Now Spotify Is Daring To Disrupt The Investment Banking Industry

When a privately owned company decides to list its shares on a public exchange. it is expected to follow the rules.

What rules? Well, for starters, the company is expected to hire an investment bank to guide it through the legal process. The bank also organizes promotional presentations for company representatives to “pitch” to potential investors. And perhaps most importantly, the bank underwrites the transaction by placing a value on the stock and then guaranteeing that the firm will receive that value during the sale.

The underwriting guarantee can be a risky proposition for banks. But by charging lucrative fees, the financial institutions can afford the risk of a massive financial obligation if the investors pay far less than expected.

Spotify, the streaming music provider that has disrupted the entertainment industry, is about to disrupt the investment banking industry by refusing to follow these rules. What does it intend to do? And why is it so daring?

The firm is not hiring an investment bank to provide any IPO services. Instead, by using an obscure “direct listing” process that has never been attempted by an organization of its size, Spotify simply intends to notify the New York Stock Exchange that it wishes to begin trading its shares.

No bank will organize any promotional presentations. None will provide any legal guidance, and none will be paid any fees. Perhaps most notably, none will provide Spotify with an underwriting guarantee.

For Spotify, this “direct listing” gambit is a reflection of its daring management style. Namely, it seeks to disrupt entire industries by eliminating the middlemen and by contracting with stakeholders directly.

In the music industry, for instance, the firm has dared to contract with the public while eliminating CD, DVD, and vinyl retailers. And now, on Wall Street, it is daring to attempt to reach investors while eliminating investment banks.

If Spotify succeeds, two different industry sectors will be disrupted by its daring strategy. Considering the buoyancy of today’s financial markets, it may prove foolish to bet against them.

We Can Now Trade Bitcoin Futures, But Should We Trust The Cryptocurrency?

It’s here! Yesterday, the Chicago Board Options Exchange (CBOE) launched its bitcoin futures trading market. Even if you’re not a currency trader, you may still be affected by the development of bitcoin as an alternative mainstream currency.

For instance, did you know that certain Subway sandwich franchises accept bitcoin payments? Imagine walking up to a Subway counter in the near future, ordering a Veggie Delight on Italian bread, and considering a choice of paying in dollars or bitcoin. With the banking sector on board, you may be able to check your mobile phone’s electronic payment app and identify which currency would be less costly for you.

Not bad, eh? Nevertheless, you must also keep in mind that a currency is only as trustworthy as the entity that manages it. The Federal Reserve System and the Treasury Department of the United States, for instance, have been managing the American dollar for more than a century.

Bitcoin, in contrast, has no national government to manage it. Instead, the public relies on the five year old Bitcoin Foundation to:

coordinate the efforts of the members of the Bitcoin community, helping to create awareness of the benefits of Bitcoin, how to use it and its related technology requirements, for technologists, regulators, the media and everyone else globally.”

But the Foundation has never been tested at a time of economic turmoil.

Furthermore, Bitcoin was launched in January 2009 when the global economy was crashing. At that unique moment in time, a fledgling currency like Bitcoin may not have seemed like a riskier bet than the currencies of collapsing nations. But today, our global economy and its national currencies are relatively stable.

So should you trust the cryptocurrency? By all means, if you’re an early adopter, please feel free to open a small Bitcoin account and purchase an occasional Subway sandwich with its funds.

But if you’re considering a far more significant investment in the currency, you may wish to think again. Although bitcoin is indeed gaining mainstream acceptance, it is still very much a recent offspring of the Great Recession. And it hardly even begins to possess the history and the durability of the American greenback.

Tenure Investing

In the academic world, junior faculty members at many schools are expected to apply for tenure after accumulating several years of experience. If they receive it, they are awarded a relatively high level of employment security, and various perks of seniority too.

But if they don’t? To put it gently, they are “expected” to seek employment elsewhere.

Many commentators have suggested that this tenure system is a relic of a bygone era, and speculate that it may be replaced by a more contemporary business employment model. But hardly any one has suggested that it may be adopted by the contemporary business community.

