Monday, December 31, 2018

Happy New Year

May you all find peace, prosperity, health, and happiness in 2019.

Thursday, December 20, 2018

AQR Capital Management, 20 for Twenty

A heads up to anyone who wants to understand how some very bright quants think. I just downloaded AQR’s anthology commemorating its 20th anniversary. It’s big, coming in at nearly 700 pages, and free for the taking in either .mobi or .epub formats. Personally, I can’t think of a better way to spend part of the holidays than reading the 20 papers that “have formed the backbone of AQR’s investment philosophy.”

Wednesday, December 12, 2018

Jacobs, Too Smart for Our Own Good

Bruce I. Jacobs’ Too Smart for Our Own Good: Ingenious Investment Strategies, Illusions of Safety, and Market Crashes (McGraw-Hill, 2018) attempts to identify the common causes of financial crises since the 1980s. Jacobs, the co-founder of Jacobs Levy Equity Management and its co-chief investment officer and co-director of research, believes that underlying all of these crises have been “free lunch” products that, in turn, have their roots in the Black-Scholes-Merton option pricing model.

Jacobs focuses on three crises and the allegedly risk-reducing, return-increasing strategies and products that led in these cases to market instability and massive losses, at least in the short term. “Of particular interest are portfolio insurance in the 1980s, arbitrage strategies pursued by LTCM in the 1990s, and the mortgage-linked securities at the center of the 2007-2008 credit crisis.” Jacobs contends that they share certain commonalities. “These commonalities include opacity and complexity, which make it difficult to anticipate the effects of the strategies and products and to discern the relationships they forge between different market participants. They also include leverage, facilitated by derivatives and borrowing, which increases their impact on security prices, markets, and the economy. And they include the underlying, option-like nature of the strategies and products, which can make markets behave in nonlinear ways, with prices bubbling up or crashing down.”

One of the major problems with products that purport to reduce risk and increase returns is that they tend to encourage more risk-taking since people believe that, with these products, they have a safety net come what may. Moreover, as the demand increases for such products, “the level of risk that must be shifted increases. The availability of counterparties to take on the risk becomes more and more questionable. Liquidity begins to dry up.”

Jacobs does not argue against option, arbitrage, and securitization strategies in general. He recognizes that they can play a useful role in portfolios. He also recognizes that the crash-inducing strategies and products of the future will be different from those that caused problems in the past. He remains convinced, however, that they will share the same fundamental characteristics. Forewarned is forearmed.

Monday, December 10, 2018

The best books of 2018

Another year, another idiosyncratic list of what I consider to be the best books I reviewed this year, with links to my reviews.

Michael Batnick, Big Mistakes

Cochrane & Moskowitz, eds., The Fama Portfolio

Annie Duke, Thinking in Bets

Sebastian Edwards, American Default

Meb Faber, The Best Investment Writing, vol. 2

Howard Marks, Mastering the Market Cycle

Michael Rees, Principles of Financial Modelling

Howard Schilit, Financial Shenanigans, 4th ed.

Paul Volcker, Keeping At It

Sunday, December 9, 2018

Ochoa-Brillembourg, Delivering Alpha

Delivering Alpha: Lessons from 30 Years of Outperforming Investment Benchmarks (McGraw-Hill, 2019) by Hilda Ochoa-Brillembourg is written for “any finance professional who wants to know how to add sustainable value to globally diversified institutional portfolios beyond what’s learned in textbooks.” The author, after an 11-year stint at the World Bank as chief investment officer of its Pension Investment Division, was the lead founder of Strategic Investment Group in 1987 and continues to serve as its chairman. Since its founding, Strategic has outperformed its benchmarks more than 75% of the time on a rolling three-year basis with less volatility than the benchmarks.

Ochoa-Brillembourg is primarily concerned in this book with institutional portfolio construction and management. Although she acknowledges the many merits of modern portfolio theory, she writes that “in practice there is significant slippage between the practical lip and the theoretical cup. Principally, the optimal portfolio will change dramatically over time with the volatility of the assets it contains and the return and risk preferences of investors and securities issuers. Market variables are unstable, and most investors have significant risk and return constraints, forcing them to engage in exercises of ‘constrained optimization’ that will move away from the most elegant MPT concepts. Life is messy and hard, and so are optimal investment choices.”

