Tuesday, December 28, 2010
Stranded in Airport Hotel
More flights got canceled tonight, I am getting sick of the crowd. This is too much!
Saturday, December 18, 2010
Thursday, December 16, 2010
Madoff's son found hanged
NEW YORK - Disgraced financier Bernard L. Madoff's eldest son hanged himself in his apartment Saturday, exactly two years after his father's arrest in a multibillion-dollar Ponzi scheme that swindled thousands of investors of their life savings.
Mark Madoff, 46, was found hanging from a ceiling pipe in the living room of his SoHo loft apartment as his 2-year-old son slept in a nearby bedroom, according to law enforcement officials.
Madoff, who reported his father to authorities, has never been criminally charged in the biggest investment fraud in U.S. history and has said he and his brother Andrew never knew of their father's crimes.
Although Mark Madoff was not known to be facing arrest, he and other relatives have remained under investigation and been named in investor lawsuits accusing them of profiting from the scheme.
"This is a terrible and unnecessary tragedy," Madoff's lawyer, Martin Flumenbaum, said in a written statement. "Mark was an innocent victim of his father's monstrous crime who succumbed to two years of unrelenting pressure from false accusations and innuendo."
A lawyer for Mark's mother, Ruth Madoff, said, "She's heartbroken."
Mark Madoff's body was discovered - hanging from a black dog leash - after he sent an e-mail early Saturday morning to his wife, Stephanie, saying that someone should check on their 2-year-old son, law enforcement officials said, speaking on the condition of anonymity because they weren't authorized to speak publicly about the death.
Madoff's wife, who was visiting Disney World in Florida with her 4-year-old daughter, sent her stepfather to the home. The toddler was found unharmed.
Bernard Madoff, 72, swindled a long list of investors out of billions of dollars. He admitted to running his scheme for at least two decades, cheating thousands of individuals, charities, celebrities and institutional investors. Losses are estimated at about $20 billion, making it the biggest investment fraud in U.S. history. He was arrested on Dec. 11, 2008, after confessing his crimes to his sons.
Just days ago, a court-appointed trustee filed a lawsuit seeking to recover any money from the fraud scheme that had been paid to members of the Madoff family, including Mark Madoff's two young children.
Calls to the FBI and U.S. Attorney's office were not immediately returned. Previously, spokesmen for the brothers had repeatedly denied that they had any knowledge of their father's crimes.
Bernard Madoff is serving a 150-year prison sentence in North Carolina. Bureau of Prisons spokeswoman Traci Billingsley said Saturday she didn't have specific information on whether he had been informed of his son's death or would be allowed to attend a service.
Mark Madoff, 46, was found hanging from a ceiling pipe in the living room of his SoHo loft apartment as his 2-year-old son slept in a nearby bedroom, according to law enforcement officials.
Madoff, who reported his father to authorities, has never been criminally charged in the biggest investment fraud in U.S. history and has said he and his brother Andrew never knew of their father's crimes.
Although Mark Madoff was not known to be facing arrest, he and other relatives have remained under investigation and been named in investor lawsuits accusing them of profiting from the scheme.
"This is a terrible and unnecessary tragedy," Madoff's lawyer, Martin Flumenbaum, said in a written statement. "Mark was an innocent victim of his father's monstrous crime who succumbed to two years of unrelenting pressure from false accusations and innuendo."
A lawyer for Mark's mother, Ruth Madoff, said, "She's heartbroken."
Mark Madoff's body was discovered - hanging from a black dog leash - after he sent an e-mail early Saturday morning to his wife, Stephanie, saying that someone should check on their 2-year-old son, law enforcement officials said, speaking on the condition of anonymity because they weren't authorized to speak publicly about the death.
Madoff's wife, who was visiting Disney World in Florida with her 4-year-old daughter, sent her stepfather to the home. The toddler was found unharmed.
Bernard Madoff, 72, swindled a long list of investors out of billions of dollars. He admitted to running his scheme for at least two decades, cheating thousands of individuals, charities, celebrities and institutional investors. Losses are estimated at about $20 billion, making it the biggest investment fraud in U.S. history. He was arrested on Dec. 11, 2008, after confessing his crimes to his sons.
Just days ago, a court-appointed trustee filed a lawsuit seeking to recover any money from the fraud scheme that had been paid to members of the Madoff family, including Mark Madoff's two young children.
Calls to the FBI and U.S. Attorney's office were not immediately returned. Previously, spokesmen for the brothers had repeatedly denied that they had any knowledge of their father's crimes.
Bernard Madoff is serving a 150-year prison sentence in North Carolina. Bureau of Prisons spokeswoman Traci Billingsley said Saturday she didn't have specific information on whether he had been informed of his son's death or would be allowed to attend a service.
Wednesday, December 15, 2010
Correlated or diversified?
Correlation? Markets moving together? Correlation is a misleading metric of little help in measuring or achieving diversification. Highly correlated assets CAN diversify portfolios but some "uncorrelated" managers are too dependent on the market. Below is a hypothetical hedge fund with +1.00 correlation to the S&P 500. Absolute returns in all years and CAGR +17.65% but PERFECTLY correlated to a risky index fund which lost money. It diversified despite that pesky correlation.
The diversification "free lunch" has been arbitraged away, at least in mainstream risky asset classes. The best way to diversify a long is with a short NOT another long. Diversify the right way not diworsify the old way but correlation is STILL used as a critical input for portfolio construction and risk management. Why? During meltdowns correlations rise but now it occurs in "normal" market conditions as well, adding to risk rather than reducing it. Securities may move together more due to herding, ETFs and algorithmic trading. The passive mania forces benchmark components up or down regardless of value whether stocks, bonds or commodities. Hasn't everyone learnt the danger of "cheap" index tracking and its expensive cost?
