SharperDingaan

Welcome to the board. Overconfidence/leverage. Nothing wrong with either of these. Assuming 50% leverage, the secret sauce is that you pay the leverage off as soon as you have a double; the sale of 1/2 your position counters the overconfidence, & severely reduces your loss exposure to the growing cockiness. Casino economics. You cash-in $100, play for a while, & cash-out with $10 (taxi fare home); the $90 was entertainment. The experienced know not to be greedy - & to cash out at around $120; the entertainment becomes free, the taxi fare is covered, & they get to take $10 home for their time. Casino, or stock market - systematically withdraw capital as you play. RIM. We also punted @ $10, but made money. Only 10%, & we left a lot on the table (at least another 10%), but we cashed out of the casino UP. Could have stayed & had a wild ride, but we would have cashed out of the casino DOWN today. Investing should not be entertainment; if you feel the need, buy a theatre ticket - its a lot cheaper! Took us many years to realize .... SD

Most microcaps are actually niche companies with dominant local market shares. Their small size, & local dominance, makes them too costly for the industry players to put out of business; & ensures that most of their share ownership is local. Essentially, if you don't live in the area; you have no idea that XYZ local company even exists. The better run, the more profitable, & the more dominant the local company, the more likelihood the company is private. Public ownership, & being a bigger company, is a major disadvantage; & usually only because the original owners needed the liquidity of an IPO to exit. Doesn't mean that every XYZ 'public' business in the local business pool is 2nd tier, it just means that most investments will be via invitation only partnerships. Most micro-cap portfolios are a collection of 10-40% partnership stakes in related businesses. Valuation is your proportionate interest of the business as a whole, less a liquidity discount typically ranging from 15-40%+. You make your money through annual distributions, & view your portfolio as a whole, as being the equivalent to a lower quality pfd share. The text book example is a retired dentist with 2-3 partnerships in small, & local, dental practices; with dentistry being the common link. Alternatively, .... a master brewer with 2-3 partnership investments in local stand-alone brew pubs/craft breweries, with the master brewer making some of the beer in each of those establishments ;) Expect to buy at around 60% of IV (after 40% liquidity discount), exit at around 85% (after 15% liquidity discount) when the sector becomes fashionable again, & make a healthy cash flow while you are waiting. Growth in IV is nice, but it is not the dominant factor (liquidity is). To use numbers: Assume IV is $100 on day 1, Year 1; $150 on day 365, Year 2, & get a distribution of $8/yr every year. You bought somebody out at a 40% discount, & sold to a new partner at a 15% discount when the sector is hot. Cost of purchase is $60 ($100 x 1-40% discount) Cash yield, Yr 1-5 is 13.33% ($8/$60) Proceeds on exit is $127.50 ($150 x 1-15% discount) Compound ROI is 27% SD

We're seldom in more than 4 equities at a time, we're often leveraged, & on a straight compounding basis we've done >20%/yr over the last 5 years. However, during those 5 years we were also down 50%+, & up 140% at various times; so volatility matters! For us it is one equity per industry, only industries where we have competency, & we buy only when that industry is experiencing issues. By default, it means that our position, & our risk, is at its largest when we initially purchase using margin; thereafter the entire focus becomes one of reducing the risk associated with that position. The downside is that a portfolio of sizeable, zero-cost, dividend paying (infinite yield), stub positions is very difficult to manage. We are also a 100% equity portfolio, & pay out roughly 60% of the closing value every 4-5 years or so. The $ buy out mortgages, fund new ventures, finance education, RRSP catch-ups, long trips, etc. We find that if you do not systematically take $ off the table there is no point to investing; money is the servant, not the master. We do not get paid a fee on AUM (agency bias), & if the portfolio went to zero tomorrow, it wouldn't bother us. All told we're fairly sure that the restrained size, focus on risk reduction, & periodic capital withdrawals is allowing us to outperform the market - would it do as well over the long term in a bull market, is an open question. If we were not periodically withdrawing capital our compound return would also be a lot higher. SD

