Book Reviews
Book Review of ‘Panic, Prosperity and Progress’
Five centuries of bubbles and panics
 
book review, Panic, Prosperity and Progress, Timothy Knight, Wiley, Isaac NewtonIn 1711, Britain was deep in debt following its debilitating war with Spain. It owed £9 million and had no means of paying it off. The prospects of government bonds being paid back were so low that they were trading at 50% discount. It made the financial elite of Britain to form a private organisation to take over and manage the government debt. In return, they demanded a monopoly to trade with the Spanish colonies of South America which, at that time, was referred to as the South Seas.
 
A new company, called The South Sea Company, was born to take over the debt. The holders of debt would get shares in the new company but the government would continue to make interest payments to the company. In essence, their cash flows were secured by interest payments and their profits by the monopoly trading rights, even though Britain was still at war with Spain till 1713.
 
The reality was different. There was hardly anything to trade with South America. For seven years after the formation of South Sea Company, not a single ship left Britain to trade. When it did, it was to trade not in products or materials, but in slaves. The agreement with Spain was too restrictive: supply the Spanish colonies with 4,800 slaves per year for 30 years and just one ship of up to 500 tonnes of other cargo. If that trade were profitable, the Spanish king would take away 25% of the profit.
 
Meanwhile, there were no interest payments by the government. Unpaid interest had accumulated to over a £1 million. Shareholders were expecting dividends from that interest. To make up, fresh shares were issued. The shares of South Sea Company got listed and started to move up gradually until late 1719 because of the expected profits from trading with distant mysterious lands. But soon war broke out again between Britain and Spain and the South Sea Company got reduced to just a building in London holding a bunch of bonds of dubious value. This did not deter massive speculative frenzy in South Sea shares. 
 
There was heady excitement about bold new frontiers in finance being conquered, with private enterprise running public finance. South Sea stock took off and, with it, stocks of newly listed companies committed to outrageously harebrained schemes such as trading in hair, horse insurance, creating a wheel of perpetual motion and “carrying on an undertaking of great advantage but nobody to know what it is.” South Sea Company promoters were unhappy with this bubble. They even got a Bubble Act passed by bribing the lawmakers requiring all traded companies to receive a royal charter. Most of them did not get the charter and were suspended. The South Sea, of course, got one and its shares shot up tenfold in six months! 
 
This caught the attention of Britain’s most distinguished scientist at that time—Sir Isaac Newton. In early 1720, he bought some shares at £150 and sold them at £350 for a princely profit of £7,000. The stock continued to climb. Newton jumped back in and put in much more money to make up for lost time (and profits), even borrowing money for it. The stock almost hit £1,000 and then crashed like a waterfall inflicting a loss of £20,000 (which, in 1720, amounted to almost all his life savings). This prompted him to say: “I can calculate the movement of heavenly bodies, but not the madness of men.” 
 
The South Sea Company is one of the great bubble and crash stories. Many books have referred to it. One of the finest is Devil Take the Hindmost by Edward Chancellor. Panic, Prosperity and Progress, by Timothy Knight, is of the same genre. It documents five centuries of such episodes starting with the Tulip Mania in Netherlands and moving on to California Gold Rush, hyperinflation of Germany, the Internet bubble and the financial meltdown of 2008. An interesting read but should be available in paperback. 

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Book Review of ‘The Aspirational Investor’
Glowingly recommended by two Nobel Laureates, it falls short
 
I have read many books on investing but have not come across one with such glowing recommendations. Praise for The Aspirational Investor by Ashvin B Chhabra comes from five extraordinary people. One is Dr Harry Markowitz known for his pioneering work on modern portfolio theory who won the Nobel Prize in 1990. Jim Simons, one of the top traders in the world, is a mathematician who applied himself to studying pattern recognition and now runs Renaissance Technologies which manages $25 billion. He says that this book is an “original programme to guide an individual.” Glowing endorsements also come from Eric Maskin, Nobel winner in 2007, as well as Burton Malkiel and Charles 
D Ellis, two seminal writers on investing. What is so great about this book? 
 
Chhabra brings some fresh thinking to financial planning. He advocates that investors should create a three-tier portfolio. The first, called essential portfolio, will help you protect your current lifestyle and  should be invested in safe products. The second, labelled important, should be to help meet long-term goals such as retirement. This should be invested in market-linked products. The third portfolio is aspirational portfolio where you should put high-risk products. This is fine in theory. How does one implement it? Chhabra outlines seven steps for this purpose.
 
Step1: Outline Your Goals: Categorise your goals as essential, important and aspirational. A young couple, at an early stage in their financial life, might have goals that include savings for college, owning a home and starting a business; while a wealthy retired couple may have only two goals: maintaining their lifestyle and leaving a legacy.
 
Step2: Goals into Cash Flows: Put numbers to your goals. Quantify the total amount needed today for virtually any goal using one easy formula: amount needed divided by the number of years. If you do this every year, you eliminate the complications of inflation-adjusted cost.
 
Step3: Create Your Wealth Allocation Snapshot: Next, put together everything you own and everything you owe. “This is the step where you will organise your assets and liabilities across the personal risk, market risk, and aspirational risk buckets” and place them in appropriate buckets. 
 