Beta is often cited as a measure of volatility. But it's really correlation adjusted for the relative volatilities of the fund and benchmark. You can have a low beta security that is high risk and a high beta fund LESS risky than the market. Idiosyncratic risk isn't a risk; it's the idiosyncratic alpha you want. Alpha and absolute returns aren't the same. The textbook calculations of beta and alpha are based on correlation which, as the example above shows, isn't useful. The identification of true beta - dependence on underlying risk factors - and true alpha - value added through skill rather than luck - is much more complicated.
The omnipotent correlation matrix drives much portfolio "optimization". A bunch of inputs from data dredging history whose forward-looking output is even more error prone. Garbage in, garbage squared out. Correlation is a bad measure of magnitude. On "up days" most stocks go up but they don't all rise by the same percentage. Relative value strategies take advantage of varying price moves even if in the same direction. I don't mind if an investment has correlation of +1.00, 0.00, -1.00 or anything in between. It's irrelevant. I do care it has minimal sensitivity to anything else in the portfolio. Sadly for investors MVO and CAPM have been shown to be simple, elegant and completely useless. MPT is pronounced EMPTY and is better called Medieval Portfolio Theory.
"Modern" portfolio theory requires lots of wild guesses known as capital market assumptions, including expected returns, expected volatilities and expected correlations. Scary how trillions are invested in this weird way and the poor "results" speak for themselves. Those variables aren't robust, stable or likely to be accurate in constructing a long term portfolio. I've kept track of such facile forecasts and the tea leaf reading so-called "experts" who made them. Pretty bad outcomes but those fortune teller predictions keep being used. We are ALL affected by assets being (mis) allocated in this failed framework. Unlike the crystal ball gazers, I find mispriced securities and safer strategies whose returns outweigh the risks. Is that so radical? At least it works.
Severe drawdowns are unacceptable. It is not surprising conventional wisdom has performed so badly with fake "Nobel" prizes awarded for such "efficient", mean variance "optimized" nonsense. Past asset class returns are no indication of the future over any time horizon including centuries, standard deviation does not measure risk and correlation gives no insight on risk factor dependence. So why is this stuff still used? Everybody knows everything so the markets are random, right? CMA causes almost as many problems as absurd actuarial assumptions. If you keep doing what you always do, you receive what you always get: growing liabilities AND declining assets. Safer to go with skill-based strategies that offer absolute alpha not repackaged beta.
Dispersion? Every month reports emerge on how AVERAGE "hedge funds" performed. Those numbers are meaningless with such disparity of skills and zero-sum nature of alpha. Many public domain strategies are too well-known now so it is not surprising AGGREGATE alpha tends to zero. Skill is rare. The average hides a range of numbers from managers performing very well to many that did not. 2008 saw huge dispersion. The typical hedge fund lost -20% but 3,000 MADE money. True diversification costs 2 and 20 and the quantitative and qualitative resources to isolate manager skill from luck. The basic arithmetic of R-squareds, covariances and variances just don't make the grade.
The best sources of low dependence are time and space diversification. High frequency trading continues to perform well. Amazing how the majority of portfolios still don't allocate to this reliable source of alpha. Last decade was great and returns have also been good this so-called "challenging" year. If algos do constitute 65% of all trading in liquid securities, perhaps a model portfolio should have 65% allocated to HFT? Despite many years of superior returns most investors avoid high frequency strategies! Perhaps "buy and hold for milliseconds" is the natural evolution from the archaic "buy and hold for years". Everything operates on short time horizons nowadays which is a mismatch with so-called "long term" investing. Instead I favor long term performance.
Emerging markets have also had high dispersion with frontier markets tending to outperform. Frontiers are less dependent on the world economy while the term "emerging markets" is often semantic arbitrage for countries that are actually developed. The big BRIC has lost badly to my BRIC but the SLIME has been the star this year. Sri Lanka, Iran, Mongolia and Estonia were missed by almost all international strategists. Could the geographic diversification strategy nowadays be to invest in places that don't offer ETFs? Don't asset allocate X% to emerging market beta. Invest 100% in alpha WHEREVER it can be found.
Unlike that unreliable, unskilled, unhedged trio of unknown FUTURE asset class statistical parameters, I know that a properly diversified portfolio of the best managers properly incentivized to work hard and apply rare skills to their money and yours will deliver over time in all possible scenarios. Changing markets and crowded trades are no excuse for not being able to deliver absolute returns. Of course no-one avoids losses sometimes which is why risk management and low similarity between strategies is important.
Two funds might or might not be correlated but one can be vastly superior and safer than the other. Avoid managers dependent on underlying markets and focus on skill-based strategies. I prefer calculating co-relation and association metrics not coRRelations. High correlations show the markets are even more inefficient. But REAL strategy diversification is what investors actually need.
The diversification "free lunch" has been arbitraged away, at least in mainstream risky asset classes. The best way to diversify a long is with a short NOT another long. Diversify the right way not diworsify the old way but correlation is STILL used as a critical input for portfolio construction and risk management. Why? During meltdowns correlations rise but now it occurs in "normal" market conditions as well, adding to risk rather than reducing it. Securities may move together more due to herding, ETFs and algorithmic trading. The passive mania forces benchmark components up or down regardless of value whether stocks, bonds or commodities. Hasn't everyone learnt the danger of "cheap" index tracking and its expensive cost?
Beta is often cited as a measure of volatility. But it's really correlation adjusted for the relative volatilities of the fund and benchmark. You can have a low beta security that is high risk and a high beta fund LESS risky than the market. Idiosyncratic risk isn't a risk; it's the idiosyncratic alpha you want. Alpha and absolute returns aren't the same. The textbook calculations of beta and alpha are based on correlation which, as the example above shows, isn't useful. The identification of true beta - dependence on underlying risk factors - and true alpha - value added through skill rather than luck - is much more complicated.
