Category: Portfolio Management

Why I Sold the Long End

Why I Sold the Long End

My bond strategy has always had a position in TLT until last week.? TLT, composed of long Treasuries. is a hedge against deflation, and has made money for my clients.

I changed last week because of significant disagreements at the Fed regarding the duration of QE, and also the selloff in the long end breaking my price drop limits.? Also, it is worthy of note that each Fed intervention is leading to smaller results.? In the process, I made more money from my credit-sensitive investments than I lost from TLT.

With stocks, I am not a technician or an active trader.? With bonds, I am both.? Why?

Bonds are more determinate than stocks and the tradeoffs are clearer.? Bonds are promises to pay under certain conditions.? Those conditions can be analyzed more readily than the open-ended conditions of stocks.

At this point in time, I am taking limited domestic credit risks, and taking larger risks in the emerging markets, where economic policy is more orthodox then it is here.

But beyond that, I have pulled in my horns, and have reduced interest rate risk.? If I see opportunities, I will act on them, but I am taking far less risk than previously.

Sorted Weekly Tweets

Sorted Weekly Tweets

Greetings

 

  • To all of my readers: Happy New Year. Here is to a blessed and fulfilling 2013, amid troubles and joys – no year is w/o them, glory 2 God $$ Jan 01, 2013
  • To all of my readers: 2012 had its joys and sorrows, but I appreciate that you read me. I will always try to bring you my best on twitter $$ Jan 01, 2013

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US Fiscal Policy

 

  • Why the fights over disaster relief in Congress keep getting worse http://t.co/NZCEwU7N Local disasters increasing funded by Feds $$ Jan 04, 2013
  • Sorry Folks, The $1 Trillion Coin Is Unconstitutional http://t.co/RXav6MlY h/t: @carney | Congress controls $$ policy, can’t delegate 2exec Jan 04, 2013
  • Why were there so many special interest provisions in the fiscal bill? Why didn’t the president veto it & ask 4a clean bill? #fiscalcliff411 Jan 04, 2013
  • Fresh Budget Fights Brewing http://t.co/lOdAltk7 Markets Breathe Sigh of Relief After Fiscal Clash, but Tax-and-Cut Battles Loom $$ Jan 03, 2013
  • Infighting in GOP Follows Scuttling of Storm-Aid Vote http://t.co/cUQxnnu5 “Tin ear” When something big hits smaller principles must bow Jan 03, 2013
  • How Deal Was Made, Unmade, Then Saved http://t.co/xhHj15fs Surprising deal between Biden & McConnell did an end-around on other tries $$ Jan 03, 2013
  • A trifecta of articles on pork in the fiscal cliff bill: http://t.co/0ymE51HH & http://t.co/iEvwLdxE & http://t.co/CCuMAXnS Shame $$ Jan 03, 2013
  • Senate-Passed Deal Means Higher Tax on 77% of Households http://t.co/WvIyEkJT What! You thought your taxes would not increase?! Hahaha! $$ Jan 03, 2013
  • Deductions Limits Will Affect Many http://t.co/D0rteMMC Taxes are going up more than you think due to the phasing-out of deductions $$ Jan 03, 2013
  • Ron Paul Rips Government in Last House Speech http://t.co/UuwfSI9o He was 2good 2b in DC; now he can be a rock star on college campuses $$ Jan 02, 2013
  • Sequestration Threat To Defense Sector Begins To Recede http://t.co/QYACs66b Grateful that I did not sell my defense stocks $$ Jan 02, 2013
  • Bipartisan House Backs Tax Deal Vote as Next Fight Looms http://t.co/Ns4SgHKX Both sides claim victory & decry dishonesty of the other $$ Jan 02, 2013
  • As an aside, when I had the chance to ask Ron Paul whether the Fed’s policies favored rich over poor, he immediately said, “Of course.” $$ Jan 02, 2013
  • House Balks at Cliff Deal; Down2Wire as Republicans Object2Lack of Spending Cuts in Senate Bill http://t.co/FkS6o1Ms Fall off cliff $$ Jan 02, 2013
  • Lawmakers push one-year extension of farm bill in bid to avert spike in milk prices http://t.co/bRroFoo4 Please, just free milk prices $$ Dec 31, 2012
  • US loses if we go over the Fiscal cliff = US wins if we go over the Fiscal cliff | Some will be b affected 4 better/worse; US will b ok $$ Dec 31, 2012

 

Energy

 

  • US petroleum rail shipments up nearly 50% in 2012 http://t.co/kQnGw63v Only way to get additional crude to the coasts in the short-run $$ Jan 04, 2013
  • Buffett Like Icahn Reaping Tank Car Boom From Shale Oil http://t.co/ekehRs3Y Buffett keeps all tank cars he produces-> BN can ship oil $$ Jan 03, 2013
  • A Novel Ship Extends Shell’s Reach http://t.co/RAEtM1fH High technology at work in offshore oil drilling. Impressive! $$ Jan 03, 2013
  • Shale-Gas Revolution Spurs Wave of New US Steel Plants http://t.co/XEuaDiKY Ask this: what other impacts exist from cheap natgas? $$ Dec 31, 2012

 

Financials

 

  • “Did the authors look at the “Call Reports” filed with the FDIC? More public data there. Kinda sloppy to miss that.” http://t.co/vCtQkZmu $$ Jan 04, 2013
  • Why Bank Disclosure Is So Awful and How to Fix It http://t.co/RwW45LG5 Did they try reading the call reports? http://t.co/vAYMh7wE @carney Jan 04, 2013
  • BofA Joins JPMorgan in Having Units Ripe for Sale, Mayo Says http://t.co/4DtCCVdR Is there enough slack $$ around 2 absorb all of these? Jan 03, 2013
  • US Money Fund Exposure and European Banks: Eurozone Rises for Fifth-Straight Month http://t.co/nfWYO4jv “Risk on” MMF trade returning $$ Jan 03, 2013
  • Insurer Sues Paulson Firm http://t.co/XFGKNGWB Does not seem like an easy win. ACA should have done more due diligence; they r pros $$ Jan 03, 2013
  • Basel Becomes Babel as Conflicting Rules Undermine Safety http://t.co/1QIyVdR5 Rules, not principles. External models, not internal $$ Jan 03, 2013
  • Big RIA Firm Uses Bible to Advise Clients http://t.co/9mtmySTo Almost every Evangelical w/$$ knows of Ron Blue; never knew he was so big $$ Jan 02, 2013
  • Buffett Combines BofA With Buybacks to Beat S&P 500 http://t.co/zo8kLdNz FD: + $BRK.B | BRK is a conglomerate fueled by insurance prems $$ Jan 02, 2013
  • Carlyle Agrees to Buy Duff & Phelps for $665.5 Million http://t.co/VoFVh6Oi Cheap price 2 become part of the ratings triopoly $$ Dec 31, 2012

