Category Archives: hedge funds

how are your mutual funds doing?

June 4, 2013 By in Constructing a Portfolio, Getting financial advice, hedge funds, index funds, Portfolio management, securities markets Tags: , , , , , , , Leave a comment

the SPIVA scorecard:  index funds rule!

Standard and Poors did a major overhaul of its website a while ago.  I’d been delaying getting familiar with the new layout while the old site still held the information I usually look for.  But S&P shut down the old page with monthly performance on it, and I was forced to move too.  I eventually found the performance data, but while I was poking around, I also stumbled across a SPIVA (S&P Indices Versus Active Funds) Scorecard report for yearend 2012.

The scorecard tally?  …about what you’d expect.

Over the three-year period 2010-2012 (all bull market) and the five-year period 2008-2012 (includes both bear and bull periods), the typical equity fund and thee typical bond fund underperformed its benchmark index.

Three exceptions:

–the median small-cap international fund outperformed its benchmark.  This is a small category, however, and all the outperformance seems to have come from having a rip-roaring 2013.

–the median large-cap value fund also outperformed.  Unfortunately, the S&P 500 Value index lagged the S&P by an average of 180 basis points a year over the past half-decade.  Actively-managed large cap value funds performed more or less in line with growth-oriented funds and “core” funds that compete against the plain-vanilla S&P 500 rather than a style-tilted version.

–investment-grade intermediate bond fund managers outperformed as well.  But, like the value equity managers, they had the weakest benchmark.

fewer funds

Over the past five years, almost 27% of the domestic equity funds either merged with other funds or simply liquidated.  23% of international equity funds did the same, as did 18% of fixed income funds.  These were presumably the ones with the worst performance records–the fund industry burying its dead, as it were.  That’s also a huge percentage.

why hire an active manager?  why not index?

For almost everyone, in my view, indexing is the way to go.  It’s the cheapest.  Because your focus on getting exposure to the asset class (stocks) at the lowest possible cost, fewer things can go wrong.  This means less time, effort and skill needed on your part to monitor this part of your overall portfolio.

Why don’t more people index?

–It’s kind of boring.  Just look for the biggest index fund (it’s Vanguard).  It’ll have the lowest costs and the most faithful mirroring of the index.  And you’re done.

–Some people have motives other than making money for being in the stock market.  Some actually like risk for its own sake, believe it or not.  Others want to feel special or be the center of attention at parties.  They likely also want the $200 oil change at the Mercedes dealer (where you get coffee and a bagel, too), not the $30 deal at Jiffy Lube.

–Many financial advisers dislike index funds.

There are typically no trailing commissions (recurring payments from the fund management company while a client continues to hold the fund).  No information seminars or reward meetings, either.

Suppose I’m your adviser and I say, “Let’s take the $1 million you’re allocating to stocks and put it in the Vanguard S&P 500 index fund.  We’ll leave it there forever.  By the way, I’m charging you $1,000 a month ($2,000?), again for ever, for this advice.”  At some point, you’re going to baulk.

More than that, because they charge high fees, actively-managed fund complexes have big marketing budgets.  And, unless they have a huge indexing operation, they don’t have cost-competitive index products.  So almost all the ads you see are for active management.  A lot of them air on financial news shows on cable.  Fat chance the talking heads will tout indexing.

one consolation for holders of actively managed funds

At least they’re not hedge funds, which continue their decade-long record of underperformance of traditional equity managers.

Quantum Partners, the George Soros investment vehicle, has acquired 7.9% of JCP

April 26, 2013 By in Current Market Thoughts, hedge funds, Stock ideas Tags: , , , , , , , , 1 Comment

the filing

Yesterday, Soros Investment Management LLC, the manager of the Cayman Islands-based Quantum Partners, filed a Schedule 13-g with the SEC.  It declares Quantum now owns 17.4 million shares, or 7.9% of the outstanding shares, of J. C. Penney (JCP) common stock.

What does this mean?

the basics

An institutional investor is required to file a Schedule 13-g within 10 days after having acquired 5% of a company’s common stock.  Soros IM crossed that threshold on April 15th.  It must make follow-up filings whenever it brings its stake up or down by .5% of the outstanding.  The disclosure requirement ends when the holding falls below 5.0%.  Mutual funds do this all the time.

The 13-g differs from Schedule 13-d, which is filed by basically anyone other than a portfolio investor.  That schedule requires the filer to state his intentions–for example, to obtain control of the company, or to take an active part in its management.  The 13-g requires no such declaration, because the presumption is that the portfolio manager has no such intentions.

Assuming his contracts with his clients permit, the filer can always change his mind, however.  He signals this by filing a 13-d.

what we can conclude

I think the conclusion the financial press has drawn that Soros IM is a purely passive investor is unjustified.  The firm is that for now, but it can always alter its stance simply by filing a 13-d.

