The Best of Five Years (8): the fading of Bloomberg radio

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #8.

first ESPN…

Over the Thanksgiving holiday my older son pointed out to me that family friend, John Koblin, had written a critical article for Deadspin on how ESPN has gradually lost its journalistic way as it chases television ratings.

The example John focusses on is the network’s apparent obsession with New York Jets football player, Tim Tebow–a legendary college football figure who appears to be the latest in the parade of Heisman Trophy quarterbacks not quite good enough to make it in the NFL.

How is Tebow a continuing story?  ESPN2’s unsuccessful morning show First Take switched format in late 2011.  The new look:  …a staged debate between two cartoonish figures who duel in vintage WWF fashion over some item of sports news.  Their favorite topic:  Tebow.

ESPN discovered that the new First Take was surprisingly popular, even taking audience share away from its mainline morning show, Sportscenter.  It reacted in two ways:

–more phony debates all over the network, complete with loud voices, exaggerated gestures and bombast, and

–Tim Tebow all the time, no matter what the ostensible topic of a given show.

I’m of two minds about this ESPN development.  As a holder of DIS shares I guess I should approve.  As a sports fan, I’ve got to find other sources of sports information and analysis.

…now Bloomberg

Yesterday I was on my way in the car to Delaware and turned on the Bloomberg Radio morning broadcast for the first time in a while.  Five years ago I used to listen every day, either live or through podcasts of important segments.  No longer.  As Bloomberg dialed down the information content and dialed up the reporter self-congratulation I began to look elsewhere.

Anyway, I caught the last part of The First Word, with Ken Prewitt, who strikes me as the only savvy professional journalist left on Bloomberg.  Then came Bloomberg Surveillance, which appears to have had a format tweaking since the last time I listened.  Mr. Prewitt is gone (…or maybe he was just taking a day off from the insanity).  What remains is a veritable First Take of loud voices and self-congratulatory glorification of trivia.

To my mind, this can’t be an accident.  The radio personalities must have been trained, à la ESPN, to speak louder, create fake “debate” and constantly tell the audience how important the topics–and the radio hosts themselves–are.

And, as with First Take, the quest for higher ratings is the most likely explanation, with Fox News and CNBC as the models.  It’s probably also cheaper to simply act as if you’re conveying relevant information rather than to do the research and analysis needed to create it.

The written Bloomberg news appears not to have been infected by this broadcast tendency.  I figure the investment professionals who pay $30,000 a year or more for Bloomberg terminals wouldn’t put up with the stuff that’s now on Bloomberg Radio.

Where is the real financial news today?  It’s in newspapers like the Financial Times  and the Wall Street Journal.  And, like sports, it’s in the blogosphere.

We may mourn the loss of Bloomberg Radio as an information source, and the fact that the search for relevant stock market information is somewhat more difficult without it.  But this also means that insights we may develop are that much more valuable–because they are less likely to have been fully disseminated into the market at the time we figure them out.

Best of Five Years (7): financial markets 2020: an IBM study

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #7.

the survey

Talk about ugly.

In the April 4th issue  of FTfmits review of the fund management industry, the Financial Times outlines the conclusions of an as yet unpublished study by IBM of the investment management industry, Financial Markets 2020.

the findings

FM2000’s bottom line?  …the worldwide investment management industry loses US$1.3 trillion of its clients’ money every year.  That’s over $100 million during the time it takes a fast reader to reach this point in the post.  Wow!!

 

The main offenders?  Here they are, in order of the magnitude of client losses:

—$459 billion        credit rating agencies and sell-side research, because the analysis is weak

—$300 billion        fees paid to underperforming portfolio managers

—$250 billion        fees paid for advisory services that underachieve

—$213 billion         excess expenses caused by investment managers’ organizational inefficiency

—$51 billion           fees paid to underperforming hedge funds.

the conclusions

IBM argues that clients are gradually waking up and smelling the coffee  …and firing the offending service providers, as they work out how bad the performance has been.  The computer giant thinks upward of a third of the people involved in today’s fund management industry will be gone before clients are through with their housecleaning.  Among sell-side researchers and credit rating agency analysts, the winnowing will remove closer to half.

my thoughts

First of all, I haven’t seen the study.  I’m assuming that it’s being accurately portrayed in the FT.

