Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Tuesday, September 18, 2007: The
essence of investing in funds you don't control is to assess the risk.
Risk factors to look for:
1. Borrowing. Also called leverage. Borrowed money magnifies the risk manyfold.
2. Shorting. Especially naked shorting.
3. How diversified or concentrated the firm's "bets" are.
4. What the firm says it will invest in versus what it actually invests in.
5. Excessive secrecy about the exact positions the fund actually has.
The lockup period. There's no reason for a long lockup except to protect the
funds are regulated into not doing things generally seen as risky --
i.e. borrowing and shorting.
funds and funds run by investment banks are not regulated. They can do
whatever they damn well please. And they do. They're designed for "sophisticated"
wealthy investors. The problem is that most wealthy investors got their wealth
from a business they formed and later sold. This makes them experts at making
jeans, servicing cars, delivering pizza, building houses. It makes them totally
inept at assessing risk.
After they sell their business, word gets out of their new wealth. The big Wall
Street sales operations -- e.g. Merills, Goldmans, Bear Stearns, Lehmans --
chase these new-rich with flattery and exclusivity. The pitch is "Join
this club offered to only select few." It's a persuasive pitch, because
the big Wall Street firms have huge reputations for making money. The reputation
is not unwarranted -- except that the reputation is making money for themselves,
not always for their investors -- a hard distinction for many wealthy,
but unsophisticated investors to make. Add all this to pressures on Wall Street
firms to get more and more money under management (2% of $1 million is nothing.
2% of $1 billion starts to add up) and you start to see the inevitable. Heady
promises, big blowups, annoyed investors....
With this introduction,
read this latest article from BusinessWeek magazine.
Hedge Fund Blowups.
Did Bear Stearns Soft-Pedal the Risks?
How inflated did the market for subprime mortgages become during the recent
bubble? Take a look at two Bear, Stearns & Co. (BSC) hedge funds that
blew up in July. Investors lost $1.6 billion all told. Now some are claiming
that Bear marketed the funds which bought risky mortgage-backed securities
largely with borrowed money as conservative investments. Even more surprising,
some of the world's savviest investors, including at least one inside Bear,
were willing to suspend their disbelief long enough to buy in.
At a London
conference in February, 2006, Matthew Tannin, a senior managing director at
Bear, told investors that buying into one of the hedge funds he was hawking,
the Bear Stearns High-Grade Structured Credit Strategies Fund, was akin to
putting money in an ordinary bank account, according to a person in attendance.
Investors say other Bear officials promised at various times that while the
value might slide in any given year, shareholders could always get their initial
investment back. The marketing was so slick it persuaded one of Bear Stearns'
top brokers, Shelley Bergman, to dive in. Says one investor who asked not
to be named and has recently hired a lawyer: "[The fund] was described
as very low volatility, very conservative, and very low risk. They said a
doomsday scenario was a 5% to 10% loss."
That, of course,
proved inaccurate. The High-Grade Structured Credit Strategies Fund and the
related Bear Stearns High-Grade Structured Credit Strategies Enhanced Fund
both imploded in June, wiping out $1.6 billion in investor capital. The funds
had gorged on collateralized debt obligations (CDOs)complex bonds often
backed by the riskiest subprime mortgagesand employed $16 billion in
borrowed money to lever up the returns. One of the funds was at times borrowing
$20 for every dollar investors put inan enormous amount even in the
freewheeling hedge fund world. The Bear funds joined a long list of leverage-driven
blowups, from Long-Term Capital Management in 1998 to Amaranth Advisors in
are crying foul. Regulatory filings reveal that 17 customer complaints have
been lodged against Tannin and Ralph R. Cioffi, the other senior managing
director who oversaw the hedge funds' operations. On Wall Street, the grievance
process usually starts with the investor filing a complaint with the firm.
