Mutual Funds10/21/2008 12:01 AM ET
Wade into the market? Or plunge?
Evidence suggests that jumping right in with your money may generate better results than investing gradually over time. Here's why.
By Tim Middleton
With the stock market wackier than Daffy Duck, risk has risen to unprecedented levels. On Thursday, the CBOE Volatility Index ($VIX.X), which measures volatility of the prices of stock-futures contracts, soared to 80 -- the highest in its history. It's often called the fear index, and any reading over 30 is considered ominous.
That's a reason one of investing's most treasured precepts -- dollar-cost averaging, or DCA -- is finding wider and wider acceptance. You do this automatically in your 401(k), contributing a fixed amount each month, whether stocks are up or down. Thus, in a period of volatility, you spread your risk. This year, prices were down in seven of the first nine months, with extreme losses in January, June and September, not to mention the first couple of weeks of October.
But dollar-cost averaging is mind balm only. It doesn't actually reduce risk, and it doesn't increase returns.
In fact, there's evidence that investors should approach the market more aggressively. Over short periods as well as long, investing lump sums is the equal of dollar-cost averaging, except in those rare times when the market is going straight up, when lump-sum investing does better.
"At our firm, we tell clients that there is no difference," says Paul A. LaViola, the vice president of RTD Financial Advisors in Philadelphia. "However, emotionally, it can make someone feel better if they DCA when the market is going down or they are unsure about the market."
My household invests both ways, twice monthly in my wife's 403(b) and our brokerage and mutual fund accounts, and lump sums into my SEP-IRA (simplified employee pension individual retirement account) two or three times a year. My wife recently changed jobs, and we'll be rolling her old 403(b) into an IRA. It's a considerable amount, and we'll reinvest all of it. DCA is pointless, except as a crutch.
Surprising results Don't believe me? You're not alone. "I am a huge proponent of dollar-cost averaging, especially in volatile times like we are currently experiencing," says Jane M. Young of Pinnacle Financial Concepts in Colorado Springs, Colo. "I have not conducted any studies, so my opinion is based on 12 years' experience working with clients." I can understand that financial novices -- the clients of financial advisers -- are soothed by DCA. But I have done some research, and here's what I've found:
Vanguard 500 Index Fund (VFINX) over 10 years
Investments of $100 per month
Lump-sum investments of $1,200 per year
Lump-sum performance (compared with monthly investments)
Date
Price
Total portfolio value
Total portfolio value
Total portfolio +/-
Annual dollar +/-
Annual percentage +/-
Market performance
Nov. 2, 1998
$108.49
$100
$1,200
Oct. 1, 1999
$126.05
$1,267
$1,394
$128
$128
10.1%
16.2%
Oct. 2, 2000
$132.02
$2,521
$2,692
$171
$44
1.7%
2.7%
Oct. 1, 2001
$97.86
$2,922
$2,961
$39
-$132
-4.5%
-19.5%
Oct. 1, 2002
$81.87
$3,493
$3,410
-$83
-$122
-3.5%
-22.3%
Oct. 1, 2003
$97.19
$5,498
$5,390
-$108
-$25
-0.5%
11.8%
Oct. 1, 2004
$104.55
$7,130
$7,078
-$52
$56
0.8%
6.7%
Oct. 3, 2005
$111.30
$8,798
$8,763
-$36
$16
0.2%
2.3%
Oct. 2, 2006
$127.04
$11,324
$11,322
-$2
$34
0.3%
10.0%
Oct. 1, 2007
$142.83
$13,999
$14,053
$54
$56
0.4%
10.4%
Oct. 1, 2008
$82.87
$8,962
$8,880
-$82
-$136
-1.5%
-39.4%
Note: Figures may not add up because of rounding.
This shows the relative performance of two portfolios established 10 years ago in the Vanguard 500 Index Fund (VFINX), the investable form of the standard stock benchmark. One investor put in $100 on the first day of every month. The other put in $1,200 on Nov. 1 of each year.
Ten years later, we can see there is no significant difference in their returns, either in their total over the period or their annual performance. Even in this disastrous year, when the fund itself has gone down 39.4% in the past 12 months, the lump-sum investor did only 1.5% worse than the DCA investor. The greatest disparities in the overall portfolio were a lump-sum advantage of $171 in 2000 and a DCA advantage of $108 in 2003.
I shared my study with several financial advisers, and one raised two pertinent questions about my method: Why did I choose to begin in November, as opposed to some other month? And why did I choose Vanguard 500 rather than a surrogate for some other benchmark, such as small caps or foreign stocks?
To answer the first, I wanted 10 full years of data, as of the most recent possible date. Beginning in November 1998 allows both investors to make identical annual contributions. Further, I chose Vanguard 500 because this is the market. Most investors have the bulk of their equity assets in domestic big caps.
The adviser didn't ask why I chose 10 years as my study period, but I'll tell you anyway: It reflects roughly five years each of bull and bear markets. In fact, the current bear market and that of 2000-02 are both monsters, marked by declines of more than 40% -- the only time besides 1973-74 this has happened since the 1930s.
If anything, such extreme downward volatility should have favored the DCA investor. But it didn't.
Continued: What advisers say
What advisers say One adviser with whom I shared my study said it was unconvincing because the lump-sum contributions each November themselves represent DCA, only annually instead of monthly. More realistic, he said, is the lump sum that arrives possibly only once in a lifetime, such as an inheritance or 401(k) rollover.
"Accordingly, for most of my clients I say, 'Why not just invest the lump sum and be done with it?' Most people will take this approach," says Warren J. McIntyre of VisionQuest Financial Planning in Troy, Mich. "However, for someone skittish about the market by nature, especially during a volatile time like now -- I think DCA is a great strategy from a psychological standpoint."
Fair enough. Every investor needs to remain in his own comfort zone. But research from DCA critics has demonstrated that lump sums aren't just the equal of DCA but are instead superior to it.
Dimensional Fund Advisors, a firm that runs sophisticated index funds that are sold only through financial advisers it trains in-house, did a study in 2004 called "To Wade or Plunge." In it, the firm studied four types of portfolios -- domestic equity, domestic balanced, global equity and global balanced -- over periods dating to 1970 for foreign securities and to 1927 for domestic stocks and bonds. In the trials, one portfolio invested on the first day of each year, while the other invested quarterly.
"For the domestic portfolios during the 1927-2003 period, plunging beat wading in about two-thirds of the trials. The average one-year excess return of plunging over wading was nearly 6% for the domestic equity portfolio and about 4% for the domestic balanced portfolio," the study says.
"For global and domestic portfolios during the 1970-2003 period, plunging again beat wading in about two-thirds of the trials. The average excess returns for plunging over wading were about 4.5% for global equity, 3% for global balanced, 5% for domestic equity and 3.4% for domestic balanced."
Despite such evidence, most of the two dozen or so financial advisers I polled last week are strong supporters of DCA. I don't blame them. What if they had recommended that a new client take the plunge on Oct. 1? By Oct. 10, the Vanguard 500 fund was down 22.5%. The client would have been gone, and everyone he met for the rest of his life would hear what a lousy adviser that poor sap turned out to be.
But if I had invested a bundle on Oct. 1, I would have gritted my teeth and held on. By Oct. 13, my loss was only 13.5%. Ten years from now I'll be lucky if I can remember what happened in those 10 days. And I would be sitting on a nice wad of money.
So take your choice. You'll probably make more money investing lump sums, but there's a chance you won't. You make choices like this all the time; you can break your neck riding a bike. TV's Monk -- whose theme song is "It's a Jungle Out There" -- doesn't strike me as the lump-sum type, but I suspect most of us are.
Meet Tim Middleton at The Money Show MSN Money's Tim Middleton will be among more than 50 investing experts gathered in the nation's capital Nov. 6-8 for the fourth annual Money Show Washington, D.C. Just days after the election, this elite group will present more than 170 free workshops to help you prepare for changes in the political landscape. Admission is free for MSN Money users.
To register, call 1-800-970-4355 and mention priority code 009554, or visit the Money Show Washington, D.C., Web site.
At the time of publication, Tim Middleton didn't own any securities mentioned in this article.
http://articles.moneycentral.msn.com/Investing/MutualFunds/wade-into-the-market-or-plunge.aspx?page=all
Wednesday, 17 December 2008
Now is the perfect time to invest
Mutual Funds12/16/2008 12:01 AM ET
Now is the perfect time to invest
It's tempting to stay on the sidelines of a turbulent stock market, but you should take advantage of today's rock-bottom prices. Here's why -- and how.
By Tim Middleton
The 2007-08 bear market has been the worst since the Great Depression, more savage than that of 1973-74, which most of us remember only dimly, if at all, and 2000-02, which we remember all too well.
What's more, the combination of two deep bears in less than a decade has poisoned many people against common stocks. The Standard & Poor's 500 Index ($INX) has gone down an average of 0.9% a year over the past 10 years, from November 1998 through November 2008. Given this sobering lesson, who would want to own these things?
You would.
Whether you're just getting started as an investor or rebuilding a portfolio shattered by the recent chaos, you need to remember that how well you do depends on what you pay at the outset. And prices now are at rock bottom.
"Today, in my view, the stock market is presenting you with one of the great buying opportunities of your lifetime -- perhaps the greatest," says Steve Leuthold, the manager of the Leuthold Core Investment (LCORX) fund, which ranks in the top 2% of similar funds over the past 10 years. "Buy 'em when they hate 'em."
Since this bear market began 14 months ago, virtually every asset class, from foreign and domestic stocks to commodities to real estate, has been driven down at least 50%. Even among bonds, only U.S. Treasurys have held up well. The benefits of diversification, in short, have proved to be illusory.
But that doesn't mean -- in the words every market loser has uttered -- that this time it's different.
"The importance of asset allocation, the insidious power of inflation, diversification using uncorrelated asset classes and long-term stock market performance still exist," says Michael L. Kalscheur, a financial consultant with Castle Wealth Advisors in Indianapolis. "Most people are looking at the most recent information and assume that's how it will always be. It will not always be this way."
Whether you're building a portfolio or rebuilding an old one, the tried-and-true lessons still apply: Balance risks against each other while relying on equities to build wealth. If you have become increasingly defensive over the past year -- and most people have -- now is the time to reverse the process.
How much worse could it get? I believe the bear market is over. But say I'm wrong and it's not. Having fallen more than 50% already, just how much further can stock prices fall? How much risk remains?
Junk bonds are yielding 22%, nearly twice their historical average. Since the vast majority of corporate bonds are rated junk, do you really believe more than half of the American private sector is going to go broke? That didn't happen even in the Great Depression.
Here is what you should not do in the coming year: Wade cautiously back into risky markets such as stocks, dollar-cost averaging your way back to a normal, stock-heavy portfolio.
This is the time to plunge. Dollar-cost averaging is almost never a good idea, as I explained in a recent column, but it's a really lousy idea right now.
That's because stock market recoveries tend to be front-loaded. Since 1900, according to Leuthold's research, "the median first-year price gain of 40.9% represents almost half of the median 83.6% total bull market gain for the Dow." Gains in the first three months are the sharpest of all, averaging just over 18%.
So take the money you've got to invest -- all of it -- and build (or rebuild) your portfolio today.
By the way: I'm doing this myself in my own portfolio, and subscribers to my newsletter, ETF Insider, have already done it, effective Dec. 1. Since bonds have remained positive throughout the bear market, we had profits in them, which we trimmed. We added that to the cash hoard we had built up when we cut back on our riskiest positions earlier in the year, and we swapped nearly everything into foreign and, primarily, domestic stock funds. We also bolstered our holdings of emerging market stocks and commercial real estate, which had been beaten down the most.
Continued: Building your portfolio
Building your portfolio How you allocate your assets is the most important decision you will make in terms of future returns. That, rather than individual-security selection, accounts for 90% of total portfolio returns.
The most attractive asset classes on a total return basis are:
Domestic small-capitalization stocks.
Domestic large-cap stocks.
Emerging-markets stocks.
Foreign developed-market stocks.
Since an investment portfolio is long term by its nature -- money you need in only a few years should be protected in Treasury bills and short-term bond funds -- at least 50% of it should be apportioned among these groups. And for Mr. or Ms. Typical Investor, I would make this equity allocation 75%.
Stocks provide the most reliable mixture of potential for capital growth and protection against inflation. For young investors, my allocation recommendation would be 100%, and indeed that's where two of my three children have their investments. (The third may buy a home soon and so holds a considerable portion in bonds.)
The most attractive assets for diversifying risk in a stock-heavy portfolio are:
Domestic high-quality bonds, particularly mortgage and corporate bonds.
Foreign high-quality bonds.
Domestic commercial real estate, in the form of funds that invest in real-estate investment trusts, or REITs.
Commodities, notably energy.
Cash, in the form of T-bills or money market accounts.
In taxable investment accounts, municipal bonds take the place of corporate, U.S. government and mortgage bonds. Munis are particularly cheap right now, yielding far more on an after-tax basis than taxable bonds.
During periods of high inflation, Treasury inflation-protected securities, or TIPS, can take the place of at least some of the high-quality bond allocation. That's not the case now, however.
Assuming you have 75% of your assets in equity funds, I would allocate the balance like this: 5% in a commodity/energy fund, 5% in REITs and 15% in domestic high-quality bonds such as Pimco Total Return (PTTRX), the most widely held such mutual fund.
I wouldn't own foreign bonds at the moment because the U.S. dollar is rallying, and currency translations are therefore increasingly unfavorable. For the same reason, I would be light on foreign developed-market equities -- but not emerging markets, where currencies play less of a role.
Both energy and REITs are down much, much more than stocks in the current market, so you could snap up real bargains there.
Higher returns ahead If you think this plan is too risky, think again. Just as relatively low stock returns this decade could have been predicted (and in fact were, by Warren Buffett, among others), based on extreme out-performance in the 1990s, relatively high returns going forward are almost reflexive. This cycle is known as reversion to the mean, and the mean returns of stocks over long periods are in the low double digits.
"History shows us that after a substantial bear market, we can expect the returns of equities to be higher in the near term," notes Tom Adams, a financial adviser with Mentor Capital Management in Elmhurst, Ill.
Having pointed out the negative returns of stocks over the past 10 years, Leuthold tracked the history of stock performance in every 10-year period in which the market averaged an annual gain of 1% or less. Then he looked at the succeeding 10 years. The worst performance in those periods was a gain of 101% between 1938 and 1948. The best was a surge of 325% between 1974 and 1984. The average was 183%.
Buffett, so negative on stocks as this decade began, has lately become outspokenly bullish. No investor in our lifetimes has proved more adept at understanding the market.
So whether you are new to investing or renewing your commitment to it, you have chosen a very favorable time. Don't dally. Your financial future depends on what you do now.
At the time of publication, Tim Middleton didn't own any fund mentioned in this article.
http://articles.moneycentral.msn.com/learn-how-to-invest/now-is-the-perfect-time-to-invest.aspx?page=all
Now is the perfect time to invest
It's tempting to stay on the sidelines of a turbulent stock market, but you should take advantage of today's rock-bottom prices. Here's why -- and how.
By Tim Middleton
The 2007-08 bear market has been the worst since the Great Depression, more savage than that of 1973-74, which most of us remember only dimly, if at all, and 2000-02, which we remember all too well.
