Special report: The perils of Paulson

Special report: The perils of Paulson
Written by Reuters
Thursday, 11 August 2011 06:52




NEW YORK/BOSTON: The crown may be slipping fast from billionaire trader John Paulson's head.

The hedge fund manager became an overnight sensation in 2007 by betting big and early on the collapse of the U.S. housing market, and then doing much of the same on a surge in gold prices, Reuters reported on Wednesday, Aug 10. But he is now emerging as one of this year's big losers in the $2 trillion hedge fund industry.

His Paulson & Co. hedge fund firm, which managed $38 billion as recently as this past March, is down to about $35 billion as of the first week of August, and it shrinks a little bit more with every big drop in the U.S. stock market.

One of Paulson's two main funds is now down more than 30 percent this year, the firm has reported to clients, compared to a much smaller 6.1 percent decline for the average hedge fund, according to Hedge Fund Research.

The problem for the 55-year-old manager: His equally daring bet that the U.S. economy and housing market would rebound strongly from the financial crisis -- a big wager that looked prescient a year ago -- isn't panning out as planned.

Paulson's funds have amassed huge, mutual fund-style stakes in shares of financial institutions like Bank of America, Citigroup, Hartford Financial, Popular Inc. and American Capital. But these are ringing up hefty losses.

And with fears of a double-dip recession in the United States mounting, coupled with this month's 13 percent plunge in the S&P 500, the talk is growing on Wall Street that unless Paulson can quickly turn things around, the hedge fund king could be hit with a wave of year-end investor redemptions.

"There are many investors who have experienced great gains with John Paulson, but a lot of the money has come into his funds after those great gains were achieved, and the relative newcomers are seeing a lot of heavy losses," said Daryl Jones, director of research at Hedgeye Risk Management, which sells investment research to institutional investors. "I would imagine it would lessen their appetite to stay with someone who is supposed to be a big superstar but is down double digits right now."

Paulson, through a firm spokesman, declined to comment. But people close to Paulson point out that other than hedge fund guru George Soros, no one has consistently made more money for clients than the man referred to by his friends and associates as "J.P."

LOYALTY TEST

This year, however, his investors' loyalty is being put to the test.

Maybe no one single trade has come to symbolize Paulson's bullishness on the U.S. economy more than Bank of America. By August 9, the troubled lender's shares were down 43 percent this year, reducing the value of the 124 million shares Paulson owned as of March 31 by $784 million. Paulson is believed to have sold some of his Bank of America shares as the stock has plunged toward the $7 mark, but the firm has refused to comment on its current position. (link.reuters.com/gem23s)

The picture isn't much prettier for Paulson's large share holdings in Citigroup, Popular (formerly Banco Popular) and SunTrust Banks. The value of Paulson's equity stake in those three banks, assuming the funds haven't sold any shares since March 31, would have declined by more than $800 million over the past four months.

And then there is Sino-Forest, the troubled Chinese forestry company. Paulson absorbed a $500 million loss on the stock in June after allegations of accounting irregularities at the Hong Kong-based company surfaced earlier in the month. (link.reuters.com/hem23s)

The series of missteps is tarnishing the near god-like status the former Bear Stearns trader has earned over the past few years.

Much of the $20 billion in outside investor money Paulson manages has come from pension funds and clients who bought in after he made $15 billion for the firm in 2007 on his well-chronicled subprime mortgage trade. Paulson raised that money by making his hedge fund one of the most widely available to wealthy customers of dozens of large and small brokerage firms.

Now some investors who got in after Paulson's so-called Alpha moment are getting out this fall, or are seriously considering doing so at year's end. Some in the industry are wondering whether Paulson's flagship Advantage funds, with $15 billion in assets, are too large and thus not nimble enough to navigate increasingly choppy markets for stocks.

Francis Bielli, executive director of the Philadelphia Board of Pensions and Retirement, said on June 30 that the board voted to submit a redemption for its entire $12.4 million investment in the Paulson Advantage fund. The Philadelphia municipal pension, which manages $3.7 billion, had originally invested $15 million with Paulson in December 2008. In June 2010, it withdrew $4 million of that money.

Joelle Mevi, of the Public Employees Retirement Association of New Mexico, invested with Paulson Advantage fund in March 2010. She is holding tight for the moment. But she says the $11.8 billion public pensions administrator is keeping a close eye on Paulson's performance and is concerned about his "exposure to financials."

Paulson won't comment on investor redemptions, but he is trying to put his clients at ease. On August 5, the firm took the unusual step of sending out a letter to investors, informing them that for the period ending September 30, investors were seeking to withdraw $420 million from the firm. The letter says that's "less than the average quarterly redemptions over the past 2 years." But the firm was silent about potential year-end redemptions.

PARTY CRASHES

Hedge fund industry watchers say what's gone on at Paulson this year is indicative of what often happens with hot managers as they get big and take larger and larger bets.

A study last year by research firm PerTrac Financial Solutions, which looked at the performance of thousands of hedge funds over a period of years, found that "investors who wish to maximize return should start their search by looking for younger funds." The report also found that except for 2008 - one of the worst years ever for the hedge fund industry - smaller funds have tended to outperform large hedge funds over the long haul.

Patrick Adelsbach, a partner and director of event-driven research at hedge fund consulting firm Aksia, says whenever a hedge fund gets too large, there is a concern about a manager getting "boxed in" by taking outsized stock positions. He says the irony is that the more assets a manager has to deploy, the more ordinary the trades can become.

When analyzing hedge funds for pension fund clients, Adelsbach says he keeps an eye out to make sure a manager isn't starting to emulate a "mutual fund strategy" in its stock trades.

