When Should Directors Intervene in Trust Management and Scottish Mortgage Ructions

The FT published an interesting article on Friday about recent events at Scottish Mortgage Investment Trust (SMT) under the headline “Inside the boardroom bust-up that shook Scottish Mortgage”. It provided some explanation of why director Amar Bhide has left and chairperson Fiona McBain is departing.

SMT has a great long-term track record which it has achieved by investing up to 30% of its assets in unlisted companies – typically high-tech “unicorns” that had good prospects of listing in the future. This all went wrong when the enthusiasm for technology companies collapsed and the share price of SMT has halved in the past 18 months (and the shares are currently on a 19% discount to Net Asset Value).

With a policy that limits the level of investment in unlisted companies, which cannot be easily sold, this has limited the company’s ability to manoeuvre and certainly inhibited new investments as the share prices of listed holdings fell.

This comes back to the old question of how much the board of an investment trust should interfere in the management of the portfolio. Should they let the managers get on with it, or should they review and possibly veto individual investments rather than just set general policy? If they don’t like what the manager is doing should they intervene?

Or should they wait long enough to see whether the manager’s decisions are clearly right or wrong? If obviously wrong they can be fired of course but often that is way too late.

I recall this was a common problem in the early days of Venture Capital Trusts. New and often inexperienced fund managers in the small cap sector took them on and boards of directors would be made up of those with general experience and willing to turn up once a month for little pay to oversee matters, but often with no background in small cap investment management. There were several disasters as a result.

Boards that reviewed new investments and intervened in the management when necessary, proved to be the best. This was not a case of second-guessing the management or looking continually over their shoulder. Simply a way of getting a kind of “peer-review” of the decisions being made.

In the case of SMT should the board have reviewed and revised the management’s predilection to invest in unlisted shares when it started to lose performance? There is not a simple answer to that question.  It should certainly have merited a review but whether it makes sense to change the strategy really depends on how long technology stocks might be out of favour.

There is certainly grounds for criticism that the board lacked directors with hands-on investment management experience and with too many academic professors plus a chair who had been there too long. These things can be easily fixed.

As a holder in SMT, I think it wise however for them to stick with the strategy of holding a significant proportion of unlisted shares. Companies in the technology sector are often reluctant nowadays to go for a stock market listing so if you ignore unlisted companies you can miss out on high growth opportunities. But valuing unlisted companies can be tricky. There is a big temptation to over-value their growth prospects as happened in new VCTs twenty years ago.

The board of SMT should be reviewing carefully the decisions of the investment manager until the company has stabilised, and not be afraid to intervene when necessary.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Bank Interest Rate Raised, the Prime Minister’s Tax Return and Credit Suisse Bond Wipe Out

The Bank of England has raised bank rate to 4.25% which will create howls of anguish among mortgage holders. The US Federal Reserve also raised its rate. But with UK inflation still above 10% p.a. it is quite justified in my view. We do need to get back to reality with real interest rates, i.e. they should be at or above the rate of retail price inflation. At least PM Rishi Sunak has made it his top priority to clamp down on inflation. Let us hope he sticks to it.

High interest rates will certainly put a damper on stock market investment but the short-term pain is worth it. As I suggested in my comments on the budget, the probability of inflation falling to 2.9% by the end of the year is a grossly optimistic forecast.

We also now have sight of Rishi Sunak’s last tax return. The prime minister paid £325,826 in capital gains tax and £120,604 in UK income tax in the last tax year. Good for him is all I can say. He clearly has a lot of investment holdings but might have done better with his tax planning. However he has contributed to the UK exchequer so we should not complain. But the politics of envy always rule in such circumstances.

The key point to remember is that someone from a modest background can become both Prime Minister and wealthy in the UK – it’s clearly the land of opportunity! Note: you don’t need to tell me how he acquired his wealth, but it was legally I believe.

