Category: Accounting

Value Investing Flavors

Value Investing Flavors

Posted on by David Merkel

I ran across this article, Value Investor or Value Pretender: Which Are You?, by who puts out The Manual of Ideas, along with Oliver Mihaljevic.? I appreciate what they do — you can learn a lot from their organization.

I told him that I was going to write this, and he said to me:

The piece was meant tongue-in-cheek but feel free to rip it apart 🙂

I will rip it apart, but gently, because every point he made is mostly true for value investors, but there are variations in the way that value investors operate, so you can do some of the things he says you can’t do, and still be a value investor — what matters is how you implement them.

There will be more parts to my “Education of a Risk Manager” series, and one of them will deal with all of the different managers that I met, and how much they varied in terms of what they thought were factors that mattered.

Thus, as I developed my own theories of value investing, I considered the range of opinion, and realized that there is a single model for value investing, but that it is complex enough that different parties use different approximations of the full model, and those approximations do better and worse in different environments.

Like a David Letterman-style Top 10 list, John Mihaljevic listed and described things that made you a value pretender.? Time to go through them:

Reason #10: You invest based on chart patterns

I don’t use chart patterns, but I do use momentum both positively & negatively.? There is decent evidence that investors are slow to react to new information, and so stocks with strong price momentum over 200 days tend to do better.? There is some evidence where there is lousy price momentum over a 4-year period, that things tend to mean-revert.

Granted, there is a tendency among some value investors to troll the 52-week low list.? I like doing that too, but you have to be careful, because maybe you are missing something that cleverer investors know.? The same would be true of short interest figures.? Whenever I see one of my stocks gain a high short interest ratio (shares sold short / volume, or % of mkt cap sold short), I do a review to see what I don’t know.? That’s why I am not afraid of the high level of shorting on Stancorp Financial.? This is a conservatively run firm that manages risk up front.? Even though disability claims rise when unemployment is high, they underwrite better than most of the industry.

There have been some very successful value plus momentum investors.? The balance is tricky, but blending two of the most powerful anomalies does bear fruit.

Reason #9: You assume multiple expansion in your investment theses

I never assume that, but if you are buying them “safe and cheap,” you often do get multiple expansion.? The challenge is figuring out where things are less bad then the implied opinion of the depressed valuation.

Reason #8: You try to figure out how a company will do vis-?-vis?quarterly EPS estimates

I don’t do that either, but I have known some value managers that incorporate prior earnings surprise data, because past earnings surprises are correlated with future surprises.? Often, near the the turnaround point for a company’s stock, there are some earnings surprises.

Reason #7: You base your decisions on analyst recommendations

I have few arguments with this, except negatively.? Sell-side analysts are trailing indicators.? I like buying companies where the sell-side is negative, but not very negative.? With very negative opinion, there are often reasons to stay away, unless you possess specific knowledge that the sell-side analysts do not have.

Reason #6: You use P/E to Growth (PEG) as a key valuation metric

I’m sorry, but PEG works, if indeed you have the growth rate right, which is a challenge.? I do try to analyze sustainable competitive advantage for the firms that I own.? That often leads to growth.? Now I am a growth skeptic, so it takes a lot to make me pay up for growth, but occasionally I will do so, when the PEG is low enough.

Reason #5: You use EBITDA as a measure of cash flow

EBITDA is not cash flow from operations, or free cash flow, but it is a valuable figure in value investing when it divides into Enterprise Value (Value of Debt + Value of Stock – Cash).? Low ratios of Enterprise value divided by EBITDA are very effective at identifying promising investments — it indicates cheap assets, and in a time when M&A is hot, it can really pay off.

Reason #4: You would worry about your portfolio if the market closed for a year

I could live with the market closed, but there are advantages to having it open.? With any given stock, there are times in a year to increase or reduce exposure — if you have a firm idea of what the firm is worth, you can buy more during dips, and sell a little into strong rallies.? Short term (one month) stock price movements are fickle, and commonly reverse.

Reason #3: You make investment decisions based on the activity or tips of others

But Manual of Ideas tracks the 13F filings of great investors.? I get good ideas from the best investors also, but you have to do your own research.? Many bright investors chat with each other, and I had many occasions at the hedge fund that I worked for where I disagreed with a friend of the boss.? I was right more often than I was wrong.

Perhaps a better way to phrase it is “choose your idea generators wisely, but do your own research as well.”

Reason #2: Your investment process centers on the market opportunity

This is largely true, but when I know a industry or sector is in horrible shape, I often buy the strongest name in the industry, realizing that they will do well as the competition dies, and they don’t.? Also, there are times when few recognize that pricing power has shifted, and it is time to take a position on a misunderstood industry that is about to grow faster than expected.? Particularly with cyclical companies this idea can be promising.

The same applies to countries where the markets are washed out.? Don’t try to time the bottom, but when a country is cheap, buy a promising/safe company in the country after things have turned up for 100 days or so.

Reason #1: Your investment theses do not reference the stock price

At some points, I like to own companies with strong management teams relative to their industry.? I will let valuation stretch at those points, because there is more of a sustainable competitive advantage there.? You get more positive surprises, and that definitely aids total returns.

That said, a focus valuation is key to all investing.? The only thing more important is margin of safety.

Margin of Safety

There are three elements to margin of safety:

  1. Sustainable Competitive Advantage (Strong Gross Margins)
  2. Strong Balance Sheet (Conservative Accounting)
  3. Cheap Price vs Likely Value

This is different from other formulations of margin of safety, because one has to take into account factors that make it less certain that we can calculate value.? Many value managers were buying cheap financials up until September 2008, only to realize that their estimates? of value were wrong because credit losses would be far worse than expected.

Good stock analysis begins with good bond analysis.? If you wouldn’t buy a bond from the firm, you probably shouldn’t buy the stock.? Value investing is conservative, and looks for situations where there is little credit risk.

Conclusion

If you want to read? summary of my portfolio rules, you can find them here.? I am a firm believer in value investing, but I realize that there are many ways to approach the process.? I watch other value investors, and continue to learn.? Good value investors are lifelong learners, and generalists with broad knowledge.? It is not a narrow discipline, but one that can accommodate new knowledge.

Full disclosure: long SFG

 

The Education of an Investment Risk Manager, Part II

The Education of an Investment Risk Manager, Part II

Posted on by David Merkel

When I worked for Pacific Standard, which had the dubious distinction of being the largest life insurance insolvency of the 1980s, I had few investment-related tasks.? Investments were handled by the overly aggressive parent company Southmark, which gave little attention to risk.

But I knew things weren’t going well, and so I interviewed widely, finally landing two job offers with Midland National and AIG.?? I chose the spot with AIG, because they led me to believe I would work on the international side.? When I arrived, lo, I had a job on the domestic side.? As far as the job went, had I known I would be placed on the domestic side, I would have rather gone to Midland National.? They thought I had real leadership potential — whether true or not, that’s what I was told, and I would not have minded living in South Dakota, or nearby.? As it was, there were many good things that happen to me as a result of living in-between Wilmington, Delaware, and Philadelphia, living on the PA side of the line for reasons of adoption and homeschooling.

When I got to AIG, there was one main thing that involved my risk management skills.? AIG parent wanted growth in GAAP earnings.? They wanted to see a 15% ROE, which few in the life industry were attaining.? In order to do that, they entered into reinsurance treaties (before I arrived).? These would lever up the balance sheets of the subsidiary companies, without incurring debt.? Most of them passed risk to the reinsurers, one did not.

So, when I was called into an examination by the Delaware State Insurance Department auditor over the one treaty that did not pass risk, he said to me, “You know this treaty does not pass risk.”? I replied, “Under ordinary circumstances, I would agree, but the reinsurer has taken a significant loss from this treaty.”? He said, “What do you mean?”? I replied that when Congress passed the DAC tax, the reinsurer suffered the loss — they paid up front, and we pay over time, with zero interest.

He looked at me and said that reinsurance treaties did not exist to cover tax policy, and that the treaty was a sham.? I just shrugged.? I was not the creator of the treaty, and would not have done it if I had been at AIG two years earlier.

But the there were the two larger treaties that passed risk with a vengeance to a large reinsurer [LR] who is no longer a reinsurer (if anyone wrote treaties like these, he might not be a reinsurer anymore either).? In one sense, the treaties were structured like the trading requirements in CDOs.? If you must trade:

  • Get more income
  • Don’t give up rating
  • Don’t extend maturity
  • And a few more smaller things.

I was not there when the treaties were created.? Had I been there, I would have paid a lot more attention to them, and instructed the investment department to set up segregated portfolios, which was not done.? As it was, bonds that underlay the treaty were casually sold as if free to do so.

Now I arrive on the scene.? After reading the treaties, and looking at the data, I conclude that the treaties have been abused on our side.? I suggested to LR that I go through the history, and reallocate bonds that would have fulfilled the treaties strictures, an re-work the accounting so that the terms of the treaty would be fulfilled.? Initially LR agreed to this.

The treaty passed all investment risk to the reinsurer, so defaults would hit them.? What was worse, the liabilities underlying the treaty were structured settlements.? (Structured settlements result from a court case where someone is injured.? The defendant offers to buy from a reputable life insurer an annuity that will make the requisite payments.? Low bid wins, and if the plaintiff is badly injured, the cost goes down for payments that terminate at death.? That’s where most of the bad estimates com in.)? In those days, structured settlements were a “winner’s curse.”? If you won, it was because you mis-bid.? AIG Domestic Life Companies regularly overbid for their business (as did most of the industry).? LR did not do enough due diligence to see the underwriting errors.

I did a mortality study to estimate how badly we needed to increase reserves, and lo, it was more than $100 million, all of which would flow to LR.? LR decided to sue.? After I had gone on to Provident Mutual, AIG settled with LR.? Our missteps with the assets made the case tough, and the reinsurance treaty was rescinded.? That should have been enough to jolt AIG’s earnings for a quarter, but it did not.? Funny that, and it always left me a little suspicious of AIG.? (And LR.)

Before I left AIG, I had clipped the wings of the underwriters of the structured settlements so that they could not write on cases for the most severely disabled.? I also shut down a tiny line of variable annuities that was losing money left and right to an outsourcer who had a sweet contract from a prior management team, but upon leaving AIG I did not feel that great, because I had not built anything — most of my time had been spent trying to limit losses from prior bad underwriting and planning.? It wasn’t fun, and I loved my next company more because I got to build.

PS – a prior note on AIG.

A Bond Deal Requiring Caution

A Bond Deal Requiring Caution

Posted on by David Merkel

Recently, a company for which I once managed bond money announced a bond offering.? An odd bond offering that I would not buy regardless of pricing.You might say, “No such thing as bad assets, only bad prices.”? Mostly I believe that, but not here.? There are some assets you should not want to take the chance on.? This is one of them.

Here is the biggest weakness: you are lending to an intermediate holding company.? When I was a bond manager, I would lend to the uppermost holding company, knowing that the stockholders did not want to hand their profitable company over to me.? I would also lend to subsidiaries that I knew a parent company would not want to lose.? But I would not lend to intermediate holding companies — owned by the parent, and owning a subsidiary not directly responsible for the debt.

I inherited such a debt in the portfolio, and it took me months to sell it at a halfway decent level.

Here is the second weakness: they will take two-thirds of the proceeds, and give it to the life insurance subsidiary in exchange for a surplus note, with similar terms compared to the note sold.? Surplus notes are weak, because state insurance departments can forbid payment of interest and principal.? The ability to repay the bond is weak.? The subsidiary borrowing does not have any significant cash flow to repay, aside from dividends from its insurance subsidiary.

