1) I started in this game as an amateur, and built up my skills gradually, reading widely. ?My academic studies ended at age 25, and it was after that that I began learning the practical knowledge. ?Though I had investment-related jobs, I never held a position in investing, until I was 38, and I never wrote on investing for the public in any significant way until I was 42, when Cramer invited me to write for RealMoney. ?I’m now 55, and I think I am still growing in my knowledge of investing.
i write this to simply say that you don’t have to take a traditional path into the investment business. ?I am grateful that I want through the circuitous path through the insurance industry, because it deepened my perspective on investing. ?All of the asset-liability modeling, where I often tried to challenge existing paradigms, helped me to understand why often the conventional wisdom is true. ?Where it is not true, there is usually an anomaly to profit from.
The other reason that I write this, is that it is possible to get significant knowledge as an amateur, and on a book basis, as good as many professionals. ?You won’t get the respect from professionals until you are a professional, but who cares? ?You can do better for yourself in investing. ?Just don’t get arrogant and forget to put risk control forst.
2) After all of the political fights are over, OPEC nations will once again agree that they will cut production as a group. ?Remember, much of OPEC has a low cost of production, and so when production decreases in a coordinated way, profits will rise for almost all OPEC nations.
In the long run, economics triumphs over politics. ?The challenge comes in the short-run from trying to figure out who cuts how much from what baseline. ?Even after that, discipline takes a while to achieve, because the incentive to cheat is high.
I stand by the view that in the intermediate term, crude oil prices will be around $50. ?Demand for crude oil is growing globally, not shrinking, and marginal supplies would price out at around $50/barrel, if OPEC nations act to maximize their profits, rather than engage in a market share war. ?(Prices would be higher still ?if OPEC nations acted to maximize the present value of their long-run profits, but I doubt that will happen until the profligate producers deplete their reserves.
3) The ferment in high yield bonds is unlikely to peak before there are significant defaults. ?It’s possible that we get a rally from here in the short run — yield spreads are relatively wide compared to earnings yields on stock. ?At this point, it doesn’t pay so well to borrow money and buy back stock. ?That isn’t stopping many corporations from doing their buybacks. ?Buybacks should be tactical rather than constant. ?Only buy back when there is a significant discount to the fair market value of the firm.
That said, it’s unusual for a large amount of credit stress to go away without defaults. ?It’s rare to see a credit problem work out by firms growing out of it. ?Thus what might be more likely than a junk rally is a fall in stock prices. ?Perhaps the most optimistic scenario would be that only energy is affected — it has defaults, and the rest of the market continues to rally. ?Not impossible.
4) Regarding F&G Life — congrats to holders, you won. ?A dumb aggressive foreign buyer jumped on the grenade for you. (Now let’s see, has that ever happened before to F&G Life?) ?Be grateful and sell. ?Let the arbs take the risk of the deal not going through.
5) One phrase that all investors should learn is, “I missed that one.” ?You can’t catch every opportunity. ?Some will pass you by despite your best efforts. ?Rather than jump on late, it is better to look for the next opportunity, lest you buy high and sell low.
On the opposite side of timing, if you tend to get to opportunities too early, maybe consider waiting until the price breaks the 200-day moving average from below. ?Let the market confirm that it agrees with your thesis, and then invest.
6) Regarding the Fed, I think too much is being made out of them for now. ?I will be watching the yield curve for clues, and seeing if the curve flattens or steepens. ?I expect it to flatten more quickly than the market currently expects,?limiting the total amount of Fed tightening.
As it is, every time the Fed tightens, the short interest-bearing deposits at banks reprice up, with some lesser amount pass-through to lending rates. ?I would expect bank profits to be squeezed.
Aside from that, most of what the FOMC will say tomorrow will just be noise. ?They don’t have a theory that guides them; they are just making it up as they go, so they wander and try to discover what their goals should be.
7) I’ve sometimes commented that at the start of a tightening cycle that those who have been cheating blow up, like Third Avenue Focused Credit, which bought assets far less liquid than the shares of its mutual fund. ?At the end of the tightening cycle, something blows up that would be a surprise now, which sometimes jolts the FOMC to stop tightening. ?The question here is: what could that group of economic entities be? ?China, Brazil, repo markets, agricultural loans, auto loans, or something else? ?Worth thinking about — we know about energy, but what else has issued the most debt since the end of 2008?
This post was triggered by a guy from the UK who sent me an infographic on reducing risk that I thought was mediocre at best. ?First, I don’t like infographics or video. ?I want to learn things quickly. ?Give me well-written text to read. ?A picture is worth maybe fifty words, not a thousand, when it comes to business writing, perhaps excluding some well-designed graphs.
Here’s the problem. ?Do you want to reduce?the volatility of your asset portfolio? ?I have the solution for you. ?Buy bonds and hold some cash.
And some say to me, “Wait, I want my money to work hard. ?Can’t you find investments that offer a higher return that diversify my portfolio of stocks and other risky assets?” ?In a word the answer is “no,” though some will tell you otherwise.
Now once upon a time, in ancient times, prior to the Nixon Era, no one hedged, and no one looked for alternative investments. ?Those buying stocks stuck to well-financed “blue chip” companies.
Some clever people realized that they could take risk in other areas, and so they broadened their stock exposure to include:
Growth stocks
Midcap stocks (value & growth)
Small cap stocks (value & growth)
REITs and other income passthrough vehicles (BDCs, Royalty Trusts, MLPs, etc.)
Developed International stocks (of all kinds)
Emerging Market stocks
Frontier Market stocks
And more…
And initially, it worked. ?There was significant diversification until… the new asset subclasses were crowded with institutional money seeking the same things as the original diversifiers.
Now, was there no diversification left? ?Not much. ?The diversification from investor behavior is largely gone (the liability side of correlation). ?Different sectors of the global economy don’t move in perfect lockstep,?so natively the return drivers of the assets are 60-90% correlated (the asset side of correlation, think of how the cost of capital moves in a correlated way across companies). ?Yes, there are a few nooks and crannies that are neglected, like Russia and Brazil, industries that are deeply out of favor like gold, oil E&P, coal, mining, etc., but you have to hold your nose and take reputational risk to buy them. ?How many institutional investors want to take a 25% chance of losing a lot of clients by failing unconventionally?