"Are you implying that only introverts can be smart?" Not at all. We put it to you that 'smartness' is at least a binary continuum - the 'book smart' introverted technical (stereotype), & the 'socially' smart gadfly (stereotype). We would also suggest that the earlier you are in your professional life the more extreme you are, and that 'experience' is in part - moving to a more balanced position. 'Book smart' & 'socially smart' don't have to be in the same person (rocket scientists managed by socially smart managers). We would also suggest that 'socially smart' is also the more valuable skill, & that it correlates with gender (female) & maturity. Who looks after the 'social stuff' in your family ? - & why is that? A current BA graduate will supposedly earn an average 12% less income than if they had never gone to university; they had a great time while they were there (socially smart), but it is not a rational decision (book smart). A current NA CFA/MBA feels very smart on graduation (book smart), but ignores that you can buy the same globally standardized skill set in Asia - for 1/3 the cost (socially dumb). Both examples are young; were they 20 years older (more maturity) their choices may have been different. SD

The smart ones aren't 'at' these conversations. They either anonymously stepped away from the controversial conversation (after noting the contents), or dropped a remark in passing (if there was a target they wanted to message to) - & walked away. They circulate, & they don't start a conversation unless they have a specific purpose. To confirm ... simply ask your wife! IQ, work, and wealth are not correlated; we just want to believe it. There are lots of very wealthy, 'dumb' people, & it is nothing new; we call them the nouveau riche. He/she may be nothing more than a lucky sperm; 'dumb' in behaviour - but with a family smart enough to give the $ to someone else to manage. When too many are gaming the conversation - you get sterility, & the message becomes the tone. And any diplomat will attest that it has nothing to do with content - content you get from your analysts. To cut through the sterility, most diplomats will deliberately stir the pot, & test the reaction with an open mind. All senior PM's have to be practiced diplomats - but the higher you rise the more filtered & nuanced the message (as tone increasingly dominates). The more unwashed the conversation you can hear, the more valuable it is; & if you can hear it in a reasonably anonymous venue - the more valuable still. It could be via a blunt weekly beer with your analysts - to hear what they really think (GE); or indirect mentoring via a BB. Then keep in mind that 'dumb' is very generational, occupational, & time sensitive. Grandpa just looks dumb because his 'smarts' were with a different technology, at a different time, & in a different industry. Anonymous contributions on a BB lets everyone get around it, to everyone's benefit. SD

Keep in mind that if FFH is part of a privatization, you are not going to see BB's numbers. It will show up in the FFH portfolios as X% of company Y, & the X will be < 10% to avoid disclosure requirements. Doesn't mean that FFH could not end up with > 10%, but it will be split between different legal entities (junior & senior entities) & investment vehicles (common, pref's, deb's, etc.)

Looks great. Can we add in the reference 1yr US T-Bill rate, & the reference levels for the exchange indexes these stocks trade on ? The ask is because as per MPT, the portfolio should do better than the investable risk free rate (1 yr US T-Bill). And hopefully .... it will also do better than the lowest cost practical alternative of simply buying the indexes in equal weightings. SD

We concur, this is not our baby .. & we look forward to seeing it evolve. Have fun! SD

"SAC was granted approval by a judge last week to continue operating until the insider-trading cases are resolved. The approved plan requires that SAC maintain at least 85 percent of the “aggregate value” of assets owned by the firm’s “entity defendants” as of July 1, and in exchange, allows for the fund to continue its lawful operations. If the assets fall below the specified level in a given month, the fund is required to “replenish” the monies, according to the Aug. 9 order" Very clever market solution. SAC is effectively short a put for 85% of the July 1 asset value, with any MTM valuation delta coming directly out of partner pockets. With their scale they can only either put on a market hedge (affecting put-call parity), or defend the July 01 market level via the option market. In practice; they either bleed cash (option premiums) or absorb market volatility & cover any losses. The wrong trade puts them out of business, the right one ensures the fines get paid, & any liquidity concern will shut them down immediately (Fed acting through GS). Their worst nightmare has to be a flash crash large enough to trigger a pile-on, & a HF trading selloff - as they would be forced into paying premium put prices, & selling down the equity positions to raise cash. Those piling on get to buy in that equity cheaply, & then cover their puts shortly after they revert to net buying. And once the options are covered, rinse & repeat ? The market as a whole gets a put at 85% of the July-01 level, & we get rising volatility the closer we get to the 85% strike. Makes one think of the manipulation in the option trading market when FFH was being targeted. SD