What's more, the combination of two deep bears in less than a decade has poisoned many people against common stocks. The Standard & Poor's 500 Index ($INX) has gone down an average of 0.9% a year over the past 10 years, from November 1998 through November 2008. Given this sobering lesson, who would want to own these things?
You would.
Whether you're just getting started as an investor or rebuilding a portfolio shattered by the recent chaos, you need to remember that how well you do depends on what you pay at the outset. And prices now are at rock bottom.
"Today, in my view, the stock market is presenting you with one of the great buying opportunities of your lifetime -- perhaps the greatest," says Steve Leuthold, the manager of the Leuthold Core Investment (LCORX) fund, which ranks in the top 2% of similar funds over the past 10 years. "Buy 'em when they hate 'em."
Since this bear market began 14 months ago, virtually every asset class, from foreign and domestic stocks to commodities to real estate, has been driven down at least 50%. Even among bonds, only U.S. Treasurys have held up well. The benefits of diversification, in short, have proved to be illusory.
But that doesn't mean -- in the words every market loser has uttered -- that this time it's different.
"The importance of asset allocation, the insidious power of inflation, diversification using uncorrelated asset classes and long-term stock market performance still exist," says Michael L. Kalscheur, a financial consultant with Castle Wealth Advisors in Indianapolis. "Most people are looking at the most recent information and assume that's how it will always be. It will not always be this way."
Whether you're building a portfolio or rebuilding an old one, the tried-and-true lessons still apply: Balance risks against each other while relying on equities to build wealth. If you have become increasingly defensive over the past year -- and most people have -- now is the time to reverse the process.
How much worse could it get? I believe the bear market is over. But say I'm wrong and it's not. Having fallen more than 50% already, just how much further can stock prices fall? How much risk remains?
Junk bonds are yielding 22%, nearly twice their historical average. Since the vast majority of corporate bonds are rated junk, do you really believe more than half of the American private sector is going to go broke? That didn't happen even in the Great Depression.
Here is what you should not do in the coming year: Wade cautiously back into risky markets such as stocks, dollar-cost averaging your way back to a normal, stock-heavy portfolio.
This is the time to plunge. Dollar-cost averaging is almost never a good idea, as I explained in a recent column, but it's a really lousy idea right now.
That's because stock market recoveries tend to be front-loaded. Since 1900, according to Leuthold's research, "the median first-year price gain of 40.9% represents almost half of the median 83.6% total bull market gain for the Dow." Gains in the first three months are the sharpest of all, averaging just over 18%.
So take the money you've got to invest -- all of it -- and build (or rebuild) your portfolio today.
By the way: I'm doing this myself in my own portfolio, and subscribers to my newsletter, ETF Insider, have already done it, effective Dec. 1. Since bonds have remained positive throughout the bear market, we had profits in them, which we trimmed. We added that to the cash hoard we had built up when we cut back on our riskiest positions earlier in the year, and we swapped nearly everything into foreign and, primarily, domestic stock funds. We also bolstered our holdings of emerging market stocks and commercial real estate, which had been beaten down the most.
Continued: Building your portfolio
Building your portfolio How you allocate your assets is the most important decision you will make in terms of future returns. That, rather than individual-security selection, accounts for 90% of total portfolio returns.
The most attractive asset classes on a total return basis are:
Domestic small-capitalization stocks.
Domestic large-cap stocks.
Emerging-markets stocks.
Foreign developed-market stocks.
Since an investment portfolio is long term by its nature -- money you need in only a few years should be protected in Treasury bills and short-term bond funds -- at least 50% of it should be apportioned among these groups. And for Mr. or Ms. Typical Investor, I would make this equity allocation 75%.
Stocks provide the most reliable mixture of potential for capital growth and protection against inflation. For young investors, my allocation recommendation would be 100%, and indeed that's where two of my three children have their investments. (The third may buy a home soon and so holds a considerable portion in bonds.)
The most attractive assets for diversifying risk in a stock-heavy portfolio are:
Domestic high-quality bonds, particularly mortgage and corporate bonds.
Foreign high-quality bonds.
Domestic commercial real estate, in the form of funds that invest in real-estate investment trusts, or REITs.
Commodities, notably energy.
Cash, in the form of T-bills or money market accounts.
In taxable investment accounts, municipal bonds take the place of corporate, U.S. government and mortgage bonds. Munis are particularly cheap right now, yielding far more on an after-tax basis than taxable bonds.
During periods of high inflation, Treasury inflation-protected securities, or TIPS, can take the place of at least some of the high-quality bond allocation. That's not the case now, however.
Assuming you have 75% of your assets in equity funds, I would allocate the balance like this: 5% in a commodity/energy fund, 5% in REITs and 15% in domestic high-quality bonds such as Pimco Total Return (PTTRX), the most widely held such mutual fund.
I wouldn't own foreign bonds at the moment because the U.S. dollar is rallying, and currency translations are therefore increasingly unfavorable. For the same reason, I would be light on foreign developed-market equities -- but not emerging markets, where currencies play less of a role.
Both energy and REITs are down much, much more than stocks in the current market, so you could snap up real bargains there.
Higher returns ahead If you think this plan is too risky, think again. Just as relatively low stock returns this decade could have been predicted (and in fact were, by Warren Buffett, among others), based on extreme out-performance in the 1990s, relatively high returns going forward are almost reflexive. This cycle is known as reversion to the mean, and the mean returns of stocks over long periods are in the low double digits.
"History shows us that after a substantial bear market, we can expect the returns of equities to be higher in the near term," notes Tom Adams, a financial adviser with Mentor Capital Management in Elmhurst, Ill.
Having pointed out the negative returns of stocks over the past 10 years, Leuthold tracked the history of stock performance in every 10-year period in which the market averaged an annual gain of 1% or less. Then he looked at the succeeding 10 years. The worst performance in those periods was a gain of 101% between 1938 and 1948. The best was a surge of 325% between 1974 and 1984. The average was 183%.
Buffett, so negative on stocks as this decade began, has lately become outspokenly bullish. No investor in our lifetimes has proved more adept at understanding the market.
So whether you are new to investing or renewing your commitment to it, you have chosen a very favorable time. Don't dally. Your financial future depends on what you do now.
At the time of publication, Tim Middleton didn't own any fund mentioned in this article.
http://articles.moneycentral.msn.com/learn-how-to-invest/now-is-the-perfect-time-to-invest.aspx?page=all
The Scope and Limitations of Security Analysis
The Scope and Limitations of Security Analysis
Analysis connotes the careful study of available facts with the attempt to draw conclusions therefrom based on established principles and sound logic. However investment is by nature not an exact science. Therefore, both individual skill (art) and chance are important factors in determining success or failure.
Graham wrote (Security Analysis, 1951 edition):
“The market and business cycles since 1933 – like those before 1927 – have provided a suitable proving ground for security analysis.
However, in the years of 1927-1933, both the advance and the decline in stock prices were so extreme during this period that the conclusions suggested by informed and conservative security analysis were found to have little practical utility. This was the more true because the business depression of the early 1930’s was so unexpectedly severe as to vitiate many conclusions regarding safety and value that had been reasonable in the light of past experience.”
The quality and quantity of the published corporate data has added to the scope and dependability of security analysis.
Three Functions of Security Analysis
The functions of analysis may be described under three headings: descriptive, selective, and critical.
1. Descriptive Function.
Descriptive analysis limits itself to marshalling the important facts relating to an issue and presenting them in a coherent, readily intelligible manner. But there are gradations of accomplishment, and of related skill, in this descriptive function.
The least imaginative type is found in the familiar and indispensible statistical presentations of the various security manuals and similar descriptive services. (These include Fitch, Moody’s and Standard & Poor’s.) Here the material is accepted essentially in the form supplied by the company; the figures are set down for a number of successive years; then certain standard calculations are added – e.g., earnings per share, number of times fixed charges were earned.
A more penetrating descriptive analysis can often go much farther than this in presenting the published figures. In many cases the latter need various kinds of adjustment in order to bring out the true operating results in the period covered, and particularly in order to place the data of a number of companies on a fairly comparable plane. Here the analyst must consider such matters as contingency reserves, special allowances for depreciation, “LIFO” versus “FIFO” inventory accounting, non-recurring gains and losses, nonconsolidated subsidiaries, and many other possible items.
On a still higher level of analysis would rank the evaluation of favourable and unfavourable factors in the position of the issue. This might include consideration of the changes in the company’s position over a long period of years, also a detailed comparison with others in the same field, also projections of earning power on various assumptions as to future conditions. The analyst who can do these jobs well will undoubtedly be ready to go forward to the stage of decision and selection.
2. The Selective Function.
The senior analyst must be ready to pass judgment on the merits of securities. He is expected to advise others on their purchase, sale, retention, or exchange.
Many laymen believe that if a security analyst is worth his salt he should be able to give good advice of this sort about any stock or bond issue at any time.
This is far from true. There are times and security situations:
· that are propitious for a sound analytical judgment;
· others which he is poorly qualified to handle;
· many others for which his study and his conclusions may be better than nothing, but still of questionable value to the investor.
Furthermore, we should acknowledge that there are some serious differences of opinion among practicing security analysts as to the basic approach to the selective function.
3. The Critical Function of Security Analysis.
The principles of investment finance and the methods of corporation finance fall necessarily within the province of security analysis. Analytical judgments are reached by applying standards to facts.
· The analyst is concerned, therefore, with the soundness and practicability of the standards of selection.
· He is also interested to see that securities, especially bonds and preferred stocks, be issued with adequate protective provisions, and more important still – that proper methods of enforcement of these convenants be part of accepted financial practice.
· It is a matter of great moment to the analyst that the facts be fairly presented, and this means that he must be highly critical of accounting methods.
· Finally, he must concern himself with all corporate policies affecting the security owner, for the value of the issue which he analyses may be largely dependent upon the acts of the management. In this category are included questions of capitalization setup, of dividend and expansion policies, of managerial competence and compensation, and even of continuing or liquidating an unprofitable business.
On these matters of varied import, security analysis may be competent:
· to express critical judgments,
· looking to the avoidance of mistakes,
· to the correction of abuses, and
· to the better protection of those owning bonds or stocks.
Analysis connotes the careful study of available facts with the attempt to draw conclusions therefrom based on established principles and sound logic. However investment is by nature not an exact science. Therefore, both individual skill (art) and chance are important factors in determining success or failure.
Graham wrote (Security Analysis, 1951 edition):
“The market and business cycles since 1933 – like those before 1927 – have provided a suitable proving ground for security analysis.
However, in the years of 1927-1933, both the advance and the decline in stock prices were so extreme during this period that the conclusions suggested by informed and conservative security analysis were found to have little practical utility. This was the more true because the business depression of the early 1930’s was so unexpectedly severe as to vitiate many conclusions regarding safety and value that had been reasonable in the light of past experience.”
The quality and quantity of the published corporate data has added to the scope and dependability of security analysis.
Three Functions of Security Analysis
The functions of analysis may be described under three headings: descriptive, selective, and critical.
1. Descriptive Function.
Descriptive analysis limits itself to marshalling the important facts relating to an issue and presenting them in a coherent, readily intelligible manner. But there are gradations of accomplishment, and of related skill, in this descriptive function.
The least imaginative type is found in the familiar and indispensible statistical presentations of the various security manuals and similar descriptive services. (These include Fitch, Moody’s and Standard & Poor’s.) Here the material is accepted essentially in the form supplied by the company; the figures are set down for a number of successive years; then certain standard calculations are added – e.g., earnings per share, number of times fixed charges were earned.
A more penetrating descriptive analysis can often go much farther than this in presenting the published figures. In many cases the latter need various kinds of adjustment in order to bring out the true operating results in the period covered, and particularly in order to place the data of a number of companies on a fairly comparable plane. Here the analyst must consider such matters as contingency reserves, special allowances for depreciation, “LIFO” versus “FIFO” inventory accounting, non-recurring gains and losses, nonconsolidated subsidiaries, and many other possible items.
On a still higher level of analysis would rank the evaluation of favourable and unfavourable factors in the position of the issue. This might include consideration of the changes in the company’s position over a long period of years, also a detailed comparison with others in the same field, also projections of earning power on various assumptions as to future conditions. The analyst who can do these jobs well will undoubtedly be ready to go forward to the stage of decision and selection.
2. The Selective Function.
The senior analyst must be ready to pass judgment on the merits of securities. He is expected to advise others on their purchase, sale, retention, or exchange.
Many laymen believe that if a security analyst is worth his salt he should be able to give good advice of this sort about any stock or bond issue at any time.
This is far from true. There are times and security situations:
· that are propitious for a sound analytical judgment;
· others which he is poorly qualified to handle;
· many others for which his study and his conclusions may be better than nothing, but still of questionable value to the investor.
Furthermore, we should acknowledge that there are some serious differences of opinion among practicing security analysts as to the basic approach to the selective function.
3. The Critical Function of Security Analysis.
The principles of investment finance and the methods of corporation finance fall necessarily within the province of security analysis. Analytical judgments are reached by applying standards to facts.
· The analyst is concerned, therefore, with the soundness and practicability of the standards of selection.
· He is also interested to see that securities, especially bonds and preferred stocks, be issued with adequate protective provisions, and more important still – that proper methods of enforcement of these convenants be part of accepted financial practice.
· It is a matter of great moment to the analyst that the facts be fairly presented, and this means that he must be highly critical of accounting methods.
· Finally, he must concern himself with all corporate policies affecting the security owner, for the value of the issue which he analyses may be largely dependent upon the acts of the management. In this category are included questions of capitalization setup, of dividend and expansion policies, of managerial competence and compensation, and even of continuing or liquidating an unprofitable business.
On these matters of varied import, security analysis may be competent:
· to express critical judgments,
· looking to the avoidance of mistakes,
· to the correction of abuses, and
· to the better protection of those owning bonds or stocks.
Securities Not Suited to Valuation Analysis
Securities Not Suited to Valuation Analysis.
There are two general types of issues that do not lend themselves satisfactorily to the intrinsic value approach (Graham, Security Analysis 1951 edition):
1. The first are those that are essentially speculative in character, meaning thereby that their apparent value is almost entirely dependent upon the vicissitudes of the future.
There are two general types of issues that do not lend themselves satisfactorily to the intrinsic value approach (Graham, Security Analysis 1951 edition):
1. The first are those that are essentially speculative in character, meaning thereby that their apparent value is almost entirely dependent upon the vicissitudes of the future.
- An extreme example would be the stock of a company controlling a promising but still undeveloped invention – such as Polaroid Corporation in 1940.
- In the same category belong shares of high-cost or marginal producers, which may have no earning power or else very high earnings according to the price-cost situation of the moment.
- The same situation may be created by a speculative capitalization structure, in which the senior securities are disproportionately large and the common stock becomes exceedingly sensitive to changes affecting earnings or value.
2. The other type is the common stock of a strong enterprise that is considered to have unusually favorable prospects of continued growth.
- The difficulty for the analyst here is to place a sound arithmetical valuation on an optimistic outlook. Since common stocks of this kind are favorites among both admitted speculators and self-styled investors, they present an unusually difficult area for the advisory function of security analysis.
Also read:
The Estimate of Future Earning Power
Analytical Judgments in Value Analysis
Six Examples of Analytical Judgments.
