Did The Technology Industry Reach Its Plateau?

Technology Plateau

The Technology Hype

There is too much hype around staggering technology startup valuations, unicorns, Apple’s cash position, Alphabet’s vision, and many more. Most of what I hear and read is whether or not the technology industry reached a plateau. Partly the reasoning is the exaggerated valuations, sometimes lavish life style of few technology entrepreneurs, and whether we really want so much new features in our mobile devices, or augmented reality?!

The Scope of the Research

That’s a very broad subject, and I spent time researching various angles that can tackle some of the questions that arise towards the technology industry. In essence, I decomposed the questions I want to answer based on different stakeholders:

Venture Capitalists: Should we raise a new fund? Should we continue investing in more startups? Is there enough room for mergers and acquisitions activity so we exit our positions?

Entrepreneurs: Should I start a new tech startup? Doesn’t it seem a bit too much crowded now to start yet a new startup? Would the big boys with big bucks have any interest/capital in the next 5 years to buy out my startup?

Executives of tech companies: How much more room we have for growth? Can we still play the acquisition game to grow our market share?

Methodology

Obviously, those questions cannot be answered in a one page blog post. However, a simple yet data driven approach can give us amazing insights into answering them.

Business Consolidations

Industries go through four stages until they become so called “mature” or “stable”. Based on the article “The Consolidation Curve” in Harvard Business Review, the four stages are Opening, Scale, Focus, and Balance and Alliance.

Briefly describing, the article tackles the consolidation curve of industries by measuring the market share of the top 3 players of the industry.

  • Opening: A monopoly that soon vanishes and the top 3 players control between 10% to 30% of the market due to an influx of competitors.
  • Scale: Major players emerge and buy up competitors. Top 3 players control between 15% to 45% of the market.
  • Focus: Top 3 players focus on aggressive growth and control 35% to 70% of the market. Still 5 to 12 major players are around.
  • Balance and Alliance: The top 3 players control about 90% of the market and form alliances between themselves.

Current Market Analysis

So if we take that segmentation as a basis to find out how much the technology market has emerged, and how much growth can it still absorb, then what we need to find out is how the top 3 players of the technology market stack against the entire market.

Unicorns and Listed Companies

My assumptions going forward would be the following:

  1. The basis of the research is the United States market.
  2. Listed Technology companies in the NASDAQ market comprise all the publicly traded technology companies. Link to the list.
  3. Private technology companies that matter are the Unicorns, i.e. startups that reached beyond the $1 Billion valuation. Link to the list.

Total Addressable Market

Listed Companies Private Companies Total
$4.687 Trillion $338 Billion $5.025 Trillion

Top 3 Players of the Tech Market

Rank Company Market Cap % of Total Market Size
1 Apple Inc. $517.9 B 10.3%
2 Alphabet Inc. $485.1B 9.7%
3 Microsoft Corp. $399.4B 7.9%

Scale Stage

Sum of the top 3 players’ market shares is: 27.9%. This puts the Technology industry into the second stage of scale based on HBR’s article.

So What Does This Mean?

To answer the questions we addressed at the beginning, we need to take a look at the scale stage. Here’s how it’s described based on HBR’s article:

Because of the large number of acquisitions occurring in this stage, companies must hone their merger-integration skills. These include learning how to carefully protect their core culture as they absorb new companies and focusing on retaining the best employees of acquired companies. Building a scalable IT platform is also crucial to the rapid integration of acquired firms. Companies jockeying to reach stage 3 must be among the first players in the industry to capture their major competitors in the most important markets and should expand their global reach.

This describes the rapid M&A activity by large players trying to acquire as much good startups as possible to ensure their own survival. In summary, the answers to the questions would be:

Venture Capitalists: Should we raise a new fund? Should we continue investing in more startups? Is there enough room for mergers and acquisitions activity so we exit our positions?

Answer: In short: Yes. There is still room. However, funds should predict the estimated timing of stage 3 of the market. VCs should focus on growth startups in the industry’s transitioning phase into the third stage. Reason why is that the big players won’t have enough time to buy out startups at early stages and can only accommodate growth startups that will immediately add to their top lines and make fast synergies with their businesses.

Entrepreneurs: Should I start a new tech startup? Doesn’t it seem a bit too much crowded now to start yet a new startup? Would the big boys with big bucks have any interest/capital in the next 5 years to buy out my startup?

