Mike and Jeroen spoke with Mr. Hoozemans, Director at Robeco Asset Management and specialist in the energy sector. He talks about the current and future developments in the energy sector and how ESG is becoming increasingly important for companies and investors. The interview is especially focused on the cause and effects of the recent drop in oil price. Could you tell us something about yourself and your career? My name is Dirk Hoozemans and I’m 37 years old. I am part of the Robeco Global Equity team and the team invests in developed markets worldwide. I studied econometrics at Tilburg University and after my graduation, I started as a Junior Portfolio Manager at Robeco in Rotterdam. The first two years I was in the Junior Program, where I did several internships learning the ins and outs of valuation and investment. After these two years I started in the Rotterdam-based North-American equities team. When Robeco switched from region-based investment teams to sector-based investing, I started looking at the energy and utilities sectors. Currently I am the specialist in the field of oil, gas and alternative energy within the Global Equity team. What does a normal working day look like? First, I take my daily train, commuting from Utrecht to Rotterdam. On the way to Rotterdam I read my incoming emails from colleagues, companies, analysts and economists. Every day is different. Basically, I analyze energy and utility companies with the aim of identifying outperformers in the space. Herein I rely on my own analysis and modelling but I am also in close contact with sell-side analyst from large brokers such as Morgan Stanley and Merrill Lynch. I also meet with analysts and companies who come to the Robeco office in Rotterdam on a regular basis to discuss investment ideas and developments in the sectors I cover. Management teams will meet with investors to discuss their growth strategy and the outlook for profits, cash flows, share buybacks and dividends. Besides meeting people in Rotterdam I often attend industry conferences and from time to time I visit oil companies in for example Houston to discuss the latest developments in the industry and seek investment candidates for the Robeco portfolio. Events such as the recent drop of the oil price or the Swiss central bank suddenly announcing it will no longer hold the Swiss Franc at a fixed exchange rate with the Euro, bring a lot of volatility but also make every working day a different (and interesting) one. You also worked in the Boston and Hong Kong branches of Robeco. Are there many differences in your daily tasks and the business culture as compared to Robeco Rotterdam? My daily tasks are basically the same but from a slightly different angle. Our subsidiary in Boston, for example, takes more of a value-investing approach. Our Hong Kong office on the other hand focuses on the fast-growing Asian markets; quite a different approach. In our Rotterdam office, we run global equity products: here we invest in global emerging markets and global developed markets but we also run our more thematic trends investing portfolios and our quantitative portfolios, based on econometric models, from Rotterdam. You hold the title of Chartered Financial Analyst. Does this give you any advantages within your daily tasks? Personally, I appreciated the CFA program greatly. As an econometrician, I was mainly trained in (quantitative) finance, modelling and statistics, but not so much in reading and interpreting balance sheet data. The CFA program was useful in getting more familiar with accounting, but also with alternative investments and fixed income instruments – which as an equity investor you obviously see little of on a daily basis. The CFA curriculum takes three years and is basically a sort of compressed master degree; some of it is repetition, some of it is new but it definitely broadens and deepens your knowledge and understanding of financial markets. Of course, the program is updated often, bringing old topics up to date and introducing new ones. Nowadays, at Robeco juniors are required to have passed CFA level 1 and 2 upon leaving the two-year junior trainee program. What is your opinion about OPECs decision to keep oil extraction at a steady level? I had expected this decision, but it still brought about a huge shock in commodity and equity markets. At the moment, there are three things happening. Firstly, non-OPEC oil extraction is growing at a rapid rate; especially unconventional or shale oil production in the United States is showing unprecedented growth. Secondly, global GDP growth is lackluster as Europe is facing problems while growth in China not at the high levels it was last decade. And finally, the dollar has been very strong, which often implies that investors sell dollar-denominated commodities. Many American oil producers had expected that OPEC would lower production quota, but by keeping production steady and focusing on market share, the oil market is now in oversupply and hence prices have dropped significantly. Note that OPEC extracts oil at a cost of some ten dollars per barrel, while in the US oil is produced at a cost of between fifty and sixty dollar per barrel. Consequently, decreasing oil prices will first hit US producers, who will have to slow down drilling to bring supply and demand back in balance in the oil market. How does the drop in the oil price influence your daily work? When the oil price decreases, future cash flows will be lower causing stocks to decrease as well. For us, as investors, it is mainly our task to focus on high quality companies. These are mostly companies producing at a low break-even point. You will notice shifts in the value chain of your investment portfolio. We will therefore invest less in suppliers, while investing more in larger integrated companies. On the other hand, this low oil price and its consequences will be an important point of discussion within our teams. One of the possible consequences is that consumers will have more money
Is it time to put a limit on high frequency trading?