The omnipotent correlation matrix drives much portfolio "optimization". A bunch of inputs from data dredging history whose forward-looking output is even more error prone. Garbage in, garbage squared out. Correlation is a bad measure of magnitude. On "up days" most stocks go up but they don't all rise by the same percentage. Relative value strategies take advantage of varying price moves even if in the same direction. I don't mind if an investment has correlation of +1.00, 0.00, -1.00 or anything in between. It's irrelevant. I do care it has minimal sensitivity to anything else in the portfolio. Sadly for investors MVO and CAPM have been shown to be simple, elegant and completely useless. MPT is pronounced EMPTY and is better called Medieval Portfolio Theory.
"Modern" portfolio theory requires lots of wild guesses known as capital market assumptions, including expected returns, expected volatilities and expected correlations. Scary how trillions are invested in this weird way and the poor "results" speak for themselves. Those variables aren't robust, stable or likely to be accurate in constructing a long term portfolio. I've kept track of such facile forecasts and the tea leaf reading so-called "experts" who made them. Pretty bad outcomes but those fortune teller predictions keep being used. We are ALL affected by assets being (mis) allocated in this failed framework. Unlike the crystal ball gazers, I find mispriced securities and safer strategies whose returns outweigh the risks. Is that so radical? At least it works.
Severe drawdowns are unacceptable. It is not surprising conventional wisdom has performed so badly with fake "Nobel" prizes awarded for such "efficient", mean variance "optimized" nonsense. Past asset class returns are no indication of the future over any time horizon including centuries, standard deviation does not measure risk and correlation gives no insight on risk factor dependence. So why is this stuff still used? Everybody knows everything so the markets are random, right? CMA causes almost as many problems as absurd actuarial assumptions. If you keep doing what you always do, you receive what you always get: growing liabilities AND declining assets. Safer to go with skill-based strategies that offer absolute alpha not repackaged beta.
Dispersion? Every month reports emerge on how AVERAGE "hedge funds" performed. Those numbers are meaningless with such disparity of skills and zero-sum nature of alpha. Many public domain strategies are too well-known now so it is not surprising AGGREGATE alpha tends to zero. Skill is rare. The average hides a range of numbers from managers performing very well to many that did not. 2008 saw huge dispersion. The typical hedge fund lost -20% but 3,000 MADE money. True diversification costs 2 and 20 and the quantitative and qualitative resources to isolate manager skill from luck. The basic arithmetic of R-squareds, covariances and variances just don't make the grade.
The best sources of low dependence are time and space diversification. High frequency trading continues to perform well. Amazing how the majority of portfolios still don't allocate to this reliable source of alpha. Last decade was great and returns have also been good this so-called "challenging" year. If algos do constitute 65% of all trading in liquid securities, perhaps a model portfolio should have 65% allocated to HFT? Despite many years of superior returns most investors avoid high frequency strategies! Perhaps "buy and hold for milliseconds" is the natural evolution from the archaic "buy and hold for years". Everything operates on short time horizons nowadays which is a mismatch with so-called "long term" investing. Instead I favor long term performance.
Emerging markets have also had high dispersion with frontier markets tending to outperform. Frontiers are less dependent on the world economy while the term "emerging markets" is often semantic arbitrage for countries that are actually developed. The big BRIC has lost badly to my BRIC but the SLIME has been the star this year. Sri Lanka, Iran, Mongolia and Estonia were missed by almost all international strategists. Could the geographic diversification strategy nowadays be to invest in places that don't offer ETFs? Don't asset allocate X% to emerging market beta. Invest 100% in alpha WHEREVER it can be found.
Unlike that unreliable, unskilled, unhedged trio of unknown FUTURE asset class statistical parameters, I know that a properly diversified portfolio of the best managers properly incentivized to work hard and apply rare skills to their money and yours will deliver over time in all possible scenarios. Changing markets and crowded trades are no excuse for not being able to deliver absolute returns. Of course no-one avoids losses sometimes which is why risk management and low similarity between strategies is important.
Two funds might or might not be correlated but one can be vastly superior and safer than the other. Avoid managers dependent on underlying markets and focus on skill-based strategies. I prefer calculating co-relation and association metrics not coRRelations. High correlations show the markets are even more inefficient. But REAL strategy diversification is what investors actually need.
Monday, December 13, 2010
Warren Buffett or George Soros?
Who's best? Warren Buffett or George Soros? Why risk hard-earned capital with managers who are not the best in the world at what they do? Warren runs the largest hedge fund but George is the top performer. They searched for successors only from hedge funds and all their liquid net worth is in absolute return strategies. The top sportspeople play in major leagues not minors and where do you find the best portfolio managers? George and Warren's edges were clear long ago so there was plenty of time to invest. Their success has brought major social benefits and secure retirements for clients.
Some even claim Warren isn't a hedge fund manager but his arbitrage, leverage, derivatives, event-driven and macro trading added much to returns and he short sold cocoa futures in a special situations deal as far back as 1954. George and Warren generated alpha from low frequency trading in various fund structures. Double Eagle - Quantum, Buffett Partnership - Berkshire Hathaway. Like many hedge funds, they don't report to databases. Neither has a PhD or CFA but both have exceptional quantitative skills. I have never found a good manager that doesn't even if they run "discretionary" styles. Skilled hedge funds do deliver reliable high returns at low risk. And prove that market prices are always wrong.
Portfolio performance is determined by MANAGER mix not ASSET mix. The more people believing in efficient markets the more inefficient markets become. Trillions in index funds creates more alpha capture opportunities for those with skill. Mid-career professionals like Warren and George are thriving while hedge fund managers aged under 80 are building up experience. Pensions worried about "longevity risk" can benefit from investment talent working longer. Over 41 years George has turned $1,000 into $14 million after fees and Warren to $3 million from his actively managed ETF. He charges LOWER fees than "cheap" unskilled long only funds.