She dubs her optimal portfolio construction theory “portfolio fit theory.” The process of improving the return to risk profile of a legacy portfolio (assuming that most assets in the portfolio are either worth preserving or inefficient to liquidate) involves adding marginal assets. “In this framework, the value of an asset needs to be assessed on the basis of its price, its expected return, its volatility of return—and, most important, its correlation with the legacy portfolio, not solely its correlation with the market portfolio.” And, an important corollary, the fair market price of an asset does not equal its value to a particular investor. “Certain assets may have a higher value to particular investors than their market price, and some assets can improve a legacy portfolio’s return-to-risk ratio and compound rate of return despite apparently suboptimal characteristics on a stand-alone basis.”

Ochoa-Brillembourg covers a lot of ground in this book, from selecting appropriate benchmarks to rebalancing versus tactical tilts, from the uses of volatility to the boundaries of risk. A sub-theme is governance. (It seems that her group has dealt with more than its fair share of clients who had less than ideal structures in place for making decisions.)

Delivering Alpha is brimming with the kind of practical wisdom that comes from years of experience in the trenches. Money managers of all stripes will profit from reading it.

Tuesday, December 4, 2018

Edmondson, The Fearless Organization

Twenty years of research inform The Fearless Organization: Creating Psychological Safety in the Workplace for Learning, Innovation, and Growth (Wiley, 2019) by Amy C. Edmondson, a professor at the Harvard Business School. Although by now most managers know, at least in theory, that they should provide an environment in which workers at all levels can share their ideas—and mistakes—without the fear of belittlement or reprisal, not enough managers know how to put this into practice. A 2017 Gallup poll found that only 3 in 10 employees strongly agreed with the statement that their opinions count at work.

Edmondson’s work bridges this gap between theory and practice. With findings from academic research and case studies from a wide range of workplace settings, she explains how to build an organization in which learning, innovation, and growth can flourish.

Thursday, November 15, 2018

Miller & Conley, Legacy in the Making

Branding has gotten a bad rap in the wake of Donald Trump’s election to the presidency. It has been conflated with egotism and narcissism. But entrepreneurs and companies work hard to develop and burnish their brands, knowing that it is an essential part of doing business. In Legacy in the Making: Building a Long-Term Brand to Stand Out in a Short-Term World Mark Miller and Lucas Conley show how some brands are charting a modern legacy on maps of their own making.

The book itself is, I assume, meant to be some kind of branding statement. It is square (9” x 9”) with glossy paper and lots of photos. It is printed in black, white, and cyan. It comes across as something of a coffee table book, although its intent is much more serious. As an effort in book design branding, I consider it a failure. Fortunately, the reader can learn to ignore the design noise and focus on the message.

The meat of the book is its profiles of brands, both for-profit and not-for-profit, based on interviews, most often with the brands’ founders. The reader can learn from, among others, Patagonia, the Tribeca Film Festival, Girls Who Code, The Honest Company, the Ritz-Carlton Hotel Company, the It Gets Better Project, Grey Goose, the Belmont Stakes, Lexus, and Wimbledon.

Legacy in the Making will inspire budding entrepreneurs and challenge executives of established brands.

Wednesday, November 14, 2018

Nasher, Convinced!

Jack Nasher’s Convinced! How to Prove Your Competence & Win People Over (Berrett-Koehler, 2018) proceeds from the well documented premise that it is not actual but perceived competence that determines the impression you make on people. In fact, modesty is probably not a virtue. Icons, top names in their field, are anything but modest or stoic. “In extreme cases, these people have an almost narcissistic personality disorder, convinced of their own grandeur—and they are extremely successful.” We have only to think of Donald Trump.

So, if you are the type who is inclined to hide your light under a bushel (which is not even a Christian thing to do), Nasher has a lot of tips on radiating competence. They range from how to deliver bad news to how to speak and move like an expert, from how to increase your popularity and attractiveness to the power of symbols.

