Tag Archives: hedge funds

thinking (some more) about PIMCO

April 14, 2014 By in Current Market Thoughts, hedge funds, Industry Analysis, Investment firms, Recent Market Action, Trading Tags: , , , , , , , , 1 Comment

Pacific Investment Management Company (PIMCO) built itself into a bond market juggernaut over the past forty+ years, thanks to a soaring bond market, savvy marketing and the superior fixed income management skills of now-septuagenarian Bill Gross.

I’m an admirer of PIMCO’s organizational success.  But, at the same time, I can’t help thinking that the firm’s “New Normal” campaign of the past several years is mostly marketing hype–and wrongheaded, at that.  No matter what the economic or market conditions, the PIMCO conclusion is “Avoid stocks and buy more bonds!!!”  For all but the most risk-averse investors, that’s bad advice.  A first-rank firm should be better than that.

This is not what I want to write about, however.  I just want to declare that I have a vaguely anti-PIMCO point of view.

PIMCO has been having problems recently.  Mr. Gross has been underperforming.  Clients–even long-term clients–have begun to head for the door.  So, too, Mr. Gross’s putative successor, Mohamed El-Erian, who resigned from the firm citing irreconcilable differences between himself and Mr. Gross.  Press reports suggest Mr. Gross had been beating Mr. El-Erian over the head with his lack of actual portfolio management experience as a reason for dismissing his questions and concerns.

Great gossipy stuff   …but not what should concern us as investors.

Mr. El-Erian may not be an accomplished portfolio manager, but that doesn’t mean he isn’t a very shrewd individual.  What would make him a high-profile, high-prestige, high-paying job, instead of just hunkering down, busying himself with his considerable marketing responsibilities and waiting Mr. Gross out?

El-Erian’s decision to leave, I imagine, came when he realized that this strategy wouldn’t work.  Mr. Gross’s behavior wouldn’t change.  And it could well have consequences that would tarnish Mr. El-Erian’s image, as well.  After all, although apparently powerless, he was the co-Chief Investment Officer.

I imagine that because Mr. Gross has had such phenomenal success for so long with an aggressive strategy, he sees no reason to adopt a more conservative approach–even though, intellectually at least, he knows that the great bull market in bonds in the US that rewarded that behavior is over.  So he continues to take extra risk.  But that translates only into extra volatility in today’s world, not extra return.  Think:  Jon Corzine, or any number of prominent hedge fund managers.

Growth stock investors went through a similar existential crisis as the Internet bubble imploded in 2000, so it wouldn’t be surprising to me if this were the case with risk-oriented bond investors today.

 

My point (finally!):  we know about Mr. Gross.  How many invisible clones does he have, however, running banks’ bond trading desks, fixed income hedge funds or private equity operations?  …what fallout will occur as/when underperformance forces all of them to change tack?  Will it be six months of really ugly bond returns?  How much will spill over into the equity markets?

 

 

 

 

 

 

 

 

 

stocks in lockstep: what’s going on

January 23, 2014 By in Portfolio management, Recent Market Action, Shaping a portfolio for 2014, Stock ideas, Strategy Tags: , , , , , , Leave a comment

US stocks have been travelling more or less in a herd–with, statistically speaking,  little to distinguish he performance of one individual issue from the next.  This sort of thing often happens at the start of a bull market, not almost five years in.

In other posts I’ve described 2013 as a year of “normalization” of the stock market.  During bear markets, fearful investors shift their focus from buying stocks based on anticipated earnings a year or so in the future to concentrating on reacting to actual earnings as they’re released.  Normally, six months or so into a recovery investors begin to reverse this stance and begin to value stocks based on (higher) future earnings rather than historicals.  During this period the market’s price earnings multiple expands.

After the Great Recession, that didn’t happen until 2013.  It took almost four years, plus two years of Treasury security losses–and the expectation that the returns from fixed income would remain negligible for a considerable time to come–for many investors to be willing to take the risk of investing in stocks again.

I think three points are important:

1.  It seems to me that any cyclical asset allocation shift away from bonds has already run its course.  Individual Baby Boomers, who hold much of the wealth in the US, have a distinct age-appropriate preference for income-generating investments. So they’re going to continue to hold some bonds, no matter how poorly they perform.   Also, in what I expect will be a flattish year for stocks, there will be little pain-induced motivation from equity gains to make further asset allocation shifts.

In addition, institutional investors appear to have reached their maximum allowable allocation to equities after a year in which the performance differential between stocks and bonds has been massive.  They may actually be forced to sell equities–although my sense is the reason institutions continue to hire hedge funds (despite a decade of continuous horrific underperformance of traditional managers) is to get around their investment guidelines by reclassifying equity exposure as “alternative” investments.