George's track record is better but Warren is richer. Why? The snowball of POSITIVE compounding for longer. Both were born in August 1930 and Warren ran his hedge fund from 1957 but George didn't set up his until 1969. Warren was lucky to be in Omaha while Dzjchdzhe Shorash was in Budapest, more affected by WW2. But Warren got into currency trading and global philanthropy later. George's outperformance is due to stronger international diversification and because reflexivity is ignored. Value investing is copied more than reflexivity investing. The boom bust of Eurozone sovereign credits and subprime CDOs are quintessential examples of reflexivity. Crises are PREDICTABLE. And profitable if you have expertise.
Alpha thrives off beta. Warren ran the partnership from 1957-1969 and has since implemented his absolute return strategies via Berkshire Hathaway. He first bought BRKA shares in 1962 at $7.60 and now it's $120,000 for a 22% CAGR. But the Buffett Partnership did better with all 13 years positive. Gross returns of 29.5% were net 23.8% to investors after his 25% incentive fee on 6% hurdle. What if, instead of "retiring" in 1970, Warren had continued the partnership and performance had persisted? Investing $1,000 in 1957 would now be $100 million. Fees that Warren might have been "paid" for turning $1,000 into $100 million would be $1 billion. That's fine since I'd have $99.9 million more than wasting time gambling on "low cost" index funds.
Academics say Warren is just an ex-post lucky outlier but some talent spotters DID seed his fund ex-ante. The S&P 500 also began in 1957 but has performed poorly by comparison - $1,000 would now be $100,000, a huge opportunity cost. Investing for absolute return using competitive edges and outside the box thinking has existed for centuries. Long only relative return is the fad. Passive indexing is even newer. The trouble with owning dartboards is that you get the treble 20 and bullseye but you also tie up precious cash in 1s and 2s. With proper analysis, average hedge funds can be avoided just like average stocks. I prefer to identify the Phil Taylor of each strategy. How many darts must you throw to show skill? George and Warren have hit many treble 20s.
Hard to prove a conjecture but to disprove it ONE counterexample suffices. Warren, George and many others have destroyed efficient market hypotheses, random walk assumptions and the myth that long term policy asset allocation drives portfolio returns. BHB Brinson, Hood, Beebower, Singer and their acolytes have cost too many investors too much money and wrecked retirement plans. Prudent investors in fact want 100% of their capital in attractive opportunities. George and Warren's alpha capture from security selection worked better than static beta bets. No-one says it's easy but if you work hard enough it is possible. Such investment teams CAN be identified at an early stage and can charge whatever hedge fund fees clients are prepared to pay.
Some hedge funds shut due to SUCCESS. Warren closed his in 1969 despite a strong track record as Stanley Druckenmiller did recently with Duquesne. The Buffett Partnership was set up when Benjamin Graham decided to end his Graham-Newman hedge fund, operating decades before AW Jones' "first" hedge fund. Warren is correct that the best investment book ever written in English is the Intelligent Investor. The second best is Alchemy of Finance though fortunately hardly anyone else bothers to try to understand it. The top hedge fund book in any language is of course Fountain of Gold written by the best hedge fund manager ever. I re-read them all every year and every year my self-directed pension ends up with double-digit ABSOLUTE RETURNS. Coincidence?
Warren wants to be judged on book value not stock price but you can't eat book value and I evaluate fund managers by what investors really receive. Partnerships are marked at NAV but the switch to BRKA subjected clients to irrational public markets. In 2008 BRKA book value dropped -9.6% but shareholders lost -31.8%. George made money that allegedly "challenging" year. While the stock has returned more than book value due to the valuation premium, volatility has been high. Warren's actual Sharpe ratio is lower than book value "Sharpe ratio", dropping sharply from 1.4 to 0.6.
The Oracle of Omaha and the Brain of Budapest have "quit" before and been searching for "successors" for a long time. George has been hiring "replacements" since 1981 and the extent of his fund management involvement has fluctuated since though never without close knowledge of and implied oversight of the portfolio. For each Li Lu or Todd Combs there was a Jim Marquez or Stanley Druckenmiller. No man is an island and both sought out strong colleagues and talented employees from early on. Jim Rogers and Charlie Munger added significantly. Accredited investors - anyone with $80 - can access Warren and Charlie's abilities through BRKB, a listed closed-end hedge fund. The active stockpickers at benchmark construction firms missed 45 years of massive growth but then add it to their "unmanaged" index!
Would Warren and George have bothered managing outside money if they hadn't been incentivized to do so and perform? It's skill that adds value. No alpha, no incentive fee. George's partnership fees were lower than Warrens's for gross returns above 25%. Since George and Warren's gross performance was in excess of 25%, George's fee structure was actually cheaper. Jim Simons and team have outperformed both for the past 20 years with much higher fees but the net returns of Medallion Fund were superior. The technological and personnel infrastructure requirements for high frequency trading cost more than for low frequency. If you don't like the fees, don't invest in hedge funds. Capacity for a good strategy is limited and demand exceeds supply of alpha. But it's expensive and dangerous waiting to find out WHETHER bargain beta might one day deliver.
Those "outrageous" fees? George charged 1% and 20% no hurdle whereas Warren charged 0% and 25% on 6% hurdle, then offered his money management skills for FREE in return for permanent, leveraged capital. But you would have done much better going with Soros Fund Management in 1969 and paying those "high" fees than you would with BRKA. I am delighted for people to be well compensated for delivering what I need, ABSOLUTE ALPHA, from their RARE abilities. If someone turns $1,000 into $100 million from skill not luck or riding the market, they deserve $1 billion. Especially when manager interests are aligned with clients by them being the largest investor in their fund. When George or Warren has a bad month, they PERSONALLY lose more than any client. That INCENTIVIZES them to do their best to minimize the downside.
You CAN eat absolute returns and I'll take $100 million over $100,000 every time. I assume you would too. So what if the manager becomes a billionaire? They deserve it for the essential entrepreneurial service they offer. If clients get rich, it is fine by me if the manager gets richer. Plenty of "discount" funds are available but at what performance? Avoiding "high" fees for alpha is like saying to a Porsche dealer you will only pay $100 for a new car because that is what the raw materials cost. Or that Shakespeare was just a lucky fool who "randomly" chose words from the dictionary. I am writing this on Apple AAPL hardware using Microsoft MSFT software uploaded to a service owned by Google GOOG. Using those products may further enrich several people who are already billionaires. Does it matter?