One of Nasher’s recommendations is not to show how much effort you put into an undertaking. Natural talent is more prized than acquired skills, so “perceived effort must be minimized to maximize perceived competence.” Reflecting this, the unofficial motto of one of the colleges at Oxford University is “Effortless superiority.”

Although here and there I cringed at some of Nasher’s suggestions, and although occasionally it took me back to my days as an insecure teenager reading pamphlets on how to be popular, on balance his points are well taken. So, if you think you’re underrated by your colleagues, your bosses, your clients, here you can learn how to convince them otherwise. And you don’t even actually have to be competent.

Tuesday, November 13, 2018

Hirsch & Mistal, Stock Trader’s Almanac 2019

The Stock Trader’s Almanac is now in its 52th edition. Not quite the track record of The Old Farmer’s Almanac, which launched in 1792, but presumably a tad more data driven.

The spiral bound almanac opens flat for easy access to its data or for jotting down notes. The format remains essentially the same as in previous years, with a calendar section, a directory of trading patterns and databank, and a strategy planning and record keeping section. The calendar section has on facing pages historical data on market performance (verso) and a week’s worth of calendar entries (recto). January’s verso pages, for example, give the month’s vital statistics, January’s first five days as an early warning system, the January barometer, and the January barometer in graphic form since 1950. Each trading day’s entry on the recto pages includes the probability, based on a 21-year lookback period, that the Dow, S&P, and Nasdaq will rise. Particularly favorable days (based on the performance of the S&P) are flagged with a bull icon; particularly unfavorable trading days get a bear icon. A witch icon appears on monthly option expiration days. At the bottom of each entry is an apt quotation. There’s about a five-square-inch space in which to write.

The Stock Trader’s Almanac pays particular attention to the presidential cycle, but 2019 may defy the normally bullish results for pre-presidential election years (only one loser in 80 years and an average gain for the Dow of 47.4% from the midterm low to the following year high). “With all the gains paid forward in 2017 and 2018, mushrooming levels of debt and deficits [plus “the waning positive impact of the tax cuts and tougher quarterly earnings comparisons, not to mention the potential for a yield curve inversion”] are likely to begin to weigh down the economy and stock market in 2019” and “awaken the long-hibernating bear.”

What about the January effect? As goes January so goes the year 75% of the time. Fifteen of the last 17 pre-presidential years followed January’s direction. And every down January since 1950 preceded a new or extended bear market, a flat market, or a 10% correction. As for the first five days of January, the last 43 times these days were up the market had full-year gains 83.7% of the time, with an average return of 13.7%. The 25 down “first five days” were followed by 14 up years and 11 down, for an average gain of 1%.

Each year the editors of the almanac choose the year’s best investment books. This year heading the list is Michael Batnick’s Big Mistakes.

This almanac is full of data that will delight those traders who believe that past is prologue. Even those who are skeptical have to pay attention to data that seasonal traders rely on and that therefore tend to move markets.

Sunday, November 11, 2018

Furr et al., Leading Transformation

Companies frequently have to reinvent themselves, a task that tends to be neglected because of comfort with the familiar and fear of the unknown. And because management simply doesn’t know how to go about envisaging a different trajectory for the company, let alone implementing it. Nathan Furr, Kyle Nel, and Thomas Zoëga Ramsøy pooled their skills and experience to write Leading Transformation: How to Take Charge of Your Company’s Future (Harvard Business Review Press, 2018).

The tools of change the authors recommend may seem bizarre—science fiction, comic books, applied neuroscience, and archetypes—but companies as diverse as Lowe’s, Pepsi, IKEA, Google, and Walmart are already successfully using them. So it behooves other companies to take their recommendations seriously.

Science fiction has inspired many notable technologies, from the submarine to earbuds. “Indeed, many argue that science fiction underpins the entire culture of Silicon Valley and the technology revolution created there.” Whether or not that’s true, the authors believe that science fiction “can be a tool to break the bonds of incrementalism and to imagine other possibilities.” Companies can use science fiction to dream bigger. Specifically, the authors suggest that companies use their existing data as a foundation and give it to five writers, asking each of them to write a short story about what the future could look like in five to ten years in light of the data. That’s, of course, only the first step, but it’s a step that might just set a company off on a wildly successful venture.

