Friday, September 28, 2012
High-Frequency Trading: What's Next?
Let's pause for a moment, if the lightning pace of high-frequency trading permits us to do so. In the U.S. today, high-frequency, electronic, computer-aided trading accounts for as much as 65 percent of all stock-volume activity.
Computers whiz and hum. Black boxes send out trading orders in thousands and millions of shares, and rout orders to exchanges and "dark pools" all over the globe. Execution occurs in fractions of a second. Algorithms and programs determine what to buy, when to buy, when to sell, when to buy and sell at the same time and on which one of a dozen or more electronic exchanges. Algorithms provide guidance on volume, prices to show, prices to execute, and prices, if only for a few seconds, to report as "bids" or "offers."
High-frequency traders dart in and out of trading positions in seconds. Some firms buy in one venue and sell in another. They earn pennies per share, but generate large profits via big volume--tens of thousands of shares bought and sold in seconds. Tens of millions of shares throughout the day. Many buy or sell shares in one venue and simultaneously sell or buy the related derivative over the counter, in another country, or in exchange thousands of miles away. Execution and profit-generation are confirmed by the flickering of light on computer screens.
Traders--or actually, their humming black boxes--study patterns, trends and data. They look for discrepancies, distortions, or something out of line. Traders (yes, humans, often quantitative analysts and experts) update computer code and write more algorithms to instruct their firms to deploy more capital to get into and out of trading positions in seconds. Timing is of the essence.
Many aim to finish the trading day with neutral positions--little or no overnight risk. Some preside over non-stop trading--trading into and out of positions, making markets, and providing bids and offers all over the globe for a continuous 24 hours.
Some trade other "asset classes," as well, exploring similar opportunities in instruments beyond equities, looking to do the same or find discrepancies and trends in foreign currencies, options, convertible bonds, and government bonds. Or they seek to decipher relationships between "asset classes" (convertibles and equities, bonds and mortgages, options and equities, interest-rate derivatives and bonds). Most trade for their own accounts; many trade or execute for customers and clients.
Over the past several years, they have include such firms with unfamiliar names as Getco, Jump, Allston, Gelber, Jane Street, Sun and Quantlab. They also include hedge funds and clients of hedge funds and asset managers. Occasionally they may include other types of funds (investment funds, pensions and endowments), all looking for an advantage based on rapid execution and "best prices."
In the realm of finance, some say this is exponential progress. Compare to the more docile manner of trading in the early 1970s, when stock certificates were exchanged, counted, bundled, boxed and rolled into the vaults of brokerage houses all over Wall Street from day to day, creating such a paper-work crisis that the industry once days off to recover from the mounds of paper.
Others say this represents a setback for retail investors or value-oriented investors. Is anybody among the throngs of high-frequency traders buying stock to support a company's investment in a new business, investment in sales growth, or investment in expansion to a new region of the country? Do they care for more than a few seconds about a company's new-product strategy or its business plans for 2013?
Many high-frequency firms rebut that they contribute to capital markets in several major ways:
(a) They provide market liquidity, active markets, and ready buyers and sellers.
(b) They provide "price discovery" with bids and offers updated continuously during the trading day.
(c) They provide "best prices," opportunities for buyers and sellers to search venues to find the best price for a particular stock.
Their detractors argue they hamper markets in many ways:
(a) Unlike the stock specialists in the past, they disappear when markets become too volatile. They balk or refuse to participate at certain times.
(b) They don't always provide honest, good-faith bids and offers. Sometimes they show their hands and wander away before execution.
(c) Skipping from venue to venue (electronic exchange to electronic exchange) with less-than-sincere bids and offers, they often try to trick or deceive markets to gain information advantages--advantages that slice profits from retail- and long-term investors.
And they cause what happened in May, 2010: the "Flash Crash," when the market fell (Dow Jones) almost 1,000 points (9 percent)--a precipitous, unfathomable, and bizarre collapse in minutes for no explained reason. Perhaps just as odd was the market's subsequent rebound the same day.
It took months for market experts, regulators, and exchange officials to figure out what happened. Some still don't agree. Most worry that flash crashes, in this new, 21st-century trading environment, will appear regularly. Many are concerned about the impact of a market (or markets covering all asset classes and many geographies) on individual investors. What are the virtues and attractions of a marketplace where the better capitalized electronic traders appear to have an ongoing advantage, where these traders get access to the best prices and best execution, and where 1,000-point, unexplained drops in the Dow are regarded as by-products of the game?
Over the past year, we've seen other debacles and unexpected turmoil in equity markets. BATS, an electronic exchange, widely known for its swiftness in execution and the technology that supports it, botched and then canceled its own IPO offering earlier this year--because of technology glitches. This summer, Knight Trading, a market-making firm, botched an electronic-trading vehicle that was intended to allow even retail investors to have better electronic access at the New York Stock Exchange. That led to losses over $400 million and several days of its existence in jeopardy.
What will happen next? And to whom? Will there be another collapse of some kind, something unpredicted, unexpected out of nowhere--blamed on high-frequency traders, but inexplicable or puzzling to the public at large?
Where do we go from here? Do we allow the marketplace by itself to resolve these quirks, collapses, and unpredictable swirls? Or should regulators (from Congress to the SEC and CFTC) rush in to take steps, even as they try to understand trading models that are racing a hundred steps ahead of them.
Attempting to understand their trading schemes (their intents, purposes and profits) can be a mind-boggling exercise for those who contemplate regulation. What are their strategies? How do the translate strategies into profits? How do they allocate capital? While the black boxes hum away, how do senior managers stay on top of the activity? Perhaps most important, how do they approach and manage risks--risks to their firms and risks to counter-parties and other traders and investors in the market?
No one knows for sure what the right next steps should be--at least in the U.S. Should there be transaction fees or taxes to restrict such activity? Should there be increased capital requirements for participants--as protection against what would likely be yet the next big loss or flash crash? Should regulatory review boards approve all trading strategies and trading innovation?
Many of the same trading firms preside over or direct trading into what are called "dark pools"--private in-house marketplaces where electronic firms can exchange thousands of shares without having to let public markets see what they are doing. In some ways in the industry, it appears what could happen next--near month or next year--is like wandering into an unknown, uncertain "dark pool.
We're likely at a precipice.
Technology innovation will continue, as long as there are profit opportunities. Some argue profit margins will decline as the number of participants increase, and that in itself could slow down the rush to be the fastest in executing trades on the planet. With other priorities on their plates (Dodd-Frank and Basel 3, most notably), regulators won't be able to catch up quickly, always hustling from several steps behind, panting while trying to project what is the worst that could possibly happen.
Meanwhile, feeling disadvantaged and sometimes clueless, worn down by the equity-market tumult from the crisis, retail investors seem to have decided to watch this play out while they remain on the sidelines.
Tracy Williams
See also:
CFN: Dark Days at Knight Capital, 2012
CFN: Market Volatility, Can You Stand It? 2011
CFN: Uncertainty in Markets, 2011
CFN: Here They Come, the Volcker Rules, 2011
Wednesday, September 19, 2012
Goldman Tweaks Banking's Ladder
Goldman Sachs leads; everybody else follows. Or most everybody else. So it has been for the past couple of decades in how corporate and investment banks structure themselves and recruit, develop, promote and pay for talent. And so it has been in how banks--from Goldman to regional banks involved in corporate banking and foreign banks that set themselves up on American shores--organize banking units.
Traditionally since the 1980s, most corporate and investment banks (including also their trading, cash-management and processing units) recruit finance professionals into the following "programs," "classes" or "levels":
1. Analysts (those with BA or BS degrees) who join a two-three-year program and who virtually learn from scratch financial analysis, accounting, capital markets and banking on the job, while toiling away long hours doing the dirtiest of work for banking teams (spreadsheets, analysis, projections, document preparation, document printing, research, and, yes, mundane errands for managing directors). They often embark on the role without a clue. To their credit by the end of the first year, many become somewhat astute about accounting, corporate firm valuation, cash-flow analysis, financial projections and the required regulatory steps to issue new corporate bonds.
2. Associates (those with MBA degrees or analysts who have been promoted to the associate position) who have substantially more responsibility and more client contact and who are expected to have mastered nuances in corporate finance, capital markets and client industries. They come with experience, maturity and ambition. Some were top-rated analysts at banks before they retreated to Wharton, Darden, or Tuck to polish their understanding of finance and markets. They learn quickly that first year that banking is brutal business, not an academic pursuit.
3. Vice Presidents who are promoted after spending three-four years as associates and who have more management responsibility and greater access and input to client, deals, transactions, and revenue-generating activity. The pressure builds for them, because performance is tied not necessarily to an in-depth knowledge of markets, financial products and balance sheets, but to their ability to generate revenues and minimize risks.
And depending on the bank, fund, or institution:
4. Executive Directors/Directors/Principals who have more senior roles in the management of client relationships, trading portfolios, and/or business units.
