With the threat of a bond market crash on the horizon, a series of new products promise to turn a profit by selling short Treasury bonds. But not all of them deliver for buy-and-hold investors – and some of may perform no better than the bond indexes they're supposed to short.
Last week, ProShares launched a new exchange-traded fund that lets investors short Treasury inflation-protected securities, or TIPS – the ninth such exchange-traded product to debut since 2008. Already investors have put more than $7.3 billion into funds that short U.S. government bonds. Since January 2010, two have more than doubled in size and one has more than tripled. And the iPath Treasury 10-Year Bear ETN ( DTYS: 55.36, -0.30, -0.53% ) , launched last August, is now 22 times the size it was six months ago.
The growing popularity of these funds is easy to understand. They basically allow investors to bet that interest rates will rise, causing bond prices to fall, says Robert Whitelaw, the chair of the finance department at New York University's Stern School of Business. Today's low rates and the prospect of future growth and inflation make rising rates likely, says Bret Barker, a fixed income specialist at TCW. Some investors may also have concerns about the country's high debt level, Barker says: Treasury prices would fall if investors around the world starting dumping Treasurys on worries about the U.S.'s ability to pay off its debt, just as prices on Greek and Irish debt fell last year.
But investors who buy these arguments shouldn't necessarily buy inverse Treasury ETFs. Most of the products are designed to give investors the inverse of the daily performance of a benchmark long Treasury index. The key word is daily: That means that returns are compounded every day. Over a month you don't get the negative of the total monthly return, but the compounded version of negative daily returns, says Whitelaw. "They're actually not the same thing." As a result, an ETF that tracks the Barclays Capital U.S. 20+ Year Treasury Bond Index ( TLT: 89.92, +0.40, +0.44% ) is down 5.27% since August 2009, while the inverse product that tracks the same index has fallen 6.16%.
The problem with compounding, mathematically, is that a loss always has a bigger impact than a gain, says John Gabriel, an ETF strategist at Morningstar. If you have $100 in an investment that gains 10% one day, you now have $110. Lose 10% the next day, and you're not even – you're in the hole, down to $99.
Add leverage, as many of these products do, and the "volatility drag" from daily compounding bites even harder, Gabriel says. Take our hypothetical $100 investment that gains 10% and then loses 10% - a two-times leveraged product would end those two days at $96 (up 20% to $120, then down 20% of that, which is $24). The real-world results prove the point: Since the Direxion Daily 20 Year Plus Treasury Bear 3x Shares ETF was launched in April 2009, the ETF that tracks long-duration Treasuries is down 13.24%, but its leveraged inverse twin is down 20.05%. That's not tracking error – these ETFs are delivering exactly the results they're designed to. "The problem with inverse ETFs is not that they're bad, it's that they don't give people exactly what they think they're getting," Whitelaw says.
Investors using these products do need to make sure they understand how they work, says Andy O'Rourke, Direxion's chief marketing officer. Because they have a daily performance goal, investors should watch their performance daily, O'Rourke says. "Volatile periods will hurt the expected performance, but if we see a period where interest rates start rising slowly but steadily, that's going to be fortuitous for a leveraged fund. If it is a steady trend, you'll actually see the performance be more than 3 times the index's return," he says.
For buy-and-hold investors, the lesser-known exchange-traded notes are actually a better solution, Gabriel says. Instead of rebalancing daily, these products provide investors with returns calculated at maturity or redemption, at a rate of 10 cents per one-point move in the underlying index. For November through January, for example, the Barclays Capital Long Bond US Treasury Futures Targeted Exposure Index is down 12.72% and the iPath US Treasury Long Bond Bear ETN ( DLBS: 55.39, -0.09, -0.16% ) is up 13.89%. Because of their different design, this and the other two iPath ETNs that short Treasuries ( DTYS ( DTYS: 55.36, -0.30, -0.53% ) and DTUS ( DTUS: 51.09, -0.17, -0.33% ) ) could comfortably be held for longer periods, Gabriel says.
Alternatively, investors could seek out a variety of assets that do well in periods of growth and inflation, including stocks , Mahn says. Unless an investor has a strong conviction about a very short-term move in Treasurys, "the longer-term view is just not to own them, period, and to own other assets," Barker says.
Read more: How to Short the U.S. Government - SmartMoney.com http://www.smartmoney.com/investing/etfs/how-to-short-the-us-government-1297787508930/#ixzz1E5nznxt6
Showing posts with label Digest. Show all posts
Showing posts with label Digest. Show all posts
Tuesday, February 15, 2011
Monday, January 17, 2011
Facebook vs. Groupon
With all of the hubbub about Facebook and Mark Zuckerberg these days, I want to remind you guys that they are not the only game in town.
In fact, there's another hottie at the dance who may not win homecoming queen, but could turn out to be better marriage material down the road.
Now that I have the attention of the feminazis and Facebook groupies, I crack open my umbrella and await the rainfall of hate and ridicule.
Groupon > Facebook...by a Country (wide) Mile
As most of you guys guffaw over Goldman's bucket shop production with Facebook as the lead, I am not impressed.
As Goldman does battle with Stanley over the coveted Groupon IPO,however, I am all eyes and ears.
This is the hot ticket in town, kids.
It's no secret that I am not a Facebook fan, not only due to the fact that I feel it is creating an even more socially retarded generation than the currently vegetative one. I am highly skeptical of Facebook's ability to monetize on all those hundreds of millions of users to the extent that the great hype machine would have us believe.
Groupon, on the other hand is a real deal old time, brick and mortar business. A cash cow, with a focused yet expansive niche.
Where Facebook is the silicone enhanced, makeup laden 10 with a fetish for cocaine, cowboys and the liquid diet.
Groupon's the solid 8 with great genetics, an angel's attitude, cooks, cleans, raises the kids, makes her own cash and has her head on straight.
Yeah...I just went there.
Groupon's recent rebuff of Google's $6 billion dollar takeover offer have sent (reasonable) IPO spec figures into the $15 billion range.
Though that is far beneath the (unreasonable) $50 billion Facebook valuation of a few weeks back, Groupon can actually back its valuation with a sea of revenue streams and (most importantly) a specific proven scalable business model.
I am going on the record. I like Groupon better than Facebook, as an investment vehicle.
In fact, I don't think Facebook is even in Groupon's league from the individual investor's perspective as far as returns go.
Of all the IPOs in recent memory, I think Groupon has the potential to be the greatest value play.
Facebook's not even in its league.
Let the hate...I mean debate begin!
Tuesday, January 4, 2011
Art Funds as Alternative Investment
According to Friedrich Kiradi, head of Merit Alternative Investments GmbH and director of the world-wide first Art Photography Fund. “Investments in material assets such as real estate, commodities, as well as art, continues to be an area that investors seem to be focusing on, with the growing importance of ‘art investment’ as bridge between the art and finance world.” In addition to the financial gains as an investor in the Art Photography Fund, holders are by request able to experience an “emotional yield” in receiving actual works held within the fund upon redemption. The Art Photography Fund has gained more than 15% since inception in March 2008.
“We are convinced that there are better opportunities for investing in sectors or artists that are currently not being ‘hyped’; but rather recognised pieces equalling the standard of works displayed in museums by ‘blue chip’ artists”, according to Johannes Faber, gallery owner and advisor to the fund. The performance of the Art Photography Fund has supported his argument, with the fund closing the rump year 2008 up 11.68% and gaining +3.11% in 2009 as of the end of May. With this, the fund was not only able to outperform equity and fixed income markets, but also various art market indices.
Blue Chip Art Works
The qualitative goal of the fund is to become the most important collection of icons in art photography of the classical modern period (approximately 1890 – 1960). The focus is on so-called Vintage Quality, in other words original prints, that the respective artists produced themselves or under their supervision. Of these prints, only a very limited number of copies are available in the open market, as many of these unique works are already held in museums or collections. This means that the supply is limited and continuously shrinking, while the demand is steadily rising.
Next to Johannes Faber, the art photography specialist and collector, Alexander Spuller, was also put in place as advisor to the fund. Their combined experience and network enables them to identify purchasing opportunities of undervalued pieces, while the portion of the fund held in cash enables them to react quickly to such opportunities.
