CategoryMutual-Hedge Funds

Harvard’s Big Bath

We are all familiar with the notion of a bath in our communal lives, but the term “big bath” is equally common in the corporate world. Big Bath is an earnings management technique whereby a one-time charge is taken against income in order to reduce the value of an  assets.  This technique is often employed in a bad year, e.g., when sales are down, or when a company reports losses, to account for overvalued assets on the balance sheet.

Although the process is discouraged by auditors, it is frequently used by public companies. A notable feature surrounding big baths is that this accounting treatment tends to coincide with new management team because the new management team can then blame the one-time charges on the prior management team while simultaneously calibrating current reported income to unusually low levels thereby making it easier to meet or beat income in future periods.   

Big Bath in Non-profit Sector

Does Big Bath happen in the non-profit sector? Bien sûr!

 Harvard University has the largest endowment fund in the world with assets around $37 billion. The new chief of Harvard University’s endowment, Narv Narvekar, actively pushed to slash the value of some of its investments in natural resources portfolio of forests, farms and vineyards given his bearish outlook on some of the assets. Although Harvard University has the largest endowment, it was the only Ivy League endowment which generated less than 10% in the most recent year, which is why there was a “change of guards” at fund management level.

New endowment chiefs often have an incentive to write down investments they inherit because it is easier to blame the losses to the prior investment chief. It also helps remove potentially overvalued assets. Mr. Narvekar described Harvard Management Co. as having “deep structural problems” that would take five years to restructure. “An honest, reflective, and clear-sighted recognition of these problems is the first critical step towards generating solutions,” he wrote in his first annual letter in September, 2017.

Under Mr. Narvekar, Harvard reduced the value of its natural-resources investments by more than 25%, which is an unprecedented amount of a write-down (Harvard had valued the portfolio at roughly $4 billion at the end of the prior fiscal year).

Big Subjective Decisions

Many asset managers and appraisers say valuing assets that trade infrequently or aren’t generating cash—trees, for example, take years to grow before they can be sold for timber—is difficult. However, the new chief investment officer indicated that some natural-resources investments carried more risk than previously calculated. Therefore, he raise the discount rate (because the risk was high), which caused some investments to lose value.

Valuations for the endowment’s private assets were approved by the board, reviewed by Harvard and “the valuation process was independently verified by external auditors,” board Chairman said in a statement.

Big Pay Day

Harvard has guaranteed Mr. Narvekar at least $6 million a year for his first three years on the job. Additionally, the Chief is expected to earn additional performance-based compensation which is expected to be closely tied to the endowment’s performance in the long term.

When a non-profit sector mimics the pay of the for-profit sector in order to generate high future returns on the largest endowment fund!

January 25, 2018

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Slumdog Millionaire May be a Destiny

For the year 2017, a well-diversified portfolio consisting of US public companies generates returns anywhere between 4% and 8% (S&P MidCap 400 gained 4%, Dow gained 6%, S&P 500 gained 8%). Quite impressive.

What about a more aggressive investor, or a more flamboyant hedge fund manager, seeking even bigger alphas/returns? Is there any country offering bigger equity returns than the US equity markets? Much of continental Europe generated relatively modest returns for the year 2017. While emerging markets may be more promising, the returns were no better than the US. Key indices in China and Brazil are up between 4% and 8%. Given the risk, the US seems a much safer bet.

There is one emerging market, however, that stands-out in 2017. India has outperformed most developed and emerging markets. Most key indexes in India are up more than 11%.

You Are My Destiny: Slumdog Millionaire

  • Roughly, half of India’s 1.2 billion population is under 25
  • The country, especially parts of the south, west and north, is entrepreneurial
  • While educating billion people remain a daunting task, much of the Indian population understands the value of good education
  • Low oil prices have been a blessing because India imports nearly 80% of its oil to sustain growth
  • In 2014, Modi, the leader of the conservative party, captured the imagination of Indians because his economic vision is tied to domestic investments and he intends to attract foreign investments by removing various barriers to foreign capital and by pledging to eradicate corruption.

