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Random Talk by Vishal Gupta Life is meant to be a random walk – my life has always been one. Through the Random Talk blog I share my experiences and perspectives on life as I perceive it. You’ll find here some original (non-mainstream) thoughts on various random topics that interest me – life,... More
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  • Money Money Money (Part I): Themes – Making Money Trendy – Social, Solar & Realty 0 comments
    Nov 6, 2013 10:54 AM | about stocks: GSVC, FB, SVVC, TWTR

    This blog post is the first of a 3-part money trilogy:

    Part 1 - Themes: How to build an investment portfolio based on major themes of the moment to make it "trendy" (pun intended)

    Part 2 - Rules: Some basic tenets to test your investment ideas and make them work

    Part 3 - Styles: Selecting an investment style consistent with your personality

    It's back - the Random Talk blog! And for this edition, I've decided to go with a 3-part trilogy. So, over the next 3 weeks, I shall be sharing my thoughts and perspectives on building and managing your personal investment portfolio. And as with everything else I write, I'll endeavour to make them as non-mainstream (or random!) as I can without compromising on the sincerity of thought which is paramount when commenting on money matters. So, hopefully, this won't be just another among the gazillions of money blogs out there, and you'll find in here some useful ideas to implement.

    Money Money Money… it's a rich man's world!

    A few happenstances

    Writing about investing wasn't necessarily an obvious choice for this edition of my blog. But, in recent times, there have been more than a few reasons why my mind has been cluttered with various random gibberish on money matters. I recount below but a few of these happenstances that have culminated in me writing this money trilogy:

    • There was the bizarre, yet clever, irony of Eugene Fama and Robert Shiller being co-awarded the Nobel prize for economics - one man used the Random Walk theory to propound the theory of efficient markets; the other profusely refuted it - market movements, he said, were intertwined with various aspects of human behaviour such as irrational exuberance, greed and fear
    • Politicians in the UK, meanwhile, sniggered, and put both those theories out of the window, with an alleged deliberate mis-pricing of the Royal Mail IPO to reward the populace with a princely 750 pounds worth of royalty each - Nobel what??
    • Any remaining semblance of belief in the efficiency, or lack thereof, of markets was put to test as I observed with keen interest the price development in the pre-IPO "grey market" for Twitter; the valuation moving by tens of billions of dollars in a flash almost as a quickly as a seasoned research analyst could do by changing a single cell in an elaborate spreadsheet valuation model - except that, this one was for real
    • Then, as the quarterly earnings season rolled in, even the more mature stock markets moved with a frenzied fever pitch, with everything from Google to the S&P 500 evidently in a race to scale all-time highs - all this at a time when we were being told, the US is this close to financial armageddon
    • Property prices in the UK, meanwhile, scaled a peak of their own (prices in London anyway always seem to be based on the highest number one can think of at a given point of time); the rise this time, we are told, is being fuelled by the Help-to-Buy mortgage scheme, which has opened its own Pandora's box of supply v/s demand and public v/s private debates on what drives markets
    • In my own personal life, I've had more than my usual roster of networking events to go to, where despite my best efforts to hide my finance pedigree, people eventually get to the bottom of that, and to make it worse, consider it polite to have at least some conversation on a finance-related topic
    • Not to forget, the Hindu festival of Diwali is just round the corner - so it's time to say our prayers to Lakshmi, the Goddess of Wealth, and ask her to usher upon us a new era of prosperity
    • And finally, to ensure I had absolutely no way to get away from thinking of financial and money matters, my wife duly asked me to present to her a detailed budget for my "flamboyant" and "devil may care" lifestyle (her words, not mine, and as any husbands reading this would know, turning the question around is never an available option in such circumstances)

    Phew! Money Money Money… if I had a little money!

    What is theme-based investing?

    Now, during my years working in Investment Banking, I have no doubt come across a mind-shattering variety of ways to identify "winning" investment strategies going by various exotic names such as growth, value, momentum, hybrid, macro, micro, delta followed by a number, beta preceded by an adjective, statistical arb, capital arb, something else arb. Then there are a multitude of research analysts who use complex spreadsheet models to determine the precise value of a company's shares or other assets (to get further insights on how they operate, read my blog post caricaturing, with due respect, these well-meaning folk as CAT-2 people). Of course, Messrs Fama and Shiller have an entirely different perspective to the debate - their question is a more fundamental whether it is possible to identify winning strategies at all. However, in our lives, we all need to act and make a decision on where and how to secure and grow our stash of cash - so let's leave that debate for the academics (who would do well to consult the politicians first, this time).

