Portfolio Management – Page 50

The Education of an Investment Risk Manager, Part V

Posted on 3 April 2013 by David Merkel

One thing that came out of our “employee empowerment project” was a need to improve our equity and bond fund offerings.? At the same time, a fund manager manager [FMM] came out of the woodwork and suggested to us that we could do multiple manager funds.? They had analyzed many managers and had found some that they thought were great.

The more we thought about it, the more we thought it would be a great idea. Here’s why:

Our own abilities to find superior managers were limited.
A few members? of our team (including me) possessed ability to analyze what FMM would bring us.? We thought we could add value.
We came up with a clever name, “The All Pro Funds.”
We also thought we could add value? in changing weightings every now and then, and firing managers that we felt had become uncompetitive because they were now running too much money, had critical staff losses, or were underperforming style-specific indexes by a wide margin.
We could increase our fee a little to pay FMM and us for the additional work entailed.

And whaddaya know?? It worked.? The portfolios in aggregate? outperformed? their indexes even after fees, and fund flows increased dramatically.? The representatives had a story to tell.? Morale improved everywhere.? We were rolling, until…

A day came where we heard from one of the underlying managers that FMM had recommended their termination because they wouldn’t rebate more of their fees back to FMM.? I would not say that we went ballistic when we heard this — instead, we went cold on FMM.? Act fast?? No, act deliberately.? The senior officers tasked me and the #2 guy in marketing to deal with the problem.

We had a rule in our division — we will pay disclosed compensation, or we will pay undisclosed compensation, but we will never pay disclosed and undisclosed compensation.? Why?? We wanted our clients to know that if compensation was disclosed, that’s all there was.? If there is no “sticker price” but you are happy with the services provided, and don’t need to know what any agent is making that’s fin with us.? But we will not pass more money quietly to those that have said, “This is the sticker price.”

FMM had violated our sense of ethics to the core.? The two of us decided to put out an RFP, asking them to bid to help manage the now $1 Billion of assets. We excluded FMM.? We chose 10 well known manager consultants. Most responded to the RFP and we invited 5 to come present to us on a given day in spring.

-=-==–=-==-=-=-=-

I need to mention one other thing.? When we first started dealing with FMM, we appreciated their qualitative research, which seemed to have some punch.? After a year, they discovered returns-based style analysis.? This allowed them to analyze many more managers just by looking at their returns, and correlating them to a variety of equity and other indexes.? They stopped the qualitative research.

The first time I saw it, I thought it was hooey, even as I think MPT is hooey.? When you have a lot of highly correlated indexes, any attempt to intuit the style of a given manager is problematic; the error bands get too wide.? It is too difficult to determine what the correct answer is.? The optimal answer mostly represents happenstance, and not fact.? Tiny tweaks to the data produce big changes in the answer.? Not a good system.

There was one incident where I met with their new quantitative analyst, a woman 10 years younger than me.? She ask if we understood how the method worked.? I replied with some mathematical jargon regarding the method, leading her to say, “Oh, so you *really* understand this.”

Also, when I analyze a manager, I like looking at what they own.? I like looking at their trades.? I want to see consistency with what they claim is their strategy.? I also like to hear why they do what they do, and what sustainable competitive advantage they think they have.? There is value in that style of analysis.? There is little value in analyzing returns.

=-=-=-===–==-==–

To our surprise, one well-known consultant [call them STAR] that had no for-profit clients was one of the five.? The leader said it was a one-time experiment, so they were evaluating us, as much as we evaluated them.

On the day when they came to present, the presentations were all over the map, from highly professional to “did not prepare.”? Some big names could not answer basic questions about what sustainable competitive advantages they brought to the process, or were fuzzy about how they earned their money.

STAR had the best presentation, services, model, ethics, etc.? It was almost “no competition,” and they liked us as well.? We hired them, much to the chagrin of FMM, who begged us to keep them.? It had the following positive results:

Management fees down by 60%
Fund manager fees down by 50%
Far better marketing cachet
Better models for investment analysis.

We reduced client fees, but had better margins, and still greater growth.? Our division was transformed thorough the two projects.? Before we started our ROE was around 8%, and we were growing AUM at a 5-10% rate.? By the time all these changes occurred, our ROE was 25%, and our growth rate was not far from that.? We were now the stars of the firm, even though the firm culturally could not acknowledge that, because the life division was so big.

I learned several things from this five-year escapade:

Creating a desirable investment product takes work.? If you do something different that seems to add value, it will attract clients. (“We manage the managers for you, so you don’t have to”)
Focus on ethics in those you work with.
Reduce fees where possible, both your own, and that of suppliers.
Name recognition helps.
Be careful what you accept as analysis.? Just because there is clever math does not mean it represents how reality works.
If you don’t take chances, you won’t achieve anything great.? We didn’t have to burn our old strategy, and move to multiple manager funds, but we did it, and it made clients a lot happier.? The added work was work that that we liked to do.
Even if you have a supplier that did something good for you, do not tolerate breaches in ethics.? Find someone else to help you even if it costs more.? That it cost us less was merely a plus.

The Education of an Investment Risk Manager, Part IV

Posted on 2 April 2013 by David Merkel

One day, when I was least expecting it, the Spanish Inquisition arrived, otherwise known as internal audit.

IA: You run the GIC business.

Me: Yes.

IA: What functions do you control here?

Me: I market, price, cashflow test, and reserve the GICs.? I also direct hedging and investment policy.

IA: Isn’t that too large of a concentration of power in your hands?? You do everything.? There are no checks and balances.

Me: It allows us to run a better operation, because we feed back our results into our underwriting.? Besides, my boss reviews my work regularly.? I am not the only one analyzing my work.

IA: But leaving reserving and pricing in the hands of the same person is wrong.

Me: In many cases I would agree with you, but these are GICs; I have little freedom in setting reserves for them, the answers are formulaic, I can’t vary them.? Besides, take a look at our cash flow testing opinion.

IA: Huh?

Me: after reading this, you will see all the controls we put on the process.? We run far more rigorous tests than other insurers do to ascertain the profitability of our business.? Have a read.? Beyond that, our financials are reconciled to the penny every night.? It would be very difficult to have fraud here.

IA: You really seem to have too much power…

Me: We are not a large division.? We have four actuaries total.? We have different functions, and we can’t spare the effort to split pricing and reserving.? The boss watches over us; go ask him for his view of what? we do.

IA: I have, and he sounds like you.

Me: And he is the best.? He built this place, and it runs more smoothly than any other division of the company.

IA: Your division is funny.? You do things that we recommend against, but we can’t find anything wrong.

Me: We’re just doing our jobs.

IA: (Sigh) Okay, thanks, but our objections will be in the report to management.

Me: That’s fine; if the boss says to change things we will do it.

One of the most important aspects of insurance is to let the results of underwriting flow back into reserving and pricing.? You want to try to change your pricing of new business such that it reflects the true risks undertaken.

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

Then there was the minor panic that happened in late 1993, early 1994.? Rates had been low for a long time, and the investment department decided to buy some 10- and 30-year Treasuries, because they couldn’t find anything with enough yield.? Thus my conversation with the manager of my portfolio:

Me: Why are we holding 10- and 30-year bonds?? The duration of my longest liability is five years.

IM: Well we couldn’t find anything you buy.? These are just placeholder assets.

Me: You could hold cash, or 3-year Treasuries.

IM: But we wouldn’t get the yield we need.

Me: I am less concerned about our income than that we cover our risks.? You have made my interest rate risk higher by a factor of two.

IM: That much?

Me: This is a leveraged operation.? We ordinarily run at a duration of 2.5.? You can’t give me assets with durations near 7 or 14.

IM: Don’t worry, assets that fit your need should show up soon, just give us time.

Me: I would rather wait in cash, but okay.

+++++++ Two months later +++++++++++

Me: We’re sitting on 10% losses on the long Treasuries now.? You are killing my year.? What are you going to do?

IM: (makes a gesture of praying)

Me: that’s not good enough!? You said you would find something soon and now the Fed is tightening.

IM: We’re looking, we’re looking.

Me: (sigh) I know, but put yourself in my shoes.? We control risk first and then seek yield.? This reverses our priorities.

IM: I know, but relative yield is hard to find these days

Me: I know, but absolute yields are rising, and we are losing in the process.

+++++++++++++++++++++++++++++++

We closed out the position two months later for a loss of 18%.? Had the bonds been held longer, it would have been worse.? As it was, once we cleared that out, I started selling GICs rapidly, and did not hedge the sales, because I had figured out that rates would keep rising for a while, as I wrote about here.

As noted in the article just cited, 1994 eventually ended up being a winner of a year, but it started with that inauspicious event.? Who could tell?? My main point is this: don’t give up your risk control discipline to make a few measly bucks.? In tough situations, focus on the risks, and ignore the yields.

The Education of an Investment Risk Manager, Part III

Posted on 30 March 201331 March 2013 by David Merkel

There’s kind of a rule of thumb in Asset-Liability management, that you match liquidity over the next 12 months, and match interest rate sensitivity overall.? I would do more than that, creating my own randomized interest rate models, as well as a new way of creating structured randomness in simulation models.? For a brief period of time, I had one of the best multivariate randomness programs out there, eliminating the problem of correlations in higher dimensions common with Hammersly points.? (My work was not theoretical, but intuitive… once I saw how the randomness was created, I figured out how to de-correlate the higher dimensions (since it was based on prime numbers, create more number than you need, and use a higher prime number to select observations.)

