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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.

Invest 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:

THE current 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.

Although the 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.

Unfortunately, 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.

Most mutual 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 for investors.

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.

Less informed 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 for success.

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.

Starting in 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.

First, hedge 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 investor.

Insiders Collected $1 Billion Before Refco Collapse. The amazing story of yet another wholesale management looting continues. From today's New York Times:

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 that deal.

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.

Mr. Bennett has denied the charges of securities fraud but has declined to comment further. Mr. Grant could not be reached.

Creditors of 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.

"Dividends 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 them."

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.

Mr. Bennett 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 $451 million.

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.

The payment to Mr. Trosten came out this year in an arbitration case that was brought against Refco by a consultant it had employed.

"Trosten 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.

The recipients 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.

According to the prospectus, these four executives had invested a total of $1.95 million in Refco at the time of the Lee transaction.

Robert Mugabe's words: 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.

Hurricanes Cause Wildlife To Get Aggressive. Here comes Wilma.
The 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.

Young alligator droppings are smaller and contain fish bones and possibly bird feathers.

Adult alligator droppings have little bells in them and smell like pepper spray.

Children's answers
A new 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 Davie?"

"No, ma'am, but I hate to see you standing there all by yourself!"

Neat upcoming movies:
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 here.
+ How my private equity fund is doing. Click here.
+ Blackstone private equity funds. Click here.
+ Manhattan Pharmaceuticals: Click here.
+ NovaDel Biosciences appeals. Click here.
+ Hana Biosciences appeals. Click here.
+ All turned on by biotech. Click here.
+ Steve Jobs Commencement Address. The text is available: Click here. The full audio is available. Click here.
+ The March of the Penguins, an exquisite movie. Click here.
+ When to sell stocks. Click here.

Harry Newton

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.
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