A Wealth Creation Journal

Author: TC (Page 1 of 3)

Thoughts on great shopping malls

Given the threat of e-commerce making inroads on convenience/time-spend of shopping (innovations such as augmented reality improve online shopping experience further), what makes a shopping mall’s future relatively bright?

On some counts, offline has advantages, on the other hand there’s weak points that need to be minimized. I make a distinction on this basis and call them “pulls to offline” and “lack of push to online”.

Pulls to offline

  • Having a “great experience”
    • Beautiful and clean mall
    • Meeting friends
    • “M’as tu vu” (requires mall to be frequented by many shoppers, ideally local)
    • Day trip allure of a mall: a whole family can enjoy a day off in one place
  • For buying apparel: human advice
    • In-store advice and advice from friends. As online is making in-roads on human advice, I believe friends’ advice is more of a selling point

Lack of push to online

As buying online is efficient w.r.t time spent, this is a weak point for some offline shop. Mitigators:

  1. Easy-to-reach
    • great location close to population with disposable income: an outlet might be a pain to reach in the middle of nowhere versus a shopping centre next to a train/tube station, or simply on the way for tourists walking by
    • population density in the neighbourhood (think city centres)
  2. Access to multiple shops at once
    • Large shopping malls offer time-efficient access to many shops
    • High occupancy rate is a win for consumers as well in this respect
  3. Access to non-shopping stores that consumers need to visit anyway
    • Mall with gyms/restaurants/grocery/barbers
      • the sunk cost of getting to these places near other stores might even make shopping before/after more time-efficient than online shopping. These places might be the next shopping mall “anchors

The points in green are arguments for large shopping malls with many tenants from diverse categories such as gyms that cannot be done online.

If some shopping malls are indeed able to offer a “great experience”, this might even pull more footfall to these outfits over time as leisure time rises around the world.

The best shopping malls are aggregators of great brands for the best consumers. As such, there are some winner-take-all dynamics at play in this weak two-sided network (weak because the network is very local, but luxury brands and shoppers compound the network effect through increased possibility of building long-term relationship).

On property management

Best property managements are therefore long-term thinkers: willing to invest in renovations / repurposing to keep footfall and tenant quality high. For example, buying back shares at 8% current yield might optically look better than making a 7% ROI renovation, while the renovation can avoid atrophy in the type of customers, tenant base indirectly for years ahead.

It seems that the number of retail shops will certainly grow slower versus the growth in retail sales as the weaker brick-and-mortar links get shut out. The highest quality shopping malls meanwhile will still see a change in tenant base as tenants with products that are great to sell online disappear (uniform products with long-tail offerings such as books, films). Experience in managing tenant base is another important treat.

Brand advertising

Some companies such as Apple (Stratechery, Scott Galloway podcast), BMW use beautiful retail stores to raise brand awareness and customer experience. Some other functions that these stores serve besides selling products:

  • advertise brand (a superior physical impression is superior to an ad on a screen; what is in particular interesting is that the human brain better memorizes physical as opposed to digital impressions example 1, example 2). The superior physical interior, product design, aroma can convince the consumer that Louis Vuitton is for example superior to Zara in a way that digital ads cannot.
  • high-end product feature awareness, customer education
  • Genius bars in themselves are a point of differentiation as competitors do not offer this service

In short, these stores are but one piece in a consumer’s product experience. In Apple’s case, an iPhone is not only hardware, but also software (iOS) and experiences such as customer support and trying out new launches of features in Apple stores, underlying again how experience is becoming more important for shopping centres.


The economics of growing sales for brands is permanently changed because of a growing online sales share. Whereas in the past brands grew by growing quantity of offline presence because of the fixed link with sales, today, brands will want to occupy the best offline spots and rather not want to be associated with inferior malls. A “flight to quality” malls seems plausible.

To remain competitive, shopping malls have to pull consumers through strengths and avoid a push to online by remaining competitive on the strong counts of online (convenience, price). Multiple factors require malls to be

  1. In the vicinity of high-density affluent population or transport anchors (metro, train, highway) (time-saver, social aspect)
  2. Beautiful and well-kept (experience)
  3. Diverse tenant base with anchors such as gyms, restaurants that will largely remain offline experiences (time saver)
  4. Big (experience for a whole family)

The advantage that offline offers in terms of branding seems most relevant for luxury brands and hence luxury malls.

As malls ideally aggregate the best brands with local consumers, it is in a sense similar to the newspaper business: you want to own the number one mall in each city.

A major risk concerning e-commerce is that luxury brands themselves might become less important in an increasingly online sales world. We see this with Amazon trying to sell white-labels as consumers increasingly weigh functionality and price over brand as information asymmetry is smaller online (driven by e.g. customer reviews).


Book Summary: The Energy World is Flat by Parilla

I read this book because its author proved to be correct on oil.  This is a non-exhaustive book summary I made last year. In the meantime, other events prove another call in the book: the book predicts convergence of global energy prices: oil has come down and the cheapest natural gas in the world (American) is rising.

The Energy World is Flat offers a refreshing view on the oil market. I found it through one of the better Real Vision interviews with Diego Parilla two years ago. The title is a variation to Tom Friedman’s best-selling book on globalization The World is Flat. Lastly, Diego Parilla and I are alumni from the same oil & gas business school.

I only read the book now as I realized that the author’s first call on the flattening of oil call has already proven profitable. These are the main calls the book makes:

  1. the term curve of oil will flatten
  2. geographic spreads will flatten
  3. spreads between energy equivalent prices of fossil fuels will flatten
  4. oil price volatility will lessen

If we compare the oil term curve between the publishing date (1/1/15) and now, we find that it has flattened considerably.

Chapter 1: the Flattening and Globalization of the Energy World

In the oil shock of the ’70s, oil was displaced for power generation and industrial uses in favour of coal, natural gas, nuclear and others because the primary consideration is price in these industries.

Today, oil still reigns over other fossil fuels for transport purposes despite its higher price (e.g. oil was 10X more expensive per energy equivalent than natural gas in the US in 2012). The main is reason is that oil is exceptionally compact both in terms of volume and weight per energy equivalent. Over the short-term, transport is very price inelastic.

Geopolitical events that created volatility sowed the seeds for more buffers ‘flatteners’: storage, demand destruction, new technologies and discoveries. A result can be found in 2014 when the exceptional combination of the below supply disruptions failed to make the oil price spike (the move was limited to 10$/barrel from bottom to peak).

  1. the arab spring (e.g. disruptions in Libya)
  2. oil sanctions in Iran,
  3. conflicts and disruptions in Sudan, Syria and Iraq

Chapter 2: Lessons from the Dotcom bubble

The tech revolution (and bust) created huge capital inflows that led to miserable investor returns over the cycle. The big winners were consumers that benefited from stranded assets such as fiber-optic broadband.

The revolution of fracking and horizontal drilling is similar. Although there is still a lot of skepticism towards shale for environmental reasons, Parilla draws a parallel with ultra-deep-water drilling that faced critics in the early ’90s but developed into a very safe technology. Peak oil sentiment similarities to the tech revolution includes huge capital investment into:

  1. LNG terminals (requires huge upfront capex)
  2. pipelines (see European and Asian projects)
  3. E&P
  4. demand efficiency

One trap for energy investors is to follow consensus according to Parilla. The sector is driven by extremely optimistic assumptions of demand growth. Every year, demand growth estimates are revised down an average of 15-20% from the January estimates (IEA, OPEC). Since 1998, only one year, 2012, has seen meaningful upward revisions. Main reasons are

  1. optimistic GDP growth estimates
  2. using the rear-view mirror correlation between GDP and energy demand that has been breaking down since 1998

Another parallel with the dotcom boom is the diversified ‘venture capital’ approach. In the energy world a lot of capex is being made in new technologies, with a lot of losers. The mentality for

  • big integrated O&G company boards is to ‘be’ invested in new areas as it looks better on paper
  • investors to be invested in all new areas as “you only need one winner”

Examples in the transportation world are:

  1. compressed natural gas (CNG)
  2. LNG for trucks, trains and ships
  3. electric and hybrid vehicles (EV’s and HV’s)

Note: according to Parilla, governments have delayed EV’s by subsidizing combustion-engine car sales (and bailing out the companies) post-recession by a 6-to-1 investment factor to EV subsidies.

