parking lots

It’s Black Friday, a shopping day that will likely reveal how widely wallets will be oepned this holiday season.  It’s also Recovery Day, from Thanksgiving overeating.

 

For no particular reason, other than I saw an article in Wednesday’s Wall Street Journal  in which a hedge fund manager reveals he has “discovered” parking lots as an investment form, I’m going to write about them.

There’s really nothing new about parking lots as an investment.  From forever, real estate companies-and enterprising individuals–have bought raw land on the edge of towns in the hope that urban expansion will reach their purchases, making them quantum leaps more valuable.  While they wait, the owners generate cash flow by making their purchases into parking lots.

In today’s time of gentrifying neglected parts of big cities, buying existing parking lots in poor neighborhoods can serve the same function.

For what it’s worth, real estate investors in the US used to do the same edge-of-town thing on a much larger scale–and with notably less success–by converting big speculative tracts into amusement parks.

The biggest drawback I can see to parking lot ownership is the fact that it involves controlling huge numbers of relatively small cash transactions.  Keeping track of them is one issue.  Making sure all the receipts are recorded is another.  A third is that, again from forever, parking lots have been a standard way for the underworld to launder the proceeds of their  illegal enterprises–making them look wildly more profitable that they actually are.

I’m not sure the hedge fund guy from two days ago realizes what he’s getting into.

hedge funds and uncorrelated returns

beta     

One of the initial topics in my first investment course in graduate school was beta, a measure of the relationship ( generated from a regression analysis) between the price changes of an individual stock and those of the market.  A stock with a beta of 1.1, for example, tends to move in the same direction as the market but 10% more strongly.  One with a beta of 0.9 tends to move in the same direction as the market but 10% less strongly.  The beta of a stock portfolio is the weighted average of the betas of its constituents.

the beta of gold stocks

At the end of the class, the teacher posed a question that would be the first item for discussion the following week.  Gold stocks have a beta of 0.  What does that mean?

The mechanical, but wrong answer, is that gold stocks lower the beta, and therefore the riskiness, of the entire portfolio.  If I have two tech stocks, their combined beta may be 1.2.  For two utility stocks, the beta might be 0.8.  For all four in equal amounts, then, the beta is 1.0, the beta of the market.  Take two tech stocks and add two gold stocks and the beta for the group is 0.6. But this doesn’t mean the result is a super-defensive portfolio.

A beta of 0 doesn’t mean the stock is riskless.  It means that the stock returns are uncorrelated with those of the stock market.  So adding one of these doesn’t lower the risk of the portfolio.  Instead, it introduces a new dimension of risk, one that may be hard to assess.

a painful lesson   

Portfolio managers who embraced beta in its infancy didn’t get this. They assumed uncorrelated= riskless, learned the hard way that this isn’t true when their supposedly defensive portfolios imploded due to sharply underperforming gold issues.

uncorrelated redux      

I’ve been looking at marketing materials for financial planning firms recently.  Allocations to hedge funds are being touted with the idea that their returns are uncorrelated to those of stocks or bonds. This is substantially different from the original claims for this investment form. Over the past fifteen years or so, the hedge fund pitch has gone from being one of higher-than-market returns, to low-but-always-positive returns, to the present uncorrelated.

The reason is that in the aggregate hedge fund returns have consistently been lower than those for index funds for many years and that they do have years where their returns are negative.  What’s left?   …uncorrelated, just like zero-beta gold stocks.  I guess it has been revived because the last “uncorrelated” investment disaster is so far in the past that few remember it.

why hedge funds?

Why have hedge funds at all in a managed portfolio?  They must have some marketing appeal, sort of like tax shelter partnerships or huge fins on the back of a car, that are aimed at the ego–not the wallet–of the client.  A darker reason is that the sponsoring organization may also run the funds, and would miss the huge fees they generate for their managers.

 

 

 

 

 

 

daily volatility, non-correlation …and beta (ii)

This post is about hedge funds.

hedge funds:  a purist’s view

To a purist, a hedge fund is about hedging.  That is, it’s about running a portfolio with offsetting long and short positions.

Conceptually, this can be done either by assembling pair trades (one long, one short, often both in the same industry) or by creating opposing portfolios of good ideas and clunkers.  By using the money obtained from borrowing, and then selling, the hoped-for clunker stocks to fund the hopefully strong-performing good ones, the hedge fund manager ends up with no net exposure to the securities market he’s working in.  His return consists in the spread, if any, between the performance of the aggregate long portfolio and the shorts.  In a perfect world, he never loses money, although the amount he makes in a given year is up in the air.  It depends on the relative valuations of the “good” and “bad” securities that his market gives him.

