Sunday, October 21, 2018

D’Aveni, The Pan-Industrial Revolution

Richard D’Aveni, a professor at Dartmouth’s Tuck School of Business, has set forth a bold hypothesis. As 3-D printing or, more generally, additive manufacturing (AM) becomes increasingly sophisticated, manufacturing will be transformed and pan-industrial companies will come to dominate the world economy. At the moment, although investors certainly haven’t bought into this story, among the leading contenders for dominance are Jabil, GE, Siemens, and United Technologies.

In The Pan-Industrial Revolution: How New Manufacturing Titans Will Transform the World (Houghton Mifflin Harcourt, 2018) D’Aveni argues that, contrary to the popular myth, “the future of additive manufacturing does not lie in a world of ‘makers’—hobbylike small-scale craftspeople producing a few items at a time in little workshops scattered all over the world.” Instead, “the logic of the pan-industrial revolution—and the power of the virtuous cycle of growth that it will set in motion—will make the drive toward bigness practically irresistible.”

Pan-industrial firms are distinguished by their ability to “use industrial platforms to build flexible supply chains and powerful business ecosystems, enabling greater product diversification than practiced by any corporation of today.” In contrast to traditional manufacturing, which puts efficiency first, platform-managed AM puts agility first. Among the characteristics of platform-managed AM are: (1) products are built all at once, eliminating assembly and permitting internal complexity, (2) flexible equipment and workers are used to make a broad range of products at an affordable cost, (3)shallow learning curves facilitated by software, AI, and machine learning make innovation and entry to new markets relatively easy, and (4) short supply chains move production close to customers and minimize costs of transportation, warehousing, and inventory control.

AM has already made great strides in industries as diverse as medical devices, fashion, construction, and food. For instance, Dubai has partnered with the Chinese company Winsun to 3D print offices and homes, with a goal of having 30 percent of the city 3D printed by 2030.

Even though the future is unlikely to play out exactly as D’Aveni foresees it, he makes a strong case for an exciting new industrial revolution, the initial stages of which we are already beginning to see.

Wednesday, October 17, 2018

Siilasmaa, Transforming Nokia

Risto Siilasmaa, the chairman of Nokia, has written a real-life business thriller, one that he lived through and, along with Nokia, survived. Transforming Nokia: The Power of Paranoid Optimism to Lead Through Colossal Change (McGraw-Hill, 2018) takes the reader from the height of Nokia’s success in the global smartphone market in 2008, when it had a more than 50 percent share, to the company’s near bankruptcy in 2012, to the sale of its iconic smartphone business to Microsoft, up to today, where it is a top player in wireless infrastructure.

Siilasmaa had founded and served as CEO of F-Secure for 18 years before, at the age of 42, he was tapped to join the Nokia board of directors in 2008, a year after Apple introduced the iPhone. The timing couldn’t have been worse. Although Nokia tried to respond to the onslaught of competition in the smartphone market, it was plagued by technological, leadership, and cultural issues. It brought on a new CEO, an American from Microsoft, in the fall of 2010, who launched Project Sea Eagle, “a sweeping internal review of Nokia’s capabilities and competitiveness.” As a result of this review, Nokia decided to partner with Microsoft on the Windows Phone. In response to this decision, a Google senior vice president tweeted, “Two turkeys do not make an eagle.” Unfortunately for Nokia, he was right.

It was under this grim set of circumstances that, in May of 2012, Siilasmaa became chairman of Nokia. In the second part of his book he describes how he transformed the company. He attributes this in large measure to being a paranoid optimist, one who combines “vigilance and a healthy dose of realistic fear with a positive, forward-looking outlook.” In practice, he writes, “paranoid optimism calls upon leaders to explore a full spectrum of scenarios: the best case, the worst case, and the options in between. By imagining the unthinkable, you won’t be surprised and can generate strategies that will help you avoid it. As a result, you can radiate an unwavering certainty of eventual victory because you have already imagined the worst that could happen and have constructed a response.”