–I’ve believed for some time that the Great Recession shattered individuals’ belief in the merits of actively managed equity mutual funds.  A shift to index products, ETFs or mutual funds, would explain why stocks have risen across the board.  True, many hedge funds are run by former traders who lack the skill to analyze individual stocks, so they’re index-only players, too.  But that’s been true for years.  Their behavior doesn’t explain why there was less differentiation among stocks in 2013 than in 2010 or 2011.

–Last year’s homogeneity sets up a potential bonanza for stock pickers this year.  There may be some segments of the stock market–the 100 largest names by market cap?  the top 200?– where the asset allocation mindset will continue to dominate, however.  My guess is it will be better to look among smaller names and among stocks that have short histories being publicly traded.  But the important thing for now is to pay attention to the market’s behavior as we get through the quirks of January and into a more normal market next month.

 

(not so) “Happy Meal” convertible bond offerings

October 20, 2013 By in Convertibles, Current Market Thoughts, hedge funds, Investment firms, the Happy Meal Tags: , , , , , , 2 Comments

Pinky, the more astute of the two eponymous stars of the long-running documentary on genetically engineered mice, once opined that “if they called them Sad Meals, no one would buy them.”  So true.

Wall Street “Happy Meals”

Recently, the Wall Street Journal has been writing about a convertible bond offering technique, known as the Happy Meal, which has come under SEC scrutiny.   It shows what a colorful, inventive but cold-blooded place Wall Street is.

The Happy Meal is/was an offering of convertible bonds, in which the issuer arranged at the same time to lend large amounts of company stock to buyers so that they could sell the stock short.

Got that?  …probably not.

So let’s pull the pieces apart.

1.  A company issues convertible bonds.

Convertibles are bonds with a provision that allows them be exchanged for a specified number of shares of the issuer’s common stock under certain circumstances.  Until they are converted, the buyer collects interest income.

Generally speaking, a company would rather issue common stock or straight bonds, or borrow from a bank.  The fact that the firm is issuing a convertible almost always means these other, more attractive, avenues aren’t open to it.

2.  In the case of the Happy Meal companies, the convertible form wasn’t inducement enough.

Conventional long-only buyers turned thumbs down.  Who would these buyers usually be?  …specialized convertible securities funds, or bond funds looking to boost their returns by holding equities.  They avoid violating the letter of their investment mandates by buying stocks wrapped up in a bond package.

3.  That left hedge funds willing to do convertible arbitrage.

That is  to say, the hedge funds would simultaneously buy the convertibles and sell the stock short.  Exactly what a given hedge fund would do varies.  One technique would be to sell short enough stock to eliminate entirely any effect of stock movements (up or down) on the position–leaving the hedge fund to collect a stream of interest payments.  But a fund could also shade its holding to the positive or negative side.

4.  There’s more.

To sell stock short, you typically borrow the stock from a third party who owns it, using a brokerage firm as a middleman.  In the Happy Meal case, that wasn’t possible–either because there weren’t enough holders of the stock or because holders were reluctant to lend.  So the issuing company itself lent the stock that hedge funds dumped out into the market right after the offering.

What a mess!  A company would have to be really starved for cash, in my view, to contemplate serving up a Happy Meal.

not so appetizing any more

Companies have begun to turn sour on Happy Meals.  Two reasons:

–enough Happy Meal issuers have suffered significant stock price declines after their offerings that simply announcing a Happy Meal issue is now enough to make the common stock swoon, and

–according to the WSJ, a retired investment banker has turned whistleblower and reported the Happy Meal to the SEC.

His claim? …that issuers and their brokers are negligent by failing to disclose in the offering documents  how aggressive post-issue short selling is likely to be.

A concerned citizen, yes.  But one who also stands to collect a bounty under the Dodd Frank Act if the SEC investigation leads to significant fines.  In other words, a vintage Wall Streeter.

Ray Dirks, Kevin Chang and other stuff

October 7, 2013 By in Getting financial advice, hedge funds, How your broker gets paid, insider trading, sell-side analysts, Trading Tags: , , , , , , 1 Comment

a $30 million fine

According to the Wall Street Journal, Citi technology analyst Kevin Chang was fired last month.  Citi was fined $30 million by state regulators in Massachusetts for his leaking the contents of a research report to influential clients the day before it was published.  Other investigations are ongoing.

What happened?

The Journal, whose account appears to be taken from the Massachusetts consent order, says Mr. Chang found out from an Apple component supplier, Hon Hai Precision, that Apple had cut back orders–meaning, presumably, that sales of iPhones were running considerably below expectations. Chang wrote up his findings in a report that he submitted to Citi’s compliance/legal departments for review.

