Category Archives: Investment firms

Goldman’s trading “huddles” are back in the news again

May 13, 2011 By in Getting financial advice, Investment firms, Trading, Where are the customers' yachts? Tags: , , , , , , Leave a comment

Reuters reported on Tuesday that the Massachusetts Securities Division is considering administrative proceedings against GS for its conduct in weekly meetings of analysts and traders, called “huddles.”

I wrote about the Goldman huddles when the news first broke a little less than two years ago, so you can read more detail in that post.  It’s not clear whether the meetings still go on, but when the Wall Street Journal revealed their existence, the huddles were weekly get-togethers of GS’s analysts and proprietary traders.  Their purpose was to develop short-term trading ideas involving stocks GS analysts covered.

The issue is how the results, which sometimes ran contrary to the recommendations in GS’s published research, were disseminated.  GS apparently used them in its own trading.  Institutional salesmen privy to the meetings’ output passed the ideas on to a small number of the firms largest clients.  However, GS didn’t inform the rest of its customers, who were left to act on an official “buy” recommendation when favored clients were being told to “sell.”

Massachusetts has long been a leader in sticking up for the rights of ordinary citizens in financial matters, so this is an interesting situation.  I don’t think the case is as open and shut, however, as, say, the Raj Rajaratnam insider trading case was.  Three reasons:

1.  Every GS research report contains several pages of disclosure in small print at the end (I’ve checked).   Sometimes the disclosure section is longer than the report.  But the fact that GS may act against its official recommendations and tell different things to different clients is among them.

2.  According to the WSJ, analysts were “guided” not to utter the words “buy” or “sell” in the meetings.  So while circumlocutions may have made it clear what the conclusions arrived at in the meetings might have been, establishing that in court might be hard.

3.  GS equity research really isn’t that good, in my opinion.  Its strength has always been the collection of large amounts of factual information about companies and industries.  Its weakness is analysts’ judgment.  And the firm has slipped badly in the annual research department rankings by the Institutional Investor magazine, among others, in recent years.  So GIGO might be another defense.

One other note:  the Reuters article refers to the recently-issued GS 10Q.  Footnote 27 to the financial statements mentions in a general way GS discussions with the Massachusetts regulator.  Either the Reuters reporter is incredibly observant, or someone (the regulator?) called her attention to it.  Can it be that what we’re seeing are the first steps in a systematic investigation by regulators of Wall Street behavior before and during the financial crisis?

ICI mutual fund data: old habits resurface

April 29, 2011 By in Academic Theories, Current Market Thoughts, Industry Analysis, Investment firms, Recent Market Action, Strategy Tags: , , , , , , , , , Leave a comment

individuals’ fund buying patterns over the past four years

Perhaps the one constant in the behavior of individual investors in the US during the recession and subsequent bounceback has been their fervent embrace of bonds and equally ardent shunning of stocks. Within that overall orientation, it’s clear that individuals have preferred taxable bonds to municipal ones and foreign stocks to their domestic counterparts.

True, there were several months of pure panic after the Lehman collapse in September 2008.  At the fund-flow nadir, in October of that year, individuals withdrew over $128 billion from mutual funds and put the money into federally-insured bank deposits.  Less than a third of that amount, however, came from bond funds.

during the bull market

By June of 2009, investors were settling into the pattern that has marked their behavior through most of the entire spectacular rise in stocks of the past two years:   net investment of around $40 billion each month, $30 billion of that into bond funds, the rest into stocks–virtually all the equity money going into foreign securities.

late 2010

As 2010 was coming to an end, two significant departures from this norm emerged:

1.  As the big problems state and local governments are having with their finances became better known, individuals started a steady stream of withdrawals from tax-free bond funds, and reinvestment of that money in taxable fixed income.  That continues. to the present.

2.  January and February 2011 saw $32+ billion of new purchases of stock funds, the largest allocation of money to equities since early 2007.  At the same time, investors, quite uncharacteristically, put the lion’s share of their equity money into domestic securities.

At the time, I remember asking myself how to interpret the fact that an investor class that happily watched a near-doubling of stocks without showing a flicker of interest suddenly started piling in–and in a big way.

In this case, would it be unfair to characterize individuals as the “dumb money”?  …no.  Was it a good sign that they’re beginning to buy?  …not at all, since having the last bear capitulate is usually a sign of the top.  On the other hand, US stocks were still cheap then, in my view. (For what it’s worth, I think they remain so.)  My conclusion was to worry a little more, but not alter my pro-cyclical portfolio stance.

the past two months

In this context, the most recent data on individual investor actions from the Investment Company Institute are very interesting:

–municipal bond withdrawals continue

–taxable bond funds are receiving net additions of $3+ billion weekly

–money flowed out of equities in March, although April has seen modest inflows resume

–investor preference for foreign equities has returned.  In five of the past eight weeks, money has been withdrawn from domestic funds.  More than 100% of the net new equity money stock funds have received in March and April has gone to non-US funds.