Third, I do not appreciate the affiliated reinsurance.? That is just a scam, with no economic difference to the enterprise as a whole.

Fourth, I do not appreciate reinsurance recoverables larger than common equity.? There is some credit risk there… how much do you rely on your reinsurers to pay claims in full?? The operating insurance subsidiaries look like they are adequately capitalized, but with that level of reinsurance, you really can’t tell for sure.

Also, some of the reinsurance agreements are specifically targeted to eliminate pesky reserves that make Statutory (regulatory) accounting more conservative than GAAP.? That’s not all that unusual with financial reinsurance, but it does lessen future statutory cash flow, which is what is needed to service the debt.

Fifth, 25% of the offering will be paid as a dividend to the parent company, which further weakens ability to repay.

Sixth, there are related party transactions within the Harbinger Group.? Harbinger Group has been through tough times and liquidity is tight.? You only do moves like this when things are desperate. Reminds me of Southmark.? The operating insurance subsidiaries have made loans to EXCO Resources, a Harbinger subsidiary, buys asset-backed securities that other Harbinger subsidaries originate, and has a large reinsurance agreement with a Harbinger subsidiary in the Cayman Islands.? I respect most reinsurers in Bermuda.? Other foreign domiciles like Ireland, Cayman Islands, etc., are more questionable.? Regulation is more lax.

Seventh, Here are some of the points from the risk factors:

Our Reinsurers, Including Wilton Re, Could Fail To Meet Assumed Obligations, Increase Rates, Or Be Subject To Adverse Developments That Could Materially Adversely Affect Our Business, Financial Condition And Results Of Operations.

Our insurance subsidiaries cede material amounts of insurance and transfer related assets and certain liabilities to other insurance companies through reinsurance. For example, a material amount of liabilities were transferred to Wilton Re pursuant to the Wilton Transaction in 2011. See ?Business?The Fidelity & Guaranty Acquisition?Wilton Transaction? below. However, notwithstanding the transfer of related assets and certain liabilities, we remain liable with respect to ceded insurance should any reinsurer fail to meet the obligations assumed. Accordingly, we bear credit risk with respect to our reinsurers, including our reinsurance arrangements with Wilton Re. The failure, insolvency, inability or unwillingness of Wilton Re or other reinsurers to pay under the terms of reinsurance agreements with us could materially adversely affect our business, financial condition and results of operations.

As noted above, reinsurance is a source of credit risk, and is a type of leverage.? Companies that use a lot of it are less strong than they seem.

Our Insurance Subsidiaries? Ability To Grow Depends In Large Part Upon The Continued Availability Of Capital.

Our insurance subsidiaries? long-term strategic capital requirements will depend on many factors, including their accumulated statutory earnings and the relationship between their statutory capital and surplus and various elements of required capital. To support their long-term capital requirements, we and our insurance subsidiaries may need to increase or maintain their statutory capital and surplus through financings, which could include debt, equity, financing arrangements or other surplus relief transactions. Adverse market conditions have affected and continue to affect the availability and cost of capital from external sources. We and HGI are not obligated, and may choose or be unable, to provide financing or make any capital contribution to our insurance subsidiaries. Consequently, financings, if available at all, may be available only on terms that are not favorable to us or our insurance subsidiaries. If our insurance subsidiaries cannot maintain adequate capital, they may be required to limit growth in sales of new policies, and such action could materially adversely affect our business, operations and financial condition.

There is kind of a pathology to insurance companies that rely on reinsurance for capital.? It fronts expected statutory profits from the future, reducing future statutory income, but increases capital.? It’s kind of an addiction.

We Operate In A Highly Competitive Industry, Which Could Limit Our Ability To Gain Or Maintain Our Position In The Industry And Could Materially Adversely Affect Our Business, Financial Condition And Results Of Operations.

We operate in a highly competitive industry. We encounter significant competition in all of our product lines from other insurance companies, many of which have greater financial resources and higher financial strength ratings than us and which may have a greater market share, offer a broader range of products, services or features, assume a greater level of risk, have lower operating or financing costs, or have different profitability expectations than us. Competition could result in, among other things, lower sales or higher lapses of existing products.

They are up against much stronger competition with better balance sheets.? In a crisis, they would have less flexibility, and have a harder time raising capital than most competitors.

The Issuer Is A Holding Company And Its Only Material Assets Are Its Equity Interests In FGLIC. As A Consequence, Its Ability To Satisfy Its Obligations Under The Senior Notes Will Depend On The Ability Of FGLIC To Pay Dividends To The Issuer, Which Is Restricted By Law.

The issuer is a holding company with limited business operations of its own. Its primary subsidiaries are insurance subsidiaries that own substantially all of its assets and conduct substantially all of its operations. Accordingly, the repayment of interest and principal on the senior notes by the issuer is dependent, to a significant extent, on the generation of cash flow by its subsidiaries and their ability to make such cash available to the issuer, by dividend or otherwise. The issuer?s subsidiaries may not be able to, or may not be permitted to, make distributions to enable it to make payments in respect of the senior notes. Each subsidiary is a distinct legal entity and legal and contractual restrictions may limit the issuer?s ability to obtain cash from its subsidiaries. While the indenture governing the senior notes will limit the ability of the issuer?s subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to the issuer, these limitations are subject to certain qualifications and exceptions. If sources of funds or cash from the issuer?s subsidiaries are not adequate, we may be unable to satisfy our obligations with respect to the senior notes without financial support from the issuer?s parent, which is under no obligation to provide such support.

(snip)

The issuer intends to use $195.0 million of the proceeds from the senior notes to purchase a surplus note from FGLIC. The interest rate and tenor of the surplus note will be substantially similar to those of the senior notes.

As pointed out above, owners of this bond would be lending to an empty shell from which it will be difficult to extract value if there is financial stress.

We And Our Subsidiaries May Be Able To Incur Substantially More Debt And Other Obligations.

We May Not Be Able To Generate Sufficient Cash To Service All Of Our Obligations, Including The Senior Notes, And May Be Forced To Take Other Actions To Satisfy Our Obligations, Which May Not Be Successful.

The Senior Notes Will Not Be Secured And Will Be Effectively Subordinated To Future Secured Debt To The Extent Of The Value Of The Assets Securing Such Debt.

The Issuer May Not Be Able To Repurchase The Senior Notes Upon A Change Of Control, And Holders Of The Senior Notes May Not Be Able To Determine When A Change Of Control Giving Rise To Their Right To Have The Senior Notes Repurchased Has Occurred Following A Sale Of ?Substantially All? Of Our Assets.

Our Principal Shareholder?s Interests May Conflict With Yours.

Lest this post go from “too long” to “way too long,” I am summarizing off of the headings of five more risk factors.? The first three show the weakness of the position of the holders of the notes, in that you can be diluted or subordinated.?? The fourth shows how the notes themselves would complicate a sale of insurance subsidiary assets.

The fifth tells you that Phil Falcone has different interests than you.? If things go well, he may do very well, while you get repaid early because of call provisions, and must reinvest.? If things go badly, recoveries on a bond like this could be very low.? When surplus notes stop paying interest and principal, they trade near zero if it looks permanent.? Remember, the Maryland Insurance Administration has every reason to be conservative about making surplus note payments if the operating insurance subsidiary is under financial stress.

Eighth, if it’s not obvious get, I eschew complexity in debt agreements.? I’m not crazy about:

  • Reserving on indexed and variable products
  • Complexity of financial operations
  • Liabilities that can run easily — I don’t have the data for that, so I don’t know how big that is, I would have to look at the Statutory books to know for sure.
  • Deferred tax assets as a part of Statutory Capital — again, I would have to look at the Statutory books to know for sure.

Ninth and Last, the covenants protecting the notes are weak, and exceptionally verbose.? I have a rule that the longer and more detailed covenants are, the less protection they usually give note owners.? It’s kind of like Proverbs 10:19, “In the multitude of words sin is not lacking, But he who restrains his lips is wise.”

For a corporate bond prospectus, this one is really long, ~320 pages, longer than some securitizations that I used to buy as a mortgage bond manager.? I assume that most of the investor interest here would be institutional, but if you give your broker some discretion over an account in which he purchases individual bonds, you might ask him to avoid this deal.? It will be a tempting bond to buy, because it will come with a fat yield in this yield-starved environment, if the deal gets completed.

As one friend of mine once said to me, “This bond deal is horrid, but it has one sweet YTNJ.”

Me: “YTNJ? Haven’t heard that one.”

Friend: “Yield to next job.”

Be like Will Rogers, the return of the money is more important than the return on the money.? Be wise, stay safe.

PS — The opinions of Moody’s & Fitch

Questions from Readers

Questions from Readers

Posted on by David Merkel

From a reader:

I have enjoyed reading your blog for the past few years. I started researching some insurance companies and went to some of your posts to help me get a better understanding of their financials. In one of your posts you talk about RGA trading below TBV and TBV ex AOCI. Why do you exclude AOCI from TBV?? Do insurance companies trade on ex AOCI multiples or regular BV and TBV multiples?

  • BV -> Book Value
  • TBV -> Tangible Book Value
  • RGA -> One great life reinsurer, Reinusurance Group of America.
  • AOCI -> Accumulated Other Comprehensive Income

We typically exclude AOCI from book value, because AOCI stems from one time events, or things that may revert.? That said, insurance stocks they tend to react to book value prior to any adjustments.? Maybe the answer is this: unless we think the AOCI should revert, the AOCI should be credited to the value of the firm, though ignored by its operating income.

In this low interest rate environment, many bonds trade above the prices at which they were purchased.? Unrealized Capital Gains are usually one of the biggest items in AOCI.? Sadly, only the asset values rise when rates fall, because liabilities aren’t publicly traded, and as such have no price to mark to market.? With life companies, because of the longer tail of obligations, and the capitalizing of deferred acquisition costs (DAC, which is a discounted measure) the unrealized capital gains are applied to reduce the DAC.? DAC, though intangible, is a hard intangible, because there are are cash flows behind it, and if those cash flows are insufficient to repay the DAC asset, the asset gets written down.

Most insurance analysts as a result exclude AOCI from book value for valuation purposes; they think it will disappear when rates rise.? Now that said, I have read research that indicates that insurance stocks track unadjusted book value more than BV less AOCI.? If true, I think that works better for short-tail insurers, because discounting of liabilities does not have so much impact.

I look at it all and kind of shrug.? After that, I do some digging to analyze whether some components of AOCI might be more permanent than otherwise considered.

Insurance stocks mostly trade in line with their book value.? I have been around long enough to see the average multiple move in the range of 0.5x to 2.0x.? Be aware of where we are in the range, and whether pricing power is rising of falling.

From another reader:

I stumbled upon your blog post regarding generating ideas. I too use google alerts to fill the inbox. Unfortunately, I have been unhappy with the results so far. I have attached my alerts (with some culling of personal ones), which can be generated from the bottom of the manage alerts page.?

?I was hoping that you would do likewise and send me your fruitful query strings.?

It would be greatly appreciated.

My Googlebots use the following phrases:

 

  • CEO resigned
  • CEO “Steps down”
  • CEO fired

Now, creating good Googlebots takes time and effort, trial and error.? I typically create them for a specific task, and when that task is complete, I retire them.? My biggest success with Googlebots occurred in 2005, when they detected the peak in the housing market.? I had about 10 Googlebots working to pick up market chatter.? In October 2005, they went through a dramatic change, where the chatter was confused, and the speed of the closing for housing sales dropped dramatically. ?After that, the chatter was subdued.? I posted my result at RealMoney?s Columnist Conversation sometime in October, and told my boss that though credit conditions were still loose, the wind was now at our back on housing prices.? We were ?too early? bears on housing, and I was the one skeptic in the shop on the timing of that.