Why do I hear crickets? ?Hmm…
Well, the game wasn’t up yet, and those that pursued diversification pursued alternatives, and they bought:
Timberland
Real Estate
Private Equity
Collateralized debt obligations of many flavors
Junk bonds
Distressed Debt
Merger Arbitrage
Convertible Arbitrage
Other types of arbitrage
Commodities
Off-the-beaten track bonds and derivatives, both long and short
And more… one that stunned me during the last bubble was leverage nonprime commercial paper.
Well guess what? ?Much the same thing happened here as happened with non-“blue chip” stocks. ?Initially, it worked. ?There was significant diversification until… the new asset subclasses were crowded with institutional money seeking the same things as the original diversifiers.
Now, was there no diversification left? ?Some, but less. ?Not everyone was willing to do all of these. ?The diversification from investor behavior was reduced?(the liability side of correlation). ?These don’t move in perfect lockstep,?so natively the return drivers of the risky components of the assets are 60-90% correlated over the long run (the asset side of correlation, think of how the cost of capital moves in a correlated way across companies). ?Yes, there are some?that are neglected, but you have to hold your nose and take reputational risk to buy them, or sell them short. ?Many of those blew up last time. ?How many institutional investors want to take a 25% chance of losing a lot of clients by failing unconventionally?
Why do I hear crickets again? ?Hmm…
That’s why I don’t think there is a lot to do anymore in diversifying risky assets beyond a certain point. ?Spread your exposures, and do it intelligently, such that the eggs are in baskets are different as they can be, without neglecting the effort to buy attractive assets.
But beyond that, hold dry powder. ?Think of cash, which doesn’t earn much or lose much. ?Think of some longer high quality bonds that do well when things are bad, like long treasuries.
Remember, the reward for taking business risk in general varies over time. ?Rewards are relatively thin now, valuations are somewhere in the 9th decile (80-90%). ?This isn’t a call to go nuts and sell all of your risky asset positions. ?That requires more knowledge than I will ever have. ?But it does mean having some dry powder. ?The amount is up to you as you evaluate your time horizon and your opportunities. ?Choose wisely. ?As for me, about 20-30% of my total assets are safe, but I?have been a risk-taker most of my life. ?Again, choose wisely.
PS — if the low volatility anomaly weren’t overfished, along with other aspects of factor investing (Smart Beta!) those might also offer some diversification. ?You will have to wait for those ideas to be forgotten. ?Wait to see a few fund closures, and a severe reduction in AUM for the leaders…
This book is not what I expected; it’s still very good. Let me explain, and it will give you a better flavor of the book.
The author, Jason Zweig, is one of the top columnists writing about the markets for The Wall Street Journal. ?He is very knowledgeable, properly cautious, and wise. ?The title of the book Ambrose Bierce’s book that is commonly called The Devil’s Dictionary.
There are three differences in style between Zweig and Bierce:
Bierce is more cynical and satiric.
Bierce is usually shorter in his definitions, but occasionally threw in whole poems.
Zweig spends more time explaining the history of concepts and practices, and how words evolved to mean what they do today in financial matters.
If you read this book, will you learn a lot about the markets? ?Yes. ?Will it be fun? ?Also yes. ?Is it enough to read this and be well-educated? ?No, and truly, you need some knowledge of the markets to appreciate the book. ?It’s not a book for novices, but someone of intermediate or higher levels of knowledge will get some chuckles out of it, and will nod as he agrees along with the author that the markets are a treacherous place disguised as an easy place to make money.
As one person once said, “Whoever called them securities had a wicked sense of humor.” ?Enjoy the book; it doesn’t take long to read, and it can be put down and picked up with no loss of continuity.
Quibbles
None
Summary / Who Would Benefit from this Book
If you have some knowledge of the markets, and you want to have a good time seeing the?wholesome image of the markets?skewered, you will enjoy this book. ?if you want to buy it, you can buy it here: The Devil’s Financial Dictionary.
Full disclosure:?The author sent a free copy?to me via his publisher.
If you enter Amazon through my site, and you buy anything, including books, 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.
WESLEY GRAY: Imagine the following theoretical investment opportunity: Investors can invest in a fund that will beat the market by 5% a year over the next 10 years. Of course, there is the catch: The path to outperformance will involve a five-year stretch of poor relative performance.? ?No problem,? you might think?buy and hold and ignore the short-term noise.
Easier said than done.
Consider Ken Heebner, who ran the CGM Focus Fund, a diversified mutual fund that gained 18% annually, and was Morningstar Inc.?s highest performer of the decade ending in 2009. The CGM Focus fund, in many respects, resembled the theoretical opportunity outlined above. But the story didn?t end there: The average investor in the fund lost 11% annually over the period.
What happened? The massive divergence in the fund?s performance and what the typical fund investor actually earned can be explained by the ?behavioral return gap.?
The behavioral return gap works as follows: During periods of strong fund performance, investors pile in, but when fund performance is at its worst, short-sighted investors redeem in droves. Thus, despite a fund?s sound long-term process, the ?dollar-weighted? returns, or returns actually achieved by investors in the fund, lag substantially.
In other words, fund managers can deliver a great long-term strategy, but investors can still lose.
That’s why I wanted to write this post. ?Ken Heebner is a really bright guy, and has the strength of his convictions, but his investors don’t in general have similar strength of convictions. ?As such, his investors buy high and sell low with his funds. ?The graph at the left is from the CGM Focus Fund, as far back as I could get the data at the SEC’s EDGAR database. ?The fund goes all the way back to late 1997, and had a tremendous start for which I can’t find the cash flow data.
The column marked flows corresponds to a figure called “Change in net assets derived from capital share transactions” from the Statement of Changes in Net Assets in the annual and semi-annual reports. ?This is all public data, but somewhat difficult to aggregate. ?I do it by hand.