In the course of this book the authors propose a series of actions that companies might take to transform themselves. They are not the run-of-the-mill suggestions that one finds in business books but what I would consider frontier ideas (as opposed to cutting-edge or fringe ideas). Maybe they will be how the new West in business will be won.

Thursday, November 8, 2018

Truthful Living: The First Writings of Napoleon Hill

It’s hard to have missed Napoleon Hill’s Think and Grow Rich, which has sold more than 100 million copies since it was published in 1937 and helped spawn the self-improvement marketplace, currently valued at $10 billion in the United States alone. A few years ago material was unearthed in the Napoleon Hill Archives that predated Think and Grow Rich by 20 years, during the time that Hill taught courses in advertising and sales at the George Washington Institute in Chicago. Jeffrey Gitomer compiled, edited, and annotated these writings. The result is Truthful Living: The First Writings of Napoleon Hill (Amazon Publishing, 2018).

Why the title “Truthful Living”? Because Hill believed that all living had to be built upon the foundation of truth. “Without this firm foundation, no person or business can hope to permanently succeed in this day of progressive policies.”

Hill also maintained that “the chief reason that ninety-five percent of the people are working for the other five percent is that ninety-five percent do not know how to think.” The beginning of all successful undertakings—he cites Andrew Carnegie, John D. Rockefeller, James J. Hill, Orville and Wilbur Wright, Andrew Graham Bell, and Guglielmo Marconi—is thought, “scientific, accurate thought!”

In order to become an accurate thinker, you must “concentrate the forces of your mind and direct them upon one subject until that subject has been mastered. The power to concentrate presupposes the ability to finish all that you start—to stick to everything you undertake with a grim persistence that knows no defeat!”

Hill suggested that “writing out our thoughts not only aids concentration, but this bodily, physical action helps us make the first step toward the crystallization of thought into reality. Thought without persistent, concentrated bodily action would be useless.”

These snippets from Hill’s first writings illustrate the thrust of his own thinking. There’s of course much more in this volume: for instance, dealing with adversity, happiness, and the principle of service. Here and there Hill’s work is dated because in some ways the world has become a darker place (hard to imagine, since 1917 wasn’t exactly an idyllic time), but for the most part it teaches the same kinds of principles that modern self-improvement writers advocate. That authors are churning out these books in record numbers shows that people feel a need for them and yet few readers ever really learn from them.

Wednesday, November 7, 2018

Speziale, Capital Compounders, 2d ed.

Robin R. Speziale, author of Market Masters, is a 31-year-old, self-taught Canadian growth investor. In this second edition of Capital Compounders: How to Beat the Market and Make Money Investing in Growth Stocks he shares the principles that have guided his wealth-building journey.

Although a skilled editor could have improved the book significantly, Capital Compounders offers many insights for the active investor, both budding and experienced. The most daunting chapter sets out the author’s 72 (!) rules for investing in stocks. Yes, 72 because of the rule of 72.

Speziale focuses on small- and mid-cap Canadian stocks, with some micro-caps added to the mix as well, but his investing process is equally applicable to the U.S. market. In fact, in his chapter on how to find ten baggers, he draws on the work of American growth investors Peter Lynch, Philip Fisher, William O’Neil, Joel Greenblatt, and T. Rowe Price, Jr. as well as Canadian managers. In a bonus chapter, his DIY investor friends share their strategies.

In many ways, this is an old-fashioned book. But old-fashioned doesn’t mean out of date. On the contrary, it’s refreshing. And, according to Speziale’s own track record, profitable.

Tuesday, November 6, 2018

Smith & McKeen, Driving IT Innovation

Driving IT Innovation: A Roadmap for CIOs to Reinvent the Future by Heather A. Smith and James D. McKeen (Prospect Press, 2019) is outside my wheelhouse, so I will simply note its publication and give a one-sentence summary.

