SharperDingaan

.... I'm wondering if you mind sharing how well has this concentration approach worked for your portfolio in the past? We have extreme ROI volatility, worsened by few equities & the use of a max $ investment in equities. Rolling 10yr compound returns of 25-30%, but in any given year we can range from -35% to +140% (43% 2013 YTD). We pick well, but are not good at assessing how long an idea may take to come to maturity, hence our focus on risk. We buy cheap punch cards & hold forever, which can be costly. ie: we hold a big position in PD at an ultra-low cost base, entirely funded with house money; but year over year it has been a terrible investment (& per convention, should therefore be sold). Totally misses that we are already up 250%+, & when we do eventually sell ... it will be a 12 bagger, with a div yield in the 20-30%/yr range, with proceeds more than enough to buy a large apartment in Manhattan - if we so desire. But in the meantime ... put up with negative ROI. Over time our volatility (& extremes) have declined. In our early days of 100% equity we relied on small size, options, & cash inflow to cover our risk. Option use changed to hedging as we could afford the actual common, & dropped away entirely as positions got big enough to warrant hedging by other methods instead. We hold FI to park $ for distribution, & hedge our positions. If we have to average down, the incremental investment is usually no more than what we have already recovered of our original investment, & invested in that FI. With growing size we add distressed debs to offset the portfolio drag; but the higher FI weighting overall lowers compound ROI & reduces volatility. You could not do this as an institution, & most would not do this as their retirement strategy. But if you think that you might want to buy a business at some future point; the equity build, & the business/industry experience that comes with it, is very useful. Our Cdn partnership was originally created to fund a brewery ;) Hopefully the patrone also gets to be a Master Brewer! SD

US residents will suffer a 15% withholding tax on any cash dividends received from Canadian investments, if those investments are not in tax sheltered accounts. There is no withholding tax if the dividend is paid in stock. Little advertised is that some well known Canadian blue-chips offer DRIPs with the DRIP shares bought at 95% of MV. To avoid the withholding tax in a non tax sheltered account, simply take shares over cash, and sell the shares ;) SD

Just to stir the pot ;) There is zero reason why she cant do something else; ie: teach English in Asia, construction, truck driving, tv production, write magazine articles/books, join the army, war correspondent, etc. Thousands before her have done exactly that - she isn't special. She made her own bed, & knew the risks. Thousands of other women before her have been in the same position, & all of them have come to their own solutions. They may not have liked their choices, but they made them; including marrying below their station. Everybody grows up. SD

Seems show (prestige) is important .... only she cant pay for it ..... Not the brightest .... will not move to a better locale, because bank of dad will not fund it (closet brat?) ... Cant declare bankruptcy.... so marrying out is the next highest & best use of depreciating age & looks .... Optimal if hubby is a rain-making sugar daddy, with the good taste to croak out within 5-10 years ? Expensive to terminate early. High risk, low return. If you're really so inclined, just buy a good hooker .... or set her up as a madam!

Couple of add-ons: Re Slave to Kelly: Kelly is just a principle applied in a particular way. Nothing prevents you from applying that principle a little differently, according to situation; as many here do. Re Concentration: For practical purposes, most concentrated positions are actually independent of each other. You invest your whole financial services sector allocation in 1 bank, not 5; & it is in either Europe, Asia, or NA. Your next allocation is in some other sector, in some other geographic location. With only 3-4 stocks & only 3-4 locations, co-variance is pretty mild. Re Time Horizon: Strategies change as time & investment thesis advance; they do not stay constant. Todays dividend paying equity investment can easily become tomorrows synthetic FI, with all accumulated house money removed via margin. SD

We should add that each stock is stand-alone idea, independent of everything else in the portfolio, and that the portfolio itself is a stand-alone asset. Example: ABC may be a new addition. It is Kelly sized, leveraged, independent of the portfolio, & a bet on European recovery. Most likely a very large bank as any kind of recovery will have to pass through the banking system. DEF may be an older addition. It has been sold down to remove the leverage, but its too early to reduce the position any further. GHI may be a maturing addition. Leveraged to remove our capital investment & fund a FI instrument, & ideally a dividend payer entirely funded with house money. JKL may be a series of FI instruments; convertibles, laddered T-Bills etc. MNO may be a leveraged portfolio overlay; options, special situations, etc. where we have high conviction. PQR may be the cash/margin you have. + 25% through -40% plus, depending on circumstance. Total of 6 investments, with only 1 being Kelly sized .... & then only temporarily. ABC investments become GHI investments over time, & CF increases semi-annually as long as we continue to invest. SD

