Due Diligence Questions For Investors

If you are thinking about investing in something, you have to do your due diligence. The finance company collapses, ponzi scheme failures and property investment scams that have been revealed following the global financial crisis ram home the fact that most investors don’t do their due diligence.

How can an average investor perform due diligence on a prospective investment? The truth is they probably can’t. If you don’t have above average knowledge of the relationship between risk and return, how probability actually works, what the law is surrounding investments and standard procedure for legitimate investment firms you should stick to investing in index funds.

The inability of the average investor to perform due diligence is why we have to make silly statements like “taking my investment advice without consulting a financial advisor or 3rd party solicitor first is really stupid”. The development of “plain English” product disclosure statements prepared in the format preferred by the Financial Markets Authority can’t account for how stupid some people are.

If you can’t explain to a reasonably clever teenager concepts like diversification, correlation of returns, the risks and rewards of Kiwisaver accounts, performance relative to benchmarks, impact of performance and management fees on long-term returns and answer questions that dullards send into Mary Holm every week you have no business going anywhere near the financial markets.

Armed with your above average knowledge of basic financial topics, you should be able to pigeon hole investment products you’re looking at. When you know the category of investment you are dealing with you can then ask the best questions for that category of investment. The Financial Markets Authority actually has some great information on its website. As does the Retirement Commission’s “Sorted”.

For example the Moa Brewery IPO can be filed under “new listing backed by guys with a track record of selling NZ brands for a premium to large corporates and non-trivial likelihood of success”. Examples of questions you’d want to answer before investing here would be:

  • How are the founders and IPO participants incentives aligned?
  • Who is managing the listing and what fees are they getting? Do they have to support the initial listing price?
  • What do the back-of-the-envelope calculations look like for the premium beer market?
  • What is the worst-case scenario if I put my money in the IPO?
  • What are the risks I am exposed to here? Currency risk? Distributor solvency risk? Consumer tastes and preferences risk?
  • Can I build a basic model in Excel that resembles what the Moa guys have put in the prospectus and test their assumptions?

If you are performing due diligence on a specific asset manager, there are lots of things you can do to lower the risk of getting “Madoffed”. Reading the disclosure documents very carefully is the first step. Then, conducting a detailed Google search on the asset manager, entities they are associated with, similar investment products, credit checks, background checks if you are investing a lot of money with one manager and testing whoever is trying to sell you the investment product with aggressive lines of questioning are all part of investigating whether an asset manager’s track record is plausible or someone is taking the mickey.

A clear understanding of probability and investment returns is also essential. Past performance does not predict future performance. Just because a hot-shot asset manager has beaten the NZX50 for the past decade doesn’t mean they possess some amazing ability. Never discount the possibility that someone has had really good luck and is rationalising their success by pointing to their “track record” and “investing acumen”.

If you’ve been reading this article and don’t understand every single concept I’m referring to, you have no business actively investing. The Financial Markets Authority should restrict investment products to people who are capable of performing due diligence independently.

Why is this? Well, it’s because in New Zealand we privatise profits and socialise the losses. If someone makes a bad investment and loses their retirement savings they will become a burden on every other Kiwi by accessing superannuation when they previously would have been able to decline it. They’ll also become eligible for nursing home subsidies if they haven’t stashed the rest of their assets in trusts.

Behavioural finance studies have proven that very few people are capable of making rational investment decisions. They are subject to enormous biases, under-estimate the likelihood that they are making a poor decision and over-estimate the likely returns from investment products they are considering. We think we know more about investing than we actually do and cry to the media when we make really dumb decisions.

I am not currently in a position to make substantial investments in hedge funds or pick individual stocks. My strategy at present is pure capital preservation and hedging against inflation. An index tracking product like the NZX SmartShares is the most reasonable level of risk I’d be comfortable with at this stage. Taking long-term bets with out-of-the-money options is too risky at present.

Handing over your entire investment strategy to a person whose incentives are not aligned with yours (think : commissions, kickbacks, golfing trips, liquid lunches at restaurants you’ve never heard of) and then losing it all is proof positive that financial darwinism exists.

If you are not prepared to do enormous groundwork in analysing potential investment products, doing the due diligence, clarifying things you don’t understand with your solicitor, asking your accountant whether claimed tax benefits are likely to result in an IRD audit or even performing a Google search on the potential investment provider and associated entities, you shouldn’t even consider index funds.