Answer: While entrepreneurship is always encouraged, and one should be dedicated to growing his/her company, I think with the tech scene becoming too crowded, tech entrepreneurs should have a solid idea regarding their possible exit strategy to one of the major players in the technology scene. That may seem trivial but from personal experience, I see lots of startup founders tackling legitimate problems but not having an idea about their exit strategy. Also, it does not necessarily mean that the exit synergy should ONLY be with Apple, Google, or Microsoft. Although these three are the giants, other major players are still very legitimate options since the industry hasn’t gone through the third stage yet.

Executives of tech companies: How much more room we have for growth? Can we still play the acquisition game to grow our market share?

Answer: Yes. There is plenty of room to grow. 27.9% of the market is way behind the 90% mark. However, acquisitions should be targeted smartly in various verticals in the sense that not only adds to the top line directly, but also makes it harder for the competitors to join that specific vertical. In short, release products and acquire startups revolving around the product to make the barriers for entry in that product’s vertical harder bracing for an aggressive competition in stage 3.

Kuwait’s Budget Reform Seen From A Different Angle

Kuwait Landscape

Kuwait’s Problem With Materialism

It’s obvious to the ~4m residents of Kuwait how much almost everyone is craving to make more money, and collect more material.

With the context of the recent harsh drop in oil prices, and the Head of State’s speech in parliament, stating that the national income is slashed by about 60%, an alarming number! It’s obvious that this hunger for fatter bank accounts, and the decline of the income will not yield a very bright future.

So where is the problem? Is it in the long list of government expenditure? The corruptive actions of the few? Or maybe the fake cancer treatments in top tier hospitals abroad that are in fact just prolonged summer holidays!

All of the above contribute to the growth of the problem, but have we ever looked at the satisfaction level of a Kuwaiti individual? And then try to connect that back to the national income and economic prosperity.

I’m going to avoid the political effects whether good or bad, and focus on the end monetary result (we’re all craving for the dinar anyways, right?!)

What do I mean by satisfaction level?

An average government employee may see his satisfaction level by the amount of bonus and salary raise he gets each year, while complaining about his job life, his never listening boss, or his long hours outside work because of no work! Or the long commute times from Mishref to Mirqab. Indeed, salary plays a role, but clearly it’s not solving the problem despite the radical irrational increases in government salaries throughout the past years. (Anyone who disagrees, please refer to the budget breakdowns and see for yourself. The numbers are freakishly huge)

Numbers Crunching Time!

Have we ever thought of traffic and its effect on GNP? Let’s take a numbers approach. Based on a 2013 statistic, a Kuwaiti national earns on average 1598 KD per month. That’s about 64 KD / working day. There are 258 thousand Kuwaiti workers in the government sector (2014 statistic). Roughly speaking, 88% of them live outside Kuwait City, that means they’d have to commute through the outrageous traffic every morning. Based on a personal time tracking, the commute takes on average 37 minutes per day. Give or take a few minutes for different towns, let’s assume a 45 minute drive per day. Crunching the numbers results in a 1.56 days spent in traffic per working month! Continuing crunching the numbers results in a 99.875 KD in unrealized losses per month per Kuwaiti national – Just because of traffic time! That’s almost 1,200 KD per year. No wonder the raises aren’t enough for the poor dude.

300 Million KDs lost per year

If we scale the numbers up, that’s about 300 million KDs per year of lost national product because of inefficient use of a citizen’s time. This isn’t only about the dinar value, it’s a major contributor to the satisfaction level of the individual, which will have a snowball effect on his productivity and sense of ownership towards his job and community.

Imagine spending that amount in putting step by step small solutions to problems like traffic, green space, better roads quality, law enforcement, cleaner buildings and the list goes on and on. Things we don’t relate to when we talk about national income and heavy expenditures and quickly turn our eyes into how we can reduce cost to survive the upcoming storm. While, if we spend intelligently in places that may seem controversial at first sight having a $45 / oil barrel, but if we deep dive into the effect of these expenses, the impact is huge. They can raise the satisfaction levels, and reduce the unrealized losses, leading to a better individual not only a fatter bank account. Then the subsequent step would be to efficiently grow our national product.

 

God bless Kuwait 🇰🇼

Customer Acquisition For The Newbie Entrepreneur

Basic Customer Acquisition

Customer Acquisition and Startup Failures

This is a post for startup founders, and entrepreneurs willing to land their very first set of customers. Often startups fail because of lack of customers (about 80% of the time). There are some obvious reasons for that:

  1. Founders are too technology/product oriented, they forget to connect with potential customers.
  2. The product doesn’t solve a real pain.
  3. The value proposition is too confusing and difficult to communicate

There maybe other reasons too, but I found those to be the most common occurring ones.