I use annual cashflows for most of the calculation. ?For the buy and hold return, i got the data from Yahoo Finance, which got it from Morningstar.
Note the pattern of cashflows is positive until?the financial crisis, and negative thereafter. ?Also note that more has gone into the fund than has come out, and thus the average investor has lost money. ?The buy-and-hold investor has made money, what precious few were able to do that, much less rebalance.
This would be an ideal fund to rebalance. ?Talented manager, will do well over time. ?Add money when he does badly, take money out when he does well. ?Would make a ton of sense. ?Why doesn’t it happen? ?Why doesn’t at least buy-and-hold happen?
It doesn’t happen because there is a Asset-Liability mismatch. ?It doesn’t matter what the retail investors say their time horizon is, the truth is it is very short. ?If you underperform for less?than a few years, they yank funds. ?The poetic justice is that they yank the funds just as the performance is about to turn.
Practically, the time horizon of an average investor in mutual funds is inversely proportional to the volatility of the funds they invest in. ?It takes a certain amount of outperformance (whether relative or absolute) to get them in, and a certain amount of underperformance to get them out. ?The more volatile the fund, the more rapidly that happens. ?And Ken Heebner is so volatile that the only thing faster than his clients coming and going, is how rapidly he turns the portfolio over, which is once every 4-5 months.
Pretty astounding I think. ?This highlights two main facts about retail investing that can’t be denied.
Asset prices move a lot more than fundamentals, and
Most investors chase performance
These two factors lie behind most of the losses that retail investors suffer over the long run, not active management fees. ?remember as well that passive investing does not protect retail investors from themselves. ?I have done the same analyses with passive portfolios — the results are the same, proportionate to volatility.
I know buy-and-hold gets a bad rap, and it is not deserved. ?Take a few of my pieces from the past:
If you are a retail investor, the best thing you can do is set an asset allocation between risky and safe assets. ?If you want a spit-in-the-wind estimate use 120 minus your age for the percentage in risky assets, and the rest in safe assets. ?Rebalance to those percentages yearly. ?If you do that, you will not get caught in the cycle of greed and panic, and you will benefit from the madness of strangers who get greedy and panic with abandon. ?(Why 120? ?End of the mortality table. Take it from an investment actuary. We’re the best-kept secret in the financial markets. )
Okay, gotta close this off. ?This is not the last of this series. ?I will do more dollar-weighted returns. ?As far as retail investing goes, it is the most important issue. ?Period.
Recently I got asked for a list of investment books that I would recommend. These aren’t all pure investment books — some of them will teach you how markets operate in general, but they do so in a clever way. I have also reviewed all of them, which limited my choices a little. Most economics, finance, investment books that I have really liked I have reviewed at Aleph Blog, so that is not a big limit.
This post was also prompted by a post by another blogger of sorts publishing at LinkedIn. ?I liked his post in a broad sense, but felt that most books by or about traders are too hard for average people to implement. ?The successful traders seem to have systems that go beyond the simple systems that they write about. ?If that weren’t true, we’d see a lot of people prosper at trading for a time, until the trades got too crowded, and the systems failed. ?That’s why the books I am mentioning are longer-term investment books.
Don’t get me wrong. ?I like many books on value investing, but the first?three are classic. ?Graham is the simplest to understand, and Klarman is relatively easy as well. ?Like Buffett, Klarman recognizes that we live in a new world now, and the simplistic modes of value investing would work if we could find a lot of stocks as cheap as in Graham’s era — but that is no longer so. ?But even Ben Graham recognized that value investing needed to change at the end of his life.
Whitman takes more of a private equity approach, and aims for safe and cheap. ?Can you find mispriced assets inside a corporation or elsewhere where the value would be higher?if placed in a different context? ?Whitman is a natural professor on issues like these, though in practice, the?stocks he owned during the financial crisis were not safe enough. ?Many business models that were seemingly bulletproof for years were no longer so when asset prices fell hard, especially those connected to housing. ?This should tell us to think more broadly, and not trust rules of thumb, but instead think like Buffett, who said something like, “We’re paid to think about the things that seemingly can’t happen.”
The last book is mostly unknown, but I think it is useful. ?Penman?takes apart GAAP accounting to make it more useful for decision-making. ?In the process, he ends up showing that very basic forms of quantitative value investing work well.
Books that will help you Understand Markets Better
The first link is two books on the life of George Soros. ?Soros teaches you about the nonlinearity of markets — why they overshoot and undershoot. ?Why is there momentum? ?Why is the tendency for price to converge to value weak? ?What do markets look and feel like as they are peaking, troughing, etc? ?Expectations are a huge part of the game, and they affect the behavior of your fellow market participants. ?Market movements as a result become self-reinforcing, until the cash flows can by no means support valuations, or are so rich that businessmen buy and hold.
Consider what things are like now as people justify high equity valuations. ?At every turning point, you find people defending vociferously why the trend will go further. ?Who is willing to think differently at the opportune time?
Triumph of the Optimists is another classic which should teach us to be slightly biased toward risk-taking, because it tends to win over time. ?They pile up data from around 20 nations over the 20th century, and show that stock markets have done very well through a wide number of environments, beating bonds?by a little and cash by a lot.
For those of us that tend to be bearish, it is a useful reminder to invest most of the time, because you will ordinarily make good money over the long haul.
After the financial crisis, we need to understand better what risk is. ?Risk is the likelihood and severity of loss, which is not constant, and cannot be easily compressed into simple figure. ?We need to think about risk ecologically — how is an asset priced relative to its future prospects, and is there any possibility that it is significantly misfinanced either internally or by its holders. ?For the latter, think of the Chinese using too much margin to carry stocks. ?For the former, think of Fannie Mae and Freddie Mac. ?They took risks that forced them into insolvency, even though over the long run they would have been solvent institutions. ?(You can drown in a river with an average depth of six inches. ?Averages reveal; they also conceal.)
