Fixed Income Vs Equity

Sometimes I feel that a portfolio manager has the easiest job in the world. I know......most people would disagree with me here...after all the portfolio manager has to keep abreast of the market conditions, stay informed, make intelligent decisions etc etc.

Let's say I give you a million dollars today and tell you that you can invest it anywhere you like. What would you do ? Now don't get into complexities about my "Expected return", "Risk tolerance" and all that b/s. It's a simple question and I expect a simple answer. I'm sure your brain is already calculating the returns that you can generate by investing in fixed income or equity or a combination.

The problem with equity is that you might lose all the money and the problem with fixed income is that you'll face a what if? situation. What if I had gone with equity ? Let me put in another dilemma. Let's say the the returns from fixed income are exactly what you need. It is the perfect investment and it perfectly completes your portfolio....how strong does the lure from equity have to be to make you change your mind.

This is where my point comes in. The portfolio manager doesn't have to think so much, he has an investment mandate, an investment policy statement to guide him. So wouldn't it be so much better if we also had a similar mandate with us.

Well, apparently that is not the case. Every day we encounter situations where we need to make a choice. Some are big decisions, others are relatively insignificant, but they all boil down to the same thing: Should I go for the safety of fixed income or should I speculate with equity. Each has its own merits and weaknesses. So in essence sometimes it's just better to not have a choice, it just makes your life simpler.

"I know I'm right.......I just don't trust myself"

Wall Street Mafia..

In the movie "The Godfather"...New York City was ruled by five mafia families...We do not have the Corleone's, Tattaglias or the Barzini's anymore....at least not by the same name....We now know them as the Goldman's, JP Morgan's and the Morgan Stanley's...!!!

In of the scenes....Vito Corleone's consigliere says...."We have the judges on our payroll...it's fine.."....flash forward to present day.....Goldman's legal says..."We have the SEC on our payroll...it's fine.."..

These big guys of Investment Banking today rule Wall Street just the same was as a mafia would. Time and again they do wrong.....and get away with petty fines...yes, a few million dollars is petty when you deal in billions.

Take this as an example....one of my favorites though...Just a few weeks ago...before the markets went berserk...it was impossible to short LinkedIn...yes, one of the reasons was that they have a very small float (around 10%)....but the biggest according to me was that its price was backed by its underwriters...namely JPM, BofA and MS.... every time you sold.....they were ready to buy and jack up the price...Reality will be very different and hurtful once these guys take off their hands.....

Maybe in a few years someone at the SEC might discover that these guys were behaving in a manner called "Intentionally trying to manipulate the market"....so what...the banks will just cough up a small fine (if they even get to that stage)....and carry on with business as usual.....well, to me this looks like mafia behavior...

So essentially, the mafia is alive and well, just that now they engage in “legal” businesses……If you want to fight them…do it at your own risk…

PS: I do not intend to dispute or defend my viewpoint…just don’t shoot the messenger…. 

Once bitten....Never Shy..!!!!

Coming soon at a theater, workplace, school, household and every institution inhabited by humans..

"We Refuse to Learn"
Starring - Goldman Sachs, Morgan Stanley, JP Morgan et al.
Directed by - The Federal Reserve
Produced by - The Department of Treasury

Not so long ago, I was reading this book, "The Big Short" and I believe in some time Michael Lewis will come out with a new one..."Tired of shorting and making money". Any sane, rational person will agree that we are seeing an asset bubble, and the best part is we all know it, we just refuse to do anything about it. Everyday I see on CNBC and every other business channel, market experts talking about this bubble, but still we do nothing. It reminds me of something the Ex Finance Minister of France said about the housing crisis.."We can see a tsunami coming, but we are busy deciding what swimsuit to wear"...

And interestingly the time period between such bubbles is reducing dramatically. Some time ago there would be a bubble once a decade, now its every couple of years.

If the last one was about housing prices, the next one will be about "social networking". All the Facebooks, LinkedIns and Twitters will lead this meltdown. I sometimes wish I had enough money to short, It seems to be the easiest way to make money these days.

