Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM Thursday, October 20, 2005: Yesterday
stockmarkets rose. The Dow rose strongly by 128.87 points or 1.25%.
Nasdaq rose by 33.91 points, or 1%. Most people had no idea why
markets rose so strongly. Some said it was a typical bear market rally (notorious
for their rare, but sharp one-day rises). Cramer stuck his neck out on TV last
night and said "This is what a bottom looks like. ... Real buyers
came into the market."
I have no idea why it happened. But my guess is that it's the typical bounce
in a secular bear market -- which I suspect we may be in. It remains a good
time to reduce your exposure to stocks.
Deutsche Bank screws up -- again: In the
old days when I felt positive to Deutsche, I transferred some securities over
to them. One of them was bond worth $1.5 million. Deutsche Bank was so lazy
it didn't ask for my purchase price. That year it reported to the IRS that I
had made a $1.5 million "profit," i.e. Deutsche Bank simply assumed
that my cost basis was zero. Deutsche Bank's slogan should be changed
to "A Passion to Perform badly."
Buying commodities like crazy. China's
economy grew 9.4% in both the third quarter and the first nine months
of this year. At this growth rate, China's economy will more than double
in size over the next eight years. That's phenomenal growth.
at Your Own Risk by David Swensen, chief investment officer at Yale
and the author of "Unconventional Success: A Fundamental Approach to Personal
Investment." You need to read this:
mania for hedge funds reaches into every corner of the investment world.
As is often the case with financial excesses, what began as a reasonable opportunity
for sophisticated investors has become a killing ground for naïve trend-followers,
with scandals and frauds prompting predictable calls for increased regulation
of hedge funds. But if Congress and the Securities and Exchange Commission
really want to protect individual investors, they should prohibit unsophisticated
players from participating in hedge funds.
roughly 8,000 hedge funds now in existence pursue so many strategies that
hedge funds almost defy definition, generally they promise to deliver every
investor's dream -- high returns with low risk. In some respects, hedge funds
are like mutual funds on steroids: they pursue complex investment strategies,
charge huge fees and reward only those few investors able to identify funds
that are worth the money they charge.
the track record of individual investors with plain-vanilla mutual funds fails
to inspire confidence. Actively managed mutual funds overwhelmingly fail to
beat the market. In a well-structured study published in 2000, an investment
manager, Robert Arnott, showed that over a two-decade period, excessive
management fees and frantic portfolio trading reduce the chance that a mutual
fund investor will beat the market to less than one in seven.
funds do not produce even minimally acceptable results because of the conflict
between the mutual fund company's profit motive and the mutual fund manager's
fiduciary responsibility. Mutual fund companies profit by gathering assets,
charging high fees and churning portfolios. Mutual fund managers produce superior
investment returns by limiting assets, assessing low fees and trading infrequently.
In case after case, profits trump returns. The mutual fund manager abrogates
fiduciary responsibility for personal gain.
Hedge fund investors
confront even more dismal circumstances. As with mutual funds, undisciplined
asset accumulation seems to be the norm. But hedge fund management fees are
even more exorbitant than those levied by mutual funds; hedge funds typically
add a "profit participation" fee, say 20 percent of any gains, to
the already-too-large base fee. Portfolio turnover often surpasses the feverish
pace posted by mutual funds, generating soft dollar kickbacks -- basically
hidden credits granted by brokers for trading securities -- that line the
manager's pocket at the investor's expense. In the zero-sum world of active
portfolio management, where every winning position requires an offsetting
losing position, over-the-top hedge fund fees virtually guarantee subpar results
Just as in the
mutual fund arena, hedge fund investors confront a problem that economists
call adverse selection. The best money managers seldom operate in a
mutual fund format, preferring to manage money for sophisticated institutional
investors. Similarly, top-tier hedge fund managers favor stable, long-term
institutions over fickle, performance-chasing individuals. As a result, individuals
have access mostly to lower-quality hedge funds, increasing their likelihood
of being defrauded by charlatans at places like the Bayou Group, Wood River
Partners and KL Group.
investors rely on an intermediary (often a fund that invests in a variety
of hedge funds) to make fund choices. Again, the principle of adverse selection
applies. The best fund managers avoid these "funds of funds,"
which operate with shorter time horizons, in favor of a direct relationship
with big long-term investors. Of course, the funds of funds add more fees
to the already overburdened hedge fund investor, further reducing chances
In the mutual
fund world, investors consistently amplify the negative impact of poor fund
management. They chase what has done well, shun what has done poorly, buy
high, sell low and damage returns. A recent study by Morningstar, the fund
research firm, shows that in each of its equity fund categories, ill-timed
moves caused investors to earn lower returns than the funds' officially reported
returns. In a worrying fact for hedge fund investors, the most volatile mutual
funds exhibited the largest gap between posted returns and investor results.
