Monthly Archives: December 2014

a bad year in the US for active equity managers

December 24, 2014 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management Tags: , , , , , Leave a comment

Too much traffic and too much last-minute bricks-and-mortar shopping mean that I’m only getting around to this post late in the day   ..and that this one will be short.

 

Reports I’ve been reading over the past month or so say that 2014 will turn out to be a very bad year for active equity managers, in two senses:

–a larger proportion of managers than normal are underperforming their benchmarks.  The figure I’ve heard tossed about is a whopping 85% vs. a more “normal” 65%;.  Also,

–the degree of underperformance is more severe than in typical years.

I’m assuming that the 85% is before fees.  The ideas that underperformance is worse across the board than normal suggests that the number of underperformers before fees could be as high as 75% – 80%.

Two questions:

–since investing is a zero-sum game, whose pockets are filling up with the money active professional managers are losing to the index?

–wha makes this year so different?

Since index funds by definition neither win nor lose vs. the index, the underperformance of professionals must end up either as fee income for middlemen (brokers, marketmakers) or dor investors who don’t publicize their returns.  The largest portion of the latter class is individuals, although I find it hard to believe that you and I are beating the index by enough to make such a big dent in professionals’ results.  On the other hand, I have no better answer.

The second point is more interesting, I think.  On a sector basis, I suspect that professionals had too little IT and too much Energy.  2014 has been a recovery year for large-cap last-generation tech like MSFT (+28%) and INTC (+44%).  AAPL, which makes up 3.5% or so of the S&P is up almost 40%, as well.  Not having these names would have been costly.  As to Energy, it’s possible that many pros bet heavily on rising crude oil prices through offshore drilling companies and unconventional oil sources like tar sands and shale oil–all of which would make the holder exceptionally vulnerable to price declines.

ln my strategy posts, I suggested that, because 2015 would be the first year in a long time in which government policy would not be clearly stimulative around the globe, the fundamental question of whether the near-term market direction will be up or down won’t obviously be “UP” for the first time since early 2009. Not knowing in advance whether to be aggressive or defensive would make portfolio structuring that much more difficult.

In hindsight, maybe the first year of no one-way bet has been 2014.  If so, it’s possible that this year’s performance by pros isn’t the outlier.  Maybe 2010-13 are.  I wonder, in other words, if this year’s poor active manager performance is a harbinger of what the future has in store.

More on this topic after Christmas.  Now to present wrapping.

HAPPY HOLIDAYS!!!

St. Gobain and Sika: are there implications for the US?

December 23, 2014 By in family owned companies, mergers and acquisitions, Recent Market Action, securities markets, stock market Tags: , , , , , Leave a comment

The French building materials company St Gobain recently agreed to acquire control of a Swiss adhesive and sealant firm, Sika, for SF2.8 billion (US$2.8 billion).  The move has caused quite an uproar in Switzerland.

The issue isn’t the purchase itself.  It’s that Sika has two classes of stock:  shares (Namenaktien) held by descendants of the firm’s founder represent 16% of those outstanding, but 52% of the voting rights.  St. Gobain is buying out the family at a very large premium. But it has no intention of buying in the publicly held shares (Inhaberaktien)   …which have lost about a quarter of their stock market value since the acquisition was announced.

Another day in the life of holders of an inferior security in Europe.

 

What’s most interesting to me about this transaction is that it’s being offered as a cautionary tale for holders of shares in US internet companies like Google, Facebook…which also have a number of classes of stock, with voting control held by the founders.

 

While a repeat of the Sika experience might in theory occur in US social media, I can see three factors that argue against this:

1.  St. Gobain/Sika is a case of a large company swallowing a smaller one.  The US internet companies with voting control by insiders are by and large already whales.  Who’s big enough to be the buyer?

2.  In my experience, obtaining operational control either through a large minority interest or a small majority–and without the possibility of tax consolidation–is a particularly European phenomenon.  US firms typically strive for at least 80% ownership, which allows funds to pass between parent and subsidiary without triggering a tax bill.

3.  This is an especially nasty sellout of minority shareholders in Sika by the controlling Berkard family.  Perfectly legal perhaps, and a possibility minority shareholders should have contemplated before buying, but nasty nonetheless.   For a firm that makes industrial forms of glue, there’s not likely to be significant negative fallout for the business.  In the case of GOOG or FB, treating loyal user/shareholders this poorly would be bound to have severe negative business consequences.

 

’tis the season to be jolly, but…

December 22, 2014 By in Information for investors, Portfolio management, Securities regulation, the SEC Tags: , , , , 1 Comment

At the end of last week I wrote a bit about one of my pet peeves, the inconsistent way in which the SEC treats inside information.  As one of my former colleagues, an SEC investigator hired by my employer at that time to advise analysts and portfolio managers how to stay on the right side of the law, once told me, “Inside information is whatever the SEC decides it is on a given day.  The cardinal rule is never to do anything that catches the SEC’s attention.”

Not very helpful counsel, is it?    …although it does accurately describe the Eliot Spitzer school of law enforcement.

Don’t get me wrong.  Honest professional investors don’t want inside information.  It taints their own research efforts and prevents them from trading on hard-won insights.  And I applaud the SEC’s efforts to shut down peddlers of stolen company information and the people who buy it from them.  What I don’t like–and what may be changing now–is the inability by the SEC so far to separate legitimate research from theft.

a second peeve

On now to my second pet peeve…selective release of information by publicly traded companies.  Yes, it still goes on, despite the fact that Regulation FD is supposed to have made this practice illegal.

Again, I’m all for a level playing field.  And I’ll admit that when I was a large shareholder by virtue of representing my money management clients I didn’t worry too much about how companies treated the average individual investor.