(By the way, I worked on, and briefly ran, a very successful short-only portfolio for an innovative institutional client in the early 1980s. We pruned “bad” stocks from an S&P 500  index fund and reinvested the money in the rest of the index.)

today’s version

In today’s world, hedge funds are a motley group of mostly strongly net long, mostly highly concentrated portfolio strategies.  They do have common characteristics, though.  They charge very high fees, and as a group they’ve underperformed the S&P 500 pretty continually for more than a decade.  Also, many times it’s hard to get your money back if you no longer want to participate.

why institutional support, despite weak returns?

Why do pension funds continue to support hedge funds with a tolerance for weak performance they would never exhibit with long-only managers?

Two reasons:

–the claim of non-correlation with stocks and/or bonds.  This is basically a rerun of the fallacy of gold as a zero-beta asset, and

–the low expected return from stocks and bonds.  To pluck numbers out of the air, let’s say that over the next five years we can expect returns of 2% annually from bonds and 6% from stocks.  A portfolio made up of equal portions of both asset classes would have an expected return of 4% per year.  Suppose the actuarial assumption of a plan sponsor is that the plan is fully- or mostly-funded if the plan can achieve of 5% annual returns–or maybe 6%.  The plan managers, who hire outside portfolio help, have no way of get to either goal using conventional long-only investments.  That’s even going all in on stocks, which sponsors find too risky.  So the managers can either tell the sponsoring organization to add more money to the pension plan   …or they can hire hedge fund managers with pie-in-the-sky stories of high potential returns.  Until very recently, my observation is that they’ve by and large chosen the latter.

 

 

 

 

a market of stocks or an overall stock market?

my worry

This is the question I was writing about a few days ago.

The outstanding characteristic of the US stock market vs. other national markets during my career has been that Wall Street has been, almost uniquely, dominated by stock pickers.  While political or macroeconomic concerns occasionally arise, the focus of the vast majority of stock market participants has been on the merits (or lack of them) of individual stocks.

Many veteran stock pickers on the sell side have either retired or been laid off over the past several years, however, and institutional pension money allocated to active investing has increasingly been funneled to trading-oriented hedge funds or other “alternative” investment vehicles in a so-far vain attempt to close the gap between the assets they have on hand and the minimum they need to meet their present and future obligations.

The result of this change has been an increasing influence on stock prices by computers that react to news of all sorts as it is published and by short-term human traders sensitive to macroeconomic trends but with (to me) surprisingly little knowledge of the ins and outs of individual companies or industries.

My worry has been that–as has happened in other countries–the macro woes of sectors like Energy and Materials, or perhaps the demise of the post-WWII industrial corporate structure, overwhelm the attractions of even large micro pockets of strength in, say, IT.

last Friday

My worries have no basis in fact, at least so far, if last Friday’s trade is any indication.

The S&P 500 was up by 1.1%, the IT-heavy NASDAQ by 2.3%.  However, consider the performance of the following companies that reported earnings before the open:

Microsoft         +10.0%

Alphabet (aka Google)          +7.7%

Amazon          +6.2%

athenahealth   (a weak performer before Friday)      +27.5%.

 

Compare that with:

VF          -12.9%

Skechers          -31.6&

Pandora Media          -35.6%%.

 

Two things stand out to me:

–most of these reactions are extreme, suggesting that the market is reacting to the news rather than anticipating it, and

–the market is very willing to differentiate sharply between individual winners and losers.

 

My conclusion:  we as individuals can still ply our stock-selecting trade.   The reward for finding superior companies, however, may come all at once, and later than we have been used to in the past.

 

Samsung and Elliott Associates

I’m not an expert on Korea.  In fact, I think of Korea in much the way I think of India or Indonesia–or Japan or Italy, for that matter.  They’re all places where very powerful family controlled industrial groups have enormous economic and political power.  As a result, the rules of the stock market game are very different from those that prevail, say, in the United States.  Piecing them together can take an enormous amount of time and effort.  I’ve believe that, except in the case of Japan in the 1980s, the reward for mastering these markets would never be large enough to justify the effort involved.

In the case of Korea, government policy, both formally and informally, is heavily tilted in favor of a set of family controlled industrial conglomerates called chaebols (much like the zaibatsu/keiretsu of Japan).  In my view, these are not American-style corporations.  They care little for profit growth/maximization or for the welfare of ordinary shareholders–Korean or foreign.  I’ve found the laws and regulations that govern them to be bewilderingly complex and their financial statements (admittedly I haven’t read one carefully in well over a decade) unreliable.

Recently, Samsung, a major chaebol, decided that one affiliate, Cheil, would buy another, Samsung C&T, at what appears to be a bargain basement price. US activist investor, Elliott Associates, then bought a bunch of Samsung C&T stock and challenged the takeover.  Its objective was presumably either to have its stake bought out at a higher price by some other Samsung company or to compel Cheil to raise the acquisition price for everyone.