That’s all for now.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Central Banking

 

  • Records Show Fed Wavering in 2007 http://on.wsj.com/SgLPoG 4 all of their vaunted intelligence, the Fed was worried, but clueless in 2007 $$
  • Three Stages of Fed Grief: Key Quotes From 2007 http://t.co/X4ygwdqU Slowly realized the economy they overlevered was getting worse $$ Jan 18, 2013
  • Fed Concerned About Overheated Markets Amid Record Bond-Buying http://t.co/wDckfD77 The sourcerer’s apprentices note there is a problem $$ Jan 17, 2013
  • Paul Moreno: Gold, Greenbacks and Inflation: A History and a Warning http://t.co/75M1jNRo Ppl forget the degree the Fed has debased $$ Jan 17, 2013
  • Once you turn base money into short-term debt, can you go back? http://t.co/pG3gxBwA @interfluidity ideas getting deserved attention $$ Jan 16, 2013
  • First Shots Are Fired in Global ‘Currency War’ http://t.co/y6GJi0V5 Japan leads “race 2 the bottom.” Who will b first 2 stop sterilizing? $$ Jan 16, 2013
  • Currency Moves? & Central Bank Bravado http://t.co/zt7BI1As Posit that the yen is falling due to war risks & Japan biz risks in China $$ Jan 16, 2013
  • Abe Rocket-Start Lowers Sony Risk With Market Fuel http://t.co/J4cLgQKJ Loose monetary has spillover benefits 2 indebted corporations $$ Jan 16, 2013
  • I’ll grant this: the government always has some role in money, even commodity money like a gold standard… http://t.co/QtVI3oeC Jan 12, 2013

 

Rest of the World

 

  • Pressure Rises on China to Scrap One-Child Policy http://t.co/iDfZ0Ssl No better way 2 have a demographic crisis; change long overdue $$ Jan 18, 2013
  • Default Alarm Rings as Trust Loans Jump Sevenfold http://t.co/2tr1vFnq China is so messed up that it makes the Eurozone look good $$ Jan 17, 2013
  • Singapore Curbs Industrial Property Sales to Avert Bubble http://t.co/vZQhsdya Increases bid-ask spread; can’t fight fundamentals $$ Jan 17, 2013
  • Mongolia?s Erdenes TT Halts Coal Exports to Biggest Buyer China http://t.co/hoTHAxxZ Probably either gross malfeasance or bribery $$ Jan 17, 2013
  • European Dividends Tumble to Four-Year Low as CEOs Hoard http://t.co/D6YdzVqD Favor European Exporters over their Domestic companies $$ Jan 17, 2013
  • Euro at 10-Month High Poses Economic Threat, Juncker Says http://t.co/bk0FsVEE The #currencywars continue. Rule: Beggar thy neighbor $$ Jan 17, 2013
  • Russia Says World Is Nearing Currency War as Europe Joins http://t.co/OvVu0ZMH Accept export slowdown? Monetize debt? Stupid QE-like stuf? Jan 17, 2013
  • Rio Tinto CEO Steps Down http://t.co/lqWyRPES Every CEO should have etched on his wall: “Paying up 4 scale acquisitions is dumb” $$ $RIO Jan 17, 2013
  • China Capital Flow: Foreign Direct Dis-Investment http://t.co/V8erkuxL Foreign inv’t inflows falling, domestic inv’t outflows rising $$ Jan 17, 2013
  • China Starts Losing Edge as World’s Factory Floor http://t.co/pG7uOFqX SE Asia benefits as China becomes more expensive 2 operate in $$ Jan 16, 2013
  • Norway Sees Deeper European Job Pain as Default Fears Recede http://t.co/ztbfvp0H Rising NOK makes exports less competitive &fewer jobs $$ Jan 16, 2013
  • Often when FX vols spike it means something might break, like the SNB not able continue its EUR peg. But if… http://t.co/fydAlRSX Jan 16, 2013
  • HSBC needs 2 end its Ping An silence with simple answers http://t.co/8xVAWiHD much alleged insider deal information has been circulating $$ Jan 14, 2013
  • Mainland alchemists turn damaged zinc into solid gold http://t.co/W4zu69k7 An example of how Chinese banking system papers over bad debts $$ Jan 14, 2013
  • Rumor: large backlog of Chinese companies want to IPO, but having hard time slowing the required 2 years of rising earnings $$ Jan 14, 2013
  • Neighbors Grow More Wary of China http://t.co/aYMUvLs2 Ex-pat Chinese moving in, looking a little graspy w/respect to resources, etc $$ Jan 14, 2013
  • Mineworker Debt Mounts as South African Lending Booms http://t.co/hTkXyCTc There are few places in the world without debt overages $$ Jan 14, 2013

 

Market Impact

 

  • Deutsche Bank Derivative Helped Monte Paschi Mask Losses http://t.co/PeqTdPBT Bad investing led to losses 2 hide. Enter Deutsche Bank $$ Jan 17, 2013
  • reaching for yield http://t.co/zFaWCA7h @researchpuzzler notes tight junk spreads, but + Ed Meigs & Dan Fuss r ?naysayers on junk credit $$ Jan 17, 2013
  • Short-term Debt and Financial Crises: What we can learn from US Treasury Supply http://t.co/UG1RvuHm Qty issue ST fin’l sector debt->crisis Jan 17, 2013
  • 22 Insights From The Most Successful Investors In History http://t.co/4u3QVRJL Very nice assemblage of quotes from the best investors $$ Jan 16, 2013
  • [Will] the Bond Bubble Finally Burst? http://t.co/1c7hOX4W Synthesis of a variety of views: Yes, but not in the short-run… $$ Jan 16, 2013
  • FINRA to brokers: know your high-yield securities http://t.co/DJHC5NvT Intelligent words from FINRA; b able2show clients all possibilities Jan 16, 2013
  • The High Yield Market is “Completely Out of Control.” http://t.co/GBUfGOa9 Watch risky debt buyers; c if they need things 2go right2survive Jan 16, 2013
  • Gold Forecasters Splitting on Peak for Bull Market http://t.co/EIEgk2Al Most-accurate gold forecasters>price will probably peak in 2013 $$ Jan 16, 2013
  • Whatever Happened 2 Good, Old-Fashioned Accountants? http://t.co/aFofQ4Mv @retheauditors explains y basic blocking&tackling go a long way $$ Jan 17, 2013
  • Yale May Buy More Hedge Fund Assets After Favoring Cash http://t.co/D0cP9LDV Timing feels wrong here w/credit spreads tight & vol low $$ Jan 16, 2013
  • Baupost Group Sitting On 116% Return From Madoff Claims http://t.co/u4MYuhJI Bankruptcy judge said ?seller?s remorse,? denied his effort $$ Jan 16, 2013
  • Leeway on Repo Rules Is Cut Back http://t.co/B16EXZfR “…we’re basically saying all repos should be accounted for as borrowings,” $$ Jan 16, 2013
  • Inside the Self-Driving Index Funds That Finish First http://t.co/XPEfHyE4 @jasonzweigwsj $BLK low fees, shares sec lending revenue $$ Jan 15, 2013
  • How2use Twitter & Facebook 2 make $$ from shares http://t.co/lXXw321E Just watch: this causes the next ‘flash crash’ h/t: @abnormalreturns Jan 14, 2013
  • KRS Spin Machine Is Smearing The Truth Again http://t.co/VGGSkxHX Kentucky Retirement Systems does not use RFPs -> “pay to play” @ KRS $$ Jan 14, 2013
  • US Not So High Yield Bonds : “It’s Starting To Feel A Lot Like 2007” http://t.co/QUGhAMqC Will supply grow, or will misfinancing start? $$ Jan 14, 2013
  • SP500 Revisited – Testing 1484/1500 zone and reversal after? http://t.co/8TMktTjD Argues for a correction in stocks in the near term $$ Jan 14, 2013
  • Hedge-Fund Leverage Rises to Most Since 2004 in New Year http://t.co/rwFVhRmz H0: flexible $$ overallocated to stocks now> correction due Jan 14, 2013
  • 39% of Fund Managers Beat the S&P in 2012 http://t.co/xRx3Juik It was a growth year & not a value year. 48% would b the 10-yr average $$ Jan 13, 2013

 

Billionaires

 

  • I suppose Bloomberg could write a book about hidden billionaires, and call it “The Billionaire Next Door.” http://bloom.bg/WN9Jo8 ?#yeah $$
  • Erie Billionaire Hagen Revealed as Car Premiums Surge http://t.co/BsMEp8gu $ERIE interesting company w/a unique asset-lite biz model $$ Jan 17, 2013
  • Hidden Billionaire Milking Saudi Dairy Fortune in Desert http://t.co/XAoRKBRp Bloomberg likes ‘outing’ obscure billionaires like this $$ Jan 14, 2013

 

Personal Finance

 

  • Why you can?t avoid dumb 401(k) mistakes http://t.co/fffPsn0k Plan sponsors chase hot managers & avoid passive options $$ Jan 16, 2013
  • Behind the indexed annuity curtain http://t.co/Qo7RdSX9 Avoid. Surrender charges r long & high 2pay commission; opaque int crediting $$ Jan 16, 2013
  • One in four savers has 401(k) ?leakage? http://t.co/TRBsFfwx Retirement seems far away, but $$ needs r near, so ppl tap their 401(k)s Jan 16, 2013
  • Seven Resolutions to Get Your Nest Egg in Shape http://t.co/cqNqpxJF Good basic advice 4 ordinary people taking care of the nest egg $$ Jan 16, 2013
  • E-Filing and the Explosion in Tax-Return Fraud http://t.co/9SAE6oPL Identity theft; 1 reason y I do it myself & file on paper $$ Jan 14, 2013
  • Housing Problems: Where To Get Help http://t.co/3hrCyQFy @retheauditors gives advice to those having issues with foreclosures $$ #goodstuff Jan 13, 2013

 

Banks and Investment Banks

 

  • More Ideological Excuse Making for Bad Banks http://t.co/0wjkQq3n It takes two to tango; it takes two to make a loan. Both deserve blame $$ Jan 17, 2013
  • A tempest in a spreadsheet http://t.co/W2mwYeHO A reason y having robust “smell tests” r needed when mathematical models get complex $$ Jan 17, 2013
  • Mortgage Nanny Added to Lender Job Description http://t.co/nRRonPBL Caveat Emptor:May make probs worse by creating illusion of safety $$ Jan 17, 2013
  • Wells Fargo to Start Jet-Leasing Venture http://t.co/a0FwgcNn FD: + $WFC | I like the fact that theyr starting small #organicgrowth $$ Jan 17, 2013
  • Jefferies Sets Table in Pay Clash http://t.co/s6utAuEy Or, they could jump 2 $JEF soon 2b $LUK. $$ motivates better, but conflicts occur Jan 16, 2013
  • Bankers Get IOUs Instead of Bonus Cash http://t.co/fKrpWXZL Will tie employees more tightly, unless they jump to related industries $$ Jan 16, 2013
  • Report of $JPM Management Task Force Regarding 2012 CIO Losses http://t.co/i7x0Ifi4 [132pp PDF] If interested in $JPM, summary in 17 pgs $$ Jan 16, 2013
  • Municipalities Should Ditch Wall Street Derivatives Deals http://t.co/Jqmgjllk If Wall St is on other side of table, watch your wallet $$ Jan 16, 2013
  • Banks say new agency’s oversight is slow, costly http://t.co/aHIGFRUh Banks pine away over the regulatory laxity they had 6-10 years ago $$ Jan 16, 2013
  • Goldman?s ?Secret? Team Shows Volcker?s Folly http://t.co/fovIyDRf Difficult to stop prop trading, better 2 remake I-banks partnerships $$ Jan 14, 2013
  • Bank Deal Ends Flawed Reviews of Foreclosures http://t.co/7DoTN8yA absurd, $$ will b distributed w/little regard 2 who was actually harmed Jan 13, 2013