And many unthinkables did happen along the way. The negotiations with Microsoft to sell Nokia’s “crown jewels” were fraught with unexpected hurdles. Siemens wanted to get rid of its share of Nokia Siemens Networks, which over the course of six years had posted a cumulative operating loss in the billions. Could Nokia buy Siemens out even though it didn’t have the funds? Was it wise to do so? What should the company do with its digital map business, HERE, and its patent portfolio? Should NSN merge with Alcatel-Lucent—and in three weeks, as the executive chairman of NSN suggested? (The unrealistic time frame was scrapped.) “Merging with Alcatel-Lucent would increase NSN’s market share in the global wireless infrastructure market from 18 percent to more than 30 percent, leapfrogging over Huawei and closing in on market leader Ericsson.”

Nokia today is indeed “a company reborn.” “Out of some 100,000 employees, fewer than 1 percent held a Nokia badge in 2012.” The route to its rebirth makes for fascinating reading.

Sunday, October 14, 2018

Iqbal, Volatility

Adam S. Iqbal is the global head of FX Exotics and Correlation at Goldman Sachs and was formerly an FX options trader and portfolio manager at Barclays and Pimco. He holds a Ph.D. in financial mathematics and financial economics.

In Volatility: Practical Options Theory (Wiley, 2018) Iqbal sets himself the goal of providing “an intuitive, as well as technical, understanding of both the basic and advanced ideas in options theory, with the aim of encouraging translational work from theory into practical application by market makers, portfolio managers, investment managers, risk managers, traders, and other market practitioners.” Only peripherally is he writing for the retail options trader with a mathematical bent. He draws his examples from the FX market.

The ability to delta hedge, Iqbal explains, means that “options are fundamentally not bets on direction, but are bets on volatility.” Moreover, the spot FX rate is a martingale, so it exhibits no mean reversion or autocorrelation. Price-based predictability therefore has no place in probability distributions used to model FX rates for the purpose of option pricing.

What matters, and what professionals who use and price options should understand before they embark on building models or, under time constraints, in lieu of relying on models, are the major principles underlying options—first- and second-order greeks as well as implied volatility and term structure (along with smile and skewness). Only after all of these concepts are described in detail does Iqbal introduce the Black-Scholes-Merton model.

Iqbal provides examples of how the trader might make decisions without invoking a full-fledged mathematical model. In the case of a risk reversal, for instance, “one way that traders use to circumvent disagreements over volatility references is to trade a contract known as a risk reversal by smile vega. The idea here is that, since the seller of the risk reversal believes in lower volatility references, if she agrees to trade at the higher volatility references, she can sell a higher notional of the put than she purchases of the call.”

Or take the case in which a normal distribution is priced into options but market participants begin to realize that the actual distribution is leptokurtic, with a higher peak and fatter tales. The peak “means that spot is more likely to remain in the center of the distribution than is currently priced. This means that they sell ATM straddles to profit from the additional probability that we observe only very small moves. Second, they realize that spot is also more likely to exhibit a very large positive or negative return than is priced. They therefore look to purchase OTM strangles. That is, market participants buy the butterfly. … [T]he more kurtosis there is in the spot PDF, the higher the fair price should be for the butterfly.”

Wednesday, October 10, 2018

Hoffman & Yeh, Blitzscaling

In my wildest fantasies I never envisage creating the next Amazon or Facebook. But I’m intrigued by the people who set out to do just that, who they are and how they do it. Blitzscaling: The Lightning-Fast Path to Building Multibillion-Dollar Scaleups by Reid Hoffman and Chris Yeh (Currency / Crown, 2018) addresses the second question. And the answer is not for the faint of heart.

