(R) Alternative Investment Opportunities – Bulgarian Capital Market

http://hedgefonder.nu/2012/04/bulgarian-capital-market/

(I) Interview for wall-street.ro

Romanian: http://www.wall-street.ro/articol/Piete-de-capital/119319/reteta-vecinilor-bulgari-pentru-dezvoltarea-bursei.html

English: http://download.bse-sofia.bg/Interviews/GBulgarski_wallStreetRo.pdf

(C) Resurrection on the Bulgarian capital markets, a matter of action not time!

Quite often I am asked “When will there be a resurrection on the Bulgarian capital market?” Well, this a fortunetellers’ type of question I dislike a lot. It is much more meaningful to search for an answer of the question: "What should we do in order to have the resurrection?"

To see recovery of the capital market we need to necessarily have efficiently working economy, for which in turn we need investments in education, R&D and efficient capital flows to sectors with high added value.

We need to immediately adopt solutions to the educational collapse. This applies as well to the participants in the financial and capital market and their attitude to their customers. In the medium term, we should propose solutions to mitigate the negative effects of the demographic shock. The financial system must perform its default "sanitizing" role in the economy by allocating resources in meaningful and economically efficient projects. It is high time we eventually reduced government participation in the economy and rationalized the activities of the public administration.

The implementation of such measures in parallel with strengthening and improving the infrastructure of the capital market will be a prerequisite for recovery of the capital market.

(C) Asset management for the so called Silver Fund (Fund for sustainable retirement system)

Bulgaria is one of the fastest aging nations in the world. Ensuring sustainability of the pension system is impossible through deposits with the central bank, yielding less than one percent annually. It is natural to expect higher returns from instruments with higher risks than deposits, such as cash instruments, bonds and shares. The investment horizon of such funds is long; therefore high weight of shares in the portfolio is commendable.

Certain criticism regarding the fund's investment framework holds place though. The guidelines are rather restrictive regarding the maximum percentage allowed for bonds and cash instruments. There is lack of opportunity for investment in commodities and prohibition on investments in precious metals or certificates on them. The investment portfolio should be consistent with economic cycles. The current investment framework on the portfolio of The Silver Fund reflects understanding for a permanent rise in the economy, which is unrealistic. Every investment vehicle has their role in the different phases of the economic cycle. In order to get the rational yield of such a portfolio it is necessary to seriously review the limitations in Art. 13 of the regulating Act.

In addition to the legislator's desire to avoid investments in the local economy, in order to insure lack of "influence" by local agents, a meaningful continuation of this policy is to consider also the investments related to the Bulgarian economy. In this line of thoughts it is necessary to prohibit / restrict investments in economies that are highly correlated with the Bulgarian one, as well as, assets which are highly correlated with the local market (e.g. banks with subsidiaries in the country). Otherwise, we can observe a lack of diversification effect of international investment, as seen in late 2007 and early 2008.

(C) How can the businesses increase the growth of the economy?

The short answer to this question is by investing in projects with significant added value.

A thorough answer would require companies to reduce investments with low returns, especially those related to the import of inefficient pseudo-investment goods. Increasing the quality of products and services by investing in modern technology, human resources development and business-oriented RD&D departments are part of the dire needs of our economy.

One should not forget the long-term environmental effects. Apart from being investment in social prestige, the environmental friendly investments are for the benefit of all our children’s future.

To put it more plain language: It is irrational to buy unnecessary luxury cars, instead of production equipment; It is indeed commendable to place our children in top schools, however, this is not enough; The businesses should actively participate in the establishment of training and development programs with schools and universities – the professionals should be actively involved in the process of career shaping of the soon-to-be labor force. It is advantageous to invest in the development of technology rather than import outdated ones.

It is necessary to realize that long-term conservation of the environment is tantamount to survival - survival for people as human beings, as our business, as the world we know it. If the discussion about global warming holds certain empirical resistance, the discussion about the disastrous ecological "advent" oppressing all of us: customers, employees and capitalists, is soon about to be outrun by the "advent" itself.

(G) Invitation to the Economist debate on Financial Innovation

I would like to invite my readers to the Economist's debate floor where the Investment Giants of the World hold discussion on Financial Innovation.

A solid high profile debate on Financial Innovation.

(C) “Financial risk insurance – a hedge vehicle to consider” OR “Get rid of the unnecessary risks”

A fundamental principle of the business management is assumption of only the business inherent, core risks. The financial loss insurance is a kind of a hedge instrument, which could be used to transfer credit and counterparty risk to third parties – insurance companies.

Once the risk assessment has been properly conducted, the rational pricing and meaningful diversification have been employed, such vehicles could be rather useful to the real economy. A deeper transparency in the economy comes as a second order effect if such products become widely recognized.