You could choose the conservative option on your Kiwisaver and keep all of your money in term deposits. But even then you’re an unsecured creditor to the Big Four banks and will get clipped if Open Bank Resolution is ever implemented. Do you even know how Open Bank Resolution will work? If not, you should take five minutes from your busy day to read about it.

I think you should read dozens of books before you go anywhere near the shark-infested waters of investing. If you don’t have a broad understanding of investing, risk and probability you are a mark for shysters who will take advantage of your naivety. Just because you have achieved success in one area of your life, namely having enough money to invest, doesn’t mean that success will transfer to your investing efforts.

I am reasonably smart. I read extremely widely in economics and finance. I have extremely low levels of confidence in the financial markets and the “professionals” who work there. Commingling of client funds and business funds, expenses being charged to investors and exceptionally poor after tax and after inflation returns make me wonder what excess return can be earned from assets even marginally more sophisticated than index funds like ETFs.

NB: For the illiterate I’m not an Authorised Financial Advisor and this shouldn’t be taken as financial advice tailored to your specific situation. If you actually don’t do your own research you are a dunce who deserves to lose everything. Search for an independent financial advisor who won’t charge commissions on investment products or read a few basic investing books before even visiting a sharebroker’s website or requesting information on something you’re unlikely to understand.

 

Leaky Homes Fiasco and FAP

The multi-billion dollar assistance scheme for leaky home victims is called the Financial Assistance Package.

It is clear no one at MoBIE realises how funny this is.

Mr Rainey asked the Ministry of Business, Innovation and Employment for details of FAP payouts, and was shocked to discover that although 1232 victims had lodged expressions of interest by the end of September:

Only 186 homeowner agreements had been finalised by the claimants and the ministry.

35 claims were proceeding, of which 31 had received one or more contribution payments.

Only 12 had received their final payments.

The FAP scheme, started last year, is a joint Government and local council plan to help people avoid having to sue and to enable them to get their houses fixed.

Are the government having a laugh with respect to leaky home owners getting assistance? Or do they really want them to just have a FAP?

The leaky buildings fiasco is one of the worst indictments of regulatory failure in the developed world. The ongoing cost that ratepayers and taxpayers will have to bear while culpable builders and industry executives waltz off into the sunset is appalling.

It is not a good thing that billions of dollars has to be spent fixing what should have been built properly in the first place. Anyone thinking that the rebuilding process will “save the construction industry” should read up on “The Broken Window Fallacy”.

The leaky homes fiasco represents billions of dollars in lost potential investment in higher productivity. It’s a major drain on the construction sector and with some homeowners saddled with hundreds of thousands of dollars worth of rebuilding expenses, a major drain on private sector consumption and saving.

NB: For those of you unaware of the meaning of “FAP” it’s a NSFW image search.

Bring Back The Bookies

It’s never hard to find a government agency wanting to rain on someone’s parade. The news that office sweepstakes on the Melbourne Cup could attract a $1,000 fine from the Department of Internal Affairs almost made me spit out my coffee this morning.

However, the Department of Internal Affairs warns that office sweepstake prize money cannot exceed $500 and those who breach the rules could face the long arm of the law.

This means tickets for the 24-horse race can cost no more than $20.83, according to a spokesman.

Any money raised must be returned as prizes and no one is allowed to profit from organising the sweepstake.

Violating these regulations could incur a fine of up to $1000.

Source: http://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=10845375

Has the Department of Internal Affairs ever considered that regulating gambling simply raises the cost of “problem gambling”?

Most Melbourne Cup office sweepstakes are an innocent little flutter. They have nothing in common with feeding $500 into a poker machine or spending all night playing blackjack without an edge.

The lower level of competition in the gaming industry means that occasional gamblers will look towards alternative options, including office sweepstakes. If it’s easier to organise an office sweepstake than go down to the TAB it means the odds at the TAB either aren’t good enough or aren’t advertised well enough for occasional gamblers.

By cracking down on naughty middle class office sweepstakes the Department of Internal Affairs is not only propping up the NZ Racing Board monopoly but raising the cost of gambling – more competition in gambling would lead to more competitive odds and thus lower the cost of gambling alongside lowering the cost of problem gambling.

