FT Article on Small Investor Voting

Yesterday in the FTMoney supplement, FT writer Aime Williams explained how small investors could influence companies. But unfortunately it misled readers on some points. I have sent Aime the following communication:

“I read your article entitled “Small investors stand up and be counted” in this weekend’s FT with interest. It is good that the article shows how private investors can have an impact on companies, and it will no doubt encourage people to attend AGMs.

But the comments from Richard Stone of the Share Centre are to say the least, somewhat inaccurate. The 2006 Companies Act did help to enfranchise those in nominee accounts in relation to giving them the ability to vote, but to say that ‘investors in nominee accounts have had the same rights as direct shareholders since the 2006 Companies Act’ is simply wrong. For example, Members of the company (i.e. those on the share register) have the ability to challenge a poll, or apply to a court to object to a change from a public to a private company. Those rights are lost if you are only a beneficial owner in a nominee account. That has been confirmed in past legal cases.

There is also the problem that there is no legal obligation for brokers to enfranchise investors except in the case of ISA accounts, and most stockbrokers do not even inform their clients of that fact or make it practically easy for them to vote. The Share Centre does but many do not. In addition there are difficulties with AIM companies.

In reality the widespread adoption of nominee accounts rather than investors being on the share register of a company has fatally undermined shareholder democracy and the vast majority of retail investors now do not vote.

The documents on this web page, which I wrote, spell out the facts about the nominee system and shareholder rights: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

It is still true that we need a complete reform of the existing system so that shareholders in companies, however they hold their shares, are given the ability to vote and to attend General Meetings, without artificial barriers. We also need regulations to ensure that they can vote easily and that Companies and Brokers inform everyone entitled to vote or attend meetings when the time arises to do so. Only then will shareholder democracy be restored.”

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

Disclaimer: Read the About page before relying on any information in this post.

Hate Crime, Fake News and Market Abuse

Yesterday saw a lot of media coverage after the Crown Prosecution Service announced that online offences of “hate crime” would in future be treated as seriously as offline offences. This is in response to the rising volume of such abuse on social media.

What is a “hate crime”? In summary, it is abuse based on race, ethnicity, religion, disability, sexual orientation or gender identity. Why just those categories? Don’t ask me – I am looking forward to abuse of baldies and fatties being made hate crimes. But this is just one aspect of the problems created by social media where anonymous posters can attack anyone whose views they do not like. Anyone in public life now regularly suffers the most vile comments from people who do not like their opinions – just ask any Member of Parliament who can tell you about it. Indeed, I have suffered from it myself.

Sometimes they do this because they know they can hide behind an anonymous google or hotmail account on the net, or by using a fictitious name. But even when it is clear who they are, there is little legal or social pressure to inhibit them. Indeed a new word has been invented to cover such behaviour – internet “troll”, which Wikipedia defines “as a person who sows discord on the Internet by starting quarrels or upsetting people, by posting inflammatory, extraneous, or off-topic messages in an online community (such as a newsgroup, forum, chat room, or blog) with the intent of provoking readers into an emotional response or of otherwise disrupting normal, on-topic discussion, often for the troll’s amusement.”

In extremis this can degenerate into “harassment” which is now a criminal offence in the UK, in addition to being subject to civil claims. For example, repetition of false allegations that cause alarm or distress is harassment. Again this is so much easier to propagate on the internet and in social media. Indeed one problem is that it can be going on without the victim being aware of it because there are now so many different platforms on which it can appear that even monitoring for it is not easy.

Another very topical subject which is linked to the above is that of “fake news” which allegedly had an impact on the US Presidential election and the Brexit vote in the UK. In effect, social media can be used maliciously to distribute false information with the intention of changing public opinion.

This can also be seen in financial markets where fake news can be used to affect share prices. Just create a rumour about a takeover bid on social media and the share price of a company will take off before the company can even deny it. Profits can be made from such behaviour, and even if the company denies it they may not be believed. Now simple cases like this are undoubtedly offences under the Financial Services and Markets Act but there are very few convictions for it. Social media have become impossible to police by the authorities in practice.

