Of integrity...

My major take-away from the Goldman Sachs session is that INTEGRITY MATTERS. I just had a conversation with someone who lost a tidy sum on Lehman-linked structured products sold by a local bank. I'm sure many others have lost money as well. Otherwise, there wouldn't be any talk of possible intervention by the Singaporean government.

It is highly disturbing that some non-financially literate investors have lost their nest egg on these structured products, having been assured of at least principal repayment (just read the news reports). I'm currently studying structured notes and it's a worrying sign when my professor admitted that over the last couple of years, no one really talked about the creditworthiness of the issuer of structured notes. Guess what folks? THIS IS ALL THAT MATTERS!

What are structured notes?

Structured Notes are fixed-income securities whose coupon and/or final payments depend upon the return of a stock, portfolio of stocks, or a market index. In the case of these Lehman notes, the returns are based on the securities packaged by them.

Let me emphasize this: It IS a DERIVATIVE SECURIY - make no mistake about that. It replicates a certain return, but you are not owning the underlying security. For retail investors (or the more informed ones at least), structured notes are attractive because it makes no sense for them to create the payoff from the various investment positions directly for whatever reason.

To be fair, the structured products reached out to this market, and that's beneficial for investors who know what they want! What about the uninformed investor? How many retail investors actually know what they are getting into? Enough said.

I can imagine RMs at our local banks telling uncles and aunties that this investment "bao jiat" (returns are certain) and subsequently explaining that risks of default on principal repayment are low because they are dealing with "dai gor" (big boys). But hey, when even people like Buffett can't understand derivatives - how can uncles and aunties know what they are buying into? I suspect that the RMs had them at "bao jiat" (think "you had me at hello" - classic line from Jerry Maguire - but less romantic).

Tell an impotent guy that Viagra's here to help and that it is "bao jiat". Next, go on and list all the negative side effects - in medical terms. Do you think he's going to say "Wah.. siao eh.. buay sai lah.. knn... sibei danger leh.. lim pei dunch know simi si cardiac arrest." I think the dude's probably going to say "Hana hana.. Eh doctor.. can one time eat 2 anot?? Lim pei sibei gian siah!"

I guess there are two reasons RM sold these products to the unsuspecting buyers. Firstly, they simply didn't know (like John McCain) of the dangers of this product. In which case they have no business being a RM. Secondly, they were eager to sell more and lock in commissions for that new Coach/Prada/Gucci/Hermes bag. Wham bam thank you mam/sir. Don't get me wrong. I'm not an angel. Neither am I pretending to be one. In fact, I've always been firm believer of caveat emptor. I remember seeing a half page offering of Lehman structure products on the Business Times about 2 years ago and telling Lohnuts that this is probably a scam cause its too good to be true. We made an effort to understand the product, but hey.. we're not law nuts, we couldn't understand the offer prospectus. I think he got his friend to look into it.. but I never quite bothered to find out more. I just knew I didn't want to go near it. Friends probably know the jokes I make about all these mass-market securities. Haha..

There's no fundamental difference between ripping hedgefunds off by $100,000,000 and screwing the poor sod who worked all his life to save $50,000. Sure, the poor sod feels it more - but as RMs or salespeople, we need to watch out for our clients' interests - especially when they aren't financially savvy! Put their interests first and your own success will follow. Even if you're not the most altruistic person in the world, remember this: you're only working for your own benefit if you look out for your clients. If you want play ball, you got to make sure others want to play ball with you! Trust me, if you lose money for the rich folks, they will remember. People only remember the bad things. Have integrity, don't sell shit to people, and they'll be less likely to shit on you in future.

On valuation:

What about integrity in valuation? Many of us have built models for Corporate Reporting, and have made our fair share of jokes on the rubbish in rubbish out nature of valuation models. Having spoken to the good folks in Cornell, think about this, what good does it do for you to model rubbish?

I think it takes great skill to get a better valuation by creatively (with absolute integrity) solving a fundamental problem for the firm - unlocking value for them in the process. This is what makes one analyst so much more valuable to the firm. We had this fun exercise in a class conducted by Barry Ridings where we had to come up with valuations for different parties involved in a restructuring case.

Naturally, the "advisors" for the shareholders tried to boost their valuation numbers by making all sorts of weird assumptions. I will always remember Barry tearing down all our assumptions and emphasizing the importance of credibility in valuation. You want to convince the other person that you are right. But how can they be convinced when even a monkey knows that you are making absurd assumptions? Don't forget, you've got competitors eager to poke holes in your assumptions just to gain one over you!

Someone raised a point that it was natural for the various parties to make assumptions which aided their case. Barry shot back, saying that our job was to get a proper and honest valuation done so that we can advise our clients honestly and accurately. For example, if we realise that the shareholders were probably going to get marginalised, advise them to strike a deal with the company and creditors, instead of trying to convince them to fight for equity value in which case failure will result in them gaining zilch.

Plus, in the professional world, people know the tricks, people have an idea of what valuations are reasonable even before seeking your advice. By coming up with crap, you'll only attract sniggers and condemnation from your peers. This reputational damage is well.. just not worth it.

I guess that's it for now, just some points for us to chew on as we all prepare for interviews with the remnants of financial institutions we have today.