Probabilities

That's what risk management comes down to. Probabilties.

The CEO of Wegelin & Co. clearly understands this. In this article, I think he makes the best quote I've heard in a while on the topic of managing risk.

It's conceptually simple, yet difficult in practice. You have to constantly calculate and re-calculate the probability of a favorable outcome, and when you have the advantage, press it HARD. When you've lost the advantage, then you don't bet. You will not always win using this system, but you'll win significantly more than you lose (based on outcome). That's what is doing here. They've lost the advantage, so they refuse to make the bet.

Will this affect some of their customers? Of course. However, they are clearly on the side of bank secrecy and that's fine. They are forward and upfront about that. The risk of having to expose their customers with US holdings is now greater than it had previously been. As Mr. Hummler noted, "My responsibility toward clients has to include any kind of probability, and if I see a real threat then we have to act." This is the kind of thinking we should all get from our fiduciaries! The risk may be small, but it is non-zero. The penalties are very real, and the overall exposure is incalculable, as well as the increased reputational risk of giving up your customers like UBS. I'd say the advantage has been, or will be, lost!!

Something to think about. Until next time...

Second Order Effects Redux

What was that I once said about second order effects? As my friend Equity Private might say, "Finem Respice".

Back in the Game

Wow!

It seems like forever since I posted. I know my readers probably feel similarly.

What happened, you ask?

The short answers is that both Velocity 2009 and Structure 09 happened. Both of these conferences, geared toward the Internet industry, occurred back to back last week in San Jose and San Francisco, respectively. Being employed in this industry, and extremely interested in the issues these conferences cover, it was imperative that I attend both. Along with, I spent some time working in my company's facility in San Jose, CA, which means that I can now officially claim a tax deduction for the airline flight to San Francisco, partial usage of the very nice rental car I gave myself, and my hotel room.

Unfortunately, my company did not see fit to send me to California to learn how to better serve our customers. Well, because, customers aren't that important anyway when you're a monopoly. You're going to get your pound of flesh one way or another, and 2 pounds on a good day. The tax deductibility of the 2 days I did work takes some of the edge off the fact that I was not fully able to enjoy my trip as a "vacation". I think I'll be returning some time in the near future, and I won't be working when I do.

I was in the Silicon Valley/Bay Area from 18 June until 25 June before taking off to Atlanta for a cousin's wedding. I have to admit, spending time in the Bay Area after such a long time away really made me consider moving back to California. There's just something about the thinking, the ecosystem, the infrastructure which has already been put in place and the people who are part of it. I don't generally like most Californians, but that could have a lot to do with spending so much time in southern California. NoCal and SoCal really are 2 separate states. For example, after Structure 09 concluded, Canaan Partners sponsored the post-event cocktail reception at which I met several very interesting people including Andrew Shafer of Reductive Labs and the great Paul Kredrosky himself. For some reason, this kind of experience only seems likely in Silicon Valley.

While I was gone, my positions in UCO and UNG didn't do too much, but they didn't move against me, which was welcome. I'm still monitoring them closely, probably even more closely now than I had been. The time is approaching when I have to unwind some of these positions. I still like the long term potential for natural gas, and I think oil is an obvious play long term. However, I also think short term technical factors may begin moving against both of these positions shortly.

While I'm at it, if anyone has suggestions for an oil ETF besides UCO, please chime in via the comments. I don't like the fact that UCO is an ultra (2x) ETF, for well known reasons. I want something with better characteristics and less inherent risk.

Anyway, that's what I did on my summer vacation. In the coming days, I plan to write a bit about some of what I did, as well as give my quarterly recap on my personal finances and goal achievement. 2Q2009 wasn't too bad on either front, and with a few tweaks to my debt payment plan, I think I'll be able to achieve my ultimate debt goal for the year.

Stay tuned, and thanks for sticking with me!

Selling Out

Yep, I did it.

I sold 60% of my position in UCO to lock in my gains. With the exception of $500, I've taken out my entire investment of $5500 (approximately). My remaining position would have to see UCO hit $2.50 in order to wipe me out. From here on, it's all profit. Having a smaller position in UCO is reassuring, as I now have some capital to deploy in other interesting ways, including possibly buying back into UCO or other oil related investments.

I still think the overall direction for the markets is down, at least from this point. How much further down and for how long are questions I don't have answers to. So getting out during yesterday's downdraft was fine by me. I really should have had a selling plan together, but I've been preparing for a trip to San Francisco and have been distracted by the details. Watching the European and pre-market US action yesterday was a wake up call!

