Wednesday, February 28, 2007

Blogs Are Put To Use As Business Machines


Posted 2/23/2007

Forget about must-see TV. Blogs are a must read by many people.

While newspaper readership drops, the buzz is about blogs and social networking Web sites like MySpace and Friendster. Business types are finding that blogs and social sites are about more than chatting online. Blogs can be awesome generators of new clients and leads.

When Martin Schwimmer, an intellectual property attorney, started a law firm in Mount Kisco, N.Y., in 2001, he had no budget for marketing. To generate buzz and interest, he launched his trademark blog (, writing about patent issues. Most people find out about it through his Google ad or via other bloggers.

Based on the traffic generated by the blog, he says that in 2006 about 50% of his referrals stemmed from clients who read his blog. "My blog creates unsolicited contacts. I strike up e-mail correspondence with readers, and sometimes they generate referrals," Schwimmer said.

Creating your own blog helps spark publicity and enhances a company's credibility, says Andy Sernovitz, chief executive of the Word of Mouth Marketing Association, which is based in Chicago. "People are already talking about you and your business right now on social networks and blogs. If you want it to be positive, you need to jump in and participate," he said.

If blogs drive people to your Web site, it boosts business, Sernovitz says. "In a word-of-mouth world, the No. 1 source of product recommendation is people like us, not professional reviewers or Consumer Reports," he said. "The overwhelming majority of purchases, close to 60 or 70%, is based on people turning to friends."

Meeting sites such as Evite (owned by IAC (IACI) ) and Meetup, business-to-business Web site LinkedIn, and News Corp.'s (NWS) social networking site MySpace can also be tapped to find new clients.

David Teten, co-author with Scott Allen of "The Virtual Handshake," says this is especially true if leads are contacted via friends or one's social network. Teten says that 83% of e-mails generated by contacts are returned.

Sernovitz said Web sites "serve different communities and have their own rules about which type of marketing is appropriate. The most important thing for people is to learn the rules and culture of each community."

MySpace concentrates on music, movies and entertainment, Linked- In is more appropriate for marketing services, and Friendster focuses on personal social networking, he says.

LinkedIn can be particularly effective in generating new business, Sernovitz notes. He advises writing a vivid personal profile incorporating a description of your business, avoiding too much self-promotion, which will turn readers off, and then use discussion groups to build relationships. "On B2B blogs, the key is doing favors for others, which helps build relationships. They owe you one and will recommend you to others," he said.

Marketing a business on a blog or social Web site can be a more effective tool than networking at a conference or generating leads via traditional ads, Teten says. Three-quarters of the people you meet at a conference aren't your target customers, and in advertising the truism is 50% of traditional advertising is wasted on people, but no one knows which 50%, he says.

On MySpace, Teten says, a fashion designer can use a member's profile to target potential clients who say they buy jewelry or accessories. Though MySpace restricts large businesses from sending e-mail blasts to 1,000 people, an entrepreneur can target profile pages on a one-to-one basis to identify potential clients.

Teten, who runs Nitron Advisors, which offers independent research, joined a Yahoo group of fund managers and then targeted them as potential clients. Teten described chatting with people on these Web sites as equivalent to attending "a cocktail party with people, which can lead to new business.", a social site, attracts "engaged, informed adults that connect around everything from politics, foods, creative writing and travel," said Tom Gerace, its chief executive, who's based in Boston. has 140,000 registered users who chat online and also participate in events held by authors or political figures.

Michael Abrashoff, a former Navy commander turned consultant, public speaker and author of "Get Your Ship Together," joined the leadership forum at On the site, he published some provocative articles on the failure of military leadership that generated lots of buzz. As a result of his postings, Gerace said Abrashoff's book, which was published three years ago, zoomed to No. 15 on Amazon's best-seller list.

"Abrashoff was extending his brand as a thought leader in business. He addressed one of the key questions for business people: How do you play in a social space?" Gerace said.

On, Smartbargains, a discount Web site, started a contest for members, asking them to explain why a room in their house needed a makeover. The winner earned $1,000 in furniture. Over 1,300 people participated, again generating buzz and presumably new business for Smartbargains.

But don't these online marketing efforts turn a social site into one extended sales pitch, alienating its members? Gerace disputed that notion, saying: "They're not getting a direct sales pitch. Advertisers must create value in the community and can't pretend to be people in the community."

Advertisers are banned from using the site for blatant commercial selling but can create their own social group. A record label, for example, like Blue Note could start the bluenote group for people who love jazz.

On Gather, Starbucks (SBUX) hosted a live chat with Mitch Albom, author of "The Five People You Meet in Heaven." Starbucks sells his book at its retail stores and also includes a link on Gather to buy the book. "Users respond to efforts that are aspirational, that give them an opportunity to do something," Gerace said, such as asking questions of Albom.

Teten advises that businesspeople join meeting sites such as Meetup or Gather to find people in their industry. Expand your network to develop potential clients. Doing things for fun, such as joining book clubs or aficionado groups, can also increase your contacts and ultimately lead to more connections and clients.

Teten also recommends that businesspeople read blog readers, such as, to ascertain what readers are saying about their blogs. "It offers one-stop shopping for reading multiple blogs," he said.

Teten says if businesspeople make their intentions clear, they won't be misleading anyone by trying to sell on a social network site.

Sernovitz added, "The most important thing is to learn the rules and culture of each community and be careful to stay within those boundaries."

Weill: Citi Breakup Is a Crazy Idea

The people who are calling for a breakup of Citigroup are “off their mind,” the banking giant’s chairman emeritus Sanford I. Weill said on CNBC Monday. (That was actually a fairly mellow reaction, considering that, when Barron’s suggested the notion of a breakup to Citigroup chief executive Charles Prince last summer, Mr. Prince called it the “dumbest idea I’ve ever heard of.”)

Mr. Weill’s comments might have been referring, albeit indirectly, to fund manager Tom Brown of Second Curve Capital, who wrote a letter to Citi’s board last week recommending that the company be split apart. Mr. Brown wrote that “the growth strategy lately being articulated by management will end in costly failure” and estimated that carving Citi into four pieces — the money center bank, the investment bank, consumer finance, and non-U.S. consumer finance — would produce a total value of $65 and $70 per share. Citi is trading at just above $52.

“Each unit, if allowed to compete on its own, would likely be more focused and efficient than the four are now as subsidiaries of a financial conglomerate,” Mr. Brown wrote.

Mr. Weill has other ideas. “Right now are very good times in the economy,” he said Monday on CNBC. “There will be a problem that arises sometime in the future. I’d rather be with a company that has a strong capital base and the diversity of income by products and regions than one that doesn’t. My guess is that if things do get negative, I think that could be a real opportunity for Citi to accelerate what they’re doing.”

But despite the “good times,” Citi’s stock still trails those of other Wall Street banks, and expenses are still growing faster than revenues, points out.

Citi has moved to address those problems, recently hiring a new chief financial officer — American Express‘ Gary Chittenden — making some other executive shuffles, and implementing a series of cost-cutting moves.

Got That Sinking Feeling?


The equity markets took a big whoosh down today, and many other asset classes suffered as well:

That's what market pundits talk about when they say that all correlations go to 1 when the market is declining. Bonds were up on the day, but that's not much solace when your equity funds are down 4%. As taken up by Nelson Freeburg in the recent issue of Formula Research, most of the risk in a typical 60/40 allocation is concentrated in equity risk. Not just 60%, but closer to 90%. What is an investor to do when structuring optimal portfolios? Risk-parity is a topic I am very interested in, and one of the reasons I originally started writing on this blog. My very first post linked to risk parity discussions from the best of the best institutional managers. (Highly recommended reading).

A quick summary - there is no reason to accept asset classes pre-packaged the way they come now - ie 100% long. An investor can either lever up or down his exposure to an asset class (many confuse risk with leverage) to achieve desired levels of risk and return. An investor could place more in bonds (or other low vol instruments like some hedge funds) and then leverage up the entire portfolio - resulting in a superior allocation than the previous portfolio.

The Bridgewater has two charts that include risk and return expectations from a Rocaton study. The first has the expected return/risk levels for various asset classes:

The second has the same asset classes (de)leveraged to the same expected return:

Confusing? Yes, but take a look a the previous links for a much more thorough discussion of the topic. A better allocation than the simple 20% equal weighted in my example would be to leverage up the bonds to 40-60% while keeping the other asset classes at 20%. . .But I want to focus on something else - the Bridgewaters of the world do a better job of explaining the topic than I do.

Many funds have rolled out alternative mutual funds and ETFs recently, and it is instructive to examine how they have performed on this down day. One in particular, the Claymore Sabrient Defender Index (DEF), was designed to "Defend" against down days. The specifics of the methodology are proprietary, but in general terms, the fund is rebalanced quarterly by looking back at the last quarter and seeing what did well on the down days. So how well did it play D today?