Hot money has a short attention span. ?It needs to make money NOW, or it will leave. ?When an asset is owned primarily by hot money, it is an unstable situation, where the trade is “crowded.” ?So it was with housing-related assets and a variety of arbitrage trades in the decade of the mid-2000s. ?Momentum blinded people to the economic reality, and made them justify and buy into absurdly priced assets.
As for the last book, hedge funds as a group are a dominant form of hot money. ?They have grown too large for the pool that they fish in, and as a result, their returns are poor as a group. ?With any individual hedge fund, your mileage may vary, there are some good ones.
These books as a whole will teach you about risk in a way that helps you understand the crisis in a systemic way. ?Most people did not understand the situation that way before the crisis, and if you talk to most politicians and bureaucrats, they still don’t get it. ?A few simple changes have been made, along with a bunch of ineffectual complex changes. ?The financial system is a little better as a result, but could still go through a crisis like the last one — we would need a lot more development of explicit and implicit debts to get there though.
An aside: the book The Nature of Risk is simple, short and cute, and can probably reach just about anyone who can grasp the similarities between a forest ecology under threat of fire, and a financial system.
Summary
I chose some good books here, some of which are less well-known. ?They will help understand the markets and investing, and make you a bigger-picture thinker… which makes me think, I forgot the second level thinking of?The Most Important Thing, by Howard Marks. ?Oops, also great, and all for now.
PS — you can probably get Klarman’s book through interlibrary loan, or via some torrent on the internet. ?You can figure that out for yourselves. ?Just don’t spend the $1600 necessary to buy it — you will prove you aren’t a value investor in the process.
I was asked to participate with 57 other bloggers in a post that was entitled?101 ETF Investing Tips. ?It’s a pretty good article, and I felt the tips numbered?2, 15, 18, 23, 29, 35, 44, 48, 53, 68, 85, 96, and 98 were particularly good, while?10, 39, 40, 45, 65, 67, 74, 77, 80, and 88 should have been omitted. ?The rest were okay.
One consensus finding was that Abnormal Returns was a “go to” site on the internet for finance. ?I think so too.
Below were the answers that I gave to the questions. ?I hope you enjoy them.
1) What is the one piece of advice you?d give to an investor just starting to build a long-term portfolio?
You need to have reasonable goals.? You also have to have enough investing knowledge to know whether advice that you receive is reasonable.? Finally, when you have a reasonable overall plan, you need to stick with it.
2) What is one mistake you see investors make over and over?
They think investment markets are magic. They don?t save/invest anywhere near enough, and they think that somehow magically the markets will bail out their woeful lack of planning.? They also panic and get greedy at the wrong times.
3) In 20 years, _____. (this can be a prediction about anything — investing-related or otherwise)
In 20 years, most long-term public entitlement and private employee benefit schemes that promised fixed payments/reimbursement will be scaled back dramatically, and most retirees will be very disappointed.? The investment math doesn?t work here ? if anything, the politicians were more prone to magical thinking than na?ve investors.
4) Buy-and-hold investing is _____.
Buy-and-hold investing is the second-best strategy that average people can apply to markets, if done with sufficient diversification. It is a simple strategy, available to everyone, and it generally beats the performance of average investors who buy and sell out of greed and panic.
5) One book I wish every investor would read is _____. (note that non-investing books are OK!)
One book I wish every investor would read is the Bible. The Bible eliminates magical thinking, commends hard work and saving, and tells people that their treasure should be in Heaven, and not on Earth.? If you are placing your future hope in a worry-free, well-off retirement, the odds are high that you will be disappointed.? But if you trust in Jesus, He will never leave you nor forsake you.
6) The one site / Twitter account / newsletter that I can?t do without is _____.
Abnormal Returns provides the best summary of the top writing on finance and investing every day.? There is no better place to get your information each day, and it comes from a wide array of sources that you could not find on your own.? Credit Tadas Viskanta for his excellent work.
7) The biggest misconception about investing via ETFs is_____.
The biggest misconception about investing via ETFs is that they are all created equal.? They have different expenses and structures, some of which harm their investors.? Simplicity is best ? read my article, ?The Good ETF? for more.
8 ) Over a 20-year time horizon, I’m bullish on _____. (this can be an asset class, fund, technology, person — anything really!)
Over 20 years, I am bullish on stocks, America, and emerging markets.? Of the developed nations, America has the best combination of attributes to thrive.? The emerging markets offer the best possibility of significant growth.? Stocks may have a rough time in the next five years, but in an environment where demographic and technological change is favoring corporate profits, stocks will do better than other asset classes over 20 years.
9) The one site / Twitter account / newsletter that I can?t do without is _____.
Since you asked twice, the Aleph Blog is one of the best investing blogs on the internet, together with its Twitter feed.? It has written about most of the hard questions on investing in a relatively simple way, and is not generally marketing services to readers.? For the simple stuff, go to the personal finance category at the blog.
10) Any other ETF-related investing tips or advice?
For a fuller view of my ETF-related advice, go to Aleph Blog, and read here.? Briefly, be careful with any ETF that is esoteric, or that you can?t draw a simple diagram to explain how it works.? Also realize that traders of ETFs tend to do worse than those that buy and hold.
I haven’t written about promoted penny stocks in a long time. ?Tonight I am not writing about promoted stocks, only penny stocks as promoted by a newsletter writer. ?He profits from the newsletter. ?Ostensibly, he does not front-run his readers.
Before we go on, let me run the promoted stocks scoreboard:
Ticker
Date of Article
Price @ Article
Price @ 12/1/15
Decline
Annualized
Dead?