Anyway, when I brought my full-interest rate curve scenarios to the investment department in 1994, they said to me, “These are the first realistic interest rate scenarios we have ever seen.? Did you constrain them?”? I told them “No, just weak mean reversion.? Noise dominates in the short run, mean reversion dominates in the long run.”

As a result, for the lines of business over which I had oversight, we measured our interest rate mismatch in terms of days, weeks, and months, but never years.? Please ignore this incident where things drifted, but worked out exceptionally well (really, that should be a part of this series).? We published a document to show everyone how well we managed interest rate risk in Provident Mutual’s pension division.? We used scenarios far beyond what was required to show how well we did our work.? The regulators never complained.

At that point in time, the ability to integrate residential mortgage-backed securities into cash flow analyses was rudimentary at best.? But I found ways to make it work, most of the time.? That said, I remember joking with the MBS manager in late 1993, and saying there was a new term for a well-protected PAC bond.? He asked, “What is it?”? I replied, “Cash.”? He sarcastically said, “Oh, you are so funny.”?? That said, I pointed out to the investment department that some of their bonds that they thought would last another four years would disappear in 2-3 months.

Then there was the floating rate guaranteed investment contract project that I eventually killed because it was impossible.? You can’t argue with expectations that are unrealistic.? Even better, I beat the Goldman Sachs representative.

In running the GIC desk at Provident Mutual, I had to review a lot of strategies because making money on short-term bonds/loans was difficult, and difficult the degree that I doubted as to whether we were in a good business.? On the bright side, I protected the firm until the day that we? could not write any more? GICs, because our credit quality was too low.? That was the fault of the less entrepreneurial part of the company, so I couldn’t so much about it, except close my operations down.? I asked the senior management team to provide a guarantee to my GICs, but they refused.

As such, I shut the line of business down.? With clients that were unreasonable over credit quality, and management unwilling to extend credit protection to GICs, the battle over GICs was ended, and I sent the line into runoff.

Five years later, as we were now part of the same firm I stood at the estate of John Dwight, with a young woman that I had sold the last GIC of Provident Mutual to, I said, “The end of the GIC business of Provident Mutual.”? We talked, she smiled, but it was part of the end of an era, because GICs were a minority of the assets in Stable Value funds.

If nothing else, this helps to highlight the impermanence of all that is done in financial firms.? I know this in my own life, but I am sure that it is true for most people in finance.

Sorted Weekly Tweets

Posted on 30 March 2013 by David Merkel

Cyprus & The Eurozone

Betray Your Bank Before Your Bank Betrays You http://t.co/H0nRJk7pLB Deposits over insured limit r a sitting target 2b taken in a crisis $$ Mar 29, 2013
Demolishing some myths about the single currency http://t.co/F34IpRQIbF A euro in Nicosia isn’t worth the same as a euro in Berlin $$ #ulose Mar 29, 2013
http://t.co/cbKK6ZNfW6 Neatest thing about the Eurozone interactive graphic: crisis comes in fits & spurts; u think it is over,& it’s not $$ Mar 29, 2013
Eurozone crisis: three-and-a-half years of pain http://t.co/VI8BUD48I8 Cool graphic that allows u2 explore the Euro-crisis blow-by-blow $$ Mar 29, 2013
Lines Form as Cyprus Banks Reopen http://t.co/0XxAiCFrwq How 2 destroy your banking system & bungle rescue, courtesy of the EZ & #Cyprus $$ Mar 28, 2013
MANDATORY CREDIT: BLOOMBERG SURVEILLANCE http://t.co/7bORsyhW8b Marc Faber talks2 Tom Keene & Alix Steel on stocks, Europe, Cyprus & gold $$ Mar 28, 2013
Italy?s failure to form a government doesn?t bode well for the euro http://t.co/V9nPcWFR60 EZone a political creature w/lousy economics $$ Mar 27, 2013
Money fled Cyprus as president fumbled bailout http://t.co/gl1J9z80MV Give the Russians credit (figuratively) 4 squeezing $$ out of Cyprus Mar 27, 2013
Euro zone overrates ability to curb contagion: Moody’s http://t.co/LpRdQ5RG2B Taxing insured deposits has opened up a can of worms $$ #dumb Mar 27, 2013
As a kid, we had a rule, “You can’t beat up my little brother. Only I get to beat up my little brother.” Cyprus: deposit insurance & levy $$ Mar 27, 2013
Cyprus banks remain closed to avert run on deposits http://t.co/JLDXoGD0T8 Won’t help; trust broken. Better 2 take money home, buy gold $$ Mar 26, 2013
Cyprus: It?s not over yet http://t.co/2qiIs9aN1b There will be a lot of pushback from Russia & wealthy Cypriots. Taxing Insured deposits? $$ Mar 26, 2013
Spain?s Swelling Debt Seen Impeding Rajoy Deficit Battle http://t.co/mapViHkfpk Unsure how Spain can escape. After that comes France $$ #woe Mar 25, 2013
Cyprus: crossing the green line http://t.co/whW4YR5a9t If I had $$ in a Greek, Italian, French or Spanish bank, I would withdraw some #theft Mar 25, 2013
Cyprus: The Operation Was a Success. Shame the Patient Died. http://t.co/79agrH1Mb5 Misery of Cyprus is a feature, not a bug $$ #norelief Mar 25, 2013
Cyprus weighs big bank levy; bailout goes down 2wire http://t.co/rm0fHJIfBo Small depositors lose 4%, big 20%. Policymakers gain new tool $$ Mar 25, 2013

Financial Sector

Why Bad Directors Aren?t Thrown Out http://t.co/ZuzGVZk99A Large Institutional Shareholders go along 2get along. Y irritate powerful ppl? $$ Mar 29, 2013
Surging Student-Loan Debt Is Crushing the System http://t.co/ckFHBbDc4R Avoid student debt if u can; most onerous form of debt in US now $$ Mar 29, 2013
Wells Fargo Beats Rivals to Oil-Boom Deposits, Study Says http://t.co/Ygt4ENMJqz FD: + $WFC | WFC bot little banks, grew them organically $$ Mar 29, 2013
Swiss Re settles dispute w/Berkshire Hathaway http://t.co/ADJ0zdufv9 Hasn’t developed same expertise U/W life policies as P&C $$ FD:+ $BRK/B Mar 29, 2013
5 Financial Advisor Red Flags http://t.co/EKFVgc0poP There r2 many fake “credentials” in investing; the person matters more than letters $$ Mar 28, 2013
5th Anniversary of Credit Crisis: Should u Buy CLOs? http://t.co/2sJzKv6LEi All loan participation funds@ prem2NAV http://t.co/qCRczPY0Mu $$ Mar 28, 2013
We?ve Already Built the Next Banking Disaster http://t.co/QjYzT4A9gz At minimum, we need to break up biggest 4 banks $C $JPM $BAC $WFC $$ Mar 28, 2013
Citigroup looks to cut cash holdings to boost earnings http://t.co/5FAoe3egno Every bank hates 2 keep slack liquid assets. Lowers ROE $$ $C Mar 27, 2013
The Best Way to Save Banking Is to Kill It @Matthew_C_Klein http://t.co/UP6c1DsMox Separating deposit-taking from credit creation $$ #yes Mar 27, 2013
A successful failure by @researchpuzzler http://t.co/cOC4Cpu9L1 Amazing what @pimco can do when it has less money to invest $BOND $$ Mar 27, 2013
US Cracks Down on ‘Forced’ Insurance http://t.co/MiWI6a5C1X Restrictions on banks profits on force placed insurance won’t harm insurers $$ Mar 27, 2013
Warren Buffett and Goldman Sachs: Explaining the Math http://t.co/H6AZImEyTl Buffett receives $GS shares equal 2 his profits on the trade $$ Mar 27, 2013
http://t.co/1a1TUDLI6H 44% of Americans think they’re covered 4 weather-related floods. Only 15% have bought a supplemental flood policy. $$ Mar 25, 2013
Falcone Follows Michael Jackson Path Taking Fortress Loan http://t.co/697JnVvocq $HRG Falcone tapping every loan source he can $$ #desperate Mar 25, 2013
Dealer inventory slump threatens market stability http://t.co/XpsoTJkrl0 Intermediation brings stability 2 mkts if intermediaries solvent $$ Mar 25, 2013
Mortgage Securitizers Didn?t Know Housing Was Going Bust http://t.co/rbw2qR2z8H Many drank the same poison Kool-aid they served to others $$ Mar 25, 2013

