Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
AM EST Monday, October 9, 2006: Columbus Day. It's
a holiday for banks, but stock exchanges will be open. The weekend in Columbia
County, upstate New York, was glorious. Hard to focus on picking stocks. For
how hard, read the article on hedge funds below.
+ Already this
year, 436 new private equity funds have raised a record $300 billion worldwide.
+ Seven of the 10 largest buyouts of all time were announced in 2006, including
hospital chain HCA for $32.1 billion and energy pipeline company Kinder Morgan
for $27.5 billion.
The size and scope of the buyouts are raising concerns about a potential wave
of credit defaults down the line. One financial columnist writes, "With
so much money chasing deals, private-equity firms are pricing for perfection,
even as they venture into unfamiliar areas. By then loading on debt, they leave
little wiggle room should any problems emerge."
backdating of options scandal:
A company backdates stock options by choosing a grant date when its stock price
was lower. This increases the options' value for employees who exercise them
later for a higher price. In backdating, the idea is that the employees make
more money. At present the practice isn't illegal. It's certainly immoral. It's
another way management has of transferring shareholder wealth to itself. I'd
be surprised if the SEC and various state attorney-generals didn't take after
companies like Apple, which have reported extensive backdating -- at least 15
Hedge funds jump on the bonds of companies who report backdating, because backdating
means the company will have to re-state its earnings. This will make its reporting
late. The bonds will default. And the company will be forced to pay them off
at full price. They also sell the stock short, since backdating means the company
has now become a cockroach stock. There will be endless stories and endless
legal wrangles and they will all pummel the stock. Apple is an example. It dropped
$1.16 on Friday. It backdated options on 15 occasions. But, despite a board
inquiry, it won't say by how much or how many. It said Steve Jobs knew about
the backdating -- but not what, where, how, etc. Why Apple hasn't come clean
beats me. The financial press will be all over them until they do.
Over 100 companies have already reported backdating. It's developing
into a major scandal. Watch for the cockroaches.
on wiring your DSL line: Reader Brian Fletcher
writes, "this site is helpful to the novice running a new cable for DSL.
Follow the instructions. You should gain about
100,000 to 150,000 bits in extra speed.
Building a new house? My new one is running
33.7% over budget -- the amount the contractor said it would cost. The
over-run has been caused by:
1. The rise in price of building materials.
2. My contractor's initial optimism, and desire for the job.
3. Upgrades in quality of some items -- e.g. from painted to wood, from shingles
to a metal roof.
4. Changes on the job, e.g. more rooms finished in the basement.
5. My family's desire for perfection.
Having checked with my friends and seen what's happened with my house, I am
now convinced it is impossible to build a house on budget.
Oil Baron Not Afraid to Be Candid. This interview
came from Saturday's New York Times. It's fascinating:
are usually cautious and secretive. Not Paolo Scaroni, the chief executive
of Eni of Italy, one of the worlds top oil companies, who doesnt
mind speaking frankly about his industrys challenges.
In a recent
stopover in Vienna, between meetings in Moscow and Rome, where he had just
announced a wide-ranging deal with Russias state-owned company Gazprom,
Mr. Scaroni answered some questions about the opaque world of oil. Following
Q: Some people
believe high oil prices are here to stay. Do you share that view?
A: First of
all prices are not very high. Sixty dollars a barrel is not very high. If
they were high, the American consumer in particular would behave differently.
As long as each American consumer burns 26 barrels of oil per year
against 12 for Europeans, this means that the prices are not high.
High means that people start to say that I can use my energy better. Today,
a barrel of oil is worth half a barrel of Coca-Cola. So you should put things
into perspective. It has been clear to everybody that the Western world can
live with oil above $30, $40, $50, $60, $70 a barrel and economies expand,
inflation is low, and consumers continue to drive SUVs and air-conditioners
are so high in American restaurants that you have to put on a coat otherwise
you get sick.