In some respects, Paulson's $15 billion Advantage funds have come to resemble a mutual fund - except that they charge the much larger fees of a hedge fund.

As of March 31, Paulson was listed as one of the largest institutional shareholders in at least eight companies, including Hartford Financial, MGM Resorts International, Mylan Inc., SunTrust, Popular, XL Group and American Capital.

In the case of MGM Resorts, Paulson's firm had 43.8 million shares as of March 31, nearly three times as many shares as four separate Vanguard funds had invested in the gambling and resort company.

Alan Gold, a Chicago resident who invests in hedge funds and real estate, says he has shied away from Paulson, although he's been pitched a number of times. Gold says he tends to avoid large hedge funds because they can be "unwieldy" to manage, which makes it harder "to find good quality investments."

Paulson's enormous 124-million-share bet on Bank of America is a classic example of a bold thematic play on a beaten-down stock.

The move can look brilliant when the shares rise - which initially happened for Paulson when he first bought nearly 168 million shares of Bank of America in summer 2009. At the time the stock was selling for around $11 and briefly traded as high as $19 in April 2010. But when things go the other way and the stock is falling like a knife, it's hard to quickly get out of that position.

In a July conference call with investors, Paulson conceded he had too much exposure to financial stocks and was reducing holdings in bank stocks with problematic mortgages such as Bank of America. But he has not offered any firm guidance on what his funds have been selling. (link.reuters.com/fem23s)

The issue of size has been raised before. In a 2008 year-end investor letter, the manager wrote investors often "ask if our large asset base impedes our ability to maintain high levels of performance." He continued: "Although that may be the case in the future, we have not reached that point yet."

GOLDEN DAYS

Some of Paulson's most attractive investment opportunities are concentrated in some of the smallest funds he manages.

His $1 billion Paulson Gold Fund, launched last year, is soaring ever higher, with the price of the precious metal reaching new heights every day. With gold now selling for around $1,792 an ounce, the Gold Fund, which had been up 2.7 percent through July could be up as much as 6 percent for the year, an investor said.

The $3 billion Paulson Recovery Fund, which is flat for the year, is booking a whopping 200 percent paper gain on its $150 million investment in OneWest, a California-based bank that emerged from the wreckage of failed savings-and-loan IndyMac. The bank, which Paulson and other deep-pocketed investors bought with help from the Federal Deposit Insurance Corp., is potentially eyeing an initial public offering next year.

Also up is the Paulson Real Estate Recovery Fund. The small, $350 million private-equity-style fund is buying vacant land with approval rights to build hundreds of single-family homes. It targets failed complexes in Colorado, Arizona, Florida and California. The fund gained 22 percent last year.

Paulson believes that in five years time, the housing market will have recovered enough to enable the small fund to make a bundle from reselling the properties, which it acquired at bargain basement prices. In the meantime, Paulson is earning income as a landlord by renting out some of the luxury homes that were previously built before the developers went bust.

But the majority of Paulson investors aren't in any of these funds, and have their money in the beleaguered Advantage funds.

Paulson, who Forbes says has an estimated net worth of $16 billion, has pointed out that he and his employees are co-investors along with his customers. So the manager and his employees are sharing in some of the suffering his clients are enduring.

It's true that about 40 percent of the firm's $35 billion in assets is either Paulson's money or that of his employees. But the firm does not require its employees to pay the typical 1.5 percent asset management fee and the 20 percent performance fee the fund collects from outside investors.

Also, a good deal of the money invested by Paulson and his employees in the Advantage funds is committed to a so-called gold-denominated share class, which is performing far better than the plain vanilla version of the funds. But many of the Wall Street brokerage houses that sell access to Paulson funds don't offer the gold-denominated alternative, which Paulson introduced in 2009. About a third of the $35 billion Paulson manages is committed to the gold-share class.

For many investors, the inability to access smaller funds or the gold-share class of the Advantage funds didn't matter when Paulson was posting high double-digit returns. But with the Advantage funds losing ground, more on Wall Street are starting to wonder about why Paulson moved so actively to rake in outside money the past few years.

Paulson was largely an unknown figure before the subprime bet paid off. He toiled in relative obscurity and managed just several billion dollars for wealthy investors and small endowments from his mid-town Manhattan office. Until recently, he took the bus to work, say investors who know him.

But the subprime bet, chronicled in the book "The Greatest Trade Ever" by Wall Street Journal reporter Gregory Zuckerman, catapulted him to rock star status and made many millionaires want to invest with him.

COME ON IN

Paulson did much to open the doors. He made his funds - in most cases just the Advantage funds - available to wealthy customers of Wall Street brokerages and small investment advisory firms.

These distribution channels, or "platforms" in hedge-fund jargon, are a cheaper way for wealthy individual investors to access Paulson. The manager normally has a $10 million investment requirement. But for as little as $100,000, an investor with several million dollars in assets can put money into a Paulson fund through these brokerage firms.

An increasing number of hedge funds, like D.E. Shaw & Co., Israel Englander's Millennium Management and Daniel Loeb's Third Point, are available to wealthy clients of UBS, Morgan Stanley and Bank of America's Merrill Lynch. But few funds are on as many of these platforms as Paulson.

In the United States, wealthy individuals can also turn to smaller firms like Mount Yale Capital Group, Luminous Capital, Krusen Capital, Altegris Investments and CAIS Capital. In Europe, Paulson funds are sold through Lyxor and Deutsche Bank. In Australia and New Zealand, a small firm called Ashton Funds sells access to Paulson.