An awful -3.00%.

Below is a chart of other funds that track alternative strategies including fund of funds, long/short equity, market neutral, arbitrage, covered calls, convertible bonds, private equity, and currency harvest. All are publicly traded in the US as mutual funds or ETFs.

Most of the funds performed as expected, namely, the lost less $ than the equity indices. There are a couple exceptions. Hussman gets the gold star for the day as the only fund that was up (he has been notably bearish for some time). Geronimo's Absolute Return FOF mutual fund (GPHIX) lost a staggering -6.2%. They must have a levered exposure to the HFR Indices, otherwise I cannot fathom how they lost that much in a day being an Absolute Return FOF.

Made in China? The blogosphere says ‘NO’

It’s not just China people, announced one blog half way though Tuesday’s global markets’ nosebleed. “It’s not China, it’s the economy (stupid!)”, wrote Barry Ritholtz at the Big Picture.

He added: “If you want to believe that some bureaucrat in China changing the margin requirements for local speculators as the cause of the US sell off, then go ahead. Me? I prefer to believe what is right before my eyes: Decaying economic fundamentals, a complacent market that is overbought and way overdue for a correction.”

TickerSense has the stats. The 416 point decline represents the seventh largest point decline in its history - and ends a streak of 1,098 days without a top ten point gain or loss, the fourth longest stretch since 1920. But there is some hope. While only two of the S&P 500 stocks ended Tuesday up, the third worst reading in the past 10 years, after the weakest days since 1997 on this advancers/decliners measure the index has gone up the following day 73 per cent of the time with an average gain of 1.19 per cent.

Eddy Elfenbein at Crossing Wall Street thinks we’re all getting a bit carried away. “Oh, boo hoo, people! You think this is crash? Please, this ain’t no crash.We’ve become so used to no volatility, we forgot what a normal market acts like. I’m sorry, but this was nothing compared to the olden days, say 1999. Yesterday may have been the worst day in four years, but going back ten years, it was ranks just twelfth. Twelfth, people! Back then, we would have laughed at this. Four hundred points? Please, that was a lunch break. There were three days worse than this in August ‘98 alone.”

On the China question, he is sceptical. “Let me get this right. My portfolio took a hit because of the Chinese National People’s Congress? Talk about globalization…..I’m sorry, but I can’t accept that some Communist bureaucrat is the reason for the loss of half-a-trillion dollars. What kind of connection does a company like Graco have to Shanghai margin requirements? Outside the occasional takeout, I’m guessing it’s pretty slim.

“Here’s the most telling fact about yesterday: There were 4.24 billion shares traded on the NYSE; 4.19 billion was down volume, just 45 million was up volume. That wasn’t a typo, 45 million. Declining volume led advancing volume by more than 93-to-1. Declining issues led advancers by more than six-to-one. This was no boat accident. And it wasn’t China either. It was a broad-based sell-off.”

Trader Mike seconds that, and runs through the charts. “The selling was broad-based today [Tuesday] — 89% of Nasdaq stocks were down and 84% of NYSE stocks declined….I’ve said before that this move higher felt like a game of musical chairs and today the music seems to have stopped for real. There’s a whole lot of technical damage in the indices. All the indices crashed through their 50-day moving averages today.”

Over at 24/7 Wall Street, there’s a feeling of wide-eyed wonder: “We can blame China, we can blame a horrible Durable Goods number, we can blame ex-FOMC head Greenspan for hinting at the risks of a recession. Blame whatever you want, but the selling built and built and when the NYSE trading curbs were lifted the market took a bungee jump. ”

Plus they have a few choice words after the troubles on Wall Street - a sudden 200 point drop in the Dow was caused by a snafu in the mechanism that calculates the average. By late afternoon traders reported having problems sending electronic buy and sell orders to the NYSE, says the WSJ. Traders went back to basics, resorting to writing buy and sell orders on a white board.

“This was a record day on NYSE volume and the system froze on many stocks. John Thain’s argument for eliminating the trading floor without people just got hosed, and rightfully so. In a FLOOR BROKER world alongside electronic trading they are obligated to maintain a somewhat orderly market,” writes John Ogg on 24/7 Wall Street.

Finally -’s Daniel Gross has a nomination for the ‘Great moments in magazine covers.’ From the current cover of Forbes, “Has the bull market just started?”

Tuesday, February 27, 2007

Subprime Game's Reckoning Day

The Wall Street Journal

February 27, 2007


Risky Lending Fallout
Threatens to Spread;
Uncertain ARM Strength
February 27, 2007; Page C1

The worst may be yet to come for mortgage lenders. And that could add to investor nervousness.

Shares of companies that specialize in lending to riskier borrowers or offer unconventional loans have tumbled because of concerns over how rapidly these mortgages are going sour.

If these so-called subprime borrowers continue to have problems paying their debts, the lenders that target them likely will have to boost how much money they set aside for bad loans, cutting into their bottom lines. That could mean even lower stock prices.

There also is a concern that if the real-estate market remains cool, some borrowers with better credit histories might also begin struggling to make payments on certain popular, but unorthodox, mortgages. These types of loans allow borrowers to skip monthly payments, carry low short-term teaser rates or don't require detailed financial documentation. If that happens, companies such as BankUnited Financial Corp. and Countrywide Financial Corp. could suffer.

When a company keeps its reserve low, it makes its earnings look better because it continues to increase its assets from loans it originates and sells off. That holds down expenses.

But when a company beefs up those reserves and the change hits its earnings, that can impair its ability to borrow the short-term funds needed to write new mortgages. Lenders need to set aside reserves to cover any possible losses when borrowers fail to make payments.

Subprime-mortgage lenders generally sell most of their loans to investors, but many keep some loans as investments. These portfolios have grown as the number of new mortgages has risen.

New Century Financial Corp. and NovaStar Financial Inc. hold billions of dollars of loans for investment. While they have been increasing their loan-loss provisions, delinquencies have been coming faster than anticipated.

NovaStar's reserves were 1.05% of its $2.1 billion in loans held for investment in the fourth quarter, up from 0.75% in the third quarter, but still ranked among the lowest in the industry, according to Zach Gast, an analyst at the Center for Financial Research and Analysis. New Century's ratio was 1.4% as of the third quarter. CFRA doesn't assign ratings on stocks.

[Mortgage Lenders]

Scott Hartman, chief executive of NovaStar, says the lender made a "substantial increase to our loan-loss reserve" in the past quarter, and that about half of those loans "tend to be of higher quality and generally performing very well."

New Century, which has said it will restate earnings for the first three quarters of 2006 to correct accounting errors regarding repurchased loans, declined to comment.

Subprime-mortgage lenders are likely to start reporting significant shortfalls in their loss reserves "as soon as the next several quarters," predicts David Honold, an analyst at Turner Investment Partners, which manages $23 billion and has avoided shares of subprime lenders. That is partly because some of the lenders could place into their investment-loan portfolio some poorly performing mortgages that they have bought back under terms of their sale agreement. That would require them to boost loan-loss reserves.

Subprime lenders already have seen their shares tumble -- NovaStar is off 50% and New Century is down 12% in the past 10 days -- and they could fall further if their credit-lines dry up because of poor loan-loss provisioning. NovaStar shares are trading at about 12 times estimated per-share earnings, but that valuation is likely to change as analysts adjust their projections to account for the company's steep fourth-quarter loss and poor earnings outlook. New Century shares also are trading at about 12 times estimated earnings for 2007.

Some investors urge caution about lenders that cater to borrowers with better credit but focus on mortgages that may suffer if weakness in housing continues, such as option adjustable-rate mortgages, or ARMs. These loans give borrowers multiple payment options, including a minimum payment that might not cover all of the monthly interest cost. The remainder of the interest payment is tacked onto the outstanding balance, causing it to rise.

About 59% of BankUnited's approximately $11.5 billion loan portfolio is made up of these loans and the bank is making more of them as it expands.

Countrywide has been cutting back on pay-option mortgages, funding just $2.7 billion in January out of a total $37 billion in new mortgages. Still, it has "significant exposure" to these risky loans, CFRA's Mr. Gast says. Countrywide declined to comment.

Does Subprime Index Amplify Risk?1

BankUnited acknowledges that borrowers are paying less of their monthly interest payments as interest rates have moved higher, and about 50% of the bank's loans have been made to residents of Florida, a weak real-estate market. And since BankUnited keeps about 70% of these loans in its own portfolio, if the borrowers run into problems it could hurt the company's earnings.

BankUnited shares, which fell 83 cents, or 3.2%, to $25.06 in 4 p.m. composite trading yesterday on the Nasdaq Stock Market, are trading at almost nine times its expected per-share earnings over the next year.

