Most investors don't think about currency when they are investing. I think that is a mistake. Today Bespoke provided a perfect example of why currency matters . . . .
If you own all domestic stocks and bonds and the dollar drops consistently against a basket of other currencies your real currency weighted return is actually much lower. Ignoring currencies is not a smart decision.
Yale's David Swensen is a pioneer in multi-asset class investing. I've taken to reading Yale's annual reports to dissect Swensen's asset allocation and methodology. Something tells me I'm not the only one doing this. When Swensen inherited Yale's $1.5 billion endowment in 1985 their asset allocation was roughly two thirds stock and one third bonds. In the graph below, the first thing you will notice is how dramatically Yale's portfolio has changed over the years. Swensen has invested heavily in hedge funds, private equity, real estate, commodities and other alternatives. Today he has only 3.8% of Yale's portfolio in fixed income and just 11.8% in domestic stocks. I expect both of those figures to continue to trend lower. You can see in the graph below that Swensen has gotten progressively lighter on domestic equities over the past 10 years and recently he has gotten rid of most of his fixed income exposure:
Yale's $22.5 billion endowment is the second largest in the country behind Harvard's $34.9 billion endowment. But, Yale has been the top performing large (>$1billion) endowment over the last 22 years. This past year was no different as Harvard turned in a very respectable 22% return under Mohamed El-Erian and Yale put in a best of class 28% return:
It is absolutely amazing that David Swensen is still at Yale and not running his own fund. If their was ever a guy who could raise $5 billion on a whim and immediately cash in it is David. There must be something else that drives him to stay in the ivory tower . . . .
Hat Tip: WSJ
I don't know why they are trying so hard . . . they should just kick back and enjoy the house mortgage free until the bank comes and kicks them out. I just don't envy that insulting tax bill that comes saying that the loss you took on that house is actually income . . .
Hat Tip: Jim the Realtor (I can finally see your pictures!)
The SEC posted a press release today that almost made me fall off my chair laughing (until I started feeling bad for the investors who fell into the trap). Allegedly a San Francisco based "Hedge Fund Manager" raised $10 million of seed capital for his startup fund in 1997. For ten years he falsified performance statements and bragged about his performance to his investors. In reality however he actually just used the fund as his personal bank account. He bought real estate, cars and European shopping sprees for his ex-wife (unlike his investors it sounds like she got out just in time) . The hedge fund was called the Fahey fund. You can check out his "low budget" website here. The guy actually has a form on his site to set up a self-directed IRA in order to invest in his fund. Now, it would seem as if a mere 5 minutes of due diligence would expose this guy, yet he lasted for a full 10 years (see the "Out Tenth Year!" celebration above), so he must have been good. You can read the full press release below:
SEC Brings Fraud Charges Against San Francisco Hedge Fund Manager
FOR IMMEDIATE RELEASE
2007-203Washington, D.C., Sept. 26, 2007 - The Securities and Exchange Commission today charged a San Francisco hedge fund manager with defrauding investors by dramatically overstating the fund's profitability and misusing fund assets. The Commission alleges that Alexander James Trabulse sent account statements to investors in his Fahey Fund that inflated the fund's returns by as much as 200 percent, while using investor money to purchase cars and finance shopping sprees for his family members.
"Trabulse betrayed the trust investors placed in him by fabricating performance figures and treating the hedge fund as if it were his own personal bank account," said Linda Chatman Thomsen, Director of the SEC's Division of Enforcement. "The Commission is determined to hold hedge fund managers accountable when they deceive investors."
Helane L. Morrison, Director of the SEC's San Francisco Regional Office, added, "Trabulse encouraged his existing investors to serve as references for new investors. As a result, his false account statements not only lulled existing investors into believing their investments were hugely profitably, but lured new investors into the fraud."
According to the Commission's complaint, filed today in federal district court in San Francisco, Trabulse founded the Fahey Fund in 1997 and raised about $10 million from approximately 100 investors. He told investors the fund invested in financial instruments like stocks, derivatives, and foreign currency. The complaint alleges that Trabulse lured investors by touting the fund's spectacular performance, when in reality the statements he provided to investors bore no relation to the fund's actual performance.
The Commission also alleges Trabulse misused fund assets to pay for a wide variety of personal expenses, using the fund's bank account to pay for cars, a home theater system, and his ex-wife's overseas shopping allowance. He even gave one relative free reign to use the fund's bank accounts for personal use, according to the Commission.