 

Economic Policy

 

  • Portfolio Manager Creates Dazzlingly Deep Presentation On What’s Really Going On With The US Economy http://t.co/vcRHWwEe Long but good $$ Jan 17, 2013
  • Obama Finds Path to Congress Deals Goes Through McConnell http://t.co/B763HV1u Give him his due; has a nose that can sniff out deals $$ Jan 16, 2013
  • The Next Tax Increase http://t.co/7beI2QUO What the US Govt has belongs 2 the US Govt. What belongs 2u is subject 2 negotiation $$ Jan 16, 2013
  • Swap the Debt Ceiling for a Rule That Makes Sense http://t.co/NVYjvTD8 Maybe limit total liabilities of US Gov’t to 2x GDP? Way past that Jan 16, 2013
  • Why U.S. might be ?a nation of deadbeats? http://t.co/UuOHrKlt Consumers have been paying down debt, but walking away from more $$ Jan 16, 2013
  • A Credit Downgrade Warning Both Sides Should Listen To http://t.co/TbB3Gbdn Rating agencies r more honest than US Govt. Fitch may d/g US $$ Jan 16, 2013
  • Treasury Bill Rate Curve Inverts Amid Debt-Ceiling Showdown http://t.co/0KOQqC7A Bill curve showing some inversion due 2 debt ceiling $$ Jan 16, 2013
  • Money-Printing Will Lead to an Inflation in Another Guise http://t.co/erqP71P7 Debt overload & slack capacity short circuit credit growth $$ Jan 16, 2013
  • Two Warning Signs for Treasuries http://t.co/BdAcNkHE “yield curve btw 2&10 years is starting to steepen” Resistance 2 neg real rates up $$ Jan 16, 2013
  • TIPS Implied Inflation 4 2018-22 rose over 2012; flat now http://t.co/R28O77bX 2014 Inflation rising http://t.co/VCfupYLT $$ Fed target 2.5% Jan 16, 2013
  • US states flirt with major tax changes http://t.co/EnZmtggx Red states moving toward sales & away from personal/corporate income taxes $$ Jan 14, 2013

 

States & Municipalities

 

  • California, Unsaved, Speeds Toward a Wall of Debt http://t.co/pyrObgbr Constants in life that r not comforting: gimmicks in CA budget $$ Jan 17, 2013
  • California Could Be the Next Shale Boom State http://t.co/r0QChYDh Energy could flow from the Land of Squandered Advantages $$ Jan 16, 2013
  • Pension Funding Gap Widens for Big Cities http://t.co/a76JAJT0 Expect 2c many fights where bens cut 4 new, active & retired employees $$ Jan 16, 2013

 

Companies

 

  • Suitors Interested in H-P’s Autonomy, EDS Units http://t.co/AXdvxjei Wouldn’t put 2 much into this; $HPQ won’t get good prices $$ Jan 16, 2013
  • Genworth Shares Soar Amid Plan for Mortgage Insurer http://t.co/Jqmgjllk $GNW moves deck chairs on the Titanic; rewarded for now $$ Jan 16, 2013
  • Chevron Signs Deal for More Oil Exploration Acres Off China http://t.co/Yqb7yY7g FD: + $CVX smiles as it rides the tiger $$ #risks Jan 16, 2013
  • My Favorite Tobacco Stock Is Intel? http://t.co/Wupvh1qk @CharlesSizemore explains y it should deliver returns, amid hatred $$ FD: + $INTC Jan 16, 2013
  • TNT Left at Altar Gets No Immediate FedEx Deal http://t.co/QSdDHarC “FedEx in a good position to wait this out & let TNT come to them.” $$ Jan 16, 2013
  • Latest IPOs Arrive In The Form of New MLPs http://t.co/cq7XuIKv All of the new MLPs r energy-related $$ Jan 14, 2013
  • ARM CEO East Says Phooey to the ?Transistor Cliff? http://t.co/wfiIeQau Cost, speed, & power use r the key factors 4 logic chips $$ Jan 14, 2013

 

Miscellaneous

 

  • Davos Pitch for Dynamism Rams Into End-of-Growth Debate http://t.co/1bNvkwD7 I don’t think growth is ended, but bad finances interfere $$ Jan 17, 2013
  • Global Piracy @ 5-Yr Low http://t.co/YgJlRQSh 2012: Pirates boarded 174 ships globally v 439 in 2011, people taken hostage 585<-802 $$ Jan 16, 2013
  • NRA Labels Obama Hypocrite on Guns for Child Protection http://t.co/DqIsubsA Administration doesn’t like the argument; hits close 2home $$ Jan 16, 2013
  • Kidnap insurers eye sales as euro crisis bites http://t.co/w5CfiwOe Stable rates: More competition, & armed guards 4 sea transport $$ Jan 16, 2013
  • Mathematicians coming of age to become the most sought after professionals http://t.co/thXJdgsS Nerds of the world unite! Big data 2analyze! Jan 16, 2013
  • The Margin Debate http://t.co/zE6p5oO1 Labor share of US GDP has fallen because growth in the global capitalist labor force, wages fall $$ Jan 13, 2013

 

Financial Blogging

 

  • Your guide 2the financial blogosphere http://t.co/9mkoln2n Comprehensive list of finance bloggers. I’m listed under “Trading & Investing” $$ Jan 14, 2013
  • What are the 100 Top (Anglo-Saxon) Finance Blogs? A Pseudo-Scientific Study http://t.co/I9UU32zP I ranked higher than I expected 🙂 $$ Jan 14, 2013
  • The purpose of this site http://t.co/Bp4sqw5o @reformedbroker ‘s excellent piece on how his blogging helps him think & invest better $$ Jan 14, 2013

?

Painting Kate Middleton

 

  • @judehere Perhaps this then? http://t.co/hstcUqPq Jan 16, 2013
  • @judehere That’s okay. You say he painted the Queen? That’s interesting. Is there an image of that out on the web? Jan 16, 2013
  • ‘ @judehere She seems to be a nice lady, so I wouldn’t be a fan of that. But Freud died in 2011, so the possibility is not there. Jan 16, 2013
  • But this portrait of Kate Middleton is worse in my opinion http://t.co/LBMKplpo No wonder only 19% like it. (2/2) $$ Jan 16, 2013
  • Learning to draw, I copied a photo of a friend w/pencil. Another friend said “You took a very pretty girl, & turned her in2 pretty girl” 1/2 Jan 16, 2013

 

 

Michael Pettis

 

  • Pettis: What I will watch in 2013: 10 things: hard commodity prices, trade numbers, Spanish Bonds, Target 2, & Japan (2/2) $$ Jan 14, 2013
  • Pettis: What I will watch in 2013: 10 things: China growth, Debt trajectory, financial scandals, bank activities, inflation (1/2) $$ Jan 14, 2013
  • Pettis: Imbalances can continue for many years, I argue, but at some point they become unsustainable & the world must adjust by reversing $$ Jan 14, 2013
  • Pettis: Policymakers do this by shortening their time horizons &managing from crisis2crisis, rather than sorting out the underlying problems Jan 14, 2013
  • Pettis: policymakers… taking steps that protect them from the consequences of the crisis but that also make the crisis worse. $$ Jan 14, 2013
  • Pettis: It is interesting that policymakers are so pleased by an end (temporarily, I assume) to the financing crisis. $$ Jan 14, 2013
  • Pettis:We ended 2012 in a burst of optimism for Europe, w/everyone cheering Mario Draghi 4having ?saved? the euro, but I am deeply skeptical Jan 14, 2013

 

Wrong

?

  • Wrong: How to Find a Fund Manager Who Can Beat the Market http://t.co/2Nq1Z9b2 Doesn’t understand difference btw correlation & beta $$ Jan 15, 2013
  • Wrong: US Budget : Federal finances continue to improve http://t.co/HKzv6pLK It is a *spending* problem that started w/Bush 43, not revenue Jan 15, 2013
  • Wrong: Municipal Bonds May Not Be Safe From Income Taxes http://t.co/MnIQIdor Would be a big shift, hit blue states hard. Won’t happen $$ Jan 14, 2013
  • Wrong: Chris Hayes’ Brilliant Explanation Of Money Is One Of The Best Things We’ve Ever Seen On TV http://t.co/e0kxN5oZ #goldstandard $$ Jan 13, 2013

 

Comments and Retweets

?