In the nitpicking department, the data seem to have come from an internet survey.  If so, its conclusions represent the input of the respondents, and may not be representative of the views of clients as a whole.   In addition, the numbers are overly (maybe “ludicrously” would be a better word) precise, suggesting inexperience on the part of the IBM Institute for Business Value, which wrote the report.  The assertion that credit rating agencies et al lose their clients $459 billion a year implies the figure is not $45billion or $460 billion.  How could IBM possibly be confident that this is right?

The general direction of the report is doubtless correct, though.  Early in my career as an investor, I remember reading the famous comment by Charles Ellis, the founder of Greenwich Associates, a pension consulting firm, that the average portfolio manager is just that–average.  At the time, I was offended.  Thirty years later, I’d be tempted to amend it to read that the average portfolio manager is just that–a little below average. The credit rating agencies have been notorious for as long as I’ve been in the business for being behind the curve.  And everyone knows, or should know, that brokers make their money by having you trade with them, not by having you achieve superior returns.

I think IBM’s idea that clients will quickly take the axe to many of their investment service providers is much too simplistic.  Yes, chronic underperformance is a big issue.  But there seem to me to be three factors IBM overlooks:

1.  The head of virtually every investment management organization is a highly polished marketer, not an investor.  A big reason for this is that investment firms are not only in the business of selling performance, they also sell intangibles–like feelings of prestige, exclusivity, reliability, safety–especially to individuals.   Some people will hire a hedge fund manager instead of buying a Vanguard index fund (which will likely provide superior returns) for the same reason they buy an $8,000 Hermès leather handbag instead of a $50 nylon equivalent, or a $150,000 Porsche instead of a $30,000 Subaru Impreza.  It’s to exhibit their wealth.  Having your yearly performance review in a major city, with dinner and a show and your favorite flowers in the hotel suite your manager provides may be just as important as the performance figures–maybe more so.

2.  Companies typically don’t want to manage their employees pension money in-house for legal reasons.  Hiring a pension consultant and a series of specialist third-party managers transfers responsibility to them.  Doing so acts as a form of insurance.

3.  Suppose you go ahead and fire all your investment advisors.  What do you do then?  What do you substitute for them?  Maybe losing a trillion dollars a year is good in comparison with the alternatives.

Best of Five Years (6): stock markets in developing countries (lV): what we can do to add value

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #6.

The easiest and safest way to invest in emerging markets is to buy a broad index fund or ETF that covers these markets.  But if you are willing to do some work, there are four things I think you can do to to focus your money on potentially higher return areas.  All contain some risk and require that you not simply buy and forget but continue to monitor your investment regularly.   You may also find yourself limited by your broker’s ability to transact in certain areas (can you buy?  …and, more important, if you change your mind, can you get out)?.

The four are:

1.  focus on healthy countries. Stable, foreigner-friendly, government is the first requirement (leaving out places like Venezuela).  Ideally, the government budget should be balanced, or close to it.   The stock of government debt, as a percentage of GDP, should not be rising rapidly.  The country should generate enough foreign exchange through exports to comfortably cover its foreign debt service.  Imports should be mostly machinery or other items to help build up the country’s industrial base–not consumer items like TVs.  (By the way, on these criteria, except for stable government, the US and the UK would flunk the emerging markets investment test.)

2.  use the export-oriented manufacturing development model. Successful developing countries have, by and large, grown by encouraging technology transfer in support of export-oriented manufacturing.  This means the country invites foreign firms to set up manufacturing bases within the country, so the local workforce can develop their skills.  To do this, the country must offer electric power, communication, fresh water, a road network and ports.  In developing countries, these are all growth industries.

3.  reach in to the developing country indirectly, through a company in a developed market that has, say, a third of its operations in the developing world.  Many western European companies, especially in consumer staples, have subsidiaries in Eastern Europe, for example.  Most former colonial powers have trading companies or telecom firms that still operate in their former colonies.  In addition to the mainland firms listed in Hong Kong, that market also has many property and trading firms with large China exposure.