Rest of the World

US Writes Its Worries About Buying IT Gear From China Into Law http://t.co/OZJt59gZ80 Just imagine the backdoors that could be installed $$ Mar 29, 2013
Grooms at $18 Fuel IPO Ambitions for Indian Matchmaker http://t.co/liu9239lyU India needs 2 have dowry go reverse way; husband pays $$ Mar 28, 2013
How Asia and Robotland have dramatically changed the US labor market http://t.co/Clo8eqpM3w Biggest thing killing off low-end jobs: tech $$ Mar 28, 2013
Mr Yen cautions on Japan’s ‘unsafe’ debt trajectory http://t.co/iX4GAYAfoR Takehiko Nakao warns of consequences from 2 much govt debt $$ Mar 27, 2013
John Mauldin:”Might I suggest that a good trade would be to be long German government debt, short French debt? ” $$ neg carry, long disaster Mar 27, 2013
North Korea?s Economic Outlook: Cloudy with a Chance of Statistics by @steve_hanke http://t.co/XXWyKDffB9 Communism often cre8s inflation $$ Mar 27, 2013
Japanese Investors Start to Cut the Cord http://t.co/9oDHAhiSp8 Mrs Watanabe starts to buy stocks, even foreign & many other investments $$ Mar 27, 2013
Chinese housing bubble fears grow http://t.co/sejx6Yaj0P China grew its economy by forced investing, & the central planning is failing $$ Mar 27, 2013
Abe?s Inflation Exceeds Merkel?s After 14-Year Lag http://t.co/4s9838al6a All a race to the bottom; sound $$ will produce greater growth. Mar 27, 2013
US shale no panacea for Japan’s crippling energy bills http://t.co/siPd1kiheZ Infrastructure doesn’t exist 4 getting lotsa LNG 2 Japan $$ Mar 27, 2013
Brazil Soy Boom Bottlenecked as China Left Waiting http://t.co/sUtvoyp8yw Need 2invest transport infrastructure; tax importers/exporters? $$ Mar 26, 2013

Companies

REITs Trigger Fed Warning as Kain Tops $100 Billion http://t.co/4Lq6xm6Ka3 Shadow banking returns amid unconventional Fed policies $$ #panic Mar 28, 2013
M&A Stumbles Amid March Deal Drought http://t.co/sJlM7ndlnr “Can u say overvaluation, boys & girls? I thought u could; you’re special.” $$ Mar 28, 2013
Here’s Why Marissa Mayer Is About To Spend ~$200 Million On A YouTube Wannabe http://t.co/E5A42QAZac Buy small $ grow organically, smart $$ Mar 27, 2013
Is the $DELL Stub the Right Investment for You? http://t.co/ut9Mg65gLa Gun to the head, I would say “no.” 2 much leverage & excess supply $$ Mar 27, 2013
Summaries of What’s Wrong w/ $YHOO ‘s Summly Buy http://t.co/npVsxAj7Hj & http://t.co/KudImnOcdL & http://t.co/OhZfXoUwM3 $$ Mar 27, 2013
How the Maker of TurboTax Fought Free, Simple Tax Filing http://t.co/CYUea9aT8O Intuit benefits from complexity in the tax code $$ #simplify Mar 27, 2013
Fredriksen Bets $2.6B New Ships Will Beat Glut: Freight http://t.co/QtxTQaxJZF A bold bet that may fail 4 lack of sufficient capital $$ $FRO Mar 27, 2013
The Scariest Stock Chart in Town @ReformedBroker http://t.co/mg54zsX9s8 Good example of analyzing balance sheet strength of stockholders. $$ Mar 27, 2013
Cisco Is Keeping Its Promise Not To Buy Companies In The US http://t.co/GtWyy2bLpx Makes sense given US Tax laws | FD: + $CSCO $$ Mar 27, 2013
T-Mobile Becomes First Major Carrier to Drop Subsidies http://t.co/7tJ0FdJYmJ Probably a good strategy; differentiates & unbundles $$ Mar 27, 2013
Customers Flee Wal-Mart Empty Shelves for Target, Costco http://t.co/PAvNMUUVEP I see it also http://t.co/83s4J9aGA2 $$ Mar 26, 2013
Dell Says Blackstone, Icahn Offers May Be Superior http://t.co/jgHkKo6Jna Not sure I would want 2 win $DELL game; fixing ops very hard $$ Mar 25, 2013
Blackstone?s $DELL Bid Sets Stage for Rare Buyout Bidding War http://t.co/8KAGIEETOw Michael Dell may lose control of company he built $$ Mar 25, 2013
Heinz Sells $3.1B of New Bonds http://t.co/kMUfvlkyys Deal upsized, rated B1/BB-/BB-, lowest financing cost ever 4a LBO@ 4.25% 7.5yrs $$ #no Mar 25, 2013

US Monetary & Fiscal Policy

How the Fed Can Create a Market-Friendly Exit Strategy: Jeremy Siegel?s Proposal
http://t.co/2VPzaCDnyg Listen 2 bank shareholders scream $$ Mar 29, 2013
Pentagon to Cut $41B After Getting More Funding http://t.co/SrcDNN4Fbn We could a lot of dead wood @ the Pentagon, expensive non-soldiers $$ Mar 29, 2013
Big Business Spars Over Rewriting Tax Code http://t.co/CRjZZzwLix Importer, Exporter, Services, REIT, MLP, PE: no common corptax position $$ Mar 29, 2013
The Exhausted US Consumer http://t.co/QgSkYM2onj Spent-up, not pent-up $$ Looks at Disposable Personal Income, which recently dropped Mar 28, 2013
Restaurant Chains Cut Estimates for Health-Law Costs http://t.co/Ed00DMDXAX Test Q: List all the ways that the PPACA fails $$ #needmorepaper Mar 28, 2013
Best Predictor of Financial Crisis: Huge Inflows of Foreign Money http://t.co/uOrBJ4OI96 Long assets financed w/short liabilities is why $$ Mar 28, 2013
Stockton Deficits May Total $100 Million, Forecast Shows http://t.co/Pu8oqu3zQA That’s the cash pmt curve of generous employee benefits $$ Mar 27, 2013
Stockton Bankruptcy Decision to Come Monday, Judge Says http://t.co/dulFxXxNwm $BEN $AGO & $MBI argue city didn’t negotiate in good faith $$ Mar 27, 2013
US Retail Sales: Very Soft Indeed! http://t.co/XSJSyChEHW Unusual in that seasonal adjustments typically go away on YOY figures $$ Mar 27, 2013
Brenner and Fridson: Bernanke’s World War II Monetary Regime http://t.co/RnHpvMlPL3 Sad but true. Bernanke robs savers to fund US Govt $$ Mar 26, 2013
States Build Cash Reserves, Raising Rainy-Day Debate http://t.co/uSiYVMjPGi State budgets should balance on an accrual basis. None do $$ Mar 25, 2013

Wrong

Wrong: Gold Declines in Worst Run Since 2001 as Economic Concerns Ease http://t.co/uB8EhvfpPk Gold is falling because of debt deflation $$ Mar 28, 2013
Wrong: Proving Greenspan Wrong Shows Why Rey Became Worthy to Bernanke http://t.co/PHHmWJpRgJ Proving Greenspan wrong is trivial $$ #tiny Mar 28, 2013
Wrong:Key US senator blames speculators for high ethanol RIN price http://t.co/PNvhTvVmXt Note Senator is from Iowa, which benefits most $$ Mar 27, 2013
Wrong: Why the Rich Don’t Give to Charity http://t.co/aHdPMnjTt1 The missing variable here is Christian faith; media is blind to that $$ Mar 27, 2013

Market Dynamics

Everybody is Furiously Looking for Bubbles http://t.co/gx4GTwxnTV Bubbles are financing phenomena; look 4 short finance of long assets $$ Mar 29, 2013
Morningstar: Stocks Are Close to Fair Value http://t.co/TLDpVrjF1M “US stock market is some 50 percent above its historic mean value” $$ Mar 28, 2013
Crises exist 2 eliminate things that don’t need 2b done; governments interfere w/ this process b/c they r in league w/those who skim society $$ Mar 28, 2013
When will the Bond Bubble Finally Burst? http://t.co/WomjY44B9I Fund flows, Fed, other CBs, Banks, & measured inflation supportive 4 now $$ Mar 27, 2013
Investors face a shrinking stock supply http://t.co/bC1ECjt2Xg Maybe we can get rid of Sarbanes Oxley b4 it kills the equity mkt entirely $$ Mar 27, 2013
Investing in a High Debt Environment http://t.co/3PxNmNg1Oz Concentrate on inflation, study interest rates & focus on business fundamentals Mar 27, 2013
Low Volume = Good Investment? Analysis of David’s “Neglected Stocks R Typically in Strong Hands” Thesis http://t.co/wbseitIGZF Good Stuff $$ Mar 27, 2013
Use free cash 4 buybacks when price < 90% of franchise value [FV], issue dividends above that. FV is where u rather issue stock than debt $$ Mar 26, 2013
Not Everyone Loves Dividends: Guy?s Argument is Worth Hearing http://t.co/BsMDyzazLZ Buybacks vs Divs: depends on undervaluation of stock $$ Mar 26, 2013
Warren Buffett and John Hussman On The Stock Market http://t.co/ynAhtJrDAY The Market Cap/GDP ratio indicates significant overvaluation $$ Mar 26, 2013
Investors Pile Into Housing as Landlords http://t.co/rteDMNUl0e Anytime investors become a large part of residential RE-> trouble $$ #bubble Mar 25, 2013
Buttonwood: Credit watch http://t.co/53WR3r3BW0 New book argues that investors should focus on the credit cycle, not economic growth $$ #duh Mar 25, 2013
How to Unlock That Stashed Foreign Cash http://t.co/qNOnrjyrVD If there are attractive foreign companies 2 buy, would b best use of $$ Mar 25, 2013