In parallel with the advantages of such instruments, several characteristics should be properly assessed: are there adequately tailored products for the emerging Bulgarian market; are there qualified actuaries and insurance brokers who have an excellent understanding of credit risk and counterparty risk; are the insurance premiums competitive compared to other financial products that could transfer those risks onto third parties?

(C) Markets’ challenge – the EU budget deficits

A glimpse of the macroeconomic map of Europe reveals traditional governance mistakes, in particular – inefficient, leftish policy in the so coined by myself “Latin” Europe.

It is impressive, how the countries from this region bear significant current account deficits, inefficient labor force, which comes hand-in-hand with higher unemployment, relatively lower GDP per capita and chronically lower GDP growth. The same “Latin” EU and Eurozone members, finance their inefficient social, or even socialist policy with fiscal expansion, through budget deficit, compensated by government debt, at relatively higher yields.

The government purchases multiplier, at which such policies are probably targeted is higher than one, only in efficient economies, which create, instead of destroy value.

As it seems the fiscal expansion has not yielded benefits as of today, and would probably not ignite the EU engine soon and at meaningful speed. Furthermore the generated to date monetary and fiscal liquidity remains frozen, by regulatory fear and bad loans hike anticipation, in the veins of the banking system.

The equity markets are not expected to benefit on the above factors. On the other side, as long as, we enjoy trust in the EU economy, the government debt markets will continue pleasing the “Latin” Europe debt investors. The divergence in the yields between Northern and “Latin” Europe will be attractive for short-long and global macro hedge-funds betting against the Euro.

(C) GDP growth for 2009 revised upwards from negative 6% to negative 4.9%. So what…?

The Ministry of Finance has recently announced upward revision of the 2009 GDP growth from -6% to -4.9%. Having in mind that 2009 is practically over, there is high probability that the ministry of finance is rather close to the real numbers. The discussion, however, should not be on the topic of “projected change in any number related to the economy”. The human inability to forecast has been rebutted empirically and the debate on forecasting, currently remains a discussion topic only in the evening classes of a third-world, vocational schooling.

The focus of the council of ministers, their aides, the financiers, the economists, the businessmen and all the individuals, should be the development of conditions favoring a sustainable economic growth, namely: diminishing role of the proved inefficient state interference in the economy; development of attractive conditions for efficient foreign direct investment, which add value in the economy; technological development, to improve the exportability of the Bulgarian goods and steps for drastic improvement of the educational and intellectual value-added, hence the value added in the products and services the country offers.

Gazing too long and too much into historical or forecasted data, I am afraid we continue neglecting the fundamental role of the above mentioned factors and continue working against our economic interests.

(G) Common Sense - Ad iudicium

It has been long time now, that I have had the feeling my blog's title does not correspond to its content. Today I have decided to get rid of this embarrassment by ... changing my blog's name.

The feeling I desire to render is the one of "Common Sense" - Ad iudicium (lat.), or rather of making decisions based on common sense.

I want to move the focus out of any geographical, theoretical and even practical framework, to our most loyal assistant - our Common Sense, which we often reject to consider...

Ad iudicium!

(C) The banking system - the backbone of the molluscous economy

As in the everyday lives, in the economics and finance a misfortune never comes alone.

The genesis of the economic crisis caused by the irrational expectations of the economic agents has been aggravated by the financial system. The Bulgarian banks, in parallel with their foreign counterparts, stimulated exuberant expectations of a narrow range of economic sectors, achieving impressive levels of industry concentration. A significant portion of the credit exposures are to capital-intensive sectors with little if any value added, which, although regulatory different, is in fact equivalent to financing the acquisition of tangible fixed assets. At present, the boomerang of the irrational credit boost returns in the courtyard of the banking system dressed in bad loans.

By analyzing the interest rate levels many borrowers and analysts remain with the initial impression that banks pile up huge profits from interest rate spreads. Despite its seemingly good capitalization and hardly secured liquidity, the banking system has generated almost threefold increase in bad credit exposures for the first three quarters of 2009. The former, after provisioning, reflects extremely negatively on the performance of banking system.

The higher risk levels, the economy vulnerability, the businesses and financial system recession fears, supplemented by the over-reaction of the financial regulators on liquidity and capital adequacy issues, may push the global economy into a global liquidity trap. Facing serious issues with new revenue generation, reaching an endogenous limit for liability increase and reporting swelling classified exposures in the loan portfolios, I personally expect banks to continue to report deterioration in their portfolios until the prices of assets serving as collateral become attractive to investors in distressed assets.

(C) Economy in the shade of recession

World & US

The two major engines of the world economy are the USA and China. We should expect the first sings of recovery for the European economies from overseas. Despite the slight recovery of the consumer price index in the US since March 2009, it stays within the critical 50 range and even worsens in October. The producer prices also demonstrate uncertain direction. The main contributor to the PPI in Q2 and Q3 of 2009 are the energy resources. Considering the seasonality of the energy products, their rising demand and prices should not be taken as a serious signal for economy recovery, at lease at this stage.