The advantage to doing this is that you get Western management, whose motivations you can easily understand, plus developing market growth potential.  One thing to watch for, though–old colonial masters may not be A-listers in a former colony.  The old Hong Kong opium firms still controlled by non-Chinese are an example.

4. find an active manager who has a consistent record of beating the index in a given area. The Matthews China Fund comes to mind as an example.  Either on a discount broker website, Morningstar, or the fund group’s website, you can see the historical record.  Make sure the same people who achieved the record are still around, though.

Best of Five Years (5): stock markets in developing countries (lll): “invisible” issues

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #5.

Every market has issues that are often well understood by local investors but not to foreigners.  China found this out a few years ago when a government-related company bid for Unocal, a US oil and gas company whose Pacific Basin reserves it found attractive.  The same for Dubai, when it bought a UK company that held US port operations.  In both cases, Washington vetoed the transactions.

The US isn’t alone in this practice.  Foreigners will find it hard to buy companies in Continental Europe–even EU members may be unable to make acquisitions in neighboring countries.   And Japan has enacted laws over the past ten years that make foreign takeovers all but impossible–as if the informal barriers already in place weren’t enough.

Stock markets in developing countries have these issues, too–but they also have others that are orders of magnitude greater.  They include: Continue reading

Best of Five Years (4): stock markets in developing countries (ll): basic questions

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #4

Anyone who wants to actively select individual country funds or individual stocks in the markets of less developed nations has to consider a number of basic issues, the answers to which investors in developed markets take for granted.  These include:

political stability, or the lay of the land. In most developed countries, politics makes for interesting discussion, but ultimately is not a crucial element in investment success.

Russia, in contrast, jumps out to me as a country where reading the political runes is more important than analyzing the assets or profit growth potential of any particular company and where the government’s attitude to foreign investors can change overnight.  But there are lots of other examples, as well, like: Continue reading

Best of Five Years (3): more on absolute vs. relative performance

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #3.

One of the earlier posts I wrote on this blog had to do with absolute vs. relative performance.  I reread it today and am generally satisfied with what I wrote then.  One exception, though.  I think the post came at the topic from the rather narrow perspective of a professional investor, who is already convinced that the best way–or at least one good way–to achieve absolute performance is to try to achieve relative results.

In this post, I’d like to broaden my discussion of the topic by adding two observations, one psychological, the other economic:

1.  One of the most important of the (many) clichés Wall Street uses is that market turns, especially upturns, come out of nowhere and catch most investors by surprise.  Not only that, but the initial move up can cover a lot of ground in a short time.  Missing this initial surge, so the argument goes, is virtually impossible to recover from.  Brokers typically cite academic studies that the greatest part of the market’s gains over a business cycle come in only about 10% of the trading days.  Be out of the market on those days and you’re toast.

I think there’s something to that argument.  I’d like to add my own twist to it, though.

In my experience, lots of professionals can either tell when the market is getting toppy or when it’s stunningly cheap.  But I don’t know anyone who has been able to do both.  Wall Street is a very gossipy place, so if there were such a person, word would get around–despite the individual’s desire to keep his ability to time the market a secret (so others wouldn’t begin to study his every move and his skill would remain his edge alone).  In addition, just off the top of my head I can think of three former professional acquaintances who “called” the top of the market, one in 1984 and two in 1986, with disastrous results for both them (two were fired) and their clients.

Look at the record of hedge funds, whose aggregate performance failed to match that of the S&P 500 every year since 2003.

Anyway, I think some investors have bearish temperaments and can call tops but not bottoms.  Others, like me, have a bullish cast of mind.  We can call bottoms but not tops.

2.  Assume that we live in a world that’s characterized by:  a) inflation; and b) economic growth.  Each implies that stock prices will tend to rise.

a.  Modern economics comes out of systematic study of the Great Depression of the 1930s.  One of the highest goals of monetary policy around the world is to avoid a recurrence.  In particular, the world wants to avoid a repeat of the deflation that marked that period.