Last parallel: the bubble accelerates the impact of the revolution. The runaway oil price in 2007 set in motion a huge supply response by oil producing and oil consuming countries alike.

Diego warns that a sum-of-the-parts valuation for companies that invest in many fashionable new technologies can be very dangerous with bad capital allocators, as the good parts might subsidize loss-making ones, and that focused companies should be welcomed.

Chapter 3: The 10 Flatteners of the Energy World

Interesting excerpt:

During the super-cyclical run up in corn prices in the 2000s, most commodities were making historical highs, from crude oil, to coal and natural gas, to copper and corn. Correlations had notably increased, which was often used as an argument to justify that speculators were driving prices. And of course, high fuel and food prices were generating inflation and increasing the risk of financial stability. One again, politicians and regulators were quick to blame the speculators. “Food inflation, how dare they?” Corn was considered too expensive and would impact the poor the most and increase inequality. How cynical.

The main reason why corn prices were going up was the surge in demand for corn-based ethanol in response to both high energy prices and the regulated mandates. Corn, which had traditionally been “food and feed”, had become “food,feed, and fuel”. [..] In 2012, following an acute drought in North America, the prices of corn reached historical highs, 400% of 2005 prices. “The speculators are taking advantage of the situation.” Yet, that year over 40% of the physical harvest went to ethanol to “feed” the car. The quantities were mandated by the government as “fuel” forced the demand destruction of “food and feed” via high prices. It was the cattle and hogs who had to change their diet, not the car. By mandate.

Do spot prices converge to futures prices, or is it the other way around? A causality study by Merill Lynch, and Parilla, say futures converge toward the physical fundamentals of the spot market. Speculators will discount future fundamentals in the price. If they improperly discount future risk factors into prices, they will lose money as the future prices converge toward the in-the-future-prevailing spot fundamentals.


Should you invest in franchises or managements? It depends.

Note we wrote this post last year.

Many investors categorize themselves and either say

  • they make judgment call on management or
  • rather focus on the franchise or business (it’s rather cool for some in the value investing church to say not getting to know management is a good thing)

Should we focus on the horse or the jockey?

Investor Robert Vinall is known to focus a lot on management. He believes it’s a hard but important question. Important, because it is difficult to quantify, and therefore there’s less competition from conventional investors and quant funds.

Guy Spier, on the other hand, likes to think of himself as a merely good investor, with lots of limitations, such as judging management. He therefore avoids talking to management. Getting to know managements opens us up to get manipulated by their – often perfect – act.

On bad business turnarounds Warren Buffett has said this:

When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

While we definitely think there’s great arguments for both point of views, we think the relative importance of analyzing franchises versus managements changes a lot with one critical variable: growth.

Focus on the racehorse and on the show jumping jockey

As the entrepreneurial HBS author of the book Buying a small business often repeats

With revenue growth comes new customers, and with new customers come new (types of) problems

In other words, growth brings change. While changing companies are not necessarily growing (e.g. turnarounds in the above Buffett quote), growing companies are always changing.

Another recent observation I had redrafting this post one year later is that venture capitalists tend to focus much more on the founder or team.

From the above, we make a case for focusing on the franchise in mature companies in markets with stable competitive dynamics.

In fast-growing companies, management becomes much more important as they need to make a lot of judgment calls in execution and capital allocation of growth investments.

In show jumping, the horse needs the jockey.

Lastly, the only competitive differentiator in commodity companies is management (companies with fast-changing circumstances).

We believe there is an opportunity in looking at jockeys in commodity industries as 

  1. investors hate commodity/capital intensive industries
  2. investors are focusing on “great franchises” right now (peak quality?) while growing more sceptical of looking at management 
  3. we believe management can be the (non-durable) competitive advantage for these businesses

While media attention tends to go to the folklore of billionaire jockeys of once-fast-growing start-ups, some examples of great commodity Jockeys: 

  1. Philip Meeson in Dart Group plc
  2. Belgian owner-operator Luc Tack in Picanol and Tessenderlo
  3. Buffett overseeing (mostly incentives) in (re-)insurance operations

We’d love to hear your under-the-radar commodity jockeys and thoughts!


Notes on IBKR’s November results and Peterffy at the ’18 Goldman Sachs conference

Disclosure: both a happy investor and client of Interactive Brokers.

Improve your net returns by massively saving on costs (i.e. the only thing you have 100% control over as an investor) now and become an Interactive Brokers client.

It is a well-known human bias to neglect large absolute trading commissions because we look at them relatively to the even bigger amount of money we invest. I am a big believer in minimizing any friction in the investment process (trading less which lessens commissions and frees up time to think long term; paying less for trades by being an IBKR client, although the cheapness creates a “casino effect” of wanting to trade more frequently).


We will cover IBKR’s November month results that were released this week. Founder Mr. Peterffy had interesting comments about them on the Goldman Sachs 2018 conference that took place yesterday.

First I’ll explain how I go about thinking about the IBKR’s monthly metrics in general.

Executive summary

  • most important monthly KPI to track: user account growth (it drives LT equity growth which is IBKR’s most important value driver)
  • November user account growth was “disappointing”, yet still in line with the last 10 year historical pace of 18% CAGR. The disappointment was driven by China curbing remittances to stellar grower – and intro broker to IBKR – Tiger Brokers
  • IBKR will start paying interest on smaller accounts
  • Israel markets will be added to IBKR
  • important question for the thesis: will exchange volumes keep on losing share to internalizers?

Let’s get started…

IBKR’s monthly metrics mental model*

*Hate using this snobby term but it made for the shortest title.

Although equity growth is the value driver for IB going forward (driving interest income) , account growth is the most useful reported number to gauge future LT equity growth, as

  • monthly equity growth numbers are affected by short term stock market movements
  • equity growth lags account growth because people only start depositing large chunks of money into their account once they are familiar with the platform (i.e. half of end-of-first-12-months money only arrives after >6 months)

Commission growth is also very noisy ( ~f(volatility)) and only 1/3rd of earnings.

In short, closely track MoM account growth to know if IB is on pace for LT equity growth.

Account growth + (ST NOISY= Clients adding deposits + asset inflation) = LT Equity growth

So I observe account growth and know that (ST NOISY) was historically 10% and should be at least 4% on avg. going forward, i.e. observed account growth + 4% =  conservative LT equity growth.

Let’s discuss the latest results and the interesting conference.

November numbers & Peterffy on the GS Conference

  • On the November numbers, IB swung up 8% intraday & ended slightly down on the day
  • I agree with the directional close-to-closing price given the numbers
    • Short-term value driver commissions were great (market volatility) while
    • accounts growth disappointed at +1.3% MoM (vs huge growth last months of course, even the annualized disappointing MoM pace is still 17%, +- on par with the 10-year CAGR of 18%)
      • Peterffy revealed on the GS conference that MoM account growth was affected by special measures by Chinese govt that constrained mainland Chinese customers to deposit money into their Beijing-based intro-broker Tiger Broker app accounts (i.e. IB bank accounts in Hong Kong). Probable reason: Yuan is under pressure and growing money outflows put further pressure on Yuan
        • Tiger Brokers grew at a stellar rate last years (now processing >200BUSD in trading volume p.a.) & has a great app with local support, advertising and investors in the mainland (the Robinhood of China but with a smarter client base as unsophisticated Chinese retail investors are not interested in global investing) but back-end of the app is 100% IBKR and the bank account is with IBKR HK
        • My take: a yuan devaluation event should be positive as the restraint can be more easily lifted afterwards & as more Chinese would consider investing outside China after a deval

Notwithstanding current market correction, IB’s LT equity growth (main value driver) should be at least 4% p.a. above account growth as clients deposit more money into their existing accounts and asset prices rise in long haul. In fact, historically the equity CAGR was 10 %-points above account CAGR. As interest rates rise and IB pays even more interest on client cash than competition, there is no reason the pace of client deposits should slow so 4% seems very conservative.

Even annualizing these disappointing MoM numbers gives us 17% account growth or in my view 21% conservative LT client equity growth, which is still 2 pp above my model of LT equity growth at 19%.