A series of six quite diverse examples were used by Graham in Security Analysis (1951 Edition) to illustrate the scope of value analysis.
Example 1: United States Savings Bonds and high-grade bond issues in the year 1950.
The broadest and perhaps the most important judgment that security analysis can make in the year 1950 is that United States Savings Bonds, Series E and Series G, are so much more attractive than other high-grade bond issues that the individual investor of moderate income should buy nothing but these for the bond portion of his portfolio.
(In the higher income brackets, the alternative purchase of tax-free state and municipal issues may be indicated.)
This recommendation is grounded on careful calculation, and it can be put forward with a maximum of confidence in its validity.
Example 2: Average price level of DJIA in 1947 – 1949
The security analyst, studying the well-known group of 30 leading stocks comprising the Dow-Jones Industrial Average, could express the opinion that they constituted a sound investment purchase, in the aggregate, at the average price level of about 175 prevailing in 1947 – 1949.
This judgment would be based mainly on an estimate of average future earning power plus consideration of standard interest rates. It assumed a much higher level of business activity than in prewar years.
There was some danger that this opinion would prove incorrect, but the hazard here was probably no greater than that involved in most careful business judgments involving the future. Hence the security analyst could feel he was discharging a sound and useful function in making this evaluation and in advising accordingly.
Example 3: Inherent nature of market behavior of income bonds as a class (Income Mortgage 4 ½% bonds of Chicago & North Western Railway in 1946)
In 1946 the Income Mortgage 4 ½% bonds of Chicago & North Western Railway sold as high as 98 ¼. A competent analyst would have suggested their sale at that price.
The reasoning did not relate to any specific projections of the earnings of the North Western, but rather to the inherent nature and the characteristic market behavior of income bonds as a class. They are subject to wide fluctuations in price, responding emphatically to changes in business conditions or sentiment.
The upper limit could not be much above 100, because of their limited coupon and their call price of 101 1/8. On the other hand, past experience showed that their low quotation could easily prove to be 50% below the current market. The case for selling was thus pretty conclusive.
(It so happened that the price of this issue fell to 60 within six months.)
Example 4: Wright Aeronautical Corporation. Here is a set of three examples, referring to common shares in the same enterprise at different times (in 1922, 1928 and December 1947).
1922 (prior to the boom in aviation securities, $8 per share)
In 1922, prior to the boom in aviation securities, Wright Aeronautical Corporation stock was selling on the New York Stock Exchange at only $8, although it was paying a $1 dividend, had for some time been earning over $2 a share, and showed ore than $8 per share in cash assets in the treasury.
In this case analysis would readily have established that the intrinsic value of the issue was substantially above the market price.
1928 ($280 per share)
Again, consider the same issue in 1928 when it had advanced to $280 per share. It was then earning at the rate of $8 per share, as against $3.77 in 1927. The dividend rate was $2; the net-asset value was less than $50 per share.
A study of this picture must have shown conclusively that the market price represented for the most part the capitalization of entirely conjectural future prospects – in other words, that the intrinsic value was far less than the market quotation.
December 1947 (Curtiss-Wright Corporation, the successor enterprise)
Curtiss-Wright Corporation, the successor enterprise, had class A stock selling at 18 ½ and common stock selling at 4 ½. The combined market price of the two issues was under $50 million.
The total net assets of the company were about $130 million; the net current assets about $106 million, and the cash assets alone $87 million.
Earnings had been poor in the postwar period, but the company was clearly undervalued at a price below the cash and government bonds on hand.
Example 5: Comparative merits of two security issues (Graham-Paige Motors Convertible and Its common stock)
Many analytical judgments turn upon the comparative merits of two security issues.
A simple and satisfactory example of these is provided by Graham-Paige Motors Convertible 4s selling at 102 in May 1946 as against the common stock simultaneously selling at 13 ¼. Each $1000 bond was convertible into 76.9 shares of common stock (76.9 x 13 ¼ = $1018.9).
Hence the bonds were selling for slightly less than the current market value of the shares for which they could be exchanged.
The common stock was paying no dividends and had shown very small earnings.
Obviously the bonds were a better purchase than the common stock, since they offered the same opportunities for profit, by reason of their conversion privilege, and they were much better protected against loss.
Sequel: Both the bonds and stock declined sharply in price after May 1946. The bondholder’s principal shrinkage was much less than the stockholder’s; and he has received full interest (to the end of 1950) while the stockholder received only one dividend of 45 cents during this period.
Example 6: “Arbitraging” the securities of railroads going through reorganization in 1941-1945.
During 1941-1945, profits at the annual rate of 20% or better could be made by “arbitraging” the securities of railroads going through organization. The operation consisted of buying existing bonds and selling against them the “when-issued” securities to be exchanged for them under the reorganization plan. The indicated proceeds were always substantially more than the cost.
The major risk involved was that of failure of the plan to be carried out; the minor risk was that consummation would be delayed so long as to make the operation relatively unattractive.
An experienced security analyst could have appraised these risks intelligently, and could have determined that most of the arbitrage operations were well worth entering upon.
Also read:
The Estimate of Future Earning Power
Analytical Judgments in Value Analysis
Securities Not Suited to Valuation Analysis
A series of six quite diverse examples were used by Graham in Security Analysis (1951 Edition) to illustrate the scope of value analysis.
Example 1: United States Savings Bonds and high-grade bond issues in the year 1950.
The broadest and perhaps the most important judgment that security analysis can make in the year 1950 is that United States Savings Bonds, Series E and Series G, are so much more attractive than other high-grade bond issues that the individual investor of moderate income should buy nothing but these for the bond portion of his portfolio.
(In the higher income brackets, the alternative purchase of tax-free state and municipal issues may be indicated.)
This recommendation is grounded on careful calculation, and it can be put forward with a maximum of confidence in its validity.
Example 2: Average price level of DJIA in 1947 – 1949
The security analyst, studying the well-known group of 30 leading stocks comprising the Dow-Jones Industrial Average, could express the opinion that they constituted a sound investment purchase, in the aggregate, at the average price level of about 175 prevailing in 1947 – 1949.
This judgment would be based mainly on an estimate of average future earning power plus consideration of standard interest rates. It assumed a much higher level of business activity than in prewar years.
There was some danger that this opinion would prove incorrect, but the hazard here was probably no greater than that involved in most careful business judgments involving the future. Hence the security analyst could feel he was discharging a sound and useful function in making this evaluation and in advising accordingly.
Example 3: Inherent nature of market behavior of income bonds as a class (Income Mortgage 4 ½% bonds of Chicago & North Western Railway in 1946)
In 1946 the Income Mortgage 4 ½% bonds of Chicago & North Western Railway sold as high as 98 ¼. A competent analyst would have suggested their sale at that price.
The reasoning did not relate to any specific projections of the earnings of the North Western, but rather to the inherent nature and the characteristic market behavior of income bonds as a class. They are subject to wide fluctuations in price, responding emphatically to changes in business conditions or sentiment.
The upper limit could not be much above 100, because of their limited coupon and their call price of 101 1/8. On the other hand, past experience showed that their low quotation could easily prove to be 50% below the current market. The case for selling was thus pretty conclusive.
(It so happened that the price of this issue fell to 60 within six months.)
Example 4: Wright Aeronautical Corporation. Here is a set of three examples, referring to common shares in the same enterprise at different times (in 1922, 1928 and December 1947).
1922 (prior to the boom in aviation securities, $8 per share)
In 1922, prior to the boom in aviation securities, Wright Aeronautical Corporation stock was selling on the New York Stock Exchange at only $8, although it was paying a $1 dividend, had for some time been earning over $2 a share, and showed ore than $8 per share in cash assets in the treasury.
In this case analysis would readily have established that the intrinsic value of the issue was substantially above the market price.
1928 ($280 per share)
Again, consider the same issue in 1928 when it had advanced to $280 per share. It was then earning at the rate of $8 per share, as against $3.77 in 1927. The dividend rate was $2; the net-asset value was less than $50 per share.
A study of this picture must have shown conclusively that the market price represented for the most part the capitalization of entirely conjectural future prospects – in other words, that the intrinsic value was far less than the market quotation.
December 1947 (Curtiss-Wright Corporation, the successor enterprise)
Curtiss-Wright Corporation, the successor enterprise, had class A stock selling at 18 ½ and common stock selling at 4 ½. The combined market price of the two issues was under $50 million.
The total net assets of the company were about $130 million; the net current assets about $106 million, and the cash assets alone $87 million.
Earnings had been poor in the postwar period, but the company was clearly undervalued at a price below the cash and government bonds on hand.
Example 5: Comparative merits of two security issues (Graham-Paige Motors Convertible and Its common stock)
Many analytical judgments turn upon the comparative merits of two security issues.
A simple and satisfactory example of these is provided by Graham-Paige Motors Convertible 4s selling at 102 in May 1946 as against the common stock simultaneously selling at 13 ¼. Each $1000 bond was convertible into 76.9 shares of common stock (76.9 x 13 ¼ = $1018.9).
Hence the bonds were selling for slightly less than the current market value of the shares for which they could be exchanged.
The common stock was paying no dividends and had shown very small earnings.
Obviously the bonds were a better purchase than the common stock, since they offered the same opportunities for profit, by reason of their conversion privilege, and they were much better protected against loss.
Sequel: Both the bonds and stock declined sharply in price after May 1946. The bondholder’s principal shrinkage was much less than the stockholder’s; and he has received full interest (to the end of 1950) while the stockholder received only one dividend of 45 cents during this period.
Example 6: “Arbitraging” the securities of railroads going through reorganization in 1941-1945.
During 1941-1945, profits at the annual rate of 20% or better could be made by “arbitraging” the securities of railroads going through organization. The operation consisted of buying existing bonds and selling against them the “when-issued” securities to be exchanged for them under the reorganization plan. The indicated proceeds were always substantially more than the cost.
The major risk involved was that of failure of the plan to be carried out; the minor risk was that consummation would be delayed so long as to make the operation relatively unattractive.
An experienced security analyst could have appraised these risks intelligently, and could have determined that most of the arbitrage operations were well worth entering upon.
Also read:
The Estimate of Future Earning Power
Analytical Judgments in Value Analysis
Securities Not Suited to Valuation Analysis
Tuesday, 16 December 2008
The Estimate of Future Earning Power
The Estimate of Future Earning Power
Any estimate of earning power extending over future years may easily fall wide of the mark, since the major business factors of volume, price, and cost are all largely unpredictable.
Assuming that profits develop as anticipated, there remains a similar doubt as to whether the multiplier, or capitalization rate, will prove correctly chosen.
A valuation may be very skillfully done in the light of all the pertinent data and the soundest judgement of future probabilities; yet the market price may delay adjusting itself to the indicated value for so long a period that new conditions may supervene and bring with them a new value. Thus even though the price ultimately converges with that new value, the old valuation may have proved undependable.
These handicaps that are attached to the value approach should be clearly recognized by the analyst, and they should make him modest and circumspect in its use. In particular he must use good judgement in distinguishing between securities and situations that are better suited and those that are worse suited to value analysis. Its working assumption is that the past record affords at least a rough guide to the future. The more questionable this assumption, the less valuable is the analysis.
Hence this technique is:
There are three general areas in which value analysis will operate most successfully.
1. That of inherently stable securities. These include
Source: Graham's Security Analysis
Also read:
The Estimate of Future Earning Power
Analytical Judgments in Value Analysis
Securities Not Suited to Valuation Analysis
Any estimate of earning power extending over future years may easily fall wide of the mark, since the major business factors of volume, price, and cost are all largely unpredictable.
Assuming that profits develop as anticipated, there remains a similar doubt as to whether the multiplier, or capitalization rate, will prove correctly chosen.
A valuation may be very skillfully done in the light of all the pertinent data and the soundest judgement of future probabilities; yet the market price may delay adjusting itself to the indicated value for so long a period that new conditions may supervene and bring with them a new value. Thus even though the price ultimately converges with that new value, the old valuation may have proved undependable.
These handicaps that are attached to the value approach should be clearly recognized by the analyst, and they should make him modest and circumspect in its use. In particular he must use good judgement in distinguishing between securities and situations that are better suited and those that are worse suited to value analysis. Its working assumption is that the past record affords at least a rough guide to the future. The more questionable this assumption, the less valuable is the analysis.
Hence this technique is:
- more useful when applied to senior securities (which are protected against change) than to common stocks;
- more useful when applied to a business of inherently stable character than to one subject to wide variations; and , finally,
- more useful when carried on under fairly normal general conditions than in times of great uncertainty and radical change.
There are three general areas in which value analysis will operate most successfully.
1. That of inherently stable securities. These include
- good quality bonds and preferred stocks, and also – because of the nature of the industry –
- the common stocks of conservatively capitalized public utilities, and perhaps of the strongly entrenched industrial and railroads as well.
2. This includes cases of extreme disparity between price and indicated value. Here the analyst relies upon a large initial margin of safety to absorb and offset the uncertainties of the future. In this area the insurance principle of diversification, or spreading of risk, is especially valuable.
3. Finally, there is the field of comparative analysis. Where the securities studied are corporately related or are affected by closely similar conditions, it may often be possible to reach a reliable and useful conclusion that one is preferable to the other.
Source: Graham's Security Analysis
Also read:
The Estimate of Future Earning Power
Analytical Judgments in Value Analysis
Securities Not Suited to Valuation Analysis
What is your optimum Return on Investment?
2008/12/13
Your Money: What is your optimum ROI?
By : Yap Ming Hui
RETURN on Investment (ROI) is an important ally in attaining financial freedom. ROI can help us overcome the threat of excessive spending and inflation. If we are serious about achieving our own financial freedom, it is important for us to understand and know ROI better.
Power of compound ROI
Table 1 shows the compounding effect of RM100,000 invested at different compound ROI compounded over 36 years. From the table, we see that differences in ROI that may appear moderate in the short-term can, with compounding, multiply into very large differences in the long term.
For example, if you don't do anything with your saving which earns about two per cent ROI then. your RM100,000 will multiply by two times to RM204,000 after 36 years. If you transfer the money into fixed deposit, you may earn about four per cent ROI and multiply your RM100,000 by four times to about RM410,000. If you grow your money at eight per cent ROI your RM100,000 will multiply by 16 times to about RM1,597,000. With a slight increase of your ROI from two to eight per cent, you end up having a huge difference of RM1,393,000. (1,597,000 - 204,000). If you grow your money at 15 per cent ROI, your RM100,000 will multiply by 153 times to about RM15,315,000. Of course, increasing the ROI means you may face higher risk of losing your money.
The price of making a mistake
Most people fail to realise the high rate of ROI required to make up for money lost in investment. For example, if you start with RM100 and lose 50 per cent of it, you would have to earn 100 per cent on the remaining RM50 just to get back to where you were at the beginning.
Table 2 shows the ROI required to overcome various losses. The time period is five years, and there are two scenarios: an ROI target of 10 per cent and of 15 per cent.
For example, you plan to increase your money for the next five years with 10 per cent ROI. Unfortunately, instead of getting 10 per cent target return, you ended up with a 25 per cent loss. In order for you to still achieve your original target, you would need to achieve 21 per cent ROI for your money for the next four consecutive years. Now, that's the price you will have to pay for making 25 per cent loss in first year.