    My point is that in making one's investment decisions one can get swamped in a quagmire of information which can stifle decision-making. There is a compelling need to distil and simplify all this information by discerning patterns a'la the Random Walk (see, I told you there was a reason I called my blog Random Talk when I started it!). That's been the genesis for what I describe as theme-based investing.

    Implementing a theme-based investing philosophy is basically a simple 3-step process:

    Step 1: Observe a few things that are in trend - at this stage, it is important to observe trends both in the real world around you and trends in financial markets (that is why it is sometimes beneficial for CAT-1 and CAT-2 people to interact with each other!)

    Step 2: Aggregate the trends by combining together those with common driving factors to arrive at a small manageable number of themes - this should also result in themes that are non-overlapping (or, orthogonal as the geeks would put it) to get some natural diversification in your portfolio

    Step 3: Distil or Extract, for each theme, a few monetisation strategies that can be acted upon - provided you've selected the theme appropriately, think laterally, as there should be more than one way of trading on that theme (else, it's probably just a trade idea, not a theme)

    Money Money Money… all the things I could do!

    The Themes - Old and New

    Now that I have described the process of theme-based investing, I would encourage you to spend some time (a few weeks if you want to be sincere in following all the steps) in identifying and implementing themes that work for you. There is no one-size-fits-all. Our observation patterns are different, how we perceive things varies, and most importantly our personalities are different, therefore the themes that different individuals choose to select must also be different - the relationship between personality and investing is something I will elaborate upon in Part III of this money trilogy. However, I have always advocated that any financial talk be actionable. So, below, I shall present an overview of what I believe to be the high potential themes currently. You can either follow these themes yourself if they make sense to you, or else use this as a template to develop themes of your own.

    Before I introduce the current themes, for reference, let me briefly mention a few popular themes of the past decade. I am selecting here based on themes that have been successful (i.e. delivered high returns) and also ones that I have personally advocated consistently over majority of the past ten years. On that basis, my top themes for the past decade are - gold, bric and bonds. Gold, and other commodities, looked significantly undervalued ten years ago and have been a beneficiary of USD weakness and currency re-alignments - the price 5-tupled in the last ten years. BRIC (as referring to Brazil, Russia, India and China), and emerging markets in general, have been key beneficiaries of demographic shifts and economic liberalisation - anyone playing the BRIC markets would have experienced a 5 -10 fold return on their capital, at a time when most developed markets went through the so-called lost decade. And finally, fixed income bonds have been a sound low risk investment benefiting both from the uplift to bond prices resulting from a secular decline in interest rates, and mostly low corporate default rates. To these, I would add a couple of other successful themes that I didn't necessarily advocate as a financial investment early enough. One being digitisation - the likes of Amazon and Google have been great plays to benefit from the explosive growth in online economic activity (10x plus return). Hardware was perhaps the other surprise growth story, with Apple defying Microsoft's software-is-king thesis and rising to become the most valuable company in the world with its glitzy devices and spawning a gadget revolution of sorts. One of my points here is that some of these themes were not so hard to identify - Chinese-manufactured goods were everywhere to be seen, the China-now story and the India-next story was all over the news, the ipods and iphones were quite the cool gadgets to have, and who wasn't shopping on Amazon or searching on Google? You didn't have to be a rocket scientist to spot these trends - simply talking to people (hopefully you know a few CAT-1 people, talking to CAT-2 people wouldn't have helped) or looking at your own life was all that was needed to spot some of these winning themes. And, what's more, you didn't have to get all of them right - even if you got one or two of them right, you've done well.

    Money Money Money… so I must leave, I have to go!

    Moving on, a number of the themes of the past decade have now run their course - gold has topped out, the BRIC story is now mostly a China story, interest rates are at rock bottom. Digitisation continues, but in a different vein. And the hardware story, post the demise of the Great Fruiterer (you'll find the reference in one of my earlier posts), is now all about the things we can do with our smart devices. So, it's time for a rethink. Below, I present my case for what I believe to be the three dominant investible themes of the moment - social, solar and realty.

    Theme #1: Social

    You know this, the one biggest change in your daily routine in recent years (apart from getting married, changing jobs, having a kid or relocating) has been the one caused by the onset of social media. Whether you are an active or passive user, chances are you've had at least some presence on Facebook, Twitter and LinkedIn. Social media is the biggest revolution of our generation. It's impact on information and communication is comparable to the arrival of the PC, the internet and mobile phones - and the companies at the forefront of those went on to become the most valuable companies in the world - Microsoft, Google, Apple. When you started using them, it was also a good idea to invest in their stocks - that's what I mean by observing trends in the real world. The good news is that financial markets (which often are late to catch up on real trends due to the preponderance of CAT-2 people who control them!), have only just started to get social media - the likes of Facebook and LinkedIn have become darlings of the stock market and I'm sure you've caught the hype surrounding the Twitter IPO.

