Tag Archives: money

the shakeup at Pimco

January 28, 2014 By in bond market, securities markets Tags: , , , , Leave a comment

Pimco shakeup

Last week bond management giant Pimco announced a number of high-level promotions.  But the biggest headline was the resignation of its well-known market commentator Mohamed El-Erian.  Mr. El-Erian, who will remain a consultant to Pimco’s parent, the German insurance company Allianz, had been touted as the heir to Bill Gross (who is Pimco’s version of Warren Buffett) when he was hired back from Harvard in 2007.

Why?

foundering equity business

A small part of this is an effort to revitalize the equity business Pimco launched several years.  It hasn’t had notable success so far.  Maybe this area didn’t have the strongest leadership.  But Pimco’s main overall marketing message continues to be that bonds are a better choice than stocks.  Hard to sell a product when your own company is telling potential customers to stay away.

who succeeds Bill Gross?

The main issue, however, is Mr. Gross himself, who will be 70 years old on his next birthday.

When a star manager reaches, say 60, the first question any potential pension client (prompted by the pension consulting firm he hires) asks in a due diligence interview will invariably be “Who is your successor?”  The client, who is spending hundreds of thousands of dollars on the search for a new manager, has two worries:  what happens if the star retires?, and what happens if the star stays on but (think: any aging sports figure) begins operating at only a fraction of his former speed?

While the manager’s performance remains stellar, this may not be a serious obstacle.  But if it begins to become merely ordinary, as seems to be the case today with Pimco, the age/successor becomes key.

That’s how I read last week’s news.  The promotion to deputy CIO of two bond managers with long practical investment experience and visible track records attributable to them says to me that clients weren’t happy with the idea of Mr. El-Erian as Mr. Gross’s successor.

Three possible reasons:

1.  Mr. El-Erian is in his mid-50s.  If Mr. Gross were to work for another five years (he’s tweeted he’s up for another 40!), then the age question recurs, only with Mr. El-Erian as the subject.  So to have a credible succession story Pimco needs forty-somethings.

2.  Mr. El-Erian’s credentials are unusual.  He’s an expert on emerging markets debt, which makes up only a tiny fraction of the total bond universe.  He worked for two years as the CIO of Harvard’s endowment, where it isn’t clear whether he had a positive or negative effect on returns.  The scanty press reports I’ve read suggest the latter.  Since his return to Pimco, Mr. El-Erian’s main role seems to have been as the public marketing face of the firm, where his professorial demeanor and/or his Pimco connection make him vary popular with financial talk show hosts.

It could be that Mr. El-Erian doesn’t have a long enough, or strong enough, identifiable track record as a portfolio manager for clients to take a chance on him.

3.  It might also be that one or more of the the forty-somethings–who have strong track records identified with them–were about to leave, either to start their own firms or to join a rival.   Their motivation to depart would be that the door to advancement was closed at Pimco by Mr. El-Erian’s presence.   If so, Pimco would have been compelled to choose between them and Mr. El-Erian.

Of course, it’s possible that…

4.  … Mr. El-Erian is leaving Pimco voluntarily.  But the lack of detail he’s providing about his future plans suggests otherwise.

Madoff and JPMorgan Chase

January 8, 2014 By in Banks, Industry Analysis Tags: , , , , , , 1 Comment

another JP Morgan legal settlement

Yesterday JP Morgan and the federal government announced a deal.  The bank has agreed to pay fines of $2.6 billion and to reform its operating practices, in return for not being prosecuted for offenses relating to the Bernie Madoff Ponzi scheme.

Although the press reports are a bit confusing, the offenses seem to fall into two areas:

–Madoff routinely made transfers in and out of his accounts in excess of $10,000 a day.  Chase did not report these to the government as required by anti- money laundering statutes.  At least some of these transfers were rapid-fire movements from bank to bank, designed to allow Madoff to illegally collect interest on the deposits from more than one institution (“check kiting”).

–Parts of JP Morgan refused to invest the bank’s money with Madoff on the grounds that he was running a Ponzi scheme.  Other parts of JP Morgan happily continued to service Madoff, to buy his products, and to help sell them to others. Also, In the days just before Madoff’s arrest, JP Morgan withdrew most of its own money from Madoff, apparently because of fears of fraud.  The bank notified the UK government of this, but, oddly, not the US.

my take

To me, the plea deal is more evidence of a sea change in the attitude of regulators toward the financial industry since Mary Jo White became head of the SEC.  Long overdue.

