When an Investment Goes Awry, Politely Ignore?

Paulson and Co. made an interesting decision last week:

"At the request of clients and consultants, we will be reporting the performance of our Gold Funds separately to investors in those funds and interested parties," Paulson wrote to clients. The firm's gold investments "have received a disproportionate amount of attention over recent months"—as gold prices plummeted—"and have detracted attention from the performance and positive developments of our other funds."

They key instigation is that despite being only 2% of the firms assets, the Gold Fund's -47% performance (not a typo) is getting all the attention. This would make sense, except that most of his fund is gold-denominated (e.g. gold-share classes). 


This means that even the funds that are doing well, such as the credit funds (up 16.7% ytd) are often overwhelmed by the gold losses. Roughly 85% of Paulson's aum is in gold share classes so that the best fund's 16.7% is usually realized as -30.3 = 16.7%-47%. In other words, gold does matter greatly to the Paulson & Co. as a whole.

I do believe this is a unique situation and opportunity to learn (and possibly profit) as it is a purely marketing and psychological move meant to soothe investors' and consultants' fears. Like a many trader when a large position moves against him/her, the natural instinct is to ignore and hope it comes back. This phenomenon is well-known and is inherent to us as humans.

(source: http://sophlylaughing.blogspot.com/2012/03/home-cognitive-dissonance-kit.html)

In this case, it is Paulson & Co.'s unwillingness to truly consider a fundamental misunderstanding of gold. Indeed, the below statement shows the fallpack to general statements:

“Federal governments have been printing money at an unprecedented rate creating demand for gold as an alternative currency for individual and institutional savers and central banks alike,” John Reade, a partner and gold strategist at Paulson & Co., said yesterday in an e-mailed statement. “While gold can be volatile in the short term and is going through one of its periodic adjustments, we believe the long-term trend of increasing demand for gold in lieu of paper is intact.”

As the the largest holder of GLD at 6.7%, it is not stretch to say that the first represents a large part of the gold bull arguments and crowd. What happens if the crowd realizes it can't take the pain?

Disclosure: I am short GDX.

Actively-Managed ETFs to Short Managers?

As one of the fastest growing segments of the already fast-growing ETF market, actively-managed ETFs could open up a whole new set of strategies - both betting on and against managers. ETFs- exchange-traded-funds- are already known as a more transparent, tax-efficient and liquid way to buy indices. They have these advantages as opposed to the commissions, spreads of trading which are now required to buy  (full comparison). Increasingly, the costs are being outweighed by the benefits.

In my opinion, however, the key attribute that has led to ETFs' success is its liquidity/transparency. Like a shiny new machine in the casino, ETFs (such as DXJ) promised even faster trades and up to date pricing that make (or break) entire companies. With this in mind, will the next generation of active etfs allow for investors/speculators to hedge their managers?


The prototypical active etf is PIMCO's Total Return etf (BOND), which has done well:

(Source: http://seekingalpha.com/article/578491-pimco-total-return-etf-off-to-a-fast-start)

Notice that the etf (top-most line) is not just being compared to its benchmark (which it handily beat), but also PIMCO's own Total Return Fund. In a very real sense, Bill Gross has beaten himself. Similar to the cash-futures basis, could there be an etf-mutual fund basis?

Now let's take this a few steps further:

1. Execution-hedging: If xyz investor has a large holding in a mutual fund that he wants to liquidate intraday (wanting, perhaps erroneously, to catch the top), he can short the etf until the close.
2. Manager-hedging: xyz investor likes abc strategy and has invested in a top tier manager. There is another manager doing the same abc strategy but the investor believes this other manager will do significantly worse than the top tier. He/she can short the etf while still invested in the top tier manager
3. "Basis" trading: If one believes that a particular manager's etf version is going to do worse or is mispriced relative to the mutual fund version, he/she can short the etf and buy the mutual fund. This is admittedly incomplete, as one cannot "short" a mutual fund easily.

This is all conjecture- but what if it were possible to hedge the LTCM/Harbinger/Paulson-like exposure to your portfolio?

Is Shiller P/E Worth It?