5. Managing Directors/Partners who, besides having senior roles and significant decision-making responsibility, have extensive experience and a meaningful ownership stake (or simply own a lot of the stock). They are the ones who have spent practically half a career in the business and are known for their contacts, networks, client relationships, experience through hardships and downturns, and uncanny knowledge of just about anything they touch from day to day.
How and when people are promoted, paid and awarded bonuses have conventionally been determined by "market benchmarks." But who sets that "benchmark"?
Often it is Goldman Sachs or occasionally one of its peer firms (JPMorgan, Citi, Morgan Stanley, Merrill Lynch, e.g.). Sometimes it is set by the industry's efforts to ward off other competing finance sectors or industries. For example, in the technology boom/bust of the early 2000s, banks felt threatened that dot-coms and other start-ups would seize their more talented recruits. Some big banks even started a brief trend, as an added incentive, of permitting analysts and associates to invest in private-equity deals the bank had been involved in. Banks regularly have reshaped, rejuggled and revamped development programs to attract analysts and associates who would otherwise be more interested in technology start-ups, hedge funds, venture-capital outfits, consulting or non-profits.
For years, however, banks have shown a tendency to copy or borrow the programs, titles, bonus payouts, perks and promotion standards of other banks. Often it has been Goldman that started a trend or Goldman that raised the bar for base pay or bonus ranges. Other banks--with the help of industry compensation experts and professional recruiters--would peek and try to match the "market" (the market set by Goldman) or at least come somewhat close to it.
That would explain, for example, why compensation offers at most of the top banks, funds, and institutions tend to follow similar trends and tend to be quite similar in amount or package content. If Goldman decides, as it has done so in the past, that MBA associates should be paid bonuses partially in common stock. Then others follow suit. If Goldman changes its mind, as it has done in the past (early 2000s), then others do, too. Some call it copying; others call it competing to stay in the game.
So whenever Goldman makes a move and tweaks some part of the ladder, the industry watches, waits and then reacts. Last week, it decided to change elements of its analyst program a wee bit. The change, announced in the Wall Street Journal, will have a trickling effect on other corporate and investment banks.
The change was not major; it was a modification, not an overhaul of the program. But because it was Goldman, it will be discussed, examined and probably duplicated by others. It decided not to hire analysts on a contract basis for two years and not to guarantee a base level compensation during that period. Analysts, therefore, can be dismissed for non-performance, and on the way out, they will not be awarded a thanks-for-your-services bonus. While on paper or in concept this doesn't appear to have any impact on corporate or investment banking, because it's Goldman, it's news.
What does it all mean anyway?
The bigger story may be that Goldman, like all banks, continues to be under burdensome pressure to manage costs when banking activity is annoyingly volatile and the industry is under siege from regulators and the public. One incremental way to manage banking-personnel costs is to start at the bottom: Don't hand out gobs of cash to under-performing or disinterested financial analysts, some of whom aren't interested in long-term careers at Goldman anyway and have an eye on applying to business school or joining a Greenwich-based hedge fund.
One immediate effect on the young graduates is that the tweaks will make the tough, grinding, difficult role of an analyst even tougher. The life of the banking analyst is one of 80-100-hour work-weeks, a grueling physical existence where one is on call all the time, even on weekend evenings. But the pay-offs were always an extraordinary bonus payment, a modicum of prestige, and the opportunity to learn massive amounts of corporate finance and capital markets almost overnight. Goldman's tweak adds pressure. Analysts now won't have the luxury of failing or slipping up, as they (right out of school) adjust to deals, markets, spreadsheets, analysis, research, irascible vice presidents, and merely the real world in general.
Another implication is that if banks tweak the analysts program, they could easily tweak the MBA associates program next. Behind closed doors right now, senior bank managers might be huddling to decide how to manage the costs of another class of new associates from top business schools. They could agree to compensate the new bankers and traders handsomely (as they have always done), but they could decide they must reorganize the program (including compensations and performance expectations) to limit overall costs in other ways: dismiss "under-performing" associates sooner, reduce the number of associates who are on track to become vice presidents, or offer compensation packages of greater portions of restricted stock. The senior bankers could also decide to encourage associates who perform adequately, but whose hearts aren't in it, to leave.
In its lofty role of setting industry standards and setting the "market" for compensation and promotion, Goldman knows by now its incremental steps will probably be copied. It's not only Morgan Stanley that might follow suit, but the modest-size boutiques, the regional corporate banks, or the West Coast investment-management firm, too, will adjust.
Many say the roles, compensation and lure of corporate and investment bankers have hardly changed in the past several years. But with these kinds of tweaks and revisions, that new day could be dawning.
Tracy Williams
See also:
CFN: Forced Ranking: Does it hurt? July-2012
CFN: The Dreaded Performance Review--2011
CFN: Becoming a Top Performer--2009
CFN: Is I-banking still Hot?--2011
CFN: How Does Goldman Do It?--2010
CFN: Mastering Technical Skills in Banking--2010
Traditionally since the 1980s, most corporate and investment banks (including also their trading, cash-management and processing units) recruit finance professionals into the following "programs," "classes" or "levels":
1. Analysts (those with BA or BS degrees) who join a two-three-year program and who virtually learn from scratch financial analysis, accounting, capital markets and banking on the job, while toiling away long hours doing the dirtiest of work for banking teams (spreadsheets, analysis, projections, document preparation, document printing, research, and, yes, mundane errands for managing directors). They often embark on the role without a clue. To their credit by the end of the first year, many become somewhat astute about accounting, corporate firm valuation, cash-flow analysis, financial projections and the required regulatory steps to issue new corporate bonds.
2. Associates (those with MBA degrees or analysts who have been promoted to the associate position) who have substantially more responsibility and more client contact and who are expected to have mastered nuances in corporate finance, capital markets and client industries. They come with experience, maturity and ambition. Some were top-rated analysts at banks before they retreated to Wharton, Darden, or Tuck to polish their understanding of finance and markets. They learn quickly that first year that banking is brutal business, not an academic pursuit.
3. Vice Presidents who are promoted after spending three-four years as associates and who have more management responsibility and greater access and input to client, deals, transactions, and revenue-generating activity. The pressure builds for them, because performance is tied not necessarily to an in-depth knowledge of markets, financial products and balance sheets, but to their ability to generate revenues and minimize risks.
And depending on the bank, fund, or institution:
4. Executive Directors/Directors/Principals who have more senior roles in the management of client relationships, trading portfolios, and/or business units.
5. Managing Directors/Partners who, besides having senior roles and significant decision-making responsibility, have extensive experience and a meaningful ownership stake (or simply own a lot of the stock). They are the ones who have spent practically half a career in the business and are known for their contacts, networks, client relationships, experience through hardships and downturns, and uncanny knowledge of just about anything they touch from day to day.
How and when people are promoted, paid and awarded bonuses have conventionally been determined by "market benchmarks." But who sets that "benchmark"?
Often it is Goldman Sachs or occasionally one of its peer firms (JPMorgan, Citi, Morgan Stanley, Merrill Lynch, e.g.). Sometimes it is set by the industry's efforts to ward off other competing finance sectors or industries. For example, in the technology boom/bust of the early 2000s, banks felt threatened that dot-coms and other start-ups would seize their more talented recruits. Some big banks even started a brief trend, as an added incentive, of permitting analysts and associates to invest in private-equity deals the bank had been involved in. Banks regularly have reshaped, rejuggled and revamped development programs to attract analysts and associates who would otherwise be more interested in technology start-ups, hedge funds, venture-capital outfits, consulting or non-profits.
For years, however, banks have shown a tendency to copy or borrow the programs, titles, bonus payouts, perks and promotion standards of other banks. Often it has been Goldman that started a trend or Goldman that raised the bar for base pay or bonus ranges. Other banks--with the help of industry compensation experts and professional recruiters--would peek and try to match the "market" (the market set by Goldman) or at least come somewhat close to it.
That would explain, for example, why compensation offers at most of the top banks, funds, and institutions tend to follow similar trends and tend to be quite similar in amount or package content. If Goldman decides, as it has done so in the past, that MBA associates should be paid bonuses partially in common stock. Then others follow suit. If Goldman changes its mind, as it has done in the past (early 2000s), then others do, too. Some call it copying; others call it competing to stay in the game.
So whenever Goldman makes a move and tweaks some part of the ladder, the industry watches, waits and then reacts. Last week, it decided to change elements of its analyst program a wee bit. The change, announced in the Wall Street Journal, will have a trickling effect on other corporate and investment banks.
The change was not major; it was a modification, not an overhaul of the program. But because it was Goldman, it will be discussed, examined and probably duplicated by others. It decided not to hire analysts on a contract basis for two years and not to guarantee a base level compensation during that period. Analysts, therefore, can be dismissed for non-performance, and on the way out, they will not be awarded a thanks-for-your-services bonus. While on paper or in concept this doesn't appear to have any impact on corporate or investment banking, because it's Goldman, it's news.
What does it all mean anyway?
The bigger story may be that Goldman, like all banks, continues to be under burdensome pressure to manage costs when banking activity is annoyingly volatile and the industry is under siege from regulators and the public. One incremental way to manage banking-personnel costs is to start at the bottom: Don't hand out gobs of cash to under-performing or disinterested financial analysts, some of whom aren't interested in long-term careers at Goldman anyway and have an eye on applying to business school or joining a Greenwich-based hedge fund.
