides to sell them because they are expensive. Then comes the question of redeploying the newly released funds. Currently the return on fixed-income investments (cash and bonds) does not compensate the risk incurred. The investor could obviously decide to stay in cash and wait for a sharp price correction in these quality names. However, experience shows that this is a very chancy approach. Alternatively, our investor could buy shares whose valuation seems more attractive. But where to find that kind of share? In recent years, equities have generally become more expensive (at least in the developed countries). Although quality stocks are more expensive than the market as a whole (and quite rightly so), we have already noted that their premium over the market has not increased. And companies whose valuation at first sight seems more attractive are often in sectors that are seriously at risk in the current context, examples being banking or highly cyclical stocks. To invest in these sectors you need to have a confidence in the global economic outlook and the financial system that we do not currently have.

3. As already noted, the current valuation of quality defensive stocks is high but not yet exorbitant. The corollary of this is that their expected return is lower than in the past but still reasonable, especially in a low-interest-rate context. As the price paid determines the return, it would be naive to think that when you are paying more for these companies than in the past, you could get the same return as in the past. So we need to lower our return expectations on quality companies. If their valuation goes on rising, there will even come a moment when the expected return becomes so low that investing in them no longer makes sense. But that moment has not yet come.   

Guy Wagner is Chief Economist and Managing Director at Banque de Luxembourg Investments.

A Matter of Time

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¿Cuánto vale el tiempo de los inversores?
CC-BY-SA-2.0, FlickrPhoto: Thiago A.. A Matter of Time

Of all the arrows in an investor’s quiver, among the most powerful is time. Yet many asset managers and owners don’t fully grasp how powerful an impact time can have on investment decision-making and outcomes.  

As a society, we’re moving at an ever faster pace – in business and in life – taking less time to do things that perhaps should take more. The need for immediacy can be all consuming. And technology certainly feeds that appetite, with its invaluable contribution to speed and efficiency. But technology can distort an investor’s sense of the time needed to allow skill and discipline to play out or manage risk when they have to take more of it. Many believe they are being efficient with their time by measuring numerous data points and reacting to them more quickly. But are they really? With so much information at their fingertips, investors and asset owners need to start distinguishing between check points and decision points.As an industry, we need to think carefully about why time matters to investors. We believe time allows skill, expertise and discipline to have the greatest impact on investment outcomes. It offers a meticulously researched investment thesis a chance to bear fruit. It favors thoughtful decision-making over reactive trading or chasing the latest fleeting trend. If investors are not taking the time to do good research – to identify value, good governance and a sustainable business, they are not investing responsibly.

Perhaps most importantly, time may allow investors to take risks more intentionally and manage them more effectively. In an environment such as we see today — in which investors must take three times the risk they did 20 years ago to earn the same returns — patience is essential. That’s true despite the angst investors might feel when taking on more risk. They need to curb the urge to micro-measure performance and make changes, which offers only a false sense of control at best.

It’s time to step back and help investors understand why, when used properly, time can be a valuable asset in getting to their desired outcome. Ultimately, the conversation isn’t about managing time. It’s about using time to manage wisely.

Carol W. Geremia is President of MFS Institutional Advisors, Inc. Co-Head of Global Distribution.

The BoJ Tweaks Its Armoury

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El Banco de Japón recoloca su arsenal
CC-BY-SA-2.0, Flickr. The BoJ Tweaks Its Armoury

With central banks across the world attempting to hit their inflation targets, the Bank of Japan (BoJ) has adopted a new policy framework named “QQE with yield curve control”.

There are two elements to the new policy. Firstly, instead of the traditional central bank model of setting the short-term rate, the Bank of Japan will now seek to set the rate on the longer-term 10-year part of the curve too (they will target a yield of around 0% at the front-end initially, close to current levels). Secondly, the central bank has committed to keeping the policy in place until inflation has overshot the inflation target of 2%. It has abandoned the explicit target of expanding the monetary base by ¥80 trillion each year, but instead says it will adopt a flexible approach.

The policy is designed to shift inflation expectations, keep banks profitable via a steeper yield curve and seek to address the issue of Japanese government bond scarcity. While Governor Haruhiko Kuroda has delivered a policy that helps banks, we doubt it is going to lead to a rapid adjustment in inflation expectations – it is more a case of adopting a policy that enables the BoJ to stay in the game for longer as it hopes the policy will require fewer bond purchases. The central bank itself admits that “a further rise in inflationary expectations is uncertain”.