Another disaffected group are those who held the Credit Suisse AT1 bonds who have been wiped out by the terms of the rescue by UBS. Investors are complaining that ordinary shareholders should have been wiped out first in priority as is normally the case. But these bonds have rather specific terms and were acquired by sophisticated institutions. They should have read the small print, as always when investing in bonds.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )You can “follow” this blog by entering your email address below. You will then receive an email alerting you to new posts as they are added

Why I Never Invest in Banks

This has been said by Terry Smith, and reiterated in a recent FT article, but it could just as well have been said by me. He says “I think it is precisely because I understand banks that I never invest in their shares. The recent events surrounding the collapse of Silicon Valley Bank (“SVB”) and Credit Suisse reinforce this stance”. Banks are inherently highly geared and on a knife edge of instability that can be disrupted by the slightest wind.

See https://www.fundsmith.co.uk/news/2023/4933-financial-times-why-i-never-invest-in-bank-shares/ for Terry’s explanation.

From my involvement in the collapse of the Royal Bank of Scotland I came to realise that the accounts of banks can conceal all kinds of risk taking and are often simply incomprehensible. Recent events reinforce that view. Banks should probably not be listed companies in my view as normal equity investors will not understand the reality.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Wandisco Update and Budget Postscript

I received an email yesterday on the subject of Wandisco (WAND). It was from someone using a fictitious name and an invalid email address so you can judge for yourself how accurate this is likely to be. This is what it said: “The inside scoop at WanDisco is that the European Sales Director has done a total number on them. Multiple huge sales reported, complete with purchase orders (which they now suspect may have been faked). Such little financial governance from the board that while they were lauding this guy as an amazing success, no one seemed to notice that the money hadn’t actually arrived. How out of control must a company be to not notice millions of bucks missing from the accounts?”

Is that credible? I don’t think so. See my previous comments in this blog post: https://roliscon.blog/2023/03/14/4704/

Were these “purchase orders” or simply “letters of intent”? In such a small company it is certainly incredible that the CEO and CFO were not familiar with the details of these orders and were not monitoring the likely cash flows. My previous comments are still relevant.

As regards the budget, Labour are apparently unhappy with the dropping of the lifetime pension allowance and will reverse it given the chance. This was always an iniquitous piece of tax legislation, effectively taxing money at high rates that was previously saved by prudent employees. The £1 million lifetime allowance was not enough to provide a comfortable lifestyle in retirement for previous high-earners. What guaranteed interest rate could they achieve? An annuity of £1 million would only likely mean an income of £60,000 p.a. for life which with inflation rapidly eroding the value is not a great proposition.

For a senior medical consultant working for the NHS the low lifetime allowance was certainly a great incentive to retire early to avoid breaching the £1 million lifetime allowance.

But another complaint is that the scrapping of the lifetime allowance and increase in the annual allowance to £60,000 will enable people to avoid Inheritance Tax. And why not? Inheritance tax is a dubious tax to start with as it taxes money previously taxed as income – effectively double taxation. It’s a tax based more on the principle of screwing as much as tolerable from personal savings rather than an equitable scheme to relieve people of what they can afford to contribute.

The whole personal taxation system needs reforming to make it more rational and simpler. There are so many loopholes and complications that making simple changes can lead to unintended consequences as seen with the latest changes.

The lifetime allowance was introduced to prevent the abuse of high tax relief on pension contributions. Scrapping the limit seems to be an ill-thought through reaction to problems in the NHS. The Labour Party could be right in that respect.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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The Budget – Not Much in it for Investors

Jeremy Hunt’s first budget was a sober affair. No fireworks and little rhetoric which is as it should be. There was very little in it for private investors unless you have children or are still putting money into a pension.

The main points to note are that while tax allowances are still frozen, the £1.07 million pension cap is being dropped and the yearly allowance increased to £60,000. These should help highly paid folks such as medical consultants. The ISA allowance will remain at £20,000 for another year.

Fuel duty will remain frozen and the energy price cap will be extended for another 3 months.