Until now! A group of financial entrepreneurs is proposing to do just that. They’ve developed a plan to create a new stock market that would specialize in corporations that adopt the principle of “tenured shareholder voting power.”

So how would it work? And what purpose would it serve?

A “tenure voting” firm would reward long term investors by increasing the amount of shareholder voting power as ownership is maintained for longer periods of time. An investor who holds onto a stock for ten years, for instance, would possess more voting power than a comparable investor who has only owned a stock for two years.

The purpose of the plan would be to encourage patience and long term thinking. Like tenured academics who remain professors for a very long time, the plan would seek to develop investors who likewise remain with a firm for extended periods.

Is there a catch? In the financial world, there is always a catch. In this situation, for instance, one may feel concern that an entrepreneurial founder of a company may exploit the tenure mechanism to earn back voting control after selling it. Thus, an individual like Mark Zuckerberg could sell voting shares in Facebook, earn back voting control through tenure, and then sell again.

Thus, this approach isn’t a perfect solution to the problem of encouraging long term investment perspectives. Nevertheless, it’s an intriguing concept, and a creative application of an academic practice that no one suspected would ever be adopted by the investment community.

Exercise Caution: A New S&P Index

At first glance, the announcement was an impressive one. At the swanky Word Economic Forum in the Swiss resort town of Davos last week, the Canada Pension Plan Investment Board joined Standard & Poor’s in announcing the creation of the new S&P Long-Term Value Creation Global Index.

Standard & Poor’s, of course, is the global provider of financial information that maintains a corporate mission of providing “data and research … (that is) independent, transparent and cost effective.” Presumably, S&P achieves its mission by utilizing its own expert professional staff to create clearly defined financial metrics without undue influence from — or overt reliance on — asset management and investment advisory firms.

In fact, that’s exactly what S&P is claiming to do with its new Long-Term Value Creation Global Index, comprised of 246 companies that purportedly “have the potential to create long-term value based on sustainability criteria and financial quality.” S&P continues:

The S&P LTVC Global Index is constructed by combining qualitative and quantitative measures into a single metric to determine the potential for long-term value addition. The Economic Dimension Scores provided by RobecoSAM are included in the qualitative assessment to gauge corporate governance effectiveness.  The quantitative assessment consists of drivers of long-term investment returns – Return on Equity, Balance Sheet Accruals ratio and leverage ratio.

Okay … but what is RobecoSAM? And are those investment metrics expertly and transparently designed to focus on long term value creation? In addition, doesn’t more than one balance sheet accrual ratio actually exist? And more than one leverage ratio as well?

Apparently, RobecoSAM is an asset management company. And one can find those investment metrics in elementary primers of standard accounting financial statements. And yes, there are many accrual and leverage ratios in active use by financial specialists.

In other words, S&P’s new Global Index of Long Term Value Creation simply takes a set of qualitative metrics that is computed by a single asset management company, and combines it with a set of generic and undefined financial metrics. Although S&P’s press release appears to imply that its qualitative assessment function encompasses other activities, it doesn’t specifically describe any additional work.

To be sure, the Canadian Pension Plan Investment Board should be commended for attempting to promote a long term value perspective in the financial industry. And S&P should certainly be encouraged to continue its mission of developing expert metrics that are “independent, transparent, and cost effective.”

Nevertheless, when the qualitative component of an S&P index emphasizes the metrics of a single asset management firm, it doesn’t bode well for the firm’s mission of independence. And when an index provides no detailed description of its investment metrics or its other qualitative assessment activities, it doesn’t bode well for the firm’s mission of transparency.

One could argue, of course, that such effortless approaches to constructing indices may help S&P achieve its mission of cost effectiveness. Nevertheless, given these other concerns, financial investors might wish to exercise a bit of caution while reviewing the S&P Long-Term Value Creation Global Index.

401(k) Flows: From Boomers To Millennials

The American economy seems to be moving in two different directions, doesn’t it? On the one hand, in industries like consumer technology and energy production, it continues to achieve ever more impressive levels of global success. But on the other hand, in sector after sector, it’s been ceding its “world’s largest market” status to China.

