Friday, April 4, 2014

Lewis' Back-door Move

Lewis takes on black-box traders
Talking about the blind side.  Best-selling author Michael Lewis, who wrote the book Blind Side about football and the book Moneyball about baseball, slipped through the back door this week and published his new book Flash Boys about electronic stock trading. Right away, the publication stirred the world of stock markets, exchanges and high-frequency trading.  Lewis had spent a year or so studying, learning and asking questions about electronic trading and the dynamics of high-frequency trading, the lightning-quick activity conducted by a small circle of black-box firms that explains most of the trading volume in equity markets in the U.S.

Lewis draws conclusions in the book. He claims a band of high-frequency traders have rigged markets, slicing bits of profits (measured in morsels, or cents per share) from billions of trades from innocent and often unknowing participants--mutual funds, pension funds, and, yes, moms and pops.

In the wake of sudden appearances on CBS-TV's Sixty Minutes and PBS's Charlie Rose, Lewis's book, his claims and conclusions have spurred loud voices on both sides of the looming questions:  Is the market rigged? Do high-frequency traders serve an important role?

When Lewis speaks (or has something to write about), a financial audience will pay attention. His track record gives him an audience each time he publishes something new. He often tackles intriguing subjects and asks questions many don't know how to pose.   His The Big Short a few years ago explained how traders and hedge-fund investors reaped billions in complex credit derivatives by betting on the demise of mortgage markets.  His book Liar's Poker, now decades old, still ranks among the most popular books ever about Wall Street trading floors. 

And now all of a sudden, Flash Boys will become a spring-time must-read, if only for market participants to decide if Lewis' claim is fair or if only to permit outsiders to understand the revolution in the way stocks are traded and market values are determined. Contrast today's stock market (or markets, since trading occurs on dozens of venues) with the old vignettes of humans (Wall Street specialists) wrestling for space in the Great Room of the New York Stock Exchange, amidst mountains of pieces of paper.

Those days are gone, although specialists and traders still show up at the Exchange and still go through motions pretending they influence markets.  These days, it's the hum of computers and black boxes and the atomic-swift movement of data through fiber optics and microwaves that dictate volume, activity, and volatility in equity markets.

Lewis' book portrays the experiences of a head equity-desk trader, Brad Katsuyama, at RBC Capital Markets in Toronto and New York. Katsuyama's team, puzzled about not getting orders filled at prices they hoped for, went on an investigative hunt and concluded that high-frequency traders were "front-running" their orders on electronic exchanges, taking advantage of RBC's expressed intent to buy or sell stocks.  The traders exploited that advantage, forcing RBC to buy or sell at less-than-optimal prices, even if just a few cents a share.

Lewis, as the interested bystander on this journey, tries to explain electronic trading and the amorphous, varying role of high-frequency traders.

Already, many in the industry say there is little new in the book. What's new to most is that Katsuyama at RBC eventually decided to beat back high-frequency traders by joining them.   He decided to set up his own exchange and is implementing techniques to change protocol. His exchange, he says, will discourage high-frequency traders from rushing ahead of the pack. It will slow them down. It's "trust" he says he is selling, as he encourages asset managers, funds, and investors to send their trades his way. He formed his exchange, IEX,  and seeks to match buyers and sellers without the involvement or  intervention of brash, bold electronic dealers.

The issue is complex.  Lewis and cohorts show how markets might be rigged.  But the big stock exchanges themselves--from Nasdaq to BATS to the New York Stock Exchange--enable such traders, encourage their activity, and even invite and induce them with pay-outs or reduced fees to boost volumes and liquidity on their respective platforms.

These are different times. In old days, stock exchanges were few. They were non-profit marketplaces, overseen by members and member institutions, run by tight rules and regulation, operating within comfortable 9-to-4 time frames, and respectful of gentlemanly ways and traditions.

Today, exchanges are abundant (at least a dozen in the U.S.). Regulation NMS from the mid-2000's facilitated the new environment.  It permitted (or encouraged) the formation of new exchanges and instructed brokers, traders and investors to roam exchange platforms in search of the best price and the best, quickest execution. 

Exchanges in these times, profit-seeking enterprises, generate revenues from brisk activity.  Therefore, they must be creative in attracting volumes of share activity from traders and investors--any legal way to lure volume to generate fees.  High-frequency traders, therefore, become their best pals, favorite participants for whom they offer privileges, advantages, a slight edge (vs. all other participants) to ensure sufficient levels of activity at all times.

So here is how the high-frequency traders and explain their side of the argument. (Over the past decade, they have included such firms with names like Getco, Jane Street, Allston, Quantlab, Sun, and Jump.)

(a) They provide market liquidity, active markets, and ready buyers and sellers.

