Bucket Shops are Back

I recently saw an advertisement on Twitter for a company, who shall remain nameless, offering to trade “fractional shares”. That means instead of buying a whole one share of expensive stocks such as Google (Alphabet) and Amazon which cost more than a thousand dollars, you can buy a fraction of a share. They offer an App which provides this with zero commission trading and CFD trading on 20% margin or less (i.e. you don’t need to put down the whole amount). What immediately sprang to mind when I read the advertisement was the provision of trading by “bucket shops” in the USA in the early 1900s.

I can do no better than to quote a Wikipedia description: “As defined by the U.S. Supreme Court, a bucket shop is an establishment, nominally for the transaction of a stock exchange business, or business of similar character, but really for the registration of bets, or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain, oil, etc., there being no transfer or delivery of the stock or commodities nominally dealt in”. See https://en.wikipedia.org/wiki/Bucket_shop_(stock_market) for more background.  They were outlawed in many US states, but if you wish to get some understanding of how they operated it’s worth reading a book called Reminisces of a Stock Operator by Edwin Lefèvre, which was possibly a pseudonym for stock market speculator Jesse Livermore. It was published in 1923 and is still readily available as it’s a book worth reading by any stock market investor.

The company advertising this new trading facility claims to be authorised by the Financial Conduct Authority (FCA) and be based in London although they also have operations and authorisation elsewhere. Their web site makes it clear that 76% of retail investors lose money when trading CFDs with them. It takes a very smart operator, as Jesse Livermore was, to make money in bucket shop operations and he soon moved on to bigger things. When stock markets are buoyant, as they have been of late, inexperienced punters get suckered into share speculation which is really gambling and most are likely to lose money.

The FCA really needs to monitor and regulate such operations a lot more closely.

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

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Slater Investments Warns on Pay, and Flybe Bail-Out

Slater Investments has issued a warning to companies of their “dissatisfaction with the framework of directors’ remuneration in most public companies”. Slater Investments run a number of funds managed by Mark Slater and others with a focus on growth companies.

The letter complains about a “relentless ratcheting of terms and conditions which have meant the interests of directors and investors have grown steadily further apart”. Specifically it complains about the award of nil-cost options which they see as a one-way bet and they also don’t like the hurdles that are set which are often simply e.p.s. rather than total return.

They also don’t like the quantum of pay awards and say: “It has become customary for executive directors to receive a handsome salary, plus the same again in cash bonus and a similar amount in nil cost options – year in, year out. Is a good salary not enough to get directors out of bed in the morning and to diligently work their allotted hours? A bonus should be determined by the return received by investors”. This is a similar complaint to my own made a week ago.

They plan to vote against remuneration reports which are longer than two pages [Comment: that means most of them at present], and vote against any schemes with nil cost options and against unresponsive members of the remuneration committee. Mark Slater and his firm are to be congratulated on taking a stand on this matter. I hope other fund managers will follow his example.

To read the letter sent to companies, go here: https://tinyurl.com/wu9jh9q

The UK Government is bailing out airline Flybe. It was obviously running out of cash and was saved from administration by the Government deferring passenger duty tax payable, a possible Government loan and more cash from the owners. Is this a good thing?

Flybe operates a number of short-haul flights in the UK and the rest of Europe. Some UK airports are apparently dependent on its operations. Is it really essential to maintain these operations when roads and rail links provide alternative transport options in most cases, albeit somewhat slower perhaps? State aid to failing companies has a very poor record in the UK – the motor industry was a good example of that. One of the few good things about the EU is its tough rules on state aid. I hope that the UK will not diverge from its principles now we are departing from the EU.

Why is bailing out failing companies a bad idea?  For several reasons. First because it effectively subsidizes poor companies which then compete with profitable companies to their disadvantage. Second, it rarely works because a bad business usually remains a bad business. For example, Flybe has been perennially unprofitable and had to be rescued via a takeover in March 2019 when it was delisted. You can see the financial track record of the company on this Wikipedia page: https://en.wikipedia.org/wiki/Flybe

Airlines are one of those businesses that I avoid. They suffer from the business model problem that they are always trying to maximise passenger loading as the economics of airlines means they need to fly the planes full to make money. This means they cut prices to fill volume when business is bad, but their competitors do the same (and their competitors can be other transport modes on short-haul flights such as buses or trains).

It has been suggested that the worlds’ airlines have never overall made money since the airplane was invented. I can quite believe it.

