Three Longs & Three Shorts

Published on: 20 Jan, 2019

At the end of each week, we will share with you our favourite reads. We would be grateful if you could reciprocate. This week’s reads focus on devaluation in the role of shareholders, homage to Jack Bogle, robots in Chinese manufacturing, impact of algos on the market and a piece each on the twin architects of India’s historic test series win Down Under.

1. Long read: Shareholders dethroned as rulers of value
Author: John Plender
Source: Financial Times (https://www.ft.com/content/42871952-0463-11e9-99df-6183d3002ee1)
In this sublime essay, John Plender explains how capitalism has changed in the last 100 years and the implications it has for how companies will be run henceforth. “When Thomas Edison’s General Electric was at its most innovative in the late 19th and early 20th century, manager and proprietor were one and the same. Control rights in the corporation at that time were put in the hands of shareholders because they were seen as the bearers of greatest risk and thus entitled to the residual profits after the claims of other stakeholders – customers, employees, creditors, the tax authorities – had been met. In a world where capital was scarce and labour plentiful that made sense.”
Plender then explains how the paradigm outlined above gradually changed as the 20th century progressed. “Yet as the shareholder base expanded ownership became dispersed, leading to the divorce between ownership and control identified by Adolf Berle and Gardiner Means in the 1930s. Owen Young, the chief executive of General Electric between the wars, declared: ‘The stockholders are confined to a maximum return equivalent to a risk premium. The remaining profit stays with the enterprise, is paid out in higher wages, or is passed on to the customer.’
The next step in the dethroning of the shareholder came in the 1980s with the shareholder value revolution, with CEOs lack Jack Welch (who believed that they, and not capital, were the scare resource) and with academics like Harvard’s Michael Jensen (who said that paying CEOs with equity helps align managers’ interests with that of shareholders). The result of this revolution in thinking was the CEOs like Welch were given financial incentives to push the share price upwards using a variety of means including using dollops of financial leverage. “Under Mr Welch, GE came to derive 40 per cent of its profits from a financial subsidiary, GE Capital. In the event, GE Capital proved to be the group’s Achilles heel. Because it was excessively reliant on short-term wholesale funding, GE was forced under Mr Welch’s successor, Jeff Immelt, to turn to the Federal Reserve in 2008 for funds to bail out the ailing subsidiary.”
Plender says that the time is now ripe for another devaluation in the role of shareholders. “Research has shown that investment is consistently and significantly higher in private rather than broadly identical public companies relative to turnover or profits. The biggest flaw in the shareholder primacy model is that the shareholder is no longer the residual risk-taker in the corporation. Bankruptcy is no great threat to institutional investors running huge, diversified portfolios. Employees are much more at risk, especially where their skills are specific to the firm. Suppliers likewise often have more at risk than shareholders.”
These forces are likely to result in increased lobbying on Governments to redefine directors’ legal duties to stakeholders other than shareholders. Whilst shareholders are likely to counter such measures with lobbying of their own, it would appear that the way capitalism is evolving in the West, a further relegation in shareholders’ status in the pecking order might not be very far away.

2.  Short read: Volatility: how ‘algos’ changed the rhythm of the market
Author: Robin Wigglesworth
Source: FT (https://www.ft.com/content/fdc1c064-1142-11e9-a581-4ff78404524e)
The single most frequently asked question to a stock market professional is “where do you think the markets are headed?”. A seemingly more pertinent question asked by clients is “shouldn’t we wait for xyz event (election, rate hike, missile launch, etc) for a better entry point?” Our own experience as market participants have made us believe that it is increasingly impossible to predict market movements, especially in the short run given the rise and rise of algos, HFTs, ETFs, etc. This piece in the FT gives some facts and nuggets to drive home the point.
“Philippe Jabre was the quintessential swashbuckling trader, slicing his way through markets first at GLG Partners and then an eponymous hedge fund he founded in 2007 — at the time one of the industry’s biggest-ever launches. But in December he fell on his sword, closing Jabre Capital after racking up huge losses. The fault, he said, was machines.”
“…the volatility in financial markets in December, when US equities suffered their biggest monthly decline since the financial crisis, despite little fundamental economic news”.
“Even hedge fund veterans admit the game has changed. “These ‘algos’ have taken all the rhythm out of the market, and have become extremely confusing to me,” Stanley Druckenmiller, a famed investor and hedge fund manager, recently told an industry TV station.”
“JPMorgan estimates that only about 10 per cent of US equity trading is now done by traditional investors. Other markets remain more human, yet are slowly but surely being transformed.”
But not everybody has a problem with the machines “But markets have always been tempestuous, and machines make a convenient, faceless bogeyman for fund managers who stumble. Meanwhile, quants point out that they are still only small players compared with the vastness of global markets. “It’s insane,” says Clifford Asness, the founder of AQR Capital Management. “People are missing the forest for the trees. That we trade electronically doesn’t change things, we just deliver the same thing more efficiently . . . It’s just used by pundits and fund managers as an excuse.” 
However, strong views are forming in Wall Street that SEC should have more control over the algo trades – “Leon Cooperman, the founder of Omega Advisors, has argued that the US Securities and Exchange Commission should investigate and tame the new “wild, wild west environment in the stock market” caused by these volatility-sensitive strategies. 
“I think your next guest ought to be somebody from the SEC to explain why they have sat back calmly, quietly, without saying anything and allowing these algorithmic, trend-following models to wreak havoc with what has, up to now, been the best capital market in the world,” he told CNBC in December.”
“We just have to accept that financial markets are nearly fully automated,” he says, “and try to make sure that things don’t get so technologically complex and inter-connected that it’s dangerous to the financial system.”