Other than in the case of Japan, which has consistently chosen to have deflation rather than permit structural societal change, the world has been successful in doing so.  Let’s suppose (and fervently pray) that this continues.  What does this mean for stocks?

Stocks are priced in nominal terms, in dollars of the day.  But they represent ownership claims on real assets and business operations.  Inflation means that nominal prices in general are rising.  So there should be a tendency for the nominal value of the corporations whose shares of stock are publicly traded to rise as well.  Ultimately, this should translate into a tendency for stock prices to rise, even in the absence of real economic growth.

b.  But, as an empirical observation, there’s real economic growth all over the place.  The US economy, which has been closer to the caboose of the world economic train than the locomotive, is still 50% larger than it was a decade ago.  New nations have entered world commerce.  We have notebooks, netbooks, tablets, iPhones, iPods, social networking, online shopping, biotech, medical advances–lots of stuff we didn’t have ten years ago.  Why?  …because many people around the world like to build and invent new things.  Publicly traded firms–where else do entrepreneurs get the money they need to grow their companies?–participate very substantially in this growth.

My point is that the path of least resistance for stocks–due to inflation and to real economic growth–is up.

Yes, I believe what I’ve just written is true.  Maybe it’s a cartoon version of the truth, but it’s true.  That’s not really what I’m trying to convey in this post, though.  What I want to say is that professional investors in general opt to try for relative performance rather than absolute because they believe this, too.

Note:  reading this post in 2014, I’m not quite as cheery today as I was back when I originally wrote it.  I’m willing to stick with the general conclusions, but dysfunction in Washington is proving a bigger headwind to growth than I’d imagined.

Best of Five Years (2): absolute vs. relative performance

I’ve been writing Practical Stock Investing for something over five years now.  I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time.  I’m going to re-post ten over the next two weeks.  This will give you a chance to see some of my earlier work that you may have missed.  And I’ll have time for home repairs I’ve been putting off.  I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #2.

absolute performance

Most individual investors judge investing success by asking whether at the end of some standard time period, say, a year, they have more money than they started with or less.  In other words, they judge performance on an absolute standard:  +8% is a good year, -3% is a bad one.

Relative performance

Professional investors normally use a different yardstick.  They, and their customers,  judge their performance by a relative standard.  How has the manager done versus a benchmark index?  How has the investor done in comparison with a universe of his peers?  Looking at performance this way, if the benchmark is the S&P 500 and it’s +10% for the year, then +8% isn’t so hot.

If the client wants a low risk approach and has said, in effect, try to get some outperformance if you can but it’s very important that you not underperform by more than 100 basis points (=1%), then +8% is horrible.  (One might reasonably ask why a client would ever hire an active manager and give him instructions like this, but I’ve seen it done.)  On the other hand, if the client wants a higher risk approach and has hired a manager he thinks will outperform over a market cycle but who will be +/- 400 bp in any given year, then two percentage points under the index isn’t so bad.

Performance vs. peers

Performance vs. peers is a secondary measure that institutional investors use.  Almost always, it’s a weaker criterion than performance vs. the index, especially so in the US.  Here, almost no active manager beats the index.  But one can argue that a manager has at least some skill if he does better than other managers.  There are times, however, when comparison vs. peers serves a very useful function.  For international managers during the Nineties, the “lost decade” for Japan, for example, virtually every manager beat the international EAFE index by underweighting the Japanese market.  So customers began to differentiate performance either by separately analyzing performance vs the index in Japan and in non-Japanese markets or, more commonly (I think) by comparing managers with each other.

Individual investors

Individual investors strike me as wanting the best of both worlds.  They want index-beating performance in the up markets, and also expect to avoid making a loss in the down years.  Hence, the appeal of Bernard Madoff or of hedge funds.  After a good several-year run, the average hedge fund has underperformed the S&P 500 every year from 2003 onward, before completely blowing up in 2008.  We all know the Madoff story.

Gains every year are hard (impossible?) to achieve

Why is absolute return so hard to achieve, apart from holding cash-like instruments like a money market fund or treasury bills (both of which are yielding pretty close to zero at the moment)?  It’s because interest rates change with the business cycle.