Recent additions to the platform Peterffy discussed:

  • Israel markets (next week)
  • New screening functions for IB’s bond platform (direct electronic access)
  • IB features in recent past makes them more & more of a bank:  IB is now considering getting banking license abroad & US. In US, broker-dealers can do almost anything but  limitations abroad are generally more extensive
  • Effective 1st of Jan IB will start paying interest for small clients with total equity lower than 100k (previously 0%). The rate these clients will get will be linearly ramping from 0% to benchmark minus 0.5% with account size from 0 to 100k, e.g. 60k client would get 60%*(bench-0.5%) on his cash

Recent SEC action on the payment for order flow “PFOF” competitor broker’s practice

  • Competitors burdened with more disclosure requirements to clients

Peterffy voiced his concern that brokers who’re accepting PFOF (the vast majority) are routing their orders increasingly to “internalizers” that execute customer orders against their private “parallel” market (e.g.  HFT arm of Citadel, public firm Virtu Financial):

  • This means less and less retail orders are going to the exchanges
    • Because retail orders are the lifeblood of market makers as they are viewed as profitable “noise”, there’s less incentive for market makers to provide liquidity-adding orders limit orders to the exchanges
  • thinks the decreasing real liquidity on exchanges is a “disaster waiting to happen”

I read the Virtu Financial prospectus, and the story is not that simple it seems: exchanges are monopolies and they have been inflating their commissions and data fees over the last years at higher than inflation. IBKR IR themselves complained about that to me when I asked about that cost item. Customers using internalizers save exchange fees that could theoretically be shared amongst client, broker and internalizer. In practice however, this windfall (and slightly worse execution when using an internalizer) goes to internalizer and broker. I still think the internalizer model is a threat to IB’s 100% direct-exchange model as this ongoing exchange trading substitution may continue. This is mitigated by IB’s tiny market share that can grow much bigger in 3 or 4 out of 5 client types (prop shops is saturated &  sophisticated individuals is saturated but only in the US).

Somewhat distressing is Peterffy exaggerating JPMorgan’s new “free trading app” clients being patsies:

Well, obviously, businesses have to make a profit or at least break even. So one day advertise no commissions. They may have to make it up somehow, and so that is partly in selling the orders, partly not paying interest on the deposits, partly charging higher margin rates. I understand that Robinhood does this, and that’s okay. But to the extent JPMorgan is doing this, I think it’s a big mistake. People don’t like to be taken for a patsy, and it’s going to be — they will regret this, I think.

There are huge differences among brokers how much they take as PFOF as they negotiate how good the client execution should be. Fidelity and Schwab have ~10x better price execution than RobinHood and earn less from PFOF. As stated above, theoretically PFOF could be compatible with great execution as exchange fees are saved.  The difference between IB’s price execution and the more established brokers is really a few basis points (insignificant for individuals), while for Robinhood it’s >20bp.


Interesting point was that not only Asian intro broker clients are growing fast. A lot of European private banks are becoming intro brokers too as they can’t keep up technologically.


Great presentation by Ben Evans


Some great points and examples being made. We are indeed still in the early phase of tech. Marketing is indeed unrightfully being forgotten when looking at digital advertising as a percentage of total ad spend. Online shopping curation – as opposed to logistics – is just getting started.

Investing implications/call to action: which public companies should capture some of the value of this opportunity, parts which are often forgotten such as shopping curation and marketing spend (largely confined to offline today)?

It seems this is a simple bull argument for digital ad duopolists FB, GOOG: well positioned with undemanding valuations.

The New IBKR Credit Card: Potentially Superior Fintech In Disguise?


  • there’s much fuzz on app-only fintechs issuing FX commission free credit cards
  • we compare these fintechs with the capabilities of the unknown and unloved new IBKR MasterCard and conclude it could be superior to any existing card
  • the IBKR card could be a game changer for IBKR investors: the card could drive further customer equity growth as IBKR accounts have been gaining turnkey online-banking and brokerage capabilities


Because of regulatory differences, Europe has been faster than the United States to adopt online-/app-only banking services such as unicorn Revolut, N26, and Monzo. Revolut already claims more than 2 million users.

These players offer online banking solutions with pre-paid credit cards that allow users to pay globally with drastically lower or “no” forex commissions. At a typical bank in the mainland of Europe, one pays 1.5-4% forex commissions outside the Eurozone, while in the UK and the US these commissions have outliers as high as 8%. Withdrawing cash from an ATM can be even more expensive, paying the same range of percentage commission with fixed costs on top as high as ~5-10 USD per withdrawal (excluding the fixed costs the ATM charge). Other benefits from these fintech services are the immediate information to consumer about a payment confirmation, never needing to go into a bank again to block your credit card, change its limits, with in-app control over security features.

In the US on the other hand, the lowest-cost online broker Interactive Brokers “IBKR” recently launched its own credit card. As opposed to the above players, IBKR credit cards are not widely known with millennials or in fintech circles. As I will show, the unknown and unloved IBKR credit card could be superior compared to all current European counterparts but has extra advantages on top such as deep borrowing capacity (the ability to pay large sums is typically a unique credit card selling point) at the absolute cheapest rate in the world. TransferWise and Revolut are launching their own credit card soon in the US as well.

While the IBKR MasterCard is currently only available to US clients, it is coming to Canada and Europe respectively in ‘Q4 ‘18 and in ’19-’20 (as per investor relations’ answer).

A comparison of the fintech players

First, let’s compare the European fintech players to pick the financially most attractive proposition to clients. I will then compare this player to the all-new IBKR credit card.

While the pan-European German start-up N26 and exclusively-UK player Monzo offer “zero commission MasterCard forex rates” (i.e. they offer the same FX terms) for payments in foreign currencies, pan-European Revolut claims to offer the “interbank rate” during weekdays, with an added 0.5% commission during weekends to “compensate for the FX risk”. Because MasterCard (and Visa) do not offer any transparency on their official FX rates calculations but do publish daily official rates here, my comparison is based on empirical data.

As it turns out, none of the providers of “commission free” credit cards are fully commission free. While the “commission free MasterCard forex rates” has a hidden wholesale FX commission for MasterCard embedded in N26 and Monzo’s case, Revolut says it uses the real-time interbank bid price. However, based on my analysis using live data from the deep IBKR forex market that is freely available for customers, I found Revolut settlement rates are a bit worse than the real interbank bid prices of IBKR. Let’s first do a comparison between the “fintech” players before we move on to why “old” IBKR could be even better.

Based on datapoints in a personal holiday in Mexico using both N26 and Revolut, I found that Revolut is generally better during weekdays, while Monzo/N26 (same FX terms) are better during the weekends. This is corroborated by another analysis I recommend here. What I find is that the officially published daily MasterCard rates are typically a bit worse on the settlement day. The typical Revolut FX improvement to the “commission free official Mastercard rates” on weekdays is about 0.2-0.4%. A misconception: “Official MasterCard daily rates” are not FX mid-prices but inherently have a small commission embedded called the wholesale FX margin for MasterCard. Note that cards based on the official MasterCard rates settle your payments based on daily published rates on the settlement day, i.e. a few days later. When I say Revolut is 0.2-0.4% better, this means Revolut uniquely settles your FX rate immediately at payment, while N26 and Monzo payments will settle days later through MasterCards system at an on average 0.2-0.4% worse rate, but this is subject to relatively large FX fluctuations. However, the interbank rate at the time of payment is of course the statistically expected forex rate of the other providers in a few days at their settlement time, minus the wholesale commission of Mastercard (or Visa) that is hidden inside these players’ published rates.

In the weekends however, Revolut’s 0.5% commission (except for a few illiquid currencies, most notably the Russian and Thai currency, the commission is 1.5% instead) will trump the MasterCard wholesale commission of ~0.3%, making payments using N26 or Monzo more attractive. For the most liquid currencies however, Revolut offers users to convert and hold monies in advance in the app, allowing them to voluntarily bypass this 0.5% commission. For many emerging market currencies, this is however not possible. Of course, holding multiple zero-yielding pre-paid currency balances for a credit card is not very attractive from an investment point of view anyway. The peace of mind of using N26 (exclusively Euros in the app) and clearing payments at a slightly worse FX rate 5 out of 7 days versus Revolut might not be so bad after all.