Despite the promise of tomorrow, there is no denying that India today remains a poor country. Even relative to the other BRIC countries, its per capital GDP is about half of China and a third of Brazil.

World Bank Sings Jai-Ho for the Bengal Tiger

The World Bank projected the Indian economy to expand at a rate of 7.8% this year and 7.9% over the next two years. The continuing slump in prices of oil, which is one of the major imported commodities in India, had a significant effect on the Indian economy over the past one year. The Bank said: “In contrast to other major developing countries, growth in India remained robust, buoyed by strong investor sentiment and the positive effect on real incomes of the recent fall in oil prices .”

The World Bank estimates India’s growth projections to be higher than that of the Dragon Warrior. The Bank expects Chinese GDP growth to be around 6.5% over the next two years. Brazil and South Africa, the two other BRICS countries, are embroiled in major corruption scandals involving their leaders, which injects enormous uncertainty for investors. Russia seems determined to inject global anarchy into the world while disregarding the welfare of its own citizens.

Domestic Consumption

A distinct attribute propelling India’s economic growth is its appetite for domestic consumption. According to Adrian Lim, a Singapore-based investment manager with Aberdeen Asset Management, which manages $11.5 billion of assets in India, “India is being seen as a relatively resilient place to invest because quite a bit of the economy is driven by domestic consumption.” Moreover, Lim asserted “More than two thirds of the stocks listed (on the Sensex) are driven primarily by domestic demand, something you can’t see on the Chinese benchmark.”

India’s stocks reached a new highs recently powered by foreign funds. India’s bellwether S&P BSE Sensex broke a two-year-old closing record Monday as it rose to end trading at 29,910.22.

Exposure to India

How can US investors play India?

Consider investing in one of the top 5 India-based ETFs, as per the US News and World report (

#1                 iShares MSCI India                                                 INDA      $5.11 billion in assets

#2                 VanEck Vectors India Small-Cap ETF         SCIF         $0.32 billion in assets

#3                  IShares MSCI India Small-Cap                        SMIN       $0.19 billion in assets

#4                  PowerShares India ETF                                       PIN           $0.26 billion in assets

#5                  Columbia India Consumer ETF                       INCO      $0.12 billion in assets

The U.S. News Best Fit ETF rankings are designed to help long-term investors evaluate and compare the structure of exchange-traded funds. Since all ETFs are intended to track an underlying index (for a variety of equities, or the price of a commodity, for example), the rankings aim to identify large, liquid funds that perform reliably. The report also compares funds’ costs and the fund’s level of diversification and success in tracking its index. We discuss each of these measures in depth below.

Consider playing Danny Boyle’s Slumdog Millionaire!

Finland, June 8, 2017

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Hamiltonian Hip Hop: Broadway to Wall Street

Giddy up! At more than 21,000, the Dow Jones Industrial Index has soared by 1,200 points or about 13% since January 2017. If you consider the run-up since February 2016, the stock market has delivered a staggering return of about 30%. The stock market has been on the best winning streak in 25 years.

One fundamental reason for the stock market rally is linked to the growth of Exchange Traded Funds, or ETFs, as retail investors have poured in $124 billion into this type of an investment vehicle in 2017 alone.

State Street Corp.’s SPDR S&P 500 ETF is the market’s oldest, largest and the most-traded security in the world.

Love Thy ETF

Introduced in 1993, ETFs, or Exchange Traded Funds, trade on an exchange like stocks. An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike actively traded mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold.

ETFs typically have lower fees than mutual funds, making them an attractive alternative for individual investors. Shareholders do not have any direct claim on the underlying investments in the fund, instead, they indirectly own these assets.

According to research firm XTF, there are around 1,800 ETF investment vehicles holding stock worth more than $2.7 trillion. There are no SEC rules governing ETFs which means ETFs are regulated via mutual fund regulation. Just three firms

—     BlackRock Inc.

—     State Street Corp.’s State Street Global Advisors

—     Vanguard Group

manage 80% of ETF assets.