One immediate effect on the young graduates is that the tweaks will make the tough, grinding, difficult role of an analyst even tougher. The life of the banking analyst is one of 80-100-hour work-weeks, a grueling physical existence where one is on call all the time, even on weekend evenings. But the pay-offs were always an extraordinary bonus payment, a modicum of prestige, and the opportunity to learn massive amounts of corporate finance and capital markets almost overnight. Goldman's tweak adds pressure. Analysts now won't have the luxury of failing or slipping up, as they (right out of school) adjust to deals, markets, spreadsheets, analysis, research, irascible vice presidents, and merely the real world in general.
Another implication is that if banks tweak the analysts program, they could easily tweak the MBA associates program next. Behind closed doors right now, senior bank managers might be huddling to decide how to manage the costs of another class of new associates from top business schools. They could agree to compensate the new bankers and traders handsomely (as they have always done), but they could decide they must reorganize the program (including compensations and performance expectations) to limit overall costs in other ways: dismiss "under-performing" associates sooner, reduce the number of associates who are on track to become vice presidents, or offer compensation packages of greater portions of restricted stock. The senior bankers could also decide to encourage associates who perform adequately, but whose hearts aren't in it, to leave.
In its lofty role of setting industry standards and setting the "market" for compensation and promotion, Goldman knows by now its incremental steps will probably be copied. It's not only Morgan Stanley that might follow suit, but the modest-size boutiques, the regional corporate banks, or the West Coast investment-management firm, too, will adjust.
Many say the roles, compensation and lure of corporate and investment bankers have hardly changed in the past several years. But with these kinds of tweaks and revisions, that new day could be dawning.
Tracy Williams
See also:
CFN: Forced Ranking: Does it hurt? July-2012
CFN: The Dreaded Performance Review--2011
CFN: Becoming a Top Performer--2009
CFN: Is I-banking still Hot?--2011
CFN: How Does Goldman Do It?--2010
CFN: Mastering Technical Skills in Banking--2010
Friday, August 31, 2012
Knocking Down Doors in Venture Capital
Jenn Wei, a Stanford MBA who once worked in investment banking, is now researching, chasing and negotiating deals in technology as a venture capitalist at Bloomberg Capital. Last week, in postings that appeared widely in business media, including VentureBeat.com, she wrote about the startling, but not surprising lack of women in venture capital--in Silicon Valley (California), in Silicon Alley (New York) and at other pivotal venture spots around the country.
She reminded us of the glaring scarcity of females at negotiating tables, within network huddles when ideas are bantered about, and in closed-door meetings where entrepreneurs, deal-doers and investors decide the right amounts for an early-round investment to support the next new thing.
She offered a few reasons why women are not prominent in the industry and dared to propose solutions. She said women desperately need role models in the industry and industry participants need to take time to understand the likes, interests, and proclivities of women.
Her observations won't knock down doors, nor will they force those who run the best-known venture-capital firms to change the look, face and appeal of the industry overnight. As much they should be, they aren't focused on demographics of who's who and who's where as much as they desperately chase the next "disruptive" technology enterprise.
But gosh, she makes a point that is obvious to anybody who takes a moment to survey who is in the industry--from those at entry levels to those who sign off on the big angel investments. Who's exactly roaming the corridors at top venture-capital firms? What did they do to prepare to be in the right place and the right time? Whom did they know?
CFN examined the statistics of the industry last year. See CFN-Venture Capital and Diversity. Women comprise about 11% of the venture-capital professionals (based on industry surveys last year), while blacks and Latinos are virtually invisible at the major firms (firms such as Accel, Greylock, Sequoia, and Kleiner Perkins). (Asians and Asian-American comprise about 9%.)
Wei pointed to the Midas List, a Forbes-magazine list of the top 100 in venture capital, those responsible for making the most lucrative investments in technology, those who have had successful track records in sniffing out the next Facebook or Zynga and getting in early, while accumulating board seats and significant numbers of pre-IPO shares. She had trouble finding women on the list. And she wondered why.
In the list's top 20, there are no women. Women have had modest success in leading technology firms (e.g., at eBay, H&P, Facebook, Yahoo, etc.). So why haven't they been leaders in venture capital? (Or why, for that matter, are blacks and Latinos still invisible in the industry?)
The top 20 on Forbes' list includes familiar names, including those who would likely be in a Venture Capital Hall of Fame, if such existed. It includes Marc Andreessen, Jim Breyer, John Doerr, Reid Hoffman, and Peter Thiel--not necessarily household names, but wealthy investors (a billionaire here and there) and legendary leaders of venture funds.
What typifies this top 20 among the top 100, beyond the fact that a little luck here and there certainly counted for some of their success and wealth?
1. While some like Thiel and Andreessen became venture investors after their blockbuster successes from a start-up they founded (PayPal, Netscape, etc.), most of the others started out working in investor funds and worked their way up because of investment-related experiences, contacts, opportunities they took advantage of, and solid track records. Many of the same--without a doubt--joined the right venture firms and fell into the arms of sympathetic mentors willing to help someone follow their paths.
2. Many of them, plugged into technology updates and gifted with insight about technology trends or market behavior, hit more than a few home runs by getting in early in recent years with investments in Groupon, Facebook, Twitter, Linkedin, NetFlix, Pandora and Zynga. One or two home runs helped build a reputation, which helped establish more contacts, funding, or entrees into whatever niche of the industry they needed or wanted to be in.
3. Many have science, math, and engineering undergraduate degrees, permitting them to exist comfortably among professional engineers, computer scientists, or 22-year-old coding geeks.
4. But most of this group are financiers at their core, competent in evaluating investments over 3-, 5- 7-year horizons, able to comprehend balance sheets and funding needs of start-up companies, expert at assessing growth prospects of a new company, sensitive to the tweaked structures of the capital structure of a young company, and experienced in deciphering board-room behavior.
So it's not a surprise that most in this group of 20 and a substantial number in the top 100 have MBAs in finance from top schools (Harvard, Stanford, and Wharton, being prominent in the top 20, and Consortium schools Berkeley and Michigan also being prominent in the top 100).
Basically qualities, characteristics and experiences many women (and others from under-represented groups) possess. The doors are slightly ajar, and they might have to be knocked down in order for everybody to get in.
Tracy Williams
She reminded us of the glaring scarcity of females at negotiating tables, within network huddles when ideas are bantered about, and in closed-door meetings where entrepreneurs, deal-doers and investors decide the right amounts for an early-round investment to support the next new thing.
She offered a few reasons why women are not prominent in the industry and dared to propose solutions. She said women desperately need role models in the industry and industry participants need to take time to understand the likes, interests, and proclivities of women.
Her observations won't knock down doors, nor will they force those who run the best-known venture-capital firms to change the look, face and appeal of the industry overnight. As much they should be, they aren't focused on demographics of who's who and who's where as much as they desperately chase the next "disruptive" technology enterprise.
But gosh, she makes a point that is obvious to anybody who takes a moment to survey who is in the industry--from those at entry levels to those who sign off on the big angel investments. Who's exactly roaming the corridors at top venture-capital firms? What did they do to prepare to be in the right place and the right time? Whom did they know?
CFN examined the statistics of the industry last year. See CFN-Venture Capital and Diversity. Women comprise about 11% of the venture-capital professionals (based on industry surveys last year), while blacks and Latinos are virtually invisible at the major firms (firms such as Accel, Greylock, Sequoia, and Kleiner Perkins). (Asians and Asian-American comprise about 9%.)
Wei pointed to the Midas List, a Forbes-magazine list of the top 100 in venture capital, those responsible for making the most lucrative investments in technology, those who have had successful track records in sniffing out the next Facebook or Zynga and getting in early, while accumulating board seats and significant numbers of pre-IPO shares. She had trouble finding women on the list. And she wondered why.
In the list's top 20, there are no women. Women have had modest success in leading technology firms (e.g., at eBay, H&P, Facebook, Yahoo, etc.). So why haven't they been leaders in venture capital? (Or why, for that matter, are blacks and Latinos still invisible in the industry?)
The top 20 on Forbes' list includes familiar names, including those who would likely be in a Venture Capital Hall of Fame, if such existed. It includes Marc Andreessen, Jim Breyer, John Doerr, Reid Hoffman, and Peter Thiel--not necessarily household names, but wealthy investors (a billionaire here and there) and legendary leaders of venture funds.
What typifies this top 20 among the top 100, beyond the fact that a little luck here and there certainly counted for some of their success and wealth?
1. While some like Thiel and Andreessen became venture investors after their blockbuster successes from a start-up they founded (PayPal, Netscape, etc.), most of the others started out working in investor funds and worked their way up because of investment-related experiences, contacts, opportunities they took advantage of, and solid track records. Many of the same--without a doubt--joined the right venture firms and fell into the arms of sympathetic mentors willing to help someone follow their paths.