The US expansionary monetary policy, aimed at economy restart, leads to serious dollar depreciation. I start to feel that the inflated into the banking system money has gained critical mass and is about to burst back into the economy through production and consumption. The continuous US sales tax decline, though hints at little backing from the consumption … yet. Additionally, the low levels of savings would barely influence the GDP growth, so no much support from that side is expected, as well. The two significant, outstanding questions for the US economy recovery remain the unemployment rate and the ability of the Fed to counter potential inflationary pressure.

Europe

The above discussion most probably suggests a continuing euro appreciation, which in turn will make the EU exports less price competitive. Furthermore, under the overreaction of the European financial regulators, huge amounts of liquidity remains clogged into the financial institutions. The relatively higher savings rate in Europe, presumes higher spending, however, the recession fears still refrain the consumers to spend. As long as the bank financing does not resume, I would not expect neither the investments, nor the consumption in Europe to restart the European economy engine. The September industrial production data for Europe is more of a blast from the bottom after protracted submersion, rather than significant indication of recovery. To sum up - before the second half of 2010 it would be premature to talk about the recovery of the European economy.

Bulgaria

Amid the absence of independent monetary policy in Bulgaria, the growth in the economy remains significantly dependent on foreign direct investment (FDI). The FDI data for the latest quarter are not encouraging at all. The government is quite limited in encouraging expansion through fiscal measures, considering the budget havoc and the reduced opportunities for debt issuance. Moreover, this is hardly a way to wake an economy, with inherent inefficient bureaucracy. The lack of a competitive economy and added value through human resources makes Bulgarian exports uncompetitive, especially with the expensive euro, to which the lev is tied. The two factors that have previously supported the country's GDP had shrunk under the influence of drastically limited incoming capital flows and the growth of savings, which has reached its limits. The most plausible winch to pull the sinking cart out of the recessionary quagmire remains the foreign investments.

Attracting direct investments depends both on the economy cycle and policy led by the Bulgarian government and central bank. If the foreign investors give credit to the policy of the GERB government and the mother banks, rather than withdraw from, inject resources to their local branches, it is likely that by the end of 2010 we shall have witnessed the revival of the Bulgarian economy.

However, we should take into account the significant delay in the reflection of economic cycles in developing economies, compared to developed ones with approximate lag range of six to eighteen months. This in turn means that if the developed economies are up and running at the end of 2010, it is more likely that our economy may wake up after one more winter hibernation.

(I) FRM Exam

To my dear readers:

Hope you'd excuse my 25 days of FRM lethargy.
Promise to get back after 21 Nov 2009.

Yours,
Georgi I. Bylgarski

(C) Subsidy of last resort

Recent claims for waving social security dues of exporting companies have been really meaningful for the companies suggesting those leftish measures. Any consideration of such ideas though would raise significant array of questions with contradictory answers.

Why the government should stimulate the exporting sector? Should the state subsidize other strong exporters such as the energy sector and air traffic services? Do we need to stimulate the ubiquitously incompetent tourist sector as well? Why not pay unemployment compensation and see the truth of the hidden unemployment, but subsidize via social security payments veto? Are the about-to-be-subsidized companies efficient enough for the taxpayers’ money to be diverted to their support rather than invested in infrastructure, human resources development or research and development? The proposed measure is a delayed detonation or solution for the inefficient producers? Why not invest in broadening international commercial relations and help the exporters this way?

With such a broad array of issues, one remains pretty hot to me as an investor: Does the state possess potential to offer long-term economy growth?
Paraphrased: Does the government’s capacity suffices road maintenance instead or clear vision for new “economy highway network”?

(C) Shares repurchase during crisis. Brave or Naive?

When a company thrives in liquidity and lacks enough profitable projects at the same time, a shares buyback seems a logical decision. On one side this signals to the investors, that the management is confident in the company’s development. On the other side, the investors should have a rational explanation of the reason why the company refrains from acquisitions during crisis, when businesses and assets are way undervalued. Crises offer this rare opportunity to buy “cheap” and extend market share.

My personal opinion is that during crisis the companies with liquid assets at hand should invest in talents’ development, market share expansion and capacity building, since those three would yield the greatest long term return for the shareholders.

Companies’ management should bear in mind that all the investors adjust the results for one-off effects, such as upward valuation of own shares, which should not add much of a benefit to the company fundamentals. Further on, the management should have a clear strategy on selling back to the market at economy rebound. A buyback with one only aim of price support could hit adversely the liquidity ratios of the company and hamper its recovery once the business cycle reverses and higher liquidity needs arise. Additionally, the shares liquidity could be negatively affected by the decreased free-float due to the shares repurchase.