The deflation of the housing bubble (which was fueled by low rates and relaxed lending standards) triggered the current financial crisis and is now impacting Main Street through deteriorating consumer confidence.

Falling home prices are a sure way to turn consumer spending levels toxic, but I think it is more than fiscal conservatism that is triggering decisions. I took a quick look at median home prices (and the year-on-year increases) and compared the gains to the average household income.

The average consumer trend for the last 5-10 years has been to live comfortably, and then refinance surplus debt (credit cards, auto-loans, etc) into the home mortgage. As the mentality that home prices will always go up persisted, it became easier for consumers to associate home gains as additional household income that could be captured through refinancing.

Although based on wide assumptions, the table below shows that consumer incomes were 10-20% higher due to average home price appreciation. This is compounded for people who purchased more expensive homes at higher multiples of their income levels.

Not only has the fall in home prices cut consumer wealth, but it has erased the homeowner’s ability to supplement their household income by tapping into home equity gains.

Until home prices stabilize / appreciate, I don’t see how the economy can increase household income levels by the c. 20% that was provided by home appreciation. Following this logic, I don’t see how consumer companies can capture the domestic earnings to get their prices back up.

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This afternoon I took a shot at building some elements of Facebook Connect into this site. Overall, it was a fairly painless process and I think the results are pretty cool.  To borrow Facebook’s language, Connect lets you:

• Seamlessly “connect” their Facebook account and information with your site
• Connect and find their friends who also use your site
• Share information and actions on your site with their friends on Facebook

In easier language, it means that this site can now recognize visitors by their Facebook profile (if allowed) and (if wanted) can now distribute information back to their profiles. For example, if you comment here you can elect to publish comments back to your newsfeed in Facebook. You can also invite friends to this community, share content back with Facebook, etc. This particular blog is running on WordPress, so I used  a plugin developed by Sociable! to get it up and running. Their documentation covers the main steps, but to highlight some points:

1. Navigate to Facebook Developer and create a new application. Make note of the API and Secret keys (needed later), set the callback URL to your website (e.g. this site is www.christianbaxter.com) and change the logo pictures.
2. Extract the plugin and load it to the plugin folder
3. Activate, select options to enable and add the keys
4. Add the Community widget to the sidebar

I’m pretty impressed with the results. On arrival, the community widget offers users the option to login via Facebook (or another method). If they login, it registers them to the community and ties into their Facebook account, with permission. From there, users can invite people to the community, easily share content back and enable the option to post comments back. I haven’t enabled the comment system because I’m still using Disqus to manage comments on this  blog (love the email features). They have synced up with Connect as well, so it should be work through their systems for now (possibly needed another login though). We can expect Facebook to continue pushing the Connect platform with more capability and features. They have the value of the strongest (my opinion) social framework to offer websites and a set of applications that will be useful outside of the walled garden.

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Tags: facebook, Wordpress

Private Equity funds (including Venture Capital funds) are largely structured under a “2 and 20″ business model. This will run through a quick example about how it works from the Limited Parter and General Partner perspective.

• Limited Partner (LP): Invest money in the fund and include: pensions, investment managers, high-net worth individuals, etc.
• General Parter (GP): Select companies for investment and manage the portfolio until exit is realized (IPO, strategic sale, recapitalization)

The 2/20 model says that the GPs receive a 2% management fee on committed capital (in this case, $100m) and 20% of any realized capital gains. The LPs, on the other hand, invest $100m into the fund and receive their initial investment plus 80% of the gains. These percentages can change, but they are fairly standard in the industry.

The management fee is used to keep the lights on and pay salaries (supposedly) and the “carry” or 20% gains is the profit share.

Now, in our example, the fund has a life of 10 years, so the total management fee is 2% times 10 years = $20m. This leaves $80m to invest in companies after fees. For simplicity, we assume 10 investments at $8m each, and mixed outcome on investments (2 winners, 5 even money, and 3 losers).

The table below outline the sample timing and fund IRR. Now, when all is done, the fund has returned a total of $200m in cash, of which $100m is consider capital gains. This gain is then split between the GPs ($20m) and the LPs ($80m).

Granted, this is a simplified example that ignores GP investment in the fund (usually 1%) and the ability to reinvest in follow-on rounds of successful businesses, but it covers the basics.

The model itself encourages big bets on companies that can give the investors the massive returns (e.g. the Apples and Googles). Funds are less interested in companies that will only return a moderate return over 3-5 years. To compensate for the losers, the fund needs to strike it big with a few names to bring home the IRR to investors — they expect in excess of 30-40%.

While this model is generally excepted and does work, there are conflicts, especially when firms raise multiple or overlapping funds. For example, investors may cherry-pick for certain funds/investors or take riskier bets on a fund that is underwater. Also, as the number of funds grow, so does the total management fee, which creates a conflict vs. need to generate excess carry.