2. Many of them, plugged into technology updates and gifted with insight about technology trends or market behavior, hit more than a few home runs by getting in early in recent years with investments in Groupon, Facebook, Twitter, Linkedin, NetFlix, Pandora and Zynga. One or two home runs helped build a reputation, which helped establish more contacts, funding, or entrees into whatever niche of the industry they needed or wanted to be in.
3. Many have science, math, and engineering undergraduate degrees, permitting them to exist comfortably among professional engineers, computer scientists, or 22-year-old coding geeks.
4. But most of this group are financiers at their core, competent in evaluating investments over 3-, 5- 7-year horizons, able to comprehend balance sheets and funding needs of start-up companies, expert at assessing growth prospects of a new company, sensitive to the tweaked structures of the capital structure of a young company, and experienced in deciphering board-room behavior.
So it's not a surprise that most in this group of 20 and a substantial number in the top 100 have MBAs in finance from top schools (Harvard, Stanford, and Wharton, being prominent in the top 20, and Consortium schools Berkeley and Michigan also being prominent in the top 100).
Basically qualities, characteristics and experiences many women (and others from under-represented groups) possess. The doors are slightly ajar, and they might have to be knocked down in order for everybody to get in.
Tracy Williams
Wednesday, August 15, 2012
On Campus: Getting Back to School
 | |
| Yale SOM's new campus: One year away |
Professors and deans get excited, too, as they are buoyed by the interests, eagerness and dreams of students. Always there is electricity during the early days of school in the fall, until students drift into an October grind, when it's time to ward off the pressures of upcoming midterms and recruiting chores.
But for now, it's August, and there are new faces and bundles of energy. New MBA Consortium students at Cornell have already touched down on campus and begun orientation. Its MBA Class of 2014 comprises 40 Consortium students; 17 have expressed an interest in finance or financial services.
During its first week, all Cornell first-year students were treated to a riveting keynote address from management consultant Frans Johansson, who spoke on "The Intersection." Johansson told the MBA first-years that business careers, ideas or projects accelerate or take off when they reach a certain "intersection," where "unexpected ideas," diverse people, and "cross-thinking" merge.
He encouraged students to recognize those "intersections," leverage them and take advantage of them--as if to say students should recognize when they are in that right place at that right time or at least should capitalize on the influx of diverse ideas, diverse people and special situations when they are in the right moment.
Last week the New York Times reviewed Yale's efforts to stand out from the business-school pack. Yale's new dean Edward Snyder comes armed with ideas, a plan and a new building. Dean Snyder left Chicago's Booth School to venture into New Haven, likely enticed by the odd-ball heritage of Yale and its experimental approaches to business-school education. Since its mid-1970s founding, Yale SOM has always been a business-school maverick or has always been perceived that way, even after it changed its degree from an MPPM (master's in public and private management) to an MBA years ago.
If other top schools are careful and methodical about education overhaul, Yale SOM has traditionally taken risks and tried new approaches. Most recently, it instituted a novel "integrated curriculum" for first-year students. It wanted to destroy the pillared approach, where finance types keep to themselves and operations and marketing types remain in their own domain. Hence, all courses attempt to address concepts or issues, for example, in finance, marketing, operations, employees, shareholders, management, social responsibility and global impact. The new approach is apparently working, as it launches its seventh year this fall.
Yale SOM also counts down the days when everybody in the school can move into its brand-new campus (Evans Hall) next year.
NYU-Stern recently announced a new degree--not to replace the MBA, but to recognize the crucial importance of data mining and data management in business. This fall it introduces the MS in business analytics within the Stern business school. Some MBAs will contemplate supplementing their degrees with this new one-year program, although Stern didn't announce such a joint-degree program. The program recognized the mammoth amount of data available to business managers and helps business managers learn how to use it to an advantage. It also helps students and managers use statistics and quantitative analysis to form business strategy, make decisions, and manage revenues, profits, costs and balance sheets.
The new degree will take a four-prong approach to analytics: (a) mining data, (b) interpreting it, (c) modeling and (d) visualization.
The arrival of fall also brings on a flood of media-related business-school rankings. The rankings are widely dreaded, often criticized, usually questionable, always controversial, wildly varied, and sometimes puzzling. But everybody takes a peek at them--from first-year students, applicants, professors, recruiters, and, yes, deans. With so many lists and rankings, there may no longer be one authoritative list.
If readers don't take them too seriously, some rankings can be amusing or at least can highlight special strengths of certain schools. Advanced Trading, a website and publication focused on sophisticated and complex trading (including high-frequency trading and global markets), provided its list (not a ranking) of the top 10 "Quant Schools," the top business schools for quantitative research and trading analytics. Four Consortium schools made the list: Carnegie Mellon, Cornell, UC-Berkeley, and NYU. The list was based on a survey of senior Wall Street managers and traders, hedge-fund managers and others.
DiversityComm, Inc. regularly provides lists of companies, organizations and schools that emphasize or promote diversity. This summer, it offers a list of the top MBA schools for African-American students. Its criteria revolved around each school's outreach and accessibility to black applicants, students and graduates. It's no surprise 15 of the 17 Consortium schools made the list (all the Consortium schools, except Emory and Wisconsin).
Tracy Williams
See also:
CFN: Composing the Class of 2014
CFN: Rankings: Take a Peek, but Be Cautious--2009
CFN: Yet Another Ranking of Business Schools--2010
CFN: Gearing up for the Fall, 2009
Friday, August 10, 2012
Morgan Stanley: Can It Please Analysts?
A financial institution strives hard to get it right--stay out of the headlines, focus on core businesses, hire talented people, manage risks, oversee diverse sources of revenue, rationalize costs and allocate capital properly. And despite all efforts, the institution is not a darling among equity analysts, investors, and market watchers. Analysts and the markets sense something is amiss. They recognize the organization is fine-tuned and structured appropriately. They reason the right managers are at the top managing a complex, global business. But they sense an undetected vulnerability. The bank experiences a periodic, surprising earnings stumble, and the market declares degrees of doom. The company is admired, its history revered, but analysts are biased toward a high probability that losses will occur from nowhere.
Sounds like Morgan Stanley. While some financial institutions have been whipped soundly in business headlines the past few years (Goldman Sachs, Bank of America, Citi, and JPMorgan Chase), Morgan Stanley has managed to hover in the media background, yet it hasn't managed to generate sterling results and win the respect of those who study every move, step and dollar earned of major banks.
The bank, in some ways, is still recovering from spirited in-house battles from over a decade ago, when the leadership then, under CEO Philip Purcell, tried to reshape it from an upper-crust investment bank to a financial super market. Those were the days of a new strategy when the firm, after affiliating itself with retail giant Dean Witter, sprouted a national network of brokers, while trying to maintain its entrenched standing as a top investment bank for the top half of the Fortune 500.
Morgan Stanley, too, is recovering from the debacles that led to the financial crisis in 2008-09. Complex, exotic mortgage securities caused debilitating setbacks at Lehman, Bear Stearns, Citi and Merrill Lynch. Morgan Stanley was also pummeled by piles of CDOs on its balance sheet.
Some old-time Morgan bankers (and partners) wished Morgan had long ago retreated to its days of pure investment banking, without regard to or worry for an expansive retail network. Sales & trading would exist as a complement to corporate-advisory work. And retail brokerage would be done, well, in another hemisphere. Old-timers preferred deep relationships with corporate behemoths, rather than moms and pops. After the in-house strife years ago, Morgan Stanley has been on a consistent, steadfast path seeking to become bankers and brokers for moms, pops, uncles, aunts, General Motors and Facebook.
Its mission is clearer, and its ambitions known. Yet somehow it occasionally trips up and reports earnings that would embarrass its peers. When others report modest declines in trading revenues, for example, it reports unseemly, unexpected losses in trading. When others have blockbuster quarters in earnings, it slips in with mediocre profts.
As a result, there are always ongoing rumblings about its stock price and its prospects for being able to compete with the creme de la creme of banks. (Its stock had climbed above $20/share in early spring, but has since plummeted to less than $14/share.) Ratings agencies, just as they did with other large banks a month ago, have battered the bank, too, placing it on "negative" watch lists and assigning it near-junk ratings (as Moody's did recently).
To its credit, Morgan Stanley, under the leadership of current CEO James Gorman, tells its story with much more confidence. While earnings are not emitting shining rays, it has done all things possible to reduce leverage, build up capital, avoid embarrassing front-page lawsuits, and do what is popularly known as "de-risking" its balance sheet. Its balance sheet is now about 10% smaller than it had been two years and is now supported by an equity capital base of over $60 billion. It has taken aggressive steps to reduce the likelihood of "a run on the bank" (by reducing reliance on short-term funding).
In recent weeks, it has reaffirmed its desires to take greater control over its joint venture with Citi running the branch network Smith Barney. It has also re-engineered, just like its peers at Goldman Sachs and JPMorgan, to prepare for Dodd-Frank and Basel III regulation. It unloaded without fuss its enormously successful hedge-fund-like, black-box trading group.