  • Good night. Blessings to all. Jan 18, 2013
  • @cogent_rambling Think of judges in a court. No one will forgive a man for doing wrong in one area, because he has done good in others Jan 18, 2013
  • @cogent_rambling It’s not a question of weakness but wrong. Divorce your wife for no good reason, cheat at your craft, all amounts 2 wrong Jan 18, 2013
  • @cogent_rambling Good question. God created Lance with a weakness. If Lance had trusted God, he could have overcome it, but he didn’t. Jan 18, 2013
  • @cogent_rambling Not those that are God-given. Mt 5:48: “Therefore you shall be perfect, just as your Father in heaven is perfect.” Jan 18, 2013
  • @cogent_rambling One last point: in the view of Jesus is there is no balancing. The least amount of evil poisons any good. Jan 18, 2013
  • @cogent_rambling Read some of the writings of Kahneman & Tversky. Bad things have 3 times the force of good things. Good doesn’t erase bad Jan 18, 2013
  • @cogent_rambling Okay, I get it. But doing good things does not erase bad things. Doing things that are notably bad tarnishes anything good. Jan 18, 2013
  • @cogent_rambling I have heard the word as a part of popular culture, but have no idea what it is beyond a phrase. Jan 18, 2013
  • @cogent_rambling Okay, I’ll bite. His charitable endeavors, but what else? Jan 18, 2013
  • @sallyeastman1 Well said Jan 18, 2013
  • My view: Lance Armstrong is best ignored. Close the browser window, change the channel on the TV, he will go away. I don’t care about him $$ Jan 18, 2013
  • @AboveAvgOdds Off to meet w/u & Chris Mayer in downtown Baltimore Jan 17, 2013
  • Endorse. I have read over half of these $$ RT @TheStalwart: The 22 books that Dylan Grice says you must read. http://t.co/QSOWvuBc Jan 17, 2013
  • @graemehein good point, but most simple models have obv intuition. Complex models have more potential 4 error b/c of 2nd+ order effects $$ Jan 17, 2013
  • @cate_long Others that did the same in 1994: Piper Jaffray’s Institutional Gov’t Income & FPA’s Fundamental US Gov’t Strategic Income funds Jan 17, 2013
  • @cate_long Combined w/levering them, and not having the mathematical savvy to price them right http://t.co/5vkUxgO6 Story near the bottom Jan 17, 2013
  • @cate_long Cate, you’re right, I’m wrong. At the time, David Askin & those like him were notable. W/Citron it was mostly structured notes Jan 17, 2013
  • @kirstensalyer Sorry, that honor belongs to the first quantitative hedge fund manager, Ben Graham, who was doing that in the 1920s Jan 17, 2013
  • @cate_long Also used complex RMBS. There was kind of a contest 2c how much negative convexity one could absorb in exchange 4 yield Jan 17, 2013
  • RT @maxrudolph: #unintendedconsequences when pension regs set up EA designation cut off practitioners from ALM development. Still catchi … Jan 17, 2013
  • Well done $$ RT @LaurenLaCapra: Jim Chanos talks to @Reuters about Herbalife & whether Ackman or Loeb will win out: http://t.co/sV7B604o Jan 17, 2013
  • @finsovet @prieur @vitaliyk Honored 2b included in such a group Jan 17, 2013
  • Think this analysis is correct, but uncertain $$ RT @mickwe: 3D printing is a lot of hype and it’ll never go mainstream http://t.co/8wkr5oxp Jan 17, 2013
  • I just left a comment in “7 gut checks before the stock market?s opening bell” http://t.co/MrSqVXZF Jan 17, 2013
  • @niubi If so, good for him. He revolutionized my economic thinking with his last book. Looking forward to the next one. Review copy coming Jan 17, 2013
  • +1 RT @dpinsen: Paging @TomFriedman: comment on How a ‘model’ employee got away with outsourcing his work to China http://t.co/wukYAV8T $$ Jan 17, 2013
  • +2, scrap IFRS RT @Alea_: +1 Britain should scrap IFRS accounting standards, MPs told http://t.co/woWmyC2v Jan 16, 2013
  • @oddballstocks very different mindsets; marketing and operations r different from finance, which is still different from investing Jan 16, 2013
  • @oddballstocks I did that as well from 1992-1998. Tried very hard to select non-name-brand mgrs w/durable competitive advantages Jan 16, 2013
  • ‘ @ClayNickel It depends on how equitylike the bonds r, & the financing composition of the holders. If the bonds r financed w/sig debt.. $$ Jan 16, 2013
  • RT @Matthew_C_Klein: The big deal about the German gold story isn’t that they’re taking some of it out of NY but that they’re moving *al … Jan 16, 2013
  • RT @Matthew_C_Klein: @izakaminska has a thoughtful take on the base money debate between @interfluidity and @NYTimeskrugman http://t.co/ … Jan 16, 2013
  • ‘ @joshuademasi Good point. After all, most nations would love to swap for Norway’s economic situation. $$ Jan 16, 2013
  • @earwulf Good insights both. We live in “interesting times” in the full meaning of the Chinese curse Jan 16, 2013
  • @ReformedBroker Rieder is a bright guy, as is my friend Ed Meigs at First Eagle; HY is okay for the short run, but 2 years out… $$ #Boom! Jan 16, 2013
  • @earwulf Yes Jan 16, 2013
  • @earwulf No, I don’t really find them persuasive. I do think that some Central Bank will stop sterilizing asset purchases, start new phase Jan 16, 2013
  • @JacPatterson I thought about that too, & think he really meant “English Language” Finance Blogs Jan 15, 2013
  • “But that also means you have to keep more $$ around if the puts get exercised, which Buffett had & many don’t.” http://t.co/uEIRn5i3 Jan 15, 2013
  • @joelight @spbaines the paragraph that starts ‘To screen out such “closet indexers,”‘ is factually wrong, does not understand statistics Jan 15, 2013
  • @joelight @spbaines I’m not arguing w/R2 as a proxy for active share, though there r better measures; article says correlation, means beta Jan 15, 2013
  • +10 Mmmmm… RT @dpinsen: Bresaola, lemon, olive oil, Parmesan, and basil joining forces for a great sandwich. http://t.co/pMMVmoI5 Jan 14, 2013
  • @abnormalreturns I’ve run into a *lot* of people trying to do this. Some are cleverer; not sure how it will work out… Jan 14, 2013
  • @JayLeonard but gold does control inflation and limits the government’s ability to use monetary policy for its own ends Jan 13, 2013
  • @JayLeonard Much of the difficulty is not gold vs not gold, but how banks were regulated — short liabs carrying long assets Jan 13, 2013
  • @GuldbergPeter Thanks, though I have heard that Canada *may* have issues. Jan 12, 2013
  • RT @GuldbergPeter: “@AlephBlog: Is there anyplace in the world that hasn’t overlent on real estate? Sweden, Canada and actually to some … Jan 12, 2013

?

FWIW

?

  • My week on twitter: 40 retweets received, 1 new listings, 67 new followers, 65 mentions. Via: http://t.co/SPrAWil0 Jan 17, 2013
Penny Wise, Pound Foolish

Penny Wise, Pound Foolish

Posted on by David Merkel

Some of the dumbest things I have seen in my life inside corporations revolve around incompetent managers, who don’t have the foggiest idea how to grow value organically, and use a variety of shortcuts or cheats to give an illusion of creating value by doing nothing.? I have given a few examples in these two articles:

Here are some more examples:

Some acquirers tend to despise the employees of firms that they acquire, and assume there is a lot of fat to be cut.? So it was that a client that I managed assets for that was acquired by a British company.? A few months after the acquisition the client firm announced that they were firing half of the accountants, and all of the accountants dealing with investing.? I went to the management of the firm that was a new client of ours and expressed my concerns, saying that they would lose all customization and control of results by outsourcing investment accounting — it could never be as responsive as retaining “in-house” staff.? Also, firing half of the remaining accountants would lose a lot of local knowledge where systems are deficient and need “hand holding’ with regular adjusting entries to make sure the accounting was correct.

In this example, the investment accountants were actually quite good, though their leader did not present well.? I had a good relationship with him and his staff, and helped them find new jobs, much as I hated to see them go.? I did the same for some of the other accountants that were let go, since I interacted with some of them as well.? It almost seemed like the new client wanted to eliminate all of the accountants with special long-term knowledge of the business, and retain the cheaper ones with less institutional knowledge/tenure.

As it was, my dealings with the new heads of financial reporting left me scratching my head, wondering why the new guys were a “trade up.”? They seemed to understand the issues less well than those they replaced, but were advertised to be really bright.? Okay, lost on me.

I relayed my concerns to my bosses, and they said, “Not much we can do.? We have the same ultimate parent company, but they’re not geared toward taking feedback at what would be such a micro level for them.? Let’s just watch and see what happens — if it is as bad as you think, it should materialize in six months or so.”

As it was, my bosses were right, and so was I.? For the first six months after the accounting change, profits were astounding.? The new management team was patting itself on the back, certain that their decisions were leading to greatly improved profitability.? (As an aside, I remember sitting through interminable meetings where new accounting software was being introduced. The old stuff was not good enough.)

Then came the year end audit, and new internal auditor plus new external auditors questioned accruals produced by the new outsourced investment accountants.? I was asked what the right approach was for accruing income on some obscure fixed income security.? Belying their cheap cost, the new investment accountants did not make the correcting entries into the system that the old accountants had, leading to a massive over-reporting of income.? Far from being more profitable than the past, it was far less profitable, despite all of the firings in accounting.

This was the first comeuppance of many for an untalented management team that eventually all got fired, as well as the ultimate CEO of the firm that trusted them, and invested a lot of money into that subsidiary.

Warnings to the wise: always analyze your profit margins in a competitive industry, and if results seem too good to be true, don’t accept them, push back and look at all of the squishier accrual items to see if there is an error.? Bad management teams accept good results without question, and criticize bad results always.? Good management teams criticize unusual results, whether good or bad, but bias income to the low side of fair, allowing small positive surprises to emerge.

Then there was the time where an insurance company that I worked for bought out a smaller company, and the hidden price of the deal was that the new CEO would be the CEO of the acquired company in a year.? Bad move.? The guy was an accountant, and his only means of “adding value” were cutting employees, and skimping on squishy accrual items.? While he was CEO, I kept track of how mach GAAP income outpaced my adjusted Statutory income, which should have been close to GAAP.

The CEO had a fragile personality as he did this, emphasizing that the team he had assembled (loyal, but less competent) was highly ethical.? As it was, the CFO tried to find ways to convert capital gains into regular income for GAAP but not tax purposes, which maximized ROE, which was the largest contributor to management bonuses.? They were even the first ones to try an unusual derivative marketed by Morgan Stanley — bull/bear notes, as they were called. It was a bond that would split in two after a certain trigger, leading to two bonds — one with a premium income that would be held, and one with a discount income that would be sold for a capital loss.

Sadly, the company had a hard time evaluating the offer, until they approached me.? (Here is where ability conflicts with ethics.)? The chief actuary (via the Peter Principle, but true of all of that management team) showed me the derivative, and I said, “Oh, that’s easy.”? I told him I would have results by the next morning, and it was 4PM already.? I took it home, worked on it through the evening, and the next day presented the result.

I told him that the math worked mostly, but that if the US Treasury applied anti-abuse rules, it would be invalidated.? I also told him that I didn’t think the transaction was ethical, because restructuring merely to avoid tax, and change the GAAP statement impact had no economic substance.

He ignored my warnings, and so I found myself a week later presenting before all of the leading managers of the company the details of the transaction to be.? (Before that, I talked to the instigator of the idea at Morgan Stanley, and showed him errors in his spreadsheet.? Do not assume that investment banks are infallible.? Also, don’t assume that actuaries or any quants are infallible.? They are human too, and subject to their own biases.? People often shout the word “science” when they are the most weak.)

I told them that I thought the idea was not ethical, but that it would do what was promised.? They were happy with that.? I was already known to be opinionated, though my results were very good.? That poisoned me with senior management which prized loyalty over truthfulness.

Two months later, I was working with a new firm, and the boss came to me and said, have you ever heard of bull/bear notes?? I roared with laughter, and puzzled, he looked at me and I said, “Heard of them?? I corrected their models!”

It should have been a warning sign because our client (the same as mentioned in the first story prior to the acquisition) was willing to consider such garbage in order to increase operating income.? Good managements don’t go for gimmicks.? Going for gimmicks means you aren’t focused on real organic growth.

So, we started in on a new transaction.? The rep from Morgan Stanley was surprised to talk to me again.? Very easy to do, because I knew the model as well as he did, or maybe better, much as I did not like it.

I went through the same schtick with the new client, but they were determined to do it no matter what.? I still remember being in a dim conference room with my boss, when FASB’s EITF [Emerging Issues Task Force] disallowed the transaction going forward, and required all of those that had done it do disclose the results in a footnote.? (Only one company had done it, my prior employer.)

-==-=–=-=-=-==-=–==-=-

The company that actually executed the bull/bear note eventually sold itself to another firm.? While I was working as a buy-side insurance company investment analyst, I got to meet the CFO of the company that bought them.? I said to him, “Would you like me to tell you the history of how this came to be?”? With a grim face he told me no.? It was a thing of pain, but he did not want to know the truth.? He kinda knew it already, and simply absorbed the loss.

With Epictetus, I can tell you that the truth will set you free.? Lies always constrain.? With Jesus, I can say, “You will know the truth, and the truth will set you free.”? This is far more personal, and useful, because Jesus himself lives to teach and protect his own. He is the Truth.

To all, I say, be wary of management teams that control results overly — this seems to be more common in finance, where results are harder to judge.? Finance is all accruals, which makes results ephemeral.

But good managers of financials are conservative.? That is the thing to look for in financials.? If my two examples above are not enough, it is not wise to buy financials that offer growth, because it often stems from scams, not real growth.

I have seen my share of fakers in this life in financial company management.? Be wary when you invest in financials; there is a reason why they are separate from industrials and utilities.? They are less reliable, particularly in time of stress.

