Missing Out on Online Gambling
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One of the biggest problems for a footsoldier working in the trenches of the capital markets is that it's extraordinarily difficult to distinguish between the short-term hysterical melodramas and the longer term, bigger picture structural changes occurring within the global marketplace. We've long had a suspicion that short-term hysterical melodramas - triggered primarily by day-trading churls and index-tracking fund management numpties in the equity market - represent what might be called 'time horizon arbitrage', whereby human being investment entities with "discipline" have the potential to outperform black-box / day-trading / turnover-driven drones by doing nothing more sophisticated than buying and holding through periods of short-term market noise while everyone else is effectively paying danegeld to their prime brokers just to stand still. The fundamental underlying this suspicion is that somebody has to pay for turnover and frequent transactional activity, and ultimately that somebody is the client. Without any guarantee of value added, money in the form of brokerage is simply being transferred in choppy but still trendless markets from clients via their fund managers to investment banks out of a misplaced belief that trading activity and mental activity are correlated.
All things being equal, and assuming that the more passive 'value' manager's stock-picking alpha is comparable to the stock-picking alpha of a more actively turned over fund, if one's portfolio turnover is less frequent than that of an over-traded commission engine, the more relaxed, passively-inclined fund is more likely to deliver meaningful returns. This argument is all the more compelling in an environment of low nominal returns, which is of course the one we all basically inhabit today.
John Gapper, writing for The Financial Times, puts his finger on what looks suspiciously like a longer term, bigger picture structural change. For those City and Wall Street employees sitting smug and pretty five years after the demise of the dotcom bubble, this structural change is internet-led, and it's online betting. Gapper cites JFK's inadvertent boost to the City back in 1963 in the form of taxing US investment in foreign securities, which essentially created the eurobond market (which London rules). Could US regulators have inadvertently repeated history by forcing online betting over to the London market? Quite possibly:
"London is experiencing a wave of initial public offerings from gaming and betting sites.. Why should New York care? The US authorities have their reasons to stop online gambling advertisements and block people from using US credit cards to play poker. Not only do they regard online betting as a breach of a 1961 federal law, but many politicians do not want what they regard as an immoral pastime to flourish.
"The problem is that the line between financial entertainment and financial services blurs as punters move from placing bets with bookmakers to wagering with others through online exchanges. As Michael Mainelli, a consultant and professor of commerce at Gresham College in London, says: 'Betting markets are clearly coming to resemble other financial markets'."
Notwithstanding the occasional value added by informed specialists in the arenas of equities, bonds and foreign exchange, self-directed investors (and the growing SIPP market in the UK points to the potential growth in affluent investors disenchanted with mediocre conventional fund management, particularly from ho-hum insurers) amount to a red-hot market. Those governments who insist on plucking too many feathers from the long-suffering tax-paying geese (UK stamp duty on equity bargains at 0.5%?) are already seeing swathes of investors migrating to online exchanges with greater dealing efficiency and liquidity and without punitive tax rates or indeed any tax rates at all. No doubt the Chancellor will try and nobble them soon, but capital online moves, and it moves across borders, pretty quickly.
The very survival of over-the-counter activities like advisory stockbrokerage and currency and eurobond dealing in a web-enabled age seems curiously anachronistic, but one lesson of the Internet Boom Part II is that the early adopter digital evangelists weren't necessarily wrong, merely too early and a little too enthusiastic. Technology and its associated functionality may evolve at something close to light speed, but human beings and our brains have several hundred thousand years' hard-wired experience of picking berries and chasing deer for a living, so we may be permitted a few months yet before we evolve into life forms consisting of pure thought. Again, we are minded to believe that the long-term impact of the internet on traditional financial services firms, stock market performance of related businesses notwithstanding, even today is underestimated.
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We have written before that ethical investing, at the fringes, is little more than a dangerous fad, in that it transfers wealth from self-determinedly constrained investors to unconstrained investors comfortable with (subjectively) morally contentious sectors like brewing, munitions or tobacco. To which we can now add gambling. Financiers attempting to take the moral high ground here should reconsider what meaningfully distinguishes a dealing room from a casino. Brokerage staff looking to hedge their career risk now have a wider choice: to short the stock of their employers or the stock of their competitors, to short the stock of listed hedge funds (and there isn't that much choice, particularly in the UK), or to go long the stock of newly listed online gambling businesses. Gapper draws some pretty sombre conclusions for many investment industry practitioners whose earnings are predicated on little more than trade execution:
"Just as equity trading has moved to electronic markets rather than using market-makers, online gambling through exchanges eliminates an expensive middleman."
And even more darkly,
"Not all of the (online gambling industry's) potential may be fulfilled, of course, but does New York really want to bet against it? Many people are against gambling in principle and care little about financial innovation. But this should not go for.. the denizens of Wall Street. There is an old saying in poker: if you cannot spot the sucker who will lose money, it is you."
Hedge fund employees have a relatively narrow choice for career / business risk hedges: Man Group and RAB Capital. Investment bank staff have a broader choice for career risk stock hedges of anything from Bear Stearns through to Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley. On the basis that the debt markets turn horrible / regress to the mean at some point in the medium term, the quick and very dirty metric of highest debt to equity ratios (total debt to common equity ratio of 2164% according to Bloomberg) allied with perhaps a greater concentration upon debt business points to Lehman Brothers stock as best career risk hedge, with Bear Stearns (total debt to common equity of 1894%) as runner-up. In any case, as Gapper suggests, anyone with a terminal can trade on a betting exchange as easily as on a stock exchange. As somebody, and we believe it might have been Bill Gates, once said: banking is necessary, but banks aren't. Internet Boom Part III really ought to wreak creative destruction on the financial services sector, particularly to those firms which are glorified execution providers. It will just take longer than originally anticipated by the digital evangelists. But what if disruptive web-based technology simply compresses everyone's transactional margins at a stroke? It did for encyclopedias. As we have said before, one does not need to be a die-hard perma-bear to find the investment case for brokerage firms in a dangerously unbalanced world largely dependent on credit looking distinctly fragile. Since US short rates are almost certainly going higher, could this be as good as it ever gets for Wall Street?
Tim PricSenior Investment StrategisAnsbacher & Co Ltd
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