(b) They provide "price discovery" with bids and offers updated continuously during the trading day.

(c) They provide "best prices," opportunities for buyers and sellers to search venues to find the best price for a particular stock.

But here is how factions like Lewis, other asset managers, and Katsuyam's IEX frame the issue:

(a) Unlike the stock specialists in the past, they disappear when markets become too volatile, too slow, or too boring. There is no moral (or legal) commitment to participate or make markets. They balk or refuse to participate at certain times. 

(b) They don't always provide honest, good-faith bids and offers. Sometimes they show their hands and wander away before execution (fake orders, or orders they cancel as quickly as they show their hands). 

(c) Skipping from venue to venue (exchange to exchange) with less-than-sincere bids and offers, they often try to trick or deceive markets to gain information advantages--advantages that extract profits from retail- and long-term investors.

Flash Boys elevates the debate to the front pages of the business media and encourages market overseers and regulators to move faster, if they have been investigating market practices. Some suggest if the rules changes, high-frequency traders won't disappear. They'll simply tweak their boxes, recalibrate the economics of trading, and proceed accordingly.

For Lewis, Blind Side and Moneyball eventually became popular movies.  Is a movie version of Flash Boys on the horizon?

Tracy Williams

See also:

CFN:  High-Frequency Trading, 2012
CFN:  Dark Days at Knight Capital, 2012
CFN:  Financial Technology, 2014

Thursday, March 27, 2014

Horowitz and His Latest "Venture"

Horowitz:  Fighting to open doors
Many MBA students and graduates who covet careers in finance perceive venture capital as closed-door clubs whose members operate by making quiet, stealth financial movements:  first-round funding, mezzanine funding, second-round investments, and then--bang!--the IPO.

Members of the club fight fiercely to determine and support the next new thing. They prefer to locate in offices near each other, the better to watch each other's steps and moves. They respect each other and occasionally band together to do deals or share ideas.

To those on the outside, the doors to the club appear bolted, opened only to outsiders who bring influence, contacts, funds, and technology patents. It is arguably the toughest network in business or finance to penetrate.

Andreessen Horowitz is one of the most acclaimed names in venture capital in Silicon Valley.  At Andreessen Horowitz, Marc Andressen is the better known name of the two.  He is the one out  front, the prodigy entrepreneur who helped create the popular Internet browser Netscape back in the 1990's. After a series of glowing entrepreneurial successes, he decided he preferred to invest in new things instead of running or operating them. From a Valley perch, he gets to decide what that next new thing will be.

He and Ben Horowitz formed their venture-capital group in 2009 after they "retired" from the life of managing the struggles and swirling phases of new companies (including also Loudcloud and Opsware).  They still dabble in new ventures and sweep across the landscape to decide which ones are worthy of their mentoring and money. They ditched their days of spending every waking hour building a new company and now run investment funds exceeding $2.5 billion. They were first-round investors in Twitter, Groupon, Zynga, and Facebook.

Andreessen is the one the business media go to for quotes and perspectives on the Valley and opinions on matters related to California's fragile economy, social media, and technology innovation. He has been a news item for much of 2014 with his spats regarding investments in Skype with investor Carl Icahn. Just this month, he declared Warren Buffet too old to understand technology investments. 

Ben Horowitz is the "other" guy, the other name on the door, although he doesn't shy away from media attention. In fact, he has written a popular blog to share his thoughts on topics ranging from  technology to business strategy, management challenges, and human resources. Sometimes he tackles accounting topics and world politics.  He shares lessons he learned in running companies that stumbled now and then on their way to financial health.

With a new book just published (The Hard Thing about Hard Things) and a Fortune magazine cover, he isn't avoiding publicity. Of course, he wants to sell  the new book, but he claims he wants to open up bolted-down doors of venture capital and technology entrepreneurship to those who have been shunned, those who were discouraged, and those who haven't benefited from the bundles of wealth that new ventures sometimes spawn. This includes those from under-represented minority groups--blacks, Latinos, and women.

Horowitz, as a successful mentor in a second phase of adulthood, is pushing the door slightly ajar, hammering a few cracks to permit others to take a peek and perhaps rush in. In recent years, besides presiding over a portfolio of investments with meteoric returns, he has devoted substantial time in roles as mentor, teacher, or coach to show those who never dreamed of starting a company or working in venture capital they might have the knack for it.  For new entrepreneurs, he lays it out: How to get the company going, how to keep a company growing and solvent. And he tells the truth: It will be hard.

Stories are widespread about Horowitz's ties to the black and Latino communities in Oakland and Los Angeles, his attraction to hip-hop culture, and his nose for finding entrepreneurial talent in areas outside the cloaked venture-capital huddles in the Bay Area.