 

Fixed Income, Gold & Monetary Policy

 

  • Gold Heads 4 Longest Run of Weekly Losses Since 2004 http://t.co/xBRfbJ8P Key Q: What happens to real interest rates; will Fed tighten? $$ Jan 04, 2013
  • Gold Set for Worst Run Since ?04 as Fed Signals End of Purchases http://t.co/xBRfbJ8P I would b skeptical here; no idea what the Fed does Jan 04, 2013
  • Risk Seen in Some Mortgage Bonds http://t.co/c7rROhEE Many CMBS bonds seem 2b priced 2 perfection, while some fundamental weakness $$ Jan 03, 2013
  • Does the Fed need a new mandate? http://t.co/NkfjhSeG Fed should have one mandate: tighten policy when goods or asset markets go crazy $$ Jan 03, 2013
  • Fed Officials Divided on Bond Buys http://t.co/7Gh6y8tn & increasingly worried about stimulus side effects http://t.co/SomUi1uK $$ Jan 03, 2013
  • While still holding $TLT, my bond strategy did well today b/c of all the emerging market bonds.TLT is a deflation hedge http://t.co/TiTMg6So Jan 02, 2013
  • TCW to Pimco Bet on Housing Bond Rally After 41% Gain http://t.co/DcXmVEj9 Feels like squeezing last drop of juice out of the lemon $$ 😉 Jan 02, 2013
  • Credit Has Best Rally in Europe Since 2009 With Central Bank Aid http://t.co/csZD3K8n At a cost of socializing future losses $$ Jan 02, 2013
  • Why Bernanke?s policies could hurt the economy more than going over the ?fiscal cliff? http://t.co/EZDkZ6Sv Favors rich over poor $$ Jan 02, 2013

 

Market Dynamics

 

  • TV is Next: Why Investors Are Getting the Media Industry Wrong http://t.co/yLoZRU55 52 pp PDF | $AMCX $CBS $DIS $NWSA $VIAB $TWC $TWX $$ Jan 03, 2013
  • U.S. Electricity Use on Wane http://t.co/dEiZBCDe A good time to avoid overpriced electrical utility stocks, and alternative energy $$ Jan 03, 2013
  • Of $30.9B Special Dividends in Q4, 28.6% Went To Insiders http://t.co/QTalSmva Interesting skew on who decided to do special divs $$ Jan 02, 2013
  • A Really Good Year?Wins and Losses of 2012 http://t.co/zS69udit Fridson: “Rather than being reassured, investors should be worried,” $$ Jan 02, 2013
  • Avis?s smart Zipcar buy http://t.co/SEgD8JPJ Too early. Depends on refinancing, expenses saves, & uncertain synergies & mgmt attention $$ Jan 02, 2013
  • Tribune Co. Emerges From Bankruptcy http://t.co/mUGITwmt So who owns the equity interests in Tribune now? Dec 31, 2012
  • Risk defined. http://t.co/eC3U00Lb @microfundy gives us three common definitions of risk & explains the virtues & deficiencies of each $$ Dec 30, 2012
  • The Six Biggest Investing Lessons of 2012 http://t.co/XWHRu0nG @reformedbroker takes us through mean reversion, momentum, & optimism $$ Dec 30, 2012

 

Rest of the World

 

  • China Poised for 2013 Rebound as Debt Risks Rise for Xi http://t.co/0P9o0HzX Investment will not work, but will the Govt free the economy? Jan 04, 2013
  • El Al?s Shamir Parachutes Into Israeli Vote as Liberman Fades http://t.co/Yyi2iGAv Would heighten tension level if Shamir is elected $$ Jan 03, 2013
  • Chavez Cancer Imperils $7 Billion Caribbean Oil Funding http://t.co/j5MLSeYx Lot of “
  • Why 49 Is a Magic Number http://t.co/F2DPpmtV France has a lot of firms that have only 49 workers b/c onerous regulations kick in at 50 $$ Jan 03, 2013
  • Great Canadian Maple Syrup Heist http://t.co/mCMokL6T Cartel reminds of De Beers. Competitive supply makes it impossible 2 fix prices $$ Jan 03, 2013
  • Used to Hardship, Latvia Accepts Austerity, and Its Pain Eases http://t.co/9v7Sf1AH If u haven’t let debt get too large, austerity works $$ Jan 03, 2013
  • Chinese Fly Cash West, by the Suitcase http://t.co/L0NCTpo7 Kind of fitting that they come to Canada & US 2gain freedom after wealth $$ Jan 02, 2013
  • At Europe’s Doorstep, Fierce War Against TB http://t.co/2Z41atWb Makes good case4 quarantine when diseases r highly infectious/deadly $$ Jan 02, 2013
  • Japan?s Population Falls by Record in 2012 as Births Decrease http://t.co/OTHuGOY1 Economies don’t work well when population falls $$ Jan 02, 2013
  • Chavez Suffers New Complications After Fourth Cancer Operation http://t.co/fqIwxz8R If he dies by 1/10, there will b a new election $$ Dec 31, 2012

 

Other

 

  • Then I Watch ‘Em Roll Away Again http://t.co/2uF2LKhf The fascinating story of Otis Redding’s final hit. cc: @reformedbroker $$ Jan 04, 2013
  • Threatening Asteroid Will Narrowly Miss Earth in 2040 http://t.co/buih448d That means it will come within twice the distance of the Moon $$ Jan 02, 2013
  • Outmaneuvered at Their Own Game, Antivirus Makers Struggle to Adapt http://t.co/wD6LAA7l Whitelisting, Petri Dishes, Cleanup programs $$ Jan 02, 2013
  • Disease Rips Through Florida Citrus http://t.co/zXlZEXX0 Bacteria Deal Slow Deaths to Trees; diversify to Brazil & California $$ Jan 02, 2013
  • Pattern time: 1-1-13 11:13 PM $$ Jan 02, 2013
  • For-Profit Nursing Homes Lead in Overcharging While Care Suffers http://t.co/6RTKMhdq Choose nursing homes 4 your loved ones w/care $$ Jan 02, 2013
  • “Minds work best when they r castles, w/a moat, drawbridge raised, defenders ready 2destroy thoughts of deceivers w/arrows & boiling oil” $$ Jan 01, 2013

 

