Category Archives: hedge funds

CalPERS is exiting its hedge fund investments

September 16, 2014 By in hedge funds, Investment firms, Private equity Tags: , , , , , 1 Comment

the CalPERS decision

The California Public Employees Retirement System (CalPERS), the largest public pension system in the US and an early adopter of hedge funds, has announced that it will terminate its entire $4 billion in hedge fund investments over the coming year.

The decision comes after a review of CalPERS’ hedge fund performance by its investment staff following the death from cancer of the organization’s Chief Investment Officer, Joseph Dear.  Mr. Dear, a strong proponent of alternative investments such as hedge funds, took the reins at CalPERS in early 2009.  His appointment came in the wake of a sharp, recession-induced drop in the value of CalPERS’ assets–and as an alternatives-related “pay to play” scandal involving pension consultants and so-called “placement agents” was unfolding (see my post).

The stated reason for the move is that hedge funds are too complex and too high-cost.  Reading between the lines, this seems to me to mean that the hedge funds CalPERS used didn’t provide either the promised diversification or superior returns.  My guess is that the professional staff, who have the best understanding of the products, wanted to act quickly, before a new political appointee could arrive to muddy the waters.

In one sense, the CalPERS move should come as no surprise.  Although there are a small number of hedge funds run by superb investors, the average offering has pretty steadily underperformed the S&P 500 for over a decade.  In addition, the elevated fee structure results in most of what profits there are going to the fund manager, not the client.  These factors call into question the rationale for having made the investments in the first place–to reduce the underfunding of pension plans through superior investment performance, so that higher contributions to the plans by the corporation or government body that sponsors them can be avoided.  The evidence seems to me to be that hedge funds generally make the underfunding problem worse, not better.

On the other hand, it takes a substantial amount of courage to fire managers who have strong local political connections.

investment significance

CalPERS is a trend-setter.  It may well be in this instance, too.  A lot depends on whether the next CIO supports the investment staff decision to end hedge fund exposure or overrides objections.  In the former case, this could signal the gradual return to less speculative trading-oriented, more fundamentally driven securities markets.

 

 

 

Detroit’s city-owned art and alternative investments

July 11, 2014 By in Current Market Thoughts, hedge funds, Investment firms, Private equity Tags: , , , , , , Leave a comment

Late last year, Detroit revealed the results of an estimate by auction house Christies of the value of the city’s art held by the Detroit Institute of Art.  The figure was a range of $464 million – $867 million.  Let’s take the mid-point and call it $650 million.

Yesterday, I saw in the Wall Street Journal a new estimate by Artvest Partners and commissioned by the city that comes in with a range of $2.8 billion – $4.6 billion.  The mid-point here is $3.7 billion.

But wait!   …there’s more.  According to Artvest, if Detroit actually wanted to sell the artwork, it’s only worth $850 million – $1.8 billion.  Mid-point:  $1.3 billion.

OK, which is it—$650 million, $1.3 billion or $3.7 billion?

There is one subtlety.

–The $650 million is the (if you’re not selling) value of the art that the city has bought with its own tax money.  It does not include work donated to the DIA, where there may be strings attached that don’t allow the works to be sold.  (An aside:  there may be a further twist here.  The DIA has presumably either provided donors with appraisals of their gifts’ value, or validated appraisals donors have provided.  In either case, donors will have used these figures, which may be–shall we say, “optimistic”–to claim income tax deductions.  a potential mess that I have no desire to comment further on.)

–The Artvest figures, on the other hand, count everything as salable.

What caught my eye in the WSJ article is the gigantic difference between what the appraiser says the art collection is worth–$3.7 billion–and what it would fetch at auction–about a third of that amount.

What struck me is that this is a lot like the way, in my experience, that the market for illiquid “alternative” assets works.  So the Detroit case gives a rare glimpse into the inner workings of alternative asset valuation.

As in the Detroit case, there’s one value that investors hear about in reports from the management company, and based on which the manager charges his fees.  That, of course, is the $3.7 billion.

The other value is what investors would get if the alternative asset pool were to be liquidated today.  It’s what mutual fund investors would call net asset value, or NAV.  That’s the equivalent of the $1.3 billion.

Yes, part of the reason the actual sales value in the Detroit case is so far below the (I don’t know what to call it) “dream” value of the artwork is the possibility of donor litigation that would freeze assets for protracted periods.  On the other hand, any investor in emerging countries can face similar political difficulties.

Several factors do make the alternative investment case different from Detroit’s:

–in at least some alternative investment situations I’ve seen, the assets are so esoteric that there are few experts other than the asset managers themselves.  So the managers end up doing the asset value appraisals.  If so, I think they’ll tend to find it hard to arrive at a figure that’s not in the rarified air of Artvest’s $3.7 billion.

