Thursday, July 03, 2014

Top 10 List: What It Takes To Become an Activist Investor

Cassandra's Exhaustive List of Prerequisites for Becoming an Activist Investor
Oh, and don't forget the Starbucks loyalty card. Happy agitating!

Tuesday, July 01, 2014

Another One Bites The Dust (mid-2014 Edition)

Things, people, and/or ideas believed to have integrity, now seemingly compromised...(the second third  fourth updated and expanded version). The bear market in integrity continues unrelentingly…2014 edition.

Jimmy Savile (tnx Anon)
Rolf Harris (tnx Anon)
US Veterans Administration
The Red Cross
Justin Bieber
The London Gold Fix
Chris Christie

US Govt Agency Data Release
The UK National Health Service
Swiss Train Safety
Nick Clegg
IM Confidentiality 
BBC Management & Oversight
Risk Parity
Segregated Customer Accounts
Investment Consultants
Bloomberg Privacy
Dark Pools
London FX PM Closing Prices
Meredith Whitney

Reinhart & Rogoff
Jérôme Cahuzac
Japanese Yen
Jamie Dimon/JP Morgan
Banca Monte dei Paschi di Siena 
IKEA Meatballs

Wen Jiabao as "Humble Servant of The People
Lance Armstrong
Top Ten Lists
Austerity as an Economic Panacea
Harvard Students' Academic Honesty
BLS Statistics
Cyclical Recovery
Book Reviews
Strong Computer Passwords
'Organic' Food
Money Velocity
Undecided Voters
The Food Pyramid
Purity of '.999 Fine Gold Bars
Penn State Football
"Top of the Pops" 
Fareed Zakaria
The "risk-free" rate
LIBOR as a Benchmark
Public Sector Pensions
HFT as a Beneficial Provider of liquidity
Diversifying properties of Hedge Fund's
Einstein's Theory of Special Relativity 
Celtic Rangers
Macroeconomic Forecasts
John Paulson
FRB Open Market Operations
Standardized Educational Testing
Swiss National Bank
A Relaxing Cruise
WTI as Oil Benchmark 
Olympus Corp.
Payment Protection Insurance
HM Revenue & Customs
Sony Playstation Network
Social Mobility
Actuarial Return Assumptions for Pension Funds
Ryan Giggs
France   AAA
Boob Jobs
David Einhorn
Nuclear Power
Deepwater Drilling
Tiger Woods
Professional Cricket
Professional Cycling
High-Frequency Trading
Professional Baseball
Professional Tennis
Municipal Bond Underwriting
The Catholic Church 
Track & Field Athletics
NCAA Sports
US Congress
UK Parliament
Analyst Research
Credit Ratings
Newtonian Physics
The Stock Market
The Food Pyramid
Incentive Stock Options
Reinsurance Brokerage 
Lou Dobbs
The Mortgage-Backed Securities Market
Hedge Funds
Social Security
Government Balance Sheets
Tooth Fairy

Errr ummm Professional Wrestling is starting to look good by comparison - at least it makes no pretensions to be anything other than it is. What's left?

Tuesday, June 24, 2014

Manna From Heaven

They call the JPX-Nikkei Index 400 smart beta. Ummmm, errrrr, yeah, sure, they can call it whatever they want, and perhaps, if they say it loud enough, and repeat it enough, some will adopt it as gospel. And God bless them - particularly the blithely gullible trustees. And my kids' trust fund blesses them - the latter benefitting large from (being as kind as kind can be) their rote sub-optimality. 

The JPX-Nikkei Index 400's  construction applies a straight-forward three-and-a-half stage process:  screen, score, score again, select by rank. Initial screening (from the TSE's website) looks like this and weeds out what, to some, is the detritus;

① Screening by Eligibility Criteria
Issues are excluded from selection if they fall under any of the following criteria. 
- Listed for under 3 years (excluding technical listings)
- Liabilities in excess of assets during any of the past 3 fiscal years
- Operating deficit in all of the past 3 fiscal years
- Overall deficit in all of the past 3 fiscal years
- Designation as Security to be Delisted, etc.
② Screening by Market Liquidity Indicator
The top 1000 issues will be selected from those eligible, excluding the above, in consideration of the following 2 items.
- Trading value during the most recent 3 years
- Market capitalization on the base date for selection

The first scoring covets OP, ROE and size, with bigger preferred to not-so-big.  The TSE calls this quantitative (noting the lower case "q" and italics, which are mine). It is a bit like an American vehicle MOT:  making sure it has four wheels (with tyres), the headlights that point straight, an engine that turns over when the fuel is ignited; the brakes stop the vehicle when in motion, and plumes of blue smoke are not being emitted from the exhaust. It is, yes, a car, in the least contentious sense.