So, to investors that care about what they invest in:

  • Analyze acquisitions — most aren’t good
  • Scrutinize accounting — most of the devils lie in accrual entries
  • Analyze management, if you can — understand their ethics, or lack thereof

I’ve written too long, but consider what I have said for your own good.? It will help you.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Before I give you the Tweets, I just want to tell you that I will be blogging? this fine accounting conference on IFRS/ US GAAP.? Those that want to attend at a discount can use this code Aleph10 to save 10%.? CFAs get a code that saves 20%.? I think the conference will be valuable, so I will be heading up to NYC on January 10th.? See you at NYSSA’s conference center near Times Square.

Now for the Tweets:

THE FISCAL CLIFF!!! AUGH!!!

 

  • The Fiscal Cliff Could Last Forever http://t.co/ay6gKOrc The upward curve in entitlement expenditures could make “fiscal cliff” normal $$ Dec 28, 2012
  • Fed Helps US Dance on Ceiling http://t.co/g2X0UijU Seiniorage revenue (stealth tax on savers) keeps the deficit lower than otherwise $$ Dec 27, 2012
  • Grand Bargain Shrinks as Congress Nears US Budget Deadline http://t.co/Dr2GCk6l No incentive 4 either side 2 do a deal $$ #shiftblame Dec 26, 2012
  • No Fiscal Cliff Deal Could Cause Jails To Release Inmates http://t.co/07gm3Drm We need less costly alternatives 2 incarceration $$ Dec 25, 2012
  • Campaign on US Debt Gains Steam http://t.co/CwdnN21X ?4 the longest time, nobody cared, nobody listened-it was 15 years of irrelevancy.? $$ Dec 24, 2012
  • Cliff Would Strike Low Incomes Hard http://t.co/aEENGola Difficult 2 say who would b most affected if we went over the fiscal cliff $$ Dec 24, 2012

 

China

 

  • China Tightens Rules for Internet Users http://t.co/HRACEhue Problem: very difficult to enforce when u have so many users $$ Dec 28, 2012
  • Chinese Scholars Demand Communist Leaders Relax Their Grip http://t.co/1bdCHHDL They think another Cultural Revolution can’t happen?… $$ Dec 28, 2012
  • Billionaire Princelings Ruin a Chinese Vision http://t.co/mTHFPt8R Crony capitalism w/Chinese “Communist” characteristics ->princelings $$ Dec 28, 2012
  • 3rd&last long article on Chinese political succession: Xi Jinping Relations Reveal Fortunes of Some Elite in China http://t.co/iFz7e6dg $$ Dec 27, 2012
  • Heirs of Mao?s Comrades Rise as New Capitalist Nobility http://t.co/ALYa5e7V It’s becoming an aristocracy in China & will that last? $$ Dec 27, 2012
  • Defying Mao, Rich Chinese Crash the Communist Party http://t.co/UTcNO2oj Looong article on wealthy in China gaining political power $$ Dec 27, 2012
  • Too big to fail? China’s wealth management products stir debate http://t.co/UM5Z5vxr China gets its turn to decide: bailout or failure? $$ Dec 26, 2012
  • Bell tolls for Beijing’s Drum Tower homes http://t.co/SJrkVhXO Forced evictions from old homes to enhance a touristy area in Beijing $$ Dec 24, 2012

 

Michael Pettis

 

  • Pettis: …illicit money out of China totaled US$420 billion in 2010… 94% of the illicit $$ flows occur through mis-invoiced trade Dec 22, 2012
  • Wow. Pettis: Trade misinvoicing is the preferred method of transferring illicit capital from all regions except the MENA region Dec 22, 2012
  • Pettis: problem is the inexorable tendency of the current development model 2generate debt faster than it generates debt-servicing capacity. Dec 22, 2012

 

Rest of the World

?

  • Euro Zone Set to Continue Contraction http://t.co/rFOZlSjy Successful austerity eliminates much debt for small GDP losses; but this? $$ Dec 28, 2012
  • Cinnabon Finds Sweet Success in Russia, Mideast http://t.co/IFewJw5p Interesting print&video interview; they customize 2 local tastes $$ Dec 28, 2012
  • Putin Set to Sign Russian Adoption Ban http://t.co/ODMcwtTP The kindness of the wicked is cruel, Pr 12:10b $$ Dec 27, 2012
  • Betting on Yen to Fall Further in 2013? Think Again http://t.co/38zvTYmk Depends on how much expectations change in the race 2 the bottom $$ Dec 27, 2012
  • Iran Says ?Irresponsible? GCC Raises Regional Tensions http://t.co/Xqut7V9z Iran cries “foul” when the Sunnis take them seriously $$ Dec 26, 2012
  • GCC to Form Unified Military Command Amid Iran ?Threats? http://t.co/EBO0aaaW Great, not. The Sunnis join forces to fight the Shia $$ Dec 25, 2012
  • Norway Looks to Spread Wealth to US http://t.co/qsDYlE3o Norway’s SWF likes 2 buy irreplaceable real estate; lotsa kronor 2put 2work $$ Dec 25, 2012
  • Deciphering the Decline in Spanish Mobile Accounts http://t.co/ckXo2TT7 Mobile subscriptions usually 1 of last things to go when $$ tight Dec 24, 2012
  • Yen Weakens to 20-Month Low on Abe?s BOJ Pledge; Euro Up http://t.co/aEENGola The race to the bottom continues, w/Japan running hard $$ Dec 24, 2012
  • Looting Tests Leader in Argentina http://t.co/mhwSo7AG Yes, cry 4 Argentina. What should b a wealthy place suffers from bad leaders $$ Dec 24, 2012

 

Fixed Income & Real Estate

 

  • Housing Wealth and Wage Bargaining http://t.co/etoJ7w7A When people think they r going to lose their houses they get desparate $$ Dec 28, 2012
  • Gross Doubles New York Bet as California Loses Lead http://t.co/l0w0wBJr NY is less of a dirty shirt than CA $$ Keeps adding to Munis Dec 27, 2012
  • Mortgage-Bond Sales Soar on Fed?s Refinance Push http://t.co/xX7Do3TY “Sales of U.S.-

backed mortgage bonds soared to a three-year high” $$ Dec 27, 2012

  • A Banner Year for Riskiest Debt http://t.co/zdb83zAa End of Affair With Corporate Bonds http://t.co/rkb2jdtZ 2013 should b ok $$ Dec 27, 2012
  • Home Prices Hit a Milestone http://t.co/cwpVuhfn Nice Graphic: http://t.co/sQggRNj8 Portrait of a dead cat bounce $$ Dec 27, 2012
  • Home-Price Gains Pick Up as US Real Estate Market Rebounds http://t.co/8ZHWeMkU Too early to say much about this dead cat bounce $$ #mew Dec 26, 2012
  • ‘Hope Note’ Strategy Is @ Times Hopeless http://t.co/5TDgdL6z 0% certificate that if everything works perfectly, might get a recovery $$ Dec 24, 2012

 

Stocks, Industries, and Market Dynamics

 

  • Refiners Beating Exxon Join Pipeline Boom for Lost Margin http://t.co/VdzNxkn4 Oil Boom Spurs New Investment http://t.co/4pGXup4P $$ Dec 28, 2012
  • Look at this graph of Barrick Gold Corporation $ABX http://t.co/T4DD2JYU Is the main reason 4 underperforming $GLD rising mining costs? $$ Dec 27, 2012
  • ICE Chief Challenges Stock Views of Trading http://t.co/9OvrtlSF Now watch $CME buy out $NDAQ & we can transform mkts, but2 what end? $$ Dec 27, 2012
  • Garbage Time http://t.co/deDDfsmp @reformedbroker on the lack of liquidity/activity @ year-end. Every real player is looking forward $$ Dec 27, 2012
  • Gus Sauter is at the Vanguard of Roping In Trading Costs http://t.co/OtLi9XBk Sauter likes HFT, uses algorithms 2 lower Vanguard’s costs $$ Dec 27, 2012
  • SEC going high-tech with real-time trade data http://t.co/AWpNNDjd The SEC can get some really fancy tools, but can they use them well? $$ Dec 27, 2012
  • It’s Time for Cramer 2 Short His Show http://t.co/QZ4UUqFF Cramer invests differently than his show; show on how he invests would b dull $$ Dec 26, 2012
  • How to Tell When a Stock Buyback Is Good for Investors http://t.co/SnnQeDoV If price rises on the announcement, it is usually LT good $$ Dec 24, 2012
  • Retiring Vanguard CIO Gus Sauter Looks Back http://t.co/q9rUbE0L A true titan of mutual funds as Vanguard served clients, not Vanguard $$ Dec 22, 2012

 

Macroeconomics And the Fed

 

  • The Mythology of Chained CPI http://t.co/UbtRkVAF Better to cut benefits directly, & not b sneaky by making a technical adjustment $$ Dec 27, 2012
  • Puzzle of weak investment jeopardizes growth rebound http://t.co/7ya8nkks People & firms will not invest 4 the future if present is weak $$ Dec 27, 2012
  • Push for Cheaper Credit Hits Wall http://t.co/48PKxWSf Watch the Fed push on a string; my aren’t they diligent? $$ #untestedtheories Dec 24, 2012
  • Evans Won New Fed Consensus Linking Rates to Unemployment http://t.co/NOelrxXm One day we will call bad economic ideas “Evans.” $$ Dec 24, 2012
  • Usage: “Where did you ever come up with an Evans like that?” “I was so embarrassed for him. At the meeting, he uncorked a real Evans.” $$ Dec 24, 2012

 

Other

 

  • Curbs on Smokers Continue to Grow http://t.co/8APeHuzz I’m allergic 2 cigarette smoke, but we r disadvantaging smokers 2 much $$ Dec 28, 2012
  • Perfect 10? Never Mind That. Ask Her for Her Credit Score. http://t.co/LWb4B7lE Even true love can be thwarted by a lousy credit score $$ Dec 27, 2012
  • 2013 Threats Predictions from McAfee, 16 pages PDF http://t.co/atec8Hpm Introduction article here: http://t.co/LTcjeTxR Surf carefully $$ Dec 27, 2012
  • Anatomy of an Air Attack Gone Wrong http://t.co/EBt24vfj A botched attack on a terror suspect kills 12 civilians & destroys a community $$ Dec 26, 2012
  • Do Unmarried Poor Have Bad Values or Bad Jobs? http://t.co/ukj2Mg99 Only 57% of couples in the program were still together after 3 yrs $$ Dec 26, 2012
  • The Great Chicago Christmas Credit Card Fiasco of 1966 http://t.co/zKR9oFjr Figures it would happen in Chicago, a sandbox 4 corruption $$ Dec 25, 2012
  • NY, Unlike Most States, Treats Education Achievements & Even Talents as Property to Be Divided Between Spouses http://t.co/totejhuX $$ Dec 25, 2012

 

Comments & Replies & Retweets

 

  • Just had a great time w/ @japhychron & @Daily_Pinch $$ RT @japhychron: Getting ready to meet @AlephBlog @ Starbucks http://t.co/f7k3gCTY Dec 28, 2012
  • Gas. Large family only buys 7 gals milk/wk max $$ RT @fundmyfund: what would cause more distress for american households? $6 gas or $6 milk. Dec 28, 2012
  • @mattrixDOTinfo @fundmyfund We had eight (5 adopted) — we briefly maxed out @ 8 gals/week, only 5 @ home now but bigger, so 7 gals/wk 4 us Dec 28, 2012
  • Fiscal Cliff: Boo! Dec 28, 2012
  • RT @randomroger: Fiscal Cliff: Boo! Dec 28, 2012
  • @DavidSchawel Mostly a fair observation, the only exception is that if u think the economy will shift & u r right, the returns can b big $$ Dec 28, 2012
  • @tarhinitrade @ReformedBroker Sound money allows businessmen to be more rational & enterprising. Also, macroeconomists r pretend 2 know $$ Dec 28, 2012
  • @XacAngXiangYin You’re welcome. China is fascinating to me. Dec 28, 2012
  • Just bought: ‘Financial Fine Print: Uncovering a Company’s True Value’ by Michelle Leder via @amazon cc: @footnoted $$ http://t.co/VKc1jdRp Dec 28, 2012
  • ‘ @TheStalwart Yeah, watching $LLL run higher over the last few months. Glad I didn’t sell. FD: + $LLL $$ Dec 27, 2012
  • So far people don’t seem 2b panicking. $$ RT @Alea_: We’ve Already Gone Over the Fiscal Cliff http://t.co/LyzU2bqo from: @cabaum1 Dec 27, 2012
  • @jucojames Thanks, that helps. Dec 27, 2012

