Monthly Archives: September 2009

The Big Winners of 2009…So Far

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According to Bespoke Investment Group, 332 stocks in the Russel 3000 have more than doubled this year…that’s more than 10% of the index! The top 40 names are in the table below, all of which have gained more than 400% so far this year.


Warren Buffett’s Successor – A Bloomberg Special

Money Manager Sues Bear Stearns for Misstatements

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By Chad Bray (WSJ)

Private Capital Management LP co-founder Bruce Sherman has sued Bear Stearns Cos., its former chief executive James Cayne and others for allegedly overstating the value of Bear’s mortgage-backed and asset-backed securities and the quality of its risk management before its collapse last year.

The lawsuit, filed Thursday in U.S. District Court in Manhattan, alleges that Mr. Cayne and others at Bear made material misrepresentations about the company’s financial health and its risk management, causing Mr. Sherman to hold shares of Bear stock he “would otherwise have sold months before Bear ultimately collapsed.”

Mr. Sherman, as PCM’s chief executive and chief investment officer, had at one time investment control over about 5.9% of Bear’s outstanding shares, according to the lawsuit. He fully exited his Bear position on March 19, 2008, suffering substantial losses. He retired from PCM earlier this year.

“Defendants knew that the market and the financial press would view Sherman’s sale of his Bear stock as a loss of confidence in Bear by a well-known and long-standing investor,” the lawsuit said. “This, in turn, would have undermined confidence in Bear’s management at a critical time when Bear’s liquidity and Bear’s valuation of its assets were open to question following the implosion of two Bear-sponsored hedge funds in the summer of 2007.”

Mr. Cayne; Warren Spector, Bear Stearns’s former co-president and chief operating officer; Bear Stearns; and its outside auditor Deloitte & Touche are defendants in the case.

Bear Stearns was forced to sell itself to J.P. Morgan Chase & Co. fter being pushed to the brink of failure because of a liquidity crunch in March 2008.

Shareholders approved the sale of the 85-year-old investment house to J.P. Morgan Chase for just $1 billion in May 2008. Bear Stearns had a market value of $20 billion in January 2008.

SEC Looks to Prohibit Flash Trade, Curb Raters

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By Kara Scannell (WSJ)

The Securities and Exchange Commission proposed banning flash orders, which give certain large traders sneak peeks at market activity, responding to concerns that some investors are getting an unfair advantage.

In a flash order, a firm wishing to buy or sell stock can elect to freeze the order on an exchange for as long as half a second. Critics say this gives a select group of high-speed traders a window into the direction of the market and lets them make lightning-quick trades to profit.

SEC Chairman Mary Schapiro said flash orders may result in a “two-tiered market” and noted “the interests of long-term investors should be upheld as against those of professional short-term traders when those interests are in conflict.”

The flash proposal, approved 5-0, is the first of several rules the SEC is studying to change the structure of stock markets. This fall, the SEC is expected to tackle dark pools, which are private electronic networks that match orders anonymously.

The SEC also passed rules aimed at reducing conflicts of interest at credit-ratings firms, which have been blamed for contributing to the financial crisis by giving mortgage-backed securities and other products rosier ratings than warranted. The agency also voted to eliminate credit ratings from certain SEC rules, hoping to foster more due diligence by investors and less reliance on ratings.

The SEC required ratings firms to disclose all upgrades, downgrades and withdrawals on products they rate. Firms, such as McGraw-Hill Cos.’ Standard & Poor’s, Moody’s Corp.’s Moody’s Investors Service and Fimalac SA’s Fitch Ratings, also would be required to share information used in ratings with other ratings providers in certain cases. The SEC hopes the step will encourage more competition.

The SEC is also weighing possible rules to deter “rating shopping,” in which debt issuers get preliminary ratings and then select the rate they like best.

The agency also voted to study whether it should rescind a rule that has given credit-ratings firms protection from some types of investor lawsuits.

Harvard, Yale Are Big Losers in ‘The Game’ of Investing

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It’s a tie in the Harvard-Yale investment game. Both schools were thrown for colossal losses.

The universities on Thursday said their endowments, higher education’s two largest, each lost 30% of their value in the year ended June 30. Combined, the pair of investment pools shrank by a staggering $17.8 billion.

Declines in the endowments have forced the two schools to cut budgets and delay plans to expand facilities and hire staff, as even the country’s top colleges are being forced by the financial crisis to retrench. The pain is being felt widely across higher education. While many private colleges are getting less help from their endowments, public universities are suffering because of state budget cuts.