Another advantage of N26 is the ease to transfer money as a client gets his own personal bank account, while Revolut – for now – requires you to wire money to an omnibus bank account with a structured code to redirect it to the user. This gets us closer to an all-purpose bank account.

ATM Withdrawals: Revolut offers a monthly 200 EUR no-commission foreign ATM withdrawal limit while charging 2% on any amount in excess of that, while N26 charges 1.7% for all amounts on top of the official Mastercard rate which has 0.3% commission embedded (both charge no fixed costs which are typically 2-6 USD per withdrawal at conventional banks). I don’t expect Revolut to continue the free 200 EUR ATM promotion for long however as they stated it is very expensive for them.

I would recommend N26 for peace of mind and efficiency, while recommending Revolut for nerds.

Lastly, there is the TransferWise MasterCard that is already available in Europe, while soon in the US. This card charges its own commissions published on TW’s website. As this ranges from 0.35% to 1% to the true mid-price, it is the “worst” card. However, for people that often get paid in foreign currencies, paying directly using monies in their foreign TransferWise “borderless account” currency balances in which they got paid (cheaper international transfers is TransferWise’s bread and butter) allow them to circumvent commissions using this MasterCard.

Some referral links to get a free card and account at N26Transferwise Borderless, or Revolut.

If you want to cherrypick the best features of any card and retro-actively change the payment from one underlying card to another card for free, start using Curve, a fintech card that aggregates all your existing credit cards into one. If you sign up with code WJ29Z here, you and I get 5 bucks.

How do these players make money

Judging from internet forums, people assume Revolut makes its money from add-ons such as buying cryptocurrency at higher commissions, insurance and premium card subscriptions. While true, I suspect the bulk of income right now is from a piece of the pie Revolut has negotiated with its issuing bank of credit cards: credit card payments collect interchange commissions charged to merchants and paid to the issuing bank. While Europe has capped credit card commissions for merchants at 0.2%, in the rest of the world these interchange commissions for the issuing bank are typically 1.2-2% (note there’s other commissions paid by merchants for the payment terminal operator and MasterCard/Visa). Lastly, I suspect Revolut makes a tiny spread on forex versus the true interbank rate it trades at, as I will detail later.

Why IBKR’s credit card could be the unknown better alternative to the current fintech players

While Revolut offers the best rates amongst its fintech peer group most of the time, it is using the rate offered in the market to convert (not the mid but the bid) and hence the customer should lose half of the bid-ask spread in a conversion. Broker customers of IBKR get direct access to the live interbank market. IBKR aggregates for its clients the best quotes of 16 of the world’s largest FX dealing banks that have an aggregate 60% global market share. Using real-time FX data as IBKR clients, we can see the real-time bid and hence can test Revolut’s claim.

Could IBKR be better than Revolut to pay in Mexican pesos?

I made screenshots of IBKR’s FX bid prices seconds before and after two consecutive Revolut payments at 11:50 and 11:53 local time. I also appended the FX traded range of the minute and compared it to Revolut’s payment settled rate (minute resolution for the zoomed candlestick chart). Note the time in my Revolut payment screenshot is shifted by 7 hours as I made this screenshot when back home and there’s a 7-hour time difference to Mexico.

Chichen Itza

Figure 1 Own screenshots of Revolut app and IBKR live forex rates

In another payment on another day, I show the bid-ask spread that is quoted minutes before the payment, and the traded price range of the minute on the other hand.

Monica Herrera.jpg

Figure 2 Own screenshots of Revolut app and IBKR live forex rates

At the second payment in my first picture, the average bid rate of the bid rate seconds before (middle screenshot) and bid rate after payment (right screenshot) was 22,74565 while my Revolut payment was settled at 22,7437. The difference is 0,00195.

In the second picture, the Revolut settlement was at 22,6553 while the bid price in the minute of payment should have been at worst 22,6585 minus 0,015 or 22,6570 (that is, the bottom of the candlestick on the minute of payment minus the bid-mid spread). IB is at least 0,0020 better.

I did not make bid screenshots for the first payment in the first figure (on the left). I believe the rate I saw but did not take a screenshot of was close to the upper end (ending price of the candlestick). Based on this, and the bid-mid, I estimate in this instance IB was 0,0033 better.

Wrap-up: it seems Revolut in this example is at least 20 pips worse than IBKR’s interbank bid price. For the Mexican Peso Euro pair, IBKR rates give you at least a 0.0088% better rate (20 pips divided by EUR MXN of ~22,7), or 0.88 basis points. However, for small trades, the IBKR FX commission is 0.2 basis points. The net improvement should be 0.68 basis points. When spending 5000 $ in Mexico, this gets you to a very small saving of 34 cents. Very small compared to the difference between Revolut and contenders N26/Monzo using the “official MasterCard FX rates” in which the difference was 0,3%. For a 5000 $ spend using Revolut versus these competitors, this makes a 15 $ difference.

Why IBKR is not as good for FX vs Revolut today, but could be: IBKR actually uses the currency conversion of MasterCard for its credit card payments (your FX payment will be deducted from your base currency in your brokerage account), while customers can trade in the interbank market on their brokerage accounts at a 0.68 basis points better FX rate than Revolut. This doesn’t make any sense and I will recommend IBKR to implement the Revolut system.

Other IBKR credit card USPs versus fintech players

  • Deep borrowing capacity: remember how credit card providers pitch deep borrowing capacity as a selling point in “gold cards”? IBKR credit card payments are only limited by your brokerage account net worth. If you want, you can heavily indebt yourself using margin debt up to 2-3X your brokerage net worth
  • Unrivalled cheap borrowing at the overnight rate plus a tiny spread (see here)
  • Commission free foreign ATM withdrawals with a fixed cost of 0.50$ (using of course Mastercard’s wholesale FX rates): remember N26 charges 1.7% on top of the wholesale FX rate for withdrawals
  • More efficient use of your assets: pooling effect as you spend from your brokerage account instead of having many zero-yielding cash balances at different brokerage/bank accounts (as of recently, IBKR added a lot of daily banking capabilities such as recurring payments etc.)


The IBKR credit card is not discussed on Fintech forums but has the potential to be even more attractive than the payment cards of Revolut, N26, Monzo and especially Transferwise*.

Another post will follow with an IBKR investment thesis, digging more into the brokerage account details.

I recommend an IBKR account for anyone above >100K$ (for smaller accounts, I only recommend IBKR if you are at least making two trades per month). You can open an account here.

To get a free FX credit card and account, here’s some affiliate links to N26Transferwise Borderless, or Revolut.

If you want to cherrypick the best features of any card and retro-actively change the payment from one underlying card to another card for free, start using Curve, a fintech card that aggregates all your existing credit cards into one. If you sign up with code WJ29Z here, you and I get 5 bucks.

* This post was about payments, but IBKR is much cheaper than TransferWise for large international money transfers: note that if IBKR clients have local bank accounts in multiple countries (e.g. a US expat living in Australia), clients can use local transfers via their IBKR brokerage accounts to transfer huge sums of money from one country to another at the real interbank rates (e.g. depositing AUD from Australian bank account to IBKR, converting at the real interbank rate, withdrawing the converted USD to a US bank account). This can save them 0.3-1% of TransferWise FX commissions. When our expat returns from Australia and buys a 1 MUSD house in San Francisco, he saves 4500$ (as per this TransferWise fee link; TW charges 0.45% for AUD-USD transfers).

Disclosure: I am/we are long IBKR and used affiliate links of the cards we recommend and used above.

Loyalty program series: Blue Chip Stamps case study

Loyalty program operators are similar to insurance operations in the sense that they issue a claim “stamps” or “air miles” in exchange for cash upfront “float” (industry term “billings”). This cash or “float” can then be invested while the clients slowly (or never, see breakage) redeem their points or miles (industry term “redemptions”).

Earning streams

Ordered by increasing amount of uncertainty, money is earned through

  1. taking a margins on a mile billed minus a mile redeemed
  2. selling customer habit analytics to companies
  3. breakage: this can be a significant ~20-50% of billings, with ~100% pre-tax margin
  4. investment income and capital gains from investing the float (other people’s money)
  5. point devaluations: this comes at the expense of the loyalty program’s reputation if done visibly, but remains largely unregulated. Companies should take an example from central banks and slowly but steadily devalue (as in “the optimal inflation target is 2% p.a.”)

