Thursday, February 28, 2013

Two Paths to Satisfaction

Yesterday, I read a post at about "Will Infrastructure Ever Find Wings?"

This got me thinking that Infrastructure is a perfect "proving ground" for pensions and other stewardship investors to develop the skills and judgment they will need to empower themselves to become investors in cash flows, directly.

Instead of looking at Infrastructure as an Asset Class that can provide the returns they are looking for (it can't because it is not large enough to meet their needs), consider it a transitional phase to cash flow based investing in the Real Economy.  That will provide the "tonnage" -- the sheer volume of investments -- they need to get some satisfaction built into their investment activities, both financially and societally.

The second transition could be a program of "going private and staying private" partnerships with Management of pubic companies, or subsidiaries of public companies, that want to opt out of the game of "maximizing shareholder value" by teaming up with stewardship investors to agree on equity splits in a negotiated base case cash flow waterfall that will provide the right blend of financial goals and societal values to stewardship investors, and a path to ownership earn-back for Management.

Right now, by all accounts, pension funds and other stewardship investors "can't get no satisfaction" from their experiences with "business as usual" trading on price, in none of its many permutations.

This is a two-step process for them to get more satisfaction by investing in cash flows, directly.

Monday, February 11, 2013

Should Stewardship Investors Take the US out of GM?

In the midst of the Financial Crisis of 2008, the US Government invested some $49.5 Billion in General Motors to save an estimated 1 million jobs.

Much of that investment has been recovered, but as of December 19, 2012, the US still owned some 500 million shares.  On that date, the Government announced its plan to sell 200 million shares back to the company, and committed to sell its remaining shares within the next 15 months (by the end of 2013).

In an article published on that date in, "Treasury to Sell G.M. Stake Within 15 Months", it was reported that the final sales would result in a loss to the taxpayers estimated to be in excess of $12 Billion.

In the article, Micelle Krebs, an analyst with the car research, was quoted as saying “The key [to the future of GM] is to watch and see if the company falls back into old habits.”

If the company is falling back into playing the game of "maximizing shareholder value" as a public company, what makes us think it won't fall back into its old habits?

As Roger Martin, retiring Dean of the Rotman School of Business at the University of Toronto, points out, managing a business to "maximize shareholder value" is inauthentic.  The authentic purpose of business is to successfully balance the conflicting interests of multiple constituencies, including customers, suppliers, organizers, the government, and the community more genially, as well as investors. Putting the interests of one of these constituencies above those of all the others through the theory of maximizing share price is widely associated with numerous undesirable outcomes.

What if the US, instead of selling its shares back to the public markets, sold them privately, to a consortium of stewardship investors, who negotiated directly with the company to recover invested capital and realize minimum threshold returns by participating on an agreed split formula in revenues to be generated by the company over time through commercial activities?

That would not be the old way the company was funded.  Maybe it would prove to be a new way of keeping them from falling back into the old way of running the business.

Think about that.

Friday, February 8, 2013

Investor Needs and Capabilities

Individuals invest with a generalized need to use their money to make more money, and with limited abilities as to the amounts of money they have available to invest, how long their money can remain invested, and the resources they can devote to identifying, qualifying, pursuing, constructing and overseeing the investments they do make.

Stewardship institutions, like pension funds, endowments, foundations, insurance companies and sovereign wealth funds, invest with the purpose of achieving the objectives of their governing charter.  They are also large, perpetual and resourceful.

How well can architectures of ownership for investment built to meet the generalized needs and work within the limited capabilities of individual investors be made to serve the purposeful needs of large, perpetual, resourceful stewardship investors?

Experience is showing, not very well.