Not all of its bi-directional activity is global in nature, though; some is strictly domestic. Last week, for instance, the retirement investment industry was abuzz with the news that outflows from 401(k) retirement accounts are finally exceeding inflows on a continuing basis.

The reason? 401(k) accounts were first established to help the baby boom generation accumulate savings for retirement. And boomers, on schedule, are finally about to start retiring in large numbers.

That means that the American macro-economy is about to start experiencing a massive aggregate shift from “saving for the future” to “spending for today.” How will that affect our society?

Well, as money is withdrawn from well diversified stock and bond retirement funds, the financial markets might slump a bit. But as that money is spent by retirees and then circulated through the economy via the multiplier effect, the markets might then rebound.

Of course, if the expenditures are primarily focused on goods and services that are demanded by retirees, other sectors of the economy may weaken. But to the extent that those retirees are withdrawing retirement savings from international (i.e outside of the United States) stock and bond markets and then spending the proceeds close to home, the American economy may reap significant benefits.

Naturally, we must also consider the impact of other demographic groups on the American economy. Many retirement asset managers, for instance, are anticipating that the millennial generation will finally leverage the benefits of a strengthening job market by settling down, getting married, buying homes, and starting families. Such activities are usually accompanied by the establishment of retirement savings plans.

Furthermore, there is always a possibility that the federal government might finally get serious about immigration reform. The legalization of millions of undocumented millennials and Generation X’ers in the United States, perhaps accompanied by expanded visa programs for additional highly trained immigrants, might create a large new pool of retirement investors.

Which of these factors will prove to be most significant? Who knows? Clearly, we should be skeptical about any one who claims to be able to predict the future of the financial markets. Although it’s easy to understand why the emerging net outflow from 401(k) funds might serve as a depressive force on the investment markets, there are many other factors that might counteract its effect.

In fact, the only thing we know with absolute certainty is that the baby boom generation will inevitably continue to pass the economic baton to successor generations.  And the future of the American economy will increasingly depend on the talents, skills, and abilities of those future generations to navigate the challenges that confront them.

Common Core and Liquidity Auctions

Is it too much of a stretch to claim that American Federation of Teachers President Randi Weingarten and New York Stock Exchange CEO Henry DeCoste share a common concern? Perhaps so, though it does appear that both are worried about the impact of performance metrics on their operating systems.

For instance, as the President of America’s foremost teacher’s union, Ms. Weingarten has protested long and hard against the student testing policies of the Common Core and No Child Left Behind programs. One concern appears to be focused on the harm that can be inflicted on the process of classroom instruction when the instructor “teaches to the test,” thereby diverting learning efforts from critical thinking activities to memorization tasks.

Meanwhile, last week, the NYSE applied for permission to launch a new initiative that addresses a similar premise. Although its adoption of a mid-day stock auction process might seem arcane to laypersons, the motivation behind the initiative is comparable to the concerns of Ms. Weingarten.

You see, investment management strategies have been shifting significantly from value trading to momentum trading activities. In other words, instead of assessing the long term value of firms and then purchasing undervalued equities, investors are increasingly assessing the movement of stock values during a trading day and then rushing through trades at the very end of that day (or at the very start of the following day).

But when large numbers of traders gravitate to such strategies, relatively few trades remain during the mid-day hours. As a result, large volumes of late day momentum trading transactions are based on relatively small volumes of mid-day trading activities, a situation that jeopardizes the stability of the entire financial system.

The NYSE’s solution is to stimulate mid-day trading by holding auctions, a strategy that may yield some incremental improvement. Nevertheless, such auctions do not address the fundamental problem that the widespread adoption of financial market performance metrics is significantly impacting the activity that it is purportedly measuring. And that very situation exists in regards to the Common Core and No Child Left Behind programs as well.