ETF vs Actively Managed Funds

  • ETFs try to track the performance of a particular market benchmark, or “index,” as closely as possible. In contrast, Actively Managed Funds (AMFs) try to outperform their benchmarks and peer group average.
  • ETFs buy all (or a representative sample) of the securities in the benchmark, while AMFs combine research, forecasting, and experience/expertise of a portfolio manager or management team.
  • Index funds tend to be more tax-efficient and have lower expense ratios than actively managed funds because they trade less frequently than AMFs.
  • Although AMFs attempt to beat the market, quite often they may also miss their targets which results in losses for the funds’ investors. In contrast, ETFs are only undertaking the underlying risk of the market benchmark.
  • Most importantly, AMFs typically charge between five and twenty-five times what ETFs charge their investors.

Not surprisingly, the pace of ETF inflows bodes negative news for asset managers. Investors have started pulling their investments from AMFs to ETFs. The largest providers of ETFs have started reducing management fees to attract even more funds. The average annual fee of ETFs bought this year is only $23 for every $10,000 invested, sharply lower than last year. Some ultralow-cost iShares Core funds cost as little as $4 a year for a $10,000 investment, which is can be about 1/25th fraction of the fees charged by most mutual funds.

Given the low-cost structure of ETFs and the raging bull market, $7.5 billion has moved into the iShares Core S&P 500 ETF and $5.4 billion into the Vanguard S&P 500 ETF in January 2017 alone!

Hamiltonian Hip Hop and ETFs

Lately, the US stock market has generated staggering returns unmatched by almost any other country. Take for instance the returns generated from an investment in S&P 500 stocks in the last eight years.

  • 2009                26%
  • 2010                15%
  • 2011                2%
  • 2012                16%
  • 2013                32%
  • 2014                14%
  • 2015                1%
  • 2016                12%

If you invested in the S&P 500 from 1928 to 2014, the per annum compound rate of return was 9.8%. Thus, if you invested $100 in 1928, your nest egg would become $346,261 in 2014.

Join and celebrate the US goldilocks economy and consider becoming an ETF shareholder.

Vermont, February 10, 2017

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Van Guarding your Assets: US Market The Best Bet

sp_chartThe annual return for investing in the U.S. stock market over the last 50 years has been around 7-8%. How can one explain this remarkable growth in the U.S. stock market? The Sage from Omaha, Warren Buffett, has a lucid and precise response. The U.S. economy, as measured by gross domestic product (GDP), has been growing, and is expected to grow, at an annual rate of about 3%. The inflation is about 2 to 3% which pushes nominal GDP growth to 5-6 %. Stocks pay about 1-2 % of dividend which increases the growth rate to about 6-8 %.

If you were fortunate enough to have invested during the bull market, i.e., 1982 to 1999, the S&P 500 Index, a common benchmark for U.S. stocks, would have crowned you with returns of about 18 percent per year. You surecannot beat these numbers unless you happen to be the humanitarian George Clooney with the reliable Ocean’s Eleven to back you up!


So where is the risk if you make 6-8% each year when the period is dull and about 18% during the bull period, which is no bull.

While these numbers are average returns, for some decades you could have easily lost money (e.g., 1970s and 2000s). Sadly, more than half the adult American population gets deprived of the “vintage bourbon” offered by the US equity market. Only 48% of adult Americans have a claim on the returns offered by the US stock market, which is such a travesty. A considerable majority has foregone the benefits of the goldilocks economy.

The Best Bet

The stock market remains the best bet for growing and preserving your financial assets. If you invested in Certificate of Deposits (CDs) with banks, you would earn about 7% in the early 1990s and about 1-2% in the last 5 years. If you invested in government bonds, which is only possible via an authorized stock broker, you would have earned between 2 and 6% in the last 30 years. If you had invested in AAA corporate bonds, you would have earned between 3 and 6% per year.

Clearly, the US stock market offers the best returns in the long run with very little risk when the investment horizon is sufficiently long.

The Van Guard(ing) your Assets

The million-dollar question for your million-dollar investment is what stocks do you pick or what fund/portfolio-manager do you choose?