I see no good economic reason why the Government should bail out Flybe in the way proposed. If it owns some profitable routes, other airlines will take them on. There might be merit in reviewing air passenger duty in general which is a tax on travel that does not apply to other transport modes, or perhaps in providing some specific funding to unprofitable routes as suggested in the FT if there are good arguments for doing so and with onerous conditions attached. But the principle should be “no money unless the business is restructured forthwith with some certainty that it can be made profitable”.

Otherwise the danger is “moral hazard” as Lord King mentioned when refusing to bail out Northern Rock, not that I think he was particularly wise in that case. It is suggested that it just encourages the directors of companies to believe they will be rescued regardless of their incompetence. The threat of no more assistance ensures directors take more care it is argued and provides an example to others. Banks may be rescued with cash that the Government prints to shore up their balance sheet, but putting cash into airlines is typically just used to fund operating losses.

Businesses that are subject to Government regulation are always tricky to invest in. If they are not subsidising the competitors, they are restricting competition by regulation. Which one of my US contacts was explaining to me a couple of weeks ago as one reason for the demise of PanAm.

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

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Serco Charges, Unilever Trading and DotDigital AGM

I like to report on the latest evidence of fraudulent accounting just to remind folks how little one can trust the accounts of companies. I have not mentioned Serco (SRP) previously but it is now reported that two executives of the company have been charged with fraud and false accounting by the Serious Fraud Office (SFO).

The charges related to false reporting of tagging of offenders to the Ministry of Justice and the company has previously entered into a deferred prosecution agreement over the allegations which date back to 2010-2013. They agreed to pay over £20 million in fines and costs.

The two defendants deny the allegations but is it not good to see the SFO pursue such cases, even if they could do so a lot quicker! Justice has to be swift if it is to an effective deterrent.

Unilever (ULVR) provided a “Sales Update” this morning. It said business was challenging in South Asia and West Africa and as a result underlying sales growth would be “slightly below its guidance” for 2019. However it also said “earnings, margin and cash are not expected to be impacted”. There were also some negative comments about growth in 2020 which is probably what really spooked the market. Regardless the share price has been falling for most of the day and is now down 7% at the time of writing which is a pretty major shift.

I recently purchased some shares in Unilever so this is another case where I misjudged a big company probably due to relying on analysts’ forecasts. However, I did not buy many shares as it was a new holding and had already sold some of them as the share price drifted down of late. Clearly the bad news had been leaking out! I’ll wait to see where it settles and for revised analyst forecasts before deciding whether to sell the remainder or buy more.

This morning I attended the DotDigital (DOTD) Annual General Meeting. I have held shares in the company for some years and it has made steady progress. Sales last year were up 15% (including discontinued operations) at £42 million and adjusted earnings up 33% with positive cash flow. The company originally focused on an email service for use in marketing, newsletter distribution, etc, but is now a multi-channel communication service. They acquired a company called Comapi to add functionality in that area last year but decided to close down part of that business which was non-core, and a large write down of goodwill was the result.

I’ll cover some the questions from attending shareholders, which were generally good ones.

One question was about how the company plans to expand, e.g geographically. The answer is that this is generally done by dipping a toe into the water before developing the market and making significant investment. Some 30% of revenue now comes from international markets and they have appointed a General Manager in North America who starts in January.

I questioned the high losses of non-exec directors in the last year and were they looking for new ones? The answer was yes they are, and hope to appoint someone soon. Founder Tink Taylor who has been acting as interim Chairman will be stepping down although he will continue to do some consultancy work for the business.

There was a question on the use of cash on the balance sheet which is now substantial, but only 10% of market cap according to the CEO, Milan Patel. They do not intend to use it for market share purchases, other than to satisfy share options. They would prefer to invest in the business or use on acquisitions, but it does not sound like there are any short-term prospects of the latter.

A question on competition was asked and Emarsys was mentioned as a competitor in the mid-range market which is a name new to me I must admit. But there is probably a very diverse competitive landscape. I use a competitor product but only because it used to be a lot cheaper and it is always a hassle to change software as one has to learn a new user interface. These kind of products are remarkably “sticky” with customers and it was mentioned that 50% of their end-users are now “integrated” in some way which would make it even more difficult for them to change supplier.

Another question was on the large amount of capitalised development cost (£5.5 million last year, with £2.5 million of previous cost amortised which is done over 5 years). You can understand why the figure is so large if you know that they have 78 development staff which was the answer to one of my questions! Some of these are ex rocket scientists based in Byelorussia and there are some in South Africa also.

There were a couple of Brexit related questions but the answers were of no great concern. I did not pick up any issues that worried me about this business and it was generally a useful AGM.