Having received the complaints, Bear can try to settle, or it can fight, at
which point the matter will go before an independent arbitration panel. Thus
far, Bear seems ready to fight. Says a spokesman: "We will defend ourselves
summary of each complaint, compiled by Bear for regulators, charges the same
thing: "Customer alleges inconsistency between the fund's described investment
strategy and actual investments." The Bear spokesman disputes the allegations,
arguing that the "high-net-worth investors in the fund were made very
aware that this was a high-risk, speculative investment vehicle." Cioffi
declined to comment. Tannin, through the spokesman, says he never compared
the fund to a bank account and never implied it was a "very safe investment."
The truth likely
lies somewhere in between. The prospectuses for the funds offered clear caveats
that "there is a risk that an investment in the fund will be lost entirely
or in part." And the degree of leverage was described in detail in monthly
reports sent to shareholders.
say Bear Stearns went out of its way to downplay the risk. A half-dozen investors
and their lawyers contacted by BusinessWeek say most investors came away from
meetings with Bear officials believing that the funds were "very conservative"
and "low-risk" ventures that promised "no loss of principal."
In a due diligence survey submitted to the Alternative Investment Management
Assn., which collects information on funds' strategies and passes it along
to investors, Bear's managers said they had taken a number of steps to reduce
risk during a "financial crisis or a broad deterioration of credit quality."
They also said the market for CDOs was "fairly liquid."
The 2006 audited
financial statement for the hedge funds, prepared by Deloitte & Touche,
tells a different story. An auditor's letter, dated Apr. 24 and sent to investors
in May, just as the funds were collapsing, notes that 70% of the funds' net
assets consisted of securities whose values were estimated by the fund managers
"in the absence of readily ascertainable market values." The auditors
warned that the difference between the real values and Bear's estimated ones
"could be material."
to believe the sunny sales talk. And not only outsiders: Bear also marketed
the funds to its own brokers during internal "road shows." Bergman
manages about $1.2 billion for some of Bear's wealthiest clients and ranked
37th among U.S. brokers in a 2006 survey published in Barron's. People who
know him say he was so convinced by the sales pitch that he put around $1
million of his own money into the funds and recommended that some three dozen
clients do the same.
Three of them
have since filed complaints. Nelson A. Boxer, an Alston & Bird lawyer
who is representing Bergman, says the broker "has never had a customer
complain about him or an investment" before this incident. In a regulatory
filing describing the complaints against him, Bergman deflects blame for recommending
the funds, arguing that the customers in question "relied upon communications
from the fund's portfolio manager" in making their investment decisions.
allegations could prove embarrassing for Bergman and Bearespecially
if investors can prove the sales pitch was a curveball. Then again, the big-league
investors buying into the risky funds should have seen it coming.
photo: I saw one of these black outfits on the streets of New York
recently. My first time. Black gloves. Black socks. The whole bit. I was stunned.
It was hot and humid. I felt for the woman. It must have been horribly uncomfortable.
Lawyer on Vacation
A lawyer was on vacation in a small farming town. While walking through
the streets on a quiet Sunday morning, he came upon a large crowd gathered by
the side of the road.
Going by instinct,
the lawyer figured that there was some sort of auto collision. He was eager
to get to the injured parties but couldn't get near the car. Being a clever
sort, he started shouting loudly, "Let me through! Let me through! I am
the son of the victim."
The crowd made
way for him. Lying in front of the car was a donkey.
A farm boy accidentally overturned his wagonload of corn. The farmer
who lived nearby heard the noise and yelled over to the boy, "Hey Willis,
forget your troubles! Come in and visit with us. I'll help you get the wagon
"That's mighty nice of you," Willis answered, "but I don't think
Pa would like me to."
"Aw come on boy," the farmer insisted.
"Well okay," the boy finally agreed, and added, "but Pa won't
After a hearty dinner, Willis thanked his host. "I feel a lot better now,
but I know Pa is going to be real upset."
"Don't be foolish!" the neighbor said with a smile. "By the way,
where is he?"
"Under the wagon!"
case of anal glaucoma
A woman calls her boss one morning and tells him that she is staying
home because she is not feeling well.
matter?" he asks.
"I have a
case of anal glaucoma," she says in a weak voice.
She replied, "I
can't see my ass coming into work today."
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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