The Commission's complaint alleges Trabulse violated the antifraud and registration provisions of the federal securities laws, and seeks disgorgement, penalties, and other relief. The Commission also has named as relief defendants several entities associated with Trabulse that received assets through Trabulse's fraud.
Hat Tip: Footnoted.org
Home price declines are accelerating after August's credit crunch put additional pressure on underwater borrowers. According to the S&P/Case Shiller Indices home prices for their 10 city index are off 4.5% year over year which is the largest fall in the index in 16 years. The Case Shiller Indices were pioneered by Karl Case and Yale economist Robert Shiller, who is perhaps best known for his best-selling book Irrational Exuberance, in which he examined asset bubbles throughout history. Shiller's second edition of Irrational Exuberance argued that the U.S. real estate market was a bubble in 2005.
I personally think that Shiller has made a very sound argument that real long term home price appreciation has been quite small (roughly 1%/year over the past 115 years). The graph he produced shows a significant break from trend in home prices in the latter half of the 1990's. It became increasingly difficult to explain the break from trend, and now it appears that home prices are moderating. How far they will fall is anybody's guess. Moody's thinks it will be about 11%, some aggressive economists are predicting a 25% total decline in prices. I bet if you asked Shiller he would be afraid to tell you for fear that you wouldn't take him seriously.
Before I start discussing the recent declines I think it is important to touch on why I rely on the Case Shiller numbers instead of median prices. I prefer the S&P/Case Shiller methodology because it tracks the price path of individual representative homes in a given geographical area by using "matched price pairs." This methodology enables the index to avoid many of the issues with using median based pricing models. For example in the current downturn home price declines were obscured in part by slower sales on the lower end of the spectrum while higher end homes continued selling at a brisk pace. So, although home prices were largely falling the lack of sales on the low end led to a drifting up of the median price, masking home prices declines. Needless to say I am not a big fan of median pricing. This is especially true because median prices are in large part reported by the National Association of Realtors, an industry group I don't see eye to eye with. The other index that is worth looking at is the OFHEO, which is calculated using a similar methodology to Case Shiller.
Here's the S&P Press Release:
New York, September 25, 2007 – Data through July released today by Standard & Poor’s for its S&P/Case-Shiller® Home Price Indices, the leading measure of U.S. home prices, shows a continuation of negative annual returns in the 10-City Composite and the 20-City Composite, as well as 15 of the 20 metro area indices. Both composite indices have registered negative annual growth rates since the beginning of the year. In addition, both indices rate of decline has become larger in each of the seven months from January through July.
If you are considering buying a hybrid you must first go check out TheIssue.com's analysis of the economics of buying a hybrid:
Hybrid cars are often considered the perfect match for the thrifty and environmentally conscience consumer. They save gas money, reduce pollutive emissions and ease demands on strained energy sources. While these benefits are almost certainly true, the cost-benefit equation is more complicated. Many would-be buyers find that the technology premium outweighs gas savings, and others point to environmental drawbacks like battery manufacturing.Read on at TheIssue.com.
Here are the key issues I am following after the Fed Rate cut earlier this week:
After much speculation in the financial press and on Wall Street the Federal Reserve cut the Federal Funds rate to 4.75%. The Fed also lowered the discount rate to 5.25% keeping the spread between the FF rate and the discount rate at 50 bps. Fed Funds futures projected a 42% chance of a 25 bp cut and a 58% chance of a 50bp cut, though most economists predicted a 25 bp cut. In what is sure to be a very controversial move the Fed pursued a drastic policy action that may look to many as if it is seeking to "bail out Wall Street." Concerns about the strength of the economy will also be heightened as the Fed took a dramatic step today to ease in the face of a prolonged credit crisis and housing downturn. The broad market indices were up this morning on positive earnings from Best Buy and Lehman and should finish strong on the Fed's decision. You should also look for the USD to weaken further against most major currencies on recession concerns.
Here is the text from today's Federal Reserve Statement:
There are dramatic changes in the release compared to August 7th's Federal Reserve Statement:The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4%.
Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.
Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric Rosengren; and Kevin M. Warsh.
In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 5-1/4%. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City and San Francisco."
The Fed statement changed dramatically in the 6 weeks since the last release. Gone is theThe Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.
Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.
Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.
language about inflation moderation being "convincingly demonstrated" and gone is the emphasis on inflation as the "predominant policy concern." The Fed is clearly at the beginning of an easing cycle, though they emphasized the need to monitor incoming information and tried their best to warn investors that they are taking a balanced view on the prospects for inflation and economic growth.