Step4: Assess Your Risk Allocation: Chhabra now wants you to do the right risk allocation across your safety, market, and aspirational portfolios. Can you? As Albert Einstein had said, “everything should be made as simple as possible but not simpler.” Sure enough, Chhabra’s approach breaks down at this stage. He writes, “Alas, there are no exact answers, but there are good guidelines. Your optimal allocation depends on a variety of objective considerations and should strike a balance between factors such as your age and earning potential, your total current wealth, and the ratio of your assets to the amount you need to sustain your lifestyle. Subjective factors such as your goals and your ability to bear losses are also key factors.” 
 
Chhabra goes on to say, “A thorough analysis of your optimal risk allocation must take into account both your financial ability and your psychological ability to bear losses. If you have no ability or desire to take on risk—or, conversely, you have a high tolerance and ability to take on risk—then either a conservative or an aggressive risk allocation may be warranted, defined by the degree to which you allocate assets on a relative basis to your safety portfolio or your aspirational portfolio.” Can anyone do this by oneself? No.
 
Step5: Implement Asset Allocation and Portfolio Diversification: Just as the goals of each risk bucket are different, so, too, are the securities that you will hold within them, as well as the way each portfolio is constructed. Once again, hard for individuals to do it.
 
Step6: Analyse & Stress Test: Chhabra asks his readers to put their portfolio through the following tests: market meltdown test, loss of employment test, sustainability test, aspirational goals test, etc. This, too, is impossible for an individual to handle.
 
Step7: Review and Rebalance: If you are able to take the six steps, you would then have to take the last step which is an annual exercise to keep your finances on track. 
 
Given how much the book is hyped up on the jacket and the recommendations the author has obtained, all this is a bit of a let-down. Perhaps financial planners may have some use of this book. 

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COMMENTS

Nilesh KAMERKAR

2 years ago

Another excellent review Mr. Basu.

It appears more will go into reading of this book than you can get out of it

Book Review of ‘The Value Elephant’
Who’s the typical reader of this book?
 
book review, The Value Elephant, Sanjay Kulkarni, economic value addition,There aren’t too many books on valuation, shareholder value or wealth creation, in the Indian context. The Value Elephant, by Sanjay Kulkarni, is, therefore, an important addition to this slim sub-genre. Kulkarni was the managing director and country head of Stern Stewart & Co, a consulting firm that brought the concept of economic value addition (EVA) that many Indian companies embraced in the 1990s. EVA separated businesses that create value, such as Nestlé or Marico, and those that don’t and, hence, need additional capital periodically to virtually stay where they are.
 
A company in the second category is Reliance Industries. Its core businesses—upstream and downstream petrochemicals—earn a low return on capital. About 16 years ago, it went into oil exploration, which not only requires a lot of capital but is a hit-or-miss business. Reliance has had more hits there than misses. Then, it went into brick-and-mortar retailing—just when e-tailing business took off in India. After nine years and thousands of crores of rupees of investments, Reliance Retail is barely profitable. And now Reliance is getting into the telecom business where competition is intense. Kulkarni had “mentored group businesses and investments at the office of Mukesh Ambani, chairman of Reliance Industries,” proudly mentions the book jacket. 
 
The pages inside showcase better achievements by him. He claims to have netted fantastic returns using his model V-GRO which identifies stocks on the basis of value, growth, risk and operating performance. According to him, value is central to this framework. Valuation gets expressed in price/earnings ratio, EBIDTA/enterprise value and price/sales, etc. Kulkarni hastens to add that “these multiples may not provide you with complete information, yet they are useful for better assessment of value as seen on bourses... what you see on the bourses is price and not value. Price is decided by the market. Value is your estimate of the underlying worth of the company.” 
 
While this is correct, unfortunately, anyone even with good grasp of finance will find it hard to move any further with this piece of knowledge. As I like to emphasise, a shareholder is an outsider. He really knows too little about the company. What estimate could he make, beyond extrapolating published information? By highlighting objective valuation ratios as a guide and immediately de-emphasising them and then shifting the focus to subjective estimates, the author gives confusing signals that will paralyse the average reader. 
 
To calculate returns of V-GRO, go for trailing five years of operating performance. But, of course, like valuation, you need to have your own estimates—the past only provides some clues. Can an average person estimate future earnings? Would the author himself be able to do so without the analytical tools of a professional set up like Stewart & Stern? The other aspects of the model are harder still. Here is a partial list of the risks Kulkarni wants you consider: risks of size, diversity, capital deployed in different geographies, business segments as proportional a of total capital deployed, concentration of revenues from or capital in one geography, product, brand, etc. 
 
Then the author wants you to assess ‘strategic risks’, such as volatility revenues, ‘economic profits’ and cash flows as well as risks of operating leverage such as fixed assets as a proportion to capital employed. “You could also consider variations in contributions margins, working capital and its individual constituents such as receivables, inventories and payables. You may consider the ‘newness’ of assets…trailing ratio of average gross assets and depreciation over five years.” Phew! And I have not even gone into ‘risk of financial leverage’ and ‘risk of investment’. Then, “beyond these quantifiable risk parameters, there can be lot more to risk and you must rely equally on qualitative assessments of risk.”
 
Finally, even if you can figure out how to handle this thicket of parameters breezily described, how do you apply them? Investing is a matter of choosing the best bets from a wide set of companies. Without the access to sort-able database of companies and their parameters, how will you even start this process? Start with any 50, or a sample of your choice, is Kulkarni’s advice. Also, there are two parts to the book. The first is for individual investors (how to find stocks to buy) and the second is for businessmen (how to become stocks that people want to buy). This is another cause of confusion: whom is this book meant for? 

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