3. Long read: I saw the making of Cheteshwar Pujara
Author: Sandeep Dwivedi
Source: The Indian Express (https://indianexpress.com/article/sports/cricket/i-saw-the-making-of-cheteshwar-pujara-5535781/)
From patience in maths to patience in life and on the cricket field, this outstanding piece on Cheteshwar Pujara has to be read and savoured. The author, Sandeep Dwiwedi, grew up with Pujara in the Indian Railways compound in Rajkot. He saw the grind that the now legendary test batsman’s parents – Arvind and Rina – had to go through to support Pujara’s training. Arvind, an Railway employee, was also Cheteshwar’s coach and from the time his son was 8, Arvind Pujara taught him to play straight in the local playground under a neem tree.
Father and son lost their biggest supporter when in the mid-2000s, Rina Pujara, passed away after battling cancer. And yet, even as coach’s around India kept berating Cheteshwar his slow strike rate, father & son maintained their faith in playing with the straight bat.
As Cheteshwar piled up the runs in domestic cricket, the legend whose shoes he would go on to fill spotted him playing a match for Indian Oil in Bangalore. “Cheteshwar was in Bangalore playing for his long-time employers, Indian Oil Company, in a corporate tournament. As usual he was scoring heavily. He had scored a couple of hundreds and was nearing the third. That’s when Rahul Dravid, the then India captain, turned up at the ground for a jog. The batsman on the centre square made him curious. He asked the scorer. True to his profession he also gave the run details of the boy who would go on to fill Dravid’s shoes as India’s reliable No.3.
It was a Saurashtra Cricket Association official who told Arvind about this. “From the stadium, he called Niranjanbhai (BCCI old hand and SCA secretary). He told him ‘take care of this boy’,” recalls Arvind. Later when Dravid came to Rajkot for a Ranji game, he would meet Cheteshwar again. Standing in the slips, he had a closer and longer look at the Saurashtra No.5. “After the game, he called the Saurashtra captain and told him that Cheteshwar should bat up the order. This shows his class,” says Arvind. Years later, Pujara would make his Test debut and he would bat at No. 5 behind Dravid and Tendulkar.”
The rest is history. A great cricketer’s achievements captured in the appropriate context by the country’s best newspaper.

4.  Short read: Robots will help Chinese firms cope with wages and the trade war
Author: The Schumpeter column
Source: The Economist (https://www.economist.com/business/2019/01/05/robots-will-help-chinese-firms-cope-with-wages-and-the-trade-war)
Esquel, a Chinese company, is a leading manufacturer of shirts for Western brands like Hugo Boss and Tommy Hilfiger and also for its own brand, PYE. The firm has 56,000 employees but is constantly focusing on mechanising tasks in the shirt making process so that its employees can focus on more value added work.
The garment supply chain is brutally competitive. “The work is repetitive; piece work makes it all the more soul-sapping. It is relatively hard to automate soft materials like textiles; making Esquel’s shirts involves up to 65 fiddly sub-processes, such as stitching sleeves and cuffs. As soon as labour costs rise, textile and garment factories tend to fly away, seeking cheaper fingers to work to the bone, be they in Bangladesh or Ethiopia. Esquel plans instead to keep lots of its work in China…even if American tariffs rise further, many Chinese companies are betting heavily on automation to remain competitive. In 2017 China’s installations of industrial robots rose by 59% to 138,000, more than in America and Europe combined. While downplaying its controversial “Made in China 2025” industrial policy, to soothe the fears of the Trump administration, the Chinese government is happy to throw money at existing manufacturing industries in order to help them tool up. That will help keep the robot revolution running.
Walk through Esquel’s biggest factory in Foshan in the Pearl River Delta and it is clear that even here the robots are coming. The hundreds of workers sitting, heads down, in pink caps are a sight to behold. They are also outnumbered by machines. On some lines, robotic arms swish, trimming collar bottoms and pressing plackets. The devices do fiddly jobs like making sure that tiny pearl-coloured buttons for Banana Republic have the word Banana on the top. Israeli cameras, adapted from military devices, use artificial intelligence to scan for flaws in the fabric, automating one of the most mind-numbing of jobs.
Some workers have been displaced but productivity has improved, keeping the firm’s profits stable despite a tripling since 2006 of its average monthly wage in China, to 4,500 yuan ($650)… Despite the frictions, Marjorie Yang, Esquel’s chairman, is in effect doubling down on China. She touts a 2bn yuan investment in a new factory in Guilin, a picturesque region, including a yarn-spinning division so high-tech that visitors are not allowed to walk the floors. So far Esquel’s products have been spared American tariffs. American clients are nervous, so if need be the firm could shift some production to its factories outside China, such as in Mauritius, while moving other lines back home.”

