Thursday links: blog bashing

Stocks driving the Nasdaq rally.  (Big Picture)

Momentum is one of the great puzzles of finance.”  (Buttonwood)

Many think that learning to trade the charts is the key to success. Nothing can be further from the truth. While TA can be very helpful, it is actually money management that is what separates the eventual winners from the losers.”  (beanieville)

Earnings aren’t everything.  Revenue continues to lag.  (Bespoke, Clusterstock)

Warren Buffett has changed his mind about his Moody’s (MCO) position.  (Jeff Matthews also 24/7 Wall St., WSJ, FT Alphaville)

“While cheap options volatility may not prove a good buy all that fast, it does provide an excellent way to hedge.”  (Daily Options Report also EconomPic Data)

Is the endowment investment model broken?  (World Beta)

A new emerging markets ETF joins the fray.  (IndexUniverse, greenfaucet also Random Roger)

A new absolute return mutual fund launches (with a 3 year track record) with a focus on fixed income markets.  (FinAlternatives)

TIPS serve as a good hedge to equity positions.  (SSRN)

Does a covered call strategy for commodities make sense?  (Minyanville)

Black Swan investing is a sucker’s game, endemic in markets, a perennial loser, and highlights asset classes to avoid, not pursue.”  (Falkenblog)

Some wisdom from Seth Klarman. (Distressed Debt Investing)

The worm has turned.  Analysts want Morgan Stanley (MS) to take more risk.  (Clusterstock also WSJ)

Goldman Sachs (GS) treads carefully when buying back its TARP warrants.  (Breakingviews, Atlantic Business, The Stash)

GE (GE) is making the most of the government’s largesse.  (Clusterstock)

Is Wall Street risking the ire of Washington by boosting compensation so soon after the crisis?  (WashingtonPost)

The credit rating agencies get a slap on the wrist from the Treasury Dept.  (Atlantic Business)

A Consumer Finance Protection Agency could reassure “burned consumers.”  (Economix)

Home inventories continue to fall.  (Calculated Risk)

To what degree does a “power elite” influence American business (and society)?  (Economist’s View)

Some additional detail on how Harvard manages (or not) its interest rate exposure.  (Greg Mankiw)

An interview with Trader Mark of Fund My Mutual Fund.  (Wall St. Cheat Sheet)

Will Covestor Investment Management be the next big thing?  (Bull Bear Trader)

Do financial journalists bend over backwards to be fair?  (Curious Capitalist)

Blog basher Dennis Kneale profiled.  (New York Observer via Dealbreaker)

Does CNBC bash bloggers as a matter of policy?  (Daily Options Report, Condor Options, Mediaite)

Investment blogs worth more than five seconds of your time.  (My $10,000)

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Wednesday links: earnings vs. revenues

“Bonds not only have outperformed stocks by a large margin over the past year because of the financial crisis, but also roughly matched stocks over the past 40 years. This begs the question, will bonds continue to outperform?”  (Morningstar)

Taking a closer look at the relationship between risk taking in the bond market and stock returns.  (Condor Options)

The market has risen on the back of better than expected earnings releases.  (Bespoke)

However, companies continue to miss on the revenue line.  (The Pragmatic Capitalist)

How is the Endowment Model doing through the first half of 2009?  (World Beta)

Is the timing right for a stock replacement strategy?  (Bull Bear Trader, WSJ)

Volatility is as low as it has been since September.  How to play it.  (Daily Options Report)

One brokerage firm, Edward Jones & Co., is going to stop trading leveraged ETFs. (WSJ)

Ban levered ETFs, because “..people will NEVER fully understand how these products work…”  (iBankCoin)

“..when we’re using the relative performance of two assets to come to a conclusion about just one of those assets, we have to make sure that we’re not confused by the inherent nature of traded asset itself.”  (MarketSci Blog)

The curious case of hedge funds (and Harvard) during the economic crisis.  (Abnormal Returns, ibid)

Hedge fund fees are coming under pressure.  (All About Alpha)

What role do unrealized capital gains have on the returns to a momentum strategy?  (SSRN)

Some less than positive news for crude oil.  (FT Alphaville)

Apple (AAPL) and Google (GOOG) are now neck-and-neck in terms of market cap.  (Newsweek)

Big investors cry foul because high frequency trading is costing investors millions.  (FT, Clusterstock, Zero Hedge)

Goldman Sachs (GS) is free of the clutches of the Treasury Department.  (24/7 Wall St.)

“But Morgan Stanley (MS) still doesn’t know what it wants to be. And an unclear mission is not good for any business — especially one stuffed with big egos and big paychecks.”  (Mean Street)

“Is there anything to salvage in the last 60 years of financial innovation post-crisis?”  (Rortybomb)

Martin Feldstein on the risks of a double dip recession.  (Big Picture, Fund My Mutual Fund)

“I fear that the United States government is mistakenly assuming that it can borrow essentially unlimited sums without undermining confidence in the dollar itself.”  (Econbrowser)

Maybe everyone just expects too much from economics. It’s not rocket science. It’s more a question of what defines sensible and decent behavior, and then devising incentives to get people to behave accordingly.”  (Emanuel Derman)

Private equity has become the land of second chances for former corporate titans.  (peHUB, Dealbreaker)

An interview with the acerbic “The Fly.”  (My $10,000 Dollars)

A guide to keeping track of the econoblogosphere on Twitter.  (Real Time Economics)

A new book chronicles the dissent inside Lehman Bros. prior to its demise.  (Deal Journal, Dealscape)

The investment “junk mail indicator” is heating up.  (Kirk Report also Clusterstock)

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Harvard and hedge funds

Just to show how quickly things move in the blogosphere we already have some follow-up items to yesterday’s post:  The curious case of hedge funds during the financial crisis.  In that piece we cited an article, “Rich Harvard, Poor Harvard” by Nina Munk at Vanity Fair (which is now online in full).  In that article she discusses the financial pressures Harvard University has come under due in no small part to some bad interest rate bets by Harvard’s former president Larry Summers.

