Every well-known person in the investment world, from Warren Buffett to Donald Trump (including DT may be like calling Paris Hilton a hotelier), is some combination of talent, drive, self-promotion, and right-place, right-time. Normally, a highly crafted public persona is all the public is permitted to see. Occasionally, though, an event occurs that gives us a chance to see behind the veil. Two such moments have caught my eye recently.
Jim O’Neill and the A-list
1. Jim O’Neill invented the term BRICs while he was the chief economist at Goldman. He’s now the head of the firm’s wealth management division, and one of the celebrity columnists the Financial Times’ has grouped together under the rubric “A-List.”
In an A-List contribution this week, Mr. O’Neil wrote that a contact of his in Japan had just tipped him off to the existence of Renesas, a semiconductor company whose loss of production capacity in the March earthquake/tsunamis is a key factor in subsequent supply chain disruptions throughout the world. Had he known about Renesas, he would have taken a less optimistic view of near-term global economic growth.
It’s hard to know what to say.
First of all, Mr. O’Neill apparently doesn’t read the newspaper–at least, neither the Wall Street Journal nor the Financial Times. In both, Renesas was quickly identified as being a key element in many supply chains and as having lost a very large amount of production capacity due to the March 11th disaster.
Also, in the early 1980s the Japanese technology industry took a disastrous wrong turn by deciding to concentrate its efforts on commodity semiconductors like memory, rather than to branch out to areas like logic, which have higher design content. This saddled Japan with a bunch of MUs rather than INTCs or TXNs. It also left the country vulnerable to price competition from emerging economies–first Korea and later China, when it designated semiconductors as a critical focus for industrial development about a decade ago. You’d think even a macroeconomist might know about that.
Finally, even if we say that it really isn’t part of Mr. O’Neill’s job to know much himself about technology or Asian industrial development, you’d hope that someone in the wealth management division would be up to date on stuff like this. There’s apparently no communication between Mr. O’Neill and whoever it is who’s actually steering the ship.
the story of Sino-Forest is another bizarre one.
2. John Paulson runs the hedge fund Paulson & Co, which has $38 billion under management. The firm made its reputation by betting heavily against the housing market from 2007 on.
If we take the assets under management and assume a 2% management fee, then the firm is generating annual revenue of about $700 million, even without considering the 20% of profits it potentially earns. Subtract $100 million for marketing and administrative expenses–I’ve just plucked that number out of the air. I think it’s much too high, but that doesn’t matter. What’s left over is $600 million, which pays for the investment research prowess of the firm’s professionals.
That’s a ton of money. It’s more than all but a handful of investment organizations globally have to fund their research organizations. It’s more than most buy-side firms have; its more than most sell-side firms allocate to research. It’s enough the Paulson should be better informed about the areas he chooses to invest in, and the securities he elects to hold, than anyone else on the planet.
I don’t know the Paulson managers, but it seems their expertise is in the US, the global bond market and in financial stocks.
Why, then, would they buy 14% of Sino-Forest, an obscure Chinese forest products company, using 1%+ of their clients’ capital to do so? And why would they know so little about the company that as soon as short-seller Muddy Waters issues a negative report on the company they sell the holding, taking a $100+ million loss (over $500 million, based on the opening stock price this year).
I’ve glanced at the Sino-Forest financials. They look ok to me. They’re audited by a major accounting firm, which gives them an unqualified opinion (in other words, a clean bill of health). The Wall Street Journal reports that Paulson looked at the financials, too, listened to management conference calls, had follow-up phone conversations with management and had an analyst visit the company in China.
For a $600 million a year research operation, that’s not doing much. And it’s certainly not enough when dealing with emerging markets. After all, too, that’s probably what the average investor with Bernie Madoff did.
Paulson also seems to have ignored a number of red flags. In particular:
–although it’s a mainland Chinese company, Sino-Forest isn’t listed on any mainland stock exchange, nor is it traded in Hong Kong. These are the natural destinations for a Chinese firm. Maybe Sino-Forest couldn’t meet the listing requirements, or withstand the informed scrutiny of local institutional investors. That would be my first assumption, and a major source of risk in the stock.
–the forest products industry in Asia is highly politically charged and has had, to my mind, more than its share of stock market scandals. So it’s not the first place I’d look to invest.
–ownership of anything in China is, in my opinion, a slippery concept. It takes a lot more than listening to management to figure out what’s going on.
–China has no structural advantages in forest products vs., say, Indonesia, Brazil or even New Zealand.So Chinese forest products isn’t even the best of a bad lot.
–the Sino-Forest story, as I gather from press reports, is that the company uses semi-legal means to acquire access to forest lands, and sells the wood it harvests through other semi-legal channels. Not a great concept. When you think about it, if the company makes its money by manipulating the laws to the disadvantage of its suppliers, what makes you think the company won;t do the same thing to you?
If we figure that the Paulson research budget was spread evenly over the positions it holds based on their size, then the company spent over $20 million since acquiring the stock in 2007 on the portion of the portfolio that Sino-Forest represented. This was the best it could come up with?
My hunch is that selling the stock when it did was the right thing for Paulson to do. But selling also seems to imply that Paulson knew nothing in-house that would refute the Muddy Waters’ research. In other words, Paulson didn’t know much at all about its close to billion dollar position.
On rare occasions, stuff like this happens, even to professional investors. Once you realize you’ve made elementary mistakes, cutting your losses is the best option. But it’s still extremely embarrassing.