Category Archives: etf

Explaining Blockchain To Traditional Investors Through Growth Capital

Note: This piece assumes some general familiarity with the blockchain technology space. If you would like an introduction to the technology that underpins Bitcoin and other cryptocurrencies, see this article on Re/code . Ever since launching CoinFund in July 2015, I’ve been viewing the blockchain technology space from the point of view of an engineer and a portfolio manager. I’ve been thinking, therefore, about how to explain the blockchain technology space to traditional investors in traditional terms. What makes blockchain companies unique and interesting opportunities in the investment landscape? To see the potential long-term implications of this fascinating space, one needs to take in a thirty minute primer of technical details: What is a blockchain? What’s interesting about decentralization and trustlessness? What’s the deal with smart contracts? In a semi-technical crowd, the audience is quickly lost in jargon and a technologist’s reasoning. Instead, I think the correct way to present the blockchain opportunity to traditional investors is through the lens of growth investments – yesterday, today, and tomorrow. It is a story of a technology that democratizes, opens, and optimizes a difficult investment environment. Where is the capital? For the last 15 to 20 years, startups have proliferated in the market across all verticals. You have ZocDoc (Private: ZDOC ) for doctors, UpCounsel for lawyers, Seamless for food delivery, Tinder for dating, and on and on. Just about every New York University junior one meets is trying to either be CEO to or a VC in the next “Uber (Private: UBER ) for X.” Take a look at this chart in which you can witness the staggering “unicorn density” of our time: Click to enlarge As more companies take up the startup model, there are more and more private companies and fewer and fewer public ones. Just a few metrics paint a clear picture. The number of firms on the U.S. stock market started declining in the mid-1990s from a high of about 7,300 listed companies. By 2015, after a lazy uptick, there were only 3,700 left. Startups, pumped by high valuations and VC capital and a tech entrepreneurial culture, stay private longer in a “psychological shift” which has been described as “Silicon Valley’s distaste for the IPO.” Between 1996 and 2014, the average time to IPO went up from 3.5 years to 6.9, according to the 2015 IPO report by WilmerHale . And most recently, the number of IPOs has been dropping globally, with the tech sector leading the way. A 58% drop in NYSE IPOs in 3Q15 YTD compared with the previous year was accompanied by a 77% drop in dollars raised, according to Ernst & Young . In short, there is a lot of capital moving from the public into the private markets for the world’s primary growth sector – technology. According to Rett Wallace’s assessment of the tech bubble , “27 times more primary capital has gone into U.S. technology companies privately than publicly. And if Box.com had actually gotten its IPO done on schedule last year, it would be 88 times more.” In such an environment, what does participating in the growth sector look like for investors? Growth investments, yesterday and today At the turn of this century, investing in growth would looked like this: Joe the Investor would identify tech as a growth sector. He would send some cash over to his Ameritrade account, and – this being 2004 – buy some Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) at the IPO. Then Joe would hold Google for 10 years. In the interim, Joe would know that he could dump some of his Google stock if technology took a downturn. Finally, Joe would sell Google in 2014 for a 12x return. And here is what growth investment looks like today: Spencer is a private investor. He has a top 1% salary and therefore qualifies as an accredited investor , which allows him to participate in private offerings. In 2009, Spencer would notice a company called Uber doing a funding round on AngelList. Spencer’s contacts on AngelList are investing, so he would follow suit. It’s not likely that these investors would be able to predict that Uber would take off, create a new industry, and become one of the greatest growth companies of all time. It’s not likely that Uber can predict that in 2009. Following his investment, Spencer would be stuck in Uber private equity for seven years with very limited options to take profits before a liquidity event. Perhaps next year Travis Kalanick will decide to take Uber public, but no one can be sure. If he does, Spencer will make a 12,700x return. When growth companies move into the private sector, traditional public investors are left with little access to growth and a precarious stock market. “Growth and value investing” seems now a fragment of the past. And even when startups do IPO, overvaluations often foil performance in the public markets. To cite some recent examples , Box (NYSE: BOX ) stock fell 30% shortly after trading. The beloved Etsy (NASDAQ: ETSY ) fell 70%. At the time of the IPO, it is simply too late for public investors to participate in the growth of startups. The chart below shows the returns that were left for public investors after the IPO of Etsy (source: