A letter from a reader:

Hi David,

What would you recommend for a long only equities portfolio?

I too think the market may be overheating, but as always, it’s impossible to tell when the party will end. I would have said the same thing last year this time as well.

This is what I am doing now:

  1. Cash is presently 16% of my portfolio.  I let that fluctuate between 0-20%.  I try to be fully invested during crises, and build up some cash when valuations are extended.  16% means valuations are high, but they could get higher — we aren’t at nosebleed levels.
  2. I have more invested in foreign companies than I normally do.  Around 40% of the portfolio is in foreign companies, which are at present undervalued relative to similar US companies.
  3. Emphasize companies with strong balance sheets, in industries that will not go away.
  4. I own cheap stocks.  The median valuation of the stocks that I own is around 10x earnings, and 1x Net Worth (Book Value).

This isn’t sexy, and if the market roars ahead, my clients and I will underperform.  But if there is a reason that emerges that causes the market to fall, my clients and I will do better than most.

I take more risk when the market is in the tank, and less when everyone thinks things are great.  This is particularly true when policymakers like the Fed are triumphant over high valuations, and low yield spreads.

This is a time to take less risk, in my opinion, but not a time to take no risk.

taking down the lion This is a tough book for me to review.  The credit distress of Tyco caused me considerable stress, and let me explain to you how that was.

I was the leading corporate bond manager at the fastest growing life insurance company 2001-2003.  We had a significant position in Tyco bonds, and as thy fell, we were concerned.  As a new corporate bond manager, I drew upon all of my analysts and portfolio managers, and asked them, “Who can give me the bear case here?”  I did my own analysis as well.  No one could come up with a way that Tyco could go broke.

So I asked the next question: Is there anyone on Wall who thinks Tyco could go broke?  We found one.  We read the analysis.  We thought the argument was ridiculous, and so we wanted to buy more.  We had a problem: our client was under pressure from the rating agencies to decrease our exposure to Tyco.

We had a large block of two-year Tyco bonds that were trading near par, and I sold them, and reinvested into a smaller market value of 30-year Tyco bonds.  Problem solved, but we were now taking more risk in Tyco debt, a bet that we would win.

The Book

Taking Down the Lion takes the view that Kozlowski had a subpar legal team which made many blunders in representing him.  It also notes how the informal management culture played against Kozlowski as things that were formal at many other corporations, and thus could not be argued, were not so at Tyco.

If the book is correct, this was a perfect storm for Kozlowski, leading to an unjust conviction and sentence.  Having worked at firms that were informal, I can believe that Kozlowski was framed during a witch-hunt era that produced the dreadful Sarbox law.  Few legislators think of what the side-effects will be from their legislation.

My Thoughts

Tyco as a corporation was not a fraud.  Yes, Kozlowski was tone-deaf regarding some conspicuous consumption that he did, or was done on his behalf.  There is no crime for being a vulgar consumer.  Supposedly Kozlowski paid for it all, but still he got judged for it in court.

Truth,  don’t know whether Kozlowski was guilty or not, but the company was well-run, and what company could you not find a few things that have some taint?


I think it is a good book, and I lean toward the idea that Kozlowski should not have been convicted,  If you want to, you can buy it here:Taking Down the Lion: The Triumphant Rise and Tragic Fall of Tyco’s Dennis Kozlowski.

Full disclosure: The PR flack asked me if I would like a copy, and I said yes.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

I met with some board members from the local CFA Society for lunch today.  I commented, “When was the last time you saw two down days in a row?”  The answers ranged from at least a month, to sometime in May.  I use the S&P 500 as a measure, as most professionals do, and the answer is June 24th.  Admittedly, one of those declines was very small, but if you want to go back further, there were three down days in a row ending on June 12th.

This teaches a lesson: in a bull market, most professionals get skittish, and are looking for the turn, and think the market is running mindlessly higher without respite.

For investors that have reduced risk, sensing overvaluation, the continued rise in prices numbs the senses, and makes things seem worse than they are for those that are trying to beat the market.

Why do I write this?  We all need to take  step back and focus on first principles.  What are our goals for clients?  What time horizon are we looking at?  Why are we looking at day-to-day performance?

Far better to try to analyze what is being neglected, than agonize over past performance.

Before I start, thanks to all those who e-mailed me over my “sorted weekly tweets.”  I am likely to continue doing them.  That will start next week, because I have had a flood of new clients, and other obligations.