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

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It’s a New Day and a New Era

It’s 7.30 on Friday morning and the Conservatives have won a very large overall majority. This is a seismic change with what one might expect to be solid working-class constituencies such as Blyth Valley, Workington, Grimsby and Leigh being won by the Tories. This was very clearly a Brexit election with the SNP winning more seats in Scotland where most people wanted to stay in the EU, but the rest of the country deciding otherwise it seems.

However the Brexit party has won no seats although they have undermined the Labour vote in some areas. This is disappointing because they might have provided some moderation in Parliament to an over-dominant Conservative Government. All the concerns of the other losing parties may be lost also which might increase social division. We might see even more street demonstrations.

The pound has already jumped up against the dollar and other currencies which might put a damper on some of the large UK listed companies with major dollar earnings. But market confidence and business confidence should now rise substantially now that some uncertainty is over. We will no doubt see in a few minutes when the market opens at 8.0 am.

Not that I have much cash in my portfolio to invest because I have been betting on a Conservative win and resolution of Brexit for some time. I did not like to mention it previously because I did not wish to encourage speculation on the outcome. Perhaps the market may have already discounted the likely outcome in the last few days but overseas investors in the UK market will now be reassured that financial stability and prudence will be in place for some time.

We are of course not totally out of the woods yet because Boris will still have to negotiate a trade deal with the EU and other aspects of the final separation. But I judge he is clever enough to do that.

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

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Technology and Media Leads the Way, and the Renew Party

The Association of Investment Companies (AIC) have just issued an interesting press release. It gives the top performing investment companies and sectors for the year to date under the headline “Technology and Media Leads the Way”.

The Technology and Media Sector was up 34%, compared with an overall average of 14% for all investment companies (excluding VCTs) in share price total return. The top performing company was Blackrock Throgmorton Trust (THRG) which is a UK smaller and mid-cap companies focused trust. It is up 49%. A quick review of how they achieved their stellar performance indicates derivatives although several other smaller company trusts were listed in the top ten.  The Blackrock web site says this: “Derivatives may be used substantially for complex investment strategies. These include the creation of short positions where the Investment Manager artificially sells an investment it does not physically own. Derivatives can also be used to generate exposure to investments greater than the net asset value of the fund / investment trust. Investment Managers refer to this practice as obtaining market leverage or gearing”.

Dan Whitestone, Manager of BlackRock Throgmorton Trust, is quoted in the AIC press release as saying: “As we have long argued, stock and industry specific outcomes can triumph over the volatility created by macro, political and economic events. This certainly held true in 2019, which has been a strong year for the trust in absolute and relative terms, aided by positive contributions from both long and short positions. The management teams of the companies the trust invests in have played a key part in helping deliver value and wealth creation for shareholders, not just this year but over the course of many years.

The premium for genuine secular growth is high, as we remain within an era of low inflation, low interest rates and weaker growth. However, we see many companies with solid business models, that have enormous growth potential, are all too often dismissed by the market as expensive. Conversely, many so-called value shares are under significant pressure from the structural changes wrought by technological disruption, resulting in fundamental changes in distribution, manufacturing and customer behaviour.

Throgmorton aims to identify and own, for the long term, the exciting, fast-growing companies that we believe are truly differentiated and disruptive and taking full advantage of the structural changes reshaping industries. Our belief is that the stock market persistently undervalues these companies, which have strong balance sheets, and have been able to heavily invest ahead of their peers. Combined with solid management teams, dominant market positions, and a compelling product offering, investing in these companies can lead to years of dramatic compound growth, regardless of the wider political or economic environment.”

I can probably agree with most of what he says, but am not sure about the use of derivatives. I’m happier with the three other UK smaller companies trusts in the top ten list who all achieved more than 40% share price total return, one of which I hold. Does the cleverness of Throgmorton result in better long-term performance? It might do so if you look at the 10-year performance figures in the UK smaller companies AIC sector where it is beaten by only one other company – the Rights & Issues Investment Trust (RIII), although they seem to have a more variable performance. I may have a closer look at Throgmorton. This is definitely one where a read of their Annual Report will be essential (all 114 pages of it).

You can read the full AIC press release here: https://www.theaic.co.uk/aic/news/press-releases/top-performing-investment-company-sectors-over-2019

Investing in UK smaller companies rather than the rest of the world probably requires you to have confidence in the UK economy after Brexit. Which brings me onto the subject of politics.

The Renew Party

I was interested to receive a flyer through my door just now for the Renew Party. Bromley & Chislehurst is one of only four constituencies where they are putting up candidates. The Renew Party have an interesting manifesto including political reform.