Under accounting rules, BankUnited counts the unpaid interest payments as revenue, however. So if a borrower pays the contractual minimum of $500 a month, rather than the $1,000 interest-only amount, the bank can count the remaining $500 as revenue. That is because it is assumed it will be repaid down the road. This revenue is a rising slice of its earnings, according to an analysis by Keefe, Bruyette & Woods.

Humberto Lopez, BankUnited's chief financial officer, says the bank focuses on borrowers with high credit scores who generally put down at least 20% of the purchase price on a home. "Our borrowers have the financial wherewithal, and they've earned the right to have options of payments," Mr. Lopez says. "We haven't seen any weakness in their ability to pay."

Exotic beta, alternative beta, alpha?

Portable alpha is so five minutes ago. The new, new investment "solutions" are exotic beta and alternative beta. Conferences are being organized, powerpoints being updated, learned papers written so these better betas must be important. Surely what matters most are absolute returns more than obsessing over which greek a particular return source belongs to. But since exotic/alternative beta is the topic-du-jour, definitions are necessary to measurably differentiate alpha from these new betas.

There are two forms of exotic beta. 1) Apply normal strategies to "exotic" assets, eg investing in African equities, timber, wine, uranium, movies or footballers. Or 2) Apply exotic strategies to normal securities, eg new trading styles or arbitrages in liquid markets. I prefer developing exotic strategies to apply to any security (traditional or "exotic") but then as a risk averse investor I am not prepared to bet on asset beta of ANY kind.

Alternative beta is NOT exotic beta. It is the expected return from an established non-exotic investment strategy that is in the public domain, has many hedge funds in the space and whose factor dependence is empirically determinable, though not necessarily constant. As hedge fund clones proliferate, many well-known alternative strategies will indeed be replicable at cheaper cost for "beta only" performance.

Alpha is best defined as the observed return minus the expected return. It is not so difficult to come up with an estimation of what a naive investor would have made in emerging markets, distressed debt or metals trading last year. Surely any outperformance of that expectation is alpha but few hedge funds operating in those areas generated ANY positive alpha in 2006. Many underperformed a replicated strategy and therefore produced negative alpha. Nowadays it is increasingly unnecessary for an investor to pay hedge fund fees for alternative beta, though many still do.

Some newer "hedge funds" claim they aren't even trying for alpha, just charging 2 and 20 to provide investors with access to exotic beta. There is almost certainly a cheaper way to get that desired exposure whether through a hedge fund clone, ETF, basket derivative or simply directly buying a few assets from the "exotic" class oneself. It is not that difficult or expensive to gain exposure to almost any "exotic" security these days.

Exotic is also in the eye of the beholder. Commodities have a MUCH longer track record than equities yet many investors still don't have a commodity allocation. Art and wine have been investible almost as long as gold so how can they be exotic? Slovenia gets classified as a frontier stock market despite being a net contributor to the EU and the average Slovenian probably enjoys a standard of living not that different to the average German. There are geographically challenged people around that still consider Singapore, South Africa and South Korea to be emerging markets which is ludicrous. Many "emerging" markets have long since emerged. Many once "exotic" trading strategies are now plain vanilla.

I just try to buy good investments and short sell bad ones. WHERE the asset is, or whether that security is classified as an equity, bond, loan, future, derivative, commodity, currency or life form isn't particularly important provided the risk can be measured, managed and easily REDUCED in a limited time frame. On this flat and interconnected planet how can anything be exotic? With the internet, free phone calls and video conferencing that actually works, nowhere seems distant. Even if you need to be physically present, no place on the earth is more than a day's flight away. There are certainly exotic investment strategies but I am not so sure there are exotic assets anymore, anywhere.

Investors pushing the envelope into the obscurest, illiquid, very low capacity instruments are likely to end up in tears with the risk/reward equation NOW so unfavorable. We have seen the extreme search for yield end badly throughout history and this time will be no different. With some exotic securities it is possible to construct an opposite pay-off or synthetic short exposure that will mitigate the risk of a disaster scenario. But with movies and footballers, for example, it is difficult to see where or what the hedge is. There are far more bad movies around than good movies, just like there are more bad stocks than good stocks, but how do you short sell a movie? Uzbek equities and catastrophe bonds are partially hedgeable and therefore acceptable hedge fund investments but is funding movies and potential sports heroes?

Diversification through multiple asset classes and numerous investment strategies is essential for all investors. But beta is NEVER exotic whereas alpha is ALWAYS exotic since it is so difficult to consistently generate. True hedge funds are in the alpha production business, NOT the movie production business or the beta bundling business.
© posted by Veryan Allen at 26.2.07

Ten Little Assets

Investment Outlook
Bill Gross | March 2007
Ten Little Assets

War! What is it good for?

Absolutely nothing!

Say it again y’all


“War” Edwin Starr

Actually it probably is good for something – war, that is. A lot of mankind’s technological advances have been bred in the bowels of wartime – radar and nuclear energy to name a few from World War II. And let’s not forget Iraq’s Humvee with its four-wheel consumer knock-off, the Hummer! Love those yellow Hummers rollin’ down the Coast Highway – 8 miles to the gallon and all – tailgating my poor little old Mercedes and threatening to roll right over it like a Bradley tank or something. In addition, war is usually justified as a defensive move – they did that to us or could do that to us, so it’s only logical we do that to them. And so it goes, and so it goes. But aside from these seemingly logical rationalities that stir jingoistic juices in a plea for our side, and a view that our dead are somehow more hallowed then their dead, I can only conclude from personal experience in Viet Nam, and redundant renderings of history books that Motown singer Edwin Starr was right – war is good for absolutely nothing.

The problem though, with this Gandhi/John Lennon “all you need is love” philosophy is that it denies the inherent genetic makeup of human nature. Survival of the fittest is inbred in our DNA and Pollyannas who suggest that human beings are pliable and malleable like a pacifist potter’s wet clay have just not joined Descartes and nearly 7 billion current participants in this 21st century Age of Reason. Still with Gandhi and Lennon in such esteemed company as Jesus and the Buddha who urged us to just give peace a chance, there must be something we can do that acknowledges our warlike genes while utilizing the rationality of progressive thinking.

The solution, quite simply, is to elect less warlike leaders, which means those with DNA tilted to nurture, as opposed to nature, which means – yes, you male chauvinist piglets – more women and fewer male presidents. I mean other than commercially sponsored and male-motivated mud wrestling, how many women do you actually see fighting each other? Behind the lines and over the cell phone, yeah sure, the backbiting can be pretty awesome, but guns and knives? Even Farrah Fawcett on Charlie’s Angels just sort of pulled hair and scratched a lot of faces. Jesting aside, however, I’m dead serious and you should be too. If we were, dead serious, there would be a lot fewer bodies in the streets of Baghdad to name just the current hot spot. And for those of you who think that women leaders would be too soft, remember Maggie Thatcher defending the Falklands or Golda Meir leading Israel? They were tough, but neither one of them was responsible for the killing of hundreds of thousands of innocents like Saddam Hussein and _________________ were. (You chastened neocons can fill in that blank.) More women leaders, fewer men is the solution if we are to avoid repeating those mistakes.1 And while that probably means a 2½ hour State of the Union speech and a little more nurture than our collective political nature is used to, women are the ones who really understand that war is good for absolutely nothing. Say it again.

What I’ve been saying over and over again on the investment side is that the Fed will cut rates later this year and that their two key criteria will be employment and asset prices. With construction laborers about to hit the unemployment lines and the U rate in jeopardy of rising more than the Fed feels comfortable with, an ease as soon as mid-year may be in the cards. I have a strong sense as well, that mortgage credit availability is in the midst of a cyclical squeeze due to subprime defaults and “better late than never” moral suasion/congressional supervision of mortgage bankers. This should not only continue to floor the housing sector but dampen consumption, as the combined effect of layoffs and Mortgage Equity Withdrawal, “withdrawal” produce a 2% or less real and a 4% or less nominal economy. Those numbers when extended for three or four quarters (which they now have been) are the stuff leading to output gaps, rising unemployment, declining inflation, and an easing in overnight Fed Funds rates.

We live in an asset based economy, however, as I’ve pointed out frequently in recent years’ and months’ Outlooks, and it’s the increasing and in some cases bubblish trajectory of those prices that have supported the U.S. and other economies – the U.K. to name a prominent addition. Because of the importance of asset prices, the Fed has in my opinion targeted not only the standard Humphrey/Hawkins components of employment and inflation, but houses, stocks, and risk spreads of all types as indicators of the future course of the economy. They may publicly announce that higher inflation is enemy #1, but such is hard to believe with worldwide prices and the U.S. core moving towards, and in some cases resting on safe ground. It’s stocks, private equities, corporate buyouts and levered risk spreads that really are front and center on the Fed’s agenda because they – not CPI inflation – represent the future threat to steady growth via their exuberance.