Harvard University and Yale University, such fierce rivals that their fall football contest is known to both sides simply as “The Game,” badly trailed the results of the typical college in the latest year. The dismal returns have exposed weaknesses in their exotic approach to investing, which after turning in chart-topping performance for years has proved to be highly risky.

The schools were hurt by investments in assets that can’t readily be sold, such as private-equity partnerships, which were pummeled in the past year after stellar results over the previous decade. In the category Harvard calls “real assets,” including timber, commodities and real estate, annual losses neared 40%.

Harvard was already budgeting for a 30% decline, but hadn’t released a final tally. On Thursday, it said its endowment shrank to $26 billion on June 30 from $36.9 billion a year before. The decline also reflects spending from the endowment and donations. The Cambridge, Mass., university’s investment loss itself was 27%, dwarfing the 18% drop in the median return for large endowments calculated by Wilshire Associates, an investment consulting firm.

Yale said its endowment fell to $16 billion on June 30 from $22.9 billion a year before. The New Haven, Conn., university didn’t break out its investment results. Yale had projected a drop of only 25% and Thursday warned of further budget cuts. In a letter to Yale faculty and staff, Richard Levin, the school’s president, and Peter Salovey, its provost, said it now projects an annual deficit of $150 million each year from 2010-11 through 2013-14.

Last winter, Yale cut staff and non-salary expenses by 7.5% for the 2009-10 academic year and signaled it would ask for further cuts in non-salary expenses of 5% for 2010-11. On Thursday, the university said it would ask for the 5% cut this year instead. The administrators pledged to preserve financial aid, but said otherwise “no area of expenditure will be immune from close scrutiny.” Messrs. Levin and Salovey said most major construction would be halted until donor support could be found or financial markets recovered. They said Yale would also slow the pace of faculty recruitment.

Facing a cash crunch last fall, Harvard has laid off staff, suspended some faculty searches and delayed a major expansion of its campus.

Other wealthy schools, including Stanford University, Princeton University and Massachusetts Institute of Technology, have predicted losses similar to Harvard and Yale’s. They all follow an investment model that de-emphasizes traditional stocks and bonds and instead loads up on alternatives unavailable to the average investor.

Yale and Harvard pioneered the approach, arguing they could afford to take big risks, because they were investing for decades, even centuries. Many copied the schools, saying they had found a high-return, low-risk strategy. But Eric Bailey, managing principal of CapTrust Financial Advisors LLC, a Tampa, Fla., firm that advises college endowments, says, “If it looks too good to be true, it probably is.”

Mr. Bailey says typical colleges outperformed Harvard last year, because they stuck to a plain-vanilla approach, typically allocating 60% of their holdings to stocks and 40% to bonds. That strategy would have generated a loss of roughly 13% in the year ended June 30. Harvard aims to have only 4% of its investments in U.S. bonds, which were one of the few safe havens over the last year. It has cut by more than half its target for investments in U.S. bonds since 2005.

The University of Pennsylvania’s endowment, by contrast, loaded up on Treasury securities in 2008 and reported a more moderate 15.7% decline. In New York City, Cooper Union for the Advancement of Science and Art, which charges no tuition, ratcheted down the risk of its investment portfolio three years ago and expects its endowment to hold steady for the year.

Yale and Harvard say their long-term results justify the strategy. Harvard’s endowment remains the largest in higher education. In fact, the $10.9 billion it lost last year is bigger than the 2008 value of the endowments of all but six colleges.

In Thursday’s report, Jane Mendillo, Harvard’s endowment manager, noted that Harvard achieved an average annual return of 8.9% over 10 years, three times its peers’ — adding $18 billion in value over what would have been earned by a 60%-stock, 40%-bond portfolio.

Ms. Mendillo said the school is better off than it would have been if it had “pursued a more conservative investment strategy over the longer term.”

In Thursday’s report, Harvard said its private-equity funds, which generally represent about 13% of its endowment model, fell almost 32%. Its real-asset segment, representing nearly a quarter of the endowment, lost 38%. Investments in “absolute return” hedge funds, designed to generate positive results in good times and bad, instead posted a 19% loss.

The report showed Harvard trimmed its endowment’s risk profile by raising cash, cutting by $3 billion its future commitments to invest in private-equity and other investment funds, and reducing its real-asset category to 23% from 26% of its model portfolio. Harvard also said the school now aims to hold 2% of its assets in cash. Previously, it targeted a negative-5% cash position, reflecting its use of borrowed money to expand its investments. Ms. Mendillo said endowment managers had learned to better reflect “the risk tolerance of the university.”