We use Kelly as the starting point, at initiation, then discontinue its use. We see the highest risk as being at initiation; a high conviction, leveraged punt, that could fall 30% the day after we buy it. The lower end of our uncertainty sets the initial size, the upper end sets the limit if we have to average down. Around 25% appreciation we sell down to remove the leverage, thereafter its a rolling quarterly 6-9 month forecast. Averaging down is a very dangerous game, when leveraged; the upper end Kelly forces selling. We focus on risk; so no leverage unless its tactical, & removal as soon as practical. Once we 'know' the security, we usually find our forecast picks up the seasonality & add a few points. It means you cant own the whole world, & that you have to be the guru/analyst on each stock you own; therefore you need the same CFA, & other technical certs, that most sell/buy side analysts have. Your advantage is few stocks, & you do not have to toe your employers line. Your disadvantage is that you are prone to sipping cool-aid; usually not a problem if you keep a lot of knuckle-draggers in your orbit! SD

Look at the I, G, & S utilities for yield, & oil/drugs for growth ;)

We don't need no stinkin' sophistication .... We got per-son-ALITY!

FFH strikes are deep out of the money, so the insurance cash costs are as cheap as possible; but FFH shareholders pay with high quarterly MTM adjustments. A valid approach. You're free to hedge FFH directly if you dont like it

You have to be able to enter/exit the hedge in scale, quickly, easily, & discretely. Equity indexes are preferred as they are also the instrument of choice for all kinds of other long/short strategies (ie: ETF's, market guaranteed rate deposits, etc.); your trades look like all those others, & nobody is any the wiser. Keep in mind they also have an oversized position in the restructured asset heavy RFP (one of a few), & a commodity collapse will trigger massive write-downs. As you cannot short your own stock, or industry sector in this case, equity indexes are the next best choice ;) They are in a box, & are executing fairly well - but are getting punished because it is too difficult for most to get their heads around. It is really an indication that they need to restructure their business into simpler, easy to understand, components. Unfortunately, we just do not see it happening any time in the forseeable future. o SD

Wests counterparty exposure: To do domestic business in China you have to do it with a partner. Either an entity that is state controlled in some fashion, or with state permission (ie: in an economic zone), or via a corrupted state mandarin giving you cover. No different to Russia. You start out with Chinese Assets, & Western Debt. Moving through time the Chinese books accumulate retained earnings that support new Chinese debt on a 1:1 basis; those Chinese debt proceeds then repay the Western debt. Western exposure is all cumulative investment less all cumulative debt repayment. Chinese exposure is all cumulative BV write-offs that have not yet occurred. The more corrupt the environment, the higher those unrecognized BV write-offs are, & the smaller the Western debt repayments. Assuming no additional investment - Western financial exposure declines over time, & Chinese exposure increases. Standard investment procedure for high risk locations. The commodities impact is not just pricing. If business is booming you open new plants closer to your buyer, & you justify the loans based on those higher commodity prices. Total investment increases, & China gets new P&E on the ground – in China. The experienced will make their state-of-the-art investments in the West, & only invest their old & used equipment in China. As much of the investment in-kind as possible. The expectation is that the music will stop, & that you will lose the entire Chinese investment. In the meantime at the company level, you book higher EPS, try to keep your payback period as short as possible, invest in commodity sellers (via the treasury portfolio), & hedge the index. When the music stops, your share price collapses, & the cash gain on the index finances your share buyback. Standard operating procedure. At the state level, you issue as much paper as practical to the Chinese, & try to lengthen the maturity as much as possible. When the music stops, you seize the paper as compensation for the lost Chinese investments. You stop paying interest, & defease the debt. Standard operating procedure. The net impact is mild, but the gross impacts are extreme & offsetting. Obviously the state level gaming is extreme, but it is nothing new (oil, arms, drugs, etc.). It is also one of the realities that hedgers do not like to remind people of. SD

Think of what would happen were China to experience material banking disruption. All those new built empty cities, debt financed, with no visible CF to service that debt ..... so just how exactly is the magic being maintained, & what are the limits. Almost all financial flows with the outside world pass through a few, & tightly controlled, portals. Counterparty risk is concentrated, & controlled centrally. Most would argue that the financial risk, net of forfeited western deposits, is actually being borne by the outside world. The net risk may be small ... but it is net of extreme gross upside and downside volatility should China have a blowout. And every expanding trade nation suffers a blowout at some point .... Remove a good chunk of the demand from a commodity & its price will drop. Do it on a lot of commodities .... & at the same time; & you get contagion. Over the short term, the replacement cost of virtually everything falls like a brick (deflation), loan collateral evaporates, banks fail. Over the medium term; cash on corporate books flows to new equipment purchases, & the old equipment (plus the people who operate it) gets scrapped. Significant & material disruption for an extended period. China can close the wall again at any time, it is a communist country, & you are not going to be foreclosing on any Chinese assets in China. Crocodiles basking at the watering hole are playing the waiting game - & eventually those jaws snap on something. SD

Hopefully just another book of business in a field that they actually know something about; but the meter is running.