The 1,000 issues selected in (1) will be scored according to the ranking of the following 3 items. (1st: 1000 points – 1000th: 1 point). Then, overall score is determined by aggregating those ranking scores with the following weights. (There are handling rules for the overall scoring with negative ROE and operating profit.) 
- 3-year average ROE: 40%
- 3-year cumulative operating profit: 40%
- Market capitalization on the base date for selection: 20%

The second scoring is qualitative, based on the admirable, but by no means universal, attributes of transparency, accounting standards, and oversight. For those that cannot distinguish what the second scoring is based upon as written,  it is "qualitative" with lower-case "q", italics and a tiny font size to highlight that this can only tweak the results by a maximum of 2%, a bit like smoking "lite cigarettes".

Following the scoring in (2), issues will be further scored based on the following 3 items. This score is complementarily added to the quantitative scores explained above (2)*.
- Appointment of Independent Outside Directors (at least 2)
- Adoption or Scheduled Adoption of IFRS (pure IFRS)
- Disclosure of English Earnings Information via TDnet (Company Announcements Distribution Service in English)
* The score is determined so that at most around 10 constituents are different from those chosen with only quantitative score above (2).

Then, it is a simple matter of letting the proverbial chips fall, or rather, rank wherever  they may, combined with an "all-change" every now-and-again.

So despite my amusement at such an offering, and thankfulness for those allocating passively to it, I am neither derisive nor pejorative in its essential mechanics, and though some might, I do not call it "dumb". It just does what it does. On the other hand, one would be forgiven for thinking proponents a tad hyperbolic in terming it "Smart". It isn't.  Beta? Yes. "Smart"? Errrr, no.  For how can something of value, that is being exchanged amongst consenting adults many of whom are meant to be fiduciaries, be "smart" when it is completely, and totally untethered from any sense of value? It is likely worse than navigating by dead reckoning, and probably inferior to the piñata method of security selection. Make no mistake, at times, it might be attractive. But, given that investors already covet consistent and high profitability in relation to their equity, with good governance, and that companies qualify only AFTER  they have had it for a good spell, it is not unlikely to forecast that it might, more often than not, yield negative alpha. So what would YOU call "smart" beta, with negative alpha? I call it "winning the battle but losing the war".

For many, however, this IS, manna from heaven. For exchanges and index licensors it means incremental revenue where none existed before. For journos it means grist for the mill. For trustees, it is a simplistic (albeit highly sup-optimal) answer to a complex investment problem. For Japan Inc. it provides convoy cover for suspicious behavior change -  yet-to-be-fully-embraced. For me, it will create a fantastic variety of relative investment opportunity whether from inflows, outflows, or re-balancing, that will keep giving and giving and giving. Hallelujah! Yes, it is manna from heaven for everyone except those investors whose money is passively and naively be thrown at something mis-labeled as "smart", though which is anything but. Blessed be index-makers...

Monday, May 26, 2014

Euro-Election Post-Mortem...

UKIP supporters, along with those of the European right are angry. And nostalgic. Nostalgic for ....ummm .....errrr..... Johnny Halliday? Johnny Rotten ? Sir Lawrence Olivier? Georges Pompidou? Chaban-Delmas? Harold Wilson? Ted Heath? Free parking? No traffic jams? A Ford Cortina or a Renault 4? Ten-pounds-a-week rent? Fifty-P a pint? Greasy chips fried in oil t'aint been changed for weeks? Baked Beans 'n'toast for breakfast? Twiggy? Cliff Richard? A white guy (not a Russian) winning at boxing or sprinting? One-piece swimming costumes? Free university? A job-fer-life? Iconic red pay-phones booths smelling of urine? Phones with an umbilical cord? Single-race marriages? The Cold War? Clean beaches? High-streets free from foreign food? Holidays in Blackpool? Turnips and root veg? Chicory drinks? Maybe. B ut I think that they are nostalgic for rising or stable real wages; a settled feeling that accompanies slower technological change; a stable job that pays a good stable real wage, with an indexed pension, and that is not undermined by someone more educated or qualified or enthusiastic, willing to work harder, for less especially if they are foreign; Oh and lower taxes. All of which are under siege. Regretfully, for sensible public policy, this has little to do with Europe, or immigrants, or the decline of religion and general moral standards. But that won't stop the angry cocks from THIS.

