Deflation and negative EV companies.

According to some financial researchers, the current inflation rates are similar to the ones seen during the Great Depression. However, this may be a good news for those planning for long term investments as some companies might have a negative enterprise value (EV)

Deflation:

A Persisting decline in prices results in a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans. Deflation is also linked with recessions and with the Great Depression.

However, care should be taken while talking about deflation as it is different from disinflation which indicates a slowing of the rate at which prices increase. Also, deflation should not be confused with a temporary fall in price. Deflation is typically caused by a shift in the supply and demand curve for goods and interest, particularly a fall in the aggregate level of demand.

What does the negative EV mean?

I asked this question to my friend who works at KPO, and this is what he had to say.

Let's say there's a company, BigB Inc., that has a market cap of $40B, $2B of debt, no preferred stock, and $45B of cash and cash equivalents, making BigB have a total enterprise value of -$3B.

Banks and Negative EV:

Further, their blog on negative EV cleared my doubts on why in the current markets cash in hand is considered to be a king. This company has more cash than the market value and if the forward EPS is attractive then many would suggest such companies to be a good buy. These companies are effectively offering profits to their shareholders for free. This is true in the case of many banks that have a lot of cash in their reserves.
The blog takes this notion of negative EV further, by highlighting the geographical distribution of the banks that have a negative EV.

Outsourcing Financial Activities

The current financial storm and the tight margins have motivated business houses throughout the world to increase the use of third parties to carry out activities that the businesses themselves would normally have undertaken. The message of importance of outsourcing is crystal clear, to organizations that have survived this crisis. Hence, outsourcing is increasingly used as a means of both reducing costs and achieving strategic aims.

Knowledge Process Outsourcing (KPO):

Knowledge Process Outsourcing (KPO), considered by many to be the future of outsourcing, is a trend which is catching the fancy of such business houses. The increasing confidence in outsource providers skills coupled with their iso 27001 standardization are some of the key features that make KPOs such as S.G. Analytics attractive.

Important Points while considering KPOs:

Some of the key points that one should look out while outsourcing financial activities are:

1. Every organization operated with some strategic long and short time goals. The service provider should relate to these goals and strengthen efforts to achieve them.
2. The total cost is always the driving factor but one must realize that despite the costs the quality should not be compromised.
   
3. Security issues are vital and should be given ample thought and time during the discussions. Financial activities form the keystone for the success of a company, hence look out for certification such as ISO 27001.
   
4. Review of the past projects gives a clear picture of how the company operates and the quality of service that can be expected.

Key Benefits of KPOs:

Save the valuable time and money is possible for business houses when they start outsourcing their financial activities to the KPOs.

Outsourcing Fund Administration

Financial valuation is the many a times considered as the corner stone of applied mathematics and economics. The performance of fund managers are many a times judged on the Net Asset Value (NAV) of the mutuals funds they manage. Computing the NAV requires valuation of funds assets and liabilities. This task is cumbersome and takes a non negligible amount of time.

Impact of time spent in computing the NAV:

Over the years the time spent by fund managers in administrative tasks such as
such as calculations and reporting of the NAV has increased. As a results of which they were forced to cut short on their analysis to devote time towards such fund administration tasks. Over the years the above activities which complement the management of the assets are being considered for outsourcing.



Role of KPOs:

Fund managers have been seeking the help of KPOs to administer their funds as they have realized that such intensive work is not efficient for internal staffing as staffing cannot commit a reliable long term support. Such forms of outsourcing is important not only for the fund administration but also for fund analysis as structured and organized records are useful in all the phases of fund management.

What does Net Asset Value (NAV) mean?

The net asset value," or "NAV," of an investment organization is the organizations total assets less its total liabilities. For example, if an investment company has assets worth $10 million and liabilities of $1 million, the investment company’s NAV is $9 million.


NAV for Mutual Funds:

This term has been extended to mutual funds as well. In the case of mutual funds, the Net Asset Value (NAV) of a mutual fund is the price per share. It is calculated by dividing the total value of all the securities in its portfolio, less any liabilities if any, by the total number of fund shares that are outstanding. Units in open ended funds are valued using this measure. The NAV is calculated at the ned of each day (after trading has been stopped) by taking the closing market value of all securities owned plus all other assets such as cash, subtracting all liabilities, then dividing the result (total net assets) by the total number of shares outstanding. For example, if a fund had net assets (considering the assets less liability) of $50 Million and there are 10 million shares of the fund, then the price per share or NAV) is $5. The popular mutual funds publish their per share NAVs in the daily newspapers.