Furthermore, somehow the institution, in whatever current state of being it is in, seems to have survived in the way Bear Stearns, Lehman and Merrill didn't. In 2008, the other three fell like dominoes; trading floors everywhere whispered, wondering if Morgan Stanley were next. It wasn't.
Hence, it fumes that it gets little credit. Investors and analysts applaud the restructuring moves, but it's all about the earnings, they counter. In the most recent quarter (second quarter, 2012), Morgan Stanley blamed a 48% drop in trading revenues (mostly from fixed-income activity) on its nearly 50% decline in earnings and its paltry 2% return on equity--yet another quarter where analysts insist they were caught off guard.
Morgan Stanley managed to win an enviable role in the Facebook IPO during the quarter. The coup was a tribute to its highly regarded technology-banking team in Silicon Valley. Many thought Goldman Sachs and JPMorgan had inside routes to the top role. But even this most anticipated IPO in years had slip-ups. Now regulators, market pundits and investors are playing a Facebook blame-game of figuring out whether Nasdaq incurred real systems mishaps or whether Morgan Stanley led in mis-pricing the shares on day one.
What can Gorman and lieutenants do to win favorable sentiments from analysts, investors, and ratings agencies?
First of all, it will need to get the ROE to rise above 10% and stay there. There is inevitable volatility in this industry, so earnings won't grow quarter after quarter. But the market wants to see some semblance of stability, even among investment banks where fees from M&A and equity underwriting can evaporate overnight.
Second, the market wants to see if Morgan Stanley, like its peers, has real solutions for the oncoming onslaught of regulation. Will the bank be able to generate revenues and returns with reduced risks, reduced leverage, stiff capital requirements, more transparency, and no longer the opportunities to ride the momentum of "prop trading"?
Third (and arguably most important in the eyes of some), the market wants to see if the firm can control costs, control risks, and reduce the likelihood of the unexpected, huge loss.
Some analysts have called for more aggressive steps. Break up the firm into separate units: the retail brokerage, the investment bank, international banking, and hedge-fund trading, says prominent bank analyst Michael Mayo, who last week reasoned that doing so could double the stock price.
Seize more of Smith Barney and pour more resources (people, brokers, and capital) into the brokerage and wealth-management businesses, say others.
Become a large-scale version of a boutique like Lazard? That means selling off other parts and maintaining the Morgan Stanley brand for a niche investment-banking business, compete with Lazard, Greenhill, Evercore, and other boutiques and beat them with more capital, an international presence and a corporate-loan unit. More easily said than done.
Continue to pare down businesses into the few where it is a market leader or what it sees as the best potential for growth? That seems to be the likely strategy or the one Morgan senior management is running with at the moment.
Go behind closed doors, and you can bet that senior management is frustrated that with all the tweaking, it continues to hustle to try to get it right. However, it is smugly satisfied that it won't bow out in a Lehman- or Bear Stearns-like way.
Tracy Williams
See also:
CFN: How Does Goldman Do It? Feb-2010
Sounds like Morgan Stanley. While some financial institutions have been whipped soundly in business headlines the past few years (Goldman Sachs, Bank of America, Citi, and JPMorgan Chase), Morgan Stanley has managed to hover in the media background, yet it hasn't managed to generate sterling results and win the respect of those who study every move, step and dollar earned of major banks.
The bank, in some ways, is still recovering from spirited in-house battles from over a decade ago, when the leadership then, under CEO Philip Purcell, tried to reshape it from an upper-crust investment bank to a financial super market. Those were the days of a new strategy when the firm, after affiliating itself with retail giant Dean Witter, sprouted a national network of brokers, while trying to maintain its entrenched standing as a top investment bank for the top half of the Fortune 500.
Morgan Stanley, too, is recovering from the debacles that led to the financial crisis in 2008-09. Complex, exotic mortgage securities caused debilitating setbacks at Lehman, Bear Stearns, Citi and Merrill Lynch. Morgan Stanley was also pummeled by piles of CDOs on its balance sheet.
Some old-time Morgan bankers (and partners) wished Morgan had long ago retreated to its days of pure investment banking, without regard to or worry for an expansive retail network. Sales & trading would exist as a complement to corporate-advisory work. And retail brokerage would be done, well, in another hemisphere. Old-timers preferred deep relationships with corporate behemoths, rather than moms and pops. After the in-house strife years ago, Morgan Stanley has been on a consistent, steadfast path seeking to become bankers and brokers for moms, pops, uncles, aunts, General Motors and Facebook.
Its mission is clearer, and its ambitions known. Yet somehow it occasionally trips up and reports earnings that would embarrass its peers. When others report modest declines in trading revenues, for example, it reports unseemly, unexpected losses in trading. When others have blockbuster quarters in earnings, it slips in with mediocre profts.
As a result, there are always ongoing rumblings about its stock price and its prospects for being able to compete with the creme de la creme of banks. (Its stock had climbed above $20/share in early spring, but has since plummeted to less than $14/share.) Ratings agencies, just as they did with other large banks a month ago, have battered the bank, too, placing it on "negative" watch lists and assigning it near-junk ratings (as Moody's did recently).
To its credit, Morgan Stanley, under the leadership of current CEO James Gorman, tells its story with much more confidence. While earnings are not emitting shining rays, it has done all things possible to reduce leverage, build up capital, avoid embarrassing front-page lawsuits, and do what is popularly known as "de-risking" its balance sheet. Its balance sheet is now about 10% smaller than it had been two years and is now supported by an equity capital base of over $60 billion. It has taken aggressive steps to reduce the likelihood of "a run on the bank" (by reducing reliance on short-term funding).
In recent weeks, it has reaffirmed its desires to take greater control over its joint venture with Citi running the branch network Smith Barney. It has also re-engineered, just like its peers at Goldman Sachs and JPMorgan, to prepare for Dodd-Frank and Basel III regulation. It unloaded without fuss its enormously successful hedge-fund-like, black-box trading group.
Furthermore, somehow the institution, in whatever current state of being it is in, seems to have survived in the way Bear Stearns, Lehman and Merrill didn't. In 2008, the other three fell like dominoes; trading floors everywhere whispered, wondering if Morgan Stanley were next. It wasn't.
Hence, it fumes that it gets little credit. Investors and analysts applaud the restructuring moves, but it's all about the earnings, they counter. In the most recent quarter (second quarter, 2012), Morgan Stanley blamed a 48% drop in trading revenues (mostly from fixed-income activity) on its nearly 50% decline in earnings and its paltry 2% return on equity--yet another quarter where analysts insist they were caught off guard.
Morgan Stanley managed to win an enviable role in the Facebook IPO during the quarter. The coup was a tribute to its highly regarded technology-banking team in Silicon Valley. Many thought Goldman Sachs and JPMorgan had inside routes to the top role. But even this most anticipated IPO in years had slip-ups. Now regulators, market pundits and investors are playing a Facebook blame-game of figuring out whether Nasdaq incurred real systems mishaps or whether Morgan Stanley led in mis-pricing the shares on day one.
What can Gorman and lieutenants do to win favorable sentiments from analysts, investors, and ratings agencies?
First of all, it will need to get the ROE to rise above 10% and stay there. There is inevitable volatility in this industry, so earnings won't grow quarter after quarter. But the market wants to see some semblance of stability, even among investment banks where fees from M&A and equity underwriting can evaporate overnight.
Second, the market wants to see if Morgan Stanley, like its peers, has real solutions for the oncoming onslaught of regulation. Will the bank be able to generate revenues and returns with reduced risks, reduced leverage, stiff capital requirements, more transparency, and no longer the opportunities to ride the momentum of "prop trading"?
Third (and arguably most important in the eyes of some), the market wants to see if the firm can control costs, control risks, and reduce the likelihood of the unexpected, huge loss.
Some analysts have called for more aggressive steps. Break up the firm into separate units: the retail brokerage, the investment bank, international banking, and hedge-fund trading, says prominent bank analyst Michael Mayo, who last week reasoned that doing so could double the stock price.
Seize more of Smith Barney and pour more resources (people, brokers, and capital) into the brokerage and wealth-management businesses, say others.
Become a large-scale version of a boutique like Lazard? That means selling off other parts and maintaining the Morgan Stanley brand for a niche investment-banking business, compete with Lazard, Greenhill, Evercore, and other boutiques and beat them with more capital, an international presence and a corporate-loan unit. More easily said than done.
Continue to pare down businesses into the few where it is a market leader or what it sees as the best potential for growth? That seems to be the likely strategy or the one Morgan senior management is running with at the moment.
Go behind closed doors, and you can bet that senior management is frustrated that with all the tweaking, it continues to hustle to try to get it right. However, it is smugly satisfied that it won't bow out in a Lehman- or Bear Stearns-like way.
Tracy Williams
See also:
CFN: How Does Goldman Do It? Feb-2010
Friday, August 3, 2012
Dark Days at Knight Capital
Despite all efforts to corral Wall Street to avert a crisis, avoid market collapse, and instill confidence in the system, guess what happens. Yet another major misstep in the marketplace by one of its big participants. And not just the rare market mistake that occurs once every year or two. Missteps, hiccups, and strange collapses seem to be occurring these days just about every other week.