Float from customers and the government (other people’s money²)

From day one the “billings” cash comes in with most of the revenue still unrecognized (except for a conservative breakage estimate), and offsetting “deferred liabilities” on the balance sheet. This means that almost no cash taxes are paid upfront.

In other words, this business uses other people’s money (clients) to earn extra money on the investment side, while deferring the cash taxes due on real loyalty earnings far into the future (after accounting for real breakage and devaluations down the road).

Powerful psychological biases working in favor of loyalty operator

I think there are some powerful psychological biases working in a loyalty card issuer’s advantage:

  • small amount of miles in every purchase “feels” like it was earned for free, or an “extra” (this is far from the truth, as loyalty programs get paid cash on day one for these points and an alternative to miles is cash back credit cards)
    • people do not value things they got for free as much as things they “worked” for
      • Result n1.: neglect of points that leads to slow devaluation of redemption liability and breakage
  • because the points are not expressed in usual fiat money terms, and they feel for free, the urge to buy unnecessary goods is bigger (perfume, hotel upgrades etc), this is similar to buying presents for friends.
    • see Dan Ariely’s The Perfect Gift : something you always wanted but never wanted to feel the pain of paying for
    • these products have a knack of carrying higher profit margins
    • the loyalty company will use its purchasing power pool to negotiate hefty discounts from retail cost on these high-margin products
      • Result n2.: sales mix is typically profitable for redemption partners (perfume, seat or hotel upgrades) and loyalty partner will take a nice piece of those economics

Case study from the past: Buffett & Munger’s investment in Blue Chip Stamps

I now want to present a very interesting case study from the past, Buffett and Munger’s purchase of loyalty program Blue Chip Stamps (’70s business).


The main takeaway is that Blue Chip Stamps’ revenue (~’gross billings’) declined heftily in 10 years, while the float more or less kept up. Why?

  • part of the declining revenue cumulatively adds to the float, while
  • the redemption frequency drops as the program loses mindshare and people forget/delay spending points


In other words, permanently declining loyalty programs can still be valuable vehicles to compound investments in, using other people’s money.

Case study today: Aimia

Today, Aimia is trading at ~1.5 x current cash flow, with gross assets (excl. loyalty card liabilities) worth about 2x current share price because of the uncertainty surrounding the major partner Air Canada “AC” that is leaving in 2020 (10% of accumulation but 50% of redemption).

Aimia’s loyalty card “Aeroplan” is one of the biggest in Canada.

Network effects of being big

There is many-sided network effects involved.

What makes the program valuable?

  • # of Accumulation Partners (partners that pay upfront cash “billings” to Aimia for offering clients miles)
  • # of Redemption Partners (partners that allow to redeem miles with products, getting paid by Aimia)
  • # of Clients

Each category interacts, e.g. more redemption and accumulation partners makes the program more valuable for clients, more redemption partners and clients makes the program more valuable for accumulation partners, etc.

Lastly, it’s all about “the big data” nowadays. More # of each category makes Aeroplan’s data analytics more valuable because the number of interactions (data) increases faster than the individual amounts.


Case study investment case


  • Aeroplan’s cash flow remains stable until 2020 and
  • post-2020 cash flows minus its real liabilities are worth at least 0, this is an attractive investment (worth ~10$ per share).

It seems unlikely that management would not be able to manage its way through a “run on the bank” redemption before the 2020 expiry of AC by delaying customer redemptions through two control mechanisms that induce clients to delay and forget:

  1. “gating” (offering limited redemption options ‘temporarily’, e.g. only flights on wednesday and sunday)
  2. devaluing points faster: this has the effect that more people will have insufficient miles to redeem products they deem valuable, hence delay and forget

Given the network effects and switching hassle for customers, I do not believe Aeroplan is going away abruptly as the market seems to think (maybe slowly, but then again Blue Chip Stamps is an interesting case).

Disclaimer: no position*

*Not yet comfortable in the industry.

Comments are welcome.


How Margin of Safety made me take more risk

In my previous contribution An exception to the no genuine value-add to society filter, I discussed a recent personal deviation from value investing.

This time I will expand on how reading Margin of Safety for a second time made me realize my personal context warrants more risk taking than generally advised in investment literature.

An imperative in investing is diversification. A portfolio of eight equal-sized stocks might be called risky “concentrated investing”.

Again, it is the context that is of great importance. For a wealthy investor holding close to 100% of net worth in stocks, I fully agree (the books are generally written by or for these types anyway). However, for investors that are invested across asset classes and/or benefit from large cash flows from relatively uncorrelated sources, the riskiness of this strategy is mitigated (e.g. an endowment with cash flows from forests, farms and real estate, or an individual that has a job and/or private business).

Seth Klarman highlights the advantage of having liquidity from high cash yielding positions in a downturn in his seminal book Margin of Safety:

The third reason long-term-oriented investors are interested in short-term price
fluctuations is that Mr. Market can create very attractive opportunities to buy and sell. If you hold cash, you are able to take advantage of such opportunities. If you are fully invested when the market declines, your portfolio will likely drop in value, depriving you of the benefits arising from the opportunity to buy in at lower levels. This creates an opportunity cost, the necessity to forego future opportunities that arise. If what you hold is illiquid or unmarketable, the opportunity cost increases further; the illiquidity precludes your switching to better bargains.


Maintaining moderate cash balances or owning securities that periodically throw off appreciable cash is likely to reduce the number of foregone opportunities. Investors can manage portfolio cash flow (defined as the cash flowing into a portfolio minus outflows) by giving preference to some kinds of investments over others. Portfolio cash flow is greater for securities of shorter duration (weighted average life) than those of longer duration. Portfolio cash flow is also enhanced by investments with catalysts for the partial or complete realization of underlying value (discussed at greater length in chapter 10). Equity investments in ongoing businesses typically throw off only minimal cash through the payment of dividends. The securities of companies in bankruptcy and liquidation, by contrast, can return considerable liquidity to a portfolio within a few years of purchase. Risk-arbitrage investments typically have very short lives, usually turning back into cash, liquid securities, or both in a matter of weeks or months. An added attraction of investing in risk-arbitrage situations, bankruptcies, and liquidations is that not only is one’s initial investment returned to cash, one’s profits are as well.

–  Margin of Safety, chapter “At the root of a value-investment philosophy” paragraph “The Relevance of temporary price fluctuations”

It was only after investing on my own and reading this book a second time that I realized that my personal situation is similar to an investor with high cash flows from sources with relatively low correlation to the price of equity markets. Indeed, I derive significant cash flow from a job (rest assured that my employer is not an asset manager. Indeed, AM typically have a revenue ‘beta’ of ~2 to the stock market).

These sources of liquidity are not often discussed in investment books, but once I came to the above realization (in my 7th out of 10 years of investing!) I was embarrassed with my own lack of independent thinking. 

Today I hold a lower cash balance in general as my “replenishment rate” is high. However, I do believe that having no cash is only “optimal” in theory. In practice, a small amount of cash can have the huge benefit of getting psychologically undamaged through a market correction, allowing oneself to rationally grasp the opportunities at hand.

Last year I started asking this:

What is the threshold of cash level that would actually make me happy when the market crashes? 

What is yours?

My answer is 20% (taking into account my moderately high replenishment rate and the fact that I am a young investor, not an older disinvestor). Note that this is a theoretical question, as a certain M. Tyson said: Everybody has a plan until they get punched in the face. Likewise, the level that will truly feel good is probably a bit higher. Lastly, remember what Warren Buffett says about plummeting markets:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.


But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.


‘[S]mile when you read a headline that says ‘Investors lose as market falls.’ Edit it in your mind to ‘Disinvestors lose as market falls— as investors gain.’ Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other.”

– Buffett in ’97 BRK chairman letter

Oddly, most newspapers and books are written for disinvestors (older and wealthier participants). We can guess to the reasons why:

  • in part because this audience has the most money to spend on content
  • on the other hand most is probably explained by the insurmountable instinct for many to focus on short-term nominal gains

In the last market correction (Feb ’16) I actually felt content, but that probably meant that my cash level was too high in practice (i.e. 30%). Today it is at 10%.



