Chris Lau - Seeking Alpha

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Tuesday, March 23, 2010

The Concise Guide to Everything in 327 slides

Confessions of a Value Investor

If there was a rule in giving presentations that no presentation shall exceed 10-20 slides, this link breaks it. It is 327 slides in length. Note: this presentation is available on many sites, but none are available for download.

Background: Professor Bakshi gave a talk entitled “Confessions of a Value Investor: A Few Lessons in Behavioral Finance.” It was given to the students of Indian Institute of Management, Lucknow.

Confessions of a Value Investor (Download)

Friday, March 19, 2010

Summary Notes: Conversation with George Soros


A Conversation with George Soros at HKU from JMSC HKU on Vimeo.

George Soros spoke at HK University, and fielded a number of questions from students and professionals. Soros was last covered on this blog last October.

If you want to spend even a moment this year on finance and economics, this is the one video (89 minutes) to watch. Soros provide his opinion on the current financial crisis, regulatory reform, the economy in developed countries versus developing countries, and on China.

Here are the summary notes:

About the Proposed Solutions to Current Crisis:

  • Will result in protection of system plus extra protection with Regulators part of that solution
  • Regulators are imperfect because bureaucratic and worse, they are subject to political influence
  • Imposing capital requirement justified (Volker proposal is valid)
At 49 minutes in the video, a young student told the audience and Soros he did not understand Soros' writings at age 13, at college, and now, at age 30, he still cannot understand it.

He asks Soros: "If you cannot influence the market, how do you spot turning points?"

Soros replies:

Markets move far away from equilibrium as well as towards equilibrium. When a positive feedback occurs, it is a bubble. When a negative feedback occurs, it is moving towards equilibrium.

Will market move as a bubble or to equilibrium? Greenspan saw bubble in 1996, but Soros said you cannot predict how far the bubble will go. Further, bubbles are not irrational. It is rational to participate in bubble. When bubble is mature, he sells or goes short.

Other important points:
  • An investor could have been short in 1996 but not alive (insolvent) in 2000. This follows the old adage that markets can remain irrational longer than an investor can stay solvent 
  • Soros shorted internet stocks after they fell, but had to cover because the stocks rose again
  • Conclusion: there is no recipe for getting the market right!

On China:
  • The China / Taiwan relationship is a negative sum gain right now
  • For world to be prosperous, a positive sum gain is required
Soros not a favorite for China. When he is asked his opinion on China opening up of society (culturally) to the world, his response is the following:

  • Open society through a critical process would raise prosperity
  • China developed an efficient critical process, but it is confined to the leadership
  • This leadership requires constant consultation to see what is being done wrong
  • One of the strengths of China today is leadership
  • China's leadership is self-critical and is anxious about doing the right thing
  • China needs to allow outside criticism as well
  • On the plus side, its internal critical process is efficient
Soros notes that China has emerged as a leading power in the world: it is rising while the U.S. is sinking; rest of the world turns towards positive influences.

China is the motor.

Finally,

  • the American consumer was the motor before financial crisis
  • Rest of world turning towards China
  • China must pay attention to how the world views it: it can only rise in a way where it is accepted by the world

   In response to a question on Soros causing the color revolution, his response is that it is easy to blame someone else than to look at one’s own shortcomings.

Soros is not in favor at all of revolutions, as revolutions destroy without creating a world order. He believes in critical thinking and gradually improving the order rather than revolutions.

His viewpoint on the current crises is that:
  • the Greek crisis will pass and (EU) solvency requirements will be met
  • China/India/Brazil will grow faster than the developed world

Sunday, March 14, 2010

Take the Leap

Rick Smith is author of the Leap *How 3 Simple Changes Can Propel Your Career from Good to Great. the Leap would appeal to people who have ...a job... but want to take a leap in self-employment: entrepreneurship.

This book is a worthwhile read. I could relate to much of the material in this book, due to my past interactions with kaChing.com's owners as the company grew its application on facebook (its application now called IQ Investing), and later on launched its investing services in October 2009.

