Equities and Alchemy

Equities and Alchemy

Buyer Beware

October. This is one of the peculiarly dangerous months to speculate in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February.
- Mark Twain


Be Grateful

 Being grateful helps to increase self-control and reduce impulsive behaviours, new research finds.


Rory Sutherland: Life Lessons from an ad man

Rory Sutherland stands at the center of an advertising revolution in
brand identities, designing cutting-edge, interactive campaigns that
blur the line between ad and entertainment.

Rory Sutherland: Life lessons from an ad man





Human nature hasn’t changed for a million years.

The Wisdom of Bill Bernbach

Despite access to more customer information than ever before product messages are clicking less often with customers. The inescapable truth is we know less about customers than we should, given the $6 billion a year companies spend trying to figure out what makes them tick.

Bill Bernbach, one of advertising’s greatest minds, would understand the problem:
“Human nature hasn’t changed for a million years. It won’t even change in the next million years. Only the superficial things have changed. It is fashionable to talk about the changing man. A communicator must be concerned with the unchanging man – what compulsions drive him, what instincts dominate his every action, even though his language too often camouflages what really motivates him.”
Bernbach was not a psychologist, but had an uncanny intuitive grasp of human behavior. While most of us may lack the intuitive competence of Bernbach, we can get to know our customers better by acquiring a deeper understanding of unchanging man. But we cannot get that understanding through traditional customer research.

Renown brain scientist Richard Restak has observed that "We have reason to doubt that full awareness of our motives, drives, and other mental activities may be possible." Cognitive scientists tell us that with the aid of new brain canning technology, they’ve learned that about 95 percent of the mental activity going into our decision-making takes place behind the curtains of consciousness. Yet, most consumer research concentrates exclusively on the contents of consumers’ conscious minds.

The roots of motivations lie beyond the knowing reach of our conscious minds. When people tell researchers’ why they do what they do, they can only speak to what appears on the screens of their conscious minds. Those images are often at odds with their more primal sources of motivations.

Marketing mostly ignores the silent 95 percent zone in the brain. Why? The “superficial things” that show up in the conscious mind are more visible, measurable and quantifiable. Companies feel more comfortable with the measurable, so they spend vast sums researching customers’ superficial attributes. Procter + Gamble alone conducts 4,000 to 5,000 customer studies a year.

It’s harder to quantify “what compulsions drive customers, what instincts dominate their every action.” To fathom the unchanging man requires understanding behavior at its roots in human biology.
Ever wonder how cravings develop? Be they for sex or chocolate, they are not consciously created. It’s 3:30 PM. Your energy is sagging. A small organ over your kidneys senses a sugar shortage and sets off a flow of neuropeptide Y to alert your brain of a need for carbs. The plea reaches your conscious mind as a craving for chocolate. You ponder whether to stick to your diet or give in, then say to yourself, “What the hell,” pop a piece of Godiva in your mouth and resolve to eat salad for dinner. You enjoy the moment by giving into the craving.

While you exercised free will (hopefully) in reacting to the craving, the action you took had its roots in your biology. So it is with behavior in general. That’s lesson #1 in understanding unchanging man. 


Direct Marketing and Copywriting

  Gary Halbert
What are The Boron Letters?  
 The Boron Letters are a message from a master copywriter, the late Gary Halbert.

Often called the godfather of copywriting, Halbert spent several years in the Boron Federal Prison Camp for fraud in the 1980’s. It was during this “vacation,” as he termed it, that he began his reemergence as a dominant force in direct marketing.

The Boron Letters were meant as an inspiration to Halbert’s children. He called them the “most heartfelt messages that I’ve ever written.” The forcefulness of the prison environment became his inspiration. Pulling no punches in their language, his prison letters became a cult-classic in direct marketing genius and have served as a guiding force ever since.

The letters formed an outline of Halbert’s philosophy of direct marketing. From the basics of good copy writing to the importance of first impressions, The Boron Letters contained ideas that would become the standard by which all copy writing was judged.

Halbert understood that good copywriting is written primarily to make money, not to gain praise. His method of turning non-sales into sales turned the direct marketing world on its head, eventually igniting the world of online business. Though he wrote his manifesto long before the World Wide Web became the driving economic force in the world, his methods found their way into the Information Age.

He started with a newsletter. With almost no promotion, Halbert found himself with readers spanning the globe. When yearly subscriptions started lining up, he decided to offer a lifetime subscription. Soon, all of his subscribers paid for the lifetime option.

Halbert realized that his knowledge was important to share with the world, and he began offering it for free on his website. He built a even larger client base with the free information than he could with any other way.

Through it all, Halbert remained one of the most creative minds in the field of copywriting. Even though Halbert was a genius, he would speak in plain English so that everyone could understand his meaning.

Gary Halbert died on April 8, 2007. He left behind one of the most profound legacies in direct marketing, and his ideas continue to influence great copywriters around the globe.

Check out one of Gary Halbert’s presentations below

Or… if you’d like to check out some of Gary’s best material click here.

Gary's Shortest Letter https://youtu.be/O7YwMgBENng



Gary Halbert. Live at the System Seminar. San Francisco, 2004.


