Documenting processes at offices

Recently I was party to a discussion about understanding office processes improving them. The arguments were standard, processes are ad hoc and it is difficult to capture tacit knowledge. That reminded me of a document I had created a long time ago on How to do exactly that. I have put that up online. Have a look.

Process Documentation & Improvement Ebook

Future of Hedge Funds

The future of hedge funds is under microscope. Some believe, hedge funds are evil and hence would die. Others believe higher regulatory burden will spell doom. I believe reality might be contrary.

Flexibility in capital allocation is critical

The need for flexibility is the central lesson from recent toxic asset debacle. Funds that are flexible are better suited to surviving the near future. Hedge Funds derive a little advantage flexible than private equity and lot of advantage over pension funds.

Flexibility applies to strategies as well

A flexible strategy may be better than a sector specific or other constraining strategies. So between strategies it might be better to allocate more capital to flexible ones.

Stock selection will undergo a change

Within the investment process changes will happen.

1) Currently, lot of funds use "owning stocks" mentality. Fund managers try to foresee how demand for those stocks will move. They are not buying companies like Warren Buffet. Due to higher volatility with lower volumes owning stocks is likely to work with very large caps (blue chips). Further, any long term (>6 months) investments will have to be "owning companies" type of investments. Some funds already work with this mindset and are consequently better off.

2) Focus on macro drivers will increase. Macro drivers impact capital flows into markets and therefore can make or break portfolios.

3) Holding periods will decline. Given the volatility in stocks, flexible managers can take advantage of capital flows.

Employment generation

Given the changes above, we are likely to see more diversely talented and diversely located teams supporting investment managers. Further, we might see a drop in capital/manager to ensure higher flexibility.

The survival game

Survival is the name of the game for next 3-5 years. Both for funds and companies. We are likely to see a drop in total money supply in the next few years. Capital will be destroyed through two ways. First through companies going bankrupt. Second volatility impacting AUM of asset managers. So picking survivors is the key.

So if any hedge funds have an opportunity for me, check out my profile and drop me a line. ;)

Market Outlook

Paul Kedrosky has a wonderful link to interview of Michael Steinhardt and others. There are a lot of quotation gems in there. I paraphrase a few ideas with my take on it:

• No one is bullish over long-term: The problems we are in, in US and globally, are too big to be wiped out by a ill-directed few trillion dollar stimulus. Government does not have information to go for precision-bombing stimulus. So for carpet bombing, that we are aiming for, we need a hell lot more bombs.
• What has changed? - Nothing: Other than extra few trillion sloshing around nothing has changed. We still seem to be playing out the same moves from great depression times. Our two most likely outcomes are a bloody great depression or a prolonged stagnation - both are grim. Markets are enforcing themselves - I mean real economy markets. Consumers are de-leveraging and increasing savings.
• We cannot estimate valuation because future is uncertain: The future is uncertain. We are not confidently able to foresee how future corporate world will look like. What will be the revenue levels? What will be the growth levels? Who will survive the crisis? In such a scenario, putting numbers to revenue projection and looking at valuation is dangerous game.
• A forecast tells more about the forecaster than the future: This is a gem. I think that is true. At the moment all analysts will be better off understanding potentially likely scenarios and potential outcomes.

Future Without Poverty

World without poverty is one of my dreams! And I fuss over it in lot of ways. My readings of current writers on Poverty suggest that we need a view on life of the poor. This ebook is an attempt to express the same. It is my contribution to understanding and eradication of poverty in the world. Download the ebook here.

Briefly it covers three main aspects:

How poor get poor?


I look at three phases over which a household gets into a poverty trap. This, I believe, is critical to understand as it harbours solutions to the poverty problems. Further, it also leads us to a basic framework for solving the poverty crisis everywhere.

Snakes and Ladders Approach


Getting a community out of poverty needs a customized solution. Each community faces its challenges (snakes) but has opportunities (ladders) hidden within its structure. This framework may be used to build a customized approach for the community.