I am not against the concept of social networking, in fact I believe that it will be the next big thing. My only concern is that we are not yet prepared for it. Agreed it makes perfect sense to catch on to this wave early, but if too many of us try to catch it we might just end up destroying it.

To put it in financial perspective. Facebook is valued at around $100bn, at this rate Facebook might as well be  a country in itself. It took Google, Microsoft and Apple years to reach that valuation and that is why today they have such strong business fundamentals.

And behind this bubble is again the "smart guys" in New York.......the Goldmans and the Merrills of the world. Remember these are  the same people that gave us "AAA rated" CDO's. These are the same people who didn't even understand their own investments, and yet we trust them.

Around 200-300 years ago, the top executives at these organisations would have been publicly whipped if not hanged for what they did in the financial crisis, but in today's world we reward them with multi-mullion dollar bonuses...!!!!.....It's like trusting a serial killer when he says he's sorry and won't do it again...!!

As Steve Eisman said...."The moment I understood the depth of the crisis I shorted Merrill Lynch, because whenever there is a catastrophe Merrill is there. When the S&L bubble burst Merrill was there, when the internet bubble burst Merrill was there....". Unfortunately Merrill is no longer there, but its legacy remains.....and only time will tell.

"Gamble.......If you can afford to lose"

The predictability of probability...

There goes an old saying "Care for what you wish…..cause you just might get it". Now here's my theory on wishing…….. 90% of the things you wish will never happen. The 10% that will happen is something you never thought would happen.

Now don't get me wrong out here, if you work hard enough...things will happen, they will happen in the same general direction you wanted them to be….only caveat…they won’t happen the way you wanted them to happen... Ultimately you will be part of a long term up trend but your movement will be a combination of moving averages and mean reverting levels.

Let me explain this in terms of stocks. Say a company has sound fundamentals…. over a 10 year period you can expect say 10-12% CAGR from the stock. Looks like a good investment doesn’t it……but will this stock make you rich??….for that you need the stock that will give you something like a 100% gain over a very short period of time…say a couple of years.

Now in the long term, the first one will give you consistent returns year over year, whereas the second one will be a series of advances and corrections, but in the long run both will come to the same mean level.

Now this is where the theory or probability comes in. Let’s say that the probability of Stock A going up is 0.6 and that probability of stock B is 0.4. The very act of investing in A since it has a greater chance of going up incrementally increases its probability over B. So essentially, the fate of A and B were decided even before the actual outcome.

At the end of the time period A will have a smooth ride to the mean level whereas B will have a roller-coaster ride to the same level. Mathematical inequalities somehow do not apply to life most of the times, the only unfortunate part is…the result was decided even before the game started…..and you thought the “odds” were on your side.

“Never take hope away from a man.........sometimes it’s the only thing he has.”

Law of the jungle

Heard this poem a long time back...just thought I'd share it...

Now this is the Law of the Jungle
As old and as true as the sky
And the Wolf that shall keep it may prosper
But the Wolf that shall break it must die
As the creeper that girdles the tree-trunk
The Law runneth forward and back
For the strength of the Pack is the Wolf
And the strength of the Wolf is the Pack

PS: Markets can remain irrational...longer than you can remain solvent...don't fight the market

Baby got WACC

It's a really cheesy one...but if you like anything to do with banking you might get the humor

Just roll it over...

Here's an interesting thing about debt...its like drugs...It's addictive..but it can be helpful if used moderately and in a responsible manner. And the best part about debt is that if conditions are in your favor...you can always roll it over.

This happened when I was in college.One of my seniors was working on this great plan he had thought about. He was going to apply for two credit cards. He'll shop using one and pay the bill with the other card. And when the second bill becomes due...he'll pay it with the first card. Now assuming that it is possible to pay one credit card with the other and to repeatedly do so, this is an awesome plan. You spend X right now, keep rolling the debt for some time,and since you have technically not defaulted on any payment, the card companies will even increase your credit limit over time. So after some time you pay the X amount and now shop for 2X and again repeat the same process.