Is the NAV the best metric to evaluate the fund performance?

As the mutual funds pay out virtually all of their income and capital gains, changes in NAV are not the best gauge of mutual fund performance. Financial researchers consider the annual total return as the best way to evaluate the performance of mutual funds.

So when any one talks about NAV please ensure that the context is known as the definition of NAVs is highly dependent on the context.

A very comprehensive article related to NAV is available at the SEC site at http://www.sec.gov/answers/nav.htm

Outsourcing of Financial Research

Over the years one of the prime concern of fund managers and other investors is the valuable time spent by the analysts on analysis. Studies have shown that a considerable amount of time was spent by the analysts in activities such as sourcing of financial information, preparing reports, populating the data required for financial research, tracking information related to mergers and acquisitions etc. Given the current mayhem at the stock markets and the need for detailed analysis of the situation has motivated the visionaries of many successful organizations to outsource a considerable amount of work to KPOs which specialize in financial research and analysis to improve their turn around time.



Services Provided by KPOs

The services of such KPOs include financial information aggregation investment research analysis, market intelligence, reporting and publishing support. The services of KPOs cover all approaches of investment decisions which encompass making an investment choice based on funds, equities, sectors, countries etc. Their clients include private equity and hedge funds, large investment banks, asset management companies, corporate finance groups, fund administrators and other financial institutions. This is achieved with a finesse as KPOs design, create and deliver customized solutions to Investment banks, Asset management companies, Private Equity groups, corporate finance groups and Large Institutional investors. One the key areas in which KPOs operate are the writing of annual reports which ease the process of mining the data present in the annual reports, and sourcing the information required for financial research. This is useful for studying and predicting the future of an organization but also giving key insights on the working of the whole sector.

Such KPOs not only help their clients create value by providing customized services which are backed by domain expertise and high-end analytical skills but they also work closely with their clients to deliver services that adapt to their evolving needs.

Financial Valuation Models

One of the critical components of financial research, due to its use in almost every aspect on financial analysis, is estimation of the market value of the financial asset/liability. It is commonly known as financial valuation and the efficiency of using these models determines the quality of research done by the financial researchers.


Which models are widely used ?

The most widely used models are the relative value models, absolute value models and option pricing models. The relative value model is widely used by the hedge fund managers to quantify the attractiveness measured of one financial instrument relative to another. Further, some Hedge funds have mastered strategies that take advantage of the difference in pricing between two related and correlated securities. Sector Researchers have taken relative pricing further to compare various sectors such as telecommunication, mining, etc.

Black-Scholes Model:

The modern pricing are some of the most mathematically complex applied areas of finance and mathematics. Financial analysts have reached the point where they are able to calculate, with alarming accuracy, the value of a stock option. The most widely used models for pricing are the Capital Asset Pricing Model, the Fama-French three-factor model and Black-Scholes pricing model. The Black-Scholes model is so popular that most of the models and techniques employed by today's analysts are rooted in this model. As the value of an option varies only with the stock price and time to expiry it supports the possibility of a hedged position consisting of a long position in the stock and a short position in calls of the same stock whose value will not depend on the price of the stock.

Hedge Funds or Short Sellers?

Hedge Funds first started gaining popularity after the 1997 asian economic crisis as the hedge funds tend to be skill-based investment strategies whose returns are considered "absolute," as they do not depend on the relative long-term return of underlying traditional stock and bond markets. As their name suggests, these funds are mainly used as hedge against the volatilities associated with the investment in securities. Evaluating the performance of hedge funds is non trivial task as the hedge fund managers are not required, and in many cases not allowed, to advertise or report performance data to any central authority. As a result, many of the top hedge fund managers are not listed in commercially available databases.




Over the years it has long been accepted that risk management is a core competency for generating absolute returns within a hedge fund strategy. Further, the hedge fund strategies have had a history of offering returns independent from the performance of stock and bond markets. One commonly used technique is by short selling. However many funds that do not hedge but are active only in short selling have recently been getting the limelight as the primary objective of the hedge funds was violated. Financial researchers have been been advising their clients to invest in these funds with caution, however many have fallen into the trap of myopic short sellers. Prior to the current market downturn, hedge fund managers were able to diffuse requests for transparency. However, increased regulation, scrutiny and transparency are knocking the doors of the hedge fund industry. This is seen as the silver lining by many investors whose faith which was the instrument of cash inflows was subject to the merciless greed of many fund managers.