This is what it says on their web site:  “Our system of politics rewards adversaries, not collaboration. These systems need radical reform to get the best, in candidates and in MPs. Whilst vigorous debate is critical to the evolution of our society, it does not need to become personal, crude and nasty…….. We support electoral reform to make representation in parliament proportional to the number of votes cast for each party. This means the abolition of the first-past-the-post voting system”.

That’s something I would vote for, but unfortunately their General Election platform also supports staying in the EU, which may be arguable, and delivering a “People’s Vote”, i.e. another referendum which is a profoundly daft idea. So they are not going to gain my vote this time.

Neither are the Labour Party who delivered a leaflet that referred to “Tory cuts” to the NHS. It’s simply not true – the real expenditure on the NHS has gone up. Indeed the service from the NHS has improved enormously over the 25 years I have been an active user of it. See https://fullfact.org/health/spending-english-nhs/ for the facts. I sent their candidate a complaint about her grossly misleading leaflet but she did not respond. Regrettably there seems no way to easily get such gross distortions by politicians stopped.

Other candidates are from the Christian People’s Alliance, the Green Party, the Liberal Democrats and the Conservative Party (no Brexit Party runner). It may not be a difficult choice.

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

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Why Shareholders Have Little Influence

There was an article in The Times newspaper this morning by Mark Atherton which covers the subject of shareholder voting and the nominee system. I am quoted as saying “The nominee system needs a total rewrite to reflect modern reality and restore shareholder democracy”.

As is pointed out in the article, only 6% of private shareholders vote the shares they own. This is mainly because of the obstruction of the nominee system. The US system is not perfect but they get 31% of shares voted. Everyone agrees that ensuring shareholders in public companies return votes for General Meetings is important. This ensures good corporate governance and “shareholder engagement”. But very few people, and hardly any institutional investors, actually attend such meetings in person. So most votes are submitted via proxies.

Fifty years ago most shares were held in the form of paper share certificates which meant two things: 1) All shareholders were on the register of the company with a name and address recorded and 2) All shareholders would be issued with a copy of the Annual Report and a paper proxy voting form. This ensured a high turnout of votes.

Due to the growth of on-line trading via “platforms” and the “dematerialisation” of shares in Crest, most shares held by “direct investors” (see below for indirect holdings) are now held in electronic form. For retail investors this means a very high proportion are held in pooled nominee accounts. This has resulted in very low numbers of investors actually voting the shares that they “nominally” own. The problem is that the nominee system obstructs both the information flow to investors and their ability to vote easily and quickly.

For institutional investors the turn-out is higher – typically above 60% but such investors often have a low interest in the outcome so tend to vote in support of all the resolutions. Institutions suffer from the “agency problem”, i.e. they are commonly not owners in their own right and thus may have other motives. For example, they may not have the same interest in controlling the pay of directors in companies which has got out of hand of late for that reason. They are keen to retain access to management which can be made difficult if they oppose management proposals or pay.

The nominee system as operated in the UK also undermines the rights of shareholders, creates major problems when stockbrokers go bust (as they regularly do) simply because of the legal uncertainty of who owns the shares. The “pooled” nominee system is particularly dangerous because it means that it is impossible to know who owns which shares in a company.

The nominee system also undermines shareholder democracy (i.e. the influence of shareholders on companies). When every direct investor was on the share register of a company, under the Companies Act one has the right to obtain the register so as to write to all shareholders to raise your concerns or invite support or resolutions (e.g. if a requisition to remove or add directors has been submitted). This is now almost impossible to do as the register simply contains mainly a list of nominee names and the nominee operator will not pass on communications to their clients. The other problem associated with the current system is that it makes it very difficult for even the companies themselves to communicate with their own shareholders.

The high cost of postage also now frustrates communication with shareholders except for very wealthy organisations or individuals. The Companies Act has really not been updated to reflect the modern digital world and the reality of how markets operate and how shares are now held and traded via electronic platforms. It needs a total rewrite to reflect modern reality and restore shareholder democracy.

Many investors and savers now hold shares indirectly via their interest in pension funds, insurance funds or mutual funds of various kinds (OEICS etc).

At the end of 2014, and based on “beneficial” ownership, the Office of National Statistics indicated that individuals held 11.9% by value of shares listed on the LSE. That compares with 16.0% held by pension funds, insurance companies and other financial institutions. But 53.8% of shares were held by foreign investors, which presumably would also be mainly held by institutions. Direct ownership had been falling for many years but seems to have increased somewhat lately perhaps due to more interest in “self-select” ISAs.