Tuesday, May 20, 2014

More Jitney's Needed?

There is considerable debate in the state of New Jersey about whether Newark or Camden is the Garden State's armpit. True connoisseurs of sweat, however, would add another - the one that gave us The Diving Horse: Atlantic City. All three have long-passed their glory days.  AC, remains a hollow shell of its mid-20th century optimistic seaside-self, despite many billions of collective investment by private casino operators and public authorities.  Camden more closely resembles war-torn Mogadishu or the bombed-out Syrian frontline of Homs than it does prosperous archetypical suburbs like Darien, CT or Merion, PA.  Newark, alone, may rise once again, like a Phoenix, recalling Philip Roth's adolescent days, if only a result of its proximity to New York.  Yet, Atlantic City, for all its flaws, retains a pragmatic solution to public transport from which many public transport authorities can learn. It is called The Jitney, and is simply an uber-practical shrunken bus.

Nothing is more galling to a taxpayer than senseless avoidable waste. Cynical fraud can at least be seen in the context of benefits delivered. Some mean-spirited Libertarians see it everywhere. I am more generous, but nonetheless loathe stupidity, rigidity and tolerance for things abysmally-sub-optimal. Where I reside, in the leafy hilly part of Kent County, everyday I see huge, aged, empty buses plying their routes with growling Spitfire-sounding diesel's that would annoy Harley riders, struggling to climb steep grades as they make their way through the lanes and up hills of my area, belching smoke, wasting petrol, blocking or slowing traffic both on major arteries and B-roads, menacing cyclists with their overtaking. And outside of the rush hour/school runs, they are empty -  or appear virtually so given the ratio of passengers to available seats.  Ghost buses. And each and every time I see this, apart from my selfish desire for less polluted air, silence, and budgetary optimization, I feel as if a crime were being committed. And I wonder: where is the Jitney? One would have thought that, if one formed opinions on the basis of hyperbole, the private sector would have ingeniously invented and tailored market solutions that would quickly eliminate (or reduce) the horrifying waste described for all of these are private concessions (Arriva, MetroBus etc.) with, one would presume, the appropriate profit motives.  

France is not without its macroeconomic and social problems. However, when it comes to public sector policy solutions and their execution, be they infrastructure, public works, or healthcare, one should take notice, not because I say so, but because they tend to pursue non-ideological pragmatic solutions to policy conundrums that would baffle ideologues from both the right and left.  In contrast, to the smoke-belching rust-buckets on spartan routes subsidized by my UK County plying their neglected, pot-holed roads, my municipality in France, delivers multiple bus solutions that pragmatically balance efficiency, cost, with public needs in pursuit of the public interest. During busy hours, and in high-demand areas,  the public authority deploys modern quiet, bendy-buses while on smaller routes, they dispatch drivers with modern Jitney equivalents that navigate country lanes without endangering on-coming traffic (and cyclists thankyouverymuch!!) and that can climb hills without draining the public fuel depot and purse. While the agency combines the resources of 13 towns surrounding our main city, the public authority also cooperates and coordinates with the regional transport authority to run convenient routes that cross jurisdictions without, as the case in my UK village, having to change buses just because of splintered geography and fractured concessions. That is even before mentioning cost which is low by any standards, but benefits everyone:   passengers, business, non-passengers (less traffic and congestion on the road) and everyone else by lowering pollution.