Bloomberg). Click to enlarge It would appear that in this regime the privilege of private investments goes to affluent individuals. Yet, while accredited investors have much greater access to outsized returns, their investment landscape is far from rosy. First, there is little data, research, or transparency in the private markets. A hedge fund trader might receive an offer to buy Lyft (Private: LYFT ) stock, but how does he judge whether it is a good one? Virtually all ridesharing competitors today are in the private sector and are thus tight-lipped about basic metrics such as revenues and customer acquisition costs – basic parameters that have been traditionally used to price stocks. Once again, this kind of uncertainty contributes to overvaluation and only when the company eventually reaches the public market do valuations start to deflate back to reality. Finally, it goes without saying that the lack of liquidity for private investors is a long-standing issue. But with the advent of efficient new trading technologies and a global market, low liquidity might become a concern of the past. Blockchain companies are models for the growth investments of the future A blockchain company is a special species of technology startup, one where its business gives it a distinct advantage in its own business operations. It’s kind of meta, but consider that Apple’s (NASDAQ: AAPL ) expenditure on its internal hardware is probably much less than Google’s – Apple manufactures computers and has vast economies of scale on hardware; or consider that it costs Twilio (Private: TWILO ) much less to send a text message compared to a startup who has to use Twilio to do the same. Just like tech startups need computers, they also need funding. And blockchain technology companies happen to be in a unique position to fund themselves because their product is highly conducive to transferring currency-like and stock-like assets between investors, entrepreneurs, and even digital organizations . In practice, the prevalent method of funding blockchain companies in recent memory has been the “crowdsale” – a fundraising model where the company sells its own cryptocurrency, cryptoequity, or cryptotoken to the public before the system is built and then uses the funds as a seed investment. When the blockchain finally launches, the stake becomes tradable and liquid and early investors stand to make a good return – in effect, the blockchain company has done an IPO that lies outside the traditional financial system. The Ethereum crowdsale is today the fifth largest crowdfunding in the history of the planet, having raised $18M against a white paper written by a gifted 20-year-old college dropout. Having used the funds to build a complex organization with tens of employees and many more on distributed projects from all over the world, and working against non-trivial negative social pressure from the established cryptocurrency community, Ethereum was released as a public blockchain a year and a half later. In March of 2016, Ethereum grew in price by a factor of 10, and became the world’s second largest cryptocurrency by market capitalization at a $750M valuation . Such an “initial cryptocurrency offering,” or ICO, has a highly favorable character for investors: First, the ICO is available globally to all investors, and in most jurisdictions there are compatible regulations that allow participation. The disparity between Joe and Spencer investors that we see in private equity on the traditional markets has been reduced, if not eliminated. It is an equity crowdfunding, so the market can potentially accommodate large raises – a boon for companies. Even in traditional markets, we have begun to recognize the value of equity crowdfunding with the JOBS Act and the proliferation of platforms like Crowdfunder and CircleUp, with this high-growth market estimated to reach nearly $100 billion ten years from now . Unlike typical private companies, blockchain projects often adopt an open source or open community model, so development and performance metrics are available and transparent. Unlike in speculative cryptocurrencies like bitcoin, cryptoequity investments often lend themselves to straightforward modeling, as they are based on a well-defined business product proposals: if the platform acquires n customers, it will generate r returns. Liquidity is one of the foremost considerations in an investment. Most ICO investments become liquid at beta, and investors only have to wait out development time (compare with Uber, above). Not only is liquidity often available over the counter during this period, but the advent of smart contracts will send the wait period to zero: you will soon be able to trade cryptoequity immediately after purchasing it at crowdsale using a decentralized exchange . Blockchains facilitate the low-cost, fast and efficient transfer of equity between stakeholders. This is a vast improvement of the stagnating, expensive, and slow process of paper deals on the private markets. It’s easy to see that with these favorable properties, ICOs have the character of the kind of high-tech and low-friction applications that we’ve become accustomed to over the last 20 years. They stand as a open and efficient model of how growth investing could be in the future. Blockchain Technology Disclosure : I hold an economic interest in CoinFund, a portfolio which invests in cryptocurrency and blockchain technology companies by way of their cryptoequity and which has a long position in Bitcoin and the cryptocurrency of Ethereum. CoinFund’s portfolio is fully transparent at http://coinfund.io . I have no formal business relationship or affiliation with any blockchain technology company or project. Disclosure: I am/we are long GOOG, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Best And Worst Q1’16: Large Cap Value ETFs, Mutual Funds And Key Holdings