The outcome of the bloodbath at the stock markets all over the world has highlighted the importance of effective governance and risk management in hedge funds coupled with the need of greater visibility into a hedge fund manager's governance and risk programs.

Custom Databases For Financial Analysis

Financial Analysis and Research relies heavily on the data mined from the various online and offline sources. Mining this offline data is many a times a herculean task as it involves not only parsing the annual reports but other records that are publicly available at various government institutions. Once this data is obtained, it needs to stored in a structured format. This article gives a nice overview on the importance of sourcing the data for such custom databases.



Custom Databases:

Many financial researchers require the databases stored in the format they have tried and tested over the years, but due to the lack of time have decided to outsource this activity to KPOs. Designing the schema to ensure that the requirements are met is a cumbersome activity. Further, this task becomes non trivial as the Atomicity, Consistency, Integrity and Durability of the database needs to be ensured. Many database engines ensure the above criteria are met however, the processes feeding this data must also ensure that none of the above criteria are violated. This is extremely critical when operating with the offline data which is entered manually.

Presenting the Data:

Storing the data in a structured format is just the tip of the iceberg, as the UI that allows users to access the data needs to be designed. KPOs that operate in the area of financial research and analysis have lately mastered the art of not only mining the data and storing them in structured and custom databases but also in providing some neat user interfaces to easily access this data. This activity has been many a times won accolades from banks and fund managers for being a time saver.

A new beginning for the Auto Sector or is it the beginining of the end?

This Tuesday shall be remembered as a dark day for the auto industry as it marked the beginning of the company wide reduction of General Motors Corp.’s salaried workforce. GM is said to have told about 160 people at its manufacturing engineering operations in Warren that they would be laid off as of April 1. GM is currently surviving on $13.4 billion in government loans and has requested another $16.6 billion. In addition to white-collar jobs, GM is expected to eliminate 18,000 more U.S. blue-collar positions by year's end to bring their labor costs to make them on par with their Japanese counterparts who are also facing the brunt of the auto sales downturn in 27 years.

The absence of this bailout package would have put the global auto sector on the brink of collapse. The critical nature dawned to the world when GM bought a few weeks of time by letting Suzuki buy back the 3% of stake GM had in Suzuki. There was a fear that if the even one of the big 3 in Detroit - Ford, GM and Chrysler - failed the auto sector would have collapsed. The supplies of the auto components at sourced from small shops across the world which tend to more than one auto major. If any one of these 3 collapsed, then there was a chance that these small industries would collapse, thus affecting the supplies of the other OEMs which have their presence scattered all over the world. Financial researchers who have mastered sector research were spending sleepless nights to study the impact this bailout on the various sectors so were the fund administrators who were worried of the health of their funds.

Save and Invest

There has always been a dilemma in my mind regarding savings or investments. I came across a nice post regarding the never ending conflict between savings and investments. Many financial researchers suggest that the cash in hand should be put to optimal use by a using financial instruments that give a perfect blend between savings and investments.

Some consider saving as a protection or insurance from the volatilities of investment in the markets, some stretch this concept further and consider hedge funds as savings that can protect them from the market turbulence. One of the oldest forms of such savings was gold. This has even been given a religious flavor as some religions encourage buying gold on special days and festivals. In India this is coupled with Government Bonds, Government Savings Schemes and Fixed Deposits.



Importance of a perfect blend of Savings and Investment:

In his speech on Mar 24, Barack Obama said, "At the end of the day, the best way to bring our deficit down in the long run is not with a budget that continues the very same policies that have led to a narrow prosperity and massive debt. .... It's with a budget that leads to broad economic growth by moving from an era of borrow and spend to one where we save and to one where we save and invest".

The need for the perfect blend of savings and investments that results in the optimum growth is the primary motivation that has led to the evolution of many financial instruments and mathematical models to optimize these instruments. Financial researchers and KPOs have been known to toil hard to study these models to ensure that the desire for this perfect blend of investments and savings is attained.

Sovereign wealth funds

Sovereign wealth funds are state-owned funds that are invested in different avenues across the globe. The money for such a fund is accumulated by the country or its central bank from sources like banking system, oil trading, foreign currency reserves, pension funds, precious metals etc. They are assets of the corresponding nation. They are generally invested with a long term horizon. Investment management entities are setup by the state to manage these funds.