Frank Kopers, Editor-in-Chief of Marketupdate, explains in this article the concept of high frequency trading and hereby discusses the implications for both the market and private and institutional investors. Probably all investors today are aware of high frequency trading, computerized trading using fast computers which are programmed to buy and sell securities in milliseconds. These computers operate on very advanced algorithms, which can take advantage of small inefficiencies on the financial markets. Computers are able to process new data way faster than human investors, giving them a substantial and profitable speed advantage. As a result of this, arbitrage became much faster and efficient year after year. The bid-ask spread for example (the difference between the prices at which investors are willing to buy and sell) decreased substantially thanks to high frequency trading. In just twenty years the bid-ask spread narrowed down from about 90 to just 3 basis points, which means there is much less overhead now then there was back then. Computerized trading also improved the arbitrage capabilities of the financial markets, according to a paper published in 2013 titled “The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response”. In this paper, the researchers looked at the differences between an ETF and a futures contract based on the same S&P 500 index between 2005 and 2011. After analyzing the data, they found out that arbitrage took 97 milliseconds in 2005, compared to just 7 milliseconds in 2011. High frequency trading works on a very short time horizon, one that is invisible for the eyes of investors. While human investors can only see the stock market movements from second to second, the computerized trading takes place on a completely different playing field within a second. The following graph shows the difference between what investor see on their computer screen and what high frequency trading computers see. The graph on the left shows the movement of an exchange traded fund and a future based on the S&P 500 index within one minute, while the graph on the right shows the price of the same securities within just 250 milliseconds. As you can see both the exchange traded fund and the future track the stock market closely in the long run, while they do fluctuate over a time horizon of just milliseconds. Those small fluctuations is where high-frequency trading can arbitrage for a profit. Race to the bottom High frequency trading has the highest profitability if your computers can front-run those of your competitor. Computers which can process new information faster and buy and sell in and out of positions faster make more profits. This is a race to the bottom, shaving off milliseconds using faster hardware, smarter algorithms and better networking technologies. The following graphs shows the result of this race to the bottom. Liquidity evaporates High frequency trading makes the financial markets more efficient, you might think. But this is not the complete story. Computerized trading can also disrupt the market, for example when algorithms get out of control. Back in May 2010, the Dow Jones index lost more than a thousand points in just a couple of minutes, the biggest drop ever witnessed on the US stock market. After a sharp drop, the same computers started buying again until prices were back at the level they were before the flash crash. In a study about the cause and effect of this flash crash, the American supervisor called it a ‘hot potato volume effect’ caused by high frequency trading. One might wonder if such volatility could take place in a market where computers do not represent more than half of the total trading volume… The speed at which high frequency trading takes place can cause instability as well. It takes time to bring buyers and sellers together and to guarantee market liquidity and everything high frequency tries to accomplish is to remove the time factor. Image a high frequency trading system trying to sell a large amount of securities, without any buyers showing up for a second. So the volume dries up, if you look at it on a millisecond scale. Going too fast? So it looks like high frequency trading can be too fast, reducing liquidity and causing volatility in the stock market. Austin Gerig and Daniel Fricke recently published a working paper titled “Too Fast or Too Slow? Determining the Optimal Speed of Financial Markets”. In this article, they collected historical data from US stocks to determine the optimal trading interval for computerized trading. After analyzing the data, they came with an efficient trading interval between 200 and 900 milliseconds. According to their research, trading is most efficient with one to five trades per second, depending on the volatility and the popularity of a specific security. Trading at a higher speed than five times per second appears to be unnecessary at best and harmful at worst. High frequency trading might be a profitable business for those companies running those systems, but for society at large it doesn’t provide any real productivity gains. All those smart people building high frequency computers do not improve the standard of living of the society as a whole. Instead of using their knowledge to develop models which can be applied in the real economy, they build models to shave a few pennies of the profit of other investors. It might be a good idea to introduce a trading frequency limit, where transactions are made in fixed batches of 0,1 second. Introducing a speed limit to trading ensures market liquidity and stability, without the harmful effects of trading on the milliseconds and nanoseconds. Sources: – Too Fast or Too Slow? Determining the Optimal Speed of Financial Markets (Fricke et al, 2015) – The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response (Budish et al, 2013) – http://www.theatlantic.com/business/archive/2014/04/everything-you-need-to-know-about-high-frequency-trading/360411/ – http://www.bloombergview.com/articles/2015-01-25/high-frequency-traders-need-a-speed-limit – http://www.businessinsider.com/high-frequency-trading–a-liquidity-hoax-2010-12?IR=T