If that is the case, observing asset price swings will be instructive, yet still not necessarily productive in front running other bond managers to lock in currently “high” yields. All of us can observe asset price ticks of all sorts and the “efficiency” of such an approach may lead to nothing other than a momentum driven, “beta” rich but “alpha-less” quest. The secret to avoiding being a fish at the current poker table is to have a collective sense of what drives asset prices, which ones are affected first, and ultimately which ones are affected last – and to decide ahead of time whether heretofore bullish risk assets are going to correct or whether they will keep on keepin’ on.

We at PIMCO, in our Forums and Investment Committee meetings, have a sense that in this U.S. and global cycle, perhaps more than any other previous one, it is the “carry” or perceived/expected “carry” of an asset over and above cash returns that is the driving force behind asset appreciation. Carry in this case refers to the return or yield relative to 5¼% in the U.S., 3½% in Euroland, and ½% in Japan. If greater than any of those rates in their respective markets, then it theoretically pays to continue to buy, even lever an asset in order to extract return, since volatility and economic recessions are “history book stuff” (sic). Chart 1 shows PIMCO’s perceived asset carry path, sort of like Agatha Christie’s “Ten Little Indians” where one guest and then another was picked off by a mysterious murderer. In this case, the murderer is known ahead of time – a 5¼% overnight rate. That is the strangler that has led to the demise of at least the first four or five of our ten little assets.

The first to be knocked off was of course the Yen as it sunk lower and lower under the burden of negative dollar carry – a 500 basis point gap as recently as three months ago, and now only slightly less. Bonds then began a mild bear market as the positive carry derived from historically low Fed Funds disappeared, resulting for the past three quarters in a negative yield curve – and negative carry. Should it have been any wonder that our third “little asset” (actually a pretty big Indian by Agatha Christie standards) was an asset supersensitive to financing costs and expectations for positive total returns? Home buyers and speculators have only recently realized that not only were they in a significant negative carry position relative to realized income (rents), but because houses have gone up so much in price that capital losses, not capital gains, might actually compound their negative carry. In the past few months, home prices have begun to sink YOY for the first time in decades. Commodities led by oil and copper were/are next, as futures prices in contango became negative carry relative to 5¼% cash. The High Yield asset-backed market appears to be “little asset number five” as delinquencies, defaults, and investors’ disenchantment wreak havoc with subprimes and ultimately other poorly underwritten mortgages. The Fed, while not smiling, is more than likely sitting back in a parental “I told you so” posture (actually Alan Greenspan did tell us so in a major speech concerning housing loans in late 2005). Contained “destruction” is what the Fed wants to see before short rates can be lowered.

How does this movie play out? Some would say not until the Fed raises interest rates even more. That, however, is increasingly unlikely. What the last six months have shown us is that the U.S. economy and its asset markets are sensitive to 5¼% overnight rates and that asset prices are going down – first for those categories most sensitive to negative carry, and ultimately for those whose prices have been driven so high that 5¼% represents increasing competition: earnings yields on stocks at 5-6% for example or even those historical double-digit returns from the king of them all – private equity. What the housing top proved is that any asset can eventually become overpriced and fall of its own weight, carry or no carry. When the last of our ten little assets bites the dust is hard to know, and let me be fair – these are PIMCO’s “Ten Little Assets.” The Fed may have five, or four, and waiting for the bloom to come off the rose on the private equity bubble is probably not on Bernanke’s priority list for eventually cutting Fed Funds. But three things are, and each of them is being strangled by a currently restrictive 5¼% overnight rate: inflation, employment, and selected carry sensitive asset markets. We at PIMCO will be watching all three in an attempt to lock in yields that 12 months from now should be significantly lower, at least on the front end of the yield curve. If risk assets like stocks, emerging market and high yield bonds, as well as risk currencies such as the Brazilian Real, Mexican Peso, and New Zealand dollar begin to weaken in future weeks and months, then the Fed should know that they’ve done their job. If they’ve done it too well, and strangled the life out of all risk markets, then…, but we get ahead of ourselves. A good author/portfolio manager should know when to stop, just as I suppose, should a good President, no matter what the gender.

William H. Gross

Managing Director

Monday, February 26, 2007

80% of S&P 500 Stocks Above 20 and 200 Day Averages

As of Tuesday's close, over 80% of the stocks in the S&P 500 were trading above their 20 and 200-day moving averages. In the chart below, we highlight prior occurrences since 2001 where the same thing occurred. The last occurrence was in December 2004, after which the market began a 6% correction. However, in 2003, we had a stretch where there were numerous occasions where 80% of the stocks in the S&P 500 were above their 20 and 200 day averages, and yet the market kept on chugging.



February 24, 2007; Page B1

As a star Wall Street trader more than two decades ago, Lewis Ranieri helped create a vast new business: selling bonds backed by millions of Americans' home-loan payments.

Today, that business has gone through what Mr. Ranieri calls a "staggering" transformation, and he doesn't like some of what he sees. The rumpled 60-year-old says he is worried about the proliferation of risky mortgages and convoluted ways of financing them. Too many investors don't understand the dangers.

Lewis Ranieri wonders if investors know the risks they have.

It isn't that Mr. Ranieri is risk-averse. The 1989 best-selling book "Liar's Poker" celebrated his billion-dollar trades in these bonds, along with his polyester suits and the junk-food "feeding frenzies" by him and his trading-desk partners at the old Salomon Brothers, where he worked.

Their innovation: combining regular mortgages into giant pools of loans that could be divided up and resold as bonds to pension funds and other institutional investors. These bonds come with a variety of credit ratings and are repackaged in endless permutations to meet investors' varying appetites for risk.

The problem, he says, is that in the past few years the business has changed so much that if the U.S. housing market takes another lurch downward, no one will know where all the bodies are buried. "I don't know how to understand the ripple effects through the system today," he said during a recent seminar.

The Brooklyn-born Mr. Ranieri, who today is a fund manager, has a long perspective on mortgages and Wall Street. He got his start in the 1960s, when he was 19 years old, with a job in the Salomon Brothers mailroom. After a spell trading utility bonds, he joined Salomon's embryonic mortgage-securities desk in 1978, when the idea of mortgages as big money spinners was far-fetched.

Within a few years, Salomon was making immense profits trading mortgages. After rising to become a vice chairman at Salomon, Mr. Ranieri was pushed out in 1987 amid a clash of personalities. (Salomon itself was eventually swallowed into what is now Citigroup Inc.).

Mr. Ranieri later helped rescue savings-and-loan institutions after interest-rate gyrations created huge losses in the 1980s, and built up his own mortgage-investment firm.

Mr. Ranieri, who today doesn't seem preoccupied with reliving his younger days as a mortgage-trading star, says he has never read "Liar's Poker," the memoir that made him famous beyond the mortgage market.

When the book came out in 1989, he says, "I had left the firm [Salomon], and I was attempting to turn the page."

The industry he helped to create is immense, and its investors scattered across the globe. As of Dec. 31, there were about $7 trillion of U.S. mortgage securities outstanding, easily exceeding the $4.3 trillion of U.S. Treasury securities.

Until the past few years, the business was dominated by Fannie Mae and Freddie Mac, the two government-sponsored providers of funding for home loans. But they have lost their dominance amid accounting scandals. At the same time, investors in mortgage-backed bonds became lulled by the real-estate boom into buying loans that would have been unthinkable a few years ago.

The housing boom kept loan losses unusually low, because borrowers who got into trouble could easily sell their homes for a profit or refinance into a cheaper mortgage. Many "subprime" borrowers (people with weak credit records) bought homes with no down payments. More than 40% of subprime borrowers last year weren't required to produce pay stubs or other proof of their income and assets, according to Credit Suisse Group. At the same time, some lenders have become more reliant on computer models to estimate the value of homes.

"We're not really sure what the guy's income is and...we're not sure what the house is worth," says Mr. Ranieri, who now runs his own investment businesses in Uniondale, N.Y. "So you can understand why some of us become a little nervous."

In recent months, amid a surge in early defaults, lenders have become much more cautious, insisting on down payments and doing more diligent checks of a prospective borrower's income. Those changes are too late to save many loans granted in 2005 and 2006.

During the boom, investment banks promoted new instruments that made it easy for more investors to dabble in mortgages. Chief among these is the collateralized debt obligation, or CDO. Money managers set up CDOs, which raise money by selling notes and shares to investors. The proceeds are used to buy a wide variety of mortgage securities. The target market: insurers, pension funds and other investors that lack the time or expertise to choose individual mortgage securities. Instead, they can buy into a CDO, just as a stock-market investor gets immediate diversification by buying a mutual fund.