Other

Corn Supply Slumps Most Since ?75 on Ethanol Profit http://t.co/ScQ3slOlQ6 Corn supplies may tighten by summer, tough if another bad crop $$ Mar 29, 2013
Business Insider Just Told College Students Their Secrets of Success http://t.co/Yd1jLTzEl3 Sprinter & marathoner, act dumb, ask Qs, etc. $$ Mar 28, 2013
Leaked Photos of Johansson Expose Cloud’s Vulnerabilities to Social Engineering http://t.co/keayvi3iDL Take security seriously $$ Mar 28, 2013
Methadone Deaths Tied to For-Profit Clinics Prompt Bills http://t.co/GHEnOWPGpr They get paid per visit; few incentives 2 act ethically $$ Mar 28, 2013
6 Reasons You Should Have Cyber Liability Insurance http://t.co/LhbASLS9pD U can make your computer invisible 2 the internet in 15 mins $$ Mar 28, 2013
Arms Race to Grow World’s Hottest Pepper Goes Nuclear http://t.co/sYW6fX5bZH I don’t get this; I eat spicy food for taste, not 2b macho $$ Mar 27, 2013
The New US Industrial Renaissance http://t.co/18ni9ClWEF A bit overstated but cheap energy & rising wages in China aid US competitiveness $$ Mar 27, 2013
Falling US Gasoline Demand: A Weaker US Economy? http://t.co/3QRS8G59a2 Gasoline is fairly core 2 consumption, when it goes down, trouble $$ Mar 27, 2013
Case-Shiller: Home Prices Post Biggest Rise Since 2006 http://t.co/nzgY1dSoZs But after the huge drop, it’s really just a dead cat bounce $$ Mar 27, 2013
Wringing Out Laundered Cash http://t.co/Ary4tMyjCF Always easier 2 press a civil suit than a criminal suit; look at the bankers 4 proof $$ Mar 27, 2013
3D-Printed Polymer Skull Implant Used For First Time in US http://t.co/4rRlfPiVGP Offers high degree of customization 4 surgical repairs $$ Mar 26, 2013

Retweets & Replies

The local situation in the US can’t run too far ahead of the world. Too interconnected $$ RT @boes_ America http://t.co/8PaIt3uKR5 Mar 29, 2013
‘ @JaredKastriner As for me, I play banker for my children. I pay 4 tuition & unavoidable costs. They pay avoidable costs& I lend 2 them $$ Mar 29, 2013
@JaredKastriner No, but it should make us consider whether college is needed, and maybe borrowing against the house might b better $$ Mar 29, 2013
‘ @AndreCimini There r many incentives 4 politicians, regulators & businessmen 2 prolong a boom; I worked 4 a firm that foresaw it & made $$ Mar 25, 2013
I hold a CFA Charter, (and was an FSA — dues too expensive) but credentialing is overrated in almost all… http://t.co/kvogKAycVS Mar 28, 2013
Commented on StockTwits: Banks got bailed out after so many bad mortgage & other loans. A few hedge funds properl… http://t.co/4wMpKOQ8Nb Mar 28, 2013
@EddyElfenbein As a Christian, it embarrasses me. They misinterpret Revelation & it makes people think they can gauge when Christ will come Mar 28, 2013
‘ @kyles09 My point is this: in 2007, the last time I saw something like this, it was right before loan pricing fell apart. That’s all. $$ Mar 28, 2013
‘ @Nonrelatedsense I’m wrong, cancel that comment on the $PSX midstream assets. Thanks 4 the correction $$ Mar 28, 2013
Bitcoin $$ RT @groditi: OK, spill it, who’s gonna be the Big Short for BitCoin?. that parabola looks like it’s about to break any second now Mar 27, 2013
RT @SoberLook: Chart: Bitcoin’s unprecedented rally. Another way for Cyprus citizens to take funds out of the country – http://t.co/3cTt … Mar 27, 2013
I like it, thanks $$ RT @adamjbonesjones: @AlephBlog Short Frenchies vs EFSF bonds (over-collateralised, positive carry)…. Mar 27, 2013
Monster, yes. Greatest? No $$ RT @MattZeitlin: Whoever decided that tables and figures go at the end of papers is history’s greatest monster Mar 27, 2013
@Matthew_C_Klein Sometimes they hand out the Nobel Peace Prize 4 what they wish the world could b, hence Obama (drones), EZ (fantasyland) $$ Mar 27, 2013
RT @Matthew_C_Klein: For this they won the Nobel Peace Prize MT @SonyKapoor: EZ has made every country feel that they’ve been hard done by Mar 27, 2013
Patient is dying. More morphine. $$ RT @TheStalwart: RT @CNBC: Fed’s Kocherlakota: “Monetary policy is currently not accommodative enough.” Mar 27, 2013
Controlling system changes it RT @MatthewPhillips @CardiffGarcia:Fantastic NYFed paper financial risk monitoring http://t.co/vwJeUwzXDm $$ Mar 27, 2013
Extra points 4 USSR & Japan parallels RT @prchovanec: Apply these last three quotes (from “This Time is Different”) to China … discuss. Mar 26, 2013
[cute dog warning] I guess you did have to. RT @moorehn: Sorry. I had to. http://t.co/rJtgXqfQtx Mar 26, 2013
‘ @kyles09 Good point, the rule mostly deals with excess cash over and above a low regular dividend $$ Mar 26, 2013
@ToddSullivan I could live with the word “moderate” 🙂 Mar 26, 2013
“Thing about low vol investing is that it is a moderate risk strategy, b/c it invests in stocks?” ? David_Merkel http://t.co/NzG183hkzG $$ Mar 25, 2013

FWIW

My week on twitter: 57 retweets received, 2 new listings, 60 new followers, 57 mentions. Via: http://t.co/cPSEMLXpb8 Mar 28, 2013

The Education of an Investment Risk Manager, Part I

Posted on 29 March 201329 March 2013 by David Merkel

This is likely to be the last series describing how I learned my skills that I still apply today.? I hope you enjoy it.

-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

It was mid-1988, and I had just earned my Associate in the Society of Actuaries [ASA] credential.? After my boss congratulated me, he told me I was now invited to the monthly management meetings.

In insurance terms, this era was the “bad old days.”? Risk-based capital regulations had not yet been developed, and aggressive companies like First Executive and Pacific Standard Life [my company] invested almost entirely in junk bonds.? These were some of the pigs Michael Milken was feeding junk bonds to.

What initially impressed me was that monthly income was so variable, and that most of the variation came from asset performance.? Now, as an actuary, I had more asset knowledge than most, but seeing the variation made me say to myself that if actuaries are risk managers in life insurers, the syllabus for teaching actuaries is wrong, because it focuses on liabilities, not assets.

Pardon this excursus — the Society of Actuaries in the US needs to be more like The Institute and Faculty of Actuaries in the UK.? Investing should be a core skill, not a peripheral skill.? Actuaries have the capability of exceeding the skill of CFA charterholders by a wide margin.? Assets vary far more than liabilities in an insurance company, most of the time.? Focus on what varies, and improve management skills there.

I was low enough in the hierarchy that there was nothing I could do to prevent Pacific Standard from failing in 1989.? That said, I accelerated my job search so that I left two months before Pacific Standard was taken into conservation by the California Department of Insurance.? But for me, that was out of the frying pan, and into the fire, because I went to work for AIG.

PS — I learned a few more things as well:

Highly levered companies are dangerous.? Southmark, which owned Pacific Standard, needed everything to go right because of the high degree of leverage.
When ever you hear of a management team that is highly litigious, stay away.? Phillips & Friedman surrounded themselves with a phalanx of lawyers, and got away with everything short of murder.? They will get it on Judgment Day, but not likely before.
When you interlace the capital of subsidiaries, it is a sign of desperation, indicating likely failure.? If you have subsidiary A buy the preferred stock of subsidiary B, and subsidiary B buy the preferred stock of subsidiary A, in the same amount, they both look a lot healthier, but nothing has happened, aside from an accounting ploy.? Pacific Standard died when the California Department of Insurance refused to accept some preferred stock as an admitted asset.
My first project was to set the GAAP reserve factors for Universal Life.?? In hindsight, my boss manipulated me into creating the best profit stream in hindsight, which produced lousy future profits.? He stripped profitability out of the future for then present management bonuses.

Stock Buybacks vs Dividends vs Reinvestment

Posted on 28 March 2013 by David Merkel

This should be short.? Let me start with some facts.

Buybacks are preferred on a taxation basis to dividends.
But buybacks are especially good when the stock is trading below its franchise value, and especially bad the further above franchise value the stock is trading.
Using slack capital to improve operations, or do little tuck-in acquisitions is probably best of all.? Organic growth is usually the best growth, and small acquisitions can facilitate that.? Small acquisitions are usually not expensive.? Be wary of acquisitions to increase scale, they don’t work so well.
Paying a dividend makes management teams more cognizant of the cost of equity capital, which makes them more effective.
In the reinsurance business in Bermuda, companies with slack capital tend to buy back shares below 1.3x book value, and issue special dividends if they are above that level.