Do you think it is easy to achieve 21 per cent for four years continuously? Of course, it is not easy. In addition, you will also notice the spread between the amount of the loss and the required ROI over the next 4 years widens as the magnitude of the loss is increased. The larger the losses, the more difficult it is to overcome. I believe you now understand why the first rule to investing, according to Warren Buffett, is "Never lose your money".
Inflation-adjusted ROI
Our money is subjected to the depletion of inflation. Therefore, to effectively grow our money, we need to attain an ROI higher than the inflation rate.
For example, if the inflation rate is four per cent, the 3.7 per cent interest rate for your fixed deposit will not help your money grow. In fact, in the long run, you lose your money safely. In this case, the inflation-adjusted ROI is actually -0.3 per cent (3.7-4).
Therefore,to grow our money, we need to seek inflation-adjusted ROI.
To achieve financial freedom, you have know what rate of ROI you actually need.There is an optimum ROI rate to target and achieve. This optimum ROI rate should be higher than the inflation rate but not too high that will risk losing money.
Therefore, the challenge for all of us who want to achieve financial freedom is to find out what that ROI is? Do you know what is your optimum ROI? If not, it is always better to find out earlier than later.
Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia.
http://www.nst.com.my/Current_News/NST/Sunday/Focus/2426202/Article/index_html
Your Money: What is your optimum ROI?
By : Yap Ming Hui
RETURN on Investment (ROI) is an important ally in attaining financial freedom. ROI can help us overcome the threat of excessive spending and inflation. If we are serious about achieving our own financial freedom, it is important for us to understand and know ROI better.
Power of compound ROI
Table 1 shows the compounding effect of RM100,000 invested at different compound ROI compounded over 36 years. From the table, we see that differences in ROI that may appear moderate in the short-term can, with compounding, multiply into very large differences in the long term.
For example, if you don't do anything with your saving which earns about two per cent ROI then. your RM100,000 will multiply by two times to RM204,000 after 36 years. If you transfer the money into fixed deposit, you may earn about four per cent ROI and multiply your RM100,000 by four times to about RM410,000. If you grow your money at eight per cent ROI your RM100,000 will multiply by 16 times to about RM1,597,000. With a slight increase of your ROI from two to eight per cent, you end up having a huge difference of RM1,393,000. (1,597,000 - 204,000). If you grow your money at 15 per cent ROI, your RM100,000 will multiply by 153 times to about RM15,315,000. Of course, increasing the ROI means you may face higher risk of losing your money.
The price of making a mistake
Most people fail to realise the high rate of ROI required to make up for money lost in investment. For example, if you start with RM100 and lose 50 per cent of it, you would have to earn 100 per cent on the remaining RM50 just to get back to where you were at the beginning.
Table 2 shows the ROI required to overcome various losses. The time period is five years, and there are two scenarios: an ROI target of 10 per cent and of 15 per cent.
For example, you plan to increase your money for the next five years with 10 per cent ROI. Unfortunately, instead of getting 10 per cent target return, you ended up with a 25 per cent loss. In order for you to still achieve your original target, you would need to achieve 21 per cent ROI for your money for the next four consecutive years. Now, that's the price you will have to pay for making 25 per cent loss in first year.
Do you think it is easy to achieve 21 per cent for four years continuously? Of course, it is not easy. In addition, you will also notice the spread between the amount of the loss and the required ROI over the next 4 years widens as the magnitude of the loss is increased. The larger the losses, the more difficult it is to overcome. I believe you now understand why the first rule to investing, according to Warren Buffett, is "Never lose your money".
Inflation-adjusted ROI
Our money is subjected to the depletion of inflation. Therefore, to effectively grow our money, we need to attain an ROI higher than the inflation rate.
For example, if the inflation rate is four per cent, the 3.7 per cent interest rate for your fixed deposit will not help your money grow. In fact, in the long run, you lose your money safely. In this case, the inflation-adjusted ROI is actually -0.3 per cent (3.7-4).
Therefore,to grow our money, we need to seek inflation-adjusted ROI.
To achieve financial freedom, you have know what rate of ROI you actually need.There is an optimum ROI rate to target and achieve. This optimum ROI rate should be higher than the inflation rate but not too high that will risk losing money.
Therefore, the challenge for all of us who want to achieve financial freedom is to find out what that ROI is? Do you know what is your optimum ROI? If not, it is always better to find out earlier than later.
Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia.
http://www.nst.com.my/Current_News/NST/Sunday/Focus/2426202/Article/index_html
Sunday, 14 December 2008
Fund Fraud Hits Big Names: "I'm wiped out."
DECEMBER 13, 2008
Fund Fraud Hits Big Names
Madoff's Clients Included Mets Owner, GMAC Chairman, Country-Club Recruits
By ROBERT FRANK, PETER LATTMAN, DIONNE SEARCEY and AARON LUCCHETTI
New potential victims emerged of Wall Street veteran Bernard Madoff's alleged giant Ponzi scheme, with international banks, hedge funds and wealthy private investors among those sorting out what could amount to tens of billions of dollars in losses.
New York Mets owner Fred Wilpon, GMAC LLC Chairman J. Ezra Merkin and former Philadelphia Eagles owner Norman Braman were among the dozens of seemingly sophisticated investors who placed money on what could prove to be history's largest financial scam.
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Bernie Madoff Asks Investors To Keep Mum 5/7/2001
Wall Street Mystery Features a Big Board Rival 12/16/1992
Giant French bank BNP Paribas, Tokyo-based Nomura Holdings Inc. and Neue Privat Bank in Zurich are also exposed, according to people familiar with the matter.
And at least three funds of hedge funds -- which raise money from investors and farm it out to hedge funds -- may have significant losses. Fairfield Greenwich Group and Tremont Capital Management of New York placed hundreds of millions of their investors' dollars into funds overseen by Mr. Madoff. On Friday, Maxam Capital Management LLC reported a combined loss of $280 million on funds they had invested with Mr. Madoff.
"I'm wiped out," said Sandra Manzke, Maxam's founder and chairman. The Darien, Conn., fund of hedge funds will have to close as a result of the losses, she said.
Mr. Madoff, the founder and primary owner of Bernard L. Madoff Investment Securities LLC in New York, was arrested and charged Thursday. Prosecutors allege that the 70-year-old Mr. Madoff hid losses, paying certain investors returns using principal he received from other investors. Prosecutors and regulators have yet to determine how much has been lost, or the amount in assets still held by Mr. Madoff's business.
The alleged fraud has "swept up some of the most prominent and wealthy Americans, along with many people who thought they were embarking on a comfortable retirement and have now been left destitute," says Brad Friedman, a lawyer at Milberg LLP, which with Seeger Weiss LLP represents more than 30 investors with losses they believe could total more than $1 billion.
In criminal and civil complaints, Mr. Madoff is quoted as saying the losses could amount to $50 billion.
"This is a real tragedy," Mr. Madoff's attorney, Ike Sorkin, said Friday. "We're going to fight through these events and do what we can to minimize the loss."
Details emerged Friday of how Mr. Madoff ran the alleged scam, fostering a veneer of exclusivity and creating an A-list of investors that became his most powerful marketing tool. From New York and Florida to Minnesota and Texas, the money manager became an insider's choice among well-heeled investors seeking steady returns. By hiring unofficial agents, tapping into elite country clubs and creating "invitation only" policies for investors, he recruited a steady stream of new clients.
During golf-course and cocktail-party banter, Mr. Madoff's name frequently surfaced as a money manager who could consistently deliver high returns. Older, Jewish investors called Mr. Madoff " 'the Jewish bond,' " says Ken Phillips, head of a Boulder, Colo., investment firm. "It paid 8% to 12%, every year, no matter what."
As his reputation grew, Mr. Madoff gained the trust of prominent businessmen, including ex-Eagles owner Mr. Braman, who owns a chain of Florida auto dealers. A voicemail message left with Mr. Braman's office was not immediately returned.
Mets owner Mr. Wilpon, who also owns real-estate investor Sterling Equities, often raved about Mr. Madoff's investment prowess and invested tens of millions of dollars of both his own money and the team's with his company, say financiers who have worked with him. Mr. Madoff handled investments for the Judy & Fred Wilpon Family Foundation, which distributed about $1 million a year in 2005 and 2006 to charities, according to its most recent federal tax returns..
Mets spokesman Jay Horowitz declined to comment Friday. Mr. Wilpon's Sterling Equities said in a statement: "We are shocked by recent events and, like all investors, will continue to monitor the situation."
Mr. Merkin, the chairman of former General Motors Corp. financing arm GMAC, is also a money manager at Ascot Partners LLC in New York. Ascot, which had $1.8 billion under management as of Sept. 30, had substantially all of its assets invested with Mr. Madoff, according to a letter to Mr. Merkin sent to clients Thursday night. Mr. Merkin said as one of the largest investors in Ascot, he believed he had personally "suffered major losses from this catastrophe."
Mr. Merkin could not be reached for comment.
Mr. Madoff tapped social networks in Dallas, Chicago, Boston and Minneapolis. In Minnesota, he attracted investors from Hillcrest Golf Club of St. Paul and Oak Ridge Country Club in Hopkins, investors say. One of them estimated that investors from the two clubs may have invested more than $100 million combined.
One of the largest clusters of Madoff investors was in Florida, where losses could be substantial. Mr. Madoff relied on a network of friends, family and business colleagues to attract investors. According to investors and agents, some of these agents were paid commissions for harvesting investors. Others had separate, lucrative business relationships with Mr. Madoff.
"If you were eating lunch at the club or golfing, everyone was always talking about how Madoff was making them all this money," one investor says. "Everyone wanted to sign up."
Jeff Fischer, a top divorce attorney in Palm Beach, says many of his clients were also Mr. Madoff's clients. "Every big divorce that came through my office had portfolio positions with Madoff," he says.
Two of his investors said that among his clients, Mr. Madoff was considered a money-management legend; they would joke that if Mr. Madoff was a fraud, he'd take down half the world with him.
Richard Spring, a Boca Raton resident and former securities analyst, says he had about $11 million -- or 95% of his net worth -- invested with Mr. Madoff. "That's how much I believed in him," Mr. Spring said.
Inside Wall Street's Madoff Scandal3:55
Another large-scale scandal rocks Wall Street as Bernard Madoff, a Wall Street titan and investment advisor was arrested for an alleged $50 billion dollar fraud against investors, WSJ's Kelsey Hubbard and Amir Efrati discuss.
Mr. Spring said he was also one of the unofficial agents who connected Mr. Madoff with dozens of investors, from a teacher who put in $50,000 to entrepreneurs and executives who would put in millions. Mr. Spring said Mr. Madoff didn't want people to put in large amounts right away. "Bernie would tell me, 'Let them start small, and if they're happy the first year or two, they can put it more.' "
Mr. Spring says he never was paid a commission, but he received fees from a small investment-research firm that counted Mr. Madoff as a client; he declined to say how much he received. He said investors would always come to him asking to invest with Mr. Madoff. "I never solicited anyone," he says.
Mr. Spring says he never detected signs of impropriety with Mr. Madoff's investing, but he concedes that he may receive some blame from some investors. "I can understand where people who lost money are looking for a scapegoat," he says. "I'm heartbroken that so many people have been hurt so badly."
Mr. Madoff's main go-between in Palm Beach was Robert Jaffe, say several investors. Mr. Jaffe is the son-in-law of Carl Shapiro, the founder and former chairman of apparel company Kay Windsor Inc. and an early investor and close friend of Mr. Madoff's. Mr. Jaffe, a philanthropist in Palm Beach, attracted many investors from the Palm Beach Country Club in Palm Beach, Fla.
A spokeswoman for Mr. Jaffe's family said several family members were investors with Mr. Madoff and were "significantly adversely impacted" by recent events. There are no indications that Mr. Jaffe or Mr. Spring are implicated in the alleged fraud. Mr. Jaffe didn't return messages yesterday.
Other investors stand to lose through their investments with the likes of Fairfield Greenwich Group and Tremont Capital Management, funds of hedge funds that invested their cash with Mr. Madoff.
"Needless to say, our level of anger and dismay over the apparent betrayal by Mr. Madoff and his organization of his 14-year relationship with Tremont is immeasurable," Tremont told clients in a letter Friday.
Fairfield Greenwich said in a statement late Friday that it is trying to assess the extent of potential losses. The firm said that on Nov. 1, it had $7.5 billion in investments connected to Mr. Madoff's firm, slightly more than half of its total assets. Founding partner Jeffrey Tucker said the firm had no indication of any potential wrongdoing. "We are shocked an appalled by this news," he said.
Ms. Manzke, 60, of Maxam Capital Management, said she met Mr. Madoff through investors in the mid-1980s and introduced him to Tremont, where she was then chief executive. That introduction led to Tremont's decision to market Mr. Madoff as a money manager to its own investors, she adds.
In November, she says, Maxam asked to pull $30 million from Mr. Madoff, and he returned the money.
"He was a low-key guy," Ms. Manzke says. "He would say, 'Look, I'm a market-maker, and I don't want anyone to know I'm running money.' It was always for select people. He was always closed, he wasn't taking new money."
Several European investors were also apparent victims. Bramdean Alternatives in the U.K. said it had more than 9% of its portfolio invested in Madoff funds. Geneva-based Banque Benedict Hentsch, a white-glove private bank, said it is exposed for $47.5 million.
BNP Paribas's exposure, the extent of which is not clear, may stem from BNP's lending relationship with a fund of funds that was a big Madoff client, said people familiar with the matter. A BNP spokeswoman declined to comment.
Nomura and Neue Privat Bank, meanwhile, together marketed access to Fairfield Sentry Ltd., a fund overseen by Mr. Madoff and sold through Fairfield Greenwich. The shares offered by Neue Privat and Nomura were leveraged three times -- meaning $3 of borrowed money was added to every $1 of capital invested in order to magnify returns, greatly increasing the potential losses for those investors.
A Nomura spokesman declined to comment. A message left with Neue Privat was not returned.
The federal complaints against Mr. Madoff allege his fraudulent activities came through a secretive private wealth-management wing of Bernard L. Madoff Investment Securities, the investment firm he founded in 1960. On Wall Street, his company was perhaps better known for its operations in market-making -- the business of serving as a middleman between buyers and sellers -- and proprietary trading.
Through those higher-profile parts of his operation, Mr. Madoff was a pioneer in trading New York Stock Exchange shares away from the exchange. He is a past chairman of the board of directors of the Nasdaq Stock Market as well as a member of the board of governors of the National Association of Securities Dealers and a member of numerous committees of the organization, according to his firm's Web site.
Mr. Madoff owns a home in Roslyn, N.Y., records show, and an elaborate beachfront home and grounds in Montauk on Long Island.
Mr. Madoff and his wife live in an apartment building on Manhattan's Upper East Side where property records list individual apartments valued at more than $5 million. One property database estimated the 2008 market value of Mr. Madoff's two-floor unit to be roughly $9 million. For years he has served as president of the building's co-op board, according to a tenant.
Tenants say he appeared down-to-earth, friendly and always greeted everyone by their first name.