The obvious 2nd step is integration of the RM strategies that are also part of this board. To do it you need a PM making the decisions, & you would compare results against the baseline portfolio. The difference is the value add, & it is wholly attributable to both the PM's skill & the RM techniques available to him/her. The fairest & most practical way to do this is via an actual real portfolio, with the benefits going to a charity, & the portfolio position published monthly. If board members wish to replicate, all they need do is monitor the month end position, & buy/sell accordingly in their own account - no fiduciary issues, taxes, etc. It would be nice to have regional portfolios as well, & each portfolio managed by a PM local to that region. It crowd sources the burden, uses local knowledge, & allows board members to mix/match across regions to improve diversification. It also builds board membership, & harnesses the competitive bias of the investment business (business school/newspaper portfolio competitions) to the greater benefit of all. Obviously a very big stretch at the moment, but no different to the typical project. Do the initial step well, to prove the concept; & the rest of it will fall into place naturally. Grab the cohones, & squeeze!

All one need do is snap-snot the investment ideas section at the end of each quarter; then compare names & the number of posts. To get the pulse of the board, simply filter for the new names, & the old names with above normal posting activity. To get market timing add a bull/bear sentiment tracker to every investment idea. Data mining 101. As the initial step focus on a baseline portfolio that is fully automated & algorithmic. Essentially portfolio weightings, & market timing, driven purely by formula - based on board posting activity. First time out it probably isn't going to be great, but over successive generations this should improve rapidly (think kaizen & multi-generation cell 'phones). It is what you measure against, & the process is a close cousin to the algorithmic search generators behind HF trading. Anyone on this board (or off it) can then compare their performance to the baseline portfolio; we get a training tool, & the board gets comparative advantage & promotion. Every CFA student will be using the board to practice on, & it will ensure a ongoing future contribution from trained investment professionals. It would also be nice to break the baseline portfolio into regional portfolios such as NA, Europe, Asia, etc. Expands the cross pollination of the board, broadens perspectives, & promotes the board globally.

Couple of suggestions: A Standard Investment Policy outlining objectives, risk tolerance, max/min portfolio weightings, permissible instruments, leverage, strategies (long-short), etc. Addendum outlining administration mechanics, selection procedures, fees, etc. Make the whole thing a charity foundation & select a manager to run it. Fund through one of the crowd sourcing sights, & make all contributions donations. Allow the foundation to issue medium term debs to raise seed capital & achieve the scale to cover its costs. 4-10 patrones with multi $M injections. Commercial terms. Set a minimum foundation payout/yr from day 1 & fully index to inflation. Fund a lump-sum investment 'X' Prize with the medium term growth, & make it a game-changer. Recognize that this is all new frontier. It could not exist without the internet, crowd sourcing technology ($, capacity, communication, competitive co-operation), the modern approach to charity (results measured by business metrics), & a large enough group of wealthy like minded patrones schooled in value investment. It is a modern version of the old masonic guilds, a successful result will set the template for others, & it is highly likely that the industry will go out of its way to see it succeed. It is generally accepted that X prizes spur break-through innovation, & that it is better suited to NA personalities. This is not a time for the kaizen approaches of Asia, & is too early for the precision or miniaturization genius of Germany & Japan. Micro-financing used to be an 'impossible' idea - as it was just not 'done'; now millions around the world benefit from it. So why is it that supposedly this cannot be done with the investment industry? A little rebellion is great for the soul! SD

For simplicity, assume that future fines negate all earnings over the next year, & there are no capital raises. BIS requires all banks to hold a minimum 10.5% of RWA as regulatory capital, effective Q1 2014. The current official minimum (in Canada) is 8.5% of RWA. To get that extra regulatory capital, you would have to rank your various LOB by RAROC, & reduce business in the lowest ranking LOB until you get to the 10.5% RWA. All you need know is average asset quality by LOB, which LOB are capital heavy, how much of that LOB the bank does, & what the new regulatory capital requirement is. All published quarterly. The more asset quality improves (& the better the bank is run) the less need for capital raises &/or exits from higher risk LOB. The lack box becomes far easier to assess. Wells beats Goldman Sacs because outcomes are less uncertain. SD