This week, it's Knight Capital, the equities market-making firm that announced losses of over $400 million after it launched new software in its trading systems. Software errors and technology glitches led the firm's black boxes to spew large orders of errant trades. By the time the firm's humans (not machines) could discover what was happening, it was too late. The losses had piled up on trades the firm had no idea it had booked and would have never wanted to make in the first place. The losses wiped out about half of its book-value equity, and now it struggles to survive intact. Until this week, Knight existed quietly in a niche role in stock trading (institutional equity brokerage, trading and market-making) and had been successful and well regarded in equity markets.
The trading mistakes resulted after Knight implemented new code to capitalize on a new form of retail-related trading with the New York Stock Exchange. They follow a series of embarrassments and other blatant mistakes all around the financial system the past two years. Knight's loss reminds us of the 2010 "flash crash," when computerized trading involving futures and equities led to a sudden, shocking, unexplained nose-dive in stock markets. Regulators afterward implemented safe-guard measures to reduce the probability of another flash crash. Or they thought they did. This week, regulators observed the unusual activity at Knight. The overall market corrected itself, but it was too late to save Knight from itself.
Beyond flash crashes and trading losses from bad computer code or faulty systems, there have been steady occurrences of bad events--almost enough to scare retail investors away from markets for the rest of the decade. In just the past several months, MF Global, the large futures brokerage, collapsed after taking on large trading positions in Europe markets and losing hundreds of millions in customer funds. The upstart trading system BATS, specializing in stock match-making and high-frequency trading, planned its own IPO, but canceled it because of technology problems in its own infrastructure.
JPMorgan Chase this spring announced over $5 billion in trading losses from trading credit-default swaps in what was supposed to have been a safe hedge on its balance sheet. The Nasdaq Exchange and Morgan Stanley are being blamed for the problems Facebook had on opening day in its IPO. Facebook and others say Nasdaq's systems mishandled orders and trading in the first moments of trading in Facebook stock. Nasdaq has acknowledged some errors, but claims those errors have little to do with underwriters' pricing the IPO too highly and with the precipitous decline in Facebook share prices since Day 1 of the IPO.
Last month another futures brokerage Peregrine Financial, less well known in futures markets, collapsed, and customers and regulators are panicking to locate their own funds. And now Knight Capital.
Knight Capital is being described as a high-frequency, algorithmic-trading firm, although its evolution is more conventional. The firm was launched in the 1990s to act as a market-maker of Nasdaq-traded stocks. Retail brokerage firms from every corner of the U.S. send their brokerage orders to Knight or similar firms that always stand ready to make markets (buy or sell), based on order flow from investors.
As equities markets advanced, became more deregulated, dispersed and decentralized and trading volumes grew and trading became more computerized, Knight advanced, too. It retained its market-making roots, but transformed into a sophisticated institutional trading organization with a prowess for high-frequency trading and black boxes humming all over its offices.
It traded on behalf of clients, counter-parties, institutions and itself. Clients routed their trades to Knight because Knight promised them fast execution and best prices (when they bought or sold stock). If mom or pop or a Vanguard mutual fund bought or sold stock, chances are the trade was routed toward Knight Capital for execution, or at least Knight had a chance to see it and make a rationale bid or offer. Or let's say, Knight's computers.
All major institutional players engage in some form of high-frequency trading today, if only to survive and have a chance to squeeze tiny profits from the system--whether they are Knight, Goldman Sachs, hedge funds like Citadel or one of the many "algorithmic traders" with names like Getco, Jump Trading, Sun Trading, Peak 6, Quantlab or Susquehanna. Some firms like Getco trade for their own accounts, jump into and jump out of markets in nanoseconds to make minuscule profits based on market tendencies and discrepancies. Market-making firms like Knight promise clients they offer technology advantages to get them into and out of markets with fast execution, best prices, and handsome profits.
JPMorgan is so large and so well-capitalized (and some argue, so important to the global system) that its billions in losses in the second quarter caused an unsightly black eye, but nothing more than a financial sprained ankle. Knight's losses wiped out half the firm's capital base, and it now struggles for survival. It may not exist a week from now.
What will likely happen?
The firm's CEO Thomas Joyce says the firm has sufficient "excess capital" based on SEC requirements. That means the firm meets SEC minimums for capital and the SEC can't force the firm to shut down immediately. It doesn't mean the SEC can't swarm the firm with regulators and investigators to see what happened, decide whether there should be penalties, or urge the firm to wind down or sell itself immediately.
At Knight, losses over $400 million imply the firm needs new funding immediately--new capital, new long- and short-term funding. Funding is necessary for ongoing, everyday operations--to support trading and market-making positions, to fund deposits at exchanges and clearing organizations, to pay down worried short-term lenders, or to pledge more collateral for other lenders. The longer it takes to replace the $400 million, the less likely Knight will survive in any form.
Already brokerage firms, trading counter-parties, institutional traders and hedge funds have stopped funneling trades its way, reducing revenue flow. They stand on the side lines to see how this story will unfurl. Perhaps they will resume trading once they see an outcome comfortable to them. Few outcomes, however, will be comfortable for Knight shareholders and employees.
The likely outcome? With lenders, creditors, clients and counter-parties retreating and not willing to engage with Knight until after figuring out what happened--and with regulators and the public crying "mismanagement" or lashing out at technology-based trading, Knight Capital will likely have to sell itself in entirety or in bulk pieces.
Once it is confirmed that the firm's loss was due to technology or programming errors and not fraud or an attempt to do something illegitimate, larger financial institutions funds will see value in its parts or whole. There is value in its order flow from hundreds of broker/dealers and hedge funds with long-term relationships with the firm (if they all choose to return when the madness dims). There is value in its existing memberships, tie-ins, and plug-ins to equity and futures exchanges. And there may be value in the existing black boxes that have worked well in normal markets (if we assume that the problem this week was all due solely to the firm's lack of patience in testing new trading code).
Bankruptcy is always a route to get to the best possible result for shareholders, who will no doubt suffer. CEO Joyce's acclaimed career in equity markets may end and his successful efforts to turn Knight into an important market participant could be forgotten.
Have we come to expect mammoth market mistakes to be the new normal, despite the good intentions of new regulation and oversight? What else could possibly occur this month, when we usually think Wall Street slows down for vacation?
And just think, all the turmoil and chaos this week because of a 15-minute, computer mistake in Jersey City.
Tracy Williams
For more, see also:
CFN: JPMorgan and Trading Losses, 2012
CFN: MF Global and Its Demise, 2011
CFN: Facebook and Its Rough IPO, 2012
This week, it's Knight Capital, the equities market-making firm that announced losses of over $400 million after it launched new software in its trading systems. Software errors and technology glitches led the firm's black boxes to spew large orders of errant trades. By the time the firm's humans (not machines) could discover what was happening, it was too late. The losses had piled up on trades the firm had no idea it had booked and would have never wanted to make in the first place. The losses wiped out about half of its book-value equity, and now it struggles to survive intact. Until this week, Knight existed quietly in a niche role in stock trading (institutional equity brokerage, trading and market-making) and had been successful and well regarded in equity markets.
The trading mistakes resulted after Knight implemented new code to capitalize on a new form of retail-related trading with the New York Stock Exchange. They follow a series of embarrassments and other blatant mistakes all around the financial system the past two years. Knight's loss reminds us of the 2010 "flash crash," when computerized trading involving futures and equities led to a sudden, shocking, unexplained nose-dive in stock markets. Regulators afterward implemented safe-guard measures to reduce the probability of another flash crash. Or they thought they did. This week, regulators observed the unusual activity at Knight. The overall market corrected itself, but it was too late to save Knight from itself.
Beyond flash crashes and trading losses from bad computer code or faulty systems, there have been steady occurrences of bad events--almost enough to scare retail investors away from markets for the rest of the decade. In just the past several months, MF Global, the large futures brokerage, collapsed after taking on large trading positions in Europe markets and losing hundreds of millions in customer funds. The upstart trading system BATS, specializing in stock match-making and high-frequency trading, planned its own IPO, but canceled it because of technology problems in its own infrastructure.
JPMorgan Chase this spring announced over $5 billion in trading losses from trading credit-default swaps in what was supposed to have been a safe hedge on its balance sheet. The Nasdaq Exchange and Morgan Stanley are being blamed for the problems Facebook had on opening day in its IPO. Facebook and others say Nasdaq's systems mishandled orders and trading in the first moments of trading in Facebook stock. Nasdaq has acknowledged some errors, but claims those errors have little to do with underwriters' pricing the IPO too highly and with the precipitous decline in Facebook share prices since Day 1 of the IPO.
Last month another futures brokerage Peregrine Financial, less well known in futures markets, collapsed, and customers and regulators are panicking to locate their own funds. And now Knight Capital.
Knight Capital is being described as a high-frequency, algorithmic-trading firm, although its evolution is more conventional. The firm was launched in the 1990s to act as a market-maker of Nasdaq-traded stocks. Retail brokerage firms from every corner of the U.S. send their brokerage orders to Knight or similar firms that always stand ready to make markets (buy or sell), based on order flow from investors.