Franchise value is management’s best estimate of the value per share of the company’s equity.? If a management team does not have a firm handle on the value of the company, it has no business buying back stock.? Stock should never be bought back over franchise value.? If you want to reward shareholders then, issue a special dividend.

I am reminded of how in 2000 the CFO of The St. Paul cleverly bought back shares in the 20s, wisely bought back shares in the 30s, stupidly bought back shares in the 40s, and foolishly bought back shares in the 50s.? He was a Johnny One Note, except that he impaired the balance sheet so badly that he became the one of the main causes of why The St. Paul sold out to The Travelers.? Price matters with buybacks.

The reinsurance industry is a good example, because well-run reinsurers are simple companies.? The book of business is worth book value.? The reserves are conservative, which is worth ~0.1x book value or so.? Future underwriting profits are worth ~0.2x book value of so.

So the reinsurers have their standard — the companies are worth around 1.3x book value.? That gives them a discipline for capital — buying back at under 1.3x book, and issuing special dividends above that.

It is my opinion that most buybacks are a waste, even with the tax advantages, given that the buybacks occur at prices over franchise value, sometimes significantly over.? It’s also my opinion that a 2% dividend makes management teams think harder about their shareholders, which is a good thing.

If you get to talk to a management team doing buybacks, ask them if they have a model for what their stock should be worth.? If they don’t have one, tell them they should not be doing buybacks, unless they are buying back the stock cheaply.? Above franchise value, buybacks are a value destroyer.

Buffett’s Career in Less Than 1000 Words

Posted on 27 March 201327 March 2013 by David Merkel

This post is at the behest of my friend Tom Brakke of The Research Puzzle.? It is meant to briefly describe how Warren Buffett’s investing changed over the years.

Compounding Capital

The basic idea of Warren Buffett’s investing is simple.? Try to compound your capital at the fastest rate consistent with a margin of safety.? That margin of safety might be a strong balance sheet, or it might be a product with high gross margins that faces little competition.? But compound capital over the long haul.? Do it, whether it is public or private investing.? Do it, regardless of the form of the asset.? Do it, if you have to change in midstream from being an asset manager, to being the manager of an investment-oriented conglomerate.

Those are themes I will explore in this essay, but who can explain Buffett well in less than 1000 words?

Buying Cigar Butts

Ben Graham had a huge influence on Buffett, but Buffett was his own man.? He had made money in many ways prior to working for Graham/Newman — he was a very driven, determined man.? But buying dud companies where the price was far lower than what the net assets were worth was a simple strategy that few followed.? It had great returns from the mid-30s to mid-60s or so.

Why? The Great Depression left the stock market in disarray, and convinced a generation not to touch stocks; they were not able to be analyzed.? So a few enterprising men analyzed and made a lot of money.

After Graham-Newman folded in 1956, Buffett started his own investing partnerships, which he eventually consolidated into one partnership in

But there were limits to this exercise.? Companies were sold for a profit, and the number of companies selling at bargain basement prices shrank dramatically.? Ben Graham folded; Warren Buffett adapted.

End of Buffett Partnership

Buffett ended his investment partnership as opportunities declined, and distributed out the shares to holders around 1969.? After a little delay, he consolidated his holdings under Berkshire Hathaway.? This was a significant move because now Buffett was running a business as an investor.? He had permanent capital, and could use it were he thought best.? Berkshire Hathaway itself was a failing textile producer.? In hindsight Buffett was too kind, and gave it too many chances, it would have been better to shut down the textile company earlier.

Textile Company to Insurance/Conglomerate Holding Company

Buffett discovered insurance early, through GEICO in 1952, and then through Berkshire Hathaway bought insurance companies which became the bedrock of the company, including buying 50% GEICO in 1974 to rescue it.? This would provide the capacity to finance/leverage investment insights.

Influence of Charlie Munger (Growth/Moat)

His friendship with Charlie Munger began in 1959, and he affected the way Buffett thought about investing.? Companies that had protected boundaries, or, sustainable competitive advantages deserved a premium valuation.? That insight began to free Buffett from the Cigar Butts, i. e., dud companies that have no growth potential, only sellout potential.? Such businesses could be bought in whole or in part, but they had to possess a durable advantage.? This would play a role as Buffett wold buy Coke, Capital Cities, American Express, Wells Fargo, and many other high quality businesses.

Willing to work Public or Private, and increasingly Private

Though Buffett was known in the 70s and 80s as a public equity manager inside a public company, he increasingly bought private companies like:

See’s Candies
Fecheimer
Kirby
Nebraska Furniture Mart
Borsheim’s
Scott Fetzer
World Book (no one is perfect)
Buffalo News (who could have predicted the Internet?)

This changed his view of what he was up to, and made him willing to run an abnormal conglomerate, one that would operate on a disaggregated basis.? Buffett would take the free cash flow from controlled companies, and the dividends from partially owned companies an reinvest them in the areas he thought had the most promise.

Scale rules out Arbitrage / Distressed Debt / Small Cap Equities / not Derivatives

Over time, Buffett invested in many ways, doing deal arbitrage, buying distressed debt, and buying small cap companies.? As time went on he had to abandon these for two reasons: he had too much capital to put to work, and competition increased, driving returns down.

Derivatives were different, Buffett was willing to take bets during times of economic stress so long as he did not have to post margin.? He took bullish bets on US Credit and Global Equities.? Much as he criticized derivatives as gambling, he was willing to take an intelligent bet where his downside was limited.

Buying companies with no auction / Tuck-in acquisitions

Buffett became the home for men who wanted to sell their companies, but preserve the culture.? Buffett didn’t pay the highest price, but he did not interfere with the new subsidiaries.

His subsidiary companies would do little tuck-in acquisitions that would further the vitality of BRK, without spending a lot.

Increasing Insurance Scale

And over time, bought all of GEICO, Gen Re, and many other smaller insurers.? Supposedly, at one point, Hank Greenberg said to Buffett, “Call me when you have a real insurance company!”? The two were frenemies for some time.? But today, the show is on the other foot — the largest insurer in the US in BRK.

The increased scale of insurance provided all the more capital to finance Buffett’s asset buys.? The underwriting discipline provided additional profits.

Opportunistic Provider of Capital

During the crisis in 2008-9, Buffett provided capital to well-regarded companies like GE and Goldman Sachs.? He was ready for odd opportunities like Burlington Northern, Lubrizol, and Heinz.

He was also willing to change his view on buying back shares, setting a line in the sand where he would but back shares, rather than doing a dividend.

Conglomerate Manager

Buffett never intended to run a conglomerate, but that is what he did, and did it very well, much like Henry Singleton, who was another compounder.

That’s what he does now.? There it is, in less than 1000 words.

Most Large Acquisitions Are Errors

Posted on 23 March 201324 March 2013 by David Merkel

Hubris:? “We can do it better than [the target company].? With additional scale, we will be able to gain operating efficiencies and marketing opportunities. We will be a big company in our industry, and we will control our own destiny.”

So some CEOs think.? It is easy to propose a large merger, wave your hands at the details, and the deal takes on a life of its own.? But large deals:

Attract competition.? If a large piece of market share is up for grabs, many will try to grab it.? Premiums to get a large deal are often uneconomic, akin to the guy who shows of a jar of nickels? in a crowded room, and invites people to bid for it.? He never clears less than a 20% profit on the jar.
Have to meld two different cultures.? This is not trivial.
Have to meld two different information technology departments.? Also not trivial.
Have synergies and cost savings that are often overestimated.
Face greater scrutiny from the government, which slows things down, and results in greater restrictions on the combined enterprise.
Have a CEO that will be severed, and he will require handsome compensation to go. Sadly, the remaining CEO will get a pay boost, after all, he is running a bigger company.
Run into the problem of Too Big To Manage.? This may not apply to large energy companies, because they are relatively simple, but with most other companies with market caps over $100 billion, performance deteriorates.? It is difficult to keep incentives sharp for employees and managers.
Have a buyer who may not appreciate some strengths of the target company.? In two insurance acquisitions, I saw the acquirer throw away valuable divisions that they could not understand, firing people more talented than the acquirer was.? At least they should have sold the division to someone else.
Generates goodwill, which makes the company harder to analyze, an lowering its valuation versus book.

That’s why I don’t buy companies that do scale acquisitions.? They tend to flounder and lose money.

But I do buy companies that do tuck-in acquisitions.? Tuck-in acquisitions are buying a little company that adds:

A new technology
A new marketing channel
A new product or service

Which is complementary to their existing business, and they will grow it organically.? With a tuck-in, the competition is less, integration issues are less, almost every difficulty versus large acquisitions are less.? Prices are low.

One use of free cash flow is acquisitions.? Companies that focus on small acquisitions and organic growth use free cash flow wisely.? Large acquisitions overpay to buy a trophy asset that the acquirer may unintentionally destroy.? Avoid such acquisitive companies.? The company? may grow, but the stock price likely will not.