Wrong

  • Wrong: In a Diverse New Congress, Several ‘Firsts’ http://t.co/Xy3HVjlo Congress not genuinely diverse; 2 types of thought @ most $$ Jan 03, 2013
  • Wrong: This Dow Component Has A 4.5% Yield And Sells For Less Than Book http://t.co/f9AFrt4t My comment: http://t.co/5T9XMJZW $$ Jan 01, 2013
  • Wrong: Benevolent Billionaires Should Buy Out Bushmaster http://t.co/iicdOxOd Monstrously dumb column asks liberal billionaires 2 lose $$ Dec 31, 2012
  • Wrong: Gauging the Guidance That Models Give the Fed http://t.co/J63vKEWM Neoclassical macro models r not capable of getting turning pts Dec 31, 2012

 

Replies, Comments & Retweets

  • @finemrespice @merrillmatter DB plans could have been managed better. Funding rules were too loose @ creation, & IRS discouraged overfunding Jan 05, 2013
  • @finemrespice It would then send out notices to the oldest people not yet retired, bringing the retiree pop up to 1/3 size of workers $$ 😉 Jan 05, 2013
  • @finemrespice At ~3 workers : 1 retiree. Yearly the government would measure the number of workers & announce the # that can retire (2/3) $$ Jan 05, 2013
  • @finemrespice It’s a good idea. It would stabilize %age of people retired vs working. Another way would b2 set the ratio directly (1/2) $$ Jan 05, 2013
  • @finemrespice Good idea – Make it a %age (~80%) of the life expectancy of a 20-yr old. %age goes up if pop proj 2 shrink & vice-versa $$ Jan 05, 2013
  • @carney Thanks, appreciated. Jan 04, 2013
  • .@Carney delegate so much of its rulemaking to study committees. Most of the Dodd-Frank law is getting designed by bureaucrats. $$ Jan 04, 2013
  • .@Carney Having a hard time commenting at @CNBC on yr articles. If Congress can’t delegate significant lawmaking, how does Dodd-Frank 1/2 $$ Jan 04, 2013
  • “I think you are right. Why is it that bad monetary ideas get more “currency” than good ones? 😉 ” ? David_Merkel http://t.co/VbCZpinR $$ Jan 04, 2013
  • You can read my comment $$ RT @BloombergView: It’s time for Japanese women to honor their Gloria Steinem | http://t.co/8brsJJ1v Jan 04, 2013
  • ‘ @TheEconomist Cover preview: America turns European. January 5th ? 11th 2013 http://t.co/JuBYRyZW Europe is in far worse shape $$ Jan 04, 2013
  • Bigtime $$ RT @NorthmanTrader: @AlephBlog speaking fees in 4 years….. Jan 04, 2013
  • @insidermonkey Bigger firms chain together a bunch of 49-person subsidiaries. The French allow it to happen. $$ Jan 04, 2013
  • @Dirty_Alfred @TFMkts Key Question: Do financial institutions have enough capital & liquidity to absorb losses,turning debt into equity? $$ Jan 03, 2013
  • @groditi I like the added duration so I don’t have to hold so much of it. More room 4 other diversifying bonds w/more potential Jan 02, 2013
  • Bigtime $$ RT @mcgilcoli: @AlephBlog a pox on both their houses! Jan 02, 2013
  • RT @AsifSuria: Agreed but they should have replaced Black Swan with Fooled by Randomness. MT @AlephBlog: This is a great list. http://t. … Jan 02, 2013
  • This is a great list. I have read almost all of them. Here are my disagreements. Aswath Damoradan… http://t.co/ATKQ6wkG Jan 02, 2013
  • If he can stop that weird grin, I can stop $$ RT @BloombergView: Can we all please stop laughing at Joe Biden? | http://t.co/xJlpt8wI Jan 02, 2013
  • @ritholtz I have a Tex-Mex Lasagne recipe near me. There r a lot of unusual/fusion recipes that borrow the layering idea from Lasagne $$ Jan 02, 2013
  • “This is why I use momentum positively in most of my investing, even though I buy a lot of undervalued companies” http://t.co/WlFQV6Py $$ Jan 02, 2013
  • “This applies to wealthy people anywhere; at times of crisis, give up 5-20% to preserve 80-95%.” ? David_Merkel http://t.co/XFa6akOC $$ Jan 02, 2013
  • @carney Great, I respect you, Carney. We don’t always agree, but I respect those that say what they think, contra politicians. $$ Jan 02, 2013
  • @McCainBlogette I am sorry, but every generation from the Baby Boomers & prior deserves progressively more blame. You don’t deserve blame $$ Jan 02, 2013
  • @carney Am I MSM, or am I just a blogger? I support the debt ceiling. Jan 02, 2013
  • Sad but true $$ RT @The_Analyst: making early call that’s your best/most accurate tweet of the year. Somehow she’s worth like $200mm. Ugh. Jan 02, 2013
  • Does she realize the she herself is a natural disaster? $$ RT @MicroFundy: Pelosi explaining how natural disasters happen. #nightisyoung Jan 02, 2013
  • Bigtime $$ RT @volatilitysmile: @TheStalwart best motivation to close a negotiation: being tired, wanting to just go home. cc @HarvardBiz Jan 02, 2013
  • U do it well RT @TheStalwart: Not to get sappy, but had a great 2012. Awesome year. Thanks everyone following and reading and all that stuff Jan 01, 2013
  • Yes, default is often the major form of deleveraging $$ RT @ZH_Crown: @AlephBlog @cate_long http://t.co/1nZlMA36 Dec 31, 2012
  • @mark_dow @cate_long & the other point is during a financial bust, enough debt has 2b liquidated/compromised/paid 4 things 2 become “normal” Dec 31, 2012
  • @fbaseggio @interfluidity @rfraserTX That could work; only difficulty is getting the data; oh, &getting the politicians 2 give up control $$ Dec 31, 2012
  • @mark_dow @cate_long Yeh, saw that at the time; one reason we were short so many financials at the hedge fund I worked at — too early Dec 31, 2012
  • @mark_dow @cate_long Good bond mgrs know that when as class of debt is plentiful, you have to avoid it. Hard 2do amid benchmarking though $$ Dec 31, 2012
  • @mark_dow @cate_long Bad institutional incentives like the CDO mkt had 1998-2007, fed by fin’l institutions reaching for yield even in AAAs Dec 31, 2012
  • @cate_long Consumers may not be as leveraged as they were in 2008, but they r still highly levered relative to history amid high unemp $$ Dec 31, 2012
  • @GonzoEcon @cate_long Businessmen do not take risks when their own leverage is high &

they know their customers r in the same boat $$ Dec 31, 2012

  • ‘ @cate_long No such thing as “animal spirits.” If leverage high, caution is warranted. Low leverage allows 4 borrowing 4 new projects $$ Dec 31, 2012
  • RT @TheStalwart: RT @tylercowen: So many say Obama is bad negotiator, but isn’t he actually rolling “the left” and secretly in league wi … Dec 31, 2012
  • @dpinsen That *is* cheap. Pity I can’t use them 4 clients — self-imposed simplicity Dec 30, 2012
  • Fingernails, def RT @ReformedBroker: Should I take the kids to the Les Miz movie? Or just stay home and pull my fingernails out one by one? Dec 30, 2012
  • “If you didn’t mention #4, I was going to. I am still long $TLT for clients, but toward the end of?” ? David_Merkel http://t.co/9CGLXgiT $$ Dec 29, 2012

FWIW

  • My week on twitter: 36 retweets received, 3 new listings, 57 new followers, 69 mentions. Via: http://t.co/SPrAWil0 Jan 03, 2013

 

Why do Value Investors Like to Index?