In my experience, in every company there’s a tension between politically powerful senior managers who are identified with, and benefit from, the revenues generated by someone like Madoff and the relatively junior researchers who understand the facts better and are more aware of what the law requires.  The former can put up immense resistance to fixing problems.  Their allies can simply refuse to act on, or even to read, the case for a different course of action.

I’ve seen some of the Madoff sales materials.  They assert that phenomenally high returns are to be had with virtually no risk.  No explanation of how this is possible, just a simple appeal to greed.

Current media coverage is highly favorable to government investigators.  What seems to be forgotten is that Harry Markopolos, a financial analyst whistleblower with very detailed evidence of the Madoff Ponzi scheme, repeatedly showed up at SEC offices from 2000 onward to present his case.  He was ignored every time.  (Markopolos was asked by his boss to create a clone of Madoff.  He soon realized that there were periods where no assets delivered the returns Madoff claimed.)

The most elementary checks of the phony documentation Madoff prepared would have revealed the fraud.  But in their periodic inspections, the SEC appears to have checked virtually nothing.  Madoff himself commented on how easy the SEC was to fool.

high yield (junk) bonds (ii)

December 2, 2013 By in bond market, Getting financial advice, Industry Analysis, Investment firms, junk bonds, junk bonds, Portfolio management, securities markets Tags: , , , , , , , , Leave a comment

what went wrong

1.  Junk bonds began to be used as a substitute for bank financing–but to a large degree by takeover specialists targeting either mediocre industrial companies or consumer staples firms of any stripe.  In both cases, more efficient management would boost cash flow enough to service the massive debt incurred in the acquisition.  Fear of the required debt service would act as a powerful motivator toward greater profitability.

Arguably, the substantial change of control among underperforming companies during the 1980s that junk bonds made possible laid the groundwork for the industrial renaissance the US experienced in the early 1990s.

Nothing wrong with that.

But in some cases, rapacious acquirers went further.  They targeted well-funded employee pension plans, replacing a conservative investment menu with a diet of exclusively junk bonds.  Others, particularly in the natural resources area, forced the acquired firms to operate for maximum near-term cash generation.  Timber companies, for example, harvested 3x-4x the usual number of trees every twelve months–leaving no time for replacement trees to grow.  As a result, companies went out of business; employees found their pension plans, after the junk bond collapse, unable to meet obligations.  The acquirers just walked away with the cash they’d drained from the firms.

Drexel also pleaded no contest to SEC charges that it illegally supported acquirers through stock manipulation and by helping them avoid 13-D reporting requirements.

2.  By the end of 1986–maybe a little later–Drexel and Milken had done all the junk bond/leveraged buyout deals in the US that made any economic sense.  What to do then  …close up shop or continue to do junk bond deals, even though they made no sense and might ultimately fail.  Drexel/Milken chose curtain #2.

By early 1989, the consequences were becoming evident.  Junk bond default rates were rising sharply, depressing junk bond prices.  To my mind, October 13th of that year marked a tipping point.  That’s when the media reported the failure of a proposed $6.75 billion leveraged buyout of United Airlines.  This was the first big junk bond deal not to get done.  Psychology changed decisively for the worse.

That’s when retail investors, who had been sold junk bonds on the idea that they had all the return potential of stocks plus all the safety of bonds, found out their dark side   ..if nothing else, how illiquid they are.  Junk bonds fell, on average, by about 30% in the following months.  Some investors also found out, to their sorrow, that up until that time their mutual funds had been pricing their holdings at what proved to be unrealistically high levels.

3.  We can all understand, though not condone, why Drexel/Milken would want to continue to sell dud junk bonds.  It’s what they did.  But why would any professional buy them (I know I characterized bond fund managers as not being among the best and brightest in my Friday post, but you;;d think they’d catch on eventually)?

The Federal government had an answer.  It was that Milken and Drexel bribed prominent junk bond fund managers to look the other way and take part in bad deals for their clients.  The Wall Street Journal had an in-depth investigative series on this issue in 1990.  I’ve been unable to find in the the WSJ online archives, however.

The government was unable to prove its case.  A New York Times article and one from the LA Times that describe the charges are the best documentation I can find.

Personally, it feels to me that the government was right, but that it had no way of getting any of the small number of people who would have been involved in a scheme like this to testify against themselves.

still, a revolutionary idea

By the early 1990s, the junk bond market had revived, though on a firmer footing as a result of the government action.

recent currency movements

October 24, 2013 By in Constructing a Portfolio, Current Market Thoughts, economics, Portfolio management, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , Leave a comment

Big macroeconomic changes that affect the relative investment attractiveness of countries vs. one another can play themselves out in two ways:

–changes in the local currency value of the country’s investable assets, and/or

–changes in the value of the country’s currency.