Blitzscaling is “prioritizing speed over efficiency in the face of uncertainty.” It can be compared to three other forms of rapid growth: classic start-up growth, classic scale-up growth, and fastscaling. Start-up growth prioritizes efficiency in the face of uncertainty (e.g., does your product satisfy a strong market demand?). Scale-up growth focuses on growing efficiently once the company has some certainty about the environment. Fastscaling, where you sacrifice efficiency for the sake of increasing growth, takes place in an environment of certainty and “is a good strategy for gaining market share or trying to achieve revenue milestones.”

And then there’s blitzscaling, which “combines the gut-wrenching uncertainty of start-up growth with the potential for a much bigger, more embarrassing, more consequential failure.” It’s hard to raise capital to blitzscale and, “to make matters worse, you usually need more money to blitzscale than to fastscale, because you have to keep enough capital in reserve to recover from the many mistakes you’re likely to make along the way.”

Blitzscaling is most applicable to high tech, but its techniques can benefit a range of industries. Two examples are the Spanish clothing retailer Zara and the shale oil company Chesapeake Energy.

This book grew out of a course that authors Reid Hoffman, the founder of LinkedIn and currently a partner at the venture capital firm Greylock Partners, and Chris Yeh, a writer and entrepreneur, co-taught at Stanford in the fall of 2015. Perhaps because of this, the authors not only explain the many intricacies and manifestations of blitzscaling but also address how to blitzscale responsibly and build companies that improve society.

Blitzscaling is about as fast-paced a book as its subject matter. It is packed with sophisticated business advice and useful examples of success and failure. Entrepreneurs and would-be entrepreneurs as well as investors in break-through companies will learn a tremendous amount from reading it. They may even decide to take up the book’s final challenge: “Race you to the future.”

Sunday, October 7, 2018

Tulchinsky, The UnRules

In some ways Igor Tulchinsky has written an “un-book,” and it’s undoubtedly the better for it. The UnRules: Man, Machines and the Quest to Master Markets (Wiley, 2018) is a short book, coming in at about 150 pages. As Tulchinsky explains in the preface, he is a man of few words. As it is, even to get to 150 pages, he blends memoir, the history of finance and mathematics, sometimes arcane examples, and quantitative analysis. But the result is a captivating personal account of what it takes for an immigrant to succeed in the world of quantitative finance and how data analytics are changing our future, and not only our financial future.

Tulchinsky is the founder, chairman, and CEO of WorldQuant, a global quantitative investment management firm. He is also the founder of WorldQuant Foundation and WorldQuant University, which offers a tuition-free two-year online master’s degree program in financial engineering and a free eight-week module on data science.

The UnRule, which Tulchinsky admits is loosely related to the liar’s paradox (loosely because it is an empirical rule), is that “All theories and all methods have flaws. Nothing can be proved with absolute certainty, but anything may be disproved, and nothing that can be articulated can be perfect.”

This UnRule informs his investing philosophy: create many competing points of view or, more precisely formulated in the case of his investment firm, alphas. In ten years WorldQuant went from 19 alphas to 10 million! “Today a typical portfolio may contain tens of thousands of alphas; the largest may contain 100,000. To our portfolio strategists, individual alphas, which may have vectors of hundreds or thousands of securities, remain black boxes. The algorithms, logic, and intellectual property remain with the researchers; the strategists know individual alphas only as mathematical expressions of a market signal. … [A] portfolio is all math.”

Readers who are looking for the mathematical secret sauce will be disappointed. But those in search of the qualities necessary for a person to thrive in today’s financial markets will be richly rewarded.

Wednesday, October 3, 2018

Belsky, The Messy Middle

We’ve all been there. We start a project with great enthusiasm. Then, as we proceed, the goal seems farther and farther away. We have self-doubts, we are mired in the mundane, we are on a roller coaster of successes and failures. The journey to make something great is definitely not linear.

In The Messy Middle: Finding your way through the hardest and most crucial part of any bold venture (Portfolio/Penguin, 2018) Scott Belsky, an entrepreneur and venture investor who is now chief product officer at Adobe, explores the ups and downs between a project launch and its (sometimes) successful conclusion.

