Previous Columns
8:30 AM Tuesday, August 31, 2004: The best news is the tennis at the U.S. Open is positively splendiferous. Exciting. Wonderful. The early rounds are a pleasure to watch. You see new young talent. You can relate to their winners and their misses, their joys and their failures. Tennis is broadcast on the USA Network from 11 AM to 5 PM and then from 7 PM to 11 PM every day until September 10 when it moves to CBS. For the full TV schedule, click here. You can find the daily schedule of play on USOpen.org. Click here. If you have to work when you should be watching the tennis, you can follow the scores by launching the "IBM On Demand Scoreboard" on your PC. Click here.

"Lay off the beautiful land and rare wine," wrote several readers. "The only worthwhile investment is in the scarcest commodity of them all -- talent. Pick great talent and give them your money." Makes sense to me if you can find them, and feel confident that yesterday's talent will also be tomorrow's talent. And since you can't feel confident, you have to hedge -- find more than one.

There is one "talent" that's in unlimited supply -- your own. Nothing matches the creative capacity and boundless energy in your own head. And best of all, when you channel that creativity and energy into your own business, you get a double bonus:

1. You get to pocket the profits as they accrue.
2. You get ten times the profits when you sell. (And these days at very favorable Federal tax rates.)

There are three reasons people don't start businesses:

1. I don't have the money. No one ever does. But there are oodles of relatives, friends, banks and financiers, who do. They'll give you the money.
2. I don't have the experience. No one ever does. You get it by starting your own business -- not by working for someone
3. I have a mortgage and a family. We all do. End of story.

America is the only place in the world that rewards success and failure. If you fail, you survive for another day. In Europe, you're dead. I actually heard an American VC say, "The guy's last three ventures went belly-up. This one won't. He's learned from his mistakes."

I don't like what I'm reading about the economy, (and what it means for the stockmarket). The latest shows slowing in income and employment. Wrote the Wall Street Journal, "Personal income grew by just $11 billion, or 0.1%, to $9.628 trillion in July, down from 0.2% in June, 0.5% in May and 0.6% in April. It's not hard to see why. In June and July, the spring's steady pace of job growth slowed to a crawl and came in below the rate needed to keep up with the entry of new people into the work force. Still, the total amount of private wages and salaries increased in July, following a small decline in June, and the payrolls of both goods-producing and service industries expanded, if not robustly. Personal consumption, however, rose by $65.6 billion, or 0.8%, to $8.238 trillion, following the 0.2% decline in June. What's perplexing is that at the same time, the growth rate of American's disposable income slowed to 0.1% from 0.2% in June, which was also slower than in the three previous months. But there was also a lot less money being put aside for a rainy day: The personal saving rate -- the percentage of disposable income that isn't spent -- dropped to 0.6% from 1.3%."

Wall Street remains conflicted: Them or us? There was always the conflict between investment banking and brokerage. Push the stuff that we make investment banking fees on -- irrespective of how bad it really is. Now there's a new conflict -- between their trading and our trading. Traditional banks and I (investment) bankers are playing with their own monies in the market. They call it trading. I call it gambling.

Frankly, I couldn't care less if the likes of Citigroup, Deutsche Bank, Merrill Lynch and Salomon Bros. want to become hedge funds, not banks. It's their money. They can lose it whichever way they like. The problem comes when I'm a brokerage client of theirs. They now know what I (and others like me) are doing and they can adjust their trades accordingly. Banks have already been caught for what's known as "front-running" -- doing trades for themselves before they do mine. Worse still is buying some of the hedge fund-like trading vehicles which the banks are creating for you and I to invest in.

You get a nagging feeling that the whole thing is fast becoming a giant unregulated, invisible, volatile, black financial hole -- another Long Term Capital , replete with all the horrible implications for the value of our own meager portfolios. This week's Economist has a piece on Deutsche Bank, Germany's largest. The story's headline "A giant hedge fund." The magazine wrote:

"Proprietary trading — punting with the bank's capital — has become an ever larger part of Deutsche Bank's business. Formerly, 80% of its trading positions were taken on behalf of customers, 20% for its own account. Now it admits to 30% for its own account, which probably means it is even higher. Even if it is not, the distinction between the two sorts of business is more apparent than real: risk, after all, is risk.