The chart above assumes fees compound without the manager needing any profits to eat, live, pay employees, run the business etc. which of course they do. In recent years, with investor demands for larger teams, deep benches and operational infrastructure, fixed costs for hedge funds have risen to the 2 and 20 mode. Two people, a computer and a phone do not get institutional money today. Sad though to see an Omaha pension fund deep in a $600 million deficit when they could so easily have hired a local hedge fund run by Warren Buffett get them into surplus. The Hungary retirement system is not in good shape either but they could have invested with George Soros and would now be doing fine. Why avoid the top absolute return managers when you have ABSOLUTE LIABILITIES to fund?
No-one is forced to invest in hedge funds. Investors are free to make do with passive beta and relative return if they so choose. Some outliers even say alpha doesn't exist! For those "surprised" by the Euro crisis in Spain, Ireland, Greece, Belgium, Portugal etc., George saw the dangers long ago. Yet macroeconomic "stability" maven Robert Mundell keeps his "Nobel" Prize for now. Optimum currency areas aren't optimal so he should give it to George. If you flip a coin 10 times and get 8 heads it might be a fluke but NOT if you flip 1,000,000 coins and get 800,000 heads. Warren and George have flipped too many coins for their returns to be considered luck. They made their clients rich, deservedly got richer themselves and are giving their wealth away for the social benefit of the world. A rare financial win/win/win.
Some even claim Warren isn't a hedge fund manager but his arbitrage, leverage, derivatives, event-driven and macro trading added much to returns and he short sold cocoa futures in a special situations deal as far back as 1954. George and Warren generated alpha from low frequency trading in various fund structures. Double Eagle - Quantum, Buffett Partnership - Berkshire Hathaway. Like many hedge funds, they don't report to databases. Neither has a PhD or CFA but both have exceptional quantitative skills. I have never found a good manager that doesn't even if they run "discretionary" styles. Skilled hedge funds do deliver reliable high returns at low risk. And prove that market prices are always wrong.
Portfolio performance is determined by MANAGER mix not ASSET mix. The more people believing in efficient markets the more inefficient markets become. Trillions in index funds creates more alpha capture opportunities for those with skill. Mid-career professionals like Warren and George are thriving while hedge fund managers aged under 80 are building up experience. Pensions worried about "longevity risk" can benefit from investment talent working longer. Over 41 years George has turned $1,000 into $14 million after fees and Warren to $3 million from his actively managed ETF. He charges LOWER fees than "cheap" unskilled long only funds.
George's track record is better but Warren is richer. Why? The snowball of POSITIVE compounding for longer. Both were born in August 1930 and Warren ran his hedge fund from 1957 but George didn't set up his until 1969. Warren was lucky to be in Omaha while Dzjchdzhe Shorash was in Budapest, more affected by WW2. But Warren got into currency trading and global philanthropy later. George's outperformance is due to stronger international diversification and because reflexivity is ignored. Value investing is copied more than reflexivity investing. The boom bust of Eurozone sovereign credits and subprime CDOs are quintessential examples of reflexivity. Crises are PREDICTABLE. And profitable if you have expertise.
Alpha thrives off beta. Warren ran the partnership from 1957-1969 and has since implemented his absolute return strategies via Berkshire Hathaway. He first bought BRKA shares in 1962 at $7.60 and now it's $120,000 for a 22% CAGR. But the Buffett Partnership did better with all 13 years positive. Gross returns of 29.5% were net 23.8% to investors after his 25% incentive fee on 6% hurdle. What if, instead of "retiring" in 1970, Warren had continued the partnership and performance had persisted? Investing $1,000 in 1957 would now be $100 million. Fees that Warren might have been "paid" for turning $1,000 into $100 million would be $1 billion. That's fine since I'd have $99.9 million more than wasting time gambling on "low cost" index funds.
Academics say Warren is just an ex-post lucky outlier but some talent spotters DID seed his fund ex-ante. The S&P 500 also began in 1957 but has performed poorly by comparison - $1,000 would now be $100,000, a huge opportunity cost. Investing for absolute return using competitive edges and outside the box thinking has existed for centuries. Long only relative return is the fad. Passive indexing is even newer. The trouble with owning dartboards is that you get the treble 20 and bullseye but you also tie up precious cash in 1s and 2s. With proper analysis, average hedge funds can be avoided just like average stocks. I prefer to identify the Phil Taylor of each strategy. How many darts must you throw to show skill? George and Warren have hit many treble 20s.
Hard to prove a conjecture but to disprove it ONE counterexample suffices. Warren, George and many others have destroyed efficient market hypotheses, random walk assumptions and the myth that long term policy asset allocation drives portfolio returns. BHB Brinson, Hood, Beebower, Singer and their acolytes have cost too many investors too much money and wrecked retirement plans. Prudent investors in fact want 100% of their capital in attractive opportunities. George and Warren's alpha capture from security selection worked better than static beta bets. No-one says it's easy but if you work hard enough it is possible. Such investment teams CAN be identified at an early stage and can charge whatever hedge fund fees clients are prepared to pay.
Some hedge funds shut due to SUCCESS. Warren closed his in 1969 despite a strong track record as Stanley Druckenmiller did recently with Duquesne. The Buffett Partnership was set up when Benjamin Graham decided to end his Graham-Newman hedge fund, operating decades before AW Jones' "first" hedge fund. Warren is correct that the best investment book ever written in English is the Intelligent Investor. The second best is Alchemy of Finance though fortunately hardly anyone else bothers to try to understand it. The top hedge fund book in any language is of course Fountain of Gold written by the best hedge fund manager ever. I re-read them all every year and every year my self-directed pension ends up with double-digit ABSOLUTE RETURNS. Coincidence?