So what's next? I have no idea. This money is my original investment, so the search is on for a worthy vehicle. My broker will be lifting day trading and margin restrictions on my account next Wednesday (hopefully) so that is very welcome. For now though, I feel like trading on a 3 - 12 month timeframe. I guess it's time to do some research. I really wish I could do equity options trading though. Certain things would be so much easier. Oh well. *shrug*

:)

Until next time...

Too Big to Fail or Unwind

Short US Treasuries and Long US Treasury CDS FTW!

Okie, I go now...

How Dasan Is Investing Now

Those of you who follow the hardcore investors and finance types on Twitter will recognize the name Dasan. A very sharp and witty guy who manages a portfolio at an unnamed hedge fund, Dasan recently published an analysis of how he is currently investing and how his investment process works. Fascinating reading from an investment professional. Check it out!

Stopped Short

I mentioned in my last post that I was stopped out on UGA. Total bummer really, but that's also the point. While the loss would have been temporary, I now have capital to re-deploy elsewhere.

So what happened, you say?

I entered this 100 share position at on 19 March 2009 at $24.82. I went light because I didn't have a lot of capital to deploy, and I really haven't like the price point on UGA. Basically, for investing in the oil patch, I get more value elsewhere.

My stop was filled at $29.26, for a per share price, after commission, of $29.19. My stop was placed at $29.25, which I thought was loose enough to prevent all but the most egregious of downdrafts based on UGA's trading history. Clearly, it should have been a bit looser.

Profit, after commission, came to 17.6%. Not too bad for a 2 month holding period. While I would have loved to continue holding UGA, I have been able to pursue some other ideas with the freed capital. So things eventually work out. I have no interest in chasing UGA on the way up, even though I think it has a bit further to run. I'd rather deploy capital in more efficient ways and focus on getting a 2 or 3 bagger, if not more.

Remember, cut those losses short. But there is nothing wrong with taking a profit. Just don't take them too aggressively. Always let your winners run if you can.

Until next time...

Ooops!

Actually, it was more like "damn!!" but you get the picture.

That's what I said on Wednesday when I pulled the trigger on a trade. Why did I curse my trade? Because I'd selected a limit order instead of a stop, and in short order, 1/6th of my holdings of UCO were gone at a price of $10.54 per share.

Let me clear. I'm not upset because I made a profit. It's kind of hard (and stupid) to be mad about that outcome. I am mad because my profit was only $1.99 per share, with an entry of $8.40 for those shares (on margin). So, if we do the math and subtract $14.00 in commissions, my gross profit was 23.67%. Not bad for a position entered on 31 March. Of course, none of this includes tax calculations, but I have enough previous losses to offset the small amount of taxes here. I've also not subtracted margin expenses, and if I can get clarity on that point, I'll update this post or post anew.

Still, my net profit works out to be about 14 - 15% over 7 weeks, or 104 - 111% annualized. Not too shabby. Now to wash, rinse and repeat!

So in the future, I warn everyone to make sure that you set the trade type appropriately with your online brokers! Don't be like me. Don't give up profits early with stupid mistakes.

NOTE: We'll discuss getting stopped out of UGA the following day in a later post.

Happy trading!

Exogenous Price Shocks

It could just be me, but what I found to be most interesting in the 20 May post from David Kotok of Cumberland Advisors was the story about corn ethanol and its effect on "food insecurity" in Zambia (and by extension, around the world). 2,500,000,000 affected by bad US policy on corn ethanol. Brilliant!

My only question is how can I benefit without trading in corn on the CME? Trading grain futures and options on them handed me my own head once. There may not be a clear path to profitability for the small speculator, but I plan to keep looking. I'm all for capitalizing on bad public policy.

That's all for now. Until next time...

Peter Thiel on Financial Markets and The Singularity

I will definitely watch this again, but a few things struck me about this presentation by Peter Thiel. (For the unaware, Thiel was the CEO of PayPal who sold the company to eBay. He runs Clarium Capital Management LLC, a global macro hedge fund, and does early stage investing, mostly through The Founder's Fund. He was one of the first investors in Facebook and a bunch of other well known Web 2.0 companies.)