CDOs, which are particularly popular with Asian and European institutional investors, have become huge buyers of the riskier slices of mortgage securities, the high-yielding portions that suffer some of the first losses if mortgage defaults are higher than initially expected.

One concern, Mr. Ranieri says, is that it isn't clear exactly which investors hold lots of the riskiest slices and whether they understand those risks. Investors in CDOs don't get as much information about the collateral backing their investments -- thousands of homes scattered across America -- as do traditional, specialist buyers of individual mortgage securities, he says.

Adding to the complexity: CDOs also often invest in other CDOs, putting another layer of opaqueness between investors and their collateral.

CDOs aren't bad, per se, but can bring mortgage exposure to "a much less sophisticated community," Mr. Ranieri says.

CDO investors rely heavily on ratings from firms like Standard & Poor's to guide them, but Mr. Ranieri says he believes the rating agencies are struggling to keep up with the rapid changes in mortgage finance. "It's almost overwhelming," he says.

Officials at S&P, a McGraw-Hill Cos. unit, say they are keeping up with the changes and have more than 100 analysts monitoring CDOs.

Mr. Ranieri isn't predicting Armageddon. Some of the riskier new types of mortgages probably will perform "horribly" in terms of defaults, leading to losses for some investors. But, he says, the "vast majority" of mortgages outstanding are based on sounder lending principles and should be fine.

Write to James R. Hagerty at

Tuesday, February 20, 2007

Baron Retains Stocks After Chance to Make `Billions'

By Nick Baker

Feb. 15 (Bloomberg) -- Ron Baron still kicks himself for missing the chance to make billions of dollars for his investors with the founders of Home Depot Inc.

Baron, chief executive officer of Baron Capital Management Inc., sold his shares in the owner of Handy Dan hardware stores in the mid-1970s. The company was run by Arthur Blank and Bernard Marcus, who went on to start Home Depot, the world's largest home-improvement retailer, with a market value of $85 billion.

``Because I sold early, I didn't get to invest in Home Depot and make untold billions,'' Baron, 63, said in an interview from his office overlooking New York's Central Park.

Baron learned from that mistake and now sticks with stocks six times longer than other fund managers. His favorites include Wynn Resorts Ltd., the casino operator created by billionaire Steve Wynn, and Whole Foods Market Inc., the largest U.S. natural-foods grocer.

The approach has paid off. The $2.7 billion Baron Partners Fund has returned 6.4 percent in 2007, almost double that of the Standard & Poor's 500 Index, and beat the U.S. stock-market benchmark three years in a row. His biggest fund, the $6.2 billion Baron Growth Fund, has doubled the S&P 500's gains in the past five years.

The Partners Fund ranks first in the past three years among 15 market-neutral funds, which aim to profit whether stocks rise or fall, according to data tracked by Bloomberg. The Growth Fund is 10th of 53 with at least $500 million in assets that buy shares of small companies.

Keeping Turnover Low

``Most people are investing to make short-term profits,'' said Baron, whose 25-year-old firm manages $18.5 billion. ``We imagine what it will become, not what it is today.''

The Baron Growth Fund's turnover rate, the portion of its holdings that changes in a calendar year, is 15 percent, compared with 86 percent for the average fund, according to research firm Morningstar Inc. in Chicago. The Baron Partners Fund's turnover is 38 percent.

Baron, who worked at the U.S. Patent Office early in his career, has owned shares of Charles Schwab Corp., the biggest U.S. discount brokerage, since 1992 and Robert Half International Inc., a staffing company, since 1991. Schwab's stock has gained an average of about 22 percent annually in the past 15 years, twice that of the S&P 500. Robert Half has increased 28 percent yearly over the same span.

Handy Dan

Three decades ago, Baron invested in Daylin Inc., owner of California-based home-improvement chain Handy Dan, together with Kenneth Langone. He sold Daylin shares after his money doubled. Langone kept his stake.

Blank, now 64, and Marcus, 77, ran Handy Dan. After they were fired in 1978, they approached Langone, who helped them found Home Depot in Atlanta. The company went public in 1981, and its shares have surged more than 1,000-fold, according to data compiled by Bloomberg. Langone, 71, owns shares valued at almost $690 million.

``You don't benefit if you've identified a big opportunity and it starts to grow and you sell,'' said Baron, whose office is filled with valuables such as a rocking chair once owned by former President John F. Kennedy and a copy of the 1920 contract that brought Babe Ruth to the New York Yankees.

Baron gets better returns than peers with the risks he takes. The Partners Fund's Sharpe ratio is 1.55 and the Growth Fund's is 0.99, compared with 0.78 for the average U.S. diversified fund, according to Morningstar. A higher Sharpe ratio means better risk-adjusted returns. Morningstar gives the Partners Fund four stars and the Growth Fund five stars, its highest rating.

Early Wynn Investor

Baron was the third investor in Wynn Resorts, which runs casinos in Las Vegas and Macau, China. He made a private-equity investment in the company in April 2001 and bought more 18 months later when it went public at $13 a share. Wynn Resorts has soared to $103.36 through yesterday, giving the company a market value of $10.5 billion.

``There's $10 billion in profits more to be made in that property in the next 10 years,'' he said, referring to Wynn Las Vegas. ``The Macau development gets you to something like $200'' a share, he said, ``and if you're successful developing the property in Las Vegas, that gets you to $300.''

Baron is willing to stay put when a company runs into trouble. Shares of Whole Foods tumbled 23 percent, the most ever, to $46.26 on Nov. 3 after the company reduced its sales forecast for this year and said new-store openings will ``significantly'' reduce profit this year and next. The Austin, Texas-based chain opened its first store in 1980 and now operates 191. Its shares closed yesterday at $45.88.

Baron, who's roughly doubled his money since becoming a shareholder in June 2003, welcomes the expansion.

``Where they're opening up, people can't get into the stores fast enough,'' he said.

To contact the reporter on this story: Nick Baker in New York at .

Last Updated: February 15, 2007 12:16 EST

Monday, February 19, 2007

Stocks -- Coach Class of Capitalism: Michael Lewis

Dec. 11 (Bloomberg) -- One of the miracles of Wall Street is its ability to create a class system without class resentment.

At any given time in the capital markets there are at least two sets of rules -- one for the rich and well-connected, another for the middle class, the Wall Street proletariat. The upper class rides in the front of the plane with their venture capitalists and hedge-fund managers; the proles ride in the back, with the mutual-fund managers.

There is, you might think, a war waiting to happen between the Haves and the Have-Mores. And yet no one much complains. One group of people simply expects to earn 20 percent or more per annum on their capital, the other is more or less content when their mutual fund underperforms the market only slightly.

That's not to say that the proles from time to time don't work themselves into a tizzy. When some Wall Street analyst is getting caught speaking ill in private of a company he has promoted in public -- especially if he is caught immediately after a general stock market collapse -- the proles take to the streets with their pitchforks and torches.

But they don't seem to be disturbed by the inequality inherent in the financial markets in good times. So long as common stocks are rising and their money isn't obviously stolen -- that is, so long as the proletariat enjoys steady, if unspectacular, returns on its capital -- the investment lower class is surprisingly docile. It's as if the pleasure of any return at all has distracted investors from a comparatively low rate.

Reshaped Markets

But it's going to be hard to keep them distracted. In the past few years the financial markets have reshaped themselves in the most extraordinary ways, and put an even finer point than usual on the class distinctions inside them. The upper class is now serviced by a vast and growing industry, loosely called Private Equity.

The job of the private-equity investor is -- again, speaking loosely -- to exploit the idiocy of the ordinary investor, and the corporate executives and mutual-fund managers who purport to serve him. Private Equity Intelligence says this year private-equity firms have raised $300 billion, up from $283 billion for all of last year -- which is up from an ignorable $10 billion or so 10 years ago.

Even those gargantuan numbers fail to do justice to this peculiar financial event. Private equity is not served up without piles of debt -- the typical debt-to-equity ratio of a company after it has been bought by a private-equity firm is 2- to-1 --and so the actual purchasing power in the hands of private equity fund managers is something like three times as much as they have in their bank accounts. It's as if a giant and especially successful new stock market has been created alongside the old one. But to invest in this new market you must already be rich, and well-connected.

A New Field

What's odd about this is that so much of the financial drama of the past five years -- the rise of Eliot Spitzer, the Sarbanes-Oxley law, the muckraking in the financial press -- has been staged, ostensibly, to level the playing field on Wall Street. But the players have responded by building a new field, apart from the old one.

The regulation, by raising the cost of doing business to public companies, has had the perverse effect of reducing the value of a company simply because it IS public, and thereby creating further incentive to take it private. Sarbanes-Oxley has done many things, but one of them is to create a lot of cheap assets for private-equity firms to buy.