GTXO
5/27/2008
2.45
0.011
-99.6%
-51.5%
BONZ
10/22/2009
0.35
0.000
-99.9%
-68.5%
BONU
10/22/2009
0.89
0.000
-100.0%
-100.0%
UTOG
3/30/2011
1.55
0.000
-100.0%
-100.0%
Dead
OBJE
4/29/2011
116.00
0.000
-100.0%
-100.0%
Dead
LSTG
10/5/2011
1.12
0.004
-99.6%
-74.2%
AERN
10/5/2011
0.0770
0.0001
-99.9%
-79.8%
IRYS
3/15/2012
0.261
0.000
-100.0%
-100.0%
Dead
RCGP
3/22/2012
1.47
0.180
-87.8%
-43.4%
STVF
3/28/2012
3.24
0.070
-97.8%
-64.7%
CRCL
5/1/2012
2.22
0.001
-99.9%
-87.2%
ORYN
5/30/2012
0.93
0.001
-99.9%
-85.4%
BRFH
5/30/2012
1.16
1.000
-13.8%
-4.1%
LUXR
6/12/2012
1.59
0.002
-99.9%
-86.3%
IMSC
7/9/2012
1.5
0.495
-67.0%
-27.9%
DIDG
7/18/2012
0.65
0.000
-100.0%
-100.0%
GRPH
11/30/2012
0.8715
0.013
-98.5%
-75.4%
IMNG
12/4/2012
0.76
0.012
-98.4%
-75.0%
ECAU
1/24/2013
1.42
0.000
-100.0%
-94.9%
DPHS
6/3/2013
0.59
0.005
-99.2%
-85.5%
POLR
6/10/2013
5.75
0.005
-99.9%
-94.2%
NORX
6/11/2013
0.91
0.000
-100.0%
-97.5%
ARTH
7/11/2013
1.24
0.245
-80.2%
-49.3%
NAMG
7/25/2013
0.85
0.000
-100.0%
-100.0%
MDDD
12/9/2013
0.79
0.003
-99.7%
-94.5%
TGRO
12/30/2013
1.2
0.012
-99.0%
-90.9%
VEND
2/4/2014
4.34
0.200
-95.4%
-81.6%
HTPG
3/18/2014
0.72
0.003
-99.6%
-95.9%
WSTI
6/27/2014
1.35
0.000
-100.0%
-99.9%
APPG
8/1/2014
1.52
0.000
-100.0%
-99.8%
CDNL
1/20/2015
0.35
0.035
-90.0%
-93.1%
12/1/2015
Median
-99.9%
-87.2%
If you want to lose money, it is hard to do it more consistently than this. ?No winners out of 31, and only one company looks legit at all — Barfresh.
But what of the newsletter writer? ?He seems to have a couple of stylized facts that are misapplied.
Every day, around 45 stocks double or more in price.
Some wealthy investors have bought stocks like these.
Wall Street firms own these stocks but never recommend them to ordinary individuals
The media censors price information about these stocks so you never hear about them
Every day, around 45 stocks double or more in price.
That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. ?Second, the stocks that do double in price can’t be found in advance — i.e., picking the day that the price will explode. ?Third, the prices more often fall hard for these tiny?stocks. ?Of the 30 stocks mentioned above that were not dead at the time of the last article, 10 fell more than 90% over the 10+ month period. ?13 fell less than 90%, 1 broke even, and 7 rose in price. ?The median stock fell 61%. ?This was during a bull market.
Now you might say, “Wait, these are promoted stocks, of course they fell.” ?Only the last one was being actively promoted, so that’s not the answer.
My fourth point is for the few that rise a lot, you can’t invest in them. ?The stocks that double or more in a day tend to be the smallest of the stocks. ?Two of the 30 stocks listed in the scoreboard?rose 900% and 7100% in the 10+ month period since my last article. ?How much could you have invested in those stocks? ?You could have bought both companies for a?little more than?$10,000 each. ?Anyone waving even a couple hundred bucks could make either stock fly.
So, no, these stocks aren’t a road to riches. ?Now the ad has stories as to how much money people made at some point buying the penny stocks. ?The odds of stringing several of these successful purchases in succession, parlaying the money into bigger and bigger stocks that double is remote at best, and your odds of losing a lot of it is high.
This idea is a less classy version of the idea promoted in the book?100 to 1 in the Stock Market. ?If it is difficult to find the 100-baggers 30 years in advance, it is more difficult to find a stock that is going to double or more tomorrow, much less a bunch of them in succession. ?You may as well go to Vegas and bet it all on Double Zero on the roulette wheel four times in a row. ?The odds are about that bad, as trying to get rich buying penny stocks.
The ad also lists three stock that at some point fit his paradigm — MeetMe [MEET],?PlasmaTech Biopharmaceuticals, Inc. (PTBI) which is now called?Abeona Therapeutics Inc. (ABEO), and?Organovo (ONVO). ?All of these are money-losing companies (MeetMe may be breaking into profitability?now) that have survived by selling shares to raise cash. ?The stocks have generally been poor. ?Have they had volatile days where the price doubled? ?At some point, probably, but who could have picked the date in advance, and found liquidity to do a quick in-and-out trade?
The author lists five future situations as a “come on” to get people to subscribe. ?I find them dubious.
As for wealthy investors, he mentions two: Icahn pulling of a short squeeze on Voltari (difficult to generalize from), and Soros with?PlasmaTech Biopharmaceuticals, Inc. ?It should be noted that Soros has a big portfolio with many stocks, and that position was far less than 1% of his assets. ?In general, the wealthy do not buy penny?stocks.
As for brokers and the media not mentioning penny stocks, that is being responsible. ?The brokers could get in hot water for recommending or buying penny stocks even under a weak suitability standard. ?The media also does not want to be blamed for inciting destructive speculation. ?Retail investors lose enough money through uninformed trading, why encourage them to do it where fundamentals are typically quite poor.
I’ve written two other pieces on less liquid stocks to try to explain the market better:?On Penny Stocks and?Good Over-the-Counter ?Pink? Stocks. ?It’s not as if there isn’t value in some of the stocks that “fly under the radar.” ?That said, you have to be extra careful.
Near the end of the ad, the writer describes how he is being extra careful also. ?Many of his rules make a lot of sense. ?That said, following those rules will get you boring companies that won’t double or more in a day. ?And that’s not a bad thing. ?Most significant money is made slowly — it doesn’t come in a year, much less in a day.
That said, I recommend against the newsletter because of the way that it tries to attract people. ?The rhetoric is over the top, and appeals to those who sense conspiracies keeping them from riches, so join my club where I hand out my secret knowledge so you can benefit.