?? @dpinsen @footnoted The price of helium is ballooning 😉 Dec 26, 2012

  • @TheStalwart Not much, man. Stocks are likely to sell of a little on the open. Bonds will rally a little. Dec 26, 2012
  • @BUDDIEE18 You have clever phrasing but you don’t have proof. Dec 26, 2012
  • ‘ @Jesse_Livermore @scott_matagrano I know one or two guys that do it professionally; I just don’t know how they get the borrow Dec 26, 2012
  • ‘ @BUDDIEE18 You may find this difficult to believe, but $TSM has a really strict policy against market manipulation for its writers Dec 26, 2012
  • ‘ @scott_matagrano Promoted penny stocks are better: -93%/yr if you can get a borrow. http://t.co/jJ79L4Ac Dec 26, 2012
  • “Given the predominance of S-T $$ in professional $$ mgmt, I think most smart $$ is slow $$. But if?” ? David_Merkel http://t.co/04qie15E Dec 26, 2012
  • Excitement @ the Merkel house today: a water main breaks, brings 5 trucks & 10 men paid triple 2 avoid annoying relatives & icky food $$ Dec 25, 2012
  • Make that 6 trucks. De bossman jus showed up, so the fine art of sitting around ceases, & swing around in2 what is loosely called action $$ Dec 25, 2012
  • @rudibest Reminds my of an article I wrote in 2009 called, “Voted for Change, Got Bush-Plus” & it has only been more so since then $$ Dec 24, 2012
  • Well said. The law was against them from the start $$ RT @munilass: Congratulations @CalPERS on your new status as Just Another Creditor Dec 22, 2012

 

 

Wrong

 

  • Wrong: High-Frequency Trading Prospers at Expense of Everyone http://t.co/jG4mgsRt This just looks like intelligent arbs doing business $$ Dec 27, 2012
  • Wrong: People Hate Losses & That Affects US Budget Talks http://t.co/uDNqcQeE Not good logic. More like envy 2 deny other side a win $$ Dec 25, 2012
  • Americans Miss $200 Billion Abandoning Stocks http://t.co/vO4s2t4S Better H/L: Open end Mutual Fundholders Miss $200B Abandoning Stocks $$ Dec 24, 2012
  • Wrong: India?s Unfinished Journey to Economic Success http://t.co/CnJ7I69y Gary Schilling’s musings on India in need of cultural reform $$ Dec 22, 2012

 

FWIW

?

  • My week on twitter: 53 retweets received, 57 new followers, 33 mentions. Via: http://t.co/SPrAWil0 Dec 27, 2012

 

 

Blog Notes

Blog Notes

Posted on by David Merkel

Once again, I have an article the Baltimore Business Review.? You can download it here.? My article is on page 40 of the PDF.

The Baltimore Business Review is unique, a collaboration between Towson University, and the Baltimore CFA Society.? The CFA Institute highlighted it in the past year, though I can’t find the link.

My article deals with what drives residential housing prices, and sadly, it comes to rather ordinary conclusions.? I hate it when I get a normal? conclusion.

Have a read, and tell me what you think.

=-=-=–=-==–=-=-=-=-==–==-=-=-=-=-=-=-=-=-=-=-=-=-=–==-=-=-=-=-=-=-=-=-=-

Second note: I will be the conference blogger for the NYSSA International Financial Reporting Conference taking place on January 10th.? There is a discount code for Aleph Blog readers: Aleph10, where you save 10%.? Note to CFAs: there is another code where you can save 20%, but I don’t remember what it is.

Accounting is important, and if you are a fundamental investor, it pays to understand it well.? I write this as one who had to learn a lot after becoming an actuary.? I might not know the nuances of all accounting, but I had to learn a lot as I did life insurance accounting, which is more complex than the accounting of most industries.

This is a conference worth attending, though many will ignorantly sneer at accounting conferences.

Sincerely,

David

Total Return Versus Long Liabilities

Total Return Versus Long Liabilities

Posted on by David Merkel

Very briefly in my career, I was Chief Investment Officer of a significant life insurer.? Sadly, that was my dream job, and to have it and lose it was a blow that I accepted, because I did what was right.

At my first meeting with the new CEO, he expressed that investment returns had been inadequate.? I explained to him that that was false — the investment department, inclusive of defaults had provided returns 0.7% better than single-A bond returns, which was notable for the industry.? He insisted that was not good enough, and that he wanted to see us trade aggressively, and produce total returns.? I tried to explain to him that that was the wrong way to manage investments for a life insurer.? The right way was occasional trading for loss mitigation, and maximization of investment spreads over the term of the liabilities.? Being the sort of Brit that disdained Americans, he told me that I didn’t know anything, and that total return was the only way to go.

For the good of the relationship between our two firms, I let it drop, but he held a grudge against me after that, which led my firm to change my position to corporate bond manager, letting another of our group be the CIO, who solicited my feedback to a high degree, because he knew that I knew what was going on, far better than the CEO did.? This is just my guess, but I think the CEO resented that I could see through him and the way he and Chief Actuary manipulated accounting results.? (I eventually spilled the beans to the regulators.? The state in question was kind of lazy — I really think they didn’t do anything with it.)

Leaving behind the past, here’s the theoretical problem: total return is a wonderful idea, but vapid, because the challenge is gaining total returns over a time horizon, after which the assets will be used to fund a liability.? In a life insurer, yes, you could manage the bonds to maximize total return in the short run, which might maximize short-run GAAP income, but might destroy long-term economic value because as high quality interest rates fall, it becomes harder to meet the longer-term promises previously made using new money interest rates.? Yes, you can realize the capital gains today, but only at the cost of reducing future net income, until net income goes negative, and recoverability testing indicates you are locking in a loss, and you have to do a writedown of your deferred acquisition cost asset.

This is why I am skeptical of hedge funds and other total return investors buying life insurers.? Good investing at a life insurer means improving the investment income spread between assets and liabilities, over the term of the liabilities, while taking account of capital use, and avoiding defaults.

It would be very difficult now to be managing a life insurer that had a large deferred annuity block, particularly one with high guarantees.? Your flexibility is strained — if rates go down, you have to still fund the guaranteed rate, and if rates go up you will wish you were invested short so that your credited rates go up, and you don’t lose money because the income off your bonds is rising.

The only normal option in such a situation would be to run a barbell — short assets and long assets, with little inbetween.? Long assets for the guarantees, short assets for the crediting rate sensitivity.? And even that might not be adequate.

I started my career at a small life insurer that grew into a medium-sized one in three short years off of capital raised by its holding company issuing junk bonds.? The holding company, Southmark (spit, spit), knew something about investing, but not about running regulated subsidiaries.? What looks simple is actually very hard.? The cash flows of the assets and the liabilities are not freely available to be used through the consolidated company.? The regulatory limits of each subsidiary are applied separately, limiting what cash flow can be sent to the overly-indebted holding company.

In the end, after interlacing the capital of the subsidiaries, such that our insurer held a lot of the equity and preferred equity of other insurers, the holding company declared bankruptcy (a two-time loser there), and the life insurer went into conservation with the California Department of Insurance.

I was just a junior actuary then, and my investment knowledge was small but growing, so I didn’t get much of it then. The company took too much credit risk with junk bonds (the regulations were loose then), and mismatched their investments short (can’t buy long junk) versus long liabilities.? As rates fell, fell and fell, junk bonds defaulted or were called.? Each reduced income, but the guarantees remained the same.

Thus I remain a skeptic of clever investors trying total return strategies versus long term promises.? In the situations I have been in, it has not worked, and with bad management teams, it is another way to make things look good for a time, until things blow up.

Now, as for the two insurers that I mentioned, their management teams didn’t end well.? The first one that I worked with left to start another insurer, while bidding unsuccessfully for the firm they left.? They never went far.

The one I mentioned at the beginning of this piece — the entire management team was let go, except for the CEO, who was forced into retirement, and the CEO of the holding company was forced to resign for wasting money pumping it into the life company.

Good investing stems from matching assets to the eventual need to pay cash at a future date.? True for individuals and institutions.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Note: Tomorrow (Saturday) I will be on WBAL Radio at 8:30 AM Eastern with local radio host Jimmy Mathis, talking about the markets.? If you are up, they do stream the broadcast.

 

Market Dynamics

 

  • Six Weeks of Green: Stocks Quietly Creep Higher http://t.co/XYxAfaOj Markets move up at half the speed they go down http://t.co/d09QUp8y $$ Aug 18, 2012
  • Premiums dominate in HY CEFs & loan participation CE funds, even the investment grade funds r seeing discounts fade. Too hot. $$ #yieldlust Aug 17, 2012
  • T. Rowe Price Small Cap Fund Veteran Preston Athey to Exit in 2014 http://t.co/Y6BRCnmW One of $TROW ‘s finest takes a less active role $$ Aug 17, 2012
  • Paulson Steps Up Gold Bet to 44% of Firm?s Equity Assets http://t.co/5ESGLVdl Makes me bearish on gold. Bad mkt could b a forced seller $$ Aug 17, 2012
  • What should I do with my money now? http://t.co/xqXtnPqb My view is this, if acctg is conservative, buy stocks P/TB < 1.5, P/E < 10 $$ Aug 17, 2012
  • Usage: That was a real Facebook of an IPO! 2) We really Facebooked the IPO buyers! 3) Avoid this IPO, it’s going 2b a real Facebook! $FB $$ Aug 17, 2012
  • Facebook puts follow-on on ice http://t.co/d2CMGLvl Avoiding adding insult to injury. Lousy IPOs in the future will be called “Facebooks” $$ Aug 17, 2012
  • It’s usually a bad sign when locals are selling, and foreigners buying. How do foreigners have more knowledge? $$ http://t.co/mhOHunFj Aug 16, 2012
  • Man overrides machine to tackle low bond yield risk http://t.co/IDTSByMr Momentum isn’t everything w/bonds, eventually mean reversion. $$ Aug 16, 2012
  • Whenever you mention CDS spreads, could you do us the favor of citing that spreads bonds are trading at? You are, aft? http://t.co/o3StHaG0 Aug 15, 2012
  • You Are Now About to Witness the Strength of Street Knowledge http://t.co/jV4bxWc4 Having a revenue model is an aid to stock performance $$ Aug 15, 2012
  • Even Amid the Current Turmoil, Stocks Still Beat Bonds http://t.co/fqTWnM6g Issuing this opinion: a crowded trade http://t.co/X6KGWp5b $$ Aug 14, 2012
  • Silver Hoard Near Record as Hedge-Fund Bulls Recoil http://t.co/gQpc19Hz Pressure for prices to fall amid ETF-based hoarding $$ Aug 14, 2012
  • Junk-Bond Buyers Plot Escape in Debt Gap http://t.co/lEVYDv9f Smart money moving up in liquidity & down in yield. Junk rally continues $$ Aug 14, 2012
  • A Green Light for Car Loans http://t.co/VqfWA4AK Banks, Finance Firms Boost Auto Lending; Fed Survey Finds Easier Standards $$ #moredebt Aug 14, 2012
  • Stocks: The ‘Safety’ Dance http://t.co/N9CNg4aO Defensive stock valuations high relative to cyclicals. Graph: http://t.co/Q17aYeiU $$ Aug 13, 2012
  • As Corporate-Bond Yields Sink, Risks for Investors Rise http://t.co/WeET5vWD Maybe. Debt-deflation has a funny way of persisting $$ Aug 13, 2012