This is actually a very good plan. Since both parties get paid without default, you get a good credit rating with them and they'll always be willing to lend to you. But again, the caveat is that...they should never speak to each to each other.

Even in real life, you can borrow from someone, keep rolling the debt, get your NPV maxed and no one will ever know, or rather no one should ever know.

"I am so evil, sometimes I scare myself"

Caught long in a bubble...!!

due diligence (noun)
(i) the care that a reasonable person exercises to avoid harm to other persons or their property
(ii) research and analysis of a company or organization done in preparation for a business transaction

I'm talking about the second definition and why it is so important. Say, you come across this one investment which really appeals to you. And since you've been a good stock picker you trust your instincts and go for it. Of-course you analyze the fundamentals and nothing seems terribly wrong, maybe a few line items here and there, but nothing serious. Seeing that you have started acquiring this stock, the market reacts favorably and all those stupid "sell-side" analysts issue positive ratings.

Somehow, it occurs to you that this could be the next big thing, so you lever up your investment, which essentially means you borrow. The banks think this looks like a good investment too, so they also lend to you at favorable rates. Slowly you start to build up a significant position in this stock. It has been some time since you've started building up a position, and now you are pretty close to filing form 13D.

Then......without anticipation, the stock starts going the other way. It is now moving against the market...and you are left wondering whats going on. After a few weeks of decline, the stock starts gaining again. You think maybe the market reacted foolishly previously and that you are back on track. A few days of up movement turned out to be a "dead cat bounce".

Then one day...the bubble bursts...and its a free fall. Due Diligence failed and you suddenly discover that the books were never audited. You are getting margin calls every day, margins you can't meet. You can't get out of the stock because now its turned illiquid.....the debt can't be rolled over anymore cause now the bankers have started talking to one another...and they are talking about you.

This just one example of how the cardinal principle of investing was violated.
Rule#1: Don't lose money
Rule#2: Follow rule #1

And it goes on and on and on...!!!

The human life cycle in some ways can be compared to that of a corporation. Here is my version of how this happens.

0-9 Months: Seed Stage Financing
As the name says, this is when the seed is planted. This period requires close monitoring since business is most susceptible to failure at this stage.

9 Months - 2 Years: Angel Financing
Mommy is the angel and you're the apple of the daddy's eye.


2 - 4 Years: Early Stage/ Venture Capital
So now you've been through the initial tests and you've passed. You've learnt how to walk and maybe talk. Now let's see if product feasibility can be established.


4 - 15 Years - Expansion
The world is your oyster. Go ahead, explore, innovate, catch the rainbow.

15 - 21 Years - Buyout
"Maybe I should ask her out". If you thought something like this, well you just entered the exotic field of M&A. And if on the other hand someone asked you out, you just received an acquisition bid.

This is actually a pretty complex stage. Some choose to merge, some either get acquired or acquire someone else and some still carry on as independent corporations.

21 - 30+ - IPO
This is when the original founders (parents) sell their stake to a professional management (your spouse)and take in the cash. Now you are liable for public reporting and distributing dividends (producing children).

And finally, when the corporation reaches a mature stage, its time to spin-off a new division and start the whole cycle again.

Please note, this pattern is not typical and you will find many exceptions, however, this is the norm and not the exception.

A penny spent ..... is a penny earned..

No, It's not a typo and no, I'm not under the influence of anything. Here I'm going to explain another unique concept I came up with which encompasses three different philosophies.

Why "Greed is Good", why "credit" is good and why you need to spend...

Now, let's begin with a simple example. Suppose you earn $1000/month and you save 25% of it (a very conservative estimate...for some people it might be as high as 50%). Anyways, so after every 4 months you have saved a months salary. So if you stopped working after one year, you could live for another 5-6 months. Isn't that a wonderful life.....If you thought "Yes", you might wanna exit the page..!!