Colleagues of Mr. Madoff said he was fair to those he dealt with and generous to charities including the Special Olympics. Mr. Madoff treated employees well and loved to take friends and colleagues on his 55-foot fishing boat, called Bull, said Frank Christensen, a retired New York Stock Exchange broker. "I really think very highly of him," said Mr. Christensen. "People make mistakes."—Matthew Futterman, Jenny Strasburg, David Enrich, and Craig Karmin contributed to this article.
Write to Robert Frank at robert.frank@wsj.com, Peter Lattman at peter.lattman@wsj.com, Dionne Searcey at dionne.searcey@wsj.com and Aaron Lucchetti at aaron.lucchetti@wsj.com
http://online.wsj.com/article/SB122914169719104017.html
Fund Fraud Hits Big Names
Madoff's Clients Included Mets Owner, GMAC Chairman, Country-Club Recruits
By ROBERT FRANK, PETER LATTMAN, DIONNE SEARCEY and AARON LUCCHETTI
New potential victims emerged of Wall Street veteran Bernard Madoff's alleged giant Ponzi scheme, with international banks, hedge funds and wealthy private investors among those sorting out what could amount to tens of billions of dollars in losses.
New York Mets owner Fred Wilpon, GMAC LLC Chairman J. Ezra Merkin and former Philadelphia Eagles owner Norman Braman were among the dozens of seemingly sophisticated investors who placed money on what could prove to be history's largest financial scam.
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Bernie Madoff Asks Investors To Keep Mum 5/7/2001
Wall Street Mystery Features a Big Board Rival 12/16/1992
Giant French bank BNP Paribas, Tokyo-based Nomura Holdings Inc. and Neue Privat Bank in Zurich are also exposed, according to people familiar with the matter.
And at least three funds of hedge funds -- which raise money from investors and farm it out to hedge funds -- may have significant losses. Fairfield Greenwich Group and Tremont Capital Management of New York placed hundreds of millions of their investors' dollars into funds overseen by Mr. Madoff. On Friday, Maxam Capital Management LLC reported a combined loss of $280 million on funds they had invested with Mr. Madoff.
"I'm wiped out," said Sandra Manzke, Maxam's founder and chairman. The Darien, Conn., fund of hedge funds will have to close as a result of the losses, she said.
Mr. Madoff, the founder and primary owner of Bernard L. Madoff Investment Securities LLC in New York, was arrested and charged Thursday. Prosecutors allege that the 70-year-old Mr. Madoff hid losses, paying certain investors returns using principal he received from other investors. Prosecutors and regulators have yet to determine how much has been lost, or the amount in assets still held by Mr. Madoff's business.
The alleged fraud has "swept up some of the most prominent and wealthy Americans, along with many people who thought they were embarking on a comfortable retirement and have now been left destitute," says Brad Friedman, a lawyer at Milberg LLP, which with Seeger Weiss LLP represents more than 30 investors with losses they believe could total more than $1 billion.
In criminal and civil complaints, Mr. Madoff is quoted as saying the losses could amount to $50 billion.
"This is a real tragedy," Mr. Madoff's attorney, Ike Sorkin, said Friday. "We're going to fight through these events and do what we can to minimize the loss."
Details emerged Friday of how Mr. Madoff ran the alleged scam, fostering a veneer of exclusivity and creating an A-list of investors that became his most powerful marketing tool. From New York and Florida to Minnesota and Texas, the money manager became an insider's choice among well-heeled investors seeking steady returns. By hiring unofficial agents, tapping into elite country clubs and creating "invitation only" policies for investors, he recruited a steady stream of new clients.
During golf-course and cocktail-party banter, Mr. Madoff's name frequently surfaced as a money manager who could consistently deliver high returns. Older, Jewish investors called Mr. Madoff " 'the Jewish bond,' " says Ken Phillips, head of a Boulder, Colo., investment firm. "It paid 8% to 12%, every year, no matter what."
As his reputation grew, Mr. Madoff gained the trust of prominent businessmen, including ex-Eagles owner Mr. Braman, who owns a chain of Florida auto dealers. A voicemail message left with Mr. Braman's office was not immediately returned.
Mets owner Mr. Wilpon, who also owns real-estate investor Sterling Equities, often raved about Mr. Madoff's investment prowess and invested tens of millions of dollars of both his own money and the team's with his company, say financiers who have worked with him. Mr. Madoff handled investments for the Judy & Fred Wilpon Family Foundation, which distributed about $1 million a year in 2005 and 2006 to charities, according to its most recent federal tax returns..
Mets spokesman Jay Horowitz declined to comment Friday. Mr. Wilpon's Sterling Equities said in a statement: "We are shocked by recent events and, like all investors, will continue to monitor the situation."
Mr. Merkin, the chairman of former General Motors Corp. financing arm GMAC, is also a money manager at Ascot Partners LLC in New York. Ascot, which had $1.8 billion under management as of Sept. 30, had substantially all of its assets invested with Mr. Madoff, according to a letter to Mr. Merkin sent to clients Thursday night. Mr. Merkin said as one of the largest investors in Ascot, he believed he had personally "suffered major losses from this catastrophe."
Mr. Merkin could not be reached for comment.
Mr. Madoff tapped social networks in Dallas, Chicago, Boston and Minneapolis. In Minnesota, he attracted investors from Hillcrest Golf Club of St. Paul and Oak Ridge Country Club in Hopkins, investors say. One of them estimated that investors from the two clubs may have invested more than $100 million combined.
One of the largest clusters of Madoff investors was in Florida, where losses could be substantial. Mr. Madoff relied on a network of friends, family and business colleagues to attract investors. According to investors and agents, some of these agents were paid commissions for harvesting investors. Others had separate, lucrative business relationships with Mr. Madoff.
"If you were eating lunch at the club or golfing, everyone was always talking about how Madoff was making them all this money," one investor says. "Everyone wanted to sign up."
Jeff Fischer, a top divorce attorney in Palm Beach, says many of his clients were also Mr. Madoff's clients. "Every big divorce that came through my office had portfolio positions with Madoff," he says.
Two of his investors said that among his clients, Mr. Madoff was considered a money-management legend; they would joke that if Mr. Madoff was a fraud, he'd take down half the world with him.
Richard Spring, a Boca Raton resident and former securities analyst, says he had about $11 million -- or 95% of his net worth -- invested with Mr. Madoff. "That's how much I believed in him," Mr. Spring said.
Inside Wall Street's Madoff Scandal3:55
Another large-scale scandal rocks Wall Street as Bernard Madoff, a Wall Street titan and investment advisor was arrested for an alleged $50 billion dollar fraud against investors, WSJ's Kelsey Hubbard and Amir Efrati discuss.
Mr. Spring said he was also one of the unofficial agents who connected Mr. Madoff with dozens of investors, from a teacher who put in $50,000 to entrepreneurs and executives who would put in millions. Mr. Spring said Mr. Madoff didn't want people to put in large amounts right away. "Bernie would tell me, 'Let them start small, and if they're happy the first year or two, they can put it more.' "
Mr. Spring says he never was paid a commission, but he received fees from a small investment-research firm that counted Mr. Madoff as a client; he declined to say how much he received. He said investors would always come to him asking to invest with Mr. Madoff. "I never solicited anyone," he says.
Mr. Spring says he never detected signs of impropriety with Mr. Madoff's investing, but he concedes that he may receive some blame from some investors. "I can understand where people who lost money are looking for a scapegoat," he says. "I'm heartbroken that so many people have been hurt so badly."
Mr. Madoff's main go-between in Palm Beach was Robert Jaffe, say several investors. Mr. Jaffe is the son-in-law of Carl Shapiro, the founder and former chairman of apparel company Kay Windsor Inc. and an early investor and close friend of Mr. Madoff's. Mr. Jaffe, a philanthropist in Palm Beach, attracted many investors from the Palm Beach Country Club in Palm Beach, Fla.
A spokeswoman for Mr. Jaffe's family said several family members were investors with Mr. Madoff and were "significantly adversely impacted" by recent events. There are no indications that Mr. Jaffe or Mr. Spring are implicated in the alleged fraud. Mr. Jaffe didn't return messages yesterday.
Other investors stand to lose through their investments with the likes of Fairfield Greenwich Group and Tremont Capital Management, funds of hedge funds that invested their cash with Mr. Madoff.
"Needless to say, our level of anger and dismay over the apparent betrayal by Mr. Madoff and his organization of his 14-year relationship with Tremont is immeasurable," Tremont told clients in a letter Friday.
Fairfield Greenwich said in a statement late Friday that it is trying to assess the extent of potential losses. The firm said that on Nov. 1, it had $7.5 billion in investments connected to Mr. Madoff's firm, slightly more than half of its total assets. Founding partner Jeffrey Tucker said the firm had no indication of any potential wrongdoing. "We are shocked an appalled by this news," he said.
Ms. Manzke, 60, of Maxam Capital Management, said she met Mr. Madoff through investors in the mid-1980s and introduced him to Tremont, where she was then chief executive. That introduction led to Tremont's decision to market Mr. Madoff as a money manager to its own investors, she adds.
In November, she says, Maxam asked to pull $30 million from Mr. Madoff, and he returned the money.
"He was a low-key guy," Ms. Manzke says. "He would say, 'Look, I'm a market-maker, and I don't want anyone to know I'm running money.' It was always for select people. He was always closed, he wasn't taking new money."
Several European investors were also apparent victims. Bramdean Alternatives in the U.K. said it had more than 9% of its portfolio invested in Madoff funds. Geneva-based Banque Benedict Hentsch, a white-glove private bank, said it is exposed for $47.5 million.
BNP Paribas's exposure, the extent of which is not clear, may stem from BNP's lending relationship with a fund of funds that was a big Madoff client, said people familiar with the matter. A BNP spokeswoman declined to comment.
Nomura and Neue Privat Bank, meanwhile, together marketed access to Fairfield Sentry Ltd., a fund overseen by Mr. Madoff and sold through Fairfield Greenwich. The shares offered by Neue Privat and Nomura were leveraged three times -- meaning $3 of borrowed money was added to every $1 of capital invested in order to magnify returns, greatly increasing the potential losses for those investors.
A Nomura spokesman declined to comment. A message left with Neue Privat was not returned.
The federal complaints against Mr. Madoff allege his fraudulent activities came through a secretive private wealth-management wing of Bernard L. Madoff Investment Securities, the investment firm he founded in 1960. On Wall Street, his company was perhaps better known for its operations in market-making -- the business of serving as a middleman between buyers and sellers -- and proprietary trading.
Through those higher-profile parts of his operation, Mr. Madoff was a pioneer in trading New York Stock Exchange shares away from the exchange. He is a past chairman of the board of directors of the Nasdaq Stock Market as well as a member of the board of governors of the National Association of Securities Dealers and a member of numerous committees of the organization, according to his firm's Web site.
Mr. Madoff owns a home in Roslyn, N.Y., records show, and an elaborate beachfront home and grounds in Montauk on Long Island.
Mr. Madoff and his wife live in an apartment building on Manhattan's Upper East Side where property records list individual apartments valued at more than $5 million. One property database estimated the 2008 market value of Mr. Madoff's two-floor unit to be roughly $9 million. For years he has served as president of the building's co-op board, according to a tenant.
Tenants say he appeared down-to-earth, friendly and always greeted everyone by their first name.
Colleagues of Mr. Madoff said he was fair to those he dealt with and generous to charities including the Special Olympics. Mr. Madoff treated employees well and loved to take friends and colleagues on his 55-foot fishing boat, called Bull, said Frank Christensen, a retired New York Stock Exchange broker. "I really think very highly of him," said Mr. Christensen. "People make mistakes."—Matthew Futterman, Jenny Strasburg, David Enrich, and Craig Karmin contributed to this article.
Write to Robert Frank at robert.frank@wsj.com, Peter Lattman at peter.lattman@wsj.com, Dionne Searcey at dionne.searcey@wsj.com and Aaron Lucchetti at aaron.lucchetti@wsj.com
http://online.wsj.com/article/SB122914169719104017.html
It's All in Our Heads - the Negative Wealth Effect
DECEMBER 2, 2008, 12:01 P.M. ET
Essay
It's All in Our Heads
We spend how we feel -- even when our reality hasn't changed much at all
By DAVE KANSAS
My workaday financial life hasn't changed much in the past year. So why am I acting as if it has?
I don't splurge on expensive dinners anymore, and I walk rather than drive places. I compare grocery prices for the first time in years.
In fact, as I look around, I find my friends and I are making all kinds of thrifty decisions that would never have crossed our minds just a few months ago. And it's a stark reminder that the way we think about money can often be detached from our immediate, personal situation.
It doesn't make any difference that most of us continue to hold down the same jobs we had before unemployment rates started to rise. It doesn't matter that our personal circumstances are the same as they've been for the past few years. What matters, instead, is the vague uncertainty that has descended on us. What matters is our unknown future.
So even if our own lives have changed little, we cite a friend's lost job as a reason to worry afresh about our own financial situation. We forget -- or ignore -- that our friends also lost jobs during periods of robust economic health. But our fiscal lens shifts when we see dark headlines barking about dire problems at General Motors or the government coughing up hundreds of billions to try to save former titans like AIG.
Reversing the Wealth Effect
All of this, of course, is well known to economists. They call it the wealth effect, and it maintains that when people feel wealthier, because of rising home values or a climbing stock market, they tend to spend more freely. Many people don't extract money from their home or their investment accounts during such periods, but the simple sense of having more money opens up the wallet. More trips are taken, more meals are eaten at nice restaurants. The economy has benefited greatly from this wealth effect in recent years.
Until now, though, many of us have never lived through the wealth effect's evil cousin: the negative wealth effect that is roiling the economy as the consumer retrenches. Everything -- homes, portfolios, blue-chip companies, the local bank -- seems to be losing value. We still aren't extracting money from our homes or our investment accounts. But the simple sense of having less money closes the wallet. And the future -- always unknown -- seems a whole lot scarier.
That fear has certainly permeated my life. It first hit me this summer when shopping for produce at the grocery store. Though I had once worked as a dairy manager at a grocery store, I had seldom checked prices on everyday items. I just kind of assumed that prices were what they were and you got what you got.
Strolling through the produce department, I found myself comparing prices of fresh cherries, and deciding they were too expensive to buy. I also realized that I had stopped buying nice bottles of wine for dinner; it seemed silly to spend that much money when a cheaper wine would be just fine.
This same scenario played out in countless other small ways -- in what I no longer did or bought.
Home for the Holidays
Many other people I know, regardless of financial circumstance, are going through a similar process. My family in Minnesota has a big Thanksgiving event every two years. In the past, people have come from all over the U.S. and from Europe. We once had to use the kitchen of a local school to include everyone. This year, the confab had fewer attendees. Despite everyone doing well, and in some cases actually doing far better financially than in the past, they balked at the high cost of air travel.
My friends are also finding their spending and saving psychology changing. Most of them still have the same jobs and same basic costs as before, but their mind-set has changed. A friend of mine in finance talked about how he and his office have set up sandwich-making contests for lunch. They order in the basics from a supermarket and have at them. In better times, he'd talk about treating colleagues to lunch at a nice restaurant. He also recently said he's thinking about leaving New York. He figures taxes are headed sharply higher and the financial crisis will bite hard. And thinking about raising his family in New York causes too much economic "brain damage," he says.