To tap into these large brokerage and smaller investment advisory firms, a few years ago Paulson hired Claudio Macchetto from Citigroup's alternative investments group to serve as director of global platform operations. Macchetto, who reports to Paulson investor relations head James Wong, heads his own team of a half dozen employees.

Overall, nearly two-dozen of Paulson's 120 employees are involved in either investor relations or marketing. That's considerably more than other leading funds.

Dan Loeb's Third Point, with about $8 billion under management, has just four people in investor relations and marketing. Steven Cohen's SAC Capital Advisors, with $14 billion under management and more than 800 employees, has about a dozen people in marketing and investor relations.

Och Ziff, founded by Dan Och in 1994, the same year Paulson went out on his own, has about 20 investor relations and marketing people, out of more than 420 employees.

Paulson's large marketing team has enabled the firm to maintain a consistent flow of new investor money coming into the firm, even as it regularly sees several hundred million dollars in redemption each quarter, according to the August 5 memo from Wong, Paulson's investor-relations director. Paulson loyalists point out the fund's assets have largely held stable the last few years and more of its growth has come from performance than taking in net new money.

For a large fund, amassing money to manage - what's called "asset gathering" in the industry - can be lucrative in and of itself.

Using a back of the envelope calculation, Paulson is taking in about $300 million a year in asset management fees from his outside investors.

"I completely understand why Paulson would want to build out exposure to independent firm platforms like ours, because it allows funds to access a different advisor and client base," says David King, a partner with U.S. Capital Advisors in Dallas, a firm that manages $1.5 billion and offers customers an opportunity to invest in the Advantage funds through an arrangement it has with CAIS Capital.

"But I am puzzled why the Paulson funds are offered on so many of the large bank and wirehouse platforms," says King.

Earlier this year, Paulson showed up at an event sponsored by UBS, which began selling Paulson's Advantage fund to its high-net worth customers last year. At that meeting, Paulson talked about why he was so bullish on shares of casino company MGM Resorts. In March, Paulson reported owning 43.8 million shares. But the stock has been a bust this year. MGM Resorts is down about 25 percent as of August 9.

Not everyone sees all this marketing by Paulson as a bad thing. It may have helped him develop a loyal investor base. He's known for throwing lavish investor gatherings in Las Vegas and Paris. Such attention may be one reason redemptions for the third quarter are running relatively low, despite the poor performance of the Advantage funds.

In fact, new money is still coming in. In the August 5 letter on redemptions, Wong hinted at that, saying: "redemptions may be offset by subscriptions."

The $2.1 billion Houston Municipal Employees Pension System put $10 million into the Advantage fund in March. And a spokesman for the $18 billion Texas County & District Retirement System, which last year invested $40 million with Paulson, says the public pension has no plans to redeem.

Dr. Lewis Feder, a Manhattan plastic surgeon with a list of celebrity patients, says he has no plans to bolt from Paulson, with whom he has invested for nearly a decade. Feder says he has money in six Paulson funds, including the small real estate recovery fund.

"He has a remarkable team employed around him," said Feder. "He doesn't go out looking for money as much as it comes to him."

A big test for investors, even Paulson's most loyal ones, comes in December, when the next opportunity to exit the fund comes up.

http://www.theedgemalaysia.com/first/191071-special-report-the-perils-of-paulson.html

Opportunities raining down

August 17, 2011

Illustration: Karl Hilzinger.

It takes courage to buy when others are fleeing the sharemarket's fury. But some fund managers have been doing just that, writes John Collett.

Shelter from the carnage on sharemarkets is not easy to find. While no listed company is bulletproof, there are some whose share prices are likely to hold up better during the turbulence and outperform the market in the long term.

Good businesses, including the big banks and the big miners, have been caught in the investor fear emanating from overseas. Although the share prices of these companies have recovered somewhat, many are still trading at knock-down prices.

Sharemarkets around the world have fallen heavily in the past three weeks as concerns over sovereign debt in the US and Europe were deepened by the historic downgrading of America's credit rating by Standard & Poor's from the highest AAA rating to AA+ with a negative outlook. Now there are fresh concerns that the world may be entering GFC Mark II and perhaps even a global recession. Australian shares are down almost 20 per cent since the post-GFC highs of April 2010. With the S&P/ASX 200 dipping to just below 4000 points last week, the market was back to where it was two years ago, though it has recovered somewhat to about 4200.

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''Ultimately, confidence is critical in terms of global growth.''

''What we are seeing is a combination of a huge vote of no-confidence collectively in governments around the world,'' the head of equity strategies at BT Investment Management, Crispin Murray, says. ''The issues that need to be addressed are being addressed in a piecemeal way, rather than quickly and decisively, and the result is that confidence continues to be eroded.

SLUGGISH ECONOMY

''There is no question the market is offering quite good value and quite a good earnings outlook but unfortunately the world economic outlook is looking much more shaky than it was,'' the head of research and senior portfolio manager at Investors Mutual, Hugh Giddy, says. ''The economy is going to be fairly sluggish for a while. And in a sluggish economy you want to be focused on the high-quality stocks that can deliver without relying on economic growth.''

But Giddy, like other leading fund managers, is still managing to see a silver lining. Unlike the amateur investors who take flight whenever markets turn ugly, fund managers see opportunities to pick up shares in good companies at bargain prices.

One of those bargains is CSL, whose share price has fallen to about $30; prices not seen since 2009 and the GFC. The blood-products maker has ''great growth prospects'' but has been caught up in the overall sell-off and the worries about healthcare spending in the US, he says.