First, Thiel really is nerdier than I expected. I was hoping there was a suaveness to him, a relaxed confidence borne of his intelligence and success both as an entrepreneur, an academic and an investor. No. There really isn't. He's as nerdy looking and sounding as one would expect from reading about him. I'm not sure what to make of this, and it really means ABSOLUTELY NOTHING, but it caught me off guard. He's also a very unpolished speaker. Again, this is not a problem or a bad thing, but I always find it difficult to listen to people who overuse "ummm" and "uhhh" and "you know" in their speech. In Thiel's case, it is probably a matter of his thinking faster than he speaks, and his speech having to catch up with this (disorganized and chaotic) thoughts. However, it only serves to obfuscate his message and, to me personally, makes it almost painful to listen to him. He should probably spend more time preparing and organizing his thoughts when he is to speak to crowds.

Second, I think Thiel has misunderstood Warren Buffett's investing strategy. Maybe Buffett, and by extension Berkshire Hathaway, has invested in The Singularity better than anyone else. However, I don't think that was his objective. Buffett and Berkshire have been doing the very logical thing - managing risks and probabilities. Insurance is the ultimate business of managing risks and probabilities. The insurance business is basically about probability, and this fits with Thiel's singularity thesis because it comes down to managing the fat tail risks.

Thiel makes the point, several times, that there are all of these potential outcomes in a non-Gaussian distribution of risks, from -- for example -- an investment boom being the beginning of "The New New Thing" which will revolutionize life on Earth to just being an extended investment mania. He uses the Japan bubble of the 1980s, the Internet bubble of the late 1990s, the real estate bubble in the US in the early part of this decade and the pursuit of the control of space in the late 1960s as is representative cases. In most of these cases, there was a span of time during which great wealth (or "wealth") was created, followed by a spectacular collapse -- boom and bust.

Thiel continues on to mention that Buffett, by way of Berkshire Hathaway, is investing in the The Singularity by writing insurance against catastrophic events -- the busts. However, I think Thiel has missed some things. First, Berkshire is not new to the insurance business. Second, insurance -- basically, writing puts against given outcomes, which I think of as the best description -- is a well known business with solid underpinnings. Buffett understands this, and uses this to his advantage. The Berkshire insurance businesses are cash generators, and Buffett has intentionally steered away from certain lines, or approached them carefully. For example, Geico only recently began writing renter's and home owner's insurance, after having been in the auto insurance business for a long time. Geico has also been known as the company that would only take on the best drivers (e.g. the lowest risk drivers) and dropping coverage for drivers after a single accident (cutting losses early). The cash thrown off by the Berkshire insurance businesses has fueled Berkshire's acquisitions of other lowly valued businesses (on a fundamental basis) as well as it's war chest, which in turn had driven it's AAA credit rating (until recently).

Even Warren Buffett's mistimed (?) derivatives bets are nothing more than insurance plays. They are bets on the probability of certain outcomes, including the level of the S&P 500 equity index in almost 20 years. While the positions are underwater now, and Buffett can be considered hypocritical for calling derivatives of all stripes "financial weapons of mass destruction", he is fundamentally making similar bets as any of the insurance lines his companies write.

I say all of this to say that Buffett doesn't invest in insurance businesses due to some recognition of or belief in The Singularity but simply because he recognizes that probability is on his side. Everything has risk, but insurance, such as it is (outside of the realm of catastrophe, for example), is well known and generally a cash cow due to the small payout in claims against the large revenue in premiums. Maybe Thiel knows this, but he seems to express a view that Buffett has some grandiose "black swan" perspective on investing. I, personally, think not.

Anyway, it is an interesting presentation and not a bad way to spend 20 minutes of your time. Will you gain any new insight here? Probably not. But you never know. Maybe something he says will land with you in a way other talks have not. Check it out if you have the time.

Until next time...

Trading Report: Risk Management

This report will describe the lessons learned from my experience trading DXO, the PowerShares DB Crude Oil Double Long ETN (exchange traded note). Hopefully my experiences will serve as a warning and a guideline to those of you reading this. We should always seek to learn from our mistakes, and to make new ones as opposed to making the same ones repeatedly.

After my previous experience trading DXO, I figured I could use it as a vehicle for some trading gains. I believe in the long term thesis around commodities, and oil in particular. I think that $200 oil and $5 gasoline are eventualities in the US. I chose DXO as the vehicle because of its extremely low price and embedded leverage, making it, as @marketfolly remarked "a call option on oil". Nice!

