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A tiny number of superstar companies account for returns from equity markets

As valuations for some of the world’s largest tech companies are being questioned as expensive by some sceptics, I am reminded of a conversation from early 2020, when the terms “lockdown” and “social distancing” were largely unheard of.

My meeting with a chief investment officer was coming to an end. We were discussing Tesla. Its prospects were finally being recognised by the market and being rewarded with massive share price growth. He leaned across the table and said, “tell me you have been selling your shares”.

What struck me was not his belief that we should sell, rather that he appeared to hold it with such absolute certainty. His assertion had nothing to do with the company itself, but rather his ingrained belief that when a share price goes up a lot, you should sell. This was common sense. To do different would be foolish, greedy and undisciplined.

This conventional wisdom pervades much of the financial industry. As the old saying goes, “it’s never wrong to take a profit”. A client is unlikely to be unhappy or indeed notice if you sell a stock that subsequently goes up significantly. The loss of foregone upside is not captured in performance data. Perhaps it should be.

On the other hand, if an investment manager continues to hold the stock in question and its price starts to fall, the drop will be clearly visible in performance data. The manager should expect to be asked, if not chastised, about it. That is why, from the investment manager’s point of view, it is never wrong to take a profit.

What about the client? For the client, equity investing is asymmetric — the upside of not selling is nearly unlimited, while the downside is naturally capped. For the client it can be very wrong to take a profit. Sadly, too few fund managers try to get investment right for investors. Most conventions and practices exist to serve, protect and enrich investment managers’ interests.

In fact, it is often not just wrong to take a profit, but it can be the worst possible mistake.

Research by Hendrik Bessembinder, a professor at Arizona State University, has found that nearly 60 per cent of global stocks over the past 28 years did not outperform one-month treasury bills. That might seem a case for not investing in equities at all.

But the reason equity investing as a whole is thankfully still worthwhile is due to a small number of superstar companies. Bessembinder calculates that about 1 per cent of companies accounted for all of the global net wealth creation. The other 99 per cent of companies were a distraction to the task of making money.

This should shake the very foundations of the investment industry. The entire active management industry should be trying to identify these superstar companies since nothing else really matters.

But, doing that requires a vastly different mentality to that displayed by the financial industry today. It requires focus on the possibility of extreme upside, not the crippling fear of capped downside.

Bessembinder’s research makes it clear that it is the long-term compounding of superstar companies’ share prices that matters. Investing requires patience to deal with the inevitable ups and downs that such companies experience as well as the ability to delay significant gratification.

Sadly, such behaviours are inconsistent with the incentives and annual bonuses of traditional finance. Nevertheless, they are prerequisites. After all, the point of superstar companies is that they can go up fivefold and then go up fivefold again.

Let’s take a practical example. In 1999, Goldman Sachs invested in Chinese ecommerce company Alibaba. Shirley Lin, who worked for its private equity fund, has said she was offered the chance to invest $5m for a 50 per cent stake. Unfortunately, she said her colleagues deemed $5m too risky and so they opted for investing a “safer” $3m.

Five years later their stake was worth $22m, a seven-fold return. At this point, the decision was taken to sell. In many ways this was a remarkably successful investment until, that is, you realise that today those shares would be worth more than $200bn. That investment alone, if held, would have been worth more than double the value of the whole of Goldman Sachs today.

When asked why Goldman Sachs sold, Lin gave a predictable answer: “they wanted quicker results”. Though this example is extreme, the point is clear: in investing, it is often not only wrong to bank profits, it can be the worst mistake you make.

Despite this, in almost every client meeting I am asked about our sell-discipline. No one has ever asked me about our hold-discipline. That is a great shame, as the larger cost to clients’ returns comes from the inability to hold on to superstar companies when their returns are ticking upwards.

The Swiss bank has grown concerned about the speciality finance firm’s exposure to a single client

LONDON— Credit Suisse Group AG CS -0.62% is looking at ways to reduce ties to Greensill Capital over concerns about the specialty finance firm’s exposure to a single client, U.K.-based steel magnate Sanjeev Gupta, according to people familiar with the matter.

The options under consideration include winding down a $10 billion suite of funds the bank runs with Greensill. The bank could also replace Greensill as the main source of assets in the funds. Moving assets tied to Mr. Gupta from the funds onto the bank’s balance sheet to protect investors is another possibility, according to the people.

U.K.-based Greensill is the brainchild of former Citigroup Inc. and Morgan Stanley financier Lex Greensill. Founded in 2011, Greensill specializes in an area known as supply-chain finance, a form of short-term cash advance that lets companies stretch out the time they have to pay their bills.

It counts former U.K. Prime Minister David Cameron as an adviser, and its main financial backer is Japanese tech conglomerate SoftBank Group Corp. Greensill owns a bank in Germany and also does deals that are closer to traditional merchant banking services, such as lending to large investment projects.