On Fixed Payment Annuities

How often do you run into articles in quality publications talking about annuities that will pay a fixed sum over your life, or over your life if you live past a certain age?  Not often, right?  Right.  Well, today I got two articles on the same day:

Longevity insurance is an important topic, and everyone should consider getting an income that they can’t outlive.  That said, there are two problems with this:

  • Inflation, and
  • Credit risk (will the insurer survive to make the payments?)

It is possible to buy inflation-protected annuities, but at a cost of a lower initial payment.  With credit risk, consider what the state guaranty funds will cover in insolvency, and realize that any payments over that amount could be lost due to insurer insolvency.  If you have a large payment, only buy from strong insurers.

Then there are the deferred fixed payment annuities.   You are 50 years old, and you want a payment stream that kicks in when you are 80, should you live so long.  You can buy a lot of income that far out, which will help you if you survive, subject to the same two main risks: inflation and credit risk.  I am not aware of any deferred inflation-adjusted payment annuities.

Now, you can think of your annuity as a replacement for long-dated fixed interest bonds.  A portfolio of fixed payment annuities, cash, maybe some commodities/gold, and stocks could be very stable, balancing the risks of inflation and deflation, and of high and low real rates.

There is the added benefit of the regular income which is useful to average people, who are okay with budgeting, but really don’t understand investments.  Just beware inflation and credit risk.

One more note: most insurance agents will never suggest immediate annuities to you because when you buy one, that’s the last commission the agent ever gets.  They would rather you buy a deferred annuity, where they can gain another commission when the surrender charge period is up, and roll you to a new product.


Longevity insurance is good, but be sure you avoid credit risk, and have other assets to compensate for potential inflation risk.

For those that want the quick hit and don’t care about the underlying ideas, here is the main idea:

A vehicle holding assets may appear more liquid than the assets themselves, but that is only true in bull markets.  When bad times come, the liquidity proves elusive, particularly for large trades.

ETPs are wonderful things, but there is one thing that ETPs can’t do.  They can’t change the underlying assets that they own.  Merely because you have the ability to buy or sell at will does not change the performance of the assets held.  Like most investment products, the amount of assets invested expands in a bull market and contracts in a bear market.

People follow trends.  As they follow trends, they tend to lose money, because they buy and sell too late.  As such, average investors in ETPs tend to lose money relative to buy and hold investors.

In this sense, liquidity is not your friend.  Just because you can trade, does not mean that you should.  Speculators tend to lose to the longer-term investors, who hold for longer periods of time.  Trading itself is a zero-sum game, but bearing risk is a positive sum game, if done with a margin of safety.

Also, if you are trying to do an institutional-size trade in an ETP, you will find that the market impact costs are significant.  Just because there is an exit door in the theater does not mean that everyone can get out instantly.

Repo Transactions

But here is my favorite bugbear in liquidity: repo transactions.  Repurchase transactions turn a long-term asset financed short into a short term asset.  Now the Fed thinks that it can control the repo market.

Honestly, the easy solution is to disallow the accounting treatment of repos, and force those who do them to display them as a long asset and a short liability.  Why?

Because in crises, the long assets are illiquid, and as such the value shrinks when liquidity is prized.  The liquid liabilities still demand to be paid at par.

The accounting change would be better than what the Fed thinks that it might do.  You can’t make long-dated assets liquid.  The cash flows are distant.  Yes, there may be some interest payments that are near, but ultimate repayment of principal is distant.

Let me suggest a better concept of liquidity: assets are liquid to the degree that you can turn the underlying into cash.  When I say that, I do not mean trading big blocks of stock, but selling companies for cash.  That is liquidity, and as such most risky assets do not have significant liquidity, though many trade every day during bull markets.

Liquidity is a scaredy cat, it disappears when it is most needed.  That happens because people think they can sell at par when they can’t.

All for now, but remember this — liquidity is a bull market phenomenon.  People are far more likely to trade when they have unrealized gains rather than losses.


I received the following from a reader of mine:

Dear Sir:

Have you removed your weekly Twitter digests? They were fantastic reading – please bring them back if you can.

I’m a huge fan of your work.


I’ve been really busy, and I haven’t been tweeting much.  I regard my blog audience as my main audience, and so I want to ask my main audience one simple question.  Do you value my “sorted weekly tweets” or not?  You can email me, and I will consider the requests; the more that email me, the more likely I continue to do it.




Most of the efforts to encourage defined benefit pension plans in the US have been an exercise in wishful thinking.  Then there are the efforts to discourage defined benefit plans, which came about because the IRS felt that they were losing too much tax revenue to overfunded plans.  Thanks, IRS… many plans were not really overfunded, but you discouraged a healthy funding of DB plans.