The easiest way to see this is to look at Japan.  The election of Prime Minister Shinzo Abe and the enactment of wide-reaching policy changes he campaigned on have produced two major effects so far:

-a one-year gain of 60% in the yen value of the Japanese stock market and

–a 20% fall in the yen against the US$.

The net result for a ¥-oriented investor is a bonanza–and more joy than the Topix has seen since the 1980s.  For a $-oriented investor, however, it’s a 28% gain.  That’s not much better than the 22% advance in dollars the S&P 500 achieved over the same span.

Looking more closely into the Japanese stock market, weak-yen beneficiaries (exporters and import-competing firms) have been rocket ship rides; domestic-oriented firms, especially those that use dollar-priced raw materials, have languished.

But this is old news.  What’s happening today?

The big movements I see are in the euro and the US dollar.

Over the past three months, the EU currency is up by 4% against the dollar and by 2% against the yen.  The dollar, in contrast, is down against everything except the Canadian currency.  It’s off by 5% against sterling, 4% against the euro, -3.5% against the Australian dollar, -2% against the yen, and -1% against the renminbi.

I think currencies are reflecting two main things:

–primarily, the belief that the EU is finally past the worst economically and is beginning the slow road back to recovery.  Same thing for the UK, only more so.

–secondarily, loss of faith in the US because of worse than usual policy paralysis in Washington.

The big question for investors of all stripes is whether we are in early days of a trend reversal or whether what we’re seeing is just white noise, or random currency movements that may soon reverse themselves.   The answer has important implications for portfolio positioning.

I’m in the former camp.  This means that in Europe, like in Japan a year ago (but on a smaller scale), I should be shifting away from foreign currency earners and toward users of foreign currency-denominated inputs.  I should be doing the opposite in the US.  So far, I’m only changing my (relatively minor) holdings in European stocks.  But I’m worming up to do more.

Atlantic City gambling in 2013

October 10, 2013 By in Casinos, Entertainment, Industry Analysis Tags: , , , 1 Comment

the current situation

In 2006, Atlantic City casinos “won” $6 billion from gamblers there.

National GDP that year was $13.9 trillion.  This year the figure will be around 20% higher.  Using this change as a(n admittedly very crude) gauge for what gambling win for the New Jersey shore resort in 2013, AC should take in $7 billion+.

In actuality, aggregate casino win will be closer to $3 billion.  …and even that 50% haircut from seven years ago may be too high.

How so?

By far the biggest reason is that similar lower-end gambling establishments have been legalized in neighboring states, notably in Pennsylvania.  Why drive when you can get your entertainment in newer venues in Philadelphia, Bethlehem or Mt. Pocono?

The profit situation in AC is in all likelihood worse than that (filings with the Casino Control Commission would show how bad things have gotten, but I haven’t looked).  For reasons best known in Trenton, the New Jersey state government offered $300 million+ in subsidies to persuade foolhardy entrepreneurs to add new capacity into a declining market by opening Revel in 2011.  Already through bankruptcy once, that casino is still up and running in its newest incarnation.  All Revel has done has been to force all casino operators to pay out larger incentives to lure customers in.

At least one more shoe may be about to drop.  Governor Cuomo of New York has been persuaded (thanks to the Lim family of Malaysia?) that his state, too, needs more non-Native American, non-racetrack casino gambling and has been pushing for legislative action in Albany for a while.

how Trenton is responding to the decline

…after the Revel disaster, that is.

–most important, it’s launching online gambling in the state.  Borgata is the first casino to have the service–customers need not be on the casino premises, but must be physically located in New Jersey while they’re online.

–the state has tried to offer sports betting in the casinos, but its thumbs-down to sports books years ago when Federal enabling legislation was being written closed the door to this possibility

–it’s trying to persuade United to service the AC airport, dangling better treatment in its Newark terminals as an incentive, and,

–newspaper reports a while ago suggest the Casino Control Commission has been asked to reconsider its ban of Ho family ownership of casinos (although unless a Ho-related entity were going to buy and refurbish/rebuild an existing casino, I don’t see any positives here).

success = slowing the AC decline?

That’s the best I think Trenton can hope for.

what catches my eye

As an analyst, what gets my attention is the combination of large amount of effort Trenton is exerting, with apparent lack of any forethought.  AC is clearly important to Trenton, but I wonder why there’s so little effective action.

From a stock market point of view, Borgata will soon be giving us some practical insight into the effect of online gambling on casino operations.  Does it bring in new customers (a clear positive)?  does it increase the amount existing customers gamble with Borgata (another positive)?   or does it mostly substitute for visits to the physical casino (presumably a negative)?