The Customer Acquisition Guide

You’re probably reading here to know a practical tip on customer acquisition, well, ask yourself these questions:

  1. How many potential users of my product did I talk to before actually building the product?
  2. Who tried my prototype?
  3. How many people praised my prototype? How many neglected it? How many said it’s awful?

The Steps to Customer Acquisition

  1. Read the questions again, and literally take a piece of paper (or an Excel sheet if you’re fancy!) and write down the names of people for each question.
  2. Now scratch the names of your family and friends who praise you no matter what you do, unless you strictly know they are pragmatic and objective people.
  3. Put an asterisk next to names who neglected your product, or said it’s awful.
  4. Now look at the list again, do anyone of those people made an investment in your product? An investment could be devoting their required resources to reach the goal you had for your product. For example, if you have an e-commerce app, the goal is to buy a product through your app, that’s an investment. For Instagram, an investment is to make an account and follow a few people and like their photos.
  5. If not, then you need to get back to your team, sketch a fresh new BMC, and start figuring out new value propositions by reshaping the problem, and the solution.
  6. After you’ve done that, get back to the list of people you made earlier, propose the new prototype with new value proposition, and record their feedback.
  7. If there is an investment, then you’ve nailed it. If not, redo the steps from all over.

Tips on Customer Acquisition

  1. Try to have a large number of people in step 1, since you’ll be filtering out the ones not needed.
  2. There is no magic number of people for your customer acquisition list.
  3. It’s not necessary to talk to your potential customers face-to-face, although it’s the most useful. You can use other channels such as Twitter, or plain-old Email.
  4. Try to expand the radius of your potential people, don’t think close friends and family. Tap into your college network, your past job, friends of friends, etc.
  5. It’s always better to show a product/prototype to your potential customers, than to just convey words and/or pictures. This way, you can immediately see if they’ll make an investment in your product and basically turn them into customers, rather than just get a verbal commitment that they will use your product!

The Conclusion on Basic Customer Acquisition

The idea here is to create a list of potential people around you, that you think may find your product attractive, and refine this list. Once you refine it, see if they have already generated revenue for you*, then they are already your first set of customers! If not, then the problem is either with your value proposition, your solution, or your implementation (the product). Go back to your team, refine those three things, and approach your potential customers again and see if they’ll do an investment this time. Redo until you hit the jack pot.

Also, don’t be shy to ask, if you’re too lazy to ask again or afraid you’re asking too much, then probably you need to rethink why you chose entrepreneurship!

 

 

* Or made a considerable time investment in your product if you don’t have a revenue generating business model yet.

High Startup Valuation = Agonizing Death

It’s a no brainer that we’re living in an era of extravagant startup valuations, and a plethora of high tech startups for virtually any service you’d think of, even if it’s inviting people for your funeral!

Nevertheless, entrepreneurs and wanna-be tech billionaires come up with garbage ideas every 12 seconds, and go to any bicycle repair shop – sorry, I mean venture capital firm – to raise money for their “Next Facebook” startup.

The Presentation and Term Sheet

Guess what? The bicycle repair guy – sorry I forgot, he’s now a VC – gets excited about the founders’ idea, which is converting Coke cans into keychains, and promises a lot of value-added services and keeps saying: buddy, the sky is your limit, how much investments do you want?

20 minutes later, after watching a Powerpoint presentation that was prepared two days ago, over pepperoni pizza using one of Microsoft Office’s templates, the VC offers a term sheet, which was also downloaded from Scribd.

The Startup Valuation

The offer is $2m of seed funding, for 5% of the company. Did the founders show any financials to support such valuation? Of course! The founders expect to gain 1% marketshare of the aluminum recycling business in 3 years, that is 1% of the $200 Billion market* which is $2 Billion. Very interesting! The deal is done the next day, and a Crunchbase page is made. The founders are now waiting for their feature in TechCrunch.

A year later, they have burnt through the money by having a weekend in Vegas to brainstorm their customer acquisition plan (assuming they know what customer acquisition is?!), and now request more funding. They call the value-adding VC who presumably knows Warren Buffet, requesting more money but he doesn’t even pick up the phone (very value adding!). Fortunately, one of the founders knows an investor two blocks away, and they set a meeting with him. They get slapped with the reality, their valuation is extravagant, and their business is worth nothing.

The Brutal Truth

The investor goes on and on questioning everything from their team, their idea, their execution, their sales strategy, etc… Basically, they were doing ‘nothing’ the past year. Assuming the business had any potential, maybe their team knew something about Python, and they could be building something else with value, it’s impossible to do it now. They have no money, and no ‘sane’ person will ever invest in a Coke to keychain conversion business at a valuation higher than $40,000,000 !