The relatively safest and least costly method is to pick an index mutual fund. Instead of hiring fund managers to actively select which stocks or bonds the fund will hold, an index fund buys all (or a representative sample) of the securities in a specific index, like the S&P 500 Index. The goal of an index fund is to track the performance of a specific market benchmark as closely as possible, which is why index funds are also referred to as a “passively managed” fund.

The all-time favorite financial company offering index funds happens to be Vanguard Group because they charge very little commission or administrative fee for managing your assets. Vanguard’s 500 Index Fund started business with $11.3 million in assets. Today, the same fund holds more than $252 billion, i.e., the Fund’s assets grew by around 23,000 times.

By investing in the Index Funds like the S&P 500, you must calibrate your expectations. You should not expect staggering returns from investing in a few darling stocks like Tesla or Amazon or Apple. Why? Because those are much riskier bets. You sure make money when the market loves those stocks, but you could also lose your shirt when the market turns its roving eye towards other more attractive beauties. By investing in the Index Fund, you have committed yourself to getting whatever returns the market offers which, in this case, happens to be returns on the S&P 500 index.


Some would advise that you seek “alphas” by investing your money in hedge funds or mutual funds choreographed by “superstar” portfolio managers. While this seems like an attractive proposition, chasing these types of funds or portfolio managers can be akin to making a million through lotto tickets. The odds are heavily stacked against you; you might as well give your money to some charity.

There is another caveat. Superstar managers and high profile mutual funds will charge you a bulky administrative fees (> 1%). In addition, you must pay about 20% performance fees, especially to hedge funds.

Possible because of the realization that it is impossible to beat the market consistently over the long run (academics have been saying this for more than 30 years), or for the fear of paying exorbitant fees, index funds have grown in astounding popularity. From their start at $11 million in 1976, index funds grew only to $511 million by 1985, and thereafter expanded more than 100-fold over the next decade to $55 billion in 1995. Their assets hit $868 billion by 2005, and the future still looks very bright so you need wear shades.

Are you ready to invest in the stock market and Index Funds to help grow your financial assets. It sure beats any other form of legitimate financial investment.

Chatham, September 20, 2016; 11A

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How Mobil(e) is ExxonMobil?

Losing Triple A Credit Rating

Losing Triple A Credit Rating

ExxonMobil Corp. had the honor and distinction of having a gold-plated AAA credit rating since the post WWII period. However, fortunes can change abruptly when one is trading products of mother nature. Last week, Standard & Poor’s (S&P) downgraded Exxon Mobil’s credit rating for the first time in almost 70 years from the coveted “AAA” rating to a “AA+” rating citing expectations of continuing low oil prices. ExxonMobil joins two other US companies with S&P AA+ credit ratings; General Electric Co. and Apple Inc. The two remaining US companies with the highest possible corporate AAA debt ratings are Johnson & Johnson and Microsoft Corp.

Exxon Mobil History

ExxonMobil is an American multinational oil and gas company based in Texas. It is the largest direct descendant of John D. Rockefeller’s Standard Oil Company. Exxon Mobil was formed in 1999 by the merger of Exxon (formerly Standard Oil Company of New Jersey) and Mobil (formerly the Standard Oil Company of New York). ExxonMobil is also the Fifth largest publicly traded company by market capitalization. ExxonMobil was the second most profitable company in 2014.

Downgrade Reasons

S&P stated that the “company’s debt level has more than doubled in the recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow.”

S&P also said that while Exxon made efforts to reduce capital spending, the maintenance of production and replacing reserves will ultimately require the company to spend more. Because the company is returning cash to shareholders, instead of building cash or reducing its debt, the company faces limits on credit improvements even when oil prices recover.

S&P cautioned that it could further lower its rating on Exxon if the company is unable to sufficiently adapt to a prolonged period of low commodity prices. The downgrade is not a complete surprise. In February, S&P downgraded rival Chevron Corp and warned that such a move was also possible for Exxon.

Shareholder Payments

ExxonMobil paid out $325 billion as dividend and share repurchases over the last 11 years which exceeded its outlays for new property, plant and equipment of $272 billion over the same period. During the fourth quarter of 2015, the company paid out $3.6 billion in dividends and share repurchases, which is more than it earned in that quarter.