In other professional and academic fields, researchers have known for decades that the presence of investigators can influence the behavior of phenomena. In the 1920s, for instance, business engineers referred to this condition as the Hawthorne Effect. And in the 1960s, sociolinguists called it the Observer’s Paradox.

A similar effect now appears to be wielding an outsized influence today in fields from primary education to the investment industry. Thus, before we respond to metrics of sub-optimal performance by modifying our operating activities, perhaps we should pause to identify the disappointing outcomes that are attributable to the measurement process itself.

Annuitizing Pension Plans: Who Wins?

Last month, Bristol Myers announced that it was jumping aboard the pension plan annuity conversion bandwagon. Instead of continuing to manage retirement obligations for its eligible employees, Bristol decided to contract with Prudential to convert its pension plan to a set of annuity contracts.

As a result, Bristol’s retirees will receive the same benefit payments during their retirement years. However, Prudential will distribute the funds in the form of annuity payments, in place of plan distributions from Bristol’s pension entity.

Two years ago, when General Motors (GM) pioneered the arrangement with Prudential, it was not yet clear whether its conversion would prove to be a unique event or a harbinger of a trend. Now that VerizonMotorola, and Bristol have followed suit, it would indeed appear to be a trend.

So who wins, and who loses, as a result of such a transaction? One could argue that every one wins. The corporation releases itself from an extremely large and unpredictable future liability, the beneficiary (i.e. the employee) gains the security of reliance on a global insurance company for professional fund management activities, and the insurer itself wins new business.

On the other hand, though, one could argue that every one loses. In the GM transaction, for instance, Prudential forced the firm to pay $29 billion to cover its $26 billion pension liability. In other words, GM effectively agreed to pay a multi-billion dollar fee to offload its liability to Prudential.

And though GM’s employees were promised that their retirement benefits would not change, they were forced to accept a private insurer’s annuity guarantee in place of a federally insured, ERISA regulated pension guarantee. As the former annuity beneficiaries of Executive Life and Mutual Benefit Life can attest, such private guarantees may offer far less protection than pension guarantees.

Even Prudential itself might not necessarily “win” in the long run by securing such new business. After all, by assuming the risk of managing benefits for pre-existing groups of beneficiaries, the insurer forfeits any opportunities to perform risk assessment pre-screening activities on its new beneficiaries. And Prudential itself possesses a somewhat spotty track record of utilizing derivatives to manage its annuity risk.

So, on the whole, is the annuity conversion trend a positive development or a negative development? It’s obviously difficult to offer a definitive answer to that question. It certainly appears that one can develop a convincing argument in favor of either position.

One cannot help but wonder, though, whether employees and retirees would benefit the most from simple self-managed IRA arrangements. Given the recent track records of insurers (like Prudential) and employers (like GM), who could argue with any employee who prefers to fully control her own retirement assets? And who wishes to select her own advisors and asset managers?

Some may argue that such an approach places all of the annuity risk on the shoulders of the employee. But in an era when financially strapped organizations can unilaterally slash pension benefits, and when insurance companies line up for federal bailouts, isn’t that where the risk ultimately falls?

Hong Kong On The Hudson

A funny thing is happening on the way to China’s future economic domination of America and the western world. Contrary to expectations, some of China’s most successful corporations are choosing to plant roots in the West instead of the East.

Alibaba, for instance, represents China’s e-commerce version of the American firm Amazon. It was initially expected to list its first major public offering of stock on the Hong Kong Stock Exchange, the second largest exchange in Asia after the Tokyo Exchange. But last week, news outlets reported that Alibaba will choose to raise up to $15 billion on the New York Stock Exchange or the NASDAQ instead.

Weibo is expected to raise $500 million in the United States as well. Weibo represents China’s version of Twitter, a service with more than 60 million active users.

Interestingly, Hong Kong appears to have lost Alibaba because of its regulatory insistence on the principle of investor control over boards of directors. Alibaba prefers to have its own managers and founders control its Board, a position that appears to be acceptable to the NYSE.

Investor control over corporate boards, of course, represents a bedrock principle of corporate governance. And yet major Chinese firms appear to be finding more flexible interpretations of this principle in the United States than in China.