Woolworths is another good defensive stock whose shares are trading at about $26 on a decent yield. Metcash, the distributor to independently-owned grocery and liquor stores, is another good business that pays a good yield, Giddy says. He also likes Telstra, which has a good balance sheet. The telco's earning are not going to be growing fast but the earnings are defensive and these are the types of stocks that investors need to be in, he says.

SHARES PRICES LOW

''While macroeconomic concerns continue to overshadow the market and impact sentiment … some companies are being impacted much less than others,'' the head of Australian equities at Fidelity, Paul Taylor, says.

Taylor's top picks include Rio Tinto, which he prefers over the smaller miners. ''Rio Tinto owns long-life, low-cost mines, has a very strong balance sheet and has just upgraded its share buyback program,'' Taylor says.

''At a share price around $70, we believe that Rio is very attractively valued and represents a great long-term investment due to its strong balance sheet, with plenty of growth options.''

Taylor also likes Wesfarmers. The turnaround at Coles, owned by Wesfarmers, is continuing and all the signs point to an improving return on invested capital, Taylor says. ''Coles is a quality asset that has maybe not been managed to its highest potential through the years but with the new management team, the improvements in returns could be substantial,'' he says.

Wesfarmers, at about $27 a share, is very attractively valued with a strong, fully franked dividend yield, Taylor says. He says Domino's Pizza represents an excellent long-term investment.

''Domino's Pizza has a strong management team, a strong balance sheet, has proven itself in a tougher economy, has excellent long-term growth prospects in Europe and, at around $6.00 a share, is also attractively valued,'' he says.

BT's Murray sees opportunities to pick up more shares in home entertainment retailer JB Hi-Fi. It is a stock that many investors would probably not want to go anywhere near given the weak consumer confidence and challenge from internet retailers. But the company has still been able to generate a decent rise in profitability despite the challenges, Murray says.

JB Hi-Fi has a relatively small chain of stores and more earnings growth could come from opening more stores.

''JB Hi-Fi has the best operating model in that market segment,'' Murray says. And, as the shares are on a cash yield of about 6 per cent, fully franked, investors get some some protection from weaknesses in the share price, he says.

DEFENSIVE STOCKS

Like Giddy, Murray also regards Telstra as a good defensive play. In coming to an agreement with the government on the National Broadband Network (NBN), where the telco will hand over its copper network, some certainty for the telco has been created, Murray says.

The way the NBN contract is structured means that even if there is a change in government, the NBN is unlikely to be unwound, he says. The telco's cash yield of almost 10 per cent, fully franked, is sustainable, he says.

Murray also likes Asciano, which owns and operates a range of infrastructure assets including ports and rail across Australia. ''It will benefit from the growth in coal volumes,'' he says. ''Its ports business is now starting to win back market share after it lost some contracts more than a year ago,'' Murray says.

The head of Australian equities at Schroder Investment Management Australia, Martin Conlon, says now is the time investors want to own good companies with competitive advantages. ''As prices fall, as they have recently, we will become more optimistic, not less,'' he says. ''The price which we pay for the cash flows of a company is likely to remain a very significant determinant of future returns.'' Conlon says the Australian sharemarket is on a price to earnings ratio (P/E) of between 10 times and 11 times compared with the long-term P/E of between 14 times and 15 times. He says the Australian sharemarket could even return between 10 per cent and 15 per cent in the next 12 months from dividends and rising share prices. Conlon looks for good-quality companies with strong balance sheets and management teams, excellent growth opportunities and attractive valuations.

His three top picks are Rio Tinto, Wesfarmers and the Commonwealth Bank, which share these characteristics.

GOOD MANAGEMENT

The head of Perennial Growth, Lee Mickelburough, says it has been a tough environment for a couple of years now but that is reflected in the prices of stocks. ''The market is cheap from a long-term perspective,'' he says.

AMP is a good example of a quality business that has been unfairly sold off by investors. At about $4 a share, it is back to levels not seen since the darkest days of the global financial crisis, he says.

AMP management has worked hard to reduce costs in recent years. Mickelburough says the acquisition by AMP of Axa was a good one and he rates AMP's management team highly. ''When [revenue] flows come through you will have a business that is [already] in great shape,'' he says. Once markets normalise, AMP could be trading at $5 or $6, Mickelburough says. He says ANZ, which has embarked on an Asian growth strategy, is particularly attractive. He also likes NAB, which has been growing its loan book a bit faster than the market.

MINERS

A portfolio manager of the EQT Flagship Australian shares fund, Shaun Manuell, says: ''There has been an awful lot of bad macro[economic] news thrown at us.'' He would be very surprised if Australian shares revisited their lows of the GFC but the market is finding it difficult to move out of the range of between 4000 points and 5000 points. Manuell continues to like BHP Billiton and Rio Tinto.

''We like them because of their size and their low costs [of production] and the long lives of their mines,'' he says.

If commodities prices fall because of their higher costs of production, smaller miners may struggle again as some did during the markets turmoil of 2008 and 2009, he says.

Manuell also likes ANZ, which has been a favourite of the fund for eight years. He likes the management and the ''Asian story'' which, if successful, will ''deliver a lot of upside.''

Golden future at silly prices

In the midst of the doom and gloom, BT Fund Management’s Crispin Murray thinks that we may even be at the low point for domestic stocks. After the ASX/S&P 200 index fell to just below 4000 points last week, it has recovered somewhat.

The Australian dollar has dipped a little, which will help exporters, oil prices are down, which will help keep inflation down, and the next change in interest rates will probably be down, which will spur consumer confidence, Murray says.

However, he expects the Australian economy to remain sluggish.

