Tag Archives: business

the business of money management vs. the craft of portfolio management

June 21, 2016 By in Constructing a Portfolio, Portfolio management, Uncategorized Tags: , , , , Leave a comment

Charles Ellis once famously wrote that the average portfolio manager is just that–average.  This is an observation that, however true, still grates with me.  But it really doesn’t explain what is commonly believed that it does, namely, why average performance by experienced professional investors virtually always falls short of benchmark target.

I think there’s another explanation for the latter.

It’s that money management firms assume clients prefer a warm and fuzzy working relationship with a financial adviser over strong investment performance.

In a sense it’s only natural that firms should think that way.  Most are run by the head marketer, with the head investor having the CIO (Chief Investment Officer) title and has little to do with strategy (this is the same jocks vs. nerds issue that has the traders controlling Wall Street firms, not the analysts). And the conclusion was probably also correct until about a decade ago.

In practical terms, the thinking went like this:

–why hire an extra analyst, even if that would mean a higher probability of matching our index vs. falling, say, 50 basis points below it?  Better to hire an extra marketer who can bring in more assets.  After all, we earn our fees based on a percentage of assets under management, not on outperforming, and our clients don’t care anyway.

–similarly, why cap the assets our star managers manage at a level where they’re more certain of outperforming?  If they manage 2x or 3x as much, they may be forced into buying larger-cap stocks than they’re comfortable with, and the chances of their beating their benchmark may be lessened by their lack of maneuverability.  The answer: clients won’t notice that, either.

However, clients have noticed    …and are leaving active managers in droves.

More tomorrow.

 

 

for-profit universities

June 20, 2016 By in for-profit universities, Uncategorized Tags: , , , Leave a comment

The stocks of for-profit universities were incredibly hot in the midst of the market meltdown from the Internet bubble of 1998-early 2000.  That’s partly because they had almost nothing to do with Technology, Media or Telecom.  It was also because they were experiencing a period of strong revenue and profit growth.  The story was that these colleges were: accredited; cheaper than traditional schools; the online instruction they offered was more flexible than bricks-and-mortar-based teaching; students could get a degree in a relevant area while still working.  To top everything else, the for-profits made money, and were piling up income gains at an accelerating rate.

It’s been mostly all downhill since then, however.

How so?

–traditional schools have responded with job-relevant, online course/degree offerings of their own

At the same time, detractors have pointed out that the for-profits:

–are highly dependent on students taking out government loans to finance their studies

–have insufficient resources devoted to keeping their non-traditional students in school

–as a result, they have unusually high numbers of dropouts, many of whom end up defaulting on their (large) student borrowings

–have sales strategies that target members of the military and low-income students, groups with the weakest defenses against inflated sales claims.

 

Over the years, regulators’ attempts to rein in for-profit abuses have centered on controlling their access to government-funded student loans, based on graduation rates and repayment histories.  Recently, however, the efforts appear to have been upped several notches.

Officials have called on the federal government to remove the credentials of the Accrediting Council for Independent Colleges and Schools, the body whose seal of approval  confers legitimacy on the for-profits and which, more importantly, is the essential step in securing access to the government’s education loan program.

Dell’s buyout underpriced;T Rowe Price’s costly mistake

June 7, 2016 By in takeover rules, Uncategorized Tags: , , , , , 1 Comment

the Dell leveraged buyout

Three years ago, Michael Dell decided to take the company he founded private in a leveraged buyout.  Last week, the Delaware Chancery court ruled that the buyout price was woefully low.  It said that a fair offering to shareholders would have been $17.62 a share (how precise!), not the $13.75/share actually paid.

Dell does not have to compensate many former shareholders, however.

What’s this all about?

Delaware rules

Most US companies are incorporated in Delaware, where the rules are well-tested and generally favorable toward business.  In Delaware, if holders of 90% of the outstanding shares of a takeover target accept the acquirer’s offer, the remaining 10% can be forced to do so, too.  Other US states and other countries may have different thresholds, but they also typically have similar rules to eliminate potentially bothersome small minority holdings.

Minorities aren’t completely without rights in Delaware, however.  They are allowed to refuse the offer and appeal the valuation in court.  This is a long and expensive procedure–three years in the Dell case.  At the end of the day minorities are not allowed to keep their shares.  The issue is solely about the price they get for selling them.  (Shareholders who are in the 10% because they don’t vote, or who don’t participate in the lawsuit, just get a check in the mail for the original takeout price.)

This is what happened with Dell.  It’s also the reason that Dell only has to compensate those who sued.  The vast majority of former Dell shareholders freely accepted a takeover offer that we now know was way too low.