“Our approach tends to be a buy and hold strategy, as investment in art always requires a longer-term investment horizon”, according to Spuller, “but selling of art works does occur on a regular basis”. Up to 50% of the annual performance should come from realised sales, so as to confirm the estimated values of holdings and also increase the cash reserves for further purchases. To date, actual sales prices achieved were approximately 10% above their respective last estimates given by the two independent valuers.
Besides the encouraging performance of +15.16% since inception in March 2008, the trio is excited about the first important exhibition. The Albertina Museum in Vienna has scheduled to display works of August Sander in January 2010. 70 pieces of works will be on display that the artist, one of the most important photographers of the 20th century, had chosen himself for his last exhibition. This mixed lot was purchased by the fund in the fall of 2008.
Broadly Diversified Portfolio
The collection of the fund is currently made up of over 1,100 works from 130 artists originating from the USA , Europe and Japan. The oldest piece is by Henry Fox-Talbot from 1843, while the youngest works by William Eggleston, Lee Freedlander and William Wegman are from the 1980s. The scope of works covers all epochs of photography and includes early salted paper prints to more recent “dye-transfer prints”. The majority of photographers represented in the fund’s holdings are considered by art historians and critics as “Old Masters of Photography”, such as Man Ray, Henri Cartier-Bresson or Ansel Adams (please see list of artists). In addition, the fund also includes several works and artists with growth potential.
Plans for an Advisory Committee
“We are currently in discussion with representatives of the financial community as well as the international art scene, as we want to have a balanced composition of members advising and supporting the fund”, according to Spuller regarding the future. The fund’s current capacity is around EUR 70 million, at which point the fund will be closed for new investments, so as to ensure that the performance targets will not be affected. The aim is to reach this target by 2011.
Art Photography Fund
The world-wide first fund investing in art photography targets institutional investors such as banks, insurance companies and foundations. Today, subscriptions into the fund can be made at most Austrian banks, in some cases with smaller denominations, as well as being used by asset managers and private bankers. Subscriptions and redemptions can be made on a quarterly basis, with the next date for investment on 30.06.2009. Up-to-date information and monthly estimated NAVs of the Art Photography Fund can be found on the homepage: www.artphotographyfund.com
Johannes Faber
Born 1952 in Vienna , lives in Vienna as gallery owner and curator. In 1983 founded a gallery for photography that has been active in international art dealing since 1995. Since then, advising national and international private collectors and museums in putting together photography collections. His activities exclusively focus on dealing in vintage prints of photography of the classical modern period of the 20th century, that are, among others, presented at world-wide renowned art fairs such as Art-Basel, ArtCologne, ARCO-Madrid, Paris-Photo, Photography-Show New York and Viennafair. The Gallery Johannes Faber is a member of AIPAD (The Association of International Photography Art Dealers) and the Association of Austrian Galleries of Modern Art, of which Mr. Faber was Chairman between 2004 and 2006.
Alexander Spuller
Born in Vienna in 1970. After graduating with a degree in construction engineering and law, Mr. Spuller worked in his family construction business. Since 1990, A. Spuller completed various property projects in Austria , the Czech Republic and Vietnam . In 1998 Mr. Spuller began collecting art photography, and from 1999 started specializing on works of the classical modern period. In 2005 he was appointed Vice Director of the Gallery Johannes Faber.
Friedrich Kiradi
Friedrich Kiradi is Managing Partner of the Merit-Group and Chief Executive of MERIT Alternative Investments GmbH, a fully licensed investment company by the Austrian Financial Market Authority (FMA), that specialises on the management of funds in managed futures, absolute return/equity hedged and real assets (commodity, art). Further areas of business of companies within the Merit-Group include asset management for foundations and risk management for corporations. Merit is regarded as independent competence centre for all applications of financial derivative instruments, and has specialised on structuring innovative and customised products for banks, fund management companies and industrial clients. The company was founded in 1988 and currently employs 40 professionals in their office in Austria , Malta and the USA.
“We are convinced that there are better opportunities for investing in sectors or artists that are currently not being ‘hyped’; but rather recognised pieces equalling the standard of works displayed in museums by ‘blue chip’ artists”, according to Johannes Faber, gallery owner and advisor to the fund. The performance of the Art Photography Fund has supported his argument, with the fund closing the rump year 2008 up 11.68% and gaining +3.11% in 2009 as of the end of May. With this, the fund was not only able to outperform equity and fixed income markets, but also various art market indices.
Blue Chip Art Works
The qualitative goal of the fund is to become the most important collection of icons in art photography of the classical modern period (approximately 1890 – 1960). The focus is on so-called Vintage Quality, in other words original prints, that the respective artists produced themselves or under their supervision. Of these prints, only a very limited number of copies are available in the open market, as many of these unique works are already held in museums or collections. This means that the supply is limited and continuously shrinking, while the demand is steadily rising.
Next to Johannes Faber, the art photography specialist and collector, Alexander Spuller, was also put in place as advisor to the fund. Their combined experience and network enables them to identify purchasing opportunities of undervalued pieces, while the portion of the fund held in cash enables them to react quickly to such opportunities.
“Our approach tends to be a buy and hold strategy, as investment in art always requires a longer-term investment horizon”, according to Spuller, “but selling of art works does occur on a regular basis”. Up to 50% of the annual performance should come from realised sales, so as to confirm the estimated values of holdings and also increase the cash reserves for further purchases. To date, actual sales prices achieved were approximately 10% above their respective last estimates given by the two independent valuers.
Besides the encouraging performance of +15.16% since inception in March 2008, the trio is excited about the first important exhibition. The Albertina Museum in Vienna has scheduled to display works of August Sander in January 2010. 70 pieces of works will be on display that the artist, one of the most important photographers of the 20th century, had chosen himself for his last exhibition. This mixed lot was purchased by the fund in the fall of 2008.
Broadly Diversified Portfolio
The collection of the fund is currently made up of over 1,100 works from 130 artists originating from the USA , Europe and Japan. The oldest piece is by Henry Fox-Talbot from 1843, while the youngest works by William Eggleston, Lee Freedlander and William Wegman are from the 1980s. The scope of works covers all epochs of photography and includes early salted paper prints to more recent “dye-transfer prints”. The majority of photographers represented in the fund’s holdings are considered by art historians and critics as “Old Masters of Photography”, such as Man Ray, Henri Cartier-Bresson or Ansel Adams (please see list of artists). In addition, the fund also includes several works and artists with growth potential.
Plans for an Advisory Committee
“We are currently in discussion with representatives of the financial community as well as the international art scene, as we want to have a balanced composition of members advising and supporting the fund”, according to Spuller regarding the future. The fund’s current capacity is around EUR 70 million, at which point the fund will be closed for new investments, so as to ensure that the performance targets will not be affected. The aim is to reach this target by 2011.
Art Photography Fund
The world-wide first fund investing in art photography targets institutional investors such as banks, insurance companies and foundations. Today, subscriptions into the fund can be made at most Austrian banks, in some cases with smaller denominations, as well as being used by asset managers and private bankers. Subscriptions and redemptions can be made on a quarterly basis, with the next date for investment on 30.06.2009. Up-to-date information and monthly estimated NAVs of the Art Photography Fund can be found on the homepage: www.artphotographyfund.com
Johannes Faber
Born 1952 in Vienna , lives in Vienna as gallery owner and curator. In 1983 founded a gallery for photography that has been active in international art dealing since 1995. Since then, advising national and international private collectors and museums in putting together photography collections. His activities exclusively focus on dealing in vintage prints of photography of the classical modern period of the 20th century, that are, among others, presented at world-wide renowned art fairs such as Art-Basel, ArtCologne, ARCO-Madrid, Paris-Photo, Photography-Show New York and Viennafair. The Gallery Johannes Faber is a member of AIPAD (The Association of International Photography Art Dealers) and the Association of Austrian Galleries of Modern Art, of which Mr. Faber was Chairman between 2004 and 2006.
Alexander Spuller
Born in Vienna in 1970. After graduating with a degree in construction engineering and law, Mr. Spuller worked in his family construction business. Since 1990, A. Spuller completed various property projects in Austria , the Czech Republic and Vietnam . In 1998 Mr. Spuller began collecting art photography, and from 1999 started specializing on works of the classical modern period. In 2005 he was appointed Vice Director of the Gallery Johannes Faber.