Where transportation is headed

.ToyotaFinancial's CFO on where transportation is headed at the 2016 conference.


Lumosity’s games may not improve users’ cognitive functioning


How Lumosity Plans To Move On After Their FTC Complaint

Brain training app company was hit with a $2 million fine by the FTC for deceptive advertising. 

Here's what's next.

Lumosity's Lost In Migration Game
[Photos: courtesy of Lumosity]

Talk about a corporate headache. Lumosity, the brain-training game app whose TV ads and web presence have been near-ubiquitous in recent years, was slapped with a $50 million fine by the FTC earlier this year over claims made about the benefits of its product. (They ended up settling for $2 million but not without a spate of nasty headlines.)

According to the FTC, Lumosity settled charges of deceptive advertising of its games, claiming that the games help users with school or office work, and reduce or delay cognitive impairment in seniors. 

Specifically, the FTC cited practices like purchasing Google AdWords related to memory, dementia, and Alzheimer’s disease for the app, and unfounded claims in the company’s advertisements.

The company says that it is sticking by its core product—and even branching out into new areas like stress management and sleep patterns—but will be more mindful of how it uses Google AdWords, says Steve Berkowitz, the CEO of Lumosity parent company Lumos Labs, in an interview with Fast Company.

Berkowitz joined the company in November 2015, well after the FTC’s investigation was under way. "The settlement was really a small setback in what's a really long journey to make cognitive training accessible to everyone," he said. "Every industry is new, things happen as companies are young, and this is about opportunity going forward."

Lumosity definitely hyped its products, and used an aggressive advertising campaign similar to what you’d see for a regular, non-"brain training" game or consumer electronics product. But was it deceptive advertising?

The jury of its peers is still out.
Adam Gazzaley heads up the University of California San Francisco’s Gazzaley Lab, where he researches the potential for video games, among other tools, to alleviate cognitive deficits. He is one of a group of scientists who signed an open letter saying Lumosity made exaggerated claims in 2014. It’s important to note, however, that Gazzaley serves on the board of a neuroscience gaming company called Akili that works in the same sphere as Lumosity.

Gazzaley, in an email to Fast Company, wrote that it is critical for companies that "create tools to enhance human performance" conduct rigorous scientific studies to "validate their offerings," and that regulators play a critical role in overseeing such firms. But he expressed concern about the impact of the Lumosity fine and that it could cast doubt on the positive effects of cognitive training via interactive media. "I remain cautiously optimistic that with high-level development and careful validation we will create a new category of cognitive enhancement tools for both healthy minds and those suffering from deficits."

USC’s Mara Mather, who heads up the university’s Emotion and Cognition Lab, signed the same open letter as Gazzaley, and says her main worry is that Lumosity’s games may not improve users’ cognitive functioning—they might just, in fact, make it easier for them to play the Lumosity game they are playing.

Here’s her take:
To date, most laboratory studies looking at effects of practicing various types of cognitive tasks have yielded disappointing results. Yes, people get much better at the task they are practicing, but they don’t usually show any benefits for other types of tasks. So practicing crossword puzzles should definitely improve your performance on crossword puzzles but might not help you remember what you need to buy at the store or the name of an acquaintance.
Mather wasn’t completely critical of Lumosity, however. She praised the company’s ongoing outreach to academia and willingness to work with outside researchers on projects related to human cognition.
Lumosity's Train of Thought Game
At Lumosity, Berkowitz seems eager to move on. As a recent hire, he wasn't named as a defendant in the FTC suit. The company’s former CEO, Kunal Sarkar, and former chief scientific officer, Michael Scanlon, were both named as co-defendants alongside Lumosity in the suit; both Scanlon and Sarkar are currently listed on Lumosity/Lumos Lab’s leadership page, and Sarkar remains the company’s chairman.

Our conversation ended up with three interesting takeaways:

New products and areas of interest: Berkowitz says part of Lumosity’s strategy for 2016 involves expanding the company’s product line into areas such as stress management and sleep patterns.

When I asked Berkowitz if this marked a departure from its emphasis on cognitive training, he told me that "If you think about it, we're about health and wellness. Introducing people to the concept of health and wellness isn’t just physical. It’s also mental health and wellness, and our goal is to introduce those things."

Those Google AdWords keyword buys might not have been the best idea: "We never focused on diseased populations," Berkowitz asserted. He also emphasized that "When ads were purchased, Google gave a suggestion of what keywords to buy. It gives thousands and thousands of suggestions, and we purchased them. We purchased a minimal number of those kind of things, and our intent continues to be on healthy adults. Our idea there is we want to give training tools and learning to help adults."

Lumosity's sticking by its core product: Berkowitz explained with a chuckle that "The best way to kill a low-quality product on the Internet is to market it. It's so easy to switch (to another product)." He added, "We recognize that, and that’s our goal. I feel like this is, as I said earlier, a small dunk in whats going to be a long future."

Though it's common for app companies using AdWords to take a carpet-bombing approach to large clouds of semi-related keywords to see what works and what doesn't, the FTC is particularly sensitive to exaggerated health claims. One of the key challenges for Lumosity is how to straddle the fine line between recreational game and cognitive improvement tool, without pushing it too far.