In February, Exxon Mobil changed its strategy and declared that it would only repurchase shares to offset dilution, and not pay back cash as dividend.  

Why Repurchase Over Dividend

Many companies prefer stock repurchase over dividends. One explanation is accounting based therefore cosmetic and the second explanation is more economic.

Investors tend to focus on accounting earnings, mostly earnings per share (EPS), which is computed as net income divided by number of shares outstanding. When a company buys back (repurchases) its own stock, it reduces the shares outstanding and thereby increases its EPS. This type of an increase in reported EPS is cosmetic (nip and tuck). Shareholders care about the pie (earnings) and not how the pie is being shared (EPS). So stock buyback initiated to increase EPS is a akin to a magician’s show intended to circumvent reality.

The advantage of stock buyback is that it is a one-time cash payout unless the company elects to announce future buybacks. Dividends, on the other hand, are more permanent in nature and investors expect continuation of dividend payments when one is announced. Therefore, companies wanting to preserve future cash prefer stock buyback over dividend.

ExxonMobil wants to buyback stock to offset the stock price decline from declining oil prices. Given the low oil prices, it has cut back on its planned investments or production capacity. However, when oil prices bound back, it wants to preserve cash to fund its future growth which is why it prefers stock buyback over dividend.

Stock Price

ExxonMobil’s stock price went down from a high of around $103 in 2014 to a low of $72 in 2015. The stock is back at around $90. With oil prices trending up, we can only expect ExxonMobil’s stock price to continue its upward trajectory.

Chatham; June 11, 2.11P

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Dragon Versus Tiger: A Growth Slugfest

india-chinaBased on World Bank estimates, India’s economy grew by 7.3% in 2015, which was higher than every other major nation including China. For the first time in more than 20 years, India recorded the highest growth rate in GDP. In sharp contrast, according to the numbers released by the Chinese government, China’ economy grew by 6.9% in 2015.

Asian Development Bank (ADB), a Manila-based multilateral bank, projects China’s economy to grow by 6.5% in 2016 and by 6.3% in 2017. Even with excessive monetary and fiscal stimulus, the consensus is that China’s average growth rate in the next five years is unlikely to exceed 6.5%. A more realistic expectation is that the growth is likely to be lower because of the weaker demand from major developed industrial economies.

ADB is predicting India to become the fastest-growing major economy.  The projected economic growth rate is 7.4% in 2016 and 7.8% in 2017  propelled by investments in the public sector and lower oil prices.   

Dragon Warrior Restrained

With a debt hang, housing glut, and excess capacity in factory production, Chinese officials are projecting tougher years ahead. Fears over a slowing economy and concerns over plunging oil and commodity prices have started to chip away into China’s phenomenal growth rate observed during the last decade.

China is transitioning from being an investment- and industrial-oriented economy into a consumption economy, which is a key indicator of a major developed and industrial economy. China’s government is expected to encourage this transition which bodes well for consumers in China. Nevertheless, the ever so competitive China might consider various ways to augment its growth by relying on deficit financing.

China’s stock market volatility is also likely to have some negative repercussions. The stock market observed a massive run-up followed by the gut-wrenching plunge, which reflects underlying uncertainty.

Tiger Unleashed

Bullish on India, the International Monetary Fund has projected a robust growth rate of 7.3% for 2016 and 7.5% for 2017. IMF welcomes India’s emphasis on public infrastructure spending, reducing subsidies, improving the labor and product markets, and enhancing the strengths of financial institutions. As one of the world’s largest oil importers, India has benefited from low oil and energy prices, which has been a major factor in propelling current growth and is a key factor in explaining future growth rates.

A key source of concern in India is that the country’s banks, especially the public banks, have a disproportionately high percentage of “bad debts” on their books which have yet to be written down. According to Reserve Bank of India, about 21% of all loans to large Indian companies were “stressed” as of June 2015, up from about 17% in September 2013.

The data on the growth rate in India must be taken with a pinch of salt and lots of spices. Most worldwide investors are often mistrusting of India’s growth numbers  because of the unreliable process by which data are gathered and assimilated. Therefore, the stock market may not reflect the renewed economic optimism as foreign direct investments may decline if institutional investors do not believe in the growth numbers.