Friedrich Kiradi
Friedrich Kiradi is Managing Partner of the Merit-Group and Chief Executive of MERIT Alternative Investments GmbH, a fully licensed investment company by the Austrian Financial Market Authority (FMA), that specialises on the management of funds in managed futures, absolute return/equity hedged and real assets (commodity, art). Further areas of business of companies within the Merit-Group include asset management for foundations and risk management for corporations. Merit is regarded as independent competence centre for all applications of financial derivative instruments, and has specialised on structuring innovative and customised products for banks, fund management companies and industrial clients. The company was founded in 1988 and currently employs 40 professionals in their office in Austria , Malta and the USA.
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, November 29, 2010
North Korea Attack Impact
Global stock markets have recovered after North Korea launched a barrage against South Korea on Tuesday. Yet military tensions are rising: the U.S. has dispatched warships into the Yellow Sea for exercises with its ally Seoul. What’s ahead for business relations between China, which has close political ties to North Korea, and South Korea?
We exchanged by email yesterday with, Yong-Tack Cho, an editor at Forbes Korea, the licensed Korean-language edition of Forbes magazine. Excerpts follow.
Q. Before this week’s attack on South Korea by the North, economic relations between South Korea and China had been expanding despite China’s close political ties to North Korea. Why have economic and business ties managed to grow despite China’s cozy relationship with the North?
A. Indeed, South Korea and China’s trade relations have developed greatly. Currently, 31% of South Korean exports are shipped to China. This is possible because both countries want to see their trade and political relations as two different things. China has wanted to grow its economy and has needed the investment and technology South Korea can provide. On the other hand, South Korea has wanted entry into the Chinese market and its natural resources. While the two countries do not share the same beliefs about North Korea diplomatically, it would have been unwise trade policy to let that get in the way of trade growth.
Q. What’s ahead for business between China and South Korea, in light of North Korea’s attack?
A. It is unlikely the recent attack will get in the way of trade between South Korea and China, as both governments do not wish for it to get in the way of business. If the situation does not escalate, the impact on economic and trade relations will be meager, as there is no proof or indication that China was involved in the attacks.
Q. What South Korean companies, if any, would be most affected by this week’s developments?
A. We expect that this week’s events will have a large impact on the tourism industry, especially from Japan and China. The Korea Tourism Organization held a meeting with its Japan and China offices on the 24th. While they deny any massive wave of travel cancelations, local travel agencies have been reporting significant losses and falling prices for travel packages to Korea. We expect prices to continue to fall for now.
Q. Before this week’s event, what would you say would likely be the outlook for China-Korean business and economic growth in 2011?
A. Before this week, China was seen as a great economic opportunity for Korea. “How to approach the Chinese economy?” was a question that local companies contemplated 10 years ago. (Since then,) Korean conglomerates such as Samsung, LG, Hyundai Motors, and Posco have regularly increased their investment and built production sites in the region. The two governments are currently formulating an FTA agreement. Even after the attack, we do not believe that it will overly impact our business outlook with China.
Q. What’s the outlook for South Korea’s stock market and currency in light of this week’s attacks?
A. The day after the Yeonpyeong Island attack, the KOSPI dropped 45.02 points (2.33%) in the morning. However, the KOSPI jumped back and closed only 2.96 points (0.15%) lower than the previous day. The Korean stock market has been able to regain its stability despite the attacks because we’ve learn from our past experiences. This isn’t the first time we’ve been attacked by North Korea, and foreign investors have been able to build a certain level of tolerance. As Lee Sung-Woo, an analyst from Daewoo Securities, says: “North Korea’s attack may have influenced the liquidity of the global market momentarily, but they can’t get in the way of a rising nation like South Korea from flourishing in the long haul.”
We exchanged by email yesterday with, Yong-Tack Cho, an editor at Forbes Korea, the licensed Korean-language edition of Forbes magazine. Excerpts follow.
Q. Before this week’s attack on South Korea by the North, economic relations between South Korea and China had been expanding despite China’s close political ties to North Korea. Why have economic and business ties managed to grow despite China’s cozy relationship with the North?
A. Indeed, South Korea and China’s trade relations have developed greatly. Currently, 31% of South Korean exports are shipped to China. This is possible because both countries want to see their trade and political relations as two different things. China has wanted to grow its economy and has needed the investment and technology South Korea can provide. On the other hand, South Korea has wanted entry into the Chinese market and its natural resources. While the two countries do not share the same beliefs about North Korea diplomatically, it would have been unwise trade policy to let that get in the way of trade growth.
Q. What’s ahead for business between China and South Korea, in light of North Korea’s attack?
A. It is unlikely the recent attack will get in the way of trade between South Korea and China, as both governments do not wish for it to get in the way of business. If the situation does not escalate, the impact on economic and trade relations will be meager, as there is no proof or indication that China was involved in the attacks.
Q. What South Korean companies, if any, would be most affected by this week’s developments?
A. We expect that this week’s events will have a large impact on the tourism industry, especially from Japan and China. The Korea Tourism Organization held a meeting with its Japan and China offices on the 24th. While they deny any massive wave of travel cancelations, local travel agencies have been reporting significant losses and falling prices for travel packages to Korea. We expect prices to continue to fall for now.
Q. Before this week’s event, what would you say would likely be the outlook for China-Korean business and economic growth in 2011?
A. Before this week, China was seen as a great economic opportunity for Korea. “How to approach the Chinese economy?” was a question that local companies contemplated 10 years ago. (Since then,) Korean conglomerates such as Samsung, LG, Hyundai Motors, and Posco have regularly increased their investment and built production sites in the region. The two governments are currently formulating an FTA agreement. Even after the attack, we do not believe that it will overly impact our business outlook with China.
Q. What’s the outlook for South Korea’s stock market and currency in light of this week’s attacks?
A. The day after the Yeonpyeong Island attack, the KOSPI dropped 45.02 points (2.33%) in the morning. However, the KOSPI jumped back and closed only 2.96 points (0.15%) lower than the previous day. The Korean stock market has been able to regain its stability despite the attacks because we’ve learn from our past experiences. This isn’t the first time we’ve been attacked by North Korea, and foreign investors have been able to build a certain level of tolerance. As Lee Sung-Woo, an analyst from Daewoo Securities, says: “North Korea’s attack may have influenced the liquidity of the global market momentarily, but they can’t get in the way of a rising nation like South Korea from flourishing in the long haul.”
Saturday, November 27, 2010
Top 10 Hedge Fund Blogs
FT Alphaville
Recent Posts from this Blog
Further reading
Swelling Spanish bond yields
Further reading
FiNTAG
Recent Posts from this Blog
THE FINTAG NEWSLETTER @ 11 February 2009
THE FINTAG NEWSLETTER @ 12 March 2009
THE FINTAG NEWSLETTER @ 27 March 2009
Hedge Fund
Recent Posts from this Blog
Correlated or diversified?
Stocks versus bonds?
Hedge fund investment?
Hedge Fund Law Blog
Recent Posts from this Blog
GSEC to Stop Clearing for Small Hedge Funds
NFA Forex Alert
SEC Proposes “Family Office” Definition
Hedge Fund News
Recent Posts from this Blog
Hedge Funds Attract $61 Billion So Far In 2010
Two Florida Hedge Fund Managers Accused In Petters Scheme
Rajaratnam Challenges Wiretap Evidence
HedgeCo.Net
Recent Posts from this Blog
The Inefficient Market Theory
MIT: Peter Thiel, entrepreneur, hedge fund investor and philanthropist
11/16 – NYC – Alpha Gen: Leading Women in Hedge Funds
HedgeFundBlogger.com
Recent Posts from this Blog
Family Office Database Selection Criteria for Capital Raising
John Kenealy Named Vice President of Prime Services Chicago
Hedge Fund Marketing Workshop Completed
HedgeWorld
Recent Posts from this Blog
Ex-RBS Sempra Heads to Launch Physical Commodity Fund
FBI Arrests 2 Longtime Employees in Madoff Fraud
Sales Drop Rattles Sears Investors Before Holidays
Hedgefund$ Weblog
Recent Posts from this Blog
Art Funds
Hedge Fund Competing To Buy British Bank
Hedge Fund Administrator of The Year
The Hedge Fund Implode-o-Meter
Recent Posts from this Blog
Man U Player Of The Century Eric Cantona Appeals For Peaceful Revolution Against Banks, Calls For Europeans To Pull Their Money
Max Keiser: Congress Will Try -- By Secret Vote -- to Retroactively Legalize Foreclosure Fraud
DID THE FED JUST CONFIRM QE2 IS A BANK BAILOUT?