In the meantime, Lumosity and Lumos Labs aren’t going anywhere. The company, despite the FTC spanking, has a healthy user base, lots of name recognition, and a favorable market position. Now, they need to refine their product and embrace the exuberance of app marketing without crossing the line.

 Link: http://www.fastcompany.com/3055942/how-brain-game-app-lumosity-plans-to-move-on-after-those-deceptive-ad-claims


'Weapons of Financial Mass Destruction'

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Wednesday, January 30, 2013

In Defense of 'Weapons of Financial Mass Destruction'

Research on derivatives concludes they can add to a company’s leverage and market value.
"Allowing firms to focus on the risks they are in business to take, while hedging against risks that they are not in business to take, can add value."
Francisco Pérez-González
Assistant Professor of finance, Stanford GSB
Financial derivatives have been in the doghouse of public opinion ever since the financial meltdown of 2008, when Warren Buffett famously described them as "weapons of mass financial destruction."
Today, a battle is still underway in Washington over how — or whether — to rein them in. But corporations and finance experts have long debated a more basic question: Does hedging actually increase the market value of corporations?
Every business exposes itself to a long list of risks. Abrupt changes in consumer demand for smartphones, for example, drastically reduced the outlook for once-dominant firms such as Nokia and Research in Motion. A sudden drop in the value of the dollar can sharply improve prospects of U.S. exporters at the expense of foreign rivals. Changes in oil prices have a big impact on airlines, trucking, and other oil-consuming industries.
Yet hedging by itself isn't inherently profitable: Some firms reap gains, while others pay for insurance they don't use. The overall effect over time is likely to be a wash.
As a result, the traditional view in corporate finance is that hedging adds nothing to overall shareholder value, especially at publicly traded firms.These firms tend to be owned by diversified investors, and investors can hedge for themselves by holding a diverse portfolio of stocks.

A 'Natural Experiment'

Does that mean derivatives and other forms of hedging are a waste of money? Not necessarily.New research, coauthored by Francisco Pérez-González, an assistant professor of finance at the Stanford Graduate School of Business, shows that hedging has indirect benefits that can increase a firm's overall value.
It has always been difficult to estimate the effects of hedging on firm value. Companies that decide to hedge are often different from companies that don't hedge, making it difficult to interpret the effect of derivatives from differences in company valuations. Financial economists don't have the luxury of setting up random experiments between comparable companies that do and don't hedge.
"We cannot randomly and unexpectedly induce large publicly traded firms to hedge, or to drop an existing risk-management program, just to observe the consequences,” says Pérez-González.
To get around that problem, he and Hayong Yun at the University of Notre Dame took a novel approach. They created a "natural experiment" by examining what had happened to weather-sensitive firms — mainly natural gas and electricity providers — after the introduction of weather derivatives for hedging against unusual swings in temperature.
Weather-derivatives first surfaced in 1997, and the Chicago Mercantile Exchange began trading options tied to unusual hot and cold spells in 1999. The contracts work like any other type of insurance: You pay for it in good times, and it only pays off if the unwanted problem arrives. For utilities, especially in some areas of the country, exceptionally hot or cold weather can dramatically affect their business costs and revenue.
Pérez-González and Yun call their study a "natural experiment" because the sudden availability of new weather derivatives created a natural control group within a given industry. That made it possible to isolate the impact of derivatives by comparing companies with large weather risk before and after the new hedging tools became available.
Not surprisingly, the researchers found that weather-sensitive utilities embraced the new derivatives more frequently than those that faced less risk. More surprisingly, the researchers found that weather-sensitive firms increased their value — as measured in ratio of market value to book value — by at least 6%.

Taking the Right Risk

But why? If hedging is ultimately a wash, sometimes paying off and sometimes not, how did the firms as a group end up ahead?
Pérez-González and Yun think they have the answer: The companies that reduced their exposure to weather risk were able to make more productive use of their capital and reap higher rewards for investors. The researchers found that companies became more financially aggressive after using the derivatives, apparently because they didn't have to reserve as much money for unpredictable weather shocks. The companies increased their leverage and their capital expenditures as weather derivatives were introduced. That, in turn, led to higher market valuations.
"Allowing firms to focus on the risks they are in business to take, while hedging against risks that they are not in business to take, can add value," says Pérez-González. "The goal of the hedging strategy should be to maximize the firm cash-flows. Our evidence shows that firms increased their cash-flows by using their balance sheets more aggressively and by investing more.”
The same lessons should apply to many other kinds of hedging, such as against swings in foreign exchange rates, oil prices, or interest rates. If the risk of such fluctuations limits management's ability to concentrate on the main business, Pérez-González says, companies have a case for managing the risks.

