I like Zero Hedge, I don’t care what anyone says. Most established writers on the financial sector start with an assumption of general trust, possibly because they are understandably dependent on industry sources who seem entirely plausible, and are then subject to the erosion of this trust as the sausage-making details become evident. The multi-headed Tyler Durden at Zero Hedge is exactly the opposite, assuming at the outset that every executive sits in their offices twisting their mustaches, hatching plots to steal from the unwitting public. They start with conspiracy theories, and then tack back towards a depiction that makes sense and if they sometimes get stuck out in the fringes in the absence of new information, that is a price I’m willing to pay.
One of Tyler’s best contributions to general financial knowledge has been a detailed explication of the despicable cesspool that is new stock issuance. (See HERE for a particularly egregious example from 2009.) Human psychology being what it is the investing public would love a convenient scapegoat for the process. The following quote from the late Steve Jobs provides a hint as to my theory in this regard:
“When you’re young, you look at television and think, There’s a conspiracy! The networks have conspired to dumb us down. But when you get a little older, you realize that’s not true. The networks are in business to give people exactly what they want. That’s a far more depressing thought. Conspiracy is optimistic! You can shoot the bastards! We can have a revolution! But the networks are really in business to give people what they want.
You can see where I’m going here. There is no conspiracy as to the selection of IPOs and secondary offerings beyond popularity. They are giving you what you want, what they can sell, and in a number of instances its crap, either in terms of objective business quality or the valuation levels stipulated at issue. Its also true that these deals are marketed in a way that emphasizes the positive aspects and minimizes the negative but that is also true of late night infomercials. What amazes me about the complaints about the poor performance of IPOs in particular is that it is often the same people who place the blame for failed subprime mortgages entirely on the borrowers who “should have known better than to sign them”, in a conveniently subjective application of the Caveat Emptor rule.
It is an axiom among professionals marketing investment ideas to long-only funds or individual investors (for all their faults, hedge fund managers are much better at this) that you know you have a great investment idea when it is completely unmarketable. Publish as many copies as you want, but stock ideas in out of favor sectors will sit and gather dust until the paper rots. What sells, both in term of ideas and new stock, are those in sectors that have been gapping higher for the longest time, despite the risk that said trend is nearly exhausted and valuation levels are approaching the ridiculous.
Referring back to Jobs’ quote, the fault is not in the networks or the investment banker, its with the audience. If PBS started getting monster ratings for in-depth, intelligent documentaries, the other networks will quickly follow suit. In exactly the same way, if investors stopped buying secondary offerings in hot sectors, which they freaking know is a bad idea but can’t help themselves, and entertained the better risk/rewards potential of out of favor ideas, they would get more of them.*
Human behavior where money is concerned has been largely unchanged since the dawn of history and I would be completely delusional to believe this blog post will have any effect in that regard. I do, however, have a simple idea to mitigate the problem that makes enough sense to be fought tooth and nail by the industry: the back page of every greensheet should list the previous equity issues of the underwriter for that calendar year, the date of issue, and the subsequent performance. I am particularly interested in how the industry would fight this as every objection would so obviously be focused on hiding bad performance.
To be fair, it is important not to forget that underwriting is arguably the most important function for investment banks in terms of their benefit to the economy as a whole. The process is designed to allocate assets from aggregate savings into the hands of effective CEOs needing funds to expand. The process often works extremely well, to everyone’s profit whether they are investors or not, but is dependent on an informed, judicious investing public.
*at the risk of fawning over Richard Bernstein to excess, he does have an investing tenet that perfectly encapsulates this: “Returns are best where capital is scarce”