In summary, as a first approximation, don’t invest in penny stocks. ?The odds are against you. ?Fools rush in where angels fear to tread. ?Don’t let greed get the better of you — after all, what is being illustrated is?an illusion that ?retail investors can’t generally achieve.
Investing is difficult. That said, it can be harder still. Let people with little to no training to try to do it for themselves. Sadly, many people get caught in the fear/greed cycle, and show up at the wrong time to buy and/or sell. They get there late, and then their emotions trick them into action. A rational investor would say, ?Okay, I missed that move. Where are opportunities now, if there are any at all??
Investing can be made even more difficult. ?Investing reaches its most challenging level when one relies on his investing to meet an anticipated and repeated need for cash outflows.
Institutional investors will say that portfolio decisions are almost always easier when there is more cash flowing in than flowing out. ?It means that there is one dominant mode of thought: where to invest?new money? ?Some attention will be given to managing existing assets ? pruning away assets with less potential, but the need won?t be as pressing.
1) The retiree doesn?t know how long he, his spouse, and anyone else relying on him will live. ?Averages can be calculated, but particularly with two people, the odds are that at least one will outlive an average life expectancy. ?Can they be conservative enough in their withdrawals that they won?t outlive their assets?
It?s tempting to overspend, and the temptation will get greater when bad events happen that break the budget, whether those are healthcare or other needs. ?It is incredibly difficult to?avoid paying for an immediate pressing need, when the soft cost?is harming your future. ?There is every incentive to say, ?We?ll figure it out later.? ?The odds on that being true will be low.
2) One conservative estimate of what the safe withdrawal rate is on a perpetuity is the yield on the 10-year Treasury Note plus around 1%. ?That additional 1% can be higher after the market has gone through a bear market, and valuations are cheap, and as low as zero near the end of a bull market.
That said, most?people people with discipline want a simple spending rule, and so those that are moderately conservative choose that they can spend 4%/year of their assets. ?At present, if interest rates don?t go lower still, that will likely (60-80% likelihood) work. ?But if income needs are greater than that, the odds of obtaining those yields over the long haul go down dramatically.
3) How does a retiree deal with bear markets, particularly ones that occur early in retirement? ?Can?he and?will he reduce his expenses to reflect the losses? ?On the other side, during bull markets, will he build up a buffer, and not get incautious during seemingly good times?
This is an easy prediction to make, but after the next bear market, look for a scad of ?Our retirement is ruined articles.? ?Look for there to be hearings in Congress that don?t amount to much ? and if they?do amount to much, watch them make things worse by?creating R Bonds, or some similarly bad idea.
Academic risk models typically used by financial planners typically don?t do path-dependent analyses.? The odds of a ruinous situation is far higher than most models estimate because of the need for withdrawals and the autocorrelated nature of returns ? good returns begets good, and bad returns beget bad in the intermediate term.? The odds of at least one large bad streak of returns on risky assets during retirement is high, and few retirees will build up a buffer of slack assets to prepare for that.
4)?Retirees should avoid investing in too many income vehicles; the easiest temptation to give into is to stretch for yield ? it?is the oldest scam in the books. ?This applies to dividend paying common stocks, and stock-like investments like REITs, MLPs, BDCs, etc. ?They have no guaranteed return of principal. ?On the plus side, they may give capital gains if bought at the right time, when they are out of favor, and reducing exposure when everyone is buying them.? Negatively, all junior debt tends to return worse on average than senior debts.? It is the same for equity-like investments used for income investing.
Another easy prediction to make is that junk bonds and non-bond income vehicles will be a large contributor to the shortfall in asset return in the next bear market, because many people are buying them as if they are magic. ?The naive buyers think: all they do is provide a higher income, and there is no increased risk of capital loss.
5) Leaving retirement behind for a moment, consider the asset accumulation process.? Compounding is trickier than it may seem. ?Assets must be selected that will grow their value including dividend payments over a reasonable time horizon, corresponding to a market cycle or so (4-8 years). ?Growth in value should be in excess of that from expanding stock market multiples or falling interest rates, because you want to compound in the future, and low interest rates and high stock market multiples imply that future compounding opportunities are lower.
Thus, in one sense, there is no benefit much from a general rise in values from the stock or bond markets. ?The value of a portfolio may have risen, but at the cost of lower future opportunities. ?This is more ironclad in the bond market, where the cash flow streams are fixed. ?With stocks and other risky investments, there may be some ways to do better.
Retirees should be aware that the actions taken by one member of a large cohort of retirees will be taken by many of them.? This makes risk control more difficult, because many of the assets and services that one would like to buy get bid up because they are scarce.? Often it may be that those that act earliest will do best, and those arriving last will do worst, but that is common to investing in many circumstances.? As Buffett has said, ?What a?wise man?does in the beginning a?fool?does in the?end.?
6) Retirement investors should avoid taking too much?or too little risk. It?s psychologically difficult to buy risk assets when things seem horrible, or sell when everyone else is carefree. ?If a person can do that successfully, he is rare.
What is achievable by many is to maintain a constant risk posture. ?Don?t panic; don?t get greedy ? stick to a moderate asset allocation through the cycles of the markets.
7) With asset allocation, retirees should overweight out-of-favor asset classes that offer above average cashflow yields. ?Estimates on these can be found at GMO or?Research Affiliates. ?They should rebalance into new asset classes when they become cheap.
Another way retirees can succeed would be investing in growth at a reasonable price ? stocks that offer capital growth opportunities at an inexpensive price and a margin of safety. ?These companies or assets need to have large opportunities in front of them that they can reinvest their free cash flow into. ?This is harder to do than it looks. ?More companies look promising and do not perform well than those that do perform well.
Yet another way to enhance returns is value investing: find undervalued companies with a margin of safety that have potential to recover when conditions normalize, or find companies that can convert their resources to a better use that have the willingness to do that. ?After the companies do well, reinvest in new possibilities that have better appreciation potential.