Joe Weisenthal at Clusterstock details the shrinkage in the endowments at both Harvard and Yale.  The implicit story being that alumni will need to step up to the plate to help these institutions.  The problem at Harvard is the rise in interest rate expense.  That interest coming from bonds issued to help cover some holes in the Harvard budget.

The Epicurean Dealmaker has a post up that shows the lengths to which Harvard went to “hedge” its future interest rate costs.  The problem being that Harvard in trying to hedge borrowings which had not even occurred was in fact speculating on interest rates.  TED writes:

Entering into a forward start swap for debt you do not intend to issue up to 20 years in the future sounds like either rank hubris or free money for Wall Street swap desks.

There is some speculation amongst Beltway-types that Larry Summers is being considered to take over as Federal Reserve Chairman when Ben Bernanke’s term is up in 2010.  Whoever still advocates this should read up on Summer’s disastrous turn at Harvard.

Were it not for the need to continue funding their private equity investments Harvard and their elite endowment brethren should be cleaning up on their hedge fund investments.  Hedge funds are in a certain sense back.  Gregory Zuckerman at the WSJ who writes:

Hedge funds are enjoying their best period in a decade. One reason: Wall Street firms are pulling back from their own “proprietary” trading, meaning less competition.

Douglas A. McIntyre at 24/7 Wall St. notes the quick resurrection in hedge funds.  Despite being only a few months removed from disastrous performance investors are jumping back into hedge funds.

The improvement in the prospects of hedge funds is a reminder of how short the memories of investors can be. March was as bad a month as most investors had experienced in a generation or longer.  March is only a little over 100 days gone.

As we discussed in our post the hedge fund model has emerged on the other side of the financial crisis largely intact.  This allows hedge funds to benefit from heightened investor demand.  It is ironic that Harvard is now being shown to be a casualty of the financial crisis.

As noted in the Vanity Fair piece Harvard excelled for some time in managing its own hedge fund-like portfolios.  The endowment had to pull back from this practice when its compensation practices came under fire.  The idea of paying hedge fund-like compensation to managers who had no ownership and none of their own capital at risk rankled many in the Harvard community.

This principle of connecting fund performance, compensation and ownership may be the reason why the hedge fund model survived.  It provides both the manager and investor some sense that they are in the same performance boat together.  When you try and shoehorn a hedge fund compensation model into a non-profit like Harvard or a larger financial services institution like an investment bank there will inevitably be tension.

Maybe that is why it makes sense to apply the hedge fund model more widely across the financial services industry.  Let risky strategies and portfolios be managed by managers who have ownership and some proverbial skin in the game.  Let those institutions who have either an implicit or explicit guarantee from the government become ‘de-risked.’

The curious incident of hedge funds during the financial crisis

“Is there any point to which you would wish to draw my attention?”

“To the curious incident of the dog in the night-time.”

“The dog did nothing in the night-time.”

“That was the curious incident,”

from “Silver Blaze” a Sherlock Holmes story by Sir Author Conan Doyle.

The curious incident of which we speak is hedge funds during the economic crisis.

Prior to the crisis there were widespread fears that hedge funds would cause a global market hiccup.  According to analysts they were too big, traded too much and worst of all they made way too much money.   One need only look the list of the top paid money management execs to see that hedge fund managers made ungodly amounts of money.

There were fears that the many crowded hedge fund trades would lead to a LTCM-like meltdown. Flash forward two years to post-economic meltdown 2009.  Who would have thought that on the back side of an financial crisis that the hedge fund business model would emerge, while badly bruised, largely intact?

While the state of hedge funds is still a bit shaky with redemptions continuing to dog hedge funds.  However the value of assets under management increased in the second quarter of 2009.  This was due in large part to positive investment returns, but absent another leg down in the markets it seems that hedge funds may have seen the storm pass.

In hindsight it wasn’t unregulated hedge funds that blew up the global economic system, it was the banks.  Bank risk management systems failed.  Banks shoved assets into off-balance sheet entities that came back to haunt them.  It was the banks around the world were forced to seek bailouts from their respective governments.

Nor were hedge funds the main culprit behind the problems facing elite university endowments.  (See “Rich Harvard, Poor Harvard” by Nina Munk at  These endowments were viewed as the best investors around.  Amidst the crisis many endowments faced a cash crunch.  This crunch came from the unfunded commitments to private equity funds and the severe drop in cash returned by private equity funds to investors.  Hedge funds are viewed as a readier source of cash and have therefore seen redemptions.

It is not like the last two years have been easy for hedge funds.  A number of hedge funds blew up, including a number of high profile funds.  Many of the funds that did not close incurred investor redemptions that forced them to invoke various gating schemes to slow the outflow of capital.  And given their poor returns many hedge funds now sit way below their high water markets unable to draw incentive feeds.

On a smaller scale one could also look to the more regulated sector of the money management business for comfort.  Again, returns on nearly every asset class in 2008 were awful and are reflected in poor hedge fund performance.  This is prompting a reduction in the number of funds, but this process goes on absent much drama to the end user.

It is ironic that the purportedly least risky sector of the investment management business, money market mutual funds, were forced to seek government aid.  This was due in part to the implication that the funds would not break the buck, and if they did the management company would bail them out.  Come late 2008 it was clear that the managers could not make good on that implied promise.  Only the government could stanch the flow out of these funds that are viewed like regulated utilities.

The hedge fund industry is made up a variety of investment strategies and levels of risk.  The term hedge fund is of course a misnomer.  Hedge funds, or private investment funds, are better described as risky funds.  Most investors recognize when they put their capital into the fund that their capital is at-risk.  Some strategies are designed to be lower risk, but there exists the potential for losses.  However absent fraud, investors will realize returns dependent on the markets and the skill of the managers.

There has been a great deal of talk recently about Goldman Sachs and the extraordinary profit performance the firm is showing just a few months removed having to be bailed out the government.  Goldman has been called just a big (levered) hedge fund.  The compensation practices certainly can compare to that of hedge funds.

However we need to view Goldman’s risk taking in a new light.  As a bank holding company viewed as too-big-to-fail Goldman should not be viewed as a hedge fund, or risky fund.  While Goldman may now feel comfortable (and overconfident) to do that, putting the US taxpayer on the hook for that sort of risk taking should be discouraged.