As equities markets advanced, became more deregulated, dispersed and decentralized and trading volumes grew and trading became more computerized, Knight advanced, too. It retained its market-making roots, but transformed into a sophisticated institutional trading organization with a prowess for high-frequency trading and black boxes humming all over its offices.
It traded on behalf of clients, counter-parties, institutions and itself. Clients routed their trades to Knight because Knight promised them fast execution and best prices (when they bought or sold stock). If mom or pop or a Vanguard mutual fund bought or sold stock, chances are the trade was routed toward Knight Capital for execution, or at least Knight had a chance to see it and make a rationale bid or offer. Or let's say, Knight's computers.
All major institutional players engage in some form of high-frequency trading today, if only to survive and have a chance to squeeze tiny profits from the system--whether they are Knight, Goldman Sachs, hedge funds like Citadel or one of the many "algorithmic traders" with names like Getco, Jump Trading, Sun Trading, Peak 6, Quantlab or Susquehanna. Some firms like Getco trade for their own accounts, jump into and jump out of markets in nanoseconds to make minuscule profits based on market tendencies and discrepancies. Market-making firms like Knight promise clients they offer technology advantages to get them into and out of markets with fast execution, best prices, and handsome profits.
JPMorgan is so large and so well-capitalized (and some argue, so important to the global system) that its billions in losses in the second quarter caused an unsightly black eye, but nothing more than a financial sprained ankle. Knight's losses wiped out half the firm's capital base, and it now struggles for survival. It may not exist a week from now.
What will likely happen?
The firm's CEO Thomas Joyce says the firm has sufficient "excess capital" based on SEC requirements. That means the firm meets SEC minimums for capital and the SEC can't force the firm to shut down immediately. It doesn't mean the SEC can't swarm the firm with regulators and investigators to see what happened, decide whether there should be penalties, or urge the firm to wind down or sell itself immediately.
At Knight, losses over $400 million imply the firm needs new funding immediately--new capital, new long- and short-term funding. Funding is necessary for ongoing, everyday operations--to support trading and market-making positions, to fund deposits at exchanges and clearing organizations, to pay down worried short-term lenders, or to pledge more collateral for other lenders. The longer it takes to replace the $400 million, the less likely Knight will survive in any form.
Already brokerage firms, trading counter-parties, institutional traders and hedge funds have stopped funneling trades its way, reducing revenue flow. They stand on the side lines to see how this story will unfurl. Perhaps they will resume trading once they see an outcome comfortable to them. Few outcomes, however, will be comfortable for Knight shareholders and employees.
The likely outcome? With lenders, creditors, clients and counter-parties retreating and not willing to engage with Knight until after figuring out what happened--and with regulators and the public crying "mismanagement" or lashing out at technology-based trading, Knight Capital will likely have to sell itself in entirety or in bulk pieces.
Once it is confirmed that the firm's loss was due to technology or programming errors and not fraud or an attempt to do something illegitimate, larger financial institutions funds will see value in its parts or whole. There is value in its order flow from hundreds of broker/dealers and hedge funds with long-term relationships with the firm (if they all choose to return when the madness dims). There is value in its existing memberships, tie-ins, and plug-ins to equity and futures exchanges. And there may be value in the existing black boxes that have worked well in normal markets (if we assume that the problem this week was all due solely to the firm's lack of patience in testing new trading code).
Bankruptcy is always a route to get to the best possible result for shareholders, who will no doubt suffer. CEO Joyce's acclaimed career in equity markets may end and his successful efforts to turn Knight into an important market participant could be forgotten.
Have we come to expect mammoth market mistakes to be the new normal, despite the good intentions of new regulation and oversight? What else could possibly occur this month, when we usually think Wall Street slows down for vacation?
And just think, all the turmoil and chaos this week because of a 15-minute, computer mistake in Jersey City.
Tracy Williams
For more, see also:
CFN: JPMorgan and Trading Losses, 2012
CFN: MF Global and Its Demise, 2011
CFN: Facebook and Its Rough IPO, 2012
Thursday, July 19, 2012
MBA Diversity: A Constant Effort to Catch Up
For the past three decades, top business schools have hustled every way they can to improve levels of diversity on their campuses. They have aggressively recruited under-represented minorities (URM) and women. They have participated in pipeline programs like the Consortium. They have sponsored scholarships and funded fellowships.
But two weeks ago, a Wall Street Journal article suggested that for many schools it's a one-step-forward, two-steps-back effort. Graduate business schools from Harvard and Stanford to the Consortium 17 have made praiseworthy progress among some segments (Asians, internationals), but insubstantial progress in others.
"While many top programs boast that ethnic or racial minorities comprise a quarter or more of their student bodies," the Journal's Melissa Korn wrote, "most of that population is Asian-American, a group that is statistically overrepresented at business schools when compared with their proportion of the U.S. population at large." Among blacks, Hispanics and Native Americans, the numbers are still low, she reported, "a sign, some say, that b-schools have much more work to do to attract students."
So what's the trend? In what statistical rut are business schools mired? At some schools, why have there been disappointing trends in URM applications?
The Journal reports that many of the top schools promote proudly the fact that in recent years in any given class, minorities make up over 25 percent (over 30 percent at many schools). Yet for under-represented minorities (excluding Asian-Americans), the percentages hover near 10 percent and below with little discernible improvement over the past several years.
The Journal and others, therefore, refer to "degrees of diversity." Certain ethnic groups, nationalities, and geographies are well-represented. Other groups are not.
Take a peek at recent numbers. Almost all top-tier business schools provide updates and class profiles and report the information in a similar manner, which makes for fair comparisons. Some schools, such as Yale and NYU, report the percentages of both minorities and under-represented minorities. Minorities (U.S. residents only) comprise 25% of last year's first-year class at Yale (SOM). Under-represented minorities (blacks, Hispanics and Native Americans), however, consisted of only 7% of the class. At NYU, the percentages were 34% and 16%, respectively.
Consortium CEO Peter Aranda was interviewed in an accompanying Journal article about the same topic and challenge. "(Business schools) have a role in preparing future business leaders to succeed in the environment we live in, where someday soon everyone will be a minority," he told the Journal's Korn. "One of the things that troubles me about the MBA curriculum is that it pays attention to diversity from an employment perspective only. We need to look at diversity as a strategic initiative. How do we develop goods and services for niche markets? How do we communicate through marketing vehicles that resonate with those communities?"
The original article touched nerves and attracted a flood of comments, many from anonymous readers making careless, insensitive statements regarding the value of diversity. Some readers harshly criticized business schools for bothering to make it priority. Some respondents swore off diversity and wished people would stop the discussion or apparent obsession. Aranda explained why businesses must care.
The deans of the same prominent business schools might admit among themselves that a whining chorus of anti-diversity makes it harder to improve statistics. Many in this chorus prefer business schools to admit solely on the basis of GMAT and GPA scores and let the numbers and percentages fall where they may. To their credit, the schools' admissions offices remain steadfast in their effort to "compose" a class of excellence, competence, diversity and variety.
The diversity challenge also incorporates business schools' ongoing struggle to ensure women are sufficiently represented on campus. Whether it is women or URM, some schools see progress in some years only to see a sudden, inexplicable downturn in other years. Many schools are not quite sure whether success is a 50-50 male-female ratio or success is ensuring the percentage of women never falls below 30%. At UCLA, NYU, Dartmouth and Yale (all Consortium schools), women comprised at least 33% of recent classes. At Harvard, 40%; at Columbia, 35%.
But two weeks ago, a Wall Street Journal article suggested that for many schools it's a one-step-forward, two-steps-back effort. Graduate business schools from Harvard and Stanford to the Consortium 17 have made praiseworthy progress among some segments (Asians, internationals), but insubstantial progress in others.
"While many top programs boast that ethnic or racial minorities comprise a quarter or more of their student bodies," the Journal's Melissa Korn wrote, "most of that population is Asian-American, a group that is statistically overrepresented at business schools when compared with their proportion of the U.S. population at large." Among blacks, Hispanics and Native Americans, the numbers are still low, she reported, "a sign, some say, that b-schools have much more work to do to attract students."
So what's the trend? In what statistical rut are business schools mired? At some schools, why have there been disappointing trends in URM applications?
The Journal reports that many of the top schools promote proudly the fact that in recent years in any given class, minorities make up over 25 percent (over 30 percent at many schools). Yet for under-represented minorities (excluding Asian-Americans), the percentages hover near 10 percent and below with little discernible improvement over the past several years.
The Journal and others, therefore, refer to "degrees of diversity." Certain ethnic groups, nationalities, and geographies are well-represented. Other groups are not.
Take a peek at recent numbers. Almost all top-tier business schools provide updates and class profiles and report the information in a similar manner, which makes for fair comparisons. Some schools, such as Yale and NYU, report the percentages of both minorities and under-represented minorities. Minorities (U.S. residents only) comprise 25% of last year's first-year class at Yale (SOM). Under-represented minorities (blacks, Hispanics and Native Americans), however, consisted of only 7% of the class. At NYU, the percentages were 34% and 16%, respectively.