Why do Value Investors Like to Index?

I think I had some good things to say in the last post, but one commenter disagreed, and he had some good things to say:

Unfortunately, the premise of this article is completely flawed, as it assumes all ?indexes? are simply S&P 500 or Total Stock portfolios. You are no doubt aware that Vanguard has Large/Mid/Small VALUE indexes as well, right?

Further, for someone wanting more pure, targeted, and consistent exposure to the lowest priced value stocks, the ?enhanced? index funds from DFA are close to unbeatable. Sorting on a simple metric of price/book and holding approximately the cheapest 25% (as opposed to 50% for Vanguard and most Value ETFs) of stocks in the respective asset class (while trading patiently, using fund cash-flows to rebalance, lending securities to earn additional revenue), DFA?s large/small value funds in the US, Int?l, and EM markets have trounced their active manager competition. Here are the stats on the % of active value funds in each asset class over the last 10 years (through November) that have been OUTperformed by DFAs simple ?structured? approach, which for all intents and purposes are index funds:

US Large Value (DFLVX) = 90%
US Small Value (DFSVX) = 83%
Int?l Large Value (DFIVX) = 91%
Int?l Small Value (DISVX) = 100%
Emerging Mkts Value (DFEVX) = 97%

And not that it matters much, as these percentages are so high to begin with, but these #s don?t include survivorship bias ? something on the order of 40% of value managers that existed 10 years ago have gone out of business, so this outperformance is only measured as a % of those professional value managers that survived!

Somewhere, over some periods, I am sure we can find some value managers who have outperformed an intelligently structured value index portfolio, but the numbers are so small as to be almost irrelevant, and there is no persistence going forward in the # who have been able to pull off the feat.

No, the case is actually quite clear, ?active? value investing is dead. All investors would be much better off simply holding broadly diversified, structured/indexed VALUE portfolios. And stop confusing ?indexing? with ?cap weighted total market index portfolios?. There are a lot of index funds beyond the Russell 3000 and S&P 500.

His main point is well taken.? Active long-only value managers have not done well versus the indexers.? I’ve stated that at other times.? This is also true for hedge fund managers, where survivorship bias is even worse.

That said, I have a few objections.

1) Index investing by its nature follows the return factors incorporated into their index (if cap-weighted) or enhanced index (if not).? Factors go in and out of favor.? Some factors are seemingly permanently in favor, like value, small size, low Net Operating Assets, and price momentum.

Occasionally, those factors can be overinvested, like in August 2007.? That doesn’t mean the factors should be abandoned — weak holders are getting shaken out.

2) Every investment strategy has a “carrying capacity.”? Indexed strategies are larger, as are value strategies.? But there is some point where value as a whole can be overinvested.? Value can become “too cool” for a time, and can get relatively overvalued.? Some market participants look at the range of P/E, P/B, or P/S ratios.? When they are thin, value is overpriced.? It’s like being a bond manager, and doing an up-in-credit trade, except that this is an up-in-growth trade: buy higher growth stocks when the difference in P/Es? and other valuation factors is relatively small.

3) Yes, I know about the many subindexes that underlie the whole of indexing.? That wasn’t my point in the prior article.? Indexers need some amount of valuation oriented? investors, whether they are portfolio managers, or that they investors willing to take the whole company private, or a public company that acquires it.? If everyone indexed to the market as a whole, there would be no price signals.? Yes, with subindexes, that is not so, but the more money you pour into a subindex, the greater the likelihood of overvaluation.

4) There is the possibility of an indexing bubble.? An indexing bubble would have a situation where stocks in major indexes are overvalued relative to companies that are not in indexes.? now, it’s hard to imagine an indexing bubble, because there is no leverage involved, and little speculation.? Now for subindexes, relative over- and undervaluation is normal.

Just as in commodity markets, you have commodities that trade on futures markets, and end up in indexes, and those that don’t, because they are less liquid, fungible, deliverable, etc.? Often the relative price difference between what is easily tradable can be an indicator of whether excess liquidity has warped prices beyond their fair value.? This can happen with stocks as well, where stocks less held by indexes those more held by indexes.

There will probably come a time when those that have invested in index funds have to liquidate to meet their long term goals, and there will not be enough new money to absorb the selling.? Unless this is disproportionately true of index investors (unlikely, but possible), this would be a whole market phenomenon.

The broader question is related to the markets as a whole.? Since most stock investing is done on an unlevered basis, the overall ability to hold a diversified stock portfolio comes down to time preference.? There is what stock investors as a group should have as their time-preference, which is largely based off of demographics.? The there is how they behave when markets get hot (optimism -> time preference lengthens) or cold (pessimism -> time preference shortens).? Note that this is the opposite of the way that absolute value investors behave.

Now, here is one problem with my thesis: DFA and Vanguard are clever traders.? In really small stocks, DFA is virtually a market maker and picks up some alpha doing it.? In my investing, I actually like it when Vanguard or DFA is a large holder, because it is an indicator of neglect.

Here’s the second problem with my thesis: the fees of active managers are too high.? Even if active managers can pick up on some inefficiencies, will it be enough to overcome their fees?? On average, impossible.? So I appreciate what the commenter said, even as I ply my trade as an active manager.? You need some degree of active management in the markets to keep prices in rough line with valuations.

And, maybe, just maybe this means that indexing will have to get to be a much larger proportion of the markets before active managers would have alpha after fees as a whole.? Until then, passive investing is a great way to go for most investors.

Follow-up from “On Watchlists”

Follow-up from “On Watchlists”

Before I start this evening, I wanted to point out something that the Googlebots dragged in.? It’s a list of all the RSS feeds currently created for Aleph Blog.? Note: I only created two of those, the main feed, and the comments feed.? The others were created by readers.? To that end, if you want a specialized Aleph Blog feed, there is probably a way to create it.? Suppose you want all my articles on insurance or personal finance, but not my icky macroeconomics posts.? There is a way to do it.? So if you only want a *part* of the Aleph Blog, set up a customized RSS feed.