“The middle,” he writes, “makes and breaks you, and ending up on the right side of this line depends on how you manage everything in between. It requires immense perseverance, self-awareness, craftsmanship, and strategy. It also requires luck, harvested whenever you encounter it.”

Belsky draws on his experience with Behance, his first company, which he founded in 2006 and sold to Adobe in 2012. He gives advice in two- or three-page bites. Among his words of wisdom: attempt a new perspective of it before you quit it; just stay alive long enough to become an expert; moving fast is great, so long as you slow down at every turn; too much scrutiny creates flaws; data is only as good as its source, and doesn’t replace intuition; the science of business is scaling, the art of business is the things that don’t.

There’s a lot of sound advice in this book. And since it’s laid out like a huge smorgasbord, you can read it that way as well, picking and choosing your way through it. And you can go back for seconds when you’re at a different stage of your endeavor.

Sunday, September 30, 2018

Marks, Mastering the Market Cycle

Howard Marks, cochairman and cofounder of Oaktree Capital Management and author of The Most Important Thing, expands on one of his twenty “most important things” in Mastering the Market Cycle: Getting the Odds on Your Side (Houghton Mifflin Harcourt, 2018). Marks paints in broad strokes, so the reader will not come away from this book with any concrete trade ideas. But, after reading Marks’s analysis, he should better understand how to sync his portfolio with the ebb and flow of the market, so as not to buy at the top and sell at the bottom, even though “the tendency of people to go to excess will never end.”

Marks discusses multiple cycles that feed into the market cycle: the economic cycle, the cycle in profits, the pendulum of investor psychology, the cycle in attitudes toward risk, the credit cycle, the distressed debt cycle, and the real estate cycle. He also looks at the cycle in success. Of these, the one he considers most important is the risk cycle. So let me summarize some of his points on this front.

It is often set forth as a truism that, since there seems to be a positive relationship between risk and return (the ubiquitous upper-sloping line), “riskier assets produce higher returns” and hence “if you want to make more money, the answer is to take more risk.” This formulation, Marks explains, “cannot be true, since if riskier assets could be counted on to produce higher returns, they by definition wouldn’t be riskier.”

In general, of course, the capital market line, or risk/return continuum, makes sense if viewed in terms of rational expectations. We expect to make a higher return on investments in small cap stocks than on investments in money market funds, and the former is perceived to be proportionally riskier than the latter. On this continuum “there won’t be particular points … where risk-bearing is rewarded much more or much less than at others (that is, investments whose promised risk-adjusted return is obviously superior to the rest).”

But fluctuations in attitudes toward risk can upset this continuum. As investors become increasingly optimistic, even euphoric, they are willing to settle for skimpy risk premiums on risky investments. “This reduced insistence on adequate risk premiums causes the slope of the capital market line to flatten.” And so, Marks writes, “risk is high when investors feel risk is low. And risk compensation is at a minimum just when risk is at a maximum.” At the other end of the spectrum, when markets sell off, investors become excessively risk averse, and the slope of the capital market line increases, offering “an exaggerated payoff for risk-bearing. Thus the reward for bearing incremental risk is greatest at just the moment when—no, rather, just because—people absolutely refuse to bear it.”

When should investors begin to buy as the market is cascading downward? Marks strongly rejects the idea of waiting for the bottom. First, there’s no way to know, except in hindsight, when the bottom has been reached. “And second, it’s usually during market slides that you can buy the largest quantities of the thing you want, from sellers who are throwing in the towel and while the non-knife-catchers are hugging the sidelines. But once the slide has culminated in a bottom, by definition there are few sellers left to sell, and during the ensuing rally it’s buyers who predominate.” So, to repeat, when should investors start to buy? For Marks, the answer’s simple: buy when price is below intrinsic value. And if price continues downward, buy more. “All you need for ultimate success in this regard is (a) an estimate of intrinsic value, (b) the emotional fortitude to persevere, and (c) eventually to have your estimate of value proved correct.”