It is also amusing that the Department of Internal Affairs has never considered the level of the fine. If the fine is only $1,000 that’s hardly an incentive against running an office sweepstake with prizes of greater than $500. If the expected profits to the promoter are greater than that, with a low probability that a random Internal Affairs inspector shows up, then it’s a rational crime under Gary Becker’s model.

I wish that New Zealand would bring back the bookies. The impersonal nature of online betting through the TAB is nowhere near as enjoyable as going to the races in Aussie and having a yarn with a quick witted bookie at Randwick or Rosehill Gardens. Who would bother with an office sweepstake when you can go to a race day event with a proper bookie?

 

Kim Dotcom And Pacific Fibre II

Lance Wiggs has a very good explanation of the hurdles any attempt to resurrect the Pacific Fibre project will have to overcome. He outlines the extremely risk-averse guarantees institutional investors want, the enormous amount of due diligence required and impact of the TelstraClear sale to Vodafone.

Kim Dotcom obviously loves the media attention. Offering to use his own money to finance Pacific Fibre is definitely an attention seeking statement. But does Kim Dotcom have the US$300 million Lance Wiggs estimates is necessary to complete the project?

Putting aside the fact that his assets are currently frozen, what is the likelihood of his new “Mega” project being the victim of US “guilty until proven innocent” seize? How credible are any commitments he would make to such a large infrastructure project?

Pacific Fibre shopped the prospectus to a large number of local and foreign investors. Some of those, perhaps government owned funds, may be regretting their decisions, but all will be far better informed for new player conversations. I believe those conversations need to be far deeper and collaborative – we are all in this together.

While it is encouraging to have a private investor offer to plug the financing gap, does the Kim Dotcom saga make it more likely or less likely that landing rights in the USA would be granted? Somehow I think there would be enormous opposition from Hollywood lobbyists on the US end.

It is very disappointing that institutional investors in New Zealand did not catch on to the enormous possiblities that Pacific Fibre could bring. International data is currently the major bottleneck that needs to be overcome. The Crown Fibre project will be for nothing if data transfer slows to a trickle as soon as international data is accessed.

Pacific Fibre II would be the ideal investment for the likes of the ACC fund or NZ Super Fund. Hell, if I was an NBR Rich Lister I would bet the farm on entering a duopoly with enormous demand increasing year-on-year at incredible rates.

Anti Money Laundering And Barriers To Trade

Over at Offsetting Behaviour, Eric Crampton despairs over the difficulty of executing arbitrage trades with respect to the US election.

For just $8.88 he could make a guaranteed return of ~10% by purchasing an InTrade Romney contract and a BetFair Obama contract.

He quotes the terms & conditions at Intrade which make it hard to deposit money in order to comply with anti-money laundering rules.

But anti-money laundering requirements are not just barriers to performing arbitrage on electoral events.

They function as barriers to actual country-to-country trade. Just think about how hard it would be for a developing country exporter to have all the correct documentation and paperwork to open a US bank account and receive payment for commodities on account. Essentially, incumbent commodities firms have an edge because they will be able to put deals together faster than an ostensibly cheaper developing country supplier.

Imposing greater “know your client” rules functions as a barrier to entry. If you can’t get an account set up in the first place because you’re starting up a business in the developing world, you’ll have to rely on more expensive banking services.

You might even skip the mainstream banking system altogether, relying on immigrant cash transfer networks.

There are so many second-order effects of anti-money laundering legislation. Making it harder to take advantage of goods arbitrage opportunities is just one I can think of.

 

Instapaper Or Readability?

There’s no point writing something if it can’t be read by your potential customers.

Many websites fall short of the mark with readability.

I’m currently alternating between the Instapaper and Readability extensions in Chrome.

Why? Because I like large text when I’m reading longer articles or blog posts. I also like the minimalist interface.

But in 2012, should I really have to resort to a browser extension to make an article readable?

Of course not!

In the age of HTML5 & CSS3 it is completely ridiculous to make your content a minor part of your site’s presentation.

If you are writing a blog or producing regular online content, it should be really easy to read your content without squinting.

Maybe my eyesight is just rubbish, but having to use a browser extension to solve a failed user experience issue on almost all websites I visit regularly i.e. not in my Google Reader shows that a lot of UI designers need to go back to the drawing board.

Larger, clear fonts and clean navigation should be the standard for any website user interface.