The stake represents and investment of about $250 million.

It’s unclear whether Soros is finished buying.  Usually, investors amassing a large stake in a publicly-traded company accumulate as much as they can without attracting attention during the ten days of anonymity they have after they hit the 5% mark.  Presumably the 17.4 million shares represents the Soros IM holding as of yesterday.  If so, we won’t know for about two weeks whether he’s continuing to purchase shares in significant amounts.

Importantly, if–as the filing states–the Soros stake represents 7.9% of JCP’s shares, this means the total outstanding must be 219.8 million shares, more or less.  This is the same number listed in the 10-k as outstanding on February 2nd, the end of the latest fiscal year.  In other words, Soros has bought its stake on the open market, not from JCP.  Therefore, JCP is not getting a cash infusion from Soros IM.  The money went to existing shareholders who are cashing out.  JCP still needs to raise money from outside sources.

does the move help JCP?

Arguably, JCP would have been best off if Soros IM had bought new shares from JCP, instead of already existing shares on Wall Street.  That way the quarter-billion dollars would have gone into Penney’s bank account.

Maybe Soros IM tried to buy shares from the company and was rebuffed.  More likely, in my view, Soros IM concluded it should seize the moment and buy while the stock price was weak.  Soros IM may well also be willing to be a buyer in any future securities offering JCP may make.  On the other hand, Soros IM has a very useful block of stock that could be sold to a new activist eager to enter the picture.

The Soros IM move consolidates the ownership of JCP further.  On the one hand, the probably makes it easier to obtain a majority vote.  On the other, it could end up adding another big ego to the boardroom.

the Soros record?

Are the Soros IM portfolio managers good stock pickers?  Is their purchase of JCP a sign that the company is a significant bargain.

I don’t know.

Most of what I know about George Soros comes from his 1987 book, The Alchemy of Finance. It’s a combination of a statement of his general investing principle (which he calls reflexivity) and a long account of his day-by-day musings about the financial markets.   I could only make it about halfway through.

Two things struck me, though:

–Mr. Soros included on the inside covers a multi-year performance record.  It consists of short periods of daring and brilliantly successful currency speculation–and long periods of continuing equity underperformance.

–the second is a petty point, but apparently not one that’s beneath me.  In the book Soros outlines his principle of reflexivity.  He calls it his original contribution to Western philosophical thought, which he put to use in financial markets after developing it as an abstract philosophical concept.  I was stunned when I read this.  Reflexivity is actually the dialectical method Hegel put forth in the early nineteenth century (take the famous description of the  evolving and reversing relationship between master and slave in the Phenomenology of Mind, for example).  These ideas were later applied to economics by Hegel’s follower Karl Marx.  Is it possible that, although he calls himself a philosopher and was educated in Europe, Soros just wasn’t aware of the most influential European thinker of the nineteenth century?  Or is he the master salesman, who figures no one will know?

Either way, not much to inspire confidence.

To the JCP point, my guess is that at the age of 82 Mr. Soros no longer plays the leading role in Soros IM investment decisions.  While I personally would hesitate to ride on Mr. Soros’s coattails, despite his fame, it’s unclear to me who exactly had the inspiration behind the JCP purchase.

My bottom line:  JCP now has what amounts to a celebrity endorsement.  It’s from a party whose stock-picking prowess is unclear and who, at least for the moment, is a passive investor.  Were Soros IM clearly supportive of Mr. Ackman et al–according to the New York Times, the two parties have offices in the same building–it would have bought its shares directly from JCP, in my opinion.

Therefore, the stake is potentially destabilizing, even though the filing of a 13-g implied no present activist intentions on Soros’s part.  One positive scenario for third-party shareholders would be if the Soros presence somehow triggered a struggle for control of JCP that drove the stock price higher.  The worst case would be if JCP depleted its cash in buying Soros out.

Personally, I’m going to watch from the sidelines.

 

what do gold and AAPL have in common?

April 22, 2013 By in Gold, hedge funds, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , , 1 Comment

common factors

–they’re both large positive bets (large holdings) of hedge funds–and of many retail investors

–both have delivered weak performance over the past year, after extended periods of substantial gains.  And the losses have occurred during a time of generally stable conditions for the world economy, with ample liquidity and strong inflows of money into financial products

–recent trading in both seems to me to be giving signs of forced or distressed selling

are these factors connected?  

It’s hard to know, since global hedge fund disclosure is incomplete–and there’s ample evidence that what disclosure there is can’t be relied on.  However, I think it’s reasonable to assume they are.

if so, what does this imply?

In my experience, a professional investor goes through a three-step process as he realizes he’s made a mistake–or that his previously good idea is no longer working.  He:

–stops adding to the position when new money comes in, effectively shrinking its relative size,

–begins to sell, to further lessen the negative effect of the position on performance, and

–accelerates the selling when the position is small enough the extra visibility and extra downward pressure on price make little difference.