Interview Jacques Wintermans
In this interview Jacques Wintermans gives his view on a variety of topics. He explains for instance the major difference between index tracking and active management in terms of risk and return. Further he talks about the future of investment tracking. Could you briefly introduce yourself and the career path you chose? I am a Civil Engineer by training but never worked as such. I started working in the travel industry during and immediately after my studies at Delft University. After that, I was a logistics manager in a factory for seven years, then seven years a marketing manager of telecom equipment in the Far East, followed by 18 years in strategic consultancy and now 10 years in fund management. What were your rationale for founding a company focused on investment tracking? Ten years ago Hendrik Meesman asked me to team up with him to start Meesman Index Investments to promote index funds. We were the first to do so in the Netherlands. He gave me a book, ‘Common Sense on Mutual Funds’, by John Bogle. After I read it, I was surprised. Scientific research had established beyond reasonable doubt that index tracking is a better investment option than active investing, mainly because of low costs and the difficulty of predicting stock prices. But most retail investors in the Netherlands had never heard of index investing. That’s when I decided to write my book ‘De Schitterende Eenvoud van Indexbeleggen’ (‘The Beautiful Simplicity of Index Investing’) for the Dutch market. How come this strategy isn’t that popular yet compared to for example the United States? Since most Americans have to take care of their own pension, they are forced to find the best way to invest their money by themselves. That’s why the average American knows much more about index investing than people in Europe. Also, American journalists write more – and better – about investing than their colleagues in Europe. There is a long running public debate in the US about the pros and cons of index tracking. As a result, index investing is very popular in the USA. More than 100 million people in the US invest in index funds. In 2014 more people invested in index funds than in active funds. If ‘only’ an index has to be tracked, what are your tasks during a normal workday? We make sure our processes run safe and smoothly. We give presentations. We talk to clients. We answer their questions. We are always looking worldwide for the best index funds to offer to our clients. We publish blogs and columns. We report to the regulatory authority. We grow 50% per year in clients and assets under management, so there are lots of things to do. Could you explain the major differences between index tracking and active management in terms of risk and return? The objective of active investing is to beat the market while the objective of passive investing is to follow the market. In order to beat the market you must be able to predict stock prices. Without this talent you fail. If your objective is to follow the market, there is no need to predict stock prices. So the key success factor for active investing is prediction of stock prices. What does science tell us about the ability of humans to predict the direction of the stock exchange? Virtually all studies (I mean 99.9%) during the last half century tell us that investors are unable to predict stock prices or market movements. This is true for private and professional investors. Both fail to successfully predict stock prices over the long run. If professional or private investors beat the market over a certain period, it is luck, not skill. And luck does not repeat itself indefinitely. I strongly advise people who can predict financial markets to invest actively. They will become rich. However, if you do not possess this rare talent, I strongly advise to invest in index funds. In the end they will be a lot richer than failed active investors. How to invest passively? Just buy a broadly diversified index fund and that’s all you do. Don’t step in and out of funds, just do nothing after you have bought the right index fund. Return is on average better than active investing and because of broad diversification, risk is less than active investing. People who invest this way for their retirement, are twice as rich in old age as people who chose active investing, but failed. If any, what are the drawbacks of adopting a passive strategy? It’s not exciting. However, it’s better to have a dull investment strategy and live an exciting life than the other way around. To what extent is investment tracking dependent on the level of active management? This is a frequently asked question but not so difficult to answer. If a high percentage of invested money, say much more than 80%, would be invested passively, it would become attractive again for clever people to invest actively again. This is because prices of securities will deviate more from their underlying value if the volume of transactions decreases substantially. The market will be less efficient if it is quiet on the stock exchange. However, less than 20% to 30% of the money is presently invested passively. So in the short run, it is better to invest in index funds. There is more than enough ADHD on the stock exchange. And don’t worry about the long term. There will always be more people who think they can beat the market by active investing than sensible people who buy index funds. Nowadays, there’s ample supply of tracking products. Is this a healthy development or do you fear negative implications? How do you know which tracking investment firm to choose from? No, this is not a healthy development. The pure and best way to invest passively is to buy two broadly diversified index funds at low cost and stay invested for the long term: one worldwide equity