Who’s to blame?

  1. Founders: they are fame-craving people wanting to ride the Silicon Valley trend in any way they can, even with the stupidest ideas. But were they aware of the principles of business and investing before to know that such valuation was simply crazy? No.
  2. The first VC: He was approached by a couple of high net worth individuals that do not want to be late to the startup trend, and want to ‘save money’ with the traditional venture capital fund expenses, so they hired him instead. He’s been in the bicycle business for 15 years so he should know how to run a business, right? So, is the VC to blame? Hmm.. Maybe but no.
  3. The sane investor: He crushed the founders and pushed them to shut the company down. Is he to blame? No. But he caused the company to die an agonizing death! I think he should earn a Medal of Business Honor for what he did.

So, who’s to blame?

 

* Imaginary numbers, don’t quote me!

Why Oil Prices Will Increase in the Future?

Pumping, drilling and oil prices

Oil prices will (and should) increase in the future. If you ask any media specialist, journalist, or a first year analyst will tell you otherwise. I beg to differ, and I think there is room for oil prices to go up, but not to the $100/barrel.

Reasons Why Oil Prices Should Increase

American drilling and the effect on prices

America’s drilling will decrease substantially (and it is already), and probably stop for a limited period of time because of the pressure on prices and decreased profit margins. While this is true, the world is in need of oil, and somewhere in the world drilling should take place, and this is where Middle East will continue drilling, and possibly increase their drilling operations. This shift in market share of drilling will increase OPEC’s power in setting the prices.

China, and it’s increasing energy demand

Media has been avoiding China and it’s increasing energy demand, and particularly, its increase in fossil fuel consumption. China’s fossil fuel consumption as % of total energy consumption has been increasing since 1999-2000, and according to World Bank, China’s fossil fuel consumption was 88.2% of total energy in 2005-2009.

In 2013, China surpassed the United States as the largest net importer of petroleum, accounting to 6.1 million barrels per day, according to the US Department of Energy.

Also, according to ExxonMobile energy outlook, China’s forecasted energy demand for 2025 is said to increase by 55%, while China set a cap on coal usage as an energy source, data does not show any caps set on petroleum usage.

Libya’s political turmoil

Libya is a significant oil producer, and accounts for large share in the daily production of petroleum. However, the country is undergoing a serious political turmoil since it’s shift in 2011, and it’s getting active in violence again since May this year. What this means is a decrease in production of oil (by force), and thus it will put an upward pressure on the price of oil because of limited supply.

Market frenzy and short selling

There is a tremendous amount of short selling on crude futures, which puts a short-lived downward pressure on oil based on market frenzy and investor fears. History has shown that fear and frenzy lives for a short period of time, and fades away once investors realize the extent of the problem. Need a refresher? Look back at 2008 and see how the market reacted, and was being said, and how does the market look today.

The $0.02 on oil prices

I’m not bullish on $100 / barrel prices, but I’m not bearish either on $30 / barrel. I think there is a middle ground that the prices will stop at and play around. That could be $70/barrel, who knows?

The alarming situation in Iran

Despite the reasons mentioned, the situation in Iran is indeed alarming to the price of oil. The main reason is the press conference held with Iran’s oil minister indicating that they are able to supply the international markets with 500,000 barrels a day within one week of releasing the sanctions, and a whopping 1,000,000 barrels / day within a month. Referring back to the history or Iran’s oil production, we will see that they are able to supply the market with an average 3.6 million barrels a day, according to Bloomberg Business. If OPEC’s decision to resist accommodating Iran remains still, then the prices would indeed go down. Otherwise, there shouldn’t be much of a difference if Iran’s production is included in OPEC’s quota, and the above reasons will most probably be sufficient to stabilize prices in the near future.

My GMAT Experience Going From 550 to 700 in 10 days

Coffee is required for beating the GMAT

I’m going to share my GMAT experience going from 550 to 700 in 10 days. If you Google around “how to get 700+ on a GMAT”, you’ll see dozens of plans and schedules that indicate you need about 3 – 6 months to get a great score. Depending on whether or not you consider 700 a great score (I do!), the ACTUAL time I spent studying was almost 10 days, and here’s the story.

I started learning about GMAT in late November when I knew that most business schools although they accept GRE, still consider GMAT significantly more preferable for MBA applications. I did the same thing I did with GRE, I bought a Kaplan book on GMAT.