Structural v/s transient poverty 


One of the central idea I want to highlight is the difference between temporary poverty - one that household can get out of versus structural poverty - one that seduces the household into believing that they can get out of poverty.

I would love to hear your feedback on the ebook. Please email me at rahuldeodhar [at] gmail [dot] com.

A Clear Policy on future bailouts

Senator Ron Paul is keen to get the Fed audited and closed. I don't know how that will pan out but I would seek clarity in one aspect of Fed's functioning. The bailout criteria needs to be defined and communicated.

We need a decision tree to understand how Fed will hereafter decide who gets bailed out. The current "case-to-case basis" and "threat to financial system" arguments are too esoteric. We need clear principles and guides to understand how such decision will be made in the future. There are four critical element of "Guidelines of future bailouts" plan:

1. We need clear understand of who can seek a bailout. Is it banks? Are insurance companies allowed? Who is allowed? Who is not? Why?
2. The next part is within this set, who are eligible for bailout, how will you choose? What self-help measures the company has to go through first before coming to Fed for the bailout? What if someone exceeds Fed's / other regulators benchmarks for leverage? Or pays excessive bonus? Will those companies get bailed out too?
3. How will the bailout amount be decided? Will it come entirely out of Fed gurantees? How about untouched bonus pools? How about unwinding risky position in hard-to-sell paper?
4. What happens after companies are bailed out? How will they be restructured? How will Fed ensure that those funding the bailout (US citizens) get control over the company?

It is right time to initiate the plan. We have Ben Bernanke at the end of his term. We have some green shoots so markets are reasonably calm to absorb and accomodate the rules of the game. I believe this will reduce uncertainty in the markets. I think it is a moral duty to explain to tax-payers how future bailouts, if any, will be decided. Moreover, I believe tough times lie ahead. It is better to be prepared with a plan - at least for things that we know we might need.

Exchange Rate appreciation

The Reserve Bank of India (RBI) announced the monetary policy on tuesday 28th. In one of the innocuous statements RBI mentioned it will allow appreciation of Rupee if there is higher capital inflow than can be managed through intervention. Not many commentators weighed in on this at the time. But that represents the most important signal.

Felix Salmon explains the dilemma of the asian central bankers in more details. RBI has sensibly tackled the financial crisis as of now and this indicates RBI is one of the intelligent central banks around. China faces this dilemma more critically as it wants an undervalued Yuan. To top its list of worries the GDP is rising really fast. If there is one way to attract big money then this is it.

There is a good chance central bankers will soon resort to good old capital restriction. This will be the first blow in the test of globalisation. This threatens to raise the friction between countries. We are witnessing increase in friction over anti-dumpting duty imposed by EU on Chinese.

Such regulatory threats have the potential to create more cycles in markets. So this is definitely going to be painful - we will have to hold our nerves. Fortunately or otherwise, we cannot, will not be able to reverse the globalisation.

Why no one saw the crisis coming?- An explaination for Queen Elizabeth II

The question reminds me of King Charles II who invited members of the Royal Society to explain why a dead fish weighs more than same fish alive. After the Royal society provided various explanations it was brought to everyone’s notice that they actually weigh the same! It is the same with current economic crisis.

The group of eminent economists could not foresee the current crisis due to “failure of collective imagination of many bright people”. In my humble view, your highness, this is incorrect. Nobody actually bothered to make the real‑world observations. How could one not notice unemployed people buying multiple homes? Or, how could they not notice people with mortgage repayments more than their incomes?

Such ignorance on the part of trusted few will cost the world dearly. The developed world, including Great Britain, is on throes of worst economic decline spurred by international debt. We are facing a decline in standard of living that will undo decades of development. In such times of calamity, the elites are busy retrofitting explanations to history. The “group of eminent economists” has been deeply inbred and so have all other eminent groups who run the financial system. These are groups formed between likeminded fellows, those conforming to specified views. These groups have shown clan-like behaviour ridiculing alternate points of view. One only needs to look at ridicule heaped on likes of Peter Schiff, Nicholas Nassim Taleb, Nouriel Roubini and others. These groups lack diversity of opinion to understand multiple facets of financial, economic innovation.