Consortium CEO Peter Aranda was interviewed in an accompanying Journal article about the same topic and challenge. "(Business schools) have a role in preparing future business leaders to succeed in the environment we live in, where someday soon everyone will be a minority," he told the Journal's Korn. "One of the things that troubles me about the MBA curriculum is that it pays attention to diversity from an employment perspective only. We need to look at diversity as a strategic initiative. How do we develop goods and services for niche markets? How do we communicate through marketing vehicles that resonate with those communities?"
The original article touched nerves and attracted a flood of comments, many from anonymous readers making careless, insensitive statements regarding the value of diversity. Some readers harshly criticized business schools for bothering to make it priority. Some respondents swore off diversity and wished people would stop the discussion or apparent obsession. Aranda explained why businesses must care.
The deans of the same prominent business schools might admit among themselves that a whining chorus of anti-diversity makes it harder to improve statistics. Many in this chorus prefer business schools to admit solely on the basis of GMAT and GPA scores and let the numbers and percentages fall where they may. To their credit, the schools' admissions offices remain steadfast in their effort to "compose" a class of excellence, competence, diversity and variety.
The diversity challenge also incorporates business schools' ongoing struggle to ensure women are sufficiently represented on campus. Whether it is women or URM, some schools see progress in some years only to see a sudden, inexplicable downturn in other years. Many schools are not quite sure whether success is a 50-50 male-female ratio or success is ensuring the percentage of women never falls below 30%. At UCLA, NYU, Dartmouth and Yale (all Consortium schools), women comprised at least 33% of recent classes. At Harvard, 40%; at Columbia, 35%.
What are the ongoing problems and challenges for business schools? Why has there been this statistical rut among URM? What can business schools do to encourage more applications?
1. Convincing URM of the value of an MBA. MBA candidates must address a list of introspective questions before they launch the long process to apply and get admitted to a top school: Do I need an MBA? How I can use it to reach certain professional goals or achieve success in business? Can I pursue the same goals without it or with other degrees or certifications (JD, CPA, MS, or CFA)? Can I gain similar knowledge in other ways (other graduate courses, part-time programs, online programs, in-house corporate training)?
Business schools seek to convince women and those from URM that the MBA has long-term (or life-time) value and is worth every bit of pain it takes to apply, get in and get out. Sometimes schools stumble and fail to get candidates to apply. The numbers show it, as applications from URM groups haven't increased significantly over the years. Moreover, all candidates (especially those from URM) wrestle with other troubling factors (salary loss, opportunity costs, relocation, getting reacquainted to rigorous academic study), factors that undermine any value they determine the MBA has.
2. Convincing URM there will be opportunities after graduation and a fair chance to pursue them. Most candidates who apply to top schools understand the difficulties of getting admitted, the chores in preparing and submitting applications, and the tough course load. Applying to Dartmouth, Chicago, Northwestern, Stanford or Virginia business schools is an exhaustive process, although programs such as the Consortium and MLT make the process easier. Applicants study for the GMATs, arrange for recommendations from reluctant bosses, write a batch of essays about their career visions, and arrange for interviews, knowing the chances for admission at top schools is slim.
They know, too, business school at Michigan, Virginia, Dartmouth or Yale will be hard. The hours are long. Students have little down time. They don't know, however, if the hard work, time, strain and perseverance will pay off.
Those in URM groups don't want guarantees that an MBA from Cornell will win them six-figure entry-level spots at Merrill Lynch or McKinsey; they usually just want assurance there is a fair chance and reasonable opportunity that two solid years immersed in school will lead to something promising. Pursuing an MBA involves taking a risk. Candidates assess that risk in the same way they might assess an investment opportunity. If they perceive (as some minorities do in some industries, such as private equity, venture capital or hedge funds) they won't have a fair chance or they won't be able to establish contacts within those networks to earn a spot, then they will be less likely to apply.
This phenomenon is especially important when current economic times induce doubt in the minds of many who consider an MBA at top school: Why pursue the degree, when the chances of getting a job at Merrill Lynch, McKinsey, BlackRock or Blackstone are remote? Why pursue the MBA if I'm told it takes special ties and connections to get on board at Kleiner Perkins or Booz Allen? Or if I get the job, will a topsy-turvy economy force me out a year later?
3. Convincing URM that the sacrifices and costs are indeed worth it (or can be offset by fellowships or long-term rewards). The costs to attend a top school are exorbitant. Add to that the two years of salary, bonus and possible advancement the student won't accrue, while she is away from current employment. There, too, will likely be relocation, time away from family, and a lingering anxiety that they might have made a wrong decision.
For some, especially among URM groups, the costs (tuition, living expenses, and travel) are too much. They can't make the numbers make sense. Why, they may ask, should I pursue an MBA at Harvard, if I must move a thousand miles to Boston, find a place to live, and spend over $70,000 and then be engulfed in scrambling to pay back student loans for decades to come? Many outstanding URM candidates curtail all efforts to apply right at the moment they assess costs. The sacrifices and costs can't be rationalized.
Business schools and pipeline programs such as the Consortium, Toigo, and MLT have done an outstanding job over the past three decades helping candidates overcome financial hurdles--especially by providing fellowships, scholarships or other forms of financial aid. Often, believe it or not, many in URM groups are not even aware of this assistance and candidate support. Business schools perhaps can do a better job explaining to candidates how going to Emory, Carnegie Mellon or Chicago is affordable.
4. Convincing URM there will be realistic chances to advance far in business. Some justify the time in school and appreciate the contacts, knowledge, networks, and experiences during those two years. Some are confident they will do well and find lucrative entry-level opportunities once they get to where they want to go.
But many may have doubts about their chances to get far beyond entry levels, get promoted, be fairly recognized and advance to high rungs in an organization. If I get into Virginia or Michigan, they perhaps ask, and if I am fortunate to gain an offer in private equity, corporate finance, venture capital, or real-estate development, will I have fair chance to advance to the top--become a principal, partner, senior vice president, chief financial officer, or part owner? Should I bother, if I know the chances for advancement to the top are remote?
5. Convincing URM there are others like them who have succeeded. Often blacks, Hispanics, women and Native Americans gain confidence in their ability to advance when they see others like them achieve. If Hispanics and women are scattered at the highest levels at the most reputable consulting firms and banks, then Hispanic and women applicants would be encouraged to pursue graduate school--if they know others with similar backgrounds are there.
In some industries or segments of finance, women and minorities have advanced to the highest levels of management, but often at a slow, sluggish pace. Still, some women and URM have quietly ascended to less-visible, yet important roles as sector heads, corporate-function heads, subsidiary heads, or substantial contributors to business goals, deals, transactions, acquisitions, and new products. Potential candidates are aware of these achievements, but not as much as they should, at least sufficiently enough to be confident they can follow right behind.
6. Most of all, convincing URM they have the ability and aptitude. They hear and read about the suffocating workloads of students in top schools (the courses, the problem sets, the cases, the group discussions, the projects, and the exams). Sometimes they fear they lack ability and time-management skills to thrive in school. Often they have the academic breadth, experiences and backgrounds to do well, but aren't confident enough they can handle the work and time pressures. Hence, they shy away from applying.
Other factors may also have an effect on the number of candidates from URM groups and women.
1. International students. While business schools eagerly pursue diversity, they also pursue international students. They are devoting time and resources to both efforts. Notice the numbers in recent years of students from India, Europe and China. Schools sell themselves to prospects, recruiters and other professors and deans on the basis of diversity, geography and foreign flavor. In a recent year, at UCLA, NYU, Dartmouth, Yale, Wharton, Columbia, and Harvard business schools, foreigners comprised at least 32% at each school. While schools are pounding the pavement to increase the numbers of women and URM, they are also criss-crossing the globe to admit international candidates.
2. The lure of other professions. There remains the possibility that lagging growth in applications among women and URM is due to the attractiveness of other professions. Business, finance, marketing and the uncertainties or whims of corporate life may be less attractive to some than, say, positions in government, education, non-profit activity, medicine, or law. A financial crisis in recent years certainly has discouraged some candidates from pursuing careers in banking, finance, and capital markets.
The admissions offices at business schools at times feel they are panting while climbing a steep uphill path. They continue their efforts, nonetheless. They are rewarded when they observe the thrilling success stories of the women, blacks, and Hispanics who do find their ways into the corridors of Cornell, Carnegie Mellon, Wisconsin, Indiana, Michigan or USC.
They applaud themselves (and the pipeline programs that climb side by side with them) when they learn their URM applicants-turned-students go on to become campus leaders and eventually outstanding deal-doers at Morgan Stanley, investment researchers at BlackRock, financial managers at American Express, business managers at John Deere, managing directors at Goldman Sachs, CFO at Eli Lily, or president of a blazing new start-up.
Tracy Williams
See also:
1. CFN: Diversity and Venture Capital, 2011
2. CFN: Diversity, Top 50, 2012
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