The Shiller P/E has been in the news lately (1, 2, 3) as various critics and proponents say say that the high level (~24 vs 17.5 average in the last century) is either indicative of danger or not applicable in this case. To review: the Shiller P/E is the 10 year inflation adjusted trailing P/E of the S&P 500. Also called the cyclically adjusted price-to-earnings ratio, the ratio is meant to smooth the volatile earnings of the business cycle and generate a genuine measure of value for the market.

After reading AQR's paper extolling the use of Shiller P/E (10 yr trailing P/E) while acknowledging its limitations, I am tempted to ask the question - Shiller P/E even worth it as a tool?

(Source: http://www.multpl.com/shiller-pe/)

There is little question that the indicator is elevated. Apart from the 90s technology craze and the 20s pre-Depression bubble the indicator has never been this high. But what does this actually mean for markets going forward? Before even questioning the assumptions behind Shiller P/E, what is its track record taken at face value? Again, AQR (and many others) have done some analysis:

As highlighted - we are in the 2nd to highest decile. This implies a measly 0.9% mean annual return going forward. But what about the volatility? The best 10yr return was 8.3% annually vs -4.4% worst. Not exactly compelling for a buy, but is it worth it to sell (short)? Selling now and being wrong means possibly missing/losing 8.3% annually for 10 yrs. Does that present an attractive risk reward?

On the other hand, buying at the lower two deciles is far more compelling. The worst case is a 4.8% return for the lowest return & 10.3% average. I'll take that all day.

Bottom line - I don't think Shiller P/E is useful for calling tops, even using the proponents' data. It is, however, possibly useful for bottoms. The market may correct severely tomorrow, but don't think that using this indicator one would have sold anywhere near the top.

Contemplating ING US (VOYA)

Ran into ING US (VOYA) while hunting for cheap price to book investments. It has turned into a bit more interesting than just that metric and indeed may be an aig-style investment.

A background:
ING US is a financial services company that until recently was part of the Dutch company ING Groep NV. It, like many global financial services companies, went to the brink of catastrophe in 2008 and more specifically received a $13.5B tarp-like capital injection from the the Dutch State. Since then, ING has been selling assets to repay the bailout, most recently with the IPO of ING US (to be renamed VOYA Financial in 2014).

Key points of a long view here include: 1) forced selling by ING's parent 2) a stabilizing retirement, insurance & asset management business:

1) Forced selling - VOYA's own prospectus calls this ipo a divestment transaction meant to repay part of the remaining 2.2B EUR ( 10B - 7.8B from previous transactions) that VOYA still needs to repay. As such, it is clearly government-driven and not focused on economic value given back to the firm.

2) While it is one of the largest life insurers in the US, nearly half of VOYA's revenues actually come from the retirement division:

Revenues from that half the firm are fairly recurring and stable as a percentage of AUM. Provide plan administration, i.e. the boring/safe side of the business. Same goes for the asset/investment management side of the business. On the insurance side, there is exposure in the variable annuity product in that VOYA provides capital protection in an equity-like product. It is risk, but one that I continue to like because of my overall positive view on us equities (see previous blog posts).

Finally, there is the issue of the closed books (i.e. the "bad bank" that holds alt-a and other legacy assets from the financial crisis). Considering the great reversal of many of these former toxic instruments and the gains from last year, I do not think they are marked aggressively).
 

As such, is such a business trading @ ~0.5x book value in an industry usually => 1x book a compelling investment? This is not meant to be a full pitch, but rather a starting point for further thoughts.

P.S. Looks like I am not the only one looking into VOYA.

Thoughts?

Disclosure: I am long VOYA

Time to Buy Big Banks? (BAC/C/WFC/JPM)

Bank-bashing has become a national pastime in the last few years (1, 2, 3, 4). From unfair subsidies as too big to fail to unwieldy conglomerations that no one knows how to value, run or even understand, there is no shortage of criticisms for TBTF banks.