It has also helped to make the relationship between the upper class and the proles more explicitly parasitical than it usually is.

Sorry Souls

The recent deal to buy, and then sell, the car-rental company Hertz Global Holdings Corp. nicely illustrates the current state of play in that relationship. In December 2005, a pair of private-equity firms, Clayton Dubilier & Rice Inc. and the Carlyle Group, bought Hertz from the Ford Motor Co. -- which is to say they bought it from the sorry souls who own shares of Ford. Eleven months later, in November 2006, they turned around and sold Hertz back to the proles in an initial public offering.

In buying the company they put up $2.3 billion in equity capital. By the time they sold it they had gotten $1.3 billion of their money back, and held shares -- which they no doubt plan to get rid of as soon as they can -- valued at another $3.5 billion or so. In less than a year they had netted a fairly clean $2.5 billion profit.

I suppose one might argue that it isn't as simple as that - -for instance, that it is riskier to invest money through a private-equity firm than it is to invest in common stocks, and so the private-equity investor is merely being paid for the added risk. But it's hard to see how Hertz is a riskier investment simply because it is owned by the Carlyle Group and not by Ford.

Buy Cheap, Sell Dear

In effect, the smartest, best-connected money has separated itself from the rest of the stock market, and has gone into the business of trading against that market. It seeks to buy from the stock market cheap, and sell to the stock market dear, and if you need evidence that this is possible you need only look to the returns on private equity, which have been running three times the returns of the public stock market.

With the shrewdest and most sophisticated investors armed with essentially unlimited capital, any company that is available to the public is almost by definition an inferior asset, i.e., an asset that the private-equity people have no interest in. We may not have arrived at the point where the publicly traded shares in a company are a sure sign that those shares are a poor investment. But that's the obvious, ultimate destination.

Which raises the question: Why do the proles continue to invest in publicly traded companies? And the obvious answer is: They have no choice.

One day the private-equity markets may expand to the point where even proles are offered a little piece of the action. That will be the day the action is no longer worth having. Trust me. The ordinary investor is now and forever cast in the role of the peasant at the king's banquet. He's so happy to have any food at all that he fails to notice that bone between his teeth isn't the meal. It's the scraps.

(Michael Lewis, the author, most recently, of ``The Blind Side,'' is a columnist for Bloomberg News. The views he expresses are his own.)

To contact the writer of this column: Michael Lewis in Berkeley, California at .

Last Updated: December 11, 2006 12:25 EST

Derivative Doom: Myths and Realities

By Emma Trincal, Senior Financial Correspondent
Friday, February 16, 2007 11:01:55 AM ET

OMAHA, Neb. (—The huge size of the derivatives market has many predicting financial calamities. Doom-and-gloom scenarios abound from pundits, from Main Street voices, from Congress, regulators. And because hedge funds are heavy participants in this large and complex market, they are part of the bleak picture painted by the Cassandras. Warren Buffet in 2003 coined the expression "financial weapons of mass destruction" to characterize derivatives. And earlier this month, the U.S. Congress pledged to issue a report on the subject by June 27, responding to concerns by lawmakers about the potential dangers of those instruments Previous HedgeWorld Story.

One latest example of such pessimistic calls is the recent warning issued by Roland Manarin, president of Omaha, Neb.-based Manarin Investment Counsel and portfolio manager of Lifetime Achievement Fund, a fund of mutual funds. Mr. Manarin, named by Barron's as one of America's top wealth advisers, has also been since 1986 the host of "It's Your Money," one of the Midwest's longest-running financial radio shows.

"While hedge funds do represent a true danger to financial markets and the public needs to be aware of the high risks, the real focus ought to be on the outrageous amount of derivatives being traded," Mr. Manarin said.

In an interview, Mr. Manarin worried about the size of the derivatives market, which he said represents nearly $300 trillion in notional value, a number nearly 25 times greater than the U.S. gross domestic product ($13 trillion.)

According to the International Swaps and Derivatives Association, the notional size of the market is indeed huge: $283 trillion as of June 2006, the latest available statistic. The December figures will be released in the spring. The ISDA defines derivatives as financial securities whose value is derived from another "underlying" financial security. Options, futures, swaps, swaptions and structured notes are all examples of derivatives securities.

Continuing his anti-derivatives thesis, Mr. Manarin said that, "Most often derivatives are used to hedge against risk but are also used by speculators hoping to make big bucks. When you enter the derivative bet, you place a huge amount of assets with a tiny amount of money, which is the major reason that these financial instruments are so dangerous."

Mr. Manarin cited derivatives as the main cause of major financial crises such as the stock market crash of 1987; the collapse of Barings Bank in 1995; the Asian market crisis in 1997; and the fall of Long-Term Capital Management. "The major banks are among the largest players in the derivatives market and [they make] their bets with money created from nothing. A 4% decline in the nominal value of traded derivatives equals to our GDP for a year, so watch out!" Mr. Manarin said.

But is if fair to blame derivatives contracts for all past financial disasters? The remarkable growth and complexity of this market also has resulted in a great deal of confusion and misconceptions, say some derivatives experts in rebuttal. To them, derivatives basically play a positive role in stabilizing the economy and reducing risk.

"If it's a huge market, it doesn't necessarily mean it's going to be the next explosion," said Willa Bruckner, member of the Financial Services and Products Group at Alston & Bird, a New York law firm. For instance, she said that the collapse of Barings was "less of a derivatives issue and more the result of an internal control issue." She said that the Asian crisis in 1997 was provoked by problems inherent to the Russian economy, not derivatives.

"Surely derivatives products have the potential of magnifying losses but they also offer the possibility of hedging losses and reducing risk by slicing risk into pieces," she said. "If properly managed and properly allocated to a portfolio, derivatives can reduce risk. It's no different than nuclear energy: It's a wonderful tool if used properly. If not, it can be incredibly destructive," she added.

The major banks have made significant progresses in clearing derivatives trade backlogs, she said, which proves that dealers instead of being the problem are "part of the solution."

"Look at Amaranth," Ms. Bruckner said. "It was a much bigger loss than LTCM, but the impact was much smaller because we now have better risk management of derivatives contracts," she said.

Finally, she pointed to the misleading aspect of "notional" figures. The notional in derivatives jargon refers to the amounts of the underlying assets traded via derivatives instruments.

Taking the example of $1 million of notional in interest rate swaps, she said that if two parties trade a derivatives contract that represents 6% of the notional, they're actually exchanging $60,000. "The biggest piece of this derivatives market is in interest rate swaps where the actual transfer of cash is much smaller than the notional," Ms. Bruckner said. She said that losses can be contained and that the frequency and the size of the losses tend to be smaller as the market evolves. Ms. Bruckner conceded that risk is not totally eliminated and that a big loss could occur in the market, but the odds are slimmer. "And this is a fact of life. You can't get away from risk. If you remove the risk, you have no game," she concluded.

Derivatives research expert Dushyant Shahrawat at TowerGroup, a research firm based in Needham, Mass., also disputed Mr. Manarin's claims. He said that "Barings was not a derivative problem. It was renegade trader in a firm with bad risk management in place. And the 1987 crash had nothing to do with derivatives. It was due to speculation."

While Mr. Shahrawat did not rule out potential risks, he stressed his contrarian view on risk: "We don't think the risk is centered around large banks. Instead, we think risk comes from hundreds of thousands of small companies," he said.

"Everybody gets excited about the notional value. You can't see it out of context. What you've got to look at is how derivatives are being utilized. A few years ago, people were using derivatives for speculation. Today, it's mostly used as a risk reduction tool," said Mr. Shahrawat.

Story Copyright © 1999-2007 HedgeWorld Limited All rights reserved.

Thomson, Bartiromo and Victorian Wall Street: Michael Lewis

Michael Lewis

By Michael Lewis

Feb. 13 (Bloomberg) -- My classmates from the 1985 Salomon Brothers training program have now scattered to the four winds. Of the original 110 only three appear to be employed by what remains of Salomon inside Citigroup; the rest have moved on to hedge funds, private-equity firms, mutual funds, other investment banks and even academia. There were only 10 women in the class and most have left the business entirely.

But a random sampling of my former classmates suggests that they still share a remarkably coherent view of the financial world. They look at Wall Street now, compare it to the Wall Street then, and note the same three big changes:

* Financial people have become a lot more quantitative and a lot less verbal.

* You need more schooling to gain entrance to the high- stakes table on Wall Street, but once you've got a seat it's easier than ever to make a fortune.

* And, finally, the culture of big Wall Street firms in 2007 is a lot more buttoned-up than it was in the late 1980s.