His new book is a guidebook for those on both sides, those inside the right circles and those outside.  He offers advice on how to manage the toughest aspects of starting a new company and keeping it alive. He provides lessons from his own hiccups and failings when he was a CEO, mostly at Loudcloud, where he harnessed the company through periodic tumbles and upturns before it was finally sold.

This is not a book of romantic reflections in building a company, nor a storybook of tales of how a product idea results in easy profits and returns. It's nuts, bolts, and late-night worries of how his company will generate cash flow to make payroll. It's about what managers should do to dampen debilitating office politics. And it's about about difficult decisions entrepreneurs will inevitably encounter to keep companies alive:  Do you sell the company, sell a unit, lay off staff, seek another round of capital or transfer out an ineffective manager?

Venture capital and private equity reside on the periphery of entrepreneurship.  Venture capitalists and private-equity investors sit in the middle of the ring to help managers in strategy, funding, hiring and product distribution.  This appeals to many business-school students, including Consortium MBA's.

However, the pathway to a prominent firm is tricky, uncertain, not neatly outlined.  The firms don't usually have close relationships with business schools. Many prefer to hire and recruit based on their own needs, schedules and whims.  And most are indifferent to general diversity hiring practices or objectives. Many support diversity initiatives, believe in them, but don't make it a public priority.

Unless MBA students have an entree, somebody they know, somebody with whom they went to school, a previous tie, acquaintance, professor or contact with a senior principal, then an entry-level spot in a major firm is almost impossible to garner. Nonetheless, it's the in-depth experience in deals, transactions, industry, corporate finance, and firm valuation that new graduates covet and need--and don't get if the doors are shut.

Signs indicate that with support from respected people like Horowitz, people who bark and insist that opportunities be made available to a wider community, some of these venture-capital doors might crumble. Horowitz, by the way, has announced that his portion of the proceeds of the book's sales will go to women's programs.

Consortium students and graduates for years have expressed interest in venture capital and private equity, even if they know they will encounter obstacles in getting inside.  They know they can't raise hands, express an interest, prove talent and experience, and then expect job offers to flow in.

Some have gotten the chance to work at big-name firms (Carlyle, Kleiner Perkins, Sequoia, and Blackstone are examples of "big names"), regional firms or firms that specialize in an industry niche or geography (real estate, manufacturing, consumer goods, the Sun Belt). Because of obstacles or because they were discouraged, others simply decided to pursue more welcoming and more familiar sectors in finance.

And then some try the boldest of tactics. They have gone off on their own to form their own small private-equity or venture-capital companies. (Capital A Partners and Romherst Capital are examples of private-equity companies launched by Consortium graduates.) They opted for the toughest road with the greatest challenges, but possibly with the best experiences and maybe with superb performance and returns--and a chance one day to bring others like them into the fold.

Horowitz, needless to say, would be pleased with these kinds of efforts.

Tracy Williams

See also:

CFN: Venture Capital Diversity Update, 2011
CFN: Knocking Down Doors in Venture Capital, 2012
CFN:  Making Demands on Diversity, 2013
CFN:  MBA Diversity:  A Constant Effort to Catch Up, 2012

Monday, March 10, 2014

What Does the Market See in Amazon?

Amazon: Amazing value with slim earnings
Check the stock price of Amazon.  Soaring, surging the past few years, maintaining a steady climb in the past year (with occasional moments of volatility). (Share-prices hovered around $150-160 back in 2010; they now trade above $365 in 2014.)

Now pull out its financial statements and peek at the company's revenues over the past several years.  Extraordinary, enviable growth.  Revenues in 2010, $34 billion, have more than doubled. They topped $74 billion in 2013.

The company has experienced exceptional growth, as it has pushed itself into multiple products and new services.  It is no longer a mere online book seller, no longer just peddles its electronic reader, the Kindle, and electronic selections.  Under its banner, it sells and delivers just about all merchandise that can be boxed and trucked to the front doors of America (and beyond). In recent years, it has ventured into computing services and unveiled what had been a secret plan to deliver products same day using drones technology, although it may take years for regulators to get comfortable with low-flying vehicles in urban areas. 

Jeffrey Bezos, CEO and founder, is the guiding hand behind all that it does and contemplates doing. For most who watch every step and every hint of a new strategy from the company, Amazon is Bezos. He provides the vision and articulates the strategy--at least to his cohorts, if not comfortably to the media. Amazon is his elaborate apparatus and network by which consumers can log on and shop for every imaginable consumer product.