Even in those days, however, I saw the tremendous preference that long-established companies gave to brokerage house analysts.  Many held private meetings for sell-side analysts only (owners of the company’s stock excluded) in which they provided detailed descriptions of their operations and offered informal access between sessions and over lunch/dinner to top technical and management employees.  This still occurs (Adobe has a similar kind of get-together that everyone can come to.  It costs $1,500 or so, however, which is probably what it costs ADM+BE to host the function and which is fine with me.).

Waht bothers me is that the firms in question givelots of  important information to brokers, that brokers turn around and charge me to get.  So I’m an owner and the only way I can obtain data about my company is to be forced to pay for it from a third party.  That’s crazy. Sometimes, too, the message gets garbled in the retelling.  At least have a broadcast of the proceedings on the company website.

Since I’ve retired I’ve also found that the Investor Relations and Public Relations departments of older, stodgier firms are much less responsive to my requests for information than they were when I ran large portfolios.  Now they sometimes ignore my repeated phone calls or emails, whether I identify myself as a shareholder, an analyst in a (small) money management firm, or a financial blogger.  Either that or they respond with a big time lag.

In a way, this lack of response is valuable information in itself.   Big, stodgy, unresponsive to owners = stay away.  In cases when new management comes in to shake up the walking dead, this is a sure sign that the turnaround hasn’t gotten as far as top management thinks.

On the other hand, I’ve also had many enjoyable conversation with CFOs or CEOs of mid-sized companies who, to my mind, get it that the idea of responsibility to their owners isn’t simply a legal fiction.  My experience is that firms of this sort tend to do better in a fast-changing world.

the December 2014 FOMC

December 19, 2014 By in Federal Reserve, Portfolio management, Recent Market Action, Strategy Tags: , , , , , Leave a comment

The US stock market has rallied strongly since the Fed released a statement from its Federal Open Market Committee meeting on Tuesday-Wednesday and Chairperson Janet Yellen had her accompanying press conference.

The broad picture:

In October, the Fed ended a long period of continually upping the level of monetary stimulation of the US economy.  It is still in a period of applying extreme stimulation but is no longer increasing the amount.  And it is now starting to focus on the nuts and bolts of how to begin to wean the economy from excessive monetary stimulus, a process the Fed envisions will take several years.

Janet Yellen’s main points:

–there’s no set timetable for withdrawing excess stimulus.  The process consists in gradually raising the Fed Funds rate for overnight money from the current zero to a normal level of 3%+.  Most FOMC members think the first rate rise should come during 2015, but the Fed is prepared to slow down the process if the economy is weaker than expected, and vice versa.

Wall Street fears that the Fed will willy-nilly raise rates according to a predetermined formula and without regard to economic conditions is completely misplaced.  The Fed will be patient in this process (the Fed estimate of where Fed Funds will be at the end of 2015 continues to come down and is now at 1.15%; speculation is that the figure Ms. Yellen has in mind is lower).  The major goal is not to disrupt growth.

–inflation is not a current problem.  The Fed has been trying hard with every tool in its arsenal to create conditions where inflation is a possibility for six years without much success.  The Fed did say that it expects inflation will only gradually rise toward its 2% target.  Wall Street fears of runaway inflation are unrealistic.

–deflation isn’t a concern, either.   Investors worried about deflation are making the rookie mistake of confusing headline inflation figures, which contain lots of transitory elements, with core inflation–which is what really counts and which is steady at somewhat under 2%.

–lower oil prices are a net plus for the US, because the country is still a large oil importer.  A Russian recession is more a trouble for the EU than the US.  US trade with Russia is very small; US holdings of Russian portfolio and capital assets are tiny.

Other than its comments about oil, almost nothing the Fed said breaks new ground.  Given the tragic example of Japan’s mistaken attempts to remove economic stimulus too soon, it’s not surprising that the Fed said it will not repeat them here.  The main takeaway from the meeting statement/press conference is that the Fed said this explicitly and in detail, leaving little for the Wall Street rumor mill to worry about.

Russia as the new Malaysia?

December 18, 2014 By in Portfolio management, Recent Market Action Tags: , , , , , , 1 Comment

To me, what made Malaysia noteworthy during the Asian financial crisis of the late 1990s was how vigorously the country defended the interests of a small cadre of insiders who had amassed mega-fortunes over the prior decade or more.  Political connections + aggressive use of financial leverage–after all, what local bank would deny them a loan?–were the keys to  their success. In the end, Kuala Lumpur imposed capital controls lasting about a year to prevent foreigners from selling assets and withdrawing the funds from the country.  That action gave Malaysian financial markets a long-lasting black eye, something that could have been avoided if Malaysia had chosen to raise interest rates to achieve the same end instead.  But doing so would have bought down more than one of the local moguls.

In current crisis among oil-producing countries, Russia is already taking the first step down the Malaysian path.  Last week Moscow orchestrated a $11+ billion sale of bonds by oil giant Rosneft.  The issue had a coupon below that of government debt.  It was reportedly taken up mostly  (entirely?) by state-owned banks.  The central bank promptly declared itself willing to accept the bonds as collateral for loans to be made at rates below the bond coupons.  Indirectly, then, the funds Rosneft raised come from the Russian equivalent of the Fed.

That President Putin should protect his cronies shouldn’t come as any surprise.  But if this is a chief aim of his government, which it appears to be,  investors have to at least consider the possibility that Moscow may be forced to impose capital controls at some point.  For you and me, this implies checking to make sure we know what exposure we may have through emerging markets or yield-hungry fixed income funds/ETFs.