Category Archives: Portfolio management

winding down for the year

December 23, 2015 By in Portfolio management, Uncategorized Tags: , Leave a comment

For professional equity investors the final two weeks of the calendar year are perhaps the only time when they can truly rest.  Two reasons:

–virtually every professional is evaluated and compensated on performance over periods–usually one year, sometimes one and three, sometimes one, three and five or other longer time frames–that conclude on December 31st.  As a result, by mid-December one’s personal financial fate is pretty well sealed.  Even those who are very close to thresholds where pay can go way up or way down may elect to remain on the sidelines with fingers crossed.  That’s because the short-term direction of prices is notoriously hard to predict–in fact, academic research argues that fluctuations over, say, a week or two are purely random.  This means yearend tweaks are just as likely to backfire as they are to make performance better.

This is the only time of the year when professionals feel completely safe in taking their hands off the tiller and resting.  It would be crazy not to take the opportunity. Trading volume for the S&P 500 yesterday was about 20% below average, for example, marketing, I think, the start of the yearend lull.

–accountants for asset managers like the books to close neatly.  They don’t want to have trades that have been agreed to in December not settle before yearend, instead hanging over into the following year.  Although every stock exchange has rules about how many days after being agreed to trades are supposed to settle, not all do.

As a result, most asset management companies “request” that their portfolio managers not enter into new bargains during, say, the last two weeks of the year.  Adminstrators take a huge risk if they order PMs to take their hands off the money:  PMs have a fiduciary obligation to do what’s best for their clients, not what’s best for the accounting department.  And there are those poor few who are hoping to rescue their year through a flash of Christmas brilliance.  Still, everyone understands what they’re being asked to do.  And almost everyone jumps at the chance to comply.

Advice for you and me:  watch prices anyway. Sometimes weird price fluctuations happen during the last couple of trading days of the year.  The fact that almost every professional is away from work can cause last-minute buy or sell orders have an unusually large impact on prices.  This can be a great chance to take the other side of the trade, since most of us don’t really care that our trade will settle in the first week of January.

extreme agency issues

November 13, 2015 By in agency problem, Portfolio management Tags: , , , , Leave a comment

The agents that we as shareholders hire to act for us can hurt us in a number of ways:

securities fraud

The 21st-century poster child here is Enron, which created the appearance of earnings growth by fabricating lots of energy trading profits.  A generation ago, the leading name would have been Equity Funding, an insurance company that had a division that made up people it “sold” insurance to.

Many times, such cases are hard to detect, since management has either corrupted or bamboozled its auditors, on whose yearly inspections of  a company’s financial accounts we, as investors, crucially depend.  There’s not much we can do to defend ourselves from fraud, other than to try to have an ear for market rumors and a nose for implausibility.

managers who do really stupid things

The name C. Michael Armstrong comes to mind.  As CEO of ATT, he attempted to diversify the company away from the Plain Old Telephone business.  By my count, however, he masterminded $100 billion worth of dud acquisitions that ultimately drained the company of its ability  to morph into something else (this “performance” earned him a seat on the board of Citigroup, however).

Then there are pets.com, whose signature achievement was its sock puppet mascot, and the gaggle of companies that all leveraged themselves to the sky to create gigantic fiber optic networks–all operating during the Internet Bubble.

 

I don’t think the Valeant Pharmaceuticals story has yet unfolded completely.  The company, a hedge fund favorite, has come under fire for acquiring mature drugs and raising their prices by huge amounts.  The attack on this practice by, among others, Charles Munger, a long-time associate of Warren Buffet, as “deeply immoral” has caused the stock price to plunge.

 

Mylan, a new twist

Drug maker Mylan completed a tax inversion early this year that transformed its country of incorporation from the US to the Netherlands.

In April it made use of a provision of Netherlands law to create a trust, called a stichting, supposedly staffed by completely neutral parties but arguably controlled by company management.  It issued the trust an option to buy new shares equal to all those previously outstanding, at a price of one euro cent each.  It then used this device to fend off a takeover bid, unwanted by management, from Teva Pharmaceuticals.

Subsequently, Mylan defended its actions by saying it had moved to the Netherlands because the US is “too shareholder-centric.”

In addition to the ability to create a stichting, moving to the Netherlands appears also to have insulated the board of Mylan from the possibility of removal by shareholder vote.