Now take the second case. Your monthly salary is the same at $1000, but now you spend $1100. So what do you do??.. you borrow..simple. So the next month either you cut down your personal spending to $900 and return the $100 (assuming no interest) or you borrow again. Now , most people would say that the first option is the correct one since people may not be able to borrow indefinitely into the future.

True, but there's another option...... generate extra $200 as income for the next month...return the loan and cut back "just a little".... So if you keep continuing this process for one year, guess who will be making more money....you or the first person ??...... This was to prove that "Greed is Good".

Now to demonstrate the second point about credit. Say company A has a lot of debt and company B has no debt. Assuming both are operationally sound and company A does not go into default, which is a better company. You might be tempted to say B, but I'd rather prefer A. In order to service the debt, company A has to generate a minimum amount of revenue year on year wheres company B's managers have no such incentive. Company B's managers can afford to have a bad year....not company A. You see my point......guess who's more motivated to perform ????

So coming to my last point. Spend more than you have.....only then will you be inclined to earn more than you do now....and the cycle goes on..!!!!!

"If you are living within your means..........you lack imagination"

Of Strippers, stock markets, dating and everything under the sun..

If you've read any of my previous blogs, I'm guessing by now you have an idea of what the topic is gonna revolve around. Plus, I must tell you...I'm really bad at writing down stuff...I'm just better at talking about it..

So whats common between stocks and strippers. Well apart from the fact that they both start with an "s".....a lot more. In any case, this blog is not about strippers in particular...I just put the word in there to make it sound "sexy". But, yes it is about stock markets and value investing.

Someone once told me "It takes potential to recognize a potential", and yes that's true in everything we do. Right from the point when as kids we pick who our friends would be...till the time we choose our life partner.

My theory is that at any time you need to make a choice, you should think like a good stock picker. You need not pick the most glamorous stock or the one that is expected to give the highest return, but you need the one that has the "potential" to give the highest returns.

Hope you get the point...!!!

PS: Use the above theory at your own risk....

You might wanna get a life..If....

1. You call your friend list on facebook your "portfolio", and adding/removing friends is called "re-balancing the portfolio".

2. When you borrow money from friends you call it "raising capital"

3. When you lend money to friends you actually plan to charge interest

4. When you do someone a favor you record it under "goodwill" and plan to test it for impairment at-least annually

5. When you purchase groceries, you plan to "depreciate" them over their useful life so that you don't have to record an immediate expense

6. You are not interested in dating because you think the NPV of the project is negative, and you have somehow managed to calculate it.

7. You think marriage is like an IPO and you actually conducted due diligence on your partner

8. You dream of a world where they have 3-D excel

9. You think stock charts are "sexy" and you get aroused at the mention of candlesticks

10. When you go out to party you "capitalize" your bill and create an intangible asset instead of recording an expense.

11. You've thought about opening a clothing brand and calling it "GAAP"

12. You can classify people into assets and liabilities, both current and non-current.

13. Going through a 10-K is called "light reading"

14. When you hear the word "models", Excel comes to your mind.

15. You can relate anything in the world to finance.

And the biggest sign you might be need to get a life: You laughed at at-least 5 of the above points.

The Short Seller..

People are just like stocks, their values go up and down with events in their life. Say, you get a new high paying job, you value goes up...and this is not just commercial value which one can monetize, its the value society puts on you. You can say/do the dumbest thing and get away with it, because you are perceived to be "fundamentally strong".

But then there is a flip side to this, once people reach a certain "valuation", they are afraid to take any more risks, just in case things don't work as planned. They wouldn't want to be downgraded from their current status. In other words they prize stability more than ambition.

Another kind of people are who slowly but steadily climb the ladder. Once they reach a certain level and look down, they see all those people below them and this boosts their ego to an extent it resembles a stock bubble. They believe that they have reached a level where nothing can go wrong......and then the short seller arrives. Just like in the markets, the short seller is viewed to be a devil whereas in fact he is actually bring you down to your fundamental level before your bubble bursts.

Mostly the short seller is a just a sequence of events, sometimes it is also a person...whoever it might be..the fact is that correction will happen be it in the stock market or in real life.