A Commons Select Committee was inquiring into fake news before the General Election caused the inquiry to be abandoned (along with all other business in Parliament). See https://www.parliament.uk/business/committees/committees-a-z/commons-select/culture-media-and-sport-committee/inquiries/parliament-2015/inquiry2/ . No report will be produced, but there was a substantial number of submissions to the inquiry. One that is particularly worth reading as it covers the abuses of financial commentators is present here: http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/culture-media-and-sport-committee/fake-news/written/48219.html

For example, it says: “Short selling and market abuse – FN (Fake News) is a short sellers dream.  Before the advent of online FN short sellers had to rely on word of mouth rumour and the occasional share tipster. Today the magnification possible wields instant and widespread damage.”

Note that I see no problem with short selling so long as it is not “naked” and where the seller has a genuinely held view on the financial prospects of a company. But the ability to affect market activity by issuing slanted news commentary from the market operator is surely dubious.

Bloggers and other “financial journalists” who comment on companies are often not regulated by the FCA, can operate behind anonymous front operations or from foreign jurisdictions that are not subject to UK libel laws. In any case UK libel laws are ineffective in tackling the abuses that can be propagated as the aforementioned article explains.

Such writers and their publishers actually have a financial motive sometimes to generate the most debate by making the most outrageous claims because this will generate more hits and links to their web site. That helps to sell advertising on the site, to attract more visitors, which generates more publicity and so the circle continues.

Regrettably the law is only slowly catching up with the problems created by social media. A story put on social media can get around the world several times in a few hours, while any legal action can take months.

These problems created by “fake news”, or simply somewhat inaccurate news, might be helped if there was some way to get the news corrected. But try asking Google to remove a false story or outrageous claim. They are unlikely to do so. They even resisted strongly the EU demand to support the “right to be forgotten” about the past history of individuals (even when palpably false) and even as implemented it is of limited use.

Now the defenders of this new world argue that it is necessary to avoid regulation so as to preserve free speech. But we have surely reached the point where fuller consideration of these issues needs to be undertaken. At present, the risk of abusive attacks is likely to inhibit people getting involved in public life so free speech and democracy will be undermined rather than protected.

These are undoubtedly complex issues, difficult to cover in a short article, let alone suggest some solutions. But what do readers think, without getting into a debate on the merits of short selling?

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

Disclaimer: Read the About page before relying on any information in this post.

How Many Stocks?

There was an interesting article in this week’s Investors Chronicle by John Rosier which discussed the number of holdings he had in his portfolio. He had attended a presentation by a well-known private investor who had 25% of his portfolio in one stock. John questioned whether he held too many stocks in his own portfolio (32 according to his portfolio list). He mused that Neil Woodford held 135 stocks in his UK Equity Income Fund but the largest 10 positions made up 42% by value. Mark Slater who runs the MFM Slater Growth Fund also had 42% in his top 10 but Nick Train in his Finsbury Growth & Income Trust has 75% in his top 10.

Now this caused me to examine my own portfolio. I actually have 95 equity holdings, and at this point in time, no bonds or other fixed interest stocks. The figures for my portfolio are:

37% in the top 10.

60% in the top 20.

85% in the top 50.

So it’s moderately concentrated and only slightly less concentrated than those mentioned above apart from Nick Train’s. As John Rosier said in his article, the concentration of the portfolio in the largest holdings is more important than the total number of holdings.

One interesting aspect is that this concentration is not just from design. It has arisen because I tend to buy more of the winners and sell the losers. Indeed, it would have become even more concentrated but I have a rule that I do not like to have any holding go over 5% of the total. That limit is even lower for smaller cap stocks because they are obviously more risky and my innate conservatism leads me to prefer to avoid large shocks to my overall wealth.

If I was younger, and not solely depending on my investments to finance my living standard then I might be able to take a more aggressive stance. Indeed, at my age (71), most financial advisors would say I should have well over 50% in fixed interest but I have taken a different view as to what is safe and what is not. More diversification, particularly across many small cap stocks with many on good dividend yields backed up by cash (ignored in the above calculations), gives me some protection. In addition with some smaller AIM stocks, it can be very difficult to buy or sell large blocks of shares so getting out when you want to can be very difficult if you have a big stake. So investors who hold AIM shares are probably sensible to have more shares in their portfolios than those who concentrate on FTSE shares alone.

