Given the damage to investor confidence and the fear in the market, a relatively safe category of financial instruments are now yielding an excellent return.

This category of financial instruments are the preferred stocks of publicly traded firms. Firms and especially banks issue preferred stock to investors in order to bolster their capital without having to issue additional common stock and hence diluting the value of common stock.These preferred stocks are either perpetual or may be redeemed by the issuing firm after a few years.  There are a lot of other wrinkles that preferred stocks have (like being convertible to common stock etc ) which are not relevant to the current discussion.

The upside for investors in preferred stock is that they are provided with dividends at a fixed/agreed upon coupon rate and these dividends have to be paid ahead of paying any dividend to the holders of common stock. The downside is that preferred stock does not usually appreciate in value similar to common stock. Preferred stock are traded on an exchange much like common stock and have more in common to bonds than to stocks.

Warren Buffett’s recent investment in preferred stock of Goldman Sachs and GE at a coupon rate of 10% has brought these instruments to the spotlight.

While the average investor may not get the same opportunity with Goldman or GE , there are other opportunities out there in the market due to the battering that preferred stocks have received (warranted or not) along with regular common stocks.

Risk and Reward

There are a few risks associated with preferred stocks :

- If the firm goes into bankruptcy, like common stock, they stand in line after creditors. However they get paid before any payments to common stock holders

- If a firm is in dire straits and if it does not pay dividend at all, unlike bond holders, preferred stock holders won’t get paid

These risks are out weighed by

- The tax benefits compared to bonds – these dividends are taxed at the lower 15% capital gains tax rate

- The materially higher dividends paid when compared to common stock and also the relatively stable preferred stock price when compared to common stock price

How to find the right preferred stock to invest in

The site www.quantumonline.com lists most of the traded preferred stocks that are eligible for the 15% dividend tax rate along with their coupon rate. This can be a launch point for your analysis.

There are a few preferred stocks that currently stand out based on their yield and their issuing firms ability to stay solvent in this turbulent environment – either due to the US Government implicit guarantee (Bank of America and JP Morgan) or due to excellent capital structures (HSBC and Allianz)

- HSBC (ticker -HCS) : Based on the current stock price, it yields 9.8%

- Allianz (ticker – AZM) : Based on the current stock price, it yields11.1%

- Bank of America (ticker – BAC-H): Based on the current stock price, it yields 9.07%

- JP Morgan (ticker – JPM-I): Based on the current stock price, it yields 8.6%

These are now worth looking at as a less risky (than common stocks) alternate to investing in bonds or staying in Cash.

Note : No asset class is safe these days with all kinds of  financial instruments which nobody realized existed getting into distress territory due to extreme fear and large out flows from them. The safest asset in the intermediate term seems to be US $ (not even gold) as no country/central bank holding it can afford to exit it without causing irrepairable self damage.

‘Peer to Peer lending’ is a loose term for individual lenders lending directly to borrowers with minimal involvement from intermediaries. This can be contrasted with the typical lending process where you place your deposits with banks or other such institutions which in turn lend to borrowers of their choice. In the typical lending process depositors don’t know who the borrowers are.

‘Prosper’ is the biggest player in this nascent ‘Peer to Peer lending’ space. It’s loan portfolio is still tiny compared to a bank and the track record is just beginning to take shape (earliest loans are dated June 2006).

Key features of Prosper

• Loans are unsecured and not FDIC insured
• Standard loan period of 3 years
• Borrowers are categorized into Credit grades of AA (760+), A (720-759), B(680-719), C(640-679), D(600-639), E (560-599)and HR (520-559). Credit scores are from Experian.
• You can automatically distribute your loan amount amongst a set of borrowers to reduce risk
• Delinquent loans are turned over to a collection agency which charges standard recovery commissions
• Prosper makes money by collecting fees from both lenders and borrowers

Given the intriguing nature of ‘Peer to Peer lending’ , I decided to do a bit of digging on how ‘Prosper’ loans pan out as an investment option. Here are some findings :

Typical Interest rates

Here are rates ( during the last 30 days) for loans between $1000- $5000. (Taken from Prosper website)

AA 7.65%
A 10.01%
B 14.32%
C 15.10%
D 21.60%
E 27.52%

Delinquency

I found a blog “Fred’s” that used Prosper’s own data (provided on its performance page) to do an analysis on how the age of a loan affects its delinquency behaviour.