Murray says the big issue is that we have an economy where policy has been set for a two-speed economy — the mining sector and the rest of the economy.

‘‘The benefits of the mining boom are not coming through [to the rest of the economy] as significantly as people had been anticipating,’’ he says.

Lee Mickelburough of Perennial Growth, says that while consumers are cautious and retail sales remain weak, there is still much about the Australian economy that is the envy of the developed world.

Unemployment is just above 5 per cent, the sharemarket offers good value and companies with defensive earnings and competitive advantages will do well.

http://www.smh.com.au/money/investing/opportunities-raining-down-20110816-1iv5t.html#ixzz1VO7SbzZp

Enterprise Value

What It Is:

Enterprise value represents the entire economic value of a company. More specifically, it is a measure of the theoretical takeover price that an investor would have to pay in order to acquire a particular firm.


How It Works/Example:

Enterprise value is calculated as follows:

Market Capitalization + Total Debt - Cash = Enterprise Value

Some analysts adjust the debt portion of this formula to include preferred stock; they may also adjust the cash portion of the formula to include various cash equivalents such as current accounts receivable and liquid inventory.

For example, let's assume Company XYZ has the following characteristics:

Shares Outstanding: 1,000,000
Current Share Price: $5
Total Debt: $1,000,000
Total Cash: $500,000

Based on the formula above, we can calculate Company XYZ's enterprise value as follows:

($1,000,000 x $5) + $1,000,000 - $500,000 = $5,500,000



Why It Matters:

When attempting to gauge the overall value Wall Street has assigned to a firm, investors often look exclusively at market capitalization (calculated by multiplying the number of outstanding shares by the current share price). However, in most cases this is not an accurate reflection of a company's true value.

Enterprise value considers much more than just the value of a company's outstanding equity. To buy a company outright, an acquirer would have to assume the acquired company's debt, though it would also receive all of the acquired company's cash. Acquiring the debt increases the cost to buy the company, but acquiring the cash reduces the cost of acquiring the company.

Debt and cash can have an enormous impact on a particular company's enterprise value. For this reason, two companies with the same market capitalizations may sport very different enterprise values. For example, a company with a $50 million market capitalization, no debt, and $10 million in cash would be cheaper to acquire than the same $50 million company with $30 million of debt and no cash.

The P/E ratio and other formulas commonly used to measure value don't typically take cash and debt into consideration. For this reason, it's sometimes called the "flawed P/E ratio." To get a better sense for a company's true valuation, many analysts and investors prefer to compare earnings, sales, and other measures to enterprise value.

To learn more about how enterprise value is used by investors, don't miss our two top articles on the subject: The Best Alternative to the Flawed P/E Ratio and With This Ratio, Cash Flows Are King.


http://www.investinganswers.com/term/enterprise-value-806

A 5% return may end up being a better deal than a 20% return!!!!!

The time it takes to realise a gain, plays a huge part in determining our annual rate of return and the overall attractiveness of the investment.

If one is able to get a 5% return in a month, can we argue that it is a better investment than one that earns us a 20% return over a two-year period?

The Reasoning:
5% rate of return in a month
= yearly rate of return of 60% (0.05 x 12 months = 0.6).

20% return at the end of two years
= yearly rate of return of 10% (0.2 / 2 years = 0.1)

Premise:
The above argument is premised on being able to re-allocate the capital that you had out at 5% for a month, at attractive rates in the preceding months.

But in theory, if you could reallocate your capital five times over a two-year period and each time earn 5% a month, it would still produce better results than getting a 20% return at the end of a two-year period.

The year is the base time standard by which one compares different investment returns.

Rules to remember:
1. The time it takes to achieve the projected profit ultimately determines a great deal of the investment's attractiveness.
2. Always adjust the return to put it into a yearly perspective.

Just How Smart Is Wall Street?

 Posted: August 12, 2011 1:48PM by Stephen D. Simpson, CFA

Individual investors see a steady stream of paeans to Wall Street, praising not only the substantial resources of professional investors, but also suggesting (sometimes subtly, sometimes not) that these professionals are smarter and more capable than the average investor. While there are certainly plenty of columns out there decrying the mistakes of professional investors and pointing out that disciplined individuals can do just as well, the fact remains that the financial media overwhelmingly tilts towards the idea that Wall Street is smarter than you or me.

TUTORIAL: World's Greatest Investors

But is it really? The word "smart" has plenty of definitions, but Wall Street has such a peculiar inability to learn from certain mistakes that it seems worthwhile to question just how smart the Street really is.

They Can't Stay Away From the BubblesNothing of any real size can happen in the investment world without the involvement of institutional investors. So while retail investors are often dismissed as the "dumb" money, it is the professionals who ultimately add the most air to investment bubbles.

It was professionals, not individual investors, who awarded absurd IPO valuations to stocks like TheGlobe.Com, Geocities or eToys.com. Professional investors were also apparently happy to pay upwards of 30 times sales for Cisco (Nasdaq:CSCO), Qualcomm (Nasdaq:QCOM) and JDS Uniphase (Nasdaq:JDSU) back in the bubble days.

Only a few years later, institutions happily dove into the housing bubble. Institutions apparently were not bothered by data that clearly showed affordability was declining at a precipitous rate and that lending standards were abysmally low. In fact, institutions got so casual about the bubble that they happily relied upon models that told them housing prices could never fall - even though there were plenty of examples from outside the U.S. that showed what could happen.

These are only two examples of how the institutional community is all too happy to believe "it's different this time" and "prices couldn't possibly fall from here." The fact is, that the Street is happy to play a game of musical chairs because the players almost always believe they'll find a seat before the music stops … even if years of history suggests otherwise. (Home price appreciation is not assured. For more, see Why Housing Market Bubbles Pop.)