I further disagree with the economists’ gracious claim that everyone was doing their job to the best of their abilities. If guarding the door “to the best of our abilities” when thieves attack through the window, you are not much of a guard, are you? Sadly, even the press has abandoned its duties of fourth estate. Our journalists no longer reflect on social implications and problems but often report from their own ivory towers. We haven't seen any pointed intelligent debate between press and policy makers even as policy response aggravates the crisis further.

To ensure such crises never occur again, we need more respectful cross-disciplinary debates involving social understanding and moral values. We need philosophers and cross disciplinary thinkers more than ever. Usually, such is the responsibility of the House of Lords. Are there, if I may humbly ask, real knights amongst your ranks, your majesty?

Note: This is a response to Guardian Story about Economists explaining how the crisis happened to the Queen.

Future of Financial innovation

There has been a lot of talk about financial innovation being bad for general populace. Economist blogs about it Financial innovation in the rearview mirror quoting Tyler Cowen and Felix Salmon. This pulls up a paralled to pharma industry in my mind.

Just like we have drug testing labs for pharma companies, we need labs and regulation for finance innovations too. In a sense, sub-prime was a drug being directly tested on population. The result is predictably disastrous. The Consumer Financial Protection Agency (CFPA) could take up such a role. Then, if pharma is any indication, we will have lot more innovation in the near future.

Pharma industry also created higher cost structure to foster innovation. The regulatory burden along with pseudo-barriers in the name of intellectual property created unaffordable costs. The opportunity before the CFPA is to set the benchmark for simplied, easy to athere but difficult to cheat, low cost regulatory structure. CFPA, all eyes are on you!

Chris Anderson explains Free / Freenium

A lot of people get confused with Chris Anderson's book free. Particularly because his book is free. Here he explains the concept in details. A fantastic read about changes in business models.
Charlie Rose - A conversation with Chris Anderson of Wired Magazine

A re-polarization in Risk Structure of Investors

Tadas Viskanta notes how hedge funds have survived the current crisis in his post The curious incident of hedge funds during the financial crisis Abnormal Returns. This refreshes an old idea I had earlier about polarisation of investor companies based on risks.

Capital providing institutions were divided into two based on this. Banks (low risk) and Equity investors (higher risk). But now we have finer risk classifications. The resultant business models were, in a crude way, spread across the risk spectrum. The downside was the risk demarcation became a little (a lot?) fuzzy. Large banks too moved towards higher risk assets (CDO etc) and were burnt. Equity investors came with low-risk schemes that have mostly lost money. The money-making strategies in current market situations align better with clear risk demarcation. That's why possibly hedge fund survive.

The investment rules getting too tight is basically a risk reduction strategy. It will be wiser, possibly, to remove constraints on fund managers. Money managers who manage their own book may be better off with the flexibility (provided their reading of markets is correct of course).

China led recovery?

The largest consumers, US, EU and Japan are spent. US has domestic and corporate indebtedness. Japan still languishes from the lost decade. EU members sit across the spectrum between US style indebtedness to that of 1980s Japan. Only country who has the right cards is China. It is significantly big and fast enough to turn the course of the history. So then will China play its hand right?

Well, it is not inspiring any confidence to say the least. Micheal Pettis points to Notes on a real estate trip in China where we realize that Chinese policy of investment driven demand is banging against the wrong wall. China is looking for the final buyer that we discussed earlier.

Meanwhile, I notice market feedback, logic structures and arguments are regaining 2007 flavour. This definitely does not auger well for any of us. It is as if markets have noted Roubini near term possibilities but are still ignoring Taleb's long term solutions. (Taleb has attacked the root causes VAR, (ill-applied) probability theory, portfolio theory and algorithm trading framed on these.)

Where is the Greenspan Model?

I remember that there is a Greenspan model that Alan Greenspan used to determine if markets were fairly valued. It pointed to over-valuation in 1998 and again in 2004. Where is that model now and what is it indicating given the current earnings scenario?