Creation of Sovereign Wealth Funds

A sovereign fund is created when a nation has excess liquidity than is desired, which cannot be immediately consumed. This liquidity is maintained in the form of reserve currencies, precious metals, oil etc. These funds are used as a source of stability or a cushion against volatility in the international market for raw materials that are imported. By employing these funds, one can control the impact on the government expenditure due to the short term volatility of markets. During the recent credit crisis there were stories of some sovereign wealth funds making bad investments in Wall Street firms that have collapsed and needed cash infusion.

Concerns regarding Sovereign Wealth Funds:

There are certain concerns regarding these funds. Lack of transparency, no clear goal sometimes and their huge size which can have a great impact on asset markets. The total worth of most of these funds globally is now more than $3 trillion and growing at a fast pace. There are also security concerns due to these foreign investments as one of the potential motive might be to control certain strategically important industries of the country.

I came across a financial research article by S G Analytics, a KPO about these funds. The article argues that protectionist barriers are not the answer to security concerns arising from the nationality of the incoming investment. A more transparent and good regulatory environment is better suited to address these concerns.

BRIC: Emerging at a Fast Pace

Brazil, Russia, India and China (BRIC) have been some of the fast growing developing economics in the past few years. The name BRIC was first coined in 2003 by Jim O'Neill, the head of global economic research at Goldman Sachs. These four countries are also being referred to as the big four in the arena of emerging markets.

Of the BRIC Nations, according to this article, India and China have caught the fancy and faith of many investors as a result of which the investments to these countries have not stopped flowing. As a result of this the services of many KPOs specializing in the research of emerging markets, have been in great demand.

Lack of Liquidity: A major concern

The lack of liquidity is a major concern for investors investing in these emerging markets. There have been many instances where the lack of liquidity has caused the complete market to crash and stay low for a long time.

Another BRIC in the Wall:

Many articles, such as Emerging Markets: Another “BRIC” Hits The Wall, state a hazy picture for R and I of BRIC, however the prospects of China appear to be bright. In the case of India, as the author pointed out, the country has immense growth possibilities however the flight of success has its wings being chopped by the wrath of of corruption and incompetent governments.

Tourism Sector: Sector Research Perspective

The year of 2008 saw the oil prices soaring to new highs and touching about 150 USD per barrel (about 40% higher than the average price in 2007). Speculator spread rumors that it could also touch 200 USD per barrel. However by Feb 2009, it stabilized in the region of about 45 USD per barrel. One of the sectors that was worst hit by these fluctuating prices was the tourism industry.




Domino Effect:

The economic downturn is also expected to have a severe impact on the business travel which according to the World Tourism Organisation (UNWTO) accounts for about 15% of the passenger arrivals worldwide.

The tourism sector had borne the major brunt of the aftermath of 9/11 attacks which saw even some national flag carriers such as Sabena and Swissair collapsing. In India some of the major airlines such as Kingfisher and Jet-Airways allegedly defaulted on some of their payments and even entered a mutual agreement which raised the eyebrows of the regulators responsible for protecting consumers from monopolies.

Sector Research: Analysis of the Domino Effect

Financial analysts have spent sleepless nights trying to analyze the impact of such cascading effects where the performance of one sector can cause havoc on the results of another sector. Employees of KPOs have spent sleepless nights trying to evaluate the impact of such variations in prices and agreements between organizations on the financial health of the funds administered by them.

The current crisis has shown that sector research is a non trivial task as it involves the a detailed impact analysis of financial health of one sector on the financial health of the other. Such domino effects can have hair raising consequences if not analyzed correctly.

Information Aggregation: The need of the hour

“Prediction is very difficult, especially if it's about the future.” -- Neils Bohr.

Predicting the financial health is one of the primary activities of financial analysts and financial researchers. It is common knowledge that the outcome of any research activity depends on the data set on which the research is performed. Over the years leading KPOs such as S.G Analytics, have emphasized the importance information aggregation. In the financial research, the outcome depends on the details present in the data used and the organization of the data for mining.

Web as the source of data:

Lately the web is being highly relied upon as a source of the data. Regulatory bodies such as the SEC have ensured that this process is simplified by the introduction of the Electronic Data-Gathering, Analysis, and Retrieval (EDGAR) filing system. The EDGAR data is available for search at http://searchwww.sec.gov/EDGARFSClient/jsp/EDGAR_MainAccess.jsp.