Perhaps the issue with my portfolio is that there are 45 stocks I hold that make up only 15% of the overall portfolio value. Why bother with them? Some of these are ones where I am building up a holding from an initial low level, and some are simply small cap speculations where I am still learning about them. A few are VCTs that I bought years ago and find it difficult to dispose of without incurring capital gains tax. Others are holdings not in my ISA and SIPP accounts where disposing of them altogether would crystalise a capital gains tax liability when I am already over the annual allowance. There are a few “duds” where the holding shrank to a very small size as I gradually sold it down as a result of following the share price trend.

The key to managing the 95 holdings is to use some automated software tools to track one’s portfolio and the individual holdings to ensure you don’t miss any share price break-outs (up or down) or any news – I use several such products and services.

Having pondered this question of “how many stocks”, I am not uncomfortable with the current structure of my portfolio but it’s probably worth doing this exercise regularly and clearing out some of the smaller holdings once per year.

Another aspect to consider is of course how diverse the holdings are in terms of them operating in different market segments – to avoid the problem of them all moving together. It is very obvious from studying the reader portfolios regularly published by Investors Chronicle that many private investors have too many holdings – typically multiple funds that are likely to move in step.

I hope this article has prompted readers to look at their own portfolios and the concentration they have in them.

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

Disclaimer: Read the About page before relying on any information in this post.

ETFs and Index Trackers – More Dangerous Than You Think

Lots of financial pundits have encouraged investors to be “passive” investors rather than try to pick stocks, or invest in funds that do that latter (“active” funds). Even the FCA has recently criticised active funds for being more expensive and the additional management fees end up impacting negatively on overall returns over time. So persuasive writers such as John Bogle have convinced many to take the “no brainer” route of buying Exchange Traded Funds (ETFs) or other index tracking funds.

But there are surely dangers creeping up on all of us from this approach evidenced by several interesting articles in the Financial Times and Investors Chronicle in the last week.

On the 7th August John Plender in FTfm showed how index tracking funds break prudent portfolio rules. He warned about the concentration of holdings in Nasdaq stocks where the top five holdings (Apple, Google (Alphabet), Microsoft, Amazon and Facebook) represent 41 per cent of the index. He said “Concentration risk that is forbidden to an active manager is considered reasonable if it happens to be an index. This is dangerous nonsense”.

The Editor of Investors Chronicle published an editorial that warned that one of his worries was the huge inflows to passive funds and said “But I am concerned at the presentation of ETFs as an investment panacea because it has created the impression that investing is easy and riskless”. That is surely very true as private investors have simply bought more and more lately in a steadily rising market in recent years, driven by “momentum” trading styles. They don’t look at the valuations of what they are buying (hey – the index must be the best valuation is it not), they just buy and sell regardless based on trends. As the IC editor also said “What happens when the US bull market comes to an end?”. A good question indeed to which there is an obvious answer – a market crash as investors who have never been through a bear market capitulate.

Just today we have a front page article in the FT headlined “surging flows into exchange traded funds drive US stocks bubble anxiety”. It covers the record breaking in-flows into ETFs this year so far. It includes a good quote from Howard Marks of Oaktree Capital: “When the management of assets is on autopilot, as it is with ETFs, then investment trends can go to great excess”.

I certainly agree that investors need to examine very carefully the costs of the funds they invest in, if they do not wish to invest directly in shares. There may even be a place for index trackers in a portfolio – not that I hold any. But the real worry is that ETFs are now distorting the market and protecting yourself against that distortion, or from the likely collapse when everyone realises the emperor has no clothes, is not easy. It has led to a general rise in asset prices, in particular share prices, while simply staying out of the market while this is going on does not make much sense either.

The situation is surely analogous one of the causes of the great Wall Street crash of 1929 where “trusts” dominated the market and were sold to investors on the basis that they only went up. That was not helped by trusts investing in other trusts in a kind of pyramid scheme, and by low cost finance to purchase shares on margin – and we surely cannot get much lower interest rates than we have now. Restrictions on credit was one immediate cause of the 1929 crash, causing margin calls to be invoked and a spiral down.

There is no simple solution to protect oneself against the hysteria of momentum investing and index tracking, but the most vulnerable shares are undoubtedly those that form a large part of any index. Those are the ones where valuations may become unrealistic and where active traders may not feel it wise to try to sail against the wind. So the message is surely to look askance at unreasonably high valuations in relation to earning or cash flows in companies. Simply “buying the index” when everyone else is doing so is not a sound approach.