The Federal Reserve sets the Fed Funds Rate and uses open market operations to keep the rate as close to the targeted rate as possible. The targeted rate has been set at 5.25% since July of last year. Since then 14 months have elapsed and the daily effective federal funds rate over those 14 months has been kept incredibly stable. In fact in 8 of those months the effective rate was exactly 5.25%. In 3 of the months the effective rate was 0.01% above the targeted rate and in 2 of the months the effective rate was 0.01% below the targeted rate. All in all, the New York Fed did a phenomenal job of controlling the rate using open market operations.
Then came August . . .
Somehow the effective federal funds rate in August was 5.02%. This would be fine if the Fed had cut the targeted rate to 5%. Yet the targeted rate still sits at 5.25%. Much has been made in the blogosphere of this "phantom" rate cut. And much of what they say is true: in reality, even though unannounced, the markets have had their rate cut for over a month. In fact if the Fed fails to cut rates on September 18th and we see the effective rate drift up towards 5.25% again that will be the equivalent of a rate increase . . . something the markets would undoubtedly not respond well to!
You can check out the effective federal funds rate data yourself on the Federal Reserve website.
I have been warning about the impending collapse in the commercial real estate world for quite some time (in May, in July). Recently more and more anecdotal stories about continued softening in CRE seem to be coming in. This most recent one is from Law.com:
The sudden queasiness of lenders has cast a pall over the once-robust real estate market in the last six weeks, Cowan and other lawyers report. Deals have been interrupted mid-stride. Some have been re-jiggered and others have just died.
With the pop of the housing bubble and the implosion of the subprime mortgage market, lawyers representing homebuilders had already seen a slowdown in transactions. But with the credit crunch that followed, high-end commercial real estate deals -- the cash cow for big-firm real estate groups -- aren't going forward.
Although the dead deals haven't come close to killing the practice, they have taken some life out of the legal fees. Some clients demand discounts from 5 percent to 15 percent if a deal doesn't go through, lawyers report.
While I don't think this is a doom and gloom report, I think this does lead one to become more and more concerned about the health of the CRE market. A good question to ask would be who would get hurt the most if the CRE market went into a tailspin?
Harvard economics professor Greg Mankiw came up with a simple equation in a 2001 paper entitled "U.S. Monetary Policy During the 1990's" as a proxy for the Fed's Taylor Rule. The equation was originally developed as a best fit for monetary policy during the 1990's. However, even today it seems to be doing a fine job of predicting the direction of interest rate movements. Here is the equation:
Federal funds rate = 8.5 + 1.4 (Core inflation - Unemployment)
Courtesy of Crossing Wall Street: "In July, the unemployment rate was 4.647% and core CPI was 2.210%. That translates to a Fed Funds rate of 5.088%, which is below where the Fed is now. Here’s a look at how the Mankiw Rate compares with the real Fed Funds rate over the past few years":
After just 2 years at Harvard, Mohamed El-Erian is returning to Pimco as Co-CEO and Co-Chief Investment Officer. His short stint at Harvard was successful, but now the door is open again for a new face to run the $34.7 billion endowment:
Sept. 11 (Bloomberg) -- Mohamed El-Erian unexpectedly resigned as head of Harvard University's $34.9 billion endowment fund to return to Pacific Investment Management Co., manager of the world's largest bond fund, as co-chief executive officer.
The 49-year-old executive, who led Harvard Management Co. to its best results in seven years after taking over in February, 2006, said in a statement that he was returning to Newport Beach, California-based Pimco to be closer to family members.
Harvard recruited El-Erian in October 2005 to fill the void left a month earlier by the departure of 15-year investment chief Jack Meyer, who left along with almost three dozen Harvard officials to start a Boston-based hedge fund. El-Erian rebuilt the staff and guided the endowment to a 23 percent gain in the fiscal year ended June 30, adding $5.7 billion to the world's biggest university endowment.
``Mohamed has done an impressive job guiding and reorganizing Harvard Management Co., and we will miss his leadership,'' said James F. Rothenberg, treasurer of Harvard University and chairman of the fund's board. ``In addition to achieving excellent investment returns, he has led ambitious efforts to rebuild HMC during his time as CEO.''
At Pimco, El-Erian will be co-chief executive officer and co-chief investment officer, starting in January, the Newport Beach, California-based fund said in a statement. El-Erian, a former managing director and senior portfolio manager at Pimco, will share the CEO position with Bill Thompson and the top investment job with company founder Bill Gross.
Emerging Markets
Rothenberg said a search for El-Erian's replacement will begin promptly. Harvard Management, founded in 1974, invests about half of the school's endowment and oversees external managers who handle the remainder.