 

Rest of World

 

  • Mexico’s big oil problem http://t.co/e3b6V19s Yrs of abuse &non-investment by PEMEX, milked by the govt, oil production declining fast $$ Aug 18, 2012
  • Iranian Currency Traders Find a Haven in Afghanistan http://t.co/Bcw8l03A Sorta fitting that Afghans make $$ breaking sanctions on Iran $$ Aug 18, 2012
  • Rate Cuts on the Cards for Norway and Sweden http://t.co/REReXdiF We need a new Gresham’s Law on Monetary Policy. See in next tweet $$ Aug 17, 2012
  • Bad monetary policy drives out good monetary policy when large countries inflate, & exporters in small countries complain about losses $$ Aug 17, 2012
  • You can say that again $$ RT @saraeisenFX: More signs of worsening credit quality in China http://t.co/KLAApyBy Aug 17, 2012
  • Aramco Says Virus Attacks Network, Oil Output Unaffected http://t.co/o0p8Rb94 What shall we call this? The Cold Techno-War? $$ Aug 16, 2012
  • The only way out for China: Andy Xie http://t.co/ROaF0C2S Problems only going2get worse as long as government interferes $$ #chinacrash Aug 15, 2012
  • Beijing Loan Guarantee Firm Teeters on the Edge http://t.co/XtapRo8W A sign of things to come, and how will China deal with the defaults? $$ Aug 15, 2012
  • China?s money outflow continues in July http://t.co/xpMby8WI The wealthy of China send capital abroad, so that they can survive anything $$ Aug 15, 2012
  • German Provinces Struggle to Lure Skilled Workers http://t.co/yN61QTaJ Europe can find work, but will have to find it in Germany $$ Aug 14, 2012
  • Correlation Breakdown as Proxies for Risk Boost Aussie, Kiwi http://t.co/4zQMFGQd Countries w/good $$ policy draw funds, harming exporters Aug 14, 2012
  • Africa’s pirates have demands – and letterhead, too http://t.co/GKbc4Jcm Not intimidation, merely “making you an offer you can’t refuse” $$ Aug 13, 2012
  • Mursi Sidelines Egypt?s Top Generals Amid Power Struggle http://t.co/KAOWGQdE Push is coming to shove; Military vs Muslim Brotherhood $$ Aug 13, 2012

 

US Economy

 

  • The case for supply-side tax cuts http://t.co/EYfStM7t Tax increase of 1% of GDP reduces output over the next 3 years by nearly 3% $$ Aug 17, 2012
  • London Firings Seen Surging as Finance Firms Add NY Jobs http://t.co/D0to5HSo Finance jobs grow where the regulations are lowest $$ Aug 17, 2012
  • 5 years forward, five year inflation: http://t.co/q98ZknDn Seems to top out @ 2.7% recently, 3% longer-term http://t.co/rqFkN26r $$ Aug 16, 2012
  • Farmland Prices Surge Across the Plains States http://t.co/we6hZAcP Poss causes: hi grain prices & widespread use of crop insurance $$ Aug 16, 2012
  • The Downside of a Recovery in Housing http://t.co/BfzmDdYr “potential uptick in inflation measures, of which housing is a big component” Aug 16, 2012
  • Will births come back with the economy? http://t.co/sYqJjBXm Yes, people have more children when they are optimistic about the future $$ Aug 15, 2012
  • Wrong: What if baby boomers don’t live forever? http://t.co/kRLnHqrA Even if mortality does not improve @ prior rate, makes little $$ diff Aug 15, 2012
  • Mathematically Possible http://t.co/ziQNoQx4 Correcting the false assumptions of Obama’s tax gurus | Govt in DC is always dishonest $$ Aug 14, 2012
  • Clarity of communication is not the Fed’s problem. If you have bad policy, it doesn’t matter how you present it. http://t.co/C27MJ2QX Aug 13, 2012

 

Pensions

 

  • Unions protest Democrats at Illinois State Fair http://t.co/uU7twsOK Govt workers learn hard reality. Benefits not protected by ERISA + $$ Aug 18, 2012
  • Which means underfunded benefits may never b paid at the level promised. Taxes can’t b raised enough to make it work, either. Sorry $$ 🙁 Aug 18, 2012
  • @mckpartners There r 3 parties not getting blame here aside from the standard ones: 1) accountants that dreamed up lousy funding rules + $$ Aug 18, 2012
  • @mckpartners 2) Actuaries didn’t pushback on investment assumptions & 3) Union negotiators thot they were smart trading salary 4 pensions $$ Aug 18, 2012
  • Annals of dubious research, 401(k) loan-default edition http://t.co/LDLsN0f1 401k loan defaults r 2% of what widely-cited study claims $$ Aug 13, 2012

 

GSE Bailout Change

 

  • Fannie?s and Freddie?s Forgettable Friday http://t.co/kvfNkBcI Investment whose value is dependent on unknowable government policy $$ Aug 18, 2012
  • GSEs expected to unload delinquent loans after Treasury change http://t.co/2g7tiIxI Portolios to shrink through prepays/writeoffs 15%/yr $$ Aug 17, 2012
  • Anybody have guesses as2what $FNMA $FMCC $FNMAT $FMCCK should be worth? Pfds ~ 2 coupon pmts? Common stock ~ 0? Prob(going-away present)? $$ Aug 17, 2012
  • Treasury to wind down GSEs faster, only to be replaced with (insert solution here) http://t.co/mAtyKpHs Future of the GSEs in question $$ Aug 17, 2012
  • Treasury to Amend Terms of Fannie, Freddie Bailout http://t.co/iZcCdXML Cancels 10% div, all profits go2 Tsy. Comm stocks down 20-25% $$ Aug 17, 2012
  • Fannie, Freddie Pfds Sink As Treasury Amends Bailout Terms http://t.co/3pGEjsrF Down 52-55% today. That was the crunch you heard $$ Aug 17, 2012

 

Municipal Bonds

 

  • Bondholders, insurers challenge San Bernardino bankruptcy http://t.co/WE2vRb6e They allege SB finances are not in a state of emergency $$ Aug 18, 2012
  • That really stinks, can’t comment there also $$ RT @Tubulus: @munilass I think your head will slam into your desk – http://t.co/8G1e0plE Aug 16, 2012
  • The Untold Story of Municipal Bond Defaults http://t.co/2UKKOIUA Trivial thots from researchers @ NYFed, my comment: http://t.co/EP5aUq29 $$ Aug 15, 2012
  • Looking for Higher Yields? Try ‘Junky’ Municipal Bonds http://t.co/qo9DfZKt Safer than corporate junk, but less liquid. Be careful $$ Aug 13, 2012

 

Other

 

  • Apple judge: ?I see risk? and 7 more newsmaker quotes http://t.co/wyBoToT7 Notable quotes in the business world $$ Aug 17, 2012
  • The Valley of Free Food: How One Firm Caters to California’s High Tech Giants http://t.co/cijDNgdC Companies r armies; travel on stomach $$ Aug 17, 2012
  • Texas Seeks Seizure of Life Partners http://t.co/MWofrEv2 ‘Bout time. Life settlements should b illegal; no insurable interest $LPHI $$ Aug 17, 2012
  • More trial, less error: An effort to improve scientific studies http://t.co/i2PLAD5h Why I am skeptical of much biometric research $$ Aug 16, 2012
  • when $AMGN ‘s scientists tried to replicate 53 prominent studies in basic cancer biology … they were able to confirm the results of only 6 Aug 16, 2012
  • Mobile pay war: Wal-Mart and others vs. Google http://t.co/Q30PZQGP So much innovation in payment systems; wonder which will win? $$ Aug 15, 2012
  • Nassim Taleb: Stay Out of the Investment Industry http://t.co/ZyomTwjB Superinvestors of Graham & Doddsville r @ work & still making $$ Aug 15, 2012
  • Deep ocean lure grows as high-tech drilling pays off http://t.co/P4UP4ZWs The technology for extracting oil grows ever more complex $$ Aug 15, 2012
  • Buyers Beware: The Goodwill Games http://t.co/eA7XEXjr Check the cash from operations. Should exceed earnings if Goodwill is valid. $$ Aug 14, 2012
  • CLEAN UP THE BALANCE SHEET: GET RID OF DEFERRED TAXES http://t.co/DTfT8bRg Future income or losses can’t be assured, so not asset or liab $$ Aug 13, 2012

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Comments

  • @BarbarianCap The firm I was with sold $AIG the day it went into the Dow. Close to a “top tick.” $HIG , did not do hearly as well 🙁 $$ Aug 18, 2012
  • @The_Dumb_Money @pkedrosky is a bright guy. Many got it right, but fads suck people in. Aug 17, 2012
  • RE: @boingboing Not too surprising. Many corporations pay low taxes b/c of govt incentives. Relationship 2 mgmt pay s? http://t.co/KoChJizm Aug 17, 2012
  • @Breakingviews The sooner the euro dissolves, the less will be the pain for all involved. It was a mistake from the start. $$ Aug 17, 2012
  • @pelias01 Many thanks for the many times you have asked people to follow me. I really appreciate it. Aug 17, 2012
  • @JimPethokoukis I’m reading it now; that’s a fair assessment. Beyond that, it reinforces how hard it is to do anything in DC $$ Aug 16, 2012
  • RT @PragCapitalist: Pushing up stock prices does not make underlying assets more profitable. The whole premise of the Bernanke Put is f … Aug 16, 2012
  • @FeeOnlyIndy I try to be fair, I don’t always succeed, and I do have my biases, so take me with a grain of salt, but thanks $$ Aug 16, 2012
  • @izakaminska Whenever I go to Boston, I always take the Water Taxi from the airport. Lets me off in Downtown –beautiful view of the city $$ Aug 15, 2012
  • @munilass Glad u said: “The Fed really ought to be embarrassed that it published something like this.” I didn’t say that & should have $$ Aug 15, 2012
  • @The_Analyst true… too much quantitative talent went to Wall Street, applied the wrong model: physics, rather than right model: ecology $$ Aug 15, 2012
  • My friend Eric Hovde sadly didn’t win the Wisconsin Republican Senate primary; Eric would’ve shaken up DC. Thompson is business as usual $$ Aug 15, 2012
  • “Proppants prop open cracks when hydraulic fracturing is done. $$” ? David_Merkel http://t.co/OuqTSMAc Aug 14, 2012
  • ?I wasn’t that impressed w/Inker’s analysis. Does not take into account dollar-weighted returns. $$ http://t.co/C5Gh0pOl Aug 13, 2012
  • @nancefinance I was pretty nerdy, though not withdrawn, back then. My mom was a self-taught investor. I caught the bug from her. $$ Aug 13, 2012
  • When I was a teenager, I remember looking through the bond tables, noting that almost all prices were below 100. Today it is the opposite $$ Aug 13, 2012
  • @japhychron @Peter_Atwater You were more than mostly right, it’s a great book. Only wish it could have been bigger. $$ Aug 12, 2012

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