There are now clear lines of distinction between the banks and their explicit and implicit federal guarantees and hedge funds.  During the crisis, hedge funds have closed (and opened) on a routine basis.  The number of closings has accelerated during the crisis, but the process is with some exceptions, unremarkable.  However the failure of a large bank, like Goldman, would bring about a whole host of additional risks to the system.

That’s it may make sense to “de-risk” Goldman and other banks so that they do not pose a future risk to the system.  If management (and shareholders) choose to stay in the riskier lines of business they can spin these operations off, removing these risky funds from the purview of the bank structure.

The hedge fund industry has seemingly escaped much in the way of additional regulation in the administration’s proposed legislation.  Under the Obama plan hedge funds would be required to register with the SEC as investment advisers and provide additional position information, but beyond that they would operate as before.

Although hedge funds have escaped the worst of the financial crisis, that is not to say that hedge funds don’t have their own problems to deal with.  Once investor redemptions are taken care of there is a whole host of outstanding issues.  The first of which is the demise of the fund of fund.  That structure is now being shunned by investors due to poor performance and the layering of fees on top of fees.

Speaking of fees that may be the one area most in need of change.  The standard fee structure of 2&20 seems generous in light of an interest rate environment of nearly 0% short-term yields and a 4% ten-year bond.  In addition, incentive fees probably need to be calculated against some sort of benchmark that isn’t 0%.  See this story by Cyrus Sanati at DealBook about a start-up hedge fund that is taking a new approach with lower fees and enhanced liquidity.

Hedge funds continue to close despite the seeming end of the financial crisis.  That is in part because many funds are so far below their high water marks that they little chance of earning performance fees any time soon.  Many of those managers re-open their funds to escape this trap.  That is why people like high profile managers like John Meriwether and T. Boone Pickens continue to operate.   While perplexing this an investor problem more than a hedge fund structure problem.

When you invest in a hedge fund you should recognize that this is a risky proposition.  The hedge fund model, while bruised and in need of a bit of an overhaul, came through the crisis largely intact.  The same cannot be said for large swaths of the rest of the financial services industry.  Perhaps it is time we applied the lessons of hedge funds to the rest of the industry by clearly delineating those institutions that should be free of risk to the taxpayer and riskier firms like hedge funds that are clearly known to be at-risk investments.

Tuesday links: incremental yield

Anything with incremental yield is on fire.”  (Across the Curve)

High yield spreads are nearing pre-Lehman bankruptcy levels.  (Bespoke)

Nearly 80% of stocks are above their 50 day moving average.  (Financial Ninja)

Semi-annual Fed chair testimony often marks market turning points.  (Sentiment’s Edge)

Is capital structure arbitrage back?  (Zero Hedge)

Auditioning replacements for Russia in the BRIC scheme.  (The Reformed Broker)

On the challenges of using VIX products to hedge a portfolio.  (TheStreet)

What David Einhorn has been buying.  (market folly)

Traders learn from their losses, not their gains. (Aiki14)

You cannot trade every ETF the same way.  (ETF Trends)

General Electric (GE) before and after Jack Welch.  (Value Expectations)

Secondary offerings come back in a hurry.  (24/7 Wall St.)

SPACs have been unable to get deals done.  (Breakingviews)

Are there common factors driving non-fuel commodity prices?  (SSRN)

Conceptualizing the EMH as there being “no free lunches.”  (Baseline Scenario)

Cheap government capital is allowing “Goldman to speculate on trades that would normally be too risky.”  (Clusterstock)

“Was the TLGP really just a GE bailout?”  (Clusterstock)

“Just how much could the bailout of the financial system end up costing American taxpayers?”  (NYTimes also EconomPic Data, MarketBeat)

Ben Bernanke, “We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.”  (WSJ also Economist’s View)

Andy Lo, “The implications of the AMH for regulatory reform are significant. Markets can be trusted to function properly in normal times, but if humans are subject to emotional extremes, animal spirits may overwhelm rationality, even among regulators and policymakers.”  (FT also Dealscape)

Elizabeth Warren defends the Consumer Financial Product Agency.  (Baseline Scenario)

“The “quality” of the financing of the US deficit has gone down.”  (Brad Setser)

Is small cap a viable alternative to US private equity?  (SSRN)

VC funding is on pace to return to pre-Internet bubble levels.  (Bits)

An interview with proprietary trader Mike Bellafiore of SMB Capital. (Wall St. Cheat Sheet)

David Wessel’s “In Fed We Trust” gets a rave review.  (NYTimes)

In praise of diversity in economic journalism. (Curious Capitalist)

“Undeniably, there is money to be made in digital publishing with free reader access, but whether that revenue leads to profits depends upon the scale and scope of the organization.”  (Daring Fireball)

“If the human tongue has a secret password, then this sweet, salty and fatty breakfast sandwich [McGriddle] is the code.”  (Frontal Cortex also Atlantic Business)

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Monday links: innovation indigestion

How much financial innovation is desirable?  (Baseline Scenario, Curious Capitalist, Felix Salmon, Free exchange)

More sentiment measures.  (The Pragmatic Capitalist, The Technical Take, TraderFeed)

T. Boone Pickens takes another shot at the hedge fund biz.  (market folly)

CIT Group (CIT) lives, for now.  (Calculated Risk, Felix Salmon)

Fortress Investment Group (FIG) is behind the eight ball.  Good thing their new Chairman is the former CEO of Fannie Mae.  (WSJ)

The risks of high frequency trading have been known for some time now.  (Zero Hedge, ibid)

Did Blackrock (BLK) pay too much for BGI?  (Institutional Investor)

Using Dr. Brett as a virtual trading adviser.  (A Dash of Insight)

Doug Kass reviews his 20 surprises for 2009.  (TheStreet)

Why do people listen to Nassim Taleb?  (Locklin on science via aleablog)

Countries with higher levels of individualism tend to demonstrate more price momentum.  (Journal of Finance)

Taking a closer look at Richard Tortoriello’sQuantitative Strategies for Achieving Alpha.”  (CXO Advisory Group)