Early contrarian investors in 08 such as Bill Miller were trampled by the herd and in retrospect buying way too high. Paulson/BAC and Ackman/C have been similarly hurt trying to time to bottom and inevitably sells at the bottom:

Paulson in BAC 2011

Ackman with Citi in 2012:

So, what is different now that could make banks a buy? I actually won't go into the fundamental reasons because they are common place. At a high level, bac/c are trading at slightly less than 1x tangible book and all are trading ~10x or less "normalized" earnings.

I don't believe fundamentals can be an effective timing tool alone here, so let's look at market psychology. Are flows finally moving into financials?

As such, is now a good time to buy and hold for the next 3-5 yrs (until normalization?)

Gold Miners - Value Traps In Waiting?

When searching for investment ideas, one thing that seems to work is the search for the weak hand. Relatively uninformed investors, or simply those who are making non-economic and indeed incorrect assumptions are often a good starting point to research the other side.

With that mind, the fact that the U.S. Mint has run out of small gold bullion coins to sell is particularly interesting. This is a mini gold craze which parallels the institutional interest but is unique because:

1. The small denomination implies mostly retail interest, e.g. those who don't have that much money to begin with. They are therefore forced to buy the small denomination.
2. The illiquid/indirect nature of the buying. One can buy GLD etf to get the same exposure with much higher liquidity. Given the world avoids anarchy (and even then), no one is forced to accept gold as payment and therefore is by definition fear-based buying.

Hypothesis: the buyers of such coins are relatively well-off people but non-investors. They see the ads on cnbc (you know which ones) to buy gold and hear that gold has outperformed the market in the last decade. They have never bought/traded commodities and hearing the massive money printing believe that buying gold is the prudent thing to do. However, not liking the volatility of futures they choose to buy a coin, something physical.

Gold mining stocks follow from that same defensive logic - they are real businesses after all. They make sales based on gold prices and in addition provide operating leverage. If it costs them 500$/oz to mine the gold and the price is now $1000 but then moves to 1500, their income doubles. On the other hand,  the gold price only moved 33%.

But is this leverage accurate? Consider this table from Barrick Gold's annual report (page 83)

 Cash costs increased by roughly 43% (=584/409) over two years. What about gold itself?

Gold etf (physical) increased by roughly 20%, roughly half that amount.
In other words, the world's largest miner had negative operating leverage in one of the most consistent bull gold markets in the last 20 yrs.

As a result, gold miners may be trading at low fcf and earnings multiples, but may deserve such low multiples. They may therefore be a value trap.  This is not even considering that most miners' do not have a consistently profitable business even in the last few years.


Disclosure: I am short GDX (etf of gold miners).

The Market as Rock, Paper, Scissors

I recently came across this old paper about a meeting between Ed Thorp and Warren Buffett in the late 1960s. Buffett had recently closed his famous partnership after the bull market in the past few years left few undervalued securities to buy. Afterwards, former clients asked him to evaluate a money manager: Ed Thorp.

Compound interest is the first (popular) discussion that's worth repeating:

if the Manhattan Indians had been able to invest the $24 for which they sold Manhattan in 1626 at, say a net return of 8%, their heirs could buy it back now (1968) with all the improvements

This is just the beginning, however:

Buffett then brings up the "three very strange dice." Labeled as A = A=(2, 2, 2, 2, 5, 6), B=(1, 1, 4, 4, 4, 4) and C=(3, 3, 3, 3, 3, 3), two people can play a game where each chooses a dice to roll. The person with the highest number then wins that round. Interestingly enough, through repeated games (and deduction) it can be shown that A > B, B > C, but C > A. They dice are intransitive. As a result, the 2nd person to pick a die should always win in the long term by # of wins if he/she recognizes this. Just like rock paper scissors, no pick is universally best.

In other words, in such a game and indeed the market a strategy's success is often very much dependent on the others being employed. I would argue that the very reason for value's outperformance in 02-03 post-dot-com crash is because of the focus on speculative technology stocks. Similarly, active investors want more short term speculators and index funds because they would provide the other side to profitable buys. On the other hand, if everyone is preaching value or quality businesses a la nifty-fifty, value investors may want to stay away.

This phenomenon is indeed well-known already, but the examples above and detailed in Ed Thorp's paper show just how pervasive and powerful this quality is.