So take a look at earnings. Uh-oh.  Choppy, erratic, and virtually non-existent until a short time ago. The company lost money in 2012.  While sales will likely pass the $80 billion mark in 2014, profits haven't topped a single billion the past three years. Returns on equity have been less than 8% since 2010, less than 4% last year.

How does the market justify high values and high share prices for a company that can no longer be fairly labeled a hot, emerging enterprise, no longer a company hustling to establish itself and seize a niche? And a company that doesn't pay a dividend. The company is already on its way to being two decades old.

This week, the company has a market value above $170 billion; its tangible book value (after adjustments for balance-sheet intangibles) amounts to about $7 billion.  Go figure.  Some analysts say the market is pricing its shares (now above $350/share for most of 2013) as if company revenues will continue to grow at rates above 15-20%/years and will exceed $400 billion annually before this decade is over.

Some will remind us to take glance at the cash it has amassed on its balance sheet: over $12 billion, resulting from years of operations and years of not paying dividends. The market acknowledges this cash reserve, but that explains a tiny fraction of the total value and it's cash that permits the company to leap to make small acquisitions whenever it wants.

Take a look, too, at the assessments from ratings agencies. They have disparate viewpoints. One agency has rated its debt a AA-, likely comforted by such pole-vaulting sales growth, industry leadership, and a well-understood business model.  Yet another agency has rated it Baa (or BBB) (on the brink of being "junk"), likely befuddled by slim earnings, tight profit margins, occasional stock repurchases, and cash flow buffeted by its success in delaying payments to suppliers.

Often when a company is in its early stages, equity markets overlook the first few years of formation, as it penetrates product markets, establishes a brand, and polishes its infrastructure. Losses in early years are tolerated, as we saw with Facebook, Twitter and other ventures.  Markets look for and expect earnings growth three, five, six years down the line.  But years have gone by, and Amazon's bottom line fluctuates unpredictably from year to year.

Its CEO is not worried a bit. He has told his story often and has convinced shareholders the tale here is not about bottom-line earnings, not free cash flow available for shareholder rewards. His story, he conveys, is about growth, expansion, and a revenue line that doesn't edge upward in small increments. It accelerates. He asks for market patience and gets it.

At least for now, the company appears to be backing up and reaffirming this strategy.  It generates a reasonably amount of cash flow from operations to maintain a growing infrastructure. It has shown it is adept at managing inventory (books, consumer products, housewares, etc.) without having to hold it in its warehouses for lengthy periods, which otherwise requires significant short-term financing.  It has also managed inventory cleverly by not paying suppliers until inventory is already out the door and in the hands of buyers. 

With shrewd ways of managing inventory and cash flows, it generates some cash, holds on to some of it, and reinvests the rest to finance more revenue growth.  In recent years, it has become more comfortable in using debt to support expansion (more warehouses, other new business ventures), but at moderate, test-the-waters levels.  Each year, the cycle repeats:  more revenues, more shrewd inventory management, insignificant pressure on cash flow, a little bit of debt (not much) and more reinvestment in the business and new ventures. Whenever (or if ever) drones become part of the business operation, inventory will be pushed out even more quickly.

Shrewd, careful balance-sheet management while continuing to build the business. That explains one ratings view.  Astounding growth in revenues, but could it endure a sudden substantial decline in revenues, although nobody imagines such a scenario? That explains another ratings view. Yet another view?  Bezos could become distracted by his own personal ventures, including his purchase of the Washington Post media group (a Bezo purchase in 2013 unrelated to Amazon).

While revenues grow consistently at stunning rates, the rest of Amazon's financial condition is an intrigue, an amusing array of situations that don't threaten the company as long as business expands.

What more does the equity market see? A strong vision, marketplace dominance, new products and services, revenues growing 15-20% every year, the ability to keep consumers glued to its web pages, and an understanding that dividends will be sacrificed to permit long-term growth. And yes, the market likes Amazon's knack for remaining nimble, new and innovative, as if it were a start-up.

But earnings returns had better get to 12-15% ROE consistently before the decade runs out and before patience runs out. 

Tracy Williams

See also:

CFN: Now It's Twitter's Turn, 2013
CFN:  Facebook Stock:  What Went Wrong in the Beginning? 2012
CFN: What Happened at JCPenney? 2013
CFN:  Apple With All That Cash, 2013
CFN:  Merger Mania:  Boom Times Ahead? 2013 
CFN:  The Verizon Deal: Big Numbers, Big Debt, 2013

Friday, February 14, 2014

Financial Technology: New Opportunities?

Axial is but one example of a new financial-technology firm
Not everybody with the buzz of an idea is seeking to start a company that will disrupt the world via social media.  Many are running new businesses by exploiting new technology---using technology to do old tricks, so to speak.  New businesses are using technology, for example, to assemble, analyze and interpret data or to deliver product to consumers in novel ways.