The problems with this particular idea were manifold. First, DXO is an exchange traded note as opposed to being an exchange traded fund. If, for some reason, the sponsor were to go bankrupt or some other restructuring, the holder of DXO becomes an unsecured creditor of the sponsor. That adds counterparty and credit risk to the inherent market risk. Over on the Market Folly blog, there was a guest post by @tradefast which covered some of the details of trading oil via ETFs and ETNs, including the counterparty risk issues. That guest post is a must read!

The next problem is that DXO is a double long ETN. It seeks to replicate 2x the movement of its underlying index. For example, if the index moves 1% up on a given trading day, DXO should move 2%. Thankfully, in the case of DXO, this calculation is done on a monthly basis as opposed to daily, making DXO slightly less volatile than it could otherwise be.

My first, and probably biggest, mistake in wielding DXO as a trading vehicle was to not use stops. I really have no excuse for such an egregiously stupid act, and the market punished me accordingly. Generally, my stops on DXO ended up being far too tight, and I would get stopped out much sooner than I really had a tolerance for. Either that or I would get stopped out right before a bottom. While setting proper stops on DXO is difficult due to the high volatility, at least having them in place would have (possibly) prevented the $6000 meltdown that I experienced.

The second problem I introduced was using bad position sizing. This may be the most critical failure. Given the price range DXO was trading in at the time (January - mid February 2009), I accumulated a sizable block of shares, somewhere in the neighborhood of 6000. This represented at least 50% and probably closer to 60% of the assets in my brokerage account. What's even worse, I had this oversize position on a security which essentially acted as a call option! This increased the overall volatility of my portfolio and created more stress than anything. It was a completely irresponsible action on my part.

My third problem was failing to construct a proper trading plan."Plan your work, work your plan." Simple, right? Not if you don't create the plan! I was trading DXO by the seat of my pants, and thus, by emotion instead of trading it in accordance with the plan I constructed. This caused me to buy at bad times, sell at bad times, and generally overtrade. Overtrading is the quickest way to deplete your funds, it seems to me. But the biggest issue with failing to construct a proper trading plan - and adhere to it - was being swept up in the daily volatility and gyrations of DXO. For a security that moves as violently as DXO, with built-in leverage to boot, you absolutely must have resolve in your idea. If the facts change enough to warrant getting out of the trade, then so be it. All of that is testable against your plan, however. If the market conditions, when compared to the plan, tell you not to do anything, then you don't. If they do, then you do. The trading plans adds clarity, focus and structure to what can easily spiral out of control into a emotional quagmire.

So, all of that said, what practices can be put into place to prevent these mistakes from recurring?

First, creating a trading journal is a must. Dr. Brett Steenbarger talks about this here. There's really nothing more for me to say on the topic.

Second, no day or swing trades will be undertaken without an accompanying trading plan. Long(er) term position trades or investments (12+ month time horizons) won't require this level of detail to enter the position. There would be nothing wrong with doing so, though. The trading plan is a tool to enforce discipline in the face of emotion. Since the emotion, for me, is a much stronger factor when dealing with the short term trades, I will focus on optimizing my routines for those cases first.

Third, I have created a new rule that any trade, long or short, will be made with an accompanying stop/loss order set. Discipline is required to keep up with this one, at least until I change to a new broker. My current online broker (who shall remain nameless to protect the guilty) sucks but there's little I can do about that at the moment.

I may delve further into this topic and the specific actions I took that led to this point. Deconstructing them may be instructional. But for now, I hope this analysis is interesting and useful to someone.

Until next time...

Trading the 401(k)

There are plenty of reasons NOT to do this, but I would expect that many personal finance bloggers do so to some degree. Definitely not all, but the number is surely non-zero. Even respected professionals such as Teresa Lo advise against it for most people. However, the opportunity is just too good to pass up. This is the first of potentially many instances in which I plan to do this over the coming years.

To start, due to the almost 20% bounce off recent market lows, my 401(k) is has gained slightly over $5000 in value. Not a huge amount, true, but hardly non-trivial. So it seemed like a good time to lock in some of these gains. I am a believe that we have not seem the bottom of this bear market, and this is simply a violent bear market rally. As well, the numbers I've seen in my 401(k) strongly suggest that to me.

I started by rebalancing completely out of my employer's equity fund. I have been greatly disturbed that my employer pays 401(k) contributions as equity. I already draw my paycheck from this company. Being doubly long by holding such a significant amount of equity (about 6.37% of the total value of the account) on top of my income is a worrisome state. Thankfully, I was able to sell all of my current holdings, which are up 10.7% since the last time I updated my asset allocation spreadsheet. Future contributions will still be made in stock, but this I can't stop so there's no sense in worrying about it.