Keep in mind that P/B, & P/E is secondary to your investment knowledge - & your industry circle of competence. Re investment knowledge: B is the last reported BV - but if you are expecting a significant gain this quarter; the BV is really lower than it should be & the current P/B is higher than it should be. Passing simply because the P/B (or P/E) ratio was too high, is to miss the opportunity entirely. And if you consistently seem to miss the upswings ... this may well be the reason why. Re bank industry competence: If you do not fully understand the dynamics of regulatory capital - & a banks ability to lend, you are materially handicapped. There is zero spread income if the bank cannot lend, & that ability is driven by BIS - & the central banker/global regulator/political bargaining behind it. Most would argue that current BV, or future 1 year E , is not a useful metric when the underlying regulation is undergoing such massive change. And if you were not fully aware of that (industry competence), you were really just placing a bet on either red/black. Back of the envelope works great - but it works because it forces you to think. SD

JBird you may want to revisit the Shape Ratio. The purpose of using EV is to systematically increase your portfolio return through active management. As you could have simply put your $ into a T-Bill, the benefit of your management is whatever you make above the T-Bill rate. Probabilities are estimates, not actuals; the difference between the portfolio actuals & estimates is expressed as the portfolios standard deviation of return. If too many of your choices are poor; over a 12 month period your portfolio return will we be lower than what you could have made if you simply put your money into a T-Bill. By actively managing, you have become in effect, your own worst enemy. If you are better at diversification than you are at probability estimation; you may actually benefit from active management, but your portfolio standard deviation will be high - & your Shape Ratio will be low. As you get better at estimation your Sharpe Ratio will rise. The more data points you take within the 12 month period, the more accurate your calculation will be. A PM will have infrastructure that calculates return and standard deviation each day, a retail investor might calculate once a month – if at all. SD

The withdrawal is a highly anticipated event It has already been going on for quite some time .... Most yield curves are now relatively normal, & no longer flat or inverted; ie: re-established risk premiums. Most 1 Yr T-Bill/Gilt/Canada rates less inflation are now either on the bubble, or only mildly negative. Most major banks now have materially better capital ratios than they once had.... & they are getting better still Most would argue that you do not start withdrawing support until you have actually have an economic take-off, & the infra-structure to support it. That infra-structure has been getting rebuilt for quite some time, & it has been designed for resiliency. It has also been getting repeated real-time tests (Cyprus, Greece, Portugal, Spain), & each test has resulted in smaller shock waves. Yes there will be the unintended goofs ... but the waves are now more likely to be moderate/heavy swells versus the all out tsunamis.

Since when have central bankers ever nailed the turn in an economic cycle? They have undershot growth for the last four years - why would they be right now? Let people fumble around long enough in a dark room, & eventually they are going to find the exit. And when they do find that exit, they are all going to rush out within a very short time of one another. Most would argue that the US is turning, same thing with the UK, & even Greece (absent the noise). At some point the greater risk will be in not participating. It does not mean suddenly going all-in, but it does warrant at least a partial roll-in. If you are right you will have an unrealized gain cutting your risk; if you are wrong, it is only a small exposure. SD

We hold a similar view to Uccmal, & cite the on-going discussion on tapering - it would not be occurring at all unless central bankers were confident they were near the end of the global recession. There are compelling values, but in the growth stocks.... And keep in mind that the refinanced cigar butts are going to act very like growth stocks when the global economy comes back, but with much less risk. ie: If they have not failed yet then they are probably not going to.

