Rees, Principles of Financial Modelling

In the old days banks wanted applicants to be comfortable with Excel. Now they’re upping the ante. Citi, for instance, wants its incoming investment bank analysts to know Python. But Excel hasn’t gone the way of the dodo. It’s still incredibly useful for a range of financial tasks. The problem is that most Excel users have no idea how to go beyond basic formulas and engage the program as a high-level tool. In Principles of Financial Modelling: Model Design and Best Practices using Excel and VBA (Wiley, 2018) Michael Rees sets out to fill this void.

Rees’s more than 500-page book is divided into six parts: (1) introduction to modeling, core themes and best practices, (2) model design and planning, (3) model building, testing and auditing, (4) sensitivity and scenario analysis, simulation and optimization, (5) Excel functions and functionality, and (6) foundations of VBA and macros. As these part titles indicate, Rees first addresses financial modeling, from design to optimization, and then explains how to use Excel and VBA to implement the models. Complementary to this book is a website, which contains 237 Excel files.

Here, to give a sense of the book, I will summarize Rees’s distinction between database and formula-driven approaches to modeling.

Traditional models, for instance those used for cash flow valuation, are formula-focused. They “often have a small set of numerical assumptions, from which large tables of calculations are performed. Certainly, where a single value is used for an assumption across multiple time periods (such as a single growth rate in revenues that applies to all future time periods), arbitrarily large tables of calculations may be generated simply by extending the time axis sufficiently, even as the number of inputs remains fixed.”

Where a large volume of data is required, however, the appropriate model will use “database concepts, functionality or data-oriented architectures and modular structures. These include the structuring of data sets into (perhaps several) contiguous ranges, using a column (field)-based approach for the model’s variables (with well-structured field identifiers, disciplined naming conventions, and so on).”

Even though in practice these two approaches to modeling can sometimes overlap, with the modeler confronted with both large data sets and potentially many formulas, Rees contends that “at the design stage, the reflection on the appropriate approach is fundamental: an inappropriate choice can lead to a model that is inflexible, cumbersome and not fit for the purpose.”

Before they set out to build models in Excel, analysts would do well to read Rees’s book. With its help, they will avoid many pitfalls.

Hall, A Carnival of Losses

I’m getting to the age that I read things about getting old. Not the advice that AARP sends out but essays by writers who are comfortably ahead of me on the march to 100. Donald Hall, the former poet laureate, delivered two such volumes of late, Essays After Eighty and A Carnival of Losses (Houghton Mifflin Harcourt, 2018), the latter written as he was nearing 90. (Hall died last month, on June 23.)

Essays After Eighty addressed old age more expansively, and humorously, than A Carnival of Losses. The new book has qualities of leftover stew: warmed-up reminiscences and bits and pieces that were probably in the literary root cellar, such as his recollections of poets. It’s still a delightful read, but if I were to recommend only a single title, it would be Essays After Eighty.

Govindarajan & Ramamurti, Reverse Innovation in Health Care

I got an advance reader’s copy of Reverse Innovation in Health Care: How to Make Value-Based Delivery Work (Harvard Business Review Press, 2018) by Vijay Govindarajan and Ravi Ramamurti. I put it aside, thinking that it was not within the scope of this blog. But then came the tornadoes that struck Connecticut, one of which touched down far too close for comfort, on May 15. My property (fortunately not the house) was devastated, with large uprooted trees all around the house and the edges of the property and the top of one mighty oak pinning, and miraculously only denting, the car sitting in the driveway. Naturally, I had no power for days, and no Internet access for days more. And so, with my usual routine upended as well, I turned to this book.

The book’s premise is that U.S. healthcare providers can learn from models that have been successful in India. The authors are not, of course, touting Indian healthcare as a whole, which is sorely wanting. But one hospital system in particular, Narayana Health, could serve as an exemplar.

Founded by Dr. Devi Shetty in 2001 with a vision to treat all patients regardless of their ability to pay, Narayana Health is now a profitable company that offers, most notably, open-heart surgery (which would normally cost between $100,000 and $150,000 in the U.S.) to paying patients for $2,100 and to subsidized patients for $1,307. The hospital’s cost for each surgery is $1,100 to $1,200. Narayana is now doing about 14,700 cardiac surgeries a year. On average, in 2016-17 Narayana’s cardiac surgeons performed two to three times as many open-heart surgeries as their U.S. counterparts. And their outcome metrics rival those of the best hospitals in the world.