If investors in the capricious hedge fund world behave like mutual fund investors,
they are likely to suffer even more substantial self-inflicted pain.
What about the
prospect of government regulation of hedge funds? Again, evidence from the
mutual fund industry provides cold comfort, in part because Congress and the
S.E.C. respond to the desires of the regulated. In providing official
sanction for soft dollar kickbacks, supplemental fund marketing fees
and product placement arrangements, the regulatory authorities have
feathered the mutual fund industry's bed. Of course, the cost of those feathers
comes right out of investors' pockets.
February, the commission will require hedge fund advisers to provide their
address, their professional history and any record of infractions, and will
start subjecting them to random audits. But this registration holds no power
to improve returns; it simply adds to the already voluminous pile of routinely
ignored disclosure data that investors already receive. The prospect of random
audits likewise carries little potential benefit; the already overburdened
commission can barely deal with its mutual fund caseload.
A better approach
would be to restrict access to hedge funds. In 1996, Congress made the mistake
of relaxing the requirements for investors in private investment vehicles
like hedge funds. Regulators should now reverse course.
funds should be required to have direct relationships with their investors,
eliminating the use of funds of funds. Second, hedge funds should be obliged
to demonstrate that their investors have sufficient expertise to participate
in this treacherous arena. Third, the existing net worth and investment portfolio
size standards should be increased substantially to weed out inexperienced
or smaller players.
Only by restricting
hedge fund access to large sophisticated investors can regulators ensure a
fair fight when the hedge fund manager lines up across from the hedge fund
Collected $1 Billion Before Refco Collapse. The amazing
story of yet another wholesale management looting continues. From today's New
In the year
before Refco sold shares to the public and then promptly made the fourth-largest
bankruptcy filing in United States history, insiders at the firm received
more than $1 billion in cash, according to the firm's financial statements.
And one insider,
Robert Trosten, received $45 million when he left his post as chief
financial officer a year ago, according to testimony at an arbitration hearing
earlier this year.
A great deal
of mystery still surrounds the collapse of Refco, a decades-old firm that
conducted billions of dollars in trades in foreign currencies, United States
Treasury securities and commodities for more than 200,000 clients last year.
But investors and customers who are facing losses in Refco's bankruptcy will
certainly want to understand how insiders could drain $1.124 billion
from the firm's coffers in the year or so leading up to its demise.
To some degree,
the money that insiders took out of the firm is not surprising, given that
Refco's executives sold a big stake in the company to Thomas H. Lee Partners,
a private equity firm in Boston, in August 2004. Indeed, most of the money
insiders received - $1.057 billion - was paid upon the completion of
Two Refco insiders
were on the receiving end of those payouts: Phillip R. Bennett, the former
chief executive who has been charged with defrauding investors by concealing
a $435 million loan he arranged with the firm, and Tone Grant, Refco's longtime
chief executive before Mr. Bennett.
has denied the charges of securities fraud but has declined to comment further.
Mr. Grant could not be reached.
Refco will almost certainly try to recover what they can from payments made
by the company to its top executives in the months leading up to its demise.
While compensation -- like salaries -- is typically not recoverable, payments
made in the sale of a company or dividends paid to its owners are fair game
if the company is insolvent, said Denis Cronin, a bankruptcy lawyer at Cronin
and Vris in New York.
or payments with respect to their stock ownership, that is vulnerable to what
is known in bankruptcy as a fraudulent conveyance or distribution," Mr.
Cronin said. "Fraudulent conveyance is a payment or distribution
made while the company was insolvent or rendered insolvent. When you make
those payments in that time frame, then creditors have a right to recover
The $1.057 billion
came in two chunks, according to the Refco prospectus. First, Mr. Bennett
and Mr. Grant appear to have shared in a $550 million cash payment in the
transaction with Thomas H. Lee Partners; then, Mr. Bennett appears to have
received another $507 million in the deal as well.
did not cash out of Refco completely. At the time of the deal with the Lee
firm, he agreed to roll over an equity stake in Refco worth $383 million,
the prospectus said. At a meeting of Thomas H. Lee Partners last year, just
after its $2.2 billion purchase of Refco, Mr. Lee introduced Mr. Bennett
to discuss the firm. According to someone who was at the meeting, Mr. Lee
boasted that Mr. Bennett's $383 million stake in Refco was among the largest
investments he had ever seen in a company by its chief executive and was an
indication of his confidence in the firm.