    So, that's my theme no.1: Social! I coined the acronym TGLF (as referring to Twitter, Google, LinkedIn and Facebook) and have now for some time been propagating the idea that TGLF is the natural successor to the BRIC theme of the past decade. To me, it's simple, ten years ago, we could identify emerging economies using geographical boundaries; in the post-digital world we need to look at communities sans borders in the online world. I sometimes play this game of asking people to map each of the constituents of TGLF to those of BRIC - e.g. is Facebook with its population of 1.1 bln akin to China, or is Google China and Facebook is India; or wait could the Twitter story pan out like the India story? Something to engross your grey cells, if they're not already over-worked trying to crack the Twitter IPO grey market or worry about the star cast of 50 shades of grey!

    Ok, so we observed a few trends (step 1) and aggregated them into the social theme (step 2). Now, the all-important step 3 of distilling investment strategies from the theme - and as I said, there should be more than one. So here's a few ways of riding the social wave. The simplest is to buy stock in any of the TGLF companies (though I'd be wary of Google as it may already be fully valued). Get in on the Twitter IPO, if you can - here's my tweet-log from earlier in the year making the 100 billion dollar valuation case for Twitter. Then there are indirect ways to buy in such as through a targeted social media ETF such as the Global X Social Media Index ETF ($SOCL). Or go for a listed venture capital vehicle geared towards social media such as GSV Capital ($GSVC) or Firsthand Tech Value Fund ($SVVC). If you are willing to bet big on the next generation of social media (and by extension cloud technology) companies, then you've also got the option of buying into them from pre-IPO exchanges such as Sharespost and Secondmarket (the likes of Dropbox and Pinterest are touted as the next hot breakout candidates, but there are others). Finally, as I said you should think laterally - marrying rich is a time-tested wealth management strategy - so even if you can't get in on the Twitter IPO, marrying someone who works there may be the best investment you'll ever make - act fast, there's only two thousand of them!

    Money Money Money…must be funny!

    Theme #2: Solar

    My second theme, solar, unlike the social theme, is more niche and not something readily observable in everyday life - no kidding, if you live in the UK, anything connected to the sun is the last thing that comes to mind. Yet, as an investment theme, it is one that I have steadily warmed towards over the past couple of years. In fact, it is a 3-in-1 theme of sorts combining the benefits of tax-efficiency, inflation protection, and advancements in renewable energy technology.

    2a) Renewables - Rising energy prices is something that anyone who's looked into their household expenses would be aware of - there is a supply problem as fossil fuels are limited in quantity. In response, most countries have made commitments to increase the proportion of energy coming from renewable sources - Europe, for example has a specific directive relating to this. In the UK, the installed solar power capacity is projected to grow 10-fold by 2020. In order to incentivise investment in solar power, governments provide various subsidies - the exact mechanism varies from one country to another. In the UK, the mechanism used is issuing ROCs (Renewable Obligation Certificates) in return for each unit of solar electricity produced, which can then be sold on the open market.

    2b) Inflation protection - If you follow the financial news, you've heard the term "quantitative easing" bandied about at no end - it refers to the hundreds of billions of dollars, pounds and euros that central banks the world over have been pumping into the economy to help it stay afloat. Of course, there is both hope and concern that all this money will eventually make its way to the economy, and when it does there could be an inflationary spiral leading to money devaluation and/or escalating asset prices. Therefore, investments with inflation-linked revenue streams have been increasing in popularity as protection against rising inflation. Indeed, while the exact contract structure varies from one country to another, most power purchase agreements (PPAs) entered into by solar plants have some degree of inflation-linkage in them. In the UK, for example, PPAs tend to be 20 or 25 years long, indexed to inflation.

    2c) Tax-efficiency - Tax is a very important aspect to consider when making investment decisions. Tax makes all investments fundamentally asymmetric in nature - any gains are taxed, while losses may not be deductible unless offset by other gains. Now, most jurisdictions offer some or the other form of tax-efficient investment avenues, though tax authorities can be notoriously fickle in their interpretation - one example, I often sight is relating to many hotels in the UK opting for fitted furniture in rooms, as that qualifies as tax-deductible expense on fixtures and fittings, while movable furniture doesn't (next time you're in a hotel room, and the bed doesn't move, you know it's the work of the tax inspector, not the interior designer!). So, anyway, against this backdrop it has been heartening to see the development and coming off age of the Enterprise Investment Scheme (EIS) in the UK. The scheme allows the investor to reclaim 30% of the investment from the income tax paid, defer capital gains, and any gains on the investment itself are exempt from capital gains tax. While the scheme has been around for a few years, it is only now that it's operational details have become well-understood by a large number of individuals and tax authorities alike, which lends to greater transparency and certainty regarding the tax treatment. This is reflected in the rapid growth and popularity of EIS-eligible investments. And, what is interesting is that many utility scale solar power installations are qualifying investments under the EIS scheme.