A Few Gaps in Their Due DiligenceAlthough plenty of institutional investors now claim to have spotted the shenanigans at Enron and Worldcom and shorted the stocks, those stocks would have deflated much sooner if all of these people were telling the truth. The fact is, plenty of institutions lost huge amounts of money in names like Enron, Worldcom, CUC/Cendant, Waste Management and so on, when their accounting scandals finally became unsupportable. In fact, when Enron blew up, well-regarded names like Alliance Capital Management, Janus, Putnam, Barclays and Fidelity owned about 20% of the stock in total, and most major firms held some number of shares.

Even in the wake of scandal after scandal, institutions have apparently not filled all the gaps in their due diligence. During the housing bubble and crash, institutions were largely blind to the balance sheet time bombs of financial companies like Washington Mutual and AIG (NYSE:AIG), to say nothing of their off-balance sheet liabilities. Even in the last few months, John Paulson reportedly lost millions of dollars on his position in Sino-Forest when evidence finally arose that the company may have grossly overstated its asset base. Likewise, plenty of other smart money investors have gotten caught up in other Chinese debacles. (For more, see Hedge Fund Due Diligence.)

Overconfidence, Especially in Their Own ModelsHowever smart Wall Street professionals are, it doesn't shield them from overconfidence in their abilities and their models. Time and time again some sharp-eyed professionals will spot a profitable anomaly in the markets - junk bonds or Latin American sovereign bonds that price in too much risk of default, undervalued mortgage bonds, unexploited absolute return strategies and so on. In the early days, there are in fact plenty of great opportunities, but eventually word gets out, other investors try to replicate the strategy and investment bankers rush to fill the supply of look-alike products.

The list of well-known implosions goes on and on - from the heyday of junk bond-fueled LBOs to the numerous emerging market sovereign debt debacles to the "see no evil" models of the U.S. housing market. In almost every case, though, the fundamentals change, the experts fail to notice, more leverage gets poured into the process and it all blows up in everyone's collective face.

The case of Long Term Capital Management (LTCM), though a 13-year-old story now, is still a great example. Mixing very experienced and successful Wall Street professionals with a small army of PhDs, LTCM used very high amounts of leverage to exploit small inefficiencies in the market. Unfortunately, early success brought more capital into the firm than it could manage, more leverage was employed to squeeze bigger returns out of smaller anomalies, and then suddenly some of the key relationships underpinning its models fell apart. The end result was a spectacular failure - one so large that the federal government stepped in to help the unwinding process from destabilizing the financial markets.

TUTORIAL: Credit Crisis: Historical Crises

The Bottom LineThese are just a few brief examples of the "factory seconds" that Wall Street churns out with surprising regularity. What of the fact that Wall Street routinely puts its faith in the projections and promises of management teams with no record of competence or success? Or what of the fact that Wall Street professionals routinely trust their investors capital with people and instruments that have previously failed?

The fact is, Wall Street is made up of people and people (even well-trained and well-compensated examples) make mistakes. Whether its greed, overconfidence or a sincere belief that it is somehow different this time, Wall Street cannot resist taking a chance on money-making opportunities. The point here is not to bury Wall Street or excoriate its professionals for their mistakes. Rather, the point is that everybody makes mistakes and investors should never be intimated out of their own good judgment and common sense just because the "smart money" thinks differently. (For more on smart money, see On-Balance Volume: The Way To Smart Money.) 

Read more: http://financialedge.investopedia.com/financial-edge/0811/Just-How-Smart-Is-Wall-Street.aspx#ixzz1VKT47J00

How To Position Your Money For The Stock Market Rebound

 Posted: August 15, 2011 9:47AM by Tim Parker

"But there is no joy in Mudville - Mighty Casey has struck out."

You've probably read the poem Casey at the Bat when you were in school. The poem is about a baseball team that was losing by two runs as the end of the game came near. The team's star player Casey was the fifth batter in the final inning. All the team had to do was somehow make it through four batters and, if they could, Casey would be up and surely win the game for the team.

The first two batters did not reach base. The crowd and the team were low on hope, especially with the next two batters being two of the weakest on the team. Sure enough, they each got on base. With the crowd energized and cheering loudly, here came Casey. He was so confident that he would win it for the team that he let the first two balls go by for strikes. Then came the third pitch …"mighty Casey has struck out."

The stock market has made all of us feel a lot like a resident of Mudville who was at the game that day. The market goes down 600 points and all hope is taken from us. The market goes up nearly 500 points and we're reenergized. The market continues to disappoint, and your portfolio might look like a big series of strikeouts leaving you fearing for your money. When we have no economic joy, we tend to look only at the now. This causes us to make bad decisions with our money.

TUTORIAL: Investing Concepts

Do you need some encouragement? "If you bet against the United States of America, you will surely lose," said Dick Grasso, former CEO of the NYSE on August 11. "We live in the greatest country on the planet … the strength of [the economy] is going to blow your socks off," said Jamie Dimon, CEO of JP Morgan Chase. Finally, don't forget the famous words of Warren Buffett who said: "Be fearful when others are greedy and greedy when others are fearful."

The world economies may look dire, and investors around the world are worried about what happens next. Great investors never look at now. They look to the future. The only thing they do right now is position themselves for the recovery. Here's how:

Do NothingIf you have a 401(k), IRA or other long term retirement account, and you won't be retiring for decades, do nothing. Leave your money alone. History is clear. When downturns such as this happen, they don't tend to cause panic while they're here. Much like a bad storm, they leave quickly.

