Facebook v GM

Facebook has 5,000 employees and is worth $135 billion.  They made $7 billion in revenue.

GM has 200,000 employees and is worth $55 billion.  They made $150 billion in revenue. 

I understand that people are upset about income inequality but if you can create that kind of value with the help of so few people, in such a short period of time, you are going to get massively rewarded.  

We all want freedom and equality but we can't complain if the market assigns more value to a business that makes it's money when you click on pictures of your best friend's kid than the one that makes cars and trucks. If value creation is how we compensate CEO's in a free market then what are we so upset about?  

If CEO's were compensated based on how many people they could employ, then the system might look different...interesting idea but tough to get shareholders and creditors behind that notion. 

This is no knock on GM really...they make 30% more cars today than they did in 1979 with 66% fewer workers. That is just the results of innovation and technology.  

As labor costs rise, companies are operating with less people and CEO salaries are reflecting their ability to create value for shareholders.  We are all free to try and compete if we think a CEO is getting paid excessively. In our society, we can start our own company and take a smaller cut of the pay if that is what we think will drive value. 

I am not sure how to make it more fair than that. 

Know the Downside

A good friend of mine called me the other day to ask me what I thought about some mutual funds that his broker suggested he buy.  The broker said the funds would return 7-8% per year and they are super safe investments with minimal volatility. 

I took a quick look at the funds and all 4 had MORE volatility than the S&P 500 with LESS returns. To add insult they were all about 90% correlated to the S&P 500. So basically they were just crappier versions of the stock market. 

These mutual funds were down between 20-50% in 2008. I am not sure if I would describe that kind of price movement as "safe." Besides, why invest in a mutual fund when just buying the stock market through the SPY ETF gets you better returns, less volatility, and lower fees? Brain scratch?  Not really. This particular broker doesn't earn much of a fee if his clients invest in ETF's.

After seeing the funds had the potential to go down between 20-50% if another 2008 were to happen, my friend could easily identify that these kinds of investments might not be a great fit given his objectives. Of course the broker focused more on the reward rather than the risk so the potential downside was never discussed. 

We can't know every risk before walking into an investment. And there is nothing to say that we are guaranteed to have another 2008, but a wise man once told me "your biggest drawdown is in front of you." This means that the next calamity will be worse than prior ones and if we invest with this in mind, we can take steps that allow us to live to invest another day. 

That doesn't mean sit with cash under your mattress and go buy a bunch of guns (been there done that). It means that your EXPECTATIONS on investing should reflect a fair measure of the risk of loss in a given day, week, month, year...etc.  

If you own stocks and you would be surprised if they went down 30% in one year, then you are fooling yourself. Maybe you should own less stocks. If you are ok with them falling 30% because you have a long term horizon and would welcome an opportunity to buy more should the market drop, then that sounds like a plan worth sticking to.

Expectations management and discipline separate the good from the ugly. 

I put a piece together that talks about the idea of having some knowledge of the expected volatility in advance and it was recently published on the CBOE website (link).  Felt like it is relevant for this blog too. 

Enjoy!

What you can get in Detroit

We used to live in the West Village in an apartment building called the Printing House.  It was an old industrial print factory that was converted into cool loft apartments in the 70's.  I recently heard the values of these apartments have gone parabolic.  

According to StreetEasy, you can buy a lovely 3 bedroom apartment in the Printing House for a cool $4.25 million. This runs for about $1,700 a sq. ft. and comes fully equipped with a doorman and all the luxury a small family could ask for. 

3 Br loft apartment in NYC's Printing House

That sounded like a pretty lofty price to a lay person like me. I wanted to see how far my money could go in Detroit.  In keeping with the "printing house" theme, I was looking for some similar loft apartments until i came across a listing for what is effectively the entire printing INDUSTRY of Detroit:  the Detroit Free Press Building.

The Detroit Free Press Building

You can own this entire historic 300,000 sq ft building for around $5 million right in the heart of downtown Detroit. They are saying it is ripe to be converted into 200 loft apartments. A sale price could come out to about $16 per sq. ft.  Not a lot of downside in this compared with owning real estate priced 100X higher. 