A friend who works on a sports Web site in New York, recently married, has started questioning whether to close on a recently purchased apartment. Even though she and her husband have good jobs and can't get the deposit back, she's wondering if putting so much of her family money into real estate is the right move in the current climate. A colleague of mine at work is going through the identical math in almost the identical situation.
Everyone seems to have caught the same bug, with minds switching off the spend gene almost in unison. Walking past a posh French restaurant (prix fixe lunch: $45) near a fund manager friend's office, I asked if he'd ever gone there for lunch. He hadn't and added that it seemed like a "pre-crisis" kind of place.
Thrift and Fear
Thrift, of course, can be a good notion. Americans have for some time spent more than they've made, leading to the first so-called negative savings rates since the 1930s. This overspending, largely driven by borrowed money, occurred in the corporate and financial sector as well. It got us into the mess we're in.
Now, as individuals rediscover thrift, companies are going through their own process of "deleveraging," or reducing their credit-bingeing ways. And this is what has sent the economy into its downward spiral.
Upon taking office in 1933, Franklin Roosevelt declared that "the only thing we have to fear is fear itself." He was talking directly to people's psychology about money. If everyone put their money under a mattress and banks feared to lend, growth would not return.
It's hard to envision things getting to that level today, but fear, once it takes hold, can be difficult to turn around. And there's little question that fear about the future is having a negative impact on our financial psychology.
How to reverse things? For me, an increase in my savings will give me more confidence and less fear (although it certainly isn't going to do much to help the economy in the short run). I suspect that's true for a great many other people as well. The headlines will also play a role. Until the news moves from "crisis" to "confidence," it's hard to erase fear and concern about what's around the next bend.
Ultimately, things will get better, as they always have. Then we will once again be optimists and less afraid of risks. Until then, though, I think I'll just pass on the cherries.—Mr. Kansas is the president of FiLife.com, a personal-finance Web site owned by Dow Jones & Co. and IAC Corp.
Write to Dave Kansas at dave.kansas@wsj.com
http://online.wsj.com/article/SB122765006147657695.html
Essay
It's All in Our Heads
We spend how we feel -- even when our reality hasn't changed much at all
By DAVE KANSAS
My workaday financial life hasn't changed much in the past year. So why am I acting as if it has?
I don't splurge on expensive dinners anymore, and I walk rather than drive places. I compare grocery prices for the first time in years.
In fact, as I look around, I find my friends and I are making all kinds of thrifty decisions that would never have crossed our minds just a few months ago. And it's a stark reminder that the way we think about money can often be detached from our immediate, personal situation.
It doesn't make any difference that most of us continue to hold down the same jobs we had before unemployment rates started to rise. It doesn't matter that our personal circumstances are the same as they've been for the past few years. What matters, instead, is the vague uncertainty that has descended on us. What matters is our unknown future.
So even if our own lives have changed little, we cite a friend's lost job as a reason to worry afresh about our own financial situation. We forget -- or ignore -- that our friends also lost jobs during periods of robust economic health. But our fiscal lens shifts when we see dark headlines barking about dire problems at General Motors or the government coughing up hundreds of billions to try to save former titans like AIG.
Reversing the Wealth Effect
All of this, of course, is well known to economists. They call it the wealth effect, and it maintains that when people feel wealthier, because of rising home values or a climbing stock market, they tend to spend more freely. Many people don't extract money from their home or their investment accounts during such periods, but the simple sense of having more money opens up the wallet. More trips are taken, more meals are eaten at nice restaurants. The economy has benefited greatly from this wealth effect in recent years.
Until now, though, many of us have never lived through the wealth effect's evil cousin: the negative wealth effect that is roiling the economy as the consumer retrenches. Everything -- homes, portfolios, blue-chip companies, the local bank -- seems to be losing value. We still aren't extracting money from our homes or our investment accounts. But the simple sense of having less money closes the wallet. And the future -- always unknown -- seems a whole lot scarier.
That fear has certainly permeated my life. It first hit me this summer when shopping for produce at the grocery store. Though I had once worked as a dairy manager at a grocery store, I had seldom checked prices on everyday items. I just kind of assumed that prices were what they were and you got what you got.
Strolling through the produce department, I found myself comparing prices of fresh cherries, and deciding they were too expensive to buy. I also realized that I had stopped buying nice bottles of wine for dinner; it seemed silly to spend that much money when a cheaper wine would be just fine.
This same scenario played out in countless other small ways -- in what I no longer did or bought.
Home for the Holidays
Many other people I know, regardless of financial circumstance, are going through a similar process. My family in Minnesota has a big Thanksgiving event every two years. In the past, people have come from all over the U.S. and from Europe. We once had to use the kitchen of a local school to include everyone. This year, the confab had fewer attendees. Despite everyone doing well, and in some cases actually doing far better financially than in the past, they balked at the high cost of air travel.
My friends are also finding their spending and saving psychology changing. Most of them still have the same jobs and same basic costs as before, but their mind-set has changed. A friend of mine in finance talked about how he and his office have set up sandwich-making contests for lunch. They order in the basics from a supermarket and have at them. In better times, he'd talk about treating colleagues to lunch at a nice restaurant. He also recently said he's thinking about leaving New York. He figures taxes are headed sharply higher and the financial crisis will bite hard. And thinking about raising his family in New York causes too much economic "brain damage," he says.
A friend who works on a sports Web site in New York, recently married, has started questioning whether to close on a recently purchased apartment. Even though she and her husband have good jobs and can't get the deposit back, she's wondering if putting so much of her family money into real estate is the right move in the current climate. A colleague of mine at work is going through the identical math in almost the identical situation.
Everyone seems to have caught the same bug, with minds switching off the spend gene almost in unison. Walking past a posh French restaurant (prix fixe lunch: $45) near a fund manager friend's office, I asked if he'd ever gone there for lunch. He hadn't and added that it seemed like a "pre-crisis" kind of place.
Thrift and Fear
Thrift, of course, can be a good notion. Americans have for some time spent more than they've made, leading to the first so-called negative savings rates since the 1930s. This overspending, largely driven by borrowed money, occurred in the corporate and financial sector as well. It got us into the mess we're in.
Now, as individuals rediscover thrift, companies are going through their own process of "deleveraging," or reducing their credit-bingeing ways. And this is what has sent the economy into its downward spiral.
Upon taking office in 1933, Franklin Roosevelt declared that "the only thing we have to fear is fear itself." He was talking directly to people's psychology about money. If everyone put their money under a mattress and banks feared to lend, growth would not return.
It's hard to envision things getting to that level today, but fear, once it takes hold, can be difficult to turn around. And there's little question that fear about the future is having a negative impact on our financial psychology.
How to reverse things? For me, an increase in my savings will give me more confidence and less fear (although it certainly isn't going to do much to help the economy in the short run). I suspect that's true for a great many other people as well. The headlines will also play a role. Until the news moves from "crisis" to "confidence," it's hard to erase fear and concern about what's around the next bend.
Ultimately, things will get better, as they always have. Then we will once again be optimists and less afraid of risks. Until then, though, I think I'll just pass on the cherries.—Mr. Kansas is the president of FiLife.com, a personal-finance Web site owned by Dow Jones & Co. and IAC Corp.
Write to Dave Kansas at dave.kansas@wsj.com
http://online.wsj.com/article/SB122765006147657695.html
Comeback Funds
Comeback Funds
By ROB WHERRY
Lately it seems that whenever we talk to advisers and industry watchers, there's one fund family that generates the most discussion: Dodge & Cox. The venerable 78-year-old firm got caught this year holding stocks like Fannie Mae, American International Group and Wachovia as those companies spiraled downward. That has caused its flagship fund, Dodge & Cox Stock, to post a 47.7% loss in 2008, worse than the Standard & Poor's 500-stock index's 41.1% decline.
That's an unaccustomed place for this company. Its funds ordinarily are ranked high in their respective categories. Indeed, Dodge & Cox Stock has returned an average annual 4.4% the past decade, a tally that puts it near the top of the large-cap value category. That leaves shareholders wondering: Will Dodge & Cox make a comeback? While we think the answer is an unequivocal yes, we also realize we don't have a crystal ball. Unfortunately for investors, there are plenty of other funds out there that sport a similar penthouse-to-doghouse track record.
By ROB WHERRY
Lately it seems that whenever we talk to advisers and industry watchers, there's one fund family that generates the most discussion: Dodge & Cox. The venerable 78-year-old firm got caught this year holding stocks like Fannie Mae, American International Group and Wachovia as those companies spiraled downward. That has caused its flagship fund, Dodge & Cox Stock, to post a 47.7% loss in 2008, worse than the Standard & Poor's 500-stock index's 41.1% decline.
That's an unaccustomed place for this company. Its funds ordinarily are ranked high in their respective categories. Indeed, Dodge & Cox Stock has returned an average annual 4.4% the past decade, a tally that puts it near the top of the large-cap value category. That leaves shareholders wondering: Will Dodge & Cox make a comeback? While we think the answer is an unequivocal yes, we also realize we don't have a crystal ball. Unfortunately for investors, there are plenty of other funds out there that sport a similar penthouse-to-doghouse track record.
This week we're focusing on those funds, with an eye toward finding the ones best poised to bounce back. We started with ones that have stellar track records over the past decade, but also were in the bottom 40% of their peer groups the past three years. We knocked out those with sales loads and added our usual fee criteria.
We were left with 28 equity funds. We handicapped that list by picking seven we think will return to form based on adviser interviews, managers' reputations, past track records, and the funds' strategy and current portfolios. The finalists are listed below.
Fees, Even Returns and Auditor All Raised Flags
By GREGORY ZUCKERMAN
Bernard L. Madoff is alleged to have pulled off one of the biggest frauds in Wall Street history. But there were multiple red flags along the way, including a series of accusations leveled against Mr. Madoff's operation. Now some are asking why regulators and investors didn't pick up on the alleged scheme long ago.
Image from Madoff.com
Bernard Madoff
"There's no smoking gun, but if you added it all up you wonder why people either did not get it or chose to ignore the red flags," says Jim Vos, who runs Aksia LLC, a firm that advises investors and came away worried after examining Mr. Madoff's operation.
On Thursday, Mr. Madoff was arrested for what federal agents described as a massive Ponzi scheme, which could leave investors with billions in losses. A spokesman for Mr. Madoff said: "Bernie Madoff is a longstanding leader in the financial services industry and we are cooperating fully with the government and regulators investigations into this unfortunate set of events."
The first tip-off for some was the steady returns generated by the firm in every kind of market. Mr. Madoff would buy a basket of stocks resembling an S&P index while simultaneously selling options that pay off for the buyer if these stocks soar, while also buying options that pay off if the index tumbles. The supposed goal was to have smooth, steady returns.
Harry Markopolos, who years ago worked for a rival firm, researched Mr. Madoff's stock-options strategy and was convinced the results likely weren't real.
"Madoff Securities is the world's largest Ponzi Scheme," Mr. Markopolos, wrote in a letter to the U.S. Securities and Exchange Commission in 1999.
Mr. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston bureaus of the SEC, according to documents he sent to the SEC reviewed by The Wall Street Journal.
Bernard L. Madoff is alleged to have pulled off one of the biggest frauds in Wall Street history. But there were multiple red flags along the way, including a series of accusations leveled against Mr. Madoff's operation. Now some are asking why regulators and investors didn't pick up on the alleged scheme long ago.
Image from Madoff.com
Bernard Madoff
"There's no smoking gun, but if you added it all up you wonder why people either did not get it or chose to ignore the red flags," says Jim Vos, who runs Aksia LLC, a firm that advises investors and came away worried after examining Mr. Madoff's operation.
On Thursday, Mr. Madoff was arrested for what federal agents described as a massive Ponzi scheme, which could leave investors with billions in losses. A spokesman for Mr. Madoff said: "Bernie Madoff is a longstanding leader in the financial services industry and we are cooperating fully with the government and regulators investigations into this unfortunate set of events."
The first tip-off for some was the steady returns generated by the firm in every kind of market. Mr. Madoff would buy a basket of stocks resembling an S&P index while simultaneously selling options that pay off for the buyer if these stocks soar, while also buying options that pay off if the index tumbles. The supposed goal was to have smooth, steady returns.
Harry Markopolos, who years ago worked for a rival firm, researched Mr. Madoff's stock-options strategy and was convinced the results likely weren't real.
"Madoff Securities is the world's largest Ponzi Scheme," Mr. Markopolos, wrote in a letter to the U.S. Securities and Exchange Commission in 1999.
Mr. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston bureaus of the SEC, according to documents he sent to the SEC reviewed by The Wall Street Journal.
View Interactive
Read more about previous Ponzi schemes.
More
Top Broker Is Accused of Fraud
Madoff Clients Are Shaken by Arrest
The Wallet: Have You Ever Been Scammed?
SEC Press Release on Madoff's Case
SEC Complaint
Press Release on Madoff's Arrest
Criminal Complaint
Archives
Bernie Madoff Asks Investors To Keep Mum 5/7/2001
Wall Street Mystery Features a Big Board Rival 12/16/1992
Read more about previous Ponzi schemes.
More
Top Broker Is Accused of Fraud
Madoff Clients Are Shaken by Arrest
The Wallet: Have You Ever Been Scammed?
SEC Press Release on Madoff's Case
SEC Complaint
Press Release on Madoff's Arrest
Criminal Complaint
Archives
Bernie Madoff Asks Investors To Keep Mum 5/7/2001
Wall Street Mystery Features a Big Board Rival 12/16/1992
In a statement late Friday, the SEC said "staff from the Division of Enforcement in New York completed an investigation in 2007, and did not refer the matter to the Commission for enforcement action." The SEC said it reopened the investigation Thursday. It's not clear what the focus of the 2007 investigation was, or why it was closed. A person familiar with the matter said it related to issues raised by Mr. Markopolos.
Also striking some as odd: Mr. Madoff operated as a broker dealer with an asset management division. Why not simply act as a hedge fund and pocket big gains, rather than profit from trading commissions as the firm seemed to be doing, they asked.
Joe Aaron, for long a hedge fund professional, found that structure suspicious and in 2003 warned a colleague to steer clear of the fund. "Why would a good businessman work his magic for pennies on the dollar?"
Conflicts of interest also proved a concern. "There was no independent custodian involved who could prove the existence of assets," says Chris Addy, founder of Montreal-based Castle Hall Alternatives, which vets hedge funds for clients seeking to invest money. "There's a clear and blatant conflict of interest with a manager using a related-party broker-dealer. Madoff is enormously unusual in that this is not a structure I've seen."
Some trading pros said Mr. Madoff's purported strategy couldn't be pulled off profitably while managing tens of billions of dollars.
"It seemed implausible that the S&P 100 options market that Madoff purported to trade could handle the size of the combined feeder funds' assets which we estimated to be $13 billion," Mr. Vos says.
Recent securities filings showed that the firm held less than $1 billion of shares, raising questions about where the rest of the money was. Some of Mr. Madoff's investors say they were told the firm put the bulk of its money in cash-equivalents at the end of each quarter, explaining why the public filings showed so few shares, but raising questions about where the proof was for all the cash.
Inside Wall Street's Madoff Scandal3:55
Another large-scale scandal rocks Wall Street as Bernard Madoff, a Wall Street titan and investment advisor was arrested for an alleged $50 billion dollar fraud against investors, WSJ's Kelsey Hubbard and Amir Efrati discuss.