5. Short read: Jack Bogle: the selfless preacher of the passive revolution
Author: The Editorial Board
Source: FT (https://www.ft.com/content/7a2a0aa0-1a5b-11e9-9e64-d150b3105d21)
We had to pay our respects. And the FT Editorial does the job in a nice, succinct way. Jack Bogle, the father of passive investing, arguably the most impactful innovation in the investment management industry, passed away last week. The editorial aptly starts by quoting Noble Prize-winning economist Paul Samuelson’s article in which he argues that “There might be stock pickers who beat others consistently but they were “remarkably well hidden” and trying to find them rather than investing in the market as a whole was a waste of money.”
Samuelson pointed out that Wall Street was ignoring this inconvenient truth, despite reams of academic evidence, and called for a revolution. “The ball is in the court of the practical men: it is the turn of the Mountain to take a first step toward the theoretical Mohammed,” he wrote.The Mountain soon arrived in the form of Jack Bogle, the charming, iconoclastic and persuasive financial pioneer who died this week at the age of 89. Bogle’s innovation — the first mutual fund to follow passively the Standard & Poor’s 500 index — changed Wall Street and saved billions in fees. “He is a hero to them and to me,” the investor Warren Buffett once wrote.”
Bogle not only highlighted the merits of passive investing but also highlighted the issue of conflict of interest at the heart of the investment industry –“ Technology needed a human face and Bogle provided it. It also needed someone to reject the conflict of interest at the heart of the investment industry. As long as mutual funds convinced people that star fund managers achieved higher returns, they could charge fat fees. Bogle was willing to court unpopularity by admitting that his fellow emperors lacked clothes.”

6. Short read: Why you gotta love Jasprit Bumrah
Author: Rohit Brijnath
Source: Mint (https://www.livemint.com/Leisure/JKMXUSUlexqh6dAYGCn73N/Why-you-gotta-love-Bumrah.html)
Rohit Brijnath is the sort of sportswriter who can make a sportslover love sport even more. But this one is about Jasprit Bumrah. And Brijnath in his typical style invokes the legends…from a Messi to Nadal to Warne to Federer. Bumrah has a long way to go before he can be quoted in the same breath but given that he, alongside Pujara sculpted what is a historic test series win Down Under, Brijnath will be excused. If Sandeep Dwivedi’s sublime prose was about Pujara’s grind up to greatness, Brijnath’s ode romanticises Bumrah’s exciting talent from a fan’s perspective. Here is why:
Because he is fast and he takes us back in time in 1970-80’s when everything was slow—“ But really in Kolkata, where I come from, life in the 1970-80s was unhurried. Even the tea seemed to brew more slowly. Babus slurped it and gravelly pondered every request as if it was an existential question. Trams rattled and wheezed, street-side bookshops were lingered at and the world was debated without conclusion at coffee shops. Bishen Singh Bedi turned his arm over at Eden Gardens like a man in a slow trance, Sunil Gavaskar batted time, Ramesh Krishnan’s serve took part of a day to cross the net and my dad wanted to take me to Alekhine Chess Club to watch carved pieces move. So excuse me if I keep staring at the radar gun after each Bumrah delivery – 140kmh. 142.5. 148..”
Because he’s an adult – “Bumrah is a send-off-free hero who is too smart to be a stereotype, too evolved to be just another swearing, pointing, glaring fast bowler.”
Because he makes things happen- “When he holds the ball, I always find my chair, as if I’m attending a private concert. There’s no one else in the Indian team I do that for. Not even Kohli (sorry, mate).”
Because He’s Always At Batsmen- “He’s suffocating in his own way, imprisoning with his accuracy, asking questions as fast and intelligently as an interrogator from an Aaron Sorkin script, frustrating batsmen, making them hurry, giving no respite”
Because Of That Action- “We’ve all played against a kid like him in our youth. Or the one who didn’t move his left arm and just rolled his right arm over. Or the cack-handed hockey guy and the tennis fellow who chased his service toss. We used to laugh because we believed only in the classical. As if there was a set way for everything.”

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