In brief, kaChing obtained $3M in venture capital funding in 2008, and an additional $7.5M in December 2009.

I cannot express in words how much was learnt in having the opportunity to work with, interact, and to learn (virtually via the Internet, emails, and phone) from the staff and owners at kaChing.

Moving back to the topic, Smith in the Leap writes about the difference between success achieved either by luck or by skill. With the stock market, succeeding in investing requires skill (over the long run).

This teaching is, and continues to be a central measurement for members on IQ Investing.

Thus, it was a surprise to read Smith's discussion on a discovery in 2005. A series of ultraviolet and infrared filters could be used to read the texts in manuscripts that were previously undecipherable.

This science discovery was then applied to obtain the writings of Aristotle's lost book Invitation to Philosophy:

So what did Aristotle have to say from his ancient pedestal that is useful and relevant to us today? A great deal, it turns out. In the restored manuscripts, he draws a critical distinction between outcomes caused by skill or intellect and those caused by chance or luck. Even when two outcomes are identical, Aristotle argues, those that result from deliberate action have much greater value than those that occur will-nilly, without any particular intent in our part.
Imagine, by way of illustration, two sailors starting out from the same dock. One tacks left and right, riding the wind and playing the tides and current as best he can. The other quickly tires of all that, furls his sail, naps on the deck, and lets the boat drift where it will. Conceivably, both could end up several hours later at the same point. It might even be a pleasant place to arrive at, but Aristotle would argue that the end point, in fact, has utterly different meaning for the two sailors because the journeys that got them there are nothing alike.
For an outcome to truly matter, for it to have deep value to our lives, we have to be in control of the actions that get us there. We have to be the one steering the ship - the one deciding which way to tack and when, and how much reach to give the sails. If we simply let ourselves drift toward happiness or fulfillment or any other goal - or if we let others determine the route that will get us there or what the goal itself will be - we have lost control of our own journey and can never fully enjoy or even, at a subconscious level, embrace the outcome.
It is my hope that my virtual "travel" on IQ Investing, the people I have met and connecting with, and the many things that I have learnt will propel a leap further than I can even imagine.

Friday, March 05, 2010

20 Lessons and 10 False Ones

In Seth Klarman's annual letter, Klarman posted his 20 lessons of 2008 from the financial crisis. 


He most aptly notes that the lessons "were either never learned or else were immediately forgotten by most market participants.”


Twenty Investment Lessons of 2008

  1. Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.
  2. When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
  3. Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
  4. Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
  5. Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
  6. Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
  7. The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of "private market value" as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
  8. A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
  9. You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
  10. Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.
  11. Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.
  12. Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
  13. At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
  14. Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
  15. Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.
  16. Financial stocks are particularly risky. Banking, in particular, is a highly leveraged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank's management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.
  17. Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.
  18. When a government official says a problem has been "contained," pay no attention.
  19. The government – the ultimate short-term-oriented player – cannot withstand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.
  20. Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.
Below, we itemize some of the quite different lessons investors seem to have learned as of late 2009 – false lessons, we believe. To not only learn but also effectively implement investment lessons requires a disciplined, often contrary, and long-term-oriented investment approach. It requires a resolute focus on risk aversion rather than maximizing immediate returns, as well as an understanding of history, a sense of financial market cycles, and, at times, extraordinary patience.

False Lessons
  1. There are no long-term lessons – ever.
  2. Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.
  3. There is no amount of bad news that the markets cannot see past.
  4. If you’ve just stared into the abyss, quickly forget it: the lessons of history can only hold you back.
  5. Excess capacity in people, machines, or property will be quickly absorbed.
  6. Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.
  7. In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.
  8. The government can reasonably rely on debt ratings when it forms programs to lend money to buyers of otherwise unattractive debt instruments.
  9. The government can indefinitely control both short-term and long-term interest rates.
  10. The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost. (Investors believe this now and, worse still, the government believes it as well. We are probably doomed to a lasting legacy of government tampering with financial markets and the economy, which is likely to create the mother of all moral hazards. The government is blissfully unaware of the wisdom of Friedrich Hayek: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”)