Even if it were a few years, that's not going to hurt your retirement accounts when you look at it in the context of a multi-decade time horizon. If you're close to retirement, you should probably still do nothing, but speaking to a financial adviser may ease your fears. (For related reading, see An Introduction to Ineligible IRA Contributions.)

Buy StocksDo you have a favorite stock? When great companies get pulled down by an economic downturn, the sale sign shows up on that stock. Buy it while it's on sale and then hold it for a long time. With many stocks down 10-20%, these stocks are priced as if they belong in the clearance bin. Buy a little now, and if the markets continue to fall, buy more at even lower prices.

Find the Accidental High YieldersCNBC's Jim Cramer advises investors to invest in accidental high yielders when the market falls. These are stocks that see their prices go down so much that their dividend yield goes up to highly attractive levels. Although this isn't a recommendation to buy these two names, Frontier Communications saw its dividend go up to 11% and Eli Lilly to nearly 6%. There are plenty of other stocks with yields that are just as attractive.

You should never buy a stock based only on the dividend yield. In downturns, great companies often become even more attractive because of their higher yields. Buy while the stock is low because the dividend yield will retreat as the stock price goes higher.

Fund Your IRAWhen the market is down, it's the perfect time to fund your IRA. That money will immediately go to work on those investments that are currently on sale. Of course, you should balance your retirement funding with protecting your finances from an economic downturn, but if you have enough money in your emergency fund put more money to work for retirement.

Get Ready to Buy an Index FundAn index fund tracks the performance of a certain index such as the Dow Jones Industrial Average, the Russell 2000 or the S&P 500. It's best to wait until the market calms down, but once it does consider buying shares of the SPDR S&P 500 ETF (SPY) or index instrument of your choice.

While this will allow you to capitalize on the recovery, you want to protect yourself. Make sure to set a stop or trailing stop so you don't lose a lot of your investment if the markets take a turn for the worse. ETFs are generally regarded as an investment for those experienced with the stock market. (For more on ETFs, see Using ETFs To Build A Cost-Effective Portfolio.)

TUTORIAL: 20 Investments You Should Know

The Bottom LineThere may not be joy in Mudville today, but successful investors know that looking at today is a losing strategy. Look years into the future, and take advantage of the low prices that are available to you. Casey may have struck out today, but never bet against a winner. His next home run isn't far away.

Read more: http://financialedge.investopedia.com/financial-edge/0811/How-To-Position-Your-Money-For-The-Stock-Market-Rebound.aspx?partner=ntu8#ixzz1VKPRMq1t

Technical Analysis: The Use Of Trend.

Technical Analysis: The Use Of Trend.

By Cory Janssen, Chad Langager and Casey Murphy

One of the most important concepts in technical analysis is that of trend. The meaning in finance isn't all that different from the general definition of the term - a trend is really nothing more than the general direction in which a security or market is headed. Take a look at the chart below:

Figure 1

It isn't hard to see that the trend in Figure 1 is up. However, it's not always this easy to see a trend: 

Figure 2

There are lots of ups and downs in this chart, but there isn't a clear indication of which direction this security is headed. 
A More Formal Definition
Unfortunately, trends are not always easy to see. In other words, defining a trend goes well beyond the obvious. In any given chart, you will probably notice that prices do not tend to move in a straight line in any direction, but rather in a series of highs and lows. In technical analysis, it is the movement of the highs and lows that constitutes a trend. For example, an uptrend is classified as a series of higher highs and higher lows, while a downtrend is one of lower lows and lower highs. 

Figure 3

Figure 3 is an example of an uptrend. Point 2 in the chart is the first high, which is determined after the price falls from this point. Point 3 is the low that is established as the price falls from the high. For this to remain an uptrend, each successive low must not fall below the previous lowest point or the trend is deemed a reversal.   

Types of Trend
There are three types of trend: 

• Uptrends
• Downtrends 
• Sideways/Horizontal Trends As the names imply, when each successive peak and trough is higher, it's referred to as an upward trend. If the peaks and troughs are getting lower, it's a downtrend. When there is little movement up or down in the peaks and troughs, it's a sideways or horizontal trend. If you want to get really technical, you might even say that a sideways trend is actually not a trend on its own, but a lack of a well-defined trend in either direction. In any case, the market can really only trend in these three ways: up, down or nowhere. (For more insight, see Peak-And-Trough Analysis.)
  
  Trend Lengths
  Along with these three trend directions, there are three trend classifications. A trend of any direction can be classified as a long-term trend, intermediate trend or a short-term trend. In terms of the stock market, a major trend is generally categorized as one lasting longer than a year. An intermediate trend is considered to last between one and three months and a near-term trend is anything less than a month. A long-term trend is composed of several intermediate trends, which often move against the direction of the major trend. If the major trend is upward and there is a downward correction in price movement followed by a continuation of the uptrend, the correction is considered to be an intermediate trend. The short-term trends are components of both major and intermediate trends. Take a look a Figure 4 to get a sense of how these three trend lengths might look.
  
  

  Figure 4

  
  
  When analyzing trends, it is important that the chart is constructed to best reflect the type of trend being analyzed. To help identify long-term trends, weekly charts or daily charts spanning a five-year period are used by chartists to get a better idea of the long-term trend. Daily data charts are best used when analyzing both intermediate and short-term trends. It is also important to remember that the longer the trend, the more important it is; for example, a one-month trend is not as significant as a five-year trend. (To read more, see Short-, Intermediate- And Long-Term Trends.)
  
