Over the weekend, our favorite Silicon Valley burrito stop made it into the travel section of the New York Times!! La Costena, or as we so lovingly call it, "La Co", was recently featured as one of three restaurants that one must ABSOLUTELY check out if visiting the Silicon Valley. For more, read the article: http://travel.nytimes.com/2009/04/17/travel/escapes/17Amer.html
We all know the tale...the man, given the gift of flight and able to fashion the perfect wings, only to take advantage just a little bit too far, melting off the coating of adhesive wax and falling back to the earth below. Time and time again throughout history, societies could have done well to heed the lessons inherent within this story. And yet, human nature drives us...no, it FORCES us to just try to take that one little bit more. That fateful..."if I could just...then I will be done...really..." The first mortgage brokers who sold subprime loans and got rich doing it...the first insurance companies who wrote massive amounts of Credit Default Swaps...the first rating agencies that "rated" packages of loans AAA...these entities were not the problem. The problem lies in the addiction...that need we all have to get just a little bit more and to eek out that last remaining possibility of performance. When bad practices with selfish aims begin to crowd out and erode more prudent foundations, it's only a matter of time before a house of cards comes crumbling down, or, better yet, wings of wax wither and melt as the fundamental forces of physics dictate a final trajectory.
2008. The year of the "structured product." There is nothing wrong with structured products. These securities, derivatives, are meant to hedge risk. Their returns are based on price movements or returns generated by some "underlying assets." The problem arises when the term "hedging risk" becomes synonomous with "eliminating risk," and clients eventually believe their accounts can never go down. The important thing to always remember, the first question to be asked with ANY security is HOW DO I POTENTIALLY LOSE MONEY? That's it, right there, plain and simple. If it's not FDIC insured...if it's not a CD...if it's paying more than some "risk free" rate, then, by definition, there is a risk, and there is a potential of loss. After 2008, it should be crystal clear to all investors that the idea that they "don't have to worry about a risk that is so miniscule, so infinitessimally small, that it could never happen", that idea, it has to be thrown out the window.
I recently read a paper regarding asset and liability matching and M-notes. Asset and Liability matching is a technical term, frequently used to duration match the cash flows of fixed income portfolios with pre-set or predetermined liabilities, or liability projections. It is used most often with large institutional pensions...they have assets that need to be there for retirees, and those assets need to be managed in such a way that there is the best possible chance that what is needed will always be there. It's tough, in my view, to take that approach and apply it to an individual person. If you think of a company as a large group of people, you feel like, as the group gets larger and larger, for the most part, the behavior of the group as a whole, which will have many common and similar interests, will be easier and easier to predict. Not with 100% certainty, and not for 100% of the members all the time. But, the averages used in the actuarial calculations for large groups of people are those for a reason...there are always deviations but, for the most part, projections can be made to reasonably conform to reality. Trying to do any such thing for an individual or single household...WOW. That would be tough. Not because the intellectual foundation is wrong or incorrect, rather, it's just so hard to know the exact liabilities that one will incur next week, next month, next year, or over the next 10 years. If one were to base their calculations on the averages for the population at large and then have an experience drastically different from the average of that population...well, I would shudder to think. Until one has a crystal ball, I'm not sure that this institutional approach is going to have widespread applicability to individuals, especially since those truly concerned can position portions of their portfolios in guaranteed products, like annuities.
M-notes are interesting. My understanding is that they cap both upside and downside of "an index." A cursory read seems to make it appear that there is no way to lose money. At worst, principal is returned. I am disconcerted, not because it seems like a horrible idea, but because it seems like too good of an idea. How is the "packager" making money? How does the investor "lose"? Where is the catch? It is unclear. Why is this different from an annuity or other product with some type of "guarantee" attached? Not enough is known to draw a complete opinion at this point, but, when in doubt I will always return to the fundamental truths. Risk always persists. Always look for the ways in which you can lose, and be surprised and even skeptical when these seem to be outweighed by the probability of a win. The extra thought and care, it will have no effect on the intrinsic value of the opportunity and, over the long-haul, you'll be glad you made the extra investment in time and effort. No idea can fly forever...they always come back to earth. Let's never be surprised.
James Bond, 007. 