Talk about opportunity!  If only the mainstream media would spend less time focusing on the disaster porn and more time on the people and businesses that are coming up with creative solutions for Detroit. There are several places in the D that have this kind of potential.  Blank canvases - looking for smart and adventurous entrepreneurs who want to build something from nothing.   

     

My Brush with Charles Ponzi

Everyone has heard of Bernie Madoff by now.  His crime was the most heinous in the history of finance. The fact is there are still thousands of Ponzi schemes happening around us and most victims do not even know what to look for.

I was introduced to an "investment opportunity" back in 2010.  A man from Detroit, living in Italy married to a famous actress, got in touch with me through some mutual acquaintances. 

I took his call, partly because he was from Detroit and I like to connect with people from my hood, and partly because I like to look at all sorts of ideas. I admit I probably donate too much of my time listening to would-be entrepreneurs but occasionally I meet great people that way. Something felt off about this guy and his partners so I indicated the investment opportunity was going to have to set sail without me.

Last week, I found out that the man I spoke with was sentenced to jail for 10 years for wire fraud and stealing money from investors in a Ponzi scheme (article).  

It motivated me to look back at my interactions with him to see what clues made me uncomfortable. Maybe some of these observations will help other targets avoid future Madoff-wannabees.

I have made plenty of bad investments in my life and the list will surely not be comprehensive, nor does it guarantee to be able to detect a fraud. These are just a few smell tests any fool can use to avoid parting with their money too quickly.  

1) Returns are not guaranteed. Promising financial benefit is not something any professional investment manager will do.  Especially in writing. He sent me this in one of his emails:      

"...if we can raise more funds we can really see the financial benefits from the product.  Let me know what you think..."  

2.) Outsized returns are LESS guaranteed.  The best and brightest in the finance space have averaged mid-single digit returns for investors over the past few years. Anyone who purports 10% returns per month should immediately get the Larry David squinty-eyed stare. 

3.) Look for "intense domain expertise." This guy was raising money for investment vehicles that were going to purchase raw emeralds in Africa, invest in gold mines in Laos, trade foreign currency markets through a Swiss entity, and buy Hong Kong stocks on the cheap. Sounds exciting, right? Sounds like bullshit to me. You cannot be a jack-of-all-trades in this industry anymore. 

4.) Investment managers cannot court you. Regulations prohibit investment managers from excessive spending on prospective investors. These guys offered to fly me out on a private jet to meet them in Rome or Switzerland (whichever was easier for me, of course). Come on! Even if it were legal, the amount of money in fees they were hoping to generate on my piddly investment wouldn't cover the cost of a trip to Europe. 

5.) "WHY ME?"  This is the most important question of all. You have to ask yourself "why is this  opportunity being presented to me?"  "How did I get so lucky to have stumbled across this brilliant idea that no one thought of before this shiny salesman brought it to me?"  You might be hearing the pitch because you don't and won't understand the investment.  It's the old "if you don't know who the sucker is, it's probably you" test.  

Through all the dumb things I have done in my life, I could have saved myself a lot of dough had I simply asked "why me?"  I knew little about the business or the industry I was being asked to invest in, but got involved anyway. Every time the outcome was identical:  a big fat doughnut.      

 

From I.B.G.Y.B.G. to I.B.H.Y.B.H.

I was 22 years old. I had my first job on a Wall St. derivatives desk. A large client calls us to do a 5 year OTC trade (for the non-wall st folk, these were customized over-the-counter transactions that the bank had to underwrite itself). As the trader and salesperson bickered back and forth about the "right price," they finally agreed at a level after one of them joked: "I.B.G.Y.B.G.?" They shared a laughed, nodded at each other, and went back to their desks.

 

 

Being the young eager grasshopper on the team, and frequently confused by the barrage of acronyms used by my colleagues, I asked what it meant:  

I'll Be Gone, You'll Be Gone.