The BoJ is trying to keep policy loose while mitigating the negative side effects of excessive asset purchases.

What does this mean?

This is tapering but with asset purchases no longer the independent variable in the policy mix. The global pool of liquidity is unlikely to keep on increasing at the current pace so the ‘hunt for yield’ trade looks less attractive. The BoJ announcement that it will target the 10-year should suppress local yield curve volatility, but could lead to volatility in other markets and asset classes.

The yen Japanese banks finished up over 7%, while the yen is 0.4% weaker vs. the US dollar (it had been 1% weaker)*. Moves in other bond markets have been muted.

Nicholas Wall is co-manager of Old Mutual Global Strategic Bond Fund.

Japan Wheels Out Its Helicopters

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Japan Wheels Out Its Helicopters

The BoJ sends an invitation to government, a challenge to markets.

The engines aren’t running yet, and the fuel is still on its way. But in last week’s announcements from the Bank of Japan there was the unmistakable sound of helicopters being wheeled out of their hangars.

Wednesday’s central bank doubleheader saw the Federal Reserve deliver the usual mix of hawkish tones and no action that we’ve come to expect, having already been upstaged by Bank of Japan Governor Haruhiko Kuroda’s headline-grabbing innovations.

‘Yield Curve Control’: A Step towards Helicopter Money

Markets had expected a commitment to negative rates combined with a tweak to the bonds purchasing program to steepen Japan’s yield curve. Instead, Kuroda announced a more aggressive commitment to a 2%-plus inflation target and a target for the 10-year yield: Bonds will be purchased to keep the latter “around the current level” of zero percent.

This is a commitment to negative deposit rates: Holding the 10-year yield at zero stops negative short rates from spreading out along the curve, and that upward slope should help banks and insurance companies survive as long as those negative rates are required.

It also doubles down on the QE “portfolio effect.” Should Japan one day succeed in generating growth and inflation, holding the 10-year at zero implies an increasingly negative real yield, and an ever-greater incentive to sell bonds and buy real assets.

But, most importantly, it is the clearest signal yet that the Bank of Japan wants the government of Japan to take on more debt and start spending aggressively. When you reach the outer bounds of what is possible with monetary policy alone, you need a fiscal policy that creates a genuine prospect of inflation, which in turn can provide the fuel for low rates to work through the portfolio rebalancing channel. Only then do the two arms of policy reinforce one another.

Back in July, we saw signs that the Japanese government was ready to contemplate new measures. By committing to buying 10-year bonds at a zero yield no matter what, the Bank of Japan has promised the “helicopter money” to finance those measures.

Some Market Players Will Fight This…

If this is an invitation to the government, it is also a challenge to financial markets. No good can come of such egregious market interventions and distortions, argue some very prominent investors; it’s unsustainable, and a lot of money can be made by those brave enough to try to break the policy. They point to failed interventions and policy targets of the past, from the Fed’s “Operation Twist” in the early 1960s, through various ill-fated currency pegs, to the unravelling of the European Exchange Rate Mechanism (ERM) after Black Wednesday in September 1992.

They may be right over the long term. Japan must hope it can rediscover modest growth and inflation with these policies before its enormous debt burden collapses the yen under its weight. That may prove impossible.

But would you bet on that failure now, when Japan has time and political commitment on its side? These are powerful forces. People have been shorting Japanese government bonds for 20 years already, and they keep getting carried off the field.

…But It Is Kuroda’s ‘Draghi Moment’

The world is very different than it was in 1992, when the ERM failed. The new era dates from 2012 and ECB President Mario Draghi’s defining pledge to do “whatever it takes” to preserve the integrity of the European single currency, the ERM’s successor. Before these words were uttered, the Greek debt crisis was dragging the euro to the edge of a very sheer cliff—and a lot of investors had been waiting years for the chance to push it over. Big, 100-year-old financial institutions had been shorted out of existence during the financial crisis, they reasoned. Surely it was a small step to do the same for the Eurozone?

They were denied their moment and we all learned the dangers of trying to short political entities out of existence when they have strong leadership and resolve.

If the ECB can hold its own while trying to satisfy 19 disagreeing masters, imagine what the Bank of Japan can do with the full backing of its government. It is already well on the way to buying up the second-biggest bond market in the world. Now its helicopters are out, and markets probably won’t have the ammunition to shoot them down.

Neuberger Berman’s CIO insight by Brad Tank