``Obviously we would prefer that he stay longer, but HMC is in great shape,'' Harvard spokesman John Longbrake said in an e- mail. ``In 18 short months, HMC has completed the transition and rebuilding phase and established conditions for sustaining superior returns over time.''
El-Erian was considered one of the world's most influential emerging-markets managers when he was hired by then-Harvard President Lawrence Summers. He had been a Pimco managing director for six year, overseeing $28 billion in bonds of developing nations and their companies when he left.
IMF Background
Previously, El-Erian spent 15 years at the International Monetary Fund, rising through the ranks to become a deputy director. He left in 1997 and was a managing director at Salomon Smith Barney before joining Pimco, a unit of Munich-based insurer Allianz AG. El-Erian's name was put forward in 2004 to be the IMF's managing director.
Meyer left Harvard to form Boston-based investment firm Convexity Capital Management LP, taking more than 30 Harvard managers and other employees with him. The departures included almost all of Harvard Management's internal bond investors.
El-Erian said he wouldn't let Harvard become overly reliant on a single team or strategy again. He cut the fund's traditional dependence on bonds, shifting more assets to buyout funds and non-U.S. markets. He also hired senior managers from Stanford University, Deutsche Bank AG and elsewhere.
In the most recent fiscal year, the only full one under El- Erian, the fund had its best performance since 2000, recording its fourth-best increase since the management company's founding in 1974.
``Harvard has been fortunate to have someone as skillful and effective as Mohamed El-Erian responsible for the management of our endowment,'' said Drew Faust, Harvard's president since July 1, in a statement. ``It will be a top institutional priority to do all we can to ensure that HMC continues to deliver superior investment returns with a focus on advancing Harvard's educational mission.'
In case you were wondering, the global credit markets aren't out of the woods yet. The London interbank offering rate, or Libor, is a widely used benchmark rate on everything from "adjustable rate mortgages in the US to giant floating-rate bank loans taken out by global corporations." How important is Libor?
Financial contracts with values of about $150 trillion are indexed to the Libor, according to a paper published in May last year by Donald MacKenzie, a sociology professor at the University of Edinburgh.Yes that is $150 trillion with a T. So naturally an increase in the 3 month US Dollar Libor from its relatively narrow range earlier in the year does not bode well for the market. After spiking up in early August LIBOR appeared to be moderating, but has since reached a 7-year high at 5.72% after 10 straight days of gains. Economist Lou Crandall of ICAP in New York had this to say about the change:
"Higher Libor rates affect the whole economy by tightening the budgets of borrowers large and small. It hurts corporate profits and tightens household budgets, too."This is hardly encouraging news for an economy seeking to find its footing and avert a recession. This becomes just another reason the Fed may have to loosen rates, though it is looking more and more like our problems will not be solved by a monetary solution.
Feel free to read on.Wall Street firms got into the pickle they are in now by doing deals that eliminated companies from the public scene. Now there is talk that to get out of the mess, they could create one.
As we discussed in this Ahead of the Tape column in The Wall Street Journal today, between now and the end of the year the firms must find somewhere to put more than $350 billion of loans and bonds, much of it from leveraged buyouts. With investors showing little appetite for the paper, there is a new theory circulating among bankers about the creation of a new company to house the debt that can’t find a home in the market.
Below is a bit more detail on how it all might work, according to a few bankers we spoke with, followed by some major caveats.
The banks would come together to create a new company we will refer to as LoanCo (though we can think of a lot of more colorful names, many of them with bathroom references). They would dump into the new company all the tranches of debt they are unable to sell to investors. These would include, say, a slice of covenant-lite loans from TXU and a pik-toggle bond issue from First Data.
Alan Greenspan's new book -- The Age of Turbulence -- comes out on September 17th. September 17th is significant for another reason however; it is the day before the next Federal Reserve meeting. This meeting might well be the most important of Chairman Ben Bernanke's tenure for a couple of reasons. First, this is the first time in over a year the consensus is that Chairman Bernanke will lower rates a quarter point to 5%. Second, this is the first Fed meeting after the credit crisis and represents the first major opportunity Bernanke has to distinguish his policies from those of Greenspan (namely on the Greenspan put issue).
The result of the meeting remains to be seen. But, one thing is for sure, with $100,000 speaking engagements, lucrative consulting arrangements (with the likes of German giants Deutsche Bank and Allianz's Pimco) and a healthy $8mm advance for his new book, Greenspan is finally cashing in on all those years he put in at the Fed. Surely Bernanke can expect similar treatment at the end of his term.