–the contracts between investors and managers often allow the latter to refuse redemption requests for an extended period, so actual NAV may be a moot point.

–if investors insist on liquidation, asset managers may be able to make a distribution in kind–meaning investors get their proportionate share of the actual assets, not cash.

Institutions will do almost anything to avoid this situation, since they’ll be forced to safeguard and value any assets they receive.  (Early in my career, when Guinness was an independent company, some one there had the crazy idea of paying a dividend in bottles of scotch instead of cash.  This would make portfolio managers like me responsible for valuing and storing the stuff, and presumably eventually selling it, on behalf of my clients.  What a disaster!)

–based on NAV, it’s not 2% of the assets per annum that moves from the investors’ pockets into the managers’.  It’s actually 6%!  Ouch.

As I’m confident you’ve worked out already, I’m not a fan of alternatives.  The risks are hard to get your arms around; information is scanty; and in my view most of the returns go to the managers.  Investors mostly get to dazzle their cocktail party friends with their daring; they lick their wounds in private.

My thoughts aside,for anyone wanting to get a peek under the covers of alternatives, watching the Detroit art case should provide an education.

 

 

 

 

 

thinking (some more) about PIMCO

April 14, 2014 By in Current Market Thoughts, hedge funds, Industry Analysis, Investment firms, Recent Market Action, Trading Tags: , , , , , , , , 1 Comment

Pacific Investment Management Company (PIMCO) built itself into a bond market juggernaut over the past forty+ years, thanks to a soaring bond market, savvy marketing and the superior fixed income management skills of now-septuagenarian Bill Gross.

I’m an admirer of PIMCO’s organizational success.  But, at the same time, I can’t help thinking that the firm’s “New Normal” campaign of the past several years is mostly marketing hype–and wrongheaded, at that.  No matter what the economic or market conditions, the PIMCO conclusion is “Avoid stocks and buy more bonds!!!”  For all but the most risk-averse investors, that’s bad advice.  A first-rank firm should be better than that.

This is not what I want to write about, however.  I just want to declare that I have a vaguely anti-PIMCO point of view.

PIMCO has been having problems recently.  Mr. Gross has been underperforming.  Clients–even long-term clients–have begun to head for the door.  So, too, Mr. Gross’s putative successor, Mohamed El-Erian, who resigned from the firm citing irreconcilable differences between himself and Mr. Gross.  Press reports suggest Mr. Gross had been beating Mr. El-Erian over the head with his lack of actual portfolio management experience as a reason for dismissing his questions and concerns.

Great gossipy stuff   …but not what should concern us as investors.

Mr. El-Erian may not be an accomplished portfolio manager, but that doesn’t mean he isn’t a very shrewd individual.  What would make him a high-profile, high-prestige, high-paying job, instead of just hunkering down, busying himself with his considerable marketing responsibilities and waiting Mr. Gross out?

El-Erian’s decision to leave, I imagine, came when he realized that this strategy wouldn’t work.  Mr. Gross’s behavior wouldn’t change.  And it could well have consequences that would tarnish Mr. El-Erian’s image, as well.  After all, although apparently powerless, he was the co-Chief Investment Officer.

I imagine that because Mr. Gross has had such phenomenal success for so long with an aggressive strategy, he sees no reason to adopt a more conservative approach–even though, intellectually at least, he knows that the great bull market in bonds in the US that rewarded that behavior is over.  So he continues to take extra risk.  But that translates only into extra volatility in today’s world, not extra return.  Think:  Jon Corzine, or any number of prominent hedge fund managers.

Growth stock investors went through a similar existential crisis as the Internet bubble imploded in 2000, so it wouldn’t be surprising to me if this were the case with risk-oriented bond investors today.

 

My point (finally!):  we know about Mr. Gross.  How many invisible clones does he have, however, running banks’ bond trading desks, fixed income hedge funds or private equity operations?  …what fallout will occur as/when underperformance forces all of them to change tack?  Will it be six months of really ugly bond returns?  How much will spill over into the equity markets?

 

 

 

 

 

 

 

 

 

hedge fund manager Seth Klarman’s market warning

March 24, 2014 By in Current Market Thoughts, hedge funds, Strategy Tags: , , , , , , Leave a comment

Seth Klarman’s shareholder letter

Seth Klarman is a value-oriented hedge fund manager who has remained in business for over thirty years and currently had $27 billion under management at the end of 2013.  I don’t know Mr. Klarman, nor am I familiar with his track record.  Nevertheless, it seems to me that thirty+ years of staying alive in a brutally competitive business and $27 billion under management earn you at least a hearing.