Read the first few pages to get to know this beast called GMAT, turns out it’s an essay section, a relatively new Integrated Reasoning section, a Math (or Quant) section, and an English (or Verbal) section. I emphasize on using Math and English because I’m coming from a background of GRE.

Read a few more pages on Verbal and Math, and did a quick practice CAT (Computer-Adaptive Test) and received a 520. Wow! Give me a break, I was expecting 650 or so!

Turned out, it’s much more than geometry and algebra, it is actually a very comprehensive test of endurance, time management, reasoning, stress management, you name it … So I tried doing a couple of quant quizzes using Kaplan’s online resources.

The First GMAT Test

I swept away in work, and forgot about GMAT, until two days before December 28th when I had an actual test scheduled. I Googled: “how to score 700 on GMAT”, turned out I needed at least 3 months to get to that 🙁

To make matters worse, my test was in a different country (4 hours drive though!). I gased the car, checked the tires, replaced the wipers, and hit the road. Next day is my test (how negligent I was !!!). Showed up 7:00 AM at the test center, and began the test 30 minutes later. Less than 4 hours later, I see 550 on the screen. Again, big disappointment 😐

The Second Trial

Quickly returned back to my home town, few days later registered for another test on February. I made a plan for myself, to make quizzes of different questions of both Verbal and Quant. When I finish each quiz, count the number of correct answers and get the ratio of how much correct answers I got, and then found a website that had a rough estimation that converted raw score to scaled score in each section and compared against it (PLEASE DON’T DO THIS, THIS IS ABSOLUTELY WRONG!!!). Nevertheless, I didn’t know that and kept on doing it. I did a good number of quizzes (maybe 10 or 12 in each section), but not one after another, rather distributed them among different times (Also, VERY WRONG!). And kept on estimating my score, in an absolutely wrong way.

I estimated that I’d receive 680, and I read in some website that Kaplan questions are usually tough, so I thought with myself that I’m already a 700 person.

On the day before my test, I had planned to take a practice test using GMAT’s own software available to download free after registering for exam. However, I was too busy at work training new employees, and having too many errands to do. The practice test got delayed until 6 AM the next morning! Literally 3.5 hours before my actual test. I did a couple of the questions on the practice test and I almost got all of them wrong. Honestly, I wasn’t terrified or anything, I thought I’m just not ready yet, but I’ll be ready in the next 3 hours. So, on to the test center.

Exam management was better this time, going to bathroom regularly, drinking water, etc… 4 hours later, I see 590 on the screen. I said to myself: You’re kidding right? Even the test center guy said, don’t worry I see lots of people getting the same score. I don’t know if he was cheering me up or discouraging me?

The Third Trial and Beating The GMAT

This time, I was much less motivated, and highly busy at work. New projects, new management, and much more responsibility. Right around May, I got motivated again to do the GMAT because I was determined (from the year before) that I want to get to B-school. I was convincing myself that a 590 won’t be discouraging, since there are people who get into HBS with a GMAT of 510 (Yes, that is actually correct, but it’s maybe one or two people!).

Three months left, no prep. It’s late July, and deadlines are around the corner in less than two months. I calculated the latest date I can take GMAT on, and registered for August. Took 12 days off from work. Sat in the home. Bought GMAT’s official book + Manhattan GMAT CAT tests. I started doing all of the questions, in batches of 10. The actual studying started on the third day (10 days before the test). I did a whopping 80 quant questions. Next day, 5 reading passages, 20 sentence correction, and 10 critical reasoning. Next day, a CAT exam and a bunch of 10-question sets.

I went almost nowhere. Ate fast food from McDonald’s and Kentucky Fried Chicken (I hated myself but it was inevitable, I needed food!). I took almost one full day off having an all nighter with a friend, flying drones to capture landscape photos (I know, it’s totally crazy but that’s just me, I can’t not have fun!). Then returned back to the ritual. My CATs were as follows:

  1. GMATPrep: 570
  2. MGMAT: 590
  3. MGMAT: 620 (No AWA or IR)
  4. MGMAT: 650 (No AWA or IR)
  5. GMATPrep: 670 (No AWA or IR)

I was like: Okay, I’m in good shape now, I’ll get around 650 hopefully. Slept for a good 7 hours, ate a bunch of walnuts, drank a nice shot of Nespresso Peru (limited edition) coffee. Wore the most relaxed clothes, and drove to the test center.

I had an amazing feeling, that I’m ready to tackle this beast that most people are scared of. Started the exam at 9:30. 4 hours later, at the last Verbal question, and I remember it was an SC question, I was drained, but I took my time and answered it with the best of (whatever left of) my ability. Clicked next, and voila! I see 700. I couldn’t believe it, but it was true. A 700, Quant 48, and Verbal 38. With an IR of 7. I was like, now we’re talking!