Inflation is forecast to fall to 2.9% by the end of 2023 and we will avoid a recession this year after all. This should boost the stock market but hasn’t so far. Perhaps like me investors don’t believe that inflation will fall that rapidly because once it is entrenched and employees demand more in a spiral then it is difficult to stop.

As with all budgets there is lots of tinkering with grants for this that and the other where the Chancellor claims to be responding to public needs but it’s all virtue signalling and mainly a waste of time. For example £200 million to fix pot holes – the Chancellor clearly has no idea how much they cost to repair and the size of the backlog!

At least that’s my view.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Silicon Valley Bank Rescue and Wandisco Discussion

Silicon Valley Bank (SVB) has been rescued both in the USA and UK. In the UK HSBC has taken over the business for £1 and put in some more cash. But bank share prices are still being negatively impacted as doubts about their stability remain.

The problem at SVB was in essence a failure to manage interest rate risks on bonds they held as security which they could not sell to meet depositor redemption requests without recognising big losses. It demonstrates the knife edge that most bank balance sheets sit on, which is why I don’t invest in banks. Lending long and borrowing short as all banks do is a recipe for disaster unless very carefully managed.

Last night there was a panel discussion of the problems at Wandisco (WAND) at the Mello event. I gave my view of the likely problem at the company which is likely to have wiped out investors in a company that was worth £905 million before the shares were suspended.

This company has been reporting numerous very large “orders” in recent months but if you read the last annual report it says this: “Commit-to-Consume contract structure to be widely utilised across all future clients, where a customer is contracted to move a minimum amount of data over a given time” and reports several new deals using that structure. What exactly were the implied commitments in terms of cash by these “orders” is the key question which is not apparent. The company revenue forecasts were probably based on more than the minimums committed and probably inherently too optimistic. We will no doubt learn more in due course.

Who was to blame for this fiasco? The sales person or persons involved as the company suggests or the CEO and CFO for not being more sceptical about the likely future cash flows? The latter I suggest. The announcements made by the company were in my view misleading and hence effectively a fraud on investors.

Can the company recover? As I said in the meeting, the company does appear to have some good technology but avoiding administration is not going to be easy. The company may need more funding urgently to meet its customer commitments but who would invest in the business as confidence in the management will have been lost and investigating the problem will take time? It may take weeks if not months to resolve and the longer the company shares are suspended the more difficult it becomes.

There was a general discussion at the Mello event on how to avoid frauds which lose investors their money. Can you spot likely frauds was one question discussed. I think you can in many cases. There were warning signs at Wandisco such as never reporting a profit since they listed which is why I never invested in it. But sometimes it’s very difficult as at Patisserie Valerie where the audited accounts were fictitious.

One of the speakers mentioned a good book on the subject entitled “Lying for Money” by Dan Davies. I have ordered a copy. I would also recommend “The Signs Were There” by Tim Steer and I cover some of the things to look at when researching companies in my own book entitled “Business Perspective Investing”.

What should be done to avoid investors losing money from frauds?

Tighter regulation of announcements was one suggestion and tougher penalties for convictions was another. In general the UK legal regime is much too weak and the FCA has historically been very lax although they have been improving.

David Stredder suggested that companies that list should contribute to an “insurance” fund in case the company suffers fraud that would compensate investors (it’s rarely possible to recover funds from the fraudsters). This is an interesting idea but it would need to be a large fund to cover the likely cases.

Note that relying on non-executive directors or Nomads to pick up and stop problems does not work. Investors need to do their own due diligence.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Silicon Valley Bank Collapse, Wandisco Discussion and Fundsmith Equity Fund Annual Meeting

The collapse of Silicon Valley Bank (SVB) is a typical story of a bank run after depositors lost confidence and rushed to the exit door. This bank may not be well known to UK investors but they were very active on funding and providing banking services to early-stage US technology companies on the West Coast. This could have a severe impact on the tech sector.

The UK entity has also ceased trading and a letter signed by more than 140 companies was sent to the Chancellor begging him to step in with emergency funding. Without access to their funds, companies won’t be able to meet payroll or other commitments so might have to also enter administration.