Next, I liquidated all holdings, both equity and fixed income. With the exception of the bond funds, all of the holdings are up double digits in the last few weeks. (I last updated my spreadsheet earlier this month.) I think a decline is imminent across most equity markets worldwide, and I want to accumulate as much dry powder as possible for future deployment. Hopefully, I will lock in significant gains and more importantly, avoid the downside after this rally fizzles out.

For the record, the holdings in my 401(k) were up as follows: US small cap equities up 16.66%; emerging market equities up 13.06%; international mid-cap equities up 12.38%; US large cap equities up 15.39%; US large cap equity index up 14.85%; international large cap equity index up 16.57%; US real estate up 20.27%.

Anyway, we'll see how this works out. I don't anticipate significant upside movement on any of my holdings, and if I'm able to avoid the next leg down, then I'll have the resources to acquire even larger blocks of shares on the way back up. Mind you, I think it will be a long way back up, several years in the making, but I'd like to take a value investing approach to this, while exercising some downside risk mitigation.

Wish me luck!

Recessions & Recency Bias

Over at Infectious Greed, Paul posted this interesting chart the other day. It illustrates how few people currently working in American society have any real experience with a severe recession. The number is pretty small indeed. Take a look.

Even someone 45 years old probably was not in the workforce, or barely in the workforce, in 1981 - 1982. There are going to be a lot of people unpleasantly surprised by the extent of this downturn, as if there haven't been enough already.

What I found most interesting is the comment from rdd regarding the best things he took away from the experience. (He mentions entering the workforce in 1981, just in time for the second half of the infamous early '80s double dip recession.) Needless to say, I agree completely with his lessons. The one that stands out most vividly is to develop skills that others don't have. One of the biggest - if not THE biggest - secrets to success I have encountered is being able to do that which other's can't, or even better, won't. If you are the one who will, you make yourself that much more indispensable. Use people's laziness to your benefit.

That is all.

PE Liquidations among Endowments

I'm wondering if any non-Ivy schools are taking advantage of this opportunity to acquire stakes in private equity funds on the secondary market. This isn't the first that we've heard of this story, and it likely won't be the last. However, if any endowments were sitting on some liquidity, this is sounds like a decent entry point with some well respected PE names.

*cough* Howard U.? *cough*

Of course, what is more likely is that these non-Ivy or non-first tier endowments are probably trying to liquidate their portfolios too. So sad.

These first tier endowments are getting hit by MTM accounting rules too? If smaller endowments can't get at least 50% off, then something is terribly wrong! At 50% or greater discounts, some of the LBOs of the last few years sound fairly reasonable. But its going to take even greater discounting to squeeze $120B in assets into $40B of investable capital.

When I originally started writing this post, Harvard had not yet reported their latest results. Down 22% (WSJ.com sub req'd) since the start of the fiscal year. Wow!

I contend that there is plenty of alpha out there to be gained, but it will take creativity, negotiation skills, and iron will to earn it. The days of easy alpha (more accurately, alternative beta) are over for the near future. Is this one way some of the second tier endowments can catapult their results into the stratosphere? Hell if I know! But I can fell the abundance of opportunity, and it gets more pronounced with every leg down. The question is who will take advantage of it?

Ratings Agencies: A New Model

One of the fundamental breakdowns of this credit crisis was in the ratings agencies (technically, the Nationally Recognized Statistical Rating Organizations - NRSROs).

This article over on the Financial Times gives a nice overview of the growth of Moody's and the NRSROs, especially in the structured finance arena. You should check it out, twice if you're not really a follower of the market.

The big takeaway from this whole crisis, on the NRSRO side, is that the appropriate compensation model for the NRSROs is for their customers to be the buyers of bonds and other credit products. Additionally, they should probably be private versus public organizations, much like SC Johnson. Many firms are public that have no good reason to be. I am all for public markets, but when a firm serves such a large public role, being publicly traded is probably a handicap as opposed to a benefit. Adding a touch of the Google internal stock market is probably a good idea for these private firms, but their shares do not need to trade on public markets. I really don't get this desire for firms to be public, except if they are struggling. Maybe all those LBO targets are on to something? (About being private, anyway. It sure isn't their business processes.)