In finance for over a decade, some companies have sprouted from scratch and used technology in clever ways to provide new services, new analytics, or new ways of doing financial transactions or providing financial analysis, advice, or processing.  And we aren't necessarily talking about technology being used to ignite explosive high-frequency, black-box trading in equity markets.

Some of these financial-technology start-ups have come and gone or been acquired by large established institutions. Some have thrived.  And others were launched in the last few years and have just begun to take off with a critical mass of clients or customer activity.

In New York last month, a few new companies made presentations at a business-school networking function to explain to investors, bankers, and industry participants what hole they wish to plug in the industry and how technology does it.  Their ideas are off and running, the business model in place, and revenues trickling in and growing steadily.

Axial  is one example.  Years after getting his MBA from Stanford and working in private equity, Peter Lehrman started the company a few years ago because he thought there was a better way to help middle-market companies and entrepreneurs seek financing from banks and investors or seek M&A advice from investment banks and advisory firms.  The firm established an electronic network to connect companies with investors, advisers, banks, investment banks, and other financial institutions.

Lehrman calls his Axial network a "Linkedin" for mid-size companies and for the banks that seek to do business with them.  Members of the growing network purchase subscriptions (which explains its revenue model), get access companies in the network and exchange relevant data and information.  Companies can find the right match with a bank or private-equity investor.  Financial institutions can find the right match in seeking a company client.  They all get to become better acquainted with each other.

Today, there are about 15,000 members of the Axial network, including over 200 small companies and entrepreneurs. Axial, founded in 2010, is based in New York.

Is there a quicker, better way of taking voluminous amounts of financial data and prepare reports for investors and clients?  Is there a faster way for financial institutions to comb through hundreds (or thousands?) of pages of transactions and business data and prepare summary reports for regulators, investors or board members?

Narrative Science, a four-year-old company based in Chicago, says it has a solution. It has a patented artificial-intelligence platform (called "Quill") that digests and analyzes data and presents a summary in the form of written reports.  The platform provides many services, depending on a client's need.  Equity research analysts or financial consultants use it to prepare investment-portfolio reports or market updates. The company claims the platform doesn't just spit out verbiage, but provides insight, analysis, and trend forecasts. 

Reports can be formatted in the way clients prefer. They can also be as long, short, detailed or simple as desirable.  The company now has about 50 clients, most of whom are financial institutions.

Leigh Drogen decided to start his company, Estimize, when he saw an opportunity to aggregate vast amounts of information from equity research analysts who provide earnings forecasts for thousands of companies.  From quarter to quarter, equity analysts provide earnings estimates based on their own research.  They often update their forecasts during the quarter, right up until the company makes a formal earnings announcement.

Investors who rely on earnings forecasts and updates have had to aggregate by themselves the views, opinions and forecasts from dozens of analysts.  For example, investors with a stake in Microsoft stock will want to know how analysts assess the company and project its earnings and stock price. They might attempt to compile the numbers of many analysts. 

Estimize uses technology to do it faster and more easily.  It aggregates the projections and earnings estimates for about 900 companies, compiling information from over 3,500 analysts who send information to the firm. The firm presents a summary of the analysts' forecasts. In describing his firm, founder Drogen says it has an "orthogonal" (independent) approach to providing earnings estimates for companies and explained that the firm is "Wikipedia"-like in providing information to clients. 

Estimize also provides estimates or projections of macroeconomic factors (e.g., interest rates, economic growth), based also on aggregates from research analysts.

Hedge funds and fund investors comprise most of its client base now.  The company, three years old, has 10 employees and is based in New York and San Diego.

David Klein was once an MBA student at Wharton who borrowed money to fund his business-school education.  At some point after graduation, he decided there was a more efficient way for students to borrow.  He started his company, CommonBond, to transform the student-loan market especially after dysfunctions in this marketplace in recent years. Klein says the company is trying to "fix the broker student-loan market."

CommonBond created an electronic network to match students directly with lenders.  Klein claims this direct match-up helps lower interest costs to students.  Like an electronic stock market, the network allows market participants to link online.  The company also has a social mission by encouraging a "community" of lenders and borrowers:  Lenders follow the progress of students, and students form community networks among themselves and keep lenders informed about their school experiences. Lenders become more engaged in their investments.

In its first phase, CommonBond is only providing loans (from a current fund of about $100 million) to MBA students.  It will expand in its next phases to law and medical students.  Until now, most loans it has arranged via the network have been refinancings of other students' loans at competitive rates.

The company employs 13, but plans to expand to 22 by this summer.