This is quite an important analysis as loans recently originated are usually less likely to be 1+ month delinquent compared to older loans. The problem is more severe as Prosper’s performance reports usually mix the performance of new and old loans and thus make it difficult to judge loan behaviour over time.

The above chart (taken from Fred’s blog) shows the following for loans originated in any one month – % of loans that are 1+ month late Vs the number of elapsed days from the loan origination month. Interpreting data for one particular month – say June ‘06, it shows that 10% of loans for that month went delinquent after 180 days (from June ‘06) and 19% of loans for that month went delinquent after 360 days (from June ‘06)

Note that the curves show the same pattern across months and on average 16-24% of loans become delinquent 360 days from when they are originated. This is a staggering rate.

However, it is very important to note that this analysis is across all credit categories.

In order to analyze delinquency by credit category, I took a snap shot of Mar ‘07 loans’ performance data from Prosper website and the situation improves dramatically for AA and A categories.

AA loans – 1+ delinquency rate is 3.55% by value and 1.11% by number of loans

A loans – 1+ delinquency rate is 12.58% by value and 6.02% by number of loans

As you can see, this is a far cry from the 16-24% one year delinquency rate across all credit categories.

Collection agency effectiveness

The record is quite dismal in this respect. Over the last 3 months, their largest collection agency by volume of delinquent loans sent to it (‘Amsher’) has collected only 8.47% of the dollar value sent to it for collections for AA and A borrowers and the % collected falls of to 3.92% for B-D borrowers.

Since loans are sent to the collection agency just one month after they are past due, the above recovery percentages are quite dismal and it means that once a loan goes delinquent there is little chance of getting your money back.

Sale of distressed debt

If loans stay uncollected for 3 months with the collection agency, the loans are sold to a distressed debt buyer. The metrics for the last such sale by prosper yielded 9.6% of principal amount for AA and A borrowers debt. The trend from Prosper’s metrics over the last year shows that distressed debt buyers are paying less and less of the principal which may be a reflection of the current economic environment and the general risk aversion to less than perfect debt.

Summary

It may pay to lend to AA borrowers as long as you spread your loan across a wide set of borrowers. I would not suggest lending to any other credit grades till Prosper tighten’s up borrower verification and collections effectiveness.

The results are in for the FCC spectrum auction. Google has lost the ‘C’ block spectrum bid to Verizon.

On the face of it, this sounds like a loss for Google, but per my earlier post, this is in fact the best possible outcome for Google. Google must have strived hard during the bidding process to loose while at the same time ensuring that a rival firm bid above the $4Billion minimum limit to keep the spectrum ‘open’. The auction ended with Verizon bidding just 3% above the FCC minimum.

‘Open access’ means that any network deployed on these airwaves would have to be open to any device and any application. That is contrary to the cellular carriers’ traditional walled garden strategy where they supplied the equipment and locked customers into their networks and favored their own content.

Firms have been using a variety of software development methodologies as they try to bring software development into the fold of engineering and science and have it be less of an art.

At the same time, expert practitioners have put forward a variety of formal methodologies to guide project teams though the software development process.

For the most part, these methods fall into two camps – the Predictive/Watefall category or the Iterative/Adaptive category.

Predictive/Waterfall approach

This is the traditional approach to software development where the team progresses sequentially through the various development phases – planning, requirements, design, coding , testing and implementation. The key aspect here is that there is no going back/revisiting once a phase is complete.  A fixed scope with no feedback loop is the biggest drawback of this process. 