Given the size, the price, & the fact that they could have easily issued low cost debt instead ... most would expect that there is more to come. SD

Drink enough cool aid - & you are going to make errors. It is going to take a while for them to show themselves; but survive the ass kicking you deserve .... & you aren't going to be making any more of them for a while. Lot of upset folks over BB, & there is a need for a target - so why would you NOT expect the stock to drift lower over the next few weeks. And if there is the slightest negative around Q4 earnings, real or imagined ........ But 3 months from today, are you really going to feel the same way about it ? SD

You might want to look tactically at FFH, over the next 2-3 months ;) SD

HFT reminds us very much of Judo ... gaming, & the concept of letting your opponent do the work for you. Link your software to trigger off the frequency of key words showing up in select locations, tie the signal to the ticker symbol & derivative markets of select deeply traded stocks, feedback words/blogs/market data to drive up the count at your source locations, & let it rip. To get ... rapid volatility perfect for option trading ... so long as everyone plays the game. So .... if I put out some favourable messaging (selling calls, buying puts, synthetic shorting), & them suddenly dump a lot of negative (buying back calls, shorting), ... & keep doing it waves; I am going to make a LOT of money, & none of it illegal. I have essentially just created a new age Pump and Dump - move over Carnegie! Until you meet those evil bastards who also know how to play the game ;D You just got the opportunity to buy in a big long position at an artificially low price (short sold stock) I can dump positive messaging - at any time - to reverse the sentiment (& use their machinery) I can average up in the physical market - at any time - to push the message (using the low cost base & their machinery) I can sell the entire position via calls - hopefully at peak frenzy (they developed the put/call market for you) I can suddenly withdraw - at any time ( & let time decay erase the value of the calls I just sold) .... leaving a long position 2-3x its former size for no additional cost .... and a welcome mat to the door of a target that I may be trying to acquire - move over Mellon! Games will be played, but most would argue that they are not in the general interest of the population as a whole. SD

Forget the stock market measures determining bull/bear status, & look at the quality of the major business in those indices. After 5-6 years of 'crises', the majority are doing very thank-you, and at today’s very low growth levels. Most have also maintained total leverage by increasing operating leverage (CM/NOI) at the expense of financial leverage - and it has largely been by scaling up to reduce variable cost/unit; ie: size matters. Increase growth by a small amount (ie: 1.00% to 1.25%) & the CM on those incremental sales flows straight to the bottom line - & if your market share is already large, that total incremental CM will be massive. But …. only if you have scale, .... & are therefore a high quality large cap. Look at the real companies, with ‘real’ (little transactional trading) businesses, & you will be very surprized. Some of those beat-up Greek, Spanish, Irish, & Icelandic banks are actually very attractive - simply because of their high DOL, and market share in markets that are at multi-generational lows. Most would argue that we’ve been in a European bull market for a few months already …. SD

"The greater trick is to identify decent companies not in secular decline these days" Look at those with a high DOL & demographic/economic trend ... there are at least one/two in Canada that you wouldn't expect ;) SD

Keep in mind that quality from a business perspective is very different than that from an investment perspective. Generally speaking, the higher the quality of the business, the easier it is to run - so quality matters. Whereas in the value world a fallen angel (ie: sh1te business), dirt cheap, is nirvana. And after a while .... you learn that putting up with the sh1te while you are waiting for changes - is not worth it. Looking at quality vs metrics is just evolution. You have begun to look at the businesses that you own - as an actual businessman. You don't need the metrics as a substitute for experience any more. SD

To each his own ... just keep in mind that long dated Treasury's and Canada's also exist; you could just buy a series of different maturities & clip coupons every 6 months. SD

We aren't the same people at 80,that we were at 60; & that assumes ongoing perfect health. Is she really going to be able to do this, if she contracts any of the stroke &/or mental diseases that come with age? ... & really the biggest part of the annuities zero investment risk. SD

Agreed re annuities, but they do serve a purpose ... & at a very low cost You are dead - when the annuity is paying out. The recipient gets a 'pension' of $X every month for life (possibly even inflation indexed). Zero investment knowledge required, or investment risk undertaken, for life. It is highly likely that on death, there will be a forfeited stub residual - but so what; you have already provided for the heirs, & the payouts were higher than they should have been during the living phase (re actuarial adjustments). The recipient could just as easily choose not to linger, as outlive the annuity; & you can do nothing about either. Your best defence really is to live life to the fullest, while you are still able, & ensure there are no regrets. SD

Involve your heirs in the investment process. If they take great, if they don't - pay off their mortgage on passing, & leave it at that. Buy your wife an annuity that runs to zero over 15-20 years. SD