Warren wants to be judged on book value not stock price but you can't eat book value and I evaluate fund managers by what investors really receive. Partnerships are marked at NAV but the switch to BRKA subjected clients to irrational public markets. In 2008 BRKA book value dropped -9.6% but shareholders lost -31.8%. George made money that allegedly "challenging" year. While the stock has returned more than book value due to the valuation premium, volatility has been high. Warren's actual Sharpe ratio is lower than book value "Sharpe ratio", dropping sharply from 1.4 to 0.6.
The Oracle of Omaha and the Brain of Budapest have "quit" before and been searching for "successors" for a long time. George has been hiring "replacements" since 1981 and the extent of his fund management involvement has fluctuated since though never without close knowledge of and implied oversight of the portfolio. For each Li Lu or Todd Combs there was a Jim Marquez or Stanley Druckenmiller. No man is an island and both sought out strong colleagues and talented employees from early on. Jim Rogers and Charlie Munger added significantly. Accredited investors - anyone with $80 - can access Warren and Charlie's abilities through BRKB, a listed closed-end hedge fund. The active stockpickers at benchmark construction firms missed 45 years of massive growth but then add it to their "unmanaged" index!
Would Warren and George have bothered managing outside money if they hadn't been incentivized to do so and perform? It's skill that adds value. No alpha, no incentive fee. George's partnership fees were lower than Warrens's for gross returns above 25%. Since George and Warren's gross performance was in excess of 25%, George's fee structure was actually cheaper. Jim Simons and team have outperformed both for the past 20 years with much higher fees but the net returns of Medallion Fund were superior. The technological and personnel infrastructure requirements for high frequency trading cost more than for low frequency. If you don't like the fees, don't invest in hedge funds. Capacity for a good strategy is limited and demand exceeds supply of alpha. But it's expensive and dangerous waiting to find out WHETHER bargain beta might one day deliver.
Those "outrageous" fees? George charged 1% and 20% no hurdle whereas Warren charged 0% and 25% on 6% hurdle, then offered his money management skills for FREE in return for permanent, leveraged capital. But you would have done much better going with Soros Fund Management in 1969 and paying those "high" fees than you would with BRKA. I am delighted for people to be well compensated for delivering what I need, ABSOLUTE ALPHA, from their RARE abilities. If someone turns $1,000 into $100 million from skill not luck or riding the market, they deserve $1 billion. Especially when manager interests are aligned with clients by them being the largest investor in their fund. When George or Warren has a bad month, they PERSONALLY lose more than any client. That INCENTIVIZES them to do their best to minimize the downside.
You CAN eat absolute returns and I'll take $100 million over $100,000 every time. I assume you would too. So what if the manager becomes a billionaire? They deserve it for the essential entrepreneurial service they offer. If clients get rich, it is fine by me if the manager gets richer. Plenty of "discount" funds are available but at what performance? Avoiding "high" fees for alpha is like saying to a Porsche dealer you will only pay $100 for a new car because that is what the raw materials cost. Or that Shakespeare was just a lucky fool who "randomly" chose words from the dictionary. I am writing this on Apple AAPL hardware using Microsoft MSFT software uploaded to a service owned by Google GOOG. Using those products may further enrich several people who are already billionaires. Does it matter?
The chart above assumes fees compound without the manager needing any profits to eat, live, pay employees, run the business etc. which of course they do. In recent years, with investor demands for larger teams, deep benches and operational infrastructure, fixed costs for hedge funds have risen to the 2 and 20 mode. Two people, a computer and a phone do not get institutional money today. Sad though to see an Omaha pension fund deep in a $600 million deficit when they could so easily have hired a local hedge fund run by Warren Buffett get them into surplus. The Hungary retirement system is not in good shape either but they could have invested with George Soros and would now be doing fine. Why avoid the top absolute return managers when you have ABSOLUTE LIABILITIES to fund?
No-one is forced to invest in hedge funds. Investors are free to make do with passive beta and relative return if they so choose. Some outliers even say alpha doesn't exist! For those "surprised" by the Euro crisis in Spain, Ireland, Greece, Belgium, Portugal etc., George saw the dangers long ago. Yet macroeconomic "stability" maven Robert Mundell keeps his "Nobel" Prize for now. Optimum currency areas aren't optimal so he should give it to George. If you flip a coin 10 times and get 8 heads it might be a fluke but NOT if you flip 1,000,000 coins and get 800,000 heads. Warren and George have flipped too many coins for their returns to be considered luck. They made their clients rich, deservedly got richer themselves and are giving their wealth away for the social benefit of the world. A rare financial win/win/win.
Monday, December 6, 2010
Equity is a buy here, by Marc Faber
Equity Markets--Last month, Faber was somewhat cautious on US stocks, saying that sentiment was overly bullish and vulnerable to a correction. So far, we have seen a slight decline in stocks as the QE euphoria fades and worries mount in the PIIGS. Faber thinks the correction could continue as things in Europe worsen. However, he does not expect the market to fall below the 1010-1050 range on the S&P 500 because of the Bernanke. Of all the developed markets, Faber likes Japan the most. He thinks a declining yen will help Japanese equities. Furthermore, Japan is under owned by institutions.
Emerging Markets--Those who are investing in emerging markets are late to the party. The market has mostly priced emerging markets to perfection, which makes further gains difficult. Faber favors frontier markets (especially those levered to natural resources) whose valuations are more favorable. Faber even likes developed markets (US, Europe, Japan) more than he likes emerging markets right now.
Gold & Silver--Faber still likes gold and continues to accumulate ounces, but he says a correction to $1200 would not surprise him. Gold bull market remains intact as the majority of individual investors and institutions remain under invested.
Bonds--Continues to hate US government bonds.The risk versus reward is not favorable as Faber does not believe bond yields will make new lows. However, he does like Russian and Central Asian corporate bonds, even though he expects interest rates to rise in the future.