Corporate governance
In this column David Hollanders discusses why corporate governance can be understood with non-quantitative methods. He explains this by using two examples: Wall Street and Margin Call. Economics is mostly practiced with the use of models.Finance in particular has been mathematized, as research in and teaching of for example option valuation, asset-liability management and corporate finance demonstrate. Even within finance there is however an important exception. Corporate governance can also –and sometimes even better- be understood with non-quantitative methods. Corporate governance is -in the words of Berk and DeMarzo in their textbook Corporate Finance– “the system of controls, regulation and incentives designed to prevent fraud”. Fraud by its nature is an informal, irregular and hidden activity, and as such is context-specific. Models however work best in stable environments where just a few parameters change –the parameters which are subsequently modeled. Fraud, misconduct, tax avoidance and cooking the books seldom provide such environments. So to get a grip on the issues involved and subsequently analyze them, non-quantitative means are called for. These include historical case-studies, thick description, investigative journalism and participant observation. They also include documentaries (such as Enron: The Smartest Guys in the Room, Inside job and Shock Doctrine) or even fictional movies. Two excellent movies illustrate the value of movies in understanding and teaching conflicts of interests in corporatations. 1. Wall Street: shareholders versus management Wall Street (directed by Oliver Stone, 1987) is as politically relevant and economically interesting as a movie gets. It depicts the dealings of investor Gordon Gekko –played by Michael Douglas. In a crucial scene, Gekko fulminates against management of a company (‘Teldar Paper’) of which he is himself a shareholder. Any socialist would no doubt subscribe to this speech which at the same time sums up the essence of shareholder-capitalism: every euro going to management is not going to shareholders. Gekko therefore calls fellow-shareholders to arms at the shareholder meeting: “You own the company. That’s right, you, the stockholder. And you are all being royally screwed over by these, these bureaucrats, with their luncheons, their hunting and fishing trips, their corporate jets and golden parachutes. (..) Teldar Paper has 33 different vice presidents each earning over 200 thousand dollars a year. Now, I have spent the last two months analyzing what all these guys do, and I still can’t figure it out. One thing I do know is that our paper company lost 110 million dollars last year, and I’ll bet that half of that was spent in all the paperwork going back and forth between all these vice presidents.” 2. Margin Call: management versus clients Margin Call (2011) is a reminder that interests of a company differ from those of its clients. Every extra euro paid by a client is good for the company. With a clear reference to the credit crisis, Margin Call depicts an over-leveraged Wall Street-investment bank overloaded with toxic financial products. When management finds out that they own shitty products, they try to sell them as soon as possible, before clients find out too. Management tells their bankers: “The firm has decided to liquidate its majority position of fixed income MBS… today. These are your packets, you will see what accounts you’re responsible for, today. I’m sure it hasn’t taken you long to understand the implications of this sale, on your relationships with your counter parties and as a result… on your careers. I have expressed this reality to the Executive Committee, and they understand. As a result, if you achieve a 93% sale of your assets, you will receive a 1.4 million dollar one-off bonus. If the floor as a whole achieves a 93% sale, you will get an additional 1.3 million dollars apiece. For those of you who’ve never been through this before, this is what the beginning of a fire sale looks like. I cannot begin to tell you how important the first hour and half is gonna be. I want you to hit every bite you can find: dealers, brokers, clients, your *mother* if she’s buying.” These two examples underscore the nature and scope of two crucial conflicts of interests in the modern corporation better than any model can. This is not to say that all movies that are instructive in the realm of corporate governance are good movies. Whereas Wall Street is a modern classic, Margin Call is just entertaining. It is also not to say that every good movie about finance is instructive. American Psycho for example is a perfect satire about the habitus of investment bankers, but does not help to understand specifics. It is all to say that movies can help to understand corporate governance in ways mathematics never can.