Recent Posts from this Blog
Further reading
Swelling Spanish bond yields
Further reading
FiNTAG
Recent Posts from this Blog
THE FINTAG NEWSLETTER @ 11 February 2009
THE FINTAG NEWSLETTER @ 12 March 2009
THE FINTAG NEWSLETTER @ 27 March 2009
Hedge Fund
Recent Posts from this Blog
Correlated or diversified?
Stocks versus bonds?
Hedge fund investment?
Hedge Fund Law Blog
Recent Posts from this Blog
GSEC to Stop Clearing for Small Hedge Funds
NFA Forex Alert
SEC Proposes “Family Office” Definition
Hedge Fund News
Recent Posts from this Blog
Hedge Funds Attract $61 Billion So Far In 2010
Two Florida Hedge Fund Managers Accused In Petters Scheme
Rajaratnam Challenges Wiretap Evidence
HedgeCo.Net
Recent Posts from this Blog
The Inefficient Market Theory
MIT: Peter Thiel, entrepreneur, hedge fund investor and philanthropist
11/16 – NYC – Alpha Gen: Leading Women in Hedge Funds
HedgeFundBlogger.com
Recent Posts from this Blog
Family Office Database Selection Criteria for Capital Raising
John Kenealy Named Vice President of Prime Services Chicago
Hedge Fund Marketing Workshop Completed
HedgeWorld
Recent Posts from this Blog
Ex-RBS Sempra Heads to Launch Physical Commodity Fund
FBI Arrests 2 Longtime Employees in Madoff Fraud
Sales Drop Rattles Sears Investors Before Holidays
Hedgefund$ Weblog
Recent Posts from this Blog
Art Funds
Hedge Fund Competing To Buy British Bank
Hedge Fund Administrator of The Year
The Hedge Fund Implode-o-Meter
Recent Posts from this Blog
Man U Player Of The Century Eric Cantona Appeals For Peaceful Revolution Against Banks, Calls For Europeans To Pull Their Money
Max Keiser: Congress Will Try -- By Secret Vote -- to Retroactively Legalize Foreclosure Fraud
DID THE FED JUST CONFIRM QE2 IS A BANK BAILOUT?
Wednesday, November 24, 2010
The Rise Of The Modern Investment Bank
From Clipper Ships to KKR
Adam Smith famously described capitalism as an invisible hand guiding the market in its allocation of goods and services. The financial engines of this hand during the 18th and 19th centuries were European merchant banks, such as Hope & Co., Baring Brothers and Morgan Grenfell. For a time, the Netherlands, and later Great Britain, ruled the waves of global commerce in far-flung ports of call such as India and Hong Kong. The merchant banking model then crossed the Atlantic and served as the inspiration for the financial firms founded by prominent families in what could perhaps be called the emerging market of the day - the United States. The structure and activities of early U.S. firms such as JP Morgan & Co. and Dillon Read and Drexel & Co. reflected those of their European counterparts and included financing new business opportunities through raising and deploying investment capital. (For related reading, see The Evolution Of Banking.)
Over time, two somewhat distinct models arose from this. The old merchant banking model was largely a private affair conducted among the privileged denizens of the clubby world of old European wealth. The merchant bank typically put up sizable amounts of its own (family-owned) capital along with that of other private interests that came into the deals as limited-liability partners. Over the 19th century, a new model came into popular use, particularly in the United States. Firms seeking to raise capital would issue securities to third-party investors, who would then have the ability to trade these securities in the organized securities exchanges of major financial centers such as London and New York. The role of the financial firm was that of underwriter - representing the issuer to the investing public, obtaining interest from investors and facilitating the details of the issuance. Firms engaged in this business became known as investment banks. (To learn more about these functions, read Brokerage Functions: Underwriting And Agency Roles.)
Firms like JP Morgan didn't limit themselves to investment banking, but established themselves in a variety of other financial businesses including lending and deposit taking (i.e. commercial banking). The stock market crash of 1929 and ensuing Great Depression caused the U.S. government to reach the conclusion that financial markets needed to be more closely regulated in order to protect the financial interests of average Americans. This resulted in the separation of investment banking from commercial banking (the Glass-Steagall Act of 1933). The firms on the investment banking side of this separation - such as Morgan Stanley, Goldman Sachs, Lehman Brothers and First Boston - went on to take a prominent role in the underwriting of corporate America during the postwar period; the largest gained fame as the so-called "bulge bracket". (For more on this, read What Was The Glass-Steagall Act?)
The term "merchant bank" came back into vogue in the late 1970s with the nascent private equity business of firms like Kohlberg, Kravis & Roberts (KKR). Merchant banking in its modern context refers to using one's own equity (often accompanied by external debt financing) in a private transaction, as opposed to underwriting a share issue via publicly traded securities on an exchange - the classic function of an investment bank. Many of the large global firms today conduct both merchant banking (private equity) and investment banking.
The Regulatory Infrastructure
In the United States, investment banks operate according to legislation enacted at the time of Glass-Steagall. The Securities Act of 1933 became a blueprint for how investment banks underwrite securities in the public markets. The act established the practices of due diligence, issuing a preliminary and final prospectus, and pricing and syndicating a new issue. The 1934 Securities Exchange Act addressed securities exchanges and broker-dealer organizations. The 1940 Investment Company Act and 1940 Investment Advisors Act established regulations for fiduciaries, such as mutual funds, private money managers and registered investment advisors. In Wall Street parlance, the investment banks represent the "sell side" (as they are mainly in the business of selling securities to investors), while mutual funds, advisors and others make up the "buy side".
Anatomy of an Offering
A company selects an investment bank to be lead manager of a securities offering; responsibilities include leading the due diligence and drafting the prospectus. The lead manager forms a team of third-party specialists, including legal counsel, accounting and tax specialists, financial printers and others.
In addition, the lead manager invites other banks into an underwriting syndicate as co-managers. The lead and co-managers will allot portions of the shares to be offered among themselves. Because their underwriting fees derive from how much of the issue they sell, the competition for lead manager and senior allotment positions is quite intense.
When a company issues publicly traded securities for the first time through an initial public offering (IPO), the lead manager appoints a research analyst to write a research report and begin ongoing coverage of the company. The report will contain an economic analysis of the business and its prospects given the market for its products and services, competition and other factors. Once the analyst initiates coverage, he or she will make ongoing recommendations to the bank's clients to buy, hold or sell shares based on the perceived fair value relative to current share price. (For more on this, read IPO Basics.)
Distribution begins with the book-building process. The underwriting syndicate builds a book of interest during the offering period, usually accompanied by a road show, in which the issuer's senior management and syndicate team members meet with potential investors (mostly institutional investors such as pension funds, endowments and insurance companies). Potential investors receive a red herring, a preliminary prospectus that contains all materially significant information about the issuer but omits the final issuing price and number of shares.
At the end of the road show, the lead manager sets the final offering price based on the prevailing demand. Underwriters seek to have the offering oversubscribed (create more demand than available shares). If they succeed, they will exercise a 15% overallotment option, called a greenshoe, which is named after the Green Shoe Company, the first issuer of such an option. This permits the underwriters to increase the number of new shares issued by up to 15% (from the number stated in the prospectus) without going through any additional registration.
The new issue market is called the primary market. The Securities and Exchange Commission (SEC) registers the securities prior to their primary issuance, then they start trading in the secondary market on the New York Stock Exchange, Nasdaq or other venue where the securities have been accepted for listing and trading. (To learn more about the primary and secondary market, read Markets Demystified.)
Wall Street's Chinese Wall
Investment banking is fraught with potential conflicts of interest. This problem has intensified through the consolidation that has swept through the financial services industry, to the point where a handful of large concerns - the fabled bulge bracket banks - account for a disproportionate share of business on both the buy and sell side.