Brits are a curious lot. Stoic. Patient. And, in the main, suspicious of collective activity as Orwell highlighted six decades prior, save for self-organizing their curiously peculiar pass-times such as birdwatching, needlepoint or plane-spotting societies. This suspicion of The Group Movement, he pointed out, insured that facism could never gain a foothold over these islands. For the mere sight of goose-steppers on the High Street with their earnestly-shined boots and silly rigid march would elicit derisive mocking laughter - a far greater deterrent than any form of counter-organization. The dark side of this combination of national traits is that the majority of people, and the public's interest  suffer at the hands of more intensely-motivated and greedy parochial interests. Private monopolists abuse inelastic demand curves with an inert and collusive political class and the result: USD$40 a train ticket into London for the scant 24 mile return journey ($50 if you wish to park your car), roads that are hopelessly pot-holed and in dis-repair despite some of the highest road taxes and fuel-surcharges in Europe; bus-service so poor and mis-fitted for purpose it makes you cry. And the people stoically, patiently, say nothing, and do nothing, as the carpet-baggers using the svengali-like mantra  of "free-market is best" empty the purses of the people extinguishing any hope of creating pragmatic efficient solutions to public policy issues. Like deploying efficient Jitney-like buses. Or maintaining authority and rectitude over monopolistic concessions sold or granted in the public's interest, rather than the Public Interest being treated like little fuck-boys of opportunists-run-amok.  And still, the monopolists continue to push, and take, and gorge, not realizing the risk they run for themselves and their investors. Even the Brits have their breaking point and make no mistake, stoic as they are, even though it's been more than eight centuries, they WILL "go postal".

How they managed to run an empire is baffling. In all likelihood, it would have baffled Cyrus and Darius too. Now, the home territories are neglected. Now, there is too little enlightenment. Too little wisdom. Too little pragmatism. And not enough Jitneys...

Monday, May 05, 2014

Edginess or Extrapolating The Unextrapolatable

Edginess. No, I am not referring to the one sought by my daughter by rolling her own and pushing boundaries (fortunately, for a parent, eschewing the tats, for now at least), but as in uneasiness, anxiety, disquietude, restiveness, worry, and an increasing sense of agitation of the type that George Soros wrote about in his journal as a feeling that gnaws at him from within his stomach.  

I am becoming more aware of my growing agitation - and rather than let it gnaw away, I will try to dissect and articulate it in order to share with you for I've been sanguine about equity risk for what seems like a long time, certainly one of the longest periods I've held my pessimism in check. During this hiatus from my natural state, I've derided perma-bears through the recovery -  through the Euro wobbles, US budget concerns, the ridiculous hyper-inflation/QE hysteria, and dismissed those both selling and wishing to buy tail risk insurance after the proverbial horse had bolted suggesting to those interested to heed Bob Litterman and SELL the insurance (SPX puts), rather than buy it. This is not because I am optimistic by nature, or otherwise bullishly inclined. Rather, it was because for much of the last five years -  scarred investors were underweight despite, in plain english, things more or less continually improving on all fronts, albeit not fast enough for those in search of instant gratification. "Up" has been the path of least resistance. Housing/construction/ was diminished, and financials were so cratered, they are still, only now, getting back to something resembling normal index weights. Couple that with much of large-cap tech undemanding at close to single digit forward multiples and the risk, as PensionPulse's Leo Kolivakis presciently called, moved more clearly to the right.  That was then. Over the past four year, investors have been squeezed in - and for the right reasons: absolute and relative valuations, cash-flows and earnings growth - all which have been more-than requited by their materialization, pwning the pessimists!!  

Now, it no longer is obvious that investors are under-invested. Now it appears that they are, en masse reasonably allocated. In the process they've taken forward-looking returns from rather attractive levels with large implied equity-risk premia, down to levels which don't leave much margin for "shit happening".  In the process, investors may very well have done too much of a good thing, inflating ratings (on a forward-looking basis) to pedestrian levels at best, or positively-unattractive ones - implying low to negative forward returns at worst.  In itself, this situation doesn't mean imminent danger, and can continue - given positive sentiment, piss-poor alternatives, supportive monetary and fiscal policy, and the chance that underlying growth may continue unabated (and even accelerate) without undue inflationary pressures, keeping the ratings high as stock prices increase further. For the avoidance of doubt, this is not a bubble in the popular sense of the word. We have indisputably had phenomenal corporate earnings growth justifying and supporting the reversion back to the reasonable from ostensibly cheap crisis levels.  In the process, investors have become comfortable increasing the rating of equities towards more historically-dubious levels, and in extrapolating forward, idiosyncratic boosters to earnings that I do not believe should be extrapolated.

Yes, I am gnawingly concerned  about the blitheness with which many investors assume that major contributions to past earnings growth will replicate themselves going forward, an occurrence that often presages an intersection of bloated expectation with the spartan-ness of a wetter and colder reality.