One more unrelated trivia question: as of the end of 2011, how many states does Berkshire Hathaway have an insurer domiciled in?? The answer did not surprise me, but it was interesting learning the answer.

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

Here’s a comment from a reader on yesterday’s post:

Love the blog, and really appreciate each new submission you create.

I?d love to hear more about ?valuation metrics, sentiment variables, and other factors.? Are these quantitative formulas that I could adopt for myself? I like the idea of ranking your current and prospective holdings. What method do you use to assign a value to each company for grouping?

First you need to read this article of mine.? As for valuation metrics, I use past earnings, forward earnings, book value, Free cash flow, and sales — I give higher weights to free cash flow, book value, and sales.? Earnings are more commonly manipulated.

Other variables: one year price momentum, four-year price momentum, insider buying/selling, yield, neglect ($ volume traded versus market cap), realized stock price volatility, net operating accruals, asset growth and sales growth.

I adjust the weightings period by period.? The changes usually aren’t big, but I adjust the weights to reflect what is out of favor.

For values that are infinite, I input 999.? One more note: I use the ranks of each variable against the stocks owned and contenders, not the actual value to do my rankings.

Here’s a comment from another reader on yesterday’s post:

A bit off topic, David, but something I?ve been thinking about:

Given your comments about incremental improvements, what do you think about the idea that investment manager performance should be judged not by the returns of the portfolio, but by the returns of the new ideas and sold ideas versus the static portfolio? i.e. measure the value of the decisions made recently versus those made in the past?

Given the wide availability of 13-Ds and our ability to copycat others with low-turnover strategies, might this not be a better measure of the value investors are getting for the fees they?re paying?

I do one unusual thing with my stocks.? I list them by order of purchase.? Why? It gives me a feel for whether old or new ideas are working.? But my experience has been that stocks I sell tend to do badly, with some exceptions.? Please don’t talk to me about the sale of NTE, which I sold because the management became more aggressive, and I did not like that.? I really failed there.

But here is the problem: investment managers choose the overall bias that they invest toward.? They should bear some responsibility for their choices, unless they have a fleet of funds that cover almost all relevant areas.

In my own investing, I have not seen any difference over the long haul regarding my new investments versus older investments.? There are times when new or old do better, and times where they are pretty similar.? Since I score my investments quarterly, older investments have to show promise regularly.? Those that show less promise get tossed.? Those with more promise get kept.

The important thing in investing (leaving aside tax implications) is focusing forward.? If something is cheap relative to prospects, don’t sell it.? It is far better to simply understand which of your existing investments are the most marginal in expected returns, so that you can use those as a source of cash when you find promising opportunities.

Full disclosure: long BRK/B

On Watchlists

On Watchlists

Before I start this evening, a quick story:

One day in March, I got an e-mail from an older gentleman, and he said, “Hi, my name is XXXXXX.? Please call me.”? The name sounded familiar but I couldn’t place it.? So I called him, and he asked, “I own a decent amount of Berkshire Hathaway.? Can you explain to me why the value of the put options Buffett sold have risen from 3Q11 to 4Q11?”? After talking to him for a little bit, he said, “So you really don’t know.”? I replied, “Yes, I don’t really know, but give me a couple of hours, and I can give you a decent answer.”? So I told him I would give him an answer via e-mail, and follow with hardcopy.? As it was, we were both wrong, the value of the put options had fallen.

But then it hit me why the name was familiar — he was one of the Superinvestors of Graham-and-Doddsville.? You never know where you might go, or who you might meet just because you write some obscure blog.? Oh, yeah, you might just get to go to the US Treasury, and meet you-know-who. 😉

And now a question from a reader:

I?ve learned a lot from your blog. Thanks for the effort you put in to maintain it. (Today?s post was great? was just listening to my Intelligent Investor CD while driving last night and was thinking about how Graham talks about the need to be businesslike when investing).

I had a question about your investing process, specifically how you track stocks that look interesting to you.

For instance, I use value line and I flip through the pages on a daily basis, jotting down interesting tickers in a notebook. I then go to a few scans and watchlists, again jotting down tickers I?d like to research further. After that, I take my list of tickers and do some brief research to determine if they should go on my watchlist. This is where I need to change a few things. I use Morningstar to track my watchlists, which is great because it keeps track of all of the financial data automatically, but the problem is that as my watchlist grows, I find certain cheap stocks on the list but I can?t recall why I put them there. There is no spot for notes on Morningstar?s watchlist, so I thought about using a google spreadsheet, but I really don?t want two different things to track.

Walter Schloss was famous for not owning a computer and simply flipping through value line. There must be a simpler way to track stocks that look interesting!

Just wondering if you could share any thoughts on how you track potential stocks and how you refine your watchlist if it starts to get too large. Thanks David.

I don’t have a permanent watchlist.? I generate ideas three ways:

1) I read a lot of articles.? When an idea sounds clever, I write it on a small piece of paper and set it in a pile to age.

2) I study industries more than companies, and look for strong companies in weak industries, and levered companies in industries that are likely to remain strong for awhile.? I use Value Line here, and screen for companies that might yield a 15%/year return, while being above average in terms of balance sheet strength.

3) I read through the 13Ds of a group of ~75 investors that I respect, and look at the companies that are large holdings relative to market cap that are still being acquired.

Then I take all of my ideas once per quarter, shortly after the 13Ds are filed, and compare them against existing portfolio holdings against a variety of valuation metrics, sentiment variables, and other factors.

I then rank all of the companies as a group, looking at where the middle company in my existing portfolio is.? Companies I don’t own that are above it are candidates for purchase.? Companies I own that are below the middle portfolio company are candidates for sale.

I then sit down and analyze, and pair off stocks to sell versus stocks to buy, unless there is some reason to increase or decrease the number of stocks in the portfolio, which is usually around 35.? Presently it is 34.? I? buy/sell 2-3 stocks per quarter.? That keeps things fresh, but allows me to hold companies for longer periods of time.? (My turnover is 25% of the open end mutual fund industry.)

After I make my series of buys and sells, I throw all my work away, and start accumulating data for the next quarter.

My sense is that it pays more to think of your portfolio versus candidates than to track candidates.

The main idea here is that we should always be improving the character/quality of the portfolio.? Trade things that are worse for things that are better.? Human beings can do that trade.? What is hard is for people to assemble the best stocks.? Getting a bunch of “pretty good” stocks can be done, and it does not mean they will outperform all the time.? Getting a portfolio of all of the best stocks is impossible.