Institutions do suffer from the “agency” problem mentioned above and the underlying investors have little influence over the actions of the investment managers. Indeed one problem with funds is that investors often know little about what the fund is invested in – see the recent problems at the Woodford Equity Income Fund for example which most holders of the fund simply did not know about until it was too late. Pension funds are even less “transparent”. This results in perverse outcomes. For example a trade union pension fund might have no influence on the affairs of companies in which the fund is invested even though that might be of very direct interest to the union members.

Mark Atherton suggests investors in funds should have the right to influence how fund managers vote the shares in the fund. But how to enable underlying investors in funds to influence how the fund manager votes their shares, or otherwise influences a company, is an exceedingly complex and difficult problem. Funds can own interests in hundreds of companies and have hundreds of thousands of underlying investors. The latter are never likely to understand or take a close interest in the affairs of individual companies held by a fund. One reason they are investing in funds is so they can ignore the details and rely on the fund manager to look after corporate governance issues.

Even direct investors often don’t bother to vote because they don’t wish to spend time considering the issues or filling out the forms. Making it easier to do the latter by providing on-line voting systems would help but would only be a partial solution. Some collective representation of private investors (such as by organisations such as ShareSoc) might be one answer. Investors would simply give ShareSoc a standing mandate to represent them. But that is currently impossible because of the nominee system as the investors cannot appoint proxies themselves – only the nominee operator can do so.

Clearly it would help to encourage direct investment rather than reliance on funds. This would reduce investors costs (intermediation costs take a very high proportion of investment returns in public companies). Note that the risk of amateur investors underperforming the professionals should be discounted. Professional fund managers mostly perform no better than a monkey with a pin and many funds are now “tracker” funds that simply follow an index. Tracker funds are particularly problematic regarding shareholder democracy as they have no interest in influencing management whatsoever. Their share trading is solely influenced by the market, not by their views on the merits of the company or its management.

The UK, although we have one of the largest stock markets in the world, has very poor legal and operational systems for recording and representing shareholder interests. This probably has arisen from our tendency to stick with Victorian traditions when we were the leader in such matters. The Companies Act, which was last revised in 2006, still primarily assumes paper processes with rather half-baked additions to support digital systems. Stockbrokers have avoided regulation and as a result have implemented electronic nominee systems that protect their own interests rather than that of their clients in ensuring shareholder rights and democracy.

Major reform is needed!

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

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Exchange Market Size in Stockopedia and BHP plus RIO

I noticed that the share prices of BHP Group (BHP) and Rio Tinto (RIO) jumped this morning – at least for these behemoths of the FTSE-100 they moved substantially at 2.8% and 3.4% respectively. I only noticed because I recently purchased some of the shares in each company.

These are of course very large mining companies so they are dependent on the price of metals and metal ore, particularly iron ore. The last time I looked at these companies was two or three years ago when they were laden down with debt and had poor returns on capital. But they have certainly had a change of heart since then and seem to be more focused on generating real profits and cash flow rather than building ever bigger holes in the ground. Debt has been cut substantially in both companies.

With the profits mainly coming from overseas, they are a good hedge against any form of Brexit, and yields are high for those who like dividends. I am not a great fan of commodity-based businesses where predicting future prices of the products is not easy and they typically go through boom and bust cycles as such companies all invest in new production capacity at the same time as prices go up. Soon after when all the new capacity comes on stream there is a bust of course. But I made a small exception in this case.

But why the share price jump this morning? Are investors moving from growth to value as other commentators have suggested? Have value shares such as BHP and RIO suddenly started to look attractive, as they did to me? Or has Nigel Farage’s impossible demands for a deal with the Conservatives to ensure Brexit over the weekend suddenly encouraged investors to look for Brexit hedges?

Stockopedia have released an updated version of their “New” software. It now includes the Exchange Market Size (EMS) which is a useful parameter to look at when trading in company shares, particularly smaller ones. Note that Exchange Market Size was previously called Normal Market Size.  It is the maximum size in terms of share trade volume at which a market maker is obligated to adhere to their quoted share prices. It is a very good indicator of the liquidity in the shares and how easy they will be to trade. When trading electronically on most retail platforms, this is a useful number to know as it will affect whether you can trade automatically, have to set a limit order or get a dealer to trade for you. In addition, any trade bigger than the EMS might be done at prices higher or lower than you expect.

This number can be very small for some AIM stocks. For example on Bango (BGO) which I hold it is currently only 3,000 shares (less than £4,000 in value) when the EMS for BHP and RIO is more equivalent to £20,000 in value.

The new Stockopedia software version has other improvements although I still seem to be having problems with the Stock Alerts feature that I use every day. Perhaps there are still some issues that have yet to be fixed but you can still revert to the old version.

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

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