The authors, both affiliated with Queen’s University, Kingston, Ontario, have published extensively on IT management issues. In this book, based on interactive sessions with groups of senior IT managers from a wide variety of industries, they outline three drivers of successful IT innovation: opportunity drivers, discovery drivers, and delivery drivers.

Sunday, November 4, 2018

Crosby, The Behavioral Investor

In 2014 Daniel Crosby, a psychologist and asset manager, co-authored the bestselling Personal Benchmark: Integrating Behavioral Finance and Investment Management and followed that up in 2016 with The Laws of Wealth. Another two years and he’s produced a new book: The Behavioral Investor (Harriman House, 2018). His “admittedly audacious” goal is for this book “to be the most comprehensive guide to the psychology of asset management ever written.” I’m not sure that he has succeeded in this task, though perhaps my hesitation comes from having read far too many books on behavioral finance and having mashed them all together in my mind. But even if he has fallen short of his own self-defined goal, he has written a sweeping account of the impediments that human beings have to overcome to become successful investors. He also points investors to a “third way” of investing, distinct from both the passive and the active approaches.

Crosby starts with findings from sociology, brain studies, and physiology—for instance, that taking financial risk causes real bodily pain. And, from John Coates’s seminal research, that during times of market volatility “the cortisol levels of traders increased a whopping 68% over a period of just eight days!”

In the second part of his book Crosby tackles four main issues in investor psychology: ego, conservatism, attention, and emotion. One takeaway from the chapter on conservatism is that, “holding outcomes equal, action is more likely to lead to regret than inaction.” So, even when action is called for, we tend to do nothing.

Part three looks at what it takes to become a behavioral investor. Let’s revisit the problem of conservatism. One of the ways we can surmount this problem is, oddly enough, to procrastinate. In a research study “subjects chose the default option 82% of the time when asked to decide in an instant, but only 56% of the time after being given a short delay.”

In his chapter on honing attention Crosby argues that “an investable factor [and he highlights the factors of value and momentum] must be empirically evident, theoretically sound and have roots in behavior.” He claims as a fact that “data without theory and theory without data both produce spurious results.”

The final part of the book analyzes how to build rules-based behavioral portfolios. The process includes an element of market timing, “infrequently taking risk off the table when the market is poised to do its worst.”

Crosby’s book is eminently readable, with ample stories and studies. Here and there we find howlers, such as his claim that Thales was a contemporary of Aristotle, just a little less egregious than my saying that I am a contemporary of Sir Isaac Newton. But the book offers the reader valuable lessons in creating a portfolio that can, at least in part, circumvent the most pervasive behavioral pitfalls.

Wednesday, October 31, 2018

Berger, The Book of Beautiful Questions

In 2014 Warren Berger wrote A More Beautiful Question: The Power of Inquiry to Spark Breakthrough Ideas. He has now followed that up with The Book of Beautiful Questions: The Powerful Questions That Will Help You Decide, Create, Connect, and Lead (Bloomsbury Publishing, 2018).

Let’s look briefly at some of the questions we might ask regarding a creative endeavor. First, to find “our big idea” we could ask: What stirs me? What bugs me? What’s missing? What do I keep coming back to? What is ripe for reinvention?

In order to see potential creative opportunities that “are all around,” we have to see the world differently. Here we can ask: What might I notice if I were encountering this for the first time? What is in the background? What here would fascinate a five-year-old? What would Seinfeld be amused by? What would Steve Jobs be frustrated by?

If you’re having trouble getting started on a creative project, Berger suggests that you ask six questions: Am I chasing butterflies? (“Meaning you keep thinking of new ideas instead of moving forward with an existing project.”) Who will hold me accountable? Am I rearranging the bookshelves? (“This refers to the act of ‘preparing to create.’ It may involve setting up a workspace, taking lessons, or doing research—each of which is fine until the point it becomes a stall tactic.”) How can I lower the bar? What if I begin anywhere? Can I make a prototype?

Berger’s book is not, of course, merely a list of questions. The questions serve to distill the points Berger makes in the text, where, understandably, he relies heavily on the work of others. He chooses his sources wisely, based on their own creativity and insights.