Sorted Weekly Tweets

Posted on 23 March 2013 by David Merkel

Pettis / China

Modified Pettis: Peripheral country depositors will remember Cyprus & it will affect their future credibility w/deposit guarantees $$ Mar 22, 2013
Pettis: the idea that urbanization creates growth may have the causality backwards. It is far more likely that growth causes urbanization $$ Mar 22, 2013
Parsing the Words of the New Premier http://t.co/KggvVUZ0bf Li Keqiang: We need to leave to the market and society what they can do well $$ Mar 22, 2013
Closer Look: Parsing the Words of the New Premier – http://t.co/8LIiTxxqi0 Previous quote taken from Pettis, led me to this article $$ Mar 22, 2013
Li Keqiang: The reform is about curbing government power. As a self-imposed revolution, it will require real sacrifice and will be painful $$ Mar 22, 2013
Pettis: It turns out that we?ve seen record growth in debt. Is it really a surprise then that [China’s] economy is still growing quickly? Mar 22, 2013
Pettis:It isn?t until you write down the debt associated with the second bridge that you end up with a more meaningful measure of GDP. (3/3) Mar 22, 2013
official measures will have them contributing the same amount to GDP, even though the former creates real value & the latter does not (2/2) Mar 22, 2013
Pettis: If you spend $100 million each on two separate bridges, one of which is actively used and the other rarely used, (1/2) Mar 22, 2013
Biggest Solar Collapse in China Imperils $1.28 Billion http://t.co/yYgYpSpjAv Even w/subsidies solar is an inefficient technology $$ #duh Mar 21, 2013

FOMC

FED Optimistic Forecasts… http://t.co/MjilXrTSX1 The FOMC is always overoptimistic; they consider that 2b a part of their jobs $$ Mar 22, 2013
Wrong:US economy needs a third term of Ben Bernanke http://t.co/fStUDLjy7g A lunatic praises a dangerous lunatic leading US 2 Stagflation $$ Mar 22, 2013
That’s all folks! #FOMC $$ Mar 20, 2013
FOMC Central Tendency for Year end Fed Funds forecast: 2013 0.29%, 2014 0.55%, 2015 1.30%, Long run 4.01% $$ #FOMC Who can tell? Mar 20, 2013
FOMC Central Tendency 4 PCE inflation fcst since December 2012: 2013 1.55%, 2014 1.75%, 2015 1.93%, Long run 2.00% $$ #FOMC Way 2 optimistic Mar 20, 2013
FOMC Central Tendency Unemployment rt fcst since December 2012: 2013 7.35%, 2014 6.77%, 2015 6.20%, Long run 5.57% $$ #FOMC Way 2 optimistic Mar 20, 2013
FOMC Central Tendency for real GDP since December 2012: 2013 2.53%, 2014 3.17%, 2015 3.25%, Long run 2.43% $$ #FOMC Too optimistic 2014-5 Mar 20, 2013
FOMC Central Tendency Change in Fed Funds fcst since December 2012: 2013 -0.11%, 2014 -0.05%, 2015 -0.11%, Long run -.03% $$ #FOMC Mar 20, 2013
FOMC Change in Appropriate Timing of Policy Firming fcst since December 2012: 2.49 yrs, which shortens by 3.4 months $$ #FOMC Mar 20, 2013
FOMC Central Tendency Change in PCE inflation fcst since December 2012: 2013 -0.20%, 2014 -0.03%, 2015 -0.01%, Long run no change $$ #FOMC Mar 20, 2013
FOMC Central Tendency Change in Unemployment rate fcst since December 2012: 2013 -0.13%, 2014 -0.15%, 2015 -0.08%, Long run -0.03% $$ #FOMC Mar 20, 2013
FOMC Central Tendency Change in real GDP since December 2012: 2013 -0.10%, 2014 -0.32%, 2015 -0.13%, Long run -0.03% $$ #FOMC Mar 20, 2013
I am shocked that the Fed doesn’t have estimates on deposit insurance subsidies. That’s either a lie, or they should have that estimate $$ Mar 20, 2013
@pdacosta Good questions on Cyprus & deposit insurance subsidies $$ Mar 20, 2013
Go Pedro! Mar 20, 2013
Federal Reserve, Expected to Continue Stimulus, Tries to Reassure Investors http://t.co/DuoAg3hYTv Doing the same, expecting different $$ Mar 20, 2013
Bernanke Tightens Hold on Fed Message Against Hawks http://t.co/JyGTM0gP1f Wondered when this would happen; naive academic focuses power $$ Mar 20, 2013
Insights from Former Fed Chairmen http://t.co/q3RbM7sm9e Greenspan, meh. Volcker says some interesting things regarding removing stimulus $$ Mar 18, 2013
Fed’s Fisher: Too-big-to-fail banks are crony capitalists http://t.co/t65lN4kaaU Break them up & eliminate their funding advantages $$ Mar 16, 2013

Companies & Industries

Proto Labs seeks 1st acquisition shuns 3D printing http://t.co/56KeW8j4In Instead of creating by layers, start w/a block & cut away $$ $PRLB Mar 22, 2013
Old Tech Stocks, New Value: Santoli http://t.co/jfDtkOAwwX Tough part: estimating moat & probability of obsolescence, margin of safety $$ Mar 22, 2013
Health Insurers Warn on Premiums http://t.co/zzZI2s1s2h Wrote about this b4 law was passed. Was accused of bias $$ http://t.co/WCECEQYuns Mar 22, 2013
Plywood Becomes Hot Item in Housing Recovery http://t.co/2LMfLI43L1 4 confirmation, look here: http://t.co/HbnVnGdJmO Plywood on fire $$ Mar 22, 2013
As Crop Prices Surge, Investment Firms and Farmers Vie for Land http://t.co/B1ESXEnefd Presence of a large amount of borrowed $$ = bubble Mar 22, 2013
Intuitive Robosurgery Training Seen Lacking in Lawsuits http://t.co/VgyqOZqLMD Accidents r common & significant training of MDs needed $$ Mar 21, 2013
Gold Giants Shrink to Fit as Paulson Pushes Breakup http://t.co/9yXUb9Z11s Miners tend 2 overpay for marginal mines w/high variable costs $$ Mar 21, 2013
Americans Cut Restaurant Spending as Taxes Bite http://t.co/VAZELXMwM2 Less $$ available for small luxuries like eating out. Mar 20, 2013
Electronic Arts Ousts CEO as New Game Consoles Await http://t.co/QMDjN8uZmN Game systems shift away from use of PCs; $EA doesn’t adjust $$ Mar 19, 2013
Revealed: The Fragility of US Wireless Customer Loyalty http://t.co/j8U5wZ9GvT May be few choices, but wireless customers r not sticky $$ Mar 18, 2013
Corporate Cash Piles Grow to Record $1.45 Trillion, Moody?s Says http://t.co/0M84CE0tRi How much is domestic & not held 4 margin $$ Mar 18, 2013
Intermediate hold co debt has none of the protections of sr unsec parent co debt, or operating subsidiary debt. Not worth risks, avoid $$ Mar 18, 2013
$HRG Announces Debt Offering by F&G Life Hldgs http://t.co/APQvmAECv3 Total desperation w/intermediate holdco debt; Avoid, avoid, avoid $$ Mar 18, 2013
Private Equity?s $36B Retail Bet Not Going So Well http://t.co/xdQ9NzdAPs Retail does not work well w/leverage aside from mortgage debt $$ Mar 16, 2013

Cyprus

It?s Up to Putin Now: Cyprus Looks to Russia For Love?and Money http://t.co/CJdlAmyM5A Many Russians would lose $$ in Cypriot Bank default Mar 22, 2013
Just Let the Troubled Banks in Cyprus Fail http://t.co/0lSyyTjWIJ @carney gets it right. Protect small deposits, wipe out equity, etc. $$ Mar 22, 2013
ECB May Cut Emergency Funding to Cypriot Banks after Refusal http://t.co/jssqb7og4u If Cyprus’ banks fail, will anything else fail? $$ Mar 21, 2013
Cyprus banks dwarf economy thanks 2funds from wealthy foreigners http://t.co/GbElR3bcTP Countries w/large financial sectors tend 2b risky $$ Mar 20, 2013
BlackRock CEO Fink Says Cyprus Instability Will Be Resolved http://t.co/E3RYIDQENi The politics r pretty toxic; time 2end euro experiment $$ Mar 20, 2013
Outcry over Cyprus bailout taxing bank accounts http://t.co/kQ7DJgUN7P If it can happen in Cyprus, it can happen where you are too $$ #boo Mar 20, 2013
Daylight robbery in Cyprus will come to haunt EMU http://t.co/HsrbbJUVKk Imagine the US grabbing a portion of bank deposits in 1933 $$ #yuck Mar 20, 2013
Deauville Zombie Strikes as Cyprus Tax Inflames Crisis http://t.co/pkStGZyh5M Hard 2 believe confiscation of deposits wouldn’t lead 2runs $$ Mar 19, 2013
The Cyprus precedent @FelixSalmon http://t.co/EXBLMXj3by Taxing via confiscation doesn’t affect incentives, except the incentive 2 hide $$ Mar 18, 2013
Cyprus: What Were They Thinking? and some other notes http://t.co/LJPQ7FRSaT Try 2tax depositors, esp Russians, trigger a bank run, great $$ Mar 18, 2013
Cypriot authorities in revised deal talks http://t.co/f7NXFf5B9S This is getting desperate. Remember when they said subprime was small? $$ Mar 18, 2013
Dejected official: ?If this is successful then it will be used in the future… If this is not successful then who cares about Cyprus.? $$ Mar 18, 2013
Depositors Pay Price in Cyprus Bailout Deal http://t.co/CssNI6QUXK Imagine waking up one morning & 10% of your bank deposits r gone $$ #augh Mar 16, 2013