Kahneman’s on what’d most improve our world understanding

Some gold from Cialdini’s new book Pre-Suasion, para. “What is salient is important”:

[Kahneman] was once asked to specify the one scientific concept that, if appreciated properly, would most improve everyone’s understanding of the world. Although in response he provided a full five-hundred-word essay describing what he called “the focusing illusion,” his answer is neatly summarized in the essay’s title: “Nothing in life is as important as you think it is while you are thinking about it.”

What is salient is indeed important, Cialdini:

As the tenth anniversary of the terrorist attacks of September 11, 2001, approached, 9/11-related media stories peaked in the days immediately surrounding the anniversary date and then dropped off rapidly in the weeks thereafter. Surveys conducted during those times asked citizens to nominate two “especially important” events from the past seventy years. Two weeks prior to the anniversary, before the media blitz began in earnest, about 30 percent of respondents named 9/11. But as the anniversary drew closer, and the media treatment intensified, survey respondents started identifying 9/11 in increasing numbers—to a high of 65 percent. Two weeks later, though, after reportage had died down to earlier levels, once again only about 30 percent of the participants placed it among their two especially important events of the past seventy years. Clearly, the amount of news coverage can make a big difference in the perceived significance of an issue among observers as they are exposed to the coverage

Kahneman’s most important thing is worth repeating for investors:

Nothing in life is as important as you think it is while you are thinking about it.



An exception to the “no genuine value-add to society” filter

TC and MC (the blog authors) discussed investing in Philly Shipyard (PHLY on Oslo Börse) a while back, and one counter-argument for not investing was that this company would not exist without the force and subsidies of the Jones Act. As such this company could not be labelled as a genuine value-add for society or customers.

Many value investors have mentioned they do not (generally) invest in companies that do not genuinely add value to their value chain or society. Usual suspects are cigarettes, gambling, time-share rentals etc. In different ways, these companies prey on humanity’s weaknesses (respectively addiction and ignorance). Another close to home company I like to use is Edenred (rearview mirror high and stable ROIC ‘great’ company that through regulation in France and Belgium enjoys operating in an oligopoly for a product that is fiscally advantaged but ultimately destroying value for society in TC’s humble opinion).

In different ways, these companies prey on humanity’s weaknesses.

However, I will explain why I have come to believe this rule is not (as) applicable to investments like Philly Shipyard ASA.

The great danger of investing in the above businesses is that they optically look like great companies from a rear-view mirror perspective (and near future perspective, with high and stable ROIC). Indeed, human weaknesses are time-invariant, or favorable (but questionable) regulations create a stable subsidized high ROIC, and these companies are generally valued as ‘quality’ by the market.

If the valuation multiples reflect quality this also means the investment only works out if the company is still flourishing 10 years from now (unless one is relying on future greater fools).  The problem is that investors are very bad at predicting the future more than five years out. Once public opinion turns against these companies’ (the timing is highly uncertain), the valuation can tank towards liquidation value. I think I sketched an investment that has unknowable (immeasurable) uncertainty to the downside. 

Value investors should prefer the inverse type of uncertainty. I believe immeasurable uncertainty vs risk is not often enough discussed, which is why I recommend having a quick read through The Dhandho Investor.

Why I made an exception and invested in Philly Shipyard

We have been following Philly Shipyard since Nov. ’16. Philly traded comfortably below liquidation value, and we found there was clarity that the Jones Act would not be repealed in the medium term (see also Trump’s slogan). Philly’s management seemed to have cared well for shareholder value in the past, and even a repeal of the Jones’ act could have accelerated the  (liquidation) value realisation, locking a small profit or loss. In other words, the Jones Act regulation was not a large risk factor by virtue of the valuation. The upside was that there was a decent ~ >50% chance that this company could soon be valued on a going concern basis once a new shipbuilding contract would get signed (in that case it would be worth 2.5X – 4X).


Clearly it is always important to assess a company’s true value-add to stakeholders. However, I hope to have made a convincing argument that this factor’s weight in decision making is dependent on the context (“great company” / “cigar butt” valuation?). In case of cigar butt valuation, this factor is not on top of my checklist. 

It is only through thinking about real-world case studies that I have found the courage to deviate from value investing dogma. Honestly, this is dramatic, as I only have one remaining personal example of a deviation worth sharing (in a next contribution). 


Summary of French Bollore documentary

For those that understand French, I very much recommend this excellent documentary on Vincent Bolloré. I found it to be quite unbiased, surprisingly.

Disclosure: long a bit of BOL (main thesis being that a full simplification is a catalyst for the unlocking of the NAV which is at ~2X the share price by virtue of the economic share count which stands at around 50% of the total share count, after accounting for the circular ownership loops. The timing is very unclear, but in the meantime NAV is compounded at a decent rate. The author did a very similar exercise as the highly recommended Muddy Waters analysis that came out just months after)

For everyone else, I have summarized the documentary:

  • in France, Vincent Bolloré has the nickname “two-faced smiling killer”
  • Bolloré has a smartphone app counting down the moment he steps down. I think this shows he is obsessed by providing the “right” company to his family successor (whatever that is, importantly it could include a simpler structure)
  • when Bolloré started at the family company after his Rothschild banking experience, he managed to negotiate a 25% wage cut in his family’s rolling paper factory legacy business when the factories faced cyclical headwinds. This is almost unheard of in France and it shows his influencing skills.
  • the name Bolloré in Africa is very famous. Bolloré uses his abundance of smarts, political connections (including personal friends Sarkozy, Hollande* and Macron), capital and synergies from the media business to gain profitable contracts in many African countries

I didn’t build my empire from one franc by being a passive investor, it’s not in my genes, I am an activist. – Vincent Bolloré at the Havas board meeting.

*Although Sarkozy is one of Vincent’s personal friends, the documentary shows an example where a Hollande visit to Africa allegedly helped Bolloré win a bid for a Cameroon port concession.

Book Summary – Capital Returns part I

Capital Returns is an excellent collection of investor letters and essays by Marathon Asset Management, edited by Edward Chancellor and originally intended to be distributed within the firm.

Although it looks like many of Marathon’s calls were prescient, there is definitely some selection bias involved in the picking of the essays (this is acknowledged by Chancellor).

Because I am a huge fan of the essays, I will be posting a large summary in three parts on the blog. We will finish with a more condensed ‘main takeaways’.


Capital Returns by Edward Chancellor

What is capital cycle analysis

Capital is attracted to high-return sectors of the economy and leaves when returns become dismal. This process is never static, always dynamic. From the economy’s point of view, this process is Schumpeterian, flushing the misallocated capital.

Capital cycle analysis is about how competitive advantages change over time from the investor’s perspective.

Professor Ken French writes that firm asset growth is a larger determinant of consecutive five year returns than value, momentum and size (Fama, French 2014).

Larger firm investment is followed by lower returns. This mean reversion is not only due to animal spirits, companies that earn more than their cost of capital expand their capital base, hence increase supply in their industry, while those that fail behave in an opposite fashion.

Corporate investment rates is also a negative predictor for corporate profitability in national aggregates. The US has had very low rates of reinvestment after the mal-investment of pre 2007 was revealed, and is subsequently earning very high profit margins.

Why does French’s ‘asset growth anomaly’ exist?