But if things are bad with corporate DB plans, it is much worse with Multiemployer Pension Plans.  These are plans meant to cover union laborers in a given industry.  What led me to write this evening were the problems with pensions in the coal-mining industry.  From the article:

Union miners are among the 10.4 million Americans with retirements tied to multiemployer pension plans, the large investment pools considered low risk because they don’t rely on a single company for financing. Two recessions, industry consolidation, and an aging workforce have the multiemployer funds facing a $400 billion shortfall. Dozens already have failed, affecting 94,000 participants.

Strong investment returns helped lift the average funding level of pension plans by three points, to 88 percent, from 2013 to 2014, according to Segal Consulting, which advises multiemployer trust funds. Yet, more plans were added to the “endangered” or “critical” lists that require fund managers to take steps to improve their financial status, including adding cash or adjusting future benefits.

“In 2001, only 15 plans covering about 80,000 participants were under 40 percent funded,” the government pension agency reported June 30. “By 2011, this had grown to almost 200 plans covering almost 1.5 million participants.”

The pension plan for union miners had about $5.8 billion in liabilities in 2012 and was only 71.2 percent funded at the end of 2013, according to Labor Department filings.

The trouble with multiemployer plans is that as some employers fail, the remainder of the employers have to pick up the bill for pensions.  In a declining or cyclical industry, that is a recipe for disaster.  As a result UPS spent $6.1 billion to exit the multiemployer plan, while still guaranteeing benefits to its own employees.  The $6.1B was the ransom payment to escape something far worse in an underfunded multiemployer plan.

Though average multiemployer plan may be better funded, the average hides a lot, as there are more people expecting benefits from plans that are dramatically underfunded.  What’s worse, is that those in multiemployer trusts have a maximum guarantee that is around 30% of what a single-employer plan would receive.

As such, to the degree that unionized industries as a whole suffer, so will benefits to unionized laborers, present and past.  People need to understand that pensions aren’t magic.

  • Adequate contributions need to be made.
  • Investment returns must be adequate.
  • Benefits promised must be reasonable relative to contributions.
  • Anti-selection should be limited in multiemployer trusts.  Perhaps employers need to put up extra capital that they would forfeit if they wanted to leave the collective industry pension promises.

As it is, participants in the worst multiemployer pension plans will suffer losses, and the PBGC will guarantee small amounts of the benefits, and that is as it should be, because the ability to drag money out of a shrinking industry is hard, very hard.

So pity participants in multiemployer defined benefit pension plans.  A significant portion of them will get far less than they expected.

51rdhXWu3BL I learned a lot from this book. India is an amalgam of nations inside one country. It is difficult to generalize about investing in India but there are a few themes to follow.

Most companies in India have a dominant shareholder, or family of shareholders.  As such, though there are some companies like this in the US, the first prism you view any Indian company through is how they treat outside passive minority shareholders, particularly foreign ones.  If they constantly give minority shareholders the short end of the stick, no matter how attractive the investment, avoid them.

Analysis of corporate governance is paramount, because it is very difficult to take a company over in a hostile manner.  Assume that the present management will never be changed.  Does the company still look cheap if the value -destroying management team will remain there?

Analyze capital allocation as well.  If management acts like value maximizing businessmen, it could be a good company to invest in.  If not, avoid.

Structure of the Book

The book is a slow ramp up as far as business goes, talking about culture, politics, economy, and financial structure, before really digging into investing.  These are good things to learn about, but the amount of time the book dedicates to making practical investment decisions in India is maybe 25% of the book.

The Main Problem

After you read this book, you will realize that without detailed local knowledge, you don’t stand a chance of investing in public Indian companies directly.  As such, the book is of limited value to most people.  So, though it is a good book, you probably would not benefit from reading it, aside from learning about Indian culture and government.  You would have to build up a lot of knowledge about the Indian families who run public corporations in India — which ones are favorable to outside passive minority investors, and which are not.

Aside from that, they mention the website for the book, but it is just a collection of documents for the companies mentioned in the book.


India is an unusual country with many challenges.  You will learn a lot about it and its economy reading this book.  When you are done reading this book, you will likely conclude that investing in Indian companies is best left to local experts like the author.  The book gives a good framework, but one embarking upon investing in India will need to develop knowledge of which Indian families treat minority shareholders fairly and who do not.  If you want to, you can buy it here: Investing in India, + Website: A Value Investor’s Guide to the Biggest Untapped Opportunity in the World (Wiley Finance).

Full disclosure: The PR flack asked me if I would like a copy, and I said yes.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.