Until at least November, 2006, the firm, which claimed to manage billions of dollars and be among the largest market makers in the stock market, used as its auditor Friehling & Horowitz, a small New City, New York firm.
Mr. Vos says his firm hired a private investigator and determined that the accounting firm had only three employees, one of whom was 78 and lived in Florida, and another was a secretary, and that it operated in a 13 foot by 18 foot office. His firm felt that was too small an operation to keep an eye on such a large firm operating a complicated trading strategy. A message left for the accounting firm was not returned.
Meanwhile, a series of media stories also raised questions about Madoff's operations, including a piece entitled "Madoff Tops Charts; Skeptics Ask How" in industry publication MAR/Hedge in May, 2001, and a subsequent story in Barron's. Mr. Madoff generally brushed off reporters' questions, citing the audited results and arguing that his business was too complicated for outsiders to understand.—Kara Scannell and Jenny Strasburg contributed to this article
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com
The Dollar Powers Through the Turmoil
DECEMBER 6, 2008, 11:58 P.M. ET
The Dollar Powers Through the Turmoil
The Dollar Powers Through the Turmoil
By JOANNA SLATER
Amid the worst financial crisis in decades, the U.S. dollar has come roaring back to life.
Over the past four months, as investors around the world fled from risk, the dollar recouped more than two years' worth of losses against a broad group of currencies, including its swoon in the early part of this year.
Amid the worst financial crisis in decades, the U.S. dollar has come roaring back to life.
Over the past four months, as investors around the world fled from risk, the dollar recouped more than two years' worth of losses against a broad group of currencies, including its swoon in the early part of this year.
Since the start of August, the dollar has strengthened 23% against the euro, 34% against the British pound, and still more against some currencies in developing countries.
Of course, the buck's recent rally hasn't fully undone its decline, which began back in 2002. Still, it represents a significant turning point for a currency whose long weakness had turned it into a source of rueful amusement for Americans.
Of course, the buck's recent rally hasn't fully undone its decline, which began back in 2002. Still, it represents a significant turning point for a currency whose long weakness had turned it into a source of rueful amusement for Americans.
Safe Port in the Storm
To the surprise of many observers, the greenback turned out to be a major beneficiary of the global flight from risky assets and the unwinding of bets based on borrowed cash, much of it in dollars. In a time of extreme financial stress, investors sought the relative safety of the world's reserve currency, and if possible, U.S. Treasury bonds.
The ever-widening scope of the crisis also helped the buck: It rapidly became clear that the U.S. is far from the only country with economic woes and hobbled banks.
For investors, the dollar's resurgence is proving a tricky puzzle. Some believe that the comeback will prove to be short-lived, given the enormous challenges facing the U.S. economy. But others say it's likely to endure well into next year as economies around the globe grapple with a sharp slowdown.
"We are roughly halfway through the rally in the dollar," predicted Stephen Jen, global head of currency research at Morgan Stanley, in a recent note. Mr. Jen thinks the dollar could face a harder slog in the second half of next year as the full costs of various government bailouts become clear.
For now, a stronger dollar is a welcome development for Americans traveling abroad, who had become accustomed to seeing their dollars buy less and less on each trip.
But for some companies, it's less desirable. A stronger dollar means that American exporters' goods and services are more expensive for foreign buyers, reducing their competitiveness. It also represents a drawback for American multinationals. Their overseas earnings will be worth less when converted back into dollars, denting sales and profits.
The dollar's rally has also helped clobber one of the most popular investing trends of recent years: buying foreign stocks. For much of the last six years, U.S. investors got an additional bonus when putting money overseas. As the dollar declined, gains in foreign currencies would convert into more dollars, sweetening returns.
Overseas Stock Losses
Now the opposite dynamic is unfolding. Global shares have plunged and the dollar has surged against nearly all currencies (with the Japanese yen the major exception). So not only have foreign shares fallen, they're also worth less in dollar terms, magnifying the losses for U.S. investors.
The impact has been substantial in some cases: For instance, the MSCI Emerging Markets Index, which tracks stocks in developing countries, has fallen by half this year in local-currency terms. But translated back into dollars, it is down about 60%.
"The dollar has been the wind at our back for the past five years," says James Moffett, who manages the $3 billion UMB Scout International Fund. "This year it's been in our face."
Mr. Moffett adds that he thinks the currency-related pain for international stocks is nearly finished -- in other words, the dollar is unlikely to strengthen further from here.
Some see clouds gathering for the dollar as the massive programs to assist the ailing economy work through the system. The problem isn't necessarily that the U.S. fiscal deficit will increase. "Neither economic theory nor the historical record provides a clear link between fiscal stimulus and [currencies]," noted a recent report from J.P. Morgan Chase.
Instead, observers are focused on the actions of the U.S. Federal Reserve, which has expanded its own balance sheet, essentially creating money to fund a variety of new programs.
Once the economy starts to recover, the massive injections of cash by the Fed could cause rampant inflation, something that's bad for the dollar because it erodes a currency's worth. Others say the Fed will curtail liquidity before that happens, by raising interest rates or through other measures. For now, the Fed is trying to avert a different risk, that of deflation -- a vicious cycle of contracting credit and falling prices.
In the back of their minds, investors also worry about another scenario, in which foreign investors could lose confidence and scale back or stop buying U.S. assets. That would send the dollar plunging and interest rates soaring.
Investment Opportunities
Of course, that possibility remains remote. In some ways, what has unfolded so far is the opposite of such a crisis. Rather than shunning assets like U.S. Treasurys, investors have flocked to them in a sign that they continue to see them as a haven in an uncertain world.
For investors, the dollar's latest surge and murky future present a number of choices. There are a number of funds that aim to track the movements of various currencies against the dollar, including nine exchange-traded funds from Rydex Investments. Such instruments essentially involve taking a view on currency directions -- which is always risky.
If you believe that, in the long run, the dollar is likely to weaken, then one strategy is to own stocks or bonds denominated in other currencies. If the dollar loses ground, the returns will be worth more when converted back into dollars.
Bonds denominated in other currencies are a more direct way to bet on such fluctuations, since most of a stock's return comes from factors other than currency gains or losses.
Write to Joanna Slater at joanna.slater@wsj.com
1931 and 2008: Will Market History Repeat Itself?
THE INTELLIGENT INVESTOR
NOVEMBER 22, 2008
1931 and 2008: Will Market History Repeat Itself?
By JASON ZWEIG
Over the two weeks ended Nov. 20, 2008, the Dow Jones Industrial Average fell 16%. Over the two weeks ended Nov. 20, 1931, the Dow fell 16%.
If you think that is scary, consider this: In the final five weeks of 1931, the Dow fell 20% further. Then it went on to lose yet another 47% before it finally hit rock-bottom on July 8, 1932.
It is vital to realize that markets are never under some obligation to stop falling merely because they have already fallen by an ungodly amount. It also is vital to explore how bad the worst-case scenario can get and to think about how you would respond if it comes to pass.
When it comes to worst-case scenarios, 1931-1932 is it. When the Dow finally stopped going down, in July 1932, it had lost 88% in 36 months. At that point, only five of the roughly 800 companies that still survived on the New York Stock Exchange had lost less than two-thirds of their value from their peak in 1929.
Look back at issues of The Wall Street Journal from 1931, as I did this week, and you may get the chills comparing it to today. "When the [automotive] industry in the near future resumes operations," declared one front-page article on Nov. 9, "it will enjoy the benefits of substantial reductions in labor costs."
The U.S. economy, as measured by gross national product, shriveled by 14.7% in 1931. Although no one expects the economy to grow in the fourth quarter of this year, it is flat year to date and shrank by "only" 0.3% in the third quarter. In 1931, one out of every six Americans was unemployed; today, one in 16 is out of work.
I don't foresee another Great Depression, but I am under no illusion that it can't happen. My parents and grandparents lived through it, and their memories of it have been branded on my brain.
If we are going into another depression, then a residual holding in stocks will be the least of your problems. Depressions hamstring nearly all forms of wealth, not just stocks. From 1929 through 1937, cash earned a compound annual return of 0.7%; intermediate-term bonds, only 4.4%.
None of us can control what the markets do to us. But we can control how we handle money, and we need to learn from our parents and grandparents who survived the Great Depression.
My grandfather was one of those people. An immigrant who bought a farm outside of Albany, N.Y., he literally became a horse trader. He bought wild horses from the Sioux in Montana for $1 apiece, transported them in a railcar to Albany and sold them for $10 each -- after his sons, whose labor cost him nothing, broke and tamed the horses.
In November 1931, my father was 15 years old. As the youngest of three brothers, he was stuck with the worst chore: fetching water at 5 a.m. He had to hang two buckets onto a shoulder yoke, fill them laboriously from the hand-powered water pump near the barn, then lug them back into the house. On winter mornings, the water would freeze on contact, and his trouser legs would creak and clatter as he carried the buckets across the snow.
Later that winter, my grandfather bought a gasoline-powered pump. The next morning, my father started the pump and filled the first bucket, excited at how easy his ordeal had become. The next thing he knew, his feet were dangling off the ground and my grandfather's fist was in his chest, pinning him against the barn wall. Terrified, my dad gasped, "Pop, what did I do?" The engine of the pump was going "ka-thump, ka-thump." My grandfather growled, "You hear them thumps? Every one of them thumps is a nickel!"
He was furious that my father had not turned off the engine between buckets.
I'm going to take a chance and hang onto my stocks. But I'm going to make sure, over the months and years to come, that I turn down the thermostat.
Email: intelligentinvestor@wsj.com
http://online.wsj.com/article/SB122731594413349829.html
NOVEMBER 22, 2008
1931 and 2008: Will Market History Repeat Itself?
By JASON ZWEIG
Over the two weeks ended Nov. 20, 2008, the Dow Jones Industrial Average fell 16%. Over the two weeks ended Nov. 20, 1931, the Dow fell 16%.
If you think that is scary, consider this: In the final five weeks of 1931, the Dow fell 20% further. Then it went on to lose yet another 47% before it finally hit rock-bottom on July 8, 1932.
It is vital to realize that markets are never under some obligation to stop falling merely because they have already fallen by an ungodly amount. It also is vital to explore how bad the worst-case scenario can get and to think about how you would respond if it comes to pass.
When it comes to worst-case scenarios, 1931-1932 is it. When the Dow finally stopped going down, in July 1932, it had lost 88% in 36 months. At that point, only five of the roughly 800 companies that still survived on the New York Stock Exchange had lost less than two-thirds of their value from their peak in 1929.
Look back at issues of The Wall Street Journal from 1931, as I did this week, and you may get the chills comparing it to today. "When the [automotive] industry in the near future resumes operations," declared one front-page article on Nov. 9, "it will enjoy the benefits of substantial reductions in labor costs."
The U.S. economy, as measured by gross national product, shriveled by 14.7% in 1931. Although no one expects the economy to grow in the fourth quarter of this year, it is flat year to date and shrank by "only" 0.3% in the third quarter. In 1931, one out of every six Americans was unemployed; today, one in 16 is out of work.
I don't foresee another Great Depression, but I am under no illusion that it can't happen. My parents and grandparents lived through it, and their memories of it have been branded on my brain.
If we are going into another depression, then a residual holding in stocks will be the least of your problems. Depressions hamstring nearly all forms of wealth, not just stocks. From 1929 through 1937, cash earned a compound annual return of 0.7%; intermediate-term bonds, only 4.4%.
None of us can control what the markets do to us. But we can control how we handle money, and we need to learn from our parents and grandparents who survived the Great Depression.
My grandfather was one of those people. An immigrant who bought a farm outside of Albany, N.Y., he literally became a horse trader. He bought wild horses from the Sioux in Montana for $1 apiece, transported them in a railcar to Albany and sold them for $10 each -- after his sons, whose labor cost him nothing, broke and tamed the horses.
In November 1931, my father was 15 years old. As the youngest of three brothers, he was stuck with the worst chore: fetching water at 5 a.m. He had to hang two buckets onto a shoulder yoke, fill them laboriously from the hand-powered water pump near the barn, then lug them back into the house. On winter mornings, the water would freeze on contact, and his trouser legs would creak and clatter as he carried the buckets across the snow.
Later that winter, my grandfather bought a gasoline-powered pump. The next morning, my father started the pump and filled the first bucket, excited at how easy his ordeal had become. The next thing he knew, his feet were dangling off the ground and my grandfather's fist was in his chest, pinning him against the barn wall. Terrified, my dad gasped, "Pop, what did I do?" The engine of the pump was going "ka-thump, ka-thump." My grandfather growled, "You hear them thumps? Every one of them thumps is a nickel!"
He was furious that my father had not turned off the engine between buckets.
I'm going to take a chance and hang onto my stocks. But I'm going to make sure, over the months and years to come, that I turn down the thermostat.
Email: intelligentinvestor@wsj.com
http://online.wsj.com/article/SB122731594413349829.html
So Many Choices to Rebalance a Portfolio, Made Cheaper by Falling Markets
ROI
OCTOBER 9, 2008, 7:52 A.M. ET
Plunge Gives Investors Chance to Diversify
So Many Choices to Rebalance a Portfolio, Made Cheaper by Falling Markets
By BRETT ARENDS
A lot of people came into this crash totally unprepared. They're holding all their money in a few stocks, or in a few mutual funds that are too similar to one another. They're getting crushed.
No wonder so many are panicking and are selling out.
But if you're in this situation, here's a better idea: Don't bail, but rebalance.
Sell your concentrated or random portfolio, and put your money into a broader mix of investments. The most stable portfolios are spread across multiple assets, asset classes, and investment styles. The good news is that today, because there are so many different investment funds on the market, anyone can do it.
Here's an illustration of what that might look like with, say, $100,000.
Let's say you wanted to put maybe 30%, or $30,000, in bonds to provide some welcome stability. They tend to be less volatile than stocks.
Right now regular Treasurys, the bonds issued by Uncle Sam, are pretty expensive. Everyone's been buying them in panic. The 30-year Treasury as a result pays a paltry 4% interest.
You might decide there are better opportunities elsewhere. Municipals, for example, are actually yielding more than Treasurys and they're tax free. So you could put $10,000 into a municipal-bond fund like Eaton Vance National Municipals, which is yielding well over 5%. You could put another $10,000 into inflation-protected Treasurys, also known as TIPS, which are still reasonably priced. Vanguard's Inflation-Protected Securities is one of the best-known funds. And you might round out your bond holdings by putting $10,000 into a flexible bond fund, like Loomis Sayles Bond, that can pick up opportunities anywhere. Veteran manager Dan Fuss sees some of the best bargains in investment-grade corporate bonds.
Let's then say you still want the bulk of your investments exposed to the world's stock markets. That is, after all, where most money is traditionally made over the long term.
But you might be looking for smart managers who have flexibility to hold cash, protect against market falls, ignore landmines, and grab opportunities where they see them.
You can pick several managers and invest $10,000 with each. Two funds I happen to own are Quaker Strategic Growth (QUAGX) and Fairholme. Both have good long-term records. There are plenty of other good ones out there. Fresh investors might prefer manager Manu Daftary's newer fund, Quaker Global Total Return, which is smaller and has even more flexibility than his Quaker Strategic Growth.