Cue Todd Thomson, chief executive officer of Citigroup Inc.'s Global Wealth Management division, to illustrate the cultural change more specifically. To recap: On Jan. 22, Citigroup issues a press release announcing Thomson's resignation, in which Thomson declares how much he's ``looking forward to exploring new challenges.'' The next day, citing three Citigroup insiders close to the situation, the Wall Street Journal reports that Thomson didn't resign but was fired by Citigroup CEO Charles Prince for ``lapses in judgment,'' including ``the inappropriate use of company aircraft.''

All Maria, All the Time

Three days later the Journal, drawing on what apparently is a direct line into the Citigroup executive suite, conveniently supplies a list of Thomson's indiscretions: flying CNBC journalist Maria Bartiromo to Asia on the Citigroup jet, then bumping Citigroup execs from the return flight so he might fly back alone with her; bankrolling Citigroup functions that feature Maria Bartiromo; using $5 million of his marketing budget to sponsor a TV show on the Sundance Channel hosted by CNBC journalist Maria Bartiromo, and naming Maria Bartiromo to a board he created inside the Wharton Business School.

Thomson also ``installed a wood burning fireplace in his office,'' but my guess is that he would have been forgiven that small romantic gesture if he hadn't made the others. I'll bet, also, that he would have been allowed to waste even more millions of dollars on causes only loosely related to the bottom line, if he had only wasted them less systematically. He was, after all, the boss of Citigroup's fastest-growing business. You don't kill the goose for spending a few of its golden eggs.

Let's Be Clear

Thomson's capital offense, obviously, was to use his status at Citigroup to underwrite his relationship with Maria Bartiromo. The Journal strongly implied but never came out and said that something more than business was going on between Thomson and Bartiromo, no doubt simply reflecting the off-the-record opinion of Citigroup's executive suite. To make its innuendo as clear as possible the Journal pointed out that after a Citigroup executive spotted Thomson dining alone with Bartiromo, Prince warned Thomson about getting too close to her. And I doubt he much cared who paid for the meal.

No, the executive in charge of the fastest-growing business at the world's largest financial company lost his mega-million dollar job for pulling strings to keep his female journalist friend happy. (Or, at least, impressed.)

The banker lost everything; in return the journalist surrendered nothing -- or at any rate nothing of her career. A few journalism professors moaned about CNBC's ethical standards - - Bartiromo interviewed Thomson on air several times -- but CNBC issued a statement saying, in effect, how proud it was of her. And that's that. All anyone will remember is that CNBC's anchor, in addition to being a babe, is as intimate with Wall Street power as a journalist can get. And while the intimacy was indeed impressive, the power clearly was not.

`I'm Huge'

The obvious question -- ``What was the man thinking?'' -- Thomson hasn't addressed, at least not publicly. But that shouldn't stop the rest of us from guessing, and my guess is that the soundtrack in the back of Todd Thomson's mind played the golden oldie from the glory days of the Wall Street alpha male:

``Look at me: I'm huge! Because I'm huge I have special needs. Because I make this place hundreds of millions a year, I can do whatever the hell I want. Technically, Prince may be my boss but I don't really have a boss, because without me he's not just short and tubby but toast. I make the money. The petty rules are for the people who don't make the money.''

Standing Ovation

He was thinking, in other words, a lot like a man in his position circa 1985 might have thought. The man's impulses were still designed for an age when, if you were a big enough hitter at a big Wall Street firm and you were caught in what appeared to be a dalliance with a prominent female journalist you got not a pink slip but a standing ovation. Even if you had used the corporate jet to pull it off.

That time has passed. Mess around on company time, using company assets, with a high-profile woman who isn't your wife and it doesn't matter how much money you make for the firm: You're fired.

You're fired, first, to prevent the firm from being scandalized in the newspapers. You're fired, also, because while the CEO might be able to rationalize your behavior to his male subordinates, or at least cow them into submission, he can't begin to explain it to the women in the firm. And, suddenly, there are a lot more of them around, in senior positions, who will make sure that the scandal, left unaddressed, finds its way into the newspapers. (Prince replaced Thomson with Sallie Krawcheck.)

New Deal

There is a new deal for the alpha male on Wall Street. He can make his millions, and he can still strut and preen and feel important. What he can't do is sexualize his financial clout. In the late 1980s it was fairly routine for men on Wall Street trading floors to order up strippers; when a prominent bond salesman was fellated in a conference room just off the trading floor his colleagues were more amused than shocked. Not long ago a pair of Morgan Stanley employees was fired for merely attending a strip club in their off hours. As one of my former classmates put it, ``the decorum in the marketplace has changed.''

Todd Thomson's mistake was that deep down he believed he hadn't made one. He's the rooster whose head has been removed but is still flapping around the barnyard, thinking he's still alive.

(Michael Lewis, the author, most recently, of `The Blind Side,' is a columnist for Bloomberg News. The views he expresses are his own.)

To contact the writer of this column: Michael Lewis in Berkeley, California, at .

Citigroup Alternative Investments Winter Journal 2007

Click here for the CAI Winter Journal - Featuring Article : Hedge Funds and the Actve Management Industry

Saturday, February 17, 2007

For Yale’s Money Man, a Higher Calling

The New York Times
February 18, 2007

New Haven

NEWS of windfalls on Wall Street have become as common and unsurprising as rain: traders collect $50 million bonuses, top hedge fund managers haul in more than $100 million in a single year. In such gilded company, annual compensation of $1.3 million looks paltry. Yet that was how much David F. Swensen took home in 2005 for supervising Yale University’s endowment, now worth $20 billion.

Mr. Swensen, one of the most well-regarded investors in the country, never appears on lists of the most highly paid money managers. Nor has he made headlines by buying expensive homes in New York or Palm Beach or by frequenting cocktail and charity circuits. But in the competitive, performance-driven world of money managers, Mr. Swensen can boast of an extraordinary record.

During his 21 years as steward of the Yale endowment, Mr. Swensen has generated an annual compound growth rate of 16.3 percent, beating the performance of Harvard’s endowment and that of every other major school in the country over the same period, according to data compiled by Yale. Over the years, he has also routinely rebuffed lucrative offers to leave Yale and to cash in on his expertise in a much grander fashion.

“People think working for something other than the most money you could get is an odd concept, but it seems a perfectly natural concept to me,” says Mr. Swensen, a slender, soft-spoken man who looks and dresses like a high school teacher. “When I see colleagues of mine leave universities to do essentially the same thing they were doing but to get paid more,

I am disappointed because there is a sense of mission,” in endowment work.

Amid outsize and often unimaginable paydays for financiers and corporate chieftains, Mr. Swensen’s philosophy may be more than simply anachronistic; in an era when many people commonly equate “successful” with the size of one’s salary, Mr. Swensen runs the risk of being dismissed as a dinosaur. Even so, he is an example of someone who has found a vibrant m├ętier that seems to suit him perfectly, for which he is comfortably — even handsomely — paid, and from which he has absolutely no desire to leave.

“People like David who run endowments are already managing a business where their skills could be immediately transferred to the for-profit sphere at multiples of what they earn,” says Bruce Greenwald, a finance professor at the Columbia University Graduate School of Business.

Multiples, indeed. Mr. Swensen’s preference for his work at Yale means that he has given up at least tens of millions — if not hundreds of millions — of dollars in personal compensation over the last decade alone. But the 53-year-old economist, who has spent most of his adult career at Yale, said in an interview in the endowment’s nondescript campus office that he plans to stay at the university “as long as they are willing to have me.”

Yale has every reason to want him to stay. After joining the university’s investment office when he was just 31, Mr. Swensen moved Yale’s portfolio away from a strict menu of stocks and bonds, favoring instead more diverse instruments like hedge funds, commodities like oil and timber, and private company investments.

That strategy revolutionized endowment investing, and other schools have followed suit. Mr. Swensen’s track record and his growing cachet have helped Yale attract donors who believe that their gifts to the university will be well deployed. Although his two books, “Pioneering Portfolio Management” and the more recent “Unconventional Success,” have helped raise his profile as an investment guru, he remains ambivalent about promoting himself. He notes that there are thousands of university professors who have also forgone more lucrative careers to put their skills to work in the academic world.

Two years ago, Yale’s president, Richard C. Levin, brandished a chart at a party celebrating Mr. Swensen’s 20th anniversary at Yale; during those two decades, the university’s endowment had grown to $14 billion from $1.3 billion. The chart showed a list of those who had made the most significant financial contributions to Yale, and included names like Harkness, Beinecke and Mellon. The name at the top of the list, however, was Swensen, with a $7.8 billion contribution — Yale’s calculation of the amount by which Mr. Swensen had outperformed average university endowments during his tenure.

“Yale is the bellwether and the benchmark against which every endowment measures itself,” said J. Ezra Merkin, who runs the investment committees for Yeshiva University and the UJA-Federation of New York.