Fail safe regulation!

Obama's financial sector regulation is under scrutiny. In one word will it prevent crisis - no. Will if prevent this crisis from occurring again - possibly. Why? Is it so ineffective? Well no, the terms are well intentioned. What we need is Fail-Safe regulation.

Fail Safe - engineering definition v/s common definition

There are two definitions of fail safe. Generally, fail safe means does not fail. Whereas in engineering fail safe means - when it fails it does not cause harm. It is impossible that regulation will never fail. So financial regulation needs to apply engineering definition.

Using Engineering fail safe regulation...
Now we need not regulate hedge funds, or investment banks or increase their capital adequacy beyond certain limit. We simply need to ensure that when banks fail they do not take the world with them. Hence I proposed the new banking system.

In the new structure, we should see polarization of financial institutions along the risk axis. The high risk FIs, like hedge funds and private equity, will never be bailed out. Investors into these asset classes should sign a government disclosure that they know they can potentially loose their money - just like hedge fund investors. We will see more groups joining hedge funds and private equity in this pole.

In any case regulation has to take responsibility for low-risk financial infrastructure part of the system, leaving other pole to dynamics of capitalism.

In Sum...
The current regulations are good intentions with potentially poor outcome. I hope Obama advisors are able to get around to the engineering fail-safe regulations.

Market turmoil and picking Survivors

Global markets showed weakness again today. Over the past few days global markets have weakened about 2% per day. There are theories that point to a three week correction before a pick up in prices.

Picking survivors
A popular anecdote highlights importance of holding stocks for long term. So people often tell me - so what if price is too high - just "sit on it" for XX years and you will be fine. Unfortunately that is a wrong strategy. Current situation is more about picking winners.

Winners change and lot of companies fall by the way-side during times such as these. In a smaller crisis, bigger companies are typically better off. But not so for structural crisis such as we are seeing now. A long term investment strategy is more about picking survivors. Survivors will loose less value when market falls and will rise higher when it gains.

Airline example - British Airways and Singapore Airlines
Airline operators were part of massive industry slowdown after 9/11. These two companies used this opportunity to replace their fleet with young more fuel efficient planes at reduced prices thus building tactical advantage for years to follow.

Stockpiling Commodities - What is China doing?

China stock-piling commodities or buying US assets seems useless to me. If US dollar were to loose value and commodities / dollar assets were to retain value – then technically Chinese Yuan should also retain same value. US dollar starts loosing value means commodity prices start shooting up. Meaning, in technical terms, US will then export its inflation to the rest of the world. There are few responses to this –

• the world keeps global exchange rates constant
• The world let dollar go down alone
• Some allow exchange rate changes some (like china) dont

If everyone keeps exchange rates same – we will have another recession and commodity prices will come down. And whatever you do this cycle will repeat itself till world is sick of the pain. The fundamentally sound parts of world can recover if they let currencies appreciate.

Holding commodity assets signals the Chinese intent to keep the Yuan (RMB) hard pegged to the dollar. This is clear signal of pushing towards "status quo". The stockpile will help China reduce the inflationary impact on its economy while US recovers. But ideally this should require inventories equal to the expected duration of such inflationary scenario.

The only other reason could be - China expects disruption is supply chain. Such disruptions occur in crisis - so China might be preparing for crisis possibly even a war.

China's domestic demand and other notes

Brad Setser starts a wonderful discussion on "How can we explain growth of China while all other export oriented economies continue to slide?" Thereafter follows a range of serve and volley explanations that are delicious treat for thought! Here are my views:

Walmart sales increased when other retailers went bankrupt because Walmart was lower cost than most. Same logic, I believe, explains partly why Chinese exports did not slowdown as much as others.

China’s monetary expansion will have two components – domestic stimulus and US treasury demand. It will be interesting to understand which will be bigger and will there be any crowding out effects.

If you push large liquidity through the system fast – high value, long-term assets (houses, stocks, etc) tend to inflate. This keeps overall inflation low (since these do not form part of consumption basket) giving an impression that everything is fine. This corners the excess liquidity to one end of the pool. Eventually the system breaks but till that time we have fantastic illusions.