In other words, we’re back to the pattern of equity avoidance that has characterized individual behavior during the best of the bull market.  Interestingly, the S&P has continued to go up in March-April, although at a more sedate pace than during January-February.

what to make of this

Theory says that as people get older and richer they become more risk-averse.  I think that’s true.  What I don’t get is why individuals, who are usually a shrewd lot, think at today’s prices and in today’s economic circumstances that bonds are a low-risk investment.

Exhibiting the perverse mindset that characterizes much of Wall Street’s thinking, I’m kind of relieved that individuals have lost interest in stocks.  That probably means that the S&P 500 still has legs.

“Financial Markets 2020”: an IBM study of the investment management industry

April 7, 2011 By in Getting financial advice, hedge funds, Industry Analysis, Investment firms, Where are the customers' yachts? Tags: , , , , , 4 Comments

the survey

Talk about ugly.

In the April 4th issue  of FTfm, its 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 $458 billion 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 $8000 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 pensions 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.

the Flatotel and the Alex Hotel: a cautionary tale for investors

April 6, 2011 By in distressed assets, growth vs value, Investment firms, Private equity, Property/housing Tags: , , , , 1 Comment

a free Wall Street Journal

I’m not a particular fan of News Corp, even though I will admit I was one of the first US-based holders of the stock–and a large one at that–in the mid-Eighties.  The Wall Street Journal is being delivered to my door every day this week as part of a campaign to gain new subscribers, however.  Yes, there’s a lot of fluff and it’s very US-centric.  But the paper is better than I remember.  To my surprise, I may end up subscribing.

That’s not my point today, though.

the underbelly of finance

The “Greater New York” section of yesterday’s paper has an interesting article in it that gives a glimpse at a part of the usually-hidden underbelly of finance.  It also shows some of the obstacles that investors in “deep value” or “distressed” assets routinely face.

Titled “Hotel Developer Must Check Out,” the article describes a recent foreclosure action in which a New York judge put two Manhattan hotels, the Flatotel and the Alex, into receivership.

Alexico

The back story is about a former gold trader and a hotel developer who met in the gym and formed a hotel management company, Alexico.  Borrowing heavily from Anglo Irish Bank (the institution, incidentally, that played the pivotal role in crashing the entire Irish economy), the two started a number of high-end hotel and condominium projects. Then the great recession came.

Anglo Irish has since been nationalized.  As part of its restructuring, it sold the loans it made Flatotel and Alex–a face value of $258 million–to a consortium of US real estate management groups for maybe half that.  They went to court to force Alexico to turn over control of the two hotels.

That’s not the interesting part.

the interesting part

This is:

–the two hotels are losing money   They haven’t made payments on their debt, nor have they paid real estate taxes, for two years.  But they did manage to pay Alexico $570,000 in management fees during that period.

–in addition, the ailing hotels scraped together enough cash to lend $5.3 million to other parts of the (now crumbling) Alexico empire.

–why didn’t Alexico extract even more money from the two failing hotels, you may ask?  A cynic, meaning someone who’s seen this movie before, would say that what Alexico took was all the cash the hotels were generating.

–besides this, the plaintiffs in the case say the hotels’ financial records are a mess (what a surprise!). No elaboration, but I don’t think the issue is that the accountants spilled coffee on the books or that the entries are all mixed up and in the wrong places.  I interpret this as meaning there’s no way of knowing how much money came in the hotels’ doors or tracing where it went.  If so, there may be more money missing than the loans.

All of this is pretty standard fare.  But there’s typically more:

–were the hotels larger, we’d probably also be talking about their employee pension plan–who manages it?  did it too lend money to other parts of Alexico?

–if Alexico built the hotels instead of buying them, we’d likely also be asking about whether the structures are up to code, or if the construction company used lower-quality materials than specified in the contracts.

when the burden of proof shifts…

As a general rule, it’s a mistake in a situation like this to think either  1) that this is the first time the people involved have done something like this, or 2) that what you’ve discovered to date is everything they’ve done to the asset in question.

This is why it takes a certain mindset to navigate through the potential minefield of a distressed asset.  All in all, I’m happier being a growth stock investor and leaving this sort of analysis to someone else.

pension consultants and placement agents: the CalPERS report

March 17, 2011 By in Getting financial advice, hedge funds, Investment firms, Private equity Tags: , , , , , Leave a comment

the situation

Imagine you’re a global equity portfolio manager.  You have a top quartile record over virtually any period during the prior ten years.  In fact, there’s no one in the US, and only one in the EU, who can equal or better your numbers.  You have presentation skills polished by intense preparation by experts both inside and outside your firm, as well as your many hours of practice.