Its penchant for betting on markets shows up in the numbers it gives for value-at-risk (VAR) — the maximum it reckons that it could lose on a bad day. As a model, VAR depends crucially on volatility: the lower the volatility of financial markets, the greater the number of positions that a bank can have for a given amount of capital. As volatility has fallen sharply since the autumn of 2002, so positions have climbed. In addition, banks have devoted more money to trading. All in all, positions are many times what they were. Deutsche is an extreme example.

Richard Evans, Deutsche's head of market risk, says that the bank is very conservative about changes in volatility. Perhaps so, but it is still taking huge positions. In any case, VAR is flawed because it does not work when it is most needed: when markets fall apart. Like others, Deutsche therefore applies weekly “stress” tests to calculate how much “economic capital” it needs to buffer its risk positions under such conditions. But those tests are only as good as their designers' imaginations.

Still, better, perhaps, to take the positions in liquid instruments, which can be sold rapidly, than in illiquid loans or in private equity. Deutsche says it reduced its positions in “alternative assets” (including private equity) from €9.7 billion ($10.2 billion) at the end of 2002, to €3.5 billion by this June. Unfortunately, that figure does not include investments in hedge funds. Like some of its biggest rivals, Deutsche is heavily involved as a financier — or prime broker — of hedge funds. That gives it useful information: banks often take the same positions as hedge funds. Moreover, as with other banks, Deutsche runs its own in-house hedge funds and provides seed money to talented traders to set up hedge funds outside the bank.

It is impossible for outsiders to determine how much of the bank's own money is invested in hedge funds. Deutsche has a hedge-fund division called DB Absolute Return Strategies, with over $9 billion of investors' money under management. It has also invested some of its own money — over $600m, it says — in the same funds. There is another division, DB Advisors, which invests the bank's own capital in hedge funds. Just to confuse things further, DB Global Masters Fund allows outside investors to piggy-back on DB Advisors' trades. Twice this year teams of the latter's star in-house hedge-fund managers left to set up on their own. Far from freezing them out, DB Advisors invested capital in them.

The biggest problem with Deutsche's metamorphosis into a trading firm is that everybody else is doing the same, and the number of strategies and talented traders is limited. Forecasters of the top investment banks' quarterly results need often look no further for an indicator than the monthly hedge-fund index returns. And these seem to be falling: hedge funds as a group have had a dismal time this year. ...

The temptation, therefore, has been to do it by other means, sometimes running legal as well as financial risks. In April, a subsidiary of Deutsche was fined by Britain's Financial Services Authority for trading ahead of a client, without informing it, to “pre-hedge” a portfolio trade. Deutsche is also being investigated for possibly misleading clients on the placement of shares in Scania, a truck maker. This month, the administrators of Parmalat sued Deutsche, among others, for seeking payment ahead of other creditors two weeks before the Italian food giant's collapse last December. ..."

Money and success bring arrogance to Microsoft: In recent days the press has criticized Microsoft for leaving out of Longhorn -- its next Windows -- some needed (and promised) features. I sent a copy of one of the longer articles to my friend at Microsoft. Our email exchange went as follows:

Friend at Microsoft: As usual, the press has story all wrong.

Harry replies: All the press has the story wrong. Therefore it’s not partisan. It’s Microsoft’s fault. You should explain your situation to the press.

Microsoft: It is actually fine by us to have the expectations squeezed out of Longhorn. Our relationship with the press has changed a lot. They feel obligated to find the “gotcha” in any story and somehow never get around to celebrating our successes. Press has less influence than ever before as well.

Of course, this is total nonsense. The press has huge influence on what computers and software people buy, e.g. Walt Mossberg of the Wall Street Journal. And the press has been very kind to Microsoft products, e.g. Office 2003, which, even I, have recommended. But it's also harsh on Microsoft when it perceives it screwing up -- as with Longhorn.