I have to say, this Daniel Craig does an absolutely incredible job, in my opinion. True, most of what he pulls off is utterly and completely unbelievable and obviously done with the help of computers and simulations, but, who cares? It's AMAZING entertainment. This new movie, the Quantum of Solace, had somewhat of an environmental twist. I noticed it especially because I have been noticing environmental things and green causes more and more these days, but this movie really made me think. To give a basic synopsis, the main villain was the CEO of a green corporation focused on the environment...or so we and the world would be led to believe. Bond obviously knows better, and he realizes and uncovers a plot that, under the guise of buying up land to create natural parks and perserves, the company is actually buying up access to fresh water in various countries. Engineering droughts and driving up the price of, of all things, water, our most valuable resource and one of the FEW things we cannot live without. The story centers around Bolivia, and, among other things, the villain's company would buy up forest land. That land would be sold to logging companies, which would then cut down all of the trees. This would lead to the earth being looser and less able to retain water, and so, without the vital root systems of the trees, water was more apt to run off into the oceans or evaporate. Additionally, river beds were strategically dynamited and damns were erected. At one point, one of the country's leaders is quoted as saying that citizens need to spend half of their paychecks just to be able to drink one bottle or bucket. Living in America, such a thing sounds unfathomable, and, I know that this was just a movie, but you can't help but to think of certain other, real world situations that have, did, and do actually occur. Situations that make you really think...just how impossible would this be?
People want cachet, they need power, and, quite frankly, it's tough to get this without having the cash to back it up. Reading a book recently, titled "Eco Barons", I read about Chile and what they do for what seems to be salmon aquaculture. I had heard of this before, but from the perspective of Wal Mart, a huge company that depends on Chile's aquaculture to sell fish cheaply in its grocery stores. The issue was debated from two sides. Fish is healthy, and Wal Mart makes it more accessible to Americans known to have serious issues with cardiovascular disease and cholesterol. By the same token, the cheap fish are coming with an expensive price. Salmon was introduced to an area of the ocean where it had not previously existed. The farmers make sure that it flourishes, and it actually flourishes to such an extent that everything else in that area dies. All the fertilizers and antibiotics and biohazard wastes cause various microbial blooms occuring at various levels of the ocean's thermocline. These blooms consume all available O2 in respiration, leaving behind an ecosystem devoid of life. So, that clean, efficiently sliced pink fish at the end of the isle. True, you can pick it up at an extreme discount. But, what if, embedded in that cost of getting that price so low it was proven that farmers providing that fish had killed a species that would have led to the cure for cancer? When we kill without truly knowing the consequences of our actions, can we really prove that this hasn't happened? Might we be the authors of our own demise? The world's ecosystems are incredibly resilient; there are ways to do things, albeit, in slight more expensive fashion, that will have less of an adverse effect. Are we in immediate danger of corporations scheming to control our world's water supply? Ha, of course not. But there are other resources and species that we should make more of an effort to preserve, especially the ones about which we know the least. They could be the ones to save us when we need it most.
I heard two stories this week with respect to investing in the stock market at this, can you say, VOLATILE time. One involved the friend of a colleague. This friend was able to put some money into Citigroup stock when it was around, let's simplify and say, about a dollar. It went to 3 or 4 dollars a short time later, allowing him to triple or quadruple his money, depending on when he exercised the sale. Ironically, my father had called me a few weeks before asking if he should put 500 dollars into Citigroup. I don't know if he ultimately did or didn't, but I had told him that the political risk had been too high and that I would not have touched the stock, even if the price was so cheap relative to "where everyone seems to think it should be." Had he invested, he too could have doubled or tripled his money. Had I been able to invest, it would appear that I would have missed out on an opportunity.
The other story concerned the other side of the coin. A buddy of mine had a friend working in Boston at an investment firm. He was a trader, involved on the equity side, and he had been doing well. Apparently, from the sound of it anyway, he had "earned" his opportunity to take a chunk of money, presumably part of a larger fund, and put it somewhere of his choosing. He chose AIG at $4.00. One word...OUCH!! Needless to say, he will now need to work his way back up to getting that opportunity again.