    The three sub-themes combined provide an attractive, secure and difficult-to-replicate return profile for solar-related investments. The monetisation strategy you choose will vary from one jurisdiction to another and how many of the sub-themes you want to participate in. In the UK, there is the option to invest directly in an operational solar power plant or purchase the index-linked annuity, without seeking the tax benefits. Sub-utility scale power plants (<5MW capacity), for instance, installations in bowling clubs, provide access to subsidised Feed-in-Tariffs (FiTs) but they are no longer eligible for the tax-efficient EIS. Hence, my preferred monetisation strategy for the solar theme is to invest in an EIS-qualifying utility scale solar power installation. You can invest directly or through an EIS fund (such as Foresight, Merepark, Octopus or Downing) which will usually invest in more than one installation. Recent fund-raisings from solar EIS funds have all experienced a clamour of investor demand, so you may be well-advised to act well in advance of the tax-year closure in April to get access to one of the better-performing funds.

    Money Money Money…always sunny!

    Theme #3: Realty

    Realty or real estate or property is my third theme, which arguably is an evergreen theme. The benefit of leverage, and utility as a housing abode (for residential property) means that an investment in property generally stands in good stead in the long run. If you, or a friend, have tried to buy a house in recent times, you know how hot the market is. From Spain to Sweden to America, house prices are on their way back up - in part due to various stimulus measure introduced by governments. Of courses, realty in big cities such as London and New York is always in demand, and in the recent financial crisis even emerged as a safe-haven asset for the global investor. Leverage is an important factor that amplifies returns from realty in a rising market, and the low interest rate environment means that the cost of the leverage is low. Of course, the lack of availability of leverage is what plagued the market during the crisis, and that is precisely an area that various governments are addressing. In the UK, the price rise is being supported and allegedly inflated by the government's Help-to-Buy mortgage scheme designed to improve mortgage availability.

    While the theme here is obvious, it is step 3 (distilling monetisation strategies), which requires closer attention to identify strategies to participate in rising property prices. Most people will start and stop by considering buying a private residence. Depending on your personal circumstances that may not be feasible or not be most efficient. If you simply want to lock in the price now, consider buying into a development for a low upfront deposit. If you can afford it, but don't already have a buy-to-let investment, ask the question why? Realty, of course, doesn't only mean buying residential property - so consider the broader gamut of investment avenues - commercial property offers better yields than residential, buy a listed REIT if you think commercial property prices will catch up residential growth, or a property focused fund or ETF, or shares in housebuilders who are the direct beneficiaries of various stimulus measures - the possibilities are many. There may even be tax-efficient avenues - for instance, in the UK, some of the highest return generating EIS schemes have been the ones investing in pubs and bars which are indirectly supported by the underlying real estate value of the premises. Whatever you do, just remember that property is a long term investment, so don't chase short term gains here.

    Money Money Money…aha, ahaaaa!

    So, that brings me to the end of part 1 of the money trilogy - providing an overview of implementing a theme-based strategy and my top three actionable themes. Note that I haven't used any complex analysis - that's what theme-based investing is about - you don't have to be an expert, it is for everyone, all you need to do is observe trends, aggregate them into themes and then distil some monetisation strategies from the themes. A meerkat could do that… Simples! And the other advantage of the theme-based process is it allows you to structure your thoughts to avoid being submerged in a mountain of information. So, as far is this blog post goes, apart from the theme-based philosophy, there are only three buzzwords you need to take away and remember - social, solar, realty. So long as you remember them, you'll find your own way to interpret and use them.

    Money Money Money… it's a rich man's world!

    Watch out for the next two parts of the money trilogy - Rules and Styles. I would love to hear if and how you've adopted parts of this blog into your investment methodology. Please also let me have your feedback by commenting, liking (or disliking), or re-tweeting this.

    Money Money Money…

    (To be continued)

    Disclaimer: This blog does not represent investment advice, it's your money, invest at your own risk

    Disclosure: I am long FB, TWTR, GSVC, SVVC.

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