Iterative/Adaptive approach

This approach has seen the most activity in terms of new methods with the Agile family of methods being the most recent and popular. The basic principle is to use shorter delivery cycles to deliver the end product/software quickly by constantly taking in feedback from the end users.

Typical methods falling under the agile umbrella include Feature driven development, Lean development, Xtreme Programming (XP) and the Dynamic systems development method.

While each of the above iterative methods have their own rules and method of operation , they are more common than they are different. In my experience I found that you don’t actually take up one specific method and follow it to the ‘T’.  It is more realistic and useful to evaluate your current situation and organizational environment and pick the aspects that work in each method to build your own process.  In real life, projects end up looking like they have followed  a mix of the above methods as each project team evolves and modifies its process as they execute projects. This happens naturally rather than by design.

How do teams pick their development methodology

I have found that the following have an impact on what development process a team ultimately gravitates to:

• Size of the technology eco system the project team is in. Is the team a part of a large technology organization ?
• How many different application teams are typically impacted by projects. Are applications very much inter-connected in an enterprise environment?
• Are all members of a project team present at the same location
• Are the end users of the software co-located with the development team
• Nature of the application – Web based Vs a thick client
• Criticality of ‘time to market’ for the organization
• Capability of key developers and management’s trust in their ability to execute independently
• Whether the project is  Product development or internal enterprise application systems enhancement
• The industry the project team’s firm belongs to

Here are a few practical examples of different flavors of software development methodologies that have been adopted by various firms that I have been associated with and also a few pointers to why they have adopted those :

A large global financial organization

- Goal is to build and enhance Enterprise application systems
- Uses Waterfall methodology with clearly defined phases for planning, requirements, design, coding , testing and implementation
- Scope change needs are addressed through a Change control process
- Co-ordinated testing and Implementation is required across applications leading to a pre-defined and common release calendar
            – A single project typically spans a lot of applications
            – Each application is impacted by multiple projects
- Large number of users who need to be formally trained. This limits the capacity/appetite for frequent releases.

An analytics products development firm
- Web based Product development
- Software used as a service by internal users as well as external clients
- Users co-located with key development staff
- Iterative development to release features quickly
- Internal professional services users can educate clients on incremental feature upgrades leading to a smooth absorption of new functionality
- Software hosted on internal servers that enables quick and seamless delivery of new features in small incerements
- Shades of Dynamic systems development method
                 – Timebox development effort to come up with a release every 2-3 months with a fixed set of resources
                 – When features involve fundamental / core changes that take longer, the time box elongates.
- Shades of feature driven development
                - When the timebox is longer,there are iterations within the release to design,build and test features incrementally. There isn’t a wait to build all features and only then test them.
- Shades of XP
                - Refactoring of code/design included along with other features during iterations

A provider of software as a service

- Revenue model – Software as a service through web based applications
- Short release cycles (<2 months)
- Iterative UI design through HTML Prototyping
- Shades of lean development
             - Build a minimal feature set to begin with for each application
             - Start selling the service
              - Add features iteratively as needed

A Technology products development firm
- Shrink wrap product development. Products are ‘installed’ by users
- End user Product release cycles are long – 6 months to a year
- Large number of iterations internally till the product is considered to have enough features to warrant a release
 - Shades of feature driven development
             - Features distributed amongst developers who built one set and then went to the next
 - Shades of XP
             - Design, coding and testing done together  
 - Emphasis on building working software and not so much on documentation
             - A working build is available each day with the latest changes.
             - Management, other developers and sales and marketing teams can watch the software being built and provide input and plan their own activities
 

I have recently created a portfolio with my stock picks. The intent like most mutual funds out there is to beat the indices – particularly the S&P 500.  Specifically in this case, the intent is to come out ahead of the S&P 500 by a decent margin by the end of 2009.

As an experiment, I have posted the portfolio holdings and its NAV (Net Asset Value) on this website under  ”My Stock Portfolio“. I will be updating the holdings and the NAV on a monthly basis.  Readers of this blog will have a chance to track the portfolio performance and make decisions for their own portfolios.