Q. Are you saying
the American economy is wasteful in its energy use?
it doesnt use energy efficiently. Look, if in America cars had the same
efficiency as European cars, we would save the total production of Iran.
Thats four million barrels a day.
Q. So its
all the fault of Detroit and carmakers?
A. Even if the
United States were independent, hydrocarbons would remain a limited resource.
We have a total interest in using that limited resource to increase our efficiency,
lengthening the life of the fossil fuels, for environmental reasons. This
will more than compensate all the efforts we make in renewable energy. This
is not to say we dont have to make renewables but the potential for
efficiencies we have is enormous.
Q. How do you
reconcile rising demand and the need for more supplies when governments make
access more difficult?
A. First, I
say its their oil not mine. As a consequence we will have access to
their oil as long as we bring something they cannot have by themselves. What
do we bring technology, project management capability, investment
something that adds value to them. If we do not add value we are out. Try
going into Saudi Arabia and help Aramco to extract the easy oil. They dont
need us. First of all they are a good company. Second the oil is easy. Why
should they share something they can do by themselves. The second concept
that I learned is that when oil prices move from $50 to $60 you cannot expect
that this $10 difference falls into your pocket. Youd be happy if half
of it went to you. All over the globe, there has been a big push to change
the terms of the agreements over the past three years.
that a risky admission for an oil executive to be making?
A. The same
thing happens when prices fall. This time we renegotiate. When oil prices
went down in the 1990s, we renegotiated. But if renegotiation goes too
far, and international oil companies leave, and then production starts to
drop. At that point governments understand that the terms and conditions are
important and that we have our own interest.
Q: Are you concerned
by the talk of possible economic sanctions being imposed against Iran?
A. I often say
that unfortunately you dont find oil in Switzerland. I cannot choose.
Since oil is not in Switzerland but it is in Russia, in Iran, in Kazakhstan,
we have to be there. Then we modulate our presence according to terms and
conditions. Terms and conditions that change all the time. But if you are
not there, you are out.
Q. Iran is one
place that has limited investments by foreign companies. It has also seen
its production decline.
A. The two things
go probably together.
Q. How so?
A. The fact
that there are not many foreign companies probably is the reason production
declines. Certainly in the fields weve been in charge of, the results
have been spectacular. Beating all more optimistic forecasts.
Results Dim Hedge Funds Luster. Excerpted
from a recent issue of the New York Times.
When the hedge
fund Archeus Capital opened to investors in 2003, it did so with high hopes
and a glittering trading pedigree. Its co-founder, Gary K. Kilberg, was one
of the aggressive Salomon Brothers bond traders memorialized in Liars
By 2005, investors,
enamored of its complex trading strategies, had poured $3 billion into the
fund. Within a year, however, some bad bets and administrative troubles resulted
in a spate of investor withdrawals and its funds shrank. Now, its assets are
down to $682 million, several partners have left and its return for the year
is a negative 1.9 percent, making Archeus the latest hedge fund to fall from
its gilded perch.
investments for institutions like pension funds and endowments and
the wealthy have hit a rough patch.
well-regarded fund, Amaranth Advisors of Greenwich, Conn., made a wrong-way
bet in the energy markets and lost more than $6 billion in a week. It will
dispose of its remaining assets. Even the flagship hedge fund run by Goldman
Sachs, whose trading prowess has few peers on Wall Street, fell 10 percent
in August. A fund at Vega Asset Management, once among the 10 largest hedge
funds in the world, fell more than 11.5 percent in September, leaving it down
17.5 percent for the year. Its assets, which once topped $12 billion, are
now $2 billion to $3 billion, a person close to the fund said.
happened is that as some of the opportunities have declined over the past
year, its been hard to make money, said Jane Buchan, chief executive
of Pacific Alternative Asset Management, which manages $7.5 billion in funds
of hedge funds. And people have had different responses: some have stuck
to their knitting, others increase leverage or trade directionally.
If bull markets
make geniuses, uncertainty unmasks them. Volatile energy markets decimated
Amaranth, and bad bond bets and administrative issues sideswiped Archeus.