  Trendlines A trendline is a simple charting technique that adds a line to a chart to represent the trend in the market or a stock. Drawing a trendline is as simple as drawing a straight line that follows a general trend. These lines are used to clearly show the trend and are also used in the identification of trend reversals. 
  As you can see in Figure 5, an upward trendline is drawn at the lows of an upward trend. This line represents the support the stock has every time it moves from a high to a low. Notice how the price is propped up by this support. This type of trendline helps traders to anticipate the point at which a stock's price will begin moving upwards again. Similarly, a downward trendline is drawn at the highs of the downward trend. This line represents the resistance level that a stock faces every time the price moves from a low to a high. (To read more, see Support & Resistance Basics and Support And Resistance Zones - Part 1 and Part 2.)
  
  
  

  Figure 5

  
  Channels A channel, or channel lines, is the addition of two parallel trendlines that act as strong areas of support and resistance. The upper trendline connects a series of highs, while the lower trendline connects a series of lows. A channel can slope upward, downward or sideways but, regardless of the direction, the interpretation remains the same. Traders will expect a given security to trade between the two levels of support and resistance until it breaks beyond one of the levels, in which case traders can expect a sharp move in the direction of the break. Along with clearly displaying the trend, channels are mainly used to illustrate important areas of support and resistance.
  
  

  Figure 6

  
  Figure 6 illustrates a descending channel on a stock chart; the upper trendline has been placed on the highs and the lower trendline is on the lows. The price has bounced off of these lines several times, and has remained range-bound for several months. As long as the price does not fall below the lower line or move beyond the upper resistance, the range-bound downtrend is expected to continue. 
  
  The Importance of Trend
  It is important to be able to understand and identify trends so that you can trade with rather than against them. Two important sayings in technical analysis are "the trend is your friend" and "don't buck the trend," illustrating how important trend analysis is for technical traders. 

Read more: http://www.investopedia.com/university/technical/techanalysis3.asp#ixzz1VCY9o28j

Technical Analysis: Fundamental Vs. Technical Analysis

Technical Analysis: Fundamental Vs. Technical Analysis

By Cory Janssen, Chad Langager and Casey Murphy

Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we've mentioned, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals. Let's get into the details of how these two approaches differ, the criticisms against technical analysis and how technical and fundamental analysis can be used together to analyze securities.



The Differences
Charts vs. Financial Statements
At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. (For further reading, see Introduction To Fundamental Analysis and Advanced Financial Statement Analysis.)


By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company's value. In financial terms, an analyst attempts to measure a company's intrinsic value. In this approach, investment decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it's a good investment. Although this is an oversimplification (fundamental analysis goes beyond just the financial statements) for the purposes of this tutorial, this simple tenet holds true.

Technical traders, on the other hand, believe there is no reason to analyze a company's fundamentals because these are all accounted for in the stock's price. Technicians believe that all the information they need about a stock can be found in its charts.

Time Horizon
Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days or even minutes, fundamental analysis often looks at data over a number of years.

The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company's value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock's market price rises to its "correct" value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This "long run" can represent a timeframe of as long as several years, in some cases. (For more insight, read Warren Buffett: How He Does It and What Is Warren Buffett's Investing Style?)

Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don't emerge on a daily basis like price and volume information. Also remember that fundamentals are the actual characteristics of a business. New management can't implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts.

Trading Versus Investing
Not only is technical analysis more short term in nature that fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools.

The Critics
Some critics see technical analysis as a form of black magic. Don't be surprised to see them question the validity of the discipline to the point where they mock its supporters. In fact, technical analysis has only recently begun to enjoy some mainstream credibility. While most analysts on Wall Street focus on the fundamental side, just about any major brokerage now employs technical analysts as well.

Much of the criticism of technical analysis has its roots in academic theory - specifically the efficient market hypothesis (EMH). This theory says that the market's price is always the correct one - any past trading information is already reflected in the price of the stock and, therefore, any analysis to find undervalued securities is useless.

There are three versions of EMH. In the first, called weak form efficiency, all past price information is already included in the current price. According to weak form efficiency, technical analysis can't predict future movements because all past information has already been accounted for and, therefore, analyzing the stock's past price movements will provide no insight into its future movements. In the second, semi-strong form efficiency, fundamental analysis is also claimed to be of little use in finding investment opportunities. The third is strong form efficiency, which states that all information in the market is accounted for in a stock's price and neither technical nor fundamental analysis can provide investors with an edge. The vast majority of academics believe in at least the weak version of EMH, therefore, from their point of view, if technical analysis works, market efficiency will be called into question. (For more insight, read What Is Market Efficiency? and Working Through The Efficient Market Hypothesis.)

There is no right answer as to who is correct. There are arguments to be made on both sides and, therefore, it's up to you to do the homework and determine your own philosophy.

Can They Co-Exist?
Although technical analysis and fundamental analysis are seen by many as polar opposites - the oil and water of investing - many market participants have experienced great success by combining the two. For example, some fundamental analysts use technical analysis techniques to figure out the best time to enter into an undervalued security. Oftentimes, this situation occurs when the security is severely oversold. By timing entry into a security, the gains on the investment can be greatly improved.

Alternatively, some technical traders might look at fundamentals to add strength to a technical signal. For example, if a sell signal is given through technical patterns and indicators, a technical trader might look to reaffirm his or her decision by looking at some key fundamental data. Oftentimes, having both the fundamentals and technicals on your side can provide the best-case scenario for a trade.

While mixing some of the components of technical and fundamental analysis is not well received by the most devoted groups in each school, there are certainly benefits to at least understanding both schools of thought.

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