Mr. Klarman has made the news recently, as a result of his yearend 2013 letter to investors (I’ve only seen excerpts from the financial press and on other blogs).  In it he cites a long list of warning signals for stock and bond markets.  They include:

–least year’s 30%+ gain in the S&P without a commensurate increase in earnings

–a near-tripling in stock prices from the market low in 2009

–record amounts of margin debt, high IPO activity

–nosebleed valuations for stocks like AMZN, NFLX, TSLA, TWTR…

–all sorts of speculative activity in the bond market, particularly in lower quality securities like junk bonds.

All these worrisome developments are the unfortunate consequences of a “Truman Show” environment orchestrated by the Fed in the aftermath of the financial collapse in 2008.

Mr. Klarman underlines his concern about the current state of Wall Street by informing clients that he will be returning (this has apparently already happened) a total of $4 billion of their money to them–forgoing a large chunk of annual management fees.  If press reports are correct, Klarman has been running with 50% of his assets in cash and feels he can find nothing at today’s prices to buy.  (In addition, if he is charging a management fee of 2% of assets (+ some percentage of profits), the big cash holding is clipping 1% yearly off his net return.)

a little arithmetic

As of December 31st, Mr. Klarman’s hedge fund held 4.9% of the outstanding shares of Micron Technology (MU).  That’s after selling 20% of his holding during the December quarter.  MU made up 32% of his publicly traded equity exposure at yearend  …meaning his entire equity holding was about $3.8 billion on January 1st.  This implies his non-equity exposure must have been just under $10 billion.  So the stock market is the least of his professional worries.  The bond market is his biggest potential risk.

his big concern

It’s the same as everyone else’s–can the Fed withdraw the excessive monetary stimulus that he believes to be (me, too) the root cause of the high degree of speculative activity without causing a great deal of direct damage to global fixed income markets and a lot of further collateral damage to stocks?

It’s not surprising that a traditional value investor would be having difficulty finding stocks to buy in today’s market.  After all, stocks in general have almost tripled from the lows, with left-for-dead deep value names having done far better.  MU, for example, is up by 10x from its late-2008 low.

In addition, in every market cycle, value works best in the early years.  Than growth takes over.  On top of that, I think that in the post-Internet world traditional value investing will work progressively less well as time goes on.

mine

It’s not what Mr. Klarman is saying.  It’s that I’m not ignoring it in the way I would have a year ago.

More tomorrow.

 

 

 

 

breaking companies apart: the cons

February 10, 2014 By in activist invstors, economics, hedge funds, Portfolio management Tags: , , , , , , 3 Comments

Many times, separating a conglomerate into its component parts creates value.  Sometimes, it can produce enormous gains.  Spinoffs of corporate stepchildren are often particularly lucrative.  Take Coach (COH) for instance.  Its stock rose by 40x in the first five   years after it was spun off, unloved and starved for expansion capital, from Sara Lee.

There are other instances, however, where breakup can be disastrous.  This may not be evident at first in the stock price action of the separate components, but the ultimate bad news can happen in a number of ways:

1.  Onerous corporate liabilities–debt, lawsuit liabilities, incompetent executives…may all be shunted into one of the new parts, which is more or less designed to fail.  No one will say this, of course.

The first place to look for this kind of imbalance is in the part where the CEO and other top executives aren’t going.  Often, executives in the disfavored part of the split will be so excited to finally be the top dog that they’re delusional about their ability to deal with the negatives they’re being loaded down with.  After all, Davy Crockett might have survived the Alamo if he’d been a step quicker;  the Donner party might have gotten through those mountains…

2.  Sometimes a proposed split will end up forcing apart two businesses which need each other to be successful.  In the current hedge fund era, when individuals with little operating experience can wield large amounts of financial capital, this is a particular danger.  Activists. for example, have wanted Target (TGT) to sell/divest its credit card operations a couple of years ago.  Yes, TGT would receive a large one-time payment, and its stock would probably go up.  But its credit-related operating costs would rise.  And the company would have lost the considerable “Big Data” advantage that it gets from being able to see all the credit transactions of its cardholders–not merely transactions done at Target stores.

I think the current talk of splitting up Microsoft (MSFT) is well worth monitoring in this regard.  Sure, spin off  the consumer device business.  To my mind, though, splitting Windows, Office and the cloud from one another is just asking for trouble.

3.  Another issue that has emerged in recent years–the activists may be bunglers.  Look at J C Penney (JCP).  Activists correctly saw that JCP was crediting profits it got from its control of valuable real estate to its retailing operations.  That covered up the true weakness of the company’s retail offering.  But their attempt to “fix” retailing before breaking up the company went horribly awry.  Worse, they persisted in their mistaken direction so long that they created a downward spiral the company has yet to pull out of.  The stock, which some speculated could be worth $50 a share, has dropped from around $30 to $5 or so as a result of their “stewardship.”