My initial reaction on reading this was that Elliott was fooled by superficial similarities with the US and didn’t understand the deeper political and cultural barriers it would face in Korea.  That has, so far, proved to be the case.  Shareholders have voted in favor of the acquisition as originally proposed.  Elliott is apparently continuing to sue to try to prevent/reverse this outcome.

The situation is a little more interesting than I’d thought, though, and bears watching:

–the Elliott effort to have Samsung C&T shareholders reject the takeover failed by only 3% of the shares voted.  This is a surprisingly small amount, in my opinion.  On the other hand,

–the deciding vote in favor was cast by the government-connected National Pension Fund, which ironically has previously been a critic of chaebol behavior.

My guess is that it’s ultimately Elliott’s foreignness that swayed the voting, particularly at the NPS.  Were a Korean equivalent to attempt the same thing, the outcome might have been different.  If so, there may be hope for investors in Korea after all.  I’ll continue to be on the sidelines until there’s more tangible evidence of change, however.

 

 

 

 

cooling the Chinese stock market fever

In the 1990s, Alan Greenspan, the head of the Fed back then, famously warned against “irrational exuberance” in the US stock market, but did nothing to stop it   …this even though he had the ability to cool the market down by tightening the rules on margin lending.  This is the stock market  analogue to raising or lowering the Fed Funds rate to influence the price of credit, but has never been used seriously in the US during my working life.

The  Bank of Japan has no such compunctions.  It has been very willing to chasten/encourage speculatively minded retail investors by tightening/loosening the criteria for borrowing money to buy stocks.

 

We have no real history to generalize from in the case of China.  But moves in recent weeks by the Chinese securities markets regulator seem to indicate that Beijing will fall into the stomp-on-the-brakes camp.

Specifically,

–at the end of last month, the regulator allowed (ordered?) domestic mutual funds to invest in shares in Hong Kong, where mainland-listed firms’ shares are trading at hefty discounts to their prices in Shanghai

–highly leveraged “umbrella trusts” cooked up by Chinese banks to circumvent margin eligibility requirements have been banned,

–a new futures product, based on small and mid-cap stocks, has been created, offering speculators the opportunity to short this highly heated sector for the first time, and

–effective today, institutional investors in China are being allowed to lend out their holdings–providing short-sellers with the wherewithal to ply their trade (although legal, short-selling hasn’t been a big feature of domestic Chinese markets until now, because there wasn’t any easy way to obtain share to sell short).

What does all this mean?

The simplest conclusion is that Beijing wants to pop what it sees as a speculative stock market bubble on the mainland.  It is possible, however, that more monetary stimulus–to prop up rickety state-owned enterprises or loony regional government-sponsored real estate projects–is in the pipeline and Beijing simply wants to dampen the potential future effects on stocks.

I have no idea which view is correct.

It’s clear, however, that Hong Kong is going to be a port in any storm, and that it is going to be increasingly used as a safety valve to absorb upward market pressure from the mainland.  So relative gains vs. Shanghai seem assured.  Whether that means absolute gains remains to be seen, although I personally have no inclination to trim my HK holdings.

 

 

uncorrelated returns: hedge funds as the new gold

Every stock market person knows what beta is.

It comes from a regression analysis, y = α + βx, where y is the return on a stock and x the return on the market).  It shows how a given stock’s past tendency to rise and fall is linked to fluctuations in the market in general.  A stock with a beta of 1.4, for example, has tended to rise and fall in the some direction as the market, but move 40% more in either direction; a stock with a beta of 0.8 has tended to exhibit only 80% of the market’s ups and downs.

The professor in a financial theory course I took in business school asked one day what it meant that gold stocks had, at the time, a beta of zero.

The thoughtless answer is that it means they aren’t risky, or that they don’t go up and down.

A consequence of this thinking is that you can lower the beta, and therefore the risk, of your investment portfolio by mixing in some gold stocks.What’s interesting is that in the early days of beta analysis that’s what some institutional portfolio managers actually did with their clients’ money.

That didn’t work out well at all.

What should have been obvious, but wasn’t, is that the zero beta didn’t mean no risk–or that gold stocks are/were a good investment.  It meant what the regression literally indicates–that none of the movement in gold stocks could be explained by movements in the stock market in general.

The riskiness of gold stocks is there, but it came/comes in other dimensions, like:  how mines develop new supply, the ruminations of the gnomes of Zürich (in today’s world, Mumbai and Shanghai), the potential for emerging country craziness, the propensity of the industry to fraud.

Why write about this now?

I heard a Bloomberg report that institutional investors as a whole are upping their exposure to hedge funds, despite the wretched performance of the asset class.  Their rationale?   …uncorrelated returns.

It sounds sooo familiar.

Admittedly, there may be a deeper game in progress.  It’s impossible to say your plan is fully funded by projecting a gazillion percent return on stocks or bonds.  But who’s to say that a hedge fund can’t do that?