The test center guy (the same person!) was like: WOW! Man how did you do it? I was so amazed by the score, I can’t remember what I told him. Got to my locker, and took my phone, and immediately texted a friend of mine that we need to get out and there is no going home, or doing errands today. And texted my brother the following: “700” + a sunglass wearing emoji.

My dad called me a few minutes later, and I told him the score. He wasn’t as happy as I was, because he was expecting more of me, but honestly, how much more can you expect from 10 days of prep? Or should I say 9 days, since I took one day off droning!

Anyways, I wanted to share this experience because it is both tiresome, and rewarding at the same time. It’s not as bad as it looks, but with proper training, you will get to 700, too. Trust me, I’m not saying cliches, I’m seriously saying, if you practice well enough, you really can get 700, or even more. Please! Just have more than 10 days so you don’t have to eat from KFC!

I want to thank everybody at GMATClub, seriously it’s the best resource you can use to study for GMAT. Specially, Bunuel and his amazing math explanations. A link to the amazing GMATClub forum. If you’re aiming for 700+, you HAVE to register in the forum and participate, it’s necessary, trust me!

Rethinking The Proposition of Wealthfront in Index Investing

Index investing in today's fast paced capital markets

Here I’ll be reviewing an article regarding index investing recently given to me by one of my friends. It’s a blog post titled “Debunking The Myth of Magical Options Strategies”. The link is at the end of the post, you can read it later. 

The blog briefly talks about how options strategies work, and how investors use options to protect their downside, while having some of the upside returns. Also, the blog post shows two tables comparing options strategies, using Sortino Ratio and Standard deviation, vs the S&P 500. In addition to another table showing the average return of hedge funds, the S&P 500 with option strategies, and Wealthfront’s own portfolio allocation method, and detailing how Wealthfront beats them all by far.

What’s Wealthfront? It’s an online financial advisory company where you can invest your money with them, and they will manage it for you with advertised low fees.

The blog’s author goes on and on that:

We continually return to the idea that there is no magic secret to investing that will deliver consistently strong returns with little or no risk. The data show that, so far, all attempts to find this Goldilocks strategy end in heartache.

And then again:

there is no such thing as a free lunch in investing because we can’t control the market.

I, myself am a proponent of index investing and diversification, and I think it’s a very handy way of investing, but is it good everybody? Well, let’s find out.

Index Investing vs. Options Strategies

The author shows a table with the 20 year return of S&P 500 hedged with at-the-money puts (-0.26%), and out-the-money puts (0.02%), and shows how each of them failed to beat the 3.50% S&P 500 return for the same period. The author cites a University of Utah professor, Robert Dubil that published those findings in his paper.

There are several assumptions in the returns the blog post mentioned:

  1. Some sort of a commission fee?
  2. Whether the option contracts were European or American style?
  3. If the Sortino Ratio mentioned is against a unified Risk-Free Return or against a different benchmark?
  4. The most important one: That options strategies are for long investment horizons.

Beginning with assumption (1)

It is possible for the author to have assumed any commission fee, and that is a very important variable in determining the return of the investment. Based on what the author said and I agree, quote:

Instead, investors should focus their attention on controlling the things they can control: diversification, costs and taxes. By doing that, they can achieve the optimal result and maximize their net-of-fees, after taxes return.

Second

If the options were American style, then it is an order of magnitude more difficult to calculate the return since the owner of the option contract has the right to exercise before maturity, therefore can lock in potential returns before the expiration date. The author may reply back and say, well all major indices are European style and therefore they have to be exercised at expiration, and well it’s easy to refute that since you can have American options on ETFs that trade the S&P 500 index!

Third

I can’t go into much details of the Sortino Ratio because frankly I don’t know what data the author used, but it is possible for some people to use a risk-free return different from the Treasury, and therefore the results can be skewed. But from the table itself that the author posted, the standard deviation of negative returns in S&P 500 with OTM options had 11.92% vs. 20.48% of the S&P 500 itself. Keep that in mind and I’ll explain below!

Fourth

Options strategies are mainly for investors who require certain amounts of flexibility in their investments because of different capital requirements. Let me give an example to make it clearer:

A corporation may allocate a percentage of its cash reserves for capital market investment activities, but does not want this capital to be locked in for more than 6 months period due to its board’s requirements. Now such investor is basically trying to ‘if possible’ obtain some upside from a trend in the market if existed. We may debate if it’s right or wrong, but nonetheless, a considerable amount of investors ask for such requirements!