There may be some justification for intervention in this case and hopefully keeping depositors protected will not cost an enormous amount.

The Nasdaq fell sharply on Friday and expect the same on Monday.

Also on Monday, Mello are hosting a panel discussion on Wandisco (I am on the panel) from 5.00 onwards – see  https://melloevents.com/mm13march2023/

I made some comments on the apparent fraud at Wandisco in a previous blog post and it is clear that many private investors were suckered into investing in the company (not me in this case). You should get some good tips on how to avoid such disasters.

I have just watched a recording of the Fundsmith Equity Fund annual shareholder meeting – see https://www.fundsmith.co.uk/tv/ . Terry Smith gave his usual slick performance and brushed off the negative 13.8% fund performance last year with the comment that “it was predictable” after such a long run of positive returns.

The detractors in the fund’s holdings were mainly tech stocks such as Meta, Paypal, Microsoft and Amazon. He reiterated the investment strategy of “only investing in good companies, don’t overpay and then do nothing”.

It is worth watching the video. I will continue to hold the fund as the formula followed is still likely to be effective.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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DotDigital Webinar, Wandisco Announcement and Immigration Laws

I watched the DotDigital (DOTD) interim results presentation on the Investor Meets Company platform this morning. I have held the shares for a number of years and have been happy with the company’s progress in general.

For the half year revenue was up 9%, with 95% being recurring. Adjusted EBITDA was slightly down but cash balance was up 24%. What are they going to do with the cash? They are looking at M&A activity.

There was a good competitive review. It is clear that the market for similar products is now quite mature so poaching from other suppliers is the name of the game and more consolidation among suppliers is likely. Their US market position is still unclear although they report “early evidence of success in the USA” after management changes and rebuilding the sales team.

It seems likely that steady growth should be achievable from more geographic expansion, more partnerships and the addition of more product features regardless of US success.

Another technology company that made a devastating announcement this morning was Wandisco (WAND). They said “The Board now expects that anticipated FY22 revenue could be as low as USD 9 million and not USD 24 million as previously reported. In addition, the Company has no confidence in its announced FY22 bookings expectations”. They blame one senior sales employee for “significant, sophisticated and potentially fraudulent irregularities with regard to received purchase orders and related revenue and bookings”. The shares have been suspended

I have looked at this share a number of times as I have a historic interest in database replication, but never acquired the shares. I can understand the need for what they sell but the accounts always looked dubious to me. Revenue very volatile and profits non-existent. I prefer to invest in relatively boring companies like DOTD with large recurring revenue based on a different business model.

On the political front an enormous amount of media coverage is on the small boat crisis and the attempts by the Government to halt illegal immigrants. These are mostly economic migrants, not people fleeing war or other disasters.

It is suggested that the proposed Government legislation would be illegal, because it contravenes the European Convention on Human Rights and the Refugee Convention. The latter was established in 1951 to help people made homeless or stateless by the Second World War and was a very positive move at the time. But it was never intended to enhance the rights of economic migrants who wish to move to a wealthier country.

I suggest that a breach of a Convention is not necessarily illegal and that the UK can withdraw from Conventions whenever it considers it necessary to do so. The country is being swamped by migrants, both legal and illegal ones.  This is putting enormous pressure on housing and social services.

For example the London Borough of Lewisham have recently published a new “Local Plan” and it reports these statistics: The population has grown by 23% over the last 20 years and is still growing rapidly. Some 46% of the residents identify as BAME heritage which rises to 76% for the school population. This shows the impact of uncontrolled immigration over the last 50 years, but the Council is still “planning for an open Lewisham”. That’s undefined but suggests that they are open to even more migration.

The BBC, as is now commonplace, spouts the views of left-wing commentators including that of a well-known footballer for no good reason. His views on football may be sound but he does not understand the problem of illegal immigrants.

Will the Government be able to halt the flow of illegal immigrants? Only if they take a very tough stance in my view.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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A Digital Pound – Do We Need It?