Energy

Sierra Club blasts new plan to improve fracking http://t.co/izJx8axguf Really depends on how much CO2 truly affects climate, jury is out $$ Mar 22, 2013
Ethanol Slumps Against Gasoline on Speculation Imports to Climb http://t.co/nFGWml3HBZ Profitable to import Brazilian ethanol caps prices $$ Mar 22, 2013
HEARD ON THE STREET: Chevron, Shell and Big Oil’s Big Divide http://t.co/zcrclj78XS FD: + $CVX | Smart move was focusing on crude oil $$ Mar 20, 2013
Wow, North Dakota, That?s a Lot of Oil http://t.co/NzKU4rhswH Up ~1000% in 10 years, would b more w/better transport (pipelines) $$ Mar 20, 2013
Consumers to Pay $13B Price as Ethanol Upends Refiners http://t.co/qRr3ZnGPnB Ethanol an expensive fuel; we would not use it w/o govt req $$ Mar 19, 2013
Valero Cancels Sale of California Refineries http://t.co/tu1lXOLBe4 Now better 2 retain them, if cheap oil can b sent there via rail $$ $VLO Mar 19, 2013
Suntech Said to Get Default Notice on $541M Unpaid Bonds http://t.co/hiA8ZfvW2K Equity likely 2b wiped out, even w/some willing 2 4bear $$ Mar 17, 2013
Canada Wonders Why Crude Oil Is Coming From Texas http://t.co/aIKRNA7UoT This is the price of not permitting pipelines; US oil by tankers $$ Mar 16, 2013
Three Years After the Spill, BP Gets Bullish http://t.co/owgnHfH9w5 FD: + $BP | Lots of valuable assets, but has the culture changed? $$ Mar 16, 2013

Financial Sector Issues

JP Morgan to Issue Its First Mortgage Bond Since 2007 http://t.co/M38KF7463e Reps & warranties weakened; harder 2 put back 2 originators $$ Mar 21, 2013
?In money management what sells is the illusion of certainty.? http://t.co/iiqXAHTRZ8 @researchpuzzler comments on words of @John_Hempton $$ Mar 22, 2013
SumZero Honors: 14 Top Buyside Analysts http://t.co/cZRnfBQJVd @sumzero does a study of buyside analysts to find the best quietly working $$ Mar 22, 2013
Proxy sites dump 1-click vote button on SEC concerns http://t.co/nycHC62TUa Levels the playing field a little bit; mgmt has 2 much power $$ Mar 21, 2013
Masked by Gibberish, the Risks Run Amok http://t.co/bKvbpCRyvZ Floyd Norris can write me 4 clarity, or read this: http://t.co/bhJwuegzP5 $$ Mar 22, 2013
Buffett Says Bet on Natural Juices of Market http://t.co/gyGA34vVMP USA is the most flexible place in the world, but stocks aren’t cheap $$ Mar 21, 2013
DeMarco pushes for 5-year wind down of GSEs http://t.co/aApiRMzoIK Don’t c how politics work here; pols don’t like 2 give up piggy bank $$ Mar 20, 2013
Could gold be the next Libor scandal? | Business http://t.co/gstTm7EWQA Looks like real trades take place, so it doesn’t seem the same $$ Mar 20, 2013
Workers Saving Too Little to Retire http://t.co/tWMYk3cpg8 I know of few people who save 20% of their incomes over 40 years $$ #prettytough Mar 19, 2013
Stock Bulls Get New Member of Club http://t.co/qEOMyG47WM I dunno, this makes me nervous. But 3% more upside in 2013 is no raving bull $$ Mar 19, 2013
Quantitative easing does little to boost gold prices http://t.co/o42EZUMk3T Gold prices react to inflation adjusted cost of carry $$ Mar 18, 2013
Traders Short Junk-Bond ETFs as Gains Top 100%: Credit Markets http://t.co/4CmFy3ebaC Short interest = 11.5% of total outstanding shares $$ Mar 18, 2013
Wrong: Want to Fix the Deficit? Get Real http://t.co/3fuRoKKw6S Increasing the deficit from here would worsen our long-term problems $$ Mar 16, 2013
Boo! Derivatives, Japan, $$ demise, pension defaults, debt jubilee RT @StockTwits: Zombie Swans from Outer Space http://t.co/jcNoTTzolI #boo Mar 16, 2013
How to Safeguard Your 401(k) http://t.co/HRCNqz1RkJ If plan has annual match, do not count on it. Avoid employer stock; know plan rules $$ Mar 16, 2013
Company Insiders Are Dumping Shares! Or Are They? http://t.co/D5cgLmM902 Best to look at what insiders do, not the large outside holders $$ Mar 16, 2013
If third-party custody fails in any significant way, i.e. bigger than what happened w/MF Global, all public investing will b ruined $$ Mar 16, 2013
Are Your Assets Safe?No Matter What? http://t.co/vWvSVno7JC @jasonzweigwsj talks about custody; strong incentive 4 present system 2 work $$ Mar 16, 2013
Golden State Hits Golden Age Of Bank M&A http://t.co/WLFhPq8jFC Higher capital requirements create demand for banks 2 merge in California $$ Mar 16, 2013

Rest of the World

Is Emerging Market Debt Undervalued? http://t.co/8hSOukeOKf I tend 2 think so, but performance so far this year has been subpar $$ Mar 22, 2013
Bank of Japan vows ‘all means available’ to smash deflation http://t.co/AJ27okuZFZ Difficult 2 have inflation w/shrinking population $$ Mar 22, 2013
BRICs: a Slowing Dilemma http://t.co/furMgL5VTO The BRICs r not a natural group; very different econ, but as GWP growth slows, so do they $$ Mar 21, 2013
RAHN: Where will the next financial crisis begin? http://t.co/x2rBMqCJUG Numerous countries r poised 2 lead global tailspin; I pick EZone $$ Mar 21, 2013
Spanish Banks Cut Developers as Zombies Dying http://t.co/CxRucV5Y7h Bottom not yet found for Spanish Real Estate $$ #bringoutyerdead #thud Mar 21, 2013
Europe?s work is far from over http://t.co/JfIY5PRW4f This is a colossal example of government management of the economy gone awry $$ #endit Mar 20, 2013
Canadian Household – Drowning in Debt http://t.co/XsdSDPBUn8 Canada: poster child 4 Central Bank-induced bubbles, amid good fiscal policy $$ Mar 20, 2013
BRICs Abandoned by Locals as Fund Outflows Reach 1996 High http://t.co/Xv4QZrNmSX Locals r throwing in the towel on stocks; time 2 buy? $$ Mar 16, 2013
Argentina Debates Pope’s Political Past http://t.co/FY25FtCCF2 Probably one where the truth will never b known; hard to fight a dictator $$ Mar 16, 2013

US Politics & Policy

Stockton Creditors Face Long Odds to End City Bankruptcy http://t.co/WcEuHjJft1 Think Stockton’s gambit will lose $$ cc: @munilass Mar 22, 2013
Gingrich-Santorum ?Unity Ticket? Almost Toppled Romney http://t.co/8jBjvs868Q G+S-> 0+0 = -1. Romney= -2. All R candidates fatally flawed $$ Mar 22, 2013
Getting the CIA Out of the Drone War http://t.co/kWcxz4mooN It matters less who does it, because there is no moral basis for it $$ #enditnow Mar 22, 2013
Mary Pat Christie Juggles Roles as Political Facilitator http://t.co/04VJb6UcbD Interesting background piece on Chris Christie’s wife $$ Mar 22, 2013
Postal Service Can?t Cut Saturday Delivery, GAO Says http://t.co/3BbcJ1arge Loss of Saturday would b start of end 4 USPS> less relevant $$ Mar 21, 2013
Rotten Tomatoes for a Billion-Dollar Farm Payout http://t.co/8FMfZnvqZC Ag is doing well in the US. Time to shut down much of the Ag Dept $$ Mar 21, 2013
California Nonpartisan Districting Ousts Life Incumbents http://t.co/1edUiXyizM Minimize internal boundaries subject 2 law requirements $$ Mar 20, 2013
Army Carbine Program May Waste $1.8 Billion, Report Finds http://t.co/WQOhHRZ5Mw Another area of DoD waste. Insiders tell me -> lots more $$ Mar 20, 2013
The Smarter Healthcare Consumer Myth http://t.co/BSdzrzQmMu Many underinsured people do not go to see a doctor when they are sick $$ Mar 19, 2013
Puerto Rico slides toward insolvency http://t.co/WaOVo1dWUa Puerto Rico exists to make California look responsible & Illinois honest $$ Mar 18, 2013
Or, as the late Bob Casey (former Governor of PA) once said, “You can’t lose if you are a pro-life Democrat.” $$ Mar 18, 2013
RNC Issues Scathing Analysis of GOP http://t.co/CsROwzkNxT Sounds dumb. Does not grasp the reliance of the GOP on moral issues voters $$ Mar 18, 2013
It’s a Lonely Quest for Land-Tax Fans, But, by George, They Press On http://t.co/yt8tPEVgjV Candidate 4 dustbin of history, dying hard $$ Mar 18, 2013
Republicans Foil What Majority Wants by Gerrymandering http://t.co/h2gMnsO5cp I live in MD, w/Democrat Gerrymander http://t.co/9ORTUnVjo9 $$ Mar 18, 2013
Roadkill May Reach Montana Menus Under Bill Allowing Fare http://t.co/5UsoOXeAsr Interesting 2c differences in state policies 4 roadkill $$ Mar 17, 2013
Obama Will Use Nixon-Era Law to Fight Climate Change http://t.co/HxRrpdoajr Expands National Environmental Policy Act to Climate Change $$ Mar 16, 2013