In supply-chain finance, Greensill competes with traditional banks such as Citigroup and JPMorgan Chase & Co. for investment-grade clients. Some of Greensill’s blue-chip clients include AstraZeneca PLC and Ford Motor Co. Greensill has also extended financing to lesser-known companies, including small start-up businesses and companies that are considered higher-risk borrowers.

Credit Suisse has been a steady supplier of investor capital to Greensill through the four funds. Sold to pensions, corporate treasurers and wealthy families, the funds invest in securities created by Greensill that fill the short-term financing needs of hundreds of companies.

Credit Suisse has grown concerned over Greensill’s relationship with Mr. Gupta, a former Greensill shareholder, according to the people. Greensill has supplied financing to his GFG Alliance group of companies, which in the space of a few years have created a metals empire by acquiring failed steel mills and other distressed industrial businesses.

Last week, a bid by one of Mr. Gupta’s companies to acquire the steel operations of Germany’s Thyssenkrupp AG failed after the company ended talks over a deal.

German banking regulator BaFin last year began probing ties between Mr. Gupta’s businesses and Greensill’s German banking unit, according to a person familiar with the probe. A report from Scope Ratings in 2019 said about two-thirds of the bank’s loan book was linked to Mr. Gupta’s businesses.

Last October, a Greensill spokesperson said the company has regular dialogue with German regulators, and said the bank’s exposure to Mr. Gupta’s companies was significantly lower at that point than at the time the report was released.

It isn’t clear what percentage of the Credit Suisse funds are currently exposed to Mr. Gupta’s companies. As of January, his companies weren’t explicitly named in the top 10 recipients of financing in the biggest of the Credit Suisse-Greensill funds, which has $7.3 billion in assets, according to a document viewed by The Wall Street Journal.

Any possible change in its relationship with Credit Suisse comes at a challenging time for Greensill. The firm had anticipated extending $173 billion in financing last year, according to a presentation viewed by the Journal, but ultimately provided $143 billion, flat from the year before. Several Greensill clients hit financial troubles last year, while companies it partnered with loosened ties.

Greensill has recently been trying to raise up to $1 billion in fresh capital. That process was initially expected to have been completed by early January, but it has stalled as the firm seeks to address the issues related to its Gupta exposure, according to people familiar with the fundraising.

Last year, Credit Suisse executives grew concerned about potential conflicts of interest in the four funds after SoftBank invested $700 million into one of them. The fund had also made loans to four of SoftBank’s Vision Fund companies. SoftBank ultimately redeemed its stake, and the bank committed to protecting investors.

Disruption to supply chains lengthens delivery times and leaves goods waiting at ports

Steve Chuang’s Hong Kong-based electronics manufacturing company has enjoyed steady demand from the US and Europe over the past year. But, like many Asian exporters, he is struggling to get his products to customers.

Chuang’s business, which makes solar energy electronics, is just one of many enjoying a trade boom that has helped the regional economy bounce back from last year’s pandemic-driven downturn.

But their success is being held back by disruption to global shipping supply chains. The surge in exports from China to the west, combined with disruption at ports due to coronavirus, has left many containers out of position, resulting in queues of ships outside ports and soaring freight rates. The Chinese media have dubbed it “a single box is hard to find”.

The amount it costs to send a 40-foot container from China to the US has more than quadrupled in the past year, Chuang said: “We have never seen anything like this in the last two decades . . . Empty containers cannot get back to Hong Kong.”

China has recovered faster from the pandemic than any other big economy and its exports of lockdown-related goods, electronics and medical equipment have soared.

Export volumes have been rising at a double-digit rate for several consecutive months, and at the end of last year China’s trade surplus hit a record high.

But the rise in demand for its products comes as pandemic-related restrictions and staffing shortages in ports across the US and Europe delay the return of containers to east Asian ports.

Roberto Giannetta, chairman of the Hong Kong Liner Shipping Association, said a lack of truckers and warehouse workers elsewhere in the world inhibited the ability of ports to return containers to China.

“There’s a huge number of containers that are just sitting around the middle of nowhere . . . Australia, eastern Europe, middle America,” he said. “It’s like a kind of perfect storm preventing containers from returning back to Asia.”

Hu Haoli, assistant to the president of Wanlong Chemical in Wenzhou, said freight rates remained elevated, although it had only a limited impact on his business because the products it sells are high-end.

But for other companies, especially China’s vast textile industry, the delays are having a more severe effect. An exporter in Shaoxing, a city on the east coast of China, said the sharp rise in freight rates in December had caused many textile businesses to shut.