Thursday, February 7, 2013

Authenticity of Sale-Based Architectures for Investment

An Architecture for Managing the Mismatches Between Individual Investors
Sale-based trading in securitized assets is an architecture of ownership for investment purpose-built (back in the 19th Century) to manage the timing differences among a large and diverse population of individuals relative to their use of cash for participation in either the capital or the commercial markets.
For all but a very small number of very wealthy persons, individuals need to be able to invest their money when they can and withdraw their money from investment when they need it, to spend in the commercial markets.  They are capable, also, of only investing relatively small amounts for relatively short periods of time, when compared to the scale and longevity of the commercial enterprises in which they are investing.  Finally, they are similarly limited in time, effort and expertise they have and can devote to the identification, qualification, pursuit, construction and oversight of investments in enterprise.
Individuals Cannot Negotiate for Themselves
In short, individuals cannot negotiate the private laws of investment directly with enterprise. They lack the scale, the longevity and the resources required for that work.
They have to Buy Into Someone Else’s Deal, Already Made
If they are to invest at all, at least in enterprise of any real scale, they must invest indirectly, as a passive participant in an investment already architected for them by others.
Managing the Mismatch in Size through Securitization
This is the essence of securitization. A set of private laws defining the rights of investment negotiated directly with enterprise are broken up into bite-sized pieces for re-sale in small increments to a large number of small shareholders. It is a classic wholesale/retail distribution model that addresses the mismatch in size between enterprise needing investment and individuals willing and able to invest.
Managing the Mismatch in Duration through Exchange Trading
To address the mismatch in timing, the exchange mechanism is used. Shares are listed for trading between investors. In this way, an individual who needs to take money out of the capital markets can do so by selling shares to another individual who has money available to invest. A certain sale is guaranteed through the exchange mechanism by letting the price at which the shares will trade float to whatever price a willing buyer will pay to a seller who is willing to sell: a certain sale at an uncertain price. That is the fundamental value proposition of the exchange.
Managing the Mismatch in Resourcefulness through Standardized Structures
To address the resource constraints of the individual as investor, a standard architecture of ownership is employed that reduces the bundle of rights held by market participants to the one, single, unfettered right to sell at will, and without any residual responsibilities remaining after the sale. In addition, a large infrastructure of standardized information focused on supporting judgments about share price is established and maintained. Finally, responsibility for reinvesting profits as earned is transferred to the enterprise, leaving individuals with the simple and effective strategy of building their profits on the power of compounding, profits that are extracted from other investors by selling out over the exchange.
An Effective Architecture for Individuals Investing at Industrial Scale
This is a construct that has proved remarkably effective at achieving its intended purpose of aggregating large sums of money for investment in large scale industrial enterprises from large numbers of small shareholders.
It is a construct that has also proved wholly inauthentic to the purposes of large, perpetual and resourceful institutional investors who it was never designed to serve.

Monday, February 4, 2013

The Joy of Stewardship Investing

As individuals, investing for our own account, we are free to pursue profit for profit's sake, each acting in our own (enlightened) self-interest.  In consequence, our portfolios are a collection of trading positions in various securitized assets, each of which we hope will increase in value over time, although we have personally no real ability to affect that outcome. For the more aggressive among us, we may trade positions more actively, working to extract profits from the markets (i.e. other investors) by buying at a discount to sell at a premium.  For each individual investment, we see only three points of value: asset, price, volume. Collectively, we see our portfolio in terms of a single point of value: it's net asset value.

For pensions, endowments and other institutions investing other people's money in furtherance of the purposes expressed in a governing charter of trust, the experience is different. These large, perpetual, resourceful stewardship investors can actually sponsor enterprises, in the process helping to drive the configuration and re-configuration of the economy as the network of exchanges adapts to the changing choices that people make through their participation in commercial transactions.

This makes investing by stewardship institutions a much richer and more rewarding exercise than it can ever be for any of us, acting alone and as individual investors.

It also creates both the need and the opportunity for stewardship investors to view their portfolios not just as a list of trading positions, but also in terms of their impact on the economy. For that, they need a map that represents visually the economy as a network of enterprises in which they are or could be investing.

What will that map look like?

Below is my first effort. If history is any guide, by the time we evolve a map we all agree is right, proper and properly useful for its intended purpose, this first effort will look quite crude.

But, there it is. We have to start somewhere.

Comments are welcome.

Sunday, February 3, 2013

Can Inauthenticity ever be Prudent?

The premise is simple.

Authenticity = Prudent + Loyal + Competent to the purposes of a governing charter for the custody and care of other people's money.

(In)authenticity = (Im)prudent + (Dis)loyal + (In)competent to the purposes of a governing charter for the custody and care of other people's money.

Authenticity is a concept I picked-up on from Roger Martin, Deal of the Rotman Business School and author of the book, "Fixing the Game", during his recent Webinar conversation with Raj Thamotheram of the Network for Sustainable Financial Markets, who co-hosted the event with the Sustainable Investment Professional Certification program at Concordia University.

Roger was making the point that business management according to the theory of "maximizing shareholder value" is inauthentic, because the authentic purpose of business is to successfully balance the competing interests of multiple competing constituencies, including customers, workers, suppliers, as well as investors. To make the interests of one of these constituencies paramount in importance above all others in inauthentic, and unsustainable.

This dichotomy of authentic/inauthentic sheds light on the question of fiduciary duty for stewardship investors, like pension funds. Consider that the authentic use of trading markets is to manage temporal mismatches between individual investors.  As a general principle, individuals invest when they can, and sell when they need the money. Timing is what drives their decision-making. To be sure, they want to buy at the best price, and sell at a better price, but the decision to buy or sell is not being driven primarily by price. It's being driven by cash flow.

Now consider how this dynamic changes when institutions, like pensions funds, become the primary market participants. Pensions are perpetual investors.  When they sell, they take their sale proceeds and buy something else. The money, once it enters trading, never exits. It just gets churned around. For pensions the motivation to trade is not their market-external needs to manage their cash flows.  Some of it is. They do have bills to pay. But not for the most part. For the most part, they sell to take profit and buy in hopes of getting a deal. In each case, they do so at the expense of another investor. As more and more of the money invested in trading platforms is institutional, more and more we see stewardship institutions seeking to take profits at the expense of each other.

Is this an authentic way for fiduciaries to behave?