The worry for Microsoft shareholders is that its new products are less and less enticing. More and more of us feel we can do without spending the extra money on what we see as a "don't-need" upgrade. Our concern has been, "Hire some more programmers and bring out the software we all crave for."

I am especially annoyed at Microsoft at present. There are a zillion simple, no-brainer changes to Microsoft Office that should be made to make it easier and faster to use. But the company won't listen. It used to, but no more.

Wrote the Washington Post, "At long last, Microsoft has put a date on when it will release the next generation of its Windows operating system. But the 2006 delivery of "Longhorn" will ship without the highly touted Windows File System feature, raising all sorts of questions about the future of the world's biggest software company. It's worth asking: Why didn't Microsoft invest some of the billions it's keeping in the bank in more software developers? Seems like a few billion spent on staff (in Redmond or Bangalore) could have paid off with a complete version of Longhorn. And is it wise to disburse some of its cash stockpile later this year in a big dividend to investors at the same time the company is failing to deliver on its next major software release?"

You can get some idea of where Microsoft's thinking is at present, go to http://sandbox.msn.com/. You can pick up a free copy of Lookout for Outlook, a super tool that finds things lickety-split in your Outlook calendar, email, contacts, notes and tasks. I like Lookout. I now use it every day.

Another victory in the battle against technology. My daughter's HP printer printed only page at time. It needed a cleaning. Exclaimed my daughter in last night's email to me: "After a good cleaning, my printer is now working and only taking one piece of paper at a time. Hooray. I used denatured alcohol, a paper towel, the instruction page from the HP web site, and my own common sense. I'm wicked smart. Cross your fingers that it continues to work." With Claire now as budding lawyer and accomplished computer technician, I shall never again worry about her future. How proficient she will be at choosing my nursing home remains to be seen. By then, I probably won't notice, or care, or remember.

Ken Fisher gets lousy press, again: I'm not a Ken Fisher fan. Neither is Business Week. A reader sent me a May 10 article. Under the headline, "Hype From A Financial Guru?" this magazine writes, "Kenneth L. Fisher may not be a household name, but that's not for lack of trying. Through Internet marketing, direct mail, and radio advertising, in which he trumpets his two-decade career as a Forbes magazine columnist, the 53-year-old Californian has built his 650-person firm, Fisher Investments Inc., into a major player in one of the fastest-growing segments of the money-management business.

Fisher sells “customized portfolios” directly to the affluent. And he is doing nicely -- to say the least. His firm manages $20 billion in client assets, five times as much as four years ago, for more than 12,000 customers who coughed up a minimum investment of $500,000 (recently raised to $750,000).

Many people flock to Fisher for a reason that he emphasizes in his advertising: his skill in designing customized portfolios that outshine ordinary mutual funds. Indeed, Fisher Investments asserts that it has a superior track record, claiming that clients have beaten the market, often by a wide margin, in 11 of the past 14 years. Such impressive numbers, and an aggressive advertising campaign, have made Fisher the most visible of hundreds of firms clamoring for market share in this booming business.

Fed by a bear market that shook investors' confidence in managing their own investments, “separately managed accounts” distributed through brokerages such as Merrill Lynch & Co. and Smith Barney totaled $498 billion at the end of 2003, a 29% gain from 2002. And the amount is expected to nearly double, to $943 billion, by 2007, says Boston researcher Cerulli Associates Inc.

But troubling questions have been raised concerning Fisher's advertised claims that he custom-tailors investor portfolios. According to various former clients and former employees interviewed by BusinessWeek, Fisher's advertised promises are long on hype and short on delivery. If the claims of overstated advertising are true, Fisher may have overstepped ethical, and even legal, strictures in his quest for client cash.

BusinessWeek has learned that the Securities & Exchange Commission is conducting an inquiry into Fisher Investments, and that several former employees have told the SEC that they believe Fisher's advertised claims are exaggerated. One former Fisher Investment counselor, Dan Laimon, president of San Diego's TriVant Custom Portfolio Group, which he started after leaving Fisher last year, told BusinessWeek: “Almost 99% of the Fisher portfolios are identical in their composition.” Laimon says that is “odd” because of “the very wide range of their clients' investment objectives, income requirements, and risk tolerance.”