For U.S. investors, both India and China continue to appear as attractive investment opportunities especially considering the weak growth rate in the US and Europe.

New York, May 5, 2016; 12.52P

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Kingdom Turns to Goldilocks Capitalism

the-oil-kings-9781439155189_hrThe Saudi royal family controls the world’s biggest oil reserves in Saudi Arabia. The riches from the black gold is the basis of the royal families’ power, influence, and legitimacy. The family is considering to take Saudi Arabia’s Oil Company (ARAMCO), which is a state owned enterprise, public. ARAMCO is one of the world’s most secretive oil companies which reveals almost no information on revenues and offers only limited information on its hydrocarbon reserves.

According to media speculation, Crown Prince Salman, who is the son of the current King and often considered the power behind the throne, made public statements about the sale of ARAMCO shares. The Prince claims that the IPO is being initiated to confront corruption and usher in transparency. In a monarchical autocracy, which is renowned for lack of democratic freedom and beholden to absolute power, it remains unclear how he intends to deliver on his promise.  

So the billion-dollar question is why consider an initial public offering (IPO) at all and then why now when the oil prices are rock bottom?


The value of ARAMCO is derived from its massive reserves of crude oil, which the company claims to be around 265 billion barrels. The cost of oil extraction is around $4 per barrel, which happens to be the cheapest exploration cost compared to the extraction cost anywhere else in the world.  In the United States, lifting that same barrel of oil could cost anywhere from $25 to $80 per barrel. The efficiency with which the Saudi company can extract oil is faster than any of its rivals. According to Forbes, ARAMCO can mine as much as 13.5 million barrels of oil a day, which equals 15% of the world’s daily oil needs.


If ARAMCO goes public, it is estimated to have a market capitalization as high as $10 trillion, which easily exceeds the market value of the world’s largest publicly traded energy company ExxonMobil. If ARAMCO were to float just 5% of its shares in an IPO, it would raise somewhere around $500 billion. Any IPO by ARAMCO would make history as the largest IPO in the world.

The investment banking industry must be doing the belly dance in anticipation. The standard IPO fee for an investment bank is 7%. Even for a 5% IPO of the oil company, an investment bank would collect around $35 billion.

Why Now?

The Economist writes that when they asked whether Saudi Arabia was undergoing a “Thatcherite revolution”, Prince Salman replied “Most certainly.” However, it certainly does not make obvious financial sense. Why cash-in on your hidden treasures and then do it when the price of that treasure is at a historic low.

Is there some rational reason for the colossal decision? Considering how deftly the royal family has managed to retain power for the longest period in the world’s most volatile region, the answer most definitely is yes.

So what is that hidden reason? Is the explanation for the IPO a financial, political or geo-political one? Only time shall tell the hidden story …… Until the story unfolds,  we can only keep guessing.

New York, April 29, 2016; 10.07P

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Mr. Minister and Malaysian Malaise

MalaysiaThe Swiss Attorney General’s office declared that approximately $4 billion has been misappropriated from state-owned companies in Malaysia much of which originated from the Malaysian State Fund, named 1MDB. Using a network of intricate financial transactions, more than $1 billion was transferred from 1MDB into the Malaysian Prime Minister’s personal bank account between 2011 to 2013.  

The Malaysian Attorney General who was investigating the illegal use of public funds concluded that the money transfer into the Malaysian Prime Minister’s private bank account was a legal donation from Saudi Arabia’s royal family. The Saudi government officials, however, have publicly denied making any such donation. In the meantime, the Malaysian Prime Minister continues to serve as the chairman of the board of advisors to 1MDB.

Why Swiss Authorities

Swiss Attorney General’s Office have found evidence of unlawful money transfers linked to 1MDB relying on the Swiss banking system. Swiss officials became interested in suspicious financial activities around 1MDB because of concerns that their banking system is being used to bribe public officials, launder money, and other criminal activities.