Its common to job jump on the Street so long-dated trades had a high probability of maturing well after the salespeople and traders moved onto bigger better jobs at competing firms. The thought was why not just dump a bunch of trades onto the bank's balance sheet, collect a boatload of commissions, and let someone else figure it out later. By the time the trade had significant risk, it would be the mess of some other sorry sap.

I get the feeling the days of I.B.G.Y.B.G. are behind us.  Couple reasons:

-People are just not able to jump around as they did pre-2008.  Less opportunity to move means taking better care to bring quality business that won't blow up the firm.

-Wall St. compensation has shifted from less upfront cash bonuses, to more deferred stock bonuses that vest over the following 3-5 years.  

-Clients are gravitating toward more transparent and liquid transactions that are NOT over-the-counter. The counterparty risk of facing a bank is higher than facing a central clearing house (like the OCC).  Products that trade on exchanges are in demand as customers want to rely less on banks for liquidity and pricing.  This means less room for the I.B.G.Y.B.G trades as volumes increase in the highly competitive listed products that do not require a bank.

Converting employees to think about transactions from start to finish is important to ensure long-term success of an organization.  This holds true for all industries.  Salespeople who just want to close crappy business to pad numbers and make the quarter have misaligned incentives with stakeholders.  Employee compensation should be tied to the long-term profitability of the business motivating them to stick around.   

Cheers to making business more about I.B.H.Y.B.H:  I'll Be Here, You'll Be Here.     

Be Prepared...but not Too Prepared

Since entering the finance industry, I have heard just about every possible warning sign of what lies ahead for Americans and how to prepare for it.  Selling “fear” is a multi-billion dollar industry: insurance brokers, doctors, politicians, religious zealots, financial advisors, are among the people who have direct or indirect compensation related to scaring you into taking some kind of action.  


Think about it:

“You will lose your job and your house if you don’t throw that other guy out of office by voting for me.”

– handsome white-toothed smiling politician

 “You must have life insurance and disability insurance and property and casualty insurance and flood insurance and renters insurance and hurricane insurance and earthquake insurance and auto insurance and travel insurance and…”

-nebishy insurance broker

“If you don’t pray 15 times a day and give all your money to the (insert religion) you are going to hell.”

-some guy on the subway


I think you get the point.  In the context of the financial crisis, which is going on its 4^th year, I have found myself suggesting ways for people to prepare for an “event” that may or may not happen one day.  Generally I tell people they should own some physical gold or silver (somewhere between 1 and 20% of their investable assets depending on their level of bearishness) and go out and buy a gun.  Both seem reasonable enough as they will not break your bank.  They are just my versions of “insurance policies” which I hope to never use, but exercise our rights as Americans to bear arms and invest in real currency.    

If you listen to the interwebs you will hear suggestions of how to prepare, above and beyond the reach of the average American:  farmland (I suggested this too but now I look at prices and it is way less affordable today), pvc and vacuum sealed organic seeds (I own these and it makes me laugh), 100 gallon drums of water, solar panels, bullet warehouses, foreign passports and bank accounts, bomb shelters, fuel storage, 6 months non-perishable food, off-site hard drive storage, escape routes, blah blah blah.  I realize now that it is impossible to live a happy life while simultaneously consuming yourself by preparing for every possible outcome.  The truth is no one really knows how and when this will all shake out if it ever does.  The powers that be are called that for a reason and they control this mess…for now.

We would go broke and spend all of our waking time preparing for every possible future event given the millions of possible outcomes.  So rather than prepare for them all, we should just prepare for a few of them by taking actions that are reasonably priced and take a reasonable amount of time.  Everything else falls under the get educated category -  heed the fact that there is some probability that anything can happen. 

My business partner says that when he thinks about all the things he needs to do to protect his family, he gets on Amazon.com and starts clicking away at dry food and supplies and suddenly his cart is full of hundreds of items.  Then he realizes he could never be fully prepared and he needs to get back to what would really help them today…like earning a living to put food on the table and buying some diapers.   

This may sound like a 180 from my previous notions but it isn’t.  There is absolutely risk out there but being surrounded by quants all day I realize there is a difference between perceived probability and actual probability.  If we cannot even predict every fathomable outcome how could we possibly be expected to prepare for them?  I am finding that I would rather live happily than live in fear.  