Chaith Kondragunta's company AnalytixInsight is four years old.  He has an MBA from Carnegie Melon and is now CEO of the company he helped found four years ago.  The company uses technology to prepare research-analysis reports on 40,000 equity stocks around the world.  It labels its service Capital Cube and produces written analyses, based on data, statistics, and macro-trends.

For example, its technology gathers significant amount of data and financial information (including data available from company annual reports, 10-K's, etc.), assembles and analyzes the data for trends, computes relevant financial ratios, and then prepares a written financial analysis with useful conclusions and recommendations with minimal input from a human analyst.

Individual investors, brokerage firms, and some media firms have subscribed to the service. The company has offices in New York, Toronto and India. 

This group of five is just a few, a coast-to-coast sample. Many other financial-technology firms exist, covering special niches in the industry. And more will continue to be founded, as someone somewhere will determine that with technology advances there's a better, quicker, more efficient way to trade securities, research stock, raise equity, issue debt, share market information, prepare investment reports or provide strategic advice to companies.

Tracy Williams

See also:

CFN:  Knocking Down Doors in Venture Capital, 2012
CFN:  Venture Capital: Diversity Update, 2011
CFN:  High-frequency trading: What's next? 2012
CFN:  Dark days at Knight Capital, 2012
CFN:  Bitcoins:  Embrace or Beware? 2014

Friday, February 7, 2014

Finance: Still a Popular Destination?

Almost a third of Tuck's grads went into finance

Take a peek at the latest statistics.  At many business schools, they're out and available. MBA graduates from the Class of 2013 have launched their post-business-school careers, and they haven’t avoided financial services as much as the popular impression suggests. 

True, countless thousands who've entered and finished graduate business school since the worst days of the crisis opted not to pursue banking, trading and investment management or other financial-services paths.  The industry has endured transformation of all kinds (regulation, business restrictions, non-stop restructuring, and souring popular sentiment).  And it’s true, too, the industry had become a turn-off to some smart students who in years past would have pursued investment banking without a thought.

In current times, the rewards, comforts and predictable career paths in finance are still uncertain. Don't forget, too, the knocks on jobs and roles that had once been perceived as  prestigious and awe-inspiring on the cocktail circuit.  Many MBA students at top schools, so goes popular sentiment, will likely prefer more humane, more constructive routes in a long business career.

But the statistics are out for recent business-school classes, and they suggest MBA students continue to flock to certain areas in financial services.  Finance will still attract those who are inherently interested in finance, those who have finance in their bones, so to speak. 

Perhaps the numbers are not surging as much as they were pre-2007, but they aren't insignificant.  Or  perhaps banks, investment managers, and trading firms are doubling down to make special efforts to present themselves more fashionably to students, describing career opportunities better, and promising easier lives on the work-life-balance front.   

However, perhaps the industry is more defined, better understood after all the years of restructuring and gearing up for an environment ensconced in new regulation.  Of course, some hard-core students, fascinated by markets, deals, transactions, and cash flows, will head toward finance despite what they hear, see or are told.

Compensation helps, too.  It continues to be one attraction.  Data and anecdotal evidence suggest financial institutions still pay well, even if the industry pulled back and rationalized (and reduced) compensation after the mid-2000’s splurge.

Let’s take a look at Dartmouth-Tuck, a Consortium school. Its career-advisory unit recently shared data for the most recent graduating class after it received a sufficient number of responses from departing students. Tuck is a good example, because it has an outstanding history preparing graduates for Wall Street, has attracted large numbers interested in finance since its early days, and has a reputable finance division.  

The Tuck data indicate consulting is the hot spot these days.  MBA graduates are flocking to what is referred in campus jargon as "MBB"--McKinsey, Bain and Booz. In Tuck's Class of 2013, consulting firms hired 27% of the class (and offered the highest amounts in compensation).  In all, 33% are working in consulting roles, including those working at non-consulting firms or working in the consulting arms of the big accounting firms (Ernst and Deloitte, e.g.)

For some MBA students, consulting offers an experience, similar to what they might have received at an investment bank. They get to do extensive research and analysis.  They get to study corporate strategy and make recommendations regarding growth, expansion, and acquisition. They participate in “live transactions” and prepare exhaustive presentations for clients. They travel around the country. 

They also get to have meaningful contact with clients and sit in meetings with clients' senior managers.  Some become experts in the industries of their clients. Hence, while consulting has always been a favorite first job for MBA students, consulting might be swiping a handful of those who a decade ago would have marched right into Goldman Sachs or Morgan Stanley (or Lehman Brothers, back then) at the first whiff of interest on the banks' part.