While his report was being processed, Chang was contacted by at least one hedge fund, SAC, which was looking for corroboration of similar conclusions drawn in an already released research report by Australian broker Macquarie.  Chang promptly emailed the guts of his report to four clients, SAC, T Rowe Price, Citadel and GLG.

The legal issue?   …selective disclosure of the research conclusions.

not the first time:  the Ray Dirks/Equity Funding case

Mr. Dirks was a famous sell-side insurance analyst back in the early 1970s.  In researching Equity Funding, a then-high flying stock, he discovered that the company’s apparently stellar growth was a fiction.  The firm had a bunch of employees whose job was to churn out phony insurance applications for made-up people, which EF then processed and showed “profits” for, just as if they were real.

When he found the fraud out, Dirks immediately called all his important clients and told them.  They sold.  Only then did Dirks inform the SEC.

Rather than being grateful for his news, the SEC found Dirks guilty of trading on inside information and barred him from the securities industry–a verdict that was reversed years later by the Supreme Court.

two observations

1.  Why put important clients first, even at the risk of career-ending regulatory action?  After all, many sell-side analysts take home multi-million dollar paychecks.

Their actions show who the analysts perceive their real employers are.  Ultimately, they collect the big bucks because powerful clients continue to send large amounts of trading commissions to pay for access to their research.  If that commission flow begins to shrink, so too does the size of the analyst’s pay.

Also, an analyst’s ability to move to another firm rests in large measure on whether these same clients will vouch for him–and will increase their commission business with the new employer.

2.  What happens to people like Dirks and Chang?

Dirks was eventually exonerated.  While he was appealing the SEC judgment, his thoughts on insurance companies continued to be circulated in the investment community.  Only they appeared under the byline of a rookie apprentice to Dirks–Jim Chanos.

Dirks eventually established his own research firm.  Interestingly, when I Googled him this morning, I found that the top search results were all basically rehashes of the favorable information put out by Ray Dirks Research itself.  No one remembers the real story.

Chang?  I don’t know.  He lives in Taiwan, where I suspect he will catch on with a local brokerage firm or investment manager.  As far as Americans are concerned, disgraced analysts or portfolio managers tend to end up in the media.  For example, Henry Blodget, who wrote all those laudatory “research” reports for Merrill touting internet stocks he actually believed were clunkers, now works for Yahoo Finance.  You can watch similar characters every day on finance TV.  Crooked, maybe.  But they’re articulate and look presentable.  And that’s all that matters.

 

 

A world awash in money?: the Bain view

August 21, 2013 By in Bond Environment, Current Market Thoughts, economics, Strategy, Trading Tags: , , , , , , , , , Leave a comment

The other day I was reading a column in the Financial Times that referred to a study by the consulting company Bain.  Published late last year (I missed it then), it’s called A World Awash in Money.

Its basic premise is that the present condition of a “superabundance” of investment capital looking for a place to go to work is a permanent feature of the financial landscape.  Therefore, asset prices will remain higher than the consensus expects; interest rates will remain lower.

Three factors are involved:

–financial innovation, high-speed computing and increased use of leverage have allowed the pool of investment capital in the advanced economies to expand at a very rapid rate over the past couple of decades

–during the same time, GDP in the US and EU has been growing slowly, providing fewer new investment opportunities, and

–emerging economies like China will soon turn from being capital users to capital exporters, significantly increasing the amount of global capital searching for high-return projects to invest in.

In Bain’s view, this situation will have a number of important consequences:

1.  interest rates will remain (much) lower than the consensus expects

2.  in a capital-glutted world, bubbles like those in 1999-2000 and 2006-2007 have a high chance of recurring.  Therefore, investors must be ready to anticipate them and take defensive action

3.  investors will be forced to consider projects with extremely long duration (think: 20 or 30 years) to achieve superior returns

4.  the risks of investing in the developing world, where capital will be needed the most, will become more palatable to return-starved global investors

5.  achieving substantial real returns will require that both portfolio investors and company treasurers abandon their buy-and-hold, long-only mindset and become more like hedge funds.

 

I always find studies like this one interesting.  It’s not necessarily because they turn out to be correct.  It’s that they force you to think about the “big picture” and form an opinion on important investment issues.  In this case, it’s what happens if interest rates stay low.

I also find studies that argue, in effect, that the current state of the economic/financial world will persist for a long time to be particularly worrying.  In my experience, most times they come just before some dramatic and unanticipated change.

My take on the Bain study tomorrow.