Investment Journal

My “Lost” Purchase

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Virtually all of us have been touched to some extent by the decline in stock prices and asset devaluations (houses). I recently was talking to someone and they mentioned this thought experiment:

What if you had spent all the money that was lost in the recent market declines instead of watching it fall in value?

I was walking through River North last weekend when my personal answer sat on the curb right in front of me – a brand new Nissan GTR, valet parked by a high-end restaurant and club. Sure it has a sticker price above $70,000, but it is about the fastest thing on the road and has a great control layout and is a Nissan, to boot (so it likely won’t end up being a rolling pile of junk after a few years).

Nissan GTR

Of course, this is now fantasy-land, since reality binds me to the GTR’s all-too-practical sibling, a 1999 Nissan Altima, nearing a decade in service but still reliable and practical for the almost no driving I do in the city.

Not that I am encouraging this type of thinking (spend it now because it is falling in value), because it is critical for everyone to keep a long term perspective and to plan for the future. These market losses are discouraging but this is life and we need to keep marching ahead and learn from our failures. It is likely that high government spending and large deficits will mean that relying on social security, always a bad plan, will become even less viable, since all the other spending will crowd out this benefit.

But it is a fun thought experiment, especially when it is sitting on the curb, right in front of you…

Cross posted at LITGM

A Random Walk…

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Random Walk
I was reading a Wall Street Journal column by James Stewart recently. He has a column called “Common Sense” which outlines his approach to selecting stocks and investing. His strategy involves buying when the stock market drops 10% and then selling when the stock market rises 25%. This type of investing (which looks at relative market levels) is a type of “technical analysis” as opposed to “fundamental analysis” which looks at the merit of individual stocks relative to financial metrics. To be fair, Mr. Stewart’s model is a mix of technical and fundamental analysis, but the “buy”and “sell” signals are pure technical analysis (in my opinion).

The headline of the article really caught my eye, however:

When bad times get worse, it’s best to stick to a system

That quote reminded me of a line from one of my favorite investing books titled “A Random Walk Down Wall Street” by Burton Malkiel. On p146 he discusses his opinions of technicians which rings eerily familiar:

I personally have never known a successful technician, but I have seen the wrecks of several unsuccessful ones. Curiously, however, the broke technician is never apologetic. If you commit the social blunder of asking him why he is broke, he will tell you quite ingenuously that he made the all-too-human error of not believing his own charts

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Stock Selection

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In the “efficient markets” hypothesis, all available information is factored into the stock price, making attempts to “beat the market” by selecting your own stocks a fool’s errand. Index funds, which were originally stock mutual funds, such as those at Vanguard, not only attempt to mimic rather than beat the index, they also sport much lower expenses. Thus even if the performance was the same for an index as a stock picker, the index would win with costs as low as 0.2% / year as opposed to 1% – 2% / year for managed funds. One advantage that remained of a stock selection methodology over mutual funds was related to taxes – individual stocks were definitely more tax efficient if handled correctly; now index ETF’s have erased that lead.

Of course, theories don’t always work in the real world, as the recent financial meltdown attests, when AAA rated financial instruments took significant losses. In a similar vein, those in favor of active stock selection could always point to a few candidates to make their cases. One candidate was Bill Miller, head of the Legg Mason Value Trust, who beat the S&P 500 for 15 consecutive years.

Bill Miller

While Bill Miller may have been the “poster boy” for those that point to active stock pickers, he was a reticent candidate. He even said that a lot of his “streak” was due to timing on the calendar and didn’t strut around like a world-beater. Thus I didn’t take much pleasure in the this article…

Bill Miller, whose Legg Mason Value Trust achieved the unlikely feat of beating the S&P 500-stock index for 15 consecutive years, has become the fund world’s punching bag. So far this year, the fund is down a devastating 56 percent on account of bad bets on stocks including AIG, Washington Mutual, and Freddie Mac. This horrific year (combined with lackluster results in 2006 and 2007) has banished Legg Mason’s crown jewel to the ranks of the worst-performing mutual funds not only for the year, but for all standard periods of measurement.

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Private Equity

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Private Equity Superman

Recently I wrote about the troubles in hedge funds, where easy money in terms of 2% of assets and 20% of profits (easy to find when the market was moving up) has evaporated. Another field where someone a few years out of (an elite) college can make millions is… private equity.

Wikipedia has a decent summary of private equity. Private equity typically consists of taking a public company private by purchasing their equity shares, taking actions to increase the value of the company, and then re-launching the company back in the public markets and “cashing out”. Another path to private equity consists of taking equity stakes in start up companies (like the famous venture capitalists in the dot.com era) and then earning profits when the company goes public. Often the private equity firms raise “funds” with a time horizon, typically ten years, where they invest the money in a variety of investments and then the money is returned to investors at the completion of the fund, whether it results in new profits or losses.

Along with hedge funds, private equity made up a large component of the “alternative investments” that many endowments and wealthy individuals started to invest in en masse in the late nineties and into the current decade in search of higher returns. Typically these sorts of investors put their money into public market equities, debt and real estate – this “alternative investments” were supposed to bring higher returns and also not be not correlated with equity, debt and real estate.

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Hedge Fund Blues

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Barrons\' Hedge Funds

The hedge fund industry is coming under close scrutiny for a variety of reasons. In fact, it seems like that bad news doesn’t stop.

– Madoff runs a giant Ponzi scheme that claims up to $50 billion in losses. The exact amounts will be different because some of the “losses” represent paper profits on statements that he sent to customers that were phantom but assuredly they are large and painful
– Worse than this scheme was the fact that so many “fund of funds” or hedge funds that are comprised of investments in other hedge funds charged a big fee for the right to invest in this fund in the first place. Gulp
– Many funds that claimed they were “hedged” against market moves (where the “hedge” in hedge funds comes from) most assuredly were not; large losses of 40% or more are common in the listings, and some very big names have been seriously bruised

More subtle than these obvious issues are the fact that these hedge funds often have “high water” provisions. Funds typically make money by charging an annual fee of 2% a year and 20% of profits. However, if the fund declines in value, the hedge fund can’t charge the 20% fee on profits until after the old “high water” mark in value is reached. Thus if your fund was down 25% this year, you have to gain 33% before you can start earning your 20% cut again. On top of the “high water” issue, if your asset base drops 40% (remember those losses, above) then you are only making 2% on 60% of your former assets.

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