A Fine Line Between Hedging and Speculation

The study doesn't settle all the questions about the impact of derivatives. Banks and Wall Street firms thought credit-default swaps could reduce, if not eliminate, their risk on subprime mortgages. But when the entire financial industry became over-confident, the total risk exposure became far higher than it would have been if no one had hedged in the first place.
"Derivatives can exacerbate both firm and systemic risk exposures," Pérez-González and Yun acknowledged in their paper. "Not surprisingly, financial derivatives have played a central role in recent financial crises."
Pérez-González cautions that there is a fine line between hedging and speculating. "Most non-financial corporations have no expertise in predicting the direction of foreign exchange rates or commodity prices, for example, but many risk managers attempt to take a view, and those bets frequently turn out to be costly. A hedge should seek to reduce risk exposure; it should not be a gamble on the direction of the market."

The Science Of Investing And The Evolving Definition Of Alpha

The Science Of Investing And The Evolving Definition Of Alpha

Aug 21 2013

includes: MMTM, TILT, TLTD, TLTE

By Samuel Lee

Though it sometimes is hijacked by ideologues, the scientific method works. 


The most successful societies entrust scientifically trained workers with the most specialized tasks, such as performing brain surgery, designing airplanes, and setting marketwide interest rates. And yet, many individuals regularly entrust their fortunes to the investing equivalents of witch doctors and astrologers. Or they take matters into their own hands for no good reason other than a vague belief that they can do it if they put their minds to it. Unlike good scientists, they're not skeptical enough of themselves or others.

Brains and education are no panacea. My father is a tenured professor of electrical engineering at one of South Korea's top research universities. When he designs a microchip, he draws on his years of education, consults industry journals, and relies heavily on the work of other engineers. When he speculates in small-cap technology stocks, his efforts are far more casual and sometimes include asking me which ones I like--I always profess ignorance. Despite admittedly subpar performance over 20-something years of investing, he refuses to give up control and index his holdings. It's as if the logical, skeptical part of his brain shuts down, and a more animal, overconfident part of his brain takes over in all matters investing. Would I, armed with nothing more than the efforts of a few spare hours each week, go into the chip-design business to compete with the likes of Intel and ARM? Of course not.

There is a science to investing. Though you may not know them by their technical names, chances are you're familiar with the fruits of Modern Portfolio Theory, the connection between risk and return, the theory of interest, and the efficient market hypothesis. Parts of financial theory are so integral to the practice of investing that most investors have forgotten they originated in academia. That said, some domains are more amenable to scientific expertise than others. The sweetest fruits of biomedicine originate from trained scientists; the best investment results don't always originate from finance Ph.D.s. In fact, some of the greatest investors are derisive of "scientific" approaches to investing. Warren Buffett warned, "Beware of geeks bearing formulas."

Why aren't finance professors dominant in investing? I can think of several reasons. The foremost reason is certainly emotion, which can consume even the finest minds. Famed logician Kurt Gödel was terrified of being poisoned and ate only food prepared by his wife, Adele. When she was hospitalized for six months, he starved himself to death. Even very smart investors can kill their retirement plans when they're in thrall to their animal brains. Investing requires unusual discipline that, by definition, most people lack. Moreover, this quality, in my experience, seems unrelated to brainpower.

Second, finance and economic researchers often don't have powerful enough tools to divine as much meaning from the available data as they'd like. That doesn't stop them from trying, though, and they often end up making astrologers look good by comparison. Not helping matters is how their work can have profound economic, social, and political implications, tempting researchers into the morass of politics, where their impartiality often withers and dies. Find me an economist who assumes nuanced positions that can't be neatly described as Democrat or Republican, and I'll show you someone who's practically irrelevant in the nation's political discourse.

Third, most of the information in the markets is not quantifiable with the tools at our disposal. By restricting themselves to hard numbers, scientific investors sometimes miss what qualitative investors see clear as day. Franco Modigliani, of the Modigliani-Miller theorem, was puzzled that so many firms paid dividends. Investors have known since the days of Ben Graham that dividends impose discipline on corporate managers, keeping them from doing too many stupid things. Soft qualities such as culture and incentives matter, even if you can't easily assign numbers to them or model them in a closed-form solution.

There are good reasons be skeptical of the things that come out of finance researchers' mouths, but it's a big mistake to completely dismiss them. I'd go as far as to say evidence-driven investing is the best approach for the majority of investors, because it's based on an efficient learning strategy. Many investors pick a terrible learning strategy: personal experience. Experience is unreliable; colored by emotions and the zeitgeist, it captures a period that's short by the standards of history. Investors traumatized by the Great Depression learned that stocks are dangerous and should be avoided; investors who rode the bull markets of the 1980s and 1990s learned that stocks are unstoppable engines of wealth. Both learned the hard way that personal experience is a flawed teacher.

A better strategy is to learn from history, so you don't repeat the mistakes past generations made. Scientific investing, at its best, is about engaging the data honestly, with the intention of learning something new, hopefully something discordant with previously held beliefs. Science as it's currently practiced has plenty of flaws, but it's still the most reliable method of acquiring the truth that I know of.

What are the fruits of science as it pertains to investing? There's a lot of nonsense, but also a great deal of sense: Factors are important, and most investors should focus on investing in them.