Note that this is an experiment and may be discontinued if personal or other situations  demand it.

At first glance the title seems to club disciplines which have nothing to do with each other.  Read further and you may change your mind.

Game theory is a discipline in mathematics that studies interactive decision-making, where the outcome for each participant or “player” in a game depends on the actions of all.

If you are a player in such a game, when choosing your course of action or “strategy”, you must take into account the choices of others. But in thinking about their choices, you must recognize that they are thinking about yours, and in turn trying to take into account your thinking about their thinking, and so on.

Take the example of a three person fight among A, B and C where each has to shoot the other two to survive. A and B have a 90% hit rate of hitting targets whereas C has a hit rate of only 30%.

Who do you think will survive ?

The answer is C! A and B’s best option is to fire against each other to eliminate the most dangerous opponent which leads to them killing each other while C survives.

Mathematician John Nash (of ’The beautiful mind’) fame had theorized what is called a ‘Nash equilibrium’ where if each participant in a game knows the options and their value for the rest of the participants, there is only one logical choice each participant will make. Any other choice will be less productive.

There have been further advances in this science including a Nobel prize in 2005 for work in this field.

A fresh example of how Game theory is being used in business is infact playing out in front of us.  The FCC bid to open up the 700MHz wireless spectrum for auction has Google, the FCC and the Telecom companies (AT&T etc) all employing game theroists to figure out what their opponents will do and how to strategize.

Interestingly enough, game theory type moves have already taken place without the auction even starting (auction  starts Jan 2008) . Google has lobbied for a rule that the winner has to allow devices free access to connect to the network (like the internet) - this is unlike the closed network policy of current wireless service providers. Google has also indicated it would step into the bidding process. FCC has agreed to the rule but with a catch, the minimum bid has to be $4 billion. This ensures Google doesn’t just pretend it will make a bid , but does so in reality.  AT&T in the meantime has said it will open up its existing network next year.

Lets evaluate  google’s options ?

a. Not bid – not a good option . Bids may come in lower than $4 billion and AT&T may not open its current network

b. Bid to win – again not a good option. It does not want to run the network, just build applications that use it

c. Bid higher than $4 billion but only just, so that it loses. This is the best option. It does not need to shell out any money but will get what it wants – a free network

Now, coming to Project Management . Game theory seems good for auctions, but how does it apply or help in project management.

The answer is pretty straightforward. On a day-to-day basis project managers need to resolve issues, put out fires so that the project stays on track. This involves mostly dealing with people , negotiating with them and arriving at a solution that keeps the project moving forward. The negotiation aspect of the above process is where game theory comes in.

Here are some things you can consider in your negotiation process :

What is the issue?  What decision are you trying to make?
Who are the players? Which players will have an impact on the success of your decision?
Develop a list of options for each player.
What are the goals of each player?  Always assume their goals and actions will be rational from their point of view.
What are the sources of gain?  Mutual gain is possible if players have different preferences, priorities, capacities, risk profile or beliefs.  Where mutual gain is likely, a negotiated outcome is possible.
Who can make credible commitments that might affect the game?
What is the time line?  Who is in a hurry, who can afford to delay?  Will players choose simultaneously, or sequentially?  Is this a one-time situation, or one of many repeated such decisions?
Who knows what?

With the dollar depreciating quite heavily against the rupee (now to a nine year low), it is quite natural for questions to be posed around the profitability of the offshore model and whether if any jobs will move back stateside.

‘The Economic Times’, India’s largest business daily, and India Knowledge@Wharton interviewed executives in Silicon Valley and other high-tech centers in the U.S., venture capitalists, consulting firms and Wharton faculty to determine the answer to these questions.

The answer was that even at current exchange rate levels, the cost differential still exists and the offshoring trend will not be reversed any time soon.