I guess you could sum it up by saying “stay educated but keep on keepin’ on.” If some terrorist wants to blow up my local diner I don’t know that I can hedge this risk out of my life completely, so I am not going to let the thought of it ruin my day.  

Livin' off the Fatta the Land

If you take a look at the right hand side of this blog you will notice a few sites that I like to follow.  One of them is Sovereignman.com (introduced to me by @Shamrock5000).  Yesterday, Sovereignman posted a link to a Stansberry Research video that sounded like a doomsday "public service announcement."  The video took about an hour to get through and contains important information about the devaluation of the dollar, piling US government debt, and a lengthy teaser advertisement for you to become a Stansberry client (boring).  If you want to take an hour to watch this click here (LINK TO VIDEO), or you can just keep reading and I will sum it up for you.  

The main point is that the US has no way out of its deficit spending and federal debt load - the interest payments on the debt will become too great, thus, the liabilities will grow in such a way that the only solution is for the dollar to be devalued even further (it fell 8% in 2010).  What does devalued really mean?  In a nutshell: your savings will be worth less because the prices of goods and services will become much much higher in the future (see my post below on "The Frog").  Stansberry suggests we can take action to protect ourselves from such events by doing some or all of the following:

-Own physical gold (buy a gold coin or buy stock in PHYS)
-Own physical silver (buy a silver coin or buy stock in PSLV)
-Have access to a rural place (call Aunt Ida on the farm and tell her you have dibs on the extra bedroom)
-Own money in a foreign currency outside the US (this is trickier)
-Own stored food in your basement (twinkies can withstand nuclear holocaust)
-Own land

I want to focus on the last one for a second.  Land.  Maybe Lenny and George from Of Mice and Men had the right idea? I recently contacted a land broker because I am curious about the idea of owning land as a hedge to the aforementioned travesty that some the doomsayers are predicting.  The investment properties of owning land appear to be multifaceted.  First, if real assets appreciate (real assets meaning things you can touch, live on, or drop on your foot and they hurt) due to inflation, then the value of the land should rise.  Second, if you are growing crops on this land and the prices of those crops rise, you stand to gain by selling those crops to the people without land (this can also be achieved by leasing parts of the land to farmers).  Third, you can eat the food grown on the land so the "personal survival" box is checked as well.  If you think about alternative investments, few cover all of these bases.  Sure you can buy food with gold and silver but what happens when you eat all your food and spend all of your gold?  Land appears to be the better hedge.   

Rather than go out and borrow money to buy a massive tract of land, I think the idea of a land collective makes total sense - pool a group of people together to buy a piece of land. There really is power in numbers here.  If you ever NEED this land (and I say this because clearly we all see that the grocery stores are still fully functional and our money still works), you have a group of people that will be farming it with you and protecting it with you.  I will take it a step further.  You want land that has access to freshwater. You need water to grow food no?  If you live in Michigan you are in a great position because you are surrounded by the equivalent of a fresh water ocean.    

I am not saying commit your entire life savings to an idea like this but why not spend 5% of it on a share of farmland that is within 2-3 hours drive from your house.  This should not break the bank.  Others are jumping on the land grab as well.  George Bush just bought 100k acres in South America.  John Malone (telecom magnate) bought an $83million piece of land in New Mexico at around $300/acre.  Bill Gates bought a 500 acre ranch in Wyoming.  Of course these are not small purchases and they have the luxury of private jet escape pods to get them to wherever they need to go, but you can see that the "smart" money is involved in this.

I am curious what people think about this topic.  It is seldom talked about and is clearly not as sexy as investing in AAPL or some high yield bond fund.  But if you were to commit some of the money going into your IRA or 401k (which the government may have some influence on in the near future) to something like this, I think you get closer to whatever a "well rounded investment portfolio" should look like.  If anyone is interested in exploring some kind of land collective/partnership/mutual fund, please let me know.  We already have a few people on board.  Something to ponder for 2011.