Take the case of a 10-year treasury bond.  Suppose you buy one for $1000.  It’s currently yielding about 3%.  So you’ll get a payment of $30 yearly from the treasury and your $1000 back in 2019.  That won’t change, no matter what happens in the economy between now and then.  The 3% yield is more or less determined by the federal funds rate (the overnight lending rate between banks) has been set very close to zero–say, .25%–because the economy is so weak.

Over the next few years, we hope, the economy will get better and the fed funds rate will rise to a more normal 3%.  The yield on a 10-year bond newly issued then will probably be around 6%.  What happens to the price of your bond?  Well, if a yearly payment of $60 plus return of principal at the end of the bond’s life is worth $1000, then our yearly payment of 3% plus return of principal must be worth less.  It’s possible that, in a given year, that the decrease of value of our bond will be greater than the 3% coupon payment we receive.  In other words, we’ll have a loss that year on our investment.

That may not matter so much to us.  We have a guaranteed stream of income and we’ll get all our principal back at the end of ten years.  So our investment objectives are probably all being met.  In fact, if we thought a bout it a little more we might conclude that what we really want is stability of income.    In addition, it may well be that having a temporary loss (short-term volatility) isn’t a particularly important investment objective for most people, even though it is the most common measure of risk used by academics and pension consultants.

Why relative performance?

What makes relative performance, as hard as index outperformance may be to achieve, so popular a way of judging managers?

For one thing, the practical task of management is easier. The question of which stock will likely perform better, AAPL or DELL, is almost entirely about the strengths and weaknesses of the two companies and about the relative valuation of their stocks.  If I’m competing against an index that has DELL in it and I hold AAPL instead, I’ll outperform if AAPL does better, no matter whether they go up or down.  In contrast, the question of whether AAPL will go up or not is also one about the state of the world economies and the direction of currencies and interest rates, among other things.  And in the past year or so, we’ve seen the stock go from about $200 a share down into the $80s, without much change in the underlying company’s results.

It allows managers to specialize.  If a manager runs a health care portfolio or specializes in Pacific Basin stocks, he can presumably develop a depth of knowledge–both about the stocks and about the composition of the index–that will enhance his returns.

Part of the responsibility for portfolio risk shifts back to the client, or at least away from the manager.  In most cases, the client has an advisor–a financial planner, a broker, a pension consultant–who helps make the ultimate decision about where a given manager fits in the client’s overall portfolio.

Another aspect of the last two points is that the manager doesn’t have to coordinate his actions with other portfolio managers, or even understand the risk perameters of the client’s overall holdings.  That’s done by the advisor or the client himself.

This way of operating–multiple managers operating in isolation but coordinated by a third party–got a huge boost from the Employee Retirement Income Security Act (ERISA) of 1974.  By setting more stringent requirements for the professional training and experience of pension managers, ERISA encouraged companies to seek third-party managers for their pension funds.  This gave rise to a bevy of consulting firms to help companies develop asset allocation strategies for their pensions, as well as to help select and monitor third-party investment managers.  The consultants promoted a philosophy of centrally (company + consultant) developed investment plan carried out by a diversified group of highly specialized managers.  As luck would have it, this created a key role, rich in fee income, for the pension consultants themselves.  Companies didn’t mind that much, because they were transferring the risk of underperformance from themselves to the managers and the risk of picking the wrong investment firms to the consultants.  Since managing corporate pensions was an immense growth business for investment companies in the Seventies and the Eighties, the consultant-approved model of highly focused managers became the industry norm.

Individuals and a Hybrid Model

The traditional model for a retiree has had two parts:

–to secure a steady stream of income through a defined benefit pension plan + social security, using an absolute standard for assessing what is good enough; and

–to hedge agains unforseen circumstances, including inflation, by holding equities, whose performance would be judged (if at all) by a relative standard.

This traditional world has been turned upside down in recent years.  But that”s a story for another day–actually it’s the story this blog hopes to tell for some time to come.

Note:  See more recent comments on this topic in my 9/29/10 post.