As for the point of credit buyers paying the ratings firms, this is ideal because they are the ones who ultimately will benefit from the research. The current structure invites severe moral hazard. The FT articles mentions that the complexity of rated products forced growth in the size of Moody's in order to rate these large entities and the esoteric products coming into the credit market. Well, maybe scale was required, but the flip side of the subscription model is that if a corporation will not allow the NRSRO to rate its product -- if the corporation willfully decreases transparency into its credit quality -- then a suitable discount must be applied in the market to compensate for the lack of information. This is the ONLY model that makes sense. Without the information, the opacity should force the market to discount the bonds, commercial paper, convertibles, or structured product being sold (or underwritten) by the corporation. That's not fair -- its just plain good sense and good business!

The final concern becomes the models themselves. As has been widely noted, the NY Times covered this recently. The models are just mathematical equations. They have no position on this subject; they are merely tools, and like any tool, they can be misused or misunderstood by those wielding them. Human frailty (and that damn good sense) come into play here again. The Times piece looks at how quickly humans were willing to set aside their reason in the pursuit of compensation, or assume that the real world was accurately reflected by the models.

The models were not then, and are not now, the problem. The problem is the gatekeepers wielding the models. Once a flaw - a programming bug, or worse, a design flaw - was found, anything rated with that software should have been re-rated. The decision to NOT re-rate those issues should be considered an act of negligence, possibly willful and criminal negligence. Models will evolve if their creators update them. Secondly, if any product has little to no history, then you cannot reasonably rate it based on historical performance of any other product.

So if you're out there in the credit market in any way, you owe it to yourself to do SOME credit analysis on any product you might buy. Whether we're talking bond funds, or direct investment in credit products, you have to understand what you're buying on some level. Credit analysis is more difficult than equity analysis. Such is life.

So to wrap this (very late) missive up, the ratings agencies can serve a useful function. However, their role of being public watchdogs, a la the press, must be honored. Otherwise, that role is better subsumed within a unified regulator (whenever the SEC and CFTC merge), and let's face it - we don't want that. This is something that is probably better suited to government functionally than most other tasks it takes on, but it still should be a market function. Government could provide credit research and publish it, for free even, but would that research be very good? Could it be subverted? A market system for credit research will go a longer way to promoting the transparency and lack of conflict that investors deserve. Adding that value should come with a price.

Clicked

This has been floating around in my mind for a while, but it all just came together right now as I finished reading the Bloomberg article referenced in my last post.

Whenever you hear someone make an analogy between almost any advanced derivative or structured product and some simpler product, the simpler product is almost always a call option. There is almost a 100% chance that the simpler product will be an option of some sort, but usually, it is a call option. If THAT doesn't convince you to just trade the underlying options directly, I don't know what does.

Just a thought.

Laziness Insurance

So I'm finally catching up on some reading, post-vacation. After getting about halfway through this piece of reporting at Bloomberg.com, I'm once again led to wonder who the hell would buy a principal protected note. Ever. From anyone.

The Japanese and Chinese investors, apparently, and as usual. Somehow they seem to embrace a product just as it is getting ready to implode.

Think about this shite. After some term, you are guaranteed - GUARANTEED - to get back your principal. Return of principal versus return on principal. Fair enough. However, did no one calculate the loss due to inflation?

No laughing!

If you're that inclined to lose money, why not just get a regular bank account (in the US)? I don't know what the HK folks had at their disposal, but somehow I imagine there were safer products, plain vanilla products, available for purchase. The whole notion of principal protection, while it sounds good, should more accurately be considered an insurance policy against doing one's research. We see how well that works out. Doing the research improves your odds.

(It made sense in my head. Hopefully it makes sense when you read it. If not, that's what the comments are for.)

So what have we learned, if nothing else, childrens?

1. To hell with the bells and whistles. If you don't understand the product, and most importantly, the risks attendant with investing in the product, you don't purchase it. Salient advice for all time.

2. The game IS risk management. This is a world of probability. While it could be said I am re-stating #1, I don't fully agree. You must always be present to the risks around you, because EVERYTHING, even the safest of activities, have some level of risk. Look at the swap spreads on US Treasuries to see what I mean - even the "risk-free" investment has risk. Can you live with the risk? Can you hedge it? Because you can't eliminate it.