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

Disclaimer: Read the About page before relying on any information in this post.

The Internet of Things – Telit and Tern

Most investors in AIM will have noted the unfolding news at Telit Communications (TCM) last week. It has culminated today with an announcement from the company that CEO Oozi Cats (a.k.a. Uzi Katz) has resigned after an independent review did indeed find that he was the subject of a US indictment 25 years ago which had not been disclosed to the board. However, they denied that other allegations about the operations and finance of the company were true. Specifically, they said “there is no substance to the speculative and accusatory articles that have been published and that it stands behind the Group’s audited accounts to 31 December 2016 and the most recently published interim statement”. Will the publisher receive yet another threat of legal action as a result? We will see, although companies are reluctant to spend time and money on such cases and it is more difficult for them (as opposed to individuals) following recent changes in libel law.

Is this yet another example of how AIM regulation is defective? The simple answer is no. Both I and ShareSoc have campaigned for improvements in that area, and the LSE have recently published a paper entitled “AIM Rules Review” which has some helpful suggestions.

But the alleged legal problems of the CEO and his wife were 20 years before the company even listed on AIM in 2015 so no amount of due diligence was likely to have discovered that issue. The more recent allegations – which are about possible fraud at the company – are not an issue of AIM regulation. Possibly more an auditing issue if any such problem exists, which the company clearly denies. However, one has to question the willingness of AIM to list companies based in foreign countries some years back. Why did they list on AIM rather than in Israel or the USA for example? Possibly because they thought there would be less scrutiny. There does appear to be more examination of new listings of late and it’s covered in the paper mentioned above also.

Now I have never invested in Telit, although I have looked at it more than once in the past. There were several aspects about this company (other than the country of residence) that put me off. The nature of the product was one – albeit it’s operating in a hot sector but was there good protectable IP? Others were the lumpy nature of hardware orders, the directors and their pay, the issue of director share sales, the failure to turn profits into cash, the repeated fund raisings…..I could go on.

In summary, this is the kind of company I do not want to own.

It’s probably just another example of a persuasive CEO encouraging investors, often unsophisticated private investors, to punt on a concept of rapid growth in a hot technology sector.

Interestingly another company focused on the “Internet of Things” sector is investment company Tern (TERN) who raised some funds via platform Primary Bid over the weekend via a placing and open offer. The latter closed early due to the demand. Indeed, the COO of Primary Bid said: “We are delighted to have facilitated the fundraise for Tern plc. It was good to see such strong demand for this Offer, demonstrating how popular Technology related companies can be with tech savvy PrimaryBid Investors. More than 50% of all investors subscribing for this offer did so via a mobile device”. Note particularly the last sentence.

I had a quick look at Tern, but had great difficulty in valuing the company because it’s largest investment by a long way is a holding in a company named Device Authority Ltd. Is there any information provided on the revenue or profits of that company in the announcements about the fund raising or in recent past company announcements, or are there any recently published accounts filed at Companies House for this UK registered company? Apparently not, so any “due diligence” is difficult. But Tern does not look expensive at face value because of their revaluation of the investment in Device Authority last year by the company in the same way as any other private equity investment is valued.

Is this another case of over-enthusiasm by private investors to get into this high tech world? We shall no doubt see in due course.

There is another thing which Telit and Tern have in common. They have both been harassed by the same “journalist”. Indeed, director Angus Forrest of Tern even went so far as to report him to the police for harassment in 2015 although the matter was not pursued (harassment can be both a criminal law and civil law case).

Investors are recommended to take a cold shower whenever anyone talks about hot technology sectors. A lot of businesses in them never turn a profit, or give a decent return on investment. You just have to look at the early history of Apple – now the largest company in the world by market cap – to see how tortuous and extended can be the path to success. And most of their early competitors simply disappeared.

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

Disclaimer: Read the About page before relying on any information in this post.

Departures – AA and Blur

Yesterday was the start of many people’s holidays. But two company chief executives are going to be taking longer holidays than they expected.

The Executive Chairman of the AA Plc (AA.) Bob Mackenzie has gone. The announcement from the company said he “has been removed by the board….for gross misconduct, with immediate effect”. According to press reports, this arose from a fracas in a bar, although there is also a suggestion that he may be suffering from a mental illness. Some newspapers just suggested it was a “Jeremy Clarkson moment”.