The potential conflict arising from this is simple to understand. Buy-side agents - investment advisors and money managers - have a fiduciary obligation to act solely in the best interests of their investing clients, without regard for their own economic incentives to recommend one product or strategy versus another. Investment bankers on the sell side seek to maximize the results to their clients, the issuers. When a firm in which the main line of business is sell side, investment banking acquires a buy-side asset manager, and these incentives can be at odds.
Unfortunately for investors, the economics of the business are such that a disproportionate amount of an investment bank's profits derive from its underwriting and trading businesses. The competition for mandates is intense, and the pressure is high on all participants - the bankers, research analysts, traders and salespeople - to deliver results.
One example in particular is research. The research analyst is supposed to reach independent conclusions irrespective of the investment bankers' interests. Regulations mandate that banks enforce a separation between research and banking, popularly referred to as a Chinese Wall. In reality, however, many firms have tied research analysts' compensation to investment banking profitability. Scrutiny following the collapse of the dotcom bubble in 2000 has led to some attempts to reform some of these flawed practices. (To learn more, read The Chinese Wall Protects Investors Against Conflicts Of Interest.)
What About Compensation?
A discussion on investment banking wouldn't be complete without addressing the enormous sums of money that investment bankers are paid. Essentially, a bank's main income-producing assets walk out of the office building every evening. Deals are completed and money is made based solely on the relationships, experience and clever thinking of the professionals who work there.
As such, an investment bank has little to do with the profits it earns except to pay the folks who produced them. It is not unusual for 50% or more of top-line revenues to go into the salaries and bonuses for an investment bank's employees. Most of this goes to the principal architects of the deals, but is also goes to the associates and analysts who toil over discounted cash flow spreadsheets and comparables models until the early hours of every morning.
The catch is that most of this compensation is paid as bonuses. Fixed salaries are by no means modest, but the big seven-figure payoffs come through bonus distributions. The risk for an investment banker is that such payouts can quickly vanish if market conditions turn down or the firm has a bad year. (For more on the life of an investment banker, read Is Investment Banking For You?)
Investment bankers spend an inordinate amount of time trying to figure out new ways to make money - in good times and bad. Business areas like M&A, restructuring, private equity and structured finance, most of which were not part of an investment bank's repertoire prior to the mid to late 1970s, provide evidence of this profession's ability to continually find new ways to make money.
The Bottom Line
For all the mystery surrounding investment banks, the role they have played throughout the evolution of modern capitalism is fairly straightforward. These institutions provide the financial means to enable Adam Smith's invisible hand to function.
Investment banks have flourished in a variety of economies, from the merchant traders of 18th-century London and Amsterdam to the behemoths of today, whose influence spans the globe. As long as there is a market economy, there are likely to be investment bankers coming up with new ways to make money, while the rest of us marvel at how they manage to do it.
Adam Smith famously described capitalism as an invisible hand guiding the market in its allocation of goods and services. The financial engines of this hand during the 18th and 19th centuries were European merchant banks, such as Hope & Co., Baring Brothers and Morgan Grenfell. For a time, the Netherlands, and later Great Britain, ruled the waves of global commerce in far-flung ports of call such as India and Hong Kong. The merchant banking model then crossed the Atlantic and served as the inspiration for the financial firms founded by prominent families in what could perhaps be called the emerging market of the day - the United States. The structure and activities of early U.S. firms such as JP Morgan & Co. and Dillon Read and Drexel & Co. reflected those of their European counterparts and included financing new business opportunities through raising and deploying investment capital. (For related reading, see The Evolution Of Banking.)
Over time, two somewhat distinct models arose from this. The old merchant banking model was largely a private affair conducted among the privileged denizens of the clubby world of old European wealth. The merchant bank typically put up sizable amounts of its own (family-owned) capital along with that of other private interests that came into the deals as limited-liability partners. Over the 19th century, a new model came into popular use, particularly in the United States. Firms seeking to raise capital would issue securities to third-party investors, who would then have the ability to trade these securities in the organized securities exchanges of major financial centers such as London and New York. The role of the financial firm was that of underwriter - representing the issuer to the investing public, obtaining interest from investors and facilitating the details of the issuance. Firms engaged in this business became known as investment banks. (To learn more about these functions, read Brokerage Functions: Underwriting And Agency Roles.)
Firms like JP Morgan didn't limit themselves to investment banking, but established themselves in a variety of other financial businesses including lending and deposit taking (i.e. commercial banking). The stock market crash of 1929 and ensuing Great Depression caused the U.S. government to reach the conclusion that financial markets needed to be more closely regulated in order to protect the financial interests of average Americans. This resulted in the separation of investment banking from commercial banking (the Glass-Steagall Act of 1933). The firms on the investment banking side of this separation - such as Morgan Stanley, Goldman Sachs, Lehman Brothers and First Boston - went on to take a prominent role in the underwriting of corporate America during the postwar period; the largest gained fame as the so-called "bulge bracket". (For more on this, read What Was The Glass-Steagall Act?)
The term "merchant bank" came back into vogue in the late 1970s with the nascent private equity business of firms like Kohlberg, Kravis & Roberts (KKR). Merchant banking in its modern context refers to using one's own equity (often accompanied by external debt financing) in a private transaction, as opposed to underwriting a share issue via publicly traded securities on an exchange - the classic function of an investment bank. Many of the large global firms today conduct both merchant banking (private equity) and investment banking.
The Regulatory Infrastructure
In the United States, investment banks operate according to legislation enacted at the time of Glass-Steagall. The Securities Act of 1933 became a blueprint for how investment banks underwrite securities in the public markets. The act established the practices of due diligence, issuing a preliminary and final prospectus, and pricing and syndicating a new issue. The 1934 Securities Exchange Act addressed securities exchanges and broker-dealer organizations. The 1940 Investment Company Act and 1940 Investment Advisors Act established regulations for fiduciaries, such as mutual funds, private money managers and registered investment advisors. In Wall Street parlance, the investment banks represent the "sell side" (as they are mainly in the business of selling securities to investors), while mutual funds, advisors and others make up the "buy side".
Anatomy of an Offering
A company selects an investment bank to be lead manager of a securities offering; responsibilities include leading the due diligence and drafting the prospectus. The lead manager forms a team of third-party specialists, including legal counsel, accounting and tax specialists, financial printers and others.
In addition, the lead manager invites other banks into an underwriting syndicate as co-managers. The lead and co-managers will allot portions of the shares to be offered among themselves. Because their underwriting fees derive from how much of the issue they sell, the competition for lead manager and senior allotment positions is quite intense.
When a company issues publicly traded securities for the first time through an initial public offering (IPO), the lead manager appoints a research analyst to write a research report and begin ongoing coverage of the company. The report will contain an economic analysis of the business and its prospects given the market for its products and services, competition and other factors. Once the analyst initiates coverage, he or she will make ongoing recommendations to the bank's clients to buy, hold or sell shares based on the perceived fair value relative to current share price. (For more on this, read IPO Basics.)
Distribution begins with the book-building process. The underwriting syndicate builds a book of interest during the offering period, usually accompanied by a road show, in which the issuer's senior management and syndicate team members meet with potential investors (mostly institutional investors such as pension funds, endowments and insurance companies). Potential investors receive a red herring, a preliminary prospectus that contains all materially significant information about the issuer but omits the final issuing price and number of shares.
At the end of the road show, the lead manager sets the final offering price based on the prevailing demand. Underwriters seek to have the offering oversubscribed (create more demand than available shares). If they succeed, they will exercise a 15% overallotment option, called a greenshoe, which is named after the Green Shoe Company, the first issuer of such an option. This permits the underwriters to increase the number of new shares issued by up to 15% (from the number stated in the prospectus) without going through any additional registration.
The new issue market is called the primary market. The Securities and Exchange Commission (SEC) registers the securities prior to their primary issuance, then they start trading in the secondary market on the New York Stock Exchange, Nasdaq or other venue where the securities have been accepted for listing and trading. (To learn more about the primary and secondary market, read Markets Demystified.)
Wall Street's Chinese Wall
Investment banking is fraught with potential conflicts of interest. This problem has intensified through the consolidation that has swept through the financial services industry, to the point where a handful of large concerns - the fabled bulge bracket banks - account for a disproportionate share of business on both the buy and sell side.