3. Beware asset gathering. Any firm which has rumors swirling around it that introduces a high return product is probably trolling for funds. So consider this, and be sure about where you land in the capital structure if said firm goes tits up. Basically, see #1. If BSC had already been chewed through, and you're an unsecured investor in Lehman Brothers, the #4 investment bank, you're next in line to be chewed through. So if you MUST buy, buy quality, and that means buy Goldman unsecured products. Duh!

4. Don't bet what you can't afford to lose. This goes for the $100 I blew in Vegas playing craps this past week, and it goes for the $2B US that those suc...investors in Hong Kong will be blessed to recover. (I'd say lucky, but you create your own luck.)

5. Do your homework. Swap spreads and the death of BSC should have told people to avoid Lehman structured debt products.

6. Homie don't play dat!

Oh, and if you ever feel the need to be separated from your money that badly, just give it to me. I accept PayPal donations. At least that way, you know its going to a good cause - liquor and women, although not necessarily in that order.

:)

G'night, all!

New FDIC Insurance Calculator

Very nice! Hat tip to Bob Brinker.

Buffett's Latest Buy

This is really just a stream of consciousness post.

A friend of mine sent along a recent Market Mover's post by Felix Salmon over at Portfolio. Anyway, in reading this, especially the comments, it occurred to me that Buffett will probably ditch the trading operation. Now, I'm not sure who the buyer might be, but considering that trading likely had something to do with making Constellation Energy the target it became, weakening it and increasing the collateral requirements, I can't see MidAmerican holding on. It seems a bit too volatile for Berkshire.

I think about the General Re acquisition some years ago. It took a long time, but Buffett unwound a bunch of contracts that Ge Re had entered into which increased the overall corporate risk exposure. I'll go dig up that story if I have some time. The same forces would appear to come into play now with CEG. Buffett will keep the parts that generate free cash and sell off the bits that detract more than they add, slowly if necessary but quickly otherwise. At least, that's the first thing that comes to my mind.

Thoughts?

Its all about risk management, baby. I think that, if nothing else, is the lesson of the week.

Investing in Endowments - The Dream that Will Never Be

I LOVE this idea from Felix Salmon about alumni being able to invest in their alma mater's endowments. Its innovative, its different, and it will never happen in our lifetimes. However, I love it.

As John Mauldin is one to point out, regular people should be allowed to invest in alternatives as a way of enhancing returns in their retirement portfolios (or whatever other funds they allocate to the alternatives space). You can find his 2003 congressional testimony on the subject here.

I imagine the biggest problems would be the administration of small(er) investor accounts and the accredited investor rules. You could attack the first problem by allowing minimum investments of greater than 6 figures, say $250K+. The second problem requires US government intervention, which makes it almost impossible to see how one would ever get past this limitation.

I also imagine many larger endowments would want to avoid the kind of incessant inquiries that small investors would bring with them. No matter how experienced those investors are, they are probably going to require or request some level of hand holding, and endowments likely aren't interested in such time sinks. The larger endowments (Harvard and Yale in particular) would not need to resort to this kind of asset gathering; it would purely be a "perk" offered to alumni. There are plenty of smaller institutions, with smaller endowments, that would probably seek to use this re-configuration of the landscape to draw assets and increase their management fees. The new laws would have to take this into account. It makes sense if this structure only imposes fees on profits when the investor withdraws, and reduces the management fees. Endowment investors shouldn't be paying standard hedge fund management fees, especially when the endowments are non-profit organizations and they employ their own managers. A range of 0.5% - 1.25% in fees seems appropriate, based on whether the endowment managers are in-house (lower) or outsourced (higher).

Even so, investing in your university's endowment, with the management fee going to your university, would be a nice way to contribute and still benefit from the expertise the university employs. (That is, if the endowment is large enough to employ in-house investment managers and strategists. If they outsource significant amounts of their endowment management, then this idea is probably unworkable.) Maybe all the drama which led to the founding of Convexity Capital by Jack Meyer could have been avoided if those vocal alumni had been able to invest alongside the endowment, instead of watching from the sidelines. Felix's idea has some obvious tax benefits as well, and if one did not need the money from the endowment, they could let it ride or donate it to the university easily. Brilliant!

Anyway, I had to comment on that idea. I'd love to see alumni offered this kind of investment opportunity. It would sure take a lot of work to make it happen though, which makes me cautiously pessimistic that it would ever occur. (Thanks to Paul Vixie for that phrase, one of my favorite quotes of all time, received from him in personal e-mail!)

Still, how awesome would this be if it became real! A man can dream, can't he?

Until next time, peeps!