Factor Investing

Unless you like to open the occasional dusty academic tome, chances are you're not intimately familiar with factor investing. It's really not as esoteric as it sounds. You've heard of style investing--small cap versus large cap, or value versus growth. If you've ever tilted to a particular style, you've engaged in factor investing. Style investing is a kind of factor investing, dealing with only two factors: size (large-small) and value (value-growth).

A working definition of a factor is an attribute of an asset that both explains and produces excess returns. Factor investing can be thought of as buying these return-generating attributes rather than buying asset classes or picking stocks.

None of this is new. The original factor theory, dating back to the 1960s, is the capital asset pricing model, or CAPM, which predicts that the only determinant of an asset's expected return is how strongly its returns move (or, in technical terms, covary) with the market's. The strength of the relationship is summarized in a variable called beta. A beta of 1 indicates that for each percentage point the market moves, an asset's price moves in the same direction by a percentage point. CAPM predicts asset returns are linearly related to market beta. However, since the 1970s, academics have known that stock returns don't seem to be related to beta. This finding spurred many fruitless or convoluted attempts to explain how market efficiency could be squared with a world in which CAPM didn't work.

Eugene Fama and Kenneth French "fixed" the CAPM, at least for stocks, by adding two factors: size and value. They observed that smaller stocks outperformed larger stocks and stocks with high book/market outperformed stocks with low book/market. More importantly, the relationships were smooth; the smaller or more value-laden the stock, the higher its return. Fama and French interpret the smoothness of the relationship as indicating the market is rationally "pricing" these attributes, which implies that size and value strategies enjoy higher expected returns for being riskier.

Further research has uncovered more stock factors, including momentum, quality, and low volatility, in nearly every equity market studied. They also display the same smooth relationship: The stronger the factor attribute, the higher the excess returns. The interpretation of these factors depends on whether you believe the market is efficient. In an efficient market, they must be connected to risk. However, if the market is not perfectly rational, some may represent quantitative strategies that exploit mispricings to produce excess returns.

I don't believe value, quality, momentum, and low-volatility strategies work because they are riskier. The strategies were exploited by investors before academics triumphantly published them in journals as "discoveries." It's also hard to reconcile them all as representing risk because if you lump them all together, you get an eerily smooth return stream.

This does not mean that all factors earn profits by identifying mispricings. Some attributes, such as illiquidity, are associated with higher returns because they obviously represent risk. So factor investing encompasses two different approaches:

Rational factor theory, which deals with the rewards that accrue to different types of risk and how the market prices them. Factor investing in this context is about finding the optimal portfolio of factor risks.

Factor investing as commonly understood by practitioners, which is the identification of simple quantitative strategies associated with excess returns.

Though it's been around for decades, factor investing has only in the past decade gained adherents. Recent converts include the Government Pension Fund of Norway, the biggest pension fund in Europe, and CalPERS, the biggest public pension fund in the United States. They've seen the light after realizing that the active managers they were richly compensating were simply offering factor risks and factor-based strategies under the guise of skill.

Redefining Alpha

An implication of factor-based investing is that what was once legitimately deemed "alpha"--excess returns attributable to skill--has morphed into "beta" (or a factor) once researchers identify a simple strategy that replicates the alpha. For instance, certain hedge fund managers in the 1980s and 1990s pursued then-exotic strategies such as merger arbitrage that produced excellent returns uncorrelated to the market. However, once researchers identified how the arbitrage strategies worked and created mechanical replications, the managers' alpha became beta.

A consequence of this process is that the hurdle for being declared a truly skilled manager has risen over time. In the 1980s, it was good enough to beat your benchmarks. These days, studies looking for evidence of skill in equity mutual funds control for exposure to size, value, and momentum factors. In other words, if your excess returns come during times that value, smaller-cap, or momentum stocks outperform, the procedure will adjust your "excess" return to zero and declare you unskilled.

If you believe the excess returns of value and momentum strategies reflect risk, then it's a reasonable adjustment. If you believe value and momentum produce excess returns because of market inefficiency, then it's not--what you've done is redefine outperformance. I'm of the latter view. From my perspective, the mountains of studies purporting to show that active equity managers can't beat the market are really showing that much of their excess returns can be replicated by a handful of factor strategies.

Disclosure: Morningstar, Inc. licenses its indexes to institutions for a variety of reasons, including the creation of investment products and the bench marking of existing products. When licensing indexes for the creation or benchmarking of investment products, Morningstar receives fees that are mainly based on fund assets under management. As of Sept. 30, 2012, AlphaPro Management, BlackRock Asset Management, First Asset, First Trust, Invesco, Merrill Lynch, Northern Trust, Nuveen, and Van Eck license one or more Morningstar indexes for this purpose. These investment products are not sponsored, issued, marketed, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in any investment product based on or benchmarked against a Morningstar index.

Source: http://seekingalpha.com/article/1649412-the-science-of-investing-and-the-evolving-definition-of-alpha

Why the price of oil will recover faster than you think.