Another probe into Fisher Investments is being conducted by the NASD. The regulator, reacting to a tip, accelerated a previously scheduled review of the firm's affiliated brokerage Purisima Securities. Fisher's lawyer says the NASD discovered no “material problems.” But that conclusion may be premature. NASD spokesperson Nancy Condon says: “The exam has not been completed.” ... Fisher acknowledges that an SEC inquiry is under way but downplays its significance, pointing out that it is a preliminary procedure and not a formal investigation. “We have never had a regulatory problem with the SEC, and we will not have a regulatory problem with the SEC,” he says.

That may indeed be the case. But the allegations surrounding some of Fisher's advertising exemplify the pitfalls investors face when they opt for personalized investment management. For one thing, separate-account managers dwell in a kind of legal twilight zone, in which key concepts, such as “customized portfolio,” are not spelled out. Federal legislation, which provides the legal framework of the business, says only that advisers are required to manage accounts on the basis of a client's “financial situation and investment objectives and in accordance with any reasonable restrictions.” ...

Consider the word “customized” itself. That often means just slightly tweaking a portfolio. While many advisers allow clients to make some special requests, such as permitting them to restrict purchases of tobacco stocks or to sell stocks to harvest tax losses, usually they are careful not to give the impression that they toil for hours to create a special portfolio. Says Pamela J. Wilson of Boston law firm Hale & Dorr LLP: “Most investment advisers bend over backward not to overstate how personalized their advice will be because they don't want to deal with angry customers down the road.”

One former Fisher client, H. Frank Rogers of San Diego, has filed a class-action complaint, which is pending in California Superior Court, alleging that Fisher's claims of providing “personal or customized portfolio management services and a customized portfolio” are false. According to the suit, clients expect advisers to design customized portfolios that meet their “unique investment needs and objectives.” Instead, it claims, Fisher advisers put clients into practically identical investments. Fisher vigorously denies the allegations in the suit, which he describes as “baseless and without any truthful support,” and is seeking its dismissal.

Previously, in a separate action, Rogers won about $136,000 in damages in an arbitration proceeding against Fisher Investments. Rogers had claimed in the arbitration that the firm inappropriately put his retirement savings into stocks in May, 2002, months before the stock market rebounded, after Rogers requested a conservative strategy that would protect against drops in excess of 10%.

The arbitrator's summary of evidence presented in the Rogers arbitration appears to support the view that Fisher Investments does not always custom-tailor its portfolios. According to the arbitration decision, Teufel testified that 80% of the firm's individual clients “had been placed...in essentially the same portfolio.” ...

Several former employees say they told the SEC that they think Fisher Investments' advertising leads clients to believe their portfolios are tailored to their needs by the top three officers of the firm. Fisher's brochure says each client's investment counselor will communicate “your needs to Ken, the rest of the investment policy committee, and our securities traders.” Former employees told BusinessWeek the firm provides only a minimal degree of customization and many clients are actually put into similar investments by lower-ranking advisers and not the “committee.” ...

When asked about allegations concerning his personal involvement in designing portfolios, Fisher initially told BusinessWeek that he doesn't review individual accounts. But he later revised his statement to say there is no “formal process” for him to do so. Teufel says Fisher's investment policy committee eyeballs less than 10% of individual clients' portfolios -- when, for example, unusual securities or complicated tax issues are involved. Most are designed by investment counselors based on guidelines set by the committee. ..."

The article contained the following chart:

Heavy accents work great:
An elderly Jewish man staying in a London hotel calls the operator and asks, in broken English with a heavy Yiddish accent, for number 266419.

Shortly afterwards there is a knock on his door.

He opens it to find two beautiful and sexy girls outside who ask him:

"Are you the guy who ordered 2 shikses for one night?"

Harry Newton

I make my daily column -- In Search of the Perfect Investment -- (Monday through Friday) freely available for three reasons:
First, 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'm hoping some of you will send me your investing ideas and concerns. My email address is . You can't click on my email address and send me an email. You have to re-type it . I did this to protect myself from irksome software scanning the Internet for email addresses to spam. I'm on enough spam lists.

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