Another good holding might be Diamond-Hill Long-Short, a fund that operates a bit like a hedge fund and seeks to produce good returns in any market.
A fourth might be Gateway, which has a long record of producing good returns with pretty low volatility: For decades, this fund has held equities and sold call options against its holdings to generate income.
You could add further strings to your bow by investing $10,000 each in, say, Japanese equities, emerging markets, and maybe commodities. Examples for the first two might be T. Rowe Price Japan and Vanguard's Emerging Markets Stock Index fund.
On commodities, you've got a pretty broad range of options. You can invest in assets themselves, or the companies that produce them. An example of the former is the streetTracks Gold Trust, an exchange-traded fund that tracks the gold price.
You might reason that gold looked a lot more interesting eight years ago, when it was $250 an ounce and no one was talking about it, than it does now, when it's nearly $900 an ounce and no one will stop talking about it.
As a novice, you might instead decide to place your tenth chip on managed timber, an asset with an excellent long-term track record of producing solid returns. Fund legend Jeremy Grantham, along with the managers of Harvard University's endowment, have been fans recently. One possible route would be to buy shares in Plum Creek, the blue-chip stock in the sector. It's a real-estate investment trust that owns timberland. A caveat: This, too, has risen quite a distance. It's nearly trebled in ten years.
Past performance is no guide to the future, of course. Nonetheless when I checked out how this portfolio would have fared during the turmoil of this decade, it stacked up pretty well.
I could only trace it back to August 2000, when several of these funds were launched. (and I could only include Diamond Hill from its launch in December).
But from August 31, 2000 through this week, with dividends reinvested, this portfolio would have gained about 61%. Wall Street overall, by contrast, is down about 21% over that period.
And this portfolio would have let you sleep a lot easier, too. Through the crash of 2000-2003 it fell just 5%, while the wider market nearly halved.
Almost nothing has been spared in the incredible worldwide crash of the last year. But this portfolio has only fallen 24% from the peak, while Wall Street overall has fallen about 35%.
Like I said, this is only an exercise and an illustration. Anyone can put together a pretty broadly diversified portfolio these days. There are an infinite number of varieties.
You could, for example, replace one of the equity funds above with one specializing in international small cap stocks, like Oakmark International Small Cap (OAKEX). They've been absolutely crushed in the last year and there are plenty of bargains to be had.
Or you could pick some other active fund managers, like Ken Heebner at CGM Focus, or Marty Whitman at Third Avenue Value, or even Warren Buffett at Berkshire Hathaway.
Or you could replace a couple of the investments with closed-end funds trading at big discounts to their net assets. The BlackRock S&P Quality Rankings Global Equity Managed Trust, which invests in top quality blue-chip stocks, is selling for 19% below net asset value. Clough Global Opportunities, a well-managed global investment fund mentioned here before, is an incredible 29% below.
The positive side to this crash is that lots of these investment options are now going cheap. That makes it easier to rebalance your portfolio into something more broadly based, and, one hopes, stable.
Write to Brett Arends at brett.arends@wsj.com
OCTOBER 9, 2008, 7:52 A.M. ET
Plunge Gives Investors Chance to Diversify
So Many Choices to Rebalance a Portfolio, Made Cheaper by Falling Markets
By BRETT ARENDS
A lot of people came into this crash totally unprepared. They're holding all their money in a few stocks, or in a few mutual funds that are too similar to one another. They're getting crushed.
No wonder so many are panicking and are selling out.
But if you're in this situation, here's a better idea: Don't bail, but rebalance.
Sell your concentrated or random portfolio, and put your money into a broader mix of investments. The most stable portfolios are spread across multiple assets, asset classes, and investment styles. The good news is that today, because there are so many different investment funds on the market, anyone can do it.
Here's an illustration of what that might look like with, say, $100,000.
Let's say you wanted to put maybe 30%, or $30,000, in bonds to provide some welcome stability. They tend to be less volatile than stocks.
Right now regular Treasurys, the bonds issued by Uncle Sam, are pretty expensive. Everyone's been buying them in panic. The 30-year Treasury as a result pays a paltry 4% interest.
You might decide there are better opportunities elsewhere. Municipals, for example, are actually yielding more than Treasurys and they're tax free. So you could put $10,000 into a municipal-bond fund like Eaton Vance National Municipals, which is yielding well over 5%. You could put another $10,000 into inflation-protected Treasurys, also known as TIPS, which are still reasonably priced. Vanguard's Inflation-Protected Securities is one of the best-known funds. And you might round out your bond holdings by putting $10,000 into a flexible bond fund, like Loomis Sayles Bond, that can pick up opportunities anywhere. Veteran manager Dan Fuss sees some of the best bargains in investment-grade corporate bonds.
Let's then say you still want the bulk of your investments exposed to the world's stock markets. That is, after all, where most money is traditionally made over the long term.
But you might be looking for smart managers who have flexibility to hold cash, protect against market falls, ignore landmines, and grab opportunities where they see them.
You can pick several managers and invest $10,000 with each. Two funds I happen to own are Quaker Strategic Growth (QUAGX) and Fairholme. Both have good long-term records. There are plenty of other good ones out there. Fresh investors might prefer manager Manu Daftary's newer fund, Quaker Global Total Return, which is smaller and has even more flexibility than his Quaker Strategic Growth.
Another good holding might be Diamond-Hill Long-Short, a fund that operates a bit like a hedge fund and seeks to produce good returns in any market.
A fourth might be Gateway, which has a long record of producing good returns with pretty low volatility: For decades, this fund has held equities and sold call options against its holdings to generate income.
You could add further strings to your bow by investing $10,000 each in, say, Japanese equities, emerging markets, and maybe commodities. Examples for the first two might be T. Rowe Price Japan and Vanguard's Emerging Markets Stock Index fund.
On commodities, you've got a pretty broad range of options. You can invest in assets themselves, or the companies that produce them. An example of the former is the streetTracks Gold Trust, an exchange-traded fund that tracks the gold price.
You might reason that gold looked a lot more interesting eight years ago, when it was $250 an ounce and no one was talking about it, than it does now, when it's nearly $900 an ounce and no one will stop talking about it.
As a novice, you might instead decide to place your tenth chip on managed timber, an asset with an excellent long-term track record of producing solid returns. Fund legend Jeremy Grantham, along with the managers of Harvard University's endowment, have been fans recently. One possible route would be to buy shares in Plum Creek, the blue-chip stock in the sector. It's a real-estate investment trust that owns timberland. A caveat: This, too, has risen quite a distance. It's nearly trebled in ten years.
Past performance is no guide to the future, of course. Nonetheless when I checked out how this portfolio would have fared during the turmoil of this decade, it stacked up pretty well.
I could only trace it back to August 2000, when several of these funds were launched. (and I could only include Diamond Hill from its launch in December).
But from August 31, 2000 through this week, with dividends reinvested, this portfolio would have gained about 61%. Wall Street overall, by contrast, is down about 21% over that period.
And this portfolio would have let you sleep a lot easier, too. Through the crash of 2000-2003 it fell just 5%, while the wider market nearly halved.
Almost nothing has been spared in the incredible worldwide crash of the last year. But this portfolio has only fallen 24% from the peak, while Wall Street overall has fallen about 35%.
Like I said, this is only an exercise and an illustration. Anyone can put together a pretty broadly diversified portfolio these days. There are an infinite number of varieties.
You could, for example, replace one of the equity funds above with one specializing in international small cap stocks, like Oakmark International Small Cap (OAKEX). They've been absolutely crushed in the last year and there are plenty of bargains to be had.
Or you could pick some other active fund managers, like Ken Heebner at CGM Focus, or Marty Whitman at Third Avenue Value, or even Warren Buffett at Berkshire Hathaway.
Or you could replace a couple of the investments with closed-end funds trading at big discounts to their net assets. The BlackRock S&P Quality Rankings Global Equity Managed Trust, which invests in top quality blue-chip stocks, is selling for 19% below net asset value. Clough Global Opportunities, a well-managed global investment fund mentioned here before, is an incredible 29% below.
The positive side to this crash is that lots of these investment options are now going cheap. That makes it easier to rebalance your portfolio into something more broadly based, and, one hopes, stable.
Write to Brett Arends at brett.arends@wsj.com
How Bernie Madoff Made Smart Folks Look Dumb
THE INTELLIGENT INVESTOR
DECEMBER 13, 2008
How Bernie Madoff Made Smart Folks Look Dumb
By JASON ZWEIG
What do George Carlin and Bernard Madoff have in common?
The late comedian immortalized oxymorons, those absurd word pairs like "jumbo shrimp" and "military intelligence." Mr. Madoff just put the silliest of all financial oxymorons into the spotlight: "sophisticated investor."
The accounts managed by Bernard L. Madoff Investment Securities LLC reported gains of roughly 1% a month like clockwork, with nary a loss, for two decades. Why did that freakishly smooth return not set off alarms among current and prospective investors?
Of all people, sophisticated investors like Mr. Madoff's clients should know that if something sounds too good to be true, then it's not. But they believed it anyway. Why?
Mr. Madoff emphasized secrecy, lending his investment accounts a mysterious allure and sense of exclusivity. The initial marketing often was in the hands of what one source described as "a macher" (the Yiddish term for a big shot). At the country club or another exclusive rendezvous, the macher would brag, "I've got my money invested with Madoff and he's doing really well." When his listener expressed interest, the macher would reply, "You can't get in unless you're invited...but I can probably get you in."
Robert Cialdini, a psychology professor at Arizona State University and author of "Influence: Science and Practice," calls this strategy "a triple-threat combination." The "murkiness" of a hedge fund, he says, makes investors feel that it is "the inherent domain of people who know more than we do." This uncertainty leads us to look for social proof: evidence that other people we trust have already decided to invest. And by playing up how exclusive his funds were, Mr. Madoff shifted investors' fears from the risk that they might lose money to the risk they might lose out on making money.
If you did get invited in, then you were anointed a member of this particular club of "sophisticated investors." Once someone you respect went out of his way to grant you access, says Prof. Cialdini, it would seem almost an "insult" to do any further investigation. Mr. Madoff also was known to throw investors out of his funds for asking too many questions, so no one wanted to rock the boat.
This members-only feeling blinded many buyers of Mr. Madoff's funds to the numerous red flags fluttering around his operation. When you are in an exclusive private club, you do not go rummaging around in the kitchen to make sure that the health code is being followed.
Here we have the biggest dirty secret of the "sophisticated investor": Due diligence often goes undone. For a brief window in 2006, the Securities and Exchange Commission required hedge funds to file standardized disclosure forms. William Goetzmann, a finance professor at Yale School of Management, found that hedge funds disclosing legal or regulatory problems and conflicts of interest ended up with lower future performance. But the disclosure of these risks had no impact at all on how much money flowed into the hedge funds.
In other words, investors were getting useful information -- and paying no attention to it. Amaranth Advisors LLC, the commodity hedge fund that collapsed in 2006 with $6 billion in losses, did not even file the required SEC form at the beginning of that year, a clear signal that something might be wrong. Instead of standing pat or pulling money out, investors poured more money in.
Last year, the Greenwich Roundtable, a nonprofit that researches alternative investments, conducted a survey of consultants, pension plans, "family offices," funds of funds and other large investors who shop for hedge funds. It's hard to imagine a more sophisticated crowd.
Yet one out of five investors in the survey reported that they "always follow" not a formal checklist or analytical procedure, but rather "an informal process" of due diligence.
That's for sure.
If you invest with anyone who claims never to lose money, reports amazingly smooth returns, will not explain his strategy, refuses to disclose basic information or discuss potential risks, you're not sophisticated. You're an oxymoron.
Email: intelligentinvestor@wsj.com
http://online.wsj.com/article/SB122912266389002855.html
DECEMBER 13, 2008
How Bernie Madoff Made Smart Folks Look Dumb
By JASON ZWEIG
What do George Carlin and Bernard Madoff have in common?
The late comedian immortalized oxymorons, those absurd word pairs like "jumbo shrimp" and "military intelligence." Mr. Madoff just put the silliest of all financial oxymorons into the spotlight: "sophisticated investor."
The accounts managed by Bernard L. Madoff Investment Securities LLC reported gains of roughly 1% a month like clockwork, with nary a loss, for two decades. Why did that freakishly smooth return not set off alarms among current and prospective investors?
Of all people, sophisticated investors like Mr. Madoff's clients should know that if something sounds too good to be true, then it's not. But they believed it anyway. Why?
Mr. Madoff emphasized secrecy, lending his investment accounts a mysterious allure and sense of exclusivity. The initial marketing often was in the hands of what one source described as "a macher" (the Yiddish term for a big shot). At the country club or another exclusive rendezvous, the macher would brag, "I've got my money invested with Madoff and he's doing really well." When his listener expressed interest, the macher would reply, "You can't get in unless you're invited...but I can probably get you in."
Robert Cialdini, a psychology professor at Arizona State University and author of "Influence: Science and Practice," calls this strategy "a triple-threat combination." The "murkiness" of a hedge fund, he says, makes investors feel that it is "the inherent domain of people who know more than we do." This uncertainty leads us to look for social proof: evidence that other people we trust have already decided to invest. And by playing up how exclusive his funds were, Mr. Madoff shifted investors' fears from the risk that they might lose money to the risk they might lose out on making money.
If you did get invited in, then you were anointed a member of this particular club of "sophisticated investors." Once someone you respect went out of his way to grant you access, says Prof. Cialdini, it would seem almost an "insult" to do any further investigation. Mr. Madoff also was known to throw investors out of his funds for asking too many questions, so no one wanted to rock the boat.
This members-only feeling blinded many buyers of Mr. Madoff's funds to the numerous red flags fluttering around his operation. When you are in an exclusive private club, you do not go rummaging around in the kitchen to make sure that the health code is being followed.
Here we have the biggest dirty secret of the "sophisticated investor": Due diligence often goes undone. For a brief window in 2006, the Securities and Exchange Commission required hedge funds to file standardized disclosure forms. William Goetzmann, a finance professor at Yale School of Management, found that hedge funds disclosing legal or regulatory problems and conflicts of interest ended up with lower future performance. But the disclosure of these risks had no impact at all on how much money flowed into the hedge funds.
In other words, investors were getting useful information -- and paying no attention to it. Amaranth Advisors LLC, the commodity hedge fund that collapsed in 2006 with $6 billion in losses, did not even file the required SEC form at the beginning of that year, a clear signal that something might be wrong. Instead of standing pat or pulling money out, investors poured more money in.
Last year, the Greenwich Roundtable, a nonprofit that researches alternative investments, conducted a survey of consultants, pension plans, "family offices," funds of funds and other large investors who shop for hedge funds. It's hard to imagine a more sophisticated crowd.
Yet one out of five investors in the survey reported that they "always follow" not a formal checklist or analytical procedure, but rather "an informal process" of due diligence.
That's for sure.
- One out of four investors surveyed will write a check without having studied the financial statements of the fund.
- Nearly one in three will not always run a background check on fund managers;
- 6% may not even read the prospectus before ever committing money.
If you invest with anyone who claims never to lose money, reports amazingly smooth returns, will not explain his strategy, refuses to disclose basic information or discuss potential risks, you're not sophisticated. You're an oxymoron.
Email: intelligentinvestor@wsj.com
http://online.wsj.com/article/SB122912266389002855.html
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