Shetty is a ruthless cost-cutter, as long as cutting costs doesn’t negatively impact quality of care. To construct Narayana’s no-frills hospitals, for example, costs about half that of its competitors. And when Shetty wanted to buy disposable surgery gowns and drapes from multinational suppliers who refused to budge on price, he had them stitched locally. Within four years, this firm became the largest manufacturer of disposable surgical gowns in India. The multinationals, unable to compete on price, left the market.

Narayana has innovated through task-shifting, allowing surgeons to do three operations in the time it takes other hospitals to do one. “[E]very motion in the operating cycle is choreographed to reduce turnaround time and optimize pay grades.” Senior surgeons do little or nothing that can be done by lower-paid, less-skilled staff.

In perhaps the most striking instance of task-shifting, in Narayana’s multispecialty hospital in Mysore, family members provide much of the post-ICU care. Since, in India, the entire family comes to the hospital with the patient and typically spends three days there, Narayana upgraded them from “underfoot” to caregivers. They get instruction from a four-hour video curriculum. “The practice of training families for in-hospital postoperative care not only frees up the nursing staff for other work but also eases the transition to reliable, high-quality home care, reducing readmissions by 30 percent.”

Narayana uses a hub-and-spoke model and, through farming cooperatives in Shetty’s home state, instituted an insurance plan to reach out to underserved villages. By 2017 the insurer had four million members who, for 22 cents a month, could get free treatment at 800 network hospitals across the state for any procedure whose cost did not exceed $2,200.

Shetty is also starting to pursue opportunities in telemedicine.

The authors highlight four new models in or near the United States that use some of the Indian tactics: Health City Cayman Islands (founded by Narayana Health), University of Mississippi Medical Center, Ascension, and Iora Health. All of these are making strides in trying to change the American healthcare system from the bottom up.

Reverse Innovation in Health Care offers ways for U.S. healthcare to save billions without compromising (indeed, perhaps with improving) quality. And it’s not simply on the back of low wages. The authors address a series of questions that skeptics raise to show that aspects of the model would be viable in the United States. As such, it’s an essential read for anyone who is prepared to tackle the change-resistant healthcare establishment.

McNally, The Promise of Failure

Why write? Especially when, in most cases, the writer faces rejection of one sort or another. This is the question John McNally raises in The Promise of Failure: One Writer’s Perspective on Not Succeeding (University of Iowa Press, 2018). Although McNally is addressing writers and would-be writers (of whom I am decidedly not one), his thoughts on failure can sometimes be generalized.

So, again, why write? “If no one out there cares if you put down your pen right now and never pick it up again, why keep doing this thing that you’re doing?” One reason is that “it’s the only thing [you’re] even remotely good at.”

So you keep writing and “putting [your] work out there,” even though you “ultimately have no control over whether something gets published or doesn’t…. It’s like letting go of a helium-filled balloon and hoping it touches an airplane. Once you let go of the string, it’s no longer in your control.” What a wonderful image for the disjunction between process and outcome. Once you hit the buy or sell button…. No, I don’t want to mash McNally’s language by forcing an analogy.

When, in the face of failure, should you just pack it in and quit doing what you’re doing? McNally says that he has “always been of the belief that as long as you’re not hurting anyone, it’s foolish not to pursue the thing you want to pursue, even if you pursue it badly.” Here it’s more difficult to analogize to trading. The writer piles up rejection slips; the trader piles up losses. Losses may not be psychologically more difficult to handle than rejection slips, but they do have a way of eroding any semblance of well-being. The losing trader either has to find some way to be profitable (and many highly successful traders have clawed their way back from nothingness) or should find something else to pursue.

But if you’re going to pursue trading, here’s McNally’s advice (and in this case it’s easy to analogize): “I measure my goals not by a typed page, not by a paragraph, not by a sentence. But by a word. One word. Because I know well enough now that one word will lead me to the next word and that this is how you get to where you’re going.”