  • Overconfidence : Managerial and investor fetishism for asset growth. Future levels of demand are very hard to forecast.
  • Competition neglect: Corporate investment that looks like it will earn above its cost of capital looks rational when looking at it from the isolated point of view. However, competitors are probably making the same decisions at the same moment. The feedback lag because of investment lead times makes this problem worse.
    • TC comment: this is discussed in Buffett’s shareholder letters on Berkshire’s textile operations as well. Textile capex for efficiency gains looks great in isolation, but every competitor is investing in the same efficiency gains. I’ll call this “the red queen effect”

Now, here, you see, it takes all the running you can do, to keep in the same place. – The Red Queen in Alice in Wonderland (TC’s analogy to Berkshire’s textile capex in reality versus )

  • Insight view and neglect of the outside view: Management focusing too much on the specifics of their investment story versus the wider base rate of success given the competitive backdrop. This leads to overemphasis on “my case is different”.
  • Extrapolation: Linear forecasts are made because of anchoring bias, anchoring on recent data because of recency bias. This myopic element creates linear extrapolations ignoring that reality is cyclical. For example, trade cycle, credit cycle, liquidity cycle, real estate cycle, profit cycle, commodity cycle, industry capital cycle. Linear extrapolation is hard-wired deep inside us. Low multiple value stocks with depressed earnings exploit this tendency to extrapolate the near past. To discriminate between low multiple depressed and inflated earnings companies means investors have to dig deeper in the capital cycle.
  • Skewed incentives
    • Executive pay is often linked to company size regardless of profitability (ROIC) so even reinvesting below cost of capital can perversely be attractive
    • Companies with large investment projects tend to exhibit short term momentum on the same time frame that executives are rewarded
    • Investment managers’ pay is also often short-term based
    • Investment banks need to cheer
      • as corporate investment is often associated with fees for raising capital for another department in the bank
      • the brokerage fees don’t help not cheering for stocks
  • Prisoner’s dilemma: Maybe future demand can accommodate one player from expanding operations. If everybody refrains from expanding for the good of the industry but one player, the non-cooperative gets the gains. Retaliations to protect market share often follow.
  • Limits to arbitrage: Shorting can be expensive in terms of risk budget (nobody knows when the cycle will turn exactly). Also, companies that invest in new assets typically have higher multiples hence market caps so not investing in them makes investors deviate much from the benchmark.


Fundamentals of analyzing the cycle

  • Focus on supply: Supply prospects are much less uncertain. Look at how capex-to-depreciation is evolving over time.
  • Beware the investment banker (analyst): Investment banks are being paid for capital expansion projects. Hence they are paid to drive the capital cycle.
  • Selecting the right corporate managers

“After 10 years on the (CEO) job, a CEO that retains 10% of earnings will typically have been responsible for 60% of the capital invested in the business”. – Warren Buffett

  • Generalists make better capital cycle analysts: Industry insiders are prone to take the inside view, as opposed to Kahneman’s Outside view, not seeing the wood for the trees. Generalists adopt the outside view and do capital cycle comparisons between industries. There’s also an element of job protection at work.
  • Adopt a long-term approach: Short-term timing the cycle is impossible. Make general calls and sit them out.

The Story of Cod

For two centuries, the pinch-point between abundance of cod on sea and scarcity on land were the small ports that processed cod. When the industry scaled to transatlantic trade, that pinch-point became the large market of Boston. A triangular route emerged where ships transported New England cod to Europe, subsequently took African slaves to the Carribean sugar plantations, and finally brought Carribean liquor to Boston.

Boston flourished until technology catched up:

  1. steam-powered ships
  2. freezing food (1920s)
  3. sonar to locate fish

Overfishing became commonplace as the new owners had to bear high fixed costs to buy these new technologies. After ports, markets and processors of cod, and consumers, became main beneficiaries of the trade.

The questions for investors is which company will become the equivalent of the Boston fishing market?

The commodity super-cycle

  • On oil (Feb 2012): OPEC countries have high spending budgets, creating a high “break-even oil price” for them. This will limit their quota discipline if prices go down
  • On buying and selling Vestas (March 2014): Marathon took a position in the wind turbine company Vestas when one of the key indicators of the capital cycle was close to bottoming out (i.e. around 1.2X capex / depreciation for a leader in a sector that has long secular tailwinds). They sold most of their stake in 2009 when Vestas had outperformed MSCI Europe by a total factor of x4 and the capex-to-depreciation multiple was at a stellar number of 3-5X. They added a lot to their residual position in 2013 after the stock got slammed and capex-to-depreciation was depressed at 0.5x.
  • Why EPS growth has lagged GDP growth (Sept 2014): EPS growth has lagged GDP growth despite general corporate profits growing from 1960 from 6% to 10% of GDP.


  • Buybacks and dilutive equity raises at the exact wrong timing
  • Management share comp.
  • M&A, IPO is procyclical
  • Private companies becoming more profitable relatively because of less agency problems

If supply outpaces demand growth, profits suffer. Hence it is possible that sectors with high demand growth bring little or no benefit to investors as capital floods in (e.g. airlines, semiconductors, mobile phones). This is also true on the country level, with negative correlations of subsequent equity returns and country GDP growth. Public equity returns in China are a perfect example.

Rather, investors should focus on supply. The starting point of company analysis should be prospective supply, not demand.

Figuur 1 Value in depressed and growth industries

Value in growth

Warning labels (Sept 2002)

High moat “quality” companies that revert slower to mediocre ROIC’s than the market implies do so because competing capital inflow is somehow restricted.

Quality small companies are easier to find in Europe because there’s an excess of large institutional investors. Some sectors are overrepresented in this universe, e.g. industrials, while sectors like pharma are overrepresented (typically >10bn companies).

A “growth” label company typically gets a “value” label after excess capital flows into its sector.

Long game (March 2003)

Long term investing works because there is less competition for really valuable bits of information.

Low turnover reduces friction costs and fewer decisions leading to hopefully fewer mistakes. The real advantage to this approach, in our opinion, comes from asking more valuable questions. The short-term investor asks questions in the hope of clues to near-term outcomes. The value of this short-term oriented data is modest at best, and to build a long term significant track record, this investor needs to pull off this trick many thousands of times to exploit marginal opportunities sustainably. The competition is ferocious.

The info Marathon seeks is long term oriented, typically capital allocation skills.

An example is Colgate’s line extension advertising investment in the ‘80s. It created a huge amount of value eventually but the focus at the time was short-term earnings drag. Apparently even today no investor questions have been raised to Colgate’s management about its large marketing spend, except for Marathon’s.

Double agents (June 2004)

In his University of California talk, Munger asked students when demand goes up if you raise prices. Students responded with certain luxury goods.

What Munger was waiting for in fact were goods sold through friendly middlemen. Geberit (also covered in Quality Investing book, extensively uses plumbers in their push – pull strategy: plumbers pull their product to where it was pushed, i.e. wholesalers. Geberit invests a lot in free plumber training so that it becomes more time efficient for them to choose Geberit. Also, Geberit invests a lot in innovation and quality of the product, as the plumber gets a commission as a percentage of sales and hence does not care about the price (indeed, a plumber rather sells a high priced product). Rather, the plumber thinks about factors such as hassle-free installation, durability and quality to protect his own reputation. By investing heavily in training for plumbers, innovation, and quality, Geberit is able to raise prices disproportionately.

The agent’s interest is typically quality, safety, reliability, availability. Cost to the customer is ideally not a concern for the agent (to the contrary, if he earns a personal commission).

Other examples: dentists, doctors, opticians, electricians, architects.

Digital moats (August 2007)

Marathon has been a long term investor in Priceline and Amazon, and stresses how investors back in the 2003-2006 days were stressing short term margins instead of focusing on execution of the long term stated plans of the founders.

Quality time (August 2011)

Commentators are focusing on mean reversion of elevated aggregate corporate profitability. Marathon stresses that it is more productive for bottom-up investors not investing in indices to focus on specific sectors and firm capital cycles (or lack thereof, in case of sustainable competitive advantages).

TC Comment: See John Hussman’s newsletters as an example for aggregate profitability views.

Escaping the semis’ cycle (Feb 2013)

The Philadelphia semiconductor index has underperformed the Nasdaq since ’94 inception by 200 basis points p.a. with greater volatility.

Some firms, such as Analog Devices, have performed well over the long term. Analog semiconductors bridge the gap between the real world and the digital world, e.g. sensors in airbags, microphones in mobile phones, temperature sensors etc. According to Marathon, sustainable competitive advantages exist in this niche of the semi sectors, because capturing what is happening in the real world is harder.

The human capital component is hard to replicate because engineering talent deepens with experience. The design process is more trial and error. To become an expert in analog devices requires many years and the tenure of the average engineer at Analog devices is 20 years. Lastly, each analog company’s process technology is quite distinct. [..] Thus, it is difficult for an engineer to be poached by another analog company without his productivity being significantly impaired. Lastly supply of new engineers is more constrained for the analog niche as new graduates are more likely to pursue the digital semi route.