The number of skilled mutual fund managers has decreased over time.  (Journal of Finance)

No wonder toxic assets are so difficult to price.  (WSJ)

The collapse in commercial real estate is going to take a toll on smaller regional banks.  (WSJ, Clusterstock, ibid)

“In the midst of this downturn, some of the biggest players in the economy—state and local governments together account for about thirteen per cent of G.D.P.—will be doing precisely the wrong thing.”  (New Yorker)

The state of California needs all the revenue it can get.  (Gregor Macdonald)

States are seeing revenue shortfalls.  (EconomPic Data)

“Guarantees operate as budgetary time bombs.”  (Clusterstock)

Why housing hasn’t bottomed yet.  (Big Picture)

Does Jamie Dimon hold the fate of the proposed Consumer Financial Protection Agency in his hands?  (Baseline Scenario also New York)

Is the New York Fed populated with too many former Wall Streeters?  (WashingtonPost)

An upside to the economic crisis.  The US trade deficit has been cut in half.  (Brad Setser)

TIPS-implied inflation is back on the march.  (Capital Spectator)

Imperfect models of risk ought to be better than no models at all but the evidence so far is that this isn’t the case – people abrogate their responsibilities and start putting unjustified faith in the models rather than thinking for themselves.”  (The Psy-Fi Blog)

Malcolm Gladwell, “From an individual perspective, it is hard to distinguish between the times when excessive optimism is good and the times when it isn’t. All that we can say unequivocally is that overconfidence is, as Wrangham puts it, “globally maladaptive.”  (New Yorker)

Business news is booming.  Business magazines are not.  (Time, Mediaite)

A couple of thoughts on blogging.  (Abnormal Returns)

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Random thoughts on blogging

We always enjoy it when we see similar ideas expressed by different authors in different settings.  The first quote is in regard to academic-style writing for financial practitioners and the second a talk given to journalists about blogging.

..I’ve written articles that I thought were wonderful and critical, and they have gone unnoticed down the path of time. I also wrote articles that I thought were interesting observations. They were conjectures, and they caught a little bit of fire.  They burned for a while, and they attracted enough attention to win Graham & Dodd Awards.

Martin Leibowitz quoted in “Popular Science,” CFA Magazine, July-Aug 2009, p. 40.

Often bloggers are the worst judges of their own work; I can give you hundreds of personal examples of blog entries I thought were really good which disappeared all but unnoticed, and of blog entries I thought were tossed-off throwaways which got enormous traction and distribution. Mostly, blogging is a lottery on the individual-blog-entry level — and if you want to win the lottery, your best chance of doing so is to maximize the number of lottery tickets you buy.

Felix Salmon, Notes on blogging for journalists.

We have had very similar experiences blogging.  We are often surprised by what posts gain traction and which linkfest items end up being clicked on the most.

We have noted previously how investment blogging is difficult.  This is in part due to the fact that “success” however defined is a slippery beast.  It seems to be nearly impossible to tell ahead of time whether a post is going to capture the interest of a wider readership.

That is why Felix’s advice may be best.  Just write all your ideas down.  You never know which one just might be a hit.

Sunday links: Internet investing

The Internet is dead as an investment.  (WSJ contra A VC)

2009 has been a good year for semiconductors.  (Bespoke, StockCharts Blog)

A round-up of investor sentiment measures.  (Trader’s Narrative)

Which is the better world equity ETF?  (greenfaucet)

Charles Schwab (SCH) is getting into the ETF business.  (Investment News)

Keeping tabs on hedge fund letters all in one place.  (Hedge Fund Letters)

Getting people save more, by helping them gamble.  (WSJ)

Explaining the equity risk premium, using a better measure of consumption, i.e. garbage.  (Real Time Economics)

On the discrepancy between natural gas and crude oil prices.  (Econbrowser)

Just how much might a firm like Goldman be making from high frequency trading?  (Zero Hedge)

Goldman should give up its government support or part of its profits.  (Barron’s, Matthew Goldstein)

Why are we surprised that the banks are showing profits?  That was the plan all along.  (Free exchange, Atlantic Business)

Are investment banks run for employees or shareholders?  (Barron’s, Economist)

Investment banking execs, “You have the best excuse in the world right now to screw over your employees.”  (Epicurean Dealmaker)

This is the moment were we take the training wheels off the economy. We had to do it at some point. We had to eventually send a message to the world of finance that not everything was going to be bailed out.”  (Accrued Interest)

On the dark side of leverage.  (Atlantic Business)

Why isn’t anybody listening to economist Joseph Stiglitz?  (Newsweek via Economist’s View)

There will likely be two bottoms for the housing market.  (Calculated Risk)

“If a consumer agency had been set up 20 years ago, would the subprime mortgage crisis have been prevented“  (NYTimes)

Hope will not end the recession.”  (Howard Lindzon)

Is China really growing at 8%?  (The Big Money)

Crowdsourcing works when it is focused.  (NYTimes)

If you think you are unbiased, think again.  (Aiki14)

An interview with the pugnacious Charlie Gasparino.  (FT)

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Friday links: conflicting signals

The 200 day moving average will soon start dropping some substantially higher prices.  (VIX and More)

Idiosyncratic moves in volatility indices require confirmation.  (Condor Options)

Option strategies for the United States Natural Gas Fund (UNG).  (Barron’s)

Are (option) collars the solution to what ails asset allocation?  (Minyanville)

Conflicting signals persist in the corporate-bond market. While demand is outstripping supply for new deals, the creditworthiness of the market as a whole continues to slide.”  (WSJ)

Just what is a “trend day“?  (Fund My Mutual Fund)

How the hedge fund boom and bust paralleled that of the dot-com bust.  (All About Alpha)

The right questions to ask about position sizing.  (Minyanville)

There are plenty of things to worry about.  Fed policy is not one of them.”  (A Dash of Insight)

According to financial theory Google (GOOG) should lever up.  (Clusterstock)

Intermodal rail traffic is still in the dumps.  (The Pragmatic Capitalist)

Getting the housing starts statistics correct.  (Big Picture)

What “sticky” housing prices mean.  (Calculated Risk)