Imagining a classical "T" account to conceptualize my edginess, I place these positive contributors to earnings growth since 2009 on the left-hand side of my construct: 

* Sustained USD weakness. (USD weakness has flattered USD translated global sales and earnings)
* Constrained capex (Squeezing existing capital stock coincidental to prior capex depreciation rolling-off, dramatically boosts EPS; investors dazzled by and extrapolating EPS growth, but at CF level, multiples are getting heady. Eventually companies will have to re-invest which will hit both operating and bottom lines)
* ZIRPy interest rates. (Low rates have one-off refinancing benefits that benefit bottom line, and remain as long as ZIRP. Corp earnings now short put on rates for refi) 
* Wafer-thin credit spreads. (Ditto above: one-off refinancing benefits to EPS but forward profile is left-skewed risk)
* Buybacks/share count squeeze. (Buybacks - whether from cash-flow or debt have materially goosed EPS over last five years. But, with capex needs increasing, and valuation ratings elevated Co's will find it increasingly difficult to justify maintaing/curtailing buybacks). Yet, only NOW in typical gamma negative behavior are co's leveraging up to buy back stock.)
* Wage restraint (Corporate pricing power coincident to falling real wages will not last forever. With economy hollowed, and jobs already offshored, one would not be remiss forecasting  that we are at or near peak disparity. The wage squeeze has given Co's enormous operating leverage during the last five years of recovery. UK real wages ticked higher than inflation for first time in years, last print. In US, with @6.7% unemployment, the balance of power favoring Co's feels like it petering out. If so, this will hit operating and bottom-lines directly. With Piketty on top of best-seller list, one might also wonder whether this is another tell-tale of the end of the squeeze on labour. ) 
* Tax holidays/optimization.  (Firms are increasingly keeping money offshore and borrowing onshore to buyback stock or pay divs rather than repatriate and pay tax); They consolidate overseas earnings gross of tax, but with increasing scrutiny of avoidance/minimization they will have to bite the bullet sooner or later;  It looks like earnings have grown, but if you can't use them or return tim to shareholders without taking a hit, there appears to be an asymmetric outcome. At best, it is baked into the price; at worst investors have discounted potential liability over-stating realizable cash flows.   
* Pension holidays. (Higher asset prices thanks to recovery have allowed firms to get actuarially onside and reduce DB plan contributions, in many cases reducing contributions that directly flatter both operating and bottom line earnings. Never mind that with asset prices high, the actuarial assumptions of most DB plans are unrealistically optimistic. With so many asset classes fully valued, and forward expected returns low - see GMO forecasts - such holidays will end. And in true to gamma-negative feedback loops, one need only imagine what might be required were asset prices to fall…). 

And In fairness, one must take into account drivers on the other side of the "T" account that may continue to have legs such as: 

* Pricing Power.  (Increasing industry scale, concentration, oligpopoly have materially diminished competition, and created competitive moats that have buoyed both prices and margins across many industries. Toothless regulators, concentrated gain to collusion and diffuse pain make it unlikely that margin gains from such sources will reverse anytime soon. It remains more attractive to collude and bank immediate benefits with certainty than pay fines in the future, in which there is reasonable likelihood, it will go completely unpunished. ) 
* Productivity.  (Benefits from IT and FA, after years of disappointment have finally gained traction. They can continue to surprise to the upside offsetting reversals in the above.) 
* EM Growth. (Volume growth outside DMs has provided meaningful surprises, and may continue to pick-up slack resulting from other erstwhile disappointments).

Despite prolonged meditation, I make no claims that either side of the T-account is complete.  But I suspect that if one took the combined income statement of the SPX, non-exptrapolatable growth boosts explain a large portion of the upside growth Co's have seen in both operating and top-line earnings. Analysts (both top down and bottom up) are well known for more or less extrapolating priors, but I surmise that at precisely the time these are getting harder to reproduce, or are on the cusp of reversing, the ratings are getting extended, and this is a recipe for concern - not because 17x or 18x earnings is an awful return in  tame inflation environment - but because expectations are primed for more of the same dancing juice. This, and the gamma-negativity of some of the variables themselves has the potential to cause a more vicious negative feedback loop, inconsistent with a tame VIX, and extremely low historical vol., and for which markets are neither prepared nor positioned. 

This is why I feel edginess, despite having been a committed "probability-adjusted optimist"… 'till now. With that said, I historically have been early….and what with parabolic-like pops as we saw in Feb/Mar, it is likely there'll be additional opps to temper exposure or put in place more attractive conditional hedges.