Problems of Europe
Europe is about 13 billion giant (excluding Russia). Problems of Europe will impact world recovery to the same / slightly more than problems of US. We have somehow left Europe out of discussion.


Domestic demand / Market
Creating domestic markets is not easy and does not simply happen by throwing capital. Domestic tastes and preferences, as we see in India, are lot different than we anticipated. Same logic should hold for China.It is easier to customize goods (like restaurant services) are easy to manage – but inflexible goods (capital goods e.g.) take long time. The changes cascade from consumer side till they reach the top end. Examples:

1. A large part of textile industry may be geared to service cotton clothes – whereas Chinese might prefer silk. (OK I simplified it a bit too much)
2. You take milk, some producers added some hormones to aid milk production. Resulting milk was not safe for children. Now we need institutions, legal, regulatory etc that create a feedback system to discover and curb such practices. These complex frameworks anchors in democratic setup – leading us to political minefield.

If someone clarified the entrepreneurial scene – we may actually get better clues about domestic demand. Large entrepreneurial pool backed by venture funds experimenting with products and distribution is the best way to create (and an indicator for thriving or potentially thriving) domestic market.

The easiest part of domestic demand stimulus is to allow top brands to enter the domestic market and give them some price leeway through currency appreciation. Louis vitton bags, Chanel perfumes etc will kick start domestic consumption faster.


Psychology of excess
This is one of the problems facing China. In its quest to stimulate – it might create excesses that can haunt it later. Large ammunition is mega problem if it explodes in you own backyard.


China is our hope
Our global recovery hopes are pinning on China. The question is does China know and will it take the responsibility?

A New Banking System

The current crisis made us realize how financial sector in general and banks in particular can hold the economy hostage. The crisis was precipitated by a credit freeze triggered by fall of Lehman Brothers. As a response Fed kept pushing money into the bank but none of it reached the deserving households or small enterprises. So we know we need a new Financial system. Mike has a nice post about The financial sector we want.

Rethinking banking - Banking as water management system
We can think of banking as water management network. We have water reservoir, the piping and usage meters, then we have used water drainage, used-water treatment and back to other reservoir. The used-water is savings that feed into the reservoir - bank deposits. The worst part of banking crisis was the looming disappearance of the the piping and drainage network.

Now, the network needs to be as big as possible, bigger the better. A larger network means accessibility across the country / world, it means freedom for the consumer. It means the network will be operated like a utility company, with very small fee and highly regulated operation.

The reservoir however, needs to be small enough to be manageable. And more the merrier. Here replacing one by other will ease the strain on the economy. In radical times, Fed can directly be the money reservoir and plug itself into the system.

Tomorrow's Banks = Today's banks - Banking infrastructure "system"
So we are looking at splitting banking into three parts - financial infrastructure system, deposit taking institutions and loan making institutions. While, the last two can be same, they cannot ever be infrastructure. Glass-Steagall Act achieved this in smaller degree. I think, looking at recent experience, it makes sense for the financial infrastructure to be government owned. At least, it needs to be heavily regulated large utility like power transmission company or water supply company. Alternatively, it can be a well-designed Internet based system as well - then no need for any company.

What is financial infrastructure system?
The role of financial infrastructure company will be that of a conduit. Citizens will have an online account, with a free (zero fee+ zero charge) debit card. It will allow the citizen to login and allocate his/her savings to deposit-taking-institution of choice that can manage it with promise of interest income. The system will collect a fee from deposit-taking-institution as an insurance against insolvency of the institution. The amount of fee retained will depend on rating of the institution.

Further, lender (including credit card providers) can lend to citizen based on report generated by system. These reports will protect privacy as per legal guidelines and give information enough for processing creditworthiness test. It may also generate a FICO-like score for the borrower. Lender, once satisfied, can be plugged into citizen's account. The system will schedule and process payments or at least set alerts to prevent defaults.