The potential conflict arising from this is simple to understand. Buy-side agents - investment advisors and money managers - have a fiduciary obligation to act solely in the best interests of their investing clients, without regard for their own economic incentives to recommend one product or strategy versus another. Investment bankers on the sell side seek to maximize the results to their clients, the issuers. When a firm in which the main line of business is sell side, investment banking acquires a buy-side asset manager, and these incentives can be at odds.
Unfortunately for investors, the economics of the business are such that a disproportionate amount of an investment bank's profits derive from its underwriting and trading businesses. The competition for mandates is intense, and the pressure is high on all participants - the bankers, research analysts, traders and salespeople - to deliver results.
One example in particular is research. The research analyst is supposed to reach independent conclusions irrespective of the investment bankers' interests. Regulations mandate that banks enforce a separation between research and banking, popularly referred to as a Chinese Wall. In reality, however, many firms have tied research analysts' compensation to investment banking profitability. Scrutiny following the collapse of the dotcom bubble in 2000 has led to some attempts to reform some of these flawed practices. (To learn more, read The Chinese Wall Protects Investors Against Conflicts Of Interest.)
What About Compensation?
A discussion on investment banking wouldn't be complete without addressing the enormous sums of money that investment bankers are paid. Essentially, a bank's main income-producing assets walk out of the office building every evening. Deals are completed and money is made based solely on the relationships, experience and clever thinking of the professionals who work there.
As such, an investment bank has little to do with the profits it earns except to pay the folks who produced them. It is not unusual for 50% or more of top-line revenues to go into the salaries and bonuses for an investment bank's employees. Most of this goes to the principal architects of the deals, but is also goes to the associates and analysts who toil over discounted cash flow spreadsheets and comparables models until the early hours of every morning.
The catch is that most of this compensation is paid as bonuses. Fixed salaries are by no means modest, but the big seven-figure payoffs come through bonus distributions. The risk for an investment banker is that such payouts can quickly vanish if market conditions turn down or the firm has a bad year. (For more on the life of an investment banker, read Is Investment Banking For You?)
Investment bankers spend an inordinate amount of time trying to figure out new ways to make money - in good times and bad. Business areas like M&A, restructuring, private equity and structured finance, most of which were not part of an investment bank's repertoire prior to the mid to late 1970s, provide evidence of this profession's ability to continually find new ways to make money.
The Bottom Line
For all the mystery surrounding investment banks, the role they have played throughout the evolution of modern capitalism is fairly straightforward. These institutions provide the financial means to enable Adam Smith's invisible hand to function.
Investment banks have flourished in a variety of economies, from the merchant traders of 18th-century London and Amsterdam to the behemoths of today, whose influence spans the globe. As long as there is a market economy, there are likely to be investment bankers coming up with new ways to make money, while the rest of us marvel at how they manage to do it.
Madoff Trustee Sues UBS For $2 billion
Irving Picard, the court-appointed trustee for Bernard Madoff’s bogus investment firm, has gone after a big bank in his expensive two-year quest to retrieve funds for some Madoff investors.
Picard filed a complaint against UBS in Manhattan’s federal bankruptcy court yesterday, accusing the Swiss bank of fraud and misconduct in connection with feeder funds that funneled investor cash into the Ponzi scheme. The lawsuit seeks to recover at least $2 billion.
In a press release, Picard claims UBS actively assisted the Madoff Ponzi scheme by sponsoring and administrating Luxalpha SICAV and Groupement Financier, two feeder funds. Picard says that UBS’s own due diligence revealed “indicia of fraud” with the UBS feeder funds, but that UBS nevertheless made Bernard Madoff the subcustodian of the feeder fund assets, allowing Madoff to “run the operation with no checks and balances.” Picard says that UBS enabled Madoff to be the “only source of information for valuing the funds.”
In the complaint, Picard claims the UBS-sponsored feeder funds withdrew $1.12 billion in the six years before the the Ponzi scheme collapsed and resulted in a bankrtupcy filing, making those funds potentially recoverable under federal bankruptcy and state law. Picard claims UBS and its affiliates made some $80 million in fees from the feeder funds.
“Madoff’s scheme could not have been accomplished unless UBS had agreed not only to look the other way, but also to pretend that they were truly ensuring the existence of assets and trades when in fact they were not and never did,” David Sheehan, Picard’s lawyer, said in a statement.
Sheehan said that Picard has “battled” with UBS over disclosure of information regarding Bernard Madoff Investment Securities.
The lawsuit is the latest effort in Picard’s controversial effort, which has included attempts to clawback funds from some of Madoff’s victims. So far Picard has recovered some $1.5 billion, but the vast majority of that sum was simply recovered by grabbing the cash that remained on hand in Madoff’s investment company following the exposure of the fraud. It has been a rich business for Picard and his firm, Baker Hostetler, yielding more than $85 million in fees.
But Picard and Sheehan claim they are on the right track. Said Sheehan: “Without UBS’s serving as promoter, custodian, manager and administrator for the feeder funds, [Madoff] would have been deprived of more than a billion dollars in investments, and Madoff’s fraud would have been diminished.”
Picard filed a complaint against UBS in Manhattan’s federal bankruptcy court yesterday, accusing the Swiss bank of fraud and misconduct in connection with feeder funds that funneled investor cash into the Ponzi scheme. The lawsuit seeks to recover at least $2 billion.
In a press release, Picard claims UBS actively assisted the Madoff Ponzi scheme by sponsoring and administrating Luxalpha SICAV and Groupement Financier, two feeder funds. Picard says that UBS’s own due diligence revealed “indicia of fraud” with the UBS feeder funds, but that UBS nevertheless made Bernard Madoff the subcustodian of the feeder fund assets, allowing Madoff to “run the operation with no checks and balances.” Picard says that UBS enabled Madoff to be the “only source of information for valuing the funds.”
In the complaint, Picard claims the UBS-sponsored feeder funds withdrew $1.12 billion in the six years before the the Ponzi scheme collapsed and resulted in a bankrtupcy filing, making those funds potentially recoverable under federal bankruptcy and state law. Picard claims UBS and its affiliates made some $80 million in fees from the feeder funds.
“Madoff’s scheme could not have been accomplished unless UBS had agreed not only to look the other way, but also to pretend that they were truly ensuring the existence of assets and trades when in fact they were not and never did,” David Sheehan, Picard’s lawyer, said in a statement.
Sheehan said that Picard has “battled” with UBS over disclosure of information regarding Bernard Madoff Investment Securities.
The lawsuit is the latest effort in Picard’s controversial effort, which has included attempts to clawback funds from some of Madoff’s victims. So far Picard has recovered some $1.5 billion, but the vast majority of that sum was simply recovered by grabbing the cash that remained on hand in Madoff’s investment company following the exposure of the fraud. It has been a rich business for Picard and his firm, Baker Hostetler, yielding more than $85 million in fees.
But Picard and Sheehan claim they are on the right track. Said Sheehan: “Without UBS’s serving as promoter, custodian, manager and administrator for the feeder funds, [Madoff] would have been deprived of more than a billion dollars in investments, and Madoff’s fraud would have been diminished.”
Monday, March 23, 2009
Soros: Ready for slow growth
Billionaire hedge fund manager George Soros has been warning of a global financial crisis for some time now. And when The Australian’s Peter Wilson interviewed the former partner of Jim Rogers lately, he noted how Soros has been handsomely-rewarded for such foresight. Wilson wrote yesterday:
And foreseeing the biggest economic crisis since the Great Depression has certainly paid off financially. In August 2007, with the first symptoms of the credit crunch on the horizon, Soros came out of semi-retirement to reassume control of his Quantum investment fund, astutely repositioning it for the tsunami about to hit. By year’s end Quantum was up almost 32 per cent for 2007, netting Soros profits of $US2.9 billion at a time when other financiers were struggling to break even.
His fortune was estimated at $US11 billion by Forbes in September 2008 and it has grown even larger amid the spreading financial carnage. That same year, in which Hedge Fund Research estimates the hedge fund industry lost a record 18.3 per cent, Soros was up another 9 per cent.