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Our thoughts on why the price of oil will recover faster than you think. @fpinvesting http://natpo.st/1Zx7BSF 


Venture Cappital - Medical Cannabis

How to Invest in Dope

Cut paper by Bovey Lee/Tom Schierlitz for The New York Times

Brendan Kennedy and Michael Blue, private-equity financiers, settled into a downtown Seattle conference room in March to meet with a start-up. Both wore charcoal blazers and polished loafers. Kennedy, 41, is the former chief operating officer of SVB Analytics, an offshoot of Silicon Valley Bank. Blue, 35, learned his trade at the investment-banking firm de Visscher & Co. in Greenwich, Conn. Two years ago they quit comfortable posts to form Privateer Holdings, a firm that operates on the Kohlberg Kravis Roberts model: they buy companies using other people’s money and try to increase their value. What sets them apart is the industry in which they invest. Privateer Holdings is the first private-equity firm to openly risk capital in the world of weed. Or as the Privateer partners prefer to call it, “the cannabis space.” 
Megan and Ben Schwarting, a casually dressed couple in their early 30s, made a presentation. Their company, Kush Creams, produces “cannabis topicals,” which are lotions andcreams infused with marijuana’s active ingredients. Kennedy and Blue had invited them in to learn more about the pot-cream market.
“We know nothing about topicals,” Blue said as he reached for a little jar of something called Purple Haze. “Walk us through this like we’re third graders,” Kennedy added.
Megan offered a nervous smile. Their products, she said, contain cannabinoids like THC and CBD. They’re medically active but won’t get you high.
“What do people use it for?” Kennedy asked.
“Pain relief, initially,” Megan said. But customers have found them useful for “everything from fibromyalgia to psoriasis.”
She told the financiers about their product line, which included eye creams, toothache drops and a first-aid spray called Owie Wowie.
“How do you extract it?” Kennedy said, referring to the cannabinoid oil that’s mixed into the lotion.
“That’s kind of our company secret,” Ben said. “We work mostly with one strain. Others don’t produce quite the same effect.”
“What led you to start the company?” Kennedy asked.
The couple acknowledged that they started years ago as pot growers. “Then we had daughters and wanted to move into something with less risk,” Megan said.
The Privateer partners are always hunting for a good investment, but it was apparent that they wouldn’t be taking a stake in topicals any time soon. Though state law allows the manufacture and sale of cannabis topicals, Kennedy and Blue worried about whether you could make the stuff without violating federal drug laws. This put topicals off-limits as an investment, at least for now. If there’s one rule that Privateer lives by, it’s “don’t touch the leaf.”
Kennedy and Blue’s venture into the cannabis space began three years ago. At the time, Kennedy was directing the operations of SVB Analytics, which specializes in entrepreneurial fields like high tech, genomics, medical devices and green energy. He spent part of his time in San Francisco and Santa Clara, Calif., for work and part in Seattle, where his wife has a high-profile career with the Pacific Northwest Ballet.
One day a call came in to the SVB office from an entrepreneur who sold inventory software to medical-marijuana dispensaries. He wanted to know how to attract venture capital. Christian Groh, who was head of sales at SVB Analytics, took the call and told Kennedy about it. They were intrigued and amused. Pot software? They knew their own firm wouldn’t touch it. “Nobody wants to be known as the first banker or venture capitalist to make an investment in the cannabis industry,” Kennedy later told me. “The risk to the firm’s reputation is too great.”
Later that week, as he drove on I-280 through Silicon Valley’s green hills, Kennedy happened to tune in a radio show on marijuana legalization. He hadn’t touched pot since he was 19, he says, but the notion proposed by one guest seemed to make sense: Marijuana should be regulated like whiskey or wine. Kennedy thought about the software developer. Maybe there was a way to get into the business without being directly involved with pot. The growing and selling of marijuana, as it becomes increasingly legal, will require many ancillary products. “When everyone is looking for gold,” the saying goes, “it’s a good time to be in the pick-and-shovel business.”
When Kennedy pulled off the highway, he called Blue, his old Yale School of Management classmate. “You know how we’ve always talked about starting something together?” he said. “I think I’ve found it. We need to start a venture-capital firm in the cannabis space.”
At the time, Blue, who is from Arkansas, was happily ensconced at a sleepy financial firm in Little Rock, where he and his wife had settled to raise their children near her parents. If you were casting a comedy, Blue would be the bow-tied square who thinks things are getting out of hand when somebody orders a second pitcher of beer. To him, Kennedy’s idea was outrageous. It was insane. And it was interesting.
That night, lying in bed, Blue turned to his wife, Christina. “I’m going to tell you something about a conversation I just had with Brendan,” he said. “No one knows about it yet. But here’s what he’s thinking.” Neither Kennedy nor Blue could shake the notion. Working during their off-hours in Santa Clara and Little Rock, they dug into the existing marijuana research. They read the 1970 Controlled Substances Act, National Institute on Drug Abuse reports, medical studies from all over the world. They made reconnaissance visits to dozens of marijuana dispensaries. They decided that the only way they’d be comfortable even seriously thinking about the idea was if they could determine that marijuana was truly helpful for medical patients.