A professional investor can go through these states in the blink of an eye, or it can take a long period of time. A lot depends on style, self-awareness and how ugly the underperformance is.  Anyone who operates on margin may also get additional feedback from his lenders.

Many retail investors, in my experience, just panic–very close to the bottom.

Recent price action in gold and in AAPL strike me as Stage-Three end-game activity–some combination of panic, response to margin calls and/or dumping of the remainders of positions being sold over long periods.

is this an opportunity to buy?

gold: 

For me, the answer here is easy.  It’s “No.”  The key supply-demand issue is whether central banks in emerging markets will continue to buy gold in the aggressive way they have done over the past several years.  I have no idea.  So I’m clearly the “dumb money” in this arena–the strongest reason there is to stay away.

AAPL:

We’ll have more information tomorrow, after AAPL reports its latest quarterly earnings.

The stock is now trading at less than 9x historic earnings and yielding 2.7%.  The shares have underperformed the S&P 500 by more than 50 percentage points since last September.

The company has no debt and its cash holdings are approaching almost half the market cap.

If there’s anything “wrong” with the stock, it’s that its fall from grace has been so extreme.  That prompts the question, “What must sellers know that I don’t?”

How do you overcome aversion, based on an extended decline, to a stock that looks like a $100 bill lying on the street?  The first step, I think, is to look for signs that the waves of selling that have pummeled AAPL are over.   This means having AAPL announce bad news and have the stock go up, rather than sell of further.  That’s why tomorrow’s earnings report may be important.

.

Einhorn stops Apple (APPL) shareholder vote on preferred stock

February 25, 2013 By in hedge funds, Preferred Stock, Recent Market Action, Stock ideas Tags: , , , , , , , , , , Leave a comment

background

Hedge fund manager David Einhorn has been urging AAPL for some time to adopt his pet idea of issuing preferred stock that would basically be backed by the company’s gigantic accumulated cash position.

APPL isn’t interested.

In the Steve Jobs days, I think the AAPL CEO would have told Mr. Einhorn, either directly or through the press, that his answer was “No!!,” and that Einhorn should stop trying to interfere with the running of AAPL’s business.  This probably would have been the end of the matter.

The current AAPL management didn’t do that.  Instead, it put on the agenda at the company’s annual meeting this week a shareholder vote to change the company’s charter in a way that would forbid the kind of perpetual preferred Einhorn is championing (see my analysis of the preferred idea).

Not only that, but AAPL wrapped this proposal in a package of others and asked for a single vote on the whole bundle.

last week

Mr. Einhorn sued, saying in effect that the bundling violates both common sense and SEC rules.  On Friday, a federal judge agreed–and barred a vote on “Proposal #2” at this annual meeting.

According to the Financial Times, by the time of the court ruling AAPL had received ballots representing 40% of the outstanding shares.  Of them, 97.5% had voted for the company and, by implication, against Mr. Einhorn.

the voting results are no surprise

In my experience, individual shareholders vote with management no matter whether it’s in their economic interest or not.  Hard for me to understand, but easy to predict.

For almost two decades, the SEC has been pushing the compliance departments of professional money managers on proxy voting.  The regulator wants them to take seriously their fiduciary obligation to vote the shares under their stewardship in the best interests of their customers–or else.  This pressure has resulted in the rise of third-party firms like ISS and Glass Lewis, which have set themselves up as independent experts in proxy analysis and making shareholder-friendly voting recommendations.  The path of least resistance for institutional investors seems to me to be to subscribe to  one of these firms’ services and vote accordingly.

Both ISS and GL recommended voting for AAPL in this matter.

In other words, all the individuals and all the traditional institutions were going to vote against Einhorn.

why a vote at all?   …and why this vote?

Mr. Einhorn points out on the Greenlight Capital website that because no one has tried his preferred suggestion, that doesn’t mean it’s a bad idea.  Of course, it doesn’t mean it’s a good one either  …or a good one for AAPL.

What’s clear, however, is that AAPL doesn’t want to discuss the idea publicly–even to say that it’s a thought, but one that won’t work for AAPL.  I think this is a mistake.

I think I understand why AAPL set up the vote as a bundle, though, rather than a straight yes-or-no on the preferred issue alone.  From my common sense viewpoint, as well as from an SEC perspective, grouping a bunch of disparate proposals together just doesn’t seem fair.  (In addition, for what it’s worth, I don’t see how narrowing the scope of possible future preferred issues serves shareholders interests.  It just makes Mr. Einhorn go away.)

Why bundle?  AAPL must know that institutions pretty much vote whatever way ISS tells them.  I think AAPL presented the preferred proposal to the advisory service in a package that it simply couldn’t recommend voting against.  It thereby also avoided the risk that if the preferred ban were offered separately ISS would recommend a “no” vote, which a ton of institutional holders would then cast.