If one is to invest, especially in these markets at this point in time, feelings of regret such as this, either at trades taken or opportunities forgone, can and will be part of the experience. I saw an article today with an incredible quote reading, "Life can only be understood backwards, but it must be lived forwards." So often, we feel the need to extrapolate future potential based solely on the past. Citi stock is cheap...why? Look at where it was a year ago... We have all heard that statement. Maybe even the "everything is cheap right now." Maybe that's true, but, what it certainly doesn't mean is, "If I pick stocks at random, since they're so low right now, they have to go up. I have to make money." If 2008 teaches us anything and we choose to extrapolate past to future, take one thing. Nothing is certain. Nothing can't happen. Anything can go down to zero...it just happens much faster from 50 cents than it does from 50 dollars. Have a process, have a reason, and go deeper than a simple "because it's cheap right now." Over the longer-term, you'll be glad you did.
Last night, after hearing interesting reviews from people who travel from all points across the Bay Area to South San Francisco, we headed to San Francisco Basque Cultural Center (http://www.
First off, the WAIT was an experience in itself! We had made reservations the day before for 8pm (we had heard from devotees that they fill up quite quickly). We arrived at 7:45 to the hostess letting us know that it was "absolutely crazy" and that it would be a "25 minute wait" for those who had made reservations at 8pm. Twenty-five minutes turned into an hour and a half- it was 9:30 before we finally sat down. I felt as if I was back in Spain...where a set time to eat is more of a guideline. Instead of complaining or yelling at the hostess (which several of the patrons who had hoped to dine at 8pm did) I sidled up to the bar among a seemingly never-ending line of true vascos. Jolly, bearded old men sharing beers with their fellow pelota players. If you decide to spend an evening (and believe me, plan on spending an entire evening) at the Basque center, go for the ambience. As soon as you enter the doors of the center, it is as if you are stepping into the town center of any given small town in Northern Spain. Families, laughter, drunken debauchery...
Once you actually sit down, the best part of the meal is that you will probably be seated next to huge parties of 15 Spaniards who just know how to have fun. They sit and linger for hours, with no sense of urgency, and although this probably leads to an anxiety attack for the hostess who is trying to turn over tables to prevent being shot by exasperated patrons, it is a welcomed reminder of how a meal should really be enjoyed. As for the food, you can probably tell I was not super impressed by anything. For the most part, the dishes lacked seasoning. We tried the sea bass, sweet breads, veal, and seafood crepe, escargot, country pate...I can't say that I would go on record to say that I'd recommend any of them. Overall, this WAS a pleasurable dining experience- despite the mediocre food. Everything was authentic and wine flowed freely (and cheaply). Next time you find yourself in South San Francisco, make an effort to visit the center.
Viva el pais Vasco!
What we'd like to do is address this update in 2 main parts:
1st- A capital markets overview, there has been so much going on! We will attempt to explain it as simply as possible.
2nd- Give you an intelligent, informed, actionable idea centering on what you can do right now to position yourself to move forward in 2009 toward your future goals
Let’s begin the overview of the capital markets by identifying the problem: nobody has any confidence in the financial strength of the nation’s biggest banks. Banks don’t even trust one another because no one is sure of the value of the loans and securities currently held on their books. The truth is, some banks will make it through this recession…and some won’t. This uncertainty has caused borrowers to have trouble getting loans and banks have been unable to sell loans or securities they don’t want.
So what is the solution?
The big news today was Secretary of the Treasury Tim Geithner’s plan to fix the banks. The plan is more easily digested when thought about it as a three-pronged plan:
Before this recession comes to an end, the credit markets must become fully functional and liquid once again.
If you watch CNBC, you might not be aware that the Fed is actually having some success in thawing out these markets. The Asset Backed Securities market is critical for keeping credit flowing to consumers (it made up roughly 40% of real estate lending before the crash). The Term Asset-Backed Securities Loan Facility launched last Thursday is what the government has put in place to get this market moving again. It allows hedge funds and other investors to borrow from the central bank at low rates so that these investors can now go out and buy newly issued securities backed by consumer financing such as auto loans and credit card debt. On Thursday and Friday alone, $4.7billion was accessed and three deals (Citi, Ford, and Nissan) went through. This is viewed as a very good sign that money is coming back into the asset backed securities market.
Many believe that a healthy credit market begets a healthy equity market...
Today the S&P has witnessed its largest comeback since 1939. And, although today’s prices may not be rock bottom, they do provide a margin of safety for the long term investor. Jeremy Grantham, one of Wall Street’s most infamous bears, came out this weekend in Barron’s advising individual investors to be ready to get back into the market “you absolutely must have a battle plan for reinvestment and stick to it.” We certainly agree with Grantham’s point. “In an environment where assets are still being re-priced and balance sheets are being restructured, it is still wise to be cautious”- however, we would encourage every investor to develop and be truly comfortable with a reinvestment plan back into the markets.