This is all compounded by the fact that analog devices have more diverse end markets. While the overall market is relatively fragmented, market segments is much more consolidated.

Pricing power is aided by the fact that analog chips play a very important role but represent only a small portion of the total cost of devices. Moreover, once an analog chip (e.g. sensor) has been designed specifically for a product, switching costs are high as the whole production process has to be revised. This makes revenues more recurring as well over the product life-cycle.

Finally, the analog production process is less standardized than most hardware, and thus less vulnerable to obsolescence from Moore’s law. More than a third of Analog Devices come from products which are more than ten years old.

To be continued,


Takeaways Q2 17 Horizon Kinetics letter

I really like the Horizon Kinetics letters. This can be interpreted in the way that Thorp qualified his ‘favorite books’ list on the Masters in Business podcast I summarized by saying

“I don’t necessarily agree with the books, I just believe that great books should provoke thoughts”. – Ed Thorp

On the NASDAQ 100 ETF

The top 5 holdings of the NASDAQ 100 ETF ‘QQQ’ account for 41% of the total AUM (FAANG + Microsoft). If this fund were active, this concentration would be forbidden in European UCITS. Yet, it is available in the passive vehicle iShares NASDAQ 100 UCITS ETF.

QQQ P/E calculation

The P/E ratio advertised for the QQQ ETF is 22.2x, by taking many assumptions:

  • trailing earnings
  • excluding loss-making companies
  • for the positive earning companies, excessive P/E companies are weighted less by using the ‘weighted harmonic mean’

TC comment

Electrical engineers are familiar to the harmonic mean, as the equivalent single resistance of two parallel electrical resistances is calculated by taking the harmonic mean of those two parallel resistances. What happens is that the harmonic mean for the equivalent resistance is closer to the smallest value (in case of QQQ, the smallest P/E companies) as electrical flow takes the path of least resistance. Another way to put it is that the smallest resistances (P/E companies) will be weighted the most in the average.

It is evident that real-world portfolios cannot return the harmonic mean of position returns.

Active manager YTD S&P500 tracking error from not owning FANG stocks

Bregman writes that by merely excluding Facebook, Apple, Amazon, Netflix, Google, Microsoft from the index, one would trail the YTD S&P500 performance by 243 basis points, or more than a quarter of the S&P500 returns!

In fact, the situation is even more dire when looked at over the last years:

  • 2015: owning 5% of the S&P500 accounted for 50% of the index return
  • 2016: the 10 best performing stocks, including FANG, accounted for more than 100% of the index return
  • 2017YTD: FANG accounted for 25% of the index return

TC comments

The key takeaway is that I think that the monstrous performance of FANG creates an unbearable fear of not owning FANG for many active managers as well. The huge upside volatility of the last years creates career risk of not owning FANG. Moreover, because of the great performance the weight increases every year so the buying pressure mounts, thus sucking in more capital each period.

It is interesting from a historical perspective to see how the fear of missing out reappears in different forms.

Google and Facebook versus AOL

The fund extrapolates 25% annualized ad spend growth on Facebook and Google, while assuming a 4% annualized growth of worldwide ad spending. Using these numbers, by 2020 the two internet giants would account for 40% of worldwide ad spending (offline + online). Today this number is at 23%.

It is funny how Horizon Kinetics voices exactly the same concern as I have written about just weeks ago on this blog:

Of course, as Google’s and Facebook’s share of worldwide advertising expenses increases, they must eventually reflect the cyclical attributes of the industry that clearly everyone expects they will dominate.

The appendix contains an Horizon piece from 1999, reasoning from first principles, how AOL was overvalued. This reasoning proved correct. For an introduction to reasoning from first principles, see the book Elon Musk and Superforecasting (and The Fermi Technique in my Superforecasting summary).

Til next time,



Takeaways from MiB podcast interview with Ed Thorp

I very much recommend listening to the podcast episode of Masters in Business with Ed Thorp, through iTunes or through this Bloomberg link. It might well be one of the greatest podcasts of 2017. Thorp talks about how much he liked working with Claude Shannon, the father of information theory (my favorite class in uni). Shannon helped Thorp to optimize his position sizing in blackjack, given the odds and the estimated edge calculated by Thorp’s own card counting system.


Some takeaways:

  1. When Thorp didn’t ace a chemistry competition because he did not bring along the right slide rule to the exam, he learned that there’s many different ways to fail in real life. Takeaway being that in investing one should think creatively about different downside scenarios.
  2. Thorp was asked whether managing money did not get scary when the stakes went higher. His response was that he gradually got used to new amounts of money and that the fundamental problem of investing does not change along with scale (although the type of successful investing changes because of scaling). I relate a lot to this argument that investors should always start small to get comfortable with managing money.  This could be one of the reasons why many of my friends that were not investing as students feel uncomfortable now with the higher amount of money that they accumulated throughout their careers as they did not “grow” into investing. For my personal portfolio, I started out with a small amount of savings 10 years ago and I am managing an amount almost two orders of magnitudes higher today. Compounding has the property to feel slow in the short-term, which is why I feel completely at ease managing this new order of magnitude. I also make abstraction of absolute money amounts as I agree with Buffett (and Thorp!) that I do not really need the money.
  3. Thorp, being both a great practitioner and scientist, likes to use the rule of 72.

 “Don’t confuse the cost of living with the standard of living.” – Buffett & Thorp

For those that are looking for position sizing literature, I recommend Thorp’s work on Kelly betting (Wikipedia). For example, this paper by Thorp (page 27-28) shows that in a world with uncertainty of Kelly parameters (i.e. not gambling but the real world), it is better to use fractional Kelly betting as one gets penalized twice in case one’s estimate of risk/reward is too good (once for extra risk and once for less growth). As I will explain below, the way I think about which fraction to choose is besides the point.

Limits of the Kelly criterion for investors

I think the use of full Kelly betting is very dangerous in the stock market as the parameters are (very) uncertain. Too many quants go bankrupt by applying full Kelly  when it turns out they had overconfidence in their ability to estimate the risk and reward parameters. This is what Nassim Taleb (a great fan of Thorp, he wrote the foreword to his biography) calls victims of the ludic fallacy.

How I use the Kelly criterion in practice

If (full) Kelly betting cannot be done in the real world with uncertainty of parameters, and we don’t know how to choose our fraction, you might ask why bother. I let some years pass to think about this (as I was not able to find someone that addresses this), and I think the point of fractional Kelly is that, although we never know which fraction to pick, we should try to do our relative position sizing between individual portfolio positions proportional to the expected value versus risk (or signal-to-noise for the information theory folks) of each pick.

For example, the way I use the criterion goes like this: if I estimate that position A has three times better risk/reward ratio than position B, it should be sized three times the size of B. This is what I call internal position sizing consistency, and I try applying this in my portfolio.

Lastly, even in a portfolio that is for example 20% cash and 80% invested with internal position sizing consistency, it is of course dangerous to trust one’s relative risk-reward estimates if some position sizes go beyond 2-5x of others and reach high absolute sizes in the portfolio, because of idiosyncratic risk.  Thus, position sizes should also be capped on an absolute basis (for the real Buffetts among us this is probably in the ballpark of 30-50% in exceptional circumstances, for the rest it might well be in the 15-20% range).

If we estimate that position A has three times better risk/reward ratio than position B, it should be sized three times the size of B. 

Remark 1

I follow Greenwood Investors letters with great interest. However, I find the following in their latest letter a bit distasteful:

At quarter-end, our ratio of reward-to-risk stood at 38.3x, which is marginally better than the 38.2x at the beginning of this year. – Q2 2017 letter Greenwood Investors

  • first of all, I find it absurd to report a difference in reward-to-risk of 38.3x Q2 vs 38.2x Q1, this looks like pseudo-accuracy to me
  • secondly, if reward-to-risk for the portfolio would really be so huge as 38x, it would take huge uncertainty on these parameters to justify not having a huge gross exposure like 500 – 2000% for a rational investor like Ed Thorp (and which I trust Greenwood doesn’t have), which kind of proves my first point.

Remark 2: W. Poundstone popularized the Kelly criterion in his book Fortune’s formula, easy read.


Til next time,




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