It appears to me that Mylan reincorporated in the Netherlands with the intention of disenfranchising shareholders.  In a highly technical sense what Mylan has done may be legal, although media reports suggest the SEC is investigating whether the company adequately disclosed to shareholders what it was doing.  Nevertheless, Mylan’s actions seem to me to be a massive breach of the bond of trust that should exist among business partners.  I’m not sure what the consequences will be.  I can’t imagine, though that they’ll be good for Mylan’s stock, or that any other US-listed company will be able to reincorporate into the Netherlands.

the agency problem

November 12, 2015 By in agency problem Tags: , , , , , Leave a comment

principal – agent

The principal – agent relationship arises when one person, the principal, hires someone else, the agent, to act on his behalf in some matter.

agency problem

The agency problem is that the agent may have a different set of economic interests from the principal and may act on them rather than do the best thing for the client.

examples

Studies seem to show that real estate agents behave differently when they sell their own houses than when they sell for a client.  Working for themselves, they take more time and achieve higher prices.  This is also the issue in the current discussion about whether brokerage financial advisors should be fiduciaries, that is, whether they should have a legal obligation to recommend the best investments for their clients.  At present, they aren’t   …and don’t.

for us as investors

If we hold shares of the common stock of individual companies, we are in some sense owners of the company.  (Note:  we can also hold shares of stock  in individual companies indirectly by buying shares of ETFs or mutual funds.  We can hold the shares in, say, a 401k account sponsored by our employer, too.  These create further layers of principal – agent relations.  In this post, I’m going to ignore them.)

The chief power we have as shareholder-owners of a company is that we vote to elect a board of directors to act as our agents.  The board, in turn, selects a management team (another set of agents) to run the operations of the company in our behalf.

an aside:  stakeholders

Management hires employees, makes ties with suppliers and customers and may borrow money from a bank.  The group comprised of this wider net of interested parties plus us as principals and the two sets of our agents is usually referred to as stakeholders.

potential stockholder – agent conflicts of interest

the board

Where do board members come from?  The slate we vote for is typically put together by the management of the company.  The list will consist of some members of top management, plus “outside” directors.  This latter group may include retired managers from other companies in the industry, or executives from suppliers or customers.  But it may also contain prominent political, military or academic figures, who have little knowledge of business generally–and still less of the particulars of the company on whose board they sit.

As agents, the board has its own set of interests and priorities.  More important, though, it can easily have a much closer attachment to the management that nominated them than the anonymous group of shareholders who voted for them and are technically their bosses.   And, of course, management may seek rubber stamps instead of gadflies.

If individual shareholders had a problem with the composition of the board, how would they take effective action?

management

Let’s say a CEO has spent 25 years rising to the top spot in a corporation, where he has, say, five years to collect high salaries and bonuses and cash in on stock option awards.

Suppose our CEO sees a severe structural problem with the business, which can be papered over for a while but which will begin to erode market share and profit margins within, say, six years.  The problem can be fixed, but only by a restructuring that will crush profits (and maybe the stock price) for at least the next two years but which will pay huge dividends toward the end of the decade.

What does he do?    …restructure and risk turning his $60 million five-year day in the sun into $25 million, or simply paper over and collect the higher sum?

 

Tomorrow:  the latest twist.

 

 

 

the record of active fund managers in Europe

October 30, 2015 By in Getting financial advice, indexing, Investment firms, Portfolio management, stock market Tags: , , , , Leave a comment

I’ve been reading the Indexology blog again.  A few days ago, the topic was the performance of actively managed equity funds managed by European fund managers over the past ten years.

The numbers are almost incomprehensibly bad.

In the “best” category, large-cap European stocks in developed markets there, 55% of the funds underperformed over the past year.  That result deteriorates pretty steadily as time progresses, with the result that on a ten-year view 87% underperform.   .and that’s the best!

The race for last place is almost a dead heat among Global, Emerging Markets and US.  Over the past year, 82% -83% of managers in these categories underperformed.  This result also deteriorates over time.  Over the past ten years, 97% – 98% underperformed.

This is the same pattern as for US active managers   …only worse.

The performance figures are after all fees–management, administrative, marketing…–except for the sales charges levied by traditional brokers.

More importantly, the figures for each period include all funds active during that time, not just the ones that made it through the entire period.  That’s key because over the past ten years about half of the funds active for part of the time were either shut down or (more likely) merged with other funds.  It’s possible that one or two of the defunct funds were great performers but  for some reason couldn’t be sold.  However, in my experience, the overwhelming majority would have been folded because the performance was bad.

Similar figures for the survivors confirms my belief.  The 10-year record for this smaller, hardier, group shows around half the funds outperforming their indices–except for the emerging markets category where over two-thirds of the surviving managers still underperform.

Why do clients put up with this?

One answer is that the absolute returns have been between 5% and 10% yearly in euros.  On the low side that means up by almost 65% over the past decade.  That’s not all that investors could reasonable have expected, but it’s not a loss.  So alarm bells don’t go off when holders get their statements.

Another is that they aren’t.  These sad figures for active managers are the biggest explanation for the popularity of passive products.