Finance and Innovation
Dr. Alberto Manconi has the reputation of giving interesting and interactive lectures; a perfect fit for Chairman of the Day during iFinance 2015. The following article, written by Dr. Manconi, is his consideration of the topics discussed during the event. Whenever I face the trite refrain that finance is “too large,” I observe that it was likely the largest industrial sector in Renaissance Florence (Medici bankers ruled the city!), the cradle of cultural renewal which got us out of the Dark Ages. So I do believe finance affects innovation, mostly in a good way – today we discuss whether it can also hinder it, how, and what we should do about it. Among the general public, much blame for an alleged innovation slowdown (and many other ills) goes to investor short-termism:[1] Shareholders expect quick results, but innovation is all about the long-run, so excessive reliance on external finance hampers progress. While this view has its merits, I’d like to raise two caveats. First, not all shareholders have equal horizons: There are deep, “structural” reasons why a pension fund may have longer horizon than a mutual fund (e.g. their respective retail investor pools). Innovative companies might simply turn to longer-horizon investors. Second, shareholder horizon affects corporate investment in a less direct way than, say, managerial incentives. For instance, a recent study[2] finds that managers are more likely to innovate when they face weaker labor market penalties for failure – i.e., when they have a freer hand to take risk. Risk, of course, is a double-edged sword. Yes, we want companies to take risk to innovate. However, we don’t want to promote risk-taking to the point of creating instability. Hence the debate on the recent changes in bank regulation and supervision, which we also discuss today. Will Basel III limit banks’ ability to lend, thus placing a constraint on corporate innovation? I admit, that is a possibility. However, banks are not necessarily the primary source of financing for innovative firms – just think of venture capital.[3] Further, addressing risk in credit markets, especially in the aftermath of the recent financial crisis, promotes trust – a second, essential ingredient to innovation. The topic of regulation brings me to my last point, the first we discuss today, and potentially the most controversial: What is the government’s role in all this? As an economist, my “Pavlov reflex” is to say that the government should simply create a good set of institutions, and then stay well out of the market. The question is just what is a good set of institutions? Does it involve additional channels for financing innovation, e.g. concessionary loans, tax breaks, etc., or are the existing channels adequate? Should the government promote innovation in certain sectors deemed more relevant, or should it let the market decide? Or, rather, should it focus on the premises of innovation, e.g. education, developing an entrepreneurial culture, etc.? These are very broad and deep issues, way too broad and way too deep to address in this short note – but I look forward to our discussion of them today. [1] E.g. Denning, S., 2014, Why Financialization Has Run Amok, Forbes 3 June 2014, available at the URL: http://www.forbes.com/sites/stevedenning/2014/06/03/why-financialization-has-run-amok/ (last accessed: 29 December 2014). [2] Custódio, C., M. Ferreira, and P. Matos, 2014, Do General Managerial Skills Spur Innovation?, Working paper, Arizona State University. [3] Cf. Kortum, S., and J. Lerner, 2000, Assessing the Contribution of Venture Capital to Innovation, RAND Journal of Economics 31, 674-692; or more recently Popov, A., and P. Roosenboom, 2012, Venture Capital and Patented Innovation: Evidence from Europe, Economic Policy 27, 447-482.