So think economically — try to improve your portfolio regularly, regular incremental improvements yield a large economic improvement over a market cycle.? At least, that has been my experience. 🙂

Why do Value Investors Like Indexing?

Why do Value Investors Like Indexing?

In general, most value investors like indexing.? Buffett and many others agree on this.? But why?

1) Most value investors that I have known want ordinary people to have an option of doing pretty well, without investing with them, because the minimums are too high — investing in index funds fits that.? Further, Vanguard, who acts in the interest of their investors is an excellent institution.? If I could have a fund there and be paid 10-20 basis points, I would do it in a heartbeat.

2) The second reason is less noble.? We like less competition.? Index money is thought-free money with respect to company and sector selection.? The more of a company that is held by index investors, the greater the probability that it is mispriced.

Now, that is not necessarily so crass on our part.? Look, good investing for most people is like holding a second job.? Do you really want to devote that much of your life to seeking out bargains?? Not many will want to do that.? (Note: there is a side benefit to doing value investing, no matter what sort of firm you work for.? You learn to think like an intelligent businessman — most employees don’t do that.? The ability to think like a intelligent businessman sets you up for greater responsibility, because you can not only do your task, but you can consider the deeper questions of business, making you a prime candidate for a promotion.)

But… there is another venue for mispriced stocks.? Some large stocks don’t get into the index because they are foreign, or have a large amount of the stock owned by a control group, which makes them less liquid.? The main idea is that stocks that few people think about are less liquid, and more likely to be mispriced, but the question remains: are they mispriced high or low?

That is the question for the value investor, and not for those that buy stocks as commodities, as many index investors do.

Sorted Weekly Tweets

Sorted Weekly Tweets

Macroeconomics

 

  • Here’s my plan for reducing the deficit: http://t.co/XJPjf8A5 #mydeficitplan via @wsj Draconian, I know, but the budget shoould b balanced Dec 21, 2012
  • Canada?s exports crucial as sluggish growth continues: IMF http://t.co/iIOJ6PoF Bank of Canada should raise rates 2 reduce excessive debt $$ Dec 21, 2012
  • Everything You Need To Know About the Economy in 2012, in 34 Charts http://t.co/aXnjSkR0 Good stuff; could have been formatted better $$ Dec 21, 2012
  • Fiscal Cliff’s Dirty Secret: It’s Not About Taxes At All, But Too Much Spending http://t.co/UY8rKW9h We need 2 deal w/SS, Medicare & Defense Dec 20, 2012
  • We?ve Nationalized the Home Mortgage Market. Now What? http://t.co/YSCrvVmK Congress loves 2 have cows around that they can milk for $$ Dec 20, 2012
  • EU Banking Re-Unions http://t.co/khSA0co0 The lack of a timetable indicates that things aren’t really finalized; not sure this will fly $$ Dec 20, 2012
  • ?Spending Cuts? Lose Something in Translation http://t.co/DYFxVMno Only in DC is reducing planned growth in spending called a cut $$ Dec 20, 2012
  • Money Funds Brace for Flood http://t.co/4J7VWuxx MMFs r between a rock & a hard place: loose Fed policy & regulatory over-reach $$ Dec 20, 2012
  • Wall Street’s Biggest Geniuses Reveal Their Favorite Charts Of 2012 http://t.co/at12mMsV Very long, but lots of good stuff $$ Dec 20, 2012
  • My forward estimates, derived from TIPS are rising, 2014 inflation, and 2018-2022 inflation. The latter has… http://t.co/tgrGfiDG Dec 19, 2012
  • Estimated 2018-2022 inflation rate continues to rise: http://t.co/ebqeM5KJ Stagflation may be coming. cc: @federalreserve #stagflation $$ Dec 19, 2012
  • Estimated 2014 inflation rate continues to rise: http://t.co/ZrvIc5Nk Stagflation may be coming. cc: @federalreserve #stagflation Dec 19, 2012
  • Economics may be dismal, but it is not a science http://t.co/I6B9LbSw No universal economic theory, & new economic thinking must be eclectic Dec 18, 2012
  • Fisher: Fed Risks ‘Hotel California’ Monetary Policy http://t.co/fRKOYl9d When the Fed starts 2 tighten, it will b hard 2 do $$ Dec 17, 2012
  • FDIC Guarantee Program Set to Expire After Senate Block http://t.co/qPdQNWQF Will squeeze the short end of the yield curve further $$ Dec 17, 2012
  • US Banks Lack Liquidity to Withstand Crisis, Study Says http://t.co/psmQEP1z Liquidity mismatches r pernicious; key risk gets ignored $$ Dec 17, 2012
  • Mkts r discounting mechanisms. Temporary events like bond ratings, debt ceiling & fiscal cliff should not affect market much $$ Dec 17, 2012
  • So, as an example, if the govt runs a deficit, it should not stimulate much b/c people discount future econ adjustment b/c of more debt $$ Dec 17, 2012
  • Same 4 monetary policy; the Fed can “stimulate” as much as it likes; mkt players discount the future removal of policy, inflation, etc. $$ Dec 17, 2012
  • Cliff? What Cliff? http://t.co/QEvklDQU Or maybe, just maybe investors don’t care whether we go over the “fiscal cliff” or not. $$ Dec 17, 2012

 

Stocks & Sectors

 

  • There are 272 gold & silver companies trading on US exchanges or OTC. 59 of them have mkt caps > $100M. 22 of them have mkt caps > $1B $$ Dec 21, 2012
  • Aviva Sells US Life Business to Apollo for $1.8B http://t.co/UqM2kqyr When Aviva bot Amerus, I said that they overpaid massively. Proof $$ Dec 21, 2012
  • Value Investing In Practice: A Conversation About Oaktree Capital http://t.co/4FVok5wz Good value investing does not hyper-diversify $$ Dec 20, 2012
  • ICE in Deal to Buy NYSE http://t.co/ik348vsZ New era; expect 2c more deals like this. As an aside average holders of $NYX stock lost $$ Dec 20, 2012
  • Buffett’s Leading The Corporate Buyback Surge http://t.co/U3piJgDv He has the $$, & 1.2x BV is a defensible floor ||| FD: + $BRK.B Dec 19, 2012
  • Investment Fads and Themes by Year, 1996-2012 http://t.co/cvLFKyRE @reformedbroker on what the broad themes this year & back to 1996 $$ Dec 19, 2012
  • Alterra up after deal, analyst positive on Bermuda peers http://t.co/Y5jTB40c Room 4 a new round of consolidation. $MKL buys $ALTE $$ Dec 19, 2012
  • $ALL Bets on Home Insurance as Stock Rally Withstands Sandy http://t.co/XBQOOSB5 Insured damages (excl flood) low4 Sandy; premratesflat $$ Dec 19, 2012
  • Stocks Held Hostage as CEOs Plan Spending Cuts http://t.co/5c7nBKAS It is difficult to avoid deflation; so much uncertainty presently $$ Dec 18, 2012