The investigators allege that funds were transferred into private accounts using a web of complex financial transactions with the help of two senior former officials of a state-owned Abu Dhabi company called Aabar Investments PJS. Abu Dhabi is the largest of the United Arab Emirate’s (UAE) seven member emirates. It is also the capital of UAE.

Malaysian State Fund

Malaysia Development Berhad (1MDB) is a strategic development company, which is wholly owned by the Government of Malaysia, established to fund strategic long-term economic development projects through global partnerships and foreign direct investment. 1MDB Fund began as a sovereign wealth fund under the name “TIA” to propel economic development of one of the states of Federal Malaysia. In 2009, the Malaysian Prime Minister broadened TIA into a federal entity and renamed the wealth fund as 1MDB. 

What Transpired

  • In 2009, Aabar Investments PJS, a state-owned Abu Dhabi company, pledged to help 1MDB acquire power plants and build a finance center in Kuala Lumpur. Aabar Investments PJS is a fully owned subsidiary of International Petroleum Investment (IPIC), an Abu Dhabi sovereign-wealth fund. IPIC guaranteed billions of dollars of 1MDB bonds.
  • In 2012, to facilitate illegal wire transfer, about $1.4 billion was paid to Aabar Investments PJS Ltd, which was a company registered in British Virgin Islands with a name similar to Aabar Investments PJS but additionally had the word “Ltd.” This company was created by senior former officials of Aabar Investments and IPIC.  
  • The money was then moved from Aabar Investments PJS Ltd to Tanore Finance Corp., which was also registered in British Virgin Islands.
  • Among other bank accounts, Tanore Finance Corp. holds bank accounts in Singapore and an account in a Swiss private bank named “Falcon Bank,” which is owned by Abu Dhabi sovereign-wealth fund. Falcon Bank had business dealings with 1MDB. 
  • Via these various interconnected accounts, Tanore Finance Corp was able to  transfer funds from its bank account in British Virgin Islands, to a bank account in Singapore, to another account in a Swiss private bank where names are concealed, and then eventually to the Malaysian Prime Minister’s personal bank account.

Corruption and Economic Development

Corruption involves the abuse of entrusted power for private gain. Because of the concentration of entrusted power in politics, the most outrageous cases of corruption involve high level politicians. According to a “Corruptions Perception Index” constructed by Transparency International, where 1 is the least corrupt country, Malaysia is ranked 54th in corruption and UAE is ranked 74th.  

Emerging markets and less developed countries must rely on reputation to attract much needed private and public funds to spur economic development. Therefore, the costs to society from corruption in these countries are disproportionately higher than wealthier countries. Yet, much too often, the most egregious cases of corruption are confined to poorer countries. Because of the massive benefits of corruption, there are few incentives to institute legal and enforcement structures to confront corruption in poorer nations, which in turn hinders economic development.

The vicious circle of corruption!

March 5, 2016; 1.48P–sector.html

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Abusing the Accounting Matching Principle

matchingCompanies have incentives to recognize revenues but not the costs associated with generating those revenues because doing so allows them to report inflated income for the current period. Under US GAAP, companies are required to “match” revenues with costs in the same period so that current earnings are an accurate predictor of economic income. Monsanto, a large multinational agricultural public company, did exactly what it was not supposed to do. It violated the most fundamental accounting rule—the matching principle. The company was eager to recognize revenues but not the costs associated with generating revenues.

The Securities and Exchange Commission (SEC), the Robocop patrolling Wall Street and the guardian angel of the average investor, charged Monsanto of misstating earnings because the company failed to properly account for the costs of sales associated with its flagship herbicide product “Roundup.” Monsanto agreed to pay $80 million in penalties. It is one of the largest accounting-related settlements by the SEC since Mary Jo White took over as the Chair of the Commission in 2013.

Accounting Abuse

One of Monsanto’s flagship and highly profitable products is a weed-killer herbicide named Roundup. Because of intense competition from generic products, and possibly facing the prospect of a sharp decline in profits, Monsanto introduced an aggressive rebate program from 2009. Under the program, the company would offer steep price reductions on the product, or pay a rebate on the product in subsequent years, if retailers and distributors met certain sales goals. In 2010 alone, Monsanto paid $44.5 million to its two largest distributors as a rebate for meeting the sales goals of Roundup for its past rebate programs.

