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Wirecard and the missing billion or so

Those subscribers who have talked to me about European funds in the recent past may recall me mentioning that Wirecard AG, a German money transmission business which had been a favourite of some well known European fund mangers for years, had been the subject of an investigation by the Financial Times who suggested that its accounts were falsified.

That generated a reaction from people in high places suggesting the FT was the patsy of operators shorting Wirecard shares. That to me seemed unlikely, given the reputation of the paper and the precision of its findings. I believe that the biggest owners of the stock secured re-assurances from the firm’s top management which they accepted. These turned out to be worthless as it is now reported that about 2 billion euros has vanished.

How is it that fund managers with decades of specialist experience owning many millions of a given company’s shares don’t find holes in the accounts that journalists (albeit specialist ones) can spot?

Primarily because not many fund managers are accountants nor do they necessarily have forensic accountants in their support team. A well organised manipulation of financial reports is devilishly hard to find from the information in the public domain. Journalists have access to whistle blowers – fund managers do not.

I personally do not fault fund managers for not seeing things that are likely invisible from the outside of a business. I do however think about why they don’t take the line ‘if it smells like a dead rat – it is a dead rat’ (well known to owners of thatched properties!). In other words, why do they accept the assurances of the management over and above the evidence presented by the investigative journalists?

I guess I really know why: a fund manager who owns a large block of a company’s stock over a long period will know the CEO and the CFO reasonably well and if he has made a lot of money up until know from the stock, he may have an unconscious bias of loyalty (in fact that is a proxy for all sorts of other recognised biases), not wanting to take the side of the doomsayers and short sellers. (I have added a Glossary item on Short Selling for subscribers)

Furthermore, if the stock takes a hit on first publication of the story, after getting a quick denial from someone they know and trust, fund managers may even see an opportunity to ‘top up’ at lower prices. One has to assume that sometimes even very senior staff in a large firm are offering re-assurances based on the real belief that all is well, not knowing of a fraud perpetrated by one person or a small inner circle.

My experience over the years of published claims of dodgy accounting by large corporates is that they are almost always validated. I think this is because the source is either a fund manager who is a bright fully qualified accountant, or a senior whistle blower. Both are very likely to be accurate in their assessment.

It is true that some short sellers employ people to actually look for overly optimistic management assessments of businesses and if you are owning that share, you naturally hate them for that. But that is a bit like hating your purchaser’s surveyor when he or she reports that your house is full of woodworm and being undermined by your favourite tree! You are bound not be pleased that the house is suddenly harder to sell, but the information might actually be of good use to you!

Someone far cleverer than me wrote the following about 4 years ago. It has taken me a while to get there, but I did work this out myself as you will have been reading.

Truly — to mix metaphors — butterflies flapping their wings now regularly create hurricanes that stop out fundamentally driven investors who cannot remain solvent longer than the market can remain irrational.

In such a world dominated by index and algorithmic funds historically logical correlations between different asset classes can remain in place long after they have ceased to be logical. More butterflies.

Index and algorithmic fund [maneuverings] also make it very hard to ascertain what the markets ‘clean’ positioning is at any given time. All of which pushes up the cost of capital.

Letter to investors from Martin Taylor when announcing closure of Nevsky Capital hedge fund – 2016 (Source: quotation from ZeroHedge via Business Insider magazine, January 2016)

And he further added:

In summary, all of the above factors now mean that it is more difficult than ever before for us to accurately forecast macroeconomic and corporate variables. This pushes up our cost of capital and substantially increases the risk of us suffering substantial capital loss on individual positions either because of a forecast error or simply because we could be caught up in an erroneous market trend, which could then persist for far longer than we could take the pain. This has made what we enjoy most — the thrill of analyzing economic data releases and company accounts – no longer enjoyable. It is therefore time to accept that what we have done has worked brilliantly for twenty years but does not work anymore and move on. We are confident our process will eventually work again – for the laws of economics will never be repealed – but for now they are suspended and may be for some time; an indefinite period involving indeterminate levels of risk during which we think it would be wrong for us to be the stewards of your money.