Instapaper vs. Readability hopefully won’t be an issue in a few years. But for now it is a workable solution to paper over poor font size and layout choices that are almost de rigeur.

Diminishing Returns And User Experience

The primary goal for a website is to obtain a successful sale.

It’s not to highlight how inspired you were in choosing an expensive web design agency to implement the complex brand strategy dreamt up by an extortionately overpriced advertising agency.

Every little gadget and obstruction between the landing page and the “place your order” button is another spanner in the works that can stop a potential sale dead in its tracks.

For some industries, showing off product capabilities with videos and diagrams is essential as part of the educational selling process.

3 Things No Potential Customer Should Experience

  1. A pop-up form asking them for email details before they’ve had a chance to see what you’re all about.
  2. Auto-playing music or video that invades a potential customer’s eardrums and concentration on matching their problem with your solution.
  3. A complex user interface they haven’t used before that they need to jump through in order to place an order or make a sales enquiry.

Diminishing returns is a concept from economics – the more workers you put on the factory floor, the more you produce up until the point where they start tripping over each other and your productivity declines.

Diminishing returns applies to user experience – the more features you have on your website will improve conversion rates up until the point that you are actually reducing your conversion rate and putting your entire web marketing strategy at risk.

Less really is more. Reduce the friction in the sales process by making it as easy as possible to get from the landing page to the successful sale.

Large Organisations And Web Technology

The other day I was looking at IT vacancies on TradeMe and Seek. It’s clear that many larger organisations are behind the curve when it comes to web technology.

If your website is built on ASP.NET you are operating at a major flexibility disadvantage to smaller organisations. A smaller organisation can take advantage of essentially “better” tools without needing to convince 20 middle managers that the new platform is safe and secure.

For example, I am currently building a niche web application on the side. I’m using AngularJS and the latest in HTML5/CSS3 to make it as lightweight and flexible as possible.

If I was a front-end web developer, working for an organisation that requires “3+ years experience in ASP.NET”, I would not have advanced beyond the stage of wireframing.

As it stands, I have a working prototype I can work with in less than a month. Working backwards from this, I’ve redesigned how the whole application should work after seeing it work in my browser window.

The friction that large organisations must deal with in order to get projects that embrace better web technology means that small organisations have an enormous competitive advantage.

If you are a smaller organisation, you should be at the forefront of experimenting with web technology because you can achieve the greatest competitive advantages from light and flexible web technology.

How A Central Organisation Wiki Reduces Risk

Every organisation has institutional knowledge that is probably written down somewhere, in some database, exactly where the team member who needs it to complete her task can’t find it when she needs it.

And the same team member probably finds herself performing tasks repeatedly that would be made much easier if all of the information she needed was in one place.

A central organisation wiki is storage place for all of the relevant information that your entire organisation needs to do its job properly. It can encourage team collaboration, make hiring temps easier, reduce the risk of losing institutional knowledge when a key team member leaves and above all provide a more efficient way to keep track of the organisation’s information.

Having an internal wiki reduces operational risk considerably. If you are using something like Atlassian Confluence you can set permissions so users can only access and contribute to things they need to. You can therefore prevent people stumbling across sensitive Word documents or Excel spreadsheets when trawling through files accessible to all team members.

Having a central repository for all of your organisation’s information makes it far easier to conduct induction training for new team members, keep everyone on the same page and reduce the risk of information silos being formed between team members or different teams.

In this day and age, not taking advantage of tools like a central organisation wiki is risky business. If you’re running a support system and find yourself opening up Word documents when there could simply be a Wiki page with the same information, you are costing your organisation a lot of unnecessary time and money.

Atlassian BitBucket vs GitHub

Australian firm Atlassian are best known for their suite of productivity enhancing software like JIRA for issue tracking and Confluence for making team collaboration far easier.

But when it comes to real world utility, BitBucket is Atlassian’s answer to GitHub.

Git makes it easy to track versions, collaborate with team members and compare code revisions. But you need to pay to keep your repositories on GitHub private.

BitBucket offers up to 5 private repos and what I think is a nicer user interface.

While collaboration and open source is wonderful, in the real world there are some code repositories better kept private – like that killer app you’re working on.

Until I integrate one of my repos with JIRA & Confluence I’ll be using BitBucket instead of GitHub.