The turnaround in the stock market the major indexes fell sharply in
the late spring and have since climbed back has also tripped up hedge
fund giants as well as some big-name start-ups that have struggled to meet
already-diminished investor expectations.
many hedge funds, which are supposed to be the market beaters, have paled
in comparison with stocks. Hedge Fund Researchs weighted composite index
is up 7.23 percent through September, according to a preliminary estimate,
compared with the Standard & Poors 500-stock index, which, with
dividends, has a total return of 12.4 percent over the same period.
And yet investors
have hardly blinked. Eager for the rich, if not always predictable, returns
that hedge funds promise, they continue to pour money into them and hope the
next fund with a big problem will not be one of theirs.
hedge fund world, everybody is looking at their portfolio and asking themselves:
Do I have another Amaranth in my portfolio? said Tim Cook,
the president of Kailas Capital, an investor in hedge funds.
The rise of
hedge funds fame and fortune happened quickly. In 2000, the stock market
began to slide, and almost overnight, a band of obscure money managers became
the new millenniums masters of the universe. Soon, huge buckets of money
rained on these stars $99 billion flooded into hedge funds in 2002,
according to Hedge Fund Research. Since the beginning of 2001, nearly 7,000
hedge funds have been started.
compensation the top manager took home $1.5 billion last year
hedge-fund performance, and the pay derived from it, redefined everything
from job prestige on Wall Street to the price for art and real estate.
So while there
has been nothing like a sweeping shakeout in the business or a market crisis
like the near collapse of Long-Term Capital Management in 1998, some hedge
funds, including some of the high-profile safe names, have failed
to show any Midas-like magic.
Many of the
big-name debuts of 2004, 2005 and even 2006 have produced lackluster results.
Eton Park, with $5.5 billion in assets, was up about 6 percent through mid-
September and 7 percent through the end of the month. Several top executives
have left, including its chief operating officer, Stu Hendel, who will return
to Morgan Stanley, and Scott Prince, former head of derivatives and trading.
was started with $2 billion to $4 billion in 2005 by a Goldman Sachs star,
Dinakar Singh, was up just 2.6 percent through August, although it rebounded
to show a return of 5.6 percent through the end of September. Old Lane, begun
by two former top Morgan Stanley executives, John P. Havens and Vikram S.
Pandit, was down 1.7 percent through August, a person briefed on the results
Big funds have
also suffered, including Ritchie Capital and Vega, the Madrid hedge fund that
in 2004 was the ninth-largest fund in the world, with $10.7 billion, according
to Institutional Investor magazine. Vega Asset Management fell more than 11.5
percent for September, leaving it down 17.5 percent for the year so far.
A Vega representative
did not return calls for comment.
A few activist
funds, those that take pride in ridiculing poor corporate management, have
also stumbled. Pirate Capital, a $1.7 billion fund, sent a letter to investors
at the end of September explaining that half its investment team had quit.
The fund is up 3 percent for the year.
Not all managers
are suffering. The Citadel Investment Group and Highbridge Capital, both of
which had tough years in 2005, are shining: Citadel is up 4.7 percent for
September and about 18 percent for the year. Highbridge is up 14 percent for
the year. And SAC Capital, run by Steven A. Cohen, was up 18 percent though
are Darwinian by nature: when returns are good, money flows in and when they
are bad, investors scramble to get their money out as soon as possible.
So the spigot
of new money into hedge funds has run hot and cold. After tapering off in
2005, with $46.9 billion flowing in, there has been a revival this year, with
more than $66 billion poured into hedge funds in the first half of 2006 alone.