8 ) Many say that the first rule of markets is to avoid losses. ?Here are some methods to remember:
Always seek a margin of safety. ?Look for valuable assets well in excess of debts, governed by the rule of law, and purchased at a bargain price.
For assets that have fallen in price, don?t try to time the bottom ? buy the asset when it rises above its 200-day moving average. This can limit risk, potentially buying when the worst is truly past.
Conservative investors avoid the areas where the hot money is buying and own assets being acquired by patient investors.
9) As assets shrink, what should be liquidated? ?Asset allocation is more difficult than it is described in the textbooks, or in the syllabuses for the CFA Institute or for CFPs.? It is a blend of two things ? when does the investor need the money, and what asset classes offer decent risk adjusted returns looking forward?? The best strategy is forward-looking, and liquidates what has the lowest risk-adjusted future return. ?What is easy is selling assets off from everything proportionally, taking account of tax issues where needed.
Here?s another strategy that?s gotten a little attention lately: stocks are longer assets than bonds, so use bonds to pay for your spending in the early years of your retirement, and initially don?t sell the stocks.? Once the bonds run out, then start selling stocks if the dividend income isn?t enough to live on.
This idea is weak.? If a person followed this in 1997 with a 10-year horizon, their stocks would be worth less in 2008-9, even if they rocket back out to 2014.
Remember again:
You don?t benefit much from a general rise in values from the stock or bond markets. ?The value of your portfolio may have risen, but at the cost of lower future opportunities.
That goes double in the distribution phase. The objective is to convert assets into a stream of income. ?If interest rates are low, as they are now, safe income will be low. ?The same applies to stocks (and things like them) trading at high multiples regardless of what dividends they pay.
Don?t look at current income. ?Look instead at the underlying economics of the business, and how it grows value. ?It is far better to have a growing income stream than a high income stream with low growth potential.
Deciding what to sell is an exercise in asset-liability management.? Keep the assets that offer the best return over the period that they are there to fund future expenses.
10) Will Social Security take a hit out around 2026? ?One interpretation of the law says that once the trust fund gets down to one year?s worth of?payments, future payments may get reduced to the level?sustainable by expected future contributions, which is 73% of expected levels. ?Expect a political firestorm if this becomes a live issue, say for the 2024 Presidential election. ?There will be a bloc of voters to oppose leaving benefits unchanged by increasing Social Security taxes.
Even if benefits last at projected levels longer than 2026, the risk remains that there will be some compromise in the future that might reduce benefits because taxes will not be raised.? This is not as secure as a government bond.
11) Be wary of inflation, but don?t overdo it. ?The retirement of so many people may be deflationary ? after all, look at Japan and Europe so far. ?Economies also work better when there is net growth in the number of workers. ?It will be tempting for policymakers to shrink what liabilities they can shrink through inflation, but there will also be a bloc of voters to oppose that.
Also consider other risks, and how assets may fare. ?Retirees should analyze what exposure they have to:
Deflation and a credit crisis
Expropriation
Regulatory change
Trade wars
Changes in taxes
Asset illiquidity
Reductions in reimbursement from government programs like Medicare, Medicaid, etc.
And more?
12) Retirees need a defender of two against slick guys who will try to cheat them when they are older. ?Those who have assets are a prime target for scams. ?Most of these come dressed in suits: brokers and other investment salesmen with plausible ways to make assets stretch further. ?But there are other scams as well ? retirees should run everything significant past a smart younger person who is skeptical, and knows how to say no when it is necessary.
Conclusion
Some will think this is unduly dour, but this?is realistic. ?There are not enough resources to give all of the Baby Boomers a lush retirement, without unduly harming younger age cohorts, and this is true over most of the developed world, not just the US.
Even with skilled advisers helping, retirees need to be ready for the hard choices that will come up. They should think through them earlier rather than later, and take some actions that will lower future risks.
The basic idea of retirement investing is how to convert present excess income into a robust income stream in retirement. ?Managing a pile of assets for income to live off of is a challenge, and one that most people?are not geared up for, because poor planning and emotional decisions lead to subpar results.
Retirees should?aim for the best future investment opportunities with a margin of safety, and let the retirement income take care of itself. ?After all, they can?t rely on the markets or the policymakers to make income opportunities easy.
Those were back in 2008, before the financial crisis. ?I made similar comments at RealMoney earlier than that, but those are lost and gone forever, and I am dreadful sorry.
1) The first thing to realize is that diversification across insurance subindustries usually does not work.
Do not mix:
Life & P&C
Financial & Anything
Health & Anything
Maybe you can mix P&C, Mortgage & Title, after all Old Republic survived.? The main point is this.? Insurance is not uniform.? Coverages are sold and underwritten differently.? Generally, higher valuations will be obtained on ?pure play? companies? Diversification is swamped by management inability.? These are reasons for AIG and Allstate to spin off their life operations.
2) Middle-sized companies tend to do best from a valuation standpoint: the large have nowhere to grow, and the small are always questionable on their viability.? With a few exceptions, I like sticking with focused mid-cap companies with my insurance names.
Both of these concepts augur in favor of a breakup of AIG — even without the additional capital needed for being a SIFI (which no insurance firm should be, they don’t collapse together, like banks do), large firms get a valuation discount, because they can’t grow quickly.
Synergies and diversification benefits between differing types of insurance tend to be limited as well. ?Focus is worth a lot more in insurance than diversity, because managements are typically not good at multiple types of insurance. ?They have different profit models, distribution systems, capital needs, and mindsets. ?Think of it this way: if you can’t get personal lines agents to sell life insurance and annuities, why do you ever think there might be synergies? ?They are very different businesses.
1) Costs aren’t overly high at AIG, and there may not be a lot to cut. ?Greenberg ran a tight ship, and I suspect those who followed tried to imitate that. ?I would try to double-check cost levels.