Currencies--Euro is going down against the dollar and will likely fall further because of the EU debt crisis. Generally, a higher dollar leads to lower stock prices. Long-term the dollar will weaken but for now it continues to benefit as the world reserve currency.
Overall, Faber expects world equity markets to remain well supported in the medium-longer term because people have nowhere else to put their money. Once bond yields start to rise, all of those people who piled into bonds will redeploy funds into equities. Also, all of those people sitting in cash are getting tired of zero percent returns and equities make the most sense.
There you have it: Faber's outlook for December. Good luck trading!
Emerging Markets--Those who are investing in emerging markets are late to the party. The market has mostly priced emerging markets to perfection, which makes further gains difficult. Faber favors frontier markets (especially those levered to natural resources) whose valuations are more favorable. Faber even likes developed markets (US, Europe, Japan) more than he likes emerging markets right now.
Gold & Silver--Faber still likes gold and continues to accumulate ounces, but he says a correction to $1200 would not surprise him. Gold bull market remains intact as the majority of individual investors and institutions remain under invested.
Bonds--Continues to hate US government bonds.The risk versus reward is not favorable as Faber does not believe bond yields will make new lows. However, he does like Russian and Central Asian corporate bonds, even though he expects interest rates to rise in the future.
Currencies--Euro is going down against the dollar and will likely fall further because of the EU debt crisis. Generally, a higher dollar leads to lower stock prices. Long-term the dollar will weaken but for now it continues to benefit as the world reserve currency.
Overall, Faber expects world equity markets to remain well supported in the medium-longer term because people have nowhere else to put their money. Once bond yields start to rise, all of those people who piled into bonds will redeploy funds into equities. Also, all of those people sitting in cash are getting tired of zero percent returns and equities make the most sense.
There you have it: Faber's outlook for December. Good luck trading!
Thursday, December 2, 2010
This time, the Oscar goes to.... ME
Take-Knowledge to Protect-Knowledge, the ever-evolving Technology
--mattewho
While the entire world is blaming Greenspan for bringing down the financial world single-handedly, I find myself having a soft spot for him. The poor guy was not only over-criticized; he was over-credited for his ability. It was the technology, the robust computers and sophisticated applications, which developed innovative derivative and structured products, that played a significant role in the 2008 financial tsunami. With 13 investment banks vanishing in six months, the long- standing US financial system, built by our founding fathers, and designed to be idiot-proof, was brought to the brink of collapse. Apparently, our genius didn’t foresee technology being the potential beast. In the middle of the crisis, I had lunch with a retired former colleague, who called computer “the sewing machine”; she was once ranked among the top 100 financial analysts on Wall Street. We were reverse engineering one derivative fund using rainbow option. She grasped the concept quickly and then bursted out: “This is too complex to calculate, how can one price it daily?” “Certainly not by your slide rule.” I replied. Of course, my rude comment almost cost us our friendship.
Not to challenge Einstein’s Twin Paradox, but time in Technology dimension does travel at a different speed. When I first joined the firm, the number of employees was about 35% of current size, but the number of servers was less than 1% of what we have now. Surprisingly, despite the fact we are an old fashion behind-the-curve investment firm, we had a State-Of-Art server at that time, a Net-FRAME server. (See news attached at bottom). The server was wrapped in large black steel; you would have to be a professional heavy weight wrestler to lift it. It had 128MB memory, and, not to scare you, 1GB hard drive! With the price tag at $30K of current money, it was the Holy Grail at the time. Fast forward 16 years, servers with 1000% more capacities are either invisible (virtualized) or built like a pizza box, and at fractional cost. Wall Street has classified the computer hardware sector as commodity. In a mere 16 years, the exquisite piece of Art in Sotheby has turned into the framed Art in Costco. It is quite an insult to the Industry; luckily, in a nice way.
The rapid growth of Internet since 1995 has become the vital force for the world economy; it has enabled business accessing, storing, and processing information, worldwide, all in split second; Aided by fast growing robust infrastructure, business was turning the vast amount of information collected from Internet into massive innovative products. By the same channel, it was marketing, selling, and distributing the products within real time of producing. In a nutshell, Internet and information technology have made information extremely fluid. As professionals in the financial industry, we all know how powerful the word “liquidity” is. In retrospect, financial service industry has benefited from Technology more than any other sectors of the world economy. Powerful combination of rapid growth infrastructure and sophisticated financial applications enabled firms to develop innovative, structured and highly complex products to meet customers’ needs. High-speed Internet pushed Finance into twenty-four-hour, seven-day-a-week global activity with vast sums flashing between markets. The ability to instantaneously interpret the financial markets and anticipate their movement has brought huge profits to Financial Service Industry.
Entering new millennium, as more information is disseminated electronically, the ability to manipulate is also growing, the vital force (Simultaneous Information sharing and transmission) that drove the world economy in the last decade, has recently started to show its dark side. After growing incidences of malicious virus attacks and identity theft, people’s sense of privacy and security is diminishing. A recent Wall Street Journal survey indicated that privacy is the issue that concerns Americans most in the twenty-first century, ahead of overpopulation, racial tensions, and global warming. Businesses can’t talk enough about privacy, and are rushing to pass laws to protect it; during an IT leader conference held in past May, the majority of the topics were about privacy regulations and security enforcement; technology for business productivity and innovation received little interest and mention. Obviously, technology is shifting towards a more defensive strategy: to secure data, to protect knowledge, and to reduce complexity.
One way to protect privacy is to set regulations. While I have no doubt about the necessity of regulations, I am less confident about the efficacy. Let’s take the corruption Index; it is higher in highly regulated countries. Let alone the lengthy process of regulation creation: Who picks and chooses the data to protect and not protect? What about information shared globally? Who would the new regulations apply to? What data are protected? What’s considered commerce? Lots of questions; few answers. This is surely just the beginning.