Anyone with an interest in the financial world should take a look at a consultation paper issued jointly by the Bank of England and HM Treasury on proposals for a “Digital Pound: A new form of money”.

A digital pound would be a new form of digital money for use by households and businesses for their everyday payments needs. As part of the wider landscape of money and payments it would sit alongside, not replace, cash – a digital counterpart to familiar, trusted banknotes and coins, subject to rigorous standards of privacy and data protection.

Unlike crypto assets and stable coins, the digital pound would be a central bank digital currency or CBDC – sterling currency issued by the Bank of England and not the private sector.

As the Paper says: “This is part of the Government’s vision for a technologically advanced, sustainable, and open financial services sector that is globally competitive and acts in the interests of communities and citizens, creating jobs, supporting businesses, and powering growth across all four nations of the UK. A UK central bank digital currency – a ‘digital pound’ – would be a new form of digital money for use by households and businesses for their everyday payments needs.

A digital pound would help to ensure that central bank money remains available and useful in an ever more digital economy, continuing to bolster UK monetary and financial stability while safeguarding the UK’s monetary sovereignty in a changing global financial system. Any future digital pound would be a major piece of national infrastructure which would likely take several years to complete. Its launch would require deep public trust in this new form of money – trust that their money would remain safe, accessible, and private”.

But do we need it? Our money is already digitised. Banks do not hold stacks of paper bank notes or gold coins. Our bank holdings are simply records in digital ledgers. We can make digital payments by simply instructing our bank to do so, or by using debit/credit cards or phones.

Introducing a central bank digital currency would introduce privacy and security risks which might have much wider impacts than individual banks at present.

But relying on commercial organisations to provide open payment systems when they might prefer to build private monopolies is a risk that should be avoided.

The consultation paper does provide a good overview of the existing use of money and payment systems.

One aspect of the proposals is that there should be quite low limits on the amount of digital pounds that any one person could hold (as little as £5,000 or up to £20,000). It is not clear why there should be such a limit.

I have not personally responded to this consultation but readers may care to do so.

Consultation Paper:  https://www.gov.uk/government/consultations/the-digital-pound-a-new-form-of-money-for-households-and-businesses

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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A New National Purpose?

The Tony Blair Institute for Global Change has published a report, jointly authored by Tony Blair, William Hague et al, which has received wide media coverage. It recommends a “radical new policy agenda” that will transcend the current fray of political ideology.

It’s worth reading (see link below) and I will pick out some of the important points in it:

It recommends “building foundational AI-era infrastructure”. This should include: 1) Government-led development of sovereign general-purpose AI systems, enabled by the required supercomputing capabilities, to underpin broad swaths of public-service delivery; 2) A national health infrastructure that brings together interoperable data platforms into a world-leading system that is able to bring down ever-increasing costs through operational efficiencies; 3) A secure, privacy-preserving digital ID for citizens that allows them to quickly interact with government services, while also providing the state with the ability to better target support.

To encourage investment in “growth equity” it suggests encouragement of pension scheme consolidation by limiting capital gains tax exemption to funds with over £20 billion under management (it argues that there are too many small schemes).

It suggests Increasing public research and development (R&D) investment to make the UK a leader among comparable nations within five years, coupled with reforms to the way our institutions of science, research and innovation are funded and regulated to give more freedom and better incentives. Investing in new models of organising science and technology research, including greatly expanding the Advanced Research and Invention Agency (ARIA), and creating innovative laboratories that seed new industries by working at the intersection of cutting-edge science and engineering.

Comments:

The proposals for a “national health infrastructure” seems to be reviving the old concept of a single monolithic patient record system which was abandoned after unsuccessful implementation and the waste of many billions of pounds. Trusts and hospitals now have disparate systems but interoperability is the key while the Government is funding “digital transformation” and having some impact on improving systems. We don’t need a new “big bang” approach with the enormous costs incurred with chosen consultancy firms.

The report appears to suggest that technology can solve all the problems in the NHS by improving productivity. But this is nonsense. Management is the problem, not lack of technology.