Ms. Mendillo pledged to manage more of the school’s money in-house, giving it readier access to securities to sell for cash. Currently, 70% is farmed out to outside managers. That move could focus more attention on its managers’ multimillion-dollar paychecks, which have provoked controversy on campus. Ms. Mendillo said “a substantial number of portfolio managers” had portions of their bonuses, awarded for past years, “clawed back” into the endowment because of poor performance.

Harvard and Yale, like other schools, also signed contracts that committed them to huge future investments in private-equity and other funds at exactly the time they could ill afford them. In Thursday’s report, Ms. Mendillo said Harvard cut its “uncalled capital commitments” to $8 billion from $11 billion.

Biogen offers $356M for Facet Biotech; FACT Surges 74%; ValueHuntr Closes Position

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We have exited our position in Facet Biotech (FACT) for a net gain of 58% since our posting on the company last April.

Biogen Idec Inc. said Friday it offered to buy its partner Facet Biotech Corp. for $356 million, and at the same time criticized Facet for entering a partnership with Trubion Pharmaceuticals Inc. last week.

Biogen said it would pay $14.50 per share for Redwood City, Calif.-based Facet. Biogen said the companies have been working together since 2005 to develop the cancer drug candidate volociximab and the multiple sclerosis drug daclizumab.

We added FACT to our portfolio last April, noting that the company was then trading at 46% of its net cash value (see article here). The big winner of FACT’s offer is Seth Klarman at Baupost Group, who doubled his stake in the company last May to 20% ownership.

In going public with its offer, Biogen was sharply critical of Facet, saying it stated its interest in August and offered to buy the company for $15 per share on Aug. 21. A week after that, Facet announced a collaboration with Trubion on a leukemia drug. Facet acquired the marketing rights to a potential leukemia treatment in return for a $10 million investment, $20 million upfront, and potential payments of as much as $176.5 million.

In a letter to Facet CEO Faheem Hasnain, Biogen said the Trubion deal reduces Facet’s value, noting that Facet shares are down 18.8 percent since the partnership was announced. Facet did not immediately return calls seeking comment.

Facet shares finished at $8.82 Thursday, making Biogen’s new bid a 64.4 percent premium. Biogen said it would not have to borrow money to complete the deal and said the bid would not require approval from its shareholders. It asked for a meeting with Facet’s board of directors.

The ValueHuntr Portfolio is now up 127% since April 2008, compared to -24% for the S&P500. The portfolio consists of secondary companies selling for less than their intrinsic value where a catalyst has been identified. For more information see here.

The performance of our portfolio can be tracked here.

Debating Shareholder Democracy

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Democracy can be a messy business — and that goes for Corporate America as well.

The long-debated issue of proxy access, which refers to the ability of shareholders to nominate directors to corporate boards, is coming to a boil this fall. That’s when the Securities and Exchange Commission is set to vote on a proposed rule that would make it much easier for directors not backed by company management to get a place on the ballot at the annual shareholder meeting.

Knowledge@Wharton, an online publication of the Wharton business school, just published an interesting analysis of the proposed rule, which many experts say has a serious chance of passing.

The rule drew a flood of comments from investors, businesses and trade groups during the comment period that ended last month. Here’s just a tiny sample of the opinions expressed:

Roy Bostock, the chairman of Yahoo, said that the proposed rule was “unnecessary” and “ill-suited to the wide range of companies in the marketplace” and argued that it could distract directors from the job of overseeing a business.
The prominent corporate law firm Wachtell, Lipton, Rosen & Katz said the rule “would have negative consequences for U.S. corporations and our nation’s competitiveness.”

But James P. Hoffa, the general president of the Teamsters union, expressed strong support for the rule and called it a “critical — and long overdue — reform.” And Joseph A. Dear, the chief investment officer of the California State Employees Retirement System, said it was a “historically significant reform that will enable investors to hold corporate boards accountable.”

If it is adopted, the rule would allow shareholders with a relatively small stake in a company — at least 1 percent for large companies, more for smaller ones — to nominate individual directors before a shareholder election, instead of having to present an entire slate of directors and wage an expensive proxy battle.

When she announced the proposal in May, Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission, said it “represents nearly seven years of debate about whether the federal proxy rules should support — or stand in the way of — shareholders exercising their fundamental right to nominate directors.”

Many businesses are fiercely opposed to the proposed rule, arguing that it would have a destabilizing effect. Supporters say it will help democratize a process that is often little more than a rubber-stamping ritual.

David F. Larcker, an accounting professor at Stanford University, tells Knowledge@Wharton that the S.E.C.’s proposal is “opening up the proxy machinery to an additional set of people” and calls it a “big deal.” Others have serious concerns, some of which Knowledge@Wharton describes here:

Some say the proposed changes could make it easier for a shareholder to mount a takeover attempt. Others warn that hedge funds with significant company assets could infiltrate boards and push companies to take on high levels of risk for the fund’s short-term gain.