 

Credit & Fixed Income

 

  • Swaps ?Armageddon? Lingers as New Rules Concentrate Risk http://t.co/QK3s19Hz Clearinghouses r not a panacea; it is possible 4 them 2 fail Dec 21, 2012
  • Americans Hacked Don?t Know Chamber Left Them Alone http://t.co/DSBDUijq Common programs place yr computr @ risk; CoC defends SW makers $$ Dec 21, 2012
  • The Indianapolis 500 of Corporate Bonds Yields http://t.co/dCamXED3 Too much $$ flowing into corporate credit; feels like 2006 Dec 20, 2012
  • India Cash-for-Gold Loans Hide Shadow-Banking Risks http://t.co/BGnO4YWI 2much lending creates a mess; 2much secured lending creates a panic Dec 20, 2012
  • Pimco Sees Spreading Slowdown Boosting [Australian] Bonds http://t.co/oDFSkGoF Pimco buying the debt of fringe developed nations $$ Dec 19, 2012
  • CAB Legislation Expected in January http://t.co/TSuxBmM4 California legislation proposed 2 limit issuance of Capital Appreciation Bonds $$ Dec 19, 2012
  • Why China May Be Facing US-Style Credit Crunch http://t.co/99xMzC3M “To some extent, this is fundamentally a Ponzi scheme,” [Xiao] said. $$ Dec 19, 2012
  • Pimco’s Gross Cuts Back on MBS http://t.co/4FaxLTKq Lightening up on MBS & Corporates, buying developed fringe, sticking w/TIPS $$ Dec 19, 2012
  • Mind the rate risk http://t.co/nVqjlWW9 Rates may stay low 4 a while, but when they run up, total returns could b worse than 1994 $$ Dec 19, 2012
  • Spain House Prices – Deconstructing Spain http://t.co/7ARRPZqS Housing prices continue 2fall, more foreclosures, setting up bad bank fund $$ Dec 17, 2012

 

Energy

 

  • Valero Received Approval 2 Ship US Crude 2 Quebec Refinery http://t.co/ojABCqu1 Could b start of something big: US exports oil FD:+ $VLO Dec 20, 2012
  • Extracting shale oil from a Dead Cow http://t.co/bok4bNE7 Interesting: after the expropriation of Repsol that oil majors line up4more $$ Dec 20, 2012
  • Gasoline at US Pumps Drops to Lowest in a Year on Supply Gain http://t.co/4pI5SXiV Good news coming to users of refined fuel products $$ Dec 19, 2012
  • California refiners dreamin’ of shale oil face hurdles http://t.co/vJgiW4rm Many efforts t get cheap oil 2 CA; $24/bbl price difference $$ Dec 17, 2012

 

Other

 

  • CEOs Concerned about the Time and Cost of Implementing Predictive Analytics http://t.co/QcABrcFH Big data facilitates cluster pricing $$ Dec 20, 2012
  • In the Flesh: The Embedded Dangers of Untested Stem Cell Cosmetics http://t.co/de2aio1V Adult stem cells can do as much harm as good $$ Dec 19, 2012
  • The First Time Tech Ruined the Music Business http://t.co/d0RE4002 As technologies improve all manner of “rights” issues crop up $$ Dec 18, 2012
  • Advisers Question Modern Portfolio Theory http://t.co/lLbCVvgL Look through the security 2 the underlying economics of the investment $$ Dec 17, 2012
  • Twitter has started rolling out the option to download all your tweets http://t.co/IIOVO6mJ Not common yet, but may b coming soon $$ Dec 17, 2012
  • Schools Safer Than 1990s as Educators Anticipate Killers http://t.co/aQaB6G6Q Students r far less likely2b killed in school than elsewhere Dec 17, 2012
  • Highest-Paid California Trooper Is Chief Banking $484,000 http://t.co/JwgYWfg2 Giving officers comp time rather than $$ 4 unused vacation Dec 17, 2012
  • ‘Followers for sale’: Twitter’s very own black market http://t.co/HKCqo074 Fake Follower Check will estimate how many followers r real $$ Dec 17, 2012
  • SEC Says Asset Firm Manipulated Trades to Enrich Some Clients http://t.co/L8IJQ77k I remember their ads, proclaiming their track record $$ Dec 17, 2012

 

Wrong

  • Bad idea: Africa Dreams of Building Telescopes to Study Space http://t.co/gSwkKIBs Would make more sense 4 Africa to fix agriculture $$ Dec 20, 2012
  • Wrong: US should intervene in Nagorno-Karabakh process at the highest level http://t.co/2tJTKtht We should stick 2r own business $$ Dec 18, 2012
  • Wrong: This is why I generally don’t like Quartz; pretending to be smart $$ RT Our favorite charts of 2012 http://t.co/w2bvLDvX Dec 18, 2012

 

Replies & Comments

  • “This would have been a better article if you had put separators between each graph/explanation.” ? David_Merkel http://t.co/uoMy61H1 $$ Dec 21, 2012
  • @EddyElfenbein Thanks, Eddy. Dec 19, 2012
  • @geekpryde Hey, thanks for the kind words, I appreciate that you follow me. Dec 19, 2012
  • @VIXandMore Ludwig is letting us down, and 3 days after his birthday. Call Schroeder 😉 Dec 19, 2012
  • @Alea_ Cool new avatar, I like it Dec 19, 2012
  • @Money_in_Stereo Well said, though I am not an expert there. Thanks for sharing that. Dec 18, 2012
  • @BarbarianCap Hint: if company is offering u a nice buyout, they r offering less than its worth, unless u no more about when u will die $$ Dec 18, 2012
  • @volatilitysmile @carney I knew a close adviser of Mozillo; he told me stories of how disconnected Angelo was w/reality in 2009 $$ Dec 17, 2012
  • @nicster There have been many changes, but they are all local, and don’t make the news. US Govt was stupid on the shoe bomb. Local better $$ Dec 15, 2012

Retweets

  • Amazing RT @moorehn: “the average lifespan of American musical superstars in the pop, rock and rap genre is only 45.” http://t.co/uXVNuStF Dec 20, 2012
  • Practically. Old bond mgr rule: underweight the most rapidly growing debt class $$ RT @ToddSullivan: didn’t they already do student loan? Dec 20, 2012
  • Remember deriving formula when younger $$ RT @munilass: Twelve Days of Christmas and tetrahedral numbers http://t.co/VVNnyU2V (via @ptak) Dec 20, 2012
  • You can say that again $$ RT @japhychron: @AlephBlog Always funny the way they call economics a science. Studying people is anything but. Dec 18, 2012
  • Banks are insolvent & w/large & rapidly growing budget deficit $$ RT @FGoria: DJ: Cyprus May Be Days Away From Default — Fin Min Official Dec 17, 2012
  • Sad & dumb $$ RT @carney: You’d never guess who has a completely self-serving & bonkers theory of the financial crisis. http://t.co/LIAd8WqB Dec 17, 2012

 

Twitter Summary

  • My week on twitter: 72 retweets received, 1 new listings, 85 new followers, 132 mentions. Via: http://t.co/SPrAWil0 Dec 20, 2012

 

Blog Notes

Blog Notes

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

Selling Options Cheaply (Did You Know?)