There are only 3 ways one can get zero change on the equity hedges .... (1) They were lifted, & therefore do not exist anymore (2) They have been re-designated out of AFS, & therefore do not mark to market anymore (3) There is a new & effective offsetting cross hedge between equity & FI, that essentially designates the equity leg as AFS & the FI leg as HTM. Most would expect (3) & (2), plus a little of (1). If there have been re-designations, it is highly likely that there has also been a fundamental reassessment of the entire equity portfolio. A slick solution & not unreasonable given the controversy these hedges have generated. SD

What do you mean by long term bonds? ... Just has to be high quality & liquid, there is no intent to hold to maturity. The longer term is just to get a better rate than T-Bills, balanced against the uncertain possibility of an intervening rate rise.

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Great thread. As we run our portfolio on a conventional business basis (not that different from Gio's), a few crumbs. Cash. 1-5% to pay the bills & that's it. Cash for an investment is actually margin. Rack it up when you buy, pay it down when you sell. Holding 30% of a portfolio in cash is actually self-destructive; why are you not holding it in a long term bond paying interest - that you subsequently borrow against. Supply/Demand. It is a grocery store - when it's hot everybody wants gelato, when it's cold they want coffee; nothing to do with the merits of gelato or coffee themselves. Sentiment is the supply/demand impact on your stock. Could just be the season, interest by new kinds of investor (momentum, investment guru, etc.), or a pretty skirt in the bull pen. IV. It's nothing but a yardstick, & your best guess; everyone around you will have a different number. We're simply trying to buy cheap & sell at something a little less cheap. The more of the price discount we try to realize on, the more risk we take. For most folk, buying at 65c on the $, & selling at 85c on the $ - is more than adequate - especially when it is a rubber yardstick. Quality. Selling fresh bananas is more profitable & less risky than selling old ones 3 days from the garbage can. Value investing is biased to old bananas. We just call the fresh bananas growth stocks & the old ones cigar butts! SD

You have to wonder what kind of deal was cut for the kind words. Then add in that Goldman may well be SAC's dominant (or only?) counterparty right now, & they cannot be thrilled at the possible regime change should SAC go under. Yet we still get this announcement, that this alleged criminal organization is a great counterparty? But if you had had a conversation with the fed, & reached an understanding ... wouldn't this then be a reasonable outcome? And if this conversation did take place - how long can it be before SAC topples ? SD

Obviously, the spiral is accelerating ..... Now a true bastard would also be short the public shares of any others in the same industry - as the ripples from a fail here, would be highly likely to swamp them as well. .... And given what we know about the alleged attitude to inside trading, one has to wonder who is probably holding the majority of the long puts & short calls on those companies. They must have redemption requests well above their capacity to pay, & there are only 5 options; repay from asset sales, repay from margin borrowing, repay from refinancing roll-overs, trade your way out, or declare a temporary moratorium. How long can it really be before the moratorium shows up - & as soon as it does; it will trigger the AM Best downgrade. Then keep in mind that if you have a large redemption order which is not being settled - you can also sue for non-payment. And you WILL sue - as your intent is to push the debtor into Chapter 11 as rapidly as possible, to retain as much collateral as possible. The cure is to pay out the redemption immediately, & in T-Bills. Except where do they get the money..... One has to think that in the climate of tapering; one of the most effective & efficient tapers would be a Fed assumption after they are in Chapter 11. Pay out the redemption orders in longer dated treasuries, & hold back that owed to the principals against future fines; very little actual cash involved, & no better position from which to impose a new industry regime going forward. If you want to make your name ........ SD

Keep in mind: In the major grid-locked cities it makes no sense to own a car. Subways & cabs move you around the city far easier, you don't have to find parking, put up with the stress of driving, or bear the ownership & operational cost, etc. If you want to travel outside the city, you rent a car - when you need it - & often from a point outside the city. Young people, no kids, & both working in the city. Retired folks, moving into the city to be close to the action. Favourable demographics & concentrated in the richer cities. It is not just convenience. For many years my spouse & I used to rent a car every weekend - picking it up Friday night & dropping it off Monday morning on the way to work. Every 3rd week was free, most times there were free automatic upgrades (frequent customer), insurance was covered by Visa, & the points generated from Visa & the rental company were enough to fly the two of us to Europe (return) for free - every 2 years. All our friends thought we were nuts, & we quite agreed with them - every time we went to the airport! The market for the Zipcars of the world, & why Zipcar is now owned by car rental company. SD