How useful is the price-to-rent ratio for spotting housing bubbles?  (Baseline Scenario)

“In sum, the economy has a raft of problems that will take a long time to resolve. But none of them can head off the imminent economic recovery that ECRI’s objective leading indexes are promising today”  (Big Picture)

How much blame for the economic crisis should we put on the Efficient Markets Hypothesis?  (Economist)

Cognitive biases are an embarrassment of riches that lead everywhere and nowhere.” (Falkenblog)

“Of all the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself.”  (Economist)

What role did income inequality play in the housing boom.  (The Stash)

A big way, food expenditures, how this downturn is unlike the Great Depression.  (Carpe Diem)

Central bank independence is overrated (and unrealistic).  (Aleph Blog contra Economist’s View)

What does “too big too fail” really mean?  (Atlantic Business)

The many ways in which Goldman Sachs (GS) continues to benefit from government largesse.  (True/Slant)

“I doubt that Goldman is making much of its money from high frequency trading.”  (Rick Bookstaber)

Goldman is getting to have its cake and it too.  (Abnormal Returns)

The rhetoric around Goldman Sachs has lost touch with reality.  (Free exchange)

The Daily Show takes on Lenny Dykstra and Goldman Sachs.  (Wall St. Cheat Sheet, Zero Hedge)

A book review of “Street Fighters.”  (market folly)

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Goldman is a little bit pregnant

As the credit crisis rolls on it scoops up villains and victims on a regular basis.  This week Goldman Sachs became, according to whom you read, both.  After announcing blow out earnings the debate over the role of Goldman in the credit crisis began anew.  (A good round-up of much of this debate.)

Prior to the earnings report Goldman had already been a topic of conversation due to a piece by Matt Taibbi in Rolling Stone that characterized the firm as a “vampire squid” that has had a role engineering many of the recent market bubbles for their own benefit.

This meme had penetrated the mainstream media and the backlash is at hand.  No firm wants to see it self pilloried on television by the likes of Bill O’ReillyGlenn Beck and Jon Stewart.  In addition, some people like Janet Tavikoli are calling for Goldman to remit to the Treasury some of the profits it has earned in the form of a “bailout tax“:

The American public is owed part of the profits Goldman was able to make because of the largesse of our Congress.

What has drawn the most attention are the plans Goldman is making for compensation.  If current trends continue Goldman is back on track to pay pre-crisis like bonuses in 2009.  The firm seemingly recognizes this by trying to fudge their employment figures to make the per-employee statistics seem more benign.

Goldman’s stock is nearly back to where it was prior to the economic crisis, and it is one of the best peforming stocks in 2009.  So for now, shareholders are happy with the status quo.  However that status quo includes a compensation system favors the few over shareholders.

According to statistics from Yahoo! Finance Goldman insiders own some 14% of the company.  Certainly higher than many companies, but by no means does it represent a controlling stake.  In contrast, institutional investors own some 68% of the stock.  John Carney at Clusterstock in an interesting article documents the way in which Goldman allocates its bonus money.  Despite the gaudy per-employee statistics, the fact is that

The biggest hitters get to eat the most pie.

It’s this contrast between private reward and public risk that gets to the heart of the matter.  Because Goldman would not exist in its current state were it not for the beneficence of the Federal Government.  Again Matt Taibbi, this time at True/Slant, notes the many ways in which the firm has benefited from a raft of government programs.  That has not fazed the company. In a piece by Robert Reich highlights comments from Goldman officials saying their “business model has not changed.”

To some degree, there is some scapegoating going on.  Goldman was not alone in this pursuit of growth and profits.  It was endemic to the industry.  The Epicurean Dealmaker writes:

In fact, I would argue that investment banking’s obsession with growth, as an industry, has contributed immeasurably to the enormity of the systemic clusterf**k in which we currently find ourselves entangled.

Now Goldman by dint of its many connections in the government is an obvious target.  However the firm has its supporters.  Erik Falkenstein at Falkenblog notes that Goldman generates alpha, and that alpha is going to get attributed to the firm’s employees whether we like it or not.  The Economist notes that much of Goldman’s profits came not from proprietary trading but from simple market making that has become more profitable as its competitors pull back.  Justin Fox at the Curious Capitalist writes:

At Goldman the focus has been on hiring the smartest group of people employed by any American institution, and putting  them to work—in the most collegial atmosphere of any major Wall Street firm—in the relentless pursuit of arbitrage opportunities (a.k.a. money).

Many of Goldman’s supporters would like us to believe that Goldman is simply playing the game smarter than the rest of its competiton.  However, that game is not being played on a level playing field.  It is some sort of hybrid where politics intersects with finance.

So in this post-crisis(?) era what exactly is Goldman Sachs?  One could argue it is too big, too risky and too greedy.

Is Goldman too big?  Let’s pose the question another way.  Does any one doubt that if Goldman announced it was in trouble, would it not get bailed out?  The only question would be how quickly it happened.  Many both in and out of government view Goldman, as currently constructed, as being too big to fail.

Is Goldman too risky?  Let’s look at Goldman’s publicly announced risk profile.  Felix Salmon and his colleague John Kemp at Reuters show that Goldman is now taking more risk with its portfolio than it ever has.  The firm does not seem at all chastened by the past year.  It may very well be the case that Goldman sees opportunities in the wreckage of its competitors.  Taking advantage of that situation is fine, but now that risk is being borne, in part by the US Treasury.

Is Goldman too greedy?  Robert Lenzner at Forbes writes in a “paean to its leadership”:

The Goldman Sachs culture is brilliant, but it’s long-term and short-term greedy.

The fact of that matter is that the current crisis represents a great opportunity for the firm to ratchet down its compensation expenses if it so chose.  The argument for high compensation is that competitors will poach their best employees.  Goldman’s competitors:  other Wall Street firms, hedge funds and private equity firms are today all hamstrung.  Goldman employees can’t easily walk across the street for a boost in pay.  So the firm is seemingly happy to return to the pre-crisis, status quo of 2006-2007.