Selling Options Cheaply (Did You Know?)

Tom Brakke, the Research Puzzler, has started up yet another site to display bits of interesting information that he has run across — Research Puzzle Pieces.? His first piece was an interesting one, and I would like to give you my spin on it.

You may remember some of my writings in this area:

One major ploy of Wall Street is to induce people who need to stretch their income to buy a high yielding security that has weak protections.? All of the options are held by the bond seller.? They might think:

  • If things go really bad, we can default.? We’ll start another firm later; thank God for limited liability, and forgetful lenders.
  • If things go neutral-to-bad, and we need to conserve cash, we just pay with more bonds at a slightly higher rate.? In that scenario, there is no way we could borrow more at a similar rate, so we win there as well.
  • If things go okay, and we don’t have cash needs, we pay the coupon and bide our time.? (This is the only good scenario for bondholders.)
  • If things go really well, we call the bonds after the first year, paying off the investors who probably do not have great reinvestment options.

For the bondholder, the upside is capped, and the downside is 100%.? The optimal outcome is that you get paid principal & interest to the stated maturity from this bond that is deep in junk territory, CCC+/Caa1-rated, where the proceeds of the deal don’t increase the value of the firm, but are paid as a dividend to the equity holders.

As I said, the bond issuer holds all of the options here.? And what might you get as yield? 8.5-9.0%?? Given the risks here, that is not enough.

Problems of a Yield-Starved Market

PIK bonds and bonds from dividend deals tend to default with higher frequency and severity than equivalently rated deals lacking PIK and/or dividends.? But people invest, hoping that they will come out okay, even in the face of structural bond weakness.? They need the income, because they don’t have enough capital.

This is not a problem unique to investing.? As for PIK toggle bonds, securities underwriting is not all that much different from insurance underwriting.? In the first part of the bull phase of the cycle, pricing/risk margins decline due to competition.? After that, terms & conditions get weakened before the cycle turns.

It is common to see protections in debt securities decline as we get closer to the end of the credit/equity risk cycle.? We may have months to go here, or maybe two years to the peak at most, but we are living on borrowed time in the debt markets at present.? One more sign: premiums paid for loan participation and junk bond closed-end funds.? Most junk closed-end funds are at a premium, which means that there is an incentive to sell more junk debt.

What a world.? Let Bernanke know that his plan to make people take more risk is working, but when you do, tell him it is working for bad, not good.? As for my clients, we are reducing credit risk.

Book Review: Think, Act, and Invest Like Warren Buffett

Book Review: Think, Act, and Invest Like Warren Buffett

This is a tough book to review, because I generally respect the author, but there are many things I don’t like about the book.? Let’s start with the main one:

My friend Alice Schroeder came to speak to the Baltimore CFA Society early in November.? It was a great talk, and afterward, I took her back to the Amtrak station.? What was our main topic of conversation?? The many authors with limited or no dealings with Warren Buffett who invoke his name in order to get better sales.? I won’t name names.? I have relationships with a number of them.

I will review “The Snowball” soon.? Alice Schroeder spent around five years creating that lengthy book, and I can see why she would be upset over those that use Buffett for their own personal gain.

This book is another example of that.? Only chapters 1 and 2 have anything to do with Buffett, and there he is quoted extensively to the point where he should be listed as a secondary author, and get a cut of the royalties.? But in the next nine sections have almost nothing from Buffett; it is all the philosophy of Larry Swedroe.

Don’t get me wrong.? Larry Swedroe is a very bright guy, and worthy of being read.? But his philosophy is not that of Buffett.? Yes, Buffett said a number of things stressing that average investors should invest passively, because they have no information edge.? But that’s not what Buffett does himself.

I have written elsewhere that Buffett cannot be imitated by the rest of us (Part one, part two).? (For those reading me at Amazon, please come to Aleph Blog to get links.)? Buffett buys whole companies.? Few of us can do that.? Buffett has a holding company that produces the ability to fund investments cheaply.? None of us have that, and this book by Larry Swedroe, does not even touch on the most powerful and distinct things that Buffett does to earn returns.

Chapters three and beyond are really basic stuff that average people should do to manage their investments wisely.? Larry Swedroe is great with that sort of thing. But it has nothing to do with Buffett.

That’s the main thing that irritates me here.? Don’t put Buffett in the title if the book is not about Buffett.? This book is not about Buffett, it is about how average people should manage what excess assets they have.

Now, all that said, if you read the personal finance section of my blog (which is free) you won’t gain any additional insights from this book, and you won’t pay any money either.? That said, giving a book like this to a friend who doesn’t get the management of assets could be very good for him.? Show a man a website, and he ignores it.? But a physical book — he might read it.

Quibbles

Swedroe does not get corporate bonds.? They are valuable during the bull phase of the credit cycle.? Those of us that follow the credit cycle make excess returns as a result.? You have to be opportunistic and disciplined to do this.? Yes, corporate bonds are hybrid investments — part equity, part guarantee.? But intelligent investors can do well with corporate bonds — it is much less efficient than the stock market.

Also, he overestimates the number of stocks needed to diversify a portfolio on page 68.

On page 77, he engages in data-mining to show what would have worked best in the past, which has no relevance to what will work well in the future.

On page 113, he tells a story from “Time Management for Dummies,” without attribution.

On pages 126-7, he errs, because risk and reward are not correlated.? Also, high yields usually portend risk, but that is not always true.

Finally, on page 131, he is too absolutist on corporate bonds.? Most of the time, it might be better to hold stocks and Treasury bonds, but there are times when corporate bonds are mispriced in a panic, and it is time to buy them.

Who would benefit from this book: ? If you want basic book on asset allocation for average people, this could have value.? If you want to imitate Buffett, this book will not help you in the slightest. If you want to, you can buy it here:Think, Act, and Invest Like Warren Buffett.

Full disclosure: I asked the publisher for the book, and he sent it.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

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

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