The creation of iFinance 2015
Youssef Essaghir, Chairman iFinance 2015, was asked to give us some insight regarding his experience at Asset | Accounting & Finance. He talks about what it is like to organize an event such as iFinance. If you would like to learn more about why he signed up for the committee or why he believes you should attend iFinance, you can read his story. Could you give a short introduction about yourself? My name is Youssef Essaghir, I’m a third-year bachelor student in Business Economics and I am planning to do my master in Finance after obtaining my bachelor. This year I am the chairman of the iFinance committee and an interviewer for the Food for Thought committee. Why did you join Asset | Accounting & Finance? Asset | Accounting & Finance is the gateway to put theory into practice. This means that you get the opportunity to organize an event in your field of study. By doing this I am able to prepare myself for my future career. For instance, I develop my organization skills and my understanding of finance. Furthermore, the steep learning curve of working as a member on projects is an ideal way to develop your problem solving skills. This is the main reason I joined Asset | Accounting & Finance. But of course this is not the only reason. It is also a great way to meet new people with the same kind of interests. What appealed to you to sign up for the committee iFinance? I knew one thing for sure, after my bachelor Business Economics; I would either do my master in accounting or finance. So that is why I was hesitating between Accounting Insight and iFinance. During that time I was treasurer of the Asset Events committee and iFinance started just after the ending of the Events committee. That made it easy to choose for iFinance. I didn’t choose for an informal committee because I thought it was time to do something where I could use my full potential. iFinance is a very dynamic event. This makes it a perfect opportunity to put my qualities to the test. What and when is iFinance? IFinance will take place on February 5th on Tilburg University. The ‘i’ of iFinance stands for interactive. This means that you will have the possibility to actively participate and discuss a current and finance related topic. During the event different propositions will be introduced by short movies, speeches and voting rounds. Our aim is to spark a discussion between our speakers and the audience after presenting the proposition and a quick presentation. This presentation will be done by one of our speakers. Which guest speakers will there be at iFinance? This year we have some prominent speakers. We will start with Prof. Dirk Schoenmaker, Dean of Duisenberg School of Finance who will elaborate the first proposition. The speakers of the second proposition will be Mrs. Vaishali Bapat, Finance Manager at Shell and Mr. Martijn Rozemuller, Managing Director of Think ETF’s. After this we will also have two speakers who will review the third proposition. The first one will be Mr. Bas Pulles, Former Managing Director NL EVD International and current Director International Programmes at Netherlands Enterprise Agency. The second speaker will be Mrs Marije Lutgendorff, Owner of Crowdlokaal. The chairman of the day will be a known professor amongst finance students, Dr. Alberto Manconi. He is professor of ‘Financial Management’ and ‘Corporate Governance and Restructuring’ at Tilburg University. Are there any possibilities to get in touch with companies? Preceding the event there will be a lunch with the recruitment of Royal Dutch Shell (Shell), which is also our main partner. During this lunch eighteen students have the ability to get in touch with the recruiters of Shell, one of the biggest companies in the world. How did you develop iFinance? What were the processes from beginning to end to organize this? The first and most difficult part of organizing the event is coming up with a subject. During the summer, we tried to keep in touch with all the financial related news articles in order to find a subject that would still be current when the event would take place. This is also what will determine the success of the event. After narrowing it down to one subject we started to contact and invite potential speakers. We tried to have speakers that would be able to clarify the subject from different perspectives e.g. political, academic, entrepreneurial and of course a financial perspective. Until last Friday we were focusing on finding partnerships in order to finance the event. The next coming days we will start with promoting the event and making sure that everything will run smoothly at the 5th of February. What are the benefits to participants of iFinance? Why should students participate? Like I mentioned before, eighteen students are able to attend a lunch with the recruitment of Shell, an ideal way of to get your foot in the door at this company. Of course the subject itself is very interesting for people interested in finance or entrepreneurship. This year we considered the rapid changes in the world of Finance, ranging from the new banking regulations to the rise of crowdfunding. The subject of our event will consequently be: ‘The Future of Finance’. Where we will look at different financing methods, ranging from well-known methods to innovative ways of financing. This subject will be a value-adding experience for students interested in finance. Where can you register? You can register on the website. Here it is possible to register for the event, but also for the lunch that will take place beforehand. I hope to see you all at iFinance 2015 on February 5th. I’m confident that this will be another great Asset | Accounting & Finance event.
