Sunday, December 14, 2014

‘Tis the Season to Make Buy Lists


The shopping malls’ parking locations are increasingly crowded as shoppers are busy executing their Christmas and Chanukah gift lists being spurred on by the new discount levels of more than 50%. The shoppers look to be pleased with their purchases.

Perhaps my coincidence in the investment world which regularly rotates to being ahead or behind the world of retail sentiment,  recognizes this past week should call all serious investors to begin their research lists to examine the discounts from the peak stock price levels being offered to them. Please note I said research lists not an axiomatic buy list. There can be some long-term concerns that make current discounts not yet attractive.

This is an old exercise for me. As an analyst whenever there was a meaningful decline in the market I would make lists of stocks with future attractive price levels. The problem with these lists was that largely the stocks did not fall to really cheap prices, the equivalent to 60%+ discounts at the mall. Thus for all of my analytical skills, usually I did not execute as many buy orders as I should have. What I learned and now recommend is that instead of single price activators, one should develop a set of steps of declining prices combined with increasing levels of purchases. Buying more at cheaper prices is good as long as the declines are not in response to long-term changes in outlooks. The late and great Sir John Templeton and his chief investment officer Tom Hansberger made considerable fortunes for their clients always looking for better bargains than what was generally “on offer” in the market.

Some large and small examples:

The current apparent concern of the general stock and bond market is that the willingness to maintain supply levels of petroleum in the face of cyclical economic declines in Europe, Japan, and China is leading to lower trading prices for petroleum. I see little in the way of evidence of the relationship between the use of energy and a change in long-term economic growth. As a matter of fact, to the extent that energy prices remain low, the conservation efforts are likely to be reversed and we will probably become inefficient in our use of “low cost” energy.

I am addicted to being a long-term investor; I do not have the trading skills that others seem to possess. With that thought in mind, for an account with more than ample cash reserves held by an investment group of present and recently retired investment professionals, I recommended that the energy component be raised from 7% to 10%. In our energy basket we include various up, mid, and down stream petroleum and alternative fuel sources, rail tank car producers, railroads and various energy services suppliers. I am reasonably confident if the group averages down and holds for a long-term, the results will be pleasing. One of the smarter, large, (actually very large) investors today is Steve Schwarzman of Blackstone. He is now launching a multi-Billion dollar Energy Fund. He remembers when it was cheaper to find oil on the floor of the New York Stock Exchange than to drill for it. We are probably not there yet, but we are already seeing foreign buyers nosing around Canadian and US companies.

Mutual funds

Turning to an arena that I spend most of my waking time on, I believe there is a great trade opportunity presently. The year-to-date average performance of 24 commodity energy funds through last Thursday was down -25.99%. On the other hand the average for 88 Health/Biotech Funds for the same period was up +27.96%. (Friday was a bad day.) While we have benefited nicely from over-sized positions of Health/Biotech stocks in general diversified funds, I suspect that an energy-oriented portfolio will have better performance over the next two years than one heavily invested in Health/Biotech stocks.

In terms of my Time Span Fund Portfolios, this decision was for the operational time span portfolio (1-2 year duration) and the replenishment portfolio (up to five year duration), but not for the endowment portfolio (ten or more years) and certainly not for the legacy portfolio (for the benefit of future generations). For the longer term portfolios I recommended that at least one of the members of their investment steering committee have a background in commodities. I am not so bold as to suggest that commodity-oriented investments should be included today. I would want the committee to be aware of future commodity price moves. Rising commodity prices will affect food, transportation, manufacturing, energy, and financial services thus can be very important to most stock and bond portfolios.

Financial services

One of my lenses through which I examine the stock market is the holdings in the private financial services fund that I manage. Some of these stocks have been falling since the beginning of the current year after a generally good 2013. Others may have temporarily peaked in early December. In December through Friday, Moody’s* broke down from its $100 handle and now is down -7.46%. I perceive no change in the incredible need for income that is driving the issuance of more bonds and other financial instruments. However, the gain in the share price for the calendar year through the end of November was well over 20%.