Yet the numbers going into finance haven’t dwindled that much. MBA graduates at top finance business schools like Tuck (and arguably NYU-Stern, Michigan-Ross, Virginia-Darden, all Consortium schools) are finding their ways back to Wall Street, but perhaps in a variety of roles.  About 30% of the Tuck Class of ’13 headed to financial institutions, and about 35% are working in finance functions. In investment banking, 14% of the class went to work there; 11% are working in classic investment-banking functions (equity or debt underwriting, M&A, client advisory, etc.)—numbers that don’t suggest a lack of interest in  this generation of students.

Tuck’s statistics, nonetheless, show a dearth of classmates headed into private equity and venture capital (only 2%).  The small percentage stands out because many go to business school with expressed interests (and great enthusiasm) about private equity and venture capital. The numbers might reflect the scarcity of opportunity in such a fiercely competitive segment and the unorthodox ways some of these firms recruit.  (Blackstone and Carlyle may recruit at top business schools across the country, but Silicon Valley venture-capital firms may recruit informally or prefer to recruit only from across the street at Stanford).

The latest statistics may also reflect the lack of opportunities on trading desks at big banks, which have had to scale back because of new regulation.  MBA graduates interested sales and trading nowadays don’t have the chance to work in structured career pathways at a Credit Suisse or JPMorgan and will likely look for opportunities, if they exist, at hedge funds, many of which struggled last year and may not be swarming business schools this year. Some students interested in sales and trading can seek similar opportunities at investment managers (Blackrock, e.g.).

Tuck’s statistics show first-year compensation in finance hasn’t fallen into a sinkhole. But the range is as wide as ever, partly because the impressive, mind-shaking salaries and bonuses have been paid out primarily at the bulge-bracket and boutique banks in financial centers (New York, Chicago, San Francisco), and not always at the smaller, regional institutions. 

Still, in a post-crisis era, compensation doesn’t seem to always drive MBA graduates’ career decisions. Indeed these are different times. MBA graduates know the time they spend at Bank of America, Aetna, or UBS right out of school won't last decades. Furthermore, they seek flexibility and a life on weekends or seek some comfort that when the next crisis occurs, they won’t appear on a bank’s long reduction-in-force list.

Tracy Williams

See also:

CFN:  Who's headed into finance, 2013? June-2013

CFN:  MBA's: Eye on summer '14, Nov-2013

CFN:  Where do you want to work? Feb-2013

CFN:  Today's bulge brackets, Jan-2013

CFN:  Goldman tweaks the banking ladder, Sept-2012

Friday, January 24, 2014

Bitcoins: Embrace or Beware?

A fad or the real deal?
Let's not beat around the bush about Bitcoins, the digital currency that has stirred up the financial world the past year or so.   

Bitcoins are a virtual currency, now accepted by some merchants and commercial enterprises as a form of payment for services or products. Because Bitcoins have a fluctuating market value, many try to exploit price volatility and treat Bitcoins as an investment--similar to investors who might purchase foreign currencies with hopes that volatile swings will result in handsome profits.

However, most participants are still not sure how Bitcoins came to be, who or what oversees the marketplace, and where all this is headed.  Let's be real. Any purchase or investment in Bitcoins is a speculative investment.  Uncertainty, volatility and mysterious (or mystical?) origins offset confidence prudent investors or users for payment purposes might have in its legitimacy.  As we saw in late 2013 when the Chinese government intervened to discourage its use, Bitcoins are enveloped by the unknown, and investors run for the hills when they sense something odd or peculiar in this marketplace.

This is a marketplace where even the most active participants are not sure the founder is one person with a vision for an online payment system or a horde of computer jocks out to amuse themselves. It’s a marketplace in its infancy.  As of mid-Jan., 2014, this is a $10 billion market with less than a million Bitcoins (BTC) traded or transferred daily.

Time will tell whether they will become a reliable currency for the long term.  Time will also tell whether this is a finance fad of the early 2010's or a landmark turning point in the history of monetary systems.

Transactions, trading and investing in Bitcoins are a global phenomenon now. A curiosity for some.  Just a year or so ago, the value of a Bitcoin was around $300. During the year, prices soared to $1,000, sank quickly to $500 last fall and then surged and stumbled again like laundry tumbling and churning in a dryer. (They were valued at about $780 in mid-Jan., 2014.)

Some argue Bitcoins (or their off-shoots or similar virtual versions) are here to stay. Bitcoin activity will be propelled by transactors attracted to a system that knows no boundaries, is not directed by government bodies or political systems, and allows for trades and payments in relative anonymity.  As with most financial trends or fads, this phenomenon is bound to stray in some direction--up or down, up and down, out of existence, or perhaps eventually into a nightmarish tangle of fraud, misrepresentation and legal quagmire.