Like the ending to some bad soap opera, Goldman and its supporters would like us to pretend that that the past year never happened.  That Goldman, like its competitors, did not get caught up in the vortex that was the credit crisis.  That it did not receive both direct and indirect government aid when it needed to.  That Goldman was in fact mortal.

The problem for Goldman is that it now needs to deal with the consequences of those decisions.  As the saying goes:  “You can’t be a little bit pregnant.”  Either Goldman is a too big to fail bank holding company that needs to bring its risk profile in line with other banks.  Or it is a shining example of capitalism that in theory existed a year ago.  In that case it needs to remove itself from explicit and implicit Federal guarantees.

One need only look at this headline from humorist Andy Borowitz to see which way the wind is blowing:

Goldman Sachs in Talks to Acquire Treasury Department

To be realistic neither its shareholders nor the government is going to force Goldman to make any tough choices in the near future.  Regulatory reform seems stalled at the moment, in part due to the need to explain this situation.  So for now Goldman will get to have its cake and eat it too.  For that, it will continue to be the poster child for much of what is wrong with the current system.

*No position in Goldman Sachs (GS).

Thursday links: obsession with growth

The VIX is up.  Should we be worried?  (Research Reloaded, Daily Options Report, VIX and More)

Catching up with June hedge fund performance.  (market folly)

Investor sentiment is still weak.  (Bespoke)

“The ProShares Credit Suisse 130/30 (CSM) fund falls under the realm of actively managed funds.”  (TheStreet)

The State of Massachusetts begins sniffing around leveraged ETFs.  (WSJ also IndexUniverse)

Is natural gas dropping due to a freeze in share issuance at the United States Natural Gas Fund (UNG)?  (WSJ)

“Some people on Wall Street are suggesting that Goldman Sachs inflated its staffing numbers to deflate its compensation figures per employee.”  (DealBook)

How pay works at Goldman Sachs (GS).  (Clusterstock)

The debate (in full) over the Matt Taibbi-penned Goldman Sachs story.  (The Opinionator, Rolling Stone)

It turns out that CIT Group (CIT) really was too small (and lent to the wrong firms) to get bailed out. (Baseline Scenario, Matthew Goldstein)

Prepare for the backlash against letting CIT Group fail.  (Clusterstock, Jeff Matthews)

“I would argue that investment banking’s obsession with growth, as an industry, has contributed immeasurably to the enormity of the systemic clusterf**k in which we currently find ourselves entangled.”  (Epicurean Dealmaker)

What role does cognitive ability play in testing behavioral finance?  (The Psy-Fi Blog)

Calpers vs. the rating agencies.  (FT Alphaville, Atlantic Business)

Are banks forced to grow due the commoditization of its core businesses?  (Dealscape)

The slack in the economy is profound.  (Atlantic Business, EconomPic Data)

It is worth maintaining the fiction that the Federal Reserve remain independent?  (Breakingviews, Real Time Economics, Crossing Wall Street)

Interviews with traders Anni Virag and aiki14.  (Wall St. Cheat Sheet, My $10,000)

Jim Cramer is now an internet hack shill.”  (Falkenblog)

How CNBC makes money these days.  (Zero Hedge)

Econblogs have become the darlings of the blogosphere, including a list of 25 top econoblogs.  (WSJ, Real Time Economics)

Abnormal Returns is a proud member of the StockTwits Network.

Wednesday links: bonus backlash brewing

Goldman Sachs (GS) risks a backlash if it pays out record bonuses.  (Clusterstock, Breakingviews, Bespoke)

Goldman is just better than their competition. (Curious Capitalist, Economist)

For investors, there is nothing to be gained by moaning about Goldman.  (Andy Swan also Falkenblog)

Goldman doesn’t always win.  It fails to get taken down.  (Telegraph)

The equity risk premium is no longer a puzzle.  (Aleph Blog also Crossing Wall Street)

An interesting development in volatility land.  (Daily Options Report)

Leveraged ETFs based on factor returns are on their way.  (IndexUniverse)

On the never ending risks of 3x leveraged ETFs.  (Aiki14)

With all the ETFs out there, is there room for three proposed funds?  (Morningstar)

Is a 130/30 ETF in your future?  (Bull Bear Trader)

On the importance of checklists in investing and more from the Value Investing Seminar.  (Manual of Ideas)

Seven questions for Roger Ibbotson.  (All About Alpha)

J.P. Morgan (JPM) is feeling a bit frisky these days.  (WSJ, Clusterstock)

How did CIT Group (CIT) become too big to fail?  (Baseline Scenario also The Stash)

The ratings agencies should be very nervous.  (Big Picture)

California muni bonds have held up during the never ending budget crisis.  (ROI also Money &Co.)

Splitting investment and commercial banking vs. a cap on bank size.  (naked capitalism)

When you are the market, stop buying.  (WSJ)

The recession may be over soon, but the good times are a ways off.  (Calculated Risk)

Is Robert Rubin the modern day Robert McNamara?  (WashingtonPost via peHUB)

Is there a market for subscription-based financial commentary? (Felix Salmon)

Taking a look at add-on programs that make using Twitter easier.  (WSJ)

Abnormal Returns is a proud member of the StockTwits Network.

Tuesday links: risk and no return

For all practical purposes, is the equity risk premium actually zero?  (Falkenblog)

“If a certain strategy [asset allocation] worked for your grandparents, that’s probably a good reason that it won’t work for you”  (Felix Salmon also Random Roger)

Goldman Sachs (GS) reports:  blow-out earnings, higher trading risk and bigger bonuses.  (Clusterstock, Zero Hedge, FT Alphaville)

Goldman shares are now a big bet on credit.  (Big Picture)

Does Goldman owe us anything for saving them from the credit crisis?  (Curious Capitalist)

AQR is launching momentum-based mutual funds.  (WSJ, Bull Bear Trader)

Never turn a hedge into a trade.  (Minyanville)

Adding diversification via single country ETFs.  (TheStreet)

When your hedge fund tracker looks like a portfolio of ETFs. (FT Alphaville)

“Do absolute mutual funds follow such a market neutral, zero beta investment strategy? The answer is resoundingly no.”  (Morningstar)