A possible explanation

All stocks, particularly those with outsized gains, are subject to the practice of wealthy investors giving significantly appreciated shares to charitable organizations who immediately convert the gift to cash. This could be a possible explanation. Let me give a particular example of the stock price of T Rowe Price*. On Monday of last week on slightly under 900,000 shares being traded, the stock hit a high price of $85.45 closing at $84.80. At the end of the week on a pressured Friday the daily volume doubled to 2 million shares with a closing price of $82 near its low for the week of $81.97.
 *Shares held personally or in the private financial services fund I manage.

Longer term outlook

I was hoping to begin this week’s post with a headline “The Bad News is the Stock Market is Rising.” The reason for this contradictory thought was based on my often-expressed fear that growing enthusiasm was leading to a speculative, parabolic stock price rise; one of the remaining missing elements to be able to declare a major top. Luckily for all of us that this week’s decline activated a pressure release valve in the beginning to boil market. I should not have worried according to David Kotok the leader of Cumberland Advisors. In his December 12th commentary he noted the reactions to his talks with the analyst societies in Providence and Boston. He asked whether 18000 on the Dow Jones Industrial Average would be the break point and whether they thought that the closing one year from the day of his talk would be higher or lower. Almost half thought lower. That view was pleasing to him as he is fully invested in ETFs. I am also relieved because without the “professionals” leading or trying to get caught up with the charge, my feared final stage won’t happen. However, I am keeping my eye on the difference between redemptions of equity mutual funds and the purchases of stock Exchange Traded Funds. What I don’t know now is how much of the ETF purchases are from sharp investors like Cumberland or how much of the purchases are from approved participants that are buying shares of ETFs to facilitate their customers shorting these ETFs (either as a hedge versus their other holdings or expressing a view on future prices). Bottom line: many are confused about the outlook for the market. As a “registered contrarian” I am reasonably assured and only become deeply concerned when all of the market passengers move to one side of the boat.

Please share with me any evidence that you now have for materially changing your long-term views on stock and bond prices.
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Sunday, December 7, 2014

Current Investments for Future Results


In our job as professional investors for others as well as personal stewards for ourselves and families we do something today that we want to have a good result in the future. This is easier said than done. To accomplish our goals we need to answer at least two basic questions: 

What are we doing?  Which future?

To help answer these questions, we should be asking ourselves on which time period are we focusing. We have created at least four time spans to put the answers into perspective. These four slices go from:

1. The immediate as defined as the next two years,
2. The following five years to replenish spent capital,
3. The succeeding ten or more years to address longer-term needs for the current decision makers, (endowment issues) and
4. Future periods to aid fulfilling the legacy of the grantor and his/her succeeding generations.

This weekend I seek to apply the items that cross my information screens to appropriate investment time spans.

The current period

To meet current and near-term needs we assume that we can convert our present investments to cash for either spending or repositioning. Too many investors look entirely to current prices and economic conditions. As someone who has grown up in the investment business, I am concerned that the changing structure of the marketplace is not being considered. What I add to my decision process (and what is missing from many strategies today) is a focus on liquidity.

The real price

Portfolio managers and analysts can learn a lot from professional traders. Traders will tell you that a stock or a bond is worth only what it can be sold for. Far too many investors use the last published price without understanding the conditions that led to the price in terms of the relative balance of supply and demand. Quite possibly because of changes of capital on trading desks or floor participants the last published price is quite stale. This is particularly true if you are a potential seller with an over-sized position. A current example of this is the recent drop of 6% in three minutes for shares of Apple*. According to some, the sudden drop was caused by one or more major players that used algorithms to significantly reduce over-sized positions in tech stocks.

Investment committees have regularly received reports on what specific days to liquidate positions based on average historic volume. Traditionally these reports are meant to show how quickly cash can be raised. Sole reliance on these reports is dangerous. First, liquidity is very much a function of the current desire for the security. Second, increasingly more volume is transacted off the floor than on it and there is no real floor for bonds thus the published volume figures are more an artifact than accurate. I wonder when looking at liquidity whether one should follow the dictum of US Supreme Court Justice Potter Stewart in ruling as to what was pornographic or not: he said he would recognize it when he saw it. To reinforce my skeptics’ view on liquidity let me use the extreme performance of Precious Metals mutual funds as an example.