T Rowe Price 

The money management firm’s internal analysis was that the Dell offer was inadequate.  It also appears to have taken part in the suit.  But the firm somehow made an administrative error in 2013 and voted to accept the Dell offer, not to protest the valuation.  The court ruled that T Rowe Price is stuck with that decision, even if it intended to do the opposite.  So it won’t benefit from last week’s ruling.  In fact, it is going to have to figure out how to pay people who owned funds containing Dell shares the $194 million they would have had, were it not for the voting mistake.  This will likely be a real pain in the neck, since it involves clients from three years ago, who may not sill be holding the funds affected.

 

dividends in the US (ii): the 1970s

May 16, 2016 By in Dividends, Uncategorized Tags: , , , , , Leave a comment

Two significant inflationary forces marked the 1970s in the US:

–the two oil crises, one during 1973-74, the other during 1978-80, which drove the price of crude from under $2 a barrel at the start of the decade to over $35 at its end, and

–the start of runaway inflation in the US, only partly due to oil, that had prices rising by 8% yearly, with economists’ projections of +11% for the early 1980s.

Both had profound–and negative–effects on investor attitudes toward dividends.

inflation

Typical dividend stocks are of companies in mature, slow-but-steadily growing businesses that generate substantial free cash flow.  Think: consumer staples.  These firms usually have very little power to raise their prices.  In the best case, they can do so in line with historical inflation.  Even then, they run the risk of having customers switch to lower-cost substitutes.  Many times, though, prices are in a steady real decline.

In a world where inflation is  currently 5% and where price rises are accelerating to 8%+ per year, a stock now yielding 4%, with a dividend that can grow at best 5%, is unattractive.  Its yield is already negative in real terms and prospects are that it can only fall further behind.

oil

Before the oil crises–and again today–the big international oils were regarded as quasi-bonds, attractive mostly for their dividend yields.  In a (mistaken) attempt to shield consumers from an increasing oil price, the US passed price control laws in the mid-1970s that set a cap on the selling price of US-produced crude from wells drilled before the oil shocks began.  This made US-based firms that had large oil reserves relatively unattractive investments.

Interest shifted instead to smaller, non-dividend-paying exploration firms that had the potential to make large finds relative to their size.

conventional wisdom

In business school I learned the conventional wisdom of the time.  It was that paying a large, growing, dividend was a sign of weakness in a firm.  It supposedly meant that the management lacked creativity.  The best they could come up with was to return excess funds to shareholders.  Therefore, dividend stocks should be shunned.

How times have changed!

Tomorrow, reversal in the 1980s.

 

the Lucky Country, the Dutch/Detroit disease and the Middle East

April 27, 2016 By in "Dutch disease", oil and natural gas, Uncategorized Tags: , , , , , , , , Leave a comment

lucky countries

where is Wikipedia when you need it?

The original “Lucky Country” was Argentina.  As I googled the term before writing this post, however, I found no trace of a link between the name and the South American agricultural giant.

Still, I began my international investing career in the mid-1980s with an Australian portfolio.  In that Cro-Magnon time the Argentina/Australia comparison was common.

The idea for both nations was that they were endowed with abundant natural resources, but that this was a curse, not a blessing.  That good luck spawned its opposite–excessive reliance on food/mineral production, insularity, dysfunctional government and resultant economic misery.  In contrast, resource-poor places like Japan or Korea were blossoming as economic powerhouses.

the Dutch/Detroit disease

I stuck in the Detroit part.  For me the Michigan analogy is much more current and powerful.

The Dutch “disease” was the discovery of gigantic offshore oil deposits.  They required a lot of labor to develop–mostly strong backs and a willingness to spend long periods of time on floating oil development platforms. 

The jobs required a lot of people, however, and paid maybe 3x normal wages.  Combine that with a small national population and the result was soaring wages and, therefore, a mass migration of non-oil industries to other countries.  When oil prices peaked in December 1980 and began a swoon that would reduce them by about 3/4, the oil business collapsed.  Government finances fell apart and unemployment skyrocketed as laid-off oil workers couldn’t find new domestic jobs.

The “disease,” then, is small area and reliance on a single industry.

Detroit is the American equivalent, with automobiles instead of oil.  The domestic auto industry grew fat and lazy in the 1970s-80s behind protective barriers erected against imports.  It paid high wages that drove most other businesses out of the area.  Heavy reliance on the “Big Three” car makers, corrupt government and the arrival of foreign auto manufacturers in lower-cost areas in the US eventually combined to drive the city into bankruptcy.

the Middle East

Economically, the typical oil producing country is Detroit in the desert.

Two twists on the all-eggs-in-one-basket theme:

— very young populations, meaning an imminent threat of significant youth unemployment; and

–a reluctance to allow women into the workforce.

Both probably turn them into Detroit on steroids.

I have no idea how this all works out.  Dubai, which has no oil, is looking a lot smarter than it did six or seven years ago.  The recent Saudi announcements of a radical restructuring of its economy are just the curtain being raised on what may be a lengthy, twisty-plot drama, I think.