The accounting problem was that Monsanto was recognizing revenues from the sale of Roundup but it failed to include an estimate of the cost of the rebate that would be paid to its retailers/distributors in future periods. Because the rebate contributed to the sale of Roundup for the current period, the company is required to include rebate estimates in the current period. The company possibly deferred recognizing the rebate costs to future periods when cash was being paid which violated the matching principle and the fundamental “accrual” notion of accounting.


In addition to the company fine of $80 million, three Monsanto accounting and sales executives agreed to pay penalties to settle individual charges against them. The SEC found that two certified public accountants (CPAs) at Monsanto either knew or should have known that Monsanto was improperly documenting costs tied to the program and were suspended from practicing as accountants of public companies.

Monsanto neither admitting nor denied any wrongdoing but agreed to hire a consultant to review its financial reporting of the rebate programs. Based on the review, the company disclosed that it was going to restate its earnings from 2009 to 2011.

Monsanto’s CEO, Hugh Grant, reimbursed the company $3,165,852 for cash bonuses and stock awards received during the period. It is not surprising or unusual for CEOs to pay back their incentive compensation if the company has accounting related misreporting. Under the “clawback” provision of the Sarbanes-Oxley Act of 2002, executives are required to pay back compensation during periods when accounting misstatements occurred, even if the executive was not directly engaged in the misconduct.

Ms. White said “Corporations must be truthful in their earnings releases to investors and have sufficient internal accounting controls in place to prevent misleading statements…. Failing to recognize expenses related to rebates is the latest page from a well-worn playbook of accounting misstatements,” she said.

Costs of Accounting Manipulations

The stock price of Monsanto has gone down from a high of $120 to a current price of around $90 which is a 25% decline. With total shares outstanding at 536 million, the magnitude of the total loss to shareholders is a staggering $16 billion in just one year. As always, ultimately, investors and shareholders lose from accounting abuses.

February 27, 2016; 3.55P

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Banks Banking on Their Debt

BankUnder the “Fair Value Option,” accounting rules allow a bank to book income when its debt has declined in value should they elect fair value accounting for their debt. Once adopted, the decision is irreversible.

Now consider a bank whose financial health has been deteriorating (a decline in credit ratings or an increase in credit default swap spreads). Under accounting rules, a financially constrained bank would record an accounting gain! Therefore, other things remaining unchanged, a healthy bank would report a loss on the income statement, while an unhealthy bank would report a profit on the income statement. Very counter-intuitive.    

Prominent Example

In 2011, JP Morgan Chase in its third quarter earnings reported a whopping $1.9 billion pretax gain because of debt valuation adjustments (DVA), i.e., it recognized a gain because the market value of its publicly traded debt had decline in value. Similarly, in the first quarter of 2012, Morgan Stanley ’s earnings were reduced by nearly $1.5 billion in losses which were tied to this rule. In the third quarter of 2011, the bank had a gain of $2.1 billion because of debt valuation adjustments. In the nine months of 2015, Morgan Stanley recorded a gain of $477 million related to the DVA rule.

You can notice the volatility in earnings that results from valuing debt at fair value. Moreover, the recording of the debt value adjustment on the income statement made it difficult for investors to value a bank’s earnings.


In 2008, when the accounting rule first came into play, which coincided with the financial crisis, banks were only too keen to adopt the fair value option for valuing their own debt. This is because, with overall deteriorating health, banks were able to mask their economic performance by booking a large accounting gain which arose from a decline in the market value of their own debt.

The Great Escape

Based on investor feedback, the US accounting rule-making body, FASB, is finally giving banks an “opt out.” Going forward, if a bank elects to adopt fair value accounting to value its own debt, it does not have to report any gain or loss from decline or rise in its market value of debt on its income statement. Instead, the gain or loss related to debt valuation adjustment is to be reported under “other comprehensive income,” which is not included in the income statement.

Accountability of accounting in banks!

February 16, 2016; 4.30P

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