Thus, New York may be evolving into “Hong Kong On The Hudson,” a moniker that does not refer solely to the prevalence of initial public offerings by Chinese firms on the NYSE or the NASDAQ. Apparently, it also refers to the willingness of stock exchange officials in the United States to accept management structures that are no longer acceptable in China.

If you were Mary Jo White, Chair of the United States Securities and Exchange Commission, would you permit the NYSE to win Chinese business by interpreting principles of corporate governance in a flexible manner?

Internet Neutrality and Market Competition

Many consumer advocates expressed concern last week when a federal court judge struck down regulations that required the “net neutrality” of internet service providers. Without such regulations, the advocates fear that telephone and cable companies that provide access to the internet may begin to wreak havoc on the existing system of web services.

On the one hand, they do have valid cause for concern, given that service providers now possess the right to manipulate web traffic patterns. But on the other hand, a little chaos in the short run may possibly benefit consumers in the long run.

What, exactly, is net neutrality? It’s the longstanding policy, first established by the Federal Communications Commission of the United States, that internet service providers must provide equal and open access to all web sites and services. Comcast Cable, for instance, had been prohibited from strengthening the competitive position of its own NBC Universal programs by slowing down or blocking rival video streaming services like Netflix or Google’s YouTube.

But as a result of last week’s court decision, internet service providers now possess the right to engage in such brazen tactics. What would be the outcome of this type of bare knuckled competitive activity?

It’s not difficult to foresee that producers of content might retaliate by developing new technologies for reaching their audiences. Google, for instance, has already introduced its own fiber based internet service network in Kansas City, Missouri. It has announced plans to introduce similar networks in Austin, Texas and Provo, Utah as well.

It’s also possible that producers of content might retrofit and then customize traditional systems of data transmission for digital use. When the original analog television broadcast spectrum was upgraded to transmit digital signals, a “digital dividend” of unused spectrum was set free for alternative uses. This unused spectrum can now be utilized for new broadband networks.

Such blending of traditional television broadcast technologies and web based data streaming services would be consistent with today’s newly emerging delivery systems. Aereo, for instance, is currently battling the legacy television broadcast networks for the right to capture free television signals via antennae, and then to stream the video (without paying royalties) over the internet to its customers.

In other words, although the deregulation of the internet service industry may strengthen the competitive positions of entrenched providers in the short term, it may incentivize new rivals with far deeper pockets to develop innovative delivery systems in the longer term.

If you were the investment director of a telecommunications industry mutual fund, would you buy or sell the stock of Comcast and other internet service providers in light of the recent net neutrality court decision?

Invest In A Football Player!

Fans of the National Football League’s Green Bay Packers have long been able to purchase shares of stock in the franchise. No other NFL organization sells ownership shares to its fans, though, a fact that is undoubtedly disappointing to the supporters of the other 31 professional football teams.

Last month, however, an investment group named Fantex offered a tantalizing alternative to fans of those 31 franchises. Instead of investing in your home team, why not invest in your favorite players?

Last Thursday, Vernon Davis of the San Francisco 49ers announced that he had sold 10% of his future earnings to Fantex. He joined Arian Foster of the Houston Texans, who had signed a similar deal with the group two weeks earlier.

Fantex intends to create a tracking stock for each of the players, a stock that would be traded by small investors on a privately owned (and thus relatively unregulated) stock exchange. It will represent, in essence, a fantasy football league … albeit one that is “played” with real money.

Fifty years have passed since stakeholders in the Oakland Raiders franchise of the original American Football League launched the world’s first fantasy football competition. Ever since then, fantasy football aficionados have been entertaining themselves by engaging in virtual player drafting and trading activities.

If Fantex is successful, though, individual investors will be able to add their favorite football players to their “real world” financial portfolios. Will they be prepared to do so in a responsible manner? For obvious reasons, many investment professionals are expressing concern; indeed, we might all be well advised to segregate our sporting interests from our financial planning strategies.