Shipping executives had hoped the traditional factory closures that usually accompany the lunar new year would slow production volumes, giving shipping lines a chance to catch up. But those hopes have failed to materialise — some Chinese factories pressed employees to keep working over the holiday in a bid to keep pace with global demand.

The delays and shortages risk pushing up goods prices. In Hong Kong, Chuang said he faced shipping delays of two to four weeks and his company is negotiating with customers to share the costs, which have increased the price of his products by between 2 per cent and 5 per cent.

Having so far mainly affected routes out of Asia, there are signs that the shortage of containers is starting to feed through into the return leg, hitting companies that import into China. In January McDonald’s in Hong Kong announced the delays had disrupted its supply of hash browns. It also experienced a brief shortage of peanuts for ice-cream sundaes.

Ports are scrambling to find more containers to help alleviate the shortages. For example at Ningbo, a big facility in China’s Zhejiang province, authorities recently helped to source an additional 730,000 empty containers.

John Fossey, head of container equipment and leasing research at Drewry, a maritime research consultancy, said production of shipping containers slumped year on year in the first half of 2020, although it ramped up in the second half, taking total output up by 10 per cent over the full year.

But these new containers will cost more: as a result of the soaring demand, combined with rising costs of raw materials such as steel, the price of a new container for delivery this summer is now about $6,200, its highest level on record, according to Fossey. This is “likely to put several owners off contracting new equipment”, he warned.

While some reports from China indicate improving activity at its ports over recent weeks, others within the shipping industry remain pessimistic about the prospects for the coming months. Willy Lin, chairman of the Hong Kong Shippers’ Council, thought there would be “no relief” until summer at the earliest.

He flagged the growing likelihood that manufacturers could turn to overland trade routes, particularly by trucking from Guangxi province in southern China to Vietnam and on to South East Asia. Chuang said that some businesses were seeking to export to Europe by land across Russia.

Meanwhile, Asian exporters are scrambling to secure shipping space.

“Just about every single available ship in the world is being used at the moment, because there’s so many ships that are just sitting there [at ports] waiting to be offloaded,” said Giannetta.

Executives warn supply is unlikely to meet demand in the first half of the year

Carmakers are preparing to weather more gruelling months of microchip shortages as executives warn that supply is unlikely to meet demand until at least the second half of the year.

The auto industry is suffering from a shortage of microchips as a faster than expected recovery in demand for cars meets a supply chain already struggling to keep pace with the lockdown boom in consumer electronics.

As the demand for chips, used to power everything from parking sensors to airbags, has soared, carmakers have found themselves behind other sectors in the queue.

Jacques Aschenbroich, the chief executive of Valeo, one of the world’s largest car parts suppliers, told the Financial Times that the global microchip shortage was likely to last until at least the summer.

“The second quarter is going to be difficult . . . There should be a recovery in the second half of the year. That’s what the entire industry is thinking about,” said Aschenbroich, who has run Valeo since 2009.

Volkswagen, the world’s second-largest carmaker by volume, warned weeks ago that it would build 100,000 fewer cars in the first three months of 2021 owing to the bottlenecks.

The shortages at the German group are now likely to last into the second half of the year, and the lost production is now too large to be made up before the end of the year, according to a person close to the company.

Continental, Germany’s largest listed car supplier, told the FT that owing to lead times in the semiconductor industry, chip stocks were unlikely to be fully replenished until the second half of 2021.

France’s Renault has also warned that the shortages are likely to peak in the coming months, before conditions get better in the third quarter — it expects to build 100,000 fewer cars this year as a result, saying it would try to keep the damage to a minimum.

Data provider IHS Markit estimates that the chip drought will see the production of 1m cars delayed in the first quarter — out of a total annual production volume of about 84.6m. Aschenbroich, unlike some executives, thinks that kind of volume could still be made up in the second half of the year.

The sudden shortage of chips, which began late last year, has also raised questions about the “just in time” supply chains that underpin the industry. Valeo produces 8m products a day, using 2bn parts that flow in and out of its factories every day.

Meanwhile, manufacturers such as Renault and VW work on much shorter lead times than do the chipmakers when planning production volumes. Some critics also said car suppliers were slow to respond when demand started to increase last year.

But Aschenbroich defended the overall model, saying that throwing it out after one crisis would be unwise: “You have the equivalent of a 100-year-old flood hitting the sector . . . Does that have to call into question the whole supply chain? I do not believe so.”

While he said the question of different lead times would have to be addressed, “we should not say the whole supply chain will change and we will become a sector with large stocks again”.

Aschenbroich said the wider supply chain had held up well during the pandemic, noting that Valeo was only monitoring 40 or so suppliers it deemed to be vulnerable — a number that hasn’t changed substantially since before the pandemic.

However, he added that plentiful government aid has been crucial to keeping companies afloat — something that could change in the coming months.