The Large Cap Value style ranks second out of the twelve fund styles as detailed in our Q1’16 Style Ratings for ETFs and Mutual Funds report. Last quarter , the Large Cap Value style ranked first. It gets our Neutral rating, which is based on aggregation of ratings of 46 ETFs and 915 mutual funds in the Large Cap Value style. See a recap of our Q4’15 Style Ratings here. Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all Large Cap Value style ETFs and mutual funds are created the same. The number of holdings varies widely (from 8 to 1021). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Large Cap Value style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 Click to enlarge * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Four ETFs are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 Click to enlarge * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Legg Mason BW Dynamic Large Cap Value Fund ( LMBGX , LMBEX ) is excluded from Figure 2 because its total net assets are below $100 million and do not meet our liquidity minimums. The FlexShares Quality Dividend Index Fund (NYSEARCA: QDF ) is the top-rated Large Cap Value ETF and the Brown Advisory Equity Income Fund (MUTF: BAFDX ) is the top-rated Large Cap Value mutual fund. Both earn a Very Attractive rating. The Global X Super Dividend US ETF (NYSEARCA: DIV ) is the worst-rated Large Cap Value ETF and the Copeland International Risk Managed Dividend Growth Fund (MUTF: IDVGX ) is the worst-rated Large Cap Value mutual fund. DIV earns a Neutral rating and IDVGX earns a Very Dangerous rating. Eaton Corporation (NYSE: ETN ) is one of our favorite stocks held by KDHIX and earns an Attractive rating. Eaton was featured as a Long Idea in December 2015. Over the past decade, Eaton has grown after-tax profits ( NOPAT ) by 14% compounded annually. The company currently earns a 9% return on invested capital ( ROIC ), up from just 4% in 2009. Despite long-term improvement in fundamentals, ETN remains undervalued. At its current price of $57/share, ETN has a price to economic book value ( PEBV ) ratio of 0.9. This ratio means that the market expects Eaton’s NOPAT will permanently decline by 10% from current levels. If Eaton can grow NOPAT by just 7% compounded annually over the next decade , the stock is worth $70/share today – a 23% upside. Advance Auto Parts (NYSE: AAP ) is one of our least favorite stocks held by Large Cap Value ETFs and mutual funds. AAP earns a Very Dangerous rating and landed on February’s Most Dangerous Stocks list. From 2010 to the last twelve months, Advance Auto Parts’ NOPAT has declined by 2% compounded annually. Over this time, Advance Auto Parts’ ROIC has declined from 12% to 5%. With the continued deterioration of the business, AAP is overvalued. To justify its current price of $153/share, Advance Auto Parts must grow NOPAT by 10% compounded annually for the next 15 years . This expectation is at odds with Advance Auto Parts declining profitability over the past few years. Figures 3 and 4 show the rating landscape of all Large Cap Value ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst Funds Click to enlarge Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Funds Click to enlarge Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Why Investors Need Independent Research

Some of the best research in the world comes from Wall Street. It has long been a leader in providing investors with ideas and strategies for investing. At the same time, it is important not to paint all Wall Street research with the same brush. Not all of Wall Street is the same, and some of the research it produces poses certain risks. Risk of Conflicts Of Interest Are Significant The “Chinese” wall exists to ensure that research analysts aren’t influenced by the desire of investment bankers to get deals. That wall is not always as solid as outsiders might think. After the tech bubble, investigations revealed that analysts got paid to help the firm win more IPO business by writing positive reports on stocks they knew were not so good. For instance, one analyst sent an internal e-mail calling a company “such a piece of crap” on the same day his firm published a “Buy” rating on the stock. That company, Excite @ Home, filed for bankruptcy the next year. One might hope that the punishments handed down in the $1.4 billion Global Research Settlement would prevent conflicts of interest affecting research ratings, but that doesn’t seem to be the case. In 2014, the Financial Industry Regulatory Authority (FINRA) fined 10 banks for allowing their analysts to participate in the pitching process for the Toys “R” Us IPO. “I would crawl on broken glass