The chairman of Soros Fund Management, whose new book The Crash of 2008 and What it Means: The New Paradigm for Financial Markets is scheduled to be released before the end of this month, shared his latest outlook for the global economy with readers of the Australian publication. From the piece:
The entire world, but especially the West, should now brace for slower economic growth, he warns, and it will be at least a decade before the US sees robust growth. One important effect will be a new wariness in China about the US economic model, Soros says. “The Chinese used to look up to the West and try to imitate the West and they have now discovered that it may not be the right thing to imitate. They now feel suddenly impelled to develop their own system and in some ways they are actually ahead of us.
“For instance, they have been using variable capital requirements as a policy tool. They changed the minimum capital requirements for banks 17 times in the past year, first raising it rapidly and then lowering it. I think we will have to learn to do the same thing.”
In any case, the Chinese government can no longer be relied on to plough money into US government debt, he warns. “They will have less money to spend because their surplus is shrinking and their exports are falling, so they will have less to dispose of, so I think that there will be a definite shift.”
And foreseeing the biggest economic crisis since the Great Depression has certainly paid off financially. In August 2007, with the first symptoms of the credit crunch on the horizon, Soros came out of semi-retirement to reassume control of his Quantum investment fund, astutely repositioning it for the tsunami about to hit. By year’s end Quantum was up almost 32 per cent for 2007, netting Soros profits of $US2.9 billion at a time when other financiers were struggling to break even.
His fortune was estimated at $US11 billion by Forbes in September 2008 and it has grown even larger amid the spreading financial carnage. That same year, in which Hedge Fund Research estimates the hedge fund industry lost a record 18.3 per cent, Soros was up another 9 per cent.
The chairman of Soros Fund Management, whose new book The Crash of 2008 and What it Means: The New Paradigm for Financial Markets is scheduled to be released before the end of this month, shared his latest outlook for the global economy with readers of the Australian publication. From the piece:
The entire world, but especially the West, should now brace for slower economic growth, he warns, and it will be at least a decade before the US sees robust growth. One important effect will be a new wariness in China about the US economic model, Soros says. “The Chinese used to look up to the West and try to imitate the West and they have now discovered that it may not be the right thing to imitate. They now feel suddenly impelled to develop their own system and in some ways they are actually ahead of us.
“For instance, they have been using variable capital requirements as a policy tool. They changed the minimum capital requirements for banks 17 times in the past year, first raising it rapidly and then lowering it. I think we will have to learn to do the same thing.”
In any case, the Chinese government can no longer be relied on to plough money into US government debt, he warns. “They will have less money to spend because their surplus is shrinking and their exports are falling, so they will have less to dispose of, so I think that there will be a definite shift.”
Wednesday, March 11, 2009
Real S&P 500 chart - inflation adjusted:
When you have to look at the same chart over and over again it can get a bit boring so here’s the ‘real’ S&P 500 - inflation adjusted:
The chart shows monthly data from 1900 to February 2009 and is logarithmically scaled so that a percentage move in any year is comparable to other years. I’ve used the CPI (monthly) data available from official US government sources. Some say it is under-reported but what other real alternatives do we have? Removing the distorting effect of inflation is important for long term charts and also because we know that the Fed is doing all it can to create inflation. The most recent data shows the largest one year increase in money supply.
Like walking down your hometown streets, things look similar but different. For example, the chart doesn’t show the massive double top that is now recognized by everyone. Also, from 1900 to 1950, the market tread water after inflation. Then a roaring bull market followed, to then be deflated by an equally intense bear market.
Most interesting is that the bear market low is July 1982 - not 1975 as we usually see on non-inflation adjusted charts. This is where the bull market that followed next was launched. The inflation adjusted level of 238 acted as support, just as it had acted as resistance on so many occasions (temporarily pierced only by the roaring bull market of the 1920’s).
A similar situation is setting up today. We had a bull market that took us to new inflation adjusted levels and subsequently almost all the air was let out because the market is now back to where it broke out from the 1968 top. To be accurate we have a little more air to let out before the market ricochets off that level once again.
Assuming that this is the playbook the market is following; and if not, cheer up! we can only go to zero.
Friday, March 6, 2009
Unemployment Number
1974 (Half of the work force)
November - 368K
December - 602K
January -360k
February -378k
March -270k
April -186k
May +160k
June -104k
2008
November - 533K
December - 589K
January - 655K
February - 651K
Stay tuned.
November - 368K
December - 602K
January -360k
February -378k
March -270k
April -186k
May +160k
June -104k
2008
November - 533K
December - 589K
January - 655K
February - 651K
Stay tuned.
Monday, March 2, 2009
Friday, February 27, 2009
Stanford: The First Arrest is Made
It's most frustrating being on a plane at JFK and reading the complaint against Laura Pendergest-Holt, knowing that you won't be able to blog it for another eight hours or so. It's a curious thing: basically she's been arrested on obstruction of justice charges because she wasn't completely forthright when she testified in early February, at the time that the Stanford story was breaking all over the press. But she was clearly set up as the patsy: because Allen Stanford himself, along with his CFO James Davis, refused to testify at all, they can't be arrested on similar charges.
On the other hand, there was some really big stuff that Pendergest-Holt knew and didn't say to investigators, not least that $1.6 billion of Stanford International Bank's "assets" consisted of a loan to Allen Stanford himself. And that the $541 million "capital contribution" that Sir Allen made to the bank in December was made up largely of real-estate holdings which the bank already owned, having bought them for $88 million earlier in the year.
Meanwhile, the FT has dug up an NASD arbitration proceeding from 2003 in which a former Stanford employee, Leyla Basagoitia, accused Stanford of running a Ponzi scheme. The NASD -- which later became Finra -- wasn't buying it:
Ms Basagoitia's allegations were denied by Stanford Group Company and dismissed by the dispute resolution panel. She was ordered to pay Stanford $107,782 in damages, in repayment of a loan advanced to her while an employee of the company.
Michael Falick, the lawyer who acted for Ms Basagoitia, said his client contacted the SEC about the alleged fraud in tandem with her NASD complaint. Mr Falick said: "It was really troubling, because the NASD was meant to be a regulatory body."
Note that this was an NASD proceeding, not an SEC proceeding (although Basagoitia did inform the SEC as well as the NASD of her suspicions). So Blodget's off base here:
Mary Schapiro wasn't running the SEC when it muffed this latest scam, so she can blame it on her predecessor.
Not true! The vice-chairman of the NASD at the time that Basagoitia made her allegations was one Mary Schapiro. And true to the NASD's nature, the arbitration panel reflexively sided with the company rather than the employee.
And elsewhere on the Stanford-victims front, I just got an email from a Stanford employee:
Employees in all U.S. offices were told by the Receiver that "Payroll would be met and benefits were still in effect" as part of their initial communication to employees (in person) as they closed offices. Funds for payroll are reportedly in Stanford's Treasury department, employees were called in to process payroll, but the Receiver has not approved the transfer of funds to meet this payroll obligation. Funds should have been transferred into employee bank accounts at midnight tonight, and paper checks mailed tomorrow.
Stanford employees were told they were not terminated last week, that in fact "it was business as usual" per the Receiver's email to global Stanford employees. "Consider it a paid vacation," a Stanford employee was told in Memphis, Tennessee. This means employees were not able to begin the process to file for unemployment or make other arrangements with creditors that their income had been suspended.
In fact, many employees were called in to assist the Receiver in many departments. All employees have been working under the assumption that the Receiver would honor the commitment made to meet payroll. Were these employees called back under false pretenses? Funds are in-house to pay employees per Receiver's promise - Receiver now apologizes for the hardship. Why is Receiver now denying to release the monies? Arethe lawyers and other "outside experts" hired by the Receiver being paid with funds promised to meet payroll?
While criminal charges against Allen Stanford or Jim Davis have not been filed, most employees feel that a crime has been committed against them by the Receiver.
Said employees almost certainly include former Fed governor Lyle Gramley. Has anybody got around to asking him anything about his employer yet?
On the other hand, there was some really big stuff that Pendergest-Holt knew and didn't say to investigators, not least that $1.6 billion of Stanford International Bank's "assets" consisted of a loan to Allen Stanford himself. And that the $541 million "capital contribution" that Sir Allen made to the bank in December was made up largely of real-estate holdings which the bank already owned, having bought them for $88 million earlier in the year.