Other

The Beatles vs. the Taxman: A Former Manager Recalls Yesterday http://t.co/wNikAvMAdh Union of music,culture &finance cc: @reformedbroker $$ Mar 22, 2013
The Odd, Enduring Power of D?rer’s ‘Praying Hands’ http://t.co/QzEQsRYalP An idol 2b destroyed; far better 2 pray, regardless of hands $$ Mar 22, 2013
‘The Croods’: Making the Cartoons Sing http://t.co/Pj50Vytvuo As a musician, I find this article makes me optimistic on popular music $$ Mar 22, 2013
‘BioShock Infinite’: A Videmeogame With a Political Philosophy http://t.co/NzxQqrTXkM Americans r exceptional; doesn’t mean they r good $$ Mar 22, 2013
The Branding of ‘Liger’: Tiger Woods and Lindsey Vonn http://t.co/AW1CGnYHLh Two attractive sports stars dating? A marketing opportunity! $$ Mar 21, 2013
Inside the Art of Handling Negative Online Reviews http://t.co/vzsenUcvjq When negative reviews come, act quickly, it could wipe you out $$ Mar 21, 2013
Silicon Valley looks to Amy Andersen for love, at $50K a pop http://t.co/yVj37tUL9C Awkward men seeking wives need tailored personal help $$ Mar 20, 2013
How To Quarantine Java Like The Disease That It’s Become http://t.co/uhUcbRhFqh Sadly, I have to keep Java 4 my trading platform $$ #poison Mar 19, 2013
Study: Delaying marriage hurts middle-class Americans most http://t.co/ynHKcN4m4x Putting off marriage often means marriages don’t happen $$ Mar 18, 2013
Helmets Preventing Concussion Seen Quashed by NFL-Riddell http://t.co/FF4Gh6Viyn Long story on how conflicts of interest led2 concussions $$ Mar 18, 2013
With Speech, Cardinal Set Path 2 Papacy http://t.co/rDDOXEwCA2 Argued RC Church was 2 introspective, better 2b out doing good, short talk $$ Mar 17, 2013
The New Unmarried Moms http://t.co/1hnxyrE67R Teen pregnancy reduced, childbearing outside wedlock rising among 20-somethings $$ #bad4kids Mar 16, 2013
New York Is Sterilizing Its Rats. Here’s How http://t.co/qryyCDiLoK Tasty stuff for rats that renders them infertile in 4 days $$ #whoknew Mar 16, 2013

Replies & Retweets

Could work $$ RT @steve_hanke: @AlephBlog @carney or try a swap. Here’s how we did it in Latin America: http://t.co/fvT6V6dX9u| #Cyprus Mar 22, 2013
@SconsetCapital In China, if the gov’t builds two bridges in a BOGO deal, I don’t think you’d want the free one 😉 Mar 22, 2013
@Donald_Shekels No, not with the Asian operations Mar 22, 2013
@Donald_Shekels I could have said worse than I did, but I worry about getting sued. Mar 22, 2013
@JPDesloges You are off to a good start at Financial Iceberg. Keep it up. Mar 21, 2013
@agnestcrane Global Inequality is dropping, though. Global wages converging. “Rethinking Comparable Worth” http://t.co/qBWe9kxnim $$ Mar 21, 2013
Get well soon! RT @StockTwits: StockTwits Is presently down. Apologies for the inconvenience. We should be back up shortly. $$ Mar 21, 2013
@exMBB No. But title insurers had a rough time after housing bubble. Fraud drives most title insurance claims. Title insurance is complex Mar 20, 2013
@exMBB It’s all heavily depreciated. Not an issue. Mar 20, 2013
Commented on StockTwits: You’ve got it, Charles. Where IB is good it is very, very good, & where it is bad it is … http://t.co/o4fpUt2j66 Mar 20, 2013
@sleepyhungry It’s like a barrier option. Once it is breached it is over — this is only the 7th time I have done this. U made me smile Mar 20, 2013
Doing what their targets do RT @rcwhalen: Foreclosure Processor Prommis Holdings Files Chapter 11 http://t.co/mE30yP1gtj $$ Mar 19, 2013
But I think he is running out of options $$ $HRG RT @Nonrelatedsense: @AlephBlog continually amazed by Falcone. How does he do it? Mar 18, 2013
Extracts purchase price, retains control, kills bond buyers RT @Nonrelatedsense: continually amazed by Falcone. How does he do it? $$ Mar 18, 2013
I liked the photo RT @fundmyfund: @ritholtz what are you looking at in the new blog photo – a bird, a plane, or superman? Mar 18, 2013
RT @Royal_Arse: Mr. Merkel @AlephBlog is far more diplomatic than I in his tweet regarding pipeline construction. https://t.co/HIE2ngC4A3 Mar 16, 2013
@pdacosta 2 create a synthetic, u need 2 speculators: yield hog who wants a security @ a high yield, & a speculator who wants 2 short it Mar 16, 2013
@pdacosta If that ever had to happen, would b a crisis b/c synthetics r more numerous than organic. They can b & were created @ will. Mar 16, 2013

FWIW

My week on twitter: 54 retweets received, 2 new listings, 31 new followers, 58 mentions. Via: http://t.co/cPSEMLXpb8 Mar 21, 2013
Here’s my NCAA Bracket: http://t.co/ZK22T2bKnV #BlindfoldBracket2013 I’m no great fan of College Basketball, but I gave it a try $$ Mar 20, 2013
David Merkel (AlephBlog) on Twitter http://t.co/PsixuvsqiX Here’s a shout-out to my 7000th Twitter follower, Peter Saris @BMCA2461. Thanks! Mar 20, 2013

On Time Horizons

Posted on 22 March 2013 by David Merkel

I wrote a piece with the same title four months ago, but this one will be different, because I want to focus on individuals, and less on institutions.? During the bull phase of market moves, people are willing to take chances.? That can take several forms:

Being willing to buy speculative companies
Lengthening the time horizon: buy-and-hold.
Committing to debt, or even just lessening cash reserves, to own assets like houses, cars, second homes, boats, furniture, etc.
Being willing to buy illiquid assets like art, private equity, hedge funds, etc.

This applies to institutions as well, because they also give into the boom-bust cycle.? They are willing to speculate in good times, and seek safety in bad times.

But for individuals, time horizons sum up asset behavior whether it is investing or buying consumer durables.? Willingness to part with cash lengthens time horizons.? Those with short time horizons hang onto cash.? But often the same people change from having a long time horizon to a short time horizon and vice-versa, and at the wrong times.

The delicious perversity of markets — they incline you to do the wrong thing at the wrong time.? Have I been taken by this?? Yes, but not as much as many, because I don’t trade much.

Optimism creates long time horizons; it simplifies thinking.? “Let the market pay your people.”? “Cash is trash.”

Pessimism creates short time horizons; it simplifies thinking.”I’m going to stick with my money market fund.”? “I will keep my savings in gold.” “I will buy long Treasuries because I want cash flows that are certain out in the future.”

Time horizons are a symptom of the bull/bear cycle.? During bull phases, people commit capital for long time periods.? During Bear phases, periods shorten to the degree that many hold only cash.

To some academics this will seem unreasonable.? People are rational, aren’t they?? They don’t regularly make bad decisions, do they?? Sorry, but with economics, the answers are no and no.? The assumption that people are rational is not proven.? A far better assumption is that people try to justify themselves, whether they succeed or not.? Winners proclaim their brilliance.? Losers blame the umpire.

Yes, people regularly make bad decisions, and those brighter than them sporadically benefit.? It is hard to buy at the bottom, but a few do.? It is hard to sell at the top but a few do.? Note: those “few” are not the same people, because native bullishness or bearishness overcomes.? No one consistently gets out at the top, and in at the bottom.? But many get out at the bottom, and in at the top.? That is the way the markets work.

You might argue that this increases inequality and is not fair.? I’m sorry, but this is fair because people misjudge the underlying businesses, and they don’t keep adequate cash around as a margin of safety.? The equity market is only for those who keep an adequate reserve of safe assets around.? It is too dangerous for anyone else.

Stocks do not reward people year after year.? It comes in fits and spurts.? That is as it should be, and get used to it.? Those who don’t have long time horizons should reduce the amount of stocks they hold, unless valuations are low, and that’s not true now.

This is a time to be cautious, and reduce exposure to risky assets.? Given the global troubles, be wary, because little things like Cyprus could prove as small as subprime, which was declared “well-contained” by someone who didn’t know which end was up, and still does not.