For that type of investor, options strategies are a MUST to protect their downside if a huge down trend hits them.

So for example, if you buy SPY (ETF tracking S&P 500) at $213, and 20 days later it is trading at $204, you have clearly lost $9/share. While if you have protected your down side by buying $213 puts at $2.50/contract + (assuming) $2.00 commissions, you would’ve lost $4.50.

Not beating the market by beating the market

Wealthfront advertises in the same blog post a 10 year annual excess return of 5.31% for its basic service, while it doesn’t include how much the S&P 500 was for 10 year (it’s only indicated for 20 years) but I’m assuming Wealthfront was not found just to tell people: Go buy an S&P 500 ETF and that’s it, clearly they have another way of managing investments.

And that is totally fine with me, but what is not fine is repeatedly saying “There Is No Magic Solution” and “… we can’t control the market.” and then right above it say that our methodology beats the market!

My question is: What’s the “market”? Is it the S&P 500? If yes, then Wealthfront is saying that they beat the market. Is it another index? Then the results shown have no value because they weren’t benchmarked against the market.

A note on hedge funds

I’ve seen numerous people comparing the returns of hedge funds to S&P 500 and be like: we outsmarted the smart guys like Paulson and Simons!

The blog post also does that by comparing the excess return of hedge funds (1.61%)  vs. Wealthfront basic service (5.31%) for 10 years.

Read this analogy:

The average acceleration time for all production cars from 0-60 miles is 11 seconds, and the acceleration of a Boeing 747-400ER from 0-60 is 4.9 seconds. Clearly, Boeing wins.

This is what the author is similarly doing, comparing apples and oranges, and averaging the apples (to get the rotten ones too!) vs. a good orange. For the past analogy, LaFerrari does 0-60 in 2.4 seconds, can we say LaFerrari is faster than Boeing 747? NO!

Averaging hedge funds is like averaging the 0-60 acceleration times for all cars in the world, and that’s not accurate. Plus, hedge funds are private and most of them are not subject to disclosure, and these indices are not reflective of the top performing ones at all.

Past results are not a guarantee of future results

Any investment professional would disclose that at the end of their statement/article/post etc. What I would expect from people who hold a doctoral degree in Finance to disclose such and believe in it even if not entirely by heart but to some good degree at least. What this means is that you can’t “Debunk” an entire set of financial instruments and investing strategies because you could achieve a 3% excess return in 20 years. As a matter of fact, the reason why options are existent is because we can’t predict the future and we’d want to be as agile as possible for what the future is holding for us.

Link to Wealthfront’s blog post.

How Solid Is My Portfolio Strategy Against Possible Crises?

I come across a lot of people willing to trying to setup an investment strategy, mostly for themselves and some for their businesses, and the most common question is: How Solid Is My Portfolio Strategy Against Possible Crises?

I have to say, I was a victim of that way of thinking, and one day when I was setting up an investment strategy for a new fund, it suddenly clicked: Am I really protecting myself against future financial crises?

You may come up with goals and strategies that ‘could’ potentially save you from crises, but the returns on the portfolio would be so low that may not break-even with the costs associated with the securities. Most of the time, people end up not going with the strategy, and not invest their money, lose-lose situation!

So what to do … ?

Let’s take a step backwards, what is a financial recession? The National Bureau of Economic Research’s (NBER) defines it as: “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Put it in simple terms: It’s a period of time where everybody from large corporations to the average Joe suffer economically.

Easily understood.. Now what should anybody do in a crisis time? Almost anyone can agree on the following two:

  1. Cut spending.
  2. Preserve cash, and be conservative with investments.

What essentially those two points say is that if you have a pile of cash sufficient enough to run your day-to-day life (or operations) for the period of the crisis, then you’ll be in a good shape compared to everyone else that doesn’t.

Now, let’s get back to our question:

How Solid Is My Portfolio Strategy Against Possible Crises?

The answer is: Not solid!

Instead you should be asking this: How Much Cash Can I Generate In Good Times To Sustain A Crisis, If Happened?

This way, you would design your investment strategy in a way to generate steady cash flows with adequate risk levels, knowing that if a recession happens, you’ll probably lose a substantial amount of asset value. But if you have generated good realized returns (e.g. dividends, bond returns) in good times, you won’t be pressured to sell your assets in a bad time, rather you can rely on your cash and survive the recession time, at the same time still own assets for after the recession ends!