2) ROEs are low at AIG likely because many life insurers have low?embedded margins and those?can’t be changed rapidly because of the long duration nature of the contracts. ?The accounting for DAC [deferred acquisition cost]?assets can be liberal at times — writedowns are not required until you are deferring losses. ?I would analyze all intangible assets, and try to estimate what they returning. ?I would also try to look at the valuation of life insurers?comparable to those at AIG, which are high complexity beasties. ?You might find that a breakup won’t release as much value as you think, at least initially.
3) Pure play mortgage insurers are fodder for the next financial crisis. ?If one of those gets spun off, it won’t come at a high valuation, particularly if you give it enough capital to maintain its credit ratings.
4) There are a variety of cross-guarantees across AIG’s subsidiaries. ?I’m assuming Icahn read about those when he looked through the statutory books of AIG. ?That is, if he did do that. ?They are mentioned in the 10K, but not in as much detail. ?Those would probably be the most difficult part of a breakup of AIG, because you would have to replace guarantees with additional capital, which reduces the benefit of breaking the companies up.
Summary
Breaking up AIG would be difficult, but I believe that focused insurance companies with specialist management teams would eventually outperform AIG as it is currently configured. ?Just don’t expect a quick or massive initial benefit from?breaking AIG up.
One final note: it would pay Carl Icahn and all of the others who would be interested in breaking up AIG to hire some insurance expertise. ?Insurance is a set of complex businesses, and few understand most of them, much less all of them. ?It would be easy to naively overestimate the ability to improve profitability at AIG if you don’t know the business,? the accounting, and how free cash flow emerges, if it ever does.
They might also want to have a frank talk with Standard and Poors as to how they would structure a breakup if the operating subsidiaries were to maintain all of their current ratings. ?Icahn and his friends might be surprised at how little value could initially be released, if any.
Before I start on this tonight, let me say that I never begrudge any salesman a fair commission. ?When I was a bond manager, I made a point of never letting my brokers “cross bonds” to me, i.e., at no commission. ?I would raise my purchase price a little to compensate them. ?Had my client known that I did that, he might have objected, but it was in his best interests that I did it. ?As a result of that and other things that I did, my brokers were very loyal to me, and worked to give my client excellent executions whether buying or selling. ?They were also more frank with me about bonds they thought I should sell. ?Fairness begets fairness under most conditions, and suspicion and tightness also have their way of breeding as well. ?Consider that in all of your dealings.
My main reason for writing tonight is to remind investors to think about how the parties you transact with are compensated.
If they are compensated on?transactions, expect to see a lot of buying and selling.
If they are compensated on asset-based fees, expect them to try to get business, and then retain it.
If they are compensated on profits, they will try to get profits. ?Be wary of how much control they might have over the accounting, they will be incented to be liberal if they have any control. ?They will also be incented toward volatility, because volatile assets offer the best possibility of a big score, even if the probability is moderate at best.
The greater the potential compensation, the greater the tendency to act along the incentives offered. ?As a result, if a life insurance salesman has a product offering a high commission, and one offering a low commission, he may act in the following way:
Figure out if you are price-sensitive or not.
Figure out if you are willing to accept a product that has a long surrender charge. ?Long surrender charges lock in business, and allow for high commissions to be paid.
Also analyze how much complexity you are willing to accept — more complex permanent policies and especially ancillary riders are far more profitable because even external actuaries would have a tough time analyzing them.
If you are price-sensitive, bring out the low commission policy that is more competitive.
If you are price-insensitive, bring out the high?commission policy that is less?competitive.
(Note: there are state laws in every state that constrain this behavior for life insurance agents, but it can never be eliminated in entire.)
Now, many agents will act in your interests in spite of their own interests, but some won’t, so be aware. ?Always ask a question like, “This seems expensive. ?Don’t you have another policy that is less expensive that accomplishes only the main goal that I am shooting for?”
You could always ask them what commission is that they will earn. ?Most won’t answer that. ?First, it’s kind of offensive, and second, they will argue that it is not material to your decision.
But it is material to your decision. ?Here’s why:
The size of the commission directly affects the size of the premium that you pay.
It also directly affects?the length and size of the surrender charge that you would pay if you terminate the policy early.
After all, the actuaries or other mathematical businessmen are trying to avoid the risk of paying a commission that they can’t recover under ALL circumstances. ?They will get their fees from you to recoup the commission cost. ?They will either get it from you coming or going, but they WILL?get it from you, at least on average.
If the?salesmen?disagree with you after mentioning this (or showing them this), you can say to them that every actuary knows this is true, don’t argue with the actuaries, they know the math. ?(And its why we tend to buy term and other simple policies. ?Shhh.)
I’ve seen more than my share of ugly products in my time. ?I’m happy I never designed any. ?I did kill a few of them. ?That said, one of the most unpleasant duties I ever had as a life actuary was about 18 years ago when I inherited a department to clean up, and I got the responsibility of talking to the clients that were the most irate, demanding to talk to the man in charge. ?I never created those products, but I was nominally in charge of the division as I cleaned up the pricing, reinsurance, reserving, accounting, and asset-liability management.
I’ll tell you, it is no fun talking to people who conclude that they have been had. ?It is even less fun to be the one who has been had. ?Thus I would tell you to view all salesmen of financial with skepticism. ?It is hard to assure a good result with intangible products that are hard to compare. ?Thus aim for simplicity and lower surrender charge and commission products.
Now, I used life insurance as my example here because I know it best, and it excels in complexity. ?But this applies to all financial products, especially illiquid ones. ?Be wary of:
Brokers who make money off of commissions
Those who sell private REITs and structured notes
Any product where you have a limited ability to liquidate or sell it.
Any product that you can’t understand how the company and salesman are making money off it.
Any product where you can’t understand what the legal form of the investment is (Stock, bond, mutual fund, partnership, derivative, insurance, etc.)
Here are some final bits of advice:
Look for advisers who are fiduciaries, and are responsible to look out for your interests (but still be wary)
Look at the fee structures, and look for lower cost alternatives.
Remember, regardless of what laws exist, you are your own best defender when it comes to your own economic interests. ?Be aware of the economic incentives of those who seek your business with financial products, and be reasonably skeptical.
Take it from an investment actuary. 
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