A number of high-profile endowment chiefs have recently bolted academia for the more lush pay packages offered by private funds in the for-profit sector. When Jack R. Meyer, who racked up stellar returns as the head of the Harvard endowment, gave up his post in 2005, for example, he and his team easily raised $6 billion for their new hedge fund. But Mr. Swensen says he has no desire to do something similar.

“I just had an e-mail from a friend who manages money for a wealthy family,” he said in an interview in the endowment’s plain campus office. “He was troubled by it: making wealthy people wealthier. I feel privileged to be in a place where the resources that we generate are applied to the world’s problems.”

He adds: “On one level you could always imagine some greater creature comfort or having more toys or more houses. That would be nice. But it certainly does not drive me.”

While Mr. Swensen has no say about how Yale spends the proceeds from its endowment, he is eager to note the beneficiaries. “One of the things that I care most deeply about is that notion that anyone who qualifies for admission can afford to go to Yale, and financial aid is a huge part of what the endowment does,” he says.

But some people think that he exaggerates the virtues of managing money for a nonprofit versus investing on behalf of private interests.

“If you are making money for the parents and in turn for their kids, why is that any less admirable than making it for Yale University?” asks Alan Reynolds, senior fellow at the Cato Institute, a libertarian research group. “For all you know the guy you are running money for is giving it all away. The presumption that it is all going into a lavish lifestyle is just a presumption.”

Mr. Swensen bristles at that observation. “I think it is extraordinarily different,” he says. “There is a clear link between the resources we generate here and doing research and providing financial assistance.

“Public service was something that always interested me when I was growing up,” he adds. “I thought that nothing would be better than to be a United States senator from Wisconsin. I could not imagine a higher calling.”

Mr. Swensen grew up in River Falls, Wis., where his father and grandfather were chemistry professors at the University of Wisconsin-River Falls. His mother, Grace, became a Lutheran minister after raising six children. His brother Stephen is a doctor at the Mayo Clinic, and one of his three sisters is also a minister.

His family’s pursuit of callings found its way into Mr. Swensen’s own thinking as well. “When I see colleagues of mine leave universities to do essentially the same thing they were doing but to get paid more, I am disappointed because there is a sense of mission,” he says.

That sense of mission has rubbed off on his apprentices at Yale, with the result that some major nonprofit organizations in the United States are now run by men and women who once worked for him: Seth Alexander at M.I.T., Andrew K. Golden at Princeton, D. Ellen Shuman at the Carnegie Corporation, Donna Dean at the Rockefeller Foundation and Paula Volent at Bowdoin College.

“He has this love of investments that is contagious,” says Ms. Volent, who spent four years at Yale’s investment office and now runs the investment committee at Bowdoin. “He taught us that we were in the business of making money for financial aid for students. If there was a dip in grants and you had a good endowment, you could continue on.”

After earning an undergraduate degree in economics at the River Falls campus, Mr. Swensen headed to Yale, where he received a doctorate in economics. His decision to head east surprised his family. To the Swensens, “it was as if there was something out there beyond Lake Wobegon, and David was conquering that frontier for us,” his brother Steven recalled.

At Yale, he also became close to James Tobin, a Nobel laureate in economics who believed that investment volatility was best reduced by diversifying across a far wider range of asset choices than only stocks and bonds.

Mr. Swensen then worked briefly on Wall Street, at Lehman Brothers and Salomon Brothers, an experience he describes as “intellectually fabulous but ultimately unsatisfying.”

“In the finance world it is very easy to measure winning and losing in dollars and cents,” he says. “That has always seemed to be an inadequate measure. The quality of life is a better way to measure winning and losing. Money is only one element of that.”

In 1985, Yale recruited Mr. Swensen to manage its endowment. “I took an 80 percent pay cut,” he recalls. “I was married, without kids. I was worried that I would miss the money, but then I didn’t. So I worried over nothing.”

Today, Mr. Swensen, now a divorced father of three, rides herd on about 100 money managers whom he entrusts with Yale’s money. Some of them say he is unyielding in seeking the best deals for Yale. One manager described him fondly as a real “stiff-backed Midwesterner.”

But within the clubby money management world, a Yale investment is akin to a seal of approval, and managers avidly court Mr. Swensen. They describe him as a thorough researcher who, with his team, scrutinizes his choices intensely before committing money.

One of his early investments was with Chieftain Capital Management, a firm run by Glenn Greenberg, a Yale graduate who met Mr. Swensen at a Yale fund-raiser.

“After he came to see us, he called up the chief executives at some of our largest holdings and asked them. ‘Who really knows your company well?’ ” Mr. Greenberg recalls of his first encounter with Mr. Swensen. “He wanted to know who did the best research. No other investors did research like that.”

When it comes to hedge funds, with their hefty fee structures, Mr. Swensen can be particularly tough. Tom Steyer, a Yale undergraduate, approached Mr. Swensen in 1987 to raise money for Farallon, his diversified hedge fund. “They turned us down flat,” Mr. Steyer recalled.

Like many hedge funds, Farallon charged a 1 percent management fee and took 20 percent of the profits. “David told us: ‘I don’t see why we would give you any money. You might shut down after a bad year,’ ” Mr. Steyer recalled.

It was only after Mr. Steyer swore that he wouldn’t shut down — and that he wouldn’t immediately charge Mr. Swensen 20 percent of his profits and other fees — that Mr. Swensen gave Mr. Steyer some of Yale’s money.

“If you make money personally by gathering a huge pile of assets, it is great for the management company because they make bigger fees,” Mr. Swensen says. “But if the fund goes from $2 billion or $3 billion to $20 billion, they are inevitably going to reduce their ability to generate investment returns. Size is the enemy of performance. What we need is people who define success by generating great investment returns, not by making as much money as they possibly can.”

Years ago, when Yale considered investing with ESL Partners, the hedge fund run by Edward S. Lampert, Mr. Swensen says Mr. Lampert refused to tell him what stocks ESL owned. An ESL spokesman declined to comment.

Ms. Swensen says: “If you are sitting in my position, how can you responsibly give money to a fund that won’t tell you what they are invested in? If I went to my investment committee and told them we are invested in this fund but we don’t know what the positions are, they should fire me.”

Yale did not even consider giving money to Steven Cohen, the money manager who takes 50 percent of his hedge fund’s profits. Mr. Cohen’s $12 billion fund has had a 43 percent average annualized return since 1992, but “the fees alone are enough to say I don’t want a meeting and there are enough people who put together fair deals,” Mr. Swensen says. A spokesman for Mr. Cohen declined to comment.

But once he likes an investor, Mr. Swensen tends to hang in, even in tough times. Yale weathered a 13 percent loss one year on funds invested with Water Street Capital, a hedge fund run by Gilchrist Berg. “I was a little bit shaky but David said to me, ‘We really value the relationship and we want to put more money with you,’ ” Mr. Berg recalls.

Other investors describe Mr. Swensen as an “extremely rational” contrarian. “He tries to think through what is the best opportunity,” Mr. Greenberg says. “He doesn’t care about being popular. And he is not afraid to go where other people don’t.”

Mr. Swensen considers trying to time the market a “fool’s errand.” Other managers say that his primary expertise involves spotting growth sectors in the economy and finding the best people to manage Yale’s investment in those sectors.

It is work that he loves. “You get to choose those investments that are the right fit,” he says. “I think Warren Buffett said it: It is like playing baseball when they don’t call the balls and strikes. You can wait and wait until it is a pitch you want to hit.”

Like Mr. Buffett, Mr. Swensen has developed a following. “In the endowment world, going to see David for advice is like going to the pope,” says a board member of an Ivy League university who insisted on anonymity because his board does not want him to comment on such matters publicly.

MR. SWENSEN clearly relishes how tenaciously some money managers court him. “We get lots and lots of unsolicited please and p-l-e-a-s,” he says, smiling. He also relishes the quality of people he has been able to recruit to work with him at the Yale endowment.

Mr. Swensen says he trolls for apprentices among Yale graduates because they care about the university’s mission, and he sometimes finds them in the economics course he teaches.

“I love the idea that undergraduates have this opportunity to study whatever they want,” he says. “Students will say to me, ‘What do I need to take to be attractive to an investment bank?’ I say: ‘Don’t do that. Take great classes that you like.’ “

Those who have worked with Mr. Swensen say he has successfully blended the notion of pursuing a calling with the raw mechanical discipline needed to be a winning steward of an endowment.

“I think that the success of many of the people who worked there related to this participating in seeing how good decisions were made and what constitutes good due diligence,” says Ms. Volent at Bowdoin.

In the end, Mr. Swensen says, successful investing — in fact, success in any profession — comes down to doing your job well and loving what you do.

What he demands of himself is exactly what he demands of the custodians of Yale’s capital: “People who define success by generating great returns, not by making as much money as they possibly can,” he says.

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.