The report has a touching faith in the possible impact of AI. So it says: “As a general-purpose technology, AI has the potential to make an unprecedented impact that will exceed those of the steam engine and electricity combined during the industrial revolutions. These previous revolutions focused on the harnessing of energy to mechanise physical labour, but our current revolution is the first in history to automate cognition itself”.

AI is improving but it so far has limited applications. The fact that products such as ChatGPT can help students to write essays (albeit with frequent factual errors) by completing sentences based on internet word frequencies does not herald a revolution in productivity.

The report strongly promotes digital identities. So it says: “Today, many of us can set up a bank account in minutes and pay for shopping at the tap of a watch or phone. For the generation now entering middle age, this level of digital simplicity and streamlining is expected as a default while those in their 20s have grown up in an entirely digital age. Despite this, government records are still based in a different era. The debate over digital IDs has raged in the UK for decades. In a world in which everything from vaccine status to aeroplane tickets and banking details are available on our personal devices, it is illogical that the same is not true of our individual public records”.

I personally would welcome a digital ID. At present I have over 500 separate log-ins for different organisations which I have to record and manage with some help from technology. But I still occasionally have to prove who I am by submitting copies of a passport or driving licence and proof of residence by a copy of a utility bill. This is archaic nonsense when companies such as Experian or GB Group can already verify my identity from their records.

But the NHS and Government bodies like HMRC have separate systems which still require separate log-ins. The report suggests personal data should be shareable between organisations but that should only be permitted for digital IDs when a user permits it.

The report says: “Governments are the original issuers and source of truth for most identity documents, from birth certificates to passports. Rather than creating a marketplace of private-sector providers to manage the government-issued identity credentials of citizens, the government should provide a secure, private, decentralised digital-ID system for the benefit of both citizens and businesses. A well-designed, decentralised digital-ID system would allow citizens to prove not only who they are, but also their right to live and work in the UK, their age and ownership of a driving licence. It could also accommodate credentials issued by other authorities, such as educational or vocational qualifications. This would make it cheaper, easier and more secure to access a range of goods and services, online and in person. A digital ID could help the government to understand users’ needs and preferences better, improving the design of public services. It would make it simpler and easier to access benefits, reducing the number of people who are missing out on support they are entitled to. It could even help the government move to a more proactive model, meeting people’s needs before they apply for a service, tailoring the services and support they are offered to their individual circumstances and reducing administrative burdens on both individuals and the public sector”.

Some of that goes far beyond what is necessary or wise. But giving everyone a digital ID from birth is surely a good idea. Almost everyone already has a National Insurance Number so this is not a new concept but it needs extending to provide digital ID verification. Other countries such as Finland and Ukraine are ahead of the UK already in this regard.

The report has some interesting things to say about the lack of investment in the UK. For example: “Despite startup financing being the focus of several government reviews and new funds, the UK has continually struggled to deliver a sufficient scale and volume of patient and growth capital to the country’s startup companies. The UK’s DB pensions industry is fragmented, with over 5,300 schemes with an average size of £330 million. Their investment strategies, driven by risk-averse corporate sponsors and finite investment horizons, have typically pursued a zero-risk approach. According to Michael Tory, co-founder of the advisory firm Ondra Partners, the UK is one of the only major economies where domestic pension funds have in effect abandoned investment in UK companies. The proportion of UK pension funds invested in bonds increased from less than 20 per cent in 2000 to 72 per cent in 2021, even as their investments in UK equities dropped from 50 per cent of their asset allocation in 2000 to just 4 per cent in 2021”.

This is certainly an area that the Government should look at. Effectively pension funds have become risk averse due to the imposition of regulations that require limitation of risk.

In conclusion the report suggests that technology can solve many of the UK’s economic and social problems. It is way too optimistic in that regard but it does contain a large number of suggestions for where improvements could be made.

Full Report: https://institute.global/policy/new-national-purpose-innovation-can-power-future-britain

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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