Before the transaction
with Thomas H. Lee Partners, Refco had three owners: Mr. Bennett and Mr. Grant
each owned 45 percent, and Bawag Overseas owned 10 percent. Bawag stands for
Bank für Arbeit und Wirtschaft, an Austrian banking company that invested
in Refco in May 1999. It is Refco's largest creditor, stating that it is owed
The $45 million
exit payment made to Mr. Trosten, the former chief financial officer, was
not mentioned in the Refco prospectus. Instead it noted that when he left
the firm in October 2004, he forfeited the shares in the company that he had
received as part of its top management. His departure seemed abrupt because
it left Refco without a chief financial officer for two months.
to Mr. Trosten came out this year in an arbitration case that was brought
against Refco by a consultant it had employed.
testified that he received a $45 million separation payment when he left the
company," said Sean O'Shea, a lawyer who represented the consultant,
Edward McElwreath, who won $3.5 million from the company. The arbitration
panel overseeing the case awarded the money to Mr. McElwreath, who contended
that he had introduced Refco officials to Thomas H. Lee Partners and was owed
a fee for the introduction. The separation payment to Mr. Trosten by Refco
was first reported by The New York Post.
Robert G. Morvillo,
a lawyer who is in the process of being retained by Mr. Trosten, said he had
advised the former Refco executive not to discuss the matter publicly. A spokesman
for the Lee firm declined to comment about Mr. Trosten's separation payment.
Four other Refco
executives shared in cash payments made just before the deal with the Lee
firm, according to Refco filings. These payments, which totaled $22 million,
related to the executives' interests in a profit-sharing pact at the firm.
were Joseph J. Murphy, chief executive of Refco Global Futures; William M.
Sexton, then Refco's chief operating officer and now its chief executive;
Santo C. Maggio, the chief executive of Refco Securities; and Dennis A. Klejna,
the firm's general counsel.
the prospectus, these four executives had invested a total of $1.95 million
in Refco at the time of the Lee transaction.
Aid agencies say 4 million of Zimbabwe's 11.5 million people are
facing famine. Mr. Mugabe, who runs one of the world's most brutal dictatorships,
says Zimbabweans are not hungry. They just can't eat their favorite foods. I
don't make this stuff up.
How to ride a donkey:
An old man, a boy and a donkey were going to town. The boy rode on
the donkey and the old man walked. As they went along they passed some people
who remarked it was a shame the old man was walking and the boy was riding.
The man and boy thought maybe the critics were right, so they changed positions.
Later, they passed
some people that remarked, "What a shame, he makes that little boy walk."
They then decided they both would walk! Soon they passed some more people who
thought they were stupid to walk when they had a decent donkey to ride. So,
they both rode the donkey.
Now they passed
some people that shamed them by saying how awful to put such a load on a poor
donkey. The boy and man said they were probably right, so they decided to carry
the donkey. As they crossed the b! ridge, they lost their grip on the animal
and he fell into the river and drowned.
The moral of the
story? If you try to please everyone, you might as well... Kiss your ass good-bye.
Cause Wildlife To Get Aggressive. Here comes Wilma.
Florida State Department of Fish and Wildlife is advising hikers, hunters, fishers,
and golfers to take extra precautions and to keep alert for alligators while
visiting Brevard, Broward, Dade, Marborough, Pinellas, Orange, Osceola, Polk,
Palm Beach and Sarasota Counties.
They advise people
to wear noise-producing devices such as little bells on their clothing to alert,
but not startle the alligators unexpectedly.
They also advise
the carrying of pepper spray in case of an encounter with an alligator.
It is also a good
idea to watch for recent signs of alligator activity. People should learn to
recognize the difference between small young alligator and large adult alligator
droppings are smaller and contain fish bones and possibly bird feathers.
droppings have little bells in them and smell like pepper spray.
teacher was trying to make use of her psychology courses. She started her class
by saying, "Everyone who thinks they're stupid, stand up!"
After a few seconds,
Little Davie stood up. The teacher said, "Do you think you're stupid, Little
but I hate to see you standing there all by yourself!"
Friday. Dead Men Don't Wear Plaid (1982). 8
PM. Turner Classic Movies.
Saturday. Arsenic and Old Lace (1944). 8PM. TCM.
Sunday. A Walk on the Moon (1999). 8PM. Encore Drama.
Recent column highlights:
+ Dumb reasons we hold losing stocks. Click
+ How my private equity fund is doing. Click
+ Blackstone private equity funds. Click
+ Manhattan Pharmaceuticals: Click
+ NovaDel Biosciences appeals. Click
+ Hana Biosciences appeals. Click
+ All turned on by biotech. Click
+ Steve Jobs Commencement Address. The text is available:
Click here. The full audio is available. Click
+ The March of the Penguins, an exquisite movie. Click
+ When to sell stocks. Click
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
click on my email address. You have to re-type it . This protects me from software
scanning the Internet for email addresses to spam. I have no role in choosing
the Google ads. Thus I cannot endorse any, though some look mighty interesting.
If you click on a link, Google may send me money. That money will help pay Claire's
law school tuition. Read more about Google AdSense, click
here and here.