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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 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.

Amazing statistics:

+ 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."

The 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 occasions.

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.

Info 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.
An Oil Baron Not Afraid to Be Candid. This interview came from Saturday's New York Times. It's fascinating:

Oil executives are usually cautious and secretive. Not Paolo Scaroni, the chief executive of Eni of Italy, one of the world’s top oil companies, who doesn’t mind speaking frankly about his industry’s challenges.
In a recent stopover in Vienna, between meetings in Moscow and Rome, where he had just announced a wide-ranging deal with Russia’s state-owned company Gazprom, Mr. Scaroni answered some questions about the opaque world of oil. Following are excerpts:

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?

A: Certainly it doesn’t use energy efficiently. Look, if in America cars had the same efficiency as European cars, we would save the total production of Iran. That’s four million barrels a day.

Q. So it’s 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 don’t 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 it’s 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 don’t 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. You’d 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.

Q. Isn’t 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 1990’s, 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 don’t 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 we’ve been in charge of, the results have been spectacular. Beating all more optimistic forecasts.

Weak 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 “Liar’s Poker.”

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.

Hedge funds — investments for institutions like pension funds and endowments and the wealthy — have hit a rough patch.

Recently, a 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.

"What’s happened is that as some of the opportunities have declined over the past year, it’s 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.

Returns for many hedge funds, which are supposed to be the market beaters, have paled in comparison with stocks. Hedge Fund Research’s weighted composite index is up 7.23 percent through September, according to a preliminary estimate, compared with the Standard & Poor’s 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.

“In the 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 millennium’s 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.

With eye-popping 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.

TPG-Axon, which 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 said.

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 August.

Hedge funds 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 hedge funds.

“The pace 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?"

Pension 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.

And endowments, 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.

“Hedge 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.

"Situations like this make people read documents much more closely," she said.

Indeed, the 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 Street’s 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 bank’s proprietary trading desk with their own reserves of entrepreneurial energy.

But as the Archeus case shows, a fund’s 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 Archeus’s assets plunged. Compounding its problems was a failure of the fund’s administrator to keep proper records, leading to more redemptions.

Mr. Kilberg 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.

"We have 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.

What remains to be seen is whether investors, chastened by the events of the last month, will give them one.

Ain't capitalism great?

How to write a Living Will
Ever 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.

I, __________________________, 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 the bills.

If a reasonable amount of time passes and I fail to ask for at least one of the following:

______a Bloody Mary,

______a Margarita,

______a Corona,

______a glass of wine,

______a steak or ribs,

______lobster or crab legs,

______the remote control,

______a bowl of ice cream,

______the sports page,

______Oreo cookies,


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.

Signature: ___________________________

Date: ______________________________

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. Please note I'm not suggesting you do. That money, if there is any, may help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
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