How often should the publicly traded hedge fund managers disclose fund performance?  (WSJ)

How the Dollar Menu saved McDonalds (MCD) and why it may be a burden going forward.  (ScienceBlog)

CIT’s bailout possibilities are now in the realm of political choice.”  (Baseline Scenario also Market Talk)

Are speculators to blame for high oil prices?  (WashingtonPost also Daily Options Report)

Two top economic forecasters see an end to the recession.  (Slate)

Nassim Taleb says let’s save the global economy through debt-for-equity swaps.  (Clusterstock, Felix Salmon)

Shadow banking revisited.  (Economist’s View)

On the difference between stupidity and villainy in the current credit crisis.  (Megan McArdle)

The factors driving the parallels between our spending on animal health and human health.  (The American also Megan McArdle, Greg Mankiw, Casey Mulligan, EconLog)

Why the Feds will end up bailing out California and every other state in trouble.  (Gregor Macdonald)

Closing the loop.  Allowing online analysts to manage real money. (New Rules of Investing)

Part two of an interview with Barry Ritholtz.  (Wall St. Cheat Sheet)

Is Business Week worth only $1?  (FT)

Reviews of The Myth of the Rational Market and Snap Judgment. (Aleph Blog, Investing with Options)

CNBC doesn’t like it when you call them an accessory to stock manipulation.  (The Reformed Broker)

It’s almost as if Lenny Dykstra never worked for  (Dealbreaker)

Abnormal Returns is a proud member of the StockTwits Network.

Monday links: second stimulus

“But to a degree unique among its peers, Goldman has turned the crisis to its advantage.”  (NYTimes also Big Picture, Clusterstock)

It’s taken some time for Jeremy Siegal’s work to come under scrutiny.  (Crossing Wall Street)

CIT Group (CIT) is GE Capital absent government support.  (Breakingviews, WSJ)

Why bother with energy futures with regulatory uncertainty on the horizon.  (FT Alphaville)

What are they going to do with all that bulk shipping coming on line in 2010?  (Research Reloaded)

Andy Lo, “Institutional investors have to start thinking on a daily time frame, because of the financial arms race that has been developing over the last several years.”   (Pensions & Investments)

“Spending our time trying to second-guess the macroeconomic future is a hopeless task. The next crisis won’t look like the last, we won’t see it coming.”  (The Psy-Fi Blog)

“Of course, you don’t have to be a management consultant to know that simply projecting recent trends into the near future—forecasting by extrapolation—is dangerous, especially today, when volatility and discontinuities are rampant.”  (The Big Money)

Why pass a second stimulus bill when the first one hasn’t even been spent yet.  (Felix Salmon, Free exchange)

The consumer protection agency for financial products is dying on the vine.  (Baseline Scenario)

Is Cheesecake Factory (CAKE) a symbol of what is wrong with American dining?  (Ezra Klein)

Justin Fox podcast on the rationality of markets. (EconTalk)

We used to wonder if we could “untrain” a generation to steal. The answer is yes. Just make it easier to get the content they want and they’ll stop stealing.”  (A VC)

20 finance blogs you might not know about.  (MoneyScience)

How should bloggers get compensated?  (Atlantic Business, NYTimes)

How to crack into the blogging game.  (Felix Salmon, Baseline Scenario)

Why do we continue to elect well-known players past their prime to the baseball All-Star game?  (Newsweek)

Seems apt.  The Chicago Cubs may declare bankruptcy to facilitate a sale of the team.  (Dealscape)

Abnormal Returns is a proud member of the StockTwits Network.

Sunday links: parasitic trading

Just how long run does stock market data really run?  (WSJ also Big Picture)

The S&P 500 is up against all sorts of moving averages.  (dshort)

What are small investors buying now?  (Fund My Mutual Fund)

Checking in on investor sentiment.  (Trader’s Narrative, The Technical Take)

Is Berkshire Hathaway (BRK-A) stock finally cheap?  (Barrons)

“Over the past decade the move to electronic trading and pricing in pennies was heralded by Street insiders as a means to improve liquidity for clients. This appears to be a deception. Virtually every facility benefitted proprietary trading at a select few firms. Who’s the patsy?”  (Big Picture)

High frequency trading is “just another form of parasitic trading.”  (Zero Hedge also The Pragmatic Capitalist)

Did you know that noted finance professor Andy Lo runs a long-short mutual fund?  (NYTimes)

Are asset allocation models broken?  (Abnormal Returns also The Wallet)

Some practical thoughts on asset allocation.  (Aleph Blog)

More evidence that mutual fund investors are awful at market timing.  (NYTimes)

Who is your investment co-pilot?  (Abnormal Returns)

ECRI leading indicators are pointing up.  (Carpe Diem)

Wall Street is an arrogant beast that more than held up its half of the devil’s bargain which drove us into our current ugly straits.”  (Atlantic Business)

Is Charles Darwin a better precursor of economics than Adam Smith?  (NYTimes)

“The potential for information technology to improve productivity is still enormous, and we don’t need netbooks or cloud computing or new operating systems or quantum computers to get there.”  (Baseline Scenario)

Happy fourth blogiversary Eddy.  (Crossing Wall Street)

Why journalists should blog, and why your sales department should hire a blogger.  (Felix Salmon, Zero Beta)

Abnormal Returns is a proud member of the StockTwits Network.

Who Is Your Investment Co-Pilot?

Did you know that when US Airways Flight 1549 struck a flock of Canadian geese on takeoff Captain Chesley (Sully) Sullenberger was not flying the plane?  It was then he said:

“My aircraft,” and took the controls, not because he thought [co-pilot] Skiles couldn’t handle the job but because he was responsible for the airplane as the pilot in command.

(Quoted from the story of Flight 1549, “Anatomy of a Miracle” by William Langewiesche in the June 2009 Vanity Fair.)

Whether you like it or not you are the pilot in command of investment portfolio. You are responsible for its performance.   The question is:  who is your investment co-pilot?

Investors these days have a number of ways to get assistance with their portfolios.  You could delegate the management of your portfolio to others like an investment adviser.  You could follow the recommendations of any number of newsletter writers.  (A misnomer since they all now provide their reports via the Internet).  Or you could take on the task yourself and manage your portfolio.