Complexity in Mining Raw Data:

Most of the raw data is available in the internet, however past records of many companies are not present. Bloomberg, Reuters, and Associated Press (Google), are some of the key sources of past information however fund managers and financial researchers may require the annual reports of companies.

Role of KPOs:

Mining such data, aggregating it and presenting it for future source is some of the areas where KPOs have lately increasing their presence. The information aggregation services of the KPOs usually includes sourcing, validating, normalizing and presenting the information through a database that meets requirements of the financial analysts.

A critical requirement for information aggregation is the ability to maintain live and large databases at low costs. This art is currently being mastered by the KPOs.

Fund Administration

The lack of knowledge about the working of the stock markets and complex financial instruments involved has played a considerable role in the growth of collective investments schemes, commonly known as mutual funds.

Key players in a mutual fund:

The key players who are involved in the life cycle of a typical mutual fund include:

• A fund manager who manages the investment decisions, and
  
• A fund administrator who manages the other activities involved in running the mutual fund
  

Primary Activities of Fund Managers:

The primary activities with fund managers is seeking and ensuring a smooth addition of investors who wish to invest in a particular fund, and managing the flow of money.
Apart from overlooking the flow of money, many administrative tasks are involved in running such schemes. Some of the activities involved in fund administration are:

• Preparation of the accounts, in many cases annual accounts
• Daily accounting, recording and maintenance of all investment activities including multi currency accounts
• Corporate actions and cash reconciliations
• Calculations and reporting of NAV, dividend accruals, total expense ratio (TER), taxable income by jurisdiction, security lending income, book cap stocks, etc.
  

Outsourcing opportunities

Over the years the above activities which complement the management of the assets are being considered for outsourcing. Fund managers have been seeking the help of KPOs such as S.G Analytics to administer their funds.

Role of KPOs

This kind of outsourcing is important not only for the fund administration but also for fund analysis. Well kept records also ease the process of information aggregation. This is also useful for mining the past records for future analysis.

Knowledge Process Outsourcing

The World Bank Institute offers a formal definition of a knowledge economy as one that creates, disseminates, and uses knowledge to enhance its growth and development. Knowledge process outsourcing (KPO), though being in its nascent stages has started to compete with its much older sibling business process outsourcing (BPO). KPOs rely heavily on the use of knowledge technologies such as knowledge engineering and knowledge management to produce economic benefits.

Sectors in which KPOs operate

Some of the various sectors that are included in KPO are illustrated in the following figure.



There are a few KPOs that are operating from India, however only a few such as S.G Analytics work in the area of Financial Services and Market Research and Analytics. The research areas of such KPOs include (but is not limited to)

• Equity research
• Sector research
• Thematic research
• Fund analysis
• M&A support
• Investor proposals
  

Challenges faced by the KPO industry:

In spite of the current economic slowdown, the market of the above research areas is expected to grow to about $10 billion by 2014. This eye-opener was first brought to public notice in the following blog post . The presentation gives an idea of recruitment challenges of the KPOs. I am glad that one of the key players in this industry has made this available

Pune as the most suitable destination for a KPO in India:

An article in rediff.com , gives some of the few reasons why India offers the highest potential for Knowledge Process Outsourcing (KPO).

• India enjoys unique advantages in having a large pool of English-speaking professionals.
  
• The Indian Diaspora are a rich source of domain expertise and can be motivated to help transfer knowledge and expertise to India and nurture a new generation of India-based thought leaders.
• The entrepreneurial and energetic business community in India has the capacity to step up to this challenge.
  

The above facts have been supported by the former president of India, Dr. A P J Abdul Kalam, in his book titled India 2020: A Vision for the New Millennium.

As pointed out by S G Analytics, the advantages of being a KPO in Pune include:

• Access to fresh talent: Termed as Oxford of the East more than 70 educational institutions (colleges and universities), 50,000 students and 3,000 MBAs graduating each year!
  
• Access to experienced and senior talent - Industrial zone with more than 30 large companies (>2000 staff) and more than 2000 SMEs. Outsourcing hub of India (IT services companies, BPO's KPO's)
  
• Access to sector research and language capabilities - Research institutions such as NCL (National Chemical Laboratory), NIV (National Institute of Virology), IUCAA (Indian equivalent of CERN) and C-DAC (Centre for development of advanced computing).
  
• Language capabilities - More than 200 certified German, 70 certified French and 50 certified Japanese translators graduating each year.