It was clear that not everyone with a medical-marijuana card was consuming pot for medical reasons. But they also came to the conclusion that many sick people were being helped. “One study after another pointed to its effectiveness for treating symptoms of multiple sclerosis, epilepsy and chemotherapy,” Blue recalled. The research wasn’t completely exculpatory, of course. Some studies suggested that chronic pot use could lead to long-term cognitive deficits, especially among people who start in their teens. Still, they found enough evidence to persuade themselves and, they hoped, potential investors.
But Kennedy and Blue were not just interested in cannabis for humanitarian reasons — they knew the payoff could be enormous. Medical marijuana is now a $1.5 billion industry, it’s estimated, operating in 18 states and Washington, D.C. Within the next year New York and three other states may join them. A recent Fox News poll found that 85 percent of Americans — and 80 percent of self-identified Republicans — approved of the medical use of marijuana if a physician prescribed it. Last November voters in Colorado and Washington State went one step further — legalizing marijuana for adults 21 and older. And recently, the Pew Research Center reported that for the first time in more than 40 years of polling, a majority of the nation’s adults now favor full legalization. (In 1991, only 17 percent of adults supported it.)
Still there was a criminal risk, though how great was unclear. Much depends on the federal response to medical-marijuana laws and the new statutes in Washington State and Colorado. The Justice Department’s current policy on medical marijuana has turned district U.S. attorneys into de facto drug czars, with some (New Mexico) allowing the handful of dispensaries to operate and others (California) raiding and closing hundreds of retail operations.
In thinking about whether to go into the pot business, Kennedy and Blue struck upon the historical example of Joseph Kennedy (no relation to Brendan) and the repeal of Prohibition. In the fall of 1933, as repeal of the 18th Amendment appeared all but inevitable, the father of the future president traveled to England, where he met with the managing director of the Distillers Company. By the time he returned home, Kennedy had locked up the American import rights to Dewar’s whisky and Gordon’s gin. According to Daniel Okrent’s Prohibition history, “Last Call,” Kennedy had previously obtained medicinal liquor permits and warehouse space. (“Medical liquor” could be legally purchased with a doctor’s prescription.) On Dec. 6, 1933, the day after Prohibition ceased, Kennedy’s Somerset Importers was up and running.
The way Brendan Kennedy saw it, he and Blue had the chance to do what Joe Kennedy did 80 years earlier. Setting themselves up in the medical-marijuana field made good short-term sense, and their early entry would position Privateer Holdings as a major player if marijuana turned fully legal.
Still, they worried. “We realized early on that the biggest risk wasn’t legal,” Kennedy told me one day between investor pitches. “It was the risk to our professional and personal reputations.” Investing in the cannabis space would most likely burn their bridges to the traditional banking world. They floated trial balloons to see how the idea played among friends and family. One of Kennedy’s older brothers, a firefighter, was open to it. He told Kennedy about an old family friend, a rock-ribbed Republican fire captain, who used cannabis to fight the nausea from chemotherapy treatments when he battled cancer in the 1990s. Kennedy had no idea.
“We heard stories like that almost every time we brought up the subject,” Blue said.
Blue’s elders at his Little Rock firm — old Southern country-club gents — reacted with interest, not disgust. Blue recalled James Atkins, the firm’s 78-year-old managing director who was known as Bum, telling him: “You’re talking about more risk than I’ve ever taken on. If you do it, do it the right way. Make sure everything’s aboveboard and legal.”
At the end of six months, Kennedy’s idea had evolved from crazy to risky. “Where are you at with this?” he asked Blue. Blue thought about it. “I’m about 70 percent in,” he said.
In January 2011, Kennedy felt that they needed to make a decision. The opening was clear. By some estimates, the size of the state-legal market could reach nearly $9 billion by 2016. That would make it equivalent to the worldwide market for mobile gaming. “This is an existing billion-dollar industry with immature companies run by unprofessional managers,” he told me. “There are no market leaders, no standards and poor branding. There’s a taboo around the product that’s rapidly changing. There’s no involvement by Wall Street, venture capital or banks — yet. I’ve never seen an opportunity like it.”
Blue needed to think it over. He and his wife dropped the kids with her parents and took a day to map out the potential risks and benefits. He would be putting marijuana on his résumé, and start-ups often fail. But Blue was excited about creating a new market with Kennedy and the rewards could be substantial. After growing up in a small town in Arkansas, he said, meeting people like Kennedy and having opportunities like this “were exactly why I’d gone to business school.” At the end of the day, Christina turned to her husband and said, “You have to do this.” Blue called Kennedy the next day. “One hundred percent,” he said. “I’m in.”
That summer, Kennedy and Blue attended a conference of cannabis-industry leaders at the Hotel Nikko in San Francisco. The two wore suits and ties. “Most people thought we were D.E.A. agents,” Kennedy recalled. They scouted for investment-worthy start-ups but found none. “It was a cavalcade of crazy,” Kennedy recalled. One panel featured industry leaders discussing the benefits of taking a cannabis company public. To Kennedy and Blue, who had actually worked on I.P.O.’s, the notion was delusional. They eventually adopted a new tactic. Every time a panelist offered a crackpot assertion, the financiers scanned the audience to see who seemed to be rolling their eyes. “Those were the people we wanted to talk to.”