Portnoy, The Geometry of Wealth

Brian Portnoy, director of investment education at Virtus Investment Partners, has written a personal finance book that goes beyond mere finance. The Geometry of Wealth: How to Shape a Life of Money and Meaning (Harriman House, 2018) approaches the subject by way of three shapes: the circle, purpose; the triangle, priorities; and the square, tactics. The circle exemplifies how we navigate life’s ups and downs, through the back-and-forth of defining and then adapting. Portnoy imagines two triangles. The first one has risk management at its base, spending and saving decisions in the middle, and big dreams at the top. The second triangle is intended to be a bridge between planning priorities and investment decisions. At its base is behavior, then comes portfolio management, and finally individual parts of portfolios at the apex. As for tactics, the four corners of the square represent the growth we hope to achieve, the emotional pain of achieving those gains, fit (“how additional decisions improve or undermine what you already own”), and flexibility.

Portnoy addresses the sources of a joyful life because, as he writes, “if wealth is defined as funded contentment, then we need to know what we’re supposed to be funding.” He suggests four such sources: the need to belong, the need to direct one’s own destiny, the need to be good at something worthwhile, and the need for a purpose outside of one’s self.

But can we afford a meaningful life? “Purpose and prosperity,” he acknowledges, “aren’t necessarily a match for each other.” We need the wherewithal to “underwrite meaning and become truly wealthy.” And so we have to set priorities—priorities such as being less wrong rather than being more right, immunizing our liabilities before maximizing our assets, and addressing psychological vagaries.

Tactics is “the part where we strive for decent outcomes.” And where Portnoy looks at how to be a successful investor, with particular reference to returns, volatility, correlation, and liquidity.

In his final chapter, “Shapeless,” Portnoy turns to the tug-and-pull between now and later, between enough and more. “At any moment in life we have to decide whether we want, as Hunter S. Thompson once framed it, ‘to float with the tide, or to swim for a goal.’ We harbor an urge to do both, to appreciate the moment, to cherish where we are, but then also to push out for that next thing, to get to that next Great Place.”

Gannett, The Creative Curve

The thesis of Allen Gannett’s The Creative Curve (Currency / Crown, 2018) isn’t revolutionary. But I guess that’s the point. If it were, the book wouldn’t sell well. It would defy the science of what becomes a hit.

More interesting, however, at least to me, than how to identify the next big thing, whether it’s a new Ben & Jerry’s ice cream flavor or a blockbuster movie, is how people prepare to be creative. Because aha moments don’t happen in a vacuum. In the shower, perhaps; in a vacuum, never.

Gannett postulates four laws of the creative curve: consumption, imitation, creative communities, and iterations. Here I’ll look only at the first law.

How can some people be such successful serial entrepreneurs? In part, it’s due to pattern recognition, the ability to develop an uncanny instinct for opportunity. “Research shows that when entrepreneurs have significant prior knowledge, they no longer need to engage in slow, deliberate searches for new ideas. On the contrary, their prior experience gives them a rich library of exemplars they can access automatically.”

To build this mental library, would-be creators voraciously consume highly relevant material. In fact, in the case of already successful creative artists, it seems to be part and parcel of their daily routine. They spend about 20 percent of their waking hours expanding their knowledge of their field. Writers read, artists go to art shows, songwriters listen to music, old and new.

The 20 percent principle, the author contends, provides the building blocks necessary for aha moments to flourish. “This accumulation of prior knowledge fills up the brain with examples and concepts that artists then use to uncover non-obvious insights. … You can’t have insights about things you don’t know anything about.”

In brief, if you want to be a creative whatever, and that includes being a creative investor or trader, you need to accumulate a large repertoire of relevant material—and keep adding to it. Aha moments come only to the well prepared.

Carreyrou, Bad Blood

On Friday Elizabeth Holmes, the founder of Theranos, and its former president Ramesh “Sunny” Balwani were criminally charged with wire fraud. These charges came three months after the SEC sued Holmes and Theranos for a “massive fraud” at the company.

John Carreyrou, a lauded investigative reporter at the Wall Street Journal who covered Theranos extensively from 2015 on, has written a spine-chilling book, Bad Blood: Secrets and Lies in a Silicon Valley Startup (Alfred A. Knopf, 2018).

It’s hard to imagine, amid all the suspicions, firings, and general upheaval, that Theranos got away with its alleged fraud for as long as it did. It was the persona of Elizabeth Holmes (along later on with some heavy legal fire power) that kept it going, that attracted big dollars from normally savvy investors and big names to the company board, that convinced companies such as Safeway and Walgreens to offer Theranos’s flawed finger-stick blood tests (although they later pulled back). People were bewitched by her “mixture of charm, intelligence, and charisma.” They didn’t see her much less flattering side.

Put Bad Blood at the top of your summer reading list. You won’t regret it