The investment of choice for many individual investors is the exchange traded fund or ETF.  Even then we must recognize that this constitutes farming out your investment in that asset class.  This decision is not without risk because some ETFs are not exactly well designed.

Absent a few rugged individualists, we all rely on the results of other providers in some form or fashion.  The question is how much weight should we put on the track record of these investment advisers?

Recent research shows that in the face of “expert advice” parts of our brains involving “valuation and probability weighting” actually turns off.  In short we gave over our decision making ability to others providing “credible” advice.  (See this piece by Dan Ariely at Predictably Irrational.)

There is no shortage of recent examples where so-called experts led investors astray.  The Bernie Madoff scandal is one where investors ignored any number of red flags due in part to the impressive returns he was supposedly generating.   On a smaller scale one need only look at the notion that Lenny Dykstra was “110-0” in his picks for his premium options newsletter.  (We would recommend any one interested in the Lenny saga peruse the Lenny archives of the Daily Options Report by Adam Warner.)

Even in the regulated world of mutual funds it is easy to see how it is that we can get lead astray by a gaudy track record.  Bill Miller of Legg Mason Value was heralded for years for his streak of beating the S&P 500.  But the fact of the matter is that we should expect to see streaks like this arise out of chance.  We really can’t say with any sort of certainty whether Miller was lucky or good.  What we can say is that holding his fund for the past five years has been a disaster.  (See this piece by Jim Bianco at the Big Picture.)

The simple fact is that there are no guarantees in the financial world.  For years the concept of asset allocation was pitched as a way to smooth out portfolio returns while sacrificing little in terms of returns.  The recent economic crisis has put that notion into doubt.  (See our piece on the state of asset allocation these days.)

Howard Lindzon, co-founder of StockTwits, may have said it best:

There are no promises in the financial world. Track records are records of the past.

Which raises a sticky point.  All we have in the investment world are track records.  If we can’t rely on those, what can we rely on? A question for which there is no easy answer.

Once we dismiss the obvious frauds and blowhards the difficult work begins.  Due diligence involves getter a better sense for the inner workings of an investment operation.  For newsletter and mutual funds this is relatively straightforward.  For something more opaque like a hedge fund the work is far more labor intensive. The bottom-line being that investors need to have some sense that the investment process being pursued is legitimate, replicable and reliable.

Thankfully in the vast majority of cases we need worry less about fraud and more about simple poor performance.  It is not a fluke that the majority of actively managed mutual funds underperform their benchmarks on a regular basis.  The fact of the matter is that investing is a tough game.

In the end no matter how much managing we actually do, we are all responsible and accountable for piloting our own portfolio.  However, nearly every investor has some sort of help in managing his or her portfolio.  The question is:  how well do you know your investment co-pilot(s)?

Are asset allocation models broken?

The failure of asset allocation during the economic crisis to protect portfolios from harm has become a popular topic of late.  Tom Lauricella at the WSJ takes a look at how asset allocation as conducted broke down and how some practitioners of asset allocation are trying to salvage it as model for the future.

This begs the question:  is asset allocation done as a practice or does it just need to be modified to keep up with the times?  We delved into the topic of rising correlations and its role in asset allocation a couple of weeks ago.  A key takeaway from that discussion was that even if the economy and markets return to some new normal the memories of this period will remain with investors.

While the implementation of asset allocation is under attack, the actual mathematics behind the key concepts are not.  Every investor engages in asset allocation whether they know it or not.  In short, the math is the math, what is being called into question are the estimates used in constructing portfolios.

Looking back over the past few decades one can see how the practice of asset allocation could go wrong.  Economists have characterized the period since the early 1980s as the “Great Moderation” where we saw a significant reduction in economic volatility.  (Virginia Postrel in The Atlantic has a nice piece on the topic.) The business cycle had seemingly been tamed with higher economic growth and inflation well contained.

In this world one can see how practitioners might be caught up in the idea that any new asset class is a worthy one.  Indeed the term, asset class, was thrown around with some abandon.  In a benign environment “new” asset classes are pretty much guaranteed to look good in an asset allocation framework.  This might lead investors down the path of “naïve diversification.”  In an earlier piece we discussed how investors needed to approach each new claim of asset class status with a skeptical eye.

One could argue that this process sowed the seeds of its own demise.  As investors piled into any number of newish asset classes the very characteristics that made them attractive dissipated.   Once certain asset classes became commoditized and traded they inevitably become more correlated with the broader capital markets.

When the economy as a whole took a hit and investors pulled back on risky assets of any kind the flaws of this approach stood out.  Seemingly unrelated assets now traded in near lockstepDavid Merkel at the Aleph Blog notes that investors of all stripes were invested in far riskier portfolios that they thought.  This structural break from the Great Moderation leaves asset allocators with an uncertain future.

If the backward-looking historical approach was flawed, what are investors to do today?

We get some clues from the WSJ piece.  In it Lauricella reports that some advisers are now focusing on those asset classes that will perform better under periods of equity market stress including:  intermediate Treasury securities, TIPS and gold.  In addition to these “safe” assets one could also include higher cash holdings.

Justin Fox at the Curious Capitalist notes that this solution is not without its own risks.   Leaving aside the systematic risks of a global economic meltdown, this additional demand for seemingly safe assets may push down their returns to levels that make them unattractive.  Once again, the paradoxical effect of the actions of investors mitigating the very benefits they are seeking.

Asset allocation models can be characterized like any other model:  garbage in, garbage out.  That is not to say that practitioners were putting garbage into their asset allocation models.  An entire generation had been raised in a world free of significant economic downturns and where volatility was seemingly tamed.  It was simply the case that this backward looking approach was flawed.

The fact off the matter is that real diversification is difficult to achieve.  As stated, so-called safe assets have generally low real returns.  Over time the economic crisis will dissipate and standard asset classes will once again look attractive on a diversification basis.  However real diversification will require a more active approach on the part of investors.  Of course, active in the world of investing also means risky.   So to decrease risk, one needs to take on risk.  Nobody said this investing thing was easy.