For now, let's acknowledge what seems to be happening in early 2014:

1.  The price movements and upward, secular trend in value have attracted speculative investors around the world.  

Whether they believe in the system or are proponents of a politics-free, digital market for payments, they see opportunities to make money in the short term. If the price increased from $300 to $1,000, why wouldn't it increase to $2,000 over the next year or two--especially if popularity continues the current course?

Speculative investors may not care much for the algorithms and calculations that influence a Bitcoin's value. They see trends in growing demand and popularity, not always sufficiently explained, and a grand opportunity for a windfall.

2.  There appears to be a growing acceptance by some merchants and businesses to accept payment in Bitcoins (BTC).

Growing acceptance offers legitimacy and comfort to consumers who choose to participate in the system.  VirginAtlantic, the airline, joined this group late last year.

In some ways, an increase in participating businesses helps boost liquidity in the system and encourages other participants to join.  The growing number of participants may eventually cause a cry for more transparency and oversight--which exists today, but in veiled ways.

3.  A Bitcoin market depends on a class of participants called "miners," who act somewhat like "brokers" or "market-makers." 

In financial markets, brokers or market-makers facilitate and process trades. Rewarded with commissions or marked-up profit spreads, they have incentives to keep a market alive, active, and liquid.  In the Bitcoin world, miners act in that role.  Like many financial markets, Bitcoin "miners" have sprouted everywhere in surprisingly large numbers, partly because of the lure of rewards ("commissions") and partly because mining Bitcoins could be considered less risky than in investing in them.

Before others leap to join the ranks of miners, note the odd wrinkle in miners' responsibilities. Miners secure, confirm and report Bitcoin transactions. They are compensated by being rewarded with a special new supply of Bitcoins, but only after they have successfully solved a math problem that requires enormous amounts of computer power.

Think of a financial broker being rewarded with an incremental new issue of a company's stock.  Or think of the Federal Reserve rewarding big banks who confirm and expedite money transfers with new-money credits at the Fed. However, imagine being paid for the service only after solving a math problem that--by Bitcoin rules--will become more difficult to solve in the future.

Those who have access to such computing heft have opportunities to reap substantial rewards. Like market-makers and brokers in a financial market, they facilitate transactions without taking on significant amounts of investment risk. (Their initial investments are those in computer servers or in space that houses computers.)

Because they bear a little less risk than speculative investors, a cottage industry of miners (and related businesses) has surfaced in global corners everywhere--from California to Iceland. There are miners, but there are also companies that support miners by selling or leasing access to computers for mining purposes. There are investors (including private-equity firm Andressen Horowitz) that are now comfortable investing in "mining" operations.

4.  Bitcoin "money supply" is controlled, and growth is restricted, planned and charted, based on an initial algorithm. 

BTC coin supply is based not on economic policy or economic objectives, but on the complex math calculations miners are required to do with their high-power computers. 

By design, the more successful miners are in finding solutions to the calculations, the more difficult the next series of calculations becomes.  It becomes harder and harder to solve the problems to get the same reward. Miners will, therefore, invest in greater computing power to earn similar revenues. Today, miners are racing to grab revenues that might be near impossible to generate a few years from now. And racing like mad.

Those calculations have less to do with how central bankers manage monetary supply, more to do with the calculating power of their computers. Governments and central bankers, we observe, manage monetary growth based on objectives they have regarding interest rates, inflation rates, and expected economic growth.  "Money supply" is ultimately finite in the world of Bitcoins. Until supply reaches a determined maximum, it is now  determined by activity, participants, and computer power. 

5.  While "mining" helps ensure the Bitcoin market is an orderly market, nobody yet knows what will happen in the worst of cases.  

If there is a sudden crash in price --a sudden collapse or a widespread panic, who will oversee the marketplace? If there are crises or disruptions caused by technology, systems or deceitful miners, who will act to revive trading and transacting? 

6. The  system, which eased quietly into the global financial system within the past few years, will continue to attract participants--not because libertarians enjoy that governments have no part to play, but because of money-making opportunities.

A steady increase in legitimate participants may eventually force the system throughout--not just in segments--to provide a blueprint for how the system will behave in worst-case scenarios.  Furthermore, crises, disruptions and crashes will have inevitable legal implications, which of course will require governments or courts to intervene in the end.   

For now governments and central bankers have been shunted aside. The system is self-policing. But the greater the number of participants and the greater the likelihood for system mishaps, then the greater the push for order and protocol that would boost confidence in the system.

But will all that occur before the system's first panic crash, the shocking catastrophic plunge that will cause large numbers of participants to flee en masse with no confidence in ever returning?

Or will the system, supported by a phalanx of miners around the world, find ways to keep itself honest, fair, and relevant?

Tracy Williams