In the week ended on December 4th the average Precious Metals fund was off -4.66%, the worst of the 30 equity funds groups tracked. However in just four weeks including the December 4th period, the average Precious Metal fund was up +10.47% which was the best of the equity fund averages. I would suggest that the fundamentals did not change that much in those four weeks, but the market did.

Another example that attitude changes greater than fundamental changes is the price and volume in the week for the stock of T Rowe Price*. On December 1st it closed at $82.61 on reported volume of 753,104 shares. On December 5th the closing price was $84.49, down slightly from its day high of $84.88 on 1,105,152 shares.

One of the Republican SEC commissioners has expressed concern about the liquidity in the bond market when interest rates start to gyrate. I believe her concerns are well placed.

The focus on liquidity is of particular importance when investing for current returns in the first or operational time span portfolio. If due to spending requirements, securities will need to be cashed-in at the same time as liquidity shrinks, the quicker the near-term portfolio will be exhausted and need to be restored by the replenishment portfolio.

Replenishment portfolio

A well thought-out piece by Marcus Brookes of Schroders Investment Management begins with the following sentence. “We end 2014 with almost every asset class offering investors scant potential return for their risk.” In looking how to build a successful replenishment portfolio I suspect that at some point over the next five years the need to earn a real return adjusted for credit risk will become apparent through a market decline. Having issued this warning, it does not relieve investors of the need to build and manage a replenishment portfolio. While many investors talk long-term they walk short-term by managing their investment against a one to five year time horizon. Under those constraints there is little room for long-term bonds or stocks that are dependent upon substantial new products or massive turn arounds.

While it increasingly looks like we may get a bout of enthusiasm, one would be wise to upgrade the quality in the replenishment portfolios even though during a speculative phase they will probably under-perform, but they will sink less when the eventual significant decline occurs. Moody’s* is recognizing that “corporate credit has become more risk averse, while the common equity market has become more tolerant.” Surviving investors normally bet with the fixed-income markets, while the traders with the stock market. Both can be correct using their preferred time periods of five and ten years for the investor and quarter, half, and full year for the trader. 
*Owned by me personally and/or by the financial services fund I manage

Legacy investing

Very long-term portfolios are often a mix of companies that benefit from sustainable demand based on demographic and geographic changes as well as disruptive companies. This somewhat hedged mix assumes that there will be evolutionary changes as well as revolutionary changes ahead. The first group of investments should provide sustainable income and capital growth until their mistakes or the disruptions created by the second group of companies hurts them. The failure rate of the second group will be high as they will lack the management skills needed to leverage their disruptive power. The first group will have fewer failures but they will be more painful with less chance for full recovery.

The 85 most disruptive ideas since 1929 were recently published by Bloomberg Business Week in celebrating its 85th birthday.  One could probably devote an entire business school education trying to understand the power of the 85 disruptive ideas and how few of their inventors or developers produced lasting fortunes. The first three are good examples of the tenet that early inventors and early investors don’t get the major benefit of their disruptive talents. The three are the Jet Engine, the Microchip, and the Green Revolution.

We do not invest in Venture Capital funds to participate in the invention of products and services. Sometimes Private Equity is the way to go as developers build out to an eventual exit strategy. We prefer to use mutual funds which invest in the users of the disruptive forces unleashed in a way that can be leveraged to the benefit of both customers and shareholders.


Pick your time period for judging investment success and that should direct the composition of your portfolio. If you need help, email me.
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Sunday, November 30, 2014

Thanksgiving and Investment Performance


Most cultures have a harvest festival where people give thanks for what they have gathered. I am particularly blessed by the opportunity to communicate with such intelligent people globally through both this blog as well as through my investment responsibilities. One of my investment blessings is uncertainty as to the future. Contrary to many people’s belief, uncertainty is the arena where most investment gains are made; as various elements sort themselves out prices will react appropriately. However once things become crystal clear the vast majority of the price movement has been achieved. Thus I am thankful for levels of uncertainty as I attempt to deal intelligently with expectations.