You visit a pension consultant in Connecticut.  You show him your numbers, make your presentation, and await his comments.

He has only two:

–your presentation skills are terrible.  Before he can recommend you to any clients, you must take a remedial course from his firm.  It costs $25,000.

–he’s not sure you know enough about foreign markets.  The only way he can gain the confidence he needs is if you subscribe to his firm’s international information service.  He shows you the latest copy.  It’s a worthless collection of news clippings–superficial, and weeks behind what your own information network provides.  It costs $50,000 a year.

Summary:  despite the fact your record is better than that of anyone he is currently recommending to clients (who are, incidentally, paying him large amounts of money to do manager searches for them), those clients will only hear your name if you agree to make an upfront payment (read: bribe) of $75,000 and agree to continuing payments of $50,000 a year.

We decline.

Welcome to the Realpolitik of pension consulting.

the CalPERS report

The consultant I’ve described lacks finesse.  It would be more common for a pension manager to agree buy analytic services from a consultant, who would examine the manager’s product offerings for their potential attractiveness to customers.  Paying the consultant to come to your offices and spend time digging through your products will not only give the consultant the knowledge of your products that might otherwise take five years of you visiting him to impart.  But it might engender a feeling of obligation as well.

The biggest weapon in the consultant’s arsenal, however, is his control over the types of products he will recommend that his client buy.  They will be all highly specialized, offering the maximum potential for the consultant to “add value” by applying asset allocation services to the individual pieces a given asset manager sells, thereby customizing a portfolio.

CalPERS wouldn’t see the sometimes seamy interaction between manager and pension consultant.  But that’s small potatoes compared with what the consultant earns by selling manager selection and asset allocation services.

None of this is mentioned in the just-released CalPERS investigative report on placement agents and consultant services.  In fact, the part about consultants is much like the amuse bouche in a five-course meal.  What the report says is this:

1.  Somehow, while it continued to pay pension consultants as neutral third-parties to find managers and monitor performance, CalPERS ended up hiring the same organizations as money managers, as well.  Talk about the fox guarding the chicken coop.

CalPERS has finally worked out that, in addition to not being a sound action from a fiduciary standpoint, this is a no-win situation for it.  If the performance is outstanding (and my casual reading suggests it isn’t), there’s still the blatant conflict of interest.  If it’s poor, there isn’t even a pragmatic justification for the breach of prudent behavior.

2.  The big issue in the report, though, is placement agents.  These are well-connected individuals who sold their privileged access to CalPERS management for tens of millions of dollars in fees paid by third-party money managers, some of whom gained CalPERS as a client.  This appears to have happened predominantly in CalPERS alternative investment and real estate areas.

The report of the investigation, lead by law firm Steptoe and Johnson, LLP, is a carefully crafted document.

The authors point out that they received “universal and unlimited cooperation”  only from CalPERS and its current employees, less than that from others.   Some relevant people, notably former CalPERS CEO Fred Vuenrostro and former board member Alfred Villalobos, refused to cooperate entirely (understandably, perhaps, in the case of the named individuals because the report notes both are defending themselves against charges brought by the California Attorney General).

As I read it, the report makes several, not entirely consistent, points about the attempts of several of CalPERS key alternative investment managers to buy influence through Villalobos and Vuenrostro:

a.  CalPERS lost no money (not relevant from an economic point of view, but likely a key point under state securities laws)

b.  the main operational failure was on the part of the board of directors in not reining Villalobos and Vuenrostro in, and in some cases, aiding their influence-peddling efforts; the staff of CalPERS consistently resisted unwarranted pressure from Vuenrostro to select certain managers or not negotiate fees diligently

c.  nevertheless, the report also cites the case of the former head of CalPERS’ alternative asset arm, who appears to have accepted inappropriate favors from Apollo Global Management, while CalPERS was negotiating to buy a stake in Apollo

d.  in addition, many of the third-party managers who paid a total of $180 million to placement agents, Apollo Global Management, in particular, remain among CalPERS’ “most trusted external managers.”

e.  again, despite the contention that the staff of CalPERS acted entirely appropriately, the report also says that four alternative asset managers, Apollo, relational, Ares and CIM, “agreed to a total of $215 million in fee reductions for CalPERS.”

my thoughts

At least this behavior is out in the open.

To me, the conclusions in the placement agent part of the report don’t add up.  It may be, however, that CalPERS is so deeply entwined with the alternative asset managers who paid placement agents all that money and who overcharged the agency by close to a quarter billion dollars that it isn’t able to extricate itself.  So it has decided to make the best of a bad situation.  We’ll probably find out more as pending lawsuits wend their way through the legal system.