Meanwhile, the FT has dug up an NASD arbitration proceeding from 2003 in which a former Stanford employee, Leyla Basagoitia, accused Stanford of running a Ponzi scheme. The NASD -- which later became Finra -- wasn't buying it:
Ms Basagoitia's allegations were denied by Stanford Group Company and dismissed by the dispute resolution panel. She was ordered to pay Stanford $107,782 in damages, in repayment of a loan advanced to her while an employee of the company.
Michael Falick, the lawyer who acted for Ms Basagoitia, said his client contacted the SEC about the alleged fraud in tandem with her NASD complaint. Mr Falick said: "It was really troubling, because the NASD was meant to be a regulatory body."
Note that this was an NASD proceeding, not an SEC proceeding (although Basagoitia did inform the SEC as well as the NASD of her suspicions). So Blodget's off base here:
Mary Schapiro wasn't running the SEC when it muffed this latest scam, so she can blame it on her predecessor.
Not true! The vice-chairman of the NASD at the time that Basagoitia made her allegations was one Mary Schapiro. And true to the NASD's nature, the arbitration panel reflexively sided with the company rather than the employee.
And elsewhere on the Stanford-victims front, I just got an email from a Stanford employee:
Employees in all U.S. offices were told by the Receiver that "Payroll would be met and benefits were still in effect" as part of their initial communication to employees (in person) as they closed offices. Funds for payroll are reportedly in Stanford's Treasury department, employees were called in to process payroll, but the Receiver has not approved the transfer of funds to meet this payroll obligation. Funds should have been transferred into employee bank accounts at midnight tonight, and paper checks mailed tomorrow.
Stanford employees were told they were not terminated last week, that in fact "it was business as usual" per the Receiver's email to global Stanford employees. "Consider it a paid vacation," a Stanford employee was told in Memphis, Tennessee. This means employees were not able to begin the process to file for unemployment or make other arrangements with creditors that their income had been suspended.
In fact, many employees were called in to assist the Receiver in many departments. All employees have been working under the assumption that the Receiver would honor the commitment made to meet payroll. Were these employees called back under false pretenses? Funds are in-house to pay employees per Receiver's promise - Receiver now apologizes for the hardship. Why is Receiver now denying to release the monies? Arethe lawyers and other "outside experts" hired by the Receiver being paid with funds promised to meet payroll?
While criminal charges against Allen Stanford or Jim Davis have not been filed, most employees feel that a crime has been committed against them by the Receiver.
Said employees almost certainly include former Fed governor Lyle Gramley. Has anybody got around to asking him anything about his employer yet?
Thursday, February 26, 2009
Jeremy Grantham Invests Cautiously These Days
Meanwhile, GMO chairman Jeremy Grantham is more upbeat — though he does expect more pain to precede any recovery.
Looking back at historic bear markets, Grantham draws comparisons to 1974 and 1982, when the S&P 500 lost roughly half its value. Since he estimates the current S&P 500 fair value at 900, Grantham puts his worst-case bottom at a hair-raising 450.
“That’s fairly scary, but on the one hand we look at the massive stimulus, and then on the other we try to work out the fact that the global economy is in worse shape than it was in ‘74 or ‘82,” says Grantham. “I’d say there are three-to-one odds that we go to a material new low. We should count on [the S&P 500] hitting 600 for a little while, and we should hope like mad it doesn’t get deep into the 500s.”
Patience rules. Another looming threat is that the market may enter an extended period of drops and rebounds that flatten long-term returns and strand buy-and-hold investors for decades.
Japan’s stalled stock market is one recent example, but the U.S. has had its shares of quagmires, too. Grantham likes to point out that investors who bought at market crests in 1929 and 1965 had to wait 19 years each time just to break even.
Still, Grantham says buy-and-hold still makes sense for long-term investors when stocks are trading below fair value. He especially favors U.S. blue chips, and his fund is on a strict, slow schedule to invest as valuations dip even lower.
“If you don’t have a schedule for investing, you will not do it,” he says. “When the market goes down, it reinforces the hoarding of cash. By the bottom, you suffer what we called in 1974 terminal paralysis — you cannot pull the trigger. Almost everyone who avoids the great pain is very slow to get back.”
Looking back at historic bear markets, Grantham draws comparisons to 1974 and 1982, when the S&P 500 lost roughly half its value. Since he estimates the current S&P 500 fair value at 900, Grantham puts his worst-case bottom at a hair-raising 450.
“That’s fairly scary, but on the one hand we look at the massive stimulus, and then on the other we try to work out the fact that the global economy is in worse shape than it was in ‘74 or ‘82,” says Grantham. “I’d say there are three-to-one odds that we go to a material new low. We should count on [the S&P 500] hitting 600 for a little while, and we should hope like mad it doesn’t get deep into the 500s.”
Patience rules. Another looming threat is that the market may enter an extended period of drops and rebounds that flatten long-term returns and strand buy-and-hold investors for decades.
Japan’s stalled stock market is one recent example, but the U.S. has had its shares of quagmires, too. Grantham likes to point out that investors who bought at market crests in 1929 and 1965 had to wait 19 years each time just to break even.
Still, Grantham says buy-and-hold still makes sense for long-term investors when stocks are trading below fair value. He especially favors U.S. blue chips, and his fund is on a strict, slow schedule to invest as valuations dip even lower.
“If you don’t have a schedule for investing, you will not do it,” he says. “When the market goes down, it reinforces the hoarding of cash. By the bottom, you suffer what we called in 1974 terminal paralysis — you cannot pull the trigger. Almost everyone who avoids the great pain is very slow to get back.”
Wednesday, February 25, 2009
Major phases of a bear market
Historically, major bear markets have also followed distinct patterns.
1. First phase
There is a sharp initial fall that removes much of the 'froth' from the market.
2. Middle phase
There is a strong rally in prices for several months, which may lull some investors into thinking that the bear market is over. The rallies can be dramatic, but have lower trading volume than the initial sell-offs. And the advances tend to be concentrated on a few selected stocks, not the whole market.
3. Third phase
There is a long slow downward grind in prices, accompanied by low volume and periodic false dawns until the bear phase ends quietly as share valuations reach rock bottom. At this point, few investors from the earlier buoyant phase in the market are interested in anything other than the most conservative investments.
1. First phase
There is a sharp initial fall that removes much of the 'froth' from the market.
2. Middle phase
There is a strong rally in prices for several months, which may lull some investors into thinking that the bear market is over. The rallies can be dramatic, but have lower trading volume than the initial sell-offs. And the advances tend to be concentrated on a few selected stocks, not the whole market.
3. Third phase
There is a long slow downward grind in prices, accompanied by low volume and periodic false dawns until the bear phase ends quietly as share valuations reach rock bottom. At this point, few investors from the earlier buoyant phase in the market are interested in anything other than the most conservative investments.
Tuesday, February 24, 2009
Worst on Records
Economists were expecting today's report on Consumer Confidence for February to come in at 35, which would have been the lowest level on record. The actual number, however, came in much lower at a level of 25. Not only is this the lowest reading on record, but it is also the fifth worst report versus expectations since at least 1999. In the chart below, we highlight the monthly readings of the Consumer Confidence report going back to 1967 (recessions highlighted in gray).
Tuesday, February 17, 2009
Friday, February 13, 2009
Stimulus Package Explained
If you spend that money at Wal-Mart, all the money will go to China.
If you spend it on gasoline it will go to Hugo Chavez, the Arabs and Al Queda
If you purchase a computer it will go to Taiwan.
If you purchase fruit and vegetables it will go to Mexico, Honduras, and Guatemala (unless you buy organic).
If you buy a car it will go to Japan and Korea.
If you purchase prescription drugs it will go to India
If you purchase heroin it will go to the Taliban in Afghanistan
If you give it to a charitable cause, it will go to Nigeria
If you spend it on gasoline it will go to Hugo Chavez, the Arabs and Al Queda
If you purchase a computer it will go to Taiwan.
If you purchase fruit and vegetables it will go to Mexico, Honduras, and Guatemala (unless you buy organic).
If you buy a car it will go to Japan and Korea.
If you purchase prescription drugs it will go to India
If you purchase heroin it will go to the Taliban in Afghanistan
If you give it to a charitable cause, it will go to Nigeria
Subscribe to:
Posts (Atom)