Faithful readers of these posts know that I visit the nearby Mall at Short Hills each Thanksgiving weekend. My report this year is mixed. By far the biggest attraction with long lines of grandparents, parents, and children was an expansive display of products and photos based on Disney’s “Frozen.” I marvel as how successful the “House of Mickey” has been with a product that was in public domain that they didn’t invent, but brilliantly promoted. The other big winner was apparently the iPhone and related merchandise. The large Apple* store was jammed, but did not have outside lines. A much smaller Verizon store was quite crowded. AT&T’s much too large store had a sprinkling of people within it. While this mall ranges from mid price points to high prices, the high-end stores looked quite empty. My walking conclusion is that it will be a good season for Apple and not so good for high-end shops. I do not have a big feel for the purchases over the Internet. Some retail groups have jumped on to it, Macy’s claims that it is the fifth largest seller on the net.
*Owned by me personally and/or by the financial services fund I manage

From an economic viewpoint the absence of many “must have” purchases may mean that the savings (not spending) ratio will not retreat from its current 5% level. The use of debit cards is probably not going to soar.

Liquidity concerns

One set of expectations on the part of members of the SEC is the rapid redemptions in bond funds and ETFs when interest rates begin their “inevitable” rise. Quietly they are asking leading fund groups and their independent boards about plans to handle the expected tidal wave. Curious to me they do not appear to be as concerned about equity liquidity which I believe under the present shortage of trading desk capital could react just as quickly. In terms of investment performance in both the debt and equity markets, it has paid off to invest in large, but illiquid positions. We will be watching intently as to how those portfolios that have been more illiquid than others handle any significant squeeze on liquidity. (More on this relating to performance below.)

Longer term economic expectations

Pensions & Investments magazine (P&I) and Aberdeen Research conducted a poll on Macroeconomic expectations over the next ten years by region. The majority of respondents would improve as shown in the following ratios of improvement vs. decline:              

Market Location
vs. decline
Emerging Markets
47% vs.13%
Frontier Markets
36% vs.
33% vs.
31% vs.
16% vs.
non-US dev.
11% vs.
9% vs.

Other major regions including US, UK, and Europe were expected to have deteriorating macroeconomics over the ten year period. I have little confidence that these projections will work out as expected. However, I believe that they are useful in understanding current price/earnings ratios in these markets.

Performance analysis

One of the elements that I am thankful for this holiday is that we are in deep discussion about managing one particular new account’s money. A vital key to a high level of satisfaction is to agree as to what is important to be measured. I have difficulty determining a worse measure to make decisions as to hiring or firing a manager than raw absolute performance or even relative performance to some securities index. These are not the primary tools we use in selecting funds for a portfolio of funds. As J.P. Morgan himself stated, he only loaned money on the basis of the borrower’s character. Thus we want to understand the managers as individuals.

We also recognize the need to be patient and that is why we look at long-term developments.

There have always been some spectacularly performing managers often with very successful sales people attached that I do not believe. Many times when I dig into their records I find a particular, undisclosed relationship that is the main engine of their success. Some of these engines can keep functioning for a number of years until they are found to be wanting. One of the keys to our analysis is to try to determine where the good and bad performance come from. In some cases all of the extreme performance comes from a limited number of securities. I remember one quite ordinary fund with a skilled portfolio manager salesman touting its good performance. When I looked further into the fund’s performance I noticed that all of the truly great performance was coming from a single analyst. I suspected that he would quickly find better employment elsewhere. When that happened the air was let out of the fund’s good numbers which eventually led to the sale of the management company.

The significance of turnover and fund flows

A rapid turnover producing a good record is not as valuable to me as one whose portfolio is turned over more slowly. The first fund may possess trading skills which are often relatively transitory while the second one may have real selection skills. As even the best investment managers have periods of significant underperformance, we need to understand both the causes of the underperformance and what the manager does about it. The impact of cash flows and how they impact the portfolio has a distinct implication to evaluating the result. Often a surge of money coming in can overwhelm either the position size or the number of holdings. (An important corollary of the surge is what the organization does with its increased profitability. Does it change the life style of the key investment personnel?) Withdrawals or redemptions can reverse some of the behavior changes. However, we are not disturbed by the outflows. I have never seen a portfolio that couldn’t benefit from some pruning.

The question that I am currently grappling with is how to introduce sound judgment into the investment performance question. With the large group of very intelligent investment professionals and sound investors reading these words, I appeal to you for help. Your assistance will give my accounts and me something to be thankful for.
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A. Michael Lipper, C.F.A.,
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Contact author for limited redistribution permission.