For instance, Ann Patchett’s description of the painful transition from a beautiful idea to the “stark disappointment” of the written word: “I reach up and pluck the butterfly from the air. I take it from the region in my head and I press it down against my desk, and there, with my own hand, I kill it. Everything that was beautiful about this living thing—all the color, the light and movement—is gone.” In its place is a creation that “rarely measures up to the vision.”

Or Adam Grant’s five stages of the creative process “that tend to trigger different emotional responses in the creator. The energized, optimistic feeling at stage 1 (‘This is awesome!’) is followed by a more realistic stage 2 (‘This is tricky’). Then comes the dreaded stage 3 (‘This is crap’), followed immediately by stage 4 (‘I’m crap’). If the creator somehow crawls out of that pit, they work their way to stage 5 (‘This might be okay’), and finally arrive at completion, stage 6 (‘This is awesome!’).”

I’ll end this post with another quotation, which makes an important, well-documented point. According to Dean Keith Simonton, “Creativity is a consequence of sheer productivity. If a creator wants to increase the production of hits, he or she must do so by risking a parallel increase in the production of misses…. The most successful creators tend to be those with the most failures.”

I suspect that Berger’s book will be a hit.

Sunday, October 28, 2018

Volcker, Keeping At It

The 91-year-old Paul A. Volcker has had a long, distinguished career, highlights of which he recalls in Keeping At It: The Quest for Sound Money and Good Government (Public Affairs / Hachette, 2018). For those with a financial memory, he is best known for his role as the Federal Reserve chairman who shepherded the economy through a period of high inflation (14.8%) in the early 1980s, raising the federal funds rate to a peak of 20% in 1981, even as the nation was in a recession (1980-1982). By 1983 inflation had been tamed. For those whose memory is not so long, his name is associated with bank regulations adopted during the Obama administration, the Volcker Rule.

Volcker’s memoirs, written with the help of Christine Harper, combine personal reminiscences with reflections on economic policy decisions in which he played a role, such as abandoning the gold standard. Among the personal reminiscences, the one that stood out for me was his cut in salary when he left his job as president of the New York Fed, which paid $110,000, and accepted the job as chairman of the Federal Reserve, which paid just $57,000. His wife, who had serious medical problems, remained in New York, and Volcker rented a one-bedroom apartment in a building full of George Washington students for $400 a month. The family’s financial squeeze led Volcker’s wife to take on a part-time accounting job and rent out their back room.

Presaging events in the financial crisis, Volcker describes the quick fix for Continental Illinois, which was suffering in the wake of the 1982 bankruptcy of a small Oklahoma bank, Penn Square, which “had originated more than $2 billion of loans to speculative oil developers” and sold them on to several large banks around the country, including Continental Illinois. The chairman of Continental said that the Penn Square loan portfolio could sink his bank. The Fed and the FDIC initially decided to follow the model they had applied successfully to the bailout of First Pennsylvania Corporation. There, “encouraged by the Fed, which was providing emergency lending, the FDIC and a group of a couple dozen banks provided a $1.5 billion rescue made up of loans and a line of credit. They also received twenty million warrants to purchase common stock—enough to provide a controlling majority.” But, in the case of Continental, the bankers were wary, and the FDIC ended up offering them its de facto guarantee to increase their line of credit. Continental survived for a while, but shareholders never recovered their losses. “This episode,” Volcker writes, “has often been credited with popularizing the phrase ‘too big to fail.’ Any ambiguity about the willingness of the government to bail out the big banks seemed to be lost when the comptroller of the currency, the supervisor of most of the big banks, went beyond his authority, seeming to commit to such support for the eleven largest in his later congressional testimony.”

Volcker’s memoirs are rich in detail about events that shaped the American economy and its financial institutions in the second half of the twentieth century. As for the future, although he has deep concerns, he quotes his mother, who said to him on an earlier occasion: “The United States is the oldest and strongest democracy in the history of the world. In two hundred years it has survived a lot. Get back to work.”

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.”