Potential mis-selling of currency contracts to small companies scrutinised in probe and lawsuits

Deutsche Bank is under pressure over its sale of complex currency products in Spain as regulators await the results of an internal probe into contracts that pushed some small companies into financial distress and led to a series of out-of-court settlements.

The Financial Times reported last month that Deutsche had launched an investigation codenamed Project Teal after clients complained they had been sold sophisticated derivatives products they did not understand.

The German lender started an investigation after becoming concerned it may have sidestepped the EU’s Mifid II rules designed to protect small businesses from risky lending. It confirmed the probe to the FT and said a “limited number of clients” might have been affected.

“Internally, this issue is seen as toxic,” said a person briefed on the investigation. The European Central Bank, Germany’s BaFin and the Spanish financial regulator CNMV are following the matter closely and will determine whether to take action after the internal review, people familiar with the situation said.

The affair adds to pressure on Deutsche chief executive Christian Sewing, who has pledged to improve the lender’s internal controls after repeated breaches and billions of euros in penalties over the past decade.

Certain senior Deutsche investment bankers in London and Spain appear to have targeted small, financially unsophisticated import/export companies with €10m-€100m of annual sales for more than a decade until 2019.

A 2009 IMF paper examined the role of these sort of instruments, sold by a variety of banks around the world, in stoking the financial crisis.

“[The SMEs] have confidence in their banks and are not aware that these products will put them in a risky position,” said Prosper Lamothe Fernández, a finance professor at the Autonomous University of Madrid. He has assessed the contracts of affected companies and provided expert testimony in court. 

Fernández estimates that between 300 and 500 Spanish companies could have suffered losses on the products as far back as 2006, including transactions with lenders other than Deutsche. The average hits were between €5m and €10m, people familiar with several of the disputes said.

The losses pushed some clients into acute financial problems, and a few companies took Deutsche to court in Spain. Some of the cases were dismissed, but the German bank settled with several others, people involved in the arbitration said.

Azimutel, an electronics components wholesaler based in Gandia, Valencia, in 2007 bought a series of foreign-exchange hedging products, which pushed it close to bankruptcy, according to court documents.

In 2011, a Madrid court nullified the contracts and ordered Deutsche to pay €1.4m to Azimutel. Deutsche’s appeal against the verdict was rejected in 2014. The court ruled that the bank did not meet its obligations under European law related to client suitability. Azimutel declined to comment.

Several other small companies — some currently in talks with Deutsche, as well as some who already settled — declined to be interviewed, citing confidentiality requirements.

The products in question are foreign exchange swaps, derivatives called “targeted accrual redemption notes and forwards” (Tarn and Tarf). They were pitched by Deutsche’s salespeople as a cheaper way to hedge exposure to currency pairs, such as the dollar-euro, than traditional exchange rate insurance.

Small companies were told the products were “zero premium” with no initial cost and could even make the clients money, according to people familiar with the matter. In a stable currency market, the derivatives sometimes benefited clients. However, if volatility increased and the exchange rate swung beyond a pre-determined barrier, the cost could rapidly multiply.

“It is impossible for the client to quantify or calculate the cost of the product,” said Julio Ribelles, a Valencia-based lawyer who successfully represented Azimutel and other claimants against Deutsche. “You are essentially betting against the bank, but they know the formulas, they have the algorithms and the specialised software.”

The practice at Deutsche continued even after Mifid II, which came into force in 2018, prohibited the sale of sophisticated derivatives to small companies. The rules permit clients to ask to be treated as more sophisticated in order to access a wider range of products, and Deutsche encouraged clients to do so.

Deutsche Bank told the FT that it “disagrees” with the notion that it mis-sold complex derivatives to a large number of Spanish SMEs over many years, and that these products pushed some clients close to bankruptcy. “This depiction of events is similar to unsubstantiated allegations already made by a Spanish law firm seemingly to encourage speculative legal action against the bank,” it said.

A person briefed on the matter said that Deutsche was aware of fewer than 10 mis-selling disputes over its two-decade history of selling the products Spain, including some that the bank won. The person added that such products were “widely sold in Spain by a wide range of banks”.

“As usual, we follow the evidence and diligently look for any potential similar activity,” Deutsche added. “We do not intend to comment further until all elements of the investigation are complete.”

The Spanish financial regulator CNMV was notified of such incidents by companies involved as far back as 2011 but has not taken action. CNMV said it is aware of the situation but would only comment when a decision or action is taken. BaFin and the ECB declined to comment.

Larger, more sophisticated companies have also shouldered big losses from similar contracts. Spanish wine exporter J García Carrión is currently suing Goldman Sachs in London’s High Court to demand a partial refund of $6.2m of losses caused by currency derivatives. Goldman argues that the products were not overly complex for a multinational company.