The share price of the AA dropped 14% on the day, which probably reflects the problems that can arise when you have an Executive Chairman dominating a business. It’s not recommended corporate governance practice and personally I tend to avoid companies who have them.

The AA is an interesting organisation which provides breakdown cover and other services for many motorists. Back in 1905, it was formed to warn drivers about speed traps. It later transmogrified into a commercial organisation when the members sold out. Now it is one of the largest operators of driver education programmes such as speed awareness courses. That has become a booming industry and more than a million drivers are now attending speed awareness courses each year. This has resulted in the funding not just of commercial organisations such as the AA but more than £40 million per year goes to the police and local authorities. For the first time in English law, it is now allegedly legal to pay the police to drop prosecutions – all you have to do is promise to attend such a course. There is no evidence that it has any benefit in road safety. More information on this dubious practice is present here: http://www.speed-awareness.org (a campaign run by the ABD against it).

The other departure yesterday was of founder and CEO of Blur Group (BLUR) Philip Letts. This was a company that listed on AIM more than 5 years ago and in 2014 traded at a price as high as 665p. It’s now 3p.

This was a company that was a typical “concept” stock. It was going to revolutionise the commissioning by SMEs of services which is still very much an informal market by introducing an internet market. Mr Letts must be a very persuasive person to keep the business alive this long by repeated fund raisings. But it’s a typical example of how unproven business models are very risky investments. Most companies would have changed the business focus and the CEO long ago, or simply wound up, but Mr Letts persisted.

Yesterday the temporary suspension on AIM was lifted as they finally published some accounts. The results were slightly improved in that losses were reduced, but it still looks an unviable business unless the new management can make substantial changes. Mr Letts was removed from the board effective on the same day.

Incidentally I do hold a few Blur shares – market value now £6 so I hope that has not prejudiced my comments. If you get enthused by the hype surrounding some early stage companies, and the persuasiveness of the management, there is one simple thing to do. That is to only invest a very small amount until the company proves its business model and actually shows that the business is likely to be profitable. Revenue alone is not enough, because anyone can generate revenue by spending lots of your money.

The other protection is when the company fails to achieve its stated business plan, to simply sell and move on. Ignore the tendency to “loss aversion” where you hold the dogs in case of recovery. Or if you fear missing out on a big recovery, simply reduce your holding to a nominal level as I did on Blur and saved myself even more money.

So I invested a very small amount initially and then reduced it later to a miniscule level.

Just one point to note is that the company actually spells its name “blur” rather than “Blur” as I have used above, thus ignoring the rules of English grammar. Such affectations in companies to be “different” are always a bad sign in my experience.

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

Disclaimer: Read the About page before relying on any information in this post.

Utilitywise Profit Warning

A trading update from Utilitywise (UTW) caused the share price to fall another 18%. It’s already down from over 350p in May 2014 to 48p the last time I checked. A pretty disastrous investment for many. This was one of those go-go small cap stocks that lots of share tipsters were promoting back in 2013/14. Revenues and profits were apparently on a strong upward trajectory from their sales of utility services to commercial users.

I even bought a few shares myself. But I sold when I came to realise that their revenue recognition practices were in my view somewhat aggressive. So far as I understood it, they were recognising profits on contracts when the customer signed up for an annual or longer contract. From today’s announcement that even included recognising profits on signature rather than contract commencement. But the real problem to my mind is that instead of most businesses where profits are taken on amounts invoiced, which is shortly before cash is paid on them, in this case the cash was received very much later. So I got cold feet and bailed out. I simply don’t like imprudent accounting and aggressive revenue recognition (Quindell was a similar example).

That is basically what is so damaging in today’s trading statement where they cover a change in accounting policy to IFRS 15 which has tougher rules on revenue recognition from contracts. Who were the auditors of Utilitywise? BDO LLP.

Respected investor Leon Boros has already tweeted that with the adjustments to their accounts required, all the historic profits of the company will disappear. As he says “always follow the cash”.

I did write a report on a Mello event for ShareSoc where Utilitywise was one of the companies presenting back in 2013, but it was not a particularly complimentary one – it mentioned possibly regulatory problems, aggressive sales practices and director share sales for example. The revenue recognition issues only became apparent at a later date.

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

Disclaimer: Read the About page before relying on any information in this post.