dragging my exposed junk to get this deal,” one analyst wrote to his colleagues . Conflicts Of Interest Are Inevitable It’s understandable why Wall Street analysts would end up getting pressured to help out the investment bankers. After all, equity research is a cost center and does not directly generate any revenue. Revenues come primarily from trading and underwriting, with IPO’s usually offering the biggest paydays. Analysts that don’t help the firm bring in more deals get fired, even if their ratings are accurate. See Fortune’s ” The Price of Being Right “. Plus, the competition for the big paydays from deals heightens the pressure on analysts. In the example above, 10 banks were pitching Toys “R” Us. Every bank knew they had to offer favorable analyst coverage as part of the package, or the retailer would go with one of their competitors. Not surprisingly Wall Street ratings have a significant positive bias. An analysis from Bespoke Investment Group found that, of the 12,122 ratings out there for all stocks in the broad market index, less than 7% were labeled sells, as shown in Figure 1. Figure 1: Wall Street Rarely Issues Sell Ratings Click to enlarge Sources: Bespoke Investment Group Wall Street Is Built On Getting and Giving The Scoop The best way to make money is to be one step ahead of other investors. Sometimes it can be hard to distinguish between “scoop” and inside information. Before Reg FD , Wall Street analysts thrived on passing inside information to their biggest and best clients. That habit is hard to break. It is not surprising that analysts are still trying to find ways to get an edge. As a result, most professional investors know that an analyst’s published research might not always tell the whole story. To get the whole story you have to meet with the analyst in person or attend an “idea dinner”. A recent FINRA fine involved analysts holding “idea dinners” where they offered opinions that sometimes contradicted their published ratings , such as highlighting a “short” call that they’d upgraded to “hold” in public. Sometimes there are reasonable explanations for these contradictions. Maybe new information has changed the analyst’s opinion but they haven’t had the chance to update their report. Maybe the individual investors they’re talking to have a different time frame from the general public. In other cases, analysts might avoid publishing negative research in order to maintain a good relationship with executives . The top investors get word from the analyst to sell, but ordinary investors reading the research reports still see a “Buy” rating. Ultimately, the clients at these “idea dinners” have privileged access because they trade more, and are therefore more valuable to the bank. Consequently, they get a different level of information than those without direct access to analysts. And that’s the real message here. There are a lot of really smart and dedicated analysts on Wall Street, but their interests are not always aligned with the average investor’s. Sometimes, the analyst’s goal to make money for his or her firm overrides the desire to serve the best interests of investors. Most Analysis Behind Ratings Is Not Rigorous The models used by most sell-side analysts tend to rely on accounting earnings or, even worse, non-GAAP earnings . Since CFO’s agree that 20% of companies have misleading earnings , those numbers are not reliable. However, there’s no real incentive for analysts to do the hard work required to reverse accounting loopholes and get to the underlying economics of a business. The lack of conviction behind investment research explains why, for instance, Goldman Sachs has already reversed itself on five of its six big calls for 2016 . Investors that based their strategies around those calls this year are now faced with some difficult decisions. The bottom line is that investors should not be making decisions based solely on Buy and Sell calls from Wall Street. There are plenty of cases where a “Buy” is not really a “Buy”, as highlighted by Integrity Research . Whether it’s to keep the boss or a big client happy, to maintain a relative sector balance, or simply due to being overworked, these ratings can be influenced by many factors besides fundamentals. Independent Research Offers Protection As we state at the beginning of this article, Wall Street provides some of the best research in the world. The connections that many analysts can make with executives sometimes give them unique insight into companies. They can offer valuable commentary on industry trends. There are, however, certain conflicts ingrained with the way Wall Street does business. There is real value in incorporating an independent perspective. Investors deserve research that gets to the core drivers of valuation . They deserve independent due diligence because it is part of fulfilling fiduciary duties and it tends to pay . This diligence helps us to identify stocks that are poised to blow up . As just one example, three months ago, we put Qlik Technologies (NASDAQ: QLIK ) in the Danger Zone. At that time, 21 out of 27 analysts had Buy or Overweight ratings on the stock, and no one had Sell recommendations. Since that date, the stock is down almost 40%. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.