With more than a trillion dollars flooding the market, we believe investors should be wary of the risk of inflation. Last week we saw the dollar decreasing in value because of these fears. What is a way to protect yourself? Diversifying your portfolio by keeping a healthy weighting in both the developed and developing worlds is a great way to mitigate this risk. International markets look attractive for a few other reasons:
Central banks in the developed world have, for the most part, done their best to mimic the comprehensive policy actions of the Fed. After China unleashed its own $585 billion stimulus plan in November, its local stock market has gone up 33%.
It is IMPOSSIBLE to go through a day and not hear something about what is becoming a dreaded word: COMPENSATION. The funny thing is that, throughout that same day, you will also hear that this is one of the bleakest periods in economic history--a veritable economic ice age--so it is ironic that anyone is making any money at all. One of the most interesting scenes that I can recall from the past few months: I was watching a video on CNBC.com (Please, personal feelings about CNBC aside, "fair" and "unbiased" was replaced with "selling" and "sensationalism" long ago) and I saw them run one of the congressional hearing clips with all of the big bank CEO's. Right on down the line, one of the congressional leaders, or, excuse me, "leaders," had these gentlemen recite their compensation for the previous year. Then their bonus. Then their compensation for the next year. Then their bonus. It was both funny and scary. Funny that time was being spent going up and down the line of say, 8-10 CEO's 4 times when each had the exact same answer, or, at least, nearly the exact same answer, to every question. Scary because, call me crazy, but CEO pay has always been set by corporate boards. If Congress, and true, they're using TARP as their "way in" in this case, starts setting CEO pay, I can't help but to think of it as a slippery slope. It's interesting how it all sounds so good, so "in the interest of the taxpayer," and yet, the taxpayer could quite possibly never be made precisely whole again in some of these cases. If you really think, it seems that Congress is capitalizing on an opportunity to seek greater and greater relevance, more and more TV spots, and an overall feeling that this nation will never be the same again unless they can save it. The funny thing, and correct me if I'm wrong, but I wasn't aware they were solely responsible for the greatest successes of this nation...
Anyhow, the point here is not to polarize our readership by going on a political tirade. I prefer to deal more in absolutes. Like, a 1.75 trillion dollar deficit (or projected deficit) is not good for the dollar. The Fed printing money will cause inflation and will require some NIMBLE maneuvering to quell before we wind up with an opposite set of problems. And, the compensation question. It is an important question, but not with regard to Edward Liddy and the pre-debacle standing contracts at AIG. That is just a CIRCUS. Nothing more. The compensation question I think about regards asset management, most specifically that of hedge funds employing the 2 and 20 strategy. 2 percent of assets under management. 20 percent of profits. Superficially, this appears to be "performance based compensation." Looking deeper and applying a little bit of thought, if that 2% figure can become large enough, say, off of a billion dollars (20 million), what is the incentive to do anything. Additionally, depending upon how the 20% is measured and what the term "performance" means, in a strong overall market environment (where indices themselves are up double digits for years in a row) that can add up to a lot. Call me crazy, but I thought the point was to pursue these "absolute" returns, good in any type of market, exhibiting low correlation overall...but the comp structure would seem to tell me that the goal is to have the portfolio manager make an awful lot of money.
I have nothing against portfolio mangers making an awful lot of money. Absolutely nothing at all. However, these are smart people who have a deep understand of statistics and how to use them to their advantage. I would challenge any of them to measure their performance purely by the alpha that they generate, or, return that they generate for other reasons than taking more or excessive risk. A rising market raises all boats equally...it doesn't make sense to be paid for the portion of the performance that could be generated sitting in an S&P 500 ETF for basis points. Managers who are so great and so smart...they should have the guts to put their money where their mouths are, and they should not be paid any more than index funds for anything less than positive alpha. It's not fair that clients lock up their money for potentially years at a time, becoming part of that asset based fee. Managers should have the same skin in the game as their clients. There shouldn't be any caps...all I am saying is that excessive fees should be taken only for excessively strong, risk-adjusted performance.
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