AAPL management hasn’t done itself any favors, 

…in my view.

The company’s unwillingness to lay out reasons–like that the preferreds might constrain needed US-sourced cash flow–for opposing the Einhorn proposal make management look weak.

The bundling makes the company look like it has something to hide.

AAPL’s odd behavior suggests there’s considerably more to this story than meets the eye.

the future of professional investment research unfolding

June 13, 2012 By in hedge funds, Industry Analysis, Investment firms, securities markets, stock market Tags: , , , , , , Leave a comment

brokers’ post-recession adjustments…

It doesn’t seem that long ago that Guy Moszkowski, top-ranked analyst of brokerage house stocks on Wall Street, shocked his colleagues by leaving Salomon for Merrill.  This was during one of Merrill’s on-again, off-again attempts to build a competent research effort to complement its powerful Thundering Herd sales force.

Don’t get me wrong.  There are excellent analysts at Merrill.  But my take on the firm is that its heart has always been in sales.  Its attitude is that three so-so analysts are a better use of the firm’s money than one research star.

Mr. Moszkowski is now leaving Merrill, according to the Wall Street Journal.  Where is he going?   …to Autonomous Research, a UK-based independent research boutique specializing in banks.

He’s the latest in a long line of similar departures from the big sell-side firms, as Wall Street brokers dismantle the research departments they built up over the past fifteen years or so.  Brokers are convinced that research is a chronic loss maker they can no longer afford to subsidize in an austere post-Great Recession era.

…are causing problems for mid-sized money managers

A generation ago, equity money management firms all had large in-house staffs of securities analysts who supported their portfolio managers.  Having your own “proprietary” analysis was considered to be a vital point for selling services to both retail and institutional investors.

In reality, these buy-side research departments were:

–expensive

–very difficult to manage

–even more difficult to train and upgrade, and

–inevitably a mix of skilled and creative, along with mediocre and pedestrian.

During the 1990s, money managers discovered that they could lay off most (or all) of their own analysts and replace them with research bought from brokerage houses.  Figure–to pluck a figure out of the air–that it costs a firm $250,000 yearly to support one analyst.  Lay off 10 and the company saves $2.5 million a year that would otherwise come from the fees clients pay to their managers.

Better still, money management firms could “pay” for brokerage research with clients’ money–by letting the broker to charge higher-than-normal trading fees for specified transactions (a practice called “soft dollars,”  as opposed to “hard dollars,” i.e., payments in cash).  Best of all, clients didn’t seem to mind either the disappearance of in-house analysts or the fact that they, rather than the money manager, were now footing the bill for investment research.

So all but the largest money management firms did just that.  They eliminated, mostly or entirely, their own research departments.

But the brokerage research departments have been gutted over the past few years.  What do those money managers do now?

rebuilding in-house research?

I think that’s the only solution for money managers who want to stay in business for themselves.  But that’s much easier said than done.

I guess it’s possible to string together a “virtual” brokerage analyst network by doing business with a bunch of the little independent research boutiques that have sprung up recently.  But many of the best sell-side analysts now work for hedge funds, venture capital or private equity.  So there’s no guarantee you’d end up with enough coverage.  Also, there’s no reason to believe that your information network would stay together for long (a topic for another post).

Another issue:  money managers are paid a percentage of their assets under management as their fee for services.  For many traditional money managers assets under management are much lower than they were a half-decade ago.  Assets are also shrinking.  Institutional clients are taking money away from traditional managers and giving it to hedge funds.  Retail clients continue to fund their 401ks, but they’re shifting their taxable money and their IRAs to lower-cost  index funds and ETFs.

So where will the money for securities analysts come from?

Let’s say a small money management company has $2 billion in assets under management.  Let’s say it collects a management fee that averages 0.5% of assets.  That’s $10 million a year.  Take away $1 million a year for sales, general and administrative expenses.  That leaves $9 million, most of which will be split among the professional employees of the firm.

Let’s say the firm needs six securities analysts + a research director to create a bare-bones research department.  At $250,000 per analyst (including office space, travel …) and $500,000 for the research director, that comes to $2 million a year, reducing operating income by almost a quarter.  This implies everyone at the firm takes a 25% pay cut to get research up and running.  …which is a recipe for having the best talent abandon ship.

For a host of reasons, it’s probably better to merge with another comparably-sized management company.

what’s important for you and me

Don’t go to work for a small money manager expecting a job for life.

The quality of aggregate buy side research is going to get worse, not better.  This instability will mean continuing high market volatility as professionals end up reacting to news they didn’t anticipate.

Less efficient markets mean more scope for ordinary individuals like you and me to know more about specific stocks than professionals.  This means more chance of making market-beating gains.