Privacy and prudence
The suggestion also raises privacy and government intrusion concerns. I am not sure I understand all the problems that may arise in such scenario. However, it is definitely an idea worth exploring.

An increased (though very small) probability for War

Probability of war seems to have increased. It is still small but definitely increased. Though it is unlikely that India will be involved in one (we never invaded any country in 5000 years - so we dont have the mindset) But, look how different war-indicating trends are catching up.

1. China has more males in its population - typically when the pop ratio gets skewed the chances of war increases. Further, income polarization is very high in China.
2. Recession will make more people (mainly youth) unemployed and in financially distressed situation - implying combative etc
3. US-china have classical debtor-creditor problem any strong arm by China will not be taken lightly by US. China believes it may be wronged by the US. If US dollar devalues then you can be sure things wont be easy on this front.
4. War is by far the biggest domestic stimulus one can give - creates domestic jobs and stuff hence politicians are ok with war in such times.
5. The typical flash points are visible - Afghanistan Pakistan is now a flash-point. If Us forces are attacked or get in some trouble then we could see drastic actions. Earlier North Korea, Malaysian protests, Demonstrations in Greece were some flash points ( though none as big as Af-Pak)
6. Religious alignments are getting more stricter - talibanization of SWAT valley in Pakistan is an indicator. To certain degree, Obama election has reduced any polarization along religious lines that we saw earlier in US.
7. US policies and other global stimuli are going to result in more income polarization. As global inflation strikes the differences will become more evident - I can foresee Mary Antoinette - "if you don't have bread eat cake" statements.
8. Usually such conditions are off-set by economic growth (that promotes peace) - but that has near about halted in past few months. Now if things do not improve we could be in for much tougher times.

Since last year I have been advising small businesses (even if uncalled for many times - and often at risk of being sounding intrusive) to preserve cash and lower debts. This is time to tighten the seat belts and check the gun in glove compartment for bullets just in case.

So I say it again - better prepared than sorry!

Global Slowdown Solution VI: Going Green and Blue!

Given that real stimulus will take a form of modified Keynesian approach- we need to know what are the "highways" of today. During the last depression, the building of highway and rail infrastructure got the US out of trouble. This time, to my mind, it has to be Green and Blue infrastructure.

Going Green

US has been victim of development invention. Most of the infrastructure / engineering of the country is based on older technology thats not green. Few years ago when the green revolution was knocking at the doorstep, it was difficult to see how US and developed world can re-engineer the entire setup to go green in a meaningful way. Luckily the current situation presents us with an opportunity to do just that. In doing so, US will lay the foundation for competitiveness for the coming decade or more while adding to comfort on global warming.

Going Blue

While green is important, blue is even more so. By blue I mean developing potable water resources. Greening, apart from using lower emission fuels, also means creating tree cover and rebuilding green-ecosystems. Initiating this will require potable water sources. Further water is the most essential commodity for sustaining life. Investing in rain water collection ponds and lakes, water seepage assistance to rebuild ground water resources etc will have to take precedence. India has got an initiative off-ground through India water portal.

Implications for cities and homesteads

If at homestead level we can create sustainable water and green infrastructure, we will have a much better self-sustaining planet. That imlies our city-oriented development models will have to be modified to make it more sustainable.

Implications for current economic slowdown

The ability of these initiatives to create jobs is under-rated. If properly deployed these initiatives may create more jobs and more self-satisfaction than most optimistic forecast. These initiatives have unique character. They need huge manpower up front and then possibly the overall manpower requirement for sustaining this effort will be about 3% of original. This means they can create enough jobs to reduce unemployment rates by some perrcentage points in initial years. And the man-power can be freed in few years as economic activity resumes full steam.

In Sum

Green and Blue are compulsions. We either take up our share of responsibility or implications are large and life-threatening. As they say, "nature does not do bailouts". The opportunity has presented itself - lets grab it!

Elizabeth Warren on John Stewart show

Elizabeth Warren speak colloquial on John Stewart show. As he says "it feels like Financial chicken soup".