Summary

  1. There is few or no cost-efficient way to hedge risks against crises when designing an investment strategy.
  2. Try to to design your portfolio in a way to generate adequate amount of realized returns in good times.
  3. In a crisis time, cut spending, survive as much as you can on your savings (if needed!), try not to liquidate your assets as much as possible, and be very conservative with investing.

The Rush For Real Estate

The Rush For Real Estate

About two weeks ago, a friend of mine asked me to write about the real estate crisis in Kuwait after he saw my tweet about the difference in prices per square meter in downtown Kuwait City vs. NYC – the financial hub of the world. Surprisingly, the financial hub of the world was cheaper than Kuwait!

The tweet

The guest blog post in Kuwaitiful

Let me begin by saying real estate is not my favorite asset class, but the urge of virtually every Middle Eastern person to acquire some sort of property makes me immensely interested in knowing the details of this sector.

Let’s dig a little deeper in what constitutes the problem in real estate in Kuwait:

Land inaccessibility

Most of us heard about ‘freeing government lands’ in the news by politicians and some economists. But what does that mean?

Simply put, KOC (the gigantic oil company) owns almost all the unused land in Kuwait, for the very reason that there is ‘potential’ oil underneath these lands, and therefore people shouldn’t live here. But wouldn’t that be absurd since KOC has shut down so many of its fields on lands because the oil ran out in that particular field. You can ask oil officials about that and let me know the answer if you could get one!

The other meaning of freeing lands is the list of less than 5 people who own vast lands in residential and commercial places and are not willing to develop, nor sell these lands. From one perspective people would hate that very list of 5, but I would say from a capitalistic point of view, why would he/she sell or develop the land if no law requires restricts him? Now you’d think yes, the government should be proactive in setting laws to prevent such things. Again, if you could find any answer from the government, let me know and I’ll buy you a Kitco chips.

Economic feasibility in a time of crisis

The other reason we have a real estate problem in Kuwait is because there is virtually no way for people to invest their money. And here I mean the general public of people, and not a list of 5 or 20 or 100. It’s me and you, when you get a raise, when you get a bonus, when you sell something and buy a cheaper alternative and you have some excess cash, and so on… In most cases, an average person likes to invest his money somewhere to ensure a brighter future for himself, and his family. The way you do this in western countries is by investing your money in retirement plans that include stocks, bonds, government treasuries, and other financial products. We do have a stock market, right? Yes, it’s that dark brown building on Boodai Square in Downtown. But how has the stock market performed from the day it operated? First, the Souk Al-Manakh crisis, then the 2008 Credit Crisis. For sure there were crises in other parts of the world, but the problem here is that the public sector did not deal intelligently with the aftermath of crises. That is why you see people still owing money from Al-Manakh crisis, or people selling their Aston Martins and riding a used Nissan Maxima after 2008. And it’s the reason you see bread bakers riot and shut down their shops, or parking lots increase their charge from 100 fils to 150 or 200 and literally the dramatic increase in consumer goods prices, hence Inflation!

Back to investments, so stocks are out, bonds? We do not have a bond market in Kuwait. Government treasuries? There is no vehicle that allows individuals to directly purchase government treasuries, it’s rather reserved for financial institutions that are run by the very elite part of the society.

Basically, the average citizen is left with only real estate to invest in. Of course, the older segment invested before 2000’s so they benefited from the low prices, and now the current generation is left with skyrocket prices because of what we discussed before, and the pure supply and demand economic issue.

Mentality

The mentality of living inside Al-Soor, and being near to Diwaniya, or Avenues, or my friend’s uncle’s house should be changed to embracing the very fact that Kuwait is a big country with over 3.5 million population and it’s not realistic to assume everybody is literally a block away from their parents or families’ residences.

Also, the fact that every newly wed with two kids requires an entire 500 sq. m block of land to build 3 stories, and a garage, and 4 ballrooms. We are way past this stage and we should embrace the reality that if we keep building 500m houses for every family, we’ll need 10 more planet earths to accommodate Kuwaiti families in year 2250 (Yes, I have made some estimations and that’s what Excel came up with!).

Ways to recover?

Long term: Create more economic opportunities for people to invest in, and reduce the pressure on real estate as an asset class.

Long term: Introduce new laws imposing taxes on multiple land owners to put pressure on land behemoths and strict the use of the taxation money to only government institutions dealing with providing housing to citizens.

Long term: Kuwaiti families embrace living in apartment buildings and try to shrink family sizes by not having too much kids.

Long term: Government sets infrastructure rules for building high rises in residential places and accommodating needs (parking, grocery stores, health, etc…)

Short term: Have fun and eat a snickers bar. If you can afford, have a Diet Coke as well.