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Tags: 2/20, venture capital

I had a class tonight (Managerial Leadership) that was taught by a guest speaker, Tim Sullivan from Madison Dearborn. It was a great lecture overall and picked up on transitional leadership elements between the military and private sector, among others.

One point that stuck out was regarding team dynamics. The research he brought up concluded that a team’s outcome is not necessarily dictated by the best performer, but more likely by the worst. This is sort of a weakest link analogy. Essentially, there were three team members you wanted to watch out for (or more importantly want to avoid being):

1) The Jerk – condescending, sarcastic, etc. 
2) The Slacker – feet on the desk, late to meetings, etc.
3) The Pessimist – bad attitude, always negative, etc.

Basically, if one or more of these characters are adamant in a given team structure, then a negative performance is more than likely. This was tested by injecting an actor into groups who convincingly played these parts and then comparing outcomes.

This is interesting, since I often looked to the strongest member to gauge performance. More helpful is that I can recognize times when I have exhibited each of the characteristics and will now (hopefully) be more aware of it’s impact on the dynamics.

It’s worth mentioning that this was based on 45 minute student group performances and may not be representative of all teams / longer relationships, but I did find it interesting and will keep it in mind. 

For more info, the research was done by Will Felps (Rotterdam School of Management) and the American Life story (source) is here.

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Tags: leadership, team structure

I’ve been debating my stance on preference between private and public markets, specifically with respect to how I’m allocating components of my portfolio. I recognize that advice leads us down the idea that public market diversification is ideal.

The logic that a 30+ stock portfolio is more diversified than holding only few companies is hard to dispute. This reduces the portfolio’s asymmetric risk (e.g. company specific risk). This way, if one company blows up, you hopefully still have 29 that are doing OK. The flip-side if that is if one does extremely well, you have diversified against the upside.

This logic leads investors to the concept of the market portfolio, which is essentially a portfolio that owns every available stock and is fully diversified. This is closely replicated through Exchange Traded Funds (ETFs) and various global indexes. The premise here is that a market return (for example, 8%) does not compensate investors for ANY asymetric risk, which can be diversified away. Therefore, the investor is best off owning every stock and being fully diversified. You get paid for taking Beta risk, that’s it.

The next step is to ajust this portfolio for your risk tolerance. Do you want very little risk? Then allocate your portfolio with 95% treasuries and 5% of the market portfolio. Feeling very bullish and lucky? Borrow debt and leverage yourself in the market portfolio. Essentially, the “Random Walk” idea is that you own market and manage risk through the use of leverage.

So what’s the problem? Although I do not propose a solution, I am seeing a lot of problems with the public company ownership model overall. 

Points that I am struggling with include:

• Boards (representing my interests) are handicapped in terms of access to information
• Management has access to insider information, I (as the investor) do not
• Executives can be distracted with quarterly earnings targets and empire building
• It’s costly and time-consuming to keep up with compliance (Sarbanes Oxley)

There are other examples to both support and contradict (liquidity, transparency, access to capital) this position. I’m still debating on a diversified portfolio of public companies or a diversified portfolio of semi-private ones.

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Tags: market theory, public vs private

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Tags: bailout, comic

Tonight I logged into my CafePress store, called BankerBullshit, and was surprised to see that sales are coming in for a few products! Hot items include Equities in Dallas shirts, Rainmaker Hats, and “Reach Out” shirts. I’m definitely surprised (but admit I bought a hat too).

Apparenly a global collapse in the field of finance and investment banking drives sales in related, niche retail.

I launched the store on the back of the Banker Bullshit Generator (crafted around 3:00am during my London banking days) and didn’t have any high expectations to generate sales. I was more curious about how the CafePress model worked from a resale perspective. Overall, I’m happy with it — but the UI / navigation is pretty terrible. And you guys are sending my checks to the wrong address (my fault)!

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Tags: banker store, generator

Google released a contact / calendar synch for the iPhone. I’m fairly sure it works, but do I really want all of my gmail contacts on my phone? They have always struggled with contacts (missing the boat on social networking – except in Brazil) and, in my opinion, since having that ‘auto-add’ feature. The result is thousands of contacts and not all of them remotely useful. Do I really want the guy who subletted my apartment stored in my local directory?

I suppose the fault is mine for not wanting to scrub through the contact list. Not this week…

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Tags: google, iphone, software

Google is rolling out Latitude, which is a location publishing service. Will be interesting to see how this performs across platforms. Will likely pull using contact numbers, since the Gmail contacts base is crude at best. Many companies will compete for this space and my guess is the best social network will win, since the technology is replicable but the social data is more difficult.

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Tags: google, iphone, software

The NYT has a great graphic that lays out keywords on Twitter against a timeline. For those that don’t know, Twitter is a form of microblogging that is quickly gaining mainstream acceptance. Although the firehouse remains closed for now, the ability to collect and analyze the millions of tweets has a lot of potential — everything from breaking news to consumer insights.

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Tags: superbowl, twitter