The conference forced them to reconsider their business model. “We’re way too early,” Kennedy said to Blue. Entrusting great sums of cash to the equivalent of Harold and Kumar seemed foolhardy. Kennedy and Blue decided they had to switch from a venture enterprise to a private-equity model, in which they could purchase companies and install their own management if necessary.
A handful of accredited investors openly backed marijuana-related companies. But most of them, including members of the ArcView Group, the most visible cannabis-financing network, had longstanding ties to medical dispensaries and marijuana activism. They were successful cannabis entrepreneurs looking to help out the industry’s next generation. Privateer wanted to be different. It would remain far from the leaf, considering investments in only those businesses that were “legal at the local, state and federal level,” as Blue put it: inventory-tracking software, lighting for indoor grow sites, security services for sites and dispensaries, business liability insurance.
Blue began to commute between Arkansas and Seattle, eventually relocating his family. Christian Groh, the SVB colleague who took that initial phone call from the pot programmer, was the firm’s third founding partner. The private-equity model proved popular with investors, who began wiring money to Privateer Holdings in November 2011. None of their investors were comfortable being named, but Kennedy said a handful of old-money families in New York and Boston have accounts with the firm. Though there aren’t any pension funds or institutional investors, the firm has attracted wealthy individuals on the political left (who often see cannabis as a humanitarian cause) and on the right (who view it as a libertarian cause). “If you put our investors in a room, they wouldn’t agree on anything other than this one issue,” Kennedy told me.
By the end of 2011, the firm had enough cash on hand to make its first purchase. They chose Leafly, a Yelp-like Web site that offers crowdsourced reviews of medical-marijuana dispensaries and cannabis strains. A big part of the site’s appeal was that it wasn’t already branded with symbols of pot culture. “It didn’t have any of the old clichés,” Kennedy said. “The site wasn’t plastered with pot leaves or pictures of Bob Marley.”
Shortly after the cannabis-topicals presentation, I went with Kennedy, Blue and Tonia Winchester, who helps direct Privateer’s corporate strategy, to Heckler Associates, a Seattle ad agency, to discuss a campaign for Leafly. “We had to pitch the Heckler partners for six hours to get them to take us on,” Kennedy told me on the way over.
Heckler is known for taking small companies and breaking them nationwide, and the firm’s lobby is decorated with logos designed for Starbucks, K2 and New Balance. Scott Lowry, the accounts director, led the Privateer team into a back office, where he laid out the contents of a Leafly marketing kit being readied for shipment to 500 medical-marijuana dispensaries. A few weeks before, Lowry and the Privateer team looked at light green Leafly promotional stickers. The logo was good. Everything about it from the rounded typeface to the red, green and purple rectangles, had been designed to be as mainstream and friendly as Amazon or Target. But the stickers’ background color sent the wrong message: hippie, head shop. Now Lowry showed the team new white stickers, which looked bright and pristine. Blue nodded, pleased.
Lowry ticked through the marketing box. “We’ve got T-shirts, hats, stickers, magnets, window clings, dispensary bags, posters and a brochure display,” he said. To reinforce the medicinal aspect of dispensaries and Leafly, the Heckler team had printed thousands of Leafly-branded bags, just like the ones handed out at the pharmacy counter at Walgreens or Rite Aid.
One item on the contents sheet caught Kennedy’s eye. “Where we list the hat, it says, ‘Skull cap,’ ” he said. “ ‘Skull cap’ is skater. It’s aggressive. What about ‘beanie’? ‘Beanie’ is happy.”
Toward the end of the meeting, Lowry revealed a Leafly ad aimed at a mainstream print publication. The ad featured two residents of an upscale New York City neighborhood. A dapper businessman exits his brownstone. “While beating cancer, Ian used Blue Dream,” the copy said, referring to a specific type of cannabis. A woman on her morning run passes nearby. “Molly prefers Kali Mist to relieve pain.” The tagline: “What’s your strain?”
It looked like a pharmaceutical ad: urban professionals each using a specific strain of cannabis to address a specific need — and using it like an antidepressant or a statin. Lowry later explained the thinking. “In the early ’60s, Honda wanted to sell motorcycles to Middle America,” he said. The problem was the motorcycle’s reputation. Hoodlums and outlaws rode motorcycles. Think of Brando in “The Wild One.” “So Honda came out with a campaign: ‘You meet the nicest people on a Honda.’ ” The ads featured mothers and daughters, wealthy dowagers, even Santa Claus, all riding Hondas. Cannabis, Lowry said, is the new motorcycle.
The Privateer team loved it. “This ad could run in The Wall Street Journal or an AARP publication,” Kennedy said as we walked out into the street. “Ultimately we’re trying to create reliable, trusted products that are attractively packaged. What this industry needs is a clean American brand.”

Bruce Barcott is a former Guggenheim Fellow who is currently writing a book about the battle over salmon and Indian treaties in the Pacific Northwest.
Editor: Ilena Silverman

Animal Parts - an illegal Market

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Jennifer believes we live in the garden of Eden and I believe that we are destroying it. Our saving grace is within ourselves, our faith, and our mindfulness. We need to make a conscious effort to respect and preserve all life.