That flood of money is not likely to end even amid the recent stumbles by
has not changed. It is still fast," said Amy Hirsch, chief executive
of Paradigm Consulting Services. "You might see a slight pause as they
evaluate what happened. The question is not, Should we invest in hedge funds?
but, In what manner should we invest in hedge funds?"
seeking to make up for years of being underfunded, have increasingly turned
to hedge funds. Many funds that cater to such institutions boast they can
deliver consistent medium-range returns 8 to 12 percent that
permit institutions to better manage their liabilities.
which were among the earliest adopters of hedge fund investing, do not appear
to be backing away. Scripps College in Claremont, Calif., with a $240 million
endowment, has almost 30 percent of its assets in hedge funds. For the fiscal
year ended June 30, the endowment at Scripps was up 17.7 percent.
funds were a big contributor to that, said Patricia S. Callan, former
chairwoman of the investment committee at Scripps and a member of the investment
committee at the Huntington Library in San Marino. Calif. She said neither
Scripps nor Huntington, which has a $200 million endowment, will change its
allocation to hedge funds.
Yet Ms. Callan
acknowledged that blow-ups like the one at Amaranth might lead investment
committee members to give greater scrutiny to hedge funds.
like this make people read documents much more closely," she said.
changes that are likely to come in the wake of Amaranth will be in the form
of increased vigilance by investors. Managers of funds of funds and consultants
say investors may now temporarily delay their investments in hedge funds as
they try to negotiate better terms to redeem their funds in the case of a
crisis. And there may be calls from investors for greater disclosure, especially
regarding how the funds are using leverage and derivatives.
In the case
of Archeus, its marketing pitch, like that of most hedge funds, was its grasp
of some of Wall Streets more abstruse trading strategies. In one of
its first letters in 2003, Mr. Kilberg and his partner claimed profits from
engaging in European rate skew trading, macro-oriented curve reshaping transactions
and zero-coupon principal curve arbitrage.
To all but the
most sophisticated trader, this is eye-glazing jargon. Which, as the hedge
fund boom took form in 2001 and 2002, was precisely the point. Mr. Kilberg
and other stars from Goldman Sachs, J. P. Morgan and Morgan Stanley were able
to present themselves as trading savants who could marry the technical expertise
of the investment banks proprietary trading desk with their own reserves
of entrepreneurial energy.
But as the Archeus
case shows, a funds fortunes can change ever so quickly once the market
turns. It shows, too, that beyond the flashy public implosions, many funds
are struggling to survive, just a few years after successful starts.
For Mr. Kilberg
and his former Salomon traders, 2005 started out well as assets peaked at
$3 billion. But within months, the fund began to suffer sharp losses as its
main trading strategy, taking positions in bonds with an underlying portfolio
of debt or derivatives, fell out of favor. Suddenly, investors were taking
their money out and criticizing Mr. Kilberg for not taking on more risk. Hedge
funds like Amaranth, with its focus on hot markets like natural gas, became
in vogue, and Archeuss assets plunged. Compounding its problems was
a failure of the funds administrator to keep proper records, leading
to more redemptions.
declined to comment.
Archeus is paring
down. It has closed its London office, laid off workers and refocused its
investment strategy. So far, results are less than promising. The fund was
up only 1 percent in September. Now the founding partners are asking investors
for a second chance.
learned a great deal from the various circumstances, events and issues we
have encountered and, admittedly, some of the mistakes we have made,"
they wrote in a letter to investors.
to be seen is whether investors, chastened by the events of the last month,
will give them one.
to write a Living Will
since the Terry Schiavo debacle there has been an increase of living wills;
from 10,000 a year to 40,000. Everyone should have a Living Will. This is the
perfect Living Will. It's easy. It makes perfect sense. It will cut paper work.
being of sound mind and body, do not wish to be kept alive indefinitely by artificial
means. Under no circumstances should my fate be put in the hands of ex-spouses,
pinhead politicians or lawyers and/or doctors interested in simply running up
If a reasonable
amount of time passes and I fail to ask for at least one of the following:
or crab legs,
______a bowl of
Then, it should
be presumed I won't ever get better. When such a determination is reached, I
hereby instruct my appointed person and attending physicians to pull the plug,
reel in the tubes, and call it a day.
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 .
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