The study is summarized in an article which highlights an aspect of outsourcing which does not usually receive the same amount of coverage / attention. This has to do with economies of scale that are involved in outsourcing which leads to third party outfits faring better when compared to captive units of the outsourcing companies.

Third party outfits like Infosys or Wipro have a large employee base and a lower salary structure compared to the Global companies which set up captive units in India. This gives them a cost advantage that lets them survive economic shocks better.

So, in effect, the exchange rate situation instead of reducing outsourcing may rather lead to a consolidation of the outsourcers.

Here is an attempt by the ‘Old’ Media to cross the bridge into the 21st century web-centric world

Business Week in its latest print edition includes a paragraph at the end of most articles titled ‘Links’ where it lists snippets from related (older) articles.

The online version of the magazine which is a verbatim reproduction without many tweaks also carries the ‘Links’ section. The screen shot above is from a sample article in the Nov5, 2007 edition

This is a novel concept but falls short of fulfilling the intent of drawing readers online to related articles. A simple extension of this idea to include keywords in the ‘Links’ section that users can use to search on the website and go to the related articles would complete the cycle.

It is interesting that one may be very close geographically to important events/activities but be quite oblivious of them. Such was the case with me.

The event that in question is a TED conference in Monterey, California. I very recently came across TED, long after I left the Monterey area. TED started out  as a conference that brings together people from the fields of Technology, Entertainment and Design, but has grown beyond that to bring great thinkers and doers from these and other fields.

The presentation  in question is by Hans Rosling, a founder of Gapminder which is a Swedish non-profit organization which develops and distributes free software to visualize human development.

The presentation is located on TED and I would urge everybody to take a look at it. It breaks commonly held myths and stereotypes about the developing world and how it relates to the developed world economically and health wise.  Through a captivating presentation of statistical data in an animated fashion, Hans Rosling shows how Asian countries have really progressed in health and wealth over the last few decades.

The presentation is made using the Trendalyzer software developed by the Gapminder foundation that uses lively animation to depict complex global trends in anthropology and global economics. This makes the presentation really come ‘alive’ in a fashion I have not  seen before in any other statistical presentations till date.

You can play hands on with the Gapminder tools to understand the power of the software. The Trendalyzer software used to create these tools was recently acquired by Google who no doubt saw its value and my prediction is that we will see it as one of the Google Apps shortly.

Till then, if somebody can get their hands on a Beta copy of the software, I would be interested in trying it out (Drop me a line if you do have it!)

Yesterday, I received an invite to the public Beta of ‘Grand Central’ and promptly registered. I was pleasantly surprised by its features. (Grand Central has recently been bought by Google.)

Grand central (GC) enables you to register/pick a brand new phone number and then attach any/all of your phones (cell, home, office, etc) to that number. With this, when anyone calls your grand central number, one or more of your phones will start ringing (based on your settings).

There are lots of features apart from the basic / core feature that is mentioned above, but what stands out is the fact that you now NEVER EVER have to change your phone number as your actual physical phone numbers (cell/landline/VOIP) that are tied to specific service providers are shielded by your grand central number which you always own.

The other neat feature is that of a single voicemail box for all of your phones that are tied to the grand central number and the ability to manage those voicemails just like you manage e-mails.

What puts this service into high gear is its ability to direct calls that come to this GC phone number to exactly the phone you want on the fly based on who is calling. For example, you can direct all office calls to your office landline, friends and family to your cell phone etc.

The biggest hurdle that needs to be crossed by anybody using this service is the building of your contacts list and tagging them right (as a friend, family, office colleague etc). There are two ways to do this – do it yourself manually by importing from outlook, yahoo or hotmail or you let GC do it by having people who are not on your GC contact list identify themselves to the service before they are connected to you.

A missing link in this exciting new service is the ability to do a reverse masking i.e convert all of your calls from your different phones into the same single GC outgoing number. This avoids confusion at the calling party end as they expect to receive a call from you from the number they used to call you.

At this time, I am still debating on how best to start using this service starting from an empty contact list.