The other way to solve the problem of data security is to spend money on technology, for instance, applying secure web gateways to prevent employee exchange of web based email and postage on social network sites. The tools are useful, but only up to a certain degree, and to a certain point. You don’t have to be technologically savvy to register a free logmein account, which would enable you to connect to home PC from work and perform all the activities blocked by employer. So ultimately, the problem cannot be solved by technology alone because it is not purely technical in nature. Although technical defense is vital, systems are inherently vulnerable to both negligent and malicious acts by people. The real challenge for IT today is learning how to influence people’s behavior; security needs to shift towards being an influential mechanism. To achieve the approach, we need first to understand the business, and then enable the business to achieve its objectives in a way that is secure.
Every revolution has its challenges; that is part of the evolution. The original date of early human use of fire for cooking was about 1.6 million year ago, yet the evidence of their ability to control fire was dated only around 400,000 years ago. For over a million years, they faced the threat of fire but never gave up cooking. If history repeats itself, as it always does, we will find the solution for privacy and security successfully.
--mattewho
While the entire world is blaming Greenspan for bringing down the financial world single-handedly, I find myself having a soft spot for him. The poor guy was not only over-criticized; he was over-credited for his ability. It was the technology, the robust computers and sophisticated applications, which developed innovative derivative and structured products, that played a significant role in the 2008 financial tsunami. With 13 investment banks vanishing in six months, the long- standing US financial system, built by our founding fathers, and designed to be idiot-proof, was brought to the brink of collapse. Apparently, our genius didn’t foresee technology being the potential beast. In the middle of the crisis, I had lunch with a retired former colleague, who called computer “the sewing machine”; she was once ranked among the top 100 financial analysts on Wall Street. We were reverse engineering one derivative fund using rainbow option. She grasped the concept quickly and then bursted out: “This is too complex to calculate, how can one price it daily?” “Certainly not by your slide rule.” I replied. Of course, my rude comment almost cost us our friendship.
Not to challenge Einstein’s Twin Paradox, but time in Technology dimension does travel at a different speed. When I first joined the firm, the number of employees was about 35% of current size, but the number of servers was less than 1% of what we have now. Surprisingly, despite the fact we are an old fashion behind-the-curve investment firm, we had a State-Of-Art server at that time, a Net-FRAME server. (See news attached at bottom). The server was wrapped in large black steel; you would have to be a professional heavy weight wrestler to lift it. It had 128MB memory, and, not to scare you, 1GB hard drive! With the price tag at $30K of current money, it was the Holy Grail at the time. Fast forward 16 years, servers with 1000% more capacities are either invisible (virtualized) or built like a pizza box, and at fractional cost. Wall Street has classified the computer hardware sector as commodity. In a mere 16 years, the exquisite piece of Art in Sotheby has turned into the framed Art in Costco. It is quite an insult to the Industry; luckily, in a nice way.
The rapid growth of Internet since 1995 has become the vital force for the world economy; it has enabled business accessing, storing, and processing information, worldwide, all in split second; Aided by fast growing robust infrastructure, business was turning the vast amount of information collected from Internet into massive innovative products. By the same channel, it was marketing, selling, and distributing the products within real time of producing. In a nutshell, Internet and information technology have made information extremely fluid. As professionals in the financial industry, we all know how powerful the word “liquidity” is. In retrospect, financial service industry has benefited from Technology more than any other sectors of the world economy. Powerful combination of rapid growth infrastructure and sophisticated financial applications enabled firms to develop innovative, structured and highly complex products to meet customers’ needs. High-speed Internet pushed Finance into twenty-four-hour, seven-day-a-week global activity with vast sums flashing between markets. The ability to instantaneously interpret the financial markets and anticipate their movement has brought huge profits to Financial Service Industry.
Entering new millennium, as more information is disseminated electronically, the ability to manipulate is also growing, the vital force (Simultaneous Information sharing and transmission) that drove the world economy in the last decade, has recently started to show its dark side. After growing incidences of malicious virus attacks and identity theft, people’s sense of privacy and security is diminishing. A recent Wall Street Journal survey indicated that privacy is the issue that concerns Americans most in the twenty-first century, ahead of overpopulation, racial tensions, and global warming. Businesses can’t talk enough about privacy, and are rushing to pass laws to protect it; during an IT leader conference held in past May, the majority of the topics were about privacy regulations and security enforcement; technology for business productivity and innovation received little interest and mention. Obviously, technology is shifting towards a more defensive strategy: to secure data, to protect knowledge, and to reduce complexity.
One way to protect privacy is to set regulations. While I have no doubt about the necessity of regulations, I am less confident about the efficacy. Let’s take the corruption Index; it is higher in highly regulated countries. Let alone the lengthy process of regulation creation: Who picks and chooses the data to protect and not protect? What about information shared globally? Who would the new regulations apply to? What data are protected? What’s considered commerce? Lots of questions; few answers. This is surely just the beginning.
The other way to solve the problem of data security is to spend money on technology, for instance, applying secure web gateways to prevent employee exchange of web based email and postage on social network sites. The tools are useful, but only up to a certain degree, and to a certain point. You don’t have to be technologically savvy to register a free logmein account, which would enable you to connect to home PC from work and perform all the activities blocked by employer. So ultimately, the problem cannot be solved by technology alone because it is not purely technical in nature. Although technical defense is vital, systems are inherently vulnerable to both negligent and malicious acts by people. The real challenge for IT today is learning how to influence people’s behavior; security needs to shift towards being an influential mechanism. To achieve the approach, we need first to understand the business, and then enable the business to achieve its objectives in a way that is secure.
Every revolution has its challenges; that is part of the evolution. The original date of early human use of fire for cooking was about 1.6 million year ago, yet the evidence of their ability to control fire was dated only around 400,000 years ago. For over a million years, they faced the threat of fire but never gave up cooking. If history repeats itself, as it always does, we will find the solution for privacy and security successfully.
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