Charles M. Elson, the chairman of the John L. Weinberg Center for Corporate Governance at the Lerner College of Business and Economics at the University of Delaware, suggests the proposed rule will just “create a bigger mess.” He says it would step on similar, more flexible measures already in place in Delaware, where many large companies are incorporated.

“The S.E.C. would be a one-size-fits-all approach, which could work in some circumstances and not work in others,” he said.

Pavel Savor, a Wharton finance professor, sees some exaggeration on both sides of the debate: “People tend to overdramatize these things,” he tells Knowledge@Wharton. “It’s not a cure-all, and it’s not something that will permanently destroy corporate America.”

Why Investors Need to See the Light and Slow Down

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By Jason Zweig (WSJ)

Don’t be happy; worry.

The Dow Jones Industrial Average is up 46% since March 9, when the world itself seemed to be coming to an end. In the entire 113-year history of the Dow, only six rebounds have been bigger and faster. But the swiftness and magnitude of this bounce-back aren’t reasons to be cheerful; they are reasons to be cautious.

In March, stocks traded as low as 11.7 times their average earnings over the previous 10 years, adjusted for inflation, according to finance professor Robert Shiller of Yale University. That put the market at its lowest valuation since January 1986. Today, however, stocks are selling at 18.4 times Prof. Shiller’s measure of earnings. That isn’t only up hugely from March but is above the long-term average of 16.3 times earnings.

Robert Rodriguez, chief executive of First Pacific Advisors in Los Angeles, says that in March, investors feared getting crushed in a further decline. Now all they seem afraid of is missing an even greater rally.

Mr. Rodriguez is convinced that the consensus — economic recovery by early next year at the latest — is wrong. “People are talking about whether the shape of the recovery will be a ‘V’ or a ‘W’ or even a ‘square root,’ ” he says, “but I think we are in what I call a ‘caterpillar economy.’ It will be up and then down, up and then down. We will be far from normal for a very long period of time. People deploying capital will end up destroying capital.”

I am not as worried as Mr. Rodriguez, but it is at times like these, when a rising market sweeps our spirits up with it, that investors need to evaluate their emotions and consider whether their beliefs and actions are justified.

In August, corporate insiders — officers and directors of public companies — sold nearly 31 times as much stock as they bought. From last September through this past March, in the depths of the bear market, that ratio was just 2 to 1, according to TrimTabs Investment Research of Sausalito, Calif. The long-term average is about 7 to 1.

The people who run companies don’t know exactly what the future holds, but they do know more about their own firms than outsiders do. If they are furiously selling, how eagerly should the rest of us be buying?

It is well-known that investors chase past performance, buying whatever has just made the most money for other people. What isn’t commonly understood is that investors also chase their own past performance, buying more of whatever they themselves have made the most money on.

Research by economist David Laibson of Harvard University shows that 401(k) participants tend to add significantly to whichever funds they already own that have gone up the most. “Investors expect,” Prof. Laibson says, “that assets on which they personally experienced past rewards will be rewarding in the future, regardless of whether such a belief is logically justified.”

That is exactly what seems to be happening now: In June, according to Hewitt Associates, 401(k) participants put 41.0% of their new contributions into stocks. In July, as the Dow shot up 725 points, they pushed that rate up to 42.3%. Participants also cut their contributions to “lifestyle” funds that keep a portion of their assets in bonds and cash.

The market’s latest hot streak makes the future feel predictable, but it isn’t. The Dow had an uncannily similar 46.5% gain in the 117 days that ended April 9, 1930; it lost almost 51% over the next year. Another 47% upswing in 1971 led to a long, choppy decline of more than 37%. The market also could go nowhere, as it did for months after a similar-size gain in 1975. Or it could hit new heights, as it did in 2004 after rising 47% from the lows of 2002.

In his classic book “The Intelligent Investor,” the great money manager Benjamin Graham wrote that “the investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances.” If you can’t exercise that kind of emotional control, then by Graham’s definition you aren’t an investor at all.

I see nothing wrong with dollar-cost-averaging into this market, purchasing a fixed amount every month — especially in a low-cost stock index fund. But to buy more of what has gone up, precisely because it has gone up, is to fall for the belief that stocks become safer as their prices rise. That is the same fallacy that led investors straight into disaster in 1929, 1972, 1999, 2007 and every other market bubble in history.

The market’s light has turned yellow. Don’t try to run it.